STRATEGIC
FINANCIAL
MANAGEMENT
Volume 1

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Content

Sl CA Final CA Final
CMA Final CMA Final Page No
No. New Old
SFM SFM SFM BV

1 Security Analysis and Valuation 5 – 52

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Part A - Discounted Cash Flow     5 - 21

Part B - Free Cash Flow and Price Multiples     22 – 35

Part C - Economic Value Added     36 – 40

Part D - Economic, Industry, Company     41 – 52

and Technical Analysis

2 Mutual Funds    × 53 – 78

3 Mergers and Acquisitions   ×  79 – 116

4 Fixed Income Securities Valuation 117 – 161

Part A - Yield and Price Calculations     117 – 126

Part B - Money Market Instruments ×   × 127 –141

Part C - Risk Analysis and Valuation   × × 142 – 161

Theorem

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THE THREE TIER PREPARATION MODEL

Break the myth that Taking Tuition = Exam Preparation

Tier 1 : Taking Tuition

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1. Class Notes : Presentation
2. Class Work : Participate in Calculations
3. Home Work : Always Do It !

Tier 2 : Self Study

1. Revision of Class Notes

2. Solving Institute Material and Scanner

Tier 3 : Audit Yourself

Take a Mock Test to check your shortcomings -

Remember its a 3 hours Game where your Question
paper has been prepared in best way to defeat you.

Never Skip Any Tier or Shift Load of One Tier

on Another

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THE EXAM HALL STRATEGY

Read rst line and the Required Portion of Each Question – To achieve this, if 5 mins
extra are required, give it.

You Know the Exact

You Know the Chapter The Question is totally
Question – Be it theory
but not the question New to you
or practical

Attempt First Attempt Second Attempt Third

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 Secure 40 Marks based on these

two attempts.  Do not keep yourself idle while
 Leave Pages for the sub reading the question.
questions where you have  Keep doing small calculations
hesitations. while reading a question. Start
 Do not over justify the answers. writing as Note 1, 2,.. and
Keep an eye on the clock. present your calculations.
 Maintain Time Target of 1 hr for  Read the next line in connection
these 40 Marks. with previous information.
 Maintain Speed and consistency Check how all information are
of writing, as if these are the last interconnected.
questions.

While presenting any answer

 Read the required portion again word by word to check any specic requirements.
 Give heading to the statement you are making for required part.
 Give smallest of possible working in brackets or in working notes.

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 Security Analysis and Valuation
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Chapter 1
Security Analysis and Valuation

Equity Analysis

Fundamental Economic Industry Company Technical

Analysis Analysis Analysis Analysis Analysis

Part D

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Discounted
Cash Flow
Free Cash
Flow
Price
Multiples
Economic
Value Added
Accounting
Based
Analysis Analysis Valuation Valuation Valuation

Part A Part B Part C

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Equity Analysis – Part A

Discounted Cash Flow Analysis

Q 1 Ex. Book No. Pg. No.

An investor with a one year horizon evaluates a stock. Stock is expected to pay dividend of ` 70 next
year. Share price at the end of the year is expected to be ` 800. If required return is 18%, calculate in-
trinsic value of the stock.

Reference What’s New

Single Period Dividend Discount Model

Q 2 Ex. Book No. Pg. No.

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The stock of X Ltd. is expected to pay the following dividends in coming years:-

Years 1 2 3 4 5
Dividend/share(`) 6 8 9 12 15

Expected share price at the end of the 5th year is ` 300. Rate of return required by equity shareholders
16%p.a, find out intrinsic value of the stock.

Reference What’s New

Multi Period Dividend Discount Model

Q 3 Ex. Book No. Pg. No.

The stock of X Ltd. reported an EPS of ` 40 for the year just ended. The stock is presently trading at `
300. Firm has 100% payout ratio & it is a no-growth firm. Assuming that the stock is trading in equilib-
rium, calculate the rate of return acquired by shareholders.

Reference What’s New

Infinite Period Dividend Discount Model No Growth

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Q 4 Ex. Book No. Pg. No.

A company has a book value per share of ` 137.80. Its return on equity is 15% and it follows a policy of
retaining 60% of its earnings. If the Opportunity Cost of Capital is 18%, what is the price of the share
today?

Reference What’s New

Infinite Period Dividend Discount Model No Growth

Q 5 Ex. Book No. Pg. No.

X Ltd. is expected to pay DPS of ` 35 next year. This is expected to grow at 4%p.a. If required rate of
return by the shareholders is 15%, calculate intrinsic value of the share. Also calculate new share price
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if sustainable growth rate becomes 6% p.a.

Reference What’s New

Infinite Period Dividend Discount Model With Constant Dividend

Growth

Q 6 Ex. Book No. Pg. No.

X Limited, just declared a dividend of ` 14.00 per share. Mr. B is planning to purchase the share of X
Limited, anticipating increase in growth rate from 8% to 9%, which will continue for three years. He
also expects the market price of this share to be ` 360.00 after three years.
You are required to determine:
(i) the maximum amount Mr. B should pay for shares, if he requires a rate of return of 13% per
annum.
(ii) the maximum price Mr. B will be willing to pay for share, if he is of the opinion that the 9% growth
can be maintained indefinitely and require 13% rate of return per annum.
(iii) the price of share at the end of three years, if 9% growth rate is achieved and assuming other
conditions remaining same as in (ii) above.

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Calculate rupee amount up to two decimal points.

Year-1 Year-2 Year-3

FVIF @ 9% 1.090 1.188 1.295
FVIF @ 13% 1.130 1.277 1.443
PVIF @ 13% 0.885 0.783 0.693

Reference What’s New

Infinite Period Dividend Discount Model With Constant Dividend

Growth

Q 7 Ex. Book No. Pg. No.

Shares of Voyage Ltd. are being quoted at a price-earning ratio of 8 times. The company retains 45%
of its earnings which are `5 per share.
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You are required to compute
(1) The cost of equity to the company if the market expects a growth rate of 15% p.a.
(2) If the anticipated growth rate is 16% per annum, calculate the indicative market price with the
same cost of capital.
(3) If the company’s cost of capital is 20% p.a. & the anticipated growth rate is 19% p.a., calculate the
market price per share.

Reference What’s New

Infinite Period Dividend Discount Model With Constant Dividend

Growth and Ke as a reciprocal
of PE

Q 8 Ex. Book No. Pg. No.

X Ltd. is not expected to pay any dividend for the next 5 yrs. It is expected to pay a dividend of ` 15
for the 6th year. This will grow at 7% p.a. forever. If required rate of return is 18% p.a., find out intrinsic
value of the share today.

Reference What’s New

Infinite Period Dividend Discount Model With Deferred Constant

Dividend Growth

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Q 9 Ex. Book No. Pg. No.

MNP Ltd. has declared and paid annual dividend of ` 4 per share. It is expected to grow @ 20% for the
next two years and 10% thereafter. The required rate of return of equity investors is 15%. Compute the
current price at which equity shares should sell.
Note: Present Value Interest Factor (PVIF) @ 15%:
For year 1 = 0.8696;
For year 2 = 0.7561

Reference What’s New

Infinite Period Dividend Discount Model With Deferred Constant

Dividend Growth

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Q 10 Ex. Book No. Pg. No.

DPS for the year just ended ` 70, sustainable growth rate 5%, required rate of return by equity share-
holders 15%, current share price ` 690.
(i) Calculate intrinsic value of the share and give your investment advice,

(ii) Reach to the same conclusion by comparing E(R) with Re

(iii) Explain the process of equilibrium.

Reference What’s New

Infinite Period Dividend Discount Model Equillibrium Price and Ke = Re

Q 11 Ex. Book No. Pg. No.

On the basis of the following information:

Current dividend (Do) ` 2.50

Discount rate (k) 10.5%
Growth rate (g) 2%

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(i) Calculate the present value of stock of ABC Ltd.

(ii) Is its stock overvalued if stock price is ` 35, ROE = 9% and EPS = ` 2.25? Show detailed calculation.

Reference What’s New

Infinite Period Dividend Discount Model Earning Growth and PE

Multiple Model

Q 12 Ex. Book No. Pg. No.

Piyush Loonker and Associates presently pay a dividend of ` 1.00 per share and has a share price of `
20.00.
(i) If this dividend were expected to grow at a rate of 12% per annum forever, what is the firm’s
expected or required return on equity using a dividend-discount model approach?
(ii) Instead of this situation in part (i), suppose that the dividends were expected to grow at a rate
of 20% per annum for 5 years and 10% per year thereafter. Now what is the firm’s expected, or
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required, return on equity?

Reference What’s New

Infinite Period Dividend Discount Model With Deferred Constant

Dividend Growth

Q 13 Ex. Book No. Pg. No.

Firm reported EPS of ` 40 for the year just ended. It’s return on equity is 30%. It has a constant pay - out
ratio of 90%. If required rate of return by equity shareholders is 12%, calculate the share price.

Reference What’s New

Infinite Period Dividend Discount Model Computing Growth Rate = b x r

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Q 14 Ex. Book No. Pg. No.

The DPS of A Ltd of past few years are –

Year 1 2 3 4 5
DPS (`) 12 14 15 18 19

Compute the share price taking equity capitalization rate as 17%.

Reference What’s New

Infinite Period Dividend Discount Model Computing Growth Rate =

Compounded Average of Past
Dividends growth

Q 15 Ex. Book No. Pg. No.

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X Ltd reported an EPS of 40 and DPS of 12 for the year just ended. Earnings are expected to grow
` `
at 60% p.a. for the next 3 years. Growth rate will then start falling linearly so as to become 6% from the
7th year and remain at that level forever. Similarly, the current payout ratio will continue for the next
2 years. It will then start rising linearly so as to become 80% from the 7th year and remain at that level
forever.
If Re for the first 7 years is 18% and beyond that it is 15% forever, calculate intrinsic value of the shares.
(The growth rate of DPS and EPS is same)

Reference What’s New

Infinite Period Dividend Discount Model Linear Growth Rate

Q 16 Ex. Book No. Pg. No.

Y ltd paid a dividend of ` 21 for the year just ended. This represents a payout ratio of 30%. Currrent
payout ratio will continue for 4 years. It will then start rising linearly so as to become 90% from the 8th
year onwards and remain at that level forever. The earnings will grow at 40% for the next 5 years and
will then decrease linearly to become 4% from the 8th year.
If equity capitalization rate (Re) is 16% for the first 8 years and 14% thereafter, calculate the intrinsic
value of the shares.

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Reference What’s New

Infinite Period Dividend Discount Model Linear Growth Rate

Q 17 Ex. Book No. Pg. No.

A company’s dividend would have a super normal growth rate of 40% for 3 years and will start falling
thereafter in such a manner that it will become 6% from the 8th year onwards. Calculate the growth
rate for the first year of the transitional phase.

Reference What’s New

Infinite Period Dividend Discount Model Non Linear or Depreciating

Growth Rate

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Q 18 Ex. Book No. Pg. No.

ABC Ltd. has been maintaining a growth rate of 10 percent in dividends. The company has paid divi-
dend @ `3 per share. The rate of return on market portfolio is 12 percent and the risk free rate of return
in the market has been observed as 8 percent. The Beta co-efficient of company’s share is 1.5.
You are required to calculate the expected rate of return on company’s shares as per CAPM model
and equilibrium price per share by dividend growth model.

Reference What’s New

DDM and CAPM

Q 19 Ex. Book No. Pg. No.

The risk free rate of return is 5%. The expected rate of return on the market portfolio is 11%. The ex-
pected rate of growth in dividend of X Ltd. is 8%. The fast dividend paid was ` 2.00 per share. The beta
of X Ltd. equity stock is 1.5.
(i) What is the present price of the equity stock of X Ltd. ?
(ii) How would the price change when:

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• The inflation premium increases by 3%

• The expected growth rate decreases by 3% and
• The beta decreases to 1.3.

Reference What’s New

DDM and CAPM Inflation Premium

Q 20 Ex. Book No. Pg. No.

SAM Ltd. has just paid a dividend of ` 2 per share and it is expected to grow @ 6% p.a. After paying
dividend, the Board declared to take up a project by retaining the next three annual dividends. It is
expected that this project is of same risk as the existing projects. The results of this project will start
coming from the 4th year onward from now. The dividends will then be ` 2.50 per share and will grow
@ 7% p.a.
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An investor has 1,000 shares in SAM Ltd. and wants a receipt of at least 2,000 p.a. from this invest-
`
ment.
Required:
(i) EVALUATE whether the market value of the share is affected by the decision of the Board.
(ii) RECOMMEND how the investor can maintain his target receipt from the investment for first 3
years and improved income thereafter, given that the cost of capital of the firm is 8%.

Reference What’s New

DDM

Q 21 Ex. Book No. Pg. No.

T Ltd. Recently made a profit of ` 50 crore and paid out ` 40 crore (slightly higher than the average
paid in the industry to which it pertains). The average PE ratio of this industry is 9. As per Balance Sheet
of T Ltd., the shareholder’s fund is ` 225 crore and number of shares is 10 crore. In case company is
liquidated, building would fetch ` 100 crore more than book value and stock would realize ` 25 crore
less.

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The other data for the industry is as follows:

Projected Dividend Growth 4%

Risk Free Rate of Return 6%
Market Rate of Return 11%
Average Dividend Yield 6%

The estimated beta of T Ltd. is 1.2. You are required to calculate value of T Ltd. using
(i) P/E Ratio
(ii) Dividend Yield
(iii) Valuation as per:
(1) Dividend Growth Model
(2) Book Value
(3) Net Realizable Value

Reference What’s New

Valuation of Company Various models

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Q 22 Ex. Book No. Pg. No.

Pragya Limited has issued 75,000 equity shares of ` 10 each. The current market price per share is `
24. The company has a plan to make a rights issue of one new equity share at a price of ` 16 for every
four share held.
You are required to:
(i) Calculate the theoretical post-rights price per share;
(ii) Calculate the theoretical value of the right alone;
(iii) Show the effect of the rights issue on the wealth of a shareholder, who has 1,000 shares assuming
he subscribes the entire rights; and
(iv) Show the effect, if the same shareholder does not take any action and ignores the issue.

Reference What’s New

Ex Right Price of Shares

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Q 23 Ex. Book No. Pg. No.

Capital structure of Sun Ltd., as at 31.3.2018 was as under:

(` in lakhs)
Equity share capital 80
8% Preference share capital 40
12% Debentures 64
Reserves 32

Sun Ltd., earns a profit of ` 32 lakhs annually on an average before deduction of income-tax, which
works out to 35%, and interest on debentures.
Normal return on equity shares of companies similarly placed is 9.6% provided:
(a) Profit after tax covers fixed interest and fixed dividends at least 3 times.
(b) Capital gearing ratio is 0.75.
(c) Yield on share is calculated at 50% of profits distributed and at 5% on undistributed profits.
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Sun Ltd., has been regularly paying equity dividend of 8%.
Compute the value per equity share of the company.

Reference What’s New

Unique Variety Can Include Risk Premium

from Interest Coverage and
Capital Gearing Ratio in Re

Q 24 Ex. Book No. Pg. No.

XYZ company has current earnings of ` 3 per share with 5,00,000 shares outstanding. The company
plans to issue 40,000, 7% convertible preference shares of ` 50 each at par. The preference shares are
convertible into 2 shares for each preference shares held. The equity share has a current market price
of ` 21 per share.
(i) What is preference share’s conversion value?
(ii) What is conversion premium?
(iii) Assuming that total earnings remain the same, calculate the effect of the issue on the basic
earning per share (a) before conversion (b) after conversion.
(iv) If profits after tax increases by ` 1 million what will be the basic EPS (a)before conversion and (b)
on a fully diluted basis?

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Reference What’s New

Convertible Preference Shares

Q 25 Ex. Book No. Pg. No.

Abhishek Ltd. has a surplus cash of `90 lakhs and wants to distribute 30% of it to the shareholders. The
Company decides to buyback shares. The Finance Manager of the Company estimates that its share
price after re-purchase is likely to be 10% above the buyback price; if the buyback route is taken. The
number of shares outstanding at present is 10 lakhs and the current EPS is `3.
You are required to determine:
(a) The price at which the shares can be repurchased, if the market capitalization of the company
should be `200 lakhs after buyback.
(b) The number of shares that can be re-purchased.
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(c) The impact of share re-purchase on the EPS, assuming the net income is same.

Reference What’s New

Market Price after Buyback

Q 26 Ex. Book No. Pg. No.

Intel Ltd., promoted by a Trans National Company, is listed on the stock exchange.
The value of the floating stock is ` 45 crores. The Market Price per Share (MPS) is ` 150
The capitalisation rate is 20 percent.
The promoters holding is to be restricted to 75 per cent as per the norms of listing requirement The
Board of Directors have decided to fall in line to restrict the Promoters’ holding to 75 percent by is-
suing Bonus Shares to minority shareholders while maintaining the same Price Earnings Ratio (P/E).
You are required to calculate;
(i) Bonus Ratio:
(ii) MPS alter issue of Bonus Shares, and
(iii) Free float Market capitalisation after issue of Bonus Shares

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Reference What’s New

Bonus Issue Free float market capitalisa-

tion

Q 27 Ex. Book No. Pg. No.

Mr. A is thinking of buying shares at ` 500 each having face value of ` 100. He is expecting a bonus at
the ratio of 1:5 during the fourth year. Annual expected dividend is 20% and the same rate is expected
to be maintained on the expanded capital base. He intends to sell the shares at the end of seventh
year at an expected price of ` 900 each. Incidental expenses for purchase and sale of shares are esti-
mated to be 5% of the market price. He expects a minimum return of 12% per annum.
Should Mr. A buy the share? If so, what maximum price should he pay for each share?
Assume no tax on dividend income and capital gain.

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Reference What’s New

Bonus Issue Maximum price

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Q 1 Ex. Book No. Pg. No.

A company has a book value per share of `137.80. Its return on equity is 15% and follows a policy of
retaining 60 percent of its annual earnings. If the opportunity cost of capital is 18 percent, what is the
price of its share?[adopt the perpetual growth model to arrive at your solution].

Reference What’s New

Infinite Period Dividend Discount Model Computing Growth Rate = b x r

Q 2 Ex. Book No. Pg. No.

A share of Tension-free Economy Ltd. is currently quoted at, a price earnings ratio of 7.5 times. The
retained earnings per share being 37.5% is ` 3 per share. Compute:
(1) The company’s cost of equity, if investors expect annual growth rate of 12%.
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(2) If anticipated growth rate is 13% p.a., calculate the indicated market price, with same cost of
capital.
(3) If the company’s cost of capital is 18% and anticipated growth rate is 15% p.a., calculate the
market price per share, assuming other conditions remain the same.

Reference What’s New

Infinite Period Dividend Discount Model

Q 3 Ex. Book No. Pg. No.

X Ltd. is expected to pay the following dividends :-

Year 1 2 3
Dividend 20 25 30
Beyond 3 years, dividend will grow at 6% p.a. If Re is 18% p.a., calculate intrinsic value of the share
today.

Reference What’s New

Infinite Period Dividend Discount Model Different Growth Rates initially

and sustainable thereafter

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Q 4 Ex. Book No. Pg. No.

Given the following information:

Current Dividend ` 5.00

Discount Rate 10%
Growth rate 2%
(i) Calculate the present value of the stock.
(ii) Is the stock over valued if the price is `40, ROE = 8% and EPS = ` 3.00. Show your calculations
under the PE Multiple approach and Earnings Growth model.

Reference What’s New

DDM, PE Multiple and Earnings Growth

Model

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Q 5 Ex. Book No. Pg. No.

A Company pays a dividend of ` 2.00 per share with a growth rate of 7%. The risk free rate is 9% and
the market rate of return is 13%. The Company has a beta factor of 1.50. However, due to a decision of
the Finance Manager, beta is likely to increase to 1.75. Find out the present as well as the likely value
of the share after the decision.

Reference What’s New

DDM and CAPM

Q 6 Ex. Book No. Pg. No.

M/s X Ltd. has paid a dividend of ` 2.5 per share on a face value of ` 10 in the financial year ending on
31st March, 2018. The details are as follows:

Current market price of share `60

Growth rate of earnings and dividends 10%
Beta of share 0.75
Average market return 15%
Risk free rate of return 9%

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Calculate the intrinsic value of the share

Reference What’s New

DDM and CAPM

Q 7 Ex. Book No. Pg. No.

In December, 2018 AB Co.’s share was sold for ` 146 per share. A long term earnings growth rate of
7.5% is anticipated. AB Co. is expected to pay dividend of ` 3.36 per share.
(i) What rate of return an investor can expect to earn assuming that dividends are expected to grow
along with earnings at 7.5% per year in perpetuity?
(ii) It is expected that AB Co. will earn about 10% on book Equity and shall retain 60% of earnings. In
this case, whether, there would be any change in growth rate and cost of Equity?

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Reference What’s New

Valuation of Equity shares

Q 8 Ex. Book No. Pg. No.

Seawell Corporation, a manufacturer of do-it-yourself hardware and housewares, reported earnings

per share of € 2.10 in 2013, on which it paid dividends per share of €0.69. Earnings are expected to
grow 15% a year from 2014 to 2018, during this period the dividend payout ratio is expected to re-
main unchanged. After 2018, the earnings growth rate is expected to drop to a stable rate of 6%, and
the payout ratio is expected to increase to 65% of earnings. The firm has a beta of 1.40 currently, and
is expected to have a beta of 1.10 after 2018. The market risk premium is 5.5%. The Treasury bond rate
is 6.25%.
(a) What is the expected price of the stock at the end of 2018?
(b) What is the value of the stock, using the two-stage dividend discount model?

Reference What’s New

Valuation of Equity shares

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Q 9 Ex. Book No. Pg. No.

ABC Limited’s shares are currently selling at ` 13 per share. There are 10,00,000 shares outstanding.
The firm is planning to raise ` 20 lakhs to Finance a new project.
Required:
What are the ex-right price of shares and the value of a right, if
(i) The firm offers one right share for every two shares held.
(ii) The firm offers one right share for every four shares held.
(iii) How does the shareholders’ wealth change from (i) to (ii)? How does right issue increases
shareholders’ wealth?

Reference What’s New

Ex Right Price of Shares

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Equity Analysis Part B

Free Cash Flow Approach and Price Multiples

Valuation of Business

Valuation
Techniques

Earning Based Market Based Asset Based

Valuation Valuation Valuation

Free Cash Cash to Capitalised Chop

Listed Unlisted
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Flow
Technique
Create
Approach
Earning
Method
Shop
Method
Companies Companies

EVA or Intangible Liquidation

Net Asset Value
adjusted Valuation Method
Asset Method
Value
Method

Free Cash Flow Approach

Valuation of Valuation of Valuation of Valuation of

Firm – FCFF Equity – FCFF Pvt. Company a Strategy

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Q 1 Ex. Book No. Pg. No.

For the next year, the following forecasts are available –

Capital spending ` 200 lakhs

Depreciation ` 80 lakhs
Change in Working Capital ` 30 lakhs
Revenue ` 500 lakhs
Operating expenses including depreciation ` 210 lakhs
Tax Rate 30%

Calculate FCFF.

Reference What’s New

Computing Free Cash Flow for the firm.

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Q 2 Ex. Book No. Pg. No.

X Ltd. furnished the following for the year just ended :-

Sales ` 800 lakhs

Operating expense excluding depreciation ` 350 lakhs
Depreciation ` 80 lakhs
Capital spending ` 180 lakhs
Working Capital ` 150 lakhs
Tax rate 30 %

All components of FCFF are expected to grow at 6% p.a, forever.

Market Value of the firms debt - ` 1,500 lakhs
Cost of capital - 10%
Find the value of equity.

Reference What’s New

Valuation of Equity Using FCFF – with Growth

Effect

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Q 3 Ex. Book No. Pg. No.

Consider the capital structure of a firm.

Equity share capital [ 50 lakhs share @ ` 10/sh ] ` 500 lakhs

Reserve & surplus ` 1,500 lakhs
10% Debt ` 1,000 lakhs
Capital employed ` 3,000 lakhs

Market price of the share is ` 80/sh, Current market interest rate on similar debt 12 %, tax rate 30%,
cost of equity 18%.
Calculate cost of capital.

Reference What’s New

Computing Kc

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Q 4 Ex. Book No. Pg. No.

A valuation done of an established company by a well-known analyst has estimated a value of `500
lakhs, based on the expected free cash flow for next year of `20 lakhs and an expected growth rate of
5%.
While going through the valuation procedure, you found that the analyst has made the mistake of
using the book values of debt and equity in his calculation. While you do not know the book value
weights he used, you have been provided with the following information:
(i) Company has a cost of equity of 12%,
(ii) After tax cost of debt is 6%,
(iii) The market value of equity is three times the book value of equity, while the market value of debt
is equal to the book value of debt.
You are required to estimate the correct value of the company.

Reference What’s New

Valuation of Firm Using FCFF Approach

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Q 5 Ex. Book No. Pg. No.

Capital spending ` 500 lakhs,

Depreciation ` 100 lakhs,
Changes in working capital ` 50 lakhs,
PAT ` 600 lakhs
Target debt financing ratio 60%
(a) Calculate FCFE.
(b) If instead of target debt financing ratio, the following additional information is given:-
Borrowing - ` 340 lakhs; Repayment of debt - ` 70 lakhs,
Calculate FCFE.

Reference What’s New

FCFE

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Q 6 Ex. Book No. Pg. No.

Calculate the value of share from the following information:

Profit of the company ` 290 crores

Equity capital of company ` 1,300 crores
Par value of share ` 40 each
Debt ratio of company 27
Long run growth rate of the company 8%
Beta 0.1
Risk free interest rate 8.7%
Market returns 10.3%
Capital expenditure per share ` 47
Depreciation per share ` 39
Change in Working capital ` 3.45 per share

Reference What’s New

Valuation of Equity Shares Using FCFE Approach

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Q 7 Ex. Book No. Pg. No.

Consider the following data for the year just ended:-

(a) Treasury yield = 6%, market risk premium = 5%, β = 2
(b) Net profit = ` 700 lakhs, No. of shares = 5 lakhs
(c) Capital expenditure per share = ` 90; Depreciation per share = ` 30; Changes in working capital
per share = ` 14; Debt financing ratio = 60%.
If all the components of FCFE will grow at the 6% p.a, forever, calculate intrinsic value of the share.

Reference What’s New

Valuation of Equity Using FCFE Approach

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Q 8 Ex. Book No. Pg. No.

XYZ Ltd. is a paints manufacturer. The analyst’s forecast of free cash flow is shown below:
Free cash flow forecast for XYZ Ltd. (` in crore)

Years
2018 2019 2020 2021 2022 2023 2024 2025
Sales 178.13 204.85 235.58 270.92 311.56 358.29 412.03 473.83
EBIT 16.33 17.25 17.19 19.58 22.17 24.95 27.89 30.95
NOPAT 10.61 11.21 11.17 12.73 14.41 16.22 18.13 20.12
+ Depreciation 3.14 2.13 2.68 2.82 2.96 3.11 3.26 3.42
Less :
Capital exp. 0 0.63 2.36 1.79 1.88 1.97 2.07 2.17
Increase in work- 0 6.44 4.12 6.10 9.45 11.67 12.97 14.32
ing capital
Free cash flow 13.75 6.27 7.37 7.66 6.04 5.69 6.35 7.05

The cost of capital of the company is 15 per cent and value of debt is ` 4.92 crores.
Assuming that the company acquiring XYZ Ltd. will not make any operating improvements or change
the capital structure and analyst expects the cash flows to grow at 10 per cent forever after 2025, de-
termine the value of Firm and Equity.

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Reference What’s New

Valuation of Firm Using Free Cash Flow

Approach - Two phase
calculation

Q 9 Ex. Book No. Pg. No.

Following information are available in respect of XYZ Ltd. which is expected to grow at a higher rate
for 4 years after which growth rate will stabilize at a lower level:
Base year information:

Revenue `2,000 crores

EBIT `300 crores
Capital expenditure `280 crores
Depreciation `200 crores
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Information for high growth and stable growth period are as follows:

High Growth Stable Growth

Growth in Revenue & EBIT 20% 10%
Growth in capital expenditure and depreci- 20% Capital expenditure are
ation offset by depreciation
Risk free rate 10% 9%
Equity beta 1.15 1
Market risk premium 6% 5%
Pre tax cost of debt 13% 12.86%
Debt equity ratio 1:1 2:3

For all time, working capital is 25% of revenue and corporate tax rate is 30%.
What is the value of the firm?

Reference What’s New

Valuation of Firm Using Free Cash Flow

Approach - Two phase
calculation

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Q 10 Ex. Book No. Pg. No.

Following information is given in respect of WXY Ltd for the year ended March 31, 2014., which is ex-
pected to grow at a rate of 20% p.a. for the next three years, after which the growth rate will stabilize
at 8% p.a. normal level, in perpetuity.

Revenues ` 7,500 Crores

Cost of Goods Sold (COGS) ` 3,000 Crores
Operating Expenses ` 2,250 Crores
Capital Expenditure ` 750 Crores
Depreciation (included in COGS & Operating Expenses) `600 Crores
During high growth period, revenues & Earnings before Interest & Tax (EBIT) will grow at 20% p.a. and
capital expenditure net of depreciation will grow at 15% p.a. From year 4 onwards, i.e. normal growth
period, revenues and EBIT will grow at 8% p.a. and incremental capital expenditure will be offset by
the depreciation. During both high growth & normal growth period, net working capital requirement
will be 25% of revenues.

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The Weighted Average Cost of Capital (WACC) of WXY Ltd. is 15%.
Corporate Income Tax rate will be 30%.
Required:
Estimate the value of WXY Ltd. using Free Cash Flows to Firm (FCFF) & WACC methodology. The PVIF @
15 % for the three years are as below:

Year 1 2 3
PVIF 0.8696 0.7561 0.6575

Reference What’s New

Valuation of Firm Using Free Cash Flow

Approach - Two phase
calculation

Q 11 Ex. Book No. Pg. No.

Find the value of equity of firm X, a private Ltd. co. in the cement sector. The forecasted FCFE is ` 60
crores and sustainable growth rate is 5 % p.a. X has a debt equity ratio of 2 : 1, pre tax cost of debt is
15%.
A similar co. Y Ltd. , whose shares are actively traded and has the beta of the shares as 1.8. Y has a debt
equity ratio of 1.5. Tax rate - at 30%, Rf - 6%, and Market risk premium - 7%.

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Reference What’s New

Valuation of a Private Company Using Pure Play and Levered

Beta

Q 12 Ex. Book No. Pg. No.

Consider a conglomerate which is present in 3 businesses viz, cement, steel and paper. The firm stra-
tegically decides to sell off its paper division & has approached you for the valuation of the same. The
paper division can ideally have a debt equity ratio of 1.2 although the conglomerate as a whole has a
debt equity ratio of 1. It is forecasted that FCFF, for the paper division would be ` 50 crores & sustain-
able growth rate of 4 % p.a,
2 proxy firms, X and Y which are pure play in the paper sector have been short listed. Their information
is given below:-

Firms Debt equity ratio Beta

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X 0.9 1.6
Y 1.5 2.8

Tax rate - 40%, Rf - 5%, Market risk premium - 4%, pre tax cost debt for the paper division - 14 %,
Find the value of the paper division.

Reference What’s New

Valuation of a Specific Division Using Pure Play and Levered

Beta

Q 13 Ex. Book No. Pg. No.

XYZ co. is considering a new sales strategy. You need to compute the value of the strategy. Informa-
tion for the year just ended –
Income statement

Amount ( `
Particulars
in crores)
Sales 50,000
Gross margin (30%) 15,000
Administrative, selling & distribution expense (5%) 2,500
EBIT 12,500

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Interest Expense 2000

EBT 10,500
Tax @ 30% 3150
PAT 7350

Balance sheet

Liability Amount (` ) Assets Amount (`)

Equity 30,000 Fixed Assets 40,000
10% long term debt 20,000 Current Assets 20,000
Current liability 10,000
60,000 60,000

If the firm maintains status quo, it will behave like a no growth firm. If it adopts new strategy, sales
will grow at 30% p.a. for 4 years, the gross margin ratio, asset turnover ratio, capital structure and the
income tax rate will remain unchanged. Cost of equity - 18 %,

Reference What’s New

Valuation of a Strategy ALCAR Approach

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Q 14 Ex. Book No. Pg. No.

ABC Co. is considering a new sales strategy that will be valid for the next 3 years. They want to know
the value of the new strategy. Following information relating to the year which has just ended, is
available.

Income Statement `
Sales 20,000
Gross margin (20%) 4,000
Administration, Selling & distribution expense (10%) 2,000
PBT 2,000
Tax (30%) 600
PAT 1,400
Balance Sheet Information
Fixed Assets 8,000
Current Assets 4,000
Equity 12,000

If it adopts the new strategy, sales will grow at the rate of 20% per year for three years. The gross mar-
gin ratio, Assets turnover ratio, the Capital structure and the income tax rate will remain unchanged.

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Depreciation would be at 10% of net fixed assets at the beginning of the year. The Company’s target
rate of return is 15%.
Determine the incremental value due to adoption of the strategy.

Reference What’s New

Valuation of a Strategy

Q 15 Ex. Book No. Pg. No.

Using the chop-shop approach (or Break-up value approach), assign a value for Cornett GMBH. whose
stock is currently trading at a total market price of €4 million. For Cornett, the accounting data set
forth in three business segments: consumer wholeselling, specialty services, and assorted centers.
Data for the firm’s three segments are as follows:

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Business segment
Consumer wholeselling € 1,500,000
Segment sales
€ 750,000 € 100,000
Segment assets Segment income

Specialty services € 800,000 € 700,000 € 150,000

Assorted centers € 2,000,000 € 3,000,000 € 600,000

Industry data for “pure-play” firms have been compiled and are summarized as follows:

Capitalization/operating
Business segment Capitalization/sales Capitalization/assets
income
Consumer wholeselling 0.75 0.60 10.00
Specialty services 1.10 0.90 7.00
Assorted centers 1.00 0.60 6.00

Reference What’s New

Valuation of Segment Chop Shop Method

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Q 16 Ex. Book No. Pg. No.

Find the value of stock of Hindustan Unilever Ltd:

Sales - ` 70,000 crores; Net profit margin - 24%; Net worth - ` 60,000 crores, No. of shares – 350 crores;
For this purpose, data on 3 comparable firms are given below –

Particulars Nestle Dabur P & G ( in crores)

Sales 15,000 12,000 25,000
Net profit margin 20% 18% 16%
Net worth 10,000 8,000 14,000
Market capital 30,000 25,000 57,000

Other factors to be considered in valuation:-

Given -
40% weightage to Nestle,
30% weightage to Dabur &
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30% weightage to P & G,
Also, give 50% weightage to P-E ratio,
30% weightage to PS ratio, &
20% weightage to PB ratio,
Since the fundamentals of HUL are stronger than the comparable firms, HUL should command a price
multiple which is 10 % higher than industry average.

Reference What’s New

Price Multiples

Q 17 Ex. Book No. Pg. No.

The stock of X Ltd. trades at a P-E multiple of 8 times. X Ltd. is a no growth firm. 90 days treasury bills
are presently trading at 98 (face value 100). Market risk premium is 4%. Calculate Beta of the stock.

Reference What’s New

Justified Price Multiple

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Q 18 Ex. Book No. Pg. No.

Consider 2 firms which are similar in all aspects other than EPS & growth:-

Particulars A B
Price 800 25
EPS 20 2.5
Growth 8% 2%

Comment on relative miss pricing.

Reference What’s New

Justified Price Multiple

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Q 19 Ex. Book No. Pg. No.

X Ltd. Reported an EBDIT of 200 crores. It has debt of market value 300 crores. 4 crores shares are out-
standing. In the industry in which X Ltd. belongs, the average EV/EBDIT multiple is 10 times. What is
the intrinsic value/share of X Ltd.?

Reference What’s New

Enterprise Value to EBDIT Ratio

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Q 1 Ex. Book No. Pg. No.

Following Financial data are available for PQR Ltd. for the year 2018:
(` in lakh)

8% debentures 125
10% bonds (2017) 50
Equity shares (` 10 each) 100
Reserves and Surplus 300
Total Assets 600
Assets Turnovers ratio 1.1
Effective interest rate 8%
Effective tax rate 40%
Operating margin 10%
Dividend payout ratio 16.67%
Current market Price of Share `14
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Required rate of return of investors 15%

You are required to:

(i) Draw income statement for the year
(ii) Calculate its sustainable growth rate
(iii) Calculate the fair price of the Company’s share using dividend discount model, and
(iv) What is your opinion on investment in the company’s share at current price?

Reference What’s New

Valuation of Share Finding Growth Rate using

ROE

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Q 2 Ex. Book No. Pg. No.

Eagle Ltd. reported a profit of `77 lakhs after 30% tax for the financial year 2011-12. An analysis of the
accounts revealed that the income included extraordinary items of `8 lakhs and an extraordinary loss
of `10 lakhs. The existing operations, except for the extraordinary items, are expected to continue in
the future. In addition, the results of the launch of a new product are expected to be as follows:

` In lakhs
Sales 70
Material costs 20
Labour costs 12
Fixed costs 10

You are required to:

(i) Calculate the value of the business, given that the capitalization rate is 14%.
(ii) Determine the market price per equity share, with Eagle Ltd.‘s share capital being comprised of
1,00,000 13% preference shares of `100 each and 50,00,000 equity shares of `10 each and the P/E
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ratio being 10 times.

Reference What’s New

Valuation of Firm Using Maintainable Profits and

PE ratio

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Equity Analysis Part C

Economic Value Added

Q 1 Ex. Book No. Pg. No.

With the help of the following information of Jatayu Limited compute the Economic Value Added:

Capital Structure Equity capital `160 Lakhs

Reserves and Surplus `140 lakhs
10% Debentures `400 lakhs
Cost of equity 14%
Financial Leverage 1.5 times
Income Tax Rate 30%

Reference What’s New

EVA
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Q 2 Ex. Book No. Pg. No.

RST Ltd.’s current financial year’s income statement reported its net income as ` 25,00,000.
The applicable corporate income tax rate is 30%.
Following is the capital structure of RST Ltd. at the end of current financial year:

Debt (Coupon rate = 11%) 40 lakhs

Equity (Share Capital + Reserves & Surplus) 125 lakhs
Invested Capital 165 lakhs
Following data is given to estimate cost of equity capital:
Beta of RST Ltd. 1.36
Risk –free rate i.e. current yield on Govt. bonds 8.5%
Average market risk premium (i.e. Excess of return on market portfolio over risk- 9%
free rate)

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Required:
(i) Estimate Weighted Average Cost of Capital (WACC) of RST Ltd.; and
(ii) Estimate Economic Value Added (EVA) of RST Ltd.

Reference What’s New

EVA

Q 3 Ex. Book No. Pg. No.

Tender Ltd has earned a net profit of `15 lacs after tax at 30%. Interest cost charged by financial insti-
tutions was `10 lacs. The invested capital is ` 95 lacs of which 55% is debt. The company maintains a
weighted average cost of capital of 13%. Required,
(a) Compute the operating income.

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(b) Compute the Economic Value Added (EVA).
(c) Tender Ltd. has 6 lac equity shares outstanding. How much dividend can the company pay before
the value of the entity starts declining?

Reference What’s New

EVA

Q 4 Ex. Book No. Pg. No.

The following information is given for 3 companies that are identical except for their capital structure:

Orange Grape Apple

Total invested capital 1,00,000 1,00,000 1,00,000
Debt/assets ratio 0.8 0.5 0.2
Shares outstanding 6,100 8,300 10,000
Pre tax cost of debt 16% 13% 15%
Cost of equity 26% 22% 20%
Operating Income (EBIT) 25,000 25,000 25,000
Net Income 8,970 12,350 14,950

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The tax rate is uniform 35% in all cases.

(i) Compute the Weighted average cost of capital for each company.
(ii) Compute the Economic Valued Added (EVA) for each company.
(iii) Based on the EVA, which company would be considered for best investment? Give reasons.
(iv) If the industry PE ratio is 11x, estimate the price for the share of each company.
(v) Calculate the estimated market capitalisation for each of the Companies.

Reference What’s New

EVA

[email protected],8420517209

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Q 1 Ex. Book No. Pg. No.

Delta Ltd.’s current financial year’s income statement reports its net income as ` 15,00,000. Delta’s
marginal tax rate is 40% and its interest expense for the year was ` 15,00,000. The company has `
1,00,00,000 of invested capital, of which 60% is debt. In addition, Delta Ltd. tries to maintain a Weight-
ed Average Cost of Capital (WACC) of 12.6%.
(i) Compute the operating income or EBIT earned by Delta Ltd. in the current year.
(ii) What is Delta Ltd.’s Economic Value Added (EVA) for the current year?
(iii) Delta Ltd. has 2,50,000 equity shares outstanding. According to the EVA you computed in (ii),
how much can Delta pay in dividend per share before the value of the company would start to
decrease? If Delta does not pay any dividends, what would you expect to happen to the value of
the company?

Reference What’s New

EVA

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Q 2 Ex. Book No. Pg. No.

Constant Engineering Ltd. has developed a high tech product which has reduced the Carbon emission
from the burning of the fossil fuel. The product is in high demand. The product has been patented and
has a market value of ` 100 Crore, which is not recorded in the books. The Net Worth (NW) of Constant
Engineering Ltd. is ` 200 Crore. Long term debt is ` 400 Crore. The product generates a revenue of `
84 Crore. The rate on 365 days Government bond is 10 percent per annum. Bond portfolio generates
a return of 12 percent per annum. The stock of the company moves in tandem with the market. Calcu-
late Economic Value added of the company.

Reference What’s New

EVA

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Q 3 Ex. Book No. Pg. No.

Herbal World is a small, but profitable producer of beauty cosmetics using the plant Aloe, Vera. Though
it is not a high-tech business, yet Herbai’s earnings have averaged around ` 18.5 lakh after tax, mainly
on the strength of its patented beauty cream to remove the pimples.
The patent has nine years to run, and Herbal has been offered ` 50 lakhs for the patent rights. Herbai’s
assets include ` 50 lakhs of property, plant and equipment and ` 25 lakhs of working capital. However,
the patent is not shown in the books of Herbal World. Assuming Herbai’s cost of capital being 14 per-
cent, calculate its Economic Value Added (EVA).

Reference What’s New

EVA

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Equity Analysis – Part D

Economic Analysis, Industry Analysis, Company Analysis and Technical Analysis

Economic Industry Company Technical

Analysis Analysis Analysis Analysis

1. ECONOMIC ANALYSIS :
Macro- economic factors e. g. historical performance of the economy in the past/ present and
expectations in future, growth of different sectors of the economy in future with signs of
stagnation/degradation at present to be assessed while analyzing the overall economy. Trends in
peoples’ income and expenditure reflect the growth of a particular industry/company in future.
Consumption affects corporate profits, dividends and share prices in the market.
Factors Affecting Economic Analysis: Some of the economy wide factors are discussed as
under:
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(a) Growth Rates of National Income and Related Measures: For most purposes, what is
important is the difference between the nominal growth rate quoted by GDP and the ‘real’
growth after taking inflation into account. The estimated growth rate of the economy would
be a pointer to the prospects for the industrial sector, and therefore to the returns investors
can expect from investment in shares.
(b) Growth Rates of Industrial Sector: This can be further broken down into growth rates of
various industries or groups of industries if required. The growth rates in various industries
are estimated based on the estimated demand for its products.
(c) Inflation: Inflation is measured in terms of either wholesale prices (the Wholesale Price
Index or WPI) or retail prices (Consumer Price Index or CPI). The demand in some industries,
particularly the consumer products industries, is significantly influenced by the inflation
rate.
Therefore, firms in these industries make continuous assessment about inflation rates likely
to prevail in the near future so as to fine-tune their pricing, distribution and promotion
policies to the anticipated impact of inflation on demand for their products.
(d) Monsoon: Because of the strong forward and backward linkages, monsoon is of great
concern to investors in the stock market too.
Techniques Used in Economic Analysis: Economic analysis is used to forecast national income
with its various components that have a bearing on the concerned industry and the company
in particular. Gross national product (GNP) is used to measure national income as it reflects the
growth rate in economic activities and has been regarded as a forecasting tool for analyzing the
overall economy along with its various components during a particular period.
Some of the techniques used for economic analysis are:
(a) Anticipatory Surveys: They help investors to form an opinion about the future state of the
economy. It incorporates expert opinion on construction activities, expenditure on plant
and machinery, levels of inventory – all having a definite bearing on economic activities.

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Also future spending habits of consumers are taken into account.

In spite of valuable inputs available through this method, it has certain drawbacks:
(i) Survey results do not guarantee that intentions surveyed would materialize.
(ii) They are not regarded as forecasts per se, as there can be a consensus approach by the
investor for exercising his opinion.
Continuous monitoring of this practice is called for to make this technique popular.
(b) Barometer/Indicator Approach: Various indicators are used to find out how the economy
shall perform in the future. The indicators have been classified as under:
(i) Leading Indicators: They lead the economic activity in terms of their outcome. They
relate to the time series data of the variables that reach high/low points in advance of
economic activity.
(ii) Roughly Coincidental Indicators: They reach their peaks and troughs at approximately
the same in the economy.
(iii) Lagging Indicators: They are time series data of variables that lag behind in their
consequences vis-a- vis the economy. They reach their turning points after the economy
has reached its own already.

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All these approaches suggest direction of change in the aggregate economic activity but
nothing about its magnitude. The various measures obtained form such indicators may give
conflicting signals about the future direction of the economy. To avoid this limitation, use
of diffusion/composite index is suggested whereby combining several indicators into one
index to measure the strength/weaknesses in the movement of a particular set of indicators.
Computation of diffusion indices is no doubt difficult notwithstanding the fact it does not
eliminate irregular movements.
Money supply in the economy also affects investment decisions. Rate of change in money
supply in the economy affects GNP, corporate profits, interest rates and stock prices. Increase
in money supply fuels inflation. As investment in stocks is considered as a hedge against
inflation, stock prices go up during inflationary period.
(c) Economic Model Building Approach: In this approach, a precise and clear relationship
between dependent and independent variables is determined. GNP model building or
sectoral analysis is used in practice through the use of national accounting framework. The
steps used are as follows:
(i) Hypothesize total economic demand by measuring total income (GNP) based on
political stability, rate of inflation, changes in economic levels.
(ii) Forecasting the GNP by estimating levels of various components viz. consumption
expenditure, gross private domestic investment, government purchases of goods/
services, net exports.
(iii) After forecasting individual components of GNP, add them up to obtain the forecasted
GNP.
(iv) Comparison is made of total GNP thus arrived at with that from an independent agency
for the forecast of GNP and then the overall forecast is tested for consistency. This is
carried out for ensuring that both the total forecast and the component wise forecast
fit together in a reasonable manner.

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2. INDUSTRY ANALYSIS:
When an economy grows, it is very unlikely that all industries in the economy would grow at
the same rate. So it is necessary to examine industry specific factors, in addition to economy-
wide factors. First of all, an assessment has to be made regarding all the conditions and factors
relating to demand of the particular product, cost structure of the industry and other economic
and Government constraints on the same. Since the basic profitability of any company depends
upon the economic prospects of the industry to which it belongs, an appraisal of the particular
industry’s prospects is essential.
Factors Affecting Industry Analysis: The following factors may particularly be kept in mind
while assessing the factors relating to an industry.
(a) Product Life-Cycle: An industry usually exhibits high profitability in the initial and growth
stages, medium but steady profitability in the maturity stage and a sharp decline in
profitability in the last stage of growth.
(b) Demand Supply Gap: Excess supply reduces the profitability of the industry because of
the decline in the unit price realization, while insufficient supply tends to improve the
profitability because of higher unit price realization.
(c) Barriers to Entry: Any industry with high profitability would attract fresh investments. The
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potential entrants to the industry, however, face different types of barriers to entry. Some
of these barriers are innate to the product and the technology of production, while other
barriers are created by existing firms in the industry.
(d) Government Attitude: The attitude of the government towards an industry is a crucial
determinant of its prospects.
(e) State of Competition in the Industry: Factors to be noted are- firms with leadership
capability and the nature of competition amongst them in foreign and domestic market,
type of products manufactured viz. homogeneous or highly differentiated, demand
prospects through classification viz customer-wise/area-wise, changes in demand patterns
in the long/immediate/ short run, type of industry the firm is placed viz. growth, cyclical,
defensive or decline.
(f) Cost Conditions and Profitability: The price of a share depends on its return, which in turn
depends on profitability of the firm. Profitability depends on the state of competition in the
industry, cost control measures adopted by its units and growth in demand for its products.
Techniques Used in Industry Analysis: The techniques used for analyzing the industry wide
factors are:
(a) Regression Analysis: Investor diagnoses the factors determining the demand for output of
the industry through product demand analysis. Factors to be considered are GNP, disposable
income, per capita consumption / income, price elasticity of demand. For identifying factors
affecting demand, statistical techniques like regression analysis and correlation are used.
(b) Input – Output Analysis: It reflects the flow of goods and services through the economy,
intermediate steps in production process as goods proceed from raw material stage through
final consumption. This is carried out to detect changing patterns/trends indicating growth/
decline of industries.

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3. COMPANY ANALYSIS:
Economic and industry framework provides the investor with proper background against which
shares of a particular company are purchased. This requires careful examination of the company’s
quantitative and qualitative fundamentals.
(a) Net Worth and Book Value : Net Worth is sum of equity share capital, preference share
capital and free reserves less intangible assets and any carry forward of losses. The total net
worth divided by the number of shares is the much talked about book value of a share.
Though the book value is often seen as an indication of the intrinsic worth of the share, this
may not be so for two major reasons. First, the market price of the share reflects the future
earnings potential of the firm which may have no relationship with the value of its assets.
Second, the book value is based upon the historical costs of the assets of the firm and these
may be gross underestimates of the cost of the replacement or resale values of these assets.
(b) Sources and Uses of Funds: The identification of sources and uses of funds is known as
Funds Flow Analysis.
One of the major uses of funds flow analysis is to find out whether the firm has used short
term sources of funds to finance long-term investments. Such methods of financing increases
the risk of liquidity crunch for the firm, as long-term investments, because of the gestation
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period involved may not generate enough surplus in time to meet the short-term liabilities
incurred by the firm. Many a firm has come to grief because of this mismatch between the
maturity periods of sources and uses of funds.
(c) Cross-Sectional and Time Series Analysis: One of the main purposes of examining financial
statements is to compare two firms, compare a firm against some benchmark figures for its
industry and to analyse the performance of a firm over time. The techniques that are used
to do such proper comparative analysis are: common-sized statement, and financial ratio
analysis.
(d) Size and Ranking: A rough idea regarding the size and ranking of the company within the
economy, in general, and the industry, in particular, would help the investment manager
in assessing the risk associated with the company. In this regard the net capital employed,
the net profits, the return on investment and the sales figures of the company under
consideration may be compared with similar data of other companies in the same industry
group. It may also be useful to assess the position of the company in terms of technical
know-how, research and development activity and price leadership.
(e) Growth Record: The growth in sales, net income, net capital employed and earnings per
share of the company in the past few years should be examined. The following three growth
indicators may be particularly looked into: (a) Price earnings ratio, (b) Percentage growth
rate of earnings per annum, and (c) Percentage growth rate of net block. The price earnings
ratio is an important indicator for the investment manager since it shows the number of
times the earnings per share are covered by the market price of a share. Theoretically, this
ratio should be the same for two companies with similar features. However, this is not so in
practice due to many factors. Hence, by a comparison of this ratio pertaining to different
companies the investment manager can have an idea about the image of the company and
can determine whether the share is under-priced or over-priced.

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Growth is the single most important factor in company analysis for the purpose of investment
management. A company may have a good record of profits and performance in the past;
but if it does not have growth potential, its shares cannot be rated high from the investment
point of view.
(f) Financial Analysis: An analysis of its financial statements for the past few years would help
the investment manager in understanding the financial solvency and liquidity, the efficiency
with which the funds are used, the profitability, the operating efficiency and the financial
and operating leverages of the company. For this purpose, certain fundamental ratios have
to be calculated.
From the investment point of view, the most important figures are earnings per share, price
earning ratios, yield, book value and the intrinsic value of the share. These five elements may
be calculated for the past 10 years or so and compared with similar ratios computed from
the financial accounts of other companies in the industry and with the average ratios for the
industry as a whole. The yield and the asset backing of a share are important considerations
in a decision regarding whether the particular market price of the share is proper or not.
Various other ratios to measure profitability, operating efficiency and turnover efficiency
of the company may also be calculated. The return on owners’ investment, capital turnover
ratio and the cost structure ratios may also be worked out.
To examine the financial solvency or liquidity of the company, the investment manager
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may work out current ratio, liquidity ratio, debt-equity ratio, etc. These ratios will provide
an overall view of the company to the investment analyst. He can analyse its strengths and
weaknesses and see whether it is worth the risk or not.
(g) Quality of Management: This is an intangible factor. Yet it has a very important bearing
on the value of the shares. Every investment manager knows that the shares of certain
business houses command a higher premium than those of similar companies managed
by other business houses. This is because of the quality of management, the confidence
that investors have in a particular business house, its policy vis-a-vis its relationship with the
investors, dividend and financial performance record of other companies in the same group,
etc. This is perhaps the reason that an investment manager always gives a close look to the
management of a company in whose shares he is to invest. Quality of management has
to be seen with reference to the experience, skills and integrity of the persons at the helm
of affairs of the company. The policy of the management regarding relationship with the
shareholders is an important factor since certain business houses believe in very generous
dividend and bonus distributions while others are rather conservative.
(h) Location and Labour-Management Relations: The locations of the company’s
manufacturing facilities determines its economic viability which depends on the availability
of crucial inputs like power, skilled labour and raw-materials, etc. Nearness to markets is also
a factor to be considered.
In the past few years, the investment manager has begun looking into the state of labour
management relations in the company under consideration and the area where it is located.
(i) Pattern of Existing Stock Holding: An analysis of the pattern of existing stock holdings
of the company would also be relevant. This would show the stake of various parties in the
company. An interesting case in this regard is that of the Punjab National Bank in which
the Life Insurance Corporation and other financial institutions had substantial holdings.
When the bank was nationalised, the residual company proposed a scheme whereby those
shareholders, who wish to opt out, could receive a certain amount as compensation in cash.

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It was only at the instance and the bargaining strength, of institutional investors that the
compensation offered to the shareholders, who wished to opt out of the company, was
raised considerably.
(j) Marketability of the Shares: Another important consideration for an investment manager
is the marketability of the shares of the company. Mere listing of a share on the stock
exchange does not automatically mean that the share can be sold or purchased at will. There
are many shares which remain inactive for long periods with no transactions being effected.
To purchase or sell such scrips is a difficult task. In this regard, dispersal of shareholding with
special reference to the extent of public holding should be seen. The other relevant factors
are the speculative interest in the particular scrip, the particular stock exchange where it is
traded and the volume of trading.
Techniques Used in Company Analysis: Through the use of statistical techniques the company
wide factors can be analysed. Some of the techniques are discussed as under:
(a) Correlation & Regression Analysis: Simple regression is used when inter relationship
covers two variables. For more than two variables, multiple regression analysis is followed.
Here the inter relationship between variables belonging to economy, industry and company
are found out. The main advantage in such analysis is the determination of the forecasted
values along with testing the reliability of the estimates.
(b) Trend Analysis: The relationship of one variable is tested over time using regression analysis.
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It gives an insight to the historical behavior of the variable.
(c) Decision Tree Analysis: Information relating to the probability of occurrence of the
forecasted value is considered useful. A range of values of the variable with probabilities
of occurrence of each value is taken up. The limitations are reduced through decision tree
analysis and use of simulation techniques.
In decision tree analysis, the decision is taken sequentially with probabilities attached to each
sequence. To obtain the probability of final out come, various sequential decisions given along
with probabilities, them probabilities of each sequence is to be multiplied and them summed up.
Thus, fundamental analysis is basically an examination of the economic and financial aspects of a
company with the aim of estimating future earnings and dividend prospects. It includes an analysis
of the macro-economic and political factors which will have an impact on the performance of the
company. After having analysed all the relevant information about the company and its relative
strength vis-a-vis other companies in the industry, the investor is expected to decide whether he
should buy or sell the securities.
Apart from these, the Group Analysis has also become an important factor. SEBI, in particular,
emphasizes the need for disclosure, in public offer documents, of all relevant parameters –
especially the financial health and promise versus performance of the group companies. RBI has
also been focusing more and more on the Group Exposure Norms of commercial Banks.

4. TECHNICAL ANALYSIS
The two basic questions that technical analyst seeks to answer are: (i) Is there a discernible trend
in the prices? (ii) If there is, then are there indications that the trend would reverse? The methods
used to answer these questions are visual and statistical.

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Technical analysts use three types of charts for analyzing data. They are:
(i) Bar Chart: In a bar chart, a vertical line (bar) represents the lowest to the highest price, with
a short horizontal line protruding from the bar representing the closing price for the period.
(ii) Line Chart: In a line chart, lines are used to connect successive day’s prices. The closing
price for each period is plotted as a point. These points are joined by a line to form the chart.
(iii) Point and Figure Chart: Point and Figure charts are more complex than line or bar charts.
They are used to detect reversals in a trend.
General Principles and Methods of Technical Analysis
1. The Dow Theory
• Oldest and the most famous technical theories.
• Helpful tool for determining the relative strength of the stock market.
• Based upon the movements of two indices, constructed by Charles Dow, Dow Jones
Industrial Average (DJIA) and Dow Jones Transportation Average (DJTA).
• The above averages reflect the aggregate impact of all kinds of information on the market.
• The movements of the market are divided into three classifications:

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 The primary movement,
 The secondary movement
 The daily fluctuations.
• The primary movement is the main trend of the market, which lasts from one year to 36
months or longer. This trend is commonly called bear or bull market.
• The secondary movement of the market is shorter in duration than the primary movement,
and is opposite in direction. It lasts from two weeks to a month or more.
• The daily fluctuations are the narrow movements from day-to-day. These fluctuations are
not part of the Dow Theory interpretation of the stock market. However, daily movements
must be carefully studied, along with primary and secondary movements, as they go to
make up the longer movement in the market.
2. Market Indicators
(i) Breadth Index: An index covering all securities traded.
(ii) Volume of Transactions: Provides useful clues on future market behaviour.
(iii) Confidence Index: Reveals investors willingness to take chance in the market.
(iv) Relative Strength Analysis: Suggests some securities exhibit relative strength.
(iv) Odd - Lot Theory: Used primarily to predict tops in bull markets, but also to predict reversals
in individual securities.
3. Support and Resistance Levels
• When the index/price goes down from a peak, the peak becomes the resistance level.
• When the index/price rebounds after reaching a trough subsequently, the lowest value
reached becomes the support level.
• The price is then expected to move between these two levels.

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• Whenever the price approaches the resistance level, there is a selling pressure because all
investors who failed to sell at the high would be keen to liquidate.
• Whenever the price approaches the support level, there is a buying pressure as all those
investors who failed to buy at the lowest price would like to purchase the share.
4. Interpreting Price Patterns
There are numerous price patterns documented by technical analysts but only a few and
important of them have been discussed here:
(a) Channel: series of uniformly changing tops and bottoms gives rise to a channel formation.
(b) Wedge: It is Formed when the tops (resistance levels) and bottoms (support levels) change
in opposite direction or when they change in the same direction at different rates over time.
(c) Head and Shoulders: It is a distorted drawing of a human form, with a large lump (for head)
in the middle of two smaller humps (for shoulders).
(i) Head and Shoulder Top Pattern: Such formation represents bearish development.
(ii) Inverse Head and Shoulder Pattern: It reflects a bullish development.
(d) Triangle or Coil Formation: It represents a pattern of uncertainty and is difficult to predict
which way the price will break out.
(e) Flags and Pennants Form: This form signifies a phase after which the previous price trend
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is likely to continue.
(f) Double Top Form: This form represents a bearish development, signals that price is
expected to fall.
(g) Double Bottom Form: This form represents bullish development signaling price is expected
to rise.
(h) Gap: A gap is the difference between the opening price on a trading day and the closing
price of the previous trading day.
5. Decision Using Data Analysis
• Moving Averages is one of the more popular methods of data analysis for decision making.
• The two types of moving averages used by chartists are the Arithmetic Moving Average
(AMA) and the Exponential Moving Average (EMA).
Unlikely the AMA, which assigns equal weight of 1/n to each of the n prices used for computing
the average, the Exponential Moving Average (EMA) assigns decreasing weights specified by the
exponential smoothing constant, also known as the exponent,
6. Bollinger Bands
• Bollinger bands consist of a centreline and two price channels, one above the centreline and
one below.
• The centreline is an exponential moving average, and the price channels are standard
deviations of the stock the chartist is studying.
• The bands will expand and contract as the price action of an issue becomes volatile
(expansion) or becomes bound into a tight trading pattern (contraction).

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7. Momentum Analysis
• Momentum measures the speed of price change and provides a leading indicator of changes
in trend.
• The momentum line leads price action frequently enough to signal a potential trend reversal
in the market.
• Momentum indicators can warn of dormant strength or weakness in the price well ahead of
the turning point.
• At extreme positive values, momentum implies an overbought position; at extreme negative
values, an oversold position.
(a) Interpretation of Momentum Line: A strongly trending market acts like a pendulum;
the move begins at a fast pace, with strong momentum. It gradually slows down, or loses
momentum, stops and reverses course.
(b) Signals: Momentum is a basic application of oscillator analysis, designated to measure the
rate of price change, not the actual price level. Three common signals are as follows:
(i) Zero-line Crossings
(ii) Trend line Violations
(iii) Extreme Values
8. The Elliot Wave Theory
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Inspired by the Dow Theory and by observations found throughout nature, Ralph Elliot formulated
Elliot Wave Theory in 1934. This theory was based on analysis of 75 years stock price movements
and charts. From his studies, he defined price movements in terms of waves. Accordingly, this
theory was named Elliot Wave Theory. Elliot found that the markets exhibited certain repeated
patterns or waves. As per this theory wave is a movement of the market price from one change in
the direction to the next change in the same direction. These waves are resulted from buying and
selling impulses emerging from the demand and supply pressures on the market. Depending on
the demand and supply pressures, waves are generated in the prices.
As per this theory, waves can be classified into two parts:-
• Impulsive patterns
• Corrective patters
Let us discuss each of these patterns.
(a) Impulsive Patterns-(Basic Waves) - In this pattern there will be 3 or 5 waves in a given
direction (going upward or downward). These waves shall move in the direction of the basic
movement. This movement can indicate bull phase or bear phase.
(b) Corrective Patterns- (Reaction Waves) - These 3 waves are against the basic direction of
the basic movement. Correction involves correcting the earlier rise in case of bull market
and fall in case of bear market.

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As shown in the following diagram waves 1, 3 and 5 are directional movements, which are
separated or corrected by wave 2 & 4, termed as corrective movements.
The Basic Pattern
5

3
ve
3

Wa
2
ve
1

Wa
4
1
ve
Wa

Complete Cycle - As shown in following figure five-wave impulses is following by a three-wave

correction (a,b & c) to form a complete cycle of eight waves.
5
Impulsive Corrective
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Wa

(Number phase) (Letter phase)

ve
e3

eb
a

3
av
Wav

Wa
ve

a
c
e2

1 c
Wav

4
e1
Wav

One complete cycle consists of waves made up of two distinct phases, bullish and bearish. On
completion of full one cycle i.e. termination of 8 waves movement, the fresh cycle starts with
similar impulses arising out of market trading.
Evaluation of Technical Analysis
The advocates of technical analysis offer the following interrelated argument in their favour:
(a) Under influence of crowd psychology trend persist for some time.
(b) Shift in demand and supply are gradual rather then instantaneous.
(c) Fundamental information about a company is observed and assimilated by the market over
a period of time.
Detractors of technical analysis present their arguments are as follows:
(a) Most technical analysts unable to offer a convincing explanation for their tools employed
(b) Empirical evidence in support of random walk hypothesis cast its shadow over the usefulness
of technical analysis.

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(c) Up trend and down trend signalled by technical analysis may already have taken place.
(d) Technical analysis must be self defeating proposition.
If technical analysis is used in conjunction with fundamental analysis, it might be useful in
providing proper guidance to investment decision makers.
9. Charting Technique
Technical analysts use three types of charts for analyzing data. They are:
(i) Bar Chart : In a bar chart, a vertical line (bar) represents the lowest to the highest price, with
a short horizontal line protruding from the bar representing the closing price for the period.
Since volume and price data are often interpreted together, it is a common practice to plot
the volume traded, immediately below the line and the bar charts.

A: Bar Chart
Price

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Trading day

(ii) Line Chart: In a line chart, lines are used to connect successive day’s prices. The closing
price for each period is plotted as a point. These points are joined by a line to form the chart.
The period may be a day, a week or a month.
B: Line Chart
Price

Trading day

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(iii) Point and Figure Chart: Point and Figure charts are more complex than line or bar charts.
They are used to detect reversals in a trend. For plotting a point and figure chart, we have
to first decide the box size and the reversal criterion. The box size is the value of each box
on the chart, for example each box could be Re.1, ` 2 or ` 0.50. The smaller the box size, the
more sensitive would the chart be to price change. The reversal criterion is the number of
boxes required to be retraced to record prices in the next column in the opposite direction.
Period Price
1 24 30
2 26 29
3 27
28 X
4 26
27 X
5 28
26 X
6 27
25 X
7 26
8 25 24 X
9 26 23
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10 23 22

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Chapter 2
Mutual Funds

MUTUAL FUNDS

1. What is a Mutual Fund

2. Classification a. Functional Classification –

i. Open Ended Funds
ii. Close Ended Funds
iii. Interval Funds
b. Portfolio Classification –
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i. Equity Funds
1. Growth Funds
2. Aggressive Funds
3. Income Funds
4. Balanced Funds
5. Equity Diversified Funds
a. Flexicap/ Multicap Fund
b. Contra Fund
c. Index Fund
d. Dividend Yield Fund
6. Equity Linked Tax Savings Scheme
ii. Debt Funds or Liquid Funds
1. Bond Funds
2. Gilt Funds
iii. Special Funds
1. Index Funds
2. International Funds
3. Offshore Funds
4. Sector Funds
5. Money Market Funds

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6. Fund of Funds
7. Capital Protection Oriented Funds
8. Gold Funds
9. Arbitrage Funds
10. Hedge Fund
11. Cash Fund
12. Exchange Traded Fund
c. Ownership Classification
i. Public Sector Funds
ii. Private Sector Funds
iii. Foreign Funds

3. Key Players in Mutual

Funds

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4. Advantages and
Disadvantages of
Mutual Funds

5. Evaluating Performance a. Net Asset Value

of Mutual Funds b. Costs Incurred
c. Return calculations

6. Criteria for Evaluating a. Sharpe Ratio

the performance b. Treynor Ratio
c. Jensen’s Alpha

7. Factors influencing the

selection of Mutual
Funds

8. Signals highlighting
the exit of the investor
from the Mutual Fund
Scheme

9. Money Market Mutual

Funds

10. Exchange Traded Funds

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Q 1 Ex. Book No. Pg. No.

Based on the following data, determine the NAV of a Regular Income Scheme

` (in lakhs)
Listed Shares at cost (ex-dividend) 20.00
Cash in hand 1.23
Bonds and Debentures at cost 4.30
Of these, Bonds not listed and quoted 1.00
Other fixed interest securities at cost 4.50
Dividend accrued 0.80
Amounts payable on shares 6.32
Expenditure accrued 0.75
Number of Units (` 10 F.V. each) 2,40,000
Current realizable value of fixed income securities of F.V. of ` 100 106.50

All the listed shares were purchased at a time when index was 1200. On NAV date, the index is ruling
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at 2120. Listed bonds and debentures carry a market value of 5 (lakhs) on NAV date.
`

Reference What’s New

NAV Computation

Q 2 Ex. Book No. Pg. No.

A Mutual Fund Co. has the following assets under it on the close of business as on:

1st February 2019 Market price 2nd February 2019 Market price
Company No. of Shares
per share ` per share `
L Ltd 20,000 20.00 20.50
M Ltd 30,000 312.40 360.00
N Ltd 20,000 361.20 383.10
P Ltd 60,000 505.10 503.90

Total No. of Units 6,00,000

(i) Calculate Net Assets Value (NAV) of the Fund on 1st Feb.

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(ii) Following information is given:

Assuming one Mr. A, submits a cheque of ` 30,00,000 on 1st Feb. to the Mutual Fund and the
Fund manager of this company purchases 8,000 shares of M Ltd; and the balance amount is held
in Bank. In such a case, what would be the position of the Fund?
(iii) Find new NAV of the Fund as on 2nd February 2019.

Reference What’s New

NAV Computation Revised number of unit calcu-

lation

Q 3 Ex. Book No. Pg. No.

A mutual fund made an issue of 10,00,000 units of ` 10 each on January 01, 2019. No entry load was
charged. It made the following investments:

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50,000 Equity shares of ` 100 each @ ` 160 80,00,000
7% Government Securities 8,00,000
9% Debentures (Unlisted) 5,00,000
10% Debentures (Listed) 5,00,000
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% respectively. Other investments are at par.
(a) Find out the Net Asset Value (NAV) per unit given that operating expenses paid during the year
amounted to ` 5,00,000.
(b) Find out the NAV, if the Mutual fund had distributed a dividend of ` 0.80 per unit during the year
to the unit holders.

Reference What’s New

NAV Computation

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WORK

Q 4 Ex. Book No. Pg. No.

A mutual fund’s opening NAV is ` 20 and its closing NAV is ` 24. If the expense per unit is ` 0.50, what
is the expense ratio?

Reference What’s New

Expense Ratio

Q 5 Ex. Book No. Pg. No.

A mutual fund, that had a net asset value of ` 10 at the beginning of the month, made income and
capital gain distribution of ` 0.05 and ` 0.04 per unit respectively during the month and then ended
the month with a net asset value of ` 10.03. Compute the monthly return.
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Reference What’s New

Computation of HPR

Q 6 Ex. Book No. Pg. No.

The unit price of Equity Linked Saving Scheme (ELSS) of a mutual fund is ` 10/-. The public offer price
(POP) of the unit is ` 10,204 and the redemption price is ` 9.80.
Calculate:
(i) Front-end Load
(ii) Back-end Load

Reference What’s New

Front end and Back end load

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Q 7 Ex. Book No. Pg. No.

The following portfolio details of a fund are available –

Stock Shares Price

A 2,00,000 35
B 3,00,000 40
C 4,00,000 20
D 6,00,000 25

The fund has accrued management fees with the portfolio totaling ` 30,000. There are 40 lakhs shares
outstanding. What is the NAV of the fund? If the fund is sold with a front end load of 5%, what is the
sale price?

Reference What’s New

NAV Computation With impact of front end load

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Q 8 Ex. Book No. Pg. No.

The following information is extracted from Steady Mutual Fund’s Scheme:

- Asset Value at the beginning of the month – ` 65.78

- Annualised return - 15 %
- Distributions made in the nature of Income (per unit) ` 0.50
- Capital gain (per unit) ` 0.32

You are required to:

(1) Calculate the month end net asset value of the mutual fund scheme (limit your answers to two
decimals).
(2) Provide a brief comment on the month end NAV.

Reference What’s New

NAV Computation

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Q 9 Ex. Book No. Pg. No.

Mr. X, an investor purchased 200 units of ABC Mutual Fund at rate of ` 8.50 p.u., one year ago. Over the
year Mr. X received ` 0.90 as dividend and had received a capital gains distribution of ` 0.75 per unit.
You are required to find out:
(a) Mr. X’s holding period return assuming that this no load fund has a NAV of ` 9.10 as on today.
(b) Mr. X’s holding period return, assuming all the dividends and capital gains distributions are
reinvested into additional units as at average price of ` 8.75 per unit.

Reference What’s New

Computation of Annual HPR to an

Investor

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Q 10 Ex. Book No. Pg. No.

A Mutual Fund having 300 units has shown its NAV of ` 8.75 and ` 9.45 at the beginning and at the end
of the year respectively. The Mutual Fund has given two options:
(i) Pay ` 0.75 per unit as dividend and ` 0.60 per unit as a capital gain, or
(ii) These distributions are to be reinvested at an average NAV of ` 8.65 per unit.
What difference it would make in terms of return available and which option is preferable?

Reference What’s New

Impact on NAV of reinvestment

Q 11 Ex. Book No. Pg. No.

A mutual fund raised ` 150 lakhs on April 1, by issue of 15 lakh units at ` 10 per unit. The fund invested
in several capital market instruments to build a portfolio of ` 140 lakhs. Initial expense amounted to `
8 lakhs. During the month of April, the fund sold certain securities costing ` 44.75 lakhs for ` 47 lakhs
and purchased certain other securities for ` 41.6 lakhs. The fund management expenses for the month
amounted to ` 6 lakhs of which ` 50,000 was in arrears. The dividend earned was ` 1.5 lakhs. 80% of
the realized earnings were distributed. The market value of the portfolio on 30th April was ` 147.85
lakhs.

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An investor subscribed to 1 unit on April 1 and disposed it off at closing NAV on 30th April.
Determine his annual rate of earning.

Reference What’s New

Computation of Annual HPR to an

Investor

Q 12 Ex. Book No. Pg. No.

A has invested in three Mutual Fund Schemes as per details below:

Particulars MF A MF B MF C
Date of investment 01.12.2018 01.01.2019 01.03.2019
Amount of investment ` 50,000 ` 1,00,000 ` 50,000
Net Asset Value (NAV) at entry date ` 10.50 ` 10 ` 10
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Dividend received upto 31.03.2019 ` 950 ` 1,500 Nil
NAV as at 31.03.2019 ` 10.40 ` 10.10 ` 9.80
Required:
What is the effective yield on per annum basis in respect of each of the three schemes to Mr. A upto
31.03.2019?

Reference What’s New

Effective Yield to the Investor

Q 13 Ex. Book No. Pg. No.

Mr. A can earn a return of 16 per cent by investing in equity shares on his own. Now he is considering
a recently announced equity based mutual fund scheme in which initial expenses are 5.5 per cent and
annual recurring expenses are 1.5 per cent. How much should the mutual fund earn to provide Mr. A
return of 16 per cent?

Reference What’s New

Computation of Annual HPR to ensure

Desired return of Investor

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Q 14 Ex. Book No. Pg. No.

Mr. X earns 10% on his investments in equity shares. He is considering a recently floated scheme of a
Mutual Fund where the initial expenses are 6% and annual recurring expenses are expected to be 2%.
How much the Mutual Fund scheme should earn to provide a return of 10% to Mr. X?

Reference What’s New

Computation of Annual HPR to ensure

Desired return of Investor

Q 15 Ex. Book No. Pg. No.

Mr. X on 1.7.2016, during the initial offer of some Mutual Fund invested in 10,000 units having face
value of ` 10 for each unit. On 31.3.2017, the dividend operated by the M.F. was 10% and Mr. X found
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that his annualized yield was 153.33%. On 31.12.2018, 20% dividend was given. On 31.3.2019, Mr. X
redeemed all his balance of 11,296.11 units when his annualized yield was 73.52%. What are the NAVs
as on 31.3.2017, 31.12.2018 and 31.3.2019?

Reference What’s New

NAV based on Effective Yield

Q 16 Ex. Book No. Pg. No.

On 01-07-2016, Mr. X Invested ` 50,000/- at initial offer in Mutual Funds at a face value of ` 10 each per
unit. On 31-03-2017, a dividend was paid @ 10% and annualized yield was 120%. On 31-03-2018, 20%
dividend and capital gain of ` 0.60 per unit was given. Mr. X redeemed all his 6271.98 units when his
annualized yield was 71.50% over the period of holding.
Calculate NAV as on 31-03-2017, 31-03-2018 and 31-03-2019.
For calculations consider a year of 12 months.

Reference What’s New

NAV based on Effective Yield

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Q 17 Ex. Book No. Pg. No.

Sun Moon Mutual Fund (Approved Mutual Fund) sponsored open-ended equity oriented scheme
“Chanakya Opportunity Fund”. There were three plans viz. ‘A’ – Dividend Reinvestment
Plan, ‘B’ – Bonus Plan & ‘C’ – Growth Plan.
At the time of Initial Public Offer on 1.4.2009, Mr. Anand, Mr. Bacchan & Mrs. Charu, three investors
invested ` 1,00,000 each & chosen ‘B’, ‘C’ & ‘A’ Plan respectively.
The History of the Fund is as follows:

Date Dividend % Bonus Ratio Net Asset Value per Unit (F.V. ` 10)
Plan A Plan B Plan C
28.07.2013 20 30.70 31.40 33.42
31.03.2014 70 5:4 58.42 31.05 70.05
31.10.2017 40 42.18 25.02 56.15
15.03.2018 25 46.45 29.10 64.28
31.03.2018 1:3 42.18 20.05 60.12
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24.03.2019
40 1:4 48.10 19.95 72.40
31.07.2019 53.75 22.98 82.07

On 31st July all three investors redeemed all the balance units.
Calculate annual rate of return to each of the investors.
Consider:
1. Long-term Capital Gain is exempt from Income tax.
2. Short-term Capital Gain is subject to 10% Income tax.
3. Security Transaction Tax 0.2 per cent only on sale/redemption of units.
4. Ignore Education Cess

Reference What’s New

Effective Yield to the Investor Impact of STCG and ST

Q 18 Ex. Book No. Pg. No.

A mutual fund company introduces two schemes i.e. Dividend plan (Plan-D) and Bonus plan (Plan-B).
The face value of the unit is ` 10. On 1-4-2013 Mr. K invested ` 2,00,000 each in Plan-D and Plan-B when
the NAV was ` 38.20 and ` 35.60 respectively. Both the plans matured on 31-3-2018.

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Particulars of dividend and bonus declared over the period are as follows:

Date Dividend% Bonus Ratio Net Asset Value(` )

Plan D Plan B
30-09-2013 10 39.10 35.60
30-06-2014 1:5 41.15 36.25
31-03-2015 15 44.20 33.10
15-09-2016 13 45.05 37.25
30-10-2016 1:8 42.70 38.30
27-03-2017 16 44.80 39.10
11-04-2017 1:10 40.25 38.90
31-03-2018 40.40 39.70
What is the effective yield per annum in respect of the above two plans?

Reference What’s New

Effective Yield to the Investor

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Q 19 Ex. Book No. Pg. No.

Five portfolios experienced the following results during a 7- year period:

Average Annual Return Correlation with the mar-
Portfolio Standard Deviation (Sp)
(Rp)(%) ket returns (r)
A 19.0 2.5 0.840
B 15.0 2.0 0.540
C 15.0 0.8 0.975
D 17.5 2.0 0.750
E 17.1 1.8 0.600
Market Risk (σm) 1.2
Market rate of Return 14.0
(Rm)
Risk-free Rate (Rf ) 9.0

Rank the portfolios using (a) Sharpe’s method, (b) Treynor’s method and (c) Jensen’s Alpha

Reference What’s New

Performance Evaluation using Sharpe

Ratio, Treynor Ratio and Jensen’s Alpha

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Q 20 Ex. Book No. Pg. No.

On 1st April, an open ended scheme of mutual fund had 300 lakh units outstanding with Net Assets
Value (NAV) of ` 18.75. At the end of April, it issued 6 lakh units at opening NAV plus 2% load, adjust-
ed for dividend equalization. At the end of May, 3 Lakh units were repurchased at opening NAV less
2% exit load adjusted for dividend equalization. At the end of June, 70% of its available income was
distributed.
In respect of April-June quarter, the following additional information are available:

` in lakh
Portfolio value appreciation 425.47
Income of April 22.960
Income for May 34.425
Income for June 45.450

You are required to calculate

(i) Income available for distribution;
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(ii) Issue price at the end of April;
(iii) Repurchase price at the end of May; and
(iv) Net asset value (NAV) as on 30th June.

Reference What’s New

Dividend equalisation effect

Q 21 Ex. Book No. Pg. No.

Mr. Y has invested in the three mutual funds (MF) 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 purchase (`) 10.30 10. 10 10
Dividend Received up to 31.03.2018 (`) 6,000 0 5,000
NAV as on 31.03.2018 (`) 10.25 10 10.20
Effective Yield per annum as on 31.03.2018 (percent) 9.66 -11.66 24.15

Assume 1 Year =365 days

Mr Y has misplaced the documents of his investment Held him in finding the date of his original in-
vestment after ascertaining the following:

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(i) Number of units in each scheme;

(ii) Total NAV;
(iii) Total Yield; and
(iv) Number of days investment held.

Reference What’s New

Missing figures

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1. What is a Mutual Fund

A mutual fund is a trust that pools the savings of a number of investors who share a common
financial goal. A mutual fund is the most suitable investment for the cautious investor as it offers
an opportunity to invest in a diversified professionally managed basket of securities at a relatively
low cost. So, we can say that Mutual Funds are trusts which pool resources from large number
of investors through issue of units for investments in capital market instruments such as shares,
debentures and bonds and moneymarket instruments such as commercial papers, certificate of
deposits and treasury bonds.
Who can invest in Mutual Funds: Anybody with an investible surplus of as little as a few
thousand rupees can invest in mutual funds by buying units of a particular mutual fund scheme
that has a defined investment objective and strategy.
2. Classification of Mutual funds–
1. Open Ended Funds –
In an open ended scheme, the investor can make entry and exit at any time. Also, the capital
of the fund is unlimited and the redemption period is indefinite.
2. Close Ended Funds –
In a close ended scheme, the investor can buy into the scheme during Initial Public offering
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or from the stock market after the units have been listed. The scheme has a limited life at
the end of which the corpus is liquidated. The investor can make his exit from the scheme
by selling in the stock market, or at the expiry of the scheme or during repurchase period
at his option.
3. Interval Funds -
Interval schemes are a cross between an open ended and a close ended structure. These
schemes are open for both purchase and redemption during pre-specified intervals (viz.
monthly, quarterly, annually etc.) at prevailing NAV based prices. Interval funds are very
similar to close-ended funds, but differ on the following points:
• They are not required to be listed on the stock exchanges, as they have an in-built
redemption window.
• They can make fresh issue of units during the specified interval period, at the prevailing
NAV based prices.
• Maturity period is not defined.
4. Growth Funds: They seek to provide long term capital appreciation to the investor and are
best to long term investors.
5. Aggressive Funds: They look for super normal returns for which investment is made in
start-ups, IPOs and speculative shares. They are best to investors willing to take risks.
6. Income Funds: They seek to maximize present income of investors by investing in safe
stocks paying high cash dividends and in high yield money market instruments. They are
best to investors seeking current income.
7. Balanced Funds: They are a mix of growth and income funds. They buy shares for growth
and bonds for income and best for investors seeking to strike golden mean.

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8. Bond Funds: They invest in fixed income securities e.g. government bonds, corporate
debentures, convertible debentures, money market. Investors seeking tax free income
go in for government bonds while those looking for safe, steady income buy government
bonds or high grade corporate bonds. Although there have been past exceptions, bond
funds tend to be less volatile than stock funds and often produce regular income. For these
reasons, investors often use bond funds to diversify, provide a stream of income, or invest
for intermediate-term goals. Like stock funds, bond funds have risks and can make or lose
money.
9. Gilt Funds: They are mainly invested in Government securities.
10. Index Funds: Every stock market has a stock index which measures the upward and
downward sentiment of the stock market. Index Funds are low cost funds and influence the
stock market. The investor will receive whatever the market delivers.
11. International Funds: A mutual fund located in India to raise money in India for investing
globally.
12. Offshore Funds: A mutual fund located in India to raise money globally for investing in
India.
13. Sector Funds: They invest their entire fund in a particular industry e.g. utility fund for utility
industry like power, gas, public works.
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14. Money Market Funds: These are predominantly debt-oriented schemes, whose main
objective is preservation of capital, easy liquidity and moderate income. To achieve this
objective, liquid funds invest predominantly in safer short-term instruments like Commercial
Papers, Certificate of Deposits, Treasury Bills, G-Secs etc.
These schemes are used mainly by institutions and individuals to park their surplus funds
for short periods of time. These funds are more or less insulated from changes in the interest
rate in the economy and capture the current yields prevailing in the market.
15. Fund of Funds: Fund of Funds (FoF) as the name suggests are schemes which invest in
other mutual fund schemes. The concept is popular in markets where there are number
of mutual fund offerings and choosing a suitable scheme according to one’s objective is
tough. Just as a mutual fund scheme invests in a portfolio of securities such as equity, debt
etc, the underlying investments for a FoF is the units of other mutual fund schemes, either
from the same fund family or from other fund houses.
16. Capital Protection Oriented Fund: The term ‘capital protection oriented scheme’ means
a mutual fund scheme which is designated as such and which endeavours to protect the
capital invested therein through suitable orientation of its portfolio structure.
The orientation towards protection of capital originates from the portfolio structure of the
scheme and not from any bank guarantee, insurance cover etc. SEBI stipulations require
these types of schemes to be close-ended in nature, listed on the stock exchange and the
intended portfolio structure would have to be mandatory rated by a credit rating agency.
A typical portfolio structure could be to set aside major portion of the assets for capital
safety and could be invested in highly rated debt instruments. The remaining portion would
be invested in equity or equity related instruments to provide capital appreciation. Capital
Protection Oriented schemes are a recent entrant in the Indian capital markets and should
not be confused with ‘capital guaranteed’ schemes.

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17. Gold Funds: The objective of these funds is to track the performance of Gold. The units
represent the value of gold or gold related instruments held in the scheme. Gold Funds
which are generally in the form of an Exchange Traded Fund (ETF) are listed on the stock
exchange and offers investors an opportunity to participate in the bullion market without
having to take physical delivery of gold.
18. Equity Diversified Funds: A Diversified funds is a fund that contains a wide array of stocks.
The fund manager of a diversified fund ensures a high level of diversification in its holdings,
thereby reducing the amount of risk in the fund.
a. Flexicap/ Multicap Fund: These are by definition, diversified funds. The only difference
is that unlike a normal diversified fund, the offer document of a multi-cap/flexi-cap
fund generally spells out the limits for minimum and maximum exposure to each of
the market caps.
b. Contra fund: A contra fund invests in those out-of-favour companies that have
unrecognised value. It is ideally suited for investors who want to invest in a fund that
has the potential to perform in all types of market environments as it blends together
both growth and value opportunities. Investors who invest in contra funds have an
aggressive risk appetite.
c. Index fund: An index fund seeks to track the performance of a benchmark market
index like the BSE Sensex or S&P CNX Nifty. Simply put, the fund maintains the portfolio
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of all the securities in the same proportion as stated in the benchmark index and earns
the same return as earned by the market.
d. Dividend Yield fund: A dividend yield fund invests in shares of companies having high
dividend yields. Dividend yield is defined as dividend per share dividend by the share’s
market price. Most of these funds invest in stocks of companies having a dividend yield
higher than the dividend yield of a particular index, i.e., Sensex or Nifty. The prices of
dividend yielding stocks are generally less volatile than growth stocks. Besides, they
also offer the potential to appreciate.
Dividend yield schemes are of two types:
• Dividend Payout Option: Dividends are paid out to the unit holders under this option.
However, the NAV of the units falls to the extent of the dividend paid out and applicable
statutory levies.
• Dividend Re-investment Option: The dividend that accrues on units under option is
reinvested back into the scheme at ex-dividend NAV. Hence investors receive additional
units on their investments in lieu of dividends.
19. Equity Linked Tax Savings Scheme: ELSS is one of the options for investors to save
taxes under Section 80 C of the Income Tax Act. They also offer the perfect way to participate
in the growth of the capital market, having a lock-in-period of three years. Besides, ELSS has
the potential to give better returns than any traditional tax savings instrument. Moreover,
by investing in an ELSS through a Systematic Investment Plan (SIP), one can not only avoid
the problem of investing a lump sum towards the end of the year but also take advantage
of “averaging”.
20. Sector Funds: These funds are highly focused on a particular industry. The basic objective is
to enable investors to take advantage of industry cycles. Since sector funds ride on market
cycles, they have the potential to offer good returns if the timing is perfect. However, they
are bereft of downside risk protection as available in diversified funds. Sector funds should

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constitute only a limited portion of one’s portfolio, as they are much riskier than a diversified
fund. Besides, only those who have an existing portfolio should consider investing in these
funds.
For example, Real Estate Mutual Funds invest in real estate properties and earn income in
the form of rentals, capital appreciation from developed properties. Also some part of the
fund corpus is invested in equity shares or debentures of companies engaged in real estate
assets or developing real estate development projects. REMFs are required to be close-
ended in nature and listed on a stock exchange.
21. Thematic Funds: A Thematic fund focuses on trends that are likely to result in the
‘outperformance’ by certain sectors or companies. In other words, the key factors are
those that can make a difference to business profitability and market values. However, the
downside is that the market may take a longer time to recognize views of the fund house
with regards to a particular theme, which forms the basis of launching a fund.
22. Arbitrage Funds: Typically these funds promise safety of deposits, but better returns,
tax benefits and greater liquidity. Pru-ICICI is the latest to join the list with its equities and
derivatives funds.
The open ended equity scheme aims to generate low volatility returns by inverting in a
mix of cash equities, equity derivatives and debt markets. The fund seeks to provide better
returns than typical debt instruments and lower volatility in comparison to equity.
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This fund is aimed at an investor who seeks the return of small savings instruments, safety of
bank deposits, tax benefits of RBI relief bonds and liquidity of a mutual fund.
Arbitrage fund finally seeks to capitalize on the price differentials between the spot and the
futures market.
The other schemes in the arbitrage universe are Benchmark Derivative, JM Equity and
Derivatives, Prudential ICICI Balanced, UTI Spread and Prudential ICICI Equity and Derivatives.
23. Hedge Fund: A hedge fund (there are no hedge funds in India) is a lightly regulated
investment fund that escapes most regulations by being a sort of a private investment
vehicle being offered to selected clients.
The big difference between a hedge fund and a mutual fund is that the former does not
reveal any thing about its operations publicly and charges a performance fee. Typically, if
it out performs a benchmark, it take a cut off the profits. Of course, this is a one way street,
any losses are borne by the investors themselves. Hedge funds are aggressively managed
portfolio of investments which use advanced investment strategies such as leveraged, long,
short and derivative positions in both domestic and international markets with the goal of
generating high returns (either in an absolute sense or over a specified market benchmark).
It is important to note that hedging is actually the practice of attempting to reduce risk, but
the goal of most hedge funds is to maximize return on investment.
24. Cash Fund: Cash Fund is an open ended liquid scheme that aims to generate returns
with lower volatility and higher liquidity through a portfolio of debt and money market
instrument.
The fund will have retail institutional and super institutional plans. Each plan will offer
growth and dividend options. The minimum initial investment for the institutional plan is
` 1 crore and the super institutional is ` 25 crore. For the retail plan, the minimum initial
investment is ` 5,000/-. The fund has no entry or exit loads. Investors can invest even

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through the Systematic Investment Planning (SIP) route with a minimum amount of ` 500
per instalment with the total of all instalments not being less than ` 5,000/-.
25. Exchange Traded Funds: An Exchange Traded Fund (ETF) is a hybrid product that combines
the features of an index fund. These funds are listed on the stock exchanges and their prices
are linked to the underlying index. The authorized participants act as market makers for
ETFs.
ETFs can be bought and sold like any other stock on an exchange. In other words, ETFs can
be bought or sold any time during the market hours at prices that a re expected to be closer
to the NAV at the end of the day.
Therefore, one can invest at real time prices as against the end of the day prices as is the
case with open-ended schemes. There is no paper work involved for investing in an ETF.
These can be bought like any other stock by just placing an order with a broker. ETFs may be
attractive as investments because of their low costs, tax efficiency, and stock-like features.
An ETF combines the valuation feature of a mutual fund or unit investment trust, which can
be bought or sold at the end of each trading day for its net asset value, with the tradability
feature of a closed-end fund, which trades throughout the trading day at prices that may be
more or less than its net asset value.
Following types of ETF products are available in the market:

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• Index ETFs - Most ETFs are index funds that hold securities and attempt to replicate the
performance of a stock market index.
• Commodity ETFs - Commodity ETFs invest in commodities, such as precious metals
and futures.
• Bond ETFs - Exchange-traded funds that invest in bonds are known as bond ETFs. They
thrive during economic recessions because investors pull their money out of the stock
market and into bonds (for example, government treasury bonds or those issues by
companies regarded as financially stable). Because of this cause and effect relationship,
the performance of bond ETFs may be indicative of broader economic conditions.
• Currency ETFs - The funds are total return products where the investor gets access to
the FX spot change, local institutional interest rates and a collateral yield.
3. Key Players in Mutual Funds
Mutual Fund is formed by a trust body. The business is set up by the sponsor, the money invested
by the asset management company and the operations monitored by the trustee. There are
five principal constituents and three market intermediaries in the formation and functioning of
mutual fund.
The five constituents are:
a. Sponsor: A company established under the Companies Act forms a mutual fund.
b. Asset Management Company: An entity registered under the Companies Act to manage
the money invested in the mutual fund and to operate the schemes of the mutual fund as
per regulations. It carries the responsibility of investing and managing the investors’ money.
Professional money managers are appointed by the asset management company to take
care that the investor’s corpus are invested in profitable securities based on the risk appetite
of the investors and according to the mutual fund scheme. The AMC typically has three
departments viz. (a) Fund Management (b) Sales & marketing (c) Operations & Accounting.

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c. Trustee: The trust is headed by Board of Trustees. The trustee holds the property of the
mutual fund in trust for the benefit of unit holders and looks into the legal requirements of
operating and functioning of the mutual fund. The trustee may also form a limited company
under the Companies Act in some situations. The trustees have the duty to monitor the
actions of the AMC to ensure compliance with the SEBI regulations and to see that the
decisions of the AMC are not against the interests of the unit holders.
d. Unit Holder: A person/entity holding an undivided share in the assets of a mutual fund
scheme.
e. Mutual Fund: A mutual fund established under the Indian Trust Act to raise money through
the sale of units to the public for investing in the capital market. The funds thus collected
are passed on to the Asset Management Company for investment. The mutual fund has to
be registered with SEBI.
The three market intermediaries are: (a) Custodian; (b) Transfer Agents; (c) Depository.
(a) Custodian: A custodian is a person who has been granted a Certificate of Registration
to conduct the business of custodial services under the SEBI (Custodian of Securities)
Regulations 1996. Custodial services include safeguarding clients’ securities along with
incidental services provided. Maintenance of accounts of clients’ securities together with
the collection of benefits / rights accruing to a client falls within the purview of custodial
service. Mutual funds require custodians so that AMC can concentrate on areas such as
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investment and management of money.
(b) Transfer Agents: A transfer agent is a person who has been granted a Certificate of
Registration to conduct the business of transfer agent under SEBI (Registrars to an Issue
and Share Transfer Agents) Regulations Act 1993. Transfer agents’ services include issue and
redemption of mutual fund units, preparation of transfer documents and maintenance of
updated investment records. They also record transfer of units between investors where
depository does not function.
(c) Depository: Under the Depositories 1996, a depository is body corporate who carries out
the transfer of units to the unit holder in dematerialised form and maintains records thereof.
4. Advantages of Mutual Fund
(a) Professional Management: The funds are managed by skilled and professionally
experienced managers with a back up of a Research team.
(b) Diversification: Mutual Funds offer diversification in portfolio which reduces the risk.
(c) Convenient Administration: There are no administrative risks of share transfer, as many of
the Mutual Funds offer services in a demat form which save investor’s time and delay.
(d) Higher Returns: Over a medium to long-term investment, investors always get higher
returns in Mutual Funds as compared to other avenues of investment. This is already seen
from excellent returns, Mutual Funds have provided in the last few years. However, investors
are cautioned that such high returns riding on the IT boom should not be taken as regular
returns and therefore one should look at the average returns provided by the Mutual Funds
particularly in the equity schemes during the last couple of years.
(e) Low Cost of Management: No Mutual Fund can increase the cost beyond prescribed limits
of 2.5% maximum and any extra cost of management is to be borne by the AMC.

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(f) Liquidity: In all the open ended funds, liquidity is provided by direct sales / repurchase by
the Mutual Fund and in case of close ended funds, the liquidity is provided by listing the
units on the Stock Exchange.
(g) Transparency: The SEBI Regulations now compel all the Mutual Funds to disclose their
portfolios on a half-yearly basis. However, many Mutual Funds disclose this on a quarterly
or monthly basis to their investors. The NAVs are calculated on a daily basis in case of open
ended funds and are now published through AMFI in the newspapers.
(h) Other Benefits: Mutual Funds provide regular withdrawal and systematic investment plans
according to the need of the investors. The investors can also switch from one scheme to
another without any load.
(i) Highly Regulated: Mutual Funds all over the world are highly regulated and in India all
Mutual Funds are registered with SEBI and are strictly regulated as per the Mutual Fund
Regulations which provide excellent investor protection.
(j) Economies of scale: The way mutual funds are structured gives it a natural advantage. The
“pooled” money from a number of investors ensures that mutual funds enjoy economies
of scale; it is cheaper compared to investing directly in the capital markets which involves
higher charges. This also allows retail investors access to high entry level markets like real
estate, and also there is a greater control over costs.

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(k) Flexibility: There are a lot of features in a regular mutual fund scheme, which imparts
flexibility to the scheme. An investor can opt for Systematic Investment Plan (SIP), Systematic
Withdrawal Plan etc. to plan his cash flow requirements as per his convenience. The wide
range of schemes being launched in India by different mutual funds also provides an added
flexibility to the investor to plan his portfolio accordingly.
5. Drawbacks of Mutual Fund
(a) No guarantee of Return – There are three issues involved:
(i) All Mutual Funds cannot be winners. There may be some who may under perform the
benchmark index i.e. it may not even perform well as a novice who invests in the stocks
constituting the index.
(ii) A mutual fund may perform better than the stock market but this does not necessarily
lead to a gain for the investor. The market may have risen and the mutual fund scheme
increased in value but the investor would have got the same increase had he invested
in risk free investments than in mutual fund.
(iii) Investors may forgive if the return is not adequate. But they will not do so if the principal
is eroded. Mutual Fund investment may depreciate in value.
(b) Diversification – A mutual fund helps to create a diversified portfolio. Though diversification
minimises risk, it does not ensure maximizing returns. The returns that mutual funds offer
are less than what an investor can achieve. For example, if a single security held by a mutual
fund doubles in value, the mutual fund itself would not double in value because that
security is only one small part of the fund’s holdings. By holding a large number of different
investments, mutual funds tend to do neither exceptionally well nor exceptionally poorly.
(c) Selection of Proper Fund – It may be easier to select the right share rather than the right
fund. For stocks, one can base his selection on the parameters of economic, industry and
company analysis. In case of mutual funds, past performance is the only criteria to fall back
upon. But past cannot predict the future.

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(d) Cost Factor – Mutual Funds carry a price tag. Fund Managers are the highest paid executives.
While investing, one has to pay for entry load and when leaving he has to pay for exit load.
Such costs reduce the return from mutual fund. The fees paid to the Asset Management
Company is in no way related to performance.
(e) Unethical Practices – Mutual Funds may not play a fair game. Each scheme may sell some
of the holdings to its sister concerns for substantive notional gains and posting NAVs in a
formalized manner.
(f) Taxes – When making decisions about your money, fund managers do not consider your
personal tax situations. For example when a fund manager sells a security, a capital gain
tax is triggered, which affects how profitable the individual is from sale. It might have been
more profitable for the individual to defer the capital gain liability.
(g) Transfer Difficulties – Complications arise with mutual funds when a managed portfolio
is switched to a different financial firm. Sometimes the mutual fund positions have to be
closed out before a transfer can happen. This can be a major problem for investors.
Liquidating a mutual fund portfolio may increase risk, increase fees and commissions, and create
capital gains taxes.
6. Factors Influencing the Selection of Mutual Funds
(1) Past Performance – The Net Asset Value is the yardstick for evaluating a Mutual Fund.
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The higher the NAV, the better it is. Performance is based on the growth of NAV during the
referral period after taking into consideration Dividend paid. Growth = (NAV1 – NAV0 ) + D1
/ NAV0.
(2) Timing – The timing when the mutual fund is raising money from the market is vital. In a
bullish market, investment in mutual fund falls significantly in value whereas in a bearish
market, it is the other way round where it registers growth. The turns in the market need to
be observed.
(3) Size of Fund – Managing a small sized fund and managing a large sized fund is not the
same as it is not dependent on the product of numbers. Purchase through large sized fund
may by itself push prices up while sale may push prices down, as large funds get squeezed
both ways. So it is better to remain with medium sized funds.
(4) Age of Fund – Longevity of the fund in business needs to be determined and its performance
in rising, falling and steady markets have to be checked. Pedigree does not always matter as
also success strategies in foreign markets.
(5) Largest Holding – It is important to note where the largest holdings in mutual fund have
been invested.
(6) Fund Manager – One should have an idea of the person handling the fund management. A
person of repute gives confidence to the investors.
(7) Expense Ratio – SEBI has laid down the upper ceiling for Expense Ratio. A lower Expense
Ratio will give a higher return which is better for an investor.
(8) PE Ratio – The ratio indicates the weighted average PE Ratio of the stocks that constitute
the fund portfolio with weights being given to the market value of holdings. It helps to
identify the risk levels in which the mutual fund operates.
(9) Portfolio Turnover – The fund manager decides as to when he should enter or quit the
market. A very low portfolio turnover indicates that he is neither entering nor quitting the

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market very frequently. A high ratio, on the other hand, may suggest that too frequent
moves have lead the fund manager to miss out on the next big wave of investments. A
simple average of the portfolio turnover ratio of peer group updated by mutual fund
tracking agencies may serve as a benchmark. The ratio is lower of annual purchase plus
annual sale to average value of the portfolio.
7. Signals Highlighting the Exit of the Investor from the Mutual Fund
Scheme
(1) When the mutual fund consistently under performs the broad based index, it is high time
that it should get out of the scheme. It would be better to invest in the index itself either by
investing in the constituents of the index or by buying into an index fund.
(2) When the mutual fund consistently under performs its peer group instead of it being at
the top. In such a case, it would have to pay to get out of the scheme and then invest in the
winning schemes.
(3) When the mutual fund changes its objectives e.g. instead of providing a regular income to
the investor, the composition of the portfolio has changed to a growth fund mode which is
not in tune with the investor’s risk preferences.
(4) When the investor changes his objective of investing in a mutual fund which no longer is
beneficial to him.
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(5) When the fund manager, handling the mutual fund schemes, has been replaced by a new
entrant whose image is not known.
8. Unit linked insurance plan vs Mutual fund
ULIP Mutual Fund
With insurance policy No insurance
Tax free Taxable
Low returns High returns
Low transparency High transparency
High cost of management Low cost of management
No switching Switching

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Q 1 Ex. Book No. Pg. No.

Based on the following data, estimate the Net Asset Value (NAV) on per unit basis of a Regular Income
Scheme of a Mutual Fund:

` (in lakhs)
Listed Equity shares at cost (ex-dividend) 40.00
Cash in hand 2.76
Bonds & Debentures at cost 8.96
- of these, Bonds not listed and not quoted 2.50
Other fixed interest securities at cost 9.75
Dividend accrued 1.95
Amount payable on shares 13.54
Expenditure accrued 1.76

Current realizable value of fixed income securities of face value of ` 100 is ` 96.50.
Number of Units ( 10 face value each): 2,75,000
`
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All the listed equity shares were purchased at a time when market portfolio index was 12,500.
On NAV date, the market portfolio index is at 19,975.
There has been a diminution of 15% in unlisted bonds and debentures valuation.
Listed bonds and debentures carry a market value of ` 7.5 lakhs, on NAV date.
Operating expenses paid during the year amounted to ` 2.24 lakhs.

Reference What’s New

NAV Computation

Q 2 Ex. Book No. Pg. No.

Following information is related to XYZ Regular Income Fund:

Particulars ` Crores
Listed shares at Cost (ex-dividend) 20
Cash in hand 1 23
Bonds and debentures at cost 4.3
Of these, bonds not listed and quoted 1

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Other fixed interest securities at cost 4.5

Dividend accrued 0.8
Amount payable on shares 6.32
Expenditure accrued 0.75
Number of units (` 10 face value) 20 lacs
Current realizable value of fixed income securities of face value of ` 100 106.5
The listed shares were purchased when Index was 1,000
Present index is 2,300
Value of listed bonds and debentures at NAV date 8

CALCULATE the NAV of scheme on per unit basis if there has been a diminution of 20% in unlisted
bonds and debentures and Other fixed interest securities are valued at cost.

Reference What’s New

NAV Computation

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Q 3 Ex. Book No. Pg. No.

Cinderella Mutual Fund has the following assets in Scheme Rudolf at the close of business on 31st
March, 2014.

Company No. of Shares Market Price Per Share

Nairobi Ltd. 25000 ` 20
Dakar Ltd. 35000 ` 300
Senegal Ltd. 29000 ` 380
Cairo Ltd. 40000 ` 500

The total number of units of Scheme Rudol are 10 lacs. The Scheme Rudolf has accrued expenses of `
2,50,000 and other liabilities of ` 2,00,000.
CALCULATE the NAV per unit of the Scheme Rudolf.

Reference What’s New

NAV Computation

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Q 4 Ex. Book No. Pg. No.

A mutual fund that had a net asset value of ` 20 at the beginning of month - made income and capital
gain distribution of Re. 0.0375 and Re. 0.03 per share respectively during the month, and then ended
the month with a net asset value of ` 20.06. Calculate monthly return.

Reference What’s New

Computation of HPR

Q 5 Ex. Book No. Pg. No.

A mutual fund that had a net asset value of ` 16 at the beginning of a month, made income and cap-
ital gain distribution of ` 0.04 and ` 0.03 respectively per unit during the month, and then ended the
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month with a net asset value of ` 16.08. Calculate monthly and annual rate of return.

Reference What’s New

Computation of HPR

Q 6 Ex. Book No. Pg. No.

An investor purchased 300 units of a Mutual Fund at ` 12.25 per unit on 31st December, 2017. As on
31st December, 2018 he has received ` 1.25 as dividend and ` 1.00 as capital gains distribution per
unit.
Required :
(i) The return on the investment if the NAV as on 31st December, 2018 is ` 13.00.
(ii) The return on the investment as on 31st December, 2018 if all dividends and capital gains
distributions are reinvested into additional units of the fund at ` 12.50 per unit.

Reference What’s New

Computation of HPR when dividends and

capital gains are reinvested

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Q 7 Ex. Book No. Pg. No.

Orange purchased 200 units of Oxygen Mutual Fund at ` 45 per unit on 31st December, 2017. In 2018,
he received ` 1.00 as dividend per unit and a capital gains distribution of ` 2 per unit.
Required:
(i) Calculate the return for the period of one year assuming that the NAV as on 31st December 2018
was ` 48 per unit.
(ii) Calculate the return for the period of one year assuming that the NAV as on 31st December 2018
was ` 48 per unit and all dividends and capital gains distributions have been reinvested at an
average price of ` 46.00 per unit. Ignore taxation.

Reference What’s New

Computation of HPR when dividends and

capital gains are reinvested

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Q 8 Ex. Book No. Pg. No.

On 1-4-2018 ABC Mutual Fund issued 20 lakh units at ` 10 per unit. Relevant initial expenses involved
were ` 12 lakhs. It invested the fund so raised in capital market instruments to build a portfolio of ` 185
lakhs. During the month of April 2018 it disposed off some of the instruments costing ` 60 lakhs for `
63 lakhs and used the proceeds in purchasing securities for ` 56 lakhs. Fund management expenses
for the month of April 2018 was ` 8 lakhs of which 10% was in arrears. In April 2018 the fund earned
dividends amounting to ` 2 lakhs and it distributed 80% of the realized earnings. On 30-4-2018 the
market value of the portfolio was ` 198 lakhs.
Mr. Akash, an investor, subscribed to 100 units on 1-4-2018 and disposed off the same at closing NAV
on 30-4-2018. What was his annual rate of earning?

Reference What’s New

Effective Yield to the Investor earning to

the Investor

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Chapter 3
Merger and Acquisitions

MERGERS AND ACQUISITIONS

PART A – BASIC CONCEPTS 1. Merger, acquisition, amalgamation and reconstruction

2. Different Types of Mergers
3. Rationale or Benefits of Merger
4. Takeover and Defense Strategies
5. Process of Acquisition
6. Participants in the Merger and Acquisition Process

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PART B – FINANCIAL EVALU- 1. Application of Valuation Models for Business Mergers
and Acquisitions
ATION OF MERGER
2. Synergistic Benefits and Distribution of Synergy Gains
3. Selection of Appropriate Cost of Capital for Valuation
4. Determination of Exchange Ratio (Swap) or Purchase
Consideration
5. Forms of Consideration and terms of Acquisitions
6. Impact of Merger on Value of Share.
7. Various Calculations
8. Wealth Distribution Effect from Equity to Debt holders
9. Conn and Neilson Effect

PART C – DEMERGER

PART D - RESTRUCTURING

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APPLICATION OF VALUATION MODELS FOR BUSINESS MERGERS AND ACQUISITIONS

Investors in a company that are aiming to take over another one must determine whether the pur-
chase will be beneficial to them. In order to do so, they must ask themselves how much the company
being acquired is really worth.
Naturally, both sides of an M&A deal will have different ideas about the worth of a target company: its
seller will tend to value the company at as high of a price as possible, while the buyer will try to get
the lowest price that he can.
There are, however, many legitimate ways to value companies. The most common method is to look at
comparable companies in an industry, but deal makers employ a variety of other methods and tools
when assessing a target company. Here are just a few of them:
1. Comparative Ratios - The following are two examples of the many comparative metrics on
which acquiring companies may base their offers:
• Price-Earnings Ratio (P/E Ratio) - With the use of this ratio, an acquiring company makes an
offer that is a multiple of the earnings of the target company. Looking at the P/E for all the
stocks within the same industry group will give the acquiring company good guidance for
what the target’s P/E multiple should be.
• Enterprise-Value-to-Sales Ratio (EV/Sales) - With this ratio, the acquiring company makes
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an offer as a multiple of the revenues, again, while being aware of the price-to-sales ratio of
other companies in the industry.
2. Replacement Cost - In a few cases, acquisitions are based on the cost of replacing the target
company. For simplicity’s sake, suppose the value of a company is simply the sum of all its
equipment and staffing costs. The acquiring company can literally order the target to sell at that
price, or it will create a competitor for the same cost. Naturally, it takes a long time to assemble
good management, acquire property and get the right equipment. This method of establishing
a price certainly wouldn’t make much sense in a service industry where the key assets - people
and ideas - are hard to value and develop.
3. Discounted Cash Flow (DCF) - A key valuation tool in M&A, discounted cash flow analysis
determines a company’s current value according to its estimated future cash flows. Forecasted
free cash flows (net income + depreciation/amortization - capital expenditures - change in
working capital) are discounted to a present value using the company’s weighted average costs
of capital (WACC). Admittedly, DCF is tricky to get right, but few tools can rival this valuation
method.
Synergy: The Premium for Potential Success
For the most part, acquiring companies nearly always pay a substantial premium on the stock market
value of the companies they buy. The justification for doing so nearly always boils down to the notion
of synergy; a merger benefits shareholders when a company’s post-merger share price increases by
the value of potential synergy.
Let’s face it; it would be highly unlikely for rational owners to sell if they would benefit more by not
selling. That means buyers will need to pay a premium if they hope to acquire the company, regardless
of what pre-merger valuation tells them. For sellers, that premium represents their company’s future
prospects. For buyers, the premium represents part of the post-merger synergy they expect can be
achieved. The following equation offers a good way to think about synergy and how to determine
whether a deal makes sense. The equation solves for the minimum required synergy:

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Post Merger Stock Price = (Pre Merger Value of Firms + Synergy) / Post Merger Number of shares
In other words, the success of a merger is measured by whether the value of the buyer is enhanced by
the action. However, the practical constraints of mergers, which we discuss in part five, often prevent
the expected benefits from being fully achieved. Alas, the synergy promised by deal makers might
just fall short
SELECTION OF APPROPRIATE COST OF CAPITAL FOR VALUATION
Capital Asset Pricing Model:
The most widely used method in calculating the cost of equity is the capital asset pricing model
(CAPM). In CAPM, the required return on equity is a risk-free return plus a risk component.
Cost of equity = Risk-free rate + market price of risk x beta
The Dividend Growth Model:
Cost of equity = Expected Dividend yield + expected growth rate.
Bond Yield Plus Equity Risk Adjustment:
Cost of equity = Bond yield + spread over bond yields.

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Cost of Debt:
Cost of debt should be on after-tax basis, as interest is tax deductible. Therefore, the cost of debt is
given by:
The after-tax cost of DEBT = Kd (1 – T) Where T = Tax rate.
Weighted Average Cost of Capital:
The financial proportions of debt and equity are used as guide.
DETERMINATION OF EXCHANGE RATIO (SWAP) OR PURCHASE CONSIDERATION
Commonly used bases to compute the Exchange Ratio

Aspect Earnings Per share (EPS) Market Price per share (MPS) Book Value per share (BVS)

EPS of Selling Co. MPS of Selling Co. BVS of Selling Co.

Computation = = =
EPS of Buying Co. MPS of Buying Co. BVS of Buying Co.

Suitability When there are no dif- When the shares of the If accounting policies are
ferential risks associated acquiring and the target to be reflected in the de-
with the two companies Firm are actively traded termination of Exchange
entering into Merger. in the market Ratio.
Demerits 1. Difference in growth 1. When the trading is Exchange ratio deter-
rate of earnings of two thin, market prices may mined under this method
companies will not be not be a reliable measure. does not reflect the pur-
highlighted. chasing power of money,
and are highly different
from true economic
values.

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2. Gains in earnings aris- 2. Market prices may be

ing out of merger are not manipulated by vested
considered to determine interest and the Ex-
Exchange Ratio. change Ratio determined
may not reflect the true
position.
FORMS OF CONSIDERATION AND TERMS OF ACQUISITION
Methods of Payment:
The two main methods of financing an acquisition are cash and share exchange.
(1) Cash: This method is generally considered suitable for relatively small acquisitions. It has two
advantages: (i) the buyer retains total control as the shareholders in the selling company are
completely bought out, and (ii) the value of the bid is known and the process is simple.
(2) Share Exchange
The method of payment in large transactions is predominantly stock for stock. The advantage of this
method is that the acquirer does not part with cash and does not increase the financial risk by raising
new debt. The disadvantage is that the acquirer’s shareholders will have to share future prosperity
with those of the acquired company and also loses the benefits from tax shield on interest which it
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would have derived.
Such settlement of an acquisition transaction through equity share of the acquirer is also technically
called as ‘Equity as the Currency of the Deal’
IMPACT OF MERGER ON VALUE OF SHARES - Shareholder Value Analysis (SVA)
Shareholder Value Analysis (SVA) focuses on the creation of economic value for Shareholders, as meas-
ured by share price performance and flow of funds.
Shareholder Value is used to link management strategy and decision to the creating of value for share-
holders.
Value Drivers: Factors or value Drivers which influence the Shareholder’s Value are identified. Exam-
ple: Growth in Sales, profit Margin, Capital Investments Decisions, etc.
Management Responsibilities: Management should pay attention to Value drivers, while taking in-
vestment and finance decisions.
Benefits
(a) SVA helps the management to concentrate on activities which create value to the shareholders
rather than on short- term profitability.
(b) SVA and EVA together helps to strengthen the competitive position of the Firm, by focusing on
wealth creation.
(c) They provide an objective and consistent framework of evaluation and decision- making across
all function, departments and units of the Company.

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Different Calculations:
1. Valuation of Shares of Target Company using valuation models -
2. Minimum and Maximum Share Prices for acquisition –
a. Minimum Price = Higher of - (i) pre merger price/ valued share price
(ii) Net worth per share
b. Maximum Price = (Present value of Target Company + Synergy ) / No. of Shares
3. Purchase Price Premium = Offer Price given to Target Co. / Pre merger MPS of Target Co.
4. Exchange or Swap Ratio =
a. Based on MPS
b. Based on EPS
c. Based on IVPS
d. Such that MPS or PE Ratio of Acquiring company remains same after merger
e. Such that EPS of Target Company remains same after merger
f. As Weighted average of several factors

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g. Based on EBITDA
5. No. of shares to be issued to Target Company
6. Post Merger EPS of the Merged Co.
7. Post Merger Equivalent EPS of Target Co.
8. Post Merger Market Value of Merged Co.
9. Post Merger MPS of Merged Co. by assuming same PE Ratio or given PE Ratio
10. Post Merger PE Ratio
11. Net Gain or Loss to both the companies after merger
12. Post Merger Equity Ownership Distribution or Equity Holding %
13. Value of Acquisition to Acquiring Company= Net Gain to Merged Company = Post Merger
value – Pre Merger value
14. True Cost of Merger to Acquiring Company = Net Gain to Merged Company

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Q 1 Ex. Book No. Pg. No.

ABC Ltd. run and managed by an efficient team that insists on reinvesting 60% of its earnings in pro-
jects that provide an ROE (return of equity) of 10%, despite the fact that the firm’s capitalization rate
(K) is 15%. The firm’s current year’s earning is ` 10 per share.
At what price the stock of ABC Ltd. sell? What is the present value of growth opportunities? Why would
such a firm be a takeover target?

Reference What’s New

Method of Valuation Market Price and Dividend

Growth Model

Q 2 Ex. Book No. Pg. No.

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ABC Company is considering acquisition of XYZ Ltd. which has 1.5 crores shares outstanding and
issued. The market price per share is ` 400 at present. ABC’s average cost of capital is 12%. Available
information from XYZ indicates its expected cash accruals for the next 3 years as follows:

Year (`) Cr.

1 250
2 300
3 400

Calculate the range of valuation that ABC has to consider.

(PV factors at 12% for years 1 to 3 respectively: 0.893, 0.797 and 0.712).

Reference What’s New

Method of Valuation Market Price and Discounted

Cash Flows

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Q 3 Ex. Book No. Pg. No.

Firm A Plans to acquire firm B. Following information is available.

Particulars Firm A Firm B

No. of Shares 20 lakhs 10 lakhs
EPS 12 8
PAT ` 240 lakhs ` 80 lakhs
PE Ratio 30 times 15 times
MPS ` 360 ` 120
Market Capitalisation ` 7,200 lakhs ` 1,200 lakhs
Investment bankers have estimated the Present value of synergy as ` 500 lakhs.
You are required to determine –
1. Minimum price required by shareholders of Firm B
2. Maximum Price that Firm A can pay to Firm B

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3. If purchase consideration of 1,400 lakhs is fixed in cash then find –
`
(a) Net gain to share holders of Firm A
(b) Net Gain to shareholders of Firm B
(c) True cost of acquisition to Firm A

Reference What’s New

Various Calculations with Synergy

Q 4 Ex. Book No. Pg. No.

The following information is provided in relation to the acquiring firm Mark limited and the target
Mask Limited

Particulars Firm Mark Limited Firm Mask Limited

Earnings after tax (` ) 200 lacs 40 lacs
Number of shares outstanding 20 lacs 10 lacs
P/E ratio 10 5
Required:
(i) What is the swap ratio in terms of current market prices?
(ii) What is the EPS of Mark Limited after acquisition?

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(iii) What is the expected market price per share of Mark Limited after acquisition assuming that P/E
ratio of Mark limited remains unchanged?
(iv) Determine the market value of the merged firm.
(v) Calculate gain/loss for shareholders of the two independent companies after acquisition.

Reference What’s New

Various Calculations

Q 5 Ex. Book No. Pg. No.

Acquiring company is considering the acquisition of Target Company in a stock- for- stock transaction
in which target Company would receive ` 90 for each share of its common stock. The Acquiring com-
pany does not expect any change in its price/ earnings ratio multiple after the merger and chooses to
value the target company conservatively by assuming no earnings growth due to synergy.
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The following additional information is available.

Particulars Acquiring Target

Earnings ` 2,50,000 ` 72,500
Number of shares 1,10,000 20,000
Market Price per Share ` 50 ` 60

Calculate:
(i) The purchase price premium
(ii) The exchange ratio based on MPS
(iii) The number of new shares issued by the acquiring company
(iv) Post-merger EPS of the combined firms
(v) Pre-merger EPS of the Acquiring company
(vi) Pre-merger P/E ratio
(vii) Post-merger share price
(viii) Post-merger equity ownership distribution.

Reference What’s New

Various Calculations

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Q 6 Ex. Book No. Pg. No.

Company X is contemplating the purchase of Company Y, Company X has 3,00,000 shares having a
market price of ` 30 per share, while Company Y has 2,00,000 shares selling at ` 20 per share. The EPS
are ` 4.00 and ` 2.25 for Company X and Y respectively. Managements of both companies are discuss-
ing two alternative proposals for exchange of shares as indicated below:
(i) in proportion to the relative earnings per share of two companies.
(ii) 0.5 share of Company X for one share of Company Y (0.5:1).
You are required:
(i) to calculate the Earnings Per share (EPS) after merger under two alternatives; and
(ii) to show the impact of merger on EPS for the shareholders of two companies under both the
alternatives.

Reference What’s New

Various Calculations

[email protected],8420517209

Q 7 Ex. Book No. Pg. No.

A Ltd. is studying the possible acquisition of B Ltd. by way of merger. The following data are available:

Firm After-tax earnings No. of equity shares Market price per share
A Ltd. ` 10,00,000 2,00,000 ` 75
B Ltd. ` 3,00,000 50,000 ` 60
(i) If the merger goes through by exchange of equity shares and the exchange ratio is set according
to the current market prices, what is the new earnings per share for A Ltd ?
(ii) B Ltd. wants to be sure that its earning per share is not diminished by the merger. What exchange
ratio is relevant to achieve the objective?

Reference What’s New

Various Calculations Exchange ratio to maintain

EPS of Target Co.

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Q 8 Ex. Book No. Pg. No.

B Ltd. is a highly successful company and wishes to expand by acquiring other firms. Its expected high
growth in earnings and dividends is reflected in its PE ratio of 17. The Board of Directors of B Ltd. has
been advised that if it were to take over firms with a lower PE ratio than it own, using a share-for-share
exchange, then it could increase its reported earnings per share. C Ltd. has been suggested as a pos-
sible target for a takeover, which has a PE ratio of 10 and 1,00,000 shares in issue with a share price of
` 15. B Ltd. has 5,00,000 shares in issue with a share price of ` 12.

Calculate the change in earnings per share of B Ltd. if it acquires the whole of C Ltd. by issuing shares
at its market price of ` 12. Assume the price of B Ltd. shares remains constant.

Reference What’s New

Post Merger EPS

[email protected],8420517209
Q 9 Ex. Book No. Pg. No.

The equity shares of XYZ Ltd. are currently being traded at ` 24 per share in the market. XYZ Ltd. has
total 10,00,000 equity shares outstanding in number; and promoters’ equity holding in the company
is 40%.
PQR Ltd. wishes to acquire XYZ Ltd. because of likely synergies. The estimated present value of these
synergies is ` 80,00,000. Further PQR feels that management of XYZ Ltd. has been over paid. With
better motivation, lower salaries and fewer perks for the top management, will lead to savings of `
4,00,000 p.a.
Top management with their families are promoters of XYZ Ltd. Present value of these savings would
add ` 30,00,000 in value to the acquisition.
Following additional information is available regarding PQR Ltd.:

Earnings per share `4

Total number of equity shares outstanding 15,00,000
Market price of equity share ` 40

Required:
(i). What is the maximum price per equity share which PQR Ltd. can offer to pay for XYZ Ltd.?
(ii) What is the minimum price per equity share at which the management of XYZ Ltd. will be willing
to offer their controlling interest?

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Reference What’s New

Range of Share Prices With Synergy effect and

Price for Controlling Interest
(Promoter’s holding)

Q 10 Ex. Book No. Pg. No.

Longitude Limited is in the process of acquiring Latitude Limited on a share exchange basis.
Following relevant data are available:

Longitude Latitude
Limited Limited
Profit after Tax (PAT) ` in Lakhs 140 60
Number of shares Lakhs 15 16
Earning per Share (EPS) – ` 8 5
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Price Earnings Ratio (P/E Ratio) (Ignore Synergy) 15 10

You are required to determine:

(i) Pre-merger Market Value per Share, and
(ii) The maximum exchange ratio Longitude Limited can offer without the dilution of
(1) EPS and
(2) Market Value per Share
Calculate Ratios up to four decimal points and amounts and number of shares up to two decimal
points.

Reference What’s New

Maximum Exchange ratio without any

dilution of Acquiring Co’s EPS and MPS

Q 11 Ex. Book No. Pg. No.

The CEO of a company thinks that shareholders always look for EPS. Therefore, he considers maximi-
zation of EPS as his company’s objective. His company’s current Net Profits are ` 80.00 lakhs and P/E
multiple is 10.5. He wants to buy another firm which has current income of ` 15.75 lakhs & P/E multiple
of 10.

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What is the maximum exchange ratio which the CEO should offer so that he could keep EPS at the
current level, given that the current market price of both the acquirer and the target company are `
42 and ` 105 respectively?
If the CEO borrows funds at 15% and buys out Target Company by paying cash, how much should he
offer to maintain his EPS? Assume tax rate of 30%.

Reference What’s New

Maximum exchange ratio

Q 12 Ex. Book No. Pg. No.

Teer Ltd. is considering acquisition of Nishana Ltd. CFO of Teer Ltd. is of opinion that Nishana Ltd. will
be able to generate operating cash flows (after deducting necessary capital expenditure) of ` 10 crore
per annum for 5 years.
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The following additional information was not considered in the above estimations.
(i) Office premises of Nishana Ltd. can be disposed of and its staff can be relocated in Teer Ltd’s office
not impacting the operating cash flows of either businesses. However, this action will generate
an immediate capital gain of ` 20 crore.
(ii) Synergy Gain of ` 2 crore per annum is expected to be accrued from the proposed acquisition.
(iii) Nishana Ltd. has outstanding Debentures having a market value of ` 15 crore. It has no other
debts.
(iv) It is also estimated that after 5 years if necessary, Nishana Ltd. can also be disposed of for an
amount equal to five times its operating annual cash flow.
Calculate the maximum price to be paid for Nishana Ltd. if cost of capital of Teer Ltd. is
20%. Ignore any type of taxation.

Reference What’s New

Maximum price of a share

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Q 13 Ex. Book No. Pg. No.

AFC Ltd. wishes to acquire BCD Ltd. The shares issued by the two companies are 10,00,000 and 5,00,000
respectively:
(i) Calculate the increase in the total value of BCD Ltd. resulting from the acquisition on the basis of
the following conditions:

Current expected growth rate of BCD Ltd. 7%

Expected growth rate under control of AFC Ltd., (without any additional capital 8%
investment and without any change in risk of operations)
Current Market price per share of AFC Ltd. ` 100
Current Market price per share of BCD Ltd. ` 20
Current Dividend per share of BCD Ltd. ` 0.60
(ii) On the basis of aforesaid conditions calculate the gain or loss to shareholders of both the
companies, if AFC Ltd. were to offer one of its shares for every four shares of BCD Ltd.
(iii) Calculate the gain to the shareholders of both the Companies, if AFC Ltd. pays ` 22 for each share
of BCD Ltd., assuming the P/E Ratio of AFC Ltd. does not change after the merger. EPS of AFC Ltd.
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is ` 8 and that of BCD is ` 2.50. It is assumed that AFC Ltd. invests its cash to earn 10%.

Reference What’s New

Net Gain to Shareholders under different

situations

Q 14 Ex. Book No. Pg. No.

P Ltd. is considering take-over of R Ltd. by the exchange of four new shares in P Ltd. for every five
shares in R Ltd. The relevant financial details of the two companies prior to merger announcement are
as follows:

P Ltd R Ltd
Profit before Tax (` Crore) 15 13.50
No. of Shares (Crore) 25 15
P/E Ratio 12 9

Corporate Tax Rate 30%

You are required to determine:
(i) Market value of both the company.
(ii) Value of original shareholders.
(iii) Price per share after merger.

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(iv) Effect on share price of both the company if the Directors of P Ltd. expect their own pre-merger
P/E ratio to be applied to the combined earnings.

Reference What’s New

Various Calculations Practice

Q 15 Ex. Book No. Pg. No.

Yes Ltd. wants to acquire No Ltd. and the cash flows of Yes Ltd. and the merged entity are given below:
(` In lakhs)

Year 1 2 3 4 5
Yes Ltd. 175 200 320 340 350
Merged Entity 400 450 525 590 620
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Earnings would have witnessed 5% constant growth rate without merger and 6% with merger on
account of economies of operations after 5 years in each case. The cost of capital is 15%.
The number of shares outstanding in both the companies before the merger is the same and the com-
panies agree to an exchange ratio of 0.5 shares of Yes Ltd. for each share of No Ltd.
PV factor at 15% for years 1-5 are 0.870, 0.756; 0.658, 0.572, 0.497 respectively.
You are required to:
(i) Compute the Value of Yes Ltd. before and after merger.
(ii) Value of Acquisition and
(iii) Gain to shareholders of Yes Ltd.

Reference What’s New

Valuation of Merged Company and Value of Acquisition (Post

Various Calculations Merger MV – Pre Merger MV)

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Q 16 Ex. Book No. Pg. No.

The following information is provided relating to the acquiring company Efficient Ltd. and the target
Company Healthy Ltd.

Efficient Ltd. Healthy Ltd.

No. of shares (F.V. ` 10 each) 10.00 lakhs 7.5 lakhs
Market capitalization 500.00 lakhs 750.00 lakhs
P/E ratio (times) 10.00 5.00
Reserves and Surplus 300.00 lakhs 165.00 lakhs
Promoter’s Holding (No. of shares) 4.75 lakhs 5.00 lakhs

Board of Directors of both the Companies have decided to give a fair deal to the shareholders and ac-
cordingly for swap ratio the weights are decided as 40%, 25% and 35% respectively for Earning, Book
Value and Market Price of share of each company.
(i) Calculate the swap ratio and also calculate Promoter’s holding % after acquisition.
(ii) What is the EPS of Efficient Ltd. after acquisition of Healthy Ltd.?
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(iii) What is the expected market price per share and market capitalization of Efficient Ltd. after
acquisition, assuming P/E ratio of Firm Efficient Ltd. remains unchanged.
(iv) Calculate free float market capitalization of the merged firm.

Reference What’s New

Swap Ratio as a weighted average of

several factors

Q 17 Ex. Book No. Pg. No.

The following information relating to the acquiring Company Abhiman Ltd. and the target Company
Abhishek Ltd. are available. Both the Companies are promoted by Multinational Company, Trident Ltd.
The promoter’s holding is 50% and 60% respectively in Abhiman Ltd. and Abhishek Ltd. :

Abhiman Ltd. Abhishek Ltd.

Share Capital (` ) 200 lakh 100 lakh
Free Reserve and Surplus (` ) 800 lakh 500 lakh
Paid up Value per share (` ) 100 10
Free float Market Capitalisation (` ) 400 lakh 128 lakh
P/E Ratio (times) 10 4

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Trident Ltd. is interested to do justice to the shareholders of both the Companies. For the swap ratio
weights are assigned to different parameters by the Board of Directors as follows:

Book Value 25%

EPS (Earning per share) 50%
Market Price 25%
(a) What is the swap ratio based on above weights?
(b) What is the Book Value, EPS and expected Market price of Abhiman Ltd. after acquisition of
Abhishek Ltd. (assuming P.E. ratio of Abhiman Ltd. remains unchanged and all assets and liabilities
of Abhishek Ltd. are taken over at book value).
(c) Calculate:
(i) Promoter’s revised holding in the Abhiman Ltd.
(ii) Free float market capitalization.
(iii) Also calculate No. of Shares, Earning per Share (EPS) and Book Value (B.V.), if after acquisition
of Abhishek Ltd., Abhiman Ltd. decided to :
(a) Issue Bonus shares in the ratio of 1 : 2; and
(b) Split the stock (share) as 5 each fully paid
[email protected],8420517209 `

Reference What’s New

Swap Ratio as a weighted average of Promoters contribution , Free

several factors Float Market Capitalisation
and Stock Split

Q 18 Ex. Book No. Pg. No.

XML Bank was established in 2001 and doing banking business in India. The bank is facing very critical
situation. There are problems of Gross NPA (Non-Performing Assets) at 40% & CAR/CRAR (Capital Ade-
quacy Ratio/Capital Risk Weight Asset Ratio) at 2%. The net worth of the bank is not good. Shares are
not traded regularly. Last week, .it was traded @ ` 4 per share.
RBI Audit suggested that bank has either to liquidate or to merge with other bank.
ZML Bank is professionally managed bank with low gross NPA of 5%.
It has net NPA as 0% and CAR at 16%. Its share is quoted in the market @ ` 64 per share. The Board of
Directors of ZML Bank has submitted a proposal to RBI for takeover of bank XML on the basis of share
exchange ratio.

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The Balance Sheet details of both the banks are as follows ;

XML Bank (` ) ZML BANK (` )

PARTICULARS
(Amount in Crores) (Amount in Crores)
Liabilities
Paid up share capital (` 10) 70 250
Reserve and Surplus 35 2,750
Deposits 2,000 20,000
Other Liabilities 445 1,250
Total Liabilities 2,550 24,250
Assets
Cash in hand and with RBI 200 1,250
Balance with other banks 0 1,000
Investments 550 7,500
Advances 1,750 13,500
Other Assets 50 1,000
Total Assets 2,550 24,250

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It was decided to issue shares at Book Value of ZML Bank to the shareholders of XML Bank. All Assets
& Liabilities are to be taken over at Book Value.
For the Swap Ratio, weights assigned to different parameters are as follows:

Gross NPA 40%

CAR 10%
Market Price 40%
Book Value 10%

You are required to :

(i) Calculate swap ratio based on above rates.
(ii) Calculate number of shares are to be issued.
(iii) Prepare Balance Sheet after Merger.
(iv) Calculate CAR and Gross NPA percentage after merger.

Reference What’s New

Bank merger Gross NPA and CAR

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Q 19 Ex. Book No. Pg. No.

T Ltd. and E Ltd. are in the same industry. The former is in negotiation for acquisition of the latter. Im-
portant information about the two companies as per their latest financial statements is given below:

T Ltd. E Ltd.
` 10 Equity shares outstanding 12 Lakhs 6 Lakhs
Debt:
10% Debentures (` Lakhs) 580 --
12.5% Institutional Loan (` Lakhs) -- 240
Earning before interest, depreciation and tax (EBIDAT) (` Lakhs) 400.86 115.71
Market Price/share (` ) 220.00 110.00

T Ltd. plans to offer a price for E Ltd., business as a whole which will be 7 times EBIDAT reduced by
outstanding debt, to be discharged by own shares at market price.
E Ltd. is planning to seek one share in T Ltd. for every 2 shares in E Ltd. based on the market price. Tax
rate for the two companies may be assumed as 30%.
[email protected],8420517209
Calculate and show the following under both alternatives - T Ltd.’s offer and E Ltd.’s plan:
(i) Net consideration payable.
(ii) No. of shares to be issued by T Ltd.
(iii) EPS of T Ltd. after acquisition.
(iv) Expected market price per share of T Ltd. after acquisition.
(v) State briefly the advantages to T Ltd. from the acquisition.
Calculations (except EPS) may be rounded off to 2 decimals in lakhs.

Reference What’s New

Exchange Ratio based on EBITDA and

Various Calculations

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Q 20 Ex. Book No. Pg. No.

Simple Ltd. and Dimple Ltd. are planning to merge. The total value of the companies are dependent
on the fluctuating business conditions. The following information is given for the total value (debt +
equity) structure of each of the two companies.

Business Condition Probability Simple Ltd. ` Lacs Dimple Ltd. ` Lacs

High Growth 0.20 820 1050
Medium Growth 0.60 550 825
Slow Growth 0.20 410 590
The current debt of Dimple Ltd. is ` 65 lacs and of Simple Ltd. is ` 460 lacs.
Calculate the expected value of debt and equity separately for the merged entity.

Reference What’s New

Wealth Redistribution Effect from Equity Value of Target Firm is less

to Debt than value of debt
[email protected],8420517209
Q 21 Ex. Book No. Pg. No.

Taran Fertilizer Corporation Plans to acquire Zaneb Chemicals Ltd. The following information is avail-
able.

Particulars Taran Fertilizer Zaneb

Total Current Earnings ` 500 million ` 200 million
No. of shares outstanding 200 million 100 million
Market Price per share ` 35 ` 25
(a) What is the maximum exchange ratio acceptable to shareholders of Taran Fertilizers if the PE
Ratio of the combined entity is 12 and there is no synergy gain?
(b) What is the minimum exchange ratio acceptable to the shareholders of Zaneb Chemicals if the
PE Ratio of the combined entity is 11 and there is a synergy gain of 5%?

Reference What’s New

Conn and Neilson effect Break even exchange ratios

based on post merger PE
Ratios

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Q 22 Ex. Book No. Pg. No.

The following information is relating to Fortune India Ltd. having two division, viz. Pharma Division
and Fast Moving Consumer Goods Division (FMCG Division). Paid up share capital of Fortune India Ltd.
is consisting of 3,000 Lakhs equity shares of ` 1 each. Fortune India Ltd. decided to de-merge Pharma
Division as Fortune Pharma Ltd. w.e.f. 1.4.2018. Details of Fortune India Ltd. as on 31.3.2018 and of
Fortune Pharma Ltd. as on 1.4.2018 are given below:

Fortune Pharma Ltd. Fortune India Ltd.

Particulars
` `
Outside Liabilities
Secured Loans 400 lakh 3,000 lakh
Unsecured Loans 2,400 lakh 800 lakh
Current Liabilities & Provisions 1,300 lakh 21,200 lakh
Assets
Fixed Assets 7,740 lakh 20,400 lakh
Investments 7,600 lakh 12,300 lakh
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Current Assets
Loans & Advances
8,800 lakh
900 lakh
30,200 lakh
7,300 lakh
Deferred tax/Misc. Expenses 60 lakh (200) lakh

Board of Directors of the Company have decided to issue necessary equity shares of Fortune Pharma
Ltd. of ` 1 each, without any consideration to the shareholders of Fortune India Ltd.
For that purpose, following points are to be considered:
1. Transfer of Liabilities & Assets at Book value.
2. Estimated Profit for the year 2018-19 is ` 11,400 Lakh for Fortune India Ltd. & ` 1,470 lakhs for
Fortune Pharma Ltd.
3. Estimated Market Price of Fortune Pharma Ltd. is ` 24.50 per share.
4. Average P/E Ratio of FMCG sector is 42 & Pharma sector is 25, which is to be expected for both the
companies.
Calculate:
1. The Ratio in which shares of Fortune Pharma are to be issued to the shareholders of Fortune India Ltd.
2. Expected Market price of Fortune India (FMCG) Ltd.
3. Book Value per share of both the Companies immediately after Demerger.

Reference What’s New

Demerger

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Q 23 Ex. Book No. Pg. No.

ABC, a large business house is planning to sell its wholly owned subsidiary KLM. Another large busi-
ness entity XYZ has expressed its interest in making a bid for KLM. XYZ expects that after acquisition
the annual earning of KLM will increase by 10%.
Following information, ignoring any potential synergistic benefits arising out of possible acquisitions,
are available:
(i) Profit after tax for KLM for the financial year which has just ended is estimated to be ` 10 crore.
(ii) KLM’s after tax profit has an increasing trend of 7% each year and the same is expected to
continue.
(iii) Estimated post tax market return is 10% and risk free rate is 4%. These rates are expected to
continue.
(iv) Corporate tax rate is 30%.

Proxy entity for KLM in the same

XYZ ABC
line of business
No. of shares 100 lakhs 80 lakhs --
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Current share price 287 375 -- ` `
Dividend pay out 40% 50% 50%
Debt : Equity at market values 1:2 1:3 1:4
P/E ratio 10 13 12
Equity beta 1 1. 1 1.1

Assume gearing level of KLM to be the same as for ABC and a debt beta of zero.
You are required to calculate:
(a) Appropriate cost of equity for KLM based on the data available for the proxy entity.
(b) A range of values for KLM both before and after any potential synergistic benefits to XYZ of the
acquisition.

Reference What’s New

Demerger Valuation based on Proxy

Entity Beta

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Q 24 Ex. Book No. Pg. No.

BA Ltd. and DA Ltd. both the companies operate in the same industry. The Financial statements of
both the companies for the current financial year are as follows:
Balance Sheet

Particulars BA Ltd. (` ) DA Ltd. (` )

Current Assets 14,00,000 10,00,000
Fixed Assets (Net) 10,00,000 5,00,000
Total (` ) 24,00,000 15,00,000
Equity capital (` 10 each) 10,00,000 8,00,000
Retained earnings 2,00,000 --
14% long-term debt 5,00,000 3,00,00
Current liabilities 7,00,000 4,00,000
Total (` ) 24,00,000 15,00,000

Income Statement
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BA Ltd. ( ) DA Ltd. ( ) ` `
Net Sales 34,50,000 17,00,000
Cost of Goods sold 27,60,000 13,60,000
Gross profit 6,90,000 3,40,000
Operating expenses 2,00,000 1,00,000
Interest 70,000 42,000
Earnings before taxes 4,20,000 1,98,00
Taxes @ 50% 2,10,000 99,000
Earnings after taxes (EAT) 2,10,000 99,000
Additional Information :
No. of Equity shares 1,00,000 80,000
Dividend payment ratio (D/P) 40% 60%
Market price per share ` 40 ` 15

Assume that both companies are in the process of negotiating a merger through an exchange of eq-
uity shares.
You have been asked to assist in establishing equitable exchange terms and are required to:
(i) Decompose the share price of both the companies into EPS and P/E components; and also
segregate their EPS figures into Return on Equity (ROE) and book value/intrinsic value per share
components.
(ii) Estimate future EPS growth rates for each company.
(iii) Based on expected operating synergies BA Ltd. estimates that the intrinsic value of DA’s equity
share would be ` 20 per share on its acquisition. You are required to develop a range of justifiable

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equity share exchange ratios that can be offered by BA Ltd. to the shareholders of DA Ltd. Based
on your analysis in part (i) and (ii), would you expect the negotiated terms to be closer to the
upper, or the lower exchange ratio limits and why?
(iv) Calculate the post-merger EPS based on an exchange ratio of 0.4 : 1 being offered by BA Ltd.
and indicate the immediate EPS accretion or dilution, if any, that will occur for each group of
shareholders.
(v) Based on a 0.4 : 1 exchange ratio and assuming that BA Ltd.’s pre-merger P/E ratio will continue
after the merger, estimate the post-merger market price. Also show the resulting accretion or
dilution in pre-merger market prices.

Reference What’s New

Various Calculations based on Balance

Sheet and Income Statement

Q 25 Ex. Book No. Pg. No.

[email protected],8420517209
H Ltd. agrees to buy over the business of B Ltd. effective 1st April, 2018.The summarized Balance
Sheets of H Ltd. and B Ltd. as on 31st March 2019 are as follows:
Balance sheet as at 31st March, 2019 (In Crores of Rupees)

Liabilities: H. Ltd B. Ltd.

Paid up Share Capital
-Equity Shares of ` 100 each 350.00
-Equity Shares of ` 10 each 6.50
Reserve & Surplus 950.00 25.00
Total 1,300.00 31.50
Assets:
Net Fixed Assets 220.00 0.50
Net Current Assets 1,020.00 29.00
Deferred Tax Assets 60.00 2.00
Total 1,300.00 31.50

H Ltd. proposes to buy out B Ltd. and the following information is provided to you as part of the
scheme of buying:
(a) The weighted average post tax maintainable profits of H Ltd. and B Ltd. for the last 4 years are `
300 crores and ` 10 crores respectively.
(b) Both the companies envisage a capitalization rate of 8%.
(c) H Ltd. has a contingent liability of ` 300 crores as on 31st March, 2019.

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(d) H Ltd. to issue shares of ` 100 each to the shareholders of B Ltd. in terms of the exchange ratio as
arrived on a Fair Value basis. (Please consider weights of 1 and 3 for the value of shares arrived on
Net Asset basis and Earnings capitalization method respectively for both H Ltd. and B Ltd.)
You are required to arrive at the value of the shares of both H Ltd. and B Ltd. under:
(i) Net Asset Value Method
(ii) Earnings Capitalisation Method
(iii) Exchange ratio of shares of H Ltd. to be issued to the shareholders of B Ltd. on a Fair value basis
(taking into consideration the assumption mentioned in point 4 above.)

Reference What’s New

Methods of Valuation of Business and

find Exchange Ratio

Q 26 Ex. Book No. Pg. No.

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AB Ltd., is planning to acquire and absorb the running business of XY Ltd. The valuation is to be based
on the recommendation of merchant bankers and the consideration is to be discharged in the form of
equity shares to be issued by AB Ltd.
As on 31.3.2018, the paid up capital of AB Ltd. consists of 80 lakhs shares of ` 10 each. The highest and
the lowest market quotation during the last 6 months were ` 570 and ` 430. For the purpose of the
exchange, the price per share is to be reckoned as the average of the highest and lowest market price
during the last 6 months ended on 31.3.18.
XY Ltd.’s Balance Sheet as at 31.3.2018 is summarised below:

Sources ` lakhs
Share Capital
20 lakhs equity shares of ` 10 each fully paid 200
10 lakhs equity shares of` 10 each, ` 5 paid 50
Loans 100
Total 350
Uses
Fixed Assets (Net) 150
Net Current Assets 200
350

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An independent firm of merchant bankers engaged for the negotiation, have produced the following
estimates of cash flows from the business of XY Ltd.:

Year ended By way of ` lakhs

31.3.19 After tax earnings for equity 105
31.3.20 Do 120
31.3.21 Do 125
31.3.22 Do 120
31.3.23 Do 100
Terminal value estimate 200
It is the recommendation of the merchant banker that the business of XY Ltd. may be valued on the
basis of the average of
(i) Aggregate of discounted cash flows at 8% and
(ii) Net assets value.
Present value factors at 8% for years: 0.93 0.86 0.79 0.74 0.68
You are required to:
(i) Calculate the total value of the business of XY Ltd.
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(ii) The number of shares to be issued by AB Ltd.; and
(iii) The basis of allocation of the shares among the shareholders of XY Ltd.

Reference What’s New

Methods of Valuation of Business and

find Exchange Ratio

Q 27 Ex. Book No. Pg. No.

The following is the Balance-sheet of Grape Fruit Company Ltd as at March 31st, 2018.

Liabilities (` in lakhs) Assets (` in lakhs)

Equity shares of ` 100 each 600 Land and Building 200
14% preference shares of ` 100/- each 200 Plant and Machinery 300
13% Debentures 200 Furniture and Fixtures 50
Debenture interest accrued and Payable 26 Inventory 150
Loan from bank 74 Sundry debtors 70
Trade creditors 340 Cash at bank 130
Preliminary expenses 10
Cost of issue of debentures 5
Profit and Loss account 525
1440 1440

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The Company did not perform well and has suffered sizable losses during the last few years.
However, it is felt that the company could be nursed back to health by proper financial restructuring.
Consequently the following scheme of reconstruction has been drawn up :
(i) Equity shares are to be reduced to ` 25/- per share, fully paid up;
(ii) Preference shares are to be reduced (with coupon rate of 10%) to equal number of shares of ` 50
each, fully paid up.
(iii) Debenture holders have agreed to forgo the accrued interest due to them. In the future, the rate
of interest on debentures is to be reduced to 9 percent.
(iv) Trade creditors will forego 25 percent of the amount due to them.
(v) The company issues 6 lakh of equity shares at ` 25 each and the entire sum was to be paid on
application. The entire amount was fully subscribed by promoters.
(vi) Land and Building was to be revalued at ` 450 lakhs, Plant and Machinery was to be written down
by ` 120 lakhs and a provision of ` 15 lakhs had to be made for bad and doubtful debts.
Required:
(i) Show the impact of financial restructuring on the company’s activities.
(ii) Prepare the fresh balance sheet after the reconstructions is completed on the basis of the above
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proposals.

Reference What’s New

Restructuring

Q 28 Ex. Book No. Pg. No.

M/s Tiger Ltd. wants to acquire M/s. Leopard Ltd. The balance sheet of Leopard Ltd. as on 31st March,
2019 is as follows:

Liabilities ` Assets `
Equity Capital ( 70,000 shares ) 7,00,000 Cash 50,000
Retained earnings 3,00,000 Debtors 70,000
12% Debentures 3,00,000 Inventories 2,00,000
Creditors and other liabilities 3,20,000 Plants & Equipment. 13,00,000
16,20,000 16,20,000

Additional Information:
(i) Shareholders of Leopard Ltd. will get one share in Tiger Ltd. for every two shares. External liabilities
are expected to be settled at ` 5,00,000. Shares of Tiger Ltd. would be issued at its current price
of ` 15 per share. Debenture- holders will get 13% convertible debentures in the purchasing
company for the same amount. Debtors and inventories are expected to realize ` 2,00,000.

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(ii) Tiger Ltd. has decided to operate the business of Leopard Ltd. as a separate division. The division
is likely to give cash flows (after tax) to the extent of ` 5,00,000 per year for 6 years. Tiger Ltd. has
planned that, after 6 years, this division would be demerged and disposed of for ` 2,00,000.
(iii) The company’s cost of capital is 16%.
Make a report to the Board of the company advising them about the financial feasibility of this acqui-
sition.
Net present values for 16% for ` 1 are as follows:

Years 1 2 3 4 5 6
PV .862 .743 .641 .552 .476 .410

Reference What’s New

Demerger after acquisition

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1. Different Types of Merger

(i) Horizontal Merger: The two companies which have merged are in the same industry,
normally the market share of the new consolidated company would be larger and it
is possible that it may move closer to being a monopoly or a near monopoly to avoid
competition.
(ii) Vertical Merger: This merger happens when two companies that have ‘buyerseller’
relationship (or potential buyer-seller relationship) come together.
(iii) Conglomerate Mergers: Such mergers involve firms engaged in unrelated type of business
operations. Such mergers are in fact, unification of different kinds of businesses under one
flagship company.
(iv) Congeneric Merger: In these mergers, the acquirer and the target companies are related
through basic technologies, production processes or markets. The acquired company
represents an extension of product-line, market participants or technologies of the acquirer.
These mergers represent an outward movement by the acquirer from its current business
scenario to other related business activities within the overarching industry structure
(v) Reverse Merger: This type of merger is also known as ‘back door listing’. This kind of merger
has been started as an alternative to go for public issue without incurring huge expenses
and passing through cumbersome process. Thus, it can be said that reverse merger leads to
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the following benefits for acquiring company:
1. Easy access to capital market.
2. Increase in visibility of the company in corporate world.
3. Tax benefits on carry forward losses acquired (public) company.
4. Cheaper and easier route to become a public company.
2. Rationale for M & A

Instantaneous growth, Snuffing out competi- • Airtel – Loop Mobile (2014) (Airtel bags
tion, Increased market share. top spot in Mumbai Telecom Circle)
• Facebook – Whatsapp (2014) (Facebook
acquired its biggest threat in chat space)
Acquisition of a competence or a capability • Google – Motorola (2011) (Google
got access to Motorola’s 17,000 issued
patents and 7500 applications)
• Flipkart – Myntra (2014) (Flipkart poised
to strengthen its competency in apparel
e-commerce market)
Entry into new markets/product segments • Airtel – Zain Telecom (2010) (Airtel enters
15 nations of African Continent in one
shot)
• Cargill – Wipro (2013) (Cargill acquired
Sunflower Vanaspati oil business to enter
Western India Market)

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Access to funds • Ranbaxy – Sun Pharma (2014) (Daiichi

Sankyo sold Ranbaxy to generate funds)
• Jaypee – Ultratech (2014) (Jaypee sold its
cement unit to raise funds for cutting off
its debt)
Tax benefits • Burger King (US) – Tim Hortons(Canada)
(2014) (Burger King could save taxes in
future)
• Durga Projects Limited (DPL) –WBPDCL
(2014) (DPL’s loss could be carry forward
and setoff )
3. Take Over Strategies:
Other than Tender Offer the acquiring company can also use the following techniques:
• Street Sweep: This refers to the technique where the acquiring company accumulates
larger number of shares in a target before making an open offer. The advantage is that the
target company is left with no choice but to agree to the proposal of acquirer for takeover.
• Bear Hug: When the acquirer threatens the target to make an open offer at a very large
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price than net worth of the target, the board of target company agrees to a settlement with
the acquirer for change of control.
• Strategic Alliance: This involves disarming the acquirer by offering a partnership rather
than a buyout. The acquirer should assert control from within and takeover the target
company.
• Brand Power: This refers to entering into an alliance with powerful brands to displace the
target’s brands and as a result, buyout the weakened company.
4. Defensive Tactics:
A target company can adopt a number of tactics to defend itself from hostile takeover through
a tender offer.
• Divestiture - In a divestiture the target company divests or spins off some of its businesses
in the form of an independent, subsidiary company. Thus, reducing the attractiveness of the
existing business to the acquirer.
• Crown jewels - When a target company uses the tactic of divestiture it is said to sell the
crown jewels. In some countries such as the UK, such tactic is not allowed once the deal
becomes known and is unavoidable.
• Poison pill - Sometimes an acquiring company itself becomes a target when it is bidding
for another company. The tactics used by the acquiring company to make itself unattractive
to a potential bidder is called poison pills. For instance, the acquiring company may issue
substantial amount of convertible debentures to its existing shareholders to be converted at
a future date when it faces a takeover threat. The task of the bidder would become difficult
since the number of shares to having voting control of the company increases substantially.
• Poison Put - In this case the target company issue bonds that encourage holder to cash in
at higher prices. The resultant cash drainage would make the target unattractive.

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• Greenmail - Greenmail refers to an incentive offered by management of the target

company to the potential bidder for not pursuing the takeover. The management of the
target company may offer the acquirer for its shares a price higher than the market price.
• White knight - In this a target company offers to be acquired by a friendly company to
escape from a hostile takeover. The possible motive for the management of the target
company to do so is not to lose the management of the company. The hostile acquirer may
change the management.
• White squire - This strategy is essentially the same as white knight and involves sell
out of shares to a company that is not interested in the takeover. As a consequence, the
management of the target company retains its control over the company.
• Golden parachutes - When a company offers hefty compensations to its managers if they
get ousted due to takeover, the company is said to offer golden parachutes. This reduces
their resistance to takeover.
• Pac-man defence - This strategy aims at the target company making a counter bid for the
acquirer company. This would force the acquirer to defend itself and consequently may call
off its proposal for takeover.
5. Process of Acquisition
The acquisition process involves the following essential stages:
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(i) Defining the Acquisition Criteria
(ii) Competitive analysis;
(iii) Search and screen.
(iv) Strategy development.
(v) Financial evaluation.
(vi) Target contact and negotiation.
(vii) Due Diligence (in the case of a friendly acquisition
(viii) Arranging for finance for acquisition
(ix) Putting through the acquisition and Post merger integration
6. Participants in the Merger and Acquisition Process
There are many professionals who play an essential role in the successful completion of a deal.
(a) Investment Bankers: Investment bankers are always at the forefront of the acquisition
process. They offer strategic and tactical advice, screen potential buyers and sellers, make
initial contact with a seller and buyer and provide negotiation support, valuation and deal
structuring. Investment bankers in addition providing investment advisory services also
provide various types of due diligence services as discussed above.
(b) Lawyers: The legal framework surrounding a typical transaction has become so complicated
that no one individual can have sufficient expertise to address all the issues. So, legal teams
consist of more than a dozen lawyers each of whom represents a specialised aspect of the law.
(c) Accountants : Accountants perform the role of auditors by reviewing the target’s financial
statements and operations through a series of interviews with senior and middle level
managers. These services are generally provided by Accounting Advisory Group of
professional accounting firms like a Big4.

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(d) Valuation Experts: They build models that incorporate various assumptions such as costs
or revenues growth rate.
(e) Institutional Investors: Institutional investors can announce how they intend to vote on a
matter and advertise their position in order to seek support and have more influence.
(f ) Arbitrageurs: Arbitrageurs provide market liquidity during transactions. With the number
of merger arbitrageurs increasing, they are becoming more proactive in trying to anticipate
takeover situations. Their objective is to identify the target before the potential acquirer is
required by law to announce its intentions.
7. Different types of Demerger
• Spinoff: This type of demerger involves division of company into wholly owned subsidiary
of parent company by distribution of all its shares to subsidiary company on Pro-rata basis.
By this way, both the companies i.e. holding as well as subsidiary company exist and carry
on business. For example, Kotak, Mahindra Finance Ltd. formed a subsidiary called Kotak
Mahindra Capital Corporation, by spinning off its investment banking division. At time
demerger also takes place by one company selling one of its line of activities and / or group
of assets including brand if required.
• Split ups: This type of demerger involves the division of parent company into two or more
separate companies where parent company ceases to exist after the demerger.
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• Equity carve out: This is similar to spin offs, except that some part of shareholding of this
subsidiary company is offered to public through a public issue and the parent company
continues to enjoy control over the subsidiary company by holding controlling interest in it.
This is also called unleashing of values.
• Promoters of a company can also dilute their holding in a listed company through ‘Offer for
Sale’ following the SEBI’s OFS Regulation of, 2012. A non-listed company can also do this,
e.g. Private Equity investors are brought in as equity partners during a distress or expansion
phase for eventual exit after valuation of the company increases manifold.
• Divestitures: These are sale of segment of a company for cash or for securities to an outside
party. Divestitures, involve some kind of contraction.
• Asset sale: This involves sale of tangible or intangible assets of a company to generate cash.
A partial sell off, also called slump sale. It involves the sale of a business unit or plant of one
firm to another. It is the mirror image of a purchase of a business unit or plant. From the
seller’s perspective, it is a form of contraction and from the buyer’s point of view it is a form
of expansion. For example, When Coromandal Fertilizers Limited sold its cement division to
India Cement limited, the size of Coromandal Fertilizers contracted whereas the size of India
Cements Limited expanded.

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Q 1 Ex. Book No. Pg. No.

Simpson Ltd. is considering a merger with Wilson Ltd. The data below are in the hands of both Board
of Directors. The issue at hand is how many shares of Simpson should be exchanged for Wilson Ltd.
Both boards are considering three possibilities 20,000, 25,000 and 30,000 shares.
You are required to construct a table demonstrating the potential impact of each scheme on each set
of shareholders:

Simpson Combined Post

Wilson Ltd.
Ltd. merger Firm ‘A’
1. Current earnings per year 2,00,000 1,00,000 3,50,000
2. Shares outstanding 50,000 10,000 ?
3. Earnings per share (` ) (1÷ 2) 4 10 ?
4. Price per share (` ) 40 100 ?
5. Price-earning ratio [4 ÷3] 10 10 10
6. Value of firm (` ) 20,00,000 10,00,000 35,00,000
7. Expected Annual growth rate in earnings in foreseea- 0 0 0
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ble future

Reference What’s New

Net Gain or Loss to the shareholders of

each company

Q 2 Ex. Book No. Pg. No.

A Ltd. wants to acquire T Ltd. and has offered a swap ratio of 1:2 (0.5 shares for every one share of T
Ltd.). Following information is provided:

A Ltd. T. Ltd.
Profit after tax ` 18,00,000 ` 3,60,000
Equity shares outstanding (Nos.) 6,00,000 1,80,000
EPS `3 `2
PE Ratio 10 times 7 times
Market price per share ` 30 ` 14

Required:
(i) The number of equity shares to be issued by A Ltd. for acquisition of T Ltd.
(ii) What is the EPS of A Ltd. after the acquisition?
(iii) Determine the equivalent earnings per share of T Ltd.

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(iv) What is the expected market price per share of A Ltd. after the acquisition, assuming its PE
multiple remains unchanged?
(v) Determine the market value of the merged firm.

Reference What’s New

Various Calculations Equivalent EPS of Target Co.

Q 3 Ex. Book No. Pg. No.

MK Ltd. is considering acquiring NN Ltd. The following information is available:

Company Earning after Tax(` ) No. of Equity Share Market Value Per Share(` )
MK Ltd. 60,00,000 12,00,000 200.00
NN Ltd. 18,00,000 3,00,000 160.00
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Exchange of equity shares for acquisition is based on current market value as above. There is no syn-
ergy advantage available.
(i) Find the earning per share for company MK Ltd. after merger, and
(ii) Find the exchange ratio so that shareholders of NN Ltd. would not be at a loss.

Reference What’s New

Post Merger EPS and Exchange Ratio to Practice

maintain EPS of Target Co.

Q 4 Ex. Book No. Pg. No.

ABC Ltd. is intending to acquire XYZ Ltd. by merger and the following information is available in re-
spect of the companies:

ABC Ltd. XYZ Ltd.

Number of equity shares 10,00,000 6,00,000
Earnings after tax (` ) 50,00,000 18,00,000
Market value per share (` ) 42 28

Required:
(i) What is the present EPS of both the companies?
(ii) If the proposed merger takes place, what would be the new earning per share for ABC Ltd.?

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Assume that the merger takes place by exchange of equity shares and the exchange ratio is
based on the current market price.
(iii) What should be exchange ratio, if XYZ Ltd. wants to ensure the earnings to members are as before
the merger takes place?

Reference What’s New

Various Calculations Practice

Q 5 Ex. Book No. Pg. No.

XYZ Ltd., is considering merger with ABC Ltd. XYZ Ltd.’s shares are currently traded at ` 20. It has
2,50,000 shares outstanding and its earnings after taxes (EAT) amount to ` 5,00,000.
ABC Ltd., has 1,25,000 shares outstanding; its current market price is ` 10 and its EAT are ` 1,25,000.
The merger will be effected by means of a stock swap (exchange).
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ABC Ltd., has agreed to a plan under which XYZ Ltd., will offer the current market value of ABC Ltd.’s
shares:
(i) What is the pre-merger earnings per share (EPS) and P/E ratios of both the companies?
(ii) If ABC Ltd.’s P/E ratio is 6.4, what is its current market price? What is the exchange ratio? What will
XYZ Ltd.’s post-merger EPS be?
(iii) What should be the exchange ratio; if XYZ Ltd.’s pre-merger and post-merger EPS are to be the
same?

Reference What’s New

Various Calculations Practice

Q 6 Ex. Book No. Pg. No.

Following information is provided relating to the acquiring company Mani Ltd. and the target com-
pany Ratnam Ltd:

Mani Ltd. Ratnam Ltd.

Earnings after tax (` lakhs) 2,000 4,000
No. of shares outstanding (lakhs) 200 1,000
P/E ratio ( No. of times) 10 5

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Required:
(i) What is the swap ratio based on current market prices?
(ii) What is the EPS of Mani Ltd. after the acquisition?
(iii) What is the expected market price per share of Mani Ltd. after the acquisition, assuming its P/E
ratio is adversely affected by 10%?
(iv) Determine the market value of the merged Co.
(v) Calculate gain/loss for the shareholders of the two independent entities, due to the merger.

Reference What’s New

Various Calculations Practice

Q 7 Ex. Book No. Pg. No.

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Reliable Industries Ltd. (RIL) is considering a takeover of Sunflower Industries Ltd. (SIL). The particulars
of 2 companies are given below:

Reliable Industries Sunflower Indus-

Particulars
Ltd tries Ltd.
Earnings After Tax (EAT) ` 20,00,000 ` 10,00,000
Equity shares O/s 10,00,000 10,00,000
Earnings per share (EPS) 2 1
PE Ratio (Times) 10 5

Required:
(i) What is the market value of each Company before merger?
(ii) Assume that the management of RIL estimates that the shareholders of SIL will accept an offer of
one share of RIL for four shares of SIL. If there are no synergic effects, what is the market value of
the Post-merger RIL? What is the new price per share? Are the shareholders of RIL better or worse
off than they were before the merger?
(iii) Due to synergic effects, the management of RIL estimates that the earnings will increase by 20%.
What are the new post-merger EPS and Price per share? Will the shareholders be better off or
worse off than before the merger?

Reference What’s New

Various Calculations Practice

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Q 8 Ex. Book No. Pg. No.

The following is the Balance-sheet of XYZ Company Ltd as on March 31st, 2019.
(` in lakh)

Liabilities Amount Assets Amount

6 lakh equity shares of ` 100/- each 600 Land & Building 200
2 lakh 14% Preference shares of ` 100/- each 200 Plant & Machinery 300
13% Debentures 200 Furniture & Fixtures 50
Inventory 150
Sundry debtors 70
Debenture Interest accrued and Payable 26 Cash at Bank 130
Preliminary Expenses 10
Loan from Bank 74 Cost of Issue of debentures 5
Trade Creditors 300 Profit & Loss A/c 485
1,400 1,400
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The XYZ Company did not perform well and has suffered sizable losses during the last few years.
However, it is now felt that the company can be nursed back to health by proper financial restructur-
ing and consequently the following scheme of reconstruction has been devised:
(i) Equity shares are to be reduced to ` 25/- per share, fully paid up;
(ii) Preference shares are to be reduced (with coupon rate of 10%) to equal number of shares of ` 50
each, fully paid up.
(iii) Debenture holders have agreed to forego interest accrued to them. Beside this, they have agreed
to accept new debentures carrying a coupon rate of 9%.
(iv) Trade creditors have agreed to forgo 25 per cent of their existing claim; for the balance sum they
have agreed to convert their claims into equity shares of ` 25/- each.
(v) In order to make payment for bank loan and augment the working capital, the company issues 6
lakh equity shares at ` 25/- each; the entire sum is required to be paid on application. The existing
shareholders have agreed to subscribe to the new issue.
(vi) While Land and Building is to be revalued at ` 250 lakh, Plant & Machinery is to be written down
to ` 104 lakh. A provision amounting to ` 5 lakh is to be made for bad and doubtful debts.
You are required to show the impact of financial restructuring/re-construction. Also, prepare the new
balance sheet assuming the scheme of re-construction is implemented in letter and spirit.

Reference What’s New

Restructuring

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Q 9 Ex. Book No. Pg. No.

Tatu Ltd. wants to takeover Mantu Ltd. and has offered a swap ratio of 1:2 (0.5 shares for everyone
share of Mantu Ltd.). Following information is provided

Tatu Ltd. Mantu Ltd.

Profit after tax ` 24.00,000 ` 4,80,000
Equity shares outstanding (Nos.) 8,00,000 2,40,000
EPS `3 `2
PE Ratio 10 times 7 times
Market price per share ` 30 ` 14

You are required to calculate:

(i) The number of equity shares to be issued by Tatu Ltd. for acquisition of Mantu Ltd.
(ii) What is the EPS of Tatu Ltd. after the acquisition?
(iii) Determine the equivalent earnings per share of Mantu Ltd.

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(iv) What is the expected market price per share of Tatu Ltd. after the acquisition, assuming its PE
multiple remains unchanged?
(v) Determine the market value of the merged firm.

Reference What’s New

Various Calculations Practice

Q 10 Ex. Book No. Pg. No.

During the audit of the Weak Bank (W). RBI has suggested that the Bank should either merge with an-
other bank or may close down. Strong Bank (S) has submitted a proposal of merger of Weak Bank with
itself. The relevant information and Balance Sheets of both the companies are as under:

Weak Bank Strong Bank Assigned

Particulars
(W) (S) Weights (%)
Gross NPA(%) 40 5 30
Capital Adequacy Ratio (CAR/Capital 5 16 28
Risk Weight Asset Ratio
Market price per Share (MPS) 12 96 32
Book value 10
Trading on Stock Exchange Irregular Frequent

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Balance Sheet (` in Lakhs)

Weak Bank Strong Bank

Particulars
(W) (S)
Paid up Share Capital (` 10 per share) 150 500
Reserves & Surplus 80 5.500
Deposits 4.000 44,000
Other Liabilities 890 2,500
Total Liabilities 5.120 52.500
Cash in Hand with RBI 400 2,500
Balance with other Banks – 2,000
Investments 1,100 19,000
Advances 3,500 27,000
Other Assets 70 2,000
Preliminary Expenses 50 –
Total Assets 5,120 52,500

You are required to

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(a) Calculate Swap ratio based on the above weights.
(b) Ascertain the number of Shares to be issued to Weak Bank:
(c) Prepare Balance Sheet after merger. and
(d) Calculate CAR and Gross NPA of Strong Bank after merger

Reference What’s New

Bank Merger

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Chapter 4
Fixed Income Security Valuation - Part A

BOND VALUATION

1. Different types of a. Zero Coupon Bond

Bonds b. Perpetual Bond
c. Conventional or Plain Vanilla Bond
d. Non Conventional Bond
e. Convertible Bonds
f. Foreign Bonds

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2. Bond Yield a. Yield to Maturity
b. Bond Equivalent Yield
c. Effective Annual Yield

3. Valuation or Pricing of
Bond and its basic rules

4. Risk Analysis of Bonds a. Relationship between Price and Yield – The Yield
Curves
b. Bond Volatility
c. Effective Duration
d. Short Cut Method
e. Macaulay’s Duration
f. Modified Duration
g. Forward Rates

5. Bond Portfolio
Management – Active
and Passive

6. Option Embedded a. Callable Bonds

Bonds – b. Puttable Bonds
c. Extendable Bonds

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7. Term Structure of
Interest Rates

8. Residuals a. Bond Pricing in between coupon dates

b. Re-investment assumption of YTM
c. Floating rate bonds
d. Calculation of Convexity

9. Convertible Debentures a. Compulsorily Convertible

b. Optionally Convertible

Basics Terms used in Bonds

(a) Par Value: Value stated on the face of the bond. It is the amount a firm borrows and promises to
repay at the time of maturity.
(b) Coupon Rate and Frequency of Payment: A bond carries a specific interest rate known as the
coupon rate. The interest payable to the bond holder is par value of the bond × coupon rate. If,
the annual interest payable on a bond with a par value of ` 100 and a coupon rate of 13.5 percent
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is ` 13.50 (` 100 × 13.5 per cent). The frequency of payment of interest also needs to be specified
(e.g. payable annually, semi annually, quarterly or monthly)
(c) Maturity Period: Corporate bonds have a maturity period of 3 to 10 years, while government
bonds can have maturity periods extending up to 30 years.
(d) Bullet Redemption: i.e. one shot repayment of principal (it could be in installments as well) at
par (could be at some premium also)
Bond Value Theorems: Some Basic Rules which should be remembered with regard to Bonds
are:
(a) When the required rate of return equals the coupon rate, the bond sells at par value.
(b) When the required rate of return exceeds the coupon rate, the bond sells at a discount. The
discount declines as maturity approaches.
(c) When the required rate of return is less than the coupon rate, the bond sells at a premium. The
premium declines as maturity approaches.
(d) The longer the maturity of a bond, the greater is its price change with a given change in the
required rate of return.

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Q 1 Ex. Book No. Pg. No.

Find yield of the following Bonds –

Particulars Bond A Bond B Bond C

Face Value 1000 20000 100
Coupon Rate 12% 0 14%
Price 912 9250 103.10
Maturity 5 yrs 7 yrs Perpetual

Reference What’s New

Bond Yield Current Yield vs Yield to

Maturity

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Q 2 Ex. Book No. Pg. No.

If the price per bond is ` 90 and the bond has a par value of ` 100, a coupon rate of 14 per cent, and a
maturity period of 6 years, calculate it’s yield to maturity.

Reference What’s New

Bond Yield Yield to Maturity of Plain

Vanilla Bond

Q 3 Ex. Book No. Pg. No.

A bond has the following features:-

Face Value ` 1,000

Current Price ` 9,360
Maturity 4 years
Coupon Rate 15%
Yield on similar bonds 13%
Income tax rate 30%
Capital gains tax rate 10%

Calculate post tax yield to maturity and advise the investor.

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Reference What’s New

Post Tax Yield Rate With Income Tax and Capital

Gain Tax effect

Q 4 Ex. Book No. Pg. No.

A bond is held for a period of 45 days. The current discount yield is 6 per cent per annum. It is expected
that current yield will increase by 200 basis points and current market price will come down by ` 2.50.
Calculate:
(i) Face value of the Bond and
(ii) Bond Equivalent Yield

Reference What’s New

Bond Equivalent Yield Face Value Calculation

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Q 5 Ex. Book No. Pg. No.

A 25 years Deep discount bond (DDB) with a face value of ` 50,000 & is presently trading at ` 4000 of
yield on similar bonds is 17% p.a. Calculate the bond’s intrinsic value & give your investment advice.

Reference What’s New

Valuation of a Deep Discount Bond

Q 6 Ex. Book No. Pg. No.

A zero coupon bond of face value ` 1,000 with yield rate of 14% is redeemable after 5 years. Calculate
its intrinsic value.

Reference What’s New

Valuation of a Zero Coupon Bond

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Q 7 Ex. Book No. Pg. No.

A perpetual bond of face value ` 1000 and a coupon rate 14% is presently trading at ` 972. If yield in
the market on similar bonds is 16%, what is its intrinsic value? Should it be purchased? What if yield
falls by 150 basis points?

Reference What’s New

Valuation of a Perpetual Bond

Q 8 Ex. Book No. Pg. No.

A bond has the following features:-

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Face Value
Coupon rate
1,000
12% payable annually
`

Remaining maturity 5 years

Current price ` 922
Yield in the market on similar bonds 14%

Calculate the intrinsic value and give your investment advice.

Reference What’s New

Valuation of a Conventional or Plain

Vanilla Bond

Q 9 Ex. Book No. Pg. No.

A bond has the following features:-

Face Value ` 100

Coupon rate 8% payable semi annually
Remaining maturity 5 years
Current price ` 103.20
Yield in the market on similar bonds 7%

Calculate the intrinsic value and give your investment advice.

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Reference What’s New

Valuation of a Semi Annual Interest

Paying Bond

Q 10 Ex. Book No. Pg. No.

On 31st March, 2019, the following information about Bonds is available:

Name of Security Face Value ` Maturity Date Coupon Rate Coupon Date(s)
Zero coupon 10,000 31st March, 2029 N.A. NA
T-Bill 1,00,000 20th June, 2019 N.A. N.A.
10.71% GOI 2029 100 31st March, 2029 10.71 31st March
10% GOI 2024 100 31st March, 2024 10.00 31st March & 30th
September

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Calculate:
(i) If 10 years yield is 7.5% p.a. what price the Zero Coupon Bond would fetch on 31st March. 2019?
(ii) What will be the annualized yield if the T-Bill is traded @ 98500?
(iii) If 10.71% GOI 2029 Bond having yield to maturity is 8%, what price would it fetch on April 1, 2019
(after coupon payment on 31st March)?
(iv) If 10% GOI 2024 Bond having yield to maturity is 8%, what price would it fetch on April 1, 2019
(after coupon payment on 31st March)?

Reference What’s New

Valuation and YTM

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Q 1 Ex. Book No. Pg. No.

There is a 9% 5-year bond issue in the market. The issue price is ` 90 and the redemption price ` 105.
For an investor with marginal income tax rate of 30% and capital gains tax rate of 10% (assuming no
indexation), what is the post-tax yield to maturity?

Reference What’s New

Post Tax Yield Rate

Q 2 Ex. Book No. Pg. No.

An investors is considering the purchase of the following Bond:

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Face value
Coupon rate
100
11%
`

Maturity 3 years
(i) If he wants a yield of 13% what is the maximum price he should be ready to pay for?
(ii) If the Bond is selling for ` 97.60, what would be his yield?

Reference What’s New

Bond Yield Yield to Maturity

Q 3 Ex. Book No. Pg. No.

Nominal value of 10% bonds issued by a company is `100. The bonds are redeemable at `110 at the
end of year 5.
Determine the value of the bond if required yield is (i) 5%, (ii) 5.1%, (iii) 10% and (iv) 10.1%.

Reference What’s New

Valuation of a Conventional Bond

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Q 4 Ex. Book No. Pg. No.

A ` 1,000 par value bond bearing a coupon rate of 14 per cent matures after 5 years, the required rate
of return on this bond is 13 per cent. Calculate the value of the bond.

Reference What’s New

Valuation of a Conventional or Plain

Vanilla Bond

Q 5 Ex. Book No. Pg. No.

If a ` 100 par value - bond carries a coupon rate of 12 per cent and a maturity period of 8 years and
interest payable semi-annually then the value of the bond with required rate of return of 14 per cent
will be what?
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Reference What’s New

Valuation of a Semi Annual Interest

Paying Bond

Q 6 Ex. Book No. Pg. No.

Calculate Market Price of:

A bond with 7.5% coupon interest, Face Value ` 10,000 & term to maturity of 2 years, presently yielding
6% . Interest payable half yearly.

Reference What’s New

Valuation of a Semi Annual Interest

Paying Bond

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Q 7 Ex. Book No. Pg. No.

Calculate Market Price of:

10% Government of India security currently quoted at ` 110, but yield is expected to go up by 1%.

Reference What’s New

Valuation of Bond

Q 8 Ex. Book No. Pg. No.

M/s Agfa Industries is planning to issue a debenture series on the following terms:

Face value 100 `

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Term of maturity 10 years
Yearly coupon rate
Years
1–4 9%
5−8 10%
9 − 10 14%

The current market rate on similar debentures is 15 per cent per annum. The Company proposes to
price the issue in such a manner that it can yield 16 per cent compounded rate of return to the in-
vestors. The Company also proposes to redeem the debentures at 5 per cent premium on maturity.
Determine the issue price of the debentures.

Reference What’s New

Valuation of Debentures Non Conventional

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Q 9 Ex. Book No. Pg. No.

Based on the credit rating of bonds, Mr. Z has decided to apply the following discount rates for valuing
bonds:

Credit Rating Discount Rate

AAA 364 day T bill rate + 3% spread
AA AAA + 2% spread
A AAA + 3% spread

He is considering to invest in AA rated, ` 1,000 face value bond currently selling at ` 1,025.86.
The bond has five years to maturity and the coupon rate on the bond is 15% p.a. payable annually. The
next interest payment is due one year from today and the bond is redeemable at par. (Assume the 364
day T-bill rate to be 9%).
You are required to calculate the intrinsic value of the bond for Mr. Z. Should he invest in the bond?
Also calculate the current yield and the Yield to Maturity (YTM) of the bond.

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Reference What’s New

Valuing a Bond

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Fixed Income Security Valuation Part B

MONEY MARKET

1. Money Market Vs
Capital Market

2. Pre Conditions of
Efficient Money Market

3. Rigidities in Indian
Money Market

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4. Money Market
Instruments
(a) Call/Notice money
(b) Inter-Bank Term money
(c) Inter-bank Participation Certificate (IBPC)
(d) Inter Corporate Deposit
(e) Treasury Bills (TBs)
(f ) Commercial Bills
(g) Certificate of Deposits (CDs)
(h) Commercial Paper

5. Recent Developments – (i) Debt Securitisation

(ii) Money Market Mutual Funds (MMMFs)
(iii) Repurchase Options (Repo.) and Ready Forward (RF)
contracts

6. Calculations (i) Issue Price

(ii) Amount received on Issue
(iii) Effective rate of interest
(iv) Effective Cost of Fund
(v) Investor’s View
i. Issue Price
ii. Bond equivalent yield
iii. Effective annual return
iv. Period of investment
v. Amount of invesment

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Q 1 Ex. Book No. Pg. No.

Z Co. Ltd. issued commercial paper worth `10 crores as per following details:

Date of issue : 16th January, 2019

Date of maturity: 17th April, 2019
No. of days : 91
Interest rate 12.04% p.a

What was the net amount received by the company on issue of CP? (Charges of intermediary may be
ignored)

Reference What’s New

Amount received on issue of Commercial

paper

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Q 2 Ex. Book No. Pg. No.

From the following particulars, calculate the effective rate of interest p.a. as well as the total cost of
funds to Bhaskar Ltd., which is planning a CP issue:

Issue Price of CP ` 97,550

Face Value ` 1,00,000
Maturity Period 3 Months
Issue Expenses:
Brokerage 0.15% for 3 months
Rating Charges 0.50% p.a.
Stamp Duty 0.175% for 3 months

Reference What’s New

Effective Rate of Interest

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Q 3 Ex. Book No. Pg. No.

AXY Ltd. is able to issue commercial paper of ` 50,00,000 every 4 months at a rate of 12.5% p.a. The
cost of placement of commercial paper issue is ` 2,500 per issue. AXY Ltd. is required to maintain line
of credit ` 1,50,000 in bank balance. The applicable income tax rate for AXY Ltd. is 30%.
What is the cost of funds (after taxes) to AXY Ltd. for commercial paper issue? The maturity of commer-
cial paper is four months.

Reference What’s New

Effective Cost of Fund

Q 4 Ex. Book No. Pg. No.

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RBI sold a 91 day T-bill of face value of 100 at an yield of 6%. What was the issue price?
`

Reference What’s New

Issue Price of a T Bill

Q 5 Ex. Book No. Pg. No.

A money market instrument with face value of `100 and discount yield of 6% will mature in 45 days.
You are required to calculate:
(i) Current price of the instrument.
(ii) Bond equivalent yield
(iii) Effective annual return.

Reference What’s New

Issue price, Bond equivalent yield and

effective annual return

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Q 6 Ex. Book No. Pg. No.

Wonderland Limited has excess cash of ` 20 lakhs, which it wants to invest in short term marketable
securities. Expenses relating to investment will be ` 50,000.
The securities invested will have an annual yield of 9%.
The company seeks your advice
(i) as to the period of investment so as to earn a pre-tax income of 5%.
(ii) the minimum period for the company to breakeven its investment expenditure overtime value
of money.

Reference What’s New

Period of investment to earn desired

return by Investor

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Q 7 Ex. Book No. Pg. No.

Bank A enters into a Repo for 14 days with Bank B in 12% GOI Bonds at a rate of 5.25% for ` 5 crores
(Face value ` 100). Assuming that the clean price be 99.42, initial margin be 2% and days of accrued
interest be 292, No. of days in a year = 360
Find
(i) Dirty Price
(ii) Start Proceeds (First leg)
(iii) Repayment at Maturity (Second leg)

Reference What’s New

Repo Contract Dirty Price

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1. Money Market vs Capital Market

Money Market Capital Market
(i) There is no classification between primary There is a classification between primary
market and secondary market market and secondary market.
(ii) It deals for funds of short-term require- It deals with funds of long-term require-
ment (less than a year). ment (more than 1 year).
(iii) Money market instruments include in- Capital Market instruments are shares and
terbank call money, notice money upto debt instruments.
14 days, short-term deposits upto three
months, commercial paper, 91 days treas-
ury bills.
(iv) Money market participants are banks, Capital Market participants include retail
financial institution, RBI and Government. investors, institutional investors like Mutu-
al Funds, Financial Institutions, corporate
and banks.
(v) Supplies funds for working capital require- Supplies funds for fixed capital require-
ment. ments.
(vi) Each single instrument is of a large Each single instrument is of a small
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amount. amount.
(vii) Risk involved in money market is less due Risk is higher
to smaller term of maturity. In short term
the risk of default is less.
(viii) Transactions take place over phone calls. Transactions are at a formal place viz. the
Hence there is no formal place for transac- stock exchange.
tions.
(ix) The basic role of money market is liquidity The basic role of capital market includes
adjustment. putting capital to work, preferably to long
term, secure and productive employment.
(x) Closely and directly linked with the Central The Capital market feels the influence of
Bank of India the Central Bank but only indirectly and
through the money market
(xi) Commercial Banks are closely regulated. The institutions are not much regulated.
2. Pre–Conditions for an Efficient Money Market
(i) Institutional development, relative political stability and a reasonably well developed
banking and financial system.
(ii) Integrity is sine qua non. Thus banks and other players in the market may have to be licensed
and effectively supervised by regulators.
(iii) There must also exist a demand for temporarily available cash either by banks or financial
institutions for the purpose of adjusting their liquidity position and finance the carrying of
the relevant assets in their balance sheets.
(iv) Efficient payment systems for clearing and settlement of transactions.
(v) Government/Central Bank intervention to moderate liquidity profile.
(vi) Strong Central Bank to ensure credibility in the system and to supervise the players in the
market.

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(vii) The market should have varied instruments with distinctive maturity and risk profiles to
meet the varied appetite of the players in the market. Multiple instruments add strength
and depth to the market; and
(viii) Market should be integrated with the rest of the markets in the financial system to ensure
perfect equilibrium.
3. Rigidities in the Indian Money Market
The most important rigidities in the Indian money market are:
(i) Markets not integrated,
(ii) High volatility,
(iii) Interest rates not properly aligned,
(iv) Players restricted,
(v) Supply based-sources influence uses,
(vi) Not many instruments,
(vii) Players do not alternate between borrowing and lending,
(viii) Reserve requirements,

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(ix) Lack of transparency, and,
(x) Inefficient Payment Systems.
(xi) RBI should encourage banks to make use of Commercial Papers instead of Cash Transfer
4. Money Market Instruments
(a) Call Money: The Call Money is a part of the money market where, day to day surplus funds,
mostly of banks, are traded. Moreover, the call money market is most liquid of all short-term
money market segments.
The maturity period of call loans vary from 1 to 14 days. The money that is lent for one day
in call money market is also known as ‘overnight money’. The interest paid on call loans are
known as the call rates. The call rate is expected to freely reflect the day-to-day lack of funds.
These rates vary from day-to-day and within the day, often from hour-to-hour. High rates
indicate the tightness of liquidity in the financial system while low rates indicate an easy
liquidity position in the market.
In India, call money is lent mainly to even out the short-term mismatches of assets and
liabilities and to meet CRR requirement of banks. The short-term mismatches arise due
to variation in maturities i.e. the deposits mobilized are deployed by the bank at a longer
maturity to earn more returns and duration of withdrawal of deposits by customers vary.
Thus, the banks borrow from call money markets to meet short-term maturity mismatches.
Moreover, the banks borrow from call money market to meet the cash Reserve Ratio (CRR)
requirements that they should maintain with RBI every fortnight and is computed as a
percentage of Net Demand and Time Liabilities (NDTL).
(b) Inter-Bank Term Money: This market which was exclusively for commercial banks and co-
operative banks has been opened up for select All India Development Financial Institutions
in October, 1993. The DFIs are permitted to borrow from the market for a maturity period
of 3 to 6 months within the limits stipulated by Reserve Bank of India for each institution.
The interest rates in the market are driven. As per IBA ground rules, lenders in the market

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cannot prematurely recall these funds and as such this instrument is not liquid. The market
is predominantly 90-days market. The market has shown a lot of transactions following
withdrawal of CRR/SLR on liabilities of the banking system.
The development of the term money market is inevitable due to the following reasons:
a. Declining spread in lending operations
b. Volatility in the call money market
c. Growing desire for fixed interest rates borrowing by corporates
d. Move towards fuller integration between forex and money market
e. Stringent guidelines by regulators/ management of the institutions
(c) Inter-Bank Participation Certificate (IBPC): The Inter Bank Participation Certificates are
short term instruments to even out the short-term liquidity within the Banking system
particularly when there are imbalances affecting the maturity mix of assets in Banking Book.
The primary objective is to provide some degree of flexibility in the credit portfolio of banks.
It can be issued by schedule commercial bank and can be subscribed by any commercial
bank.
The IBPC is issued against an underlying advance, classified standard and the aggregate
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amount of participation in any account time issue. During the currency of the participation,
the aggregate amount of participation should be covered by the outstanding balance in
account.
There are two types of participation certificates, with risk to the lender and without risk to the
lender. Under ‘with risk participation’, the issuing bank will reduce the amount of participation
from the advances outstanding and participating bank will show the participation as part
of its advances. Banks are permitted to issue IBPC under ‘with risk’ nomenclature classified
under Health Code-I status and the aggregate amount of such participation in any account
should not exceed 40% of outstanding amount at the time of issue. The interest rate on IBPC
is freely determined in the market. The certificates are neither transferable nor prematurely
redeemable by the issuing bank.
Under without risk participation, the issuing bank will show the participation as borrowing
from banks and participating bank will show it as advances to bank.
The scheme is beneficial both to the issuing and participating banks. The issuing bank
can secure funds against advances without actually diluting its asset-mix. A bank having
the highest loans to total asset ratio and liquidity bind can square the situation by issuing
IBPCs. To the lender, it provides an opportunity to deploy the short-term surplus funds in
a secured and profitable manner. The IBPC with risk can also be used for capital adequacy
management.
(d) Inter Corporate Deposit: The inter corporate market operates outside the purview of
regulatory framework. It provides an opportunity for the corporates to park their short-term
surplus funds at market determined rates. The market is predominantly a 90 days market
and may extend to a maximum period of 180 days. The market which witnessed flurry of
activities has received a serious jolt in the wake of series of defaults.

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Why do companies go for ICD?

• Immediate capital for short term requirements
• Transactions are free from bureaucratic and legal hassles
• Better than bank loans
The market of inter-corporate deposits maintains secrecy. The brokers in this market never
reveal their lists of lenders and borrowers, because they believe that if proper secrecy is
not maintained the rate of interest can fall abruptly. The market of inter-corporate deposits
depends crucially on personal contacts. The decisions of lending in this market are largely
governed by personal contacts.
(e) Treasury Bills (TBs): Among money market instruments TBs provide a temporary outlet for
short-term surplus as also provide financial instruments of varying short-term maturities
to facilitate a dynamic asset-liabilities management. The interest received on them is the
discount which is the difference between the price at which they are issued and their
redemption value. They have assured yield and negligible risk of default. The TBs are short
term promissory notes issued by Government of India at a discount for 14 days to 364 days.
Features of T-bills:
Form: The treasury bills are issued in the form of promissory note in physical form or by
credit to Subsidiary General Ledger (SGL) account or Gilt account in dematerialised form.
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Eligibility: TBs can be purchased by any person, firm, company corporate body and
institutions. State Government, Non-Government Provident Funds governed by the PF Act,
1925 and Employees Provident Fund and Miscellaneous Provisions Act, 1952 are eligible
to participate in the auctions of 14 days and 91 days TBs on a non-competitive basis. Non-
competitive bids are accepted at the weighted average price arrived at on the basis of
competitiveness bids accepted at the auctions. TBs are approved securities for the purpose
of SLR. While Reserve Bank of India does not participate in the auctions of 14 days and
364 days TBs, it will be at its liberty to participate in the auctions and to buy part or the
whole of the amount notified in respect of 91 days TBs. The Primary Dealers also underwrite
a minimum of 25% of the notified amount of the 91 days TBs. They also underwrite the
amount offered by RBI in respect of 14 and 364 days TBs.
Minimum Amount of Bids: TBs are issued in lots of ` 25,000 (14 days and 91 days)/` 1,00,000
(364 days).
Repayment: The treasury bills are repaid at par on the expiry of their tenor at the office of
the Reserve Bank of India, Mumbai.
Availability: All the treasury Bills are highly liquid instruments available both in the primary
and secondary market.
Day Count: For treasury bills the day count is taken as 364 days for a year.
Additional Features: T- Bills have the following additional features:
(1) Government’s contribution to the money market,
(2) Mop-up short-term funds in the money market,
(3) Sold through auctions,
(4) Discount rate is market driven, and
(5) Focal Point for monetary policy
(6) Helps to meet the temporary mismatches in cash flows

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Advantages to Investors:
(i) Manage cash position with minimum balances,
(ii) Increased liquidity,
(iii) Absence of risk of default
(iv) Market related assured yield,
(v) Eligible for repos,
(vi) SLR security,
(vii) No capital loss,
(viii) Two-way quotes by DFHI/Primary Dealers (PDs)/Banks.
(ix) Low transaction cost
(x) No tax deducted at source
(xi) Transparency
(xii) Simplified Settlement
(xiii) High degree of tradability and active secondary market facilitates meeting unplanned
fund requirements.
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The PDs have assumed the role of market makers in treasury bills and they regularly provides
two-way quotes. This has added to the liquidity and deepened the secondary market of
this instrument. Thus treasury bills have emerged as an effective instrument for dynamic
asset liability management. Apart from liquidating the treasury bills in the secondary
market, treasury bills can be used for transactions which will help the fund managers to
temporarily deploy or borrow funds without altering their assets portfolio. Due to its mode
and periodicity of issue (weekly and fortnightly auctions) as also the existence of a well
developed secondary market, the fund manager could build-up a portfolio of treasury bills
with varying maturities which will match their volatile liabilities.
(f) Commercial Bills: A commercial bill is one which arises out of a genuine trade transaction,
i.e. credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer
for the amount due. The buyer accepts it immediately agreeing to pay amount mentioned
therein after a certain specified date. Thus, a bill of exchange contains a written order from
the creditor to the debtor, to pay a certain sum, to a certain person, after a creation period.
A bill of exchange is a ‘self-liquidating’ paper and negotiable; it is drawn always for a short
period ranging between 3 months and 6 months.
Bill financing is the core component of meeting working capital needs of corporates in
developed countries. Such a mode of financing facilitates an efficient payment system. The
commercial bill is instrument drawn by a seller of goods on a buyer of goods.
(g) Certificate of Deposits (CDs): The CDs are negotiable term-deposits accepted by
commercial bank from bulk depositors at market related rates. CDs are usually issued in
demat form or as a Usance Promisory Note.
Eligibility: All scheduled banks (except RRBs and Co-operative banks) are eligible to issue
CDs. They can be issued to individuals, corporates, trusts, funds and associations. NRIs can
also subscribe to CDs but on non-repatriable basis only. In secondary markets such CDs
cannot be endorsed to another NRI.

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Term: The CDs can be issued by scheduled commercial banks (excluding RRBs) at a discount
to face value for a period from 3 months to one year. For CDs issued by Financial institutions
maturity is minimum 1 year and maximum 3 years.
Denomination: The CDs can be issued for minimum amount of ` 5 lakhs to a single investor.
CDs above ` 5 lakhs should be in multiples of ` 1 lakh. There is, however, no limit on the total
quantum of funds raised through CDs.
Transferability: CDs issued in physical form are freely transferable by endorsement and
delivery. Procedure of transfer of dematted CDs is similar to any other demat securities. The
CDs can be negotiated on or after 30 days from the date of issue to the primary investor.
Others: The CDs are to be reckoned for reserve requirements and are also subject to stamp
duty. Banks are prohibited from granting loans against CDs as buy-back of their own CDs.
Discount: As stated earlier, CDs are issued at discount to face value. The discount is offered
either front end or rear end. In the case of front end discount, the effective rate of discount
is higher than the quoted rate, while in case of rear end discount, the CDs on maturity yield
the quoted rate. The discount on CDs is deregulated and is market determined. Banks can
use the CD Scheme to increase their deposit base by offering higher discount rates than on
usual time deposits from their retail customers.
(h) Commercial Paper: Commercial paper (CP) has its origin in the financial markets of
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America and Europe. The concept of CPs was originated in USA in early 19th century when
commercial banks monopolised and charged high rate of interest on loans and advances. In
India, the CP was introduced in January 1990 on the recommendation of Vaghul Committee
subject to various conditions. When the process of financial dis-intermediation started in
India in 1990, RBI allowed issue of two instruments, viz., the Commercial Paper (CP) and the
Certificate of Deposit (CD) as a part of reform in the financial sector. A notable feature of
RBI Credit Policy announced on 16.10.1993 was the liberalisation of terms of issue of CP. At
present it provides the cheapest source of funds for corporate sector and has caught the
fancy of corporate sector and banks. Its market has picked up considerably in India due to
interest rate differentials in the inter-bank and commercial lending rates.
CPs are unsecured and negotiable promissory notes issued by high rated corporate entities
to raise short-term funds for meeting working capital requirements directly from the market
instead of borrowing from banks. Its period ranges from 15 days to 1 year. CP is issued at
discount to face value and is not transferable by endorsement and delivery. The issue of
CP seeks to by pass the intermediary role of the banking system through the process of
securitisation.
It partly replaces the working capital limits enjoyed by companies with the commercial
banks and there will be no net increase in their borrowing by issue of CP.
Timing of CP
The timing of the launch of the CP issue would be indicated by RBI while giving its permission,
to ensure an orderly approach to the market.
Denomination and size of CP
Minimum size of CP issue – ` 25 lakhs.
Denomination of CP note – ` 5 lacs or multiples thereof.
Maximum size of CP issue – 100% of the issuer’s working capital (fund based) limits
(determined by the consortium leader).

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The entire approved quantum of CP can be issued on a single date, or in parts on different
dates, within two weeks of the Reserve Bank of India’s approval, subject to the condition
that the entire amount of issue matures on the same date.
Period of CP
Minimum currency – 15 days from the date of issue.
Maximum currency – 360 days from the date of issue.
No grace period for repayment of CP.
If maturity date happens to be a holiday, issuer has to make the payment on the immediate
preceding working day.
The entire approved amount should be raised within a period of 2 weeks from the date of
approval of RBI.
Each CP issue (including roll-over) has to be treated as a fresh issue has to seek permission
from RBI
Mode of CP
CP has to be issued at a discount to face value.
Discount rate has to be freely determined by the market.
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Negotiability of CP: CP (being usance promissory note) would be freely negotiable by
endorsement and delivery.
Underwriting/co-acceptance of CPs: The CP issue cannot be underwritten or co-accepted
in any manner. Commercial Banks, however, can provide standby facility for redemption of
CPs on the maturity date.
Printing of CP: Issuer has to ensure that CP is printed on good quality security paper and
that necessary precautions are taken to guard against tampering with the documents, since
CP will be freely transferable by endorsement and delivery. CP should be signed by at least
2 authorised signatories and authenticated by the issuer’s agent (bank).
Issue expenses: The issue of CP would be subject to payment of stamp duty. All issue
expenses such as dealer’s fees, issuing and paying agent’s fees, rating agency fees, charges
levied by banks for providing redemption standby facilities and any other charges connected
with the issue of CPs are to be borne by the issuer.
The issuer: The CP issuer can be a Company incorporated under the Companies Act subject
to some requirements.
Benefits of Commercial Paper
CPs have been introduced in the Indian market so as to provide a diversified source of
funding to the borrowers as well as an additional investment option to the investors. CPs
can now be issued as a low cost alternative to bank financing to meet a part of working
capital requirements.
Benefits to the Issuer – The following are major benefits to issuer of CP
(i) Low interest expenses: The interest cost associated with the issuance of CP is normally
expected to be less than the cost of bank financing, as among other things, it is related
to the inter-corporate money market rate, which in normal times is within the cost of
bank finance.

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(ii) Access to short term funding: CP issuance provides a company with increased access
to short term funding sources. By bringing the short term borrower into direct contact
with investors, the CP market will, to some extent, disintermediate the established role
of banks and pass on the benefit to both issuers and investors.
(iii) Flexibility and liquidity: CP affords the issuer increased flexibility and liquidity in
matching the exact amount and maturity of its debt to its current working capital
requirement.
(iv) Investor recognition: The issuance of CP provides the issuer with favourable exposure
to major institutional investors as well as wider distribution of its debt.
(v) Ease and low cost of establishment: A CP programme can be established with ease
at a low cost, once the basic criteria have been satisfied.
Benefits to the Investor – The following are major benefits to investor of CP
(i) Higher yield: Higher yields are expected to be generally obtainable on CP than on
other short term money market instruments like bank deposits. Investment managers
are increasingly looking to match investible excess cash with higher yielding securities
as compared to those presently available in the market.
(ii) Portfolio diversification: Commercial Paper provides an attractive avenue for short
term portfolio diversification.
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(iii) Flexibility: CPs can be issued for periods ranging from 15 days to less than one year,
thereby affording an opportunity to precisely match cash flow requirements.
(iv) Liquidity: Liquidity in CP is generally provided by a dealer offering to buy it back from
an investor prior to maturity, for which a market quote will be available. The investment
in CP will therefore be quite liquid.
5. Debt Securitisation
Debt Securitisation is a method of recycling of funds. This method is mostly used by finance
companies to raise funds against financial assets such as loan receivables, mortgage backed
receivables, credit card balances, hire purchase debtors, lease receivables, trade debtors, etc.
and thus beneficial to such financial intermediaries to support their lending volumes. Thus,
assets generating steady cash flows are packaged together and against this assets pool market
securities can be issued. Investors are usually cash-rich institutional investors like mutual funds
and insurance companies.
The process can be classified in the following three functions:
1. The origination function – A borrower seeks a loan from finance company, bank, housing
company or a financial institution. On the basis of credit worthiness repayment schedule is
structured over the life of the loan.
2. The pooling function – Many similar loans or receivables are clubbed together to create
an underlying pool of assets. This pool is transferred in favour of a SPV (Special Purpose
Vehicle), which acts as a trustee for the investor. Once the assets are transferred they are
held in the organizers portfolios.
3. The securitisation function – It is the SPV’s job to structure and issue the securities on the
basis of asset pool. The securities carry coupon and an expected maturity, which can be asset
base or mortgage based. These are generally sold to investors through merchant bankers.
The investors interested in this type of securities are generally institutional investors like

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mutual fund, insurance companies etc. The originator usually keeps the spread available (i.e.
difference) between yield from secured asset and interest paid to investors.
Generally, the process of securitisation is without recourse i.e. the investor bears the credit risk of
default and the issuer is under an obligation to pay to investors only if the cash flows are received
by issuer from the collateral.
6. Money Market Mutual Funds (MMMFs) : MMMFs are primarily intended for individual investors
including NRIs who may invest on a non–repartriable basis. MMMFs would be free to determine
the minimum size of the investment by a single investor. There is no guaranteed minimum rate
of return. The minimum lock in period would be 46 days.
The resources mobilised by MMMFs should be invested exclusively in various money market
instruments.
7. Repo and a Reverse Repo
The term Repurchase Agreement (Repo) and Reverse Repurchase Agreement (Reverse Repo) refer
to a type of transaction in which money market participant raises funds by selling securities and
simultaneously agreeing to repurchase the same after a specified time generally at a specified
price, which typically includes interest at an agreed upon rate. Such a transaction is called a Repo
when viewed from the perspective of the seller of securities (the party acquiring funds) and
Reverse Repo when described from the point of view of the supplier of funds.
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Indian Repo market is governed by Reserve Bank of India. At present Repo is permitted between
64 players against Central and State Government Securities (including T-Bills) at Mumbai.

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Q 1 Ex. Book No. Pg. No.

From the following particulars, calculate the effective interest p.a. as well as the total cost of funds to
ABC Ltd., which is planning a CP issue:

Issue Price of CP = ` 97,350

Face Value = ` 1,00,000
Maturity period = 3 months.
Issue Expenses:
Brokerage: 0.125% for 3 months.
Rating Charges: 0.5% p.a.
Stamp duty: 0.125% for 3 months

Reference What’s New

Effective Rate of Interest

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Q 2 Ex. Book No. Pg. No.

RC Ltd. is able to issue commercial paper of Rs 50,00,000 every 4 months at a rate of 15% p.a. The cost
of placement of commercial paper issue is Rs 2,000 per issue. RC Ltd. is required to maintain line of
Credit of Rs 2,00,000 in bank balance. The applicable income tax rate for RC Ltd. is 30%.
What is the cost of funds (after taxes) to RC Ltd. for commercial paper issue? The maturity of commer-
cial paper is four months.

Reference What’s New

Effective Cost of Fund

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Q 3 Ex. Book No. Pg. No.

M Ltd. has to make a payment on 30th January, 2010 of Rs. 80 lakhs. It has surplus cash today, i.e. 31st
October, 2009; and has decided to invest sufficient cash in a bank’s Certificate of Deposit scheme of-
fering an yield of 8% p.a. on simple interest basis. What is the amount to be invested now?

Reference What’s New

Investor’s view Amount to be invested by

investor

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Fixed Income Security Valuation - Part C

Q 1 Ex. Book No. Pg. No.

A 6 years Zero Coupon Bonds of Face value ` 1,000 presently yielding 9.40%, calculate its Effective
Duration for an interest rate shock of 70 basis points.

Reference What’s New

Effective Duration

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Q 2 Ex. Book No. Pg. No.

A bond has the following features:-

Face value ` 1,000
Maturity 5 years
Coupon Rate 12% payable semi annually
Current Price ` 946
Interest rate shock 40 basis points
Calculate its effective duration.

Reference What’s New

Effective Duration

Q 3 Ex. Book No. Pg. No.

A bond has the following features:-

Face value ` 1,000

Maturity 4 years
Coupon Rate 15%
Yield to maturity 17%

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Calculate price volatility.

Reference What’s New

Modified Duration Price Volatility

Q 4 Ex. Book No. Pg. No.

A bond has the following features:-

Face value ` 1,000

Maturity 8 years
Coupon Rate 13%
Present traded price ` 976

Calculate its price volatility.

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Reference What’s New

Modified Duration Price Volatility

Q 5 Ex. Book No. Pg. No.

A bond has the following features:-

Face value ` 1,000

Maturity 6 years
Coupon Rate 10% semi annual
Present traded price ` 965

Calculate its price volatility.

Reference What’s New

Modified Duration Semi Annual Coupon

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Q 6 Ex. Book No. Pg. No.

The following data are available for a bond

Face value ` 1,000

Coupon Rate 16%
Years to Maturity 6
Redemption value ` 1,000
Yield to maturity 17%

Find
(a) The current market price,
(b) Duration
(c) Volatility of this bond
(d) The expected market price, if increase in required yield is by 75 basis points.

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Reference

Modify Duration Price calculated from volatility

What’s New

Q 7 Ex. Book No. Pg. No.

A bond has the following features. You are required to find the missing figures.

Face value ` 1,000

Maturity 3 years
Coupon Rate ?
Present traded price `?
Yield to maturity 14%
Duration 2.62 years

Reference What’s New

Missing figures of Modified Duration

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Q 8 Ex. Book No. Pg. No.

Find the current market price of a bond having face value ` 1,00,000 redeemable after 6 year maturity
with YTM at 16% payable annually and duration 4.3202 years. Given 1.166 = 2.4364.

Reference What’s New

Valuation of a Conventional or Plain Using concept of duration

Vanilla Bond

Q 9 Ex. Book No. Pg. No.

(a) Consider two bonds, one with 5 years to maturity and the other with 20 years to maturity. Both
the bonds have a face value of ` 1,000 and coupon rate of 8% (with annual interest payments)
and both are selling at par.

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(i) Assume that the yields of both the bonds fall to 6%, whether the price of bond will increase
or decrease?
(ii) What percentage of this increase/decrease comes from a change in the present value of
bond’s principal amount?
(iii) What percentage of this increase/decrease comes from a change in the present value of
bond’s interest payments?
(b) Consider a bond selling at its par value of ` 1,000, with 6 years to maturity and a 7% coupon rate
(with annual interest payment), what is bond’s duration?
(c) If the YTM of the bond in (b) above increases to 10%, how it affects the bond’s duration? And
why?

Reference What’s New

Bond Duration

Q 10 Ex. Book No. Pg. No.

Current traded price of a bond is ` 900

Modified Duration 6%
Interest rate is expected to fall by 50bp
(i) Calculate the new price using Modified duration?

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(ii) Think of convexity and state whether the true bond price will be higher or lower than the answer
arrived in (i) above.

Reference What’s New

New Bond Price using Modified Duration

Q 11 Ex. Book No. Pg. No.

A 3 year bond of face value ` 1000 has an annual coupon rate of 12%.
Calculate its price today (Po); after 1 year (P1); after 2 years (P2), assuming that yield remains at 15%.

Reference What’s New

Bond Value Theorems

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Q 12 Ex. Book No. Pg. No.

Arrange the following bonds in the descending order of the duration (calculations not allowed) :-

Bonds Maturity Coupon Rate YTM

A 5 13% 11%
B 5 0% 11%
C 5 15% 12%
D 5 13% 12%

Reference What’s New

Bond Value Theorems

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Q 13 Ex. Book No. Pg. No.

The investment Portfolio of a Bank is as follows as on 31st March 2018:

Bonds Coupon Rate Purchase Rate Duration in Years

A 11.68% 106.5 3.5
B 7.55% 105 6.5
C 7.38% 105 7.5
D 8.35% 110 8.75
E 7.95% 101 13
(i) Calculate the actual investment in the portfolio if current value of investment in each bond is ` 5
Crores.
(ii) Calculate duration of bond portfolio
(iii) What is the suitable action to churn out the investment portfolio in the following scenarios -
(a) Interest rate are expected to decrease by 25 basis points
(b) Interest rate are expected to increase by 75 basis points
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Also Calculate the revised portfolio duration in each scenario

Reference What’s New

Active Bond Portfolio Management

Q 14 Ex. Book No. Pg. No.

A Pension fund has the following liabilities :

Years Liabilities (Amount ` in Lakhs)

2 80
3 120
5 100

Opportunity cost of funds is 9%.

The following two bonds have been short listed for investment –
Short term Bond A – It is a ZCB of maturity 1 yr & presently yielding 9%
Long term Bond B – It is a ZCB of maturity 6 yrs & presently yielding 9%
(a) Calculate the proportion of funds to be invested in each bond for immunization.
(b) Show the process of immunization if the interest rate after year 1 falls to 8%

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Reference What’s New

Passive Bond Portfolio Management

Q 15 Ex. Book No. Pg. No.

Mr. A will need ` 1,00,000 after two years for which he wants to make one time necessary investment
now. He has a choice of two types of bonds. Their details are as below:

Bond X Bond Y
Face value ` 1,000 ` 1,000
Coupon 7% payable annually 8% payable annually
Years to maturity 1 4
Current price ` 972.73 ` 936.52

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Current yield 10% 10%

Advice Mr. A whether he should invest all his money in one type of bond or he should buy both the
bonds and, if so, in which quantity? Assume that there will not be any call risk or default risk.

Reference What’s New

Passive Bond Portfolio Management

Q 16 Ex. Book No. Pg. No.

A bond has the following features:-

Face value ` 1,000

Present traded price ` 970
Maturity 20 years
Coupon Rate 12%
Redemption Amount ` 1,000

The bond is callable after 5 years at a premium of 15%.

Calculate Yield to maturity and yield to call.

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Reference What’s New

Option Embedded Bonds Callable

Q 17 Ex. Book No. Pg. No.

Tere Naam Ltd. has issued convertible debentures with coupon rate 12%. Each debenture has an op-
tion to convert to 20 equity shares at any time until the date of maturity. Debentures will be redeemed
at ` 100 on maturity of 5 years. An investor generally requires a rate of return of 8% p.a. on a 5-year
security. As an investor when will you exercise conversion for given market prices of the equity share
of (i) ` 4, (ii) ` 5 and (iii) ` 6.
Cumulative PV factor for 8% for 5 years: 3.993 PV factor for 8% for year 5 : 0.681

Reference What’s New

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Optionally Convertible Debentures Puttable

Q 18 Ex. Book No. Pg. No.

Pet feed plc has outstanding, a high yield Bond with following features:

Face Value £ 10,000

Coupon 10%
Maturity Period 6 Years
Special Feature Company can extend the life of Bond to 12 years.

Presently the interest rate on equivalent Bond is 8%.

(a) If an investor expects that interest will be 8%, six years from now then how much he should pay
for this bond now.
(b) Now suppose, on the basis of that expectation, he invests in the Bond, but interest rate turns out
to be 12%. six years from now, then what will be his potential loss / gain.

Reference What’s New

Optionally Convertible Debentures Extendable

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Q 19 Ex. Book No. Pg. No.

ABC Ltd. has ` 300 million, 12 per cent bonds outstanding with six years remaining to maturity. Since
interest rates are falling, ABC Ltd. is contemplating of refunding these bonds with a ` 300 million issue
of 6 year bonds carrying a coupon rate of 10 per cent. Issue cost of the new bond will be ` 6 million and
the call premium is 4 per cent. ` 9 million being the unamortized portion of issue cost of old bonds can
be written off no sooner the old bonds are called off. Marginal tax rate of ABC Ltd. is 30 per cent. You
are required to analyse the bond refunding decision.

Reference What’s New

Bond Refunding Decision Callable Bond

Q 20 Ex. Book No. Pg. No.

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M/s Transindia Ltd. is contemplating calling 3 crores of 30 years, 1,000 bond issued 5 years ago with
` `
a coupon interest rate of 14 per cent. The bonds have a call price of ` 1,140 and had initially collected
proceeds of ` 2.91 crores due to a discount of ` 30 per bond. The initial floating cost was ` 3,60,000.
The Company intends to sell ` 3 crores of 12 per cent coupon rate, 25 years bonds to raise funds for
retiring the old bonds. It proposes to sell the new bonds at their par value of ` 1,000. The estimated
floatation cost is ` 4,00,000. The company is paying 40% tax and its after tax cost of debt is 8 per cent.
As the new bonds must first be sold and their proceeds, then used to retire old bonds, the company
expects a two months period of overlapping interest during which interest must be paid on both the
old and new bonds. What is the feasibility of refunding bonds?

Reference What’s New

Bond Refunding Decision Callable Bond

Q 21 Ex. Book No. Pg. No.

The following zero coupon treasury bonds are of face value ` 1,000 each.

Bond Maturity (years) Price

A 5 680
B 10 370
C 15 210
D 20 180

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Calculate the spot rates for various maturities.

Reference What’s New

Term structure Spot rates

Q 22 Ex. Book No. Pg. No.

A bond has the following features :-

Face Value ` 1,000

Coupon Rate 10%
Maturity 3 years

The term structure is as follows :- r0n = 11+n/2

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Calculate:
(i) Bond price
(ii) YTM of the bond
(iii) Duration of the bond
(iv) Bond volatility

Reference What’s New

Term Structure Pricing

Q 23 Ex. Book No. Pg. No.

Consider the following bonds –

Bonds Maturity Face Value Coupon Rate Price

A 1 1000 10% 960
B 2 1000 11% 980
C 3 1000 12% 990

Derive the term structure using the boot strapping.

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Reference What’s New

Term structure Boot strapping - Spot rates

Q 24 Ex. Book No. Pg. No.

From the following data for Government securities, calculate the forward rates:

Face value (`) Interest rate Maturity (Year) Current price (`)
1,00,000 0% 1 91,500
1,00,000 10% 2 98,500
1,00,000 10.5% 3 99,000

Reference What’s New

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Term Structure Forward rates

Q 25 Ex. Book No. Pg. No.

Consider the following term structure :-

Maturity (Yrs) Spot Rate

1 10%
2 11%
3 12%

Consider a 3 year Zero Coupon Bonds of face value ` 1,000, buy it now and sell it after 1 year, Calculate
the expected return assuming pure expectations theory holds good .

Reference What’s New

Term structure Forward rate

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Q 26 Ex. Book No. Pg. No.

ABC Ltd. issued 9%, 5 year bonds of ` 1,000/- each having a maturity of 3 years. The present rate of
interest is 12% for one year tenure. It is expected that Forward rate of interest for one year tenure is
going to fall by 75 basis points and further by 50 basis points for every next year in further for the same
tenure. This bond has a beta value of 1.02 and is more popular in the market due to less credit risk.
Calculate
(i) Intrinsic value of bond
(ii) Expected price bond in the market

Reference What’s New

Term structure Forward rate

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Q 27 Ex. Book No. Pg. No.

Consider the valuation date to be 1st November 2018. A bond has the following features –

Face Value ` 1,000

Coupon Rate 12% payable semi annually – June and December
Maturity Date 31st December 2026
Yield applicable 15%

Calculate full price and the clean price of the bond.

Reference What’s New

Valuing a Bond Clean Price and Dirty Price

Q 28 Ex. Book No. Pg. No.

MP Ltd. issued a new series of bonds on January 1, 2010. The bonds were sold at par (`1,000), having a
coupon rate 10% p.a. and mature on 31st December, 2025. Coupon payments are made semiannually
on June 30th and December 31st each year. Assume that you purchased an outstanding MP Ltd. bond
on 1st March, 2018 when the going interest rate was 12%.

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Required:
(i) What was the YTM of MP Ltd. bonds as on January 1, 2010?
(ii) What amount you should pay to complete the transaction? Of that amount how much should be
accrued interest and how much would represent bonds basic value.

Reference What’s New

Valuing a Bond Clean Price and Dirty Price

Q 29 Ex. Book No. Pg. No.

A bond with the following features:-

Face value ` 1000, Coupon rate 12% annual, Maturity 5 years, Market price is ` 962.
i) Calculate YTM of the bond and state its assumptions.
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ii) If the intermediate cash flows are not re invested at all, calculate realized yield.
iii) If the intermediate cash flows are re invested at rate 7%p.a. calculate realized yield.

Reference What’s New

Reinvestment assumption of YTM

Q 30 Ex. Book No. Pg. No.

XL Ispat Ltd. has made an issue of 14 per cent non-convertible debentures on January 1, 2007. These
debentures have a face value of ` 100 and is currently traded in the market at a price of ` 90.
Interest on these NCDs will be paid through post-dated cheques dated June 30 and December 31.
Interest payments for the first 3 years will be paid in advance through post-dated cheques while for
the last 2 years post-dated cheques will be issued at the third year. The bond is redeemable at par on
December 31, 2011 at the end of 5 years.
Required :
(i) Estimate the current yield and YTM of the bond.
(ii) Calculate the duration of the NCD.
(iii) Assuming that intermediate coupon payments are, not available for reinvestment calculate the
realised yield on the NCD.

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Reference What’s New

Reinvestment assumption of YTM

Q 31 Ex. Book No. Pg. No.

Face value 1000, coupon rate 12%, maturity 3 years, Ytm 15%,
Calculate duration and convexity.

Reference What’s New

Calculation of Convexity

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Q 32 Ex. Book No. Pg. No.

Consider a 5 yrs partly convertible debenture with the following features:

Face value ` 1000, Coupon rate 12%
a) Convertible FV ` 600 – it will be converted into 4 shares, 3 years from now.
b) Non-convertible FV ` 400 – it will be redeemed after 5 years at par.
It is expected that the stock will have a P-E multiple of 25 times at the end of 3 years. Also, expected
EPS for the 3rd year = ` 10/share.
If the investor requires a return of 15%p.a., calculate intrinsic value of the partly convertible deben-
ture.

Reference What’s New

Partly Convertible Debentures

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Q 33 Ex. Book No. Pg. No.

Consider an Optionally Convertible Debenture with the following features:-

Face value ` 1000

Coupon rate 10%
Maturity 5yrs
Conversion ratio 10 shares
Share price ` 92
Yield on similar bonds without conversion feature - 14 %
DPS `6

Calculate price of the Optionally Convertible Debenture, given that option value is 5% of floor value.

Reference What’s New

Optionally Convertible Debentures

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Q 34 Ex. Book No. Pg. No.

GHI Ltd., AAA rated company has issued, fully convertible bonds on the following terms, a year ago:

Face value of bond ` 1000

Coupon (interest rate) 8.5%
Time to Maturity (remaining) 3 years
Interest Payment Annual, at the end of year
Principal Repayment At the end of bond maturity
Conversion ratio (Number of shares per bond) 25
Current market price per share ` 45
Market price of convertible bond ` 1175

AA rated company can issue plain vanilla bonds without conversion option at an interest rate of 9.5%.
Required: Calculate as of today:
(i) Straight Value of bond.
(ii) Conversion Value of the bond.
(iii) Conversion Premium.
(iv) Percentage of downside risk.

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(v) Conversion Parity Price.

t 1 2 3
PVIF0.095, t 0.9132 0.8340 0.7617

Reference What’s New

Convertible Bonds Different Calculations

Q 35 Ex. Book No. Pg. No.

Face value of the Convertible Debenture ` 500,

Maturity 5 yrs
Coupon rate 10%

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Conversion price
Share price
`100,
` 92
Dividend/share `8
Market price of the Convertible Debenture ` 540
Yield on similar bonds without conversion feature 11%
a) Calculate conversion value.
b) Calculate straight debt value.
c) Calculate conversion parity price.
d) Calculate percentage of down side risk.
e) Calculate conversion premium/share.
f ) Calculate premium over conversion value.
g) Calculate favourable income differential/share.
h) Calculate the premium payback period.

Reference What’s New

Convertible Debentures

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Q 36 Ex. Book No. Pg. No.

The data given below relates to a convertible bond :

Face value ` 250

Coupon rate 12%
No. of shares per bond 20
Market price of share ` 12
Straight value of bond ` 235
Market price of convertible bond ` 265

Calculate:
(i) Stock value of bond.
(ii) The percentage of downside risk.
(iii) The conversion premium
(iv) The conversion parity price of the stock.
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Reference What’s New

Convertible Bonds Different Calculations

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Q 1 Ex. Book No. Pg. No.

A pension fund has the following stream of liabilities :-

Years Liabilities (Amount ` in Lakhs)

2 300
3 400
5 500

Opportunity cost of funds is 12%, the following two bonds have been short listed for investment –
Bond X – It is a ZCB of maturity 1 yr & presently yielding 12%
Bond Y – It is a ZCB of maturity 6 yrs & presently yielding 12%
Calculate the proportion of funds to be invested in each bond for immunization.

Reference What’s New

Passive Bond Portfolio Management

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Q 2 Ex. Book No. Pg. No.

John inherited the following securities on his uncle’s death:

Types of Security Nos. Annual Coupon % Maturity Years Yield %

Bond A (`1,000) 10 9 3 12
Bond B (`1,000) 10 10 5 12
Preference shares C (` 100) 100 11 * 13*
Preference shares D (`100) 100 12 * 13*

*likelihood of being called at a premium over par.

Compute the current value of his uncle’s portfolio.

Reference What’s New

Bond Portfolio Valuation

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Q 3 Ex. Book No. Pg. No.

A convertible bond with a face value of ` 1,000 is issued at ` 1,350 with a coupon rate of 10.5%. The
conversion rate is 14 shares per bond. The current market price of bond and share is `1,475 and ` 80
respectively. What is the premium over conversion value?

Reference What’s New

Convertible Bonds Conversion Premium

Q 4 Ex. Book No. Pg. No.

Pineapple Ltd has issued fully convertible 12 percent debentures of ` 5,000 face value, convertible
into 10 equity shares. The current market price of the debentures is ` 5,400. The present market price
of equity shares is ` 430.
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Calculate:
(i) the conversion percentage discount, and
(ii) the conversion value

Reference What’s New

Convertible debentures Discount

Q 5 Ex. Book No. Pg. No.

Mr. A is planning for making investment in bonds of one of the two companies X Ltd. and Y Ltd. The
detail of these bonds is as follows:

Company Face Value Coupon Rate Maturity Period

X Ltd. ` 10,000 6% 5 Years
Y Ltd. ` 0,000 4% 5 Years

The current market price of X Ltd.’s bond is ` 10,796.80 and both bonds have same Yield To Maturity
(YTM). Since Mr. A considers duration of bonds as the basis of decision making, you are required to
calculate the duration of each bond and your decision.

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Reference What’s New

Bond duration

Q 6 Ex. Book No. Pg. No.

The following data is available for a bond;

Face Value ` 1,000

Coupon Rate 11%
Years to Maturity 6
Redemption Value ` 1,000
Yield to Maturity 15%

(Round-off your answers to 3 decimals)

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Calculate the following in respect of the bond:
(i) Current Market Price.
(ii) Duration of the Bond.
(iii) Volatility of the Bond.
(iv) Expected market price if Increase in required yield is by 100 basis points.
(v) Expected market price if decrease in required yield is by 75 basis points.

Reference What’s New

Bond duration

Q 7 Ex. Book No. Pg. No.

The price of a bond just before a year of maturity is $ 5,000. Its redemption value is $ 5,250 at the end
of the said period. Interest is $ 350 p.a. The Dollar appreciates by 2% during the said period. Calculate
the rate of return.

Reference What’s New

Bond Yield Foreign Exchange Impact

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