CONCEPTS

1. What is Earnings per share? How do you calculate it?

It is one of the most commonly used corporate profitability measures for Publicly Traded firms.
Formula for basic EPS- Net Income- Pref Dividends/Weighted Average No of shares O/S
Formula for Diluted EPS-Adjusted Income available for common shares/ Weighted Average No of shares O/S

2. What do you understand by Operating Profit?

Operating profit is derived from subtracting variable & fixed cost from the net sales. It tells us how much f the revenue is
being converted to operating income & more the conversion better the profitability.

3. What do you understand by Return on Equity?

A key ratio used to determine management efficiency is the accounting return of equity. Its formula is PAT/Average
Equity. Higher ROE is generally viewed as positive for the firm, but the reason for an increase should be examined. For
instance if book value is decreasing more rapidly than net income, ROE will increase. This is however not positive for
the firm as firm may raise debt to bring down its equity thus increasing the ROE but at the same time making the shares
riskier due to increased leverage.

4. As there is no explicit cost of retained earnings, these funds are free of cost? Explain the statement.
There is an opportunity cost to retained earnings as these funds could be invested on a decent rate of return above the
risk free rate (10 Year G-Sec Bond).So the company must be prudent to use these funds to generate a return more than
the expected return.

5. Dividend, Investment and Financing decisions are interdependent. Explain.

Lets take retained earning which has a opportunity cost of 10%,company has two options either to by retaining more by
investing & expand its operations or give its as dividends to its shareholders. But in both the situations the main aim of
the company is to maximise the returns of the shareholders. So if the ROE is more than opportunity cost shareholders
will be better placed if the company expands its operations & give shareholder returns via capital appreciation in stocks
or simply if the ROE is less than expected return than one may simple give more dividends to its shareholders.

6. Cost of debt is always cheaper as compared to other sources of funds. Why?

It is cheaper than equity finance, since the lender faces less risk than a shareholder would, and also because
the debt interest is tax deductible. However, the interest is an obligation which cannot be avoided, so debt is a less
flexible form of finance than equity

7. What is Price Earnings ratio? How is it calculated?

It is used for valuation. It is calculated Current market price of a share/ EPS. The P/E ratio indicates the expected
price of a share based on its earnings. As the company EPS begins to rise, so does their market value per share. A
company with high P/E ratio usually indicated positive future performance& investors are willing to pay more for this
company shares. A company with a lower ratio on the other hand, is usually an indication of poor current & future
performance. This could prove to be a poor investment. So generally company with higher P/E are expected to grow &
perform better in future.

8. What is the difference between Gross Profit, Operating profit and Net Profit?
GP is the amount that remains after the direct costs of producing a good or service subtracted from revenues. Further
subtracting operating expenses, such as selling, general & administrative expenses from GP results in another subtotal
known as Operating Profit. Subtracting Interest expenses & income tax from operating profit results in firms net income.

9. Suggest suitable channels to a company for investment of its idle cash.

Fixed Deposit, Buy Back of Shares, Pay its Debt, Commercial Papers, Certificate of Deposit, Government Bonds,
Mutual Funds, Venture Capital Funds, Real Estate, Foreign Overseas Fund.

10. Companys current ratio is very high but the quick ratio is very low. Interpret.
The formula for Current Ratio is Current Assets/Current Liabilities whereas formula for quick ratio is Cash marketable
Securities+ Receivables/Current liabilities thus the quick ratio excludes Inventories which may not be able to be
liquidated for requirement of urgent money. If Current ratio is higher than quick ratio it indicates company is sitting on
too much inventories.
11. Company is following an erratic dividend policy. Comment
This dividend policy seems to be indifferent to the welfare of equity shareholders. Dividends are paid erratically
whenever the management believes it will not strain its resources. Companies that follow erratic dividend policy are
ignored by any investor that craves dividend stability. These companies by the very nature of their business models are
simply in no position to guarantee that dividends will remain constant & growing.
12. What are the factors that a finance manager must take into consideration while taking decisions on the
firms capital structure?
Tax Consideration, Reserve Borrowing Capacity, Cash Flows for servicing debt capital, Signalling to market,
Management control of business, Financing Flexibility, Asset Structure, Credit Rating of debt securities, Market outlook

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13. Define Modified Internal rate of return?
The calculation of IRR implicitly assumes that the positive cash flows earned during the life of a project are re-invested
at the rate of the IRR until the end of the investment period. This could cause the IRR to be overly optimistic. MIRR was
developed to counter this assumption. MIRR calculates the return on investment based on the more prudent assumption
that the cash inflows from a project shall be re-invested at the rate of the cost of capital. As a result, MIRR usually tends
to be lower than IRR.

14. Explain the need for a debt service coverage ratio. How is it calculated?
It allows us to determine whether firm is earning enough operating revenues to satisfy all its debt obligations (Interest &
Principal).Its formula is EBIT/(Interest Exp + (Principal payments/(I-t)).

15. Explain the term Ploughing back of profits?

Ploughing back of profits is an important source of Internal or self-financing by a company.It refers to the process of
retaining a part of companys net profits for the purpose of reinvesting in the business itself. It is the amount remaining
after a paying a reasonable amount of dividends the shareholders of the company to meet its present & future financial
requirements. This reduces their dependence on funds from external sources.

16. Why exporters suffer when rupee gets strengthened?

When a currency appreciates/strengthens in relation to other currencies exports get costlier & imports get cheaper. The
reason exports get costlier is because the exporter receives less rupee for every dollar worth of goods exported
whereas in imports the importer has to pay less rupee for every dollar worth of goods imported. For Instance it the rupee
strengthens from Rs 65/1$ to Rs60/1$ the exporter which had previously exported good when the Exchange rate was
pegged at Rs per dollar not stand to get only Rs 60 per dollar, a net loss of Rs 5.

17. What is a money market?

While the G-Secs market generally caters to the investors with a long term investment horizon, the money market
provides investment avenues of short term tenor. Money market transactions are generally used for funding the
transactions in other markets including G-Secs market and meeting short term liquidity mismatches. By definition,
money market is for a maximum tenor of up to one year. Within the one year, depending upon the tenors, money market
is classified into:
i. Overnight market - The tenor of transactions is one working day.
ii. Notice money market The tenor of the transactions is from 2 days to 14 days.
iii. Term money market The tenor of the transactions is from 15 days to one year.

18. What is a capital market?

Capital market consists of primary markets and secondary markets. Primary markets deal with trade of new issues of
stocks and other securities, whereas secondary market deals with the exchange of existing or previously-issued
securities. Another important division in the capital market is made on the basis of the nature of security traded, i.e.
stock market and bond market. It is a market where buyers and sellers engage in trade of financial securities like bonds,
stocks, etc. The buying/selling is undertaken by participants such as individuals and institutions.

19. Define PV, INT, FV, PVA, FVA, and Annuity?

PV-The current value of future cash flows to be received
INT-The Annual Discount Rate
FV-The par value or selling price at the end of an assumed holding period
FVA-The future value of stream of payments (annuity) assuming the payments are invested at a given rate of interest.
Annuity-It is series of payments either varied or fixed.

20. Define ordinary annuity and annuity due?

An ordinary annuity is a series of equal payments made at the end of consecutive periods over a fixed period of time. It
can be paid monthly, quarterly, semi-annually, annually.
An annuity due is a series of payments made at the beginning of consecutive periods over a fixed period of time. It can
be paid monthly, quarterly, semi-annually, annually.

21. Define the terms compounding and discounting.

Compound interest is interest calculated on the initial principal and also on the accumulated interest of previous periods
of a deposit or loan. Compound interest can be thought of as interest on interest, and will make a deposit or loan grow
at a faster rate than simple interest, which is interest calculated only on the principal amount. The rate at which
compound interest accrues depends on the frequency of compounding; the higher the number of compounding periods,
the greater the compound interest. Thus, the amount of compound interest accrued on $100 compounded at 10%
annually will be lower than that on $100 compounded at 5% semi-annually over the same time period. Compound
interest is also known as compounding.
Discounting- Discounting is the process of determining the present value of a payment or a stream of payments that is
to be received in the future. Given the time value of money, a dollar is worth more today than it would be worth
tomorrow. Discounting is the primary factor used in pricing a stream of tomorrow's cash flows.

22. Define the terms par value, maturity date, coupon rate with respect to a bond?

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Par Value- The face value (also known as the par value or principal) is the amount of money a holder will get back once
a bond matures
Coupon Rate- The coupon is the amount the bondholder will receive as interest payments. It's called a "coupon"
Maturity Date- The maturity date is the date in the future on which the investor's principal will be repaid.

23. What is a premium bond and what is a discount bond?

A premium bond is a bond trading above its par value; a bond trades at a premium when it offers a coupon rate higher
than prevailing interest rates. This is because investors want a higher yield and will pay more for it.
A discount bond is a bond currently trading for less than its par value in the secondary market where the coupon rate is
less than the prevailing interest rates.

24. Define deep discount bonds and zero coupon bonds?

Zero coupon bonds are bonds with no coupon payments. However, like T- Bills, they are issued at a discount and
redeemed at face value. The Government. Of India issued such securities in the nineties, It has not issued zero coupon
bond after that.
Deep Discount Bond is technically called a Zero Coupon Bond. This means the deposit does not give any interest pay-
outs. Instead the interest is accumulated and paid out at the time of maturity. This way it is similar to a fixed deposit with
cumulative option. The Deep Discount Bond is however different from a cumulative deposit in the much longer tenure.
Where a standard cumulative deposit scheme has a maximum tenure of 5 years in India, the deep discount bond has a
minimum of 5 year tenure.

24. Define the terms capital budgeting, regular payback period and discounted payback period?
Capital Budgeting is a process of identifying & evaluating capital projects that is where the cash flows of the firm will be
received over a period of 1 year. It is a cost-benefit exercise where the benefits from improved decision making should
exceed the costs of capital budgeting efforts. It is mainly used in Replacement decisions to maintain the business,
Existing product or market expansion, New products and services, Regulatory safety and environmental
Regular Payback Period- Payback period (PP) is the number of years it takes for a company to recover its original
investment in a project, when net cash flow equals zero. In the calculation of the payback period, the cash flows of the
project must first be estimated. Generally the shorter the payback period the better.
Discounted Payback period- The discounted payback period is the number of years it takes to recover the original
investment in terms of the present value of the cash flows. The present value of each cash flow is calculated and then
added to arrive at the discounted payback period.

25. Define independent projects and mutually exclusive projects?

Mutually exclusive projects indicate there is only one project among all possible projects that can be accepted.
Independent projects are potential projects that are unrelated, and any combination of those projects can be accepted

26.Define the term capital structure, business risk and financial risk?
Capital structure is the proportion of debt and preference and equity shares on a firms balance sheet.
Business Risk- Business risk is the possibility a company will have lower than anticipated profits or experience a loss
rather than taking a profit. Business risk is influenced by numerous factors, including sales volume, per-unit price, input
costs, competition, the overall economic climate and government regulations.
Financial Risk- A Companys financial risk, however, takes into account a company's leverage. If a company has a high
amount of leverage, the financial risk to stockholders is high - meaning if a company cannot cover its debt and enters
bankruptcy, the risk to stockholders not getting satisfied monetarily is high.

27. Define the terms gross working capital and net working capital?
Gross Working Capital- Gross working capital is the sum of all of a company's current assets (assets that are
convertible to cash within a year or less). Gross working capital includes assets such as cash, checking and
savings account balances, accounts receivable, short-term investments, inventory and marketable securities
Net working capital is a liquidity calculation that measures a companys ability to pay off its current liabilities with
current assets. This measurement is important to management, vendors, and general creditors because it shows the
firms short-term liquidity as well as managements ability to use its assets efficiently.
Net Working Capital-Current Assets Current Liabilities

28. Define the terms inventory conversion period, receivables collection period, creditors payment period, cash
conversion cycle?
All these ratios like Inventory conversion, Creditors payment ratio come under Activity Ratios. It is desirable to have
these ratios close to the industry norm.
Inventory conversion period Formula is 365/Inventory Turnover where inventory turnover is COGS/Average
Inventory. Interpretation is processing period that is too high might mean that too much capital is tied up in inventory &
thus the inventory is obsolete whereas a low inventory processing period signifies firm has less stock in hand which
might hurt sales.
Receivable Collection Period formula is 365 / Receivable turnover where receivable turnover is Annual Sales/Average
Receivables. Interpretation is if that collection period is too high, it signifies customers are slow in paying their bills which
further means lot of capital is ties up in assets whereas a low collection period indicates firm credit policy is too rigorous,
which might be hampering sales.

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Creditors payment period formula is 365/ Payables turnover ratio where Payables turnover is Purchases/ Average
Trade Payables. It is the average time it takes the company to pay its bills.
Cash Conversion Cycle-The formula is (Inventory conversion+ Receivable Collection Period- Creditors payment
period).It indicates the times taken to convert the firms cash investment in inventory back into cash.
29. What are trade discounts?
A trade discount is the reduction granted by a supplier of goods/services on the list or catalogue prices of the goods
supplied. It is provided due to business consideration such as trade practices, large quantity orders, etc. It is given on
both cash & credit transactions. Trade discount is not separately shown in the books of accounts, and all amounts
recorded in a purchases or sales book are done in the net amount only.

30. What is permanent working capital and temporary working capital?

Permanent Working Capital- It refers to that minimum amount of investment in current assets that has always to be
available. It is the working capital required to carry out the minimum level of activities of the business. It is also called
core working capital, regular working capital or fixed working capital.
Temporary working capital- It refers to that part of total working capital which is required by a firm over and above its
permanent working capital. It is required because the actual level of activities of the business most of the time exceeds
the minimum level of activities. As the level of business activities fluctuates, the volume of temporary working capital
also may keep fluctuating. Temporary working capital is also known as fluctuating or variable or circulating working
capital.

31. What do you understand by credit policy, credit period, collection policy, cash discounts?
A firms credit policy is the set of principles on the basis of which it determines who it will lend money to or gives credit. It
is a set of guidelines that highlight the terms & conditions for supplying the goods on credit, Customer Credit worthiness,
Collecting procedure, Precautionary steps in case of default.
Credit Period- The credit period is the number of days that a customer is allowed to wait before paying an invoice. The
concept is important because it indicates the amount of working capital that a business is willing to invest in its
Accounts receivable in order to generate sales.
Cash Discounts-Incentive offered by a seller to a buyer for settling the invoice immediately on delivery or in a period
substantially shorter than the conventional period in that industry.
Collection Policy-Collection policy is to ensure the earliest possible payment of receivables without any customer
losses. Early collections reduce the investment required to carry receivables & the costs associated with it.

32. What do you understand by Accounts receivables, aging schedule?

Account Receivable-Accounts receivable is the money that a company has a right to receive because it had provided
customers with goods/services.
Aging Schedule-Aging schedule is a table that shows a summarized breakup of accounts receivable into different time
brackets. Its an important tool used in working capital management to project pattern collections & estimate doubtful
debts.

33. What do you understand by moderate, aggressive and conservative financing of working capital?
The aggressive approach is a high-risk strategy of working capital financing wherein short-term finances are utilized
not only to finance the temporary working capital but also a reasonable part of the permanent working capital. In this
approach of financing, the levels of inventory, accounts receivables and bank balances are just sufficient with no
cushion for uncertainty. There is a reasonable dependence on the trade credit.
Conservative approach is a risk-free strategy of working capital financing. A company adopting this strategy maintains
a higher level of current assets and therefore higher working capital also. The major part of the working capital is
financed by the long-term sources of funds such as equity, debentures, term loans etc. So, the risk associated with
short-term financing is abolished to a great extent.

34. What do you understand by factoring?

Factoring is a transaction in which a business sells its accounts receivable, or invoices, to a third party commercial
financial company, also known as a factor. This is done so that the business can receive cash more quickly than it
would by waiting 30 to 60 days for a customer payment. Factoring is sometimes called accounts receivable financing.

35. What is a commercial paper?

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. Corporates,
primary dealers (PDs) and the all-India financial institutions (FIs) that have been permitted to raise short-term resources
under the umbrella limit fixed by the Reserve Bank of India are eligible to issue CP. CP can be issued for maturities
between a minimum of 7 days and a maximum up to one year from the date of issue.
36. What is a certificate of deposit?
Certificate of Deposit (CD) is a negotiable money market instrument and issued in dematerialised form or as a Usance
Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Banks
can issue CDs for maturities from 7 days to one a year whereas eligible FIs can issue for maturities 1 year to 3 years.
37. What are external commercial borrowings?
It refers to commercial loans in the form of bank loans, buyers credit, suppliers credit; securitized instruments (e.g.
floating rate notes and fixed rate bonds, non-convertible, optionally convertible or partially convertible preference

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shares) availed of from non-resident lenders by Indian corporations & PSUs with a minimum average maturity of 3
years.

38. What are Treasury Bills?

A class of central government securities referred to as T-bills. T-Bills are issued by Government of India against their
short term borrowing requirements with maturities ranging between 14 to 364 days. Treasury bills are issued at a
discount and are redeemed at par. For example a Treasury bill of Rs.100 face value issued for Rs.95/- gets
redeemed at the end of its tenure at Rs.100. The Government of India issues three types of treasury bills through
auctions, namely, 91-day, 182-day and 364-day. There are no treasury bills issued by State Governments.

39. What is Repo & Reverse Repo?

Repo means repurchase agreement.
When RBI repurchases its issued govt. securities, it is called Repo transaction
RBI increases the liquidity in the market. Bank gets money for selling Govt. securities to RBI.
Repo transaction is carried at repo rate which is changed by RBI from time to time.
Increase in repo rate, signals that deposit and advance rates of banks are likely to increase
Reverse Repo means reverse repurchase agreement.
RBI has power to issue the Govt. securities.
When RBI sells govt. securities to banks, it is called a reverse repo transaction.
RBI will take decision to sell Govt. securities when RBI wants to absorb or decrease the liquidity in the market.

40. What is Call Money?

Integral part of Indian Money Market where the day-to-day surplus funds (mostly of banks) are traded.
Call Money - Money lent for one day.
Notice Money Money lent for a period between 1 to 14 days
Term Money - Money lend for 15 days or more in Inter-bank
Banks borrow from call money market for the following purpose:
To fill the gaps or temporary mismatches in funds. To meet the CRR & SLR mandatory requirements as stipulated by
the Central bank.To meet sudden demand for funds arising out of large outflows.

41. Explain G-Sec Market?

Government Borrowings help in execution of Fiscal Policy Measures and is means for deficit financing. The RBI is the
Merchant Banker for the Government for all its borrowings. By imposing an SLR (whereby a certain portion of Banks
deposits have to be invested in G-securities), the RBI effectively ensures a captive market for its borrowing. Primary
dealers have also been created by RBI to participate in both Primary as well as Secondary G-sec markets. For MFs,
Corporate, Pension Funds, Insurance, G-securities form the most creditworthy investment. Foreign Investors are also
noteworthy investors, who participate according to FII Limit

42. Explain some of the characteristics of debentures?

Instrument of loan
Interest is paid at a fixed rate P.A
Debenture has a common seal of the company
Debenture-holders are creditors of the company & not owners.
At the time of liquidation, first priority is given to debenture holders at the time of repayment.

43. Define the terms pre-shipment and post shipment credit?

'Pre-shipment' means any loan or advance granted or any other credit provided by a bank to an exporter for financing
the purchase, processing, manufacturing or packing of goods prior to shipment, on the basis of letter of credit opened in
his favour by the importer.
Post Shipment Finance is a kind of loan provided by a financial institution to an exporter or seller against a shipment
that has already been made. This type of export finance is granted from the date of extending the credit after shipment
of the goods to the realization date of the exporter proceeds. Exporters dont wait for the importer to deposit the funds.

44. What do you understand by public deposits?

Deposit includes and shall be deemed always to have included any receipt of money by way of deposit or loan or in
any other form, but does not include amounts raised by way of share capital, amounts raised by way of share capital,
amounts received from a scheduled bank or a co-operative bank, amounts received in the ordinary course of business,
by way of Security Deposit, dealership deposit, Earnest Money etc.
45. What is venture capital financing?
These are funds invested in early stages of their development. The investment is often in the form of equity but can be
convertible preferred shares or convertible debt. While the risk of Start-up Company is often great, returns on successful
companies can be very high.

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46. Define the terms operating lease and financial lease?
Operating Lease-It is an essentially a rental arrangement. No asset or liability is reported by lessee & the periodic lease
payments are simply recognised as rental expense in the income statement.
Finance Lease-A purchase of an asset that is financed by debt. Accordingly, at the inception of lease, the lessee will
add equal amounts to both assets & liabilities on the balance sheet. Over the term of lease, the lessee will recognise
depreciation expense on the asset & interest expense on the liability.

47. What are the two principal reasons for holding cash?
The Two principal reasons of holding cash are- Reserves for any contingencies, Distributing as dividends to
shareholders & Using as working capital.

48. Name the various financial instruments dealt with in the international market?
T-Bills, Commercial Paper, Certificates Of Deposit, Currency Future, Options, Swaps, ECBs, Overseas Funds

49. Differentiate between factoring and bill discounting?

Meaning-
Trading the bill before it become due for payment at a price less than its face value is known as bill discounting
A financial transaction in the which the organization sell its book debts to the financial institution at a discount is known
as factoring
Arrangement
The entire bill is discounted & paid when the transaction takes place.
The factor gives maximum part of the amount as advance when the transaction takes place & remaining amount of the
time at the time of settlement.
Parties
Drawer, Drawee, Payee
Factor, Debtor, Client

50. Discuss the features of equity capital as a method of long term finance?
Right to Income-Equity holders have a residual claim on the income of the company after paying the preference
dividends to preference shareholders.
Claim on Assets-Equity shareholders have a residual claim on the ownership of company assets after utilizing the
assets to meet the requirements of creditors & preference shareholders.
Voting Rights-Each equity share carries one vote & the shareholders have votes equal to the number of equity share
held by them. Hence equity holders have an indirect control over the working of the company.
Limited Liability- One distinct feature of equity of equity shares is limited liability. Although they are the real owners of
the company, their liability is limited to the value of shares they have purchased.

51. Discuss the features of preference share capital as a method of financing?

A preference share is an equity security that combines the features of both equity and a debt instrument. For this
reason, it is generally considered a hybrid instrument. The term preference is with respect to payment of profits and
sale, implying that dividends/ profits and proceeds from the sale of company assets are disbursed first to the preference
shareholders, since they are given preference over equity shareholders. Preference shares can be convertible (into
ordinary shares) as well as non-convertible. The following table outlines the differences between preference shares and
equity shares. They do not enjoy any voting rights.

52. What is operating cash flow? And how is it calculated?

Operating cash flow is a measure of the amount of cash generated by a company's normal business operations.
Operating cash flow indicates whether a company is able to generate sufficient positive cash flow to maintain and grow
its operations, or it may require external financing for capital expansion.
Cash Flow from Operating Activities = Net income + Noncash Expenses + Changes in Working Capital
The noncash expenses are usually the depreciation and/or amortization expenses listed on the firm's income statement

53. What is FCFF? What is the discounting rate used to discount FCFF?
Free cash flow for the firm (FCFF) is a measure of financial performance that expresses the net amount of cash that is
generated for a firm after expenses, taxes and changes in net working capital and investments are deducted. FCFF is
essentially a measurement of a company's profitability after all expenses and reinvestments. It's one of the
many benchmarks used to compare and analyse financial health.
FCFF = (EBIT + Other income) * (1- tax rate) + Depreciation Capex Increase in working capital

54. If a company issues gift vouchers and they are redeemed by the customer what are the accounting entries?
I record the Sale of the Gift cards as follows:
Debit - Cash
Credit - Deferred Revenue from Gift Cards
When a Gift card is redeemed I record the following entry:
Debit - Deferred Revenue from Gift Cards
Credit Sales

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Define the terms fully convertible, non-convertible and partly convertible debentures?
Non-Convertible Debentures (NCD): These instruments retain the debt character and cannot be converted in to equity
shares
Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at
notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription.
Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer's notice. The ratio of
conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of
the company.

55. Define the term overdraft?

Overdraft facility is a credit given to an individual against his or her fixed assets as collateral with banks. As collateral,
you can offer following assets to banks: house, insurance policies, bank fixed deposits, shares and bonds, etc.
However, interest rates charged and overdraft sanctioned by banks vary on each of the collateral.

56. What is cash credit? Inter Corporate Deposits? Secured Premium Notes?
Cash Credit (CC) is granted against hypothecation of stock such as raw materials, work-in-process, finished goods and
stock-in-trade, including stores and spares.
What are inter-corporate deposits?
Inter-corporate deposits are deposits made by one company with another company, and usually carry a term of six
months. The three types of inter-corporate deposits are: three month deposits, six month deposits, and call deposits.
Three month deposits are the most popular type of inter-corporate deposits. These deposits are generally considered by
the borrowers to solve problems of short-term capital inadequacy. This type of short-term cash problem may develop
due to various issues, including tax payment, excessive raw material import, breakdown in production, payment of
dividends, delay in collection, and excessive expenditure of capital.
The annual rate of interest given for three month deposits is 12%. Six month deposits are usually made with first class
borrowers, and the term for such deposits is six months.
The annual interest rate assigned for this type of deposit is 15%. The concept of call deposit is different from the
previous two deposits. On giving a one day notice, this deposit can be withdrawn by the lender. The annual interest rate
on call deposits is around 10%.
What are secured premium notes?
Secured premium notes (SPNs) are financial instruments which are issued with detachable warrants and are
redeemable after certain period. SPN is a kind of non-convertible debenture (NCD) attached with warrant. It can be
issued by the companies with the lock-in-period of say four to seven years. This means an investor can redeem his SPN
after lock-in-period. SPN holders will get principal amount with interest on instalment basis after lock in period of said
period. However, during the lock in period no interest is paid.
Thus, SPNs are nothing but a share warrant which are only issued by the listed companies after getting the approval
from the central government. SPN is a hybrid security i.e. it combines both features of equity and debt products.
57. What are zero interest fully convertible bonds?
A fixed income instrument that is a combination of a zero-coupon bond and a convertible bond. Due to the zero-coupon
feature, the bond pays no interest and is issued at a discount to par value, while the convertible feature means that the
bond is convertible into common stock of the issuer at a certain conversion price.

58. What do you understand by the term seed capital assistance?

Seed capital is the funding required to get a new business started. This initial funding, which usually comes from the
business owner(s) and perhaps friends and family, supports preliminary activities such as market research, product
research and development (R&D) and business plan development.
59. What is a letter of credit?
A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for
the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to
cover the full or remaining amount of the purchase. Due to the nature of international dealings, including factors such as
distance, differing laws in each country, and difficulty in knowing each party personally, the use of letters of credit has
become a very important aspect of international trade.
What is collateral security?
Collateral security is any other security offered for which are directly associated with the business / project of the
borrower for which the credit facility has been extended.
60. What is multiple price auctions?
The successful bidder are required to pay for the allotted quantity of security at the respective prices /yield at which
they have bid. This is also known as winners Curse.
61. What is uniform price option?
All successful bidders pay the same price that is cut-off price at which the market clears the issue.
62. What do you mean by impairment of assets?
The asset is impaired if its carrying amount exceeds its recoverable amount. The recoverable amount is defined as the
higher of the 'fair value less costs to sell' and the 'value in use'. Any impairment loss is recognised as an expense in
profit or loss for assets carried at cost.

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63. What is capital and revenue expenditure?
An amount spent to acquire or upgrade productive assets (such as buildings, machinery and equipment, vehicles) in
order to increase the capacity or efficiency of a company for more than one accounting period. Also called capital
spending.
Revenue expenditure is an amount that is expensed immediatelythereby being matched with revenues of the current
accounting period. Routine repairs are revenue expenditures because they are charged directly to an account such as
Repairs and Maintenance Expense.

64. What is capital adequacy ratio?

It is the measure of a bank's financial strength expressed by the ratio of its capital (net worth (Tier-1) and subordinated
debt(Tier-II) to its risk-weighted credit exposure (loans). It is also called CRAR-Capital to Risk-weighted Assets Ratio.
The Reserve Bank of India (RBI), currently prescribes a minimum capital of 9% of risk-weighted assets, which is higher
than the internationally prescribed percentage of 8%. Most banks in India have a capital adequacy of more than 12 %. A
bank with a higher capital adequacy is considered safer because if its loans go bad, it can make up for it from its net
worth.

65. What is a diluted EPS?

Diluted earnings per share, also called diluted EPS, is a profitability calculation that measures the amount of income
each share will receive if all of the dilutive securities are realized. In other words, it shows the effect of dilutive securities
like stock options, rights to purchase common shares, bond and preferred stock that can be converted to common
shares on the basic earnings per share.

66. What is the difference between future and forward contracts?

It is a contractual agreement between two parties to buy/sell an underlying asset at a certain future date for a particular
price that is predecided on the date of contract. Both the contracting parties are committed and are obliged to honour
the transaction irrespective of price of the underlying asset at the time of delivery. Since forwards are negotiated
between two parties, the terms and conditions of contracts are customized. These are Forward Contracts..
A futures contract is similar to a forward, except that the deal is made through an organized and regulated exchange
rather than being negotiated directly between two parties. Indeed, we may say futures are exchange traded forward
contracts.

67. What is the difference between future and option?

A futures contract is similar to a forward, except that the deal is made through an organized and regulated exchange
rather than being negotiated directly between two parties. Indeed, we may say futures are exchange traded forward
contracts.
An Option is a contract that gives the right, but not an obligation, to buy or sell the underlying on or before a stated date
and at a stated price. While buyer of option pays the premium and buys the right, writer/seller of option receives the
premium with obligation to sell/ buy the underlying asset, if the buyer exercises his right.

68. What do you understand by mark to market?

In futures market, while contracts have maturity of several months, profits and losses are settled on daytoday basis
called mark to market (MTM) settlement. The exchange collects these margins (MTM margins) from the loss making
participants and pays to the gainers on daytoday basis.
Let us understand MTM with the help of the example. Suppose a person bought a futures contract on November 3,
2015, when Nifty was at 8000. He paid an initial margin of Rs. 60,000 as calculated above. On the next trading day i.e.,
on November 4, 2015 Nifty futures contract closes at 8100. This means that he/she benefits due to the 100 points gain
on Nifty futures contract. Thus, his/her net gain is Rs 100 x 75 = Rs 7,500.This money will be credited to his account
and next day the position will start from 8100.

69. Which valuation multiple is relevant for valuing banking companies? And why?
Price to Book value is relevant for valuing banking companies because most assets and liabilities of banks are
constantly valued at market values.

70. What is Consumer Price Index?

The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer
goods and services, such as transportation, food and medical care. It is calculated by taking price changes for each item
in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes
associated with the cost of living; the CPI is one of the most frequently used statistics for identifying periods
of inflation or deflation.

71. What is minority interest?

A minority interest, which is also referred to as non- controlling interest (NCI), is ownership of less than 50% of a
company's equity by an investor or another company. For accounting purposes, minority interest is a fractional share of
a company amounting to less than 50% of the voting shares. Minority interest shows up as a noncurrent liability on
the balance sheet of companies with a majority interest in a company, representing the proportion of
its subsidiaries owned by minority shareholders.

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72. What is consolidated EPS?
Consolidated EPS take into account the performance of subsidiaries and the share of minorities and associate
companies; this in many cases has a huge impact on the EPS of the consolidated entity.

73. What is a Differential Voting Right (DVR)? Why are these issued by companies?
A DVR share is like an ordinary equity share, but it provides fewer voting rights compared to the shareholder. So, for
instance, while a normal Gujarat NRE Coke shareholder can vote as many times as the number of company shares
he/she holds, someone who holds the companys DVR shares will need to hold 100 DVR shares to cast one vote. The
number of DVR shares required to be held will differ from one company to another.
Companies issue DVR shares for prevention of a hostile takeover and dilution of voting rights. It also helps strategic
investors who do not want control, but are looking at a reasonably big investment in a company.

74. What are ESOPs? What are the advantages of ESOPs? Which kind of companies issue ESOPs?
An employee stock ownership plan (ESOP) is an employee-owner program that provides a company's workforce with
an ownership interest in the company. In an ESOP, companies provide their employees with stock ownership, often at
no upfront cost to the employees thus acting as a motivator. ESOP shares, however, are part of employees'
remuneration for work performed. Shares are allocated to employees and may be held in an ESOP trust until the
employee retires or leaves the company. The shares are then either bought back by the company for redistribution or
voided. Companies belonging to IT Sector as human capital is valued & young companies like start-ups who want to
retain the talent & motivate them.

75. What are Sharpe and Treynor ratios? What do they signify?
The Sharpe ratio aims to reveal how well an equity investment portfolio performs as compared to a risk-free
investment. The common benchmark used to represent a risk-free investment is U.S. Treasury bills or bonds. The
primary purpose of Sharpe ratio is to signify excess returns per unit of total portfolio risk & higher the Sharpe ratios
indicate better risk-adjusted portfolio performance.
Formula of Sharpe ratio- R(p)-R(f)/ (p)
The Treynor ratio also seeks to evaluate the risk-adjusted return of an investment portfolio, but it measures the
portfolio's performance based on systematic risk. The treynor measure is calculated as R (p)-R (f)/ (p) interpreted as
excess returns per unit of systematic risk.

76. What is NAV? How is it calculated?

The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV).
Mutual funds invest the money collected from investors in securities markets. In simple words, NAV is the market value
of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies
on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units
of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is INR 200
lakh and the mutual fund has issued 10 lakh units of INR 10 each to the investors, then the NAV per unit of the fund is
INR 20 (i.e.200 lakh/10 lakh). NAV is required to be disclosed by the mutual funds on a daily basis

77. What do you mean by liquid funds?

Liquid funds are a type of mutual funds that invest in securities with a residual maturity of up to 91 days. Assets invested
are not tied up for a long time as liquid funds do not have a lock-in period.
Return is not guaranteed as the performance of fund depends upon how the market performs unlike fixed deposits
which are not dependant on the market. An investor looking for better returns prefers investing in a liquid fund over fixed
deposit.

78. What are gilt funds?

Gilt Funds are mutual funds that invest only in government securities. They are preferred by risk averse and
conservative investors who wish to invest in the shadow of secure government bonds.Since gilt funds invest only in
government bonds, investors are protected from credit risk. The instruments where these funds invest have sovereign
guarantee. Hence no default risk is associated with these instruments.

79. What are ETFs?

An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of
assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs
experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and
lower fees than mutual fund shares, making them an attractive alternative for individual investors.

80. What are index funds?

These types of funds invest in a specific index with an objective to generate returns equivalent to the return on index.
These funds invest in index stocks in the proportions in which these stocks exist in the index. For instance, Sensex
index fund would get the similar returns as that of Sensex index. Since Sensex has 30 shares, the fund will also invest
in these 30 companies in the proportion in which they exist in the Sensex.

81. Who are primary dealers? And what is their role in financial markets?

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Primary dealers are registered entities with the RBI who have the license to purchase and sell government securities.
They are entities who buys government securities directly from the RBI (the RBI issues government securities on behalf
of the government), aiming to resell them to other buyers. In this way, the Primary Dealers create a market for
government securities.

82. What is liquidity adjustment facility?

LAF is a facility extended by the Reserve Bank of India to the scheduled commercial banks (excluding RRBs) and
primary dealers to avail of liquidity in case of requirement or park excess funds with the RBI in case of excess liquidity
on an overnight basis against the collateral of Government securities including State Government securities. Basically
LAF enables liquidity management on a day to day basis. The operations of LAF are conducted by way of repurchase
agreements (repos and reverse repos) with RBI being the counter-party to all the transactions. The interest rate in LAF
is fixed by the RBI from time to time. Currently the rate of interest on repo under LAF (borrowing by the participants) is
6.5% and that of reverse repo (placing funds with RBI) is 6%. LAF is an important tool of monetary policy and enables
RBI to transmit interest rate signals to the market.

83. What is MSF?

MSF rate is the rate at which banks borrow funds overnight from the Reserve Bank of India (RBI) against approved
government securities. This came into effect in may 2011. Under the Marginal Standing Facility (MSF), currently banks
avail funds from the RBI on overnight basis against their excess statutory liquidity ratio (SLR) holdings. Additionally, they
can also avail funds on overnight basis below the stipulated SLR up to 2.5% of their respective Net Demand and Time
Liabilities (NDTL) outstanding at the end of second preceding fortnight.

84. What are contingent liabilities in banks?

A contingent liability is a potential liability that may occur, depending on the outcome of an uncertain future event. A
contingent liability is recorded in the accounting records if the contingency is probable and the amount of the liability can
be reasonably estimated. If both of these conditions are not met, the liability may be disclosed in a footnote to the
financial statements or not reported at all.
Outstanding lawsuits and product warranties are common examples of contingent liabilities, because each outcome is
uncertain.

85. What is SENSEX and how is it calculated?

S&P BSE SENSEX, first compiled in 1986, comprises of 30 component stocks representing large, well-established and
financially sound companies across key sectors. Since September 1, 2003, S&P BSE SENSEX is being calculated on a
free-float market capitalization methodology.
In various businesses, equity holding is divided differently among various stake holders promoters, institutions,
corporates, individuals etc. Market has started to segregate this on the basis of what is readily available for trading or
what is not. The one available for immediate trading is categorized as free float. And, if we compute the index based on
weights of each security based on free float market cap, it is called free float market capitalization index. Indeed, both
Sensex and Nifty, over a period of time, have moved to free float basis. SX40, index of MSEI is also a free float market
capitalization index.

86. What is NIFTY and how is it calculated?

The Nifty 50 is a well diversified 50 stock index accounting for 13 sectors of the economy. It is used for a variety of
purposes such as benchmarking fund portfolios, index based derivatives and index funds. Nifty 50 is owned and
managed by India Index Services and Products Ltd. (IISL). From June 26, 2009, Nifty 50 is computed based on free
float methodology
87. What are time and demand liabilities for a bank?
Demand Liabilities: The liabilities which bank have to pay on demand. Current deposits, demand liabilities portion of
savings bank deposits, margins held against letters of credit/guarantees, balances in overdue fixed deposits, cash
certificates and cumulative/recurring deposits, outstanding Telegraphic Transfers (TTs), Mail Transfer (MTs), Demand
Drafts (DDs), unclaimed deposits, credit balances in the Cash Credit account and deposits held as security for
advances which are payable on demand come under Demand Liabilities.
Time Liabilities: The liabilities which bank have to pay after specific time period. Fixed deposits, cash certificates,
cumulative and recurring deposits, time liabilities portion of savings bank deposits, staff security deposits, margin held
against letters of credit if not payable on demand, deposits held as securities for advances which are not payable on
demand and Gold Deposits come under Time Liabilities.

88. What are the sources of non-interest income for a bank?

Non-interest income is bank and creditor income derived primarily from fees including deposit and transaction
fees, insufficient funds (NSF) fees, annual fees, monthly account service charges, inactivity fees, check and deposit
slip fees, Underwriting fees, M&A Fees and so on. Institutions charge fees that provide non-interest income as a way of
generating revenue and ensuring liquidity in the event of increased default rates.

89. What are Gross NPAs and Net NPAs? When does an account become an NPA?
An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank.
Banks should, classify an account as NPA only if the interest due and charged during any quarter is not serviced fully
within 90 days from the end of the quarter.

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The Reserve Bank of India defines Net NPA as Net NPA = Gross NPA (Balance in Interest Suspense account +
DICGC/ECGC claims received and held pending adjustment + Part payment received and kept in suspense account +
Total provisions held)

90. How do you calculate NIM?

The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into
account the positive effects of investing noninterest bearing deposits in earning assets. Formula is Net Interest
Margin/Average Earning Assets.

91. Explain terms AUM, Expense Ratio, Portfolio Turnover Ratio, Alpha
AUM- AUM or Assets under Management is the total market value of investments managed by an asset management
company (AMCs).
Expense Ratio- The ratio is the annual expenses incurred by the funds expressed in percentage of their average net
asset. To make the choice between two similar funds, you should consider the expenses charged by them. Lower
expenses benefit you in the longer term. Usually, schemes with higher assets have lower expense ratio than that of a
small sized fund.
Portfolio Turnover Ratio- Portfolio Turnover Ratio is the percentage of a fund's holdings that have changed in a given
year. This ratio measures the fund's trading activity, which is computed by taking the lesser of purchases or sales and
dividing by average monthly net assets.
Alpha-The simplest definition of an alpha would be the excess return of a fund compared to its benchmark index. If a
fund has an alpha of 10%, it means it has outperformed its benchmark by 10% during a specified period.
92. Describe the process of ASBA?
Application Supported by Blocked Amount (ASBA) refers to an application mechanism for subscribing to initial public
offers (IPO).The system, which ensures that the applicant's money remains in his/her bank account till the shares are
allotted, was introduced by Sebi for retail investors in 2008. Now it has been extended to corporate investors and HNIs
as well (from January 1, 2010, onwards).The mechanism requires the applicant to give an authorisation to block his/her
application money in the bank account for subscribing to the IPO. His/her bank account is debited only after the basis of
allotment is finalised, or the IPO is withdrawn or fails

93. What is Book-Building IPO Process?

Book Building is basically a process used in Initial Public Offer (IPO) for efficient price discovery. It is a mechanism
where, during the period for which the IPO is open, bids are collected from investors at various prices, which are above
or equal to the floor price. The offer price is determined after the bid closing date.

94. What is Escrow Account?

An escrow account is a temporary pass through account held by a third party during the process of a transaction
between two parties. This is a temporary account as it operates until the completion of a transaction process, which is
implemented after all the conditions between the buyer and the seller are settled.

95. Who are Anchor Investors?

An anchor investor in a public issue refers to a qualified institutional buyer making an application for a value of Rs 10
crore or more through the book-building process. Securities and Exchange Board of India (Sebi) introduced the concept
of "anchor investor" in public issues in July 2009 with a view to create a significant impact on pricing of initial public
offers. Since equity markets are volatile, it is believed that companies going for initial public offering (IPO) would benefit
from anchor investors. An anchor investor can attract investors to public offers before they hit the market to infuse
confidence. The volume and value of anchor subscriptions will serve as an indicator of the company's reputation and
soundness of the offer. Finally, the anchor investor sets a benchmark and gives a guideline for issue pricing and interest
among Qualified Institutional Buyers (QIBs).
96. What is role of Lead Manager in IPO?
In the pre-issue process, the Lead Manager (LM) takes up the due diligence of company's operations/ management/
business plans/ legal etc. Other activities of the LM include drafting and design of Offer documents, Prospectus,
statutory advertisements and memorandum containing salient features of the Prospectus. The BRLMs shall ensure
compliance with stipulated requirements and completion of prescribed formalities with the Stock Exchanges, RoC and
SEBI including finalisation of Prospectus and RoC filing. Appointment of other intermediaries viz., Registrar(s), Printers,
Advertising Agency and Bankers to the Offer is also included in the pre-issue processes.
The LM also draws up the various marketing strategies for the issue. The post issue activities including management of
escrow accounts, coordinate non-institutional allocation, intimation of allocation and dispatch of refunds to bidders etc
are performed by the LM. The post Offer activities for the Offer will involve essential follow-up steps, which include the
finalization of trading and dealing of instruments and dispatch of certificates and demat of delivery of shares, with the
various agencies connected with the work such as the Registrar(s) to the Offer and Bankers to the Offer and the bank
handling refund business. The merchant banker shall be responsible for ensuring that these agencies fulfill their
functions and enable it to discharge this responsibility through suitable agreements with the Company.

97. How is role of Syndicate Members in IPO?

A Syndicate Member/Broker is a member of the Stock Exchange to whom the investor has to submit the IPO
Bid/Application form. The Syndicate Member / Broker receive the bid and uploads the same on to the electronic book of

11
the stock exchange. Bids which are not uploaded into the electronic book are not considered for the purpose of
allotment. The Syndicate Member/Broker , then submits the bid with cheque to the bankers. In case of online
application, the Syndicate Member/Broker generates the electronic application form and submits the same to the
registrar with proof of having paid the bid amount.
98. What is Risk? Systematic and Unsystematic Risk?
Investment risk is associated with the probability of low or negative future returns. It is divided into 2 parts-Systematic
Risk & Unsystematic Risk.
Systematic Risk or Market risk is that part of the risk which cannot be eliminated, and it stems from fac-tors which
systematically affect most firms, such as war, inflation, recessions, and high interest rates. It can be measured by the
degree to which a given stock tends to move up or down with the market. Thus, market risk is the relevant risk, which
reflects a securitys contribution to the portfolios risk.
Unsystematic Risk or Diversifiable risk is that part of the risk of a stock which can be eliminated. It is caused by
events that are unique to a particular firm.
99. Explain the concept of CAPM, Efficient Frontier, SML & CML
The CAPM holds that, in equilibrium, the expected return on risky assets E(R) is the risk-free rate R(f) plus a beta-
adjusted market-risk premium. Beta measures systematic risk. CAPM Formula=R (f) + ( E(R) R (f))
Efficient Frontier-Assuming Investors are risk-averse; investors prefer the portfolio that has the greatest expected
return when choosing among portfolios that have the same standard deviation of returns. Those portfolios that have the
greatest expected return for each level of risk (Standard deviation) make up the efficient frontier.
CML- The line of possible portfolio risk & return combinations given the risk-free rate & the risk & return of a portfolio of
risky assets is referred to as Capital Allocation Line (CAL).For an individual investor, the best CAL is the one that offers
the most preferred set of possible portfolios in terms of their risk & return. If each investor has different expectations
about the expected returns of, standard deviations of, or correlation between different risky asset returns each investor
will have a different CAL. Under the Modern Portfolio theory the assumption is that investors have homogenous (Same)
Expectations (Same risk, return etc.) meaning investors will have the same optimal risky portfolio & CAL. Under this
assumption the optimal CAL for any investor is the one that is just tangent to the efficient frontier. This optimal CAL for
all investors is termed the Capital Market Line.
SML- It is the representation of the CAPM model. It displays the expected rate of return of an individual security as a
function of systematic, non-diversifiable risk.
100. Explain Sharpes Single Index Model
A single factor model with the return on the market, Rm as its only risk factor can be written as E - Rf = (E(Rm) R(f)
Here, the expected excess return (Return above the risk-free rate) is the product of the factor weight or factor sensitivity,
Beta & the risk factor which in this model is the excess return on the market portfolio or market index, so this is
sometimes also called Single-Index Model.
101. Explain Arbitrage Pricing Model (APT)
The APT developed by Ross holds that there are four factors which explains the risk premium relationship of the
particular security. Several factors been identified e.g. Inflation, interest rate, money supply, industrial production &
private consumption have aspects of being inter related.
According to CAPM E(r) = R (f) + (), Where - Average Market Risk Premium
In APT E( r) = R(f) + 1 1 + 2 2 + 3 3 + 4 4
Where 1 ,2, 3, 4 are average risk premium of the four factors in the model & 1 ,2, 3, 4 are measures of
sensitivity of the particular security to each of the fur factors.

102. Explain MTM Concept

Mark-to-market (MTM) is an accounting method that records the value of an asset according to its current market price.
103. Explain Var (Value at Risk) concept
Value at Risk is the minimum loss over a period that will occur with a specific probability. Consider a bank that has a
one-week VAR of 200 million euros with a probability of 3%.That means a one-week loss of at least 200 million euros is
expected to occur 3% of the time. Note this is not the maximum one-week loss that the bank will experience, it is the
minimum loss that will occur 3% of the time. VAR does not provide a maximum loss for the period. It has become
accepted as a risk measure for banks & is used in establishing minimum capital requirements.

104. Explain Efficient Market Hypothesis Concept?

Professor Eugene Fama originally developed the concept of market efficiency & identified three forms of market
efficiency. The difference among them is that each is based on a different set of information.
Weak-Form Market efficiency-It states that current security prices fully reflect all currently available security market
data.
Semi-Strong Market Efficiency-It states that current security prices fully reflect all publicly available information.
Strong-Form market efficiency-It states that current prices fully reflect all information from both public & private
sources.

105. Explain Traditional Portfolio Theory and Modern Portfolio Theory

The traditional approach to portfolio management concerns itself with the investor, definition of portfolio objectives,
investment strategy, diversification & selection of individual investment as detailed below
Investors study includes an insight into his

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 age, health, responsibilities, other assets, portfolio needs
Need for income, capital maintenance, Liquidity
Attitude towards risk,
Taxation Status
Portfolio objectives are defined with reference to maximising the investors wealth which is subject to risk. The higher
the level of risk borne the more the expected returns.
Investment strategy covers examining a number of aspects including balancing fixed interest securities against equities,
Finding the income of the growth portfolio, Balancing transaction cost against capital gains from rapid switching,
Retaining some liquidity to seize upon bargains.
Diversification reduces volatility of returns & risks & thus adequate equity diversification is sought. Balancing of
equities against fixed income securities is also sought.
Selection of individual investments is made on the following principles-Finding the intrinsic value of the share &
comparing with the current price(Fundamental Analysis) or Trying to predict future share prices from past share price
movement(Technical Analysis),Expert advice is sough besides study of published accounts to predict intrinsic value,
Inside information is sought & relied upon to move to diversified growth companies, companies with good asset backing,
dividend growth, high quality management with appropriate dividend paying policies, & leverage policies are traced out
constantly to make selection of portfolio holdings.
In India most of the stock brokers & follow the traditional approach for selecting portfolio for clients.
Modern Portfolio Theory
Originally developed by Harry Markowitz in the year 1950s, portfolio theory sometimes referred as Modern Portfolio
Theory-provides a logical/mathematical framework in which investors can optimize their risk & return. The central plant
of this theory is the theory is that diversification through portfolio formation can reduce risk, and return is a function of
expected risk.
Harry Markowitz is regarded as father of Modern Portfolio Theory. According to him investors are concerned with two
properties of an asset, risk & return. The essence of this theory is that risk of an individual asset hardly matters to an
investor. What matters is the contribution it makes to the investors overall risk. By turning this technique into useful
technique for selecting the right portfolio from a range of different assets, he developed the mean-variance analysis in
1952.

106. What are Steps of Portfolio Management Process?

There are 3 major steps in the portfolio management process
The planning step begins with an analysis of the the investors risk tolerance, return objectives, time horizon, tax
exposure, liquidity needs, income needs & any unique circumstances or investor preferences.
The analysis results in an Investment policy statement (IPS) that details the investors investment objectives &
constraints. It should also specify an objective benchmark (such as an index return) against which the success of the
portfolio management process will be measured. The IPS should be updated at least every few years & any time the
investors objectives or constraints change significantly.
The execution step involves an analysis of the risk & return characteristics of various assets classes to determine how
fuds will be allocated to the various assets types. Often in what is referred as a top-down analysis, a portfolio manager
will examine current economic conditions & forecasts of such economic variables as GDP growth, inflation, and interest
rates in order to identify the asset classes that are most attractive. The resulting portfolio is typically diversified across
such asset classes as cash, fixed-income securities, publicly traded equities, hedge funds, private equity & real-estate
as well as commodities & other real assets.
Once the assets allocations are determined portfolio managers may attempt to identify the most attractive securities
within the asset class. Security analysts use model valuations for securities to identify those that appear undervalued in
what is termed as bottom-up security analysis.
The feedback step is the final step. Overtime investor circumstances will change, risk & return characteristics of asset
classes will change, and the actual weights of the assets in the portfolio will change with asset prices. The portfolio
manager must monitor these changes & the rebalance the portfolio periodically in response, adjusting the allocations to
the various assets classes back to their desired percentages. The manager must also measure portfolio performance &
evaluate it relative to the return on the benchmark portfolio identified in the IPS.

107. What is Organization Structure of Mutual Fund

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Sponsor
Akin to the Promoter of the company,
Contribution of minimum 40% of net worth of AMC,
Possess sound financial record over five years period,
Establishes the Fund,
Gets it registered with the SEBI,
Forms a trust, & appoints Board of trustee.
Trustees
Holds assets on behalf of unit holders in trust,
Trustees are caretaker of unit holders money,
Two third of the trustees shall be independent persons (not associated with the sponsor),
Trustees ensure that the system, processes & personnel are in place,
Resolves unit holders GRIEVANCES,
Appoint AMC & Custodian, & ensure that all activities are accordance with the SEBI regulation.
Custodian
Holds the funds securities in safekeeping,
Settles securities transaction for the fund,
Collects interest & dividends paid on securities,
Records information on corporate actions.
Asset Management Company
Floats schemes & manages according to SEBI,
Cannot undertake any other business activity, other than portfolio mgmt services,
75% of unit holders can jointly terminate appointment of AMC,
At least 50% of independent directors,
Chairman of AMC cannot be a trustee of any MF.
Distributor / Agents
Sell units on the behalf of the fund,
It can be bank, NBFCs, individuals.
Banker
Facilitates financial transactions,
Provides remittance facilities.
Registrar & Transfer Agent
Maintains records of unit holders accounts & transactions
Disburses & receives funds from unit holder transactions,
Prepares & distributes a/c settlements,
Tax information, handles unit holder communication,
Provides unit holder transaction services.

108. Classify Mutual Funds based on Investment Objectives

Equity (Growth) only in Stocks Long Term (3 years or more)
Debt (Income) only in Fixed Income Securities
Liquid/Money Market Short-term Money Market (CPs, CDs, Treasury Bills)
Balanced/Hybrid Stocks + Fixed Income Securities (1-3 years)
Gilt Funds Primarily in G-Sec

109. Classify Mutual Fund based on structure

Open-Ended anytime enter/exit
Close-Ended Schemes listed on exchange, redemption after period of scheme is over.

110. How will design an Optimal Portfolio

Investors have to consider their indifference curves & efficient frontier & go for the portfolio on the farthest northwest
indifference curve known as Global minimum-variance portfolio where the indifference curve is tangent to the efficient
frontier.
Indifference Curves-Indifference curves reflect an investors attitude towards risk as reflected in his/her risk or return
trade-off function. They differ among investors because of differences in risk-aversion.
Optimal Portfolio- an optimal portfolio is defined by tangency point between the efficient set & the investors
indifference curves.

111. What you mean by Portfolio Revision?

Portfolio revision means changing the assets allocation of a portfolio. Due to dynamic developments in the capital
markets and the changes in the circumstance, even a well-constructed portfolio tends to become inefficient and hence
need to be monitored and revised periodically. This usually entails two things i.e. Portfolio rebalancing and portfolio
upgrading.

112. Explain Different methods of Portfolio Revision

Portfolio rebalancing: This involves reviewing and revising the portfolio composition / mix i.e. shifting from
stocks to bonds or vice-versa. There are three basic policies in portfolio rebalancing.

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 Buy and hold policy: where no change is effected and portfolio mix of debt equity is allowed to drift.
Constant mix policy: where the desired target proportion of debt and equity is maintained when relative values
of debt and equity in the portfolio changes. E.g. if the target debt equity mix was 50:50 portfolio rebalancing is
done to maintain this target of 50:50 when any changes takes place in their market values.
Portfolio insurance policy: increasing the exposure to stocks when portfolio appreciates in value and vice-
versa.
Portfolio updating: This involves re-assessing the risk-return characteristics of various securities, selling the
over priced securities and buying the under priced securities. It also entails other change the investor may
consider necessary to enhance the performance of the portfolio.

113. Distinguish between Active Portfolio Management v/s Passive Portfolio Management
Active Portfolio Strategy:
An active portfolio strategy is followed by most investment professionals and aggressive investors who strive to earn
superior returns after adjustment for risk. It involves aggressive management of portfolio with a view to obtain superior
risk adjustment return. The four principal areas of an active strategy are:
Market Timing: In this case according to the market trend forecasts, the portfolios are churned. E.g. if equity stocks are
likely to perform better then bond market then the proportions of equity is increased in the portfolio and vice versa. It is
obvious that switching from offensive and defensive portfolio is subject to risk.
Sector Rotation: Sector or group rotation may apply to both the stocks based on their assessed outlooks. For e.g. if
infrastructure and engineering goods sectors would do well in the forthcoming period then stocks portfolio should be
titled more towards these sectors.
Security Selection: Security selection involves a search for under-priced securities. If we resort to active stocks
selection we may employ fundamental and / or technical analysis to identify stocks which seem to promise superior
returns.
Use of Specialization Investment Concept: A fourth possible approach to achieve superior returns is to employ a
specialized concept or philosophy particularly with respect to investment in stocks. Some of the concept that have been
exploited successfully by investment practitioners are Growth stocks, Technology stocks, Cyclic stocks

Passive Strategy:
The passive strategy is based on the premises that the capital market is fairly efficient with respect to the available
information. It involves adhering to the following guidelines:
Create a well-diversified portfolio at a predetermine level of risk.
Hold the portfolio relatively unchanged over times, unless it becomes inadequately diversified or inconsistent with the
investors risk return preference.

114. Distinguish between Discretionary Portfolio management services v/s Non-Discretionary Portfolio
management services
The discretionary portfolio manager individually and independently manages the funds of each client in accordance
with the needs of the client.
The non-discretionary portfolio manager manages the funds in accordance with the directions of the client.

115. Explain Cost of Carry-The cost of carry summarizes the relationship between the futures price and the spot price.
It is the cost of "carrying" or holding a position from the date of entering into the transaction up to the date of maturity. It
measures the storage cost plus interest that is paid to finance the asset less the income earned on the asset. As far as
Equity Derivatives are concerned the Cost of Carry represents the "Interest Cost".

116. Explain the MTM Margin, Maintenance Margin

Maintenance Margin-This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin
account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor
receives a margin call and is expected to top up the margin account to the initial margin level before trading commences
on the next day.
MTM Margin-In futures market, while contracts have maturity of several months, profits and losses are settled on day-
to-day basis called mark to market (MTM) settlement. The exchange collects these margins (MTM margins) from the
loss making participants and pays to the gainers on day-to-day basis. Let us understand MTM with the help of the
example. Suppose a person bought a futures contract on August 7, 2010, when Nifty was 5439.25. He paid an initial
margin of Rs.27196.25 as calculated above. Next trading day i.e. August 8, 2010 Nifty futures contract closes at 5482.
This means that he benefits due to the 42.75 points gain on Nifty futures contract. Thus, his net gain is of Rs. 2137.5
(42.75 * 50). This money will be credited to his account and next day the position will start from 5482.
117. Explain Cost Carry Arbitrage, Reverse Carry Arbitrage
Cash-and-carry-arbitrage is a combination of a long position in an asset such as a stock or commodity, and a short
position in the underlying futures. This arbitrage strategy seeks to exploit pricing inefficiencies for the same asset in the
cash (or spot) and futures markets, in order to make riskless profits. The arbitrageur would typically seek to "carry" the
asset until the expiration of the futures contract, at which point it would be delivered against the futures contract.
Therefore, this strategy is only viable if the cash inflow from the short futures position exceeds the acquisition
cost and carrying costs on the long asset position.

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Reverse Carry Arbitrage- Traders sell shares and buy stock futures to profit from the price differences. The strategy is
just the opposite of a regular cash-futures arbitrage.

118. What is interest rate Swap?

A swap is an agreement made between two parties to exchange cash flows in the future according to a prearranged
formula. Swaps are series of forward contracts. Swaps help market participants manage risk associated with volatile
interest rates, currency exchange rates and commodity prices.
Interest Rate Swap-In a simple interest rate plain vanilla swap floating rate interest rate payments are exchanged for
fixed-rate payments over multiple settlement dates.

119. What is Credit Default Swap?

Credit default swap are a form of insurance that makes a payment if an issuer defaults on its bonds. They can be used
by bond investors to hedge default risk. They can also be used by parties that will experience losses if an issuer
experiences financial distress & by others who are speculating that the issuer will experience more or less financial
trouble that is currently expected.

120. What are Delta, Gamma, Vega and Rho?

Delta-This is the sensitivity of derivative values to the price of the underlying asset
Gamma-This is the sensitivity of delta to changes in the price of the underlying asset.
Vega-This is the sensitivity of the derivative values to the volatility of the price of the underlying asset
Rho-This is the sensitivity of derivative values to changes in the risk-free rate.

121. What is Monday and January Affect?

The January effect or turn-of-the-year effect is the finding that during the first five days of January, stock returns,
especially for small firms are significantly higher than they are the rest of the year. In an efficient market, traders would
exploit this profit opportunity in January.
Monday Effect- A theory that states that returns on the stock market on Mondays will follow the prevailing trend from
the previous Friday. Therefore, if the market was up on Friday, it should continue through the weekend and, come
Monday, resume its rise.

122. What is Assumption of CAPM?

Risk Aversion-To accept a greater a degree of risk, investors require a higher expected return.
Utility Maximising Investors-Investors choose the portfolios based on their individual preferences with the risk & return
combination that maximises their utility.
Frictionless Markets-They are no taxes, transaction costs, no other impediments to trading.
One-period Horizon- All investors have the same one-period time horizon
Homogenous Expectations-All investors have the same expectations for assets, expected returns, standard deviation
of returns & returns correlation between assets.
Divisible Assets-All investments are infinitely divisible
Competitive Markets- Investors take the market price as given & no investor can influence prices with their trades.

123. What is limitation of CAPM?

A number of recent studies have raised concerns about the validity of the CAPM.
A recent study by Fama and French found no historical relationship between stocks returns and their market betas.
They found two variables which are consistently related to stock returns: (1) a firms size and (2) its market/book ratio.
After adjusting for other factors, they found that smaller firms have provided relatively high returns, and that returns are
higher on stocks with low market/book ratios. By contrast, after controlling for firm size and market/book ratios, they
found no relationship between a stocks beta and its return.
As an alternative to the traditional CAPM, researchers and practitioners have begun to look to more general multi-beta
models that encompass the CAPM and address its short-comings.
In the multi-beta model, market risk is measured relative to a set of factors that determine the behaviour of asset
returns, whereas the CAPM gauges risk only relative to the market return.
The risk factors in the multi-beta model are all no diversifiable sources of risk.

124. GDP Concepts

Base Year- Base year analysis is done to eliminate the effects of inflation and to give a more meaningful picture of the
data. Monetary value is first calculated in nominal terms or at current prices. It is then adjusted for inflation over time and
is thus, expressed in terms of the general price level of some reference year, called the base year
GDP at factor costs-is a measure of National Income that is based on the cost of factors of production. It is essentially
looking from the producers side
GDP at market prices essentially looks at economic activity from the consumers angle. It measures GDP at the last
step of the transactions, which is the market price paid by the consumer
Current Scenario
Earlier "GDP at factor cost" was known as the "GDP" in India. Now, industry-wise estimates are presented as GVA at
basic prices, while "GDP at market prices" is referred to as "GDP .This change from GDP at factor cost to GDP at
market prices was done to make Indias growth rates comparable internationally

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