Question Paper

Investment Banking and Financial Services - I : July 2001

Part A : Basic Concepts (30 Points)
• This part consists of questions with serial number 1 - 30.
• Answer all questions.
• Each question carries one point.
• Maximum time for answering Part A is 30 Minutes.

1. Which of the following is false with respect to asset-backed securitization?

a. It is generally backed by easily traceable movable property like real estate
b. Asset need not exist at the time of securitization such as future cash flows can also be securitized
c. Process takes into consideration depreciation in the value of the assets
d. They give high yields to the investor
e. Legal hassles are relatively less as compared to mortgage backed securities.
2. The devolvement of RBI in auction of T-Bills is
a. 20% of the total devolvement
b. 25% of the total devolvement
c. 75% of the total devolvement
d. 80% of the total devolvement
e. Residuary after the devolvement of all the primary dealers.
3. The stamp duty payable on a commercial paper of maturity above 9 months but less than 12 months is -
______ %.
a. 0.125
b. 0.250
c. 0.375
d. 0.500
e. 0.575
4. Which of the following is true with respect to mortgaged backed bonds?
I. Use of collateral is more efficient than in case of mortgage pass throughs
II. Certainty of cash flow is more predictable than in case of collateral mortgage backed bonds
III. Liquidity is more excellent than treasury bills.
a. Only (I) above
b. Only (II) above
c. Both (I) and (II) above
d. Both (II) and (III) above
e. None of the above.
5. The maximum amount of deposits a AA rated NBFC having net owned funds of more than Rs.25 lakhs and
complying all prudential norms with capital adequacy capital ratio of 15% can mobilize is ______ times its
net owned funds.
a. 1.00
b. 2.50
c. 4.00
d. 6.00
e. 10.00.

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6. The minimum net worth required to qualify as a merchant banker as per the latest guidelines of SEBI is
a. Rs.2.50 crores
b. Rs.5.00 crores
c. Rs.6.00 crores
d. Rs.7.50 crores
e. Rs.10.00 crores
7. As per the SEBI Guidelines one of the conditions an existing private or closely held company should fulfil
to freely price its issue is to have networth of not less than ________ in 3 out of last ______ years with
minimum networth in the immediately preceding ______ years.
a. Rs. 10 lakhs, 7, 3
b. Rs. 50 lakhs, 5, 2
c. Rs.100 lakhs, 5, 2
d. Rs.100 lakhs, 4, 2
e. These stipulations are done away as per the latest amendments.
8. Akash Finance wants to register itself with SEBI as a Category I Registrar. The minimum net worth Akash
Finance should have is
a. Rs.2 lakhs
b. Rs.3 lakhs
c. Rs.5 lakhs
d. Rs.6 lakhs
e. Rs.10 lakhs.
9. The minimum underwriting obligation of a lead manager is
a. 5% of total underwriting commitment
b. 3% of total underwriting commitment
c. Rs.25 lakhs
d. Maximum of (b) and (c) above
e. Minimum of (a) and (c) above.
10. The applicant in a public issue is required to quote his Permanent Account Number (PAN) in the
application form if the size of the application exceeds
a. Rs. 10,000
b. Rs. 25,000
c. Rs. 50,000
d. Rs. 75,000
e. Rs.1,00,000
11. Tilak Tazza Tea is coming up with a public issue, which opens on July 28, 2001. The issue announcement
advertisement should be released on
a. July 8, 2001
b. July 14, 2001
c. July 18, 2001
d. July 23, 2001
e. July 28, 2001.
12. The US dollar denominated bond issued by foreign borrowers in the US market is known as
a. Alpine bonds
b. Bulldog bonds
c. Samurai bonds
d. Shibosai bonds
e. Yankee bonds.

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13. The credit rating obtained for a commercial paper cannot be more than _____ old as per the RBI
Guidelines.
a. 1 month
b. 2 months
c. 3 months
d. 6 months
e. 1 year.
14. Which of the following is false with respect to credit rating?
a. A credit rating reflects borrower’s accountability
b. A credit rating reflects the borrower’s expected capability and interest to pay the interest and principal
amount on time
c. A credit rating is a general purpose evaluation of the issuer
d. A credit rating is not an extensive audit of the issuing company
e. A credit rating involves issue specific evaluation.
15. Prudential Factoring Services Ltd. discounts the L/C backed bills of its clients at 25% p.a. The effective
rate of interest per annum of such a bill of usance period 90 days (assuming 360 days a year) is _______ %.
a. 25.00
b. 26.37
c. 26.67
d. 27.44
e. 29.45.
16. In which of the following types of factoring the factor provides an advance generally varying between 75-
85 % of the value of the receivables factored and the balance is paid upon collection or on the guaranteed
payment date?
a. Recourse factoring
b. Maturity factoring
c. Advance factoring
d. Supplier guarantee factoring
e. Full factoring.
17. Elegant Emeralds have taken a machine worth Rs.1000000 in hire purchase from Fabulous Finance
Limited at the following terms:
Rate of interest 14% flat
Repayment period 4 years
Frequency of payment Monthly in arrears
Down payment 25%

If after paying the 30th installment Elegant Emeralds want to repay the loan and purchase the machine,
what interest rebate it can enjoy according to the Rule of 78 method?
a. Rs.50,000
b. Rs.56,965
c. Rs.60,000
d. Rs.61,071
e. Rs.62,465.
18. Which of the following can operate as both lender and borrower in the call/notice money market?
a. LIC
b. UTI
c. SBI Mutual Fund
d. Discount and Finance House of India Ltd
e. Export Credit and Guarantee Corporation of India.

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19. Which of the following is false regarding Hire Purchase?
I. The interest component of each hire purchase installment is computed on the basis of a flat
rate of interest
II. Only goods of merchantable quality can be utilized for a hire purchase scheme
III. Sales tax cannot be levied on hire purchase transactions structured by finance companies
provided these companies are not dealers in the class of goods let on hire
a. Only (I) above
b. Only (II) above
c. Both (I) and (II) above
d. Both (I) and (III) above
e. None of the above.
20. Which of the following is not required to be disclosed in a Finance Lease in the books of the lessee as per
the provisions of IAS: 17?
a. Amount of each asset that is subject to finance lease on each balance sheet date
b. Liabilities related to these assets differentiating between the current and long term portions
c. Commitments for minimum lease payments in summary form giving the amounts and the periods in
which these payments will become due.
d. Significant financing restrictions, renewal or purchase options, contingent rentals, etc., included in the
finance lease contract.
e. None of the above.
21. Which of the following risks are relevant for a lease portfolio?
a. Default risk
b. Residual value risk
c. Political risk
d. Both (a) and (b) above
e. All (a), (b) and (c) above.
22. The following data pertains to a particular lease contract, where the lease rental, which is payable annually
increases at a constant rate per annum.
Initial annual lease rental Rs.12,000
Duration of lease 3 years
Pre-tax yield p.a. 21%
Constant rate of increase p.a. 10%
The present value of such lease rental stream is
a. Rs.24,840
b. Rs.25,840
c. Rs.27,131
d. Rs.31,131
e. Rs.32,716.
23. Which of the following model does not assume that lease is a substitute of debt?
a. Weingartner’s Model
b. Equivalent Loan Model
c. Bower-Herringer-Williamson Model
d. Bower Model
e. None of the above.

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24. Which of the following statements is false?
a. In operating lease the lessee enjoys the right to terminate the lease at short notice without any
significant penalty.
b. A dry lease is a finance lease where the lessee bears the costs of insuring and maintaining the leased
equipment.
c. In finance lease the lease term is for a major part of the useful of the asset.
d. A direct lease can only be of two types – bipartite or tripartite.
e. Cross-border leases offer funding on a long-term basis at fixed rates of interest, which may not be
available to the lessee in his country.
25. Which of the following is\are true regarding consumer credit transactions?
I. They can be structured either as a down payment or deposit linked schemes.
II. They can be structured in the form of hire purchase transactions.
III. They are unsecured transactions.
a. Only (II) above
b. Both (I) and (II) above
c. Both (II) and (III) above
d. Both (I) and (III) above
e. All (I), (II) and (III) above.
26. As per the latest amendments of SEBI the minimum amount for listing in a stock exchange is
a. Rs.2 crores
b. Rs.5 crores
c. Rs.7 crores
d. Rs.10 crores
e. Decided by the individual stock exchanges.
27. LYONS are
a. Optionally convertible debentures
b. Third party convertible debentures
c. Zero coupon convertible notes
d. Tax saving bonds
e. Cumulative convertible preference shares.
28. In case of warrants, the currency of the instrument should not exceed beyond ______ months from the date
of issue of the relevant instrument.
a. 18
b. 24
c. 30
d. 36
e. There is no such stipulation.
29. Which of the following is/are true regarding charge card?
a. It is built around revolving credit concept
b. The issuer does not charge any interest to the card holder.
c. It is a pay now product.
d. Bank account should essentially be opened by the cardholder.
e. Both (a) and (b) above.
30. The maximum amount of sub-ordinated debt that can be included in the Tier II capital of a finance
company is
a. 100% of Tier I capital
b. 80% of Tier I capital
c. 50% of Tier I capital
d. 50% of Tier II capital after inclusion of such debt
e. None of the above.

END OF PART A
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 Part B : Problems (50 Points)
• This part consists of questions with serial number 1 - 5
• Answer all questions.
• Points are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Part B.

1. Priyanka Polymer Pvt. Ltd. (PPPL) a growing company manufacturing polyester yarn and clothing needs to
expand its business for keeping with up growing demand in poly products. For this Priyanka Polymer needs
some special spinning machine costing Rs.1 crore inclusive of CST @ 4%. The estimated economic life of
the machinery is 4 years after which the salvage value will be Rs.15 lakhs.
The M.D. of Priyanka Polymer got 2 alternatives as given by the M.D. of Arihant Financial Services Ltd.
(AFSL) – Lease or Hire purchase. The details of the two alternatives are as below:
Lease:
Lease Rentals : Rs. 30 ptpm
Payment : Quarterly in arrears
Lease Period : 4 years
Hire Purchase:
Down Payment : 30%
Flat rate of interest : 12%
Payment : Monthly in advance
Hire period : 4 years
Other relevant information regarding Priyanka Polymer
Tax relevant rate of depreciation : 30%
Tax rate applicable : 35%
Marginal cost of debt : 15%
Marginal cost of capital : 18%
Interest is allocated on SOYD basis
You are required to
a. Assist the M.D. of Priyanka Polymer in suggesting the best mode of asset financing.
b. Find the flat rate of Interest under the H.P. option, at which the M.D. of Priyanka Polymer would
be indifferent between these two modes of financing.
(10 + 4 = 14 points)
2. Suparna Ltd. had a turnover of Rs.400 lakhs in 2000-2001 and expects an increase of 20% in the next year.
The credit terms of Suparna are 1/10 net 30 days. 25% of the customers pay on the tenth day and avail the
early discount. The rest accept the bills drawn by Suparna for a period of 30 days. However as per the
records, on an average only 75% of the bills accepted are honored on due date while the balance of the bills
are dishonored and payment for the same is made within 45 days.
Suparna avails short-term finance from VCK Finance Ltd for funding 75% of receivables at 20% p.a. The
pretax cost of funds of Suparna is 25%. The administrative expenses for credit recovery is Rs.1 lakhs.
VCK has given an offer of non-recourse factoring service to Suparna, the terms of which are as follows:
Discount charge 24%
Commission 2.5%
Advance Payment 90% of factored receivables
Agreed payment time 20 days

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 Suparna wants to opt for this service in order to curtail the administrative expenses and increase its sales.
The variable to sales ratio of Suparna is 0.60.
As a financial analyst you are required to compute the minimum increment in sales for Suparna so that
factoring becomes a better option.
(9 points)
3. Nilima has taken a loan of Rs.500000 from Nilambar Housing Finance Ltd., for purchasing an apartment at
graduated payment mortgage scheme for 10 years.
Terms and conditions of the loan are as follows:
i. Tenure – 10 years.
ii. Payment – Monthly
iii. Interest – 12% p.a. compounded monthly
iv. The borrower needs to make graduated monthly payments for 5 years increasing at a rate of 5% every
year and thereafter the payments would be as equated monthly instalments.
Draw a payment schedule of the housing loan taken by Nilima.
(7 points)
4. The following balance sheet pertains to Gulmohar Ltd. for the year ending March 31, 2001.
(Rs. Crore)
Liabilities Amount Assets Amount
Share Capital Net Fixed Assets 12.25
Authorized Share capital
10.00 Investments 1.25
(2 cr shares of Rs.5 each)
Issued and Paid up 5.00
Current Assets 4.50
(1.cr. shares of Rs.5 each)
Reserves
General reserve 3.25
Capital redemption reserve 1.00
Capital reserve 0.25
Revaluation reserve 0.25
Share Premium 0.65 5.40
16% FCDs 1.60
Secured Loans 4.00
Current liabilities & Provisions 2.00
18.00 18.00
The following information is extracted from the books of Gulmohar Ltd.
I. Capital reserve consists of Rs.10 lakhs profit realized on sale of some old machinery this year.
II. Gulmohar Ltd. purchased some valuable patents from Mr.Solanki, the purchase consideration of
Rs.40 lakhs being settled by allotting Rs.1 lakh equity shares of Gulmohar
III. FCDs of face value of Rs.100 each is due to be converted to 2 equity shares of Rs. 50 on October 2001
The Board of directors of Gulmohar Ltd. are intending to declare bonus issue at its AGM to be held during
August 2001.
You are required to
a. Compute the maximum permissible bonus ratio.
b. Recast the balance sheet of Gulmohar Ltd. after the bonus issue.
c. State the latest by which date, Gulmohar Ltd. has to implement this proposal of bonus issue?
(6 + 3 + 1 = 10 points)
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5. SDE Prameela Techno Park is a newly built techno park in the Hitec City of Hyderabad. For further
expansion, SDE Prameela is contemplating taking a foreign currency loan worth Rs.880 crores. Dresdner
Bank, Frankfurt has given a proposal of extending this loan in Euro at the following terms and conditions:
Draw down 2 equal installments on January 01, 2002 and January 01, 2003.
Maturity 8 years
Coupon Paid annually at 250 BPs over LIMEAN
Commitment fee 60 BPs per annum
Management fee 50 BPs payable upfront
Guarantee fee 80 BPs payable at the beginning of the year
Agency fee 100,000 Euro per annum payable at the end of the year
Underwriting fee 30 BPs payable upfront
Amortization 2 equal installments at the end of 7th and 8th year.
The expected LIBOR and LIBID rates of Euro as predicted by the Dresdner Bank’s Forex Department is as
follows:
Year LIBOR (%) LIBID (%)
2001 3.5 3.2
2002 3.8 3.5
2003 4.0 3.8
2004 4.6 4.0
2005 4.2 3.9
2006 4.0 3.7
2007 4.2 3.8
2008 4.4 4.2
2009 4.9 4.7

The prevailing exchange rate can be assumed as 1 Euro = Rs.44.

You are required to compute the effective cost of borrowing to the company
(10 points)
END OF PART B

Part C : Applied Theory (20 Points)

• This part consists of questions with serial number 6 - 7.
• Answer all questions.
• Points are indicated against each question.
• Do not spend more than 25 -30 minutes on Part C.

6. It is said “Financial Engineering involves design, development and implementation of innovative financial
instruments and processes and the formulation of creative solutions to the problems in the finance. In this
context discuss the factors that have accelerated the process of financial innovation in India and the factors
that drive financial engineering.
(10 points)
7. In a market just waking up to Internet commerce but overwhelmed by concerns over security of credit card
deals Indian e-commerce firm Smartcc has come up with a unique idea - pre-paid cash cards. What are pre-
paid cash cards and how will they operate? What is its future in the Indian market?
(10 points)
END OF PART C

END OF QUESTION PAPER

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 Suggested Answers
Investment Banking and Financial Services - I : July 2001
Part A : Basic Concepts
1. Answer : (a)
Reason : All the alternatives except (a) are the features of asset backed securitisation. Mortgage backed
securitisation is backed by easily traceable immovable property.
2. Answer : (d)
Reason : In case of devolvement in the auction of T-Bills, all the PDs shall have to underwrite up to a
fixed percentage of the gap between the amount accepted and the amount notified and the total
commitment from all PDs put together should be 20% of the gap i.e. devolvement and the
balance 80% of the devolvement will be taken up by RBI.
3. Answer : (d)
Reason : The stamp duty payable on the issue of commercial paper varies depending on the maturity of
the issue. Accordingly, if the maturity of the issue is above 9 months the stamp duty payable by
the issuer is 0.5% of the issue amount.
4. Answer : (e)
Reason : Comparing the features of mortgage securities and alternative investment instruments, the use of
collateral is more efficient in case of mortgage pass throughs, certainty of cash flow is more
predictable in case of collateral mortgage obligations and the liquidity is excellent in case of
treasury bills. Hence, all the statements, I, II and III are not true in respect of mortgage backed
bonds.
5. Answer : (c)
Reason : According to the Prudential norms of NBFCs as given by RBI, the maximum amount of deposits
a AA rated NBFC complying the conditions as mentioned in the given question is 4 times its net
owned funds.
6. Answer : (b)
Reason : With the abolition of the categories of merchant bankers, all the merchant bankers are stipulated
to follow the eligibility norms of the erstwhile category I merchant banker. Hence, the minimum
networth required to qualify as a merchant banker is Rs.5 crores.
7. Answer : (c)
Reason : According to SEBI guidelines no unlisted company shall make a public issue of any equity share
unless the company fulfills the stipulated two conditions. One of condition is to have a
minimum networth of Rs.1 crore in three out of the preceding five years with the minimum
networth to be met during immediately preceding two years.
8. Answer : (d)
Reason : According to SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993 an
applicant to the registration of Category I registrar should have a minimum net worth of Rs.6
lakhs.
9. Answer : (e)
Reason : According to SEBI (Guidelines and Investor Protection) Guidelines, the minimum underwriting
obligation of the lead merchant banker is 5% of the total underwriting commitment or Rs.25
lakhs whichever is less.
10. Answer : (c)
Reason : An applicant to a pulic issue with the application size of Rs.50000 or more should necessarily
quote his/her Permanent Account Number in the application form.
11. Answer : (c)
Reason : The issue announcement advertisement should be released 10 days prior to the opening of the
issue. Hence, if the issue opens on July 28, 2001, the issue announcement advertisement should
be released on July 18, 2001.

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12. Answer : (e)
Reason : The US dollar denominated issues by foreign borrowers in the US bond market are known as
foreign bonds and are referred to as Yankee bonds.
13. Answer : (b)
Reason : According to the RBI guidelines, the minimum credit rating required is P2 from CRISIL or an
equivalent rating from CARE, ICRA and DCR India and the rating should not be more than two
months old.
14. Answer : (c)
Reason : According to the various definitions given by the rating agencies, a rating is not a general
evaluation of the issuing organization but reflects the probability of timely repayment of
principal and interest by a borrower company. Hence, the correct answer is (c).
15. Answer : (e)
Reason : The effective rate of interest is calculated as
Discount charge at the rate of 25% per annum (assuming the value of the bill is Rs.100) is
Rs.25 × 90/360 = Rs.6.25
Value received by the client = 100 – 6.25 = Rs.93.75
Effective rate of interest per quarter is 6.25/93.75 × 100 = 6.667%
The effective rate of interest per annum is (1.0667)4 – 1 × 100 = 29.45%
16. Answer : (c)
Reason : In advance factoring, the factor provides an advance and the balance is paid upon collection or
on the guaranteed payment date. In recourse factoring, the factor purchases the receivables on
the condition that the loss arising on account of irrecoverable receivables will be borne by the
client. A recourse factoring can be structured in form of maturity factoring or advance factoring.
A maturity factoring is that type of factoring in which the factor does not provide any advance
but makes the entire payment on an agreed payment date or on the date of collection. In case of
supplier guarantee factoring, the factor guarantee the payment to the foreign supplier and instead
of making an advance payment to the distributor makes entire payment to the supplier and
makes the final payment to the distributor on collecting the dues from the customer. Full
factoring consists of the features of non-recourse factoring and advance factoring. As in the
given situation it is not mentioned whether the factoring is with recourse or without recourse the
correct answer can be deduced as (c).
17. Answer : (d)
t (t + 1)
Reason : According to the rule of 78 method, interest rebate is calculated as xD
n (n + 1)
where t = number of installments that are not due and outstanding, n = total number of
installments and D is the total charge for credit.
In the given situation t = 18, n = 48 and D = 1000000 × 0.75 × 0.14 x 4 = Rs.420000 and hence,
interest rebate is equal to Rs.61071. Hence, the correct answer is (d).
18. Answer : (d)
Reason : Participants in the call money market are divided into two categories. The first category
comprises of banking companies who can lend and borrow in the call money market. The second
category comprises of financial institutions and mutual funds who can lend but cannot borrow.
Apart from banking companies intermediaries like DFHI and STCI and Primary Dealers are also
allowed to lend and borrow in the call money market. In the given question only DFHI is
allowed to act both as lender and borrower in the call money market. Hence, correct answer is (d).
19. Answer : (e)
Reason : One of the salient features of the hire purchase transaction is that the interest component of each
hire installment is computed on the basis of the flat rate of interest method. Hence, statement I is
correct. Only goods of merchantable quality can be utilized for hire transaction. Hence,
statement II is also correct. According to the sales-tax aspects of hire transaction, sales tax is not
levied on hire transactions structured by the finance companies provided these companies are not
dealers in the class of goods let on hire. Hence, statement III is also correct. Hence the correct
answer is (e).

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20. Answer : (e)
Reason : According to the IAS guidelines on lease accounting, all the given alternatives have to be
disclosed in the books of the lessee in case of finance lease. Hence, the correct answer is (e).
21. Answer : (e)
Reason : A lease portfolio is prone to all the risks mentioned in the given situation.
22. Answer : (c)
Reason : Present value of lease rental stream is calculated as follows:
12000 PVIF21,1 + 12000 PVIF21,2 x 1.1 + 12000 (1.1)2 PVIF21,3
= 12000 [0.826 + 1.1 x 0.683 + (1.1)2 x 0.564]
= 12000 x 2.259 = Rs.27,108
23. Answer : (a)
Reason : Of the models, Weingartner’s model does not assume that lease is a substitute of debt.
24. Answer : (b)
Reason : Of the alternatives, (b) is not correct because a dry lease is a operating lease where lessee bears
the costs of insuring and maintaining the leased equipment.
25. Answer : (b)
Reason : Of the statements given, statement III is not correct since a consumer credit is secured through a
first charge on the asset concerned and the borrower is prohibited from selling or pledging or
hypothecating the asset during the credit period. Hence, the correct answer is (b).
26. Answer : (b)
Reason : The minimum amount for listing on a stock exchange is Rs.5 crores.
27. Answer : (c)
Reason : Zero coupon convertible notes are referred to as LYONS.
28. Answer : (a)
Reason : According to the SEBI guidelines, in case of warrants, the currency of the instrument should not
exceed 18 months from the date of the issue of the instrument.
29. Answer : (b)
Reason : A charge card is a plastic card wherein the whole amount of purchase is paid within the month of
purchase and there is no carried forward amount and hence, the issuer does not charge any
interest in case of charge card. A plastic card which is built around the revolving credit concept
is termed as credit card and a card which is considered as a pay now product is termed as debit
card.
Hence, the correct answer is (b).
30. Answer : (c)
Reason : According to the capital adequacy norms, while calculating the Tier II capital sub-ordinated debt,
if any, is included upto the maximum amount of 50% of Tier I capital.

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 Part B : Problems

1. a. Evaluation of the two alternatives:

Lease
Cost of asset to AFSL
100
= × 1.1 = Rs.105.77 lakhs
1.04
(As the lessor is not eligible to the concessional rate of CST @ 4%). Hence lease rentals are charged
on Rs.105.77 lakhs).
Cost of lease = PV of Lease Rentals (LR) – PV of tax shield on Lease Rentals (TS)
PV of LR = 0.030 × 12 × 105.77 × PVIFA(15%, 4) × i/i4
= 0.03 × 12 × 105.77 × 2.855 × 1.0546 = Rs.114.65 lakhs
PV of TS on LR = 0.030 × 12 × 105.77 × PVIFA(18, 4) × 0.35
= 0.03 × 12 × 105.77 × 2.69 × 0.35 = Rs.35.85 lakhs
COL = 114.65 – 35.85 = Rs.78.80 lakhs

Hire Purchase
As hire purchase is equivalent to sale, the cost of the machinery of AFSL will be same at Rs.1 crore.
Down payment = 0.30 × 100 = Rs. 30 lakhs
70 × 0.12 × 4 + 70
Monthly hire instalment =
48
= Rs.2.158 lakhs
PV of hire instalment (HI) = 2.158 × 12 × PVIFA15%, 4 × i/d12
= 2.158 × 12 × 2.855 × 1.0795
= Rs.79.81 lakhs
PV of depreciation tax shield (DTS)
(Rs. In Lakhs)
YR Depreciation PVIF @ 18% PV
1 30.00 0.847 25.41
2 21.00 0.718 15.08
3 14.70 0.609 8.95
4 10.29 0.516 5.31
547.55

PV of DTS = 54.75 × 0.35 = Rs.19.16 lakhs.

PV of Net Salvage Value (NSV) = 15 × PVIF18%, 4
= Rs.7.74 lakhs
PV of Interest Tax Shield (ITS) :
Total charge for credit = 2.158 × 48 – 70
= Rs.33.58 lakhs
Year SOYD Factor Interest charge PVIF @ 18% PV
1. 510/1176 14.56 0.847 12.33
2. 366/1176 10.45 0.718 7.50
3. 222/1176 6.34 0.609 3.86
4 78/1176 2.23 0.516 1.15
24.84

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 PV of ITS = 24.84 × 0.35 = Rs.8.69 lakhs
Cost of Hire Purchase (COHP) = Down payment + PV (HI) – PV (ITS) – PV (DTS) – PV (NSV)
= 30 + 79.81 – 8.69 – 19.16 – 7.74
= Rs.74.22 lakhs
As COHP < COL, hire purchase should be adopted

b. Let EMIs be Rs. A lakhs at which COL = COHP

Computation of COHP
PV of HI = 12 × A × PVIFA15%, 4 × i/d12
= Rs.36.98A lakhs
Total charge for credit = A × 12 x 4 – 70
= Rs.4 (12 A – 17.5) lakhs
(Rs.lakhs)
Year SOYD Factor Interest Charge PVIF @ 18% PV
1 510/1176 1.73 (12A-17.5) 0.847 1.4653(12A-17.5)
2 366/1176 1.24(12A-17.5) 0.718 0.8903(12A-17.5)
3. 222/1176 0.76(12A-17.5) 0.609 0.4628(12A-17.5)
4 78/1176 0.27(12A-17.5) 0.516 0.1393(12A-17.5)
2.9577(12A-17.5)
PV of ITS = 0.35 × 2.9577 (12A – 17.5)
= 1.0352 (12A – 17.5)
COHP = 30 + 36.98A – 1.0352 (12A – 17.5) – 19.16 – 7.74
COHP = COL
⇒ 30 + 36.98A – 12.42A + 18.12 – 19.16 – 7.74 = 78.80
⇒ 24.56A = 57.58
⇒ A = Rs.2.344 lakhs

As EMI is Rs.2.344 lakhs, flat rate of interest

=
(2.344 × 4 × 12) − 70
70 × 4
= 15.18%
At a flat rate of interest of 15.18%, the M.D. of Priyanka Polymer would be indifferent between these 2
modes of financing.

2. a. Cost Benefit analysis of Factoring :

Benefits of factoring:
It is assumed that this increase is irrespective of the method of financing receivables
∴ Sales predicted for 2001-02 = 400 × 1.2 = Rs.480 lakhs

A. Cash discount = 480 × 0.25 × 0.01 = Rs.1.2 lakhs

Average collection period
= 0.25 × 10 + 0.75 [0.75 × 30 + 0.25 × 45]
= 27.8 days
B. Cost of own funds
27.8
= 480 × × 0.25 × 0.25 = Rs.2.28 lakhs
365
C. Cost of Finance from finance co.
27.8
= 480 × × 0.75 × 0.20 = Rs.5.48 lakhs
365
D. Avoidable administrative expenses = Rs. 1 lakhs

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 E. Let Rs.A lakhs be the increment in sales over & above Rs.480 lakhs because of factoring.
Contribution gained on increased sales
= A × 0.40 = Rs.0.4A lakhs.
∴ Total benefits of factoring = A + B + C + D + C
= 1.2 + 2.28 + 5.48 + 1 + 0.4A
= Rs. (9.96 + 0.4A) lakhs.
Costs of factoring:
Sales = Rs.(480 + A) lakhs
20
F. Discount Charge = (480 +A) × 0.90 × × 0.24
365
= Rs.(5.68 + 0.0118A) lakhs.

G. Commission = (480 + A) × 0.025

= Rs. (12 + 0.025A) lakhs

20
H. Cost of own funds = (480 + A) × 0.10 × × 0.25
365
= Rs (0.66 + 0.0014A) lakhs
Total Costs = F + G + H = 5.68 + 0.0118A + 12 + 0.025A + 0.66 + 0.0014A
= Rs. (18.34 + 0.0382A) lakhs
Hence 9.96 + 0.4A = 18.34 + 0.0382A
⇒ 0.3618A = 8.38
⇒ A = 23.16 lakhs
Hence, minimum increment in sales Suparna needs to achieve over and above Rs.480 to make
factoring a better option is Rs.23.16 lakhs.

3. Let the monthly installment in the Ist year be Rs.X

∴ 12x X PVIFA(1%12) + 1.05 x 12 x X[PVIFA(1%,24) – PVIFA(1%, 12)]
+ (105)2 x 12 x [PVIFA(1%,36) – PVIFA(1%,24) ]
+ (105)3 x 12 x [PVIFA(1%,48) – PVIFA(1%,36)]
+ (1.05)4 x 12 x X [PVIFA(1%,120) – PVIFA(1%,48)]
= 500000
⇒ 12x [11.255 + 1.05 (21.243 – 11.255) + (105)2 . (30.107 – 21.243) + (1.05)3 (37.973 – 30.107)
+ (1.05)4 ( 69.700 – 37.973] = 500000
⇒ x = 526.19
∴ Monthly installment in the 1st year = Rs.526.19
∴ Monthly installment in the 2 year
nd
= Rs.526.(1.05) = 552.50
∴ Monthly installment in the 3rd year = Rs.552.5 (1.05) = Rs.580.12
∴ Monthly installment in the 4 Year
th
= 580.12 (1.05) = Rs.609.13
from 5th year onwards = Rs.609.13 (1.05) = Rs.639.59

Repayment schedule
Year Graduated monthly
payment made (Rs)
1 526.1
2 552.50
3 580.12
4 609.13
5-10 639.59

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4. a. Computation of Eligible Reserves for Bonus Issue.
Rs. Cr.
General reserve 3.25
Capital redemption reserve 1.00
Profit realized on sale of old machinery 0.10
Share premium received in cash {0.65 – 0.01(40 – 5)} 0.30
4.65
Computation of numbers of shares eligible for bonus issue
(in Crores)
Existing number of equity shares 1.00
Equity shares on conversion – (0.016 × 2) 0.032
1.032
4.65
No. of Bonus shares that can be issued = = 0.93 cr.
5
No. of shares eligible for bonus issue = 1.032 cr.
∴ Maximum permissible bonus ratio = 1.10
That is for every 11 shares held on 10 bonus shares can be issued.

b. Post Bonus Issue Balance Sheet of Gulmohar Ltd.

(Rs. Crores)
Liabilities Amount Assets Amount
Share Capital Net Fixed Assets 12.25
Authorized Share Capital Investments 1.25
2 Cr. Shares of Rs. 5 each 10.00 Current Assets 4.50
Issued and paid up 9.65
1.93 cr. Shares of Rs. 5 each
Reserves
Capital reserve 0.15
Revaluation reserve 0.25
Share premium 0.35 0.75
16% FCDS 1.60
Secured Loans 4.00
Current Liabilities & Provisions 2.00
18.00 18.00

c. As per SEBI Guidelines a company which announces a bonus issue after the approval of the Board of
Directors must implement the proposals within a period of 6 months from the date of such approval
Hence Gulmohar Ltd., has to implement this proposal of bonus issue latest by January 15, 2002.

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5. Computation of LIMEAN
Year LIBOR LIBID LIMEAN Interest
2002 3.80% 3.50% 0.0365 0.0615
2003 4.00% 3.80% 0.0390 0.0640
2004 4.60% 4.00% 0.0430 0.0680
2005 4.20% 3.90% 0.0405 0.0655
2006 4.00% 3.70% 0.0385 0.0635
2007 4.20% 3.80% 0.0400 0.0650
2008 4.40% 4.20% 0.0430 0.0680
2009 4.90% 4.70% 0.0480 0.0730

Amount required to be borrowed in Euro = 8800 millions/44 = Euro 200 millions

(All figures are in Euro Million)
Particulars Upfront 31.12.2002 31.12.2003 31.12.2004 31.12.2005 31.12.2006 31.12.2007 31.12.2008 31.12.2009
Draw down 100 100 0 0 0 0 0 0 0
Amortization 0 0 0 0 0 0 0 100 100
Interest 0 6.15 12.8 13.6 13.1 12.7 13 13.6 7.3
Management fee 1 0 0 0 0 0 0 0 0
Commitment fee 0 0.6 0 0 0 0 0 0 0
Gaurantee fee 0.8 1.6 1.6 1.6 1.6 1.6 1.6 0.80 0
Underwriting fee 0.6 0 0 0 0 0 0 0 0
Agency fee 0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1
Total cash outflow 2.4 8.45 14.5 15.3 14.8 14.4 14.7 114.5 107.4
Net cash flow 97.6 91.55 –14.5 –15.3 –14.8 –14.4 –14.7 –114.5 –107.4
The effective cost borrowing is the value of I in the following:
91.55 14.5 15.3 14.8 14.4 14.7 114.5 107.4
97.6 + − − − − − − − =0
1 + i (1 + i) 2 (1 + i ) 3 (1 + i) 4 (1 + i) 5 (1 + i) 6 (1 + i ) 7 (1 + i) 8
Hence, the effective cost of borrowing of SDE Prameela is approximately 7.7%.

Part C: Applied Theory

6. Over the last two decades, financial engineering has brought about a remarkable change in the global
financial markets. The deregulation of the financial services sector has resulted in increasing stress being
placed on ability to design new products, develop superior processes and implement structured solutions to
complex financial problems. A number of factors have accelerated the process of financial innovation.
They include:
• interest rate volatility
• exchange rate volatility
• price volatility
• regulatory and tax changes
• globalization of the markets
• increased competition among investment bankers.
According to John Finnerty “Financial engineering involves design, development and implementation of
innovative financial instruments and processes and the formulation of creative solutions to the problems in
finance.” The soul of this definition is captured by the words `innovative’ and `creative’. This may involve
a quantum leap through the introduction of a revolutionary new idea like the first swap deal or the first
Leveraged Buy Out transaction. At other times it may involve adding a new dimension to an existing
product or novel extension of an existing idea. For eg., a new variant of a derivative.
Miller characterizes financial engineering as unpredictable improvement in the variety of available
financial products resulting from unforeseen changes. Kane views financial engineering from the point of
view of regulatory dialectic. He sees regulatory dialectic as a cyclical process in which opposing forces of
regulation and avoidance by regulates perpetually try to outwit each other. Silber perceives innovative

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 financial instruments and processes as endeavors by corporations to mitigate the financial constraints they
face. According to him, the cost of following the rules provides the impetus for innovative activities.
Financial engineering relaxes the constraints and thereby reduces the cost of compliance. Van Horne takes
a more critical view, maintaining that a new product or process cannot be considered ‘truly’ innovative
unless it makes the financial markets operate more efficiently or makes them more complete. According to
him, financial markets are made more complete by the introduction of new securities whose contingent
after tax cash flows cannot be replicated by any combinations of existing securities.
The following are some of the factors which drive financial engineering:
• reducing transaction costs
• reducing agency costs
• leveraging tax asymmetries
• unbundling and reallocation of risks
• enhancing liquidity
• overcoming regulatory constraints
• technological advances
• advances in financial theory
• arbitrage opportunities.

7. In a market just waking up to Internet commerce but overwhelmed by concerns over security of credit card
deals, Indian e-commerce firm Smartcc is betting on what it says is a unique idea — pre-paid cash cards.
The cards allow online shoppers to buy the scratch-and-use cards called Green through a chain of retail
outlets and Internet cafes spread over the country and charge these to an Internet site after an electronic
verification process. The codes on the cards have to be entered during Internet transactions linked to the
company’s own Website. In contrast to the use of credit card numbers on the Internet, there is no possible
risk of misuse, such company officials say.
E-tailers can use the money credited to their account and shop on a number of affiliated Web sites, which
have back-end deals with these companies.
The firms pre-paid cash cards have been launched in many Indian cities including Bombay, Delhi and
Bangalore and the company plans to aggressively expand its reach.
With India’s low credit card penetration and added concerns over security of card deals on the Internet,
many Internet portals are betting on cash on delivery, pre-paid cash cards and debit cards to give an
impetus to the nascent e-tailing market.
Smartcc, formed by three technology professionals, has backing from venture capital firm Jumpstartup
Fund Advisors. Its flagship software product Green has a patent pending technology.
It has tied up with many Indian sites and its cards are currently accepted at 15 including Fabmart.com,
Sify.com and Rediff.com. About a dozen e-commerce portals are fighting it out in a market where India’s
Internet subscribers are forecast to jump to 15 million by end-2003 from the current over two million.
Smartcc hopes to help e-shoppers overcome their concerns about Internet security, a major deterrent to
online shopping.
Payment options are fundamental to any transaction and hence until infrastructure issues such as access to
Internet and payment options are tackled, the Internet economy would not grow.

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