Question Paper

Investment Banking and Financial Services-I (261) : October 2005

Section A : Basic Concepts (30 Marks)
• • This section consists of questions with serial number 1 - 30.
• • Answer all questions.
• • Each question carries one mark.
• • Maximum time for answering Section A is 30 Minutes.

1. Which of the following functions of the financial system ensures a smooth flow of funds from <
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Answer

savings to investments in order to stabilize the economy?

(a) Savings function (b) Policy function (c) Credit function
(d) Financial function (e) Investment function.
2. Bokadia Financial Services Ltd., an NBFC which is in the business of leasing or hire purchase, is< >
Answer

planning to accept fixed deposits. For this purpose it should have been in existence for at least ___
years and it should have minimum credit rating of ___ issued by CARE.
(a) 5, AA (b) 3, AA (c) 2, BBB (d) 2, A (e) 3, A.
3. In a financial system, financial assets + real assets = financial liabilities + savings. Which of the <
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Answer

following is/are the assumption(s) of this relationship?

I. There are no external borrowings in the system.
II. Financial liabilities include stock issued to the outsiders.
III. Financial assets equal financial liabilities; the real assets will be financed by savings.

(a) Only (I) above (b) Only (III) above

(c) Both (I) and (II) above (d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer
4. Which of the following is not the objective of borrower? >
(a) Minimum terms and conditions attached with the usage of funds
(b) Satisfying the statutory reserve requirements and capital adequacy norms
(c) Minimum lead time in obtaining the required funds
(d) Minimum monitoring and interference
(e) Low rates of interest.
5. If the Government increases the SLR requirement for banks, the yields for the GOI securities tend to <
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Answer

(a) Increase (b) Decrease (c) No change

(d) At first increase then decrease (e) At first decrease then increase.
6. Scout Ltd. is a Primary Dealer in the Government Securities. During the auction of Dated Securities,<>
Answer

it has an agreement with the RBI for the underwriting commitment of 10% of the shortfall. The
devolvement on Scout Ltd. is Rs.2.5 crore. The competitive bids accepted at cut-off price (including
non-competitive bids) are Rs.1000 crore. The amount notified for the bids is
(a) Rs.800 crore (b) Rs.900 crore (c) Rs.1100 crore
(d) Rs.1200 crore (e) Rs.1300 crore.
< Answer
7. Which of the following statements is not true regarding bill finanacing? >
(a) Bill which is payable at a specified later date is called a usance bill
(b) Bill accepted by the drawee to accommodate the drawer without having received any
consideration is called an accommodation bill
(c) Bill drawn in India and made payable out side India is called a Foreign bill
 (d) Bill accompanied by the documents of title to goods such as lorry receipt or bill of lading is
called a clean bill
(e) Bill which arises out of supply of goods by manufacturing concerns is called a supply bill.
< Answer
8. Which of the following statements is true? >
(a) Banks can issue CDs for a minimum period of one year to a maximum of 3 years
(b) CDs are not subject to stamp duty
(c) CDs can be transferred immediately after issue
(d) Premature payment or loans against CDs by the issuer is not allowed
(e) CDs are not subjected to usual reserve requirements.
9. The lock-in period after the rights issue for the shareholdings held by the promoters prior to the <
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Answer

rights issue is
(a) 6 months from the date of allotment in the rights issue
(b) 12 months from the date of allotment in the rights issue
(c) 18 months from the date of allotment in the rights issue
(d) 24 months from the date of allotment in the rights issue
(e) 36 months from the date of allotment in the rights issue.
10. Bhanu Financial Services Ltd. (BFSL) is an underwriter for the preference issue of Rs.20 lakh <
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Answer

pertaining to Chaggan Ltd. The maximum rate of underwriting commission that BFSL can receive
on the amount subscribed by the public is
(a) 1.0% (b) 1.5% (c) 2.0% (d) 2.5% (e) 3.0%.
11. Which of the following is/are true in the context of application for grant of certificate of registration <
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Answer

as a Merchant Banker with SEBI?

I. The applicant can be an individual or body corporate.
II. Any associated company, group company or subsidiary company of the applicant should have
been registered as a Merchant Banker.
III. The applicant should have a minimum net worth of Rs.5 crore.

(a) Only (I) above (b) Only (III) above

(c) Both (I) and (II) above (d) Both (II) and (III) above
(e) All (I), (II) and (III) above.
< Answer
12. Which of the following is/are not true regarding SRO? >
(a) Most of the SROs have a code of conduct for their members
(b) The SROs monitor the functioning of their members with regards to compliance of laws,
statutory regulations as well as their code of conduct
(c) The SROs assist SEBI in formulation of policies as well as various regulations and rules
(d) The SROs form an important layer of regulatory structure in the developing markets
(e) SROs conduct professional development and training program for their members.
< Answer
13. Which of the following are true with respect to the issue of ADR Level-I ? >
I. These instruments are listed and traded in the US stock exchanges.
II. The issuer need not comply with the US GAAP.
III. The issuer should make significant disclosures to the SEC.
IV. This instrument is traded in the US OTC market.
V. The issuer is permitted to raise the fresh capital from the market.

(a) Both (I) and (III) above

(b) Both (II) and (IV) above
(c) Both (III) and (V) above
(d) (I), (II), (IV) and (V) above
(e) (II), (III), (IV) and (V) above.
 < Answer
14. Rating given by US-based credit rating agency FITCH to preferred stock with speculative nature is >
(a) BBB (b) BB (c) B (d) CCC (e) CC.
< Answer
15. Which of the following activities is/are involved in Capital Issue Management? >
I. Helping in determining the issue price.
II. Arranging for marketing and placing of the issue.
III. Seeking relevant approval for the purpose of public issue.
(a) Only (I) above (b) Only (II) above
(c) Both (I) and (III) above (d) All (I), (II) and (III) above
(e) Both (II) and (III) above.
< Answer
16. As per the EXIM policy, one of the eligibility criteria for undertaking import leasing is >
(a) The company must be in operation for the last five years
(b) Barring public sector leasing company, a leasing company must be listed on a recognized stock
exchange
(c) The leasing company must have a minimum net worth of Rs. 10 crore
(d) The Articles of the company must include leasing as an objective
(e) The company has shown profits for the past 6 years.
17. Laila Ltd. is contemplating investment in a new machine costing Rs.50 Lakh. Laila Ltd. can < >
Answer

purchase equipment by raising additional debt at a cost of 18% p.a. Alternatively, Laila Ltd. can take
equipment on finance lease with five year primary lease period at the rate of Rs. 20 ptpm payable
monthly in arrears. Marginal tax rate for Laila Ltd. is 46%. Financial advantage of leasing will be
(a) (-) Rs.9.47 lakh (b) (-)Rs.8.77 lakh (c) Rs.7.55 lakh
(d) Rs.8.77 lakh (e) Rs.9.47lakh
< Answer
18. A direct lease, a sale and leaseback, and a leveraged lease are all examples of >
(a) Operating lease
(b) Financial lease
(c) Full-service lease
(d) Off-balance sheet methods of financing
(e) Dry lease.
19. There is an operating lease agreement between Suraj Equipment Ltd. and Chandraj Manufacturing< >
Answer

Ltd., where Suraj Equipment Ltd. acts as a lessor and provides the operating know-how, and the
related services to Chandraj Manufacturing Ltd. and undertakes the responsibility of insuring and
maintaining the equipment. This type of operating lease can be defined as
(a) Hell or high water lease
(b) Dry lease
(c) Capital lease
(d) Full pay out lease
(e) Wet lease.
< Answer
20. In which of the following situation leasing is more likely to be used as a tool for asset financing? >
I. The expected use of the asset is short, relative to the useful life of the asset.
II. The corporate bond contract contains specific financial policy convents.
III. The value of asset is highly sensitive to use and maintenance decision.

(a) Only (I) above (b) Only (II) above (c) Only (III) above
(d) Both (I) and (II) above (e) All (I), (II) and (III) above.
< Answer
21. The hurdle rate for the gross yield is given by >
(a) Marginal cost of capital
(b) Marginal cost of debt
 (c) Post-tax marginal cost of debt plus a profit margin
(d) Pre-tax cost of fund plus a profit margin
(e) Pre-tax marginal cost of debt plus a profit margin.
< Answer
22. Which of the following statements is not true? >
(a) As per the actuarial method of allocation of the unexpired finance charge, the interest
component in lease payment decreases in the later periods
(b) IAS 17 requires the effective rate of interest method to allocate the unexpired finance charge to
each accounting period
(c) The unexpired finance charge is the difference between sum of the lease payments over the
entire lease period and present value of lease payments
(d) Actuarial method is also known as the flat rate of interest method
(e) As per AS 17 the lessor has to record the present value of lease rentals over the lease term as a
part of current assets.
23. In which of the following situations loss suffered by the firm on the deprivation of asset is the <
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Answer

realizable value of the asset?

(a) RC>EV>RV (b) EV>RV>RC (c) EV>RC>RV (d) RC>RV>EV (e)
RV>EV>RC.
24. Richa Consumer Finance Ltd. is offering a loan of Rs.40000 for 3 years for a monthly installment of<
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Answer

Rs._______. The effective rate of interest by approximation method is 5.39%.

(a) 1300 (b) 1250 (c) 1200 (d) 1400 (e) 1150
< Answer
25. Which of the following is also known as confidential factoring? >
(a) Advance Factoring
(b) Invoice Discounting
(c) Full Factoring
(d) Bank Participation Factoring
(e) Supplier Guarantees Factoring.
26. Which of the following venture capital financing is working capital for the initial expansion of the<
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Answer

company that is producing and shipping and has growing accounts receivable and inventories?
(a) Seed Financing (b) Second Stage Financing
(c) Start-up Financing (d) First Stage Financing
(e) Mezzanine financing.
< Answer
27. Which of the following is not true regarding whole loan sale? >
(a) The seller may retain the right to service the loans
(b) A whole loan sale may be with recourse or without recourse to the seller
(c) The whole loans are highly useful as a medium of liquidity
(d) In a whole loan sale, all rights and responsibilities connected with mortgage loan are
transferred to the purchaser
(e) Only a buyer with proven expertise in assessment of mortgages could invest in the whole
loans.
28. Under which of the following type of mortgages the seller is required to deposit some portion of <
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Answer

down payment in a savings account so that additional amount required may be drawn and paid along
with the mortgage payment done by the buyer?
(a) Graduated - Payment Mortgages (b) Pledged - Account
Mortgages
(c) Traditional Mortgages (d) Buy Down Loans
(e) Adjustable – Rate Mortgages.
< Answer
29. Which of the following is/are features of the Real Estate Investment Trust (REIT)? >
 I. REITs can be viewed as mutual funds that invest in real estate properties and/or mortgages.
II. They are exempt from tax.
III. The income received by the shareholders of REIT is subject to the double taxation.

(a) Only (I) above (b) Only (II) above (c) Only (III) above
(d) Both (I) and (II) above (e) Both (II) and (III) above.
< Answer
30. Which of the following is/are not true regarding difference between credit card and debit card? >
I. Credit card is ‘Pay Later’ product while debit card is ‘Pay Now’ product.
II. In credit card risk of fraud does not exist, while in debit card risk of fraud exists.
III. Credit card does not have access to current and savings account while Debit card does have.
IV. In credit card it is not essential to open a bank account while it is essential to open a bank
account for debit card.

(a) Only (II) above (b) Only (III) above

(c) Both (III) and (IV) above (d) Both (II) and (III) above
(e) Both (I) and (IV) above.

END OF SECTION A
 Section B : Problems (50 Marks)
• • This section consists of questions with serial number 1 – 5.
• • Answer all questions.
• • Marks are indicated against each question.
• • Detailed workings should form part of your answer.
• • Do not spend more than 110 - 120 minutes on Section B.
1. Mahesh Industries Ltd. (MIL) is considering an investment in a machinery costing Rs.50 lakhs exclusive of central
sales tax @ 4%. The useful life of the machinery is 5 years after which its salvage value is estimated to be 20% of
its book value. The machine is depreciated at the rate of 10% on straight line basis in the company’s books.
However, the tax relevant rate of depreciation is 10% on WDV basis.
MIL has received a proposal from Beta Financial Services Ltd. to either lease finance or hire purchase the machine
from Beta. The lease terms are Rs.80 ptpq and flat rate of interest in hire purchase transaction is 12%. Both lease
or hire rentals are payable quarterly in arrears over a period of 5 years. The marginal cost of debt and equity are
16% and 24% respectively. The debt-equity of MIL is 3:1. MIL is in the tax bracket of 35%.
MIL allocates interest on the basis of SOYD Method in case of hire purchase.
You are required to evaluate the three options – purchase, lease and hire purchase and determine the option that
MIL should choose. Use Weingartner’s Model for lease evaluation.
(16 marks) < Answer >
2. Creative Financial Services Ltd. offers two types of fund based facilities, recourse factoring and non-recourse
factoring. Terms and conditions of both kind of factoring are as follows.
Recourse Factoring: The factoring agreement provides for an advance payment of 70% of the value of factored
receivables. Advance carries a rate of interest of 16%p.a. and the factoring commission is 1.5% of the value of
factored receivables. Both the interest and commission are collected upfront.
Non-recourse factoring: The factoring agreement provides for an advance payment of 70% of the value of
factored receivables. Advance carries a rate of interest of 17.5% p.a. and the factoring commission is 2.5% of the
value of factored receivables. Both the interest and commission are collected upfront.
The Manager (Finance) of Chilling Air Conditioners has recently approached Creative Financial Services to
factor the receivables. After the careful analysis of the sales ledger of Chilling Air Conditioners, the VP - Finance
of Creative Financial Services agrees to a guaranteed payment period of 45 days. The Manager Finance of
Chilling Air Conditioners is not clear about the type of factoring he should opt for and seeks your help in this
regard.
He provides you with the following information:
• • His company sells on terms 2/10, net 45. On an average 60% of the customers pay on the 10th day
and avail the discount and the remaining customers pay 75 days after the invoice date.
• • The sales executives are responsible for following up collections and on an average spend 25% of
their time on collection.
• • The bad debts amount to 5% of the sales.
• • If the sales executives are relieved from collection responsibilities, the annual sales would increase
by 10%.
• • The gross margin on sales is 25% and the projected sales for the year (without considering the
increase) are Rs.300 lakhs.
• • By giving off sales ledger administration and credit monitoring, Chilling Air Conditioners can save
administrative overheads up to Rs.1.5 lakhs.
• • Chilling Air Conditioners has been financing its investments in receivables through a mix of bank
 finance and long-term funds in the ratio of 3: 1. The effective rate of interest on bank finance is 18% and
the cost of long-term funds is around 20.0% p.a.
You are required to advise the Finance manager of Chilling Air Conditioners regarding the type of factoring he
should select.
(11 marks) < Answer >

3. The following balance sheet pertains to Jainsons Ltd. for the year ending March 31, 2005.
(Rs. Crore)
Liabilities Amount Assets Amount
Share Capital Net Fixed Assets
Authorized Share capital
10.00 Investments
(2 cr shares of Rs.5 each)
Issued and Paid up 5.00
Current Assets
(1.cr. shares of Rs.5 each)
Reserves
General reserve 3.25
Capital redemption reserve 1.00
Capital reserve 0.30
Revaluation reserve 0.20
Share Premium 0.65 5.40
16% FCDs 1.60
Secured Loans 4.00
Current liabilities & Provisions 2.00
18.00
The following information is extracted from the books of Jainsons Ltd.
I. Capital reserve consists of Rs.10 lakhs profit realized on sale of some old machinery this year.
II. Jainsons Ltd. purchased some valuable patents from Mr.Rakesh, the purchase consideration of Rs.40 lakhs
being settled by allotting 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 2005.

The Board of directors of Jainsons Ltd. are intending to declare bonus issue at its AGM to be held during
August 15, 2005.
You are required to
a. Compute the maximum permissible bonus ratio.
b. State the latest by which date, Jainsons Ltd. has to implement this proposal of bonus issue?
(5 + 1 = 6 marks) < Answer >
4. Dipti Metals requires funds to the extent of Rs.45 lakhs for two years. It proposes to raise the funds by issuing
Commercial Papers for one year and then roll it over for another year. Its Investment Banker is of the opinion that
as the company is new in the market, it needs to pay an interest rate of minimum 18% per annum and it has to pay
the maximum brokerage charges.
You are required to compute the effective rate per annum Dipti Metals would incur if it raises the funds through
the issue of CPs.
(8 marks) < Answer >
5. Suleiman Financial Services Ltd. offers car loans to customers on the following terms and conditions:
(a) Deposit of 25% of the cost of the asset should be made at the inception of the transaction.
(b) 36 EMIs have to be made each at the beginning of every month.
 (c) Deposit carries an interest of 12% p.a. compounded monthly and would be repaid on the payment of the
last installment.
(d) A service fee of Rs.1,500 is charged.
(e) Suleiman Financial Services also offers an interest rebate at four-fifths of the rebate calculated in
accordance with the Modified Rule of 78 method with α = 2.
Mr. Somanko wants to purchase an Alto car, cost of which is approximately Rs.4 lakhs. One of his colleagues
suggested him to go for a car loan from Suleiman Financial Services. Mr. Somanko is a software engineer and
does not have much idea about finance. He approaches you for some advice. With some efforts you could make
out that Somanko’s effective cost of fund is 20% p.a.
You are required to advise Somanko in calculating the:
(a) Maximum monthly payments that Somanko needs to make.
(b) Flat rate of interest of the above transaction. (You can assume the EMIs as obtained in (a) above).
(c) Effective interest rate on the completed transaction if Somanko likes to make the prepayment at the end of 30
months. (You can assume the EMIs as obtained in (a) above).
(4 + 2 + 3 = 9 marks) < Answer >

END OF SECTION B

Section C : Applied Theory (20 Marks)

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

6. One innovation in housing finance sector has been the introduction of ‘floating rate home loans’. What
consideration a customer should seriously look into before choosing ‘floating rate home loan’ or a ‘fixed rate home
loan’? Discuss.
(10 marks) < Answer >
7. Indian Depository Receipts is a mechanism to enable Indians to own overseas stock. What are Indian Depository
Receipts? Discuss the advantages of the same.
(10 marks) < Answer >

END OF SECTION C

END OF QUESTION PAPER

 Suggested Answers
Investment Banking and Financial Services-I (261): October
2005
Section A : Basic Concepts
1. Answer : (b) < TOP >

Reason :Policy function of a financial system ensures smooth flow of funds from
savings to investments in order to stabilize the economy. Hence, alternative
(b) is answer. Savings function ensures mobilization of savings to provide a
potentially profitable and low risk outlet. Credit function ensures the
savings transform into the necessary credit for investment and spending
purposes.
Hence, option (b) is the correct answer.
2. Answer : (c) < TOP >

Reason :Along with other relevant guidelines, a NBFC, to accept fixed deposits
should have been in existences for at least 2 years and it should have
minimum credit rating of BBB issued by CARE, if it is an equipment
leasing or hire purchase company.
Hence, option (c) is the correct answer.
3. Answer : (e) < TOP >

Reason :Financial assets represent the obligations on the part of their issuer. Hence,
all financial assets will be equal to the financial liabilities. The assets will be
funded either by using savings or by borrowings. Since borrowings
represent financial liabilities, the accounting equation can be altered as
follows:
Assets = Liabilities
Financial Assets + Real Assets = Financial Liabilities + Savings
Since financial assets equal financial liabilities, the real assets will be
financed by savings. This relationship has the following implicit
assumptions:
There are no external borrowings in the system.
Financial liabilities include stock issued to the outsiders.
Since all statements are true, alternative (e) is answer.
4. Answer : (b) < TOP >

Reason :The borrowers generally consider the following while entering into a deal:
* Low rates of interest
* Minimum lead time when money is required
* Access to funds up to the desired period of time
* Minimum terms and conditions attached with the usage of funds
* Minimum monitoring and interference from the lender
 * Freedom to set the repayment schedule according to the convenience of
the borrower.
Satisfying the statutory reserve requirements and the capital adequacy
norms is the objective of the borrower not the lender.
Hence, option (b) is the correct answer.
5. Answer : (b) < TOP >

Reason :In such a scenario, the banks in order to meet their statutory requirements,
invest more in gilts thus driving the yields down. Hence, option (b) is the
correct answer.
6. Answer : (c) < TOP >

Reason :When Scout Ltd. accepted for 10% of short fall, its total devolvement
accounted for Rs.2.5 crore.
Total devolvement on PDs = Rs.2.5 crore/0.10 = Rs.25 crore.
In case of dated securities, total devolvement on PDs is 25% of total short
fall
Therefore, total short fall = Rs.25 crore/0.25 = Rs.100 crore
If the bids accepted at cut-off price are Rs.1000 crore, the amount notified is
Rs.1100 crore, (Rs.1000 crore + Rs.100 crore).
Hence, option (c) is the correct answer.
7. Answer : (d) < TOP >

Reason :Bill which is accompanied by documents of title to goods such as railway

receipt/lorry receipt/bill of lading is called a documentary bill. Bill which is not
accompanied by any such documents of title of goods is called a clean bill.
Therefore, statement (d) is false.
Hence, option (d) is the correct answer.
8. Answer : (d) < TOP >

Reason :Following are some guidelines relating to CDs:

* Banks can issue CDs for a minimum period of 15 days to a maximum of
one year, whereas
a financial institution can issue it for a minimum of one year and a
maximum of 3 years.
* CDs are subjected to stamp duty.
* CDs can be transferred only after a lock-in period of 45 days.
* Premature payment or loans against CDs by the issuer is not allowed.
*All CDs are subjected to usual CRR and SLR requirements.
Hence, option (d) is the correct answer.
9. Answer : (d) < TOP >

Reason :Shareholding held by the promoters prior to the rights issue has a lock-in
period of two years from the date of allotment in the rights issue.
 Hence, option (d) is the correct answer.
10. Answer : (a) < TOP >

Reason :In case of preference shares issue, when the issue amount exceeds Rs.5 lakh,
the maximum rate of underwriting commission on the amount subscribed by
public is 1.0%. Hence, alternative (a) is answer.
11. Answer : (b) < TOP >

Reason :Registration with SEBI is mandatory to carry the business of Merchant

Banking in India. An application for grant of Certificate of Registration
must be made to SEBI in Form A. The applicant should be a body corporate.
Any associate company, group company, subsidiary or interconnected
company of the applicant has not been registered as Merchant Banker. The
applicant should ha e minimum net worth of Rs.5 crore. Since, statements
(I) and (II) are false and only statement (III) is true, alternative (b) is answer.
12. Answer : (d) < TOP >

Reason :The SROs form an important layer of regulatory structure in the developed
markets.
Hence, alternative (d) is answer.
13. Answer : (b) < TOP >

Reason :The issue of ADR level-I is often the first step for an issuer into the US
public equity market. Issuer can enlarge the market for existing shares and
thus diversify the investment base. In this instrument only minimum
disclosure is required to the SEC and the issuer need not comply with the
US GAAP (Generally Accepted Accounting Principles). This type of
instrument is traded in the US OTC market. The issuer is not allowed to
raise fresh capital or list on any one of national stock exchanges. Since,
statements (II) and (IV) are correct, alternative (b) is answer.
14. Answer : (b) < TOP >

Reason :Fitch Ratings to preferred stock are as follows:

Highest safety AAA
High safety AA
Good/Medium A
Satisfactory/Low-Medium BBB
Speculative BB
High speculative B
Possibility of Default/Hazardous CCC Hence, alternative
(b) is answer.
15. Answer : (d) < TOP >

Reason :All of the above activities are included in Capital issue management
Hence, correct answer is (D).
16. Answer : (b)
Reason :Barring public sector leasing company, a leasing company must be listed on
a recognized stock exchange. All other statements are false. Hence (b) is the
 correct answer.
17. Answer : (e) < TOP >

Reason :Present value of loan payment = Rs. 50 lakh

i
50 x0.02 x12 x
xPVIFA(18,5)
12
Present value of lease payment = i
= Rs.40.53 lakh
Financial advantage of leasing = P.V. of Loan Payment – P.V. of Lease
Payments
= 50-40.53
= Rs. 9.47lakh
Hence, option (e) is correct answer.
18. Answer : (b) < TOP >

Reason :A direct lease, a sale and leaseback, and a leveraged lease are all examples
of financial leases. Hence, alternative (b) is answer.
19. Answer : (e) < TOP >

Reason :The lessor usually provides the operating know-how, suppliers, and related
services and undertakes the responsibility of insuring and maintaining the
equipment which case an operating lease is called a ‘wet lease’. Hence,
alternative (e) is answer.
20. Answer : (d) < TOP >

Reason : Under following situations leasing is more likely to be used as a tool for asset
Financing.
• • The value of asset is less sensitive to use and maintenance decision.
• • The asset is not specialised to the lessee firm.
• • The expected use of asset is short relative, to useful life of the asset.
• • The coroprate bond contract contain specific financial policy convenants.
• • The lessor has a comparative advantage in asset disposal.
• • The management componants contracts contain provisions specifying
pay offs as a function of the return on invested capital.
Therefore, both statement (I) and (II) are correct and statement (III) is false.
Hence, option (d) is the correct answer.
21. Answer : (d) < TOP >

Reason :The cut-off rate or the hurdle rate is determined as the pre-tax cost of funds
plus a profit margin, the latter being a subjectively determined figure.
Hence, option (d) is the correct answer.
< TOP >
22. Answer : (d)
Reason :Actuarial method is also known as the Effective Rate of Interest Mehtod.
Hence, option (d) is the correct answer.
< TOP >
23. Answer : (d)
Reason :Under situation (a) loss suffered by the firm if it is deprived of the asset is
 the economic value.
Under situation(b) and (c) loss suffered by the firm if it is deprived of the
asset is the replacement cost.
Under situation (d) loss suffered by the firm on the deprivation of asset is
the realizable value of the asset.
Under situation (e) loss suffered by the firm on the deprivation of asset is
the economic value of the asset.
Hence (d) is the correct answer.
24. Answer : (c) < TOP >

Reason :Repayment period = 36 months

Suppose flat rate of interest = X%
n
Effective rate of interest = n + 1 x 2xF
36
5.39 = 37 x 2x X
X = 2.77%
Suppose total charge for credit = Rs. Y
Y 1
x
Therefore, 3 40000 = 0.0277
Therefore Y= Rs.3324
Suppose monthly rentals to be charged = Rs. M
Therefore, (Mx36)-40000= Rs.3342
40000 + 3324
Therefore, M = 36 = Rs.1203
= Rs.1200 (approx)
Hence, option (c ) is the correct answer.
25. Answer : (b) < TOP >

Reason :Invoice discounting is known as confidential factoring.

Hence, alternative (b) is the correct answer.
26. Answer : (b) < TOP >

Reason :Second stage financing is working capital for the initial expansion of the
company that is producing and shipping and has growing account
receivable and inventories.
Hence (b) is the correct answer.
27. Answer : (c) < TOP >

Reason :The whole loans are not highly useful as a medium of liquidity, because the
buyer had to inspect each loan assigned to him individually and this means
that only a buyer with proven expertise in assessment of mortgages can
 invest in whole loans.
Hence, (c) is the correct answer.
28. Answer : (d) < TOP >

Reason :Under Buy Down Loans some portion of the down payment as required
under traditonal mortgage is deposited in a savings account by the seller of
the property so that additional amount required may be drawn and paid
along with the mortgage payment done by the buyer.
Hence, option (d) is the correct answer.
29. Answer : (a) < TOP >

Reason :The indirect real estate equity investment is done predominantly through
equity real estate investment trusts (REITs). In a loose sense, REITs can be
viewed as mutual funds that invest in real estate properties and/or mortgages
instead of securities such as bonds and shares. Hence, (I) is true. Statement
(II) and (III) are false.
Hence, option (a) is the correct answer.
30. Answer : (a) < TOP >

Reason :In a credit card risk of fraud exists while in a debit card risk of fraud is
minimized trough PIN based system. Hence statement (III) is not true. All
other statements are true.
Hence, option (a) is the correct answer.

Section B : Problems

1. To determine which option should MIL choose, first lease vs purchase option should be evaluated.
Lease vs purchase based on Weingartner’s Model:
3 1
× 0.16 × 0.65 + × 0.24
Cost of capital = 4 4
= 0.078 + 0.06
= 13.8%
A. A. Investment cost = 50(1.04) = Rs.52 lakhs
B. Cost of machine to the lessor = 50(1.1) = Rs.55 lakhs
i
4
PV of lease rentals = 0.08 × 55 × 4 x PVIFA 13.8%,5 × i = 4.4 x 4 x 3.4496 x 1.0504
= Rs.63.77 lakhs
C. PV of tax shield on lease rentals = 4 x 4.4. x PVIFA13.8,5 × 0.35
= 17.6 x 3.4496 x 0.35
= Rs.21.25 lakhs
D. PV of DTS @ 10% WDV:
Cost of asset is taken as Rs.52 lakhs
 (Rs. in lakhs)
Year Depreciation PVIF @13.8% PV
1 5.2 0.879 4.57
2. 4.68 0.772 3.61
3. 4.21 0.678 2.85
4. 3.79 0.596 2.26
5. 3.41 0.524 1.79
15.08 PV of DTS = 15.08 × 0.35 = Rs.
5.28 lakhs
E. PV of NSV = 0.2(52 – 5.2 × 5) PVIF 13.8, 5 = Rs. 5.2 × PVIF13.8,5
= Rs.2.72 lakhs
NAL = A – B + C – D – E
= 52- 63.77+21.25-8.92-2.72 = Rs. 1.48 lakhs.
As NAL is positive lease is a better option than purchase.
Lease Vs HP.
Cost of Lease:
i
4
F. PV of LR = 4 x 4.4 × PVIFA 16,5 × i = 4.4 × 4 × 3.2743 × 1.0581
= Rs. 60.98 lakhs
G. G. PV of tax shield on LR = 4.4 × 4 × PVIFA13.8,5 × 0.35
= Rs.21.25 lakhs
COL = F – G = Rs.60.98 – 21.25 = R s.39.73 lakhs
Cost of Hire Purchase
55 × 0.12 × 5 + 55 33 + 55
EQI = 5 × 4 = 20 = Rs 4.4 lakhs
i
4
H. H. PV of hire rentals = 4 × 4.4 × PVIFA16,5 × i
= 17.6 × 3.2743 × 1.0581 = Rs.60.98 lakhs
I. I. PV of DTS (calculated earlier) = Rs. 5.28 lakhs
J. J. PV of NSV (calculated earlier) = Rs. 2.72 lakhs
Allocation of Interest:
Total charge for credit = Rs.55 x 0.12 x 5 = Rs.33 lakhs
(Rs. lakhs)
 Year SOYD factor Interest PV
1. 20 + 19 + 18 + 17 74 11.63 10.913
=
20 + 19 + ...... + 1 210
2. 16 + 15 + 14 + 13 58 9.11 7.034
=
20 + 19 + ...... + 1 210
3. 12 + 11 + 10 + 9 42 6.60 4.478
=
20 + 19 + .... + 1 210
4. 8+7+6+5 26 4.09 2.439
=
20 + 19 + .... + 1 210
5. 4 + 3 + 2 +1 10 1.57 0.822
=
20 + 19 + .... + 1 210
24.966

K. K. PV of tax shield on finance charges = 24.966 x 0.35 = Rs.8.74 lakhs

COHP = H–I–J–K
= 60.98 – 5.28 – 2.73 – 8.74
= Rs.44.23 lakhs.
As COL < COHP and COP > COL, lease option should be choosen.
< TOP >

2. Relevant costs for in-house management of receivables:

 Cash discount =

Sales turnover x Cash discount x % of customers availing the discount = 300 3.60
x 2% x 60 % =
Average collection period =

% of customers on 10th day x No. of days + % of customers on 75th day x

No of days = 60% x 10 + 40% x 75 =36
Cost of bank finance =

300 x (3/4) x (36/360) x 18% = 4.05

Cost of long term funds =

300 x (1/4) x (36/360) x 20.0% =1.5

Cost of funds invested in receivables =

4.05 + 1.5 = 5.55

Bad debt losses =
300 x 5% = Rs.15
Hence, expected increase in sales if the sales executives are relieved from collection
responsibilities = 10% of Rs.300 lakhs = Rs.30 lakhs.
Contribution lost on foregone sales =
30 x 25% = Rs.7.5
Avoidable costs of sales ledger and administrative and credit monitoring = Rs.1.5 lakhs
Total costs of in-house management of receivables = 33.15
 Relevant Costs of Recourse Factoring:

Factoring commission =
330 x 1.5% = Rs.4.95
Discount charge =

330 x 70% x 16% x (45/360) = Rs.4.62 lakhs

Cost of long term funds invested in receivables =

330 x 30% x 20% x (45/360) = Rs. 2.475 lakhs

Bad debts = 0.05 x 330 = 16.5
Total costs of recourse factoring 28.545
Relevant Costs of Non Recourse Factoring:
Factoring commission =

330 x 2.5% = Rs.8.25lakhs

Discount charge =

330 x 70% x 17.5% x (45/360) = Rs. 5.05lakhs

Cost of long term funds invested in receivables =

330 x 30% x 20% x (45/360) = Rs.2.475 lakhs

Total costs of non-recourse factoring = 15.775
Hence non recourse factoring is recommended.
< TOP >

3. 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 – 0.30
0.01(40 – 5)}
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
No. of Bonus shares
 4.65
that can be issued = 5 = 0.93 cr.
No. of shares eligible for bonus issue = 1.032 cr.
∴ Maximum permissible bonus ratio = 1.10
That is for every 11 shares held, 10 bonus shares can be issued.
b. 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
Jainsons Ltd., has to implement this proposal of bonus issue latest by February 15, 2006.
< TOP >

4.
Funds required Rs.45,00,000
Interest rate per annum 18%
Hence, face value of the CPs = 45,00,000 (1.18) Rs.53,10,000
Interest obligation in the first year Rs.8,10,000
Brokerage charges payable upfront = 0.10% of Issue amount Rs.5,310
Stamp duty payable upfront = 0.50% of the Issue amount Rs.26,550
Rating charges payable upfront = 0.5% of the Issue amount Rs.26,550
(As the company has to pay the maximum brokerage charges, the brokerage charges are
payable @ 0.10% of FV)
When the CP is rolled over, the Face Value becomes the Issue price at the
beginning of the 2nd year.
Face value at the beginning of the 2nd year = 53,10,000 x 1.18 Rs.62,65,800
This rollover is treated as a fresh issue and the stamp duties and rating
charges would be incurred again.
Brokerage charges would not be required.
Stamp duty payable at the beginning of the 2nd year = 0.50% of Issue Rs.31329
amount
Rating charges payable at the beginning of the 2nd year = 0.50% of the Rs.31329
Issue amount
Cash Flow Chart
 Particulars Upfront 1st year 2nd year
Issue Amount 4500000
Brokerage 5,310
charges
Stamp duties 26,550 31329
Rating charges 26,550 31329
Face value 62,65,800
redeemed
Net cash flow 44,41,59 –62658 –62,65,800
0 IRR =
19.49%
Effective cost per annum is the internal rate of return = 19.49%
< TOP >

5. a. i. Cost = Rs.4 lakhs

ii. Deposit = 4 × 0.25 = Rs.1 lakh
Let Monthly Installment be Rs.M lakhs
iii. PV of Installments = 12M × i/d12 PVIFA 20%,3 = Rs.27.933M lakhs
iv. Service charge = Rs.0.015 lakhs
Accumulated value of deposit = 1 FVIF 1%, 36 = Rs.1.431 lakhs
v. PV of deposit to be collected at the end = 1.431 PVIF 20%, 3 = Rs.0.828 lakhs
Hence, i – ii – iii – iv + v = 0
4 – 1 – 27.933M – 0.015 + 0.828 = 0
27.933M = 3.813
∴ M = 3.813 / 27.933 = Rs.0.13651 lakhs
b. Flat rate of interest:
Total charge for credit = 0.13651 x 36 – 4 = Rs.0.914 lakhs
Flat rate = 0.914 / (4 x 3) = 7.62%

c. Total charge for credit = Rs.0.914 lakhs

Interest rebate as per Modified Rule of 78 = [{(6-2)(6-2+1)}/(36x37)]x0.914
= Rs.0.0137 lakhs
Amount payable on early settlement = 0.13651 x 6 – 0.0137 = Rs.0.8053 lakhs
Accumulated value of deposit by the end of 30 months = 1 FVIF 1%, 30 = Rs.1.3478
lakhs
Effective rate of interest is ‘i’ is the following.
i
4 – 1 – 0.13651 x 12 x PVIFAi,2.5 x d12 – 0.015 – 0.8053 PVIFi,2.5 + 1.3478 PVIF i,2.5 = 0
At I= 18% , we get,
 4 –1 - (0.13651 x 12x 1.883 x 1.0950) – 0.015 – (0.8053 x 0.661) + (1.3478 x
0.661)
= 3 – 3.378 – 0.015 – 0.532 + 0.891
= - Rs.0.034 lakhs.
At I = 20%, we get,
4 – 1 – (0.13651 x 12 x 1.830 x 1.1053) – 0.015 – (0.8053 x 0.634) + (1.3478 x
0.634)
= 3 – 3.313 – 0.015 – 0.511 + 0.854
= Rs.0.015 lakhs.
By, interpolation, we get I = 19.39% p.a.
Hence, effective rate of interest on completed transaction, to Mr. Somanko will be
19.39% p.a.

< TOP >

Section C: Applied Theory

6. Ideally, loan seekers should opt for a floating rate home loan when it is expected that interest
rates will decline going forward. Fixed rate loans should be preferred when interest rates are
expected to rise. But is making a choice that simple? In today's environment, when there is a lot
of talk about rising interest rates, should investors shun floating rate home loans altogether? Or
is there still some merit in this instrument? All said and done, in the last one year, there was a
trend of floating rate home loans being more popular as compared to the fixed rate loan and as
of now, this trend is continuing.
There are three important issues which one needs to consider before opting for one type of a
loan over the other.
First, an important determinant of what one should go in for should be the long term
expectation of interest rates. For example, if the loan seeker (or the experts) expect rates to rise
for the next one year, but then decline gradually over the next several years, a floating rate
product may be preferable. The other option of going in for a fixed rate product and then
switching at the end of the year will entail costs (there could be a penalty of 1% - 2% of the
outstanding loan amount) and may not make financial sense. Moreover, floating rate home
loans do not change the rate of interest every quarter (even though they may review the rate
every quarter). The attraction of a floating rate home loan is that it does not attract a part
prepayment charge. This could appeal to individuals who get lump sum bonuses which they can
use to reduce their loan exposure.
Second, the issue whether fixed rate home loans are actually `fixed rate'. When considering a
fixed rate home loan over a floating rate home loan a strong selling point is that if interest rates
were to rise dramatically the loan seeker will be `protected'. Apparently the reality is somewhat
different. It seems that companies that have given out fixed rate loans can revise their rates
upwards in exceptional circumstances (significant rise in interest rates for one). So if one thinks
that rates will remain range bound over the near term and decline over the long term, one is still
better off with a floating rate product.
 Third, a fixed rate loan is generally priced higher as compared to a floating rate product. This
holds true in the current environment where the fixed rate loan is at a higher interest rate as
compared to a floating rate loan. The difference is currently about 0.25% to 1.00%. So if one
expects that interest rates are likely to move up, but only to the extent of this differential, then
one should ideally be indifferent between the two types of a loan. The deciding factors then
should be when one thinks the rates will increase, and also the long term expectations of
interest rates.
As always, there is no one answer to whether a customer should go in for a floating or a fixed
rate home loan. A person with very little appetite for risk or negative surprises should opt for
the fixed rate home loan. But in case the customer can take on some risk, a floating rate home
loan is worth a look.
< TOP >

7. Indian Depository Receipt/Share (IDS) is a mechanism to enable Indians to own overseas stock
i.e. derivative Indian securities, where the underlying asset is the equity share in an overseas
company.
IDSs have several applications, foremost that it would enable Indians to invest in the equity and
accordingly share the growth of overseas companies. More importantly, it would provide
domestic companies seeking mergers or acquisitions, an alternative security (to ADSs/GDSs or
cash) to settle such a transaction.
The significant advantages of IDS are, they:
• • Increase the number of available potential targets, both in terms of quality and strategic fit;
• • Provide an engine for high velocity growth by increasing the flexibility to the merged/combined
company’s capital structure;
• • Maintain the competitiveness of Indian bourses as a preferred/necessary destination among global
stockmarkets for international listing;
• • Prepare the local markets for closer operational integration with counterparts overseas;
• • Provide experience prior to capital convertibility;
• • Grow the pool of foreign currency assets belonging to the nation;
• • Channel additional non-resident Indian investment into India;
• • Reduce the flight of domestic capital overseas through invisible, un-administrable modes;
• • Provide Indian investors an opportunity to participate in the growth of world-class Indian companies;
and
• • Allow Indian stakeholders to participate in global companies with significant (by local standards)
Indian operations partaking of international profits and not just that of an MNC’s domestic operations.
< TOP >
< TOP OF THE DOCUMENT >