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Financial management
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Financial management

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  • 1. Financial Management WORKBOOK The ICFAI University # 52, Nagarjuna Hills, Hyderabad - 500 082
  • 2. © 2005 The Icfai University Press. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means – electronic, mechanical, photocopying or otherwise – without prior permission in writing from The Icfai University Press. ISBN : 81-7881-969-4 Ref. No. FMWB 11200502 For any clarification regarding this book, the students may please write to us giving the above reference number of this book specifying chapter and page number. While every possible care has been taken in type-setting and printing this book, we welcome suggestions from students for improvement in future editions.
  • 3. Preface The ICFAI University has been upgrading its study material to make it more beneficial to the students for self-study through the Distance Learning mode. We are delighted to publish a workbook for the benefit of the students preparing for the examinations. The workbook is divided into three parts. Effective from April, 2003, the examinations for all the subjects of DBF/CFA (Level-I) consist of only multiple choice questions. Brief Summaries of Chapters A brief summary for each of the chapters in the textbook is given for easy recollection of the topics studied. Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) Students are advised to go through the relevant textbook carefully and understand the subject thoroughly before attempting Part I. In no circumstances should the students attempt Part I without fully grasping the subject material provided in the textbook. Frequently used Formulae Similarly the formulae used in the various topics have been given here for easy recollection while working out the problems. Part II: Problems and Solutions The students should attempt Part II only after carefully going through all the solved examples in the textbook. A few repetitive problems are provided for the students to have sufficient practice. Part III: Model Question Papers (with Suggested Answers) The Model Question Papers are included in Part III of this workbook. The students should attempt all model question papers under simulated examination environment. They should self score their answers by comparing them with the model answers. Each paper consists of Part A and Part B. Part A is intended to test the conceptual understanding of the students. It contains 40 questions carrying one point each. Part B contains problems with an aggregate weightage of 60 points. Please remember that the ICFAI University examinations follow high standards that demand rigorous preparation. Students have to prepare well to meet these standards. There are no shortcuts to success. We hope that the students will find this workbook useful in preparing for the ICFAI University examinations. Work Hard. Work Smart. Work Regularly. You have every chance to succeed. All the best.
  • 4. Contents PAPER I Brief Summaries of Chapters Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) 1 10 Frequently Used Formulae 101 Part II: Problems and Solutions 108 Part III: Model Question Papers (with Suggested Answers) 333 PAPER II Brief Summaries of Chapters 467 Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) 480 Frequently Used Formulae 560 Part II: Problems and Solutions 570 Part III: Model Question Papers (with Suggested Answers) 749
  • 5. Detailed Curriculum Paper I Introduction to Financial Management: Objectives, Functions and Scope, Evolution, Interface of Financial Management with Other Functional Areas, Environment of Corporate Finance. Indian Financial System: a. Financial Markets: Money Market, Forex Market, Government Securities Market, Capital Market, Derivatives Market, International Capital Markets. b. Participants: i. Financial Institutions: IDBI, IFCI, ICICI, IIBI, EXIM Bank, SFCs, SIDCs ii. Insurance Companies: LIC, GIC iii. Investment Institutions: UTI, Mutual Funds, Commercial Banks; Non-Banking Financial Companies; Housing Finance Companies; Foreign Institutional Investors. c. Regulatory Authorities: RBI, SEBI, IRA. Time Value of Money: Introduction; Future Value of a Single Cash Flow, Multiple Flows and Annuity, Present Value of a Single Cash Flow, Multiple Flows and Annuity. Risk and Return: Risk and Return Concepts, Risk in a Portfolio Context, Relationship between Risk and Return. Leverage: Concept of Leverage, Operating Leverage, Financial Leverage, Total Leverage. Valuation of Securities: Concept of Valuation, Bond Valuation, Equity Valuation: Dividend Capitalization Approach and Ratio Approach, Valuation of Warrants and Convertibles. Financial Statement Analysis: Ratio Analysis, Time Series Analysis, Common Size Analysis, Du Pont Analysis, Funds Flow Analysis, Difficulties associated with Financial Statement Analysis. Financial Forecasting: Sales Forecast, Preparation of Pro forma Income Statement and Balance Sheet, Growth and External Funds Requirement. Paper II Sources of Long-Term Finance: Equity Capital and Preference Capital, Debenture Capital, Term Loans and Deferred Credit, Government Subsidies, Sales Tax Deferments and Exceptions, Leasing and Hire Purchase. Cost of Capital and Capital Structure Theories: Cost of Debentures, Term Loans, Equity Capital and Retained Earnings, Weighted Average Cost of Capital, Systems of Weighting, Introduction to Capital Structure, Factors affecting Capital Structure, Features of an Optimal Capital Structure, Capital Structure Theories: Traditional Position, MM Position and its Critique Imperfections. Dividend Policy: Traditional Position, Walter Model, Gordon Model, Miller & Modigliani Position, Rational Expectations Model. Estimation of Working Capital Needs: Objectives of Working Capital (Conservative vs. Aggressive Policies), Static vs. Dynamic View of Working Capital, Factors affecting the Composition of Working Capital, Interdependence among Components of Working Capital, Operating Cycle Approach to Working Capital. Financing Current Assets: Behavior of Current Assets and Pattern of Financing, Accruals, Trade Credit, Provisions, Short-Term Bank Finance, Public Deposits, Commercial Paper, Factoring, Regulation of Bank Credit. Management of Working Capital: a. Inventory Management: Nature of Inventory and its Role in Working Capital, Purpose of Inventories, Types and Costs of Inventory, Inventory Management Techniques, Pricing of Investments, Inventory Planning and Control; b. Receivables Management: Purpose of Receivables, Cost of Maintaining Receivables, Credit Policy Variables (Credit Standard, Credit Period, Cash Discount, Collection Program), Credit Evaluation, Monitoring Receivables; c. Treasury Management and Control; d. Cash Management: Meaning of Cash, Need for and Objectives of Cash Management, Cash Forecasting and Budgets, Cash Reports, Factors and Efficient Cash Management. Capital Expenditure Decisions: The Process of Capital Budgeting, Basic Principles in Estimating Costs and Benefits of Investments, Appraisal Criteria: Payback Period, Average Rate of Return, Net Present Value, Benefit-Cost Ratio, Internal Rate of Return, Annual Capital Charge, Infrastructure Decisions and Financing. Current Developments.
  • 6. Brief Summaries of Chapters Introduction to Financial Management • The financial goal of any firm including public sector firms is to maximize the wealth of the shareholders by maximizing the value of the firm. • The objective of financial manager is to increase or maximize the wealth of owners by increasing the value of the firm which is reflected in its earning per share and market value of the firm. • Function of finance manager includes mobilization of funds, deployment of funds, control over the use of fund, and balancing the trade-off between risk and return. • The advantages of sole proprietorship are (i) easy and inexpensive set up. (ii) few governmental regulations and (iii) no firm tax. Partnership firm is a business owned by two or more persons. They are partners in business and they bear the risks and reap the rewards of the business. A partnership firm is governed by the Indian Partnership Act, 1932. Hence it is relatively free from governmental regulations as compared to the joint stock companies. A group of persons working towards a common objective is a company. It represents different kinds of associations, be it business or non-business. • Corporate investment and financing decisions are circumscribed by a government regulatory framework. The important elements of these framework are: (i) Industrials policy (ii) Industrial licensing provisions and procedure (iii) Regulation of Foreign Collaborations and Investment (iv) Foreign Exchange Management Act (v) Companies Act and (vi) SEBI. Indian Financial System • The economic development of a country depends on the progress of its various economic units, namely the Corporate Sector, Government Sector and the Household Sector. • The role of the financial sector can be broadly classified into the savings function, policy function and credit function. • The main types of financial markets are: money market, capital market, forex market and credit market. • The financial markets are further sub-divided into the Primary market and the Secondary market. • A market is considered perfect if all the players are price takers, there are no significant regulations on the transfer of funds and transaction costs, if any, are very low. • The accounting equation: Assets = Liabilities, can be altered as Financial Assets + Real Assets = Financial Liabilities + Savings. • The main types of financial assets are deposits, stocks and debt. • While designing a financial instrument, the issuer must keep the following in mind: cash flows required, taxation rules, leverage expected, dilution of control facts, transaction costs to be incurred, quantum of funds sought, maturity of plan required, prevalent market conditions, investor profile targeted, past performance of issues, cost of funds to be borne, regulatory aspects to abide by. • While investing in a financial instrument, the investor must keep the following in mind: risk involved, liquidity of the instrument, returns expected, possible tax planning, cash flows required and simplicity of investment. • Various financial intermediaries came into existence to facilitate a proper channel for investment. The main ones are: stock exchanges, investment bankers, underwriters, registrars, depositories, custodians, primary dealers, satellite dealers and forex dealers.
  • 7. Time Value of Money • • • • • • • Additional compensation required for parting with say Rs.1,000 now is called ‘interest’. There are two methods by which the time value of money can be taken care of compounding and discounting. Under the method of compounding, we find the Future Values (FV) of all the cash flows at the end of the time horizon at a particular rate of interest. Under the method of discounting, we reckon the time value of money now i.e. at time zero on the time line. So, we will be comparing the initial outflow with the sum of the Present Values (PV) of the future inflows at a given rate of interest. To determine the accumulation of multiple flows as at the end of a specified time horizon, we have to find out the accumulations of each of these flows using the appropriate FVIF and sum up these accumulations. Annuity is the term used to describe a series of periodic flows of equal amounts. To determine the present value, we have to first define the relevant rate of interest. Risk and Return • The risk associated with a common stock is interpreted in terms of the variability of its return. The most common measures of riskiness of security are standard deviation and variance of returns. • Unsystematic risk is the extent of the variability in the security’s return on account of the firm specific risk factors. This is also called diversifiable or avoidable risk factors. • Systematic risk refers to factors which affect the entire market and hence the firm too. This is also called non-diversifiable risk. • If a portfolio is well diversified, the unsystematic risk gets almost eliminated. The non-diversifiable risk arising from the wide movements of security prices in the market is very important to an investor. The modern portfolio theory defines the riskiness of a security as its vulnerability to market risk. This vulnerability is measured by the sensitivity of the return of the security vis-á-vis the market return and is called beta. • The concept of security market line is developed by the modern portfolio theory. SML represents the average or normal trade-off between risk and return for a group of securities. Here the risk is measured typically in terms of the beta values. Application of Security Market Lines: The ex post SML is used to evaluate the performance of portfolio manager; tests of asset-pricing theories, such as the CAPM and to conduct tests of market efficiency. The ex ante SML is used to identify undervalued securities and determine the consensus, price of risk implicit in the current market prices. Depending upon the value of alpha, using SML it is possible to estimate whether the scrip is underpriced (it is then eligible to be purchased) or overpriced (it is then eligible to be sold). Valuation of Securities • Value of any security can be defined as the present value of the future cash streams i.e., the intrinsic value of an asset should be equated to the present value of the benefits associated with it. • Book value is an accounting concept. Assets are recorded at historical costs and they are depreciated over years. Book value includes intangible assets at acquisition cost minus amortized value. The book value of debt is stated at the outstanding amount. The difference between the book value of assets and liabilities is equal to shareholder’s funds or net worth (which is equal to paid-up equity capital plus reserves and surplus). • Replacement Value is the amount that a company would be required to spend if it were to replace its existing assets in the current condition. 2
  • 8. • Liquidation Value is the amount that a company could realize if it sells its assets after having terminated its business. It is generally a minimum value which a company might accept if it sells its business. • Going Concern Value is the amount that a company could realize if it sells its business as an operating one. Its value would always be higher than the liquidation value, the difference accounting for the usefulness of assets and value of intangibles. • Market Value of an asset or security is the current price at which the asset or the security is being sold or bought in the market. • Face Value: This is the value stated on the face of the bond and is also known as par value. It represents the amount of borrowing by the firm which it specifies to repay after a specific period of time i.e., at the time of maturity. A bond is generally issued at face value or par value which is usually Rs.100 and may sometimes be Rs.1,000. • Coupon Rate or Interest: A bond carries a specific rate of interest which is also called as the coupon rate. The interest payable is simply the par value of the bond × Coupon Rate. Interest paid on a bond is tax deductible for the issuer. • Maturity: A bond is issued for a specific period of time. It is repaid on maturity. Typically corporate bonds have a maturity period of 7-10 years whereas government bonds have a maturity period up to 20-25 years. • Redemption Value: The value which a bondholder gets on maturity is called redemption value. A bond may be redeemed at par, at premium (more than par value) or at discount (less than par value). • Market Value: A bond may be traded in a stock exchange. Market value is the price at which the bond is usually bought or sold in the market. Market value may be different from Par Value or redemption value. • One Period Rate of Return: If a bond is purchased and then sold one year later, its rate of return over this single holding period can be defined as rate of return. • Current Yield measures the rate of return earned on a bond if it is purchased at its current market price and if the coupon interest is received. • Coupon rate and current yield are two different measures. Coupon rate and current yield will be equal if the bond’s market price equals its face value. • Yield-to-Maturity (YTM): It is the rate of return earned by an investor who purchases a bond and holds it till maturity. The YTM is the discount rate which equals the present value of promised cash flows to the current market price/purchase price. • Based on the bond valuation model, several bond value theorems have been derived which state the effect of the following factors on bond values: I. Relationship between the required rate of return and the coupon rate. II. Number of years to maturity. III. Yield-to-maturity. When the required rate of return (kd) is equal to the coupon rate, the value of the bond is equal to its Par Value. i.e., If kd = Coupon Rate; then value of a bond = Par Value. When the required rate of return (kd) is greater than the coupon rate, the value of the bond is less than its par value. If kd > coupon rate; then value of a bond < par value. When the required rate of return (kd) is less than the coupon rate, the value of the bond is greater than its par value. i.e., if kd < coupon rate; then value of a bond > par value. • • • 3
  • 9. • When the required rate of return (kd) is greater than the coupon rate, the discount on the bond declines as maturity approaches. • When the required rate of return (kd) is less than the coupon rate, the premium on the bond declines as maturity approaches. • A bond’s price is inversely proportional to its yield to maturity. • For a given difference between YTM and coupon rate of the bonds, the longer the term to maturity, the greater will be the change in price with change in YTM. • Given the maturity, the change in bond price will be greater with a decrease in the bond’s YTM than the change in bond price with an equal increase in the bond’s YTM. That is, for equal sized increases and decreases in the YTM, price movements are not symmetrical. • For any given change in YTM, the percentage price change in case of bonds of high coupon rate will be smaller than in the case of bonds of low coupon rate, other things remaining the same. • A change in the YTM affects the bonds with a higher YTM more than its does bonds with a lower YTM. A warrant is a call option to buy a stated number of shares. • The exercise price of a warrant is what the holder must pay to purchase the stated number of shares. • A convertible debenture, as the name indicates, is a debenture which is convertible partly or fully, into equity shares. If it is partially converted, it is referred to as ‘partly convertible debenture’ and if the debentures are converted into equity shares at the end of maturity fully, it is referred to as ‘fully convertible debentures’. The option of conversion is either at the discretion of the investor, i.e., (optional) or compulsory (if it is specified). • The conversion ratio gives the number of shares of stock received for each convertible security. If only the conversion ratio is given, the par conversion price can be obtained by dividing the conversion ratio multiplied by the face or par value of the convertible security. • The conversion value represents the market value of the convertible if it were converted into stock; this is the minimum value of the convertible based on the current price of the issuer’s stock. • Intrinsic value is the value of a stock which is justified by assets, earnings, dividends, definite prospects and the factor of the management of the issuing company. • According to the dividend capitalization approach, which is a conceptually sound approach, the value of an equity share is the discounted present value of dividends received plus the present value of the resale price expected when the equity share is sold. • The E(P/E) ratio is formed by dividing the present value of the share by the expected earnings per share denoted by E(EPS). Financial Statement Analysis • A financial statement is a compilation of data, which is logically and consistently organized according to accounting principles. • Financial Statement Analysis consists of the application of analytical tools and techniques to the data in financial statements in order to derive from them measurements and relationships that are significant and useful for decision making. • The financial data needed in the financial analysis come from many sources. • The important tools of analysis: 1. Ratio Analysis – Comparative Analysis – Du Pont Analysis 2. 4 Funds flow Analysis.
  • 10. • The analysis of a ratio can disclose relationships as well as bases of comparison that reveal conditions and trends that cannot be detected by going through the individual components of the ratio. The usefulness of ratios is ultimately dependent on their intelligent and skillful interpretation. • Financial ratios fall into three groups: 1. Liquidity Ratios 2. Profitability or Efficiency Ratios 3. Ownership Ratios – – – • Earnings Ratios Dividend Ratios Leverage Ratios a. Capital Structure Ratios b. Coverage Ratios. Liquidity implies a firm’s ability to pay its debts in the short run. • Current Ratio: The liquidity ratio is defined as: • Current assets include cash, marketable securities, debtors, inventories, loans and advances, and pre-paid expenses. Current liabilities include loans and advances taken, trade creditors, accrued expenses and provisions. Quick Ratio Quick-test (also acid-test ratio) is defined as: = • Current Assets Current Liabilities Quick Assets Quick Assets − Inventories = Current Liabilities Current Liabilities Bank Finance to Working Capital Gap Ratio = Short − term bank borrowings Working capital gap where Working capital gap is equal to current assets less current liabilities other than bank borrowings. • Accounts receivable turnover ratio = • Average collection period = = Net credit sales Average accounts receivable 360 Average accounts receivable turnover Average accounts receivable Average daily sales Cost of goods sold Average inventory • Inventory turnover = • The Gross Profit Margin Ratio (GPM) is defined as: Gross Pr ofit Net Sales Where net sales = Sales – Excise duty. • The Net Profit Margin ratio (NPM) is defined as: • Asset turnover ratio is defined as: Net Pr ofit Net Sales Sales Average assets 5
  • 11. • Earning power is a measure of operating profitability and it is defined as: Earning before interest and taxes Average total assets • Return on Equity The Return on Equity (ROE) is an important profit indicator to shareholders of the firm. It is Net income calculated by the formula: Average equity • Ownership ratios are divided into three main groups. They are: 1. 2. • Earnings Ratios Leverage Ratios – Capital Structure Ratios – Coverage Ratios 3. Dividend Ratios. The earnings ratios are Earnings Per Share (EPS), price-earnings ratio (P/E ratio), and capitalization ratio. From earnings ratios we can get information on earnings of the firm and their effect on price of common stock. Net income (PAT) Number of outstanding shares • Earning Per Share (EPS) = • Price earnings multiple = • Capitalization rate = • Debt equity ratio = Debt Equity • Debt-Asset ratio = Debt Assets • Interest coverage ratio = • Fixed charges coverage ratio Earning = • Earnings per share Market price of the share EBIT Interest expense before depreciation, debt interest and lease rentals and taxes Debt interest + Lease rentals + Loan repayment installment + Preference dividends (1− tax rate) (1− tax rate) Debt Service Coverage Ratio = • Market price of theshare Earnings per share PAT + Depreciation + Other non − cash charges + Interest on term loan Interest on term loan + Repayment of the term loan Dividend Pay-out Ratio This is the ratio of Dividend Per Share (DPS) to Earnings Per Share (EPS) Dividend per share Market price of theshare • Divident yield = • Different types of comparative analysis are: 1. 2. 3. 6 Cross-sectional analysis Time-series analysis a. Year-to-year change b. Index analysis Common-size analysis.
  • 12. • Cross-sectional analysis is used to assess whether the financial ratios are within the limits, they are compared with the industry averages or with a good player in normal business conditions if an organized industry is not there. • A comparison of financial statements over two to three years can be undertaken by computing the year-to-year change in absolute amounts and in terms of percentage changes. • When a comparison of financial statements covering more than three years is undertaken, the year-to-year method of comparison may become too cumbersome. • In the analysis of financial statements, it is often instructive to find out the proportion that a single item represents of a total group or subgroup. In a balance sheet, the assets, the liabilities and the capital are each expressed as 100%, and each item in these categories is expressed as a percentage of the respective totals. Similarly, in the income statement, net sales are set at 100% and every other item in the statement is expressed as a percentage of net sales. • Analyzing return ratios in terms of profit margin and turnover ratios, referred to as the Du Pont System. Funds Flow Analysis • A funds flow statement is a statement which explains the various sources from which funds are raised and the uses to which these funds are put. • The major difference, however, between a true funds flow statement and a balance sheet lies in the fact that the former captures the movements in funds, while the latter merely presents a static picture of the sources and uses of funds. • A funds flow statement would enable one to see how the business financed its fixed assets, built up the inventory, discharged its liabilities, paid its dividends and taxes and so on. Similarly, it would enable one to see how the business managed to meet the above capital or revenue expenditure. • The simplest funds flow statement for a period is the difference between the corresponding balance sheet items at the beginning and the end of the period, such that all increases in liabilities and decreases in assets are shown as sources of funds and all decreases in liabilities and increases in assets are shown as applications of funds. • FFS can also be prepared with the help of the two balance sheets (opening and closing) and the profit and loss statement of the intervening period. Such a funds flow statement defines funds as “total resources” and the sources of funds will always be equal to the uses of funds. 7
  • 13. • A funds flow statement may be so prepared as to explain only the change in the working capital (current assets and current liabilities) from the beginning of a period to the end of the period. • Sources of funds that increase cash are: – A net decrease in any asset other than cash or fixed assets. – A gross decrease in fixed assets. – A net increase in any liability. – • Proceeds from the sale of equity or preference stock. – Funds from operations. Uses of funds which decrease cash include: – A net increase in any asset other than cash or fixed assets. – A gross increase in fixed assets. – A net decrease in any liability. – A retirement or purchase of stock. – Cash dividends. • Gross changes in fixed assets is calculated by adding depreciation for the period to net fixed assets at the ending financial statement date. From this figure, the net fixed assets at the beginning of financial statement date is deducted. • An increase in a current asset results in an increase in working capital. • A decrease in a current asset results in a decrease in working capital. • An increase in a current liability results in a decrease in working capital. • A decrease in a current liability results in an increase in working capital. Leverage • • Leverage is the influence which an independent financial variable has over a dependent/ related financial variable. Operating leverage examines the effect of the change in the quantity produced on the EBIT of the company and is measured by calculating the Degree of Operating Leverage (DOL). • A large DOL indicates that small fluctuations in the level of output will produce large fluctuations in the level of operating income. • DOL is a measure of the firm’s business risk. Business risk refers to the uncertainty or variability of the firm’s EBIT. So, every thing else being equal, a higher DOL means higher business risk and vice-versa. • The financial leverage measures the effect of the change in EBIT on the EPS of the company. Financial leverage refers to the mix of debt and equity in the capital structure of the company. The measure of financial leverage is the Degree of Financial Leverage (DFL) • If the management decides to finance a part of the total investment required of through debt financing, the following two factors are important: The proportion of total investment which the management decides to finance through debt (Debt Equity Ratio the firm aspires to) and the interest rate on borrowed funds. • The greater the tax rate, the more is the tax shield available to a company which is financially leveraged. • As the company becomes more financially leveraged, it becomes riskier, i.e., increased use of debt financing will lead to increased financial risk which leads to: Increased fluctuations in the return on equity and increase in the interest rate on debts. • The greater the use of financial leverage, the greater the potential fluctuation in return on equity. 8
  • 14. • As the interest rate increases, the return on equity decreases. Even though the rate of return diminishes, it might still exceed the rate of return obtained when no debt was used, in which case financial leverage would still be favorable. • A combination of the operating and financial leverages is the total or combined leverage. Thus, the Degree of Total Leverage (DTL) is the measure of the output and EPS of the company. DTL is the product of DOL and DFL • There is a unique DTL for every level of output. At the overall break-even point of output the DTL is undefined. If the level of output is less than the overall break-even point, then the DTL will be negative. If the level of output is greater than the overall break-even point, then the DTL will be positive. DTL decreases as the quantity of sales increases and reaches a limit of one. • DTL measures the changes in EPS to a percentage change in quantity of sales. • DTL measures the total risk of the company since it is a measure of both operating risk and total risk. Financial Forecasting • Financial forecasting is a planning process with which the company’s management positions the firm’s future activities relative to the expected economic, technical, competitive and social environment. • There are three main techniques of financial projections. They are proforma financial statements, cash budgets and operating budgets. • Proforma statements are projected financial statements embodying a set of assumptions about a company’s future performance and funding requirements. • Cash budgets are detailed projections of the specific incidence of cash moving in and out of the business. • Operating budgets are detailed projections of departmental revenue and/or expense patterns, and they are subsidiary to both proforma statements and cash flow statements. • Sales Budget can be prepared by making a sales forecast, sales forecast can be made from subjective and objective methods. • Subjective methods use the judgments or opinions of knowledgeable individuals within the company, ranging from sales representatives to executives. • Objective methods are statistical methods which range in sophistication from relatively simple trend extrapolations to the use of complicated mathematical models. More and more companies are relying on computers to predict causal relationships. 9
  • 15. Part I: Questions on Basic Concepts Introduction to Financial Management 1. 2. 3. 4. 5. 6. 7. The financial goal of a public sector firm fully owned by the government is to a Maximize the book value per share b. Maximize the profits earned by the firm c. Maximize the present value of stream of equity returns d. Maximize the return on equity e. Both (a) and (d) above. Which of the following is not an objective of financial management? a. Maximization of wealth of shareholders. b. Maximization of profits. c. Mobilization of funds at an acceptable cost. d. Efficient allocation of funds. e. Ensuring discipline in the organization. Which of the following is not a function of a finance manager? a. Mobilization of funds. b. Deployment of funds. c. Control over use of funds. d. Manipulate share price of the company. e. Maintain a balance between risk and return. The market value of the firm is the result of a. Dividend decisions b. Working capital decisions c. Capital budgeting decisions d. Trade-off between cost and risk e. Trade-off between risk and return. Which of the following is related to the control function of the financial manager? a. Interaction with the bankers for arranging a short-term loan. b. Comparing the costs and benefits of different sources of finance. c. Analysis of variance between the targeted costs and actual costs incurred. d. Assessing the costs and benefits of a project under consideration. e. Deciding the optimum quantity of raw materials to be ordered for procurement. The minimum number of persons required to form a private limited company and a public limited company respectively are a. 2 and 5 b. 5 and 7 c. 2 and 7 d. 7 and 2 e. None of the above. Which of the following is an advantage of a sole proprietorship? a. Life of a firm is limited to the life of the owner. b. Fund raising from outside is easy. c. Limited personal liabilities. d. Easy and inexpensive to set-up. e. Expansion of Business is possible.
  • 16. Part I 8. Which of the following is an advantage of partnership firms? a. The life of the firm is perpetual. b. Personal liabilities of the partners are limited. c. Its ability to raise funds is virtually unlimited. d. It is relatively free from Governmental regulations as compared to joint stock companies. e. None of the above. 9. The objective of financial management is to a. Generate the maximum net profit b. Generate the maximum retained earnings c. Generate the maximum wealth for its shareholders d. Generate maximum funds for the firm at the least cost e. All of the above. 10. Which of the following statements represents the financing decision of a company? a. Procuring new machineries for the R&D activities. b. Spending heavily for the advertisement of the product of the company. c. Adopting state of the art technology to reduce the cost of production. d. Purchasing a new building at Delhi to open a regional office. e. Designing an optimal capital structure by using suitable financial instruments. 11. The amount that can be realized by a company when it sells its business as an operating one is termed as a. Going concern value b. Market value c. Book value d. Replacement value e. Liquidation value. 12. Which of the following functions of the financial system facilitates conversion of investments in stocks, bonds, debentures etc., into money? a. Savings function. b. Liquidity function. c. Payment function. d. Risk function. e. Policy function. 13. The objective of financial management to increase the wealth of the shareholders means to a. Increase the physical assets owned by the firm b. Increase the market value of the shares of the firm c. Increase the current assets of the firm d. Increase the cash balance of the company e. Increase the total number of outstanding shares of the company. 14. Which of the following is a function of the finance manager? a. Mobilizing funds. b. Risk return trade off. c. Deployment of funds. d. Control over the uses of funds. e. All of the above. 11
  • 17. Financial Management Indian Financial System 15. A financial asset should necessarily have a. A claim to a payment in the form of an instrument b. An underlying asset, with a charge over it c. Parting of money today with an expectation that it will be returned in future with some addition to it d. Both (a) and (c) above e. All of (a), (b) and (c) above. 16. Which is/are the essential feature(s) of a Call Money Market? a. Maturity periods of 1-15 days. b. Market determined interest rates. c. Low liquidity. d. High agency costs. e. Both (a) and (b) above. 17. The apex financial institution in India that promotes housing finance is a. Housing & Urban Development Corporation (HUDCO) b. Housing Development Finance Corporation Ltd. (HDFC) c. Cooperative Housing Finance Society d. National Housing Bank (NHB) e. LIC Housing Finance Limited. 18. “Single Window Lending” refers to a. An arrangement by which the lead bank in a consortium of banks releases the initial requirements of the borrower b. Loans given by commercial banks to the agricultural sector, which are subject to efinance from NABARD c. A specialized cell set up in scheduled banks exclusively for the purpose of industrial loans d. Priority sector lending by nationalized banks e. Loans given by NBFCs to some sectors to which nationalized banks are not allowed to give. 19. The difference(s) between Commercial Paper (CP) and Certificate of Deposit (CD) is/are a. CP is secured while CD is unsecured b. CPs can be issued by private sector companies while CDs can be issued by scheduled banks c. CP is sold at a discount and redeemed at face value whereas for CD the principal and interest are payable upon maturity d. Both (b) and (c) above e. All of (a), (b) and (c) above. 20. The money lent in money market for a period of 2 to 15 days is referred to as a. b. Demand loan c. Term loan d. Notice money e. 12 Call money None of the above.
  • 18. Part I 21. Which of the following are feature(s) of Gilt-edged securities? a. Only repayment of principal is secured. b. They are issued by non-governmental service organizations. c. They are issued by government entities. d. The repayments of both principal and interest are secured. e. Both (c) and (d) above. 22. Which of the following provides liquidity to money market instruments by creating a secondary market where they can be traded? a. Discount and Finance House of India. b. National Securities Depository Limited. c. State Bank of India. d. Reserve Bank of India. e. Over the Counter Exchange of India. 23. Which of the following is an example of non-fund based activity of an NBFC? a. Bill discounting. b. Leasing. c. Issue management. d. Hire purchase. e. Inter-corporate loans. 24. The minimum maturity period for a Certificate of Deposit is a. Fifteen days b. One month c. Three months d. Six months e. No specific time limit is prescribed. 25. Statutory Liquidity Ratio (SLR) refers to the a. Percentage of secret reserves which acts as a cushion for nationalized banks b. Percentage of reserves banks are required to park with instruments approved by RBI c. Ratio between current account and fixed account deposits of banks d. Percentage of reserves banks are required to utilize only for forex transactions e. Percentage of reserves meant for priority sector lending. 26. Public debt in the Indian economy is being managed by a. SBI on behalf of Government of India b. Ministry of Finance c. RBI d. All nationalized banks and term lending institutions e. Ministry of Commerce and Trade. 27. In which of the following instances bought-out deal is more appropriate? a. Companies do not wish to disclose information by way of public issue. b. Promoters do not want to dilute their stake by going public. c. Small projects require funds but costs of public issue are substantially high. d. Foreign Institutional Investors offload their shares when market is down. e. Board for Industrial and Financial Reconstruction (BIFR) offers a sick unit to existing blue chips in that industry. 13
  • 19. Financial Management 28. Which of the following is/are not a feature(s) of National Stock Exchange? a. NSE was promoted by FIs at the bentest of GOI. b. The trading is on-line in national network. c. The volume of trading in it is less than that of BSE. d. It has a debt market segment. e. The weights to the stocks on NIFTY are based on total share holding. 29. Which of the following is/are not true in respect of PSU bonds? a. There is no secondary market. b. Market lot for trading purposes is minimum of Rs.10 crore. c. They come under “approved investments” by RBI. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. 30. Unit banking refers to the system a. With a single bank having units at different places b. With the overall operations of a bank conducted from a single office c. Which deals with the units of UTI d. Which deals with the units in small-scale sector e. Either (a) or (b) above. 31. Which of the following is not a function performed by a financial system? a. Savings function. b. Liquidity function. c. Risk function. d. Social function. e. Policy function. 32. The maturity period of a Certificate of Deposit (CD) issued by a bank is a. Not less than 1 month and not more than 6 months b. Not less than 2 months and not more than 9 months c. Not less than 15 days and not more than 12 months d. Not less than 4 months and not more than 12 months e. Not less than 1 month and not more than 12 months 33. If in an order to buy/sell shares from a stock exchange is limited by a fixed price it is called a. Limit order b. Limited discretionary order c. Stop loss order d. Best rate order e. None of the above. 34. ‘Gilt edged’ securities are the bonds issued by a. b. Multinational corporates c. Global corporations d. Central government e. 14 Big corporates Financial institutions.
  • 20. Part I 35. Medium dated government securities have maturities ranging from a. 1 to 3 years b. 1 to 5 years c. 3 to 5 years d. 3 to 10 years e. 5 to 10 years. 36. Which of the following maturity of T-Bills does not have a provision? a. 30-day. b. 91-day. c. 182-day. d. 364-day. e. None of the above. 37. In secondary spot capital market, the delivery and payment is completed a. On the same day of the date of contract b. On the next day of the date of contract c. Within four days from the date of contract d. Within 2 days from the date of contract e. Beyond fourteen days from the date of contract. 38. The primary capital market a. Imparts liquidity and marketability to long-term financial instruments b. Helps companies to raise funds to finance their projects c. Provides an auction market for long-term securities d. Operates through the medium of stock exchanges e. Both (a) and (c) above. 39. In a private company maximum number of members permissible is a. 5 b. 10 c. 25 d. 50 e. 100. 40. Banks borrow in call money market to a. Give loans b. Invest in high yielding securities c. Meet the Cash Reserve Ratio (CRR) d. Meet sudden demand for funds arising due to large payments and remittances e. Both (c) and (d) above. 41. Which of the following is not a feature of Commercial Paper (CP)? a. Purely secured instrument. b. Maturity varies between 15 days and a year. c. Buy-back facilities are available. d. Negotiable by endorsement and delivery. e. None of the above. 15
  • 21. Financial Management 42. Which of the following is not a money market instrument? a. Treasury bills. b. Certificate of deposits. c. Debentures. d. Call money. e. None of the above. 43. Private placement of shares can be made out of a. Mutual funds quota b. Promoters quota c. Public quota d. Financial institutions quota e. All of the above. 44. An order to sell shares, where brokers are given a particular limit for sustenance of loss is known as a. Limited discretionary order b. Limit order c. Cancel order d. Stop loss order e. Best rate order. 45. Which of the following is not true with regard to commercial paper? a. It is issued in multiples of Rs.5 lakhs. b. The minimum amount to be invested by a single investor is Rs.20 lakhs. c. The maturity period cannot exceed 1 year. d. These are unsecured promissory notes. e. The issuing company must have a high credit rating. 46. Which of the following enables a company to increase its paid-up share capital without receiving any payment from the recipients of the shares? a. Public issue. b. Bonus issue. c. Private placement. d. Bought-out deal. e. Rights issue. 47. In which of the following types of orders the members of stock exchange are not given any price or time limit by the client for execution of order? a. Limit order. b. Best rate order. c. Immediate or cancel order. d. Limited discretionary order. e. Open order. 48. Which of the following statements is false? a. All scheduled banks except co-operative banks and regional rural banks are eligible to issue CDs. b. CDs can be issued to individuals. c. CDs are issued at a discount to face value. d. The maturity period of CDs issued by banks varies from 15 days to one year. e. CDs are issued in multiples of one lakh subject to the minimum size of each issue of Rs.50 lakh. 16
  • 22. Part I 49. Which of the following methods of issuing additional shares does not result in an increase in the net worth of the company? a. Public issue. b. Rights issue. c. Bonus issue. d. Private placement. e. Bought-Out Deal. 50. The major categories of investors in primary market of government securities include a. Reserve Bank of India b. Financial institutions c. Foreign financial institutions d. Commercial banks e. All of the above. 51. Which of the following is an asset of a bank? a. Balances with other banks. b. Savings deposits. c. Demand and time deposits from other banks. d. Refinance from NABARD. e. None of the above. 52. The National Housing Bank extends refinance on housing loans to a. Scheduled commercial banks b. Co-operative banks c. Housing finance companies d. Apex cooperative housing finance societies e. All of the above. 53. According to the guidelines of Money Market Mutual Funds, the minimum lock in period of an investor’s investment is a. Nil b. 15 days c. 30 days d. 45 days e. 60 days. 54. One of the important functions of a well developed money market is to channel savings into productive investments like working capital. Which of the following is not a money market instrument? a. Corporate debentures. b. Call money. c. Treasury bills. d. Commercial paper. e. Certificate of deposits. 55. Which of the following is not a feature of a commercial paper? a. They are transferable by endorsement and delivery. b. They are issued in multiples of one lakh. c. Their maturity varies from 15 days to one year. d. They are unsecured in nature. e. They normally have buy-back facility. 17
  • 23. Financial Management 56. Which of the following is not an advantage of a bought out deal? a. The promoters are assured of immediate funds. b. The time consuming and costly public issue can be avoided. c. It is easier to convince the wholesale investor rather than the general public. d. The shares issued via bought out deal can be bought back by the company at any time. e. It is the cheapest and quickest source of finance for small to medium sized companies. 57. If a company wants to raise funds through commercial paper market, the minimum fund based working capital limit should be a. Rs.1 crore b. Rs.2 crore c. Rs.3 crore d. Rs.4 crore e. Rs.5 crore. 58. In a Bought-Out Deal a. Companies issue shares to the public b. Companies issue shares to the existing shareholders c. Mutual funds buy out a part of promoter’s share d. A part of the equity of an unlisted company is bought by a sponsor/merchant banker e. Financial institutions buy out a significant portion of share capital of a listed company. 59. Which of the following is not a financial asset? a. Secured premium notes. b. National defence gold bond. c. Capital investment bond. d. Bullion. e. Special bearer bond. 60. Bills rediscounting facility is offered by a. All public sector banks b. Some co-operative banks c. IDBI d. All SFCs e. Both (c) and (d) above. 61. Which of the following statements is/are true? i. A cash credit is a running account. ii. Cash credits may become long-term loans due to repeated roll-overs. iii. Overdrafts are allowed only against the security of inventories. a. Only (i) above. b. Only (ii) above. c. Only (iii) above. d. Both (i) and (ii) above. e. All of (i), (ii) and (iii) above. 62. Which of the following is not a money market instrument? a. Treasury bill. b. Commercial paper. c. Convertible debenture. d. Certificate of deposit. e. Both (b) and (c) above. 18
  • 24. Part I 63. Which of the following statements is true regarding issuance of Commercial Paper (CP)? a. Corporates need prior approval of RBI for CP issue. b. Underwriting of a CP issue is not mandatory. c. Minimum size of a CP issue is Rs.10 lakhs. d. CPs have to be backed by a bank guarantee. e. CPs are issued in multiples of Rs.1 lakh. 64. Which of the following statements is/are true regarding the call money market? a. Surplus funds of banks constitute a major component. b. Major corporates participate as lenders. c. Banks often borrow from it for maintenance of SLR and CRR. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. 65. Which of the following statements is/are true regarding 91-day Treasury Bills? a. They are also referred to as PSU bonds. b. They are issued through auctions conducted by RBI. c. They are risky instruments as their interest rates fluctuate widely. d. They cannot be rediscounted with RBI. e. None of the above. 66. CRISIL a. Rates, Debentures and fixed deposits. b. Was set up by the Industrial Development Bank of India. c. Gives the highest rating of “P1” to short-term instruments. d. Does not consider non-financial factors while valuing a company’s securities. e. None of the above. 67. Which of the following is not a money market instrument? a. Call Loans. b. Commercial Papers. c. Certificates of Deposit. d. Treasury Bills. e. None of the above. 68. Which of the following is a form of direct assistance by All India Financial Institutions? a. Underwriting. b. Subscribing to a company’s shares. c. Bills Rediscounting. d. All of the above. e. Both (a) and (b) above. 69. Which of the following statements is not true? a. The Industrial Credit and Investment Corporation of India has merged with ICICI bank. b. The Industrial Development Bank of India is the apex term lending financial institution. c. The Industrial Finance Corporation of India is an All India term lending financial institution. d. The Industrial Reconstruction Bank of India is the central agency for rehabilitation of Industrial units declared sick by BIFR only. e. None of the above. 19
  • 25. Financial Management 70. Which one of the following was not an objective of governmental control over major banks? a. Achieving wider spread of bank credit. b. Nationalization and greater Preventing misuse of resources of banks. c. Reducing the influence of business houses on banks. d. Bringing larger income to the government. e. None of the above. 71. Private Banks a. Should not be registered as public limited companies b. Need not adhere to capital adequacy norms determined by RBI c. Are covered by the Banking Regulation Act, 1949 d. Should not be listed on any stock exchanges e. Both (a) and (d) above. 72. Which of the following are the reasons for low profitability of the Commercial Banks? a. High incidence of bad debt. b. Inefficient procedures. c. Overstaffing. d. Priority sector lending. e. All of the above. 73. Gilt-edged securities a. Have fairly active secondary market b. Have low interest rates c. Are subscribed mainly by commercial banks, provident funds and other institutional investors d. Are held by banks to satisfy their SLR requirements e. All of the above. 74. Which of the following is not true? a. There has been a general down trend in the nominal interest rates in the past few years. b. Term finance rates have been higher than the working capital finance rates. c. Interest rates in the organized sector in India are fixed by the government. d. Interest rate policy of the government is designed to mobilize substantial savings. e. Interest rate policy of the government is designed to facilitate government borrowing cheaply. 75. Certificates of Deposits (CDs) a. Are freely transferable by endorsement and delivery b. Are issued at a discount stipulated by RBI c. Are issued by RRBs d. Have no fixed maturity e. Have an active secondary market. 76. Which of the following statements is true? a. IDBI’s deep discount bonds are zero coupon bonds. b. When a company wants to raise a given amount of capital through a rights issue, the subscription price should ideally be higher than the current market price. c. Regional stock exchanges are unrecognized. d. The rupee is convertible on the capital account. e. 20 The alpha (α) of a security measures the return on the market portfolio.
  • 26. Part I 77. The changes in the banking structure through nationalization has resulted in a. Deeper penetration into rural areas b. Increase in deposits c. Channelization of bank credit d. Lower operational autonomy for banks e. All of the above. 78. The following indirect financial assistance is extended by the financial institutions to help the industrial units a. Underwriting b. Guarantee for foreign currency loans c. Deferred payment guarantee d. All of the above e. None of the above. 79. Money market deals with a. Mortgage loans b. Certificate of deposits c. Deposits with RBI under CRR d. Fixed Deposit Receipts e. Both (a) and (b) above. 80. In a well-functioning capital market, shareholders will vote for the goal of a. Modifying the investment plan of the firm to help shareholders achieve a particular time pattern of investment b. Making shareholders as wealthy as possible by investing in real assets with positive net present values c. Inviting shareholders and giving them costly articles in annual general meetings d. Having employees as shareholders e. Choosing high or low risk projects to match shareholders risk preferences. 81. Capital markets differ from money market in that a. Capital markets are regulated while money markets are not b. The maturity of securities in the capital are long-term while in the money market it is short-term c. Limited companies which operate in capital markets cannot operate in money markets d. Unorganized money markets are larger than unorganized capital market e. Both (a) and (d) above. 82. Which of the following members would you not find in the secondary stock market? a. Investors. b. Stock Exchanges. c. Stock Brokers. d. Companies. e. Underwriters. 83. In terms of the maturity of assets issued, which of the following markets have the shortest maturity period? a. Call Money Market. b. Commercial Paper Market. c. Treasury Bills Market. d. Certificates of Deposit Market. e. All of the above. 21
  • 27. Financial Management 84. Which of the following is true regarding the issuance of commercial paper? a. The minimum net worth of Rs.10 crore is required. b. The maximum discount rate is 16%. c. The minimum credit rating required is P1. d. Prior approval of RBI for the issue is required. e. Minimum investment by an individual is Rs.5 lakh. 85. The minimum maturity of treasury bills is a. 14 days b. 28 days c. 45 days d. 60 days e. 90 days. 86. Which of the following statements is/are true regarding call money market? i. Financial institutions and mutual funds can participate only as lenders in this market. ii. The interest on call loan is regulated by Reserve Bank of India. iii. The maximum maturity of notice money is 3 days. a. Only (i) above b. Only (ii) above c. Both (i) and (ii) above d. Both (i) and (iii) above e. Both (ii) and (iii) above. 87. Which of the following is true regarding a Bought-Out Deal? a. It involves direct selling of securities to a limited number of institutional or high net worth individuals. b. The costs involved in a bought-out deal are generally higher than the costs of a public issue. c. The company proposing to place its securities through this route can price its securities to reflect the intrinsic value. d. The procedural complexities are very high. e. New companies cannot make bought-out deals. 88. The maximum number of persons in a private limited company is a. 1 b. 2 c. 3 d. 7 e. 50. 89. The service of which of the following entities is generally not useful to the retail investors for raising funds? a. b. Commercial banks. c. Hire purchase finance companies. d. Housing finance companies. e. 22 Merchant Banks. Nidhis.
  • 28. Part I 90. Which of the following is not traded in the money market? a. Commercial papers. b. Certificate of deposits. c. Treasury bills. d. 6 months term deposits. e. None of the above. 91. Which of the following is a function of the primary capital market? a. To allow the Foreign Institutional Investors (FIIs) to invest in the Indian capital markets. b. To allow the companies to raise funds to meet their short term funds requirements through new securities. c. To provide a market for trading with the outstanding long term securities. d. To provide a market for trading with the existing short term securities. e. None of the above. 92. In which of the following types of issue, new securities are offered to the existing shareholders of the company on a pro rata basis? a. Public issue b. Rights issue c. Bonus issue d. Private placement e. Both (b) and (c) above. 93. Which of the following is a disadvantage of Bought-Out Deals? a. It is difficult to convince a wholesale investor. b. The promoters of the company do not get the funds immediately. c. It is a very time consuming procedure. d. The issue expenses are more than that of a public issue. e. Sponsor may exploit the situation. 94. Which of the following companies generally provide risk capital to the technology oriented and high-risk business entities? a. Lease finance companies. b. Venture capital funding companies . c. Commercial banks. d. Hire purchase finance companies. e. Insurance companies. 95. Which of the following is/are the characteristics of the money market instruments? a. Long term maturity. b. High liquidity. c. Highly secured. d. Issued by the Governments only. e. Both (b) and (d) above. 96. Which of the following situations leads to the greatest increase in volatility in the call money market? a. Reduction in cash reserve ratio b. Prepayment of term loans by a large number of borrowers c. Entry of the financial institutions (FIs) into the market d. Payment of large amount of advance taxes by the banks and FIs e. Decrease in the demand for loanable funds in the economy. 23
  • 29. Financial Management 97. Which of the following is/are correct with respect to the act(s) of the arbitrageurs in the derivatives market? a. To protect one’s position in the spot by taking suitable instrument(s) in the derivatives market. b. To protect one’s anticipated position in the spot by taking suitable instrument(s) in the derivatives market. c. To make profit from the subsequent price movements of any particular instrument in the derivatives market. d. To make risk free profits by simultaneously buying and selling different instruments in different markets. e. Both (a) and (b) above. 98. Which of the following results in a public limited company to have a significant advantage over a proprietorship firm? a. Limited liability. b. Difficulty of transfer of ownership interest. c. Limited life. d. Inability to mobilize a lot of funds. e. None of the above. 99. Which of the following is not a marketable instrument? a. Commercial Paper. b. Certificate of Deposit. c. Inter Corporate Deposit. d. Preference Shares. e. Treasury Bills. 100. Which of the following functions is/are served by the primary capital market of an economy? a. It allows the corporate houses to raise the long term capital by issuing new securities. b. It offers a market to trade for the outstanding long term securities. c. It offers a market to trade for the outstanding short term securities. d. It offers an excellent exit route for the venture capital funding companies. e. Both (a) and (d) above. 101. Which of the following functions of the financial system channelises the savings from the savers to the producers in the economy? a. Financial Intermediation function. b. Liquidity function. c. Payment function. d. Risk function. e. Policy function. 102. In which of the following markets, are the outstanding long-term financial instruments traded? a. b. Forex market. c. Primary capital market. d. Secondary capital market. e. 24 Money market. Call money market.
  • 30. Part I 103. Corporate investment and financing decisions are limited by a governmental regulatory framework which seeks to a. define avenues of investment available to business enterprises in different categories, ownership and size-wise b. Induce investment along certain lines by providing incentives, concessions and reliefs c. Specify the procedures for raising funds from financial markets d. Both (a) and (c) above e. All of (a), (b) and (c) above 104. Which of the following entities issues the “Gilt edged” securities? a. Multinational companies. b. Reputed domestic companies. c. Private sector enterprises. d. Small scale companies. e. Central and state governments. 105. Long dated government securities have maturities ranging from a. Up to 1 year b. 1 to 5 years c. 5 to 8 years d. 8 to 10 years e. 10 to 30 years. 106. What is the maximum limit on the number of members in a private limited company? a. 5. b. 8. c. 15. d. 50. e. Unlimited. 107. Which of the following regulations no more relevant in today’s business environment? a. Foreign Exchange Regulation Act, 1973. b. Monopolies and Restrictive Trade Practices Act, 1969. c. Companies Act, 1956. d. Income Tax Act, 1961. e. SEBI Act, 1992. Time Value of Money 108. Which of the following statement(s) is/are true for given values of ‘i’ and ‘n’? a. Present Value Interest Factor is the reciprocal of Future Value Interest Factor. b. Future Value Interest Factor Annuity is the reciprocal of Present Value Interest Factor Annuity. c. Capital recovery factor is a product of Future Value Interest Factor and reciprocal of Future Value Annuity Factor. d. Both (a) and (c) above. e. Both (b) and (c) above. 109. The product of PVIF, FVIF, FVIFA and Capital Recovery Factor is a. FVIF b. PVIFA c. PVIF d. FVIFA e. None of the above. 25
  • 31. Financial Management 110. The nominal rate of interest is equal to a. Real Rate + Risk Premium – Inflation b. Real Rate + Risk Premium + Inflation c. Real Rate – Risk Premium + Inflation d. Real Rate – Risk Premium – Inflation e. Real Rate. 111. The accurate doubling period n given a rate of return R can be calculated by a. (1 + R)n = 2 b. 72/R c. 0.35 + 69/R d. All of the above e. None of the above 112. The inverse of sinking fund factor is given by a. 1 − (1+ k) n k b. 1 − (1+ k) n k c. (1+ k) n 1 − k k d. k (1+ k) n − 1 e. (1+ k) n − 1 . k 113. If P = principal amount, i = interest rate per annum, m = frequency of compounding per year, n = number of years and A = accumulation at the end of the year n, then which of the following expressions is correct? mn a. A = P(1 + i/n) b. P = A(1 + i/m) c. A = [P(1 + i/m) ] mn m n mn d. A = P(1 + i/m) e. None of the above. 114. If ‘k’ is the rate of interest and ‘n’ the number of years, then the capital recovery factor is given as a. b. (1+ k) n (k) (1+ k) n +1 c. (1+ k) n − 1 k(1+ k) n d. (1+ k) n (1+ k) (1+ k) n (k) e. 26 k(1+ k) n (1+ k) n − 1 (1+ k) k (n) . (1+ k) n − 1
  • 32. Part I 115. Which of the following statements is not true? a. b. c. d. 116. 117. 118. 119. 120. The more frequent the compounding, the higher the future value, other things being equal. For a given amount, the greater the discount rate, the less is the present value. Capital recovery is the inverse of FVIFA. PVIFA = (1+ k) n − 1 k(1+ k) n e. All of the above. An interest rate that has been annualized using compound interest is termed as a. Simple interest rate b. Annual interest rate c. Discounted interest rate d. Effective annual interest rate e. Compounded interest rate. When an investment pays only simple interest rate, this means a. The interest rate is lower than on comparable investments b. The future value of investment will be low c. The interest earned is non-taxable to the investor d. Interest is earned only on the original investment e. Interest is earned on previously earned interest. Cash flows occurring in different periods should not be compared unless a. Interest rates are expected to be stable b. The flows occur no more than one year from each other c. High rates of interest can be earned on the flows d. The flows have been discounted to a common date e. Interest rates are expected to increase over a period of time. Sinking fund factor is the reciprocal of a. Future value interest factor b. Present value interest factor c. Future value interest factor of annuity d. Present value interest factor of annuity e. Capital recovery factor. The present value interest factor of annuity is equal to a. (1 + k) n − 1 k(1+ k) n b. FVIFA (k, n) FVIF (k, n) c. FVIFA(k,n) x PVIF(k,n) d. Reciprocal of sinking fund factor for k% and n years x PVIF (k,n) e. All of the above. 121. Which of the following statements is true? a. Increased frequency of compounding reduces the effective rate of interest. b. According to Rule of 72, the period within which the amount will be doubled can be obtained by dividing 72 by the interest rate and adding 0.35 to the value arrived at. c. Effective interest rate is always more than or equal to the nominal interest rate. d. An annuity is a lump sum payment. e. A project is financially viable if the present value of the future cash inflows is positive. 27
  • 33. Financial Management 122. Money has time value because a. The individuals prefer future consumption to present consumption b. A rupee today is worth more than a rupee tomorrow in terms of its purchasing power. c. A rupee today can be productively deployed to generate real returns tomorrow d. The nominal returns on investments are always more than inflation thereby ensuring real returns to the investors e. Both (b) and (c) above. 123. Which of the following equations is correct? a. PV = FVn x FVIF(k, n) n b. PV = FVn ÷ (1 + k) c. PV = FVn × PVIF(k, n) d. FVn = PV × (1 + k) FVA = {(1 + k)n – 1} ÷ k. e. n n 124. Which of the following statements is not true? a. The Present Value Interest Factor for an Annuity (PVIFA) is equal to the product of the future value interest factor for annuity and the present value interest factor. b. The inverse of PVIFA factor is called the capital recovery factor. c. The nominal rate of interest is equal to the effective rate of interest when the interest is compounded annually. d. The present value of cash flow stream of any periodicity can be calculated using FVIFA tables. e. The sinking fund factor is used to determine the amount that must be deposited periodically to accumulate a specified sum at the end of a given time period. 125. Which of the following is not true? a. The inverse of PVIFA factor is called the capital recovery factor. b. The nominal rate of interest is equal to the effective rate of interest when the interest is compounded annually. c. The present value of interest factor for annuity is equal to the product of the inverse of future value interest factor for annuity and the present value interest factor. d. The present value of any cash flow stream can be calculated using PVIFA tables. e. The sinking fund factor is used to determine the amount that must be deposited periodically to accumulate a specified sum at the end of a given period at a given rate of interest. 126. With an increase in the frequency of compounding a. The nominal rate of interest becomes greater than the effective rate b. The effective rate of interest increases at an increasing rate c. The nominal rate of interest becomes equal to the effective rate of interest d. The effective rate of interest increases at a decreasing rate e. Both (a) and (d) above. 127. Sinking fund explains a. The maturity value in year ‘t’ for an amount deposited in year ‘1’ b. The amount to be deposited annually to accumulate a predetermined sum in year ‘t’ c. The discounted value in year zero for an uneven series occurring in several years in future d. The amount to be deposited in year zero for a periodical withdrawal in future for a specified period e. The effective rate of interest. 28
  • 34. Part I 128. Which of the following statements is/are true? i. ii. Only (i) of the above. d. 133. Both (i) and (ii) of the above. c. 132. All (i), (ii) and (iii) of the above. b. 131. The present value of a perpetuity is infinity. a. 130. The product of PVIF and FVIFA factors is PVIFA factor. iii. 129. The inverse of the PVIFA factor is sinking fund factor. Only (ii) of the above. e. Only (iii) of the above. The nominal rate of interest a. Is lesser than the effective rate of interest under inflationary conditions b. Is equal to the effective rate of interest minus inflation c. Does not consider risk premium d. Is the real rate of interest plus inflation plus risk premium e. Is also referred to as the prime lending rate. When compounding of interests is done at intervals which are less than a year a. The effective rate of interest will be the same as the nominal rate of interest b. The effective rate of interest will be lesser than the nominal rate c. The nominal rate of interest will be lesser than the effective rate d. There is no difference between the effective and nominal rates in the first year e. It cannot be ascertained as to which rate is more unless the frequency of compounding is known. If any investment (P) has to be doubled at an interest rate of k, then the doubling period ‘n’ is exactly equal to a. 72/k b. 0.35 + 69/k c. Log2/log (1 + k) d. 2 e. Both (a) and (b) above. Which of the following is/are true? a. Inverse of FVIF is PVIF. b. Inverse of FVIFA is PVIFA. c. Inverse of capital recovery factor is FVIFA. d. PVIFA is the product of inverse of FVIFA and PVIF e. Both (a) and (d) above. The relationship between effective rate of interest (r) and nominal rate of interest (i) is best represented by m a. r ⎞ ⎛ i = ⎜1+ ⎟ − 1 ⎝ m⎠ b. i ⎞ ⎛ r = ⎜1+ ⎟ − 1 m⎠ ⎝ m n d. r⎞ ⎛ i = ⎜ 1+ ⎟ − 1 ⎝ n⎠ r = (1+m)i – 1 e. i = (1+r)m – 1. c. 29
  • 35. Financial Management 134. If compounding is done twice in a year, the effective rate of interest is equal to a. 2 × nominal rate of interest b. Nominal rate of interest/2 c. (1 + nominal rate of interest/2)2 –1 d. ((1 + nominal rate of interest)/2) e. (1 + nominal rate of interest/2) × 2. 2 135. Which of the following is/are true? a. FVIF is the reciprocal of PVIF. b. Product of FVIF and PVIFA is equal to FVIFA. c. FVIFA is the reciprocal of PVIFA. d. Both (a) and (b) above. e. Both (a) and (c) above. 136. Time value of money considers a. The preference of the individuals for future consumption to present consumption b. Increase in purchasing power of rupee with the passage of time c. The uncertainty of the future d. The productivity of money to earn real returns over time e. Both (c) and (d) above. 137. Which of the following statements is/are true with respect to Present Value Interest Factor of Annuity (PVIFA)? i. The cash flow is assumed to occur at the end of the period under consideration ii. The cash flow is assumed to occur at the start of the period under consideration iii. It is reciprocal to capital recovery factor. a. Only (i) above. b. Only (ii) above. c. Only (iii) above. d. Both (ii) and (iii) above. e. Both (i) and (iii) above. 138. Which of the following may be considered as the correct reason for money having time value? a. It is the legal tender for carrying out any type of transaction. b. In India, it is guaranteed by the union government. c. Its purchasing power increases with the passage of time due to inflation. d. Money can be productively invested to generate real returns over a period of time. e. None of the above. Risk and Return 139. A risk-free stock has a beta of a. b. Zero c. 0.5 d. 1 e. 30 –1 Infinity.
  • 36. Part I 140. Which of the following is not an assumption under CAPM? a. Investors make their investment decisions on a single period horizon. b. If the perceived risk is high, a risk-averse investor expects higher return. c. The investor is not limited by his wealth and price of the asset. d. Assets can be bought at the going market price. e. CAPM is based on all the above assumptions. 141. If the slope of the Security Market Line is zero, which of the following is/are true? a. Risk-free return = Market return. b. Market return = Expected return. c. Expected return = Risk-free return. d. Both (a) and (c) above. e. All of (a), (b) and (c) above. 142. Which of the following is not a non-diversifiable risk? a. Lock-out in a company due to workers demanding a wage hike. b. Slump in the industry. c. Lack of strategy for the management in a company. d. A change in the tax-structure for corporates in the Union Budget. e. Both (a) and (c) above. 143. The amount of risk reduction depends on a. Degree of correlation b. Number of stocks in the portfolio c. The market index movement d. Both (a) and (b) above e. All of (a), (b) and (c) above. 144. Which of the following is diversifiable risk? a. Inflation risk. b. Interest-rate risk. c. Market risk. d. Business risk . e. Both (b) and (d) above. 145. If a person holds a diversified portfolio the risk a security adds would be a. Specific risk b. Systematic risk c. Portfolio risk d. Liquidity risk e. Diversifiable risk. 146. Portfolio Beta a. b. c. d. e. Is the risk of a diversified portfolio Is the weighted average of individual security betas, weights being the proportions of individual returns Is the weighted average of individual security beta, weights being the proportions of the investments in the respective securities Both (a) and (b) above Both (a) and (c) above. 31
  • 37. Financial Management 147. Which is true regarding kj=rf + β (km – rf)? a. rf can be the rate of return earned on gilt-edged securities. b. β will be > 1 if the security is volatile. c. Lower β would give a low risk premium. d. There is a possibility that a zero beta exists. e. All of the above. 148. The slope of the security market line denotes a. The expected return by the investors b. The market volatility c. Beta of the security d. The influence of unsystematic risk e. The risk premium required. 149. If the security’s return plots below the SML, then, it can be said that a. It is overpriced b. The required rate of return is much lower than the actual rate of return c. The investors would try to buy more of the security d. It is a defensive security e. Both (a) and (b) above. 150. A security is said to be aggressive when it a. Has a beta of > 1 b. Plots on the upper part of SML c. Gives below average returns d. Both (a) and (b) above e. Both (b) and (c) above. 151. Which of the following is not a non-diversifiable risk? a. Interest rate risk. b. Purchasing power risk. c. Operating risk. d. Market risk. e. Political risk. 152. Risk-return trade-off implies a. Increasing the profit of the firm through increased production b. Not taking any loans which increases the risk of the firm c. Not granting credit to risky customers d. Taking decisions in such a way which optimizes the balance between risk and return e. Minimizing all risks. 153. Which of the following is a specific risk factor? a. b. Inflation risk. c. Interest rate risk. d. Financial risk. e. 32 Market risk. None of the above.
  • 38. Part I 154. Security Risk premium in the Capital Asset Pricing Model (CAPM) is given by a. Rf b. km – Rf c. β (km – Rf) d. βKm e. β( Rf – km ). 155. The risk arising due to uncertainty about the time element and the price concession in selling a security is called a. Price risk b. Market risk c. Trading risk d. Liquidity risk e. Financial risk. 156. Standard deviation as a measure of risk is preferred because a. Standard deviation considers every possible event and assigns each event equal weight b. Standard deviation is a measure of dispersion around the median value c. Standard deviation is a familiar concept and many calculators and computers are programmed to calculate it d. Standard deviation considers every possible event and assigns each event a weight equal to its probability e. Both (c) and (d) above. 157. Which of the following is not a diversifiable or specific risk factor? a. Company strike. b. Bankruptcy of a major supplier. c. Death of a key company officer. d. Unexpected entry of new competitor into the market. e. Industrial recession. 158. Which of the following statements is true of beta? a. Beta of a security is the slope of the Security Market Line (SML). b. Beta of a security is a measure of the diversifiable risk of a security. c. High beta of a security assures high return. d. Beta of a security can never be negative. e. Beta of a security is a measure of systematic risk of a security. 159. Which of the following is not an assumption of Capital Asset pricing Model (CAPM)? a. Investors are risk-averse and use the expected rate of return and standard deviation of return as appropriate measures of return and risk respectively. b. Investors make their investment decisions based on a single period horizon i.e. the next immediate time period. c. Transaction costs in financial markets are low enough to ignore and assets can be bought and sold in any unit desired. d. Taxes do not affect the choice of buying assets. e. Investors make their investment decisions based on multi-period horizon. 33
  • 39. Financial Management 160. Ceteris Paribus, a security is to be bought if. a. The required rate of return is less than expected rate of return b. The required rate of return is greater than the expected rate of return c. Security has a beta greater than one d. The security has beta of less than one e. The security has a large amount of floating stocks in the market. 161. Which of the following statements is true? a. If one portfolio’s variance exceeds that of another portfolio, its standard deviation will also be greater than that of the other portfolio. b. For investment horizons greater than 20 years, long-term corporate bonds will outperform common stocks. c. Due to their short maturity, the average real rate of return for treasury bills approximately equals their average nominal rate of return. d. When inflation is expected to be low, the nominal risk premium on common stocks is expected to be low. e. Market risk can be eliminated in a stock portfolio through diversification. 162. Real rates of return are typically less than nominal rates of return due to a. Inflation b. Capital gains c. Dividend payments d. Deflation e. Recession. 163. Real rates of return will be positive as long as a. The nominal return is positive b. The inflation rate is positive c. The nominal return exceeds inflation rate d. Inflation rate exceeds the real return e. None of the above. 164. The major benefit of diversification is to a. Increase the expected return b. Increase the size of the investment portfolio c. Reduce brokerage commissions d. Reduce the expected risk e. Increase the expected return over and above the risk-free rate of return. 165. Which of the following is not true? a. b. Market risk refers to the variability of returns due to a wide range of factors exogenous to the securities themselves. c. Inflation risk is the loss of purchasing power due to inflation. d. As inflation rate increases the interest rate risk decreases. e. 34 Interest rate risk is the variability in a security’s return resulting from changes in interest rates. Business risk is the risk of doing business in a particular industry.
  • 40. Part I 166. What is the cost of a debenture if it is issued at face value of Rs.100. The coupon is 13%, the maturity is 6 years, redemption is at 6% premium and realizable amount is Rs.97.50 and Tax = Rs.38%. a. 9.25% b. 9.56% c. 9.13% d. 9.31% e. 9.49% 167. Which of the following statements is true? a. Interest rate risk refers to the variability of returns due to fluctuations in the securities market. b. Market risk refers to the reduction in purchasing power. c. The interest rates on securities tend to go up with inflation. d. Business risk refers to the risk due to debt financing. e. Financial risk is associated with the secondary market in which a particular security is traded. 168. Financial risk arises due to the a. Reduction in purchasing power of the assets employed by the firm b. Variability of returns due to fluctuations in the securities market c. Changes in prevailing interest rates in the market d. Leverage used by the company e. Liquidity of the assets of the company. 169. The diversifiable risk includes the risk due to a. Inflation b. Industrial recession or slow down c. Natural calamities d. Strike in the company e. Changes in economic policy. 170. Which of the following would reduce the applicability of Capital Asset Pricing Model (CAPM)? a. Investors having different time horizons for investments. b. The presence of high transaction costs in the market. c. The influence of taxes on the choice of assets. d. The different expectations of the investors regarding the risk and return associated with various securities. e. All of the above. 171. Which of the following is a diversifiable risk factor? a. An increase in inflation rate. b. Unexpected entry of a new competitor in the market. c. A change in economic policy of government. d. Industrial recession. e. Increase in international oil prices. 35
  • 41. Financial Management 172. If a security is less risky than the market portfolio, then its beta would be a. Negative b. More than market beta c. Equal to Zero d. Less than 1 e. More than 1. 173. Which of the following statements is true? a. Expected returns and ex post returns are same. b. There are only two types of returns i.e., realized returns and historical returns. c. Risk is a motivating force for an investor. d. The objective of any investor is to maximize his returns as well as risk. e. The investor compensates for the uncertainty in returns by requiring an expected return that is sufficiently high to offset the risk or uncertainty. 174. Which of the following types of risks is/are not systematic risk? a. Credit risk. b. Interest rate risk. c. Purchasing power risk. d. Market risk. e. Both (a) and (d) above. 175. The security market line shows the relationship between the a. Expected rate of return and diversifiable risk b. Realized rate of return and beta c. Required rate of return and unsystematic risk d. Expected rate of return and beta e. Realized rate of return and systematic risk. 176. The risk that arises due to change in the purchasing power is called a. Financial risk b. Interest rate risk c. Business risk d. Market risk e. Inflation risk 177. The risk aversion of an investor can be measured by a. Risk-free rate of return b. Market rate of return c. Variance of the return from a security d. The difference between the market rate of return and the risk-free rate of return e. None of the above. 178. The risk of a portfolio of two securities increases if there is _______ between their returns. a. b. Perfect negative correlation. c. Moderate positive correlation. d. Moderate negative correlation. e. 36 Perfect positive correlation. Both (a) and (c) of the above.
  • 42. Part I 179. Which of the following types of risk is not a diversifiable risk? a. Business risk. b. Financial risk. c. Credit risk. d. Purchasing power risk. e. Technology risk. 180. Market portfolio contains a. Frequently traded securities in the stock market b. All the securities in proportion to their market capitalization c. All securities listed in the specified group of a stock exchange d. The securities having large volumes in terms of number of transactions and market capitalization e. None of the above. 181. Security market line shows the relationship between return on the stock and a. Return on market portfolio b. Risk-free rate of return c. Standard deviation of the stock returns d. Beta of the stock e. Variance of the stock returns. 182. If a security’s return plots above the Security Market Line (SML), it means a. Security is overpriced b. Security is underpriced c. Security’s beta is more than one d. Security’s beta is less than one e. Security’s beta is equal to zero. 183. Which of the following statements is true? a. The Capital Asset Pricing Model (CAPM) establishes the relationship between an asset’s return and its systematic risk. b. The above relationship can be graphically plotted as the Security Market Line. c. An undervalued security is a very desirable asset to own. d. All of the above. e. Both (a) and (b) above. 184. Characteristic line is the relationship between return on stock and a. Return on market portfolio b. Risk-free rate of return c. Return on Government bond d. Both (b) and (c) above e. None of the above. 185. In booming (share) market, the companies are to be selected with Beta (β) a. β=0 b. β>1 c. β<1 d. β=1 e. Beta is not relevant. 37
  • 43. Financial Management 186. Which of the following is not an assumption of CAPM? a. Capital markets are perfect. b. Lending rate is more than borrowing rate. c. No individual is capable of affecting market. d. Homogenous expectations. e. All the above are assumptions. 187. Systematic Risk Factor(s) involved in investing in bonds a. Purchase-Power risk b. Interest rate risk c. Yield risk d. Both (a) and (b) above e. Both (b) and (c) above. 188. The slope of the Security Market Line (SML) changes with a. Change in risk-free rate of return b. Change in risk attitude of investors c. Change in inflation d. All of the above e. Both (a) and (c) above. 189. The relationship between β of a security and required rate of return is represented by a. Characteristic line b. Security market line c. Capital market line d. All of the above e. None of the above. 190. If investors expect the inflation rate to fall in future and they expect themselves to become less risk-averse then a. SML shifts up and the slope increases b. SML shifts up and the slope decreases c. SML shifts down and the slope increases d. SML shifts down and the slope decreases e. SML does not change as the above changes offset each other. 191. The return from an investment is calculated by using the formula a. b. d t + (Pt − Pt − 1 ) where dt = dividend in year t; Pt–1 and dt = prices in the years t and t–1 Pt − 1 respectively n ∑ k j pi where ki = ith possible rate of return; pi = Probability associated with the i =1 occurrence of the ith rate of return c. d. Both (a) and (b) above e. 38 Rf + β (Rm – Rf) where Rf = Risk-free rate of return; β = Beta coefficient of the security; Rm = Return from the market portfolio All of (a), (b), and (c) above.
  • 44. Part I 192. The required rate of return calculated as per Capital Asset Pricing Model (CAPM) a. Is the minimum return required by the investor b. Is the same as expected rate of return under equilibrium conditions c. Depends on returns of market portfolio and risk-free rate of return d. All of the above e. CAPM does not define required rate of return. 193. Which of the following does not contribute to systematic risk? a. Change in the interest rates. b. Change in the level of government spending. c. Emergence of a new competitor. d. Change in the industrial policy. e. Both (b) and (d) above. 194. Security Market Line (SML) cuts the Y-axis at a. Expected rate of return on the market portfolio b. Expected rate of return on individual security c. Expected rate of inflation d. Real rate of return on risk-free securities e. Nominal rate of return on risk-free securities. 195. An equity share with beta greater than unity would be called a. A defensive stock, because it is expected to decrease more than the market increases b. An aggressive stock, because it is expected to increase more than the market increases c. A defensive stock, because it is expected to increase more than the market decreases d. An aggressive stock, because it is expected to decrease more than the market increases e. A stock moving against the market. 196. Riskiness of a portfolio is a function of a. Proportions invested in the components b. Riskiness of the components c. Correlation of the returns on the component securities d. All of the above e. Only (b) and (c) of the above. 197. Which of the following will cause an increase in the required rate of return? a. Decrease in inflation. b. Decrease in risk-free rate. c. Increase in interest rate. d. Decrease in risk aversion. e. All of (a), (b) and (c) above. 198. The Security Market Line a. Is also referred to as the Characteristic Line b. Is a graphical representation of the Capital Asset Pricing Model c. Has beta as its slope d. Manifests the relationship between returns on the market and returns on the security e. Measures the behavior of returns overtime. 39
  • 45. Financial Management 199. If the slope of Security Market Line (SML) = 0, which of the following is/are true? a. Expected rate of return is more than the market return. b. Expected return is equal to risk-free rate of return. c. Risk-free rate of return is equal to zero. d. Expected return shall be beta times of the risk aversion. e. Both (a) and (b) of the above. 200. Diversification can eliminate risk if the securities of a portfolio are a. Perfectly positively correlated b. Perfectly negatively correlated c Weakly positively correlated d. Weakly negatively correlated e. Not correlated. 201. Systematic risk of a security is measured by a. Standard deviation b. Variance c. Covariance d. Beta e. Correlation coefficient. 202. Which of the following instances relating to ABC Ltd., do not represent unsystematic risk? a. An open offer for takeover of the company. b. Workers declare strike in the company. c. Company makes a breakthrough in process innovation. d. Introduction of Minimum Alternative Tax. e. Raid on the company for tax evasion. 203. If there is zero correlation among the securities in a portfolio, the resulting graph will be a(n) a. Straight line with a slope of 45 degrees b. Straight line with a negative slope of 45 degrees c. Scattered d. Ellipse e. Hyperbola. 204. Which of the following is an example of systematic risk? a. Risk of non-availability of a major raw material to a company making aluminium bars. b. Death of the finance manager of a company providing financial services. c. Unexpected entry of a multi-national company in the tea industry. d. Reduction of tax rate by the government. e. Sudden strike called by the workers of a jute manufacturing company demanding for the wage revision. 205. Which of the following statements does not involve risk-return trade-off decision? a. b. To improve the paying habit of the customers by framing an attractive credit terms. c. To maximize profits by ensuring the maximum usage of the production facilities. d. To maximize the profit by resorting to debt financing. e. 40 To increase the sales revenue through an aggressive advertisement campaign. None of the above.
  • 46. Part I 206. If a security’s return is plotted above the security market line, then a. The risk free rate is equal to the required rate of return on the security b. The security’s rate of return is more than the return on the market portfolio c. The security’s beta is less than one and hence a conservative security d. The security is said to be overvalued e. The security is to be bought immediately. 207. Which of the following is/are an assumption(s) of CAPM? a. Investors use the expected return and standard deviation of returns as the appropriate measures of return and risk of the portfolios. b. Investors are risk averse. c. Investors agree with each other on the nature of return and the risk associated with each instrument where investment may be made. d. The assets can be bought and sold in any unit as desired by the investors. e. All of the above. 208. If the rates of return from a security move perfectly in tandem with respect to the market returns, then the beta for that security will be a. Equal to 1 b. 0 c. Between 0 and 1 d. Greater than 1 e. Less than –1. 209. Which of the following is an example of non-systematic risk to a firm? a. Volatility of interest rates. b. Sudden increase in the rate of inflation. c. The possibility of the imposition of surcharges by the government to reduce fiscal deficit. d. Sudden scarcity of cement in the market. e. Non-availability of sufficient power supply to overall business sector. 210. If the return on a security lies below the security market line, then a. The security is conservative security b. The security is aggressive security c. The risk free rate of return is more than the expected return from that security d. The security is over priced e. The security is under priced. 211. Which of the following relationships is represented by the Characteristic Regression Line (CRL)? a. The return from an equity share and the variance of its returns. b. The return from an equity share and the return from the market index. c. The return from an equity share and its beta. d. The return from an equity share and the risk free rate of return. e. The return from an equity share and the market risk premium. 41
  • 47. Financial Management 212. What is the significance of the beta coefficient with respect to the risk of a security? a. It indicates the unsystematic risk of the security. b. It indicates the systematic risk of the security. c. It indicates the total risk of the security. d. It indicates the operating risk of the company that has issued the security. e. It indicates the financial risk of the company that has issued the security. 213. Which of the following is an assumption of CAPM? a. The investors are risk lovers. b. The assets can be sold or bought in the lots of 100 units. c. Transaction costs and taxes are of a significant amount. d. Expectations of one investor is not same as that of the another in relation to the expected returns from a security and the risks associated with it. e. The investors considers the expected return and the standard deviation of returns as the criteria for making investment. Valuation of Securities 214. Which of the following is/are not feature(s) of bonds issued by a government agency? a. They are secured. b. They are issued at discount and redeemed at the face value. c. The interest rate can be changed before the maturity of the bond if government wishes so. d. Both (a) and (c) above. e. Both (b) and (c) above. 215. If a 2-year redeemable bond is purchased and held till maturity, the rate of return earned is called a. Coupon rate b. Required rate of return c. Yield to maturity d. Current yield e. Either (b) or (d) above. 216. When the required rate of return is equal to the coupon rate, value of the redeemable bond is equal to its a. Market value b. Face value c. Present value of the stream of interest inflows d. Average of par value and maturity value e. None of the above. 217. When the coupon rate is less than the required rate of return the discount on the bond ____ as maturity approaches. a. b. Increases c. Does not change d. First decreases and then increases e. 42 Decreases First increases and then decreases.
  • 48. Part I 218. Given the maturity, an increase in bond’s yield causes a price decrease that is ___ the price increase caused by an equal size decrease in yield. a. Higher than b. Smaller than c. Equal to d. Greater than or equal to e. Smaller than or equal to. 219. A change in YTM affects those bonds with a higher YTM ____ it affects bonds with a lower YTM. a. Less than b. More than c. Same as d. Either of (a) or (c) above e. Either of (b) or (c) above. 220. An investor would buy a bond if a. The intrinsic value is lower than the market value b. The intrinsic value is higher than the market value c. The current market value is lower than the redemption value d. The current market value is less than the face value e. The required rate of return is equal to coupon rate of interest. 221. Nadir Shah purchases a bond today and sells 6 months before its maturity. The yield realized is known as a. Holding period return b. Current yield if coupon interest is received c. Yield to maturity d. Both (a) and (b) above e. All of (a), (b) and (c) above. 222. For abond held to maturity, YTM is not affected by a. Annual interest payment b. Discount rate c. Redemption value d. Number of years to maturity e. Current market price of the bond. 223. Which of the following statements is false? a. The required rate of return determines the premium or discount on the bond value. b. If the YTM increases the bond’s market price decreases. c. The coupon rate affects the YTM. d. If the market price and face value are equal then coupon rate is more than YTM. e. All of the above. 224. If the coupon rate of bond X is greater than bond Y with the same YTM and maturity a. The bond X’s price will change more than Y for a change in YTM b. The market price of bond Y is more than that of X c. The current yield of both the bonds would be same d. The bond Y’s price would change more than that of X for a change in YTM e. Both (b) and (d) above. 43
  • 49. Financial Management 225. The price of the share will increase if a. The dividend decreases b. The required rate of return increases c. The growth rate increases d. Both (b) and (c) above e. All of (a), (b) and (c) above. 226. Prabhasa Constructions Ltd., is showing a low dividend yield and high price earnings ratio. Then, a. Price of its share is high b. There is growth in the company c. The investors in this share can expect capital gains d. Both (a) and (b) above e. All of (a), (b) and (c) above. 227. The book value approach is criticized because a. It can be established easily b. It values the firm’s share without any future projections c. It is based on accounting figures which can be manipulated d. Both (a) and (b) above e. Both (b) and (c) above. 228. The factor(s) which affect(s) P/E ratio is/are a. Growth rate b. Debt proportion c. Retention ratio d. Quality of management e. All of (a), (c) and (d) above. 229. The coupon rate on a bond is set equal to a. Its yield to maturity b. A percentage of its market price c. A percentage of its maturity value d. A percentage of its par value e. A percentage of its issue price. 230. The amount a company can realize if it sold its business as an operating one is called a. Market value b. Book value c. Replacement value d. Liquidation value e. Going concern value. 231. Which of the following statements is not true? a. Ceteris Paribus, as the expected growth in dividend increases, the expected return depends more on the capital gain yields, and less on dividend yield. b. Ceteris Paribus, the price-earnings ratio increases as the expected growth rate in dividend increases. c. High dividend yield and low price-earnings ratio imply limited growth prospects. d. Low dividend yield and high price-earnings ratio imply low growth prospects. e. Low dividend yield and high price-earnings ratio imply considerable growth prospects. 44
  • 50. Part I 232. Which of the following statements is false? a. When required rate of return (kd) is equal to coupon rate (kc), the value of bond (V) is equal to its par value (F). b. When kd is greater than kc, V is less than F. c. When kd is greater than kc, the discount on bond declines as maturity increases. d. When kd is less than kc, the premium on the bond declines as maturity approaches. e. None of the above. 233. Which of the following statements is false? a. Market value is the amount that a company could realize if it sold its assets after terminating its business. b. Replacement value is the amount required to replace its existing assets in the current condition. c. Going concern value is the amount that a company could realize if it sold its business as an operating one. d. Book value is an accounting concept. e. The difference between the book value of assets and liabilities is equal to shareholder’s funds. 234. Which of the following is true? a. The book value of a company is equal to the historic value of its assets. b. Intangible assets cannot form part of the book value of a company. c. The book value of debt is equal to the outstanding amount of debt. d. The difference between book value of shareholders funds and the liabilities is equal to the book value of the firm. e. Book value is also known as liquidation value. 235. Which of the following statements is false? a. A change in YTM affects a bond with a higher YTM more than a bond with lower YTM. b. For a given difference between YTM and coupon rate, bonds with longer term to maturity will have greater price change. c. A bond’s price moves inversely proportional to YTM. d. For any changes in YTM, the percentage price change in case of bonds of high coupon rate will be smaller than bonds with low coupon rate. e. None of the above. 236. If the maturity of a bond increases, the a. Volatility of the bond decreases b. Volatility of the bond increases c. Volatility remains unaffected d. Change in volatility depends on the required rate of return e. None of the above. 237. When the required rate of return on a bond is less than the coupon rate, then a. The value of the bond is equal to its par value b. The discount on the bond declines as maturity approaches c. The premium on the bond increases as maturity approaches d. The value of the bond is greater than its par value e. The value of the bond is less than its par value. 45
  • 51. Financial Management 238. Which of the following statements is true? a. The intrinsic value of a stock is equal to the discounted value of the stream of future earnings per share. b. The intrinsic value of a stock is equal to the present value of earnings per share plus the net present value of future growth opportunities. c. The intrinsic value of a stock is equal to the present market price per share less the purchase price per share. d. The intrinsic value of a stock is equal to the discounted value of the stream of future dividends per share. e. The intrinsic value of a stock is equal to the market capitalization divided by the number of outstanding shares. 239. Which of the following statements is/are true regarding changes in bond prices? a. The shorter the term to maturity the greater would be the price change with change in yield to maturity. b. With a change in YTM the percentage change in bond prices would be lower in case of high coupon bonds than in the case of low coupon bonds. c. The changes in bond prices move inversely to change in yield to maturity. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. 240. If maturity of bond lengthens, what happens to the volatility of bond? a. Volatility increases. b. Volatility decreases. c. Volatility sometimes increases, sometimes decreases. d. Volatility remains unchanged. e. None of the above. 241. Which of the following is true? a. When the expected price earnings ratio exceeds the actual price earnings ratio of a stock, the stock is overpriced. b. When the expected rate of return is equal to the required rate of return, the stock is correctly priced. c. An overpriced stock should be purchased as it is undervalued. d. All of the above. e. Both (a) and (b) above. 242. When the required rate of return on a bond is greater than the coupon rate a. The premium on the bond declines as maturity approaches b. The discount on the bond declines as maturity approaches c. The value of the bond is greater than its par value d. The greater is its price change, in response to a given change in the required rate of return e. None of the above. 243. In an ever changing scenario of interest rates in the bond market, if discount bonds and premium bonds are sold at the same price, it indicates that a. The bonds have approached maturity b. The YTM = Coupon rate c. The bonds are having the same coupon rate, same maturity value and same face value d. 46 The investors cost of funds are approximately equal e. All of the above.
  • 52. Part I 244. Coupon yield is equal to current yield, if and only if a. The market interest rates are regulated b. The market price of the bond is equal to the face value of the bond c. The bonds are highly volatile d. The market price is more than the par value e. The face value is more than the market value. 245. What is the value of Beta when the required rate of return is 21.4%, the risk free rate is 6% and the market return is 17%? a. 1.2. b. 0.8. c. 1.3. d. 1.4. e. 1.5. 246. Which of the following is true regarding the value of a share? a. The value of a share equals the discounted stream of future earnings per share. b. The value of a share equals the present value of earnings per share plus the net present value of future growth opportunities. c. The value of a share is equal to the present market price per share less the purchase price per share. d. The value of a share equals the discounted stream of future dividends per share. e. The value of a share equals the market capitalization divided by the number of outstanding shares. 247. Which of the following is false regarding the value of a bond? a. The value of a bond varies inversely with the interest rate. b. Bonds of short maturity have less interest rate risk compared to the bonds of long maturity. c. Bonds of high coupon have high interest rate risk compared to small coupon bonds. d. The value of the bond will be equal to face value if the coupon rate is equal to the YTM. e. The discount on the bond decreases as maturity approaches if the coupon rate is less than the interest rate. 248. Yield to maturity of a perpetual bond is equal to a. Interest/Face value b. Interest/Market price c. Interest/Average of face value and market price d. Interest rate e. (Interest + Annual Redemption)/Average Investment. 249. Which of the following statements is/are true regarding bond value theorems? i. When the required rate of return is greater than the coupon rate, the premium on the bond increases as maturity approaches. ii. For a given difference between yield to maturity and coupon rate, the longer the term to maturity, greater will be the change in price with the change in yield to maturity. iii. The effect of a change in yield to maturity on the price of the bond is more in case of lower yield bonds than in bonds with higher yields. a. Only (i) above. b. Only (ii) above. c. Both (i) and (ii) above. d. Both (ii) and (iii) above. e. Both (i) and (iii) above. 47
  • 53. Financial Management 250. Which of the following is most likely to result in a higher P/E ratio for a firm, other things being equal? a. Lower growth rate in dividends. b. Reduction in the stock’s required rate of return. c. Lower dividend yield. d. Lower stock price. e. Higher cost of insolvency. 251. Which of the following statements is correct regarding cash dividends on common stocks? a. Dividend payments are guaranteed. b. Dividends are the only form of return on investment. c. Low dividend yields indicate out of favor stocks. d. Dividend yields are based on current stock price. e. None of the above. 252. The value of common stock is likely to decrease if a. Investment horizon decreases b. The growth rate of dividends increases c. The discount rate increases d. Dividends are discounted back to present e. Dividends pay-out ratio remains constant. 253. The “g” in the constant-growth dividend discount model refers to i. The annual growth rate of dividends ii. The annual growth rate of stock price iii. The annual growth rate of earnings per share a. Only (i) above. b. Only (ii) above. c. Both (i) and (ii) above. d. Both (i) and (iii) above. e. All of (i), (ii) and (iii) above. 254. Which risk is associated with a particular security traded on the secondary market? a. Interest rate risk. b. Market risk. c. Liquidity risk. d. Financial risk. e. Both (b) and (c) above. 255. Given the difference between YTM and coupon rate a. b. The shorter the term to maturity the greater will be the change in price with change in YTM. c. The longer the term to maturity the greater will be the change in price with change in YTM. d. The term to maturity does not influence the change in price for any change in YTM. e. 48 The longer the term to maturity the lesser will be the change in price with change in YTM. The term to maturity influences the change in price for any change in YTM in an unpredictable manner.
  • 54. Part I 256. Which of the following is an external factor that influences the intrinsic value of a stock? a. Earning power and profitability of the operations. b. Dividends paid and payable in future. c. Growth in earnings over time and expectations of the same in future. d. Quality of management. e. Growth rate of the industry to which the company belongs. 257. Current yield of a bond equals a. Coupon rate when the price of the bond is greater than the face value of the bond b. Coupon rate when the price of the bond is less than the face value of the bond c. Coupon rate when price of the bond is equal to the face value of the bond d. Yield to maturity (ytm) when the price of the bond equals the face value of the bond e. Both (c) and (d) above. 258. Other things being equal, which of the following will cause an increase in the value of a bond? a. Decrease in the term to maturity. b. Increase in the required rate of return on maturity. c. Decrease in the discount on the bond on issue. d. Increase in the premium on maturity of the bond. e. Decrease in the coupon rate of the bond. 259. Which of the following is/are false when the required rate of return on a bond is more than the coupon rate? i. The discount on the bond decreases as the maturity approaches ii. The market value of the bond is less than its par value iii. The premium on the bond decreases as the maturity approaches a. Only (i) above b. Only (ii) above c. Only (iii) above d. Both (i) and (ii) above e. Both (ii) and (iii) above. 260. Which of the following is not true with regard to the warrants issued by a company? a. It is a call option to buy certain number of shares of the company that issued the same. b. The warrant holder is entitled to receive dividends. c. The warrant holder may sell the warrant at any point of time prior to the exercise date. d. Warrants are generally issued with an objective to sweeten the public offer. e. All are the above. 261. Which of the following is not true with regard to the multi period valuation model of equity shares? a. There is a pre-specified maturity period. b. The value of an equity share is equal to the present value of its entire dividend stream. c. The model can be applied to the instances of constant dividends and constant growth in dividends. d. The model can also be applied in case of variable growth in dividends. e. The cost of equity of the company can vary from time to time. 49
  • 55. Financial Management 262. Which of the following factors, other things remaining the same, will decrease the bond value? a. Increase in coupon rate. b. Decrease in the yield of the bond. c. Increase in maturity premium. d. Increasing the term of the bond. e. Increase in the yield of the bond. 263. The amount that a company may realize if it sells its business after having terminated the same is called a. Going concern value b. Book value c. Market value d. Liquidation value e. Replacement value. 264. Which of the following statements is true, if the required rate of return from a bond is more than the coupon rate? a. The intrinsic value of the bond is more than the par value of the bond. b. The intrinsic value of the bond is less than the par value of the bond. c. The discount on the bond increases as the maturity approaches. d. The discount on the bond decreases as the term to maturity increases. e. The premium on the bond decreases as the maturity approaches. 265. Which of the following factors are to be considered in the valuation of the equity shares of a company through price-earning ratio approach? a. Book value of the assets of the company. b. Liquidation value of the assets of the company. c. Growth rate of the earnings. d. Number of equity shareholders. e. Whether preference shares have been issued by the company. Financial Statement Analysis 266. Long-term solvency is indicated by a. Liquidity Ratio b. Debt-equity Ratio c. Interest Coverage Ratio d. Return on Capital Employed e. Both (b) and (d) above. 267. Current ratio is chiefly used to assess the a. b. Application of debt c. Liquidity position d. Levels of inventory piled up in different forms e. 50 Effective utilization of capital Prompt payment of long-term liabilities.
  • 56. Part I 268. Which of the following indicates the Debt-Service Coverage Ratio (DSCR) of 1.5 of a firm? a. The total obligations (i.e. interest plus repayment on the long-term loan) of the firm are 1.5 times its PBDIT. b. The total obligations are 1.5 times its PAT. c. The post-tax cash earnings are 1.5 times its total obligations. d. The post-tax earnings after depreciation are 1.5 times its total obligations. e. The total obligations are 1.5 times the equity earnings. 269. Which of the following is/are false statement(s) regarding common-size analysis? a. It is used for comparing performance of a company in one year with that of another year. b. The industry average is compared with the performance of a company. c. All items in the financial statements are expressed as percentages of the respective totals. d. Both (a) and (c) above. e. Both (b) and (c) above. 270. A fixed charges coverage ratio of 4 signifies a. Pre-tax operating income is 4 times all fixed financial obligations b. Post-tax income plus depreciation is 4 times all financial obligations c. Pre-tax income before lease rentals is 4 times all fixed financial obligations d. Post-tax income less preference dividends is 4 times all fixed financial obligations e. Post-tax income plus debt interest and lease rentals is 4 times all fixed financial obligations. 271. Which of the following statement(s) is/are true? a. Average collection period evaluates all aspects of credit policy. b. All other things remaining the same, issue of new shares for cash will improve the current ratio. c. Ratio analysis is technique of planning and control. d. Both (a) and (c) above. e. All of (a), (b) and (c) above. 272. If a firm has realized its debtors and has paid-off its creditors to the same extent then a. The current ratio will increase if it was less than 1 previously b. The current ratio will decrease if it was more than 1 previously c. The current ratio will increase if it was equal to 1 previously d. Both (a) and (c) above e. All of (a), (b) and (c) above. 273. Receivables turnover ratio of 10 means a. The net credit sales for the year are 10 times the average receivables b. Receivables are generated 10 times during the year c. It takes 36 days to collect credit sales on an average d. Both (a) and (c) above e. All of (a), (b) and (c) above. 274. If the realized collection period is more than the terms of trade, it can be said that a. The collection job is poor b. The quality of debtors is poor c. The average daily sales are low d. Both (a) and (b) above e. All of (a), (b) and (c) above. 51
  • 57. Financial Management 275. Low assets turnover may indicate a. Low assets b. High costs of maintenance c. Idle assets d. Higher sales e. Both (b) and (c) above. 276. A gross profit margin ratio may not indicate a. Earning power b. The efficiency of production c. The efficiency of pricing d. The gap between net sales and cost of goods sold e. The balance left to meet the administration and financing expenses. 277. The long-term solvency positions are measured by a. Coverage ratios b. Earnings ratios c. Structural ratios d. Both (a) and (c) above e. Both (a) and (b) above. 278. Dividend Pay-out Ratio is a. A ratio between dividend paid and the number of equity shares b. DPS divided by EPS c. A ratio between PAT and the dividend paid d. The percentage of equity earnings over EBIT e. EPS divided by DPS. 279. Which of the following would affect the dividend yield directly? a. Retention ratio. b. Book value per share. c. Face value of a share. d. The cost of equity capital. e. Debt-equity ratio. 280. While doing the time series analysis you found that the ROE is decreasing. Which of the following may be a probable reason? a. The net profit margin is increasing. b. Assets turnover is decreasing. c. The debt assets ratio is decreasing. d. Both (a) and (b) above. e. Both (b) and (c) above. 281. Which of the following is/are the problem(s) encountered in financial statement analysis? a. b. Window dressing. c. Price level changes. d. Interpretation of results. e. 52 Development of benchmarks. All of the above.
  • 58. Part I 282. Equity multiplier is defined in Du Pont Analysis as a. EPS/Market price of shares b. EPS/Book value of shares c. PAT/Net worth d. Average assets/Average equity e. None of the above. 283. Which of the following statements is true? a. The income statement of a firm shows the value of its assets and liabilities over a specified period of time. b. The difference between the current and quick ratio is that inventory has been subtracted from current liabilities. c. The net working capital of a firm will increase when accrued wages are paid with cash. d. The lower the times interest coverage ratio, the lower is the interest expense. e. Other things being equal, a decrease in average accounts receivable will increase the firm’s return on assets. 284. A common size balance sheet portrays the firm’s accounts as a percent of the a. Industry’s assets b. Firm’s net income c. Firm’s total assets d. Strongest competitor’s assets e. Current assets. 285. An asset’s liquidity measures a. Its potential for generating a profit b. Its usefulness to the corporation c. Its ease and cost of being converted into cash d. Its proportion of equity financing e. Its proportion of debt financing. 286. The current ratio is the ratio of a. Current assets to total assets b. Current liabilities to total liabilities c. Current assets to current liabilities d. Current liabilities to equity e. Current assets to fixed assets. 287. If the current ratio is less than 1 then it can be definitely said that a. The net working capital is negative b. The net working capital is positive c. The inventories are inadequate d. The current assets other than inventories are inadequate e. Cash in hand is inadequate. 53
  • 59. Financial Management 288. 1 year = 365 days. The expression a. Receivables turnover ratio b. Average collection period c. Quick ratio d. Current ratio e. Average Receivable x 365 is known as Annual Credit Sales Leverage ratio. 289. If the debt-equity ratio of a company is 2:1 then it can be understood that for every a. 2 rupees of equity there is 1 rupee of debt b. 2 rupees of total assets there is 1 rupee of equity c. 3 rupees of total assets there is 1 rupee of debt d. 3 rupees of total assets there are 2 rupees of debt e. 3 rupees of debt there are 2 rupees of equity. 290. Which of the following statements is true? a. Liquidity implies a firm’s ability to pay its debt in the long run. b. Working capital gap is equal to current assets plus total current liabilities. c. The number of days it takes to collect accounts receivables is known as average collection period. d. Lesser the inventory turnover ratio, higher the efficiency of inventory management. e. PE ratio is one of the most important profitability ratios. 291. How does financial statement analysis help in understanding financial statements? a. Window dressing. b. Price level changes. c. Correlation among ratios. d. Differences in accounting policies. e. None of the above. 292. Working capital gap a. Shows the degree of the firm’s reliance on long-term bank finance b. Shows the degree of the firm’s reliance on shareholders funds c. Is equal to current assets less current liabilities other than bank borrowings d. Is equal to the total current assets e. Is equal to current assets less current liabilities plus bank borrowings. 293. Which of the following is an efficiency ratio? a. Asset turnover ratio. b. Fixed charges coverage ratio. c. Accounts receivable turnover. d. Price-earnings ratio. e. Debt-service coverage ratio. 294. Capitalization rate is calculated as a. Total assets-to-debt ratio b. Market price of the share to earnings per share c. Earning per share to book value of the shares d. 54 Earning per share to market price of the shares e. Total assets-to-equity ratio.
  • 60. Part I 295. An interest coverage ratio of 2.25 indicates that a. EBIT is 2.25 times the interest payable b. EBT is 2.25 times the interest payable c. EAT is 2.25 times the interest payable d. Retained earnings are 2.25 times the interest payable e. None of the above. 296. Which of the following is a liquidity ratio? a. Debt-equity ratio. b. Dividend pay-out ratio. c. Net profit margin. d. Interest coverage ratio. e. Acid test ratio. 297. Which of the following is/are not a liquidity ratio? a. Current ratio. b. Quick ratio. c. Average collection period. d. Bank finance to working capital gap ratio. e. Both (c) and (d) of the above. 298. Earnings Per Share (EPS) is equal to a. Profit before tax/No. of outstanding shares b. Profit after tax/No. of outstanding shares c. Profit after tax/Amount of equity share capital d. Profit after tax/Net worth e. Profit after tax less equity dividends/No. of outstanding shares. 299. Current ratio indicates a. Amount of cash with the company b. Amount of current assets out of total assets of the company c. Capacity to meet current liabilities d. Ability to repay debt installments e. None of the above. 300. Which of the following is not considered while determining the appropriate P/E ratio for a firm? a. Industry growth rate. b. Book value to earnings per share ratio. c. Stability of earnings. d. Size of the company. e. Dividend pay-out ratio. 301. Which of the following is/are true regarding common size analysis? a. It states items in the balance sheet as percentages of total assets. b. It expresses items in balance sheet as an index relative to the base year. c. It is the same as time series analysis. d. It is done to find the intrinsic value of the company’s stock. e. Both (a) and (c) above. 55
  • 61. Financial Management 302. Days’ Sales Outstanding a. Is the ratio of receivables outstanding to average daily sales b. Is similar to the Average Collection Period c. If higher, indicates an efficient credit policy d. Both (a) and (b) above e. Both (a) and (c) above. 303. A high inventory turnover ratio a. Could mean that inventory could have increased even when net sales remained constant b. Is generally an indicator of efficient inventory management c. Could also be an indicator of over trading d. All of the above e. Only (b) and (c) above. 304. When current assets and current liabilities increase by the same amount a. The current ratio remains the same b. The current ratio increases, if it is greater than 1 c. The current ratio decreases, if it is greater than 1 d. The current ratio becomes 1:1 e. None of the above. 305. The basic ratio for measuring the firm’s ability to meet its interest charges is the a. Cash flow coverage ratio b. Interest coverage ratio c. Debt service coverage ratio d. Acid test ratio e. None of the above. 306. The starting point of Du Pont chart is a. Return on equity b. Return on investment c. Return on total assets d. Return on fixed assets e. None of the above. 307. Return On Investment (ROI) and Return On Equity (ROE) are exactly 0.25. This indicates that a. ROE has been calculated wrongly b. ROI pertains to the previous year c. The firm has no debt in their capital structure d. The firm does not pay income taxes e. Both (c) and (d) of the above. 308. The market value to book value ratio is 2. This indicates that a. b. There is heavy speculation in the market c. The firm has doubled the wealth of the shareholder d. The net wealth of shareholder is reduced to half e. 56 The book value is understated Accounts are not being maintained properly.
  • 62. Part I 309. In the Du Pont chart the left apex term is a. Earnings Per Share (EPS) b. Return on equity c. Net profit to total assets d. Operating profit before interest and taxes to total assets e. Net profit margin. 310. The use of debt in a project increases ROE if the firm a. Has more outside liabilities than equity b. Has more assets than equity c. Pays more taxes than interest d. Has an asset turnover more than 2 e. Earns higher return than the rate of interest on debt. 311. Interest coverage ratio of 6 indicates a. Sales are 6 times of interest b. Profit after tax is 6 times of interest c. Profit before tax is 6 times of interest d. Earning before interest and taxes is 6 times of interest e. Profit after tax is equal to 1/6 th of interest. 312. In the context of financial statements analysis, cross-sectional analysis involves comparison between a. Two divisions of a company b. Historical and current data c. A company and its competitor d. A company and the industry e. None of the above. 313. Earning Power measures the a. Profitability of equity funds invested in the firm b. Operating performance of the firm c. Efficiency of production as well as pricing d. Efficiency of fixed assets employed e. Efficiency of total assets employed. 314. The current ratio and quick ratio of BCC Ltd. are nearly the same. This suggests that a. The company has got a sizeable investment in inventory b. The liquidity position of the company is unclear c. The company has got a low investment in inventory d. The quick assets of the company are low e. The company is a highly profitable one. 315. The leverage ratio used in ROE analysis is a. Sales ratio b. Profit margin c. Total assets to net worth d. Tangible net worth to total assets e. Long-term debt to equity ratio. 57
  • 63. Financial Management 316. Which of the following is/are true with respect to earning power? a. It measures operating profitability of the firm. b. It measures the efficiency of the capital employed. c. It is not influenced by the financial structure of the firm. d. All of (a), (b) and (c) above. e. Both (a) and (c) above. 317. Earnings per share divided by book value is equal to a. Net worth b. Return on equity c. Net profit d. Net worth/Net profit e. Reciprocal of return on equity. 318. For assessing the future market value of a company, it is best to depend on a. Turnover ratios b. Earnings ratios c. Efficiency ratios d. Profitability ratios e. Liquidity ratios. 319. Dividend yield is equal to a. Dividend Rate b. Dividend per share/Face value of the share c. Dividend per share/Earnings per share d. Dividend per share/Retained earnings per share e. Dividend per share/Market value per share. 320. Which of the following is a liquidity ratio? a. Return on equity. b. Return on investment. c. Acid-test ratio. d. Debt-equity ratio. e. Debt-asset ratio. 321. In common size analysis the items in the income statement are expressed as percentage of a. Total assets. b. Net sales. c. Total expenses. d. Gross sales. e. Total fixed assets. 322. Which of the following ratios indicates the capital structure? a. b. Inventory turnover ratio c. Total asset turnover ratio d. Return on equity e. 58 Debt-assets ratio Return on assets.
  • 64. Part I 323. Which of the following ratios indicates the ability of a firm to service the financial charges? a. Dividend pay-out ratio. b. Fixed charges coverage ratio. c. Net profit margin ratio. d. Inventory turnover ratio. e. Acid test ratio. 324. In which of the following situations, price earnings ratio is applied? a. To determine the financial risk of a business entity. b. To determine the expected market value of the shares of a company. c. To assess the earning potential of a company in the near future. d. To examine the operational efficiency of a company. e. To check how efficiently the assets are utilized by a firm. 325. How can a company lower its debt-to-total assets ratio in its capital structure? a. Borrowing more funds from the market by issuing debentures. b. Using short-term funds against the fixed assets of longer life. c. Using long-term funds against the current assets of the company. d. Planning for a rights issue. e. Borrowing more funds from the financial institutions. 326. The reserves and surplus at the base year is set at 100 percent whereas for the subsequent years, it may be less than or more than 100 percent. Which types of analysis is supposed to be carried out? a. Cross-sectional analysis. b. Year-to-year change analysis. c. Index number trend analysis. d. Common size analysis. e. Expected annual income analysis. 327. A cement manufacturing company has a debt-to-equity ratio of 1.6 compared with the industry average of 1.4. This means that the company: a. Will never experience any difficulty with its creditors b. Has more borrowing capacity than the other companies in the industry c. Will be viewed as having high creditworthiness d. Has greater than average financial risk when compared to companies in the same industry e. Has a better ability to meet its financial commitments towards its stakeholders. 328. High asset turnover ratio indicates a. Large amount of investment in the fixed assets b. Large amount of investment in the current assets c. Large amount of sales value in comparison to total assets d. Inefficient utilization of the assets e. High debt-equity ratio. 329. A 15% debenture of face value Rs.100 of 8 years to maturity is trading at a premium of 9%. Realized amount Rs.95 and tax rate is 40%. What is the yield? a. 10.21%. b. 10.44%. c. 10.76%. d. 10.54%. e. 10.12%. 59
  • 65. Financial Management 330. Which of the following methods of financial statement analysis is based on the interrelationships among various components of the financial statements? a. Common size analysis. b. Time series analysis. c. Index analysis. d. Du Pont analysis. e. Cross-sectional analysis. 331. In which of the following methods of financial statement analysis, the items in the income statement are expressed as percentages of total sales? a. Common size analysis. b. Time series analysis. c. Index number trend analysis. d. Du Pont analysis. e. Cross-sectional analysis. Funds Flow Analysis 332. The meaning of “fund” in funds flow statement is a. Cash b. Net working capital c. Gross working capital d. Profit e. Either (a) or (b) above. 333. Which of the following change(s) does/do not appear in a Cash Flow Statement? a. Issue of equity shares. b. Conversion of all FCDs into equity shares. c. Bonus issue of equity shares. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. 334. Which of the following is true with respect to sources and uses of funds? a. Depreciation and decrease in NWC are sources of funds. b. Depreciation and decrease in NWC are uses of funds. c. Depreciation is a source of fund but decrease in NWC is a use of fund. d. Depreciation is a use of fund but decrease in NWC is a source of fund. e. Depreciation and increase in NWC are uses of funds. 335. Which of the following is true? a. Depreciation is a use of funds. b. Increase in liability is a source. c. Decrease in an asset, other than cash is a use. d. Increase in bills payable is a use. e. Increase in equity is a use. 336. Which of the following items represent potential use of funds? a. b. Dividend proposed and not yet declared. c. Sale of trade marks and patent rights. d. Net loss from operations. e. 60 Sale of land and building at loss. Amortization of goodwill.
  • 66. Part I 337. Which of the following represents cash from operations? a. Net profit + non-cash expenses. b. Net profit + decrease in current liabilities. c. Net profit + increase in current assets. d. Net profit. e. Earnings before interest, depreciation and tax + decrease in current assets. 338. Which of the following is/are true regarding funds flow statement? a. Amortization of preliminary expenses is a use of funds. b. Increase in provision for taxation decreases working capital. c. Cash or credit sales at a profit increases the working capital. d. Both (a) and (b) above. e. Both (b) and (c) above. 339. Which of the following is a source of fund? a. Increase in cash. b. Increase in accrued expenses. c. Decrease in reserve. d. Dividend payment. e. All of the above. 340. Which of the following is not a use of funds? a. Increase in Fixed Assets. b. Buy-back of shares. c. Decrease in working capital. d. Increase in depreciation. e. Both (c) & (d) only. 341. Which of the following is not a benefit of funds flow statement analysis for an organization? a. Detection of imbalances. b. Divisional performance appraisal. c. Evaluation of firm’s financing. d. Evaluation of the quality of firm’s top management. e. Planning of future financing. 342. Which of the following is not a method of sales forecasting? a. Jury of Executive Opinion. b. Sales force estimate. c. Trend analysis via extrapolation. d. Ratio analysis. e. Regression analysis. 343. Which of the following assumptions is true while calculating the external funds requirements? a. The assets of the firm will increase proportionately to cost of goods sold. b. Net profit margin will increase at a constant rate. c. Dividend pay-out ratio and debt-equity ratio will remain constant. d. External issue of equity will be resorted to. e. Net profit margin will increase at an increasing rate. 61
  • 67. Financial Management 344. Which of the following is a source of working capital in a funds flow statement drawn on working capital basis? a. Net Income. b. Dividends. c. Taxes. d. Increase in short-term loans. e. Decrease in receivables. 345. Which of the following is a source of cash in a funds flow statement drawn on cash basis? a. Dividend payment. b. Increase in fixed assets. c. Increase in receivables. d. Repayment of short-term bank loan. e. Depreciation. 346. Which of the following is not an item of current liabilities? a. Sundry creditors. b. Hire purchase dues. c. Fixed deposit made for 18 months. d. Unclaimed dividends. e. Advances from customers. 347. Which of the following is not a source of funds? a. Increase in owner’s equity. b. Decrease in plant and machinery. c. Payment of dividends. d. Decrease in debtors. e. Sale of investments. 348. Which of the following will not result in an increase in net working capital? a. Increase in cash. b. Decrease in creditors. c. Decrease in bank borrowings. d. Decrease in inventory. e. Decrease in bills payable. 349. Which of the following is not a source of fund? a. Increase in share capital. b. Increase in working capital. c. Increase in a long-term liability. d. Increase in profits. e. Increase in depreciation. 350. An increase in which of the following is considered as a source of funds while preparing funds flow statement on a working capital basis? a. b. Increase in working capital. c. Repayment of a term loan. d. Purchase of fixed assets. e. 62 Issue of share capital. None of the above.
  • 68. Part I 351. Which of the following appears as a use in a funds flow statement? a. Taxes. b. Increase in equity. c. Increase in long-term loans. d. Decrease in fixed assets. e. Decrease in working capital. 352. Which of the following is a use of funds? a. Decrease in current liabilities. b. Increase in current assets. c. Increase in cash. d. All of the above. e. Both (a) and (c) of the above. 353. Which of the following is not a source of fund? a. Increase in profits. b. Increase in liabilities. c. Increase in share capital. d. Increase in assets. e. Increase in depreciation. 354. Which of the following sources/uses of funds is not considered while preparing funds flow statement on a working capital basis? a. Issue of share capital. b. Payment of dividend. c. Depreciation. d. Purchase of fixed assets. e. Purchase of raw materials. 355. Which of the following increases the cash flow from operations? a. Increase in debtors. b. Increase in inventory. c. Decrease in prepaid expenses. d. Decrease in income tax paid in advance. e. Both (c) and (d) above. 356. Which of the following alternatives result(s) in an increase in working capital? a. Issue of bonus shares. b. Issue of equity shares. c. Conversion of debentures to equity. d. Both (a) and (c) above. e. All of (a), (b) and (c) above. 357. Which of the following can be considered as a use of cash? a. Increase in provisions. b. Increase in prepaid expenses. c. Increase in taxes due, but not paid. d. Decrease in investments. e. Decrease in current assets. 63
  • 69. Financial Management 358. Which of the following is not shown by a funds flow statement on cash basis? a. The sources of cash. b. The uses of cash. c. Decrease in cash . d. The net change in working capital. e. Increase in cash. 359. Which of the following is true with respect to funds flow statement of a company? a. It helps to judge the quality of management. b. It shows whether the ownership pattern of the business entity has been changed. c. It cannot be manipulated by the unscrupulous promoters. d. It fails to identify the operational ineffectiveness in a business entity. e. It identifies whether short-term fund is used for the procurement of long-term asset. 360. Which of the following statements shows the source of funds while making funds flow analysis on total resources basis? a. Retirement of high cost debt. b. Installation of a capital asset. c. Conversion of debentures into equity shares. d. Selling an old car today in order to buy a new one after three months. e. Buying back the equity shares. 361. Which of the following is not a source of fund in a funds flow statement on cash basis? a. A gross decrease in fixed assets. b. A gross increase in fixed assets. c. A net increase in current liabilities. d. Sale of any fixed asset. e. Funds from the operations. 362. Which of the following is not a use of funds flow analysis for an organization? a. Planning for the future financing strategy. b. Identification of imbalances with respect to the sources and uses of funds. c. Divisional performance appraisal. d. Assessment of the firm’s financing. e. Assessment of the market leadership for the products of the company. 363. Which of the following statements is/are true with respect to funds flow statement? a. It shows the changes in the ownership patterns of the company. b. It shows the sources and uses of funds at any particular date in a year. c. It can be considered as a snapshot picture for the operations of the business. d. It cannot be manipulated by means of window dressing. e. It indicates how the business financed its fixed assets. 364. A funds flow statement is also known as a. b. Profit and loss statement c. Income statement d. Proforma statement e. 64 Balance sheet Statement for the changes in financial position.
  • 70. Part I Leverage 365. Degree of total leverage can be applied in measuring change in a. EBIT to a percentage change in quantity b. EPS to a percentage change in EBIT c. EPS to a percentage change in quantity d. DFL to a percentage change in DOL e. Quantity to a percentage change in EBIT. 366. DFL becomes zero when a. The firm does not have to pay any tax b. EBIT is just equal to the sum of interest and dividend components c. The firm does not earn any operating profit d. The interest component equals the preferred dividend e. DFL will never become zero. 367. The firm is now operating at the BEP. Then a. The DTL will increase if the quantity produced increases b. The DTL will be negative if the quantity increases c. The DTL will start decreasing as the quantity increases d. The DTL will not be affected by quantity unless the fixed costs also change e. The DTL at the BEP is undefined. 368. The measure of business risk is a. Operating leverage b. Financial leverage c. Total leverage d. Working capital leverage e. Debt-equity ratio. 369. The value of EBIT at which EPS is equal to zero is known as a. Break even point b. Financial break even point c. Operating break even point d. Overall break even point e. None of the above. 370. Which of the following is not a leverage ratio? a. Debt-asset ratio. b. Debt-equity ratio. c. Debt service coverage ratio. d. Fixed charges coverage ratio. e. Bank finance to working capital gap ratio. 371. Degree of financial leverage is a measure of relationship between a. EPS and EBIT b. EBIT and quantity produced c. EPS and quantity produced d. EPS and sales e. EPS and interest payment. 65
  • 71. Financial Management 372. Operating leverage examines a. The effect of the change in the quantity on EBIT b. The effect of the change in EBIT on the EPS of the company c. The effect of the change in output to the EPS of the company d. The effect of change in EPS on the output of the company e. The effect of change in EPS on the EBIT of the company. 373. Which of the following statements is not true? a. Each level of EBIT has a distinct DFL. b. DFL is undefined at financial breakeven point. c. DFL will be negative when the EBIT level goes below the financial breakeven point. d. DFL will be positive for all values of EBIT that are above the financial breakeven point. e. DOL (Degree of Operating Leverage) is undefined at level of output below the financial breakeven point. 374. Which of the following is the expression for operating leverage? a. Contribution/EBIT. b. EBT/Contribution. c. Contribution/EAT. d. Quantity/EBIT. e. Contribution/Quantity. 375. Which of the following statements regarding Degree of Financial Leverage is false? a. Each level of EBIT has a distinct DFL. b. DFL is undefined at financial break-even point. c. DFL is negative when EBIT is below financial break-even point. d. DFL starts declining as EBIT increases. e. With the help of DFL one can understand the impact of the change in output on EBIT of the company. 376. Which of the following statements is true? a. Degree of Total Leverage (DTL) measures the changes in EPS to a unit percentage change in EBIT. b. DTL measures the total risk of the company. c. DTL measures the variability of EBIT for a given error in forecasting the total quantity sold. d. The sum of operating and financial leverage is called total leverage. e. The DTL is equal to one at the overall break-even point of output. 377. If the degree of operating leverage is 2 and the degree of financial leverage is 1.5, it means that a. 1% change in sales will result in 1.5 percent change in EBIT b. 1% change in EBIT will result in 2% change in EPS c. 1% change in EPS will be caused by 3.5% change in sales d. 1% change in EPS will be caused by 3% change in EBIT e. 1% change in sales will result in 3% change in EPS. 378. If DOL represents degree of operating leverage and DFL represents degree of financial leverage, degree of total leverage can be defined as a. DOL + DFL b. DOL – DFL c. DOL × DFL d. DOL/DFL e. None of the above. 66
  • 72. Part I 379. Which of the following statements is false about financial leverage? a. It measures the effect of change in EBIT on the EPS. b. Each level of EBIT has a distinct DFL. c. At financial break even point DFL is zero. d. If EBIT is less than the financial break even point, DFL will be negative. e. If EBIT is more than the financial break even point, DFL will be positive. 380. Which of the following statements is true if the Degree of Financial Leverage (DFL) of a firm is zero? a. The firm does not pay preference dividend. b. The firm does not pay taxes. c. The firm does not pay interest. d. The EBIT of the firm is zero. e. None of the above. 381. Which of the following is/are true regarding the Degree of Operating Leverage (DOL)? a. Each level of output has a unique DOL. b. DOL is undefined at operating break even point. c. DOL is positive beyond the operating break even point. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. 382. If we observe the behavior of DOL, in general, we find the following a. Unique DOL for each level of output. b. DOL is well defined at operating break even point. c. DOL is positive beyond the operating break even point. d. Both (a) and (b) above. e. Both (a) and (c) above. 383. Operating Leverage is the response of changes in a. EBIT to the changes in sales b. EBIT to the changes in selling price c. EPS to the changes in EBIT d. Production to the changes in sales e. None of the above. 384. Operating Leverage a. Exists because of the presence of fixed expenses like interest payments b. Measures the responsiveness of earnings per share to variability in earnings before interest and taxes c. Is undefined at the operating break even point d. All of the above e. None of the above. 385. The operating break even point a. Is that point below which the degree of financial leverage is negative b. Is that quantity produced and sold at which the profit after tax is zero c. Is that value of earnings before interest and taxes at which earnings per share is zero d. Is that quantity produced and sold at which the profit before interest and taxes is zero e. Both (a) and (d) above. 67
  • 73. Financial Management 386. The use of preference share capital as against debt finance a. Reduces DFL b. Increases DFL c. Increases financial risk d. Has no effect on either financial risk or financial leverage e. Both (a) and (c) above. 387. Which of the following is true of the Degree of Operating Leverage (DOL)? a. DOL is negative beyond the operating break even point, implying that an increase in the quantity sold leads to a decrease in EBIT. b. DOL is positive beyond the operating break even point and as the level of quantity increases, DOL will also increase. c. DOL is undefined at the operating break even point. d. All of the above. e. Both (b) and (c) above. 388. When the firm changes the technology leading to increase in fixed costs, it a. Increases DOL b. Decreases DOL c. Decrease operating break even point d. Loses all abandonment value e. Decreases DFL. 389. The Degree of Financial Leverage (DFL) a. Measures financial risk of the firm b. Is zero at financial break even point c. Increases as EBIT increases d. Is undefined below financial break even point level e. Both (a) and (d) above. 390. Operating leverage measures the sensitivity of the ____________ to changes in quantity. a. Earnings per share b. Profit after tax c. Earnings before interest and taxes d. Profit before tax e. Dividend per share. 391. If Degree of Financial Leverage (DFL) becomes zero, then a. The firm does not pay preference dividend b. The firm does not pay taxes c. The firm does not pay interest d. The firm does not earn any operating profit e. Both (b) and (d) above. 392. The degree of operating leverage below the operating break even point will be a. b. 0 c. Less than zero d. Either (b) or (c) e. 68 1 Undefined.
  • 74. Part I 393. If the output is less than the operating break-even point, then the degree of operating leverage will be a. Greater than 1 b. Less than –1 c. Equal to Zero d. Less than Zero e. None of the above. 394. Which of the following is true with regard to the Degree of Operating Leverage (DOL) for a company? a. Irrespective of the level of output, DOL of a company remains same. b. DOL of a company is positive above the operating break-even point. c. DOL of a company is positive below the operating break-even point. d. DOL of a company is negative above the operating break-even point. e. DOL is zero at the operating break-even point. 395. Which of the following is true with regard to the Degree of Financial Leverage (DFL)? a. DFL helps to measure the business risk of any corporate entity. b. DFL can be used to analyze the implications of retiring debts by using the proceeds of preference capital. c. DFL is applied by a corporate house for its production and sales planning. d. DFL is used to estimate the revised EPS following a change in sales volume. e. DFL is used assess the change in EBIT owing to any change in sales volume. 396. At operating break-even point, which of the following is true? a. Sales revenue just covers the fixed cost. b. Sales revenue is just equal to the variable cost. c. Fixed cost is same as that of the variable cost. d. EBIT is zero. e. EBIT is positive. 397. Other things remain the same, what will be the impact on the Degree of Operating Leverage (DOL) of a firm, if it issues equity shares in lieu of debentures? a. DOL will increase. b. DOL will decrease. c. DOL will remain the same. d. DOL will become zero. e. Cannot be predicted. 398. Which of the following results from the early repayment of the debenture capital by a firm? a. The degree of operating leverage increases. b. The degree of operating leverage decreases. c. The degree of financial leverage increases. d. The degree of financial leverage decreases. e. The degree of total leverage remains unchanged. 69
  • 75. Financial Management 399. If the degree of total leverage of a firm is zero, then which of the following statements will always be valid? a. The firm does not produce and sale any output. b. The firm does not have any interest burden in a strict sense. c. The firm has never issued any preference share. d. The firm does not bear any fixed cost burden. e. The contribution is zero. 400. Which of the following is true with respect to the Degree of Operating Leverage (DOL)? a. DOL is same for any level of output of the firm. b. DOL is well defined at the operating break-even point. c. DOL measures the business risk of a company. d. DOL assesses the impact on the profitability of the company against the changes in the interest rate. e. Using the concept of DOL, one may judge the possibility of committing default by a company with respect to the payment of interest. 401. If a company appoints a number of skilled managers with a very high amount of compensation package, which of the following conditions may occur immediately after the appointment? a. The operating break-even point of the company will come down. b. The company will be able to reach the financial break-even point easily. c. The degree of operating leverage will be zero. d. The degree of total leverage will reduce to zero. e. The degree of total leverage will increase. 402. What will be impact on the operating leverage of a firm, if it proceeds for additional borrowings? a. It will increase. b. It will decrease. c. It will remain unchanged. d. It will increase or decrease depends on the cost of borrowings. e. Cannot be analyzed. Financial Forecasting 403. The major assumption in trend analysis via extrapolation is a. The erratic movements which occurred in the previous years will reoccur in the coming years b. Sales for the coming period will increase by the average growth rate of the concerned industry c. Sales for the coming period will change to the same degree as sales changed from the prior period to the current period d. Sales in the coming period will increase by the general economic growth rate, after adjusting for the erratic events e. Both (a) and (c) above. 404. Sustainable growth rate refers to the rate a. The firm uses for its internal purposes like project appraisal, etc. c. Which can be maintained only with external borrowing d. By which the firm expects its sales to increase in the coming years e. 70 Which can be maintained without resorting to external finance b. By which the assets of the firm have been increasing in the past several years.
  • 76. Part I 405. The credit extended by the suppliers of goods and services is a. Long-term sources of finance b. Short-term sources of finance c. Spontaneous source of finance d. Both (a) and (c) above e. Both (b) and (c) above. 406. The starting point of the financial forecasting exercise is the a. Sales forecast b. Forecast of labor cost c. Forecast of material cost d. Forecast of operating expenses e. Cash flow statement. 407. The percent of sales method of financial forecasting assumes that a. The future relationship between the manufacturing costs only and sales will be similar to their historical relationship b. The future relationship between the selling and administrative costs only and sales will be similar to their historical relationships c. All the cost elements change by the same percentage as the change in sales d. All the cost elements will bear the same relationship with sales as in the past e. Only the variable cost elements will bear the same relationship with sales as in the past. 408. The starting point in the preparation of pro forma income statement is the projection of a. The amount of sales for the next year b. The amount of raw material to be purchased in the next year c. The quantum of product to be manufactured in the next year d. Anticipated EPS for the next year e. None of the above. 409. Which of the following is not an objective method of sales forecasting? a. Sales force estimates. b. Extrapolation and trend analysis. c. Regression analysis. d. Sustainable growth rate. e. None of the above. 410. Which of the following is/are objective method(s) of sales forecasting? a. Jury of executive opinion. b. Sales force estimate. c. Market survey. d. Regression analysis. e. Both (b) and (d) above. 411. Given that all the other factors are constant, the external funds requirement is a. Directly related to growth rate of sales b. Inversely related to growth rate of sales c. Inversely related to dividend pay-out ratio d. Directly related to net profit margin ratio e. Cannot be determined with certainty. 71
  • 77. Financial Management 412. The basic assumption in percent of sales method for preparation of pro forma income statement is a. Similar relationship between future costs and sales to their historical relationship exists b. Cost elements are unchanged c. Sales increase by ten percent d. Both (a) and (b) above e. Both (b) and (c) above. 413. Which of the following methods is preferred to prepare pro forma income statement? a. Percent of sales method. b. Budgeted expense method. c. Combination of above two methods. d. Time series projection method. e. None of the above. 414. Which of the following is not a subjective model of sales forecasting? a. Trend analysis. b. Sales force estimates. c. Regression analysis. d. (a) and (c) only. e. All of (a), (b) and (c) above. 415. Growth with internal equity will increase with the a. Increase in debt ratio b. Decrease in dividend pay-out ratio c. Decrease in profit margin d. Increase in assets to sales ratio e. Both (a) and (d) above. 416. The growth rate of sales that can be sustained by a firm without raising external equity increases with a. An increase in net profit margin b. A decrease in the debt to equity ratio c. A decrease in the retention ratio d. An increase in the assets to sales ratio e. Both (a) and (d) above. 417. Which of the following is not an assumption for estimating the sustainable growth rate? a. The assets of the firm will increase proportionately with the increase in sales . b. The company will maintain the same capital structure. c. The profitability of the company will remain same. d. The company will pay the same amount of dividend. e. None of the above. 418. While preparing proforma financial statement by using budgeted expense method, a. b. The items related to various expenses are projected on the basis of the anticipated changes c. The future cost-sales ratio is assumed to be prevailed as per historical relationship d. A regression equation may be framed to project the costs during the future years e. 72 The method of extrapolation is applied to assess the total expenses of the company in proportion to increase in sales All the expenses are increased by a fixed percentage.
  • 78. Part I 419. Which of the following is/are subjective method(s) of sales forecasting? a. Jury of executive opinion. b. Sales force estimate. c. Regression Method. d. Time Series Projection Method. e. Both (a) and (b) above. 420. Calculate the DTIL from the following information Quantity sold = 6,000 Units S.P/Unit = Rs.500 Variable Cost/unit = Rs.200 Fixed Expenses = Rs.8,00,000 Interest = Rs.80,000 Preference Dividend = Rs.60,000 Tax rate = 40% a. 2.119 b. 3.416 c. 2.195 d. 2.519 e. 2.159. 421. In relation to the preparation of the proforma income statement by using budgeted expense method, a. The future relationship between various costs to sales is assumed to follow historical relationship b. The estimation of the various items are made on the basis of the expected developments c. A extrapolation using trend analysis is always made to assess the total expenses of the company d. A regression equation is always modeled to project the amount of future expenses e. None of the above. 73
  • 79. Part I: Answers on Basic Concepts (with Explanatory Notes) Introduction to Financial Management 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. (c) The financial goal of any firm including public sector firms is to maximize the wealth of the shareholders by maximizing the value of the firm. (e) Ensuring discipline in the organization is a function of human resource management. (d) The objective of a finance manager will be to maximize the wealth of the owners by increasing the value of the firm which is reflected in the Earnings Per Share (EPS) of the firm and the market price of the shares. He does not manipulate the share price of the company. (e) Decision making in order to achieve the objectives in all areas of management including financial management involves the balancing of the trade-off between risk and return. (c) Analysis of variance between the targeted costs and the actual costs incurred is related to ‘control’ because it helps management to take timely corrective action to ensure the planned results are achieved. (c) According to Section 3(1)(iii) of Companies Act, 1956 the minimum number of persons required to form a private and public limited company are 2 and 7. (d) The advantages of sole proprietorship are (i) easy and inexpensive set up. (ii) Few governmental regulations and (iii) no firm tax. (d) Partnership firm is a business owned by two or more persons. They are partners in business and they bear the risks and reap the rewards of the business. A partnership firm is governed by the Indian Partnership Act, 1932. Hence it is relatively free from governmental regulations as compared to the joint stock companies. (c) The objective of financial management is to increase the wealth of the owners by increasing the value of the firm, which is reflected in the EPS of the firm and the market price of the shares. (e) An optimal capital structure can satisfy the return expectations of the stakeholders at a lower cost that will result in share price of the company to a healthier one. It is a financing decision. While the cases mentioned in the other alternatives are the investment decisions as these may bring return to the company over a period of time. (a) The amount that a company can realize if it sells its business as an operating one is called going concern value. Replacement value indicates the value that a company would be required to spend if it were to replace its existing assets in the present situation. Liquidation value is the amount that a company could realize by selling its assets following the termination of its business. Market value of an asset is the current market price at which it may be sold or bought in the market. (b) The liquidity function of the financial system facilitates conversion of investment in stocks, bonds etc., into money. Savings function leads to the flow of savings from the savers to the consumers of an economy while payment function facilitates the payment of dues in an easy and convenient way. Risk function provides the required tools for the protection against life, health and income risks whereas policy function enables the regulating authorities of a country to take suitable policy measures to influence the policy variables in the macro-economy. (b) According to the objective of financial management to increase the wealth of the shareholders means to increase in the market value of the shares issued by the firm. Increasing the physical assets or current assets of the company may not provide adequate returns to the shareholders, if it is done through incremental borrowing. Increasing cash balance imparts more liquidity to a company but decreases the returns on investments. Increase in the total number of outstanding shares of the company does not make any impact on the total value of the firm. (e) All the functions as specified in the given options are the salient functions of a finance manager. Indian Financial System 15. (e) Financial assets represent a claim to the payment of a sum of money sometime in the future and/or periodic payment in the form of interest or dividend. 16. (e) The call money loans are of short-term in nature with maturity period of 1-15 days. Any amount can be lent or borrowed at a convenient interest rate, which is acceptable to both the borrower and the lender. These loans are highly liquid, as they are repayable on demand.
  • 80. Part I 17. (d) The National housing bank is set up in July, 1988 as an apex level housing finance institution as a wholly owned subsidiary of the RBI. 18. (a) Single window lending refers to an arrangement by which the lead bank in a consortium of banks releases the initial requirements of the borrower and also takes documentation on behalf of all the banks. 19. (b) Commercial paper is an unsecured, short-term promissory note issued mainly by companies, mostly on the discount basis whereas certificate of deposit is a title to a time deposit with a commercial bank, which can be negotiated. All the scheduled banks, other than regional rural banks and scheduled co-operative banks are eligible to issue CDs. 20. (d) The money that is lent for one day in call money market is known as call money and if it exceeds one day (but less than 15 days) is referred as notice money. 21. (e) Gilt-edged securities are securities issued by the Government of a country for which repayments of principal as well as interest are totally secured, being first charge on the nation’s purse. 22. (a) DFHI was established as a company under the Companies Act 1956, to provide liquidity to money market instruments by creating a secondary market where they can be traded. 23. (c) Issue management is a function related to issue of securities and does not involve any fund-based activity. 24. (a) The minimum maturity period for a certificate of deposit is 15 days. 25. (b) Statutory Liquidity Ratio is the percentage of reserves banks are required to maintain specified reserves in the form of government securities, specified bonds and approved securities. 26. (c) Public debt in the economy is being managed by RBI. 27. (c) In a bought out deal a company, initially places its equity shares, with a sponsor/ merchant banker who in turn offloads the shares at the appropriate time, by offering to the public at a later date. Bought out deals come to the rescue of promoters of small projects. 28. (c) The Volume of trading is more than that of BSE. 29. (d) There is a fairy large secondary market for PSU bonds. The market lot for PSU bonds for the purposes of trading is a minimum of Rs.5 crore. Such investments come under approved investments. 30. (b) In unit banking system, the bank conducts its overall operations from a single office. 31. (d) The functions performed by a financial system are savings function, payment function, liquidity function, risk function and policy function. 32. (c) The maturity period for the certificate of deposits issued by a bank is not less than 15 days and not more than 12 months. 33. (a)Limit order is an order fixed by a fixed price. It may or may not include brokerage. 34. (d) Securities issued by the central Government are usually referred to as `gilt-edged’ securities as repayments of principal as well interest are totally secured, being first charge on the nation’s purse. 35. (e) Long dated Government securities have maturities exceeding 10 years from the issue date, medium dated securities have maturities ranging from 5-10 years. 36. (a) There are 5 types of T-bills based on the maturities. 14 days, 28 days, 91 days, 182 days, 364 days. However, at present (since May, 2001) there are only two types of treasury bills issued by the government, 91 days and 364 days. 37. (d) Presently, in the secondary capital market, delivery and payment has to take place within two days from the date of contract. 38. (b) Primary market creates long-term instruments through which corporate entities borrow from capital markets. Companies in order to meet the financial requirements of its projects raise capital through issue of securities in the primary market. 39. (d) According to Section 3 of Companies Act, 1956 the min and max members permissible in a private company are 2 and 50 respectively. 75
  • 81. Financial Management 40. (e) Banks borrow in call money market to: i. Fill the temporary gaps, or mismatches that arise, as the banks normally lend out the deposits they mobilize. ii. Meet the cash reserve ratio requirements, which they should maintain with the RBI. iii. Meet sudden demand for funds, which may arise due to large payments and remittances. 41. (a) Commercial papers are short-term, unsecured promissory notes issued at a discount to face value by well-known companies that are financially strong and carry a high credit rating. 42. (c) Debentures are long-term instruments which are issued in the capital markets. 43. (b) Private placement market financing is a direct sale by a public limited company or a private limited company of its securities to a limited number of sophisticated investors like UTI, LIC, GIC, etc., through investment bankers. Private placement can be made out of promoter’s quota but it cannot be made with unrelated investors. 44. (d) In stop loss order a particular limit is given for sustenance of loss. If the price falls below that, broker is authorized to sell immediately to stop further occurrence of losses. 45. (b) The minimum amount to be invested by a single investor is Rs.5 lakh in a commercial paper. 46. (b) Bonus shares are shares issued by companies to their existing shareholders in the ratio of existing shares from profits in lieu of dividends. The shareholders do not have to make any additional payment for these shares. 47. (e) When the client does not fix any time or price limit for execution of order, it is called an open order. 48. (e) CDs are issued in multiples of 1 lakh subject to the minimum size of each issue of Rs.5 lakh. 49. (c) Bonus shares are shares issued by companies to their existing shareholders in the ratio of existing shares from profits in lieu of dividends. The shareholders do not have to make any additional payment for these shares. 50. (e) All the given alternatives are major categories of investors in primary market of government securities. 51. (a) Savings deposits, demand and time deposits from other banks and refinance from NABARD liabilities of a bank as the bank owes to somebody. 52. (e) The National housing bank is set up in July, 1988 as an apex level housing finance institution as a wholly owned subsidiary of the RBI. It extends refinance to all the above. 53. (a) As per the new guidelines on money market mutual funds, the minimum lock-in period is reduced to nil from 15 days (earlier 30 days). 54. (a) Call money, Treasury bills, Commercial paper, Certificates of deposits are all money market instruments where the function of money markets is to channel savings into short-term productive investments like working capital. A corporate debenture is a capital market instrument. 55. (b) Commercial papers are issued in multiples of 5 lakh. 56. (d) In a bought out deal a company, initially places its equity shares, which are offered to the public at a later date to a sponsor/ merchant banker who in turn offloads the shares at the appropriate time. Bought out deals come to the rescue of promoters of small projects. They cannot be bought back by the company. 57. (d) As per the latest guidelines, if any private or public sector company wants to raise money through CP market, its fund based working capital limit should not be less than 4 crore, and tangible net worth not less than 4 crore as the latest audited statement. 58. (d) In a bought out deal a company, initially places its equity shares, which are offered to the public at a later date to a sponsor/ merchant banker who in turn offloads the shares at the appropriate time. Bought out deals come to the rescue of promoters of small projects. 59. (d) Financial asset represents a claim to the payment of a sum of money sometime in the future/or periodic payment in the form of interest. Bullion is not a financial asset as it does not meet the above requirements. 60. (c) IDBI finances industries directly and also support State Financial Corporations and State Industrial Development corporations by providing refinance and through the bills rediscounting scheme. 76
  • 82. Part I 61. (d) Cash credits and overdrafts are running accounts, from which the borrower can withdraw funds as and when needed up to a credit limit sanctioned by his banker. Cash credit is given against the security of commodity stocks, OD’s are allowed on personal or on joint current accounts. 62. (c) Convertible debenture is a capital market instrument. 63. (b) No prior approval of RBI is needed for CP issues; minimum size of CP issue is 5 lakh. CP’s are purely unsecured as they are backed by the credit of the issuing company; they are issued in multiples of 5 lakhs. Underwriting of CP is not mandatory. 64. (e) The call money market forms a part of the national money market, where day-to-day surplus funds, mostly of banks are traded. 65. (b) Treasury bills are short-term instruments issued by the government to tide over short-term liquidity shortfalls. The RBI acts as an agent for issuing the T-bills and it issues them either by tender or by tap. 66. (a) CRISIL is a rating agency, which rates equity, debentures and fixed deposits. Equity rating has not picked up in India. 67. (e) Call loans, Commercial papers, Certificates of deposits, Treasury bills are all short-term money market instruments. 68. (b) Direct assistance is provided All India financial institutions by subscribing to the company’s shares. 69. (b) The Industrial Development bank of India is an apex financial institution to coordinate the functioning of all other financial institutions. 70. (d) Options (a) to (c) were objectives of Nationalization of Banks but not option (d). 71. (c) As per the guidelines laid by the RBI a private bank will be governed by the provisions of RBI Act, 1934, and the banking regulation Act, 1949 and other relevant statutes. 72. (e) All the given alternatives are reasons for low profitability of commercial banks. 73. (e) Securities issued by the Central Government are called Gilt-edged securities. 74. (c) The RBI fixes interest rates in the organized sector, based on the market. 75. (a) CDs are freely transferable by endorsement on delivery, they are issued at discount rate freely determined by the issuing bank and the market, or carry a coupon rate, they are issued by scheduled banks excluding RRB’s, they have fixed maturity ranging from 15 days to 1 year for banks 1-3 years for financial institutions and they have no secondary market. 76. (a) A deep discount bond does not carry any coupon rate but is issued at a steep discount over its face value. It is also referred to zero coupon bond. The Industrial Development Bank of India issued deep discount bonds in 1996 which have a face value of Rs.2 lakh and a maturity period of 25 years. The bonds were issued at Rs.5,300. 77. (e) The changes in the banking structure through nationalization has resulted in all the above. 78. (d) The financial institution provides indirect financial assistance to industrial units by providing underwriting facility, guarantee for foreign currency loans, guarantee for deferred payment, etc. 79. (b) Money market deals with short-term instruments with the objective of meeting the working capital requirements. Certificate of deposit is a money market instrument. 80. (b) Investing in real assets with positive net present values is an optimum decision in well developed capital markets. 81. (b) Money market deals with all transactions in short-term instruments with a period of maturity of one year or less whereas capital markets deal market deals with transactions related to long-term instruments with a period of maturity of above one year. 82. (e) The role of underwriters is restricted to only the primary market. 83. (a) Call money market is a very short-term market with maturity period ranging from 1-15 days. 84. (e) As per the latest audited statement corporates, primary dealers, satellite dealers and all India Financial Institutions are eligible to issue commercial paper. The minimum net worth required is Rs.4 crore, the minimum credit rating is P-2 and there is no maximum discount rate prescribed. 77
  • 83. Financial Management 85. (a) There are 5 types of T-bills based on the maturities. 14 days, 28 days, 91 days, 182 days, 364 days. However, only 91 days and 364 days treasury bills are issued in India since May, 2001. 86. (c) The interest rate on call loan is largely subjected to be influenced by the forces of supply and demand for funds. The money that is lent for one day in call money market but not for more than 15 days is referred as notice money. 87. (c) In a bought out deal a company initially places its equity shares, which are to be offered to the public at a later date, to the sponsor / merchant banker, who in turn offloads the shares at the appropriate time. A company proposing to place its securities through this route can price its securities to reflect the intrinsic value. 88. (e) The maximum number of persons can form a private limited company are 50. 89. (a) Merchant banks are generally engaged in several services like, management, underwriting and marketing of new issues; project promotion services and project finance; syndication of credit and other facilities; leasing including project leasing; corporate advisory services; etc. These services are generally not useful for the retail investors. While the other entities as mentioned in the other alternatives generally deal with the retail investors for raising funds from them as well as for lending to them. 90. (d) A term deposit made by a depositor is held for a specific term or maturity with a bank as mutually agreed by both the parties; it is not marketable. All other instruments as mentioned in the other alternatives are marketable instruments in the money market. 91. (a) Primary capital markets help in the creation of new long term securities. These long term securities are issued by the companies to raises funds for meet their long term financing requirements. It neither helps for trading with the outstanding long term as well as the short term securities. But it allows the FII to invest in the Indian capital markets. 92. (e) In rights issue as well as bonus issue, new securities are offered to the existing shareholders of the company on the ratio of existing shares held by the investors i.e. on a pro rata basis. But in public issue, the shares are directly issued to the general public while in private placement; the securities are issued to few selected entities as decided by the management of the company. 93. (e) Since, in a bought-out-deal, the shares are initially offered to the sponsor and the sponsor has the discretion to offload the shares to the public at an appropriate time in future as per the discretion of the sponsor. The sponsor may exploit the situation where the promoter of the company may be in the dire need for funds by offering a substantially low price and may also misuse its discretion to divest the shares in favor of the public. All these facts may affect the interests of the promoters of the company. The points as stated in the other options are not correct with respect to bought out deals. 94. (b) Venture capital funding companies generally provide risk capital to the technology oriented and high risk business entities. Lease finance companies allows their customers to use the capital as per the terms of the leases while hire purchase companies allows their clients to procure the capital assets against the payment of the regular hire rentals. Commercial banks are engaged in the business of raising funds mainly through deposits and lending the same while insurance companies undertake the pure risks of their clients against the payment of the upfront premium. 95. (b) The characteristics of the money market instruments are the short term maturity and easy liquidity. These are generally issued by the government – union as well as the state, Public sector enterprises, banks and financial institutions, reputed corporate entities from the public sector as well as the private sector, etc. The CPs issued by the private companies are not at all secure one. 96. (d) The volatility in the call money market increases with the reduction of the liquidity in the market. It generally comes down with the following reasons: • Increase in Cash Reserve Ratio (CRR) • Larger amount borrowed by several borrowers following an increase in demand for the loanable funds • Withdrawal of funds by the banks and financial institutions suddenly to meet their respective corporate requirements Payment of a large amount of advance taxes by the banks and FIs will lead to the reduction in liquidity in the system thereby increases the volatility in the call money market. Hence, the option (d) is the answer. 78
  • 84. Part I 97. (d) The options (a) and (b) represent the acts of hedgers who are interested to minimize their risk in a volatile market. The option (c) represents the act of the speculators who wants to make profits from the price movements in a volatile market through speculation. The option (d) represents the act of the arbitrageurs who take the opportunity of improper pricing in different markets and imparts a better efficiency in the system. 98. (a) A public limited company is said to be in a significant advantage owing to its limited liability. If the company turned to an insolvent one, the members don’t have any further liability to bail out whereas in a proprietorship firm, the liability of the owner is unlimited. However, for a public limited company, the ownership can be easily transferred and resources can be mobilized with a unlimited life. But for a proprietorship company, these advantages are not available to a proprietorship company 99. (c) Inter Corporate deposits are not traded in the market. The instruments as mentioned in the other options are traded in the respective financial markets. 100. (a) Primary market allows the corporate houses to raise long term funds by issuing new securities like, shares – equity and preference as well as debentures. The venture capital funding companies generally dilute their stakes in a company by selling their holdings in any company to the investors through secondary capital market route. 101. (a) Financial Intermediation function encourages the household sector to save money through the various channels in the financial system like, banks, insurance companies, capital markets, etc. These funds are ultimately channelised to the productive sector that needs money. The other functions do not play any role in this context. 102. (d) The long term financial instruments – equity shares, preference shares and debts - are traded in the secondary market that have been issued earlier. Primary capital market allows the corporate houses to raise the long term capital by issuing new securities. Money market and forex market deal with the short term debt instruments and the transactions related to the foreign exchange respectively. So, the option (d) is the answer. 103. (e) All of (a), (b) and (c) are included in the regulatory framework. 104. (e) The word “Gilt edged securities” signifies the government securities that can be issued only by the government – central as well as state. 105. (e) Long dated government securities have maturities ranging from 10 to 30 years 106. (d) In a private limited company, the maximum number of members is limited to 50 only. 107. (a) Foreign Exchange Regulation Act, 1973 has been replaced by Foreign Exchange Management Act, 2000 in order to facilitate the external trade and payments as well as to promote an orderly maintenance of the foreign exchange market in India. So, the option (a) is correct. Time Value of Money 108. (d) The future value of a single cash flow compounded annually is given as FV = PV (1 + k)n and the present value of a sum (FVn) receivable after n years at a rate of interest k is given as PV = FVn/(1+ k)n . Hence present value interest factor is the reciprocal of future value interest factor. Capital recovers factor FVIF x k (1+ k) n 1 k 1 = (1 + k)n x = = PVIFA PVIFA (1+ k) n − 1 (1+ k) n − 1 109. (a) PVIF = 1 (1+ k) n FVIF = (1 + k)n ⎡ (1+ k) n − 1 ⎤ FVIFA = ⎢ ⎥ k ⎣ ⎦ 79
  • 85. Financial Management ⎡ (1+ k)n ⎤ CRF = ⎢ ⎥ n ⎣ (1+ k) − 1 ⎦ Product of the above ⎡ (1+ k) n − 1 ⎤ k(1 + k) n x (1+ k) n x ⎢ ⎥x n k (1+ k) n ⎣ ⎦ (1+ k) −1 1 = (1 + k)n = FVIF. 110. (b) Nominal or market rate of interest = Real rate of interest + Expected rate of inflation + Risk premiums to compensate for uncertainty. 111. (a) The accurate doubling period n given a rate of return R, of an amount A will be n A x FVIF (r, n) = 2A = (1 + R) = 2. 112. (e) Sinking fund represents the amount that has to be invested at the end of every year for a period of n years at the rate of interest k, in order to accumulate Re.1 at the end of the period. n It is given by k/(1 + k) – 1. 113. (d) The generalized for shorter compounding periods is given as mxn FVn = PV (1 + k/m) Where, FVn = future value after n years PV = cash flow today k = nominal rate of interest m = number of times compounding is done during a year n = number of years for which compounding is done 114. (a) Manipulating the relation between PVAn, A, k and n we get the equation: n n A = PVAn {k (1 + k) / (1 + k) – 1} n 115. 116. 117. 118. 119. 120. Where {k (1 + k) /(1 + k) n – 1} is known as the capital recovery factor. (c) Capital recovery factor is the inverse is PVIFA. (d) Effective rate of interest is the rate of interest per annum under annual compounding that produces the same result. (d) When an investment pays only simple interest, it means that interest is paid only on the original investment as simple interest is calculated as a percentage of rate of interest on the original amount. (d) Cash flows obtained in various periods can be compared only after discounting each one to a common date. (c) The expression k / (1 + k)n – 1 is called the sinking fund factor which is the reciprocal of the future value interest factor annuity. (e) The present value of annuity A receivable at the end of every year for a period of n years at a rate of interest k is equal to PVAn = A x PVIFA k, n Where, PVIFA is called the present value interest factor annuity and is given as n n {(1 + k ) – 1/ k ( 1 +k ) }. FVIFA (1 + k) n −1 1 = x = PVIFA FVIF k (1 + k) n FVIFA x PVIF = (1 + k) n − 1 1 (1 + k) n − 1 x = = PVIFA k (1 + k)n k (1 + k)n FVIFA x PVIF = PVIFA 80
  • 86. Part I 121. (c) The general relationship between effective and nominal rate of interest is given by r = (1 + k/m) m –1 Where, r = effective rate of interest k = nominal rate of interest m = frequency of compounding per year Hence effective interest rate is always more than or equal to nominal interest rate. 122. (e) Money has time value because in an inflationary period, a rupee today has a higher purchasing power than a rupee in the future, money can be employed productively to generate real returns and since future is characterized by uncertainty, individuals prefer current consumption to future consumption. 123. (e) Only ‘e’ is correct. For alternatives (b), (c) and (d), the effective result is ‘a’, where ‘a’ is the amount. 124. (d) The present value of cash flow stream of any periodicity can be calculated by using PVIFA tables. 125. (c) The present value interest factor for annuity is equal to the product of the future value interest factor for annuity and the present value interest factor. 126 (d) The general relationship between effective and nominal rate of interest is given by r = (1 + k/m) m –1 Where, r k m = effective rate of interest = nominal rate of interest = frequency of compounding per year With an increase in m the effective rate of interest increases but at a decreasing rate. 127. (b) Sinking fund represents the amount that has to be invested at the end of every year for a period of n years at the rate of interest k, in order to accumulate Re.1 at the end of the period. 128. (d) (i) The inverse of FVIFA is sinking fund factor. Therefore (i) is false = 1 (1+ k) n − 1 x k (1+ k) n = (1+ k) n − 1 = PVIFA k(1+ k) n Therefore (ii) is true. (iii) PV of perpetuity = value of perpetuity . interest rate Hence it is not infinity. Therefore (iii) is false. 129. (d) Nominal or market rate of interest = Real rate of interest + Expected rate of inflation + Risk premiums to compensate for uncertainty. 130. (c) When compounding is done more than once in a year the effective rate of interest is greater than the nominal rate of interest. 131. (e) The doubling period is the time taken for the amount invested to be doubled for a given rate of interest. The doubling period can be calculated approximately by using rule of 72 according to which doubling period is 72/rate of interest or by using rule of 69 according to which doubling period is 0.35 + 69/rate of interest. 81
  • 87. Financial Management 132. (a) PVIF = 1 1 = n (1+ k) FVIF FVIFA = (1+ k) n − 1 k PVIF = 1 (1+ k)n 1 k x PVIF = x (1+ k) n n FVIFA (1+ k) −1 = k(1+ k) n 1 = PVIFA (1+ k) n − 1 PVIFA = (1+ k) n − 1 1 × k (1+ k) n PVIFA is product of FVIFA and PVIF. Inverse of capital recovery factor is PVIFA, and inverse of IVIFA is sinking fund. Therefore only (b), (c) and (d) are false. (a) is true. 133. (b) The general relationship between effective and nominal rate of interest is given by m r = (1+ i/m) – 1 where, r = effective rate of interest i = nominal rate of interest m = frequency of compounding per year. 134. (c) The general relationship between effective and nominal rate of interest is given by m r = (1 + k/m) – 1 where, r = effective rate of interest k = nominal rate of interest m = frequency of compounding per year When compounding is done twice a year r 2 = (1 + k/2) – 1. 135. (d) FVIF = (1 + k)n = PVIFA = 1 PVF (1+ k) n − 1 k(1+ k) n FVIF x PVIFA = (1+ k) n − 1 = FVIFA k only (a) and (b) are true. 82
  • 88. Part I 136. (e) Individual preference of present consumption to future consumption, gradually decreasing purchasing power of money, uncertainty of the future and the possibility of the productive deployment of money to generate real returns in future are the factors behind the time value of money. Hence, the alternatives (c) and (d) both are correct and so the option (e) is the answer. 137. (e) For the calculation of the present value interest factor of an annuity (PVIFA), it is assumed that the cash flow will occur at the end of the period under consideration. PVIFA is also reciprocal to the capital recovery factor. Hence, the option (e) is the correct one. 138. (d) Being a legal tender and having the government guarantee do not have any role in relation to the time value of money. The purchasing power of money gradually decreases due to inflation and so the individuals prefer to spend money, rather than saving the same without any suitable incentives. But money may be productively invested to generate higher returns in future. Hence the option (d) is the correct one. Risk and Return 139. (b) β measures the relative risk associated with any individual portfolio as measured in relation to the risk of the market portfolio. It is the measure of non-diversifiable or systematic risk of an asset relative to that of the market portfolio. A risk-free stock has a β of zero. 140. (c) CAPM is based on one of the assumption that the investor is limited only by his wealth and the price of the asset. 141. (e) The graphical representation of the CAPM models is the SML. The SML equation is given by E (r) = Rf + βj (Rm – Rf). The SML intersects the vertical axis at the risk-free rate of return Rf and (Rm – Rf) is the slope of the SML. When the slope of SML is zero then Risk-free rate = Expected return and risk-free rate = Market return. Hence all the given statements are true. 142. (e) Non-diversifiable risks are those risks which cannot be managed or reduced. Lockout in a company due to workers demanding a wage hike and lack of strategy for the management in a company can be managed and hence are diversifiable risks. Slump in the industry and change in the corporate tax structure are non-diversifiable risks as they cannot be managed or diversified. 143. (d) The amount of risk depends on (i) degree of correlation-the lower the degree of positive correlation, the greater is the amount of risk reduction that is possible and (ii) number of stocks in the portfolio – as the number of stocks increases, the diversifying effect of each additional stock diminishes. 144. (d) Business risk is the risk of doing business in a particular industry or environment and hence can be diversified. 145. (b) If a person holds a diversified portfolio the unsystematic risk is diversified, and the only risk a security adds would be systematic risk i.e the non-diversifiable risk which is a part of total risk from various sources like interest rate risk, inflation risk, financial risk, etc. 146. (e) Beta measures the relative risk associated with any individual portfolio as measured in relation to the risk of the market portfolio. Hence it is a risk of diversified portfolio and is the weighted average of individual security beta, weights being in proportions of the investments in the respective securities. 147. (e) The equation represents the CAPM which establishes a linear relationship between the required rate of return of a security and its systematic or undiversifiable risk or beta. Hence all the above statements are true. 148. (e) SML intersects the vertical axis at the risk free rate of return Rf and Km – Rf, i.e., risk premium is the slope of the SML. 149. (a) If the security’s return plots below the SML, it is said that it is overpriced and unattractive because it is expected to produce a return lower than stock with similar betas. 150. (d) The securities with beta > 1 and plotting on the upper part of the SML are classified as aggressive securities, and those with beta < 1 and plotting on the lower part of SML are classified as defensive securities. 83
  • 89. Financial Management 151. (c) Operating risk is the risk of doing business in a particular industry or environment and it gets transferred to the investors who invest in that business. Hence it is a diversifiable risk. 152. (d) Trade off between risk and return implies taking decisions in such a way which optimizes the balance between risk and return. 153. (d) Financial risk is the risk arising from the use of debt capital and hence a specific risk factor. 154. (c) The CAPM is represented by kj = Rf + βj (km – Rf) Explicit measures of security risk premium is the product of beta for a particular security j and the market risk premium Km – Rf. Hence risk premium = β j (Km – Rf) 155. (d) A security which can be bought or sold quickly without significant price concession is considered liquid. Hence the risk arising due to uncertainty about the time element and the price concession in selling a security is called liquidity risk. 156. (e) Standard deviation considers every possible event and assigns each event a weight equal to its probability. It is a very familiar concept and many calculators and computers are programmed to calculate it. It is a measure of dispersion around the expected (or average) value. Standard deviation is obtained as a square root of the sum of squared differences multiplied by their probabilities. This facilitates comparison of risk as measured by standard deviation and expected returns as both are measured in the same costs. This is why standard deviation is preferred as a measure of risk. 157. (e) Industrial recession cannot be attributed to a specific risk factor. It is related to the general economy. Hence is a non-diversifiable risk. 158. (e) Beta measures the relative risk associated with any individual portfolio as measured in relation to the risk of the market portfolio. Hence it is a measure of systematic risk of a security. 159. (e) CAPM assumes that investors make their investments based on single period horizon, i.e. the next immediate time period. 160. (a) To gain from a security it has to be bought only when the required rate of return is less than the expected rate of return. 2 161. (a) Variance = (Standard deviation) Hence if one portfolio’s variance exceeds another portfolio, its standard deviation will also be greater than that of the other portfolio. 162. (a) Nominal rate of return = Real rate of return + Inflation Hence real rates of return are typically less than nominal rates of return due to inflation. 163. (c) Nominal rate of return = Real rate of return + Inflation. Hence when nominal rate of return is more than inflation, real rate of return is positive and when nominal rate of return is less than inflation, real rate of return will be negative. 164. (d) Through diversification the loss arising from one security is compensated by a gain arising from some other security. Hence the expected risk can be reduced. 165. (d) Interest rates go up with inflation as inflation is directly related to interest rates. (106 − 97.50) 6 = 0.0931 106 + 97.50 2 13(1 − 0.38) + 166. (d) Kd = ∴ Kd% = 9.31%. 167. (c) Interest rate is directly related to inflation hence interest rates of securities tend to go up with inflation. 168. (d) Financial risk arises from the use of debt capital or leverage used by the company. The more the company resorts to debt financing, the greater is the financial risk. 84
  • 90. Part I 169. (d) Strike in the company is specific to the company and can be diversified. 170. (e) The CAPM model assumes that investors have single period time horizon, low transaction costs in the market, taxes do not affect the choice of buying assets and that all investors agree on the nature of return and risk associated with each investment. Hence all the statements would reduce the applicability of CAPM. 171. (b) Unexpected entry of a new competitor in the market is risk specific to a particular industry and hence diversifiable. 172. (d) Beta measures the relative risk associated with any individual portfolio as measured in relation to the risk of the market portfolio. Hence, if a security is less than the market portfolio, then its beta would be less than 1. 173. (e) Realized return is ex-post return, the two types of returns are realized or historical return and expected return, the objective of any investor is to maximize his returns and minimize risk, return is the motivating factor for an investor. The investor compensates for the uncertainty in returns by requiring an expected return that is sufficiently high to offset the risk or uncertainty. 174. (a) Systematic risk is non-diversifiable risk. Credit risk is diversifiable. 175. (d) The SML equation is E(r) = Rf + βj (km – Rf) It shows the relationship between the expected rate of return and beta. 176. (e) With rise in inflation there is reduction of purchasing power, hence inflation risk is also referred to as purchasing power risk and affects all securities. 177. (d) Because investors are risk averse they will expect a risk premium to compensate them for the additional risk assumed in investing in a risky asset. Risk premium = Required rate of return – Risk-free rate. 178. (a) When there is perfect positive correlation the loss in one security cannot be compensated by a gain in another. Hence, the risk of a portfolio of two securities increases if there is perfect positive correlation. 179. (d) With a rise in inflation there is reduction of purchasing power, this is referred as purchasing power risk. It is related to the general economy and cannot be diversified. 180. (b) Market portfolio contains all the securities in proportion to the market capitalization. 181. (d) The graphical representation of the CAPM model is the SML. The SML equation is given by E(r) = Rf + βj (km – Rf) Hence it shows the relationship between return on the stock and beta of the stock. 182. (b) When a security plots above the SML it means the security is undervalued or priced too low because its average rate of return is inappropriately high for the level of risk it bears. 183. (d) All the given alternatives are true. 184. (a) The CRL i.e. the characteristic regression line is a graphic representation of the market model. It is given as kj = αj + βj km + ej. This explains the relationship between return on stock kj and return on market portfolio. 185. (b) Beta measures the relative risk associated with any individual portfolio as measured in relation to the risk of the market portfolio. In a booming market the share prices tend to be on a rise. Hence those companies whose β>1 are to be selected. 186. (b) CAPM assumes that individuals can borrow and lend freely at a risk less rate of interest. 187. (d) Systematic risks are risks which cannot be diversified. Purchasing power risk and interest rate risk are undersifiable risk whereas yield risk can be diversified. 188. (a) The graphical representation of the CAPM model is the SML. The SML equation is given by E(r) = Rf + βj (km – Rf). Where (km – Rf) is the slope of the SML. Hence it changes with change in the risk-free rate of return. 85
  • 91. Financial Management 189. (b) The graphical representation of the CAPM model is the SML. The SML equation is given by E(r) = Rf + βj (km – Rf). Hence the relationship between beta of the security and the required rate of return is represented by the security market line. 190. (d) If investors expect the inflation rate to fall in future and they expect themselves to become less risk averse then SML shifts down and the slope decreases. 191. (e) All the given alternatives are used to calculate the return from an investment. 192. (d) As per CAPM model the required rate of return = Risk-free rate + Risk premium. Hence all the above statements are true. 193. (c) Emergence of a new competitor is a un- systematic risk which can be diversified as it can be attributable to that particular industry. Hence it does not contribute to systematic risk. 194. (e) As per the CAPM assumptions, any individual security’s expected return and beta statistics should lie on the SML. The SML intersects the vertical axis at the risk-free rate of return Rf = 236. 195. (b) As per the CAPM assumptions, any individual security’s expected return and beta statistics should lie on the SML. Those with beta greater than one and plotting on the upper part of the SML are classified as aggressive securities as they earn above average returns with higher risks. 196. (d) Riskiness of a portfolio is the function of all the above factors. 197. (c) Prices of security move inversely with the interest rates. Hence, increase in interest rate will cause an increase in the required rate of return. 198. (b) The graphical representation of the CAPM model is the SML. The SML equation is given by E(r) = Rf+ βj (km – Rf). It shows the relationship between return on the stock and beta of the stock. 199. (b) The graphical representation of the CAPM model is the SML. The SML equation is given by E(r) = Rf + βj (km – Rf). The SML intersects the vertical axis at the risk free rate of return Rf and (km – Rf) is the slope of the SML. Hence when SML = 0, the expected rate of return is equal risk-free rate of return. 200. (b) When the securities in the portfolio are negatively correlated the loss in one security can be offset by a gain in another security. Hence by diversification we can eliminate risk. 201. (d) Beta measures the relative risk associated with any individual portfolio as measured in relation to the risk of the market portfolio. It is a measure of systematic risk of a security. 202. (d) Introduction of minimum alternative tax cannot be diversified. Hence it does not represent unsystematic risk. 203. (c) When there is zero correlation between the securities in a portfolio it means that there is no relationship among the different securities. Hence the graph will be scattered. 204. (d) Reduction of tax rate by the government will affect all the companies in the market and so can be considered as a systematic risk. While the factors mentioned in the other options will affect a particular company or the companies belonging to a particular industry. Hence, these factors may be termed as non-systematic risk. 205. (c) A finance manager is required to examine whether the opportunity is worth more than the cost thereafter he must take a decision by duly balancing the risk and return associated with that decision. An aggressive advertisement campaign may increase the sales revenue but improper appeal may cost a company too for the advertisement cost. An attractive credit term may improve the sales turnover but may inability to implement the same may cost the company in some other way. A borrowing firm enjoys tax shield against the payment of interest to its lenders but a risk of failure to make such payment may result in the risk of insolvency. But to maximize profit through maximum usage of the production facilities is not a risk, as it leads to the reduction in cost per unit of production, to the finance manager of any manufacturing company. 86
  • 92. Part I 206. (e) If a security’s return plots above the Security Market Line (SML) then the return on the security is more than the required rate of return on the security according to the SML. A greater return means a lesser price of the security than its intrinsic value that implies the security is under priced and hence that should be bought immediately to book profit in future as its price increases. 207. (e) The assumptions of CAPM are as follows: • Investors use the expected return and standard deviation of returns as the appropriate measures of return and risk of the portfolios • Investors are risk averse • Investors agree with each other on the nature of return and the risk associated with each instrument where investment may be made • The assets can be bought and sold in any unit as desired by the investors Hence, the option (e) is the correct choice. 208. (a) Beta of security represents the relationship between the rates of return from a security as well as from the market. It shows the responsiveness of the security to the general market and indicates how extensively the return of the security will vary with the changes in the market return. As the rates of return from a security move perfectly in tandem with respect to the market returns, then the beta for that security will be equal to unity. 209. (d) Volatility of interest rates, sudden increase in the rate of inflation, the imposition of surcharge and the non-availability of electricity affect the profitability of all the companies in the market almost in the same manner. But a sudden scarcity of cement affects only those companies, which use cement as one of their inputs like; construction companies, housing sector, etc. 210. (d) As the return on a security lies below the security market line, the security is over priced as the expected return is less than the required return. The statements as stated in the options (a), (b) and (c) are not related to the security market line. 211. (b) The equation for the Characteristic Regression Line (CRL) is given as: K j = α j + β jk m + e j The CRL is plotted by plotting Kj along the Y-axis and Km along X-axis. 212. (b) The beta coefficient of a security indicates the systematic risk of a security while the unsystematic risk is estimated by deducting it from total risk i.e. variance of returns from that security. The total risk and financial risk of a company, not for a security, is measured by the total leverage and financial leverage of the company at a certain level of operations. There is no measurement called the operating risk of a company. 213. (e) The salient features for the assumptions of CAPM are: • The investors are risk averse • The assets can be sold or bought in any small number of units • Transaction costs and taxes are negligible • Expectations of one investor is same as that of the another in relation to the expected returns from a security and the risks associated with that • The investors consider the expected return and the standard deviation of returns as the criteria of investment. Hence, the option (e) is correct. Valuation of Securities 214. (c) The bonds issued by the government are secured. T-Bills are issued at a discount and redeemed at a face value and Government buy term bonds carry a coupon rate of interest. Interest rate cannot be changed before the maturity of the bond. 215. (c) The rate of return earned by an investor, who purchases a bond and holds it till maturity, is called the yield to maturity. 87
  • 93. Financial Management 216. (b) This is the theorem showing the effect on the bond values influenced by the relationship between the required rate of return and the coupon rate. When the required rate of return is equal to the coupon rate, the value of the bond is equal to its par value. 217. (a) This is a bond theorem showing the effect of the number of years to maturity on the bond values. When the coupon rate is less than the required rate of return the discount on the bond decreases as maturity increases. 218. (b) This is the theorem showing how YTM determines a bonds market price and vice versa, as bond’s price will fluctuate in response to the change in market interest rates. For equal sized increases and decreases in the YTM, the price movements are not symmetrical. 219. (b) This is the bond theorem showing how YTM determines a bond’s market price. A change in YTM affects those bonds with a higher YTM more than it affects bonds with a lower YTM. 220. (b) When the intrinsic value or the present value of a bond is higher than the market value, it implies that the bond is under priced. Hence, an investor would buy a bond. 221. (a) The rate of return earned by an investor who purchases a bond and does not hold till maturity is called the holding period return. 222. (e) For a bond held to maturity YTM is the discount rate which equals the present value of promised cash flows, and hence is not affected by the current market price of the bond. 223. (d) Bond’s price moves inversely proportional to its yield to maturity. When market price and face value are equal, the coupon rate is equal to the YTM. 224. (d) Since coupon rate of bond Y is relatively less, the bond Y’s price would change more than that of X for a change in YTM. 225. (c) The price of the share is given by P = D/k – g. Other things being equal as the expected growth in dividends increases, the expected return increases. 226. (e) Low dividend yield and high price earnings ratio imply considerable growth prospects. High dividend yield and low price earning ratio imply limited growth prospects. 227. (e) The book value per share is the net worth of the company (paid-up equity capital plus reserves and surplus) divided by the number of outstanding equity shares. This approach is criticized because it values the firm’s share without any future projections and it is based on accounting figures which can be manipulated. 228. (e) The factors which effect the P/E ratio are growth rate, stability of earnings, size of the company, quality of management, dividend pay-out ratio and debt preperation. 229. (d) The interest rate payable on a bond = Par value x Coupon rate. Hence the coupon rate is set on equal to a percentage of its par value. 230. (e) The amount a company can realize if it sold its business as an operating one is called going concern value. 231. (d) Low dividend yield and high price earnings ratio imply considerable growth prospects. Hence the statement given is not true. 232. (e) All the given statements are true. 233. (a) Market value of an asset or security is current price at which the asset or the security is being sold or bought in the market. The amount that a company could realize if it sold its assets after terminating its business is liquidation value. 234. (c) Assets are recorded at historical costs and they are depreciated over years, book value may indicate intangible assets at acquisition cost minus amortized value. It is stated as outstanding amount. The difference between the book value of assets and liabilities is equal to shareholder’s funds or net worth. 235. (a) This is a bond theorem showing how YTM determines a bond’s market price. A change in the YTM affects the bond with a lower YTM more than it does bonds with higher YTM. Hence statement (a) is false. 236. (b) Longer the maturity of the bond , the greater its price change in response to a given change in the required rate of return. Hence if the maturity of the bond increases, the volatility of the bond increases. 237. (d) This is the bond theorem showing the effect on the bond values influenced by the relationship between the required rate of return and the coupon rate. When the required rate of return on a bond is less than the coupon rate then the value of the bond is less than the face value. 88
  • 94. Part I 238. (d) The intrinsic value of a stock is equal to the discounted value of the stream of future dividends per share. It is given by P0 = D1/(1 + g) + P1/(1 + ke) Where, D1 is the expected dividend a year hence, P1 is the expected price of the share Ke is the required rate of return. 239. (d) All the statements are related to the bond value theorem showing the how YTM determines the prices of the bonds. Statement (d) is false because the longer the term to maturity, the greater will be the change in price with change in YTM. 240. (a) Longer the maturity of the bond, the greater its price change in response to a given change in the required rate of return. Hence if the maturity of the bond increases, the volatility of the bond increases. 241. (b) When the expected rate of return is equal to the required rate of return the value of the bond is equal its par value. Hence it is rightly priced. 242. (b) When the required rate of return on a bond is greater than the coupon rate the discount then the value of the bond is less than the par value. This discount on the bond declines as maturity approaches. 243. (a) The discount or premium on a bond declines as maturity approaches. Hence if discount bonds and premium bonds are sold at the same price, it indicates that the bonds have approached maturity. 244. (b) When the required rate of return is equal to the coupon rate, the value of the bond is equal to its par value. 245. (d) ke = Rf + β (Rm – Rf) ∴β= ke − R e 21.4 − 6 = 1.40. = Rm − Rf 17 − 6 246. (d) The value of a share is its economic value as a going concern, taking into account its characteristics, the nature of its business and the investment environment. The value of the share equals the present value of earnings per share plus the net present value of future growth opportunities. 247. (c) Interest rate risk is the variability in a security’s return resulting from changes in the level of interest rates. Bonds with low coupon rate have high interest rate risk as the return on the bond is less than the actual interest at that period. 248. (b) Yield to maturity of a perpetual bond i.e., bonds with no maturity is equal to the interest divided by the market price. 249. (b) When the required rate of return on a bond is greater than the coupon rate the discount then the value of the bond is less than the par value. This discount on the bond declines as maturity approaches. For a change in YTM, the percentage price change in case of bonds of high coupon rate will be smaller than in the case of bonds of low coupon rate. Hence only (ii) is true. 250. (c) P/E = MPS/EPS. When there is low dividend yield the EPS decrease and hence the P/E ratio tend to increase. 251. (d) Dividend yield = Dividend paid/Current market price. Thus, we can conclude that dividend yield is based on current stock price. 252. (c) The value of common stock increases with increase in growth rate of dividend. The value of common stock decreases with increase in investment horizon. If dividend pay-out ratio remains constant the value of the stock would also remain the same. The value of common stock, other thing remaining same, decreases with the increase of discount rate. 89
  • 95. Financial Management 253. (a) The value of a share when dividend increase at a constant, compound rate is given by P0 = D1/k – g Where, P0 is the current market price of the equity share D1 is the expected dividend a year hence D1 = D0 (1 + g) where D0 is the last paid dividend k is the expected rate of return or the required rate of return g = annual growth rate. 254. (e) A security traded in the secondary market in subject to market risk and liquidity risk. 255. (c) For a given difference between YTM and coupon rate of the bonds, the longer the term to maturity, the greater will be the change in the price with change in YTM. This is because, in case of long maturity bonds, a change in YTM is cumulatively applied to the entire series of the coupon payments and the principal payment is discounted at the new rate for the entire number of years to maturity; whereas in case of short-term maturity bonds, the new YTM is applied to comparatively few coupon payments and also the principal payment is discounted for only a short period of time. 256. (e) Growth rate of the industry to which the company belongs is an external factor that influences the intrinsic value of a stock. 257. (e) Current yield measures the rate of return earned on a bond if it is purchased at its current market price and if the coupon interest is received. Coupon rate and current yield will be equal if the bond’s market price equals its face value. Yield to maturity and current yield will be equal when price of the bond equals the face value. 258. (d) Intrinsic value of bond = C x PVIFA(k,n) + F x PVIF(k,n) where, C is the coupon payment on the bond, F is the amount payable at maturity, k is the discount rate or the required rate of return and n is the number of years of maturity to the bond. From the above expression of the intrinsic value of a bond, we can see that other things being equal if the amount payable at maturity (F) increases, the value of bond also increases correspondingly. While decreasing the term to maturity and the coupon rate of the bond as well as increasing the required rate of return on the bond will decrease the intrinsic value of the bond. The discount on the bond at the time of issue does not have any role to play in this context. Hence, the alternative (d) is correct. 259. (d) When the required rate of return on a bond is more than the coupon rate the intrinsic value of the bond is less than its par value; hence the bonds are sold at a discounts on its par value. The amount of discount on the bond decreases as the maturity approaches. The question of premium on the bond price does not arise in this case. Hence, the alternative (c) is true. 260. (b) The warrant holder is not at all entitled to receive any dividend from the company that issued the same. While the features as stated in the other alternatives are the regular features of the warrants generally issued by the companies. Hence, the option (b) is the correct choice. 261. (a) The salient features of the multi-period valuation model are as follows: • Cash flows to the investors in the form of dividends over an infinite duration are considered. • The value of an equity share is equal to the present value of its entire dividend stream over an infinite duration • The model can be applied to the instances of constant dividends and constant growth in dividends • The model can also be applied in case of variable growth in dividends • It assumes that the cost of equity of the company will remain constant. Hence, the option (a) is the answer. 90
  • 96. Part I 262. (e) If the market interest rate increases, the value of the bond will also be adjusting itself in such a way that the yield of the bond matches with the market interest rate. Hence as the interest rate increases, the value of the bond will also decreases correspondingly in order to keep in pace with that of the new rate of interest. The factors as mentioned in the other options increase the value of the bonds 263. (d) In going concern value, the assets of the company are sold as the operating assets and their values are generally higher than any other criterion of measurement. Book value is an accounting concept that is historical cost minus depreciation. Market value of any asset is the value at which that is generally bought and sold in the market. Replacement value is the amount that a company is required to spend if it decides to replace the existing assets by new one. But liquidation value is the amount that a company may realize by selling the assets on terminating its business. 264. (b) If the required rate of return from a bond is more than the coupon rate the value of the bond will be less than the par value of the bond as the bond value adjusts itself against the movement of the interest rates. The discount rate on the bond decreases as maturity approaches, if the required rate of return from a bond is more than the coupon rate. The premium on the bond decreases as the maturity approaches, if the required rate of return is less than the coupon rate. 265. (c) In the valuation of the equity shares of the company through price-earning ratio approach, the growth rate of the company is considered only. Book value and the liquidation value of the company do not have any role in this context. Maturity of the debentures and issue of preference shares do not affect the valuation process for the company under this method. Financial Statement Analysis 266. (b) Debt equity ratio indicates the relative contributions of creditors and owners, which indicate the long-term solvency. 267. (c) Liquidity implies a firm’s ability to pay its debts in the short run. This ability can be measured by the use of current ratio. 268. (c) Debt service coverage ratio = PAT + Depreciation + Other non-cash charges + Interest on term loan/Interest on term loan + Repayment of the term loan 1.5 indicates that the firm has post-tax earnings which are 1.5 times the total obligation (interest and loan repayment) in the particular year to the financial institution. 269. (d) The common size analysis is used for inter company comparison because the financial statements of a variety of companies can be recast into the uniform common size format regardless of the size of individual companies. In the balance sheet, the assets as well as the liabilities and capital are each expressed as 100 percent and each item in these categories is expressed as a percentage of the respective totals. 270. (a) Fixed charges coverage ratio measures debt servicing ability comprehensively. The fixed charges coverage ratio of 4 signifies that its pre-tax operating income is 4 times all fixed financial obligation. 271. (b) The current assets increase as a result of increase in cash balance, hence the current ratio increases. 272. (c) Current ratio = Current assets/Current liabilities The firm’s current assets are converted into cash to provide funds for the payment of current liabilities. So CA will not change while CL will decrease. 273. (e) The receivable turnover ratio shows how many times accounts receivable (debtors) turn over during a year. It is defined as Net credit sales/Average accounts receivable. 274. (d) If the realized collection period is more than the average collection period it would reflect that collection job is poor, customers are facing financial problems, and in spite of careful collection efforts there is difficulty in obtaining prompt payments. 275. (c) Assets turnover ratio highlights the amount of assets that the firm used to produce its total sales. Low ratio indicates idle or improperly used assets. 276. (a) Gross profit margin = Gross profit/Net sales This shows the profit relative to sales. It may be used as an indicator of the efficiency of the production operation and the relation between production costs and selling prices. 91
  • 97. Financial Management 277. (d) Coverage ratios give the relationship between the financial charges of a firm and its ability to serve them. Structural ratios measure the long term solvency of a firm. 278. (b) Dividend pay out ratio is the ratio of DPS to EPS. It indicates what percentage of total earnings is paid to the shareholders. 279. (a) Dividend yield exists for only those firms which declare dividends. Hence the retained earnings directly affect the dividend yield. 280. (e) ROE = Net income/Average equity. 281. (e) All the given alternatives are problems encountered in financial statement analysis. 282. (d) According to the Du Pont Analysis Equity multiplier = (Average assets/Average equity) = 1/1 – (Debt to assets ratio). 283. (e) The accounts receivable is used in the evaluation of liquidity of receivables. Other things being equal, a decrease in the average accounts receivable will increase the firm’s return on assets. 284. (c) A common size balance sheet portrays the firm’s accounts as a percent of the firm’s total assets. 285. (c) Liquidity of an asset implies the speed at which it can be converted into cash. It measures the ease and cost of being converted into cash. 286. (c) Current ratio = Current assets/Current liabilities. It is a measure of a firm’s liquidity. 287. (a) The net working capital = Current assets – Current liabilities. A current ratio of less than 1 implies that the firm’s current liabilities are more than the current assets. Hence, a current ratio of less than 1 implies that the net working capital is negative. 288. (b) Average collection period = Average accounts receivable/Average daily sales = Average accounts receivable x 365/Average credit sales Average collection period indicates the speed of collections. 289. (d) The total assets comprises of debt and equity. If the debt equity ratio is 2:1 then the total assets will be 3. Hence, for every 3 rupees of total assets there is 2 rupees of debt and 1 rupee of equity. 290. (c) Liquidity implies a firm’s ability to pay its debt in the short run. Working capital gap is equal to current assets less total current liabilities other than bank borrowings. Higher the inventory turnover ratio higher the efficiency of inventory management. PE ratio is one of the most important ownership ratios. Only statement (c) is true. 291. (c) Financial statement analysis helps to know the correlation among ratios. 292. (c) Working capital gap is equal to the current assets less current liabilities other than bank borrowings. 293. (a) Asset turnover ratio highlights the amount of assets that the firm used, to produce its total assets. It measures the efficiency of the firm’s activities and its ability to generate profits. 294. (d) Capitalization rate = Earning per share/Market price of the share 295. (a) Interest coverage ratio = EBIT/Interest expense It is the measure of a firm’s ability to handle financial burdens. An interest coverage ratio of 2.25 indicates that the EBIT is 2.25 times the interest payable. 296. (e) Acid test ratio or quick ratio = Quick assets/Current liabilities It is a measure of liquidity of a firm. 297. (c) Average collection period is a turnover ratio Average collection period is defined as the number of days it takes to collect accounts receivable. 298. (b) Earnings per share = Profit after tax/Number of outstanding shares 299. (c) Current ratio = Current assets/Current liabilities. It is a measure of a firm’s liquidity, i.e., the ability to pay its debts. 300. (b) In determining the appropriate PE ratio for a firm the factors to be considered are growth rate, stability of earnings, size of the company, quality of management and dividend pay-out ratio. 301. (a) In common size analysis, each item in the balance sheet is expressed as a percentage of their respective totals. 302. (a) Days sales outstanding is the ratio of receivables outstanding to average daily sales. 92
  • 98. Part I 303. (e) Higher the inventory turnover ratio, greater the efficiency of inventory management. Since inventory turnover ratio is a measure of the adequacy of goods available to sell in comparison to the actual sales orders a high inventory turnover ratio may indicate over trading. 304. (c) When current ratio is greater than one, a similar increase in current assets and current liabilities will result in the decrease in current ratio. 305. (b) Interest coverage ratio measures the firm’s ability to handle financial burdens. This ratio tells how many times the firm can cover or meet the interest payments associated with debt. Interest coverage ratio = EBIT/Interest expense. 306 (c) Analyzing return ratios in terms of profit margin and turnover ratios, referred to as the Du Pont system. The starting point of Du Pont chart is return on total assets. 307. (e) Return on equity = Net income/Average equity Return on investments = EBIT/Total assets Hence it means that the firm does not have any debt in its capital structure as average equity = Total assets and that the firm does not pay taxes as EBIT = Net income. 308. (c) The ratio of market value to book value indicates the contribution of a firm to the wealth of the society. Hence Market value = 2 x Book value, indicates that the firm has doubled the wealth of the shareholder. 309. (e) Analyzing return ratios in terms of profit margin and turnover ratios, is referred to as the Du Pont system. In the Du Pont chart the left apex term is net profit margin. 310. (e) Debt is used in the capital structure only when the interest paid on such debt is less than the return. Such use of debt increase. Return on equity if the firm earns higher return than the rate of interest on debt. Return on equity = Net income/Average equity 311. (d) Interest coverage ratio measures the firm’s ability to handle financial burdens. This ratio tells how many times the firm can cover or meet the interest payments associated with debt. Interest coverage ratio = EBIT/Interest expense. Hence interest coverage ratio of 6 indicates EBIT is 6 times of interest. 312. (d) In the context of financial statement analysis, cross sectional analysis involves comparison between a company and an industry. The industry averages or the standard player’s averages are used as benchmarks. 313. (b) Earning power = EBIT/Average total assets It is a measure of the operating business performance which is not affected by interest charges and tax payments. 314. (c) Current ratio = Current assets/Current liabilities Quick ratio = Current assets – Stock/Current liabilities Hence when the current ratio and quick ratio are nearly the same it means that the company has got low investment in inventory. 315. (c) According to the Du Pont analysis Return on Equity = Net profit margin x Asset turnover ratio x Asset – Equity ratio Leverage ratios measure the long-term solvency of a firm. Total assets to net worth is the leverage ratio used in ROE analysis. 316. (d) Earning power is a measure of operating profitability and it is defined as Earnings before interest and tax/Average total assets. It does not consider the effect of financial structure and tax rate. 317. (b) ROE = Net income/Average equity or ROE = EPS/ Book value. 318. (b) Earning ratios helps in getting the information on earnings of the firm and their effect on price of common stock. Hence for assessing the future market value of the company, it is best to depend on earnings ratio. 319. (e) Dividend Yield = dividend per share/Market price per share. It gives current return on investment. 93
  • 99. Financial Management 320. (c) Debt-equity ratio and debt-asset ratio are leverage ratios for a company. Return on equity and return on investment represents the profitability ratios of a business entity. Acid test ratio indicates the liquidity status of a company. 321. (b) In common size analysis the items in the income statement are expressed as percentage of net sales. 322. (a) Debt asset ratio indicates the capital structure of a company. Inventory turnover ratio and total asset turnover ratio are the turnover ratios that indicate how efficiently the assets are utilized by a company. While return on equity and return on assets are the profitability ratios of a business entity. 323. (b) Dividend pay out ratio indicates the amount of dividend paid out of net profit earned by the company. Net profit margin represents the amount of profit as a percentage of total sales. Inventory turnover ratio implies how efficiently the inventories are used by a company while acid test ratio shows the liquidity status for a company. But fixed chares coverage ratio represents the ability of a firm to meet its financial obligations to make service the debts as well as to pay the lease rentals. 324. (b) The financial risk of a firm may be estimated by using the leverage and coverage ratios while the earning potential of a company may be evaluated through the profitability ratios. The operational and the level of efficiency in utilizing the assets may measured by using the turnover ratios. But price-earnings ratio is used to determine the expected market price per share of the company. One may project the EPS of a company for the next few years and thereafter by assuming the continuity of the same P/E multiple, the future market price per share may be calculated. 325. (d) If the company resorts to external borrowings by issuing debentures or from the financial institutions, the debt-to-total assets will go up. Using short-term funds for the long-term purposes and vice-versa does not serve the purpose and may lead to the liquidity mismatch. However, further issue of the equity shares through rights issue will increase the share capital that may be used to retire the old debt – partially or wholly – thereby reducing the debtequity ratio. 326. (c) In index number trend analysis, every figure for the first year is considered as 100 percent while the corresponding figures for the subsequent years are mentioned as a percentage of the first year figure. In cross-sectional analysis, the relevant figures are presented for more than one companies while in year-to-year change analysis, the respective ratios or data as required, are presented without making any change. In commonsize analysis, every element in the balance sheet is presented as a percentage of the total asset or total liabilities whereas the figures of the income statement are presented as a percentage of the sales value. There is no analysis called as expected annual income analysis. 327. (d) As the debt-equity ratio of the company is higher than the other companies in the same industry, the company can be termed to have a higher than average financial risk in comparison to the other companies in the same industry for the higher debt burdens. So, its borrowing capacity is less compared to its peers. It has the higher probability to experience some difficulties with its creditors in future. The creditworthiness of the company is at low level owing to the higher interest burden and also its ability to meet the financial commitments towards its stakeholders. 328. (c) Asset turnover of a company is defined as the ratio between the sales value and total assets. High asset turnover is possible only when a company can generate a high sales volume in comparison to the amount invested in the fixed assets and current assets. 109 − 95 8 = 0.1054 109 + 95 2 15 (1 − 0.40) + 329. (d) Kd = ∴Kd = 10.54% 330. (d) In Du Pont analysis, the return on equity (ROE) is expressed as the product among net profit margin (NPM), total assets turnover ratio (TATR) and the equity multiplier (EM). But in the other cases, the interrelationships among three ratios are not observed. 94
  • 100. Part I 331. (a) In commonsize analysis, the income statement is expressed as a percentage of total sales. In index number trend analysis, every figure for the first year is considered as 100 percent while the corresponding figures for the subsequent years are mentioned as a percentage of the first year figure. In cross-sectional analysis, the relevant figures are presented for more than one company while in year-to-year change analysis, the respective ratios or data as required, are presented without making any change. In Du Pont analysis, the return on equity of the company is analyzed. Funds Flow Analysis 332. (e) Funds in funds flow statement represent either net working capital or cash. 333. (d) Conversion of all FCDs into equity shares, and bonus issue of equity shares does not result in any inflow or outflow of cash. Hence they do not appear in the cash flow statement. 334. (a) Depreciation is an appropriation of profits hence it is a source of funds. Decrease in net working capital may be because of the increase in current liabilities; hence it is a source of fund. 335. (b) Increase in liability results in inflow of cash through loan or credit. Hence it is a source of fund. 336. (d) Net income from operations is a source of funds whereas net loss from operations is a use of funds. 337. (a) Cash from operations is obtained by adding all non-cash expenses like depreciation the profit after tax or the net profit. 338. (e) Increase in provision for taxation results in increase in current liabilities and cash or credit sales at a profit increase the current assets. 339. (b) Increase in accrued expenses result in increase in current liabilities which is a decrease in working capital, hence a source. 340. (e) Decrease in working capital is a source of fund. Increase indepreciation is also a source of fund. 341. (d) Funds flow statement is a statement which explains the various sources from which funds were raised and the uses to which these funds were put. Hence evaluation of the quality of firm’s top management is not a benefit of funds flow statement analysis. 342. (d) Ratio analysis is a tool for financial analysis. 343. (c) The following assumptions are made will calculating the external fund requirement – The assets of a firm will increase proportionately to sales. – Net profit margin is constant. – Dividend pay-out ratio and debt equity ratio will remain constant. – External issue of equity ratio will remain constant. 344. (a) The net income increases the cash balance, and hence is a source of working capital as an increase in current asset increases the working capital or vice versa. 345. (e) Depreciation is an appropriation made to profits. It is a non-fund expenditure, and it is a source of internal finance. 346. (c) Current liabilities includes liquid items of duration less than a year. Hence fixed deposit made for 18 months is not an item of current liabilities. 347. (c) Payment of dividend is a use of fund. 348. (d) Decrease in inventory result in decrease in current assets and hence will not result in an increase in net working capital. 349. (b) Increase in working capital is a use of fund. 350. (a) Issue of share capital results in inflow of cash or funds in the form of capital, hence it is a source of funds. 351. (a) Taxes result in outflow of cash. Hence it is a use of fund. 95
  • 101. Financial Management 352. (b) Decrease in current liabilities is a source of funds and increase in current assets is an applications of funds. 353. (d) Increase in asset is because of use of some source to purchase then asset, hence it is a use of fund. 354. (c) Depreciation is a source of long-term internal finance which can be used for purchase of a new asset. It is not considered while preparing funds flow statement on a working capital basis. 355. (d) Decrease in prepaid expenses result in decrease of Current Assets and decrease in income tax paid in advance result in increase of in cash available for business operations. 356. (b) Issue of equity shares result in inflow of capital in the form cash and the current assets increase resulting in an increase of net working capital. 357. (b) Increase in prepaid expenses is an application of cash. 358. (d) A funds flow statement on cash basis does not show the net change in working capital. 359. (e) Funds flow statements are not helpful for the judgements of the following matters: The quality of management The ownership pattern of the company The operational efficiency of the company It also may be manipulated by the unscrupulous managers of any corporate entity. However, it may be used to detect whether short-term fund is used for the procurement of the long term asset. 360. (d) Retirement of high cost debt, the installation of a capital asset and buy back of the equity shares – are the examples of the uses of funds by a business entity. Conversion of debentures into equity shares is a matter of capital restructuring that does not lead to any financial transaction. But selling an old car today to buy a new one after three months leads to the inflow of cash to a company that may be used for the next quarter which may be considered as a source of funds to the company. 361. (b) A gross increase in fixed assets is not considered as a source of fund, but as an use of funds while making funds flow analysis on cash basis. The conditions mentioned in the other options increase cash balance of a company and hence can be termed as the source of funds for the company. 362. (e) Funds flow analysis can be studied in order to detect the imbalances in regards to the sources and uses of funds as well as for the planning for the future financing strategies. But the assessment of the market leadership for the products of the company are not reflected in the funds flow statements. 363. (e) The features related to the funds flow statements are as follows: • It does not show the changes in the ownership patterns of the company • It does not show the sources and uses of funds at any particular date in a year, that is shown in the balance sheet of the company • It cannot be considered as a snapshot picture for the operations of the business • It can also be manipulated by means of window dressing. Hence, the option (e) is correct. 364. (e) A funds flow statement is known through different terms one of them is mentioned in the given option (e). A balance sheet states the financial position of a company as on a particular date while profit and loss statement or income statement shows the financial performance of a company during a year or a particular time period. Proforma statements are prepared to project the financial position (proforma balance sheet) of a company and the financial performance (proforma income statement) of a company in future. Leverage 365. (c) Degree of total leverage is a combination of the operating and financial leverages. Thus, it is a measure of the output and EPS of the company. DOL = % Change in EBIT / % Change in output DFL = % Change in EPS / % Change in EBIT Hence DTL = DOL x DFL = % Change in EPS / % Change in output. 96
  • 102. Part I 366. (c) DFL is use to know the impact of a change in EBIT on EPS of the company. DFL is zero when the firm does not earn any operating profits. 367. (e) When the firm is operating at BEP, DTL is undefined. 368. (a) Greater the DOL, the more sensitive is EBIT to a given change in unit sales, i.e. the greater is the risk of exception losses if sales become depressed. DOL is therefore a measure of the firm’s business risk. 369. (b) Financial Break Even Point is the level of EBIT at which EPS of the company is zero and DFL is undefined. 370. (e) Leverage ratios measure the long-term solvency of a firm. Bank finance to working capital gap ratio shows the degree of firm’s reliance on short-term bank finance for financing the working capital gap. It is a liquidity ratio. 371. (a) DFL = % Change in EPS/% Change in EBIT. 372. (a) Operating leverage examines the effect of the change in the quantity produced on the EBIT of the company. DOL = Δ EBIT Δ Output 373. (e) DOL is negative at the level of output below the operating breakeven point. 374. (a) Operating leverage examines the effect of the change in the quantity produced on the EBIT of the company. Operating leverage = Contribution/EBIT 375. (e) With the help of DFL one can understand the impact of the change in EBIT on EPS of the company. 376. (b) DTL is the product of DOL and DFL and hence measures the total risk of the company. 377. (e) DTL = DOL x DFL or % Change in EPS/% Change in output = 1.5 x 2 = 3. i.e., one percent change in output will lead to 3% change in EPS. 378. (c) The combination of operating and financial leverages is the total or combined leverage. The degree of total leverage is the measure of output and EPS of the company. 379. (c) At financial break even point DFL is undefined, i.e., it is equal to infinity. 380. (d) EBIT DFL = EBIT EBIT − I − DP (I − t) EBIT – I – Dp/(1 – t) x DFL = 0 If DFL is zero then EBIT must be zero. 381. (e) Operating leverage examines the effect of the change in the quantity produced on the EBIT of the company. All the above are true regarding the degree of operating leverage. 382. (e) By calculating the DOL for various levels of output we find that there is unique DOL for each level of output, DOL is positive beyond the operating break even point, DOL is undefined at the operating break even point. 383. (a) DOL = % Change in EBIT/% Change in output. 384. (c) By calculating the DOL for various levels of output we find that there is unique DOL for each level of output, DOL is positive beyond the operating break even point, DOL is undefined at the operating break even point. 385. (d) The operating BEP is that quantity which is produced and sold at which EBIT is zero. 386. (b) EBIT EBIT EBIT − I − (DP ) /(1 − t) If preference share capital increases then the Dp increases, which in turn increases the DFL. DFL = 97
  • 103. Financial Management 387. (c) By calculating the DOL for various levels of output we find that there is unique DOL for each level of output, DOL is positive beyond the operating break even point, DOL is undefined at the operating break even point. 388. (a) Q (S – V) = contribution DOL = Q(S − V) Q(S − V) − F Increase in fixed costs then DOL increases. 389. (a) Financial leverage refers to the mix of debt and equity in the capital structure of the company. As the company becomes more financially leveraged, it becomes riskier, i.e increased use of debt financing will lead to increased financial risk. 390. (c) DOL = % Change in EBIT/% Change in quantity Operating leverage measures the sensitivity of the earnings before interest and tax to change in quantity. 391. (e) DFL = EBIT EBIT − I − (DP ) /(1 − t) When DFL is zero EBIT is also zero. Hence the firm does not earn profits, so tax liability is zero. 392. (c) The degree of operating leverage below the operational break even point will be negative. 393. (d) If the output is less than the operating break even point, then DOL will be negative. 394. (b) The following statements are correct with respect to the Degree of Operating Leverage (DOL) for the operations of a company: • Each level of output has a distinct DOL • DOL is always negative below the operating break even point • DOL is always positive above the operating break even point • DOL is undefined at the operating break even point. Hence, the option (b) is the answer. 395. (b) The following points are true with respect to the DFL of a company: • DFL helps to measure the financial risk of any corporate entity • DFL can be used to analyze the implications of retiring debts against the proceeds of the issue of the preference capital. • DOL is applied by a corporate entity for its production and sales planning • DFL is used to relate the percentage change in EPS against every percentage change in EBIT. Hence, the option (b) is the correct choice. 396. (d) At the operating break even point, the EBIT is zero i.e. the sales revenue of the company just covers the fixed and variable costs incurred by the company. Hence, the operating break even point can be expressed in quantity of sales or value of sales. 397. (c) The DOL of a company depends on the contribution margin, sales quantity and the fixed costs. It is not at all related to the interest expenses of the company. Hence, the issue of equity shares in lieu of debentures will not affect the DOL of a company. 398. (d) If a firm retires its debentures prematurely, its interest burden will come down that will decrease the financial leverage and total leverage of the company. It does not have any impact on the operating leverage of the company. So, the option (d) is correct. 98
  • 104. Part I 399. (e) As the degree of total leverage for the firm is zero, the contribution received by the firm by selling its product will also be zero or the EBIT for the firm is zero. So the option (e) is the answer. The conditions mentioned in the other options are not true, as any of such conditions cannot make the DTL to zero. 400. (c) DOL measures the business risk of the company by assessing the change in EBIT owing to a change in the level of production and sales volume. DOL has a distinct value at every level of output of a firm while it is undefined at the operating breakeven point. The concept of the degree of financial leverage is used to assess the conditions as mentioned in the option (d) and (e). So, the option (c) is correct. 401. (e) Appointment of the managers at a very high compensation package will increase the fixed cost of the company thereby decreasing the denominator of the DOL, DFL and DTL. As a result of this, these leverages will go up. So, the operating break-even point and the financial breakeven point will increase. So, the option (e) is correct 402. (c) If a firm goes for additional borrowings, its operating leverage will not be changed as the degree of operating leverage does not depend on interest expenses. Financial Forecasting 403. (c) In the trend analysis via extrapolation, the past trend in sales is identified and this trend is projected into the future. Hence, it is assumed that sales for the coming period will change to the same degree as sales changed from the prior period to the current period. 404. (a) Sustainable growth is the rate which can be maintained without resorting to external finance. 405. (e) The credit extended by the suppliers of goods and services is short-term source of finance or spontaneous source of finance. 406. (a) Financial forecasting is a planning process with which the company’s management positions the firm’s future activities relative to the expected economic, technical, competitive, and social environment. Sales forecast provides the basis around which the firm’s planning process is centered. 407. (d) The percent of sales method assumes that the future relationship between various elements of costs to sales will be similar to their historical relationship. 408. (a) The starting point in the preparation of pro forma operating statement is a projection of the unit and rupee volume of sales. 409. (a) Objective methods are statistical methods which range in sophistication from relatively simple trend extrapolations to the use of complicated mathematical models. Sales force estimates is not based on the above. It is a subjective model. 410. (d) Objective methods are statistical methods which range in sophistication from relatively simple trend extrapolations to the use of complicated mathematical models. Regression analysis is more objective than any other model. 411. (a) EFR = A/S (S) – L/S (S) – mS (1 – d) This equation highlights that the amount of external financing depends on the firm’s projected growth in sales. 412. (d) The percent of sales method assumes that the future relationship between various elements of costs to sales will be similar to their historical relationship and the cost elements remain unchanged. 413. (c) To prepare the pro forma income statement the percent of sales method is used in the estimation of cost of goods sold and budgeted expense method is used for estimating the value of various items on the basis of expected developments in the future period. 414. (d) The methods which use the judgments or opinions of knowledgeable individuals within the company are called the subjective methods. Regression analysis and trend analysis are objective methods of financial forecasting. 99
  • 105. Financial Management 415. (b) g = m(1 − d) A/E A/SO − m (1 − d) A/E The above equation depicts the rate of growth without resorting to external financing. When there is decrease in the dividend payout ratio then the growth increases. 416. (a) g = m(1 − d) A/E A/SO − m (1 − d) A/E The above equation depicts the rate of growth without resorting to external financing. When the net profit margin increases the growth rate also increase. 417. (d) The assumptions for the sustainable growth rate are as follows: • The assets of the firm will increase proportionately to sales • Net profit margin is constant • Dividend pay-out ratio, not the amount of dividend and debt-equity ratio will remain constant • External issue of equity will not be resorted to Therefore, the alternative (d) is the correct choice. 418. (b) The trend analysis, through the method of extrapolation and regression analysis are used for the projection of sales volume of the company. The future relationship between various costs to sales is assumed to follow historical relationship in case of percent of sales method. But in budgeted expense method, the estimation of the various items is considered on the basis of the expected changes to be happened in the market for the preparation of the proforma income statement. Hence, the option (b) is the answer. 419. (e) In Jury of Executive opinion method, the personal judgements of many senior executives from different fields are taken into account while in sales force estimates method, the personal judgement of the sales personnel operating at the ground level are considered. But mathematical tools and techniques are applied in the methods mentioned in the options (c) and (d). Hence, the option (e) is answer. 420. (c) DTL = Q (S − V) Q (S − V) − F − I − = Dp (1 − t ) 6000 (500 - 200) 6000 (500 - 200) − 8,00,000 − 80,000 − 60,000 (1- 0.40 ) = 2.195. 421. (b) The future relationship between various costs to sales is assumed to follow historical relationship in case of percent of sales method. But in budgeted expense method, the estimation of the various items are considered on the basis of the expected developments in the context of the preparation of the proforma income statement. Trend analysis and regression analysis are used for the projection of sales volume of the company. Hence, the option (b) is the answer. 100
  • 106. Frequently Used Formulae Time Value of Money 1. Nominal interest rate = Real rate of interest or return + Expected rate of inflation + Risk premiums to compensate for uncertainty. 2. Future Value of a single cash flow = FVn = PV(1 + k)n Where FVn – Future Value of the initial flow ‘n’ years hence PV – Initial cash flow K – Annual rate of interest n – Life of investment. 3. Doubling Period (i) Rule of 72: 72/number of years (ii) Rule of 69: 0.35 + 4. 69 interest rate Future value for shorter compounding periods k⎞ ⎛ FVn = PV ⎜1 + ⎟ ⎝ m⎠ mxn m – number of times compounding is done during a year n – number of years for which compounding is done. 5. Relationship between Effective and Nominal rates of interest: m k⎞ ⎛ r = ⎜1 + ⎟ – 1 ⎝ m⎠ r – Effective rate of interest k – Nominal rate of interest m – Frequency of compounding per year. 6. ⎡ (1 + k) n − 1 ⎤ Future value of Annuity FVAn = A ⎢ ⎥ k ⎣ ⎦ A = Amount deposited/invested at the end of every year for ‘n’ years. K = Rate of interest n = Time horizon FVAn = Accumulation at the end of ‘n’ years. k 7. Sinking Fund Factor = 8. Present Value of a single flow PV = 9. (1 + k) n − 1 FVn (1 + k) n Present value of an annuity ⎡ (1 + k) n − 1 ⎤ PVAn = A × ⎢ n ⎥ ⎣ k(1 + k) ⎦
  • 107. 10. Capital Recovery Factor = K(1 + k) n (1 + k) n − 1 11. Present value of Perpetuity P∞ = A x PVIFA k,∞ . Risk and Return 1 1. n ⎡ 1 ⎤2 Standard deviation = σ = ⎢ ∑ (rit − ri )2 ⎥ ⎣ (n − 1) t =1 ⎦ 2. Variance = σ 2 3. Covariance = σ12 = 4. Coefficient of correlation = ρ12 = 5. Variance of portfolio = σ 2 = p Σ(x1 − x1 )(x 2 − x 2 ) (n − 1) σ12 σ1 x σ 2 n ∑ σi2 Wi2 + i=t 6. β = 8. ∑ σ2j Wj2 +2 ∑ Covij Wi Wj j=t 2 Systematic risk of a security = βi2 σ m 7. n 2 Unsystematic risk = σi2 (1 − ρim ). σ im σ2 m Valuation of Securities 1. V0 (or P0) = C1 1 (1 + k) + C2 (1 + k) + .. + 2 n Cn (1 + k) n = C t ∑ (1 + k)t t =1 Where, V0 Value of the asset at time zero P0 = Present value of the asset Ct = Expected cash flow at the end of period t k = Discount rate or required rate of return on the cash flows n 2. = = Expected life of an asset. Instrinsic value or the present value of a bond: n V0 (or P0) = 1 ∑ (1 + k t =1 d) t + F (1 + k d )n = I (PVIFA(k d ,n) ) + F (PVIF(k d ,n) ) V0 Where, V0 P0 I F n Intrinsic value of the bond Present value of the bond Annual interest payable on the bond Principal amount (par value) repayable at the maturity time Maturity period of the bond kd 102 = = = = = = Cost of Capital.
  • 108. 3. The bond values with semi-annual interest 2n = V0 I/2 ∑ (1 + k t =1 d / 2) t + F (1 + k d / 2)2n = I/2 (PVIFA(k d / 2,2n) ) + F(PVIFA(k d / 2,2n) ) Where, V0 = Value of the bond I/2 = Semi-annual interest payment F = Par value of the bond payable at maturity kd/2 = 2n 4. Required rate of return for the half-year period Maturity period expressed in half-yearly periods. = One period rate of return ⎛ Pr ice gain or loss ⎞ ⎛ Coupon int erest ⎞ ⎜ during holding period ⎟ + ⎜ (if paid) ⎟ ⎠ ⎠ ⎝ = ⎝ Purchase price at the beginning of ⎞ ⎛ ⎜ ⎟ the holding period ⎝ ⎠ 5. ∴ Current Yield = 6. P0 = n 1 ∑ (1 + k t =1 7. d) t + Coupon interest Current Market Price F (1 + k d )n As trial and error method calculations are too tedious the following approximation formula can be employed to find out the approximate YTM on a bond. I + (F − P) / n I + (F − P) / n or 0.4F + 0.6P (F + P) / 2 YTM Where, YTM = Yield to maturity I = Annual interest payment F = Par value or redemption value of the bond P = Current market price of the bond n = Years to maturity. 8. Conversion value = Conversion Ratio x Stock’s Current Market Price. 9. The value of convertible is determined as follows: n C ∑ (1 + r)t + (Pn ) x Conversion ratio t =1 (1 + r)n Where, C = Coupon r = Required rate of return Pn = Expected price of equity share on conversion n = Number of years to maturity. 103
  • 109. 10. According to single period valuation model D1 P1 + (1 + k e ) (1 + k e ) P0 = Where, P0 = Current market price of the share D1 = Expected dividend a year hence P1 = Expected price of the share a year hence ke = Required rate of return on the equity share. 11. According to multi-period valuation model = P0 D1 1 (1 + k e ) Where, P0 D1 D2 D∞ + D2 (1 + k e ) 2 + ... + D∞ (1 + k e ) ∞ ∞ = D ∑ (1 + kt t =1 e) t = = = = = ke Current market price of the equity share Expected dividend a year hence Expected dividend two years hence Expected dividend at infinite duration Expected rate of return or required rate of return. 12. Valuation with Constant Dividends Assume that the dividend per share is constant year after year, whose value is D, then value of share is determined as follows: D P0 = 1 (1 + k e ) + D (1 + k e ) 2 + ... + D (1 + k e )∞ The above on simplification becomes P= D ke 13. Valuation with Constant Growth in Dividends It is assumed that dividends tend to increase over time because business firms usually grow over time. Therefore, if the growth of the dividends is at a constant compound rate than: = D0(1 + g)t Dt = Dividend for year t D0 = Dividend for year 0 g = Constant compound growth rate. Dt Where, The valuation of the share where dividend increases at a constant, compound rate becomes P0 = D1 D (1 + g) D1 (1 + g) 2 + 1 + + ..... (1 + k e ) (1 + k e ) 2 (1 + k e )3 On simplification P0 = D1 ke − g 14. Valuation with Variable Growth in Dividends Some firms have a super normal growth rate followed by a normal growth rate. If the dividends move in line with the growth rate, the price of the equity share of such firm would be 104
  • 110. P0 = D (1 + g a ) D1 (1 + g e ) n −1 D n (1 + g n ) n −1 D n (1 + g n ) 2 D1 + 1 + + + + ..... (1 + k e ) (1 + k e )2 (1 + k e ) n (1 + k e ) n +1 (1 + k e ) n + 2 Where, P0 = Price of the equity share D1 = Expected dividend a year hence ga = Super normal growth rate of dividends gn = Normal growth rate of dividends. 15. Book Value = Net worth (Paid-up equity capital + Reserves + Surplus) ÷ Number of outstanding equity shares. 16. Liquidation value per share is equal to: ⎛ Value realized from liquidating ⎞ ⎛ Amount to be paid to all the ⎞ ⎜ ⎟−⎜ ⎟ all the assets of the firm Creditors and preference shareholders ⎠ ⎝ ⎠ ⎝ Number of outs tan ding equity shares 17. P/E Ratio = Expected earnings per share x Appropriate price – Earnings ratio The expected earnings per share is: Expected PAT − Pr eference dividend Number of outs tan ding equity shares 18. E(P/E) = PV per share E(EPS) 19. E(P/E) = D 1 D / E(EPS) × or k − g E(EPS) (k − g) Financial Statement Analysis Ratios LIQUIDITY Current Ratio Quick Ratio Inventory Turnover Definition Current Assets Current Liabilities Current Assets − Inventor Current Liabilities Cost of GoodsSold or Sales Average Inventory LEVERAGE Debt-equity Ratio Total Debt Net worth Debt-asset Ratio Total Debt Total Assets Interest Coverage Ratio EBIT Interest PROFITABILITY Gross Profit Margin Gross Pr ofit Net Sales 105
  • 111. Net Profit Margin Net Pr ofit Net Sales Return on Equity Net Income Average Equity Earning Power Assets Turnover EBIT Average Total Assets Sales Average Assets Leverage 1. LY/LX = ΔY / X ΔX / X Where, LY/LX Measure of the leverage which dependent Y has with independent X ΔX – Change in X ΔY – Change in Y ΔX X – Percentage change in X ΔY Y 2. – – Percentage change in Y. Total Revenue = Quantity Sold(Q) x Selling Price (S) Hence, EBIT = Q x S – Q x V – F = Q(S – V) – F EPS = [(EBIT – I) (1 – T) – DP]/N = [Q(S − V) − F − I] (1 − T) − D P N Where, N 3. = DOL = = Number of Equity Shareholders. Percentage change in EBIT / Percentage change in Output ΔEBIT / EBIT ΔQ / Q EBIT = Q(S – V) – F Substituting for EBIT, we get DOL = [Q(S – V)] / [Q(S – V) – F]. DFL = (Percentage change in EPS) / (Percentage change in EBIT) DFL = 4. ( Δ EPS/EPS) / ( Δ EBIT/EBIT) Substituting Eq.(ii) for EPS we get DFL = EBIT EBIT − 1 − 106 DP (1 − T)
  • 112. 5. DTL = = DTL = = % change in EPS / % change in output ( Δ EPS / EPS) ( Δ Q/Q) DOL x DFL {[Q(S – V)]/[Q(S – V) – F]} x {[Q(S – V) – F]/ Q(S – V) – F – I – [Dp/1–T)]} Q(S − V) = Q(S − V) − F − I − 6. DP (1 − T) The overall break even point is that level of output at which the DTL will be underfined and EPS is equal to zero. This level of output can be calculated as follows: DP (1 − T) (S − V) F +1+ Q = Financial Forecasting 1. EFR = A L (ΔS) − (ΔS) − mS1 (1 − d) S S Where, EFR = A/S = Expected increase in sales L/S = Spontaneous liabilities as proportion of sales m = Net profit margin S1 = Projected sales for next year d g= Current assets and Fixed assets as proportion of sales ΔS = 2. External financing requirement = Dividend pay-out ratio. m(1 − d)A / E . A / S0 − m(1 − d)A / E 107
  • 113. Part II: Problems Indian Financial System 1. 2. 3. 4. If 182-day T-Bills are issued at a discounted price of Rs.96.52, then the yield is a. 6.98% b. 7.13% c. 7.23% d. 7.58% e. 8.05%. If 364-day T-bills of face value Rs.100 are issued at a yield of 11.50%, then the issue price is a. Rs.88.50 b. Rs.89.69 c. Rs.89.71 d. Rs.89.78 e. Rs.89.88. If the bid received by RBI from a bank for a 364-day T-Bill having a face value of Rs.100 is Rs.88.24, and the bank calculates yield based on 365-day year, the yield to the bank will be a. 11.760% b. 11.792% c. 13.291% d. 13.327% e. 13.364%. Mr. B purchases a 91-day T-bill on 12.06.99 at Rs.98.12. The bill has a maturity of 61 days. The yield realized by Mr. B by holding the bill till maturity is a. 5.87% b. 6.10% c. 7.54% d. 7.69% e. 11.46%. Time Value of Money 5. X deposited Rs.1,00,000 on retirement in a bank which can be withdrawn Rs.16,274 annually for a period for 10 years. What is the interest rate? a. b. 20% c. 10% d. 8%. e. 6. 14%. 18%. Vision Ltd., an NBFC offers car loans with two schemes. Scheme A offers 10% discount on cash payment. Scheme B asks for a down payment of Rs.18,000 and Rs.4,100 per month for 5 years. If the cost of the car is Rs.2.5 lakhs and the required rate of return is 9%, which of the following represents the present value of cash inflows of both the Schemes? a. Rs.2,50,000; Rs.2,17,000. b. Rs.2,25,000; Rs.2,17,000. c. Rs.2,25,00;Rs.2,17,182. d. Rs.2,25,0000; Rs.2,17,582. e. Rs.2,35,000; Rs.2,17,500.
  • 114. Part II 7. Mr. Rohit is considering two options for investing Rs.5,000 for 4 years. In the first option, he will get an assured return of Rs.7,000 plus percentage gain on the sensex at the end of 4th year over today’s closing index. The second option assures him an interest rate of 15% p.a. compounded annually. Today’s closing index = 4000, Sensex at the end of 4th year = 5000. What amount will Rohit receive at he end of 4th year, if he is considering, the two options independently? a. Rs.8,250; Rs.8,545. b. Rs.8,250; Rs.8,745. c. Rs.8,545; Rs.8,745. d. Rs.8,645; Rs.8,845. e. Rs.8,745; Rs.8,845. 8. Which of the following alternatives gives the highest return assuming an interest of 14% per annum? a. Rs.1,00,000 now. b. Rs.2,00,000 after 6 years. c. Rs.15,000 p.a. in perpetuity d. Rs.1,000 per month for a year and Rs.95,000 at the end of the year. e. Rs.18,000 per year for the next 10 years. 9. How much amount should be deposited today in order to receive Rs.5,000 next year, and which grows at the rate of 4% forever? Assume that the discount rate is 14% per annum. a. Rs.50 b. Rs.500 c. Rs.5,000 d. Rs.50,000 e. Rs.5,00,000. 10. Hi-tech Ltd., offers a scheme under which an investor has to deposit Rs.1,500 per year for a period of 10 years. After he can get back Rs.23,905 at the end of 10th year. What is the irrelevant interest rate. a. 10% b. 12% c. 13% d. 14% e. 20% 11. Ms. Sunita needs Rs.1,00,000 after 10 years. She can receive the required amount at the desired time under two schemes. Under scheme A, she has to invest Rs.10,000 at the end of every year for the first four years. Under scheme B, she has to invest Rs.5,000 at the end of every year for the first 8 years. What are the implied interest rates in both the schemes? a. 12.69%, 16.87%. b. 12.85%, 16.79%. c. 12.36%, 16.61%. d. 12.69%, 16.97%. e. 12.41%, 16.54%. 12. Ms. Kusum has retired recently. She received Rs.5 lakh as her retirement benefits, which she had invested in a bank at 15% rate of interest. If she expects to live independently for another 15 years, how much money she can withdraw at the end of every year so as to leave a nil balance in her account at the end of maturity? a. Rs.40,65,040. b. Rs.85,514. c. Rs.61,448. d. Rs.10,509. e. Rs.4,064. 109
  • 115. Financial Management 13. Mr. Amol wants to have an annual income of Rs.60,000 starting from the 11th year, which should increase to Rs.90,000 from the 16th year and should continue till perpetuity. At 15% rate of interest, how much should he invest amount annually for 10 years to get the desired returns? a. Rs.24,592. b. Rs.99,486. c. Rs.14,687. d. Rs.5941.4. e. Rs.1,23,411. 14. Mr. Rajan Lal requires a sum of Rs.10 lakh at the end of 5 years from now for his son’s education. He is considering the following alternatives to accumulate the funds required: i. Deposit a fixed sum in bank at the beginning of every year for five years, which will fetch him on maturity an amount equal to Rs.10 lakh. Bank pays him interest at the rate of 12% p.a. ii. Buy a plot now by borrowing the amount required to buy it and sell it after 5 years so that it realizes Rs.10 lakh. He has identified an area in which the market price is expected to grow at the rate of 24% per annum. The purchase price is repayable in 5 equal installments at the beginning of each year, the first installment being paid now. The loan carries interest at the rate of 18% p.a. What is the outflow of funds required for Mr. Rajan Lal under both the options? a. 1.00 lakh; 0.90 lakh. b. 1.41 lakh; 0.92 lakh. c. 1.42 lakh; 0.95 lakh. d. 1.45 lakh; 0.95 lakh. e. 1.47 lakh; 0.97 lakh. 15. Mr. Chandramouli Singh is considering to take a life insurance policy of LIC for 20 years. The insurance agent is advising him to take a money back policy. The scheme offers money back at the end of 5th, 10th, 15th and 20th year to the extent of 25%, 25%, 25% and 25% of the insured amount. The premium he will have to pay is Rs.62 annually for every Rs.1,000 insured. The insurance agent also, informs him that he will get a minimum bonus to the extent of 40% at the end of the insurance term. Mr. Singh is of the opinion that the premium for the money back policy is on the higher side. If the banks are offering a rate of 11% on the long-term deposits, what is the effective return (K) on the policy and advise Mr. Singh. a. K = –2.56% and it is advisable for Mr. Singh to go for policy b. K = 2.56% and it is advisable for Mr. Singh to go for policy c. K = 2.56 % and it is not advisable for Mr. Singh to go for policy d. K = –2.56% and it is not advisable for Mr. Singh to go for policy e. None of the above. 16. Mr. Farooq is considering to purchase a commercial complex that will generate a net cash flow of Rs.4,00,000 at the end of one year. The future cash flows are expected to grow at the rate of 4% per annum. Mr. Farooq’s required rate of return is 12%. How much sould Mr. Farooq pay for the complex if it produces cash flows forever. a. b. Rs.50,000 c. Rs.5,00,000 d. Rs.50,00,000 e. 110 Rs.20,00,000 Rs.2,00,000.
  • 116. Part II 17. Mr. Prasad is considering to purchase a commercial complex that will generate a net cash flow of Rs.4,00,000 at the end of one year. The future cash flows are expected to grow at the rate of 4% per annum. Mr. Prasad’s required rate of return is 12%. Mr. Prasad would be willing to pay the amount of ________ for the complex if he wishes to sell it at the end of four years at Rs.40 lakh, net of transaction costs. a. Rs.49,58,921 b. Rs.38,26,958 c. Rs.1,56,13,927 d. Rs.1,61,51,256 e. Rs.1,82,77,509. 18. Modern Textiles Ltd., has to redeem debentures worth Rs.1 crore by paying Rs.30 lakh at the end of 8th year, Rs.30 lakh at the end of 9th year and Rs.40 lakh at the end of 10th year from now. How much amount should the firm deposit in a sinking fund account at the end of every year for 7 years in order to meet the aforementioned payments? (Assume that the interest rate earned on the deposit account is 8% per annum). a. Rs.49,73,803 b. Rs.4,97,380 c. Rs.9,55,410 d. Rs.95,541 e. Rs.9,550. 19. The present value of cash flows of Rs.950 per year forever at an interest rate of 8% and 10% are _________ and _____________ respectively. a. Rs.9,375 and Rs.7,500 b. Rs.8,500 and Rs.9,670 c. Rs.11,875 and Rs.9,500 d. Rs.7,345 and Rs.9,450 e. Rs.9,150 and Rs.8,965. 20. The present value of Rs.4,500 receivable in 7 years at a discount rate of 15% is __________. a. Rs.975 b. Rs.1150 c. Rs.1692 d. Rs.1890 e. Rs.1555. 21. The present value of an annuity of Rs.8,000 starting in 7 years time lasting for 7 years at a discount rate of 10% is ______ a. Rs.16,000 b. Rs.21,964 c. Rs.24,750 d. Rs.16,875 e. Rs.15,700. 22. The present value of an annuity of Rs.550 starting after 1 year for 6 years at an interest rate of 12% is ______. a. Rs.5,435 b. Rs.4,712 c. Rs.2,261 d. Rs.2,795 e. Rs.5,195. 111
  • 117. Financial Management 23. The present value of an annuity of Rs.1,300 starting immediately and lasting until 9th year at a discount rate of 20% is _______ a. Rs.5,755 b. Rs.4,586 c. Rs.6,798 d. Rs.6,288 e. Rs.5,915. 24. The present value of a perpetuity of Rs.800 starting in the beginning of year 3 at a discount rate of 18% is ___ a. Rs.24,160 b. Rs.2,796 c. Rs.3,191 d. Rs.2,831 e. Rs.1,794. 25. _____ is the present worth of operating expenditures of Rs.4,00,000 per year which are assumed to be incurred continuously throughout in 8 year period if the effective annual rate of interest is 12%. a. Rs.15,75,000 b. Rs.19,87,200 c. Rs.14,27,995 d. Rs.15,67,813 e. Rs.18,27,500. 26. Kiran Automobiles purchases a machinery for Rs.8,00,000 by making a down payment of Rs.1,50,000 and remainder in equal installments of Rs.1,50,000 for six years. The rate of interest to the firm is ______. a. 10% approximately b. 11% approximately c. 8% approximately d. 14% approximately e. 6% approximately. 27. Ten years from now Mr. X will start receiving a pension of Rs.8,000 a year. The payment will continue for sixteen years. If his interest rate is 10%, now the worth of pension is ______. a. Rs.24,160 b. Rs.18,760 c. Rs.21,365 d. Rs.23,414 e. Rs.20,775. 28. Assume that a deposit is to be made at year zero into an account that will earn 8% compounded annually. It is desired to withdraw Rs.6,000 after three years from now and Rs.7,000 after six years from now. The size of the year zero deposit that will produce these future payments is _______. a. Rs.8,400 b. Rs.9,650 c. Rs.11,000 d. Rs.9,174 e. 112 Rs.8,120.
  • 118. Part II 29. _______is the minimum amount which a person should be ready to accept today from a debtor who otherwise has to pay a sum of Rs.4,000 today Rs.5,000, Rs.7,000 and Rs.8,000 and Rs.10,000 at the end of year 1, 2, 3 and 4 respectively from today. The rate of interest may be taken at 14%. a. Rs. 29,540 b. Rs. 28,409 c. Rs. 25,000 d. Rs. 18,750 e. Rs. 25,088. 30. The present value of the investment Rs.7,500 due in 10 years discounted @10 percent annual rate is _______. a. Rs.1,009.10 b. Rs.2,038.95 c. Rs.2,891.57 d. Rs.3,195.80 e. Rs.6,610.75. 31. The fixed deposit scheme of ICICI Bank offers the following interest rates. Period of deposit Rate per annum 58 days to 187 days 12.0% 188 days to < 1 year 12.5% I year and above 13.0% An amount of Rs.1,00,000 invested today will grow in 3 years to __________ a. Rs.1,55,000 b. Rs.1,44,200 c. Rs.1,67,500 d. Rs.1,52,000 e. Rs.1,45,000. 32. What is the doubling period according to the ‘Rule of 69’ if the interest rate is 18%? a. 4.45 yrs. b. 4.90 yrs. c. 5.67 yrs d. 5.28 yrs. e. 4.18 yrs. 33. If you deposit Rs.10,000 today at 12% rate of interest, in how many years does this amount grow to Rs.80,000 (Use ‘Rule of 72’)? a. 6 years b. 12 years c. 18 years d. 14 years e. 24 years. 34. What is the future value of Rs.20,000 invested now for a period of 5 years at an interest rate of 8%? a. Rs.29,380. b. Rs.41,350. c. Rs.30,710. d. Rs.20,700. e. Rs.28,000. 113
  • 119. Financial Management 35. What is the future value of the following series of payments @ 5% rate of interest at the end of 5 years? At the end of 1st year = Rs.2,000 2nd year = Rs.3,000 3rd year = Rs.4,000 4th year = Rs.5,000 5th year = Rs.6,000 a. Rs.14,750. b. Rs.12,516. c. Rs.21,559. d. Rs.16,041. e. Rs.15,000. 36. The present value of Rs.20,000 to be received after five years from now assuming 6% time preference for money is ______. a. Rs.14,940 b. Rs.16,776 c. Rs.12,551 d. Rs.11,500 e. Rs.20,740. 37. The present value of the following cash flows assuming a discount rate of 8% is _______ Year Cash flows 1 Rs.30,000 2 Rs.20,000 3 Rs.10,000 4 Rs.10,000 a. Rs.60,210 b. Rs.35,165 c. Rs.41,210 d. Rs.50,500 e. Rs.46,785. 38. Mr. A has to receive Rs.9,000 per year for 6 years. The present value of the annuity is ______, assuming that he can earn interest on his investment @12% p.a. a. Rs.22,750 b. Rs.15,650 c. Rs.36,999 d. Rs.18,975 e. Rs.32,515. 39. The amount of equal annual payment to be made for a loan of Rs.4,00,000, taken for a period of 4 years @10% rate of interest is _________. a. Rs.64,009.60 b. Rs.63,091.48 c. Rs.71,568.10 d. Rs.1,26,183 e. Rs.1,76,000. 40. A company offers to pay you Rs.4,025 annually for 8 years if you deposit Rs.20,000 today with the company. The interest rate earned will be ______. a. 13% b. 16% c. 18% d. 12% e. 22%. 114
  • 120. Part II 41. An investment company offers to pay Rs.25,959 at the end of 10 years to investors who deposit annually Rs.1,000. The implied interest rate is __ a. 12% b. 14% c. 16% d. 18% e. 20% 42. If you deposit Rs.20,000 today at 12% rate of interest, in how many years will this amount grow to Rs.80,000 using rule of 72. a. 10 years b. 12 years c. 14 years d. 16 years e. 18 years. 43. Payment of a 9-years annuity of Rs.10,000 will begin 7 years hence. The value of this annuity now if the discount rate is 12%? a. Rs.44,315. b. Rs.27,000. c. Rs.35,675. d. Rs.13,400. e. Rs.22,975. 44. X deposits Rs.1,00,000 on retirement in a bank which pays 10% annual interest. How much can be draw annually for a period of ten years if PVIFA @10% is 6.145. a. Rs.16,273.79 b. Rs.18,797.10 c. Rs.20,000 d. Rs.11,567.15 e. Rs.15,850. 45. At the time of his retirement Mr. Swamy is given a choice between two alternatives. i. An annual pension of Rs.20,000 as long as he lives. ii. A lump sum payment of Rs.1,50,000. If Mr. X expects to live for 15 years and rate of interest is 15%, which alternative should he select. a. Option (i) only. b. Option (ii) only. c. Both (a) and (b) above d. Either (a) or (b) e. None of the above. 46. A person can save Rs. ________ annually to accumulate Rs.4,00,000 by the end of 10 years, if the saving earns an interest of 12 percent. a. 22,795 b. 18,500 c. 25,700 d. 21,350 e. 19,475. 115
  • 121. Financial Management 47. Ram expects to receive Rs.1,000 annually for 3 years, each receipt occurring at the end of the year. What is the present value of this stream of benefits if the discount rate is 10%? a. Rs.3,568.50. b. Rs.2,486.85. c. Rs.3,541.19. d. Rs.2,796.71. e. Rs.3,119.18. 48. Andhra Bank has opened a scheme to all individuals/firms. A lump sum deposit is remitted and the principal is received with interest at the rate of 12 percent p.a. in 12 monthly installments. The interest is compounded at quarterly intervals. The amount of initial deposit to receive a monthly installment of Rs.1000 for 12 months is _________. a. Rs.19,709 b. Rs.21,756 c. Rs.18,494 d. Rs.11,256 e. Rs.10,764. 49. A intends to invest Rs.600 at the end of each of the next eight years at an interest rate of 11 percent. Determine the amount A will have at the end. a. Rs.7,384 b. Rs.7,304 c. Rs.7,117 d. Rs.6,957 e. Rs.6,845. 50. On a contract, there are two options. Option 1: Receiving Rs.25,000 six years from now Option 2: Receiving Rs.50,000 twelve years hence. What is the implied discount rate that equates these two amounts? a. 10.3%. b. 11.3%. c. 12.25%. d. 13.52%. e. 13.75%. 51. The present value of the wages receivable for the next thirty years for C is Rs.400000. If C saves 10% of his salary and invests the same at an interest rate of 12% what is the value of the savings after 30 years. a. Rs.11,18,375 b. Rs.12,00,020 c. Rs. 9,85,645 d. Rs.11,98,400 e. Rs. 9,69,725. 52. An asset appreciating at 10 percent approximately doubles in 7 years. Calculate the approximate present value of an asset that pays Rs.1 a year in perpetuity beginning from year 8. a. Rs.6 b. Rs.7 c. Rs.5 d. Rs.8 e. Rs.4. 116
  • 122. Part II 53. If an insurance firm X uses an interest rate of 5% in its calculations, what must Mr.Cohen pay at the outset for an annuity providing him Rs.10,000 per year? (Assume annual payments are at the end of each of the 15 years). What would be the purchase price if the interest rate were 10%? a. Rs.1,10,679; Rs.76,050. b. Rs.1,10,967; Rs.75,060. c. Rs.1,03,800; Rs.76,061. d. Rs.1,03,880; Rs.75,071. e. Rs.1,04,760; Rs.76,070. 54. Mr. X wants to buy a house which would cost him Rs..8, 00,000. SFCL has offered to provide 90% finance for a period of 8 years. Mr. X has to bring in 10% of the cost of the house at the time of purchase. He will borrow the amount of his contribution from one of his relatives and will pay back his relative Rs.40,000 and Rs.50,000 (which include the amount borrowed and the interest) at the end of the first year and the second year respectively. The amount borrowed from SFCL has to be repaid along with interest in equated monthly installments of Rs.12,800 each, payable at the end of every month over a period of 8 years. If Mr. X borrows 90% of the purchase price from SFCL Ltd., and the rest from his relative, the effective rate of interest per annum involved is a. 15.36% b. 16.75% c. 17.89% d. 18.00% e. 18.75%. 55. If the interest rate is 10 percent calculate the present value of an asset that pays Rs.10 a year in perpetuity, and the approximate present value of an asset paying Rs.1 every year for each of the next seven years. a. Rs.100 and Rs.5 b. Rs.100 and Rs.50 c. Rs.10 and Rs.50 d. Rs.10 and Rs.5 e. Rs.100 and Rs.7. 56. Mr. Prakash deposits Rs.100 at the beginning of every month in the recurring deposit scheme of Hyderabad Bank for five years. If the bank offers an interest rate of 12 percent per annum compounded monthly, the amount accumulated by the end of five years is (round off your answer to the nearest integer) a. Rs.7,624 b. Rs.6,121 c. Rs.8,167 d. Rs.8,249 e. Rs.8,538. 57. In order to buy a car woth Rs.5,00,000, you are planning to take loan of Rs.400,000 from a Commercial Bank. The loan is to be repaid along with interest in equated monthly installments of Rs.9,000 within a period of 5 years, payable at the end of every month. However, the margin money of Rs.100,000 is to be borrowed from a local money lender that is to be repaid with interest at a rate of 20 percent by the end of the year. What is the implicit cost of your borrowed funds? a. 12.41%. b. 12.91%. c. 13.31%. d. 13.71%. e. 14.11%. 117
  • 123. Financial Management 58. The money invested in Kisan Vikas Patra today doubles in eight years and six months. What is the approximate rate of interest per annum as per the “Rule of 69”? a. 8.08%. b. 8.23%. c. 8.47%. d. 8.53%. e. 8.68%. 59. Setwin Corp Ltd., has taken a loan of Rs.5 lakh from Sec’bad Bank at 12 percent per annum compounded annually. If the loan is to be repaid along with interest in 5 equated annual installments (where the first installment is to be paid after one year from today and the interest is calculated on the diminishing balances), what should be the amount of installment? (Round off your answer to the nearest Rs.100). a. Rs.1,47,400 b. Rs.1,38,700 c. Rs.1,55,300 d. Rs.1,23,800 e. Rs.1,25,300. 60. In order to buy a car, on January 1, 2007, presently available at a price of Rs.2,50,000, you started to deposit your money in the monthly recurring deposit scheme of a bank from January 31, 2004. The bank offers a rate of interest of 12 percent per annum compounded monthly. If the car price is expected to go up by 4 percent per annum, how much amount should you deposit every month in that scheme? (Round off your answer to the nearest integer) a. Rs.5,828 b. Rs.6,178 c. Rs.6,528 d. Rs.6,670 e. Rs.7,028. 61. If the rate of return from a security is 6 percent per annum, what is the doubling period under the ‘Rule of 72’? a. 11.85 years. b. 11.87 years. c. 12 years. d. 13 years. e. 15 years. 62. The nominal rate of interest is 6 percent per annum. What is the effective rate of interest, if it is compounded quarterly? a. 6.00%. b. 6.06%. c. 6.14%. d. 6.24%. e. 6.36%. 63. If long term rate of interest offered by a bank is 6.19 percent per annum. What is the doubling period under the “Rule of 69”? a. 11.15 years. b. 11.50 years. c. 11.85 years. d. 12.15 years. e. 12.50 years. 118
  • 124. Part II 64. You are planning to buy a car after 5 years that is presently available at a price of Rs.2,50,000. If the price is expected to go up by 20 percent by that time, how much amount should you deposit at the beginning of every year at a rate of 6 percent per annum in order to make your plan a success? a. Rs.71,225. b. Rs.67,193. c. Rs.53,220. d. Rs.50,207. e. Rs.45,038. 65. Hyderabad Finance Ltd., offers a deposit scheme where the investor is required to deposit Rs.100 at the end of every month for a period of 4 years 2 months in order to get an amount of Rs.7,500 at the end of 5 years. What is the effective rate of interest? a. 11.30%. b. 12.30%. c. 13.30%. d. 14.30%. e. 15.30%. 66. Mr. Sadhu plans to buy a house for a price of Rs.5 lakh. State Bank of India offers loan at a rate of 9 percent per annum quarterly compounded for 80 percent of the purchase price of the house. How much will be the equated monthly installments, if Mr. Sadhu plans to repay the loan with interest in the next ten years? a. Rs.5,041. b. Rs.5,142. c. Rs.5,242. d. Rs.5,342. e. Rs.5,442. 67. If a loan of Rs.3,00,000 is to be repaid in 6 annual installments with a coupon rate of 12% p.a. then the equated annual installment will be a. Rs.71,967 b. Rs.72,975 c. Rs.74,005 d. Rs.75,995 e. Rs.76,004. 68. A person took a loan of Rs.10,000 on January 1, 2003. At the end of every month he has to pay Rs.1,000 for 12 months so that his loan will be totally repaid by December 31, 2003. The implied interest rate per annum is (approximately) a. 20% b. 25% c. 28% d. 30% e. 35.1%. 69. The difference between the effective rate of return of a bond with a coupon rate of 12% when compounded monthly and quarterly is a. 0.03% b. 0.10% c. 0.13% d. 0.19% e. 0.45%. 119
  • 125. Financial Management 70. If the annual cash inflow for a bond is Rs.200, the present value of the bond, if the inflows continue for 5 years at a required rate of 11%, is a. Rs.639 b. Rs.739 c. Rs.839 d. Rs.869 e. Rs.939. 71. The fixed deposit scheme of Nagarjuna Bank offers 10% interest for a three-year deposit. If the compounding is done semi-annually, then effective annual interest rate is a. 10.00% b. 10.25% c. 10.38% d. 10.50% e. None of the above. 72. An income stream provides Rs.2000 for first three years and Rs.3000 for next three years, if interest rate is 14%, then the present value of income stream is a. Rs.8650.85 b. Rs.8860.50 c. Rs.9403.20 d. Rs.9624.25 e. Rs.9345.00. 73. Mr. Naresh deposited Rs.1000 every month in a bank for five years, if the interest rate is 12% p.a. compounded monthly, then the accumulated amount he will get after 5 years is a. Rs.44,955 b. Rs.67,200 c. Rs.81,600 d. Rs.83,264 e. Rs.96,000. 74. Tripti Foods Ltd., had taken a loan of Rs.500 lakh from a bank. The loan is to be repaid in ten equal annual installments. If the annual interest rate is 16%, then each installment is a. Rs.102.78 lakh b. Rs.103.46 lakh c. Rs.111.43 lakh d. Rs.113.50 lakh e. Rs.132.13 lakh. 75. Mr. Pandit expects to receive from his friend an amount of Rs.2000 per annum for 10 years. If his required rate of return is 12% p.a. what is the present value of these cash inflows? a. b. Rs.15,000. c. Rs.11,300. d. Rs.10,500. e. 120 Rs.20,000. Rs.10,000.
  • 126. Part II 76. If a bank agrees to pay 9 percent per annum for a certain sum of money deposited with it, and if the interests are paid semi-annually, then the effective rate of interest is a. 18.00% p.a. b. 9.00% p.a. c. 9.20% p.a. d. 10.00% p.a. e. 12.00% p.a. 77. A loan of Rs.5,00,000 is to be repaid in 10 equal annual installments. If the loan carries a rate of interest of 12% p.a., the equated annual installment is a. Rs.75,000 b. Rs.80,000 c. Rs.88,496 d. Rs.95,496 e. Rs.1,00,000. 78. If the effective annual rate of interest is 17.87%, then on a debt that has quarterly payments, what is the nominal annual rate? a. 16.78%. b. 18.92%. c. 20.93%. d. 21.00%. e. 22.36%. 79. If a share of a stock provided a 19.5% nominal rate of return while the real rate of return was 14%, then the inflation rate was a. 4.83% b. 7.18% c. 8.54% d. 10.12% e. 26.24%. 80. If a borrower promises to pay Rs.20,000 eight years from now in return for a loan of Rs.12,550 today, what effective annual interest rate is being offered? a. 1.59%. b. 5.00%. c. 6.00%. d. 7.00%. e. 7.42%. 81. Rs.10,000 is borrowed to be repaid in four equal annual payments with 8% interest. Approximately, how much principal is amortized with the first payment? a. Rs.800. b. Rs.2219. c. Rs.2500. d. Rs.3281. e. Rs.3300. 121
  • 127. Financial Management 82. If the nominal rate of interest is 10% p.a. and the frequency of compounding is 4 times a year then the effective interest rate is a. 10.38% b. 10.40% c. 10.42% d. 10.44% e. 10.46%. 83. The future value of a regular annuity of Re.1.00 earning a rate of interest of 12% p.a. for 5 years is equal to a. Rs.6.250 b. Rs.6.353 c. Rs.6.425 d. Rs.6.538 e. Rs.6.625. 84. Rs.100, 180-day T-bills is currently selling at Rs.95. The yield on the bills, assuming 365-day year is a. 10.00% b. 10.50% c. 10.67% d. 10.88% e. 11.25%. 85. What real rate of return is earned by a one year investor in a bond that was purchased for Rs.1000, has a 12% coupon and was sold for 980 when the inflation rate was 6%? a. 2%. b. 4%. c. 6%. d. 10%. e. 16%. 86. The amount that has to be invested at the end of every year for a period of 6 years at a rate of interest of 15% in order to accumulate Rs.1000 at the end of 6 years is equal to a. Rs.112.42 b. Rs.114.24 c. Rs.114.42 d. Rs.112.44 e. Rs.112.24. 87. If rate of interest is 16% and maturity period of a loan is 15 years, the sinking fund factor will be equal to a. 0.01558 b. 0.01935 c. 0.9735 d. 1.0667 e. 1.9357. 88. If the nominal rate of interest compounded quarterly is 18%, then the effective rate of interest will be equal to a. 16.6% b. 16.7% c. 16.8% d. 16.9% e. 19.25%. 122
  • 128. Part II 89. The present value of Rs.10,00,000 receivable after 60 years, at a discount rate of 10% is a. Rs.3,284 b. Rs.6,898 c. Rs.18,649 d. Rs.39,440 e. Rs.48,376. 90. If the interest rate on a loan is 1.5% per month, the effective annual rate of interest is a. 18% b. 18.63% c. 18.79% d. 19.15% e. 19.56%. 91. According to the ‘Rule of 69’, doubling period of an investment at an interest rate of 16% is a. 4.2 years b. 4.5 years c. 4.7 years d. 5.0 years e. 5.2 years. 92. If the return on a security is 6%, then what is the doubling period according to the Rule of 69 for investments in that security? a. 5.75 years. b. 11.50 years. c. 11.58 years. d. 11.85 years. e. None of the above. 93. If the interest rate is 12% p.a., the amount to be invested today to earn an annuity of Rs.1,000 for five years commencing from the end of first year is a. Rs.6,353 b. Rs.5,672 c. Rs.4,037 d Rs.3,605 e. Rs.3,037. 94. If the rate of interest is 10%, the amount that should be deposited now so that a constant annual income of Rs.10,000 can be withdrawn indefinitely is a. Rs.9,00,909 b. Rs.1,10,000 c. Rs.1,00,000 d. Rs.90,000 e. Cannot be determined. 95. If the nominal rate of interest is 16% and compounding is done quarterly, the effective rate of interest will be a. 17.52% b. 16.99% c. 16.00% d. 15.12% e. 12.49%. 123
  • 129. Financial Management 96. M/s. Lee Ltd., has Rs.10,00,000 worth of debentures to be redeemed after five years from now. If the interest rate is 14% p.a., the amount that has to be invested every year in a sinking fund to retire the above bonds is a. Rs.6,61,010 b. Rs.3,43,308 c. Rs.2,91,284 d. Rs.1,51,284 e. Rs.1,34,330. 97. ICI Ltd., promises to double your investment in 4 years 9 months. The rate of interest promised by ICI according to the ‘Rule of 69’ is a. 13.14% b. 13.53% c. 14.53% d. 15.16% e. 15.68%. 98. As per the ‘Rule of 72’, in how many years will the amount deposited today at an interest rate of 16% double? a. 4.50 years. b. 4.60 years. c. 4.62 years. d. 4.95 years. e. None of the above. 99. The amount that should be deposited now so that a constant monthly income of Rs.1,000 can be withdrawn indefinitely, if the rate of interest is 12% p.a. is a. Rs.90,000 b. Rs.1,00,000 c. Rs.1,15,000 d. Rs.9,00,900 e. Insufficient information. 100. The amount to be invested today to earn an annuity of Rs.1000 for five years commencing from the end of two years from today if the interest rate is 12% per annum is a. Rs.3,219 b. Rs.5,993 c. Rs.2,874 d. Rs.3,873 e. Rs.4,873. 101. How much is a Rupee worth today, if you can expect to receive it a year from now, with no risk of default? a. Less than Re.1. b. Re.1. c. Zero. e. 124 More than Re.1. d. Data insufficient.
  • 130. Part II 102. As per ‘Rule of 69’ in how many years will the amount deposited today at an interest rate of 15% become double? a. 4.62 years. b. 4.60 years. c. 4.95 years. d. 4.49 years. e. None of the above. 103. The IDBI deep discount bond offers investors Rs.2,00,000 after 25 years, for an initial investment of Rs.5,500. The interest rate implied in the offer is a. 14.8% b. 15% c. 15.5% d. 16.5% e. Not possible to determine from the given data. 104. Mr.Dhanasekhar borrows from Sind Bank Limited Rs.5,00,000 to be repaid within five years at an interest rate of 15% per annum on the opening balances of every year. The equated annual payment to be made by him, so that by the end of five years the entire amount of principal and interest would be repaid, is a. Rs.1,25,000 b. Rs.1,75,000 c. Rs.1,49,165 d. Rs.1,00,000 e. Rs.2,48,633. 105. Ms. D Positor has placed a deposit of Rs.5000 with Acceptor Ltd., at 15% p.a. interest compounded semi-annually. In three years her investment will grow to a. Rs.7,250 b. Rs.7,344 c. Rs.7,500 d. Rs.7,604 e. Rs.7,716. 106. How much should a company invest at the beginning of each year at 14% so that it can redeem debentures of Rs.10 lakhs at the end of year 10? a. Rs.45,363. b. Rs.48,195. c. Rs.51,714. d. Rs.65,236. e. Rs.71,535. 107. The probability that stock X will rise by 25% is 30% and the chance that it declines by 5% is 70%. The expected return and standard deviation of stock X are ________ and ________, assuming return on X and Y is 1% currently. a. Expected return = 4%, standard deviation = 13.75% b. Expected return = 4%, standard deviation = –13.75% c. Expected return = – 4%, standard deviation = 13.75% d. Expected return = 11%, standard deviation = 93.1% e. Expected return = –11%, standard deviation = 93.1%. 125
  • 131. Financial Management 108. There is a 40% chance that stock A will rise by 20% and the probability for it decline by 8% is 60%. The expected return and standard deviation of stock X are ________ and ________, assuming return on X and Y is 1% currently. a. Expected return = 4%, standard deviation = –13.75% b. Expected return = 3.0%, standard deviation = 19.02% c. Expected return = 3.2%, standard deviation = 13.72% d. Expected return = –3.0%, standard deviation = –19.02% e. Expected return = 4%, standard deviation = 19.02%. 109. The standard deviation of stock X and Y are 13% and 13% respectively. If the correlation coefficient between X and Y is 0.5% then the covariance is ________. a. 0.0084 b. 0.0090 c. 0.0087 d. 0.0088 e. 0.01. 110. For XYZ Ltd., if the market and stock returns are – 0.5 and 6.83, with beta value as 0.584 then value of alpha from the equation of characteristic line is _____. a. 7.22 b. 7.02 c. –7.02 d. –7.22 e. 7.12. 111. Given the risk-free rate is 12% and the expected return on the market portfolio is 18%. The following are the expected returns for three stocks with their betas: Expected return (%) Expected beta Stock I 19 1.5 Stock II 18.5 0.75 Stock III 22 1.4 Based on these expectations, which of the following statements is true? a. Stock I and II are overvalued whereas stock III is undervalued. b. Stock I is overvalued whereas stock II and III are undervalued. c. Stock I and II are undervalued whereas stock III is overvalued. d. Stock I and III are undervalued whereas stock II is overvalued. e. Stock I, II and III are undervalued. 112. The standard deviation of Greaves Ltd. stock is 24% and its correlation coefficient with the market portfolio is 0.5. The expected return on the market is 16% with a standard deviation of 20%. If the risk-free return is 6%, the required rate of return on Greaves Ltd., scrip is ________. a. b. –12% c. 11% d. 11.5% e. 126 12% –11%.
  • 132. Part II 113. Mr. Ramesh has the following scrips in his portfolio: Industries Beta Proportion (%) of investment Ballarpur Industries 0.95 15 GE Shipping 1.1 20 SBI 1.25 30 Ahmedabad Electric Co. 0.8 5 BSES 1.05 20 Bombay Dyeing 0.7 10 The required rate of return (%) on his portfolio is ______, if risk-free return is 4% and return on market is 14%. a. 14.575 b. 14.570 c. –14.575 d. 14.757 e. 14.857. 114. The risk-free return is 10% and the market return is 15%. Stock A has a beta of 1.2 and is currently selling for Rs.30. If the expected dividend on the stock is Rs.4, then the growth rate of the company is ______. a. 2.16 b. 2.11 c. 2.33 d. 2.67 e. 2.70. 115. The shares of Sumanta Ltd. are expected to provide the following returns in different scenarios: Scenario Probability Expected Return Recession 0.3 –10% Low growth 0.4 5% High growth 0.3 20% The standard deviation is: a. 11.0% b. –11.0% c. 11.62% d. –11.62% e. 12.0%. 116. Consider stock P and Q. The expected return on stock P and stock Q are 10% and 20% respectively. If standard deviation of stock P is 2% and stock Q is 5%, the expected return and standard deviation of a portfolio combining these two stocks in equal proportion are _____ if their correlation coefficient is 0.4. a. E(r) = 15% and standard deviation is 3.04% b. E(r) = 11% and standard deviation is 2.76% c. E(r) = 18.5% and standard deviation is 5.31% d. E(r) = 16.0% and standard deviation is 4.75% e. E(r) = 14.8% and standard deviation is 2.98%. 117. ______ is the equilibrium price of a share for which beta is 1, current dividend is Rs.2.5 per share, growth rate is 6%, risk free return is 9% and return on market is 18%. a. Rs.22 b. Rs.21.01 c. Rs.22.08 d. Rs.44 e. Rs.44.02. 127
  • 133. Financial Management 118. ABC Ltd., has following dividend per share and the market price per share for the period 2002 and 2003. Year DPS Market Price 2002 1.53 Rs.37.25 2003 1.53 28.75 The annual rate of return for year 2003 is _____. a. 18.7% b. –18.7% c. 28.7% d. –28.7% e. –27.1%. 119. Surana Industries has following dividend per share and the market price per share. Year DPS Market Price 2002 2.00 200.00 2003 2.00 280.00 The annual rate of return for the year 2003 is ___. a. 58% b. –41% c. –58% d. –56% e. 41%. 120. The following information of Ram and Co. Ltd., is available in respect of the return from security X under different economic conditions: Condition Economic Return Probability Good 18% 0.1 Average 15% 0.4 Bad 12% 0.3 Poor 5% 0.2 The expected return of the security and the risk associated with that are ______ and _________. a. 18% and 7.8% b. 14% and 8.6% c. 15% and 7.9% d. 19% and 6.4% e. 12.4% and 4.1%. 121. The market price of the share of ABC Ltd., and XYZ Ltd., are Rs.200 each. The total annual return expected under different economic condition are as follows: Condition Probability ABC Ltd XYZLtd Economic Rs. Rs. Good 0.3 200 250 Average 0.4 210 230 Bad 0.2 220 190 Poor 0.1 240 160 Using the above data the expected return and standard deviation are _________ and ______ in case of 10 shares of ABC Ltd. a. Rs.2200 and120.35% b. Rs.2120 and 116.62% c. Rs.2050 and 89.75% d. Rs.2100 and 110% e. Rs.2360 and 135.45%. 128
  • 134. Part II 122. Using the data of problem 121, the expected return and standard deviation are _______ and __________, in case of 10 shares of XYZ Ltd. a. Rs.2365 and 136.98% b. Rs.2200 and 128.71% c. Rs.2210 and 291.38% d. Rs.2400 and 250.41% e. Rs.2760 and 215.75%. 123. Assume Rf is 7%, Km is 16% for a security X and has a beta factor of 1.4, the required return of the security is _________. a. 21.6% b. 20.0% c. 17.4% d. 19.6% e. 23.2%. 124. A security Y has a beta factor of 1.0 and Rf is 9% and Km is 15%, then the required return of the security is __________. a. 17% b. 16% c. 18% d. 14% e. 15%. 125. If a security Z has a beta factor of 2.3 and Rf is 11% and Km is 17%, then the required return of the security is _________. a. 33.12% b. 20.61% c. 24.80% d. 25.8% e. 27.6%. 126. The risk-free rate is 8% and the required return on the market portfolio is 18% of security A. The required return of security A is ________ if the Beta is 2.6. a. 39.2% b. 28.76% c. 34.0% d. 41.3% e. 25.55%. 127. The standard deviation of return of security Y is 15 and of market portfolio is 10. The beta of Y is _________ if Corym = –0.25. a. 0.375 b. –0.375 c. 0.295 d. –0.295 e. –0.475. 128. From the following data beta of security x is ___. σx = 15, σm = 12 and Corxm = + 0.72. a. 1.00 b. 0.88 c. 0.73 d. 0.90 e. 1.06. 129
  • 135. Financial Management 129. An investor is seeking the price to pay for a security, whose standard deviation is 4.00 percent. The correlation coefficient for the security with the market is 0.8 and the market standard deviation is 3.2 percent. The return from the government securities is 6.2 percent and from the market portfolio is 9.8 percent. The investor knows that, by calculating the required return, he can then determine the price to pay for the security The required return on security is _________. a. 11.57% b. 10.21% c. 12.31% d. 9.8% e. 12.56%. Based on the following information, Answer Questions 130 to 133. The expected return on the market portfolio and the risk-free rate of return are estimated to be 15% and 11% respectively. XYZ Ltd., has just paid a dividend of Rs.3 per share with annual growth rate of 9%. The sensitivity index β of XYZ Ltd., has been found to be 1.2. 130. The equilibrium price for the shares of XYZ Ltd., is Rs.__________. a. 31.47 b. 48.08 c. 26.39 d. 39.41 e. 34.57. 131. If the risk Premium further increases by 2%, then the change in price is Rs.________. a. 25.00 b. 29.50 c. 35.54 d. 24.32 e. 26.00. 132. If the expected growth rate in dividends increases to 12%, then the new price is Rs._______. a. 61.50 b. 88.42 c. 57.90 d. 62.35 e. 60.15. 133. The change in price is Rs._____ if market sensitivity index of XYZ Ltd., becomes 1.5. a. 31.57 b. 48.72 c. 35.44 d. 29.72 e. 40.87. 134. The following data relate to two securities, A and B A B Expected return 32% 27% 1.5 0.7 Beta factor (β) Assume: Rf = 20% and Km = 28%. Find out whether the securities, A and B are correctly priced? a. Only security A is not correctly priced. b. Only security B is not correctly priced. c. Both security A and B are not correctly priced. d. Both Security A and B are correctly priced. e. Data provided is insufficient. 130
  • 136. Part II Based on the following information Answer Questions 135 to 137. Following information is provided concerning the returns on the shares of Zeenath Ltd., and on the market portfolio, according to the various conditions of the economy. Condition of economy (1.) (2.) (3.) Prob. of condition occurring 0.2 0.4 0.4 Return on Zeenath Ltd. 10% 15% 20% Return on market 5% 16% 18% 135. The current risk-free interest rate is 9 percent. The coefficient of correlation between the returns on Zeenath Ltd., is __________. a. 1.02 b. 0.86 c. 0.65 d. 0.89 e. 0.31. 136. The beta factor for Zeenath Ltd., is _________. a. 0.81 b. 0.75 c. 0.94 d. 0.69 e. 1.02. 137. Is Zeenath Ltd., efficiently priced according to the CAPM and the information given above? a. Share price is lower and not efficiently priced. b. Share price is higher and efficiently priced. c. Share price is equal to expected return. d. Share price is higher and not efficiently priced. e. Share price is lower and efficiently priced. Based on the following information Answer Questions 138 to 139. The following are the different state of economy, the probability of occurrence of that state and the expected rate of return from security M and N in these different states: State Probability Rate of return Security M Security N Recession 0.20 –0.25 0.30 Normal 0.50 0.30 0.40 Boom 0.30 0.70 0.50 138. The expected returns for these two securities are ___________ and _____________ a. 31%, 41% b. 27%, 35% c. 35%, 27% d. 30%, 32% e. 24%, 29%. 139. The standard deviations for Security M and Security N are ________ and ________. a. 28%, 10% b. 22.4%, 9% c. 32.92%, 7% d. 25.1%, 8% e. 23.2%, 7.5%. 131
  • 137. Financial Management 140. The following in available in respect of securities X and Y. β Expected return X 2.8 42.00% Y 2.6 40.40% Security Are these securities correctly priced? a. Both securities are not correctly priced. b. Both Securities are correctly priced. c. Security X is correctly priced. d. Security Y is correctly priced. e. Data provided above is insufficient. 141. A certain equity stock consists of following information: Price at the beginning of the year Rs.60.00 Dividend paid at the end of the year Rs. 2.40 Price at the end of the year Rs. 69.00 Then, the rate of return on this stock is _______ a. 15% b. 16% c. 17%