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Question Paper

Investment Banking and Financial Services – I (261) : July 2002


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

1. Which of the following is/are true regarding Participation Certificates?


I. They are issued by banks to other banks to share the credit assets of the banks.
II. They provide long term funds while they are also used for risk reduction.
III. The rate of these instruments is negotiable.

a. Only (I) above


b. Only (III) above
c. Both (I) and (II) above
d. Both (I) and (III) above
e. All (I), (II) and (III) above.
2. Which of the following is/are true regarding reverse repos?
I. Simultaneous buying and selling of same security at a predetermined future date
and predetermined price is referred to as reverse repo
II. NBFCs cannot enter into reverse repos
III. The minimum maturity for repo transaction is 1 day.

a. Only (I) above


b. Only (II) above
c. Only (III) above
d. Both (I) and (II) above
e. Both (I) and (III) above.
3. The maximum intra-day trading limit for a broker, as set by SEBI, is
a. 33.33% of the base minimum capital
b. 33.33% of the base minimum capital and additional capital
c. Equal to base minimum capital and additional capital
d. 33.33 times the base minimum capital
e. 33.33 times the base minimum capital and additional capital.
4. Which of the following is/are true regarding Bankers to the Issue?
I. A scheduled bank can be a banker to the issue.
II. Registration with SEBI to act as banker to the issue is not mandatory
III. There are no restrictions on the number of banks that can be associated with an
issue.

a. Only (II) above


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

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5. Which of the following is/are true regarding financial and operating leases?
a. According to FASB, if the present value of lease payments exceed 75 per cent of the
fair market value of the asset at the inception of the lease, then the lease is termed as
financial lease.
b. In operating leases, the leases fully amortize over the lease period.
c. In an operating lease if the lessee bears the cost of insuring, maintaining , then the lease
is referred to as dry lease.
d. The lessee enjoys the right to terminate the lease at short notice without significant
penalty in case of financial leases.
e. Operating leases are generally structured for leasing investment intensive assets.
6. Easy Finance offers hire purchase plan for its corporate borrowers on the following terms:
Flat rate of interest 10 per cent
Repayment period 4 years
Frequency of payment Quarterly in advance
Down payment 25 per cent
The annual percentage rate using the approximation formula is
a. 28.4%
b. 26.7%
c. 21.3%
d. 18.8%
e. 16.0%.
7. Which of the following is/are true regarding Mortgage Backed securitization?
I. Mortgage has to exist necessarily at the time of securitization
II. It is backed by movable and easily traceable immovable property
III. It gives high yields to the investor compared to asset backed securitization

a. Only (I) above


b. Only (II) above
c. Both (I) and (II) above
d. Both (II) and (III) above
e. All (I), (II) and (III) above.
8. Recently, RBI issued a tender notification for 91-day treasury bills of Rs.100 each for
Rs.500 crores. Mr.X, one of the competitive bidders who responded to the notification has
submitted the tender quoting a price of Rs.98.95. If the cut-off price was determined as
Rs.98.45 and the tender of Mr.X was accepted, the yield that would be earned by Mr.X will be
a. 3.95%
b. 3.97%
c. 4.26%
d. 5.21%
e. 6.31%.
9. Appointment of which of the following intermediaries is/are mandatory for an issue?
a. Brokers to the issue
b. Underwriters to the issue
c. Legal advisor
d. Bankers to the issue
e. Both (a) and (d) above.

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10. Which of the following is/are true regarding Pledged-account Mortgages (PAMs)?
I. The repayments under PAMs resemble graduated payment mortgages from the
borrower’s point of view
II. Under PAMs, a pledged account is created by the seller out of his profits in order
that additional amounts required may be drawn and paid along with the mortgage
payments
III. PAMs are used by borrowers who have sufficient cash on hand, but face an
income or cash flow shortage for the first few years.
a. Only (I) above
b. Only (II) above
c. Both (I) and (II) above
d. Both (I) and (III) above
e. All (I), (II) and (III) above.
11. In which of the following forms of factoring, service elements of factoring are not carried by
the factor?
a. Invoice Discounting
b. Supplier Guarantee Factoring
c. Bulk Factoring
d. Old Line Factoring
e. Both (a) and (c) above.
12. Which of the following conditions should a company fulfill to raise capital through ADR
level -III issue?
a. The company has to comply with the US GAAP
b. The company has to be registered with SEC
c. The company has to comply with listing requirements of AMEX/ NYSE
d. Both (a) and (b) above
e. All (a), (b) and (c) above.
13. Consider the following information regarding a finance scheme offered by Flexi Finance
Ltd.:
Repayment Period 60 months
Equated monthly Installment Rs. 3,500
Deposit Rs. 10,000
Cost of the asset Rs.1,25,000.
The flat rate of interest of the above scheme is
a. 11.1%
b. 12.0%
c. 13.6%
d. 15.2%
e. 16.5%
14. The US dollar denominated bond issued by foreign borrowers in the US market is known as
a. Alpine bonds
b. Bulldog bonds
c. Samurai bonds
d. Shibosai bonds
e. Yankee bonds.

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15. Which of the following is/are true regarding Commercial Papers (CPs)?
I. Primary dealers are not allowed to raise funds through CPs
II. Foreign institutional investors are allowed to invest in CPs
III. Issuers are allowed to buy-back their own CPs.
a. Only (II) above
b. Both (I) and (II) above
c. Both (I) and (III) above
d. Both (II) and (III) above
e. All (I), (II) and (III) above.
16. XYZ Ltd. has accepted public deposits amounting to Rs.25 lakhs that are payable after 15
months. The maximum amount of brokerage payable for soliciting these deposits is
a. Rs.25,000
b. Rs.30,000
c. Rs.37,500
d. Rs.50,000
e. Rs.62,500.
17. Rights issue should be kept open for a minimum period of
a. 15 days
b. 30 days
c. 40 days
d. 45 days
e. 60 days.
18. Vani Agro Products Ltd has leased an equipment costing Rs.100 lakhs at an annual lease
rental of Rs.36 ptpm for a period of 3 years. The cost of capital and cost of pre-tax debt of
the company is 9 per cent and 15 per cent respectively. If the effective tax rate of the
company is 25%, according to Bower Model the amount of debt which will be raised in lieu
of lease will be equal to
a. Rs. 98.63 lakhs
b. Rs.100.00 lakhs
c. Rs.113.42 lakhs
d. Rs.125.54 lakhs
e. Rs.130.60 lakhs.
19. Which of the following forms of real estate loans advanced by savings and loan associations
in addition to the bank construction loan enables the developer to obtain 100% financing for
the real estate development without the need to bring in personal funds?
a. Mini-perms
b. Gap loans
c. Bow-tie arrangement
d. Both (a) and (b) above
e. None of the above.

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20. Which of the following is/are true regarding hire purchase contract?
I. On early repayment, if interest rebate is calculated as per Rule of 78, the effective
rate of interest on completed transaction will be lower than the effective interest
rate of original transaction
2 t 
II. Interest rebate calculated as per Hire purchase Act, 1972 (i.e.  × × D  will be
3 n 
lower than the interest rebate as per Rule of 78 if the number of unpaid and not-
due installments exceed 2/3 × (number of installments – 1)
III. Interest rebate calculated as per Modified Rule of 78 will be zero if not-due and
outstanding installments is less than or equal to the deferment period
a. Only (II) above
b. Only (III) above
c. Both (I) and (II) above
d. Both (II) and (III) above
e. All (I), (II) and (III) above.
21. The maximum reservation in a proposed public issue to the employees of the issuer company
is
a. 3%
b. 5%
c. 10%
d. 20%
e. 25%
22. If a bank issued a Certificate of Deposit of face value of Rs.5 lakhs with maturity period of
91 days and at a discount rate of 9 per cent per annum, the discounted value of the deposit is
a. Rs.4,89,027
b. Rs.4,58,716
c. Rs.4,57,422
d. Rs.2,85,321
e. Rs.3,63,750.
23. Second Factors Ltd. has agreed to advance a sum of Rs.75 lakhs against the receivables
purchased from ABC Ltd. The factoring agreement provides for an advance payment of 75%
of value of the factored receivables and for guaranteed payment after 3 months from the date
of purchasing the receivables. The advance carries a rate of interest of 16% p.a. compounded
quarterly and the factoring commission is 1 percent of the value of the factored receivables.
Both the interest and commission are collected upfront. The per annum effective cost of
funds made available to ABC Ltd. is
a. 16.92%
b. 17.74%
c. 18.02%
d. 23.10%
e. 24.49%.
24. Consider the following information:
Aggregate value of the house Rs.12,00,000
Land component 30%
Progress of construction 75%
Borrower’s contribution Rs.2,00,000
Cumulative disbursement made Rs.4,00,000
The amount of disbursement that will be made by the housing finance company is
a. Rs.2,41,000
b. Rs.3,90,000
c. Rs.5,90,000
d. Rs.7,90,000
e. Rs.9,60,000.

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25. Which of the following is/are true regarding rights issue by listed companies?
I. If the rights issue exceeds Rs.40 lakhs, appointment of SEBI registered merchant
banker is mandatory
II. If the company does not receive atleast 90% of the issue amount (including
devolvement from underwriters) within 42 days from the date of closing the issue,
the amount received should be refunded.
III. No bonus issue should be made within 1 year from the date of issue.

a. Only (I) above


b. Only (II) above
c. Both (I) and (II) above
d. Both (II) and (III) above
e. All (I), (II) and (III) above.
26. In which of the following types of plastic money, revolving credit payment is available to the
user?
a. Credit card
b. Debit card
c. Charge card
d. Both (a) and (c) above
e. None of the above.
27. Which of the following is false with respect to credit rating?
a. A credit rating reflects borrower’s accountability
b. A credit rating reflects the borrower’s expected capability and interest to pay the
interest and principal amount on time
c. A credit rating is a general purpose evaluation of the issuer
d. A credit rating is not an extensive audit of the issuing company
e. A credit rating involves issue specific evaluation.
28. Videsh Electronics Limited has leased an equipment costing Rs.70 lakhs from Perfect Leases
Limited for a period of 4 years at a lease rental of Rs.350 ptpa payable annually in advance.
If the marginal cost of debt and marginal cost of capital of Videsh is16 per cent and 12 per
cent respectively, of Perfect Leases Ltd. is 12 percent and 10 percent respectively, the asset
should be capitalized at
(Assume negligible salvage value of the asset).
a. Rs.70.00 lakhs in the books of Videsh Electronics Ltd.
b. Rs.70.00 lakhs in the books of Perfect Leases Ltd.
c. Rs.74.41 lakhs in the books of Perfect Leases Ltd.
d. Rs.79.52 lakhs in the books of Videsh Electronics Ltd.
e. Rs.79.52 lakhs in the books of Perfect Leases Ltd.
29. ABC Finance Ltd. had share underwriting obligations worth Rs.5 lakhs in its off balance
sheet items. The risk adjusted value of the item while calculating the capital adequacy ratio is
a. Rs.1.25 lakhs
b. Rs.2.50 lakhs
c. Rs.3.75 lakhs
d. Rs.5.00 lakhs
e. Rs.7.50 lakhs.
30. Quasi-equity instruments for funding venture companies entailing a minimum obligation at
reasonably low levels of performance and an upside sharing component
a. Are the least preferred financial instruments by the venture companies
b. Involve payments during the growth phase of the investee company
c. May carry with them a number of protective covenants
d. Cannot be structured
e. Both (b) and (c) above.

END OF PART A
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Part B : Problems (50 Points)
• This part consists of questions with serial number 1 – 5.
• Answer all questions.
• Points are indicated against each question.
• Detailed workings should form part of your answer.
• Do not spend more than 110 - 120 minutes on Part B.
1. Zed Pharma Ltd. (ZPL) requires a plant costing Rs.20 crore for its expansion program. The inflows from
the expansion are estimated to begin from the end of one year. The life of the required plant is 5 years and
the salvage value at the end of 5 years is estimated to be negligible. The tax relevant rate of depreciation of
the plant is 25%. ZPL has approached Siti Financial Services Ltd. (SFSL) to fund its investment through
leasing.
SFSL offers leasing, hire purchase and bill discounting facilities to its customers. SFSL, under leasing
structures flexible lease transactions so that it earns a gross yield of 24% p.a. To match with its inflows
ZPL has requested SFSL to structure the lease transaction in such a way that the lease payments would
begin from the end of one year and increase at the rate of 4% p.a. for a period of 4 years. SFSL requires
quarterly in advance lease payments. However, assume the lease payments during a year are equal.
SFSL, alternatively, has offered the hire purchase facility for a period of 5 years under which it charges a
flat rate of interest of 14%. Under hire purchase, SFSL requires quarterly in advance hire payments.
The marginal cost of debt and capital of ZPL is 16% and 12% respectively and its marginal tax rate is 35%.
The allocation of interest is based on SOYD method.
Assume that under hire purchase, SFSL will agree for deferment of the first four quarter payments to be
paid along with the fifth quarter payment without any substantial penalty from ZPL.
You are required to
a. Determine the lease rentals payable by ZPL.
b. Compare lease and hire purchase facilities from the view point of ZPL and choose the best alternative
of funding its investment.
(4 + 11 = 15 points)
2. Raj Techno Park, a newly built techno park, proposed to raise a foreign currency loan worth Euro 10
million for further expansion. A foreign bank has given a proposal of extending the loan in Euro on the
following terms and conditions:
Draw down Euro 6 million on August 01, 2002 and Euro 4 million on August 01, 2003
Coupon Paid annually at 250 BPs over LIBOR
Commitment fee 50 BPs per annum payable at the end of the year
Management fee 40 BPs payable upfront
Guarantee fee 60 BPs per annum payable at the beginning of the year
Agency fee 0.05 percent of the loan amount sanctioned, payable at the end of every year
Underwriting fee 15 BPs payable upfront
Amortization Euro 5 million payable on July 31, 2007
Euro 5 million payable on July 31, 2008
The following LIBOR rates and the exchange rates as on the payment day during the year are predicted by
Raj Techno Park:
Year LIBOR (%) Rs./Euro
2002 3.0 46
2003 3.5 48
2004 3.8 50
2005 4.2 48
2006 4.6 47
2007 4.4 46
2008 4.3 45

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Assume the foreign bank will release the loan in Euro which will be converted in to rupees by the borrower
and the borrower will repay the loan in Euro to the foreign bank at the prevailing exchange rate as
predicted above.
You are required to determine whether Raj Techno Park should avail the loan or not if the maximum
effective cost of loan to Raj Techno Park is 6%.
(9 points)
3. The following balance sheet pertains to Geekay Ltd. for the year ending March 31, 2002:
(Rs. Crore)
Liabilities Amount Assets Amount
Share Capital Net Fixed Assets 14.75
Authorized Share capital
40.00 Investments 2.50
(4 cr shares of Rs.10 each)
Issued and Paid up 8.00
Current Assets 6.00
(1.cr. shares of Rs.8 each)
Reserves
General reserve 5.00
Capital redemption reserve 1.50
Capital reserve 0.75
Revaluation reserve 0.50
Share Premium 1.00 8.75
16% FCDs 2.00
Secured Loans 3.00
Current liabilities & Provisions 1.50
23.25 23.25
The following information is extracted from the books of Geekay Ltd.
i. Capital reserve consists of Rs.50 lakhs profit realized on sale of some old machinery during the
year.
ii. Geekay Ltd. purchased some valuable patents from Beekay Ltd. The purchase consideration of
Rs.60 lakhs being settled by allotting 6 lakh equity shares of Geekay Ltd.
iii. FCDs of face value of Rs.150 each is due to be converted to 3 equity shares of
Rs.50 each on October 2002.
iv. Revaluation reserves consists of Rs.40 lakhs which was realized on a machinery that was
revalued earlier and sold during the year 2001-2002 at its revalued amount.
The Board of directors of Geekay Ltd. are intending to utilize the reserves to make the partly paid shares
fully paid up and declare bonus issue at its AGM to be held during July 2002.
You are required to
a. Compute the maximum permissible bonus ratio.
b. State the latest by which date, Geekay Ltd. has to implement this proposal of bonus issue.
(7 + 1 = 8 points)
4. First Venture Biotechnics Ltd. (FVBL) has projected their next year sales at Rs.400 crores. The finance
manager of FVBL has developed an analysis on their management as follows:
Terms of credit 1/15, net 30
th
Proportion of customers paying on 15 day 20%
Proportion of customers paying on 30th day 50%
Proportion of customers paying on 50th day 30%
Bad-debts to sales ratio 0.01
Jai Hind Bank finances 70% of receivables at 20% p.a. and the balance 30% is financed through own funds
at a pre-tax cost of 26%.
The finance manager of FVBL was approached by Best Factor Services Ltd. and was offered the following
factoring arrangement.

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a. Factor’s commission of 2.5% will be charged
b. Factor shall advance 75% of the face value of receivables
c. 50% of the factor reserves will be provided by National Bank Ltd. at the rate of 22% p.a. and the
balance of money will be remitted on 30th day of sales
d. The factoring is of non-recourse type.
The finance manager of FVBL estimates to avoid the following costs if factoring is availed:
i. Cost of accounting and collection of receivables of Rs.1 crores
ii. Loss of sales of Rs.20 crores on account of using the sales force on collection of receivables. The
gross profit margin on sales is 23.25%.
Assume 360 days in a year.
You are required to find out the maximum interest rate that can be payable by FVBL on the factor
advances so that factoring is beneficial when compared to the in-house management of receivables.
(9 points)
5. Mega Financial Services Ltd. (MFSL) offers finance to individuals to purchase four wheelers on the
following terms:
i. Deposit of 20% of the cost of the asset should be made at the inception of the transaction.
ii. 48 EMIs have to be made each at the beginning of every month
iii. Front end service charge of 2% should be made.
Deposit carries an interest of 12% p.a. compounded monthly and would be repaid on the payment of the
last installment.
You are required to:
a. Calculate the maximum monthly payments to be made by a borrower if his effective cost of fund is
20% p.a. and cost of the asset is Rs.3 lakhs.
b. Calculate the flat rate of interest of the above transaction. Assume the EMIs as obtained in (a) above.
c. Calculate the effective interest rate on the completed transaction if the borrower would like to make
the prepayment at the end of 36 months. The company offers an interest rebate calculated in
accordance with the Rule of 78 method. Assume the EMIs as obtained in (a) above.
(4 + 1 + 4 = 9 points)
END OF PART B

Part C : Applied Theory (20 Points)


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

6. The Indian venture capital industry has attempted to maintain the risk-reward sharing nature of the
relationship through a variety of innovative instruments for structuring the investment. Discuss the various
categories of investments in the Indian venture capital industry.
(10 points)
7. RBI has introduced Commercial Papers (CPs) with a view to enable highly rated corporate borrowers to
diversify their sources of short-term borrowings and also providing an additional instrument to investors.
(a) Discuss the issuing procedure of CPs and (b) state the various reasons for the underdevelopment of CPs.
(7 + 3 = 10 points)
END OF PART C

END OF QUESTION PAPER

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Suggested Answers
Investment Banking and Financial Services – I (261) : July 2002
Part A : Basic Concepts
1. Answer : (d)
Reason : Statement I is “true” because the major activity of a bank is credit accommodation, which places
the bank in a tight liquidity position. In order to ease their liquidity position. The banks can share
their credit risk with other banks by issuing participation certificates. Statement III is also “true”.
The rate at which the participation certificates are issued is negotiable and depends upon the
interest rate scenario. Statement II is “False” because the participation certificates can be used
for providing short-term funds and also for risk reduction. Therefore (d) is the correct
alternative.
2. Answer : (e)
Reason : Statement I is “true”; Reverse repos are forward deals or agreements involving buying of a
security with an undertaking to sell the same security at a predetermined price and time in future.
Hence it involves a simultaneous buying and selling. Statement (III) is true; From 10th October
2000, the minimum maturity for repo transactions is reduced to 1 day following the
recommendations of Narasimham Committee. Statement II is “false” because NBFCs are
permitted to enter into both repo and reverse repo transactions. Therefore ‘e’ is correct
alternative.
3. Answer : (e)
Reason : As a part of the capital adequacy norms for the brokers, SEBI had directed that the intra-day
trading limits for a broker would be 33 1/3 times the sum of their base minimum capital and
additional capital.
4. Answer : (e)
Reason : Statement I is “true”; it is one of pre-conditions that the banker to issue should be a scheduled
bank before SEBI grants a Certificate of Registration as banker to issue. Statement III is also
“true”; there are no restrictions on the number of banks that can be associated with an issue.
Each bank designates one particular branch as the controlling branch. Statement II is “False”
because registration with SEBI is mandatory for offering services as Banker to an issue.
Therefore ‘e’ is the right answer.
5. Answer : (c)
Reason : Statement ‘c’ is true; an operating lease where the lessee bears the costs of insuring and
maintaining the leased equipment is called a ‘dry lease’. Statement ‘a’ is not true. According to
the FASB definition, if the lease term exceeds 75% of the useful life of the asset or if the present
value of the minimum lease payments exceeds 90% of the fair market value of the asset at the
inception of the lease, it is termed as finance lease. Statement ‘b’ is not true because in operating
leases, the lease is not fully amortised. Statement ‘d’ is false because the lessee enjoys the right
to terminate the lease at short notice without any significant penalty in a operating lease (and not
in finance lease). Statement ‘e’ is not true because finance leases are structured for leasing
investment intensive assets and operating leases are generally structured in Sunrise Industries
which are characterized by high degree of technological risk. Therefore ‘c’ is the right answer.
6. Answer : (c)
Reason : Given that the payments are made in advance, according to Approximation Formula,
n
Iapp = × 2.F
n −1
N = no. of payments = 4 × 4 = 16
F = 10%
16
∴ Iapp = × 2 × 0.1
15
= 21.33%

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7. Answer : (c)
Reason : Statement (I) and (II) are true; In Mortgage Backed Securitization, (MBS) mortgage has to exist
necessarily at the time of securitization and it is backed by easily traceable immovable property
like real estate. Statement (III) is false; MBS gives low yields to the investors compared to the
Asset Backed Securitization. Therefore, ‘c’ is the right answer.
8. Answer : (c)
 FaceValue  365
Reason : Yield in Treasury Bills =  −1 ×
 Price  No. of days to maturity
F. value = 100
Price = 98.95
Days to maturity = 91
 100  365
∴ Yield =  − 1 × = 0.04256
 98.95  91
= 4.26%
The cut-off price is immaterial for the calculation of yield to the investor as auction of T-Bills
are done according to English Auction.
9. Answer : (d)
Reason : Only the appointment of Bankers to the issue is mandatory for an issue. Appointment of other
intermediaries like Brokers, Underwriters and legal advisor to the issue is optional and not
mandatory.
10. Answer : (d)
Reason : Statements (I) and (III) are true. Pledged – Account Mortgages (PAMs) are structured such that
the repayments resemble traditional mortgages from the lender’s point of view and the
repayments resemble Graduated Payment Mortgages (GPMs) from the borrower’s point of view.
Also PAMs are used by borrowers who have sufficient cash on hand, but face an income or cash
flow shortage for first few years. Statement (II) is untrue because it is under Buy Down Loans
(and not PAMs) that a pledged account is created by the seller out of his profits in order that
additional amounts required may be drawn and paid along with mortgage payments done by the
borrower. Therefore ‘d’ is the correct alternative.
11. Answer : (e)
Reason : Invoice Discounting a form of factoring in which the factor provides pre-payment but does not
carry the service elements of factoring. If the invoice discounting facility is not confidential, the
customers of the client are advised to make payment directly to the factor. In such a case Invoice
Discounting is referred to as ‘Bulk Factoring’. In supplier Guarantee Factoring, the factor offers
services like following up with the customer, etc and in old-line factoring the factor provides the
entire spectrum of services. Therefore (e) is the correct alternative.
12. Answer : (e)
Reason : ADRs are divided into 3 levels based on the regulation and privilege of each company’s issue.
ADR Level-III is used for raising fresh capital through public offering in the US capital markets.
The company has to be registered with the SEC and comply with the listing requirements of
MAEX/NYSE while following the US-GAAP. Thus company should fulfill all the conditions.
Hence, ‘e’ is the correct alternative.
13. Answer : (c)
Reason : Loan amount = Rs.1,25,000
Repayment period = 60 months.
Total charge for credit = (3500 × 60) – 1,25,000
= Rs.85,000
85,000
∴ Annual charge = = Rs.17,000
5
Annual charge 17,000
∴ Flat rate of interest = ×100 = ×100
Loan amount 1,25,000
= 13.6%

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14. Answer : (e)
Reason : Yankee bonds are the US dollar denominated issues by foreign borrowers (usually foreign
governments or entities, supranational and highly rated corporate borrowers) in the US bond
markets. Bulldog bonds are sterling denominated foreign bonds which are raised in the UK
domestic securities market. Samurai bonds are bonds issued by non-Japanese borrowers in the
domestic Japanese markets. Shibosai bonds are privately placed bonds issued in the Japanese
markets. Hence ‘e’ is the right answer.
15. Answer : (d)
Reason : Statements (II) and (III) are true; Recently SEBI has permitted foreign institutional investors
(FIIs) to invest in Commercial Papers (CPs) within a ceiling of $ 1.5 billion of total FII inflows
for debt funds set down by RBI. Unlike in Certificate of Deposits (CDs), the issuer can buy-back
its own CPs. Statement (I) is wrong; Since any private sector company, public sector unit, non-
banking company, Primary Dealers (PDs), Satellite Dealers (SDs), etc. can raise funds through
CPs. Hence (d) is the right alternative.
16. Answer : (c)
Reason : Brokerage is 1.5% of the amount of public deposits raised if the tenure of the deposit is between
one and two years.
∴ Brokerage = 25,00,000 × 0.015
= 37,500.
17. Answer : (d)
Reason : According to SEBI guidelines a rights issue should be kept open for a minimum of 30 days and
a maximum of 60 days. Hence, (b) is the correct answer.
18. Answer : (b)
Reason : According to Bower’s model, the amount of debt raised in lieu of lease is equal to the cost of
leased equipment i.e. Rs.100 lakhs.
19. Answer : (c)
Reason : Gap loans are lent by both larger and smaller savings and loan associations to the developer to
cover the gap between the bank construction loan and the total cost of the project. They provide
100% financing to the developer without the need to bring in personal funds or to form a
partnership. Also the developer is entitled to usual percentage of profits.
Alternatives (a) and (b) are not correct because Bow-ties and Mini perms protect the borrowers
from volatile interest rates. They provide short-term loans as a bridge finance until the developer
can obtain financing of a permanent nature.
20. Answer : (b)
Reason : Statements (II) and (III) are true. If ‘t’ (number of installments unpaid and not-due) exceeds
2
× (n – 1), the Rule of 78 will provide an interest rebate higher than the amount calculated as
3
2 t
per the formula × × D. According to the Modified Rule of 78, if the number of unpaid
3 n
and not-due installments are less than the deferment period, interest rebate will be Zero.
Statement (I) is false; if the hirer opts for an early repayment and gets interest rebate according
to Rule of 78, then he will pay an effective rate of interest higher than that implied by original
transaction.
21. Answer : (c)
Reason : According to SEBI Guidelines, the maximum reservation in a public issue for the employees of
the issuer company is 10%.

12
22. Answer : (a)
F
Reason : Discounted value (DR) =
 Ix N 
1 +  
 100 x 365 
F – Face Value – Rs.5,00,000
I – discount rate – 9%
N – Days to Maturity – 91 days

5,00,000
DR = = Rs.4,89,027
 9 x 91 
1+  
 100 x 365 
23. Answer : (c)
Reason : Funds made available to ABC Ltd. :
Maximum permissible Advance 75 lakhs
Less: Commission @ 1% on factored 1 lakhs
 75 
receivables  × 0.01
 0.75 
74 lakhs
90
Less: Discount @ 16% = 75 × 0.16 × 3 lakhs
360
∴ Funds available to ABC Ltd. 71 lakhs
3
Discount charge expressed as percentage of funds available = ×100 = 4.23%
71
Effective cost of funds per annum = [(1.0423)4 – 1] × 100 = 18.02%.
24. Answer : (b)
Reason : Amount of disbursement (RD) is calculated as follows:
Given Aggregate value (AV) = Rs.12,00,000
Land component (LC) = 30%
à Cost of construction (CC) = 70%
Progress of construction (PC) = 75%
Borrower’s contribution (BC) = Rs.2,00,000
Cumulative Disbursement made (CM) = Rs.4,00,000
∴ RD = AV × CC/100 × PC/100 + AV × LC/100 – BC – CM
70 75 30
= 12,00,000 × × + 12,00,000 × – 2,00,000 – 4,00,000
100 100 100
= Rs.3,90,000
25. Answer : (d)
Reason : Statements (II) and (III) are true; If the company does not receive at least 90% of the issued
amount (including accepted devolvement from underwrites), within 42 days from the date of
closing the issue, the amount of subscription received is required to be refunded. No bonus issue
is to be made within 12 months from the date of issue. Statement (I) is wrong; when issue of
shares by way of rights by a listed company does not exceed Rs.50 lakhs, appointment of a
merchant banker is not mandatory.

13
26. Answer : (a)
Reason : Revolving credit facility on amount of payment is available to credit card holders. In case of
charge card, amount of payment is 100% of the purchase and in case of debt card, the holder is
required to open a deposit account and on every purchase, the amount of purchase is directly
debited to his account.
27. Answer : (c)
Reason : Credit rating is not done to evaluate the issuer. Rating reflects the borrower’s accountability,
expected capability and inclination to pay interest and principal in a timely manner. It involves
issue-specific evaluation. Rating is not an extensive audit of the issuing company.
28. Answer : (a)
Reason : According to the new ICAI guidelines, the leased asset should be capitalized in the books of
lessee at the fair market value or the present value of the minimum payments, whichever is
lower.
i. Fair Market Value of the equipment – Rs.70 lakhs
ii. Present value of the minimum lease payments for Videsh is:

 350 
=  70 x  × PVIFA(16,4) × 1.16
 1000 
= (70 x 0.35) × 2.798 × 1.16
= Rs.79.52 lakhs
As the present value of the minimum lease payments is more than the fair market value, the asset
should be capitalized at Rs.70 lakhs in Videsh Electronics Ltd.
Perfect Leases Ltd. should record the present value of lease rentals as part of current assets.
29. Answer : (b)
Reason : The risk adjusted value of any off-balance sheet item is calculated by multiplying the face value
of each of the balance sheet items by the “credit conversion factor” (in percent) For the
shares/debenture underwriting obligations, conversion factor is 50%
∴ If ABC Finance Ltd. had share underwriting obligations worth Rs.5 lakhs in its off-balance
sheet items, risk adjusted value = 5 × 0.5 = Rs.2.5 lakhs
30. Answer : (e)
Reason : Quasi-equity instruments come in the form of a loan on which there is a minimum obligation
contracted at reasonably low levels irrespective of performance and an upside sharing
component. Sometimes they come with a number of protective covenants including option to
appoint nominee(s) and occasionally an option to convert the loan into equity shares in the
investee company. They also involve cash pay-outs from the investee company during its growth
phase, when the company needs to conserve case. Hence, (b) and (c) are true. Term loans are
generally least preferred financial instruments.

14
Part B : Problems
1. a. Let the lease rentals payable by ZPL be Rs.x crores per quarter in the second year.
Then,
PV of lease rentals =
[4x × i/d4 PVIF24,1 + 4x(1.04)PVIF 24,2 i/d4 + 4x (1.04)2 PVIF 24, 3 i/d4
+ 4x(1.04)3 PVIF 24,4 i/d4] PVIF 24,1
= 4x × i/d4 [PVIF 24,1 + 1.04 PVIF 24,2 + (1.04)2 PVIF 24,3 + (1.04)3 PVIF 24,4] PVIF 24,1
= 4x × 1.146 [0.806 + 1.04 × 0.65 + (1.04)2 0.524 + (1.04)3 0.423] × 0.806
= 11.573x × 0.806 = Rs.9.328x
At the gross yield of 24% p.a.,
PV of lease rentals = Investment cost
⇒ 9.328x = 20
20
x = = Rs.2.144 crores.
9.328
b. Cost of leasing
i. PV of lease rentals at pre-tax cost of debt of 16%
= 4x × i/d4 [PVIF16,1 + 1.04 PVIF16,2 + (1.04)2 PVIF16,3 + (1.04)3 PVIF16,4] PVIF16,1
= 4.392x [0.862 + 0.773 + 0.693 + 0.621] 0.862
= 11.165x = 11.165 × 2.144 = Rs.23.938 crores
ii. PV of tax shield on lease payments
= PVIF12,1 × 4 x 2.14 + [PVIF12,1 + 1.04 PVIF12,2 + (1.04)2 PVIF12,3 + (1.04)3 PVIF12,4] 0.35
= 0.893 × 4 × 2.144 [0.893 + 0.797 × 1.04 + 0.712 + 1.042 + 0.636 × 1.043] 0.35
= 7.658 [3.207] 0.35
= Rs.8.596 crores
Cost of leasing = (i) – (ii)
= 23.938 – 8.596
= Rs.15.342
Cost of Hire Purchase:
20 × 0.14 × 5 + 20
Quarterly hire installments = = Rs.1.7 crores
5× 4
iii. PV of hire rentals = 4 × 1.7 PVIF16,1 + 4 × 1.7 PVIFA16,4 PVIF16,1 × i/d4
= 5.862 + 18.010
= Rs.23.872 crores
Total charge for credit = 20 × 0. 14 × 5 = Rs.14 crores
Allocation of total charge based on SOYD method
(Rs. crores)
PVIF factor
Year SOYD Factor Charge PV
@ 12%
1 (20 + 19 + 18 + 17)/1+---+20 = 74/210 4.933 0.893 4.405
2 (16 + 15 + 14 + 13)/1+---+20 = 58/210 3.867 0.797 3.082
3 (12 + 11 + 10 + 9)/1+----+20 = 42/210 2.800 0.712 1.994
4 (8 + 7 + 6 + 5)/1+----+20 = 26/210 1.733 0.636 1.102
5 (4 + 3 + 2 + 1)/1+----+20 = 10/210 0.667 0.568 0.379
10.962
iv. PV of tax shield on charge for credit
= 10.962 × 0.35 = Rs.3.837 crores
v. PV of depreciation tax shield
= [5 PVIF12,1 + 3.75 PVIF12,2 + 2.81 PVIF12,3 + 2.11PVIF12,4 + 1.58 PVIF12,5] 0.35
= 11.694 × 0.35 = Rs.4.093 crores.
COHP = (iii) – (iv) – (v)
= 23.872 – 3.837 – 4.093 = Rs.15.942 crores
Since COL < COHP, leasing should be preferred.
15
2. (million Euros)
August August August August August August August
2002 2003 2004 2005 2006 2007 2008
A. (Inflow) (6.000) (4.000)
Outflows :
Coupon – 0.360 0.630 0.670 0.710 0.690 0.340
Commitment fee – 0.020 – – – – –
Management fee 0.040 – – – – – –
Guarantee fee 0.036 0.060 0.060 0.060 0.060 0.030 –
Agency fee – 0.005 0.005 0.005 0.005 0.005 0.005
Underwriting fee 0.015 – – – – – –
Amortization – – – – – 5.000 5.000
Net cashflow in Euros (5.909) (3.555) 0.695 0.735 0.775 5.725 5.345
Ex Rate Rs/Euro 46 48 50 48 47 46 45
NCF in Rs. (271.814) (170.64) 34.75 35.28 36.425 263.35 240.525
PV @ 6% (271.814) (160.981) 30.927 29.622 28.852 196.79 169.561
Raj Techno Park will avail the loan if the PV of inflows is more than the PV of outflows at the cost of 6%
(or) the net cash outflow is less than zero
As the net cash outflow at 6% is Rs.22.958 million, the company should not avail the loan.

3. a. Computation of eligible reserves;


Rs. Crores
Share premium (1.00 – 0.12) 0.88
General Reserve 5.00
Capital Redemption Reserve 1.50
Capital Reserve 0.50
Revaluation Reserve 0.40
8.28
Less: Required to make partly paid shares fully paid 2.00
Amount left for bonus issue 6.28
Computation of number of shares entitled to receive bonus shares:
Crores
Shares issued and paid up 1.00
2 crore 0.04
Shares arising out of conversion = ×3
150
1.04
6.28
Number of shares that can be issued as bonus = = 0.628 crores
10
0.628
Bonus ratio = = 0.604 i.e. for every share a bonus share of 0.604 is received.
1.04
Working Notes:
Rs. 60 lakhs
Share premium received in kind : = Rs.10 per share
6 lakh
Paid up value/share = Rs.8 per share
Total amount in kind = 2 × 6 = Rs.12 lakhs
b. According to SEBI guidelines, a company which announces its bonus issue after the approval of the
Board of Directors must implement the proposal within a period of six months from the date of such
approval and shall not have the option of changing the decision.
Therefore, since the Board of Directors have taken the decision in July 2002, the company has to
implement the proposal of bonus issue before December 2002.

16
4. Cost of in-house management of receivables:
i. Cash discount = 0.2 × 400 × 0.01 = Rs.0.8 crores
Average collection period = 0.2 × 15 + 0.5 × 30 + 0.3 × 50
= 33 days
ii. Bad debts = 0.01 × 400 = Rs.4 crores
iii. Costs of accounting and collection of receivables = Rs.1 crores
iv. Contribution forgone on lost sales = 20 × 0.2325 = Rs.4.65 crores
33 33
v. Cost of funds = 400 × 0.7 × 0.2 × + 400 × 0.3 × 0.26 × = Rs.7.99 crores
360 360
Total costs of in house management = i + ii + iii + iv + v = 0.8 + 4 + 1 + 4.65 + 7.99 = Rs.18.44 crores
Cost of factoring
vi. Factor’s commission = 0.025 × 420 =Rs.10.5 crores
30 30
vii. Cost of funds = 420 × 0.75 × x × + 420 × 0.25 × 0.5 × 0.22 ×
360 360
30
+ 420 × 0.25 × 0.5 × 0.26 ×
360
= Rs.26.25x + 2.1 crores
The maximum interest rate that is payable by FVBL on the factor advance is the value of x in the
following:
vi + vii = i + ii + iii + iv + v = 10.5 + 2.1 + 26.25x = Rs.18.44 crores
5.84
x = = 22.25%
26.25
Interest on factor advances should be maximum 22.25% p.a.

5. a. i. Cost = Rs.3 lakhs


ii. Deposit = 3 × 0.2 = Rs.0.6 lakhs
Let Monthly Installment be = Rs.M lakhs
iii. PV of Installments = 12M × i/d12 PVIFA 20%,4 = Rs.34.339M lakhs
iv. Service charge = 3 × 0.02 = Rs.0.06 lakhs
Accumulated value of deposit = 0.6 FVIF 1%, 48 = Rs.0.967 lakhs
v. PV of deposit to be collected at the end = 0.967 PVIF 20%, 4 = Rs.0.466 lakhs
EMI is ‘M’ in the following:
i – ii – iii – iv + v = 0
= +3 – 0.6 – 34.339M – 0.06 + 0.466 = 0
2.806
∴ M = = Rs.0.0817 lakhs
34.339
b. Flat rate of interest:
Total charge for credit = 0.0817 × 48 – 3 = Rs.0.9216 lakhs
0.9216
Flat rate =
4×3
= 7.68%

17
c. Total charge for credit = Rs.0.9216 lakhs
12 ×13
Interest rebate as per Rule of 78 = × 0.9216 lakhs
48 × 49
= Rs.0.06 lakhs
Amount payable on early settlement
= 0.0817 × 12 – 0.06 = Rs.0.9204 lakhs
Accumulated value of deposit by the end of 36 months = 0.6 FVIF1%, 36 = Rs.0.859 lakhs
Monthly effective interest is ‘i’ is the following.
3 – 0.6 – 0.0817 × 12 × PVIFAi,3 × i/d12 – 0.06 – 0.9204 PVIFi,3 + 0.859 PVIFi,3 = 0
At i = 20%, LHS = 0.023
At i = 18%, LHS = –0.030
By interpolation,
− 0.030
i = 18 + × 2 = 19.09%.
− 0.030 − 0.0.023

Part C: Applied Theory

6. The Indian VC industry has attempted to maintain the risk-reward sharing nature of the relationship
through a variety of innovative instruments for structuring the investment.
Essentially these could be classified into three broad categories with individual tweaks and twists to the
basic forms. These are:
i. Equity investments
ii. Quasi equity forms of hybridized debt
iii. Normal loan.
Equity Investments
Almost all VC funds/companies appear to prefer a minority position in the investee company. When its
risky the equity investment usually carries with it a number of protective covenants (especially in situations
where the VC investor is a significant stockholder) including several standard ones such as the right to
appoint nominee(s) on the Board of Directors, authority to examine books of accounts, carry out concurrent
audit and sometimes even power to veto decisions on a set of issues that may be agreed upon with the
company’s management/promoters. The timing of the disinvestment, though, will be at the VC investors’
option. The VC investor also requires the investee, through the agreement, to have the company’s stock
listed on one or more stock exchange(s) as desired by the VC investor. The pricing of the sale-back of the
equity to the promoters/management is often linked either to the market price upon listing of the scrip or
some formula. The equity investments also carry ‘a first right of refusal in favor of the promoter’. A
number of models with various terms and conditions obtain in the industry presently on this issue. What
needs to be noted is that most VC funds/investors provide the buyback ‘comfort’. It may not be inaccurate
to conclude that this provision is also in response to the Indian entrepreneur’s tendency to maximize his
share holding in the company over a period of time.
Quasi Equity Investments
Most quasi equity investments, as mentioned earlier, have evolved in response to the regulatory framework
as also to the reluctance of the average Indian entrepreneur to permit external participation in ‘his’
company’s equity. The quasi equity loans come in two broad types.
i. A loan whose servicing is linked entirely to the company’s/project’s performance and thus participate
totally in the downside and significantly in the upside in a manner agreed upon upfront.
ii. A loan on which there is a minimum obligation (be it of interest or principal) contracted at reasonably
low levels irrespective of performance and an upside sharing component.

18
In the former type the servicing is through a percentage charge on sales that is contracted upfront taking
into account the future sales and profitability of the project/company and the servicing capacity available in
the company’s cash flow. The charge is fixed at a level that would provide a discounted rate of return (on
the loan) commensurate with a high-risk equity investment. The charge payment period is normally co-
terminus with the maturity of the venture fund. Interestingly these also carry, occasionally, some collateral
cover as well such as a charge on the company’s assets. The rate of return on a reasonable set of revenue
and profitability expectations would be comparable to that achievable on equity investments. Sometimes
the charge on sales payable is subject to a cap on the total amount payable. In the latter type again two
models obtain. The VC investor either stipulates a fixed repayment schedule for the loan and a variable rate
of charge in lieu of interest; or a fixed repayment schedule, a fixed floor rate of interest and a variable
premium to share the upsides. This type of quasi equity loans also carry collateral.
The quasi-equity investments also come with a number of protective covenants including option to appoint
nominee(s) and occasionally an option to convert the loan into equity shares in the investee company in the
event of consecutive, willful default or non-achievement of some agreed upon performance milestones. The
intent in such situations is to be able to obtain control of the company and effect restructuring plans, if any
required.
Quasi-equity instruments such as the above suffer from a number of apparent shortcomings. Firstly, they
involve cash pay-outs from the investee company during the growth phase, when the company needs to
conserve cash most. A second shortcoming is from the investor’s standpoint: that of tracking and
accounting the payments and ensuring the accuracy of the sales accounting by the investee company. This
latter is also a point of potential abuse. The quasi-equity loan will perhaps continue to be a necessary evil
till such time as the pricing regime for equity issues permits equity shares to be the instrument for sharing
risk and reward equitably and providing financial incentives to the participants that matter.
Normal loans: Of all the financial instruments mentioned above, it may be safely stated that the normal
(term) loan is the least preferred alternative. The reason, presumably and understandably, is that it is not
ideally suited for VC situations where the cash flows of the firm cannot be predicted with even a reasonable
degree of certainty to be able to contract fixed repayment and interest obligations. The limited normal loans
that VCs provide appear to be to meet short-term/medium-term requirements of portfolio companies to help
them tide over temporary cash shortages. These are short-term maturities (ranging from six to eighteen
months) and carry interest at a rate equal to (or slightly higher) then the lending rate of commercial banks.

7. a. A corporate planning to issue CP requires to fulfill the eligibility criteria prescribed by RBI, then it
needs to select a merchant banker and an Issuing and Paying Agent (IPA) (mandatory) and obtain a
resolution from the company board for issue of commercial paper. After the resolution is passed, the
company needs to get the CP credit rated by one of the approved credit rating agencies like
CRISIL/ICRA/CARE/DCR, as prescribed by RBI.
The company then has to approach its principal banker with a proposal (in the form of schedule-II
given in the appendix) along with the credit rating certificate for approval. The banker will then
scrutinize the same and verifies whether all conditions stipulated by RBI are met, and forwards the
application to the RBI for intimation (as the approval from RBI is no more required).
On the other hand, the Merchant Banker or Issuing and Paying Agent (at times, company appoints
IPA as a dealer) will locate the clients and get their quotes for different maturity periods as discussed
above. Then the company and merchant banker/IPA take a decision on the maturity, discount rate and
the quantum of the issue. A company can opt for various maturity periods within the stipulated span
i.e. if a company plans to issue a CP for a span of 6 months, it can raise the money in tranche with
different maturity periods of either 1 month, 2 months or 3 months, etc. based on the market quotes. If
a company decides on a 2 months CP, it can raise the finance within a period of 2 weeks from the date
on which the proposal is taken on record by the bank and it can issue paper on a single day or in parts
on different dates (but the whole issue should be redeemed on the same date).
The issue proposed should be completed within a span of 2 weeks and the company should intimate
the banker to reduce the working capital limit to the extent of the amount raised. The company should
pay the applicable stamp duty based on the maturity. After the issue is completed, within 3 days, the
company needs to intimate the RBI the actual amount raised through CPs. The CP is not allowed to
be underwritten.
On maturity the holder of the CP presents the instrument to the paying agent, who arranges the
payment. The agent will receive the amount and brokerage for the services provided (the brokerage
fee charged by them is given below). There is no grace period allowed for the repayment of the paper.
If the maturity date is a holiday, the issuer is supposed to make the payment on the following working
19
If the maturity date is a holiday, the issuer is supposed to make the payment on the following working
day. Every issue of CP is treated as a fresh issue (including roll over) and the issuer needs to intimate
RBI while doing so.
b. The following are the reasons of underdevelopment:
• One of the reasons for the non-development of primary market for CPs is the restricted entry of
corporates into this market. The stringent conditions laid down by the RBI has made entry
difficult to good but small companies.
• A company is prompted to issue a CP if the cost of funds is lower when compared to the PLR of
the banks which is usually the rate the top class companies will be obtaining. Since the cost of
CP includes rating charges, stamp duty, IPAs’ fee in addition, to the discount, the effective cost
should be lower than the PLR. Otherwise, it will not be prudent for a corporate to issue CP. All
these costs have to be incurred each time a company issues a CP thus increasing the effective
cost. Hence, a company may not be able to come out with a CP issue if the difference in the
effective cost and PLR is marginal.
• The minimum size of investment for an individual investor is too high, there are no tax benefits.
Hence, the individuals and other small investors are away from this market.
• The financial institutions such as LIC, GIC and UTI, etc. are not permitted to park their funds in
CPs, as per specific investment patterns, which are laid by the government. This, however, is
changing now.

20