Q.1.- Show the relationship between required rate of return and coupon rate on the value of a bond. Ans.

It is important for prospective bond buyers to know how to determine the price of a bond because it will indicate theyieldreceived should the bond be purchased. In this section, we willrun through some bond price calculations for various types of bond instruments.Bonds can be priced at a premium,discount, o r a t par . If the bonds price is higher than its par value, it will sell at a premium because its interest rate is higher than current prevailing rates. If the bonds price is lower than its par value, the bond will sell at a discount because its interestrate is lower than current prevailing interest rates. When you calculate the price of a bond, you are calculating the maximum price you would want to pay for the bond, given the bonds couponrate in comparison to the average rate most investors are currently receiving in the bond market.Required yield or required rate of return is the interest rate that a security needs to offer in order to encourage investors to purchase it. Usually the required yield on a bond is equal to or greater than the current prevailing interest rates.Fundamentally, however, the price of a bond is the sum of the present valuesof all expectedcouponpayments plus the present value of the par value at maturity.Calculating bond price iss i m p l e : a l l w e a r e d o i n g i s d i s c o u n t i n g t h e k n o w n f u t u r e c a s h f l o w s . R e m e m b e r t h a t t o calculate present value (PV) which is based on the assumption that each payment is re-investedat some interest rate once it is received we have to know the interest rate that would earn us aknown future value. For bond pricing, this interest rate is the required yield. (If the concepts of present and future value are new to you or you are unfamiliar with the calculations, refer to Understanding the Time Value of Money .)H e r e i s t h e f o r m u l a f o r c a l c u l a t i n g a b o n d s p r i c e , w h i c h u s e s t h e b a s i c present value ( P V ) formula:C = c o u p o n p a y m e n t n = n u m b e r o f p a y m e n t s i = i n t e r e s t r a t e , o r r e q u i r e d y i e l d M = value at maturity, or par valueThe succession of coupon payments to be received in the future is referred to as anordinary annuity, which is a series of fixed payments at set intervals over a fixed period of time. (Couponson a straight bond are paid at ordinary annuity.) The first payment of an ordinary annuity occursone interval from the time at which the debt security is acquired. The calculation assumes thistime is the present. You may have guessed that the bond pricing formula shown above may be tedioust o c a l c u l a t e , a s i t r e q u i r e s a d d i n g t h e p r e s e n t v a l u e o f e a c h f u t u r e c o u p o n payment. Because these payments are paid at an ordinary annuity, however, wec a n u s e t h e s h o r t e r P V - o f - o r d i n a r y a n n u i t y f o r m u l a t h a t i s m a t h e m a t i c a l l y equivalent to the summation of all the PVs of future cash flows. This PV-of-ordinaryannuity formula replaces the need to add a l l t h e p r e s e n t v a l u e s o f t h e f u t u r e coupon. The following diagram illustrates how present value is calculated for anordinary annuity: Each full moneybag on the top right represents the f i x e d c o u p o n p a y m e n t s ( f u t u r e v a l u e ) received in periods one, two and three. Notice how the present value decreases for those coupon payments that are further into the future the present value of the second coupon payment is worthless than the first coupon and the third coupon is worth the lowest

amount today. The farther intothe future a payment is to be received, the less it is worth today is the fundamental concept for which the PV-of-ordinary-annuity formula accounts. It calculates the sum of the present valueso f a l l f u t u r e c a s h f l o w s , b u t u n l i k e t h e b o n d p r i c i n g f o r m u l a w e s a w e a r l i e r , i t d o e s n t require that we add the value of each coupon payment. (For more on calculating the time valueof annuities, see Anything but Ordinary: Calculating the Present and Future Value of Annuities and Understanding the Time Value of Money .) By incorporating the annuity model into the bond pricing formula, which requires usto also include the present value of the par value received at maturity, we arrive atthe following formula: Lets go through a basic example to find the price of a plain vanilla bond. Example 1: Calculate the price of a bond with a par value of $1,000 to be paid in ten years, acoupon rate of 10%, and a required yield of 12%. In our example well assume that coupon payments are made semi-annually to bond holders and that the next coupon payment is expectedin six months. Here are the steps we have to take to calculate the price: 1. Determine the Number of Coupon Payments: Because two coupon payments will be madeeach year for ten years, we will have a total of 20 coupon payments. 2. Determine the Value of Each Coupon Payment: Because the coupon payments are semi -annual, divide the coupon rate in half. The coupon rate is the percentage off the bonds par value.As a result, each semi-annual coupon payment will be $50 ($1,000 X 0.05). 3. Determine the Semi-Annual Yield: Like the coupon rate, the required yield of 12% must bedivided by two because the number of periods used in the calculation has doubled. If we left therequired yield at 12%, our bond price would be very low and inaccurate. Therefore, the requiredsemi-annual yield is 6% (0.12/2). 4. Plug the Amounts Into the Formula: From the above calculation, we have determined that the bond is selling at a discount; the bond price is less than its par value because the required yield of the bond is greater than the couponr a t e . T h e b o n d m u s t s e l l a t a d i s c o u n t t o a t t r a c t i n v e s t o r s , w h o c o u l d f i n d h i g h e r i n t e r e s t elsewhere in the prevailing rates. In other words, because investors can make a larger return inthe market, they need an extra incentive to invest in the bonds. A c c o u n t i n g f o r D i f f e r e n t P a y m e n t F r e q u e n c i e s In the example above coupons were paid semi -annually, so we divided the i n t e r e s t r a t e a n d coupon payments in half to represent the two payments per year. You may be now wonderingwhether there is a formula that does not require steps two and three outlined above, which arerequired if the coupon payments occur more than once a year. A simple modification of the

above formula will allow you to adjust interest rates and coupon payments to calculate a bond price for any payment frequency: Notice that the only modification to the original formula is the addition of F, which representsthe frequency of coupon payments, or the number of times a year the coupon is paid. Therefore,for bonds paying annual coupons, F wo uld have a value of one.

Should a bond pay quarterly payments, F would equal four, and if the bond paid semi-annual coupons, F would be two.

Q2. What do you understand by operating cycle . Ans. An operating cycle is the length of time between the acquisition of inventory and the sale of that inventory and subsequent generation of a profit. The shorter theoperating cycle, the faster a business gets areturn on investment (ROI) for theinventory it stocks. As a general rule, companies want to keep their operatingcycles short for a number of reasons, but in certain industries, a long operatingcycle is actually the norm. Operating cycles are not tied to accounting periods, butare rather calculated in terms of how long goods sit in inventory before sale.When a business buys inventory, it ties up money in the inventory until it can besold. This money may be borrowed or paid up front, but in either case, once thebusiness has purchased inventory, those funds are not available for other uses. Thebusiness views this as an acceptable tradeoff because the inventory is aninvestment that will hopefully generate returns, but keeping the operating cycleshort is still a goal for most businesses so they can keep their liquidity high.

Keeping inventory during a long operating cycle does not just tie up funds.Inventory must be stored and this can become costly, especially with items thatrequire special handling, such ashumidity controls or security. Furthermore,inventory can depreciate if it is kept in a store too long. In the case of perishablegoods, it can even be rendered unsalable. Inventory must also be insured andmanaged by staff members who need to be paid, and this adds to overall operatingexpenses. There are cases where a long operating cycle in unavoidable. Wineries anddistilleries, for example, keep inventory on hand for years before it is sold, becauseof the nature of the business. In these industries, the return on investment happensin the long term, rather than the short term. Such companies are usually structuredin a way that allows them to borrow against existing inventory or land if funds areneeded to finance short-term operations.Operating cycles can fluctuate. During periods of economic stagnation, inventorytends to sit around longer, while periods of growth may be marked by more rapidturnover. Certain products can be consistent sellers that move in and out of inventory quickly. Others, like big ticket items, may be purchased less frequently.All of these issues must be accounted for when making decisions about orderingand pricing items for inventory.

Q3. Q.3 What is the implication of operating leverage for a firm. Ans.Operating leverage: Operating leverage is the extent to which a firm uses fixedcosts in producing its goods or offering its services. Fixed costs include advertising expenses, administrative costs, equipment and technology, depreciation, and taxes,but not interest on debt, which is part of financial leverage. By using fixedproduction costs, a company can increase its profits. If a company has a largepercentage of fixed costs, it has a high degree of operating leverage. Automatedand high-tech companies, utility companies, and airlines generally have highdegrees of operating leverage.

As an illustration of operating leverage, assume two firms, A and B, produce andsell widgets. Firm A uses a highly automated production process with roboticmachines, whereas firm B assembles the widgets using primarily semiskilled labor. Table 1 shows both firms operating cost structures. Highly automated firm A has fixed costs of $35,000 per year and variable costs of only $1.00 per unit, whereas labor-intensive firm B has fixed costs of only $15,000per year, but its variable cost per unit is much higher at $3.00 per unit. Both firmsproduce and sell 10,000 widgets per year at a price of $5.00 per widget.Firm A has a higher amount of operating leverage because of its higher fixed costs,but firm A also has a higher breakeven point

the point at which total costs equaltotal sales. Nevertheless, a change of I percent in sales causes more than a I percent change in operating profits for firm A, but not for firm B. The degree of operatingleverage measures this effect. The following simplified equation demonstrates the type of equation used to compute the degree of operating leverage, although tocalculate this figure the equation would require several additional factors such asthe quantity produced, variable cost per unit, and the price per unit, which are usedto determine changes in profits and sales:Operating leverage is a doubleedg ed sword, however. If firm As sales decrease by I percent, its profits will decrease by more than I percent, too. Hence, the degreeof operating leverage shows the responsiveness of profits to a given change insales. Implications: Total risk can be divided into two parts: business risk and financial risk. Business risk refers to the stability of a companys assets if it uses no debt or preferred stock financing. Business risk stems from the unpredictable nature of doing business, i.e., the unpredictability of consumer demand for products andservices. As a result, it also involves the uncertainty of long-term profitability.When a company uses debt or preferred stock financing, additional risk financialrisk is placed on the companys common shareholders. They demand a higher expected return for assuming this additional risk, which in turn, raises a companys costs. Consequently, companies with high degrees of business risk tend to befinanced with relatively low amounts of debt. The opposite also holds: companieswith low amounts of business risk can afford to use more debt financing whilekeeping total risk at tolerable levels. Moreover, using debt as leverage is asuccessful tool during periods of inflation. Debt fails, however, to provide leverageduring periods of deflation, such as the period during the late 1990s brought on bythe Asian financial crisis.

Q2. What are the factors affecting financial plan of a company?

Ans. We live in a society and interact with people and environment. What happens tous is not always accordance to our wishes. Many things turn out in our live areuncontrollable by us. Many decisions we take are the result of external influences.So do our financial matters.There are many factors affect our personal financial planning. Range from economic factors to global influences.Aware of factorsaffecting your money matters below will certainly benefit your planning.Factors Affecting Financial Plan1.Nature of the industry:- Here, we must consider whether it is a capital intensive of labour intensive industry. This will have a major impact on the total assets that the firm owns. 2. Size of the company: -The size of the company greatly influences the availability offunds from different sources.A small company normally finals it difficult to raise funds from long term sources at competitive terms. On the other hand, large companies like Reliance enjoy the privilege of obtaining funds both short term and long term at attractive rates. 3. Status of the company in the industry:-A well established company enjoying agood market share, for its products normally commands investors confidence.Such acompany can tap the capital market for raising funds in competitive term for implementation new projects to exploit the new opportunity emerging from changing

business environment.

4. Sources of finance available:-Sources of finance could be group into debt andequity. Debt is cheap but risky whereas equity is costly.A firm should aim at optimum capital structure that would achieve the least cost capital structure.A large firm with a diversified product mix may manage higher quantum of debt because the firm may manage higher financial risk with a lower business risk.Selectionof sources of finances us closely linked to the firms capacity to manage the risk exposure.

5.The capital structure of a company:- Capital structure of a company is influencedby the desire of the existing management of the company to remain control over the affairs of the company.The promoters who do not like to lose their grip overthe affairs of the company normally obtain extra funds for growth by issuing preference shares and debentures to outsiders.6. Matching the sources with utilization:-The product policy of any good financialplan is to match the term of the source with the term of investment.To finance fluctuating working capital needs, the firm resorts to short term finance.All fixed assets-investment are to be finance by long term sources. It is a cardinal principal of financial planning.7. Flexibility:-The financial plan of company should possess flexibility so as to effectchanges in the composition of capital structure when ever need arises. If the capital structure of a company is flexible, it will not face any difficulty in changing the sources of funds.This factor has become a significant one today because of the globalization of capital market.8. Government Policy:-SEBI guidelines, finance ministry circulars, various clauses ofStandard Listing Agreement and regulatory mechanism imposed by FEMAa ndDepartment of CorporateAffairs (Govt of India) influence the financial plans ofcorporate today. Management of public issues of shares demands the companies with many status in India.They are to be compiled with a time constraint.