Financial Management (MB211) – January 2006 Questions

Question Paper
Financial Management (MB211) – January 2006
Section A : Basic Concepts (30 Marks)
• This section consists of questions with serial number 1 - 30.
• Answer all questions.
• Each question carries one mark.
• Maximum time for answering Section A is 30 Minutes.
1. Which of the following money market instruments has a maturity period varying from 2 to 15 days?
(a) Call money (b) Commercial Paper (c) Notice money
(d) Treasury Bill (e) Certificate of Deposit.
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2. Which of the following will decrease with an increase in the interest rate?
(a) Future Value Interest Factor
(b) Future Value Interest Factor For Annuity
(c) Capital Recovery Factor
(d) Present Value Interest Factor for a perpetual annuity
(e) Inverse of Present Value Interest Factor For Annuity.
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3. Which of the following is true?
(a) A change in YTM affects bonds with a lower YTM more than it does bonds with a higher YTM
(b) Given the maturity, for equal sized increases or decreases in the YTM, price movements are not
symmetrical
(c) When the required rate of return is greater than the coupon rate, the value of the bond is more than
its par value
(d) Bond’s price is directly proportional to its YTM
(e) When the required rate of return is more than the coupon rate, the premium on the bond declines as
maturity approaches.
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4. Which of the following statements is/are true?
I. Beta of a security increases with an increase in the variance of market returns.
II. Beta of a security increases with a decrease in standard deviation of the security’s return.
III. Beta of a security increases with an increase in the value of the correlation coefficient between the
security’s return and market return.
(a) Only (I) above (b) Only (II) above (c) Only (III) above
(d) Both (I) and (II) above (e) Both (I) and (III) above.
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5. Which of the following is not true about Commercial Papers (CPs)?
(a) CPs are negotiable by endorsement and delivery
(b) The minimum maturity period of CPs is 15 days
(c) CPs are unsecured in nature
(d) CPs cannot be issued at a discount to face value
(e) Prior approval of RBI is not needed for CP issues.
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6. Which of the following assumptions associated with Capital Asset Pricing Model (CAPM) is/are not
true?
I. The greater the perceived risk of a portfolio, the higher is the return expected by a risk-averse
investor.
II. All individuals agree on the nature of return and risk associated with each investment.
III. The choice of buying assets is affected by taxes.
(a) Only (I) above (b) Only (II) above (c) Only (III) above
(d) Both (I) and (II) above (e) Both (II) and (III) above.
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7. Which of the following is an example of a diversifiable risk?
(a) Ability of a company to obtain adequate supply of raw materials
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(b) Changes in the tax structure
(c) Reduction in the purchasing power of money
(d) Recession in the economy
(e) Introduction of a restrictive credit policy by RBI.
8. Who among the following categories of people try to obtain risk free profits by simultaneously buying and
selling similar instruments in different markets?
(a) Arbitrageurs (b) Speculators (c) Factors
(d) Brokers (e) Authorized Dealers.
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9. The sinking fund factor is the inverse of
(a) Capital Recovery Factor
(b) Future Value Interest Factor
(c) Future Value Interest Factor for Annuity
(d) Present Value Interest Factor for Annuity
(e) Present Value Interest Factor.
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10. Consider the following data
Annual credit purchase = Rs.72,72,000
Opening balance of accounts payable = Rs.17,66,400
Closing balance of accounts payable = Rs.29,20,000
The average payment period assuming 360 days in a year is
(a) 36 days (b) 66 days (c) 96 days (d) 116 days (e) 136 days.
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11. Under which of the following factoring arrangements does the factor not make any prepayment to the
client?
(a) Recourse factoring (b) Invoice discounting (c) Maturity factoring
(d) Non-recourse factoring (e) Both (c) and (d) above.
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12. Which of the following statements is/are true?
I. Collection float indicates the amount of cheques issued by a company, awaiting payment by the
bank.
II. If the collection float is more than the payment float, the company is said to have positive net float.
III. When the bank balance as per the books of the company is less than that in the bank’s books, the
company can play the float.
(a) Only (II) above (b) Only (III) above (c) Both (II) and (III) above
(d) Both (I) and (III) above (e) All (I), (II) and (III) above.
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13. Which of the following statements is/are true as per the Net Operating Income Approach?
I. Overall capitalization rate remains constant for all degrees of leverage.
II. Cost of equity remains constant for all degrees of leverage.
III. Cost of equity is a constant linear function of the debt-equity ratio.
IV. Cost of debt remains constant for all degrees of leverage.
(a) Only (III) above (b) Only (IV) above (c) Both (I) and (II) above
(d) Both (II) and (IV) above (e) (I), (III) and (IV) above.
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14. Which of the following is not the source of long-term finance?
(a) Secured Premium Notes (b) Fully Convertible Debentures
(c) Cumulative Preference Shares (d) Commercial Paper
(e) Lease Arrangement.
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15. Which of the following will increase the duration of the operating cycle?
(a) Increase in the raw material storage period
(b) Decrease in the average collection period
(c) Increase in the average payment period
(d) Decrease in the conversion period
(e) Both (a) and (c) above.
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16. Which of the following appraisal criteria is useful for evaluating mutually exclusive projects providing
similar service but having differing patterns of cost and unequal life spans?
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(a) Net Present Value (b) Internal Rate of Return
(c) Accounting Rate of Return (d) Benefit Cost Ratio
(e) Annual Capital Charge.
17. Which of the following approaches to compute the cost of equity capital assumes that actual returns will
be in line with the expected returns?
(a) Realized Yield Approach
(b) Bond Yield Plus Risk Premium Approach
(c) Earnings-Price Ratio Approach
(d) Dividend Capitalization Approach
(e) Capital Asset Pricing Model.
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18. Which of the following is/are not true?
I. If credit standards are made more stringent, sales are likely to decrease and less amount of money
will be locked up in receivables.
II. If credit period is lengthened, sales are likely to increase but bad debt losses are likely to decrease.
III. If cash discount is increased, discount paid is likely to increase and amount of receivable is likely to
reduce.
(a) Only (II) above (b) Only (III) above (c) Both (I) and (II) above
(d) Both (II) and (III) above (e) Both (I) and (III) above.
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19. Which of the following is not an assumption made under the Modigliani and Miller approach for
explaining the irrelevance of dividends policy for a firm?
(a) Existence of perfect capital markets
(b) Non-existence of differential tax rates for the dividend income and capital gains
(c) Non-influence of single investor on the share value
(d) Absence of transaction costs
(e) Higher growth rate of dividends compared to cost of equity capital.
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20. Which of the following is spontaneous source of financing current assets?
(a) Note lending (b) Trade credit (c) Cash credit
(d) Letter of credit (e) Overdraft.
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21. Consider the following projects.
I. Project B which has a Net Benefit Cost Ratio less than one but more than zero.
II. Project C whose present value of inflows is less than the present value of outflows.
III. Project D which has a cost of capital less than the internal rate of return.
IV. Project E which has the highest annual capital charge compared to all other projects.
Which of the projects mentioned above could be accepted?
(a) Only (I) above (b) Both (I) and (III) above
(c) Both (III) and (IV) above (d) (II), (III) and (IV) above
(e) (I), (III), and (IV) above.
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22. Which of the following statements is true about the terms of trade credit 4/10, net 30?
(a) A 10% cash discount is offered for payment before 30 days
(b) A 4% cash discount can be taken for payment before the 10th of the following month after
invoicing
(c) A 10% cash discount can be taken if paid by the fourth day after invoicing
(d) No cash discount is offered from the eleventh day onwards after the date of purchase
(e) 4% cash discount is awarded for payment on the 30th day after purchase.
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23. Which of the following statements is true in case of a direct quote?
(a) Exchange margin is to be added to the bid rate and ask rate
(b) Exchange margin is to be added to the bid rate and deducted from the ask rate
(c) Exchange margin is to be deducted from the bid rate and the ask rate
(d) Exchange margin is to be deducted from the bid rate and added to the ask rate
(e) Exchange margin is to be added to the bid rate only.
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24. Which of the following is not an appropriate hedging strategy for a likely devaluation of a currency?
(a) Reduce the level of cash (b) Reduce the local borrowing
(c) Delay accounts payable (d) Sell the weak currency forward
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(e) Tighten credit terms.
25. The following are the exchange rates quoted in NewYork:
CHF / $ 1.3591 / 93
$ / CAD 0.6570 / 72
The synthetic quotes of Swiss Franc per Canadian dollar are
(a) CHF / CAD 0.8929 / 33 (b) CHF / CAD 0.8930 / 32
(c) CHF / CAD 2.0683 / 86 (d) CHF / CAD 2.0680 / 89
(e) CHF / CAD 0.4833 / 36.
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26. Bank of the Middle East, Dubai is maintaining an account with SBI Mumbai. SBI Mumbai calls this
account as
(a) Nostro account (b) Vostro account (c) Loro account
(d) Mirror account (e) Shadow account.
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27. Suppose that a speculator anticipates depreciation of US $ against Euro 3-months from now from the
current 3 months forward rate. To make profit, the speculator should
(a) Sell US $ spot and buy Euro 3-month forward
(b) Buy US $ spot and sell Euro 3-month forward
(c) Sell US $ 3-month forward
(d) Buy Euro 3-month forward
(e) Sell Euro 3-month forward.
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28. The value of a forward contract at its initiation is
(a) Zero (b) Forward price (c) Bid - ask spread
(d) Spot price minus forward price
(e) Present value of forward price at risk less interest rate less spot price.
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29. In a swap transaction where two fixed-floating currency swaps are combined to form a fixed to fixed
currency swap is known as
(a) Roller-coaster swap (b) Amortized swap (c) Amortizing swap
(d) Circus swap (e) Forward swap.
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30. Which of the following equation is true?
(a) Short underlying asset + long call = long put
(b) Short underlying asset + long put = long call
(c) Long underlying asset + short call = long put
(d) Short underlying asset + long put = short call
(e) Long underlying asset + long call = short put.
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END OF SECTION A
Section B : Problems (50 Marks)
This section consists of questions with serial number 1 – 5.
Answer all questions.
Marks are indicated against each question.
Detailed workings should form part of your answer.
Do not spend more than 110 - 120 minutes on Section B.
1. The debenture of Marvel Graphite Ltd. is selling at a discount of 5 percent from its face value. The face value of
the debenture is Rs.100, coupon rate is 8 percent and the interest payments are made at the end of every six
months. The next interest payment will fall due at the end of six months from now. The debenture will be
redeemed in two equal annual installments; the first installment will be payable at the end of five years and six
months from now, and the second installment will be payable at the end of six years and six months from now.
You are required to determine the yield that you will realize if you invest in the debenture now and hold it till its
maturity.
(10 marks) <>
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2. You are given the following information by your banker.
Spot Rs./HK $ : 5.60 / 65
Rupee Interest rates (p.a.)
Six months : 6% / 7%
HK $ Interest rates (p.a.)
Six months : 4% / 5%
You are required to determine the limits for six-month forward rates that would prevent covered interest
arbitrage.
(10 marks) <>
3. Pfizer Industries Ltd. uses 4900 tonnes of steel in a year. The purchase price is Rs.15,625 per tonne. However, the
supplier has offered a discount of 0.8 percent per tonne if the order size is at least 80 tonnes. The fixed cost per
order is Rs.1,800 and carrying cost of the inventory is 25 percent of the inventory value.
You are required to find out
(a) The economic order quantity.
(b) The optimal order quantity (ignoring taxes).
(2 + 6 = 8 marks) <>
4. Horizon Industries Ltd. is planning to invest in a new project. It is estimated that the total long term financing
required by the project will be around Rs.500 lakhs. However, the actual financing requirement may vary due to
the uncertainties involved.
The company has planned to finance the long-term requirements of the project using term loan, debentures and
equity capital in the following proportions:
Equity capital 40%
Term loan 40%
Debentures 20%
The following information has been collected by the company from its investment bankers and the financial
institutions:
Source of finance Range of financing
(Rs. In lakhs) Cost (%)
Upto 140 15.00
140 – 200 15.5Equity capital 0
200 and above 16.00
Upto 150 7.50
Term loan 150 – 220 8.00
220 and above 8.50
Debentures 90 Uanpdto a 9b0o ve 88..0500
You are required to
(a) Find out the marginal cost of capital schedule.
(b) Estimate with the help of the marginal cost of capital schedule, the average cost of capital if the actual
financing required is Rs.600 lakhs, the financing structure remaining the same.
(10 + 2 = 12 marks) <>
5. On September 13, 2005, a trader buys one Nifty Index futures contract at 1,870. The initial margin requirement for
the contract is Rs.10,000 while the maintenance margin is 75% of initial margin. (Nifty Index futures are traded in
multiples of 200.) Its settlement prices for the next 8 trading days are as follows:
Date Settlement Price
September 13 1865
September 14 1858
September 15 1853
September 16 1847
September 17 1849
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September 20 1855
September 21 1872
September 22 1879
On September 23, the investor closes his position when futures price was 1883.
You are required
a. Prepare the margin account showing all the cash flows (assume no amount is withdrawn from the margin
account).
b. Calculate profit/loss.
(8 + 2 = 10 marks) <>
END OF SECTION B
Section C : Applied Theory (20 Marks)
This section consists of questions with serial number 7 - 8.
Answer all questions.
Marks are indicated against each question.
Do not spend more than 25 -30 minutes on section C.
6. Briefly explain how certificates of deposit (CD) benefit both issuers and investors.
(6 marks) <>
7. Explain briefly the forms in which liquidity may be maintained by an organization in order to manage the
requirements for cash.
(8 marks) <>
8. Many business organizations undertake business largely on a credit basis. Briefly explain the costs associated with
maintaining receivables arising out of credit sales.
(6 marks) <>
END OF SECTION C
END OF QUESTION PAPER