VERITY PREPARATION CASELET

FCFE: Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment.
This is a measure of how much cash can be paid to the equity shareholders of the company after
all expenses, reinvestment and debt repayment.

FCFF: This is a measurement of a company's profitability after all expenses and reinvestments.

Can beta be ve : No because a security cannot have negative risk as beta signifies systematic risk which
cannot be negative as there always exist some type of systematic risk for the firm which it cannot estimate
and control. But it can happen in case of gold where gold prices go down when market goes up.
How would u calculate free cash flow? : Adding Non-cash expenses and non-operating expenses to PAT
ROE: Net Profit/Shareholders Equity. Shareholders Equity= Equity Capital + Reserves and Surplus.
Cost of Capital= Cost of acquiring funds required to run the business. It includes cost to service equity
shareholders (ke) and pref. shareholders (kp), cost of debt (kd).
Cash Flow: Amount of cash that was utilized and/or generated in the following business activities: Operating,
Investing, Financing.
Terminal Value: The value of a bond at maturity, or of an asset at a specified, future valuation date, taking
into account factors such as interest rates and the current value of the asset, and assuming a stable growth
rate thereafter. It is also called continuing value or horizon value. Final year cash flow(1+g)/k-g
How do you do the pricing of an option?: Black Scholes Formula
IRR: The discount rate often used in capital budgeting that makes the net present value of all cash flows from
a particular project equal to zero. Higher the IRR, better it is. It can thus help in ranking the projects and
choosing the one with highest IRR. IRR is sometimes referred to as "economic rate of return (ERR).
PEG Ratio= PEG ratio = Price / Earnings Annual EPS Growth. The PEG is commonly used for indicating the
possible true value of a stock. PEG ratio is similar to PE ratio in the way that lower ratios of both means
undervalued stock. Since PEG takes into account the growth aspect, it is sometimes chosen over the P/E
ratio.

Relation between gold price and dollar: When the demand for the US dollar falls, banks as well as investors
around the world invest more in gold. This measure helps them protect their money and hedge against
uncertainties. The demand, and consequently the value of gold hence increase. Similarly, when the US dollar
appreciates, an increasing number of investors shift their investments from gold to the US dollar. This fall in
demand causes the value of gold to depreciate. This behavior of investors creates an inverse relationship
between gold and the US dollar.
NPV: The difference between the present value of cash inflows and the present value of cash outflows. NPV
is used in capital budgeting to analyze the profitability of an investment or project.
Solvency ratio: Solvency ratio is used to measure the ability of a company to meet its long term debts.
Solvency ratio = (After Tax Net Profit + Depreciation) / Total liabilities
What if beta is zero: then the security is risk free
How do u calculate risk free rate: GOI 10 year T bill
Difference between nominal value and real value: Nominal Value is the absolute value i.e. value in present
year. Real value is the value adjusted in accordance with the base year or inflation adjusted
Calculation of market return: Return from the index like nifty, sensex. (Present Previous )/ Previous
Impairment: a loss to company during revaluation. It reduces companys stated capital. It occurs due to poor
estimation of losses or gains
Pay-back period: Payback Period = Cost of Project / Annual Cash Inflow. The length of time required to
recover the cost of an investment.
Price to book value ratio for banking industry: A valuation ratio used by investors which compares a stock's
per-share price (market value) to its book value (shareholders' equity). Higher ratio indicates high
performance.
PEG Ratio, mathematical or subjective: A stock's price-to-earnings ratio divided by the growth rate of its
earnings for a specified time period. The price/earnings to growth (PEG) ratio is used to determine a stock's
value while taking the company's earnings growth into account, and is considered to provide a more complete
picture than the P/E ratio. P/E ratio Annual EPS Growth. Lower the ratio, better it is because it shows
earning potential in future

MM Theory: Modigliani-Miller Theorem. A financial theory stating that the market value of a firm is
determined by its earning potential and the risk of its underlying assets, and is also independent of its capital
structure or distributes dividends. It states no difference between financing through debt or equity. The
basic M&M proposition is based on the following key assumptions:

No taxes

No transaction costs

No bankruptcy costs

Equivalence in borrowing costs for both companies and investors

Symmetry of market information, meaning companies and investors have the same information

No effect of debt on a company's earnings before interest and taxes

Market alpha: The abnormal rate of return on a security or portfolio in excess of what would be predicted by
an equilibrium model like the capital asset pricing model (CAPM).
DSCR: the debt-service coverage ratio can be explained as the amount of cash flow to congregate the annual
interest and principal payments on debt. DSCR= EBITDA/ (Debt Service). Debt Service= Principal Repayment
+ Interest Payments
NPV & IRR, when can they be same: When a project is an independent project, meaning the decision to invest
in a project is independent of any other projects, both the NPV and IRR will always give the same result,
either rejecting or accepting a project.
Depreciation in cash flow statement: Non-Cash Expense. Added to PAT in cash flow from operating activities
PE Ratio: Market Price/EPS. This shows price paid by investor for per unit of EPS
Market Capitalization: Number of outstanding shares x Current Market Price
Derivative Strategies: Future, Forward, Options and Swaps
Difference between Fund Flow and Cash Flow: Funds Flow Statement states the changes in the working
capital of the business in relation to the operations in one time period.

A Cash Flow Statement is a statement showing changes in cash position of the firm from one period to
another. The inflows of cash may occur from sale of goods, sale of assets, receipts from debtors, interest,
dividend, rent, issue of new shares and debentures, raising of loans, short-term borrowing, etc. The cash
outflows may occur on account of purchase of goods, purchase of assets, payment of loans loss on operations,
payment of tax and dividend,
WACC = Ke*We + Kp*Wp + Kd*Wd*(1-t). Weighted average cost of capital

Difference Between Amortization and Impairment: The value of the firms assets reduces over time and,
therefore, need to be adjusted to their fair market value. Asset impairment and amortization are concepts
related to the adjustment of an assets cost to its fair market value.
When an asset is amortized, its cost is prorated over a time period that the asset is in use, in order to
show a more realistic and fair value of the intangible asset.
Impairment occurs when the values of the assets reduces drastically, as a result of damage to the
asset, the asset becoming obsolete, or other scenarios in which the value of the asset fall and create
the need for the value of the asset to be written down to its true market value.
What is Depreciation: Depreciation refers to two aspects of the same concept
The decrease in value of assets (fair value depreciation), and
The allocation of the cost of assets to periods in which the assets are used
The former affects the balance sheet of a business or entity, and the latter affects the net income that they
report
What is writing down the value of the asset and why would you separately write down the value of the asset::
Reducing the book value of an asset because it is overvalued compared to the market value. A write-down
typically occurs on a company's financial statement, when the carrying value of the asset can no longer be
justified as fair value and the likelihood of receiving the cost (book value) is questionable at best.
What is Beta and what type of risk does it signify: Beta is a historical measure of volatility. Beta measures
how an asset (i.e. a stock, an ETF, or portfolio) moves versus a benchmark (i.e. an index).

A beta of 1.0 implies a positive correlation (correlation measures direction, not volatility) where the
asset moves in the same direction and the same percentage as the benchmark. A beta of -1 implies a
negative correlation where the asset moves in the opposite direction but equal in volatility to the
benchmark.

A beta of zero implies no correlation between the assets. Any beta above zero would imply a positive
correlation with volatility expressed by how much over zero the number is. Any beta below zero would
imply a negative correlation with volatility expressed by how much under zero the number is. For
example a beta of 2.0 or -2.0 would imply volatility twice the benchmark. A beta of 0.5 or -0.5 implies
volatility one-half the benchmark. I use the word implies because beta is based on historical data and
we all know historical data does not guarantee future returns.

Beta = COVAR (market, security)/VAR (Market)

What is Alpha: Alpha is used to measure performance on a risk adjusted basis. As an investor we want to
know if we are being compensated for the risk taken. The return of investment might be better than a
benchmark but still not compensate for the assumption of the risk.
An alpha of zero means the investment has exactly earned a return adequate for the risk assumed. An
alpha over zero means the investment has earned a return that has more than compensated for the
risk taken. An alpha of less than zero means the investment has earned a return that has not
compensated for the risk assumed.
By risk adjusted we mean an investment return should compensate for Beta (volatility). If an
investment is twice as volatile as the benchmark an investor should receive twice the return for
assuming the additional risk. If an investment is less volatile than the benchmark an investor could
receive less return than the benchmark and still be fairly compensated for the amount of risk taken.

PE Ratio: The P/ E Multiple (or Ratio) is one of the most common indicators to judge the worth of a
companys shares. The multiple basically tells investors what is the price to be paid per share for one rupee
of earning generated by that company.
The P/E multiple is one important measure to understand whether a rise or fall is justified by the earnings
prospects of the company.
P/E multiple: (Price per share/ Earnings Per Share)
Higher P/E ratio means that investors are paying more for each unit of income, indicating that the stock
is more expensive compared to one with a lower P/E ratio all other parameters being equal.
Stocks with higher forecast earnings growth will usually have a higher P/E, and those expected to have
lower earnings growth will in most cases have a lower P/E.
It is usually not enough to look at the P/E ratio of one company and determine its status. Usually, one
should look at a company's P/E ratio compared to the industry the company is in, the sector the
company is in, the indices it could be benchmarked against, as well as the overall market.
Financial Ratio: Ratio analysis is a useful management tool that will improve your understanding of financial
results and trends over time, and provide key indicators of organizational performance. Managers will use
ratio analysis to pinpoint strengths and weaknesses from which strategies and initiatives can be formed.
Funders may use ratio analysis to measure your results against other organizations or make judgments
concerning management effectiveness and mission impact.
For ratios to be useful and meaningful, they must be:
Calculated using reliable, accurate financial information
Calculated consistently from period to period
Used in comparison to internal benchmarks and goals
Used in comparison to other companies in your industry
Viewed both at a single point in time and as an indication of broad trends and issues over time
Carefully interpreted in the proper context, considering there are many other important factors and
indicators involved in assessing performance.
Ratios can be divided into four major categories:
Profitability Sustainability
Operational Efficiency
Liquidity
o Leverage (Funding Debt, Equity, Grants)
CAPM: CAPM risk-return relation to estimate the cost of equity capital. The prescription is to estimate a
stocks market beta and combine it with the risk-free interest rate and the average market risk premium to
produce an estimate of the cost of equity.

The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and
risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the
investors for placing money in any investment over a period of time. The other half of the formula represents
risk and calculates the amount of compensation the investor needs for taking on additional risk. This is
calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of
time and to the market premium (Rm-rf).

DCF Method: Discounted cash flow tries to work out the value of a company today, based on projections of
how much money it's going to make in the future. DCF analysis says that a company is worth all of the cash
that it could make available to investors in the future. It is described as "discounted" cash flow because cash
in the future is worth less than cash today.

Hedge Funds: A hedge fund is an alternative investment vehicle available only to sophisticated investors,
such as institutions and individuals with significant assets Like mutual funds; hedge funds are pools of
underlying securities. Also like mutual funds, they can invest in many types of securitiesbut there are a
number of differences between these two investment vehicles.
NPV: The difference between the present value of cash inflows and the present value of cash outflows. NPV
is used in capital budgeting to analyze the profitability of an investment or project.

Valuation of Firm: An economic measure reflecting the market value of a whole business. It is a sum of
claims of all claimants: creditors (secured and unsecured) and equity-holders (preferred and common).
Enterprise value is one of the fundamental metrics used in business valuation, financial
modeling, accounting, portfolio analysis. The process of determining the current worth of an asset or
company.
Valuation Techniques:
Market Valuation- Discounted Cash Flow
Adjusted Present Value (APV) method
Weighted Average Cost of Capital (WACC) method
FCFE Method
Comparable Transactions Method
PE Multiple
Sales Multiple
EBITDA Multiple
Asset Based Valuation Model
Book value method
How stock price moves according to beta: Beta measures a stock's volatility - the degree to which its price
fluctuates in relation to the overall market. In other words, it gives a sense of the stock's market risk
compared to the greater market. Beta is used also to compare a stock's market risk to that of other stocks.
Investment analysts use the Greek letter '' to represent beta.
Credit Default Swaps: A credit default swap (CDS) is a kind of insurance against credit risk
Privately negotiated bilateral contract
Reference Obligation, Notional, Premium (Spread), Maturity specified in contract
Buyer of protection makes periodic payments to seller of protection
Generally, seller of protection pays compensation to buyer if a credit event occurs and contract is
terminated.

Foreign Exchange Hedging: A foreign exchange hedge (also called a FOREX hedge) is a method used by
companies to eliminate or "hedge" their foreign exchange risk resulting from transactions in foreign
currencies (see foreign exchange derivative).
This is done using either the cash flow hedge or the fair value method.
The accounting rules for this are addressed by both the International Financial Reporting Standards (IFRS) and
by the US Generally Accepted Accounting Principles (US GAAP) as well as other national accounting standards.
A foreign exchange hedge transfers the foreign exchange risk from the trading or investing company to a
business that carries the risk, such as a bank. There is cost to the company for setting up a hedge. By setting up
a hedge, the company also forgoes any profit if the movement in the exchange rate would be favourable to it.
Monetary policy is a term used to refer to the actions of central banks to achieve macroeconomic policy
objectives such as price stability, full employment, and stable economic growth.
Fiscal policy is a broad term used to refer to the tax and spending policies of the federal government.
How are they Aligned
There is a dilemma as to whether these two policies are complementary, or act as substitutes to each other for
achieving macroeconomic goals. Policy makers are viewed as interacting as strategic substitutes when one
policy maker's expansionary (contractionary) policies are countered by another policy maker's contractionary
(expansionary) policies. For example: if the fiscal authority raises taxes or cuts spending, then the monetary
authority reacts to it by lowering the policy rates and vice versa. If they behave as strategic complements, then
an expansionary (contractionary) policy of one authority is met by expansionary (contractionary) policies of the
other.
The issue of interaction and the policies being complements or substitutes for each other arises only when the
authorities are independent of each other. But when, the goals of one authority are made subservient to those
of the other, then one authority solely dominates the policy making and no interaction worthy of analysis
would arise. Also, it is worthwhile to note that fiscal and monetary policies interact only to the extent of
influencing the final objective. So long as the objectives of one policy are not influenced by the other, there is
no direct interaction between them.
Time value Money: The idea that money available at the present time is worth more than the same amount
in the future due to its potential earning capacity. This core principle of finance holds that,
provided money can earn interest, any amount of money is worth more the sooner it is received.
Derivatives: A derivative is a special type of contract that derives its value from the performance of an
underlying entity. This underlying entity can be an asset, index, or interest rate, and is often called the
"underlying". Derivatives can be used for a number of purposes - including insuring against price
movements (hedging), increasing exposure to price movements for speculation or getting access to
otherwise hard to trade assets or markets.
Butterfly Spread: The butterfly spread is a neutral strategy that is a combination of a bull spread and a bear
spread. It is a limited profit, limited risk options strategy. There are 3 striking prices involved in a butterfly
spread and it can be constructed using calls or puts.

Straddle strategy: A straddle is a strategy that is accomplished by holding an equal number of puts and calls
with the same strike price and expiration dates. The following are the two types of straddle positions.
Long Straddle - The long straddle is designed around the purchase of a put and a call at the exact same strike
price and expiration date. The long straddle is meant to take advantage of the market price change by
exploiting increased volatility. Regardless of which direction the market's price moves, a long straddle position
will have you positioned to take advantage of it.
Short Straddle - The short straddle requires the trader to sell both a put and a call option at the same strike
price and expiration date. By selling the options, a trader is able to collect the premium as a profit. A trader
only thrives when a short straddle is in a market with little or no volatility. The opportunity to profit will be
based 100% on the market's lack of ability to move up or down. If the market develops a bias either way, then
the total premium collected is at jeopardy.
Difference between ROCE and ROIA(Return on Invested assets):
ROCE- NOPAT / (Fixed assets + working capital, i.e. "Capital Employed")
ROIC- NOPAT / (BV of Equity + BV of Debt - Cash)
Flaws in IRR: The first disadvantage of IRR method is that IRR, as an investment decision tool, should not be
used to rate mutually exclusive projects, but only to decide whether a single project is worth investing in.
IRR overstates the annual equivalent rate of return for a project whose interim cash flows are
reinvested at a rate lower than the calculated IRR.
IRR does not consider cost of capital; it should not be used to compare projects of different duration.
In the case of positive cash flows followed by negative ones and then by positive ones, the IRR may
have multiple values.
Market Country Risk: Country risk analysis provides insights into that part of the risk of an investment
specific to a certain country. Country Risk, in general refers to the risk associated with those factors that
determine or affect the ability and willingness of a sovereign state or borrower from a particular country to
fulfill their obligations towards one or more foreign lenders and / or investors
Cost of Capital= Cost of funds used to run business. Cost of Equity (dividend rate), Cost of debt (interest rate
on loans and borrowing), Cost of Pref. Shares (dividend rate).
Tangible Common Equity: Tangible common equity (TCE) is calculated by subtracting intangible assets,
goodwill and preferred equity from the company's book value.
Private Equity: Pvt. Ltd. company sells its equity stake to a firm/investor in return of cash.
Private Placement: Before making IPO, a part of shares to be issues is offered to few selected individuals.