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Question Paper

Investment Banking and Financial Services – I : January 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. Euro Commercial Papers are instruments issued at


a. London
b. Any European trade center
c. USA
d. Both USA and Europe
e. Both USA and UK.
2. The minimum success ratio for the Primary Dealers for T-Bills is ___ %
a. 25.00
b. 30.00
c. 33.33
d. 40.00
e. 66.66.
3. Which of the following institutions is permitted to participate in the Call Money Market as
both lender and borrower?
a. Life Insurance Corporation of India
b. Unit Trust of India
c. Securities Trading Corporation of India Ltd
d. Industrial Finance Corporation of India
e. Industrial Development Bank of India.
4. The stamp duty payable for a CD of 6 months is
a. 0.125% of the face value
b. 0.125% of the issue price
c. 0.250% of the face value
d. 0.250% of the issue price
e. 0.375% of the face value.
5. Which of the following statements is true?
a. Clean bills should possess the documents of title to goods
b. Banks cannot rediscount bills, which were originally discounted with them by their
corporate clients
c. Banks can rediscount the bills arising out of share transactions
d. Banks can rediscount the accommodation bills
e. In ‘post-shipment finance’ the banker runs the risk of dealing only with the documents
and not in goods.
6. Which of the following risks is/are not covered by the Export Credit and Guarantee
Corporation?
a. Insolvency of the buyer
b. Civil war
c. Causes inherent in the nature of the goods
d. Both (a) and (c) of the above
e. All (a), (b) and (c) of the above.

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7. Secured Premium Notes are
a. Issued at face value and do not carry any interest and are redeemed by repayment in a
series of installments at a premium over the face value
b. Issued at a discount to their face value and are redeemed at par on expiry of their tenure
c. Sold at a large discount on their face value and mature at par value
d. Also called LYONS
e. Both (b) and (c) of above.
8. Kalyanam Pvt. Ltd. wants to operate as a Category I Registrar in the capital market. The
minimum net worth required by it is Rs.____ lacs.
a. 2
b. 3
c. 5
d. 6
e. 10.
9. Skyline Couriers is coming up with an IPO of Rs.100 crore. The registration fee payable to
SEBI by Skyline is Rs.______.
a. 10,000
b. 15,000
c. 20,000
d. 25,000
e. 50,000.
10. As per the latest SEBI Guidelines, creation of a Debenture Redemption Reserve is mandatory
if the redemption period exceeds ______ months.
a. 12
b. 15
c. 18
d. 24
e. 60.
11. Tatanova is coming up with a public issue of Rs.15 crore. The minimum number of
collection centers it should have is
a. 4
b. 8
c. 10
d. 15
e. 30.
12. For issuance of CP, the credit rating should not be older than _____ month(s).
a. 1
b. 2
c. 3
d. 4
e. 6.
13. The maximum amount of underwriting commission payable to an underwriter on equity
shares is ___% on the amount devolving on the underwriter.
a. 1.0
b. 1.5
c. 2.0
d. 2.5
e. 3.0.

2
14. Not more than ____% of the Foreign Currency Convertible Bonds raised by an Indian
company should be used for general corporate restructuring including working capital
requirements.
a. 10
b. 15
c. 20
d. 25
e. 30.
15. Yankee bonds are
a. US Dollar denominated bonds issued by foreign borrowers in the domestic markets
b. Bonds issued by non-Japanese borrowers in the domestic Japanese markets
c. Sterling denominated foreign bonds raised in the UK domestic securities market
d. Privately placed bonds issued in the Japanese market
e. Sterling denominated bonds issued in the Japanese market.
16. Under bank participation factoring, First Factors Limited has agreed to factor the receivables
of Standard Manufacturers Limited (SML) of Rs.500 lakhs and provide an advance of 70
percent of the receivables. ABC Bank has agreed to finance 80% of the factor reserves. The
amount of receivable that SML has to finance from its own funds is
a. Rs.350 lakhs
b. Rs.150 lakhs
c. Rs.120 lakhs
d. Rs. 50 lakhs
e. Rs. 30 lakhs.
17. Which of the following is/are true regarding charge card?
I. There is no charge of interest
II. There is no preset spending limit
III. Essential to open a bank account.

a. Only (II) above


b. Both (I) and (II) above
c. Both (II) and (III) above
d. Both (I) and (III) above
e. All (I), (II) and (III) above.
18. Consider the following data:
Value of the asset leased = Rs.40 lakhs
Lease rentals = Rs.32 ptpm
Lease period = 4 years
Payment pattern = Payable quarterly in advance.
The add-on yield in the above lease transaction is
a. 13.4%
b. 21.4%
c. 25.2%
d. 28.6%
e. 35.7%.

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19. Sri Finance offers a hire purchase plan for its corporate borrowers on the following terms :
Flat rate of interest 12%
Repayment period 3 years
Frequency Monthly in advance
Deposit at the inception of hire agreement 20% of the cost of the asset.
The annual percentage rate using the approximation formula is
a. 18.0%
b. 19.8%
c. 23.4%
d. 24.7%
e. 36.0%
20. Gap loan, a form of real estate loan is a
a. Loan extended during the gap the borrower is able to find out a suitable lender
b. Loan extended to the developer to cover the difference between the bank construction
loan and the total cost of the project.
c. Loan extended on which additional payment is required to be made to cover the gap
between market interest rate and the ceiling rate agreed upon.
d. Loan on which the interest charged is generally lower than the prime lending rate.
e. Both (b) and (d) above.
21. A firm sells on terms 2/12 net 50 days. On an average 30% of the customers pay on the 12th
day and avail the discount. The remaining customers pay on an average in 60 days. The
average collection period of the receivables is
a. 38.6 days
b. 45.0 days
c. 45.6 days
d. 54.0 days
e. 57.0 days
22. Which of the following is true regarding factoring and forfaiting?
I. Factoring can be structured either as recourse or non-recourse arrangement but
forfaiting can be structured only as non-recourse arrangement.
II. Factoring can be structured so that service elements are not carried by the factor
whereas under forfaiting the forfaiter has to take the responsibilities of receivables
accounting.
III. In factoring the factor need not participate in the credit granting process but the
forfaiter under forfaiting has to participate.

a. Only (I) above


b. Both (I) and (III) above
c. Both (I) and (II) above
d. Both (II) and (III) above
e. All (I), (II) and (III) above.
23. Which of the following is/are true regarding Collateralized Mortgage Obligations?
a. They are preferred to pass through securities by issuers as funds can be raised more
cheaply.
b. They are not preferred by investors because of low level of credit quality.
c. Investors who wants to avoid call risk prefer short tranche CMOs.
d. Investors who prefers to have low interest rate risk avoids shorter tranche CMOs.
e. Both (a) and (c) above.

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24. Which of the following is/are true regarding the accounting treatment of a hire purchase
transaction?
I. Capital content of outstanding hire purchase installments is shown as liability in
the books of hirer
II. Present value of hire purchase installments or cash price of the asset, whichever is
minimum, is capitalized in the books of hirer
III. Finance income component of hire purchase installments is recorded as current
liability in the books of the finance company

a. Only (I) above


b. Only (II) above
c. Both (I) and (II) above
d. Both (II) and (III) above
e. Both (I) and (III) above.
25. Which of the following can be termed as a cross-border lease transactions?
I. The lessor and lessee are located in India and the supplier is located in England
II. The lessor and supplier are located in India and the lessee is located in England.
III. The lessee is located in India, lessor is located in England and the supplier is
located in USA.

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. Assets worth Rs.20,000 of Classic Finance Limited remained doubtful for 2 years. If 50% of
the assets are secured, the provision to be made against these doubtful assets is
a. Rs. 6,000
b. Rs.13,000
c. Rs.16,000
d. Rs.26,000
e. None of the above.
27. Venture capital provided for a major expansion of a company when its sales volume is
increasing and it is breaking even or becoming profitable is referred to as
a. First stage financing
b. Second stage financing
c. Third stage financing
d. Bridge financing
e. None of the above.
28. A short term loan extended at the time of completion of the project to provide bridge finance
until the developer can obtain financing of a more permanent nature is referred to as
a. Bow ties
b. Mini perms
c. Gap loans
d. Buy down loans
e. None of the above.

5
29. Which of the following is\are true regarding pledged account mortgages?
I. They resemble traditional mortgages from the lender’s point of view.
II. The pledged account under this type of mortgage is created by the seller out of his
profits.
III. This type of mortgages are preferred by borrowers who have sufficient cash on
hand, but face cash flow shortage for the first few years.

a. Only (I) above


b. Only (II) above
c. Both (I) and (III) above
d. Both (II) and (III) above
e. All (I), (II) and (III) above.
30. Consider the following information:
Rs.
Amount of consumer loan 2,00,000
Repayment period 24 months
Equated monthly installment 10333
After 12 months, if a borrower opts for early repayment, the interest rebate allowed to the
borrower as per rule of 78 method is
a. Rs. 8,576
b. Rs.12,478
c. Rs.23,996
d. Rs.24,956
e. Rs.32,238.

END OF PART A

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. BeeCee Chemicals Limited (BCL) is presently managing its account receivables internally through its
credit department. Sales for the current year are Rs.400 lakhs. Its credit terms are 2/10 net 50. On an
average 20% of the customers pay on the 10th day and avail the discount while the balance pay within 60
days. Its bad debts to sales ratio is 0.015 and its contribution margin is 25%.
Currently, the firm is financing its receivables by a mix of bank finance and own funds in the ratio of 4:3.
The rate of interest on bank finance is 18% whereas its pre-tax cost of own funds is 22%.
BCL has received a proposal from Aybee Factors Limited (AFL) for factoring its receivables under the
bank participating factoring arrangement with Sind Bank providing an advance of 60 percent of factor
reserves at an interest of 21%. AFL has agreed for advance payment of 80% of receivables at a guaranteed
payment of 40 days. The interest and the commission charged by AFL is 20% and 1.5% respectively. The
factoring arrangement is with recourse to BCL.
BCL has projected its sales for the next year to increase by 20% without factoring arrangement and by 25%
with factoring arrangement. The collection expenses are expected to be reduced by Rs.1.5 lakhs due to the
factoring arrangement.
(Assume 365 days in a year).
You are required to suggest whether BCL should go for the factoring arrangement or not. Support your
answer with detailed workings.
(10 points)

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2. Aramusk Ltd. is issuing CPs of face value Rs.50 lacs for 90 days at an effective interest rate of 15% per
annum.
a. What is the issue price per CP?
b. What is the brokerage charge payable by Aramusk? Assume that they are paying the maximum
prescribed brokerage.
c. What are the rating charges for these CPs?
d. Compute the effective cost of these CPs to Aramusk.
e. Is standby facility mandatory for the company that issues CP?
(3 + 2 + 2 + 1 + 2 = 10 points)
3. Mr. Ramesh plans to purchase a vehicle worth Rs.50,000. He approaches GE Citywide to finance the
purchase of vehicle under its Express Cash Personal Loans Scheme.
The following details are provided by GE Citywide:
• Monthly outgoings are :
Loan Amount Monthly Installment (Rs.)
(Rs.) 12 months 24 months 36 months
25,000 2,417 1,375 1,033
50,000 4,833 2,750 2,066
75,000 7,250 4,125 3,099
• 2% processing fee (minimum Rs.300) to be paid upfront.
• No prepayment charges.
• On the day of prepayment the borrower has to pay only the balance of capital. Interest is allocated to
the installments on a straight line basis.
You are required to
a. Calculate the flat rate and effective rate of interest that would be charged on the loan granted to Mr.
Ramesh by GE Citywide for a loan period of 36 months.
b. Calculate the effective rate of interest assuming Mr. Ramesh prepays the loan at the end of the 30th
month under GE Citywide finance scheme.
(4 + 4 = 8 points)
4. Leasewell Ltd. has a client who wants to lease an equipment worth Rs.100 lakhs. Leasewell Ltd. is facing a
liquidity crunch and is looking for an equity participant for the lease deal who can finance it to the extent of
Rs.30 lakhs. The equipment has a useful life of 5 years and its salvage value is expected to be Rs.5 lakh. It
can be depreciated at 30% on WDV basis. The company contacted Wellfin Ltd., which agreed to
participate in the lease. The terms quoted by Wellfin Ltd. are an interest of 16% and repayments in equal
quarterly installments including interest over five years. If the Leasewell Ltd. expects a gross yield of at
least 30%, what is the minimum quarterly lease rental that should be quoted to the client ? Lease rentals are
to be paid in arrears.
Leasewell Ltd. is thinking of offering a hire purchase plan to the client if he is willing to make a down
payment of Rs.30 lakhs. The company wants the hire rentals to be paid monthly in arrears. What is the
minimum flat rate of interest that should be quoted to the client if Leasewell Ltd. should not lose on this
transaction compared to the lease transaction? Ignore interest tax. The income tax rate applicable to the
company is 30%.
(16 points)

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5. The following balance sheet pertains to Shilpa Sarees Ltd. as on March 31, 2001.
Liabilities Rs. lacs Assets Rs. lacs
Share Capital 20000000 shares of Rs.10 each fully Freehold land
2000.00 500.00
paid-up
Reserves and Surplus: Buildings 650.00
- Share Premium 600.00 Plant and Machinery 3000.00
- General Reserve 700.00 Misc. Fixed Assets 300.00
- Revaluation reserves 150.00 Inventory 1250.00
- Dividend Equalization Reserve 250.00 Sundry Debtors 750.00
- Contingency Reserve 75.00 Cash and Bank balance 300.00
15% FCDs of Rs.170 each 1700.00
Term Loans 775.00
Sundry Creditors 500.00
6750.00 6750.00
The following additional information is available:
• The company had purchased plant and machinery worth Rs.500 lacs during April 1999. The purchase
consideration was paid in the form of allotment of 10 lacs fully paid equity shares of the company.
• Regarding the FCDs,
− Part A of Rs.50 would be converted into 1 equity share on April 2002
− Part B of Rs.120 would be converted into 2 equity shares of Rs.60 each on April 2003.
As per the latest SEBI Guidelines you are required to compute the maximum permissible bonus ratio.
(6 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. Mrs. Gruhalakshmi earning Rs.1.8 lakhs p.a. has applied for a housing loan of Rs.15 lakhs under Gruha
Yojana Scheme of A P Housing Co. Ltd. Briefly discuss the procedure to be adopted by A P Housing Co.
Ltd. for appraising the application of Mrs. Gruhalakshmi.
(10 points)
7. Credit rating ahs emerged as one of the most important financial services. Discuss the various steps of
credit rating. How does a shadow rating vary from a formal rating?
(10 points)

END OF PART C

END OF QUESTION PAPER

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Suggested Answers
Investment Banking and Financial Services – I : January 2002
Part A : Basic Concepts

1. Answer : (a)
Reason : Self explanatory.
2. Answer : (d)
Reason : According to the RBI guidelines, the minimum success ratio for PDs for T-Bills is 40%.
3. Answer : (c)
Reason : Participants in the Call Money Market are divided into two categories and the participants in the
first category can borrow and lend in the market and the participants in the second category can
only lend but cannot borrow. Of the alternatives only STCI belongs to the first category & hence
can borrow and lend in the call money market.
4. Answer : (c)
Reason : CDs are subjected to stamp duty based upon the redemption period. For the redemption period
upto 6 months stamp duty payable for a CD is 0.25% of the face value.
5. Answer : (e)
Reason : Bills accompanied by documents of title to goods are known as documentary and hence (a) is not
true. Banks are allowed to rediscount bills, which were originally discounted by them. However,
bills arising out of share transactions and accommodation bills are not rediscounted by them.
Hence (b), (c) and (d) are not true. In post shipment finance the banker runs the risk of dealing
only with the document and not in goods. Hence (c) is true.
6. Answer : (c)
Reason : ECGC covers commercial risks such as insolvency of the buyer, covers political risks such as
civil war but not does not cover risks such as commercial disputes, causes inherent in the nature
of the goods. Hence, (c) is the answer.
7. Answer : (a)
Reason : Instruments issued or sold at discount and redeemed at par are known as zero coupon bonds and
partly convertible bonds are known as Lyons. Instruments described in alternative (a) are known
as Secured Premium Notes.
8. Answer : (d)
Reason : As per SEBI guidelines to operate as a category I Registrar, the minimum net worth required is
Rs.6 lakhs.
9. Answer : (e)
Reason : Based on the size of the issue, registration fees varies. The registration fees payable for
registration of an IPO of Rs.100 crores is Rs.50,000.
10. Answer : (c)
Reason : If the redemption period exceeds 18 months, debenture redemption reserve has to be
compulsorily created.
11. Answer : (e)
Reason : As per SEBI guidelines, in case of issues above Rs.10 Crores, there should be atleast 30
mandatory collection centers and in case of issues below Rs.10 Crores collection centers should
be situated in four metropolitan cities and at all such places where stock exchanges are located,
in the region where the registered office of the company is situated.
12. Answer : (b)
Reason : As per the RBI guidelines, for insurance of CPs, credit rating is compulsory and it should be
minimum P2 or a similar rating from the other approved rating agencies but a rating should not
be more than 2 months old.

9
13. Answer : (d)
Reason : Underwriters are exposed to the risks of undersubscription and they are paid commission for
assuming the risk. The commission payable depends on the instruments issued. In case of equity
issue, underwriting commission payable is 2.5% on the amount desolving on the underwriter.
14. Answer : (d)
Reason : As per the guidelines, only upto 25% of the amount raised through the issue of FCCBs should be
used for general corporate restructuring.
15. Answer : (a)
Reason : Bonds floated in the domestic market denominated in domestic currency by non-resident entities
are known as foreign bonds. Yankee bonds are dollar denominated foreign bonds issued in US
markets by non-US entities.
16. Answer : (e)
Reason : Under bank participating factoring, a bank contributes to the part of factor reserves. In the given
case,
Amount of receivables = Rs.500L
Factor reserves = 30% of Rs.500 = Rs.150L
Bank participation = 80% of 150 = 120
Hence, own funds required = 150 – 120 = Rs.30L.
17. Answer : (b)
Reason : In plastic cards, for issue of credit cards a spending limit is pre-specified and interest is charged
on the amount outstanding. For a debit card to be issued it requires opening of bank account
compulsory. Whereas, for issue of charge card, there is no present spending limit and the entire
amount charged against the card has to be paid at the end of the stipulated period. Hence, I and II
are true.
18. Answer : (a)
Reason : Add – on yield is similar to flat rate of interest. In the given case it is calculated as follows:
0.032 x 12 x 40 x 4 − 40
Add – on yield = x 100 = 13.4%
4 x 40
19. Answer : (d)
n
Reason : Approximate Annual percentage rate in case of advance payments is calculated as x 2F ,
n −1
where n is number of installments and F is the flat rate of interest. In the given case, APR =
36
x 2 x 12 x 100 = 24.7%.
35
20. Answer : (b)
Reason : The type of arrangement described in alternative (a) is termed as Mini – perms, alternative (c) is
termed as bow ties. In Gap loan, the loan arrangement is as described in alternative (b) and the
instrument charged is generally higher the prime lending rate. Hence, correct answer is (b).
21. Answer : (c)
Reason : Average collection Period = 0.3 × 12 + 0.7 × 60 = 45.6 days.
22. Answer : (a)
Reason : A forfaiting transaction is always structured on a non-recourse basis whereas factoring can be
structured either on recourse or non-recourse basis. In forfaiting, the forfaiter does not take the
responsibilities of receivables accounting, etc and relies on the unconditional and irrevocable
guarantee provided by the avalling bank and does not participate in the credit granting process.
Hence only I is true.

10
23. Answer : (a)
Reason : Because of the underlying collateral, CMOs are considered to have a high level of credit quality.
Hence (b) is not true. For investors who wants to avoid call risk generally prefer long tranche
CMOs and investors who prefer to have low interest rate risk generally prefer shorter tranche
CMOs. Hence, statements (c) and (d) are also not true. As given in alternative (a), funds can be
raised more cheaply due to segmentation.
24. Answer : (e)
Reason : While accounting for a hire purchase transaction, the hirer capitalizes the asset at the cash
purchase price and shows the capital content of the hire installments as a liability. Hence,
statement I is true and statement II is not true. In a hire purchase transaction, at the inception of
the transaction, the finance company records the hire purchase installments receivable as a
current asset and finance income component of these installments as a current liability. Hence
statement III is also true.
25. Answer : (d)
Reason : In a cross border lease transaction, the lessor and lessee are domiciled in different countries and
the domicile of the supplier is immaterial. Hence the lease arrangement described in II and III
can be termed as cross border lease transactions.
26. Answer : (b)
Reason : Provision = 50% of 20,000 × 100% + 50% of 20,000 × 30%
= 10,000 + 3,000 = Rs.13,000.
27. Answer : (c)
Reason : The funds provided as a venture capital to a company for major expansion when sales are
increasing and it is breaking even is referred to as third stage financing.
28. Answer : (b)
Reason : The type of loan as described in the given case is referred to as mini perms.
29. Answer : (c)
Reason : Under PAMs, the borrower pays increasing installments as in the case of graduated payment
mortgages while the lender receives equal installments. The difference is drawn from the deposit
maintained by the borrower. As the borrower is required to deposit substantial amount at the
beginning, this type of mortgage is preferred by borrowers described in III. Hence, both I and III
are true.
30. Answer : (b)
t (t + 1)
Reason : Interest rebate as per rule of 78 = xD
n (n + 1)
Where t is number of installments outstanding = 12,
n is total number of installments = 24 and
D is total charge for credit = 24 × 10333 – 2,00,000
= Rs.47,992
12 x 13
∴ Interest rebate = x 47992
24 x 25
= Rs.12,478.

11
Part B : Problems

1. Relevant costs of in-house Management :


Expected sales = Rs.400 × 1.2 = Rs.480 lakhs
A. Cash discount = Rs.480 × 0.2 × 0.02 = Rs. 1.920 lakhs
Average collection period = 0.2 × 10 + 0.8 × 60 = 50 days
B. Cost of funds :
4 50
Cost of bank finance = Rs.480 × × 0.18 × = Rs. 6.763 lakhs
7 365
3 50
Cost of own funds = Rs.480 × × 0.22 × = Rs. 6.200 lakhs
7 365
Total cost of funds = Rs.12.963 lakhs
C. Cost of forgone sales = Rs.20 × 0.25 = Rs.5.0 lakhs
[Rs.400(25% – 20%) = Rs.20]
D. Avoidable administration expenses = Rs.1.5 lakhs
Total costs of in-house management = A+B+C+D
= Rs.1.920 + Rs.12.963 + Rs.5.0 + Rs.1.5
= Rs.21.383 lakhs.
Relevant costs of bank Participating Factoring :
Expected sales = Rs.400 × 1.25 = Rs.500 lakhs
E. Commission = Rs.500 × 0.015 = Rs.7.5 lakhs
F. Cost of funds:
40
Discount charges = Rs.500 × 0.8 × 0.2 × = Rs.8.767 lakhs
365
40
Interest to Sind Bank = Rs.500 × 0.2 × 0.6 × 0.21× = Rs.1.381 lakhs
365
40
Cost of own funds = Rs.500 × 0.2 × 0.4 × 0.22 × = Rs.0.964 lakhs
365
Total cost of funds = Rs.11.112 lakhs
Total cost of bank participating factoring = E + F = Rs.7.5 + Rs.11.112
= Rs.18.612 lakhs
As cost of bank participating factoring is less than cost of in-house management, SCL should opt for the
factoring arrangement.

F 50,00,000
2. a. Issue price = = = Rs.4821664.50
I× N 15 × 90
1+ 1+
100 × 365 100 × 365
b. Maximum prescribed brokerage for 90 days = 0.025% of the issue amount.
= 50,00,000 × 0.25%
= Rs.1,250
c. Rating charges = 0.5% p.a.
∴ Rating charges = 50,00,000 × 0.5% = Rs.25,000
d. Discount = Face value – Issue price
= 50,00,000 – 48,21,664.50 = Rs. 1,78,335.50
Brokerage = Rs. 1,250.00
Rating charges = Rs. 25,000.00
Stamp duty (upto 3 months) = 50,00,000 × 0.125% = Rs. 6,250.00
Total cost = Rs. 2,10,835.50

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210835.50
Effective cost to Aramusk = = 4.3727%
4821664.50
365
∴ Effective cost of Aramusk for 1 year = 4.3727 ×
= 17.73%
90
e. RBI from 1994 has abolished the standby facility to companies issuing CPs. Hence now standby
facility will not be available.

3. a. Loan = Rs.50,000
EMI = Rs.2066
2066 × 36 − 50,000
Flat rate of interest = = 16.25%
3 × 50,000
Effective rate of interest is ‘i’ in the following:
2066 PVIFAi, 36 + 1000 – 50,000 = 0
‘i’ is approximately 2.456% p.m. = 33.8% p.a.
50,000 × 0.1625
b. Interest per month on straight line basis = = Rs.677
12
As interest is charged on straight line basis each EMI has an interest portion of Rs.677 and a principal
portion of Rs.1389.
∴ Capital repaid upto 30th installment = Rs.41670
Balance principal to be repaid = Rs.8330
Effective rate of interest is ‘i’ in the following:
2066 PVIFAi, 30 + 1000 + 8330 PVIFi, 30 = 50,000
‘i’ is approximately 2.25% p.m. = 30.6% p.a.

30 30
4. Loan repayment = = = Rs.2.21 lakhs
PVIFA (4%, 20) 13.590
As gross yield required is 30%,
i
x× × 4 × PVIFA(30,5) + 5 × PVIF(30, 5) = 100 – 30
i4
where x is the lease rental required by Leasewell Ltd. after paying the loan installment.
x × 1.1064 × 4 × 2.436 + 5 × 0.269 = 70
x × 10.78 + 1.35 = 70
70 − 1.35
x= × = 6.37
10.78
Lease rental to be quoted = 6.37 + 2.21 = Rs.8.58 lakhs
8.58 1
or × 1000 × = 28.60 ptpm
100 3
As Leasewell should not loose on HP transaction, the IRR on hire transaction should be equal to the IRR
on the lease transaction.
IRR on lease transaction is `i’ in the following :
– Initial investment + PV of lease rentals – PV of tax on lease rentals + PV of depreciation tax shield + PV
of salvage value = 0.
i
–70 + 6.37 × × 4 × PVIFAi, 5 – 6.37 4 0.3 PVIFAi, 5
i4
+ [9PVIFi, 1 + 6.3 PVIFi, 2 + 4.41PVIFi,3 + 3.09PVIFi, 4 + 2.19PVIFi, 5] + 5 PVIFi, 5 = 0
Let i be 26%, LHS will be equal to
–70 + 25.48 × 1.0928 × 2.635 – 7.64 × 2.636 + [9 × 0.794 + 6.3 × 0.63 + 4.41 × 0.5 + 3.09 × 0.397
+ 2.19 × 0.315] + 5 × 0.315 = 0.043
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Let i be 28%, LHS will be equal to
–70 + 25.48 × 1.0996 × 2.532 – 7.64 × 2.532 + [9 × 0.781 + 6.3 × 0.61 + 4.41 × 0.497 + 3.09 × 0.373
+ 2.19 × 0.291] + 5 × 0.291 = –2.095
By interpolation,
i = 26 + 2
= 26.04%
As Leasewell should not loose on HP transaction, the IRR required by it on the hire transaction should be
26.04% or say 26%.
Let required flat rate be F%
F
70 + 70 × ×5
100 70 + 3.5F
EMI = = = 1.167 + 0.058 F
60 60
Total charge for credit = 3.5F

Allocation of Finance charge on SOYD method


(Rs. crores)
Year SOYD Factor Interest PV at 26%
1 654/1830 1.251F 0.993F
2 510/1830 0.975F 0.614F
3 366/1830 0.7F 0.350F
4 222/1830 0.425F 0.169F
5 78/1830 0.149F 0.047F
2.173F
As required IRR is 26%, NPV(HP) at 26% = 0
Hence,
– Initial Investment + PV of hire rentals – PV of tax on finance income = 0
–70 + (1.167 + 0.058F) 12 × 1.1142 × 2.635 – 2.173F × 0.3 = 0
–70 + 41.115 + 2.043F – 0652F = 0
1.391F = 28.885
F = 20.77%
Flat rate to be charged on HP transaction should be 20.77%.

5. a. Computation of Eligible Reserves


Amount
Particulars
(Rs. lakhs)
Share premium 200
General reserve 700
Dividend equalization reserve 250
Contingency reserve 75
Eligible reserves 1225
Note: Share premium not eligible = 10 (50 – 10) = Rs400 lakhs. This is because this was accrued to the
share premium account on account of notional premium charged to the machinery supplier. As this
premium is not collected in cash, the same is not included in the computation of eligible reserves.

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Computation of Number of Share Entitled to Receive Bonus Shares
Shares issued and paid up 20000000
Shares arising out of conversion of FCDs
Part A 1000000
Part B – 1000000 × 2 = 2000000 3000000
Total 23000000
Computation of Maximum Permissible Bonus Ratio
Par value of each share = Rs.10
Therefore, number of shares that can be issued to capitalize the eligible reserves
= Rs.1225 lakhs/Rs.10 = 122.5 lakhs
Bonus ratio
122.5
= = 0.5326 i.e., 532 bonus shares for every 1000 shares held
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b. As per the latest SEBI Guidelines, par value of a share can be in Re.1 or multiple of Re.1. Hence the
maximum permissible Stock Split ratio = 10:1, i.e, 10 shares for each share held.

Part C: Applied Theory

6. Any proposal will be considered only if the applicant satisfies all the following conditions stipulated by
NHB as tests of eligibility. Broadly the eligibility criteria are as follows:
• The loans should be directly to individuals or groups of individuals.
• A co-applicant, if there is any, either the spouse of the applicant or son or brother (if there were no
male children in the family) or daughter (if only child), co-applicant may be a co-owner of the
property. Minors cannot be co-applicants.
• Residential active (earning) life of the applicant reckoned at 60 years - should cover the repayment
period.
• Any other criteria that may be stipulated by NHB from time to time.
Appraisal
Having decided upon the eligibility, the application is accepted with the processing fee (ranging from
0.8%-1% depending upon the institution) along with the necessary documents. The third step consists of
appraisal of the proposal. This appraisal can be broadly divided into 3 steps:
• Credit Appraisal
• Legal Appraisal
• Technical Appraisal.
Credit Appraisal
The main objective of this credit appraisal is mainly to assess the applicants sustained repayment capacity
over the period. The main points which are considered here are:
• Income
• Age
• Academic Background and Employment Stability
• Family Background
• Assets and Liabilities
• Servicing record in respect of other institutional borrowings
• Savings history/capacity
• Number of dependents
• Income and expenditure pattern.
The list cannot be exhaustive and fool proof. The inputs differ from case to case.

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The sources of income of the individual may be:
• Employment (salary)
• Business/Profession
• Other Income (to be specified and verified)
Income from Employment (Salary)
Three main factors are to be considered here
i. Gross Salary
ii. Deductions
iii. Adjusted take-home salary
Business or Professional Income
In this category the individual may be a sole proprietor or a partner or a Director of a Private Limited
Company, May be a manufacturer or a Trader or a provider of a service.
In all these cases the income is to be ascertained from the financial statements for three years produced,
supported by other relevant documentary evidence.
Other Income
This may be from Investments, Rental, Agricultural or Vocational.
Legal Appraisal
After credit appraisal is done, the next step is legal appraisal wherein all the other documents like original
title deeds, revenue receipts, encumbrance (search) certificates for the past 30 years are verified by an
experienced lawyer to confirm that the withholder can create an equitable mortgage in favor of the Housing
Finance Company by simple deposit of title deeds.
Technical Appraisal
The technical officer will first verify the original documents and counter check upon all the furnished
information, records, approval, clearance, certificates and orders. The applicant should submit all the
documents relating to guarantees, collateral securities (LIC policies, fixed deposits, etc.). The needed
documents differ from case to case depending upon, whether the house is being purchased - and, if so from
whom - or whether it is a self construction.
By scrutiny of documents submitted, prior information about the proposed property like approval and
clearance from competent authorities can be verified. A check on the estimate submitted can prevent the
HFC financing additional amount more than the actual cost of property.
It should be appreciated that after the credit appraisal, technical appraisal is the most important stage in the
processing of any loan. Technical appraisal safeguards the borrowers interest before and after the property
is selected by him.

7. RATING PROCESS
The following steps indicate the process involved in credit rating:
1. The rating process commences when a client approaches the credit rating agency to analyze and
provide a rating symbol/report to a security/individual/borrower, etc.
2. The rating agency then assimilates all the necessary information required for this by meeting the
management of the company/borrower. The information provided for rating process will be highly
confidential and will not be used for any other purpose.
3. Based on the analyses of the report, the rating will be decided.
4. The rating will then be communicated to the client along with the reasons supporting the rating. If this
rating is not agreeable, the client may appeal for reviewing the rating for which additional/new
information will have to be provided.
5. If the rating is accepted by the client it will then be declared to the public by the credit rating agency.
6. Since rating is not a one time process, there will be a continuous monitoring of the client’s
performance and its operational environment. Based on this information the rating may be affirmed,
upgraded or downgraded. Any changes will, however, be informed to the public.
The rating services in the international markets can be classified into Shadow Rating and Formal Rating.
The basic distinction between these two types of ratings is that the shadow rating is an indicative rating and
will give the issuer an idea of its formal rating and suggests if it would be beneficial to go for a formal
rating.
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Shadow Rating: The issuer will not have to disclose the rating to the public.
The firm can, either independently or with the help of its investment banker, assess its shadow rating by
proceeding in the following manner:
1. After collecting the relevant information, various financial ratios used by rating agencies can be
computed.
2. Identify companies with similar projects having published ratings. The financial ratios of these
companies can be used for comparison.
3. Apart from these financial ratios, assess the management quality, performance of parent/group
companies.
4. Give more weightage to those factors/ information that have a major impact on the performance of the
company. Based on this also identify the strengths and limitations of the firm.
5. Use the ratings of the industry averages, other companies with similar projects and assign an
indicative rating.
6. To this indicative rating apply the sovereign limitations to get the final indicative rating. This rating
should preferably be in the form of a range and not as a specific rating.
Formal Rating: The issuer will have to announce the rating assigned in Formal Rating to the public.
The process involved in formal rating will be more detailed than the shadow rating process, since there will
be a need for more disclosures, and sometimes even plant visits may be involved in it. Further, the shadow
rating will not require any annual fee and meetings. While on the other hand, since formal rating will
involve monitoring, there will be an annual fee for such ratings. In addition to this there will also be annual
meetings.
The information that a rating agency would be looking for while providing formal ratings will include the
following:
Financial Data: Here the agency would focus on both the current performance and historical data. With
the latest information, key ratios that indicate the credit position of the company will be assessed and
compared with the industry averages. Supplementing this information will be the financial track record of
the company. This helps in identifying key factors that influence the business.
Financial Projections: By projecting the future financial performance of the company, the rating agency
will be able to assess the credibility of the company.
Financial Support: The extent of support obtained from outside sources, including parent company, helps
in assessing the strength of the company.
Market Position: The rating agency assesses the market position of the company within the industry and
studies its plans to maintain or expand its market share.
Management: Information relating to the role and responsibility of senior management and their
background will also be sought.
Business Environment: The rating agency collects information on the industry outlook and assesses the
factors influencing the business environment.

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