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OBJECTIVE TYPE QUESTIONS

FOR PRACTICE (COVERS ALL MODULES)

Net Interest income is

(i) Interest earned on advances

(ii) Interest earned on investments(iii) Total interest earned on advances and investment

(iv) Difference be!een inere" e#rne$ #n$ inere" %#i$

Interest rate risk is a type of

(i) Credit risk

(ii) M#r&e ri"& (iii) Operational risk

(iv) All the above

European opinion can be exercised on any day at the option of the buyer on orbefore the expiry of the option

(i) True

(ii) F#'"e

!hat is the beta factor for corporate finance under "tandardi#ed approach $

(i) %&'

(ii) *

(iii) %'

(iv) None of the above

A bank suffers loss due to adverse market movement of a security The security

as hoever held beyond the defeasance period !hat is the type of therisk that the bank has suffered $

(i) *arket +isk

(ii) O%er#i+n#' Ri"&

(iii) *arket ,i-uidation +isk

(iv) Credit +isk

%

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(iv) 3.4*

>o many accounts have suffered ratin1 mi1ration in the folloin1 table

+atin1 *i1ration of %99 A +ated Accounts

*i1ration beteen ?%9?9< and ?%9?9@

L#"

R#in5

N+. +f

Acc+6n"

Pre"en R#in5

A77 A7 A B7 B C Def#6'

A %99 % % @/ %9 = ?

(i) 3

(ii) %/

(iii) %(iv) &

The risk that arises due to orsenin1 of credit -uality is

(i) Intrinsic +isk

(ii) Cre$i "%re#$ Ri"&

(iii) 3ortfolio risk

(iv) Counterparty risk

A debenture of face value of As %99 carries a coupon of %&' If the current yield

is %&' !hat is the current market price $

(i) +s%99

(ii) R".38

(iii) +s%&9(iv) +s%&

In order to develop an capability to actively mana1e an credit portfolio one musthave in place the folloin1

(a) Credit +atin1 *odel (or models for different cate1ories of loans andadvances)

(b) 7evelop and maintain necessary data on defaults of borroers ratin1

cate1ory ise6 ie6 B+atin1 *i1ration

(i) B+0 #n$ 3 #re re96ire$

(ii) Only % is re-uired

(iii) Only is re-uired(iv) None of the above

?

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An increase in cash reserve ratio ill cause yield curve to

(i) "hift donard(ii) +emain unchan1ed

(iii) 0ecome steeper

(iv) Bec+2e f'#er

The model that combines five financial ratios usin1 reported accountin1information and e-uity values to produce on obDective measure of

borroers financial health is

(i) A'2#n:" 3 "c+re

(ii) BCredit *etrics

(iii) Credit +isk


A bank holds a security that is rated A The ratin1 of the security mi1rates to A!hat is the risk that the bank has faced $

(i) *arket risk (ii) Operational risk

(iii) *arket li-uidation risk

(iv) Cre$i ri"&

!hen interest rates 1o up6 prices of fixed interest bonds F

(i) 8o up

(ii) ;+ $+!n

(iii) +emain unchan1ed

5a+ is not enou1h to assess market risk of a portfolio "tress testin1 is desirable

because

(i) It helps in calibratin1 5a+ module

(ii) It helps as an additional risk measure

(iii) I 0e'%" in #""e""in5 ri"& $6e + #bn+r2#' 2+ve2en +f 2#r&e

%#r#2eer"

(iv) It is used as 5a+ measure is not accurate enou1h

STUDY T

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(COVERS ALL MODULES)

(a) 0ond ith B000 ratin1 ill carry loer interest rate than one ith BAAratin1

i. F#'"eii True

iii 7ifficult to say

(b) Gall in interest rate cause the rate causes the bond prices also to fall

i. F#'"e

ii Trueiii 7ifficult to say

(c) A normal yield curve is slopin1 upard

i Galseii. Tr6eiii 7ifficult to say

(d) "tamp duty on transfer of dematted shares is loer

i. F#'"e

ii True


(e) ,ar1e 8overnment borroin1 can cause yield curve to shift upard

i Galse

ii. Tr6e


(f) 8roth Gunds assure 1roth in return

i. F#'"e


(1) If short term interest rates remain hi1her than the lon1 term interest rates6the yield curve ill be inverted

i Galse

ii. Tr6e


&

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(h) Credit ratin1 a1encies determine interest rates on debt securities

i. F#'"e

ii True


(i) The shares of softare companies carry hi1h 3:E ratio

i Galse

ii. Tr6e


(D) Closed end mutual funds are tradin1 at discount to NA5

i Galse

ii. Tr6e


(k) In a risin1 interest rate phase Hero coupon bond ill be traded at apremium

i. F#'"e

ii True


(l) A sharp decline in short term interest rates ill cause yield curve to besteeper

i Galse

ii. Tr6e


(m) A fall in interest rates reduces the demand for bonds in the secondary

market

i Galse

ii. Tr6e


(n) Increase in the cash reserve ratio can cause the yield curve 1oin1

temporarily inverted

i Galse

ii. Tr6e


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(o) 7emateriali#ation of stocks has increased turnover on the stock market

i Galse

ii. Tr6e


(p) Ti1ht money and credit policy ill cause bond prices to fall

i Galse

ii. Tr6e


(-) Increasin1 8overnment borroin1 ill raise interest rates

i Galse

ii. Tr6eiii 7ifficult to say

(r) 0ond carryin1 BAA ratin1 ill carry hi1hest interest rate than one

carryin1 B000 ratin1

i. F#'"e

ii True


(s) *utual fund redemption brin1 bearish influence on the stock market

i Galse

ii. Tr6e


(t) 7ecline in the interest rates on lon1 dated 8ovt bonds ill cause yield

curve to be steeper

i. F#'"e

ii True


(u) 7emat shares carry loer stamp duty on transfer than physical shares

i. F#'"e

ii True


(v) Increase in interest rates ill cause bond prices to fall

@

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i Galse

ii. Tr6e


() 8roth fund is a mutual fund that invests primarily in e-uity shares

i Galse

ii. Tr6e


(x) "tamp duty on transfer of demated shares is loest

i. F#'"e

ii True


(y) ,ar1e 8overnment borroin1 in the market can make the yield curve shift

upard

i Galse

ii. Tr6e


(#) 0ond ith BA ratin1 ill carry hi1her interest rate than one carryin1

B000 ratin1

i. F#'"e




!hen the interest rates fall6 the market price of a fixed rate bond

(i) falls

(ii) ri"e"

(iii) does not chan1e

2

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A transaction here financial securities are issued a1ainst the cash flo 1enerated

from a pool of assets is called

(i) Sec6rii>#i+n

(ii) Credit 7efault "aps

(iii) Credit ,inked Notes(iv) Total +eturn "aps

8roth Gund is a mutual fund that

(i) assures 1roth in income

(ii) invests in fixed income securities

(iii) 1ives fixed return

(iv) inve"" %ri2#ri'1 in e96iie"

Operational +isk arises from

%) Inade-uate or failed internal processes

) 3eople and systems?) External Events

=) 7efaults

!hich of the folloin1 is true $

(i) All of them

(ii) None of them

(iii) (#) , (b) #n$ (c)

(iv) (a) 6 (b) and (e)

A decline in cash reserve ratio ill cause the yield curve to

(i) shift upard

(ii) "0if $+!n!#r$

(iii) become flatter

(iv) remain unchan1ed

The third consultative paper recommended for

(a) Cause based classification(b) Effect based classification

(c) Event based classification

Gor operational risk !hich of the folloin1 is true

(i) (a)

(ii) None of them

/

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(iii) (c)

(iv) (b)

%' 8overnment of India security is -uoted at +s%9 If interest rates 1o don

by %'6 the market price of the security ill be

(i) +s %9

(ii) R".??.?

(iii) +s %9/(iv) +s %=9

0enefits of inte1rated risk frame ork are

(a) To relate capital and reserves more effectively to their

actual level of risk exposure(b) To evaluate pricin1 decisions and product profitability

(c) In makin1 risk transfer decisions


(i) A'' +f 0e2

(ii) None of them(iii) (a) and (b)

(iv) (b) and (c)

+eards of proper mana1ement of operational risks are

(a) ,esser risk capital

(b) Cost reductions in operations

(c) Competitive ed1e


(i) All of them

(ii) None of them

(iii) (a) 6 (b) and (c)

(iv) (#) #n$ (b)

A fall in lon1 term interest rates on 8overnment securities ill make the yield

curve become

(i) f'#er

(ii) steeper (iii) shift donard

%9

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A bank expects fall in price of a security if it sells it in the market !hat is the

risk that the bank is facin1 $

(i) *arket risk

(ii) Operational risk

(iii) A""e Li96i$#i+n ri"&(iv) *arket li-uidity risk

(i) An 2;year 2' semi;annual bond has a 035 of +s%& The yield

on the bond has

%%' 8overnment of India security is -uoted at +s %%96 the yield ill be F

(i) %%'

(ii) 8*

(iii) /'(iv) None of these

% day 5a+ of a portfolio is +s&996999 ith /&' confidence level In a period of

six months (%& orkin1 days) ho many times the loss on the portfolio

may exceed +s&996999 $

(i) = days

(ii) & days

(iii) - $#1"

(iv) @ days

A fall in interest rates ill make prices of 8overnment "ecurities ;

(ii) 8o don

(iii) ;+ 6%

(iv) +emain unchan1ed

(v) None of these

"ystemic risk the risk of

(i) Gailure of a bank6 hich is not adherin1 to re1ulations

(ii) Gailure of to banks simultaneously due to bankruptcy of one bank(iii) !here a 1roup of banks fail due to conta1ion effect

(iv) F#i'6re +f enire b#n&in5 "1"e2

If the yield on lon1 dated 8ovt securities falls6 then the yield curve ill became;

(i) "teeper

(ii) F'#er

%%

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(iii) "hift donard

%%' 8ovt of India security is -uoted at +s%%9 If the interest rates 1o don by

%' the market price of the security ill be

(i) +s%%9

(ii) +s%9/

(iii) R".33.3

(iv) +s%?9

0alanced fund is a mutual fund that

(i) Assures income

(ii) Invests in debt and e-uity

(iii) A""6re 5r+!0

(iv) 8ives fixed returns

0ack testin1 is done to

(i) Test a model

(ii) C+2%#re 2+$e' re"6'" #n$ #c6#' %erf+r2#nce

(iii) +ecord performance


nder 0asel II6 Capital re-uirement under the accord is

(i) The maximum Capital that is re-uired to be maintained

(ii) The minimum Capital that is re-uired to be maintained

(iii) T0e c#%i#' #" "%ecifie$ b1 0e re56'#+r1 #60+ri1 i" re96ire$

+ be 2#in#ine$


STUDY T

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(bb) "teeper yield curve means lon1 term interest rates are much loer than

short term interest rates

i. F#'"e


(cc) *utual fund mobili#ation has bearish influence on the stock market

i. F#'"e

ii True


(dd) Convertible debentures carry an element of e-uity shares

i Galseii. Tr6eiii 7ifficult to say

(ee) Credit +atin1 a1encies fix interest rates on bonds or debentures issued by

companies

i. F#'"e

ii True


(ff) *utual Gunds invest only in e-uity shares

i. F#'"e

ii True


(11) Gavorable monsoon bri1htens the prospects for stock market

i Galse

ii. Tr6e


(hh) ,ar1e 8overnment borroin1s cause debt securities prices to rise

i. F#'"e

ii True


%?

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(ii) Gallin1 interest rates have benefited investors in debt securities mutual

funds

i Galse

ii. Tr6e


(DD) ,ar1e 1overnment borroin1 ould cause interest rates to 1o don

i. F#'"e

ii True


(kk) Gallin1 interest rates cause NA5s of debt mutual fund to 1o don

i. F#'"e


(ll) 0ond ith B000 ratin1 ill carry loer interest rates than one ith BA

ratin1

i. F#'"e

ii True


(mm) *oney market mutual funds do not invest in e-uity shares

i Galse

ii. Tr6e


(nn) "E0I 1ives credit ratin1 to securities issued in the capital market

i. F#'"e


(oo) *utual funds can offer 1uaranteed returns

i. F#'"e

ii True


(pp) ,ar1e 1overnment borroin1s ill cause interest rates to 1o up

%=

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i Galse

ii. Tr6e


(--) A mutual fund schemeJ ith a entry load ill have its sale price hi1herthan its NA5

i Galse

ii. Tr6e


(rr) "ecurity ith A ratin1 ill carry hi1her interest rate than one ith 00ratin1

i. F#'"e




A fall in the interest rates causes 8ovt "ecurities to

(i) +emain stable

(ii) Gall

(iii) Ri"e

Capital char1e for credit risk re-uires input for 376 ,876 EA7 and * nderadvanced I+0 approach6 ho provide the input for ,87

(i) B#n&

(ii) "upervisor

(iii) Gunction provided by 0C0"


A debenture of +s%99 carryin1 %&' coupon rate is -uoted in the market at

+s%?&:; The current yield on this debenture ill be

(i) %?&'

(ii) %&'

(iii) .*

(iv) %9'

Investment in 3ost Office time deposit is

%&

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(i) @er+ ri"& inve"2en

(ii) ,o risk investment

(iii) *edium risk investment(iv) >i1h risk investment

If the short term interest rates are temporarily hi1her than the lon1 term interestrates6 the yield curve ill be

(i) "lopin1 upard

(ii) Invere$

(iii) Hi1#a1

(iv) >ori#ontal

3remature payment of a term loan ill result in interest rate risk of type

(i) 0asis risk

(ii) 4ield curve risk(iii) E2be$$e$ +%i+n ri"&(iv) *ismatch risk

A company ith e-uity capital of +s&9 crores (Gace 5alue of +s%9:; per share)

makes 1ross profit of +s@9 crores and net profit after tax of +s& crores

If the market price of its e-uity share is +s&96 the 3E ratio ill be

(i) &9

(ii) &

(iii) 8

(iv) 9

7aily volatility of a stock is %' !hat is its %9 days volatility approximately $

(i) ?*

(ii) %9'(iii) %'

(iv) ='

If call money rates are temporarily hi1her than the lon1 term interest rates6 theyield curve ill be

(i) "loppin1 upards(ii) Hi1#a1

(iii) Invere$

(iv) >ori#ontal

Capital char1e component of pricin1 accounts for

%) Cost of capital

%

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) Internal 1eneration of capital

?) ,oss provision

!hich of the folloin1 is true$

(i) All the statements are correct(ii) S#e2en" #n$ 3 #re c+rrec(iii) "tatements and ? are correct

(iv) "tatements ? and % are correct

E-uity oriented mutual funds

(i) Assure income(ii) Assure 1roth

(iii) Invest in debentures

(iv) Inve" in "0#re"

A bank funds its assets from a pool of composite liabilities Apart from credit and

operational risks6 it faces

(i) B#"i" ri"&

(ii) *ismatch risk(iii) *arket risk

(iv) ,i-uidity risk

A branch sanctions +s% core loan to a borroer6 hich of the folloin1 risks the

branch is takin1

%) ,i-uidity risk

) Interest rate risk

?) *arket risk=) Credit risk

&) Operational risk

(i) All of them(ii) %6 and ? only

(iii) %6= and & only

(iv) ,3, #n$ 4 +n'1

A rise in 8overnment securities prices ill make yield curve F

(i) "lope upard

(ii) S0if $+!n!#r$

(iii) +emain stable

(iv) "hift upard

%@

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+isk miti1ation measures result in

%) +educin1 donside variability

) +educin1 upside potential hich of the folloin1 is true

(i) B+0 0e "#e2en" #re c+rrec

(ii) 0oth the statements are not correct

(iii) "tatement % is correct

(iv) "tatement is correct/' 8overnment of India security is -uoted at +s%9 The current yield on the

security ill be F

(i) %'(ii) /'

(iii) /.4*

(iv) %??'

Ginancial +isk is defined as

(i) Uncer#inie" re"6in5 in #$ver"e v#ri#i+n +f %r+fi#bi'i1 +r

+6ri50 '+""e"

(ii) ncertainties that result in outri1ht losses(iii) ncertainties in cash flo

(iv) 5ariations in net cash flos

"trate1ic +isk is a type of

(i) Interest +ate +isk

(ii) Operation +isk

(iii) ,i-uidity +isk

(iv) N+ne +f 0e #b+ve

ObDective of li-uidity mana1ement is to

(i) Ensure profitability(ii) Ensure li-uidity

(iii) Either of to

(iv) B+0

%2

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A mutual fund char1es %' entry load and no exit load Its NA5 is +s%

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(i) 2&&'

(ii) -.34*

(iii) @@&'(iv) @'

A company ith e-uity capital of +s%& crores makes 30I7T of +s%& crores and3AT of +s%9 crores The face value of its share is +s& and 3E is %96 the

market price ill be ;;;;;;;;;

(i) +s&9

(ii) +s

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3AT

K ;;;;;;;;;;;;;;;; N!

%9K ;;;;;;;;;;;;;; x %99

=&

K '

(iv) 7ebt;e-uity ratio

K ?& =& K @/

(v) 3:E ratio

3E K *3 : E3" K %&9 : %9 K %&

(vi) 3ayout ratio

7ividend &

K ;;;;;;;;;;; x %99 K ;;;;;;;; x %99 K &9'

3AT %9

A company ith e-uity of +s %9 crore earns 30I7T of +s =9 crore It incurs

interest of +s& crore6 depreciation of +s & crore and pays tax of +s %9 crore Ithas reserves of +s ?9 crore (Excludin1 current years profits) and lon1 term debt

of +s &9 crore It pays %99' dividend and transfers remainin1 profit to reserves

Its share of +s %9 face value is -uoted at price of +s 99 Gind the folloin1

(i) 0ook value of share after current yearLs profit transferred to reserves

0ook 5alue K E-uity +eserves Current years (3AT F 7iv)

K %9 ?9 (9 F %9) K +s&9

(ii) Earnin1 per share

=9 F ( &&%9)

E3" K 3AT : E-uity K ;;;;;;;;;;;;;;;;;; x %9 %9

9

;;; x %9 K +s9

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%9

(iii) +eturn on net orth

3AT x %99 9=9' +eturn on net orth K ;;;;;;;;;;;; K ;;;;;;; x %99 K =9'

N! &9

(iv) 7ebt;e-uity ratio

&9

%% 7ebt e-uity ratio K ;;;;;; K %%&9

(v) 3:E ratio

%9 *3 K E3s x 3E99 K 9 x 3E

3E K %9

(vi) 3ayout ratio

&9'

7ividend %9

;;;;;;;;;;; K ;;;; K &9' 3AT 9

IMPORTANT EY =ORDS FOR PRACTICE

A%%reci#i+n

An increase in the market value of an asset

Arbir#5e

(i) 7ealin1 beteen to centres to take advanta1e in the rate due to a temporary

difference in the rates beteen to places

(ii) The simultaneous tradin1 (purchase:sale O+ sale:purchase) of assets to take advan;

ta1e of price differentials

A""e cre#i+n

Ac-uisition of assets: investments

B#'#nce "0ee

?

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A Ginancial "tatement that indicates the type and amount of assets6 liabilities and Capital

of a firm as on a particular date

B#"e c6rrenc1

The currency a1ainst hich another currency is -uoted ME1 IN+ ?/=229:"7Fherein

IN+ is -uoted currency and "7 is base currency

B R

0ankers +eceipt This is a receipt issued by the 0ond: security sellin1 bank hen the

ori1inal scrip: 0ond is not immediately deliverable for settlement

Bi$

The price -uoted by someone to buy the asset or borro funds

Br+&er

Intermediaries ho match buyers and sellers Or borroers and lenders and receive a

commission (brokera1e) for such intermediation

C+nc6rren #6$i+r

A professional6 1enerally an external 1uy (not a staff)6 ho checks: audits the day to day

transactions and reports >is main task is to check hether the laid don

systems:procedures:policy has been complied ith6 in each transaction and report the

discrepancies to the *ana1ement

C+ver

To take out forard contracts to protect a1ainst exchan1e fluctuation beteen todays

date and due payment date

De#'

A transaction undertaken by the 7ealer in the domestic market or Gorei1n Exchan1e

market bindin1 the 0ank

De#' c+nfir2#i+n

=

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!ritten advice from one counterparty in a deal to the other in hich the main terms and

conditions of the deal are confirmed

Fie$ r#e c6rrenc1

Currency havin1 a fixed rate of exchan1e ithin narro limits versus another reference

currency6 usually the dollar

F'+#in5 r#e c6rrenc1

Currency havin1 its exchan1e rate determined by market forces includin1 Central 0ank

intervention

F+re

Gorei1n Exchan1e

F+r!#r$ c+nr#c

Any contract for settlement later than spot date

F+r!#r$F+r!#r$ $e#'

"imultaneous purchase and sale of one currency for different forard value dates

F6n$in5 +f #""e"

0orroin1 done6 hen assets are more than the ,iabilities of the bank

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The variation in net income and market value of bank e-uity caused by the banks

difficulty in obtainin1 immediate funds6 either by borroin1 or sellin1 assets

LIBOR

,ondon Interbank Offered +atethe rate at hich maDor 0anks in ,ondon offer to lend

in the interbank market

N+"r+ #cc+6n

A 0anks account ith a forei1n 0ank

NSE

National "tock Exchan1e

NSE er2in#'"

Computer nodes throu1h hich screen driven tradin1 can be conducted in the N"E

Offer

+ate at hich the 0ank:dealer sells or lends

O%en %+"ii+n

7ifference beteen total purchases and total sales in a 1iven currency on hich an

exchan1e risk is run

Pre2i62

7ifference beteen spot price and price for forard settlement

Pr+#cive

One ho acts in advance before others react6 anticipatin1 the market move

Re"erve"

Pualifyin1 assets to meet the statutory reserve re-uirements

Se'e2en +f $e#'"

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5erification of the deal terms:calculations6 obtention of 7eal confirmation from the

counterparty6 0rokers contract6 documentation of the transaction and arran1in1 the

delivery of the documents

S;L #cc+6n

"ubsidiary 8eneral ,ed1er Account maintained ith +0I for 8ovt "ecurities

transactions

S%+ $e#'

A deal for currency for delivery to business days from today

S%+ ne

A deal from the spot date until the next day6 either as a deposit or a sap

S%re#$

7ifference beteen the cost of funds and return from the funds

V+'#i'e 2#r&e

*arket herein the prices:rates are fluctuatin1 in a ide band: ran1e

V+"r+ #cc+6n

A forei1n 0anks account ith a local 0ank

=ire #5enc1

Nes reporters6 hich are transmittin1 the information:nes instantaneously throu1h

tele;net ork

Re"erve"

Assets -ualifyin1 to meet statutory re-uirements

CRR

Cash +eserve +atio

SLR

@

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"tatutory ,i-uidity +atio

A""eLi#bi'i1 M#6ri1 Mi"2#c0e"

Case hen either 1ross Ginancial Assets out1ros Capital Q ,iabilities or vice versa

De2#n$ #n$ Ti2e Li#bi'iie" (DTL)

"um of 7emand 7eposits and Gixed deposits includin1 inter bank deposits

;+vern2en S+c&L+#nSec6riie";i'"

,oans raised by 8overnment to meet its fiscal deficits These are issued in the form of

tradable bonds

NDTL f+r SLR

8ross 7T, less Inter 0ank 7eposits

NDTL f+r CRR

N7T, for ",+ less exempted cate1ories of liabilities

De'iver1 ver"6" P#12en (DVP) S1"e2

"ystem here the securities are delivered a1ainst simultaneous payment As both the le1s

of Bdelivery and Bpayment are simultaneous "ettlement +isk is avoided

S;L Tr#n"fer F+r2

+0I prescribed format printed on semi security paper for effectin1 security transactions

in the "8, account of the bank

A60+ri>e$ Si5n#+rie"

Officials (1enerally back office staff) ho are authori#ed to execute: si1n "8, Transfer

Gorms and other documents and hose specimen si1natures are lod1ed ith +0I andother counterparts in the market

B#n& R#e

2

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Interest rate at hich +0I lends to "ch Comm 0anks +efinance +ates and penalty on

default of C++ are pe11ed to 0ank +ate +0I is usin1 0ank +ate as a tool to send

interest rate si1nals to the market

L+c#' B#n& Acc+6n

Account ith "0I and:or such other 0ank6 hich is mana1in1 the Clearin1 house6

throu1h hich the Clearin1 net proceeds are and here the 0ank is maintainin1 a current

account for passin1 the Clearin1 inflos and outflos

C#"0 S6r%'6" Br#nc0

0ranch hich collectin1 and holdin1 cash more than its stipulated limit: normal payment

re-uirement

P6rc0#"e$ F6n$"

Gunds sourced at the at market determined rates (different from rates offered to the

public)

Re%+#b'e Sec6riie"

"ecurities hich are approved for +epo transactions

Di"crei+n#r1 Li#bi'iie"

,iabilities:resources raised at the discretion of the borroer

B61er" M#r&e

*arket here the demand is less and supply is more 0uyer has better choice for

selection:ne1otiation since sellers (supply) outnumbers the buyers (demand)

CAR

Capital Ade-uacy +atio

DVP S1"e2

B7elivery versus 3ayment (753) system is the "ettlement system herein delivery of

the "tock:security and 3ayment of consideration are made simultaneous In case if one

side of the transaction doesnt 1o throu1h (say6 for ant of 1ood delivery)6 the +0I holds

/

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back the other side of the transaction (payment of consideration) 0y this6 settlement risk

is totally hed1ed

Deriv#ive U"#nce Pr+2i""+r1 N+e (DUPN)

sance 3romissory note dran by the discountin1 0ank a1ainst the underlyin1 0ills!hile rediscountin1 the 0ills6 actual endorsement and delivery of these 0ills are not

necessary Instead this 3romissory Note is delivered "ince this Note derives its value

from the underlyin1 0ills6 this is called 7erivative sance 3romissory Note

M#i2i>#i+n +f S%re#$"

7ifference beteen the Total cost of funds and total return from it 1ives the spread

"preads can be maximi#ed either by reducin1 the cost and:or increasin1 the return from

it

M#i2i>#i+n +f Ne !+r0

Increasin1 the profits of the business so that maximum profits can be plou1hed back to

+eserves This maximi#es the Net orth of the Company and thereby increases the

"hareholders value

;AP

It is the difference beteen the +ate "ensitive Assets (+"A) and +ate "ensitive

,iabilities (+",) 8A3 is said to be positive hen +"A R +",

D6r#i+n ;AP

7ifference beteen the a11re1ate duration of Assets and a11re1ate duration of ,iabilities

is 7uration 8ap

M#r&e Inere" R#e

The interest rate6 or discount rate6 or yield to maturity is an interest rate hich chan1es

constantly6 dependin1 on various factors like demand:supply of the Ginancial asset6 future

economic outlook6 etc

F#ce V#'6e

?9

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The principal value or the *aturity value of the 0ond6 hich is printed on the bond and

hich is fixed throu1hout the bonds life

C+6%+n R#e

The fixed rate of interest hich is printed on the 0ond certificate is called Coupon rate

Coupon rates are contractual rates that cannot be chan1ed after the bond is issued

Ti2e V#'6e +f M+ne1

In order to understand this concept6 it is important that e are familiar ith discounted

cash flo analysis

It is knon that

a 3eople have a positive time preference for moneyJ

b A rupee today is orth more than a rupee received in the futureJ

c 3eople postpone their current consumption and save only if their future

consumption opportunities ill be more because of their savin1sJ

d "ince money earns interest6 it takes more future rupees to e-ual the value of a rupee

today

The above sho that money has a time value

F66re V#'6e

The process of 1oin1 from todays value or 3resent 5alue (35) to Guture 5alue (G5) is

called compoundin1 To understand this6 consider the case here an investor put +s %99

in the 0ank at %9 per cent pa

This means that +s %99 today is e-uivalent to its Guture value of +s %99 x (% 9%9) K +s

%%9 one year from no

Guture 5alue at the end of second year is +s%%9 x (% 9%) K +s %%

This can be expressed by the formula

G5 K 35 (%i) n

?%

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!here i K interest rate and n is number of years

Pre"en V#'6e

The process of calculation from Guture 5alue to todays value (3resent 5alue) is called

discountin1 In the above -uoted example the 3resent value of +s %% to be received from

the 0ank at an interest rate of %9 per cent is +s %9999 The process of discountin1 is

simply the inverse process of compoundin1 Accordin1ly6 the 3resent 5alue (35) can be

found out as follos

35 K G5 : (%i) n

Ne Pre"en V#'6e

"uppose an investment of +s%99 1enerates a net cash flo of +s %%& from one year fromno and if the cost of funds for the 0ank is %9 per cent6 the investment is orth doin1

To find out ho much ealth does the investment creates for the capital6 the future value

of +s %%& is discounted at the cost of capital6 ie6%9 per cent

%%&

35 of +s %%& K K +s %9=&&

(% 9%)

"ince the initial cost of investment is only +s %996 the Net 3resent 5alue6 ie6 the ealthcreated for the shareholders6 is found out as

N35 K 35 of the future revenue F initial cost K %9=&& F%99 K +s =&&

The net present value (N35) approach can be extended to more complex situations

sin1 the same lo1ic as above6 to find the N35 of an asset ith an initial investment of

cost of C and net cash flos at subse-uent dates from year % to year Bn is

cash flo % cash flo cash flo n

N35 K (F) C

(%r)% (%r) (%r) n

B+n$ V#'6#i+n

0ond is a contractual obli1ation to pay

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i Coupon:interest specified on the 0ondJ

ii at fixed intervalsJ

iii 3rincipal amount ith or ithout premium6 if specified any6 at maturity

The 3resent value or price of the 0ond is therefore

i 35 of the future stream of cash flos (interest payments and 3rincipal) discounted

at prevailin1 market interest ratesJ

ii At the time of ne issue6 coupon interest and market interest are ideally the same

and expressed as follos

C% C C? (Cn *)

0ond 5alue (50) K

(%i) (%i)

(%i)?

(%i)n

n C *

K

t K% (%i)t (%i) n

!here

C% Cn K period coupon payment from year % to n

i K market interest rates6 prevailin1

n K period to maturity

* K 3rincipal ith : ithout redemption premium

The value of the 0ond ill chan1e if there is a chan1e in the market interest rate (i) If

market interest rate 1oes up beyond the coupon rate6 the value of the bond ill fall so that

the ne investor (buyer) ould earn market interest rate despite the fact that the coupon

of the 0ond ould continue to 1ive fixed loer income ,ikeise if market interest rate

declines belo the coupon rate6 the value of the bond ill appreciate so that the ne

investor (buyer) earn only loer market interest rate despite the fact that the coupon of

the 0ond ould continue to 1ive fixed hi1her income "uch e-uilibratin1 adDustment in

bond price: value is knos as bond dynamics

??

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!e learnt that the value of the 0ond depends on the coupon rate vis;S;vis prevailin1

market interest rates !e can summari#e the above as follos

i !henever the market interest rate rise above the coupon rate of the bond6 the price

of the bond ill fallJ

ii if the market interest rate falls belo the coupon rate of bond6 the price of bond ill

appreciateJ

iii if there is no chan1e in the market interest rate from bond coupon rate6 the price of

bond ill remain the same

Ann6i1

This is a series of e-ual payments made at fixed intervals for a specified number of

periods If the payments are made at the end of the period6 it is knon as ordinary annuity

or deferred annuity If payments are made at be1innin1 of period6 then it is an annuity

due

Gormula for Guture value of an ordinary :deferred annuity is

G5An K A (%r) A (%r) A

!here G5An K Guture value of an annuity ith Bn periods

A K Constant:re1ular cash flo

r K Interest rate

n K 7uration of the annuity

YIELD

4ield is defined as an overall return to an investor on his investment !ith respect to

yield on 0onds:8OI securities6 three types of yields are discussed

N+2in#' 1ie'$

?=

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This is the annual interest rate specified on the 0onds6 irrespective of its price (ie6

hether -uoted at a premium or at a discount) This is also knon as Coupon of the

0ond

C6rren 1ie'$

This is the effective yield an investor earns keepin1 in mind the current market price of

the 0ond This is 1iven by the formula

Nominal yield or Coupon

Current 4ield K x %99

Current market 3rice

Yie'$ + 2#6ri1

This term popularly knon as 4T* connotes redemption yield and is very useful for

Treasury *ana1ers hose investment hori#on is lon1 term 4T* can be interpreted as

the bonds avera1e compounded rate of return if the bond is bou1ht at the current asked

price and held until it matures and the face value is repaid That is6 4T* can be defined

as the discount rate that e-uates present value of all cash flos to the present market price

of the 0ond Guture cash flos includes interest and capital 1ain:loss This can be

al1ebraically expressed as follos ,et the 0ond ith a face value of BA of coupon BC

ith a term to maturity of Bn years is -uoted:traded at a market price of 36 then

C C C (C A)3 K

(%y)% (%y) (%y)? (%y)n

?&

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!here By is the discount rate (to be found by trial Q error method ) at hich the cash

flos are discounted so that the ri1ht hand side of the above e-uation tallies:e-uates ith

the 3rice 3 (left hand side) of the 0ond

The LyL so derived ould be the 4ield to maturity (4T*) of the bond It implies that6 ifthe 0ond is held till maturity and the Coupons:Cash flos received are reinvested at the

LyL rate itself6 the overall yield on the 0ond ill be LyL6 hich is its 4T*

An example ould further help to understand the mechanics of the 4T* "uppose the

market value of +s %99 (face value) bond carryin1 coupon of %? per cent pa maturin1

after @ years is -uoted +s %9/=& in the market The 4T* of the bond is found by

discountin1 the yearly coupon flos of +s %? in the next < years and +s %%? (3rincipal of

+s %99 coupon of +s %?) at the end of @ year at a rate (to be found by trial Q errormethod)6 say Br so that the 3resent value of such cash flos sums to +s %9/=& +s %?

(35IGA) +s %99 (35IG) K +s %9/=& 35IGA bein1 the 3rice 5alue Interest Gactor for

the @ year Annuity and 35IG the 3rice 5alue Interest Gactor for @ years to be taken from

the 35IGA table and 35IG table (available in all standard Ginance Text 0ooks) for a @

year term6 by trial and error method

Accordin1ly for @ years (35IGA) at %%' K =@%

and for @ years (35IG) at %%' K 9=2

Then ,>" of the e-uation becomes %? x (=@%) %99 x (9=2) K +s %9/=&

Then %% per cent is said to be the 4T* of the bond6 also described as the Internal +ate of

+eturn6 (I++) In other ords6 in the above example6 if the above bond is held by the

buyer till maturity the overall return from the 0ond ill be %% per cent >oever as the

above process ill be time consumin16 4T* can be found by approximation as follos

C (A F 3):n4T* K %99

(A 3) :

!here C K coupon

A K Gace 5alue:maturity 5alue

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3 K 3rice paid for the 0ond

n K term to maturity

Applyin1 this in the above example6

%? (%99 F%9/=&): @ %? (F /=&:@)

4T* K K

(%99 %9/=&): %9=@&

%? F %?&

K %99 K %%%'

%9=@&

>oever underlyin1 assumption in the 4T* concept is that the coupons:cash flos

received durin1 the tenure of the bond is reinvested at 4T* rate6 hich may not be true

since the market interest rates ill alays be chan1in1 from time to time

e$ Yie'$

!hen the holder:investor is 1oin1 to disinvest the 0ond before its maturity6 the overall

yield earned by him from the 0ond is knon as >oldin1 3eriod 4ield or +eali#ed 4ield

,et us understand this ith the help of an example

"uppose you are holdin1 a %9 year 0ond ith a Gace value of +s %99 and coupon 2 per

cent After ? years6 hen the interest rates move up to %9 per cent for @ years term6 you

ant to sell this 0ond As the interest rates have moved up6 naturally you may have to

sell the 0ond at a discount The sellin1 price for the 0ond by usin1 the 0ond 5aluation

Gormula as follos

2 2 2 %92

K /9&

(%%9) (%%9) (%%9)? (%%9)@

?@

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This shos that the 0ond have to be sold at a belo par value of +s /9&6 thereby

incurrin1 a capital loss of

(%99 F /9&) K +s /@&

No to find the +eali#ed yield on the 2 per cent bond for the period of ? years held and

ith a redemption value of +s /9& (as the sale proceeds of the 0ond)6 the 4T*

formula is used as follos

2 2 (2 /9&)

K %99

(%r)% (%r) (%r) ?

!here Br is the +eali#ed or >oldin1 3eriod 4ield

Accordin1ly6 e 1et the +eali#ed yield Br K =/ per cent

>oever as it is much loer than the promised yield of 2 per cent6 the seller incurs a loss

of (2 F =/) K ?% per cent returns on his 0ond

Yie'$ S%re#$"

4ield spreads are the differences beteen the yields of any pair of bondsusually a #ero

risk bond and another risky bondof same maturity

U4ield on risky bondVF U4ield on #ero risk bondsV K Uyield spreadV

4ield spreads are also called Brisk;premiums because they measure the additional yield

that risky bonds pay to induce investors to buy more;risky bonds rather than less risky

bonds

Yie'$ +n Di"c+6ne$ in"r62en"

The issue price of a discounted instrument is calculated as follos

G

7 K

?2

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% U( r x n):?

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GI+"T ,E8:+EA74 ,E8 on %9%999& (0ank A sold %%&9 per cent 8OI 99@ to

0ank 0)

Calculation for first le1 is as if 0ank A is sellin1 the security (%%& per cent 8OI 99@)

outri1ht to 0ank 0 at the market price of +s %99 This is as follos

3rincipal (+s %9 crs W %9999) K +s %9699699699999

Accrued inton the stock

K (%9 crs x %%&' x &:?

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"ettlement amt F Accrued interest K %969=6

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be carried on to achieve the basic obDective of the firm The basic obDective of the

firm is to 1et maximum profits out of minimum efforts

& !hat are the obDectives of financial plannin1$Ans a) to ensure availability of fund henever re-uired

b) to see that the firm does not raise funds unnecessarily

< !hat is !orkin1 Capital $Ans The capital re-uired for day to day operations of the business is called

!orkin1 capital

@ "tate the difference beteen 1ross orkin1 capital and net orkin1capital

Ans 8ross orkin1 capital is the sum: a11re1ate of the current assets6

hereas

Net orkin1 capital K Current assets F current liabilities2 !hat is meant by capital bud1etin1 decision$

Ans A lon1 term Investment decision is called capital bud1etin1 decision

/ !hen is financial levera1e considered favorable$

Ans) Ginancial levera1e is considered favorable hen return on investment ishi1her than the cost of debt

%9 >o does production cycle effect orkin1 capital$Ans) orkin1 capital re-uirement is hi1her ith lon1er production cycle %% !hat do

you mean by floatation cost$

Ans) Cost incurred for raisin1 funds% !hat is capital structure of a company$

Ans Capital structure is the relative proportion of different sources of lon1

term finance In other ords Capital structure of a company refers to the make

up of its capitali#ation">O+T AN"!E+ PE"TION" (? : = *X")

% Are the share holders of a company likely to 1ain ith a debt component in

the capital employed $ Explain ith the help of an example$Ans) The shareholders of a company are very likely to 1ain ith debt component

in the capital employed by ay of tradin1

On e-uity as it increases the earnin1 per share(E3") of the share holders 7efine current assets and 8ive four examples

Ans Current assets also called as floatin1 assets or fluctuatin1 assets are short

term assets hose value fluctuates in the short period These assets are re-uired to

pay off the current liabilities Gor e1 cash in hand:0ank6 Inventory6 7ebtors0ills receivable6 *arketable securities etc

? YTo avoid the problem of shorta1e and surplus of funds6 hat is re-uired

in Ginancial mana1ement$ Name the concept and explain four points ofimportance

AnsGinancial 3lannin1 is re-uired to avoid shorta1e or surplus of finance

Importance of financial plannin1 isa) 0y plannin1 utili#ation of finance6 it reduces aste 6duplication of efforts

and

1aps in the plannin1

b) It helps in coordinatin1 the various business activities such as sales6

=

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purchases6 production6 finance etc

c) It is a techni-ue of control It helps in settin1 up standard and compare

ith the actual performance The deviations6 if any are then analysedCauses found out and corrective measures are taken

(d)It helps in avoidin1 shocks and surprises as proper provision re1ardin1

"horta1e or surplus is made in advance by anticipatin1 future receipts and3ayments

= Explain the role of BOperational efficiency in the determination oforkin1 capital re-uirement

Ans The firm ith a better operational efficiency has to invest less in orkin1

capital because;

a) they convert ra materials -uickly into finished 1oods6 and sell them at theirearliest ie converts stock into sales -uickly

b) 3romptly collects debts from debtors and bills receivable & 7iscuss ho !orkin1

capital affects both the li-uidity and profitability of

a businessAns "hort term Investment decisions are concerned ith the decisions about the

level of cash6 inventory and debtors etc (orkin1 capital)Efficient cash mana1ement6 Inventory mana1ement and receivable mana1ement

are essential in1redients of sound orkin1 capital mana1ement

The orkin1 capital should be neither more or less than re-uired 0oththe situations are harmful If the amount of orkin1 capital is more than re-uired6

it ill no doubt increase the li-uidity but decrease the profitability "imilarly if

there is a shorta1e of orkin1 capital6 it ill face the problem of meetin1 day to

day re-uirementsThus optimum amount of current assets and current liabilities should

be determined so that the profitability of the business remains intact and there is

no fall in the li-uidity< >o does BInterest covera1e ratio affects the capital structure

Ans The interest covera1e ratio refers to the number of times earnin1s before

interest and taxes of a company covers the interest obli1ationsInterest covera1e ratio K E0IT:Interest

>i1her the ratio6 better is the position of the firm to pay its interest

obli1ations6 so

it should issue debt On the other hand if it is lo6 the firm should avoid usin1debt as

interest is to be paid irrespective of profits

@ !hy Capital bud1etin1 decisions are more important$Ans The lon1 term Investment decision is called capital bud1etin1 It is more

important due to the folloin1 reasons;

a) ,on1 term 1roth and affects As capital bud1etin1 decisions involveinvestment in lon1 term fixed assets6 it affects the lon1 term 1roth

b) ,ar1e amount of funds involved As hu1e amount of fund is blocked for a

lon1 period6 the decision should be taken rationally

c) +isk involved As such a decision affects the returns of the firm as a hole6 it

=?

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involves more risk

d) Irreversible decisions These lon1 term decisions taken once cannot be

reversed back6 ithout incurrin1 heavy losses It ill lead to aste of fund6 ifreversed

Thus capital bud1etin1 decisions should be taken after careful study and deep

analysis2 !hat is Ginancial risk$ >o does it arise$

Ans It refers to the risk of the company not bein1 able to cover its fixed financial

cost Gixed financial cost includes payment of interest that is to be paidirrespective of profit

The hi1her level of risk are attached to hi1her de1rees of financial levera1e If

E0IT(Earnin1s before interest and tax) decreases6 financial risk increases as the

firm is not in a position to pay its interest obli1ations Thus the risk of default is calledGinancial risk The firm should overcome the situation accordin1ly or ill

be forced toards li-uidation

,ON8 PE"TION" ( &:< *X")

%!hat are the determinant of capital structure of a company$O+

B7etermination of capital structure of a company is influenced by a number offactors explain six such factors

Ans Capital structure refers to the relative proportion of different sources of lon1

term finance Golloin1 factors are to be considered before determinin1 capitalstructure

a) Cash flo position The cash available ith the company should be enou1h to

meet the fixed interest liabilities Interest on debt is to paid irrespective of

profits A company has to meet orkin1 capital re-uirements6 invest in fixedassets and also pay the interest and principal amount of debt after a particular

stipulated period If cash position is sound6 debt van be raised6 and if not

sound debt should be avoidedb) Interest covera1e ratio it is the ratio that expresses the number of times the

Net profit before interest and tax covers the interest liabilities >i1her the

ratio6 better is the position of the firm to raise debtc) Control Issue of E-uity shares dilutes the control of the existin1 shareholders

6 hereas issue of debt does not as the debenture holders do not participate in

the mana1ement decisions as they are not the oners of the fir Thus if control

is to be retained6 e-uity should be avoidedd) "tock market conditions If the stock market is bullish6 the investors are

adventurous and are ready to invest in risky securities6 e-uity can be issued

even at a premium hereas in the 0earish phase6 hen the investors becomecautious6 debt should be issued as there is a demand for fixed cost security

e) +e1ulatory frameork 0efore determinin1 the capital structure of a company

6 the 1uidelines of "E0I and concerned re1ulatory authority is to beconsidered Gor e1 companies Act6 0ankin1 re1ulation Act etc are to

considered

f) Tax rate As interest on debt is treated as an expense6 it is tax deductable

7ividend on e-uity is the distribution of profit so is not tax deductable Thus

==

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if the tax rates are hi1h6 issue of debt is an attractive means as it is economical

in nature

Explain briefly five factors determinin1 the amount of fixed capitalAns Gixed capital refers to the capital hich is used for the purchase of fixed assets6

such as land6 buildin16 machinery etc

Golloin1 factors are to be considered before determinin1 its re-uirementa) Nature of 0usiness If a firm is a manufacturin1 fir6 it re-uires to purchase

fixed assets for the production process It needs investment in fixed assets6 so

re-uire more fixed capital "imilarly if it is a Tradin1 firm here the finished1oods are only traded ie purchased and sold6 it needs less fixed capital

b) "cale of operations lar1er the si#e and scale of operations lar1er is the

re-uirement of the fixed capital and vice versa c) Choice of techni-ue The

*anufacturin1 firm usin1 the modern6 latesttechnolo1y machines has to invest more funds in the fixed assets6 so they

re-uire more fixed capital On the other hand6 firms usin1 the traditional

method of production here the task is performed manually by the labourers6

it re-uires less fixed capitald) 7iversification There are fe firms and or1ani#ations ho deal in a sin1le

product These investment in fixed assets is lo6 hereas the firms dealin1 innumber of products ( 7iversification) re-uires more investment in purchasin1

different fixed assets6 it re-uires more fixed capital

e) Ginancin1 alternatives If the manufacturin1 firm actually buys the assets andblocks hu1e funds in the fixed assets6 it re-uires more fixed capital The

companies ho ac-uire the fixed asset and use them by obtainin1 leasin1

facilities6 it re-uires less fixed capital ,easin1 is suitable in hi1h risk lines of

business here hu1e funds should not be blocked in the fixed assets? !hat is meant by !orkin1 capital$ >o is it calculated$ Explain the

determinants of orkin1 capital re-uirements

Ans !orkin1 capital is the capital re-uired for meetin1 day to dayre-uirements:operations of the business

Net orkin1 capitalK current assets F current liabilities

Golloin1 factors are to be considered before determinin1 the re-uirement of orkin1capital

a) "cale of operations There is a direct link beteen the scale of business and

orkin1 capital ,ar1er business needs more orkin1 capital as compared to

the small or1ani#ationsb) Nature of 0usiness The manufacturin1 or1ani#ations are re-uired to purchase

ra materials6 convert them into finished 1oods6 maintain the stock of ra

materials6 semi finished 1oods and finished 1oods before they are offered forsale They have to block their capital for labour cost6 material cost etc6 so they

need more orkin1 capital In the tradin1 firm processin1 is not performed

"ales are affected immediately after receivin1 1oods for sale Thus they do notblock their capital and so needs less orkin1 capital

c) Credit alloed If the inventory is sold only for cash6 it re-uires less orkin1

capital as money is not blocked in debtors and bills receivable 0ut due to

increased competition6 credit is usually alloed A liberal credit policy results

=&

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in hi1her amount of debtors6 so needs more orkin1 capital

d) Credit availed If 1oods are purchased only for cash6 it re-uires more orkin1

capital "imilarly if credit is received from the creditors6 the re-uirement oforkin1 capital decreases

e) Availability of +a materials If the ra materials are easily available in the

market and there is no shorta1e6 hu1e amount need not be blocked ininventories6 so it needs less orkin1 capital 0ut if there is shorta1e of

materials6 hu1e inventory is to be maintained leadin1 to lar1er amount of

orkin1 capital "imilarly if the lead time is hi1her6 hi1her amount of orkin1capital is re-uired

= BEvery *ana1er has to take three maDor decisions hile performin1 the

finance function briefly explain them Ans The three important decisions taken by the

finance mana1er are as follos F%) Investment decision It refers to the selection of the assets in hich investment

is to be made by the company Investment can be made in ,on1 term fixed

assets and short term current assets Thus Investment decision is divided in

to parts (a) ,on1 term Investment decisions "uch decisions are also called Capital

0ud1etin1 decisions It relates to the investment in lon1 term fixed assetsAs such decisions affects the 1roth of the firm6 it involves hu1e fund to be

blocked for a lon1 period6 and such decisions are irreversible in nature6 they

should be taken carefully after makin1 a comparative study of variousalternatives available

(b) "hort term Investment decision (!orkin1 capital decision) It refers to

investment in short term assets such as cash6 inventory6 debtors etc Ginance

mana1er has to ensure that enou1h orkin1 capital is available to meet theday to day re-uirements It should also ensure that unnecessarily hi1h

reserve of orkin1 capital should not be retains as it decreases the

profitability Thus profitability and ,i-uidity are to be compared andappropriate amount kept as orkin1 capital

Ginancin1 decision There are various sources of obtainin1 lon1 term finance

such as E-uity shares6 preference shares6 term loans6 7ebentures etc Gor takin1financin1 decision and decidin1 the capital structure various factors are to be

considered and an analysis of cost and benefit is made

? 7ividend decision It refers to the decision related to the distribution of profit

The finance mana1er has to decide as to ho much amount of profit is to bedistributed as 7ividend and ho much to be retained in the business If too

much retained earnin1s are maintained6 it dissatisfies the shareholders as they

receive less dividend "imilarly if a liberal dividend policy is folloed6 thou1hthe shareholders are satisfies6 but the firm does not have enou1h reserve for

future 1roth6 expression6 meetin1 contin1ency etc

& !hat is meant by BGinancial mana1ement Explain its importanceAns Ginancial mana1ement refers to that part of the mana1ement hich is concerned

ith the efficient plannin1 and controllin1 the financial affairs of the enterprise

Ginancial mana1ement plays the folloin1 role;

a) 7etermination of fixed assets Gixed assets have an important contribution in

=

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increasin1 the earnin1 capacity of the business ,on1 term investment decisions also

called capital bud1etin1 decision raise the si#e of fixed assets

b) 7etermination of current assets Current assets are needed to meet the day to daytransactions of the business The total investment in current assets is to be determined

and the split up into its elements is re-uired Gor e1 if it is decided to maintain

current assets of +s %9 lakh6 further decision is to be made as to ho much cash isre-uired6 ho much amount to be invested in debtors6 stock etc

c) 7etermination of lon1 term and short term finance nder this a Ginance mana1er

has to maintain a proper ratio of short term and lon1 term sources of finance afterestimatin1 its re-uirement d) 7etermination of Capital "tructure A balanced decision

related to capital structure

is to be made The proportion of debt and e-uity is to be determined

e) 7etermination of various items in the 3rofit and loss account;The financialdecisions affect the various items to appear in the profit and loss account Gor e1

depreciation on fixed assets6 interest on debt etc"T74 *ATE+IA,;

CA"> G,O! "TATE*ENT

Pus% !hy is the cash flo statement not a suitable Dud1e ofprofitability $

Ans Cash Glo statement is prepared on cash basis of accountin1 butprofit is calculated on accrual basis"o cash flo statement is not a

Dud1e of profitability

Pus nder hich accountin1 standard 6 cash flo statement isprepared $

Ans nder accountin1 standard;?(+evised)

Pus? !hy do e add back non cash items to net profit hile

calculatin1 cash flo from operatin1 activitiesAns Non cash items reduce the net profit ithout reducin1 the cash

balance

Pus= >o ill you classify loans 1iven by >7GC hilepreparin1 cash flo statement

Ans As Operatin1 Activities

Pus& >o ill you classify deposits by customers in "0I hilepreparin1 cash flo statement

Ans Operatin1 Activities

Pus< !here ill you sho purchase of furniture in cash flo

statement $Ans As Outflo under Investin1 Activities

Pus@ 8ive examples of non cash transactions

Ans 8ive any to examples;(i) Ac-uisition of fixed asset by issue of debentures or

shares

(ii) Conversion of debentures into sharesPus2 A company receives a dividend of +s & ,akhs on its

investment in other companys share ill it be Cash inflo from

operatin1 or investin1 activities in case of a

(i) Ginance Company

=@

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(ii) Non;Ginance Company Ans It ill be operatin1 activities in case of a finance

company and

investin1 activities in case of non;Ginancin1 CompanyPus/ 8ive four example of movement beteen cash and cash

e-uivalents

Ans Cash deposited into bank6 Cash ithdran from bank foroffice use6 purchase of short term marketable securities6 6 sale of

short term marketable securities

Pus%9 >o are various activities classified as per A";?(+evised) $

Ans (i) Operatin1 Activities

(ii)Investin1 Activities

(iii)Ginancin1 ActivitiesPus%% 8ive one example each of an extra ordinary item under

operatin16 investin1 and financin1 activity

Ans Examples of extraordinary items under;

(a) Operatin1 activity F claim received from insurance companya1ainst loss of stock

(b) Investin1 activity F amount of compensation received a1ainstac-uisition of land belon1in1 to the enterprise

(c) Ginancin1 activity F payment for buy;back of e-uity shares of

the companyPus%% Cash flo from operatin1 Activities Cash flo from

Investin1 Activities Cash flo from Ginancin1

Activities KZZZZZZZ

Ans ZK Net Increase :7ecrease in cash and Cash E-uivalentsPus% !hat are the to methods hich can be employed to

calculate net cash flo from operatin1 activities $

Ans 7irect *ethod and Indirect *ethodPus%? *odern Toys ,td 3urchased a machinery of

+s96996999 for manufacturin1 toys "tate 1ivin1 reason

!hether the cash flo due to the purchase of machineryill be cash flo from operatin1 activities6

Investin1 activities or Ginancin1 activities $

Ans Investin1 Activities 0ecause ZZZZZ

Pus%= *:s,akshmi Electrical Appliances furnish thefolloin1 information ; Calculate net cash flo from financin1 activities;

3articulars

?%%99@ ?%%992E-uity share capital 6996999 =6&96999

%9' debentures %6996999 ;

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ratio of =% durin1 the year

Ans CA,C,ATION OG NET CA"> G,O! G+O*

GINANCIN8 ACTI5ITIE"3articulars

+s

Cash proceeds from issue of ?69969993ref "hares e-uity shares 6&96999

+edemption of %9' debentures (%6996999)

Interest paid (&6999)7ividend paid on e-uity shares (=96999)

Net cash flo from financin1 activity

=69&6999

Pus%& A company had the folloin1 balance ;3articulars

+s

Investment at the be1innin1 of the period ?6=96999

Investment at the end of the period 62969997urin1 the year6 the company sold =9' of investments at the

be1innin1 at a profit of 2=6999 Calculate cash fro6 investin1activities F

3articulars

+sInflo from sale of investment

Cost of investment 8old 696999 (=9' of +s?=9999) K %?

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To ,oss on sale of Gurniture

To 8oodill ritten Off

To 0ad 7ebtsTo Office Expenses

To 7iscount alloed

To 3roposed 7ividendTo 3rovision for Tax

To Net 3rofit

(+s)%6999

&6999

%&6999

%9699926999

?6999

%26999

@6999?96999

6999&6299

696299

0y 8ross 3rofit0y 3rofit on "ale of *achine

0y Tax +efund

0y +ent received =6999

Add +ent accrued %6999(+s)

%626999

%6999?6299

&6999

696299Note There as increase in Closin1 stock by +s &6999

Ans Cash from Operatin1 Activities +s%69?6299 Pus%@ 3repare Cash flo "tatement

from the folloin1

information of ,O47 35T ,T7 Gor the year ended *arch?%699=

0A,ANCE ">EET" OG ,O47 35T

,T7 A" ON *A+C> ?%699=,iabilities

99? 99= Assets 99? 99=

"harecapital

3rofit Q

,oss

Account

&9

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8eneral

+eserve

Tax3rovision

Creditors

0ill3ayables

7epreciation

3rovision(+s)

?6996999

%696999

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(+s)

?96999

?696999?6996999

%62&6999

@96999=96999

?96999

/6@&6999Additional Information

%Investment costin1 +s&96999 ere sold for +s =26999 durin1

the year

Tax paid durin1 the year +s@96999?Interest received on Investment +s %6999

Ans (i) Cash Inflo Grom Operatin1 Activities +s296 999

(ii)Cash Outflo on Investin1 Activities +s%6

166108862 Sap Fico Gl

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