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Pinnacle Academy
Mock Test Series for
May 2016 C A Final Examination
2nd Floor Florence Classic, 10, Ashapuri Society,
Besides Unnati Vidhyalay, Opp. VUDA Flats, Jain Derasar Rd., Akota, Vadodara-20
Time Allowed-2½ hours
SFM Mock Test 2
Maximum Marks- 80
26th March 2016
Q 1 is compulsory.
Answer any 4 from the remaining.
Q1
(a)
An investor is considering purchasing shares of D Ltd. Based on deliberations with
the stock broker and personal reading and research following Probabilistic Return
Schedule has been developed for D Ltd. and the Equivalent Market Benchmark:
Probability Return from Return from
D Ltd.
Market
0.10
- 10 %
- 20 %
0.15
20 %
10 %
0.25
30 %
20 %
0.50
45 %
25 %
The current treasury bill rate is 5.75 %. The investor’s existing portfolio consists of
following shares:
Shares of Shares of Shares of
A Ltd.
B Ltd.
C Ltd.
Beta Coefficient
Expected Return
Standard Deviation
No. of shares purchased
Purchase Price per share
Current Market Price per share
2.50
30 %
15 %
1,000
Rs.100
Rs.200
0.25
15 %
10 %
50
Rs.1,500
Rs.1,300
1.25
25 %
12 %
1,000
Rs.25
Rs.65
The investor wishes to invest Rs.1,00,000 in shares of D Ltd. The investor wants to
arrange for Rs.1,00,000 by selling any overpriced security in his existing portfolio.
This overpriced security or securities shall be sold only to the extent of availing
Rs.1,00,000. The correlation coefficient between A and B is 0.5, A and C is 0.25, A
and D is 0.8, B and C is 0.5, B and D is 0.25 and C and D is 0.5. Determine Portfolio
Return and Portfolio Risk of portfolio consisting of all the four shares. Is the risk
(standard deviation) of the above portfolio higher than that of equivalent market
benchmark?
(10 Marks)
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(b)
(c)
The probability that Stock A will rise by 25 % is 30 % and the chance that it declines
by 5 % is 70 %. Similarly, probability that Stock B will rise by 40 % is 60 % and it
shall decline by 10 % is 40 %. An investor has invested 70 % in Stock A, 20 % in
Stock B and 10 % in treasury-bill yielding 3 % return. What is the portfolio return and
risk if correlation between A and B is 0.75?
(6 Marks)
Consider the following portfolio:
Company
A
B
C
No. of shares
5,000
10,000
3,000
MPS
50
25
30
Beta
2.198
1.500
1.200
An investor has additional Rs.1,47,500 to invest. He wishes to keep his systematic
risk index for portfolio to 1.5. What should the beta of the new security be so that he
can achieve his objective?
(4 Marks)
Q2
(a)
Following information is available in respect of Falcon Ltd.:
Year
EPS
DPS
MPS
2000-01
2001-02
2002-03
2003-04
2004-05
12.00
13.53
15.26
17.20
19.39
7.20
9.15
11.64
14.79
18.80
184.25
228.06
275.69
340.13
415.84
Calculating Dividend Payout ratio, Price Engineering multiple and constant multiplier
“m” comment whether Falcon Ltd. obeys the Graham and Dodd’s Dividend model.
(5 Marks)
(b)
A treasurer of a company is having a need to raise Rs.20,00,000 for three months
and he has an option to borrow in any of the following currencies:
US $
UK £
EU €
INR
Spot Rate
46.47 / 54 67.60 / 74 39.84 / 98 ----3-m forward
20 / 30
70 / 110
15 / 20
----Interest Rate
6.25 %
6%
4%
10 %
Expected Spot Rate 46.64 / 80 67.70 / 85 40.50 / 70 ----Required:
i. In which currency should the treasurer borrow if exchange risk is covered?
ii. In which currency should the treasurer borrow if exchange risk is not covered?
(10 Marks)
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Q3
(a)
Merger proposal between HR Ltd. and AR Ltd. is under consideration. Following
details related to free cash flows for each firm are available:
(Rs. in crores)
Year
1
2
3
4
5
Independently
Only for HR Ltd.
80
92
100
112
120
Independently
Only for AR Ltd.
15
15
18.75
11.25
7.5
Combined
Entity
100
112
125
127
138
Beyond year 5 free cash flows are expected to grow at compound growth rate of 7 %
p.a. for the combined entity, at 6 % p.a. independently for HR Ltd. and at 5 % p.a.
independently for AR Ltd. The number of shares currently outstanding is 10,00,000
for HR Ltd. and 8,00,000 for AR Ltd. The proposed exchange rate for merger is 0.20.
The cost of capital for both the firms is 14 %. Applying DCF technique decide the
following on the basis of value of merger to shareholders of each firm:
i. Should HR Ltd. take over AR Ltd.?
ii. Should AR Ltd. accept the offer of HR Ltd.?
(7 Marks)
(b)
Q4
(a)
Mechanics Ltd. wishes to acquire a machine having cash price of Rs.2,40,000 by
way of leasing. The terms of leasing are: (i) Annual lease rent: Rs.70,000 and (ii)
lease rent payable at the end of each year for 4 years. The incremental borrowing
rate for Mechanics Ltd. is 12%. Tax rate be assumed to be 50% and depreciation as
per SLM. Should the leasing alternative be selected? Decide by determining the net
advantage of leasing. Use concept of Equivalent Loan.
(8 Marks)
State any three advantages and disadvantages of investing in mutual funds.
(5 Marks)
(b)
For Leo Mutual fund the NAV as on 1st day of the months of January 2007 to June
2007 is Rs.21, Rs.21.63, Rs.22.6, Rs.22.15, Rs.23.48 (ex-dividend) and Rs.23.13.
The NAV as on 30th June 2007 is Rs.24 per unit. Leo Mutual fund also declared
dividend at 20 % on 1st day of May 2007. Face value per unit is Rs.10. An investor
has invested in following two options namely:
(i) Invest Rs.5,000 in a Systematic Investment Plan (SIP) with dividend reinvestment
option every month beginning from 1st January to 1st June.
(ii) Invest lumpsum Rs.30,000 in growth plan on 1st January
The applicable entry load is 2.25 %. There is no exit load. The investor shall liquidate
all of the units at 30th June NAV. Ignore income tax and time value of money. Which
option gives higher return to the investor?
(10 Marks)
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Q5
(a)
(b)
A Rs.100 10-years plain vanilla bond carrying annual coupon of 8 % trades at par as
current yield in the market is 8 %. It is felt that in the coming few months bond
markets shall remain volatile. Consequently, the yield may either fall by 100 basis
points or 50 basis points or may increase by 75 basis points or even 150 basis
points. You are required to prepare short-term yield curve. What does the yield curve
indicate?
(8 Marks)
Answer the following:
i. For A Ltd. expected return is 16 %. Its beta is 0.8. Market return is 18% and risk-free
return is 5%. Is the share worth purchasing?
ii. For B Ltd. beta is 1.75 and it is priced in such a manner that it offers return of
12.75%. Market risk premium is 7% and risk free return is 4%. It is known that slope
of SML is 5. Is B Ltd. correctly priced?
iii. For C Ltd. expected return is 25%. Market portfolio offers return of 15%. An investor
requires return of 22%. What proportion of funds should be invested in C Ltd. and
market portfolio to achieve target return?
iv. D Ltd. and E Ltd. have risk (standard deviation) of 12% and 20% respectively. The
correlation coefficient between the two securities is 0.3. What proportion of funds
should be invested in D Ltd. and E Ltd. to ensure that portfolio risk is minimum?
(1 + 1 + 2 + 3 = 7 Marks)
Q6
(a)
Answer: (any two)
i.
ii.
iii.
Distinguish between Factoring and Bills Discounting
Distinguish between Systematic and Unsystematic Risk
Write short note on Bought Out Deal
(8 Marks)
(b)
Following are the cash flows expected from two projects:
Project/ Year
0
1
2
3
4
5
I
(50,000) 1,20,000 1,00,000 80,000 75,000 60,000
II
(25,000)
65,000
55,000
45,000 30,000 20,000
The management perceives Project I to be riskier than Project II. The cost of capital
of the firm is 8 %. It considers 7.5 % and 5 % risk premium to be apt for Projects I
and II respectively.
Using Risk Adjusted Discount rate technique, suggest which project is acceptable?
Also, determine for both the projects, what % decline in cash inflows shall result into
zero NPV?
(7 Marks)
(Assessed answer papers shall be returned on 14th April 2016)
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Solution of
SFM Mock Test 2
26th March 2016
Q1
(a)
Hints: Using the CAPM formula calculate required return, which shall be 33.875 %
for A, 8.5625 % for B and 19.8125 % for C. Comparing required return with expected
returns of 30%, 15 % and 25 %, it is evident that security A is overpriced.
(2 Marks)
Since the current MPS of A is Rs.200, to avail Rs.1 lakh 500 shares shall be sold.
Thus, composition of revised portfolio shall be –
A:
B:
C:
D:
500 shares X Rs.100
50 shares X Rs.1500
25 shares X Rs.1000
50,000
75,000
25,000
1,00,000
2,50,000
20 %
30 %
10 %
40 %
(1 Mark)
Now, expected return from D is 32 %
So, portfolio return is: 30 (0.2) + 15 (0.3) + 25 (0.1) + 32 (0.4) i.e. 25.8 %
(1 Mark)
Variance of D is:
(- 10 – 32)2 (0.1) + (20 – 32)2 (0.15) + (30 – 32)2 (0.25) + (45 – 32)2 (0.5)
i.e. 176.4 + 21.6 + 1 + 84.5 = 283.5
Standard deviation (risk) of D is: √283.5 = 16.84 %
(1 Mark)
So, portfolio variance is:
(15)2 (0.2)2 + (10)2 (0.3)2 + (12)2 (0.1)2 + (16.84)2 (0.4)2
+ 2 (15) (0.2) (10) (0.3) (0.5) + 2 (15) (0.2) (12) (0.1) (0.25) + 2 (15) (0.2) (16.84)
(0.4) (0.8)
+ 2 (10) (0.3) (12) (0.1) (0.5) + 2 (10) (0.3) (16.84) (0.4) (0.25)
+ 2 (12) (0.1) (16.84) (0.4) (0.5)
= 9 + 9 + 1.44 + 45.43 + 9 + 1.8 + 32.33 + 3.6 + 10.10 + 8.08 = 129.78
Portfolio Standard deviation (risk) of D is: √129.78 = 11.39 %
(3 Marks)
Also, expected return from Market is 17 %
Variance of Market is:
(- 20 – 17)2 (0.1) + (10 – 17)2 (0.15) + (20 – 17)2 (0.25) + (25 – 17)2 (0.5)
= 136.9 + 7.35 + 2.25 + 32 = 178.5
Standard deviation (risk) of Market is: √178.5 = 13.36 %
(2 Marks)
Conclusion: The risk of the portfolio is less than that of the market benchmark.
(b)
Return from A: 25 (0.3) + -5 (0.7) = 4 %; Return from B: 40 (0.6) + -10 (0.4) = 20 %
Variance of A: (25 – 4)2 (0.3) + (-5 – 4)2 (0.7) = 132.3 + 56.7 = 189
Standard deviation (risk) of A is: √189 = 13.75 %
(2 Marks)
Solution prepared by
CA. Ashish Lalaji
6
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Variance of B: (40 – 20)2 (0.6) + (-10 – 20)2 (0.4) = 240 + 360 = 600
Standard deviation (risk) of B is: √600 = 24.5 %
(2 Marks)
Portfolio Return = 4 (0.7) + 20 (0.2) + 3 (0.1) = 7.1 %
Portfolio Variance = (13.75)2 (0.7)2 + (24.5)2 (0.2)2 + 2(13.75)(0.7) (24.5) (0.2) (0.75)
= 187.39
Portfolio Risk is: √187.39 = 13.69 %
(2 Marks)
(c)
Calculation of Portfolio Beta:
Company
Product
A
B
C
No. of shares
5,000
10,000
3,000
MPS
50
25
30
Amount Invested Beta
2,50,000
2,50,000
90,000
5,90,000
Weighted
2.198
1.500
1.200
5,49,500
3,75,000
1,08,000
10,32,500
Portfolio beta = Weighted Product / Amount invested
= 10,32,500 / 5,90,000 = 1.75
Let β of new security be “x”.
Accordingly –
Revised Weighted product = 10,32,500 + 1,47,500x
Revised Investment = 5,90,000 + 1,47,500 = 7,37,500
Revised Portfolio Beta, 1.5 = 10,32,500 + 1,47,500 x / 7,37,500
(Solving) x = beta of new security = 0.50
(4 Marks)
Q2
(a)
Calculation of D/P ratio, P/E ratio and Constant Multiplier “m”:
Year
2000-01
2001-02
2002-03
2003-04
2004-05
D/P
ratio
P/E
ratio
“m”
60.00%
67.62%
76.28%
85.99%
96.96%
15.35
16.86
18.07
19.78
21.45
16.45
16.70
16.48
16.57
16.46
The conclusions of Graham and Dodd’s model are:
1. There is direct relationship between D/P ratio and P/E ratio i.e. as D/P ratio
increases, the P/E ratio also increases and vice versa.
2. The multiplier “m” remains constant over the years for the share prices.
As both of the above conclusions are true for the above company one can conclude
that Graham and Dodd’s model is been obeyed.
(3 + 2 = 6 Marks)
Solution prepared by
CA. Ashish Lalaji
7
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(b)
Calculation of 3-month forward rates:
US $
UK £
EU €
Spot Rate
46.47 / 54
67.60 / 74
39.84 / 98
3-m forward
20 / 30
70 / 110
15 / 20
3-m forward rate 46.67 / 84 68.30 / 68.84 39.99 / 40.18
(2 Marks)
The amount will have to be borrowed currently in foreign currency. The amount
should be such that when converted into Indian rupees it amounts to Rs.20,00,000.
The foreign currency borrowed will have to be sold and hence bank will buy at spot
bid rate. If exchange risk is covered the repayment will be at forward rate; otherwise
at expected spot rate. After 3-months the original foreign borrowing is to be repaid
and hence will have to be purchased at future offer rate.
(2 Marks)
(a) Amount to be borrowed
(b) Spot Rate
(c) Amount borrowed (a/b)
(d) Interest Rate
(e) Interest (c X d X 3/12)
(f) Amount repaid (c + e)
(g) 3-m forward rate
(h)
Amount
repaid
when
exchange risk covered (f X g)
(i) Expected Spot Rate
(j)
Amount
repaid
when
exchange risk not covered (f X i)
US
Dollar
Pounds
Euros
Rupees
20,00,000
46.47
43,038.52
6.25 %
672.48
43,711.00
46.84
20,47,423
20,00,000
67.60
29,585.80
6%
443.79
30,029.59
68.84
20,67,237
20,00,000
39.84
50,200.80
4%
502.01
50,702.81
40.18
20,37,239
20,00,000
----20,00,000
10 %
50,000
20,50,000
----20,50,000
46.80
67.85
40.70
----20,45,675 20,37,508 20,63,604 20,50,000
When exchange rate risk is covered, the outflow after three months is lowest for
euro borrowings. When exchange rate risk is not covered, the outflow after three
months is lowest for pound borrowings.
(6 Marks)
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Q3
(a)
Calculation of Value of Business With and Without merger:
Year
PVF
Combined
[14 %]
Entity
Cash
Inflows
Only
Only
Combined
Only
HR
AR
Ltd.
Ltd.
Entity
HR Ltd.
Cash
Cash
PV
PV
Inflows Inflows
1
2
3
4
5
0.877
100
80
15.00
0.770
112
92
15.00
0.675
125
100
18.75
0.592
127
112
11.25
0.519
138
120
7.50
PV of Cash I/f during Explicit Forecast Period
5
0.519
2109.431
1590
87.5
Value of Business
87.70
86.24
84.38
75.18
71.62
405.12
1094.79
1499.92
70.16
70.84
67.50
66.30
62.28
337.08
825.21
1162.29
Only
AR
Ltd.
PV
13.16
11.55
12.66
6.66
3.89
47.91
45.41
93.33
1: Continuing value = 138 + 7 % / (0.14 – 0.07) and so on.
(4 Marks)
Additional shares to be issued for merger = 8,00,000 X 0.2 = 1,60,000
Share of existing shareholders of HR in Combined Entity = 10,00,000 / 11,60,000 = 0.862
Share of existing shareholders of AR in Combined Entity = 1,60,000 / 11,60,000 = 0.138
NPV of merger for HR = 1499.92 (0.862) – 1162.29 = Rs.130.64 crores
NPV of merger for AR = 1499.92 (0.138) – 93.33 = Rs.113.66 crores
(3 Marks)
Conclusion: As NPV of merger is positive for both the firms, HR should take over
AR and AR should accept the offer of HR.
(b)
Statement showing determination of Net Advantage of Leasing:
Benefits of Leasing:
Cost of Asset Saved
2,40,000
Present value of tax shield on lease rent
[70,000 X 50 % X PVF (6%, 4) i.e. 35,000 X 3.465]
1,21,275
Total Benefits (A)
3,61,275
Costs of Leasing:
Present Value of Lease Rent Paid
2,12,590
[70,000 X PVF (12%, 4) i.e. 70,000 X 3.037]
Present Value of tax shield on depreciation foregone
[60,000 X 50 % X 3.465]
1,03,950
Present Value of tax shield on interest foregone
[as per working note]
29,952
Total Costs (B)
3,46,492
Net Advantage of Leasing
(A – B) 14,783
Solution prepared by
CA. Ashish Lalaji
9
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Working for calculation of tax shield on interest:
Year
Loan
o/s
at start
Interest
Total
Due
Installment
Loan
o/s
at end
Tax
shield
PVF
1
2
3
4
212590
168101
118273
62466
25511
20172
14193
7534
238101
188273
132466
70000
70000
70000
70000
70000
168101
118273
62466
------
12755
10086
7096
3767
PV
(6%)
0.943
0.890
0.840
0.792
12033
8977
5958
2984
29952
(8 Marks)
Q4
(a)
Advantages of Investing in Mutual Fund:
1. Professional Management: The funds are managed by skilled and professionally
experienced managers with a back-up of research team.
2. Diversification: Mutual funds offer diversification in portfolio which reduces risk.
3. Convenient Administration: There are no administrative risks of share transfer as
most of the mutual funds offer services in demat form, which saves investors’ time
and delay.
4. Higher Returns: Over a medium to long term investment, investors usually get
higher returns in mutual funds compared to other avenues of investments.
5. Low Cost of Management: No mutual fund can increase the cost beyond
prescribed limits of 2.5% maximum and any extra cost of management is to be borne
by the AMC.
6. Liquidity: In all open-ended funds, liquidity is provided by direct sales / repurchase
by mutual fund and in case of close-ended funds liquidity is provided by listing the
units on the stock exchange.
7. Transparency: Mutual funds have to disclose their portfolios on half-yearly basis as
per SEBI guidelines. However, many mutual funds disclose this information on
monthly basis. NAV has to be determined on daily basis in case of open-ended
funds and are also required to be published in newspapers.
8. Highly Regulated: Mutual funds are to be registered with SEBI and are strictly
regulated as per the Mutual Fund Regulations to protect the interests of the
investors.
9. Other benefits: Different kinds of plans are available to suit different requirements of
investors. For instance, certain mutual funds have systematic investment plan
requiring monthly investment of just Rs.500.
Solution prepared by
CA. Ashish Lalaji
10
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Disadvantages of Investing in Mutual Fund:
1. No guarantee of return: Mutual funds invest in equity shares on behalf of their
investors. As stock markets fluctuate, so shall the return of the mutual fund. Thus,
mutual funds are subject to the vagaries of the stock market and hence return from
the mutual fund is also volatile. At times, investor can also lose the principal invested
in the mutual funds.
2. Selection of proper fund: Compared to mutual funds, selecting a share for
investment is easier. There is plethora of data available for an equity share based on
which an investor can make the selection. For mutual funds the only data available is
past data but past performance need not be repeated in future.
3. Cost: Mutual funds charge entry and exit loads at the time of investing and
liquidating investment in mutual funds. This substantially reduces the return
generated from the mutual fund. These charges are payable whether the mutual
fund is performing well or not.
4. Unethical practices: Mutual funds may not play a fair game. Each scheme may sell
some of its holdings to its sister concerns for substantive notional gains and posting
NAV in a formalized manner.
(Any three are expected. 5 Marks)
(b)
Calculation of Return from Systematic Investment Plan (SIP):
Date
Amount
Sale Price
Invested (NAV + Entry Load)
1st Jan 2007
5,000
21.47
1st Feb 2007
5,000
22.12
st
1 Mar 2007
5,000
23.11
1st Apr 2007
5,000
22.65
1st May 2007
1,792*
24.01
5,000
24.01
1st Jun 2007
5,000
23.65
No. of Cumulative
Units
Units
232.88
232.88
226.04
458.92
216.36
675.28
220.75
896.03
74.64
970.67
208.25
1,178.92
211.42
1,390.34
* 896.03 units X Rs.10 X 20 %
th
Sale proceeds on 30 June 2007 = 1,390.34 units X Rs.24 = Rs.33,368.16
Periodic Return = 33,368.16 – 30,000 / 30,000 = 11.23 %
Annualised Return = 11.23 X 12 / 6 = 22.46 %
(6 Marks)
Calculation of Return from Growth Option:
No. of units purchased = 30,000 / 21.47 = 1,397.3 units
Sale proceeds on 30th June 2007 = 1,397.3 units X Rs.24 = Rs.33,535.2
Periodic Return = 33,535.2 – 30,000 / 30,000 = 11.78 %
Annualised Return = 11.78 X 12 / 6 = 23.56 %
(4 Marks)
Q5
(a)
Calculation of Value of Bond at expected yields in future:
Year
1 – 10
10
Cash
Inflows
PVF
8%
8
6.710
100
0.463
Value of Bond
PV
8%
PVF
7%
PV
7%
PVF
7.5%
PV
7.5%
PVF
8.75%
PV
8.75%
PVF
9.5%
PV
9.5%
53.68
46.30
99.98
7.024
0.508
56.19
50.80
106.99
6.864
0.485
54.91
48.50
103.41
6.489
0.432
51.91
43.20
95.11
6.279
0.404
50.23
40.40
90.63
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Yield Curve
Bond Value
7
7.5
8
8.75
9.5
Yields
Yield curve shows inverse relationship between yield and bond value.
(5 + 3 = 8 Marks)
(b)
i. CAPM required return = 5 + 0.8 [18 – 5] = 15.4 %. For A Ltd. expected return is 16%.
Thus, the given share is under-priced and worth purchasing.
ii. For B Ltd., CAPM required return = 4 + 1.75 [7] = 16.25 %. Now, slope of SML for B
Ltd. is: 16.25 – 4 / 1.75 = 7. But actual slope of SML is 5. Since, slope for B Ltd. is
different from that given, B Ltd. is not correctly priced.
iii. Portfolio Return = rc wc + rMP wMP
i.e. 22 = 25 wc + 15 (1 – wc)
i.e. 22 = 25wc + 15 – 15 wc
i.e. 22 – 15 = 10 wc
i.e. wc = 7/10 = 0.7
wMP = 1 – 0.7 = 0.3
Thus, one should invest 70% in C Ltd. and 30% in market portfolio to obtain desired
return of 22%.
iv. rDE = Cov (D,E) / σD σE
i.e. Cov (D,E) = rDE σD σE
i.e. Cov (D,E) = 12 (20) (0.3) = 72
W D = (20)2 – 72 / (12)2 + (20)2 – 2 (72) = 328 / 400 = 0.82 i.e. 82%
W E = 1 – 0.82 = 0.18 i.e. 18%
Thus, one should invest 82% in D Ltd. and 18% in E Ltd. to ensure that portfolio risk
is minimum.
(1 + 1 + 2 + 3 = 8 Marks)
Solution prepared by
CA. Ashish Lalaji
12
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Q6
(a)
(i) Difference between factoring and bills discounting:
1. The scope of factoring services is wide. It does not simply include financing
against invoices of trade bills. It also includes services of books maintenance,
asset management, customer credit analysis, consultancy and many other
value-added services. Bills discounting is narrow in its scope since it only
covers financing services.
2. In case of non-recourse factoring deals, even the risk of bad debts can be
transferred to the factor. Such facility is not available at the time of bills
discounting.
3. Factoring services are a sophisticated method of managing book debts, while
bills discounting is a traditional method of borrowing funds from commercial
banks.
4. Factoring agreements can provide for advance payment on book debts. No
such provision is made in case of bills discounting.
5. The parties involved in factoring agreements are factor, client and debtor; while
the parties involved in bills discounting are drawer, drawee and payee.
6. Bills discounting is covered by the Negotiable Instruments. Factoring services
are not covered by any Act.
7. In case of bills discounting grace period of three days is allowed. No such
grace time is allowed in case of factoring.
(ii) Systematic and Unsystematic Risk:
Systematic Risk
Unsystematic Risk
Systematic Risk is that portion of risk, which
affects each and every firm at large.
Unsystematic Risk is that portion
of risk, which is firm or industry
specific.
Security return of each and every security is
affected by this type of risk and hence an
investor is not able to eliminate systematic
risk by efficient diversification.
Investor is able to reduce or
eliminate unsystematic risk by
efficient diversification.
This risk is also known as unavoidable or
non-diversifiable risk.
This risk is also known
avoidable or diversifiable risk.
Systematic risk comes mainly in form of
market risk, interest rate risk and inflation risk.
Unsystematic risk comes mainly
in form of external business risk,
internal business risk and financial
risk.
Examples:
Political anarchy
Steep rise in prices of international crude oil
Fluctuations in the prevailing general level of
interest-rates
High Inflation, etc.
Examples:
Changes in government policies
Changes
in
tastes
and
preferences of consumers of the
firm
Strike, lock outs, labour unrest in
the firm, etc.
Solution prepared by
as
CA. Ashish Lalaji
13
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(iii)
Short Note on: Bought-out-deals / Offer for Sale:
A small project costing around Rs.5-6 crore of rupees shall find it costly to go in for a
public issue which may eat up to 20% of the project funds. For such small and
medium sized projects as well as companies, bought-out-deals come to rescue. In a
bought-out-deal, company initially places its equity shares to a sponsor/merchant
banker. These shares are meant to be offered to the public at a later date since such
sponsor/merchant banker shall offload such shares at appropriate time. It is to be
noted here, that in a direct offer, the sponsor/merchant banker is a conduit through
which the company routes its shares to public, whereas in a bought-out-deal, the
sponsor/merchant banker is also an intermediate investor who buys stakes in the
company and eventually disinvests the same in favour of public at an appropriate
time. In a bought-out-deal, generally, the shares are offloaded through Over The
Counter Exchange of India, or any other recognized stock exchange.
Usually, offloading of shares via OTCEI is preferable, since OTCEI ensures a fair
play. This is because a bought-out-deal between the company and the sponsor has
to be registered with the OTCEI. In case of any default by the sponsor, the matter
shall be referred to an arbitration committee set up by OTCEI and in case if any
member fails to abide by the arbitration award, the said member can even be
expelled by the OTCEI committee.
Bought-out-deals have following advantages:
•
•
•
•
Promoters are assured of immediate funds
Companies can avoid the time consuming and costly public issue
It is easier to convince a wholesale investor about the merits of the project than the
general public
It is the cheapest and the quickest source of finance for small to medium-sized
companies.
However, it should be noted that the sponsor is supposed to offload the shares at an
appropriate time. It is quite possible that the sponsor may offload the shares to
another intermediary who may be the rival group of the company concerned. In a
bought-out-deal such misuse or abuse of power is possible by the sponsor/merchant
banker.
Another serious short coming of this method is that the securities are sold to the
investing public usually at a premium. The margin thus between the amount
received by the company and the price paid by the public does not become
additional funds of the company, but it is pocketed by the issuing houses or the
existing shareholders.
(4 Marks each for any two)
(b)
Calculation of risk adjusted discount rates:
Project I: [(1.08) (1.075)] – 1 = 16.1 %
Project II: [(1.08) (1.05)] – 1 = 13.4%
(1 Mark)
Solution prepared by
CA. Ashish Lalaji
14
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Calculation of Risk-adjusted NPV:
Project I
Project II
Year
CFAT
PVF (16.1%)
PV
CFAT PVF (13.4%)
PV
0
- 50,000
1.000
-50,000 -25,000
1.000
-25,000
1
1,20,000
0.861
1,03,320 65,000
0.882
57,330
2
1,00,000
0.742
74,200 55,000
0.778
42,790
3
80,000
0.639
51,120 45,000
0.686
30,870
4
75,000
0.550
41,250 30,000
0.605
18,150
5
60,000
0.474
28,440 20,000
0.533
10,660
NPV 2,48,330
NPV 1,34,800
Conclusion: Project I is acceptable in view of higher NPV.
(4 Marks)
% Decline in Cash Inflows to result into zero NPV:
Project I:
If PV of cash inflows reduce by Rs.2,48,330 from existing level of Rs.2,98,330 i.e. %
decline = 2,48,330 / 2,98,330 = 83.24%
Project II:
If PV of cash inflows reduce by Rs.1,34,800 from existing level of Rs.1,59,800 i.e. %
decline = 1,34,800 / 1,59,800 = 84.36%
(2 Marks)
Solution prepared by
CA. Ashish Lalaji
15
Dear Student,
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Examiner’s observations on assessment of Answer books for this test
have been enumerated hereunder. A glance at these comments may help
you elevate your marks in the Final Examination. Hope you reap the
benefits of one more student friendly step taken by Pinnacle Academy.
Sharing with you the observations of the evaluator.
Yours lovingly
CA. Ashish Lalaji
Observations on evaluation of Answer Books for FMQuestion Paper Dated; 26-Mar-16
1(a)
- Many students arrived at incorrect composition of revised portfolio using Current Market price
of shares instead of Purchase price.
1 (b)
- Satisfactory.
1(c)
- Satisfactory.
2 (a)
- Calculation of D/P ratio & P/E ratio was satisfactory in all cases, while some students couldn’t
correctly answer constant multiplier ‘m’ and conclusions of Graham & Dodd’s mode.
2 (b)
- Correct selection among bid/offer rate for calculation was most critical factor where many
students interchanged the selection and eventually ended up with wrong answer.
3 (a)
- Satisfactory.
3 (b)
- Many students considered Loan o/s at Start Rs 240,000 instead of Rs 212,590 and ended up
with wrong answer.
4 (a)
- Satisfactory.
4 (b)
- Satisfactory.
5 (a)
- Satisfactory.
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5 (b)
- (i) & (ii) answered correctly by most of all students, (iii) & (iv) by very few students.
6 (a)
- Most of all students are well aware of points of distinction among factoring vs bill discounting
and Systematic vs Unsystematic Risk. However, some students wrongly interchanged meanings
of Systematic & Unsystematic Risk.
6 (b)
- Satisfactory.
General Observation:
Certain students attempted excess questions.
Please note that as per current practice of evaluation if student has attempted excess
question then last attempted optional question will be considered as Excess and no
evaluation should be done for said question.
For instance if you answer Q7 and score 16 but Q7 is an excess question & answered last
and you have also attempted Q6 before Q7 and scored 6 marks in it. Marks of Q 7 shall not
be considered as you attempted that last. So your final total of marks shall be less by 10
marks.
Suggestion for the student would be to attempt question first in which they are sure and
confident.
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