1.Financial Management WORKBOOK The ICFAI University # 52, Nagarjuna Hills, Hyderabad - 500 082

2. 2005 The Icfai University Press. All rights reserved.No part of this publication may be reproduced, stored in a retrievalsystem, used in a spreadsheet, or transmitted in any form or by anymeans electronic, mechanical, photocopying or otherwise withoutprior permission in writing from The Icfai University Press.ISBN : 81-7881-969-4Ref. No. FMWB 11200502For any clarification regarding this book, the students may please write to us giving the abovereference number of this book specifying chapter and page number.While every possible care has been taken in type-setting and printing this book, we welcomesuggestions from students for improvement in future editions. 3. PrefaceThe ICFAI University has been upgrading its study material to make it more beneficial to thestudents for self-study through the Distance Learning mode.We are delighted to publish a workbook for the benefit of the students preparing for theexaminations. The workbook is divided into three parts.Effective from April, 2003, the examinations for all the subjects of DBF/CFA (Level-I) consist ofonly multiple choice questions.Brief Summaries of ChaptersA brief summary for each of the chapters in the textbook is given for easy recollection of thetopics studied.Part I: Questions on Basic Concepts and Answers (with Explanatory Notes)Students are advised to go through the relevant textbook carefully and understand the subjectthoroughly before attempting Part I. In no circumstances should the students attempt Part I withoutfully grasping the subject material provided in the textbook.Frequently used FormulaeSimilarly the formulae used in the various topics have been given here for easy recollection whileworking out the problems.Part II: Problems and SolutionsThe students should attempt Part II only after carefully going through all the solved examples inthe textbook. A few repetitive problems are provided for the students to have sufficient practice.Part III: Model Question Papers (with Suggested Answers)The Model Question Papers are included in Part III of this workbook. The students should attemptall model question papers under simulated examination environment. They should self score theiranswers by comparing them with the model answers. Each paper consists of Part A and Part B.Part A is intended to test the conceptual understanding of the students. It contains 40 questionscarrying one point each. Part B contains problems with an aggregate weightage of 60 points.Please remember that the ICFAI University examinations follow high standards that demandrigorous preparation. Students have to prepare well to meet these standards. There are no short-cuts to success. We hope that the students will find this workbook useful in preparing for theICFAI University examinations.Work Hard. Work Smart. Work Regularly. You have every chance to succeed. All the best. 4. ContentsPAPER IBrief Summaries of Chapters 1Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) 10Frequently Used Formulae 101Part II: Problems and Solutions108Part III: Model Question Papers (with Suggested Answers) 333PAPER IIBrief Summaries of Chapters467Part I: Questions on Basic Concepts and Answers (with Explanatory Notes) 480Frequently Used Formulae 560Part II: Problems and Solutions570Part III: Model Question Papers (with Suggested Answers) 749 5. Detailed Curriculum Paper IIntroduction to Financial Management: Objectives, Functions and Scope, Evolution, Interface ofFinancial Management with Other Functional Areas, Environment of Corporate Finance.Indian Financial System:a. Financial Markets: Money Market, Forex Market, Government Securities Market, Capital Market, Derivatives Market, International Capital Markets.b. Participants: i.Financial Institutions: IDBI, IFCI, ICICI, IIBI, EXIM Bank, SFCs, SIDCs ii. Insurance Companies: LIC, GIC iii. Investment Institutions: UTI, Mutual Funds, Commercial Banks; Non-Banking Financial Companies; Housing Finance Companies; Foreign Institutional Investors.c. Regulatory Authorities: RBI, SEBI, IRA.Time Value of Money: Introduction; Future Value of a Single Cash Flow, Multiple Flows andAnnuity, Present Value of a Single Cash Flow, Multiple Flows and Annuity.Risk and Return: Risk and Return Concepts, Risk in a Portfolio Context, Relationship betweenRisk and Return.Leverage: Concept of Leverage, Operating Leverage, Financial Leverage, Total Leverage.Valuation of Securities: Concept of Valuation, Bond Valuation, Equity Valuation: DividendCapitalization Approach and Ratio Approach, Valuation of Warrants and Convertibles.Financial Statement Analysis: Ratio Analysis, Time Series Analysis, Common Size Analysis, DuPont Analysis, Funds Flow Analysis, Difficulties associated with Financial Statement Analysis.Financial Forecasting: Sales Forecast, Preparation of Pro forma Income Statement and BalanceSheet, Growth and External Funds Requirement. Paper IISources of Long-Term Finance: Equity Capital and Preference Capital, Debenture Capital, TermLoans and Deferred Credit, Government Subsidies, Sales Tax Deferments and Exceptions, Leasingand Hire Purchase.Cost of Capital and Capital Structure Theories: Cost of Debentures, Term Loans, EquityCapital and Retained Earnings, Weighted Average Cost of Capital, Systems of Weighting,Introduction to Capital Structure, Factors affecting Capital Structure, Features of an OptimalCapital Structure, Capital Structure Theories: Traditional Position, MM Position and its CritiqueImperfections.Dividend Policy: Traditional Position, Walter Model, Gordon Model, Miller & ModiglianiPosition, Rational Expectations Model.Estimation of Working Capital Needs: Objectives of Working Capital (Conservative vs.Aggressive Policies), Static vs. Dynamic View of Working Capital, Factors affecting theComposition of Working Capital, Interdependence among Components of Working Capital,Operating Cycle Approach to Working Capital.Financing Current Assets: Behavior of Current Assets and Pattern of Financing, Accruals, TradeCredit, Provisions, Short-Term Bank Finance, Public Deposits, Commercial Paper, Factoring,Regulation of Bank Credit.Management of Working Capital:a. Inventory Management: Nature of Inventory and its Role in Working Capital, Purpose of Inventories, Types and Costs of Inventory, Inventory Management Techniques, Pricing of Investments, Inventory Planning and Control;b. Receivables Management: Purpose of Receivables, Cost of Maintaining Receivables, Credit Policy Variables (Credit Standard, Credit Period, Cash Discount, Collection Program), Credit Evaluation, Monitoring Receivables;c. Treasury Management and Control;d. Cash Management: Meaning of Cash, Need for and Objectives of Cash Management, Cash Forecasting and Budgets, Cash Reports, Factors and Efficient Cash Management.Capital Expenditure Decisions: The Process of Capital Budgeting, Basic Principles in EstimatingCosts and Benefits of Investments, Appraisal Criteria: Payback Period, Average Rate of Return,Net Present Value, Benefit-Cost Ratio, Internal Rate of Return, Annual Capital Charge,Infrastructure Decisions and Financing.Current Developments. 6. Brief Summaries of ChaptersIntroduction to Financial Management The financial goal of any firm including public sector firms is to maximize the wealth of theshareholders by maximizing the value of the firm. The objective of financial manager is to increase or maximize the wealth of owners byincreasing the value of the firm which is reflected in its earning per share and market value ofthe firm. Function of finance manager includes mobilization of funds, deployment of funds, controlover the use of fund, and balancing the trade-off between risk and return. The advantages of sole proprietorship are (i) easy and inexpensive set up. (ii) fewgovernmental regulations and (iii) no firm tax. Partnership firm is a business owned by twoor more persons. They are partners in business and they bear the risks and reap the rewards ofthe business. A partnership firm is governed by the Indian Partnership Act, 1932. Henceit is relatively free from governmental regulations as compared to the joint stockcompanies. A group of persons working towards a common objective is a company. Itrepresents different kinds of associations, be it business or non-business. Corporate investment and financing decisions are circumscribed by a government regulatoryframework. The important elements of these framework are: (i) Industrials policy(ii) Industrial licensing provisions and procedure (iii) Regulation of Foreign Collaborationsand Investment (iv) Foreign Exchange Management Act (v) Companies Act and (vi) SEBI.Indian Financial System The economic development of a country depends on the progress of its various economicunits, namely the Corporate Sector, Government Sector and the Household Sector. The role of the financial sector can be broadly classified into the savings function, policyfunction and credit function. The main types of financial markets are: money market, capital market, forex market andcredit market. The financial markets are further sub-divided into the Primary market and the Secondary market. A market is considered perfect if all the players are price takers, there are no significantregulations on the transfer of funds and transaction costs, if any, are very low. The accounting equation: Assets = Liabilities, can be altered asFinancial Assets + Real Assets = Financial Liabilities + Savings. The main types of financial assets are deposits, stocks and debt. While designing a financial instrument, the issuer must keep the following in mind: cashflows required, taxation rules, leverage expected, dilution of control facts, transaction costs tobe incurred, quantum of funds sought, maturity of plan required, prevalent market conditions,investor profile targeted, past performance of issues, cost of funds to be borne, regulatoryaspects to abide by. While investing in a financial instrument, the investor must keep the following in mind: riskinvolved, liquidity of the instrument, returns expected, possible tax planning, cash flowsrequired and simplicity of investment. Various financial intermediaries came into existence to facilitate a proper channel forinvestment. The main ones are: stock exchanges, investment bankers, underwriters,registrars, depositories, custodians, primary dealers, satellite dealers and forex dealers. 7. Time Value of Money Additional compensation required for parting with say Rs.1,000 now is called interest. There are two methods by which the time value of money can be taken care of compoundingand discounting. Under the method of compounding, we find the Future Values (FV) of all the cash flows atthe end of the time horizon at a particular rate of interest. Under the method of discounting, we reckon the time value of money now i.e. at time zero onthe time line. So, we will be comparing the initial outflow with the sum of the Present Values(PV) of the future inflows at a given rate of interest. To determine the accumulation of multiple flows as at the end of a specified time horizon, wehave to find out the accumulations of each of these flows using the appropriate FVIF and sumup these accumulations. Annuity is the term used to describe a series of periodic flows of equal amounts. To determine the present value, we have to first define the relevant rate of interest.Risk and Return The risk associated with a common stock is interpreted in terms of the variability of itsreturn. The most common measures of riskiness of security are standard deviation andvariance of returns. Unsystematic risk is the extent of the variability in the securitys return on account of thefirm specific risk factors. This is also called diversifiable or avoidable risk factors. Systematic risk refers to factors which affect the entire market and hence the firm too. This isalso called non-diversifiable risk. If a portfolio is well diversified, the unsystematic risk gets almost eliminated. Thenon-diversifiable risk arising from the wide movements of security prices in the market isvery important to an investor. The modern portfolio theory defines the riskiness of a securityas its vulnerability to market risk. This vulnerability is measured by the sensitivity of thereturn of the security vis--vis the market return and is called beta. The concept of security market line is developed by the modern portfolio theory. SMLrepresents the average or normal trade-off between risk and return for a group of securities.Here the risk is measured typically in terms of the beta values.Application of Security Market Lines:The ex post SML is used to evaluate the performance of portfolio manager; tests ofasset-pricing theories, such as the CAPM and to conduct tests of market efficiency.The ex ante SML is used to identify undervalued securities and determine the consensus,price of risk implicit in the current market prices.Depending upon the value of alpha, using SML it is possible to estimate whether the scrip isunderpriced (it is then eligible to be purchased) or overpriced (it is then eligible to be sold).Valuation of Securities Value of any security can be defined as the present value of the future cash streams i.e., theintrinsic value of an asset should be equated to the present value of the benefits associatedwith it. Book value is an accounting concept. Assets are recorded at historical costs and they aredepreciated over years. Book value includes intangible assets at acquisition cost minusamortized value. The book value of debt is stated at the outstanding amount. The differencebetween the book value of assets and liabilities is equal to shareholders funds or net worth(which is equal to paid-up equity capital plus reserves and surplus). Replacement Value is the amount that a company would be required to spend if it were toreplace its existing assets in the current condition.2 8. Liquidation Value is the amount that a company could realize if it sells its assets after havingterminated its business. It is generally a minimum value which a company might accept if itsells its business. Going Concern Value is the amount that a company could realize if it sells its business as anoperating one. Its value would always be higher than the liquidation value, the differenceaccounting for the usefulness of assets and value of intangibles. Market Value of an asset or security is the current price at which the asset or the security isbeing sold or bought in the market. Face Value: This is the value stated on the face of the bond and is also known as par value. Itrepresents the amount of borrowing by the firm which it specifies to repay after a specificperiod of time i.e., at the time of maturity. A bond is generally issued at face value or parvalue which is usually Rs.100 and may sometimes be Rs.1,000. Coupon Rate or Interest: A bond carries a specific rate of interest which is also called as thecoupon rate. The interest payable is simply the par value of the bond Coupon Rate. Interestpaid on a bond is tax deductible for the issuer. Maturity: A bond is issued for a specific period of time. It is repaid on maturity. Typicallycorporate bonds have a maturity period of 7-10 years whereas government bonds have amaturity period up to 20-25 years. Redemption Value: The value which a bondholder gets on maturity is called redemptionvalue. A bond may be redeemed at par, at premium (more than par value) or at discount (lessthan par value). Market Value: A bond may be traded in a stock exchange. Market value is the price at whichthe bond is usually bought or sold in the market. Market value may be different from ParValue or redemption value. One Period Rate of Return: If a bond is purchased and then sold one year later, its rate ofreturn over this single holding period can be defined as rate of return. Current Yield measures the rate of return earned on a bond if it is purchased at its currentmarket price and if the coupon interest is received. Coupon rate and current yield are two different measures. Coupon rate and current yield willbe equal if the bonds market price equals its face value. Yield-to-Maturity (YTM): It is the rate of return earned by an investor who purchases a bondand holds it till maturity. The YTM is the discount rate which equals the present value ofpromised cash flows to the current market price/purchase price. Based on the bond valuation model, several bond value theorems have been derived whichstate the effect of the following factors on bond values:I. Relationship between the required rate of return and the coupon rate.II. Number of years to maturity.III. Yield-to-maturity. When the required rate of return (kd) is equal to the coupon rate, the value of the bond isequal to its Par Value.i.e., If kd = Coupon Rate;then value of a bond = Par Value. When the required rate of return (kd) is greater than the coupon rate, the value of the bond isless than its par value.If kd > coupon rate; then value of a bond < par value. When the required rate of return (kd) is less than the coupon rate, the value of the bond isgreater than its par value.i.e., if kd < coupon rate; then value of a bond > par value.3 9. When the required rate of return (kd) is greater than the coupon rate, the discount on the bonddeclines as maturity approaches. When the required rate of return (kd) is less than the coupon rate, the premium on the bonddeclines as maturity approaches. A bonds price is inversely proportional to its yield to maturity. For a given difference between YTM and coupon rate of the bonds, the longer the term tomaturity, the greater will be the change in price with change in YTM. Given the maturity, the change in bond price will be greater with a decrease in the bondsYTM than the change in bond price with an equal increase in the bonds YTM. That is, forequal sized increases and decreases in the YTM, price movements are not symmetrical. For any given change in YTM, the percentage price change in case of bonds of high couponrate will be smaller than in the case of bonds of low coupon rate, other things remaining thesame. A change in the YTM affects the bonds with a higher YTM more than its does bonds with alower YTM. A warrant is a call option to buy a stated number of shares. The exercise price of a warrant is what the holder must pay to purchase the stated number ofshares. A convertible debenture, as the name indicates, is a debenture which is convertible partly or fully,into equity shares. If it is partially converted, it is referred to as partly convertible debenture and ifthe debentures are converted into equity shares at the end of maturity fully, it is referred to as fullyconvertible debentures. The option of conversion is either at the discretion of the investor, i.e.,(optional) or compulsory (if it is specified). The conversion ratio gives the number of shares of stock received for each convertiblesecurity. If only the conversion ratio is given, the par conversion price can be obtained bydividing the conversion ratio multiplied by the face or par value of the convertible security. The conversion value represents the market value of the convertible if it were converted intostock; this is the minimum value of the convertible based on the current price of the issuersstock. Intrinsic value is the value of a stock which is justified by assets, earnings, dividends, definiteprospects and the factor of the management of the issuing company. According to the dividend capitalization approach, which is a conceptually sound approach,the value of an equity share is the discounted present value of dividends received plus thepresent value of the resale price expected when the equity share is sold. The E(P/E) ratio is formed by dividing the present value of the share by the expectedearnings per share denoted by E(EPS).Financial Statement Analysis A financial statement is a compilation of data, which is logically and consistently organizedaccording to accounting principles. Financial Statement Analysis consists of the application of analytical tools and techniques tothe data in financial statements in order to derive from them measurements and relationshipsthat are significant and useful for decision making. The financial data needed in the financial analysis come from many sources. The important tools of analysis:1.Ratio Analysis Comparative Analysis Du Pont Analysis2.Funds flow Analysis.4 10. The analysis of a ratio can disclose relationships as well as bases of comparison that revealconditions and trends that cannot be detected by going through the individual components ofthe ratio. The usefulness of ratios is ultimately dependent on their intelligent and skillfulinterpretation. Financial ratios fall into three groups:1. Liquidity Ratios2. Profitability or Efficiency Ratios3. Ownership Ratios Earnings Ratios Dividend Ratios Leverage Ratios a. Capital Structure Ratios b. Coverage Ratios. Liquidity implies a firms ability to pay its debts in the short run. Current Ratio:Current AssetsThe liquidity ratio is defined as: Current LiabilitiesCurrent assets include cash, marketable securities, debtors, inventories, loans and advances,and pre-paid expenses. Current liabilities include loans and advances taken, trade creditors,accrued expenses and provisions. Quick Ratio Quick-test (also acid-test ratio) is defined as: Quick AssetsQuick Assets Inventories== Current LiabilitiesCurrent LiabilitiesShort term bank borrowings Bank Finance to Working Capital Gap Ratio =Working capital gapwhere Working capital gap is equal to current assets less current liabilities other than bankborrowings.Net credit sales Accounts receivable turnover ratio = Average accounts receivable 360 Average collection period =Average accounts receivable turnoverAverage accounts receivable=Average daily salesCost of goods sold Inventory turnover =Average inventory Gross Pr ofit The Gross Profit Margin Ratio (GPM) is defined as:Net SalesWhere net sales = Sales Excise duty.Net Pr ofit The Net Profit Margin ratio (NPM) is defined as:Net Sales Sales Asset turnover ratio is defined as: Average assets 5 11. Earning power is a measure of operating profitability and it is defined as: Earning before interest and taxesAverage total assets Return on EquityThe Return on Equity (ROE) is an important profit indicator to shareholders of the firm. It isNet incomecalculated by the formula: Average equity Ownership ratios are divided into three main groups. They are:1.Earnings Ratios2.Leverage Ratios Capital Structure Ratios Coverage Ratios3. Dividend Ratios. The earnings ratios are Earnings Per Share (EPS), price-earnings ratio (P/E ratio), andcapitalization ratio. From earnings ratios we can get information on earnings of the firm andtheir effect on price of common stock. Net income (PAT) Earning Per Share (EPS) = Number of outstanding sharesMarket price of theshare Price earnings multiple =Earnings per shareEarnings per share Capitalization rate =Market price of the shareDebt Debt equity ratio = Equity Debt Debt-Asset ratio = AssetsEBIT Interest coverage ratio =Interest expense Fixed charges coverage ratio Earning before depreciation, debt interest and lease rentals and taxes=Debt interest + Lease rentals + Loan repayment installment + Preference dividends(1 tax rate) (1 tax rate) Debt Service Coverage RatioPAT + Depreciation + Other non cash charges + Interest on term loan=Interest on term loan + Repayment of the term loan Dividend Pay-out RatioThis is the ratio of Dividend Per Share (DPS) to Earnings Per Share (EPS) Dividend per share Divident yield = Market price of theshare Different types of comparative analysis are:1.Cross-sectional analysis2.Time-series analysisa. Year-to-year changeb. Index analysis3.Common-size analysis.6 12. Cross-sectional analysis is used to assess whether the financial ratios are within the limits,they are compared with the industry averages or with a good player in normal businessconditions if an organized industry is not there. A comparison of financial statements over two to three years can be undertaken bycomputing the year-to-year change in absolute amounts and in terms of percentage changes. When a comparison of financial statements covering more than three years is undertaken, theyear-to-year method of comparison may become too cumbersome. In the analysis of financial statements, it is often instructive to find out the proportion that asingle item represents of a total group or subgroup. In a balance sheet, the assets, theliabilities and the capital are each expressed as 100%, and each item in these categories isexpressed as a percentage of the respective totals. Similarly, in the income statement, netsales are set at 100% and every other item in the statement is expressed as a percentage of netsales. Analyzing return ratios in terms of profit margin and turnover ratios, referred to as theDu Pont System.Funds Flow Analysis A funds flow statement is a statement which explains the various sources from which fundsare raised and the uses to which these funds are put. The major difference, however, between a true funds flow statement and a balance sheet liesin the fact that the former captures the movements in funds, while the latter merely presents astatic picture of the sources and uses of funds. A funds flow statement would enable one to see how the business financed its fixed assets,built up the inventory, discharged its liabilities, paid its dividends and taxes and so on.Similarly, it would enable one to see how the business managed to meet the above capitalor revenue expenditure. The simplest funds flow statement for a period is the difference between the correspondingbalance sheet items at the beginning and the end of the period, such that all increases inliabilities and decreases in assets are shown as sources of funds and all decreases in liabilitiesand increases in assets are shown as applications of funds. FFS can also be prepared with the help of the two balance sheets (opening and closing) andthe profit and loss statement of the intervening period. Such a funds flow statement definesfunds as total resources and the sources of funds will always be equal to the uses of funds.7 13. A funds flow statement may be so prepared as to explain only the change in the workingcapital (current assets and current liabilities) from the beginning of a period to the end of theperiod. Sources of funds that increase cash are:A net decrease in any asset other than cash or fixed assets.A gross decrease in fixed assets.A net increase in any liability.Proceeds from the sale of equity or preference stock.Funds from operations. Uses of funds which decrease cash include:A net increase in any asset other than cash or fixed assets.A gross increase in fixed assets.A net decrease in any liability.A retirement or purchase of stock.Cash dividends. Gross changes in fixed assets is calculated by adding depreciation for the period to net fixedassets at the ending financial statement date. From this figure, the net fixed assets at thebeginning of financial statement date is deducted. An increase in a current asset results in an increase in working capital. A decrease in a current asset results in a decrease in working capital. An increase in a current liability results in a decrease in working capital. A decrease in a current liability results in an increase in working capital.Leverage Leverage is the influence which an independent financial variable has over a dependent/related financial variable. Operating leverage examines the effect of the change in the quantity produced on the EBITof the company and is measured by calculating the Degree of Operating Leverage (DOL). A large DOL indicates that small fluctuations in the level of output will produce largefluctuations in the level of operating income. DOL is a measure of the firms business risk. Business risk refers to the uncertainty orvariability of the firms EBIT. So, every thing else being equal, a higher DOL means higherbusiness risk and vice-versa. The financial leverage measures the effect of the change in EBIT on the EPS of the company.Financial leverage refers to the mix of debt and equity in the capital structure of thecompany. The measure of financial leverage is the Degree of Financial Leverage (DFL) If the management decides to finance a part of the total investment required of through debtfinancing, the following two factors are important: The proportion of total investment whichthe management decides to finance through debt (Debt Equity Ratio the firm aspires to) andthe interest rate on borrowed funds. The greater the tax rate, the more is the tax shield available to a company which is financiallyleveraged. As the company becomes more financially leveraged, it becomes riskier, i.e., increased use ofdebt financing will lead to increased financial risk which leads to: Increased fluctuations inthe return on equity and increase in the interest rate on debts. The greater the use of financial leverage, the greater the potential fluctuation in returnon equity.8 14. As the interest rate increases, the return on equity decreases. Even though the rate of returndiminishes, it might still exceed the rate of return obtained when no debt was used, in whichcase financial leverage would still be favorable. A combination of the operating and financial leverages is the total or combined leverage.Thus, the Degree of Total Leverage (DTL) is the measure of the output and EPS of thecompany. DTL is the product of DOL and DFL There is a unique DTL for every level of output. At the overall break-even point of output theDTL is undefined. If the level of output is less than the overall break-even point, then theDTL will be negative. If the level of output is greater than the overall break-even point, thenthe DTL will be positive. DTL decreases as the quantity of sales increases and reaches alimit of one. DTL measures the changes in EPS to a percentage change in quantity of sales. DTL measures the total risk of the company since it is a measure of both operating risk andtotal risk.Financial Forecasting Financial forecasting is a planning process with which the companys management positionsthe firms future activities relative to the expected economic, technical, competitive andsocial environment. There are three main techniques of financial projections. They are proforma financialstatements, cash budgets and operating budgets. Proforma statements are projected financial statements embodying a set of assumptions abouta companys future performance and funding requirements. Cash budgets are detailed projections of the specific incidence of cash moving in and out ofthe business. Operating budgets are detailed projections of departmental revenue and/or expense patterns,and they are subsidiary to both proforma statements and cash flow statements. Sales Budget can be prepared by making a sales forecast, sales forecast can be made fromsubjective and objective methods. Subjective methods use the judgments or opinions of knowledgeable individuals withinthe company, ranging from sales representatives to executives. Objective methods are statistical methods which range in sophistication from relativelysimple trend extrapolations to the use of complicated mathematical models. More and morecompanies are relying on computers to predict causal relationships. 9 15. Part I: Questions on Basic ConceptsIntroduction to Financial Management1. The financial goal of a public sector firm fully owned by the government is to a Maximize the book value per share b. Maximize the profits earned by the firm c. Maximize the present value of stream of equity returns d. Maximize the return on equity e. Both (a) and (d) above.2. Which of the following is not an objective of financial management? a. Maximization of wealth of shareholders. b. Maximization of profits. c. Mobilization of funds at an acceptable cost. d. Efficient allocation of funds. e. Ensuring discipline in the organization.3. Which of the following is not a function of a finance manager? a. Mobilization of funds. b. Deployment of funds. c. Control over use of funds. d. Manipulate share price of the company. e. Maintain a balance between risk and return.4. The market value of the firm is the result of a.Dividend decisions b. Working capital decisions c. Capital budgeting decisions d. Trade-off between cost and risk e. Trade-off between risk and return.5. Which of the following is related to the control function of the financial manager? a. Interaction with the bankers for arranging a short-term loan. b. Comparing the costs and benefits of different sources of finance. c. Analysis of variance between the targeted costs and actual costs incurred. d. Assessing the costs and benefits of a project under consideration. e. Deciding the optimum quantity of raw materials to be ordered for procurement.6. The minimum number of persons required to form a private limited company and a public limited company respectively are a. 2 and 5 b. 5 and 7 c. 2 and 7 d. 7 and 2 e. None of the above.7. Which of the following is an advantage of a sole proprietorship? a. Life of a firm is limited to the life of the owner. b. Fund raising from outside is easy. c. Limited personal liabilities. d. Easy and inexpensive to set-up. e. Expansion of Business is possible. 16. Part I 8. Which of the following is an advantage of partnership firms? a. The life of the firm is perpetual. b. Personal liabilities of the partners are limited. c. Its ability to raise funds is virtually unlimited. d. It is relatively free from Governmental regulations as compared to joint stockcompanies. e. None of the above. 9. The objective of financial management is to a. Generate the maximum net profit b. Generate the maximum retained earnings c. Generate the maximum wealth for its shareholders d. Generate maximum funds for the firm at the least cost e. All of the above.10. Which of the following statements represents the financing decision of a company? a. Procuring new machineries for the R&D activities. b. Spending heavily for the advertisement of the product of the company. c. Adopting state of the art technology to reduce the cost of production. d. Purchasing a new building at Delhi to open a regional office. e. Designing an optimal capital structure by using suitable financial instruments.11. The amount that can be realized by a company when it sells its business as an operating oneis termed as a. Going concern value b. Market value c. Book value d. Replacement valuee. Liquidation value.12. Which of the following functions of the financial system facilitates conversion of investmentsin stocks, bonds, debentures etc., into money?a. Savings function.b. Liquidity function.c. Payment function.d. Risk function.e. Policy function.13. The objective of financial management to increase the wealth of the shareholders means toa. Increase the physical assets owned by the firmb. Increase the market value of the shares of the firmc. Increase the current assets of the firmd. Increase the cash balance of the companye. Increase the total number of outstanding shares of the company.14. Which of the following is a function of the finance manager?a. Mobilizing funds.b. Risk return trade off.c. Deployment of funds.d. Control over the uses of funds.e. All of the above.11 17. Financial ManagementIndian Financial System15. A financial asset should necessarily have a. A claim to a payment in the form of an instrument b. An underlying asset, with a charge over it c. Parting of money today with an expectation that it will be returned in future with someaddition to it d. Both (a) and (c) above e. All of (a), (b) and (c) above.16. Which is/are the essential feature(s) of a Call Money Market? a. Maturity periods of 1-15 days. b. Market determined interest rates. c. Low liquidity. d. High agency costs. e. Both (a) and (b) above.17. The apex financial institution in India that promotes housing finance is a. Housing & Urban Development Corporation (HUDCO) b. Housing Development Finance Corporation Ltd. (HDFC) c. Cooperative Housing Finance Society d. National Housing Bank (NHB) e. LIC Housing Finance Limited.18. Single Window Lending refers to a. An arrangement by which the lead bank in a consortium of banks releases the initialrequirements of the borrower b. Loans given by commercial banks to the agricultural sector, which are subject toefinance from NABARD c. A specialized cell set up in scheduled banks exclusively for the purpose of industrialloans d. Priority sector lending by nationalized banks e. Loans given by NBFCs to some sectors to which nationalized banks are not allowed togive.19. The difference(s) between Commercial Paper (CP) and Certificate of Deposit (CD) is/are a. CP is secured while CD is unsecured b. CPs can be issued by private sector companies while CDs can be issued by scheduledbanks c. CP is sold at a discount and redeemed at face value whereas for CD the principal andinterest are payable upon maturity d. Both (b) and (c) above e. All of (a), (b) and (c) above.20. The money lent in money market for a period of 2 to 15 days is referred to as a. Call money b. Demand loan c. Term loan d. Notice money e. None of the above.12 18. Part I21. Which of the following are feature(s) of Gilt-edged securities? a. Only repayment of principal is secured. b. They are issued by non-governmental service organizations. c. They are issued by government entities. d. The repayments of both principal and interest are secured. e. Both (c) and (d) above.22. Which of the following provides liquidity to money market instruments by creating asecondary market where they can be traded? a. Discount and Finance House of India. b. National Securities Depository Limited. c. State Bank of India. d. Reserve Bank of India. e. Over the Counter Exchange of India.23. Which of the following is an example of non-fund based activity of an NBFC? a. Bill discounting. b. Leasing. c. Issue management. d. Hire purchase. e. Inter-corporate loans.24. The minimum maturity period for a Certificate of Deposit is a. Fifteen days b. One month c. Three months d. Six months e. No specific time limit is prescribed.25. Statutory Liquidity Ratio (SLR) refers to the a. Percentage of secret reserves which acts as a cushion for nationalized banks b. Percentage of reserves banks are required to park with instruments approved by RBI c. Ratio between current account and fixed account deposits of banks d. Percentage of reserves banks are required to utilize only for forex transactions e. Percentage of reserves meant for priority sector lending.26. Public debt in the Indian economy is being managed by a. SBI on behalf of Government of India b. Ministry of Finance c. RBI d. All nationalized banks and term lending institutions e. Ministry of Commerce and Trade.27. In which of the following instances bought-out deal is more appropriate? a. Companies do not wish to disclose information by way of public issue. b. Promoters do not want to dilute their stake by going public. c. Small projects require funds but costs of public issue are substantially high. d. Foreign Institutional Investors offload their shares when market is down. e. Board for Industrial and Financial Reconstruction (BIFR) offers a sick unit to existingblue chips in that industry. 13 19. Financial Management28. Which of the following is/are not a feature(s) of National Stock Exchange? a. NSE was promoted by FIs at the bentest of GOI. b. The trading is on-line in national network. c. The volume of trading in it is less than that of BSE. d. It has a debt market segment. e. The weights to the stocks on NIFTY are based on total share holding.29. Which of the following is/are not true in respect of PSU bonds? a. There is no secondary market. b. Market lot for trading purposes is minimum of Rs.10 crore. c. They come under approved investments by RBI. d. Both (a) and (b) above. e. All of (a), (b) and (c) above.30. Unit banking refers to the system a. With a single bank having units at different places b. With the overall operations of a bank conducted from a single office c. Which deals with the units of UTI d. Which deals with the units in small-scale sector e. Either (a) or (b) above.31. Which of the following is not a function performed by a financial system? a. Savings function. b. Liquidity function. c. Risk function. d. Social function. e. Policy function.32. The maturity period of a Certificate of Deposit (CD) issued by a bank is a. Not less than 1 month and not more than 6 months b. Not less than 2 months and not more than 9 months c. Not less than 15 days and not more than 12 months d. Not less than 4 months and not more than 12 months e. Not less than 1 month and not more than 12 months33. If in an order to buy/sell shares from a stock exchange is limited by a fixed price it is called a. Limit order b. Limited discretionary order c. Stop loss order d. Best rate order e. None of the above.34. Gilt edged securities are the bonds issued by a. Big corporates b. Multinational corporates c. Global corporations d. Central government e. Financial institutions.14 20. Part I35. Medium dated government securities have maturities ranging from a. 1 to 3 years b. 1 to 5 years c. 3 to 5 years d. 3 to 10 years e. 5 to 10 years.36. Which of the following maturity of T-Bills does not have a provision? a. 30-day. b. 91-day. c. 182-day. d. 364-day. e. None of the above.37. In secondary spot capital market, the delivery and payment is completed a. On the same day of the date of contract b. On the next day of the date of contract c. Within four days from the date of contract d. Within 2 days from the date of contract e. Beyond fourteen days from the date of contract.38. The primary capital market a. Imparts liquidity and marketability to long-term financial instruments b. Helps companies to raise funds to finance their projects c. Provides an auction market for long-term securities d. Operates through the medium of stock exchanges e. Both (a) and (c) above.39. In a private company maximum number of members permissible is a. 5 b. 10 c. 25 d. 50 e. 100.40. Banks borrow in call money market to a. Give loans b. Invest in high yielding securities c. Meet the Cash Reserve Ratio (CRR) d. Meet sudden demand for funds arising due to large payments and remittances e. Both (c) and (d) above.41. Which of the following is not a feature of Commercial Paper (CP)? a. Purely secured instrument. b. Maturity varies between 15 days and a year. c. Buy-back facilities are available. d. Negotiable by endorsement and delivery. e. None of the above. 15 21. Financial Management42. Which of the following is not a money market instrument? a. Treasury bills. b. Certificate of deposits. c. Debentures. d. Call money. e. None of the above.43. Private placement of shares can be made out of a. Mutual funds quota b. Promoters quota c. Public quota d. Financial institutions quota e. All of the above.44. An order to sell shares, where brokers are given a particular limit for sustenance of loss isknown as a. Limited discretionary order b. Limit order c. Cancel order d. Stop loss order e. Best rate order.45. Which of the following is not true with regard to commercial paper?a. It is issued in multiples of Rs.5 lakhs.b. The minimum amount to be invested by a single investor is Rs.20 lakhs.c. The maturity period cannot exceed 1 year.d. These are unsecured promissory notes.e. The issuing company must have a high credit rating.46. Which of the following enables a company to increase its paid-up share capital withoutreceiving any payment from the recipients of the shares?a. Public issue.b. Bonus issue.c. Private placement.d. Bought-out deal.e. Rights issue.47. In which of the following types of orders the members of stock exchange are not given anyprice or time limit by the client for execution of order?a. Limit order.b. Best rate order.c. Immediate or cancel order.d. Limited discretionary order.e. Open order.48. Which of the following statements is false?a. All scheduled banks except co-operative banks and regional rural banks are eligible toissue CDs.b. CDs can be issued to individuals.c. CDs are issued at a discount to face value.d. The maturity period of CDs issued by banks varies from 15 days to one year.e. CDs are issued in multiples of one lakh subject to the minimum size of each issue ofRs.50 lakh.16 22. Part I49. Which of the following methods of issuing additional shares does not result in an increase inthe net worth of the company? a. Public issue. b. Rights issue. c. Bonus issue. d. Private placement. e. Bought-Out Deal.50. The major categories of investors in primary market of government securities include a. Reserve Bank of India b. Financial institutions c. Foreign financial institutions d. Commercial banks e. All of the above.51. Which of the following is an asset of a bank?a. Balances with other banks.b. Savings deposits.c. Demand and time deposits from other banks.d. Refinance from NABARD.e. None of the above.52. The National Housing Bank extends refinance on housing loans toa. Scheduled commercial banksb. Co-operative banksc. Housing finance companiesd. Apex cooperative housing finance societiese. All of the above.53. According to the guidelines of Money Market Mutual Funds, the minimum lock in period ofan investors investment isa. Nilb. 15 daysc. 30 daysd. 45 dayse. 60 days.54. One of the important functions of a well developed money market is to channel savings intoproductive investments like working capital. Which of the following is not a money marketinstrument?a. Corporate debentures.b. Call money.c. Treasury bills.d. Commercial paper.e. Certificate of deposits.55. Which of the following is not a feature of a commercial paper?a. They are transferable by endorsement and delivery.b. They are issued in multiples of one lakh.c. Their maturity varies from 15 days to one year.d. They are unsecured in nature.e. They normally have buy-back facility. 17 23. Financial Management56. Which of the following is not an advantage of a bought out deal? a. The promoters are assured of immediate funds. b. The time consuming and costly public issue can be avoided. c. It is easier to convince the wholesale investor rather than the general public. d. The shares issued via bought out deal can be bought back by the company at any time. e. It is the cheapest and quickest source of finance for small to medium sized companies.57. If a company wants to raise funds through commercial paper market, the minimum fundbased working capital limit should bea. Rs.1 croreb. Rs.2 crorec. Rs.3 crored. Rs.4 croree. Rs.5 crore.58. In a Bought-Out Deala. Companies issue shares to the publicb. Companies issue shares to the existing shareholdersc. Mutual funds buy out a part of promoters shared. A part of the equity of an unlisted company is bought by a sponsor/merchant bankere. Financial institutions buy out a significant portion of share capital of a listed company.59. Which of the following is not a financial asset?a. Secured premium notes.b. National defence gold bond.c. Capital investment bond.d. Bullion.e. Special bearer bond.60. Bills rediscounting facility is offered bya. All public sector banksb. Some co-operative banksc. IDBId. All SFCse. Both (c) and (d) above.61. Which of the following statements is/are true?i.A cash credit is a running account.ii. Cash credits may become long-term loans due to repeated roll-overs.iii. Overdrafts are allowed only against the security of inventories.a. Only (i) above.b. Only (ii) above.c. Only (iii) above.d. Both (i) and (ii) above.e. All of (i), (ii) and (iii) above.62. Which of the following is not a money market instrument?a. Treasury bill.b. Commercial paper.c. Convertible debenture.d. Certificate of deposit.e. Both (b) and (c) above.18 24. Part I63. Which of the following statements is true regarding issuance of Commercial Paper (CP)? a. Corporates need prior approval of RBI for CP issue. b. Underwriting of a CP issue is not mandatory. c. Minimum size of a CP issue is Rs.10 lakhs. d. CPs have to be backed by a bank guarantee. e. CPs are issued in multiples of Rs.1 lakh.64. Which of the following statements is/are true regarding the call money market? a. Surplus funds of banks constitute a major component. b. Major corporates participate as lenders. c. Banks often borrow from it for maintenance of SLR and CRR. d. Both (a) and (b) above. e. All of (a), (b) and (c) above.65. Which of the following statements is/are true regarding 91-day Treasury Bills? a. They are also referred to as PSU bonds. b. They are issued through auctions conducted by RBI. c. They are risky instruments as their interest rates fluctuate widely. d. They cannot be rediscounted with RBI. e. None of the above.66. CRISIL a. Rates, Debentures and fixed deposits. b. Was set up by the Industrial Development Bank of India. c. Gives the highest rating of P1 to short-term instruments. d. Does not consider non-financial factors while valuing a companys securities. e. None of the above.67. Which of the following is not a money market instrument? a. Call Loans. b. Commercial Papers. c. Certificates of Deposit. d. Treasury Bills. e. None of the above.68. Which of the following is a form of direct assistance by All India Financial Institutions? a. Underwriting. b. Subscribing to a companys shares. c. Bills Rediscounting. d. All of the above. e. Both (a) and (b) above.69. Which of the following statements is not true?a. The Industrial Credit and Investment Corporation of India has merged with ICICI bank.b. The Industrial Development Bank of India is the apex term lending financial institution.c. The Industrial Finance Corporation of India is an All India term lending financialinstitution.d. The Industrial Reconstruction Bank of India is the central agency for rehabilitation ofIndustrial units declared sick by BIFR only.e. None of the above. 19 25. Financial Management70. Which one of the following was not an objective of Nationalization and greatergovernmental control over major banks? a. Achieving wider spread of bank credit. b. Preventing misuse of resources of banks. c. Reducing the influence of business houses on banks. d. Bringing larger income to the government. e. None of the above.71. Private Banks a. Should not be registered as public limited companies b. Need not adhere to capital adequacy norms determined by RBI c. Are covered by the Banking Regulation Act, 1949 d. Should not be listed on any stock exchanges e. Both (a) and (d) above.72. Which of the following are the reasons for low profitability of the Commercial Banks? a. High incidence of bad debt. b. Inefficient procedures. c. Overstaffing. d. Priority sector lending. e. All of the above.73. Gilt-edged securitiesa. Have fairly active secondary marketb. Have low interest ratesc. Are subscribed mainly by commercial banks, provident funds and other institutionalinvestorsd. Are held by banks to satisfy their SLR requirementse. All of the above.74. Which of the following is not true?a. There has been a general down trend in the nominal interest rates in the past few years.b. Term finance rates have been higher than the working capital finance rates.c. Interest rates in the organized sector in India are fixed by the government.d. Interest rate policy of the government is designed to mobilize substantial savings.e. Interest rate policy of the government is designed to facilitate government borrowingcheaply.75. Certificates of Deposits (CDs)a. Are freely transferable by endorsement and deliveryb. Are issued at a discount stipulated by RBIc. Are issued by RRBsd. Have no fixed maturitye. Have an active secondary market.76. Which of the following statements is true?a. IDBIs deep discount bonds are zero coupon bonds.b. When a company wants to raise a given amount of capital through a rights issue, thesubscription price should ideally be higher than the current market price.c. Regional stock exchanges are unrecognized.d. The rupee is convertible on the capital account. e. The alpha () of a security measures the return on the market portfolio.20 26. Part I77. The changes in the banking structure through nationalization has resulted in a. Deeper penetration into rural areas b. Increase in deposits c. Channelization of bank credit d. Lower operational autonomy for banks e. All of the above.78. The following indirect financial assistance is extended by the financial institutions to help theindustrial unitsa. Underwritingb. Guarantee for foreign currency loansc. Deferred payment guaranteed. All of the abovee. None of the above.79. Money market deals witha. Mortgage loansb. Certificate of depositsc. Deposits with RBI under CRRd. Fixed Deposit Receiptse. Both (a) and (b) above.80. In a well-functioning capital market, shareholders will vote for the goal ofa. Modifying the investment plan of the firm to help shareholders achieve a particular timepattern of investmentb. Making shareholders as wealthy as possible by investing in real assets with positive netpresent valuesc. Inviting shareholders and giving them costly articles in annual general meetingsd. Having employees as shareholderse. Choosing high or low risk projects to match shareholders risk preferences.81. Capital markets differ from money market in thata. Capital markets are regulated while money markets are notb. The maturity of securities in the capital are long-term while in the money market it isshort-termc. Limited companies which operate in capital markets cannot operate in money marketsd. Unorganized money markets are larger than unorganized capital markete. Both (a) and (d) above.82. Which of the following members would you not find in the secondary stock market?a. Investors.b. Stock Exchanges.c. Stock Brokers.d. Companies.e. Underwriters.83. In terms of the maturity of assets issued, which of the following markets have the shortestmaturity period?a. Call Money Market.b. Commercial Paper Market.c. Treasury Bills Market.d. Certificates of Deposit Market.e. All of the above.21 27. Financial Management84. Which of the following is true regarding the issuance of commercial paper? a. The minimum net worth of Rs.10 crore is required. b. The maximum discount rate is 16%. c. The minimum credit rating required is P1. d. Prior approval of RBI for the issue is required. e. Minimum investment by an individual is Rs.5 lakh.85. The minimum maturity of treasury bills is a. 14 days b. 28 days c. 45 days d. 60 days e. 90 days.86. Which of the following statements is/are true regarding call money market? i. Financial institutions and mutual funds can participate only as lenders in this market. ii.The interest on call loan is regulated by Reserve Bank of India. iii. The maximum maturity of notice money is 3 days. a. Only (i) above b. Only (ii) above c. Both (i) and (ii) above d. Both (i) and (iii) above e. Both (ii) and (iii) above.87. Which of the following is true regarding a Bought-Out Deal? a. It involves direct selling of securities to a limited number of institutional or high networth individuals. b. The costs involved in a bought-out deal are generally higher than the costs of a publicissue. c. The company proposing to place its securities through this route can price its securitiesto reflect the intrinsic value. d. The procedural complexities are very high. e. New companies cannot make bought-out deals.88. The maximum number of persons in a private limited company is a. 1 b. 2 c. 3 d. 7 e. 50.89. The service of which of the following entities is generally not useful to the retail investors forraising funds? a. Merchant Banks. b. Commercial banks. c. Hire purchase finance companies. d. Housing finance companies. e. Nidhis.22 28. Part I90. Which of the following is not traded in the money market? a. Commercial papers. b. Certificate of deposits. c. Treasury bills. d. 6 months term deposits. e. None of the above.91. Which of the following is a function of the primary capital market?a. To allow the Foreign Institutional Investors (FIIs) to invest in the Indian capital markets.b. To allow the companies to raise funds to meet their short term funds requirements through new securities.c. To provide a market for trading with the outstanding long term securities.d. To provide a market for trading with the existing short term securities.e. None of the above.92. In which of the following types of issue, new securities are offered to the existingshareholders of the company on a pro rata basis?a. Public issueb. Rights issuec. Bonus issued. Private placemente. Both (b) and (c) above.93. Which of the following is a disadvantage of Bought-Out Deals? a. It is difficult to convince a wholesale investor. b. The promoters of the company do not get the funds immediately. c. It is a very time consuming procedure. d. The issue expenses are more than that of a public issue. e. Sponsor may exploit the situation.94. Which of the following companies generally provide risk capital to the technology orientedand high-risk business entities?a. Lease finance companies.b. Venture capital funding companies .c. Commercial banks.d. Hire purchase finance companies.e. Insurance companies.95. Which of the following is/are the characteristics of the money market instruments?a. Long term maturity.b. High liquidity.c. Highly secured.d. Issued by the Governments only.e. Both (b) and (d) above.96. Which of the following situations leads to the greatest increase in volatility in the call moneymarket?a. Reduction in cash reserve ratiob. Prepayment of term loans by a large number of borrowersc. Entry of the financial institutions (FIs) into the marketd. Payment of large amount of advance taxes by the banks and FIse. Decrease in the demand for loanable funds in the economy. 23 29. Financial Management97. Which of the following is/are correct with respect to the act(s) of the arbitrageurs in thederivatives market? a. To protect ones position in the spot by taking suitable instrument(s) in the derivativesmarket. b. To protect ones anticipated position in the spot by taking suitable instrument(s) in thederivatives market. c. To make profit from the subsequent price movements of any particular instrument in thederivatives market. d. To make risk free profits by simultaneously buying and selling different instruments indifferent markets. e. Both (a) and (b) above.98. Which of the following results in a public limited company to have a significant advantageover a proprietorship firm? a. Limited liability. b. Difficulty of transfer of ownership interest. c. Limited life. d. Inability to mobilize a lot of funds. e. None of the above.99. Which of the following is not a marketable instrument? a. Commercial Paper. b. Certificate of Deposit. c. Inter Corporate Deposit. d. Preference Shares. e. Treasury Bills.100. Which of the following functions is/are served by the primary capital market of an economy? a. It allows the corporate houses to raise the long term capital by issuing new securities. b. It offers a market to trade for the outstanding long term securities. c. It offers a market to trade for the outstanding short term securities. d. It offers an excellent exit route for the venture capital funding companies. e. Both (a) and (d) above.101. Which of the following functions of the financial system channelises the savings from the savers to the producers in the economy? a. Financial Intermediation function. b. Liquidity function. c. Payment function. d. Risk function. e. Policy function.102. In which of the following markets, are the outstanding long-term financial instruments traded? a. Money market. b. Forex market. c. Primary capital market. d. Secondary capital market. e. Call money market.24 30. Part I103. Corporate investment and financing decisions are limited by a governmental regulatory framework which seeks to a. define avenues of investment available to business enterprises in different categories,ownership and size-wise b. Induce investment along certain lines by providing incentives, concessions and reliefs c. Specify the procedures for raising funds from financial markets d. Both (a) and (c) above e. All of (a), (b) and (c) above104. Which of the following entities issues the Gilt edged securities? a. Multinational companies. b. Reputed domestic companies. c. Private sector enterprises. d. Small scale companies. e. Central and state governments.105. Long dated government securities have maturities ranging from a. Up to 1 year b. 1 to 5 years c. 5 to 8 years d. 8 to 10 years e. 10 to 30 years.106. What is the maximum limit on the number of members in a private limited company? a. 5. b. 8. c. 15. d. 50. e. Unlimited.107. Which of the following regulations no more relevant in todays business environment? a. Foreign Exchange Regulation Act, 1973. b. Monopolies and Restrictive Trade Practices Act, 1969. c. Companies Act, 1956. d. Income Tax Act, 1961. e. SEBI Act, 1992.Time Value of Money108. Which of the following statement(s) is/are true for given values of i and n? a. Present Value Interest Factor is the reciprocal of Future Value Interest Factor. b. Future Value Interest Factor Annuity is the reciprocal of Present Value Interest FactorAnnuity. c. Capital recovery factor is a product of Future Value Interest Factor and reciprocal ofFuture Value Annuity Factor. d. Both (a) and (c) above. e. Both (b) and (c) above.109. The product of PVIF, FVIF, FVIFA and Capital Recovery Factor is a. FVIF b. PVIFA c. PVIF d. FVIFA e. None of the above. 25 31. Financial Management110. The nominal rate of interest is equal to a.Real Rate + Risk Premium Inflation b.Real Rate + Risk Premium + Inflation c.Real Rate Risk Premium + Inflation d.Real Rate Risk Premium Inflation e.Real Rate.111. The accurate doubling period n given a rate of return R can be calculated by a. (1 + R)n = 2 b. 72/R c. 0.35 + 69/R d. All of the above e. None of the above112. The inverse of sinking fund factor is given by 1 (1+ k) n a.k 1 b. (1+ k) n k (1+ k) n 1 c.kk k d. (1+ k) n 1 (1+ k) n 1 e. . k113. If P = principal amount, i = interest rate per annum, m = frequency of compounding per year, n = number of years and A = accumulation at the end of the year n, then which of the following expressions is correct?mn a.A = P(1 + i/n) mn b.P = A(1 + i/m) m n c.A = [P(1 + i/m) ] mn d. A = P(1 + i/m) e. None of the above.114. If k is the rate of interest and n the number of years, then the capital recovery factor is given ask(1+ k) n a. (1+ k) n 1 (1+ k) n (k) b. (1+ k) n +1 (1+ k) n 1c.k(1+ k) n (1+ k) n (1+ k)d. (1+ k) n (k) (1+ k) k (n) e. . (1+ k) n 126 32. Part I115. Which of the following statements is not true? a. The more frequent the compounding, the higher the future value, other things being equal. b. For a given amount, the greater the discount rate, the less is the present value. c. Capital recovery is the inverse of FVIFA.(1+ k) n 1 d. PVIFA = k(1+ k) n e. All of the above.116. An interest rate that has been annualized using compound interest is termed as a. Simple interest rate b. Annual interest rate c. Discounted interest rate d. Effective annual interest rate e. Compounded interest rate.117. When an investment pays only simple interest rate, this means a. The interest rate is lower than on comparable investments b. The future value of investment will be low c. The interest earned is non-taxable to the investor d. Interest is earned only on the original investment e. Interest is earned on previously earned interest.118. Cash flows occurring in different periods should not be compared unless a. Interest rates are expected to be stable b. The flows occur no more than one year from each other c. High rates of interest can be earned on the flows d. The flows have been discounted to a common date e. Interest rates are expected to increase over a period of time.119. Sinking fund factor is the reciprocal of a. Future value interest factor b. Present value interest factor c. Future value interest factor of annuity d. Present value interest factor of annuity e. Capital recovery factor.120. The present value interest factor of annuity is equal to(1 + k) n 1 a. k(1+ k) nFVIFA (k, n) b. FVIF (k, n) c. FVIFA(k,n) x PVIF(k,n) d. Reciprocal of sinking fund factor for k% and n years x PVIF (k,n) e. All of the above.121. Which of the following statements is true? a. Increased frequency of compounding reduces the effective rate of interest. b. According to Rule of 72, the period within which the amount will be doubled can be obtained by dividing 72 by the interest rate and adding 0.35 to the value arrived at. c. Effective interest rate is always more than or equal to the nominal interest rate. d. An annuity is a lump sum payment. e. A project is financially viable if the present value of the future cash inflows is positive.27 33. Financial Management122. Money has time value because a. The individuals prefer future consumption to present consumption b. A rupee today is worth more than a rupee tomorrow in terms of its purchasing power. c. A rupee today can be productively deployed to generate real returns tomorrow d. The nominal returns on investments are always more than inflation thereby ensuring real returns to the investors e. Both (b) and (c) above.123. Which of the following equations is correct? a. PV = FVn x FVIF(k, n)n b. PV = FVn (1 + k) c. PV = FVn PVIF(k, n)n d. FVn = PV (1 + k) e. FVA = {(1 + k)n 1} k. n124. Which of the following statements is not true? a. The Present Value Interest Factor for an Annuity (PVIFA) is equal to the product of thefuture value interest factor for annuity and the present value interest factor. b. The inverse of PVIFA factor is called the capital recovery factor. c. The nominal rate of interest is equal to the effective rate of interest when the interest iscompounded annually. d. The present value of cash flow stream of any periodicity can be calculated using FVIFAtables. e. The sinking fund factor is used to determine the amount that must be depositedperiodically to accumulate a specified sum at the end of a given time period.125. Which of the following is not true? a. The inverse of PVIFA factor is called the capital recovery factor. b. The nominal rate of interest is equal to the effective rate of interest when the interest iscompounded annually. c. The present value of interest factor for annuity is equal to the product of the inverse offuture value interest factor for annuity and the present value interest factor. d. The present value of any cash flow stream can be calculated using PVIFA tables. e. The sinking fund factor is used to determine the amount that must be depositedperiodically to accumulate a specified sum at the end of a given period at a given rate ofinterest.126. With an increase in the frequency of compounding a. The nominal rate of interest becomes greater than the effective rate b. The effective rate of interest increases at an increasing rate c. The nominal rate of interest becomes equal to the effective rate of interest d. The effective rate of interest increases at a decreasing rate e. Both (a) and (d) above.127. Sinking fund explains a. The maturity value in year t for an amount deposited in year 1 b. The amount to be deposited annually to accumulate a predetermined sum in year t c. The discounted value in year zero for an uneven series occurring in several years in future d. The amount to be deposited in year zero for a periodical withdrawal in future for aspecified period e. The effective rate of interest.28 34. Part I128. Which of the following statements is/are true? i. The inverse of the PVIFA factor is sinking fund factor. ii.The product of PVIF and FVIFA factors is PVIFA factor. iii. The present value of a perpetuity is infinity. a. All (i), (ii) and (iii) of the above. b. Both (i) and (ii) of the above. c. Only (i) of the above. d. Only (ii) of the above. e. Only (iii) of the above.129. The nominal rate of interest a. Is lesser than the effective rate of interest under inflationary conditions b. Is equal to the effective rate of interest minus inflation c. Does not consider risk premium d. Is the real rate of interest plus inflation plus risk premium e. Is also referred to as the prime lending rate.130. When compounding of interests is done at intervals which are less than a year a. The effective rate of interest will be the same as the nominal rate of interest b. The effective rate of interest will be lesser than the nominal rate c. The nominal rate of interest will be lesser than the effective rate d. There is no difference between the effective and nominal rates in the first year e. It cannot be ascertained as to which rate is more unless the frequency of compounding is known.131. If any investment (P) has to be doubled at an interest rate of k, then the doubling period n is exactly equal to a. 72/k b. 0.35 + 69/k c. Log2/log (1 + k) d. 2 e. Both (a) and (b) above.132. Which of the following is/are true? a. Inverse of FVIF is PVIF. b. Inverse of FVIFA is PVIFA. c. Inverse of capital recovery factor is FVIFA. d. PVIFA is the product of inverse of FVIFA and PVIF e. Both (a) and (d) above.133. The relationship between effective rate of interest (r) and nominal rate of interest (i) is best represented by mr a. i = 1+ 1 m mi b. r = 1+ 1m n r c. i = 1+ 1 n d. r = (1+m)i 1 e. i = (1+r)m 1. 29 35. Financial Management134. If compounding is done twice in a year, the effective rate of interest is equal to a. 2 nominal rate of interest b. Nominal rate of interest/2 c. (1 + nominal rate of interest/2)2 1 2 d. ((1 + nominal rate of interest)/2) e. (1 + nominal rate of interest/2) 2.135. Which of the following is/are true? a. FVIF is the reciprocal of PVIF. b. Product of FVIF and PVIFA is equal to FVIFA. c. FVIFA is the reciprocal of PVIFA. d. Both (a) and (b) above. e. Both (a) and (c) above.136. Time value of money considers a. The preference of the individuals for future consumption to present consumption b. Increase in purchasing power of rupee with the passage of time c. The uncertainty of the future d. The productivity of money to earn real returns over time e. Both (c) and (d) above.137. Which of the following statements is/are true with respect to Present Value Interest Factor of Annuity (PVIFA)? i. The cash flow is assumed to occur at the end of the period under consideration ii.The cash flow is assumed to occur at the start of the period under consideration iii. It is reciprocal to capital recovery factor. a. Only (i) above. b. Only (ii) above. c. Only (iii) above. d. Both (ii) and (iii) above. e. Both (i) and (iii) above.138. Which of the following may be considered as the correct reason for money having time value? a. It is the legal tender for carrying out any type of transaction. b. In India, it is guaranteed by the union government. c. Its purchasing power increases with the passage of time due to inflation. d. Money can be productively invested to generate real returns over a period of time. e. None of the above.Risk and Return139. A risk-free stock has a beta of a. 1 b. Zero c. 0.5 d. 1 e. Infinity.30 36. Part I140. Which of the following is not an assumption under CAPM? a. Investors make their investment decisions on a single period horizon. b. If the perceived risk is high, a risk-averse investor expects higher return. c. The investor is not limited by his wealth and price of the asset. d. Assets can be bought at the going market price. e. CAPM is based on all the above assumptions.141. If the slope of the Security Market Line is zero, which of the following is/are true? a. Risk-free return = Market return. b. Market return = Expected return. c. Expected return = Risk-free return. d. Both (a) and (c) above. e. All of (a), (b) and (c) above.142. Which of the following is not a non-diversifiable risk? a. Lock-out in a company due to workers demanding a wage hike. b. Slump in the industry. c. Lack of strategy for the management in a company. d. A change in the tax-structure for corporates in the Union Budget. e. Both (a) and (c) above.143. The amount of risk reduction depends on a. Degree of correlation b. Number of stocks in the portfolio c. The market index movement d. Both (a) and (b) above e. All of (a), (b) and (c) above.144. Which of the following is diversifiable risk? a. Inflation risk. b. Interest-rate risk. c. Market risk. d. Business risk . e. Both (b) and (d) above.145. If a person holds a diversified portfolio the risk a security adds would be a. Specific risk b. Systematic risk c. Portfolio risk d. Liquidity risk e. Diversifiable risk.146. Portfolio Beta a. Is the risk of a diversified portfolio b. Is the weighted average of individual security betas, weights being the proportions ofindividual returns c. Is the weighted average of individual security beta, weights being the proportions of theinvestments in the respective securities d. Both (a) and (b) above e. Both (a) and (c) above. 31 37. Financial Management147. Which is true regarding kj=rf + (km rf)? a. rf can be the rate of return earned on gilt-edged securities. b. will be > 1 if the security is volatile. c. Lower would give a low risk premium. d. There is a possibility that a zero beta exists. e. All of the above.148. The slope of the security market line denotes a. The expected return by the investors b. The market volatility c. Beta of the security d. The influence of unsystematic risk e. The risk premium required.149. If the securitys return plots below the SML, then, it can be said that a. It is overpriced b. The required rate of return is much lower than the actual rate of return c. The investors would try to buy more of the security d. It is a defensive security e. Both (a) and (b) above.150. A security is said to be aggressive when it a. Has a beta of > 1 b. Plots on the upper part of SML c. Gives below average returns d. Both (a) and (b) above e. Both (b) and (c) above.151. Which of the following is not a non-diversifiable risk? a. Interest rate risk. b. Purchasing power risk. c. Operating risk. d. Market risk. e. Political risk.152. Risk-return trade-off implies a. Increasing the profit of the firm through increased production b. Not taking any loans which increases the risk of the firm c. Not granting credit to risky customers d. Taking decisions in such a way which optimizes the balance between risk and return e. Minimizing all risks.153. Which of the following is a specific risk factor? a. Market risk. b. Inflation risk. c. Interest rate risk. d. Financial risk. e. None of the above.32 38. Part I154. Security Risk premium in the Capital Asset Pricing Model (CAPM) is given by a. Rf b. km Rf c. (km Rf) d. Km e. ( Rf km ).155. The risk arising due to uncertainty about the time element and the price concession in selling a security is called a. Price risk b. Market risk c. Trading risk d. Liquidity risk e. Financial risk.156. Standard deviation as a measure of risk is preferred because a. Standard deviation considers every possible event and assigns each event equal weight b. Standard deviation is a measure of dispersion around the median value c. Standard deviation is a familiar concept and many calculators and computers areprogrammed to calculate it d. Standard deviation considers every possible event and assigns each event a weight equalto its probability e. Both (c) and (d) above.157. Which of the following is not a diversifiable or specific risk factor? a. Company strike. b. Bankruptcy of a major supplier. c. Death of a key company officer. d. Unexpected entry of new competitor into the market. e. Industrial recession.158. Which of the following statements is true of beta? a. Beta of a security is the slope of the Security Market Line (SML). b. Beta of a security is a measure of the diversifiable risk of a security. c. High beta of a security assures high return. d. Beta of a security can never be negative. e. Beta of a security is a measure of systematic risk of a security.159. Which of the following is not an assumption of Capital Asset pricing Model (CAPM)? a. Investors are risk-averse and use the expected rate of return and standard deviation ofreturn as appropriate measures of return and risk respectively. b. Investors make their investment decisions based on a single period horizon i.e. the nextimmediate time period. c. Transaction costs in financial markets are low enough to ignore and assets can bebought and sold in any unit desired. d. Taxes do not affect the choice of buying assets. e. Investors make their investment decisions based on multi-period horizon.33 39. Financial Management160. Ceteris Paribus, a security is to be bought if. a.The required rate of return is less than expected rate of return b.The required rate of return is greater than the expected rate of return c.Security has a beta greater than one d.The security has beta of less than one e.The security has a large amount of floating stocks in the market.161. Which of the following statements is true? a.If one portfolios variance exceeds that of another portfolio, its standard deviation will also be greater than that of the other portfolio. b.For investment horizons greater than 20 years, long-term corporate bonds will outperform common stocks. c.Due to their short maturity, the average real rate of return for treasury bills approximately equals their average nominal rate of return. d.When inflation is expected to be low, the nominal risk premium on common stocks is expected to be low. e.Market risk can be eliminated in a stock portfolio through diversification.162. Real rates of return are typically less than nominal rates of return due to a.Inflation b.Capital gains c.Dividend payments d.Deflation e.Recession.163. Real rates of return will be positive as long as a.The nominal return is positive b.The inflation rate is positive c.The nominal return exceeds inflation rate d.Inflation rate exceeds the real return e.None of the above.164. The major benefit of diversification is to a.Increase the expected return b.Increase the size of the investment portfolio c.Reduce brokerage commissions d.Reduce the expected risk e.Increase the expected return over and above the risk-free rate of return.165. Which of the following is not true? a.Interest rate risk is the variability in a securitys return resulting from changes in interest rates. b.Market risk refers to the variability of returns due to a wide range of factors exogenous to the securities themselves. c.Inflation risk is the loss of purchasing power due to inflation. d.As inflation rate increases the interest rate risk decreases. e.Business risk is the risk of doing business in a particular industry.34 40. Part I166. What is the cost of a debenture if it is issued at face value of Rs.100. The coupon is 13%, the maturity is 6 years, redemption is at 6% premium and realizable amount is Rs.97.50 and Tax = Rs.38%. a. 9.25% b. 9.56% c. 9.13% d. 9.31% e. 9.49%167. Which of the following statements is true? a. Interest rate risk refers to the variability of returns due to fluctuations in the securitiesmarket. b. Market risk refers to the reduction in purchasing power. c. The interest rates on securities tend to go up with inflation. d. Business risk refers to the risk due to debt financing. e. Financial risk is associated with the secondary market in which a particular security istraded.168. Financial risk arises due to the a.Reduction in purchasing power of the assets employed by the firm b.Variability of returns due to fluctuations in the securities market c. Changes in prevailing interest rates in the market d. Leverage used by the company e.Liquidity of the assets of the company.169. The diversifiable risk includes the risk due to a.Inflation b.Industrial recession or slow down c. Natural calamities d. Strike in the company e.Changes in economic policy.170. Which of the following would reduce the applicability of Capital Asset Pricing Model (CAPM)? a.Investors having different time horizons for investments. b.The presence of high transaction costs in the market. c.The influence of taxes on the choice of assets. d.The different expectations of the investors regarding the risk and return associated with various securities. e. All of the above.171. Which of the following is a diversifiable risk factor? a. An increase in inflation rate. b.Unexpected entry of a new competitor in the market. c.A change in economic policy of government. d.Industrial recession. e. Increase in international oil prices.35 41. Financial Management172. If a security is less risky than the market portfolio, then its beta would be a.Negative b.More than market beta c.Equal to Zero d.Less than 1 e.More than 1.173. Which of the following statements is true? a.Expected returns and ex post returns are same. b.There are only two types of returns i.e., realized returns and historical returns. c.Risk is a motivating force for an investor. d.The objective of any investor is to maximize his returns as well as risk. e.The investor compensates for the uncertainty in returns by requiring an expected return that is sufficiently high to offset the risk or uncertainty.174. Which of the following types of risks is/are not systematic risk? a.Credit risk. b.Interest rate risk. c.Purchasing power risk. d.Market risk. e.Both (a) and (d) above.175. The security market line shows the relationship between the a.Expected rate of return and diversifiable risk b.Realized rate of return and beta c.Required rate of return and unsystematic risk d.Expected rate of return and beta e.Realized rate of return and systematic risk.176. The risk that arises due to change in the purchasing power is called a.Financial risk b.Interest rate risk c.Business risk d.Market risk e.Inflation risk177. The risk aversion of an investor can be measured by a.Risk-free rate of return b.Market rate of return c.Variance of the return from a security d.The difference between the market rate of return and the risk-free rate of return e.None of the above.178. The risk of a portfolio of two securities increases if there is _______ between their returns. a.Perfect positive correlation. b.Perfect negative correlation. c.Moderate positive correlation. d.Moderate negative correlation. e.Both (a) and (c) of the above.36 42. Part I179. Which of the following types of risk is not a diversifiable risk? a. Business risk. b. Financial risk. c. Credit risk. d. Purchasing power risk. e. Technology risk.180. Market portfolio contains a. Frequently traded securities in the stock market b. All the securities in proportion to their market capitalization c. All securities listed in the specified group of a stock exchange d. The securities having large volumes in terms of number of transactions and marketcapitalization e. None of the above.181. Security market line shows the relationship between return on the stock and a. Return on market portfolio b. Risk-free rate of return c. Standard deviation of the stock returns d. Beta of the stock e. Variance of the stock returns.182. If a securitys return plots above the Security Market Line (SML), it means a. Security is overpriced b. Security is underpriced c. Securitys beta is more than one d. Securitys beta is less than one e. Securitys beta is equal to zero.183. Which of the following statements is true? a. The Capital Asset Pricing Model (CAPM) establishes the relationship between anassets return and its systematic risk. b. The above relationship can be graphically plotted as the Security Market Line. c. An undervalued security is a very desirable asset to own. d. All of the above. e. Both (a) and (b) above.184. Characteristic line is the relationship between return on stock and a. Return on market portfolio b. Risk-free rate of return c. Return on Government bond d. Both (b) and (c) above e. None of the above.185. In booming (share) market, the companies are to be selected with Beta () a. =0 b. >1 c. 1 and plotting on the upper part of the SML are classified as aggressive securities, and those with beta < 1 and plotting on the lower part of SML are classified as defensive securities.83 89. Financial Management151. (c) Operating risk is the risk of doing business in a particular industry or environment and it gets transferred to the investors who invest in that business. Hence it is a diversifiable risk.152. (d) Trade off between risk and return implies taking decisions in such a way which optimizes the balance between risk and return.153. (d) Financial risk is the risk arising from the use of debt capital and hence a specific risk factor.154. (c) The CAPM is represented by kj = Rf + j (km Rf) Explicit measures of security risk premium is the product of beta for a particular security j and the market risk premium Km Rf. Hence risk premium = j (Km Rf)155. (d) A security which can be bought or sold quickly without significant price concession is considered liquid. Hence the risk arising due to uncertainty about the time element and the price concession in selling a security is called liquidity risk.156. (e) Standard deviation considers every possible event and assigns each event a weight equal to its probability. It is a very familiar concept and many calculators and computers are programmed to calculate it. It is a measure of dispersion around the expected (or average) value. Standard deviation is obtained as a square root of the sum of squared differences multiplied by their probabilities. This facilitates comparison of risk as measured by standard deviation and expected returns as both are measured in the same costs. This is why standard deviation is preferred as a measure of risk.157. (e) Industrial recession cannot be attributed to a specific risk factor. It is related to the general economy. Hence is a non-diversifiable risk.158. (e) Beta measures the relative risk associated with any individual portfolio as measured in relation to the risk of the market portfolio. Hence it is a measure of systematic risk of a security.159. (e) CAPM assumes that investors make their investments based on single period horizon, i.e. the next immediate time period.160. (a) To gain from a security it has to be bought only when the required rate of return is less than the expected rate of return.2161. (a) Variance = (Standard deviation) Hence if one portfolios variance exceeds another portfolio, its standard deviation will also be greater than that of the other portfolio.162. (a) Nominal rate of return = Real rate of return + Inflation Hence real rates of return are typically less than nominal rates of return due to inflation.163. (c) Nominal rate of return = Real rate of return + Inflation. Hence when nominal rate of return is more than inflation, real rate of return is positive and when nominal rate of return is less than inflation, real rate of return will be negative.164. (d) Through diversification the loss arising from one security is compensated by a gain arising from some other security. Hence the expected risk can be reduced.165. (d) Interest rates go up with inflation as inflation is directly related to interest rates.(106 97.50)13(1 0.38) +166. (d) Kd = 6 = 0.0931106 + 97.50 2 Kd% = 9.31%.167. (c) Interest rate is directly related to inflation hence interest rates of securities tend to go up with inflation.168. (d) Financial risk arises from the use of debt capital or leverage used by the company. The more the company resorts to debt financing, the greater is the financial risk.84 90. Part I169. (d) Strike in the company is specific to the company and can be diversified.170. (e) The CAPM model assumes that investors have single period time horizon, low transaction costs in the market, taxes do not affect the choice of buying assets and that all investors agree on the nature of return and risk associated with each investment. Hence all the statements would reduce the applicability of CAPM.171. (b) Unexpected entry of a new competitor in the market is risk specific to a particular industry and hence diversifiable.172. (d) Beta measures the relative risk associated with any individual portfolio as measured in relation to the risk of the market portfolio. Hence, if a security is less than the market portfolio, then its beta would be less than 1.173. (e) Realized return is ex-post return, the two types of returns are realized or historical return and expected return, the objective of any investor is to maximize his returns and minimize risk, return is the motivating factor for an investor. The investor compensates for the uncertainty in returns by requiring an expected return that is sufficiently high to offset the risk or uncertainty.174. (a) Systematic risk is non-diversifiable risk. Credit risk is diversifiable.175. (d) The SML equation is E(r) = Rf + j (km Rf) It shows the relationship between the expected rate of return and beta.176. (e) With rise in inflation there is reduction of purchasing power, hence inflation risk is also referred to as purchasing power risk and affects all securities.177. (d) Because investors are risk averse they will expect a risk premium to compensate them for the additional risk assumed in investing in a risky asset. Risk premium = Required rate of return Risk-free rate.178. (a) When there is perfect positive correlation the loss in one security cannot be compensated by a gain in another. Hence, the risk of a portfolio of two securities increases if there is perfect positive correlation.179. (d) With a rise in inflation there is reduction of purchasing power, this is referred as purchasing power risk. It is related to the general economy and cannot be diversified.180. (b) Market portfolio contains all the securities in proportion to the market capitalization.181. (d) The graphical representation of the CAPM model is the SML. The SML equation is given by E(r) = Rf + j (km Rf) Hence it shows the relationship between