Investment Banking and Financial Services
Workbook
The ICFAI University # 52, Nagarjuna Hills, Hyderabad – 500 082
© ICFAI June, 2004. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means - electronic, mechanical, photocopying or otherwise - without prior permission in writing from The ICFAI University.
Ref. No. IBFSWB 06200443 For any clarification regarding this book, the students may please write to the ICFAI University giving the above reference number of this book specifying chapter and page number. While every possible care has been taken in type-setting and printing this book, the ICFAI University welcomes suggestions from students for improvement in future editions.
Contents
Brief Summaries of Chapters
Part I : Questions and Answers on Basic Concepts (with Explanatory Notes)
1
31
Frequently used Formulae
132
Part II : Problems and Solutions
136
Part III : Applied Theory Questions and Answers
327
Part IV : Case Studies Problems and Solutions
368
Part V : Caselets Questions and Answers
534
Part VI : Model Question Papers (with Suggested Answers)
593
Preface The ICFAI University has been upgrading the study material so that it is amenable for self study by the Distance Learning Students. We are delighted to publish a Workbook for the benefit of the students preparing for the examinations. The workbook is divided into six parts. Brief Summaries of Chapters A brief summary of all the chapters in the textbook are given here for easy recollection of the topics studied. Part I: Questions and Answers on Basic Concpets (with Explanatory Notes) Students are advised to go through the relevant textbook carefully and understand the subject thoroughly before attempting Part I. Under no circumstances the students should attempt Part I without fully grasping the material included in the textbook. Frequently used Formulae Similarly the formulae used in the various topics have been given here for easy recollection while working out the problems. Part II: Problems and Solutions The students should attempt Part II only after carefully going through all the solved illustrations in the textbook. A few repetitive problems are provided for the students to have sufficient practice. Part III: Applied Theory: Questions and Answers All theory questions are applied in nature. Having understood the basics in the textbook, the students are expected to apply their knowledge to certain real life situations and develop relevant answers. To be able to answer the applied theory questions satisfactorily all the students are advised to follow regularly the Analyst magazine, business magazines and financial dailies. Part IV: Case Studies: Problems and Solutions A case study attempts to test the cognitive skills of the student in integrating various concepts covered in the subject with focus on quantitative aspects. Hence, students should attempt them only after they are thorough with the entire subject. Part V: Caselets: Questions and Answers A caselet also tests the cognitive skills of the student in integrating various concepts but with focus on qualitative aspects. Students are advised to try to answer the questions given at the end of the articles in the ICFAI Analyst to develop their skills further. The caselets given in this part also help students gain the adequate exposure on how current events of interest can be analyzed and interpreted. Part VI: Model Question Papers (with Suggested Answers) The students should attempt all model question papers under simulated examination conditions. They should self score their answers by comparing them with the model answers. Please remember that the ICFAI University examinations are quite rigorous and demanding. The student has to prepare well for each examination. There are no short-cuts to success. We hope that the students will find this workbook useful in preparing for the ICFAI University examinations. Work Hard. Work Smart. Work Regularly. You have a good chance to succeed. All the best.
Brief Summaries of Chapters INVESTMENT BANKING, FINANCIAL SYSTEMS AND FINANCIAL MARKETS Investment Banking Industry •
Investment banking is a very vast area in the field of banking and finance.
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It includes raising and managing funds, advising clients about investments and marketing financial products.
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The main activities under investment banking are: Advisory functions, administrative functions, underwriting functions, distribution functions, investment management functions, mergers & acquisitions and other finance related activities.
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Investment banking in the US is a very old industry and the top investment banking firms have become MNCs with presence in most of the countries across the globe.
Financial Systems and Financial Markets •
The economic development of a country depends on the progress of its various economic units, namely the corporate sector, government sector and the household sector.
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The role of the financial sector can be broadly classified into the savings function, policy function and credit function.
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The main types of financial markets are: Money market, capital market, forex market and credit market.
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The financial markets are further sub-divided into the primary market and the secondary market.
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A market is considered perfect if all the players are price takers, there are no significant regulations on the transfer of funds and transaction costs, if any, are very low.
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The accounting equation ASSETS = LIABILITIES, can be altered as FINANCIAL ASSETS + REAL ASSETS = FINANCIAL LIABILITIES + SAVINGS.
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The main types of financial assets are deposits, stocks and debt.
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While designing a financial instrument, the issuer must keep the following in mind: Cash flows required, taxation rules, leverage expected, dilution of control facts, transaction costs to be 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, regulatory aspects to abide by.
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While investing in a financial instrument, the investor must keep in mind the following: Risk involved, liquidity of the instrument, returns expected, possible tax planning, cash flows required and simplicity of investment.
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Various financial intermediaries came into existence to facilitate a proper channel for investment. The main ones are: Stock exchanges, investment bankers, underwriters, registrars, depositories, custodians, primary dealers, satellite dealers and forex dealers.
CREDIT MARKET •
Banks, financial institutions and non-bank finance companies providing credit for varying consumer requirements and corporate sectors of the economy are said to be the intermediaries of the credit market.
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Consumer loans are auto-finance loans, credit card loans, housing loans and loans to acquire consumer durables. Most of these loans are provided against financial or real assets.
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Credit extended to consumers is usually for short- or medium-term, except for housing loans which tend to be medium- and long-term loans.
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Corporate loans are extended for project finance or for expansion/modernization/ diversification (purposes). Working capital loans are extended for short-term requirements like day-to-day operational requirements and for maintaining adequate level of current assets.
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Project loans are usually known as term loans and working capital loans are in the form of cash credit, overdraft facility or bill financing.
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In countries like India, 40% of the loanable funds are to be given to the priority sector, in order to ensure proper use of institutional credit.
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Credit extended to the project finance and priority sector is usually for medium- and longterm while working capital loans are usually for short-term periods only.
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Intermediaries base their lending rates on three factors: Their cost of funds, transaction costs and required spreads. They also give due consideration to risk exposure that the loan may be subject to.
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The main sources of funds to the intermediaries are public deposits and other financial markets.
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Transaction costs depend on the efficiency with which transfer of funds takes place. It includes all the costs in the decision-making process while approving the client’s proposal and the documentation costs.
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Spread cost is the margin of profitability levied by the banks over the cost of borrowing and transaction costs incurred in order to make a profit.
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Risk exposures also add a certain margin to the lending rate in order to cover the credit risks and interest rate risks perceived by the bank at the time of lending.
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Generally, short-term loans have fixed rate and long-term loans have a floating rate.
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LIBOR is used as a reference rate for Euroloans while the Bank Rate (BR) and the Prime Lending Rate (PLR) are used in India.
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Borrowers prefer the following features in their borrowings: Low rate of interest, minimum lead (processing) time, easy access to funds, minimum terms and conditions on usage of funds, minimum monitoring and interference of the lender and freedom of time to repay.
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Lenders prefer the following features in their lendings: Maximum spreads, adequate coverage for risks, satisfaction of statutory reserve requirements and capital adequacy norms.
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The following measures have been taken to enhance the Indian credit market: Withdrawal of government funds as a source of funds to financial institutions, restriction of dependence of NBFCs on public money, prudential norms for intermediaries, allowing private banks to operate in new areas, widening the scope of financial institutions, adoption of new technology, permitting the access to overseas funds and offshore banking.
MONEY MARKET Introduction to Money Market •
Liquidity mismatch happens often in the short run as cash inflows and outflows rarely synchronize.
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It is important to manage the same carefully, to avoid liquidity crisis in case of deficit and idle funds that do not bear interest in case of surplus.
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The money market is a formal financial market that deals with short-term fund management.
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The money market involves high volumes and is dominated by a relatively small number of players, namely: Government of the country, central bank, banks, financial institutions, corporates, mutual funds, foreign institutional investors, discount houses, acceptance houses and market makers (primary and satellite dealers).
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The main money market instruments are: Government and Quasi-Government securities, banking sector securities and private sector securities.
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Government and Quasi-Government securities include Treasury bills and Government dated securities or Gilt-edged securities.
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Banking sector securities include Call and notice money market securities, Term money market securities, Certificates of deposit and Participation certificates.
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Private sector securities include Commercial paper, Bills of exchange, Inter-corporate deposits/Investments and Money market mutual funds.
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Repo transactions are popular mechanisms to deploy/borrow short-term funds in the money market, by selling securities to another party with an agreement to buy back the same at a later date.
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The main risks associated with money market instruments/investments are: Market risk, interest rate risk, reinvestment risk, default risk, inflation risk, currency risk and political risk.
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The main money market securities in the US market are: Government securities (T-bills), Municipal notes, Federal agency securities, Call loan market, Repos and reverses, Certificates of deposit, Eurodollar deposits and Eurodollar CDs, Yankee CDs, Loan participations, Bankers’ acceptances, Commercial papers, Euro commercial papers in Europe and commercial bills.
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The main objectives of the monetary policy are: Price stability and economic growth.
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The most critical factors in a monetary policy are: Money supply, interest rate stability and exchange rate stability.
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Monetary contraction can be resorted to control inflation, by adopting one of the following measures: Increase the statutory reserves (CRR and SLR), undertake repo transactions or go in for open market operations.
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The RBI controls the money market in India by adopting the following measures: Changes in CRR, changes in SLR, open market operations, reduction in bank and repo rates.
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There are two types of dealers in the Indian money markets, namely, primary dealers and satellite dealers.
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The main objectives of the primary dealers are: Enhance liquidity of the money market, become underwriters and market makers for government securities, activate the secondary market for government securities and aid the RBI in open market operations.
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Subsidiaries of nationalized banks, FIs and security business companies can become primary dealers, if they have a minimum of Rs.50 crore as net owned funds. Subsidiaries of FIIs can become primary dealers subject to permission from the FIPB.
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The RBI extends the following support to the PDs: Liquidity support, permission to borrow and lend in the market, access to current and subsidiary general ledger accounts, repos and refinance, permission to raise funds through commercial papers and permission to transfer funds from one center to the other.
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Satellite dealers support the functions of the primary dealers.
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The main objectives of the satellite dealers are: Further increase the depth of the secondary market of government securities; enhance the liquidity of the same and provide a retail outlet to the government securities due to their wide branch network.
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Subsidiaries of nationalized banks, FIs and security business companies can become satellite dealers, if they have a minimum of Rs.5 crore as net owned funds. 3
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The RBI extends the following support to the SDs: Access to current and subsidiary general ledger accounts, permission to borrow and lend funds in the money market and recommend the government of India to enter into ready forward transactions in securities with eligible institutions.
Call Money •
The call money market is the part of the money market where the surplus funds of the banks are traded on a daily basis. Borrowers use funds to match short-term mismatches of assets and liabilities and to match the CRR requirements. This market is a measure of the liquidity of the overall money market.
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Maturity period varies from 1 to 14 days.
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Money that is lent for a day is called overnight money.
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All private sector, public sector and co-operative banks, term lending institutions, insurance companies and mutual funds participate in this market. Primary dealers, DFHI and STCI can participate only in the local call money markets.
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Interest paid on call loans is known as call rates and is calculated on a daily basis.
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Call money markets are located in the cities that have the major stock exchanges in India, namely Mumbai, Kolkata, Delhi, Chennai and Ahmedabad. Mumbai has the largest market in India.
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The RBI acts as a regulator of the call money market, but neither borrows from nor lends to it. It uses repos and open market operations to control the market.
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An efficient call money market should be less volatile and provide an opportunity to the players to transact at comparatively stable rates of interest.
Treasury Bills •
Treasury bills are issued by the government to raise short-term funds in the money market. They are a major portion of the borrowings of the Government of India.
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The RBI acts as the banker to the Government of India to issue the T-bills.
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The main investors in T-bills include: Banks (to meet their SLR requirements), primary dealers, financial institutions (for primary cash management), insurance companies, provident funds (as per the investment guidelines), non-banking finance companies, corporations, FIIs, state governments and individuals (to a very minor extent).
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T-bills are issued in the form of promissory notes or credited to the SGL account. They are for a minimum of Rs.25,000 and multiples thereof, issued at a discount and redeemed at par and do not carry any yield.
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At present there are five types of T-bills in India: 14-day, 28-day, 91-day, 182-day and 364day, out of which the 28-day T-bills have not yet been launched. The bills are available in paper as well as in scripless form.
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Ad hoc T-bills are issued in favor of the RBI when the government needs to replenish the cash balances and to provide temporary surpluses to state governments and foreign central banks. These are not available to the public.
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On tap T-bills were issued by the RBI to investors on any day and with no limit on investment. They were for a minimum of 91 days and the discount rate was around 4.6% redeemable at par. They were discontinued from April 1, 1997.
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14-day and 91-day T-bills are auctioned weekly on Fridays and payment in respect to the allotments is made on Saturdays.
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The auction for 182-day and 364-day is held weekly on Wednesdays and payment in respect to the allotments is made on Thursdays.
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T-bills are important market instruments in the US, where the minimum denomination is $10,000 and in multiples of $5,000 thereof. The American T-bills are mainly classified as ‘regular-series T-bills’ and ‘irregular-series T-bills’.
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Regular-series of 13-week, 26-week and 52-week maturities are issued weekly or monthly while irregular-series are issued for a special cash need of the treasury.
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The US T-bills are sold in auctions and issued at a discount to face value.
Commercial Paper (CP) •
Commercial Papers (CPs) are a short-term unsecured usance promissory notes issued at a discount to face value by reputed corporates with high credit rating and strong financial background.
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CPs are open to individuals, corporates, NRIs and banks, but the NRIs can invest on nonrepatriable/non-refundable basis. FIIs have also been allowed to invest their short-term funds in CPs.
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The features of CPs are: They do not originate from specific trade transactions like commercial bills. They are unsecured, involve much less paper work and have very high liquidity.
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CPs have a minimum maturity of 15 days and a maximum maturity of 1 year. They are available in denomination of Rs.5 lakh and multiples of Rs.5 lakh and the minimum investment is Rs.5 lakh per investor.
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CPs can be direct paper if issued directly to the investors by the corporate or dealer paper if issued through an intermediary/merchant banker. CPs are usually placed with the investors by issuing and paying agents.
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Secondary market trading takes place in lots of Rs.5 lakh each usually by the banks. The transfer is done by endorsement and delivery.
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The main reasons for poor development of the CPs market are: Restricted entry of corporates, tendency to issue CPs only if the total cost is lower than the PLR of banks, high minimum investment of individual investors and no tax benefits.
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In the US markets, CPs are defined as short-term, unsecured usance promissory notes issued at a discount to face value with fixed maturity by financially strong companies with high credit ratings.
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The main purpose of issuing CPs in the US is to finance current assets.
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The main features are: High liquidity and safety, high quality instruments negotiable by endorsement and delivery, issued in multiples of $1,000 as bearer documents at a discount to the face value. They are unsecured by nature and tailored to the user requirement as far as maturity period is concerned.
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There are also two types of CPs in the US: Direct paper (issued directly by the corporates and large banks) and dealer paper (issued by the dealers on behalf of their corporate clients).
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The innovations in the American CP market are: Master note (financial paper issued by finance companies to bank trust departments with interest pooled by the investors), medium-term notes (unsecured obligation papers with maturity of 9-10 months issued by investment grade corporations at fixed rate) and asset-backed commercial papers (packages of pooled loans or credit receivables with lower rates of interest and placed with a special purpose entity).
Certificate of Deposits (CDs) •
Certificate of Deposits (CDs) is a usance promissory note, negotiable and in marketable form bearing a specified face value and number. Scheduled commercial banks and the major financial institutions can issue CDs.
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Individuals, corporates, trusts and NRIs are the main investors on CDs (on non-repatriable basis). 5
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The features of CDs are: It is a title document to a time deposit, riskless, liquid and highly marketable, issued at a discount to face value, being part of the time liabilities of banks, either in registered or bearer form, freely transferable by endorsement and delivery. It does attract stamp duty.
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The benefits of issuing CDs to the banks are: Interest can be determined on a case to case basis, there is no early maturity of a CD, rates are more sensitive to call rates.
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To the investors the benefits of subscribing to CDs are: It is a better way of deploying short-term funds as higher yield is offered, secondary market liquidity is available and repayment of interest and principal is assured.
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CDs are issued for a period of 15 days to one year (normally one to three years by the financial institutions) at a minimum amount of Rs.5 lakh and in multiples of 1 lakh thereafter with no upper limit.
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There is no specific procedure to issue the CDs. It is available, on tap, with the bankers.
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CDs are the largest money market instruments traded in dollars. They are also issued by either banks or depository institutions, mostly in bearer form enabling trading in the secondary market.
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Individuals, corporates and other bodies also buy the CDs in the US.
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The features of American CDs are: They are bearer instruments, negotiable, with a minimum denomination of $100,000, maturity of 30 days to 5 years. CDs with more than one year maturity are known as term CDs.
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CDs have undergone various innovations: Asian dollar CDs, jumbo CDs, yankee CDs, brokered CDs, bear and bull CDs, installment CDs, rising rate CDs and foreign index CDs, all with different features. Many more innovations are expected in this uprising market.
Bill Financing •
Monetary policy refers to the use of the official instruments under the control of the central bank of the country to regulate the availability, cost and use of money and credit.
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The bank standard rate is the rate at which the bank is prepared to buy or rediscount bills of exchange or other commercial paper eligible for purchases.
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A bill of exchange has been defined as an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument.
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The specific features of a negotiable instrument are: There must be three parties to the exchange, namely drawer, drawee and payee, the instrument must be in writing, containing an order (not a request) to a certain person to pay, unconditionally, a certain sum of tender legal money, duly signed by the drawer and presented to the drawee for acceptance. It should also have date, number, place and other considerations found in the bills of exchange.
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Bills of exchange can be classified as demand or usance bills, documentary or clean bills, D/A or D/P bills, inland or foreign bills, supply bills or government bills or accommodation bills.
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Bills can also be classified as traders bills, bills with co-acceptance, bills accompanied by letter of credit and drawee bills.
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Originally discounted bills can be rediscounted by banks for their corporate clients with financial institutions, as long as such bills arise out of genuine trade transactions.
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The RBI has instructed banks to restrain from rediscounting bills outside the consortium of banks and initially discounted by finance companies and merchant bankers. Further discounting should be only for the purpose of working capital/credit limits and for the purchase of raw materials/inventory. Accommodation bills are not to be discounted under any circumstances.
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DEBT MARKET Gilt-Edged Securities Market •
Gilt-edged securities mean securities of the best quality, where the repayment of principal and interest is secured by the government. They are risk-free investments.
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Government securities are issued by central and state governments, semi-government authorities and government financial institutions.
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Individuals, corporates, other bodies, state governments, provident funds and trusts are allowed to invest in government securities.
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Government securities play a vital role in the open market operations conducted by the central bank of the country.
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The minimum investment is Rs.10,000 and multiples thereof and they can be longdated, medium-dated and short-dated, with maturities of 10-20 years, 5-10 years and less than 5 years respectively.
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In the primary market, government securities can be issued through auctions, preannounced coupon rates, as floating rate bonds, as zero-coupon bonds, as stock on tap, as stock for which payment is to be made in installments or as stock on conversion of maturing treasury bills/dated securities.
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There is a huge demand for government securities in the secondary market as they are the first choice of banks to comply with the SLR requirements.
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The RBI usually undertakes the following transactions with banks: Open market operations, repo transactions and switch deals.
Repurchase Agreements (REPOs) •
Repos are ready forward deals or agreements involving sale of a security with an undertaking to buy-back the same security at a predetermined price and time in future. To the seller, it is known as a repo and to the buyer it is known as a reverse repo.
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The market participants in repos are: Banks, DFHI, financial institutions, non-banking entities like mutual funds that hold current and SGL accounts with the RBI.
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The operational aspects of a repo depend on: Size of the loan, selection of security, interest rate and settlement system.
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The procedure to issue repos involves the acceptance of tenders, announcement of auction results and the payment.
Public Deposits •
Corporates prefer public deposits to bank loans because as they are unsecured debts and the funds can be deployed at the discretion of the company.
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Non-banking finance companies have been defined as loan companies or hire purchase finance companies or investment companies or equipment leasing companies or mutual benefit financial companies, while non-banking non-financial companies are those involved in manufacturing, trading or service sector.
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Public deposit is any money borrowed by a company, but does not include advances, guarantees from any government, bank borrowings, security deposits, funds from the promoters or directors, share capital or debentures funds.
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Public deposits should be of 12 to 60 months tenure.
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The maximum rate of interest is decided by the RBI and the brokerage paid to the agents depends on the duration of the deposit. The maximum amount of deposits cannot exceed 25% of the paid-up capital and free reserves. In addition, the company can accept deposits from shareholders up to 10% of the paid-up capital and free reserves. 7
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The company must maintain liquid assets to the extent of 15% of the deposits maturing by the end of the financial year (March 31). The liquid assets can be deposits with scheduled banks without any lien, unencumbered securities of central and state governments, other unencumbered securities or bonds of HDFC. The liquid amount can never fall below 10% of the maturing deposits.
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Receipts of deposit must be issued within 8 weeks of acceptance and premature deposits are allowed after a period of 3 months from the date of deposit, subject to the penalty for early withdrawals.
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Every company accepting deposits should maintain a register of deposits at the registered head office with the basic details of each depositholder, for a period of 8 years from the financial year in which the latest entry is made.
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A company inviting public deposits must advertise the details of the company and the profitability in an English and a local language newspaper.
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In order to market its public deposits successfully, a company has to develop a mix of the following factors: Product differentiation, pricing, promotion, quality service and distribution.
Financial Guarantees •
A guarantee is a contract to perform or to discharge the liability of a third person in case of his default. There are three parties involved in a guarantee: The lender, the borrower and the guarantor.
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There are three major types of guarantees: Personal, governmental and institutional (usually by financial institutions, banks, insurance companies, etc.).
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The government of India has also set-up two specialized public guarantee institutions: Deposit Insurance and Credit Guarantee Corporation (DICGC) and Export Credit and Guarantee Corporation (ECGC).
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While DICGC undertakes insurance of deposits on banks, guarantee for credit extended by banks to priority sector and guarantee for credit extended to small scale industries, ECGC offers cover to exporters against commercial risks and political risks.
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The main services offered by ECGC are: Standard policy, small exporters policy, specific policy, guarantees to banks and special schemes (transfer guarantee, overseas investment insurance and exchange rate fluctuation risk).
CAPITAL MARKET An Overview of the Capital Market •
Of late the following broad trends like disintermediation, institutionalization, globalization and modernization are being observed in the capital markets in India.
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The primary markets in India have observed the following major changes: Free pricing of instruments, introduction of entry norms, improvement in the quality of disclosures, introduction of the book building process to price new share issues, streamlining all the procedures and registration of intermediaries like merchant bankers, registrars and share transfer agents, brokers to issue, bankers to issue and debenture trustees.
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The secondary markets in India have observed the following major changes: Computerized trading system, depository participants and dematerialization of issues, settlement of clearing corporations for the stock exchanges, change in the settlement system, banning of carry forward system, introduction of the margin system, minimum capital norms for brokers, implementation of a vibrant secondary market for debt issues, review of the share indices, strict regulations to maintain integrity of the markets, introduction of derivatives and latest introduction of the daily rolling settlement process.
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Regulation of the Capital Market •
SEBI was instituted by the Government of India to perform disciplinary (disincentives and penalties for errant and unfair behavior) and developmental (incentives for constructive activities) roles.
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The main objectives of SEBI are: Protection of the interests of investors in securities, development of the securities markets in India and regulation of the securities markets.
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The activities of SEBI are divided into: Primary market department, issue management and intermediaries department, secondary market department, institutional investment department, investigation department and legal department.
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The major steps initiated by SEBI include: Registration of intermediaries, redressal of investors’ grievances, improvement in the functioning of primary and secondary markets, regulation of takeovers, emergence of institutional investors and entry of private mutual funds in the markets, maintenance of fairness and integrity of the markets.
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The main objectives of the International Organization of Securities Commissions (IOSCO) are: Promotion of high standards of regulations, exchange information on past experiences, establishment of standards of conduct and provision of mutual assistance for promotion of integrity.
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IOSCO has three types of members: Ordinary members, associate members and affiliate members and various committees that meet every year to discuss important issues relating to international securities and futures markets.
MERCHANT BANKING An Overview of Merchant Banking •
Merchant bankers act as intermediaries between the issuers of capital and the ultimate investors who purchase the securities. Merchant banker means a person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory services in relation to such issue management.
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The scope of merchant banking in India covers: Management of debt and equity issues, placement and distribution of investment proposals, corporate advisory services, project advisory services, loan syndication, venture capital and mezzanine financing, mergers and acquisitions, divestitures of assets, takeover defense activities and financial engineering.
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Merchant banking mushroomed in India in the ‘80s and ‘90s when the entry barriers were low and many issues by dubious promoters were being floated.
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In order to control this trend, SEBI came up with stricter guidelines, like making the same rules for all classes of merchant bankers, increasing the net worth requirements and the fee structure. This resulted in some control over the mushrooming trend of fly-by-night operators in the capital markets.
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Entry barriers in the merchant banking business are still low; competition is high; pressure from substitute options is fast growing; bargaining power of buyers (clients) is very high; and the bargaining power of suppliers (merchant bankers) is very low.
Management of Public Issues, Initial Public Offerings and Pricing of Various Instruments •
An Initial Public Offering (IPO) is the first public offer of equity shares by a company since its inception.
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An IPO is used as a financing strategy (to raise funds) or as an exit strategy (to offload holding to the general public).
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There are various advantages and disadvantages of going public. It is to be noted that despite so many issues hit the Indian markets, most of them get subscribed. 9
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The eligibility norms for IPO are: The company should be in existence for the last 5 years with dividend payment for at least 3 years or the project for which funds are required should be appraised by a bank or financial institution who should invest in at least 10% of the equity or debt capital of the company. The issue size does not exceed 5 times the preissue net worth.
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The company has to appoint various intermediaries like: Merchant bankers, registrars and share transfer agents, bankers to the issue, debenture trustees (if applicable), advertising agency and printers of stationery, underwriters to the issue, brokers to the issue, auditors and legal advisor to the issue.
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The contribution of the promoter should be 20% of the post-issue equity capital. The percentage of holding for a new company coming out with an issue at a premium depends on the size of the issue. The lock-in requirement for the promoters’ holdings is 3 years.
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Contribution of the promoters should not include: Shares issued within one year of filing prospectus with SEBI if the price is below the issue price; bonus shares out of revaluation reserves; shares issued in consideration other than cash.
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SEBI has made some special mandatory provisions for debenture issues: Mandatory credit rating; appointment of SEBI registered debenture trustee; creation of debenture redemption reserve; option of redemption in case of roll-over of NCD/PCD; optional conversion of debentures above 18 months; availability of optional conversion of debentures after 18 months or before 36 months for debentureholders; no issue of FCD for more than 3 years without optional conversion with put and call option facility.
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The marketing of a public issue depends on: Timing of the issue, retail distribution network, reservation portion in the issue and advertising campaign for the issue.
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The allotment of shares in case of oversubscription should be tilted towards the small investors (those with applications up to 1000 shares) in order to avoid concentration of power in few hands. There ought to be at least 5 investors per Rs.1 lakh of equity capital.
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In case of undersubscription of less than 90% of the issue size, the company must refund the proceeds to the investors. In order to avoid refunds, the company can take the help of underwriters who have to subscribe to the balance shares as per their pre-decided commitments.
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While designing the capital structure of a company, the following points must be kept in mind: Type of asset being financed, nature of the industry in which operating, degree of competition, obsolescence of one’s products, product life cycle, financial policy and past/current capital structure.
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While deciding about the financial instrument, the following points must be kept in mind: Purpose of the offer, debt servicing, tax considerations, credit rating, asset cover and dilution of ownership.
•
The Indian capital markets have seen the following innovative financial instruments in the recent past: Zero-coupon bonds, secured premium notes, deep discount bonds, optional convertible bonds, third party convertible bonds, zero coupon convertible notes, tax saving bonds, cumulative convertible preference shares, non-convertible debentures with equity warrants, floating rate instruments, auction rated debt, zero-coupon bonds with equity warrants, among others.
•
New companies should price their issues at par, but private companies with profitability track record can price their issues at a premium and listed companies can price their issues freely. At present, 10% of the issue has to be made by the book building method.
•
There are various alternatives to price an issue: Dividend discount model, yield expectation of the public, book value of share, current market price, past price behavior, Japanese auction pricing, book building method, brand equity of the company, etc.
•
Indian companies tend to justify their premiums through qualitative as well as quantitative factors.
10
•
The pricing of an IPO in the Indian capital market is as follows: Estimation of the preliminary price, deciding on the price band and determining the actual offer price.
•
An issue could be overpriced, rightly priced or underpriced. The factors underlying underpricing are: Asymmetric information, early fixation of offer price, interest rate float, liquidity premium, building shareholders loyalty, rewarding the favored clients of the merchant bankers and to attract the financial institutions.
•
The factors responsible for persistent underpricing in the market are: The Winner’s curse, information disclosure in the pre-selling period, informational cascades, avoidance of litigation (not in India), signaling for a future issue, information asymmetry between firms and investment bankers, regulatory constraints, political goals and market incompleteness.
Rights Issues, Bonus Issues, Private Placements and Bought-out Deals •
Rights shares are shares offered to the existing shareholders as a matter of legal right.
•
The objectives of Sec. 81 are: Equitable distribution of shares, voting rights not to be affected, shareholders interest in reserves/net worth not to be impaired.
•
SEBI has come out with detailed guidelines for rights issues as well as the action plan on how to go about a rights issue.
•
A rights issue affects the wealth of those shareholders who renounce adversely, but does not change the wealth of those who exercise their rights or sell the rights to someone else.
•
The advantages of a rights issue are: It enables existing shareholders to retain their proportionate ownership of the company, the company can also concentrate on the existing shareholders without increasing the shareholder base and its cost of making is lower than that of a public issue.
•
The main disadvantage of a rights issue is that it takes a long time to complete the transaction.
•
Bonus issue is the process of capitalizing reserves to convert the quasi-capital into equity capital, generally to bring the paid-up capital in line with the capital employed.
•
A bonus issue does not affect the wealth of a shareholder.
•
SEBI has also come up with a regulatory framework for bonus issues.
•
A private placement is a method to raise funds under which companies directly sell their securities to a limited number of sophisticated and discerning investors.
•
The main features of a private placement are: No entry barriers, no need of registration with SEBI, terms are negotiable between the parties, company has a choice of investors, transaction costs are low, credit rating is optional and the time lag is shorter.
•
Mutual funds, FIs, banks, insurance companies, FIIs, rich individuals and private equity funds are the players in the placement market.
•
The main issuers are: Listed companies, FIs, unlisted companies, closely-held companies, PSUs and government companies.
•
The merits of private placement are: Accessibility, speed, flexibility, lower transaction costs and confidentiality.
•
A buy-out is a process whereby an investor buys a significant portion of the equity of a company with a view to make it public within an agreed time-frame. It is also known as a wholesome investment.
•
The main reasons for bought-out deals are: Funds requirement in adverse market conditions, funds requirement when the company is not entitled to an IPO, when the company cannot go for an IPO at a premium and when the offer of an investor is more lucrative than an IPO.
•
The advantages of a bought-out deal as compared to a public offer are: Price privilege, quick fix, cost advantage and time to realize the funds.
11
INTERNATIONAL MARKETS •
The Indian companies have many opportunities to raise funds in the international equity markets for the right kind of usage.
•
There are various types of instruments in the international markets like: Yankee bonds, Samurai bonds, Bulldog bonds, Euro bonds, etc., as well as ADR/GDR/IDRs for equity issues.
•
The major players in the international markets are: Borrowers/issuers, lenders/investors and intermediaries. The institutional investors can be classified as: Market specific investors, time specific investors and industry specific investors.
•
Intermediaries are mainly: Lead and co-managers, underwriters, agents and trustees, lawyers and auditors, listing agents and stock exchanges, depository banks, custodians and lastly, printers.
•
Resource mobilization depends on the following factors: Currency requirements, pricing of the issue, investment, depth of the market, international positioning, regulatory aspects, disclosure requirements and investment climate.
•
The issuance of GDRs requires the following steps: Approval of the shareholders, appointment of lead manager, finalization of the structure, documentation (prospectus, depository agreement, underwriting agreement, subscription agreement, custodian agreement, trust deed, paying and conversion agreement, listing agreement), the launching of the GDR, marketing and road shows, pricing and finally closing.
•
Eurodollars are liabilities denominated in US dollars, but not subject to US banking regulations. Mostly banks located outside the US issue Eurodollar deposits.
•
There are various advantages of Eurodollar deposits, the main being, lesser regulatory impediments, lower cost of deposit intermediation and less intense supervisory scrutiny by the authorities.
•
The main instruments in the Eurodollar market are: Eurodollar Certificate of Deposits (CDs), Eurodollar Floating Rate CDs (FRCDs), Eurodollar Floating Rate Notes (FRNs), Note Issuance Facilities (NIFs) and EuroCommercial Papers (CPs).
•
The three basic risks with Eurodollar deposits are: Chances of interference of transfer of funds by the host country government, potential jurisdiction of international disputes and soundness of deposits of banking offices of foreign countries with relation to the US.
•
Most of the Euroloans are today sourced through a syndicate of banks or lenders. The process is almost similar to the process of syndication of loans from internal sources.
•
The advantages of syndicated loans are: Size of the loan, speed and certainty of funds, maturity profile of the loan, flexibility in repayment, lower cost of funds, diversity of currency, simpler banking relationships and possibility of renegotiation.
•
The costs associated with the Euroloan are periodic costs (interest charges and commitment charges on the indrawn portion) and upfront costs (management fees, out of pocket expenses and agency costs). The largest portion of the management fee retained by the lead bank is known as ‘praecipicium’.
•
Multi-currency loans are loans denominated in one currency with an option to borrow in one or more currencies. They are basically an expansion of the Eurodollar loans. The documentation of multi-currency loans is similar to the Eurodollar loans.
•
The following are the main types of multi-currency loans: Term loan, revolving credit facility, evergreen facility, back-stop facility and swingline.
•
The fee charged for the multi-currency loans is almost similar to the fee charged on the Eurodollar loans.
12
•
External Commercial Borrowings (ECBs) are borrowings of Indian corporates made outside India. The advantages of ECBs are: Longer maturity, low borrowing cost, useful in infrastructure projects and export financing.
•
The Government of India has recently liberalized the regulations for ECBs in order to attract more foreign investment in the country. However, the uses of ECB funds for investment in the stock market and speculation in real estate is still restricted.
•
After analyzing the performance of the Indian issuers, the following factors are identified for successful international equity/convertible issues: The fundamentals of the company, the experience of the lead manager, the size of the issue, the innovative packaging of the instrument, the timing of the issue, the care taken in the pricing, the effectiveness of the marketing/salesmanship, the after market services and up to date information about the developments in the global market.
•
The sources to raise forex finance in the international markets are: Official channels and Commercial channels (for equity and debt).
•
Corporate finance managers must first ascertain the resource requirements and define the borrowing criteria and then identify the right sources to borrow funds.
•
Foreign Institutional Investors (FIIs) including mutual funds, pension funds, investment trusts, endowment funds, insurance funds, university funds, charitable societies, etc., can invest in the Indian stock markets subject to the RBI and SEBI regulations.
•
Foreign Direct Investment (FDI) takes place when an investor based in one country acquires an asset in another country with the intention of managing it. Except arms and ammunition, atomic energy, mineral oils, atomic energy minerals and railway transport, FDIs are allowed to invest in most of the industries.
•
The Foreign Investment Promotion Board (FIPB) has been set-up specially to: Promote FDI investments in India, grant speedy clearance to new projects and promote transparency in the rules and regulations for FDI deposits.
•
The Non-Resident Indians (NRIs) are persons of Indian origin, even if born and brought up abroad, with or without Indian passport, including HUFs, AOPs, partnership firms, companies, societies, trusts and Overseas Corporate Bodies (OCBs) who maintain accounts with authorized dealers.
•
The NRIs can open savings accounts, current accounts and term deposit accounts (fixed deposit, recurring deposit and reinvestment deposit).
•
The NRIs can open NRO, NRNR, NRE, FCNR and NRSR accounts in India. These accounts have various features like repatriation of interest, non-taxability of interest and higher interest rates.
CREDIT RATING •
Ratings serve as a benchmark to the risk involved in a particular instrument of investors. A good rating can help a company raise money at a relatively lower cost and from a larger body of individuals, leading to a broader investor base.
•
Till recently, ratings were mostly concentrated in the area of debentures, fixed deposits and other short-term instruments. The changing economic environment has thrown open new areas like equity rating, individual rating, mutual fund scheme rating, chit funds rating, country risk rating and a plethora of other new areas.
•
There are three factors to be considered while conducting a rating review: One, the performance of the industry; Two, the performance of the company; Three, the performance of the stock market of the country.
•
While companies sign a mandatory letter from the rating agency wherein they undertake to provide information regularly, not all do so. While the good ones are more than pleased to approach their raters with the required information, the rating agencies have to run after the bad ones to seek information. 13
•
Another problem is of rating convenience. A company that is not satisfied with the rating assigned to its instrument by a rating agency can approach another rating agency for a fresh rating, and disclose only the second rating to the public, if it proves to be favorable. The company is free not to disclose the first rating or the fact that it went for a second rating. Unless a mechanism of transparency is thrown open, rating will lose its charm.
•
Today, CRISIL, ICRA and CARE are the main raters in the Indian market, while STANDARD AND POOR’S and MOODY’S are the main players in the international markets.
•
Rating has become innovative: ONICRA has even started rating individuals in India and even the banks rate the individuals that come to them for loans. Banks and financial institutions are also coming forward to being rated; equities are being graded and a bunch of other players and instruments are being rated.
EVOLUTION OF FINANCIAL SERVICES •
The term Financial Services encompasses all those services that have money as the raw material.
•
Financial Services include: –
Leasing
–
Hire Purchase
–
Consumer Finance and Installment Credit
–
Plastic Money Cards
–
Insurance
–
Housing Finance
–
Venture Capital
–
Mutual Funds
–
Portfolio Management Schemes
–
Credit Rating
–
Capital Issue Management
–
Factoring and Forfaiting
–
Plantation Schemes.
•
Leasing and Hire purchase have been the oldest kind of financial services both in India and around the world. Some of the financial services in India such as venture capital and credit rating are relatively of recent origin.
•
Financial services has been mostly regulated by the Securities and Exchange Board of India. Some of the services such as banking are regulated by the Reserve Bank of India.
•
A few of the financial services such as Insurance, Housing Finance and Mutual Fund are witnessing better times due to various factors:
14
•
Insurance industry has been opened to private sector participation and the Insurance Regulatory Authority has been given statutory powers.
•
Housing Finance will see increased importance due to changes in the National Housing Bank Act and changes in the tax treatment for housing loans.
•
Mutual Funds industry has witnessed ups and downs. With the savings rate going up and a capricious equity market, 1997-98 was the best year for mutual funds.
AN INTRODUCTION TO EQUIPMENT LEASING •
While leasing has a history spanning over more than 5000 years, equipment leasing is of a recent origin. It is said that the practice of equipment leasing began when the rail road companies in the USA. and Europe resorted to leasing of rail cars and locomotives to expand their operations. By the mid-sixties, equipment leasing came into popular use in the developed countries. Today equipment leasing is confined not just to leasing of equipments, but to large infrastructural facilities, power plants and other capital-intensive projects as well.
•
In concept, an equipment lease is a contractual arrangement under which the owner (lessor) transfers the right to use the equipment to the user (lessee) for an agreed period of time in return for rent. At the end of the lease period the asset reverts to the lessor. It is important to note that in the Indian context a lease cannot be structured with a provision for transfer of ownership or with a feature of purchase option. Introducing any one of these features can result in the lease being classified as hire purchase transaction which has a different set of accounting and tax implications.
•
The features of an equipment lease transaction can vary along the following dimensions: Extent to which risks and rewards of ownership are transferred, number of parties to the transaction, domiciles of the equipment manufacturer, the lessor, and the lessee. Based on these dimensions, the following classifications are possible: –
Finance Lease and Operating Lease
–
Sale Lease and Operating Lease
–
Single Investor Lease and Leveraged Lease
–
Domestic Lease and International Lease.
•
Of the aforesaid classifications, the classification in terms of finance lease and operating lease is of fundamental importance to the financial analysis and accounting of leases. The distinction is drawn on the basis of the risks and rewards of ownership transferred from the lessor to the lessee. If a lease transfers a substantial part of the risks and rewards it is classified as a finance lease; otherwise, it is called an operating lease. The Financial Accounting Standards Board (FASB) of the USA was the first professional body to evolve the criteria for this classification and these criteria with some minor modifications have been adopted by the International Accounting Standards Committee (IASC).
•
There are various factors which influence the decision to lease. The important ones are: –
Flexibility
–
User-Orientation
–
Tax Based Advantages
–
Convenience
–
Expeditious Disbursement of Funds
–
Hundred Percent Financing
–
Better Utilization of Own Funds.
•
A lease is often marketed on the strength of a dubious advantage called the “Off-Balance Sheet Financing” which purports that a liability off the balance sheet does not affect the debt capacity of a firm. It must be noted that a finance lease whether on or off the balance sheet affects the borrowing capacity and increases the financial risk.
•
There are of course, deterrents to leasing. These deterrents include the restrictive convenants on the usage of the asset, the non-cancelable feature of a finance lease which restricts the flexibility to disinvest, threat to real borrowing capacity and the high cost of lease finance visá-vis most forms of borrowing.
15
LEASING IN INDIAN CONTEXT •
The equipment leasing industry in India came into being in 1973 but did not come of age until the early eighties.
•
The leasing boom of the early eighties propelled a large number of private sector finance companies, commercial banks and financial institutions into this industry. The Banking Regulation Act, 1949 was amended in 1983 to permit commercial banks to undertake equipment leasing operations through the subsidiary route. These subsidiaries have been recently permitted to undertake hire purchase operations.
•
The entry of financial institutions and subsidiaries of commercial banks made the lease rates more competitive. The fall in the lease rates coupled with high cost of funding and imposition of sales tax on lease rentals forced many private sector finance companies to close down or resort to concentric and conglomerate diversification. Today the dominant players in the industry are the subsidiaries of commercial banks like SBI Caps and Canfina; Financial Institutions like ICICI and IFCI; and about twenty private sector finance companies like First Leasing Company of India, Twentieth Century Finance Corporation and Sundaram Finance. The commercial banks and State Financial Corporations have been recently permitted to directly enter the business of leasing and hire purchase.
•
The equipment leasing industry has grown almost at the rate of 50 percent per annum during the eighties and is poised to achieve a comparable growth rate in the nineties. The recent measures of liberalization must accelerate the process of capital formation in the country, and leasing has a major role to play in the process.
•
The business of equipment leasing is not subject to any dedicated legislation. By and large, the obligations of the lessor and the lessee are governed by the provisions of bailment contained in the Indian Contract Act, 1872. The Hire Purchase Act which was introduced in 1972 and later amended in 1989 is yet to be made operational.
•
Funding of finance companies is subject to the RBI (Non-Banking Financial Companies) Directions, 1977. These directions have been considerably revised recently and financial companies are not required to adhere to the capital adequacy norms similar to those applicable to commercial banks.
•
The conventional sources of funding a financial company include equity, debentures, term loans, bank borrowings, public deposits, intercorporate deposits and commercial paper. Of late these companies have been toying with the idea to securitize the lease and hire purchase receivables.
LEGAL ASPECTS OF LEASING •
In the Indian context, there is no legislation that exclusively relates to equipment lease transactions. Since the features of an equipment lease transaction closely resemble the features of bailment, the provisions of the Indian Contract Act, 1872 which govern contracts of bailment are applied to equipment lease transactions. This enactment defines the implied obligations of the bailor and the bailee.
•
Since the lessor plays the role of a financier in a typical equipment lease transaction, the implied obligation of the bailor relating to the fitness of the bailed goods is expressly negated by the lease agreement.
•
The lease agreement provides the lessee with a number of obligations which do not form a part of his implied obligations under the Indian Contract Act. Usually the lessor and the lessee enter into a Master Lease Agreement which enables the lessee to add on leased equipment up to a predetermined limit in terms of value. Registration of an equipment lease agreement is optional under the Indian Registration Act, 1908.
•
The lease documentation process is fairly simple. It starts with the submission of a proposal by the lessee. On approval, the lessor issues a letter of offer detailing the terms and conditions of the lease. The letter of offer is accepted by the lessee by passing a Board resolution. This is followed by the lessor and lessee entering into a formal lease agreement.
16
•
There are a number of legal issues to be considered before drafting the lease agreement. Some of these issues are (a) legal relationship between the equipment supplier, the lessor and the lessee, (b) insurance, (c) usage and maintenance, (d) sub-lease, (e) set-off provisions and (f) defaults and remedies.
TAX ASPECTS OF LEASING •
The tax aspects of leasing can be divided into two parts – the income tax aspects and the sales tax aspects.
•
The income tax aspects of leasing are primarily concerned with (a) lessor’s claim for depreciation tax shields on the leased assets; (b) lessee’s claim for lease rentals and to treat the operating costs of the leased assets as tax-deductible expenses; and (c) tax liability on rental income in the hands of the lessor.
•
The Income Tax Act, 1961 does not explicitly provide for the lessor’s eligibility to claim depreciation allowance on the leased assets. But this eligibility can be deduced from the Tribunal and Court judgments on the subject.
•
To date, no capital allowances (like investment allowance) have been directly linked to investment in plant and machinery. Hence, the lessor does not derive any investment related tax shield other than depreciation tax shields.
•
The rental income derived by the lessor is included under the head ‘Profits and Gains of Business or Profession’ for the purpose of assessing the income tax liability.
•
From the lessee’s angle, the rental expense can be treated as a tax-deductible expense. The costs incurred to insure and maintain the leased asset are also tax-deductible.
•
By virtue of a circular issued by the Central Board of Direct Taxes (CBDT) in 1943, the lease agreement must not provide for a transfer of ownership of the leased asset or a bargain purchase option to the lessee. Inclusion of either of these provisions will result in the lease transaction being treated as a hire purchase transaction. The tax implications of a hire purchase transaction are not the same as those of a lease transaction.
•
Leasing can be used as a tax planning device by (a) exploiting the flexibility in structuring lease rentals; (b) transferring the investment related tax shields from a firm which has a low appetite for such tax shields to a lessor who can absorb them. The firm transferring the tax shields can benefit through a reduction in the lease rentals.
•
Sales tax affects a lease transaction at the following stages: (a) when the asset is purchased by the lessor for the purpose of leasing; and (b) when the right to use the asset is transferred to the lessee for a valuable consideration; and (c) when the asset is sold by the lessor at the end of the lease period.
•
The lessor is at a disadvantage with regard to interstate purchase of equipment because the concessional rate of Central Sales Tax which applies to such transactions (on fulfillment of certain prescribed criteria) is not made available to an equipment supplier supplying equipments to a lessor.
•
The Constitution (Forty-Sixth Amendment) Act, 1981 provides for sales tax on the “transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash, deferred payment or other valuable consideration”. After this enactment several states amended their sales tax laws to provide for sales tax on lease rentals.
•
The validity of the provision to levy sales tax on lease transactions and the other related aspects have been challenged by the leasing companies and stay orders have been obtained from different state High Courts. Consequently, the lessor’s liability to pay sales tax on rental income remains a contingent liability.
17
LEASE EVALUATION: THE LESSEE’S ANGLE •
A finance lease can be evaluated either as an investment alternative or as a financing alternative depending upon the a priori information available about the financial desirability of a capital investment. In the absence of any a priori information about the financial desirability, ‘Leasing’ and ‘Buying’ are evaluated as two mutually exclusive investment alternatives. Given prior knowledge of the financial desirability or need for a capital investment, ‘Leasing’ is evaluated as one of the financing alternatives.
•
There are a number of financial models available to evaluate a ‘lease’ and there is no consensus till date on the most appropriate model. The following four financial models represent the spectrum of views on this issue reasonably well: –
Weingartner Model
–
Equivalent Loan Model
–
Bower-Herringer-Williamson Model
–
Bower Model.
Barring the first model, the other three models evaluate leasing as a financing alternative. •
•
The application of the Weingartner Model to evaluate a ‘lease’ as an investment alternative involves the following steps: a.
Compute the NPVs of the ‘lease’ and ‘buy’ alternatives.
b.
Select the alternative with the higher positive NPV.
The application of the Weingartner Model for evaluating a ‘lease’ as a “financing alternative” involves the following steps: a.
Compute Net Advantage of Leasing (NAL) defined as: Initial Investment – P.V. (Lease Rentals) – Management Fee + P.V. (Tax Shield on Lease Rentals) + P.V. (Tax Shield on Management Fee) – P.V. (Tax Shield on Depreciation) – P.V. (Net Salvage Value).
b.
Lease the equipment if NAL is positive. Buy the equipment if NAL is negative.
The discount rate employed is the marginal cost of capital based on the mix of debt and equity in the target capital structure. The model assumes that debt includes present and future lease obligations as well. •
18
The Equivalent Loan Model, the BHW Model and the Bower Model view ‘Leasing’ as a financing alternative and is based on the premise that every rupee of lease finance displaces an equal amount of long-term debt. In other words, these models assume that the debt component in the target capital structure does not include present and future lease obligations. So, these models consider the interest tax shields on the displaced debt as an explicit cash flow in the computation of NAL. The models, however, differ from one another in terms of the discount rates applied to the components of NAL viz., lease
payments, tax shields (shelters) and net salvage value. The following table provides the different discount rates employed by these models. Components of Equivalent Loan Model BHW Model Bower Model NAL Lease Payments Pre-tax Cost of Debt Pre-tax Cost of Debt Pre-tax Cost of Debt Marginal Cost of To be Specified by Post-tax Cost of Debt Tax Shields* Capital the Decision-Maker Marginal Cost of Net Salvage -do-doCapital Value * The tax shields include the tax shields on lease payments, management fees, depreciation and interest on displaced debt. •
We believe the risks that characterize the lease payments on the one hand and the realization of the tax shelters and net salvage value on the other, are different. Hence, different discount rates have to be used to discount the two sets of cash flows. For reasons stated in the current chapter we also believe that the debt-displacement effect of leasing must be explicitly recognized, and we define NAL as follows: NAL =
Investment Cost – P.V. (Lease Payments discounted at Kd) + P.V. (Tax Shields on Lease Payments discounted at K) – Management Fees + P.V. (Tax Shield on Management Fees discounted at K) – P.V. (Depreciation Tax Shields discounted at K) – P.V. (Interest Tax Shields discounted at K) – P.V. (Residual Value discounted at K)
Where, Kd
= Pre-tax cost of debt
K
= Marginal cost of capital.
Setting NAL to zero and solving the unknown rental value provides the break even rental from the lessee’s point of view – The maximum lease rental acceptable to the lessee. •
•
In practice, the decision to lease is significantly influenced by several non-tax based factors like –
Simple Documentation.
–
Expeditious Sanction.
–
Absence of Restrictive Financial Covenants in the Lease Agreement.
–
No Requirement for Detailed Post-sanction Reporting.
–
Flexibility in terms of Structuring Lease Rentals.
–
Off-Balance Sheet feature of Finance Lease (which helps maintain the apparent borrowing capacity of the firm).
Given the long-term relationship envisaged by a finance lease, the unlimited innovative ways to structure a lease and the legal and tax complexities that go with such structuring and selecting the right type of lessor assume special significance. The following factors must be taken into account while selecting the lessor: –
Role of the Lessor as a Financier
–
Financial position of the Lessor
–
Experience of the Lessor
–
Product Range. 19
LEASE EVALUATION: THE LESSOR’S ANGLE •
The Net Advantage of Leasing (NAL) from the lessor’s point of view can be defined as follows: NAL = – Initial Investment + P.V (Lease Payments) – P.V. (Tax on Lease Payments) + P.V. (Management Fee) – P.V. (Tax on Management Fee) + P.V. (Tax shields on Depreciation) + P.V. (Net Salvage Value) – P.V. (Initial Direct Costs) + P.V. (Tax Shield on Initial Direct Costs). The discount rate to be used is the marginal cost of capital based on the debt/equity mix in the target capital structure of the lessor. The lease rental for which the NAL is equal to zero is defined as the break even rental of the lessor – the minimum lease rental the lessor will charge.
•
The bargaining area or the range within which the rentals can be negotiated between the lessor and the lessee is determined by the break even rentals of the lessor and the lessee. The upper limit is determined by the break even rental of the lessee and the lower limit is set by the break even rental of the lessor. Clearly, no negotiable range will exist if the break even rental of the lessor exceeds that of the lessee.
•
Lessors who use the gross-yield approach to price the lease define the gross yield as that rate of interest which equates the present value of the lease rentals plus the present value of the residual value of the investment cost.
•
The flat rate of interest applicable to a lease is called the add-on yield. The assumption underlying the computation of “add-on yield” is that the investment in the lease remains constant over the lease period, which is untrue. The add-on yield is always less than the (effective) gross yield defined above.
•
The Internal Rate Of Return (IRR) on a lease is that rate of interest for which the NAL is equal to zero. The lease proposal is accepted if and only if IRR is greater than the marginal cost of capital.
•
The total risk of a lease portfolio can be divided into the following types of risk: –
Default Risk
–
Residual Value Risk
–
Interest Rate Risk
–
Purchasing Power Risk
–
Political Risk
–
Currency and Cross-border Risk.
•
The relevant and dominant risk characterizing a finance lease is the default risk. The default risk is a function of the creditworthiness of the lessee which is influenced by the character and capacity of the lessee and the collateral value of the asset.
•
The overall credit rating of the lessee based on the relevant factors can be determined through the Explicit Judgemental Approach and the Statistical Approach. These approaches primarily help in discriminating between the good and the bad lessee accounts and also help in developing a risk classification table.
•
The credit risk can be managed by altering one or more of the lease structuring variables like lease rentals, lease term or pattern of payment. The lessor can also seek protection against credit risk by insisting on personal and bank guarantees.
•
The relevant risk in the case of an operating lease is the product risk or the risk inherent in realizing the expected salvage value. In countries like the USA and the UK, insurance companies offer the residual value of the insurance policies to cover such risks.
20
LEASE ACCOUNTING AND REPORTING •
The first accounting standard for lease accounting was issued by the Financial Accounting Standards Board (FASB) of the US (FASB Statement 13: Accounting of Leases). Drawing largely on this standard, the International Accounting Standards Committee (IASC) issued the IAS:17 on Accounting for Leases. In 1988, the Institute of Chartered Accountants of India (ICAI) issued a Guidance Note on this subject which favored the adoption of IAS:17 in the long run and recommended a set of accounting guidelines for the interim period keeping in view the state of the leasing industry in India and the tax framework.
•
The IAS:17 requires a finance lease to be reflected in the balance sheet of a lessee as an asset and as a liability in order to properly account the economic resources and the level of obligations of the lessee firm. The guidelines require (a) the asset and liability to be recorded at the inception of the lease at an amount equal to the fair market value of the asset or, if lower, at the present value of the minimum lease payments; (b) the rentals to be apportioned into interest and capital contents using the effective rate of interest (actuarial) method or any other acceptable approximation; (c) expense the interest (finance) charge and (d) depreciate the asset in line with the depreciation policy pursued in respect of the assets owned. The leased asset must be fully depreciated over the shorter of the lease term or its useful life.
•
The ICAI guidelines require the lessee to expense the lease rentals payable under the finance lease on an accrual basis and disclose the details concerning the leased asset and the unexpired commitments for lease payments, as on the balance sheet date, by way of a note in the balance sheet.
•
The IAS:17 requires a finance lease to be recorded as a receivable in the books of the lessor at an amount equal to the net investment in lease i.e., gross investment in lease less unearned finance income. This accounting standard recommends the use of the effective rate of interest method to allocate the unexpired finance income to the relevant accounting period.
•
The ICAI guidelines for the interim period provide for the disclosure of leased assets in the balance sheet of the lessor as “fixed assets”. These guidelines require the lessor to (a) allocate the unearned finance income over the primary lease period on some systematic basis; (b) depreciate the leased assets over its primary lease period; and (c) disclose the policies pursued with regard to income recognition and depreciation.
•
The accounting standards prescribed by IASC and ICAI are more or less similar to an operating lease. The lessee is required to allocate the aggregate rental over the lease period on the straight line basis or on any other systematic basis which is more representative of the time pattern of the user’s benefit.
•
Lease of land where the title is not transferred from the lessor to the lessee on expiry of the lease term is accounted for as an operating issue. Likewise long-term lease of buildings where there is a provision to revise rentals periodically must be accounted for as an operating lease.
•
An exploratory survey conducted to assess the reaction of the leasing industry to introduce accounting standards has revealed that lessors are not opposed to the idea of disclosing the lease commitments by way of notes in the balance sheet of the lessee. Infact, fifty percent of the respondents have favored capitalization of lease in the books of the lessee provided there is a tacit assurance from the income tax authorities that the tax treatment will not be linked to the accounting treatment. 21
HIRE PURCHASE •
Hire purchase can be defined as a contractual arrangement under which the owner lets his goods on hire to the hirer and offers an option to the hirer to purchase the goods in accordance with the terms of the contract. The two distinct features of a hire purchase transaction are: (i) the option provided to the hirer to purchase the goods at any time during the term of the agreement; and (ii) the right available to the hirer to terminate the agreement at any time before the payment of the last installment. Hire purchase plans can be of two types: (i) Down Payment Plan and (ii) Deposit Linked Plan.
•
The rate of interest quoted on a hire purchase transaction is always a flat rate. To convert the flat rate (F) into the effective rate (i) under a Down Payment Plan we can use the following approximation formula: i=
•
n .2F where n denotes the number of repayments. n +1
If the installments are payable at the beginning of each period, the relationship between i and F is given by the formula: i=
n .2F n −1
•
In the case of a deposit-linked plan, the effective rate of interest is calculated as follows: (a) The cash flows over the relevant periods are defined. (b) The rate of interest which equates the P.V. of the cash inflows to the P.V. of cash outflows is calculated. This rate of interest reflects the effective rate of interest implicit in the plan.
•
If the hirer exercises the purchase option before the payment of the last installment, then the amount to be paid by him will be equal to the aggregate amount of the outstanding hire purchase installments less an interest rebate. The true interest rebate can be calculated using the Effective Rate of Interest Method. Alternatively, it can be calculated as per the Rule of 78 given by the formula: R
=
Where, R t n D
t(t + 1) xD n(n + 1)
= = = =
interest rebate number of installments outstanding total number of installments and total charge for credit.
•
The interest rebate calculated under the Rule of 78 will be always less than the true interest rebate.
•
As far as the legal aspects are concerned, the Hire Purchase Act, 1972 provides a comprehensive coverage. But since this Act has not been made operational, the legal aspects of hire purchase transactions are governed by the provisions of the Indian Contract Act, 1872, Sale of Goods Act, 30 and the judgments pronounced by the English and the Indian Courts from time to time.
•
The income tax aspects of hire purchase transactions are governed by the provisions of a circular issued by the Central Board of Direct Taxes in 1943. According to this circular, the hirer is entitled to the tax shields on (i) depreciation calculated with reference to the cash purchase price of the asset; and (ii) the ‘consideration for hire’ or the finance charge component of the hire purchase installments. The circular provides for an even allocation of the total finance charge over the term of the hire purchase agreement.
•
As per the 46th Amendment to the Constitution, the hire purchase transactions are eligible to sales tax. However, there are court rulings which state that hire purchase transactions structured by finance companies (not dealing in the class of goods let on hire) are in essence financing transactions and therefore not liable to sales tax.
22
•
The Finance Act, 1991 reintroduced the Interest Tax Act, 1974 which provides for an interest tax at 3 percent on the interest income implicit in hire purchase transactions.
•
From the hirer’s standpoint the financial evaluation of a hire purchase vis-á-vis a lease is done by comparing the costs of hire purchase and cost of the lease. The Costs Of Hire Purchase (COHP) and Lease (COL) are defined as follows: COHP =
Down Payment + Documentation & Service Charges + P.V. (Hire purchase installments discounted at Kd) – P.V. (Depreciation Tax Shields discounted at kc) – P.V. (Net Salvage Value discounted at kc) – P.V. (Interest Tax Shields discounted at kc) – P.V. (Tax Shield on documentation & Service charges discounted at kc)
Where kd kc COL =
= Pre-tax marginal cost of debt = Post-tax marginal cost of capital. P.V. (Lease payments discounted at kd) – P.V. (Tax shields on lease payments discounted at kc)
If COHP exceeds COL, the asset must be leased; otherwise it can be acquired under the hire purchase plan. •
From the finance company’s point of view, the financial evaluation will involve comparing the Net Present Values (NPV) of the two asset-based financing plans. These NPVs are defined as follows: NPV (Finance Lease) = – Initial Investment – Initial Direct Costs + Lease Management Fee + P.V. (Lease Rentals) – P.V. (Tax on Rental Income) – P.V. (Tax on Lease Management Fee) + P.V. (Tax Shield on Direct Costs) + P.V. (Tax Shields on Depreciation) + P.V. (Net Salvage Value) NPV (Hire Purchase) =
– Loan Amount – Initial Direct Costs + Documentation & Service Fee + P.V. (Tax Shield on Direct Costs) – P.V. (Tax on Documentation & Service Fee) + P.V. (Hire Purchase Installments) – P.V. (Income Tax on Finance Income) – P.V. (Interest Tax on Finance Income) + P.V. (Tax Shield on Interest Tax)
The discount rate used is the marginal cost of capital of the company. If NPV (Finance Lease) exceeds NPV (Hire Purchase) the finance company must have a product mix weighted in favor of leasing; otherwise the product mix must be slanted in favor of hire purchase. In practice NPV (Hire Purchase) tends to exceed NPV (Lease). •
A hire purchase transaction is reflected in the books of accounts of the hirer as follows: (a) The cash purchase price of the asset is capitalized and an amount equal to the cash purchase price less downpayment is recorded as a liability. (b) Depreciation is charged on the cash purchase price in line with the depreciation policy pursued by the hirer for similar owned assets. (c) The total charge for credit is spread over the accounting periods (constituting the hire term) based on one of the following methods: (1) Effective Rate of Interest Method (2) Sum of the Years Digits Method or (3) Straight Line Method.
•
In the books of the finance company, the hire purchase installments receivable is shown as a current asset under the head ‘Stock on Hire’ and the (unearned) finance income component of these installments is shown as a current liability under the head ‘Unmatured Finance Charges’. The unearned finance income is spread over the accounting periods using one of the methods listed above. The direct costs associated with the transaction is either expensed immediately or suitably amortized over the relevant accounting periods. 23
CONSUMER CREDIT •
The term consumer credit encompasses all types of asset based financing plans offered primarily to acquire consumer durables. A typical credit transaction is one where the customer pays a small fraction of the cash purchase price on delivery of the goods and agrees to pay the balance with interest over a specified period of time.
•
The consumer credit industry in India grew at a phenomenal rate in the late eighties, thanks to the efforts of Citibank and other multinational banks in creating a widespread awareness of the concept. Consumer credit is made available for cars, two-wheelers, personal computers and high-value household gadgets like TVs, VCRs, washing machines, refrigerators, food processors, etc.
•
The financing institution screens individual credit applicants on the criteria of gross annual income, take-home salary and tenure of employment with the present employer. In the case of business organizations, it looks for a profitable track-record and a minimum level of sales, net worth, and cash profit.
•
The consumer loans usually carry a flat rate of interest that varies between 13%–15% and a repayment period that varies between 12 and 60 months. The repayment is required to be made by issuing post-dated cheques at the time of availing the loan. The loan is secured by a first charge on the asset concerned and is also guaranteed by a guarantor.
•
The consumer finance schemes can be of the down-payment type or of the deposit-linked type. In the deposit-linked schemes, the term to maturity of the deposit is matched with the credit period. The deposit earns a nominal rate of interest not exceeding 15 percent.
•
Consumer credit is not regulated by separate legislation in India. But in most countries where the practice is in popular use, it is subject to a detailed legislative framework which, inter alia, seeks to (a) make the customer more aware of the true cost of credit implicit in a lending scheme; and (b) protect the customer against the unscrupulous ones as soon as the agreement is made. Examples of such legislations are the Consumer Credit Act, 1974 of the UK and the Consumer Credit Protection Act, 1968 of the US.
•
One of the important steps to manage a consumer credit portfolio is to streamline the procedure evaluating credit applicants. To pre-screen the credit applicants, mechanical credit-scoring system can be used. These systems can be developed using sophisticated statistical techniques like the Multiple Discriminant Analysis (MDA).
•
Managing a Consumer Credit Portfolio effectively calls for accounting records that are accurate and consistent and persistent collective efforts.
FACTORING AND FORFAITING •
Factoring can be defined as the sale of book debts by a firm (client) to a financial intermediary (factor) on the understanding that the factor will pay for the debts purchased as and when they are collected or on the guaranteed payment date fixed in relation to the maturity dates of the debts purchased. So, the factor basically manages the collection of debts on behalf of the client and maintains the sales-ledger. To render these services, he charges a commission which is expressed as a percentage of the value of debts purchased.
•
The factor often provides a prepayment (advance payment) up to a specified percentage of the debts purchased and charges interest on the prepayment for the period between the date of prepayment to the date of collection or the guaranteed payment date. This arrangement is referred to as the advance factoring arrangement. If the factor provides credit protection to the client, the factor assumes the risk of bad debt loss – the arrangement is referred to as Non-Recourse Factoring. A factoring arrangement which provides the services of collection, sales-ledgering, finance and credit protection is referred to as Full factoring or Old line factoring.
24
•
Factoring differs from bill discounting in the following respects: (i) In a bill discounting arrangement, the financial intermediary does not assume the responsibilities of sales-ledger administration and collection of debts which the factor does under the factoring arrangement. (ii) Unlike factoring, no notice of assignment is provided to the customers of the client under the bill discounting arrangement. (iii) The bill discounting arrangement is with recourse to the client whereas a factoring arrangement can be without recourse.
•
The legal relationship between the factor and the client is governed by the provisions of the factoring agreement. Under this agreement, the client (i) warranties that the debts sold are valid, enforceable, undisputed and recoverable; (ii) undertakes to settle problems of dispute, damages and deductions in relation to the bills assigned to the factor; and (iii) provides copies of all relevant credit sales invoices along with proof of dispatch to the factor. As between the factor and the customer, the legal status of the factor is that of an assignee. Once the notice of assignment is served to the customer, he is under a legal obligation to pay the factor.
•
From the client’s angle, factoring offers the following advantages: (i) Factoring reduces the uncertainty associated with collections thereby reducing the cash float and improving the velocity of current assets turnover ratio. (ii) Since the factor assumes the responsibility to collect and credit administration, the firm can sharply focus on market development. (iii) Unlike other forms of financing, advance factoring does not impair the current ratio of the firm. In fact, through a judicious use of the funds made available by the factor, the client can improve the current ratio. Although factoring offers a number of advantages, a firm which has been managing its receivables must necessarily do a costbenefit analysis before resorting to factoring.
•
In the Indian context, factoring is still in the pioneering state. Based on the recommendations made by the High Powered Committee under the Chairmanship of Shri C S Kalyanasundaram, the Reserve Bank of India has permitted commercial banks to promote factoring subsidiaries. At the time of writing, the two factoring companies in operation are the SBI Factors & Commercial Services Limited and the Canbank Factors Limited. Both these companies offer recourse factoring facility with respect to inland receivables with a provision for prepayment up to 80 percent of the value of the receivables. The commission charged varies between 1-2 percent of the value of receivables and the discount charge varies between 19-22 percent per annum.
•
While factoring has a large market to cater, there are some operational problems to be sorted out before factoring can graduate to the rapid growth stage. First there is a need for credit information services that will provide reliable credit information for a large number of business firms. Without this service, the factor will find it extremely difficult to evaluate the credit quality of his client’s receivable portfolio.
•
Second, the funding norms applicable to factoring companies must be clearly spelt out and these companies must be placed on par with leasing and hire purchase companies in terms of the eligibility to raise debt. Finally, factoring transactions must be exempted from the levy of stamp duty (which is now applicable to assignment of any form of debt) so that the transaction costs are reduced.
SECURITIZATION •
Securitization is the process of selling assets by the person holding them to an intermediary who in turn will break such assets into marketable securities. Any resource that has a predictable cash flow can be securitized. The person holding the assets is called the originator and the entity specially created for the purpose of transfer of assets is called Special Purpose Vehicle (SPV). The underlying assets should preferably be homogenous in nature and of same quality, in terms of the risk associated with them or their maturity periods. The marketable securities are called Pay or Pass through Certificates and the investors may be banks, mutual funds, government, etc.
•
If the process of securitization is backed by assets, it is called Asset-Backed Securitization (ABS). If the deal is backed by mortgage it is called Mortgage-Backed Securitization (MBS). 25
•
All credit rating agencies rate securitization deals and consider only those assets that are to be securitized in the balance sheet of the originator. Such ratings will have a ‘SO’ suffixed to the deal to indicate the instrument is a ‘Structured Obligation’ and has met all the parameters of credit rating.
•
Longer maturity loans can be converted into short-term marketable securities in whole loan securitization and the rights and responsibilities are transferred to the purchaser. In such a case, the seller may retain the right to service the loans and also the right to initiate foreclosure proceedings in case of default.
•
Mortgage Participation Certificates are designed to reduce the amount of loan by loan review that is needed to be performed by a purchaser of a pool of loans.
•
Mortgage Pass-Through Certificates are created when mortgages are pooled together and the undivided interest in the pool is sold. The originator of these certificates can either issue a private pass-through security or a pass-through security backed by a guarantor.
•
Mortgage-Backed Bond is a collateralized term-debt offering, secured by mortgages with a market value that is far more than the principal amount of the bond. The mortgages are not sold to the holder of the security, but are used as collaterals for the bonds which are used to raise finance.
•
Advantage of securitization: Securitization provides liquidity to the originators. Securitized debt is cheaper and with this deal the originator can beat the rating given by the rating agencies and diversify the credit risk. NBFCs can plan their capital adequacy requirements by using securitization to reduce the risk weighted assets.
•
The concept of securitization has not picked up in India yet due to the absence of an active secondary market, heavy stamp duties, strict foreclosure norms and other legal and regulatory aspects.
MORTGAGES AND MORTGAGE INSTRUMENTS •
•
Mortgage is the pledge of property to secure payment of a debt. If the mortgagor fails to pay to the lender, then the lender can foreclose the loan, seize the property and sell in order to realize his dues. i.
Mortgage verifies the amounts outstanding on any other loans taken by the borrower;
ii.
The net worth and the monthly/annual income of the borrower from all sources.
The two basic rules to assess the repaying capacity of the borrower are: i.
Total mortgage payment should not exceed 25% of the borrower’s total income less any obligations.
ii.
Total mortgage payments plus other housing expenses should not exceed 33% of the borrowers total income less all payments due to other obligations.
•
Originator (original lender) services the mortgage loan of the borrower.
•
Originator continues to service the loan even if the mortgage loan is sold to some one.
•
The Loan-To-Value (LTV) ratio indicates the percentage of down payment required by the lenders from the borrower, it creates a margin of safety for the lender in case of any default by the borrower or short fall in realization. A loan to value ratio of 80% means that the down payment is 20%.
•
Morgtages are classified into traditional and non-traditional mortgages.
•
In the traditional mortgage the interest is charged on the loan for the entire term and the loan is to be repaid in equated monthly installments which contain both principal and interest components.
26
•
The amount of principal outstanding at any time is called mortgage balance. The difference between the current market value of the home and the mortgage balance is called homeowner’s equity.
•
The non-traditional mortgages are also called Alternative Mortgage Instruments (AMI). They do not have monthly installments and the repayment structure is different.
•
In Graduated-Payment Mortgages (GPM), the payments start at a low level, rise for a specified number of years and then become equal after a specified number of years as per the mortgage agreement.
•
In Pledged-Account Mortgages (PAM) the borrower deposits the portion of the down payment in a savings account. Hence, the repayment of installments will be structured such that PAMs appear as GPMs from the borrower’s point of view and traditional mortgages from the lender’s perspective.
•
A Buy Down loan is arranged by the seller of the property. The seller places cash in a separate account and indirectly fulfills the down payment requirement of the borrower. The mortgage lender may not allow the inbuilt high cost of the property.
•
Adjustable Rate Mortgage has complex features. They can have maturities as well as interest rates. The mortgage interest rate is based on index rate. Periodic gap and lifetime gap are two distinct common features of ARMs. The major disadvantage of ARMs is that they cannot be sold in pooled or security form as there are no standard clauses in ARMs.
•
In Share-Application Mortgages the borrower pays a very low interest on the funds but shares a part of the increase in the property value with the lender when the property is sold or the loan matures.
•
Mortgage Pass-Through Certificates are created when mortgages are pooled together and the undivided interest in the pool is sold. The originator of these certificates can either issue a private pass-through security or a pass-through security backed by a guarantor.
•
The Collateralized Mortgage Obligations (CMO) are the bonds or debt obligations issued by mortgage originators by offering whole loan mortgages or mortgage pass-through certificates as collateral. The cash flows generated by the assets in the collateral pool are first used to pay interest and then the principal to the CMO bondholders.
REAL ESTATE FINANCING: RISK AND RETURN •
Real Estate Financing is predominant in the West which is done in the form of asset-based financing.
•
A real estate transaction is tripartite involving exchange of economic resources between a seller, buyer and in most of the cases, a financial entity.
•
Three types of properties exist for financing. They are: (a) Property occupied by the purchaser (b) Property developed to provide for continuous income and (c) Property developed for sale.
•
Real estate differs from other assets in many ways.
•
Some of the aspects of real estate are: (a) Durability (b) Require substantial outlay of funds (c) Transaction cost tend to be higher (d) Takes a large physical space (e) Value of the real estate depends on various parameters concerning local and regional economic conditions (f) A good hedge against inflation and (g) Tax treatment is favorable for real estate investments.
•
Real Estate Financing may be done essentially in three broad segments: (a) Acquisition development or improvement financing (b) Construction financing and (c) Permanent financing.
•
Prominent sources of real estate financing in US are: (a) Commercial Banks (b) Savings and Loan Associations (c) Life Insurance Companies (d) Pension Funds (e) Real Estate Investment Trusts (f) Foreign Investors (g) Mortgage Companies.
27
HOUSING FINANCE IN INDIA •
The Indian housing finance industry comprises Housing and Urban Development Corporation (HUDCO), the National Housing Bank (NHB), co- operative housing finance societies, insurance companies, commercial banks, co-operative banks and 26 companies approved by the NHB, the apex financial institution in India for housing loans.
•
NHB was formed as a subsidiary of the RBI when the National Housing Policy was announced in 1988 to regulate housing finance industry in India. The NHB Act stipulates various norms for other housing finance companies. The NHB provides refinance facilities to Housing Finance Companies (HFC).
•
The NHB prescribes regulatory guidelines for various HFCs relating to the capital adequacy norms, income recognition norms, loans/lending norms, interest rate ceilings for loans of various maturities and the procedures to conduct general business.
•
HFCs insist on two guarantors as sureties for the proposed loan. HFCs should consider lending to sound, healthy and viable proposals which satisfy all the eligibility criteria prescribed by the NHB.
•
The loan application will be appraised in three steps – Credit appraisal, Legal appraisal and Technical appraisal.
•
Objective of credit appraisal is to assess the applicant’s sustained repayment capacity over the loan period.
•
In legal appraisal the HFC will scrutinize the documents to confirm that the title to the property is clean and the applicant can create a charge (mortgage) in favor of the HFC.
•
In technical appraisal HFC will verify all the information, records, approvals, clearances, certificates etc., submitted by the applicant.
•
The NHB guidelines prescribe a maximum permissible loan of 70% of the cost proposed including land cost. The difference between the property cost and the maximum loan permissible is called the margin or own contribution and it is to be met by the applicant.
•
The loan repayment shall be in Equated Monthly Installments (EMI), which cover both principal and interest components.
•
After the appraisals and fixation of loan amount, the HFC accords sanction of the loan.
•
The NHB launched the Home Loan Account Scheme to individuals on 1 July, 1989 and the same is being offered by 28 public sector banks, 24 private banks and select state cooperative banks and urban co-operative banks.
•
The HDFC is the leading HFC in India and offers various housing loans to individuals and NRIs. HDFC also offers Line of Credit (LOC) to the corporate employees for their homes in two methods. In LOC ‘Thru’ the employees nominated by the company are the borrowers. In LOC ‘TO’ the company itself takes the loan and later disburses it among its employees.
•
The LIC Housing Finance is another premier housing finance company in India offering various housing loan schemes.
•
The government is taking various steps to facilitate the growth of housing sector in India. The housing sector has been accorded the infrastructure status and many concessions exist in the Income Tax and Wealth Tax Acts for individuals and companies engaged in this business. The Income Tax Act allows deduction of interest on the borrowed capital meant for housing purposes of individuals.
•
HDFC has securitized housing loans worth Rs.50 crore through IL & FS but securitization of housing loans has certain constraints such as stamp duty.
•
NHB has come out with Pass Through Certificate mechanism for securitization.
•
The RBI has relaxed certain conditions in sanctions of housing loans by banks.
28
PLASTIC MONEY •
A credit card (or plastic money) is a payment mechanism which allows the cardholders to purchase goods/services without paying money immediately. The payment could be made up-front or over several installments after a specified period of time by availing credit from the issuer of the card.
•
There are four parties to a credit card transaction (i) card issuer, (ii) customer, (iii) member establishment and (iv) franchiser of the credit card.
•
The principal issuers of credit cards are the banks; the customers can be the salaried individuals, business people and companies. The Member Establishment (ME) is any firm or outlet that is enlisted by the credit card issuer to accept credit card for the goods purchased or the services rendered. The franchisers are those that permit the use of their brand name and act as clearing agencies. Master Card and Visa Card are the major franchisers in the world.
•
Sometimes there would be Member Affiliates (MA) who enter into a tie-up with the issuer so that they can issue their own cards which are similar to those of the issuer except that the MA’s name and logo will also appear on the card apart from the issuer’s.
•
The principal source of income to a credit card issuer is the percentage commission collected from the MEs on the goods/services sold through credit cards. The issuer charges interest on the balance unpaid by the customer for the period beyond the expiry of the credit period.
•
The debit card is a ‘Pay Now’ mechanism whereby the account of the customer will be debited immediately to the extent of the transaction value.
•
Issuers will issue credit cards to the customers after due evaluation of his/her creditworthiness.
•
The credit limit and the payment terms will be determined by the issuer. While issuing the card, entrance fee and annual service charge are collected. The card becomes operational as soon as it is issued. When a customer presents it to a ME, the retailer checks the authenticity of the card by tallying the signature of the customer with the one on the card. The ME approaches the issuer bank periodically with the sales vouchers and the purchase statement. The bank pays the amount after deducting a fixed commission on the amount.
•
The credit card industry in India is growing fast. To cope with the increasing competition in the credit card industry, banks in India are offering additional facilities to their cardholders such as free personal accident insurance, cash withdrawal facility, temporary increase in credit lines, add-on facility to dependents who are majors, leveraged investment facility, etc.
SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF FINANCIAL SERVICES •
NBFCs are companies involved in providing financial services in India. They perform various activities like leasing, hire purchase, bill discounting, etc.
•
The RBI has set-up certain rules for acceptance of deposits by NBFCs, including a minimum credit rating, limit for public deposits and the procedure for acceptance of public deposits.
•
There are regulations for premature withdrawal of deposits, brokerage payment, etc.
•
The income of an NBFC should be recognized as: Term loans beyond one year, lease rentals/hire purchase installments, bills purchased/discounted and other credit facilities. 29
•
Similarly, assets of an NBFC are classified as: Standard assets, sub-standard assets, doubtful assets and loss assets.
•
The capital adequacy norms for NBFCs depend on risk weighted capital ratio, preference shares, revaluation reserves, general provisions and loss reserves, hybrid capital instruments, subordinated debt, minimum capital funds requirement and risk weighted assets and off-balance sheet items.
•
The capital of the NBFC is divided into Tier I and Tier II capital.
30
Part I: Questions On Basic Concepts INVESTMENT BANKING, FINANCIAL SYSTEMS AND FINANCIAL MARKETS 1.
2.
3.
4.
5.
6.
Which of the following is/are not the function(s) of the financial system? a.
Mobilize savings to provide a potentially profitable and low risk outlet.
b.
Ensure smooth flow of funds from savings into investments.
c.
Ensure that savings will transform into the necessary credit for investment and spending purposes.
d.
Both (b) and (c) above.
e.
None of the above.
Who among the following are the player(s) in the money market? a.
Banks.
b.
The Government.
c.
Individuals.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Which of the following is/are example(s) of open market? a.
A bought out deal.
b.
A car loan.
c.
Public issue of securities.
d.
Housing finance.
e.
Both (a) and (c) above.
Financial Markets are said to be perfect when a.
All the information relating to the security is available to all the players in the market
b.
The market price of the security reflects all the available information
c.
The participants in the markets have homogenous expectations
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
Who among the following is/are the intermediary(ies) in the Capital Market? a.
Underwriters.
b.
Primary Dealers.
c.
Investment Bankers.
d.
Registrars.
e.
All of (a), (c) and (d) above.
Which of the following is/are consequence(s) of the presence of intermediaries in the financial markets? a.
Intermediaries ease the funds flow process taking place in the financial markets.
b.
The cost of lending and borrowing may rise due to the presence of intermediaries.
c.
The presence of intermediaries in a market that is not well regulated increases the risks to the investors.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Investment Banking and Financial Services
7.
8.
9.
Which of the following is not an important consideration of the issuer while designing an instrument? a.
Minimizing the cost of funds.
b.
Minimizing tax liability.
c.
The repayment schedule of the instrument.
d.
Market conditions.
e.
None of the above.
Which of the following is/are characteristic(s) of the money market? a.
It is a wholesale debt market.
b.
Only highly liquid and short-term instruments are dealt in the money market.
c.
The instruments dealt in the money market constitute high risk.
d.
Both (a) and (b) above.
e.
Both (a) and (c) above.
Which of the following is/are true of the primary market? a.
It is a place for issue of fresh (new) securities.
b.
The primary market provides liquidity to the investors.
c.
The transactions taking place in the primary market outnumber the transactions taking place in the secondary market.
d.
The securities issued in the primary market will necessarily have to be listed on the stock exchanges to enable trading activity.
e.
Both (a) and (d) above.
CREDIT MARKET 10.
11.
12.
32
The Indian credit market is dominated by which of the following players? a.
Corporates.
b.
Mutual Funds.
c.
Banks.
d.
Individuals.
e.
Government.
The credit market a.
Operates in a disintermediation stage
b.
Allows funds to flow to an intermediary which invests in the securities issued by the corporates
c.
Operates in an intermediate stage due to lack of infrastructural support for direct flow of funds to take place
d.
Both (b) and (c) above
e.
None of the above.
Which of the following statements is/are true? a.
The overdraft facility is provided to corporates to finance their long-term requirements.
b.
In the overdraft facility, the bank will allow the firm to overdraw from its current account to a predetermined level of credit.
c.
Under the overdraft facility, the credit limit is sanctioned against the security of commodity stocks.
d.
Both (a) and (b) above.
e.
Both (b) and (c) above.
Part I
13.
14.
15.
16.
17.
In India, priority sector lending constitutes about ____ percentage of the total funds provided as loans by banks in that particular year. a. 10 b. 20 c. 30 d. 40 e. 50. Which of the following statements is/are true? a. Consortium lending helps banks to minimize their risk by diversifying their term loan portfolio. b. When consortium lending is resorted to, banks have joint appraisal and subsequent follow-up of projects for which loans are given. c. In consortium lending, one bank meets the short-term requirements of the corporate while another bank meets the long-term requirements. d. Both (a) and (b) above. e. Both (b) and (c) above. Which of the following statements is/are false regarding cash credit facility? a. It is provided by banks for financing working capital needs of corporates. b. It is an unsecured advance. c. It is repayable on demand. d. Interest on this facility is charged on the credit limit sanctioned. e. Both (b) and (d) above. Intermediaries base their lending rate decisions on which of the following criteria? a. Cost of funds. b. Transaction costs. c. Required spreads. d. Both (a) and (c) above. e. All of (a), (b) and (c) above. Indus Financial Institution has received a loan proposal from a client. Given the following information what should be its lending rate? Transaction costs Bank rate a. 10 percent.
– 1.5 percent – 10 percent
b.
14.5 percent.
c.
Bank rate plus required spread.
d.
Bank rate plus transaction costs.
e.
Minimum of (a) and (b) above.
MONEY MARKET Introduction to Money Market 18.
For its proposed project of constructing a national highway, which of the following instruments can be used by the Government to raise funds from the money market? a. 91-day treasury bill. b. 182-day treasury bill. c. 364-day treasury bill. d. Government dated securities. e. Both (c) and (d) above. 33
Investment Banking and Financial Services
19.
20.
21.
22.
23.
24.
25.
34
Which of the following instruments is/are considered to be risk-free instrument(s)? a. Treasury bills. b. Government dated securities. c. Commercial paper. d. Certificate of deposits. e. Both (a) and (b) above. Which of the following features is/are characteristic(s) of money market mutual funds? a. Low liquidity. b. Low risk. c. High returns. d. Both (a) and (c) above. e. Both (b) and (c) above. Which of the following statements is/are true? a. The interest rate risk/market risk is minimum in the money market. b. In a declining interest rate scenario, investors of money market instruments are exposed to reinvestment risk. c. Government securities are considered as risk-free securities due to the absence of default risk. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. Monetary contraction can be made possible by a. Decreasing the CRR b. Increasing the SLR c. Resorting to open market purchases d. Both (b) and (c) above e. All of (a), (b) and (c) above. Primary dealers are required to have net owned funds of a minimum of Rs. _____. a. 30 crore b. 40 crore c. 50 crore d. 60 crore e. 70 crore. Which of the following instruments has the highest risk levels? a. Treasury Bills. b. Certificate of Deposits. c. Commercial Paper. d. Promissory Note. e. Both (c) and (d) above. The required amount of successful bids by a primary dealer who participated in the bidding for government securities is Rs.540 crore. The commitment to aggregate bidding would have been a. Rs.1,350 crore b. Rs.1,620 crore c. Rs.2,000 crore d.
Rs.2,050 crore
e.
Rs.2,200 crore.
Part I
26.
27.
28.
29.
30.
31.
Which of the following best describes the objective of the Statutory Liquidity Ratio? a.
It restricts the expansion of bank credit.
b.
It augments the investment of the banks in government securities.
c.
It ensures solvency of the banks.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Which of the following statements relating to short-term fund management is/are true? a.
A financial institution need not be concerned about short-term fund management since it deals only in large amounts.
b.
Banks can manage their short-term deficits by diverting their long-term funds.
c.
Government actively participates in lending short-term funds.
d.
Short-term fund management of the households affects the liquidity in the system.
e.
All the above.
For a forthcoming project on public transportation, the government is planning to raise funds. Which of the following instruments can be used to raise the funds in the money market? a.
364/91-day T-Bills.
b.
182-day T-Bills.
c.
Dated securities.
d.
Both (a) or (c) above.
e.
None of the above.
Royal Steels Ltd., a highly rated company, requires on an average Rs.5 cr for the next 15 days after which it expects sufficient cash inflows. To meet this short-term deficit, it plans to issue CPs. The treasurer is against the issue of CPs. Which of the following statements best argues his case? a. The maturity period of CPs will reduce the cost of funds for the company. b. It can raise cheaper funds for 15 days by way of ICDs. c. It can borrow from the call market on each day as per the requirement as it will reduce its costs and risks. d. It can raise a term loan from bank. e. None of the above. The yields of the money market instruments are closely linked to each other. If CD rates are ranging between 11-13% and if the bank PLRs are ranging between 14-16%, which of the following range of rates will hold good for CPs? a. CP rates will range between 11-16%. b. CP rates will range between 13-16%. c. CP rates will range between 11-14%. d. The floor for the CP rates will generally be set by the PLRs. e. The ceiling for the CP rates will generally be set by the CDs. Swift Gilts Ltd., a primary dealer in the Indian money market, participated in the T-Bills auction during the year. If the successful bids to be maintained by Swift Gilts Ltd. is given as Rs.420 cr., then its commitment to aggregate bidding would have been a. Rs.1,260 cr. b. Rs.1,050 cr. c. Rs.168 cr. d. Rs.140 cr. e.
None of the above. 35
Investment Banking and Financial Services
32.
33.
34.
35.
36.
Swift Gilts Ltd. had tendered bids of Rs.500 cr. in the auction T-bills which were accepted. Using the information given in question (31) above, state which of the following statements is/are true? a.
Swift Gilts Ltd. has adhered to its commitments and successful bids.
b.
Swift Gilts Ltd. has adhered to its commitments only.
c.
Swift Gilts Ltd. has adhered to its successful bids only.
d.
Swift Gilts Ltd. has neither adhered to its commitments nor the successful bids.
e.
Insufficient data.
Which of the following can be expected in a rising interest rate scenario? a.
Monetary restrictions can be imposed in order to contain the interest rate rise.
b.
The RBI may enter into reverse repo transactions.
c.
The RBI can conduct open market purchases of G-Secs to lower the interest rates.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
Which of the following statements can be true for a system having excess liquidity? a.
There may be a rise in the call rates.
b.
Banks would prefer to enter into repo transactions to ease the situation.
c.
There may be a rise in the statutory reserve requirements.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
Which of the following statements will be true, if there is a cut in the bank rate? a.
There may be a fall in the interest rates on CP.
b.
There may be a fall in the Prime Lending Rates (PLR).
c.
There may be a fall in the interest rates on IBPs.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Market risk in money market investments arises in which of the following cases? a.
If the interest rates are declining at the time of redemption of the money market investments.
b.
If the change in the average prices results in decreasing the purchasing power of the investor.
c.
If there are fluctuations in the rates of instruments in the money market.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
Call Money 37.
36
Who among the following can act only as a lender in the call market? a.
Banking Companies.
b.
Financial Institutions.
c.
DFHI.
d.
STCI.
e.
Both (c) and (d) above.
Part I
38.
39.
40.
41.
42.
43.
44.
Which of the following is/are true? a. Call money is lent mainly to even out the short-term mismatches of assets and liabilities. b. Call money is used to meet CRR requirements of banks. c. Money is borrowed in the call market for short periods for discounting commercial bills. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. Which of the following is/are the characteristics of the Indian call money market? a. Call loans have a maturity of more than a fortnight in India. b. Call loans are unsecured in India. c. Transactions in the Indian call money market are characterized by seasonal variations. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. ‘Term Money’ is the money that is a. Lent for one day b. Lent for a period varying from 1 to 14 days c. Lent for a period varying from 2 to 15 days d. Lent for more than 14 days e. None of the above. Notice money refers to the money a. Lent in the call market for less than 14 days b. Lent in the call market, and a notice is served for making the payment before the due date c. Lent in the call market for more than 14 days d. Both (a) and (b) above e. All of the above. Intermediaries like DFHI and STCI in call money market can a. Only lend in the call market b. Only borrow in the call market c. Lend and borrow in the call market d. Can borrow in specific instances e. Can lend if they find an arbitrage opportunity. Money is lent/borrowed in call money market a. For evening out the short-term mismatches of assets and liabilities of banks b. For earning interest on short-term funds that are available to the banks as surplus c. For discounting the commercial bills in the market d. For meeting statutory requirements of the bank e. All of the above. Call loans in US are a. Extended by banks to security brokers for buying common stock b. Extended by banks to dealers in government securities c. Borrowed to meet the reserve requirements of banks d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above. 37
Investment Banking and Financial Services
Treasury Bills 45.
46.
47.
48.
49.
50.
38
Which among the following is/are the characteristic(s) of a treasury bill? a.
Eligibility for inclusion in SLR.
b.
Assured yield.
c.
Low liquidity.
d.
Negligible capital depreciation.
e.
All of (a), (b) and (d) above.
Treasury bills are issued for a minimum of ____ days and a maximum of ____ days. a.
14 and 28
b.
14 and 91
c.
14 and 182
d.
14 and 364
e.
14 and 365.
The face value of a 364-day T-bill is Rs.100. If the purchase price is Rs.86, then the yield on such a bill is a.
12.45%
b.
13.36%
c.
16.32%
d.
16.56%
e.
17.13%.
Which of the following is a characteristic feature of ad hoc treasury bills? a.
They are issued and made available to the public.
b.
These bills serve the purpose of replenishing cash balances of the Central Government.
c.
These bills have maturity period of 364 days.
d.
They carry a discount of 6.4 percent.
e.
They can be extinguished only on maturity.
The 182-day treasury bills cannot be purchased by a.
State Governments
b.
Provident Funds
c.
Individuals Resident in India
d.
Both (a) and (b) above
e.
Both (b) and (c) above.
Which of the following statements is/are true? a.
Treasury bills carry a coupon rate.
b.
Treasury bills are issued at a discount.
c.
The yields on treasury bills is higher when compared to other money market instruments.
d.
The yields on T-bills are considered as a representative of interest rates in the economy in general.
e.
Both (b) and (d) above.
Part I
51.
52.
53.
54.
55.
56.
57.
Which of the following statements is/are false? a. Treasury bills are issued by both the Central and State Governments. b. Though the tender for treasury bills is invited for competitive bids, bids will be allotted to both competitive and non-competitive bids. c. The purchases and sales of treasury bills is effected through the Subsidiary General Ledger (SGL) account maintained by the RBI for the investors. d. Both (a) and (b) above. e. Both (b) and (c) above. In the US markets, non-competitive bids are submitted by a. Large investors b. Banks c. Securities dealers d. Small investors e. Both (a) and (b) above. Treasury bills are raised by the a. Banks to meet their short-term liabilities b. Corporates to meet their short-term liabilities c. The RBI to meet short-term liabilities d. The RBI to meet government requirements e. Both (c) and (d) above. Which of the following instruments has highest liquidity? a. Certificate of Deposit. b. Dated Securities. c. Treasury Bills. d. Commercial Paper. e. Commercial Bills. Distinctive features of treasury bills are a. Zero default risk b. High liquidity c. High coupon rates d. Both (a) and (b) above e. All of (a), (b) and (c) above. T-bills are in the form of a. Promissory notes b. Finance bills c. Discounted bills d. Credit to SGL accounts e. All of (a), (b) and (d) above. Which of the following statement/s is/are true in case of non-competitive bidders? a. They submit the tenders giving price and amount. b. State Governments, PFs, FIs, Insurance Companies, Nepal Rastra Bank come under the category of non-competitive bidders. c. They can submit multiple bids. d. Their bids are accepted at the weighted average price of successful competitive bidders. e. All of the above. 39
Investment Banking and Financial Services
58.
59.
60.
61.
62.
Which of the following statements is/are true in case of 364-day T-bill? a. They are auctioned on a monthly basis. b. The RBI does not notify the amount in advance i.e. during notification. c. The RBI does not interfere in the auction of these bills. d. They are not rediscounted by the RBI. e. Both (b) and (c) above. Ad hoc T-bills are issued to a. The RBI b. FIs and Banks c. Non-competitive bidders d. General public e. Both (a) and (c) above. The treasury bills that are available for investment now are a. Ad hoc T-bills b. On tap T-bills c. Auction T-bills d. Both (b) and (c) above e. All of the above. Which of the following statements is false? a. Treasury bills are issued by the RBI to facilitate government borrowing. b. Treasury bills help in OMO of the RBI. c. Treasury bills serve as a medium for short-term investments. d. Yields on T-bills are considered as a benchmark for other short-term investments. e. None of the above. In the US, the strip bills form a part of a. Irregular series bills b. Regular series bills c. Cash management bills d. Both (a) and (c) above e. None of the above.
Commercial Paper (CP) 63.
64.
40
Which of the following statements is true regarding commercial paper? a. Companies raising funds through commercial paper have to satisfy the eligibility criteria prescribed by SEBI. b. A commercial paper is a long-term, secured promissory note issued by companies for raising funds. c. NRIs can invest in commercial paper only on a non-repatriable and non-transferable basis. d. Commercial paper has a maximum maturity of 180 days. e. The minimum size of each commercial paper issue is Rs.20 lakh. Commercial paper a. Originates from a specific trade transaction b. Does not originate from a specific self-liquidating transaction c. Issued to the investors through intermediaries is called dealer paper d.
Both (a) and (c) above
e.
Both (b) and (c) above.
Part I
65.
66.
67.
68.
69.
70.
Commercial paper a.
Constitutes a cheap source of funds to corporates when compared to bank finance
b.
Provides returns to investors that are lower when compared to the banking system
c.
Is highly liquid as it is a negotiable/ transferable instrument
d.
Is not backed by any assets and hence it is unsecured
e.
All of (a), (c) and (d) above.
The brokerage charged on commercial paper having a maturity period of 6 months is _____ of the issue amount. a.
0.025%
b.
0.050%
c.
0.100%
d.
0.125%
e.
0.250%.
A company planning to raise money through issue of commercial paper should a.
Have a tangible net worth of not less than Rs.10 crore as per the latest audited statement
b.
Company has been sanctioned working capital limit by banks or All India Financial Institutions
c.
Have a minimum current ratio of 1.33:1 as per the latest audited balance sheet
d.
Both (b) and (c) above
e.
All of (a), (b) and (c) above.
Identify the reasons that can be attributed to the underdevelopment of the CP market. a.
Restricted entry of corporates
b.
High effective cost of issuing commercial paper
c.
Absence of tax benefits
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
X purchased a commercial paper of Sterling Inc., issued for 90 days in the market for 9,84,840 dollars. The company issued the commercial paper with a face value of 10,00,000 dollars. The rate of return which X earns is a.
6%
b.
6.15%
c.
6.24%
d.
6.56%
e.
7.05%.
The credit rating obtained by companies tapping the commercial paper market a.
Should not be more than one month old
b.
Should not be more than two months old
c.
Should not be more than three months old
d.
Should not be more than four months old
e.
Should not be more than five months old. 41
Investment Banking and Financial Services
71.
72.
73.
74.
75.
76.
42
Which of the following statements is/are true? a.
Only listed companies are eligible to issue commercial paper.
b.
The aggregate amount that can be raised by issuing commercial paper can be more than the fund based working capital limit sanctioned by banks to the issuer company.
c.
A company issuing commercial paper should acquire a minimum credit rating of P2 from CRISIL.
d.
A single investor willing to enter the CP market needs to invest Rs.50 lakh as minimum investment.
e.
All of (a), (b), (c) and (d) above.
Which of the following statements is/are false? a.
CP is issued in the form of unsecured usance promissory note.
b.
CP arises out of self-liquidating transactions like commercial bills.
c.
CPs are generally backed by fixed assets.
d.
CPs provide a cheaper source of finance to companies.
e.
Both (b) and (c) above.
The maturity period of CP ranges from a.
Three months to six months
b.
Fifteen days to one year
c.
One month to one year
d.
Thirty days to one year
e.
Thirty days to ninety days.
Corporates prefer CPs due to a.
Less paperwork and other formalities
b.
High liquidity
c.
Lower interest rates
d.
Free transferability
e.
Both (a) and (c) above.
The minimum investment required for a single investor in CP market is: a.
50 lakh
b.
25 lakh
c.
5 lakh
d.
1 lakh
e.
No stipulated amount.
Which of the following is not a condition for issuing CP? a.
The company should be listed on one of the SEs.
b.
The fund based working capital limit of company should not be less than Rs.4 crore.
c.
The tangible net worth of the company should not be less than Rs.4 crore.
d.
The company should reduce the working capital limits by the amount of CP issue.
e.
The company needs to obtain specified rating.
Part I
Certificate of Deposits (CDs) 77.
78.
79.
80.
81.
82.
Which of the following is/are false regarding Certificate of Deposits (CDs)? a.
They are issued by corporates in the form of usance promissory notes.
b.
They are available for subscription by non-resident Indians on a repatriable basis.
c.
They are negotiable as they are payable either to the bearer or to the order of the depositor.
d.
They are also known as negotiable certificates of deposits because of their negotiable nature.
e.
Both (c) and (d) above.
Issuers of CDs are benefited as a.
All investors will be paid the same rate of interest
b.
Availability of funds is assured for a specific period
c.
Interest will be determined on a case to case basis
d.
Both (a) and (b) above
e.
Both (b) and (c) above.
CDs issued by a financial institution will have a minimum maturity period of a.
3 months
b.
6 months
c.
12 months
d.
24 months
e.
36 months.
Identify the statements which is/are true? a.
Banks are not permitted to buy-back their CDs prematurely.
b.
Banks are allowed to grant loans against CDs.
c.
CDs are freely transferable by endorsement and delivery after a lock-in period of 15 days and can be traded in the secondary market from the date of issue.
d.
Both (a) and (c) above.
e.
None of the above.
DFHI which was set-up to activate the secondary market for money market instruments has not been successful. In the case of CDs the reasons (for this) are: a.
Investors tend to hold CDs till maturity because of the high yield
b.
Lack of information among investors regarding facilities available with DFHI
c.
Reluctance of banks to issue CDs when they have high liquid funds at their disposal
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
Jumbo CDs a.
Are issued by foreign banks in the US
b.
Are issued by savings and loan associations in large volumes such as 1,00,000 dollars and above
c.
Are CDs whose returns are linked to stock market performance
d.
Are sold through brokers or dealers in denominations of 1,00,000 dollars to qualify for federal deposit insurance
e.
Offer a return linked to fluctuations in foreign currency values and economic developments abroad. 43
Investment Banking and Financial Services
83.
84.
85.
86.
87.
88.
89.
44
Certificate of Deposits are issued in the form of a.
Bill of Exchange
b.
Demand Promissory Notes
c.
Usance Promissory Notes
d.
Usance Bill of Exchange
e.
Term deposits.
Which of the following statements is false? a.
Certificate of Deposits are maturity dated obligations.
b.
CDs attract stamp duty.
c.
CDs are issued at a discount to face value.
d.
CDs form a part of time liabilities.
e.
None of the above.
Banks prefer to issue CDs as a.
Funds would be available to them for specific period
b.
They have control over cost of funds
c.
CDs are not subjected to reserve requirements
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
The minimum maturity period of CD is a.
One year to three years
b.
Thirty days to one year
c.
Three months to three years
d.
15 days
e.
Thirty days to three years.
Which of the following is not considered while determining the issue price for a CD? a.
The amount of funds available.
b.
Maturity of the CD.
c.
Relationship with the customer.
d.
Prevailing call money rates.
e.
None of the above.
Which of the following statements is/are false? a.
Banks are permitted to buy-back CDs prematurely.
b.
Banks are allowed to grant loan against CDs.
c.
Banks can avail grace period while making payments.
d.
Banks may or may not issue CDs at a discount to face value.
e.
All of the above.
CDs are similar to conventional term deposits. Except that which of the following is a unique feature? a.
CDs are traded in secondary market, after a lock-in-period.
b.
CDs are available on tap.
c.
CDs (only) have a specified time period.
d.
CDs form a part of NDT liabilities.
e.
All of the above.
Part I
90.
Which of the following statements is true? a.
There is no ceiling on the amount that can be raised by means of CDs by banks.
b.
CDs are not subjected to stamp duty.
c.
CDs can be transferred immediately after issue.
d.
CDs are issued in multiples of 25 lakh.
e.
CDs are not subjected to usual reserve requirements.
Bill Financing 91.
92.
93.
94.
95.
A demand bill a.
Is a bill in which no time for payment is specified
b.
Is payable immediately ‘at sight’ or ‘on presentment’ to the drawee
c.
Is a bill that is payable at a specified later date
d.
Both (a) and (b) above
e.
None of the above.
An inland bill a.
Is a bill drawn or made in India, and payable in India
b.
Is drawn on any person resident in India
c.
May be endorsed in a foreign country and remain in circulation there
d.
Is a bill drawn in India and made payable outside India
e.
Both (a) and (b) above.
Which of the following is/are true with regard to a negotiable instrument? a.
A negotiable instrument need not be in writing.
b.
A negotiable instrument must contain an order to pay and not a request.
c.
In some cases, the drawer and the payee of a negotiable instrument may be the same person.
d.
Both (a) and (c) above.
e.
Both (b) and (c) above.
Under the Bill market scheme introduced in 1952 a.
Advances were granted to scheduled banks by way of demand loans on the security of eligible usance bills
b.
The lodgement of bills with the RBI was for the purpose of rediscounting
c.
Export bills were not eligible for credit facilities
d.
Both (b) and (c) above
e.
None of the above.
Which of the following is a feature of the Bill Rediscounting Scheme, 1970? a.
Under this scheme only genuine bills were eligible for rediscounting with the RBI.
b.
The aim of the scheme was to provide bill finance in such a way that it does not undermine the selective control policy of the RBI.
c.
To provide bill finance throughout the year and not just to meet seasonal stringency.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above. 45
Investment Banking and Financial Services
96.
97.
The measure(s) introduced by the RBI based on the Vaghul Committee Recommendations in order to promote and develop bill culture in India are: a.
Approaching the Central Government for remission of stamp duty on bills of exchanges
b.
Permitting a larger number of financial institutions to rediscount bills
c.
Setting up the DFHI for the development of money market including the market for commercial bills
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
Which of the following is/are the factor(s) responsible for underdevelopment of the bill market in India? a.
98.
99.
100.
101.
b.
Domination of the bill market by indigenous bankers.
c.
Decrease in the quantum of supply bills.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Which of the following is/are characteristic(s) of a well developed bill market? a.
The supply of bills should be continuous and quite large.
b.
Commercial bank’s preference to use a bill of exchange as an instrument for providing credit to their customers.
c.
The number of times a bill changes hands will be higher.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
Which of the following is/are the recommendation(s) of the Chore Committee in order to promote bill culture in India? a. Making it compulsory for banks to extend at least 50% of the cash credit limit against raw materials to manufacturing units by way of drawee bills. b. Setting up the DFHI as a major financial institution for the development of the money market including the market for commercial bills. c. Remission of stamp duty on bills of exchange. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. The rate at which the RBI rediscounts eligible bills from commercial banks is the a. Bank rate b. Hundi rate c. Bazar bill rate d. SBI discount rate e. None of the above. Which of the following is the characteristic of the bills rediscounting scheme of IDBI? a. The scheme covers bills arising out of the sales and purchases of imported capital equipment. b. The bills to be eligible for rediscounting by IDBI should be drawn, made, accepted or endorsed by an industrial concern as defined by the IDBI Act, 1964. c. The period of maturity of the bill should not be less than 3 months. d. The minimum amount of a transaction covering a set of bills eligible for rediscounting has been fixed at Rs.25,000. e.
46
Other cheaper sources of finance.
Payment from the acceptor is obtained by IDBI on the due date.
Part I
102.
103.
104.
105.
106.
107.
Which of the following statements is/are true? a. The structures of market interest rates are indirectly influenced by the discount rate used by the central bank to refinance the bills of exchange. b. Bill market scheme was introduced by the RBI in the year 1970. c. Darshani Hundi, which is similar to bills of exchange of today, originated and operated within the local limits. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. Which of the following is/are specific features of negotiable instrument? a. A negotiable instrument should contain either an order or a request to pay. b. It must be signed by the drawee and presented to the drawer for the acceptance. c. The holder of a negotiable instrument can endorse it. d. Sometimes the drawee and payee of the negotiable instrument may be the same person. e. None of the above. Which of the following statements is/are true? a. Usance bills are to be paid on presentation. b. Clean bills should possess the documents of title to goods. c. A D/A bill in which documents are deliverable just against acceptance, becomes a clean bill immediately after the delivery of documents. d. When a bill is accepted by drawee without having received any consideration then it is known as accommodation bill. e. Both (c) and (d) above. Which of the following statements is/are true? a. The mechanism of ‘Bills with acceptance’ involves the discounting of the bill by the buyers bank for the account of the buyer. b. In ‘post-shipment finance’ the banker runs the risk of dealing only with the documents and not in goods. c. Banks cannot rediscount the bills which were originally discounted with them by their corporate clients. d. Based on the Daheja Committee recommendations the government of India has set-up the Discount and Finance House of India. e. None of the above. Which of the following is/are true with respect to bill rediscounting by banks? a. Banks can rediscount the bills that were discounted by finance companies. b. Banks can rediscount the bills arising out of share transactions. c. Banks can rediscount the bills arising out of the genuine trade transactions and originally discounted by the banks. d. Banks can rediscount the accommodation bills. e. Both (a) and (c) above. As per the Bill Market Scheme 1952, a. Licensed Scheduled commercial banks having deposits of 20 crore rupees or more are eligible under this scheme. b. Eligible Banks can avail the demand loans against the security of usance promissory notes to the extent of Rs.50 lakh. c. Under this scheme the banks can withdraw any number of bills lodged. d.
Both (a) and (c) above.
e.
All of (a), (b) and (c) above. 47
Investment Banking and Financial Services
108.
109.
110.
Which of the following statements is/are true? a.
Since November, 1973 scheme banks are required to lodge all the eligible bills with the Reserve Bank under Bill Rediscounting Scheme.
b.
Since 1975 banks are allowed to rediscount bills with all the other financial institutions.
c.
The draw back of Bill Market Scheme 1952 was that it permitted the conversion of cash credits/overdrafts into usance promissory notes.
d.
Bill Finance Scheme of 1970 will not provide Bill Finance through out the year, it is mainly meant to meet the seasonal stringency of the funds.
e.
All of the above.
Which of the following is/are true regarding the Vaghul Committee? a.
The committee recommended that banks have to extend at least 50% of the cash credit limit against raw materials to manufacturing units by way of drawee bills.
b.
On its recommendations the Central Government has notified remission of the stamp duty on bills of exchange.
c.
The RBI has set-up the DFHI as a major financial institution for the development of the Money Market based on the committee’s recommendation.
d.
Both (a) and (b) above.
e.
Both (b) and (c) above.
Which of the following is/are true with respect to bills rediscounting scheme of IDBI? a.
The period of the maturity of the bill should not be more than one year.
b.
The supplier gets the bills discounted by his bank and the sellers bank in turn gets the bill rediscounted with the DFHI.
c.
IDBI receives payments directly from the buyer.
d.
The scheme does not cover the bills/promissory notes arising out of the purchase of imported capital equipment and machinery.
e.
Both (b) and (d) above.
DEBT MARKET Gilt-Edged Securities Market 111.
112.
48
Which of the following statements is/are true? a.
Government of India securities are debt obligations of the Central Government.
b.
GoI securities are debt obligations of the State Governments.
c.
GoI securities are debt obligations of financial institutions owned by the Central and State Governments.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Which of the following is false regarding a gilt-edged security? a.
It is an unsecured financial instrument.
b.
The rate of interest on these securities is relatively low when compared to other money market instruments.
c.
The minimum amount of investment in government securities for a single investor is Rs.10,000 and in multiples thereof.
d.
Both (a) and (b) above.
e.
Both (a) and (c) above.
Part I
113.
114.
115.
116.
117.
Who among the following are not eligible to invest in Government Securities? a. Non-Resident Indians. b. Overseas Corporate Bodies. c. Foreign Institutional Investors registered with SEBI. d. Provident Funds. e. None of the above. Short dated Government Securities are those securities which mature within a. 1 year b. 2 years c. 4 years d. 5 years e. 6 years. Which of the following is/are true? a. The issue of Government securities helps in implementing the fiscal policy of the Government. b. Financial institutions like commercial banks are required to maintain their Statutory Liquidity Reserve in the form of Government securities. c. From April 1995, the Reserve Bank has begun auctioning Government Securities competitively and since then interest rates have been increasingly set at market determined levels. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. Which of the following statements is/are true? a. There is no prescribed settlement period in case of debt market as is found in the capital market. b. Stock on tap is issued by the RBI with predetermined price, maturity and coupon with no aggregate amount indicated in the notification. c. The secondary market in Government Securities is also known as Telephone market. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. Which of the following statements is/are true? a. In case of floating rate bonds, the stock will carry a coupon rate which will vary according to the change in the base rate to which it is related. b. No interest is paid on zero-coupon bonds before maturity. c. When the RBI undertakes Repo transactions it will be buying the securities in the first leg and sell them back later. d. Both (a) and (b) above. e. Both (b) and (c) above.
Repurchase Agreements (REPOs) 118.
Which of the following statements is/are true? a. A repo transaction essentially involves borrowing money at a price like other money market instruments. b. A repo transaction will be viewed as a reverse repo from the point of seller of security. c. The purpose of introducing repo transactions was to even out interest rates in the call money market. d. Both (a) and (c) above. e. Both (b) and (c) above. 49
Investment Banking and Financial Services
119.
120.
121.
Who among the following are not eligible to participate in Repo transactions? a.
DFHI.
b.
State Government.
c.
Banks.
d.
Financial institutions which maintain SGL and current account with the RBI.
e.
None of the above.
Which of the following statements is/are true? a.
NBFCs are permitted to enter into repo as well as reverse repo transactions.
b.
When RBI enters into reverse repos with banks, it sucks out liquidity from the system.
c.
Repo is an avenue of NBFCs to deploy short-term surplus funds, but not to raise funds.
d.
Both (b) and (c) above.
e.
None of the above.
Which of the following statements is/are false? a.
Repo Transactions may also be undertaken on the NSE Wholesale Debt Market.
b.
Interest rate on repo transactions is usually higher than the rate prevailing in the call money market.
c.
All GoI securities and treasury bills in demat form are eligible for Repo transactions subject to the condition that the transaction takes place at Mumbai.
d.
Provident Funds are not eligible to participate in Repo auctions.
e.
Both (c) and (d) above.
Public Deposits 122.
123.
124.
50
Non-banking non-finance companies include a.
An equipment leasing company
b.
A hire purchase company
c.
Companies engaged in the services sector
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
As per the Companies (Acceptance of Deposit) Rules 1975, which of the following is not a public deposit? a.
Advance received for supply of goods or services.
b.
Any amount received by a company from any other company.
c.
Any amount received as a loan from any of the notified financial institutions.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
The minimum tenure for which public deposits can be accepted or renewed is a.
3 months provided such deposits do not exceed 10% of the paid-up capital and free reserves of the company
b.
6 months
c.
12 months
d.
18 months
e.
Either (a) or (c) above.
Part I
125.
126.
127.
128.
129.
The maximum maturity period for public deposits cannot exceed a.
12 months
b.
24 months
c.
36 months
d.
48 months
e.
60 months.
Which of the following statements is/are true? a.
Deposits repayable on demand or on notice can be accepted by a company.
b.
The interest payable on public deposits cannot exceed 16% per annum.
c.
The interest payable on public deposits cannot be compounded for periods shorter than quarterly rests.
d.
Any security deposit received by the company from an employee or an agent falls under the category of public deposit.
e.
Both (b) and (d) above.
The maximum brokerage payable on a deposit having a tenure between one and two years is a.
1%
b.
1.5%
c.
2%
d.
2.5%
e.
3%.
Which of the following statements is/are false? a.
Payment of brokerage on public deposits is on a one-time basis.
b.
The total amount of public deposits that can be outstanding at any point of time cannot exceed 25% of the aggregate of paid-up capital and free reserves.
c.
A company accepting public deposits is required to maintain liquid assets to the extent of 10% of the deposits maturing during the financial year ending March 31, next.
d.
The liquid assets required to be held by a company accepting public deposits can be in the form of deposits held with a scheduled bank, free from lien or charge.
e.
The amount held in liquid assets can be used only for the purpose of repayment of deposits.
Which of the following statements is/are true? a.
The company shall, on acceptance or renewal of deposit, furnish a receipt within a period of 8 weeks to the depositor.
b.
The deposit receipt issued by a company is negotiable and can be transferred to another person by endorsement or delivery.
c.
When a company makes premature repayment, the rate of interest payable by the company on such deposits shall be reduced by 1.5% from the rate which the company would have paid if the deposit had been accepted for the period for which it had run.
d.
The deposit receipt need not contain the address of the depositor.
e.
Both (a) and (b) above.
51
Investment Banking and Financial Services
130.
131.
132.
Which of the following statements is/are false? a. Every company accepting deposits shall file a return of deposits with the Registrar of Companies on or before 31st March every year. b. It is enough if every company intending to invite deposits issues an advertisement about the same in a leading English newspaper. c. Any advertisement issued by a company about the acceptance of public deposits will be valid up to a period of 6 months from the closure of the financial year for which it was issued. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. Every company accepting public deposits is required to maintain a certain level of liquid assets. Which of the following is/are not permitted as investments in this regard? a. Unencumbered securities of Central or State Government. b. Unencumbered securities approved under Indian Trusts Act, 1882. c. Unencumbered bonds issued by Housing Development Finance Corporation Limited. d. All (a), (b) and (c) above. e. None of the above. Which of the following statements is/are false? a. Every company accepting deposits is also required to file a return of deposits with SEBI. b. Fixed deposit is an intangible financial product. c. The scope for innovation is limited when it comes to the pricing aspect of fixed deposits. d. The amount held in liquid assets shall not, at any point of time, fall below 10% of the amount of outstanding deposits maturing before 31st March next. e. Both (b) and (c) above.
Financial Guarantees 133.
134.
135.
52
The volume of personal guarantees in the organized sector has decreased over time because of a. Abolition of the managing agency system b. Rise of a new entrepreneurial class c. Professionalization of managerial cadres d. Improvement in the financial and technical appraisal of proposals e. All of the above. An endorser of a bill is liable as a guarantor to pay the holder with respect to the debt represented by the instrument. This is a case of: a. Secured Guarantee b. Implicit Guarantee c. Continuous Guarantee d. Explicit Guarantee e. Performance Guarantee. Which of the following statements is/are true? a. There are two parties accompanied by a guarantee in a loan transaction. b. The purpose of seeking guarantee is to reduce the risk of default. c. A guarantee cannot be oral. d. A guarantee can be treated as a perfect substitute for tangible security. e. Both (b) and (d) above.
Part I
136.
137.
138.
139.
140.
141.
142.
Which of the following guarantees is usually extended by insurance companies? a. Guarantees extended to non-financial contracts. b. Guarantees on behalf of hire purchase companies to banks and other institutions. c. Guarantees to cover short-term loans from banks. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. The premium payable by banks for insurance of deposits with DICGC is a. 0.25% per half year b. 0.25% per year c. 0.5% per half year d. 0.5% per year e. 0.75% per half year. Which of the following activity is not undertaken by DICGC? a. Guarantee for credit extended by banks to priority sector. b. Guarantee for credit extended by banks to small scale industries. c. Improving exporters financial standing. d. Insurance of deposits of banks. e. Both (b) and (c) above. Which of the following is/are true with regard to the SSI scheme? a. All the loans which are eligible for guarantee will have to be covered and there is no choice to the bank to selectively cover the loan accounts. b. The bank cannot make a claim for a minimum period of 5 years. c. The prescribed claim forms have to be submitted to DICGC only when the borrower defaults. d. Both (a) and (b) above. e. Both (a) and (c) above. Which of the following risks are not covered by the export credit and guarantee corporation? a. Insolvency of the Buyer. b. War, Civil War, revolution or civil disturbances in the buyer’s country. c. Fluctuations in the exchange rate. d. Cancelation of valid import license. e. Imposition of restrictions by the Government of the buyer’s country. Standard policy is designed to cover risks in respect of goods exported on credit not exceeding more than _____. a. 90 days b. 150 days c. 180 days d. 280 days e. 360 days. Which of the following statements is/are true? a. Transfer guarantee is issued at the option of the bank to cover only political risks. b. Export finance guarantee covers post-shipment advances granted by banks to exporters against export incentives receivable in the form of cash assistance. c. The risks of war, expropriation and restriction on remittances are covered under the overseas investment insurance scheme of ECGC. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. 53
Investment Banking and Financial Services
CAPITAL MARKET An Overview of Capital Market 143.
144.
145.
146.
147.
148.
54
Which of the following statements is/are true? a.
The abolition of the Control on Capital Issues has given a big boost to the process of disintermediation in the capital market.
b.
The institutionalization of the market has had a negative effect on the quality of intermediation services and on disclosure standards.
c.
The process of globalization of the Indian capital markets started with the opening of these markets for foreign portfolio investment.
d.
Both (a) and (b) above.
e.
Both (a) and (c) above.
The Malegam Committee was appointed to deal with which of the following areas? a.
Mutual Fund Regulations.
b.
Suggest measures to increase the levels of disclosures by Indian Issuers.
c.
Problems relating to transfer of shares by companies.
d.
Modalities of short selling in Indian stock market.
e.
Revamp of securities laws.
Which was the first exchange to introduce screen based trading in India? a.
The National Stock Exchange.
b.
The Bombay Stock Exchange.
c.
Over the Counter Exchange of India.
d.
The Calcutta Stock Exchange.
e.
The Madras Stock Exchange.
Which of the following statements is false regarding dematerialization? a.
Dematerialization enables transfer of securities by book entries.
b.
The risk of bad deliveries increases as a result of dematerialization.
c.
Transfer of securities through depository does not attract stamp duty.
d.
The depository handles all corporate actions like exercising for rights, collection of dividends, credit for bonus, etc., on behalf of the investor.
e.
Both (b) and (c) above.
Which was the first stock exchange to set-up a clearing corporation? a.
The National Stock Exchange.
b.
The Bombay Stock Exchange.
c.
Over the Counter Stock Exchange.
d.
The Hyderabad Stock Exchange.
e.
The Madras Stock Exchange.
Which of the following statements is/are true? a.
In case of trading in dematerialized securities, rolling settlement has been introduced.
b.
Trading on the National Stock Exchange commences every Tuesday and concludes on the following Wednesday.
c.
Trading weeks which are not uniform give rise to arbitrage opportunities.
d.
Both (a) and (c) above.
e.
All of (a), (b) and (c) above.
Part I
149.
150.
151.
152.
153.
154.
Which of the following committees was constituted to work out the modalities for reintroduction of the carry forward system with proper cheques and balances? a. The J R Varma Committee. b. The L C Gupta Committee. c. The G S Patel Committee. d. The Chandratre Committee. e. The Bhave Committee. The Committee which recommended introduction of derivatives in India is a. The Chandratre Committee b. The Malegam Committee c. The L C Gupta Committee d. The J R Varma Committee e. The Bhave Committee. The system of margining whereby the difference between the current closing price and the transaction price is collected from the trading member is called as a. Concentration Margin b. Initial Margin c. Carry Forward Margin d. Mark to Market Margin e. Special Margin. The trading cycle on The National Stock Exchange operates from a. Monday to Friday b. Wednesday to Tuesday c. Thursday to Wednesday d. T + 3 rolling basis e. T + 5 rolling basis. The office of The Controller of Capital Issue was abolished in the year a. 1986 b. 1989 c. 1991 d. 1992 e. 1994. The G S Patel Committee was constituted to look into a. Reintroduction of the badla system b. Disclosure norms in offer documents c. Book building d. Redrafting of The Companies Act, 1956 e. Uniform norms for bad delivery.
Regulation of the Capital Market 155.
Which of the following have not yet been brought within the registration framework by SEBI? a. Portfolio Managers. b. Depositories. c. Credit Rating Agencies. d. Mutual Funds. e. Venture Capital Funds. 55
Investment Banking and Financial Services
156.
157.
158.
159.
160.
161.
162.
56
It is mandatory for all issuers to deposit _____ of the size of the issue as security deposit with the regional stock exchange. a. 0.5% b. 1% c. 1.5% d. 1.75% e. 2%. The maximum time period for allotment has been reduced by SEBI to _____ days from the closure of the issue. a. 20 days b. 25 days c. 30 days d. 35 days e. 40 days. The task of vetting the offer document lies with a. The Lead Manager b. SEBI c. Bankers to the issue d. Underwriters e. Either (a) or (b) above. Issues below Rs. _____ in size are permitted to be listed only on the OTCEI. a. 2 crore b. 3 crore c. 4 crore d. 5 crore e. 6 crore. Which of the following statements is/are false? a. Trading in dematerialized securities takes place on T+2 basis. b. Setting up of Trade Guarantee Fund is to ensure timely completion of settlement in the event of defaults by member brokers. c. SEBI has introduced the stock lending scheme to facilitate timely delivery of securities. d. The limits for listing on regular stock exchanges has been raised to 5 crore by SEBI. e. Both (a) and (d) above. The upper limit for gross exposure for brokers has been fixed by SEBI at a. 20 times the base minimum capital b. 20 times the base minimum capital and additional capital c. 33.33 times the base capital d. 33.33 times the base minimum capital and additional capital e. 50 times the base capital and additional capital. The takeover code is triggered when an acquirer obtains ____ equity stake in a company. a. 10% b. 15% c. 20% d. 25% e. 30%.
Part I
163.
164.
165.
166.
167.
168.
Which of the following Self Regulatory Organizations have been formed in India? a. Association of Merchant Bankers of India. b. Association of Mutual Funds of India. c. Registrars Association of India. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. Which of the following intermediaries is not required to be registered with SEBI? a. Debenture Trustees. b. Portfolio Managers. c. Foreign Institutional Investors. d. Depository. e. Advertising Agency to the Issue. The maximum intra-day trading limit for a broker, as set by SEBI, is a. 20 times the base capital b. 20 times the base capital and additional capital c. 33.33 times the base capital d. 33.33 times the base capital and additional capital e. 50 times the base capital and additional capital. The regulatory body for the securities market of UK is a. Securities Exchange Commission b. Securities and Exchange Board c. Securities Regulatory Commission d. Securities Investment Board e. Securities Regulatory Board. The minimum paid-up capital required to enable a company to obtain listing on stock exchanges was raised by SEBI to a. Rs.1 cr b. Rs.3 cr c. Rs.5 cr d. Rs.7 cr e. Rs.10 cr. To enable the process of price discovery, SEBI has introduced the system of a. Screen based trading b. Book building in securities c. Underwriting d. Vetting of premium issues e. Dematerialization.
MERCHANT BANKING An Overview of Merchant Banking 169.
Which of the following conditions needs to be satisfied for a listed security to be classified as a Group A security? a. The shares should be fully paid-up equity shares. b. The shares must not be shares of banking companies. c. The shares must have been admitted to dealings for at least two years on the given exchange. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. 57
Investment Banking and Financial Services
170.
171.
172.
173.
174.
175.
176.
58
Which was the first financial institution in India to offer merchant banking services? a. IFCI. b. IDBI. c. ICICI. d. IRBI. e. ECGC. A merchant banker is not permitted to carry on which of the following activities? a. Underwriting. b. Advisory services. c. Bills discounting. d. Mergers and Acquisitions. e. Venture Capital Placements. Merchant Bankers in India are classified under which of the following categories? a. I, II, III, IV and V. b. I, II III and IV. c. I, II and III. d. I and II. e. Multiple categories of merchant bankers have been abolished. Which of the following statements is/are true? a. Registration with SEBI is mandatory for carrying on the business of merchant banking in India. b. An applicant desiring to carry on the business of merchant banking should be a body corporate. c. The norm that a merchant banker should not carry on any business other than those connected with the securities market is not applicable to banks and financial institutions. d. Both (a) and (c) above. e. All of (a), (b) and (c) above. The minimum net worth required for an applicant to carry on the business of merchant banking is a. Rs.3 crore b. Rs.4 crore c. Rs.5 crore d. Rs.6 crore e. Rs.10 crore. The certificate of registration issued to merchant bankers by SEBI is valid for a period of a. 1 year b. 2 years c. 3 years d. 4 years e. 5 years. Which of the following is a characteristic of the merchant banking industry in India? a. High entry barriers. b. Low competition. c. High bargaining power of customers. d. Both (a), (b) and (c) above. e. Both (b) and (c) above.
Part I
177.
Which of the following statements is/are false? a.
In the Merchant Banking Industry there are no switching costs to the customers.
b.
The minimum net worth required for merchant bankers has been increased from one crore so as to make it an effective entry barrier.
c.
The concept of bought out deal was introduced for the first time by JM Financial.
d.
Both (a) and (b) above.
e.
None of the above.
Management of Public Issues, Initial Public Offerings and Pricing of Various Instruments 178.
A company intending to make an IPO should fulfill which of the following eligibility norms? a.
The issuer company should have been in existence for the past three years.
b.
The issuer company should have been in existence for the past five years.
c.
179.
180.
181.
182.
The project appraising body should have participated in the financing of the project to the extent of at least 15% of the project cost. d. The participation of the project appraising body can be only in the form of debt. e. The company should have paid dividends in the form of cash in any two of the three years of its existence. Which of the following statements is/are false? a. The number of co-managers cannot exceed the number of lead managers appointed for a particular public issue. b. The maximum number of advisors/consultants to an issue is 2. c. An associate company of the issuer company can be appointed as underwriter or advisor/consultant to the issue. d. Both (b) and (c) above. e. None of the above. When the size of the issue is between Rs.100 crore to Rs.200 crore the maximum number of lead managers who can be associated with the issue is a. 2 b. 3 c. 4 d. 5 e. No limit but subject to SEBI approval. A category I registrar can act a. As a registrar to the issue and as a share transfer agent b. Either as a registrar to the issue or as a share transfer agent c. Only as a registrar to the issue d. Either as a registrar to the issue or as a share transfer agent (to be specified at the time of registration with SEBI) e. Can act as Registrar and Underwriter to the issue. The minimum net worth requirement for a category II registrar is a. 2 lakh b. 3 lakh c. 4 lakh d. 5 lakh e.
6 lakh. 59
Investment Banking and Financial Services
183.
184.
185.
186.
187.
188.
60
Which of the following is not a function of the Registrar to the issue? a.
Assist the Lead Manager in selection of the bankers to the issue and the collection centers.
b.
Collection of daily subscription figures from collecting branches and reporting the same to the company and the lead manager.
c.
Refund of application money to unsuccessful applicants.
d.
Assisting the company in listing of the security on stock exchanges.
e.
Redressal of investor grievances.
Which of the following is applicable to a banker to a public issue? a.
Issue banking falls under the regulatory ambit of the RBI.
b.
It is necessary that a banker to a public issue is a scheduled bank.
c.
The maximum number of banks which can be associated with a public issue is 5.
d.
Every banker to an issue shall enter into an agreement with the body corporate for whom it is acting as banker to an issue.
e.
Both (b) and (d) above.
The total outstanding underwriting obligation of an underwriter at any point of time cannot exceed ______ times his net worth. a.
10
b.
15
c.
20
d.
25
e.
30.
Which of the following statements is/are false? a.
Underwriters are paid underwriting commission for assuming the risk of undersubscription.
b.
Underwriting commission is paid on the face value of the security.
c.
Underwriting an issue is optional and not mandatory.
d.
In case of underwritten issues, the minimum underwriting commitment of the lead manager shall be to the extent of 5% of the size of the offer or Rs.25 lakh, whichever is more.
e.
Both (b) and (d) above.
The minimum net worth which an underwriter should have is a.
5 lakh
b.
10 lakh
c.
15 lakh
d.
20 lakh
e.
25 lakh.
Which of the following statements is/are true? a.
It is not mandatory for brokers to be registered with SEBI.
b.
Any member of any recognized stock exchange can be appointed as broker to the issue.
c.
Appointment of brokers to the issue is not mandatory as per SEBI guidelines.
d.
Both (a) and (b) above.
e.
Both (b) and (c) above.
Part I
189.
190.
191.
192.
193.
194.
Which of the following statements is/are false? a. 15 copies of the draft prospectus have to be filed with SEBI. b. Even though SEBI has given up vetting of draft prospectuses, it reserves the right to order any amendments to the draft prospectus. c. If no observations are received from SEBI within a stipulated period of 20 days, the offer document will be deemed to have been cleared by SEBI. d. Both (a) and (c) above. e. All of (a), (b) and (c) above. The draft prospectus filed with SEBI need not be accompanied by which of the following documents? a. Statement of inter se allocation of responsibilities. b. Due diligence certificate from the lead manager. c. Copy of MOU between the company and the lead manager(s). d. Both (a) and (c) above. e. None of the above. The registration fee payable to SEBI for an issue of the size of Rs.55 crore is a. Rs.15,000 b. Rs.25,000 c. Rs.50,000 d. Rs.2,50,000 e. Rs.5,00,000. Where the issue size exceeds Rs.100 crore, the minimum promoter’s contribution is a. 10% of the post-issue equity capital b. 15% of the post-issue equity capital c. 20% of the post-issue equity capital d. 25% of the post-issue equity capital e. 30% of the post-issue equity capital. Which of the following shares will be considered as ineligible for the purpose of computation of promoter’s contribution? a. Shares issued during the 12-month period preceding the filing of prospectus with SEBI at a price lower than the issue price. b. Bonus shares issued out of revaluation reserves or from any other reserve created without the accrual of cash, during the preceding 2 accounting years. c. Shares issued for consideration other than cash wherein the transaction involves revaluation of assets or capitalization of intangible assets, during the preceding 5 accounting years. d. Both (b) and (c) above. e. None of the above. Which of the following statements is/are true? a. Promoters contribution in excess of the minimum specified contribution will not attract any lock-in. b. Promoters have the option of bringing in their contribution before or after the opening of the issue. c. Shares under promoters quota can also be offered for subscription to the relatives, friends and associates of the promoters. d. The entire promoters contribution shall be locked in for a period of 5 years. e. The lock-in period for minimum promoters contribution will commence from the date of allotment or from the date of commencement of commercial production whichever is earlier. 61
Investment Banking and Financial Services
195.
196.
197.
198.
199.
200.
201.
62
An issue of the size of Rs.15 crore will be required to have a. At least 10 mandatory collection centers b. 20 mandatory collection centers c. At least 30 mandatory collection centers d. Below 30 mandatory collection centers e. 35 mandatory collection centers. The minimum and maximum period for which an issue should be kept open is a. 2 and 8 days respectively b. 3 and 10 days respectively c. 4 and 10 days respectively d. 5 and 12 days respectively e. 5 and 15 days respectively. An applicant is required to quote his Permanent Account Number in the application form if the size of the application a. Is Rs.40,000 b. Exceeds Rs.40,000 c. Is Rs.50,000 d. Exceeds Rs.50,000 e. Either (c) or (d) above. The minimum amount of application money should not be less than ____ of the issue price. a. 10% b. 15% c. 20% d. 25% e. 30%. The minimum subscription required for an issue is _____. a. 50% b. 70% c. 75% d. 90% e. 95%. Which of the following provisions are applicable for issue of debentures? a. Where the redemption/conversion period of any debenture issue exceeds 12 months, credit rating is mandatory. b. If the maturity period of the debenture exceeds 18 months, appointment of SEBI registered debenture trustee is mandatory. c. A company should compulsorily create debenture redemption reserve if the maturity period of the debenture is less than 18 months. d. Both (a) and (b) above. e. Both (b) and (c) above. Which of the following statements is/are false? a. A company issuing FCDs having conversion period exceeding 18 months can make such an issue only if conversion is made optional with put and call options . b. In case the non-convertible portion of a NCD is to be rolled over, a compulsory option is to be given to the debenture holders to redeem and encash their debentures. c. In case the issuer company fails to get the minimum subscription, excluding devolvement on the underwriters, the entire issue amount should be refunded to the investors. d. Both (a) and (b) above. e. Both (a) and (c) above.
Part I
202.
203.
204.
205.
206.
The market lot depends upon the issue price of the share. For an issue price of Rs.300 the market lot will be a.
10 shares
b.
50 shares
c.
100 shares
d.
150 shares
e.
200 shares.
An overseas corporate body is a foreign firm where a.
At least 50% of the ownership stake is held directly or indirectly by Resident Indians
b.
At least 50% of the ownership stake is held directly or indirectly by Non-Resident Indians
c.
At least 60% of the ownership stake is held directly by Resident Indians
d.
At least 60% of the ownership stake is held directly or indirectly by Non-Resident Indians
e.
At least 75% of the ownership stake is held directly or indirectly by Non-Resident Indians.
Alpha Ltd. plans a public issue of Rs.140 cr. Which of the following statements are correct with reference to this issue? i.
The company can appoint a maximum of 4 Lead Managers
ii.
The number of Co-Managers cannot exceed the number of Lead Managers appointed for the issue
iii.
The issue can have only one Advisor.
a.
(i) only
b.
(ii) only
c.
(iii) only
d.
All of the above
e.
None of the above.
Which of the following statements is false? a.
Reservation made to a particular class of investors is called as firm reservation.
b.
When reservation on firm basis is undersubscribed, the amount will be added to the net offer to the public.
c.
The class of investors to whom reservations can be made in an issue includes employees and group shareholders.
d.
Both (a) and (b) above.
e.
Both (b) and (c) above.
Which of the following statements is/are true? a.
The issue announcement advertisement should be issued at least 5 days before the opening of the issue.
b.
The issue announcement advertisement should be issued at least 10 days before the opening of the issue.
c.
The issue announcement advertisement should be issued at least 12 days before the opening of the issue.
d.
The issue announcement advertisement should be issued at least 15 days before the opening of the issue.
e.
The issue announcement advertisement should be issued at least 20 days before the opening of the issue.
63
Investment Banking and Financial Services
207.
208.
209.
210.
211.
212.
64
Which of the following guidelines have to be observed with regard to issue advertisement? a. It is not necessary to highlight the risk factors associated with the issue in the advertisement. b. During the period when the issue is open for subscription, no advertisement stating that the issue is fully subscribed or oversubscribed will be issued. c. No announcement about the closing of the issue will be made, except on the date of closure of the issue. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. The reservation for employees in a public issue cannot exceed a. 200 shares per employee b. 500 shares per employee c. 1000 shares per employee d. 5% of the size of the issue e. 10% of the size of the issue. A new company can price its issue at a premium, only if i. The promoter company has a 5-year record of consistent profitability. ii. The promoters contribution is 50%. iii. The Lead Manager gives a safety net to the investors. a. (i) only b. (ii) only c. (iii) only d. Both (i) and (ii) above e. All of the above. Which of the following are important determinants in designing capital structure? a. Nature of industry. b. Type of asset financed. c. Degree of competition. d. Both (a) and (c) above. e. All of (a), (b) and (c) above. Which of the following statements is/are true? a. Short-term liabilities should be used to create short-term assets and long-term liabilities for long-term assets. b. In non-seasonal businesses, investment in current assets assume the characteristics of fixed assets and hence needs to be financed by long-term liabilities. c. The risk of financial leverage increases for businesses subject to large cyclical variation. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. Which of the following statements is/are false? a. A business characterized by low level of competition and high entry barriers decreases the volatility of the earnings stream. b. A low leverage limits the firm’s ability to respond to an obsolescence crisis. c. When a business reaches maturation stage, leverage is likely to decline as cash flows accelerate. d. Both (b) and (c) above. e. None of the above.
Part I
213.
214.
215.
216.
217.
218.
The profit earned by selling a security will be treated as short-term capital gain if the holding period is a.
Less than 12 months
b.
Less than 24 months
c.
Less than 36 months
d.
More than 36 months but less than 48 months
e.
Less than 48 months.
Which of the following statements is/are true? a.
A new company which is promoted by an existing company with a 3-year record of consistent profitability can freely price its issue.
b.
An existing private or closely held public company can freely price its issue, if it has a 3-year record of consistent profitability.
c.
A new company can price its shares either at par or at premium.
d.
Both (a) and (b) above.
e.
Both (b) and (c) above.
Which of the following statements is/are false? a.
Underpricing an IPO deprives the promoter or the company of an opportunity to raise more funds.
b.
Underpricing helps in giving shareholders good returns as an IPO is mainly intended as a long-term financing strategy.
c.
Underpricing could result in a lower net worth on an increased equity, which might make dividend pay-outs or future investments difficult.
d.
All of (a), (b) and (c) above.
e.
None of the above.
Zero-coupon bonds are: a.
Issued at face value and do not carry any interest
b.
Issued at a discount to their face value and are redeemed at par on expiry of their tenure
c.
Debt instruments with warrants allowing the investors to subscribe to the equity of another company at a predetermined price
d.
Redeemed by repayment in a series of installments at a premium over the face value
e.
Convertible into equity of the issuer at a price set at the time of issuance.
Which of the following is a feature of auction rated debt? a.
These are convertible short-term debentures.
b.
Auction rated debts are fully redeemable non-convertible short-term debentures.
c.
Auction rated debt is usually unsecured in nature.
d.
Auction rated debt is redeemed at regular intervals and then re-auctioned.
e.
Both (b) and (d) above.
Which of the following companies was the pioneer in introducing auction rated debt in India? a.
TISCO.
b.
Vadilal Dairy International Limited.
c.
Ashok Leyland.
d.
Jindal Photofilms.
e.
Reliance Petrochemicals Limited. 65
Investment Banking and Financial Services
219.
220.
221.
Which of the following is not used by the Malegam Committee to justify the pricing of a share? a.
Dividend Discount Model.
b.
Earnings Per Share.
c.
Price Earnings Multiple.
d.
Return on Net Worth.
e.
Net Asset Value.
Which of the following statements is/are true? i.
A zero coupon bond is issued at a discount to its face value and is redeemed at par on maturity.
ii.
A debenture with a warrant entitling the holder to acquire the shares of another company is called as third party convertible debenture.
iii.
Lyons are zero coupon convertible notes.
a.
(i) only
b.
(ii) only
c.
(iii) only
d.
All of the above
e.
None of the above.
Which of the following statements is/are false? i.
Preference shares cannot carry dividend rate higher than 16%.
ii.
Preference shares cannot be irredeemable.
iii.
Cumulative preference shares cannot be issued in India.
a.
(i) only
b.
(iii) only
c.
Both (i) and (iii) above
d.
Both (ii) and (iii) above
e.
Both (i) and (ii) above.
Rights Issues, Bonus Issues, Private Placements and Bought-out Deals 222.
223.
66
In which of the following circumstances, a company need not offer further issue of shares to the existing shareholders? a.
Where the company is a private company.
b.
In case of an issue or allotment of shares within 2 years of the formation of a company or within one year after the first allotment, whichever event occurs earlier.
c.
Where a special resolution is passed in the general meeting providing that the shares need not be offered to the existing equity shareholders.
d.
Both (a) and (c) above.
e.
All of (a), (b) and (c) above.
Which of the following statement(s) is/are true? a.
A rights issue should be compulsorily underwritten.
b.
Where the rights issue of listed companies does not exceed Rs.50 lakh, appointment of a merchant banker is not mandatory.
c.
A rights issue should not be kept open for more than 60 days.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
Part I
224.
225.
226.
227.
228.
229.
In case of a rights issue, if the company does not receive at least 90% of the issued amount including accepted devolvement from underwriters, within _____ days from the date of closing of the issue, the amount of subscription received is required to be refunded. a. 30 b. 35 c. 42 d. 51 e. 63. Which of the following is/are true? a. The letter of offer pertaining to rights issue should be vetted by SEBI. b. The rights issue should not dilute the value or rights of the fully or partly convertible debenture holders. c. Companies are permitted to retain the oversubscription amount in a rights issue. d. Along with the rights issue, preferential allotment can be made as well. e. Both (c) and (d) above. Sri Limited is planning a rights issue of equity shares in the ratio of 1 rights share for every 3 shares held. The rights issue is being priced at Rs.16 per share. The current market price of the share is Rs.25. The value of the rights is a. Rs.2.20 b. Rs.2.25 c. Rs.2.27 d. Rs.2.30 e. Rs.2.52. Vijay Limited is planning a rights issue of equity shares in the ratio of 1 right share for every 5 shares held. The current market price of the share is Rs.45, while the rights issue is being priced at Rs.30. The expected market price of the share after the rights issue is a. Rs.40 b. Rs.40.5 c. Rs.41 d. Rs.42.5 e. Rs.45. Beta Limited has tapped the markets with rights issue priced at Rs.60 per share. The rights is being offered in the ratio of 1 share for every 2 shares held. The shares are currently quoting at Rs.90 in the market. Murthy is currently holding 500 shares of the company. The change in the wealth of Murthy if he allows his rights to expire is a. –5,000 b. –10,000 c. +15,000 d. –20,000 e. –25,000. Which of the following guidelines are applicable to bonus issues by companies? a. Pending conversion of FCDs/PCDs, no company shall issue any shares by way of bonus unless similar benefit is extended to the holders of such PCDs or FCDs. b. Bonus shares can be issued out of share premium collected in cash and revaluation reserves. c. An issue of bonus shares cannot be made unless the partly paid shares are made fully paid-up. d. Both (a) and (c) above. e.
All of (a), (b) and (c) above. 67
Investment Banking and Financial Services
230.
231.
232.
233.
234.
235.
68
Which of the following statements is/are true regarding bonus shares? a. Bonus shares are always fully paid. b. Bonus shares are issued to the existing members free of charge. c. Similar to rights shares, bonus shares may be renounced by a member in favor of his nominee. d. Both (a) and (b) above. e. Both (a) and (c) above. In a composite issue, the gap between the closure dates of the rights issue and public issue should not exceed a. 7 days b. 15 days c. 21 days d. 30 days e. 60 days. The maximum time period for which a rights issue can be kept open for subscription is a. 10 days b. 21 days c. 30 days d. 45 days e. 60 days. Which of the following reserve(s) are not eligible for issuing bonus? a. Revaluation reserve. b. General reserve. c. Capital reserve. d. Share premium. e. Both revaluation reserve and capital reserve. Which of the following are essential features of the private placement market? a. The private placement market is characterized by high entry barriers. b. The company tapping the private placement market has a choice of investors. c. The transaction costs in the private placement market are very high. d. Credit rating of debt instruments is compulsory in case of private placement. e. Both (a) and (b) above. Which of the following statements is/are true? a. The issue of shares on a preferential basis can be made at a price not less than the average of the weekly high and low of the closing prices on a stock exchange during the six months or two weeks preceding 30 days prior to the general body meeting of shareholders, whichever is lower. b. The issue of shares on a preferential basis can be made at a price not less than the average of the weekly high and low of the closing prices on a stock exchange during the six months or two weeks preceding 30 days prior to the general body meeting of shareholders, whichever is higher. c. The issue of shares on a preferential basis can be made at a price not more than the average of the weekly high and low of the closing prices on a stock exchange during the six months or two weeks preceding 30 days prior to the general body meeting of shareholders, whichever is lower. d. The issue of shares on a preferential basis can be made at a price not more than the average of the weekly high and low of the closing prices on a stock exchange during the six months or one week preceding 30 days prior to the general body meeting of shareholders, whichever is lower. e. The issue of shares on a preferential basis can be made at a price not more than the average of the weekly high and low of the closing prices on a stock exchange during the six months or two weeks preceding 60 days prior to the general body meeting of shareholders, whichever is lower.
Part I
236.
237.
238.
239.
240.
The lock-in period for shares of a listed company privately placed with the promoters is a.
2 years
b.
3 years
c.
5 years
d.
There is no lock-in period
e.
The lock-in period will be decided by the issuer company.
The lock-in period for shares of a listed company privately placed with investors other than the existing promoters is a.
2 years
b.
3 years
c.
5 years
d.
There is no lock-in period
e.
The lock-in period will be decided by the issuer company.
Which of the following statements is/are true? a.
Buy-outs are nothing but wholesale investments.
b.
Buy-outs happen when the company needs money fast and market conditions are adverse.
c.
Buy-outs happen when an investor group makes an offer to a company which is more lucrative.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
Which of the following can be considered as an advantage of bought out deals? a.
Price is not subject to the vagaries of the market place.
b.
Funds can be obtained at a minimal cost without fear of undersubscription.
c.
The intermediary usually earns a higher return on a bought out deal when compared to the fee earned on conventional merchant banking services.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
In case of warrants on private placement basis, the amount payable upfront should be at least a.
1% of the exercise price
b.
2.5% of the exercise price
c.
5% of the exercise price
d.
7.5% of the exercise price
e.
10% of the exercise price.
INTERNATIONAL MARKETS 241.
Which of the following statements is/are true? a.
In the ADR Level I issue, there are no disclosures required.
b.
In the ADR Level I issue, ADRs can be traded only on the US-OTC market.
c.
In the ADR Level I issue, the company need not comply with the US-GAAP.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above. 69
Investment Banking and Financial Services
242.
243.
244.
245.
246.
247.
70
In a depository receipts issue, which of the following will be the role(s) played by the custodian? a.
To hold the shares underlying the DRs on behalf of the depository.
b.
To collect rupee dividends on the underlying shares.
c.
To disseminate information from the issuer to the DR holder.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Which of the following statements is/are true regarding the foreign bonds issued in the international bond markets? a. Yankee bonds are pound denominated bonds issued in the UK by non-UK firms. b. Samurai bonds are yen denominated bonds issued in the Japanese market by nonJapanese firms. c. Bulldog bonds are dollar denominated bonds issued in the UK by domestic companies. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. Belgian dentist is a term used to describe a.
An institutional investor who makes market specific investments
b.
An institutional investor who makes market and industry specific investments
c.
An institutional investor who makes time specific investments
d.
A high net worth individual investor in bonds/DRs to ensure safety for the surplus funds
e.
Both (b) and (c) above.
Which of the following statements describes the Gensaki rate? a.
It is the short-term benchmarket rate used in Japanese markets.
b.
It is the benchmark rate used to price the Samurai bonds.
c.
It is the long-term prime rate used in the Swiss markets.
d.
It is the treasury rate used in the US markets.
e.
None of the above.
Which of the following statements is/are true in the case of Eurodollar deposits? a.
Eurodollar deposits cannot be owned by individuals.
b.
Eurodollars are not subject to US banking regulations.
c.
Eurodollar volume is not measured as the dollar denominated deposit liabilities of banks located outside the US.
d.
The sum of a few dollar-denominated liabilities of banks outside the United States measures the gross size of the Eurodollar market.
e.
The net size of the Eurodollar market is constructed by netting all the deposits owned by individuals.
The reserve requirements on the transaction deposits have been reduced from _____ to _____. a.
10%, 9%
b.
11%, 9%
c.
12%, 10%
d.
12%, 11%
e.
12%, 10.5%.
Part I
248.
249.
250.
251.
252.
253.
Which of the following is/are features of Eurodollar Certificate of Deposits (CDs)? a.
It is a negotiable receipt for a dollar deposit at a bank outside the United States.
b.
The investors sell the Eurodollar CDs only after they mature.
c.
Tranche deposits are issued in very small denominations.
d.
They pay a fixed, competitively determined rate of return.
e.
Secondary market makers’ spreads for short-term fixed rate CDs have been 5 basis points for European bank dollar CDs.
Which of the following is false in the case of Eurodollar Floating Rate Notes (FRNs)? a.
They are issued by banks and sovereign governments.
b.
They are negotiable bearer papers.
c.
The coupon or interest rate is set above the LIBOR for sovereign borrowers and below the LIBOR for US banks.
d.
Yields on Eurodollar FRNs range from 1/8 percent under LIBID up to LIBOR.
e.
The spread quoted on FRNs in the secondary market is 10 cents per $100 face value for the liquid sovereign issues.
Which of the following is a source of risk not associated with Eurodollar deposits? a.
The interference of the authorities in the movement or repatriation of the principal of the deposit or the interest paid on it.
b.
Blockage of the deposits of the foreign residents by the US Government.
c.
The potential for international jurisdictional disputes.
d.
Soundness of deposits at banking offices in foreign countries relative to banking offices located in the United States.
e.
Lesser cost of evaluating foreign investments than the local investments.
Which of the following is true in case of loan syndication? a.
In direct loan syndication, there is a principal-agent kind of relationship among the participant banks.
b.
The managing banks provide assistance and suggestions to the lead manager in managing the loan.
c.
The lead manager never plays the role of an agent bank in the syndicate.
d.
Syndication can be done only on a best effort basis.
e.
Merchant banker cannot act as a lead manager.
Which of the following is an upfront cost associated with pricing of Eurodollar loans? a.
Out of pocket costs.
b.
Commitment charge on the undrawn portion.
c.
Interest charges on loan amount.
d.
Agency cost.
e.
Interest on the undrawn portion of the loan.
Which of the following is true in case of multicurrency loans? a.
Multicurrency loans represent a natural expansion of the use of eurodollar loans.
b.
Multicurrency loans do not carry any currency risk.
c.
“Business day” is any working day.
d.
Interest rate for multicurrency loans is based on the LIBOR.
e.
None of the above. 71
Investment Banking and Financial Services
254.
255.
256.
257.
258.
259.
72
Which of the following is not considered as a provision to loan agreement? a.
Currencies.
b.
Legality.
c.
Exchange rate.
d.
Increased costs.
e.
Multilender considerations.
Which of the following gives the borrower more flexibility about the outstanding principal during the loan’s life? a.
Swingline.
b.
Evergreen facility.
c.
Revolving credit facility.
d.
Back-stop facility.
e.
Term loan.
Which of the following is not an advantage of syndicated loans? a.
Uncertainty of funds.
b.
Diversity of currency.
c.
Simpler banking relationship.
d.
Possibility of renegotiation.
e.
Lower cost of funds.
Which of the following is not an objective of ECB guidelines? a.
Keep borrowing costs low.
b.
Keep borrowing maturities long.
c.
Encourage infrastructure.
d.
Export sector financing.
e.
Earn profits.
Which of the following statements is false? a.
The “all-in-cost ceilings” for normal projects is 300 basis points over six months LIBOR.
b.
The “all-in-cost ceilings” for infrastructure projects is 300 basis points over six months LIBOR.
c.
The “all-in-cost ceilings” for long-term ECBs is 450 basis points over six months LIBOR.
d.
Corporates having foreign exchange earnings are permitted to raise ECB up to three times the average amount of annual exports during the previous three years.
e.
In case of structured obligations, if default takes place, the default should be the foreign exchange equivalent amount of principal and interest outstanding should be calculated.
Which of the following is true in case of foreign direct investment? a.
It decreases the efficiency with which the world’s scarce resources are used.
b.
It provides stimulus to economic growth.
c.
It is viewed as an obstacle that could slowdown the pace of integration in the world economy.
d.
In home countries, the FDI exports jobs and puts downward pressure on wages.
e.
In host countries the balance of payments are affected.
Part I
260.
261.
262.
263.
264.
265.
“Mergers and Acquisitions” and “Greenfield” Investments are part of which form of FDI? a.
Reinvested earnings.
b.
Equity capital.
c.
Long-term borrowing.
d.
Short-term borrowing.
e.
Term loans.
Which of the following is true in case of a vertical spillover? a.
It occurs when the affiliate has a new technology that is subsequently copied or learned by competing firms.
b.
It occurs when the affiliate transfers free of charge technology to firms supplying inputs or servicing “downstream” operations.
c.
It occurs when technology is licensed by the affiliate to a domestic firm.
d.
It benefits the MNC bringing in the technology.
e.
It is a kind of diffusion of technology for firms in the host country.
Which of the following is false with respect to FDI in India? a.
FDI is in the form of investment from Non- Resident Indians (NRIs) and Overseas Corporate Bodies(OCBs).
b.
FDI is not allowed in the services sector.
c.
The automatic route for FDI is not available to those who have joint venture or technology transfer/trademark agreement in India.
d.
Same rules apply to existing companies and new ventures.
e.
FERA rules the FDIs in India.
Which of the following is not an objective of Foreign Investment Promotion Board? a.
To undertake investment in India and abroad.
b.
To facilitate investment in the country through international companies, Non-Resident Indians and other foreign investors.
c.
To delay clearance of proposals submitted to it.
d.
To review policy and put in place appropriate rules and procedures for investment promotion and approvals.
e.
To deal in the matters related to FDI.
In which of the following forms of bank account is the deposit amount payable on the maturity date? a.
Reinvestment Deposit.
b.
Fixed Deposit Account.
c.
Recurring Deposits.
d.
Savings Account.
e.
Current Account.
Which of the following is not a characteristic of Non-Resident Non-Repatriable Rupee account (NRNR)? a.
Low rate of interest.
b.
Exempted from all taxes.
c.
Interest income is repatriable.
d.
Loan can be availed against deposit.
e.
High rate of interest. 73
Investment Banking and Financial Services
CREDIT RATING 266.
267.
268.
269.
270.
271.
Fine Steels Limited is planning to raise funds by issue of CPs and gets the security rated. The rating given by the credit rating agency will indicate a.
The general evaluation of Fine Steels Limited
b.
The possibility of repayment of the principal and interest by Fine Steels Limited
c.
The credit risk involved in making long-term investments with Fine Steels Limited
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
Which of the following aspects is not involved in technical analysis of credit evaluation? a.
Operat ive efficiency of plant.
b.
Availability of quality sources for major inputs.
c.
Need for modernization.
d.
In-house expertise.
e.
None of the above.
First Invest Limited is an institutional investor and approaches a credit rating agency to analyze the equity assessment of JP Pharmaceuticals Limited. Which of the following statements refer to equity assessment process? a.
It is an analysis done upon the request of the investor and the company.
b.
It is for the specific purpose of the investor who has requested for the assessment.
c.
Instead of a credit rating symbol, there will be a report on the analysis.
d.
Both (b) and (c) above.
e.
Both (a) and (c) above.
Which of the following indicates the steps involved in the explicit judgmental approach used in sovereign rating? a. Factors relevant for rating the entity are defined and weights are attached to them for quantitative assessment. b. A score is obtained on the basis of the weights. c. A score is obtained on the basis of quantitative assessment. d. Both (a) and (c) above. e. All of (a), (b) and (c) above. HK Limited is an institutional investor assessing the risks that may arise by making direct investments in overseas companies. Which of the following risks will the overseas investor be exposed to? a. Political risks of confiscation. b. Political risks of expropriation. c. Risks due to depreciation methods. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. In the absence of confiscation, the cash flows to an overseas investor are expected to be Rs.12 lakh. If the probability of confiscation is 0.05 for the investment period of 5 years, then the expected cash flow in year 5 after adjusting for this probability will be a. Rs.0.60 lakh b. Rs.3 lakh c. Rs.9.29 lakh d. Rs.11.40 lakh e.
74
Rs.11.32 lakh.
Part I
272.
273.
274.
275.
Real Finance Limited is a consumer finance company planning to get individual credit rating for its borrowers. Which of the following aspects should be analyzed? a.
Duration of stay in present place of residence.
b.
Future job prospects.
c.
Financial assets.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
Which of the following ratios are used while rating a CP? a.
Total debt/capitalization including short-term debt.
b.
Long-term debt/capitalization.
c.
Pre-tax return on average long-term capital employed.
d.
Both (a) and (c) above.
e.
All of (a), (b) and (c) above.
If the probability of the firm being confiscated is 0.05, then assess the expected cash flows for the investment of Rs.12 lakh. Discounted rate is 10%. a.
Rs.6.33 lakh
b.
Rs.76 lakh
c.
Rs.10.9 lakh
d.
Rs.120 lakh
e.
None of the above.
Which of the following statements is/are true? a.
Shadow rating need not be disclosed to the public.
b.
Formal rating will need considerably lesser information than shadow rating.
c.
If the shadow rating indicates a good rating, then there would be no need for formal rating.
d.
Both (a) and (c) above.
e.
All of (a), (b) and (c) above.
EVOLUTION OF FINANCIAL SERVICES 276.
277.
Which of the following statements is/are true? a.
20th century Leasing Ltd. is the first leasing company in India which came into existence in 1973.
b.
Normally equipment leasing carries the convertibility clause that can result in dilution of ownership and control.
c.
Equipment leasing provides hundred percent finance.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Which of the following statements is/are true? a.
SBI capital markets limited was set-up by SBI, which is the first commercial bank to set-up a financial services subsidiary.
b.
As per the RBI guidelines banks are allowed to provide hire purchase and leasing services through a subsidiary only.
c.
In installment credit, the ownership of the product is transferred to the user after paying the last installment.
d.
The interest rates quoted for consumer finance are based on the effective rate of interest.
e.
None of the above. 75
Investment Banking and Financial Services
278.
279.
280.
281.
Which of the following statements is/are true? a. A lease contract should essentially consist of the transfer of ownership from the lessor to lessee at the end of the lease period. b. In hire purchase, ownership of the equipment is transferred only after the user exercises his option to purchase it. c. Hire purchase facility is not available for the consumer goods like television, audio, systems, refrigerators etc. d. Both (a) and (c) above. e. None of the above. Which of the following statements is/are true in respect of credit cards? a. The largest share in the market of credit cards goes to CitiBank. b. Credit cards were first introduced in India as Diners cards in 1962. c. Master and Visa cards were first launched by CitiBank. d. The mode of payment in this mechanism is through the usage of ‘plastic cards’. e. All of the above. Which of the following statements is/are true with respect to housing finance? a. National housing bank is a fully owned subsidiary of the RBI. b. All the housing finance companies in India, are registered with National Housing Bank. c. Commercial banks capture the largest market share in this market. d. Both (b) and (c) above e. None of the above. Which of the following statements is/are true? a. The largest of the private sector mutual funds is Kothari mutual fund. b. Portfolio management schemes provide investor participation in non-discretionary portfolios whereas mutual funds do not allow the direct involvement of the investors in the investment process. c. Credit rating in India started with the establishment of Investor Information and Capital Credit Rating agency in 1988. d. The minimum net worth of credit rating agency should be at least two crore, as per SEBI regulations. e. All of the above.
AN INTRODUCTION TO EQUIPMENT LEASING 282.
283.
As per the FASB specifications which of the following is/are termed as finance lease? a. Lease term 5 years; useful life 10 years. b. Lease term 5 years; useful life 8 years. c. Lease term 5 years; useful life 6 years. d. Lease term 5 years; useful life 12 years. e. All of the above. Given that the fair market value of the equipment is Rs.400 lakh at the time of inception of lease and based on the present value of lease rentals given below, which of the following can be categorized as a finance lease as per FASB specifications? a. Rs.300 lakh. b. Rs.250 lakh. c. Rs.50 lakh. d. Rs.380 lakh. e.
76
Rs.200 lakh.
Part I
284.
285.
286.
287.
288.
289.
A fully pay-out lease means that a.
The lessor should take the responsibility for repairs, maintenance and insurance of the asset
b.
The lessee should bear the cost for repairs, maintenance and insurance of the asset
c.
The lessee has to pay lease rentals irrespective of the condition or suitability of the asset
d.
The lease operates over the entire economic life of the asset
e.
The present value of the lease rentals should be equal to the cost of the equipment.
In a leveraged lease transaction a.
There are only two parties to the transaction
b.
The debt funds raised by the leasing company are with recourse to the lessee
c.
Lender generally receives the debt service component of annual lease rental through a trustee
d.
The lessor cannot claim tax shields on depreciation and other capital allowances on the entire investment cost
e.
Both (b) and (c) above.
Which of the following statements is/are true? a.
In a finance lease, the lessee generally has to undertake the ‘hell or high water’ obligation.
b.
A ‘wet lease’ is a variant of finance lease.
c.
A ‘sale and leaseback’ transaction is a direct lease.
d.
In a ‘swap lease’ the lessor happens to be the equipment supplier.
e.
Both (a) and (d) above.
Which of the following are the characteristics of an operating lease? a.
All the equipment related business and technological risks are shifted from the lessor to the lessee.
b.
The present value of minimum lease payments is equal to the fair market value of the asset at the time of inception of the lease.
c.
The ownership of the asset is transferred to the lessee at the end of the lease period.
d.
The lease can be generally terminated by the lessee at short notice without any significant penalty.
e.
Both (a) and (d) above.
In a perfectly competitive financial market, a.
The cost of leasing is more than the cost of other forms of borrowing
b.
The cost of leasing is less than the cost of other forms of borrowing
c.
The cost of leasing is equal to the cost of other forms of borrowing
d.
The cost of leasing is significantly different from the cost of other forms of borrowing, but whether it is high or low depends on other specific factors
e.
The cost of leasing is generally lower than the yield on 5-year GoI securities.
Which of the following statements is/are true? a.
Upgrade lease and swap lease are variants of operating lease.
b.
Upgrade lease helps in hedging the risk of obsolescence.
c.
All operating leases are generally bipartite leases.
d.
Double dip or multiple dip advantages are associated with cross-border leases.
e.
All of the above.
77
Investment Banking and Financial Services
290.
291.
292.
293.
294.
78
Which of the following statements is true? a.
In a single investor lease, there are always one equity participant and one debt participant.
b.
A leveraged lease transaction entitles the lessee to claim the capital allowances on the entire investment cost.
c.
A leveraged lease transaction is routed through a trustee who looks after the interest of the lender and the lessee.
d.
In a leveraged lease transaction, the leasing company invests in the equipment by borrowing a large chunk of the investment with full recourse to itself and no recourse to the lessee.
e.
In a leveraged lease transaction, the leasing company invests in the equipment by borrowing a large chunk of the investment with full recourse to the lessee and no recourse to itself.
A walk-away lease is the same as a.
An open-ended lease
b.
A closed-ended lease
c.
Sale and leaseback
d.
A leveraged lease
e.
A cross-border lease.
Which of the following is/are features of an ‘equipment leasing’? a.
The lessor transfers the right to use the equipment to the lessee.
b.
If the end of the lease period is over the asset automatically goes into the possession of the lessee.
c.
The lessor usually bears the costs of insuring and maintaining the asset.
d.
Both (a) and (b) above.
e.
All of (a), (b), and (c) above.
Which of the following statements is/are true? a.
The features of a finance lease transaction are similar to that of a hire purchase transaction.
b.
The features of an operating lease transaction are similar to that of conditional sales agreement.
c.
An operating lease transaction cannot provide transfer of ownership from the lessor to lessee.
d.
Any asset based financing plan will normally carry the feature of transfer of ownership from lessor to lessee.
e.
None of the above.
As per the ‘International Accounting Standards Committee’ a.
The finance lease transaction is more or less similar to that of a hire purchase transaction.
b.
The term of the lease covers the major part of the useful life of the asset, if it were to be a finance lease.
c.
The present value of the minimum lease payments should be greater than or equal to the fair market value of the asset at the inception of the financial lease.
d.
Both (b) and (c) above.
e.
All of (a), (b), and (c) above.
Part I
295.
296.
297.
298.
299.
300.
Which of the following features is/are borne by a financial lease in the Indian context? a.
By the end of the lease term the ownership of the asset will be transferred to the lessee.
b.
The lease term is for a major part of the useful life of the asset.
c.
The lease transaction is almost similar to that of the conditional sales agreement.
d.
The present value of the lease payments is substantially less than the fair market value of the asset at the inception of the lease.
e.
All of the above.
According to the Financial Accounting Standard Board of the US, for a financial lease, the lease term should exceed a.
90% of the useful life of the asset
b.
75% of the useful life of the asset
c.
95% of the useful life of the asset
d.
At least 50% of the useful life of the asset
e.
None of the above.
The discount rate to be used by the lessee for the purpose of determining the present value of the asset in a financial lease is a.
The rate of interest implicit in the lease
b.
The rate at which lessee can borrow funds
c.
The incremental rate of borrowing
d.
The lessee’s weighted average cost of capital
e.
None of the above.
“Hell or High water” clause means a.
The commitment of the lessor to replace the asset in the face of any event affecting the usage of the asset
b.
The operation of the asset by the lessee over the entire life of the equipment
c.
The lessor should take responsibility for repair and maintenance and should pay insurance
d.
The unconditional obligation of the lessee to pay rentals over the entire life of the asset
e.
None of the above.
“A fully pay-out lease” is a.
A lease in which a substantial part of the payments are made at the front end of the transaction
b.
A finance lease which operates over the entire economic life of the equipment
c.
A lease in which the title would be passed automatically from the seller to the buyer at the end of lease period
d.
Both (a) and (c) above
e.
None of the above.
Which of the following features characterize an operating lease? a.
Lease term is significantly shorter than the economic life of the equipment.
b.
The lease contract can be terminated by the lessor at short notice.
c.
The present value of the lease rentals should be greater than or equal to the fair market value of the asset at the inception of the lease.
d.
Both (a) and (b) above.
e.
All of (a), (b), and (c) above. 79
Investment Banking and Financial Services
301.
302.
303.
304.
305.
306.
80
A “wet lease” a.
Is an operating lease
b.
Will provide the operating know-how, suppliers and the related services to the lessee.
c.
Characterized by the lessor’s responsibility of insuring and maintaining the equipment
d.
Both (a) and (b) above.
e.
All of (a), (b), and (c) above.
State which of the following statements is/are true. a.
In a “dry lease” the lessor bears the costs of insuring and maintaining the leased equipment.
b.
An operating lease transfers the equipment related business and technological risks from the lessor to the lessee.
c.
The lessor while structuring a financial lease largely depends upon the realization of a substantial resale value.
d.
An operating lease calls for an in-depth knowledge of the equipments and a secondary market for such equipments.
e.
The operating leases are most popular in India.
Which of the following is/are true about the sale and lease back transaction? a.
The lease back arrangement should be in the form of finance lease only.
b.
It enjoys the uninterrupted use of the asset.
c.
It unlocks the firm’s investment in low income yielding assets.
d.
Both (b) and (c) above.
e.
All of (a), (b), and (c) above.
State which of the following statements is/are true. a.
A sale and lease back transaction can be considered as a direct lease.
b.
A direct lease should essentially consist of three different parties – the equipment supplier, the lessor and the lessee.
c.
The sale and lease back arrangement can be in the form of a “finance lease” or an “operating lease”.
d.
In a finance lease the lessor is responsible for repair, maintenance and insurance of the asset.
e.
“Hell or high water” obligation applies to the lessee in operating leases only.
“Sales-aid-lease” a.
Is essentially a tripartite lease
b.
Is a transaction catalyzed by the equipment supplier
c.
Is a transaction that confers the discounted lease rentals to the leasing company
d.
Is supported by a recourse to the supplier in the event of default by the lessee
e.
All of the above.
In a leveraged lease transaction a.
The number of parties to the transaction are two
b.
Lessor is the loan participant
c.
The debt portion is invested in the equipment without recourse to the lessee
d.
The lender obtains a first mortgage on the leased asset
e.
The lessee has to pay the lease rentals directly to the lender.
Part I
307.
308.
309.
310.
311.
State which of the following statements is/are true. a.
In a domestic lease the lessor and the lessee should be domiciled in the same country where as the domicile of the equipment supplier is immaterial.
b.
Domestic lease is exposed to country risk whereas the international lease is exposed to the currency risk.
c.
Import lease transactions cannot be considered as International lease transactions.
d.
A cross-border lease is invariably a big ticket leveraged lease
e.
None of the above.
Which of the following statements is/are false? a.
In a cross-border lease transaction the domicile of the supplier is immaterial.
b.
In import lease transaction the lessor is domiciled in a country different from that of the lessee.
c.
Cross-border lease transaction is prepared to take higher residual value exposure.
d.
The lease rentals in cross-border lease transactions are cheaper.
e.
None of the above.
Which of the following leases hedges the risk of obsolence? a.
Finance lease.
b.
Operating lease.
c.
Upgrade lease.
d.
Leveraged lease.
e.
Swap lease.
Which of the following is/are the advantages of leasing? a.
Leasing decreases the financial risk of a firm.
b.
Leasing is highly beneficial in a perfectly competitive financial market.
c.
For a firm which does not have the capacity to absorb the tax shelters associated with the investments, leasing becomes more sensible.
d.
Leasing is always cheaper than debt financing.
e.
Both (a) and (c) above.
The non-capitalization of a finance lease in the lessee’s balance sheet results in a.
Under statement of the assets turnover ratio
b.
Overstatement of the return on investment
c.
Understatement of gearing ratio
d.
Both (a) and (b) above
e.
Both (b) and (c) above.
LEASING IN INDIAN CONTEXT 312.
Which of the following statements is true? a.
The lease rental payable during the primary period is called the ‘pepper-corn’ consideration.
b.
Equipment leasing may result in dilution of control because of the convertibility clause associated with it.
c.
The Standard Chartered Bank was the first foreign bank to participate in the equity of a leasing company.
d.
The Industrial Development Bank of India was the first financial institution to enter into equipment leasing industry.
e.
None of the above. 81
Investment Banking and Financial Services
313.
314.
315.
316.
317.
318.
82
Which of the following restrictions are applicable to a finance company intending to tap the intercorporate market? a.
The maximum maturity period of the ICD should not be more than 15 months.
b.
The total amount that can be raised by way of intercorporate deposits cannot exceed two times the free reserves of the company.
c.
A minimum liquidity reserve of 15% of the intercorporate deposits is required to be maintained by the company planning to tap the ICD market.
d.
Both (a) and (b) above.
e.
Both (b) and (c) above.
The issue price (rounded off to nearest rupee) of a cash certificate of face value Rs.3,000, which is to be redeemed at par after 12 months so as to yield 15% p.a. is a.
Rs.1,492
b.
Rs.445
c.
Rs.895
d.
Rs.1,490
e.
Rs.2,609.
Which of the following statements is/are true with respect to public deposits? a.
The true yield of a public deposit is influenced by the term to maturity of the deposit.
b.
A leasing company can use the entire finance raised through public deposits for lease investments.
c.
The true yield on a public deposit is always less than the simple interest yield.
d.
The compounded yield on a public deposit is always higher than the simple interest yield.
e.
Both (a) and (d) above.
A leasing company can raise bank borrowings up to a.
10 times net owned funds
b.
4 times net owned funds
c.
3 times net owned funds
d.
2 times net owned funds
e.
None of the above.
Which of the following is not included within the definition of deemed deposits? a.
Intercorporate deposits.
b.
Borrowings and monies received from the shareholders of private limited companies.
c.
Borrowings and monies received from the directors of private limited companies.
d.
Monies raised through debentures and bonds secured by immovable properties.
e.
Funds raised through unsecured non-convertible debentures.
There is a ceiling on the interest rate or discount rate given by the leasing companies if they raise the finance through a.
Public deposits
b.
Intercorporate deposits
c.
Commercial paper
d.
Both (b) and (c) above
e.
All of (a), (b) and (c) above.
Part I
319.
320.
321.
322.
323.
324.
The maturity mismatch is more pronounced for leasing companies in the case of a.
Public deposits
b.
Bank borrowings
c.
Intercorporate deposits
d.
Commercial paper
e.
Both (c) and (d) above.
Which of the following is true regarding bank lending to a finance company? a.
It can be in the form of cash credit only and should not exceed 4 times the NOF.
b.
It can be in the form of term loan only and should not exceed 6 times the NOF.
c.
It can be in the form of bill discounting only and should not exceed 4 times the NOF.
d.
It can be in the form of cash credit only and should not exceed 6 times the NOF.
e.
None of the above.
Which of the following statements is/are true? a.
The implicit cost of the deemed deposits is more than their explicit cost.
b.
An exchangeable bond is a combination of debt of one company which is converted into equity of another company.
c.
The provisions of the Indian Contract Act, 1872 governing bailment prohibit the lessee from entering a sub-lease.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Mr Anand deposited Rs.7,000 under the cumulative deposit scheme of Garg Finance Limited. The tenure of the deposit is 12 months and the rate of interest is 15% p.a. (compounded monthly). The annual yield on this deposit is a.
15%
b.
16.08%
c.
17.52%
d.
18%
e.
18.15%.
Kavya deposits Rs.2,000 in a deposit scheme of Sneha Finance Company. The nominal rate of interest on this deposit is 15% p.a. compounded monthly. If the tenure of the deposit is 12 months, the amount receivable by Kavya on maturity is a.
2,240
b.
2,300
c.
2,322
d.
2,400
e.
None of the above.
As per SEBI guidelines, a finance company issuing non-convertible debentures will have to get the issue rated by an approved rating agency, if the initial term to maturity exceeds ______ months. a
12
b.
15
c.
18
d.
24
e.
36.
83
Investment Banking and Financial Services
325.
326.
327.
328.
Securitization is advantageous because a.
It enables the originator to unlock its investment in certain illiquid assets
b.
It provides funds with maturity comparable to the maturity of the assets securitized
c.
It involves very low development costs
d.
The time and effort required to co-ordinate an issue is low
e.
Both (a) and (b) above.
As per the prudential norms for non-banking financial companies, sub-standard assets are those assets which have remained NPA for a period a.
Not exceeding six months
b.
Not exceeding one year
c.
Not exceeding two years
d.
Exceeding two years
e.
None of the above.
A cash certificate of Rs.2,000 is issued at a discount and redeemed at par after 12 months. Given that the yield is 15%, the issue price will be a.
Rs.1,550
b.
Rs.1,579
c.
Rs.1,739
d.
Rs.1,790
e.
None of the above.
In the credit rating symbols given by CRISIL, adequate safety of timely payment of interest and principal is indicated by: a.
BB
b.
B
c.
A
d.
AA
e.
AAA.
LEGAL ASPECTS OF LEASING 329.
330.
84
The implied obligations of lessor and lessee in an equipment lease transaction can be understood from the a.
Transfer of Property Act, 1882
b.
Indian Contract Act, 1872
c.
Hire Purchase Act, 1972
d.
Indian Registration Act, 1899
e.
None of the above.
Which of the following statements is/are true with respect to the ‘process of lease documentation’? a.
A ‘letter of offer’ is prepared by the lessee indicating the acceptable terms and conditions of the lease proposal.
b.
In master lease agreement the lease facility is offered to the lessee in the form of a lease line.
c.
Equipment lease agreement should be registered as per the Indian Registration Act, 1908.
d.
The warranties in respect of the equipment can be availed by the lessee.
e.
Both (b) and (d) above.
Part I
331.
332.
333.
334.
335.
336.
The denial of lessor’s responsibility for any defects in the equipment is defined in which of the following clauses? a.
Description clause.
b.
Ownership clause.
c.
Exemption clause.
d.
Repairs and alterations clause.
e.
Default clause.
Which of the following is/are true regarding a contract of bailment? a.
Bailment does not commence until the goods are delivered to the bailee.
b.
The bailee has an implied obligation not to act in a manner inconsistent with the terms of the bailment.
c.
The bailor need not disclose to the bailee any faults in the goods bailed of which the bailor is aware.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
In a lease agreement, the clause which specifies that upon expiry of the lease term the lessee must deliver the equipment to the lessor is referred to as: a.
Exemption clause
b.
Ownership clause
c.
Equipment delivery clause
d.
Surrender clause
e.
None of the above.
The clause in a lease agreement which states that no right, title or interest in the leased asset shall pass to the lessee is called the a.
Description clause
b.
Exemption clause
c.
Ownership clause
d.
Default clause
e.
Surrender clause.
Which of the following statements is/are false? a.
The definition of ‘bailment’ under The Indian Contract Act, 1872 closely resembles the equipment lease transaction.
b.
Bailor ‘can be taken as counterpart of the lessor’ and the ‘bailee’ can be taken as the counterpart of the lessee.
c.
The commencement of ‘bailment’ requires the delivery of the goods.
d.
If the goods are destroyed, bailee is not liable to indemnify the bailor for loss.
e.
The goods must be delivered to the bailor on the expiry of fixed time.
The differences between the bailment and the equipment leasing is/are a.
Equipment lease in the Indian context contains a purchase option whereas bailment does not
b.
Bailor has to supply the goods to the bailee according to his specifications
c.
‘Equipment lease’ requires the equipment supplier sometimes whereas the ‘bailment’ transaction does not require
d.
Creditors of the bailor can take by law possession of the ‘bailed goods’ from bailee which is not possible in lease transaction
e.
None of the above. 85
Investment Banking and Financial Services
337.
338.
339.
340.
341.
342.
86
‘Process of lease documentation’ contains a. A ‘letter of offer’ which is to be sent to lessee specifying the terms and conditions b. A ‘letter of offer’ which should be passed by the board of leasing company because it is required statutorily c. Registration of the equipment lease transaction which is essential d. ‘Tripartite agreement’ under which the lessor is to select the equipment supplier e. Both (a) and (d) above. Which of the following statements is true? a. The implied obligations of the lessor and the lessee in an equipment lease transaction are defined by the Transfer of Property Act, 1882. b. Bailment, by definition includes a lease with a purchase option. c. A contract of bailment is similar to a hire purchase contract in the sense that it provides an option to the bailee to purchase the goods concerned as per the terms and conditions of the contract. d. There is no uniform format for lease agreement. e. None of the above. Which of the following statements is/are true? a. The change of location of the equipment by the lessee sometimes requires the prior permission of the lessor. b. The lessor owns no responsibility for any defect in the equipment. c. Lessee is not entitled to avail the benefits of the warranties provided by the manufacturer. d. Both (a) and (b) above. e. Both (b) and (c) above. Which of the following statements is/are false? a. Lessor should take the responsibility of delivering the equipment on the specified date. b. Any improvements made to the equipment by the lessee will belong to the lessee. c. A sale and lease back transaction is an example of bailment involving constructive delivery. d. A tripartite lease is a leveraged lease transaction involving three parties, the loan participant, the equity participant (lessor) and lessee. e. Both (a) and (c) above. Which of the following statements is/are true? a. In a tripartite commercial agreement, the supplier recognizes the interests of the lessor. b. The Hire Purchase Act, 1972 defines the implied obligations of the lessee and the lessor. c. The letter of offer is usually made by the lessee wherein it indicates the acceptable terms and conditions of the lease. d. A finance lease agreement invariably requires the lessee to insure the equipment. e. All of the above. ‘Set-off provisions’ a. Are primarily meant to protect the interests of the ‘lessee’ b. Are primarily meant to protect the interests of the ‘lessor’ c. Include hell or high water clause d. Both (a) and (c) above e. Both (b) and (c) above.
Part I
TAX ASPECTS OF LEASING 343.
344.
345.
346.
347.
Which of the following statements is/are true? a.
As per the new accounting standard AS-19 lessee can claim depreciation tax shields.
b.
The lessee can claim depreciation allowance on leased assets like furniture and fixtures because any asset used in the assessee’s trade is eligible for depreciation.
c.
The lessor can claim depreciation tax shield.
d.
Depreciation on leased assets cannot be claimed by lessor or the lessee.
e.
Both (a) and (b) above.
As per Income Tax Act, 1961 a.
The rental expense on leased assets can be treated as a tax deductible expense in the accounts of lessee
b.
The expenses incurred by lessee towards insuring and maintaining the equipment are not allowed as tax deductible expenses
c.
If the lessor has acquired the asset for commercial purpose and let it on lease or hire, the rental income must be assessed under the head ‘Income from Other Sources’
d.
If it is alleged that the main purpose of a sale and leaseback transaction is to reduce the lessor’s liability to income tax, the onus of proof is on the assessing officer
e.
Both (a) and (d) above.
The annual tax shield associated with leasing an equipment costing Rs.300 lakh for an annual lease rental of Rs.44.3 ptpm, if the marginal tax rate is 46%, is a.
Rs.130.9 lakh
b.
Rs.132.9 lakh
c.
Rs.140 lakh
d.
Rs.61.13 lakh
e.
Rs.66.45 lakh.
Alankar Ltd. is evaluating the leasing alternative of the equipment whose cost is Rs.80 lakh (exclusive of sales tax) from Evan Leasing Company. What would be the cost of equipment inclusive of sales tax to ELC and to Alankar Ltd., if it were to purchase the equipment? a.
Rs.88 lakh and Rs.83.2 lakh
b.
Rs.83.2 lakh and Rs.88 lakh
c.
Rs.88 lakh and Rs.88 lakh
d.
Rs.83.2 lakh and Rs.83.2 lakh
e.
None of the above.
Which of the following statements is/are true? a.
An equipment supplier for leasing transactions cannot claim the concessional rate of sales tax.
b.
If a leasing company buys an equipment from a supplier within the same state and leases it to a lessee within the same state, the equipment is exempted from second levy of sales tax.
c.
Clause 29A of 46th amendment states that the tax on purchase or sale of goods includes a tax on the transfer of the right to use the goods for any purpose for cash deferred payment or other valuable consideration.
d.
Both (a) and (c) above.
e.
Both (b) and (c) above. 87
Investment Banking and Financial Services
348.
349.
350.
351.
352.
353.
88
The cost of a capital equipment exclusive of sales tax is Rs.60 lakh. The quote of leasing company on a five-year lease is Rs.27.5 ptpm payable at the end of every month excluding sales tax. The leasing company is required to pay sales tax at 5 percent on the quoted lease rental. The lease rental to be collected is a.
Rs.1.92 lakh
b.
Rs.1.906 lakh
c.
Rs.1.737 lakh
d.
Rs.1.815 lakh
e.
Rs.1.65 lakh.
As per the Income Tax Act, 1961, depreciation is calculated a.
On WDV method only at the rates given in the Act
b.
On WDV method or SLM method at the rates given in the Act
c.
On blocks of assets by clubbing all the assets of same rate of depreciation together
d.
On individual assets
e.
Both (a) and (c) above.
Which of the following is not considered as a sale under the CST Act? a.
Transfer of property in goods for deferred payment.
b.
Hire purchase.
c.
Hypothecation.
d.
Pledge.
e.
Both (c) and (d) above.
Depreciation allowance on leased assets a.
Is claimed by the lessor
b.
Is claimed by the lessee
c.
Is claimed by both lessee and lessor in the case of cross-border lease
d.
Both (a) and (c) above
e.
Both (b) and (c) above.
As per the Income Tax Act, 1961 a.
Lessee can claim the depreciation tax shields on leased assets
b.
Lessee can claim the maintenance costs of the leased assets
c.
In a sale and leaseback transaction, the lessee cannot claim depreciation on a cost which is higher than the book value of the asset as on the date of transsfer
d.
A lease where more than ninety percent of the cost of the asset is recovered over the non-cancellable term is not regarded as a “true lease”
e.
Both (b) and (d) above.
As per the Section 32 of Income Tax Act, 1961 a.
Depreciation is allowed as a tax-deductible expense if the asset is used by the assessee for the purpose of business
b.
Depreciation is computed with reference to the actual cost of the asset
c.
WDV method is used for plant and machinery and SLM method is used for the rest of the items
d.
Depreciation is charged not on an individual asset but on a block of asset
e.
All of the above.
Part I
354.
355.
356.
357.
358.
359.
Which of the following statements is/are true? a. The lessor can claim the depreciaton tax shields as the leased assets are deemed to be used in the lessors business of leasing and hire purchase. b. Any asset used in the assessee’s leasing and hire purchase business is treated as a plant. c. The lessor cannot claim the depreciation tax shields as he transfers the right to use the asset to the lessee. d. Both (a) and (b) above. e. Both (b) and (c) above. Which of the following statements is/are true? a. IT Act, 1961 does not distinguish between an operating lease and finance lease to determine the allowable tax deductions for both the lessor and lessee. b. As per the provisions of CBDT circular issued in 1943 an open-ended lease will qualify as a hire purchase transaction. c. A lease transaction which covers a short period of the life of the asset and substantially recovers the investment cost is treated as hire purchase transaction for the income tax purpose. d. Both (a) and (c) above. e. All of (a), (b) and (c) above. Which of the following statements is/are false? a. A purely tax driven rental structure is not allowed by the Income Tax authorities. b. Lessee can reduce the tax liability by using flexibility in structuring lease rentals. c. Lessee can obtain the benefit of unabsorbed capital allowances in the form of lower lease rentals. d. A 100% EOU company cannot avail the acquisition-related tax shields but can avail the lease related tax shelters. e. None of the above. A lease transaction attracts sales tax i. When the asset is sold by the lessor at the end of the lease period. ii. When the asset is purchased by the lessor for the purpose of leasing. iii. When the right to use the asset is transferred to the lessee for valuable consideration. a. (i) only b. All (i), (ii) and (iii) above c. (ii) only d. (iii) only e. (i) and (iii). Levy of Sales Tax a. Is governed by the Central Sales Tax Act, 1957 b. Is governed by the Sales Tax Laws enacted by the state legislatures c. Depends upon the nature of the sale d. Both (a) and (b) above e. All of (a), (b) and (c) above. A sale or purchase which takes place in the course of Export or Import a. Attracts Central Sales Tax b. Attracts State Sales Tax c.
Attracts both Central and State Sales Tax
d.
Attracts concessions from the Central Sales Tax
e.
None of the above. 89
Investment Banking and Financial Services
360.
361.
362.
363.
364.
365.
90
Sales Tax on interstate purchase of equipment a. Will attract the Section 8 of the CST Act b. Will include the Sales Tax at the rate of 4% or at the rate applicable within the appropriate state c. If it is for the purpose of resale cannot avail the concessional rate of sales tax d. Both (a) and (b) above e. None of the above. Sales Tax at a concessional rate of 4% cannot be availed in which of the following cases? a. When the equipment is purchased for the purpose of leasing. b. When the equipment is purchased for the purpose of resale. c. When the equipment is purchased for the manufacturing process. d. Both (a) and (b) above. e. Both (b) and (c) above. Which of the following statements is/are false? a. As per the Central Sales Tax Act lease is not a form of sale. b. Value of lease rentals is always less than the cost of equipment if purchased directly. c. Concessional sales tax is not applicable when equipment is purchased for the purpose of leasing. d. The cost of equipment is always greater to the lessor than to lessee due to the different rates of CST. e. None of the above. Which of the following statements is/are true? a. An equipment lease which transfers the right to use an equipment for a very short period of time is not deemed a sale under Article 366 (29A) of the Constitution. b. The Sales Tax Law of a state cannot levy Sales Tax on a lease transaction which transfers the right to use goods for domestic purposes. c. Article 366 (29A) of the Constitution does not provide for a tax on the transfer of the right to use goods not supported by a valuable consideration. d. 46th Amendment is made to the constitution to levy tax on non-conventional sales or purchases. e. Both (c) and (d) above. State which of the following statements is/are false. a. An equipment lease transaction suffers a multipoint levy irrespective of the goods covered by the transaction b. Section 3(a) of CST Act gives the definition for interstate lease c. As per the Article 286 of the constitution, an interstate sale is outside the taxing powers of the state d. The lessee should pay the additional Central Sales Tax suffered by the lessor and bear the sales tax on lease rentals e. None of the above. State which of the following statements is/are true. a. A hire purchase transaction is not a deemed sale under the Central Sales Tax Act. b. Article 286 of the constitution imposes certain restrictions on the taxing powers of the states. c. The taxable rent for the purpose of levying Sales Tax on lease rentals is the transfer of the right to use. d.
Both (a) and (b) above.
e.
Both (a) and (c) above.
Part I
366.
367.
368.
369.
Unexpired finance charge is the a.
Present value of the lease payments
b.
Difference between the present value of the lease payments and fair market value of the asset
c.
Sum of the lease payments over the entire lease period
d.
Difference between the sum of the lease payments over the entire lease period and present value of the lease payments
e.
None of the above.
As per IAS 17 a.
The lessor has to charge the depreciation on leased equipment to profit and loss account
b.
The lessor has to capitalize the minimum of fair market value of the equipment or present value of the minimum lease payments
c.
The lessee has to debit the finance charges to profit and loss account
d.
The lessor has to disclose the leased equipment as fixed assets in his balance sheet
e.
All of the above.
As per IAS 17 requirements the unexpired finance charge can be allocated as per a.
Actuarial Method
b.
Straight Line Method
c.
Sum of Digits Method
d.
At the discretion of the lessee
e.
Both (a) and (c) above.
Which of the following statements is/are true? a.
ICAI guidelines require the lessee to capitalize the leased asset.
b.
The SOYD method is also known as Rule of 78 method.
c.
Lease rentals should be charged to the P&L account by the lessee, as per IAS-17.
d.
As per IAS 17, the finance charge and depreciation charge for each accounting period should be equal.
e.
Both (c) and (d) above.
LEASE EVALUATION: THE LESSEE’S ANGLE 370.
371.
As per the Weingartner’s model the equipment should be leased if a.
NPV(L) > 0
b.
NPV(L) < NPV (B)
c.
NPV(L) > NPV (B)
d.
NPV(L) > NPV (B) > 0
e.
NPV(L) < NPV (B) < 0.
Weingartner’s model assumes that the target capital structure is a mix of a.
Debt and equity
b.
Replaced debt and equity
c.
Debt, lease finance and equity
d.
Lease finance and equity
e.
Debt and lease finance. 91
Investment Banking and Financial Services
372.
373.
374.
375.
376.
The discount rate to be used as per Weingartner’s model is/are a.
Marginal cost of capital
b.
Pre-tax marginal cost of debt
c.
Post-tax marginal cost of debt
d.
Multiple discount rates
e.
None of the above.
Which of the following model assumes that the debt which will be raised in lieu of the lease will be equal to the initial investment? a.
Equivalent Loan Model.
b.
Bower-Herringer-Williamson Model.
c.
Weingartner’s Model.
d.
Bower’s Model.
e.
Both (b) and (d) above.
Which of the following statements is/are false? a.
Financial advantage of lease is given by cash flow stream related to tax shields and residual value.
b.
Under Bower’s Model the discount rate to be used for tax shields is at the discretion of decision maker.
c.
BHW Model assumes that the risk characterizing the lease tax shields is equal to the risk complexion of the firm.
d.
Equivalent Loan Model uses the pre-tax marginal cost of debt as risk adjusted discount rate.
e.
All of the above.
Break even lease rental for the lessee a.
Reflects the minimum rental which the lessee is willing to pay
b.
Decreases if the upfront payment is larger
c.
Decreases with a higher tax relevant rate of depreciation
d.
Increases with a longer primary lease period
e.
Increases with a higher net salvage value.
In a Back-to-Back short-term lease arrangement a.
Each short-term lease is a cancellable lease
b.
The cost of the asset is fully amortized over one short-term lease
c.
The lessor enjoys the right of cancelation after each short period
d.
The lease rates at which the future leases will be renewed are to be determined at the inception of the lease
e.
None of the above.
LEASE EVALUATION: THE LESSOR’S ANGLE 377.
92
The break even lease rental a.
Is a floor price of a lease to the lessee
b.
Is the maximum lease rental that a lessor can expect
c.
For the lessor can be obtained by equating the net value of lease from the lessor’s point of view to zero
d.
Both (a) and (c) above
e.
All of (a), (b) and (c) above.
Part I
378.
379.
380.
381.
382.
383.
384.
If the tax relevant rate of depreciation is 100% and the lease transaction is set-up at the end of the financial year a. The lessor can claim 100% of the first year depreciation as tax deductible expense b. The lessor can claim 50% of the first year depreciation as tax deductible expense c. The lessor cannot claim the first year depreciation as tax deductible expense d. The lessor can claim 25% of the first year depreciation as tax deductible expense e. None of the above. Negotiation of lease rentals is possible only a. When the break even rental of the lessor is less than that of the lessee b. When the break even rental of the lessor exceeds the break even rental of the lessee c. When the net advantage of lease is positive for the lessor only d. When the net advantage of lease is positive for the lessee only e. Both (a) and (d) above. Which of the following will influence the gross yield on a lease proposal from the point of view of the lessor? a. Tax shield on depreciation. b. Tax payable on lease rentals. c. Residual value of the equipment. d. Tax shield on displaced debt. e. All of the above. Add-on yield a. Is a true measure of the interest rate implicit in a lease transaction b. Is more or less similar to the effective rate of interest c. Does not recognize the fact that every lease rental paid under the finance lease has a capital content and an interest content d. Is always higher than the gross yield of a lease e. Both (b) and (d) above. Calculate the add-on yield for the Sumitra Leasing Company which is proposing to give an equipment costing Rs.36 lakh for lease with a monthly rental of Rs.25 ptpm payable in advance for 5 years? a. 10% b. 12% c. 15% d. 19.53% e. 20%. The hurdle rate for the gross yield is given by a. Marginal cost of capital b. Marginal cost of debt c. Post-tax marginal cost of debt plus a profit margin d. Pre-tax cost of funds plus a profit margin e. None of the above. In the explicit judgmental approach to credit rating a. ‘Zero’ refers to the most favorable assessment b. The weights assigned to the various factors are subjectively determined c. Highly complex procedure is involved d. Rating is based on qualitative analysis only e. Techniques of statistical analysis are employed to identify the set of factors deemed relevant for credit rating. 93
Investment Banking and Financial Services
LEASE ACCOUNTING AND REPORTING 385.
386.
387.
388.
Which of the following statements is/are true? a. There is no difference of opinion between the IASC and leasing industry about the accounting aspects of operating lease. b. As per IAS 17 the finance lease transactions have to be revealed in the lessee’s balance sheet. c. As per IAS 17 the lessor has to record the present value of the lease rentals over the lease term as a part of current assets. d. Capitalization debate is the disagreement that is existing between the leasing industry and the accounting bodies. e. All of the above. Which of the following statements is/are false? a. As per the actuarial method of allocation of the unexpired finance charge, the interest component in lease payments decreases in the later periods. b. IAS 17 requires the effective rate of interest method to allocate the unexpired finance charge to each accounting period. c. The unexpired finance charge is the difference between sum of the lease payments over the entire lease period and present value of the lease payments. d. Actuarial method is also known as the flat rate of interest method. e. All of the above. As per AS-19 guidelines, in an operating lease a. The aggregate lease rentals must be spread over the relevant account periods on a straight line basis b. The prepaid rental will appear as a current liability in the books of the lessee c. The lessor should normally recognize the rental income on a straight-line basis d. Both (a) and (b) above e. All of (a), (b) and (c) above. Long-term leases of land and buildings a. Should be treated as finance leases b. Should be treated as operating leases c. Will transfer substantial risks and rewards associated with ownership to the lessee d. Both (a) and (c) above e. Both (b) and (c) above.
HIRE PURCHASE 389.
390.
94
The ownership is transferred in a hire purchase transaction a.
When the hirer pays the first installment
b.
When the hirer pays the last installment
c.
When the hirer exercises the option to purchase
d.
Both (b) and (c) above
e.
None of the above.
Hire purchase transaction entails the hirer a.
The right to cancel the agreement at any time before the payment of last installment
b.
The right to purchase the asset at any time before the payment of last installment
c.
The right to own the asset after the payment of the last installment
d.
Both (b) and (c) above
e.
All of (a), (b) and (c) above.
Part I
391.
392.
393.
394.
395.
The ownership on the asset will be transferred to the buyer on the payment of first installment in a.
Hire purchase transaction
b.
Installment sale
c.
Lease transaction
d.
Both (b) and (c) above
e.
All of (a), (b) and (c) above.
Which of the following statements is/are true? a.
In a hire purchase transaction the buyer is committed to pay the full price.
b.
The interest component of each hire purchase installment is always calculated on the basis of effective rate of interest.
c.
A common feature of hire purchase option and conditional sale is the transfer of ownership on the asset on payment of the first installment.
d.
A lease with purchase option can be considered as hire purchase transaction.
e.
None of the above.
Which of the following statements is/are true? a.
Effective rate of interest ignores the fact that the original amount of loan is repaid in installments over the term of loan.
b.
For a given effective rate of interest, the equivalent flat rate of interest is always higher.
c.
The approximation formula i =
d.
The approximation formula i =
e.
Both (c) and (d) above.
n . 2f is used to determine the effective rate of n +1 interest in a hire purchase transaction when hire payments are in arrears. n . 2f is used to determine the effective rate of n −1 interest in a hire purchase transaction when the hire payments are in advance.
Given the rate of interest of 14% flat, repayment period 4 years, frequency of payment being monthly in advance, which of the following will reflect the annual percentage rate? a.
28.6%
b.
14%
c.
27.42%
d.
20.0%
e.
16%.
Which of the following statements is/are true? a.
Change in profile of monthly payments from ‘advance’ to ‘arrears’ will always increase the effective rate of interest.
b.
Flat rate of interest in a hire purchase transaction will reflect the effective cost of funds.
c.
The approximation formula i =
d.
The effective rate of interest implied by a down payment plan is generally less than the effective rate of interest implied by deposit linked plan.
e.
Both (c) and (d) above.
n(n + 1) . 2f assumes that the payments are in arrears. n
95
Investment Banking and Financial Services
396.
397.
398.
399.
400.
96
Which of the following statements is/are true? a.
The effective rate of interest charged by finance companies is not subject to any regulations.
b.
Interest rebate to the borrower can be obtained by applying the effective rate of interest method only according to the Hire Purchase Act.
c.
If a deferment period is applied while calculating interest rebate, the rebate will decrease.
d.
Both (a) and (c) above.
e.
All of (a), (b) and (c) above.
Given that the charge for credit is Rs.300 and repayment period is 36 months, calculate the interest rebate using sum of years digits method if the borrower wishes to repay the outstanding loan after the payment of 24th installment? a.
Rs.35.14
b.
Rs.67.45
c.
Rs.50.42
d.
Rs.30.12
e.
Rs.60.12.
Given the total credit charge as Rs.318, repayment period 3 years, calculate the interest rebate if the borrower wishes to repay the outstanding amount after the payment of 24th installment using the modified Rule of 78 method using the deferment period of 2 months? a.
Rs.25.00
b.
Rs.26.26
c.
Rs.37.24
d.
Rs.30.12
e.
Rs.25.23.
The interest rebate calculated by a.
Effective rate of interest method is more accurate than interest rebate calculated by other methods
b.
Sum of years digit method is greater than the interest rebate calculated by modified Rule of 78 method
c.
Rule of 78 method is greater than the interest rebate calculated by effective rate of interest method
d.
Both (a) and (b) above
e.
Both (b) and (c) above.
Which of the following statements is/are true regarding hire purchase? a.
The title to the goods should be transferred to the hirer at the time of delivering the goods.
b.
The possession of goods by the hirer should not be hampered by the acts of third parties.
c.
The effective rate of interest on the completed transaction is less than the effective rate of interest on the original transaction if the interest rebate is calculated as per the Rule of 78 method.
d.
Some occasional delays in payment over the hire period empower the owner to terminate the contract.
e.
Both (b) and (d) above.
Part I
401.
402.
403.
Which of the following statements is/are true? a.
As per the Hire Purchase Act, 1972, the lessor is required to arrange for a comprehensive insurance cover for the goods hired.
b.
A hire purchase agreement provides for the right of the hirer to determine the hire purchase contract at any time before the final payment.
c.
A hire purchase transaction establishes a direct contractual relationship between the hirer and the equipment supplier.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Legal aspects of hire purchase transaction are governed by a.
Hire Purchase Act, 1972
b.
Indian Contract Act, 1872
c.
Sale of Goods Act, 1930
d.
Judgments pronounced by the English and Indian Courts from time to time
e.
All of the above.
Which of the following statements is/are true? a.
The cash purchase price less the down payment is capitalized in the books of hirer.
b.
Depreciation is charged on the cash purchase price of the asset.
c.
Unmatured finance income is shown as a current liability in the books of the finance company.
d.
Both (a) and (b) above.
e.
Both (b) and (c) above.
CONSUMER CREDIT 404.
405.
406.
Mr. Gopal purchased a Videocon Color Television set with a consumer loan of Rs.14,000. He pays an EMI of Rs.780 each for a period of 24 months. Calculate the flat interest charged from him. a. 9.50% b. 16.85% c. 11.25% d. 12.00% e. None of the above. State which of the following statement(s) are false, with respect to Consumer Credit Act, 1974 of the UK. a. The Act allows borrower to pause and reflect over his decision after signing the agreement under certain circumstances. b. It permits the borrower to opt for early repayment. c. It defines the types of ancillary charges to be included for the purpose of determining the total charge for credit. d. It does not insist on a license for the intermediary which provides consumer credit. e. Both (a) and (d) above. A consumer credit transaction is not structured in the form of a. Hire purchase b. Conditional sale c. Credit sale d. Lease with an option to purchase e.
None of the above. 97
Investment Banking and Financial Services
407.
408.
409.
410.
Which of the following criteria is not considered while extending consumer loans to individuals? a. Minimum level of annual emoluments. b. Minimum take-home salary. c. Net worth of employing company. d. Number of years in the present employment. e. None of the above. Which of the following statements is/are true? a. The difference between the consumer credit and hire purchase is that the hire purchase is secured through a first charge on the asset while the consumer credit is not. b. Consumer credit transaction is always a tripartite transaction. c. In a conditional sale contract, the ownership is transferred to the customer on payment of the first installment. d. ‘Consumer credit’ encompasses all asset-based financing plans. e. All of the above. Consumer Credit a. Is asset-based financial plan b. Allows customer to pay in installments to acquire the asset c. Is a financing plan offered primarily to buyers of consumer durables d. Allows customers to choose the repayment schedule based on their convenience e. All of (a), (b) and (c) above. Effective rate of interest is given by a.
n 2f, if payments are in advance n +1
b.
n 2f, if payments are in arrears n −1
c.
The rate of interest which equates the present value of all the cash flows in the transaction to zero
d.
Both (a) and (b) above
e.
All of (a), (b) and (c) above.
FACTORING AND FORFAITING 411.
412.
Which of the following is not a function of a factor? a. Credit rating. b. Collection of receivables. c. Maintaining sales ledger. d. Credit protection. e. None of the above. In which of the following types of factoring does the factor purchase the receivables on the condition that the loss arising on account of irrecoverable receivables are transferred to the client? a. Advance factoring. b. Recourse factoring. c. Non-recourse factoring. d. Maturity factoring. e.
98
Full factoring.
Part I
413.
414.
415.
416.
417.
418.
Which of the following is true with respect to cross-border factoring? a.
The export factor collects the dues directly from the importer.
b.
The export receivables are always factored on a recourse basis.
c.
The import factor collects the receivables and directly remits to the exporter.
d.
It is known as the four-factor system.
e.
Export factor enters into a contract with an import factor, who carries out the work of credit checking, sales ledger administration and collection.
Which of the following is/are not (a) form(s) of factoring? a.
Invoice discounting.
b.
Bill discounting.
c.
Supplier guarantee factoring.
d.
Forfaiting.
e.
Both (b) and (d) above.
Which of the following statements is/are true? a.
The exporter sells the goods to the importer on a deferred payment basis spread over 15-20 years.
b.
In credit insurance, insurance company not only helps in collection of receivables, but also settles the claims of insured accounts.
c.
A factor charges delcredere commission in credit granting process under nonrecourse factoring.
d.
In full factoring, factor extends services like credit protection, collection, and shortterm finance.
e.
Both (c) and (d) above.
Under which of the following types the factor does not make any advance payment to the client? a.
Bank participation factoring.
b.
Full factoring.
c.
Non-recourse factoring.
d.
Maturity factoring.
e.
Recourse factoring.
Which of the following statements is false? a.
Delcredere commission is not charged by factor in recourse factoring.
b.
The factor provides advance payment in case of full factoring.
c.
In supplier guarantee factoring, the supplier or dealer makes arrangements for shipping the supplies directly to the customer on approval.
d.
Maturity factoring is also known as ‘confidential factoring’.
e.
Cross-border factoring is referred as two-factor system of factoring.
In which type of factoring does the factor guarantee payment to the supplier in respect of a specific shipment? a.
Cross-border factoring.
b.
Supplier guarantee factoring.
c.
Forfaiting.
d.
Invoice discounting.
e.
Confidential factoring.
99
Investment Banking and Financial Services
419.
420.
Which of the following is false with respect to forfaiting? a.
The importer draws a series of promissory notes in favor of exporter for the payments to be made exclusive of interest charges.
b.
The promissory notes are guaranteed by a reputed international bank or importer’s bank.
c.
The exporter sells the availed notes to a forfaiter at a discount without recourse.
d.
The forfaiter may hold these notes till maturity or sell these notes to groups of investors.
e.
None of the above.
In which of the following forms of factoring does the factor extend all the related services to his client? a.
421.
Maturity factoring.
b.
Advance factoring.
c.
Full factoring.
d.
Bank participation factoring.
e.
Recourse factoring.
Mohita Factors Ltd. extends an advance of Rs.14 lakh to its client Naidu Pharma Ltd. at an interest rate of 4.75% per quarter. What is the effective annualized rate of interest paid by NPL? a.
18.11%
b.
20.40%
c.
19.23%
d.
21.11%
e.
19.86%.
SECURITIZATION 422.
423.
424.
100
Which of the following statements is/are true? a. Any resource with predictable cash flows can be securitized. b. Securitization means selling old debts in the form of securities. c. Securitization helps an institution in raising funds out of its debt portfolio. d. Both (b) and (c) above. e. All of (a), (b) and (c) above. ‘Special Purpose Vehicle’ a. Originates the assets through receivables, leases, housing loan or any other form of debt b. Will issue debt and purchase receivables from the originator c. Will obtain an investment credit rating and make the transaction attractive to the investors d. Is intended to manage the issue of the securities e. All of the above. Which of the following statements is/are not true? a. Securitization transforms an illiquid asset on the balance sheet into cash. b. In a whole loan sale all rights and responsibilities connected with a mortgage loan are transferred to the purchasers. c. Whole loan requires the loan-by-loan review by the purchaser. d. A whole loan sale is always with recourse to the seller. e. None of the above.
Part I
425.
426.
427.
428.
429.
430.
Which of the following is a collateralized term-debt offering? a.
Mortgage-backed bond.
b.
Mortgage pass-through securities.
c.
Collateralized mortgage obligation.
d.
Both (b) and (c) above.
e.
All of (a), (b) and (c) above.
Which of the following statements is/are true? a.
The average life of mortgage pass-throughs depends on prepayment experience of underlying mortgages.
b.
The pattern of cash flows is highly uncertain in CMO’s.
c.
The returns to the investors of interest only and principal only securities move in opposite direction.
d.
Both (a) and (b) above.
e.
Both (a) and (c) above.
Which of the following is/are features of asset-backed securities? a.
The installment contract asset-backed securities investor will have an ‘undivided’ interest in a trust formed by the issuer.
b.
The revolving credit asset-backed securities are usually backed by credit card receivables.
c.
The asset-backed security market is dominated by securities backed by automobile loans and credit receivables.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Which of the following is not an advantage of securitization? a.
The loan originators can raise money as soon as they originate loans.
b.
Securitization deals help the originator beat the credit rating given to the company.
c.
It enables the originator to take advantage of more profitable investment opportunities.
d.
It enables raising of funds without altering the capital adequacy ratio.
e.
None of the above.
STRIPs are a.
Securitized Trade Related Investment Proposals
b.
Securities Tranche Investment and Principal
c.
Separate Tranche Interest and Principal
d.
Separate Trading of Registered Interest and Principal Securities
e.
Both (c) and (d) above.
Which of the following is false with respect to whole loans? a.
A whole loan sale is always without recourse to the seller.
b.
A seller may retain the right to service the loans.
c.
The loan documents and trust deeds are transferred to the buyer with a proper assignment deed.
d.
Whole loans are not of much use as a medium of liquidity.
e.
Both (a) and (d) above. 101
Investment Banking and Financial Services
431.
432.
Which of the following factors are considered as impediments with respect to development of securitization in India? a. Levy of high stamp duty. b. Restrictions on transfer of property without intervention of the court of law. c. Strict capital adequacy norms. d. Both (a) and (b) above. e. All of (a), (b) and (c) above. The mortgage pass-through securities were designed to serve the following purpose a. To enhance the creditworthiness of the sale of mortgage loans b. To create a security that would be more freely tradeable and transferable c. To create a security that would not necessarily involve the inspection of each loan as done in case of whole loan sales d. Both (b) and (c) above e. All of (a), (b) and (c) above.
MORTGAGES AND MORTGAGE INSTRUMENTS 433.
434.
435.
436.
102
An adjustable rate mortgage is the same as: a. CMO b. Roll over mortgage c. Buy down loan d. SAM e. PAM. Which of the following statements is false? a. Mortgage-backed bonds are debt obligations of mortgage originator. b. CMOs retain many of the yield and credit quality advantages of pass-throughs, while eliminating some of less desirable elements of the traditional mortgage-backed security. c. SAMs use inflation as a way of paying for the property. d. GPMs have equal installments unlike traditional mortgages. e. In pledged amount mortgages the borrower pays a variable amount of installment while the lender receives an equated amount. Which of the following is not a feature of ARM? a. The mortgage interest may change only once in six months period and may not be changed at all during the first six months. b. The mortgage interest in the US is based on the weighted average cost of savings index published by the Federal Home Loan Bank of San Francisco. c. The mortgage interest rate may not rise beyond a predetermined level irrespective of the rise in the index. d. Whenever the mortgage rate is increased to a rate higher than its initial level, the borrower may opt to keep his monthly payment constant by extending the maturity of the mortgage. e. Decrease in the mortgage rate is optional on the part of the lender, but an increase is mandatory. The Loan To Value ratio or LTV a. Will increase as the mortgage balance decreases b. Indicates the percentage of down payment required by lenders c. Will be quoted high in times of lower interest rates d.
Both (a) and (b) above
e.
Both (b) and (c) above.
Part I
437.
438.
439.
440.
441.
442.
A Loan To Value (LTV) ratio of 85% means a. The borrower can be sanctioned a loan equal to 15% of the value of the property on which the mortgage is taken b. The borrower can be sanctioned a loan which can be repaid with 15% of his net income c. The borrower has to make a down payment of 15% of the value of the property d. The borrower has to provide a security deposit of 15% of the value of the property e. None of the above. A traditional mortgage is characterized by a. Floating rate of interest b. The payment of equated monthly installments c. The payment of interest on monthly basis and the payment of principal after a stipulated period d. The interest payment every month and equal portions of principal every month e. None of the above. Which of the following statements is/are true? a. As the mortgage balance decreases, in a traditional mortgage the homeowner’s equity rises. b. Mortgage balance at any time is the outstanding amount of principal and interest up to that point of time. c. The difference between the current market value of the home and the mortgage balance equals the homeowner’s equity. d. Both (a) and (b) above. e. Both (a) and (c) above. Which of the following statements is/are true with respect to Graduated Payment Mortgages? a. Graduated Payment Mortgage is a traditional form of mortgage. b. These are characterized by the higher initial payments than the traditional mortgages. c. Sometimes the initial payments are so low that they do not even cover the interest. d. Mortgage balance may increase with increase in time in the initial years. e. Both (c) and (d) above. Which of the following statements regarding Pledged Account Mortgages is/are true? a. The lender receives equated monthly installments. b. The lender is paid low level installments in the initial years and equated monthly installments after the specified number of years. c. The borrower pays low level installments in the initial years and equated monthly installments after the specified number of years. d. Both (a) and (b) above. e. Both (a) and (c) above. Which of the following statements is/are true? a. In graduated payment mortgages the initial payments made by the borrower may cover only the interest. b. In ‘traditional mortgages’ a fixed rate of interest is charged on the loan for its entire term. c. For a borrower under pledged account mortgages the payments resemble a traditional mortgage payments. d. The borrower under graduated payment mortgages is required to deposit some amount at the beginning. e. Both (a) and (b) above. 103
Investment Banking and Financial Services
REAL ESTATE FINANCING: RISK AND RETURN 443.
444.
445.
446.
447.
448.
104
A ‘Mini-perm’ loan is a.
Intended to protect both the borrower and the lender against volatile interest rates
b.
Designed to provide long-term finance to the real estate investors
c.
A medium-term loan and provides bridge finance till the real estate developer obtains the financing of a more permanent nature
d.
Covers the difference between the bank loan for construction and total cost of the project
e.
None of the above.
Which of the following will provide the developer the margin that he would have otherwise invested from his own funds? a.
Gap loans.
b.
Bow ties.
c.
Mini-perms.
d.
Direct Development and Syndications.
e.
None of the above.
Which of the following forms of loan will hedge against interest rate risk? a.
Gap loans.
b.
Bow ties.
c.
Mini-perms.
d.
Both (a) and (b) above.
e.
All of the above.
Which of the following is/are features of the Real Estate Investment Trusts (REIT)? a.
These can be viewed as mutual funds.
b.
They are exempt from tax.
c.
The income received by the shareholders of REIT is subject to the double taxation.
d.
Both (a) and (b) above.
e.
All of the above.
Which of the following is not a feature of real estate? a.
Its value depends on local and regional economic conditions.
b.
It is a durable asset with a long economic life.
c.
Though there are very few buyers, the market is very active, and hence, it is easy to assess the value of assets.
d.
Transaction costs are higher when compared to other fixed assets.
e.
None of the above.
Which one of the following is/are not active in real estate financing? a.
LIC.
b.
HDFC.
c.
Commercial Banks.
d.
HUDCO.
e.
NBFCs.
Part I
449.
Which of the following statements is/are false regarding real estate financing? a.
A bow tie arrangement is designed to protect both borrower and the lender against volatile interest rate.
b.
Some large savings and loan associations enter into land acquisition and construction loans with the developers.
c.
S&Ls also lend to cover the difference or gap between the bank construction loan and total project cost.
d.
S&L will not fund real estate development through joint ventures.
e.
Both (b) and (d) above.
HOUSING FINANCE IN INDIA 450.
451.
Mr. Manish obtained a housing loan of Rs.3,50,000 for his flat @14.5% for 20 years from HDFC. Calculate the monthly EMI that he has to pay to HDFC? (Calculate assuming that interest is compounded monthly.) a.
Rs.4,525.
b.
Rs.4,586.
c.
Rs.4,356.
d.
Rs.4,480.
e.
Rs.4,624.
Which of the following document is not essential while applying for housing finance for self-construction from a HFC? a.
Approved plan.
b.
Non-encumbrance certificate.
c.
Lay-out plan.
d.
Clearance under ULC.
e.
None of the above.
PLASTIC MONEY 452.
453.
Which of the following is false with respect to a credit card? a.
It enables the holder of the card to purchase goods without parting with cash immediately.
b.
There is a provision for spreading the payment over several installments.
c.
The card is generally issued by business houses.
d.
The interest charged on the credit allowed after the initial no-interest period is generally much higher than interest on loans.
e.
None of the above.
Which of the following statements regarding credit card and debit card is/are false? a.
The former is a ‘pay later’ product and latter is a ‘pay now’ product.
b.
The former provides a credit for 35-50 days, while the latter does not.
c.
In former, sometimes it is essential to open a bank account, whereas it is not necessary to the latter.
d.
In the former, sophisticated telecom network is essential, whereas such network is not required by the latter.
e.
Both (c) and (d) above. 105
Investment Banking and Financial Services
454.
455.
456.
457.
458.
459.
106
Which of the following statements regarding the difference between charge cards and credit cards is false? a.
The former is issued mainly on the basis of account designated for charge and the latter is always based on the creditworthiness of the applicant.
b.
The former provides a credit period of 30 days after purchase, whereas the latter extends a revolving credit of 45 days.
c.
The former entails an interest rate of 2.5%-3%, whereas the latter does not call for any interest.
d.
Both annual service charges and commission are charged on the former, whereas only annual service charges are levied on the latter.
e.
None of the above.
Which of the following is a ‘pay before’ card? a.
Charge cards.
b.
Credit cards.
c.
Merchant cards.
d.
Travel and Entertainment cards.
e.
Traveller’s cheques.
Which of the following is a ‘pay now’ card? a.
Charge card.
b.
Credit card.
c.
Merchant cards.
d.
Debit card.
e.
Travel and Entertainment card.
Which of the following is a ‘pay later’ card? a.
Charge card.
b.
Traveller’s cheques.
c.
Merchant card.
d.
Debit cards.
e.
None of the above.
Which of the following is/are the features of a credit card? a.
This is built around the revolving credit concept.
b.
The card does not have any pre-set limit for spending.
c.
The holder has to pay 75% of the outstanding value of the purchase at the end of the month.
d.
The balance outstanding at the end of a month carries a rate of interest of not more than 18% per annum.
e.
Both (a) and (d) above.
Which of the following is/are the features of a charge card? a.
There are no interest charges collected by the issuer from the holder.
b.
The discount collected from the member establishments is the principle source of income for the issuer.
c.
The cardholder has to make a consolidated payment to the issuer for all purchases effected during a specified period.
d.
Both (a) and (b) above.
e.
All of (a), (b) and (c) above.
Part I
460.
461.
Which of the following is not a feature of ‘debit card’? a.
Both merchant establishment and cardholder should open the bank account.
b.
It is highly capital-intensive.
c.
It requires a computer terminal known as ‘point of sale’ terminal at every point of sale.
d.
Holder does not require to have any amount in his account.
e.
None of the above.
Which of the following statements is/are true? a.
The less expensive route to avail a share in the credit cards market is to become an affiliate to the principal issuer.
b.
Gold Standard visa card is issued by ‘Standard Chartered Bank’.
c.
Master Card International is a clearing agency.
d.
Both (a) and (b) above.
e.
Both (a) and (c) above.
SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF FINANCIAL SERVICES 462.
463.
464.
465.
Which of the following is not undertaken in India by NBFCs? a.
Leasing.
b.
Housing finance.
c.
Bill discounting.
d.
Credit rating.
e.
Both (b) and (d) above.
Which of the following should not be treated as ‘NPA’ by NBFC? a.
If the interest amount remains ‘past due’ for six months, on a term loan.
b.
If the interest and entire outstanding loan is overdue and unpaid for more than six months.
c.
If a bill remains overdue and unpaid for six months.
d.
If lease rentals/hire purchase installments are past due for more than three months, but less than six months.
e.
Any credit facility of short-term nature if any payment that is due is not received for past six months.
An asset which remains an NPA for more than two years should be classified as a.
Standard asset
b.
Substandard asset
c.
Doubtful asset
d.
Loss asset
e.
None of the above.
If a NBFC offers an interest rate of 16% per annum at monthly rests, what is the effective rate of interest per annum? a.
17.23%
b.
16.32%
c.
17.65%
d.
16.23%
e.
26.12%.
107
Investment Banking and Financial Services
466.
467.
468.
469.
470.
471.
108
Which of the following the RBI recognized credit rating agencies rate domestic NBFCs? a.
Duff & Phelps, CARE, ICRA, CRISIL and MDRA.
b.
Duff & Phelps, CARE, ICRA, CRISIL and Department of Supervision at RBI.
c.
CARE, ICRA, CRISIL and MDRA.
d.
CARE, ICRA, CRISIL and Department of Supervision at RBI.
e.
None of the above.
A financial services company is involved in the activity which can be simply said to be of the nature of pooling money from the members every month to give to the neediest person of the lot at the cost of foregoing his right to claim the money in future. Such a company is regulated by: a.
The RBI under the Section 24 of the RBI Act
b.
The RBI under Non-Banking Finance Companies, 1972 Act
c.
SEBI under the SEBI Act
d.
Company Law Board under Section 56B of the Companies Act
e.
None of the above.
What is/are the profitable option(s) available to a depositor who holds a FD at a NBFC at a lower rate than the rate that is being offered by the NBFC now? a.
Prematurely withdraw the deposit and redeposit it at a higher rate for the remaining maturity.
b.
Allow the fixed deposit to mature and deposit the matured amount at a higher rate.
c.
Ask the NBFC under Section 54B (ii) through form 15I to appropriately adjust the rate.
d.
Renew the deposit for a longer maturity through prescribed form.
e.
None of the above.
The minimum maturity for a deposit at a NBFC is: a.
1 year and 1 day
b.
2 years
c.
1 year
d.
364 days
e.
365 days.
General Provisions and Loss Reserves of a NBFC are Rs.150 crore. What is the contribution from this head towards the Tier II capital if the risk-weighted assets of a bank are Rs.240 crore? a.
Rs.1.875 crore.
b.
Rs.450 crore.
c.
Rs.3 crore.
d.
Rs.4.5 crore.
e.
Rs.4.875 crore.
I deposited Rs.10,000 at Aarti Financial Services that is offering 15% per annum as interest rate calculated at monthly rests on 31st December, 20x0. If I approach the NBFC for a loan on 4th April, 20x1, which of the following may be said by Aarti Financial Services? a.
Eligible for a maximum of Rs.7,000 with an interest of 15%.
b.
Eligible for a maximum of Rs.7,500 with an interest of 17%.
c.
Eligible for a maximum of Rs.7,500 with an interest of 15%.
d.
Eligible for a maximum of Rs.10,000 with an interest of 16%.
e.
Not eligible for a loan before 30th June, 20x1.
Part I: Answers to Questions on Basic Concepts INVESTMENT BANKING, FINANCIAL SYSTEMS AND FINANCIAL MARKETS 1.
(e) The financial system, through the savings function, policy function and credit function aims at mobilizing resources from the surplus sections of the society and re-distributing the same to the deficit sectors of society.
2.
(e) The money market comprises of banks, government and financial institutions, as well as individual investors.
3.
(c) In the open market, the securities will be offered to a large number of investors who can buy and sell them any number of times. A public issue mobilizes funds from a vast number of investors through the open market system.
4.
(e) A financial market is said to be perfect when options (a), (b) and (c) are satisfied.
5.
(e) The role played by investment bankers in the capital market is to provide corporate advisory services, issue of securities. Underwriters provide subscription to unsubscribed portion of securities. Registrars handle issue securities to the investors on behalf of the company and the share allotment and transfer activity.
6.
(e) Financial intermediaries ensure the smooth transfer of funds from the lenders to the borrowers, but their presence may increase the risk to the investors, who may invest in risky securities on their advice and they definitely increase the costs of lending and borrowing.
7.
(e) Issuers ensure that the cost of raising funds should be minimized. Instrument is designed in such a manner by the issuer to get certain tax incentives for the company and to the investors.
8.
(d) The money market is a wholesale debt market for low-risk, highly liquid, short-term instruments. Funds are available in this market for periods ranging from a single day up to a year.
9.
(e) The primary market is a place for the issue of fresh securities. Corporates, banks, FIs and government can issue new securities and raise funds for investment and pending purposes from the primary market.
CREDIT MARKET 10.
(c) Banks play a critical role in the Indian credit market by mobilizing the small savings and routing them for corporate investment.
11.
(c) The credit market operates in an intermediation stage to fulfill the credit requirements of the different sectors of the economy as the lenders and borrowers are not directly connected to each other.
12.
(b) In the overdraft facility, the bank will allow the firm to overdraw from its current account to a predetermined level of credit. The credit limit should be set based on the security offered by the firm. Credit facility will generally be short-term in nature not exceeding a year, and need not be only based on commodity stocks as security.
13.
(d) For a developing economy such selective credit control becomes essential to ensure the proper use of institutional credit since a major portion of the savings lie with these intermediaries as loanable funds.
14.
(d) Where the project is very large and the funds cannot be provided by a single institution consortium lending will be resorted to. Two or more intermediaries will join together to finance large project proposals.
15.
(e) The interest charged will be on the daily outstanding in this account and will generally be paid on a quarterly basis. The CC limit is usually secured on stocks and book debts of the company.
Investment Banking and Financial Services
16.
17.
(e) The sources of funds will determine the cost of funds for the intermediaries. Transaction costs will depend mostly on the efficiency with which the transfer of funds is enabled. The lending rate fixed by the intermediaries will also include a certain percentage as a spread for making the lending activity profitable. (b) The bank will decide its lending rate based on the cost of funds + transaction costs + its required spread (margin). So, in this case, the lending rate is 11 + 1.5 + 2 = 14.5%.
MONEY MARKET Introduction to Money Market 18.
(d) These are medium to long-term government securities and carry a coupon rate. These instruments set a benchmark for long-term interest rate. The other instruments are too short for such a huge project.
19.
(e) As these instruments are issued by the RBI on behalf of the government.
20.
(e) As the investment done by MMMF will generally be in high quality securities i.e., government/banks/highly rated corporates, which carry low risk and high rate of return.
21.
(d) Investors who park their funds in short-term instruments will, at the time of redemption, have to reinvest these funds at lower rate of interest. Default risk is non-existent in government securities.
22.
(b) This will reduce the liquidity of banks since there will be transfer of assets in the form of cash into securities and lead to monetary contraction.
23.
(c) The Primary Dealers should have net owned funds of a minimum of Rs.50 crore. Net owned funds are owned funds, represented by paid-up capital, free reserves, balance in share premium account and capital reserves, less accumulated loss balance and book value of intangible assets, if any.
24.
(e) As both are issued by corporates.
25.
(b) The minimum success ratio for the PDs should be 33.33% for G-secs.
26.
(e) SLR objective is to maintain a certain level of liquidity.
27.
(d) The short-term fund requirements of the corporates and other borrowers are initially met by short time lenders and short-term depositors of funds into the financial system.
28.
(c) Dated securities carry a coupon rate unlike the T-bills which are issued at a discount and they are long-term instruments. These instruments set a benchmark for the long-term interest rates.
29.
(a) CP is basically issued by highly rated corporates and it is cheaper than the bank interest rate and so that cost of funds can be reduced.
30.
(a) CP rate will be between the rate of CD and bank PLRs. Rate of interest on CD and CP will be alike, rate of interest on CP will be lower than the PLRs.
31.
(b) The minimum success ratio for the PDs should be 40% for T-Bills.
32.
(c) Only the successful bids will be included in final bidding.
33.
(c) The RBI may alter the interest rate structure by using open market operations and through proper pricing of the OMOs, by purchasing G-secs.
34.
(c) By increasing the statutory reserves, banks will have to transfer their loanable funds into cash reserves for meeting the CRR or convert it into SLR securities. Both these actions will reduce the extent of liquidity in the system.
35.
(e) As all the money market instruments are interlinked, any changes in any one will lead the changes to whole equation. Reduction in one will lead to reduction in all.
36.
(c) Arising due to the fluctuations in the rates of the instruments, this type of risk should be of prime concern in money market investments. This is a result of large volumes of funds and the speed of the transactions taking place.
110
Part I
Call Money 37.
(b) Financial institutions (and mutual funds) can only lend in the Call Market, but cannot borrow.
38.
(e) All the three options given under (a), (b) and (c) speak about the main objectives of the Call Money Market.
39.
(d) Call loans are unsecured and demand varies according to seasonal demand.
40.
(d) Term loan is lent for more than 14 days.
41.
(b) The funds borrowings for a period of one day up to a fortnight but they do not have a specified repayment date when the deal is entered. The lender will simply issue a notice to the borrower 2–3 days before the funds are to be repaid.
42.
(c) Intermediaries like DFHI and STCI have been permitted to operate both as borrowers and lenders in the call money market.
43.
(e) The call money market is the most liquid of all short-term money market segments and the maturity period of call loans vary from 1-14 days.
44.
(d) Borrowers of federal funds include securities dealers, corporations and government. This is a unique market that performs the functions listed in (a) and (b).
Treasury Bills 45.
(e) These instruments have distinct features like zero default risk, assured yield, low transactions cost, negligible capital depreciation, high liquidity and are eligible for inclusion in SLR.
46.
(d) Treasury bills are issued for minimum of 14 days and maximum of 364 days.
47.
⎛ 100 ⎞ 365 − 1⎟ x (c) Yield = ⎜ = 16.32%. ⎝ 86 ⎠ 364
48.
(b) It serves to replenish cash balances of the central government, and to provide a medium of investment for temporary surplus funds of the state governments.
49.
(d) The state governments and provident funds were not allowed to participate in these auctions.
50.
(e) Treasury bills are issued at a discount and yields on T-bills are considered as a representative of interest rates in economy.
51.
(a) Tenders were invited for competitive bids, bids will be allotted to both competitive and non-competitive bids. But T-bills are issued by the RBI on behalf of GoI only.
52.
(d) In US non-competitive bids are submitted by small investors, and their bidding amount is limited to $1 million or less.
53.
(d) T-bills constitute a major portion of short-term borrowings by the Government of India.
54.
(c) T-bills are supposed to be high liquid as they are backed by the Government of India.
55.
(d) T-bills have distinct features like zero default risk and high liquidity.
56.
(e) T-bills are issued in the form of promissory notes or finance bills, through credit to the SGL account.
57.
(d) The bids are accepted at the weighted average of the successful bids if the notified amount is not fully subscribed to.
58.
(e) The RBI neither discounts these bills nor participates in the auction, and does not notify the amount in advance.
59.
(a) Ad hoc T-bills are issued in favor of the RBI when the government needs cash.
60.
(c) These T-bills are issued through auctions conducted by the RBI on every Friday for a notified amount. 111
Investment Banking and Financial Services
61.
(e) T-bills are issued by the RBI to facilitate government borrowing, when the government needs money, to help in OMOs, as a medium for short-term investment of temporary state government funds, and the yield of these bills is a benchmark for the rates of other shortterm investments.
62.
(a) Strip bills are a package of bills requiring investors to bid for an entire series of bills with different maturities.
Commercial Paper (CP) 63.
(c) NRIs can only invest on a non-repatriable and non-transferable basis.
64.
(e) CP does not originate from a specific self-liquidating transactions like normal commercial bills which generally arise out of specific trade transactions. If issued through a dealer it is known as a dealer paper.
65.
(e) CPs are backed by the liquidity and earning power of the issuer, corporates prefer this mode of finance as they can determine the cost and maturity and the liquidity is high because it can be transferred by endorsement and delivery.
66.
(b) The brokerage charged on period of 6 months is 0.050%.
67.
(b) A corporate would be eligible to issue CP provided (a) the tangible net worth of the company, as per the latest audited balance sheet, is Rs.4 crore, (b) the company has been sanctioned working capital limit by bank/s or All India Financial Institutions, and (c) the borrowal account of the company is classified as a Standard Asset by Financing bank/s or institutions.
68.
(e) The stringent conditions laid by the RBI has made entry difficult. The cost of CP includes rating charges, stamp duty, IPA’s fee. All these costs have to be incurred each time a company issues a CP thus increasing the effective cost.
69.
(c) 6.24%
70.
(b) The RBI insists a fresh rating and the rating should not be more than 2 months old.
71.
(c) The minimum credit rating is P2 of CRISIL or an equivalent rating by other agencies.
72.
(e) Commercial paper does not originate from a specific self-liquidating transaction like normal commercial bills which generally arise out of specific trade transactions. CPs are backed by the liquidity and earning power of the issuer. They are unsecured, as they are not backed by any charge on fixed assets.
73.
(c) CP has a minimum maturity period of 30 days and a maximum of 364 days.
74.
(e) Issuing a CP involves less of paper work/formalities and high liquidity.
75.
(d) CP can be issued in denominations of Rs.5 lakh or multiples. Amount invested by single investor should not be less than Rs.5 lakh (face value).
76.
(a) Any company can issue a CP, whether private or public.
Certificate of Deposits (CDs) 77.
(b) They are available for subscription to NRIs also, but only on non-repatriable basis.
78.
(e) CDs offer assured availability of funds for specific period and interest is determined on a case to case basis.
79.
(c) CDs issued by a financial institution will have minimum maturity period of 12 months and maximum of 36 months.
80.
(d) The minimum lock-in period for transfer is 15 days, and there is no premature buyback. To sell CDs, investors must approach the secondary market.
81.
(e) Certain impediments in the way of DFHI, the yield on CDs being high, the investors hold the instrument till the end of maturity to gain the maximum benefit and the banks have high liquid funds at their disposal due to high interest rate to be paid on CDs.
82.
(b) Jumbo CDs are issued by savings and loan associations in large volumes such as $1,000,000 and at higher yields.
112
Part I
83.
(c) CDs are issued in the form of usance promissory notes and due to their negotiable nature, they are also known as negotiable certificate of deposits.
84.
(e) All the features mentioned above are features of CDs.
85.
(d) Being time deposits, banks have control over the amounts invested with them and can lend the same for specified periods. This is basically control over the funds.
86.
(d) The minimum maturity period for a certificate of deposit is 15 days.
87.
(e) All the features mentioned above are true for CDs.
88.
(e) All the characteristics mentioned above are false for CDs. CDs are always issued at discount to face value, no premature buy-back is allowed, no loans can be granted on them and no grace period is allowed on repayment.
89.
(a) CDs are traded in the secondary market, after the lock-in period of 15/30 days from the date of issue, unlike fixed deposits, which cannot be traded in the secondary market.
90.
(a) The ceiling on amount raised on CDs has not been fixed, as CDs have been developed to deploy short-term surplus funds.
Bill Financing 91. 92. 93. 94. 95. 96. 97.
98. 99.
100. 101. 102. 103. 104.
105.
106.
(b) A demand bill is a bill payable ‘at sight’ or ‘on presentment’ to the drawee. (e) An inland bill must be drawn or made in India and must be payable in India or drawn on any person resident in India. (e) A negotiable instrument must contain an order (and not a request) to pay and the drawee and payee may be the same person. (a) Under the Bill Market Scheme, 1952, the RBI made demand loans to eligible schedule banks against the security of usance promissory notes of their constituents. (e) The Bill Rediscounting Scheme, 1970 was started to bring out some control on the bill rediscounting system. Points (a), (b) and (c) are the main features of the scheme. (e) The features mentioned under (a), (b) and (c) are some of the measures introduced in the bill discounting market based on the Vaghul Committee recommendations. (d) The bill market is not organized in India and is mostly dominated by indigenous bankers with limited resources. Also, cash credit and bank overdraft are cheaper sources of finance. (e) All the options mentioned above are the characteristics of a well developed bill market. (d) Chore Committee stressed the importance of increasing the share of bank credit granted in the form of bill finance, particularly drawee bills by making it compulsory for banks to extend at least 50% of the cash credit limit against raw materials to manufacturing units by way of drawee bills. (a) Bank rate is the standard rate recognised by the RBI for discounting bills. (b) The scheme of bill rediscounting scheme introduced by IDBI in April, 1965 has the main condition as mentioned in point (b). (a) The bank rate or the discount rate, is the standard rate at which the bank is prepared to buy or rediscount bills of exchange. (c) The drawee or payee who is in possession of the bill is called the holder of the bill and can endorse it. (e) DA are bills on the basis of whether the documents are deliverable just against acceptance and become a clear bill immediately after for delivery of documents. When a bill is accepted by the drawee without receiving consideration it becomes an accommodation bill. (b) In post-shipment finance, all documents of export should be routed through an authorized foreign exchange dealer within 1 day of shipment of goods. Even a minor detail unnoticed/ignored while scrutinizing the documents will entail heavy penalty. (c) Banks can rediscount the bills arising out of genuine trade transactions, which were originally discounted with them by their corporate clients. 113
Investment Banking and Financial Services
107. 108. 109. 110.
(c) The borrowing banks under this scheme had the facility to withdraw any number of the bills lodged as also to replace them by other eligible bills. (b) From January 1975 banks were allowed to rediscount bills with other financial institutions and commercial banks. (e) Remission of stamp duty and setting up of DHFI were two of the major achievements of the Vaghul Committee recommendations. (d) The scheme covers bills/promissory notes arising out of the sales and purchases of indigenous capital equipment and machinery only.
DEBT MARKET Gilt-Edged Securities Market 111.
(e) In India, Government of India Securities (GOI Secs) include debt obligations of the central government, state government and other financial institutions owned by Central and State Governments. Gilt-edged security means ‘security of the best quality’.
112.
(a) It is absolutely secured financial instrument which guarantees the capital as well as the income.
113.
(e) All are eligible to invest in the Government Securities.
114.
(d) Short-dated securities are those which mature within 5 years.
115.
(d) These instruments facilitate implementation of the fiscal policy of the Government. The major investors such as commercial banks, NBFCs, insurance companies hold GOI securities for meeting their statutory requirements. In spite of low yields, they are bound to invest in these bonds.
116.
(d) There is no prescribed settlement period in case of debt market as is found in the capital market. Hence, the deals may be entered for settlement on the same day or 1 or 2 days after the date of trading.
117.
(d) In floating rate bonds, the stock will carry a coupon rate which will vary according to the change in the base rate to which it is related. Zero-coupon bonds are issued at discount and redeemed at par, thus implying no payment of interest till maturity.
Repurchase Agreements (REPOs) 118.
(d) Government introduced REPOs in order to manage the excess of liquidity in the system and also to even out interest rates in the call/notice money market.
119.
(b) Banks, DFHI, Financial Institutions and other non-bank entities (including mutual funds) holding both current and SGL account with the RBI Mumbai, can participate in REPO transactions only.
120.
(c) NBFC can buy securities in the first leg and then reverse the transaction in the second leg, but they can now enter into REPOs. REPOs is an avenue to NBFCs for development of short-term surplus funds, but not an avenue to raise funds.
121.
(b) Borrowing under REPO is a secured borrowing. Hence, the interest rate is likely to be lower than the rate prevailing in call.
Public Deposits 122.
(c) These include all manufacturing companies, trading companies and companies engaged in the services sector.
123.
(e) As per the definition of the Companies (Acceptance of Deposit) Rules 1975, options (a), (b) and (c) are not termed as public deposits.
124.
(b) The minimum tenure for which public deposits can be accepted or renewed is 12 months, or 3 months if such deposit do not exceed 10% of the aggregate of paid-up capital and reserves.
125.
(e) The maximum maturity period for the deposits cannot exceed 60 months.
126.
(b) NBFCs cannot pay more than 16% per annum.
114
Part I
127.
(b) The maximum amount of brokerage payable for soliciting public deposits between one and two years is 1.5%.
128.
(c) The company shall maintain liquid assets to the extent of 15% of the deposits maturing during the financial year ending 31st March next. The amount held in liquid assets shall not at any point of time fall below 10% of the amount of outstanding deposits maturing before 31st March next.
129.
(a) The company shall on acceptance or renewal of deposit, furnish to the depositors a receipt within a period of 8 weeks.
130.
(d) Every company shall file a return of deposits with the Registrar of Companies, on or before 30th June every year. A copy of the return shall be simultaneously filed with RBI. Every company intending to invite deposits shall issue an advertisement in a leading English and a vernacular newspaper circulating in the state in which the registered office of the company is situated.
131.
(e) All the options are permitted investment for the company in Public Deposits to contain liquid assets.
132.
(a) Every company shall file a return of deposits with the Registrar of Companies and one copy with the RBI.
Financial Guarantees 133.
(e) The abolition of the managing agency system led to the disappearance of reputed, creditworthy guarantees, risk of new entrepreneurial and professional appraisal of the project by the managerial cadre reduced the need for personal guarantees.
134.
(b) The Lender seeks a guarantee, a form of security demanded by the creditor to reduce the default risk.
135.
(b) As per the Indian Contract Act, Sec. 126, ‘a guarantee is a contract to perform or to discharge the liability of the third person in case of his default’.
136.
(d) Insurance companies issue generally guarantees extended to non-financial contracts, and extend guarantees on behalf of hire purchase companies to banks and other institutions.
137.
(a) The premium payable for the insurance is at the rate of 2.5 paise per half-year for every 100 rupees.
138.
(c) DICGC undertakes: Insurance of deposits of banks, guarantee for credit extended by banks to priority sector, guarantee for credit extended by banks to small scale industries.
139.
(e) These are some of the regulations regarding the SSI Scheme of DICGC.
140.
(c) ECGC does not cover the risk of exchange rate fluctuations.
141.
(c) Standard policy which is also known as shipments policy, is designed to cover risks in respect of goods exported on short-term credit not more than 180 days.
142.
(d) Banks extended post-shipment finance to exporters through purchase, negotiation or discount of export bills or advances against such bills qualifying for guarantee.
CAPITAL MARKET An Overview of Capital Market 143.
(e) In the year 1992 abolition of the control on capital issues lead corporate sector access the market and as due to globalization of Indian capital market, process of foreign portfolio investment started.
144.
(b) Malegam Committee was appointed to suggest measures to increase the levels of disclosure by Indian issuer, an attempt is being made to bring out disclosure norms in conformity with global standards.
145.
(c) Over The Counter Exchange of India (OTCEI) was the first exchange to introduce screen based trading in India.
146.
(b) Due to the dematerialization, risk of bad deliveries is totally eliminated. 115
Investment Banking and Financial Services
147.
(a) NSE was the first stock exchange to set-up clearing corporation named as NATIONAL SECURITIES CLEARING CORPORATION. It assumes the counterparty risk in all trading deals made on the exchange.
148.
(d) Rolling settlement has been introduced in demat stocks and the settlement week has been changed in the NSE from Wednesday–Tuesday to Monday–Friday to match the settlement week of BSE and avoid wide arbitrage opportunities.
149.
(c) G S Patel Committee was set-up to work out the modalities for reintroduction of the carry forward system.
150.
(c) The L C Gupta Committee recommended the introduction of options and futures in the Indian Markets.
151.
(d) Mark to Market Margin is the difference between the current closing price and the transaction price and is collected from trading member.
152.
(a) Trading period starts from Monday to Friday.
153.
(d) 1992.
154.
(a) To work-out the modalities for reintroduction of the system with proper checks and balances.
Regulation of the Capital Market 155.
(c) Credit rating agencies are not brought under the registration framework of SEBI.
156.
(b) SEBI has now made it mandatory for all issuers to deposit 1% of the size of the issue as security deposit with the regional stock exchange.
157.
(c) SEBI has also reduced the maximum time period for allotment to 30 days from the closure of the issue in order to prevent fraudulent encashment of refund orders, and interest loss to the investors on delayed refunds.
158.
(a) SEBI has now delegated the task of vetting the offer document to the Lead Manager. The Lead Manager is required to exercise due diligence with regard to the accuracy and adequacy of the disclosures made in the offer document.
159.
(d) Issues below Rs.5 crore in size are permitted to be listed only on OTCEI.
160.
(a) Trading in demat securities takes place on T + 2 basis.
161.
(b) SEBI has directed that the upper limit for gross exposure would be fixed at 20 times the sum of their base minimum capital and additional capital.
162.
(b) The takeover code is triggered when an acquirer obtains 15% equity stake in a company.
163.
(e) All these organizations have been formed in India are self-regulatory.
164.
(e) It does not come under the jurisdiction of SEBI.
165.
(d) SEBI has introduced capital adequacy norms for brokers. SEBI has directed that the upper limit for gross exposure would be fixed at 20 times the sum of their base minimum capital and additional capital. The intra day trading limits of 33⅓ times the sum of their base minimum capital and additional capital.
166.
(d) The equivalent of SEBI in UK is the Securities Investment Board.
167.
(c) The minimum limit for listing on regular stock exchanges was raised by SEBI to Rs.5 crore.
168.
(b) Book building facilitates the process of price discovery and also reduces transaction costs.
MERCHANT BANKING An Overview of Merchant Banking 169.
(d) The fully paid equity shares and security should not be of banking sector shares.
170.
(c) In 1973 ICICI started providing Merchant Banking services.
116
Part I
171.
(c) Main area - instrument designing, pricing the issue, registration of the offer document, underwriting support, marketing of the issue, allotment, refund and listing on stock exchange.
172.
(e) There is a single uniform category – Merchant Banker, following the abolition of multiple types.
173.
(e) For merchant banking, permission and registration with SEBI is mandatory and it should be a corporate body, no other business except merchant banking can be conducted and it excludes banks and FIs as they are connected to securities market, and thus can carry on other activities too.
174.
(c) The applicant should have a minimum net worth of Rs.5 crore.
175.
(c) SEBI will grant the certificate of Registration and it is valid for a period of 3 years.
176.
(d) Merchant banking industry in India is characterized by low entry barriers, high competition, and high bargaining power of customers.
177.
(c) Videocon Leasing and Industrial Finance Ltd. introduced the concept of Bought-Out Deal for the first time for raising capital for Patheja Forgings Ltd.
Management of Public Issues, Initial Public Offerings and Pricing of Various Instruments 178.
(b) The issuer company should be in existence for the past five years.
179.
(b) There can be only one Advisor/Consultant to the issue.
180.
(c) If the size of the issue is between 100 crore to 200 crore maximum number of Lead Managers will be 4.
181.
(a) A category I Registrar can act as both Registrar to the issue and as a Share Transfer Agent.
182.
(b) The minimum net worth requirement for a Category II Registrar is Rs.3 lakh.
183.
(d) Assisting the company in listing of the security on stock exchanges.
184.
(b) The Banker to the issue must be a scheduled bank.
185.
(c) The total outstanding underwriting obligation of an underwriter at any point of time cannot exceed 20 times the underwriter’s net worth.
186.
(e) The underwriting commission is payable on the issue price of the security i.e., face value plus premium underwritten on the issue. The minimum underwriting commitment of the Lead Manager shall be to the extent of 5% of the size of the offer or Rs.25 lakh, whichever is less.
187.
(d) An underwriter should have a minimum net worth of Rs.20 lakh and the total outstanding underwriting obligation at any point of time cannot exceed 20 times the underwriter’s net worth.
188.
(e) Any member of any recognized stock exchange can be appointed as a broker to the issue and their appointment is not mandatory by SEBI.
189.
(d) SEBI would make the observations within 21 days from the date of filing. In case no observations are received from SEBI within the stipulated period of 21 days, the offer document is deemed to have been cleared by SEBI. Ten copies of draft are to be filed with SEBI.
190.
(e) All the mentioned documents must accompany the draft prospectus filed with SEBI.
191.
(c) The registration fee payable to SEBI if size of the issue lies between Rs.50 crore to Rs.100 crore, then the fees will be Rs.50,000.
192.
(c) The minimum promoter’s contribution is 20% of the post-issue equity capital for issue size up to Rs.100 crore and 20% of the post-issue equity capital for issue size exceeding Rs.100 crore. 117
Investment Banking and Financial Services
193.
(c) Shares issued for consideration other than cash wherein the transaction involved revaluation of assets or capitalization of intangible assets, during the preceding 3 accounting years, are not eligible.
194.
(c) Promoters can invite their friends and relatives to subscribe the promoters’ quota.
195.
(c) In case of issues above Rs.10 crore there should be at least 30 mandatory collection centers.
196.
(b) An issue should be kept open for a minimum period of 3 days and maximum period of 10 days.
197.
(d) The applicant is required to quote his Permanent Account Number (PAN) in the application form if the size of the application exceeds Rs.50,000.
198.
(d) The minimum amount of application money should not be less than 25% of the issue price.
199.
(d) The minimum subscription required for an issue is 90% or the entire collection is to be refunded.
200.
(b) Appointment of SEBI registered Debenture trustee is mandatory if the maturity period of the instrument exceeds 18 months.
201.
(e) No issue of FCDs having conversion period exceeding 36 months unless conversion is made optional with put and call options is allowed and in case the issuer company fails to get the minimum subscription, including devolvements on the underwriters, the entire issue amount should be refunded to the investors.
202.
(b) For an issue price between Rs.100 to Rs.400 the market lot is 50 shares.
203.
(d) An overseas corporate body is a foreign firm where at least 60% of the ownership stake is held directly or indirectly by Non-Resident Indians or an overseas trust in which at least 60% of the beneficial interest is irrevocably held by such persons.
204.
(d) All the options given are applicable.
205.
(d) If the reservation is made for a particular class of investors, it is called reservation on competitive basis and in case of undersubscription of the portion reserved on firm basis, the amount has to be brought in by the promoters with 3-year lock-in period.
206.
(b) Issue announcement advertisement must be published at least 10 days before opening of the issue. This advertisement contains an abridged version of the prospectus.
207.
(d) No advertisement stating that the issue is fully subscribed or oversubscribed will be issued during the period when the issue is open for subscription, nor about the date of closure, except on the date of closure.
208.
(e) The reservations for employees of the issuer company cannot exceed 10% of the total size of the issue.
209.
(d) The promoter company must have a 5 year track record of profitability and the promoters’ contribution must be 50% of the issue.
210.
(e) The nature of industry specifies the need of capital and the capital structure is decided according to the nature of business.
211.
(e) Capital structure is to be designed so as to integrate well with the financial goals at the corporate level and all the factors mentioned in (a), (b) and (c) should be considered.
212.
(b) Excessive leverage can limit the firm’s ability to respond to such crisis.
213.
(a) The holding period is less than 12 months, it will be treated as short-term capital gains.
214.
(b) As per SEBI clarifications, the company should have made profits after providing for interest, depreciation and tax as per the audited accounts in 3 of the preceding 5 years with profits in the last 2 years prior to the issue.
215.
(e) Underpricing can be related to timing of the issue and prevailing market conditions particularly in the secondary market. As a result of underpricing the promoter or the company loses the opportunity to raise more funds.
216.
(b) These bonds are issued at discount to their face value and are redeemed at par on expiry of their tenure. There is no payment of interests on these instruments.
118
Part I
217.
218. 219. 220. 221.
(e) They are fully redeemable non-convertible short-term debentures, secured by specific movable and immovable assets of the company. It is redeemed at regular intervals and then reauctioned. Interest rate will be determined by the market. (c) Ashok Leyland is the pioneer in launching this investment in India. (a) Dividend discount model is not used by Malegam Committee to justify the pricing of a share. (d) LYONS are convertible into equity of the issuer at a price set at the time of issuance. If the investors choose to convert the notes into equity they forego all interest. (b) Cumulative preference shares can be issued in India.
Right Issues, Bonus Issues, Private Placements and Bought-out Deals 222. 223.
224. 225.
(d) According to rule laid down in Section 81(A), the further issue of shares to existing equity shareholders does not apply to a private company. (d) Where issue of shares by way of rights by a listed company does not exceed Rs.50 lakh, appointment of merchant banker is not mandatory. Rights issue open for a maximum period of 60 days from the date of opening of issue. (c) Within 42 days from the date of closing of the issue. (b) The proposed rights issue should not dilute the value or rights of the fully or partly convertible debentureholders.
226.
(b) Formula to be used – R =
227.
(d) Formula applied here: Pe = Pr – R R=
P −S r
N +1
=
P −S r
N +1
=
25 − 16 9 = = 2.25 3 +1 4
45 − 30 15 = = 2.2 5 +1 6
∴Pe = 45 – 2.5 ∴Pe = 42.5 228.
229.
230.
231. 232. 233. 234. 235.
(c) If he allows his rights to expire Market value of original shareholding at the rate of Rs.90 = 90 x 500 = 45,000. Market value of 1,000 shares held after the right issues at the rate of Rs.60 = 60 x 1,000 = 60,000 Change in wealth = Rs. (60,000 – 45,000) = Rs.15,000. (d) No company should be pending conversion of FCDs/PCDs issue any shares by way of bonus unless similar benefit is extended to the holders of such PCDs/FCDs and the bonus issue should not be made unless the partly paid shares are made fully paid-up. (d) This is done by issuing fully paid shares representing the increased capital. The shareholders to whom the shares are allotted, do not have to pay anything to acquire the share. (d) 30 days. (e) 60 days. (a) Bonus shares cannot be issued out of revaluation reserves. (b) These are no entry barriers for the private placement market. The transaction costs are low. Credit rating is optional in case of debt instruments. (b) The issue of shares on a preferential basis can be made at a price not less than the higher of the following: The average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the six months preceding the relevant date or the average of weekly high and low of the closing prices of the related shares quoted on a stock exchange during the two weeks preceding the relevant date. Relevant date for this purpose means the date 30 days prior to the date on which the meeting of general body of shareholders is convened to consider the proposed issue. 119
Investment Banking and Financial Services
236.
(b) SEBI has issued a clarification according to which the lock-in period will not be applicable to preferential issues except in those cases where preferential issues are made to the promoters and even in such cases lock-in period is for 3 years.
237.
(d) There is no lock-in period.
238.
(e) A buy-out is a process whereby an investor or a group of investors buys-out significant portion of the equity of an unlisted company with a view to make it public within an agreed time frame. It is nothing but wholesome investment.
239.
(e) For the issuer with a good project, it means obtaining funds upfront at a minimal cost without the fear of undersubscription in a depressed market.
240.
(e) An amount equivalent to at least 10% of the price fixed would become payable for the warrants on the date of their allotment.
INTERNATIONAL MARKETS 241.
(d) In this instrument only minimum disclosure is required to the SEC and the issuer need not comply with US GAAP. This type of instrument is traded in the US OTC market.
242.
(d) In a depository receipt issue the roles played by the custodian is to hold the shares underlying the DRs on behalf of the depository and to collect rupee dividends on the underlying shares.
243.
(b) These are bonds issued by non-Japanese borrowers in the domestic Japanese markets.
244.
(d) Belgian dentist is a term used to describe a high net worth individual investor in bonds/DRs to ensure safety for the surplus funds.
245.
(a) Gensaki rate is short-term benchmark rate used in Japanese markets.
246.
(b) Eurodollars are bank deposit liabilities denominated in US dollars but are not subject to US banking regulations.
247.
(c) Recently reserve requirements have been eliminated on all time deposits in the United States and have been reduced from 12 to 10 percent on transaction deposits.
248.
(a) The Eurodollar Certificate of Deposit is an important Eurodollar instrument and it is a negotiable receipt for a dollar deposit at a bank located outside the United States or in a US IBF (International Banking Facility).
249.
(c) The coupon or interest rate is set below the LIBOR for sovereign borrowers and below LIBOR for US banks.
250.
(e) Owing to the risk factors, the cost of evaluating foreign investments is greater than the cost of evaluating the domestic investments.
251.
(b) Since the managing banks provide a larger share than the other participating banks, their share is also larger.
252.
(d) Only agency cost is an upfront cost. The reimbursement of out of pocket costs is an upfront charge but not out of pocket costs. The remaining two costs are periodic costs.
253.
(a) Multicurrency loans are used to take advantage of the growing international economy and a part of them are a natural expansion to the use of Eurodollar loans.
254.
(b) Legality is not one of the provisions. Illegality is considered as one of the provisions. It is intended to address the possibility that the bank’s lending office in foreign country may restrict the branch from accepting the deposits required to the loan or from making the loan.
255.
(c) Revolving credit facility gives the borrower more flexibility about the outstanding principal during the loan’s life.
256.
(a) The speed and certainty of funds is one of the advantages of syndicated loans.
257.
(e) Earning profits is not the objective of External Commercial Borrowings.
258.
(b) The “all-in-cost ceilings’’ for infrastructure projects is 400 basis points over six months LIBOR.
259.
(b) The main objective of the Foreign Direct Investment is to stimulate economic growth in many of the world’s poorest countries because of the expected continued decline in the role of development assistance and the resulting search for alternative sources of foreign capital.
120
Part I
260.
(b) The equity capital category of FDI includes both “mergers and acquisitions’’ and “greenfield’’ investments, which are the latest facilities available.
261.
(b) A vertical spillover occurs when the affiliate transfers free of charge technology to firms supplying inputs or servicing “downstream’’ operations like distribution and retailing.
262.
(b) FDI is freely allowed in all sectors including the services sector, except where the existing and the notified sectorial policy does not permit FDI beyond a ceiling.
263.
(c) Early delivery of proposals submitted to it through purposeful negotiation and discussion with potential investors.
264.
(b) In fixed deposit account, the interest is payable every quarter and the deposit amount is payable on the maturity date.
265.
(a) Low interest rate is not a characteristic of NRNR.
CREDIT RATING 266.
(e) All the characteristics listed are the benefits of credit rating.
267.
(b) Except (b) all options are taken into consideration while doing the Technical Evaluation in Credit Rating.
268.
(d) The equity assessment process commences at the request of an investor and the consent of the company being assessed. The end result is not in the form of a symbol but an assessment report specific to the investor’s need.
269.
(e) The set of factors, deemed relevant for rating purposes is clearly defined. The weight assigned to these factors are specified. A quantitative assessment is made of the rated entity on each of the factors. A numerical credit score or index is arrived at on the basis of the weights and quantitative assessments.
270.
(d) The overseas investors are exposed to the political risks of confiscation and expropriation.
271.
(c) Probability of Non-confiscation is: (1 – p) t CFt = (1 – 0.05)5 x 12 lakh = (0.95)5 x 12 lakh = 9.29 lakh.
272.
(e) The borrower’s years of residence in present place, future prospects in his current jobs and his financial assets will be examined.
273.
(e) The key ratios – Pre-tax interest coverage, pre-tax interest and full rental coverage, cash flow/long-term debt (%), cash flow/total debt (%), pre-tax return on average long-term capital employed (%).
274.
(b) Probability of Non-Confiscation is V =
275.
(a) The issuer will not have to disclose the rating to the public.
CF(1 − P) 12(1 − 0.05) = = 76 lakh. (re + P) (0.05 + 0.10)
EVOLUTION OF FINANCIAL SERVICES 276.
(c) It is the only advantage of the “equipment leasing’’.
277.
(a) This is in accordance with the Banking Regulation Act, 1949.
278.
(b) It is one of the conditions of hire purchase.
279.
(e) All the statements given are facts.
280.
(a) Alternative (b) is not true because out of 350 housing finance corporations in India, only 23 are registered with the National Housing bank. Alternative (c) is not true because housing finance in India is provided by both governmental and non-governmental organizations.
281.
(b) Alternative (a) is wrong because Kothari Mutual Fund is the first private sector fund in India, but not the largest. Alternative (c) is wrong because the credit rating in India started with CRISIL. Alternative (d) is wrong because minimum net worth should be Rs.50 lakh.
121
Investment Banking and Financial Services
AN INTRODUCTION TO EQUIPMENT LEASING 282. 283.
284. 285.
286.
287.
288.
289. 290. 291. 292. 293. 294. 295. 296. 297. 298. 299. 300. 301. 302.
303. 304.
122
(c) According to FASB definition, if the lease term exceeds seventy five percent of the useful life of the asset, the lease is classified as a financial lease i.e. 75% of 6 years. (d) According to FASB definition, if the present value of the minimum lease payments exceeds ninety percent of the fair market value of the asset at the inception of the lease, the lease is classified as a financial lease i.e., 90% of 400 lakh. (d) A finance lease, which operates over the entire economic life of the asset, is called a “full pay-out lease’’. (e) In a leveraged lease transaction, the leasing company in the investments by borrowing a large chunk of investments with full recourse to the lessee and without recourse to the lessor. The lessor obtains an assignment of lease and rentals to be paid by the lessee and the transaction is routed through a trustee who looks after the interests of the lessor and lessee. (e) The alternative (b) is wrong because, a ‘wet lease’ is a variant of operating lease. Alternative (c) is wrong because a direct lease is that, which is not a ‘sale and leaseback’ transaction. (d) Alternative (a) is wrong because, in this type of lease, the equipment related and technological risks cannot be shifted from lessor to lessee. Alternatives (b) and (c) are also not the characteristics of an operating lease. (c) In a perfectly competitive financial market, the cost of leasing tends to be equal to the costs of other forms of borrowing. In such a market, a borrower (lessee) can afford to be indifferent between the options of leasing and borrowing. (e) All are true. The first three alternatives come under the Bipartite lease and the fourth alternative comes under the international lease. (e) In a single investor lease, there are two parties to the transaction. Alternatives (b) and (c) are not the characteristics of a leveraged lease. (b) A walk-away lease is same as a close-ended lease. (a) At the end of the lease period, the asset goes back to the possession of the lessor. The lessee bears the costs of insuring and maintaining the asset. (c) In an operating lease transfer of ownership does not take place. (e) All the alternatives are true according to the “International Accounting Standards’ Committee’’. (b) In a finance lease, the lease term is for a period exceeding 75% of the life of the asset. (b) In a finance lease, the lease term is for a period exceeding 75% of the life of the asset. (c) The incremental borrowing rate is used by the lessee to determine the present value of the asset in the financial lease. (d) It is an obligation for the lessee to pay rentals regardless of the condition or the suitability of the asset. (b) A finance lease, which operates over the entire economic life of the equipment is called a “full pay-out lease’’. (d) Only alternatives (a) and (b) are the characteristics of operating lease. (e) All the alternatives are true in case of a ‘wet lease’. (d) In a dry lease, the lessee bears the costs of insuring and maintaining the leased equipment. An operating lease does not transfer the equipment related business and technological risks from the lessor to the lessee. The lessor while structuring an operating lease largely depends upon the realization of a substantial resale value. (d) The alternative (a) is false because leaseback arrangement in the transaction can be in the form of a finance lease or an operating lease. (c) Alternative (a) is wrong because a sale and leaseback transaction cannot be considered as a direct lease. Alternative (b) is wrong because a direct lease consists of only two parties. Alternative (d) is wrong because in a financial lease, the lessor does not take up repairing, insuring and maintenance of the assets. Alternative (e) is wrong because “Hell or high water’’ obligation applies to the lessee in a financial lease.
Part I
305.
(e) All the alternatives are true in case of a “Sales-aid-lease’’.
306.
(d) The lender/loan participant obtains an assignment of the lease and the rentals to be paid by the lessee and a first mortgage on the leased asset. There are three participants in a leveraged lease. The lender is a loan participant. The debt portion is invested with recourse to the lessee. The lessee has to pay the lease rentals to the lessor.
307.
(d) Alternative (a) is wrong because the lessor, lessee and the equipment supplier should be domiciled in the same country. Alternative (b) is wrong because the international lease is exposed to both country risk and currency risk. Alternative (c) is wrong because an import lease is very much an international lease transaction.
308.
(b) In an import lease transaction, the lessor and lessee are from the same country and the equipment supplier from a different country.
309.
(c) An upgrade lease is used to upgrade the equipment or make additions to the original equipment configuration, which effectively hedges the risk of obsolescence.
310.
(e) Leasing decreases the financial risk of the firm, as it is an off-balance sheet item: For financially weak firms which cannot absorb tax shelters like depreciation, leasing is a way of reducing the cash outflow that would be there in case of purchase.
311.
(e) If the lease is not capitalized in the balance sheet, the fixed assets and total assets figure will be less by that much, thus resulting in a better ROI and Gearing Ratio figure.
LEASING IN INDIAN CONTEXT 312.
(c) Standard Chartered was the first foreign bank to venture into Indian leasing.
313.
(c) The alternatives (a) and (b) are wrong because the maximum maturity period of the intercorporate deposit should not exceed 12 months and the total amount that can be raised cannot exceed two times the net owned funds. Only (c) is correct.
314.
(e) The issue price is (Face value)/FVIF(k, t)=
3, 000 FVIF
(15%,1)
=
3, 000 = 2068.69 i.e., (app) 2069. 1.15
315.
(c) The true yield is the compound yield. It is always lesser than the simple yield. So, alternative (d) is wrong. Alternative (b) is wrong because a firm cannot use hundred percent of finance raised through public deposits for lease investments. Alternative (a) is wrong because a true yield is influenced by the maturity value of the deposit, initial amount of the deposit and number of months to maturity.
316.
(b) The maximum amount that can be lent by a bank to a leasing company cannot exceed four times the net owned funds of the company.
317.
(e) Deemed deposits do not include funds raised through unsecured non-convertible debentures.
318.
(a) If the leasing companies raise finance through public deposits, there is a ceiling on the interest rate or the discount rate given by them.
319.
(c) The maturity mismatch is more pronounced when lease and hire purchase investments are funded via intercorporate deposits because the deposits have a shorter maturity than the underlying assets being financed, thereby leading to the refinancing before the maturity of the assets.
320.
(a) The bank lending to a leasing company can be only in the form of cash credit facility and should not exceed four times the Net Owned Funds (NOFs).
321.
(d) Only alternatives (a) and (b) are correct. 123
Investment Banking and Financial Services
322.
323. 324.
325. 326.
327. 328.
(b) The yield that can be calculated from the given data would be a simple yield. If compounded monthly, you get compound annual yield. The relationship between the effective annual rate of interest (r) and the nominal rate of interest (i) per annum compounded “m’’ times a year would be (1 + r) = (1 + i/m)m i = 15%, m = 12 (1 + r) = (1 + 0.15/12)12 r = 16.08% (c) Calculate r in the same manner as above. After one year, she would be getting 2000 (1 + 0.1608) = 2321.6. i.e., (app) Rs.2,322. (c) The SEBI guidelines permit a finance company to issue non-convertible debentures at a rate of interest freely determined by the issuer for any desired maturity period. However, the debentures must be rated by an approved rating agency if the initial term to maturity exceeds 18 months. (e) Only alternatives (a) and (b) are advantages of securitization. (c) According to prudential norms for NBFCs, all loans and advances, which have remained as NPAs for a period not exceeding two years are classified as sub-standard assets. (c) Issue price = 2000/FVIF (15%,1) = 2000/0.8696 = Rs.1,739. (c) According to credit rating symbols given by CRISIL, adequate safety of timely payment of interest and principal is indicated by the symbol ‘A’.
LEGAL ASPECTS OF LEASING 329. 330. 331.
332. 333.
334.
335.
336.
337. 338. 339.
124
(b) The definition of equipment lease transaction resembles the definition provided for ‘bailment’ under the Indian Contract Act, 1872. (e) Alternative (a) is wrong because a ‘letter of offer’ is prepared by the lessor and alternative (c) is wrong because the registration of the equipment lease is optional. (c) Through the exemption clause, the lessor expressly denies any obligation as to the fitness or merchantability of the equipment, and disowns responsibility for any defects in the equipment or the operations thereof. (d) Only alternatives (a) and (b) are correct. Alternative (c) is wrong because the bailor has to disclose to the bailee any faults in the goods bailed, of which the bailor is aware. (d) The surrender clause states that upon expiry of the lease term or earlier termination of the lease, the lessee must deliver the equipment to the lessor at the place where it is to be located in good working order and condition. (c) The ownership clause states that no right, title or interest in the equipment shall pass to the lessee and the lessee shall at no time, contest or challenge the lessor’s sole and exclusive right, title and interest in the equipment. (d) The bailee is bound to take responsible care of the leased asset. He is liable for his own negligible acts and for those of his employees and agents. However, if the goods are damaged or destroyed through no fault of the bailee then in the absence of a provision to the contrary, the bailee is not liable to indemnify the bailor for the loss. (c) In equipment leasing, the lessor is only a financial intermediary whose role is limited to purchasing the equipment from the supplier and delivering it to the lessee. The equipment supplier is identified by the lessee and the equipment specifications and the terms and conditions relating to its performance are negotiated by the lessee. (a) A ‘letter of offer’ that contains the acceptable terms and conditions. (d) There is no uniform format for a lease agreement and the clauses included in the agreement vary from one lease agreement to another. (d) Only alternatives (a) and (b) are correct and alternative (c) is wrong because the lessee is entitled to avail the benefits of the warranties provided by the manufacturer.
Part I
340.
(a) The responsibility of taking delivery of the equipment solely lies on the lessee.
341.
(d) A finance lease agreement invariably requires the lessee to insure the equipment. The description clause provides the description of the lessor, the lessee, the equipment and the locations where the equipment is to be installed. The lessor usually stipulates that the equipment shall not be removed from the described location without its prior permission.
342.
(e) They do not protect the rights of lessee.
TAX ASPECTS OF LEASING 343.
(e) As per the new accounting standard, lessee gets a right to claim depreciation.
344.
(e) Alternative (b) is wrong because the expenses incurred by lessee towards insuring and maintaining the equipment are tax deductible expenses and alternative (c) is also wrong because if the lessor has acquired the asset for commercial purpose, then the rental income should be put under the head “Profits and Gains of Business or Profession’’.
345.
(d) Lease rentals = 0.443 x 300 = 132.9 Tax shield = 132.9 x 0.46 = 61.13
346.
(b) Cost of the equipment to ELC = Rs.80 lakh x 1.04 = Rs.83.2 lakh. Cost of the equipment to Alankar Ltd. = Rs.80 lakh x 1.1 = Rs.88 lakh.
347.
(d) Alternative (d) is correct because when the lessor purchases the equipment with the intention of leasing it, then CST does not recognize it as a sale. Therefore, the equipment supplier cannot claim concession on the sales tax. Alternative (a) is the clause (29 A) of the 46th Amendment.
348.
(e) Lease rental = cost of capital equipment x quote of leasing company payable at the end of every month excluding the sales tax i.e., 60 x 27.5/1000 = 60 x 0.0275 = 1.65 lakh.
349.
(c) The Act specifies rates of depreciation for different block of assets. Generally, depreciation is applied to block of assets rather than individual assets.
350.
(e) Hypothecation and pledge are not considered as a sale under CST.
351.
(a) Lessees claim for depreciation tax shields on the leased assets.
352.
(b) Lessee can claim for lease rentals, maintenance and insurance costs of the leased asset.
353.
(e) All the alternatives given are true.
354.
(d) The alternative (c) is wrong because the lessor can claim the depreciation tax shield.
355.
(d) Alternative (b) is not correct because for a transaction to be treated as a hire purchase transaction, the lease agreement must not provide for a transfer of ownership of the leased asset. But an open-ended lease provides for a transfer of ownership.
356.
(d) A hundred percent EOU company can neither avail of the lease related tax shelters nor avail of the acquisition related tax shelters.
357.
(b) All the statements are correct.
358.
(e) All the statements are true.
359.
(e) A sale or purchase which takes place in the course of export or import does not attract either the central sales tax or the states sales tax.
360.
(a) When a lessor purchases equipment from a supplier in another state (the purchase results in the movement of the equipment from one state to another), the transaction will attract central sales tax.
361.
(a) Leasing is not included in the purposes for which the dealer selling the goods can pay sales tax at a concessional rate of 4% of the sales price.
362.
(e) All the statements are true.
363.
(e) Alternatives (a) and (b) come under the purview of Sales Tax Act.
364.
(b) Section 3(a) of CST defines the interstate sale of goods and not interstate lease.
365.
(c) The appropriate state will be the state where the taxable rent takes place and in the case of equipment lease, the taxable rent is the transfer of the right to use the equipment. 125
Investment Banking and Financial Services
366.
(d) The method for allocating the unexpired finance charge is known as the Effective Rate of Interest Method or the Actuarial Method.
367.
(c) The lessee treats the lease rental payable over the lease term as a charge to the profit and loss account. IAS 17 states that the lease rentals must be allocated to each accounting period in a manner that is representative of the time pattern of the user’s benefit.
368.
(e) Allocating the unexpired finance charge is known as Effective Rate of Interest Method or the Acturial Method. There are two other methods for allocating the unexpired finance charge and they are the sum of years – Digit Method and Straight Line Method.
369.
(b) Sum of Digits Method also known as Rule of 78.
LEASE EVALUATION: THE LESSEE’S ANGLE 370.
(d) The net present value of the lease alternative and the net present value of the buy alternative are compared and the equipment should be only when the condition is satisfied.
371.
(c) The model assumes that the target capital structure consists of a mix of debt, lease finance and equity and that each investment is deemed to be financed using this mix.
372.
(a) The discount rate (k) to be used for calculating the net present values is the marginal cost of capital including the marginal cost of debt and marginal cost of equity.
373.
(b) Bower-Herringer-Williamson (BHW) model assumes that the debt which will be raised in lieu of the lease will be equal to the present value of the lease payments.
374.
(a) Under the BHW model, the lease related cash flow stream is divided into two parts: The part relating to financing per se and the part relating to tax shields and residual value. The cash flow stream related to financing is called financial advantage of leasing.
375.
(c) A higher tax relevant rate of depreciation decreases the rental. A larger upfront payment and a higher cost of capital increases the break even rental. The break even rental decreases with a longer primary lease period and a higher net salvage value.
376.
(c) The disadvantages of short-term arrangement are: Lease runs the risk if being deprived because the lessor enjoys the right of cancelation; the lease rentals for the short-term leases beyond the initial one are not specified at the inception of the arrangement.
LEASE EVALUATION: THE LESSOR’S ANGLE 377.
(c) To determine the break even rental from the lessor’s point of view, the present value of the lessor’s cash flow stream is set to zero to solve for the lease rental.
378.
(b) From A.Y. 1992-93, if an asset is put to use for less than 180 days in the year of acquisition (including asset given on lease), the depreciation allowed will be at 50% of the rates allowed for normal depreciation on the said type of asset.
379.
(a) The difference LB – LB’ is the spread between the break even rentals of the lessor and lessee. Here, LB is the break even rental of lessee and LB’ is the break even rental of the lessor. For the rental to remain within the range the break even rental of lessor should be less than that of lessee.
380.
(c) Residual value of the equipment has considerable influence in the calculation of gross yield. The other factor which influences the gross yield is the payment profile.
381.
(c) The ‘add-on-yield’ is similar to the ‘flat rate of interest’, which assumes that the investment in the lease remains constant over the lease period. It does not recognize that every lease rental paid under the finance lease has a capital content and an interest content. It is not a true measure of the interest rate implicit in a lease.
382.
(a) Cost of equipment = Rs.36 lakh Aggregate lease rentals = (0.025 x 36 x 60)= Rs.54 lakh Aggregate interest charge for the lease over the lease period = Rs.(54 – 36) = Rs.18 lakh Add-on yield =
126
3.6 x100 = 10% 36
Part I
383.
(d) The cut-off rate or the hurdle rate is determined as the pre-tax cost of funds plus a profit margin, the latter being a subjectively determined figure.
384.
(b) An explicit approach is to define the subjective probability distribution for the residual values and use the expected value of the probability distribution as the input for computing the gross yield.
LEASE ACCOUNTING AND REPORTING 385.
(c) The lessee acquires the economic benefits of the use of the leased asset for the major part of its useful life in return for entering into an obligation to pay for that right.
386.
(d) Actuarial method is also known as the Effective Rate of Interest Method.
387.
(c) As per AS-19, lease payment under operating lease should be recognized as an expense in the profit and loss statement on a straight line basis over the lease term.
388.
(b) Lease of land where the title is not transferred from the lessor to the lessee on expiry of the lease term is accounted for as an operating issue. Likewise long-term lease of buildings where there is a provision for revising rentals periodically must be accounted for as an operating lease.
HIRE PURCHASE 389.
(d) In a hire purchase transaction, the ownership is transferred to the hirer only when he exercises the option to purchase or on payment of last installment.
390.
(e) All the alternatives are correct.
391.
(b) In an installment sale, the ownership of the asset is transferred to the buyer on the payment of first installment.
392.
(e) A buyer is committed to pay full price in a conditional sale. The interest component of hire purchase installment is calculated on the basis of flat rate of interest. In hire purchase, ownership is transferred on the payment of last installment. A lease contract with a (call) purchase option is considered as a hire purchase contract.
393.
(e) The approximation formula is used to calculate the effective rate of interest per annum as an alternative to the trial and error method. But the formula used is different when the payments are in arrears and in advance.
394.
(a)
n x 2F ⇒ n = 48(12 x 4) n −1
∴ iapp =
48 x 2 x 0.14 = 28.59 ≈ 28.6% 47
395.
(d) Because in a deposit linked plan, the rate of interest reflects the effective rate of interest implicit in the plan.
396.
(d) Interest rebate to the borrower can be
t(t + 1) x D obtained by applying ‘Rule of 78’ n(n + 1)
method. 397.
(a)
t(t + 1) 12 x13 xD= x 300 = 35.14 n(n + 1 36 x37
398.
(b)
(t − α) (t − α + 1) (12 − 2)(12 − 2 + 1) xD= x 318 = 26.26. n(n + 1) 36 x 37
399.
(d) Alternative (c) is wrong because the rebate calculated using the ‘Rule of 78’ is less than the rebate calculated using the effective rate of interest method. Modified ‘Rule of 78’ includes the deferments also.
400.
(b) If there is a third party, then a contractual relationship exists between the hirer and the dealer. Thus, the hire purchase contract is hampered.
401.
(b) It is one of the rights provided to the hirer by the hire purchase agreement. 127
Investment Banking and Financial Services
402.
(e) Apart from the provisions of HP Act, 1972, legal aspects of the HP transaction have to be ascertained from the provisions of the Indian Contract Act, 1872, Sale of Goods Act (1930) and the judgments pronounced by the courts on the issues related to such contracts.
403.
(e) Depreciation is charged on the cash purchase price of the asset and the unearned finance components of the installments or the unmatured finance income is shown as a current liability in the books of the finance company.
CONSUMER CREDIT 404.
(b) Repayment period = 24 months. Total charge for credit = (780 x 24) – 14000 = 4720 Annual charge = 4720/2 = 2360 Flat rate of interest =
2,360 x100 = 16.85% 14, 00
405.
(d) The Act requires every intermediary, which provides consumer credit or acts as a credit reference agency, debt collector or credit broker to obtain a license from the Office of Fair Trading (OFT) to carry on business.
406.
(d) A consumer credit transaction can be structured in the form of hire purchase, conditional sale or credit sale transaction.
407.
(c) The eligibility criteria for individual borrowers include a minimum level of annual emoluments, minimum no. of years in the present employment and minimum take-home salary. For partnership firms and companies, the criteria include a profitable track-record, minimum levels of sales and net worth.
408.
(d) The term ‘consumer credit’ encompasses all types of asset based financing plans offered primarily for acquiring consumer durables.
409.
(e) The alternatives (a), (b) and (c) are true. The alternative (d) is not exactly true because in most cases the consumer finance schemes may be of two types: Down-payment type or of the deposit-linked type.
410.
(c) The effective rate of interest implied by the deposit schemes will be that rate of interest, which equals the present value of the cash flow stream to zero.
FACTORING AND FORFAITING 411.
(a) A factor offers one or more of the following functions: Collection, sales ledger administration/maintenance, credit protection, short-term funding, advisory services.
412.
(b) Under recourse factoring, the factor purchases the receivables on the condition that the loss arising on account of irrecoverable receivables will be borne by the client (or) the factor has recourse to the client if the debt purchased turns out to be irrecoverable.
413.
(c) The export factor enters into a contract with an import factor and contracts out certain tasks to him for an agreed fee. The debt is usually not assigned to the import factor.
414.
(e) Both bill discounting and forfaiting are not forms of factoring.
415.
(e) Alternative (b) is wrong because in credit insurance the insurance company does not help in collection of receivables. Alternative (a) is wrong because the exporter sells goods to the importer on a deferred payment basis spread over 3-5 years.
416.
(d) Under maturity factoring arrangement, the factor does not make any advance payment, he pays the client either on a guaranteed payment date or on the date of collection.
417.
(d) Invoice discounting is referred to as ‘confidential factoring’.
418.
(b) In supplier guarantee factoring, the factor guarantees payment to the foreign supplier in respect of specific shipment. Upon shipment, he credits the account of the distributor and debits the account.
419.
(a) The importer draws a series of promissory notes in favor of the exporter for the payments to be made inclusive of interest charges.
128
Part I
420.
(c) Under full factoring, the factor provides the entire spectrum of services – collection, credit protection, sales-ledger administration and short-term finance.
421.
(b) = [(1 + 0.0475 – 1] x 100
4
∴annualized interest rate = 20.397% (or) approximately 20.40%.
SECURITIZATION 422.
(e) All the options are true.
423.
(b) Transfer of assets by the originator to a person specially created SPV. SPV is a separate entity.
424.
(d) A whole loan may be with or without recourse to the seller.
425.
(a) A mortgage-backed bond is a collateralized term-debt offering.
426.
(e) The average life of mortgage pass-throughs and mortgage-backed bonds depends on the prepayment experience of underlying mortgages, while in the case of collaterized mortgage obligations, the prepayment is more predictable for fast pay bonds.
427.
(e) The revolving credit asset-backed securities are usually backed by credit card receivables for specified period. Those ABS do not amortize principal. These ABS offer investors an undivided interest in a trust formed by the issuer. All the loans on automobiles of credit card are pooled to create the trust.
428.
(d) By Securitization, the capital adequacy ratio can be improved. A NBFC may increase its capital adequacy ratio by securitizing some of its homogeneous assets, thus decreasing the risk weightage of the assets while fulfilling the regulatory guidelines.
429.
(e) STRIP security is created by taking the cash flows from the underlying collateral and splitting them into two or more classes that have the same maturity as the underlying collateral.
430.
(a) A whole loan sale may be with recourse or without recourse to the seller.
431.
(d) Any asset securitization deal will have to pay hefty stamp duties thereby increasing the overall cost of the deal process and foreclosure norms that restrict the transfer of property without the intervention of court of law.
432.
(e) The mortgage pass-through securities were also thought to be made more attractive to capital market investors by subjecting these securities to credit rating.
MORTGAGES AND MORTGAGE INSTRUMENTS 433.
(b) Many different kinds of ARMS have originated with their own features are even referred to as ARMS. Terms such as VRM, ROM, RRM.
434.
(d) The payments on GPMs unlike the payments on traditional mortgages are not equal.
435.
(e) Increases in the mortgage rate are optional on the part of the lender, but decreases are mandatory.
436.
(e) LTV is used by the lenders to indicate the percentage of down payment required by them. High LTVs are quoted only for newer, readily marketable properties and in times of lower interest rate.
437.
(c) The borrower would have to make a down payment of 15% of the value of the property.
438.
(b) Loan is repaid in equated monthly installments consisting of both principal and interest.
439.
(e) The difference between the current market value of the home and the mortgage balance equals the homeowner’s equity and as the mortgage balance declines the equity rises.
440.
(e) The mortgage balance increases for a short period of time because smaller payments in the initial years do not even cover the interest.
441.
(e) The lender is, however, paid equated monthly installments by drawing the difference between the installment paid by the borrower and the installment due from the pledged savings account. 129
Investment Banking and Financial Services
442.
(e) A feature of GPM is that mortgage balance increases for a short period of time because smaller payments in the initial years do not even cover the interest.
REAL ESTATE FINANCING: RISK AND RETURN 443.
(c) It is a medium-term stop gap arrangement to the borrower till he finds a more permanent source of finance.
444.
(a) The main benefit of a gap loan is that 100% financing is provided without the need to bring in the margin money. The rate of interest on gap loans is much higher than the PLR.
445.
(b) A bow tie protects both the lender and the borrower against the volatility in interest rates. If the market rates of interest exceed the ceiling rate agreed upon on the documentation, an additional amount may have to be added as a balloon payment to the principal at maturity.
446.
(a) REITs work on the principle of pooling the capital of a large number of individual investors and issues of debt and then either invest the capital in the ownership of real estate or lend the capital to real estate borrowers on the security of mortgages. This is akin to mutual funds that pool the funds of many investors and invest the same in the equity or debt markets.
447.
(c) Unless there is a considerable number of buyers, the market will not be active and the assessment of the value of a property will not be done properly. After all, the value of a property depends on the perceived value of buyers and sellers in the market.
448.
(e) NBFCs are not allowed to operate in the real estate markets.
449.
(d) S&Ls offer real estate financing through direct joint ventures too.
HOUSING FINANCE IN INDIA 450.
451.
240 ⎡ ⎛ 0.145) ⎞ ⎤ 350000 x 0.145 1 + ⎢ ⎜ ⎟ ⎥ 1 ⎢ 12 ⎠ ⎥ ⎝ (d) = Rs.4,480. 240 ⎥ 12 ⎢ ⎛ 0.145 ⎞ −1 ⎢ ⎥ ⎜1 + ⎟ 12 ⎠ ⎝ ⎣ ⎦
(e) All the options mentioned are essential while applying for housing finance for selfconstruction from a HFC.
PLASTIC MONEY 452.
(c) The card is generally issued by banks as they are called principal issuers.
453.
(c) For debit card you have to open an account and no need to open a bank account in credit card.
454.
(c) There is no charge or interest on charge cards and for credit card interest is between 2.5%-3%.
455.
(e) All other cards are ‘buy now pay later’.
456.
(d) It debits the bank account directly.
457.
(c) Merchant Card, which is a kind of credit card.
458.
(a) Credit cards offer the benefit of revolving credit. This facility permits the cardholder to choose the manner in which he wants to pay for the amount due at the end of a billing cycle.
459.
(e) No interest charge, commission or annual payment and whatsoever be the amount will have to pay at the end of month otherwise penalty will be imposed.
460.
(d) If cardholder wants to purchase anything and he uses his card before that he should have so much of balance otherwise transaction will be declined, as his account will be debited directly.
461.
(c) As the banks are principal issuer of credit cards and have a pact with clearing agency like Master Card International.
130
Part I
SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF FINANCIAL SERVICES 462.
(e) As they are not entitled to do so.
463.
(d) Where lease rentals/hire purchase installments are past due for six months the entire dues from the lessee/hirer should be treated as NPA.
464.
(c) A doubtful asset is one which has remained NPA for a period exceeding two years.
465.
(a) The interest of 16% per annum compounded at monthly rates would be equal to an effective rate of 17.23% p.a.
466.
(e) The RBI has no such directive towards NBFCs.
467.
(e) It is not legal to do so in India.
468.
(d) If the depositor renews his deposit for a period longer than the remaining period of the original contract and the interest on the expired period of deposit is reduced by one percentage point from the contracted rate.
469.
(a) 1 year and 1 day.
470.
(c) 3 crore → whichever is less in actual and 1.25% of RWA will be taken → 1.25% of RWA = 3 crore.
471.
(b) After 3 months from the date of deposit, NBFCs can grant loans to the depositor up to 75% of the amount of public deposit kept by the depositor. Interest rate that can be charged by the NBFC can be minimum of 2%, above the interest rate payable on the deposit.
131
Frequently Used Formulae MONEY MARKET Introduction to Money Market 1.
Annual Turnover of Primary Dealer/Satellite Dealer =
Total Purchases and Sales during the year* Average month-end stocks during the year
* Purchases include primary market purchases and sales include redemption of maturities.
Treasury Bills 1.
365 ⎛ Face Value ⎞ − 1⎟ x Yield on T-bill = ⎜ ⎝ Price ⎠ Days to Maturity
Commercial Paper (CP) 1.
P=
F (I x N) 1+ 100 x 365
Where,
2.
P
= Issue Price
I
= Effective interest rate p.a.
F
= Face/Maturity in days
N
= Usance period in days.
Rate of Return =
Par Value − Purchase Price 360 x Par Value Days to Maturity
Certificate of Deposits (CDs) 1.
F (I x N) 1+ 100 x 365 Where, DR = Discount value N = Issuance period F = Face value I = Effective interest rate p.a. DR =
MERCHANT BANKING Management of Public Issues, Initial Public Offerings and Pricing of Various Instruments 1.
Dividend Discount Model P0 =
D0 (1+g) r−g
Where, P0
= Price of share
D0
= Current dividend per share
g
= Expected growth rate in dividends
r
= Expected return by the investor.
2.
Return on Stock i (Underpriced/Overpriced) ⎛P ⎞ R it = ⎜⎜ it − 1⎟⎟ x100 P ⎝ io ⎠
Where,
3.
Rit
= Returns on stock i in period t in %
Pit
= Price of stock i in period t
Pio
= Offer price of stock i.
Return on Market Index ⎛P ⎞ R mt = ⎜ mt − 1⎟ x100 ⎝ Pmo ⎠
Where, Rmt = Returns on market index in period t in % Pmt = Value of market index in period t Pmo = Value of market index on date of offer of stock. 4.
Adjusting the Return on Stock to Return on Market ARit = Rit – Rmt Where, ARit = Adjusted returns to market index.
5.
Wealth Relative I n ∑ rit i=1 N WR it = I n 1+ ∑ rmt N t=1 1+
Rights Issues, Bonus Issues, Private Placements and Bought-out Deals 1.
Value of a Share after the Rights Issue =
NP0 +S N +1
Where,
2.
N
= Number of existing shares for the rights issue
P0
= Cum-rights market price per share
S
= Subscription price at which the rights shares are issued.
Value of a Right = R =
Pr − S N +1
Where,
3.
R
= Value of a right
Pr
= Market value of share trading with rights on
S
= Strike price
N
= Number of rights to purchase a new share.
Share Price Ex-Rights Pe = Pr – R Where, Pe = Price of share ex-rights. 133
4.
Market Value of each Right after the Rights Issue R=
5.
Pe − S N
Value of shareholding after subscription = NP0 + S.
LEASE EVALUATION: THE LESSOR’S ANGLE 1.
Cost of funds to lessor: ⎛ E ⎞ K′ = Ke x ⎜ ⎟ K d (1 − T) x ⎝ D+E ⎠
⎛D ⎞ ⎜ +E⎟ D ⎝ ⎠
Where,
2.
K′ =
Marginal cost of funds
Ke
=
Marginal cost of equity
Kd
=
Marginal cost of debt
D:E =
Debt-equity ratio of the lessor
T
Tax rate.
=
Present value of rental stream: ⎛ (1+ j) ⎞ PV = L x ⎜ ⎟ + PVIFA (j,n) ⎝ (1+ i) ⎠
Where, PV = Present value of rental stream where rentals increase/decrease at constant rate p.a.
3.
L
= Lease rental per period
n
= Duration of lease in years
j
= [(i – g)/(1 + g)]
i
= Pre-tax yield p.a.
g
= Constant rate of increase/decrease p.a.
IRR based pricing: i = iF + ie + id Where, i
= Adjusted rate of return
iF
= Risk-free rate of return
ie
= Premium for the risk characterizing the existing lease investments
id
= Premium for the differential risk characterizing the lease investment under review.
CONSUMER CREDIT 1.
Index of Creditworthiness: Z = aX1 + bX2 Where,
134
Z
= Index of creidtworthiness
X1
= Take-home monthly income (in Rs.)
X2
= No. of years spent in the current job.
HOUSING FINANCE IN INDIA 1.
Disbursement Amount: RD = AV x AV
CC PC LC x + AVx − BC − CM 100 100 100
Where, RD = Recommendation for Disbursement in Rs. AV = Aggregate Value = LC + CC PC = Progress of Construction in % points LC = Land Component CC = Cost of Construction + Overheads + Profits BC = Borrower’s Contribution CM = Cumulative Disbursement Made. 2.
Equated Monthly Installements: 1 ⎛ Lr(1+ r)n ⎞ ⎜ ⎟ 12 ⎝ (1+ r) n − 1 ⎠
Where, L
= Loan
r
= Rate of interest in decimals
n
= Period.
135
Part II: Problems MONEY MARKET Introduction to Money Market 1.
a.
TRQ Ltd. and XYZ Ltd. are primary dealers operating in the Indian money markets. The commitment of TRQ Ltd. and XYZ Ltd. for the aggregate bidding for G-Secs is Rs.1,000 crore and Rs.1,200 crore respectively. What would be the required amount of successful bids for each of these PDs for the year?
b.
If the tendered and accepted bids for an auction of G-Secs by each of these PDs are given below, then would they be meeting the requirements for their commitments and successful bids? (Rs. crore) TRQ Ltd.
XYZ Ltd.
Tendered bids
800
1,400
Accepted bids
700
1,000
2.
The required amount of successful bids for STL Ltd. in a T-bills auction was assessed at Rs.315 crore. What should be the minimum amount of tendered and accepted bids that this PD should maintain if it has to adhere to the requirements?
3.
The notified bid amounts for G-Secs and T-Bills were Rs.3,700 crore and Rs.2,200 crore respectively. Sterling Gilts Ltd. which is participating in this auction has an underwriting commitment with the RBI to an extent of 10% of the shortfall in case of G-Secs and 5% of the shortfall in case of T-bills. If the bids received and bids accepted are as given below, then assess devolvements on all PDs, RBI and on Sterling Gilts Ltd. (Rs. crore) Bids received: G-Secs
4,000
T-Bills
2,700
Bids accepted at cut-off price
4.
G-Secs
3,100
T-Bills
1,800
The commitment for aggregate bidding for G-Secs and Auction T-Bills of 4 PDs are as follows: (Rs. crore.) P Ltd.
Q Ltd.
R Ltd.
S Ltd.
G-Secs:
800
900
600
400
Auction T-Bills
900
1,200
1,500
1,700
The bids tendered and accepted are as given below: (Rs. cr.) P Ltd.
Q Ltd.
R Ltd.
S Ltd.
G-Secs: Tendered
850
1,000
500
600
Accepted
300
250
150
300
Tendered
1,000
700
1,700
1,900
Accepted
300
250
620
750
Auction T-Bills:
Part II
Based on the data provided above, answer the following:
5.
i.
Assess the required amount of successful bids for the year for these PDs in each of the instruments.
ii.
State whether the PDs have adhered to the commitments for aggregative bidding and achieving the acquired amount of successful bids during the year.
Ross Ltd. is a primary dealer in government securities. During the auction of dated securities and 91-day T-Bills made by the RBI, Ross Ltd. has, in agreement with the RBI, given an underwriting commitment of 15% of the shortfall in case of government dated securities and 10% of the shortfall in case of 91-day T-Bills. The amounts notified for the bids were Rs.600 crore for the dated securities and Rs.200 crore for the 91-day T-Bills. From the various cases given below, identify those cases where devolvement has occurred and assess the amount devolved on (a) All PDs; (b) Ross Ltd. and (c) the RBI. (Rs. crore.) Bids received
Competitive bids accepted at cut-off price
G-Secs
91-day T-Bills
G-Secs
91-day T-Bills
Case 1
900
400
600
200
Case 2
900
400
500*
150*
(* includes non-competitive bids.) 6.
The commitment for aggregative bidding for Government Securities and Auction Treasury Bills of four primary dealers is as follows: (All figures in Rs. crore) Particulars
PNB Gilts Ltd. SBI Gilts Ltd. Gilts Securities Trading Corporation
Government securities Auction treasury bills
ICICI Securities and Finance Company Ltd.
900
1,000
800
700
1,300
1,500
1,100
1,800
The bids tendered and accepted are as given below: (All figures in Rs. crore) Particulars
PNB Gilts SBI Gilts Ltd. Gilts Securities ICICI Securities and Ltd. Trading Corporation Finance Company Ltd.
Government securities: Tendered
1,000
900
1,100
650
Accepted
400
350
412
200
Auction treasury bills: Tendered
1,500
1,400
1,200
1,600
Accepted
500
450
350
500
You are required to a.
Assess the required amount of successful bids for the year for these primary dealers in each of these instruments.
b.
State whether these primary dealers have adhered to the commitments for aggregative bidding and achieving the required amount of successful bids during the year. 137
Investment Banking and Financial Services
Treasury Bills 7.
The RBI offers 91-day T-Bills to raise Rs.5,000 crore. The following bids have been received. Bidder
Bid rate
Amount (Rs. crore)
A
98.95
1800
B
98.93
700
C
98.92
1,000
D
98.90
1,200
E
98.90
600
F
98.87
200
G
98.85
350
H
98.85
150
Who are the winning bidders and how much of the security will be allocated to each winning bidder? Calculate the yield for each of the winning bidders. If this auction is a single price auction, what is the price to be paid by the winning bidders? 8.
If the face value of a 364-day T-Bill is Rs.100 and if the purchase price is Rs.91.35 for a treasury bill, what is the yield on such a bill?
9.
Sun Limited has offered the following bond for subscription. Face Value Tenure
– –
Rs.10,000 6 years
Each bond would be paid Rs.2,750 for the first 5 years from the date of allotment. The amount of Rs.2,750 would consist of both interest and principal portion. The amount would be first adjusted towards the interest on principal outstanding at the time and the balance towards principal. The last payment would be made at the end of year 6 towards the interest and the balance principal outstanding. The interest would be computed at a mark up of 3% over the yield on 364-day treasury bill. According to CMIE, the yield on 364-day T-bills is expected to be as follows: Probability 0.3
0.5
0.2
1
11.0
11.5
12.5
2
10.0
10.5
11.5
3
10.5
9.5
10
4
9
9
10.5
5
8.5
9.5
11
6
8.0
8
9.5
Year
If the yield is in fraction of a percentage, it should be rounded off to the nearest half percentage (i.e. in multiplies of 50 basis points only). The minimum interest rate is 11.5% and the maximum interest is 14.5% during the entire tenure of the bond. You are required to compute the cost of the bond to Sun Ltd. if its average tax rate is 17.5%. 138
Part II
10.
On November 2, the RBI issued a tender notification for 182-day T-Bills for Rs.600 crore. There were 4 competitive bidders – A, B, C and D – who responded to the notification of T-Bills. Based on the data given below you are required to determine the successful bidders and the amount of T-Bills allotted to them. Also calculate the weighted average yield for the issue as well as the average yield for each successful bidder. Sl. No.
Name of bidder
Price (Rs.)
Amount (Rs. in cr.)
Cumulative amount (Rs. in cr.)
1
B
98.93
50
50
2
A
98.91
100
150
3
B
98.90
120
270
4
A
98.89
180
450
5
C
98.85
300
750
6
A
98.85
200
950
7
A
98.70
100
1,050
8
B
98.65
150
1,200
9
C
98.50
100
1,300
10
D
98.45
200
1,500
11
C
98.43
250
1,750
12
D
98.41
300
2,050
11.
What should you pay for a $1 million, 5-year zero coupon bond, now assuming the appropriate interest rate to be 8%?
12.
If the face value of a 182-day T-bill is Rs.100 and if the purchase price is Rs.92.05 for treasury bill, then what is the yield on such a bill?
13.
A 2-year zero coupon bond with a face value of $10,000 is selling for $9022.87. What interest rate would you earn if you held it to maturity?
14.
What is the yield to maturity of a 8%, 5-year bond with face value of $1000, with semi-annual coupons if its market price is $850.75?
Commercial Paper (CP) 15.
Mr. Anil purchased a commercial paper of Zenith Inc. issued for 6 months in the market for $9,61,000. The company issued the CP with a face value of $10,00,000. Determine the rate of return which Mr. Anil earns.
16.
Star Ltd. is planning a CP issue of Rs.25 lakh. Given the following details, you are required to calculate the issue price of commercial paper.
17.
Face Value
= Rs.25 lakh
Maturity period
= 3 months
Effective interest p.a.
= 10.5%.
Given the following details you are required to calculate the effective interest p.a. as well as the total cost of funds to Rajdeep Textiles Ltd. which is planning a CP issue. Issue price of C.P.
= Rs.98,250
Face value
= Rs.1,00,000
Maturity period
= 3 months
Issue Expenses: Brokerage
0.025% of issue amount (for 3 months)
Rating charges
0.5% p.a.
Stamp duty
0.125% (for 3 months). 139
Investment Banking and Financial Services
18.
The maturity value of a 45-day CP is Rs.5 crore. The effective interest per annum is 14%. a.
At what price should the CP be issued?
b.
What would be the stamp duty chargeable on this issue?
c.
What can be the maximum permissible brokerage on this issue?
d.
If the issuer pays the maximum permissible brokerage and he pays rating charges @ 0.5% per annum, what is the effective cost of the CP to the issuer?
Certificate of Deposits (CDs) 19.
Suppose a bank offers a 6-month CD at an Annual Percentage Rate (APR) of 11.5% compounded monthly and a 1-year CD with an APR of 11.3% compounded weekly. You are required to find out which of them offers a higher rate of interest.
20.
Given the following details, you are required to compute the cost of funds to Secunderabad Bank Ltd. Face value of CD
–
Rs.15 lakh
Issue price
–
Rs.14,45,000
Tenure
–
5 months
Stamp duty
–
0.25% of face value.
Bill Financing 21.
Naveen Financiers Ltd. discounts the bills of its clients at the following rates. Clean bill
–
25% p.a.
Usance bill
–
23% p.a.
Calculate the effective rates of interest implied by a clean bill with a usance period of 60 days. 22.
Rajeev Finance Ltd. discounts the L/C backed bill of its clients at the rate of 23% p.a. Calculate the effective rate of interest implied by an L/C backed bill with a usance period of 90 days.
MERCHANT BANKING Management of Public Issues, Initial Public Offerings and Pricing of Various Instruments 23.
140
Surety Venture Fund is a leading American Venture Capital Fund. The fund has specialized in providing finance mezzanine to companies planning public offering of their equity. The time horizon of all the investments made by this fund is 1 year. The fund has recently opened a branch office in Mumbai. The fund has received an investment proposal from Redmond Ltd. The company is an existing profit making, dividend paying company. The company proposes to increase its capacity by 30% by adding certain balancing equipment. The company has requested the fund to finance the program with an equity of Rs.3.5 crore. The current EPS of the company is Rs.7. The expected growth in EPS for the next year is as follows: Growth in EPS (in percent)
Probability
0
0.15
10
0.25
20
0.20
30
0.30
40
0.10
Part II
Based on the study of Indian capital markets, the research wing of the fund has forecasted the P/E ratio for the industry in which Redmond operates as follows: P/E ratio
Probability
6
0.15
8
0.25
10
0.40
12
0.20
The fund is expected to price its divestment at the industry P/E ratio. The target return on any investment made by the fund is 35%. The fund invests only in those proposals where the probability of getting the target return is at least 0.74. What should be the price at which the venture fund would make the investment in Redmond Ltd.? Clearly state your assumptions. 24.
Digital Software has been set up by a team of young technocrats. The team has developed a new software package. The estimated project cost is Rs.2 crore. The team is able to invest only a sum of Rs.80 lakh as equity at a face value of Rs.10 each. The balance is proposed to be financed through venture capital. The company offers two alternative investment packages to the VC firm. a.
Straight equity investment
b.
Fully convertible debentures with a coupon of 18%. At the end of 4 years the FCD would be converted into equity. The conversion would take place at a P/E ratio of 11 on the weighted average EPS of the preceding 3 years with weights 1, 2 and 3 for the EPS of 2nd, 3rd and 4th year respectively.
The company plans to tap the capital market with an IPO at the beginning of the 6th year. The IPO is expected to be priced at a P/E multiple of 12.5 on the EPS of the 5th year. The VC firm intends to divest its holding at the time of the IPO. The company proposed to maintain a dividend pay-out of 10% for all the 5 years. The expected EBIT for the 5 years is Probability Year 1 Year 2 Year 3 Year 4 Year 5 Ignore taxes.
0.2
0.3 1.2 1.4 1.7 1.8 2.5
1.35 1.70 1.75 1.85 2.60
0.5 (Rs. in crore.) 1.02 1.30 1.45 1.50 2.80
You are required to choose the alternative investment to be made by the VC firm if its required rate of return is 15%. 25.
Lavanya Textiles Ltd. proposes to go for a backward integration project at a cost of 36 crore which is entirely financed by equity capital. Total capital structuring is as follows: (Rs. crore) Total size of the issue 36 Less: Subscription by promoters 10.5 Offer through prospectus 25.5 Reservation for FIIs (competitive basis) 3 Reservation for mutual funds 4.5 (firm basis) Reservation for Banks 1.5
141
Investment Banking and Financial Services
The issue is priced at par value of Rs.10. The subscription pattern is as follows: Banks
– 1.5 crore
FIIs
– 1.5 crore
Mutual Funds
– 3 crore
The public portion in the issue is subscribed as follows: No. of shares No. of applications 200 35,000 300 27,000 500 20,000 800 13,000 1,000 8,000 4,000 2,500 10,000 1,000 25,000 400 1,00,000 50 You are required to compute the basis of allotment giving the following details: a.
The number of shares available for allotment to each category;
b.
The number of successful applicants in each category;
c.
The number of shares allotted per applicant in each category.
Note: SEBI permits retention of 10% over subscription for the purpose of rounding off to market lots. 26.
Midland Ltd. tapped the capital market with an IPO of Rs.42 crore. The company complies with SEBI guidelines on pricing and has priced its IPO at Rs.50 per share (i.e. Rs.40 premium). The following are the details of the reservation in the issue: Category
Type of No. of shares reservation reserved FIIs Firm 7 lakh Mutual funds Competitive 7 lakh Banks/FIs Firm 3.5 lakh The response to the issue was as follows: Category
No. of Applications
100
75,000
200
35,000
500
27,000
1000
12,000
2500
7,000
5000
1,500
10,000
800
The response in the reserved category was as follows: FIIs
7 lakh shares
Mutual Funds
3.5 lakh shares
Banks/FIs
Nil
Required: Compute the detailed basis of allotment for the above issue. 142
Part II
27.
Care Bank Ltd. recently tapped the primary market with an IPO of Rs.160 crore. The IPO was priced at par because of the moribund state of the capital markets. The low pricing created a lot of interest in the issue and the issue was oversubscribed. The following reservations were made in the issue. Category
No. of shares reserved
Type of reservation
Mutual funds
Firm
NRIs
Competitive
FIIs Banks
No. of shares applied
1,00,00,000
90,00,000
50,00,000
30,00,000
Firm
2,00,00,000
2,00,00,000
Firm
1,00,00,000
60,00,000
Employees Competitive 1,00,000 The subscription pattern in the issue was as follows:
Nil
Category
No. of applications
200
4,40,000
500
2,20,000
800
1,00,000
1000
1,00,000
2000
60,000
5000
10,000
10,000 You are required to
2000
Compute the detailed basis of allotment showing the number of applicants in each category. 28.
Premier Automobile Ltd. enters the capital market with a public issue of 260 lakh of shares of Rs.10 each at a premium of Rs.30 per share. The company has the following reservations in the issue. •
24 lakh shares reserved for mutual funds on competitive basis.
•
18 lakh shares reserved for FIIs on competitive basis.
After the closure of the issue, the Registrar to the issue collected the following subscription figures. Reserved Portion Category
No. of applications
Mutual funds FIIs
Total no. of shares
8
16,00,000
14
4,00,000
Public portion (applications for below 1000 shares) Size of the application (Shares)
No. of applications
200
40,000
400
20,000
600
15,000
800
10,000
1000
8,000 143
Investment Banking and Financial Services
On the basis of the above statement, draw a detailed basis of allotment statement giving the following information.
29.
a.
The number of shares available for allotment to each category;
b.
The number of successful applicants in each category; and
c.
The number of shares allotted per applicant for each category.
Excel Ltd. has made a public issue of 220 lakh equity shares at par. The subscriptions received for 1000 and less shares are as given below. Calculate the number of proportionate shares available to each category of 1000 shares or less and number of successful applicants and the number of shares allotted per applicant. The issue was oversubscribed 6 times. Category
Applications received
200
30,000
300
25,100
400
20,000
500
15,000
600
11,000
700
9,200
800
3,700
900
2,600
1000
2,000 1,18,600
30.
Consider the following information in respect of a public issue of equity shares, through prospectus, of Rs.10 each for cash at par to Indian public. Particulars
No. of shares
Net offer to the resident Indian public Add: Unsubscribed portion reserved for mutual funds on competitive basis Net shares available to Indian public Total number of shares applied for against the total public offer
Face Value (Rs.)
Issue Price (Rs.)
10,70,000
10
10
1,09,000
10
10
11,79,000
10
10
2,50,81,600
10
10
The following details are also available to you in respect of applications for 1000 shares and below. Sl. No.
No. of shares applied for
No. of applications received
% of total
1
500
1397
12.59
2
600
418
3.77
3
700
220
1.98
4
800
395
3.56
5
900
682
6.15
6
1000
7980
71.94
11,072
100.00
Based on the information provided above you are required to draw up the following schedule for the basis of allotment. 144
Part II
31.
PI Ltd. has made a public issue by prospectus of equity shares of Rs.10 each for cash at a premium of Rs.40 per share. The following information was collected by KC Ltd., the Registrars to the issue, for the purposes of determining the basis of allotment. No.of shares offered through prospectus
5,00,00,000
No.of shares subscribed and allotted to IDBI, UTI, MFs and FIIs on firm basis
1,00,00,000
No.of shares subscribed and allotted to the employees of PI Ltd. and other group companies
1,00,00,000
No.of shares subscribed and allotted to NRIs on repatriation basis
50,00,000
Subscription as multiple of the entire net offer to public
6000 times
For the category of applicants who have applied for 1000 shares or less, the following information is available: No. of shares applied for (category-wise)
No. of applicants
100
1,60,000
200
1,00,000
300
50,000
400
25,000
500
22,950
600
12,000
700
8,000
800
7,000
900
6,500
1000
6,000
From the information given above, you are required to calculate a.
The number of proportionate shares available to each category of 1000 shares or less, and
b.
The number of shares that could be allotted to each allottee in each of the applicant category of 1000 shares or less.
32.
Power Mats Private Ltd. has made an Initial Public Offer (IPO) of 25,00,000 equity shares of Rs.10 each at par. The issue was underwritten by MB Financial, ICI Finance and Global Bank for 30%, 30% and 40% respectively. Applications for a total of 23,00,000 equity shares were received. The marked applications received for the three underwriters were 3,50,000 shares, 4,00,000 shares and 13,50,000 shares respectively. Prepare a statement showing the underwriters’ liability to the IPO of Power Mats Private Ltd.
33.
Excel Fabrics Limited has made a public issue of Rs.100 crore by prospectus of equity shares of Rs.10 each for cash at a premium of Rs.40 per share. Of the issue the following reservations were made: Mutual funds
25%
Financial institutions
15%
Employees
5%
145
Investment Banking and Financial Services
The total applications received for 1000 shares or less categories are as follows: No. of shares applied for
No. of applicants
200
30,000
300
25,100
400
20,000
500
15,000
600
11,000
700
9,200
800
3,700
900
2,600
1,000
2,000
From the information given, you are required to calculate the number of successful applicants and number of shares that could be allotted to each successful applicant in each category of 1,000 or less shares. 34.
Meena Automobiles Ltd. enters the capital market with a public issue of 220 lacs of shares of Rs.10 each at a premium of Rs.40 per share. The company has the following reservations in the issue: 20 lacs shares reserved for Mutual Funds on competitive basis; and 15 lacs shares reserved for FIIs on competitive basis. After the closure of the issue, the Registrar to the issue collected the following subscription figures: Reserved Portion Category
No. of Applications
Mutual Funds FIIs
Total No. of Shares
6
12,00,000
17
3,00,000
Public Portion (applications for below 1000 shares) Size of the Application
No. of Applications
200 Shares
50,000
400 Shares
25,000
600 Shares
20,000
800 Shares
10,000
1000 Shares
10,000
On the basis of the above statement, draw a detailed Basis of Allotment statement giving the following information:
35.
146
a.
The number of shares available for allotment to each category;
b.
The number of successful applicants in each category; and
c.
The number of shares allotted per applicant for each category.
Prompt Service Bank Ltd. recently tapped the primary market with an IPO of Rs.144 crore. The IPO was priced at par because of the moribund state of the capital markets. The low pricing created a lot of interest in the market and the issue was oversubscribed.
Part II
The following reservations were made in the issue. Category
Type of Reservation
Mutual Funds
Firm
NRIs
Competitive
No. of shares reserved
No. of shares applied
1,00,00,000
80,00,000
50,00,000
40,00,000
FIIs
Firm
2,00,00,000
2,00,00,000
Banks
Firm
1,00,00,000
50,00,000
Employees
Competitive
1,00,000
Nil
The subscription pattern in the issue was as follows: Category No. of shares
No. of Applications
200
4,00,000
500
2,00,000
800
1,50,000
1,000
1,00,000
2,000
50,000
5,000
20,000
10,000
5,000
You are required to
36.
a.
Compute the detailed basis of allotment showing the number of applicants in each category.
b.
State whether it is mandatory for this company to associate a SEBI nominated public representative to oversee the process of allotment. Give reasons.
Reshma Floritech Ltd. is engaged in the business of floriculture. The products of the company are well accepted in the international markets. The company is planning an expansion program and proposes to fund it through an IPO of Rs.17 crore at par. The company entered the market in June, 20x0 and the details of the same are as follows: Type of Reservation
Shares Reserved
Shares Applied
Mutual Funds (firm basis)
20,00,000 10,00,000
FIIs (competitive basis)
20,00,000 10,00,000
The response to the issue was as follows: Category
No. of Applicants
200
75,000
300
40,000
700
25,000
1,000
18,000
2,000
12,500
4,000
7,000
5,000
2,000
Compute the detailed Basis of Allotment as per SEBI guidelines. 37.
Chimanbhai Popatlal & Sons, a century old firm, is a leading stock broker operating on both the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). The firm is actively engaged in inter-exchange arbitrage and is, therefore, required to take very large positions in select counters. Though this is a very profitable business, the firm requires large amount of funds for margins and to settle their positions, as the trading cycles are different in both the exchanges. At present the firm is losing some good arbitrage 147
Investment Banking and Financial Services
opportunities due to shortage of capital. To overcome this problem, the firm has decided to corporatize itself and make a public offering of its shares. The firm intends to have a post-issue paid-up capital of Rs.25 crore. The current proprietor Mr. Totharam intends to hold 40% stake in the company after the public issue. Taking advantage of the latest SEBI Guidelines, the company decides that its shares will have a face value of Rs.5 and will be offered at par. The firm made the following reservations in its IPO: Category
Type of Reservation
No. of shares reserved
Mutual Funds
Firm
25,00,000
NRIs
Competitive
50,00,000
The response to its IPO is as follows: Category
No. of applications
400 shares
10,000
500 shares
8,000
800 shares
5,000
1,000 shares
5,000
2,000 shares
1,000
10,000 shares
500
20,000 shares
200
50,000 shares
100
The response in the reserved category is as follows: Mutual Funds
20,00,000 shares
NRIs
25,00,000 shares
You are required to compute the basis of allotment as per the current SEBI Guidelines. Rights Issues, Bonus Issues, Private Placements and Bought-out Deals 38.
Stanford Export Ltd. has proposed to expand its operations for which it requires funds of $3.75 million, net of issue expenses which amounts to 2.5% of the issue size. It proposed to raise the funds through a GDR issue. It considers the following factors in pricing the issue. i.
The expected domestic market price of the share is Rs.250.
ii.
4 shares underlie each GDR.
iii.
Underlying shares are priced at 15% discount to the market price.
iv.
Expected exchange rate is Rs.40/$.
You are required to compute a.
The number of GDRs to be issued.
b.
Cost of GDR to the company if the dividend expected to be paid is 15% with a growth rate of 10% p.a.
c.
Gain/loss to a holder of 100 GDRs, if the company proposes a rights issue after the GDR issue in the ratio of 1:2 at a subscription price of Rs.150 per share. Assume the GDR holder exercises the rights and sells his entire holdings at the prevailing GDR price which will be at a premium of 20% to the prevailing domestic price.
Assume the Rs./$ exchange rate at the time of rights issue and sale by GDR holder to be Rs.48/$. 148
Part II
39.
Ravi Cements decides to capitalize its reserves. The details of the same on March 31, 20x1 are as follows: Rs. crore Authorized Capital 2,00,00,000 shares of Rs.10 each Paid-up Capital 90,00,000 shares of Rs.10 each Reserves & Surplus General reserve 17,00,00,000 Share premium 7,00,00,000 Revaluation reserve 7,00,00,000 The company had allotted 15 lakh 15% FCDs of Rs.150 terms of the issue were as follows:
20,00,00,000 9,00,00,000
31,00,00,000 each on March 31, 20x1. The
•
Part A of Rs.30 would be converted into 2 equity shares of Rs.15 per share, 12 months from the date of allotment.
•
Part B of Rs.120 would be converted into 3 equity shares of Rs.40 per share, 24 months from allotment.
The company had purchased plant and machinery worth Rs.4 crore during April 20x1. The purchase consideration was paid in the form of allotment of 12,00,000 equity shares to the vendor. You are required to
40.
a.
Compute the maximum permissible bonus ratio as per current SEBI guidelines.
b.
Discuss further specific measures which this company would require to take.
The balance sheet of M/s Machine Tools Ltd. as on 31.3.20x1 is as follows: Liabilities Authorized capital 2 crore at Rs.10 face value Issued and Paid-up Capital 0.5 crore fully paid-up 0.3 crore – Rs.5 per share paid-up Reserves and Surplus General Reserve Contingency Reserve Capital Reserve Share Premium Dividend Equalization Reserve Revaluation Reserve Term Loan Current Liabilities
Rs. in crore Assets 20.00 Land
5.00 1.50 4.00 2.50 1.50 9.00 1.00
Rs. in crore 6.00
Building Plant and Machinery Miscellaneous 6.50 Fixed Assets Investments
4.00 27.00 10.00 5.00
Current Assets
20.50
35.00 17.00 14.00 72.50 72.50 The finance director of the company has given the following additional information.
i.
17.00
The company had purchased a machinery worth Rs.7 crore in May 20x1. The entire purchase consideration was paid in the form of allotment of 15 lakh equity shares to the vendor. The vendor had sold 5 lakh equity shares in September 20x1 and 6 lakh equity shares in January 20x2 to other investors through the secondary market. The vendor currently holds only the balance of 4 lakh shares originally allotted to him. 149
Investment Banking and Financial Services
ii.
The finance director also informs you that the company has secret reserves of Rs.10 crore, which is not currently disclosed in the balance sheet. The company follows extremely conservative accounting policies and had created secret reserves as a buffer to meet any unforeseen eventualities.
iii.
The finance director also informs that the company is not interested to make any call on the partly paid-up shares but is interested in capitalizing its huge reserves.
You are required to
41.
a.
Compute the maximum permissible bonus ratio as per the current SEBI guidelines.
b.
Discuss the specific measures the company has to take.
c.
i.
Explain the concept of secret reserve and how it can be created.
ii.
It is the contention of the finance director that secret reserves can be treated as eligible reserves for computation of bonus ratio, if the company discloses the same through an advertisement in a newspaper. Do you agree with the finance director? Give reasons.
The balance sheet of Megha Ltd. is as follows: (Rs. in lakh) Liabilities
Assets
Share Capital
35 Land
20
General Reserve
20
Buildings
25
Share Premium
15
Plant & Machinery
48
Revaluation Reserve
35
Misc. Fixed Assets
20
Capital Reserve
14
84 Closing Stock
43
16% Debentures
25 Receivables
27
Current Liabilities
47 Cash
8
191
191
The company intends to declare a bonus issue. Compute the maximum permissible bonus ratio. 42.
The balance sheet of M/s Aryan Ltd. as on 31.3.20x1 is as under: (Rs. in crore) Liabilities
Amount
Share Capital
6.00 Land
Reserves & Surplus General Reserves
Assets
20.00
Amount 8.00
Buildings
12.00
Plant & Machinery
24.00
Share Premium
9.00
Misc. Fixed Assets
7.00
Contingency Reserve
4.00
Investments
1.50
Capital Reserves
3.00
Inventory
8.50
Revaluation Reserves
10.00
12.5% Convertible Debentures
46.00 Sundry Debtors 2.00 Cash
T. Loan
12.00
Current Liabilities
10.00 76.00
12.00 3.00
76.00
The following information is provided. a.
150
The company had issued 12.5% FCDs (Face value = Rs.10) on 1st July, 20x0. The debentures would be converted into equity at par, after 12 months from the date of allotment.
Part II
b.
The company purchased a building worth Rs.3.5 crore during 20x0-x1. The purchase consideration was paid by allotting 10 lakh equity shares.
(You may assume that the face value of each share is Rs.10.) Required to compute: The maximum permissible bonus ratio as per SEBI guidelines. 43.
The balance sheet of Panama Chemicals Ltd. as on 31st March, 20x1 is as follows: (Rs. crore) Liabilities
Assets
Share Capital (Face value Rs.10)
15.00 Land & Buildings
19.00
Reserves & Surplus
75.00 Plant & Machinery
52.00
Debentures
26.00 Misc. Fixed Assets
20.00
Current Liabilities
35.00 Current Assets
60.00
151.00
151. 00
The profit after tax for 20x0-x1 is Rs.9 crore. The EPS is expected to increase by 40% during 20x1-x2. The market discounts the share at 22 times its expected earnings. The company proposes to set up a Heavy Chemicals Plant involving a project outlay of Rs.490 crore. The project is proposed to be financed by term loan of 291.84 crore from IDBI, Rs.60 crore through private placement of NCDs, Rs.55 crore from internal accruals and the balance through a rights issue. The rights issue is proposed to be priced at 75% of its current market price. The company had issued 10,00,000, 16% PCDs of Rs.150 each in June 20x1. Part A of Rs.100 will be converted into 6 shares, 15 months from the date of allotment. The balance will be redeemed at the end of 5 years. The company had raised a sum of $9 million by issue of 7,50,000 GDRs in March 20x1. The paid-up capital of Rs.15 crore includes 30,00,000 shares underlying the GDRs. You are required to compute: a.
The ratio for issue of rights shares and the pricing.
b.
The value of the rights.
c.
The gain or loss, in dollars, to a GDR holder who holds 100 GDRs, exercises the rights and sells his entire holding at the prevailing GDR price.
Assume the GDRs are quoting at 25% premium to their domestic price and the Rs./$ exchange rate to be as follows:
44.
•
At the time of issue of GDRs – Rs.38/$
•
At the time of rights and sale by GDR holder – Rs.42/$.
Megasoft Ltd. plans to expand its operations and estimates the total cost of the expansion to be Rs.24 crore. The same is proposed to be financed by internal accruals of Rs.9 crore and the balance through a rights issue. The current share capital of the company is Rs.2.40 crore. The shares of the company are currently quoting at Rs.345. The company proposes to price the rights at Rs.250. Based on the above information a.
Compute the ratio of the rights.
b.
Calculate the value of the rights.
c.
Determine the gain/loss of a shareholder, if he i.
Exercises his rights in the rights issue
ii.
Allows his rights to expire
iii.
Sells his rights.
151
Investment Banking and Financial Services
45.
The financial data of Godavari Papers is as follows: Paid-up capital (Rs.2 crore. shares)
Rs.20 crore
Reserves & Surplus
Rs.120 crore
Profit after Tax
Rs.15 crore
The shares of the company are listed and are currently quoting at P/E multiple of 9. The company has taken up an expansion project at a cost of Rs.280 crore. It proposes to fund it with a term loan of Rs.140 crore from IDBI, Rs.60 crore from internal accruals and balance by a rights issue. The right will be priced at Rs.40 per share (30 premium). You are required to compute
46.
a.
The value of the rights;
b.
The market capitalization of the company after the rights issue; and
c.
The net asset value of the shares after the rights issue.
Consider the following information with respect to Coromandel Construction Ltd. (CCL): Paid-up Capital (18,00,000 shares of Rs.10 each)
Rs.1,80,00,000
Reserves and Surplus
Rs.2,40,00,000
Profit after Taxes
Rs.1,80,00,000
Market Price per share
Rs.80
Some of the additional information with respect to the company are also available as given below: i.
The profits before taxes have grown at the rate of 20% every year for the first 5 years.
ii.
Corporate tax rate of 40% is applicable to CCL.
Based on the information provided above, you are required to consider two independent situations as mentioned in (a) and (b) below, respectively, and answer the question(s) contained therein. a.
CCL wishes to capitalize its large base of Reserves and Surplus by issuing bonus shares to its shareholders. What is the maximum permissible bonus ratio that could be adopted by CCL as per the regulatory requirements?
b.
CCL is planning to tap the opportunity of developing a prime property in Hyderabad and is considering a rights issue of equity shares amounting to 4.5 lakh shares at a subscription price of Rs.50 each. Calculate the impact of this rights issue on the wealth of a shareholder, who already holds 100 shares in CCL, under the following situations: i.
the shareholder exercises his rights in full, and
ii.
the shareholder sells his rights in its entirety.
What conclusions do you draw from your calculations? 47.
Present capital structure of Prince Constructions Limited, a company listed on BSE, is as follows. Rs. lakh Authorized capital 50 lakh equity shares of Rs.10 each Issued, subscribed and paid-up 45 lakh equity shares of Rs.8 each paid Reserves and Surplus Free reserves 220 Revaluation Reserves 45 Term loans and other debt
152
500 360
265 500
Part II
Free reserves of Rs.220 lakh include share premium of Rs.80 lakh, half of which was collected in cash. The company is planning to capitalize a part of its reserves. Keeping the existing SEBI guidelines in view, you are required to a.
Calculate the maximum ratio at which the company can issue bonus shares, and
b.
State whether the company can go ahead with bonus issue? Give reasons. If not, what is the additional provision it has to comply with to issue bonus shares?
State assumptions, if any made. 48.
49.
Sriram Industries Limited, a listed company at National Stock Exchange is currently trading at Rs.80. The management is contemplating a rights issue of 2:5 to revamp the operations and fund their increased working capital requirement. The paid-up capital of the company is Rs.10 crore. The company plans to price the rights issue at Rs.65 per share. a.
Find the value per share after the rights issue.
b.
What is the value of rights?
Consider the following information with respect to Wright Constructions Limited (WCL). Equity capital: Issued and fully paid
Rs.
(10,00,000 shares of Rs.10 each)
1,00,00,000
Reserves & surplus
1,80,00,000
Long-term debt
3,50,00,000
Market price per share
Rs.20
Earnings per share
Rs.4
Effective corporate tax rate
33%
Out of the total long-term debt of Rs.3,50,00,000 the company wishes to redeem a loan of Rs.30,00,000 carrying an interest rate of 10% by making a rights issue. You are required to calculate a.
The number of right shares, rights ratio and dilution in EPS if the shareholders expect the subscription price to be 20% below the existing market price.
b.
Calculate the ex-rights price of the shares and the corresponding P/E ratio if rights issue is made based on (a) above.
c.
Calculate the change in wealth of a shareholder who owns 1000 shares in WCL i.
if he sells his rights
ii.
if he allows his rights to expire.
Comment on the above. 50.
Unique Graphics Limited is currently trading on the stock exchange at Rs.80 per share of Rs.10 face value. During the year 20x1-x2 it proposed to expand by increasing its existing capacity of production with an estimated cost of Rs.90 lakh. The capital and reserves and surplus of the company as at the end of March 20x2 (estimated) are as follows: (Rs. lakh) Issue, Subscribed and paid-up (9 lakh equity shares of Rs.10 each)
90
Reserves and surplus
110
3 lakh of Partly Convertible Debentures of Rs.100 each
300
Rs.80 of each PCD which are issued during March 20x2 are convertible into 1 equity share of face value of Rs.10 at a premium of Rs.70 each at the end of March 20x3. 153
Investment Banking and Financial Services
Its estimated earnings per share for the year 20x1-x2 is Rs.3. Due to expansion it expects its post-tax earnings to increase by 20% for the year 20x2-x3. To reduce the issue expenses it proposes to raise the funds for expansion through rights issue during 20x2-x3. In pricing the issue it had the following objective: –
The dilution in EPS should not be more than 20%.
Assuming that the price of the share would be around Rs.80 before rights issue Calculate
51.
i.
The minimum subscription price of right shares and the maximum ratio of rights
ii.
Change in the wealth of a shareholder who owns 1000 shares if he allows his rights to lapse.
Dawn Ltd. had entered the market with an IPO in June 19x9 and its shares are currently trading at Rs.78. The company intends to finance one of its new ventures with a rights issue of 3 shares for every 1 share held. The rights shares are to be priced at Rs.65 per share. You are required to compute a.
The value of the rights
b.
The expected ex-rights price of the share
c.
The gain/loss to Mr. Karan holding 100 shares if he – exercises his rights – allows his rights to lapse – sells his rights.
52.
The financial data of Excellent Paper is as follows: Paid-up Capital (4 crore. shares)
Rs.40 crore
Reserves & Surplus
Rs.160 crore
Profit After Tax
Rs.18 crore
The shares of the company are listed and are currently quoting at P/E multiple of 12. The company has taken up an expansion project at a cost of Rs.355 crore. It proposes to fund it with a term loan of Rs.155 crore. from ICICI, Rs.80 crore. from internal accruals and the balance by a rights issue. The right will be priced at Rs.40 per share (Rs.30 premium). You are required to compute
53.
a.
The value of the rights;
b.
The market capitalization of the company after the rights issue; and
c.
The Net Asset Value of the share after the rights issue.
Minco Steel decides to capitalize its reserves. The details of the same on 31/03/20x0 are as follows: Rs.
Authorized Capital 1,50,00,000 shares of Rs.10 each
15,00,00,000
Paid-up Capital 70,00,000 shares of Rs.10 each
7,00,00,000
Reserves & Surplus
154
General Reserve
15,00,00,000
Share Premium
9,00,00,000
Revaluation Reserve
4,00,00,000 28,00,00,000
Part II
The company had allotted 10 lacs 16.5% FCDs of Rs.170 each on 13/11/19x8. The terms of the issue were as follows: •
Part A of Rs.50 would be converted into 2 equity shares @ Rs.25 per share, 12 months from allotment.
•
Part B of Rs.120 would be converted into 3 equity shares @ Rs.40 per share, 24 months from allotment.
The company had purchased Plant and Machinery worth Rs.5 crore during April, 19x9. The purchase consideration was paid in the form of allotment of 10,00,000 equity shares to the vendor. You are required to:
54.
a.
Compute the maximum permissible bonus ratio as per current SEBI guidelines.
b.
Discuss further specific measures which this company would require to take.
The Balance Sheet of Ujwala Chemicals Ltd. as on 31st March, 20x0 is as follows: (Rs. crore) Liabilities
Assets
Share Capital (Face Value Rs.10)
10.00 Land & Buildings
16.00
Reserves & Surplus
68.00 Plant & Machinery
47.00
Debentures
30.00 Miscellaneous Fixed Assets
24.00
Current Liabilities
32.00 Current Assets
53.00
140.00
140.00
The Profit After Tax for 19x9-20x0 is Rs.6 cr. The EPS is targeted to increase by 25% during 20x0-x1. The market discounts the share at 20 times its expected earnings. The company proposes to set up a heavy chemicals plant involving a project outlay of Rs.465 crore. The project is proposed to be financed by term loan of Rs.255 crore. from ICICI, Rs.80 crore. through private placement of NCDs, Rs.40 crore. from internal accruals and the balance through a rights issue. The rights issue is proposed to be priced at 80% of its current market price. The company had issued 10,00,000 17% PCDs of Rs.120 each in July, 19x9. Part A of Rs.100 will be converted into 4 shares, 15 months from the date of allotment. The balance will be redeemed at the end of 5 years. The company had raised a sum of $8.75 million by issue of 6,25,000 GDRs in March, 19x9. The paid-up capital of Rs.10 crore. includes 25,00,000 shares underlying the GDRs. You are required to compute: a.
The ratio for issue of rights shares and the pricing
b.
The value of the rights
c.
The gain or loss, in dollars, to a GDR holder who holds 100 GDRs, exercises the rights and sells his entire holdings at the prevailing GDR price.
Assume the GDRs are quoting at 20% premium to their domestic price and the Rs./$ exchange rate to be as follows: At the time of issue of GDRs
Rs.36/$
At the time of rights issue and sale by GDR holder
Rs.42/$ 155
Investment Banking and Financial Services
55.
Mathura Engineering Works Ltd. is a component supplier to several manufacturers of automobile and earth moving equipments. The balance sheet of the company as on 31st March, 20x0 is as follows: Liabilities
(Rs. in crore.) Assets
(Rs. in crore)
Land
4.00
Authorized capital: 1.4 crore. at Rs.10 face value
14.00 Buildings
Issued and paid-up capital
Plant and Machinery
0.3 crore. fully paid-up
3.00
Miscellaneous Fixed Assets
0.2 crore. - Rs.5 per share paidup
1.00 4.00 Investments
Reserves & Surplus
Current Assets
General Reserve
3.00
Contingency Reserve
2.75
Capital Reserve
1.25
Share Premium
7.00
Dividend Equalization Reserve
1.00
Revaluation Reserve
9.00 22.00 7.00 3.00 15.00
15.00 30.00
Term Loan
14.00
Current Liabilities
12.00 60.00
60.00
The Finance Director of the company has given the following additional information: 1.
The company had purchased a machinery worth Rs.4 crore. in May, 19x9. The entire purchase consideration was paid in the form of allotment of 10 lakh equity shares to the vendor. The vendor had sold 2 lakh shares in August, 19x9 and 3.5 lakh shares in February, 20x0 to other investors through the secondary market. The vendor currently holds only the balance of 4.5 lakh shares originally allotted to him.
2.
The Finance Director also informs you that the company has secret reserves of Rs.8 crore, which is not currently disclosed in the balance sheet. The company follows extremely conservative accounting policies and had created secret reserves as a buffer to meet any unforeseen eventualities.
3.
The Finance Director also informs that the company is not interested to make any call on the partly-paid up shares but is interested in capitalizing its huge reserves.
You are required to
156
i.
Compute the maximum permissible bonus ratio as per the current SEBI guidelines.
ii.
Discuss the specific measures the company has to take.
iii.
a.
Explain the concept of ‘Secret Reserve’ and how it can be created.
b.
It is the contention of the Finance Director that Secret Reserves can be treated as eligible reserves for computation of bonus ratio if the company discloses the same through an advertisement in a newspaper. Do you agree with the Finance Director? Give reasons.
Part II
56.
The Balance Sheet of Ashwini Plastics Ltd. as on 31st March, 20x0 is as follows: (Rs. in crore.) Liabilities
Amount Assets
Share Capital 20,00,000 shares of Rs.10 each fully paid-up
Amount
Freehold Land
1.00
Buildings
3.50
2.00
Reserves & Surplus:
Plant & Machinery
17.50
Misc. Fixed Assets
0.50
Share Premium
2.25
Inventory
5.50
General Reserve
2.50
Sundry Debtors
3.50
Dividend Equalization Reserve
1.25
Cash
0.50
Special Reserve
1.50
Contingency Reserve
0.50
14% Fully Convertible Debentures (98 series)
8.00 1.50
Term Loans
14.00
Sundry Creditors
6.50 32.00
32.00
a.
The company, on July 8, 20x0, had issued 2,50,000 14% Fully Convertible Debentures of Rs.60 each. Each FCD will be converted into 2 equity shares of Rs.10 each, at a premium of Rs.20 per share, 12 months from the date of allotment.
b.
The existing share capital includes 2,00,000 shares which were issued as purchase consideration to a machinery supplier. The cost of the machinery was Rs.70 lakh and the entire purchase consideration was paid only in the form of shares.
Compute the maximum permissible bonus ratio as per the current SEBI guidelines. 57.
The Balance Sheet of Rathi Electrocastings Ltd. as on March 31, 20x1 is as under: (Rs. in crore) Liabilities
Assets
Share Capital
Land 50.00 Building
(5,00,00,000 shares of Rs.10 each) Reserves & Surplus
57.00 23.00
18.00
Miscellaneous Fixed Assets
Contingency Reserve
13.00
Patents
9.00
General Reserve
15.00
Revaluation Reserve
42.00
Share Premium
12.00
31.00
Plant & Machinery
Capital Reserve Dividend Equalization Reserve
14.00
Current Assets
8.00 113.00
109.00 11% FCDs
25.00
Current Liabilities
62.00 246.00
246.00
157
Investment Banking and Financial Services
The following information is also provided: i.
The patents were purchased in December, 19x9 from an American scientist Mr. Jimmy Hilton. He was paid the entire purchase consideration in the form of allotment of 10,00,000 equity shares.
ii.
The 11% FCDs with a face value of Rs.100 each are due for conversion in September, 20x0. Each FCD will be converted into 1 equity share.
iii.
Revaluation reserves includes an amount of Rs.12 crore calculated on a fixed asset which was revalued upwards is sold during the year at its book value.
You are required to answer the following: a.
Compute the maximum permissible bonus ratio as per the current SEBI Guidelines.
b.
Alternatively, the company is examining the possibility of a stock-split. Determine the maximum permissible stock-split ratio as per current SEBI Guidelines.
Note: The two alternatives are mutually exclusive events. 58.
Zuari Industries Ltd. wants to raise an equity capital of Rs.110 crore. The company wants to raise the maximum possible amount through the book building process. The promoters do not intend to invest more than the minimum requirement. The following bids are received from the investors through the syndicate members:
a.
59.
Price (Rs.)
Number of shares applied
52.00
101,03,000
53.00
85,90,400
54.50
72,11,300
55.25
58,97,600
57.00
41,83,700
58.00
36,55,300
59.00
17,99,400
60.00
8,32,200
61.00
5,00,100
62.00
1,75,700
63.00
82,800
64.00
25,500
Compute the amount of capital that i.
Can be raised through book building
ii.
Can be raised through fixed public offer
iii.
The promoters have to bring in.
b.
Based on the information given above compute the allotment of shares by the book building process and the cut-off rate.
c.
Within the book building portion, is there any need to reserve any share for small investors?
Milton Telecom Ltd. has licenses to offer cellular service in four telecom circles. The company proposes to part finance the project with a Level III ADR issue. The company proposes to raise $150 m net of issue expenses of 4%. The share will be offered at a premium of 20% to its domestic market price of Rs.600 (face value Rs.5). Each ADR will have 4 underlying shares. The current exchange rate is $1 = Rs.47.65. The company pays a dividend of 50%. You are required to compute
158
a.
Number of ADRs required to be issued.
b.
The cost of the ADR to the company if the growth rate is 15% p.a.
Part II
c.
Merrill Lynch Telecom Fund invests in 25000 ADRs. At the end of 1 year the company makes a right issue of 1 share for every 4 shares held. The rights is priced at Rs.600 per share, when the prevailing domestic price is Rs.1000 per share. The fund exercises the rights and immediately exits from the investment. The ADRs are quoting at a premium of 30% over the ex-rights price in the domestic market. The exchange rate is $1 = Rs.50 at the time of the rights issue as well as the divestment.
Compute the gain/loss to Merrill Lynch Telecom Fund on this transaction. 60.
Rockwood Ltd. is a closely held existing profit making company. The company proposes to expand its capacity to meet the growing demand for its product. The cost of the project is estimated at Rs.25 crore. The project will be financed by term loans of Rs.10 crore and the balance through a public issue. The company appoints Emerald Capital Company (ECC) as their Merchant Bankers. ECC advises them against tapping the market. Instead they suggest a bought out deal on the following terms: i.
ECC will buy out the entire issue at Rs.62.5 per share.
ii.
ECC will offload the shares through an offer for sale at the end of 3 years.
iii.
ECC will be assured an IRR of 22% on their investments. In case the divestment takes place at a lesser price, the promoters would compensate ECC for the differential amount.
iv.
In case, ECC offloads at a price which gives them an IRR of over 22%, the surplus would be shared equally by the promoters and ECC.
The current EPS is Rs.10 and is expected to grow by 20% annually over the next 3 years. The company proposes to declare dividend at 15%, 20%, 25% for the next three years respectively. The divestment takes place at a P/E multiple of 8. You are required to a.
Compute the divestment price of the share;
b.
The total post-issue returns to ECC on their investment; and
c.
The amount of cash outflow/inflow to the promoters on divestment.
INTERNATIONAL MARKETS 61.
SK Steel Limited has proposed to expand its operations for which it requires funds of $4.02 crore net of issue expenses. It proposed to raise the required funds through a GDR issue. It considers the following factors in pricing the issue: i.
The expected market price of the company’s equity share in the domestic market is Rs.180.
ii.
6 shares should underlie each GDR.
iii.
The underlying shares are priced at a discount of 10% to the market price.
iv.
The expected exchange rate is Rs.42/$.
v.
Dividend expected on the equity share is 15% with a growth of 8% p.a. forever.
vi.
The issue costs amount to 2% of the issue size.
You are required to a.
Compute the number of GDRs that have to be issued and also the cost of GDR to the company.
b.
Discuss the factors that the company should consider to choose between domestic and international market.
159
Investment Banking and Financial Services
62.
Rockland Engineering Ltd. has awarded HSBC Bank a syndication mandate for US$ 200 million, 5-year facility. The Bank underwrites US$ 100 million and two other banks underwrite US$ 50 million each. The company agrees on the following terms: Tenure
:
5 years
Repayment
:
Bullet payment
Spread
:
Payable annually at 100 basis points over LIBOR
Facility fee
:
35 basis points per annum
Management fee
:
25 basis points payable upfront as under: – 10 basis points on amount of loan – 15 basis points on amount underwritten
Each underwriter retains US$ 25 million and there are 10 participant banks with US$ 12.5 million each. Citibank is the appointed agent bank with annual fee of US$ 15,000. You are required to calculate the
63.
a.
Cost of the loan facility for Rockland Engineering Ltd. if LIBOR remains constant at 5%.
b.
Fees earned by HSBC on this transaction.
Fine Apparels Ltd. is a leading Hyderabad based garment manufacturer. The company intends to raise ECBs in the international market. The company has received the following offer from Citi bank: Amount
–
200 million Euros
Maturity
–
6 years
Drawdown
–
100 million Euros (1st July, 20x0)
–
100 million Euros (1st July, 20x1)
Interest
–
Paid annually at 130 BP over Euribor
Management Fee
–
50 BP
Commitment Fee
–
30 BP per annum
Underwriting Fee
–
60 BP
Agency Fee
–
30,000 Euros per annum
Guarantee Fee
–
80 BP per annum
Amortization
–
2 equal installments at the end of 5th and 6th year.
The terms of agreement state that the agency fee is paid at the end of each year while commitment fee (wherever applicable) and guarantee fee are to be paid at the beginning of each year. The expected EURIBOR as per a study conducted is as follows: July 20x0 – June 20x1
3.5%
July 20x1 – June 20x2
3.25%
July 20x2 – June 20x3
4.5%
July 20x3 – June 20x4
3.75%
July 20x4 – June 20x5
3.25%
July 20x5 – June 20x6
3.00%
Required: Compute the effective cost of borrowing to the company. 160
Part II
64.
Sequel Information Technologies Ltd. is a leading software company engaged in developing banking software and system integration. The company intends to takeover a software company in the USA. The company proposes to finance the acquisition by the ECB route. The company has approached Chase Manhattan Bank for the same. The Bank has agreed for the loan on the following conditions. Amount
$100,000,000
Maturity
6 years from the date of loan agreement
Grace period
2 years
Amortization
Equal half-yearly installments after the grace period
Drawdown
50% immediate 50% at the beginning of the 2nd year
Interest
100 basis points over LIMEAN
Management Fee
60 basis points payable upfront
Commitment Fee
20 basis points per annum payable half-yearly on undrawn balances
Underwriting Fee
25 basis points payable upfront
Agency Fee
$6500 per annum at the end of each year
Security
Guarantee of commercial bank
BNP-Paribas has offered to provide the bank guarantee. The guarantee fee is 40 basis points per annum payable half-yearly on the outstanding balances. The fee is payable at the beginning of the period. The loan agreement is proposed to be signed on 1st January, 20x0. The expected interest rates are as follows: Particulars
LIBOR
LIBID
January-June 20x0
5.25
5.10
June-December 20x0
5.15
4.95
January-June 20x1
5.30
5.10
June-December 20x1
5.20
5.10
January-June 20x2
5.10
5.00
June-December 20x2
5.15
4.95
January-June 20x3
5.10
4.90
June-December 20x3
5.35
5.20
January-June 20x4
6.10
5.90
June-December 20x4
6.20
5.95
January-June 20x5
4.65
4.50
June-December 20x5
5.20
5.10
Advise the company on its effective cost if it accepts the offer. 65.
Mayur Steel Industries Ltd. is planning a backward integration project, the estimated cost of which works out to Rs.2,400 crore. The company plans to finance the project, inter alia, with a syndicated loan of $400 million. The company has received an offer from ABN Amro Bank with the following terms. Amount $400 million Maturity 7 years Drawdown
$150 million – $150 million – $100 million –
immediate 1.1.20x1 1.1.20x2 161
Investment Banking and Financial Services
Grace period – 3 years Amortization – Equal annual installments payable on 31.12.20x3
–
I installment
31.12.20x4
–
II installment
31.12.20x5
–
III installment
31.12.20x6
–
IV installment
Interest rate – Paid annually in arrears at 120 BP over LIBOR Management Fee
–
60 BP
Commitment Fee
–
80 BP per annum
Underwriting Fee
–
50 BP
Agency Fee
–
$15,000 per annum
Guarantee Fee
–
75 BP per annum
The following additional information is provided. i.
The effective date of the loan agreement is 1.1.20x0.
ii.
Commitment fee and agency fee are payable at the end of each year, while guarantee fee is payable at the beginning of each year.
The LIBOR may be assumed as follows: 20x0
6%
20x1
4%
20x2
5%
20x3
7%
20x4
6%
20x5
8%
20x6
7%
Compute the effective cost of borrowings to the company. 66.
Avis Engg. Ltd. has awarded National Westminster Bank a syndication mandate for US $300 million, 5 year facility. The Bank underwrites US $100 million and 4 other Banks underwrite US $50 million each. The company agrees on the following terms: Tenure
5 years
Repayment
Bullet Payment
Spread
Payable annually at 100 Basis Points over LIBOR
Facility Fee
25 Basis Points per annum
Arrangement Fee
50 Basis Points payable upfront as under: –
15 Basis Points on amount of loan
–
25 Basis Points on amount underwritten
–
10 Basis Points on amount of commitment.
Each underwriter retains US $30 million and there are 15 participant banks with US $10 million each. British Bank of Middle East is appointed Agent Bank with annual fee of US $10,000. You are required to calculate the
162
a.
Cost of the loan facility for Avis Engg. if LIBOR remains constant at 5%.
b.
Fees earned by National Westminster on this transaction.
Part II
67.
Microhard Information Technologies Ltd. is a leading software company engaged in developing banking software and systems integration. The company intends to takeover a software company in USA. The company proposes to finance the acquisition by the ECB route. The company has approached Chase Manhattan Bank for the same. The Bank has agreed for the loan on the following conditions: Amount
$200,000,000
Maturity
6 years from the date of loan agreement
Grace Period
2 years
Amortization
Equal half-yearly installments after the grace period
Drawdown
50% immediate 50% at the beginning of 2nd year
Interest
150 basis points over LIMEAN
Management Fee
75 basis points payable upfront
Commitment Fee
25 basis points per annum payable half-yearly on undrawn balances
Underwriting Fee
25 basis points payable upfront
Agency Fee
$5000 per annum payable at the end of each year
Security
Guarantee of Commercial Bank
BNP-Paribas has offered to provide the Bank guarantee. The guarantee fee is 50 basis points per annum payable half-yearly on the outstanding balances. The fee is payable at the beginning of the period. The loan agreement is proposed to be signed on 1st January, 20x0. The expected interest rates are as follows: Particulars
LIBOR
LIBID
January - June, 20x0
5.10
4.90
June - December, 20x0
5.30
5.20
January - June, 20x1
5.25
4.75
June - December, 20x1
5.20
4.80
January - June, 20x2
6.10
5.90
June - December, 20x2
6.20
5.80
January - June, 20x3
4.60
4.40
June - December, 20x3
5.30
5.10
January - June, 20x4
5.60
5.40
June - December, 20x4
5.10
4.90
January - June, 20x5
5.35
5.15
June - December, 20x5
5.65
5.35
Advise the company on its effective cost if it accepts the offer. 163
Investment Banking and Financial Services
68.
Shruthi Steel Industries Ltd. is a leading producer of Cold Rolled Coils (CR coils). The company is planning a backward integration project to produce 1.7 million ton of Hot Rolled Coils (HR Coils). The project cost is estimated at Rs.2,400 crore. The company plans to finance the project, inter alia, with a syndicated loan of $400 million. The company has received an offer from ABN Amro Bank with the following terms: Amount Maturity Drawdown
$ 400 millions 7 years $ 100 mn. - immediate $ 150 mn. - 1/1/20x1 $ 150 mn. - 1/1/20x2 Grace Period 3 years Amortization Equal annual installments payable on 31/12/20x3 - I Installment 31/12/20x4 - II Installment 31/12/20x5 - III Installment 31/12/20x6 - IV Installment Interest Rate Paid annually in arrears at 100 BP over LIBOR Management Fee 50 BP Commitment Fee 75 BP per annum Underwriting Fee 40 BP Agency Fee $ 10,000 per annum Guarantee Fee 60 BP per annum The following additional information is provided. 1.
The effective date of the loan agreement is 1/1/20x0.
2.
Commitment fee and agency fee are payable at the end of each year while guarantee fee is payable at the beginning of each year.
The LIBOR may be assumed as follows: 20x0 6% 20x1 5% 20x2 6% 20x3 4% 20x4 7% 20x5 8% 20x6 6% Compute the effective cost of borrowings to the company. 69.
Naveen Industries Ltd. is a leading producer of consumer electronics. The company plans to expand its production facilities to meet the growing demand for its product. The company intends to finance its expansion primarily through ECB. The company has received the following offer from Bank of Tokyo – Mitsubishi. Amount Maturity Drawdown Interest Management Fee Underwriting Fee Commitment Fee Agency Fee Amortization
164
– 20 billion Yen – 8 years – 10 billion Yen on 1/1/20x1 10 billion Yen on 1/1/20x2 – 100 BP over Yen LIBOR payable annually – 15 BP – 25 BP – 10 BP – 25 million Yen per annum – 4 equal installments at the end of 5th, 6th, 7th and 8th year.
Part II
Bank of America has agreed to provide guarantee cover on this loan. The guarantee fee payable is 50 BP per annum. The guarantee fee is payable at the end of each year. Commitment Fee is payable at the beginning of the year. Agency Fee is also charged at the beginning of the year. The expected Yen LIBOR, as per a survey conducted by Japanese Bond Research Institute (JBRI), is as follows: Year Yen LIBOR (%) 20x0 1.50 20x1 1.00 20x2 1.25 20x3 1.50 20x4 2.00 20x5 3.00 20x6 2.50 20x7 2.00 20x8 1.50 Compute the effective cost of the loan to Naveen Industries Ltd. 70.
Rashtriya Mills Ltd. is a major player in the textile industry. The company is currently a market leader in both cotton textile segment as well as in manmade fabrics. The company has been in existence for almost eight decades. Some of the existing plants were set up in the sixties and are over 30 years old. The company is planning a comprehensive modernization and technological upgradation program at an estimated cost of Rs.800 crore. The company proposes to part finance this project with an ECB. The company has received the following offer from UBS Bank, Zurich for a syndicated loan: Amount Maturity Drawdown
CHF 100 million 8 years CHF 40m (1/1/20x0) CHF 40m (1/1/20x1) CHF 20m (1/1/20x2) Interest 80 BPs over CHF LIMEAN payable on December 31, each year Amortization 2 equal installments at the end of 7th and 8th year Management Fee 30 BPs Underwriting Fee 40 BPs Commitment Fee 30 BPs payable at the end of the year Guarantee Fee 50 BPs payable at the beginning of the year Agency Fee CHF 100,000 per annum payable at the end of the year. Kotak Mahindra Capital Corp. is the regular investment banker to the company. As per their research, the expected interest rates are as follows: Year 20x0 20x1 20x2 20x3 20x4 20x5 20x6 20x7 20x8 20x9 201x
CHF LIBID 4.90% 4.45% 5.30% 6.10% 5.70% 5.60% 4.95% 4.20% 4.55% 4.35% 4.80%
CHF LIBOR 5.10% 4.55% 5.40% 6.20% 5.90% 5.80% 5.05% 4.30% 4.60% 4.42% 4.90% 165
Investment Banking and Financial Services
You are required to: Calculate the effective cost of borrowings to the company. Note: Compute the solution up to two decimal points only.
AN INTRODUCTION TO EQUIPMENT LEASING 71.
XYZ Limited has recently leased equipment costing Rs.350 lakh for three years. The terms and conditions of the lease are as follows: –
Lease rentals: Rs.435 per thousand per annum
–
Frequency of payment: Annually in arrears
The incremental borrowing rate for XYZ Limited is 20% p.a. You are required to determine if the above transaction can be classified as a finance lease according to the FASB, given the following information:
72.
a.
The useful life of the asset is 5 years.
b.
The useful life of the asset is 8 years.
Genius Finance Co. Limited has recently structured a leveraged lease transaction involving an investment cost of Rs.65 crore. The investment is funded in the following manner: Genius Finance Co. Limited being the equity participant is to invest 30% of the total cost. The balance is to be raised by means of debt from Sterling Bank which is the loan participant. The rate of interest on the loan component is 16% p.a. and the repayment is to be made in 5 equated annual installments. You are required to calculate the annual lease rental, assuming that the required rate of return of Genius Finance Co. Limited is 20% p.a.
73.
74.
75.
With the help of the given data, you are required to determine the annual lease rentals to be charged under the following rental structures. a.
Equated
b.
Deferred (Assuming a deferment of 1 year)
Rs.45.00 lakh • Investment cost 22.00% • Pre-tax required rate of return 5.00 years • Primary lease period Nil • Residual value after the primary period From the following data given by Raj Limited, you are required to determine the lease rentals as per the stepped (increase of 10% p.a.) and ballooned (annual rental for years one to four is Rs.3 lakh) rental structures. Rs.80 lakh • Cost of the asset • Lessor’s required pre-tax rate of return 20.5% 5 years • Lease period Nil • Residual value of the primary lease The summarized income statement and balance sheet of Lakshmi Textiles Limited is given below: Income Statement for the year ended March 31, 20x1 Net Sales Cost of Goods Sold General Expenses Interest Charges Depreciation Profit before Tax Tax Profit after Tax
166
Rs. in lakh 9,000 4,500 1,590 675 660 1,575 630 945
Part II
Balance Sheet as on March 31, 20x1 Sources of Funds A: Shareholder’s Funds Share Capital Reserves and Surplus
450.00 1,250.00 1,700.00
B: Loan Funds 10% Debentures
1,460.00
Term Loans
872.00
Cash Credit
1,068.00 3,400.00
C: Total (A + B)
5,100.00
Application of Funds D: Fixed Assets Original Cost Less: Accumulated Depreciation
5,000.00 1,500.00
Net Block
3,500.00
Add: Capital work-in-progress
500.00
E: Investments
500.00
F: Current Assets Cash and Bank Balances
500.00
Receivables
750.00
Inventory
1,000.00
Other Current Assets
200.00 2,450.00
G: Less: Current Liabilities Accounts Payable
1,000.00
Provisions
850.00 1,850.00
H: Net Current Assets (F – G) I: Total The following additional information is available:
600.00 5,100.00
•
At the beginning of the year, the company had acquired plant and machinery costing Rs.950 lakh through a term loan carrying a rate of interest of 18.5% p.a. The term loan is repayable in 5 equal annual installments, the first installment falling due at the end of the first year, i.e. March 31, 20x1.
•
The company could have leased plant and machinery on a 5-year non-cancelable lease at a rate of Rs.375 per thousand payable annually in arrears.
•
The depreciation policy of the company requires plant and machinery to be 1 depreciated at the rate of 33 % p.a. on the WDV method. 3 167
Investment Banking and Financial Services
You are required to compute:
76.
77.
a.
Leverage ratio, the fixed assets turnover ratio and the return on investment based on the given financial statements.
b.
Recast the financial statements assuming that the assets have been leased as per the aforesaid terms and compute the leverage, assets turnover and the ROI ratios based on these statements.
Global Products Limited has recently leased equipments worth Rs.670 lakh from Capital Leasing Limited. The lease period is seven years of which the primary lease period is 5 years. The lease rates are as follows: •
Lease rentals during the primary lease period: Rs.22 per thousand per month.
•
Lease rentals during the secondary lease period: Re.1 per thousand per month.
•
The incremental borrowing rate for Global Products Limited compounded monthly is 18% p.a. The lease rentals are payable monthly in advance.
a.
If the average economic life of the equipment is 10 years, will you classify the lease as a finance lease? Give reasons.
b.
You are further informed that the physical life of the equipment is 12 years, the technological life is 8 years and the product market life is 9 years. Will you still classify the lease as a finance lease? Substantiate.
Rhombus Technologies Ltd. (RTL) is planning to lease certain equipment which costs Rs.50 lakh. When the equipment becomes operational, the EBDIT of the company will be higher by Rs.20 lakh for five years. The company approached Scientific Leasing Ltd. (SLL), a finance company that specializes in leasing out equipment of this kind. But, SLL is quoting a lease rental of Rs.35 ptpm, payable quarterly in advance, which RTL thinks is too high. The alternative that RTL is evaluating is a loan from a bank at an interest of 14%, repayable in five equal annual installments including interest. The cost of equity capital of RTL is 22% and the company generally maintains a debt-equity ratio of 2:1. The equipment is eligible for depreciation at 25% on WDV basis and the tax rate applicable to RTL is 35%. The salvage value of the equipment is expected to be twice its book value at the end of the fifth year. You are required to advise the company, with necessary workings, on whether a.
It should acquire the equipment at all
b.
If it should acquire, whether it should be through leasing or buying.
LEASING IN INDIAN CONTEXT 78.
Allsip Finance Ltd. is planning to issue bonds with a face value of Rs.100 and carrying coupon payments at five percent above the inflation rate of the year. The company wants to price the bond in such a way that investors get a return on 18% on it. The expected rates of inflation during the five-year tenure of the bond are as follows: Year
Rate of Inflation (%)
1
5.0
2
4.5
3
5.0
4
6.0
5 What is the price at which the bond can be issued? 168
7.5
Part II
79.
The most recent audited summarized balance sheet of M/s Aryan Financial Services Limited is given below: Balance Sheet as on March 31, 20x1 Liabilities
Rs. in million Assets
Equity share capital
Rs. in million
Fixed assets: 45.00 Assets on lease
Reserves & Surplus
300.00
(Original cost: 450 million) 95.00
Term loan from IDBI
56.00 Other fixed assets
Public deposits
40.00
120.00 Investments (in wholly owned subsidiaries) Current Assets: 85.00 Stock on hire
60.00
ICDs
60.00 Receivables
25.00
180-day commercial paper
40.00 Other current assets
25.00
Bank borrowings
Miscellaneous. expenditure (not written off) a. b.
80.
15.00
36.00
501.00 501.00 You are required to calculate the net owned funds of the company as on March 31, 20x1. The company intends to enhance its investments in the lease portfolio by Rs.450 million and for this purpose it plans to raise funds by way of bank borrowings and term loans from financial institutions in that order. Determine the financing mix.
A company has issued PTCs backed by a pool of property receivables aggregating to Rs.235 lakh. The equated monthly payments to be made to the PTC holder are as follows: During the first 12 months
Rs.11 lakh p.m.
During the next 12 months
Rs.9 lakh p.m.
During the next 6 months
Rs.7 lakh p.m.
Calculate the promised rate of return to the investor. 81.
The following financial data has been extracted from the books of Sarita Leasing Limited for the year 20x0-x1. Rs. in crore –
Equity share capital
–
Share premium
56.00
–
General reserve
126.40
–
Revaluation reserves
96.80
–
Profit on sale of assets
54.70
–
Intangible assets (at book value)
33.60
–
Investments in shares and debentures of subsidiary companies
32.92
Loans and companies
21.98
– –
advances
140.00
to
group
Deposits with subsidiary companies
15.64
Calculate the amount of owned funds and net owned funds. 169
Investment Banking and Financial Services
82.
The audited Balance Sheet of Rockland Leasing Company as on March 31, 20x1 is presented below: Balance Sheet as on March 31, 20x1 Liabilities
Rs. in lakh Assets
Rs. in lakh
Paid-up Share Capital
150 Fixed Assets
Reserves & Surplus – Capital Reserves
Investments in wholly owned 100 subsidiaries Current Assets
140
310
750
– Free Reserves Secured Loans – Term Loans – Bank Borrowings
1,700
– Stock on Hire
Miscellaneous Expenses 90 (to the extent not written off) 705
85
Unsecured Loans – Public Deposits
720
Current Liabilities
600
Total
2,675 Total
2,675
70% of the revenue earned by the company is derived from equipment leasing and hire purchase. a.
Calculate the net owned funds of the company.
b.
Calculate the maximum permissible level of debt and the additional amount of debt that can be raised.
83.
Reality Financial Services is contemplating a bond issue (Face value Rs.100) with a stepped up coupon interest structure, the step up rate being 12% p.a. The bonds will carry a coupon rate of interest of 10% p.a. for the first year and will be redeemed at 110 percent of the face value after seven years from the date of issue. The bond issue is to be priced so as to yield a pre-tax redemption yield of 18.5% to the investor. Calculate the issue price.
84.
Based on the data given below, you are required to develop a Cash Certificate Scheme. Period (in months)
Minimum Amount (Rs.)
Rate of Interest*(%)
Maturity Value
Annual Yield
13
5000
14.5%
5,845
15.60%
36
5000
14.5%
7,705
18.03%
48
5000
14.5%
8,899
19.49%
60
5000
14.5%
10,279
21.11%
* Interest is compounded monthly.
TAX ASPECTS OF LEASING 85.
The following data is available on the portfolio of leased assets of Stallion Leasing Ltd. for a given financial year. Block
Rate of depreciation
WDV at the beginning (Rs. in lakh)
Additions during the year (Rs. in lakh)
A
25%
224
100
Sale of assets during the year have been Rs.13 lakh. a.
Calculate the tax relevant depreciation charge for the year.
b.
It is expected that fresh investments to the tune of Rs.40 lakh will be made during the following financial year. The disinvestment proceeds are likely to be around Rs.22 lakh. 50% of the fresh investment will be made before September 30 of the financial year. Calculate the projected depreciation charge for the following year.
170
Part II
86.
Vindhya Ltd. plans to acquire capital equipment from Samastha Ltd. based at Cochin. The cost of the equipment exclusive of sales tax is Rs.67 lakh and the rate of CST payable is 4%. Vindhya Ltd. is considering to lease the equipment from Malathi Financial Services. The quote on a 3-year lease is Rs.55.28 per thousand per month payable at the end of every month. Calculate the lease rentals payable by Vindhya Limited.
87.
The following data is available on the portfolio of leased assets of Radial Leasing Ltd. for the year 20x0-x1. Block
Rate of depreciation
WDV at the beginning (Rs. in lakh)
Additions during the year (Rs. in lakh)
A
25%
186
200
B
40%
125
56
Sale of assets during the year have been Rs.25 lakh and Rs.44 lakh in respect of block A & B respectively. a.
Calculate the tax relevant depreciation charge for the year 20x0-x1.
b.
It is expected that fresh investments to the tune of Rs.85 lakh will be made during the year 20x1-x2 as follows: Block
Amount of Investment (Rs. in lakh)
A
60
B
25
The disinvestment proceeds are likely to be around Rs.25 lakh with the following break up Sale proceeds (Rs. in lakh) A
10
B
15
It is expected that about 50% of the fresh investments will be made before September 30 of the financial year and the rates of depreciation applicable to Blocks A and B will be 25% and 40% respectively. Calculate the projected depreciation charge for the following years. 88.
Highway Industries is contemplating a capital investment of Rs.415 lakh during the current year. There are two ways of funding the investment; The company can finance the investment by debt carrying a rate of interest of 16.5% p.a. repayable in 5 equal annual installments (principal repayable in equal installments). Alternatively, it can lease the assets on the following terms. •
Lease Rental
: Rs.310 per thousand per annum
•
Lease Period
: 5 years
•
Frequency of Payment : Annually in arrears
The tax relevant rate of depreciation is 25% and the marginal tax rate is 46%. The company anticipates substantial tax liabilities during the current year and in the following year. Given that the objective of the company is to reduce the tax liability, which of the two alternatives will you recommend? 89.
Radhika Spinning Mills Ltd. (RSML) is a 100% export-oriented unit engaged in manufacturing textiles. It is finalizing a modernization plan at a cost of Rs.65 lakh. It is planning to lease the required plant and machinery from Sumeet Leasing Ltd. Sumeet Leasing Ltd. has offered to structure a 7-year non-cancelable finance lease with rentals payable on an equated annual basis in arrears. If the marginal cost of debt of Radhika Spinning Mills Ltd. is 17.5%, calculate the maximum lease rental p.a. Radhika Spinning Mills Ltd. will be willing to pay. Assume no salvage value for the equipment at the end of 7 years. 171
Investment Banking and Financial Services
90.
Innovative Ltd. based at Hyderabad is contemplating purchase of some capital equipment from Rohit Ltd. based at Chennai. The cost of the capital equipment exclusive of sales tax is Rs.115 lakh and the rate of CST is 4%. Innovative Ltd. is considering whether it will be better off by leasing the equipment from Digital Leasing Ltd. (DLL). The quote of DLL on a 5-year lease is Rs.24.5 per thousand per month payable at the end of every month. Calculate the lease rentals payable by Innovative Ltd.
LEASE EVALUATION: THE LESSEE’S ANGLE 91.
Indusway Limited is considering investment in capital equipment for which the following information is available: Cost of the equipment (inclusive of CST @ 4%)
: Rs.21.4 lakh
Tax relevant rate of depreciation
: 25%
Useful life
:
5 years
Net salvage value at the end of 5 years
:
35% of the book value after 5 years
The company can either purchase the equipment under the bill rediscounting scheme of IDBI or acquire it on a finance lease. The effective interest rate under the IDBI bill rediscounting scheme is 17.5% p.a. The company has received an offer from Nova Leasing Ltd. to structure a finance lease for a 5-year term at a rental of Rs.28.5 per thousand per month payable annually in arrears. The lease rental has to be calculated on the cost of the equipment to the lessor which will include CST @ 10%. The target debt-equity ratio of Indusway Ltd. is 2:1 and the cost of debt and equity are 17.5% and 22% respectively. The corporate tax rate is 46%. The investment is likely to generate an incremental EBDIT of Rs.20 lakh per annum for the first 3 years and Rs.17 lakh for the last 2 years of the project life. You are required to advise Indusway Ltd. as to whether it should buy or lease the equipment. Also calculate the break even rental for Indusway Ltd. 92.
Ramon Tiles Ltd. is considering investment in a balancing equipment, regarding which the following information is available: •
The cost of the equipment is Rs.62.8 lakh inclusive of CST @ 4%.
•
The acquisition will be funded through a mix of term loan and own funds in the ratio of 4:1. The loan carries interest at 18.5% p.a. and is repayable in 5 equal annual installments.
•
The planning horizon for such investments is 5 years. After 5 years, the equipment is expected to fetch a net salvage value of Rs.7.5 lakh.
•
The tax relevant rate of depreciation is 25%.
•
The investment is expected to generate an EBDIT of Rs.46 lakh in year 1, Rs.37 lakh in year 2 and Rs.24 lakh in year 3, through 5.
The commercial bank which has agreed to finance the investment has recently informed the company that the loan can be disbursed only after 3 months. Since the equipment is urgently required, the following alternatives are being considered by the company.
172
–
Finance the acquisition through a 3-month intercorporate loan at a cost of 6% per quarter and liquidate the liability utilizing the bank loan made available 3 months later.
–
Lease the equipment.
Part II
The company has received an offer from Empire Leasing Ltd., the terms of which are as follows: Primary lease period
: 5 years
Secondary lease period
: 2 years
Management fee
: 1% of investment cost
Annual rental During primary period
: Rs.310 per thousand
During secondary period
: Rs.30 per thousand
The lease rentals are payable annually in arrears, but the management fee is payable immediately on signing the lease. The leasing company is not entitled to the concessional CST and has to pay sales tax @ 10% on the cost of the equipment. Ramon Tiles has an explicitly stated target debt- equity ratio of 2:1. The marginal costs of debt and equity are 18.5% and 22% respectively. The marginal rate of tax is 46% including surcharge. Based on economic considerations, which alternative would you recommend? 93.
Pavan Agro Tech Ltd. is contemplating investment in equipment costing Rs.47 lakh. The company can purchase the equipment by raising additional debt at a cost of 16.5% p.a. Alternatively, the company can take the equipment on a finance lease with a 5-year primary lease period at the rate of Rs.325 per thousand per annum payable annually in arrears. The marginal tax rate is 46% and the tax relevant rate of depreciation is 25%. The salvage value of the equipment after 5 years is negligible. Calculate the net value of the lease. Should the company lease the equipment?
94.
Resin Ltd. is contemplating investment in equipment worth Rs.56 lakh and one of the alternative being considered is a finance lease offered by Shruti Leasing Ltd. at a rental of Rs.315 per thousand payable annually in arrears over a non-cancelable period of 5 years. The tax relevant rate of depreciation is 25% and the marginal rate of tax (inclusive of surcharge) is 46%. The marginal cost of debt is 16% (pre-tax) and the marginal cost of capital is 13.5%. Assume that the net salvage value of the equipment after 5 years is Rs.2 lakh. Answer the following questions based on the equivalent loan model. a.
95.
Calculate the amount of borrowing displaced by the finance lease.
b.
Compute the present value of the interest tax shields on the displaced debt.
c.
Should the company accept the lease proposal? Give reasons.
Rajdeep industries is contemplating investment in equipment about which the following particulars are available: Investment cost
Rs.72 lakh
Tax relevant rate of depreciation
25%
Useful life
5 years
Estimated salvage value after 5 years
Rs.8 lakh
The company can either borrow and buy the equipment or lease the equipment. Its cost of capital is 13% p.a. and the marginal rate of tax is 46%. The cost of debt is 16% p.a. The company has received a quote from Midas Leasing which has offered to structure a 5-year full pay-out lease at the rate of Rs.315 per thousand payable annually in arrears. Compute the NAL. 96.
Surya (Private) Ltd. is planning to invest in equipments worth Rs.54 lakh and one of the alternatives being considered is a finance lease offered by Never Lease Ltd. at a rental of Rs.333 per thousand payable annually in arrears over a non-cancelable period of 5 years. The tax relevant rate of depreciation is 40% and the marginal rate of tax (inclusive of surcharge) is 46%. The marginal cost of debt is 17% (pre-tax) and the marginal cost of capital is 12%. Assume that the net salvage value of the equipments after 5 years is Rs.5 lakh.
173
Investment Banking and Financial Services
Answer the following questions based on the BHW model.
97.
a.
What is the amount of borrowing displaced by the finance lease?
b.
Compute the present value of the interest tax shields on the displaced debt.
c.
Should the company accept the lease proposal? Explain.
Remington Ltd. is planning to invest in certain equipment, the particulars of which are as follows: Cost of the equipment
Rs.25 lakh
Tax relevant rate of depreciation
40% p.a.
Useful life
3 years
Salvage value after 3 years
Rs.1.5 lakh
The company has an option to either buy or lease the equipment. The cost of capital is 14% p.a. and the tax rate is 46%. Cost of debt is 19% p.a. The company has received a lease quote from Everlasting Leasing Ltd. at the rate of Rs.38.6 per thousand per month payable monthly in advance. Calculate the net advantage of leasing for Remington. 98.
Haryana Mills Ltd. (HML), promoted by the Adayar Group, is a cotton yarn spinning unit with a capacity of 56,000 spindles. The company has approached Mandakini Financial Services Ltd. (MFSL) for arranging lease of machinery worth Rs.225 lakh. MFSL has proposed the following terms: Primary lease period Lease rental
5 years Rs.26 per thousand per month payable quarterly in advance The cost of the equipment includes 4% central sales tax on outright purchase but, the rate of central sales tax for MFSL is 10%. Further, lease rentals also attract a local sales tax of 4.5%. HML’s pre-tax cost of debt and equity are 15% and 24% respectively. The marginal tax rate is 42% and long-term debt-equity ratio is 2. The tax relevant depreciation rate applicable 1 to the machinery is 33 % (WDV). The asset is expected to fetch a residual value of Rs.25 lakh 3 at the end of 5 years.
99.
: :
You are required to calculate net advantage of leasing using a. Equivalent loan model and give your recommendations. b. Suggested model and give your recommendations. Provided here below are the details of lease quotes received from M/s Implease Ltd. and other relevant details of Steel Alloys Ltd. which is intending to purchase certain essential equipments:
Cost of equipment If purchased, the equipment will be funded by a term loan bearing an interest rate of 18% and repayable in equal installments of principal over 5 years Primary lease period Management fee Rentals are payable annually in arrears Applicable rate of depreciation (WDV) Tax rate applicable Estimated salvage value Target debt-equity ratio Marginal cost of debt Marginal cost of equity Lease rental, Proposal A Lease rental, Proposal B 174
Rs.100 lakh
5 years 1% of the cost 25% 43% Rs.10 lakh 2:1 18% 24% Rs.320 per Rs.1000 Rs.400 per Rs.1000
Part II
You are consulted to evaluate these lease proposals using both suggested model and Weingartner’s model. Comment on the strengths and weaknesses of these models. Elaborate on how these models react to a given change in lease rentals. (Round off the interest rates). 100.
ACC Construction Company has decided to acquire a crane which costs Rs.10 crore. The useful life of the crane is four years. If the company acquires the crane, its EBDIT will increase by Rs.5 crore. The company is in a dilemma on whether to buy or lease the crane. If it leases the crane, it will have to pay rentals at the rate of Rs.32 ptpm quarterly in advance and an upfront processing fee of 0.5% of the cost of the asset. For tax purposes, the crane can be depreciated at 25% and the tax rate applicable to the company is 30%. The salvage value is expected to be 10% of the cost. The company’s marginal cost of equity and debt are 20.5% and 14% respectively and it generally maintains a debt equity ratio of 1.5. You are required to suggest, with the necessary calculations, whether the equipment should be purchased or leased based on the Weingartner’s model.
LEASE EVALUATION: THE LESSOR’S ANGLE 101.
Evergreen Ltd. typically writes 5-year leases with rentals payable annually in arrears. The following information is available about a lease under review: Equipment cost
: Rs.47 lakh (Inclusive of CST @ 10%)
Salvage value after 5 years
: 5% of the original cost
Initial direct cost
: Rs.0.5 lakh (front ended)
Management fee
: Rs.0.75 lakh (front ended)
The marginal cost of capital to Evergreen Ltd. is 16% and the marginal rate of tax is 46%. Calculate the break even rental for Evergreen Ltd. assuming a tax relevant rate of depreciation of (i) 25% (ii) 40% (iii) 100% 102.
Starlight Financial Services writes the following types of lease contracts Type
Duration of primary lease period
Tax relevant rate of depreciation
RV. as % of original cost
I
3
25%
5%
II
5
40%
3%
The marginal tax rate applicable to the company is 46% and the post-tax cost of funds is 16% p.a. On interstate purchases of capital equipment the company is required to pay CST @ 10% on the basic price.
103.
a.
You are required to calculate the minimum rental which the company should quote under the two types of lease contracts. Assume that the company collects lease rentals on a monthly basis in advance.
b.
Calculate the minimum monthly rental to be charged on a 5-year non-cancelable lease proposal which involves leasing an equipment costing Rs.75 lakh (exclusive of CST).
Riverside Manufacturing Co. Ltd. (RMCL) has decided to invest in an equipment for which the following particulars are available: a.
Cost of the equipment
:
Rs.42 lakh
b.
Tax relevant rate of depreciation
:
25%
c.
Useful life
:
3 years
d.
Estimated net salvage value after 3 years
:
Negligible
The company has received a lease proposal from Rainbow Leasing Ltd. (RLL) to structure a finance lease at a rental of Rs.47.50 per thousand per month payable at the beginning of every month for three years.
175
Investment Banking and Financial Services
104.
105.
106.
176
The marginal cost of debt and marginal cost of capital for RMCL are 16% (pre-tax) and 15% respectively. You have been informed that Rainbow Leasing Ltd. requires a minimum return of 14% on its lease portfolio. a. Determine the break even rentals for RMCL and RLL. b. Comment on the spread available between the two break even rentals. Rohit Varma, the Managing Director of Rohit Financial Services estimates the pre-tax cost of funding leases to be 23% p.a. Based on this estimate, he believes that all lease investments of his company must provide a gross yield of 25% p.a. after taking into account the salvage value at 10% of the original cost. He has two alternate structures in mind which are detailed below: Structure I: Equated monthly pattern under which rentals are collected at the beginning of every month from the first month to the sixtieth month. Structure II: Ballooned pattern under which 10% of the monthly rental calculated under Structure I is collected at the beginning of every month for the first 48 months and ballooned level (equal) rentals are calculated at the beginning of every month for the next 12 months. Required: a. Calculate the monthly rentals under Structures I and II assuming an investment of Rs.1,000. b. Calculate the add-on yield on the five-year lease transaction, under both structures. Alpha Industries is negotiating a lease proposal with Beta Leasing Limited for an imported energy conservation equipment costing Rs.360 lakh which carries a (tax relevant) depreciation rate of 100%. The useful life of the equipment is three years after which the net salvage value of the equipment is expected to be 20% of its book value at that point of time (assuming a book depreciation rate of 30% p.a. under written down value method). Given its cash flow profile and estimated tax liability for the next three years, the company wants a back-ended lease to be structured as follows: Months Lease rental per month 1 – 12 L 13 – 24 1.5L 25 – 36 2.0L The marginal cost of capital and the pre-tax cost of debt for the company are 14% and 18% respectively. Beta Leasing requires a post-tax return of 14% p.a. on all its lease investments. As a matter of policy, the residual value of any leased equipment is taken at 5% of its original cost for the purpose of pricing a lease. The initial direct costs are estimated to be 0.2% of the investment cost. The company does not follow the practice of collecting an upfront management fee. The marginal tax rate applicable to both the companies is 45%. Ignore surcharge. Assume that lease rentals are payable at the beginning of every month. Required: a. Calculate the maximum value of L from the point of view of Alpha Industries. b. Calculate the minimum value of L from the point of view of Beta Leasing. c. Comment on the spread available between the values obtained in (a) and (b). Foremost Financial Services Limited (FFSL) has recently structured a five-year non-cancelable leveraged lease transaction involving an investment cost of Rs.120 crore with Bhatt Commercial Bank (BCB) as the loan participant. FFSL has financed 20% of the investment cost. The remaining 80% was funded by BCB. If the (pre-tax) gross yield required by FFSL is 24% per annum, calculate the annual lease rental to be charged. Assume that the loan funds provided by BCB carry an interest of 18% p.a. and is to be amortized in five equated annual installments. The corporate tax rate is 43%.
Part II
107.
Chinni Cement Company Limited (CCCL) is contemplating a sale and leaseback arrangement in respect of its plant and machinery costing Rs.120 lakh. The plant and machinery was acquired about two years back and the written down value of this asset as on date is Rs.70 lakh. The company has received a quotation from the State Financial Corporation (SFC) under which the SFC is prepared to buy it for a price of Rs.80 lakh and lease it back on the following terms: Lease period
–
5 years
Lease rental (payable monthly in advance) during primary period
–
Rs.25.5 per thousand per month
The tax relevant rate of depreciation is 25%. The estimated salvage value after five years is expected to be negligible. Required:
a.
On economic considerations, will you recommend the ‘sale and leaseback’ arrangement to CCCL? You are informed that CCCL is a profit making company. Its marginal cost of debt is 16% and post-tax cost of capital is 12%. The marginal tax rate is 43%.
b.
You are informed that the marginal cost of funds to the SFC is 12% and its marginal tax rate is 26%. Given this information, will you recommend the proposed investment to the SFC? Show all calculations that are required to support your recommendation.
c.
Is it possible to structure a mutually advantageous lease proposal? Answer this question with reference to the results obtained in (a) and (b).
State the assumptions, if any. 108.
Navyug Industries is contemplating import lease as one of the alternative for importing capital goods worth Rs.128 lakh (inclusive of duty) from Smith Plc based at England. It has approached Clarity Leasing Co. of India (CLC) for designing an import lease with a rental structure tailored to suit its cash flows position over the next 5 years. After a careful analysis of the projected pattern of cash flows for the next 5 years, the marketing manager of CLC has proposed a deferred cum stepped structure of lease rentals as follows: Profile of Lease Rentals (Payable annually in Arrear)
Year
1
2
3
4
5
Lease Rental
–
L
1.15L
1.3225L
1.5208L
You are provided with the following additional information. •
The tax relevant rate of depreciation is 40% p.a.
•
The marginal rate of tax (inclusive of surcharge) is 46%.
•
The marginal costs of debt and equity are 16% and 18% respectively and the target debt-equity mix is 2:1.
•
The lease rentals are payable annually in arrears.
•
The salvage value of the capital goods may be taken as 10% of cost.
a.
Calculate the net advantage of the finance lease.
b.
Determine the equated annual break even rental.
Assume that the lease rentals have been worked out by CLC based on a pre-tax yield of 20% p.a. You can make some additional assumptions if necessary.
177
Investment Banking and Financial Services
109.
The finance manager of Minerva Ltd. evaluates lease proposals in terms of the risk adjusted gross yield. For this purpose, he has developed the following risk classification table which provides information on the risk adjusted pre-tax yields required for different default risk classifications. Risk class
Required yield (%)
A
20
B
22
C
25
D
26
The finance manager is currently reviewing a proposed lease transaction with Navaratan Ltd. about which the following details are available: Investment
Rs.22 lakh
Primary lease period
4 years
Secondary lease period
3 years
Monthly rental during primary period
Rs.28.3 per thousand
Monthly rental during secondary period
Rs.1 per thousand
You are required to calculate the add-on-yield. 110.
The General Manager of Indotech Finance Ltd. evaluates lease proposals in terms of the risk adjusted gross yield. For this purpose, he has developed the following risk classification table which provides information on the risk adjusted pre-tax yields required for different default risk classifications. Risk class
Required yield (%)
A
18
B
20
C
23
A proposed lease transaction with Macro Works Ltd. is being evaluated by the General Manager. Information regarding the said transaction is as follows: Primary lease period : 4 years Lease rentals payable in advance : Rs.31.25 per thousand per month The credit risk evaluation exercise undertaken by him puts the lease in ‘C’ category of risk.
111.
a.
Should the general manager recommend the proposal?
b.
Assume that the lessee is prepared to pay 4 months rental in advance, of which 3 months rental will be maintained as an interest free security deposit and adjusted against the payments due for the last 3 months of the primary lease period. Does this alter your answer to (a)?
The management of Rocky Leasing Ltd. is evaluating a lease proposal from Rivet Manufacturing Ltd, information available regarding which is as follows: Primary lease period
3 years
Secondary lease period
2 years
Monthly lease rental during the primary lease period
Rs.35.06 per thousand
Monthly rental during secondary period
Rs.1 per thousand
The target debt-equity ratio of Rocky Leasing Ltd. is 3:1 and the marginal cost of debt and equity are 19% and 22% respectively. The marginal rate of tax inclusive of surcharge is 46%. The tax relevant rate of depreciation is 40%. The salvage value after the third year is insignificant. Based on the IRR of the lease proposal, determine whether the proposal should be accepted or not. 178
Part II
112.
Leasewell Ltd. has a client who wants to lease an equipment worth Rs.100 lakh. Leasewell Ltd. is facing a liquidity crunch and is looking for a loan participant for the lease deal who can finance it to the extent of Rs.30 lakh. The equipment has a useful life of 5 years and its salvage value is expected to be Rs.5 lakh. It can be depreciated at 30% on WDV basis. The company contacted Wellfin Ltd., which agreed to participate in the lease. The terms quoted by Wellfin Ltd. are an interest of 16% and repayments in equal quarterly installments including interest over five years. If the Leasewell Ltd. expects a gross yield of at least 30%, what is the minimum quarterly lease rental that should be quoted to the client? Lease rentals are to be paid in arrears. Leasewell Ltd. is thinking of offering a hire purchase plan to the client if he is willing to make a down payment of Rs.30 lakh. The company wants the hire rentals to be paid monthly in arrears. What is the minimum flat rate of interest that should be quoted to the client if Leasewell Ltd. should not lose on this transaction compared to the above lease transaction? Ignore interest tax. The income tax rate applicable to the company is 30%.
113.
Shubhlabh Financial Services Ltd. (SFSL) has a client who wants to lease an equipment that costs Rs.50 lakh. The current lease rate applicable to such leases is Rs.35 ptpm payable annually in arrears. The company is at present not in a position to finance the lease entirely by itself. It is therefore looking for a loan participant to finance at least Rs.10 lakh. The supplier of the equipment is willing to finance it through its finance subsidiary and wants the amount to be repaid over five years with interest at 16%, in equal annual installments (including interest). SFSL wants a gross yield of 25% on this transaction. You are required to advise SFSL whether it should go ahead with this transaction or not. (Support your answer with suitable workings).
LEASE ACCOUNTING AND REPORTING 114.
Anand Petro Chemicals Limited (APCL) has recently signed a lease agreement for acquiring machinery costing Rs.450 lakh on a five-year non-cancelable lease at a rate of Rs.312 per thousand payable at the end of every year. The salvage value of the machinery after five years is estimated to be negligible. The other relevant information is as follows: Marginal cost of capital
12%
Pre-tax marginal cost of debt
18%
Marginal tax rate (inclusive of surcharge)
51.75%
Rate of depreciation
30%
Required:
Based on the guidelines issued by the International Accounting Standards Committee (IASC) for lease accounting and reporting, answer the following questions: i.
Calculate the present value of the minimum lease payments.
ii.
Determine the value at which the machinery must be capitalized in the balance sheet of APCL.
iii.
Calculate the unexpired finance charge at the inception of the lease.
iv.
Prepare a schedule showing the allocation of the unexpired finance charge using the actuarial method.
v.
Prepare the schedule required in (iv) using the sum of the digits method. Do the IASC guidelines recognize this method of allocation? Explain.
vi.
Prepare the schedule required in (iv) using the straight line method. Is this method conceptually flawed? Explain.
vii.
Show how the transaction will be reflected in the financial statements of APCL at the end of the first year of the lease period. The problem has been solved according to IAS:17 and AS:19 (Indian Standards). 179
Investment Banking and Financial Services
115.
Jumbo Industries is contemplating an import lease for acquiring equipments costing Rs.72 lakh. The lease terms require Jumbo Industries to pay a lease rental of Rs.105 ptpq, quarterly in arrear over a non-cancelable period of 3 years. The marginal cost of debt is 18% p.a. and the marginal rate of tax applicable to the company is 43%. The tax relevant rate of depreciation is 25%. Assume that the lease has to be capitalized in the books of the lessee as per the guidelines of IAS:17 and AS:19 Show how the transaction will be reflected in the financial statements of Jumbo Industries prepared at the end of each year of the lease period. The company follows the effective rate of interest method (the actuarial method) for spreading over the unexpired finance charge. Ignore salvage value.
116.
117.
118.
119.
Run Industries is contemplating to lease an industrial equipment costing Rs.65 lakh. The lease terms require Run Industries to pay a lease rental of Rs.25.50 per thousand per month payable monthly in advance over a period of 5 years. Its marginal cost of debt and equity are 16% and 22% respectively. The long-term debt-equity ratio is 2 : 1. The tax relevant depreciation and effective tax rate are 30% (WDV) and 34% respectively. According to the IAS:17/AS:19 show how the transaction is reflected in the financial statements of Run Industries during the lease period. Assume that the salvage value for the asset is nil and interest allocation is made by the company using effective rate of interest method. Layman Ltd. has recently signed a lease for an equipment costing Rs.47 lakh. The lease is for a non-cancelable period of 3 years and the lease rentals are payable at the rate of Rs.456 per thousand annually in arrear. The company depreciates the equipment @ 25% p.a. as per the WDV method. Its incremental borrowing rate and the marginal rate of tax are 18% and 46% respectively. a. Determine the capitalized value of the equipment. b. Prepare a schedule showing the allocation of the unexpired finance charge. c. Prepare all relevant ledger accounts for the 3 years of the lease in the books of lessee and show how the ledger balances will be reflected in the financial statements for these periods. You may answer the above questions according to IAS:17/AS:19. Creative Finance Limited has signed a lease agreement for equipment costing Rs.87 lakh. The lease is non-cancelable for a period of 5 years and the lease rentals receivable are 312/1000 annually in arrears. Creative Finance Ltd. depreciates the equipment at the rate of 25% p.a. as per the WDV method. The incremental borrowing rate and marginal tax rate are 17% and 46% respectively. The residual value after 5 years is expected to be Rs.8.5 lakh. The initial direct cost of the lease transactions is Rs.0.5 lakh. a. Prepare a schedule showing the allocation of unearned finance income. b. Prepare all relevant ledger accounts for the first 3 years of the lease and show how these ledger balances will be reflected in the financial statements for the respective periods. You may follow IAS:17/AS:19 for answering this question. Cordial Systems Ltd. is a dealer (lessor) in pollution control equipment. The products of the company are sold either on hire purchase basis or on a 5-year non-cancelable lease. The cash price of the equipment is Rs.20 lakh which includes a profit margin of 20% on cost. The lease rate is 26.5 per thousand per month and the lease rentals are payable annually in advance. The estimated unguaranteed residual value of the equipment at the end of the lease period is 3% of the initial cash price. The prevailing market rate of interest for medium-term loans is 16.5% per annum. a. Determine the sales revenue to be recognized under the finance lease plan. b. Prepare a schedule showing the allocation of financial income over the lease period. c. Prepare the relevant ledger accounts in the books of Cordial Systems Ltd. for the first year of the lease period. Also show how the transaction will be reflected in the financial statements prepared at the end of the first year of the lease period. You may follow IAS:17/AS:19 to answer this question.
180
Part II
HIRE PURCHASE 120.
Tristar Chemicals has recently acquired some equipments costing Rs.100 lakh under the industrial hire purchase scheme of Synergy Finance. The company is required to pay a hire purchase installment of Rs.3,94,440 per month for a period of 36 months. a.
Calculate the flat rate of interest charged by Synergy Finance.
b.
Calculate the effective rate of interest p.a. implicit in the scheme. Assume that the hire purchase installments are payable at the end of every month.
c.
Tristar Chemicals follows the sum of the digits method for allocating the interest charged over the 3-year period. Calculate the interest allocated to each year by Tristar Chemicals.
Note:
121.
PVIFA(1%, 36 months)
= 30.108
PVIFA(1%, 35 months)
= 29.409
PVIFA(2%, 36 months)
= 25.489
PVIFA(2%, 35 months)
= 24.999
PVIFA(3%, 36 months)
= 21.832
PVIFA(3%, 35 months)
= 21.487
Finex Financial Services company is evaluating the financial flexibility of the following hire purchase plan: Cost of asset
:
Rs.30,000
Down payment
:
25%
Rate of interest
:
12% p.a. flat
Duration
:
3 years
Frequency of payment
:
Monthly in arrears
The asset is entitled to a tax relevant rate of depreciation of 25% and the net salvage value after 3 years is estimated to be 10% of the original cost. The D/E ratio of the company is 4 : 1. Its pre-tax cost of debt is 20% and expected return on equity is 24%. The company attracts a tax rate of 43%. Given the above information, you are required to
122.
a.
Calculate the NPV of the hire purchase plan, assuming FFS company follows the SOYD method for spreading the total charge for credit. Ignore Interest Tax.
b.
Calculate the effective rate of interest using the approximation formula.
Monopoly Financial Services Ltd. is offering equipment finance under the following schemes: Hire Purchase Down payment 20% Flat rate of interest 15% Duration 3 years Repayment Monthly in advance Lease Primary lease period 5 years Lease rental 27 ptpm Frequency of lease rentals Monthly in advance Pratibha Steels Corporation (PSC) has considered a modernization program for which it requires to invest in an equipment worth Rs.280 lakh.
The company has given the following information. a.
Tax rate applicable is 30%
b.
Debt-equity ratio 3 : 1 181
Investment Banking and Financial Services
c.
Cost of debt 16%
d.
Cost of equity 28%
e.
Tax relevant depreciation for the assets is 25%.
Assume that the salvage value is insignificant and interest allocation is according to the SOYD method. Ignore Interest Tax. You are required to recommend which scheme should PSC opt for. State assumptions made, if any. 123.
Rama Financial Services (RFS) offers both lease and hire purchase plans to its corporate clientele. The salient features of these plans are as follows: A.
B.
Lease Plan Primary period
5 years
Lease rate
Rs.28 per thousand per month (per thousand per month)
Frequency of payment
Monthly in advance
Hire Purchase Plan Hire period
3 years
Rate of interest
16% p.a. flat
Frequency of payment
Monthly in arrear
Down payment
20%
Sowmya Industrial Corporation (SIC) which is contemplating a capital expenditure of Rs.360 lakh on modernization and technology upgradation is evaluating the financial desirability of the two plans. The following information is available: Useful life of plant and machinery
5 years
Residual value after 5 years
Rs.45 lakh
Tax relevant rate of depreciation
25%
Marginal rate of tax
51.75%
Marginal cost of capital
16%
Marginal (pre-tax) cost of debt
20%
SIC follows the sum of the years digits method for spreading over the total charge for credit (unexpired finance charge) under the HP Plan. Based on a financial evaluation, which plan will you recommend? Ignore interest tax. 124.
The Bank of Cauvery, a private sector bank of a long standing in Southern India, is planning to offer fund-based services such as leasing and hire purchase. A study commissioned by the bank has revealed that the corporate clients who opt for leasing prefer non-cancelable five-year finance leases with rentals payable quarterly in arrear. Those corporate clients who are interested in industrial hire purchase plans prefer three-year plans with hire charges payable quarterly in arrear. The bank is keen to determine the break even rental and hire charges for its lease and hire purchase plans taking into account the preferences of the corporate clients regarding tenure, frequency and profile of payments. The bank wants to ascertain the break even lease rental for equipments carrying a tax relevant depreciation rate of 25% and is willing to assume a residual value exposure of 5% of the original cost after five years. Likewise the bank wants to determine the minimum hire charges to be collected assuming a down payment of 25% of the asset cost under the hire purchase plan. The marginal tax rate applicable to the bank is 30% and the post-tax cost of funds is 10% p.a.
182
Part II
Required: a. Calculate the minimum lease rental to be quoted on an asset cost of Rs.1,000. Ignore sales tax. b. Calculate the minimum hire charges to be quoted on an asset cost of Rs.1,000. Assume that the bank recognizes finance income under the SOYD (Sum of Years Digits) Method. Ignore sales tax and interest tax. c. Calculate the add-on yield implied by the lease rental determined in (a) and the effective rate of interest (approximate rate of interest) implied by the hire charges determined in (b)). 125.
PTS Chemicals Limited manufactures a wide range of speciality chemicals which find applications in a number of industries such as detergents, cosmetics, leather, textiles, pharmaceuticals and pesticides industries. In order to step up its capacity, the company has incurred a capital expenditure of Rs.1,200 lakh of which equipments costing Rs.600 lakh have been acquired under a hire purchase plan on the following terms: Rate of interest
– 16% flat
Frequency of payments
– Annually in arrear
Pattern of payment
– Equated
Down payment
– 25%
Period
– 4 years
The company follows the straight line method of depreciation and charges depreciation at the rate of 12% p.a. for similar equipments.
126.
a.
Prepare tables showing the year-wise allocation of finance charge using (i) the effective rate of interest method (ii) the SOYD method and (iii) the straight line method.
b.
Show how the transaction will be reflected in the financial statements of PTS Chemicals at the end of the first year of the hire period.
Sindhiya Finance offers a hire purchase plan for its borrowers on the following terms. Rate of interest : 13.5% flat Repayment period : 4 years Frequency of payment : Monthly in arrear Down payment : 25% Calculate the effective rate of interest per annum or the annual percentage rate (APR) using (a) the trial and error approach and (b) the approximation formula.
127.
Sahadev Financial Service offers a hire purchase plan under which the hirer is provided with 100% finance in the following terms: Rate of interest
= 14%
Repayment period
= 4 years
Frequency of payment
= Monthly in arrear.
The hirer is required to invest 25% of the investment cost in the cumulative fixed deposit scheme of the company for a period of 4 years. The company offers a rate of interest of 15% p.a. compounded monthly. Calculate the APR of the scheme. 128.
Sunanda Finance offers a hire purchase plan for its corporate borrowers on the following terms: : 13.5% • Rate of Interest : 4 years • Repayment period Monthly in arrear • Frequency of payment : Immediately after paying the 26th monthly installment the borrower wishes to repay the outstanding loan and purchase the equipment. Calculate the interest rebate according to the effective rate of interest method. 183
Investment Banking and Financial Services
129.
Srivani Finance offers a hire purchase plan for its borrower. Details of the plan are as follows: Rate of interest
–
14% flat
Repayment period
–
3 years
Frequency of payment
–
Monthly in arrear
Down payment
–
25%
Immediately after paying the 24th monthly installment, the borrower works to repay the outstanding loan and purchase the equipment. Calculate the interest rebate that can be allowed to him according to the rule of 78. 130.
Sujan Financial Services offers both leasing and hire purchase plans to its clientele. The salient features of these plans are as follows: A.
Lease Plan
Primary period
:
5 years
Lease rate
:
Rs.26.5 per thousand per month
Frequency of payment : B.
Monthly in advance
Hire Purchase Plan
Hire period
:
3 years
Rate of interest
:
15.5% flat
Frequency of payment
:
Monthly in advance
Down payment
:
25%
Sriven Industrial Corporation (SIC) is contemplating a capital expenditure of Rs.270 lakh. Given the following information, evaluate the two plans for SIC: A.
Tax rate of depreciation
:
40%
B.
Marginal rate of tax
:
46%
C.
Marginal cost of capital
:
17%
D.
Marginal cost of debt
:
20%
Assume that Sriven follows the SOYD method to spread the total charge for credit under the hire purchase plan. The planning horizon is 5 years. The net salvage value of the plant and machinery after 5 years is expected to be Rs.32 lakh. 131.
Consider the following data about a hire purchase plan available to Mathur Industries Ltd. for purchase of factory equipment. Investment
Rs.378 lakh
Hire period
3 years
Flat rate of interest
13.5% p.a.
Frequency of payment
Monthly in advance
Amount of finance provided
100%
Initial deposit requirement (interest free)
25%
Term of deposit
3 years
Tax relevant rate of depreciation
25%
Marginal rate of tax
46%
Marginal cost of capital
14.5%
Marginal cost of debt
16%
Show how the transaction will be reflected in the financial statements over the hire purchase period. The company follows the SOYD method for allocating the total charge for credit. 184
Part II
132.
A commercial bank has recently diversified into industrial hire purchase business. The bank proposes to offer a down payment plan with the following features: Down payment (as a % of investment cost)
: 20
Repayment Period
: 3 years
Frequency of Payment
: Quarterly in advance
The bank is required to pay interest tax at the rate of 3% on the finance income and income tax at the rate of 26%. The bank follows the SOYD method to allocate the unexpired finance charge. Required:
If the average cost of capital for the bank is 9%, is a flat rate of 14% profitable to it? Support your answer with necessary workings. 133.
Zeta Financial Services Ltd. (ZFSL) offers finance to individuals to purchase four wheelers on the following terms: •
Deposit of 20% of the cost of the asset should be made at the inception of the transaction.
•
48 EMIs have to be made each at the beginning of every month.
•
Front end service charge of 2% should be made.
•
Deposit carrying an interest of 12% p.a. compounded monthly would be repaid at the end of 48 months.
You are required to:
134.
a.
Calculate the maximum monthly payments to be made by a borrower if his opportunity cost of funds is 18% p.a. and cost of the asset is Rs.4 lakh.
b.
Calculate the effective interest rate on the completed transaction if the borrower would like to make the prepayment at the end of 36 months after paying 36 installments. Deposit would be repaid at the end of 36 months. The company offers an interest rebate calculated in accordance with the Rule of 78 Method. Assume the EMIs as obtained in (a) above.
Brick-well Construction Limited has proposed to acquire a machinery costing Rs.100 crore. The equipment has a life of 7 years. The tax relevant rate of depreciation is 25%. The target debt-equity ratio is 2:1. The cost of debt and equity are 15% and 18% respectively. Alternatively, the company can lease the equipment or take it on hire. It had approached Vibrant Financial Services which offers both lease and hire purchase to corporates. The lease terms are as follows: Lease rentals during primary lease period of 4 years
32 ptpm payable monthly in advance
Lease rentals during secondary 2 ptpq payable yearly in advance period of 3 years The hire terms of the company are as follows: Flat rate of interest
13%
Structure
Payable monthly in advance
Hire period
4 years
The marginal tax rate of BCL is 30%. BCL follows SOYD method of interest allocation. The planning horizon is 4 years. Assume negligible salvage value at the end of 4 years. You are required to a.
Choose the best alternative between lease and hire purchase from BCL point of view
b.
Choose the best alternative between purchase and the alternative obtained in (a) above.
185
Investment Banking and Financial Services
135.
Fair Finance Ltd (FFL) offers the following finance scheme to its customers: Amount (Rs.)
4,00,000
Repayment Period (Mths)
48
Equated Monthly Installment (Rs.) (Payable at the beginning of every month)
9,250
Down Payment
25%
The company levies a service fee of Rs.2000 and offers a prompt payment bonus of Rs.8 per Rs.10,000 per month on expiry of the repayment period. After paying 36 installments (at the end of 3 years) one of the borrower opts for an early settlement. The company allows the prompt payment bonus in respect of the installment paid and offers an interest rebate in accordance with the Rule of 78 method. You are required to calculate the effective rate of interest on the completed transaction. 136.
The following information relates to the loans and advances, hire purchase receivables and lease assets of A to Z Finance Ltd., a non-banking finance company. Loans and Advances
Category of loans and advances
Amount at the beginning of the year (Rs. lakh) 180 50
Recovery during the year leading to closure of accounts — 25%
Standard Sub-standard Doubtful Up to 1 year 12 20% 1-3 years 8 10% More than 3 years 7 5% Loss 25 5% Loans and advances extended during the year amount to Rs.30 lakh, which remained as a standard asset. Of the sub-standard assets, Rs.5 lakh became doubtful while Rs.10 lakh worth of assets were upgraded. Out of the doubtful assets, Rs.3 lakh were upgraded. The entire amount of outstanding doubtful debts is fully secured. Hire Purchase Assets
Total dues (Stock on hire) Unmatured finance charges Original cost of the assets Amount realizable Accumulated depreciation
Current year 95 20 75 95 29
(Rs. lakh) Previous year 88 18 70 88 14
(Rs. lakh) Net Book Values of HP and Lease Assets Overdue for HP Assets Lease Assets Up to 12 months 30 40 12-24 months 15 24 24-36 months 5 10 More than 36 months 3 10 In the 12-24 months category of HP assets and 24-36 months category of Lease assets, amounts of Rs.5 lakh and Rs.3 lakh respectively are outstanding for more than 12 months after the due date of the last payment. Required: Calculate the provisions to be made by the company on the above assets.
186
Part II
137.
138.
Zaveri Finance Company (ZFC) offers hire purchase schemes on the following terms: Down payment 20% Duration 5 years Frequency of payment Monthly in arrears. Mohan Industries Ltd. (MIL) is contemplating an investment of Rs.75 lakh for purchase of a plant. The plant attracts a tax relevant depreciation rate of 25% and has a salvage value of 10% of initial cost. MIL has approached ZFC to avail the above hire purchase plan. ZFC’s cost of capital is 12%. It is in the tax bracket of 30%. Assume ZFC recognizes finance income on the basis of the SOYD method and attracts an interest tax of 2%. You are required to a. Determine the minimum flat rate of interest to be charged by ZFC on the above HP plan. b. Reflect the above hire purchase transaction in the books of ZFC for the first three years of HP term. Assume the flat rate of interest as arrived at in (a) above. Mr. Gangaram, one of the partners of M/s Gangaram and Brothers intends to purchase a car costing Rs.5,60,000 on monthly installments for his personal use. Standard Finance Ltd. (SFL) offered the following finance scheme to him: Deposit (to be made at the beginning) 20% of the cost of the car Interest earned on the deposit (at monthly rests) 6% p.a. Flat rate of interest charged 11% p.a. Repayment period 36 months Payment structure At the beginning of every month SFL levies a front ended documentation and service fee of 0.5% of the cost and offers a prompt payment bonus of Rs.18 per Rs.20,000 per month on the expiry of the repayment period. The deposit is refunded at the end of 36 months along with accumulated interest. Realizable value at the end of 3 years is estimated to be negligible and the tax rate applicable to Mr. Gangaram is 30%. Assuming that all installments have been paid on the due date, you are required to determine:
139.
a.
The effective rate of interest per annum implied in the above financing scheme.
b.
The effective rate of interest per annum assuming M/s Gangaram and Brothers purchased the car. The firm is in the tax bracket of 20%. Its pre-tax cost of debt is 14%, and weighted average cost of capital is 20%. The car can be depreciated at the rate of 30% on WDV basis.
Aditya Steels (P) Ltd. (ASL) is contemplating to modernize its operations for which it requires a new plant costing Rs.800 lakh inclusive of CST @ 4%. It estimates the economic life of the plant to be 5 years after which it is estimated to realize Rs.12 lakh. The tax relevant rate of depreciation is 30%. The finance manager of ASL has approached Kavya Financial Services (KFS) to finance its modernization program either through leasing or hire purchase. KFS forwarded the following details to ASL: Leasing Lease rentals : Rs.25 ptpm Payment : Quarterly in arrears Lease period : 5 years Hire Purchase Down payment : 25% Flat rate of interest : 12% Payment : Monthly in advance Hire period : 5 years. The marginal cost of debt and marginal cost of capital of ASL are 14% and 16% respectively. ASL is in the tax bracket of 35% and it allocates interest on SOYD basis.
187
Investment Banking and Financial Services
You are required to
140.
a.
Suggest the mode of financing suitable to ASL.
b.
Determine the flat rate of interest under hire purchase option at which ASL is indifferent between leasing and hire purchase.
Jumbo Financial Services (JFS) offers car loans for a maximum period of 4 years. The details of the same are as follows: Loan Amount
80% of the cost of asset
Flat rate of interest
12% p.a.
Payment pattern
Monthly in arrears
Processing fee
1% of the amount financed
Mr. Abishek, considering to purchase a car worth Rs.3,75,000 applies for a loan for a period of 3 years. You are required to calculate the effective rate of interest on the completed transaction if Mr. Abishek opts for a early settlement after paying the 24th installment. Assume JFS calculates the interest rebate according to the Rule of 78 method.
CONSUMER CREDIT 141.
Esanda Finanz has a number of schemes offered to a variety of cars: Vehicle Model
Price (Rs.)
Maruti 800
2,12,050
Maruti Zen
3,54,000
Ambassador
3,17,000
Cielo
6,50,000
Opel Astra
7,01,000
Ford Escort
7,68,000
Pal Peugeot
4,50,000
Fiat Uno
4,01,000
These schemes cover a period of 12 months to 48 months as under: a.
b.
c.
Down payment scheme (15% down payment)
Tenure in months
12
24
36
48
Interest flat rate (p.a.)
12.47
12.40
12.66
13.46
Tenure in months
12
24
36
48
Interest flat rate (p.a.)
12.51
12.39
12.62
13.43
One EMI in advance scheme
100% Finance with advance EMI scheme
Tenure in months
12
24
36
48
Interest flat rate (p.a.)
12.58
12.37
12.56
13.32
Variable rates are given for the higher value vehicles and repeat customers get a benefit of 0.5% reduction in interest rates. Calculate the equated monthly installment and the effective rate of interest per annum or the annual percentage rate, if you opt to repay in 24 months under scheme (a) and buy Pal Peugeot? 188
Part II
142.
Epsilon Finance Company offers the following type of Deposit Linked Scheme for acquiring cars. Deposit Scheme
25% Deposit
Amount (Rs.)
1,00,000.00
Repayment Period (in months)
36
Equated Monthly Installment (Rs.) (Payable at the end of every month)
3,835.00
Accumulated Interest on Deposit (after 36 months) – interest is cumulated with quarterly rests
13,886.40
The company levies a front-ended documentation and service fee of Rs.2,000 and offers a prompt payment bonus of Rs.10 per Rs.10,000 per month on expiry of the repayment period. The EMI is payable at the end of every month. After 24 months, one of the borrowers (who has borrowed Rs.1,00,000) under the scheme opts for an early settlement. The company levies a service charge of 2% on the principal outstanding on the date of settlement. It offers an interest rebate calculated in accordance with the Rule of 78 method. Calculate the effective rate of interest on the completed transaction. 143.
Premier Financial Services (PFS) offers car loans for a maximum period of 4 years. The company finances up to 80% of the cost of the cars and its repayment schedule for loan amount of Rs.1,00,000 is as follows: Loan Tenure (in months)
12
24
36
48
60
Equated Monthly Installment (Rs.)
9,260
5,173
3,835
3,183
2,807
The company charges processing fee of 1% of the amount financed. Mr. Avinash applied for the loan to finance the purchase of a car costing Rs.4,20,000. Required:
144.
145. 146. 147.
a.
Calculate the flat rate of interest if Mr. Avinash opts for a loan tenure of 3 years.
b.
Calculate the effective rate of interest on the completed transaction if he opts for an early settlement after paying the 24th installment. Assume PFS calculates the interest rebate according to the Rule of 78 method.
Mrs Laxmi is contemplating to purchase a Maruthi Zen costing Rs.3.50 lakh by availing a consumer finance of Rs.2.50 lakh. She is considering the following schemes: Citi Bank scheme calls for 15% down payment on the cost price of the car and their rate of interest is 16% flat. The loan is repayable in 36 equal monthly installments payable in arrears. The bank also permits 3 months as deferment period at the beginning of the transaction. The bank charges Rs.2,500 as processing fee and in case of a prepayment the bank allows interest rebate equal to 80% of interest rebate as calculated according to effective rate of interest method. You are required to: a. Calculate the EMI assuming that the actual amount financed is Rs.2.50 lakh. b. If Mrs. Laxmi opts for an early repayment after completion of 18 months from the beginning of the repayments, calculate the effective rate of interest on the completed transaction. A consumer loan of Rs.40,000 is repayable in 36 monthly installments (in arrear) of Rs.1,500. Calculate the APR of the transaction. A washing machine which costs Rs.19,000 can be purchased by 52 weekly installments of Rs.380, payable in arrear. What is the APR of this transaction? The car finance scheme of Meridian Finance Company permits a self-employed professional to borrow up to Rs.2.75 lakh repayable in 12 monthly installments in arrear calculated at a flat rate of interest of 13% p.a. Calculate the monthly repayment on a loan amount of Rs.2 lakh and find the APR of the transaction. 189
Investment Banking and Financial Services
148.
Mr. Anil plans to purchase a car worth Rs.4,25,000. The finance company whom Anil approached has offered him the following scheme: The loan requires a down payment of 25% and the loan period is 20 years. It carries an interest of 12.5% p.a. compounded monthly. Calculate the equated monthly installment which is to be paid by Anil under the scheme. Also, calculate the EMIs, if the loan does not require the down payment.
149.
Sahitya Finance Company offers a credit plan under which a loan amount P is to be repaid by a single installment of amount (P + D) after n (> 0) years. Under the credit plan offered by the company, a customer availed a loan of Rs.75,000 on July 10, 20x0 to be repaid one year later by a single installment of 80,000. On December 10, 20x0, he opted for an early settlement. In respect of loan repayable by a single installment, the Consumer Credit regulation requires that the interest rebate should be proportional from the settlement date to the originally specified repayment date. The regulation, however, permits the lender to take the settlement date on the actual date of the early settlement deferred by 2 months for a loan of an original term of 5 years or less. Determine the sum paid by the borrower on early settlement and the APR on the completed transaction.
150.
The equated monthly installments for a consumer loan of Rs.54,000 under these repayment options are as follows. Repayment (in months)
period EMI (Rs.)
12
5,062.5
24
2,835.0
36
2,107.5
Calculate the flat and the effective rates of interest for each option. 151.
Rehana Finance Company offers the following types of deposit linked schemes to acquire cars. Deposit scheme
Zero Deposit
25% deposit
90,000
90,000
Repayment period in months
36
36
Equated monthly installment
3,475
3,300
Bullet installment at the end (Rs.)
7,200
–
Amount (Rs.)
Accumulated interest on deposit (after 36 months)
11,720
The company levies a front ended documentation and service fee of Rs.1,500 and offers a prompt payment bonus of Re.1 per thousand per month on expiry of the repayment period. The EMI is payable at the end of every month. Calculate the effective rates of interest implied by the two schemes. 152.
Under the car finance plan of Meridian Finance Company a self-employed professional can borrow up to Rs.1.10 lakh repayable in 12 monthly installments in arrears calculated at a flat rate of interest of 12.5% p.a. After making the sixth monthly repayment, the borrower pays off the outstanding loan. The company calculates the amount required for early settlement by using the modified rule of 78 with α = 1. Determine the amount payable by the borrower and the effective rate on the completed transaction.
153.
190
Zeta Finance Company offers 20% deposit and 20% down payment schemes for acquiring consumer durables. Prabhat approached the company to finance a washing machine costing Rs.25,000 under 20% deposit scheme. The flat rate of interest charged is 10% p.a. Prabhat is required to pay 24 equal monthly installments in arrears and keep the deposit at the beginning of the contract which would be repaid on the day of payment of the last installment with interest @ 15% p.a. compounded monthly.
Part II
You are required to
154.
a.
Calculate the effective rate of interest for the above transaction.
b.
Assume Prabhat availed 20% down payment scheme, recalculate (a) State the reasons for the difference, if any, in the effective rates of interest.
Citi Bank provides car finance on second hand cars up to 70% of the value of the car, if the car is not older than 4 years. Mr. Raghunadhan who wanted to purchase a second hand Maruthi car for Rs.1,70,000 is falling short of Rs.1,00,000 and approached Citi Bank. Citi Bank has appraised his creditworthiness and agreed to finance the car at a flat rate of interest of 16%, repayable in 36 equal monthly installments in arrears. Processing fee payable is Rs.2,000. You are required to a.
Find EMI payable by Mr. Raghunadhan
b.
If Mr. Raghunadhan repays the entire loan after 20 months and city bank provides interest rebate under Rule of 78 and charges 2% of the outstanding principal on prepayments, find the effective rate of interest to Mr. Raghunadhan for the complete transaction.
FACTORING AND FORFAITING 155.
Precision Instruments is a unit manufacturing clinical instruments in the Thane district of Maharashtra. The company offers its dealers a 3 percent discount on cash and carry transactions. Its credit terms are 2/10 net 45. The company has been plagued by a bad debt problem averaging 2 percent of credit sales for the past several years. Dealers representing approximately 10 percent of total sales opt for the cash and carry offer. On an average 50% of the receivables are paid at the end of ten days thus availing the 2% discount. The rest of the receivables are usually paid 50 days after sales. The company has been financing 50% of its receivables from Bank of India at a cost of 22 percent p.a. The remaining half is financed through own funds whose notional cost is estimated at 24 percent p.a. The costs associated with credit administration totals Rs.8 lakh. Imfacs, a factoring company, has approached Precision Instruments with a factoring proposal. The details are given below: Type of contract
Non-recourse, Advance Factoring
Interest on advances
22.5% p.a. payable in advance
Factoring commission
3.5% of the face value of factored receivables
Factor reserve
20% (percentage applied on receivables net of commission payable)
Average maturity period
30 days
The credit administration costs can be totally avoided when the receivables are factored. Assuming that all figures mentioned hold good for the year 20x1-20x2 and if projected sales for the same year is Rs.800 lakh, would you recommend that Precision Instruments go in for a factoring arrangement? Your recommendation must be based on a cost-benefit analysis, assuming 360 days to a year and ignoring taxes. 156.
Challenge Biotechnics Ltd. has completed their final accounts and found that their sales stand at Rs.450 crore. They have projected their next year sales at Rs.600 crore. Mr. Ranganathan, the finance manager, has developed an analysis on their receivables management. The particulars are as under: Terms of credit Proportion of customers paying on 10th day Proportion of customers paying on 30th day Proportion of customers paying on 50th day
2/10 net 30 25% 50% 25% 191
Investment Banking and Financial Services
Present financing plan of receivables is as under: Citibank finances 75% of receivables @ 22% and the remaining 25% is financed through own sources at a pre-tax cost of 28%. Additional costs for the company on account of receivables management are as under: a.
Cost of accounting and collection of receivables is Rs.3 crore p.a.
b.
Loss of sales on account of using the sales force on collection of receivables is Rs.80 crore p.a. The gross profit margin on sales is 23.25%.
c.
2% of sales are expected to become bad debts.
Mr. Ranganathan was approached by Mr. David of Margarett Factor Services Ltd. and offered the following factoring arrangement. a.
Factor’s commission 2% on the face value of all factored receivables.
b.
Factor shall advance 90% of face value of factored receivables @ 20% p.a.
c.
Factor shall remit balance of money on 30th day of sales whether the collection is made or not at their end.
d.
The factoring is on non-recourse basis.
You are required to
Evaluate the factoring alternative and suggest whether to go for factoring or not. 157.
Given below is the Balance Sheet as on 31.03.20x0 of M/s Factors Client Ltd. who intends to avail factoring line from a factoring company which keeps a margin of 20%. A bank is also willing to finance the receivables on a similar margin. Balance Sheet as on March 31, 20x0
Rs. in lakh Liabilities
Assets
Net worth
90 Fixed assets
60
Long-term debt
30 Inventory
50
Current liabilities
90 Receivables
90
Cash 210
10 210
You are required to
158.
a.
Find out the impact of Advance Factoring and Bank Overdraft and recast the balance sheet.
b.
Recast the balance sheet if M/s Factors utilizes the additional cash received through factoring or bank to reduce its current liabilities by Rs.36 lakh.
c.
Comment on the impact on liquidity ratios in (a) and (b) above.
Under an advance factoring arrangement, Sandeep Factors Ltd. has agreed to advance a sum of Rs.22 lakh against the receivables purchased from Saket Traders Ltd. The factoring agreement provides an advance payment of 75% of the value of factored receivables for guaranteed payment after 3 months from the date of purchasing the receivables. The advance carries a rate of interest of 16.5% p.a. compounded quarterly and the factoring commission is 1.25% of the value of factored receivables. Both the interest and commission are collected upfront.
192
a.
Compute the amount actually made available to Saket Ltd.
b.
Calculate the effective cost of funds made available to Saket Ltd.
c.
Assume that the interest is collected in arrears and the commission is collected in advance. Calculate the effective cost of funds made available to Saket Ltd.
Part II
159.
Penguin Factors, the subsidiary of Meridian Bank offers the following fund-based facilities: Facility
Recourse Factoring
Non-Recourse Factoring
A
Discount charge (payable upfront)
19.5% p.a.
19.5% p.a.
B
Reserve
20% p.a.
20% p.a.
C
Commission
2%
3%
The finance manager of Sameer Textiles has recently approached Penguin Factors to factor the receivables. After a careful analysis of the sales ledger of Sameer Textiles, the VicePresident (Operations) of Penguin Factors agrees to a guaranteed payment period of 60 days. The finance manager of Sameer Textiles is not clear about the type of factoring he should opt for and seeks your help in this regard. He provides you with the following additional information.
160.
a.
The firm sells on terms 2/10 net 60. On an average 50% of the customers pay on the 10th day and avail the discount. On an average the remaining customers pay 90 days after the invoice date.
b.
The bad debts and losses amount to 2% of the sales invoices.
c.
The sales executives are responsible for following up collectors and on an average, spend 25% of their time on collection efforts. Subjective assessment is that the firm can increase its annual sales by Rs.15 lakh if the sales executives are relieved from collection responsibilities. The gross margin on sales is 25% and the projected sales turnover for the following year (without considering the increase of Rs.15 lakh) is Rs.260 lakh.
d.
By hiving off sales ledger administration and credit monitoring, the firm can save administrative overheads to the time of Rs.1.25 lakh per annum.
e.
As of now, the firm has been financing its investment in receivables through a mix of bank finance and long-term funds in the ratio of 2:1. The effective rate of interest on bank finance is 18.5% p.a. and the cost of long-term funds is around 23% p.a. (pre-tax).
Thirumalai Chemicals Limited (TCL) involved in petrochemicals has an annual turnover of Rs.800 lakh, about 20% of which is cash sale. The company has an average collection period of 45 days. The gross margin on sale is 20%. The cost of long-term funds (pre-tax) for TCL is 20% and banks interest rate is 16% p.a. The bank finance to long-term funds ratio is 2:1. Annual expenditure on maintaining and collecting accounts is about Rs.10 lakh. The bad debt averages around 1% of the credit sale. Wipro Factors Limited (WFL) recently approached the management of TCL and offered factoring services under the following terms: Non-recourse Factoring Discount charges (Upfront)
19% p.a.
Commission charges (Upfront)
2.0%
Reserve
25.0%
There is a possibility that WFL would agree for 40 days collection period. TCL is expected to avoid 75% of expenses incurred in maintaining and collecting accounts, if it avails factoring services. Is factoring a better way to manage receivables than the current practice? Show all calculations. Make suitable assumptions. 193
Investment Banking and Financial Services
161.
Duncan Bearings is a medium-scale unit engaged in the manufacture of roller bearings. The principal customers of the company include the major manufacturers of two-wheelers and commercial vehicles. The firm sells on credit and the present terms are 1/10 net 60. A recent analysis of the outstanding receivables using the Ageing Schedule revealed the following position: Age group (in days)
Standard Percentage of Receivable
Actual Percentage of Receivables
0 - 03
35
20
31 - 45
60
40
46 - 90
5
30
> 90
–
6
The adverse changes in the pattern of payment as revealed by the Ageing Schedule prompted the firm to review its practices relating to receivables management. The finance manager of the firm found that: a.
The average collection period is 66 days on an annual sales turnover of Rs.780 lakh.
b.
The proportion of sales on which customers currently take discount is 0.3.
c.
The bad debts to sales ratio is 0.01. The average cost of funds is 16% p.a. To expedite collection of receivables and reduce the collection period, the finance manager has proposed the following alternatives: i.
Factoring: The firm can opt for either Recourse Advance Factoring or NonRecourse Advance Factoring on the following terms:
Recourse Factoring
Non- Recourse Factoring
Interest rate on advance
18%
18%
Commission (as a % of invoice value)
0.5%
1%
The firm can negotiate for a fixed maturity period of 50 days and the firm can save about Rs.3.4 lakh in terms of administrative overheads associated with collection of debts. ii.
Change in Credit Policy: The firm can relax its discount terms to 2/10 net 45. Such a relaxation coupled with vigorous collection efforts can reduce the average collection period to 36 days and increase the proportion of discount sales to 0.6.
Based on economic considerations, which one of the alternatives will you recommend? Show all calculations that are relevant for supporting your recommendations. 162.
Swan Silk Mills Limited (SSML) is a medium sized, composite textile and silk mill based at Hyderabad. The company is producing pure and artificial silk fabrics, sarees, cushions, etc. During the year 20x0-x1 it had a sales turnover of Rs.48 crore and expects it to increase by 10% during 20x1-x2. Currently, the company follows credit terms of 1/10 net 45 days. 20% of the customers pay within 10 days and the balance accepts the bills drawn by the company with a usance period of 45 days. However, only 80% of the bills receivable would be honored within the 45 days and the balance pay within 70 days. The company has a policy to avail short-term bank finance at an interest rate of 18% p.a. to fund 80% of the receivables and the rest is sourced from the company’s own funds at an effective cost (in pre-tax terms) of 21% p.a. The company spends around Rs.0.6 crore for the purpose of collecting dues, ledger administration and credit monitoring.
194
Part II
The finance manager of the firm has been approached by Swift Factors Limited (SFL) which provides advance non-recourse factoring for working capital finance to small and medium sized companies. The terms and conditions of factoring are as follows: •
Discount charge is 19% p.a.
•
Commission is 1.5%
•
Advance payment as proportion of factored receivables is 80%.
•
Agreed payment time is 30 days.
If factoring is availed the administration expenses can be avoided. Assume 360 days in a year. You are required to: Suggest the alternative of working capital finance to the finance manager of SSML. 163.
Siddi Prints is a medium-sized, composite textile mill based at Hyderabad. During the year 20x0-x1 it has a sales turnover of Rs.80 lakh and expects it to increase by 10% during 20x1-x2. The company currently follows credit terms of 2/10 net 60 days. 30% of the customers are expected to pay within 10 days and avail the discount. The balance 70% accepts the bills drawn by the company, on the day of sale, with a usance period of 60 days. However, only 90% of the bills receivable would be honored within 60 days and the remaining are paid within 90 days. The company has a policy to avail short-term bank finance at an interest rate of 16% p.a. to fund 75% of the receivables and the rest is sourced from the company’s own funds at an effective cost (in pre-tax terms) of 24% p.a. The company spends around Rs.0.8 lakh for the purpose of collecting dues, ledger administration and credit monitoring. Bad debts amount to 1% of the credit sales. The finance manager of the firm has been approached by Swift Factors Limited which offers bill discounting and advance non-recourse factoring for working capital finance to small and medium-sized companies. The terms and conditions under bill discounting option are as follows: i.
Discount charge is 20% p.a.
ii.
On the 60th day, the payment day of the bills, the bank agrees to extend the time of unpaid bills to 90 days charging an interest of 3% which the company would be collecting from the customers.
The terms of factoring are as follows: i.
Discount charge is 19% p.a. and commission is 2%.
ii.
Advance payment as proportion of factored receivables is 85%.
iii.
Agreed payment time is 50 days.
While the finance manager was assured by Swift Factors that any of the above alternatives would be better than the existing in-house management of receivables, he is unable to decide among the three. You are required to evaluate the cost benefit analysis of bill discounting and factoring and suggest the alternative of working capital finance to the finance manager of the company. (Assume 360 days in a year and administration expenses can be avoided if factoring is availed). 164.
Sri Chemicals Limited (SCL) is presently managing its accounts receivables internally through its credit department. Sales for the current year are Rs.360 lakh. Its credit terms are 1/15 net 40. On an average 20% of the customers avail the discount while the remaining pay within 45 days. Its bad debts to sales ratio is 0.015 and its contribution margin is 20%. The firm currently is financing its receivables by a mix of bank finance and own funds in the ratio of 3:2. The rate of interest on bank finance is 20% whereas its pre-tax cost of own funds is 24%.
195
Investment Banking and Financial Services
SCL has received a proposal from Charan Factors Limited (CFL) to factor its receivables under a bank participation factoring arrangement with Sind Bank providing an advance of 60 percent of factor reserves at an interest of 22%. CFL has agreed for advance payment of 80% of receivables at a guaranteed payment of 40 days. The interest (payable upfront) and the commission charged by CFL is 20% and 3% respectively. The factoring arrangement is without recourse to SCL. SCL has projected its sales for the next year to increase by 10% without a factoring arrangement and by 20% with factoring arrangement. The collection expenses are expected to be reduced by Rs.1.5 lakh due to the factoring arrangement. (Assume 365 days in a year). You are required to suggest whether or not SCL should go for the factoring arrangement. Support your answer with detailed workings. 165.
Sritex Ltd. (SL) is a medium-sized, composite textile mill based at Kakinada. During the year 20x0-x1 it had a sales turnover of Rs.250 lakh and expects it to increase by 10% during the year 20x1-x2. The credit terms of SL are 1/15 net 60 days. 20% of the customers pay within 15 days and avail the discount. The remaining customers accept the bills drawn by the company for a period of 60 days. However, the past records show that on an average 80% of the bills accepted are honored on the due date while the remaining 20% of the bills are dishonored and the payment of the same is made within 80 days. SL has a policy to avail short-term bank finance from Finex Bank (FB) to fund 70% of receivables at an interest of 18% p.a. The cost of SL’s own funds is 24% p.a. (in pre-tax terms). The cost of sales ledger maintenance and receivables collection is estimated to be Rs.0.6 lakh. FB has recently started offering non-recourse factoring services and has also approached SL for the same. The terms of factoring are Discount charge
22% p.a.
Commission
2.5%
Advance payment
80% of factored receivables
Agreed payment time
40 days
SL has opted for factoring since SL expects to avoid the administration expenses and increase its sales revenue. The SL’s variable to sales ratio is 0.7. Assume 365 days in a year. You are required to determine the minimum increment in sales at which factoring is better than bank financing. 166.
Sujana Industries Ltd. offers credit to its customers at 2/10, net 45. At present, about 25% of the customers pay on the 45th day, 50% pay on the 55th day and the rest pay on the 75th day. Bad debts generally amount to 2% of sales. The company now finances 50% of its receivables through a bank loan at 16% and the rest through own funds. It is planning to factor its receivables with Fairfacts Ltd. which agreed to factor the receivables at a commission of 2%. The factor will also provide an advance of 75% of the receivables at an interest of 15% and pay the balance at the end of the 50th day. The cost of the company’s own funds is 20%. The sales of the company are at present Rs.500 crore and are expected to increase to Rs.575 crore if the sales force is relieved from the collection efforts. The variable costs generally form 75% of the sales. Further, a saving of Rs.5 lakh is expected annually due to the accounting services provided by the factoring company. You are required to advise the company whether factoring is desirable or not. (Support your answer with suitable workings. Assume 360 days in a year).
196
Part II
MORTGAGES AND MORTGAGE INSTRUMENTS 167.
Reviera Finance Company has offered the following scheme to Sunil who had approached the company for a loan to purchase a house. The amount of the loan is Rs.2,25,000. Other details of the scheme are as follows: The borrower is required to deposit an amount of Rs.15,000 in a pledged savings payment which earns an interest of 10.5%. The loan carries an interest of 11% p.a. compounded monthly and the loan period is 25 years. The borrower would make graduated payments for 5 years increasing at a rate of 6% every year and thereafter payments would be as equated monthly installments. You are required to work out the equated monthly installment, graduated monthly payment made by the borrower and the amount to be drawn from the savings account as the lender receives the equated monthly installment throughout the scheme.
168.
Savita is intending to own a house worth Rs.3,75,000. She wishes to finance the investment with a mortgage. She is sanctioned 75% of the cost of the house. You are required to calculate: a.
EMIs assuming that the loan is to be repaid at an interest of 15% p.a. [compounded monthly] in 20 years.
b.
Monthly payments under graduated payment mortgage scheme in which payments are expected to rise by 4% per year for the first 4 years and then become equal through 20 years. The interest is same as given above.
HOUSING FINANCE IN INDIA 169.
Calculate the recommendations for disbursing a loan of Rs.4,25,000 on a flat. Its cost of construction is Rs.3,75,000, and progress of construction is 50%. Aggregate value is Rs.4,75,000 and borrower’s contribution is Rs.1,10,500 and the cumulative disbursement made is Rs.85,000.
170.
Mr. Rajesh has approached HDFC to get a housing loan of Rs.3,60,000 for a period of 20 years. The rate of interest on the loan is 16%. Calculate the equated monthly installment required to be paid by Rajesh.
171.
Calculate the monthly installment for a loan given by the HDFC on the following terms: Loan amount
172.
Rs.15,00,000
Period
15 years
Rate of interest
15% p.a.
HFC Ltd., a housing finance company, has been approached by Mr. & Mrs. X for a housing loan for a flat. As per HFC’s policies, housing loans are given subject to: a.
A maximum of 75% of the cost of the house/flat.
b.
The EMI not exceeding one-third of the take-home per month salary of the borrower(s).
c.
The maximum tenure of the loan is 15 years.
d.
The interest rates applied by HFC are given below: Amount of Loan
Interest rate
0
– 1,00,000
15% p.a.
1,00,000 – 3,00,000
16% p.a.
3,00,000 – 10,00,000
17% p.a.
10,00,000 and above
18% p.a.
You are also provided the following information about the salary income of Mr. & Mrs. X.
197
Investment Banking and Financial Services
Mr. X Mrs. X Rs. p.m. Rs. p.m. Salary 20,000 12,000 Provident fund 800 600 Vehicle loan deduction 600 600 Income tax 4,000 2,000 You are now required to advice HFC the maximum amount of loan which can be given to Mr. & Mrs. X and the maximum value of the flat which the couple can consider buying?
SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF FINANCIAL SERVICES 173.
The summarized Balance Sheet of Apt Finance Ltd. (AFL) as at 31st March, 20x0 is as follows:
Capital and Liabilities Shareholders’ Fund: – Subscribed and called upEquity Capital 5567.31 Less: Call money receivable 0.42 – Cumulative Preference Shares of Rs.100 each to be converted to equity at the end of 31st March, 2001 – Capital Reserve (represented by surplus on sale of assets) – General Reserve – Share Premium Account – Revaluation Reserves – Debenture Redemption Reserve Secured Loans – Banks – Secured Redeemable Non-convertible Debentures Unsecured loans – Loans and Advances – Public Fixed Deposits Current Liabilities and Provisions – Sundry Creditors – Unmatured Finance Charges – Others – Provisions
198
Amount Assets Fixed Assets (Net) – Own Assets
5,566.89
– Leased Assets – Capital Work-in-progress Investments
(Rs. lakh) Amount 3,246.58
18,952.75 18,027.62
200.00 514.33
–
3,612.19
–
Investments in Government securities
Investment in Subsidiary Companies 14,131.02 – Trade Investments 2,517.00 Current Assets, Loans & Advances 4,100.00 – Stock on hire
27,378.03 14,198.03
480.05 37,299.39
– – –
Sundry Debtors Cash & Bank Balance Loans and Advances
– To subsidiaries – Others
5,790.27
2,220.00 5,316.83 45,487.00 3,559.01 3,844.76
2,421.51 10,026.03
1,949.85 656.42 5,088.06 1,201.10 1,18,892.36
1,18,892.36
Part II
Notes to accounts include the following contingent liabilities: Rs. lakh i.
Guarantees issued and outstanding
1,694.79
ii.
Pending appeals under sales tax laws
10.77
iii.
Partly paid-up shares and debentures
24.53
You are required to calculate the capital adequacy ratio of the company and compare it with the minimum prescribed by the RBI.
199
Part II: Solutions MONEY MARKET Introduction to Money Market 1.
a.
The success rate that is to be maintained by the PDs for G-Secs is 33.33% of the commitment. (Rs. crore)
Commitment for aggregate bidding for G-Secs by TRQ Ltd.
1000
Commitment for aggregate bidding for G-Secs by XYZ Ltd.
1200
Required amount of successful bids for TRQ Ltd. (1000 x 33.33%) 333.3 Required amount of successful bids for XYZ Ltd. (1200 x 33.33%) 399.96 b. For the PDs to meet the requirements of their commitments, the tendered bids should be greater than their commitments. Similarly, the bids accepted by them should be greater than the successful bids for them to meet the requirements. Adherence to Commitments (Rs. crore) Bids Tendered
Commitments (Y/N) Adhered (Y/N)
TRQ Ltd.
800
<
1000
N
XYZ Ltd.
1400
>
1200
Y
Adherence to Successful Bids (Rs. crore) Bids Accepted
Required Commitment
AdherenceY/N
TRQ Ltd.
700
>
333.3 Y
XYZ Ltd.
1000
>
399.96 Y
From the table given above it can be observed that though TRQ Ltd. has adhered to the successful bids, it does not adhere to the commitments. XYZ Ltd. has, however, adhered to both its commitments and the successful bids. 2.
The success ratio to be maintained by PDs while bidding for a T-bills auction is 40%. Hence the commitment of aggregate bidding by STL Ltd. would have been 315 x 100/40 = Rs.787.5 crore. For a PD to adhere to the commitments, the bids tendered should be greater than their commitment for aggregate bidding. And for a PD to adhere to the successful bids, the bids accepted should be greater than the required amount of successful bids. The minimum amounts of tendered and accepted bids for STL Ltd. in order to adhere to the requirements will be Rs.787.5 crore and Rs.315 crore respectively.
3.
(Rs. crore) G-Secs
T-Bills
Notified Amount
3700
2200
Bids Accepted
3100
1800
Due to the amount of accepted bids falling below the notified amounts for g-secs and T-Bills, both the issues will devolve on the PDs and the RBI. (Rs. crore) Total devolvement in the G-Secs issue 600 Total devolvement in the T-Bills issue 400 The devolved amount will have to be shared by all PDs, RBI and Sterling in the following manner.
Part II
Devolvement in G-Secs (Rs. crore) Amounts devolved on all PDs
=
600 x 0.25 =
150
Amount devolved on RBI
=
600 x 0.75 =
450
Amount devolved on Sterling
=
150 x 0.10 =
15
Devolvement in T-Bills Amount devolved on all PDs
= 400 x 0.20
= 80
Amount devolved on RBI
= 400 x 0.80
= 320
Amount devolved on Sterling
= 80 x 0.05
= 4
In case of devolvement, the collectively underwritten portion by all PD’s will be fixed at a level not exceeding 25% of an issue in the case of dated securities and 20% in case of T-Bills. The RBI will underwrite the remaining 75% and 80% respectively. 4.
i.
The success ratio to be maintained by PDs in G-Secs
= 33.33%
The success ratio to be maintained by PDs in Auction T-Bills
= 40% (Rs. crore)
P Ltd. Q Ltd.
R Ltd. S Ltd.
G-Secs (commitment x 33.33%)
267
300
200
133
Auction T-Bills (commitment x 40%)
360
480
600
680
ii.
G-Secs Adherence to commitments Bids tendered
Commitments
Adherence to successful bids
Adhered Bids accepted Required Y/N commitments
Adhered Y/N
P Ltd.
850 >
800
Y
300 >
267
Y
Q Ltd.
1,000 >
900
Y
250 <
300
N
R Ltd.
500 <
600
N
150 <
200
N
S Ltd.
600 >
400
Y
300 >
133
Y
From the above table it can be observed that R Ltd. did not adhere to the commitment on aggregative bidding or on the required amount of successful bids. Q Ltd. has adhered only to their commitment on aggregative bidding but not to the required amount of successful bids. Auction T-Bills (Rs. crore) Adherence to commitments
Adherence to successful bids
Bids Commitments Adhered Bids tendered Y/N accepted
Required commitment
Adhered Y/N
P Ltd.
1000 >
900
Y
300 <
360
N
Q Ltd.
700 <
1200
N
250 <
480
N
R Ltd.
1700 >
1500
Y
620 >
600
Y
S Ltd.
1900 >
1700
Y
750 >
680
Y
It can be observed that Q Ltd. has not adhered to either to the commitment on aggregative bidding or to the required amount of successful bids while P Ltd. has not adhered to the required amount of successful bids. 201
Investment Banking and Financial Services
5.
Case 1 (Rs. crore)
Notified amount
G-Secs
91-day T-Bills
600
200
Bids accepted 600 200 There is no shortfall in the subscription of G-Secs and 91-day T-Bills since the bids received for G-Secs and the T-Bills are equal to the notified amount. Hence, there is no devolvement. Case 2 (Rs. crore) G-Secs
91-day T-Bills
Notified amount
600
200
Bids accepted
500
150
It can be observed that the bids accepted for the G-Secs and 91-day T-Bills fall short of the notified amount by Rs.100 crore and Rs.50 crore respectively. Hence there is a devolvement in the issues. The devolvement on PDs, Ross Ltd. and RBI will be assessed based on the following: Devolvement on RBI in case of G-Secs
= 75% of the devolvement
Devolvement on RBI in case of T-Bills
= 80% of the devolvement
Devolvement on PDs in case of G-Secs
= 25% of the devolvement
Devolvement on PDs in case of T-Bills
= 20% of the devolvement
Devolvement on Ross Ltd. in case of G-Secs = 15% of the amount devolved on PDs Devolvement on Ross Ltd. in case of T-Bills = 10% of the amount devolved on PDs (Rs. crore) G-Secs
6.
91-day T-Bills
Amount of shortfall
100
50
a.
Devolvement on PDs
100 x 0.25 = 25.00 50 x 0.20 = 10.00
b.
Devolvement on Ross Ltd.
25 x 0.15 = 3.75 10 x 0.10 = 1.00
c.
Devolvement on RBI
100 x 0.75 = 75.00 50 x 0.80 = 40.00
a.
The success ratio to be maintained by the primary dealers in Government securities = 33.33%. And, the success ratio to be maintained by the primary dealers in Auction T-Bills = 40% Required Amount of Successful bids for each Primary Dealer (All figures in Rs. crore) Particulars
202
PNB Gilts Ltd.
SBI Gilts Ltd.
Gilts Securities Trading Corporation
ICICI Securities and Finance Company Ltd.
Government Securities
300
333
267
233
Auction T-Bills
520
600
440
720
Part II
b. Government Securities (All figures in Rs. crore) Particulars
Adherence to commitments Bids tendered
PNB Gilts Ltd. SBI Gilts Ltd.
1,000 900
Adherence to successful bids
Commit- Adhered Bids ments (Y/N) accepted >
Required commitment
Adhered (Y/N)
900
Y
400
>
300
Y
< 1,000
N
350
>
333
Y
Gilts > 267 Y 1,100 > 800 Y 412 Securities Trading Corporation ICICI < 233 N 650 < 700 N 200 Securities and Finance Company Ltd. From the above table it can be observed that ICICI Securities and Finance Company Ltd. has not adhered to the commitment on aggregative bidding or on the required amount of successful bids and SBI Gilts Ltd. has not adhered to the commitment on aggregative bidding.
Auction T-Bills (All figures in Rs. crore) Particulars
Adherence to commitments Bids
Commit- Adhered
tendered
ments
(Y/N)
Adherence to successful bids Bids
Required
Adhered
accepted
commitment
(Y/N)
PNB Gilts Ltd.
1,500
>
1,300
Y
500
<
520
N
SBI Gilts Ltd.
1,400
<
1,500
N
450
<
600
N
Gilts Securities 1,200 > 1,100 Y 350 < 440 N Trading Corporation ICICI 1,600 < 1,800 N 500 < 720 N Securities and Finance Company Ltd. From the above table it can be observed that only PNB Gilts Ltd. and Gilts Securities Trading Corporation has adhered to the commitment on aggregative bidding but none of the primary dealers have adhered to the amount of successful bids.
Treasury Bills 7.
Fully accepted bids will be as follows: Bidder
Price Quoted
Approved Amount (Rs. cr.)
A
98.95
1800
B
98.93
700
C
98.92
1000
Total
3500 203
Investment Banking and Financial Services
D and E will be allotted proportionately in the following manner: Bidder
Price
Amount
Proportionate amount
D
98.90
1200
allotted (Rs. crore) 1000
E
98.90
600
500
1800
1500
365 ⎡ Face value ⎤ ⎢ Pr ice − 1⎥ x Days to maturity ⎦ = ⎣
Yield A
⎡ 100 ⎤ 365 =⎢ − 1⎥ x = 4.26% ⎣ 98.95 ⎦ 91
B
⎡ 100 ⎤ 365 = ⎢ = 4.34% − 1⎥ x ⎣ 98.93 ⎦ 91
C
⎡ 100 ⎤ 365 = ⎢ = 4.38% − 1⎥ x ⎣ 98.92 ⎦ 91
D and E
⎡ 100 ⎤ 365 − 1⎥ x = 4.46% = ⎢ 98.90 ⎣ ⎦ 91
If this auction is a single price auction, the price to be paid by the winning bidder would be Rs.98.90. 8.
365 ⎡ Face Value ⎤ Yield = ⎢ −1x ⎥ Days to maturity ⎣ Pr ice ⎦ ⎡ 100 ⎤ 365 = ⎢ − 1⎥ x ⎣ 91.35 ⎦ 364
= 9.495%. 9.
a.
The interest rate for each of the 6 years is Year T-Bill yield
Coupon for each year
1
11.55*
14.55
14.5%
2
10.55
13.55
13.5%
3
9.90
12.90
13.0%
4
9.30
12.30
12.5%
5
9.50
12.50
12.5%
6
8.30
11.30
11.5%
Year
204
Mark up of 3%
Coupon
Payment (Rs.) Interest (Rs.) Principal (Rs.)
1
14.50%
2750.00
1450.00
1300.00
2
13.50%
2750.00
1174.50
1575.50
3
13.00%
2750.00
926.19
1823.83
4
12.50%
2750.00
662.59
2087.41
5
12.50%
2750.00
401.66
2348.34
6
11.50%
964.40
99.47
864.93
Part II
b. The post-tax cash flow Year
Pre-tax interest
Post-tax interest @ 17.5%
Principal
Cash flow
0
–10000.00
1
1450.00
1196.25
1300.00
–2496
2
1174.50
968.96
1575.50
–2544
3
926.19
764.10
1823.82
–2588
4
662.59
546.63
2087.41
–2634
5
401.66
331.37
2348.34
–2680
6
99.47
82.06
864.93
–947 11.14%
The post-tax cost to the company is (i) in the following: 10,000 =
2, 496 2,544 2,588 2, 634 2, 680 947 + + + + + 2 3 4 5 (1 + i) (1 + i) (1 + i) (1 + i) (1 + i) (1 + i)6
Solving, By i = 11.14%. * T–Bill Yield for year 1 (11.0 x 0.3) + (11.5 x 0.5) + (12.5 x 0.2) = 11.5. Similarly you can calculate for the remaining years also. 10.
The optimal cut-off price is Rs.98.85. Below this point the amount of bids is short by Rs.150 crore and at this point, it has a surplus of Rs.350 crore. The first 4 bids given by A and B are accepted completely and the next quote given by the 2 bidders being the same RBI allots them proportionately. The fully accepted bids are (Rs. crore) Name of the bidder
Price Quoted
Approval Amount
A
98.91
100
A
98.89
180
B
98.93
50
B
98.90
120
Total
450
The RBI allots the 2 bidders proportionately in the following manner. Name of the bidder
Price
Amount
Proportionate Amount Allotted (Rs. crore)
A
98.85
200
60
C
98.85
300
90
500
150
365 ⎡ Face Value ⎤ Yield = ⎢ − 1⎥ x ⎣ Pr ice ⎦ Days to maurity 205
Investment Banking and Financial Services
Weighted average yield for the issue Name of
Price
Amount
Proportion
The Bidder
(i)
(ii)
(ii)/600 = (iii)
Weight x Price Yield (i x iii = iv)
(v)
Weight Yield (vi)
A
B C
98.91
100
0.17
16.485
0.0221 0.00368
98.89
180
0.30
29.667
0.0225 0.00675
98.85
60
0.10
9.885
0.0233 0.00233
98.93
50
0.08
8.244
0.0217 0.00181
98.90
120
0.20
19.780
0.0223 0.00446
98.85
90
0.15
14.828
0.0233 0.00350
98.889
0.02254
600
1.00
Yield for each of the bidders A: Average yield for A 100 ⎤ ⎡ 180 ⎤ 60 ⎤ ⎡ ⎡ + ⎢98.85 x + ⎢98.89 x ⎢98.91 x ⎥ = 98.89 *⎥ *⎥ 340 ⎦ ⎣ 340 ⎦ 340* ⎦ ⎣ ⎣
* (100 + 180 + 60 = 340) ⎡ 100 ⎤ 365 ⎢ 98.89 − 1⎥ x 182 = 2.25% ⎣ ⎦
Yield =
B: Average yield for B 50 ⎞ ⎛ 120 ⎞ ⎛ = ⎜ 98.93 x + 98.90 x ⎟ * ⎟ ⎜ 170 ⎠ ⎝ 170* ⎠ ⎝ = 98.91 * (50 + 120 = 170) ⎡ 100 ⎤ 365 Yield = ⎢ − 1⎥ x = 2.21% ⎣ 98.91 ⎦ 182 ⎡ 100 ⎤ 365 C= ⎢ − 1⎥ x = 2.33% 98.85 ⎣ ⎦ 182 $10, 00, 000
11.
P=
12.
365 ⎡ Face Value ⎤ Yield = ⎢ − 1⎥ x Pr ice days to maturity ⎣ ⎦
(1.08)5
= $680583
⎡ 100 ⎤ 365 ⎢ 92.05 − 1⎥ x 182 = 17.32% ⎣ ⎦ 1/ t
13.
⎛A⎞ i =⎜ ⎟ ⎝P⎠
i=
206
−1
$10, 000 − 1 = 5.28% $9022.87
Part II
14.
The bond pays $40 semi-annual coupons and there are ten 6-month periods to maturity. The 6-month periodic rate is the value of i that satisfies $850.75 = i
$40 $40 $40 + …… + + 2 1+ i (1 + i) (1 + i)10
=
6.03% which must be converted into an effective annual rate (1.0603)2
(1 + i) = i =
12.43%
* (Effective annual rate ⇒ i = (1+ nominal rate)n – n → no. of compoundings.)
Commercial Paper (CP) 15.
Rate of return = =
16.
Par value − P urchase price 12 x Purchase price No. of months to maturity
$10, 00, 000 − $9, 61, 000 12 $39, 000 12 x = x = 8.11% $9, 61, 000 6 $9, 61, 000 6
Issue price
=
F ⎛ I N ⎞ 1+ ⎜ x ⎟ 365 ⎠ ⎝ 100
where, F
=
Face value
I
=
Effective interest p.a.
N
=
Usance period
=
17.
25, 00, 000 = Rs.24,36,907.46 ⎛ 10.5 90 ⎞ 1+ ⎜ x ⎟ ⎝ 100 365 ⎠
Effective interest Issue price =
98,250 =
i
Face Value N ⎞ ⎛ i 1+ ⎜ x ⎟ ⎝ 100 365 ⎠ 1, 00, 000 90 ⎞ ⎛ 1 + ⎜i x 365 ⎟⎠ ⎝
= 7.22%
Cost of funds to the company Effective interest rate
=
7.22%
Brokerage (0.025 x 4)
=
0.1%
Rating charges (0.125 x 4)
=
0.5%
Stamp duty
=
0.5% 8.32%
18.
a.
P=
p.a.
F IxN 1+ 100 x 365
where, P = Issue price F = Face value or maturity value 207
Investment Banking and Financial Services
I
= Effective interest rate per annum
N
= Usance period i.e. number of days.
Therefore, the issue price, P
=
5, 00, 00, 000 14 x 45 1+ 100 x 365
= Rs.4,91,51,630 (Approximated) b.
Stamp Duty
As the tenure of the CP is less than 3 months, the stamp duty chargeable = 0.125% of Rs.5 crore = Rs.62,500 c.
Maximum Permissible Brokerage
For a CP is less than 90 days (the tenure here is 45 days), maximum permissible brokerage
d.
=
0.025% of Rs.5 crore
=
Rs.12,500
Computation of the Effective Cost to the Issuer
Particulars
Amount (Rs.)
Interest = Rs.50,000,000 – Rs.49,151,630 = Rating charges = (0.5% of Rs.50,000,000) x 45/365 =
8,48,370 30,822
Stamp duty
62,500
Brokerage
12,500 9,54,192
Cost to the issuer = (9,54,192/50,000,000) x 100 = 1.908% ∴ Annualized cost to the issuer = [(1.01908)365/45 – 1] x 100 = 16.57%
Certificate of Deposits (CDs) 19.
Effective annual interest rate on the 6-month CD. 11.5% = 0.958% 12
Monthly interest rate
=
1000 x (1.00958)12
= 1121.214
1121.214 − 1000 x 100 1000
= 12.12%
For the 2nd CD, the periodic rate
11.3% = 0.217% 52
Since, it is compounded weekly, at the end of the year, we would have 1000 x (1.00217)
52
= 1119.315
1119.315 − 1000 = 11.93% = 11.93% 1000
The effective annual interest rate on the 2nd CD is lower than that of the first CD.
208
Part II
20.
Issue price
=
14,45,000
=
i
=
Face value N ⎞ ⎛ i 1+ ⎜ x ⎟ 100 365 ⎝ ⎠ 15, 00, 000 150 ⎞ ⎛ i 1+ ⎜ x ⎟ ⎝ 100 165 ⎠
9.26%
Cost of funds to the Bank
= Effective interest rate + Stamp duty = 9.26% + 0.25% = 9.51%
Bill Financing 21.
Discount charge = 100 x 0.25 x
60 = Rs.4.17 360
For every Rs.100 worth of bills discounted the bimonthly interest rate =
4.17 = 4.35% 100 − 4.17
Effective rate = (1.0435)6 – 1 = 29.12% 22.
Value of the L/C backed bill = Rs.1,000 Discount charge = 1,000 x 0.23 x
90 = Rs.57.5 360
Value received by the client = Rs.942.5 (1000 – 57.5) Effective rate of interest per quarter =
57.5 x 100 = 6.1007%. 942.5
Effective rate of interest per annum = [(1.061007) 4 – 1] x 100 = 26.72%.
MERCHANT BANKING Management of Public Issues, Initial Public Offerings and Pricing of Various Instruments 23.
Probability of getting the target return should be equal to or more than 0.74. Growth in EPS P/E ratio (in percent) 0 10 20 30 40 0 10 20 30 40 0 10 20
6 6 6 6 6 8 8 8 8 8 10 10 10
Estimated price EPS (1+g) x P/E 42.0 46.2 50.4 54.6 58.8 56.0 61.6 67.2 72.8 78.4 70.0 77.0 84.0
Joint probability 0.0225 0.0375 0.0300 0.0450 0.0150 0.0375 0.0625 0.0500 0.0750 0.0250 0.0600 0.1000 0.0800 209
Investment Banking and Financial Services
Growth in EPS P/E ratio (in percent) 30 40 0 10 20 30 40
10 10 12 12 12 12 12
Estimated price EPS (1+g) x P/E 91.0 98.0 84.0 92.4 100.8 109.2 117.6
Joint probability 0.1200 0.0400 0.0300 0.0500 0.0400 0.0600 0.0200
Estimated price
Joint probability
Cumulative probability
42.0
0.0225
0.0225
46.2
0.0375
0.0600
50.4
0.0300
0.0900
54.6
0.0450
0.1350
56.0
0.0375
0.1725
58.8
0.0150
0.1875
61.6
0.0625
0.2500
67.2
0.0500
0.300
70.0
0.0600
0.3600
72.8
0.0750
0.4350
77.0
0.1000
0.5350
78.4
0.0250
0.5600
84.0
0.0800
0.6400
84.0
0.0300
0.6700
91.0
0.1200
0.7900
92.4
0.0500
0.8400
98.0
0.0400
0.8800
100.8
0.0400
0.9200
109.2
0.0600
0.9800
117.6 0.0200 1.0000 From the table it is seen that the probability of the divestment price being Rs.61.6 or less is 0.25. Hence, the probability of divestment price being Rs.67.2 and above is 0.75 which is greater than the specified limit of 0.74. Hence, the minimum divestment price can be taken as Rs.67.2. The company should earn a target return of 35%. Hence, the purchase price (P) should be 67.2 − P x 100 P
= 35
(67.2 – P) x 100
= 35P
6720 – 100P
= 35P
6720
= 65P
P
= Rs.49.78
Hence, the fund should invest in Redmond Ltd. at a price of Rs.49.78 per share. 24.
210
The EBIT for the 5 years is (the EBIT multiplied by the probabilities)
Part II
Year
Rs. in crore
1
0.24
+
0.405
+
0.51
= 1.155
2
0.28
+
0.51
+
0.65
= 1.440
3
0.34
+
0.525
+
0.725
= 1.590
4
0.36
+
0.555
+
0.75
= 1.665
5
0.5
+
0.78
+
1.4
= 2.680
a.
In case of equity investment of Rs.120 lakh (2 crore – 80 lakh) by the VCF.
The dividend for the 5 years
(Rs. in lakh) Year
EBIT (Rs. in lakh)
10% Dividend pay-out (Rs. in lakh)
Dividend inflow to VCF
1
115.5
11.55
6.93
2
144.0
14.40
8.64
3
159.0
15.90
9.54
4
166.5
16.65
9.99
5
268.0
26.80
16.08
The EPS for the 5th year is =
PAT Rs.268 lakhs = = Rs.13.4 No. of shares Rs. 20 lakhs
Hence the divestment price will be 13.4 x 12.5 = Rs.167.5 Cash flow from divestment = Rs.167.5 x 12 = Rs.2,010 lakh The NPV for the investment will be Year
Cash flow (Rs.)
Present value (Rs.) @ 15%
0
(120,00,000)
–120,00,000
1
6,93,000
6,02,910
2
8,64,000
6,53,184
3
9,54,000
6,27,732
4
9,99,000
5,71,428
5
20,26,08,000
10,06,96,176 9,11,51,430
b.
Investment in FCDs Year
EBIT
Interest
(Rs. in lakh)
(120 L x 0.18)
EBT
EPS
1
115.5
21.6
93.9
11.74
2
144.0
21.6
122.4
15.30
3
159.0
21.6
137.4
17.18
4
166.5
21.6
144.9
18.11
Conversion Price 211
Investment Banking and Financial Services
EPS
Weights
Weighted EPS
15.30
1
15.30
17.18
2
34.36
18.11
3
54.33 103.99
Weighted EPS =
103.99 = 17.33 6
The P/E multiple for conversion is 11. Conversion price = 17.33 x 11 = Rs.190.63 Rounded off to Rs.191. Hence the FCDs of 120 lakh would be converted into 62,827 shares. EPS during the 5th year = (268 – 0)/(8 + 0.62827) = Rs.31.06 The divestment price = 31.06 x 12.5 = Rs.388.25 The NPV of the investment is Year
Cash flow
PV factor
Present value
0
(120,00,000)
1.000
–120,00,000
1
21,60,000
0.870
18,79,200
2
21,60,000
0.756
16,32,960
3
21,60,000
0.658
14,21,280
4
21,60,000
0.572
12,35,520
5
2,45,87,723
0.497
1,22,20,098 63,89,05,800
(62,827 x 3.106) + (388.25 x 62,827) = 1,95,140.66 + 2,43,92,583 = 2,45,87,723 Alternative (a) is to be chosen. 25.
Particulars Net offer to public (Rs.25.5 crore – 9 crore)/10
No. of shares 1,65,00,000
Add: Unsubscribed reserved portion under competitive basis Revised net offer to public
15,00,000 1,80,00,000
Unsubscribed portion of reserved category under firm allotment should be brought in by promoters and the unsubscribed portion of reserved category under competitive basis should be added to the net offer to public. Applications above 1000 shares Shares per allottee 212
Part II
Category
No. of
No. of shares Proportionate
applicants
applied
(2)
(3)
(1)
Before
After
No. of
Shares Rounding Rounding Allottees available for off off (after allotment adjustment) (5) = (4) = (3) ÷ 3.89*
(4) ÷ (2)
4,000
2,500
100,00,000
25,71,428
1,029
1,000
2,410
10,000
1,000
100,00,000
25,71,428
2,571
2,600
1,000
25,000
400
100,00,000
25,71,428
6,429
6,400
400
1,00,000
50
50,00,000
12,85,716
25,714
25,700
50
350,00,000
90,00,000
Oversubscription ratio
=
350, 00, 000 ~ 3.89 90, 00, 000
Note: * (3.8888....9). In col. (4), the figure taken is the original oversubscription ratio figure and not the rounded off figure).
* 50% of 1,80,00,000 shares reserved for investors below 1000 shares. Oversubscription rate =
4,35, 00, 000 = 4.83 90, 00, 000
Applications below 1000 shares Category
No. of applicati on
No. of shares applied
Proportionate shares available for allotment
Shares per allottee
No. of allottees (after adjustments)
Before After rounding rounding off off 1
26.
2
(3) = (1) x (2)
(4) = (3) 4.83*
÷
(5)
(6)
(7)
200
35,000
70,00,000
14,48,276
41
100
14,483
300
27,000
81,00,000
16,75,862
62
100
16,759
500
20,000
100,00,000
20,68,966
103
100
20,000
800
13,000
104,00,000
21,51,724
166
200
11,380
1000
8,000
8,00,000
16,55,172
207
200
8,000
4,35,00,000
90,00,000
Basis of allotment for below 1000 shares 213
Investment Banking and Financial Services
Size No. of Applications
Share Applied
% of total
Shares Shares per R/o No. of Adjustments Final no. of available application allottees allottees
100 75,000
75,00,000 18.75% 6,56,250
8.75 100
6,563
0
6,563
200 35,000
70,00,000 17.50% 6,12,500
17.50 100
6,125
0
6,125
500 27,000
135,00,00 33.75% 11,81,250
43.75 100
11,813
0
11,813
1000 12,000
120,00,00 30.00% 10,50,000
87.50 100 10,500
0
10,500
4,00,00,000 O/S Ratio = 11.43
35,00,000
Basis of allotment for above 1000 shares Size
No. of applications
Shares applied
% of total
Share vailable
Shares per application
R/o
No. of allottees
Adjust Final No. of allottees
2,500
7,000 1,75,00,000
53.03% 18,56,061
265
300
6,187
6,199
5,000
1,500
75,00,000
22.73%
7,95,455
530
500
1,591
1,500
10,000
800
80,00,000
24.24%
8,48,485
1061 1,100
771
800
3,30,00,000 O/S Ratio = 9.43
35,00,001
Working Notes:
Number of shares to be issued =
Rs. 42 crore = 84,00,000 Rs. 50
Computation of Net Offer to Public
Total shares offered Less: Reservations – FII’s – Mutual funds – Banks/FIS
84,00,000 7,00,000 7,00,000 3,50,000
Add: Unsubscribed portion mutual funds 27.
17,50,000 66,50,000 3,50,000 70,00,000
Computation of Net Offer to Public
Total shares offered Less: Reservations Mutual funds NRIs FIIs Banks Employees Add: Unsubscribed portion* NRI Employees
(Figures in crore) 16.00 1.00 0.50 2.00 1.00 0.01
4.51 11.49
0.20 0.01 0.21 0.21 11.70 *Unsubscribed portion of reservation on firm basis will be bought in by the promoters with
214
Part II
3-year lock in period and unsubscribed portion of reservation on competitive basis will be added to the public portion. 50% of the net public offer is reserved for applicants who applied for 1000 or less shares. Thus, the oversubscription rate for the category = Total number of shares applied ÿ 50% of 11.70 crore 37,80, 00, 000 = 6.46 5,85, 00, 000
Oversubscription rate =
19, 00, 00, 000 = 3.25 5,85, 00, 000
Basis of Allotment for below 1000 Shares Size
No. of Total shares applied Proapplications portionate shares available
Shares per applicant Before rounding 5
No. of Adjust. of Final allottees surplus No. of allottees
After rounding
1
2
3
4 = (Col.3 6.46)
200
4,40,000
8,80,00,000
1,36,19,048
6
500
2,20,000
11,00,00,000
1,70,23,810
77
100
1,70,238
800
1,00,000
8,00,00,000
1,23,80,952
124
100
1,23,810
1,000
1,00,000
10,00,00,000
1,54,76,190
155
200
77,381
37,80,00,000
5,85,00,000
31
7
100
8
9
1,36,190
1,36,190 1,70,238 23,810
1,00,000 89,286
Basis of Allotment for above 1000 Shares Size
No. of applications
1
28.
2
Total shares applied
Proportionate share available
Shares per applicant
Before rounding
After rounding
3
4
5
6
No. of allottees
Adjust. of surplus
Final no. of allottees
7
8
9
2,000
60,000
12,00,00,000
3,69,47,368
616
600
61,579
1,579
60,000
5,000
10,000
5,00,00,000
1,53,94,737
1539
1,500
10,263
263
10,000
10,000
2,000
2,00,00,000
61,57,895
3079
3,100
1,986
–
2,000
19,00,00,000
5,85,00,000
As per the prospectus the issue pattern is as follows: Offer in terms of prospectus Less: Reservation for mutual funds
260 lakh shares 24 lakh shares
Reservation for FIIs
18 lakdh shares 218 lakh shares
Subscription on Reservation
(Shares in lakh) Category
Reservation
Subscription
Surplus/ Deficit
Mutual funds
24
16
+8
FIIs
18
4
+14
Net surplus in reserved category = 22 lakh shares. This is to be added to the net offer to public.
∴ Offer to public = 218 + 22 = 240 lakh shares. Application for Below 1000 Shares
215
Investment Banking and Financial Services
Category
1
No. of No. of shares applications applied
2
Shares allotted (3) ÷ 3402
3
Share per applicant
Before After rounding rounding 5 6
4
No. of allottees
7
200
40,000
80,00,000
23,41,463
59
100
26,000
400
20,000
80,00,000
23,41,463
117
100
20,000
600
15,000
90,00,000
26,34,146
176
200
15,000
800
10,000
80,00,000
23,41,463
234
200
10,000
1,000
8,000
80,00,000
23,41,463
293
300
8,000
4,10,00,000
1,20,00,000
Oversubscription rate = =
Total no. of shares applied 50% of net offer to public
4,10, 00, 000 4,10, 00, 000 = 3.417 = [(240) ÷ 2] lakh 1, 20, 00, 000
29.
Category Applications Total received received
200
30,000 60,00,000
13,36,844
44.56
No. of Surplus Success applications Full applicants 100 13,368
300
25,100 75,30,000
16,77,740
66.84
100
16,777
400
20,000 80,00,000
17,82,459
89.12
100
17,825
500
15,000 75,00,000
16,71,055
111.40
100
16,711
1,711
600
11,000 66,00,000
14,70,529
133.68
100
14,705
3,705
700
9,200 64,40,000
14,34,879
155.97
200
7,174
800
3,700 29,60,000
6,59,510
178.25
200
3,298
900
2,600 23,40,000
5,21,369
200.53
200
2,607
7
2,000 20,00,000 4,45,615 4,93,70,000 1,10,00,000
222.81
200
2,228
228
1,000
216
Proportionate Shares per Rounded Shares applicant off available
Category
No. of applicants after adjustments
200
13,368
300
16,777
400
18,854
500
15,000
600
11,000
700
9,200
800
3,700
900
2,600
1,000
2,000
Part II
Oversubscription rate
=
4,93, 70, 000 = 4.488 1,10, 00, 000
50% of net offer to public
=
2, 20, 00, 000 = 1,10,00,000 2
30.
Category
Applications received
Total received
Proportionate Shares per Shares applicant available 6,98,500 41,123 29.44
Rounded off 100
No. of successful applicants 411
500
1,397
600
418
2,50,800
14,765
35.32
100
148
700
220
1,54,000
9,066
41.21
100
91
800
395
3,16,000
18,604
47.10
100
186
900
682
6,13,800
36,136
52.99
100
361
1,000
7,980
79,80,000 4,69,806
58.87
100
4,698
1,00,13,100 Oversubscription ratio
=
1, 00,13,100 = 16.986 5,89,500
50% of net offer to public
=
11, 79, 000 = 5,89,500 2
Category
Surplus applications
No. of applicants after adjustments
500
–
411
600
–
148
700
–
91
800
–
186
900
–
361
1000
–
4,698
31.
Net offer to public No. of shares offered through prospectus
5,00,00,000
Less: No. of shares subscribed and allotted to IDBI, UTI, 1,00,00,000 MFs and FIIs on firm basis Less: No. of shares subscribed and allotted to the 1,00,00,000 employees of PI Ltd. and other group companies Less: No. of shares subscribed and allotted to NRIs on repatriation basis Net offer to public
50,00,000
2,50,00,000
217
Investment Banking and Financial Services
Category
No. of applications
No. of Shares applied
Proportioate shares available for allotment
Shares per allottee
100
1,60,000
1,60,00,000
19,46,946
Before rounding 12.17
200
1,00,000
2,00,00,000
24,33,682
300
50,000
1,50,00,000
400
25,000
500
No. of allottees after adjustment
After rounding 100
19,469
24.34
100
24,337
18,25,262
36.51
100
18,253
1,00,00,000
12,16,841
48.67
100
12,168
22,950
1,14,75,000
13,96,325
60.84
100
13,963
600
12,000
72,00,000
8,76,126
73.01
100
9,309
700
8,000
56,00,000
6,81,431
85.18
100
8,000
800
7,000
56,00,000
6,81,431
97.35
100
7,000
900
6,500
58,50,000
7,11,852
109.52
100
6,500
1000
6,000
60,00,000
7,30,105
121.68
100
6,000
10,27,25,000 1,25,00,000 100, 00, 00, 000 = 8.218 50
Oversubscription ratio
=
50% of net offer to public
= 50% of 2,50,00,000 = 1,25,00,000
32.
Statement of Underwriter’s Liability MB Financial ICI Finance 30% Gross liability Less: Unmarked applications
30%
Global
Total
Bank 40%
7,50,000
7,50,000
10,00,000
25,00,000
60,000
60,000
80,000
2,00,000
6,90,000
6,90,000
9,20,000
23,00,000
3,50,000
4,00,000
13,50,000
21,00,000
3,40,000
2,90,000
–4,30,000
2,00,000
– 2,15,000
– 2,15,000
+4,30,000
–
(23,00,000 – 21,00,000) (21,00,000 = 3,50,000 + 4,00,000 + 13,50,000) Less: Marked applications
Excess of Global B/k to MB and ICI in the ratio of 1:1 33.
2,00,000 1,25,000 75,000 – Public issue of Rs.100 crore of equity shares of Rs.10 each for cash at a premium of Rs.40 per share. No. of shares
= =
Less: Reservations 218
100, 00, 00, 000 50 2,00,00,000
Part II
Mutual funds 25%
=
50,00,000
Financial institutions 15%
=
30,00,000
Employees 5%
10,00,000
Net offer to public
=
1,10,00,000
50% of net offer to public
=
55,00,000
Category
No. of No. of shares Proportionate Shares per allottee No. of applications applied shares vailable Allottees for allotment After adjustment Before After rounding rounding
200
30,000
60,00,000
6,68,422
22.28
100
6,689
300
25,100
75,30,000
8,38,870
33.42
100
8,389
400
20,000
80,00,000
8,91,229
44.56
100
8,912
500
15,000
75,00,000
8,35,528
55.70
100
8,355
600
11,000
66,00,000
7,35,264
66.84
100
7,353
700
9,200
64,40,000
7,17,440
77.98
100
7,174
800
3,700
29,60,000
3,29,755
89.12
100
3,532
900
2,600
23,40,000
2,60,685
100.26
100
2,600
1,000
2,000
20,00,000
2,22,807
111.40
100
2,000
4,93,70,000
55,00,000
Oversubscription ratio = 34.
4,93, 70, 000 = 8.976. 55, 00, 000
As per the prospectus, the issue pattern is as follows: Offer in terms of prospectus – 220 lakh shares Less: Reservation for Mutual Funds –
20 lakh shares
Reservation for FIIs
– 15 lakh shares
Net offer to public
– 185 lakh shares
Subscription in Reservation
(Shares in lakh) Category
Reservation Subscription Surplus/Deficit
Mutual Funds
20
12
+8
FIIs
15
3
+12
Net surplus in Reserved Category – 20 lakh shares. This is to be added to net offer to public. 219
Investment Banking and Financial Services
Application Below 1000 Shares
Category No. of app. No. of shares applied (1) (2) (3)
Shares Share per allotted applicant (5) = (1) Rounded (4) = (3) (3) ÷ 4.878** (1) ÷ 4.878 off to nearest 100 (6)
No. of allottees (7) = (4) ÷ (6)
200
50,000
100,00,000
20,50,021
41
100
20,500 + 4,600 + 500*
400
25,000
100,00,000
20,50,021
82
100
20,500
600
20,000
120,00,000
24,60,025
123
100
20,000
800
10,000
80,00,000
16,40,016
164
200
8,200
1000
10,000
100,00,000
20,50,021
205
200
10,000
500,00,000
102,50,104
* The surplus in 600 & 1000 shares category adjusted to the 200 shares category. Surplus in 600 shares category = (24,60,025 – 20,00,000) = 4,60,025. Surplus in 1,000 shares category = 20,50,021 – 2,00,000 = 50,021. Additional shares to 200 shares category = 5,10,046. Hence, additional successful applicants = 5,100. **Oversubscription rate = = 35.
Total number of shares applied 50% of net offer to public
5, 00, 00, 000 = 4.878 [(185 + 20) ÷ 2] lakh
a. Computation of Net Offer to Public (Figures in crore) Total shares offered
14.40
Less: Reservations Mutual funds
1.00
NRIs
0.50
FIIs
2.00
Banks
1.00
Employees
0.01
4.51 9.89
Add: Unsubscribed Portion* NRI
0.10
Employees
0.01
Net Public Offer
0.11 10.00
*Unsubscribed portion of reservation on firm basis will be brought in by the promoters with 3 year lock-in period and unsubscribed portion of reservation on competitive basis will be added to the public portion.
220
Part II
Basis of Allotment Below 1000 Shares Size
No. of
Total
Pro-
Shares per
No. of
Adjustment
Final
Applications
shares
portionate
Applicant
allottees
of surplus
no. of
applied
Shares
allottees
available
(1)
(2)
(3)
(4) = (3) 8*
Before
After
rounding
rounding
(5) = (1) 8*
(6)
(7)
(8)
(9) = (7) + (8)
200
400000
80000000
10000000
25.0
100
100000
25000**
125000
500
200000
100000000
12500000
62.5
100
125000
0
125000
800
150000
120000000
15000000
100.0
100
150000
0
150000
1000
100000
100000000
12500000
125.0
100
125000
–25000**
100000
400000000
50000000
*50% of the net public offer is reserved for applicants who applied for 1000 or less shares. Thus, the oversubscription rate for the category = Total number of shares applied 50% of 10 crore = 8. ** Number of allottees is more than the number of applications in 1000 size category and hence excess adjusted to the minimum number of shares category. Basis of Allotment Above 1000 Shares Size
No. of applications
(1)
(2)
Total shares applied
Proportionate shares available
(3)
Shares per Applicant Before rounding (5)
(4) = (3)
÷
5*
= (1)
÷
After rounding (6)
No. of allottees
Adjustment of surplus
Final no.of allottees
(7)
(8)
(9) = (7) +(8)
5*
2000
50000
100000000
20000000
400
400
50000
—
50000
5000
20000
100000000
20000000
1000
1000
20000
—
20000
10000
5000
50000000
10000000
2000
2000
5000
—
5000
250000000
50000000
*Oversubscription rate =
25 crore =5 5 crore
b. According to SEBI guidelines a SEBI nominated public representative should oversee the process of allotment if a par issue is oversubscribed by 5 or more times. Being a par issue and oversubscribed by more than 5 times, a SEBI nominated public representative should oversee the allotment process. 36.
Basis of Allotment Below 1000 Shares Size
(1)
Number of Shares Applied % of Shares Available Applications Total (4) x 70 lakh (2)
(3)
(4)
(5)
Share per Application (5) (2)
Rounded Off
Number of Allottees (5) (7)
(6)
(7)
(8)
÷
÷
Adjustment Final of Surplus Number of Allottees (9)
(10)
200
75,000
1,50,00,000
24.0
16,80,000
22.4
100
16800
+216000
18960
300
40,000
1,20,00,000
19.2
13,44,000
33.6
100
13440
–
13440
700
25,000
1,75,00,000
28.0
19,60,000
78.4
100
19600
–
19600
1000
18,000
1,80,00,000
28.8
20,16,000
112.0
100
18000
–216000
18000
6,25,00,000
70,00,000 O/S Ratio = 8.92857
221
Investment Banking and Financial Services
Basis of Allotment Above 1000 Shares Size
Number of Applications
Shares Applied
% of Total
(1) 2000
(2) 12500
(3) 2,50,00,000
(4) 39.7
Shares Available (4) x 70 lakh (5) 27,77,778
4000
7000
2,80,00,000
44.4
31,11,111
444.44
5000
2000
1,00,00,000
15.9
11,11,111
555.55
6,30,00,000
Share per Application (5) (2)
÷
Rounded Off
(6) 222.22
Number of Allottees (5) (7)
200
12500
Adjustment of Surplus [{(7) x (8)}– (5)] (9) –2,77,778
500
7000
+3,88,889
7000
2000
–1,11,111
2000
÷
(7)
(8)
500
Final Number of Allottees (10) 12500
70,00,000 O/S Ratio = 9
Working Notes:
i.
Shares available for public offer: Initial shares available for public offer =
17, 00, 00, 000 = – 40,00,000 10
1,30,00,000
Undersubscription of FIIs
10,00,000
Shares available for public offer
1,40,00,000
The undersubscription in reservations for FIIs (10,00,000 shares) has been added back to public offer as the reservation was on a competitive basis. The undersubscription in the Mutual Fund portion has to be brought in by the promoters as the same was on a firm basis. 50% of shares available to public offer i.e. 70,00,000 shares should be reserved to the small investor. ii.
While alloting to `1000 shares’ category, the number of applicants are 18000. Therefore, number of allottees are 18000. The surplus of [2016000 – 18000 x 100] i.e. 216000 shares are allotted to the ‘200’ category.
37.
Basis of Allotment Below 1000 Shares Size
Number of Applications
Shares applied
% of Total
Shares available
Share per application
Rounded off
Number of allottees
Surplus Adjustment
Final number of allottees
400
10000
4000000
23.52
2941176
294.12
300
9804
–24
58824
10000
500
8000
4000000
23.52
2941176
367.65
400
7353
–24
118024
7648
800
5000
4000000
23.52
2941176
588.24
600
4902
–24
24
4902
1000
5000
5000000
29.41
3676471
735.29
700
5000
176471
–176471
5000
17000000
12500000
Oversubscription ratio = 1.36 Basis of Allotment Above 1000 Shares Number Size of Applications 2000 1000
Shares applied
% of Total
Shares available
Share per Rounded Number of Surplus Adjustment off allottees application
2000000
12.50
1562500
1562.50
1600
977
–700
10000
500
5000000
31.25
3906250
7812.50
7800
500
6250
–6250
500
20000
200
4000000
25.00
3125000
15625.00
15600
200
5000
–5000
200
50000
100
5000000
31.25
3906250
39062.50
39100
100
–3750
3750
100
16000000
12500000
Working Notes:
Over Subscription Ratio = 1.28 Initial shares available for public offer =
222
Final number of allottees 7100 981
60% of (25, 00, 00, 000 − (25, 00, 000 + 50, 00, 000) 5
Part II
= 3,00,00,000 – 75,00,000
= 2,25,00,000
Add: Undersubscription of NRIs
= 25,00,000
Shares available for public offer
= 2,50,00,000
Shares reserved for 1000 below shares
= 50% of 250 lakh = 125 lakh
∴ Oversubscription ratio
=
170 = 1.36 125
Rights Issues, Bonus Issues, Private Placements and Bought-out Deals 38.
a.
Shares are priced at 15% discount to domestic market price Domestic Market Price
= Rs.250
15% discount to market price
= Rs.212.5
Price of each GDR
= 212.5 x 4 = Rs.850
Price of GDR in $
=
850 = $21.25 40
=
$3.75 million 0.975
Total amount to be raised through GDR issue
= $3.85 million No. of GDRs to be issued
=
$3.85 m 21.25
= 1,81,200 (rounded off) b.
D1 6 +g= + 0.1 = 10.72% = 10.72% P(1 − f ) 850(0.975)
Where, f = issue cost c.
Rights issue ratio = 1:2 Subscription price of rights = Rs.150 per share Ex-rights price of the share = =
N Pr + S N +1
(2 x 250) + 150 650 = = Rs.217 2 +1 3
Shares are sold by the GDR holder at 20% premium to the then market price = 217 x 1.20 = Rs.260.4 No. of rights shares offered and subscribed by GDR holder holding 100 GDR 1 x 100 x 4 = 200 = 2 Gain/loss made by the GDR holder Purchase cost of 100 GDRs = $2125 200 x 150 Investment in rights issue = = $625 48 $2750 223
Investment Banking and Financial Services
Sale of GDRs at 20% premium = Profit 39.
a.
(100 x 4 + 200) x 260.4 = $3255 48
= $505
Part B of the 15% FCDs is convertible into equity within 1 year of bonus issue. Hence any bonus decision will affect the FCD holders. The conversion of Part B would result in additional 45,00,000 shares. Hence these have to be taken into consideration while computing the bonus ratio. The reserves eligible for capitalizing are (Rs. crore) General Reserves
17,00,00,000
Share Premium* (Rs.2,80,00,000 premium not
4,20,00,000
collected in cash excluded) 21,20,00,000 The shares eligible for bonus are Equity shares
90,00,000
Shares arising from conversion of 15% FCDs
45,00,000 1,35,00,000
Hence the maximum permissible bonus ratio is 1.57. * Share premium not collected in cash is not eligible for bonus issue and is therefore excluded. Premium not collected in cash = Cost of Plant and Machinery purchased less face value of shares issued to the vendor in lien of payment = 4crore– (12,00,000 x 10) = Rs.2,80,00,000.
40.
b.
After bonus and conversion the increased capital of Rs.36.20 crore would be more than the authorized capital of Rs.20 crore. Hence the company has to pass a specified resolution to give effect to the increased authorized capital.
a.
All reserves in the balance sheet of the company except revaluation reserves are eligible reserves for bonus issue. However, share premium given in the balance sheet includes premium not collected in cash which has to be excluded from eligible reserves for bonus issue. Share premium not collected in cash is equal to the difference between the payment to the vendor and the face value of the shares allotted. Hence it is equal to Rs.7 crore – 15 lakh x 10 = Rs.5.5 crore.* The eligible reserves for computation of bonus are General Reserves
4.00
Contingency Reserves
2.50
Capital Reserves
1.50
Share Premium (Rs.9 – Rs.5.5* Crore)
3.50
Dividend Equalization Reserves
1.00
Total Eligible Reserves
12.50
The finance managers contention that there would not be any calls and reserves can be capitalized is not justified as the equity capital consists of both fully paid and partly paid shares. Utilization of reserves for making partly paid shares to make fully paid shares would result in injustice to the fully paid shareholders. Thus, assuming that the company calls up the partly paid shares and all the shareholders pay up in full, the maximum bonus ratio can be worked out as under:
224
Part II
The maximum number of bonus shares that can be issued from eligible reserves =
Rs.12.5 crore = 1.25 crore shares. Rs.10 per share
No. of existing shares = 0.8 Hence the maximum permissible bonus ratio = b.
1.25 = 1.5625 0.8
The partly paid shares should be made fully paid-up before the bonus issue. The total paid-up capital after bonus issue would be equal to Rs.8 crore + Rs.12.5 crore = Rs.20.5 crore. As the paid-up capital would be exceeding the authorized capital of Rs.20 crore, the company has to pass a special resolution to increase its authorized capital.
c.
i.
ii.
41.
Secret reserve is a hidden financial strength of the company. It is not disclosed in the balance sheet of the company. Companies build secret reserves to meet any unforeseen eventualities. Normally secret reserves are created by the following means: •
Making excess provisions than is required
•
Showing contingent liabilities as firm liabilities
•
Undervaluing intangibles like goodwill, etc.
Secret reserve is an undisclosed financial strength and not in the nature of an accounting reserve. Hence it cannot be capitalized. Disclosing the same through newspaper advertisement does not entitle the company to declare bonus from it.
Computation of maximum permissible bonus ratio. Eligible Reserve
Rs. in lakh
General Reserve
20.00
Share Premium
15.00
Capital Reserve
14.00 49.00
Hence a maximum of 4,90,000 shares can be issued as bonus shares. The maximum permissible bonus ratio would be 4,90,000 : 3,50,000
= 7:5
7 bonus shares against every 5 existing shares. 42.
Computation of Eligible Reserves: Rs. crore General Reserves
20.00
Share Premium
6.50
Contingency Reserve
4.00
Capital Reserve
3.00
Eligible Reserve
33.50
Rs.2.5 crore was accrued to the share premium account on account of notional premium charged to the seller of the building. As this premium account was not collected in cash, the same is not included in computation of eligible reserves. 225
Investment Banking and Financial Services
Shares entitled to receive Bonus Shares: Shares issued and paid-up
60,00,000
Shares arising out of conversion of 12.5% convertible
20,00,000
debentures Number of shares entitled to receive bonus
80,00,000
3,35,00,000 shares can be issued by capitalizing the eligible reserves of Rs.3.35 crore. Hence, the maximum permissible bonus ratio is 4.1875. (3.35/0.8) 43.
a.
Size of the rights issue = 490 – (291.84 + 60 + 55) = 83.16 crore EPS for 20x1-20x2
= EPS during 20x1 x 1.40 =
Current market price = 8.40 x 22
9 x 1.40 = Rs.8.40 1.5
= Rs.184.8
Pricing of the rights = Rs.184.8 x 0.75 = Rs.138.6 Number of rights shares to be offered =
83.16 cr. = 60,00,000 138.6
As PCDs are converted into equity shares within 1 year of rights issue, the PCD holders are also eligible for right shares in proportion to their holdings. Thus the number of shares which are entitled to rights share are Existing equity shares
150 lakh
Shares arising out of conversion of PCDs (10,00,000 x 6)
60 lakh 210 lakh
Rights ratio =
60, 00, 000 6 = 2,10, 00, 000 21
The rights will be issued in the ratio of 6 shares for every 21 shares held. 8,57,143 rights shares will be offered to GDR holders in the ratio of 6 rights shares for every 5.25 GDRs held. b.
Value of the rights (R) =
Pr − S N −1
where, Pr is the current market price S is the subscription price and N is the number of shares required for 1 rights share R=
c.
184.8 − 138.6 = Rs.10.27 21 +1 6
No. of shares per GDR
=
30, 00, 000 =4 7,50, 000
Issue price per GDR
=
90, 00, 000 = $12 7,50, 000
Ex-rights Price of the Share =
Ex-rights price of the share =
226
N Pr + S N +1 21 x 184.8 + 138.6 6 = Rs.174.53 21 +1 6
Part II
Shares are sold by GDR holder at 25% premium to the then market price = 174.53 x 1.25 = Rs.218.17 Number of rights shares offered and subscribed by GDR holder holding 100 GDRs =
6 x 100 x 4 = 114 21
Gain/loss made by the GDR holder holding 100 GDRs is calculated as follows: Purchase cost of 100 GDRs Investment in rights issue
=
$ 1200
114 x 138.6 = 42
Total investment
=
Sale of GDRs at 25% premium
=
$ 376 $ 1576 (100 x 4 + 114) x 218.17 = $ 2670 42
Therefore, 44.
a.
Profit
=
$ 1094
Total size of the project outlay
=
Rs.24 crore
Less: Internal accruals
=
9 crore
Size of the proposed rights issue
=
15 crore
Pricing of the rights – Rs. per share 250 per share (15 crore/250) (2.4 crore/10) Number of right shares
= 6,00,000
Existing capital
= 24,00,000 shares
Hence, the rights ratio is 1 rights share for every 4 shares held. b.
Computation of the value of rights R=
Pr − S N +1
Where, R is the value of the rights S is the strike price of the rights share Pr is the market value of share N is the number of existing shares required to get 1 rights share. 345 − 250 R = = Rs.19 4 +1 c.
Gain/Loss to a shareholder i.
The ex-rights price of the share is expected to be =
N Pr + S N +1
(4 x 345) + 250 4 +1
= Rs.326 Assume X holds 100 shares. If the invests in the rights issue Existing wealth
=
100 x 345
=
Rs.34,500
Subscription in rights issue
=
25 x 250
=
6,250
=
40,750
Total
227
Investment Banking and Financial Services
Expected post-rights market value of his portfolio = 125 @ Rs.326 = Rs.40,750 No gain/loss to the shareholder. ii.
Allows the rights to expire: Existing wealth
= Rs.34,500
Post-rights market
iii.
value of his holdings (100 x 326)
= Rs.32,600
Loss in the wealth of shareholder
= Rs. 1,900
Sells his rights Existing wealth
= Rs.34,500
Amount realized by sale of rights (100 x 19)
= Rs.1,900
Post-rights market value of the holding (100 x 326)=
32,600 Nil
There will be no change in the wealth of the shareholder if he sells the rights. 45.
The amount to be raised by rights issue = Rs.280 – (140 + 60)
= 80 crore
Subscription price/rights share = Rs.40 No. of rights shares on offer
= 2,00,00,000
Hence ratio of rights is 1 share for every share held. EPS
= Rs.7.50
P/E
=9
Market price = Rs.67.5 a.
Value of the rights R =
P0 − S N +1
Where, Po
=
Market price before rights issue
S
=
Subscription price
N
=
Number of shares required for 1 rights share
=
67.5 − 40 = Rs.13.75 1+1
NP + S
b.
Market value after the rights issue
=
0
N +1
=
1 x 67.5 + 40 1+1
= Rs.53.75 No. of shares outstanding after rights issue
= Existing + Rights shares = 2 + 2 = 4 crore
Market capitalization = Ex-rights price x No. of outstanding shares = 53.75 x 4 = Rs.215 crore
228
Part II
c.
NAV per share after the issue Paid-up capital
Rs.40 crore
Reserves and Surplus: Existing
120
Premium on rights issue
60
180 crore
Net worth of the company
220 crore
No. of shares
4 crore
NAV per share
46.
Rs.220 crore = Rs.55 4 crore
Computation of maximum permissible bonus ratio a.
Reserves and surplus Rs.2,40,00,000 Shares entitled to receive bonus shares Paid-up capital Rs.1,80,00,000 Rs.18,00,000 shares of Rs.10 each 24,00,000 shares can be issued by capitalizing the eligible reserves of Rs.2,40,00,000. Hence the maximum permissible bonus ratio is 1.33:1. (2,40,00,000/1,80,00,000 = 1.33) i.e. 4 bonus shares for every 3 shares held.
b.
No. of the right shares
= 4.5 lakh shares
Pricing of the rights issue
= Rs.50 each
No. of shares
= 18,00,000 shares
Hence the rights ratio is 1 rights share for every 4 existing shares held. Impact of rights issue on the wealth of a shareholder, who already holds 100 shares in CCL. i.
If the shareholder exercises his rights in full Rs. Existing wealth = 100 x 80 Subscription in rights issue
= 8,000 = 25 x 50
= 1,250 9,250
Ex-rights price of share is Value of rights NP + S
=
r
N +1
=
(4 x 80) + 50 4 +1
P −J
R
=
r
N +1
80 − 50 5 = Rs.6
= Rs.74
=
Expected post rights market value of his portfolio = 125 shares @ 74 = Rs.9,250 No gain/loss to the shareholder. ii.
If the shareholder sells his rights in its entirety Existing wealth
= 100 x Rs.80
= Rs.8,000
Amount realized by sale of rights
= (100 rights @ 6) = Rs.600
Post rights market value of the holding
= 100 x 74
= Rs.7,400
There will be no change in the wealth of the shareholder if he sells the rights in its entirety. 229
Investment Banking and Financial Services
47.
Partly paid-up shares should be made fully paid-up before the bonus issue. Eligible reserves for computation of bonus are Free reserves
220 lakh
Less: Share premium not collected in cash
40 lakh 180 lakh
The maximum number of bonus shares that can be issued from eligible reserves Rs.180 lakh = 18 lakh shares Rs.10 per share Number of existing shares = 45 lakh shares
=
Hence the maximum permissible bonus ratio =
2 18 (i.e. ) 5 45
2 bonus shares for every 5 equity shares held. Share capital after the bonus issue would be equal to Rs.180 lakh + Rs.450 lakh = Rs.630 lakh. Which is more than the authorized capital of Rs.500 lakh. The company will thus have to pass a special resolution to increase its authorized capital. 48.
Current market price of the scrip = Rs.80 Rights issue in the ratio of 2 right shares for every 5 equity shares held Paid-up capital of the company = Rs.10 crore Pricing of the rights issue = Rs.65 per share. a.
Value per share after the rights issue NP + S 0
=
N +1
Where,
b.
N
=
Number of existing shares required for a rights share
P0
=
Cum-rights market price per share
S
=
Subscription price at which the rights shares are issued
=
2.5 x 80 + 65 = Rs.75.71. 2.5 + 1
Value of rights P −S
R
=
r
N +1
=
80 − 65 2.5 + 1
= 49.
a.
15 3.5
= 4.29
Market price per share = Rs.20 Earnings per share
= Rs.4
Subscription price
= 20% below the existing market price = Rs.16
Number of right shares = 30, 00, 000 16 = 1,87,500
230
Part II
Rights ratio
Existing shares
= 10,00,000
Number of additional = 1,87,500 equity shares proposed to be issued as rights shares 3 rights shares for every 16 shares held. Dilution in EPS: EPS
= Rs.4
EPS
=
PAT PAT =4= No. of shares 10, 00, 000
PAT = 40,00,000 Effect of rights issue on EPS PAT
= 40,00,000
PBT
= 59,70,149
Add: Interest saved as a result of redemption of loan = 3,00,000 62,70,149 Less: 33% Tax
= 20,69,149 42,01,000
EPS
b.
=
PAT Number of shares
=
42, 01, 000 = Rs.3.54. 10, 00, 000 + 1,87,500
Ex-rights price of the share NP + S
=
0
N +1
N
=
Number of existing shares required for a rights share
P0
=
Cum-rights market price per share
S2
=
Subscription price at which rights shares are issued. ⎛ 16 ⎞ ⎜ x 20 ⎟ + 16 ⎝ 3 ⎠ = Rs.19.37 = Rs.19.37 16 ⎛ ⎞ ⎜ + 1⎟ ⎝ 3 ⎠
P/E ratio = c.
i.
Market price 19.37 = 5.47 = EPS 3.54
If a shareholder who owns 1000 shares sells his rights. Market value of original shareholding @ Rs.20 = 1000 x 20 = 20,000 P −S
Value realized from the sale of rights R =
0
N +1
231
Investment Banking and Financial Services
=
20 − 16 ⎛ 16 ⎞ ⎜ + 1⎟ 3 ⎝ ⎠
= 0.6315
1000 x 0.6315
=
631.57
Post-rights market value of the holding 1000 x 19.37 = 19,370.00 20,001.57 ii.
50.
i.
If he allows his rights to expire Current market value of the investment = 1,000 x 20
= 20,000
Market value after the rights issue @ 1,000 x 19.37
= 19,370
Change in Wealth
= 630
Proposed amount of rights issue = Rs.90 lakh EPS for 20x1-x2 = Rs.3 PAT PAT EPS = =3= No. of shares 9 lakh PAT = 27 lakh for 20x1-x2 Post-tax earnings for year 20x2-x3 to increase by 20% = 27 lakh x 1.20 = Rs.32.4 lakh Dilution in EPS should not be more than 20%. EPS cannot be less than Rs.2.4 Minimum subscription price of right shares 32.4 lakh 2.4 = 12 lakh + X X = 1.5 lakh X = No. of rights shares to be issued Total amount of rights issue proposed Minimum subscription price of right shares
12, 00, 000 = 8 :1 1,50, 000 1 rights share for every 8 shares held. If a shareholder who holds 1000 shares allows his rights to lapse, then
Ratio of rights
ii.
= 90 lakh 90 lakh = = Rs. 60 1.5 lakh
=
Rs. Current market value of investment = 1000 x 80
80,000
Market value after the rights issue = 1000 x 77.78
77,778
Change in wealth Ex-rights price of the share NP + S 0 = N +1
232
=
(8 x 80) + 60 8 +1
=
640 + 60 700 = Rs.77.78 = 9 9
2,222
Part II
51.
a.
Value of the rights Pr − S 78 − 65 = = Rs.9.75 N +1 1.33
R=
1 ⎛ ⎞ ⎜ N = = 0.33 ⎟ 3 ⎝ ⎠
b.
Expected ex-rights price of the share =
= c.
NP + S 0
N +1
=
(0.33 x 78) + 65 1.33
90.74 = Rs.68.25 1.33
Gain/Loss if the shareholder exercises his rights:
Market value of original shareholding at the rate= of 78 per share (100 x 78)
Rs.7,800
Additional subscription price paid for 300 right= shares @ Rs.65 per share
Rs.19,500
Total Investment
=
Rs.27,300
Market value of 400 shares @ Rs.68.25 per share =
Rs.27,300
If the rights are allowed to lapse:
Market value of original shareholding @ Rs.78 per share = Rs.7,800 Market value of 100 shares held after the rights issue @ Rs.68.25 per share = Rs.6,825 Change in wealth (Rs.6825 – Rs.7800) = Rs.(975) If the rights are sold:
52.
Market value of original shares @ 78 per share
= Rs.7,800
Value realized from sale of 100 rights at Rs.9.75
= Rs.975
Market value of 100 shares held after rights issue
= Rs.6,825
Change in Wealth (Rs. 6825 – Rs. 7800)
= Rs.(975)
The amount to be raised by rights issue = Rs.355 – (155 + 80) = Rs.120 crore. Subscription price/rights share = Rs.40. No. of right shares on offer = 300,00,000. Hence ratio of rights is 3 shares for every 4 shares held 3 : 4. EPS
–
Rs.4.50
P/E
–
12 since
Market Price –
Rs.54
Value of the rights
R=
MPS = 12 EPS
P −S
a.
0
N +1
Where, P0
= Market price before rights issue
S
= Subscription price
N
= Number of shares required for 1 rights share =
54 − 40 = Rs.6. 1.33 + 1
Rights ratio = 0.75 233
Investment Banking and Financial Services
b.
Market value after the rights issue
=
NPo + S N +1
=
(1.33 x 54) + 40 1.33 + 1
=
71.82 + 40 2.33
= Rs.48 No. of shares outstanding after rights issue = Existing + Rights shares
= 4 + 3 = 7 crore Market capitalization = Ex. Rights price x No. of outstanding shares = 48 x 7 = Rs.336 crore c.
NAV per share after the issue: Paid up capital
Rs.70 cr.
Reserves & surplus: Existing Premium on rights issue
160 + 90
Net worth of the company No. of shares a.
Rs.320crore 7crore
NAV per share 53.
Rs.250crore
= Rs.45.71
Part B of the 16.5% FCD is convertible into equity within one year of bonus issue. Hence any bonus decision will affect the FCD holders. The conversion of Part B, would result in additional 30,00,000 shares. Hence these have to be taken into consideration while computing the bonus ratio. The reserves eligible for capitalizing are General Reserves Rs.15,00,00,000 Share Premium (Rs.4,00,00,000 premium not Rs.5,00,00,000 collected in cash excluded)* Rs.20,00,00,000 The shares eligible for bonus are: Equity shares 70,00,000 Shares arising from conversion of 16.5% 30,00,000 FCDs 1,00,00,000 Hence, the maximum permissible bonus ratio is 2 bonus shares for every share held. (20crore /1crore x 10)
* Share premium not collected in cash are not eligible for bonus issue and as such are excluded. Premium not collected in cash = Cost of plant & machinery purchased less face value of shares issued to the vendor in lieu of payment = 5 cr. – 10,00,000 x 10 = Rs.4crore.
54.
b.
After bonus, the increased capital of Rs.27crore would be more than the authorized capital of Rs.15crore. Hence, the company has to pass a special resolution to give effect to the increased authorized capital.
a.
Size of the rights issue= 465 – (255 + 80 + 40) = Rs.90crore. EPS for 20x0-x1
= EPS during 19x9-20x0 x 1.25 =
Current market price = 7.5 x 20 = Rs.150
234
6 x 1.25 = Rs.7.5 1
Part II
Pricing of the rights = Rs.150 x 0.8 No. of rights shares offered
= Rs.120
90 crore = 75,00,000 120
=
As PCDs are converted to equity shares within one year of rights issue, the PCD holders are also eligible for right shares in proportion to their holdings. Thus, the member of shares which are entitled to rights shares are: Existing equity shares
100 lakh
Shares arising out of conversion of PCDs (10,00,000 x 4)
40 lakh 140 lakh
Rights ratio =
75 15 = 140 28
The rights will be offered in the ratio of 15 shares for every 28 shares held by existing shareholders. The rights will be offered to the debentureholders in the ratio of 15 shares for every 7 debentures held. 13,39,286 rights shares will be offered to GDR holders in the ratio of 15 rights shares for every 7 GDRs held. b.
P −S r
Value of the rights (R) =
N +1
Where Pr is the current market price; S is the subscription price; and N is the number of shares required for 1 rights share R=
c.
150 − 120 = Rs.10.47 28 +1 15
No. of shares per GDR =
Issue price of GDR =
25, 00, 000 =4 6, 25, 000
87,50, 000 = $14 6, 25, 000
NP + S
Ex-rights price of the share =
r
N +1
28 x 150 + 120 = 15 = Rs.139.53 28 +1 15
Shares are sold by GDR holder at 20% premium to the then market price = 139.53 x 1.2 = Rs.167.44 Number of rights shares offered and subscribed by GDR holder holding 100 GDRs
235
Investment Banking and Financial Services
=
15
x 100 x 4 = 214
28
Gain/loss made by the GDR holder, holding 100 GDRs is calculated as follows:
Purchase cost of 100 GDRs (14 x 100) = $1400
55.
i.
214 x 120 = $611 42
Investment in rights issue
=
Total cost
= $2011
Sales of GDRs at 20% premium
=
Therefore, Profit
= $437
(100 x 4 + 214) x 167.44 = $2448 42
All reserves given in the balance sheet of the company except revaluation reserves are eligible reserves for bonus issue. However, share premium given in the balance sheet includes premium not collected in cash which has to be excluded from eligible reserves for bonus issue. Share premium not collected in cash is equal to the difference between the payment to the vendor and the face value of the shares allotted. Hence, it is equal to Rs.4crore – 10lakh x 10 = Rs.3crore. The eligible reserves for computation of the bonus are: General Reserves Contingency Reserves Capital Reserves Share Premium (Rs.7crore – 3 crore) Dividend Equalization Reserve Total eligible reserves
3.00 2.75 1.25 4.00 1.00 12.00
The finance manager’s contention that there would not be any calls and reserves that can be capitalized is not justified as the equity capital consists of both fully paid shares and partly paid shares. Utilization of reserves for making partly paid shares to make fully paid shares would result in injustice to the fully paid shareholders. Thus, assuming that the company call-up the partly paid shares and all the shareholders pay up in full the maximum bonus ratio can be worked out as under. The maximum number of bonus shares that can be issued from eligible reserves: Rs.12 crore = 1.2 crore shares Rs.10 per share
No. of existing shares = 0.5 Hence, the maximum permissible bonus ratio =
1.2 = 2.4 i.e. for every 5 shares 10.5
held 11 bonus shares can be issued. ii.
a.
The partly paid shares should be made fully paid up before the bonus issue.
b.
The total paid up capital after bonus issue would be equal to Rs.5crore + Rs.11 crore = Rs.16 crore. As the paid up capital would be exceeding the authorized capital of Rs.14 crore, the company has to pass a special resolution to increase its authorized capital.
iii.
236
a.
Secret reserve is a hidden financial strength of the company. It is not disclosed in the balance sheet of the company. Companies build secret reserves to meet any unforeseen eventualities. Normally secret reserves are created by the following means:
Part II
– – – b.
56.
Making excess provisions than is required Showing contingent liabilities as firm liabilities Undervaluing intangibles like goodwill, etc.
Secret reserve is an undisclosed financial strength and not in the nature of an accounting reserve. Hence, it cannot be capitalized. Disclosing the same through newspaper advertisement does not entitle the company to declare bonus from it.
Computation of Maximum Permissible Bonus Ratio Computation of Eligible Reserves
Particulars
Rs. cr.
Share Premium
1.75
General Reserves
2.50
Dividend Equalization Reserve
1.25
Special Reserve
1.50
Contingency Reserve
0.50
Eligible Reserve
7.5
Note: Rs.0.5 crore was accrued to the share premium account on account of notional premium charged to the machinery supplier. As this premium amount was not collected in cash, the same is not included in the computation of eligible reserves. Computation of Number of Shares Entitled to Receive Bonus Shares Shares issued & paid up Shares arising out of the conversion of 14% Fully Convertible Debentures – 2,50,000 x 2
20,00,000 5,00,000 25,00,000
Par value of each share = Rs.10 Number of shares that can be issued to capitalize the Eligible Reserves of Rs.7.5 crore =
7,50, 00, 000 = 75,00,000 10
Hence the maximum permissible bonus ratio as per current SEBI guidelines is 3:1 (3 bonus shares per every existing share held). 57.
a.
Computation of maximum possible bonus ratio. Computation of Eligible Reserves
Particulars
Rs. crore
Contingency reserve 13.00 Dividend equalization reserve 9.00 General reserve 15.00 Share premium 5.00 Capital reserve 18.00 Revaluation reserve 12.00 Eligible reserves 72.00 Note: Rs.7 crore was accrued to the share premium account in notional premium charged to the American scientist. As this premium amount is not collected in cash, the same is not included in the computation of eligible reserves. Computation of Number of Shares Entitled to Receive Bonus Shares Shares issued and paid-up Shares arising out of the conversion of 11% fully convertible debentures
5,00,00,000 25,00,000 5,25,00,000
Par value of each share = Rs.10 237
Investment Banking and Financial Services
Number of shares that can be issued to capitalize the eligible reserves of Rs.72,00,00,000. =
72, 00, 00, 000 = 7, 20, 00, 000 10
Hence the maximum permissible bonus ratio = 14.4:10.5 (rounded off to 14 bonus shares for every 10 existing shares held)
58.
b.
As per the latest guidelines of SEBI, the par value concept of a share is abolished. The value of share can be Re.1 or in multiples of Re.1. Hence as the present book value of each share is Rs.10, in case of a stock split, the maximum permissible stock-split ratio will be 1:10 i.e. one existing share can be split to 10 shares of Re.1 each.
a.
Amount to be raised by Zuari Industries = Rs.110 crore As per the SEBI Guidelines the promoters’ contribution shall not be less than 20% of the post-issue capital. It is given that the promoters do not intend to invest more than the minimum requirement. ∴ Promoters’ contribution should be 20% of Rs.110 crore = Rs.22 crore. Hence, amount to be raised through the book building process and fixed price public offer = Rs.110 crore – Rs.22 crore = Rs.88 crore.
Let the amount to be offered by book building = Rs.x crore. Allocation to individual investors applying not through the syndicate members but during the time when the issue is open should be 10% of the issue size offered to the public through the prospectus i.e. 10% of x = x/10 Thus, x + x/10 ⇒
x
= 88 = Rs.80 crore.
⇒ 10% of x = Rs.8 crore.
b.
∴ Amount raised through book building is Rs.80 crore
... (i)
Amount raised through fixed price public offer is Rs.8 crore
... (ii)
Promoters will bring in Rs.22 crore
... (iii)
Computation of the Allotment of Shares by Book Building and the Cut-off Rate
Price (Rs.) (1)
238
Number of shares applied (2)
Cumulative shares (3)
(4) (1) x (3) (Rs.)
64.00
25,500
25,500
16,32,000
63.00
82,800
1,08,300
68,22,900
62.00
1,75,700
2,84,000
1,76,08,000
61.00
5,00,100
7,84,100
4,78,30,100
60.00
8,32,200
16,16,300
9,69,78,000
59.00
17,99,400
34,15,700
20,15,26,300
58.00
36,55,300
70,71,000
41,01,18,000
57.00
41,83,700
1,12,54,700
64,15,17,900
55.25
58,97,600
1,71,52,300
94,76,64,575
54.50
72,11,300
2,43,63,600
1,32,78,16,200
53.00
85,90,400
3,29,54,000
1,74,65,62,000
Part II
Price (Rs.) (1)
Number of shares applied (2)
52.00
Cumulative shares (3)
1,01,03,000
4,30,57,000
(4) (1) x (3) (Rs.) 2,23,89,64,000
From the table above we can infer that Rs.55.25 is the cut-off rate. All the applications for shares at Rs.57 or higher will get full allotment @ Rs.55.25. Total amount to be raised through book building
= Rs.80 crore
Amount that can be raised from the applications at Rs.57 or more = Rs.64,15,17,900 ∴ Amount to be raised from applications at Rs.55.25
=
Rs.80,00,00,000 – Rs.64,15,17,900
=
Rs.15,84,82,100
Number of shares to be issued in the category of Rs.55.25 = 15,84,82,100/55.25 = 28,68,454 shares Number of shares applied for in the category of Rs.55.25 = 58,97,600 shares In the category of Rs.55.25 for every 206 shares applied, 1 share would be allotted subject to the allotment being in market lots.
59.
c.
Yes, within the book building portion, at least 15% of the issue size shall be reserved for allocation to individual investors applying up to 10 market lots through the syndicate members. This is in adherence to the latest SEBI Guidelines.
a.
Gross amount to be raised
=
$150 million 0.96
Price of each ADR
=
600 x 1.2 x 4 = $60.42 47.65
Number of ADRs required b.
Current dividend per share
156.25 60.42 = 50% x 5 = Rs.2.5 x 1.15
=
= $156.25 million
= 2.58 million = Rs.2.5 = 2.875
D1 Price of ADR (in Rupees) = (600 x 1.2 x 4) = Rs.2,880 Dividend expected on one ADR = Rs.2.875 x 4 = Rs.11.5 D 1 Cost of ADR (k) = P (1 − f ) 0
=
11.5 + 0.15 = 15.4% 2,880 x 0.96
D
⎛ 11.5 ⎞ ⎜ 2,880 + 0.15 ⎟ ⎠ = 16% Cost of ADR can also be calculated as o =⎝ 1− f 0.96 1
P
NP + S
c.
Domestic ex-right price
=
o
N +1
+g
=
4 x 1, 000 + 600 = Rs.920 5
920 x 4 x 1.3 = $95.68 50 Initial investment = 25,000 x 60.42 = $15,10,500 25, 000 Number of ADRs bought under rights issue = = 6,250 ADRs 4
Ex-rights price of an ADR
=
239
Investment Banking and Financial Services
Investment in rights issue Total investment Divestment proceeds
60.
a.
Profit to MLTF Divestment Price:
6, 250 x (600 x 4) = $3,00,000 50 = $18,10,500 = (25,000 + 6,250) x $95.68 = $29,90,000 = $11,79,500.
=
EPS for 3 years
b.
Year 1
12.00
Year 2
14.40
Year 3
17.28
The divestment takes plakhe at P/E of 8 and this is equal to Rs.17.28 x 8 = Rs.138.24 Required IRR of ECC = 22% 15crore No. of shares invested by ECC = = 24 lakh 62.5 Let the minimum value of divestment be X. Thus the cash flow to ECC will be (Rs. in lakh) Year 0
Investment value
–1,500
Year 1
Dividend 24 x 10 x 0.15
36
Year 2
Dividend 24 x 10 x 0.2
48
Year 3
(Dividend + Divestment) (60 + X) (24 x 10 x 0.25) + X
The discounted cash flow @ 22% is Year 0 –1500 x 1 = –1500 Year 1 36 x 0.820 = 29.51 Year 2 48 x 0.672 = 32.25 Year 3 (60 + X) x 0.551 = 33.042 + 0.551X 1,500 = 29.51 + 32.25 + 33.042 + 0.551X
Hence the divestment price =
Rs. 2,550.268 24 lakh shares
= Rs.106.26
The cash flows to ECC from divestment would be = 24,00,000 x 50 ⎤ ⎡ ⎢ Rs.106.26 + (Rs.138.24 − Rs.106.26) x 100 ⎥ ⎣ ⎦
= 24,00,000 x 122.25 = Rs.29,34,00,000 The IRR to ECC on their investment is Year 0
–15,00,00,000
Year 1
36,00,000
Year 2
48,00,000
Year 3
29,34,00,000
IRR is 27.57% c.
The amount of cash inflow to the promoters is = 24,00,000 x (138.24 – 106.26) x
240
50 = Rs.3,83,76,000 100
Part II
INTERNATIONAL MARKETS 61.
Total issue amount =
$4.02 crore
= $4.102 crore
0.98 = 4.102 x 42 = Rs.172.2857 crore Price of each GDR = 180 x 0.9 x 6 = Rs.972 No. of GDRs issued =
Rs.172.2857 = 0.177249 crore Rs.972
Cost of GDRs is computed as follows: Current market price of GDR (Po) = Rs.972 Dividend expected on each GDR (D1) = 10 x 0.15 x 6 = Rs.9 Growth rate (g)
= 8% p.a.
Cost of GDR (k)
=
D1 +g Po (1 − f)
where f is the issue cost = 62.
9 + 008 = 8.945% 972 x (1 − 0.02)
The cash flow in the zero year is Loan Less: Arrangement Fee
$200.0 million $0.5 million $199.5 million
Annual cash outflows: in $ million Interest 12.000 Facility Fee 0.700 Agent Fee 0.015 12.715 The annual cash flows are as follows: Year
Cash flow (million $)
0
+ 199.5
1
–12.715
2
–12.715
3
–12.715
4
–12.715
5
–212.715
Cost of loan is the value of (i) in the following equation 199.5
=
−12.715 (1 + i)
i
+
−12.715 (1 + i)
2
+
−12.715 (1 + i)
3
+
−12.715 (1+ i)
4
+
−212.715 (1 + i)5
i = 6.42% (by trial and error) 241
Investment Banking and Financial Services
Fees earned by HSBC 10 BP on amount of loan i.e. $200 million 15 BP on amount underwritten i.e. $100 million
$ million 0.20 0.15 0.35
The total fees earned by HSBC is $0.35 million. 63. Amount in million crore Upfront
30.06.20x1
30.6.20x2
30.06.20x3
30.06.20x4
30.06.20x5
30.06.20x6
Interest
0.000
4.800
9.1
11.6
10.1
9.1
4.3
Amortization
0.000
0.00
0
0
0
100
100
Management Fee
1.000
0.00
0
0
0
0
0
Underwriting Fee
1.200
0.00
0
0
0
0
0
Commitment Fee
0.300
0.00
0
0
0
0
0
Agency Fee
0.000
0.03
0.03
0.03
0.03
0.03
0.03
Guarantee Fee
0.800
1.6
1.6
1.6
1.6
0.8
0
Total
3.300
6.43
10.73
13.23
11.73
109.93
104.33
Computation of Effective Cost of Borrowings
Year
Cash flows
0
+96.70
1
+93.57
2
–10.73
3
–13.23
4
–11.73
5
–109.93
6
–104.33
IRR = 6.08% 64.
(in million $)
242
1
2
3
4
5
6
7
8
9
Half-Year Ended
Loan o/s at the beginning
LIMEAN*
Annual Interest Rate (%)
Interest Paid (2 x 4) 2
Guarantee Fee
Agency Fee and Commitment
Principal repaid
Cash outflow = 5+6+7 +8
÷
June 20x0
50
5.175
6.175
1.544
0.10
0.05 (C)
–
1.6940
Dec. 20x0
50
5.05
6.05
1.512
0.20
0.0565(A)
–
1.7685
June 20x1
100
5.20
6.20
3.1
0.20
–
–
3.3000
Dec. 20x1
100
5.15
6.15
3.075
0.20
0.0065(A)
–
3.2815
June 20x2
100
5.05
6.05
3.025
0.18
–
12.5
15.*05
Dec. 20x2
87.5
5.05
6.05
2.647
0.15
0.0065(A)
12.5
15.3040
June 20x3
75
5
6
2.25
0.13
–
12.5
14.8800
Dec. 20x3
62.5
5.275
6.275
1.961
0.10
0.0065(A)
12.5
14.5680
June 20x4
50.0
6
7
1.75
0.08
–
12.5
14.3300
Part II Dec. 20x4
37.5
6.075
7.075
1.327
0.05
0.0065(A)
12.5
13.8840
June 20x5
25.0
4.575
5.575
0.697
0.03
-
12.5
13.2270
Dec. 20x5
12.5
5.15
6.15
0.384
0
0.0065(A)
12.5
12.8910
* LIMEAN is the average of LIBOR and LIBID. Upfront costs in January 20x0
$ millions Management Fee (100 x 0.6%) 0.6 Underwriting Fee (100 x 0.25%) 0.25 Commitment Fee (Jan. – June 20x0 (50 x 0.2%)/2 0.05 Guarantee Fee (50 x 0.4%)/2 0.10 The effective cost to the company is the value of k which equates 50 +
50 1.444 1.520 12.828 =1+ + + ...... + 2 1 + k) (1 + k) (1 + k) (1 + K)12
By solving k
=
2.76%
Annual effective cost
=
(1 + k) 2 – 1
=
(1 + 0.0276)2 – 1
=
5.60%
Assumptions:
65.
i.
Commitment fee is paid at the beginning of the half-year period.
ii.
Repayment starts from the end of the half year after the grace period i.e. from the end of June 20x2.
The payment towards interest and various fees in respect of the syndicated loan are as follows: (in $ million) Upfront 31.12.20x0 31.12.20x1 31.12.20x2 Opening Balance of Loan Interest
0.00
Amortization
0.00
31.12.20x3
31.12.20x4
31.12.20x5
31.12.20x6
150.00
300.00
400.00
400.0
300.0
200.0
100.0
10.80
15.60
24.80
32.8
21.6
18.4
8.2
100.0
100.0
100.0
100.0
Management Fee
2.4
0
0
0
0
0
0
0
Underwriting Fee
2.0
0
0
0
0
0
0
0
Commitment Fee
0.0
02.00
0.800
Agency Fee
0.0
0.015
0.015
0.015
0.015
0.015
0.015
0.015
Guarantee Fee
1.125
2.25
3.00
3.00
2.25
1.50
0.75
0
Total Payment
5.525
15.065
19.415
27.815
135.065
123.115
119.165
108.215
Working Notes:
i.
Management fee is payable upfront on the entire syndicated loan. It is equal to $400 million x 0.6% = $2.4 million.
ii.
Underwriting fee is also payable upfront on the entire loan. It is equal to $400 million x 0.5% = $2 million.
iii.
Commitment fee is calculated on undrawn balances at 0.8% p.a. It is calculated as follows: 243
Investment Banking and Financial Services
I year : $250 million x 0.8% = $2 million II year : $100 million x 0.8% = $0.8 million iv.
Guarantee fee payable in advance = 0.75% on outstanding balances 0th year $150 million x 0.75%
$1.125 million
I year
$300 million x 0.75%
$2.25 million
II year
$400 million x 0.75%
$3 million
III year $400 million x 0.75%
$3 million
IV year $300 million x 0.75%
$2.25 million
V year
$1.5 million
$200 million x 0.75%
VI year $100 million x 0.75%
$0.75 million
The net cash flow during each year is calculated as follows: Year
Cash Inflow Cash Outflow Net Cash flow
0
+ 150
–5.525
144.475
1
+ 150
–15.065
134.935
2
+ 100
– 19.415
80.585
3
–27.815
–27.815
4
–135.065
–135.065
5
–123.115
–123.115
6
–119.165
–119.165
7 –108.215 –108.215 The effective cost of the loan is the value of `r’ in the following: 0 = –144.475 −
134.935 90.585 27.815 135.065 108.215 + + + − 1+ r (1 + r) 2 (1 + r)3 (1 + r)4 (1 + r)7
= 8.35% 66.
The cash inflow in the 0th year is Loan
–
$300.0 mln.
Less: Arrangement Fee
–
$ 1.5 mln. $298.5 mln.
Annual cash outflow Interest
–
$ 18.00 mln.
Facility Fee
–
$ 0.75 mln.
Agent Fee
–
$ 0.01 mln. $ 18.76 mln.
The annual cash flows are as follows:
244
Year
Cash flow (million $)
0
+298.50
1
–18.76
2
–18.76
Part II
3
–18.76
4
–18.76
5
–317.26
Cost of loan is value of `i’ in the following: 18.76 18.76 18.76 18.76 317.26 2 3 1 + i (1 + i) (1 + i) (1 + i) 4 (1 + i)5
= 298.5 –
At i = 6%, the above is equal to –4.31 At i = 7%, it is equal to 7.68 Hence, ‘i’ lies between 6% and 7% By interpolation i = 6.35% Fees earned by National Westminster Bank: 15 BP on amount of loan i.e. $300 million
0.45
25 BP on amount underwritten i.e. $100 million
0.25
10 BP on amount of commitment i.e. $30 million
0.03 0.73
The total fees earned by National Westminster Bank is $1 million. 67.
(in million $) Half-year ended
Loan o/s at the beginning
LIMEAN*
(1)
(2)
(3)
Annual Interest Rate (%) (1.5% over limean) (4)
Interest Paid
Guarantee Fee
Agency Fee & Commitment
Principal Repaid
Cash outflow
(5) = (2) x (4) 2
6
7
8
(9)=(5)+ (6)+(7)+(8)
÷
June, 20x0
100
5-00
5.075
2.5375
0.2500
0.125(C)
—
2.9125
Dec., 20x0
100
5-25
5.329
2.664
0.2500
0.005(A)
—
2.9190
June, 20x1
200
5-00
5.075
5.075
0.5000
—
—
5.5750
Dec., 20x1
200
5-00
5.075
5.075
0.5000
0.005(A)
—
5.5800
June, 20x2
200
6-00
6.09
6.09
0.5000
—
25
6.5900
Dec., 20x2
175
6-00
6.09
5.329
0.4375
0.005(A)
25
30.7720 28.8010
June, 20x3
150
4-50
4.568
3.426
0.3750
—
25
Dec., 20x3
125
5-20
5.278
3.299
0.3125
0.005(A)
25
28.6170
June, 20x4
100
5-50
5.583
2.792
0.2500
—
25
28.0420
Dec., 20x4
75
5-00
5.075
1.903
0.1875
0.005(A)
25
27.0960
June, 20x5
50
5-25
5.329
1.332
0.1250
—
25
26.4570
Dec., 20x5
25
5-50
5.5825
0.698
0.0625
0.005(A)
25
25.7660
*
LIMEAN is the average of LIBOR and LIBID.
Upfront costs in January, 20x0 $ millions 1.
Management Fee (200 x 0.75%)
1.500
2.
Underwriting Fee (200 x 0.25%)
0.500
3.
Commitment Fee (Jan. - June, 20x0 – 100 x 0.25% Invalid EQN syntax: symbol ÿ 2)
0.125
4.
Guarantee Fee (100 x 0.5% ÷ 2)
0.250 245
Investment Banking and Financial Services
2.375 The effective cost to the company is the value of k which equates – 100 +
100 2.9125 2.919 25.766 = 2.375 + + + ............. + 2 (1 + k) (1 + k) (1 + k) (1 + k)12
0
= – 97.625 –
97.088 3.88 25.88 + + ............... + 2 (1 + k) (1 + k) (1 + k)12
Assumptions:
68.
i.
Commitment fee is paid at the beginning of the half-year period.
ii.
Repayment starts from the end of the half-year after the grace period i.e. from the end of June, 2001.
The payment towards interest and various fees in respect of the syndicated loan are as follows: (in $ millions) Up-front 31.12.20x0 31.12.20x1 Opening Balance of loan
31.12.20x2 31.12.20x3 31.12.20x4 31.12.20x5
31.12.20x6
100.00
250.00
400.00
400.00
300.00
200.00
100.00
Interest
0.00
7.00
15.00
28.00
20.00
24.00
18.00
7.00
Amortization
0.00
0.00
0.00
0.00
100.00
100.00
100.00
100.00
Management fee (W.N. i)
2.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Underwriting Fee (W.N. ii)
1.60
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Commitment Fee (W.N. iii)
0.00
2.25
1.13
0.00
0.00
0.00
0.00
0.00
Agency Fee
0.00
0.01
0.01
0.01
0.01
0.01
0.01
0.01
0.60
1.50
2.40
2.40
1.80
1.20
0.60
9.86
17.64
30.41
122.41
125.81
119.21
107.61
Guarantee Fee (W.N. iv) Total payment
3.60
Working Notes:
i.
Management fee is payable upfront on the entire syndicated loan. It is equal to $400 million x 0.5% = $ 2 million.
ii.
Underwriting fee is also payable upfront on the entire loan. It is equal to $400 million x 0.4% = $1.6 million.
iii.
Commitment fee is calculated on undrawn balances at 0.75% p.a. It is calculated as follows:
iv.
246
I Year
$300 million x 0.75%
= $2.25 million.
II Year
$150 million x 0.75%
= $1.13 million.
Guarantee fee payable in advance = 0.6% on outstanding balances 0th Year
$100 million x 0.6%
$0.6 million
I Year
$250 million x 0.6%
$1.5 million
II Year
$400 million x 0.6%
$2.4 million
III Year
$400 million x 0.6%
$2.4 million
IV Year
$300 million x 0.6%
$1.8 million
Part II
V Year
$200 million x 0.6%
$1.2 million
VI Year
$100 million x 0.6%
$0.6 million
The net cash flow during each year is calculated as follows: Year
Cash inflow
Cash outflow
Net cash flow
0
+100
–3.6
+96.40
1
+150
–9.86
+140.14
2
+150
–17.64
+132.36
3
–
–30.41
–30.41
4
–
–122.41
–122.41
5
–
–125.81
–125.81
6
–
–119.21
–119.21
7 – –107.61 –107.61 The effective cost of the loan (IRR) is the value of `r’ in the following:
0 = –96.4 –
140.14 132.36 30.41 122.41 125.81 119.21 107.61 r = 7.84% + + + + + 2 3 1 + r (1 + r) (1 + r) (1 + r) 4 (1 + r)5 (1 + r)6 (1 + r)7
69. (Amount in billion Yens) Upfront
31.12.20x0
31.12.20x1
31.12.20x2
31.12.20x3 31.12.20x4 31.12.20x5 31.12.20x6
31.12.20x7
Interest
0.000
0.250
0.400
0.450
0.500
0.600
0.600
0.350
0.150
Amortization
0.000
0.000
0.000
0.000
0.000
5.000
5.000
5.000
5.000
Management Fee
0.030
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
Underwriting Fee
0.050
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
Commitment Fee
0.010
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
Agency Fee
0.025
0.025
0.025
0.025
0.025
0.025
0.025
0.025
0.000
Guarantee Fee
0.000
0.050
0.100
0.100
0.100
0.100
0.075
0.050
0.025
Total
0.115
0.325
0.525
0.575
0.625
5.725
5.700
5.425
5.175
Computation of Effective Cost of Borrowings
Year
Cash flows
0
10 – 0.115 = 9.885
1
10 – 0.325 = 9.675
2
–0.525
3
–0.575
4
–0.625
5
–5.725
6
–5.700
7
–5.425
8
–5.175 247
Investment Banking and Financial Services
Year
Cash flows
IRR
3.47%
∴ Effective cost of loan to Naveen Industries Ltd. is 3.47%.
70. Particulars
Upfront
31.12.x0
31.12.x1
31.12.x2
31.12.x3
31.12.x4
31.12.x5
31.12.x6
31.12.x7
Interest
0.00
2.32
4.24
6.15
6.95
6.60
6.50
5.80
2.53
Amortization
0.00
0.00
0.00
0.00
0.00
0.00
0.00
50.00
50.00
Management fee
0.30
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Underwriting fee
0.40
0.00
0.00
0.00
0.00
0000
0.00
0.00
0.00
Commitment fee
0.00
0.18
0.06
0.00
0.00
0000
0.00
0.00
0.00
Agency fee
0.00
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
Guarantee fee
0.20
0.40
0.50
0.50
0.50
0.50
0.50
0.25
0.00
Total
0.90
3.00
4.90
6.75
7.55
7.20
7.10
56.15
52.63
Computation of Effective Cost of Borrowings
Year
Cash flows
Year 0
39.10
Year 1
37.00
Year 2
15.10
Year 3
–6.75
Year 4
–7.55
Year 5
–7.20
Year 6
–7.10
Year 7
–56.15
Year 8
–52.63
IRR
6.97%
Working Notes: Computation of CHF Limean
248
Year
CHF LIBID (%)
CHF LIBOR (%)
CHF Limean (%)
2000
4.90
5.10
5.00
2001
4.45
4.55
4.50
2002
5.30
5.40
5.35
2003
6.10
6.20
6.15
2004
5.70
5.90
5.80
2005
5.60
5.81
5.70
2006
4.95
5.05
5.00
Part II
2007
4.20
4.30
4.25
249
Investment Banking and Financial Services
AN INTRODUCTION TO EQUIPMENT LEASING 71.
a.
i.
Lease term
3 years
ii.
Useful life of the asset
5 years
iii.
(i) as a percentage of (ii)
60.00%
* Since the lease term does not exceed 75% of the useful life of the asset, it cannot be classified as a finance lease. Present value of minimum lease payments = 0.435 x 350 = 152.25 = 152.25 x PVIFA(20,3) = 152.25 x 2.106 = 320.64 Fair market value of the asset at the time of = Rs.350.00 lakh inception of the lease Present value as a percentage of the fair ⎛ 320.64 ⎞ = Rs.91.61% ⎜ market value ⎟ ⎝ 350.00 ⎠ ** As the present value of minimum lease payments exceeds 90% of the fair market value of the asset, the lease can be classified as a finance lease. b.
i.
Useful life of the asset
8 years
ii.
Lease term
3 years
iii.
(ii) as a percentage of (i) 37.50% As the lease term does not exceed 75% of the useful life of the asset, it cannot be classified as a finance lease. However, considering the fact that the present value of minimum lease payments exceeds 90% of the fair market value of the asset at the time of inception, the transaction can be classified as a finance lease. * For a lease to be classified as a financial lease, the lease term should exceed 75% of the useful life of the asset. ** For a lease to be classified as a finance lease, the PV of minimum lease payment should exceed 90% of the fair market value of the asset.
72. Loan component
65.00 x 0.70 crore
Equity component
19.50 crore (65 x 0.3)
Equated annual installment
45.50 crore
45.50 /PVIFA(16,5) 45.50/3.274
13.89 crore
Denote the annual rental as Y Then (Y – 13.89) x PVIFA(20,5)
= Rs.19.5 crore
(Y – 13.89) x 2.991
= Rs.19.5 crore
Y – 13.89
= Rs.6.52 crore
Y
= Rs.20.41 crore
In terms of the standard quote, the lease rental works out to be 20.41 x 1,000/65 314.00/1,000 per annum i.e. 314 per thousand per annum. 73.
a.
Let the Equated Rental be denoted by ‘L’. L x PVIFA(22,5)
= 45 lakh
L x 2.86
= 45
L
= 15.73 lakh 250
Part II
b.
When the lease rental is deferred for 1 year, the rental structure will be as follows: Year
Rental (a) 0 L L L L
1 2 3 4 5
L x 2.044
PV factor @ 22% (b) 0.819 0.672 0.551 0.451 0.370
axb L(0) L(0.672) L(0.551) L(0.451) L(0.370) L(2.044)
= 45 lakh
L = 45/2.044 = 22.02 The deferred lease rental will thus be
74.
Year Lease Rental 1 0.00 2 22.02 3 22.02 4 22.02 5 22.02 The lessor will have to price his lease so as to obtain a gross pre-tax return of 20.5% p.a. Lease Rental under the Stepped Rental Structure: Assume the lease rental to be charged is L, and the lease rental increases by 10% p.a. L x PVIF(20.5,1) + 1.10L x PVIF(20.5,2) + 1.21L x PVIF(20.5,3) + 1.33L x PVIF(20.5,4) Rs.80 lakh + 1.46L x PVIF(20.5,5) = (L x .830) + (1.10L x .689) + (1.21L x 0.572) + (1.33L x .474) + (1.46L x .394) = Rs.80 lakh L(0.83) + L(0.76) + L(0.69) + L(0.63) + L(0.58) = Rs.80 lakh L(3.49)
=
Rs.80.00 lakh
L
=
80/3.48 = Rs.22.92 lakh
Lease rentals Year 1 2 3 4 5
Rs. in lakh 22.92 (22.92 x 1.1) = 25.21 (25.21 x 1.1) = 27.73 (27.73 x 1.1) = 30.51 (30.51 x 1.1) = 33.56
Ballooned Rental Structure: 3 x PVIF(20.5,1) + 3 x PVIF(20.5,2) + 3 x PVIF(20.5,3) + 3 x PVIF(20.5,4) + L x PVIF(20.5,5) = Rs.80 lakh (3 x 0.830) + (3 x 0.689) + (3 x 0.572) + (3 x 0.474) + (L x 0.394) = Rs.80 lakh 2.49 + 2.07 + 1.72 + 1.42 + L(0.39) = Rs.80.00 lakh L(0.39)
= Rs.80.00 – 7.70
L
= Rs.185.39 lakh
251
Investment Banking and Financial Services
The ballooned payment to be made in the fifth year is Rs.185.39 lakh. Therefore, the lease rental structure will be Lease Rental (Rs. in lakh) 3.00 3.00 3.00 3.00 185.39
Year 1 2 3 4 5 75.
a.
Leverage Ratio Total Debt Long − term Debt = or Net Worth Net Worth Total Debt/Net Worth Loan Funds + Current + Liabilities = Net Worth =
3, 400 + 1,850 = 3.09 1, 700
Long-Term Debt/ Net Worth =
Loan Funds − Cash Credit Net Worth
=
3, 400 − 1, 068 = 1.37 1, 700
Fixed Assets Turnover Ratio =
Net Sales Net Fixed Assets
=
9, 000 = 2.57 3,500
Return on Investment
b.
=
PBIT x100 Total Assets
=
2, 250 x 100 = 32.37 6,950
The revised financial statements will be as follows: Income Statement for the Year Ended March 31, 1999 Rs. in lakh Net sales 9,000 Cost of goods sold 4,500 General expenses 1,590 Lease rental (950 x 0.375) 356.25 Interest charges (675 – 175.75) 499.25 Depreciation 660 – (950 x 0.333) 343.65 Profit before tax 1,710.85 Tax @ 40% 684.34 Profit after tax 1,026.51
252
Part II
Balance Sheet as on March 31, 1999 Sources of Funds: A: Shareholders’ Funds Share Capital Reserves and Surplus (1250 – 945 + 1026.51) B: Loan Funds 10% Debentures Term Loans (872 + 190 – 950) Cash Credit C: Total (A + B) Application of Funds: D: Fixed Assets Original Cost (5000 – 950) Less: Acc. Depreciation (1500 – 316.35) Net Block Add: Capital Work-in-progress
E: F:
G:
Investments Current Assets Cash and Bank Balances (500 + 190 + 175.75 – 356.25) Receivables Inventory Other Current Assets Less: Current Liabilities Accounts Payable Provisions (850 – 630 + 684.34)
450 1,332 1,782 1,460 112 1,068
2,640 4,422
4,050 1,183 2,867 500 3,367 500 510 750 1,000 200 2,460 1,000 904 1,904
H: I:
Net Current Assets (F – G) Total Total Debt 2, 640 Leverage Ratio = = = 1.48 1, 782.2 Net Worth
556 4,423
or Loan Funds − Cash Credit 1,572 = = 0.88 1, 782 Net Worth
Fixed Assets Turnover Ratio Net Sales 9, 000 = = 3.14 Net Fixed Assets 2,867 ROI =
PBIT 2, 210 x100 = 34.94% x100 = 6,327 Total Assets
253
Investment Banking and Financial Services
76.
a.
Borrowing rate per month =
18 = 1.50 12
Present value of monthly lease rentals payable at the beginning of every month
= 0.022 (1 + 1.5%) x 670 x PVIFA(1.5,60) = 14.74 x (1 + 1.5%) x PVIFA(1.5, 60) = 14.74 x 1.015 x PVIFA(1.5,60) = 14.74 x 1.015 x 39.38 = Rs.589.17 lakh
i. Cost of the asset
= Rs.670.00 lakh
ii. PV of monthly lease payments
= Rs.589.17 lakh
(ii) as a percentage of (i)
87.94%
As the present value of monthly lease payments does not exceed 90% of the asset cost at the time of inception of the lease the transaction is not a finance lease. i.
Economic life of the asset 10 years
ii.
Lease term (ii) as a percentage of (i)
7 years 70%
As the percentage does not exceed 75%, it cannot be classified as a finance lease. b.
In case of (b), the economic life is 8 years being least of the physical life, technological life and the product market life Lease term
= 7 years
Lease term as a percentage of the economic life
= 7/8 x 100 = 87.50
As the percentage exceeds 75%, the transaction can be treated as a finance lease. 77.
a.
Cost of capital = 14 x
2 1 x 0.65 + 22 x = 13.4% 2 3
NPV (Buy) i.
Present value of EBDIT (1 – T): EBDIT =Rs.20 lakh Tax rate = 35% EBDIT (1 – T) = 20(1 – 0.35) = Rs.13.00 lakh Present value = 13.00 x PVIFA(13.4,5)
= ii.
13.00 x 3.483 = Rs.45.28 lakh
Present value of depreciation tax shields: Year
Depreciation @ 25%
PVIF(13.4, i)
Present value
1
12.50
0.882
11.03
2
9.38
0.778
7.30
3
7.03
0.686
4.82
4
5.28
0.605
3.19
5
3.96
0.533
2.11
38.15
28.45
Tax shield = 28.45 x 0.35 = Rs.9.96 lakh. 254
Part II
iii.
Present value of interest tax shield: As the evaluation is based on suggested framework the amount replaced by leasing is assumed to be the PV of lease rentals. PV of lease rentals = 50 x 0.035 x 3 x i/d4 x 4 x PVIFA(14,5) = Rs.78.30 lakh 78.30 = Rs.22.808 lakh Equated Annual Installment = PVIFA (14, 5)
Actual annual lease payment = 50 x 0.035 x 12 = Rs.21 lakh Adjustment factor = 22.808 – 21 = Rs1.808 lakh. Adjusted interest = Interest – Adjustment factor. Interest Amortization Schedule (Rs. lakh) Year Loan amount outstanding 1 78.300 2 66.454 3 52.950 4 37.555 5 20.005
iv.
v.
vi. vii.
viii.
b.
Interest @ 14% 10.962 9.304 7.413 5.258 2.801
Capital Equated annual Adjusted content installment interest 11.846 22.808 9.154 13.504 22.808 7.496 15.395 22.808 5.605 17.550 22.808 3.450 20.007 22.808 0.993
PV @ 13.4% 8.073 5.832 3.845 2.088 0.529 20.367
PV of interest tax shield = 20.367 x 0.35 = Rs.7.13 lakh. Present value of salvage value: Book value at the end of fifth year = 50 – 38.15 = Rs.11.85 lakh Salvage value = 2 x 11.85 = Rs.23.70 lakh Present value of salvage value = 23.7 PVIF(13.4,5) = Rs.12.63 lakh NPV (Buy) = – Initial investment + PV of EBDIT (1 – T) + PV of depreciation tax shields + PV of interest tax shield + PV of salvage value = –50 + 45.28 + 9.96 + 7.13 + 12.63 = Rs.25.00 lakh Present value of lease rentals (already calculated) = Rs.78.03 lakh Present value of tax shield on lease rentals = 50 x 0.035 x 12 x 0.35 x PVIFA(13.4,5) = 21 x 0.35 x 3.483 = Rs.25.60 lakh NPV (Lease) = Present value of EBDIT(1 – T) – PV of lease rentals + PV of tax shield on lease rentals = 45.28 – 78.30 + 25.60 = – Rs.7.42 lakh The company should acquire the equipment as the NPV of buy is positive. As the NPV (Buy) is positive and greater than NPV (Lease), the company should buy the equipment.
LEASING IN INDIAN CONTEXT 78.
The coupon payments will be at the following rates: Year 1 2 3 4 5
Coupon rate (%) = Inflation rate + 5% 10.0 9.5 10.0 11.0 12.5
The price at which the bond can be issued = 10 x PVIF(18,1) + 9.5 x PVIF(18,2) + 10 x PVIF(18,3) + 11 x PVIF(18,4) + 112.5 x PVIF(18,5) = 10 x 0.847 + 9.5 x 0.718 + 10 x 0.609 + 11 x 0.516 + 112.5 x 0.437 = Rs.76.22 255
Investment Banking and Financial Services
79.
a.
Net owned funds of the company as on March 31, 1999 = Equity share capital + Reserves and surplus – Investments in wholly owned subsidiaries – Miscellaneous expenditure (not written off) = 140 – 15 – 36 = Rs.89.00 million
b.
Maximum debt capacity = 89 x 10 = Rs.890.00 million Outstanding amount of debt= Rs.261.00 million (56 + 120 + 85) Amount of debt that can be raised = Rs.629.00 million Additional amount of bank borrowings that can be raised = 89 x 4 – 85 = Rs.271.00 million Since the company wants to raise 450 million, the desired financing mix will be as follows:
80.
Bank borrowings
Rs.271.00 million
Term loan
Rs.179.00 million
Define im as the monthly rate of return implied by the cash flow stream. im can be calculated as: + 9 x PVIFA x PVIF + 7 x PVIFA x PVIF 235 = 11x PVIFA (i ,12) m
81.
(i ,12) m
(i ,12) m
(i ,6) m
(i , 24) m
Assuming im = 1% = 11 x 11.255 + 9 x 11.255 x 0.887 + 7 x 5.795 x 0.787 = 123.805 + 89.84 + 31.92 = 245.565 Assuming im = 2% = 11 x 10.575 + 9 x 10.575 x 0.788 + 7 x 5.601 x 0.621 = 116.325 + 74.99 + 24.31 = 215.625 Since the required value of aggregate receivables lies between the two values 245.565 @ 1% and 215.625 @ 2%, the value of im lies between 1% and 2%. By interpolating, 245.565 − 235.00 10.565 0.01 + x1 = 1% + x 1 = 1 + 0.35 = 1.35% 245.565 − 215.625 29.94 = 1.35% im i = (1 + im)12 – 1 = (1.0135)12 – 1 = 1.1745 – 1 = 0.1745 = 17.45% Rs. in crore Equity share capital 140.00 Share premium 56.00 General reserve 126.40 Profit on sale of assets 54.70 377.10 Less: Intangible assets 33.60 Owned funds 343.50(A) Investments in shares and debentures of subsidiary companies 32.92 Loans and advances to group companies 21.98 Deposits with subsidiary companies 15.64 70.54(B) Excess of B over 10% of owned funds 36.19(C) Net owned funds (A – C) 307.31
256
Part II
82.
a.
Net owned funds = Paid-up Share Capital + Free Reserves – Miscellaneous Expenses – Investments in wholly owned subsidiaries = 150 + 310 – 85 – 140 = 460 – 225 = Rs.235 lakh
b.
Maximum permissible borrowings (10 times of NOF) Existing level of borrowings
= 235 x 10 = Rs.2,350 lakh = Term loans + Bank borrowings + Public deposits = 90 + 705 + 720 = Rs.1,515 lakh
Additional amount of debt that can be raised
= 2,350 – 1,515 = Rs.835 lakh
Working Notes:
i.
It is assumed that current liabilities do not include deemed deposits like Inter Corporate Deposits. If ICDs are included in current liabilities, then borrowings as defined above will include inter corporate deposits.
ii. 83.
Net owned funds has been computed using the formula provided by the NonBanking Financial Companies (Reserve Bank) Directions, 1977.
10 x PVIF(18.5,1) + 11.2 x PVIF(18.5,2) + 12.54 x PVIF(18.5,3) + 14.05 x PVIF(18.5,4) + 15.74 x PVIF(18.5,5) + 17.62 x PVIF(18.5,6) + 19.74 x PVIF(18.5,7) + 110 x PVIF(18.5,7) = 10 x 0.844 + 11.2 x 0.712 + 12.54 x 0.601 + 14.05 x 0.507 + 15.74 x 0.428 + 17.62 x 0.361 + 19.74 x 0.305 + 110 x 0.305 = 8.438 + 7.975 + 7.538 + 7.124 + 6.734 + 6.364 + 6.015 + 33.524 = Rs.83.7
84.
True Yield* Maturity period True Yield (in months) (%) 13 15.50% 36 15.50% 48 15.50% 60 15.50% Under the cash certificate scheme, a cash certificate of face value Rs.5,000 will be issued at a discount and redeemed at par after 13 months so as to yield 15.50% p.a. Issue price will, therefore, be =
5, 000 FVIF
= Rs.4227.5
(15.50, 1.083)
Note: 13/2 = 1.083
The issue price for other maturities can be calculated similarly (but the value of ‘m’ changes accordingly). Cash Certificate Scheme
Period Issue price Maturity value True yield Simple (in months) (Rs.) (Rs.) (%) interest yield (%) 13 4,278 5000 15.5% 15.6% 36 3,245 5000 15.5% 18.03% 48 2,809 5000 15.5% 19.49% 60 2,433 5000 15.5% 21.11% * The relationship between the effective annual rate of interest (r) and the nominal rate of interest (i) per annum compounded ‘m’ times a year is given by the formula: 257
Investment Banking and Financial Services
1 + r = (1 + i/m)m i = 14.5% m = 12 12
⎛ 0.145 ⎞ Therefore, 1 + r = ⎜1 + ⎟ 12 ⎠ ⎝ ⇒ r = 15.5%
TAX ASPECTS OF LEASING 85.
a.
Depreciation charge for the current financial year WDV at the beginning of the year Add: Cost of assets acquired during the year Less: Proceeds on sale of assets during the year Written down value for charging depreciation Depreciation allowance for the year
b.
Written down value at the end of the year Depreciation charge for the following financial year
Rs. 224.00 100.00 324.00 13.00 311.00 311.00 77.75 233.25 233.25 Rs.
Written down value as at the beginning of the year Add: Cost of assets to be acquired during the year Less: Proceeds on sale of assets likely to be realized during the year Depreciation allowance for the year Working Notes:
Normal depreciation allowance Less: Depreciation allowance inadmissible in respect of assets acquired after September 30 20* x 0.25 x 0.5 Admissible allowance * 50% of the fresh investment.
233.25 40.00 273.25 22.00 251.25 60.31 190.94 Rs. 62.81
2.5 60.31
86.
A. Cost of the equipment to Vindya Ltd
= 67 x 1.04 = Rs.69.68 lakh 67 x 1.10* B. Cost of the equipment to Malathi Financial Services = = Rs.73.7 lakh Lease rentals to be paid by Vindhya Ltd. = 73.7 x 0.05528 = Rs.4.07 lakh per month. * The lessor bears the impact of sales tax at the normal rate of 10%.
258
Part II
87.
a.
Depreciation charge for the current financial year Block Rate of depreciation (%)
A 25 186 200 386 25 361 361 90.25 270.75
A. WDV at the beginning of the year Add B. Cost of assets acquired during the year A+B Less Proceeds on sale of assets during the year
b.
D. WDV for reckoning depreciation E. Depreciation allowance for the year F. WDV as at the end of the year Depreciation charge for the following financial year Block Rate of depreciation (%) A.
D. E. F. Notes:
WDV at the beginning of the year Add: B. Cost of assets to be acquired during the year A+B Less: C. Proceeds on sale of assets expected to be realized during the year (see note 2) WDV for reckoning depreciation Depreciation allowance for the year WDV as at the end of the year
1.
Block
88.
A 25 270.75 60.00 330.75 10.00
B 40 82.20 25.00 107.20 15.00
320.75 76.43 244.31
92.20 34.38 57.82
(Rs. in lakh) A
(Rs. in lakh) B
Normal depreciation allowance
80.19
36.88
Less: Depreciation allowance in-admissible in respect of assets acquired after September 30th of the year
30 x 0.25 x 0.5 12.5 x 0.40 x 0.5 (50% of the fresh investment 2.5 3.75
Admissible allowance 2.
B 40 125 56 181 44 137 137 54.8 82.2
76.43
34.38
Where the entire block of assets have been sold during a year for an amount higher than (A + B) or where the sale proceeds on the part of the block that has been sold is higher than (A + B), the difference will be treated as shortterm capital gain and taxed at the marginal rate of tax; in the case of widely held companies, where the entire block of assets has been sold for an amount less than (A + B), the difference will be treated as Short-term Capital Loss and the assessee will be entitled to a tax shield at the marginal rate of tax.
Alternative I: Debt Financing
Year 1 (Rs. in lakh) Tax deductible expense Interest on long-term debt
Year 2 (Rs. in lakh)
(415 x 0.165) [(415 – 103.75) x 0.25] 68.475 54.78
Depreciation
103.750
77.81
Total (A)
172.225
132.59
79.220
60.99
Tax shield (A x 0.46)
259
Investment Banking and Financial Services
Alternative II: Finance Lease
Tax deductible expenses
(415 x 0.310)
(415 x 0.310)
Lease Rentals (B)
128.65
128.65
Tax Shield (B x 0.46)
59.179
59.179
Alternative I is recommended as it generates a higher amount of tax shield. Working Notes:
1.
Debt Repayment Schedule: Year Loan outstanding at the beginning Interest @ 16.5% p.a. Loan installment Loan outstanding at the end
2.
89.
Depreciation Schedule Year Opening WDV Depreciation Closing WDV
Rs. in lakh 1 415.00 68.48 83.00 332.00
1 415.00 103.75 311.25
Rs. in lakh 2 332.00 54.78 83.00 249.00
2 (415 – 103.75) = 311.2500 77.8120 233.4375
Being a 100% EOU, the company can neither avail of the lease related tax shelters nor avail of the acquisition related tax shelters. Therefore, the company will not be willing to accept a rental stream whose present value exceeds Rs.65 lakh; Put differently, if ‘L’ denotes the maximum annual lease rental RSML is willing to pay, the value of L can be determined from the equation L x PVIFA(17.5,7) 3.866L L
= = =
65 65 16.81
If the annual lease rental charged by Sumeet Leasing Ltd. is less than 16.81, RSML will find it worthwhile to lease the equipments. 90.
Cost of the equipment to Innovative Ltd. including = 115 x 1.04 = Rs.119.6 lakh sales tax Cost of the equipment to DLL
= 115 x 1.10* = Rs.126.5 lakh
Lease rentals to be paid to DLL = 126.5 x 0.0245 = Rs.3.099 lakh p.m. By opting for a lease, Innovative Ltd. is able to avert the initial outflow of Rs.119.6 lakh. But then, it ends up paying lease rentals on an enhanced investment cost because the lessor bears the impact of sales tax at the normal rate of 10%. So other things being equal, the present value of the lease rentals paid by Innovative Ltd. will be higher than Rs.119.6 lakh.
LEASE EVALUATION: THE LESSEE’S ANGLE 91.
a.
In order to determine as to whether Indusway should lease or buy the equipment; the NPV(L) and the NPV(B) should be calculated. NPV(L) = PV[EBDIT (1 – T)] – PV (LR) + PV (Tax shield on lease rental – Management Fee) + PV (Tax Shield on Management Fee) Discount rate to be applied is the marginal cost of capital which is calculated as under D E x K D x (1 − T ) + x KE D+E D+E ⎤ ⎤ ⎡1 ⎡2 = ⎢ x 17.5 x 0.54⎥ + ⎢ x 22⎥ = 6.33 + 7.33 = 13.63% 3 3 ⎦ ⎦ ⎣ ⎣ K=
260
Part II
PV [EBDIT (1 – T)] = [20 x 0.54 x PVIFA (13.63,3)] + [17 x 0.54 x PVIFA(13.63,2) x PVIF(13.63,3)] = = =
(20 x 0.54 x 2.336) + (17 x 0.54 x 1.654 x 0.682) 25.23 + 10.36 Rs.35.59 lakh
PV of Lease Rentals
=
21.40 x1.10 x 12 x 0.0285 x PVIFA(13.63, 5) 1.04 22.63 x 12 x 0.0285 x 3.463 = 26.80
=
PV(LR) x 0.46
=
26.80 x 0.46 = Rs.12.32 lakh
NPV(L)
=
35.59 – 26.80 + 12.32 = Rs.21.11 lakh
NPV(B)
=
– A + PV [EBDIT (1 – T)] + PV(DT) + PV(RV)
A
=
Acquisition cost = Rs.21.4 lakh
=
PV(LRT)
PV[EBDIT (1 – T)] = Rs.35.59 lakh PV[DT] = [*5.35 x PVIF(13.63,1) + 4.01 x PVIF(13.63,2) + 3.01 x PVIF(13.63,3) + 2.26 x PVIF(13.63,4) + 1.69 x PVIF(13.63,5)] x 0.46
PV(RV) NPV(B)
=
[(5.35 x 0.88) + (4.01 x 0.77) + (3.01 x 0.68) + 2.26 x 0.599 + 1.69 x 0.5279] x 0.46
=
[4.708 + 3.108 + 2.051 + 1.354 + 0.894] x 0.46
= =
12.11445 x 0.46 = Rs.5.57 lakh 1.78** x PVIF(13.63,5)
=
1.78 x 0.5279 = Rs.0.94 lakh
=
–21.4 + 35.59 + 5.57 + 0.94 = Rs.20.70 lakh
As NPV (L) is greater than NPV (B), leasing is recommended. b.
Let us denote the annual break even rental as L. The value of L can be obtained by solving for L in the equation NPV(L) – NPV(B) = 0 = –3.463L + (0.46 x 3.463)L + 21.4 – 5.572 – 0.94 = 0 = –3.463L + 1.593L = –21.4 + 5.572 + 0.94 = –1.87L = –14.89 L =
14.89 = Rs.7.96 lakh. 1.87
* 21.4 x 0.25 = 5.35 5.35 – (5.35 x 0.25) = 4.0125 4.0125 – (4.0125 x 0.25) = 3.01 3.01 – (3.01 x 0.25) = 2.26 2.26 – (2.26 x 0.25) = 1.69 **21.4 – (5.35 + 4.01 + 3.01 + 2.26 + 1.69) = 5.08 Net salvage value / Residual value = 5.08 x 0.35 = 1.778 ~ 1.78 92.
Marginal cost of capital =
2 1 x 0.185 x (1 – 0.46) + x 0.22 3 3
= 0.0666 + 0.0733 = 13.99% or say 14% 261
Investment Banking and Financial Services
The present value of the net cash flow stream associated with the purchase option can be defined as: NPV(B) = – Initial investment + PV of [EBDIT stream (1 – Tax Rate)] + PV of [Tax shields on depreciation] + PV of [Net salvage value] PV of [EBDIT stream (1 – Tax Rate)] =
46 x [PVIF(14,1)] + 37 x PVIF(14,2) + 24 x [PVIF(14,3) + PVIF(14,4) + PVIF(14,5)] x 0.54
=
(46 x 0.877) + (37 x 0.770) + 24 [0.675 + 0.592 + 0.519] x 0.54 [40.35 + 28.48 + 1.24 x (1.786)] x 0.54
=
[40.35 + 28.48 + 42.88] 0.54 111.71 x 0.54
=
Rs.60.32 lakh.
PV of (Tax shields on depreciation) = [*15.70 x PVIF(14,1) + 11.78 x PVIF(14,2) + 8.83 x PVIF(14,3) + 6.62 x PVIF(14,4) + 4.97 x PVIF(14,5)] x 0.46 = [15.70 x 0.877) + (11.78 x 0.770) + (8.83 x 0.675) + (6.62 x 0.592) + (4.97 x 0.520)] x 0.46 =
(13.773 + 9.062 + 5.962 + 3.923 + 2.581) x 0.46 = 35.30173 x 0.46
=
16.23879 = Rs.16.24 lakh
PV of Interest on Intercorporate Borrowings = =
4 ) x PVIF(14,0.25) 5 3.0144 x 0.968 = Rs.2.92 lakh
(0.06 x 62.8 x
PV of (Interest tax shield on Intercorporate Borrowings) =
3.0144 x 0.46 x [PVIF(14,1)]
=
3.0144 x 0.46 x 0.877 = Rs.1.216 lakh
PV of (Net salvage value) = 7.5 x PVIF(14,5) = 7.5 x 0.519 = Rs.3.90 lakh NPV of purchase option = –62.8 + 60.32 + 16.24 – 2.92 + 1.216 + 3.90 = Rs.15.86 lakh The present value of the cash flow stream associated with the lease option is defined as follows: NPV(L) = –PV (Lease rentals) + PV[(EBDIT stream) x (1 – Tax Rate)] + PV (Tax shield on lease rentals) – Management fee + PV (Tax shield on Management fee) Lease Rentals 62.8 = x 1.10 x 0.310 = Rs.20.59 lakh 1.04 PV of lease rentals =
20.59 x PVIFA(14,5)
=
20.59 x 3.433 = Rs.70.69 lakh
PV [EBDIT stream (1 – Tax Rate)] =
Rs.60.32 lakh
PV (Tax shield on Lease rentals) =
20.59 x 0.46 x PVIFA(14,5)
=
20.59 x 0.46 x 3.433 = Rs.32.52 lakh 262
Part II
Management fee =
66.42 x 0.01 = Rs.0.66 lakh
PV (Tax shield on Management fee) =
0.66 x 0.46 x PVIF(14,1)
=
0.66 x 0.46 x 0.877 = Rs.0.26 lakh
NPV(L) =
–70.69 + 60.32 + 32.52 – 0.66 + 0.26
=
Rs.21.75 lakh. NPV(L) > NPV(B) > 0
Therefore, the equipment must be leased. *62.8 x 0.25 47.1 x 0.25 35.32 x 0.25 26.49 x 0.25 19.87 x 0.25 93.
= = = = =
15.7 11.78 8.83 6.62 4.97
Kd = 16.5 (1 – 0.46) = 16.5 x 0.54 = 8.91% a.
Initial investment
= Rs.47 lakh
b.
Present value of lease payments
= 47 x
c.
PV of tax shield on lease payments
325 x PVIFA(16.5%,5) 1000
= 15.275 x 3.236 = Rs.49.436 lakh = 15.275 x 0.46 x PVIFA(8.91,5) = 15.275 x 0.46 x 3.898 = Rs.27.39 lakh d.
PV of depreciation tax shields = [11.75 x PVIF(8.91,1) + 8.81 x PVIF(8.91,2) + 6.61PVIF(8.91,3) + 4.96 x PVIF(8.91,4) + 3.72 x PVIF(8.91,5)] x 0.46 = [(11.75 x 0.918) + (8.81 x 0.843) + (6.61 x 0.774) + (4.96 x 0.711) + (3.72 x 0.653)] x 0.46 = (10.789 + 7.427 + 5.117 + 3.525 + 2.428) x 0.46 = 29.286 x 0.46 = 13.471
e.
Present value of interest tax shields
= [*8.157 x PVIF(8.91,1) +6.982 x PVIF(8.91, 2) + 5.614 x PVIF(8.91, 3) + 4.020 x PVIF(8.91, 4) + 2.163 x PVIF(8.91, 5)] x 0.46 = (7.490 + 5.887 + 4.346 + 2.857 + 1.412) x 0.46 = 21.991 x 0.46 = Rs.10.116 lakh
Amortization Schedule for Equivalent Debt
Year 1 2 3 4 5
Amount of outstanding loan 49.436 42.318 34.025 24.365 13.110
Capital content 7.118 8.293 9.661 11.255 13.11
Interest content @ 16.5% p.a 8.157 6.982 5.614 4.020 2.163
Debt service charge 15.275 15.275 15.275 15.275 15.275
Net value of lease 47 – 49.436 + 27.39 – 13.471 – 10.116 = 1.367 Since NVL is positive the equipment should be leased. 263
Investment Banking and Financial Services
* Additional debt
= P.V. of lease payments
= 49.436 L
In the year I, P.V. of lease payments (debt O/S)
= Rs.49.436 L
Interest content @ 16.5% p.a.
= Rs.8.157
Now, the lease rental (debt service charge)
= 15.275 i.e. (47 x 0.325)
Therefore, capital content in the P.V. of lease payment = 15.275 – 8.157 = 7.118 L In the year II, debt O/S = 49.436 – 7.118
= 42.318.
The interest and capital contents are calculated as above. This is continued for all the years. 94.
a.
Amount of borrowing displaced by lease = 56 x 0.315 x [PVIFA(16.0,5)] = 56 x 0.315 x 3.274 = Rs.57.75 lakh
b.
The amortization schedule for displaced borrowing is as follows: Year
Debt Interest outstanding @ 16% p.a. 1 57.75 9.240 2 49.35 7.890 3 39.60 6.330 4 28.30 4.520 5 15.19 2.430 Post-tax cost of debt = 16 x 0.54 = 8.64%
Capital 8.400 9.740 11.303 13.112 15.209
Debt service charge 17.64 17.64 17.64 17.64 17.64
PV of Interest tax shields discounted at 8.64% = 9.24 x PVIF(8.64,1) + 7.89 x PVIF(8.64,2) + 6.33 x PVIF(8.64,3) + 4.52 x PVIF(8.64,4) + 2.43 x PVIF(8.64,5) = [(9.24 x 0.920) + (7.89 x 0.847) + (6.33 x 0.78) + (4.52 x 0.718) + (2.43 x 0.661)] x 0.46 = 24.99 x 0.46 = Rs.11.49 lakh c.
To decide whether or not the company must accept the lease proposal, the NVL has to be evaluated. A. Investment cost
= Rs.56 lakh
B. PV of lease rentals
= 57.75 lakh
C. PV (Tax shield = 17.64 x 0.46 x PVIFA(8.64, 5) on lease rentals) = 17.64 x 0.46 x 3.926 = 31.85 D. PV (Dep. tax shields discounted @ 8.64%)
= *14 x PVIF(8.64,1) + 10.5 x [(PVIF(8.64, 2) + 7.88 x PVIF(8.64, 3) + 5.91 x PVIF(8.64, 4) + 4.43 x PVIF(8.64,5) ] x 0.46
= (12.89 + 8.90 + 6.14 + 4.24 + 2.93) x 0.46 = 35.09 x 0.46 = Rs.16.14 lakh E. PV (Residual Value)
= 2 x PVIF(8.64,5) = 2 x 0.661 = 1.32 lakh
F. NVL
= 56 – 57.75 + 31.85 – 16.14 – 1.32 – 11.497 = Rs.1.143 lakh
As NVL is positive lease is recommended. * 56 x 0.25
= 14
42 x 0.25
= 10.5
31.5 x 0.25
= 7.875
23.625 x 0.25 = 5.90625 17.719 x 0.25 = 4.429 264
Part II
95.
A. B.
Initial investment = Rs.72 lakh PV of lease = (0.315 x 72) x PVIFA(16, 5) = 22.68 x 3.274 = Rs.74.25 lakh rentals PV of tax shield = (72 x 0.46 x 0.315) x PVIFA(13, 5) on lease rentals = 10.4328 x 3.517 = Rs.36.69 lakh PV of tax shields = [18 x PVIF(13,1) + 13.5 x PVIF(13,2) + 10.13 x PVIF(13,3) + 7.59 x PVIF(13,4) + 5.70 x PVIF(13,5) ] x 0.46 on depreciation = Rs.18.99 lakh PV of interest tax = [11.88 x PVIF(13, 1) + 10.15 x PVIF(13, 2) + 8.15 x PVIF(13,3) + 5.82 x PVIF(13, 4) + 3.13 x PVIF(13, 5)] x 0.46 shield on displaced debt = [(11.88 x 0.885) + (10.15 x 0.783) + (8.15 x 0.693) + (5.82 x 0.613) + (3.13 x 0.543)] x 0.46 = 29.381 x 0.46 = Rs.13.515 lakh PV of net salvage = 8 x PVIF(13, 5) = 8 x 0.543 = Rs.4.342 lakh value Net advantage of = A – B + C – D – E – F leasing = 72 – 74.25 + 36.69 – 18.99 – 13.515 – 4.342 = –Rs.2.41 lakh
C.
D.
E.
F. G.
Since NAL is negative leasing is not recommended. Displaced Debt Amortization Schedule
Year
Loan Outstanding at the beginning 74.25 63.45 50.93 36.40 19.55
1. 2. 3. 4. 5. 96.
Interest content @ 16% 11.88 10.15 8.15 5.82 3.13
Capital content 10.80 12.52 14.53 16.85 19.55
Rental 22.68 22.68 22.68 22.68 22.68
a.
Amounts of borrowing displaced by the lease = Investment cost = Rs.54 lakh.
b.
Debt service charge associated with the displaced debt of Rs.54 lakh at the rate of interest of 17%. 54 54 = = Rs.16.87 lakh PVIFA (17,5) 3.199
=
The amortization schedule associated with the displaced debt is as follows: Year 1 2 3 4 5
Debt outstanding 54.00 46.31 37.31 26.79 14.47
PV of interest tax shield discounted @12%
c.
i.
Interest @17% 9.18 7.87 6.34 4.55 2.46
Principal 7.69 9.00 10.53 12.32 14.41
Debt service charge 16.87 16.87 16.87 16.87 16.87
= PVIF(12,1) and likewise
= Financial Advantage = of Leasing (FAL) = =
[(9.18 x 0.893) + (7.87 x 0.797) + (6.34 x 0.712) + (4.55 x 0.636) + (2.46 x 0.567)] x 0.46 Rs.10.71 lakh PV (Debt service payments) – PV (Lease payments) 54 – [54 x 0.333 x PVIFA(17,5)] 54 – [54 x 0.333 x 3.199] = –Rs.3.52 lakh 265
Investment Banking and Financial Services
ii.
PV (Depreciation tax shields) = [*(21.6 x 0.893) + (12.96 x 0.797) discounted @ 12% + (7.78 x 0.712) + (4.67 x 0.636) + (2.80 x 0.567)] x 0.46
iii.
PV of interest tax shields @ 12%
= Rs.10.71 lakh
iv.
PV of (RV) @ 12%
= 5 x PVIF(12, 5)
= 39.706 x 0.46 = Rs.18.26 lakh
= 5 x 0.567 = Rs.2.84 lakh v.
PV of tax shield on lease rental
= (54 x 0.333 x 0.46) x PVIFA(12, 5) = 8.271 x 3.604 = Rs.29.82 lakh
OAL
= v – ii – iii – iv = 29.82 – 18.26 – 10.71 – 2.84 = –Rs.1.99 lakh
NAL
= FAL + OAL = –3.52 + (–1.99) = –Rs.5.51 lakh
Since NAL is negative leasing is not recommended. *54 x 0.4
=
32.4 x 0.4
= 12.96
21.6
19.44 x 0.4 = 7.776 11.664 x 0.4 =
4.67
6.994 x 0.4 = 2.7976 97.
A. B.
Initial investment PV of lease rentals
= Rs.25 lakh = (25 x 0.0386 x 12) x PVIFA m (19, 3)
= 11.58 x
D.
= PV of tax shield on lease payments = = PV of tax shields on depreciation =
E.
= = =
C.
PV of interest tax shields on displaced debt of Rs.27.26 lakh PV of Salvage Value
F.
=
1 x PVIFA(19, 3) d12
11.58 x 1.1002 x 2.140 = Rs.27.26 lakh (25 x 0.0386 x 12) x PVIFA(14, 3) x 0.46 11.58 x 2.322 x 0.46 = Rs.12.36 lakh [10 x PVIF(14, 1) + 6 x PVIF(14, 2) + 3.6 x PVIF(14, 3)] x 0.46 (10 x 0.877 + 6 x 0.769 + 3.6 x 0.675) x 0.46 15.819 x 0.46 = Rs.7.276 lakh [4.02 x PVIF(14, 1) + 2.58 x PVIF(14, 2) + 0.87 x PVIF(14.3)] x 0.46 = Rs.2.81 lakh 1.5 x PVIF(14, 3) = 1.5 x 0.675 = Rs.1.012 lakh
Debt Amortization Schedule
Year 1 2 3
Debt outstanding at the beginning 27.26 19.70 10.70
Capital
Interest
Repayment
7.56 9.00 10.71
4.02 2.58 0.87
11.58 11.58 11.58
NAL = A – B + C – D – E – F = 25 – 27.26 + 12.36 – 7.276 –2.81– 1.012 = –Rs.1.00 lakh As NAL is negative leasing is not recommended. 266
Part II
98.
a.
Equivalent Loan Model Lease rental per quarter
= Rs.
Kd = 15% Kdq Post-tax cost of debt Cost of the asset PV of lease rentals PV of tax shield on lease rentals PV of depreciation tax shields
225
x 1.10 x 0.026 x 1.045 x 3 = Rs.19.40 lakh 1.04 = (1.15)1/4 – 1 = 3.56% = 15 (1 – 0.42) = 8.7% = Rs.225 lakh = 19.40 x PVIFA (3.56, 20) x (1.0356) = 19.40 x 14.124 x 1.0356 = Rs.283.76 lakh = 19.40 x 4 x 0.42 x PVIFA(8.7,5) = Rs.127.76 lakh =
⎡ 75 50 33.33 22.22 14.81 ⎤ 0.42 + + + + ⎢ 2 3 4 5⎥ ⎣1.087 (1.087) (1.087) (1.087) (1.087) ⎦ = Rs.68.43 lakh = 25 x PVIF(8.7,5) = Rs.16.47 lakh
PV of salvage value Interest allocation
Effective installment per annum = 19.4 FVIFA(3.56,4) x (1.0356) = Rs.84.76 lakh Actual installment Year
= 19.40 x 4 = Rs.77.60 lakh
Balance outstanding 283.76 241.57 193.05 137.24 73.07
1 2 3 4 5
Eff. Int @ 15% 42.56 36.23 28.95 20.58 10.96
Principal 42.19 48.52 55.81 64.17 73.80
Adjusted Interest * 35.40 29.08 21.79 13.42 3.80
PVIF(8.7) Present Value (Rs.) 0.920 32.56 0.846 24.60 0.778 16.95 0.716 9.60 0.659 2.50 86.21
Tax shield on interest = 86.21 x 0.42 = 36.21 NAL
= 225 – 283.76 + 127.76 – 68.43 – 36.21 – 16.47 = –Rs.52.09 lakh
Since NAL is negative leasing is not recommended. b.
Suggested Model Cost of capital
i.
=
2 1 15(1 – 0.42) + x 24 = 5.8 + 8 = 13.8% 3 3
ii.
Cost of the asset = Rs.225 lakh
iii.
PV of lease rentals = 19.4 x PVIFA(3.56, 20) x (1.0356) = Rs.283.76 lakh
iv.
Tax shield on lease rental = 19.4 x 4 x 0.42 x PVIFA(13.8,5) = Rs.112.43 lakh
v.
Tax shield on depreciation = Rs.62.22 lakh
vi.
PV of salvage value = 25 PVIF(13.8,5) = Rs.13.10 lakh
vii.
Interest calculated as above
Year Interest PVIF(13.8,t) PV of Interest Total = 78.31
1 35.400 0.878 31.080
2 29.080 0.772 22.450
3 21.790 0.679 14.800
4 13.420 0.596 7.990
5 3.800 0.524 1.990
267
Investment Banking and Financial Services
Tax shield on interest = 78.31 x 0.42 = Rs.32.89 lakh NAL = 225 – 283.76 + 112.43 – 62.22 – 32.89 – 13.10 = –Rs.54.54 Since NAL is negative leasing is not recommended according to the suggested model also. Adjusted interest = Actual installment – Principal Principal = Effective installment per annum – Effective interest @ 15%. 99.
Steel Alloys Ltd’s evaluation of lease using Weingartner model and Suggested model A: lease rental = Rs.320 per thousand B: lease rental = Rs.400 per thousand Cash flows
Sign
Weingartner Model
Suggested Model
A
B
A
B
Initial payment
+
100.0
100.0
100.0
100.0
PV lease rentals
–
108.60
135.78
100.1
125.1
PV net salvage value
–
5.0
5.0
5.0
5.0
LRs
+
46.3
57.9
46.3
57.9
Dep
–
23.8
23.8
23.8
23.8
Interest
–
–
–
18.6
23.3
Management Fee
+
0.4
0.4
0.4
0.4
Management Fee
–
1.0
1.0
1.0
1.0
8.3
(7.2)
(1.8)
(19.9)
PV tax shield on:
Net Advantage of Leasing Change in NAL (A–B)
15.5
18.1
Discussion:
In general, it can be seen that the salvage value, management fee, and tax shield on it and even the tax shield on depreciation do not cause much differences among the two models considered. Major differences arise from PV of lease rentals, tax shield on lease rentals and tax shield on interest on displaced debt. These cause difference because of their size and the different discounting rates used to find the PVs. Weingartner’s model evaluates the proposal A as positive because the effect of displaced debt is ignored by the model. This result strongly points to the necessity to explicitly consider the debt displacement effect. 100.
Cost of capital =
1.5 1 x 0.14 x 0.7 + x 0.205 2.5 2.5
= 0.0588 + 0.0820 = 14.08% or say 14% PV(EBDIT Stream) = EBDIT(1 – T) x PVIFA(14, 4) = 5(1 – 0.3) x 2.914 = Rs.10.20 crore Processing fee = 10 x 0.005 = Rs.0.05 crore PV(Lease rentals) =
32 x 3 x 4 x 1.0861 x 2.914 x 10 = Rs.12.15 crore 1000
PV(TS on Processing fee) 268
Part II
= 0.05 x 0.30 x
1 = Rs.0.0132 crore 1.14
PV(TS on LR) 32
=
1000
x 10 x 12 x 0.30 x PVIFA(14,4) = Rs.3.36 crore
PV(DTS): (Rs. crore) Year 1 2 3 4
Depreciation 2.50 1.88 1.41 1.06
TS 0.75 0.56 0.42 0.32
PV @ 14% 0.66 0.43 0.28 0.19 1.56
PV(Salvage value) = 10 x 0.10 x PVIF(14, 4) = Rs.0.59 crore NPV(B) = – Initial investment + PV(EBDIT) + PV(DTS) + PV(NSV) = –10 + 10.20 + 1.56 + 0.59 = Rs.2.35 crore NPV(L)= –PV(LR) + PV(TS on LR) + PV(EBDIT) – Processing fee + PV(TS on rocessing fee) = –12.15 + 3.36 + 10.20 – 0.05 + 0.0132 = Rs.1.3732 crore As the NPV(B) is higher, the company should buy the equipment.
LEASE EVALUATION: THE LESSOR’S ANGLE 101.
Define L as the annual break even rental for Evergreen; the components of NPV(L) to Evergreen can be computed as follows: a.
Equipment cost
b.
Present value of lease payments = L x PVIFA(16, 5) = 3.274L
c.
PV of tax on lease rentals
= 0.46 x L x PVIFA(16, 5) = 0.46 x L x 3.274 = 1.506L
d.
i.
= 11.75 x PVIF(16, 1) + 8.81 x PVIF(16,2) + 6.61 x PVIF(16,3) + 4.96 x PVIF(16,4) + 3.72 x PVIF(16, 5)] x 0.46
PV of tax shield on depreciation @ 25% p.a.
= Rs.47 lakh
= [(11.75 x 0.862) + (8.81 x 0.743) + (6.61 x 0.641) + (4.96 x 0.552) + (3.72 x 0.476)] x 0.46 = 25.42 x 0.46 = Rs.11.69 lakh ii.
PV of tax shield on depreciation @ 40% p.a.
= [18.80 x PVIF(16,1) + 11.28 x PVIF(16,2) + 6.77 x PVIF(16,3 ) + 4.06 x PVIF (16, 4) + 2.44 x PVIF(16, 5)] x 0.46 = [(18.80 x 0.862) + (11.28 x 0.743) + (6.77 x 0.641) + (4.06 x 0.552) + (2.44 x 0.476)] x 0.46 = 32.32 x 0.46 = Rs.14.87 lakh
iii. PV of tax shield on depreciation @100%
= 47 x PVIF(16,1) x 0.46 = 47 x 0.862 x 0.46 = Rs.18.63 lakh
e.
PV of initial direct costs
= Rs.0.5 lakh
f.
PV of management fee
= Rs.0.75 lakh
g.
PV of tax shield on initial direct= 0.5 x 0.46 x PVIF(16, 1) cost = 0.5 x 0.46 x 0.862 = Rs.0.198 lakh 269
Investment Banking and Financial Services
h.
PV of tax on management fee
= 0.46 x 0.75 x PVIF(16, 1) = 0.46 x 0.75 x 0.862 = Rs.0.297 lakh
i.
PV of salvage value
= 2.35 x PVIF(16, 5) = 2.35 x 0.476 = Rs.1.12 lakh
Given a tax relevant depreciation rate of 25% p.a., L can be obtained from the equation –47 + 3.274L – 1.506L + 11.69 – 0.5 + 0.75 + 0.198 – 0.297 + 1.12 = 0 1.768L = 34.04 L=
34.04 1.768
= Rs.19.25 lakh
Where the tax relevant depreciation rate is 40% p.a., L is equal to –47 + 3.274L – 1.506L + 14.87 – 0.5 + 0.75 + 0.198 – 0.297 + 1.12 = 0 = 1.768L – 30.85
=0
1.768L
= 30.85
L =
30.85 1.768
= Rs.17.45 lakh
Where rate of depreciation is 100% L = –47 + 3.274L – 1.506L + 18.63 – 0.5 + 0.75 + 0.198 – 0.297 + 1.12 = 0 11.768L – 27.10 1.768L 27.10 L = 1.768 102.
a.
=0 = 27.10 = Rs.15.33 lakh
Assuming that the investment cost is Rs.1,000, the monthly break even rentals for the two types of lease contracts can be denoted as L1 and L2 respectively. To determine L1 we must set the NPV(L) equation involving L1 to zero. For this purpose we must determine the following: i.
Investment cost
= Rs.1,000
ii.
PV of lease rentals
= 12L1 x PVIFA M (16, 3) =
12L1 x
i x PVIFA(16, 3) where i = 16% d12
= 12L1 x 1.0847 x 2.246 = 29.23L1 iii.
PV of tax on lease rentals
= 12L1 x PVIFA(16, 3) x 0.46 = 12L1 x 2.246 x 0.46 = 12.39L1
iv.
PV of tax shields on depreciation
= [250 x PVIF(16,1) + 187.50 x PVIF(16,2) + 140.63 x PVIF(16, 3)] x 0.46 = [(250 x 0.862) + (187.5 x 0.743) + (140.63 x 0.641)] x 0.46 = (215.52 + 139.34 + 90.09) x 0.46 = 204.6
v.
PV of residual value
= 1,000 x 0.05 x PVIF(16, 3) = 1,000 x 0.05 x 0.641 = 32.05
Setting the NPV(L) equation to zero, we get –1,000 + 29.23L1 – 12.39L1 + 204.6 + 32.05 = 0 = 16.84L1 – 763.35 = 0
270
Part II
16.84L1 = 763.35 L1 =
763.35 = 45.32. 16.84
Therefore, the minimum lease rental Starlight must charge for writing a lease contract will be Rs.45.32 ptpm. The break even rental for a type II contract will be i. ii.
Investment Cost PV of lease rentals
= Rs.1,000 = 12L1 x PVIFA m (16 ,5 ) =
= = = iii. PV of tax on lease rental = = iv. PV of tax shields = on depreciation =
PV of residual value
= =
i x PVIFA(16, 5) d12 12L1 x 1.0847 x 3.274 12L1 x 1.0847 x 3.274 42.61L1 12L1 x PVIFA(16, 5) x 0.46 12L1 x 3.274 x 0.46 = 18.07L1 [400 x PVIF(16, 1) + 240 x PVIF(16, 2) + 144 x PVIF(16,3) + 86.40 x PVIF(16,4) + 51.84 x PVIF(16, 5)] x 0.46 [(400 x 0.862) + (240 x 0.743) + (144 x 0.641) + (86.4 x 0.552) + (51.84 x 0.476)] x 0.46 = 316.40 1,000 x 0.05 x PVIF(16,5) 1,000 x 0.05 x 0.476 = 23.8 12L1 x
–1,000 + 42.61L1 – 18.07L1 + 316.40 + 23.8 = 0 L2 = 26.88 ptpm.
103.
b.
Minimum monthly rental for the given lease proposal will be 75 x 1.10 x 0.02688 = Rs.2.22 lakh.
a.
Let us work out with an amount of Rs.1,000. The break even rental for RMCL can be calculated as follows: A. B.
Investment cost PV of lease rentals
C.
PV of tax shield on lease rentals
D.
PV of tax shields forgone on depreciation
=
Rs.1000
=
12LB x PVIFA M (16, 3)
=
12LB x
i x PVIFA(16, 3) (d ) P
=
12LB x
i x PVIFA(16, 3) (d)12
= =
12LB x 1.0743 x 2.322 = 29.23 12LB x PVIFA(15,3) x 0.46 =12LB x 2.28 x 0.46 12.58LB [250 x PVIF(15, 1) + 187.50 x PVIF(15 , 2) + 140.63 x PVIF(15, 3)] x 0.46 [(250 x 0.870) + (187.5 x 0.756) + (140.63 x 0.658)] x 0.46 451.63 x 0.46 = 207.75 [3.67 x PVIF(15,1) + 2.33 x PVIF(15, 2) + 0.79 x PVIF(15, 3)] x 0.46 [(3.67 x 0.870) + (2.33 x 0.756) + (0.79 x 0.658)] x 0.46 = 2.516LB
= = =
E.
PV of interest tax shields on displaced debt
= = =
271
Investment Banking and Financial Services
Debt Repayment Schedule Year Amount outstanding Capital content Investment at the beginning content adjusted 1 29.23LB 8.33LB 3.67LB 2 20.90LB 9.66LB 2.33LB 3 11.23LB 11.21LB 0.79LB Setting the NAL of the lease proposal equal to zero, we get
Installment 12LB 12LB 12LB
A–B+C–D–E=0 1000 – 29.23LB + 12.58LB – 207.75 – 2.516LB = 0 –19.16LB + 792.25 = 0 LB = 41.34 Break even rental = Rs.41.34 ptpm The break even rental of RLL is as follows: F. G.
Initial Investment PV of lease receipts
= 1,000 = 12 LB′ x PVIFA M (14, 3) = 12 LB′ x
i
x PVIFA(14,3) d = 12 LB′ x 1.0743 x 2.322 = 29.93 (12 )
H.
PV of the tax liability on lease receipts
= 12 LB′ x 0.46 x PVIFA(14,3) = 12 LB′ x 0.46 x 2.322 = 12.81 LB′
I.
PV of depreciation tax shields
= [250 x PVIF(14,1) + 187.5 x PVIF(14,2) + 140.63 x PVIF(14,3)] x 0.46 = [(250 x 0.877) + (187.5 x 0.769) + (140.63 x 0.675)] x 0.46 = 210.907
Break Even Lease Rental =–F+G–H+I=0 = – 1,000 + 29.93 LB – 12.81 LB + 210.907 = 0 = – 789.09 + 17.12 = 0 LB′
104.
= 46.09 ptpm
b.
The maximum lease rental that RMCL can pay (Rs.41.34 ptpm) is less than the minimum that RLL can accept (Rs.46.09 ptpm). Therefore, it is not possible to strike a deal for the two.
a.
i.
Let the cost of the asset = Rs.1,000 Define L as the monthly lease rental. The value of L can be determined from the equation: Lx
ii.
i x 12 x PVIFA(25,5) + 100 x PVIF(25,5) d12
= 1,000
i.e.
36.493L + (100 x 0.328)
= 1,000
i.e.
36.493L
= 967.2
or
L = Rs.26.50 per thousand per month
Define L as the equated ballooned rental collected from months 49-60 in advance. The value of L can be obtained from the equation: (0.1 x 26.5 x 1.0188 x PVIFA(1.88,48)) + (L x 1.0188 x PVIFA(1.88,12) x PVIF(25,4)) + (100 x PVIF(25,5) )= 1,000 i.e. i.e.
(2.65 x 32.047) + (L x 10.856 x 0.410) + (100 x 0.328) 4.451L + 117.72 = 1,000 272
Part II
i.e.
L = Rs.198.22 per thousand per month
Therefore, the lease rental for the first 48 months is Rs.26.5 ptpm and for the next 12 months it is Rs.198.22 ptpm. b.
Structure I Initial investment cost Gross investment in lease
Structure II
= Rs.1,000
1,000
= (26.5 x 12 x 5) + 100
2,605.84
= 1,690
105.
a.
Unexpired finance charge
= Rs.690
1,605.84
Average annual finance charge
= Rs.138
321.17
Add-on yield
= 13.8%
32.12%
Maximum value of L from the point of view of Alpha Industries can be calculated as follows: A. B.
Acquisition cost = Rs.360 lakh PV of Lease Rentals @ 18% p.a. i i i = 12L x (12) x PVIF(i, 1) + 18L x (12) x PVIF(i, 2) + 24L x (12) x PVIF(i, 3) d d d where, i
= 0.18 or 18% = 12L x 1.095 x 0.847 + 18L x 1.095 x 0.718 + 24L x 1.095 x 0.609 = 41.29L
C.
PV of tax shields on lease rentals @ 14% p.a. = [12L x PVIF(14,1) + 18L x PVIF(14,2) + 24L x PVIF(14,3)] x 0.45 = [(12L x 0.877) + 18L x 0.769) + 24L x 0.675)] x 0.45 = 18.25L
D.
PV of tax shield on depreciation @ 14% = 360 x 0.877 x 0.45 = 142.07
E.
PV of residual value @ 14% = 24.70 x PVIF (14,3) = 24.7 x 0.675 = 16.67
F.
PV of interest tax shields @ 14% (Refer displaced debt amortization schedule given below) = [6.29L x PVIF(14,1) + 4.69L x PVIF(14,2) + 1.73L x PVIF(14,3)] x 0.45 = [(6.29L x 0.877) + (4.69L x 0.769) + (1.73L x 0.675)] x 0.45 = 4.63L Displaced Debt Amortization Schedule
Year
Outstanding Debt
Int. Content @ 18% p.a.
Cap. Content
Repay
Adj. Int.
1
41.29L
7.43L
5.71L
13.14L
6.29L
2
35.58L
6.40L
13.31L
19.71L
4.69L
3
22.27L
4.01L
22.27L
26.28L
1.73L
The maximum value of L can be obtained from the equation: A–B+C–D–E–F=0 i.e. 360 – 41.29L + 18.25L – 142.07 – 16.67 – 4.63L = 0 i.e. 201.26 – 27.67L = 0 i.e. 27.67L = 201.26 i.e. L = Rs.7.27 lakh 273
Investment Banking and Financial Services
b.
Minimum value of L from the point of view of Beta leasing can be obtained as follows: A.
Initial outlay = Rs.360 lakh
B.
PV of lease receipts i i i = 12L x (12) x PVIF(i,1) + 18L x (12) x PVIF(i,2) + 24L x (12) x PVIF(i,3) d d d where i
C.
= 0.14 or 14% = 12L x 1.0743 x 0.877 + 18L x 1.0743 x 0.769 + 24L x 1.0743 x 0.675
= 43.58L PV of tax liability on lease receipts = [12L x PVIF(14,1) + 18L x PVIF(14,2) + 24L x PVIF(14,3)] x 0.45 = [(12L x 0.877) + (18L x 0.769) + (24L x 0.675)] x 0.45 = 18.25L
D.
Initial direct costs = 0.002 x 360 = 0.72
E.
PV of tax shield on initial direct cost = 0.72 x PVIF(14,1) x 0.45
F.
PV of tax shield on depreciation = 360 x 0.45 x PVIF(14, 1)
= 0.72 x 0.877 x 0.45 = 0.28
= 360 x 0.45 x 0.877 = 142.07 G.
PV of tax shield on residual value = 360 x 0.05 x PVIF(14,3) = 18 x 0.675 = 12.15
H.
The minimum value of L can be obtained from the equation: –A+B–C–D+E+F+G=0
106.
i.e.
– 360 + 43.58L – 18.25L – 0.72 + 0.28 + 142.07 + 12.15 = 0
i.e.
– 206.22 + 25.33L = 0
i.e.
L = Rs.8.14 lakh
Investment cost
= Rs.120 crore
Equity component Debt component
= Rs.24 crore (120 x 0.2) = Rs.96 crore (120 x 0.8)
Equity-related cash flow is given by the equation and is denoted by E E x PVIFA(24,5) E
= 24 24 = Rs.8.74 crore = 2.745
Annual debt service charge is given by the equation in which debt repayment is denoted as D. D x PVIFA(18,5) D
= 96 =
96 = Rs.30.70 crore 3.127
Annual lease rental = Rs.39.44 crore 107.
a.
NAL for the lessee
A.
Initial Investment
B.
PV[LR] @ 16%
= Rs.80 lakh = 80 x 0.0255 x 12 x
i d
(12 )
x PVIFA(i,5) where i = 16%
= 80 x 0.0255 x 12 x 1.0847 x 3.274 = Rs.86.94 lakh
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Part II
C.
PV[TS on LR] @ 12%
= 80 x 0.0255 x 12 x 0.43 x PVIFA(12,5) = 80 x 0.0255 x 12 x 0.43 x 3.605 = Rs.37.95 lakh
D.
PV[DTS] @ 12%
= [17.5 x 0.893 + 13.12 x 0.797 + 9.84 x 0.712 + 7.38 x 0.636 + 5.54 x 0.567] x 0.43 = Rs.17.60 lakh Amortization Schedule
(Rs. in lakh) Year
Lease initial investment outstanding
Interest
Capital content
Lease rental
Adjusted interest
1
86.94
13.91
12.64
26.55
11.84
2
74.30
11.89
14.66
26.55
9.82
3
59.64
9.54
17.01
26.55
7.47
4
42.63
6.82
19.73
26.55
4.75
5
22.90
3.66
22.90
26.56
1.59
PV [Interest tax shields] = [11.84 x 0.893 + 9.82 x 0.797 + 7.47 x 0.712 + 4.75 x 0.636 + 1.59 x 0.567] x 0.43 = Rs.11.89 NAL = 80 – 86.94 + 37.95 – 17.60 – 11.89 = Rs.1.52 b.
NAL from lessor’s angle
Initial Investment PV[LR]
PV[Tax on LR] PV[DTS] NAL
108.
= Rs.80 lakh i x PVIFA(i,5) where i = 12% d (12) 80 x 0.0255 x 12 x 1.0639 x 3.605 = Rs.93.89 lakh 80 x 0.0255 x 12 x 0.26 x PVIFA(12,5) 80 x 0.0255 x 12 x 0.26 x 3.605 = Rs.22.95 lakh 17.60 x 0.26 = Rs.10.64 lakh 0.43 – 80 + 93.89 – 22.95 + 10.64 = Rs.1.58 lakh
= 80 x 0.0255 x 12 x = = = = =
c.
Since NAL for both the lessor and the lessee are positive it is possible to structure a mutually advantageous lease transaction.
a.
The value of L can be obtained by solving the equation = [L x PVIF(20,2) + 1.15L x PVIF(20,3) + 1.3225L x PVIF(20,4) + 1.5208L x PVIF(20,5)] = Rs.128 lakh = (L x 0.694) + 1.15L x 0.579 + 1.3225L x 0.482 + 1.5208L x 0.402) = 128 = 0.694L + 0.666L + 0.637L + 0.611L = 128 2.608L = 128 L = Rs.49.07 lakh Marginal cost of capital ⎛2 ⎞ ⎛1 ⎞ = ⎜ x 16 x 0.54 ⎟ + ⎜ x 18 ⎟ = 11.76% . 3 3 ⎝ ⎠ ⎝ ⎠
275
Investment Banking and Financial Services
The net advantage of leasing will be as follows: A. Initial investment
= Rs.128 lakh
B. PV (Lease rentals)
= 49.06 x PVIF(16, 2) + (1.15 x 49.06) x PVIF(16, 3) + (1.3225 x 49.06) x PVIF(16, 4) + 1.5208 x 49.06 x PVIF(16,5) = (49.06 x 0.743) + (1.15 x 49.06) x 0.641 + (1.3225 x 49.06) x 0.552 + (1.5208 x 49.06) x 0.476 = 36.46 + 36.15 + 35.83 + 35.52 = Rs.143.96 lakh
C. PV of tax shield on lease rentals
= 49.06 x PVIF(11.76, 2) x 0.46 + 56.42 x PVIF(11.76, 3) x 0.46 + 64.88 x PVIF(11.76,4) x 0.46 + 74.61 x PVIF(11.76,5) x 0.46 = (49.06 x 0.801 x 0.46) + (56.42 x 0.716 x 0.46) + (64.88 x 0.645 x 0.46) + (74.61 x 0.46 x 0.574) = Rs.75.48 lakh
D. PV (tax shields on = [(51.20 x 0.895) + (30.72 x 0.801) + (18.43 x 0.716) depreciation) @ 11.76 + (11.06 x 0.641) + (6.64 x 0.574)] x 0.46 = 94.506 x 0.46 = Rs.43.47 lakh E.
PV (Residual value) at 10%
= 12.8 x PVIF(11.76, 5) = 12.8 x 0.574 = Rs.7.34 lakh
The amortizaton schedule for the displaced debt is as follows: (Rs. in lakh) Year 1 2 3 4 5 F.
Debt outstanding 143.96 166.99 144.65 111.38 64.32
Interest @ 16% 23.03 26.72 23.14 17.82 10.29
Principal –23.03 22.34 33.28 47.06 64.32
DSC – 49.06 56.42 64.88 74.61
PV of Interest tax shields = [23.03 x PVIF(11.76, 1) + 26.72 x PVIF(11.76, 2) discounted @11.76% + 23.14 x PVIF(11.76, 3) + 17.82 x PVIF(11.76, 4) + 10.29 x PVIF(11.76,5) ] x 0.46 = [(23.03 x 0.895) + (26.72 x 0.801) + (23.14 x 0.716) + (17.82 x 0.641) + (10.29 x 0.574)] x 0.46 = 75.907 x 0.46 = Rs.34.917 lakh
G. NAL
= A–B+C–D–E–F = 128 – 143.96 + 75.48 – 43.47 – 7.34 – 34.917 = –Rs.26.21 lakh
As NAL is negative leasing is not recommended. b.
Define L′ as the break even rental payable annually in arrear PV (Lease rentals) = L′ x PVIFA(16,5) = Rs.3.274 L′ lakh PV (tax shield on lease rentals) = 0.46 L′ PVIFA(11.76, 5) = 0.46 L′ x 3.626 = Rs.1.668 L′ lakh.
276
Part II
The amortization schedule associated with the displaced debt will be as follows: Year 1 2 3 4 5
Debt outstanding 3.274 L′ 2.798 L′ 2.245 L′ 1.605 L′ 0.862 L′
Interest 0.524 L′ 0.448 L′ 0.359 L′ 0.257 L′ 0.138 L′
Principal 0.476 L′ 0.552 L′ 0.641 L′ 0.743 L′ 0.862 L′
Debt Service Charge L′ L′ L′ L′ L′
PV of interest tax shields discounted @ 11.76% = Rs.0.61 L′ lakh L′ can be found from the following equation
128 – 3.274 L′ + 1.668 L′ –43.47–7.34 – 0.61 L′ =0 = 77.19 – 2.216 L′ = 0 L′ =
77.19 = Rs.34.83 lakh 2.216
109. Initial Investment Aggregate lease rentals payable under the lease during the primary period Aggregate interest charge for the lease period Average annual interest charge
110.
= Rs.22 lakh = 0.0283 x 22 x 48 = Rs.29.88 lakh = Rs.7.88 lakh 7.88 = Rs. = Rs.1.97 lakh 4 Add-on-yield 1.97 = x 100 22 = 8.96% a. Define ‘i’ as the annual pre-tax yield implied by the lease transaction. The value of i can be obtained from the equation: = (31.25 x 12) x PVIFA m (i , 4) = 1,000 = 375 x
i x PVIFA(i, 4) (d)12
=
1000 i x PVIFA(i,4) = 12 375 (d )
=
i x PVIFA(i,4) = 2.667 (d)12
at i at i
= 1,000
= 24%, LHS of the equation = 1.1257 x 2.404 = 2.706 = 26%, LHS of the equation = 1.1359 x 2.320 = 2.635
Interpolating the range we get 2.667 − 2.706 ⎤ ⎡ = 25.09% = 0.24 + ⎢0.02 x 2.635 − 2.706 ⎥⎦ ⎣
As the gross yield is more than required yield, the proposal can be recommended. b.
111.
The value of ‘i’ can be determined from the following equation: 31.25 x 3 + 31.25 + 31.25 x PVIFA(i,44) = 1,000 i = 2.20% (monthly gross yield) Annualized gross yield = (1.022)12 – 1 = 0.2986 or 29.86% Since the gross yield is higher than the required yield, the proposal can be recommended. The marginal cost of capital 277
Investment Banking and Financial Services
⎛3 ⎞ 1 = ⎜ x 0.19 x 0.54 ⎟ + x 0.22 = 13.19% 4 ⎝ ⎠ 4
Define ‘i’ as the IRR of the proposal. The various components of NAL valued at `i’ will be as follows: A. Initial investment
= Rs.1,000
B. PV of lease payments
= 35.06 x 12 x PVIFA M ( i , 3) =
C. PV of tax liability on lease payments
420.72 x
i x PVIFA(i, 3) d12
= 35.06 x 12 x 0.46 x PVIFA(i, 3) = 193.53 x PVIFA(i, 3)
D. PV of tax shields on depreciation = (400 x PVIF(i, 1) + 240 x PVIF(i, 2) + 144 x PVIF(i, 3)) x 0.46 NAL = – A + B – C + D = 0 i x PVIFA(i,3) – 193.53 x PVIFA(i,3) + 400 x PVIF(i,1) d12 + 240 x PVIF(i,2) + 144 x PVIF(i,3) x 0.46
– 1000 + 420.72 x
NAL = –1,000 + (420.72 x 1.0162 x 2.829) – (193.53 x 2.829) + 343.32 = 5.32 at i
= 4% – 1,000 + (420.72 x 1.0215 x 2.775) – (193.53 x 2.775) + 337.88 = –6.56
i
= 3.45%
Since IRR is less than the marginal cost of capital, the transaction cannot be accepted. 112.
Loan repayment =
30 30 = = Rs. 2.21 lakh PVIFA ( 4%, 20) 13.590
The lease rental to be collected can be calculated as follows: Xx
i x 4 x PVIFA(30, 5) + 5 x PVIF(30, 5) = 100 – 30 i4
where X is the lease rental required by Leasewell Ltd. after paying the loan installment. X x 1.1064 x 4 x 2.436 + 5 x 0.269 = 70 X x 10.78 + 1.35 = 70 70 − 1.35 = 6.37 X= 10.78 Lease rental to be quoted = 6.37 + 2.21 = Rs.8.58 lakh or
8.58 1 x 1000 x = Rs. 28.60 ptpm 100 3
If Leasewell should not loose on HP transaction, the IRR on hire transaction should be equal to the IRR on the lease transaction. IRR on lease transaction is `i’ in the following: i x 4 x PVIFAi, 5 – 6.37 x 4 x 0.3 x PVIFAi, 5 + [9PVIFi, 1 + 6.3 PVIFi, 2 + i4 4.41PVIFi, 3 + 3.09PVIFi, 4 + 2.19PVIFi, 5 ] + 5 PVIFi, 5 = 0
–70 + 6.37 x
Let i be 26%, LHS will be equal to –70 + 25.48 x 1.0928 x 2.635 – 7.64 x 2.636 + [9 x 0.794 + 6.3 x 0.63 + 4.41 x 0.5 + 3.09 x 0.397 + 2.19 x 0.315] + 5 x 0.315 = 0.043 Let i be 28%, LHS will be equal to 278
Part II
–70 + 25.48 x 1.0996 x 2.532 – 7.64 x 2.532 + [9 x 0.781 + 6.3 x 0.61 + 4.41 x 0.497 + 3.09 x 0.373 + 2.19 x 0.291] + 5 x 0.291 = –2.095 By interpolation, i = 26 +
0.043 − 0 x 2 = 26.04% 0.043 + 2.095
As Leasewell should not loose on HP transaction, the IRR required by it on the hire transaction should be 26.04% or say 26%. Let required flat rate be F%. F x5 70 + 3.5F 100 = = 1.167 + 0.058F 60 60
70 + 70 x
EMI =
Total charge for credit = 3.5F Allocation of Finance charge on SOYD method (Rs. crore) Year
SOYD Factor
Interest
PV at 26%
1
654/1830
1.251F
0.993F
2
510/1830
0.975F
0.614F
3
366/1830
0.700F
0.350F
4
222/1830
0.425F
0.169F
5
78/1830
0.149F
0.047F 2.173F
As required IRR is 26%, NPV (HP) at 26% should be equal to zero. Hence, – Initial Investment + PV of hire rentals – PV of tax on finance income = 0 –70 + (1.167 + 0.058F) 12 x 1.1142 x 2.635 – 2.173F x 0.3 = 0 –70 + 41.115 + 2.043F – 0.652F = 0 1.391F = 28.885 F = 20.77% Flat rate to be charged on the HP transaction is 20.77%. 113.
A.
Initial investment = Rs.50 – 10 = Rs.40 lakh
B.
PV of lease rentals at gross yield of 25% = 0.035 x 12 x 50 x PVIFA(25%,5) = Rs.56.469 lakh
C.
PV of loan repayment installments: Loan repayment installment =
Rs.10 lakhs 10 = = Rs.3.054 lakh PVIFA (16,5) 3.274
Therefore, PV of loan repayment installments = 3.054 x PVIFA(25%,5) = Rs.8.212 lakh. NPV of the lease transaction = –A + B – C = –40 + 56.469 – 8.212 = Rs.8.257 lakh As the NPV is positive, SFSL can go ahead with the lease transaction. Alternatively, the solution can be worked out by finding out the IRR of the lease transaction. IRR is the rate at which the following equation is equal to zero.
–A+B–C=0 – 40 + 21PVIFA(i%,5) – 3.054PVIFA(i%,5) = 0 279
Investment Banking and Financial Services
– 40 + 17.946 PVIFA(i%,5) PVIFA(i%,5) =
40 17.946
= 0 = 2.229
At i = 32%, PVIFA(32%,5)
= 2.345
At i = 36%, PVIFA(36%,5)
= 2.181
Hence, i is between 32% and 36% and by interpolation, i
= 32 + (36 – 32) x
= 32 + 4 x
2.345 − 2.229 2.345 − 2.189
0.116 = 34.9% 0.164
As the IRR is greater than the required gross yield of 25%, SFSL can go ahead with the transaction.
LEASE ACCOUNTING AND REPORTING 114.
i.
Present value of minimum lease payments = 450 x 0.312 x PVIFA (18, 5) = Rs.439.03 lakh.
ii.
The machinery must be capitalized at the present value of the minimum lease payments or at the fair market value whichever is less. Since the present value of minimum lease payments is less than the fair market value in this case, the machinery must be capitalized at the value of Rs.439.03 lakh – the present value of minimum lease payments.
iii.
Unexpired finance charge at the inception of the lease = (450 x 0.312 x 5) – 439.03 = Rs.262.97 lakh
iv.
Allocation of unexpired Finance Charge (Actuarial Method) Year 1 2 3 4 5
v.
Net amount outstanding 439.03 377.65 305.23 219.77 118.93
Finance charge (@ 18%) 79.02 67.98 54.94 39.56 21.41
Capital content Lease payment 61.38 72.42 85.46 100.84 118.93
140.40 * 140.40 140.40 140.40 140.34
Allocation of Unexpired Finance Charge (Based on sum of the Years Digits Method) Year (A) 1 2 3 4 5
Factor (B) 5/15 4/15 3/15 2/15 1/15
Finance charge (C) = 262.97 x (B) 87.66 70.19 52.59 35.06 17.53
The IASC states that the Actuarial Method or some form of approximation of this method can be applied for allocating the unexpired finance charge. Since the Sumof-years Digits Method produces an allocation which is close to what is obtained under the Actuarial Method, we can say that this method is acceptable to the IASC.
280
Part II
vi.
Allocation of Unexpired Finance Charge (Based on Straight Line Method) Year
Finance Charge [= 262.97/5]
1
52.61
2
52.59
3
52.59
4
52.59
5
52.59
The method is conceptually flawed because it does not produce an allocation that results in a constant periodic rate of interest on the remaining balance of the lease liability during each period. vii.
Disclosure in the Financial Statements Finance charge allocated by actuarial method. Year 1 Income Statement
(Rs. in lakh) Depreciation (439.03 x 0.30)
131.71
Finance Charge
79.02 Balance Sheet
(Rs. in lakh)
Liabilities
(Rs. in lakh)
Assets Assets on Lease
439.03
Less: Depreciation 131.71
307.32
Secured loans Lease Liability
305.23
Current Liabilities & Provisions Lease Liability
72.42
* Lease payment = (P.V. of minimum lease payments + Unexpired finance charge at the inception of the lease)/5 = (439.03 + 262.97)/5 = 140.4 115.
A.
PV[LR] = 72 x 0.105 x 4 x 1.0652 x 2.174 = 70.03 FMV = 72 Since, PV[LR] < FMV the equipments need to be capitalized at Rs.70.03 lakh.
B.
Amortization Schedule Year
PV(LR)
Cap.
Int.
LR
Adj. Int
1
70.03
19.61
12.60
32.21
10.63
2
50.41
23.14
9.07
32.21
7.10
3
27.27
27.27
4.91
32.18
2.94
281
Investment Banking and Financial Services
C.
Disclosure in Financial Statements Year 1 Profit & Loss Account
(Rs. in lakh) Depreciation
17.51
Interest component of LR
10.63
Balance Sheet
(Rs. in lakh) Liabilities
Assets Fixed Assets - Assets on lease 27.27 - Gross Block - Less. Depreciation - Net Block
Secured Loans - Lease liability
Current Liabilities - Lease liability
70.02 17.51 52.51
23.14 Year 2 Profit and Loss Account
Depreciation - Leased Assets
13.13
Interest component of lease rental
7.10
Balance Sheet
Liabilities Secured loans - Lease liability
Assets Fixed Assets - Assets on lease - Gross Block - Less: Acc. Dep. - Net Block
Nil
Current liabilities - Lease liability
52.51 13.13 39.38
27.27 Year 3 Profit and Loss Account
Depreciation - Leased Assets
9.85
Interest component of lease rental Balance Sheet Liabilities
2.94
Assets Fixed Assets - Assets on lease - Gross Block Less: Accumulated Depreciation
39.38 9.85 282
Part II
- Net Block
116.
Lease rental = Rs.
29.54
25.50 x 65 = Rs.1.66 lakh 1000
Present value of lease rental = 1.66 PVIFA(1.25, 60) x (1.0125) =
1.66 x 42.095 x 1.0125 = Rs.70.75 lakh
Since the present value is more than the FMV, the asset will be capitalized at Rs.65 lakh. Effective rate of interest 1.66 x PVIFA (km 60) (1 + km)= 65 PVIFA (km, 60) (1 + km) km = 1.5%, LHS km = 1.75, LHS ∴ km ∴ k
= 39.156 = 39.971 = 37.611 = 1.59% = (1.0159)12 – 1 = 20.84%
Effective installment p.a.
= 1.66 x 1.0159 x FVIFA(1.59,12) = Rs.22.10 lakh
Actual Installment p.a.
= Rs.19.92 lakh.
Interest adjustment
= 22.10 – 19.92 = 2.18 Interest Allocation
Year 1 2 3 4 5
Balance o/s. 65.00 56.45 46.12 33.63 18.53
Interest @20.84 13.55 11.76 9.61 7.00 3.86
Principal 8.55 10.33 12.49 15.10 18.53
Adjusted Interest 11.37 9.58 7.43 4.82 1.39
Lease Equipment Account
Year 1 2 3 4 5
To Lease payable To Balance b/d To Balance b/d To Balance b/d To Balance b/d
65 65 65 65 65
Year 1 2 3 4 5
By Balance c/d By Balance c/d By Balance c/d By Balance c/d By Balance c/d
65 65 65 65 65
Lease Payable Account
1
To Lease rental To balance c/d
2
To Lease rental To Balance c/d
3
4
To Lease rental To Balance c/d To Lease rental To Balance c/d
8.55 56.45 65.00 10.33 46.12 56.45 12.49 33.63 46.12 15.10 18.53 33.63
1 By Lease equipment
65.00
2 By Balance b/d
65.00 56.45
3 By Balance b/d
56.45 46.12
4 By Balance b/d
46.12 33.63 33.63 283
Investment Banking and Financial Services
5
To Lease rental
18.53 18.53
5 By Balance b/d
18.53 18.53
Lease Rental Account
1
To Bank
19.92
2
To Bank
19.92 19.92
3
To Bank
19.92 19.92
4
To Bank
19.92 19.92
To Bank
19.92 19.92
5
1 By Lease payable By Finance charges 2 By Lease payable By Finance charges 3 By Lease payable By Finance charges 4 By Lease payable By Finance charges 5 By Lease payable By Finance charges
19.92
8.55 11.37 19.92 10.33 9.58 19.92 12.49 7.43 19.92 15.10 4.82 19.92 18.53 1.39 19.92
Accumulated Depreciation
1
To Balance c/d.
19.50
2
To Balance c/d
33.15 33.15
3
To Balance c/d
1. 2.
By Depreciation By Balance b/d By Depreciation
3.
By Balance b/d By Depreciation
4.
By Balance b/d By Depreciation
5.
By Balance b/d By Depreciation
42.70 42.70
4
To Balance c/d
49.39 49.39
5
To Balance c/d
54.07 54.07
19.50 19.50 13.65 33.15 33.15 9.55 42.70 42.70 6.69 49.39 49.39 4.68 54.07
Profit and Loss Account
Year 1
To Finance Charges
11.37
To Depreciation
19.50
2
To Finance charges
3
To Finance charges
7.43
To Depreciation
9.55
To Finance charges
4.82
To Depreciation
6.69
To Finance charges
1.39
To Depreciation
4.68
To Depreciation
4 5
9.58 13.65
284
Part II
Balance Sheet
1
2
3
4
5
117.
Secured Loan Lease payable Current Liabilities Lease payable Secured Loan Lease payable Current Liabilities Lease payable Secured Loans Lease payable Current Liabilities Lease payable Secured Loan Lease payable Current Liabilities Lease payable Secured Loans Lease payable Current Liabilities Lease payable
46.12 10.33 33.63 12.49 18.53 15.10 – 18.53 – –
1 Fixed Assets Gross lease equipment Less: Acc. Depreciation Net block 2 Fixed Assets Gross lease equipment Less: Acc. Depreciation Net block 3 Fixed Assets Gross lease equipment Less: Acc. Depreciation Net block 4 Fixed Assets Gross lease equipment Less: Acc. Depreciation Net block 5 Fixed Assets Gross Lease equipment Less: Acc. Depreciation Net block
i.
Fair market value of the equipment = Rs.47 lakh
ii.
PV of minimum lease payment
65.00 19.50 45.50 65.00 33.15 31.85 65.00 42.70 22.30 65.00 49.39 15.61 65.00 54.07 10.93
= (47 x 0.456) x PVIFA (18,3) = 21.432 x 2.174 = Rs.46.59 lakh The asset must be capitalized at Rs.46.59 lakh as it is less than fair market value. The journal entry for capitalization will be Leased Equipment a/c Dr
46.59
To lease payable a/c
46.59
The unexpired finance charge is equal to (47 x 0.456 x 3) – 46.59 = Rs.17.70 lakh. Allocation of Unexpired Finance Charge
(Rs. in lakh) Year 1 2 3
Outstanding lease liability 46.59 33.544 18.150
Rate of Interest interest charge 0.18 8.386 0.18 6.038 0.18 3.267 Ledger Accounts
Principal amount 13.046 15.394 18.165
Lease payment 21.432 21.432 21.432
Leased Equipment Account
Year 1
Year Amount (Rs. in lakh) To Lease payable a/c 46.59 1 By Balance c/d
Amount (Rs. in lakh) 46.59 285
Investment Banking and Financial Services
2 3
To Balance b/d To Balance b/d
46.59 46.59
2 By Balance c/d 3 By Balance c/d
46.59 46.59
Accumulated Depreciation a/c (On the Lease Equipment)
Year 1 2
To Balance c/d To Balance c/d
Amount in lakh 11.648 20.383
3
To Balance c/d
26.93
Year 1 2
By Depreciation By Balance b/d By Depreciation a/c
3
By Balance b/d By Depreciation
26.934
Amount in lakh 11.648 11.648 8.736 20.383 20.383 6.552 26.934
Depreciation a/c (On the Leased Equipment)
Year 1. 2. 3.
To Accumulated depreciation a/c To Accumulated depreciation a/c To Accumulated depreciation a/c
Amount Year Amount in lakh in lakh 11.648 1 By P & L a/c 11.648 8.736 2 By P & L a/c 8.736 6.552 3 By P & L a/c 6.552
Lease Rentals a/c
Year
Year 1
By By
Lease payable Finance charges Lease payable Finance charges
1
To Bank a/c
Amount in lakh 21.432
2
To Bank a/c
21.432
2
By By
21.432
3
By By
3
To Bank a/c
Lease payable Finance charges
Amount in lakh 13.046 8.386 21.432 15.394 6.038 21.432 18.165 3.267 21.432
Finance Charges a/c
Year Amount in lakh Year 1 To Lease rental a/c 8.386 1 By P & L a/c 2 To Lease rental a/c 6.038 2 By P & L a/c 3 To Lease rental a/c 3.267 3 By P & L a/c
Amount in lakh 8.386 6.038 3.267
Lease Payable a/c
Year 1. To Lease rental a/c To Balance c/d 2. To Lease rental To Balance c/d
Amount Year in lakh 13.046 1 By Leased equipment a/c 33.544 46.59 15.394 2 By Balance b/d 18.150
Amount in lakh 46.59 46.59 33.544
286
Part II
33.544 18.165
3. To Lease rental a/c
3
33.544 18.150
By Balance b/d
Disclosure in Financial Statements Year 1 Profit and Loss a/c
Amount in lakh 8.386 11.648
Finance charge Depreciation
Amount in lakh
Balance Sheet
Liabilities
Assets
Amount in lakh
Secured loans Lease payable Current liabilities Lease payable
Amount in lakh
Fixed Assets 15.394 Leased Equipment: Gross block Less: Accumulated Depreciation 18.150
46.59 11.648 34.942
Year 2 Profit and Loss a/c
Dr.
Finance charges Depreciation Liabilities Secured Loans Lease payable Current Liabilities Lease payable
Cr. Amount (Rs. in lakh)
Amount (Rs. In lakh) 6.038 8.736 Balance Sheet Amount (Rs. in lakh)
Assets
Amount (Rs. in lakh)
18.150 — Year 3 Profit and Loss a/c
Dr. To Finance charges To Depreciation 118.
Amount in lakh 3.267 6.552
Cr. Amount in lakh
The interest rate implicit in the lease transaction is given by the equation (87 x 0.312) x PVIFA(r, 5) + 8.5 x PVIF(r, 5) = 87 At r = 18%, LHS of equation is equal to: (27.144 x 3.127) + (8.5 x 0.437) = 88.599 At r = 19%, LHS of the equation is equal to = (27.144 x 3.058) + (8.5 x 0.419) = 96.558 ⎛ 1% x 87 − 88.599 ⎞ r = 18% + ⎜ − 88.579 ⎟ = 18.78% 86.558 ⎝ ⎠
287
Investment Banking and Financial Services
Unearned Finance Income at the beginning: = Rs.[(87 x 0.312 x 5) + 8.5 – 87) lakh = Rs.(135.72 + 8.5 – 87) lakh = Rs.57.22 lakh The allocation of the unearned financial income is given as under. Allocation of Unearned Finance Income
Year 1 2 3 4 5
O/s investment at the beginning 87.00 76.195 63.360 48.115 30.007
Interest content 16.339 14.309 11.899 9.036 5.635
Capital content 10.805 12.835 15.245 18.108 30.007
Lease receipt 27.144 27.144 27.144 27.144 35.642
Ledger Accounts Gross Investment in Lease a/c
Dr. Year 1
To To
2
To
3
To
Year Amount (Rs. in lakh) Inventory 87.00 1 By Unearned finance income 57.22 By 144.22 Balance b/d 117.076 2 By By 117.076 Balance b/d 89.932 3 By By 89.932
Cr. Amount (Rs. in lakh) 27.144 117.076 144.22 27.144 89.932 117.076 27.144 62.788 89.932
Bank a/c Balance c/d Bank a/c Balance c/d Bank a/c Balance c/d
Unearned Finance Income a/c
Dr.
To To To To To To
Cr. Amount (Rs. in lakh) Finance income a/c 16.339 By Balance c/d 40.881 57.22 Finance income A/c 14.309 By Balance c/d 26.572 40.881 Finance income a/c 11.899 By Balance c/d 14.673 26.572
Gross Investment in lease
Amount (Rs. in lakh) 57.22
Balance b/d
57.22 40.881
Balance b/d
40.881 26.572 26.572
Finance Income a/c
Dr. Year
Amount (Rs. in lakh) 1 To Profit & Loss a/c 16.339 1 By 2 To Profit & Loss a /c 14.309 2 By 3 To Profit & Loss a/c 11.899 3 By
Cr. Amount (Rs. in lakh) Unearned finance income a/c 16.339 Unearned finance income a/c 14.309 Unearned finance income a/c 11.899
Initial Direct Costs a/c
288
Part II
Dr. Year 1
Cr. Year
Amount (Rs. in lakh) 0.5
To Bank a/c
1
Amount (Rs. in lakh) 0.5
By Profit & Loss a/c
Disclosure in Financial Statements Year 1 Profit & Loss a/c
Dr. Expenses Initial direct cost
Income Amount (Rs. in lakh) 0.5 Finance income
Cr. Amount (Rs. in lakh) 16.339
Balance Sheet
Dr. Liabilities
Cr. Amount (Rs. in lakh)
Assets
Amount (Rs. in lakh)
Current Assets Net investment in lease (144.22 – 57.22 – 10.805)
76.195
Year 2 Profit & Loss a/c
Dr. Expenses
Cr. Amount (Rs. in lakh) 14.309
Income
Amount (Rs. in lakh)
Finance Income Balance Sheet
Dr. Liabilities
Cr. Amount (Rs. in lakh)
Assets
Amount (Rs. in lakh)
Current Assets Net investment in lease (76.195 – 12.835)
63.36
Year 3 Profit & Loss a/c
Dr. Expenses
Cr. Amount (Rs. in lakh)
Income Finance Income
Amount (Rs. in lakh) 11.899
Balance Sheet
Liabilities
Amount (Rs. in lakh)
Assets Current Assets Net Investment in lease (63.36 – 15.245)
119.
a.
Amount (Rs. in lakh) 48.115
i. Annual lease rental = 20 x 0.0265 x 12 = Rs.6.36 lakh Present value of the annual lease rental (receivable in advance) plus the 289
Investment Banking and Financial Services
unguaranteed residual value discounted @ 16.5% per annum is equal to = 6.36 x PVIFA(16.5, 5) x 1.165 + 0.6 x PVIF(16.5, 5) = Rs.24.26 lakh
Cost of Goods Sold a/c
Dr.
Cr.
Year 1
To Inventory a/c (20 x 0.83) ii.
Year Amount (Rs. in lakh) 16.6 1 By profit & loss a/c
Amount (Rs. in lakh) 16.6
Fair Market Value = Rs.20 lakh Since (ii) < (i), the sales revenue should be recorded at Rs.20 lakh.
b.
The rate of interest implicit in the proposal (r) is given by the equation = 6.36 x PVIFA(r, 5) + 0.6 x PVIF(r, 5) = 20 = 6.36 x PVIFA(r, 5) x (1 + r) + 0.6 x PVIF(r,5) = 20 = 31.28%. Unearned Finance Income = [(6.36 x 5) + 0.6)] – 20 = Rs.12.4 lakh. Allocation of Unearned Finance Income
(Rs. in lakh)
Year Investment outstanding Interest content Capital content Lease related receipt at the beginning 1
20.00
4.27
2.09
6.36
2
17.91
3.61
2.75
6.36
3
15.16
2.75
3.61
6.36
4
11.55
1.62
4.74
6.36
5
6.81
0.14
6.81
6.95
Dr. Year 1
Cr.
Finance Income a/c
To Profit & Loss a/c
Year Amount (Rs. in lakh) 4.27 1 By Unearned finance income
Amount (Rs. in lakh) 4.27
Disclosure in the Financial Statements
Dr.
Cr.
Profit & Loss a/c
Cost of goods sold
Amount (Rs. in lakh) 16.6
Amount (Rs. in lakh) 20.00 4.27
Sales Finance income
Balance Sheet
Liabilities
Assets
Amount (Rs. in lakh)
Amount (Rs. in lakh)
Current Assets Net Investment in lease 20 – 2.09 17.91
HIRE PURCHASE 120.
a.
Cash price of equipments
= Rs.100 lakh
Monthly installments payable = Rs.3,94,440 290
Part II
Total hire purchase price Flat rate of interest
=
= 3,94,440 x 36 = Rs.141,99,840
1, 41, 99, 840 − 1, 00, 00, 000
x 100 x
1, 00, 00, 000
b.
1 = 13.9% ~ 14% 3
Rate of interest implicit in the scheme is that rate which would equate the present value of rentals to the cash price. 3,94,440 x PVIFA(k,36) = 100,00,000 PVIFA(k,36) =
100,00,000 = 25.3524 3,94,440
From the additional information given, PVIFA(2%,36) = 25.489 PVIFA(3%,36) = 21.832 k=2+
25.489 − 25.3524 = 2.04% 25.489 − 21.832
The implicit rate of interest per annum = (1 + 0.0204)12 – 1 = 27.42% c.
The sum-of-the-years digits would be, 36 + 35 + 34 + ....... + 3 + 2 + 1 = 666 Total interest payable for the three-year period = Rs.41,99,840. Year 1
Interest Allocation
Rs.
** 366 x 41,99,840 = 23,08,020 666
2
222 x 41,99,840 666
= 13,99,947
3
78 x 41,99,840 666
= 4,91,873
Since the interest rate is charged over a three year period. **
121.
a.
= 36 + 35 + .... + 25 = 366 36 + 35 + .... + 1 666 =
24 + 23 + .... + 13 222 = 36 + 35 + .... + 1 666
=
12 + 11 + .... + 1 78 = 36 + 35 + .... + 1 666
Cost of Capital = 20 (1 − 0.43) x
4 1 + 24 x 5 5
9.12 + 4.8
= 14 (approx.)
Loan amount
= 30,000 x 0.75 = Rs.22,500
Monthly HP
=
PV of HP
= 12 x 850 x PVIFA(14,3) x
22,500 + 22,500 x 0.12 x 3 = Rs.850 36 i * i12
= 10,200 x 2.322 x 1.0626 = Rs.25,167 * i = Effective rate of interest implied by the completed transaction i/i12 can be found out from the Table 1 at the end of the textbook. 291
Investment Banking and Financial Services
For i = 0.14, i/i12
= 1.0626
Total charge for credit = 22,500 x 0.12 x 3 = 8,100
Year SOYD 1 366/666 x 8100 2 222/666 x 8100 3 78/666 x 8100 PV of tax on finance charge =
[4,451 PVIF(14,1) + 2,700 PVIF(14,2) + 949 PVIF(14,3)] x 0.43
=
(4,451 x 0.877 + 2,700 x 0.769 + 949 x 0.675) x 0.43 = Rs.2847.3
NPV =
–22,500 + PV of HP – PV of tax on finance charge
= b.
122.
Annual Financial Income (Rs.) 4,451 2,700 949
–22,500 + 25,167 – 2847.3 = – Rs.180.3
Effective rate of interest n 36 = (2F) = x 2 x 12 = 23.35 n +1 37
Cost of capital =
3 1 x 16 x 0.7 + x 28 = 15.4 4 4
Cost of Leasing
A.
PV of Lease Rentals =
B.
0.027 x 280 x 12 x
i d12
*
x PVIFA(16%,5) = 322.17
PV of TS on Lease Rentals = COL =
280 x 0.027 x 12 x PVIFA(15.4%,5) x 0.3 = 90.384 A – B = 231.79
Cost of Hire Purchase 224 + 224 x 0.15 x 3 = 9.02 36
C.
EMI =
D.
PV of Hire payments
= 9.02 x 12 x PVIFA(16%,3) x
i = 263.70 d12
Total charge for credit = 224 x 0.15 x 3 = 100.8 Interest Allocation
E.
Year SOYD Factor 1 366/666 2 222/666 3 78/666 PV of TS on charge for credit =
F.
Interest Allocation 55.39 33.60 11.81
[55.39 PVIF(15.4,1) + 33.6 PVIF(15.4,2) + 11.81 PVIF(15.4,3)] 0.3=Rs.24.28
PV of DTS = PVIF(15.4,4)
[70 PVIF(15.4,1) + 52.5 PVIF(15.4,2) + 39.38 PVIF(15.4,3) + 29.53(15.4,4)
COHP = =
C+D–E–F 56 + 263.7 – 24.28 – 45.97 = Rs.249.45 lakh
+ 22.15 PVIF(15.4,5)] 0.3 = Rs.45.97 lakh
COHP > COL, leasing is recommended. 292
Part II
* For i = 0.16, d12 = 0.1475 ⇒
i = 1.0847 d12
(From Table A.1 (Relationship between Nominal and Effective Rates of Interest and Discount) from the textbook.) 123.
Cost of leasing can be determined as follows: A. Present value of lease payments = 360 x 0.028 x
i d
(12 )
* x 12 x PVIFA(20,5)
= 360 x 0.028 x 1.1053 x 12 x 2.991 = Rs.339.88 lakh Present value of tax shield on lease payments = 360 x 0.028 x 12 x 0.5175 x PVIFA(16,5) = 62.6 x 3.274 = Rs.204.94 lakh Cost of hire purchase can be determined as follows: C. Down Payment = 360 x 0.2 = Rs.72 lakh D. Monthly hire purchase installment
B.
= E.
360 x 0.8 (1 + 0.16 x 3) = Rs.11.84 lakh 36
Present value of monthly HP installments = 11.84 x
F.
i i
(12 )
= 11.84 x 1.0887 x 12 x 2.107 = Rs.325.92 lakh Unexpired finance charge at the inception of the HP transaction = 360 x 0.8 x 0.16 x 3 = Rs.138.24 lakh Allocation of the unexpired finance charge over the lease period based on the SOYD method will be as follows: Year 1
G.
** x 12 x PVIFA(20,3)
Factor
Finance charge
36 + 35 + .... + 25 366 366 = = 75.97 138.24 x 36 + 35 + .... + 1 666 666
2
24 + 23 + .... + 13 222 = 36 + 35 + .... + 1 666
138.24 x
222 = 46.08 666
3
12 + 11 + .... + 1 78 = 36 + 35 + .... + 1 666
138.24 x
78 = 16.19 666
Present value of tax shield on finance charge = [(75.97 x PVIF(16,1) + 46.08 x PVIF(16,2) + 16.19 x PVIF(16,3)] x 0.5175 = [(75.97 x 0.862 + 46.08 x 0.748 + 16.19 x 0.641)] x 0.5175 = Rs.56.98 lakh
H.
I.
Present value of depreciation tax shields =
[(90 x PVIF(16,1) + 67.5 x PVIF(16,2) + 50.62 x PVIF(16,3) + 37.97 x PVIF(16,4) + 28.48 x PVIF(16,5)] x 0.5175
=
[(90 x 0.862) + (67.5 x 0.743) + (50.62 x 0.6,41) + (37.97 x 0.552) + (28.48 x 0.476)] x 0.5175 = Rs.100.75 lakh
Present value of net salvage value =
45 x PVIF(16,5)
=
45 x 0.476 = Rs.21.42 lakh
J.
Cost of Leasing = A – B = Rs.194.94 lakh
K.
Cost of HP = C + E – H – I – G = Rs.218.67 lakh Since cost of leasing is less than the cost of hire purchase leasing is recommended. 293
Investment Banking and Financial Services
* For i = 20% = 0.20, **For i = 20% = 0.20, 124.
a.
i = 1.1053 (From Table A.1) d12 i i
12
= 1.0887 (From Table A.1)
The first step is to calculate the break even rental for the lessor. Define L as the break even rental payable quarterly in arrear on an asset cost of Rs.1,000 A.
Initial Investment
= Rs.1,000
B.
PV of lease rentals
= 4L x
i i
( 4)
* x PVIFA (10,5)
= 4L x 1.0368 x 3.791 = 15.721L C.
PV of Tax on lease rentals = 4L x 0.3 x PVIFA(10,5) = 4L x 0.3 x 3.791 = 4.549L
D.
PV of Depreciation tax shields = [250x0.909 + 187.5x0.826 + 140.63 x 0.751 + 105.47 x 0.683 + 79.10x0.621] x 0.3 = 182.67
E.
PV of residual value = 50 x 0.621 = 31.05
F.
L can be obtained from the equation –1,000 + 15.721L – 4.549L + 182.67 + 31.05 = 0 i.e 11.172L = 786.28 L = Rs. 70.38 ptpq
b.
Define F as the flat rate of interest associated with the hire purchase plan. 750 + (750 x F x 3) = (62.5 + 187.5F) 12 i PV of quarterly installments = (62.5 + 187.5F) x 4 x ( 4) x PVIFA(i,3) i
Quarterly installment =
where i
= 10% = (62.5 + 187.5F) x 4 x 1.0367 x 2.487 = 644.57 + 1933.70F
Unexpired Finance Income = 750 x F x 3 = 2,250F Allocation of unexpired finance income under SOYD method will be as follows: Year 1 2 3
SOYD Factor 42/78 x 2,250F 26/78 x 2,250F 10/78 x 2,250F
Finance Income 1,211.54F 750.00F 288.46F
PV of Tax on Finance Income = [1211.54F x 0.909 + 750.00F x 0.826 + 288.46F x 0.751] x 0.3 = 581.23F The value of F can be obtained from the equation: 644.57 + 1,933.70F – 581.23F = 750 i.e. 1,352.47F = 105.43 or F = 7.8% Minimum Quarterly Installment ⎡ 750 + (750 x 0.078 x 3) ⎤ =⎢ ⎥ = Rs.77.125 12 ⎦ ⎣ c.
i.
Total lease rentals
= 70.38 x 4 x 5 = 1407.6
Cost of asset
= 1000 294
Part II
Total interest charge
= 407.6
Average annual interest charge 407.6 = = 81.52 5 Add-on yield ii.
=
⎛ n ⎞ Effective Rate of Interest implied by hire charges = 2F ⎜ ⎟ ⎝ n +1 ⎠
= 2 x 0.078 x * For i = 10%, 125.
a.
81.52 x 100 = 8.15% 1000
12 = 14.4% 13 i i
12
= 1.0368 (from table A.1 at the end of the textbook)
Loan amount = 600 x 0.75
= Rs.450 lakh
Total charge for credit = 450 x 0.16 x 4
= Rs.288 lakh
Equated annual installment =
450 + 288 = Rs.184.5 lakh 4
The effective rate of interest (r) can be computed from the following equation of value. 184.5 x PVIFA(r,4)
= 450
PVIFA(r,4)
= 2.439
r = 23%
PVIFA(23,4)
= 2.448
r = 24%
PVIFA(24,4)
= 2.404
Interpolating in the range of (23%, 24%) we get ⎛ 0.009 ⎞ r = 23 + ⎜ x 1⎟ = 23.2% ⎝ 0.044 ⎠
Year-wise allocation of Total Charge for Credit (unexpired finance charge). i. Effective Rate of Interest Method (Rs. lakh) Year
Investment Outstanding
Interest (23.2%)
Principal
Equated Annual Installment
1
450.00
104.40
80.10
184.50
2
369.90
85.82
98.68
184.50
3
271.22
62.92
121.58
184.50
149.64
184.35
4 ii.
149.64 34.71 Sum of Years Digits Method
(Rs. lakh) Year
SOYD Factor
Interest Charge
1
4 4 = 1 + 2 + 3 + 4 10
0.4 x 288
=
115.20
2
3 10
0.3 x 288
=
86.40
3
2 10
0.2 x 288
=
57.60
295
Investment Banking and Financial Services
1 10
4
iii.
0.1 x 288
=
28.80
Year-wise allocation under the straight line method =
288 4
= Rs.72 lakh for all years b.
We will assume allocation of unexpired finance charge using effective rate of interest method. Income Statement
(Rs. lakh) Expenses Depreciation related to equipments acquired under HP plan Finance charge
Incomes 72.00 104.40
Balance Sheet
(Rs. lakh) Liabilities
Assets Fixed assets
Secured loans
Assets acquired under HP plan
HP outstandings
271.22 Gross block
Current liabilities
Less: Acc. Depreciation
HP outstandings 126.
a.
600 72
98.680 Net Block
528.00
We will work with an amount of Rs.1,000. Amount of loan
= 0.75 x 1,000
= Rs.750
Total charge for credit = 750 x 0.135 x 4 = 405 Monthly installment = (750 + 405)/48 = Rs.24.06 Define (i) as the effective rate of interest per annum or the APR. The value of i can be obtained from the equation: = (24.06 x 12) x PVIFA m (i , 4) = 750 = 288.75 x =
i i
(12 )
i x PVIFA(i,4) = 750 i (12)
x PVIFA(i, 4) = 2.597
i = 25.64% b.
Using the approximation formula, ‘i’ can be calculated as follows: 48 n x 2F = x 2 x 13.5 = 26.45% 49 n +1
127.
We will work with an amount of Rs.1,000. The charge for credit Monthly installment
= (1,000 x 0.14 x 4) = Rs.560 =
1560 = Rs.32.5 48 296
Part II
Amount of deposit at time 0
= Rs.250
⎡ 0.15 ⎤ Accumulated value of deposit after 4 years = 250 ⎢1 + 12 ⎥⎦ ⎣
48
= Rs.453.83.
Monthly Cash Flows
Month 1
Loan amount 2
Initial deposit 3
Net cash flow Investment Accumulated amount value of deposit 4 5 6 – (2) – (3) – (4) + (5)
0 1,000 250 750.0 1 32.5 –32.5 2 32.5 –32.5 – – – 47 32.5 –32.5 48 32.5 453.83 +421.338 Setting the present value of the cash outflows equal to the present value of the cash inflows at the rate of interest (i) we get 32.5 x 12 x PVIFA(m) [I, 4] = 750 + 453.83 x PVIF(i, 4) or 390 x
i i
(12 )
x PVIFA(i, 4)
= 750 + 453.83 x PVIF(i, 4)
128.
at i
= 0.36, LHS – RHS = 3.62
at i
= 0.38, LHS – RHS = –9.81
i
3.62 ⎤ ⎡ = ⎢0.36 + 0.02 x = 36.005 = 36% 13.35 ⎥⎦ ⎣
Let the amount of finance be Rs.1,000. Monthly hire charge =
1000 x 0.135 x 4 + 1000 = Rs.32.08 48
Effective rate of interest if all the payments are made on the due date: = 1,000 – 32.08 x PVIFA(i,48) = 0 i
= 1.92%
Payment value of the payments not yet due = 32.08 x PVIFA(1.92,22*) = 32.08 x 17.81
= Rs.571.35.
Total amount payable = 32.08 x 22
= Rs.705.76
Rebate = 705.76 – 571.35
= Rs.134.41
* Since 22 installments are yet to be paid (48 – 26) = 22
129.
Total charge for credit: 750 x 0.14 x 3 = Rs.315 Interest rebate:
12 x 13 x 315 = Rs.36.89. 36 x 37
297
Investment Banking and Financial Services
130.
Cost of Leasing
A.
Present value of lease payments = 270 x 0.0265 x 12 x
i d
(12 )
x PVIFA(i, 5)
where i = 20% = 270 x 0.0265 x 12 x 1.1053 x 2.991 = Rs.283.85 lakh B.
Present value of tax shield on lease payments @ 17% = 270 x 0.0265 x 12 x PVIFA(17, 5) x 0.46 = 270 x 0.0265 x 12 x 3.199 x 0.46 = Rs.126.34 lakh
C.
Cost of leasing = 283.77 – 126.34 = Rs.157.43 lakh
Cost of Hire Purchase
D.
Total charge for credit = 270 x 0.75 x 0.155 x 3 = Rs.94.1625 lakh The allocation of total charge for credit based on the SOYD method is presented in the following table: SOYD Factor 366 666 222 666 78 666
Year 1 2 3 E.
Charge for credit (Rs. in lakh) 51.746 31.387 11.028
Present value of tax shield on charge for credit [(51.746 x 0.855) + (31.387 x 0.731) + (11.028 x 0.624)] x 0.46 = Rs.39.07 lakh
F.
Down payment = Rs.67.5 lakh (270 x 0.25)
G.
Monthly hire purchase installment =
H.
(270 x 0.75) + (202.5 x 0.155 x3) = Rs.8.24 lakh 36
Present value of HP installment = 8.24 x 12 x
i d
(12 )
x PVIFA(20, 3)
= 8.24 x 12 x 1.1053 x 2.991 = Rs.326.89 lakh I.
Present value of depreciation tax shields @ 17% = [108 x PVIF(17,1) + 64.80 x PVIF(17,2) + 38.88 x PVIF(17,3) + 23.33 x PVIF(17,4) + 14 x PVIF(17,5)] x 0.46 = [92.308 + 47.337 + 24.276 + 12.449 + 6.384] x 0.46 = Rs.84.06 lakh
J.
Present value of net salvage value = 32 x PVIF(17, 5) = Rs.14.59 lakh
K.
COHP = F + H – D – I – J = Rs.261.67 lakh
Since the cost of leasing is less than the cost of hire purchase, the assets are to be acquired under the lease plan. 131.
Year
Depreciation
1
94.50 (378 x 0.25)
2
70.88 (283.5 x 0.25) 298
Part II
3
53.16 (212.62 x 0.25)
Monthly hire rental =
378 x 0.75 x 0.135 x 3 + 378 x 0.75 = Rs.11.06 lakh 36
Total charge for credit: 378 x 0.75 x 0.135 x 3 = Rs.114.82 Allocation of Finance Charge
(Rs. lakh) Year
SOYD factor
Interest allocation
Hire rentals paid
Principal
1
366 x 114.82 666
63.10
132.72
69.62
2
222 x 114.82 666
38.27
132.72
94.45
3
78 x 114.82 666
13.45
132.72
119.27
Year 1 Income Statement
Year 1
Year 2
Year 3
To Depreciation
94.50
To Finance charge
63.10
To Depreciation
70.88
To Finance charge
38.27
To Depreciation
53.16
To Finance charge
13.45
Balance Sheet
Year
Liabilities
1
Secured Loans Hire purchase outstandings
119.27
Current Liabilities Hire Purchase outstandings
94.45
2
Secured loans Hire purchase outstandings Current Liabilities Hire purchase outstandings
3
132.
Year 1
Assets Fixed Assets: Equipment } on HP Gross Block Less: Depreciation
378.00 94.50 283.50
2 – 94.45 3
Fixed Assets: Equipment on HP Gross Block
378.00
Less: Depreciation (94.50 + 70.88)
165.38 212.62
Secured loans Hire purchase outstandings
Fixed Assets: Equipment on HP Gross Block
378.00
–
Current liabilities Hire purchase outstandings
Less: Depreciation (94.50+70.88+53.16)
218.54 159.46
–
Let us work out NPV (HP) for Rs.1,000. a.
Down payment
= Rs.200
b.
Quarterly rental
= 800 x 0.14 x 3 + 800 = (0.42 + 1) 800 299
Investment Banking and Financial Services
c.
Total charge for credit = 800 x 0.14 x 3 = Rs.336
d.
Present value of hire rentals = 94.67 x
i x 4 x PVIFA(9,3) d4
= 94.67 x 1.0556 x 4 x 2.531 = Rs.1012.69 e.
Interest tax and income tax on interest income Year 1 2 3
SOYD factor 42 x 336 78 26 x 336 78 10 x 336 78
Interest allocation
Interest tax
Income tax
PVIF(9,n)
180.92
5.43*
45.63
0.917
112.00
3.36
28.25
0.842
43.08
1.29
10.87
0.772
PV (Interest tax)
=
Rs.8.80**
PV (Income tax)
=
Rs.74.01*** Rs.82.82
NPV (HP)
= – Loan amount + PV (Hire payments) – PV (Interest tax) – PV (Income tax) = – 800 + 1012.69 – 82.82 = Rs.129.87
* Interest tax @ 3% on interest allocation ∴ 3% on 180.92 = 5.43
Now income tax = (180.92 – 5.43) x 0.26
= 45.63
** 5.43 x 0.917 + 3.36 x 0.842 + 1.29 x 0.772 = 8.80 ***45.63 x 0.917 + 28.25 x 0.842 + 10.87 x 0.772 = 74.02 133.
a.
A. B.
Cost
= Rs.4 lakh
Deposit
= Rs.0.8 lakh
Let Monthly Installment be
= Rs.M lakh 12
C.
PV of Installments = 12M x i/d PVIFA18%, 4
= Rs.35.347M lakh
D.
Service charge = 4 x 0.02
= Rs.0.08 lakh
Accumulated value of deposit = 0.8 FVIF1%, 48
= Rs.1.29 lakh
E.
PV of deposit to be collected at the end 1.29 PVIF18%, 4 = Rs.0.666 lakh EMI is ‘M’ in the following: A – B – C – D + E = 0 = +4 – 0.8 – 35.347M – 0.08 + 0.666 lakh = 0 M=
3.786
= 0.107 lakh
35.347
b.
Total charge for credit = 0.107 x 48 – 4 = 1.136 lakh Interest rebate as per Rule of 78 =
12 x 13 x 1.136 lakh = Rs.0.075 lakh 48 x 49
Amount payable on early settlement = 0.107 x 12 – 0.082 = Rs.1.209 lakh Accumulated value of deposit by the end of 36th month = 0.8 FVIF1%, 36 = Rs.1.145 lakh Monthly effective interest is ‘i’ is the following: 300
Part II
4 – 0.8 – 0.107 x 12 x PVIFAi,3 x i/d12 – 0.08 – 1.202 PVIFi,3 + 1.145 PVIFi,3 = 0 At
i = 18%,
RHS = 4 – 0.08 – 1.284 x 1.0950 x 2.174 – 0.08 – 1.209 x 0.609 + 1.145 x 0.609 = 0.024 At
i = 16%
RHS = –0.049
By interpolation, i = 16 + 134.
a.
0.049 = 16.67% 0.073
Cost of lease to BCL:
Investment cost = Rs.100 crore A.
PV of lease rentals = 0.032 x 100 x 12 x i/d12 x PVIFA15%,4 = 0.032 x 100 x 12 x 1.0795 x 2.855 = Rs.118.347 crore Cost of capital 2 1 = x 0.15 x 0.7 + x 0.18 = 0.13 = 13% 3 3
B.
PV of tax shield on lease rentals = 0.032 x 100 x 12 x PVIFA13%,4 x 0.3 = 0.032 x 100 x 12 x 2.974 x 0.3 = Rs.34.260 crore Cost of lease = A – B = 118.347 – 34.260 = Rs.83.74 crore Cost of Hire Purchase to BCL:
Equated monthly installments 100 x 0.13 x 4 + 100 = 48 = Rs.3.167 crore C.
PV of hire rentals = 3.167 x 12 x i/d12 x PVIFA15%,4 = Rs.117.12 crore PV of depreciation tax shield (DTS): (Rs. crore) Year 1 2 3 4
Depreciation 25.000 18.750 14.063 10.547
PV @ 13% 22.125 14.681 9.746 6.465 53.017
D.
PV of DTS = 53.017 x 0.3 = Rs.15.905 crore
E.
PV of interest tax shield: Total amount of charge = 100 x 0.13 x 4 = Rs.52 crore (Rs. crore) Year
SOYD factor
Interest
PV @ 13%
1
48 + ....... + 37 510 = 48 + ........ + 1 1176
22.551
19.958
2
36 + ....... + 25 366 = 48 + ........ + 1 1176
16.184
12.672
301
Investment Banking and Financial Services
24 + ....... + 13
3
48 + ........ + 1
=
222
12 + ....... + 1 78 = 48 + ........ + 1 1176
4
9.816
6.802
3.449
2.114
1176
41.546 F.
PV of tax shield on finance charge of hire rentals = 41.546 x 0.3 = Rs.12.464 crore Cost of hire purchase = C – D – E = 117.12 – 15.905 – 12.464 = Rs.88.75 crore As COL < COHP, lease should be opted by BCL.
b.
Comparison of purchase with lease can be done by calculating the net advantage of lease (NAL). If NAL > 0, lease should be opted and if NAL < 0, purchase would be preferable. NAL = Investment cost – PV of lease rentals + PV of tax shield on lease rentals – PV of depreciation tax shield – PV of interest tax shield PV of interest tax shield: Total charge for credit = 12 x 0.032 x 100 x 4 – 100 = Rs.53.6 crore (Rs. crore) Year
SOYD factor
Interest
PV @ 13%
1
510/1176
23.245
20.572
2
366/1176
16.682
13.062
3
222/1176
10.118
7.012
4
78/1176
3.555
2.179 42.825
PV of interest tax shield = 42.825 x 0.3 = Rs.12.848 crore NAL = 100 – 118.347 + 34.26 – 15.905 – 12.848 = –Rs.12.84 crore As NAL is (–)ve, purchase alternative should be opted by BCL. 135.
A.
Loan Amount = 4,00,000 x 0.75 = Rs.3,00,000
B.
PV of installments paid = 9250 x 12 x i/d12 x PVIFAi,3 = 1,11,000 x i/d12 x PVIFAi,3
C.
Service fee
D.
PV of amount payable on early settlement:
= Rs.2,000
Total charge for credit = 9250 x 12 x 4 – 3,00,000 = Rs.1,44,000 Interest rebate as per rule 78 =
t ( t + 1) xD n (n + 1)
where, t
= Installments not due and unpaid;
n
= Total number of installments; and
D
= Total charge for credit
302
Part II
12 x 13 x 1,44,000 = Rs.9,551 48 x 49
=
Rebate for prompt payment =
8 x 9250 x 36 = Rs.266.40 10,000
Amount payable on early settlement = (9250 x 12) – 9551 – 266.40 = Rs.1,01,183 PV of the amount = 1,01,183 x PVIFi,3 Effective rate of interest is ‘i’ in the following equation: 3,00,000 – 1,11,000 x i/d12 x PVIFAi,3 – 2000 – 1,01,183 x PVIFi,3 = 0 At
i = 24%,
LHS = –2551.191
At
i = 28%,
LHS = 12114.901
‘i’ is between 24% and 28%. By interpolation, −2551.191 − 0 = 24.7% − 2551.191 − 12114.901
i = 24% + 4 x 136.
Loans and Advances
Assuming that the Rs.3 lakh of upgraded assets belong to doubtful assets of less than one year, the following workings can be made: (Rs. lakh) Asset Standard Sub-standard Doubtful < 1 year 1 - 3 years > 3 years Loss
Opening 180 50
Increase 30 + 10 3
Decrease — 12.5 + 5 + 10
Closing 220.00 25.50
Provision — 2.55
10%
12 8 7 25
5 — — —
2.4 + 3 0.80 0.35 1.25
11.60 7.20 6.65 23.75
20% 30% 50% 100%
2.32 2.16 3.33 23.75 34.11
Hire Purchase Assets
Rs. lakh
Basic provisioning:
Total dues Less: Unmatured finance charges Depreciated value Realizable value Less: Lower of the two
95 20 46 95 46 29 (Rs. lakh)
Additional provision:
Time period < 12 months 12 - 24 months 24 - 36 months > 36 months
Amount o/s 30 15 - 5* = 10 5 3
Rate of provision — 10% 50% 100%
Amount of provision — 1.0 2.5 3.0 6.5
Additional provision on HP assets
= 6.5 + 5* = 11.50
Total provision on HP assets
= 29 + 11.50 = Rs.40.50 lakh 303
Investment Banking and Financial Services
Lease Assets
(Rs. lakh) Amount o/s 40 24 10 - 3* = 7 10
< 12 months 12 - 24 months 24 - 36 months > 36 months
Rate of provision — 10% 50% 100%
Amount — 2.4 3.5 10.0 15.9
Provision on leased assets
= 15.9 + 3.0* = 18.90
Total provision
= 34.11 + 29 + 40.50 + 15.90 = Rs.119.51 lakh
*As 12 months have expired after the due date of the last payment, entire net book value has to be provided for. 137.
a.
Down payment = Rs.75 x 0.2 = Rs.15 lakh A.
Amount of loan = Rs.75 – Rs.15 = Rs.60 lakh
B.
Let the flat rate of interest be F% F x 5 + Rs.60 100 EMI = 12 x 5 = Rs. (0.05F + 1) lakh Rs.60 x
C.
PV of hire payment = Rs.(0.05F + 1) 12 PVIFA12%, 5 x
i 12
i = Rs.(0.05F + 1) 12 x 3.605 x 1.0539 = Rs. (2.28F + 45.592) lakh
D.
Unmatured finance charges = Rs.60 x
F x 5 = Rs.3F lakh 100
Allocation of unmatured finance charges (Rs. lakh) Year
SOYD factor
Finance income (Rs.)
1 2 3 4 5
654/1830 510/1830 366/1830 222/1830 78/1830
1.072F 0.836F 0.600F 0.364F 0.128F
Interest tax @ 2% (Rs.) 0.021F 0.017F 0.012F 0.0073F 0.0026F
Net interest (Rs.) 1.051F 0.819F 0.588F 0.357F 0.125F
PV @ 12% PV @ 12% of of net interest tax interest (Rs.) (Rs.) 0.938F 0.01875F 0.653F 0.01355F 0.419F 0.00854F 0.227F 0.00464F 0.071F 0.00148F 2.308F 0.04696F or 0.047F
E.
PV of interest tax = Rs.0.047F lakh
F.
PV of income tax on net interest income = Rs.2.308F x 0.3 = Rs.0.692F lakh NPV(HP) =–A+C–E–F=0 = – 60 + 2.28F + 45.592 – 0.047F – 0.692F = 0 or,
1.541F = 14.408 304
Part II
or, b.
F=
Rs.14,408 = 9.35% Rs.1,541
Monthly hire installment = 0.05F + 1 = Rs.(0.05 x 9.35) + 1= Rs.1.468 lakh Equated yearly payment = Rs.1.468 x 12 = Rs.17.616 lakh Amortization Schedule
(Rs. lakh) Year 1 2 3 4 5
Installment (Rs.) 17.616 17.616 17.616 17.616 17.616 88.080
Interest (Rs.) 10.023 7.817 5.610 3.403 1.197
Capital content (Rs.) 7.593 9.799 12.006 14.213 16.419
Interest tax @ 2% (Rs.) 0.196 0.159 0.112 0.068 0.024
Profit and Loss Account
(Rs. lakh) Year 1 (Rs.) Interest tax 0.196
Year 2 (Rs.) 0.159
Year 3 (Rs.) 0.112
Year 1 Year 2 Year 3 (Rs.) (Rs.) (Rs.) 10.023 7.817 5.61
Finance income
Balance Sheet
(Rs. lakh)
Unmatured finance income
138.
a.
Year 1 (Rs.)
Year 2 (Rs.)
Year 3 (Rs.)
Year 1 (Rs.)
Year 2 (Rs.)
18.027 (7.817 + 5.61 + 3.403 + 1.197)
10.210 (5.61 + 3.403 + 1.197)
4.600 Current 70.464 52.848 35.232 (3.403 + assets (88.08 – (70.464 – (52.848 1.197) 17.616) 17.616) –17.616)
A.
Cost of car
= Rs.5,60,000
B.
Deposit
= 5,60,000 x 0.2 = Rs.1,12,000
C.
EMI
=
D.
PV of EMIs = 20,689 PVIFAi, 36 (1 + i)
E.
Documentation fee = 0.005 x 5,60,000 = Rs.2,800
F.
Deposit with interest refunded = 1,12,000 FVIF0.5%, 36 = Rs.1,34,028
G.
Year 3 (Rs.)
5,60,000 x 0.11 x 3 + 5,60,000 = Rs.20,689 36
PV of deposit refunded
= 1,34,028 PVIFi, 36
Prompt payment rebate
=
18 x 20,689 x 36 = Rs.670 20,000
PV of rebate = 670 PVIFi, 36 305
Investment Banking and Financial Services
H.
PV of tax on interest from the deposit = (1,34,028 – 1,12,000) x 0.30 x PVIF(i, 36) = 6608 x PVIFi, 36 Effective rate of interest is value of i in the following: A–B–D–E+F+G–H =0 5,60,000 – 1,12,000 – 20,689 PVIFAi, 36 (1 + i) – 2800 + (1,34,028 + 670 – 6608) PVIFi, 36 = 0 20,689PVIFAi, 36 (1 + i) – 1,28,090 PVIFi, 36 = 4,45,200 At
i = 2%
LHS = 20,689 x 25.489 x 1.02 – 1,28,090 x 0.49 = 4,75,125 At
i = 3%
LHS = 20,689 x 21.832 x 1.03 – 1,28,090 x 0.345 = 4,21,042 By interpolation, Effective rate of interest = 2+ = 2+
4, 75,125 − 4, 45, 200 4, 75,125 − 4, 21, 042 29,925 = 2.55% 54,083
Yearly rate = 35.3% b.
As the finance scheme is in the form of hire purchase transaction and the car is used for business purposes, depreciation and interest tax shield can be claimed. I.
PV of depreciation tax shield (Rs.) Year 1 2 3
Depreciation 1,68,000 1,17,600 82,320
PV = Rs.[1,68,000 PVIFi, 12 + 1,17,600 PVIFi, 24 + 82,320 PVIFi, 36] x 0.2 J.
PV of tax on interest from deposit = (134028 – 112000) 0.2 PVIFi, 36 = Rs.4406 PVIFi, 36
K.
Total charge for credit = 20,689 x 36 – 5,60,000 = Rs.1,84,804 SOYD Method of Interest Allocation
Year
SOYD factor
Interest
1
366/666
101554
2
222/666
61604
3
78/666
21644
PV of ITS = 20311 PVIFi, 12 + 12321 PVIFi, 24 + 4328 PVIFi, 36 L.
PV of TS on documentation fees = 2800 x 0.2 PVIFi, 12 =
Rs.560 PVIFi, 2
Effective cost is i in the following: A–B–D–E+F+G+I–J+K+L=0 306
Part II
5,60,000 – 1,12,000 – 20,689 PVIFAi, 36 (1 + i) – 2800 + 1,34,028 PVIFi, 36 + 670 PVIFi, 36 – 4406 PVIFi, 36 + 33,600 PVIFi, 12 + 23,520 PVIFi, 24 + 16,464 PVIFi, 36 + 20,311 PVIFi, 12 + 12,321 PVIFi, 24 + 4328 PVIFi, 36 + 560 PVIFi, 12 = 0 4,45,200–20,689 (1 + i) PVIFAi, 36+54,472 PVIFi, 12+35,840 PVIFi, 24 + 1,51,085 PVIFi, 36=0
At i = 1%, LHS is equal to 4,45,200 – 20,689 (1.01) 30.108 + 54,472 x 0.887 + 35,840 x 0.788 + 1,51,085 x 0.699 = –1,766 At i = 2%, LHS is equal to 4,45,000 – 20,689 (1.02) 25.489 + 54,472 x 0.788 + 35,840 x 0.622 + 1,51,085 x 0.490 = 46,559 i is between 1% and 2% By interpolation, i
= 1+
−1766 − 1766 − 46559
= 1 + 0.03 = 1.03% p.m. = (1.0103)12 = 13.08% p.a. 139.
a.
Leasing
Cost of the asset to the finance company as the lessor is not eligible to the 800 concessional rate of sales tax of 4% = x 1.1 = Rs.846 lakh 1.04 Lease rentals are charged on Rs.846 lakh Cost of lease = PV of Lease Rentals (LR) – PV of Tax Shield (TS) on lease rentals PV of LR = 0.025 x 12 x 846 x PVIFA14%,5 x
i = Rs.915.82 lakh. i4
PV of TS on LR = 0.025 x 12 x 846 x PVIFA16%,5 x 0.35 = Rs.290.86 lakh COL
= 915.82 – 290.86 = Rs.624.96 lakh.
Hire Purchase
As hire purchase is equivalent to sale, the cost of asset to the finance company will be same as Rs.800 lakh Down payment
= 0.25 x 800 = Rs.200 lakh
Monthly Hire Installment =
600 x 0.12 x 5 + 600 = Rs.16 lakh 60
PV of Hire Installment = 16 x 12 PVIFA14%,5 x
i d12
= 16 x 12 x 3.433 x 1.0743 = Rs.708.11 lakh PV of Depreciation Tax Shield (DTS) (Rs. in lakh) Year 1 2 3
Depreciation 240.00 168.00 117.60
PVIF@16% 0.862 0.743 0.641
PV 206.88 124.82 75.38 307
Investment Banking and Financial Services
4 5
82.32 57.62
0.552 0.476
45.44 27.43 479.95
PV of DTS = 479.95 x 0.35 = Rs.167.98 lakh PV of Net Salvage Value (NSV) = 12 PVIF16%,5 = Rs.5.712 lakh. PV of Interest Tax Shield (ITS): Total charge for credit = 16 x 60 – 600 = Rs.360 lakh Year
SOYD factor
Interest charge
PVIF
1
654/1830
128.66
0.862
110.90
2
510/1830
100.33
0.743
74.55
3
366/1830
72.00
0.641
46.15
4
222/1830
43.67
0.552
24.11
5
78/1830
15.34
0.476
7.30 263.01
PV of ITS = 263.01 x 0.35 = Rs.92.05 Cost of Hire Purchase (COHP) = Down Payment + PV of hire installments – PV of tax shield on finance changes of hire installments – PV of depreciation TS – PV of NSV = 200 + 708.11 – 92.05 – 167.98 – 5.712 = Rs.642.37 As COL < COHP, leasing should be opted. b.
Let EMIs be Rs.F lakh at which COL = COHP COHP
PV of EMIs = 12 x F x PVIFA14%,5 x i = Rs.44.257F. d12 Total charge for credit = F x 12 x 5 – 600 = 60 (F – 10) Year
SOYD Factor
Interest
PV
1
654/1830
21.44F - 214.43
18.48F - 184.84
2
510/1830
16.72F - 167.21
12.42F - 124.24
3
366/1830
12.00F - 120.00
7.69F - 76.92
4
222/1830
7.28F - 72.79
4.02F - 40.18
5
78/1830
2.56F - 25.57
1.22F - 12.17 43.83F - 438.35
PV of ITS = [43.83F – 438.35] x 0.35 = 15.34F – 153.42 COHP: 200 + 44.26F – 167.98 – 5.71 – 15.34F + 153.42 = 28.92F + 179.73 COHP = COL i.e.
28.92F + 179.73
= 624.96
28.92F
= 445.23
F Flat rate of interest = ∴
= 15.40 (15.40 x 60) − 600 = 10.8% 600 x 5
The flat rate of interest should be 10.8% for ASL to be indifferent between leasing and hire purchase. 308
Part II
140.
Loan amount = Rs.3,75,000 x 0.8 = Rs.3,00,000 EMI =
3,00,000 x 0.12 x 3 + 3,00,000 = Rs.11,333 36
PV of EMI’s = 11,333 PVIFAim,36 Processing fee = 0.01 x 3,00,000 = Rs.3,000 Total charge of credit (D) = 3,00,000 x 0.12 x 3 = Rs.1,08,000 Installments not due (t) = 12 Interest rebate according to Rule of 78 =
t ( t + 1) xD n (n + 1)
12 x 13 x 1,08,000 = Rs.12,649 36 x 37
=
Payment on early settlement = 11,333 x 12 – 12,649 = Rs.1,23,347 Monthly effective rate of interest is im in the following: –3,00,000 + 11,333PVIFAim,24 + 3,000 + 1,23,347 PVIFim,24 = 0. At
1%,
LHS = 40,895.20
At
2%,
LHS = –5961 i
= 1+
40,895.20 = 1.87 40,895.23 + 5,961
Yearly effective rate = (1.0187)12 – 1 = 24.90%
CONSUMER CREDIT 141.
Initial investment cost = Rs. 4,50,000 Amount of loan
= 0.85 x 4,50,000
= 3,82,500
Total charge for credit = 3,82,500 x 0.1240 x 2 = 94,860 Monthly installment
= (3,82,500 + 94,860) /24 = 19,890
Employing the approximation formula i
=
n x 2F n +1
24 x 2 x 0.1240 = 23.81 25 Using the IRR Method: 19,890 x PVIFA(km, 24)
= 3,82,500
km = 1.85% Annual percentage rate = (1.0185)12 – 1 = 0.245 or 24.6% 142.
Let flat rate = E EMI (3835) =
1,00,000 x E x 3 + 1,00,000 36
E
=
3,835 x 36 − 1,00,000 = 12.69% 3,00,000
A.
Loan = 4,20,000 x 0.8
= Rs.3,36,000 309
Investment Banking and Financial Services
EMI = 0.03835 x 3,36,000
= Rs.12,886
B.
PV of EMI = 12 x 12,886 PVIFA(i,2) x i/i12
C.
Processing fee = 0.01 x 3,36,000 = 3,360
D.
Total charge for credit
= 1,27,896
Interest rebate
=
12 x 13 x 1,27,896 = Rs.14,979 36 x 37
E.
Amount payable on early settlement = 12,886 x 12 – 14,979 = 1,39,653 PV = 1,39,653 PVIF(i,2)
F.
Service charge @ 2% on principal = (1,54,632 – 14,979) x 0.02 = 2,793 Effective rate of interest is i in the following A–B–C–E=0 3,36,000 – 1,54,632 PVIFA(i,2) x i/i12 – 3,360 – 1,39,653 PVIF(i,2) + 2,793 PVIF(i,2) By trial and error i = 23.21%
143.
a.
⎛ 3, 835 x 36 ⎞ ⎜ 1, 00, 000 x 3, 36, 000 ⎟ − 3, 36, 000 ⎝ ⎠ = 12.69% 3, 36, 000 x 3
Note: 4,20,000 x 0.8 = 3,36,000
b.
Calculation of effective rate of interest: Amount financed: 4,20,000 x 0.80 = 3,36,000 3,835 EMI = x 3,36,000 = 12,886 1,00,000 Processing fee = 3,36,000 x 0.01 = 3,360 Amount payable as on the date of prepayment Total interest = 12,886 x 36 – 3,36,000 = 127,896 Rebate =
12 x 13 x 1,27,896 = 14979 36 x 37
Amount payable = 12,886 x 12 –14,979 = 1,39,653 The effective rate of interest is ‘i’ in the following equation. 3,36,000 – 3,360 – 12,886 x
i i
12
x PVIFA(i,2) = 0
– 1,39,653 x PVIF(i,2) = 0 By trial and error, i = 23.66%. 144.
a.
Flat rate
= 16%
Effective rate
=
Monthly interest
= (1.3114)1/12 – 1 = 2.284%
PVIFA(2.284, 36)
= 24.369
EMI =
2,50,000 24,369
36 x 2 x 16 37
= 31.14%
= Rs.10,259
Alternatively
310
Part II
2,50,000 +2,50,000 x 0.16 x 3 = 10,278 36
EMI = b.
Balance of installments due = 10,259 x 18 = Rs.1,84,662 As bank permits 3 months deferment period, Mrs. Laxmi would, in effect, be making the prepayment at the end of 21 months and prepays 18 installments. PV of installments due = 10,259 PVIFA(2.284,18) = Rs.1,50,031 Interest rebate = 1,84,662 – 1,50,031 = Rs.34,631 Interest rebate according to the scheme = 0.8 x 34,631 = Rs.27,705 Net repayment after 21 months = 1,84,662 – 27,705 = Rs.1,56,957 If km is the monthly effective rate in the following equation, then 250,000 – 2,500 – 10,259 PVIFA ( k
m ,18 )
PVIFA ( k
m , 3)
– 1,56,957 ( k
m , 21)
=0
i = 2.03% p.m. or 27.27% p.a. 145.
Define ‘i’ as the Annual Percentage Rate (APR) implied by the consumer loan scheme. The value of i can be obtained from the equation 1,500 x 12 x i i
(12 )
i i
(12 )
PVIFA (i,3)
x PVIFA(i,3)
=
i x PVIFA(i,3) i (12)
40,000 18,000
= 2.222
at
i = 22%, LHS
= 2.240
at
i = 24%, LHS
= 2.190
By interpolation i 146.
= 40,000
= 22.72%
Define ‘i’ as the APR of the transactions. The value of i can be obtained from the equation 380 x 52 x
147.
i x PVIFA(i,1) = 19,000 i 52
i x PVIFA(i,1) i (52)
= 0.9615
At
i = 7.95%, LHS
= 0.9615
∴
The APR of the transaction is 7.95% (approx.)
Monthly installment =
2 + (2 x 0.13) lakh = Rs.18,833 12
The APR of the transaction is given by 12 x 18,833 x i i
(12 )
x PVIF(i,1)
i x PVIFA(i,1) i12
i i
(12 )
x PVIFA(i,1) = 2,00,000
= 0.885 = 0.885 311
Investment Banking and Financial Services
at
i = 28%, RHS = 1.1226 x 0.781 = 0.877 i = 24%, RHS = 1.1057 x 0.806 = 0.891 i = 24 + 4 x
148.
EMI =
=
0.891 − 0.885 0.891 − 0.877
= 25.71%
4,25,000 − 1,06,250 * n = 20, i = 12.5 PVIFA[1 / 12, n x 12] 3,18,750 x 0.0104 x [1.0104]240 = Rs.3,616.95 [(1.0104) 240 − 1]
* 1,06,250 = 4,25,000 x 0.25 EMI =
Loan Amount PVIFA [i / 12, n x12 ]
EMI if the loan does not carry the down payment requirement EMI =
4, 25, 000
= Rs.4,822.60
PVIFA (1.04, 240)
149.
Since there is a deferment period of 2 months, the settlement date is taken as February 10, 1999. The total charge for credit is 5,000, and the interest rebate allowed for an early settlement = 5,000 x
5 = Rs.2,083. 12
Amount payable on early settlement = 80,000 – 2,083 = Rs.77,917 The rate of interest (i) implied by the completed transaction is given by the equation: 75,000 (1 + i)5/12 = Rs.77,917 12 ⎤ ⎡ ⎛ 77,917 ⎞ 5 ⎢ i = ⎜⎜ ⎟⎟ − 1⎥ = 9.58% ⎥ ⎢⎝ 75,000 ⎠ ⎥⎦ ⎣⎢
The APR(i) associated with the original transaction is 75,000 (1 + i) = 80,000 i = 6.67% 150.
i.
ii.
Repayment period
= 12 months
Total charge for credit
= (5,062.5 x 12) – 54,000 = 6,750
Flat rate of interest
=
6,750 x 100 = 12.5% 54,000
Effective rate of interest
=
n x 2F n +1
=
12 x 25 = 23.07% 13
Repayment period
= 24 months
Total charge for credit
= (2,835 x 24) – 54,000 = 14,040
Annual charge
= 7,020
Flat rate of interest
=
7,020 x 100 = 13% 54,000
312
Part II
iii.
=
Repayment period
= 36 months
Total charge for credit
= (2107.5 x 36) – 54,000 = 21,870
Annual charge
= 7,290
Flat rate of interest
=
a.
7,290 x 100 = 13.5% 54,000
36 x 27 = 26.27% 37 The effective rate of interest implied by the deposit scheme will be that rate of interest which equates the present value of the following cash flow stream to zero. i.e. Loan Amount – PV (Installment paid) – Service fee + (PV (Accumulated value of Deposit) + PV (Prompt payment bonus) = 0 (Loan amount = 90,000 x 0.25 = 22,500) Accumulated value of 25% deposit = 22,500 + 11,720 = 34,220 (after 36 months) 3,475 Prompt payment bonus under zero deposit plan = x 1 x 36 = 125.1 1,000 Effective rate of interest
151.
24 x 2 x 13 = 24.96% 25
Effective rate of interest
=
Prompt payment bonus under 25% deposit plan =
3,300 x 1 x 36 1,000
= Rs.118.8 = Rs.119 We will define i1, and i2 as the effective rates of interest implied by the zero deposit scheme and the 25% deposit scheme respectively. The value of i1 can be obtained from the equation: i 90,000 – 1,500 – [3,475 x 12 x (12) x PVIFA(i,3)] – [7,200 x PVIF(i,3)] i + [125.1 x PVIF(i,3)]=0 i = 28.71% The value of i2 can be obtained from the equation: 67,500 – 1,500 – [3,300 x 12 x
i i
(12)
x PVIFA(i,3)] + 34,220 x PVIF(i,3)
+ [119 x PVIF (i,3)] = 0 at 28%, LHS = – 687.257 at
30%, LHS = 290.6
By interpolation i = 29.40% Therefore, the effective rate of interest implied by the two schemes are 28.71% and 29.40% respectively. 152.
Monthly installment =
1.10 + (1.10 x 0.125) = Rs.10,312 12
Total charge for credit at the inception of the transaction = (1,10,000 x 1.125) – 1,10,000 = Rs.13,750 Interest rebate as per the modified rule of 78 (6 − 1) (7 − 1) = Rs.2,644 12 x 13 Amount repayable on early settlement
= 13,750 x
= (10,312 x 6) – 2,644 = Rs.59,228 313
Investment Banking and Financial Services
Define im as the monthly rate of interest implied by the completed transaction. The value of im can be obtained from the equation: 10,312 x PVIFA[i
( m ) ,8 ]
+ 59,228 x PVIFA[i
m ,6]
= 1,10,000
i = 2.1%; 153.
Annualized effective rate of interest = [(10.210)12– 1] x 100 = 28.32% a. 20% deposit scheme A.
Investment
B.
Deposit
20 x 25,000 = Rs.5000 100 Equated monthly installment (EMI)
= C.
= Rs.25,000
=
25,000 x 0.1 x 2 + 25,000 = Rs.1250 24
PV of EMIs = 1250 x 12 x i/i12 x PVIFAi,2 = 15,000 x i/i12 x PVIFAi,2 Future value of deposit = (1.0125)24 5000 = Rs.6736.755
D.
PV of deposit = 6736.755 PVIFi,2 Effective rate of interest is ‘i’ in the following: A–B–C+D=0 25,000 – 5000 – 15,000 x i/i12 x PVIFAi, 2 + 6736.755 x PVIFi,2 = 0 Let
i = 24%
LHS= 25,000 – 5000 – 15,000 x 1.1057 x 1.457 + 6736.755 x 0.65 = Rs.213.817 lakh Let
i = 20%
LHS = 25,000 – 5000 –15,000 x 1.0887 x 1.528 + 6736.755 x 0.694 = –Rs.277.696 lakh Therefore, i lies between 20% and 24% By interpolation, i = 20% + (24 – 20)
b.
−277.696 − 0 − 277.696 − 213.817
= 20% + 2.26% = 22.26% 20% down payment scheme A.
Investment cost = Rs.25,000
B.
Down payment = 25,000 x 0.2 = Rs.5000 Equated monthly installment 20,000 x 0.1 x 2 + 20,000 = = Rs.1,000 24
C.
PV of EMIs
= 1,000 x 12 x PVIFAi,2 x i/i12
Effective rate of interest is i in the following: A–B–C=0 25,000 – 5000 – 12,000 x PVIFAi,2 x i/i12 = 0 Let i = 20%, LHS = 25000 – 5000 – 12,000 x 1.0887 x 1.528 = 37.597 314
Part II
Let i = 18%, LHS = 25000 – 5000 – 12,000 x 1.08 x 1.566= – 295.36 Therefore, by interpolation, i =018 + 2 x
154.
a. b.
+295.36 = 19.77% 332.957
As the down payment reduces the investment cost, effective interest in down payment scheme is less than in deposit scheme. 1,00,000 + 1,00,000 x 0.16 x 3 EMI = = 4,111 36 i.
Amount payable in the balance period = 4,111 x 16 = 65,776 Total interest payable (D) = 48,000
ii.
Interest rebate 16 x 17 = 9,802 36 x 37 Capital outstanding after 20 months = 65,776 – 9,802 = 55,974
= 48,000 x
iii.
Service charges payable = 55,974 x 0.02 = 1,119
iv.
Amount payable = 55,974 + 1,119 = 57,093
4111 PVIFA (km, 20) + 57093 PVIFA ( k m , 20) = 98,000
km km
=2
PVIFA(2,20)
= 16.351 PVIF(2,20) = 0.673
∴ LHS
= 1,05,642
= 2.5 PVIFA(2.5,20) ∴ LHS
km
= 2.7 PVIF(2.7,20) ∴ LHS
= 16.351 PVIF(2.5,20) = 0.610 = 98,913 = 15.29 PVIF(2.7,20) = 0.587 = 96,407
913 = 2.507 2506 ∴ Effective rate of interest = (1.02507)12 – 1 = 34.6%
∴ km = 2.5 + 0.02
FACTORING AND FORFAITING 155.
The projected sales are Cash Sales (10% of total sales) Credit sales
Rs. in lakh 80 720 800
The benefits associated with factoring are a.
Savings in bad debt losses = 2% x 720 = Rs.14.4 lakh
b.
Savings in terms of cash discount not incurred = 2% x [50% x 720] = Rs.7.2 lakh
c.
Savings in credit administration costs = Rs.8 lakh
d.
Savings in interest cost
315
Investment Banking and Financial Services
= [720 x 23%* x
30 30 30 ] – [(720 – 25.2) x 0.8** x 22.5% x + 164.16 x 24% x ] 360 360 360
= Rs.(13.80 – 13.70) lakh = Rs.0.10 lakh * 23% is the average cost of owned funds 24% and borrowings 22% ** only 80% of receivables net commission will be available as advance. So total benefit of the factoring option = 14.4 + 7.2 + 8.0 + 0.10 = Rs.29.7 lakh The costs associated with factoring are Factoring commission = 3.5% x 720 = Rs.25.2 lakh So the net benefit of the factoring option = 29.7 – 25.2 = Rs.4.5 lakh As the benefits from factoring outweigh the costs, factoring is recommended. Note:
Average collection period = (50% x 10 days) + (50% x 50 days) = 30 days. 156.
Costs Associated with In-house Management
a.
Cash discount = 0.25 x 600 x 0.02 = Rs.3 crore.
b.
Cost of funds ACP = 0.25 x 10 + 0.50 x 30 + 0.25 x 50 = 2.5 + 15 + 12.5 = 30 days Cost of bank finance = 600 x
30
x 0.75 x 0.22 = Rs.8.25 crore
360 Cost of own funds = 600 x
30
x 0.25 x 0.28 = Rs.3.50 crore
360
Total cost = Rs.11.75 crore c.
Cost of collection = Rs.3.00 crore
d.
Cost of bad debts = 0.02 x 600 = Rs.12.00 crore
e.
Contribution lost on foregone sales = 80 x 0.2325 = 18.6
Total cost = 3 + 11.75 + 3 + 12 + 18.6 = 48.35. Costs Associated with Factoring
a. b.
Factor commission Discount charge
c.
Cost of own funds
600 x 0.02 600 x 0.9 x 0.2 x 600 x 0.1 x 0.28 x
Total cost
= Rs. 12.00 crore 30 360
= Rs. 9.00 crore
30 = Rs. 1.40 crore 360 = Rs. 22.40 crore
As the costs associated with factoring are lower, factoring is preferable. 157.
a.
Advance Factoring Balance Sheet as on 31.03.20x0
Liabilities
Rs.
Assets
Rs. in lakh Rs. 316
Part II
Net worth Long-term debt Current liabilities
90 Fixed assets 30 Inventory 90 Factoring reserve (1) Cash (2) 210
60 50 18 82 210
1.
Factoring reserve = Factor margin = 0.2 x 90 = Rs.18 lakh
2.
Cash = Opening balance + Advance factoring received = 10 + 0.8 x 90 = Rs.82 lakh Current ratio =
50 + 18 + 82 Current assets = = 1.67 90 Current liabilities
Current ratio (before factoring) =
50 + 90 + 10 = 1.67 90
Bank Overdraft
Rs. in lakh
Balance Sheet as on 31-03-20x0
Liabilities
Rs.
Assets
Rs.
Net worth
90 Fixed assets
60
Long-term debt
30 Inventory
50
Current liabilities
90 Receivables
90
Bank overdraft
72 Cash (1)
82
282 1.
282
Cash = Opening balance + Bank overdraft received = 10 + 72 = Rs.82 lakh Current ratio (Bank overdraft) 50 + 90 + 82 = = 1.37 90 + 72
b.
Advance Factoring Balance Sheet as on 31.03.20x0
Liabilities
Rs.
Assets
Rs. in lakh Rs.
Net worth
90 Fixed assets
60
Long-term debt
30 Inventory
50
Current liabilities
54 Factoring reserve
18
Cash (1) 174
46 174
1. Cash = Opening balance + Factoring receipt + Repayment of current liabilities = 10 + 72 – 36 = Rs.46 Current ratio after factoring =
50 + 18 + 46 = Rs.2.11 lakh 54
Bank Overdraft Balance Sheet as on 31.03.20x0
Rs. in lakh
317
Investment Banking and Financial Services
Liabilities
Rs.
Assets
Rs.
Net worth
90 Fixed assets
60
Long-term debt
30 Inventory
50
Current liabilities
54 Receivables
90
Bank overdraft
72 Cash (1)
46
246 1.
246
Cash = Opening Balance + Bank Overdraft – Current Liabilities = 10 + 72 – 36 = Rs.46 lakh Current ratio after (Bank overdraft) 50 + 46 + 90 = = 1.48 54 + 72
c.
Due to the factoring facility the current ratio in (a) is not affected but it has reduced from 1.67 to 1.37 due to the use of bank overdraft facility. Hence, it can be said that use of factoring facility improves the liquidity ratios of the firm. Further if the factoring facility is used to pay-out the current liability, the current ratio is increased to 2.11; 1.418 in case of bank overdraft. Still less than original current ratio. Thus, the liquidity position is further strengthened. Thus factoring facility is more advantageous for the company. (Rs. in lakh)
158.
a.
⎛ 22 ⎞ Value of factored receivables ⎜ ⎟ ⎝ 0.75 ⎠
29.33
Maximum permissible advance
22.00
Less: Commission @ 1.25% = (29.33 x 0.0125)
0.37 21.63
Less: Discount charge (22 x 0.165 x 90/360) Funds made available to Saket Ltd. b.
0.91 20.72
Discount charge expressed as a percentage of funds made available to Saket Ltd. 0.91 x 100 = 4.39% 20.72 Therefore, the effective rate of interest is 4.39% per quarter. The annualized rate of interest [(1.0439)4 – 1)] x 100 = 18.75% Put differently the annualized cost of funds made available to Saket Ltd. is 18.75%.
c.
Maximum permissible advance Less: Commission payable up front = (29.33 x 0.0125) Funds made available to Saket Ltd. Interest charge collected in arrears [22 x 0.165 x 90/360]
22.00 0.36 21.64 0.90
Interest charge expressed on a percentage of funds made available =
0.90 x 100 = 4.158%. 21.64
Annualized interest cost = [(1.0415)4 – 1] x 100 = 17.66% 159.
The relevant costs associated with in-house management of receivables and the alternative forms of factoring are listed below: 318
Part II
Relevant Costs of In-house Management of Receivables
A.
Cash discount
= 260 x 0.02 x 0.5 = Rs.2.6 lakh
Average collection period = (10 x 0.5) + (90 x 0.5) = 50 days 2 50 )x x 0.185 = Rs.4.45 lakh 3 360
Cost of bank finance
= (260 x
Cost of long-term funds
= 260 x
B.
Cost of funds invested in receivables
= Rs.7.22 lakh
C.
Bad debt losses
= 260 x 0.02 = Rs.5.2 lakh
D.
Contribution lost on foregone sales
= Rs.15 x 0.25 = Rs. 3.75 lakh
E.
Avoidable costs of sales = Rs.1.25 lakh ledger administration and credit monitoring
1 50 x x 0.23 = Rs.2.77 lakh 3 360
Relevant Costs of Recourse Factoring
F.
Factoring commission
G.
Discount charge
H.
Cost of long-term funds invested in receivables
= 275 x 0.02 = Rs.5.5 lakh 60 = Rs.7.15 lakh = 275 x 0.8 x 0.195 x 360 = 0.2 x 275 x 0.23 x
60 = Rs.2.10 lakh 360
Relevant Costs of Non-Recourse Factoring
I.
Factoring commission
J.
Discount charge
K.
Cost of long-term funds invested in receivables
= 275 x 0.03 = Rs.8.25 lakh 60 = Rs. 7.15 lakh = 0.8 x 275 x 0.195 x 360 = 0.2 x 275 x 0.23 x
60 = Rs.2.10 lakh 360
Cost-benefit Analysis of Recourse Factoring
L.
Benefit associated with = A+B+D+E recourse factoring = Rs.14.82 lakh M. = F + G + H = Rs.14.75 lakh Costs associated with recourse factoring N. Net benefit = L – M = Rs.0.07 lakh Cost-benefit Analysis for Non-Recourse Factoring O. P. Q.
Benefits associated with = A + B + C + D + E = Rs.20.02 lakh non-recourse factoring = Rs.17.5 lakh Costs associated with non- = I + J + K recourse factoring Net benefit = O–P = Rs.2.52 lakh
Since the net benefit associated with non-recourse factoring is higher than that of recourse factoring, the firm is advised to opt for non-recourse factoring. 160.
Assumptions:
a.
Cost Associated with present Credit Policy of TCL:
Credit sales = 80% of sales A.
Cost of in-house financing receivables:
319
Investment Banking and Financial Services
Cost of long-term own funds = 800 x 0.8 x
45 1 x 0.2 x = Rs.5.33 lakh 360 3
45 2 x 0.16 x = Rs.8.53 lakh 360 3 = 800 x 0.8 x = Rs.6.4 lakh = Rs.10 lakh
= 800 x 0.8 x
Cost of bank finance B. C.
Cost of bad debt loss Cost of maintaining and collecting accounts Cost of Non-Recourse Factoring: D. Factoring commission = 800 x 0.8 x 0.02 = Rs.12.8 lakh 40 E. Discount charges = 800 x 0.8 x 0.75 x 0.19 x 360 = Rs.10.13 lakh 40 =Rs.3.56 lakh F. Cost of own funds = 800 x 0.8 x 0.25 x 0.2 x 360 Cost of maintaining and G. = Rs.2.5 lakh collecting accounts Net benefit of non-recourse factoring A + B + C – (D + E + F + G) = 30.26 – 28.89 = Rs.1.37 lakh The benefits outweigh the cost incurred. Hence TCL should go for factoring. 161.
Relevant Costs of Existing Credit Policy:
A. B.
Cash discount = 780 x 0.3 x 0.01 = Rs.2.34 lakh Cost of funds invested in receivables 66 x 0.16 = Rs.22.88 lakh = 780 x 360
C. D.
Bad debts = 780 x 0.01 = Rs.7.80 lakh Administrative costs = Rs.3.40 lakh
Relevant Costs of Proposed Credit Policy: E. Cash discount = 780 x 0.6 x 0.02 = Rs.9.36 lakh F. Cost of funds invested in receivables 36 = 780 x x 0.16 = Rs.12.48 lakh 360
G. H.
Bad debts = 780 x 0.01 = Rs.7.8 lakh Administrative costs = Rs.3.4 lakh
Relevant Costs Associated with recourse Advance Factoring: I. Commission = 780 x 0.005 = Rs.3.9 lakh 50 x 0.18 = Rs.19.50 lakh 360
J.
Interest cost
= 780 x
K.
Bad debts
= Rs.7.8 lakh
Relevant Costs Associated with Bon-recourse Advance Factoring: L. Commission = 780 x 0.01 = Rs.7.8 lakh M. Interest cost = Rs.19.50 lakh Cost-benefit analysis of proposed credit policy: Net benefits = (E + F + G + H) – (A + B + C + D) = Rs.3.38 lakh (benefit) Cost-benefit analysis of recourse advance factoring: Net benefit = (I + J + K) – (A + B + C + D)
320
Part II
= Rs.5.22 lakh (benefit) Cost-benefit analysis of non-recourse advance factoring: Net benefit = (L + M) – (A + B + C + D) = Rs.9.12 lakh (benefit) Recommendation:
Based on the net benefit criterion non-recourse advance factoring is recommended. 162.
Sales turnover in 20x1-x2 = 48 x 1.1 = 52.8 crore Relevants Costs of In-house Management:
A.
Cash discount ACP
= 52.8 x 0.01 x 0.2 = Rs.0.1056 crore. = 0.2 x 10 + 0.8 [0.8 x 45 + 0.2 x 70] = 42 days
B.
Cost of bank finance = 0.8 x 52.8 x 0.18 x
42 = Rs.0.887 crore 360
C.
Cost of own funds
42 = Rs.0.259 crore 360
D.
Administration expenses = Rs.0.6 crore
= 0.2 x 52.8 x 0.21 x
Total costs = A + B + C + D = Rs.1.85 crore. Relevant Costs of Factoring:
M.
Factoring commission
= 52.8 x 0.015 = Rs.0.792 crore
N.
Discount charge
= 52.8 x 0.8 x 0.19 x
30 360
= Rs.0.669 crore O.
Cost of own funds
= 52.8 x 0.2 x 0.21 x
30 360
= Rs.0.185 crore. Total Costs = M + N + O = Rs.1.646 crore As total costs are lower, factoring should be preferred. 163.
Total Sales = 80 x 1.1 = Rs.88 lakh Costs of Bill Discounting
bill discounting is another way of financing debts in the form of bills. As management of bills receivable is maintained by the company all the costs other than cost of funds associated with the in-house management have to be borne apart from the discount charge of bill discounting. Thus, costs of bill discounting includes: A. B. C.
Cash discount = 0.02 x 0.3 x 88 = Rs.0.528 lakh Bad debts = 0.01 x 88 = Rs.0.88 lakh Administration expenses = Rs.0.8 lakh
D.
Discount charge = 0.20 x 0.7 x 88 x
60 = Rs.2.053 lakh 360
Total costs of bill discounting = A + B + C + D = Rs.4.261 lakh Costs of Factoring
E.
Commission = 0.02 x 88 = Rs.1.76 lakh
F.
Discount = 0.19 x
50 x 88 x 0.85 = Rs.1.974 lakh 360
321
Investment Banking and Financial Services
G.
Cost of own funds = 0.24 x
50 x 88 x 0.15 = Rs.0.44 lakh 360
Total costs of factoring = Rs.4.174 lakh As factoring costs are less than bill discounting costs, factoring should be preferred. 164.
Relevant Costs of In-house Management:
Expected sales = Rs.360 x 1.1 = Rs.396 lakh A.
Cash discount
= Rs.396 x 0.2 x 0.01 = Rs.0.792 lakh
Average collection period B.
= 0.2 x 15 + 0.8 x 45 = 39 days
Cost of funds: Costs of bank finance
= Rs.396 x
3 39 x 0.2 x = Rs.5.077 lakh 5 365
Costs of own funds
= Rs.396 x
2 39 x 0.24 x = Rs.4.062 lakh 5 365
Total cost of funds = Rs.9.139 lakh C.
Bad debts = Rs.396 x 0.015
= Rs.5.94 lakh
D.
Loss of profit due to foregone sales
= Rs.36 x 0.20 = Rs.7.2 lakh
E.
Avoidable administrative expenses
= Rs.1.5 lakh
Total costs of in-house management
=A+B+C+D+E
= Rs.0.792 + Rs.9.139 + Rs.5.94 + Rs.7.2 + Rs.1.5 = Rs.24.571 lakh. Relevant costs of bank Participating Factoring: Expected sales = Rs.360 x 1.2 = Rs.432 lakh F.
Commission = Rs.432 x 0.03 = Rs.12.96 lakhs
G.
Cost of funds: Discount charges
= Rs.432 x 0.8 x 0.2 x
40 = Rs.7.575 lakh 365
Interest to Sind Bank = Rs.432 x 0.2 x 0.6 x 0.22 x
40 = Rs.1.25 lakh 365
Cost of own funds
= Rs.432 x 0.2 x 0.4 x 0.24 x
40 = Rs.0.9095 lakh 365
Total cost of funds
= Rs.9.734 lakh
Total cost of bank participating factoring = Cost of funds + Commission = Rs.9.734 + Rs12.96 = Rs.22.694 lakh As costs of bank participating factoring are less than costs of in-house management SCL should opt for the factoring arrangement. 165.
Cost and Benefit Analysis of Factoring:
Benefits of factoring: (Assuming that the 10% increment in sales is irrespective of the method of financing receivables). New sales = 250 x 1.1 = Rs.275 lakh A.
B.
Cash discount
= 275 x 0.2 x 0.01 = Rs.0.55 lakh
Average collection period: 0.2 x 15 + 0.8 [0.8 x 60 + 0.2 x 80] = 54.2 days 54.2 Cost of own funds = 275 x x 0.3 x 0.24 = Rs.2.94 lakh 365
322
Part II
54.2 x 0.7 x 0.18 = Rs.5.15 lakh 365
C.
Cost of bank finance = 275 x
D.
Avoidable administration expenses = Rs.0.6 lakh
E.
Let the increment in sales because of factoring over and above Rs.275 lakh be Rs.X lakh. Contribution gained on increased sales = X x 0.3 = Rs.0.3X lakh Total benefit of factoring =A+B+C+D+E = 0.55 + 2.94 + 5.15 + 0.6 + 0.3X = (9.24 + 0.3X) lakh
Costs of factoring: Sales under factoring option are Rs.(275 + X) lakh. F. G. H.
40 x 0.22 = Rs.5.30 + 0.019X lakh 365 Commission = (275 + X) 0.025 = Rs.6.88 + 0.025X lakh 40 Cost of own funds = (275 + X) 0.2 x x 0.24 = Rs.1.45 + 0.005X lakh 365
Discount charge = (275 + X) 0.8 x
Total costs = F + G + H = Rs.13.63 + 0.049X lakhs Minimum increment in sales is the value of ‘X’ in the following: 9.24 + 0.3X = 13.63 + 0.049X X = Rs.17.49 lakh. 166.
Costs of In-house Management of Receivables
A.
Bad debts = 0.02 x 500 = Rs.10 crore (assuming non-recourse factoring)
B.
Average collection period
= 0.25 x 45 + 0.5 x 55 + 0.25 x 75 = 57.5 days
Cost of bank finance
= 500 x 0.5 x
57.5 x 0.16 = Rs.6.39 crore 360
Cost of own funds
= 500 x 0.5 x
57.5 x 0.2 = Rs.7.99 crore 360
Cost of financing receivables = Rs.14.38 crore C.
Savings in administration expenses = Rs.0.05 crore
D.
Contribution foregone on increased sales = 75 x 0.25 = Rs.18.75 crore Total costs = A + B + C + D = 10 + 14.38 + 0.05 + 18.75 = Rs.43.18 crore.
Cost of Factoring
E.
Commission
= 575 x 0.02 = Rs.11.5 crore
F.
Discount charge
= 575 x 0.75 x 0.15 x
G.
Cost of own funds
= 575 x 0.25 x 0.2 x
50 = Rs.8.98 crore 360 50 = Rs.3.99 crore 360
Total costs of factoring = E + F + G = 11.5 + 8.98 + 3.99 = Rs.24.47 crore As total costs of factoring are lower than the total costs of in-house management, factoring can be considered. However, if we assume that the factoring is with recourse, the total costs of in-house management of receivables remain unchanged at Rs.43.18 crore whereas costs of factoring increases by Rs.11.5 crore (i.e 575 x 0.02 crore) to Rs.35.97 crore. Even recourse factoring, is desirable, as its costs are lower than the costs of in-house management. 323
Investment Banking and Financial Services
MORTGAGES AND MORTGAGE INSTRUMENTS 167.
EMI =
=
2,25,000 x [1.009166]12 x 25 x 0.009166 = Rs.2205.124 [1 + 0.009166]12 x 25 − 1
Year 1 2 3 4 5-25 168.
2,25,000 ; i = 0.11 i PVIFA[ ; n x 12] 12
a.
Graduated monthly payment made by the borrower (Rs.) 1,746.66 1,851.46 1,962.55 2,080.31 2,205.12
Amount to be drawn from savings account (Rs.) 458.46 353.66 242.57 124.82 0
Payment made to lender (Rs.) 2,205.124 2,205.124 2,205.124 2,205.124 2,205.124
Amount of loan = 3,75,000 x 0.75 = Rs.2,81,250 Rate of interest = 15% Period of loan = 20 years 2,81,250 i PVIFA[ , n x 12] 12 2,81,250 x 0.0125 x [1.0125]240 = Rs.3,703.47 = [1.0125 240 − 1]
EMI =
b.
Year
GPM
1
3165.74
2
3,292.37
3
3,424.06
4
3,561.02
5-20
3,703.47
HOUSING FINANCE IN INDIA 169.
Progress of construction (PC) = 50% Land component (LC)
= Aggregate value – Cost of construction = 4,75,000 – 3,75,000 = 1,00,000 1,00,000 x 100 4,75,000 = 21.05%
=
Construction Cost (CC)
=
3,75,000 = 78.95% 4,75,000
Cumulative disbursement made (CM) = 85,000 Borrowers Contribution (BC)
= 1,10,500
Recommendation for disbursement (RD) is given by
324
Part II
= AV x
LC CC PC + AV x − BC − CM x 100 100 100
= 4,75,000 x
78.95 x 50
+ 4,75,000 x
100 x100
170.
21.05 – 1,10,500 – 85,000 = Rs.91,993.75 100
Amount of Loan = Rs.3,60,000 Period of Loan = 20 years Rate of Interest = 16% 1 ⎡ Lr(1 + r ) n ⎤ ⎢ ⎥ 2 ⎣ (1 + r ) n − 1 ⎦
EMI =
171.
⎡ ⎛ 1 + r ⎞12 n ⎤ ⎟ ⎥ ⎢ Lr ⎜ 1 ⎢ ⎝ 12 ⎠ ⎥ = 12 ⎢ ⎛ 1 + r ⎞12 n −1 ⎥ ⎥ ⎢⎜ ⎟ ⎦⎥ ⎣⎢ ⎝ 12 ⎠
240 ⎡ ⎛ 1 + 0.16 ⎞ ⎤ ⎟ ⎥ ⎢ 3,60,000 x 0.16 ⎜ 1 ⎝ 12 ⎠ ⎥ = Rs.5,008.5 = ⎢ 240 −1 ⎥ ⎢ 12 ⎛ 1 + 0.16 ⎞ ⎥ ⎢ ⎜ ⎟ ⎝ 12 ⎠ ⎦⎥ ⎣⎢ The approximate amount of installment can be calculated as follows:
1 15,00,000 = Rs.21,377 x PVIFA (15,15) 12
The amount of installment can be calculated accurately as follows: 15,00,000 = Rs.20,994 PVIFA (1.25,180)
172.
Maximum EMI permissible =
1 ([20,000 – 800 – 600 – 4,000] + [12,000 – 600 – 600 – 2,000]) = Rs.7,800 p.m. 3
EMI
=
1 ⎡ Lr(1 + r ) n ⎤ ⎢ ⎥ 12 ⎣ (1 + r ) n − 1 ⎦
Applying 17% interest, the loan amount can be calculated as follows: 7,800 =
1 ⎡ L 0.17(1.17)15 ⎤ 1 ⎡ L 0.17(10.539) ⎤ ⎢ ⎥= 12 ⎣ (1.17)15 − 1 ⎦ 12 ⎢⎣ 10.539 − 1 ⎥⎦
1.79163 L 9.539
or
96,000 =
or
L = Rs.4,98,344
Maximum value of the flat = Rs.6,64,459.
SOURCES OF FINANCE AND REGULATORY ENVIRONMENT OF FINANCIAL SERVICES 173.
(Rs. lakh) Tier I Capital
Paid-up equity capital Preference capital
5566.89 200.00 325
Investment Banking and Financial Services
Free Reserves
3612.19
Share Premium
14131.02
Capital Reserve Debenture redemption reserve Owned funds Less: Investment in subsidiaries Loans and Advances to subsidiaries
514.33 4100.00 28124.43 2220.00 2421.51 4641.51
Less: 10% of owned funds
2812.44
1829.07
Tier I Capital
26295.35
Tier II Capital
Revaluation reserves (discounted by 55% = 2517 x 0.45)
1132.65
Tier II capital
1132.65
Total capital funds = Tier I + Tier II capital = 26295.35 + 1132.65 = Rs.27428 lakh Risk Weighted Assets
(Rs. lakh) Book Value Fixed Assets: Own Assets Leased Assets Capital work-in-progress Investments: Investment in government securities Investment in subsidiaries 2220.00 Less: Amount deducted from Own Funds 874.83 ⎛ 1829.07 ⎞ x 2220 ⎟ ⎜= 4641 . 51 ⎝ ⎠
Trade investments Current Assets: Stock on hire (net of finance charges) Sundry debtors Loans and Advances to subsidiaries 2421.51 Less: Amount deducted from OFs – 954.24 ⎛ 1829.07 ⎞ x 2421.51⎟ ⎜= 4641 . 51 ⎝ ⎠ Loans and Advances to others Cash and Bank balance Total Weighted Assets
Risk Factor Risk Weighted (%) Value
3246.58 18952.75 18027.62
100 100 100
3246.58 18952.75 18027.62
5790.27
0
0
1345.17
100
1345.17
5316.83
100
5316.83
44830.58 3559.01
100 100
44830.58 3559.01
1467.27
100
1467.27
10026.03 3844.76
100 0
10026.03 0 106771.84
Off-Balance Sheet Exposure
Book value
Credit conversion
(Rs. lakh)
Risk weight Risk adjusted 326
Part II
factor (%) Guarantees issued Pending appeals Partly paid shares
1694.79 10.77 24.53
100 50 100
(%) 100 100 100
value 1694.79 5.39 24.53 1724.71
Total risk weighted assets = 106771.84 + 1724.71 = Rs.108496.55 lakh
% of capital funds to risk weighted assets 26295.35 x 100 = 24.24% 108496.55 1132.65 Tier II capital = x 100 = 1.04% 108496.55 27428 x 100 = 25.28% Total = 108496.55 Minimum Prescribed by RBI = 10%
Tier I capital =
AFL has a capital adequacy ratio of 25.28% which is well above the minimum of 10% required for the year ended March, 1998.
327
Investment Banking and Financial Services
Part III: Applied Theory (Questions) 1.
Prior to April 1997 the budget deficit was monetized through the creation of Ad hoc T-Bills. It was phased out by paving the way to a new system of Ways and Means of Advances. What are Ad hoc T-Bills? Describe how Ad hoc T-Bills were issued earlier, and how WMA is different from Ad hoc T-Bills.
2.
In the recent past, instruments were designed to cater various financial requirements of lenders and borrowers. Discuss the various types of short-term financial instruments that were seen in the recent past.
3.
The Reserve Bank issues treasury bills on competitive and non-competitive basis. It invites tenders and allocates T-bills on the basis of multiple price auction method. Explain the procedure involved with an illustration and also calculate yields for successful bidders.
4.
Vemoplast Ltd. is a leading manufacturer of aluminum foils. Currently, it requires shortterm funds, and Mr. Pai, the Finance Manager is thinking of various alternatives to raise funds. Kartik Mundae, Vice President (finance), suggested to Mr. Pai, to raise funds by issuing Commercial Paper. Help Mr. Pai to list out the requirements to be fulfilled by Vemoplast before issuing the CP.
5.
Certificate of Deposit is a money market instrument issued by banks to mobilize short-term funds apart from their usual deposits. List out the guidelines given by the Reserve Bank to be fulfilled by banks before issuing CDs.
6.
Government securities are referred to as ‘gilt-edged securities’, as they are absolutely secured. The RBI, being the banker to the Government, issues different types of paper on behalf of the latter, to cater various requirements. Discuss the various types of Government securities that are issued by the RBI.
7.
Satellite Dealers (SDs) undertake a supporting function in the operations of Primary Dealers (PDs). They are required to have a standing arrangement with the RBI, undertaking certain obligations. What are the obligations that a SD needs to fulfill while undertaking its responsibilities?
8.
The prevalence of obsolete systems and antiquated practices were the main drawbacks of the Indian capital markets till the early ‘90s. The government had initiated reforms to modernize the capital markets. What are the major recent changes in the primary capital markets in India?
9.
Recently Indian markets witnessed lot of restructuring in the cement industry. Gujarat Ambuja acquiring a substantial stake in ACC and Lafarge’s acquisition of the cement division of TISCO are two examples. As a merchant banker, what are the aspects that you would examine, while advising a client to divest a business operation?
10.
A sound regulatory framework in regulating capital markets is expected to provide transparency, maintain market integrity, fairness and ensure investor protection. However, lack of adequate regulations can lead to manipulations which endanger the integrity of the market and damage the confidence of investors. What are the regulatory measures taken by SEBI to ensure the confidence of investors and market participants in India?
11.
FACIT is a company manufacturing PCs and printers. The company has an existing equity base of Rs.20 cr, 8% preference of 18 cr. and 10% debentures of 15 cr. in its capital structure in the last audited statement. Observing the recent innovations in financial instruments in the country, the company is planning to expand its business by manufacturing other accessories and I/O devices. Mr. Ganguli, VP Finance is planning to raise long-term funds, and he has approached a merchant banker. What are the options that a merchant banker can suggest to Mr. Ganguli?
12.
While floating an IPO, promoters may not disclose certain information or they may mislead the investing public through window dressing. Such activities are common to overprice a scrip. While pricing an IPO, the role of a lead manager or a merchant banker to the issue is to exercise due diligence. What are the aspects that a merchant banker or a lead manager needs to look into, in course of a due diligence exercise in this regard? 328
Part III
13.
Omega Plastics is planning to raise capital. Mr. Goutam Parekh, MD, is thinking that it is wise to raise funds through private placement rather than from the public. List out the features and merits of private placements to Mr. Parekh.
14.
Mulchand Electronics Limited are small scale manufacturers of electronic equipments. The company has a turnover of Rs.5 cr. It is contemplating to expand its capacity and needs funds immediately. The Finance Manager, Mahinder Singh is of the opinion that he may not be able to get the right price for the shares if he opts for an IPO. But, he still wants his company to be listed. Is there any way out to raise funds without going public? If so, discuss the distinctive advantages of the same over a public offering.
15.
The prime function of a rating agency is to provide investors with authentic information about the creditworthiness of issuers. Standard & Poor’s rating agency is considered as one of the best credit rating agencies in the world. In this context, discuss the rating obligations (both long-term and short-term) of S&Ps.
16.
The concept of free pricing rests on the premise that “market knows best”. Both underpricing and overpricing have negative consequences. Explain whether SEBI guidelines are adequate to ensure proper pricing.
17.
Most of the developing nations are tapping foreign investments to accelerate their economic development, but the investors need to assess the country’s economic, social, political and financial position through a reliable credit rating agency for investing their funds. S&P does sovereign rating for nations all over the world. Discuss the key factors considered by S & P while rating local currency debt.
18.
The responsibilities of intermediaries form a crucial role in international capital markets. In this regard, discuss briefly the role of various intermediaries in international capital markets.
19.
Till the early ‘90s, investors faced liquidity problems, risk of bad deliveries, lack of transparency, etc., in secondary markets for equity. What are the major changes that have been initiated in the secondary market to address the above problem?
20.
Ranj Kunj Petrochem Ltd. is into extracting petro products for the last 25 years. It is planning forward integration for which it needs huge funds which cannot be catered by the Indian investors; hence it is planning to issue ADRs. Discuss the various levels of ADR.
21.
Arnica Chemicals and Extracts Ltd. is planning to diversify into related areas. It plans to raise finance by accepting public deposits rather than approach any financial institution. Discuss various factors that Arnica Chemicals needs to consider while marketing its public deposits.
22.
The call money market is referred to as the most sensitive barometer measuring the liquidity conditions prevailing in financial markets. What are the various purposes for which call money is lent in India?
23.
Manjari Publishers is a good market player in publishing journals, textbooks and also undertakes bulk screen printing work. It has recently, come out with its public issue, and when it was listed on BSE, it was underpriced. What do you think are the probable factors for underpricing in case of the Manjari Publishers?
24.
XYZ Ltd. is a company involved in the leasing business. It had applied for registration with the RBI and is still awaiting its approval. What are the parameters of XYZ Ltd. that will be considered by the RBI before granting the certificate of registration?
25.
A NBFC with over Rs.25 lakh paid-up capital has recently received its auditors’ comment stating that the mix of Tier I capital and Tier II capital is disproportionate compared to the stipulated norms for the calculation of the CAR. Where do you think the NBFC must have gone wrong? State the methodology of calculating Tier I capital.
26.
The management of the Avenue Finance Ltd., a new company, was quite relieved to receive a communication from the RBI granting it the certificate of registration. They now propose to accept fixed deposits as per the RBI guidelines so as to provide funds to their principal area of business leasing. What are the various regulations concerning maintenance of a register, advertisement for deposits, nominations and loans, that have to be followed by the management with regard to acceptance of fixed deposits? 329
Investment Banking and Financial Services
27.
The NPAs of Path Financial Services are at a very high level of 10%. The consultant of the company says that the company needs to make more provisions because of its asset mix being skewed towards leasing and hire purchase rather than loans and advances. What are the provisions that has to be done in case of loans, advances and other credit facilities and in case of Lease and Hire Purchase of assets?
28.
“Though the lease rental is a bit on the higher side, in view of the high rate of technological obsolescence in the industry, we better go for an operating lease for the equipment, rather than a finance lease”, said Mr Avadhani, Director (Technical) of Prudent Technologies Ltd. to the Manager (Finance) during a meeting called to finalize the mode of acquisition of the latest brand of balancing equipment. The Director (Marketing), who was also present, could not understand what it meant. Explain to him the distinction between a finance lease and an operating lease to him.
29.
Leasing is widely known to be an off-balance sheet form of financing. But, is it the only advantage of leasing? Explain the advantages of leasing.
30.
“Though leasing appears to be a highly flexible form of finance, the finance lease contract being non-cancellable makes it somewhat unattractive” says the Finance Manager of Duraplastic Ltd. Do you agree with him? Explain the shortcomings of leasing as a form of finance.
31.
Tax treatment of lease rentals and leased assets and their representation in financial statements were controversial issues for quite some time. But now, there is a general agreement on the issue – mostly due to various circulars and notes issued by government agencies and bodies. Briefly explain the tax and accounting aspects of leasing.
32.
Purchase of consumer durables, particularly through consumer credit has gained a lot of momentum in India in the last five years. Explain the characteristic features of consumer credit transactions.
33.
Mr Ramchandani wants to buy a color television costing Rs.20,000 on installment basis and approaches Rajkamal Electronics Ltd., a big distributor of consumer goods. Rajkamal Electronics Ltd. has a financing arrangement with World Wide Consumer Finance Ltd. for financing purchases made from it. Explain how Mr Ramchandani will be evaluated by the company to decide whether or not he should be granted the installment payment facility.
34.
Financial markets always create new instruments to overcome the difficulties associated with instruments already in use. The same phenomenon can be seen in the mortgage-backed securitized instruments. The innovative instruments are generally referred to as nontraditional instruments. Describe any four of them.
35
Housing finance being a long-term finance, the possibility of steep changes in interest rates has always been a matter of concern for both borrowers and lenders. To address the concerns of the two, floating rate loans have been introduced. The HDFC has recently (in June, 1999) announced plans to provide floating rate loans. In the West, a more sophisticated instrument called the Adjusted Rate Mortgage (ARM) is in use. Explain what is meant by an ARM and its advantages.
36.
Real estate, for long, has been known for providing good returns. Though the real estate market in some cities has seen a slump in the recent past (second half of 1998), investment interest in real estate is still very strong. What are the characteristic features of real estate that make it a good investment? What are the aspects that should be kept in view while selecting and managing real estate?
37.
Credit rating is always helpful in selling an issue of debt. But is credit rating necessary for securitizing the receivables of a company? Explain.
38.
In hire purchase, the hirer is allowed to claim depreciation on the hired assets from the year the assets are taken on hire. But, the ownership is said to be passed on only at the time of exercise of option to buy/payment of the last hire rental. In such a situation, when should the transaction be subjected to sales tax, if at all? Explain the sales tax provisions relating to hire purchase. 330
Part III
39.
The finance manager of Grindwell Manufacturing Co. Ltd. is seriously thinking of using factoring to reduce the company’s funds that are blocked in accounts receivable. But, he wants to know about factoring in detail before taking any concrete steps in that direction. Explain the mechanism of factoring to him.
40.
The process of factoring involves some legal complications as it involves the assignment of the right to collect a debt from the client company to the factor company. Explain the legal aspects of factoring in detail.
41.
A part of the working capital finance given by banks is generally in the form of a bill discounting limit for discounting the bills of exchange received in the course of business. What are bills of exchange? Explain their features.
42.
Just as physical assets are depreciated, finance companies also write-off their assets. The write-off is not based on the passage of time, but on the quality of the asset as evidenced by the receipt of the interest payments and principal payments. Explain the provisions required for loans and advances made by NBFCs.
43.
Bills of exchange are used very frequently while trading with parties in far-off locations. Mr Raja Ram, the manager of a newly set-up trading concern, M/s Ranvir Trading Co, is not very sure of how bills of exchange come into existence and how they are useful in transacting with other parties. Explain the same with reference to different types of bills to him.
44.
Though Indian exporters want to reduce the lag between the export of goods and receipt of proceeds, they are looking up to the government to provide them finance at lower rates of interest rather than use services such as cross-border factoring and forfaiting. The reasons appear to be lack of awareness regarding forfaiting and presence of very few companies offering the service of forfaiting. Explain the process of forfaiting.
45.
The use of credit cards has increased phenomenally in the last few years. This has induced many banks to come out with credit cards. The competition among banks is increasing. Explain the advantages of credit cards to all the parties involved.
331
Investment Banking and Financial Services
Part III: Applied Theory (Answers) 1.
Ad hoc T-bills are issued in favor of the RBI when the Government needs cash. They are neither issued nor available to the public. These bills are purchased by the RBI on tap and they are held in its Issue Department. The RBI issues currency notes against these bills to the Government if required, and bills are renewed at maturity. Ad hoc T-bills are issued to serve two purposes. Firstly, to replenish cash balances of the Central Government and secondly, to provide a medium of investment for temporary surpluses to State Governments, semi-government departments and foreign central banks. The RBI acts as banker to the Central Government, hence, the Government needs to maintain a minimum balance of Rs.50 crore on Fridays and Rs.4 crore on other days free of obligation to pay interest thereon and further whenever the balance in the account of the Government falls below the minimum agreed amount, the account will be replenished by the creation of ad hoc treasury bills in favor of the bank. Ad hocs have a maturity period of 91-days and carry a discount rate of 4.6 percent. These bills can be redeemed before maturity. The maximum incremental outstanding limit of T-bills at the end of the year should be Rs.5,000 crore and within the year, the incremental ad hoc T-bills cannot exceed Rs.9,000 crore for a period greater than ten consecutive days. In case this is not adhered to, the RBI would automatically reduce the level of ad hoc T-bills by auctioning them or selling fresh Government of India dated securities in the market thereby, bringing down the level of ad hocs to the maximum level permitted. This is essentially an arrangement between the Central Government and the RBI and the actual operational aspects may vary from time to time. It is adequate to state that this is essentially a mechanism through which the Central Bank (RBI) funds the government. T-bills have to be repaid by the government when it has adequate cash flows. However, there was no compulsion that they have to be repaid. When they were outstanding for more than 90 days, the RBI converts them into dated securities. As the expenditure of the government always exceeded its income, some amount of T-bills remain unpaid at the end of the year thus becoming a permanent source to finance the budget deficit, which could lead to fiscal indiscipline resulting in serious imbalances in the economy. As there was no limit on the amount that can be raised by the government on its own, the government itself decided to put a cap on it. Subsequently an agreement was signed in March 1997, bringing into existence the new system of Ways and Means Advances (WMA) – replacing the old system of ad hoc treasury bills. WMA is not a permanent source of financing government deficit. But, this is likely to provide greater autonomy to the RBI in conducting the monetary policy. According to the agreement, the RBI will no more monetize the fiscal deficit and the government should borrow from the market to finance the fiscal deficit. But, the RBI will extend the advances to the Central and State Governments to tide over temporary or short-term finance requirements which need to be repaid in three months. Withdrawals in excess of the WMA limit will be allowed for a maximum of ten consecutive days. The RBI allows for three types of Ways and Means Advances: The clean WMAs (unsecured), the secured WMAs (which are secured against central government securities) and the special WMAs which are allowed in exceptional circumstances against the pledge of government securities. The system of WMA broadly works as follows: – The limit of WMA is decided in terms of mutual consultations between the RBI and the central government. – The interest charged up to the WMA limit would be three percent less than the average implicit yield at the cut-off prices of 91-day T-bills in the previous quarter and for the amount in excess of the WMA limit, it is two percent more than the normal rate. – The interest rate is decided on, and can be altered by mutual agreement between the RBI and the government. 332
Part III
The outstanding balance of WMA at the end of the year should be repaid by the central government (it should be brought down to zero). If the balance remains unpaid for more than two weeks after the end of the year, the RBI converts the amount into dated securities at the market rate of interest. If 75 percent of the limit is utilized, the RBI should initiate a fresh floatation of central government securities. 2.
Short-term liquidity being the main purpose of the money market, various instruments have developed to suit short-term requirements. For instance, the requirement of funds by banks to meet their statutory reserves will vary from one day to a fortnight. Similarly, corporates may require funds for their working capital purpose for any period up to a year. Given below is a broad classification of the money market instruments depending upon the type of issuer and the requirements they meet. Government and Quasi-Government Securities •
Treasury Bills (T-Bills)
•
Government Dated Securities/Gilt-Edged Securities
Banking Sector Securities •
Call and Notice Money Market
•
Term Money Market
•
Certificate of Deposit
•
Participation Certificates
Private Sector Securities •
Commercial Paper
•
Bills of Exchange (commercial and trade bills/factorization bills)
•
Inter-corporate Deposits/Investments
•
Money Market Mutual Funds.
Except for their debt nature, the securities listed above differ from each other in their characteristics relating to maturity, issuer, type of investors, the risk-return profile, liquidity, marketability, negotiability, transferability, etc. Money market instruments, however, do not include any equities.
Government Securities Treasury Bills: T-Bills are issued to enable the government to tide over short-term liquidity requirements with maturities varying from a fortnight up to a year. These instruments are issued at a discount to the face value. Being issued by the government they are considered to be risk-free. Due to this, they are highly marketable. Investors in T-Bills generally include banks, other institutional investors and individuals. Government Dated Securities: These are medium- to long-term government securities. Unlike the T-Bills which are issued at a discount, these securities carry a coupon rate. In spite of being long-term instruments, these government securities form a part of the money market due to their liquidity. These instruments set a benchmark for the long-term interest rates. Issuers will clearly be the central/state government and other quasi-governmental bodies while the investors will be banks, FIs, other institutional investors and individuals. Government securities have fairly high liquidity compared to other money market instruments.
Banking Sector Securities The banking sector has a very vital and active role in the money market. The short-term requirements of banks vary from a single day up to a year for meeting reserve requirements and credit accommodation purposes. Based on this requirement, various instruments/ markets with differing maturities have developed. 333
Investment Banking and Financial Services
Call and Notice Money: These funds represent borrowings made for a period of one day up to a fortnight. However, there exists a difference in the mechanism adopted for lending funds between the call and the notice money markets. In the call money market, funds are lent for a predetermined maturity period that can range from a single day to a fortnight. However, with identical range for maturity period, the funds lent in the notice money market do not have a specified repayment date when the deal is entered into. The lender will simply issue a notice to the borrower 2-3 days before the funds are to be repaid. On receipt of this notice, the borrower will have to repay the funds within the given time. While both these funds serve the general purpose of meeting reserve requirements, the reliance of the banks, however, is mostly on the call money market. It is here that it raises overnight money, i.e. funds for a single day. Term Money: Short-term funds having a maturity of 15 days and over are categorized as term money. Banks access this term money route for the purpose of bringing greater stability to their short-term deficits. While making a forecast of the funds requirement, banks will be in a position to assess the likely surplus and deficit balances that are to occur during the forecasted period. In view of such a forecast, banks assess the amount that needs to be borrowed/lent in order to prevent any severe liquidity mismatch. Certificate of Deposits (CDs): Banks issue CDs to raise short-term funds having a maturity of 3 months to 1 year. These instruments are issued for deposits of individuals/corporates/institutions, etc. These are usance promissory notes which require the holder to establish his identity before redeeming the amount. Being negotiable instruments they are easily transferable. They are issued at a discount to face value. The funds raised through certificates of deposit form a part of the deposits and hence attract reserve requirements. Participation Certificates (PCs): The major activity of a bank is credit accommodation. This service of the banks, apart from increasing the risks, may place the banks in a tight liquidity position. To ease their liquidity, banks have the option of sharing their credit asset(s) with other banks by issuing Participation Certificates. These certificates are also known as InterBank Participations (IBPs). With this participation approach, banks and FIs come together either on a risk sharing or non-risk sharing basis. Thus, while providing short-term funds, PCs can also be used for risk reduction. The rate at which these PCs can be issued will be negotiable and depends on the interest rate scenario. Like CDs, PCs are also issued by banks for similar maturity periods i.e. 3 months to 1 year.
Private Sector Securities Commercial Papers (CPs): CPs are promissory notes with fixed maturity, issued by highly rated corporates. This source of short-term finance is used by corporates as an alternative to the bank finance for working capital. Corporates prefer to raise funds through this route when the interest rate on working capital charged by banks is higher than the rate at which funds can be raised through CP. The maturity period ranges from 30 days to 364 days. Bills of Exchange: It is a financial instrument that facilitates funding of a trade transaction. It is a negotiable instrument and hence is easily transferable. Further, depending on the repayment period and the documents attached, these bills of exchange are classified into different types. The period for which these bills are drawn generally ranges between 1 – 6 months. Factorization Bills: This is an instrument arising due to the factoring of the bills of exchange. Factors, who are generally banks or FIs, purchase the bills from the creditors with or without a recourse facility and collect the dues from the debtors. The market for factorization of bills depends on the level of activity in the bill market. Inter Corporate Investments/Deposits (ICDs): In the ICD market, the borrowers and issuers are the corporates. The interest rates of these instruments are generally higher than the other short-term sources since the risk is higher. 334
Part III
3.
Money Market Mutual Funds (MMMFs): The Money Market Mutual Funds provide an avenue for the retail investor to invest in the money market. Retail investors normally deposits short-term surplus funds into a savings bank account, the returns from which are relatively low. By investing in the money market through MMMFs the returns earned will be higher than what is obtained by depositing in a bank. Further, this also provides adequate liquidity and the investor can plan for short-term deployment of funds. The safety level of these funds will also be high since the investments will generally be in high quality securities, i.e., government/bank/highly rated corporate securities. Thus, MMMFs represent a low-risk and high-returns avenue to the retail investors in the money market. Auction Procedure The process of T-Bill is explained through an illustration. Say on 2nd November, the RBI issued a tender notification for 91-day T-bill for Rs.500 crore. There were 4 competitive bidders namely, A, B, C and D who responded to the notification of T-bills, and submitted sealed tenders to the RBI. The overall amount quoted through the tender is Rs.1,900 crore. A General Manager of the Public Debt Office (Mumbai) opened the tenders, and compiled the following information for the sake of determining the cut-off point. Sl. No. Name of the Bidder Price Amount Cumulative Amount (Rs.) (Rs. in cr.) (Rs. in cr.) 1 B 98.95 50 50 2 A 98.90 40 90 3 A 98.80 60 150 4 C 98.80 80 230 5 B 98.75 50 280 6 C 98.65 120 400 7 C 98.50 200 600 8 A 98.50 100 700 9 B 98.50 100 800 10 A 98.45 200 1000 11 B 98.40 120 1120 12 C 98.35 280 1400 13 D 98.45 70 1470 14 D 98.35 120 1590 15 D 98.30 150 1740 16 D 98.25 160 1900 Based on the above information, the GM needs to decide the cut-off price and allocate the T-bills to bidders at respective rates. The GM decides the optimal cut-off price as Rs.98.50. Below this point, amount of bids is short by Rs.100 crore and at this point, it has a surplus of Rs.300 crore. The first six bids given by A, B and C are accepted completely, and the next quote given by the three bidders being the same, the RBI allots T-bills proportionately. The fully accepted bids are: Name of the Price Quoted Approved Amount Bidder A 98.90 40 A 98.80 60 B 98.95 50 B 98.75 50 C 98.80 80 C 98.65 120 Total 400 The RBI allots the three bidders proportionately in the following manner: Name of the Proportionate Amount Price Amount Allotted (cr) Bidder A 98.50 100 25 B 98.50 100 25 C 98.50 200 50 400 100 335
Investment Banking and Financial Services
100 x 100 = 25. Thus, a proportionate allotment is done to three bidders. 400
The yield is calculated by the following formula: 365 ⎡ Face Value ⎤ − 1⎥ x Yield = ⎢ ⎣ Price ⎦ Days to Maturity
Weighted Average Yield for the Issue Name of the Bidder
Price (i)
Amount (ii)
Proportion (iii)
A
98.90
40
0.08
7.904
0.0446
0.00356
98.80
60
0.12
11.856
0.0487
0.00584
98.50
25
0.05
4.925
0.0610
0.00305
98.95
50
0.10
9.895
0.0425
0.00425
98.75
50
0.10
9.875
0.0507
0.05078
98.50
25
0.05
4.925
0.0610
0.00305
98.80
80
0.16
15.808
0.0487
0.00779
98.65
120
0.24
23.676
0.0548
0.00131
98.50
50
0.10
19.700
0.0610
0.00610
1.00
98.722
B
C
Wt. Price (i x iii = iv)
Yield (v)
Wt.Yield (vi) = (iii*v)
0.051876
The non-competitive bidders would have to pay weighted average cut-off price which is obtained by taking the average of prices, which works out to be 98.722 in this particular issue. The non-competitive bidders would get an yield of 5.1876 percent. Let us calculate the yield based on the above inputs for each of the bidders: A.
Average Yield for A: (98.90 x 40/125 + 98.80 x 60/125 + 98.50 x 25/125) = 98.77
⎡ 100 ⎤ 365 −1⎥ x = 4.99% Yield = ⎢ ⎣ 98.77 ⎦ 91 or (0.0446 x 40/125 + 0.0487 x 60/125 + 0.0610 x 25/125) = 4.984% B.
Average Yield for B: (98.95 x 50/125 + 98.75 x 50/125 + 98.50 x 25/125) = 98.78
⎡ 100 ⎤ 365 −1⎥ x = 4.95% Yield = ⎢ ⎣ 98.78 ⎦ 91 (0.0425 x 50/125 + 0.0507 x 50/125 + 0.0610 x 25/125) = 4.948% C.
Average Yield for C: (98.80 x 80/250 + 98.65 x 120/250 + 98.50 x 50/250) = 98.668
⎡ 100 ⎤ 365 −1⎥ x = 5.414% Yield = ⎢ ⎣ 98.668 ⎦ 91 or (0.0487 x 80/250 + 0.0548 x 120/250 + 0.0610 x 50/250) = 5.41% 336
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4.
5.
6.
Vemoplast can raise Commercial Paper (CP) by fulfilling the following conditions: •
The tangible net worth of Vemoplast should not be less than Rs.4 crore as per the latest audited statement (tangible net worth will comprise of paid-up capital plus free reserves less accumulated balance of losses, balances of deferred revenue expenditure and also other intangible assets).
•
Its fund-based working capital limit should not be less than Rs.4 crore.
•
The minimum credit rating required from the approved agencies should be P2 from Credit Rating Information Services of India Ltd. (CRISIL), A2 from Investment Information and Credit Rating Agency of India (ICRA) and PR2 from Credit Analysis and Research Ltd. (CARE) which should not be more than two months old.
•
Vemoplast should have a minimum current ratio of 1.33:1 as per the latest audited balance sheet.
•
The aggregate amount to be raised by issuance of commercial paper should not exceed the working capital (fund-based) limit sanctioned by bank/banks to the issuer company i.e., CP can be raised to the extent of 100 percent of the working capital limit.
•
The working capital limit of Vemoplast should be correspondingly reduced by the banking system. As the CP will be carved out of the working capital (fund-based) limits of the company, by issuance of CP there should not be any increase in the level of short-term borrowing facilities.
•
A Board resolution authorizing Vemoplast Ltd. for issue of CP is essential.
The RBI guidelines relating to CDs are as follows: •
All scheduled banks, other than Regional Rural Banks and Scheduled Co-operative Banks are eligible to issue CDs, and there is no limit to the total amount raised.
•
CDs should be issued in the form of usance promissory notes with a fixed maturity date without any grace period.
•
The size of the issue should be in multiples of Rs.1 lakh subject to the minimum size of each issue being Rs.5 lakh.
•
The banks can issue CDs ranging from 3 months to 1 year whereas financial institutions can issue CDs ranging from 1 year to 3 years.
•
CDs become freely transferable by endorsement and delivery but only after a lock-in period of 30 days.
•
All CDs are subjected to the usual CRR and SLR requirements.
•
CDs are subject to stamp duty.
•
Premature payment or loans against CDs by the issuer is not allowed.
The Reserve Bank on behalf of issuers may issue different types of stocks from time to time depending on their requirements: Types of Government Stocks i.
Issue of Stock through Auction: The RBI, on behalf of the government, issues notification for auctioning of government securities, stating the amount and time. An applicant may submit more than one bid at different yields through separate applications for each bid. The aggregate amount of bids submitted by a person should not exceed the aggregate amount of Government Stock offered for sale. On the basis of the bids received, the Reserve Bank of India will determine the cut-off rate of yield, at which point, offers for the purchase of Government Stock will be accepted at the auction depending upon the notified amount. The coupon of the stock is decided in an auction. The successful bids offered at the cut-off rate of yield as determined by the RBI will be accepted at par. Other bids tendered at rates lower 337
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than the cut-off rate of yield determined by the RBI will be accepted at cut-off rates as quoted in the bid. The bidders will be issued these securities at a premium which will be determined in such a way that yield-to-maturity to the bidder will be equal to the rates at which they have bid. Bids quoted at rates higher than the cut-off rate of yield determined by the RBI will be rejected. The stock carries the same coupon till maturity. ii.
Issue of Stock with Pre-announced Coupon Rates: The RBI also announces the coupon on stock before the date of floatation and the stock is issued at par. The interested bidders need to submit the application form to the RBI. If the total subscription exceeds the aggregate amount offered for sale in respect of a fixed coupon stock, the RBI will make partial allotment to all the applicants.
iii.
Stock with Variable Coupon Rates, viz., Floating Rate Bonds, etc.: In case of floating rate bonds, the stock will carry a coupon rate which will vary according to the change in the base rate to which it is related. The description of the base rate and the manner in which the coupon rate is linked to the base rate, floor and cap to the coupon rate, if any, will be announced by the RBI at the time of issue. The procedure for issuance is similar to pre-announced coupon rates.
iv.
Zero-coupon Bonds: Zero-coupon bonds are issued at a discount and redeemed at par. No interest is paid on such bonds before maturity. Zero-coupon bonds are issued by means of auction, with a face value of say Rs.100. The bidders need to clearly specify the purchase price expressed up to two decimal points in the application. An applicant needs to submit more than one bid at different prices through separate applications for each bid (but the aggregate amount of bids submitted by a person should not exceed the aggregate amount of bonds offered for sale). The RBI will determine the cut-off price at which tenders for purchase of zero- coupon bonds will be accepted at the auction. All the bids at prices higher than the cut-off price will receive full allotment, while the bids at prices lower than the cut-off price will be rejected. The bids at the cut-off price may receive full or partial allotment depending on the total amount of bids and the notified amount.
7.
v.
Stock on Tap: Stock on tap is issued by the RBI with predetermined price, maturity and coupon with no aggregate amount indicated in the notification. Sale of such stock will be kept open so long as the RBI desires. The sale may be closed at any time at the discretion of the RBI.
vi.
Stock for which the payment is made in installments: The stock is issued either by auction or by pre-announcing a coupon rate. The special feature of the stock is that the payment can be made by the investors in installments. It means that the stock will be initially issued as partly paid stock which will become fully paid at the end of the last installment. The total amount is usually paid in four installments. The interest is paid on the paid-up value of the stock.
vii.
Issue of Government Stock in conversion of Maturing Treasury Bills/Dated Securities: In this mode, the RBI gives an option to the holders of the Treasury Bills of certain specified maturities, to convert the respective treasury bills at specified prices into a new stock offered for sale. The conversion prices are predetermined by the RBI depending on the remaining term to maturity of the respective treasury bills.
The SD will be required to have a standing arrangement with the RBI based on the execution of an undertaking. The registration letter issued by the RBI covers the following aspects. Role and Obligations of SDs i. A satellite dealer should commit to generate outright turnover of the Central Government securities including T-Bills of not less than Rs.30 crore in a year. 338
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ii.
iii.
iv. v.
vi. vii.
viii.
8.
The annual turnover including repos of the SD should not be less than five times in government securities including T-Bills. Of the total turnover, turnover in respect of outright transactions should not be less than three times. The turnover will be Total purchases and sales during the year* calculated as under: Average month end stocks during the year * Purchases are inclusive of primary market purchases and sales are inclusive of redemption of maturities. A satellite dealer should achieve a portfolio of not less than 20 percent in government securities in relation to total assets before the end of the first year of operations after registration. A satellite dealer should maintain the minimum capital standards at all points of time. A satellite dealer should have adequate organizational structure with good distribution channels across the country and in terms of office computing equipment, communication facilities like telex/fax, telephone, etc. and skilled manpower for efficient marketing and to provide advice and education to investors. A satellite dealer should have an efficient internal control system for fair conduct of business and settlement of trades and maintenance of accounts. A satellite dealer should meet such registration and other requirements stipulated by the Securities Exchange Board of India (SEBI) including operations on the Stock Exchanges. A satellite dealer should subject itself to all prudential and regulatory guidelines issued by the RBI.
ix. A satellite dealer should submit periodic returns as specified by the RBI. Major changes in the primary market that had taken place in recent past are: i. Free Pricing: The abolition of the office of the Controller of Capital Issues resulted in the emergence of a new era in the primary markets. All controls on the pricing, designing and tenure of the instruments were abolished. A wide variety of instruments were designed to meet the specific requirements of the issuers and the investors. The issuers were also given the freedom to price the instruments. It was left to the market forces to decide the appropriateness of the pricing. ii. Entry Norms: Hitherto there were no restrictions for a company to tap the capital markets. This resulted in a massive surge of small cap issues. Many of the companies were promoted by persons with dubious credentials. Most of these shares were not even traded in the secondary markets after listing. Several investors lost heavily by investing in these shares. The need for transparent entry barriers was felt. SEBI introduced eligibility norms in the form of track record of divisible profits for existing companies and compulsory appraisal of their projects for new companies. iii. Disclosures: The quality of disclosures in the offer documents was extremely poor. Several vital pieces of adverse information were not disclosed in the offer document. SEBI has introduced stringent disclosure norms. The Malegam Committee was appointed to suggest measures to increase the levels of disclosure by Indian issuers. Most of the recommendations of the Committee have been implemented. An attempt is being made to bring our disclosure norms in conformity with global standards. iv. Book Building: Book Building is the process of price discovery. One of the drawbacks of free pricing was the pricing mechanism. The issue price had to be decided around 60-70 days before the opening of the issue. Further, the issuer has no clear idea about the market perception of the price determined. Introduction of book building helps in overcoming this limitation and results in market driven pricing of securities. v. Streamlining the Procedures: All the procedural formalities were streamlined. Many of the operational aspects were hitherto unregulated and different practices were being followed. SEBI issued guidelines to ensure uniform procedures. Many aspects of the operations have been made more transparent. 339
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vi.
9.
Registration of Intermediaries: SEBI started the process of registration of some of the intermediaries associated with the process of issue management. This is done to ensure professionalization of the intermediaries and to curb the malpractices indulged by some of the intermediaries. Registration has been made mandatory for the following primary market intermediaries: •
Merchant Bankers
•
Registrars and Share Transfer Agents
•
Brokers to the Issue
•
Bankers to the Issue
•
Debenture Trustees.
Merchant bankers have a vital role to play in the divestiture process. Divestitures involve sale of assets or business entities. The assets may be tangible like manufacturing unit, product line, etc., or intangible assets like brand, distribution network, etc. Sometimes the business entity as a whole may be sold to a third party. The reasons for divestitures can be broadly classified as: Planned: A company may plan for the sale of a particular asset/business. The reasons may be varied: •
Strategic decision to exit from a certain industry.
•
Poor business fit with other operations of the company.
•
Severe competition.
•
Technological factors.
•
Continuous losses in a particular line of activity.
•
Shrinking margins.
Opportunistic: In such cases, the vendor company has no intentions to divest in the normal course. However, the management is tempted by the buyer with a very high bid. If the company feels that the price offered is substantially more than the worth of the asset/business, it may divest. The reason for the sale is solely profit motive. Forced: The reason for the sale is the prevalence of circumstances beyond the control of the company. The company may be facing a severe liquidity crunch and the only solution to raise cash may be through divestiture. Sometimes the asset/business may be sold to avoid a takeover or to make a takeover bid unattractive. Sometimes a divestiture may be a part of a rehabilitation package for the turnaround of a sick company. 10.
The SEBI is a regulatory body established to provide transparency, maintain market integrity and ensure investor protection. According to the SEBI Act, 1992, the main functions performed by SEBI to meet its objectives are: i.
Regulating the securities market.
ii.
Recognition and regulation of the Stock Exchanges.
iii.
Registering and regulating the working of various intermediaries including Merchant Bankers, Registrars, Share Transfer Agents, Stock Brokers, Sub-brokers, Debenture Trustees, Bankers to the Issue, Underwriters, Portfolio Managers, etc.
iv.
Registering and regulating the functioning of Depositories, Custodians and Depository Participants.
v.
Registration of Foreign Institutional Investors.
vi.
Registering and regulating the working of Venture Capital Funds, Mutual Funds and other collective investment schemes including plantation schemes. 340
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vii.
Promotion and regulation of Self-Regulatory Organizations.
viii.
Prohibiting fraudulent and unfair trade practices relating to securities market.
ix.
Prohibiting insider trading in securities.
x.
Regulating substantial acquisition of shares and takeover of companies.
xi.
Promoting investor education and training of intermediaries.
xii.
Conducting research relating to securities market.
In the recent past, the Indian capital market has witnessed innovations in the financial instruments owing mainly to the liberalization measures. Zero-coupon Bonds: These bonds are issued at discount to their face value and are redeemed at par on expiry of their tenure. There is no payment of interest on these instruments. The yield on these bonds can be computed from the difference between the issue price and the redemption price adjusted for time factor. Secured Premium Notes: SPNs are issued at face value and do not carry any interest. They are redeemed by repayment in a series of installments at a premium over the face value. The premium amount is distributed equally over the period of maturity of the installment. SPNs may also be issued with a detachable warrant which may be converted into share(s) for cash after a certain period. They are secured by mortgage on all immovable properties of the company. Deep Discount Bonds: These bonds are sold at a large discount on their face value and mature at par value. There are no interest payments and investors obtain their return as accretion to the par value of the instrument over its life. The advantage to the issuer is that it does not entail any cash outflow till the time of redemption. This instrument is similar to ZCBs described above. However, the term of this instrument is usually around 20 to 25 years and it provides an option to the investor to exit say at the end of 5 years, 10 years, etc. Optionally Convertible Debentures: These debentures carry a predetermined coupon and have a stated tenure. The debenture can either be redeemed or be converted into equity shares on its maturity. The option for conversion or redemption is vested with the investor. Third Party Convertible Debentures: These are debt instruments with warrants allowing the investor to subscribe to the equity of another company at a certain price. This is a convenient means of fund raising for companies which do not have a track record, but have strong companies in the group whose stock can be offered. Zero Coupon Convertible Note or LYONS: This is convertible into equity of the issuer at a price set at the time of issuance. If the investors choose to convert the notes into equity they forego all interest. Tax Saving Bonds: The investor in these bonds is entitled to certain tax shields. The issuer can, therefore, offer lesser coupon on these bonds. The issue of such bonds require the prior approval of Central Board of Direct Taxes (CBDT). For example, the interest earned on these bonds may be deductible under Sec. 80L. Some bonds provide for exemption from Capital Gains Tax under Sec. 54EA and Sec. 54EB, if such amount is invested in these approved bonds. Cumulative Convertible Preference Shares (CCPS): CCPS are similar to convertible bonds excepting that CCPS pays fixed dividend and cumulative deposits attract interest till conversion. The major advantage of CCPS is that it is considered as part of net worth even before its conversion. This instrument is suitable for companies which want the equity component to remain low, maintain its EPS without becoming overcapitalized, increase the leveraging capacity of the company as it is considered owners’ capital. This, in turn, increases the net worth of the company and allows the issuer to go in for more debt. 341
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One inherent advantage presented by this instrument is that promoter’s stake does not get diluted during the public issue. 12.
13.
The lead manager exercises his due diligence by checking all the important aspects of the company going public. Along with this exercise, he compares the company with other companies whose shares are being publicly traded and develops his own forecast of prices at which the scrip would be traded. The price band is agreed upon after negotiations between the issuing company and the merchant banker. Usually, the merchant banker approves the price band based on the following indicators about the company: •
Past track record of performance.
•
Comparison of issuing company with other similar companies with respect to future earnings, cash flow from operations and fundamental asset values.
•
SWOT analysis of the issuing company.
•
Half-yearly or quarterly earnings of the company during the current year and its expectations in the next quarter.
•
Information on retail and institutional interest in the proposed offering and an indication of buying at different levels.
•
Information on the overall trend in the IPO market and the success rate of similar issues during the period.
•
Taking into account the shareholding pattern before and after the issue and identifying the potential selling shareholders upon listing the stock.
•
Taking into account, the part of the issue which has to be underwritten and finding out market-making to the issue.
•
Feasibility of perceptions about the company’s management from the brokers and prospective investor from road shows and investor conferences.
•
Products and services of the company and what the future holds for them.
•
The company’s accounting methods and whether there had been any changes in recent years and reasons behind the changes.
Private placement of securities is one of the most popular avenues of raising capital. Private placement is a method of raising capital in which companies directly sell their securities to a limited number of ‘sophisticated and discerning’ investors. The distinct features of private placement are: i.
There are no entry barriers for the private placement market.
ii.
There is no need for registration of the offer document with SEBI. The procedural formalities are simple.
iii.
The terms of the issue can be negotiated between the issuers and the investors.
iv.
The company has a choice of investors.
v.
The transaction costs are low.
vi.
Credit rating is optional in case of debt instruments.
vii.
The execution of the deal is faster.
Merits of Private Placement The private placement market has witnessed an exponential growth during the last 3 years. The inherent advantages of private placement as an efficient route for raising capital and profitable avenue for investments makes it acceptable to both the issuers and the investors. i.
Accessibility: There are no entry barriers for a company to access the private placement market. Unlike the public issue market, an existing company does not require a track record of divisible profits for 3 years nor does a greenfield project require mandatory appraisal and funding by a Bank/Financial Institution. This route is also available to unlisted and closely held public companies. Further, public offering may not be viable if the amount proposed to be raised is very small. 342
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ii.
14.
Speed: A private placement deal can be executed successfully and much faster than a public offering. The procedural formalities for a private placement transaction are minimal. The time-frame required to plan and complete a public offering ranges between 4 to 6 months (or even more in some cases). On the other hand, a private placement deal can be successfully closed in 4 to 6 weeks. This results in substantial saving of time and energy for the issuer. iii. Flexibility: In a private placement, there is greater flexibility in working out the terms of the issue. In addition to greater flexibility at the time of structuring the issue initially, there may be more latitude to renegotiate the terms of the issue subsequently and even roll-over the debt. This is because the issuer has to deal with only a few institutional investors in the Private Placement Market (PPM). Besides, one of the most attractive features of PPM is that it can be tailored to the needs of first generation entrepreneurs who are comparatively less known to the public which makes their public issue less attractive. It also satisfies investors who want large holdings, but whose needs cannot obviously be met in case of public issue. Thus, for large investors, stocks will be available in the quantity they desire at reasonable transaction cost compared to secondary market buying. iv. Lower Transaction Cost: A public issue entails several statutory and non-statutory expenses associated with underwriting, brokerage, printing, mailing, announcements, promotion and so on. In the absence of advertisement and prospectus, the issue expense in case of private placement is as low as 2% of the total issue amount as compared to 10 to 12% in case of public issues. v. Confidentiality: Private placements also have the advantage of confidentiality of information. In a competitive environment, keeping strategic business secrets pertaining to a firm is of crucial importance. A buy-out is a process whereby an investor or a group of investors buys out a significant portion of the equity of an unlisted company with a view to make it public within an agreed time-frame. To put it simply, buy-outs are nothing but wholesale investments. Distinctive competitive advantages of a bought-out deal in comparison to a public offer. • The price privilege: One of the main advantages in a bought-out deal as compared to a run-of-mill public issue is that the price is not subject to the vagaries of the market place as the buyer of the stock is sophisticated enough to gauge the future earnings capacity of a company without the help of imperfect signals from the stock market. While this price may not necessarily reflect a company’s earning potential to the fullest extent, the discount is the price the issuing company has to pay to get the money upfront. • The quick fix: The small investor, who had lost money in the primary market due to companies with dubious record, has a general mood of skepticism to all new issues. Often a promoter cannot convince the lay public about the merits of a project, especially if it is an unknown company or a greenfield project. In such a case, selected investors in the form of one or several investment bankers are easier to convince about a projects’ future earnings capacity. So, some companies will find it easier to go in for a bought-out deal. • The cost advantage: If the size of an issue is small, it sometimes makes sense for companies to avoid a public issue. The support for this contention is based on the fact that the fixed costs of a retail capital offering like mandatory advertisements, printing of forms, underwriting and the like are rising steadily. Merchant bankers estimate that for a small issue of Rs.1.5-2 crore, costs may be as high as 15-20% of the issue size. This cost advantage has already made its presence felt as a catalyst for private placements. A bought-out deal takes the argument to its logical culmination. • Time is money: For a company, public issue translates into a six months ordeal of convincing merchant bankers, regulatory body and investors. In a bought-out deal, a company normally saves that amount of time. For an entrepreneur, valuable time is wasted in raising money especially when he should be concentrating on the usage of funds. The possible results are faster implementation of projects and fewer chances of cost overruns. 343
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15.
Standard & Poor’s specialize in credit rating both long-term as well as short-term obligations. They rate all public corporate bonds and preferred stock issues of $10 million or above with or without a request of the issuer. Presently, they have confined their rating operations to the following types: Rating Obligations a. Long-term obligations: i. US market long-term obligations. ii. Non-US market long-term obligations. iii. Euro-bond rating. b. Short-term obligations: i. Commercial paper (maturity of not more than 365 days) of US and Non-US issuers upon request. c. Sovereign rating. d. Rating criteria. Debt instruments covered under the above heading are described below. a.
Long-term Obligations i.
US market long-term obligations: Standard & Poor’s rates the following US Capital market long-term obligations upon request of issuer and have the publication right of the rating assigned to these obligations: •
Private placements of debt instruments.
•
Mortgage-related financing such as mortgage backed bonds and passthrough certificates of banks, and thrift institutions.
•
Insured Certificates of Deposit of US Banks.
•
Uninsured Certificates of Deposit of US Banks.
ii.
Non-US market long-term obligations: Long-term obligations in the nonUS capital market are rated on issuers’ request in the overseas markets. Such rating reflects an assessment of the probability of timely repayment of principal and interest in the currency of denomination of the issuer. There is no assessment of foreign exchange risk taken by the investor while opting to make the investment. The overseas market issues for which S&P rate the debt obligations includes Euro-currency bonds, domestic Pound Sterling, French Francs, Swiss Francs, and Deutsche Marks issues.
iii.
Euro-bond rating: Euro-bond rating of both US and Non-US entities has been undertaken by S&P with the internationalization of the world’s capital market. Since mid-1982, the rating is done on request or without request of the issuer. No fee is charged by S&P’s where rating is unrequested. The main advantage of rating on Euro-bond obligation is that the issuer can have access to the US capital market, under the US Securities and Exchange Commission’s Rules.
b.
Rating of Short-term Obligations S&P undertakes rating on request by the US or non-US issuers of short-term obligations, such as commercial paper (having an original maturity of not more than 365 days). Issuers retain the initial publication right of the rating, but once the rating has been published, S&P’s can publish the revised rating.
16.
The guidelines issued by SEBI for pricing of issues are on follows: i.
A new company can price its shares only at par. A new company has been defined as one which has not completed 12 months of commercial operations and its audited operative results are not available and where it is set-up by enterpreneurs without track record. 344
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ii.
17.
A new company, which is promoted by an existing company with a 5 year trackrecord of consistent profitability can freely price its issue. In such case the minimum promoter contribution should be 50%. The term ‘consistent profitability’ should not be construed as continuous profitability. SEBI has clarified that the promoter companies should have profits after providing for interest, depreciation and tax as per the audited accounts, in 5 of the 7 preceding years with profits during the last 2 years, prior to the issue. iii. An existing private or closely held public company can freely price its issue, if it has a 3-year track of consistent profitability. As per SEBI clarifications, the company should have made profits after providing for interest, depreciation and tax as per the audited accounts in 3 of the preceding 5 years with profits in the last 2 years prior to the issue. iv. An existing listed company is allowed to raise capital by freely pricing the issue. The premium will be fixed by the issuer in consultation with the lead manager(s) to the issue. Different variables need to be considered while rating a government’s local and foreign currency debt. The key economic and political risk factors considered by Standard and Poor’s while rating local currency debt are as follows: Stability of Political Institutions: The decision-making relating to the various economic policies aimed to bring about progress depend on the stability and the level of participation of the government in the economic progress. Economic Structure: This factor is essential since a free market economy enables decentralized decision-making where the market forces play a key role, while in a closely regulated economy, the government will be playing a key role in various economic factors viz., interest rates, etc. Fiscal and Monetary Policies: The purpose and the magnitude of the public sector borrowings and its implication on inflation are the aspects related to fiscal policy that may have a major influence on the government’s ability to service public debt. Government may further, with its monetary powers, mobilize funds for deficit financing. However, heavy monetization of budget deficits will increase the public debt burden of the government which may adversely affect its sovereign creditworthiness. Inflation: Apart from affecting economic progress, price rise may also lead to political problems/instability. To evaluate the inflationary pressures, S&P’s assesses the inflation using the past behavior. Other factors that are considered here are total borrowings of the government, the maturity structure of public debt, future borrowing programs and the ability of the Central Bank to check fiscal imbalances. Apart from the above mentioned factors, the performance of the country’s financial markets are also examined by S&P while conducting local currency debt-rating. While rating the foreign currency debt obligations of a country, S&P’s considers most of the factors used while rating local currency debt. Other than these, it also focuses on the following: Balance of Payments (BoP): A nation’s BoP situation should be adequate and should sustain any risk that might arise so as to enable the government to service its debt. Changes in domestic and foreign environments influence the BoP. To prevent any adverse impact on the BoP situation, timely and appropriate measures need to be taken. Current account vulnerability to any changes in the environment depends on the structure of the trade and service, the exports and imports, international competitiveness, etc. On the other hand, flexibility to the BoP position can be obtained by ensuring greater capital inflows by way of direct investment in equity and other assets. Capital inflows by way of debt will expose the country to interest rate, exchange rate and liquidity risks. S&P’s studies the past data on the BoP situation and based on the likely policy measures, forecasts the future trend. External Financial Position: S&P’s focuses on the burden of external public debt, contingent liabilities and the ability of the country’s reserves to service the debt. 345
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The factors affecting external financial position are as follows: •
Net public/private external debt – Total public/private debt less public/private sector financial assets.
•
The invisible assets/liabilities, which have one way movement.
•
Direct and portfolio equity investments.
•
Net debt service capacity of the economy.
Other considerations involved while examining the external financial position include the policies relating to currency convertibility, exchange rates and the accessibility to concessional/market related foreign credit. Economic and Political Prospects: The debt servicing ability of a nation is strongly influenced by its economic and political prospects. The economic plans of a nation are reviewed in the light of the various constraints, both internal and external. The future borrowing requirements of the nation are assessed by forecasting the economic scenario. 18.
The intermediaries involved in the International Capital Markets include Lead Managers/Co-lead managers, Underwriters, Agents and Trustees, Lawyers and Auditors, Listing Agents and Stock Exchanges, Depository Banks and Custodians. An overview of the functions performed by each of them is given below: i.
Lead and Co-managers: The responsibilities of a Lead Manager include undertaking due diligence and preparing the offer circular, marketing the issues including arranging the roadshows. Lead manager, sometimes in consultation with the issuer, can choose to invite a syndicate of investment banks to buy some of the bonds/DRs and help sell the remainder to other investors. ‘Co-managers’ are thus invited to join the deal, each of whom agrees to take a substantial portion of the issue to sell to their investor clients. Usually, there will be more than one lead manager as mandates are sometimes jointly won, or the investment bank which actually won the mandate from the issuer may decide that it needs another institution to ensure a successful launch.
ii.
Underwriters: The lead managers and co-managers act as underwriters for the issue, taking on the risk of interest rates/markets moving against them before they have placed bonds/DRs. Lead managers may also invite additional investment banks to act as sub-underwriters, thus forming a larger underwriting group. A third group of investment banks may also be invited to join the issue as members of the selling group, but these institutions only receive a commission in respect of any bonds/DRs sold and do not act as underwriters. The co-managers and the underwriters are also members of the selling group.
iii.
Agents and Trustees: These intermediaries are involved in the issue of bonds/convertibles. The issuer of bonds/convertibles, in association with the lead manager, must appoint ‘paying agents’ in different financial centers, who will arrange for the payment of interest and principal due to investors under the terms of the issue. These paying agents will be banks.
iv.
Lawyers and Auditors: The lead manager will appoint a prominent firm of solicitors to draw up documentations in evidence of the bond/DRs issue. The various draft documents will be scrutinized by lawyers acting for the issuer and in due course by the co-managers and any other party signing a document related to the issue. Auditors or reporting accountants will become involved as well, supplying financial information, summaries and an audit report which will be incorporated into the ‘offering circular’. The auditors provide comfort letters to the lead manager on the financial health of the issuer.
v.
Listing Agents and Stock Exchanges: The listing agent helps facilitate the documentation and listing process for listing on the stock exchanges and keeps on file information regarding the issuer such as annual reports, articles of association, the depository agreement, etc. 346
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The Stock Exchange (Luxembourg/London/AMEX/NYSE as the case may be) reviews the issuers application for listing of the bonds/DRs and provides comments on offering circular prior to accepting the securities for listing.
19.
vi.
Depository Bank: The depository bank is involved only in the issue of DRs. It is responsible for issuing the actual DRs, disseminating information from the issuer to the DR holders, paying any dividends or other distributions and facilitating the exchange of DRs into underlying shares when presented for redemption.
vii.
Custodian: The custodian holds the shares underlying DRs on behalf of the Depository and is responsible for collecting rupee dividends on the underlying shares and repatriation of the same to the Depository in US dollars/foreign currency.
viii.
Printers: The printers are responsible for the printing and delivery of the preliminary and final offering circulars as well as the DRs/bond certificates.
The major changes initiated in secondary markets are on follows: i.
Trading System: Trading on all the stock exchanges was being carried out by ‘public outcry’ in the trading ring. This was an inefficient system and also resulted in lack of transparency in the trades. The Over The Counter Exchange of India (OTCEI) was the first exchange to introduce screen based trading in India. Listing on OTCEI was restricted to small and midcap companies. Screen based trading received a big boost with the setting up of the National Stock Exchange. The NSE provided nationwide access to investors by setting up trading terminals all over the country. These terminals were networked through satellite links. The fully automated trading system enabled market participants to log in orders, execute deals and receive on-line market information. The competition from the NSE forced the regional stock exchanges including the BSE to switch over to screen based trading. The NSE trading system is order driven while the OTCEI system is quote driven. In an order driven environment, the system captures all the orders and matches the orders with each other to execute the transaction. A quote driven system is based on market making concept (dealer giving two way quotes) and the order logged in is matched against the best quote given by the market maker. The BSE On-line Trading (BOLT) is a mixture of both quote driven and order driven system as the system permits both jobbing and direct matching of orders.
ii.
Depository: One of the major drawbacks was/is that the securities were/are held in the form of certificates. This led to the problems in physical storage and transfer of securities. There was also the risk of bad delivery for the buyer. The transaction costs were also higher due to physical movement of paper and the incidence of stamp duty. The National Securities Depository Ltd. (NSDL) was set-up in 1996 as India’s first depository. A depository is an entity which holds the securities in electronic form on behalf of the investor. This is done through dematerialization of holdings at the request of the investor. Dematerialization is a process by which physical certificates of the investor are destroyed and an equivalent number of securities are credited to the account of the investor. This also enables transfer of securities by book entries. The risk of bad deliveries is also eliminated. The transaction costs are also reduced due to less flow of paper and transfer of securities through depository does not attract stamp duty. Further, the depository also handles all the corporate actions like exercising for rights, collection of dividends, credit for bonus, exercising of warrants, conversion option, etc., on behalf of the investor.
iii.
Clearing Mechanism: The clearing houses attached to the stock exchanges were functioning only as conduits to delivery of securities and money. The default risk by the counterparty in the transaction continued. The NSE was the first stock exchange to set-up a clearing corporation. The National Securities Clearing Corporation (NSCC) assumes the counterparty risk in all trading deals made on the exchange. The NSCC acts as the counterparty for all the trades and the default risk in the deal is borne by it. The NSE has created a special Trade Guarantee Fund for this purpose and loss due to defaults will be met by drawing from its corpus. 347
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iv.
Settlement System: The exchange followed the calendar system of settlement. For example, in case of A group shares on the BSE, the trading cycle was for 14 days. Trading in equities internationally is done on the basis of rolling settlement. The settlement is done on either T+3 or T+5 system (i.e. the trade will be settled on the 3rd/5th day from the date of execution of the transaction). SEBI has encouraged the stock exchanges to shorten their settlement cycle. The exchanges currently follow a 7 day settlement cycle. However, the trading week is not uniform giving rise to arbitrage opportunities. In case of trading in dematerialized securities, the rolling settlement has been introduced. Further, with the availability of the facility of electronic funds transfer, the Delivery Versus Payment (DVP) system is being introduced. The trading on the NSE commences every Wednesday and concludes on the following Tuesday and thus a month normally has four trading periods. With the introduction of rolling settlement from July 2, 2001, the settlement is to be done on daily basis and the NSE period will also be from Monday to Friday.
v.
Carry Forward System: The Indian Stock Exchanges have been an amalgam of cash market and forward market. The prices of the scrips on the exchange did not reflect their ‘true’ price in the underlying cash market. Further there was indiscriminate and rampant speculation in the market. Defaults were common and other members were forced to “accommodate” the defaulting member. Often, the defaults had a snowballing effect and the entire market would be in the throes of a major payment crisis. This resulted in frequent closure of the exchanges for a few days. In order to curb the prevailing malpractices, SEBI banned carry forward transactions on all the stock exchanges. A modified carry forward system was introduced and the badla procedure was also streamlined. Now, with the rolling settlement system, modified carry forward and badla have been banned.
vi.
Margin System: The role of the margin system for smooth running of any stock exchange cannot be overemphasized. The margin system was dysfunctional in most of the stock exchanges. The lack of stringent margin requirements and the laxity in collection of the margins resulted in utter chaos, whenever there was a default. The margin system has now been streamlined. SEBI has introduced the concept of mark to market margin. In addition to this, other margins like initial margin, concentration margin, etc., have been introduced.
vii.
Capital Adequacy: Most of the brokers in the stock exchanges operated on a small capital base. They were, therefore, unable to bear the risks associated with the business. The result was a high incidence of defaults in the Stock Exchange. SEBI has now introduced minimum capital norms for all brokers. Further, the capacity of a broker to assume a position in the market would be a function of his capital.
viii.
Liquidity for Debt: An important feature of a good capital market is the existence of a vibrant secondary debt market. Indian markets were characterized by lack of liquidity for corporate debt. This called for widening and deepening of the debt market. The NSE set-up a separate trading system called the wholesale debt segment for trading in all debt instruments. This has provided nationwide trading access to debt investors. Market making would further enhance the liquidity in the debt market.
ix.
Indices: An index is an important tool to measure the price behavior of the overall market. The return on the index provides a benchmark for portfolio risk-return analysis. Several new indices have been constructed based on various parameters. The 30 share BSE Sensex and the 50 share S&P CNX Nifty are the popular sensitive indices to measure the daily market volatility. Some of the new indices like BSE Dollex and NSE Defty are denominated in dollars. The S&P CNX 500 is a more broad based index covering a larger portion of the total market capitalization. Apart from these indices some industry specific indices have also been constructed to reflect the price volatility of the shares of the companies in a particular industry. The construction and maintenance of well-designed and responsive indices has become critical with the introduction of index futures. 348
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20.
x.
Regulation: SEBI has taken a number of steps to maintain the integrity of the markets and to ensure investor protection. Insider trading has been declared as a criminal offense and prosecutions have been initiated in cases violating of the insider trading regulations. SEBI has also started investigating into instances of price rigging and penal action is taken against the guilty. SEBI has also attempted to bring transparency into broker-client relationships. The system of circuit breakers has been introduced to prevent excessive volatility in price movements.
xi.
Derivatives: Derivatives are important tools for portfolio management. The introduction of derivatives resulted in a paradigm shift in the investment strategies of the Indian investors. The L C Gupta committee had recommended the introduction of options and futures in India. In the light of the experience gained, options were introduced at a later stage. While trading in options and futures has started, the market has not yet witnessed high volumes, as the investors are not very comfortable with these instruments.
Level one: There is a formal agreement between the issuer and one depository bank. Like the unsponsored ADR, Form F-6 is filed seeking exemption under Rule 12g3-2(b) of the SEC from the full reporting requirements. The company does not have to comply with the US Generally Accepted Accounting Principles (GAAP). Level one ADRs cannot be listed on the national stock exchanges but can be traded at over the counter market and listed in the pink sheets. Over The Counter Bulletin Board will no longer be available for Level one ADRs although pink sheets would still be available. Pink sheets contain wholesale price quotes and are distributed by the National Quotation Bureau of Brokers and Dealers. This can support a Rule 144A ADR facility but cannot be used for raising capital. Level One ADRs allow the company to enjoy the benefit of a traded security without complying with the reporting requirements. In the US, in addition to federal laws and regulations, state level ‘blue sky’ regulations govern the offer and sale of securities. These regulations require state registration before intrastate offering can be made. Issuers who establish an unlisted ADR can publish certain financial data in a recognized security manual to provide adequate source of investment information. This eliminates the need to individually list securities in fifty states in the US. Level two: As in level 1 the issuer initiates the program and there is a formal agreement with the depository bank. In addition to filing Form F-6, the issuer is also required to file Form 20-F and comply with other disclosure rules, including partial reconcilation of the financial statements as per the US GAAP, to the extent there are differences in major line items in the balance sheet and income statement. Financial statements for individual business segments need not be reconciled to the GAAP. Listing of securities exempts foreign issuers from complying with the ‘blue sky’ regulations. This program may be used to fund the ESOP (Employee Stock Ownership Plan) and management compensation plans. This ADR is more expensive and time consuming because of elaborate reporting requirements and higher legal and listing costs. It cannot be used for raising capital through the listing process. Level three: It is identical to level two. In addition, the issuer is required to file Form F-1. This is similar to Form S-1 for the US companies. The issuer is required to have the securities registered and fully reconcile the financial statement to the US GAAP. The offering can be used for various purposes including funding ESOPs or raising capital for the US acquisition. The issuer also selects an investment banker to advise, underwrite, and market the offering. Infosys, Rediff, Silverline ICICI Bank, ICICI and Satyam Info have raised capital in the international market by issuing level 3 ADRs.
21.
Arnica Chemicals needs to develop a mix of factors like product differentiation, pricing, promotion, service and distribution to successfully market their public deposit schemes. 349
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Product Differentiation: Fixed deposit is an intangible financial product. The needs of the potential depositors have to be kept in mind while designing the product. Generally, the target market is the middle class household. They normally look for safety and security of their savings. The safety factor can be projected by highlighting the credit rating. Different saving schemes may be developed to suit varying financial needs. Some of the popular schemes include regular income schemes where interest is paid at monthly, quarterly, half-yearly or annual intervals, cumulative deposits where the interest alongwith the principal is paid on maturity and recurring deposit schemes where a fixed amount is invested regularly and a lump sum is paid on maturity. Some company deposit schemes have sweeteners like free accident insurance cover for their depositors. Pricing: The pricing aspect is regulated by the Government and the maximum coupon is capped at 15% p.a. Hence, scope for innovation is limited. However, it can design schemes with various maturities and differential interest rates can be offered subject to the statutory ceiling. Promotion: Arnica Chemicals should first identify the segment of the market that it would like to tap. This strategy enables it to focus on specific target segments instead of scattering their marketing efforts. At any point of time, potential depositors are in different stages of readiness – some are unaware, some aware, some informed, some interested, some curious and some intending to invest. Thus, the promotion effort should aim at building high awareness through advertising. The promotional campaign can be carried through various media like the print media, audio-visual media, outdoor displays like hoardings and posters, direct mailers, novelties like calendars and key chains, catalogues and brochures, circulars, etc. Arnica needs informational advertising to build primary demand. The use of a catchy message or slogan could be a good tool for communication. The advertisement has to put the message across in a way that captures the attention and interest of the potential investors. The message has to be exclusive, desirable and believable to create the necessary impact. Some companies have attempted to create an identity for their public deposits by providing them with brand names. Quality Service: Good and courteous service helps in earning the goodwill of the depositors. The depositors are provided with post-dated interest warrants payable at par, prompt repayment on maturity, loans against deposits, etc. A mechanism for prompt redressal of depositor grievances should also be created. Personalized and prompt service will have a self-propelling effect and can bring in more depositors by word of mouth. It acts as pseudo-marketing. Distribution: It should decide on the geographical areas that it needs to focus on. However, careful attention should be paid to variations in geographical needs and preferences. Arnica Chemicals can practice direct marketing of their deposits. The company staff directly contacts the potential depositors and explains to them the salient features of their schemes. It can also canvass by holding depositor meets and make presentation about the company and its deposit products, for which it needs to have a clearly defined target segment e.g. pensioners, double income households, young managers, etc. 22.
In India, call money is lent mainly to even out the short-term mismatches of assets and liabilities and to meet CRR requirements of banks. Some banks may borrow and lend simultaneously from the market if they find an opportunity to arbitrage. Firstly, the short-term mismatches arise due to variation in maturities i.e., the deposits mobilized are deployed by the bank at a longer maturity to earn more returns and the duration of withdrawal of deposits by customers varies (since it is effectively a demand liability). Thus, banks borrow from call money markets to meet short-term maturity mismatches such as large payments and remittances. 350
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23.
24.
Secondly, the banks borrow from this market to meet the Cash Reserve Ratio (CRR) requirements which they should maintain with the RBI every fortnight. Cash Reserve Ratio (CRR) represents the balances to be maintained by banks with the RBI which is computed as a percentage of the Net Demand and Time Liabilities (NDTL). Thirdly, the money is borrowed in the call/notice market for short periods for discounting commercial bills. The volume of call loans for serving this purpose is very small in India, this is due to the underdeveloped bill markets. Thus, the utility of the call money for meeting short-term mismatches form a significant volume when compared to the other purposes. The generic factors responsible for underpricing of IPOs are: i. Asymmetric information: The most basic problem of the IPO process is the presence of both ‘good’ and ‘bad’ firms going public, coupled with asymmetric information between firms and investors. Firms know themselves reasonably well but investors do not. When information and analysis is costly, it is optimal for investors not to learn about a firm thoroughly. Superior information disclosures can reduce this asymmetry and should help reduce underpricing. ii. Fixing the offer price early: The firm sets the offer price at time 0 and the issue opens at time T. Firms are likely to be risk-averse with respect to the prospects of the issues failing. Hence they underprice to forestall this possibility. The delay between choosing an offer price and the issue date has diminished in some sense with the current SEBI policy allowing firms to choose a price band at the time of vetting the prospectus instead of a precise price. iii. Interest rate float: The issuing company controls the application money for a month. Even if stock-invests are widely used, the interest rate on stock-invests is quite low. At equilibrium, markets would compensate investors for this low rate of return, through underpricing. This problem can be solved if issuing firms and merchant bankers become more efficient and shorten the lags between the issue date and the listing date. iv. Liquidity premium: Investors who apply for public issues lose liquidity on the amount paid at issue price. Usually at equilibrium, the markets would compensate them for this by paying a liquidity premium, which would show up in IPO underpricing. v. Building loyal shareholders: Firms may have an incentive to underprice when they expect to return to the capital market to raise further resources at a later date, via a rights issue or a public issue. vi. Merchant banker rewarding favored clients: The interaction between the merchant banker and the company going public is typically a one shot interaction, but the merchant banker is in a repeated game with many of his clients, especially the large institutional investors. In this situation the merchant banker has an incentive to underprice to retain his established clients. XYZ Ltd. is a leasing company. The RBI has issued directives to all the leasing, hire purchase and other non-banking finance companies to apply for registration by July, 1998. With XYZ Ltd. applying for registration, it has in-principle approval from the RBI to carry on its business until the RBI scrutinizes the application in detail and either grants or cancels the certificate of registration to the company. XYZ Ltd. can operate as usual until the RBI responds to the application of registration. A non-banking financial company can commence business after 8th January, 1997 or an existing NBFC, like XYZ Ltd. can carry on the business of a NBFC only after: i. Obtaining a certificate of registration from the RBI, and ii. Having minimum net owned funds of Rs.25 lakh. However, if XYZ Ltd. does not have a Net Owned Funds (NOF) of Rs.25 lakh, the company should either register itself by enhancing the NOF or cease operations as it is unable to be registered. 351
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The following factors concerning XYZ Ltd. will be evaluated by the RBI prior to the granting of the certificate of registration:
25.
a.
XYZ Ltd. should be in a position to pay its present or future depositors in full and when their claims accrue.
b.
The affairs of XYZ Ltd. should not be in a manner detrimental to the interests of its present or future depositors.
c.
The general character of the management or the proposed management of XYZ Ltd. should not be prejudicial to the public interest or the interests of the depositors.
d.
Whether XYZ Ltd. has adequate capital structure and earning prospects.
e.
The grant of certificate of registration should not be prejudicial to the operation and consolidation of the financial sector consistent with monetary stability and economic growth considering such other relevant factors.
f.
Any other condition, fulfillment of which in the opinion of the RBI, should be necessary to ensure that the commencement of, or carrying on of the business in India by XYZ Ltd. should not be prejudicial to the public interest or in the interest of the depositors.
The NBFC must have proportionately maintained the stipulated ratio of Tier I capital and Tier II capital. The total of Tier II elements should be limited to a maximum of 100% of the total of Tier I capital for the purpose of calculation of Capital Adequacy Ratio (CAR). Tier I capital consists of paid-up capital, preference shares which are compulsorily convertible into equity, free reserves, balance in share premium account and capital reserves representing surplus arising out of sale proceeds of assets but excluding reserves created by revaluation of assets. From the total of these items, accumulated loss balance, deferred revenue expenditure and book value of intangible assets, if any, are deducted to arrive at the owned funds. From the resultant sum, the aggregate of: •
Investment in shares of other NBFCs
•
Investment in shares, debentures and bonds of subsidiaries and
•
Loans and advances to subsidiaries and companies of the same group are reduced, to the extent it is more than 10% of net owned funds.
That is: Owned funds = (Paid-up equity capital) + (Preference shares to be compulsorily convertible into equity) + (Free reserves which may include any or all of General Reserves, Share Premium, Capital Reserves, Debenture Redemption Reserve, Capital Redemption Reserve, Credit Balance in P&L account or other specified free reserves) – (Accumulated balance of loss) – (Deferred Revenue Expenditure) – (Other Intangible Assets) Tier I capital will be =
Net owned funds + [Total of the deductions specified below – 10% of the Net owned funds; or Nil, whichever is higher]
Deductions are:
26.
i.
Investments in shares of subsidiaries, companies in the same group, other nonbanking companies.
ii.
The book value of debentures, bonds, outstanding loans and advances in subsidiaries and companies in the same group.
Every NBFC has to follow a set of procedures for accepting fixed deposits. The procedures have been put in place to ensure transparency in operations of the NBFC and also to ensure easy supervision and genuineness of the operations.
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Maintenance of Register: Avenue Finance Ltd. (AFL) is accepting fixed deposits and therefore, has to maintain a set of registers in respect of all the deposits that contain specific details of each of the depositors. The details should include i.
Name and address of the depositor,
ii.
Date and amount of each deposit,
iii.
Duration and the due date of each deposit,
iv.
Date and amount of accrued interest or premium on each deposit,
v.
Date of claim made by the depositor,
vi.
The reasons for delay in repayment beyond five working days, and
vii.
Any other particulars relating to the deposit.
These registers should be kept at the registered office of the company and should be maintained for the next 8 calendar years following the financial year. Advertisement for Deposits: Regulations concerning raising of deposits by NBFCs stipulate that these entities should not accept deposits without issuance of advertisement inviting them in the first place. The advertisement must be issued in a leading English newspaper and one vernacular newspaper circulating in the state in which the registered office of the AFL is situated, after approval from the RBI. Such advertisement will be valid till the expiry of six months from the date of closure of the financial year in which the advertisement is so issued or until the date on which the balance sheet is laid before the company in the general meeting. The same procedure is applicable for renewal of deposits also.
27.
If AFL proposes to accept public deposits without inviting or allowing or causing any other person to invite such deposit, then it must prepare a statement in lieu of advertisement containing the prescribed particulars. Nomination by Depositors: Any depositor or all the depositors together have a right to nominate one person to whom the amount of deposit may be returned by AFL in the event of death of the sole depositor or the death of all the depositors. Upon the death of the sole depositor/all depositors, the nominee will be entitled to receive the deposit from AFL and to all the rights of the depositor(s) in relation to such deposits, to the exclusion of other persons. This right of the nominee against AFL supersedes any other law or testament (will). Loans to Depositor: After 3 months from the date of deposit, AFL can grant loans to the depositor up to 75% of the amount of public deposit kept by the depositor. Interest rate that can be charged by AFL can be a minimum of 2% above the interest rate payable on the deposit. The provisions for Path Financial Services in respect of loans, advances and other credit facilities including bills purchased and discounted are as under: a. Sub-standard Assets: A general provision of 10% of total outstandings must be made. b. Doubtful Assets: i. 100% provision must be made to the extent of the unsecured portion. ii. Additional provision: In addition to (i) above, depending upon the period for which the asset has remained doubtful, provision to the extent of 20% to 50% of the secured portion must be made on the following basis: Period for which the asset has been considered as doubtful Up to 1 year 1-3 years More than 3 years
% of provision 20% 30% 50% 353
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c.
Loss Assets: The entire loss asset must be written off. If the asset continues to remain in the books for any reason, 100% of the outstanding amount should be provided for.
Provisions for Lease and Hire Purchase Assets: Basic Provisions The total provision required to be made is broken up into basic provision and additional provisions. The basic provision is required to be made only in respect of hire purchase transactions and not in respect of lease transactions, and is required to be made once an asset becomes a NPA. The basic provision is not linked to the number of months (beyond 12 months) for which the installments are overdue, whereas the additional provisions are linked. Hire Purchase Assets The basic provision is 100% of the following: •
Total dues (overdue and future installments taken together, whether shown as stockin-trade or as receivables in the balance sheet).
•
As reduced by the finance charges not credited to the profit and loss account and carried forward as unmatured finance charges.
•
As further reduced by the depreciated value or net realizable value, whichever is lower.
The depreciated value for this purpose must be notionally computed at the original cost of the asset as reduced by the Straight Line Method (SLM) of depreciation at 20% p.a. As the SLM rate of depreciation is at 20% per annum, in case the asset is used for a part of a year, pro rata depreciation has to be calculated. Additional Provisions Hire Purchase/Lease Assets The additional provision is dependent on the number of months for which the hire charges/lease rentals are overdue, and is calculated as a percentage of the net book value of the hire purchase/lease asset. The additional provision required is as under: Overdue hire charges/lease rentals
Provisions required
Percentage of net book value Up to 12 months
Nil
More than 12 months but up to 24 months
10%
More than 24 months but up to 36 months
50%
More than 36 months
100%
Net book value is defined in para 2(1)(xi) of the RBI Regulations: a. In the case of hire purchase assets, the aggregate of overdue and future installments receivable as reduced by the balance of unmatured finance charges and further reduced by the provisions made as per paragraph 8(2)(i) of these directions. b. In the case of leased asset, the aggregate of the capital portion of overdue lease rentals accounted as receivables and the depreciated book value of the leased asset as adjusted by the balance of the lease adjustment account. The amount of caution money/margin money or value of any other security to which the NBFC has valid recourse can be deducted against the additional provision (but not against the basic provision made for overdues) and only the balance additional provision needs to be made.
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Provision after the last due date has passed On the expiry of 12 months after the due date of the last hire purchase installment/lease rental, the entire net book value must be provided for. This provision requirement overrides the additional provision requirements. In other words, once the overdues are for more than 12 months after the due date of the last hire purchase installment/lease rental, 100% of the net book value must be provided for and the benefit of additional provision at 10%/50%/100% depending upon the period of overdues will not apply. Also, in such a case, the benefit of deducting the amount of caution money/margin money or value of any other security from the additional provision will not be available. 28.
The distinction between a finance lease and an operating lease is of fundamental importance in the financial evaluation and accounting of leases. The distinction is based on the extent to which the risks and the rewards of ownership are transferred from the lessor to the lessee. Finance Lease A lease is defined as finance lease if it transfers a substantial part of the risks and rewards associated with ownership from the lessor to the lessee. According to the International Accounting Standards Committee (IASC), there is a transfer of a substantial part of the ownership related risks and rewards if: i.
The lease transfers ownership of the asset to the lessee by the end of the lease term; (or)
ii.
The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair market value at the date the option becomes exercisable and, at the inception of the lease, it is reasonably certain that the option will be exercised; (or)
iii.
The lease term is for a major part of the useful life of the asset. The title may or may not eventually be transferred; (or)
iv.
The present value of the minimum lease payments is greater than or substantially equal to the fair market value of the asset at the inception of the lease. The title may or may not be eventually transferred.
The aforementioned criteria are largely based on the criteria evolved by the Financial Accounting Standards Board of the US. The FASB has in fact defined certain cut-off points for criteria (iii) and (iv). According to the FASB definition of a finance lease, if the lease term exceeds seventy five percent of the useful life of the asset or if the present value of the minimum lease payments exceeds ninety percent of the fair market value of the asset at the inception of the lease, the lease will be classified as a finance lease. For the purpose of determining the present value, the discount rate to be used by the lessor will be the rate of interest implicit in the lease and the discount rate to be used by the lessee will be its incremental borrowing rate. In the Indian context, conditions (i) and (ii) are inapplicable because inclusion of any of these conditions in the lease agreement will result in the agreement being treated as a hire purchase agreement. Therefore, a lease is to be classified as a finance lease if one of the conditions (iii) or (iv) is satisfied. Operating Lease The International Accounting Standards Committee defines an operating lease as ‘any lease other than a finance lease’. An operating lease has the following characteristics: a.
The lease term is significantly less than the economic life of the equipment.
b.
The lessee enjoys the right to terminate the lease at a short notice without any significant penalty. 355
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c.
29.
The lessor usually provides the operating know-how, suppliers, the related services and undertakes the responsibility of insuring and maintaining the equipment in which case an operating lease is called a wet lease. An operating lease where the lessee bears the costs of insuring and maintaining the leased equipment is called a dry lease. An operating lease does not shift the equipment related business and technological risks from the lessor to the lessee. The lessor structuring an operating lease transaction has to depend upon multiple leases or on the realization of a substantial resale value (on expiry of the first lease) to recover the investment cost plus a reasonable rate of return thereon. Therefore, specializing in operating leases calls for an indepth knowledge of the equipments per se and the secondary (resale) market for such equipments. Of course, the prerequisite is the existence of a resale market. Given the fact that the resale market for most of the used capital equipments in our country lacks breadth, operating leases are not in popular use. But then this form of lease ideally suits the requirements of firms operating in the sunrise industries characterized by a high degree of technological risk. The advantages of leasing are: Flexibility Equipment leasing is a flexible financing arrangement in the sense that the lease rentals can be structured in a manner that squares with the cash flow pattern anticipated by the lessee. If the lessee expects a constant net cash flow stream from the project in which the leased assets are employed, the lease rentals can be evenly spread over the lease term. On the other hand, if the lessee anticipates a steadily increasing stream of cash flows, the lease rentals can be stepped up gradually. If the lease finance is availed for a project with a gestation period, the lease rentals can be structured with a deferment period. User-Oriented Variants There are several variants of a lease transaction which are designed to meet the specific requirements of the lessee. Examples of such innovative variants are the Upgrade Lease, which helps in hedging the risk of obsolescence or the cross-border lease which reduces the cost of the lease from the lessee’s point of view. There are also leases which provide all services related to the usage and maintenance of the asset. For example, in a full service car lease, the lessee pays a predetermined charge for the use of a car or a fleet of cars and he gets the entire spectrum of services ranging from the provision of chauffeurs to breakdown maintenance. Less Paperwork and Expeditious Disbursement Compared to the term loan arrangement, a lease arrangement requires (a) less of paperwork to be done by the lessee and (b) involves a shorter lead time between the date of submitting the proposal and the date of disbursement of funds. Convenience Convenience determines the decision to lease when a firm intends using an asset for a very short period of time. For example, a firm which requires the use of a fleet of cars for a week will find it easier to rent the fleet for a week than to buy it on Monday morning and sell it on Saturday evening. Apart from convenience, it is also a financially sensible proposition because the transaction costs associated with buying and selling like search costs, legal charges, selling commissions, etc., will outweigh the rentals to be paid for the short-term lease. Hundred Percent Financing The proponents of leasing often emphasize this feature of leasing as an advantage not available with the other forms of equipment financing. For example, the Equipment Finance Scheme of IFCI requires a borrower’s contribution of 25% of the equipment cost. Most of the other financing plans including hire purchase call for down payments varying between 15 to 25 percent. While it is true that equipment leasing does not call for as high a margin as other financing schemes, the fact remains that where lease rentals are payable say monthly in advance, the first installment amounts to a down payment. For example, a lease contract which requires lease rentals to be paid at the rate of Rs.25 ptpm (per thousand rupees per month) in advance can be viewed as a contract which requires a down payment of 2.5% of the asset cost. 356
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Better Utilization of Own Funds The proponents argue that leasing is the sensible route for acquiring non-income generating assets like air-conditioners, office equipments and vehicles. The firm can deploy its own funds in more productive channels. Off-Balance Sheet Financing From our discussion of the characteristics of finance lease, it is clear that this form of lease with its non-cancellable and full pay-out features is like a secured loan to be repaid over a period of time. We are also aware that secured loans and the assets acquired out of these loans are reflected in the balance sheet of the borrower. But surprisingly neither the financial commitments nor the value of the assets acquired under a finance lease needs to be disclosed in the balance sheet of the lessee. This phenomenon which goes by the name of ‘Off-Balance Sheet Financing’ is projected as a unique advantage of leasing over other forms of financing. Other Firm-Specific Advantages A small-scale unit which is on the verge of losing its SSI (Small Scale Industry) status by virtue of its investment exceeding the prescribed investment limit can postpone the inevitable for sometime by taking care of its immediate investment requirements through leasing. Likewise closely-held companies are likely to find leasing to be a convenient method of equipment financing because it does not result in dilution of control. 30.
31.
Yes, the finance manager is right. Lease financing suffers from the following shortcomings: a.
Given the fact that most of the equipment lease transactions are structured as finance leases, the flexibility of the lessee to disinvest is seriously undermined. The noncancellable feature is a serious disadvantage particularly where the equipments leased have uncertain technological and/or product-market lives.
b.
Propelled by the dubious advantage of “Off-Balance Sheet Financing” no firm can afford to increase its exposure to leasing beyond reasonable limits. Firms which are highly geared (with a high debt-equity ratio) and firms which are subject to a high degree of business risk must be particularly wary about leasing because it reduces the debt capacity of such firms and increases the financial risk.
c.
In a perfectly competitive financial market, the cost of leasing tends to be equal to the costs of other forms of borrowing. Therefore, in this market a borrower (lessee) can afford to be indifferent between the options of leasing and borrowing. But in an imperfect financial market where the tax shields associated with leasing and owning are different, where some long-term interest rates are regulated, etc., the costs of leasing and borrowing can be significantly different. More often than not leasing turns out to be costlier than most forms of borrowing. So, the lessee has to necessarily evaluate the costs of leasing and borrowing before choosing to lease or buy.
Tax Aspects of Leasing Leasing as a Tax Shelter Even though we have an elaborate literature on taxation practices in India, the procedures relating to the treatment of tax for lease services India is far from sufficient. This is due to the reason that our tax rules do not present clear-cut guidelines as to the identification of appropriate lease transaction (true lease transaction) for the purposes of calculation of taxes. In case of instance of a financial lease, the recovery of the asset by the lessor from the lessee is considered in a dual way: One part as real income and the other part as the realization of the capital by the lessor. In a strict sense, the later is not an income, if presented for tax calculations. Only a part of the whole realized by the lessor is accounted as real income i.e., the sum received as lease rental. This allows the lessee to incur a tax gain whereas the lessor suffers a tax loss. In the absence of any definite rules for 357
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distinguishing a true lease and financial lease, the treatment of tax laws have necessitated a further look at the lease transaction because •
32.
Several NBFCs of national repute and a number of financial institutions have resorted to leasing as a tool for tax shelter. • A lot of other players had joined the leasing, as there was no restriction on the utilization of leasing against other income. This prompted companies to get into leasing to avail these taxation benefits. • The main purpose for the companies to get into the leasing to avail tax benefit is due to the financial management decisions by the companies, which provides a better look to the balance sheet of the company. For example, the tax shield earned by the company can be shown as an income for that year, thus giving a better EPS, dividend and net worth projections of the company for that year. Sales Tax on Lease Transactions Apart from the income tax, the lease transactions attract sales tax for the transactions entered into by them. This fact is the greatest irritant of the leasing industry in India. Leasing is a business which follows a ‘singularly revenue driven approach’ whereas the sales tax is accompanied by a multi-point levy. This theoretical distinction itself is a sufficient justification as to why there should not be any sales taxes on the lease transactions. Due to the presence of sales tax, the players are tempted to underprice their transactions. There are some taxing anomalies with respect to the leasing transactions. Many lease transactions are of interstate in nature, and of course fall outside the tax laws for computation of sales taxes. But in practice, such transactions are actually charged by the states. These non-clarity of the tax laws allows the states to take advantage and the leasing companies tend to suffer. Accounting Aspects of Leasing The ICAI guideline 19 deals with the accounting treatment of the leasing transaction for companies in India. However, internationally, companies were following the standard 17 of the International Accounting Standard. The Indian companies are free to follow any of the two directives depending on their expertise. Besides, there is hardly any difference between the objective and accounting treatment as recommended by ICAI 19 and IAS 17. The Institute of Chartered Accountants of India (ICAI) has issued Accounting Standard no.19 (AS 19) on accounting for leases which has been taken in response to the long-standing demands of the leasing industry to the authorities to give a re-look at the existing accounting standards. The apex institute in tax practices in India has finalized and released the standards and made it applicable for all the assets leased during the accounting period commencing from 1st April, 2001. Being an accounting standard, the new guideline is applicable to all the lessors and their lessees; irrespective of the fact of their legal status viz. they may be banks, NBFCs, companies or individuals. The law treats all the parties uniformly. Since there is hardly anything to distinguish between a lease and a hire purchase transaction, both practically and theoretically, the new guideline rightly makes it binding for the hire purchase companies to adhere to the guidelines with equal honesty. To give example of a significant shift in the policy for the hire purchase financiers the hire purchase financiers traditionally had been following the straightline methods of depreciation in their books of accounts. The new tax rule has made that method unnecessary; hence the hire purchase financiers would not be able to recognize the revenue evenly or equally throughout. They now have to charge the depreciation on the diminishing balance. The accounting standard 19 states in detail as to the treatment of specific lease transactions in the books of the lessor and the lessee. The salient features of consumer credit transactions are as follows: Number of Parties to the Transaction The transaction can be either a bipartite one involving the dealer-cum-financier and the borrower/customer or a tripartite one where the dealer and the financier are two distinct entities. The tripartite transaction can be of the sales-aid type where the dealer arranges for finance and does the necessary paperwork on behalf of the borrower. Under such transactions, the credit granting decision lies with the dealer, of course subject to the eligibility criteria stipulated by the finance company. Such transactions are structured with recourse to the dealer. On the other hand, a tripartite transaction can be of the conventional type where the customer approaches the finance company to avail the credit facility. 358
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Structure of the Transaction A consumer credit transaction can be structured in the form of hire purchase, conditional sale or credit sale transaction. As we have discussed earlier a hire purchase is a contract of hire with the option to purchase. The customer, while having the option to purchase, need not do so and can terminate the agreement and return the goods at any time subject to the terms and conditions of the agreement. In a conditional sale contract, the ownership is not transferred to the customer until the total purchase price (including the charge for credit) is paid and the customer cannot terminate the agreement before the purchase price is paid. In a credit sale contract the ownership is transferred to the buyer on payment of the first installment. The customer, however, cannot cancel the agreement before the total purchase price is paid. Most of the tripartite consumer finance transactions are of the hire purchase type. Down Payment Consumer Finance Schemes can be broadly classified under two categories: Down Payment Schemes and Deposit Linked Schemes. The down payment varies between 20% and 25% of the value of the consumer durable. Likewise the security deposit under the Deposit Linked Scheme varies between 15-25 percent of the amount financed (which is equal to the investment outlay). The deposit is of cumulative nature carrying interest at a prescribed rate (which at the time of writing cannot exceed 15% compounded monthly). Some finance companies also offer Zero Deposit Scheme under which the Equated Installment (EMI) is higher than the EMI under the 15% and 25% deposit schemes. Repayment Period and Rate of Interest The repayment schedule is drawn on the basis of monthly installments over a period varying between 12 months and 60 months. The borrower is permitted to choose the most convenient repayment period from the given range of options. While the rate of interest is typically expressed as a flat rate, some financial intermediaries like Citibank disclose the effective rate of interest. In recent times many finance companies have dispensed with the practice of disclosing the rate of interest. Instead they disclose the equated monthly installments associated with the different repayment periods and require the borrower to figure out the effective rate of interest for himself. The repayment is required to be made through post-dated cheques. In respect of institutional consumer credit schemes where the finance is routed through the organization which employs the borrower, the organization concerned is required to deduct EMI at source and transmit the payments to the finance company. Most of the schemes provide for early repayment of the loan subject to certain conditions. They also provide for either a rebate for prompt payment (prompt payment bonus) or for a delayed payment charge. Security The consumer credit is secured through a first charge on the asset concerned and the borrower is prohibited from selling or pledging or hypothecating the asset during the credit period. 33.
The first step in the streamlining process is to define and articulate a clear-cut procedure for evaluating customers. This is an onerous and difficult task. It is onerous because the number of customers to be credit rated is quite large. It is difficult because there are no hard data on the past payment record or on the financial position of the borrower (like the audited financial statements) to judge the willingness and the ability to repay. In some countries credit reference bureaus do provide a large part of information required for evaluating the credit applicant. The typical data stored on the individual file include: •
Record of all registered county court judgments and decrees in the last six years.
•
Information supplied by other traders with regard to bad debts, slow paying accounts and repossessions.
•
Records of bankruptcies and administration orders.
•
Voters roll information. 359
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Some credit bureaus also file details of all satisfactory credit transactions reported to them by other users. In the Indian context, there are no credit bureaus to aid the credit-granting decision. For the credit evaluation of an individual borrower, the finance company calls for a copy of the salary certificate and the name and address of the employer. For the credit evaluation of business entities like sole proprietorships and partnerships, the finance company looks for the financial statements for the last two years duly certified by a chartered accountant and the addresses of the bankers with whom the business entity has credit facility. Thus, checking with the employer and the banker seem to be the only ways of obtaining independent reference information in India. Since a finance company engaged in offering consumer credit has to assess the creditworthiness of a large number of individual borrowers, it makes a lot of sense to use a mechanical scoring system for a preliminary evaluation of the credit applicants. A perusal of the below given questionnaire reveals that what we are trying to obtain is an overall risk index for the loan applicant. The way to do it is to add-up the relevant probabilities of default in different categories. In the example given in the question, if Mr. Ramchandani gives the most unfavorable response to each question he will have a risk index of 28 and if he gives all favorable responses he will have a risk index of 3. To discriminate between the good and the bad risks, the finance company will have to define its own acceptable risk index. For instance, it may decide that all loan applicants with a credit risk index of more than 10 will be rejected. Questionnaire for Evaluation of Loan Applicants with Default Rates 1. Do you have a telephone at residence?
2.
3.
4.
5.
6.
Yes
(0.7)
No
(1.0)
Do you: Own Your Home
(0.7)
Rent a House
(2.4)
Rent a Room
(6.5)
How long have yoUSpent in your present job? Less than 6 months
(8.4)
7 to 24 months
(3.2)
More than 24 months
(0.2)
What is your take-home monthly pay? Less than Rs.2,500
(8.8)
Between Rs.2,500 to Rs.4,500
(3.3)
Above Rs.4,500
(0.4)
How many members are there in your family? One to Two
(0.2)
Three to Five
(0.7)
More than Five
(2.0)
For how long do you require the loan? 12 months or less
(1.3)
More than 12 months
(0.8)
The reader must have observed that the method employed for separating the sheep from the goats is conceptually weak because adding up the probabilities ignores the interactions between the different factors. As an alternative, we can use the information provided by the questionnaire to identify the factors relevant for credit rating and combine them using the 360
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statistical technique of Multiple Discriminant Analysis. If only two such factors are considered, one can also use the graphical approach. For example, if we consider the takehome pay and the number of months spent on the present job as two relevant factors, then the credit index can be defined as follows: Z = aX1 + bX2 Where, Z = index of creditworthiness X1
= take-home monthly income (in rupees)
X2
= number of years spent on the present job.
Based on a sample drawn from the past data (consisting of both defaulters and nondefaulters) a scatter diagram is plotted as shown below.
In this diagram Os represent the customers who have defaulted and Xs denote the customers who have paid on time. A visual inspection of the scatter of points reveals a discriminating line intercepting the X1-axis at 3.2 and X2-axis at 2.4 such that the two groups – the defaulters and non-defaulters – are kept as far apart as possible. The equation is therefore Z = 3X1 + 4X2 or Index = 3 (Take-home monthly pay in thousands of rupees) + 4 (Number of months spent on the current job expressed as a fraction of the year) Credit applicants with an index1 of 9.6 or more will be accepted and applicants with an index of less than 9.6 will be rejected. 34.
1
There are various forms of non-traditional mortgages, also known as Alternative Mortgage Instruments (AMIs). Some of the popular forms of non-traditional mortgages are: a. Graduated Payment Mortgages The payments under Graduated Payment Mortgages (GPM) are not equal, with payments starting at a relatively low level and rising for a specified number of years and then become equal after the specified number of years. The frequency of quantum of increase and the specified number of years after which the payment becomes equal depends upon the plan indicated in the mortgage instrument. GPMs are preferred by those whose current income is not sufficient to take a large loan, but whose income is expected to increase rapidly in the near future. Since the smaller payments in the initial years do not even cover the interest, initially the mortgage balance increases for a short period. However, with the increase in monthly payments, the mortgage balance decreases and eventually reaches zero by the end of the term.
Note that the equation of the line is X1/3.2 + X2/2.4 = 1 or 3X1 + 4X2 = 9.6.
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b.
35.
Pledged Account Mortgages (PAM) PAMs are so structured that the repayments resemble traditional mortgages from the lender’s point of view and the repayments resemble GPMs from the borrower’s point of view. Under PAM, some portion of the down payment as required in traditional mortgage is deposited in the savings account. The borrower then pays installments which are lower than those under traditional mortgage. These installments are increased at a specified percentage for a definite number of years and thereafter the borrower pays equal installments. Thus, for the borrower the payments resemble a GPM. The lender is, however, paid equated monthly installments by drawing the difference between the installment paid by the borrower and the installment due from the pledged savings account. c. Buy Down Loans The buy down loan is similar to the PAM; however, it is the seller of the property and not the buyer/borrower who places cash in a segregated account in order that additional amounts required may be drawn and paid along with the mortgage payments done by the borrower. The pledged account is created by the seller out of his profits as in the absence of such pledged account, the borrower may not be eligible for any kind of loan. The amount that the seller pledges is a direct reduction of the sale proceeds for him and the borrower uses the seller’s money without himself having to repay this amount to the seller. Though, theoretically this cost incurred by the seller may be inbuilt in the price by increasing it, the mortgage lender may not allow it. Buy down loans are arranged by sellers who are anxious to sell their property. d. Share Appreciation Mortgages (SAMs) High interest rates in the early 1980s brought about this innovative mortgage arrangement. SAMs use inflation as a way of paying for the property. The lender agrees to charge a very low level of interest on the funds and in turn, the borrower agrees to share part of the increase in the property value with the lender when the loan matures, or when the property is sold or at some other specified time. Many different kinds of ARMs have originated with their own features with the result that not all ARMs are even referred to as ARMs. Terms such as VRM (Variable-Rate Mortgage), ROM (Roll Over Mortgage), RRM (Renegotiated-Rate Mortgage) and the like are used to refer to ARMs. To understand the complex features of an ARM, the structure of a VRM used by a savings and loan association is given below: i. The mortgage interest is based on the weighted average cost of savings index published by the Federal Home Loan Bank of San Francisco. In general, the spread between the mortgage rate and the index rate is held constant; that is, when the index changes, there is an equal change in the VRM interest rates. However, there are other provisions which may prevent such equal changes taking place all the time. ii. The mortgage interest may change (up or down) only once in any six-month period and may not be changed at all during the first six months. iii. The mortgage interest may not change (up or down) more than 0.25 percent (25 basis points) at a time, no matter how much the index changes. Combined with provision (ii) above, this means that the mortgage interest may not change more than 0.5 percent per year. iv. The mortgage interest rate must change at least 0.1 percent (10 basis points) at a time, except to bring the rate to a level previously impossible because of the 25basis points limitation. For instance, if the index rises 5 basis points from the original level, the VRM rate would not rise. However, if the index rises 30 basis points from the original level, the VRM rate will rise by 25 basis points (the agreed upon maximum) after six months, and by the other 5 basis points in another six months. 362
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v.
The mortgage interest rate may not rise more than 2.5 percent (250 basis points) higher than its initial level, no matter how much the index rises.
vi.
Increases in the mortgage rate are optional on the part of the lender, but decreases are mandatory.
vii.
Within 90 days of any time the mortgage rate is increased, or at any time the mortgage rate exceeds its initial level, the borrower may prepay the loan in whole or in part without prepayment penalty.
viii.
Whenever the mortgage rate is increased to a rate higher than its initial level, the borrower may opt to keep his monthly payment constant by extending the maturity of the mortgage. However, there is usually a limit up to which the extension of the maturity period will be allowed. For example, a 30-year mortgage may give the option to the borrower to extend the term by 10 years, which means that the total term to maturity of the mortgage cannot exceed 40 years.
In spite of all these complexities, the ARM became popular due to the following reasons:
36.
i.
ARM reduces interest rate risk for the lender. Hence, for thrift institutions such as the S & Ls, ARMs, in spite of the life time caps, offer obvious advantages.
ii.
Borrowers accept ARMs because the lenders by offering lower initial rates express their preference for ARMs. Depending on the competition and aggressiveness of the lender the initial interest rate on ARM could be 1/2 percent to 2 percentage points or more below the rates being quoted for fixed-rate mortgages. ARMs tend to be most popular when interest rates are high and buyers hunt for arrangements that could lower initial outflows.
Real estate transactions involve exchange of economic resources between a seller, buyer, and normally, a financial entity. Investment in real estate is always found to be reliable in hedging against inflation. Returns from real estate are not highly correlated with the returns from shares and bonds. Therefore, by including real estate in the diversified portfolio of investment, a diversification of risk and hence enhancing the risk-return characteristics, may be achieved. •
Direct investment in real estate entails tax benefits through deductibility of depreciation (on buildings). Also, any debt financing used could lead to tax losses (as per US tax laws), which would be used to shelter other income;
•
Real estate assets offer attractive total returns. Apart from the income stream of rental, the prospects for growth in both rental and value are attractive when compared to expected returns from financial assets.
Real Estate: Selection and Management Office buildings, industrial warehouses and shopping centers are the three types of real estate included in most institutional portfolios. In selecting a real estate one should take care to analyze and inspect the property before making the purchase. A good real estate manager is one who has the expertise to distinguish between a good and mediocre property. Once the real estate is acquired, the management of the property becomes very important. An important objective of property management is inflation hedging. Short-term leases are probably ideal for investor protection. Another important property management objective is to maximize a property’s current income. To add to the rentability and value of the real estate, capital improvements should be made which make the building attractive and get the highest possible rent. Professional property management is increasingly being recognized by institutional owners of real estate. 37.
Credit rating forms an integral part of the securitization deal. After identifying the homogeneous pool of assets that are to constitute a securitization deal, rating is sought by the originator to rate the securitization deal based on the tentative parameters on other parts of the deal. The credit rating agency considers that part of assets that are to be securitized without considering the assets in the balance sheet. By this, as mentioned above, there exists a possibility of securitized assets having a higher rating than the rating of the company itself. All the credit rating agencies rate securitized instruments. CRISIL, Duff 363
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38.
39.
and Phelps, CARE and ICRA have rated securitized deals. All such ratings will have a ‘SO’ suffixed to the deal to indicate that the rated instrument is a ‘Structured Obligation’, which essentially means that the deal has met all the parameters of credit rating and has been structured for the purpose of credit rating and marketing of the instruments. Credit rating helps the investors to gauge the risk of investing in the deal. It also helps the originator to beat its own company’s rating thereby enabling it to borrow funds at a cheaper rate. These companies may securitize their pool of hire purchase receivables or any other assets that have a stream of future cash flows which will give them a better rating for the deal, thereby achieving liquidity and enabling cheaper borrowing. The parameters considered by the credit rating agency while rating a securitized deal are similar to the parameters used for rating any other similar borrowing instrument like the fixed deposits. The variance will be in consideration with the pool of assets. The sales tax aspects of hire purchase contracts have to be gleaned from the provisions of the Constitution (Forty-Sixth Amendment) Act, 1982 and a maze of High Court and Supreme Court rulings on the subject. The salient sales tax aspects are as follows: a. Hire purchase transactions per se are liable to sales tax. The Forty-Sixth Amendment Act clearly states that the “tax on the sale or purchase of goods includes a tax on the delivery of goods on hire purchase or any other system of payment by installments”. b. For the purpose of levying sales tax a sale is deemed to take place only when the hirer exercises the option to purchase. c. The amount of sales tax must be determined with reference to the depreciated value of the goods at the time when the hirer exercises the purchase option. The appropriate method for computing the depreciated value is to be determined by the sales tax authorities. d. The state in which the goods have been ‘delivered’ (to the hirer) is the state entitled to levy and collect sales tax. e. Sales tax on hire purchase will not be levied if the state in which the goods are ‘delivered’ has a single point levy system in respect of such goods and if the owner (finance company) had purchased the goods within the same state. f. Sales tax cannot be levied on hire purchase transactions structured by finance companies provided these companies are not dealers in the class of goods let on hire. g. There is no uniform rate of sales tax applicable to hire purchase transactions. The rate varies from state to state. h. Does the Central Sales Tax (CST) apply to hire purchase transactions? As per Section 2(g) of the CST Act, transfer of goods on hire purchase or any other system of payment by installments is included within the definition of ‘Sale’. But then the statement of objects and reasons to the 46th Amendment Act clearly states that a ‘Sale’ is deemed to take place only at the time of exercising the purchase option. Since the interstate movement of goods would have occurred before the hirer exercises the option to buy, no hire purchase transaction is likely to be subject to central sales tax. Factoring basically involves transfer of the collection of receivables and their related bookkeeping functions from firm to a financial intermediary called the factor. In addition, the factor often extends a line of credit against the receivables of the firm. Thus, factoring provides the firm with a source of financing its receivables and facilitates the process of collecting the receivables. Usually the factor immediately makes a part-payment to provide liquidity to the client. For rendering the services of collection and maintenance of sales ledger, the factor charges commission up front. The factor charges interest at a rate that is marginally higher than the rate of interest charged by banks on working capital advance for making an immediate partpayment against the debts purchased. The interest charge is calculated for the period between the date of advance payment and date of collection or the guaranteed payment date. 364
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40.
The legal relationship between a factor and the client is governed by the provisions of the factoring agreement or the master agreement. Some of the salient features of the agreement are as follows: a. The client gives an undertaking to sell its receivables and the factor agrees to purchase the same subject to the terms and conditions mentioned in the agreement. b.
The client warranties that the debts are valid, enforceable, undisputed and recoverable. The client also undertakes to settle problems of dispute, damage and deductions relating to the bills assigned to the factor.
c.
The client agrees that the bills purchased by the factor on a non-recourse basis (called approved bills) will arise only from transactions specifically approved by the factor or those falling within the credit limits authorized by the factor.
d.
The client agrees to serve a notice of assignment in the prescribed form to all customers whose receivables have been factored.
e.
The client agrees to provide copies of all invoices, credit notes, etc., relating to the factored accounts to the factor and to remit monies received by the client against the factored invoices to the client.
f.
The factor acquires the power of attorney to further assign the debts and to draw negotiable instruments in respect of such debts.
g.
The time-frame for the agreement and the mode of termination are specified.
As between the factor and the customer, the legal status of the factor is that of an assignee. Therefore, the customer has the same set of defences against the factor as he would have against the client. The customer whose account has been factored and has been notified of the assignment is under a legal obligation to remit the money due directly to the factor. Consequently, a customer who continues to make such payments directly to the client is not discharged from his obligation to pay the factor until and unless the client remits the amount to the factor. 41.
The origin and concept of bill can be traced back to the 4th century B.C. when the Greeks made use of bills. From times immemorial, banks and business houses have been using ‘Hundi’, the indigenous kind of bills of exchange. There were two kinds of hundis which were in vogue. Of the two, ‘darshani hundi’ is similar to the bill of exchange of today with respect to the purpose for which it is drawn. Its place of origin may be quite different from the place of operation. The ‘muddati hundi’ is quite different. It is confined to local limits in which it is drawn. Section 5 of the Negotiable Instruments Act, 1881, defines Bill of Exchange as ‘an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument’. A bill attains the character of negotiability only if it contains the features of negotiable instruments. The specific features of a negotiable instrument are as follows: a. Parties to a bill of exchange – drawer, drawee and payee. The maker of the instrument who directs to pay is the drawer, the person to whom the direction is given is the drawee (when he accepts the bill, he becomes the acceptor) and the person to whom payment is to be made is the payee. In some cases the drawer and the payee may be the same person. The drawer or the payee who is in possession of the bill is called the holder. When the holder endorses it, he is called the endorser. The person to whom it is endorsed is called the endorsee. When in the bill or any endorsement thereon the name of any person is given in addition to the drawee (to be resorted to in case of need), such person is called a drawee in case of need. Drawee in case of need can be resorted to only when the bill is dishonored by non-acceptance or non-payment. b. The instrument must be in writing. c. It must contain an order to pay and not a request. d. A bill of exchange cannot be drawn so as to be payable conditionally. 365
Investment Banking and Financial Services
e. f.
42.
43.
The sum payable must be certain. The person to whom the direction is given or to whom the payment is to be made must be certain. g. It must be signed by the drawer and presented to the drawee for acceptance. h. The order to pay should be in legal tender money. i. All other formalities like date, number, place and consideration are usually found in bills though not essentially required by law. Taking into account the time-lag between an account becoming doubtful of recovery, its recognition the realization of the security and the erosion over time in the value of security charged, it has been decided that NBFCs should make a provision against sub-standard assets, doubtful assets and loss assets as given below. The provisions in respect of loans, advances and other credit facilities including bills purchased and discounted are as under: a. Sub-standard Assets: A general provision of 10% of total outstandings must be made. b. Doubtful Assets: i. 100% provision must be made to the extent of the unsecured portion. ii. Additional provision: In addition to (i) above, depending upon the period for which the asset has remained doubtful, provision to the extent of 20% to 50% of the secured portion must be made on the following basis: % provision Period for which the asset has been considered as doubtful Up to 1 year 20% 1-3 years 30% More than 3 years 50% c. Loss Assets: The entire loss asset must be written off. If the asset continues to remain in the books for any reason, 100% of the outstanding amount should be provided for. The concept of bill of exchange can be explained as follows: Suppose seller A sells goods to the buyer B. In most cases A would want to have money immediately but B would like to make payment only after sometime, say, when he resells the goods he has purchased. To solve the difficulty, A draws a bill of given maturity on B. A, the creditor, is known as the drawer of the bill, and B, the debtor, is known as the drawee of the bill. A then sends the bill to B who acknowledges his responsibility for the payment of the amount on terms mentioned on the bill by writing his ‘acceptance’on the bill. When B has ‘accepted’ the bill, he has closed the transaction for the time being. A can now take the ‘accepted bill’ to a bank and hand it over in exchange for ready money. This act of handing over of the endorsed bill in exchange for ready money is called ‘discounting the bill of exchange’. The margin between the ready money paid and the face value of the bill is called the ‘discount’ and is calculated at a rate percent per annum on the maturity value. The act of discounting is not to be interpreted as borrowing on the security of the bill, it is an act of selling the bill. In India, however, in almost all cases, even of ‘bills purchased’ by banks, they hold the bills only as a security for the advances. There are four types of procedures while dealing with trade finance bills. The steps involved are as follows: a. Trader’s Bill: (a) A seller supplies goods and submits the bill to the buyer for the value of goods supplied, (b) the buyer accepts the bill along with the goods supplied, (c) the seller receives the accepted bill from the buyer and discounts the bill with the seller’s bank, and (d) the buyer makes the payment on due date. b. Bills with Co-acceptance: (a) A seller supplies goods and submits the bill to the buyer for the value of goods supplied, (b) the buyer accepts the bill along with the goods supplied, (c) the buyer’s bank also co-accepts the bill, and (d) the seller receives the bill accepted by the buyer and co-accepted by the buyer’s bank and discounts it the seller’s bank. 366
Part III
c.
44.
Bills Accompanied with Letter of Credit (LC): (a) A seller supplies goods and submits the bill to the buyer for the value of goods supplied, (b) the buyer accepts the bill along with the goods supplied, (c) the buyer’s bank opens the LC in favor of the seller, and (d) the seller receives the accepted bill along with the LC opened by the buyer’s bank in favor of the seller and discounts the same with the seller’s bank. d. Drawee Bills: (a) A seller supplies goods and submits the bill to the buyer for the value of goods supplied, (b) the buyer accepts the bill along with the goods supplied, and (c) the buyer’s bank discounts the bill for the account of the buyer. In international trade transactions, forfaiting is a common form of financing export-related receivables. Under this arrangement: • • •
•
•
The exporter sells the goods to the importer on a deferred payment basis spread over 3-5 years. The importer draws a series of promissory notes in favor of the exporter for the payments to be made inclusive of interest charges. The promissory notes are avalled or guaranteed by a reputed international bank which can also be the importer’s banker. (An aval is an endorsement on the promissory notes by the guaranteeing bank that it covers any default of payment by the buyer.) The exporter sells the avalled notes to a forfaiter (which can be the exporter’s banker) at a discount and without recourse. The discount rate applied by the forfaiter will depend upon the terms of the promissory notes, the currencies in which they are denominated, the credit rating of the avalling bank, the country risk of the importer, and the prevailing market rate of interest on medium-term loans. The forfaiter may hold these notes till maturity or sell them to groups of investors interested in taking up such high-yielding unsecured paper.
The mechanics of forfaiting is graphically presented below.
45.
Mechanics of Forfaiting A. Promissory notes sent for avalling to the importer’s bank B. Avalled notes returned to the importer C. Avalled notes sent to exporter D. Avalled notes sold at a discount to a fortfaiter on a non-recourse basis E. Exporter obtains finance F. Fortfaiter holds the notes till maturity or securitizes these notes and sells the shortterm paper either to a group of investors or to investors at large in the secondary market. Credit Cards: The Concept This is the age of credit cards. People prefer credit cards to paper currency. The culture of plastic money seems to be fast catching up in the country with more banks offering credit card facility, more establishments willing to accept them in place of cash and more consumers finding the concept a more convenient mode of making payments. 367
Investment Banking and Financial Services
Credit cards enable its holders to make purchases/avail the services at various designated Member Establishments (MEs) like departmental stores, shops, star hotels, airlines, railways, etc., who accept all valid credit cards in lieu of cash payment. As such, the cardholder can avoid the risk of carrying cash. The concept of the credit card was pioneered in the country by foreign banks like Citibank who continues to be the biggest player both in the domestic and the international market. Indian banks, though not far behind, have been less aggressive compared to the foreign banks. Credit cards are also issued to non-individual entities like corporate bodies and noncorporate establishments. For instance, the Cancards issued to corporate bodies are called Corporate cards and those issued to the non-corporate business establishments are called Business Cards. Uses of Credit Cards Credit cards can be used for: a.
Cash withdrawals at any of the branches or ATMs of the issuer/member affiliate of the issuer and
b.
Purchasing/availing of the services at any of the MEs.
Cash Withdrawal Facility: Credit cardholders are normally permitted to draw cash at any of the branches/offices of the issuer and at any branches/offices of member affiliates. Usually the maximum amount that can be drawn on each occasion is fixed with reference to the overall ceiling limit under the credit card. Usually there is a service charge for cash withdrawals to cover the cost of funds drawn. And now with the advent of the ATM, potential customers are being lured even more. Automatic Teller Machines: The ATM makes standing in queues and spending time unnecessarily at the banks, things of the past. By simply inserting a card into an ATM, the cardholder can withdraw crisp new notes at anytime of the day or night. Added Advantages of Credit Cards to Cardholders: In addition to the above uses, the cards provide certain added privileges to the cardholders. Cancard-Visa issuer Canara Bank bears premium for insurance cover of the cardholder to meet unforeseen circumstances. Overdraft Facility: Some card issuers like Citibank provide overdraft facility whereby a cardholder can spend more than he is entitled to. The amount depends on the individual cardholder’s credit rating. Benefits to Issuer/Affiliate and MEs: The reason for more and more banks jumping into the bandwagon is the high profitability that the business of credit card offers. For instance, banks charge a 2.5 percent commission from establishments selling goods and services through credit cards. There are instances of banks charging as much as 7 percent for high margin MEs like antique shops. Banks offer a credit period of 30 to 45 days to the customers but charge about 2.5 percent on all outstandings. Thus, a single purchase transaction through the credit card, assuming the customer does not pay within the stipulated credit period, will fetch a commission of five percent to the bank which works out at as much as 60 percent per annum, miles ahead of the prime lending rate of many banks. Benefits accrue to the member establishments from the larger number of customers that the card brings. There is a general feeling that a credit card tempts one to over spend. Even the MEs, especially the retail outlets, agree that a person with a credit card ends up spending more than required, since he does not feel the pinch at the time of purchase. Given the multiple advantages and conveniences of the plastic money, to all concerned, fueled by aggressive marketing, the popularity of credit cards is growing and will continue to grow by leaps and bounds in the future. Competition is going to hot up not only amongst issuers but even amongst the member establishments. From August 2001, all the charges levied by credit card companies in India will attract 5% service tax, which will simply increase the costs to the cardholders. 368
Part IV
Part IV: Case Studies (Problems) Case Study 1 Read the case carefully and answer the following questions. 1. Identify the various alternatives available to an investor in this issue considering the multiple options available on warrants and the non-convertible portion. (Hint: For example, an investor who is allotted shares in this issue, could decide to exercise the warrants and retain the non-convertible portion also). 2.
What are the net cash inflows (post-tax) and outflows from the investors’ perspective in each of the above alternatives?
3.
Calculate the effective return to the investor to the nearest percentage (using time value of money) in any two of the above alternatives.
a.
The CAMPBELL CORPORATION LTD. (CCL) was incorporated on 1st November, 20x0. It began commercial production of cables and wires in February, 20x1 at its factory at Andheri, Mumbai. Promoted by two well-known industrial houses from Mumbai, the Rajputs and the Thackereys and two renowned companies from Germany, Bosch & Folten, the Company secured technical collaboration from Bosch and was among the first to manufacture PVC insulated cables. The Company now plans to set up a new unit to manufacture power and control cables and expand and modernize an existing plant at Andheri. The Company is approaching the capital markets to part finance the project.
b.
The Issue is scheduled to open on 17th February, 20x2 and close on 27th February, 20x2. The CCL is making a public issue of 33,75,000 16% Secured Redeemable Partly Convertible Debentures of Rs.140 each for cash at par aggregating Rs.4,725.00 lakh with detachable warrants. The PCD will be converted into one equity share of Rs.70 on allotment. The remaining non-convertible portion of Rs.70 shall carry a coupon of 16% p.a. payable annually and shall be redeemed in the 4th (Rs.20), 5th (Rs.20) and 6th year (Rs.30). Warrants are exercisable between 6 and 24 months at 40% discount to the market price subject to a minimum of Rs.70 and a maximum price of Rs.90. The project is being part financed to the extent of Rs.3,150 lakh through warrants at a base price of Rs.70 each. The Promoters have undertaken to subscribe to equity shares in exchange of warrants to the extent of Rs.787.50 lakh. In the event of warrants for the balance amount of Rs.2,362.5 lakh, not being exercised, the Company proposes to meet the shortfall, if any, through internal accruals and/or by liquidating its investments.
c.
Terms of the Issue Principal Terms of Debentures Face Value Each debenture will have a face value of Rs.140 and shall consist of two parts. i.
Convertible Part A of Rs.70, and
ii.
Non-Convertible Part B of Rs.70 but the Warrant by itself will not have any face value.
Terms of Appropriation of Payment For all applicants (except for NRIs/OCBs/FIIs and firm allottees)
On Application On Allotment
Total (Rs.) 35.0 105.0
Appropriation Part A Equity (Rs.) Paid-up Share Capital Premium 5.0 20.5 5.0 39.5
Part B NCD (Rs.)
9.5 60.5 369
Investment Banking and Financial Services
d.
Conversion Part A of each debenture of face value of Rs.70 will be automatically and compulsorily converted into one equity share of Rs.10 at a premium of Rs.60, on allotment of the debentures. Thus for every Part A of Rs.70 there will be a constructive receipt of Rs.70 by the Company and constructive payment of the same amount by the debentureholder to the Company towards the price of one fully paid-up equity share. Upon such conversion, the face value of Part A of the debenture will be reduced to NIL.
e.
Interest Debentures will carry interest at the rate of 16% per annum on the outstanding principal amount from time to time, payable annually, subject to deduction of income tax at source, in accordance with the provisions of the Income Tax Act, 1961 and the Rules made thereunder or any statutory modifications or re-enactments thereof. The first payment of interest will be made 12 months after the date the issue closes.
f.
Redemption Part B of the debentures of face value Rs.70 will be redeemed in 3 installments of Rs.20, Rs.20 and Rs.30 per debenture at the end of the 4th, 5th and 6th year respectively, from the date the issue closes.
g.
Arrangement for the Purchase of the Non-Convertible Portion of the Debenture. (Hereby called the portion.) The Company has finalized a scheme for buy-back of Part B of the debentures with the Unit Trust of India, Life Insurance Corporation of India, LIC Mutual Fund, IDBI Mutual Fund and National Insurance Corporation, for the benefit of allottees (the offer is also open to NRIs/OCBs/FIIs, subject to RBI approval) who may not wish to retain the portion. The Scheme has been confirmed vide their letters dated 20.12.20x1, 12.01.20x2, 10.01.20x2, 15.01.20x2, 01.01.20x2 respectively, whereby they have agreed to buy the Non-Convertible Portion up to Rs.28.65 crore. The principal terms and conditions of the Offer are as follows:
h.
i.
Applicants are entitled to offer for buy-back the portion relating to the debentures allotted to them. The option to offer the portion for buy-back must be exercised for ALL the debentures applied for by the applicants. In no event can the applicants exercise this option for only a part of the debentures applied for.
ii.
The non-convertible portion of the face value of Rs.70 each should be offered for sale at a price of Rs.60.50 per portion (on fully paid-up basis and accrued interest, if any, is included in the sale price). The above purchase price is no indication of the price at which the portion will be quoted and traded on the floor of the Stock Exchange.
iii.
The persons exercising the option to sell the portion will be doing so at an upfront discount of Rs.9.50 on the face value of the portion. As a result, the effective cost per equity share would be Rs.79.50 for the convertible Part A of each debenture applied for and allotted. The sale will be on cum interest basis.
iv.
Under the terms of the Issue, an amount of Rs.9.50 out of the amount payable on application towards the debentures is appropriated towards the face value of the nonconvertible portion. The balance amount of Rs.60.50 towards the face value of the portion would be paid as per the `Terms of Payment’ mentioned elsewhere in the prospectus. In the event of the applicant opting to sell the portion, his liability to pay the amount on allotment/call(s) towards the portion will stand reduced to nil as the purchaser would arrange to make the payment of the balance amount to the company.
Principal Terms of Warrants Each debenture will have one detachable warrant which can be freely and separately traded. The warrant holder will have the right to apply for and seek allotment of one equity share of Rs.10 for each warrant at 40% discount to the average of the daily high and low prices of three months before exercise. The warrants, however, will be exercised at a minimum price of Rs.70 per share, and a maximum price of Rs.90 per share. 370
Part IV
i.
j.
k.
The warrant would be exercisable between the 6th month and the 24th month from the date of allotment of the debentures. The warrant will come into existence only on the allotment of the debenture. The Company has made applications to have the warrants listed on the Mumbai, Ahmedabad and Delhi Stock Exchanges, where the existing shares are listed. Arrangement for Buy-back of Warrants This is applicable to all investors including body corporates (excluding firm allottees). For the benefit of the prospective investors in this issue, the Company has finalized arrangements for the sale of the detachable tradeable warrants by the successful allottees if they so wish. M/s Kartik Finance Limited (KFL), Mumbai and M/s Namco Finance Limited (NFL), Mumbai have agreed to purchase the same at Rs.9.50 per warrant vide their letters dated January 10, 20x2. The scheme for disposal of warrants in particular, will work as under: i. The offer for sale is purely voluntary in nature. The warrantholders are free to make any other arrangement for disposal of the warrants. ii. The above purchase price of Rs.9.50 is no indication of the price at which the warrant will be quoted and traded on the floor of the Stock Exchange. iii. The option to offer warrants for buy-back must be exercised for all the warrants entitled to the applicants. In no event can the applicants exercise this option for only a part of the warrants entitled to. iv. The offer for sale of warrants is only exercisable at the time of making an application in the issue. v. The amount of Rs.9.50 received from M/s KFL or NFL under this scheme will be deemed to have been paid by the warrantholder and appropriated towards moneys due on allotment. Under Section 48 of the Income Tax Act, the Long-term Capital Gains arising out of sale of shares will be computed by deducting the indexed cost of acquisition/improvements from the full value of the consideration. The Long-term Capital Gains would be charged to tax at the flat rates, as under, plus surcharge if any: Assessee Rate of Tax Individuals 20% + 10% surcharge Others 30% + 10% surcharge Projected Profitability Statement The projected financials of the Company have not been appraised and are in-house estimates of the company. The following table gives the projected profitability based on exercise of warrants in the FY20x3. (Rs. crore) Year ended Turnover (inclusive of excise) Other Income (including extraordinary items) Profit before Interest, Depreciation and Tax Interest Depreciation Profit Before Tax Provision for Taxation Profit After Tax Paid-up Equity Capital Reserves and Surplus Earning per Share (Rs.) Book Value (Rs.) Dividend (%) * Including extraordinary items
03/20x2 227.35 20.54 52.26 8.40 4.50 39.36 11.84 27.52 9.00 91.52 30.57* 109.85 40
03/20x3 282.92 2.42 47.21 10.32 7.96 28.93 9.57 19.36 18.00 159.03 13.24** 96.79 40
03/20x4 364.22 2.42 63.25 9.45 12.42 41.38 15.75 25.63 18.00 177.46 14.24 107.21 40
** On weighted average basis 371
Investment Banking and Financial Services
l.
Stock Market Data The high and low prices recorded in each of the last three financial years (FY) as was recorded at the Mumbai Stock Exchange are given below:
m.
Year
High (Rs.)
Low (Rs.)
Average (Rs.)
19x8
225.00
120.00
175.50
19x9
300.00
220.00
260.00
180.00
86.00
133.00
20x0 Past Performance
09/19x8
03/19x9
03/20x0
101.51
180.81
166.53
PAT (Rs. crore)
20.02
7.76
11.32
EPS (Rs.)
22.30
8.60
12.60
Book Value (Rs.) 105.70 Price/Earnings Ratio of the Industry
82.20
76.30
Turnover (Rs. crore)
n.
The offer price of Rs.70 per share after conversion of the debentures, discounts the projected earnings per share (EPS) of FY19x8, FY19x9 and FY20x0 of Rs.30.57, Rs.13.24, Rs.14.24 by 2.29, 5.29 and 4.92 times respectively. The industry average for the power cable industry is 8.2. Assumptions You may make the following assumptions to answer the questions given at the beginning of this case: a.
Interest income is also exempt from income tax.
b.
The shares will quote at the industry P/E in future (based on expected EPS).
c.
All shares held by the investor will be sold only in March 20x1 at a brokerage of 2%.
d.
Warrants will be exerciseable in February 20x0.
e.
The indexing of securities for capital gains purposes will be done at an 8% increase p.a.
f.
The warrants are likely to trade at 8-10% of the prevailing market price per share.
g.
The non-convertible portion is likely to trade between the repurchase price and the redemption value in the secondary market.
h.
Round off your calculations to the nearest 5 paise.
i.
Ignore the time lag between Application and Allotment.
Case Study 2 Read the case carefully and answer the following questions. 1.
Briefly describe the procedure adopted by IDCC for the issue under Book Building.
2.
i.
Yield for Deep Discount Bond under both Option I and Option II assuming that the bond is held up to maturity. Consider pre-tax returns for your calculations.
ii.
Yield for Deep Discount Bond for each of the Early Redemption period from the deemed date of allotment (as given in Exhibit I). Consider pre-tax returns for your calculations.
3.
Provide (as a merchant banker to the issue) a write up on “Management Discussion and Analysis of Results of Operations and Financial Condition” which could be included in the prospectus in consonance with the SEBI guidelines. Consider only a comparison of the significant items of income and expenditure between six months ended 30th September, 20x2 and six months ended 30th September, 20x1.
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Part IV
GENERAL INFORMATION Offer of Bonds IDCC is offering the following categories of Unsecured Redeemable Bonds in the nature of Promissory Notes for public subscription. 1.
Deep Discount Bonds
2.
Monthly Income Bonds
3.
Money Back Plus Bonds
4.
Regular Return Bonds.
Authority to issue This issue of Bonds is being made pursuant to the Resolutions at the Board of Directors of IDCC, passed at their meetings held on January 19, 20x5, July 17, 20x5 and March 13, 20x6 and Resolution of the Committee of Directors of IDCC passed at their meeting held on March 23, 20x5. This is within the overall borrowing limit set out in the Resolution passed under Section 293 (1)(d) of the Act at the General Meeting of the Members of IDCC held on September 17, 20x3. The Company has made an application to The Reserve Bank of India (RBI) vide its letter No. RES/31394 dated January 4, 20x5 seeking approval that the present issue of Bonds is covered under its exemption order DFC (COC) No.073.186.00-01 dated February 15, 20x4. The present issue of the bonds is being made in accordance with the terms of the DFI Guidelines and in accordance with terms prescribed in Clarification No. XIII regarding the Guidelines relating to Book Building Process dated October 12, 1995 issued by SEBI to the extent applicable to DFIs. Deep Discount Bond The investor can choose either of the following options: Option I Each Deep Discount Bond of the face value of Rs.2,00,000 will be issued at a discounted price of Rs.5,200 and will be redeemed at its face value of Rs.2,00,000 at the end of the 25th year from the Deemed Date of Allotment. Option II A set of five Deep Discount Bonds of the face value of Rs.40,000 each (aggregating Rs.2,00,000) will be issued at a discounted price of Rs.1,040 each (aggregating Rs.5,200 per set). Each Bond in the set will be separately redeemed at its their face value at the end of 23rd, 24th, 25th, 26th and 27th year from the Deemed Date of Allotment. An application can be made for a minimum of one set or in multiples thereof and no application can be made for an individual bond. Further, each set will be listed and traded only as a set till the end of the 20th year from the Deemed Date of Allotment. Thereafter (after the end of the 20th year from the Deemed Date of Allotment) each bond under the set will be separately listed and traded. Exercise of Option The investors will have to clearly indicate their option at the time of making the application and no change of option will be permitted. Early Redemption at the Option of the Bondholders/ the Company A Bondholder or the Company will have a right to exercise the option of Early Redemption of Bonds (in case of Option I) or a set of Bonds (in case of Option II) at their deemed face value as follows: Exhibit I Early Redemption period from the Deemed Face Value (in Rs.) for Option I & Deemed Date of Allotment Option II* 5 years 11,000 10 years 24,000 15 years 50,000 20 years 1,00,000 * as a set of bonds 373
Investment Banking and Financial Services
Procedure for Early Redemption by Bondholders Bondholders desirous of exercising the option for Early Redemption of the Deep Discount Bond (Option I) or a set of Deep Discount Bonds (Option II) on any of the above dates, should submit their requests, in writing, to IDCC/Registrars or to such persons at such addresses as may be notified by the Company from time to time, along with the Bond Certificate(s), duly discharged by Sole/all the Joint holders {signed at the reverse of the Bond Certificate(s)}, not more than 6 months and not less than 3 months prior to the relevant date. The Bondholder will be entitled to receive the applicable deemed face value only if the request is received in writing within the specified time. In case of option II the entire set of five bonds must be offered for early redemption and individual bonds will not be eligible for early redemption. Procedure for Early Redemption by the Company In case IDCC decides for an early redemption of bonds, it will announce its intention to do so at least 6 months prior to the relevant date. Operational & Financial Performance of the Company Operating Results Data (in Rs. crore, except per share data) Six Months Ended 30th September 20x4
20x5
Project loans (2)
765.91
961.09
Financial services (3)
216.95
247.48
Debenture interest
39.37
92.78
Capital gains (4)
38.63
46.28
Dividend income
29.01
41.44
Commissions and fee (5)
16.93
27.98
Income from securities (6)
22.01
29.95
1128.81
1447.00
722.76
927.25
Interest tax (7)
27.00
34.25
Depreciation of leased assets
61.09
80.64
Depreciation of other assets
2.13
5.72
19.98
35.41
832.96
1083.27
Written off
18.67
27.57
Provided for
19.36
16.50
Profit before tax
257.82
319.66
Provision for tax
41.00
54.95
216.82
264.71
87.7
8.8
–
–
2.47
30.14
Income from Operation (1)
Total Income from Operations Expenses Interest expenses
Other expenses (net of other income) (8) Total Expenses before Bad Debts Bad/doubtful debts (9)
Profit
Profit after tax Per share data (10) Earning per share (11) Dividend per share Weighted Average Shares outstanding in crore (12)
374
Part IV
Notes: 1.
Prior to the financial year 20x2, IDCC showed income and expenses net of write-offs and recoveries in respect of bad debts as opposed to its current practice of disclosing write-offs separately in the revenue account.
2.
Project loan income includes interest, commitment charges and front end fees on project loans.
3.
Financial services income represents income from the leasing, asset credit, deferred credit and installment sale businesses.
4.
Capital gains are stated net of losses on the sale of investments and amounts written-off in respect of investments (primarily holdings of equity and debenture securities).
5.
Includes commissions from underwriting, guarantees and letter of credit activities. Also includes fees from advisory and consultancy services and custodial and debenture trusteeship activities.
6.
Represents amounts earned primarily on unlent balances on the interbank deposit market.
7.
The Income Tax Act provides for a 20.4% tax on interest income. This tax is separate from corporate income tax.
8.
Other expenses primarily include employment and overhead related expenses. Other income primarily includes rental income from premises leased to subsidiaries, interest on delayed refund of income tax and profits on the sale of leased assets.
9.
Prior to March 20x3, there were no formal guidelines on provisioning norms for bad/doubtful debts of Financial Institutions in India. Doubtful debts were either charged off to revenue or a provision was created. Since the financial year 20x3, IDCC has followed the policy established by the RBI to provide for bad/doubtful debts. Write-off amounts are stated net of recoveries of amounts previously written-off.
10.
Equity shares of face value Rs.100 each were subdivided into 10 shares of face value of Rs.10 each in February 20x4. Consequently, the profit after tax per share, dividends per share and weighted average shares outstanding data refer to the Rs.100 face value shares prior to the financial year 20x4 and Rs.10 face value shares from financial year 20x4 onwards.
11.
Does not include up to 3.45 crore shares that may be issued between 20x5 and 20x8 at a price of Rs.15 per share upon conversion of the outstanding rupee denominated convertible debt of IDCC. Also does not include up to 2.84 crore shares that may be issued at any time up to March 20x7 at a price of Rs.239 per share (at an exchange rate of Rs.45 = US $1.00) upon the conversion of the outstanding dollar denominated convertible debt of IDCC. Balance Sheet Data (in Rs. crore, except per share data) As at 30th September 20x3
20x4
Rupee loans
9317.00
11006.50
Foreign currency loans
2634.43
3226.30
Assets Loans (1)
Less: Provisions
107.92
155.42
11843.51
14077.38
Equity
845.89
1453.09
Debentures
581.73
1430.52
Others
249.42
279.01
Net loans Investments
375
Investment Banking and Financial Services
As at 30th September 20x3 Current assets (2)
20x4
2965.72
3183.16
Leased assets
649.68
1082.48
Other fixed assets
53.87
237.29
Other balances (3)
16.95
14.00
17206.77
21756.94
1033.14
1580.38
2863.93 6882.17 2748.03
2863.93 9870.41 2527.58
1936.84
2465.12
15464.11
19307.42
254.62 — 1488.04 1742.66 17206.77
301.30 75.00 2073.22 2449.52 21756.94
Total assets Liabilities Current liabilities Loans Rupee loans guaranteed by government of India Others Foreign currency loans guaranteed by government of India Others Total liabilities Shareholders funds Equity capital Preference capital Reserves and surplus Total Total liabilities and shareholders funds Notes: 1.
Includes project loans, deferred credit and asset credit loans.
2.
Principally includes cash and deposits with other banks and interest accrued but not yet due at period end. Assets and liabilities in foreign currencies are translated into rupees at the year-end or period-end rates. The differences in exchange arising on such translation are held in various suspense accounts and included in current assets or current liabilities, as appropriate.
3.
In the financial year 20x3, expenses of Rs.17.93 crore relating to the US $ 200 million 2.5% Convertible Bonds issued in February 20x3 were capitalized and included in other balances. This amount is being amortized over seven years.
Average Balance Sheets and Interest Rates The following table shows average balances and interest rates of interest earning assets (excluding leases and unlent balances) and interest bearing liabilities for the past two financial half years. Average balances in this table are calculated based on balances at the beginning and end of each period. Interest expense figures do not include interest tax. Loan fees are included in interest income. Six Months Ended 30th September (in Rs. crore, except %) 20x3 Average Balance
Interest
20x4 Average Rate
Average Balance
15.9%
9533.86
Interest
Average Rate
Assets Rupee Project loans
7828.25
621.88
773.68
16.2% 376
Part IV
20x3 Average Balance Financial services loans
Interest
20x4 Average Rate
Average Balance
Average Rate
Interest
1105.43
104.58
18.9
1217.26
106.99
17.6
537.10
39.37
14.7
1217.49
92.78
15.2
Total rupee loan assets
9470.77
765.83
16.2
11968.62
973.46
16.3
Foreign currency loans
2605.46
144.03
11.1
3115.82
187.41
12.0
9090.98
575.83
12.7
12061.01
775.75
12.9
Debentures
Liabilities Rupee loans
Foreign currency loans 4933.32 146.93 6.0 4916.89 151.50 6.2 The following tables set forth certain financial ratios and credit quality data relating to ICICI for the six months period ended 30th September, 20x3 and 20x4. Financial Ratios (in Rs. crore except %) (Six Months Ended 30th September) 20x3 Average interest earning assets (2)
20x4
11977.99
14937.27
Interest income (3)
909.86
1160.87
Net interest income (4)
160.11
199.36
15.2
15.5
Gross yield (%) (5) Net interest margin (%) (6)
2.7
2.7
10.7
11.3
Yield spread (%) (8)
4.5
4.2
Credit risk (9)
0.6
0.6
Net yield spread (10)
3.9
3.6
3.1
3.1
205.5
212.2
32.0
28.5
2.6
2.6
172.9
175.7
26.9
23.6
Average shareholders’ capital to assets (%)
1.5
1.5
Average shareholders’ capital and reserves to assets (%)
9.7
10.8
Cash dividends declared
–
–
Dividend pay-out ratio (%)
–
–
Average cost of loan funds (%) (7)
Profit before tax to: Average total assets (%) Average shareholders’ capital (%) Average shareholders’ capital and reserves (%) Profit after tax to: Average total assets (%) Average shareholders’ capital (%) Average shareholders’ capital and reserves (%)
Notes: 1.
In the case of a six-month ratio, results are annualized.
2.
Interest earning assets consists of project loans, financial services loans and debentures (net of provisions excluding unlent balances and leases).
3.
Interest income consists of income from project loans, financial services loans and debentures but excludes income from leases and treasury operations. Interest income is presented without deducting interest tax. 377
Investment Banking and Financial Services
4.
Net interest income consists of interest income for the period minus interest expense for such period, including interest tax paid. Net interest income figures are understated in all periods to the extent they reflect the cost of the interest bearing funds used for leases, equity investments and other non-interest bearing assets such as office premises but not the income generated from such non-interest earnings assets.
5.
Gross yield equals interest income divided by average interest earning assets.
6.
Net interest margin represents net interest income divided by average interest earning assets.
7.
Average cost of loan funds is the total interest expense (including interest tax) divided by average interest bearing liabilities.
8.
Yield spread represents the difference between gross yield and average cost of loan funds.
9.
Credit risk represents write-offs and provisions charged against income during the period divided by average interest earning assets.
10.
Net yield spread represents yield spread less credit risk.
Case Study 3 Read the case carefully and answer the following questions. You are provided, hereunder, with an abstract from the prospectus of a public issue of Mohanty Fabrics Ltd. which opened for subscription on 8th July, 20x1. Some additional information is also provided towards the end. Based on the information provided as well as your understanding of public issues and merchant banking activities, you are required to answer the following questions: 1.
2.
3.
The abstract makes a mention of minimum subscription of 90% of the issued amount including the devolvement of underwriters. Subsequently, it also makes a mention of allotment letters/refund orders: a.
Was it mandatory for the issuer to have a clause with respect to minimum subscription and underwriting? Explain.
b.
Briefly outline some of the key features with respect to underwriters and underwriting arrangements.
c.
State the present requirement with respect to the period of completion of allotment activity and despatch of refund orders. What is the consequence of non-adherence?
The table on Capital Structure provides the details of the present issue as well as the earlier paid-up capital and the authorized capital. a.
Distinguish between “Shares reserved for firm allotment” and “Shares reserved for preferential allotment”.
b.
Discuss the regulatory issues with respect to “firm allotment” as well as “preferential allotment”.
c.
i.
Calculate the promoters’ contribution in the post-issue capital.
ii.
Is it adequate as per the regulatory requirements? Explain.
iii.
Does it endanger the minimum requirements of net offer to the public? Explain.
iv.
What is the minimum size of application for promoters’ contribution and when should the contribution be brought into the company?
The terms of payment for issue give details of the amount of payment and the mode of payment. a.
Is there any change in requirement with respect to the minimum application size by the resident Indian Public? If yes, state the requirement and the reasons for the change.
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Part IV
b.
Enumerate the essential features and guidelines for the usage of “stockinvest” as a mode of payment for share application.
4.
Are the issuer and the merchant bankers to the issue correct in making the issue at par? Explain fully after considering the value of the share in terms of the i. P/E approach ii. Book value approach iii. Dividend capitalization approach. 5. Briefly enumerate the key internal risk factors and the management’s perception of internal risk factors that would have formed a part of the disclosure in the prospectus of this public issue. What is the other category of risk factors that should form a part of the prospectus and what does it usually pertain to? Public Issue of 3,53,90,000 Equity Shares of Rs.10 each for cash at par aggregating Rs.3539 lakh I. GENERAL INFORMATION Corporate Status Mohanty Fabrics Ltd. was incorporated on November 27, 19x5 as a Public Limited Company under certificate of incorporation issued by Registrar of Companies, New Delhi and obtained certificate of commencement of business on 8th January, 19x6. Acknowledgement Card The company has obtained the Acknowledgement Card vide letter December 13, 19x8 from the Securities & Exchange Board of India (SEBI). Authority for the Present Issue Authorization of the Shareholders of the Company under Section 81(1-A) of the Companies Act, 1956 has been obtained for this Issue by a special resolution passed at the Extraordinary General Meeting of the Company, held on July 19, 19x8. Listing Applications have been made to the Stock Exchanges at Delhi (the Regional Stock Exchange), Mumbai and UP as well as NSE for permission to deal in and for an official quotation of the equity shares being issued in terms of this prospectus. Minimum Subscription If the Company does not receive the minimum subscription of 90% of the issued amount including devolvement of underwriters within 60 days from the date of closure of the issue, the Company shall forthwith refund the entire subscription amount received. For a delay beyond 78 days, from the opening of the issue, the Company and the Directors of the Company shall be jointly and severely liable to repay the amount due by way of refund with interest @ 15% p.a. Allotment Letters/refund Orders The Company shall ensure that the allotment letters/refund orders marked “Account Payee” are issued within a period of 10 weeks from the closure of the issue. The Company shall also ensure despatch of refund orders/unused stockinvests of value above Rs.1500 and share certificate by Registered Post only. Refund orders of value up to Rs.1,500 will be despatched under the Certificate of Posting. Adequate funds for the purpose will be made available to the Registrar. II. CAPITAL STRUCTURE (Rs.) SHARE CAPITAL A. B.
AUTHORIZED CAPITAL 9,00,00,000 Equity Shares of Rs.10 each ISSUED, SUBSCRIBED & PAID UP CAPITAL 70 Equity Shares of Rs.10 each
NOMINAL VALUE 90,00,00,000 700
379
Investment Banking and Financial Services
SHARE CAPITAL C.
PRESENT ISSUE 7,38,80,000 Equity Shares of Rs.10 each for cash at par
D.
OUT OF THE PRESENT ISSUE
E.
73,88,00,000
3,84,90,000 Equity Shares of Rs.10 each for cash at par reserved for firm allotment to the promoters, their friends, relatives and associates
38,49,00,000
NOW OFFERED THROUGH PROSPECTUS 3,53,90,000 Equity Shares of Rs.10 each for cash at par
35,39,00,000
F.
OUT OF WHICH
i.
43,90,000 Equity Shares of Rs.10 each for cash at par are reserved for preferential allotment to NRIs/Persons of Indian origin residing abroad/OCBs and Foreign Institutional Investors on competitive basis
4,39,00,000
ii. 60,00,000 Equity Shares of Rs.10 each for cash at par are reserved for preferential allotment to Indian Financial Institutions and Banks on competitive basis
6,00,00,000
30,00,000 Equity Shares of Rs.10 each for cash at par iii. are reserved for preferential allotment to Indian Mutual Funds on competitive basis
3,00,00,000
G. H
NET OFFER TO RESIDENT INDIAN PUBLIC 2,20,00,000 Equity Shares of Rs.10 for cash at par
22,00,00,000
PAID-UP CAPITAL AFTER THE PRESENT ISSUE 7,38,80,070 Equity Shares of Rs.10 each
III.
NOMINAL VALUE
73,88,00,700
TERMS OF THE PRESENT ISSUE Rights of Equity Shareholders The Equity Shares being issued are subject to the terms of this Prospectus, the Application Form and the Memorandum and Articles of Association of the Company, the provisions of the Act and other stipulations, if any, made by appropriate authorities. Ranking The Equity Shares now being offered shall rank pari passu with the existing equity shares of the Company in all respects save and except that the holders of the equity shares now offered will be entitled to dividend, if any, from the respective date of allotment and in proportion to the amount paid-up thereon and pro rata for the period during which such capital is paid-up. Terms of Payment by Indian Public On Application
: Rs.5
On Allotment
: Rs.5
PROCEDURE FOR APPLICATION By Resident Indian Public 1.
Applications must be made only: i.
On the prescribed Application Form and completed in full in BLOCK LETTERS in ENGLISH in accordance with the instructions contained in the Application Form and are liable to be rejected if not so made.
ii.
In single or joint names (not more than three).
iii.
For a minimum of 500 equity shares and in multiples of 100 equity shares thereafter. 380
Part IV
IV.
2.
Application Forms duly completed as per the instructions contained therein together with Cash/Cheque/Bank Draft/Stockinvest for the amount payable on application at the rate prescribed should be lodged before the closure of Subscription List with the Bankers to the Issue at their designated branches mentioned in the Application Form and NOT to the Company or the Lead Managers, Co-Managers or Registrars to the Issue. Applications not made so are liable to be rejected.
3.
Payments should be made in cash or by cheque/bank draft/stockinvest drawn on any bank (including a co-operative bank) which is situated at and is a member or submember of the Banker’s Clearing House located at the center where the application is submitted.
PARTICULARS OF THE ISSUE Objects of the Issue The Company is setting up a 100% EOU for the manufacture of wide width cotton sheetings and premium shirtings with an installed capacity of 25,200 spindles, 120 shuttleless looms (96 Airjet loom from Picanol, Belgium and 24 Projectile loom from Sulzer, Switzerland) with necessary processing facilities. The objects of the present issue are: i.
To raise a part of the finance required for setting up the project
ii.
To meet the expenses of the issue and other incidental expenses
iii.
To list the equity shares of the Company on the Stock Exchange(s).
Cost of Project MFL’s project was appraised by IDBI in March 20x1 for the purpose of sanction of Foreign Currency loans equivalent to Rs.4,700 lakh. The cost of the project was assessed at Rs.14,350 lakh and the project was expected to commence commercial operations from October 20x2. A mid-term review of the project was taken up by IDBI in June 20x2 when the estimated cost of the project was assessed at Rs.16,698 lakh. Out of the overall increase in the cost of Rs.2,348 lakh, an amount of Rs.1,305 lakh is notional (due to foreign exchange rate fluctuation) and the balance amount of Rs.1,043 lakh is accounted for by increase in the cost of civil construction, miscellaneous fixed assets and preliminary and pre-operative expenses. The plant was expected to go on stream in January 20x3. However, there was a delay of three months in project implementation and the commercial production is now expected to commence in April 20x3. Consequent increase in pre-operative expenses/interest during the construction period of about Rs.250 lakh is proposed to be met out of the contingency provision and hence the project is expected to be implemented within the cost estimates. The details of the cost of the project, estimated at Rs.16,698 lakh, are as under: Land and Site Development Buildings Plant and Machinery – Imported – Indigenous Misc. Fixed Assets – Imported – Indigenous Preliminary and Pre-operative Expenses Provision for contingencies Margin Money for Working Capital Total
(Rs. lakh) 291 1169 8932 1395 1305 1631 1270 303 402 16698 381
Investment Banking and Financial Services
Means of Finance The cost of the project is proposed to be financed in the following manner: (Rs. lakh) Share Capital – Promoters
3849
– Public Issue
3539
7388
Term Loan - Forex Loan – IDBI
6005
– SBI
3290 9295
State Capital Subsidy
15
Total 16698 The foreign currency term loans have been tied-up with IDBI and SBI against their letter dated 26/6/20x1 and dated 9/11/20x1 respectively. The Company has already made application to State Govt. of Uttar Pradesh for sanction of capital subsidy of Rs.15 lakh. In case the subsidy is not made available to the Company, it proposes to arrange unsecured loans to meet the shortfall. Up to 31st January, 20x3 the Company had incurred an expenditure of Rs.14,402 lakh comprising Rs.266 lakh on land and site development, Rs.1,173 lakh on building and advance to contractors and building materials, Rs.10,619 lakh on imported machinery, Rs.731 lakh on misc. fixed assets, Rs.417 lakh on indigenous machinery and Rs.1,196 lakh on security deposits, preliminary and pre-operative expenses, etc. The expenditure incurred till date has been financed through the promoter’s equity/share application money of Rs.3,850 lakh, FI loans of Rs.9,799 lakh (IDBI Rs.6,089 lakh and SBI Rs.3,710 lakh), and balance Rs.528 lakh by way of unsecured loans and Rs.225 lakh from sundry creditors and interest on deposits. Working Capital Working capital requirements have been calculated based on 2.5 months’ requirement of raw materials, 3 months’ consumable stores/spares and 1 month’s finished goods. The working capital requirement in the first full year of operation (20x3-20x4) is estimated at Rs.1893 lakh which would be met through bank borrowings to the extent of Rs.1,491 lakh, the balance of Rs.402 lakh has been provided in the project cost as margin money for working capital. The Company has already approached SBI (its regular banker) for sanction of working capital finance and is confident of obtaining the sanction at an early date. Schedule of Implementation PFL’s civil construction work is at an advanced stage of completion. All major imported plant and machinery have been shipped and most of them have already arrived at the site; the remaining are expected to reach the site by March 20x3. Orders for most of the indigenous equipment have been placed and the same have started arriving at the site. Erection of equipment have commenced from September 20x2. After installation of plant and machinery and trial runs, the commercial production is expected to commence by April 20x3. The expected delay of about 3 months in implementation of the project as compared to the projections made by IDBI in its revised appraisal was mainly due to delay in receipt of imported machinery. Consequent increase in pre-operative expenses/interest of about Rs.250 lakh during the construction period is proposed to be met through the contingency provision. The company has incurred/committed substantial expenditure on the project. Keeping in view the progress made on the project, the cost is expected to be contained within the estimates. The management is reasonably confident of completing the project within the revised schedule i.e. by April 20x3.
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Part IV
Profitability As per the appraisal done by IDBI in June 20x2, the abstract of projected financial performance is as follows: (Rs. lakh) 20x4
V.
20x2 20x3 Year Ending March 31st Expected Sales 7574 8584 9089 Other Income 142 161 170 Total Cost of Production 4367 4932 5224 Interest 1038 1041 930 Depreciation 1359 1371 1382 Preliminary Expenses written-off 42 42 42 Dividend (%) 8 10 15 Reserves and Surplus 452 1071 1642 The Company has not made any public/rights issue of capital since its incorporation. The particulars pertaining to issue of capital by other listed companies in the group which have made any public issue of capital in the last three years preceding the date of this prospectus are as follows: Mohanty Spinning and Weaving Mills Ltd. Year of Issue Type of Issue Amount of Issue
19x9 Rights Issue 23,53,948 PCDs of Rs.50 each for cash at par aggregating Rs.11,76,97,400 Date of Closure 27.10.19x9 Objects of the To meet the initial expenditure relating to expansion project for Issue installing spindles for manufacturing synthetic blended yarn Rate of Dividend 19x9-20x0 – 25% Paid 20x0-x1 – 25% Promises vs. Performance (Rs. lakh) Particulars 19x9-20x0 20x0-x1 Turnover
PAT
EPS
Turnover PAT
EPS
Projected
6728
657
20.53
6867
548
9.87
Actual
7437
434
13.50
9454
533
9.34
Mohanty Acrylon Ltd. Year of Issue
19x9
Type of Issue
Rights Issue
Amount of Issue
1,81,40,000 Equity Shares of Rs.10 each for cash at par aggregating Rs.18,14,00,000
Date of Closure
15.11.19x9
Objects of the Issue
To finance the expansion project by increasing the capacity of acrylic fibers from 15,000 tpa to 18,000 tpa and also to meet the working capital requirement
Rate of Dividend Paid
20x0-x1 - nil 20x1-x2 - nil
383
Investment Banking and Financial Services
Promises vs. Performance (Rs. lakh) Particulars Projected Actual
20x0-x1 Turnover 16,114 14,023
PAT 781 (661)
EPS 1.52 –
20x1-x2 Turnover 16,873 15,198
PAT 14.91 (231)
EPS 2.35 –
The company had projected an income of Rs.16,873 lakh and PAT of Rs.1,491 lakh for the year 20x1-x2 while the actual income was Rs.15,198 lakh and the Company incurred a loss of Rs.231 lakh. Acrylic fiber industry as a whole is passing through a difficult time due to competition from imports and also due to a steep rise in the prices of raw materials in the international market, which resulted in an increase in cost of production. Additional Information 1. The company may be placed in the industry titled as “Textiles – Composite/Cotton/ Blended/Fabric”. 2. The P/E ratios for the industry reported in capital market dated March 25, 20x3 are as below: i. Highest P/E 13.9 ii. Lowest P/E 4.0 iii. Composite P/E 9.4 3.
It is expected that the company would be in a position to give a dividend at the rate of 25% for the year ended 31st March, 20x3 at which the rate of dividend will stabilize for the future period.
4.
364-day T-Bills rates (proxy for risk-free rate) are approximately 9% and the risk premium per unit of risk is estimated to be 10%. The company’s beta is estimated at 1.30.
5.
The company has chosen to avail the benefits u/s 10B of the Income Tax Act, 1961 with effect from the first year of operations itself.
Case Study 4 Read the case carefully and answer the following questions. 1. Calculate the price at which the company can issue shares to raise funds for financing the project. Give justifications which should include justifications required as per the existing SEBI guidelines. For justifying the premium, the funds raised by equity can be assumed to be Rs.500 lakh. 2. Give qualitative reasons for the issue price arrived at (1) above. 3. If the company expects an increase of 80% in its earnings before interest and taxes and the shareholders accept a dilution in EPS by 30%, calculate the debt-equity ratio for the funds required for expansion. Assume that of the total funds required, Rs.315 can be sourced by internal accruals and that equity is priced at the amount arrived at in (1) above. 4. State the various ways by which the company can raise equity funds. Discuss the pros and cons of each method. 5. State whether investment can be made in such a company highlighting the risk factors involved. State assumptions, if any. History and Business of the company: Hi-Tech Enterprises Limited was incorporated as a private limited company during 19x1 and was converted into a public limited company during 19x5. Hi-tech, promoted by Shri Mohan Reddy and his associates, was incorporated as a Private Limited Company on August 28, 19x1 under the name of Hi-Tech Enterprises Private Ltd., with the objective of creating facilities for software development and its export thereof to global markets. The Company commenced commercial operations in September 19x2. 384
Part IV
IDBI sanctioned start-up assistance of Rs.97 lakh under the Venture Capital Scheme in 19x1 for the Company’s first project (costing Rs.122 lakh), envisaging creation of facilities for conversion of paper based drawings into a Computer Aided Design and Drafting (CADD) and Geographical Information System (GIS) formats and for developing other software packages. The project was successfully completed in September 19x2. IDBI converted a portion of its loan amounting to Rs.15 lakh into equity in 19x4. The company obtained a second loan of Rs.100 lakh from IDBI for expansion of its facilities (the scheme costing Rs.150 lakh) in 19x4, which was successfully completed in January 19x5. Having stabilized its operations and gaining a stable foothold in the export market, Hi-Tech is now embarking on an expansion plan envisaging: (i) entry into engineering consultancy for 3D modelling, (ii) expansion (by over 60%) of its CAD/GIS conversion Capacity and (iii) doubling of capacity for handling Software projects and product development. Hi-Tech shares a fully functional 128 KBPS Satellite Link, provided by STP, Hyderabad and has established its own home page on its World Wide Web Server on the INTERNET. Identified Niche Areas and Product-Mix Hi-Tech has well identified niche areas for software development in tune with its relative expertise and skill. The basic thrust areas are: (i) Computer Aided Design and Drafting (CADD) and (ii) Geographic Information System (GIS). The Company undertakes software development as well as offers ‘Software Services’ in the above two selected areas. Projects: The projects Hi-Tech undertakes are under DOS, Windows and UNIX environments. Projects executed included implementing OLÉ 2 functionally in CADKEY for Windows, enhancing the functionality of CK Architect using CODe (CADKEY Object Developer) and developing a Universal Post Processor for Cutting Edge Technologies, USA. Recognized as ‘R&D’ Unit by Ministry of Science & Technology, Govt. of India: Hi-Tech is a recognized ‘R&D Unit’ by the Department of Scientific & Industrial Research, Ministry of Science & Technology, Government of India – which allows the Company the option to write off the entire amount spent on R&D for IT purposes. ISO 9000 Certification: Hi-Tech was given the ISO 9002 certificate by BVQI, London for its CADD/GIS conversion services. The Company has applied and is confident of obtaining the ISO 9001 certification for `Software Development’ by June 20x2. The Company exports it services/products mainly to USA, Europe, Japan, Australia and SouthEast Asia, mainly through its Strategic Alliance partners located in USA, Germany, Australia and Belgium. Hi-Tech has been getting regular orders from clients in UK, Malaysia and Singapore. Promoters: Hi-Tech is promoted by Shri BVR Mohan Reddy, Shri K Rajan Babu both technically qualified computer professionals, and Smt. B Sucharitha (wife of Shri Mohan Reddy) Shri Mohan Reddy (aged 46 years) has over twenty years of engineering and management experience. He was awarded “Entrepreneur of the year” by Hyderabad Management Association for the year 1996. Shri Reddy has two degrees in masters, one in Management Engineering from the University of Michigan, Ann Arbor, USA (in 1977), the other in Industrial Engineering from the Indian Institute of Technology, Kanpur (in 1975). His basic graduation was in Mechanical Engineering from Andhra University (in 1971). Shri Reddy started his career with the DCM Group in 1974 as a senior management trainee, was with MICRO BOSCH (the German auto part giant) for three years as senior systems officer (1977 to 1980) and with HCL (now the Hewlett Packard joint venture in India) as Regional Manager (1980 to 1982). Within a short period Shri Reddy graduated from Management Trainee to Regional Manager. Shri Mohan Reddy joined OMC Computers initially as Marketing Manager (in 1982) and grew to be General Manager, President and then became the Managing Director of OMC. Shri Reddy left OMC in June 1992. 385
Investment Banking and Financial Services
Shri Reddy was the President of Electronics Industries Association of Andhra Pradesh (ELIAP) for two years (1990 and 1991) and has been the President of Hyderabad Software Exporters Association (HYSEA) since 1993. He was also on the board of AP Electronics Development Corporation in 1985. Shri Rajan Babu (44 years) is an Engineering graduate from Osmania University (1974). Smt. Sucharitha (44 years) is a post-graduate in Chemistry from Shri Venkateshwara University, Tirupathi (in 1973). She has 3 years experience of working in computers/systems in Bhavani & Co., Hyderabad, from 1988 till she became a promoter-director in Hi-Tech. The Financial Highlights of the Company are as follows: The profits of the company for the period 19x1-20x2 are set out hereunder after making adjustments (Rupees in lakh) Particulars
31/03/x2 (estimated)
31/03/x1
502.29
274.81
127.90
Employees Remuneration & Benefits
103.04
57.96
34.07
Processing
153.99
94.58
46.32
Depreciation
26.70
13.43
8.02
Financial charges
24.77
16.41
11.21
Royalty
25.04
7.62
3.00
TOTAL
333.54
190.00
102.62
Net Profit for the year
168.75
84.81
25.28
5.30
NIL
1.00
TOTAL INCOME
31/03/x0
EXPENDITURE
Less: Provision for taxes
Profit after tax 163.45 84.81 24.28 Assets and Liabilities of the company as on 31st March 20x0, 31st March, 20x1 and 31st March, 20x2 (estimated) are set out below: (Rs. lakh) Particulars
31-03-x2 (estimated)
31-03-x1
31-03-x0
276.49
139.21
75.29
50.73
24.23
10.80
Net Block
225.76
114.98
64.49
Subtotal (a)
225.76
114.98
64.49
Add: Current Assets Loans and Advances:
277.78
201.60
108.40
Total (A) a + b
503.54
316.58
172.89
48.51
36.68
17.63
Provisions
5.30
Nil
1.40
Total (B)
53.81
36.58
19.03
Fixed Assets Gross Block Less: Depreciation
INVESTMENT (b)
Less: Current Liabilities and Provisions Current Liabilities
386
Part IV
Particulars
31-03-x2 (estimated)
31-03-x1
31-03-x0
449.73
280.00
153.93
0.00
0.07
0.07
449.73
280.07
153.93
Authorized Share Capital
300.00
100.00
50.00
Issued, Subscribed & Paid-up
150.00
75.00
25.00
173.70
85.80
35.93
Secured Loans IDBI Venture Capital Fund - 1
50.76
64.04
93.00
Secured Loans IDBI Venture Capital Fund - 2
75.00
51.00
—
0.27
4.23
—
449.73
280.07
153.93
Net Tangible Assets (A–B) Miscellaneous Expenditure (To the extent not written off or adjusted) Gross worth (Total Assets) Represented by:
(Equity shares of Rs.10 each) Reserves and Surplus Loan Funds:
SBH/GTBL Packing Credit Total Notes: 1.
The Company adopts the accrual concept in the preparation of accounts.
2.
Assets and Liabilities are recorded at historical cost to the company. The costs are not adjusted to reflect the changing value in the purchasing power of money.
3.
Depreciation on fixed assets has been charged on the Straight Line Method in the manner and at the rates prescribed under the Companies Act.
The Company has proposed to: a.
Set-up new facilities for handling Engineering Consultancy-3D modeling.
b.
Enhance the capacity for software development (projects) from 3,88,500 hrs. per annum to 6,25,500 hrs. per annum.
c.
Double the capacity for product development (software/data products) from 24,000 hrs. per annum to 48,000 hrs. per annum.
The aggregate requirement for the expansion scheme is estimated at Rs.1,250 lakh, a broad breakup of which is given below: Cost of the Project (Rs. lakh) Particulars Land and Buildings Plant and Machinery: – Imported – Indigenous Software: – Imported – Indigenous Miscellaneous Fixed Assets Public Issue Expenses Provision for Contingencies Working capital Requirements Total
Cost 266 297 1 158 154 238 50 53 33 1250 387
Investment Banking and Financial Services
Location: The company’s present facilities are located at: i.
Ameerpet, Hyderabad - where the company has an area of 5044 sq.ft. taken on rental basis from the Software Technological Park, Hyderabad. The current rental charges are @ Rs.13.70 per sq.ft.
ii.
Punjagutta, Hyderabad - where the company has taken 6,878 sq.ft. (plinth area), from Smt. B Sucharitha, the whole-time Director of the Company, on a monthly rent of Rs.50,000 (Rupees fifty thousand only). In addition, the Company was required to make an interest free security deposit of Rs.3 lakh with the Lessor (being equivalent to six months rent). The initial lease is for a period of 3 years, with the option for the Company to renew the lease agreement for another period of 3 years, subject to a 20% increase in rent. The additional facilities envisaged under the expansion scheme will initially be installed in the 3rd floor of the Company’s premises at Punjagutta, where about 2,000 Sq.ft. of area is available. The Company proposes to construct a seven storied building in an one acre plot allotted to it by Andhra Pradesh Industrial Infrastructure Corporation Ltd. (APIIC) at Madhapur Village near Jubilee Hills, at the outskirts of Hyderabad and shift all activities to the new premises. Under the Allotment scheme a total land measuring 4840 sq. yards (1 acre) has been allotted to the company for a price of Rs.62.05 lakh. As per the scheme the land will be developed by APIIC with metal roads, water supply assistance, telephone connections, power connections, street lights, etc. The implementation is in progress.
Building and Civil Works: The company envisages construction of a seven storied (including normal as well as stilts floor) building, with about 50,000 Sq.ft. area. The building would be of RCC construction and would be fully air-conditioned and furnished. The company has appointed KSA Consultants Pvt. Ltd. (KSA), Hyderabad as architects and civil engineers. The company has taken possession of the land from APIIC on February 5, 20x1. The company would shortly apply for obtaining the necessary approvals for construction and is confident of obtaining the same well in time as per schedule. Temporary Facilities and Shifting to New Premises The company proposes to initially install its facilities at its existing sites and then shift them to its new premises, once the construction is over. The same workstations (proposed under the scheme) are initially proposed to be installed in the existing facilities and then are to be shifted to the new premises. The cost of shifting will be very marginal and no special provision is required for the same. Technology For the CAD/GIS conversion services, Hi-Tech follows a unique process developed by it. This `heads-up’ Interactive approach was developed and systematically refined based on the expertise build-up over the years. This approach helps to maintain high accuracy levels (of 99.5% and above) at predictable and manageable costs. The emphasis is on the process and extensive use of software tools developed in-house to increase productivity and meet quality norms. Utilities The present contracted demand is 100 KVA at the Company’s private STP at Gayathri Hills. In addition, a DG set of 35 KVA has been installed. UPS facility of capacity of 17 KVA has also been provided. The peak load is 60 KVA. The additional requirement would be about 35 KVA which can be taken care of with the existing contracted demand. At its STP, Ameerpet, the contracted load is 60 KVA. The company has a share of 35 KVA out of the 250 KVA DG set capacity installed at the STP by the Government. The Company has installed the UPS system of capacity of 26 KVA. No addition to the capacity is envisaged. The power requirement at the new premises, envisaged at Madhapur would be 500 KVA (including additional miscellaneous facilities and future expansion), which is proposed to be met from APSEB supply to the STP. Provision has been made to install a diesel generating set of 125 KVA capacity to take care of the power requirements in case of power failure. An uninterrupted power supply systems of 50 KVA rating is proposed to be procured to take care of any tripping. 388
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The Company is yet to make arrangements to obtain sanction of power for its proposed new unit at Madhapur. However, as per the project implementation schedule, full commercial operations would commence at its existing sites, where it has enough sanctioned power limits. Human Resources The existing manpower and the future requirements are as under: Existing Managerial Cadre CAD/GIS Engineers, Software Engineers/ Executives/Programmers Adm. Staff & others Total
Additional
Total Requirements
29
16
45
274
193
467
4
3
7
307
212
519
Hi-Tech’s management is fully alive to the problem of turnover of skilled manpower in the Information Technology Industry. In additional to having an on-going recruitment plan, based on the turnover in the Company, Hi-tech proposes to tackle this problem by giving relatively high compensation (based on productivity), opportunity to work in the latest technologies (with on-line services through the dedicated lines) and providing a challenging and encouraging work environment. Environmental Aspects The company falls under the non-polluting industry category and the software development process does not involve generation of any effluents. However, the company would be required to obtain formal clearance from the State Pollution Control Board of Andhra Pradesh. The company has applied to the AP State Pollution Control Board for the necessary approvals and is confident of obtaining the same in due course. Implementation Schedule As per the implementation schedule it is expected to complete the project and start commercial operations at Madhapur by October, 20x2. Assumptions: 1.
Financial charges include interest on the existing debt.
2.
Industry average P/E for medium/small computer software companies is 6.8.
Case Study 5 Read the case carefully and answer the following questions. 1.
Justify the pricing of the share as per Malegam Committee Report.
2.
Delineate a set of highlights and risk factors for this issue.
3.
MCS Ltd. was appointed as Registrar to the Issue. What do you think was the role of MCS Ltd. in this issue?
4.
You are appointed as a consultant by the company to assist in its IPO. Discuss the regulatory framework that you would keep in mind while designing the advertisement campaign.
5.
Based on the forecasted figures, compute the market adjusted returns and state whether issue is underpriced or overpriced. Give the implications of the same.
Public issue of 12,50,000 equity shares of Rs.10 each for cash at a premium of Rs.45 per share aggregating Rs.6,87,50,000.
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Investment Banking and Financial Services
Existing Capital Structure of the Company (Amount in Rs.) Share Capital A.
50,00,000 Preference shares of Rs.10 each
3,75,00,000
1,25,00,000
6,87,50,000
Paid-up capital after the present issue 50,00,000 Equity shares of Rs.10 each
E.
5,00,00,000
Present issue to the public in terms of this prospectus 12,50,000 Equity shares of Rs.10 each for cash at a premium of Rs.45 per share to the public (including NRIs/OCBs)
D.
10,00,00,000
Issued subscribed and fully paid-up 37,50,000 Equity shares of Rs.10 each
C.
Aggregate Value
Authorized capital 1,00,00,000 Equity shares of Rs.10 each
B.
Nominal Value
5,00,00,000
Share premium account Before the issue After the issue
Nil 5,62,50,000
Notes: 1.
Bonus Shares The members of the Company, vide a special resolution at the Company’s Annual General Meeting held on 26th April, 20x1, authorized the Board to capitalize a sum of Rs.1,25,00,000 towards issue of 12,50,000 equity shares to be allotted to the existing shareholders in the proportion of 1 bonus equity share for every 2 existing equity shares. The Board vide a special resolution dated 28th April, 20x1, capitalized a sum of Rs.1,25,00,000 towards issue of 12,50,000 equity shares. Thus, the present issued, subscribed and paid-up capital stands at 37,50,000 equity shares of Rs.10 each.
2.
Shares issued for consideration other than cash No shares have been issued for consideration other than cash except the bonus shares on 28th April, 20x1 as detailed in Note 1 above.
Particulars of the Issue Objects of the present Issue: The present offer of equity shares is being made to: i.
Expand its software development center at Mumbai, and to purchase as well as upgrade its hardware and software
ii.
Invest in subsidiaries in the UK, Germany and USA to support its marketing activities.
iii.
Augment the long-term working capital resources of the Company.
iv.
Meet the expenses of the Issue.
v.
List the Company shares on the stock exchanges.
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Cost of the project and means of finance The cost of the project and the means of finance as estimated by the Company are given below: (Rs. in lakh) Cost of the Project Expansion of software development center – Deposit for Premises
25.00
– Purchase of Hardware
75.96
– Purchase of Software
30.00
– Miscellaneous Fixed Assets
69.00
199.96
Investment in Overseas Wholly Owned Subsidiaries – Investment in subsidiary in the UK
99.40
– Investment in subsidiary in Germany
50.16
– Investment in subsidiary in the US
91.16
Long-term working capital resources of the Company
240.72 233.43
Expenses of the issue and listing of the Company’s shares
46.00
Contingencies
41.57
Total
761.68 (Rs. in lakh)
Means of Finance Present Issue of Equity
687.50
Internal Accruals
74.18
Total
761.68
Notes: Any increase in the cost of the project is proposed to be met from the internal accruals of the Company. The expenditure incurred on the project till 25th June, 20x1 has been Rs.14.75 lakh and has been met from the internal accruals of the Company. The total project cost of Rs.761.68 lakh is proposed to be incurred in the financial year ending 31st March, 20x2. Schedule of Implementation The schedule of implementation as per the company’s estimates and the current status is as follows: Activity
Completion date
Current status
Expansion of software August, 20x1 development center
MOU for availing use of the expanded premises has been signed and possession taken.
Purchase of hardware September, 20x1 and software
Quotations have been invited from vendors.
Investment in the UK September, 20x1 subsidiary
RBI approval for setting up the subsidiary has been received on 19th June, 20x1.
Investment in German November, 20x1 subsidiary
RBI approval for setting up the subsidiary has been received on 19th June, 20x1.
Investment in the US March, 20x2 subsidiary
An application for RBI approval for setting up the subsidiary has been made.
391
Investment Banking and Financial Services
PRESENT BUSINESS AND MAIN OBJECTS Brief History The Company was incorporated as a private limited company by the name of Amex Computers and Services Private Limited on 26th September, 19x3 in the state of Maharashtra. The Company was converted into a public limited company vide a special resolution dated 31st March, 19x7 and the name was changed to Amex Information Technologies Limited. The certificate consequent to change in name and conversion was issued by the Registrar of Companies, Mumbai on 21st April, 19x7. The company was originally promoted by Mr. Ashok Ranade and his family members. There was very little business activity in the Company till August, 19x7 when the present promoter group acquired the controlling interest and tookover the management of the Company. The present promoters consist of three professionals, Mr. G.S. Chandrashekar, Mr. Sharad Gupta and Mr. Aniket Jathar. Mr. Sharad Gupta brings with him skills in marketing of IT related products and services. Mr. Aniket Jathar brings with him the experience of software development. Mr. Chandrashekar has extensive prior experience in the field of finance. The Company started with a focus on on-site services and year 20x2 compliance related projects. This tool has been modified to carry out Impact Analysis for Euro-Conversion related projects. In the past one year, it has widened its scope of activities to the areas of re-engineering migration, data warehousing, ecommerce (web enabling and NET dynamics) and client server development. The Company has grown from 37 employees in September, 19x9 to 80 employees in March, 20x1. Total income of the Company increased from Rs.173.54 lakh in the Financial Year 20x0 to Rs.848.66 lakh in the Financial Year 20x1. The Company generated export income to the extent of Rs.795.66 lakh in the Financial Year 20x1 as against Rs.173.54 lakh in the Financial Year 20x0. A substantial portion of this revenue came from the UK market, as also from the Netherlands and Germany. Present Business The company was incorporated with the objectives of carrying out the business of developing, designing, manufacturing, processing and assembling products allied to computer hardware and software in and outside India. Present activities of the company can be broadly divided into Onsite consulting services and Off-shore project execution. On-site Consulting Services: Several of the company’s software consultants are engaged in providing on-site consultation to customers in Europe. Consultation ranges from the IBM mainframe to client-server platforms. Application areas converted include re-engineering, migration, data warehousing and product development. The Company’s overseas on-site activity is also marketed by Profund International Management Consulting-Germany, Oakwood Technical Services Limited UK & Softlines (UK) Limited. Through these arrangements, the Company’s professionals have been placed in various organizations. The Company plans to build on all these arrangements by starting three subsidiary companies, in the UK, Germany and USA. It plans to put together a marketing team to develop business potential in Europe and USA. Off-shore Project Execution: The Company has successfully carried out in 20x2 compliance projects with the help of its automated compliance tool TRYST. This tool has also been modified to carry out the Impact Analysis for Euro-conversion related projects. A plot project for the same is also underway. The company is currently working on the following tools which aim to automate parts of the software development process such as TRYST, GRAFTERM and DAD. The five main clients of the Company during the financial year ended 31st March, 20x1 were Oakwood Technical Services Limited – UK, Profund International Management Consulting – Germany, Softlines (UK) Limited, Streamlines – Netherlands & ACS Consulting – USA. They contributed 83% of the total income for the year. The Company wishes to leverage the expertise and the association that it has developed through its network valued-added project implementation, rather than standard software outsourcing. This will be done directly for the same set of clients where the Company’s professionals currently work. Quality Procedures and Guidelines: The company has developed Total Quality System based on ISO 9000 guidelines and procedures with a view of achieving this certification in the near future. By utilizing quality management techniques, the software development team can solve problems, improve and manage the process, resolve out of control conditions and take effective steps for constant improvement. 392
Part IV
Human Resource Policy: Participation by consensus is the key success factor. The company, therefore, invests in its people to build up high quality human assets. Staff is carefully selected, intensively trained and appropriate growth paths are charted out for future advancement. Special emphasis is placed on industry relevant skills and quality assurance. To achieve excellence in these areas, the company has formal training and development plans for employees. The company also plans to offer ESOP to its employees. Financial Highlights The key financial indicators of the company based on the audited accounts are given below: Statement of Profit and Loss
Particulars Software development – On-site – Off-shore – Domestic A. Total Sales Y2K related revenue included in above B. Other income from operations a. Total income Expenditure Cost of goods sold Interest and finance charges Lease Rental Charges b. Total expenditure c. Operating income Operating expenses Employee cost/on-site expenses Administrative expenses Depreciation Preliminary expenses written off Miscellaneous expenses written off d. Total operating expenses e. Profit from operations f. Other income g. Net profit before tax h. Taxation i. Profit after tax Dividend rate j. Dividend k. Corporate dividend tax l. Transfer to general reserve Profit and Loss B/F m. Balance transferred to balance sheet
(Rs. in lakh) 1.4.19x6 to 31.3.19x7 (12m)
1.4.20x0 to 1.3.20x1 (12m)
1.10.19x9 to 31.3.20x0 (6m)
1.4.19x8 to 30.9.19x9 (18m)
1.4.19x7 to 31.3.19x8 (12m)
704.54 91.12 53.00 848.66 123.11
173.54 – – 173.54 32.71
33.17 – 61.75 94.92 1.79
– – 38.07 38.07 –
– – 5.97 5.97 –
0.00
0.00
0.00
0.00
0.00
848.66
173.54
94.92
38.07
5.97
0.00 5.48 22.30 27.78 820.88
0.00 1.21 7.13 8.34 165.20
0.00 1.12 1.96 3.08 91.84
0.00 0.08 0.00 0.08 37.99
0.00 0.00 0.00 0.00 5.97
502.46
109.71
35.24
18.27
3.02
64.20 26.84 1.25
28.42 2.33 0.62
34.69 2.87 1.71
13.59 0.05 0.01
2.76 0.00 0.01
0.00
0.00
0.00
0.00
0.00
594.75 226.13 2.03 228.16 5.00 223.16 7.5% 18.62 1.86 190.00 32.21 44.89
141.08 24.12 1.17 25.29 1.50 23.79 7.5% 7.46 0.75 1.90 18.53 32.21
74.51 17.33 0.62 17.95 0.44 17.51 Nil 0.00 0.00 1.09 2.11 18.53
31.92 6.07 0.08 6.15 2.60 3.55 10% 1.62 0.00 0.00 0.18 2.11
5.79 0.18 0.05 0.23 0.14 0.09 15% 0.00 0.00 0.00 0.09 0.18
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Investment Banking and Financial Services
Statement of Assets and Liabilities
Particulars
Assets Fixed assets Gross block Accumulated depreciation Net block (I) Investment (II) Current assets, loans and advances Inventory Sundry debtors Other current assets Loans and advances Total (III) A: (I) + (II) + (III) Less: Liabilities Loan fund Secured Unsecured Total (IV) Current liabilities and provisions (V) B: (IV + V) Net assets (A – B) Represented By Equity capital Share application money Reserves and surplus (Free reserves) Total Less: Miscellaneous expenditure Total (Net Worth)
1.4.20x0 1.10.19x9 1.4.19 x 8 1.4.19x7 1.4.19x6 to to to to to 31.3.20x1 31.3.20x 0 30.9.19x 9 31.3.19x8 31.3.19x 7 (12m) (6m) (18m) (12m) (12m)
147.72 32.10 115.62 0.00
108.23 5.26 102.97 55.39
90.96 2.93 88.03 54.89
7.76 0.05 7.71 5.20
0.08 0.01 0.07 0.00
0.00 246.23 117.51 29.83 393.57 509.19
0.00 59.73 21.46 26.21 107.40 265.76
0.00 76.16 17.68 18.37 112.21 255.13
0.00 36.45 11.17 29.95 77.57 90.48
0.00 0.00 0.79 0.02 0.81 0.88
2.19 0.00 2.19 28.00 30.19 479.00
20.59 0.00 20.59 15.45 36.04 229.72
24.79 0.00 24.79 10.00 34.79 220.34
2.05 0.00 2.05 6.77 8.82 81.66
0.00 0.17 0.17 0.29 0.46 0.42
250.00 0.00 237.90 487.90 8.90 479.00
178.93 25.73 35.21 239.87 10.15 229.72
99.02 112.46 19.63 231.11 10.77 220.34
80.09 1.00 2.12 83.21 1.55 81.66
0.30 0.00 0.19 0.49 0.07 0.42
Management Discussion and Analysis of Results of the Company for the last Three Accounting Periods Total income of the company increased from Rs.173.54 lakh in the financial year 20x0 to Rs.848.66 lakh in the financial year 20x1 registering an increase of 144%. During the same period the net profit of the company increased from Rs.23.79 lakh to Rs.223.16 lakh, a growth of 369%. The company generated export income to the extent of the Rs.795.66 lakh (94% of revenues) in the Financial Year 20x1 as against Rs.173.54 lakh in the Financial Year 20x0. However, these growth rates of total income and net profit have been achieved due to the fact that the initial size of the company’s operations were comparatively small. These growth rates are likely to decline in the future. The company consolidated its presence in the European markets and increased the number of consultants from 22 in September, 19x9 to 67 in March, 20x1. It was also accompanied by successful execution of off-shore projects. The total income of the company increased from Rs.94.92 lakh in the financial year 19x9 to Rs.173.54 lakh in the financial year 20x0, registering an increase of 448%. During the same period the net profit of the company increased from Rs.17.51 lakh to Rs.23.79 lakh, a growth of 307%. The expenditure of the company (excluding 394
Part IV
taxation) increased from Rs.77.59 lakh in the financial year 19x9 to Rs.149.43 lakh in the financial year 20x0 and Rs.622.53 lakh in the financial year 20x1. The company competes with similar other software services companies on its strengths which include its successful track record, professionally qualified and experienced personnel and their available skills. There have been no unusual or infrequent events or transactions during the past accounting periods of three years. The company’s business of software development is not seasonal. No significant general economic changes have taken place in the past three accounting periods to materially affect the operations or profitability of the company. No significant economic change is likely to materially affect the income from continuing operations. No material changes in the future relationship between costs and revenues are known as on date. No new product or entry into a new business segment has been publicly announced since the date of the last financial statements. The five main clients of the company during the financial year ended 31st March, 20x1 were Oakwood Technical Services Limited – UK, Profund International Management Consulting – Germany, Softlines (UK) Limited, Streamlines – Netherlands and ACS Consulting – USA. They contributed 83% of the total income for the year. There were no special events, trends or any uncertainties that at any time adversely affected the income from continuing operations. The management does not anticipate any adverse changes taking place in the future also. Future changes in revenue are expected to arise primarily from the company’s increased volume of activity. Profitability forecast for financial year ending 31st March, 20x2 A forecast of operations and profit for the year ended 31st March, 20x2 along with the major assumptions as estimated by the company and certified by K. P. Joshi and Company, the Auditors of the company, to be arithmetically accurate and in accordance with the assumptions are: Particulars Sales and other income Employee cost/On-site expenses
(Rs. in lakh) 1,598.44 942.78
Administrative and Other expenses
87.92
Interest and financial charges
22.20
Miscellaneous expenses written off Depreciation Profit before tax Tax Profit after tax Assumptions
8.75 40.04 496.75 4.53 492.22
The benefits from expansion and diversification project are expected to accrue during the second half of the financial year. The revenue for on-site and off-shore services has been assumed on the basis of 160 hours per man month working. It has also been assumed that there are 25 working days in a month. Sales overheads are taken at the rate of 3% of revenue. Administrative overheads are taken at the rate of 2% of the net revenue. Depreciation on fixed assets has been charged on straight line method at the rates specified in the Companies Act, 1956. Revenue from on-site staff has been taken for 11 months, whereas salary and allowance is taken for 12 months. Exchange Rate for UK Pound is taken at Rs.70. Exchange rate for US Dollar is taken at Rs.42. Exchange rate for Euro is taken at Rs.43. Tax has been calculated taking into consideration 80 HHE benefits under Income Tax Act. Company, management, the promoters and their background The Promoters of Company and their brief background is outlined below: Mr. G S Chandrashekar, Managing Director of the company, aged 45 years, is a Chartered Accountant, and has over 18 years experience in finance. Between 1977-88, he was with the Apte group of companies and his last assignment was as Vice President (Finance) of Lakshmi Vishnu Textiles Limited. Before joining the company, between 1989-1995, in his capacity as a Financial Consultant, he implemented projects on turnkey basis for Simplex Mills Limited, Neha Proteins Limited and Bagade India Engineering Limited. He has also handled a large software-exports project for Twinstar Software Exports Limited, on a turnkey basis, including setting up of centers, marketing 395
Investment Banking and Financial Services
tie-ups, selection of hardware and software vendors and appointment of personnel. Mr. Sharad Gupta, Director-Marketing, aged 43 years, B.Sc, MA with a Diploma in Marketing and Sales, has over 15 years experience in Marketing and Sales of Computer Hardware and Software. He has held marketing positions in companies like Birla Consultancy and Software Services Limited, National Electronics Company Limited, Jumbo Electronics Limited, Datamatics Limited and Blue Star Limited (Hewlett Packard, Motorola and Software Export Division). He has extensive experience in international marketing of software, managing Indian operations, setting up marketing teams, and has successfully developed business in the Far East, Middle East, Europe and USA. Mr. Aniket Jathar, Director-Technical aged 36 years, with a Post-Graduate Diploma in Software Technology and Computing Techniques from NCSDCT, has over 9 years experience in the software development business. He was with OMC Computers Limited and then with Neo Computers Private Limited before joining the company. He has been instrumental in the development of the Impact Analysis and Conversion tool that is used for the software exports projects contracted to the company. He oversees the training and development of the software professionals employed by the company. FUTURE BUSINESS STRATEGY Business Streams The five main business streams in the future would be: Client-Server Development: The Company’s personnel have been trained to execute projects using well-defined methodologies and quality procedures. With strong project management skills and over 80 man-years of experience in the Company, it can undertake a variety of large and complex client server developments right from system study to implementation. IT Support for European Monetary Union (EMU): The impact on the IT systems due to the single Euro-currency will be driven by the business decisions to be taken by the organization and the respective country’s participation in the EMU. The company has developed a tool that detects the currency field in a module and hence assists in EMU problem. The company’s services include: Analysis of existing system to understand current business processes, Impact Analysis of affected systems in view of the proposed changes, re-coding test suite design, test data generation and implementation. E-commerce Application Development: E-commerce activity is expected to exceed US$349 billion by the year 20x2. Business on the NET is booming and destroying old habits and creating new opportunities. Keeping this in mind, the company has developed skills that can be provided to end-users at competitive costs. Impact Analysis and Conversion Tool: This is a tool that has been developed by the company. The Y2K problem essentially revolves around locating all the date-fields throughout the length of the source code (normally a few million lines per program). The Impact Analysis tool simplifies the activity and reduces the time taken to modify the program and reduces possible oversights. The company has successfully executed projects using this tool and has received repeat orders for the same. On-site Development: These are the current on-site activities that are being carried out by the company. The company can provide personnel with any or all of the following skill set: Oracle, Developer 2000, Designer 2000, Sybase, Powerbuilder, Visual C++, Visual Basic, Java, Networking. Competition: The company competes with other software services companies on its strengths which include, successful track record, professionally qualified and experienced personnel and their skills. Growth Strategy The company has consciously looked at the European market to begin with, instead of the US where large numbers of Indian software companies operate focusing mainly on on-site consulting. Having established itself in the European market, the company is now focusing on the following: Direct contact with the end user: The company plans to start fully owned susidiaries in the UK, Germany and USA with marketing and support staff, which will focus on off-shore projects and direct contracting with end-users resulting in a high credibility of the company, enhancing its marketing abilities for projects and on-site development activities. 396
Part IV
Increasing geographic reach: By establishing subsidiaries in the UK and Germany, markets in Belgium, the Netherlands, France, Austria and Switzerland would be directly accessible to the company. New markets: Japan is the second largest IT market after the US. The company is taking the services of a software language translator to overcome the language barrier and enter this market. The US remains the largest market and it is still growing. New technologies evolve mainly out of the US and hence the market cannot be ignored. The emphasis of the US subsidiary will be on offshore projects through strategic alliances. Increase off-shore development: The company started its operation with major dependence on on-site consulting, which gave consistent revenues and margins. Since then, the company has successfully implemented off-shore projects and proposes to emphasize on the same in the future. Focus on high technology areas: The increasing and fast growing web based applications offer tremendous opportunities. Object technologies being the paradigm for the next generation software development, the company will invest in high technology areas like Distributed Object Management using CORBA and DCOM. Component programming and legacy system integration using object encapsulation will also be the focus. Presence in domestic market: The company will increase its presence in the growing domestic market by enhancing the skill set of its professionals in domain specific applications at low risk. The company is developing a banking product and an interactive telephony product that it proposes to sell in the domestic market. Note: 1.
The highest P/E ratio in the software industry is 121.7 and the lowest is 0.3. The average industry P/E is 25.1.
2.
Use annualized EPS for all the computations.
Assume the sensex at the time of issue as 4,750 and at the end of March, 20x0 as 5,460.
Case Study 6 Read the case carefully and answer the following questions. 1.
What are the conditions imposed by SEBI for a company to be eligible to tap the market with an IPO at premium?
2.
How many Lead Managers, Co-Managers and Advisors can be appointed for this issue?
3.
Justify the premium on this issue as per the Malegam Committee recommendations. State clearly both the qualitative and quantitative factors.
4.
Draw a list of highlights and risk factors for this issue.
5.
According to the SEBI guidelines state the minimum application by public for such an issue.
6.
a.
What would be the public holding after the issue is successfully completed? Will it be meeting the listing requirements as specified by SEBI?
b.
State the formalities associated with listing and give its advantages.
7.
Analysts feel that this is an underpriced issue. State the implications of the same.
Public Issue of 4,00,00,000 Shares of Rs.10 each at a Premium of Rs.35 per share aggregating Rs.180,00,00,000 during April, 20x0. Objects of the Offer 1.
To comply with the license condition stipulated by the RBI that the bank shall have 60% of its equity held by the public. Further dilution would take place in subsequent tranches.
2.
To augment the net worth of the bank for meeting future capital adequacy requirements.
3.
To get the bank shares listed on the stock exchanges.
Brief History of the Bank The Bank was incorporated on 31st January, 19x6 as a private bank. The Bank commenced commercial operations on 12th April, 19x6. 397
Investment Banking and Financial Services
As on 31.03.20x0, the bank was the largest private sector bank in terms of assets, deposits and net profits. Further the Bank was ranked as `Best Bank’ by the Financial Express Survey among 86 nationalized, foreign and private sector banks. Overview of the Bank’s Business The Bank has a network of 20 fully computerized and automated branches covering 10 states and 2 Union Territories. All Branches are connected through the satellite to a Central Database offering the facilities of `anywhere banking’ and instant funds transfer. The bank has a deposit base of Rs.3093.10 cr. The Bank’s Certificate of Deposit Program has been rated PR1+ by CARE for the last 3 consecutive years. The total staff strength is 294. According to the Financial Express survey the bank has been ranked No.1 in terms of business per employee and No.3 in terms of operating profit per employee. Income Recognition and Loan Provisioning Particulars
Amount in Crore
Standard Assets
1887.64
Sub-standard Assets
46.79
Doubtful Assets
1.98
Loss Assets
—
Total Assets
1936.41
Provisions as per RBI norms
8.75
Net Advances
1927.66
Net Non Performing Assets
40.02
NPAs to Net Advances
2.08% Capital Adequacy Position of the Bank (Rs. in crore)
Particulars
31.03.19x8
31.03.19x9
31.03.20x0
Risk Weighted Assets
488.28
1279.62
2165.91
Capital
161.67
232.77
279.46
33.11%
18.19%
12.90%
Capital Adequacy Ratio
Credit Deposit Ratio Particulars
Global Bank
Industry
19x7-x8
72.03%
54.69%
19x8-x9
79.39%
58.31%
19x9-20x0
62.32%
54.91%
Estimated Profit Forecast for 20x0-x1 Particulars
Amount in Crore
Interest Income
585.25
Other Income
146.31
Total Income
731.56
Interest Expended
449.18
Operating Expenses
79.58
Provisions & Contingencies
99.40
Total Expenses
628.16
Net Profit
103.40 398
Part IV
Financial Performance for the Last Three Years (Rs. in crore) Particulars
31.03.19x8
31.03.19x9
31.03.20x0
Interest Income
61.53
191.22
409.30
Other Income
18.11
36.55
81.87
Total Income
79.64
227.77
491.17
Interest Expense
37.14
134.20
310.07
9.23
27.51
56.15
Total Expenses
46.37
161.71
366.22
Operating Profit
33.27
66.06
124.95
Provisions & Contingency
11.44
20.44
51.63
Net Profit
21.83
45.62
73.32
100.00
120.00
120.00
6.83
111.34
159.46
Net worth
106.83
231.34
279.46
Deposits
649.89
1412.23
3093.10
Advances
500.54
1121.19
1927.65
188.04
357.50
1054.54
Operating Expense
Share Capital Reserves & Surplus
Investments Other Information
Industry P/E Ratio for Private Sector Banks 1.
Average P/E ratio
7.8
2.
Highest P/E ratio
35.8
3.
Lowest P/E ratio
2.6
Case Study 7 Read the case carefully and answer the following questions. 1.
Design a suitable instrument for XYZ Ltd. to mobilize funds from the public. The instrument designed should meet the constraints given. Give reasons wherever necessary.
2.
Determine the cost of the above instrument to XYZ Ltd.
3.
What are the important areas focussed by a credit rating agency in assigning rating to a debt instrument?
4.
What is the role and responsibility of a debenture trustee in case of a debt issue?
5.
The CEO has informed you that the company would like to offer the instrument designed by you in demateralized form. a.
Explain the concept of dematerialization of securities.
b.
What are the various benefits of dematerialization to the investors?
c.
Is it mandatory to give the option of rematerilization to the investors?
Make suitable assumptions wherever necessary and state them clearly. XYZ Company Limited (XYZ) is a profit making dividend-paying listed company engaged in manufacture of synthetic ropes. It has technical collaboration with a major foreign company for its existing product range. The company registered a sales turnover of Rs.5200 lakh and a net profit of Rs.2089 lakh for the year ended March 31, 20x1. 399
Investment Banking and Financial Services
XYZ has taken up an expansion project to increase the capacities of existing products, in technical and financial collaboration with the foreign company. The project was estimated to cost Rs.19000 lakh. The means of financing includes term loans of Rs.6500 lakh and Rs.2500 lakh from Indian promoters, Rs.3500 lakh from the foreign collaborator in the form of equity, Rs.1500 lakh in the form of internal accruals, and the balance Rs.5000 lakh from the public. Performance The financial performance of the company for the last five years is as follows: Year ended March 31 19x7 Sales 400 PBIDT 125 Financial Charges 30 Depreciation 15 PBT 80 Tax 5 PAT 75 Share capital 43 Reserves & surplus 116 Dividend (%) 10 Shareholding Pattern and price movements
19x8 700 180 30 18 132 1 131 85 239 12.50
19x9 825 190 15 18 157 2 155 85 375 16
20x0 2000 875 120 40 715 0 715 460 1883 18
(Rs. lakh) 20x1 5200 2484 300 95 2089 0 2089 460 3382 30
The shareholding pattern of XYZ’s existing Share Capital of Rs.460 lakh is as follows: Holding Promoters
46.39%
FIIs & Public 53.61% The price movement of the scrip on the Mumbai Stock Exchange since it is listed in July, 19x8 is as under: Month/Year 19x9 (Average) April, 20x0 May, 20x0 June, 20x0 July, 20x0 August, 20x0 September, 20x0 October, 20x0 November, 20x0 December, 20x0 January, 20x1 February, 20x1 March, 20x1 April, 20x1 May, 20x1 June, 20x1 July, 20x1 August, 20x1 September, 20x1
Share Price (in Rupees) High Low Average 115.0 40.0 77.50 115.0 85.0 100.00 97.5 85.0 91.25 100.0 90.0 95.00 110.0 92.5 101.25 90.0 82.5 86.25 110.0 85.0 97.50 113.0 89.0 101.00 102.0 97.0 99.50 138.0 97.0 117.50 166.0 133.0 149.50 204.0 143.0 173.50 153.0 148.0 150.50 150.0 101.0 125.50 141.0 102.0 121.50 125.0 114.0 119.50 138.0 118.0 128.00 135.0 118.0 126.50 172.0 130.0 151.00 400
Part IV
The scrip is currently being quoted at Rs.109 at a P/E multiple of 2.4 times the EPS of 20x0-x1. ABC Company Ltd. is the only other player in the market engaged in manufacture of ropes similar to that of XYZ. For the year ending March 31, 20x1, ABC posted a turnover of Rs.120 crore and a net profit of Rs.12.2 crore on an equity capital of Rs.20 crore. The scrip is being discounted at 5.9 times and currently quoted at Rs.36. Future Profitability of XYZ For the project Year Ended March 31 Capacity Utilization (%) Sales PBIDT G P Margin (%) For the Company as a whole Year Ended March 31 Sales PBIDT Interest Depreciation PAT Implementation
20x3 (6 months) 60.00 2860.00 1193.00 41.71 20x2 5591 2298 384 163 1485
20x3 8451 3484 801 1031 1308
20x4 70.00 6674.00 2763.00 41.40 20x4 12265 5046 1171 1898 1800
20x5 80.00 7627.00 3144.00 41.22 20x5 13218 5418 922 1898 2443
The new project of XYZ is expected to commence operations by September end, 20x2. Constraints in designing the instrument to mobilize funds from public: •
Straight equity issue is ruled out because of:
•
bearish market conditions in the equity market, natural resistance to premium issues
•
low pricing of equity is not acceptable to promoters
•
dilution in equity would immediately affect the bottom line of the company, while the project would generate cash flows only from October, 20x2.
Pure debt issue cannot be made as: •
The project cannot absorb interest expense before commencement of commercial production.
•
Further leveraging the capital structure is not acceptable to financial institutions.
Additional Information Research Reports by leading Investment Banks suggest that the market is expected to improve significantly from the second quarter of 20x2.
Case Study 8 Read the case carefully and answer the following questions. 1.
Compute the YTM/realized yield for the following bonds: i.
Encash bond assuming the investor opts for early redemption at the end of 5 years and 6 months from the date of allotment.
ii.
Money multiplier bond – Option III
iii.
Tax saving bond – Option I. Assume the investor avails the benefit under Section 88 of the Income Tax Act, 1961.
iv.
Tax saving bond – Option III: a.
Assume the investor is not availing the benefit under Section 54EC
b.
Assume the entire investment is made out of the net sale proceeds of a longterm asset and 60% of the investment is the capital gains realized on the sale of the asset. 401
Investment Banking and Financial Services
2.
Explain, with reasons, the types of investors to whom the regular income bond and the money multiplier bond would appeal.
3.
Explain, in detail, the concept of market making.
4.
What are the dimensions involved while designing innovative financial products by financial engineering?
5.
Is it mandatory for ICICI to pay interest on the application money as mentioned in the case? Give reasons.
6.
Discuss the steps required to create a vibrant debt market in India.
Clearly state your assumptions. ICICI has made a public issue of unsecured redeemable bonds in the nature of debentures aggregating Rs.400 crore with a right to retain oversubscription up to Rs.400 crore. TERMS OF THE ISSUE: ENCASH BOND Face Value
: Rs.5000
Redemption
: At face value i.e. Rs.5,000 at the end of 7 years from the Deemed Date of Allotment.
Interest
: Interest will be payable annually at the following rates:
Years Applicable rate of interest for respective years (%)
1st
2nd
3rd
4th
5th
6th
7th
11.00
12.00
13.50
15.00
16.00
17.00
18.00
Early Redemption at the option of the Bondholders (Encash Facility) An original individual allottee has the option of Early Redemption of the Bonds (‘Early Redemption’) at any time after the expiry of 12 months from the Deemed Date of Allotment till one month prior to the Redemption Date (‘Relevant Period’) at any of the branches of the ICICI Banking Corporation Limited. Payment on Early Redemption An investor who exercises the option of Early Redemption during Relevant Period, will receive the face value of the bond by way of cheque/pay order, etc. on presentation of duly discharged Bond Certificate to the Specified Branch. In case the bondholder exercises the option of Early Redemption of the Bond during the Relevant Period, the interest for the broken period (i.e. from the time of payment of interest for the previous year till the date of receipt of Bond Certificate by specified branch or such person at such address as may be notified by ICICI from time to time) will be paid to the bondholder by ICICI. TAX SAVING BOND Investors can avail rebate u/s 88 or tax benefits u/s 54EC of the Income Tax Act, 1961, by investing in bonds issued by a public financial institution for the purpose of deploying these funds towards infrastructure projects. The Central Board of Direct Taxes, Department of Revenue, Ministry of Finance, Government of India has, vide its notification nos. 10278 and 10279 dated March 4, 1997, declared the bonds issued by ICICI as specified assets for the purposes of Sections 54EC of the Income Tax Act, 1961 and vide its notification F No.178/94/97-ITA-I dated August 10, 1998 declared the Tax Saving Bond Option I and Option II as eligible security for the purposes of Section 88 of the Income Tax Act, 1961. Investors desirous of availing rebate u/s 88 or tax benefits u/s 54EC of the Income Tax Act, 1961 from payment of tax on capital gains can invest in the relevant option of this bond. The investor may choose any of the following options in respect of subscription for Tax Saving Bond.
402
Part IV
Option I Tax Benefit under Sec. 88 Issue Price (Rs.) 5,000 Face Value (Rs.) 5,000 Redemption Period 3 years Interest (%) (Payable annually) 12.50 The bonds are redeemed at face value.
II 88 5,000 7,350 3 years 3 months @ Zero Coupon Bond
III 54EC 5,000 5,000 7 years 13.00
REGULAR INCOME BOND Face Value : Rs.5,000 Redemption : At Face Value The investors can choose any of the following three options in respect of payment of interest: Option I II Minimum Application (Rs.) 15,000 10,000 Redemption Period (years) 5 5 Interest (%) 13.00 13.25 Interest Payable Monthly Half-Yearly MONEY MULTIPLIER BOND (in the nature of Deep Discount Bond)
III 5,000 5 13.75 Annually
Each Money Multiplier Bond in the nature of Deep Discount Bond will have different face values under each option and will be issued at a discounted price of Rs. 4000 each. Minimum Application: One Bond The investors can choose any of the following options (as per the table below) in respect of the Money Multiplier Bond. Option I II III Issue Price (Rs.) 4,000 4,000 4,000 Face Value/ Redemption Value (Rs.) 8,000 16,000 1,00,000 Redemption Period 5 years 4 months 10 years 7 months 24 years 5 months Payment of Interest on Encash Bond and Options I, III and IV of Tax Saving Bond: Interest will be paid on June 30 each year. The first interest payment will be made on June 30, 20x1 for the period commencing from the Deemed Date of Allotment and the last interest payment will be made at the time of Redemption of the Bond on a prorata basis. Interest on Application Money: Interest on Application Money @ 5.00 percent p.a. on the amount allotted for the period commencing from the 3rd day after the date of deposit of application form with the bankers to the issue till a day prior to the Deemed Date of Allotment. Such interest will be paid for the period commencing from the third day after the date of lodgment of the Application Form at the bank branches listed in the Application Form till a day prior to the Deemed Date of Allotment. The date of receipt of the Application Form as given by the bank branch will be considered as final. An investor should not deduct the interest on application money receivable by him from the amount payable on application. However, in case interest on application money is less than or equal to Rs.25 then the same would be paid along with the first interest payment/redemption, depending upon the instrument chosen, along with appropriate interest. Investors applying through stockinvest will not be entitled to any interest on application money. No interest on application money will be paid on the amount refunded, if any. Market Making: ICICI is making arrangements for market making of these bonds. Deemed Date of Allotment: The Deemed Date of Allotment for the issue has been fixed as 30 days from the date of closure of the issue or date of utilization of proceeds, whichever is earlier. All benefits relating to the bonds will be available to the investors from the Deemed Date of Allotment. The actual allotment may occur on a date other than the Deemed Date of Allotment. Market Lot: The market lot will be one Bond (‘Market Lot’). Ignore the time lag between the application date and allotment date. Assume the deemed date of allotment to be January 1, 20x1 and the tax on interest in the hands of the investors as nil. 403
