CA PRAVIIN MAHAJAN
Q1a A bank enters into a forward purchase TT covering an export bill for Swiss francs 1,00,000 at 32.4000 due on
25th April and covered itself for same delivery in the local inter bank market at 32.4200. However on 25th
March, exporter sought for cancellation of contract as the tenor of the bill is changed
In singapore market, swiss Francs were quoted against US dollars as under :
5 Marks
Spot
USD 1 = Sw.Fcs 1.5076/1.5120
One month forward
1.5150/1.5160
Two month forward
1.5250/1.5270
Three month forward
1.5415/1.5445
And in the inter bank market US dollars were quoted as under:
Spot
USD 1 = 49.4302/.4455
Spot/April
.4100/.4200
Spot/May
.4300/.4400
Spot/June
.4500/.4600
Calculate the cancellation charges payable by the customer if exchange margin required by the bank is 0.10%
on buying and selling
Comment - Simple ques of Cancellation of forward contract . DONE IN CLASS
Ans
Bank made forward contract to purchase SF 1,00,000 @ 32.40 on 25th april. On 25th march customer
approached bank to cancell contract. For cancellation bank will sell 1,00,000 $ to customer at one month
forward rate
For cancellation Bank will sell SF 1,00,000 at
(49.4455 +0.4200 +
32.947
0.1
100
x 49.8655)
1
1.5150
b.
32,40,000
3.
4.
5.
c.
CA PRAVIIN MAHAJAN
volatality of bond
3881.31
=
848.35
1 +
4.575 years
4.575
1.15
= 3.98 %
Mr Dayal is interested in purchasing equity share of ABC Ltd which are currently selling @ 600 each. He
expects that price of share may go upto 780 or may go down to 480 in three months. The chances of
occuring such variations are 60% and 40% respectively. A call option on shares of ABC Ltd can be excersised at
the end of three months with a strike price of 630.
1. What combination of share and option should Mr dayal select if he wants a perfect hedge?
2. What should be the value of option today (the risk free rate is 10% p.a)
5 marks
3. What is the expected rate of return on option.
Comment : It is the simple question of binomial model same as Q 42 of derivatives of our
book. Since probability of high price and low price is given, so vl use risk neutralisation model. But
hedge ratio is computed acc to binomial model. DONE IN CLASS
Ans
1.
Hedge ratio
2.
Value of option
780 630
780 480
CA PRAVIIN MAHAJAN
= 0.5 or 50%
. +
1+
(1+ )
1.3 1.025
1.3 0.8
0.45
Value of option =
3.
= 0.55
0 0.55
= 65.85
x 100
0 0.4
2.5
3
x 12 = 10%
If risk is neutralised then return on option is equal to risk free return i.e 10%
d
XYZ an indian firm, will need to pay JAPANESE YEN (JY) 5,00,000 on 30th June. In order to hedge the risk .
involved in foreign currency transaction, the firm is considering two alternative methods i.e forward market
cover and currency options contract.
On 1st april, following quotations (JY/INR) are made available
Spot
3 months forward
1.9516/1.9711
1.9726/1.9923
The prices for forex currency option are as follows
Strike price
JY 2.125
Call option (June)
JY 0.047
Put option (June)
JY 0.098
For excess or balance of JY covered, the firm would use forward rate as future spot rate
You are required to recommend cheaper hedging alternative for XYZ.
5 marks
Comment : This is the question of currency option with INDIRECT QUOTE. Q 91 c, pg 3.23 . If students
are habitual of coverting direct quote into indirect quote, answer will not be correct. So it is
utmost importance that student should be able to do and read indirect quote as it is. DONE IN CLASS
Ans
CA PRAVIIN MAHAJAN
5,00,000
2.125
= 2,35,294.12
23,059 JY
11,815
2,35,294.12
2,47,109.12
E Ltd
20 lakhs
1000 Lakhs
10.00
600.00 Lakhs
9.50 Lakhs
H Ltd
15 lakhs
1500 Lakhs
5.00
330.00 Lakhs
10.00 Lakhs
The Board of directors of both the companies have decided to give a fair deal to the shareholders. Accordingly,
the weights are decided as 40%, 25% and 35% respectively for earnings, book value and market price of share
of each company for swap ratio.
Calculate the following:
10 Marks
1.
2.
3.
4.
5.
Market price per share, earning per share and Book value per share
Swap ratio
Promoters holding percentage after acquisition
EPS of E Ltd after acquisition of H Ltd
Expected market price per share and Market capitalisation of E Ltd after acquisition assumingPE ratio
of E ltd remains unchanged
6. Free flow market capitalisation of merged firm.
Comment : Simple question of Merger and acquisition. Q8 pg 4.3. DONE IN CLASS
1.
CA PRAVIIN MAHAJAN
MP per share
E
H
50
100
EPS
MP/PE ratio
50/10
100/5
5
20
E
H
Book Value per share
E
H
2.
Swap ratio
3.
5.
6.
=
=
57.5 lakh
9.50 lakh
10 x 2.5 = 25 lakh
34.5 lakh
34.5
57.5
= 60%
5 20 + 20 15
57.5
= 6.96
Q2b Mr A will need 1,00,000 after 2 years for which he wants to make one time necessary investment now. He
has a choice of 2 types of bonds. Their details are below:
Bond X
Bond Y
Face value
1000
1000
6 Marks
Coupon
7% payable annually 8% payable annually
Years to maturity
1
4
Current price
972.73
936.52
Current yield
10%
10%
Advise Mr A whether he should invest all his money in one type of bond or he should buy both the bonds and
if, so, in which quantity. Assume that there will not be any call risk or default risk
5
CA PRAVIIN MAHAJAN
1070 0.9091
972.73
= 1 yr
3335.68
936.52
= 3.562
For immunisation Duration of liablity portfolio i.e 2 should match with duration of bond portfolio
Duration of bond portfolio is weighted average of duration of each bond in portfolio
W X D X + WY D Y = 2
X . 1 + (1 - x ) 3.562 = 2
X + 3.562 - 3.562 x = 2
2.562x = 3.562 2
X =
1.562
2.562
= 0.61
Investment in Bond Y
82,600 x 39 = 32,214
No. of units of Bond Y = 32,214/936.52 = 34.39 units
Q3a On 1st April, 2015 an investor has a portfolio consisting of eight securities as shown below
Security
A
B
C
D
E
F
G
H
6
Market price
29.40
318.70
660.20
5.20
281.90
275.40
514.60
170.50
No. of shares
400
800
150
300
400
750
300
900
value
0.59
1.32
0.87
0.35
1.16
1.24
1.05
0.76
CA PRAVIIN MAHAJAN
The cost of capital for the investor is 20% p.a continuosly compounded. The investor fears a fall in the
prices in the prices of the shares in the near future. Accordingly, he approaches you for the advice to protect
the interest of his portfolio.
You can make use of the following information
1. The current Nifty value is 8500
8 Marks
2. Nifty futures can be traded in units of 25 only
3. Futures for may are currently quoted at 8700 and Futures for june are being quoted at 8850
You are required to calculate :
i.
The beta of his portfolio
ii.
The theoretical value of the futures contracts expiring in may and june
(Given e0.03= 1.03045, e0.04= 1.04081, e0.05 = 1.05127)
iii.
The number of Nifty contracts that he would have to sell if he desires to hedge until june in each
of the following cases:
(A) His total portfolio
(B) 50% of his portfolio
(C) 120% of his portfolio
Comment : Lengthy but very simple and basic question of Derivatives.
Q97 pg2.9. similar to May 13. DONE IN CLASS
Ans
i.
Statement of Portfolio
Security
Market price
A
B
C
D
E
F
G
H
29.40
318.70
660.20
5.20
281.90
275.40
514.60
170.50
No. of
shares
400
800
150
300
400
750
300
900
Portfolio =
ii.
Value
of share
11,760
2,54,960
99,030
1560
1,12,760
2,06,550
1,54,380
1,53,450
9,94,450
1095832.3
9,94,450
= CMP ert
=
=
=
=
value
Value x
0.59
1.32
0.87
0.35
1.16
1.24
1.05
0.76
6938.4
336547.2
86,156.1
546
1,30,801.6
2,56,122
1,62,099
1,16,622
1095832.3
= 1.102
iii.
=
=
=
=
CA PRAVIIN MAHAJAN
b.
=
=
=
=
=
=
=
=
=
The finance manager of ABC corporation is analyzing firms policy regarding computers which are now being
leased on yearly basis on rental amounting to 1,08,000 per year. The computers can be bought for
5,00,000. The purchase would be financed by 16% and the loan is repayable in 4 equal annual installments.
On account of rapid technological progress in the computer industry, it is suggested that a 4-year economic
life should be used instead of a 10-year physical life. It is estimated that the computers would be sold for
2,00,000 at the end of 4 years.
8 marks
The company uses the straight line method of depreciation . Corporate tax rate is 35%.
a. Whether the equipment be bought or be taken on lease.
b. Analyze the financial viability from the point of view of the lessor, assuming 14% cost of capital.
c. Determine the minimum lease rent at which lessor would break even.
Comment : Lengthy but simple question of leasing
CA PRAVIIN MAHAJAN
ABC corporation is analysing its policy of leasing or purchasing a computer costing 5,00,000
If computers are taken on lease
Company will pay annual lease rent of 1,08,000
Statement of cash outflow if asset is taken on lease
Particulars
Amount
period
factor
PV
16(1-0.35)=10.4%
Lease Rent
1,08,000
1-4e
3.143
3,39,444
Tax saving on lease rent
(37,800)
1-4e
3.143
(1,18,805)
PV of cash outflow
2,20,639
If asset is purchased
Co. will purchase the asset by borrowing from bank @ 16%, repayable in 4 equal annual installments
Amount of each installment
Installment x factor = loan
Inst x 2.798 = 5,00,000
Inst = 1,78,699
Statement of Principal and interest
Installment
Interest
Principal
loan o/s
tax sav on int
1,78,699
80,000
98699
4,01,301
28,000
1,78,699
64,208
1,14,491
2,86,810
22,473
1,78,699
45,890
1,32,809
1,54,001
16,062
1,78,699
24,698
1,54,001
8644
Statement of cash outflow if asset is purchased
Particulars
Amount
period
factor 10.4% PV
Installment
1,78,699
1-4e
3.143
5,61,651
Tax saving on interest 28,000
1e
0.906
(25,368)
22,473
2e
0.820
(18,428)
16,062
3e
0.743
(11,934)
8,644
4e
0.673
(5,817)
Tax saving on dep
5,00,000 2,00,000
x
4
Salvage value
Ii.
0.35 26,250
2,00,000
1-4e
3.143
(82,504)
4e
0.673
(1,34,600)
2,83,000
CA PRAVIIN MAHAJAN
Factor14%
1
Pv
(5,00,000)
2.914
2.914
0.592
1.8941x
76,493
1,18,400
0
3,05,107
1.8941
= 1,61,083
XYZ ltd, a company based in India, manufactures very high quality modern furniture and sells to a
small number of retail outlets in India and Nepal. It is facing tough competition. Recent studies on
marketability of products have clearly indicated that customer is now more interested in variety and
choice rather than exclusivity and exceptional quality. Since the cost of quality wood in India is very
high, the company is reviewing the proposal for import of woods in bulk from Nepalese supplier.
The estimate of net Indian and Nepalese currency (NC) cash flows for this proposal is shown below:
Net cash flows (in Millions)
Year
0
1
2
3
NC
-25,000
2,600
3,800
4,100
Indian
0
2,869
4,200
4,600
The following information is relevant :
8 marks
i.
XYZ evaluates all investments by using discount rate of 9% p.a. All nepalese customers are
invoiced in NC. NC cash flows are converted to Indian () at the forward rate and discounted
at the Indian rate.
ii.
Inflation rates in Nepal and India are expected to be 9% and 8% p.a respectively. The current
exchange is 1 = NC 1.6
Assuming that you are the finance manager of XYZ Ltd, calculate the NPV and Modified IRR of the
proposal.
You may use the following values with respect to discount factor 1 @ 9%
Year
1
2
3
Present Value
0.917
0.842
0.772
Future Value
1.188
1.090
1
Comment : Simple question of fischer effect, foreign exchange.
10
Question is silent if nepalese and Indian cash flows are real or money cash flows. So it can be
assumed Cash flows given are Real cash flows . Alternatively it can be assumed that cash
flows given are Money cash flows
CA PRAVIIN MAHAJAN
NC Real CF
-25,000
2600
3800
4100
Inflation9%
1
1.09
(1.09)2
(1.09)3
Inflation8%
1
1.08
(1.08)2
(1.08)3
Money CF
0
3099
4899
5795
2834
1.09
1.6 x 1.08
1755
2770
4515
1.6 x
5310
1.6 x
Particulars
Cash Flows
Cash Inflows
(1.09)2
(1.08)2
(1.09)3
(1.08)3
3228
Statement of NPV
Amount
period
15,625
0
Factor 9%
1
PV
(15,625)
1755
3099
4854
0.917
4451
2770
4899
7669
0.842
6457
3228
5795
9023
0.772
NPV
6966
2249
Modified IRR
IRR assumes that all intermediate cash flows of project are reinvested at the rate of IRR. To rectify this flaw of
IRR Modified IRR is computed. Modified IRR assumes that all positive cash flows are reinvested at cost of cap
-
Compute future value of cash flows assuming cash flows are reinvested at cost of capital
Invested for remaining period in the project
Maturities
4854 earned at the end of 1st year invested for 2 years 4854 (1.09)2
7669 earned at the end of 2nd year invested for 1 year 7669 (1.09)
9023 earned at the end of 3rd year not reinvested
5766
8359
9023
23,148
23,148
15,625
CA PRAVIIN MAHAJAN
- 1
14%
II
Year
0
1
2600
3800
4100
Particulars
Cash Flows
Cash Inflows
1.09
1.6 x 1.08
1610
1.6 x (1.08)2
2331
(1.09)2
(1.09)3
1.6 x (1.08)3
2492
Statement of NPV
Amount
period
15,625
0
Factor 9%
1
PV
(15,625)
1610
2869
4479
0.917
4107
2331
4200
6531
0.842
5499
2492
4600
7092
0.772
NPV
5475
(544)
Modified IRR
Invested for remaining period in the project
4479 earned at the end of 1st year invested for 2 years 4479 (1.09)2
6531 earned at the end of 2nd year invested for 1 year 6531 (1.09)
7092 earned at the end of 3rd year not reinvested
-
Maturities
5321
7119
7092
19532
12
=
=
19,532
15,625
- 1
7.73%
CA PRAVIIN MAHAJAN
Q4b Mr X on 1.7.2012 during the initial public offer of a mutual fund invested 1,00,000 at face value of 10. On
31.03.2013, the MF declared a dividend of 10% when Mr X calculated that his holding period rate of return
was 115%. On 31.3.2014, MF again declared a dividend of 20%. On 31.3.2015, Mr X redeemed all his
investment which had accumulated to 11,296.11 units when his holding period return was 202.17%
Calculate The NAV as on 31.03.2013, 31.03.2014, 31.03.2015
8 marks
115%
+ ( )
= 1.15
1 + ( 10)
10
= 1.15
= 20.5
NAV on 31.03.14
All dividend received is reinvested
Units purchased on 31.03.13
10,000
20.5
= 487.80
= 10,487.80
= 10,487.8 x 10 x 0.2 = 20,976
=
11,296.11 units
=
11,296.11 10,487.8 = 808.31
NAV on 31.03.14
20,976
808.31
= 25.95
NAV on 31.03.15
HPRR on 31.03.15
202.17%
NAV on 31.03.15
13
=
=
1,00,000
2,02,170
3,02,170
11,296.11
3.02,170
11,296.11
= 26.75
CA PRAVIIN MAHAJAN
Q5a ABC Ltd., a US Firm will need 5,00,000 in 180 days. In this connection, the following information is available:
Spot rate 1 = $ 2.00
180 days forward rate of as of today is $ 1.96
Interest rates are as follows
US
UK
180 days deposit rate
5.0%
4.5%
180 days borrowing rate
5.5%
5.0%
A call option on that expires in 180 days has an exercise price of $ 1.97 and a premium of $ 0.04
ABC Ltd. has forecasted the spot rates for 180 days as below:
Future rate
Probability
$ 1.91
30%
$1.95
50%
$ 2.05
20%
Which of the following strategies would be cheaper to ABC Ltd?
i.
ii.
iii.
iv.
8 Marks
Forward contract
A money market hedge
A call option contract
No hedging option
Comment : Simple question of currency options.Q95 pg 3.24. DONE IN CLASS
Ans
20,000 $
Due date
EP
MP
$ 1.97 /
1.91 x 0.30 + 1.95 x 0.5 + 2.05 x 0.20
= $ 1.958
MP < EP , call will not be exercised
US firm will purchase from market @ $ 1.958 /
Amount paid 5,00,000 x 1.958
2. Money market hedge
Process ($ borrow, deposit )
1. Deposit present value of 5,00,000 , co. will deposit
5,00,000
1.0225
14
9,79,000 $
9,99,000 $
4,88,998
CA PRAVIIN MAHAJAN
$ 9,77,996
$ 10,04,891
$ 9,79,000
i.
ii.
15
CA PRAVIIN MAHAJAN
=
19.125
=
Op NAV 2 %
= 18.75 0.02 x 18.75
=
18.375
iii.
Repurchase price
iv.
5625 lakh
114.75 lakh
(55.125 lakh)
102.825lakh
(71.9775 lakh)
425.47 lakh
6140.9425
303 lakh
20.267
Q6a XYZ Ltd wants to purchase ABC Ltd by exchanging 0.7 of its share for each share of ABC Ltd. relevant financial
data are as follows:
Equity share outstanding
10,00,000
4,00,000
EPS ))
40
28
Market price per share ()
250
160
10 MARKS
i.
ii.
iii.
iv.
Comment : Again utmost simple ques of Merger. Examiner aiways use one point in ques, which we
extensively discussed and proved in class, i.e PE ratio after merger is given
Ans
i.
16
CA PRAVIIN MAHAJAN
= 36.57
250
40
x 36.57
228.5625
iv.
250
228.5625
21.4375
10 lakh x 21.4375 = 214.375 lakh
5.2
4
= 1.3 :1
Q6b X Ltd is a shoes manufacturing company, it is all equity financed and has a paid up capital of 10,00,000 ( 10
per share)
X Ltd has hired Swastika consultants to analyse the future earnings . The report of Swastika consultants states
as follows:
i.
The earnings and dividend will grow at 25% for the next 2 years
ii.
Earnings are likely to grow at the rate of 10% from 3rd year and onwards
iii.
Further , if there is a reduction in earnings growth, DP ratio will increase to 50%
17
CA PRAVIIN MAHAJAN
Ans i.
Year
2015
2016
2017
Year
2015 - 1
2016 - 2
2017 - 3 2
Statement of CMP
Cash flow
Factor 15%
4.8
0.870
6
0.756
8.25
=
0.15 0.10
165
0.756
PV
4.176
4.536
124.74
133.452
ii.
18
PE ratio
133.452
9.6
= 13.90125 times