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Question Paper
Financial Management-I (MB2E1): October 2008
- Answer all 72 questions.
- Marks are indicated against each
question.
Total Marks : 100
1. Which of the following implies the significant advantage of a public limited company over a
proprietorship firm?
(a) Limited liability
(b) Difficulty to transfer ownership interest
(c) Limited life
(d) Inability to mobilize large funds
(e) Fewer government regulations. ( 1 mark)
2. Which of the following players cannot act as a borrower in the call money market?
(a) Discount and Finance House of India
(b) SBI Mutual Fund
(c) State Bank of India
(d) Securities Trading Corporation of India
(e) Reserve Bank of India. ( 1 mark)
3. Which of the following statements represents the financing decision of a company?
(a) Procuring new machineries for the R & D activities
(b) Recruiting the new employees in order to increase the productivity of the company
(c) Adopting state of the art technology to reduce the cost of production
(d) Purchasing a new building to expand the business
(e) Designing an optimal capital structure by using suitable financial instruments. ( 1 mark)
4. Which of the following is not a feature of certificate of deposit issued by a bank?
(a) It is a document of title to a time deposit
(b) There is no lock-in period for transferring it to others
(c) It is not subject to the reserve requirement of the bank
(d) It is transferable by endorsement and delivery
(e) The maximum maturity period is one year. ( 1 mark)
5. Which of the following is a sterling denominated foreign bond raised in the United Kingdom domestic
securities market?
(a) Samurai Bonds
(b) Yankee Bonds
(c) Bulldog Bonds
(d) Shibosai Bonds
(e) Matador Bonds. ( 1 mark)
6. Which of the following instruments in the international capital market are fixed-interest securities
having a maturity of over one year?
(a) Commercial Papers
(b) Medium-Term Notes
(c) American Depository Receipts
(d) Treasury Bills
(e) Global Depository Receipts. ( 1 mark)
7. If an amount of Rs.50 crores is borrowed in the call money market, then the interest rate is decided by
( 1 mark)
(a) The lender
(b) The borrower
(c) The Reserve Bank of India as the amount involved is huge
(d) Negotiation between lender and borrower
(e) Both lender and borrower but within the maximum limit prescribed by RBI.
8. M/s. Pee & Cee Ltd., has received the third highest credit rating for its issue of commercial paper. If its
fund based working capital limit is Rs.3 crores, and assuming other requirements are met then which of
the following is true?
(a) It can issue commercial paper within the maximum limit of Rs.3 crores
(b) It can issue commercial paper but the amount should not be less than Rs.5 lakhs
(c) It can issue commercial paper but the amount should be less than Rs.5 lakhs
(d) It can issue commercial paper to any amount
(e) It cannot issue commercial paper. ( 1 mark)
9. In the foreign exchange market if an agreement on a transaction took place on July 1, 2008 and the
value date is July 3, 2008, then the transaction is said to be a part of the
(a) Spot market
(b) Tom market
(c) Cash market
(d) Ready market
(e) Forward market. ( 1 mark)
10. Which of the following situations leads to the increase in volatility in the call money market?
(a) Reduction in cash reserve ratio
(b) Prepayment of term loans by a large number of borrowers
(c) Entry of the financial institutions (FIs) into the market
(d) Payment of large amount of advance taxes by the banks and FIs
(e) Decrease in the demand for loanable funds in the economy. ( 1 mark)
11. If the effective rate of interest is 10.25% per annum and the nominal rate of interest is compounded
twice a year, then the nominal rate of interest per annum is
(a) 9.00%
(b) 10.00%
(c) 10.50%
(d) 11.00%
(e) 12.00%. ( 1 mark)
12. Mr. Sameer is considering investing in the equity shares of Wilson Company. He gathers the following
information on the equity shares of the company:
Return on the stock when the market return is zero 4%
Rate of return on the market 12%
Beta of the shares 0.
Expected Earnings per share next year Rs.
Pay-out ratio 60%
Current market price of the share Rs. Mr. Sameer expects the
earnings of the company to grow at a constant rate and the pay-out ratio to remain constant.
If the equity share is in market equilibrium, the expected price of the share at the end of five years will
be (convert to the nearest integer)
(a) Rs.
(b) Rs.
(c) Rs.
(d) Rs.
(e) Rs.35. ( 2 marks)
13. Vision Ltd., a Non-Banking Financial Company (NBFC) offers car loans with two different schemes.
Scheme A offers 10% discount on down payment of cash. Scheme B asks for a down payment of Rs.
18,000 and a monthly payment of Rs. 4,100 for 5 years.
If the cost of the car is Rs. 2.5 lakhs and the required rate of return is 9%, which of the following
( 2 marks)
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) Both (I) and (III) above.
19. Which of the following is/are true regarding variability?
I. Higher the range, higher the standard deviation.
II. Of the two probability series, the one which has the highest mean value, has the highest standard
deviation.
III. Higher the variance, higher the standard deviation.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) All (I), (II) and (III) above. ( 1 mark)
20. Which of the following relationships is represented by the characteristic regression line (CRL)?
(a) The return on the portfolio and the variance of its returns
(b) The return on the portfolio and the return on the market index
(c) The return on the portfolio and its beta
(d) The return on the portfolio and the risk free rate of return
(e) The return on the portfolio and the market risk premium. ( 1 mark)
21. The stock of Golden Technologies Ltd., is currently quoting at Rs.60 per share in the market and it is
expected to pay a dividend of Rs.2 per share in the current year. The stock price expected one year
hence has the following probability distribution:
Probability 0.30 0.50 0.
Price (Rs.) 70 80 90 The expected return from investing in the stock is
approximately
(a) 15%
(b) 19%
(c) 23%
(d) 25%
(e) 35%. ( 2 marks)
22. The current purchase price of a security is Rs.50, the last dividend paid is Rs.2 and the growth rate is
7%. If the required rate of return on security according to CAPM is 10%, then what should be the
increase/decrease in the price of the security such that it is at equilibrium?
(a) Increase by Rs.21.
(b) Decrease by Rs.21.
(c) Increase by Rs.
(d) Decrease by Rs.
(e) Security is already at equilibrium. ( 2 marks)
23. An investor has purchased a security that has a beta of 0.6. The investor is expecting this security to
provide a return of 12%. If the expected risk free rate is 6% and expected return on the market index is
14%, which of the following is/are true according to CAPM?
I. The security falls above the SML.
II. The security is overvalued.
III. Alpha intercept is positive.
IV. The security can be purchased.
(a) Only (II) above
(b) Both (I) and (III) above
(c) Both (II) and (III) above
(d) (I), (III) and (IV) above
(e) (II), (III) and (IV) above. ( 2 marks)
24. India Investment Fund holds the following portfolio:
( 2 marks)
Stock Investment (Rs. crore) Beta
A 200 0.
B 200 2
C 100 4
The required rate of return on the market
is 14% and that of the above portfolio according to CAPM is 20.4%. The fund manager has proposed to
sell C for Rs.100 crores and use the proceeds to purchase stock D which has a beta of 3. The required
rate of return of the new portfolio according to CAPM is
(a) 12.8%
(b) 18.1%
(c) 18.8%
(d) 20.2%
(e) 21.3%.
25. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50 percent of Portfolio P is invested in Stock A
and 50 percent is invested in Stock B. If the market risk premium were to increase but the risk-free rate
remained constant, which of the following would occur?
(a) The required return will decrease by the same amount for both Stock A and Stock B
(b) The required return will increase for both stocks but the increase will be greater for Stock B than
for Stock A
(c) The required return will increase for Stock A but will decrease for Stock B
(d) The required return will increase for Stock B but will decrease for Stock A
(e) The required return on Portfolio P will remain unchanged. ( 1 mark)
26. Mr.Amit bought 100 equity shares of a company. After a year, he found that the ratio of the price of an
equity share at the end of a 1-year period to its price at the beginning of the 1-year period is 5:4. What
is the capital gain yield from the equity share?
(a) 20%
(b) 25%
(c) 60%
(d) 75%
(e) 80%. ( 1 mark)
27. If the beta of a stock is equal to zero, which of the following statements is/are true according to
CAPM?
I. Slope of SML is zero.
II. Required rate of return of the given stock is equal to the risk free rate of return.
III. Stock will lie on the SML.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) All (I), (II) and (III) above. ( 1 mark)
28. Which of the following statements is not true?
(a) Each level of EBIT has a distinct DFL
(b) DFL is undefined at financial breakeven point
(c) DFL will be negative when the EBIT level goes below the financial breakeven point
(d) DFL will be positive for all values of EBIT that are above the financial breakeven point
(e) DTL above breakeven point increases as quantity produced keeps on increasing. ( 1 mark)
29. Which of the following is a key determinant of operating leverage?
(a) Sales variability
(b) Physical location of production facilities
(c) Cost of debt
(d) Capital structure
(e) Level of fixed costs. ( 1 mark)
30. Other things remaining the same, which of the following will increase the quantity produced at the
operating break-even point?
( 1 mark)
I. They are also referred to as PSU bonds.
II. They are issued through auctions conducted by RBI.
III. They cannot be rediscounted with RBI.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (II) and (III) above
(e) Both (I) and (III) above.
36. Which of the following bonds will have the greatest percentage increase in value if all interest rates
decrease by 1 percent?
(a) 20-year, zero coupon bond
(b) 10-year, zero coupon bond
(c) 20-year, 10 percent coupon bond
(d) 20-year, 5 percent coupon bond
(e) 10-year, 5 percent coupon bond. ( 1 mark)
37. Which of the following is/are not true regarding the dividend ratios?
I. Dividend yield is always expressed as a percentage of earnings of the company.
II. Dividend yield is calculated as dividend pay-out ratio divided by the P/E ratio.
III. It is desirable to invest in a company having a high dividend yield irrespective of its profitability
and liquidity.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (II) above
(e) Both (I) and (III) above. ( 1 mark)
38. A zero-coupon bond that matures 5 years from today has a par value of Rs.2,500 and yield to maturity
of 11.5% per annum, what is the current value of the issue?
(a) Rs. 685
(b) Rs.1,
(c) Rs.1,
(d) Rs.2,
(e) Rs.2,500. ( 1 mark)
39. Ajanta's stock is currently selling for Rs.11.44. This year the firm had earnings per share of Rs.2.80 and
the current dividend is Rs.0.68. Earnings are expected to grow 7% a year in the foreseeable future. The
risk-free rate is 10 percent and the expected market return is 14.2 percent. What will be the effect on the
price of Ajanta’s stock if systematic risk of the stock increases by 40 percent, all other factors
remaining constant?
(a) An increase of Rs.1.
(b) A decrease of Rs.0.
(c) A decrease of Rs.1.
(d) An increase of Rs.0.
(e) Remains same. ( 3 marks)
40. Three bonds A, B and C with same coupon rate, par value and maturity have yields to maturity (YTMs)
of 10%, 8%and 12% respectively. Then which of the following expressions is/are true regarding the
value of bonds A, B and C?
(a) A>B>C
(b) A>C>B
(c) B>A>C
(d) C>A>B
(e) C>B>A. ( 1 mark)
41. Which of the following will lead to an increase in the expected Price-Earning ratio?
I. Increase in the expected dividend payout ratio.
II. Increase in the cost of equity capital.
( 1 mark)
III. Increase in the growth rate.
(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (III) above
(e) Both (II) and (III) above.
42. Which of the following statements is not true with regard to valuation of bonds?
(a) An increase in the required rate of return, other things remaining the same, will decrease the
bond value
(b) An increase in the number of years to maturity, other things remaining the same, will increase
the present value of the face value of the bond payable at maturity
(c) An increase in the coupon rate, other things remaining the same, will increase the bond value
(d) An increase in the face value of the bond payable at maturity, other things remaining the same,
will increase the bond value
(e) An increase in yield to maturity will occur if the amount payable at maturity increases, other
things remaining the same. ( 1 mark)
43. Which of the following is not true with regard to the multi period valuation model of equity shares?
(a) There is a pre-specified maturity period
(b) The value of an equity share is equal to the present value of the dividends over an infinite
duration
(c) The model can be applied to the instances of constant dividends and constant growth in
dividends
(d) The model can also be applied in case of variable growth in dividends
(e) The model can be applied to find out the fair value of the shares. ( 1 mark)
44. Which of the following is/are true with regard to the convertible debentures?
I. The conversion value is the minimum value of the convertible based on the current price of the
issuer’s stock.
II. In case of optionally convertible debentures, on the exercise of the option of conversion the holder
of the instrument has to pay the issuer the specified amount.
III. Conversion premium is the difference between the conversion price and the conversion value.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (II) above
(d) Both (I) and (III) above
(e) Both (II) and (III) above. ( 1 mark)
45. When the market is low, which of the following methods of raising capital are preferred?
I. Initial public offer.
II. Bought-out deal.
III. Private placement.
IV. Rights issue.
(a) Both (I) and (II) above
(b) Both (I) and (IV) above
(c) Both (II) and (III) above
(d) (I), (II) and (IV) above
(e) All (I), (II), (III) and (IV) above. ( 1 mark)
46. Who among the following players in the international capital markets collect the rupee dividends on the
underlying shares and repatriate the same to the depository in US dollars/foreign equity?
(a) Lead Managers
(b) Underwriters
(c) Custodians
(d) Corporate borrowers
(e) Lenders. ( 1 mark)
47. Which of the following is a feature of secured premium notes (SPN)?
( 1 mark)
Walter model is
(a) Rs.1,10,00,
(b) Rs.2,20,00,
(c) Rs.3,30,00,
(d) Rs.4,40,00,
(e) Rs.5,50,00,000.
55. The following details are available regarding the long term sources of finance of M/s.Magnet
Enterprises:
Sources of
Finance
Range of new financing from the source
(Rs. in crores)
Post tax Cost (%)
Equity 0-
Preference 0-
1 and above
Debt 0-
The
company is considering to expand its operations and requires Rs.50 crores for the same. It is planning to
raise funds from these sources in the following proportions:
Equity 30%
Preference 10%
Debt 60%
The weighted marginal cost of capital of new financing in the range of Rs.30 crores - Rs.50 crores is
(a) 8.95%
(b) 9.95%
(c) 10.95%
(d) 11.95%
(e) 12.95%. ( 3 marks)
56. The following information is given about the debentures issued by M/s. Alpha Ltd.:
Face Value = Rs.1,
Rate of interest = 8% p.a.
Amount realized per debenture = Rs.
Corporate tax rate = 30%
Debenture is redeemable at a premium of 5% after 5 years. The cost of debenture capital is
approximately
(a) 5.2%
(b) 6.2%
(c) 7.5%
(d) 8.8%
(e) 9.2%. ( 2 marks)
57. BNN Ltd., has the following data:
Market value of equity Rs.60 lakh
Market value of debt Rs.40 lakh
Cost of equity 17%
Cost of debt 15% Assuming that the firm is operating under the
regime of no taxes, the net operating income for the firm is
(a) Rs.13.2 lakh
(b) Rs.14.2 lakh
(c) Rs.15.2 lakh
(d) Rs.16.2 lakh
(e) Rs.17.2 lakh. ( 2 marks)
58. Consider the following data of KSN Ltd., and GSN Ltd.
( 2 marks)
KSN Ltd. (Rs.) GSN Ltd. (Rs.)
Net operating income 5,00,000 5,00,
Interest on debt @ 8% - 2,40,
Corporate tax rate 50% 50% As per the MM Hypothesis,
the value of levered firm exceeds the unlevered firm by
(a) Rs.15,00,
(b) Rs.20,00,
(c) Rs.24,00,
(d) Rs.25,00,
(e) Rs.30,00,000.
59. MSK Ltd., has an equity of Rs.8,40,000 and 15% preference share capital of Rs.6,00,000. The face
value of its shares is Rs.10 and market value is Rs.20 and it had posted a profit after tax of Rs.9,00,
this year. The company paid Rs.3,36,000 by way of equity dividends. If the dividends grow at 5% then
the cost of equity according to earning price ratio approach is
(a) 25.01%
(b) 35.61%
(c) 45.51%
(d) 50.61%
(e) 55.01%. ( 2 marks)
60. The cost of which of the following sources of finance can be found out by the bond yield plus risk
premium approach?
(a) Bonds
(b) Term loan
(c) Trade credit
(d) Preference capital
(e) Equity capital. ( 1 mark)
61. Which of the following is not a merit of using book values as weights for calculating the weighted
average cost of capital?
(a) The book value weights are independent of the fluctuations of the market prices
(b) The calculation of weights is simple
(c) The book values of the different sources of finance are approximately related to their present
economic values
(d) The book value weights are suitable for a firm whose securities are not traded regularly
(e) The book value weights are the most suitable for the unlisted firms. ( 1 mark)
62. The following information regarding the equity shares of M/s. Mars Ltd., is given below:
Market Price = Rs.58.
Dividend per share = Rs. 5.
Multiplier = 7
According to the traditional approach to the dividend policy, the EPS for M/s. Mars Ltd., is
(a) Rs. 5
(b) Rs.
(c) Rs.
(d) Rs.
(e) Rs.25. ( 2 marks)
63. Fast Foods posted a net income of Rs.15 million this year. Financial planners at
Fast Foods anticipate to have a capital budget of approximately Rs.18 million. The firm also anticipates
retaining its target capital structure of 60% equity and 40% debt. If the firm follows a strict residual
dividend policy, what is their expected dividend payout ratio?
(a) 28%
(b) 36%
(c) 50%
(d) 64%
(e) 72%. ( 2 marks)
(a) 12,000 shares
(b) 18,000 shares
(c) 20,000 shares
(d) 24,000 shares
(e) 30,000 shares.
70. The dividend payout ratio of a firm is 40%. The firm follows traditional approach to dividend policy
with a multiplier of 6. The P/E ratio of the firm is
(a) 4.
(b) 5.
(c) 6.
(d) 8.
(e) 9.5. ( 1 mark)
71. Biogenerics Ltd., has paid a dividend of Rs.3.50 per share on a face value of Rs.10.00 in the financial
year ended 31
st
March, 2008. The relevant data regarding the company and the market are as under:
Current market price of share = Rs.
Growth rate of earnings and dividends = 7.5%
Beta of share = 0.
Average market return = 12.5%
Risk free rate = 6%
The intrinsic value of the stock is
(a) Rs. 60.
(b) Rs. 80.
(c) Rs. 89.
(d) Rs. 94.
(e) Rs.104.25. ( 2 marks)
72. Consider the following data regarding the bonds issued by Xeta Ltd., on July 15, 2006 to be redeemed
on July 15, 2013:
Face value of the bond Rs.
Issued at a discount of 10%
Redeemable at a premium of 10%
Interest payable semi-annually 8% p.a.
Current market price as on July 15, 2008 Rs.
The yield to maturity of the bond to a prospective investor is
(a) 9.27%
(b) 10.90%
(c) 12.24%
(d) 12.66%
(e) 13.55%. ( 2 marks)
END OF QUESTION PAPER
Suggested Answers
Financial Management-I (MB2E1): October 2008
ANSWER REASON
1. A A public limited company is said to be in a significant advantage owing to its limited
liability. If the company turned to an insolvent one, the members don’t have any further
liability to bail out whereas in a proprietorship firm, the liability of the owner is
unlimited. However, for a public limited company, the ownership can be easily
transferred and resources can be mobilized. Moreover it has unlimited life. The
governmental regulations for a public limited company are more than applicable to a
partnership firm. Hence (a) is true. But for a proprietorship company, these advantages
are not available.
2. B All the participants in the call money market are split into two categories. The first
comprises the entities who can borrow as well as lend in the market and the second
comprises only lenders i.e. the participants in the second category cannot borrow in the
call money market. RBI, DFHI, STCIL and commercial banks belong to the first category
and all the financial institutions and mutual funds belong to the second. Hence, (b) cannot
borrow in the call money market.
3. E An optimal capital structure can satisfy the return expectations of the stakeholders at a
lower cost that will result in share price of the company to a healthier one. It is a
financing decision. While the cases mentioned in the other alternatives are the investment
decisions as these may bring return to the company over a period of time.
Hence (e) is the answer.
4. C Certificate of deposit (CD) is a financial instrument where an investor has to invest a
certain sum to get a fixed amount (principal and accrued interest) on maturity at the
contracted rate. So it is similar to a time deposit. CDs are transferable simply by
endorsement and delivery by the holder without any restriction, whereas its maturity
period ranges from 15 days to one year. But as it is a liability to the issuing banks, CDs
are also subjected to the reserve requirements of the bank. Hence (c) is not a feature of
CDs.
5. C Bulldog bonds are sterling denominated foreign bonds, which are raised in the United
Kingdom domestic securities market. Hence option (c) is the correct choice. Samurai
bonds are bonds issued by non-Japanese borrowers in the domestic Japanese markets.
Yankee bonds are US dollar denominated bonds issued by foreign borrowers in the US
domestic markets. Shibosai Bonds are Yen denominated privately placed bonds issued in
the Japanese Markets. Matador bonds are foreign bonds issued in Spain.
6. B Medium-Term Notes (MTNs) are defined as sequentially issued fixed-interest securities
which have a maturity of over one year. It enables an issuer to issue Euronotes for
different maturities, from one year up to the desired level of maturity.
Hence (b) is the correct choice.
Commercial Papers are short-term, unsecured promissory notes issued by well known
companies that are financially strong and carry a high credit rating.
American Depository Receipts (ADRs) are dollar denominated negotiable certificates and
they represent a non-US company’s publicly traded equity.
Treasury Bills are short-term instruments issued by the government. Global depository
receipts are negotiable instruments which represents publicly traded local currency equity
share.
Hence, options (a), (c), (d) and (e) are false.
7. D In the call money market day-to-day surplus funds of banks are traded. The call loans are
of very short term in nature and any amount of money can be lent or borrowed at a
convenient interest rate, which is acceptable to both the lender and the borrower and there
is no maximum ceiling on the interest rate. Hence, in the given case, though the amount is
huge, the interest is decided by the lender and the borrower and RBI has no role in the
interest determination. The correct answer is (d).
8. E Commercial papers are short-term, unsecured promissory notes issued at a discount to
face value by well-known companies that are financially strong and carry a high credit
rating. As per the guidelines, any company wishing to raise money through CP has to
fulfill the following requirements:
i. The tangible net worth of issuing company should not be less than Rs.4 crores.
ii. The fund based working capital limit should not be less than Rs.4 crores
iii. The company should obtain the second highest credit rating from one of the
approved credit rating agencies.
iv. Board resolution authorizing the issue is required.
Of the above, in the given case, the company has not met (ii) and (iii). Hence, it cannot
issue commercial paper of any amount. Hence, (a), (b) and (c) are not correct. (d) is also
not correct because the condition (ii) will be met but the condition (iii) will not be met.
PVIFA
(r,6y)
6, 50, 000
1, 50, 000 PVIFA (r,6y)
PVIFA
(10%,6y)
In PVIFA table, value of 4.333 for 6 years is found nearer at 10% column. So, the
effective rate of interest is 10% approximately.
15. B Risk premium = β(R m
– R
f
Probability k m
(k m
m
k
) (k m
m
k
2
.p
m m
k = k P ∑ =8.
A
β
A m
m
Cov(k k )
Var(k )
Hence, option (b) is the correct choice.
Risk premium = 0.884 (8.75 – 6) = 2.43%.
16. C Capital recovery factor is the inverse of the PVIFA factor. It can be applied to find out
the amount that can be withdrawn periodically for a certain length of time, if a given
amount is invested today. Hence statement III is true and the answer is (c).
17. A The effective annual interest is the value of ‘r’ in the following:
2000 FVIFA
(r,8)
FVIFA
r,
At r = 8%, L. H. S. = 10.
Hence, r = 8%.
18. C The amount of risk reduction depends on the degree of correlation between the stocks.
The portfolio risk will be minimum if the stocks are perfectly negatively correlated.
Hence, statement III is correct.
Lower the degree of positive correlation, greater is the amount of risk reduction that is
possible. Hence, statement II is incorrect.
Statement I is incorrect as the diversifying effect of each additional stock diminishes with
increase in number of stocks. Hence, (c) is the answer.
19. C Standard deviation, a measure of dispersion around the expected (or average), is the
square root of the variance of the rates of return. If the variance is higher, the standard
deviation will also be higher. Hence, III is true and the answer is (c).
Range is referred as the difference between the highest and lowest values. Standard
deviation may be the highest, irrespective of the range being the lowest or highest. Hence,
I is not true. Highest mean does not mean that it should have highest standard deviation.
Hence, II is also not true.
20. B The equation for the Characteristic Regression Line (CRL) is given as:
j j j m j
K = α + β k +e
The CRL is plotted by plotting Kj along the Y-axis and Km along X-axis.
21. E Expected price = Σ x i p i
Where, ‘x i ’ is the price expected and ‘p i ’ is the probability
Hence, expected price = 70 × 0.3 + 80 × 0.5 + 90 × 0.2 = Rs.
The expected one year return is calculated as
Priceatthe beginning
(Expected Priceattheend Expecteddividend) Priceatthe beginning
×
Expected return =
×
22. A
0
0
e
D (1 g)
P
k g
0
P 71.
Therefore the increase in the price of the security = 71.33 – 50 = Rs.21.33.
23. D
R
i
= R
f +β (R m
-R
f
R
i
As the required return from the stock is lower than the actual return produced by the
stock, the stock is undervalued, will fall above the SML and will have positive alpha.
Hence the stock can be purchased and the answer is (d).
24. C Weighted beta = (200 × 0.5 + 200 × 2 + 100 × 4)/500 = 1.
Required rate of return according to CAPM = R f
– R
f
=R
f
+ 1.8(14 – R
f
R
f
+ 25.2 – 1.8 R
f
= 20.4 = 0.8 R
f
R
f
New weighted Beta = (200 × 0.5 + 200 × 2 + 100 × 3)/500 = 1.
New required rate of return = 6 + 1.6(14 – 6) = 18.8%.
25. B The required return will increase for both stocks but the increase will be greater for Stock
B than for Stock A.
26. B
Capital gain yield from an equity share =
1 0
0
P P
P
×
1
0
P 5
P 4
− × = − × =
Therefore, option (b) is the correct answer.
27. B
According to CAPM, required rate of return = R f
– R
f
Where R f is the risk-free rate of return, β is the Beta of the stock and R m is the market
return. If Beta is equal to zero, required rate of return is equal to risk-free rate of return.
Hence, (II) is true.
In the SML equation, slope is measured by R m
– R
f and the Beta of the stock is not
relevant to find the slope of SML. Hence, (I) is not true. A stock whether it will lie below
or above the SML depends on whether the stock’s required rate is more than or less than
the expected rate of return. It is immaterial whether the Beta is equal to zero or not.
Hence, (III) is not true and the answer is (b).
28. E If the level of output is greater than the overall break-even point, then the DTL will be
positive. DTL decreases as Q increases and reaches a limit of 1. Hence, (e) is not correct
and the rest are correct.
29. E DOL determines the change in the EBIT with change in sales. It is determined by the
level of fixed costs.
30. D
The quantity produced at operating break-even point is computed as
F
(S −V)
where F represents the fixed costs of the firm
S represents the selling price per unit.
V is the variable cost per unit.
Other things remaining the same, increase in fixed costs will increase the quantity
produced at operating break-even point.
Other things remaining the same, increase in the variable costs will decrease the
Percentage change in EPS
DTL
Percentage change in sales revenue
∴ Percentage change in sales revenue =
Percentage change in EPS
DTL
Give : Desired increase in EPS = 25%
∴ Required increase in net sales =
=10.04% (approx.)
34. C EPS, DPS and required rate of return being the same, low dividend yield and high P/E
ratio implies that there is considerable growth prospects in Vipul. Hence, II is correct. As
the growth rate increases, the expected return depends more on the capital gains yield and
less on the dividend yield. Hence, III is correct. As growth prospects are higher the price
of Vipul should be higher. Hence, I is not correct and the answer is (c).
35. D Treasury bills are also referred to as gilt securities. PSU bonds are the securities issued by
the public sector entities. Hence, I is not true. 91 days Treasury bills are issued by
auctions conducted by RBI. Hence, II is true. RBI neither rediscounts nor participates in
auctions of these T-Bills. Hence, III is also true and the answer is (d).
36. A For zero-coupon bonds, duration will be the maturity. Longer the term to maturity, higher
will be the price change. Of the 20-year zero coupon bond and 10-year zero coupon bond,
price change is higher in case of 20 year bond. Smaller the coupon rates, higher is the
price change with a change in YTM. Hence, of (a), (c) and (d), the change in price is
higher in case of (a).
37. E Dividend yield is the dividend per share divided by market price per share. It can also be
calculated as dividend pay out ratio divided by P/E ratio. A company must be liquid and
profitable to pay consistent and adequate dividends. Hence, II is correct and I and III are
not true.
38. B
Value of zero coupon bond =
5
= Rs.1,450.60 = Rs.1,451.
39. C k e
= R
e
(R
m
-R
f
Old ke = 0.10 + β j (0.142 - 0.10) = 0.10 + 0.042β j
P = Rs.0.68(1.07)/(0.10 + 0.042β j
β j
New ke = 0.10 + 0.8(1.4)(0.142-0.1) =0.
P =Rs. 0.68(1.07)/(0.147 - 0.07) = Rs.9.
A decrease of Rs.(11.44-9.45) = Rs.1.99 a share.
40. C According to the bond value theorems, price of the security and the yield to maturity are
inversely related. As YTM increases, other things remaining constant, the value of the
bond decreases. Hence, in the given question the value of bond B will be greater than the
value of bond A which is greater than the value of bond C. Hence, the answer is (c).
41. D
Expected Price-earning ratio is computed as
Expected Dividend payout ratio
Cost of capital −growth rate
From the above equation, we can conclude that increase in the expected dividend payout
ratio and increase in the growth rate will lead to increase in Expected Price-earning ratio.
Hence statements I and III are correct. Therefore, option (d) is the answer.
Increase in the cost of capital will decrease the Expected Price-earning ratio.
Hence, (II) is incorrect.
42. B In the intrinsic value formula the face value of the bond is multiplied with the factor
PVIF(r,n). The factor PVIF(r,n) decreases as the number of years to maturity increases,
other things remaining the same. Hence, other things remaining the same, the present
value of the face value of the bond decreases as the number of years to maturity
increases. Therefore alternative (b) is not true. All other alternatives are true.
43. A There is no pre-specified maturity period in the multi-period valuation model of equity
shares; cash flows over an infinite duration are considered.
44. D The conversion value represents the market value of the convertible if it were converted
into stock. This is the minimum value of the convertible based on the current price of the
issuer’s stock. Hence, I is true. Conversion premium is the difference between the
conversion price and the conversion value. Hence, III is also true and the answer is (d).
Whether it is optionally convertible debenture or compulsorily convertible debenture,
whether it is fully convertible or partially convertible debenture, on conversion cash is
not involved. It is merely, the old security is exchanged for the appropriate number of
new securities is issued in turn. Hence, II is incorrect.
45. C When the market is low, public issue and rights issue may not be successful. Of the given
methods of private placement and bought out deal should be preferred. Of the two,
bought out deal is the most preferred because the sponsor or the merchant banker who is
involved in the deal takes up the issue with an intention of offloading to the public at a
later stage when the market picks up.
46. C Custodians hold the underlying shares and collect rupee dividends on the underlying
shares and repatriate the same to the depository in US dollars/foreign equity.
Hence (c) is the answer.
Lead managers undertake activities like preparation of offer circular, marketing the issues
etc.
Underwriters of the issue bear interest rate or market risks moving against the issuer
before they have placed bonds or depository receipts.
47. A SPN is a kind of non-convertible debenture with an attached warrant. It is neither a
convertible or partly convertible debenture nor any option can be attached to it. The
warrants attached to the SPN does not gives holders the right for the preference shares. It
is also not an example of participating preference shares. Therefore only option (a) is
correct. Rest are incorrect.
48. D Preference shareholders have preference over equity shareholders on the post tax earnings
of the firm. Preference dividends are not tax deductible. Voting rights can not be given to
the cumulative preference shares. Preference shares (except participating preference
shares) do not participate in the surplus. Preference shares can be redeemable or
irredeemable. Perpetual preference share capital will remain with the company forever.
Thus only option (d) is correct. Rest are incorrect.
49. C
Ex-rights value of share =
N 1
NP S
0
Where N, P o and S have their usual meanings
Given:
N = 5
P
o = Rs. 56 per share
Ex-rights price = Rs. 54 per share
5 ( 56 ) S
or S = 54 (6) – 56 (5)
or S = Rs. 44 per share.
50. C The debt capital is the cheapest source of financing but it should be used within
reasonable limits.
51. D Agency cost are cost on account of restriction imposed by creditors on the firm in the
form of some protective covenants. Commission payable by the company to its
purchasing and selling agents, the expenses incurred in distribution of the products of the
company, or the dividends paid by the company does not come under the agency cost.
52. E In the realized yield approach one of the implicit assumptions is that the equity
shareholders will continue to expect the same returns from the share as in the past. Hence
option (e) is the correct answer.
