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GENERAL FINANCE QUESTIONS

1. What does inventory turnover ratio shows?

The inventory turnover ratio is an efficiency ratio that shows how effectively inventory is
managed by comparing cost of goods sold with average inventory for a period.

2. What is return on equity?

Return on equity (ROE) is a ratio that provides investors with insight into how efficiently
a company is managing the equity that shareholders have contributed to the company.
Return on equity measures a corporation's profitability by revealing how much profit a
company generates with the money shareholders have invested.

Return on Equity = Net Income – Pref. dividend (if, any) / Shareholder's Equity.

3. What is net worth of a company?

Net worth is the amount by which assets exceed liabilities. Net worth is a concept
applicable to individuals and businesses as a key measure of how much an entity is
worth. A consistent increase in net worth indicates good financial health

4. What is operating cycle / Cash Conversion Cycle ?

The operating cycle is also known as the cash conversion cycle. In the context of a
manufacturer the operating cycle has been described as the amount of time that it takes
for a manufacturer's cash to be converted into products plus the time it takes for those
products to be sold and turned back into cash.

5. What is the difference between EBIT and EBIDTA. Can EBIT be greater that
EBIDTA?

EBIT represents the approximate amount of operating income generated by a business,

while EBITDA roughly represents the cash flow generated by the operations of a
business.
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6. Distinguish between Budgeting and Forecasting?

Budgeting and financial forecasting are financial planning techniques that help a business
enterprise to achieve its desired levels of profits.

Budgeting uses estimation to quantify the desired levels of revenues, profits, and cash
flows that a business wants to achieve for a future period, whereas financial forecasting is
used to estimate the amount of revenues that will likely be achieved. Budgeting
essentially is a plan for where a business wants to go, whereas financial forecasting
indicates where the business is headed given the scenario.

Budgeting is essentially planning whereas forecasting is estimating based on the given

indicators. Hence, forecasting would indicate whether budgets will be achieved or not.

7. What is nifty and Sensex?

SENSEX:

The Sensex, also called the BSE 30, is a stock market index of 30 well-established and
financially sound companies listed on Bombay Stock Exchange (BSE).

30 companies are selected based on the free float market capitalization. These are
different companies from the different sectors representing a sample of large, liquid, and
representative companies.

The base year of Sensex is 1978-79 and the base value is 100.
It is an indicator of market movement.
If Sensex go up, it means that most of the stocks in India went up during the given period.
If the Sensex goes down, this tells you that the stock price of most of the major stocks on
the BSE have gone down.

NIFTY

The NIFTY 50 index is National Stock Exchange of India’s benchmark stock market
index for Indian equity market. Nifty is owned and managed by India Index Services and
Products (IISL).
The base year is taken as 1995 and the base value is set to 1000.
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Nifty is calculated on 50 stocks actively traded in the NSE

50 top stocks are selected from 24 sectors.

8. What is EPS and diluted EPS ?

EPS is the portion of a company's profit that is allocated to every individual share of the
stock. It is a term that is of much importance to investors and people who trade in the
stock market. The higher the earnings per share of a company, the better is its
profitability.

EPS - PAT/ TOTAL NO. O/S SHARES

Diluted EPS

Diluted EPS considers what would happen if dilutive securities were exercised. Dilutive
securities are securities that are not common stock but can be converted to common stock
if the holder exercises that option. If converted, dilutive securities effectively increase the
weighted number of shares outstanding, and this in turn decreases EPS, because the
calculation for EPS uses a weighted number of shares in the denominator.

9. What is derivative

A derivative is a security with a price that is dependent upon or derived from one or more
underlying assets. The derivative itself is a contract between two or more parties based
upon the asset or assets. Its value is determined by fluctuations in the underlying asset.
The most common underlying assets include stocks, bonds, commodities, currencies,
interest rates and market indexes.

Derivatives can either be traded over the counter (OTC) or on an exchange. OTC
derivatives constitute the greater proportion of derivatives in existence and are
unregulated, whereas derivatives traded on exchanges are standardized. OTC derivatives
generally have greater risk for the counterparty than do standardized derivatives.

10. What is option trading?

Options are a type of derivative security. They are a derivative because the price of an
option is intrinsically linked to the price of something else. Specifically, options are
contracts that grant the right, but not the obligation to buy or sell an underlying asset at a
set price on or before a certain date. The right to buy is called a call option and the right
to sell is a put option.
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11. Difference between call and put options?

Call options - provide the holder the right (but not the obligation) to purchase an
underlying asset at a specified price (the strike price), for a certain period. If the stock
fails to meet the strike price before the expiration date, the option expires and becomes
worthless. Investors buy calls when they think the share price of the underlying security
will rise or sell a call if they think it will fall. Selling an option is also referred to as
''writing'' an option.

Put options - give the holder the right to sell an underlying asset at a specified price (the
strike price). The seller (or writer) of the put option is obligated to buy the stock at the
strike price. Put options can be exercised at any time before the option expires. Investors
buy puts if they think the share price of the underlying

stock will fall or sell one if they think it will rise. Put buyers - those who hold a "long" -
put are either speculative buyers looking for leverage or "insurance" buyers who want to
protect their long positions in a stock for the period covered by the option. Put sellers
hold a "short" expecting the market to move upward (or at least stay stable) A worst-case
scenario for a put seller is a downward market turn.

The maximum profit is limited to the put premium received and is achieved when the
price of the underlying is at or above the option's strike price at expiration. The maximum
loss is unlimited for an uncovered put writer.

12. Explain Future and Forward Contract?

A forward contract is a customized contractual agreement where two private parties

agree to trade a particular asset with each other at an agreed specific price and time in the
future. Forward contracts are traded privately over the counter, not on an exchange.

A futures contract — often referred to as futures — is a standardized version of a

forward contract that is publicly traded on a futures exchange. Like a forward contract, a
futures contract includes an agreed upon price and time in the future to buy or sell an
asset — usually stocks, bonds, or commodities, like gold.
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13. What are Swaps

A swap is an agreement between two parties to exchange sequences of cash flows for a
set period. Usually, at the time the contract is initiated, at least one of these series of cash
flows is determined by a random or uncertain variable, such as an interest rate, foreign
exchange rate, equity price or commodity price. Conceptually, one may view a swap as
either a portfolio of forward contracts, or as a long position in one bond coupled with a
short position in another bond. This article will discuss the two most common and most
basic types of swaps: the plain vanilla interest rate and currency swaps.

14. Explain valuation and techniques

Valuation is the process of determining the current worth of an asset or a company; there
are many techniques used to determine value. An analyst placing a value on a company
looks at the company's management, the composition of its capital structure, the prospect
of future earnings and market value of assets.

Techniques

1. Discounted cash flow (DCF) analysis.

2. Comparable transactions method.
3. Market valuation.
4. Book value

15. What is financial risk management

Financial risk management is the practice of economic value in a firm by using financial
instruments to manage exposure to risk: Operational risk, credit risk and market risk,
foreign exchange risk, Shape risk, Volatility risk, Liquidity risk, Inflation risk, Business
risk, Legal risk, Reputational risk, Sector risk etc. Like general risk management,
financial risk management requires identifying its sources, measuring it, and plans to
address them.

16. What is SLR, CRR, REPO, Reverse Repo, and rates

Repo rate also known as the benchmark interest rate is the rate at which the RBI lends
money to the banks for a short term. When the repo rate increases, borrowing from RBI
becomes more expensive. If RBI wants to make it more expensive for the banks to
borrow money, it increases the repo rate similarly, if it wants to make it cheaper for banks
to borrow money it reduces the repo rate. Current repo rate is 5.40%.
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Reverse Repo rate is the short-term borrowing rate at which RBI borrows money from
banks. The Reserve bank uses this tool when it feels there is too much money floating in
the banking system. An increase in the reverse repo rate means that the banks will get a
higher rate of interest from RBI. As a result, banks prefer to lend their money to RBI
which is always safe instead of lending it others (people, companies etc) which is always
risky. Rate – 3.35%

CRR - Cash Reserve Ratio - Banks in India are required to hold a certain proportion of
their deposits in the form of cash. However, Banks don't hold these as cash with
themselves, they deposit such cash (aka currency chests) with Reserve Bank of India,
which is considered as equivalent to holding cash with themselves. This minimum ratio
(that is the part of the total deposits to be held as cash) is stipulated by the RBI and is
known as the CRR or Cash Reserve Ratio. Rate – 4.50%

SLR - Statutory Liquidity Ratio - Every bank is required to maintain at the close of
business every day, a minimum proportion of their Net Demand and Time Liabilities as
liquid assets in the form of cash, gold, and un-encumbered approved securities. The ratio
of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio
(SLR). Rate –18%

17. Difference between broad money and narrow money

Narrow money is a category of money supply that includes all physical money like coins
and currency along with demand deposits and other liquid assets held by the central bank.
In the United States, narrow money is classified as M1 (M0 + demand accounts).

Broad money is the most inclusive method of calculating a given country's money
supply. The money supply is the totality of assets that households and businesses can use
to make payments or to hold as short-term investments, such as currency, funds in bank
accounts and anything of value resembling money.

18. Explain dividend models?

Dividend growth Model

The Gordon growth model is used to determine the intrinsic value of a stock based on a
future series of dividends that grow at a constant rate. Given a dividend per share that is
payable in one year, and the assumption the dividend grows at a constant rate in
perpetuity, the model solves for the present value of the infinite series of future
dividends.
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Value of Stock = Dividend pay-out next year / Required rate of return + Expected
growth rate
Dividend Discount Model
The dividend discount model (DDM) is a procedure for valuing the price of a stock by
using the predicted dividends and discounting them back to the present value. If the value
obtained from the DDM is higher than what the shares are currently trading at, then the
stock is undervalued.
Value of Stock = Dividend pay-out next year / Discount rate – Expected growth rate

19. What is sin tax

A sin tax is an excise tax specifically levied on certain goods deemed harmful to society,
for example alcohol and tobacco, candies, drugs, soft drinks, fast foods, coffee, sugar,
gambling, and pornography. Two claimed purposes are usually used to argue for such
taxes.

20. What is STT?

STT is levied on every purchase or sale of securities that are listed on the Indian stock
exchanges. This would include shares, derivatives, or equity-oriented mutual funds units.

21. What is deferred tax liability and asset?

Deferred tax asset is an accounting term that refers to a situation where a business has overpaid
taxes or taxes paid in advance on its balance sheet. These taxes are eventually returned to the
business in the form of tax relief, and the over-payment is, therefore, an asset for the company.
Deferred tax liability is an account on a company's balance sheet that is a result of temporary
differences between the company's accounting and tax carrying values, the anticipated and
enacted income tax rate, and estimated taxes payable for the current year. This liability may be
realized during any given year, which makes the deferred status appropriate.

22. Explain cash equivalents?

Cash and cash equivalents refer to the line item on the balance sheet that reports the value
of a company's assets that are cash or can be converted into cash immediately. These
include bank accounts, marketable securities, commercial paper, Treasury bills and short-
term government bonds with a maturity date of three months or less. Marketable
securities and money market holdings are considered cash equivalents because they are
liquid and not subject to material fluctuations in value.
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23. Difference between Depreciation, Depletion and Amortization

Depletion refers to the allocation of the cost of natural resources over time. For example,
an oil well has a finite life before all the oil is pumped out. Therefore, the oil well's setup
costs are spread out over the predicted life of the oil well.

Depreciation is an accounting method of allocating the cost of a tangible asset over its
useful life. Businesses depreciate long-term assets for both tax and accounting purposes.

Amortization is an accounting term that refers to the process of allocating the cost of an
intangible asset over a period. It also refers to the repayment of loan principal over time.

24. What is accumulated depreciation?

Accumulated depreciation is the total depreciation for a fixed asset that has been charged
to expense since that asset was acquired and made available for use.

25. What are free cash flows?

FCF is an assessment of the amount of cash a company generates after accounting for all
capital expenditures, such as buildings or property, plant and equipment. The excess cash
is used to expand production, develop new products, make acquisitions, pay dividends
and reduce debt.

FCF - EBIT (1-tax rate) + (depreciation) + (amortization) - (change in net working

capital) - (capital expenditure).

26. Profitability and valuation ratios

Profitability Ratio
1. Gross Profit
2. Net profit
3. Return on equity
4. Return on assets

Valuation Ratios
1. P/E ratios
2. EPS
3. Price / Book value
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27. Difference between solvency and liquidity?

Solvency is defined as the firm’s potential to carry on business activities in the

foreseeable future, to expand and grow. It is the measure of the company’s capability to
fulfil its long-term financial obligations when they fall due for payment.

28. Difference between operating lease and financial lease?

Finance lease is often used to buy equipment for a major part of its useful life. The goods
are financed ex GST and have a balloon at the end of the term. Here, at the end of the
lease term, the lessee will obtain ownership of the equipment upon a successful 'offer to
buy' the equipment. Traditionally this 'offer' is the balloon amount.
An operating lease agreement to finance equipment for less than its useful life, and the
lessee can return equipment to the lessor at the end of the lease period without any further
obligation.

29. What is asset acquisition?

An asset acquisition strategy is the purchase of a company by buying its assets instead of
its stock. An asset acquisition strategy may be used for a takeover or buyout if the target
is bankrupt.

liquidity is the firm’s ability to fulfil its obligations in the short run, normally one year. It
is the near-term solvency of the firm, i.e., to pay its current liabilities.

30. Explain leverage ratio and solvency ratio

A leverage ratio is any one of several financial measurements that look at how much
capital comes in the form of debt (loans) or assesses the ability of a company to meet
financial obligations.

The solvency ratio indicates whether a company’s cash flow is sufficient to meet its
short-term and long-term liabilities. The lower a company's solvency ratio, the greater the
probability that it will default on its debt obligations.

31. Difference between current ratio and quick ratio?

The current ratio is a financial ratio that investors and analysts use to examine the
liquidity of a company and its ability to pay short-term liabilities (debt and payables) with
its short-term assets (cash, inventory, receivables). The current ratio is calculated by
dividing current assets by current liabilities.
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The quick ratio, on the other hand, is a liquidity indicator that filters the current ratio by
measuring the amount of the most liquid current assets there are to cover current
liabilities (you can think of the “quick” part as meaning assets that can be liquidated fast).
The quick ratio, also called the “acid-test ratio,” is calculated by adding cash &
equivalents, marketable investments, and accounts receivables, and dividing that sum by
current liabilities.

The main difference between the current ratio and the quick ratio is that the latter offers a
more conservative view of the company’s ability to meets its short-term liabilities with its
short-term assets because it does not include inventory and other current assets that are
more difficult to liquidate (i.e., turn into cash). By excluding inventory (and other less
liquid assets) the quick ratio focuses on the company’s more liquid assets.

32. What is working capital and what is net working capital?

Working capital is the amount of a company's current assets minus the amount of its
current liabilities. The adequacy of a company's working capital depends on the industry
in which it competes, its relationship with its customers and suppliers, and more.

33. Components of cash flows Statement

 Cash flow resulting from operating activities.

 Cash flow resulting from investing activities.
 Cash flow resulting from financing activities.
 It also may include a disclosure of non-cash financing activities.

34. What is goodwill?

Goodwill is an intangible asset that arises because of the acquisition of one company by
another for a premium value. The value of a company’s brand name, solid customer base,
good customer relations, good employee relations and any patents or proprietary
technology represent goodwill. Goodwill is considered an intangible asset because it is
not a physical asset like buildings or equipment. The goodwill account can be found in
the assets portion of a company's balance sheet.

35. How to calculate goodwill?

1. Calculating Goodwill Using Average Profits – Avg profits * no of years.

2. Goodwill using super profits (Actual profit – normal profit)
3. Goodwill by capitalization of profits
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36. What is contingent liability?

A contingent liability is a potential liability that may occur, depending on the outcome of
an uncertain future event. A contingent liability is recorded in the accounting records if
the contingency is probable, and the amount of the liability can be reasonably estimated.

37. What is NPA?

A nonperforming asset (NPA) refers to a classification for loans on the books of financial
institutions that are in default or are in arrears on scheduled payments of principal or
interest. In most cases, debt is classified as nonperforming when loan payments have not
been made for a period of 90 days.
Around 7.7 Lakh cr of NPA in India in the year 2017.

38. What is REITs?

REIT, or Real Estate Investment Trust, is a company that owns or finances income-
producing real estate. Modelled after mutual funds, REITs provide
investors of all types of regular income streams, diversification, and long-term capital
appreciation. ... In turn, shareholders pay the income taxes on those dividends.

39. What is book value of a business?

Equity shares holdings + Reserves and surplus + Net profit

40. What is financial modelling?

It is the goal of the analyst to accurately forecast the price or future earnings performance
of a company. Numerous valuation and forecast theories exist, and financial analysts can
test these theories by recreating business events in an interactive calculator referred to as
a financial model. A financial model tries to capture all the variables in a particular event.

41. What is the difference between a private equity and venture capital?

Private equity firms mostly buy mature companies that are already established. The
companies may be deteriorating or not making the profits they should be due to
inefficiency. Private equity firms buy these companies and streamline operations to
increase revenues. Venture capital firms, on the other hand, mostly invest in start-ups
with high growth potential.
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42. Which is cheaper debt or equity?

A company should always optimize its capital structure. If it has taxable income it can
benefit from the tax shield of issuing debt. If the firm has immediately steady cash flows
and is able to make their interest payments it may make sense to issue debt if it lowers the
WACC.

43. What is accretion and dilution?

Accretion is asset growth through addition or expansion. Accretion can occur through a
company’s internal development or by way of mergers and acquisitions.
Dilution is a reduction in earnings per share of common stock that occurs through the
issuance of additional shares or the conversion of convertible securities. Adding to the
number of shares outstanding reduces the value of holdings of existing shareholders.

44. What is the difference between commercial and investment banking?

Commercial bank: accepts deposits from customers and makes consumer and commercial
loans using these deposits.
Investment bank: acts as an intermediary between companies and investors. Does not
accept deposits, but rather sells investments, advises on M&A, etc…loans and
debt/equity issues originated by the bank are not typically held by the bank, but rather
sold to third parties on the buy side through their sales and trading arms.

Meaning and formula of WACC

WACC – Weighted Average cost of capital - (ME/E+D Re) + (MD/E+D*Rd)*(1-t)

ME – Market Value of Equity
E – Equity
D – Debt
Re – Cost of equity
Rd – Cost of Debt
T – Tax rate

A company is typically financed using a combination of debt (bonds) and equity (stocks).
Because a company may receive more funding from one source than another, we
calculate a weighted average to find out how expensive it is for a company to raise the
funds needed to buy buildings, equipment, and inventory.
It's important for a company to know its weighted average cost of capital to gauge the
expense of funding future projects. The lower a company's WACC, the cheaper it is for a
company to fund new projects.
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45. Implications of (1 – T) in the WACC formula?

There are tax deductions available on interest paid, which is often to companies’ benefit.
Because of this, the net cost of companies’ debt is the amount of interest
they are paying, minus the amount they have saved in taxes as a result of their tax-
deductible interest payments. This is why the after-tax cost of debt is considered.

46. What is cost of debt and cost of equity?

Cost of Debt - Total interest payable / Total Debt * 100

Cost of Debt is the total Cost(interest) that a company is required to pay on the borrowed
money. Cost of debt refers to the effective rate a company pays on its current debt.
Cost of Equity = CAPM AND DIVIDEND GROWTH MODEL
Cost of equity refers to a shareholder's required rate of return on an equity investment. It
is the rate of return that could have been earned by putting the same money into a
different investment with equal risk.

47.Explain CAPM?

CAPM = Rf + B (Rm-Rf)
Rf = Risk Free rate
B = Beta
Rm = Market risk

The capital asset pricing model (CAPM) is a model that describes the relationship
between systematic risk and expected return for assets, particularly stocks. CAPM is
widely used throughout finance for the pricing of risky securities, generating
expected returns for assets given the risk of those assets and calculating costs of capital.
The CAPM model says that the expected return of a security or a portfolio equals the rate
on a risk-free security plus a risk premium. If this expected return does not meet or beat
the required return, then the investment should not be undertaken. The security market
line plots the results of the CAPM for all different risks (betas).

48. Meaning of BETA and can it be negative?

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in

comparison to the market.

A security's beta is calculated by dividing the covariance the security's returns and the
benchmark's returns by the variance of the benchmark's returns over a specified period.
A beta of 1 indicates that the security's price moves with the market. A beta of less than 1
means that the security is theoretically less volatile than the market. A beta of greater
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than 1 indicates that the security's price is theoretically more volatile than the market. For
example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market.

Conversely, if an ETF's beta is 0.65, it is theoretically 35% less volatile than the market.
beta less than 0, which would indicate an inverse relation to the market - is possible but
highly unlikely. However, some investors believe that gold and gold stocks should have
negative betas because they tended to do better when the stock market declines.

49. What is required rate of return?

The required rate of return (RRR) is the minimum annual percentage earned by an
investment that will induce individuals or companies to put money into a particular
security or project. The RRR is used in both equity valuation and in corporate finance.
Investors use the RRR to decide where to put their money, and
corporations use the RRR to decide if they should pursue a new project or business
expansion.

50. What is risk free return

Risk-free return is the theoretical rate of return attributed to an investment with zero risk.
The risk-free rate represents the interest on an investor's money that he or she would
expect from a risk-free investment over a specified period.