MBA 2nd Semester

Solution
Financial Management and Corporate Finance (KMB-204)
Duration: 1hour 30 minutes Max. Marks: 30

Note: Attempt all the Questions

Section-A (5*1=5)
Q. No. Question Marks CO BL
1. a. Why money should have time value? 1 1 1
Ans. The main reason behind the time value of money is inflation. Time
value of money takes the present value and future value of the money into
account. The present value of money helps an investor to decide the amount
he should invest today to receive a particular amount of money in the future.
b. What is offer for sale? 1 1 1
Ans. Institutional investors like venture funds, private equity funds etc.,
invest in unlisted company when it is very small or at an early stage. When
the company becomes large, these investors sell their shares to the public,
through issue of offer document and the company’s shares are listed in stock
exchange. This is called as offer for sale.
c. Why systematic risk is always at macro in nature? 1 1 2
Ans. Systematic risk is always at macro in nature because it can be generated
by the whole economy and it can’t be control by an organisation.
d. Differentiate between debenture and bank loan? 1 1 1
Ans. The following difference are:
 Lending Partner: In debenture, the public lends its money to the
company in return for a certificate promising afixed rate of interest. In
loans, the lending institutions are banks and other financial institutions.
 Collateral: Debentures do not require any physical asset or
collateral from the firm, whereas banks and other institutions
require collateral for the loans unless it is a small amount of unsecured
loan.
 Transferability: Debentures can be transferred from one person
to another. However, bank loans are non-transferable.
e. Discuss the functions of primary market? 1 1 1
Ans. The functions of primary market are:
1. Origination: It simply means origin of the new issue. It is the work
which begins before an issue is actually floated in the market. The
following things is being determined before origin of issue i.e.
a. Time of floating the new issue.
b. Type of issue
c. Price
2. Underwriting: It is a kind of guarantee undertaken by an institution or
firm of brokers ensuring the marketability of an issue. It is a method in
which the guarantor promises to the issuing company that he/she would
purchase certain specific shares if the public not invested in it. The
following organisations who give guarantee are:
a. LIC
b. GIC
 c. Development Banks (IDBI, ICICI, etc.)
d. Brokers, etc.
3. Distribution: It involves the function of sale of shares and debentures to
the investors. It is performed by brokers and agents. Brokers can
maintain regular list of clients and directly contact for purchase and sale
of securities.

Section-B (4*5=20)
Q. No. Question Marks CO BL
2. a. “The Indian financial system was fairly well-developed even on the eve of 5 1 2
planning.” Justify the statement?
Ans. It is a system that allows the exchange of funds between lenders,
investors, and borrowers. It operates at national, global, and firm-specific
levels. Money and credit are used as media of exchange in this system. It
serve as a medium of known value for which goods and services can be
exchanged as an alternative to barter system. A modern financial system may
include banks (operated by the government or private sector), financial
markets, financial instruments and financial services. It allows funds to be
allocated, invested, or moved between economic sectors. It link between
savers and investors. It allocates risk. Price-related information available.
Reduce cost of transaction and borrowing. Financial expansion and
development.
b. What is primary market? Discuss the methods to raise equity capital in the 5 1 2
primary market?
Ans. Market where new securities i.e. shares and bonds first time issued.
Both the new companies and the existing ones can issue securities in this
market to raise capital. In this market transactions are made between an
issuer and the investors. This market is directly regulated by SEBI. The
process of selling new issues to investors is called underwriting. In the case
of a new stock issue, this sale is called as an Initial Public Offer (IPO).
The methods are:
1. Public issue: When a company raises funds by issuing its shares,
debentures and bonds to the public, it is called as a public issue.
2. Initial Public Offer (IPO): When a company makes a public issue for
the first time and gets its shares listed on stock exchange, the public issue
is called as initial public offer (IPO).
3. Follow-on public offer (FPO): When a listed company makes additional
public issue on running projects to raise capital, it is called follow-on
offer (FPO).
4. Offer for sale: Institutional investors like venture funds, private equity
funds etc., invest in unlisted company when it is very small or at an early
stage. When the company becomes large, these investors sell their shares
to the public, through issue of offer document and the company’s shares
are listed in stock exchange. This is called as offer for sale.
5. Private Placement: It is the sale of securities to a relatively small
number of select investors for raising capital. Investors involved in
private placements are usually large banks, mutual funds, insurance
companies and pension funds. Private placement is the opposite of a
public issue, in which securities are made available for sale on the open
 market.
6. Rights Issue: When a company raises funds from its existing
shareholders by issuing them new shares / debentures, it is called
as rights issue. The offer document for a rights issue is called as
the Letter of Offer. The issue is open for 90 days.
7. Bonus Issue: The Company issues new shares to its existing
shareholders. Shareholders need not pay any money to the company for
receiving the new shares.
c. What do you understand by shares? Discuss atleast four types of shares? 5 2 2
Ans. Shares are units of ownership interest in a corporation or financial asset
that provide for an equal distribution in any profits, if any are declared, in the
form of dividends. A share is a single unit of ownership in a company or
financial asset. It is essentially an exchangeable piece of value of a company
which can fluctuate up or down, depending on several different market
factors. Companies divide capital into shares as a means of raising capital.
The four types of shares are:
 Equity Shares: It is basically issued against the ownership of the
business. It represents the ownership capital. It is also called as ordinary
shares. The holders of these shares are the real owners of the company.
They have a voting right in the meetings of holders of the company. They
have control over the working of the company. The rate of dividend on
these shares depends upon the profits of the company. Equity
shareholders take risk both regarding dividend and return of capital.
Equity share capital cannot be redeemed during the life time of the
company.
 Preference Shares: Preference shares, more commonly referred to
as preferred stock, are shares of a company’s stock with dividends that
are paid out to shareholders before common stock dividends are issued.
Most preference shares have a fixed dividend, while common stocks
generally do not. If the company is in a position of loss the fixed
dividend can be carry forward to the next year and company can pay
return of both the years. If the company enters bankruptcy, the
shareholders with preferred stock are entitled to be paid from company
assets first. Preferred stock shareholders also typically do not hold
any voting rights of the company.
 Right Share: These are the shares issued to the existing shareholders of a
company. Such kind of shares is issued to protect the ownership rights of
the investors.
 Bonus Share: These are the type of shares given by the company to its
shareholders as a dividend.
d. Explain the various sources of finance which need to be arranged and 5 1 2
managed efficiently?
Ans. The following sources are:
1. Business Growth: It can be categorised into two parts:
a. Internal Sources of Finance and Growth: It is as follows:
 ‘Organic growth’ – growth generated through the development and
expansion of the business itself. Can be achieved through:
 Generating increasing sales – increasing revenue to impact on
overall profit levels.
 Use of retained profit – used to re-invest in the business.
  Sale of assets – can be a double edged sword – reduces capacity?
b. External Sources of Finance and Growth: It is as follows:
 Long Term
 Shares
 Ordinary Shares
 Preference Shares
 New issue Shares
 Rights Issue
 Bonus Issue
 Loans
 Debentures
 Bank loans
 Merchant or Investment Banks
 Short Term
 Bank loans
 Overdraft facilities
 Trade credit
 'Inorganic Growth’:
 Acquisitions- ownership of more than 50%.
 Merger- ownership distributed among both the firms.
 Takeover- one firm controls other at 100% level.
2. Business Angels: It is as follows:
 Individuals looking for investment opportunities.
 Generally small sums.
 Could be an individual or a small group.
 Generally have some say in the running of the company.
3. Venture Capital: It is as follows:
 Pooling of capital in the form of limited companies – Venture Capital
Companies.
 Looking for investment opportunities in fast growing businesses or
businesses with highly rated prospects.
 May also buyout firms in administration who are going concerns.
 May also provide advice, contacts and experience.
 In India, venture capitalists have invested ₹ 500 Lakh crore since
2019.

Section-C (2*5=10)
Q. No. Question Marks CO BL
3. a. “Finance plays a key role in the part of economic and business activities of 5 1 2
the country.” Justify the statement with the help of suitable examples.
Ans. The functioning of an economy depends on the financial system of a
country. The financial system includes banks as a central entity along with
other financial services providers. The financial system of a country is deeply
entrenched in society and provides employment to a large population.
According to Baily and Elliott, there are three major functions of the financial
system:
Credit Provision – Credit supports economic activity. Governments can invest
in infrastructure projects by reducing the cycles of tax revenues and
correcting spends, businesses can invest more than the cash they have and
individuals can purchase homes and other utilities without having to save the
entire amount in advance. Banks and other financial service providers give
this credit facility to all stakeholders.
Liquidity provision – Banks and other financial providers protect businesses
and individuals against sudden cash needs. Banks provide the facility of
demand deposits which the business or individual can withdraw at any time.
Similarly, they provide credit and overdraft facility to businesses. Moreover,
banks and financial institutions offer to buy or sell securities as per need and
often in large volumes to fulfil sudden cash requirements of the stakeholders.
Risk management services – Finance provides risk management from the
risks of financial markets and commodity prices by pooling risks. Derivative
transactions enable banks to provide risk management. These services are
extremely valuable even though they receive a lot of flak due to excesses
during the financial crisis.
The above three major functions are important for the running and
development activities of any economy. Apart from these functions, an
economy’s growth is boosted by the savings-investment relationship. When
there are sufficient savings, only then can there be a sizeable investment and
production activity. This savings facility is provided by financial institutions
through attractive interest schemes. The money saved by the public is used by
the financial institutions for lending to businesses at substantial interest rates.
These funds allow businesses to increase their production and distribution
activities.
Another important work of finance is to boost the growth of capital markets.
Businesses need two types of capital – fixed and working. Fixed capital refers
to the money needed to invest in infrastructures such as building, plant and
machinery. Working capital refers to the money needed to run the business on
a day-to-day basis. This may refer to the ongoing purchase of raw materials,
cost of finishing goods and transport of finished goods to stores or customers.
The financial system helps in raising capital in the following ways:
Fixed capital – Businesses issue shares and debentures to raise fixed capital.
Financial service providers, both public and private, invest in these shares and
debentures to make profits with minimal risk.
Working capital – Businesses issue bills, promissory notes etc. to raise short
term loans. These credit instruments are valid in the money markets that exist
for this purpose.
In order to support the export and import businessmen, there are foreign
exchange markets whereby businesses can receive and transmit funds to other
countries and in other currencies. These foreign exchange markets also enable
banks and other financial institutions to borrow or lend sums in other
currencies. Moreover, financial institutions can invest and reap profits from
their short term idle money by investing in foreign exchange markets.
Governments also meet their foreign exchange requirements through these
markets. Hence, foreign exchange markets impact the growth and goodwill of
an economy in the international markets.
Governments use the financial system to raise funds for both short term and
long term fund requirements. Governments issue bonds and bills at attractive
interest rates and also provide tax concessions. Budget gaps are taken care of
by government securities. Thus, capital markets, foreign exchange markets
and government securities markets are essential for helping businesses,
 industries and governments to carry out development and growth activities of
the economy.
The growth of different sectors of an economy is balanced through the
financial system. There are primary, secondary and tertiary sector industries
and all need sufficient funds for growth. The financial system of the country
funds these sectors and provides sufficient funds for each sector – industrial,
agricultural and services.
Thus, finance plays a key role in the development of any economy and no
economy can run successfully without a sound financial system.
b. Define unsystematic risk? Discuss the types of unsystematic risk? 5 1 2
Ans. Unsystematic risk is the risk that is inherent in a specific company or
industry. By investing in a range of companies and industries, unsystematic
risk can be drastically reduced through diversification. Synonyms include
diversifiable risk, non-systematic risk, residual risk and specific risk.
The types of unsystematic risk are:
 Business or liquidity risk: Business risk is also known as liquidity risk.
It is so, since it originates from the sale and purchase of securities
affected by business cycles, technological changes, etc.
 Financial or credit risk: Financial risk is also known as credit risk. It
arises due to change in the capital structure of the organization. The
capital structure mainly comprises of three ways by which funds are
sourced for the projects. These are as follows:
i. Owned funds. For e.g. share capital.
ii. Borrowed funds. For e.g. loan funds.
iii. Retained earnings. For e.g. reserve and surplus.
 Operational risk: Operational risks are the business process risks failing
due to human errors. This risk will change from industry to industry. It
occurs due to breakdowns in the internal procedures, people, policies and
systems.

Section-C (2*5=10)
Q. No. Question Marks CO BL
4. a. Suppose you are a CFO of a company and you want to take decision as 5 2 5
which type of instruments have to issue in the prosperity and recession
market? Justify with suitable reasons?
Ans. In prosperity market the instruments which companies have to issue are
ordinary shares and preference shares because in the market the
opportunities for both company and investors are at optimum level. Business
is capable to pay and investors are capable to invest in risky instruments.
In recession market the instruments which companies have to issue are
debentures, bonds and mutual funds because in the market the opportunities
for both company and investors are at low level. There is a shortage of
money and opportunities in the market and the investors are not capable to
invest in risky instruments. Investors want some fixed return and if the
companies need the fund from the investors then company have to issue the
instrument which have a fixed return paying capacity.
b. Differentiate between finance and accounting? 5 1 2
Ans. The following differences are:
 Accounting concentrates on record keeping and submitting of financial
 statements whereas Finance focuses on making decisions and carrying
out analysis based on information presented by accounting.
 Accounting tends to be more concerned with the past whereas Finance
tends to be more interested in present and the future.
 Accounting tends to have an income focus and Finance tends to have a
cash flow focus.

Section-C (2*5=10)
Q. No. Question Marks CO BL
5. a. Explain in detail the different types of financial decisions as required for the 5 1 5
smooth functioning of an organization?
Ans. The types are:
1. Investment Decisions:
 Should we built this component or buy it?
 What specific assets should be acquired?
 Should we introduce a new product?
 Which projects should be undertaken?
2. Financing Decisions:
 What is the best structure of financing (debt versus equity)?
 How much of our debt should be short-term as opposite to long-term?
 What is the best dividend policy?
 How will the funds be physically acquired?
3. Asset-Management Decisions:
 How do we manage existing assets efficiently?
 Greater emphasis on current asset management than fixed asset
management
b. What do you understand by secondary market? Explain the different 5 1 2
functions performed by secondary market?
Ans. A secondary market is a market where stockbrokers and traders can buy
and/or sell stocks (also called shares), bonds and other securities. It is a
market place where listed securities buy and sell for investment or
speculation. It is an organised and regulated market for various securities
issued by corporate sector and other institutions. It is a privately organised
market which is used to facilitate trading of securities. It is as ready market
where buyers and sellers are always available to buy and sell the securities.
The securities of corporations, trusts, Government, municipal corporations,
etc. are allowed to deal at stock exchange. It is a market wholly governed
and regulated by SEBI.
The functions are:
1. Ensure Liquidity of Capital: It provides a place where securities are
converted into cash. It is a market where buyers and sellers are always
available and those who need hard cash can sell their securities.
2. Contributes to Economic Growth: In secondary market securities of
various companies are bought and sold. This process of investment and
re-investment helps to invest in most productive investment proposal
and this leads to capital formation and economic growth.
3. Spreading of Ownership culture: Secondary market encourages
people to invest in ownership securities by regulating new issues, better
trading practices and by educating public about investment.
4. Providing Scope for Speculation: To ensure liquidity and demand of
supply of securities the stock exchange permits healthy speculation of
securities.
5. Better Allocation of Capital: The shares of profit making companies
are quoted at higher prices and are actively traded so such companies
can easily raise fresh capital from stock market. The general public
hesitates to invest in securities of loss making companies. So stock
exchange facilitates allocation of investor’s fund to profitable channels.
6. Promotes the Habits of Investment: The stock market offers attractive
opportunities of investment in various securities. These attractive
opportunities encourage people to save more and invest in securities of
corporate sector rather than investing in unproductive assets such as
gold, silver, etc.
7. Safety of Transactions: In stock market only the listed securities are
traded and stock exchange authorities include the companies names in
the trade list only after verifying the soundness of company. The
companies which are listed they also have to operate within the strict
rules and regulations. This ensures safety of dealing through stock
exchange.