Mock Test Paper - Series I: September, 2024

Date of Paper: 11th September, 2024

Time of Paper: 2 P.M. to 5 P.M.
FINAL COURSE: GROUP – I
PAPER – 2: ADVANCED FINANCIAL MANAGEMENT
ANSWER TO PART – I CASE SCENARIO BASED MCQS
1. Option (d)
2. Option (b)
3 Option (b)
4. Option (a)
5. Option (a)
6. Option (b)
7. Option (d)
8. Option (a)
9. Option (c)
10. Option (d)
11. Option (b)
12. Option (a)
13. Option (d)
14. Option (b)
15. Option (d)

ANSWERS OF PART – II DESCRIPTIVE QUESTIONS

1. (a)
Particulars Amount (`)
Amount available in bank account 7,00,000
Minimum balance to be kept 1,000
Available amount which can be used for potential 6,99,000
exposure in market for 4 days
Maximum Loss for 4 days at 99% level 6,99,000
Maximum Loss for 1 day at 99 % level = Maximum Loss 3,49,500
for 4 days / √No. of days = 699000/ √4
Z Score at 99% Level 2.33
Volatility in terms of Rupees (Maximum Loss/ Z Score at 1,50,000
99% level) = 349500/ 2.33
Maximum Possible Exposure (Volatility in Rupees/Std 1,00,00,000
Deviation) = 150000/.015
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(b) D0 = ` 4
D1 = ` 4 (1.20) = ` 4.80
D2 = ` 4 (1.20)2 = ` 5.76
D3 = ` 4 (1.20)2 (1.10) = ` 6.34
D1 D2 TV
P= +
2
+
2
(1+ k e ) (1+ k ) (1+ k e )
e

D3 6.34
TV = = = 126.80
ke - g 0.15 - 0.10

P= 4.80 5.76 126.80

+ +
(1+ 0.15) (1+ 0.15)2 (1+ 0.15)2

= ` 4.80 x 0.8696 + ` 5.76 x 0.7561 + ` 126.80 x 0.7561

= ` 4.17 + ` 4.36 + ` 95.87
= ` 104.40
(c) A Unicorn is a privately held start-up company which has achieved a
valuation US$ 1 billion. This term was coined by venture capitalist
Aileen Lee, first time in 2013. Unicorn, a mythical animal represents the
statistical rarity of successful ventures.
A start-up is referred as a Unicorn if it has following features:
(i) A privately held start-up.
(ii) Valuation of start-up reaches US$ 1 Billion.
(iii) Emphasis is on the rarity of success of such start-up.
(iv) Other common features are new ideas, disruptive innovation,
consumer focus, high on technology etc.
However, it is important to note that in case the valuation of any start-
up slips below US$ 1 billion it can lose its status of ‘Unicorn’. Hence a
start-up may be Unicorn at one point of time and may not be at another
point of time.
In September 2011, InMobi, an ad-tech startup, became the first
Unicorn of India. SoftBank invested US$ 200 million in InMobi valuing
the mobile advertising company at over US$ 1 billion, making it India’s
first unicorn. InMobi was founded in 2007 and took four years to
achieve the Unicorn status in 2011 In 2018, Udaan, a B2B e-commerce
marketplace, became the fastest growing startup by becoming a
Unicorn in just over two years’ time.

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2. (a) (i) Rupee – Dollar Selling Rate: = ` 82.85
Dollar – Hong Kong Dollar Buying Rate: = H.K.$ 7.8880
Hong Kong Dollar (Selling) Cross Rate: = ` 82.85 / 7.8880
= `10.5033
(ii) Profit / Loss to the Bank
Amount received from customer
(HK$ 10 million × 10.55) ` 10,55,00,000
Amount paid on cover deal
(HK$ 10 million × `10.5033) ` 10,50,33,000
Profit to Bank ` 4,67,000
(iii) To some extent, we agree with views of Internal Auditor as the
gain on the same transaction is bit lesser keeping in view the
amount involved.
(b) Decision Tree showing pay off
Year 0 Year 1 Pay off
260 0
200
120 160 - 120 = 40
First of all we shall calculate probability of high demand (P) using risk
neutral method as follows:
8% = p x 30% + (1-p) x (-40%)
0.08 = 0.30 p - 0.40 + 0.40p
0.48
p= = 0.686
0.70
The value of abandonment option will be as follows:
Expected Payoff at Year 1
= p x 0 + [(1-p) x 40]
= 0.686 x 0 + [0.314 x 40]
= ` 12.56 crore
Since expected pay off at year 1 is ` 12.56 crore. Present value of
expected pay off will be:
12.56
= ` 11.63 crore.
1.08
This is the value of abandonment option (Put Option).
(c) Some of the Qualitative factors that need to be taken into account in
addition to Quantitative Factors are as follows: -
(1) Quality of Portfolio: - Quality of stocks and securities in the
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 portfolio of the Mutual Funds is an important qualitative
parameter. The reason is that the quality of the portfolio plays a
big role in achieving superior returns. The qualitative
characteristic of portfolio of Equity Mutual Fund involves allocation
of funds in top Blue-chip companies, large companies and how
diversified is the portfolio. The style followed can be growth, value
or blend of the same. In Debt Funds, the quality of portfolio is
measured on the basis of credit quality, average maturity and
modified duration of the fixed asset securities.
Not only that it is necessary that Mutual Fund should hold good
quality stocks or securities, but it is also necessary the investment
should be as per the objective of the Fund. Under normal
circumstances, the fund having lower Portfolio Turnover ratio is
considered to be better.
(2) Track record and competence of Fund Manager: - Since Fund
Manager decides about the selection of securities and takes
investment decisions, his/her competence and conviction plays a
very big role. The competence of a Fund Manager is assessed
from his/her knowledge and ability to manage in addition to past
performance.
(3) Credibility of Fund House Team: - Team of Fund House also plays
a big role towards the investors’ interest. In addition to investment
decisions, there are some other administrative tasks also such as
redemption of units, crediting of dividend, providing adequate
information etc. which play a crucial role in qualitative assessment
of any mutual fund house.
3. (a) (i) Mr. A’s position in the two securities are +1.50 in security X and -
0.5 in security Y. Hence the portfolio sensitivities to the two
factors:-
λ1 =1.50 x 0.80 + (-0.50 x 1.50) = 0.45
λ2 = 1.50 x 0.60 + (-0.50 x 1.20) = 0.30
(ii) Mr. A’s revised position:-
Security X ` 9,00,000 / ` 3,00,000 = 3
Security Y - ` 3,00,000 / ` 3,00,000 = -1
Risk free asset - ` 300000 / ` 300000 = -1
λ1 = 3.0 x 0.80 + (-1 x 1.50) + (- 1 x 0) = 0.90
λ2 = 3.0 x 0.60 + (-1 x 1.20) + (-1 x 0) = 0.60
(iii) Expected Return = Risk Free Rate of Return + Risk Premium for
each sensitivity factor
Accordingly
15 = 10 + 0.80 λ1 + 0.60 λ2
20 = 10 + 1.50 λ1 + 1.20 λ2
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 On solving equation, the value of λ1 = 0
Yes, Mr. D is correct in his observation.
(b) To compute the value of A Ltd. first, we shall calculate WACC of the
company. Since its share is not trading in the market, we shall use
proxy beta to calculate the cost of equity. Since the unlevered beta of
the industry is 1.8 the levered beta of the company will be:
1.8[1+(1-0.3)*40/60)] = 2.64
The Cost of equity in accordance with CAPM = r (f) + β (Rm – Rf)
= 5% + 2.64 (11% - 5%) = 20.84%
The WACC = Cost of Equity + Cost of Debt
= 20.84 (60/100) + 12.0 (1-0.3) (40/100) = 15.864
Finally, the free cash flows can be discounted at the WACC obtained
above as under –
Year 1 Year 2 Year 3
Free Cash Flows 10 12 15
Discount factor 0.863 0.745 0.643
PVs of cash flows 8.63 8.94 9.645
Value of X Pvt. Ltd. (` Crore) 27.215
(c) The various types of Swaps are as follows:
(i) Plain Vanilla Swap: Also called Generic Swap or Coupon Swap
and it involves the exchange of a fixed rate loan to a floating rate
loan over a period of time and that too on notional principal.
Floating rate basis can be LIBOR, MIBOR, Prime Lending Rate
etc.
For example, Fixed interest payments on a generic swap are
calculated assuming each month has 30 days and the quoted
interest rate is based on a 360-day year. Given an All-In-Cost of
the swap, the semi-annual fixed-rate payment would be:
(N)(AIC)(180/360),
Where,
N denotes the notional principal amount of the agreement.
AIC denotes the fixed rate
Then, the floating-rate receipt is determined by the formula:
(N)(R)(dt/360)
Where,
dt denotes the number of days since the last settlement
date
R denotes the reference rate such as LIBOR, MIBOR etc.
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(ii) Basis Rate Swap: Also, called Non-Generic Swap. Similar to
plain vanilla swap with the difference that payments are based
on the difference between two different variable rates. For
example, one rate may be 1 month LIBOR and other may be 3-
month LIBOR. In other words, two legs of swap are floating but
measured against different benchmarks.
(iii) Asset Swap: Like plain vanilla swaps with the difference that it is
the exchange fixed rate investments such as bonds which pay a
guaranteed coupon rate with floating rate investments such as
an index.
(iv) Amortising Swap: An interest rate swap in which the notional
principal for the interest payments declines during the life of the
swap. They are particularly useful for borrowers who have issued
redeemable bonds or debentures. It enables them to do interest
rate risk hedging attached with redemption profile of bonds or
debentures.
OR
There are four principles of an Active Portfolio Strategy (APS). These
are:
(i) Market Timing: This involves departing from the normal i.e.,
strategy for long run asset mix to reflect assessment of the
prospect of various assets in the near future. Market timing is
based on an explicit or implicit forecast of general market
movement. In most cases investors may go largely by their
market sense. Those who reveal the fluctuation in the market may
be tempted to play the game of market timing but few will succeed
in this game. Further an investment manager has to forecast the
market correctly and 75% of the time he is only able to break even
after taking into account the cost of errors and cost of
transactions.
(ii) Sector Rotation: Sector or group rotation may apply to both stock
and bond component of the portfolio. It is used more compulsorily
with respect to strategy. The components of the portfolio are used
when it involves shifting. The weighting for various industry
sectors is based on their asset outlook.
With respect to bond portfolio sector rotation it implies a shift in
the composition of the bond portfolio in terms of quality as
reflected in credit rating, coupon rate, term of maturity etc.
(iii) Security Selection: Security selection involves a search for under-
priced security. If one has to resort to active stock selection he
may employ fundamental / technical analysis to identify stocks
which seems to promise superior return and concentrate the stock
components of portfolio on them.

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 As far as bonds are concerned security selection calls for
choosing bonds which offer the highest yields to maturity and at a
given level of risk.
(iv) Use of Specialised Investment Concept: To achieve superior
return, one has to employ a specialised concept/philosophy
particularly with respect to investment in stocks. The concept
which have been exploited successfully are growth stock,
neglected or out of favour stocks, asset stocks, technology stocks
and cyclical stocks.
4. (a) (i) Receipts using a Forward Contract = US$ 10 Million/0.012195
= ` 820,008,200
(ii) Receipts using Currency Futures
The number of contracts needed is (US$ 10
Million/0.012189)/32,816,474 = 25
Initial margin payable is 25 contracts x ` 27,500 = ` 687,500
On April 1,2023 Close at 0.012198
Receipts = US$ 10 Million/0.012199 = ` 819,739,323
Variation Margin =
[(0.012198 – 0.012189) x 25 x 32,816,474]/0.012199
OR
(0.000009 x 25 x 32,816,474)/.012199
= 7383.71/0.012199 =` 605,271
Less: Interest Cost – ` 6,87,500 x 0.07 x 3/12 =` 12,031
Net Receipts ` 820,332,563
(iii) Receipt if exposure is kept unhedged
US$ 10 Million/0.012199 ` 819,739,323
Advise: The most advantageous option would hedge with Futures
because it has highest receipt.
(b) (i) Conversion rate is 14 shares per bond and Market price of share
is ` 400 then
Stock Value of Bond shall be: 14 × ` 400 = ` 5,600
1775
(ii) Premium over Conversion Value (` 7375 - ` 5600) = x 100
5600
= 31.70%
(c) Yes, this statement is correct since the securitization is based on the
pools of assets rather than the originators, the assets must be
assessed in terms of its credit quality and credit support available.
Rating agency assesses the following:
 Strength of the Cash Flow.
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  Mechanism to ensure timely payment of interest and principle
repayment.
 Credit quality of obligors.
 Liquidity support.
 Strength of legal framework.
5. (a) Working Notes:
To prepare Revised Balance Sheet we need to calculate swap ratio,
number of shares to be issued to Weak Bank and Capital Reserve or
Goodwill on merger as follows:
(1) Calculation of Book Value per Share
Particulars Weak Strong
Bank (W) Bank (S)
Share Capital (` Lakhs) 300 1,000
Reserves & Surplus (` Lakhs) 160 11,000
460 12,000
Less: Preliminary Expenses (` Lakhs) 100 --
Net Worth or Book Value (` Lakhs) 360 12,000
No. of Outstanding Shares (Lakhs) 30 100
Book Value Per Share (`) 12 120
(2) Swap Ratio
Gross NPA 1:8 1/8 x 30% 0.0375
CAR 5:16 5/16 x 28% 0.0875
Market Price 12:96 12/96 x 32% 0.0400
Book Value Per Share 12:120 12/120x 10% 0.0100
0.1750

Thus, for every share of Weak Bank, 0.1750 share of Strong Bank
shall be issued.
(3) No. of equity shares to be issued:
300
× 0.1750 = 5.25 lakh shares
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(4) Calculation of Capital Reserve
Book Value of Shares ` 360.00 lac
Less: Value of Shares issued ` 52.50 lac
Capital Reserve ` 307.50 lac

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 Balance Sheet after Merger
` lac ` lac
Paid up Share 1052.50 Cash in Hand & RBI 5800.00
Capital
Reserves & Surplus 11000.00 Balance with other 4000.00
banks
Capital Reserve 307.50 Investment 40200.00
Deposits 96000.00 Advances 61000.00
Other Liabilities 6780.00 Other Assets 4140.00
115140.00 115140.00
(b) The SWIFT plays an important role in Foreign Exchange dealings
because of the following reasons:
 In addition to validation statements and documentation it is a
form of quick settlement as messaging takes place within
seconds.
 Because of security and reliability helps to reduce Operational
Risk.
 Since it enables its customers to standardise transaction it
brings operational efficiencies and reduced costs.
 It also ensures full backup and recovery system.
 Acts as a catalyst that brings financial agencies to work together
in a collaborative manner for mutual interest.
6. (a) To determine which of the two projects bears more risk for every
percent of expected return first we shall calculate Variance and
Standard Deviation of both the projects.
(i) Project X
Expected Net Cash Flow
= (0.10 x 220) + (0.20 x 260) + (0.40 x 300) + (0.20 x 340) + (0.10
x 380)
= 22 + 52 + 120 + 68 + 38 = 300
2 2 2 2 2 2
( ) ( ) ( ) ( ) (
σ = 0.10 220 – 300 + 0.20 260 – 300 + 0.40 300 – 300 + 0.20 340 – 300 + 0.10 380 – 300)
= 640 + 320 + 0 + 320 + 640 = 1920
σ = 1920 = 43.82
(ii) Project Y
Expected Net Cash Flow
= (0.10 X 180) + (0.25 X 260) + (0.30 X 340) + (0.25 X 420) +
(0.10 X 500)
= 18 + 65 + 102 + 105 + 50 = 340
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 2 2 2 2 2
σ
2
= 0.10 (180 – 340 ) (
+ 0.25 260 – 340 ) + 0.30 (340 – 340 ) (
+ 0.25 420 – 340 ) (
+ 0.10 500 – 340 )
= 2560 + 1600 + 0 + 1600 + 2560 = 8320
σ= 8320 = 91.21
Now we shall calculate Coefficient of Variation
Standard Deviation
Coefficient of Variation =
Mean
43.82
Project X = = 0.146 or 14.61%
300
91.21
Project Y = = 0.268 or 26.83%
340
Project Y bears more risk for every percent of expected return.
(b) (i) Determination of Economic Value Added (EVA)
$ Million
EBIT 360.00
Less: Taxes @ 35% 126.00
Net Operating Profit after Tax 234.00
Less: Cost of Capital Employed [W. No.1] 145.20
Economic Value Added 88.80
(ii) Determination of Market Value Added (MVA)
$ Million
Market value of Equity Stock [W. No. 2] 1000
Equity Fund [W. No. 3] 850
Market Value Added 150
Working Notes:
(1) Total Capital Employed
Equity Stock $ 200Million
Reserves and Surplus $ 650Million
Loan $ 360Million
$ 1210Million
WACC 12%
Cost of Capital employed $ 1210 Million х 12% $ 145.20 Million
(2) Market Price per equity share (A) $ 50
No. of equity share outstanding (B) 20 Million
Market value of equity stock (A) х (B) $ 1000 Million
(3) Equity Fund
Equity Stock $ 200 Million
Reserves & Surplus $ 650 Million
$ 850 Million

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(c) As the name suggests, venture capital firms have made this famous.
Such investors seek a return equal to some multiple of their initial
investment or will strive to achieve a specific internal rate of return
based on the level of risk they perceive in the venture.
The method incorporates this understanding and uses the relevant
time frame in discounting a future value attributable to the firm.
The post-money value is calculated by discounting the rate
representing an investor’s expected or required rate of return.
The investor seeks a return based on some multiple of their initial
investment. For example, the investor may seek a return of 10x, 20x,
30x, etc., their original investment at the time of exit.
New-age startups are disruptors in their own right and a necessary
tool for global innovation and progress. By their very nature, startups
disrupt set processes and industries to add value. In that process,
they transcend traditional indicators of success like revenues,
profitability, asset size, etc. Accordingly, it is no mean feat to uncover
the actual value of a startup.
While the traditional methods fall short, there is no shortage of new
innovative methods used to value startups based on their value
drivers. However, the valuation of a startup is much more than the
application of ways – it is about understanding the story of the future
trajectory and communicating that narrative using substantial
numbers.

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