SANJAY SARAF. 10 Marks. Ans.

Transcription

1 Q1) Quality Marine Products (P) Ltd., Kolkata imported deep freezing equipment from Holland. The company has a choice to invoice in the following currencies The company has the choice to pay at the end of 1st month or 2nd month along with interest at the applicable rates. However the pay-out at the end of 2nd month has to be made in Euro and actual pay-out depends on how the rates are fixed with Euro. If the Rs./ Euro is 58, after 2 months compute the limits for SKr/Euro and CHF/Euro that will make invoicing in SKr and CHF a better choice than. Which currency should the company prefer to pay at the end of first month? (CHF) Swiss Franc is the best currency for making payment at the end of the first month. Outflow in Rs. if payment is made in after two months: x = Rs Value of the outflow in Euro = 1, 66, 33, 825/58 = Break even SKr/Euro rate = 26,35,808/ = Break even CHF/Euro rate = 4,35,580/ = Hence, payment in SKr and CHF will be better choice if the SKr/Euro and CHF/Euro rates are less then the break even rates.

2 Q2) A foreign institutional investor (FII) proposes to invest $10 million in an Indian security with a beta of 1.10 and standard deviation of returns 7%. The holding period of investment will be one year. The current rupee-dollar exchange rate is Rs / $. The expected depreciation of rupee against dollar over the period is 2% with a standard deviation of 10%. The expected return from the market portfolio in India is 12% and the correlation between the return on security and the exchange rate is The risk free rate of return in India is 5%. You are required to calculate the expected return and risk for the FII. Expected return from the security = Rf + ß (Rm Rf) = ( ) = 12.70%

3 Q3) The closing value of the Sensex for the month of October 2001 is given as below:

4 You are required to test the weak form of efficient market hypothesis by applying the Run test at 5% and 10% level of significance.

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6 Q4) The current stock price of Telesoftek Ltd. is quoting at Rs.75. The standard deviation of continuously compounded annual rate of return from the stock is 25%. The risk-free rate in the economy is 8%. You are required to a. Calculate the value of a call option with strike price Rs.100 and time to expiration 6 months using Black Schole s option valuation model. b. Calculate the value of a put option with strike price Rs.100 and time to expiration 6 months.

7 Q5) The following options are quoted at the market:

8 A trader is looking at the above options and planning to adopt long strip or long strap strategy to make profit from the rupee dollar exchange rate volatility. You are required to a. Show the pay-off profile and indicate break-even points for strip and strap strategies in a price range of Rs.47 Rs.50 for a dollar. b. Comment on the desirability of the above two option strategies. a. Strip Strategy Buy one call at Buy two puts at Total initial outflow = = Rs.0.40 Break-even points are and Strap Strategy Buy two calls at Buy one put at Total initial outflow = = Rs.0.65.

9 Break-even points are and b. The buyer of strip and strap expects there will be a significant movement in the spot price. Strip strategy is more desirable if the spot price is more likely to fall than to rise and strap strategy is desirable if spot price more likely to rise. Strip will give profit if spot price falls below or rises above Strip will give profit if price falls below or rises above So, the trader will buy strip if he expects rupee to appreciate and will buy strap if he expects rupee to depreciate significantly. Q6) Talent Search Ltd. is interested in acquiring Innovative Pvt. Ltd. whose owner desires to retire. Presently, 100% owned by the current owner Innovative Pvt. Ltd. has revenues of Rs.10 lakh and an EBIT of Rs.2 lakh for the year ended March 31, The market value of the firm s debt is Rs.5 lakh and the book value of equity is Rs.4 lakh. For publicly traded firms in the same industry, the average D/E is 0.4 (based on the market value of debt and equity), and the marginal tax rate is 35%. Typically, the ratio of the market value of equity to book value for these firms is 2. The average of publicly traded firms that are in the same business is Capital expenditure and depreciation amounted to Rs.3 lakh and Rs.2 lakh in the prior year. Both items are expected to grow at the same rate as revenues for the next 5 years. Capital expenditure and depreciation are expected to be equal beyond 5 years (i.e., capital spending will be internally funded). Due to excellent\ working capital management practices, the change in working capital is expected to be essentially zero throughout the forecast period and beyond. The revenues of this firm are expected to grow 15% annually for the next 5 years, and 5% per year there after. Net income is expected to increase 15% a year for the next 5 years and 5% thereafter. The 364-day T-bill is yielding 5.5%. The pre-tax cost of debt for a non rated firm is 10%. No adjustment is made in the calculation of the cost of equity for a marketability discount. You are required to estimate the shareholder value of the firm.

10 Q7) A portfolio manager is considering the following two bonds for inclusion in the portfolio: a. Bond A is a 25-year maturity bond currently selling at Rs It pays an annual 8%. b. Bond B is a 15-year maturity bond selling at Rs It pays an annual 7.25% He predicts an upward sloping yield curve and forecast that after 5 years a 20-year bond will give an YTM of 9% and a 10-year bond will give an YTM of 8%. If investment

11 horizon of the portfolio manager is five years, which bond should he pick? The reinvestment rate is 5%. Q8)

12 The rates of return in different scenarios should be changed in to rupee pay-off per share as indicated below: Construction of an arbitrage portfolio requires formation of a zero investment portfolio. The essential condition is that portfolio must not give negative returns. If we short sell two stocks each of the Himani Ltd and Kothari Biotech one stock of Polar softech can be purchased and this portfolio will qualify as zero investment portfolio: ( 2) x 12 + ( 2) x = 0 The pay off form this arbitrage portfolio under different market conditions: Net payoff from the portfolio clearly shows that this is an arbitrage portfolio as it has produced positive return in all the market scenarios. Q9) Perfect Enterprises Limited had issued 10 year debentures on January 1, 2002 carrying a coupon rate of 11 percent payable semi-annually. As per the terms and conditions of the issue the company can repurchase these debentures after January 1, 2004 at a price, which is 5 percent more than the nominal value of these debentures. As per the latest balance sheet the long-term debt to equity ratio of the company is 1.6 and the net worth of the company is Rs.250 lakh. The long-term debt consists of a term loan and the aforementioned debentures. The total interest expense of the company in the recently completed financial year was Rs.45.6 lakh, which wholly consists of the interest on account of the term loan and the debentures. The ratio of the interest on term loan to the interest on the debentures is 8:11. The company is planning to repurchase these debentures on January 1, 2006 and replace them at the same time by new debentures carrying a coupon rate of 10 percent payable semi-annually and having a maturity period of 6 years. The new debentures will be issued at par and company expects that the net amount realized from the issue of the new debentures will be equal to the nominal value of the existing debentures, and the issue cost will amount to 1.5 percent of the total nominal value of the issued debentures. The coupon rate and the terms of payment of interest on the new debentures will reflect effective annual rate of interest on similar securities issued by similar companies. You are required to answer the following questions:

13 a. What is total cost that is directly associated with the decision to replace the existing debentures with new ones? b. Is the decision to repurchase the existing debentures beneficial to the company in financial terms? Justify your answer. a. Costs directly associated with the replacement decision = Floatation cost + Premium payable on repurchase Premium on repurchase = Total nominal value x 0.05 Total long term debt = Long term debt to equity ratio x Net worth = 1.6 x 250 = Rs. 400 lakh. Total interest = Interest on term loan + Interest on existing debentures or 45.6 = 8x + 11x or x = 45.6/19 = 2.40 So Interest on debentures = 11 x 2.40 = Rs lakh So total nominal value of existing debentures = 26.4/0.11 = Rs. 240 lakh So Premium payable on repurchase = 240 x 0.05 = Rs. 12 lakh (A) Floatation cost of new debentures = Total issue price of the new debentures x Total issue price (T) = Net amount realized + Issue expense = Nominal value of existing debentures T = T or T T = 240 or T = 240/0.985 = Rs lakh So Floatation cost of new debentures = x = Rs lakh (B) Total cost directly associated with the decision to replace the existing debentures = A + B = Rs lakh b. Financial viability of the replacement decision : Considering in terms of half year : Interest savings after the new issue = Total interest on new debentures = Total interest on old debentures Total interest on new debentures = x 0.10/2 = Rs lakh (A) Total interest on old debentures = 240 x 0.11/2 = Rs lakh (B) Interest savings every half year = B A = Rs lakh Number of half yearly periods = 6 x 2 = 12 Discount rate = Coupon rate on the new debentures/2 = 0.10/2 = 0.05 (5%) Because the coupon rate and terms of coupon payment on the new debentures reflect the prevailing effective annual rate of interest. NPV = PVIFA (5%, 12) PVIFA (5%, 12) = ((1.05) 12-1)/ (1.05) 12 (0.05) = NPV = ( x 8.863) = Rs Since the NPV is negative the decision to replace the existing debentures is not financially viable.

14 Q10a) The following figures are collected from the annual report of Ranbaxy Pharmaceuticals Ltd.: Net profit Rs.30 lakh Outstanding Preference shares Rs percent per annum Number of equity shares 300,000 Cost of equity shares 16 percent Return on Investment 20 percent What should be the approximate dividend pay out ratio, so as to keep the share price at Rs.42 by using Walter model? 6 Marks Net profit = Rs.30 lakh Less: Preference Dividends = Rs.12 lakh Earnings for the equity shareholders = Rs.18 lakh Therefore, earnings per share = 18/3 = Rs.6.00 Let, the dividend pay out ratio be x and so the share price will be: P = Here, D = 6x, E = Rs.6, r = 0.20 and k e = 0.16 and P = Rs.42 Or, Rs.42 = x (1 x) or, x = or, x = Q10b) The current price of a share of Kaykay Pharmaceuticals Ltd. is Rs.55. The company is planning to issue 1 right share for every 4 equity shares.if the company targets that the exrights value of a share shall not fall below Rs.52, Find the subscription price for one rights share. 4 marks Ex-rights value of a share = (NPo+S)/(N+1)

15 Where, N is number of existing shares required for a rights share. Po is the cum rights price per share S is the subscription price 52 (4x55+S)/(4+1)