For the existing schemes, they would require the approval of their unit holders. The minimum contract value would be Rs 1 lakh, which would also apply in the case of individuals.

CAPM

THE Capital Asset Pricing Model (CAPM) is an economic model that describes how securities are priced in the marketplace. It has its roots in the normative mean-variance approach to investing, which was first developed by Markowitz. f certain assumptions are made, then it can be shown that the expected return of an asset will be positively and linearly related to the level of its beta.

The assumptions underlying CAPM are:

Two projects

CYBER Company is considering two mutually exclusive projects. The investment outlay of both the projects is Rs 5,00,000 and each is expected to have a life of five years. Under three possible situations their annual cash flows and probabilities are as shown in Table 1.

The cost of capital is 7 per cent, which project should be accepted? Explain with workings. (3 marks)

The solution is presented in Table 2. As both the projects yield same NPV, the decision is indifferent for both the projects.

a) Which project will you recommend based on the data given in Table 3? Explain whether your opinion will change if you use coefficient of variation as a measure of risk. Which measure is more appropriate in this situation and why? (3 marks)

i) Project Y having highest NPV shall be selected.

ii) The opinion will change on account of applying co-efficient of variation (see Table 4) as a measure of risk. Project with a lower percentage shall have the lower risk factor. On that basis, Project Y shall be selected.

iii) The measure as per (ii) is more appropriate as it includes risk factor too.

Mutual funds

WRITE short notes on the role of mutual funds in the financial market. (6 marks)

Mutual funds have opened new areas to investors and imparted much needed liquidity to the system. In this process they have challenged the dominant role of the commercial banks in the financial market and the national economy.

Their role with respect to household savings, capital market and corporate finance are as follows:

Mutual funds and household savings: In India, there has been a steady increase in the share of mutual funds in household savings. It has risen from 0.3 per cent in 1980-81 to 7 per cent in 1992-93.

Mutual funds and the capital market: According to Centre for Monitoring Indian Economy (CMIE), mutual funds cornered 12 per cent of the total market capitalisation, especially in equities. This indicated that mutual funds have strongly supported the equity market. While non-UTI mutual funds have tended more towards equities and debentures, the UTI has rendered better support to the government securities market.

Mutual funds and corporate finance: According to the RBI's flow of funds statistics, the share of mutual funds in filling the resource gap of the corporate sector has risen more rapidly when compared to the banking sector.

Spot rate

IN MARCH 2003, a multinational makes the following assessment of dollar rates per British pound to prevail as on September 1, 2003:

$/pound 1.60, probability 0.15; 1.70, 0.20; 1.80, 0.25; 1.90, 0.20; and

2.0, 0.20. What is the expected spot rate for September 1, 2003?

If, as of March 2003, the six-month forward rate is $1.80, should the firm sell forward its pound receivables due in September 2003? (6 marks)

Solution: Table 7 presents the expected spot rate. When the firm sells pound receivable at $1.80, it would be recovering a cent less for every pound by resorting to forward.

Buy, sell or hold

AN INVESTOR is holding 1,000 shares of Fatlass Company. At present, the rate of dividend being paid by the company is Rs 2 per share and the share is being sold at Rs 25 per share in the market. However, several factors, as indicated in Table 8, are likely to change during the course of the year. In view of this, should the investor buy, hold or sell the shares? And why? (8 marks)

The basic information is as follows:

do = 2

Po = 25

New growth rate = 9 per cent

d1 = 2(1+0.09) = 2.18

new rf = 10

new rm - rf = 4

new beta = 1.25

SML return:

rs = rf + (rm - rf) x ß

rs = 10+(4 x 1.25)

rs = 15 per cent

Expected price: Po = d1

Ke - g

= 2.18 = Rs 36.33

0.15 - 0.09

The present price of Rs 25 is less than Rs 36.33 and, hence, the situation is under-priced. The strategy is to buy some more shares to encash the under-priced situation.

GDRs, ECBs

WRITE short notes on global depository receipts (GDRs) and euro convertible bonds (ECBs). (4 marks)

GDRs: A depository receipt is basically a negotiable certificate denominated in dollars that represents a non-US-company's publicly-traded local currency equity shares. These depository receipts, like any other dollar-denominated security, may trade freely in the overseas markets either on a foreign stock exchange or in over-the-counter market, or among a restricted group.

Indian companies have taken to the GDR route basically to reflect the fact that the issues are marketed globally rather than in a specific country or market.

ECBs: A convertible bond is a debt instrument which gives the holders of the bond an option to convert the bond into a predetermined number of equity shares of the company. Usually, the price of the equity shares at the time of conversion will have a premium element. The bonds carry a fixed rate of interest.

If the issuer company desires, such bonds may carry two options — call or put. In the case of ECBs, the payment of interest on, and the redemption of, bonds will be made by the issuer company in dollars.

(To be concluded)

(Suggested answers to the May 2003 CA (Final) paper on management accounting and financial analysis.)

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