The Hindu Business Line : Smiling back from the exams

Q1(a) : This question on capital budgeting is an unbelievable real sitter even by PCC standards. To top that, it carries 12 marks. For the time it takes to solve, six marks should have been adequate.

Q1(b): This is a good question partly on portfolio and partly on risk analysis. It comes in three parts. It tests concepts and that is as it should be.

i) Involves computation of return of individual stocks and that of portfolio. Dividends are received half way into the year. It is not clear whether IRR needs to be computed or whether simple return would do. Of course conceptually IRR should be calculated, though under exam conditions, given the fact that financial calculators aren't allowed, it would be a time-consuming call. In all likelihood, simple return calculation would perhaps be accepted as right answer.

ii) This is similar to (i) except that dividends are received at the year end and estimation of market price at year end is required to be calculated with the help of probabilities

iii) This one involves computing standard deviation and could fox some since the deviation is required to be computed for a stock across two years rather than in respect of multiple observations in a year. If probability in this case is considered redundant, one would have been able to crack it.

Q2(a): This question, again on portfolio management, comes in three parts.

i) Ha, there is a small play in grammar, that I believe opens itself to two interpretations. What does "A company invests 20 per cent of its investment in the first two mutual funds" mean?

Would it be 20 per cent in each or 20 per cent on the whole, with a split between the two left to the choice of the student. Apart from this minor irritant, this too is a sitter involving computation of portfolio beta using the concept of weighted average beta

ii) A question almost identical to (i) above except that the investment percentages are different. It really beats me as to why the examiner would like to test the student on the same concept, weighted average beta, twice.

iii) This one stumps me. The term expected return is being used apparently to mean the same as required return.

Remember, required return is the return mandated by CAPM for the risk level involved while expected return is what the investor expects to earn keeping in mind current price levels. The risk-free rate is missing and without assuming a number it doesn't appear that one can figure it out.

Q2(b): Gosh! This one on portfolio and CAPM has appeared umpteen times with numbers changed and with market return consistently missing in all the exams! An assumption would have to be made. Candidates would have had no difficulty solving this. The 10 marks are there for the asking.

Q3(a): This is a good one from the ICAI. It could be dubbed a case study.

Something on these lines appeared a few years back. Issues involved herein are: Is preference capital debt or equity? Can cost of debt be higher than cost of preference? Can and should a tax rate be assumed? Should we fill the debt-equity ratio to the brim? Is equity the cheapest source of financing? How are retained earnings to be considered?

The only problem is that the question whose answer can definitely be open ended carries 16 marks and this could put off a candidate.

Q3(b): This is a four mark theory question on difference between repo and reverse repo and is an exam regular.

Q4(a): Again, an unbelievably simple question on valuing a share.

There is a surprising reference to additional depreciation on account of revaluing assets. Given the minimal time that it should take to solve this, 16 marks appears too much.

Q4(b): A decent four marks theory question on SCBA.

Q5(a): This is a standard question on Modigliani Miller model on dividend irrelevance. The eight marks are justified. Most textbooks would be carrying such a question.

Q5(b): It's hard to figure out to why this question, apparently on international finance, carrying eight marks appeared here. The question involves computation of profits and losses on forward contracts. I have always held the view that forward contracts are like buying insurance cover. When you take car insurance and there is no accident you don't say I have lost money equivalent to the premium. You have simply bought peace of mind.

The difference between the spot rate on maturity of the forward contract and the forward rate, adjusted for upfront premium and interest cost thereon constitutes the gain or loss.

Q5(c): This is a short theory question for four marks on refinancing.

Q6: The usual suspect; twenty marks on short notes. Barring inter-bank participation certificate, the other four should have been easy. Venture capital financing, money market and capital market, credit card and finally stock lending are current and candidates should have had no difficulty in tackling them.

Break-up of marks

The theory-problem break-up of the 120 marks shows 80 for problems and 40 for theory. However 16 of the 40 marks for theory come from Question 3(a), which I elect to call a case study. The topic-wise break up of marks are as follows:

Problems: Capital budgeting, 12 marks; portfolio, 28; international finance, 8; business valuation, 16; dividend, 8; and capital market, 8.

Theory: Project finance, 20; international finance, 4; miscellaneous, 4; and financial services, 12.

On the whole, the candidates ought to be smiling. That's not something that they often do after a MAFA exam, if the past is anything to go by!

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