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Institute of Chartered Accountants of India

Certificate Course of Forex and Treasury

Paper: 1

Suggested Answers

(d) All the options are true.

2. (d) 8/15 net 90 indicates that a discount of 8% will be given if the payment is made
within 15 days, otherwise the entire amount has to be made within 90 days.

3. (c) 4/10 net 30 indicates that 4% cash discount is given if the payment is made within 10
days, otherwise the full amount has to be paid within 30 days.
4. (d) Cost of trade credit
= (Rate of discount / 1-Rate of discount) x (Number of days in a year / Credit
period-Discount period)
= (0.05 / 1 0.05) x (360 / 90-10) = 23.68%
= 24% approximately.
5. (d) Subjective methods use the judgments or opinions of knowledgeable individuals within
the company, ranging from sales representatives to executives.
Objective methods use statistical techniques which range in sophistication from
relatively simple trend extrapolations to the use of complicated mathematical models.
6. (d) In a multi-division corporation techniques like netting, leading and lagging help in
efficient cash management.
7. (c) Forecasting inconsistencies can be reduced if current economic forecasts are used
throughout the firm.
8. (c) Increase in cash is a source of funds. Decrease in current liabilities and increase in
current assets increase the net working capital. An increase in the net working capital is an
application of funds.
9. (d) A letter of credit which allows the issuing bank to make payments in installments is
known as Deferred L/C.

10. (a) To ensure that there is no triangular arbitrage, the following conditions are to be

(A/B)bid x (B/C)bid (A/C) ask

(A/B)ask x (B/C) ask (A/C) bid

Correct answer is (a)

11. (b) Options (a), (c) and (d) are assumptions of the Theory of Comparative Advantage. The
theory assumes that no technological innovations take place in both the markets.
12. (c) Sales force estimate is a subjective method of estimating sales in which the estimates
are based on the sales representatives knowledge of the probable demand.
13. (b) Proportion of quick assets to total current assets = (0.50/2) x 100 = 25%.
14. (d) The Modigliani and Miller approach explains the irrelevance of the firms dividend
15. (d) Carrying costs are expenses incurred in storing goods. Thus, storing inventories will
increase and not reduce carrying costs.
16. (b) Cash management techniques are used for delaying accounts payable and in
accelerating the collection of accounts receivables.
17. (d) Net float is the difference between Payment float and Collection float, where
collection float is the amount of cheques deposited by the company, awaiting clearance
and payment float is the amount of cheques issued by the company, awaiting payment
by the bank.
18. (c) The functions of the CFO are broadly categorized as that of a controller and a
treasurer. As a treasurer he deals with the liquid assets and has a major responsibility of
being a custodian of cash and other liquid assets. The controller of the organization has
to record the transactions of the liquid assets.

(d) Relevant date for determining the holding period, determination of full value of
consideration, expenditure incurred for acquisition, determination of cost of
acquisition, determination of cost of improvement, determination of indexed cost of
acquisition and determination of indexed cost of improvement are factors that should
be considered while computing capital gains.


(d) Option in (a), (b) and (c) are examples of primary reserves. Investment in
commercial paper is an example of secondary reserves.


(d) Lock box systems receive payments which are then processed, deposited and often
electronically transferred to the companys cash concentration bank account in the
headquarters. It reduces the float involved in the payment process and eliminates the
manual entry of receipts and payments, which are often done at the company itself.


(c) Legally, the right of managing a company belongs to the shareholders, as they are
the real owners of the company. However, since it is not practical, managerial personnel
employed by the company undertakes this work.


(d) All the factors mentioned effect the P/E ratio.


(d) During the normal course of business operations, a company will usually have ready
access to certain sources for financing its current assets to some extent. As these sources
emerge in the normal course of business, they are referred to as spontaneous sources.
These include accrued expenses, provisions and trade credit.


(c) Realization of debtors involves conversion of receivables to cash. To that extent the
current assets remain constant. Raw materials purchased on credit causes an equal
increase in current assets (inventory) and current liabilities (Sundry creditors).
Conversion of preference shares in to equity involves the conversion of one form of long
term finance to another form of long term finance. Considering the above we can say
that there is no change in the NWC.


(c) Alternative (a) is a part of the mobilization of funds / financing function of the
finance manager. Alternative (b) involves partly the funds mobilization function and
partly the riskreturn tradeoff function. Alternative (c) is the control function.
Alternative (d) is a part of the deployment of funds function.


(d) All the alternatives except (d) represent uses of cash.


DOL = 3 implies that 1% change in sales will cause a three times (3 x 1) = 3%, change in
DTL = DOL x DFL = 3 x 2 = 6 implies that 1% change in sales will cause a six times, 6 x
1 = 6%, change in EPS.


(b) External Funds required = Expected increase in assets Expected increase in

spontaneous liabilities Expected increase in retained earnings

= 9 4 2 = Rs.3 lakhs.

(b) All other alternatives will cause either an equal increase in current assets and
current liabilities or an increase in one current asset and decrease in another current

asset by the same amount or an equal decrease in current liabilities and current assets
or a decrease in one current liability and increase in another current liability by the
same amount. These will not cause any change in the working capital position. Hence,
these are not considered while preparing funds flow statement on working capital basis.

(d) Statement (I) is true and self-explanatory. Statements (II) and (III) are true and,
are the characteristics of the DFL which arise as a result of the way it is calculated.


(b) Check the reason:


Growth with internal equity (g) =

A / So m(1 d) A/E
It can be observed from the formula that
As debt-equity ratio increases the assets to equity ratio (A/E) increases and g
As dividend payout ratio (d) increases, g decreases.
As profit margin (m) increases g increases.
As assets to sales ratio (A/S) decreases g increases.
33. (a) Let A be the amount invested and R be the rate of return, then the accurate doubling
period can be calculated as

A (1 + R)n = 2A. Therefore, (1+R)n = 2.

34. (d) Profitability Index is an appraisal criterion used for evaluating mutually exclusive
projects or alternatives which provide similar service but have different patterns of costs
and unequal life spans.

35. (b) The cost of equity capital is higher than any other source of capital because of the
transaction and floatation costs involved.

36. (d) I = (ACPN ACPO) [SO/360] + V(ACP)N x S/360, where I = Increase in investment;
ACPN = New average collection period; ACPO = Old average collection period; S =
Increase in sales Substituting the given values, we get, I = Rs. 1,08,000.

37. (c) Price of the share, P = D1/(k g)

Hence, price of the share will increase with increase in growth rate.

38. (a) The retention ratio decided by a firm indicates the extent to which the earnings are
going to be retained by the company and this would have an impact on the dividend yield.

39. (b) NPV (in % ) = 0.16 (0.18 + 0.12) = -0.14 and hence to be rejected.

40. (b) According to the system of pre-authorized debits, the seller is authorized to receive his
own payments by drawing funds from the buyers bank account.

41. (c) Demand for call money tends to widen in December, March, June, i.e. when quarterly
advance tax payments are to be made.

42. (c) Return on equity (ROE) = Net Profit margin x Asset turnover x Equity multiplier
Where equity multiplier = 1 / 1-(debt to asset ratio)
Hence, if the asset turnover and the debt to asset ratio decrease, then the ROE decreases.
43. (c) A country experiencing deflation relative to other countries would see a rise in exports
which would lead to demand for currency, which would lead to a rise in value of the
domestic currency and not a fall (A). (B) The reserve account would remain unchanged in
this case for a country that allows its currency to float. (D) The supply of domestic
currency would fall not rise with increase in demand.
44. (c) Portfolio investment is not a part of the current account in a Countrys balance of
payments statement. It is a part of the capital account.
45. (b) According to the purchasing power parity, the percentage change in spot rate, equals
the difference in the inflation rates divided by one plus the inflation rate.
= (0.05 0.02) / (1 + 0.02) x
= 0.735%
46. (d) Options in (a), (b) and (c) are true. Option in (d) is false.
47. (d) The one month interest rate after 2 months is expected to be
{1 + (0.036 / 6)} {1 + (r/12)} = {1 + (0.04/4)}

r = {(1 + 0.01) / 1.006 1} x 12

r = 4.77%

48. (c) The sum of procurement, processing and storage time = 360 / Cash turnover ratio =
360/4 = 90.

(b) The optimal level of cash,

Where, F is the fixed transaction cost, T is the total demand for cash for a specific period
and I is the interest rate on marketable securities for the period.


(d) The initial dividend theory propounded by Modigliani and Miller is based on
various assumptions like perfect markets, no taxes, etc. Since perfect markets and
absence of floatation and transaction costs are situations which do not happen in
reality, therefore these assumptions are not valid.


(b) Treasury bills have zero default risk. They do not require any grading or further
endorsement like ordinary bills as they are claims against the government.


(c) NPV/I = (PV-I)/I = PV/I-1 = BCR-1.


(b) In India, bill finance is either repayable on demand or can be payable on a fixed
date, usually 90 days (3 months).


(c) In the US, wire transfers are accomplished either by the FEDWIRE or the
BANKWIRE, FEDWIRE is a same day transfer vehicle and BANKWIRE is a means of
advice given for a transfer.


(c) At the overall break even point of output, the DTL is underfined. If the level of
output is greater than the overall break even point, then the DTL will be positive. DTL
decreases as the Q (quantity) increases and reaches a limit of 1.


(d) Netting helps in reduce the number of transactions, and hence reduce transaction


(a) In devaluation government lowers the value of domestic currency when fixed
exchange rate system prevails.

58. (d) The Banker who is authorised to transfer the LC


(c) If there is heavy forex inflow then there is chance that rupee will appreciate against
foreign currencies.


(c) If interest parity holds good and transaction cost is zero, then borrowing in foreign
currency and covered through forward market will be equal to domestic borrowing as
the foreign interest rate plus differential in exchange rate will be equal to domestic
interest rate.


(c) In Temporal method items are classified based on whether they are valued at
historical basis or on market price basis.



23680 (1 + r)9 = 40000

Or, r = [40000/23680] 1/9 1 =0.05998 0.06 i.e. 6%.


(b) If the YTM of bond X is greater than the YTM of bond Y, other things remaining the
same, then the market price of bond X is less than the market price of bond Y. So II is
true. I is true according to the bond value theorem, A change in YTM affects the bonds
with a higher YTM more than it does bonds with a lower YTM.
Hence alternative (b) is correct.



k = (F P)/P X 365 / d
Or, P = F / {1 + (d*k)/365} = 100 / {1 + (91 x 0.12)/365 = 97.093 Rs.

According to the rule of 69,
Doubling period (in years) = 0.35 + 69/i
4 + 7/12 = 0.35 + 69/i
Solving the above equation we get i = 16.3%


Current yield = Coupon amount / Market price
Coupon rate = Coupon amount / Face value
Current yield = Coupon rate implies that market price = face value. Further this means
that the bond is trading at its face value. Hence both (I) and (II) are true.


Stock turnover = Cost of goods sold / Average inventory
Or, 6 = 54000 / Average inventory
Or, Average inventory = 54000/6 = Rs. 9,000
Average inventory = (Opening stock + Closing Stock) / 2

Or, 9000 = (8000 + Closing Stock) / 2

Or, Closing Stock = 9000 x 2 8000 = Rs. 10,000

Present value interest factor of annuity

{(1+k)n 1} / {k(1+k)n}

[{(1+k)n 1} / k] x {1 / (1+k)n}

FVIFA(k,n) / (1 + k)n

FVIFA(k,n) / FVIF(k,n)

= Reciprocal of sinking fund factor for k% and n years x 1/FVIF(k, n)

= Reciprocal of sinking fund factor for k% and n years x PVIF(k,n)
[Sinking fund factor = 1 / FVIFA(k,n) ]



(a) The functions of the CFO are broadly categorized as that of a controller and a

Issue price =1,00,000 / (1.12)20 = Rs. 10,367

As a treasurer, he deals with the liquid assets and has a major responsibility of being a
custodian of cash and other liquid assets. The controller of the organization has to
record the transactions of the liquid assets.

(b) The purchasing power parity principle or the law of one price states that the price of
a commodity, in equilibrium condition has to be the same across the world. Hence
movement of capital across the global is not an assumption.


(b) Reducing the local borrowing is not a hedging strategy for a likely devaluation of a
currency since as the local currency devalue, borrowing will be cheaper.


{1 + (0.06/2)} {1 + (r/4)}

{1 + 0.08 x (9/12)}

Or, 1.03{1 +(r/4)}


Or, r = {(1.06/1.03) 1} x 4


74. (d) Due to the nature of money market, the instruments used in it represent short-term
claims. At times, the liquidity of a security may make it a part of the money market even
though the maturity may be beyond a year.

75. (b) Cross-elasticity of demand studies the effect of change in price of a related product on
the quantity demanded.

76. (b) Cash flows should be defined in post-tax terms and not in pre-tax terms.
77. (d) Nominal or market interest rate = Real rate of interest + Expected rate of inflation +
Risk premiums to compensate for uncertainty.
78. (b) The Chief Financial Officer is a member of the top management and is involved in
the formulation of policies and decision-making.
79. (c) In case of Demand bills, time for payment is not specified. Demand bills are due for
payment immediately at sight or on presentation.
80. (b) Cost of trade credit
= Rate of discount / 1 Rate of discount
X Number of days in a year / Credit period Discount period
Cost of trade credit for A
= (0.02 / 1 0.02) x (360 / 60-10) = 14.69%
Cost of trade credit for B
= (0.02 / 1 0.02) x (360 / 30-15) = 48.98%
81. (c) The difference between the time of introduction of a product in one country and the
time when the producers in the other country start producing it, is termed as imitation lag.

(c) Value of the firm, V = O(I - tc )/ k + tc B

Where O is the operating income, B is the market value of debt, t is the corporate tax rate
and k is the required return.
In other words, V = PAT / k + Tax shield
Solving the above equation, we get, Tax shield = Rs. 20.00 lakh.


(c) Present value of cash inflows in advance

= (1 + 0.16) [1,00,000 x PVIFA(16%, 5)]
=Rs. 3,79,784.
Present value of cash inflows in arrears
= [1,00,000 x PVIFA (16%, 5)] = Rs. 3,27,400.
Hence, the difference = Rs. 52,384.

84. (d) WAC = WeKe + WdKd

=0.4 x 0.08 + 0.6 x 0.15 = 0.032 + 0.09

= 0.122 or 12.2%

(a) Excessive stock piling, abnormal bad debts and bad collection mechanism will
increase the costs for the company, thus leading to a low working capital.


(c) Long-dated or undated government securities are called funded debt.


(b) The segment of institutional investors includes mutual funds, insurance companies,
pension and retirement funds and professional fund managers. The number of
institutional investors is small, but their holdings are quite large, making them the most
influential group of investors.


(d) Factoring is a financial service under which the factor undertakes collection,
accounting and management of the clients debts. Thus, the factor is an intermediary
between the suppliers and the customers who perform financing and debt collection

89. (a) PVIF X FVIF X FVIFA X Capital Recovery Factor

= 1/(1+k)n x (1+k)n x [{(1+k)n 1} / k] x [{k(1+k)n } / {(1+k)n
=(1+k)n = FVIF

(b) Current market price = Coupon interest / Coupon yield = Rs. 777.77 = Rs. 778.


(b) Deposits of NRIs with banks is accounted under capital accounts.


(b) According to the SML equation:

kj = Rf + j (km Rf)
The slope is (km Rf). When the slope is zero, kj = Rf + 0 = Rf
Further, km Rf = 0 implies that km = Rf
Rf = km = kj
i.e. Risk free rate of return = Market return = Expected return of the given security.



= Cov (i,m)/2m or Cov (i,m)= .)/2m

= 1.63(16.25)2 = 430.42%2


Required rate of return on the stock =

{(D1 / Po) + g} = [{Do (1 + g)} / Po] + g
= {2(1.12)/52.50} + 0.12

= 0.1627 i.e 16.27%


Alternatives (a), (c) and (d) represent risk factors which are specific to the firm and can
be diversified away.
(d) Integration of financial markets helps in getting the benefits of (a) efficient transfer
of resources from surplus units to deficient units (b) Smoother consumption pattern
enjoyed by all the countries over a period of time and (c) enjoying the benefits of


(b) It is not correct to say that SDRs are only used to cover current account deficit.


(b) Intervention of central banks, to smoothen the fluctuation or manage the value of
domestic currency is called as Dirty Float.


(a) The applicants of a foreign L/C is the buyer of goods who is called as importer in
international trade.

100. (b) The responsibility of the seller ceases, once the goods and made available at his
premises or at any other named place. This contract is called as Ex works contract.

(c) 5,500 x FVIFA (X%, 25) = 2,00,000

FVIFA(X%, 25) = 2,00,000/5,500 = 36,364
FVIFA(15%, 25) = 32.919, FVIFA (16%, 25) = 40.874
X = 15 +(36.364 32.919) / (40.874 32.919 = 15.433.

102. (a) Prime Lending Rate (PLR) is the minimum lending rate of commercial banks.
103. (d) Statutory Liquidity Ratio (SLR) is the specified reserve which the banks are
required to maintain with the RBI in the form of government securities, specified bonds
and approved securities. With the help of SLR, the RBI regulates the liquidity of the
banking system. SLR also helps in restricting the expansion of bank credit beyond a
certain limit, in ensuring solvency of the banks and in augmenting the banks
investments in government securities.
104. (c) Commercial Paper (CP) is a short-term unsecured usance promissory note issued at
a discount to face value by well-known reputed companies and these companies should
carry a high credit rating and have a strong financial background.

(c) The Reserve Bank of India (RBI) issues government stock to the investors by
crediting their Subsidiary General Ledger account maintained with it or in the form of
stock certificate.

106. (d) Since the company is having a low dividend yield and high price earnings ratio, it
indicates that the firm is having good investment opportunities and thus the investors
can expect capital gains.


(a) In the short run under highly mobile international financial markets, unanticipated
restrictive monetary policy will raise real interest rates, lower GDP growth, and reduce
inflation all of which would increase the currency value. The loose fiscal policy will raise
real interest rates, increase GDP growth, and increase inflation. Only the raise in real
interest rates will increase the currency value; however, in the short term under mobile
markets the interest rate effect will dominate. The net result is increase in currency
Under tight monetary policy the rise in interest rates will decrease the current account
while lower GDP and inflation will increase the CA. But in the short term under mobile
markets interest rate effect dominates. Under loose fiscal policy, real rates, GDP growth,
and inflation will all rise, all of which will decrease the current account. The net effect is
that the current account will decrease.

108. (c) Sterling denominated foreign bonds issued in the U. K. are called Bull dog bonds.
109. (b) The determination of exchange rates between the two currencies, on the basis of the
rates at which the respective currencies could be converted in to gold is called the mint
110. (d) Options in (a), (b) and (c) can cause a change in the bid-ask spread. Market downturn
will cause rates to fall but not necessarily the spread. Correct answer is (d).
111. (d) Exchange margin is to be deducted from the bid rate and added to the ask rate, in the
case of a direct quote. In the case of a direct quote the principle is buy low - sell high. For
example the interbank quote for US$ is 47.70/71. The exchange margin, say 5 paise is to be
deducted from 47.70 and added to 47.71. By this the quote now is 47.65 - 47.76. The bank
buys at 47.65 from the customer and sells at the market buying rate of 47.70. Similarly the
bank sells at 47.76 to the customer by buying at market selling rate of 47.71. Hence option
(d) is correct.
112. (d) Forward spread means the spread between forward rate and spot rate other. Options in
(a), (b) and (c) are not correct.
113. Answer : (b)
(b) An irrevocable Letter of Credit is one which can not be cancelled by the issuing bank
without the consent of the beneficiary.
(a) A Letter of Credit which can be cancelled at the request of the applicant, without the consent
of the beneficiary is called Revocable Credit.
(c) A Letter of Credit whereby the credit available to the beneficiary gets reinstated after being
utilized once, is called a revolving letter of credit.
(d) A Letter of Credit which permits advance to the beneficiary at preshipment stage is called
red clause credit.
Hence the correct answer is (b).
114. (a) Statement (I) is correct. If foreign inflation is higher than domestic inflation, then
domestic residents will want to buy the relatively cheaper domestic goods, and therefore,

they will reduce the demand for the foreign currency, which means reducing the supply of
the domestic currency in the foreign exchange market.
Statement (II) is false, because an increase in foreign income will cause an increase in
the demand for imports and therefore an increase in the demand for the currency of
other nations.
Statement (III) is false, because if foreign interest rates rise faster than domestic rates,
then there would be an increase in the demand for foreign currency, which means the
supply of domestic currency would rise in the foreign exchange market.
115. (d) Sales of first month which are realized in the third month = 0.40 x 0.60 x 60 =Rs. 14.4
Sales of second month which are realized in the third month = 0.60 x 0.60 x 60 = Rs.
21.6 lakh. Cash sales of third month = Rs. 24 lakh.
Total amount realized in the third month = 14.4 + 21.6 + 24 = Rs. 60 lakh.

(c) One of the assumptions of the MM model on dividend policy is the existence of
perfect markets in which all investors are rational.


(d) Stock market is a part of the capital market. Alternatives (a), (b) and (c) are parts of
the money market.

118. (b)

Expected rate of return =


= (10x0.30) + (12x0.10) + (15x0.40) + (20x0.20)

= 14.2%

(a) In a free trade area, there are no barriers to trade among the member countries and
the member countries individually decides upon their trade policies for non-member

120. (d) Copyrights, trade marks, Geographical indication, industrial designs, patents,
integrated circuits and trade secrets are protected under an agreement of TRIPS.
121. (d) The investment and financing services provided by banks help in meeting the treasury
requirements of the corporate clients by dealing in money market instruments.
122. (d) Book value approach is an accounting concept and hence it can be manipulated. Under
this method, assets are recorded at historical costs and no future projections are made.

123. (a) In order to get cash from operations, non-cash expenses like depreciation have to be
added back to profit after tax.
124. (a) With the commencement of the Companies Act, 1956, the issue of preference shares
with voting rights has been restricted only to the following cases:
There are arrears in dividends for two or more years in case of cumulative
preference shares,
Preference dividend is due for period of two or more consecutive preceding years,
In the preceding six years including the immediately preceding financial year, if
the company has not paid the preference dividend for a period of three or more
125. (a) After 1990, there are two call rates in existence, the interbank call rate and the lending
rate of DFHI (Discount and Finance House of India).
126. (a) Earlier, Certificate of Deposits (CDs) were issued by all scheduled commercial banks
other than the scheduled Co-operative bank and Regional Rural banks. In 1993, six
financial institutions namely, SIDBI, IDBI, IFCI, ICICI, IRBI and EXIM bank were also
permitted to issue CDs.
127. (c) Carrying costs and ordering costs have an inverse relationship between them. With
increase in the quantity ordered, the total ordering costs will decrease while the total
carrying costs will increase.

128. (a) Repo is an agreement which involves a sale of a security with an undertaking to buyback the same security at a pre-determined price at a future date. The transaction is called
repo from the point of the seller, whereas the same is viewed as reverse repo from the point
of the buyer of the security.
129. (d) The age-wise distribution of accounts receivable at a given time is depicted in the
ageing schedule.

130. (b) A Yankee bond is a dollar denominated bond issued in the US by a non US entity.

(c) Self-explanatory. Buy-back


(d) Self-explanatory. Financial Risk


(d) Issuing of bonus shares does not involve any cash transactions and therefore is not
a part of a short-term cash budget.

facilities are not available for CPs


(c) Capitalization rate = Earnings per share / Market price of the share.
Earnings per share = 20 lakh / 5.6 lakh = Rs. 3.5714 per share.
Capitalization rate = 3.5714/28 = 0.1275


(b) Infosys conceptualized, researched and developed Finacle to take Fare of bank
treasury, ALM and risk management.


Answer : (d)
Reason: A prospectus must be in writing. It is an invitation to the public to subscribe for
shares or debentures of a company. An advertisement in television or a film is not
treated to be a prospectus.


Answer : (d)
Reason: Force majeure clause gives a protection against extra ordinary events. The
contract is not for supply of that onion grown but generally the commodity.


Answer : (d)
Reason: When a bank obtains payment on a crossed cheque on behalf of its customer,
the fact that the customers title to the cheaque is defective will not render the collecting
bank liable for conversion to the true owener only if the collecting bank is acting as an
agent for receiving the payment. Collecting banker will not get protection for the
options in (a), (b) and (c) . Correct answer is (d).


Answer : (b)
Reason: Section 4 defines a promissory note as on instrument in writing containing an
unconditional undertaking, signed by the maker to pay a certain sum of money only to,
as to the order of a certain person, or to the bearer or the instrument. There are two
parties maker and the payee. It should contain an express promise to pay like that of
(a), (c) and (d). Answer (b) does not contain any express promise and hence is not
promissory notes

140. Answer : (a)

Reason: ROI equals income divided by invested capital. If a company is already
profitable, increasing sales and expenses by the same percentage will increase ROI.
Hence, answer (b) is not correct. (c) is not correct because increasing sales & expenses
by the same rupee amount will not change income or ROI. (d) is not correct because
increasing investment and operating expenses by the same rupee amount will lower

Answer : (d)
Reason: The profitability index is the ratio of the present value of future cash inflows to
the initial net cash investment. It is a variation of the NPV method that facilitates
comparison of different-sized investments. A profitability index greater than 1 indicates
a profitable investment, or one that has a positive net present value. (a) is not correct
because, if the index is 1.20 and the discount rate is the cost of capital, the NPV is
positive, and the IRR must be higher than the cost of capital. (b) & (c) are not correct
because the IRR is the discount rate at which the NPV is Rs.0, which is also the rate at
which the profitability index is 1. The IRR cannot be determined solely from the index.


Answer : (c)
Reason: An efficiency variance compares the actual use of inputs with the budgeted
quantity of inputs allowed for the activity level achieved. The variance equals this
difference multiplied by the budgeted unit price. (a) is not correct because this is a price
variance (b) is not correct because it determines a volume, not an efficiency variance.
(d) is not correct because an efficiency variance cannot be determined using only
income amounts.


Answer : (b)
Reason: The continuous process of comparing products and operations against the best
practices in the industry is known as benchmarking. Continuous process improvement
is the philosophy of doing business with striving for perfection. Target costing,
benchmarking and benchtrending and process quality teaming are methods of
Continuous process improvement. Target costing aims at reducing the costs of the
product over a products life cycle. To improve the overall improvement, process quality
teaming is carried out.


Answer : (b)
Reason: The interest rate usually specified on an annual basis in a loan agreement or
security is known as the nominal rate of interest. If compounding is done more than
once a year, the actual rate of interest paid (or received) is called effective interest rate.
Effective interest rate would be higher than the nominal interest rate. The effective rate
of interest increases with increase in the frequency of compounding. For example, the
effective rate of interest under quarterly compounding will be more than the effective
rate of interest under semi-annual compounding. Hence option (b) is correct.


Answer : (c)
Reason: Custodians hold the underlying shares and collect rupee dividends on the
underlying shares and repatriate the same to the depository in US dollars/foreign
equity. Hence (c) is the answer. Lead managers undertake activities like preparation of
offer circular, marketing the issues etc. Underwriters of the issue bear interest rate or
market risks moving against the issuer before they have placed bonds or depository


Answer : (a)
Reason: Note Issuance Facility (NIF) is a medium-term legally binding commitment
under which a borrower can issue short-term paper, of upto one year. Hence (a) is the
answer. Commercial papers are short-term unsecured promissory notes, which pay a
fixed amount. Straight debt bonds and floating rate notes are long-term instruments
having a maturity of over one year.


Answer : (c)
Reason: The Debt-Asset ratio measures the extent to which the borrowed funds support
the firms assets. It is an example of capital structure ratios. Hence option (c) is the
correct choice.

148. Answer : (d)

Reason: Degree of Financial Leverage (DFL) is computed as EBIT / {(EBIT I) - DP
/ (I-T)}
If DFL = 0, then it implies that EBIT = 0.


Answer : (b)
Reason: Book Value is an accounting concept. Assets are recorded at historical costs and
they are depreciated over years. Book value may include intangible assets at acquisition
cost minus amortized value. Replacement Value is the amount that a company would be
required to spend if it were to replace its existing assets in the current condition.
Liquidation Value is the amount that a company could realize if it sold its assets after
having terminated its business. Going Concern Value is the amount that a company
could realize if it sold its business as an operating one. Market Value of an asset or
security is the current price at which the asset or the security is being sold or bought in
the market.


Answer : (c)
Reason: For equal size increases and decreases in the YTM, price movements are not
symmetrical. For a given maturity, the change in bonds price will be greater with a
decrease in the bonds YTM than the change in bond price with an equal increase in the
bonds YTM. Hence (c) is not true. The intrinsic value of the bond is the present value of
coupon payments and the redemption value. Hence, if there is an increase in the
redemption value, the value of the bond will increase. Hence, (a) is true. In case of long
maturity bonds, a change in YTM is applied to a series of coupon payments which is
longer than the shorter maturity bonds and the principal payment is discounted at the
new rate for a longer number of years compared to shorter maturity bonds. Hence, the
longer the term, to maturity, the greater will be the change in price with a change in
YTM. Hence (b) is also true. The percentage price change in case of high coupon bonds
will be smaller than the price change in case of smaller coupon bonds with a change in
YTM. Hence, (d) is true.