International finance security analysis portfolio management

International Finance

Section A: Objective Type (30 marks)

This section consists of Multiple choice & Short Answer type questions. Answer all the questions. Part One questions carry 1 mark each & Part Two questions carry 5 marks each.

Part One:

Multiple choices:

1. Maintenance margin money denotes the minimum level to which the margin is allowed to fall in the sequel of loss, if the balance drops below this, one has to deposit, a. Initial margin amount b. Variation margin amount c. Maintenance margin amount d. Initial as well as variation margin amount.

2. The two kind of swap in the forward market are a. Forward swap and reverse swap. b. Reverse swap and option swap. c. Forward and option less swap. d. Forward swap and option swap.

3. International Fisher Effect or generalized version of the Fisher effect is a combination of a. PPP theory and Fisher’s open proposition. b. Fisher’s open and closed proposition. c. PPP theory and Fisher’s closed proposition. d. None of the above.

4. Exchange rates are quoted as ‘direct’ and ‘indirect’ ,if the direct quote of a country ‘X’ (currency unit ‘a’) with country ‘Y’ (currency unit ‘b’), is “ a 50/ b 20” then the indirect quote will be a. b 2.5/ a 1 b. b 0.4/ a 1 c. b 10/ a 1 d. Cannot be calculated.

5. If the investors are risk neutral ie forward prices are equal to the expected spot prices at delivery then the covariance of marginal rate of substitution and the exchange rate of contract at delivery is a. Always unity b. Zero c. Infinite d. Between Zero and unity

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Examination Paper of Finance Management

6. In cylinder or tunnel option, the correct option is a. If the spot rate is lower than the lower strike rate then buyer has to pay lower spot rate. b. If the spot rate is lower than the lower strike rate then buyer has to pay lower strike rate. c. If the spot rate is higher than the higher strike rate then buyer has to pay lower strike rate. d. If the spot rate is higher than the higher strike rate then buyer has to pay higher strike

rate.

7. The concept of parallel loan says a. Amount of the loan moves out of the county but it serves the purpose of internal loan

also. b. Amount of the loan moves out of the county but it serves the purpose of cross border

loan. c. Amount of the loan moves within the county and it serves the purpose of external loan

only. d. Amount of the loan moves within the county but it serves the purpose of cross border

loan.

8. According to one of the earliest theory proposed by Hymer on the imperfect market a. Multinational firm is a typical imperfect market. b. Multinational firm is a perfect market c. One should not look for control if want the maximum profit d. None

9. If the NVP(net present value) from parent’s perspective and from the subsidiary’s perspective are positive and negative respectively then a. Project cannot be accepted b. Project shall be accepted c. Project may be accepted but it is doubtful how far useful for parent unit. d. Project may be accepted but chance of loss in host country currency will be there.

10. If ‘A’ and ‘B’ are the price elasticity of demand for import and export respectively then devaluation helps to improve current account balance, only if a. 2A + B is greater than 1. b. A - B is equal to 0. c. A+B is greater than 1. d. A + B is lesser than 0.

Part Two:

1. Write a note on ‘Fixed Parity System’ for exchange rates.

2. What are Direct & Indirect Quotes of exchange rates?

3. What is ‘Forward Market Hedging’?

4. How could ‘Optimization of Portfolio’ be achieved?

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END OF SECTION A

Section B: Caselets (40 marks)

This section consists of Caselets. Answer all the questions. Each caselet carries 20 marks. Detailed information should form the part of your answer (Word limit200 to 250 words).

Caselet 1

MANAGING EXCHANGE RATE RISK

Mahindra International (India) imported spares of an engine from a US manufacturer for $ 5,000 per annum at a price of $ 2.5 per piece. The average exchange rate during 2001-02 was Rs. 47.70/$. The Indian company imported the spares also from a British manufacturer. In fact, it had diversified its import in view of reducing the risk associated with the supply. The import from the USA was competitive in view of the fact the same spares imported from the UK was slightly costlier. The American spares cost Rs. 119.25 per piece, while the British spares cost Rs. 120.00 per piece. In 2002-03, US dollar appreciated to Rs. 48.40 with the result that the cost of American spares turned higher than the British spares. In the sequel of the appreciation of US dollar, the Indian importer cut its demand from 2,000 pieces to 500 pieces. The loss to the US exporter was colossal. But at the same time, the Indian Importer suffered a lot. It had to pay a higher price for the US spares in terms of rupee. And also, it had to divert its import from the USA to the UK insofar as the pound sterling did not appreciate during this period. All this happened in the wake of the exchange rate changes.

1. Mention the loss borne by the US exporter in the sequel of appreciation of dollar.

2. What strategy the Indian importer needs to follow to hedge the exchange rate risk?

Caselet 2

ABN AMRO BANK AND CORRESPONDENT BANKING IN INDIA

ABN AMRO bank has emerged as a major correspondent bank owing to a large network. In India, it operates in six major cities, viz. Baroda, Chennai, Kolkata, Mumbai, New Delhi and Pune. Being a correspondence bank, its product offerings are found primarily in the area of trade and clearing. It is doing well in these owing to strong tie-up with local Indian banks reaching 350 centres across the country. As a result, payments are effected speedily and effectively.

Cash Management

The customized products in the area of cash management include cheques payable at par at all its branches across the country, apart from traditional collection services, such as collection of outstation/upcountry cheques drawn on other banks. ABN AMRO is a member of all major clearing

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centers in the major financial centers. It has an electronic delivery system and structures multilateral netting of cash.

Trade Services

Under trade services, the Bank offers a comprehensive range of products, such as:

1. LC reimbursement 2. Indian rupee trade payments 3. Handling documentary bills for collection 4. Bills negotiation 5. Letter of credit advising 6. Letter of credit confirmation 7. Guarantees

Treasury Services

Treasury services at ABN AMRO Bank (India) are available round-the-clock. Rupee funding at its treasury desk is provided at competitive rates along with advice on market trends and rates. It provides also advisory services on the request of financial institutions and corporate in the area of regulatory, economic and financial matters including depository services.

1. Describe the network of ABN AMRO Bank in India.

2. What role does it play for global cash management?

END OF SECTION B

Section C: Applied Theory (30 marks)

This section consists of Long Questions. Answer all the questions. Each question carries 15 marks. Detailed information should form the part of your answer (Word limit 150 to 200 words).

1. Crawling peg is the compromise between fixed exchange rate and floating exchange rate discuss.

2. Is international working capital management more complex than the domestic working capital management?

END OF SECTION C

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Security Analysis and Portfolio Management

Section A: Objective Type (30 marks)

This section consists of Multiple choice questions & Short Answer type questions. Answer all the questions. Part One questions carry 0.5 mark each & Part Two questions carry 5 marks each.

Part One:

Multiple choices:

1. Covariance of the returns of security i and market portfolio is 270. Standard deviation of market portfolio is 15. Calculate β of security i. a. 1.2 b. 2.4 c. 3.0 d. 3.8 e. 4.2

2. In an economy the level of confidence can be gauged by examining the following factors. a. The current investment climate b. The current capacity utilization c. Overall economic conditions d. Financial performance of companies e. All of the above

3. Default free bonds can still have a. Price change risk b. Interest rate risk c. Marketability risk d. Political risk e. All of the above

4. The analyst should take into account the following characteristics while evaluating a company for investment purpose. a. Permanence b. Labor conditions c. Government policies and regulations d. Past earnings performance and future expectations e. All of the above

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5. B1 and B2 group shares in BSE can be settled through a. Carry forward settlement b. Spot delivery c. Hand delivery d. Kerb trades e. None of the above

6. Which among the following factors are considered while conducting five factor ROE analysis? a. Pre-tax margin b. Operating margin c. Asset turnover d. Total leverage e. All of the above

7. The ratio of market capitalization to book value can be used as a proxy for a. ROE b. ROA c. EBIT d. EBDIT e. None of the above

8. A stop loss order is given when the market is a. Highly volatile b. Experiencing a downtrend c. Experiencing a bull run d. Inactive e. None of the above

9. The low exit and high entry barriers can be found in industries which have a. Low and stable returns b. Low but risky returns c. High and stable returns d. High but risky returns e. None of the above

10. Which of the following companies deal in commodities? a. HLL b. Reliance c. Wipro d. Grasim e. Both (b) and (d) above

11. Which among the following is unique to a security? a. Risk-free rate b. Risk premium c. Rates of expected inflation d. Nominal interest rates e. None of the above

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12. To prove the independent nature of price changes in stocks, analysts conduct which of the following tests? a. Auto-correlation tests b. Residual analysis c. Event studies d. Runs test e. Both (a) and (d) above

13. A “Connected Person” according to the SEBI Regulations, 1992 is defined as a. A company under the same management b. A merchant banker or a share transfer agent or a broker c. An employee of a public financial institution d. The company’s banker e. All of the above

14. The slope of the CAPM line is also referred to as the a. Systematic risk b. Market price of the risk c. Unsystematic risk d. Both (a) and (b) above e. None of the above

15. The risk of the whole market as measured by ‘Beta’ is a. 1 b. 0 c. -1 d. Greater than 1 e. None of the above

16. Securities which are plotted above the SML line are a. Underpriced b. Those whose intrinsic value is equal to the market value c. Overpriced d. Favorable investments e. Both (a) and (d) above

17. In India, the secondary market for shares is regulated by a. RBI b. Ministry Finance c. SEBI d. Company Law Board e. There is no regulatory authority

18. Banker’s acceptances are traded in a. Money market b. Capital market c. Derivative market d. Forex market e. None of the above

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19. Which among the following is/are market determined? a. Havala rate b. Carry forward margin c. Badla charges d. Making up price e. None of the above

20. High growth rates in earnings and market shares is a characteristic of companies which are in a. Maturity stage b. Expansion stage c. Pioneering stage d. Declining stage e. None of the above

Part Two:

1. Explain ‘Discretionary Order’, a type of order available to stock traders.

2. What does ‘β’ (Beta) mean in risk measurement?

3. Define ‘Liquidity’.

4. What is ‘Beta Control’?

END OF SECTION A

Section B: Caselets (40 marks)

This section consists of Caselets. Answer all the questions. Each caselet carries 20 marks. Detailed information should form the part of your answer (Word limit 200 to 250 words).

Caselet 1

Why do firms grow? It is an important question. Yet economists, management gurus and business-school boffins have so far failed to answer it convincingly. There are three main competing theories. The traditional explanation is that firms grow to reap economies of scale, and to increase their market power. They stop growing once they reach an optimum size, when they run out of profitable investment opportunities or become too big and bureaucratic to manage. Life cycle theories, which became popular in the 1970s and 1980s, identify several stages in the growth of firms, including an entrepreneurial phase, maturity and finally a period of decline. A third view, currently fashionable, attributes firms’ growth to their ‘core competencies’. Admittedly, this is a somewhat nebulous concept. But in essence, it means that a firm’s performance is determined by building on a set of key skills that distinguish it from its rivals. These might include better technology, a trusted brand name, or the experience of its employees. All these theories seem plausible. Yet none of them squares with the evidence. The most important empirical finding, confirmed by study after study of companies big

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and small, is that a firm’s growth largely follows a ‘random walk’ – an erratic and unpredictable course. That is not quite the same as saying that it is driven purely by chance or good luck. But it does undermine the theories that purport to explain, and hence predict, corporate growth. But it is not total mystery. There is in fact evidence that smaller firms grow faster than bigger ones. In particular, very small, very new firms tend to grow much faster than established ones. But company sizes do not appear to converge, either within particular industries, or across them. More surprisingly firms’ growth rates are only weakly correlated with that of the economy as a whole or, indeed, with that of their own industry. Recessions seem to hit only a few firms badly; most are largely unaffected, while some actually prosper. Two other findings complement the observation that corporate growth is erratic. The first is that firms typically restructure their operations in big, infrequent bursts, rather than with small, continuous adjustments. This tends to make it hard to predict the timing of companies’ growth. The second is that most firms are sporadic innovators. Although most big companies frequently spend money on research, few make a habit of producing big innovations or patents. Typically, firms innovate every once in a long time before doing so again. This is also likely to make firms’ growth spurts unpredictable. These findings cast doubt on all three rival theories of corporate growth. Take the traditional model. The idea of an optimal size is incompatible with the finding that firm size grows in a random way. The theory can be rescued by assuming that a firm’s optimal size varies unpredictably. But that makes it almost useless, since it does not explain why such variations occur. Also, it would imply that corporate decisions could not decisively influence a firm’s growth. That is hard to believe. Some firms react quickly to shocks, while others try to resist change; most try to alter their competitive environment to their advantage.

The life cycle model also looks shaky. It implies that firms’ growth follows a set, long run trend – which is not what evidence suggests. At first glance, the core-competencies model seems to stand up better. It is consistent with the finding that corporate growth rates differ widely and show little correlation with firm size or business cycle. It also chimes with the evidence that some companies are far more profitable than others and that differences in profitability tend to persist. But there is a problem with this theory, too: it implies that some firms will grow faster than others over long periods, because they possess durable competencies that are difficult to imitate. But that is not so. Although differences in profitability may persist, differences in corporate growth do not. So if the accumulation of competencies is really what fuels growth, those competencies either are themselves transitory, so have only temporary effects on growth.

Is it corporate growth inexplicable? Not necessarily. It has been observed that a firm that has just innovated will be reluctant to do so again if that would weaken its position or cannibalize the returns from its original innovation. But it may sometimes be forced to, and it may to do so willingly if later innovations enhance its position or do not eat its existing revenue streams. This would explain why innovation appears erratic. Since innovation is erratic, so too is growth. Also firms are unlikely to respond to a shock immediately if they plan to restructure soon. They will respond only after enough pressure has built up to convince them that the shock is permanent and important. That corporate growth depends on this kind of creative destruction is an appealing idea. It also seems to fit the facts.There may be better explanations for companies’ erratic growth performance.

1. Which company do you think in India confirms to the traditional explanation of why firms grow?

2. Which company do you think in India has improved its valuation after focusing on its core competencies.

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Caselet 2

The proposed move of the Securities and Exchange Board of India to expand the universe of stocks for compulsory trading in dematerialized from (paperless mode) ought to be welcomed from the long-term perspective. More important, the SEBI plans to bring all stocks in the ‘Specified Group’(A Group) of the Bombay Stock Exchange under compulsory demat trading for all investors. At present, only 84 of the 140 stocks in the specified group are covered by the compulsory demat trading. Once the entire specified group universe is brought under the compulsory demat ambit and the problems in the intervening period ironed out, the face of the Indian capital market would undergo a significant change. Of course, with rolling settlement too to begin in phase from December, it may well be the right thing to usher in compulsory demat trading in the entire group of 140 stocks. This is where much of the market action is, and it would be in the fitness of things to have this segment move over to a paperless mode as soon as possible. At present, trading in dematerialized mode is compulsory for 104 stocks spread across different classification by the stock exchanges. The last set of stock was added to this universe of 104 stocks in May. The 104 stocks were identified for compulsory demat trading in a short period of six months starting January. The subsequent pause was unavoidable, given the troubles faced by investors. There was the pressure on the system as paperless trading was mandated for 104 stocks in a short span of time. The process was new to investors and this to posed problems. There was also the possible misuse of the process by market participant, affecting small investors. Now the depository participants and companies have also been asked to help expedite the process of conversion of physical shares into dematerialized mode. Though there may still be kinks in the system for some investors, the time has come to move on, and SEBI is done doing just that. The system may also be more tuned to ushering to compulsory demat in a larger universe of stocks now, as there is the experience of the last nine months to go by. The fact that demat charges have been cut sharply should also help the process.

Interestingly, the National Stock Exchange had own its own proposed to expand the list of stocks, in which trading in the paperless mode would be mandatory. The NSE had indicated plans in this regards with the top management citing the increase risk posed by physical certificate in the market and the rising volumes in trading activity. A couple of years back, had the NSE tried such a move, it might have backfired. But now, with a sizeable number of investors getting use to trading in the paperless mode and others becoming aware of the concept, the chances of success may be better. But a separate NSE list of stocks for compulsory trading in the demat mode may crate divergences across stocked exchanges and the unnecessary complications that go with it. While the move may have led to loss of market share for the NSE initially, the other exchanges may have had to follow suit in due course. The NSE initiative is certainly welcome. But with SEBI’s plans of ushering in compulsory demat for all specified group stocks; it may be better for the NSE to go slow on its planned suo motto move. Ensuring a smooth transition in the 140 stocks may be better from the systemic point of view than having its own list of additional stocks. Perhaps when SEBI expands the list of stocks for compulsory demat trading, it could consider some measures to ease the burden on small investors. For the new set of stocks selected, SEBI, the National Securities Depository Ltd. (NSDL) and the Central Securities Depository Ltd. (CSDL) could. Together with the companies, identify investors with small holdings (of, say, less than 500 shares). An extra effort to reach out to such investors by the companies and the depository participants can be initiated so that their holdings are brought into the paperless mode without much trouble. Otherwise, similar problems, as in the past few months, may crop up. Perhaps, SEBI and the depositories could consider a waiver of costs for the first year or two for such investors. Then on, the custody charges and other costs can be levied in the normal course. The better course may be for the companies to join the one-time custody charges payment scheme which would cut costs further for the investors across the board.

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1. How does the introduction of rolling settlement complement the stock being traded in the demat format?

2. What are the advantages to the company whose shares are traded in the demat form?

END OF SECTION B

Section C: Applied Theory (30 marks)

This section consists of Long Questions. Answer all the questions. Each question carries 15 marks. Detailed information should form the part of your answer (Word limit 150 to 200 words).

1. Investment in bond assures the investor a fixed return with some element of risk. Elaborate on the various risks involved in bond investment and recommend the techniques to reduce these risks.

2. Explain where in the companies resort to manipulative accounting techniques with respect to the following areas.

END OF SECTION C

Economy & Finance

International finance security analysis portfolio management