additional solved mini cases

8/10/2019 Additional Solved Mini Cases

1/23

CHAPTER 4: RISK AND RETURN

The monthly closing share prices for 31 months for ITC, Reliance Industries, Tata Steel ,Wipro

and Nifty, are given below:

Date ITC RelianceIndustries

TataSteel

WIPRO NIFTY

3/30/2012 226 748 469 439 5296

2/29/2012 208 815 474 436 5385

1/31/2012 204 818 453 413 5199

12/30/2011 201 693 334 398 4624

11/30/2011 200 783 383 381 4832

10/31/2011 214 875 480 367 5327

9/30/2011 198 806 415 340 4943

8/30/2011 200 785 468 335 5001

7/29/2011 209 828 563 391 54826/30/2011 203 895 612 418 5647

5/31/2011 193 952 590 447 5560

4/29/2011 192 985 616 450 5750

3/31/2011 183 1052 622 476 5834

2/28/2011 169 962 609 437 5333

1/31/2011 163 920 639 441 5506

12/31/2010 175 1058 681 491 6135

11/30/2010 172 986 586 419 5863

10/29/2010 170 1097 588 419 6018

9/30/2010 178 987 652 452 60308/31/2010 164 916 522 398 5402

7/30/2010 308 1009 536 412 5368

6/30/2010 306 1089 486 385 5313

5/31/2010 284 1047 500 674 5086

4/30/2010 266 1032 619 671 5278

3/31/2010 264 1075 632 707 5249

2/26/2010 234 979 575 673 4922

29/01/2010 250 1046 569 648 4882

12/31/2009 251 1093 617 681 5201

11/30/2009 258 1058 578 631 5033

10/30/2009 256 1927 472 610 4712

9/30/2009 233 2202 509 602 5084

Note the following bonus declarations

Bonus ratio 1:1 1:1 2:3

EX-Bonus date August 3,2010 November 26,

2009

June 15,

2010


2/23

a) What are the monthly returns on ITC, Reliance Industries, Tata Steel, Wipro and

Nifty? You may ignore the dividend yield.

b) What are the average returns (arithmetic and geometric) on ITC, Reliance

Industries, Tata Steel, Wipro and Nifty?

c) What are the standard deviations of the returns on ITC, Reliance Industries,

Tata Steel and Nifty?

CHAPTER 5: THE TIME VALUE OF MONEY


3/23

1. As an investment advisor, you have been approached by a client called Shyam for advice

on some financial matters. Shyam is 35 years old and has Rs.200, 000 in bank. He plans to

work for 25 years and retire at the age of 60. His present salary is Rs.400, 000 per year. He

expects his salary to increase at the rate of 12 percent per year until his retirement.Shyam has decided to invest his bank balance and future savings in a balanced mutual

fund scheme which he believes will provide a return of 10 percent per year.

Shyam seeks your help in answering several questions given below. In answering these

questions, ignore the tax factor.

(i) Once he retires at the age of 60, he would like to withdraw Rs.600,000 per year for his

consumption needs for the following 20 years (his life expectancy is 80 years). Each

annual withdrawal will be made at the beginning of the year. How much should be the

value of his investments when he reaches the age of 60, to meet his retirement need?

(ii) How much should Shyam save each year for the next 25 years to be able to withdraw

Rs.600, 000 per year from the beginning of the 26th

year for a period of 20 years?

Assume that the savings will occur at the end of each year. Remember that he already

has some bank balance. Give the answer to the nearest 000.

(iii) Suppose Shyam wants to donate Rs.500, 000 per year in the last 5 years of his life to a

charitable cause. Each donation would be made at the beginning of the year. Further,

he wants to bequeath Rs.4, 000,000 to his son at the end of his life. How much should

he have in his investment account when he reaches the age of 60 to meet this need for

donating and bequeathing? Approximate it to the nearest 000.

(iv) Shyam wants to find out the present value of his lifetime salary income. For the sake of

simplicity, assume that his current salary of Rs. 400,000 will be paid exactly a year from

now, and his salary is paid annually. What is the present value of his life time salary

income, if the discount rate applicable to the same is 9 percent? Remember thatShyam expects his salary to increase at the rate of 12 percent per year until retirement.

2. Sardar Kartar Singh is a resident of Thailand for the past two decades and is the owner

of a flourishing business there. He has a son, Satnam, 10 years old and a baby girl


4/23

Jasleen who will be one year old this day. The family has come to India to celebrate her

birthday in Punjab. Also, Kartars wife has made some grand plans for the future

financial security of the family and they intend to use their present visit for placing

suitable deposits with their bank in New Delhi as per those plans.

According to the plan, Satnam would be doing his MBA after 10 years. It would be a

two year course in a premier private business school in India. For that the all inclusive

expenditure at present rates would be Rs.20 lakhs and Rs.25 lakhs in the beginning of

the first and second year respectively. Jasleen would marry at the end of her 21styear

and for that an amount of Rs.3 crores would then be needed. Kartars wife is insistent

that her presence would be essential in India in the best interests of both the

children- to keep a watchful eye on Satnam during his stint at the business school and

most importantly, to have ample time to renew the old network with family and

friends for ensuring a very good match for the girl. Funds would have to be tied up for

her and childrens relocation to India at the end of ten years from now.

Kartar Singh always had great respect for his wifes commonsense and logic (though he

was always shy of acknowledging it!). To arrange the funds, he has very recently sold

one of his investments, a flat in a prime locality in Bangkok, for a hefty sum. For

Satnams MBA he has decided to open two recurring deposit accounts, maturing on the

10thand 11thyears respectively. For Jasleensmarriage he wants to open a cumulative

term deposit for 20 years. For family maintenance in India after 10 years, he wants to

open another cumulative term deposit for 10 years with the maturity value of which he

could immediately purchase an annuity due for the following 10 years. It is expected

that after 10 years the family in India would need Rs.12 lakhs per year without taking

inflation into consideration.

To make the calculations on the specific amounts needed etc. he has called you, an

upcoming financial consultant. He asks you to make the calculations in such a way that

he could easily understand the logic thereof. You understand from him that as all the

deposits would be made out of his NRE account with the bank, it would not deduct any

tax amount from the interest to be earned.

Specifically you are required to calculate the amounts that need to be deposited now in:

(i)

the two Recurring Deposit accounts, in the beginning of each month.

(ii)

a cumulative fixed deposit for meeting the cost of Jasleens marriage.


5/23

(iii)

a cumulative fixed deposit with the bank for purchasing the annuity due needed by the family

in India after 10 years from an insurance company which is expected to give a return of 10

percent per year.

You set to work with the following data:

For both cumulative fixed deposit and Recurring deposit , nominal interest rate for periods of

more than 5 years is 8 percent and compounding is done once in a quarter. Inflation in India

after 10 years is expected to be 5 percent for the next ten years. The MBA course expenses are

likely to grow at 5 percent per annum. S how your detailed working.

CHAPTER 6: FINANCIALSTATEMENT ANALYSIS


6/23

The financial statements* of Infosys and Reliance Industries are given below:

Profit and Loss Account (Rs. in crores)

Infosys Reliance Industries

For year ending 31-3-08 31-3-07 31-3-08 31-3-07

Net sales/income 15,648 13,149 133,443 111,693

Cost of goods sold/Software

development expenses 8,876 7,278 104,197 85,876

Gross profit 6,772 5,871 29,246 25,817

Operating expenses 2,355 2,115 10,787 10,586

Operating profit 4,417 3,756 18,459 15,231

Non-operating surplus 683 379 5,629 478

Profit before interest and tax 5,100 4,135 24,088 15,709

Interest 1,077 1,189

Profit before tax 5,100 4,135 23,011 14,520

Tax/Provision for tax 630 352 3,552 2,577

Profit after tax 4,470 3,783 19,459 11,943

Balance Sheet (Rs. in crores)

Infosys Reliance Industries

As on 31-3-0831-3-

0731-3-08 31-3-07

Liabilities & Equity

Share capital 286 286 3,136 1,453

Reserves & surplus 13,204 10,876 78,313 62,514Loan funds 36,480 27,826

Deferred tax liabilities 7,873 6,982

13,490 11,162 125,802 98,775


7/23

Assets

Net fixed assets 3,931 3,107 84,889 71,189

Investments 964 839 22,064 16,251

Deferred tax assets 99 79

Current assets, loans & advances

Inventories 14,248 12,137

Receivables 3,093 2,292 6,228 3,732

Cash & bank balance 6,429 5,470 4,280 1,835

Other current assets 73 3

Loans & advances 2,705 1,199 18,058 12,206

Less:

Current liabilities & provisions 3,731 1,824 24,038 18,578

Net current assets 8,496 7,137 18,849 11,335

13,490 11,162 125,802 98,775

*The statements are based on the published annual reports of these companies.

Items have been suitably regrouped for analytical purposes.

** Treat this as loan funds for analysis.

1) Prepare the Dupont chart for Reliance Industries and Infosys for the year endedon 31stMarch 2008.

2) Prepare the common size Balance Sheet and Profit and Loss Account for RelianceIndustries and Infosys for the years 2007 and 2008.

3)

Make three key observations for each company.

CHAPTER 7 : PORTFOLIO THEORY


8/23

Mr. Banwarilal, a wealthy businessman, has approached you for professional advice on

investment. He has a surplus of Rs. 100 lakhs which he wishes to invest in share market in the

name of his wife on their marriage anniversary falling due the next week. His wife is a senior

employee in BPDL, a reputed public sector oil marketing company. In the course of your

discussions, you find that he is a first timer to the secondary market and by nature much riskaverse. He also tells you that he had wondered if investing in BPDL itself could be a good idea

as it is quite profitable and is owned by the government. Besides, his wife would have reasons

to know well in advance of any possible disasters for the company, being their employee for

nearly two decades. Also, she could justifiably be proud of owning such a stake in her

company.

While you agree with him on the choice of BPDL, you suggest that by way of risk

reduction, it would be prudent to invest part of the money in ONGD, an equally reputed oil

exploration company, also state owned. At the end of the discussions, before committing the

funds for the next one year, Mr. Banwarilal desires to know from you specific answers to the

following:

1. What would be the likely return and risk if he invests equal amounts in each of the

two stocks?

2. What would be the likely return from a portfolio of the two stocks which could be

the least risky?

3. Out of the above two alternatives, which would you recommend and why? How

many shares of each stock would then have to be bought?

You have the following historical data at your disposal which you intend to use for analysing

the pattern of co-movement between the stocks:

Period( years preceding the current one) 1 2 3 4 5 6 7 8 9 10

Return(in %) on BPDL (RB) 32 14 24 -8 -2 15 8 28 -7 -3

ONGD (RO) 14 5 - 6 12 22 14 5 -14 26 20

The current market price of a share of BPDL is Rs. 500 and that of ONGD is Rs. 300.

On the future returns on the two stocks over the next one year, you are able to obtain the

following forecast from a reputed firm of portfolio managers:

State of the Economy Probability Return (in %) on

BPDL ONGD

Recession 0.2 -5 - 3

Normal 0.5 10 14

Boom 0.3 35 22

CHAPTER 8 : CAPITAL ASSET PRICING MODEL AND ARBITRAGE PRICING THEORY


9/23

1. Refer to the monthly closing share prices for 31 months for ITC, Reliance Industries,

Tata Steel ,Wipro and Nifty, given in the additional minicase in Chapter 4:

a) Calculate the betas for ITC, Reliance Industries and Tata Steel.

b) Why do they differ?

2. Seth Ratanlal, who was issueless and widower, had left his substantial wealth as legacy to

his nephew and niece through a will. Detailed instructions had been left on how the estate

should be shared between the two, once both of them attained the age of majority. A

week before his demise he had taken a fancy to the capital market and had invested a

sizeable amount in equity shares, specifically, Rs.6 million in Arihant Pharma, Rs.4.8 million

in Best Industries and Rs. 1.2 million in Century Limited. As the partition among the siblings

had to wait for at least one more year as the girl was still a minor, the portfolio of shares

had to be maintained as they were for the time being. The will had entrusted the job of

administering the estate for the benefit of the beneficiaries and partitioning in due course

to the reputed firm of Chartered Accountants, Karaniwala and Karaniwala. Meanwhile the

young beneficiaries were very eager to know certain details of the securities and had asked

the senior partner of the firm to brief them in this regard. For this purpose the senior

partner has asked you to prepare a detailed note to him with calculations using CAPM, to

answer the following possible doubts.

1. What is the expected return and risk (standard deviation) of the portfolio?

2. What is the scope for appreciation in market price of the three stocks-are they

overvalued or undervalued?

You find that out the three stocks, your firm has already been tracking two viz. ArihantPharma (A) and Best Industries (B)-their betas being 1.2 and 0.8 respectively.

Further, you have obtained the following historical data on the returns of Century

Limited(C):

Period Market return (%) Return on

Century Limited (%)

-------- ------------- -------------------------------

1 8 10

2 (6) 8

3 12 25

4 10 (8)


10/23

5 9 14

6 9 11

On the future returns of the three stocks, you are able to obtain the following forecast

from a reputed firm of portfolio managers.

-------------------------------------------------------------------------------------------------------

State of the Probability Returns ( in percentage ) on

Economy Treasury Arihant Best Century Nifty

Bills Pharma Industries Limited

-------------------------------------------------------------------------------------------------------

Recession 0.2 6 (10) (8) 15 (8)

Normal 0.4 6 18 12 6 15

Boom 0.4 6 30 20 (10) 25

Prepare your report.

3. You have recently graduated as a major in finance and have been hired as a financial planner

by Jubilee Securities, a financial services company. Your boss has assigned you the task of

investing Rs.1, 000,000 for a client who has a 1-year investment horizon. You have been

asked to consider only the following investment alternatives: T-bills, stock A, stock B, stock C,

and market index.

The economics cell of Jubilee Securities has developed the probability distribution for the

state of the economy and the equity researchers of Jubilee Securities have estimated the

rates of return under each state of the economy. You have gathered the following

information from them:

Returns on Alternative Investments

State of the

EconomyProbability T-Bills Stock A Stock B Stock C

Market

Portfolio

Recession 0.2 6.0% (18.0%) 25.0% (6.0%) (10.0%)


11/23

Normal 0.5 6.0 20.0 5.0 15.0 16.0

Boom 0.3 6.0 42.0 (12.0) 26.0 30.0

Your client is a very curious investor who has heard a lot relating to portfolio theory and

asset pricing theory. He requests you to answer the following question:

a. What is the expected return and the standard deviation of return for stocks A, B, C, and

the market portfolio?

b. What is the covariance between the returns on A and B? returns on A and C? returns

on B and C?

c. What is the coefficient of correlation between the returns of A and B?

d. What is the expected return and standard deviation on a portfolio in which the weights

assigned to stocks A, B, and C are 0.4, 0.4, and 0.2 respectively?

e. The beta coefficients for the various alternatives, based on historical analysis, are as

follows:

Security Beta

T-bills 0.00

A 1.30

B (0.60)

C 0.95

i. What is the SML relationship?

ii. What is the alpha for stocks A, B, and C?

f. Suppose the following historical returns have been earned for the stock market and the

stock of company D.

Period Market D

1 (5%) (15%)

2 4 7

3 8 14

4 15 22

5 9 5

.


12/23

What is the beta for stock D? How would you interpret it?

CHAPTER 11- BOND PRICES AND YIELDS

Jerome DSouza, a successful bond dealer had come to Bangalore to deliver a lecture in a

seminar organised by a leading bank as part of its training programme to finance managers. He

has been requested to explain the basic concepts and tools useful in bond analysis. To enable

him to make the presentation Mr. DSouza has asked you to prepare answers for the following

questions.

a. How is the value of a bond calculated?

b. What is the value of a 8-year, Rs100 par value bond with a 12 percent annual coupon, if its

required rate of return is 8 percent?

c. What is the value of the bond described in part (b) if it pays interest semi-annually, other

things being equal?

d. What is the YTM of a 5-year, Rs 100 par value bond with a 13 percent annual coupon, if it

sells for Rs 95?

e. What is the YTM of the bond described in part (d) if the approximate formula is used?

f. What is the yield to call of the bond described in part (d) if the bond can be called after 2

years at a premium of Rs5?

g. What is the realised yield to maturity of the bond described in part (d) if the reinvestment rate

applicable to the future cash flows from the bond is 15 percent?

h. The holders of the bond described in part (d) expect that the bond will pay interest as

promised, but on maturity bondholders will receive only 90 percent of par value. What will be

difference between the expected YTM and stated YTM? Use the approximateYTM formula.


13/23

CHAPTER 12- BOND PORTFOLIO MANAGEMENT

From Rajendra Place in New Delhi as a sub broker to Dalal Street as a full fledged stock broker had beena long journey for the ambitious Ramesh Gupta. While his pet area remained stock broking, the

thinning margin has forced him to diversify into related businesses like portfolio management etc. A

firm believer in acquiring quality manpower, he had spotted talent on hearing you talk on debt

securities in a seminar conducted by the local Rotary Club. To confirm his instincts, he has invited you

to give a lecture to the board of directors of his company to elucidate certain concepts in bond analysis.

He has requested you to use the following data on bond B which is currently one of the most actively

traded bonds:

Bond B

Face value Rs. 1,000

Coupon (interest rate) 8 percent payable annuallyTerm to maturity 5 years

Redemption value Rs. 1,000

Current market price Rs. 1,020

a. What is the yield to maturity of bond B?

b. What is the duration of bond B?

c. What is the convexity of bond B?

d. If the yield on bond B increases by 25 basis points, what will be the percentage change in the bond

price?

e. Two years from now, bond B will sell at a yield of 9 percent and the coupon incomes over the next

two years can be reinvested in short-term securities at a rate of 11 percent. What is the expected

annualised rate of return over the two-year period?


14/23

CHAPTER 13 EQUITY VALUATIONS

Arun Dalmia heads the portfolio management schemes division of Pioneer Investments, a wellknown financial services company. Arun has been requested by Matrix Systems to give an

investment seminar to its senior managers interested in investing in equities through the

portfolio management schemes of Pioneer Investments. Dhanush, the contact person of Matrix

Systems, suggested that the thrust of the seminar should be on equity valuation. Arun has

asked you to help him with his presentation.

To illustrate the equity valuation process, you have been asked to analyse Transcend Remedies

which manufactures formulations and bulk drugs. In particular, you have to answer the

following questions:

a. What is the general formula for valuing any stock, irrespective of its dividend pattern?

b. How is a constant growth stock valued?

c. What is the required rate of return on the stock of Transcend Remedies? Assume that the risk-free rate is 6 percent, the market risk premium is 7 percent, and the stock of Transcend

Remedies has a beta of 1.4.

d. Assume that Transcend Remedies is a constant growth company which paid a dividend of Rs

3.00 yesterday (Do= Rs 3.00) and the dividend is expected to grow at the rate of 15 percent per

year forever.

(i) What is the expected value of the stock a year from now?

(ii) What is the expected dividend yield and capital gains yield in the first year?

e. If the stock is currently selling for Rs 400, what is the expected rate of return on the stock?

f. Assume that Transcend Remedies is expected to grow at a supernormal growth rate of 35

percent for the next 5 years, before returning to the constant growth rate of 15 percent. What

will be the present value of the stock under these conditions? Assuming that the required rate

of return is 16 percent, what is the expected dividend yield and capital gains yield in year 3?

year 6?

g. Assume that Transcend Remedies will have zero growth during the first 3 years and then

resume its constant growth of 15 percent in the fourth year. What will be the present value of

the stock under these conditions?

h. Assume that the stock currently enjoys a supernormal growth rate of 35 percent. The growth

rate, however, is expected to decline linearly over the next six years before settling down at 15

percent. What will be the present value of the stock under these conditions?

i. Assume that the earnings and dividends of Transcend Remedies are expected to decline at a

constant rate of 6 percent per year. What will be the present value of the stock? What will be

the dividend yield and capital gains yield per year? Assume a discount rate of 16 percent.

j. Assume that the earnings and dividends of Transcend Remedies are expected to grow at a rate

of 35 percent per year for the next 3 years and thereafter the growth rate is expected to decline

linearly for the following 5 years before settling down at 15 percent per year forever. What will

be the present value of the stock under these conditions, if the discount rate remains 16

percent?


15/23

CHAPTER 15: COMPANY ANALYSIS

1. Innovative Industries Ltd was set up 15 years ago. After a few years of initial turbulence, the

company found a few market segments in which it had some competitive advantage. The

financials of the company for the last 5 years are given below:

Rs. in million

Income Statement Summary 20 x 1 20 x 2 20 x 3 20 x 4 20 x 5

Net sales 2000 2400 2760 3310 3905

Profit before interest & tax 700 840 995 1195 1480

Interest 140 151 198 215 282

Profit before tax 560 689 797 980 1198

Tax 162 193 220 272 333

Profit after tax 398 496 577 708 865

Dividends 160 175 200 269 320

Retained earnings 238 321 377 439 545

Balance Sheet Summary

Equity capital (Rs.10 par) 200 200 200 200 200

Reserves and Surplus 800 1121 1498 1937 2482

Loan funds 200 220 298 320 450

Capital employed 1200 1541 1996 2457 3132

Net fixed assets 800 950 1140 1432 1892

Investments 150 160 170 185 200

Net current assets 250 431 686 840 1040

1200 1541 1996 2457 3132


16/23

Market price per share(year ended) 180 248 259 352 506

The year 20x5 has just ended. The current market price per share is Rs.506. The market price per share

at the beginning of 20x1 was Rs.160.

(a) What was the geometric mean return for the past 5 years?

(b) Calculate the following for the past 2 years? return on equity, book value per share, EPS, PE ratio,

(Prospective), market value to book value ratio.

(c) Calculate the CAGR of Sales & EPS for the period 20 x 120 x 5?

(d) Calculate the sustainable growth rate based on the average retention ratio and the average return

on equity for the past 2 years?

(e) Decompose the ROE for the last 2 years in term of 5 factors.

(f) Estimate the EPS for the next year (20 x 6) using the following assumptions.

(i) Net sales will grow at 25%

(ii) PBIT as a percentage of net sales ratios will improve by 2% This means that if it

were x%, it will become x + 2%.

(iii) Interest will increase by 3% over its 20 x 5 value.

(iv) Effective tax rate will be 30%.

(g) Derive the PE ratio using the constant growth model. For this purpose use the following assumptions.

(i) The dividend payout ratio for 20 x 6 will be equal to the average dividend payout ratio for the

period 20 x 420 x 5.

(ii) The required rate of return is estimated with the help of the CAPM (Risk free return = 9%, Market

risk premium = 12%, Beta of Innovative Industries Stock = 1.2).

(iii) The expected growth rate in dividends is set equal to the product of the average return on

equity and average retention ratio for the previous 2 years.


17/23

2. Atlas Corporation was set up 20 years ago. After few years of initial turbulence the company

found a few market segments in which it had some competitive advantage. The financials of

the company for the last five years are given below:

Rs. in million

Income Statement Summary 20 x 1 20 x 2 20 x 3 20 x 4 20 x 5

Net sales 1500 1620 1700 1800 1920

Profit before interest & tax 225 235 250 261 285

Interest 50 54 59 62 67

Profit before tax 175 181 191 199 218

Tax 49 52 56 58 64

Profit after tax 126 129 135 141 154

Dividends 44 45 50 52 59

Retained earnings 82 84 85 89 95

Balance Sheet Summary

Equity Capital (Rs.10 par) 150 150 150 150 150

Reserves and Surplus 700 784 869 958 1053

Loan Funds 300 340 350 375 425

Capital employed 1150 1274 1369 1483 1628

Net fixed assets 800 825 860 880 940

Investments 100 108 110 120 130

Net current assets 250 341 399 483 558

1150 1274 1369 1483 1628

Market price per share(year end) 85 83 97 103 107

The year 20 x 5 has just ended. The current market price per share is Rs.107. The market price per

share at the beginning of 20 x 1 was Rs.75.

(a) What was the geometric mean return for the past 5 years?

(b) Calculate the following for the past 2 years: return on equity, book value per share, EPS, PE ratio(Prospective), market value to book value ratio.

(c) Calculate the CAGR of Sales & EPS for the period 20 x 120 x 5.

(d) Calculate the sustainable growth rate based on the average retention ratio and the average return

on equity for the past 2 years.


18/23

(e) Decompose the ROE for the last two years in term of five factors.

(f) Estimate the EPS for the next year (20 x 6) using the following assumptions.

(i) Net sales will grow at 8%

(ii) PBIT / Net sales ratio will improve by 0.5% over its 20 x 5 value.

(iii) Interest will increase by 10% over its 20 x 5 value.

(iv) Effective tax rate will be 30%.

(g) Derive the PE ratio using the constant-growth model. For this purpose use the following assumptions.

(i) The dividend payout ratio for 20 x 6 will be equal to the average dividend payout ratio for the period

20 x 420 x 5.

(ii) The required rate of return is estimated with the help of the CAPM (Risk free return = 6% Market risk

premium = 8%, Beta of Atlas Corporations Stock = 0.9).

(iii) The expected growth rate in dividends is set equal to the product of the average return on equity and

average retention ratio for the previous 2 years.


19/23

CHAPTER 17: OPTIONS

On majoring in finance you have got selected as the finance manager in Navin Exports, a firm owned by

Navin Sharma a dynamic young technocrat. The firm has been registering spectacular growth in recent

years. With a view to broad base its investments, the firm had applied for the shares of Universal

Industries a month back during its IPO and got allotment of 5000 shares thereof. Recently Mr. Sharma

had attended a seminar on capital markets organised by a leading bank and had decided to try his hand

in the derivatives market. So, the very next day you joined the firm, he has called you for a meeting to

get a better understanding of the options market and to know the implications of some of the

strategies he has heard about. For this he has placed before you the following chart of the option

quotes of Universal Industries and requested you to answer the following questions, based on the

figures in the chart.

Universal Industries Option Quotes

(All amounts in rupees)

Stock Price: 350

Calls Puts

Strike Price Jan Feb March Jan Feb March

300 50 55 - * - - -

320 36 40 43 3 5 7

340 18 20 21 8 11 -

360 6 9 16 18 21 23

380 4 5 6 - 43 -

* A blank means no quotation is available

1) List out the call options which are out-of-the-money.

2) What are the relative pros and cons (i.e. risk and reward) of selling a call against the 5000

shares held, using (i) Feb/380 calls versus (ii) March 320/ calls?

3) Show how to calculate the maximum profit, maximum loss and break-even associated with the

strategy of simultaneously buying say March/340 call while selling March/ 360 call?

4) What are the implications for the firm, if for instance, it simultaneously writes March 380 call

and buys March 320/put?

5) In what range of values of the stock price will February /340 straddle profitable?

6) What should be value of the March/360 call as per the Black-Scholes Model? Assume that t=3

months, risk-free rate is 7 percent and the standard deviation is 0.40


20/23

7) What should be the value of the March/360 put if the put-call parity is working?

CHAPTER 18-FUTURES

Siddharth had sold his apartment on the outskirts of the city for a hefty profit and was laughing

all his way to ICICI Bank to deposit the bankers cheque for Rs.80 lakhs on the morning of 2nd of April

2012. . He already had planned to invest that whole amount in purchase of another property for which

the payment has to be made in two instalments, half on signing the agreement on 18th

May 2012 and

the balance at the time of registration of the property on 18th

June 2012. As there was still some time

before the bank opened, he had sauntered to a nearby tea stall when he happened to spot his close

friend Rahul. Rahul, a dynamic share broker, was aghast on hearing that his friend intended to make a

bank deposit of such hefty amount at a time when the equity market was in full swing. He argues that

given his faith in ICICI Bank, why not consider investing the money on that bank shares instead.

Rahul is confident of the bank stock rallying from early next month to reach new highs by June.

For maximising the profit he suggests investing the entire amount in the futures market rather than the

cash market. Siddharth has a high opinion of his friend, having known him for years as a topper in his

class. While broadly agreeing on investment in the futures market, he is insistent on the risk being kept

at a minimum. Rahul then devises the following action plan:

The amounts would be invested such that they are available on the due dates for making the

payments for the proposed property purchase. For the amount due the next month, to have a calendar

spread and for the final payment amount, to have a market hedge. He explains that in a calendar

spread, as an equal number of futures contracts on the same security are simultaneously bought in oneseries and sold in another series, unlike the normal margin, only a much lower margin is levied. To

show Siddharth the possible extent of the profits, Rahul decides to brief you, his partner at the office,

in detail and asks you to make the following calculations based on your forecast of the market:

a. How the calendar spread would be executed? How many pairs of contracts could be bought

and what would be the actual margin?

b. How the market hedge would be executed? How many futures contracts have to be

bought?

c. What could be the likely gains from the two positions on the due dates for payment, based

on your forecast of the market?

For simplifying the calculations, you decide to ignore all other charges like commission etc. and also

assume that (a) there is enough money available to meet all margin calls in time and (b) all

settlement payments in the exchange are made immediately. For the calculations, you gather the

following prevailing margin data on the futures market, as on 2ndApril 2012:


21/23

crip Expiry Rate Lot

Size

Normal

Margin(%)

Calendar Spread

Margin (%)

per month on one

month calendar

spread

Rate

forecastedas on 18-05-

2012

Rate

forecastedas on 18-

6-2012

ICICIBANK 26/04/2012 882.35 250 16.27 1.02

ICICIBANK 31/05/2012 888.55 250 16.30 890

ICICIBANK 28/06/2012 898.85 250 16.26 905 925

NIFTY 26/04/2012 5290.65 50 10.10 1.02

NIFTY 31/05/2012 5325.90 50 10.13 5370

NIFTY 28/06/2012 5342.95 50 10.16 5400 5450

Note: To calculate the calendar spread margin per pair of contracts, multiply the value of one

farther month contract with the margin percentage given above and the number of monthsinvolved in the spread.

What would be your report with the calculations?


22/23

CHAPTER 22-PORTFOLIO MANAGEMENT FRAMEWORK

When the Kurla Cricket Club sent out a request for donations to its past members, to its pleasant

surprise, the response was overwhelming. They could collect a little over a crore and half rupees! And

then followed the inevitable arguments. While it was agreed that most of the funds collected should

be wisely invested in the capital market, there were fierce arguments between two groups on the

investment strategy. One team led by Choksi, a veteran of the stock markets was of the opinion that it

was futile to try to beat the market and any such attempt would only enrich the brokers. On the other

hand, the other team led by the young Ritesh had no such inhibitions and believed in adopting some

flexible strategy. After some fierce arguments, the club decided to allow the teams Rs.75 lakhs each for

investment over a three year horizon. They however asked both the teams to consult you, a well

respected investment consultant and follow any advice that you may give to them in this regard.

You find that Team Choksi knew exactly what to do and does not need any guidance. You think it fit to

put some restraint on the ambitious Team Ritesh. You suggest that in view of the prevailing

uncertainties, to start with, they should go in for a balanced portfolio with equal weightage for equities

and bonds and change to a CPPI strategy if the portfolio makes a profit in any year. You also suggest an

annual rebalancing of the portfolio as on the first of each financial year, based on the closing prices of

the previous year. Lest the team fumbles on stock selection, you suggest that they should invest only in

the equity stocks of HDFC Bank, TCS, Godrej Industries and Tata Motors. If in the course of rebalancing,

fresh stocks need to be purchased, then such purchase should be confined only to shares of those

stocks that performed the best during the completed year. Bond investment should be confined to

only PSU bonds.

Both the teams follow your advice and make the investment on 1-4-2009. If the market prices turn out

to be as follows, during the three years, what is the compounded annual growth rate achieved by each

team? While working out, you may ignore fractional shares, commissions, taxes, interest on bonds etc.

For the CPPI strategy, use the formula: Investment in stocks = 1.4(Portfolio value60 lakhs).

Exhibit

Closing

price

Nifty HDFC Bank TCS Godrej Consumer

Products

Tata Motors

31-3-09 3021 973 539 133 18031-3-10 5249 1933 781 261 758

31-3-11 5834 2346 1184 365 1248

31-3-12 5296 520 1160 480 275


23/23

Corporate

action

Stock split from Rs.10 face

value to Rs.2 face value-

trading on ex-split basis

from 14-7-2011

1:1 bonus-

trading on ex-

bonus basis from

16-6-2009

Stock split from

Rs.10 face value

Rs.2 face value-

trading on ex-sp

basis from 12-9-

Chapter 25 Guidelines for Investment Decisions

George Kurien is 30 years old and his annual income for the just concluded year was Rs. 750,000. He

expects his income to increase by 10 percent per year till he retires at the age of 55. George expects to

live till the age of 75. In the post-retirement period, George would like his annual income from his

financial investments to be 50 percent of his salary income in his last working year. Further, he would

like the same to be protected in real terms.

George owns a house (on which all the mortgage payments have been made) and has Rs. 2,000,000 of

financial assets. Only a year back he was blessed with twins-a son and a daughter. On their first

birthday he thought it was time he made some serious financial planning for the future of his family.

He wants to bequeath the house to his son and Rs. 20,000,000 to his daughter when he dies. The

current financial assets and the future savings of George are expected to earn a nominal rate of return

of 9 percent per annum. The expected inflation rate for the next 50 years is likely to be 5 percent.

1. What proportion of his salary income should George save till he retires so that he can meet his post-

retirement financial goals?

2. If George wants to retire at the age of 50, to pursue other interests in life, what Proportion of his

salary income should he save?

additional solved mini cases

Documents