Amendment, May 2021
Chapter 3 : Security Analysis
What are the charts used by Technical Analysis?
Line Chart – In a line chart, lines are used to connect successive day’s prices. The closing price for each period is plotted as a point. These points are joined by a line to form the chart. The period may be a day, a week or a month
Bar Chart – a vertical line (Bar) represents the lowest to the highest price, with a short horizontal line protruding from the bar representing both the opening and closing prices for the period
Japanese Candlestick Chart
This chart more visualizes the trend as change in the opening and closing prices is indicated by the colour of the candlestick
While Black candlestick indicates closing price is lower than the opening price the white candlestick indicates its opposite
White Candlestick indicates a Bullish trend and a black Candlestick indicates a bearish trend.
The lowest and highest prices are indicated by vertical bar and opening and closing prices are shown in the form of rectangular (as per above-mentioned colour scheme) placed in between this bar.
Point and Figure Chart – Point and Figure charts are more complex than line or bar charts. They are used to detect reversals in a trend. For plotting a point and figure chart, we have to first decide the box size and the reversal criterion. The box size is the value of each box on the chart
Chapter 4 : Security Valuation
Term Structure Theories
The term structure theories explain the relationship between interest rates or bond yields and different terms or maturities. The different term structures theories are as follows:
(a) Expectation Theory: As per this theory the long-term interest rates can be used to forecast short- term interest rates in the future as long-term interest rates are assumed to unbiased estimator of the short term interest rate in future.
(b) Liquidity Preference Theory: As per this theory investors are risk averse and they want a premium for taking risk. Long-term bonds have higher interest rate risk because of higher maturity, hence, long-term interest rates should have a premium for such a risk. Further, people prefers liquidity and if they are forced to sacrifice the same for a longer period, they need a higher compensation for the same. Hence, as per this theory, the normal shape of a yield curve is Positive sloped one.
(c) Preferred Habitat Theory (Market Segmentation Theory): This theory states that though as per different investors may be having different preference for shorter and longer maturity periods and therefore, they have their own preferred habitat. Hence, the interest rate structure depends on the demand and supply of fund for different maturity periods for different market segments. In case there is a mismatch between these forces, the players of a particular segment should be compensated at a higher rate to pull them out from their preferred habitat; hence, that will determine the shape of the yield curve. Accordingly, shape of yield curve will be determined which can be sloping upward, falling or flat.
Money Market Instruments (MMI)
Similar to Bonds, the money market instruments are important source of finance to industry, trade, commerce and the government sector for meeting their short-term requirement for both national and international trade. They are those instruments which are available for a period of less than one year. Example: Certificate of deposit, Commercial Paper, T-Bills, etc.
M Ltd. has to make a payment on 30th March 04 of ₹ 80 lacs. It has surplus cash today, i.e.31st Dec 03 & has decided to invest sufficient cash in a bank’s Certificate of Deposit scheme offering a yield of 8% p.a. on simple interest basis. What is the amount to be invested now? Take 91 days of investment. Solutions:
Calculation of Investment Amount
Let the amount to be invested now be ₹ X
Then we have X+X× 8/100×91/365 = ₹ 80,00,000 => X = ₹ 7843558.61187
RBI Sold a 91 day T Bill of face value of ₹ 100 at a yield of 6%. What was the issue price?
Let the issue price be X. Now we have, X+X× 6/100 x 91/365 = > X = 98.526
(i) The maturity value of treasury bill is always equal to face value. (ii) Treasury bills are always issued at a discount.
X Ltd. issued commercial paper as per following detail: Date of issue: 17thJanuary, 1998; Date of Maturity: 17th April, 1998; No. of days 90; Interest Rate: 11.25% p.a. What was the net amount received by the company on issue of commercial paper? Assume Maturity Value or Face Value to be 500 lacs.
Let the net amount received by the company be X.
Then we have, X+X× 11.25/100 x 90/365 = ₹ 500,00,000 => x = ₹ 48650449.85
QUESTION NO. 1
A money market instrument with face value of ₹ 100 and discount yield of 6% will mature in 45 days. You are required to calculate:
1. Current Price of the Instrument.
2. Rate of Interest.
3. Effective Annual Return.
(1 Year=360 Days )
Effective Yield under Money Market Instruments
Effective Rate of Interest = (FV – issue price)/ issue price x (12/ required period ) x 100
Cost of Funds:
Effective rate of Interest p.a + Brokerage p.a
+ Rating Charges p.a + Stamp Duty p.a
= Total cost of Funds p.a
Amount of Issue – ₹ 100 Period – 6 months
Rate of discount – 20%
Discount = 100× 20% x 6/12 x 100 = 10
Hence CD will be issued for ₹ 100 – 10 = ₹ 90.00. The effective rate to the bank will, however, be calculated on the basis of the following formula:
Effective Rate of Interest/Effective Yield = (FV – issue price)/ issue price x (days or months in a year/ required period ) x 100
Accordingly, the Yield as per the data given in the example will be:
100-90/90 x 12/6 x100 = 22.22 % p.a.
From the following particulars, calculate the effective interest p.a. as well as the total cost of funds of ABC Ltd., which is planning a CP issue:
Issue price of CP -► ₹ 97,350;
Face Value -► ₹ 1,00,000;
Maturity period -► 3 months
Issue Expenses :
Brokerage : 0.125% for 3 months;
Rating Charges: 0.5% p.a.;
Stamp Duty: 0.125% for 3 months.
Effective Rate of Interest = (FV – issue price)/ issue price x (12/ required period ) x 100
= 10.89 p.a.
Cost of fund to the Company:
Effective Interest 10.89
Brokerage (.125 × 12/3) 0.5
Rating Charges 0.5
Stamp Duty(.125 × 12/3) 0.5
From the following particulars, calculate the effective rate of interest p.a. as well as the total cost of funds to Bhaskar Ltd., which is planning a CP issue:
Issue Price of CP ₹ 97,550
Face Value ₹ 1,00,000
Maturity Period 3 Months Issue Expenses:
Brokerage 0.15% for 3 months
Rating Charges 0.50% p.a
Stamp Duty 0.175% for 3 months
1. Z Co. Ltd. issued commercial paper worth ₹10 crores as per following details:
Date of issue : 16th January, 2019 Date of maturity: 17th April, 2019 No. of days : 91 Interest rate 12.04% p.a
What was the net amount received by the company on issue of CP? (Charges of intermediary may be ignored)
QUESTION NO. 4
AXY Ltd. is able to issue commercial paper of ₹ 50,00,000 every 4 months at a rate of 12.5% p.a. The cost of placement of commercial paper issue is ₹ 2,500 per issue. AXY Ltd. is required to maintain line of credit ₹ 1,50,000 in bank balance. The applicable income tax rate for AXY Ltd. is 30%. What is the cost of funds (after taxes) to AXY Ltd. for commercial paper issue? The maturity of commercial paper is four months.
QUESTION NO. 5
Wonderland Limited has excess cash of ₹ 20 lakhs, which it wants to invest in short term
marketable securities. Expenses relating to investment will be ₹ 50,000.
The securities invested will have an annual yield of 9%.
The company seeks your advice
(i) as to the period of investment so as to earn a pre-tax income of 5%.
(ii) the minimum period for the company to break even its investment expenditure over time value of money.
Repurchase Options (Repo.) and Reverse Repurchase Agreement (Reverse Repo):
The term Repurchase Agreement (Repo) and Reverse Repurchase Agreement (Reverse Repo) refer to a type of transaction in which money market participant raises funds by selling securities and simultaneously agreeing to repurchase the same after a specified time generally at a specified price, which typically includes interest at an agreed upon rate. Sometimes it is also called Ready Forward Contract as it involves funding by selling securities (held on Spot i.e. Ready Basis) and repurchasing them on a forward basis.
QUESTION NO. 6
Bank A enter into a Repo for 14 days with Bank B in 10% Government of India Bonds 2028 @ 5.65% for ₹ 8 crore. Assuming that clean price (the price that does not have accrued interest) be ₹ 99.42 and initial Margin be 2% and days of accrued interest be 262 days. You are required to determine
(i) Dirty Price
(ii) Repayment at maturity. (consider 360 days in a year)
Enterprise Value (EV)
Calculate Enterprise Value (EV) in two ways:
a) Take Entity Value as the base, and then adjust for debt values for arriving the ‘EV’;
b) Take a balance sheet based approach and arrive at EV.
Let’s apply the above concepts into a relative valuation illustration:
A Ltd. made a Gross Profit of ₹ 10,00,000 and incurred Indirect Expenses of ₹ 4,00,000. The number of issued Equity Shares is 1,00,000. The company has a Debt of ₹ 3,00,000 and Reserves & Surplus to the tune of ₹ 5,00,000. The market related details are as follows:
Risk Free Rate of Return 4.5%
Market Rate of Return 12%
β of the Company 0.9
1) Per Share Earning Value of the Company.
2) Equity Value of the company if applicable EBITDA multiple is 5.
a) Capitalization Rate using CAPM 4.5% + 0.9(12% – 4.5%) = 11.25% Calculation of Earning Value Per Share
Gross Profit 1000
Less: Indirect Expenses (400)
Earning Value of Company(600/ 0.1125) 5333.33
Number of Shares. 100000
Earning Value Per Share 53.33
(b) Equity Value of Company
EBITDA Multiple 5
Capitalized Value 3000
Less: Debt (300)
Add: Surplus Funds 500
Equity Value (Enterprise Value) 3200
This approach attempts to identify multi-industry companies that are undervalued and would have more value if separated from each other. In other words as per this approach an attempt is made to buy assets below their replacement value.
This approach involves following three steps:
Step 1: Identify the firm’s various business segments and calculate the average capitalization ratios for
firms in those industries.
Step 2: Calculate a “theoretical” market value based upon each of the average capitalization
Step 3: Average the “theoretical” market values to determine the “chop-shop” value of the
Capital/ Sales Ratio = 0.75
Sales = 15,00,000
Calculate Capitalized Value?
Capitalized Value = Sales × 0.75
= 15,00,000 × 0.75 => 11,25,000
Chapter 9 : Foreign Exchange Exposure & Risk Management
As per FEDAI Rule 6 a forward contract which remains overdue without any instructions from the customers on or before due date shall stand automatically cancelled within 3 working days after the maturity date. Though customer is liable to pay the exchange difference arising there from but not entitled for the profit resulting from this cancellation.
For late delivery and extension after due date as mentioned above the contract shall be treated as fresh contract and appropriate rates prevailing on such date shall be applicable as mentioned below:
1. Late Delivery: In this case the relevant spot rate prevailing on the such date shall be applicable.
2. Extension after Due Date: In this case relevant forward rate for the period desired shall be
As mentioned earlier in both of above case cancellation charges shall be payable consisting of following:
(i) Exchange Difference: The difference between Spot Rate of offsetting position (cancellation rate) on the date of cancellation of contract after due date or 3 working days (whichever is earlier) and original rate contracted for.
(ii) Swap Loss: The loss arises on account of offsetting its position created by early delivery as bank normally covers itself against the position taken in the original forward contract. This position is taken at the spot rate on the date of cancellation earliest forward rate of offsetting position.
(iii) Interest on Outlay of Funds: Interest on the difference between the rate entered by the bank in the interbank market and actual spot rate on the due date of contract of the opposite position multiplied by the amount of foreign currency amount involved. This interest shall be calculated for the period from the due date of maturity of the contract and the actual date of cancellation of the contract or 3 working days whichever is later.
Please note in above in any case there is profit by the bank on any course of action same shall not be passed on the customer as normally passed cancellation and extension on or before due dates.
Chapter 11 : Interest Rate Risk Management [IRRM]
Types of Interest Rate Risk
Various types of Interest rate risk faced by companies/ banks are as follows:
A gap or mismatch risk arises from holding assets and liabilities and off-balance sheet items with different principal amounts, maturity dates or re-pricing dates, thereby creating exposure to unexpected changes in the level of market interest rates. This exposure is more important in relation to banking business.
The positive Gap indicates that banks have more interest Rate Sensitive Assets (RSAs) than interest Rate Sensitive Liabilities (RSLs). A positive or asset sensitive Gap means that an increase in market interest rates could cause an increase in Net Interest Income (NII). Conversely, a negative or liability sensitive Gap implies that the banks’ NII could decline as a result of decrease in market interest rates.
A negative gap indicates that banks have more RSLs than RSAs. The Gap is used as a measure of interest rate sensitivity.
Positive or Negative Gap is multiplied by the assumed interest rate changes to derive the Earnings at Risk (EaR). The EaR method facilitates to estimate how much the earnings might be impacted by an adverse movement in interest rates. The changes in interest rate could be estimated on the basis of past trends, forecasting of interest rates, etc. The banks should fix EaR which could be based on last/current year’s income and a trigger point at which the line management should adopt on-or off- balance sheet hedging strategies may be clearly defined.
Gap calculations can be augmented by information on the average coupon on assets and liabilities in each time band and the same could be used to calculate estimates of the level of NII from positions maturing or due for repricing within a given time-band, which would then provide a scale to assess the changes in income implied by the gap analysis.
The periodic gap analysis indicates the interest rate risk exposure of banks over distinct maturities and suggests magnitude of portfolio changes necessary to alter the risk profile.
Although the Gap Report is very useful for analysis of Risk but it also suffers from following limitations:
- The Gap report quantifies only the time difference between re-pricing dates of assets and liabilities but fails to measure the impact of basis and embedded option risks.
- The Gap report also fails to measure the entire impact of a change in interest rate (Gap report assumes that all assets and liabilities are matured or re-priced simultaneously) within a given time-band and effect of changes in interest rates on the economic or market value of assets, liabilities and off-balance sheet position.
- It also does not take into account any differences in the timing of payments that might occur as a result of changes in interest rate environment.
- Further, the assumption of parallel shift in yield curves seldom happen in the financial market.
- The Gap report also fails to capture variability in non-interest revenue and expenses, a potentially important source of risk to current income.
Chapter 14 : Start-Up Finance
STARTUP INDIA INITIATIVE
Startup India scheme was initiated by the Government of India on 16th of January, 2016. As per GSR Notification 127 (E) dated 19th February 2019, an entity shall be considered as a Startup:
i. Upto a period of ten years from the date of incorporation/ registration, if it is incorporated as a private limited company (as defined in the Companies Act, 2013) or registered as a partnership firm (registered under section 59 of the Partnership Act, 1932) or a limited liability partnership (under the Limited Liability Partnership Act, 2008) in India.
ii. Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded one hundred crore rupees.
iii. Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.
Provided that an entity formed by splitting up or reconstruction of an existing business shall not be considered a ‘Startup’.
What is a Startup to avail government schemes?
Up to 10 years from its date of incorporation / registration
Incorporated as either a Private Limited Company or a Registered Partnership Firm or a Limited
Liability Partnership in India
Turnover for any fiscal year has not exceeded INR 100 crore
Entity should not have been formed by splitting up or reconstruction a business already in existence
Working towards innovation, development, deployment or commercialization of new product,
Processes or services driven by Technology or Intellectual Property