CA Final May 2026 Suggested Answers Paper 2 Advanced Financial Management

FOR CA FINAL EXAM PREPARATION

CA Final 2026
Suggested Answers ·
Paper 2 Advanced
Financial Management
EXAM YEAR TYPE

CA Final 2026 Suggested Answers
SUBJECT DATE

Paper 2 Advanced Financial Management May 2026

Notes · Sample Papers · Previous Year Papers · Mock Tests

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PAPER – 2 : ADVANCED FINANCIAL
MANAGEMENT
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PART – I Multiple Choice Questions

l a a
aTheg Government of India issues a 5-year Sovereign Gold Bond (SGB) at an issue
Case Scenario -I

price of ` 5,000 per gram. An investor, Mr. JK, has purchased 200 grams SGB
under this scheme. The bond carries a coupon rate of 2.5% per annum, calculated
as simple interest on the initial investment amount, with interest payable
annually. At the end of five years, the bond will be redeemed at the prevailing
market price of gold. The annual interest received is taxable at the investor's
applicable marginal income tax rate. Any capital gain arising on redemption is
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taxable at 20% after considering the benefit of indexation. The inflation rate

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during the holding period is assumed to be 4% per annum.
From the information given above,schoose
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a
Nos. 1 to 3:
1. An investor Mr. JK purchases 200 grams of SGB at ` 5,000 per gram. The
investor falls in the 30% tax bracket. Inflation is 4% per annum. What are the
post-tax annual interest income and the approximate real post-tax return
(%) on initial investment?
(A) ` 25,000 and 2.25%

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(B) ` 17,500, and -2.25%

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(C) ` 17,500 and 1.75%
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(D) ` 17,500 and -1.75%

l ais constant at 4% se (2 Marks)
las annually. What is the indexed cost of acquisition and a
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2. After 5 years, gold price becomes 6,800 per gram. Inflation

ag Mr. JK?
taxable capital gain to

(A) Indexed cost ` 12,00,000; Taxable gain ` 1,60,000

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

(B) Indexed cost ` 11,69,860; Taxable gain ` 1,90,140
(C) Indexed cost ` 12,16,653; Taxable gain ` 1,00,343

(D) Indexed cost ` 12,16,653; Taxable gain ` 1,43,347 (2 Marks)
3. Assume SGB redeems at ` 6,800 per gram and Mr. JK is in 30% tax bracket.
What is the net amount received after capital gains tax (20% with
indexation)?
(A) 13,56,331
(B) 13,16,996

(C) 13,31,331
(D) 13,28,000 (2 Marks)
Case Scenario - II

NewChem Ltd., a leading chemical manufacturing firm based in Telangana, is
evaluating the installation of a new-generation solar power plant to meet the
energy needs of its primary manufacturing unit. This initiative is part of
NewChem's long-term sustainability and cost-reduction goals.
The total cost of installing the solar plant is ` 3.20 crore. Based on the current
state electricity tariffs, the plant is projected to generate savings in electricity
expenses of ` 25 lakh per year in perpetuity.
However, there is regulatory uncertainty. A new state government is expected to
take office in one year and it is anticipated that electricity tariffs will be revised.
Based on industry analysis, the annual savings from the solar plant could change
to one of two possibilities:
Scenario 1 (Low Savings): Savings could decrease to ` 15 lakh per year in
perpetuity.
Scenario 2 (High Savings): Savings could increase to ` 40 lakh per year in
perpetuity.

The company's Weighted Average Cost of Capital (WACC) is 9.5% and the current
risk-free rate of return, based on 10-year government bonds, is 6.5%.

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From the information given above, choose the correct answer to the Questions
No. 4 to 6:

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4. NewChem Ltd. (Telangana) plans to invest ` 3.20 crore today in a solar power
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plant generating annual electricity savings of ` 25 lakh in perpetuity. The

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WACC is 9.5%. After one year, savings may change to ` 40 lakh (high

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scenario) or ` 15 lakh (low scenario) perpetuity due to tariff revisions.
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ag ` crore).
Calculate NPV if invested today and NPV after one year in both scenarios (in

(A) Today: - 0.45; High: 1.01; Low: - 1.62
(B) Today: - 0.57; High: 1.21; Low: - 1.42
(C) Today: - 0.57; High: 1.01; Low: - 1.62
(D) Today: - 0.63; High: 0.95; Low: - 1.58 (2 Marks)

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5. For NewChem's ` 3.20 crore solar plant (WACC 9.5%), after one year savings
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will be ` 40 lakh or ` 15 lakh perpetuity. Risk-free rate is 6.5%. Using risk-

a s
neutral valuation, compute returns in both scenarios and risk-neutral
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probability of high savings scenario (%).
a
(A) High: 31.56%; Low: - 50.63%; Prob: 69.5%
(B) High: 28.45%; Low: - 48.25%; Prob: 65.2%
(C) High: 31.56%; Low: - 50.63%; Prob: 73.8%
(D) High: 35.20%; Low: - 52.15%; Prob: 69.5% (2 Marks)

6. New-Chem can invest ` 3.20 crore in solar plants today or wait one year,

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when savings will be ` 40 lakh or ` 15 lakh perpetuity (WACC 9.5%,

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risk-free 6.5%). Using risk-neutral probability (69.5% high), Compute PV of
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option to wait one year, discounted at risk-free rate and WACC (in ` lakh).

s em (A) PV at RF rate: ` 70.23 Lakh; WACC: ` 68.50 Lakh
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a (C) PV at RF rate: ` 44.15 Lakh; WACC: ` 42.30 Lakh
(D) PV at RF rate: ` 19.53 Lakh; WACC: ` 18.98 Lakh (2 Marks)

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

Case Scenario - III
XYZ Ltd. is professionally engaged in providing consultancy services related to
corporate mergers and acquisitions. It is on an expansion mode and decided to
hire freshly qualified Chartered Accountants for the post of "M&A Consultant".
For selection of the candidate, each of the candidates needs to pass a written test.
Following are some of the questions asked in the test to identify the concepts
related to M&A.
You are a examinee in written test paper therefore, you are required to choose
the correct option to the Question Nos. 7 to 9:
7. AB Ltd., the target* company may issue substantial amount of convertible
debentures to its existing shareholders to be converted at a future date when
it faces a takeover threat. The tactic used by AB Ltd. is called ____________.
(A) White Knight
(B) Poison Put
(C) Poison Pill
(D) White Squire (2 Marks)
* In the question paper, ‘target’ was mistakenly referred to as ‘acquiring’.
8. Identify the correct meaning from among the following options when X Ltd,
a target company adopts "Greenmail" tactics to defend itself from hostile
takeover.
(A) When X Ltd. issues bonds that encourage the holder to cash in at higher
prices.
(B) When X Ltd. offers hefty compensations to its managers if they get
ousted due to takeover.
(C) When X Ltd, makes a counter bid for the acquirer company.
(D) When X Ltd. offers the acquirer a higher price for its shares than the
market price. (2 Marks)
9. R Ltd. is a parent company and J Ltd. is its subsidiary company. J Ltd. is
growing at a faster pace than R Ltd. and also carries higher valuations than
other businesses owned by R Ltd. To unlock the value of J Ltd., and generate

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cash, a strategic avenue which R Ltd. may take is to make J Ltd. go public
through an IPO but keep a controlling stake in the newly traded subsidiary.

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Such tactic adopted by R Ltd. is called ______________.

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(A) Split-up

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(B) Carve
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(C)
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a (D) Spin-Off (2 Marks)
Case Scenario - IV

Mr. X a portfolio Manager invests ` 25,00,000 in stock Alpha and Beta in ratio of
60 : 40. The daily standard deviation of stock Alpha is 1.20% and stock Beta is
0.90%. The correlation between Alpha and Beta is 0.6. Mr. X wanted to measure
VAR for confidence level 99% and 90% level. (Z score: 99% confidence level: 2.33

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and 90% confidence level: 1.28) Assume 252 trading days in a year and mean
return is zero.

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From the information given above, choose

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Nos. 10 to 12:
10. What is the approximateaannual Value at Risk (VaR) of the portfolio in rupee
terms at the given 99% confidence level?
(A) ` 57,027
(B) ` 5,43,162

(C) ` 9,05,271

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(D) ` 7,94,080 (2 Marks)

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11. What is the approximate diversification benefit (per day) of the portfolio

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while you calculate amount of VaR at 90% confidence level?

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las (A) ` 11,540
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ag (B) ` 23,060

(C) ` 34,580
(D) ` 3,252 (2 Marks)

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

12. If the correlation between Stock Alpha and Stock Beta increases from 0.60 to
0.80, what will be the impact on the portfolio's annual Value at Risk (VaR) at
the 99% confidence level?
(A) VaR increase by ` 48,085
(B) VaR decrease by ` 48,085

(C) VaR increase by ` 3,029
(D) VaR decrease ` 3,029 (2 Marks)
Case Scenario - V
Green Agro Exports Ltd. entered a 3-month forward contract on January 1, 2026
to buy USD 2,00,000 (import payment due April 1, 2026).
USD-INR Bank Quotes:

Date Spot Spot 1M 1M 2M 2M 3M 3M
Bid Ask Fwd Fwd Fwd Fwd Fwd Fwd
Bid Ask Bid Ask Bid Ask
01.01.2026 83.20 83.55 - - - - 83.60 84.00
01.02.2026 83.80 84.15 - - 83.95 84.35 - -
01.03.2026 83.40 83.75 83.70 84.05 84.10 84.45 - -
01.04.2026 83.20 84.50 84.30 84.65 - - - -
From the information given above, choose the correct answer to the Questions
No. 13 to 15:
13. Green Agro Exports Ltd. entered 3-month USD 2,00,000 forward on Jan 1,
2026. On March 1, 2026, what is maturity settlement cost vs. net extra cost
of closing original and rebooking 1-month forward?
(A) Maturity ` 1,68,00,000; Extra ` 60,000
(B) Maturity ` 1,68,00,000; Extra ` 10,000
(C) Maturity ` 1,68,00,000; Extra ` 70,000
(D) Maturity ` 1,67,20,000; Extra ` 70,000 (2 Marks)
14. If import obligation is settled early on March 1, 2026, what total cash outflow
is required that day to close forward contract and make import payment?

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(A) ` 16,740,000
(B) ` 16,810,000
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(C) ` 16,870,000

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(D) ` 16,890,000 (2 Marks)
15. Greenm
e contract (Jan 1, 2026; 84.00 Ask). What are the mark-to-market gla
Agro Exports Ltd. cancels the import and closes the USD 2,00,000 s
a s
lgain/(loss)
forward
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a (A) Feb 1: - ` 10,000; Mar 1: - ` 60,000; Apr 1: + ` 40,000
on the following dates?

(B) Feb 1: + ` 10,000; Mar 1: + ` 60,000; Apr 1: - ` 40,000
(C) Feb 1: - ` 30,000; Mar 1: - ` 60,000; Apr 1: + ` 40,000
(D) Feb 1: - ` 10,000; Mar 1: - ` 30,000; Apr 1: + ` 20000 (2 Marks)
Answer Key

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MCQ No. Correct Option
1. (B)
.
2. (D)
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3. (C)
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4. (C) a
5. (A)
6. No correct option
7. (C)
8. (D)
9. (B)
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10. (C)

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se
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g la
gla 13. (C)
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15. (A)

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

PART – II Descriptive Questions
Question No.1 is compulsory.
Candidates are also required to answer any four from the remaining five
questions.
Working notes should form part of the respective answer.

Question 1
(a) Bharat Infrastructure Ltd (BIL), a premier Indian Engineering firm, has been
invited to establish and operate a high-speed data center infrastructure in
the Republic of Valoria. The initial investment required for the project is 4,000
million Valors (VL).
Under the agreement, BIL will sell the project back to the Valorian
government after 4 years for a guaranteed sale price of 8,000 million VL.
During the four-year operational period, BIL will provide technical
maintenance and security protocols at an annual fee of 80 million VL,
payable at the end of each year.
To hedge the foreign exchange risk associated with the initial capital
investment, BIL's investment bankers have proposed a Currency Swap
arrangement with the following terms:
• BIL will swap the principal amount of 4,000 million VL for Indian Rupees
immediately (Year 0) at today's spot rate.

• The swap will be reversed at Year 4, with both parties re-exchanging the
same principal amounts at the same spot rate locked in at inception.
• The bank will charge an annual facilitation fee of 0.30% (calculated on
the ` principal amount), payable at the end of each year.
The currency swap covers only the initial investment and terminal principal.
BIL's policy is to hedge all other foreign currency cash flows using forward
contracts at the respective forward rates prevailing in the market today.

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Financial Data:
The current market data and exchange rates (VL/`) are as follows:
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Spot 1 Year 2 Year 3 Year 4 Year
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. Rate (VL/`) 50.00 53.00 56.18
Forward Forward Forward Forward
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eFactor @ 14% 1.000 0.877 0.769
Exchange 59.55 63.12
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lCumulative PVFA for 4 years at 14%. = 2.913
PV 0.675 0.592
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Assume a risk-adjusted discount rate of 14% per annum. Ignore taxation.
You are required to evaluate the project's financial viability using the Net
Present Value (NPV) method, with all cash flows expressed in Indian Rupees
(` million). (6 Marks)
(b) XYZ Ltd. recently paid a dividend of ` 40. The company is entering a 5-year
transition phase where its current 15% growth rate will decline linearly to a

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stable perpetual rate.

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Financial Parameters:

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• Transition Period: 5 years (declining

ag and a retention ratio of 25%.
• Current Data: ROE of 20%
• Terminal Data (Year 6+): ROE of 12% and a retention ratio of 50%.
• Market Data: Required return of 13% and Market Price of ` 850.
You are required to:
(i) Estimate the intrinsic value per share using the H-Model.
(ii) Given the current market price of ` 850 per share, assess whether the

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stock is undervalued or overvalued and calculate the percentage

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.to fund its
c. o (c) MT Ltd. has approached you for an additional loan of ` 20 crores
deviation from intrinsic value. (4 Marks)
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a ratio is already
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aggressive expansion plans. The company's current sustainable

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a the industry is
is 10%, but it aims to grow at 16% annually. Its debt-to-equity

ag at the maximum permissible limit of 2.5:1. Additionally,
experiencing 5% inflation, which is increasing the company's asset financing
requirements.

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

As a credit analyst, you explain the key concerns regarding this loan request
and suggest two alternative courses of action available to the company to
achieve its growth objectives sustainably. (4 Marks)
Answer
(a) Working Notes:
(1) Swap Calculations
● Initial Investment (Year 0): 4,000 m VL/ 50.00 = ` 80.00 Million
● Annual Bank Charges: `80.00 m x 0.30% = ` 0.24 Million p.a. for
years 1 to 4.

● Swap Terminal Receipt (Year 4): Since the swap is at the spot rate,
BIL receives back ` 80 million in exchange for 4000 million VL.
(2) Project Cash Flows (` in Million)
The annual technical fees and the excess buy-back amount (portion
not covered by the swap) are converted using the representative
forward rates.
● Year 1 Fee: 80 m VL/ 53.00 = ` 1.51 m
● Year 2 Fee: 80 m VL/ 56.18 = ` 1.42 m
● Year 3 Fee: 80 m VL/ 59.55 = ` 1.34 m
● Year 4 Fee: 80 m VL/ 63.12 = ` 1.27 m
● Year 4 Excess Sale Receipt:

Total Sale Price 8000 m VL
Less: Amount covered by swap reversal (4000 m VL)
Excess to be converted at Forward Rate 4000 m VL
Forward Rate (4-year) VL 63.12/`
` Equivalent: 4000 / 63.12 ` 63.37 m

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DCF Analysis of the Project
(` in Million)

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Year Particulars VL Spot/ Cash PVF @ PV (` in

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Million Forward Flow 14% Million)

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Rate (` in

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Million)
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(80.0000)
(Swap)
Technical Fee 80 53.00 1.5094 0.877 1.3237
2 Technical Fee 80 56.18 1.4240 0.769 1.0951
3 Technical Fee 80 59.55 1.3434 0.675 0.9068
4 Technical Fee 80 63.12 1.2674 0.592 0.7503
4 Swap Principal 4000 50.00 80 0.592
47.3600
Receipt

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(28.5641)

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Less: PV of Facilitation Fee (0.30% x 4000 x 2.913) (0.6991)

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63.12

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Add: PV of Excess Receipt 4000 x 0.592)
37.5158
63.12
Net Present Value
8.2526
OR
Net Present Value - if cash flows discounted to only two
8.25
decimals
* Note: 2.913 is the cumulative PVFA for 4 years at 14%.
Conclusion: Since the NPV is positive ` 8.2526 Million or 8.25 Million, BIL
should accept the invitation to operate the project in the Valoria.
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(b) (i) Estimation of Intrinsic Value of share based on H Model
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D0 �1 + gn �
+
D0 H1 � gc - gn �

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las r-gn
g
r-gn
Where g = Normal Growth Rate Long Run (12%ax 0.50) = 6%
ag n

gc = Current Growth Rate i.e. initial short term growth rate (15%)
H1 = Half of duration of the transition growth period

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

Accordingly Intrinsic Value of share shall be:
` 40 (1 + 0.06) ` 40 ×2.50 ( 0.15- 0.06)
= +
0.13-0.06 0.13-0.06

= ` 605.71 + ` 128.57 = ` 734.28
Thus, the intrinsic value of share shall be ` 734.28.
(ii) Given the current market price of ` 850 per share, it is overvalued.
The percentage deviation from the intrinsic value shall be computed as
follows:
` 850- ` 734.28
= = 15.76% Or
` 734.28

` 850 - ` 734.28
= = 13.61%
` 850

(c) Key Concerns:
(i) Excessive Debt Risk: The loan request creates a potentially risky
situation of too much debt and too little equity, as the company’s
debt-to-equity ratio is already at the maximum limit of 2.5:1.
(ii) Growth Rate Mismatch: The company’s planned growth rate (16%)
exceeds its sustainable growth rate (10%), which cannot be maintained
without increasing financial leverage beyond permissible limits.
(iii) Inflationary Impact: The 5% inflation increases the amount of external
financing required and increases the debt-to-equity ratio when
measured on a historical cost basis. Thus, inflation lowers the firm's
sustainable growth rate.
Alternative Courses of Action:
(i) Raise Additional Equity: The Company must raise additional equity
capital to support the higher growth rate while maintaining the debt-
to-equity ratio within permissible limits.
(ii) Reduce Expansion Rate: The Company will have to reduce the rate of
expansion to a level (10% or lower) that can be sustained without an
increase in financial leverage, aligning actual growth with sustainable
growth rate.

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Question 2
(a) Mr. RJ own two securities X and Y are priced according to a two-factor
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Arbitrage Pricing Model. The factor sensitivities and expected returns are as

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follows:

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Particulars
e with factor 1 (β )
Security X Security Y
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Beta
l Beta with factor 2 (β )
1 1.2 0.8
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a Expected (actual) return 2 0.5 1.4
14% 16%

Additional Information:
Risk-free rate = 6%,
Risk premium for Factor 1 = 4%,
Risk premium for Factor 2 = 5%.

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Required:

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(i) Evaluate whether Security X and Security Y are correctly priced under the

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two-factor Arbitrage Pricing Theory Model.

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(ii) Mr. RJ has ` 1,00,000 available and intends to construct a long-short
a
portfolio by taking a long position in Security X* and a short position in
Security Y*. You are required to analyses and determine the amount to
be invested in Security X* and the amount to be sold short in Security Y*
if the desired portfolio sensitivities are 1.40 with respect to Factor 1 and
0.05 with respect to Factor 2. (6 Marks)
* In the question paper, Security X and Security Y were mistakenly referred
to as Security A and Security B, respectively.

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(b) On 1 July, ALPS Company shares trade at ` 2,000. An investor enters the

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following option: (3-month maturity):
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Option Type Strike (`) Premium (`)

la se
las A Call 1920 130
g
85a
ag B Call 2000
C Call 2080 45
D Put 1920 40

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

E Put 2000 95
F Put 2080 155

Contract size =100 shares.
Risk-free rate =6% p.a. (continuous compounding not required) and the stock
does not pay dividends.
Ignore transaction costs. Assume that investor chosen any one option.
Required:
(i) Assess the ITM, ATM, OTM of each option A to option F at initiation and
evaluate the intrinsic and time value components embedded in the
premiums.
(ii) In the next 3 months expiry price may increase by 150 or may decrease
150. Under each expiry scenario, examine which options will be
rationally exercised and appraise the net profit or loss per contract.
(4 Marks)
(c) The technology start-up, Fincorp Pvt. Ltd., is in its early growth stage and is
evaluating multiple sources of financing including Angel Investment, Venture
Capital (VC), Convertible Notes, SAFE and IPO.
Evaluate the following statements and state whether they are True or False,
giving brief justification in each case:
(i) In early-stage start-ups, valuation is primarily based on discounted cash
flow (DCF) using stable historical earnings.
(ii) Venture capital financing typically involves staged funding to reduce
agency problems and mitigate investment risk.
(iii) Bootstrapping reduces dilution risk but may limit growth due to capital
constraints.
(iv) Angel investors generally invest at a later stage than venture capitalists
and demand stronger control rights. (4 Marks)
Answer
(a) (i) λ1 = 4% and λ2 = 5%
APT required return (X) = R f + λ1 β1 + λ2 β2 + λ3 β3 … + λn βn
= 6% + (1.2 x 4%) + (0.5 x 5%) = 13.3%

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Expected (actual) return 14% > required return 13.3%, Security X is
underpriced (offer higher return than required) or Not correctly priced

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APT required return (Y) = R f + λ1 β1 + λ2 β2 + λ3 β3 … + λn βn

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= 6% + (0.8 x 4%) + (1.4 x 5%) = 16.2%

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eoverpriced (offer lesser return than required) or Not correctly priced or la
Expected (actual) return 16% < required return 16.2%, Security Y is

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ag (ii) Targeted sensitivities F1 = 1.40 and F2 = 0.05, calculation of amount to
approximately correctly priced

be invested in Long position indicated as L and Short position as S
Security X (F1) = β1 = 1.20; Security Y = β1 = 0.80
Security X (F2) = β2 = 0.5; Security Y = β2 = 1.4
Equation 1.20L – 0.8S = 1,40,000 (i) (sensitivity 1.40 x 100000)
Equation 0.50L – 1.4S = 5,000 (ii) (sensitivity 0.05 x 100000)

m
co
Multiply equation first by 1.4 and second by 0.8 and subtracted (ii) from
.
em
(i)
1.68L – 1.12S = 1,96,000
l a s
0.40L – 1.12S = 4,000
a g
1.28L = 192000 so long position L = ` 1,50,000
Now put value of L in equation (i)
1,80,000 – 0.8S = 1,40,000
So, amount of short position = 40,000/0.8 = ` 50,000
Analysis

m
Mr. RJ is using ` 1,00,000 of his own capital and creating: A larger long

m .c o
exposure ` 1,50,000 and financed partly through short selling ` 50,000.

c. o OR
e m
This means the portfolio is leveraged, becauseastotal exposure
s em (` 2,00,000 is greater than own funds) and theglportfolio is highly
gla a
a sensitive to Factor 1.

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

(b) (i) Intrinsic and Time Value
Option Type Strike Spot Price Status Premium IV TV
Price (`) (`) (`) (`) (`) (`)

A Call 1,920 2,000 ITM 130 80 50
B Call 2,000 2,000 ATM 85 -- 85
C Call 2,080 2,000 OTM 45 -- 45
D Put 1,920 2,000 OTM 40 -- 40
E Put 2,000 2,000 ATM 95 -- 95
F Put 2,080 2,000 ITM 155 80 75

(ii) Position of Net Profit/ Loss under different scenario
(A) Price increase by ` 150
Option Expected Status Profit Premium Net Profit/ Lot Total
Price (`) (`) (`) Loss Per Size Profit/
Share (`) Loss (`)
A 2,150 Exercise 230 130 100 100 10,000
B 2,150 Exercise 150 85 65 100 6,500
C 2,150 Exercise 70 45 25 100 2,500
D 2,150 Decline -- 40 - 40 100 - 4,000
E 2,150 Decline -- 95 - 95 100 - 9,500
F 2,150 Decline -- 155 - 155 100 - 15,500

(B) Price decrease by ` 150
Option Expected Status Profit Premium Net Profit/ Lot Total
Price (`) (`) (`) Loss Per Size Profit/
Share (`) Loss (`)
A 1,850 Decline -- 130 - 130 100 - 13,000
B 1,850 Decline -- 85 - 85 100 - 8,500
C 1,850 Decline -- 45 - 45 100 - 4,500
D 1,850 Exercise 70 40 30 100 3,000
E 1,850 Exercise 150 95 55 100 5,500
F 1,850 Exercise 230 155 75 100 7,500

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SUGGESTED ANSWERS ADVANCED FINANCIAL MANAGEMENT

(c) (i) False
Justification: Early-stage start-ups usually lack stable historical earnings
m
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and predictable cash flows. Therefore, DCF is unreliable.

o m m
c
(ii) True
. s e
eA,mB, etc.). Staging: Reduces information asymmetry, moral hazard, gla
Justification: VC financing is commonly structured in stage (Seed. Series

s
la Links funding to milestone achievement, Limits downside exposure.a
g
a Exposure. It is a key risk-management mechanism in venture investing.
(iii) True
Justification: Bootstrapping involves self-financing through personal
savings or internal cash flow.
Advantage: No equity dilution, Retained control.
Disadvantages: Limited capital, Slower scaling, Higher founder financial

m
risk.

.
Thus, growth potential may be constrained. co
(iv) False
s em
g l a
Justification: Angel investors typically invest in the seed or very early
a
stage, often before institutional VC funding. They usually take minority
stakes and exercise relatively informal control compared to VCs.
Venture capitalists invest at later stages and demand stronger
governance rights such as board seats, veto rights, and protective
provisions.
Question 3
(a) An Indian company is investing in a 2-year project in Europe (EURO).

m
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Initial Investment = €4,000,000
m .
c. o Annual after-tax operating cash flow = €2,500,000

se
m
em la
Life = 2 years

las Unlevered cost of capital = 12%
a g
ag Spot rate = ` 90/€
Corporate tax rate (India) = 30%
Financing Options (50% Debt Required)

17

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

Option Borrowing Currency Interest Rate (p.a.)
A India (INR) 9%
B Euro (EUR) 5%
C USA (USD) 3%

Additional Data:
Spot USD/INR = ` 75
Spot EUR/USD = 1.20
Interest rate in USA = 3% p.a.
Interest rate in Europe = 5% p.a.
Assume: Interest Rate Parity (IRP) holds and No transaction cost
Required:
(i) Identify which option is the cheapest and why?
(ii) Compute Adjusted Present Value (APV) under cheapest option.
Present Value Factor: 1st Year 2nd Year
12% 0.893 0.797
5% 0.952 0.907

(6 Marks)
(b) A mutual fund offers two plans: Dividend Plan and Bonus Plan. An investor
invests ` 12,00,000 on 1 April, 2025 in the ratio 60:40 respectively. Initial
NAV of both plans is ` 48.
Entry load is 2% and exit load is 1% (on redemption value).
Under the Dividend Plan, a dividend of ` 5 per unit is declared on
30 September, 2025 when NAV is ` 56. After declaration, NAV becomes ` 51.
The dividend is reinvested at ` 51. Closing NAV on 31 March, 2026 is ` 54.
Under the Bonus Plan, a bonus issue of 1:4 is declared on 30 September, 2025
when NAV is ` 60. After bonus adjustment, NAV becomes ` 45, Closing NAV
on 31 March, 2026 is ` 52.
Ignore taxation.

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SUGGESTED ANSWERS ADVANCED FINANCIAL MANAGEMENT

You are required to:
Evaluate the total return and Holding Period Return under each plan after
m
c. o
considering loads and assess which plan provides higher effective return.

o m m
c
(4 Marks)
(c) "Transfer. of NPAs through securitization improves balance sheet health but e
mayem involve regulatory and valuation challenges." Comment on the la
s
l a s (4 Marks)ag
g statement
aAnswer
above.

(a) (i) Working Notes:
Applicable Forward Rates as per IRP

USD/INR EUR/USD EUR/INR
Spot INR 75 USD 1.20 INR 75 x USD 1.20

m
= INR 90

c. o
(1.09) (1.03)
Year 1 INR 75 x (1.03) USD 1.20 x (1.05) INR 79.37 x USD 1.177

em= USD 1.177
Forward Rate
s
= INR 79.37 = INR 93.42
Year 2
g
(1.09)
l a 2
(1.03) 2

a
INR 75 x 2 USD 1.20 x INR 83.99 x USD 1.155
Forward Rate (1.03) (1.05)2
= INR 83.99 = USD 1.155 = INR 97.01

Step 1: Compare borrowing options:
Option A: Borrow in INR @ 9% pre-tax so post tax effective rate = 9 x 0.7
= 6.3%
Option B: Borrow in EUR @ 5% pre-tax so post tax effective rate = 5 x 0.7

m
= 3.5%

m c. o
Option C: Borrow in USD @ 3%. Here we need to apply IRP between EUR

c. o and USD.
em
So, as per IRP: F = 1.20 x 1.03/1.05 =1.177, i.e. EURsis expected to
s em g la
gla depreciate.
a
a If you borrow in USD, effective EUR Cost = 1.03 x 1.05/1.03 = 1.05 = 5%
Post Tax USD effective rate becomes 3.5% which is equal to EUR rate.

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

Lower interest currency appreciates and wipes out or neutralizes interest
advantage in USA, so there is no real advantage if borrowed from USA.
Therefore, Option B Borrow in EUR is the best option.
Step 2: Compute unlevered NPV
Initial Investment in INR = 4 million x 90 = ` 360 million
Discount rate = Unlevered cost of capital = 12%
Year 1 = EUR 2.50 Million x 93.42 x 0.893 = ` 208.5601 million
Year 2 = EUR 2.50 Million x 97.01 x 0.797 = ` 193.2924 million
Total PV = ` 401.8525 million
Unlevered NPV = ` 401.8525 million – ` 360 million = ` 41.8525 Million
Step 3: Computation of PV of Tax Shield on Interest
PV of Tax Shield for 2 years discounted @ before tax cost of debt i.e.
@ 5%:
= (30,000 x 0.952 x 93.42) + (30,000 x 0.907 x 97.01) = ` 5.3077 million
Final APV:
= ` 41.8525 million + ` 5.3077 million = ` 47.1602 million.
Alternative Answer
(i) Working Note:
Applicable Forward Rates as per IRP

USD/ INR EUR/ USD EUR/ INR
Spot INR 75 USD 1.20 INR 75 x USD 1.20
= INR 90
Year 1 INR 75 x (1.09) USD 1.20 x
(1.03)
INR 79.37 x USD 1.177
Forward (1.03) (1.05)
= INR 79.37 = USD 1.177 = INR 93.42
Rate
Year 2 (1.09)2 (1.03)2
INR 75 x USD 1.20 x INR 83.99 x USD 1.155
Forward (1.03)2 (1.05)2
= INR 83.99 = USD 1.155 = INR 97.01
Rate

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SUGGESTED ANSWERS ADVANCED FINANCIAL MANAGEMENT

Option A (Borrowing in INR)

Initial Investment EUR 40,00,000 x INR 90 INR 36,00,00,000
m
m
Debt Required INR 18,00,00,000
c. o
.co
Interest Cost for 2 INR 18,00,00,000 x 9% x 2 (A) INR 3,24,00,000
s em
m
e Repayment of
Years
l a
a s
l Debt (B)
INR 18,00,00,000
ag
ag
Total Outflow INR 21,24,00,000

Option B (Borrowing in EUR)

Initial Investment EUR 40,00,000 x INR 90 INR 36,00,00,000
Debt Required EUR 20,00,000
Interest Cost for Year 1 EUR 20,00,000 x 5% EUR 1,00,000

m
&2

.
Applicable Forward Rate for Year 1
co INR 93.42

e m
s
Interest Payment for Year 1 (A) INR 93,42,000
Applicable Forward Rateafor Year 2
l
agYear 2 (B)
INR 97.01
Interest Payment for INR 97,01,000
Repayment of Debt EUR 20,00,000
Applicable Forward Rate for Year 2 INR 97.01
Repayment of Debt in INR (C) INR 19,40,20,000
Total Outflow in INR INR 21,30,63,000

Option C (Borrowing in USD)

o m
m
Initial Investment EUR 40,00,000 x INR 90
.c
INR 36,00,00,000

c. o Debt Required
m
e USD 1.20
EUR 20,00,000
s
s em Spot Rate of EUR/ USD
g USD 24,00,000 la
gla a
a Interest Cost for Year 1 & 2 USD 24,00,000 x 3% USD 72,000
Applicable Forward Rate for Year 1 INR 79.37
Interest Payment for Year 1 INR 57,14,640

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

Applicable Forward Rate for Year 2 INR 83.99
Interest Payment for Year 2 INR 60,47,280
Repayment of Debt USD 24,00,000
Applicable Forward Rate for Year 2 INR 83.99
Repayment of Debt in INR (C) INR 20,15,76,000
Total Outflow in INR 21,33,37,920

Since cash outflow is least in case of borrowing in INR same option
should be opted for.
(ii) Computation of Adjusted Present Value under the cheapest option
First, we shall compute the base NPV of the Project as follows:

Year Cash Flow Applicable Amount in PVF PV
EUR Rate INR

0 -40,00,000 90 -36,00,00,000 1 -36,00,00,000

1 25,00,000 93.42 23,35,50,000 0.893 20,85,60,150

2 25,00,000 97.01 24,25,25,000 0.797 19,32,92,425

NPV 4,18,52,575

Now we shall calculate PV of side effect of Financing in INR.

Year Interest Tax Shield PVF @9% PV in INR

1 1,62,00,000 48,60,000 0.917 44,56,620

2 1,62,00,000 48,60,000 0.842 40,92,120

85,48,740

Thus, the Adjusted Present Value of the Project Using the Forward Rate
base NPV:
= Base NPV + PV of Tax Shield of Financing
= INR 41,852,575 + INR 85,48,740 = INR 5,04,01,315

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SUGGESTED ANSWERS ADVANCED FINANCIAL MANAGEMENT

(b) Dividend Plan

Particulars Amount in `
m
m
Investment amount ` 12,00,000 X 0.60 (A) 7,20,000.00
c. o
.co
NAV per Unit on 1 April 2025 48.00
s em
em l a
a s
Entry Load 2%
l Applicable NAV
0.96
ag
ag No. of Units acquired
48.96
14,705.88
Dividend declared on 30 Sep 2025 per unit 5.00
Total Dividend received 73,529.40
NAV per unit on 30 September 2025 (post Dividend) 51.00
New Units acquired 1,441.75

om
Revised Holding 16,147.63

. c
m
NAV per unit on 31 March 2026 54.00
NAV post Exit Load `54 x 0.99 e
s
la(B)
53.46

a g
Amount realized on maturity 8,63,252.30
Amount of Gain (B) – (A) = (C) 1,43,252.30
Effective Return (C) / (A)% 19.8962%

Bonus Plan

Particulars Amount in `

m
c. o
Investment amount ` 12,00,000 X 0.40 (A) 4,80,000.00

m
c. o m
NAV per Unit on 1 April 2025 48.00

em
Entry Load 2%
se 0.96
la 48.96
las Applicable NAV
a g
ag No. of Units acquired 9,803.92
Bonus Units declared for every 4 units on 30 1.00
September 2025

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

Total Bonus Units received 2,450.98
Revised Holding 12,254.90
NAV per unit on 31 March 2026 52.00
NAV post Exit Load `52 x 0.99 51.48
Amount realized on maturity (B) 6,30,882.35
Amount of Gain (B) – (A) = (C) 1,50,882.35
Effective Return (C) / (A)% 31.4338%

Thus, Bonus Plan provides higher effective return.
Alternative Answer
Dividend Plan
Investment in dividend plan ` 12,00,000 x 0.60 = ` 7,20,000 and Bonus plan
= ` 4,80,000
Number of Units allotted (dividend plan) =` 7,20,000 - ` 14,400 (entry
load)/ 48 = 14,700 units
Dividend reinvested amount = 14,700 x 5 = ` 73,500
No of units purchased = ` 73500 /` 51 = 1441.18, total holding 14700 +
1441.18 = 16141.18 units
Redemption value = 16141.18 x ` 54 = ` 8,71,623.72 - ` 8,716.24
= ` 8,62,907.48 (exit load 1% of ` 871623)
Total wealth = ` 8,62, 907
Gain = ` 8,62,907 – ` 7,20,000 = ` 1,42,907 and holding period return
= ` 1,42,907/ ` 7,20,000 = 19.85%
Bonus Plan
Number of Units allotted (bonus plan) = ` 4,80,000 - ` 9,600 (entry load)/
` 48 = 9,800 units
Bonus = 9800/4 = 2450 units total units 9800 + 2450 = 12250 units
Gross redemption value at closing price 12250 x ` 52 = ` 6,37,000
After exit load = ` 6,37,000 – ` 6,370 = ` 6,30,630
Total gain = ` 6,30,630 – ` 4,80,000 = ` 1,50,630

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Holding period return = ` 1,50,630/ ` 4,80,000 = 31.38%
The Bonus Plan gives higher effective return (31.38%) compared to the
m
c. o
Dividend Plan (19.85%).

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(c) Transfer of NPAs through securitization allows banks to transfer stressed

m .
assets to SPVs or ARCs under the framework of the SARFAESI Act.
s e
s e l a
a ag
Benefits of Transfer of NPAs through securitization:

g l● By removing NPAs from their books, banks can:
a o Reduce Gross NPAs
o Improve Asset Quality Ratios
o Enhance Capital Adequacy
o Release provisions tied up against bad loans
o Improve Investor Confidence

o m
Enable Banks to focus on fresh lending
c
o

RBI guidelines provide structured.mechanisms for securitization through:
Risk Retention Norms se
m
●

la
o

o
a g
Valuation Standards
o Disclosure Requirements
o Transparency and Market Discipline
Challenges involved in securitization:
1. Valuation Issues
o Determining fair value of stressed assets is difficult due to uncertain
m
co
recovery prospects.

m .
c. o m
Overvaluation may shift losses to investors.

se
o

em la
Undervaluation may cause losses to banks.
s
o

la 2. Regulatory Compliance
a g
ag o Strict norms relating to:
▪ Minimum holding period
▪ Risk retention
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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

▪ Provisioning
▪ Disclosure requirements
o These increase procedural complexity.
3. Moral Hazard Risk
o Banks may originate lower-quality loans if they expect to transfer risk
through securitization.
4. Market Appetite
o Successful securitization depends on:
▪ Investor confidence
▪ Demand for security receipts
Conclusion
● Securitization is a powerful tool for NPA management, but it requires:
o Regulatory prudence
o Robust valuation mechanisms
o Long-term financial stability safeguards
Question 4
(a) A portfolio manager is analysing four equity securities to construct an
optimal risky portfolio using Sharpe's Single Index Model. The securities are
traded in an efficient market and follow CAPM assumptions.
The following information is available:

Security Expected Return E (Ri) Beta (βi) Residual Variance
(σei2)
A 17% 1.4 0.0225
B 15% 1.1 0.0196
C 13% 0.9 0.0144
D 11% 0.6 0.01

Additional information:
Risk-free rate (Rf) = 6%

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SUGGESTED ANSWERS ADVANCED FINANCIAL MANAGEMENT

Market expected return E(Rm) = 14%
Market variance (σm²) = 0.040
m
c. o
Cut-Off Rate (C*) = 7.95

o m m
.c
You are required to:
s e
(i) Givenm
eportfolio.
the cut-off rate, identify the securities to be included in the optimal
l a
s
l(ii)a Compute the proportion of investment in each selected security. a g
g
a (iii) Using CAPM, compute the expected return and valued of each selected
security.
(iv) Why the portfolio constructed using Sharpe's Model is consistent with
CAPM assumptions? (6 Marks)
(b) Consider the recent performance of the closed ended fund.

m
Period NAV (`) Premium/ Discount %
0 20 0
. c o
-5m
1 22.5
s e
l a
ag
2 19.5 2.3
3 21 -3.2
4 22.3 4

Required:
(i) Evaluate the average return per period (based on Geometric mean) for
an investor who bought 1000 units* of the closed fund at the invitation
and then sold her position at the end of the period 4.

o m
(ii) Geometric growth rate in NAV over the same period and interpret the
c
m * In the question paper, ‘units’ was mistakenly referred to as ‘shares’.
.
c. o
results. (4 Marks)

em
em l s
a (4 Marks)
las (c) Explain the Elliot Wave Theory of Technical Analysis.
a g
ag OR
(c) ABC Ltd. has a ` 100 Crores floating-rate loan, reset annually for 4 years.
It enters into a collar strategy to hedge against interest rate risk.

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

Cap Rate = 9.5%
Expected Interest rates & Discounting Factors:
Year Expected Rate Discounting Factor
1 7.8 0.96
2 8.6 0.92
3 9.2 0.88
4 10.6 0.84

You are required to identify a Floor Rate that makes the collar a zero cost
collar. (Ignore Volatility) (4 Marks)
Answer
(a) (i) Securities whose excess-return to risk ratio is above the cut-off ration
of 7.95 are selected and all whose ratios are below are rejected.
Security Calculation Ratio C* = Cut Decision Rule
[E(ri )-Rf ]/βi off Rate
A (17 – 6) / 1.40 7.86 7.95 Ratio below C*, Rejected
B (15 – 6) / 1.10 8.18 7.95 Ratio above C*, Selected
C (13 – 6) / 0.90 7.77 7.95 Ratio below C*, Rejected
D (11 – 6) / 0.60 8.33 7.95 Ratio above C*, Selected

Select Security D & B in the optimal portfolio and reject Security A &
C from the optimal portfolio selection.
(ii) Calculation of percentage to be invested in each security:
Using the formula:

Zi values for Security D = 0.60 / 0.0100 x (8.33 – 7.95) = 60 x 0.38 = 22.80
Zi values for Security B = 1.10 / 0.0196 x (8.18 – 7.95) = 56.12 x 0.23 = 12.91
Weight of D in the Portfolio = 22.80 / (22.80 + 12.91) = 22.80 / 35.71 x 100
= 63.8%

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Weight of B in the Portfolio = 12.91 / (22.80 + 12.91) = 12.91 / 35.71 x 100
= 36.2%

m
c. o
(iii) CAPM expected return and Valuation:
m Return as per CAPM
.co
Security Expected Status

s em
em Return
l a
l a s B 6% + 1.1 x 8% 15% Undervalued (Buy)
ag
ag
= 14.80%
D 6% + 0.6 x 8% 11% Undervalued (Buy)
= 10.80%

(iv) The portfolio constructed using Sharpe’s Single Index Model is fully
consistent with CAPM, as it included only securities offering superior
risk-adjusted returns.
(b) (i) Market price after premium/ discount

o m (1 Net
Premium/ Market Price
c
Period NAV (`) P/D%
. Discount
- rate) = NAV X Net
0 em
0 20
s
la-5
0 0 0.0000
1
2
22.5
g
19.5 a 2.3
-0.05
0.023
0.95
1.023
21.3750
19.9485
3 21 -3.2 -0.032 0.968 20.3280
4 22.3 4 0.04 1.04 23.1920

Gain = Sales price 4th year – Investment, ` 23,192 – ` 20,000 = ` 3,192
Total Return for holding period = (3192/20000) x 100 = 15.96%

m
Average return per period = 15.96/4 = 3.99%

m .co
c. o
1
Geometric return per period = (1 + 0.1596)4 - 1 = 1.03771 – 1 =
m
se
0.037714 or 3.771%

s em Or
g la
gla 1
a
a
 23.1920  4
Geometric return per period =   - 1 = 1.03771 – 1 =
 20 
0.037713 i.e 3.771%

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

(ii) GM growth of NAV
Growth rate in NAV = (22.30 -20) / 20 X 100 = 11.50%
GM growth in NAV = (1 + 0.115) ¼ - 1 = 1.027587 – 1 = 0.027587 or
2.76%
Or
1
 22.30  4
Geometric Growth in NAV =   - 1 = 1.027587 – 1 = 0.027587
 20 
or 2.76%
Growth rate in NAV is lower than return percent Investment return >
NAV growth, the market price has increased more than the NAV.
(c) Inspired by the Dow Theory and by observations found throughout nature,
Ralph Elliot formulated Elliot Wave Theory in 1934. This theory was based
on analysis of 75 years stock price movements and charts. From his studies,
he defined price movements in terms of waves. Accordingly, this theory was
named Elliot Wave Theory. Elliot found that the markets exhibited certain
repeated patterns or waves. As per this theory wave is a movement of the
market price from one change in the direction to the next change in the
same direction. These waves are resulted from buying and selling impulses
emerging from the demand and supply pressures on the market.
Depending on the demand and supply pressures, waves are generated in
the prices.
As per this theory, waves can be classified into two parts:-
• Impulsive patterns
• Corrective patters
Let us discuss each of these patterns.
(1) Impulsive Patterns-(Basic Waves) - In this pattern there will be 3 or 5
waves in a given direction (going upward or downward). These waves
shall move in the direction of the basic movement. This movement can
indicate bull phase or bear phase.
(2) Corrective Patterns- (Reaction Waves) - These 3 waves are against the
basic direction of the basic movement. Correction involves correcting
the earlier rise in case of bull market and fall in case of bear market.

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One complete cycle consists of waves made up of two distinct phases,
bullish and bearish. On completion of full one cycle i.e. termination of
8 waves movement, the fresh cycle starts with similar impulses arising
m
m
out of market trading.
c. o
(c) OR c. o s e m
A zerom a
s e cost collar results when the premium earned by selling a floor exactly
g l
g a
lFor
offsets the cap premium.
a
a a zero-cost collar, Value of Cap = Value of Floor.
Since volatility is ignored, intrinsic value method is used.
Calculation of Cap payoff:
Cap pay only when expected rate is > 9.5%
Cap payoff in Year 4 = 100 x (10.6% - 9.5%) = 100 x 1.1% ` 1.10 crore
Total value of Cap = Present value of Cap payoff: PV1.10 x 0.84 = ` 0.924

m
c. o
crore

<m
Calculation of Floor payoff:
Floor pays when: Expected Rate e
a s Floor rate
l apply in Year 1, Year 2 and Year 3
ag
From expected rates, floor will
Floor payoff = Notional Value of loan x (F-R)
Present Value of Floor payoffs =
Year 1: PV1 =100 (F - 7.8%) × 0.96
Year 2: PV2 =100 (F - 8.6%) × 0.92
Year 3: PV3 =100 (F - 9.2%) × 0.88

m
Total Floor value (PV) = 100[(F - 7.8%) x 0.96 + (F - 8.6%) x 0.92 + (F - 9.2%)

m
x 0.88]
.c o
c. o Applying the zero-cost condition, Cap Value = Floor Value m
s e x0.88]
s em g l a
0.924 = 100(F-7.8) %) x 0.96 + (F - 8.6) %) x 0.92 + (F - 9.2) %)

gla a - 8.096)]
0.924 = 100 [(0.96F - 7.488) + (0.92F - 7.912) + (0.88F
a 0.924 = 100 [2.76F - 23.496)]
0.00924 = 2.76F - 23.496

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

F = 23.50524/2.76 = 8.516% or say 8.5%
Floor rate for zero-cost collar ≈ 8.5% (approx.) or 8.85%*
* If % sign is considered along with variables of right-hand side of equation.
Question 5
(a) A "momentum-driven" investment consultant is pitching Lumina Cloud
Systems (LCS) to your client. The consultant claims LCS is a bargain because
its Cash Flow from Operations (CFO), when capitalized at the prime lending
rate of 9%, yields a value of ` 425 per share. LCS currently trades at ` 240
per share.
You are required to perform a Two-Stage FCFE Valuation to verify these
claims.
Financial Data & Assumptions:
• Net Income (Base Year): ` 180 Crores.
• High-Growth Stage (Years 1-2): Net Income will grow by 25% annually.
• Net Investment in Operating Assets: This is projected to be ` 240 Crores
in Year 1 and ` 280 Crores in Year 2. (Note: This represents capital
expenditure less depreciation plus the increase in working capital).
• Debt Policy: The Company finances 30% of its net investment in
operating assets through new debt.
• Cost of Equity: The risk-free rate is 6%, the company's Beta is 1.20 and
the Equity Risk Premium (ERP) is 5%.
• Stable Stage (Year 3 onwards): Net investment in operating assets will
drop to 20% of Net Income each year.
• Outstanding Shares: 60 Crores.
Present Value Factor: 1st Year 2nd Year 3rd Year
12% 0.893 0.797 0.7118
Requirements:
(i) Calculate the total Present Value of the FCFE for the high-growth period
(Stage 1).

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(ii) If the current market price of ` 240.00 is considered "fair" by the market,
calculate the implied sustainable growth rate for the terminal stage
(Year 3 onwards). (5 Marks)
m
m c. o
c. o
(b) Zenith Commercial Bank's ALCO is evaluating the re-pricing risk for the

em
s
0-90 days' time bucket. The following quarterly data is available:

s em Data: l a
ag
Financial

g l•a Rate Sensitive Assets (RSAs): ` 12,500 Crores
a • Rate Sensitive Liabilities (RSLs): ` 15,800 Crores
• Quarterly Net Interest Income (NII): ` 450 Crores
Risk Policy:
The bank's Earnings at Risk (EaR) limit is 8% of quarterly NII. Hedging is
mandatory if the potential NII impact in any scenario exceeds this threshold.
You are required to:
m
(i)
. co
Identify the Gap Position (Positive/Negative) and determine which of the

em
following scenarios is favourable for the bank's NII, providing a brief
justification:
l a s
•
a g
Scenario A: Repo rate increase of 50 bps.
• Scenario B: Repo rate decrease of 25 bps.
(ii) Calculate the Earnings at Risk (EaR) in ` Crores and as a percentage of
NII for both scenarios. Based on the bank's risk policy, advice whether
management should activate hedging strategies or not. (7 Marks)
(c) Briefly justify why transaction exposure is generally considered more critical
than translation exposure from a financial risk management perspective.

m
co
(2 Marks)

m Answer .
c. o (a) Working Notes: se
m
s em g la
l a (1) Computation of Cost of Equity (k )
a
ag
e

Using the CAPM formula
ke = 6% + 1.20% (5%) = 12%
(2) Calculation of FCFE for High-Growth Period (Stage 1)

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

Since 30% of net investment is debt-financed, the equity-funded
portion is 70%

Particulars (` in Crores) Year 1 Year 2 Year 3
onwards
Net Income 180 x 1.25 225 x 1.25 281.25
= 225 = 281.25
Less: Net Investment 240 x 0.70 280 X 0.70 281.25 x 0.20 x
(Equity portion 70%) = 168.00 = 196.00 0.70 = 39.375
FCFE 57.00 85.25 241.875
PV Factor at 12% 0.893 0.797
PV of FCFE 50.90 67.94
(i) Total PV of Stage 1 Cash Flows = ` 50.90 Crores + ` 67.94 Crores
= ` 118.84 Crores
(ii) Implied Sustainable Growth Rate (g):
To find the growth rate (g) implied by the market price of ` 240, we
solve for the Terminal Value (TV2)
● Total Market Capitalization: ` 240 per share x 60 crore shares
= ` 14,400 Crores
● PV of Terminal Value (at Year 0): ` 14,400 Crores – ` 118.84 Crores =
` 14,281.16 Crores
● Terminal Value at end of Year 2
= 14,281.16 x (1.12)2 = ` 17,914.29 Crores
● FCFE for Year 3 (FCFE_3)
Gordon Growth Model: 17,914.29 = 241.875 x (1+g)/ (0.12 – g)
Solving for (g):
2,149.7148 - 17,914.29g = 241.875 + 241.875g
g = 0.1051 i.e. 10.51%
The market is pricing in an implied sustainable growth rate of 10.51%.
Alternative Presentation
(i) Cash flow from operation per share = ` 425 x 0.09 = ` 38.25

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SUGGESTED ANSWERS ADVANCED FINANCIAL MANAGEMENT

Since number of outstanding shares is 60 crore
Total Cash from Operation shall be ` 2295 Crore (` 38.25 x 60 crore)
m
c. o
ke = 6% + 1.20 x 5% = 12%
m
c. o ` Crore
s em
mParticulars
e Net Income l a
s
Year 1 Year 2

l a ag
ag
225.00 281.25
Net Investment through Equity 168.00 196.00
57.00 85.25
PVF@12% 0.893 0.797
PV 50.901 67.944
Total Present Value of FCFE for the High Growth Period is
` 118.845 Crore.

m
(ii) Now let g be the implied sustainable growth rate then FCFE in Year 3
o
and onward shall be:
. c
m
e– 39.375g
s
= 281.25 x (1+g) – [281.25(1+g) x 0.20 x 0.70]

l a
ag
= 281.25 + 281.25g – 39.375
= 241.875g + 241.875
If ` 240 is considered as Fair Value as Fair Value = ` 240 x 60 crore
= ` 14400 crore
Accordingly,
 241.875+241.875g 
118.845 +   x 0.797 = 14400
 0.12-g 

o m
m
On solving the equation g = 0.1050 i.e., 10.50%
.c
c. o (b) (i) Gap Position & Favorability em
m ● Gap Calculation: ` 12,500 crore – ` 15,800 crore a =s- ` 3,300 Crore
s e g l
l a (Negative Gap)
a
ag ● Un-Favorable Senario: Senario A (50 bps). In a negative (liability-
sensitive) gap, increase in rates causes liabilities to reprice upward
more than assets, leading to a decrease in Net Interest Income.

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

● Favorable Senario: Senario B (-25 bps). In a negative (liability-
sensitive) gap, a decrease in rates causes liabilities to reprice
downward more than assets, leading to an increase in Net Interest
Income.
(ii) EAR in two different scenarios
Scenario A:
EAR = (RSA – RSL) x Change in Interest Rate x (1/4)
= (` 12500 crore – ` 15800 crore) x 0.50% x (1/4)
EAR = - ` 4.125 crore
Or (` 12500 crore – ` 15800 crore) x 0.50% x (90/365) = - ` 4.0685 crore
EAR in %= -4.125/450=-0.9167% Or -4.0685/450=-0.90411%
Bank Ear = 8% x ` 450 Crore = ` 36 crore
Since EAR - 0.9167% Or - 0.90410% is less than EaR 8% limits no need
of hedging.
Scenario B:
EAR = (RSA – RSL) x Change in Interest Rate x (1/4)
= (` 12500 crore – ` 15800 crore) x (- 0.25%) x (1/4)
EAR = ` 2.0625 crore Or
= (` 12500 crore – ` 15800 crore) x (- 0.25%) x (90/365)
EAR = ` 2.0342 crore
EAR in % = 2.0625/450 = 0.4583% or 0.4521%
Since Value is positive no need of hedging.
(c) Transaction exposure is more critical than translation exposure because it
directly affects a firm's actual cash inflows and outflows. It arises from
contractual foreign currency transactions such as exports, imports, and
foreign currency borrowings. Exchange rate fluctuations between the
contract date and settlement date can result in real gains or losses, thereby
impacting profitability, liquidity, and working capital management. If left
un-hedged, in may even create financial distress.

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In contrast, translation exposure arises from the conversion of foreign
subsidiaries, financial statements into the parent company's reporting
currency. It is an accounting adjustment that does not involve immediate
m
m
cash flow movement. Therefore, from a risk management perspective, firms
o c. o
Question 6 .
c
give higher priority to managing transaction exposure.
e m
e m l a s
a s
lacquisition a g
g
(a) Arotech Industries Ltd. (A), a listed engineering major, are evaluating the

a laboratory. Financial parameters as of 31 March, 2025 are as follows:
of MedGen Labs Pvt. Ltd. (M), an unlisted pharmaceutical

Particulars Arotech MedGen Labs (M)
Industries
(A)
Profit After Tax (PAT) ` 6,000 crore ` 450 crore
No. of Equity Shares 500 crore 5 crore

o m
c.
P/E Ratio 30x 1.2 x Industry Avg

em ` 360.00
P/E

a s
Market Price / Standalone Fair Value To be determined

Additional Information: gl
1.
a
Combined Entity: Post-merger PAT is estimated at ` 6,850 crore
(including synergies). The expected P/E of the combined entity is 34x.
2. Synergy Value: The total synergy gain (increase in combined entity value
over the sum of standalone values) is capped at ` 34,000 crore.
3. Settlement Offers (Per 1 share of MedGen):
Offer 1 (Cash): ` 4,000 (Premium of 5.82% over the standalone fair
m
•

m
value of MedGen).
c o
• Offer 2 (Hybrid Equity): ` 1,000 Cash + Arotech shares (X) .(Premium
c. o s em
em laBonds of Arotech
of 21.69% over standalone fair value).

las a g
• Offer 3 (Hybrid Debt): ` 1,150 Cash + 5 Convertible

ag 4.
(Premium of 25.66% over standalone fair value).
Bond Terms (Arotech): Face Value ` 500, 4-year term, 10% discount rate.
Each bond converts into 2 Arotech shares or redeems at ` 680.24.

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

You are required to:
(i) Determine the annual post-merger synergies (PAT basis) and MedGen's
standalone P/E ratio.
(ii) Calculate the Industry Average P/E and MedGen's Standalone Fair Value
per share.
(iii) Solve for the number of Arotech shares (X) offered in Offer 2.
(iv) Rank all three offers from MedGen's perspective assuming Arotech's
share price has fallen to and remains at ` 330 at the time of
settlement/conversion. (7 Marks)
(b) The current price of F Ltd is ` 120 and a European option with an exercise
price of ` 115 will expire in 50 days. The annual continuously compounded
risk free rate of interest is 8%. The standard deviation of annual returns on
F Ltd. is 30%.
Value of (d₁) = 0.5375; Year =365 days and value of e-rt = 0.9891.
Using Black-Scholes Model, you are required to calculate:
(i) The Hedge Ratio
(ii) The probability that price in spot market on expiration would be higher
than the exercise price of the call option.
(iii) Value of call and put options.
Cumulative Area Table extract

0.00 0.01 0.02 0.030 0.04 0.05
0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736
0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422

(7 Marks)

Answer
(a) (i) Annual Synergies and MedGen P/E
● Annual Post-Merger Synergies (PAT basis):
Synergy PAT = Combined PAT - (PAT_ A+PAT_ M)

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Synergy PAT = ` 6,850 - (` 6,000 + ` 450) = ` 400 crore
● MedGen Standalone P/E Ratio:
m
m
Using the Synergy Value cap:
c. o
c. o Total Fair Value (M) = Combined Value – Value A - Synergy Value
s e m
s em `Total Fair Value (M) = (` 6,850 Crores × 34) - (` 500 Crores × ` 360) –
g l a
g la MedGen P/E = Total Fair Value/PAT_ M
34,000 Crore = ` 18,900 crore
a
a
= 18 ,900/450 = 42x
(ii) Industry Average P/E and Fair Value per share
● Industry Average P/E:
● Industry P/E = MedGen P/E/1.2 = 42/1.2 = 35
Standalone Fair Value (SFV) per share:
m
●

c o
.in Offer 2
SFV_M = 18, 900 cr (Total Value) / 5 cr shares = `3,780.00

e m
s
(iii) Number of Arotech Shares (X)

l a
ag× 1.2169(Premium) = ` 4,599.88 or ` 4,600.00
● Value of Offer 2 per share:
● Value = 3,780(SFV)
● Solving for X:
1,000(Cash)+ X * 360 (Price_ A) = 4,599.88 or 4,600
360X = 3, 600 or X = 10 shares
Or

m
Since ` 1,000 cash is not the part of ` 4,599.88 or ` 4,600 the number

m .co
of shares to be exchanged can also be computed as follows:

c. o 4599.88 or 4600
se
m
em
= 12.78 i.e. 13 shares
la
360

las a g
g
(iv) Ranking of Offers at ` 330 Price Drop

a ● Revised Valuation of Arotech Convertible Bond:
1. Redeemable Value of the bond : ` 680.24
2. Conversion Value: 2 shares x ` 330 = ` 660.00

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SUGGESTED ANSWERS FINAL EXAMINATION: MAY 2026

Higher of above = ` 680.24.
● Revised Offer Values (Per MedGen Share):

Offer Calculation at ` 330 Revised Value Rank
Offer 3 1,150 Cash + (5 x 680.24) ` 4,551.20 1
Offer 2 1,000 Cash +(10x330) ` 4,300.00 2
Offer 1 Fixed Cash ` 4,000.00 3

Note: Offer 3 is the most beneficial as the convertible bonds maintain
their value through conversion even at ` 330 and would still provide a
"debt floor" of ` 680.24 even if the price fell much further, unlike Offer
2 which has no downside protection.
Or (Based on 13 shares)
Revised Offer Values (Per MedGen Share):

Offer Calculation at ` 330 Revised Value Rank
Offer 2 1,000 Cash +(13 x 330) ` 5,290.00 1
Offer 3 1,150 Cash + (5 x 680.24) ` 4,551.20 2
Offer 1 Fixed Cash ` 4,000.00 3

(b) (i) Hedge Ratio i.e. N(d1)
Since d1 is given, we shall calculate N(d1) i.e. N (0.5375) and we shall use
Interpolation method as follows:

Cumulative Area under Normal Curve for N (0.54) 0.7054
Cumulative Area under Normal Curve for N (0.53) 0.7019
Cumulative Area under Normal Curve for N (0.01) 0.0035
Difference Variable 0.5375 – 0.53 0.0075

0.0035 0.002625
The additive value to 0.53 = × 0.0075
0.01
Cumulative Area under Normal Curve for N (0.5375) 0.7045

Thus, Hedge ratio shall be approximately 0.70 or 70%

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(ii) Probability that price in spot market on expiration would be higher
than exercise price of the Call is N(d2)

m
c. o
d2 = d1 - σ t
m
c. o
d2 = 0.5375 – 0.30 50/365
s em
dm a
se ag
l
= 0.4264

la N (0.4264) we shall use Interpolation method as follows:
2

ag
Cumulative Area under Normal Curve for N (0.43) 0.6664
Cumulative Area under Normal Curve for N (0.42) 0.6628
Cumulative Area under Normal Curve for N (0.01) 0.0036
Difference Variable 0.4264 – 0.42 0.0064

0.0036 0.002304
The additive value to 0.42 = × 0.0064
m
c. o
0.01

emin spot market on expiration would be
Cumulative Area under Normal Curve for N (0.4264) 0.6651

s
laof the call option shall be approximately 67%.
Thus, the probability that price

a g
higher than the exercise
(iii) Value of Call Option

= ` 120 x 0.7045 – ` 115 x 0.9891 x 0.6651
= ` 84.54 – ` 75.65
= ` 8.89
m
m
Value of Put Option
.co
c. o VP = - VS + VC + PV(E)
se
m
s em = -120 + 8.89 + 0.9891 x 115
g la
gla = ` 2.63 a
a

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