Suggested answer November 2020 - Strategic financial management

New Course and Old course both answer

New Course

2c Peer-to-peer lending. In this process group of people come together and lend money to each other. Peer to peer to lending has been there for many years. Many small and ethnic business groups having similar faith or interest generally support each other in their start up endeavors. Crowdfunding. Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business initiative. Crowdfunding makes use of the easy accessibility of vast networks of people through social media and crowdfunding websites to bring investors and entrepreneurs together.

3c Bootstrap

4c a Side Pocketing in Mutual Funds leads to separation of risky assets from other investments and cash holdings. The purpose is to make sure that money invested in a mutual fund, which is linked to stressed assets, gets locked, until the fund recovers the money from the company or could avoid distress selling of illiquid securities. The modus operandi is simple. Whenever, the rating of a mutual fund decreases, the fund shifts the illiquid assets into a side pocket so that current shareholders can be benefitted from the liquid assets. Consequently, the Net Asset Value (NAV) of the fund will then reflect the actual value of the liquid assets. Side Pocketing is beneficial for those investors who wish to hold on to the units of the main funds for long term. Therefore, the process of Side Pocketing ensures that liquidity is not the problem even in the circumstances of frequent allotments and redemptions. Side Pocketing is quite common internationally. However, Side Pocketing has also been resorted to bereft the investors of genuine returns. In India recent fiasco in the Infrastructure Leasing and Financial Services (IL&FS) has led to many discussions on the concept of side pocketing as IL&FS and its subsidiaries have failed to fulfill its repayments obligations due to severe liquidity crisis. The Mutual Funds have given negative returns because they have completely written off their exposure to IL&FS instruments.

5c Detractors of technical analysis believe that it is an useless exercise; their arguments are as follows:

(a) Most technical analysts are not able to offer a convincing explanation for the tools employed by them.

(b) Empirical evidence in support of random walk hypothesis cast its shadow over the useful ness of technical analysis.

(c) By the time an up trend and down trend may have been signalled by technical analysis it may already have taken place.

(d) Ultimately technical analysis must be self defeating proposition. With more and more people employing it, the value of such analysis tends to decline.

6c Pass Through Certificates (PTCs)

As the title suggests originator (seller of the assets) transfers the entire receipt of cash in the form

of interest or principal repayment from the assets sold. Thus, these securities represent direct

claim of the investors on all the assets that has been securitized through SPV.

Since all cash flows are transferred the investors carry proportional beneficial interest in the asset

held in the trust by SPV.

It should be noted that since it is a direct route any prepayment of principal is also proportionately

distributed among the securities holders. Further, due to these characteristics on completion of

securitization by the final payment of assets, all the securities are terminated simultaneously.

Skewness of cash flows occurs in early stage if principals are repaid before the scheduled time.

Pay Through Security (PTS)

As mentioned earlier, since, in PTCs all cash flows are passed to the performance of the

securitized assets. To overcome this limitation and limitation to single mature there is another

structure i.e. PTS.

In contrast to PTC in PTS, SPV debt securities are backed by the assets and hence it can

restructure different tranches from varying maturities of receivables.

In other words, this structure permits desynchronization of servicing of securities issued from cash

flow generating from the asset. Further, this structure also permits the SPV to reinvest surplus

funds for short term as per their requirement.

Since, in Pass Through, all cash flow immediately in PTS in case of early retirement of receivables

plus cash can be used for short term yield. This structure also provides the freedom to issue

several debt tranches with varying maturities.

or

Economic Value Added (EVA) and Market Value Added (MVA)

Economic Value Added (EVA) is a holistic method of evaluating a company’s financial

performance, which means that EVA is used not only as a mere valuation technique, but also to

find the economic contribution of a company to the society at large. The core concept behind EVA

is that a company generates ‘value’ only if there is a creation of wealth in terms of returns in

excess of its cost of capital invested. So if a company's EVA is negative, it means the company is

not generating value from the funds invested into the business. Conversely, a positive EVA shows

a company is producing value from the funds invested in it.

Old Course

Direct from Practice manual question with figures change

1a Q 15 page 4.13 

1b Q 8 page 6.10 

1c Q 60 page 12.62 

1d Q 60 page 13.84 

2a Q 41 page 5.32 

2b Q 58 page 12.57 

3a Q 23 page 9.19 

3b New but from Chapter 2 

4a Q 14 page 8.12 

4b Q 18 page 3.29 

5a Q 13 page 7.11 

5b Q 52 page 5.41 

6a Q 30 page 13.33 

6b Q 14 page 10.10

7a The success of any business is measured in financial terms. Maximising value to the shareholders is the ultimate objective. For this to happen, at every stage of its operations including policymaking, the firm should be taking strategic steps with value-maximization objective. This is the basis of financial policy being linked to strategic management. The linkage can be clearly seen in respect of many business decisions. For example : 

(i) Manner of raising capital as source of finance and capital structure are the most important dimensions of strategic plan. 

(ii) Cut-off rate (opportunity cost of capital) for acceptance of investment decisions. 

(iii) Investment and fund allocation is another important dimension of interface of strategic management and financial policy. (iv) Foreign Exchange exposure and risk management. 

(v) Liquidity management 

(vi) A dividend policy decision deals with the extent of earnings to be distributed and a close interface is needed to frame the policy so that the policy should be beneficial for all.

(vii) Issue of bonus share is another dimension involving the strategic decision. Thus from above discussions it can be said that financial policy of a company cannot be worked out in isolation to other functional policies. It has a wider appeal and closer link with the overall organizational performance and direction of growth. 

7b The fundamental differences between an investment bank and a commercial bank can be outlined as follows: 

1. Investment Banks help their clients in raising capital by acting as an intermediary between the buyers and the sellers of securities (stocks or bonds) 

1. Commercial Banks are engaged in the business of accepting deposits from customers and lending money to individuals and corporate 

2. Investment Banks do not take deposits from customers 

2. Commercial banks can legally take deposits from customers. 

3. The Investment Banks do not own the securities and only act as an intermediary for smooth transaction of buying and selling securities. 

3. Commercial Banks own the loans granted to their customers. 

4. Investment Banks earn underwriting commission 

4. Commercial banks earn interest on loans granted to their customers. 

7c FCCBs are important source of raising funds from abroad. Their salient features are – 

1. FCCB is a bond denominated in a foreign currency issued by an Indian company which can be converted into shares of the Indian Company denominated in Indian Rupees. 

2. Prior permission of the Department of Economic Affairs, Government of India, Ministry of Finance is required for their issue 

3. There will be a domestic and a foreign custodian bank involved in the issue 

4. FCCB shall be issued subject to all applicable Laws relating to issue of capital by a company. 

5. Tax on FCCB shall be as per provisions of Indian Taxation Laws and Tax will be deducted at source. 

7d In interbank transactions, foreign exchange is transferred from one account to another account and from one centre to another centre. Therefore, the banks maintain three types of current accounts in order to facilitate quick transfer of funds in different currencies. These accounts are Nostro, Vostro and Loro accounts meaning “our”, “your” and “their”. A bank’s foreign currency account maintained by the bank in a foreign country and in the home currency of that country is known as Nostro Account or “our account with you”. For example, An Indian bank’s Swiss franc account with a bank in Switzerland. Vostro account is the local currency account maintained by a foreign bank/branch. It is also called “your account with us”. For example, Indian rupee account maintained by a bank in Switzerland with a bank in India. The Loro account is an account wherein a bank remits funds in foreign currency to another bank for credit to an account of a third bank. 

7e Synergy may be defined as follows: 

V (AB) greater than V (A) + V (B) 

In other words the combined value of two firms or companies shall be more than their individual value. Synergy is the increase in performance of the combined firm over what the two firms are already expected or required to accomplish as independent firms. This may be result of complimentary services economics of scale or both. A good example of complimentary activities can be that one company may have a good networking of branches and the other company may have efficient production system. Thus,the merged companies will be more efficient than individual companies.