Tag: Financial and Investment Management

Financial and Investment Management

This set covers: Value & Returns, Capital Budgeting, Dividend Policy, Mergers & Acquisitions, Portfolio Management, Derivatives, Working Capital, and International Finance

---

🔹 Section A – Value & Returns (Time Value of Money, Bonds, Shares, Risk & Return)

1. The concept that “money today is worth more than the same sum tomorrow” is known as:
A. Risk premium
B. Time value of money
C. Inflation
D. Compounding
Answer: B
Explanation: Money has time value due to earning capacity and uncertainty of future.*

---

2. Future Value (FV) formula is:
A. $FV=PV\times (1+r{)}^n$
B. $FV=PV\mathrm{/}(1+r{)}^n$
C. $PV=FV+r$
D. $PV=FV-r$
Answer: A

---

3. Present Value (PV) decreases when:
A. Interest rate increases
B. Time period decreases
C. Discount rate decreases
D. Cash flow increases
Answer: A

---

4. For an ordinary annuity, payments are made:
A. At the beginning of each period
B. At the end of each period
C. Randomly
D. Twice per year
Answer: B

---

5. If coupon rate is higher than required return, bond sells at:
A. Par
B. Discount
C. Premium
D. Zero value
Answer: C

---

6. The value of a bond is equal to:
A. Present value of interest + present value of principal
B. Sum of profits
C. Book value
D. Face value only
Answer: A

---

7. In Gordon’s Model, share value increases if:
A. Growth rate increases
B. Dividend payout decreases
C. Required return increases
D. Retention ratio decreases
Answer: A

---

8. Risk is measured statistically by:
A. Mean
B. Standard deviation
C. Variance
D. Both B & C
Answer: D

---

9. Coefficient of variation measures:
A. Absolute risk
B. Relative risk
C. Expected return
D. Portfolio beta
Answer: B

---

10. If expected return = 10% and risk-free rate = 5%, risk premium = ?
A. 15%
B. 5%
C. 10%
D. 2%
Answer: B

---

🔹 Section B – Capital Budgeting

11. Capital budgeting is concerned with:
A. Long-term investment decisions
B. Short-term financing
C. Inventory management
D. Dividend policy
Answer: A

---

12. Payback period measures:
A. Liquidity of investment
B. Profitability
C. NPV
D. IRR
Answer: A

---

13. NPV method considers:
A. Time value of money
B. Accounting profits only
C. Depreciation
D. Book value
Answer: A

---

14. A project is acceptable if:
A. NPV > 0
B. NPV = 0
C. NPV < 0
D. None
Answer: A

---

15. Internal Rate of Return (IRR) is that rate at which:
A. NPV = 0
B. Profit = 0
C. Cost = Benefit
D. Cash inflow = Cash outflow
Answer: A

---

16. Profitability Index (PI) =
A. PV of inflows / PV of outflows
B. Outflows / Inflows
C. ROI / Investment
D. None
Answer: A

---

17. ARR stands for:
A. Accounting Rate of Return
B. Actual Rate of Return
C. Average Risk Return
D. Annual Real Return
Answer: A

---

18. Discounted cash flow methods include:
A. NPV and IRR
B. ARR
C. Payback period
D. None
Answer: A

---

19. Risk-adjusted discount rate method adjusts:
A. Discount rate for risk
B. Cash flows
C. Profit margin
D. Inflation rate
Answer: A

---

20. Sensitivity analysis studies:
A. Impact of changes in variables on NPV
B. Market fluctuations
C. Inflation
D. Fixed costs
Answer: A

---

🔹 Section C – Dividend Theories

21. Walter’s Model assumes:
A. Constant cost of capital
B. Variable cost of equity
C. No retained earnings
D. Market imperfections
Answer: A

---

22. According to Walter, if r > k, the firm should:
A. Pay no dividend
B. Pay maximum dividend
C. Pay 50% dividend
D. Ignore dividend
Answer: A
Explanation: When return exceeds cost of capital, reinvestment is better.*

---

23. Gordon’s Model is also called:
A. Bird-in-hand theory
B. Clientele theory
C. Residual theory
D. None
Answer: A

---

24. M–M Theory assumes:
A. Perfect capital market
B. Taxes exist
C. Transaction cost
D. Inflation
Answer: A

---

25. Dividend irrelevance theory is given by:
A. Walter
B. Gordon
C. M–M
D. Keynes
Answer: C

---

26. Retention ratio is denoted by:
A. b
B. r
C. k
D. g
Answer: A

---

27. Growth rate (g) =
A. Retention ratio × Return on equity
B. Dividend / EPS
C. EPS / Dividend
D. Profit / Sales
Answer: A

---

28. Walter’s model uses:
A. D, E, r, k
B. PV, FV, r
C. Rf, β
D. ROI, WACC
Answer: A

---

29. Under M–M, dividend policy affects:
A. Not the firm’s value
B. Firm’s value
C. Stock price positively
D. Negatively
Answer: A

---

30. Which model is most suitable for growth firms?
A. Walter’s
B. Gordon’s
C. M–M
D. None
Answer: A

---

🔹 Section D – Mergers, Acquisitions & Corporate Restructuring

31. A merger between firms in same industry is:
A. Horizontal merger
B. Vertical merger
C. Conglomerate merger
D. None
Answer: A

---

32. A merger between supplier and manufacturer is:
A. Vertical merger
B. Horizontal merger
C. Circular merger
D. Conglomerate merger
Answer: A

---

33. Value creation occurs when:
A. Combined value > Individual values
B. Combined value < Individual values
C. Combined value = Individual values
D. None
Answer: A

---

34. Synergy means:
A. 2 + 2 > 4
B. 2 + 2 = 4
C. 2 + 2 < 4
D. None
Answer: A

---

35. Leveraged buyout (LBO) is financed through:
A. Debt
B. Equity
C. Both
D. Retained earnings
Answer: A

---

36. Hostile takeover means:
A. Without consent of target management
B. Mutual consent
C. Legal merger
D. Reverse merger
Answer: A

---

37. Reverse merger means:
A. Smaller company takes over a larger one
B. Conglomerate merger
C. Partial acquisition
D. None
Answer: A

---

38. Spin-off refers to:
A. Creating a new company from parent
B. Selling shares
C. Buying back shares
D. None
Answer: A

---

39. Mergers achieve:
A. Economies of scale
B. Cost reduction
C. Market expansion
D. All of the above
Answer: D

---

40. Due diligence in mergers means:
A. Evaluation before merger
B. Legal compliance
C. Accounting audit
D. Investment decision
Answer: A

---

🔹 Section E – Portfolio Management (CAPM & APT)

41. Portfolio diversification reduces:
A. Unsystematic risk
B. Systematic risk
C. Inflation
D. Market volatility
Answer: A

---

42. Systematic risk is caused by:
A. Market factors
B. Company factors
C. Management decisions
D. Product defects
Answer: A

---

43. Beta (β) in CAPM measures:
A. Systematic risk
B. Unsystematic risk
C. Liquidity
D. Credit risk
Answer: A

---

44. CAPM formula is:
A. $E(R_i)=R_f+{\beta }_i[E(R_m)-R_f]$
B. $E(R_i)=R_m+R_f$
C. $R_i=R_f\times \beta$
D. None
Answer: A

---

45. If β = 1.5, Rf = 6%, Rm = 12%, then Expected Return = ?
A. 15%
B. 9%
C. 12%
D. 10%
Answer: A
(6 + 1.5 × (12 − 6) = 15)

---

46. If β < 1, the security is:
A. Defensive
B. Aggressive
C. Neutral
D. Risk-free
Answer: A

---

47. Arbitrage Pricing Theory (APT) was given by:
A. Stephen Ross
B. William Sharpe
C. Markowitz
D. Fisher Black
Answer: A

---

48. According to APT, returns are affected by:
A. Multiple macro factors
B. Single factor only
C. Micro factors
D. None
Answer: A

---

49. Diversification can:
A. Eliminate unsystematic risk
B. Eliminate systematic risk
C. Eliminate all risk
D. None
Answer: A

---

50. The efficient frontier is a concept of:
A. Modern Portfolio Theory
B. CAPM
C. Dividend theory
D. Risk-free asset
Answer: A

---

🔹 Section F – Derivatives

51. Derivatives derive value from:
A. Underlying assets
B. Real assets
C. Shares only
D. Bonds only
Answer: A

---

52. A forward contract is:
A. Customized OTC contract
B. Standardized exchange-traded
C. Option
D. None
Answer: A

---

53. Futures are traded:
A. On exchanges
B. Privately
C. Only by banks
D. None
Answer: A

---

54. A call option gives right to:
A. Buy an asset
B. Sell an asset
C. Hold an asset
D. None
Answer: A

---

55. A put option gives right to:
A. Sell
B. Buy
C. Exchange
D. Lend
Answer: A

---

56. Option premium means:
A. Price paid to buy the option
B. Strike price
C. Spot price
D. None
Answer: A

---

57. Payoff of call option =
A. Max(0, S – K)
B. Max(0, K – S)
C. S – K
D. None
Answer: A

---

58. Payoff of put option =
A. Max(0, K – S)
B. Max(0, S – K)
C. S × K
D. None
Answer: A

---

59. Black–Scholes model is used for:
A. Option pricing
B. Bond valuation
C. Cash management
D. Portfolio management
Answer: A

---

60. Swap is:
A. Exchange of cash flows
B. Exchange of shares
C. Loan contract
D. Equity deal
Answer: A

---

🔹 Section G – Working Capital Management

61. Working capital =
A. Current Assets − Current Liabilities
B. Fixed Assets − Long-term Liabilities
C. Total Assets − Total Liabilities
D. None
Answer: A

---

62. Objective of working capital management:
A. Maintain liquidity & profitability balance
B. Increase sales only
C. Minimize debt
D. None
Answer: A

---

63. EOQ =
A. $\sqrt{\frac{2AO}{C}}$
B. $2AO\mathrm{/}C$
C. $A+O+C$
D. None
Answer: A

---

64. Cash management ensures:
A. Availability of funds when needed
B. Profit maximization
C. Tax payment
D. None
Answer: A

---

65. Factoring means:
A. Selling receivables to a factor
B. Buying raw materials
C. Paying suppliers
D. Issuing shares
Answer: A

---

66. Permanent working capital means:
A. Minimum level required continuously
B. Seasonal requirement
C. Temporary loans
D. None
Answer: A

---

67. Working capital cycle starts from:
A. Purchase of raw materials
B. Sale of finished goods
C. Receipt of cash
D. Payment to creditors
Answer: A

---

68. Optimum working capital means:
A. No shortage or surplus
B. Maximum liquidity
C. Minimum debt
D. None
Answer: A

---

69. Inventory cost includes:
A. Ordering & carrying cost
B. Selling cost
C. Depreciation
D. Labour cost
Answer: A

---

70. Average collection period measures:
A. Receivable efficiency
B. Payables control
C. Cash turnover
D. None
Answer: A

---

🔹 Section H – International Financial Management

71. International finance deals with:
A. Cross-border financial decisions
B. Domestic accounting
C. Local banking
D. None
Answer: A

---

72. Foreign exchange market is a:
A. Global decentralized market
B. Local market
C. Regulated monopoly
D. None
Answer: A

---

73. Spot rate means:
A. Rate for immediate delivery
B. Future delivery rate
C. Average rate
D. None
Answer: A

---

74. Forward rate means:
A. Agreed rate for future transaction
B. Present rate
C. Exchange margin
D. None
Answer: A

---

75. Floating exchange rate is determined by:
A. Market forces
B. Central bank
C. IMF
D. Government
Answer: A

---

76. Fixed exchange rate is maintained by:
A. Government or central bank
B. Market
C. Investors
D. None
Answer: A

---

77. Transaction exposure arises from:
A. Contractual cash flows in foreign currency
B. Change in asset value
C. Inflation
D. None
Answer: A

---

78. Translation exposure affects:
A. Accounting statements
B. Real cash flows
C. Inflation
D. Tax
Answer: A

---

79. Economic exposure affects:
A. Long-term cash flows and competitiveness
B. Tax liability
C. Asset valuation only
D. None
Answer: A

---

80. Forward contracts are used to:
A. Hedge foreign exchange risk
B. Increase speculation
C. Control inflation
D. None
Answer: A

---

🔹 Section I – Advanced & Applied Concepts

81. Arbitrage means:
A. Risk-free profit from price difference
B. Long-term investment
C. Portfolio rebalancing
D. None
Answer: A

---

82. Currency swap involves:
A. Exchange of principal and interest in different currencies
B. Interest rate change
C. Option trading
D. None
Answer: A

---

83. Hedging aims to:
A. Minimize risk
B. Increase speculation
C. Maximize risk
D. None
Answer: A

---

84. Diversification is most effective when securities are:
A. Negatively correlated
B. Positively correlated
C. Independent
D. None
Answer: A

---

85. Beta = 0 means:
A. Risk-free security
B. Market portfolio
C. Aggressive stock
D. None
Answer: A

---

86. Interest coverage ratio =
A. EBIT / Interest
B. EBIT / Tax
C. EBIT / Sales
D. EBIT / Debt
Answer: A

---

87. High β (>1) indicates:
A. Greater volatility
B. Lower volatility
C. No risk
D. None
Answer: A

---

88. Sharpe ratio =
A. (Rp – Rf) / σ
B. (Rf – Rp) / σ
C. Rp × Rf
D. None
Answer: A

---

89. Portfolio risk is minimized when:
A. Correlation = −1
B. Correlation = +1
C. Correlation = 0
D. None
Answer: A

---

90. Risk-free asset has β =
A. 0
B. 1
C. >1
D. <0
Answer: A

Financial and Investment Management

This unit integrates financial decision-making, investment analysis, corporate restructuring, and international finance — one of the most important for both theory and numerical concepts in UGC NET.

---

🔹 1. Value and Returns

A. Time Preference for Money

Concept:
A rupee today is worth more than a rupee tomorrow because of its earning capacity.

Reasons:

1. Risk and uncertainty

2. Inflation

3. Consumption preference

4. Investment opportunities

Future Value (FV):

$$FV=PV(1+r{)}^n$$

Where,
PV = Present Value, r = Interest rate, n = Number of periods

Present Value (PV):

$$PV=\frac{FV}{(1+r{)}^n}$$

Annuity: Equal payments made at regular intervals.

• Ordinary Annuity: Payments at the end of period

• Annuity Due: Payments at the beginning of period

---

B. Valuation of Bonds

A bond is a long-term debt instrument.

Value of Bond:

$$V_B=\sum _{t=1}^n\frac{I}{(1+kd{)}^t}+\frac{P}{(1+kd{)}^n}$$

Where:
I = Interest (coupon), kd = required rate of return, P = Par value, n = years to maturity

If Coupon Rate > Required Return → Premium Bond
If Coupon Rate < Required Return → Discount Bond

---

C. Valuation of Shares

1. For Preference Shares:

$$V=\frac{D}{K}$$

(D = fixed dividend, K = required rate)

2. For Equity Shares (Dividend Growth Model):

$$P_0=\frac{D_1}{K_e-g}$$

Where D₁ = expected dividend next year, Ke = cost of equity, g = growth rate.

---

D. Risk and Return

Return (R):

$$R=\frac{(CurrentIncome+CapitalGain)}{InitialInvestment}$$

Risk:
Deviation of actual return from expected return.

Standard Deviation (σ):

$$\sigma =\sqrt{\sum (R_i-\bar{R}{)}^2{P}_i}$$

Coefficient of Variation (CV):

$$CV=\frac{\sigma }{\bar{R}}\times 100$$

→ Used to compare relative risk between investments.

---

🔹 2. Capital Budgeting

Nature of Investment:

Capital budgeting involves long-term investment decisions in fixed assets (projects, plants, equipment).

Objectives:

• Maximize shareholder wealth

• Ensure efficient use of capital

---

Evaluation Methods:

Decision Rules:
✅ Accept project if:

• NPV > 0

• IRR > cost of capital

• PI > 1

• Shorter payback (for liquidity)

---

Risk and Uncertainty in Capital Budgeting:

1. Risk-adjusted Discount Rate

2. Certainty Equivalent Approach

3. Sensitivity Analysis

4. Scenario Analysis

5. Simulation Analysis

---

🔹 3. Dividend Theories and Determination

A. Dividend Policy

Decides how much profit is distributed and how much retained.

Factors Affecting Dividend:

• Liquidity position

• Future growth needs

• Shareholder expectations

• Legal restrictions

---

B. Theories of Dividend

Walter’s Model Formula:

$$P=\frac{D+\frac{r}{k}(E-D)}{k}$$

Gordon’s Model:

$$P=\frac{E(1-b)}{k-bg}$$

where b = retention ratio, g = growth rate = br

---

🔹 4. Mergers, Acquisitions & Corporate Restructuring

A. Mergers and Acquisitions (M&A):

• Merger: Two companies combine to form one.

• Acquisition: One company purchases another.

Types:

1. Horizontal: Same industry (e.g., Vodafone–Idea)

2. Vertical: Supplier–buyer relationship

3. Conglomerate: Unrelated industries

---

B. Corporate Restructuring

Process of reorganizing ownership, capital, or structure to increase efficiency.

Objectives:

• Synergy

• Cost efficiency

• Tax benefits

• Diversification

---

C. Value Creation in M&A

Occurs if V(AB) > V(A) + V(B)
Reasons: economies of scale, market power, improved management.

---

D. Leveraged Buyout (LBO):

Acquisition financed largely through borrowed funds, where assets of the target are used as collateral.

---

E. Takeover:

When a firm acquires controlling interest in another.

• Friendly Takeover: Mutual consent

• Hostile Takeover: Without consent

---

🔹 5. Portfolio Management

A. Meaning:

Portfolio = combination of different investments to maximize return and minimize risk.

---

B. Risk Diversification:

Diversification reduces unsystematic (firm-specific) risk.

Total Risk = Systematic + Unsystematic

---

C. Capital Asset Pricing Model (CAPM):

$$E(R_i)=R_f+{\beta }_i[E(R_m)-R_f]$$

Where,
Rf = Risk-free rate,
β = Systematic risk,
Rm = Market return.

Interpretation:

• β = 1 → average market risk

• β > 1 → aggressive stock

• β < 1 → defensive stock

---

D. Arbitrage Pricing Theory (APT):

Proposed by Stephen Ross, APT assumes multiple factors affect returns (inflation, GDP, interest rate, etc.).

$$E(R)=R_f+b_1{F}_1+b_2{F}_2+\dots +b_n{F}_n$$

---

🔹 6. Derivatives

Derivatives: Financial instruments whose value depends on underlying assets like stocks, bonds, or commodities.

---

A. Types:

1. Forward Contracts: Customized agreements to buy/sell at future date.

2. Futures Contracts: Standardized exchange-traded forwards.

3. Options: Right (not obligation) to buy/sell asset at fixed price.

4. Swaps: Exchange of cash flows or interest rates.

---

B. Options Terminology:

• Call Option: Right to buy.

• Put Option: Right to sell.

• Strike Price: Agreed price.

• Premium: Option cost.

Payoff:

• Call Option Payoff = Max(0, S − K)

• Put Option Payoff = Max(0, K − S)

---

C. Option Pricing Models:

1. Binomial Model – Step-by-step valuation.

2. Black–Scholes Model – Continuous model for European options.

---

🔹 7. Working Capital Management

A. Concept:

Working Capital = Current Assets − Current Liabilities
→ Ensures liquidity and smooth operations.

---

B. Determinants of Working Capital:

1. Nature of business

2. Credit policy

3. Inventory level

4. Business cycle

5. Production policy

---

C. Components:

• Cash Management – maintaining optimum cash balance.

• Inventory Management – controlling stock levels (EOQ model).

• Receivables Management – credit control, collection period.

• Payables Management – managing supplier payments.

• Factoring: Selling receivables to a factor for immediate cash.

---

EOQ (Economic Order Quantity):

$$EOQ=\sqrt{\frac{2AO}{C}}$$

Where,
A = Annual demand,
O = Ordering cost,
C = Carrying cost per unit.

---

🔹 8. International Financial Management

A. Definition:

Deals with financial management in international operations, including foreign exchange, risk, and cross-border investment.

---

B. Foreign Exchange Market:

A global market where currencies are traded.

Functions:

• Currency conversion

• Hedging and speculation

• Financing international trade

---

C. Exchange Rate Systems:

1. Fixed Exchange Rate: Controlled by government.

2. Floating Exchange Rate: Determined by market forces.

3. Managed Float: Partial control by central bank.

---

D. Types of Foreign Exchange Risks:

1. Transaction Risk – due to exchange rate changes before settlement.

2. Translation Risk – affects accounting statements.

3. Economic Risk – affects long-term competitiveness.

---

E. Hedging Techniques:

• Forward contracts

• Futures

• Options

• Swaps