Unit 4 Business Finance PYQ’s 26th Nov 2021 Shift 1

The correct answer is – Lagging

Key Points

• Leads and lags in international business usually refer to the deliberate acceleration or delaying of payments due in a foreign currency in order to take advantage of an expected change in currency exchange rates.
• A strengthening of the currency being paid out would lead to a smaller payout for the entity in question, while a weakening of the currency would lead to increased costs the longer the payment was delayed.
• A corporation or government can control the schedule of payments received or made, within reasonable limits.
• When a payment to a foreign entity is involved, the organization may opt to pay earlier or later than scheduled.
• These changes would be made in anticipation of capturing the benefit from a change in currency exchange rates.

Additional Information

Netting- Netting includes offsetting the value of multiple positions or payments due to be exchanged between two or more parties. It can be used to determine which party is owed remuneration in a multiparty agreement. Netting is a general concept that has a number of more specific uses, including in the financial markets.

Risk Hedging- Hedging is a risk management strategy employed to offset losses in investments by taking an opposite position in a related asset. The reduction in risk provided by hedging also typically results in a reduction in potential profits. Hedging requires one to pay money for the protection it provides, known as the premium.

Hence, the correct answer is Lagging.

The correct answer is – Financial slack

Key Points

Financial Slack

• Businesses go through various conditions in their lifetime.
• There are times when companies earn high income which can be termed as profits or growth of revenues. On the other hand, some companies may go through a downturn in sales, profits, or revenues.
• In order to sail through such conditions, a company must have extra money. This extra money that can be used when the company is in trouble is known as the financial slack of the company.
• Financial slack is the untapped debt potential of a company. It may be availed from unused debt capacity, un-utilized lines of credit, excess liquid assets, and various other sources of cash.
• Slack is an important measure related to the debt capacity of a company. If a company uses all of its debt capacity, the amount of financial slack will be zero.
• In such conditions, the company will be unable to meet unexpected costs that may be necessary for the good health of the company.

Hence, Companies strive to stockpile internally generated cash. Such a cash reserve is called Financial slack.

Additional Information

Margin of Safety- Margin of safety is a principle of investing in which an investor only purchases securities when their market price is significantly below their intrinsic value.

Financial Float- In financial terms, the float is money within the banking system that is briefly counted twice due to time gaps in registering a deposit or withdrawal.

The correct answer is – 18 per cent

Key Points

Sustainable Growth Rate:

• The maximum rate of growth that a business or social enterprise may maintain without needing to raise more capital or take on more debt is known as the sustainable growth rate (SGR).
• It measures how quickly a business can expand using only internal revenue and without borrowing money from other sources.

Important Points

Sustainable Growth Rate = Return on Equity × (1 − Dividend Payout Ratio)

Sustainable Growth Rate = 30% × (1 − 40%)

Sustainable Growth Rate = 0.3 × (1 − 0.4)

Sustainable Growth Rate = 0.18 = 18%

The sustainable growth rate of the company that enjoys return on equity = 30 percent and a dividend payout ratio of 40 percent is 18%

The correct answer is – “Traders who make a living by ‘beating the market’ through trading”

Key Points

Roll’s Critique for markets to become efficient:

• Roll’s critique is an economic idea that suggests that it is impossible to create or observe a truly diversified market portfolio.
• This is an important idea because a truly diversified portfolio is one of the key variables of the capital asset pricing model (CAPM), which is a widely used tool among market analysts.
• According to Roll’s critique, a true “market portfolio” would include every investment in every market, including commodities, collectibles, and virtually anything with marketable value.
• Roll’s critique is a reminder of the fact that one can only diversify a portfolio so much, and that investors’ attempts to understand and know the market as a whole are just attempts.

Hence, According to Richard Roll, for making a market efficient Traders who make a living by ‘beating the market’ through trading becomes an essential pre condition.

The correct answers are – A, C and E only

Key Points

Cash flows:

The term cash flow refers to the net amount of cash and cash equivalents being transferred in and out of a company. Cash received represents inflows, while money spent represents outflows.

Important Points

Another contemporary form of capital planning that considers the time worth of money is the internal rate of return method.

• The terms “time adjusted rate of return,” “discounted rate of return,” “discounted cash flow,” “yield method,” and “trial and error yield method” are also used to describe it.
• The cut-off rate, which is a fixed or specified rate used in the net present value approach, is used to calculate the net present value of a project.
• However, the internal rate of return method uses a hit-and-miss approach to discount a project’s cash flows at a proper rate, resulting in a net present value that is equal to the investment’s amount.
• This method is known as the internal rate of return method since the discount rate is established internally.
• The rate of discount at which the present value of cash inflows and outflows are equal is known as the internal rate of return.

The correct answer is – B, C and E only

Key Points

MM-approach:

The Miller and Modigliani Hypothesis, often known as the MM Approach, contends that the investment policy, not the dividend policy, determines how much a company’s shares are worth.

Important Points

Assumptions of MM approach of Dividend Policy

• Perfect Capital Market
• Investors are rational.
• There is no transaction cost.
• Securities are infinitely divisible.
• No investor is large enough to influence market price of securities.
• There are no floatation costs.
• 100 % dividend payout ratio.

The correct answer is – A, D and E only

Key Points

Credit policy:

• In accounting, the term ‘credit policy’ comes into existence whenever an account for receiving the granted debts is established.

Important Points

Components of Credit Policy:

• Terms of Sales: The “Terms of Sale” are written and arranged in line with the terms under which the business sells its products in the market, whether for cash or on credit. Along with the cash discount and discount duration that are assessed in accordance with the transaction, it also contains the time frame for the products acquired on credit terms.
• Credit Analysis: The “credit analysis” identifies the elements that influence the choice of whether to approve or disapprove a transaction performed on credit terms to a certain customer. It comprises a thorough examination of a person who expresses a desire to buy goods on credit, including a breakdown of all of his financial resources.
• The Collection Policy: In the overall structure of “credit policy,” it is the final element that places emphasis on monitory receivables. It makes sure that consumers have paid any outstanding balances on their previous accounts.

The correct answer is – Both A and R are correct and R is the correct explanation of A

Key Points

The dividend discount model (DDM) is a quantitative technique for forecasting the price of a company’s stock based on the idea that, when discounted back to their present value, all of the company’s future dividend payments are worth the present price of the stock. It considers the dividend distribution criteria and the market expected returns in an effort to determine the fair value of a company regardless of the current market conditions. The stock is undervalued and is a candidate for a buy if the value determined by the DDM is greater than the current trading price of shares, and vice versa.

The correct answer is – A – lll, B – lV, C – ll, D – l

Key Points

Hedging – By purchasing a second investment that you anticipate will perform in the opposite way, you can use the investment strategy known as hedging to offset a potential loss on the first one.

Important Points

European option – An option contract that only allows for the day of expiration for right exercise is known as a European option.

Option premium – The current market value of an option contract is known as an option premium. Thus, it is the money that the seller (writer) of an option contract receives from the opposite side. Premiums for in-the-money options are made up of intrinsic and extrinsic value.

In-money option- A call option that is in the money allows the holder to purchase the securities for less than its current market value. If a put option is in-the-money, it allows the holder to sell the security for a higher price than it is currently trading for.

American option – An American Option is a form of options contract (Call or Put) that allows the option holder to exercise the option whenever they choose prior to the expiration date. It enables the option holder to profit from the security or stock whenever it is advantageous to do so.