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FIN ANC IA L MANA G E MEN T

TWO MARKS QUESTION AND ANSWERS

Chapter 1: Financial ManagementAn

overview

1. Define financial management.

Kenneth Midgley and Ronald Burns state "Financing is the

process of organizing the flow of funds so that a business can carry

out its objectives in the most efficient manner and meet its

obligations as they fall due."

2. Highlight the scope of financial management.

The Scope of financial management is dividend into two broadcategories: (a) Traditional Approach

(b) ModernApproach

3. Write a note on the traditional approach.

1. The approach equated finance function with raising and

administering of funds only. The limitation was that internal

decision-making was completely ignored.2. The focus was on financing problems of corporate enterprises(i.e.

Companies). Non corporate organizations lay outside itsscope.

3. The approach laid over emphasis on the problems of long

term financing. Hence day to day financial problems and

working capital management of a business did not receive anyattention.

4. Write a note on the modern approach.

The modern approach views the term 'Financial management' in a

broad sense and providesa conceptual and analytical frame work

for financial decision making. According to

it Finance function covers both

acquisitions of funds as well as their allocations. Thus the

Financial Management, in the modern sense of the term, can be

broken down in to

3 major decisions as functions of


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Finance.

1. The investmentDecision

2. The FinancingDecision

3. The Dividend PolicyDecision.

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5. What are the basic financial

decisions? (1) Investment decision

(2) Financingdecision

(3) Dividenddecision

6. What is meant by investment decision?

The investment decision relates to the selection of Assets in which

funds will be invested by a firm. The Assets which can be acquired

fall in to two broad categories.

(a) Long Term or Fixed Assets, which yield a return over a period of

time in future.(b) Short term or Current Assets which in the normal course of

business are convertible in to cash usually within a year.

7. Write a note on financing decision.

The financing decision of a firm relates to the choice of the

proportion of these sources to finance the investment requirements

8. What do you mean by dividend decision?

It is the decision relating to divide nd policy. Two alternatives are

available in dealing with the profits of the firm. They can be

distributed to the share holders in the form of dividends or they

can be retained in the business itself. The final decision will

depend upon the preference of the share holders and the

investment opportunities available within the firm.

9. What are the objectives of financialmanagement? (1) Profit Maximization

Approach

(2) Wealth MaximizationApproach

10. Write a note on profit maximisation approach.

According to this approach, actions that increase profits

should be undertaken and that decrease profits should beavoided. The Company should select those assets, projects, and

decisions which are profitable

and reject those which are


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not.

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11. Is profit maximisation an operationally feasible criterion? What

are its limitations?

No, profit maximisation is not an operationally feasible criterion

because of its following limitations:

(1)Ambiguity,

(2) Timing of benefitsand

(3) Quality ofbenefits.

12. Objective of a finan ce manager is to maximize the wealth ofthe owners

of the organisation comment.

Wealth maximization means maximizing the Net Present

Value (or wealth) of a course of action. A financial action which

has a positive Net Present Value creates wealth and therefore it is

desirable. The objective of wealth maximisation takes care of the

questions ofthe timing and risk of expected benefits.

13. Comment on the emerging role of the finance manager in India(1) To look after the cash and bank account (2) Investment

decisions (3) Tax and insurance (4) Credit and collection and (5)

investors relation.

14. What do you mean by agency problem?

Agency problem is the likelihood that managers may place

personal goals ahead of corporate goals.

15. How to reslove the agency problem?

The agency problem can be minimised byacts of

(1). MarketForces

(2). AgencyCosts.

Chapter 2: Time Value of Money

1. What is meant by time value of money?

Time Value of Money means that the value of money changes


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over a period of time. A rupee received today has more value

than a rupee

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receivable after a year. The time value of money can also be

referred to as time preference for money.

2. Why does money have value? Or General ly individuals show a

timepreference for money

. Give reasons forsuch preference. Or List outthe reasons for time value of money.

(a) Money can be employed productively to generate real returns;

(b) In an inflationary period, a rupee today has higher purchasing

power than a rupee in the future;

(c) Due to uncertainties in the future, current consumption is

preferred to future consumption.

3. List out the techniques or methods of adjusting the cash flows

for time value of money.

(1) Compounding

(2) Present Value or Discounting.

4. What do you mean by compounding?

Compounding is the process of finding the future values of cash

flows by applying the concept of compound interest. Compoundinterest is the interest that is received on the original amount

(Principal) as well as on any interest earned byt not withdrawn

during earlier periods.

5. What do you mean by future value of money?

It means determining the future value of a lump sum amount

invested at one point of time.

6. What is meant by an annuity?

An annuity is a stream of equal annual cash flows.

7. What is meant by present value of money?

Present value is the current value of a future amount to be

received. The present value of a rupee that will be received in the

future will be less than the value of a rupee in hand today. It is for

this reason theprocedure of finding Present values is commonly called discounting.

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8. Explain briefly the effective rate of interest.

If compounding is done more than once a year, the actual

annualised rate of interest would be higher than the nominal

interest rate and it is called as the Effective Interest Rate.

9. What is rule 72? Or Rules of thumb?

The length of period which an amount is going to take to double

at a certain given rate of interest is known as Rule of 72 or Rules

of thumb. Doubling period can be calculated by adopting the

rules of thumb.

Rule of 72: Doubling period = 72 / rate of

interest

Chapter 3: Valuation of Bonds and shares

1. What is meant by Valuation?

Valuation is the process that links risk and return to

determine the worth of an asset / security.

2. What is meant by valuation of security?

The value of a security is the present value of all future

cashflows (returns) associated with it over the specified

period. The expected returns are discounted, using the required

return commensurate with the risk of the asset as the appropriate

discount rate.

3. What are the features of

bond? (1) Face Value

(2) Interestrate

(3)Maturity

4. List out the categories of bonds.

Bonds withMaturity

Pure discountbonds

Perpetualbonds.


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5. What do you mean by bond with maturity?

The government and companies issue bonds that specify the

interest rate and the maturity period. The present value of a

bond is the discounted

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value of its cash flows; that is, the annual interest payme nts plus bonds

terminal or maturityvalue.

6. Write a note on Pure discount bond.

Pure discount bond do not carry an explicit rate of interest. It

provides for the payment of lump sum amount at a future date in

exchange for the current price of the bond. The difference

between the face value of the bond and its purchase price gives

the return or YTM to the investor. It is also called as deep-discount

bonds or Zero interest bonds or Zero coupon bonds. The market

interest rate is also called as market yield, is used as the discount

rate.7. Define Perpetual bond.

It is also called as consols. It has an indefinite life and therefore it

has no maturity period.

8. What is meant by Yield to Maturity (YTM)?

The yield to maturity (YTM) is the rate of return that investors

earn if they buy a bond at a specified price and hold it until

maturity. It assumes that the issuer of the bond makes all due

interest payments and repayment of principal as promised.

9. What is meant by amortisation of Principal?

It means repayment of principal every year rather atmaturity.

10. List out the categories of preference

shares. (i) Redeemable preference

shares

(ii) Irredeemable preferenceshares

1. DefineReturn.

Chapter 4: Risk and Return

Return is the actual income received plus any change in market

price of an asset / investment. Total return comprises of both

dividend and


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capital gain.

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2. Define risk.

Risk is the variability of actual return from the expected

return associated with a given asset.

3. How a risk associated with an asset is measured?

The risk associated with asingle asset is assessed from both

a behavioural and a quantitative /statistical point of view.

4. What are the various methods used under behavioural view tomeasure

risk?

(1) Sensitivity analysis and (2)

Probability5. Define Sensitivity analysis.

Sensitivity analysis takes into account a number of possible

returns estimates while evaluating an asset risk. In order to have

a sense of the variability among return estimates, a possible

approach is to estimate the worst, the expected and the best

return associated with the asset.

6. Define Probability.

Probability is the chance that a given outcome (return) willoccur.

7. What are the various methods used under statistical view to

measure risk?

(1) Standard deviation and (2) Coefficient ofvariation.

8. Define Standard deviation.

Standard deviation measures the dispersion around the expected

value. It represents the square root of the average squared

deviation of the individual returns from the expected returns. The

greater the standard deviation of returns, the greater the

variability of returns and the investment is considered risky.

9. Define Coefficient of variation.

Coefficient of variation is a measure of risk per unit of expected

return. It converts standard deviation of expected values into

relative values to


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enable comparision of risk associated with assets havingdifferent

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expected values. The larger the CV, the larger the relative risk of

the asset.

10. What is meant by Portfolio?

A Portfolio means a combination of two or more securities(assets).

11. Define Portfolio expected return.

The expected rate of return on a portfolio is the weighted average

of the expected rate of return on assets comprising the portfolio.

12. Define Portfolio risk.

Portfolio risk consists of the risk of individual securities plus

the covariance between securities.

13. Why the correlation between securities return in a portfolio isimportant?

The magnitude of the portfolio risk depends on the correlation

between the securities.

14. What is the significance of getting perfect negative correlation

between two securities?

When the correlation coefficient between asset returns is

negative, it is possible to combine them in a manner that will

eliminate all risk. The portfolio risk can be reduced to zero.

15. What are the two types of risk?

(1) Systematicrisk

(2) Unsystematic

risk

16. Define systematic risk.

Systematic risk arises on account of the economy wide

uncertainties and the tendency of individual securities to move

together with changes in the market. This risk cannot be

reduced through diversification os securities. E.g. Increase in

inflation rate, changes in interest rate etc.

17. Define unsystematic risk.

Unsystematic risk arises from the unique uncertainties of

individual securities. These uncertainties are diversifiable if a


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large numbers of

securities are combined to form well diversifiedportfolio.

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Chapter 5: Capital Budgeting

1. Define Capital budgeting.

Capital budgeting is a process of making decisions regarding

investments in fixed assets.2. Highlight the nature / features of capital

budgeting. (i) It involves huge capital

(ii) Long terminvestment

(iii) Involves forecasting of several years profit in advance to

judge the profitability of project.

3. What are the significance of capital budgeting?

(i) Indirect forecast ofsales

(ii) Comparative study of alternativeprojects

(iii) Timing of asset acqusition

(iv) Cashforecast

(v) Wealth maximisation ofshareholders

4. What are the various types of

projects? (i) Mutually exclusive

investments

(ii) Independent

investments

(iii) Contigentinvestments

5. What are mutually exclusive projects?

Mutually exclusive investments compete with each other. If one

investment is undertaken, other investments will have to be

excluded. Such investment proposals are known as mutually

exclusive projects.

6. What are independent investments?

Independent investments do not compete with each others.

Depending on the profitability and availability of funds, the


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company can undertake all investments.

7. What are contingent investments?

Contingent investments are dependent projects; the choice of

one investment necessitates undertaking one or more

other investments.

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8. List the phases of capital budgeting.

(1) Organisation of investment

(2) Screening the proposal

(3) Evaluation of projects

(4) Establishing priorities

(5) Final approval

(6) Evaluation.

9. What are the components / techniques of capital

budgeting? (1) Traditional method

(a) Pay back period

(b) Accounting Rate of Return

(2) Discounted Cash Flowmethod

(a) Net Present Value

(b) Profitability Index

(c) Internal Rate of Return

10. Write a note on discounted cash flow method.The meth od is also known as 'Time adjusted rate ofretur nmethod. The

method is based on the assumption that future rupee value

cannot be taken as equivalent to the rupee value in the present.

When we compare the returns or cash inflows with the amount

of investment or cash outflows, both must be stated on a present

value basis. The time value of money is to be given due

importance.

11. List out the merits of discounted cash flow method.

(1) The method takes into account the entire economic life of the

project investment and income.

(2) It gives due weightage to time factor offinancing

(3) It produces a measure which is precisely comparably among

projects, regardless of the character and time shape of

their receipts an

outlays.


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(4) This approach provides for uncertainty and risk by

recognizing the time factor. It measures the profitability of

capital expenditure by reducing the earnings to the present

value.

(5) It is the best method of evaluating project where the cashflows are

uneven.

12. List out the demerits of discounted cash flow method.

It is quite difficult to obtain estimates of cash flows

due to uncertainty.

It is also difficult to measure discount rate.

At times fails to indicate correct choice between mutually

exclusive projects.

13. What is Net Present Value? What are its merits?

This method takes into account time value of money. In this

method present value of cash flows is calculated for which

cash flows are discounted. The rate of interest is called cost of

capital and is equal to minimum rate of return which must

accrue from the project. Later, present value of cash out

flows is calculated in same manner and subtracted from

present value of cash inflows. This difference is called Net Present

value or NPV.

Merits

1) It takes into account time value of

money.

2) It considers cash inflows form project throughout itslife.

3) In this method variable discount rates can be used for the

projects with longer life period.

4) This method is more closely related to firm s objective of

maximising wealth of shareholders.

5) True measure ofprofitability.

14. What are the limitations of Net Present Value

method? (1) Difficult to use, calculate &


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understand.

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(2) To determine the required rate of return which is called

cost of capital is a difficult task.

(3) At times fails to indicate correct choice between mutually

exclusive projects.15. What is Profitability Index? What are its merits?

It is Benefit Cost ratio (B/C Ratio) or Profitability Index (P1). It is

the ratio of value of future cash benefits at required rate or

return to the initial cash outflow of the investment.

Merits

1. Considers all cash

flows.

2. This method considers all benefits during the life time of theproject.

This method takes into account the time value ofmoney.

3. Pl method is considered better to NPV in case when the initial

costs of projects are different for eg. The NPV of two project is

equal ie, Rs5000. The initial cost of project is Rs 40,000 and that of projectB Rs

20,000. Project should be selected on the basis of profitability

index, whereas under NPV method both the projects will be

considered equally profitable.

4. Generally consistent with the wealth maximisation

principle.16. What are the limitations of PI method?

1). It is difficult to understand and implement this method.

2). Requires estimates of the cash flows which is a tedious task.

3). At times fails to indicate correct choice between mutually

exclusive projects.

17. What is meant by Internal Rate of return? What are its merits?

Internal rate of return is the rate of interest or discount at which

the present value of expected cash flows is equal to the total

investment outlay.

Merits


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1. IRR attempts to find the maximum rate of interest at which

funds invested in the project could be repaid out of cash inflows

arising from that project.

2. It considers the time value ofmoney

3. It considers cash flows throught out the life of theproject

4. It is consistent with the objective of shareholders wealth

maximisation.

18. What are the limitations of IRR method?

(1) Calculation of IRR is quite tedious and it is difficult tounderstand

(2) It implies that profits can be reinvested at internal rate of

return, which is not logical

(3) It produces multiple rate of return which can be confusing

(4) It may fail to indicate a correct choice between mutually

exclusive projects undercertain situation.

19. What is meant by Pay back period? What are its merits?

Pay Back Period is the number of year requir ed for the original

investment to be

recouped. Merits

1. Easy to understand andcompute.

2. This method follows short terms view point, as a result,

the obsolescence are minimum.

3. Emphasis liquidility, therefore useful for the company whichfaces

the problem of liquidity. Such companies will invest their funds in

such projects in which investment can be recovered in minimum

time.

4. Suitable for those organisations which emphasise on

short-term investments rather than long terms development.

5. Uses cash flowinformation.

6. Easy and crude way to cope with


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risk.

20. What are the limitations of pay back period

method? (1) Ignores the time value of money.

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(2) Ignores the cash flows occurring after the pay back

period. (3) No objective way to determine the

standard payback.

(4) No relation with the wealth maximisationprinciple. (5) Not a measure of profitability.

21. What is meant by Accounting rate of return? What are itsadvantages?

This method is also called Accounting Rate of Return Method.

This method is based on accounting information rather than cash

flows. Advantages

(1) Easy to understand.

(2) Give more weightage to future receipts.

(3) Uses accounting data with which executives are familiar.

22. What the limitations of ARR

method? (1) Ignore the time

value of money.

(2) It uses accounting profits, not cash flow.

(3) No objective way to determine the minimum acceptable

rate of return.

(4) ARR method does not consider the size of investment for each

project.

23. Define Capital Rationing.

Capital rationing implies the choice of investment unde

financial constraints of capital expenditure budget.

24. Define indivisible project.

It is a project which can be accepted / rejected in its entirely.

25. Define divisible project.

It is a project which can be accepted / rejected in part.

Chapter 6: Cost ofCapital

1. Define Cost of capital.

According to Solomon Ezr a, Cost of Capital is the minimum


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required rate of earnings or the cut-offrate ofcapital expendi tures.

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2. What are the significance of cost of capital?

(1) As an Acceptance Criterion in Capitalbudgeting

(2) As a Determinant of Capital Mix in Capital StructureDecisions

(3) As a Basis for Evaluating the FinancialPerformance

(4) As a Basis for taking other FinancialDecisions

3. Define marginal cost of capital.

The current rate of interest on longterm debts or current rate of

return is treated as the marginal cost of capital. Marginal cost or

explicit cost tends to increase proportionately as the amount of

debt increases.

4. What is meant by cost of debt?

The cost of debt is the rate of return required by thelenders.

5. What is cost of preference?

The cost of preference capital may be defined as the dividend

expected by the preference shareholders.

6. What is cost of equity?

The cost of equity capital indicates the minimum rate which

must be earned on projects before their acceptance and the raising

of equity funds to finance those projects.

7. List out the various methods of computing cost of equity.

(1) Dividend priceapproach

(2) Constant dividend growthapproach

(3) Earnings priceapproach

(4) Realised yieldapproach

8. Define cost of retained earnings.

The cost of retained earnings may be defined as opportunity cost in

terms of dividends forgone by the equity shareholders.


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9. What is meant by weighted average cost of capital / overall

cost of capital?

Weighted average is an average of the costs of specific source of

Capital employed in a business, properly weighted by theproportion, they hold in

the firm's capital structure.

1. What isleverage?

Chapter 7: Leverage

Leverage is the employment of an asset / source of finance for

which the firm pays fixed cost / fixed return.

2. List out the types of

leverages. (1) Operating

leverage

(2) Financial leverage

(3) Combined leverage

3. What is operating leverage?

The leverage associated with investment (asset acquisition)

activities is referred to as operating leverage.

4. What is financial leverage?

The leverage associated with financiang activities is called

financial leverage.5. What type of risk is associated with each type of leverage?

High operating leverage increases the operating risk. The

Operating risk is the risk of the firm not being able to cover its

operating costs.

High financial leverage increases the financial risk. The financialrisk

refers to the risk of the firm not being able to cover its fixed

financial cost.

6. What is EBITEPS analysis?

The EBIT EPS analysis is a method to study the effect of


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leverage. It involves the comparison of alternative methods of

financing under

various assumptions of EBIT.

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7. What is indifference point?

The EBIT level at which the EPS is the same for two

alternative financial plans is referred to as the indifference

point/level.

Chapter 8: Capital Structure

1. What is Capital structure?

Capital structure is the proportion of debt, preference and equityshares

on a firm s balance sheet.

2. What is optimal capital structure?

The optimum or balanced capital structure means an ideal

combination of borrowed and owned capital that may attain the

maximum value of the firm

3. Different between capital strucutre and financial structure.

Financial structure refers to the left hand side of the balance

sheet, represented as total liabilities. Therefore Financial

structure includes current liabilities, long term debt, preference

shares and equity share capital.

Capital structure is a part of financial structure, which representsonly

long term debt, preference share and equity sharecapital.

4. What is meant by trading on equity?

A company may raise funds either by issue of shares or by

debentures. In case if the rate of return (ROI)

on the total capital employed (shareholders' funds plus

long-term borrowed funds) is more than the rate of interest on

debentures or rate of dividend on preference shares, it is said that

the company is trading on equity.

5. Name various theories of capital structure. Net Income Approach

Net Operating Income Approach

The Traditional Approach


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Modigliani and Miller Approch

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Chapter 9: DividendPolicy

1. Define dividend.

Dividends refer to the corporate net profits distributed

among shareholders.

2. List out the various types of dividend policies.

a) Constant dividend per share, b) Constant payout ratio and c)

Stable rupee dividend plus extra dividend.

3. What are the various forms of dividend?

(a) Scrip, (b) bond, (c) Property, and (d) Stockdividend

4. Define scrip dividend.

In this form of dividend, the equity share holders are issued

transferable promissory notes for a shorter maturity period that

may or may not bear interest.

5. What is bond dividend?

The equity shareholders are issued bonds that carries longer

maturity period with interest.

6. What is property dividend?

It means payment of dividend in the form of asset. This form of

dividend takes place only when a firm has assets that are no

longer necessary in the operation of business and share holders

are ready to accept dividend in the form of Assets.7. Define stock dividend.

Stock dividend is payment of additional shares of common stocks

to the ordinary shareholders. Bonus shares are

issued to the existing shareholders.

8. What are the reasons / objectives for stock dividend?

It tends to bring the market price per share within a more

popular range.

It promotes more active trading

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It reduces the nominal rate of dividend, which may

attract the impression of profiteering

It increases the paid up share capital

It improves prospects of raising additional funds.

9. Define stock split.

It is a method commonly used to lower the market price of

shares by increasing thenumber of shares belonging to each share

holder.

10. Differentiate between bonus shares and stock split.

Par value of share: Is unchanged in issue of bonus share,

whereas it is reduced in stock split.

Capitalization of reserves: Capitalization takes place in

issue of bonus share, whereas there is no capitalization in

stock split.

Share holders proportion: There is no change in the shareholders

proportion; it remains unchanged in both the cases.

Book value, earnings and market price per share: In both the

cases book value,earnings and market price per share decline.

Market price per share: The market price is bought within a

popular trading range, where as in stock split it is bought

within a more popular trading range.

11. What are the reasons for stock split?

To make trading attractive Indication of higher profits in the future

To give higher dividends to shareholders.

Chapter 10: Working Capital Management

1. Define Working capital.

Working Capital is the funds required to meet day-to-day

operations of a business firm.

2. List out the kinds of working capital.

(1) Concept based


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(i) Gross Working Capital

(ii) Net Working Capital

(2) Time based

(i) Permanent or Fixed Working Capital

(ii) Fluctuating or Variable Working Capital.

3. Define permanent working capital.

This minimum level of investment in current assets that is

required to continue the business without interruption is referred

to as permanent working capital.

4. Define variable working capital.

It is also known as the circulating or transitory working

capital. is required to maintain additional current assets

temporarily over and above permanent working capital to satisfy

cyclical demands. Additional working capital is required to meet

unforeseen events like floods, strikes, fire, price hike tendencies

and contingencies.

5. What is meant by operating cycle?The time between purchase of inventory items (raw material or

merchandise) for the production and their conversion into cash is

known as operating cycle or working capital cycle.

6. What is manufacturing cycle?

The Manufacturing Cycle is conversion of raw material into

work-in- process into finished goods, is a component of

operating cycle, and therefore, it is a major determinant of

working capital requirement. Manufac turing cycle depends on the

firm s choice of technology and production policy.

7. Define Cash management.

Cash is the basic input that keeps business running continuously

and smoothly. Too much cash and too little cash will have a

negative impact on the overall profitability of the firm as too muchcash would mean cash

remaining idle and too less cash would hamper the smoothrunning of


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the operations of the firm.Therfore the trade-off between liquidity

and cost is known as Cash Management.

8. What are the objectives of cash management?

To meet payment scheduleTo minimize funds committed to cash balance.

9. List out the motives for holding cash.

Transaction Motive

Precautionary Motive

SpeculativeMotives

Compensating Motive10. What is transaction motive?

This refers to holding of cash to meet routine cash requirements to

finance the transaction in the normal course of business.

11. What is meant by precautionary motive?

This refers to holding of cash to meet unpredictableobligations.

12. What is a speculative motive?

It refers to holding of cash to quickly take advantage of opportunity

typically beside the normal course of business. Eg., Opportunity to

purchase raw material at a reduced price on payment of immediate

cash.

13. What is compensating motive?

It refers to holding of cash to compensate banks for providing certain

services or loans.

14. What are the cash management strategies followed in an organisation?

CashPlanning

Managing the cashflows

Optimum cashlevel

Investing surpluscash

15. Define Float.

The term Float refers to the amount of money tied up in cheques that have

been written, but yet to be collected and encashed. There are two ways


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of doing it: They are (a) Paying from a distant bank (b) Cheque

encashment analysis.

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16. Define optimum cash level.

The firm should decide about the appropriate level of cash balances.

The cost of excess cash and danger of cash deficiency should be

matched to determine the optimum level of cash balances.

17. Define Receivables Management.Management of account receivables may be defined as the

process of making decisions relating to the investment of funds

in this asset which will result in maximising the over all return of

the investment ofthe firm.

18. What are the objectives of receivables management?

The trade-off between the benefits and cost associated with the

extension of credit. The benefits are increased sales and anticipated

increased profits.

19. What are the costs associated with receivables management?

CapitalCosts

AdministrativeCost.

CollectingCost

DefaultingCost

20. Define capital cost.

Maintenance of A/C receivables results in blocking of the firms

financial resources. This is because there is a time lag between the

sale of goods to customers and the payments by them. Thefirm has to arrange for additional funds to meet its own

obligations, such as payment to employees, suppliers of raw

materials, etc while awaiting for payments from its customers.

21. Write a note on administrative cost.

The firm has to incur additional administrative cost for

maintaining Account Receivables in the form of salaries to

the staff kept for maintaining accounting records relating to

customers, cost of conducting

investigation regarding customers creditworthiness etc.


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22. What is meant by collecting cost?

The firm has to incur costs for collecting payments from its

credit customers. Some times additional steps may have to be

taken to recover money from defaulting customers.

23. Define defaulting cost.

The firm has to incur costs for collecting payments from its

credit customers. Some times additional steps may have to be

taken to recover money from defaulting customers.

24. What are the various crucial decisions involved in

receivables management?

1) Credit Policies (2) Credit terms (3) CollectionPolicies.

25. What is meant by credit policies?

The credit policy provides a framework to determine whether to extend

credit or not and how much to extend credit. The two broad dimensions

are (a) Credit standards (b) Credit analysis.

26. What is meant by credit terms?

Credit terms specify the repayment terms. The credit terms have

three components: (a) Credit period (b) Cash discount (c) Cash discount

period.

27. Define cash discount.

Cash discount is the incentive to customers to make earlypayments.

28. Write a note on collection policies.

Collection policies refer to the procedure followed to collect the

receipts when they become due. The collection policy can be classified

into strict and liberal. The effect of tightening the credit policy would

be decline in debts, decline in collection period resulting to lower

interest costs, increase in collection costs and decline in sales. The

effect of lenient policy would be exactly the opposite.

29. Define inventory.

Inventory refers to the stockpile of the products a firm would sell in

future in the normal course of business operation and the components

that make up the


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product. The firm stores three types of inventories, namely, Raw

materials, work-in-progress, finished goods, consumables and spares.

30. What are the objectives of inventory management?

The objective of inventory management consists of two

counterbalancing parts: (1) to minimize investments in inventory and

(2) to meet the demand for products by efficiently organizing the

production and sales operations.

31. List out the costs involved in inventory management.

(i) Orderingcost

(ii) Carrying

cost32. Define ordering cost.

Ordering costs are associated with the ordering of inventory

such as dispatching of orders and issuance of reminders, costs

incurred by the goods received bay, inspection and handling.

33. Define carrying cost.

Carrying cost arises due to the storing ofinventory.

34. Define factoring.

Factoring may be defined as an arrangement between the financial

institution and the business concerns which is selling goods on credit.

35. List out the benefits of factoring.

It provides liquidity to the suppliers as the tied up receivable isreleased

The funds released by the factoring agencies facilitate more

investment in fixed assets

Factoring agreement minimizes bad debts as the factor chooses thecorrect

party

Supplier is relieved of the botheration of administering sales ledger

and control of debts

36. What is meant by trade credit?

Trade credit is the credit extended by one trader to another for

the purchase of goods and services. Trade credit facilitates the

purchase of supplies without immediate payment. Such credit

appears in the records


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of the buyer of goods as sundry credito rs or accounts payable .

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37. Define commercial paper.

Commercial paper is an unsecured promissory note issued by a

firm to raise funds for a short period, varying from 90 days to

364 days. It is issued by one firm to other business firms,insurance companies, pension funds and banks. CP carries a fixed

rate of interest.

38. What is meant by overdraft?

When a bank allows its depositors or account holders to withdraw

money in excess of the balance in his account upto a specified

limit, it is known as overdraft facility. This limit is granted purely

on the basis of creditworthiness of the borrower.

Chapter 11: CapitalMarket

1. What is meant by financial system?

All those activities related to finance and organized into a system

are called as Financial System. A financial system comprises of

financial institutions, financial services, financial markets and

financial instruments.

2. Define financial market.

Financial market facilitate buying and selling of financial

assets / securities. It consists of capital market, money market,

foreign exchange market and government securities market.

3. Define capital market.

Capital market deals with shares and debentures. It can be

further classified as Primary market and Secondary market.

4. Define money market.

Money market deals with short term funds. There is no fixed

place as money market. It refers to all institutions which are

dealing short term funds.

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5. What are financial instruments?

A financial instrument / securities / assets are (1) direct (shares

and debentures) (2) indirect (Mutual funds) and (3) derivatives

(futures and options).

6. List out the functions of new market.

(1) Origination, (2) underwriting and (3)distribution.

7. What are the methods available to float securities?

(1) Public issue through prospectus (2) Offer for sale (3)

Private placement (4) Right issue and (5) Book building.

8. Define offer for sale.

It involves two stages. In first stage, the securities are issued to

stock brokers or issuing houses at an agreed fixed price. In the

second stage, the issuing houses sell the securities to the ultimate

investors.

9. What is meant by private placement?

It also involves two stages. In the first stage, shares are issued to

issuing houses or stock brokers. In the second stage, they are

made available to their investors-clients.

10. Define Right issue.

In this method the shares are offered to the existing share

holders. They can subscribe to new shares in proportion to the

number of shares they already hold. This offer is made by circularto

existing shareholders only.

11. What is meant by book building?

It is price discovery and investors response mechanism. The

issuing company incorporates all the details of the proposals

in the offer document including the minimum price. The

investors are required to quote the number of securities and

the price at which they wish to acquire. The book runners and

the issuing company determine the issue

price based on the bids recei ved through syndic ate member s .


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Chapter 12: Leasing and Hire Purchase Financing

1. Define lease.

Leasing is a contract between the owner of the asset(lessor) and the

user of the asset (lessee) where in the lessor gives the lessee the right to

use the asset for a particular period called the lease period and as a

consideration the lessee pays lease rental. At the end of the lease

period the lessee returns back the asset to the lessor.

2. What is meant by operating lease?

a). Short term cancelable lease

b). Lease period is around 3-5 years

c). Maintenance of the asset will be done by the

lessor d). Risk of obsolescence falls on the lessor

e). Lease rentals will be high

3. Write a note on financial lease.

a). Long term non-cancelable lease

b). Lease period is more than 5 years

c). Maintenance of the asset will be done by the

lessee d). Risk of obsolescence falls on the lessee

e). Lease rentals are moderate.

4. What is meant by sale and lease back?

It is a kind of financial arrangement. The owner of the asset in order to

manage a financial crunch will sell the asset to the lessor and takes it back

on lease. The lessor pays a huge amount for the cost of the asset. With

this huge amount received the financial crisis is settled.

5. What is update lease?

In an update lease the lessor promises to update the asset if a newtechnology arises and in return the lessee is expected to pay higher

lease rentals.

6. What is meant by direct lease?

In a direct lease the lessee chooses the asset directly from

manufacturer. The lessor buys that asset and gives it on lease to the

lessee.

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7. What is leveraged lease?

The lessor purchases the asset by borrowing from the financier,

lessor contribution may be around 25% of the asset only. The

remaining amount is provided by the financier. The lessor leases theasset to the lessee. The lessee pays installments to the financier.

8. Define cross border lease.

When the lessor and lessee belong to different countries the lease is said

to be a cross border lease.

9. What is meant by closed ended lease and open ended lease?

In a closed ended lease the lessee must return the asset to the lessor

after the lease period. In an open ended lease the choice is given tothe lessee to either purchase the asset or return back the asset.

10. List out the various advantages of leasing.

It avoids huge cash outlay

The time spent in negotiating for the asset is minimized

In an operating lease the maintenance and risk of obsolescence is

taken by the lessor

In a financial lease the lease rentals are moderate

In a sale and lease back lease financial crunch can be managed

In a direct lease the lessee can choose the asset from themanufacturer.

In an update lease the lessee gets the updated asset

In an open ended lease the lessee has got the choice to purchase theasset

The lease rent is a tax deductable expenses and hence there is

a tax advantage.

11. What are the disadvantages of leasing?

The pride of ownership is not available to lessee

Lessee cannot claim depreciation for the asset because he is not theowner.

So tax advantage on depreciation is notavailable

Acute care has to be taken in handling the assets. If damages

occur penalty has to be paid

Lease renewals may be difficult. It involves lot of paper work

In case of the financial lease the lessee takes up the risk of


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obsolescence.

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12. What are the various features of hire purchase financing?

The essence of the agreement between the seller and the buyer is

that the ownership of goods does not pass to the buyer until he

pays the last installment.There are two parties to the hire purchase agreement. Seller andthe

buyer

The buyer has to make a down payment of 20 to 25% of the cost

and the remaining amount has to be paid in equal monthly

installments.

The buyer may even return back the goods, if he is not satisfied

with their quality or performance

But this is different from installment sale, in which the ownership

of the goods passes to the buyer immediately on payment of the

first installment and the buyer has no option to return the goods.

Chapter 13: Venture Capital

1. Define Venture Capital.

A Venture capital can be defined as defined as a temporary

equity investment in a growth oriented small or medium business

managed by a highly motivated entrepreneur.The

investment is combined with managerial

assistance.

2. What are the features of venture capital?

It is basically financing of new companies which are

finding it difficult to go to the capital market at their early

stage of existence.

This finance can also be loan based or convertible debentures

so that they carry a fixed yield for the providers of venture

capital.

Those who provide venture capital aim at capital gain due to

the success achieved by the borrowing concern.

Venture capital is always a long term investment andmade in


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companies which have high growth potential. The

provision of venture capital will bring rapid growth for the

business.

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The venture capital provider will also take part in the business

of borrowing concern whereby the venture capital financier

not merely confines to finance but also provides managerial

skill.

3. What are the techniques followed by VCIs to achieve objectives?

Personal discussions

Plant visits

Feedback from nominee directors

Periodic reports

Commissioned studies

4. What are the methods available for VCIs to realise the investment?

Going public

Sale of shares to entrepreneurs

Trade sales to another company

selling to a new investor and

Liquidation.

2 marks for 5 units

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