21. Differentiate between Business risk and financial risk?
Business Risk and Financial Risk
Business risk refers to the risk associated with the firm’s operations. It is an unavoidable risk because of the environment in which the firm has to operate and the business risk is represented by the variability of earnings before interest and tax (EBIT). The variability in turn is influenced by revenues and expenses. Revenues and expenses are affected by demand of firm’s products, variations in prices and proportion of fixed cost in total cost.
Whereas, financial risk refers to the additional risk placed on firm’s shareholders as a result of debt use in financing. Companies that issue more debt instruments would have higher financial risk than companies financed mostly by equity. Financial risk can be measured by ratios such as firm’s financial leverage multiplier, total debt to assets ratio etc.
22. Explain the term ‘Ploughing back of Profits’?
Ploughing back of Profits:
Long-term funds may also be provided by accumulating the profits of the company and by ploughing them back into business. Such funds belong to the ordinary shareholders and increase the net worth of
the company. A public limited company must plough back a reasonable amount of its profits each year keeping in view the legal requirements in this regard and its own expansion plans. Such funds also entail almost no risk. Further, control of present owners is also not diluted by retaining profits.
23. Discuss the features of deep discount bonds?
Features of Deep Discount Bonds:
Deep discount bonds are a form of zero-interest bonds. These bonds are sold at discounted value and on maturity; face value is paid to the investors. In such bonds, there is no interest payout during the lock- in period. The investors can sell the bonds in stock market and realize the difference between face value and market price as capital gain.
IDBI was the first to issue deep discount bonds in India in January 1993. The bond of a face value of Rs. 1 lack was sold for Rs. 2700 with a maturity period of 25 years.
24. Explain the methods of venture capital financing?
Some Common Methods of Venture Capital Financing
(a) Equity financing: The venture capital undertaking requires long-term funds but is unable to provide returns in initial stage so equity capital is the best option.
(b) Conditional Loan: A conditional loan is repayable in the form of a royalty after the venture is able to generate sales. No interest is paid on such loans.
(c) Income note: It is hybrid security; the entrepreneur has to pay both interest and royalty on sales but at substantially low rates.
(d) Participating debenture: Such security carries charges in three phases - in the start-up phase, no interest is charged, next stage a low rate of interest up to a particular level of operation is charged, after that, high rate of interest is required to be paid.
25. Explain the concept of Debt securitization?
Debt securitization is a method of recycling of funds. It is especially beneficial to financial intermediaries to support the lending volumes. Assets generating steady cash flows are packaged together and against this assets pool, market securities can be issued. The debt securitization process can be classified in the following three functions.
1. The origination function: The credit worthiness of a borrower seeking loan from a finance company, bank, housing company or a leasing company is evaluated and a contract is entered into and repayment schedule is structured over the life of the loan.
2. The pooling function: Similar loans or receivables are clubbed together to create an underlying pool of assets. This pool is transferred in favors of a special purpose vehicle (SPV).
3. The securitization function: After structuring, issue the securities on the basis of asset pool. The securities carry a coupon and an expected maturity, which can be asset based or mortgaged based. These are generally sold to investors through merchant bankers.
The process of securitization is generally without recourse i.e. the investor bears credit risk or risk of default and the user is under an obligation to pay to investor only if the cash flows are received by him from the collateral.
26. Name the various financial instruments dealt with in the international market?
Financial Instruments in the International Market: Some of the various financial instruments dealt with in the international market are:
(a) Euro Bonds
(b) Foreign Bonds
(c) Fully Hedged Bonds
(d) Medium Term Notes
(e) Floating Rate Notes
(f) External Commercial Borrowings
(g) Foreign Currency Futures
(h) Foreign Currency Option
(i) Euro Commercial Papers.
27. Differentiate between Factoring and Bills discounting?
The differences between Factoring and Bills discounting are:
(a) Factoring is called as “Invoice Factoring’ whereas Bills discounting is known as ‘Invoice discounting.”
(b) In Factoring, the parties are known as the client, factor and debtor whereas in Bills discounting, they are known as drawer, drawee and payee.
(c) Factoring is a sort of management of book debts whereas bills discounting is a sort of borrowing from commercial banks.
(d) For factoring there is no specific Act, whereas in the case of bills discounting, the Negotiable Instruments Act is applicable.
28. Explain the concept of Multiple Internal Rate of Return?
In cases where project cash flows change signs or reverse during the life of a project for example, an initial cash outflow is followed by cash inflows and subsequently followed by a major cash out-flow, there may be more than one internal rate of return (IRR).
29. Explain the concept of discounted payback period?
Concept of Discounted Payback Period
Payback period is time taken to recover the original investment from project cash flows. It is also termed as break even period. The focus of the analysis is on liquidity aspect and it suffers from the limitation of ignoring time value of money and profitability. Discounted payback period considers present value of cash flows, discounted at company’s cost of capital to estimate breakeven period i.e. it is that period in which future discounted cash flows equal the initial outflow. The shorter the period, better it is. It also ignores post discounted payback period cash flows.
30. Explain the term “Desirability factor”?
Desirability Factor: In certain cases we have to compare a number of proposals each involving different amount of cash inflows. One of the methods of comparing such proposals is to work out, what is known as the ‘Desirability Factor’ or ‘Profitability Index’. In general terms, a project is acceptable if the Profitability Index is greater than 1.
More Questions & Answers :-
Part1 Part2 Part3 Part4
Business Risk and Financial Risk
Business risk refers to the risk associated with the firm’s operations. It is an unavoidable risk because of the environment in which the firm has to operate and the business risk is represented by the variability of earnings before interest and tax (EBIT). The variability in turn is influenced by revenues and expenses. Revenues and expenses are affected by demand of firm’s products, variations in prices and proportion of fixed cost in total cost.
Whereas, financial risk refers to the additional risk placed on firm’s shareholders as a result of debt use in financing. Companies that issue more debt instruments would have higher financial risk than companies financed mostly by equity. Financial risk can be measured by ratios such as firm’s financial leverage multiplier, total debt to assets ratio etc.
22. Explain the term ‘Ploughing back of Profits’?
Ploughing back of Profits:
Long-term funds may also be provided by accumulating the profits of the company and by ploughing them back into business. Such funds belong to the ordinary shareholders and increase the net worth of
the company. A public limited company must plough back a reasonable amount of its profits each year keeping in view the legal requirements in this regard and its own expansion plans. Such funds also entail almost no risk. Further, control of present owners is also not diluted by retaining profits.
23. Discuss the features of deep discount bonds?
Features of Deep Discount Bonds:
Deep discount bonds are a form of zero-interest bonds. These bonds are sold at discounted value and on maturity; face value is paid to the investors. In such bonds, there is no interest payout during the lock- in period. The investors can sell the bonds in stock market and realize the difference between face value and market price as capital gain.
IDBI was the first to issue deep discount bonds in India in January 1993. The bond of a face value of Rs. 1 lack was sold for Rs. 2700 with a maturity period of 25 years.
24. Explain the methods of venture capital financing?
Some Common Methods of Venture Capital Financing
(a) Equity financing: The venture capital undertaking requires long-term funds but is unable to provide returns in initial stage so equity capital is the best option.
(b) Conditional Loan: A conditional loan is repayable in the form of a royalty after the venture is able to generate sales. No interest is paid on such loans.
(c) Income note: It is hybrid security; the entrepreneur has to pay both interest and royalty on sales but at substantially low rates.
(d) Participating debenture: Such security carries charges in three phases - in the start-up phase, no interest is charged, next stage a low rate of interest up to a particular level of operation is charged, after that, high rate of interest is required to be paid.
25. Explain the concept of Debt securitization?
Debt securitization is a method of recycling of funds. It is especially beneficial to financial intermediaries to support the lending volumes. Assets generating steady cash flows are packaged together and against this assets pool, market securities can be issued. The debt securitization process can be classified in the following three functions.
1. The origination function: The credit worthiness of a borrower seeking loan from a finance company, bank, housing company or a leasing company is evaluated and a contract is entered into and repayment schedule is structured over the life of the loan.
2. The pooling function: Similar loans or receivables are clubbed together to create an underlying pool of assets. This pool is transferred in favors of a special purpose vehicle (SPV).
3. The securitization function: After structuring, issue the securities on the basis of asset pool. The securities carry a coupon and an expected maturity, which can be asset based or mortgaged based. These are generally sold to investors through merchant bankers.
The process of securitization is generally without recourse i.e. the investor bears credit risk or risk of default and the user is under an obligation to pay to investor only if the cash flows are received by him from the collateral.
26. Name the various financial instruments dealt with in the international market?
Financial Instruments in the International Market: Some of the various financial instruments dealt with in the international market are:
(a) Euro Bonds
(b) Foreign Bonds
(c) Fully Hedged Bonds
(d) Medium Term Notes
(e) Floating Rate Notes
(f) External Commercial Borrowings
(g) Foreign Currency Futures
(h) Foreign Currency Option
(i) Euro Commercial Papers.
27. Differentiate between Factoring and Bills discounting?
The differences between Factoring and Bills discounting are:
(a) Factoring is called as “Invoice Factoring’ whereas Bills discounting is known as ‘Invoice discounting.”
(b) In Factoring, the parties are known as the client, factor and debtor whereas in Bills discounting, they are known as drawer, drawee and payee.
(c) Factoring is a sort of management of book debts whereas bills discounting is a sort of borrowing from commercial banks.
(d) For factoring there is no specific Act, whereas in the case of bills discounting, the Negotiable Instruments Act is applicable.
28. Explain the concept of Multiple Internal Rate of Return?
In cases where project cash flows change signs or reverse during the life of a project for example, an initial cash outflow is followed by cash inflows and subsequently followed by a major cash out-flow, there may be more than one internal rate of return (IRR).
29. Explain the concept of discounted payback period?
Concept of Discounted Payback Period
Payback period is time taken to recover the original investment from project cash flows. It is also termed as break even period. The focus of the analysis is on liquidity aspect and it suffers from the limitation of ignoring time value of money and profitability. Discounted payback period considers present value of cash flows, discounted at company’s cost of capital to estimate breakeven period i.e. it is that period in which future discounted cash flows equal the initial outflow. The shorter the period, better it is. It also ignores post discounted payback period cash flows.
30. Explain the term “Desirability factor”?
Desirability Factor: In certain cases we have to compare a number of proposals each involving different amount of cash inflows. One of the methods of comparing such proposals is to work out, what is known as the ‘Desirability Factor’ or ‘Profitability Index’. In general terms, a project is acceptable if the Profitability Index is greater than 1.
More Questions & Answers :-
Part1 Part2 Part3 Part4
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