Corporate Finance, Governance and Development — DU B.A. (Hons.) Economics Previous Year Question Papers

1. (a) What does the separation theorem tell us about the physical investment line? Explain in case of single owner firm. (b) What are the advantages and disadvantages of payback, profitability index and return on capital employed (ROCE) rules of investment decisions? (c) What are the risks that a domestic company faces if it decides to invest in a foreign country? 7. (a) What are the determinants of foreign exchange rates? (b) An Indian firm imports a key raw material from South Africa. The firm wants to predict INR/ZAR spot rates over the next three years. The current INR/ZAR spot rate for buying the South African rand is 0.0695, and estimates of Indian and South African inflation rates over the three years are as follows: India South Africa How much will be the IND/ZAR spot rate forecasted in the 3'd year? 2. (a) When will an investor be risk averse, risk neutral, and risk seeking? Explain graphically by using expected utility theorem. (b) Draw the shape of the utility function when an investor is planning an investment with an outcome of Rs. 5000 with 80% and 20% chance of an outcome of Rs. -2000. The investor assigns a certainty equivalent of Rs. -2000 with a utility index of 0.68. Draw the utility function when the utility index of Rs 3600 is 0.80. (c) How do you define and measure risk of a portfolio? What is downside risk? (6+6+6) 3. (a) Consider two assets, A and B, and their expected returns and standard deviations are (IA, 'B), (O1, OB). Assume that an investor invests a proportion of total investment in asset A and 1 - a of the total investment in asset B where 0 ≤ a ≤1. Derive the formula for the expected return and risk of the portfolio and draw the portfolio diagram. 6. (a) Define weighted average cost of capital (WACC). (b) Consider a firm whose asset value is Rs.500 million, out of which debt contributes Rs.200 million with expected return on debt I = 7.5%, and equity constitutes Rs.300 million with expected return on equity IE = 15%. Now, the country witnesses downswings in economic activities. The chief financial officer (CFO) of the company decides to generate fresh capital of Rs. 50 million by issuing debt with the existing cost of debt (7.5%). Calculate the followings : (i) Weighted Average Cost of Capital (WACC) in the pre-crisis situation. (i) Expected return on equity and WACC after leveraging the capital by additional borrowing. (iii) Compare the results obtained in (i) & (ii). (c) Explain the law of conservation of value. (b) Under what conditions there will no risk reduction and maximum risk reduction of the portfolio? (c) Explain systematic and unsystematic risks. 4. (a) Explain the Black and Sholes option valuation model. (b) Using the Black and Sholes model, calculate the premium on the XYZ call option. The option has an exercise price of Rs.100 and expires in 2.5 years. The current XYZ share price is Rs.115. The volatility of XYZ's share price is 20%, the risk-free interest rate is 10% per annum, Nd,) =