STUDY NOTES ADVANCED FINANCIAL MANAGEMENT (AFM PDF

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FINAL : PAPER - 14 ADVANCED FINANCIAL MANAGEMENT (AFM) FINAL STUDY NOTES The Institute of Cost Accountants of India CMA Bhawan, 12, Sudder Street, Kolkata - 700 016 First Edition : May 2013 Second Edition (Revised & Updated) : August 2014 Published by : Directorate of Studies The Institute of C...

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FINAL : PAPER -

14

ADVANC ED FINANC IAL MANAG EMENT FINAL (AFM) STUDY NO TES

The Institute of Cost Accountants of India CMA Bhawan, 12, Sudder Street, Kolkata - 700 016

First Edition : May 2013 Second Edition (Revised & Updated) : August 2014

Pub lishe d b y :

Directorate of Studies The Institute of Cost Accountants of India (ICAI) CMA Bhawan, 12, Sudder Street, Kolkata - 700 016 www.icmai.in

Printe d a t :

Das Printers 61, Surya Sen Street, Kolkata - 700 009

Copyright of these Study Notes is reserved by the Insitute of Cost Accountants of India and prior permission from the Institute is necessary for reproduction of the whole or any part thereof.

Sylla b us Sylla b us Struc ture

A B C D

Financial Markets and Institutions Financial Risk Management Security Analysis and Portfolio Management Investment Decisions

30% 25% 20% 25%

D 25%

C 20%

A 30%

B 25%

ASSESSMENT STRATEG Y

There will be written examination paper of three hours. O BJEC TIVES

To provide expert knowledge on setting financial objectives and goals, managing financial resources, financial risk management, thorough understanding of investment portfolios and financial instruments. Le a rning Aim s

The syllabus aims to test the student’s ability to :  E valuate the role of agents and instruments in financial markets  Interpret the relevance of financial institutions  A nalyze the degree of risk for its effective management  Advise on investment opportunities Skill set required Level C: Requiring skill levels of knowledge, comprehension, application, analysis, synthesis and evaluation. Se c tio n A : Fina nc ia l Ma rke ts a nd Institutio ns

1. 2. 3. 4.

Agents in Financial Markets Financial Market Instruments Commodity Exchange Infrastructure Financing

Se c tio n B : Fina nc ia l Risk Ma na g e m e nt

5. 6. 7. 8.

30%

25%

Capital Market Instruments Types of Financial Risks Financial Derivatives as a tool for Risk Management Financial Risk Management in International Operations

Se c tio n C : Se c urity Ana lysis a nd Po rtfo lio Ma na g e m e nt

20%

9. Security Analysis & Portfolio Management Se c tio n D : Inve stm e nt De c isio ns

25%

10. (a)Investment Decisions under uncertainty (b) Investments in advanced technological environment (c) International Investments SEC TIO N A: FINANC IAL MARKETS AND INSTITUTIO NS 1.

Ag e nts in Fina nc ia l Ma rke ts

(a) (b) (c)

Reserve Bank of India; SEBI; Banking Institutions Non-Bank Financial Corporation’s (NBFCs) Insurance, Pension Plans and Mutual Funds

[30 MARKS]

2.

Fina nc ia l Ma rke t Instrum e nts

(a) (b) (c) 3.

C o m m o dity Exc ha ng e

(a) (b) (c) (d) (e) 4.

Call money, Treasury Bills, Commercial Bills, Commercial Paper; Certificate of Deposits, Government Securities and Bonds, Repo, Reverse Repo and Promissory Notes Futures, Options, other Derivatives Money Market Instruments & Mutual Funds Regulatory Structure, Design of markets Issues in Agricultural, Non-Agricultural Markets, product design, contract specifications, spot price and present practices of commodities exchanges Intermediaries, Clearing house operations, risk management procedures and delivery related issues Issues related to monitoring and surveillance by exchanges and regulator, Basic risk and its importance in pricing Commodity options on futures and its mechanism

Infra struc ture Fina nc ing

(a)

(b)

(c)

Financial objectives, policies on financing, investments and dividends. Financial forecasting, planning and uncertainties, interest rates, inflation, capital gains and losses exchange control regulation, government credit policies and incentives statistics on production, price indices, labour, capital market based on published statistical data Internal source, retained earnings, provisions etc, Issues in raising finance, legal form of organisation, provisions of the companies Act, control of capital issues. Short term sources : Trade credit, factoring, Bill of exchange, Bank Loan, Cash credit, overdraft, public deposit, SEBI regulations, primary and secondary markets Securitization, Viability, GAP Funding

SEC TIO N B: FINANC IAL RISK MANAG EMENT 5.

(a) (b) (c) (d) (e) (f) (g) (h) 6.

Primary and secondary markets and its instruments Optionally convertible debentures, Deep discount bonds Rolling settlement, Clearing house operations Dematerialization, Re-materialization Depository system Initial Public Offering (IPO)/ Follow on Public Offer (FPO); Book Building Auction, Insider trading Credit rating- objective, sources, process, credit rating agencies in India

Type s o f Fina nc ia l Risks

(a) (b) 7.

[25 MARKS]

C a pita l m a rke t instrum e nts

Asset based risk , Credit Risk, Liquidity Risk, Operational Risk Foreign investment risk, Market Risk

Fina nc ia l De riva tive s a s a to o l fo r Risk Ma na g e m e nt

(a)

(b)

Forward & Futures – meaning, risks associated, difference, features, stock futures, benefits of future market, components of future price, index and index futures, margin, hedging, hedging risks and portfolio returns using index futures, hedge ratio, cross hedge, perfect and imperfect hedge, stock lending scheme, forward rate interest, computation of appropriate interest rate Options – meaning, types, call and put options, terms and timing of exercise in options contract, determination of premium, intrinsic value and time value, strategy – spread, bull

(c) (d) 8.

spread, bear spread, butterfly spread, box spread, combination, straddle, strangle, strips and straps, put-call parity, binomial tree approach, risk neutral valuation, Black-Scholes and Merton, evaluation of option pricing – delta, gamma, vega/lambda, theta, rho. Swaps and Swaption – meaning, types, features, benefits, role of financial intermediaries, interest rate swaps, valuation of different swaps Interest rate derivatives – meaning, interest rate caps, interest rate collars, forward rate agreements, interest rate futures

Fina nc ia l Risk Ma na g e m e nt in Inte rna tio na l O pe ra tio ns

(a)

(b)

(c) (d)

(e) (f) (g)

Forex market, equilibrium exchange rate, exchange rate arrangements, bid-ask rate and bidask rate spread, cross rate, currency arbitrage: two-point and three-point, parity conditions in International Finance: Purchasing Power Parity – Unbiased Forward Rate Theorem – Interest Rate Parity – Fisher Effect – International Fisher Effect, arbitrage operations, covered interest arbitrage Exchange rate risk management – forex hedging tools, exposure netting, currency forward, cross currency roll over, currency futures, options, money market hedge, asset-liability management Foreign Investment Analysis: International Portfolio Investment – International Capital Budgeting. Sources of Foreign currency, debt route, depository receipts, American Depository Receipts (ADRs) – sponsored, unsponsored, Global Depository Receipts (GDRs), Warrants, Foreign Currency Convertible Bonds (FCCBs), Euro Issues, Euro Commercial Paper, Euro Convertible Bonds, Note Issuance Facility, Participating Notes Foreign Investment in India, Joint Ventures, Foreign Technology Taxation Issues in cross-border financing and investments, International Transfer Pricing – Objectives – Arm’s length pricing – techniques, advance pricing agreements, Maximization of MNC’s income through Transfer Pricing strategy

SEC TIO N C : SEC URITY ANALYSIS & PO RTFO LIO MANAG EMENT 9.

(a) (b) (c) (d) (e) (f) (g)

Security analysis, Fundamental analysis, Economic analysis, Industry analysis, Company analysis, Technical analysis, Momentum analysis – arguments and criticisms Market indicators, Support and resistance level, Patterns in stock price Statistic models, Bollinger bands Portfolio Management – meaning, objectives and basic principles, discretionary and nondiscretionary portfolio managers Theories on stock market movements – Daw Jones Theory, Markowitz Model Risk analysis – types, systematic and unsystematic risk, standard deviation and variance, security beta, market model, alpha Portfolio analysis – CAPM and assumption, Security and Capital market line, decision-making based on valuation, risk return ratio, arbitrage pricing model, portfolio return, portfolio risk co-efficient of variance, co-variance, correlation coefficient, correlation and diversification, minimum risk portfolio, hedging risks using risk free investments, project beta, levered and unlevered firms and proxy beta

SEC TIO N D: INVESTMENT DEC ISIO NS 10.

[20 MARKS]

Se c urity Ana lysis & Po rtfo lio Ma na g e m e nt

(a ) Inve stm e nt de c isio ns unde r unc e rta inty

(i) (ii) (iii)

Estimation of project cash flow Relevant cost analysis Project reports – features and contents

[25 MARKS]

(iv) (v) (vi) (vii)

Project appraisal steps – general, inflationary and deflationary conditions Techniques of project evaluation Investment decisions under uncertainties Difference in project life – EAC and LCM approaches, Capital Rationing, NPV vs. PI, NPV vs. IRR (viii) Social Cost Benefit Analysis, Break-even Analysis (ix) Inflation and Financial Management (x) Sensitivity Analysis, Certainty Equivalent Approach, Decision Tree Analysis, Standard Deviation in Capital Budgeting (xi) Hiller’s Model, Hertz’s Model (xii) Discount Rate Component, Risk Adjusted Discount Rate (xiii) Option in Capital Budgeting (b)

Inve stm e nt in a dva nc e d te c hno lo g ic a l e nviro nm e nt

(i) (ii) (iii) (iv) (v)

Financial forecasting Strategic management and Strategy levels Interface of financial strategy with corporate strategic management Completed financial plan, Corporate taxation and financing, Promoter’s contribution Cost of capital – cost of different sources of capital, weighted average cost of capital, marginal cost of capital, capital asset pricing model (vi) Debt financing – margin money, refinancing, bridge finance, syndication of loan and consortium, seed capital assistance, venture capital financing, deferred payment guarantee (vii) Lease financing – finance and operating lease, lease rentals, sale and lease back, crossborder leasing (viii) Debt securitization - features, advantages, factoring, forfeiting, bill discounting (c)

Inte rna tio na l Inve stm e nts

(i) (ii) (iii) (iv) (v)

World financial markets Foreign portfolio investments Modern portfolio theory Issues posed by portfolio investment Foreign portfolio trends in India – emerging trends and policy developments

C o nte nt SEC TIO N A – FINANC IAL MARKETS AND INSTITUTIO NS Study No te 1 : Ag e nts in Fina nc ia l Ma rke ts 1.1

Financial System

1.1

1.2

Reserve Bank of India (RBI)

1.13

1.3

Banking Institutions

1.25

1.4

Securities and Exchange Board of India (SEBI)

1.32

1.5

Non-Banking Financial Company (NBFC)

1.34

1.6

Insurance

1.45

1.7

Pension Plans

1.47

1.8

Mutual Funds

1.50

Study No te 2 : Fina nc ia l Ma rke t Instrum e nts 2.1

Financial Market

2.1

2.2

Money Market

2.2

2.3

Money Market Instruments

2.5

2.4

Government Securities and Bonds

2.21

2.5

Repo and Reverse Repo

2.29

2.6

Promissory Note

2.31

2.7

Futures, Options and Other Derivatives

2.31

2.8

Mutual funds

2.34

Study No te 3 : C o m m o dity Exc ha ng e 3.1

Commodity Exchange

3.1

3.2

Commodities Exchanges in India

3.4

3.3

Commodity Exchange – Structure

3.13

3.4

Indian Commodity Market - Regulatory Framework

3.17

3.5

Indian Economy and Role of Agricultural Commodity

3.22

3.6

Unresolved Issues and Future Prospects

3.28

3.7

Contract Specifications (For Tutorial Reference only)

3.30

3.8

Instruments Available for Trading

3.31

3.9

Participants of Commodity Market

3.34

3.10

Intermediaries of Commodity Markets

3.35

3.11

Product Specification

3.36

3.12

How the Commodity Market Works

3.39

3.13

Clearing House Operations

3.41

3.14

Risk Management

3.46

3.15

Basis and Basis Risk

3.47

3.16

Market Monitoring and Surveillance

3.48

3.17

Commonly Futures and its Mechanism

3.51

3.18

Commonly Used Terms in Commodity Market

3.71

Study No te 4 : Infra struc ture Fina nc ing 4.1

Introduction

4.1

4.2

Evolution of Financing Needs in Indian Infrastructure

4.4

4.3

Infrastructure Financing methods- Present Scenario

4.5

4.4

Project Financing versus Capital Financing

4.7

4.5

Risk Management in Infrastructure Projects

4.7

4.6

Financing Infrastructure Development: Recent Trends and Institutional Initiatives

4.8

4.7

SEBI regulations relating to Infrastructure Sector

4.13

4.8

Legal form of Organisation

4.17

4.9

Sources of infrastructure investment in India

4.20

4.10

Financial Objective

4.22

4.11

Projected Investment in the Infrastructure Sector during the Twelfth Plan

4.24

4.12

Investment and Dividend Decision

4.25

4.13

The Interest Rates have been recently revised by the Board

4.30

4.14

Issues in Infrastructure Financing

4.36

4.15

Need for an Efficient and Vibrant Corporate Bond Market

4.37

4.16

Measures taken by the Central Government

4.38

4.17

Price Indices

4.45

4.18

Internal Sources of Finanace

4.47

4.19

Short Term Sources

4.49

4.20

Issues and Challenges constraining Infrastructure Funding

4.51

4.21

Primary & Secondary Market Structure

4.53

SEC TIO N B: FINANC IAL RISK MANAG EMENT Study No te 5 : C a pita l Ma rke t Instrum e nts.1 5.1

Capital Market

5.1

5.2

Primary and Secondary Markets and its Instruments

5.2

5.3

Optionally Convertible Debentures and Deep Discount Bonds

5.6

5.4

Rolling Settlement, Clearing House Operations

5.7

5.5

Dematerialisation & Rematerialisation

5.8

5.6

Depository System

5.10

5.7

Initial Public Offer (IPO)/ Follow on Public Offer (FPO); Book Building

5.13

5.8

Auction & Insider Trading

5.20

5.9

Credit Rating - Objectives, Sources, Process, Credit Rating Agencies in India

5.22

Study No te 6 : Type s o f Fina nc ia l Risks 6.1

Financial Risk – Meaning and Nature

6.1

6.2

Asset Backed Risk, Credit Risk, Liquidity Risk, Operational Risk

6.10

6.3

Foreign Investment Risk & Market Risk

6.14

6.4

Financial Risk Identification based on the Balance Sheet Information

6.16

6.5

Hedging & Diversification

6.20

Study No te 7 : Fina nc ia l De riva tive s a s a to o l fo r Risk Ma na g e m e nt 7.1

Farward & Future

7.2

7.2

Options

7.3

Swaps & Swaption

7.128

7.4

Interest Rate Derivatives

7.143

7.65

Study No te 8 : Fina nc ia l Risk Ma na g e m e nt in Inte rna tio na l O pe ra tio ns 8.1

Foreign Exchange Market

8.1

8.2

Foreign Exchange Rate Management

8.5

8.3

Parity Conditions in International Finance

8.14

8.4

Exchange Rate Risk Management

8.24

8.5

Foreign Investment Analysis

8.37

8.6

Sources of Foreign Currency

8.49

8.7

Foreign Investment in India

8.60

8.8

Taxation Issues in Cross-Border Financing and Investment

8.65

8.9

International Transfer Pricing

8.85

SEC TIO N C : SEC URITY ANALYSIS & PO RTFO LIO MANAG EMENT Study No te 9 : Se c urity Ana lysis a nd Po rtfo lio Ma na g e m e nt 9.1

Inve stme nt – Ba sic s And Ana lysis o f Se c uritie s

9.1

9.2

Ma rke t Ind ic a to rs, Sup p o rt a nd Re sista nc e Le ve l, Pa tte rns in Sto c k Pric e

9.21

9.3

Sta tistic Mo d e ls, Bo lling e r Ba nd s

9.26

9.4

Po rtfo lio Ma na g e me nt

9.28

9.5

The o rie s o n Sto c k Ma rke t Mo ve me nts

9.31

9.6

Risk Ana lysis

9.34

9.7

Po rtfo lio Ana lysis

9.39

SEC TIO N D: INVESTMENT DEC ISIO NS Study No te 10 : Inve stm e nt De c isio ns 10.1

Inve stme nt d e c isio ns und e r unc e rta inty

10.2

Inve stme nt in Ad va nc e d Te c hno lo g ic a l Enviro nme nt

10.3

Inte rna tio na l Inve stme nts

10.1 10.91 10.124

Se c tio n A Fina nc ia l Ma rke ts a nd Institutio ns

Study No te - 1 AG ENTS IN FINANC IAL MARKETS

This Study No te inc lude s 1.1

Fina nc ia l Syste m

1.2

Re se rve Ba nk o f India (RBI)

1.3

Ba nking Institutio ns

1.4

Se c uritie s a nd Exc ha ng e Bo a rd o f India (SEBI)

1.5

No n- Ba nking Fina nc ia l C o m pa ny (NBFC )

1.6

Insura nc e

1.7