Financial Fundamentals Question Bank PDF

FINANCIAL FUNDAMENTALS QUESTION BANK WITH ANSWERS: 1) Explain the difference between Equity & Debt wrt - Instruments, Cashflows, Tax, Life, Control & Cost ANSWER) Equity and debt represent two different ways of raising capital for a company, each with distinct characteristics in terms of...

FINANCIAL FUNDAMENTALS QUESTION BANK WITH ANSWERS: 1) Explain the difference between Equity & Debt wrt - Instruments, Cashflows, Tax, Life, Control & Cost ANSWER) Equity and debt represent two different ways of raising capital for a company, each with distinct characteristics in terms of instruments, cashflows, tax implications, life, control, and cost. Let's break these down: 2) What are Financial Covenants? Give Examples ANSWER Financial covenants are specific clauses in loan agreements or bond indentures that impose financial obligations or restrictions on the borrower. These covenants are designed to protect the lender by ensuring that the borrower maintains a certain level of financial health throughout the loan. Violating these covenants could lead to penalties, increased interest rates, or even the immediate repayment of the loan. 3) What is the difference between Face Value, Book Value, Intrinsic Value, and Market Value per share? ANSWER ) 3) Face Value: ○ Also known as the nominal or par value, face value is the original value of a stock or bond as stated in its charter or bond certificate. For shares, this is the value at which the company initially issues the shares, and it’s usually very low (₹10 or ₹1 per share, for example). ○ In the case of bonds, the face value is the amount that the issuer will pay back to the bondholder at maturity. Book Value: ○ Book value is calculated as the total assets of the company minus its total liabilities. When it comes to shares, book value per share is the company’s net asset value (NAV) divided by the number of outstanding shares. ○ Book value indicates the company’s actual worth based on its financial statements, ignoring intangible assets like goodwill. ○ Formula: Book Value per Share=Total Assets−Total LiabilitiesTotal Shares OutstandingBook Value per Share=Total Shares OutstandingTotal Assets−Total Liabilities​ ○ Example: If a company has ₹100 crores in assets and ₹40 crores in liabilities, with 10 crore shares, the book value per share would be ₹6. Intrinsic Value: ○ Intrinsic value is the actual value of a company's share based on an analysis of its financials, growth potential, cash flows, and other fundamental metrics. It reflects the true worth of the company’s share, unlike market value which fluctuates based on investor sentiment. ○ Investors use different models like Discounted Cash Flow (DCF) or Dividend Discount Model (DDM) to calculate intrinsic value. Market Value: ○ Market value is the price at which a share is currently trading on the stock exchange. It is determined by supply and demand, and it fluctuates due to investor sentiment, market conditions, and company performance. ○ Market value can often differ from intrinsic value due to market perceptions, news, and broader economic conditions. 4) What is a Share Premium ANSWER: A Share Premium is the excess amount received by a company over the face value of its shares when issued to investors. It represents the difference between the issue price and the nominal (face) value of the shares. For example, if a share with a face value of ₹10 is issued at ₹15, the ₹5 difference is the share premium. This is recorded in the Securities Premium Account on the balance sheet. Key Points: 1. Uses of Share Premium (as per legal regulations): ○ Issuing bonus shares. ○ Writing off preliminary expenses. ○ Funding share buybacks. ○ Paying premiums on redeeming preference shares or debentures. 2. Purpose: ○ Allows a company to raise extra funds without diluting equity too much. ○ Reflects the perceived market value of the company. 3. Restrictions: Share premium cannot be used for dividends or general expenses; its usage is limited to specific purposes as dictated by law. Example: If 1,000 shares with a ₹10 face value are issued at ₹15 each, the share premium is ₹5 per share, totaling ₹5,000 in the Securities Premium Account. In summary, share premium is the additional capital from issuing shares above face value, governed by strict usage rules. 6) What are pre-emptive Rights? ANSWER: Pre-emptive rights are the rights granted to existing shareholders to purchase additional shares of a company before the company offers them to new investors. These rights are intended to protect existing shareholders from dilution of their ownership. If a company plans to issue new shares, pre-emptive rights ensure that current shareholders have the first opportunity to maintain their proportional ownership by buying new shares at a price usually set by the company. Example: Suppose Rajita holds 10% of a company's shares, and the company is issuing additional shares. Pre-emptive rights allow Rajita to purchase enough of the newly issued shares to maintain her 10% ownership. Without this right, Rajita's ownership could be diluted, reducing her voting power and dividend entitlements. Sums Example: If a company has 1,000 shares outstanding and plans to issue 100 new shares, and Rajita holds 100 shares (10% ownership), she has the right to buy 10 shares out of the 100 new shares to maintain her 10% stake. 7) Difference between Term Loans & Debentures ANSWER: 8) Difference between Mortgage & Hypothecation ANSWER: Mortgage: A loan secured by immovable property such as real estate. The lender holds the right to take possession of the property if the borrower defaults on the loan. ○ Example: A home loan where the bank holds a mortgage over the house. Hypothecation: A loan secured by movable property like vehicles or stock, where the borrower retains ownership of the asset. In case of default, the lender can take possession of the asset. ○ Example: A car loan, where the car remains in the borrower’s possession, but if the loan is not repaid, the bank can seize the car. Key Difference: Mortgage involves immovable property, whereas hypothecation involves movable assets. 9) Features of Preference Capital ANSWER: Preference capital refers to shares that offer a fixed dividend to shareholders and have preference over equity shares when it comes to dividend payments and repayment of capital during liquidation. The key features include: 1. Fixed Dividend: Preference shareholders are entitled to a fixed rate of dividend before any dividend is paid to equity shareholders.  2. Preference in Repayment: In the event of liquidation, preference shareholders are paid back their capital before equity shareholders. 3. No Voting Rights: Preference shareholders typically do not have voting rights in company matters unless their dividend is in arrears. 4. Convertible vs Non-Convertible: Preference shares may be converted into equity shares after a certain period, or they may be non-convertible. 5. Redeemable vs Irredeemable: Redeemable preference shares have a fixed maturity period and are repaid by the company after a certain time. Irredeemable shares do not have a maturity period 10) Reasons to issue/subscribe to preference shares ANSWER: For Companies: 1. Cost-effective: It is often cheaper than raising equity since dividends are fixed. 2. No dilution of control: Preference shareholders typically don’t have voting rights, so the control of the company is not diluted. 3. Tax Benefit: Dividends paid to preference shareholders are fixed and thus predictable. For Investors: 1. Fixed Returns: Preference shares offer a fixed dividend, making them attractive to investors who seek regular income. 2. Priority in liquidation: In case of liquidation, preference shareholders get paid before equity shareholders, reducing the risk. 3. Convertible Option: Convertible preference shares can provide the opportunity to benefit from the growth of the company if converted into equity. 11) Stages of PE-VC funding ANSWER: 1. Self-funding 2. Seed-capital 3. Venture 4. Series A 5. Series B 6. Series C 7. Series D 8. IPO ( initial public offering ) 12) Terminologies of IPO ANSWER: 1. Prospectus: A legal document issued by a company that is planning to go public. It contains information about the company’s financials, business model, risk factors, and the purpose of the IPO. 2. Red Herring Prospectus (RHP): A preliminary version of the prospectus that lacks details on the price and number of shares being offered. 3. Book Building Process: A method of IPO pricing where investors place bids for the shares at various prices within a set price band. The final price is determined by the demand. 4. Underwriters: Financial institutions that help the company in the IPO process by guaranteeing the purchase of shares that are not bought by the public. 5. Lock-in Period: A period after the IPO during which certain investors (usually promoters and insiders) cannot sell their shares 13) Investor classification for IPOs ANSWER: Retail Individual Investors (RIIs): These are individual investors who apply for shares with an investment amount of up to ₹2 lakhs. Non-Institutional Investors (NIIs): These investors invest more than ₹2 lakhs in an IPO but are not QIBs. Qualified Institutional Buyers (QIBs): Institutions like mutual funds, banks, financial institutions, etc., that meet the SEBI criteria for QIBs. Anchor Investors: A sub-category of QIBs who are allotted shares ahead of the IPO at a price decided by the company. 14) Types of Offer ANSWER: 1. Fresh Issue: When a company issues new shares to raise capital. The proceeds go to the company for growth, debt repayment, or other corporate purposes. 2. Offer for Sale (OFS): Existing shareholders (promoters, venture capitalists, etc.) sell their shares to the public. The company does not receive any proceeds from this offer. 3. Follow-on Public Offer (FPO): This is an issuance of shares after the company has already gone public through an IPO. It is usually done to raise additional capital. 15) Advantages & Disadvantages of IPO ANSWER: Advantages: 1. Access to Capital: IPOs provide companies with access to a large pool of capital for expansion, debt repayment, or other needs. 2. Increased Visibility: Being publicly listed increases the company’s visibility, credibility, and public image. 3. Liquidity for Shareholders: Existing shareholders, including founders and employees, can sell their shares in the open market, providing them with liquidity. Disadvantages: 1. High Costs: The process of going public involves substantial costs, including underwriting fees, legal fees, and compliance costs. 2. Regulatory Scrutiny: Public companies are subject to stringent regulatory requirements and must regularly disclose financial and operational information. 3. Pressure to Perform: Public companies face pressure from shareholders and analysts to meet quarterly earnings expectations, which can lead to short-term decision-making. 16) IPO Eligibility Norms : ANSWER: According to SEBI guidelines, for a company to be eligible for an IPO, it must meet certain criteria: 1. Track Record: The company must have a track record of profitability for at least three of the last five years. 2. Net Tangible Assets: The company must have net tangible assets of at least ₹3 crores in each of the preceding three years. 3. Paid-up Capital: The company must have a minimum paid-up capital of ₹1 crore. 4. No Default: The company should not have defaulted on any dues to financial institutions or banks. 17) IPO Issue Pricing ANSWER : There are two main methods of pricing an IPO: 1. Fixed Price: The price at which shares are offered is set beforehand and disclosed in the prospectus. 2. Book Building: The company offers a price range (price band) for the shares, and investors place bids at different prices within that range. The final price is determined by the demand. 19) IPO Intermediaries & their roles: ANSWER : Lead Managers: Investment banks or financial institutions that manage the IPO process, including pricing, underwriting, and marketing. Underwriters: They guarantee the sale of shares by purchasing any unsold shares, thus ensuring the company raises the required funds. Registrars: They manage the documentation and process investor applications. Brokers: They facilitate the sale of shares to retail investors. Legal Advisors: They ensure compliance with regulatory requirements and legal formalities. 20) Objectives of Money Markets: ANSWER: Money markets are used for short-term borrowing and lending, typically for periods of less than one year. The objectives include: 1. Liquidity Management: They provide a mechanism for managing the short-term liquidity needs of businesses and financial institutions. 2. Monetary Policy: Central banks use the money market to implement monetary policy by influencing short-term interest rates. 3. Facilitating Trade: It facilitates the settlement of short-term transactions and aids in the efficient functioning of financial markets. 21) Constituents of Money Markets along with their features ANSWER: Treasury Bills (T-Bills): Short-term government securities with maturities of up to one year. They are issued at a discount and redeemed at face value. 1. Commercial Paper (CP): Unsecured, short-term debt issued by corporations to meet short-term liabilities. 2. Certificates of Deposit (CD): Negotiable instruments issued by banks, representing a fixed-term deposit. 3. Repurchase Agreements (Repo): Agreements where one party sells a security and agrees to repurchase it at a higher price on a later date. 4. Call Money: Very short-term loans are used by banks to meet their daily reserve requirements. 22) Repo / Reverse Repo / Bank Rates ANSWER:  Repo Rate: The rate at which the central bank lends short-term money to commercial banks against government securities. It is used to control inflation and liquidity in the economy. Reverse Repo Rate: The rate at which the central bank borrows money from commercial banks. It is used to absorb excess liquidity from the system. Bank Rate: The rate at which the central bank lends to commercial banks without any collateral. It influences long-term lending rates and is used for controlling credit expansion. Learn the following: REPO RATE REVERSE REPO RATE 1) Explain the difference between Equity & Debt wrt - Instruments, Cashflows, Tax, Life, Control & Cost ANSWER) Equity and debt represent two different ways of raising capital for a company, each with distinct characteristics in terms of instruments, cashflows, tax implications, life, control, and cost. Let's break these down: