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Q.1.- Show the relationship between required rate of return and coupon rate on the value of a

bond.Ans. It is important for prospective bond buyers to know how to determine the price of abond because it will indicate theyieldreceived should the bond be purchased. In this section, we willrunthrough some bond price calculations for various types of bond instruments.Bonds can be pr iced ata premium,discount, o r a t par . If the bonds price is high er than i ts par value, it will sell at a

premium because its interest rate is higher than current prevailing rates. Ifthe bonds price is lowerthan its par value, the bond will sell at a discount because its interestrate is lower thancurrent prevailing interest rates. When you calculate the price of a bond, you

are calculating the maximum price you would want to pay for the bond, given the bonds couponrate incomparison to the average rate most investors are currently receiving in the bond market.Required yieldor required rate of return is the interest rate that a security needs to offer in order to encourage investors topurchase it. Usually the required yield on a bond is equal to or greater than the current prevailing interestrates.Fundamentally, however, the price of a bond is the sum of the present valuesof allexpectedcouponpayments plus the present value of the par value at maturity.Calculating bondprice

iss i m p l e : a l l w e a r e d o i n g i s d i s c o u n t i n g t h e k n o w n f u t u r e c a s h f l o w s .R e m e m b e r t h a t t o calculate present value (PV)which is based on the assumption that eachpayment is re-investedat some interest rate once it is receivedwe have to know the interestrate that would earn us aknown future value. For bond pricing, this interest rate is therequired yield. (If the concepts of present and future value are new to you or you areunfamiliar with the calculations, refer to Understanding the Time Value of Money.)H ere i s t h e fo rmu l a f o r ca l cu l a t i n g a b on d s p r i c e , wh i ch u se s t h e ba s i cp r e s e n t v a l u e( P V ) formula:C = c o u p on p a y m e n t n =

n u m b e r o f p a y

m e n t s i = i n t e r e s t r a t e ,o r r e q u i r e d y i e l d M = value at maturity, or par valueThesuccession of coupon payments to be received in the future is referred to asanordinaryannuity, which is a series of fixed payments at set intervals over a fixed period of time.(Couponson a straight bond are paid at ordinary annuity.) The first payment of an ordinary annuityoccursone interval f rom the time a t which the debt security is acquired. The calculationassumes this time is the present.You may have guessed that the bond pricing formula shown above may be

t e d i o u s t o c a l c u l a t e , a s i t r e q u i r e s a d d i n g t h e p r e s e n t v a l u e o f e a c hf u t u r e c o u p o n payment. Because these payments are paid at an ordinaryannu ity, however, we c a n u s e t h e s h o r t e r P V - o f - o r d i n a r y -a n n u i t y f o r m u l a t h a t i s m a t h e m a t i c a l l y equivalent to the summation of all the

PVs of future cash flows. This PV-of-ordinary-annu i t y f o rmu la rep laces t he need t o addal l t he pr es ent va lu es of the fu tu re coupon. The following diagram i llustrateshow present value is calculated for anordinary annuity:E a c h f u l l m o n e y b a g o n t h e t o p r i g h t r e p r e s e n t s t h e

f i x e d c o u p o n p a y me n t s ( f u t u r e v a l u e ) received in periods one, two and three. Notice how the

present value decreases for those coupon payments that are further into the future the present value of the

second coupon payment is worthless than the first coupon and the third coupon is worth the lowest

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Should a bond pay quarterly payments, F would equal four, and if the bond paid semi-annualcoupons, F would be two.

Q2.What do you understand by operating cycle.

Ans.An operating cycle is the length of time between the acquisition ofinventory and the sale of thatinventory and subsequent generation of a profit. The shorter theoperating cycle, the faster a business getsareturn on investment (ROI) for theinventory it stocks. As a general rule, companies want to keep theiroperatingcycles short for a number of reasons, but in certain industries, a long operatingcycle is actually

the norm. Operating cycles are not tied to accounting periods, butare rather calculated in terms of howlong goods sit in inventory before sale.When a business buys inventory, it ties up money in the inventoryuntil it can besold. This money may be borrowed or paid up front, but in either case, once thebusiness haspurchased inventory, those funds are not available for other uses. Thebusiness views this as an acceptabletradeoff because the inventory is aninvestment that will hopefully generate returns, but keeping theoperating cycleshort is still a goal for most businesses so they can keep their liquidity high.

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Keeping inventory during a long operating cycle does not just tie up funds.Inventory must be stored andthis can become costly, especially with items thatrequire special handling, such ashumidity controls orsecurity. Furthermore,inventory can depreciate if it is kept in a store too long. In the case ofperishablegoods, it can even be rendered unsalable. Inventory must also be insured andmanaged by staffmembers who need to be paid, and this adds to overall operatingexpenses.There are cases where a longoperating cycle in unavoidable. Wineries anddistilleries, for example, keep inventory on hand for years

before it is sold, becauseof the nature of the business. In these industries, the return on investmenthappensin the long term, rather than the short term. Such companies are usually structuredin a way thatallows them to borrow against existing inventory or land if funds areneeded to finance short-termoperations.Operating cycles can fluctuate. During periods of economic stagnation, inventorytends to sitaround longer, while periods of growth may be marked by more rapidturnover. Certain products can beconsistent sellers that move in and out of inventory quickly. Others, like big ticket items, may bepurchased less frequently.All of these issues must be accounted for when making decisions aboutorderingand pricing items for inventory.

Q3. Q.3 What is the implication of operating leverage for a firm.

Ans.Operating leverage:Operating leverage is the extent to which a firm uses fixedcosts in producing its goods or offeringits services. Fixed costs include advertising expenses, administrative costs, equipment and technology,depreciation, and taxes,but not interest on debt, which is part of financial leverage. By usingfixedproduction costs, a company can increase its profits. If a company has a largepercentage of fixedcosts, it has a high degree of operating leverage. Automatedand high-tech companies, utility companies,and airlines generally have highdegrees of operating leverage.

As an illustration of operating leverage, assume two firms, A and B, produce andsell widgets. Firm Auses a highly automated production process with roboticmachines, whereas firm B assembles the widgets

using primarily semiskilled labor.Table 1 shows both firms operating cost structures.Highly automated firm A has fixed costs of $35,000 per year and variable costs of only $1.00 per unit,

whereas labor-intensive firm B has fixed costs of only $15,000per year, but its variable cost per unit ismuch higher at $3.00 per unit. Both firmsproduce and sell 10,000 widgets per year at a price of $5.00 perwidget.Firm A has a higher amount of operating leverage because of its higher fixed costs,but firm A alsohas a higher breakeven point

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the point at which total costs equaltotal sales. Nevertheless, a change of I percent in sales causesmore than a I percentchange in operating profits for firm A, but not for firm B. The degree of operatingleverage measuresthis effect. The following simplified equation demonstrates thetype of equation used to compute the degree of operating leverage, although tocalculate this figure theequation would require several additional factors such asthe quantity produced, variable cost per unit, and

the price per unit, which are usedto determine changes in profits and sales:Operating leverage is a double-edged sword, however. If firm As sales decreaseby I percent, its profits will decrease by more than I percent, too. Hence, the degreeof operating leverageshows the responsiveness of profits to a given change insales.Implications:Total risk can be divided into two parts: business risk and financialrisk. Business risk refers to the stability of a companys assets if it uses no debt orpreferred stock financing. Business risk stems from the unpredictable nature of doing business, i.e., theunpredictability of consumer demand for products andservices. As a result, it also involves the uncertaintyof long-term profitability.When a company uses debt or preferred stock financing, additional risk

financialriskis placed on the companys common shareholders.They demand a higherexpected return for assuming this additional risk, which in turn, raises a companyscosts. Consequently, companies with high degrees of business risk tend to befinanced with relatively lowamounts of debt. The opposite also holds: companieswith low amounts of business risk can afford to usemore debt financing whilekeeping total risk at tolerable levels. Moreover, using debt as leverage isasuccessful tool during periods of inflation. Debt fails, however, to provide leverageduring periods ofdeflation, such as the period during the late 1990s brought on bythe Asian financial crisis.

Q2. What are the factors affecting financial plan of a company?

Ans. We live in a society and interact with people and environment. What happens tous is not alwaysaccordance to our wishes. Many things turn out in our live areuncontrollable by us. Many decisions wetake are the result of external influences.So do our financial matters.There are many factors affect ourpersonal financial planning. Range from economic factors to global influences.Aware of factorsaffectingyour money matters below will certainly benefit your planning.Factors Affecting Financial Plan1.Natureof the industry:- Here, we must consider whether it is a capital intensive of labour intensive industry.

This will have a major impact on the total assets that the firm owns.2. Size of the company: -The size of the company greatly influences the availability offunds fromdifferent sources.A small company normally finals it difficult to raise funds from long term sources atcompetitive terms. On the other hand, large companies like Reliance enjoy the privilege of obtainingfunds both short term and long term at attractive rates.3. Status of the company in the industry:-A well established company enjoying agood market share, forits products normally commands investors confidence.Such acompany can tap the capital market forraising funds in competitive term for implementation new projects to exploit the new opportunityemerging from changing

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business environment.

4. Sources of finance available:-Sources of finance could be group into debt andequity. Debt is cheap butrisky whereas equity is costly.A firm should aim at optimum capital structure that would achieve the least

cost capital structure.A large firm with a diversified product mix may manage higher quantum of debtbecause the firm may manage higher financial risk with a lower business risk.Selectionof sources offinances us closely linked to the firms capacity to manage the risk exposure.

5.The capital structure of a company:- Capital structure of a company is influencedby the desire of theexisting management of the company to remain control over the affairs of the company.The promoterswho do not like to lose their grip overthe affairs of the company normally obtain extra funds for growthby issuing preference shares and debentures to outsiders.6. Matching the sources with utilization:-Theproduct policy of any good financialplan is to match the term of the source with the term ofinvestment.To finance fluctuating working capital needs, the firm resorts to short term finance.All fixed

assets-investment are to be finance by long term sources. It is a cardinal principal of financial planning.7.Flexibility:-The financial plan of company should possess flexibility so as to effectchanges in thecomposition of capital structure when ever need arises. If the capital structure of a company is flexible, itwill not face any difficulty in changing the sources of funds.This factor has become a significant onetoday because of the globalization of capital market.8. Government Policy:-SEBI guidelines, financeministry circulars, various clauses ofStandard Listing Agreement and regulatory mechanism imposed byFEMAa ndDepartment of CorporateAffairs (Govt of India) influence the financial plans ofcorporatetoday. Management of public issues of shares demands the companies with many status in India.They areto be compiled with a time constraint.