Question 1

Ethics in finance mainly refers to:

Accepted Answer

Ethics means moral principles guiding conduct (concept).

Question 2

Capital budgeting mainly deals with decisions related to:

Accepted Answer

Capital budgeting evaluates long-term investment projects.

Question 3

Payback method’s key limitation is that it:

Accepted Answer

Simple payback ignores TVM and cash flows after payback (concept).

Question 4

Cash management aims to maintain:

Accepted Answer

Firms maintain optimum cash to balance liquidity and idle funds (concept).

Question 5

Compounding is used to find:

Accepted Answer

Compounding moves a present sum to its future value.

Question 6

Which is NOT a component of cost of capital?

Accepted Answer

Cost of packaging is not a financing cost component.

Question 7

Return from an investment includes:

Accepted Answer

Total return = income (interest/dividend) + capital gain/loss.

Question 8

If WACC is 10%, a project should generally be accepted when expected return is:

Accepted Answer

Projects should exceed the hurdle rate to create value (concept).

Question 9

Which is a principle of good corporate governance?

Accepted Answer

Transparency is a core governance principle (concept).

Question 10

A shorter operating cycle generally means:

Accepted Answer

Shorter cycle means cash returns faster, reducing WC need (concept).

Question 11

Risk in finance mainly refers to:

Accepted Answer

Risk is uncertainty that actual return differs from expected return.

Question 12

Cost of capital is commonly used as the ______ in NPV computation.

Accepted Answer

Cost of capital is used as the discount rate/hurdle rate (concept).

Question 13

Quick ratio is also called (concept):

Accepted Answer

Quick ratio is known as acid-test ratio (concept).

Question 14

Unsystematic risk is primarily:

Accepted Answer

Unsystematic risk relates to a firm/industry and can be reduced by diversification.

Question 15

Fairness in governance (concept) means:

Accepted Answer

Fairness relates to equitable treatment of stakeholders/shareholders (concept).

Question 16

IRR is the discount rate at which:

Accepted Answer

IRR is the rate that makes PV of inflows equal PV of outflows (NPV=0).

Question 17

The 'bird-in-hand' view is associated with (concept):

Accepted Answer

Gordon suggests investors prefer certain dividends over uncertain gains (concept).

Question 18

If IRR is greater than the required rate of return, the project should be:

Accepted Answer

IRR decision rule: accept if IRR exceeds required rate/cost of capital (concept).

Question 19

If ROI exceeds cost of debt, leverage can:

Accepted Answer

Positive leverage: debt can enhance EPS if earnings exceed interest cost (concept).

Question 20

Dividend payout directly results in:

Accepted Answer

Dividend typically causes cash outflow and affects liquidity (concept).

Question 21

Cost of capital is used as discount rate in NPV. (True/False)

Accepted Answer

True. Cost of capital is used as the **discount rate** (hurdle rate) in NPV (concept).

Question 22

Define financial statement analysis. (concept)

Accepted Answer

Financial statement analysis is evaluating financial statements to judge a firm’s **performance** and **financial position** (concept).

Question 23

What is dividend payout ratio? (concept)

Accepted Answer

Dividend payout ratio = Dividend / Earnings (profit available to shareholders) (concept).

Question 24

What is diversification?

Accepted Answer

Diversification means investing in different assets to reduce **overall risk** (concept).

Question 25

State one function of financial markets.

Accepted Answer

Financial markets provide **liquidity** (easy buying/selling) and help in price discovery (any one).

Question 26

State one example of systematic risk (concept).

Accepted Answer

Change in **interest rates** or inflation affecting the overall market (concept).

Question 27

Why is after-tax cost of debt considered? (one point) (concept)

Accepted Answer

Because interest is usually **tax-deductible**, the effective cost of debt is reduced after tax (concept).

Question 28

Define capital structure.

Accepted Answer

Capital structure is the mix of **long-term debt and equity** used to finance the company (concept).

Question 29

What is compliance? (concept)

Accepted Answer

**Compliance** means following applicable laws, regulations and internal policies while conducting business (concept).

Question 30

State the formula for current ratio.

Accepted Answer

**Current ratio** = Current assets / Current liabilities (concept).

Question 31

Explain how supplier credit affects working capital requirement (brief) using points/table (concept).

Accepted Answer

Effect of supplier credit (concept):

| Aspect | Impact on working capital |
|---|---|
| **Credit period from suppliers** | delays cash outflow for purchases |
| Operating cycle | effectively shortens cash conversion period |
| Result | reduces cash tied up, so **working capital requirement decreases** |

Thus, higher supplier credit generally lowers the firm’s working capital need (concept).

Question 32

Explain the scope of finance (any three areas).

Accepted Answer

Scope of finance (any three):

- **investment decisions** (projects/assets to invest in)
- **financing decisions** (equity, debt, retained earnings)
- **dividend decisions** (payout vs retention)
- working capital management (cash, inventory, receivables)

Any three areas with brief meaning are enough.

Question 33

Differentiate capital structure and financial structure (any three points) using a table.

Accepted Answer

Capital structure vs financial structure:

| Basis | **Capital structure** | **Financial structure** |
|---|---|---|
| Coverage | long-term funds (debt + equity) | all funds (long-term + short-term) |
| Includes | equity, long-term debt, preference (concept) | includes current liabilities also (concept) |
| Focus | long-term financing mix | overall financing pattern |

Thus, capital structure is a part of the broader financial structure.

Question 34

List any three unethical practices in finance (points).

Accepted Answer

Any three unethical practices (concept):

- **insider trading**
- window dressing / misrepresentation of accounts
- misleading disclosures / false projections (concept)
- conflict of interest and biased advice
- bribery and improper payments (concept)

Any three points are sufficient.

Question 35

Explain risk–return trade-off (brief) with a table and conclusion.

Accepted Answer

Risk–return trade-off: higher expected return generally comes with higher **risk**.

| Investment (concept) | Risk | Expected return |
|---|---|---|
| Fixed deposit | low | low–moderate |
| Shares | high | higher (uncertain) |

Conclusion: investors demand **risk premium** for taking additional risk.

Question 36

Write an exam-style note on unsystematic risk: meaning, examples and how diversification reduces it (include a flowchart and conclusion).

Accepted Answer

### Meaning
**Unsystematic risk** is company/industry-specific risk.

### Examples (concept)
- strike, fraud, management failure
- product failure, loss of major customer

### Diversification effect (flow)
Many different securities → different company-specific risks → losses in one may be offset by gains in another → **overall portfolio risk reduces**

### Conclusion
Diversification reduces unsystematic risk because it spreads company-specific shocks across multiple investments.

Question 37

Write an exam-style note on systematic risk: meaning, sources and why it cannot be eliminated (include a table and conclusion).

Accepted Answer

### Meaning
**Systematic risk** is market-wide risk that affects most securities due to economy-level factors.

| Source (concept) | How it impacts |
|---|---|
| **Interest rate** changes | affects borrowing cost and valuations |
| Inflation | reduces purchasing power; affects cash flows |
| Recession | lowers demand and profits across sectors |

### Conclusion
Systematic risk cannot be fully eliminated by diversification because it impacts the entire market, not just one company (concept).

Question 38

Write an exam-style answer on capital structure: meaning, factors affecting it, and conclusion (include a table).

Accepted Answer

### Meaning
**Capital structure** is the long-term mix of debt and equity.

### Factors (concept)
| Factor | Effect |
|---|---|
| Business risk | higher risk → prefer lower debt |
| Cost of debt vs equity | cheaper debt may be used more (concept) |
| Cash flow stability | stable cash flows can support debt |
| Control considerations | issuing equity may dilute control (concept) |

### Conclusion
An optimal capital structure balances **return** and **risk** by choosing an appropriate debt–equity mix (concept).

Question 39

Write an exam-style answer explaining fund flow in primary and secondary markets with a flowchart and conclusion.

Accepted Answer

### Flowcharts
Primary market (new issue): Investors → **Issuer** (company/government) → funds used for projects

Secondary market (trading): Buyer investor → Seller investor (ownership transfers; issuer not directly funded in that trade)

| Market | Funds go to | Benefit |
|---|---|---|
| **Primary** | issuer | capital raising |
| **Secondary** | seller | **liquidity** + price discovery |

### Conclusion
Primary market creates new securities and funds the issuer, while secondary market provides liquidity and market pricing.

Question 40

Explain financial institutions and their role in the financial system (exam-style) with a table and conclusion.

Accepted Answer

### Meaning
Financial institutions are intermediaries (banks, insurance, mutual funds etc.) that collect savings and provide credit/investment avenues (concept).

| Role | How it helps |
|---|---|
| **Intermediation** | channels savings to investment/credit |
| Services | payments, settlement, advisory (concept) |
| Risk sharing | pooling and diversification (concept) |

### Conclusion
Institutions make the financial system efficient by mobilising savings, improving access to funds, and supporting economic growth.

Principles of Finance — Question Paper

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