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By the end of the fourth year. Thus, more generally, if there were n cash flows, the number of IRR would be n - 1. Asset's estimated net scrap, salvage or trade in value on the estimated date of disposal. Every transaction has two aspects. When the payments are made at the beginning of the payment period. Years to Maturity Bond Value 7 The IIBF aims at developing professionally qualified and able bankers through a process of training, education, counselling and examinations along with proper development programmes.
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For anyone aspiring to be a world-class financial analyst, these books are a great source of self-study material you can use to learn financial modeling, valuation, and Excel-based analysis. Enroll today to advance your career! How much will you have in the bank after 7 years? How much will you have in the bank after 25 years? How much will you have in the bank after one year? After four years? How long will it take to have Rs.
In problems 6 and 7. This formula. Investing this way to meet some future obligation is commonly called sinking fund. In problems 4 and 5. If you deposit Rs. C in the bank. Do the same calculations as in the problem Sinking funds are used to pay-off debts.
Calculate the annuity payment for the second year and for the third year. Calculate the real annuity payment assuming that inflation is 2 per cent per year. What is the annuity payment?
In the third year. Show that after four years the ending balance is exactly zero. Suppose that you have Rs. Suppose that you deposit Rs. Find the monthly payment on a thirty year mortgage with a Rs. If the inflation rate is 5 per cent. In the problems In the second year. How much will you have to deposit each year?
Suppose that you want to have Rs. Find the monthly payment on a five year auto loan with a Rs. B is the initial balance. Since the amount needed in the sinking fund. Such a fund is called a sinking fund. How much will you have after you make your deposit at the start of the tenth year? The formula for finding the monthly payment on a mortgage or an auto loan is the same as the formula for an annuity.
What is the real interest rate that would be used to calculate a real annuity payment? The annuity payment in the first year is equal to the real annuity payment. Show that the annuity works.
A schedule www. Suppose that the inflation rate is 2 per cent per year. Calculate the actual annuity payments for each of the four years. Illustration 1. An annuity consists of monthly repayments of Rs. A construction company plans to purchase a new earthmover for Rs. Determine the annual savings required to purchase the earthmover if the return on investment is 12 per cent. If you wish an annuity to grow to Rs.
How much money will a student owe at graduation if she borrows Rs. When money is lent. It should be noted that the sinking fund remains under the control of the borrower. At the end of the term of the loan. In order to provide funds for the difference between the replacement cost and the salvage value. This fee is called 'interest'— 'simple' interest or 'flat rate' interest.
If the fund earns 7 per cent compounded annually. A new machine at that time is expected to sell for Rs. The sum of the interest payment and the sinking-fund payment. When the sinking-fund method is used. Type To solve the previous two problems using Excels' built-in functions: Illustration In 10 years. The book value of the debt. The amount of simple interest paid each year is a fixed percentage of the amount borrowed or lent at the start.
A sum of money is lent out at compound interest for two years at 20 per cent p. Give your answer to the nearest Re. Sinking Fund: When there is a need for a specified amount of money at a specified future date. Calculate the total amount of his savings at the end of the third year. Find the annual payment. If the same sum of money is lent out at a compound interest at the same rate per cent per annum.
This is compounding of interest or more simply stated compound interest. A man borrowed a certain sum of money and paid it back in 2 years in two equal instalments. Find the rate of interest and the principal. A man borrows Rs. A sum of Rs.
The rule allows us to determine the number of years it takes your money to double whether in debt or investment. Divide the number 72 by percentage rate you are paying on your debt or earning on your investment Annuities: They are essentially a series of fixed payments required from you or paid to you at a specified frequency over the course of a fixed period of time. A man saves every year Rs. If the rate of compound interest was 4 per cent per annum and if he paid back Rs.
Calculate the sum of money lent out. When interest is added to the account against returning it immediately to the customer.
A loan of Rs. He repays Rs.
Calculate the amount outstanding at the end of the third payment. A person invests Rs. Compounding Period: The time interval. Find the value of each instalment.
The simple interest on a certain sum for 3 years is Rs. The interest is compounded annually at 10 per cent. If the rate of depreciation is 10 per cent. Assuming that land appreciates at 20 per cent annually and building depreciates at 20 per cent for first 2 years and at 10 per cent thereafter.
Find the amount which he has to pay at the end of the fourth year. How much should he invest? A gets the same amount as B gets after 5 years.
Find out EMI if loan is Rs. If money is worth 5 per cent compounded semi-annually to him. Also find the effective rate of interest.
The rate of interest charged is 20 per cent annually. The rate of compound interest is 5 per cent per annum. At the birth of a daughter. After 3 years. The present value of a machine is Rs. If it is supposed to depreciate each year at 8 per cent of the value at the beginning of the year.
Answers 1. In buying a house. The machinery of a certain factory is valued at Rs. Find the nominal rate compounded monthly equivalent to 6 per cent compounded semi-annually. The population of a town increased from 2 lakh to 8 lakh in last 10 years.
A debtor may discharge a debt by paying a Rs. X pays Rs. Find the amount of each instalment. If rate of interest is 15 per cent compounded annually. If Mr. The cost of a refrigerator is Rs. Two partners A and B together invest Rs. If its value depreciates 6 per cent in the first year. If the same trend continues. Divide Rs. A person buys a land at Rs. If it depreciates at 10 per cent per annum. X takes a housing loan of Rs. Find their shares in the sum of Rs. At 6 per cent compounded semi-annually.
Prepare a schedule for this problem. What quarterly deposits for the next 5 years will cause the fund to grow to Rs. Make out the rest three and last three lines of the schedule. A couple is saving a down payment for a home. He should accept b Rs. Make out schedule for this problem. What quarterly deposit is required in a bank account to accumulate Rs. A city needs to have Rs. A company wants to save Rs. A cottagers' association decides to set up a sinking fund to save money to have their cottage road widened and paved.
How much is in the fund at the end of 3 years? What annual deposit is required per cottager if there are 30 cottages on the road? Show the complete schedule. How much must be deposited in the fund at the end of each year? Make out a schedule showing the growth of the fund. They want to have Rs. Find the quarterly deposits necessary to accumulate Rs. Find the amount in the fund at the end of 9 years and complete the rest of the schedule. What monthly deposits are required if the fund earns 5 per cent compounded daily?
Show the first three and the last two lines of the sinking-fund schedule. How much is in the sinking fund at the end of 4 years? A homeowners' association decided to set up a sinking fund to accumulate Rs. Do a complete schedule for this sinking fund.
The company sets up a sinking fund to finance the replacement of the machine. If the fund contains Rs. A city borrows Rs. PartD 1. Find the value of the sinking fund at the end of the 1 Oth year. At the same time. Find a the semi-annual expense of the debt.
Verify that the sum-of-the-interest column plus the sumof-the-deposit column equals the sum of the increase-in-the-fund column. PartC 1. What monthly deposit is required to accumulate Rs. A company issues Rs. A borrower of Rs. Consider an amount that is to be accumulated with equal deposits R at the end of each interest period for 5 periods at rate i per period. In its manufacturing process. On a debt of Rs. How many years to the nearest quarter will it take them. What is the total annual expense of the debt?
They can save Rs. A couple wants to save Rs. A sinking fund accumulating at. Recommendations on Capital Charge 2. Cooke The distinctive feature of the Herstatt failure was the way it disrupted the clearing mechanism for spot foreign exchange transactions. Basel II norms are centred on sustained economic development over the long haul and include www. Basel 'not to harmonise national laws and practices but rather to interlink disparate regulatory regimes with a view to ensuring that all banks are supervised according to certain broad principles'.
It was. Bankhaus Herstatt. After much discussion. By end. The Basel committee on banking supervision had come out with a new consultative paper on 'New Capital Adequacy Framework' in June. Against this background. On 26th June. There were widespread losses affecting several West German banks as well as Italian and Japanese banks whose own national authorities at that time were poorly placed to provide emergency dollar support.
The new standards are mandatory for Internationally active banks. It came into effect by end Basel I was originally designed to apply only to internationally active banks in the G countries. The third world debt crisis of the early s also exposed the fragility of the international banking system and the urgency of preventing capital erosion and strengthening banks' balance sheets. The G supervisors joined in. What is Capital Adequacy? It is a cushion against unexpected losses Under the new accord.
The Second Pillar. In this. High non-performing assets exacerbate the pressure on bank's capital by reducing the ratio of capital to risk-weighted assets the absolute value of capital and leaking revenue availability of less free capital. It sets the minimum ratio of capital to risk weighted assets and in doing so.
The new risk sensitive approach seeks to strengthen the safety and soundness of the industry by focusing on: Risk-based capital Pillar 1. Each of these three pillars has risk mitigation as its central plank. It proposes. Influence of level ofNPAs. The revised credit risk measurement methods are more elaborate than the current accord. Basel II focuses on improvement in measurement of risks.
Minimum Capital Requirement The first pillar sets out the minimum capital requirement. The new framework maintains the minimum capital requirement of 8 per cent of risk assets. The new proposal is based on three mutually reinforcing pillars that allow banks and supervisors to evaluate properly the various risks that banks face and realign the regulatory capital more closely with the underlying risks. Supervisory Review Process Supervisory review process has been introduced to ensure.
Credit Risk Basel II proposes three principle options: It is proposed to be effected through a series of disclosure requirements on the capital. The Third Pillar. These disclosures should be made at least semi-annually and more frequently if appropriate. Market Discipline Market discipline imposes strong incentives to banks to conduct their business in a safe. Credit Loss within the entire banking group are considered. Alternative methods for computing capital requirement for credit risk are depicted below.
For the measurement of credit risk. To ensure that risks e. Qualitative disclosures such as risk management objectives and policies.
The IRB method proposes two approaches: The requirements under this pillar are common to all regulated firms. The process has four key principles: This is similar to credit risk.
Specific risk. As banks in India are still in a nascent stage of developing internal risk management models. Three approaches have been proposed for the measurement of operational risks: The Basel committee suggested two broad methodologies for computation of capital charge for market risk.
As per the guidelines. The specific risk charges are divided into various categories such as investments in Govt securities. Trading book includes: The guidelines address the issues involved in computing capital charge for interest rate related instruments in the trading book. General market risk Specific Risk: Capital charge for specific risk is designed to protect against an adverse movement in price of an individual security due to factors related to the individual issuer.
General Market Risk: Capital charge for general market risk is designed to capture the risk of loss arising from changes in market interest rates. We also have cooperative banks in large numbers. For this purpose. On the other hand. Approach to Prudential Norms The Reserve Bank's approach to the institution of prudential norms has been one of gradual convergence with international standards and best practices.
Foreign bank branches operate profitably in India and. There are also the Regional Rural Banks with links to their parent commercial banks. RBI prefers that banks measure all of their general market risk by calculating the price sensitivity modified duration of each position separately. We have the dominance of Government ownership coupled with significant private shareholding in the public sector banks.
As the duration method is a more accurate method of measuring interest rate risk. RBI has stipulated and achieved a minimum capital adequacy of 9 per cent. This has also been the guiding principle in the approach to the new Basel Accord.
The aim has been to reach global best standards in a deliberately phased manner. The process of providing financial services is changing rapidly from traditional banking to a one-stop shop of varied financial services. Issues Proposed Measures www. The framework adopted by banks would need to be adaptable to changes in the business. Enhancing the area of disclosures Pillar III.
Improving the level of corporate governance standards in banks. These are largely in alignment with the international best practices. In terms of AS The non-fund based exposures to entities. Secured advances 10 per cent of total outstanding.
As a result. The provisioning requirements on substandard assets may be increased to 20 per cent for secured advances and 30 per cent for unsecured advances. The age of delinquency may also be reviewed to ensure that all working capital exposures beyond a delinquency of 36 months are fully provided.
Unsecured advances. The proposed schedule for provisioning should be as under: Category Category Age of delinquency Provisioning per cent Substandard 90 days to 15 months.
The system should move forward to a differential capital regime. Banks are maintaining capital for both credit risk and market risk exposures. Migration to Basel II at the minimum approaches would be making the banks' capital adequacy framework more risk sensitive than under the Basel I.
Migration to a fuller CAC is likely to throw up numerous challenges to the banks' risk management systems. The 'complex' banks as defined in Paragraph 7.
The capital adequacy framework. The working capital exposures in the NPA accounts will attract a per cent provisioning requirement on both the secured and unsecured portions. As of March In view of this and since the system may not be able to rank risk objectively. The Indian banking system will be adopting the standardised approach for credit risk. Considering the fact that retail exposures include a much wider weaker segment. It may be raised to at least 66 per cent.
On a quick broad assessment. Banks will be maintaining capital for operational risks under the Basel II in addition to the credit risks and market risks. The risk. Reserve Bank has advised banks in India to implement the revised capital adequacy framework popularly known as Basel II with effect from 31st March. RBI should decide on the methodology for setting off the losses against capital funds.
Capital Adequacy It is the cushion against the unexpected losses and refers to the minimum capital requirement expressed in terms of percentage of the risk assets. Operational Risk Risk associated with unexpected disasters and events. They should be required to set off losses against capital funds. Credit Risk Risk associated with the lending of loans. Market Risk Risk associated with interest and other returns. What are the three pillars of Basel II framework? How is the capital adequacy measured?
Explain the types of risks and name the methods prescribed for measuring them. Definition and Meaning 3. The former means. In a less technical sense. By a liquid debt. In India. When the debtor fails to meet the conditions of repayment as per the contract of loan.
The holder of debt capital does not receive a share of ownership of the company when they provide funds to the firm. In cases of insolvent estates. In a still more enlarged sense. Debts are discharged in various ways. The mode and time of repayment are clearly expressed in the documents. In the payment of debts.
Debts are also divided into active and passive. Loans are granted by the banks or institutions based on the records and documentary evidences and. In return for loaning this money. This tax deducibility of debt payments means that the debt capital provides a 'tax-shield' which is not provided by the equity capital and.
If the company fails to pay the coupon interest or the redemption value. Bonds are negotiable promissory notes that can be used by individuals. In addition to the fact that debt is cheaper than equity capital because there is less risk.
The expected cash flows consist of annual interest payments plus repayment of principal. Coupon rate: A bond carries a specific rate of interest.
It is to be repaid on maturity. Irrespective of the level of profits or losses. Bonds issued by the government or the public sector companies are generally secured. It represents the amount borrowed by the firm. This entitles the bondholder to receive Rs. Redemption Value: The value. At the end of tenth year. Market value is the price at which the bond is usually bought or sold in the market.
In contrast. The interest payments on debt are said to be tax-deductible. The mix of debt and equity is known as the capital structure of the firm. This advantage relates to the differential tax treatment of interest payments on debt and dividend payments on equity. With the dividends now being taxed on the companies. A bond is redeemable after a specific period. In case of a bond. Market value may be different from the par value or the redemption value.
Market Value: A bond may be traded on a stock exchange. The fact that debt capital has a lower cost than equity capital. A bond is generally issued at a discount less than par value and redeemed at par. Private sector companies can issue secured or unsecured bonds. A bond is issued for a specified period. Face Value: Also known as the par value and stated on the face of the bond.
The required rate of return on bond is 10 per cent. What is the value of this bond? It is quite clear that the holder of a bond receives a fixed annual interest payment for a certain value equal to par value at the time of maturity. The required rate of return on the bond is 10 per cent. Illustration Consider a Rs. Using it. What would be the rate of return that an investor earns if he purchases the bond and holds until maturity?
Solution If kd is the yield to maturity then. The bond carries a coupon rate of 8 per cent and has the maturity period of nine years. The YTM is the discount rate.
The market value of this bond will be Rs. If the YTM increase by 20 per cent, i. YTM of bond X rises to 12 per cent 10 x 1. Bond ABC: Theorems for Bond Valuation - When the required Rate of Return is equal to the coupon rate, the value of the Bond is equal to its par value. When the required rate of return is less than the coupon rate, the value of the bond is greater than its par value etc.
This is always negative as both move in opposite direction. A capital project involves capital outflow investment and capital inflows net profit over the life of the project. PV will depend on the discount rate cost of capital. Depreciation is a method of allocating the cost of a tangible asset over its useful life.
Businesses depreciate long-term assets for both tax and accounting purposes. It is a decrease in an asset's value caused by unfavorable market conditions. Machinery, equipment, currency are some examples of assets that are likely to depreciate over a specific period of time.
Sum of years digits method; Example, if an asset is to be depreciated over five years, add digits 5,4,3,2,1. The total is Make provision for replacement of assets Factors of depreciation Cost of asset. Accounting is language of business. Communicate the result of business operations and its other aspects. Accounting is an art of recording classifying and summarizing in a significant manner and in terms of money transactions and events which are in part at least of financial character and interpreting the results thereof.
Accounting is often called the language of business. Book-keeping and Accounting not one and the same Book-keeping means recording the business Transactions. Accountancy means compilation of accounts in such a way that one is in a position to know the state of affairs of the business.
Book keeping is merely recording the business transactions in books and ledgers Accountancy is wider concept: Users of financial statements are income tax department, S.
It is in the interest of all that financial statements reflect true and fair view of state of affiairs of a business entity. Accountancy involves: Systematic classification of business transactions in terms of money and financial character. Financial Statements: To facilitate rational decision making To satisfy requirement of law and useful in many respects.
Types of Accounting: Concepts of Accountancy Cost Concept: Business transactions are recorded in books at cost price. Fixed assets are kept at cost of purchase and not at their market price. Every transaction is recorded with present value and not any future value. Unrealized gains are ignored. Cost of an asset that has long but limited life is systematically reduced by a process called depreciation. But such depreciation has no relation to market value of asset. Money Measurement Concept: Every transaction is measured in terms of money.
Inflation or deflation not included in value of any asset. Business Entity Concept This concept separates the entity of proprietor from the business transaction. Capital contributed by the owner is liability for business because business is different from owner. Any money withdrawn by prop. Is drawings. Profit is liability and loss is an asset. All entries are kept from the point of view of business and not from owner.
An enterprise is economic unit separate from owner. Realisation Concept This concept tells us when revenue is treated as realised or earned. It is treated as realized on the date when property in goods passes to buyer and he becomes legally liable to pay. No future income is considered. Goods sold on approval will be included in sales but on cost only. Going Concern Concept Business is a going concern and transactions are recorded accordingly. If an expense is incurred and utility is consumed during the year, then it is treated as an expense otherwise it is recorded as an asset.
Reserves and provisions are created for any future liability. Deferred revenue expenditure is written off over number of years. Why loss is shown under assets side? Dual Aspect Concept Every transaction has double effect. Accounting equation: Accounting Period Concept Business will run through long period. Hence accounts of each period is recorded. Results of operations can be known precisely only after business ceases to operate and entire assets are sold and entire liabilities paid.
But one is interested in knowing periodically operating results of business say yearly or half yearly or quarterly. Hence all the expenses or income during this accounting period has to be taken into consideration irrespective of whether they are realised in cash or paid in cash.
Accounting for full disclosure Disclosure of material facts. Convention or Principles of Conservatism All possible losses to be taken into consideration and anticipated profits to be ignored. Creation of provision for doubtful debts. Value of stock Convention of consistency: Double Entry System Scientific system: Every transaction has two aspects.
Crux of accountancy is to find out which two accounts are effected and which is to be debited and which is to be credited. Journal Journal records each and every record. But to find out a transaction effecting a person, expenses account or asset one has to turnover all pages of journal. Hence transactions are posted from journal to particular pages of ledger.
Hence journal contain a column L. Cash Book Cash book keeps records of all cash transactions i. All receipts are recorded on right side and all payments on left side. Cash book is book of original entry. Record keeping basis Recording: Journal is book of original or first entry. Ledger is book of secondary entry. It is customary to use to and by while posting ledger. Balancing an account means equalizing two sides. If debit side of account exceed credit side, difference is put on credit side and it is said to have debit balance and vice versa..
Adjusting and closing entries While preparing trading and profit and loss account all expenses and income for the full period are to be taken into consideration. If expenses have been incurred but not paid during that period , liabilities for unpaid amount should be created before the accounts can be said to show the actual profit and loss. All expenses and income should properly be adjusted through accounting entries.
Trial balance is prepared from the books of accounts of organization.
Final accounts are the final process of accounting. Once the trial balance is prepared the books are half way closed. Now all adjusting entries passed at the time of preparing the final accounts have dual effect i. Hence all adjusting entries passed after Trial balance drawn will have two effects. One in either trading and profit and loss account and other in Balance sheet or one in trading account and other in Profit and loss account.
Some examples: Closing stock adjustment: Will be shown in asset side of balance sheet and will be shown in credit side of trading account. Goods lost by fire: Will be shown in credit side of trading account. Will be shown on debit side of profit and loss account.
Outstanding expenses: Will be shown in debit side of profit and loss account. Will be shown in liabilities side of balance sheet. Prepaid expenses: It is fall in value of asset due to use or passage of time.
Depreciation Dr. To asset account. Accounting standards: Institute of chartered accountants of India recognising the need to harmonise the diverse accounting policies and practices constituted an accounting standards board in the year Day book and GLB posting in a bank The general ledger balance is virtually trial balance of the bank on a particular day.
It reflect the balances of all accounts. While preparing balance sheet and profit and loss account of branch of bank the GLB balances are taken.
Balance sheet of all branches together when consolidated becomes the balance sheet of bank. Generally accepted accounting principles. The common set of accounting principles, standards and procedures that companies use to compile their financial statements.
GAAP are a combination of authoritative standards set by policy boards and simply the commonly accepted ways of recording and reporting accounting information. GAAP are imposed on companies so that investors have a minimum level of consistency in the financial statements they use when analyzing companies for investment purposes. GAAP cover such things as revenue recognition, balance sheet item classification.
Companies are expected to follow GAAP rules when reporting their financial data via financial statements. That said, keep in mind that GAAP is only a set of standards. What is important that its underlying objectives are followed in true perspective. Basic Accountancy procedures At the recording stage: Business entity concept Money measurement concept Objective evidence concept Historical record concept Cost concept Dual aspect concept.
Some of the important Accounting Standards are: At the reporting: Going Concern concept Accounting period concept Matching concept Conservatism concept Full disclosure concept Materiality concept. Bank reconciliation B. Credit the giver and debit the receiver B. Causes of differences Cheque issued but not presented for payment Cheque deposited but not yet realized Bank charges Interest on saving bank Int. Instructions Dishonor of a Cheque Direct payment into bank by customer errors.
Trial balance A Trial Balance is a list of accounts and their current balances at a given date. It is usually prepared on the last day of the accounting period and the list of account balances are arranged according to debit and credit balances.
Before preparing financial statements at the end of a period, the books must be balanced, i. This is determined by preparing a trial balance. Debit balances are listed in one column and credit balances are listed in another. The two column totals should be equal. When this occurs, the ledger is said to be in balance. Preparing a trial balance for a company serves to detect any mathematical errors that have occurred in the double-entry accounting system.
Provided the total debts equal the total credits, the trial balance is considered to be balanced, and there should be no mathematical errors in the ledgers. A trial balance is prepared for two reasons To check the arithmetic accuracy, i. The debit totals and the credit totals should be equal if the double- entry system of book-keeping is followed. To write up the financial statements, i. Types of Errors.