Solution to Previous Year Questions

Course Code: 506

Course Name: Advanced Financial

Management

Year: 2019

Prepared By: Shafi Al Mehedi

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1.a ) Explain the motives of issuing convertible securities.
Convertible securities are financial instruments issued by companies that can be converted into a certain number
of the company's common shares after a predetermined time period or under specific conditions. There are several
motives behind issuing convertible securities:
1. Attracting Investors: Issuing convertible securities can attract investors who are looking for potential
capital appreciation. These investors are willing to accept lower interest or dividend rates in exchange for
the option to convert the security into common stock if the company performs well.
2. Lower Interest Rates: Convertible securities often offer lower interest rates than regular debt securities
because of the conversion feature. Investors are willing to accept lower coupon payments in anticipation
of potential gains from the conversion of the security into common shares.
3. Flexibility in Financing: Companies might issue convertible securities to raise capital with more
flexibility. If the company's stock price rises significantly, the conversion of these securities results in
equity dilution, but the company does not need to repay the principal amount in cash. If the stock price
doesn’t rise, the company pays back the principal, similar to regular debt financing.
4. Delaying Dilution: If a company needs to raise capital but believes its stock is currently undervalued,
issuing convertible securities allows it to delay equity dilution. The conversion of these securities into
common shares happens in the future when the stock price might be higher, reducing the dilution impact
on existing shareholders.
5. Strategic Acquisitions: Convertible securities can be used strategically in acquisitions. If a company
wants to acquire another business in the future, it can issue convertible securities and use the proceeds if
and when the acquisition happens. If the acquisition does not occur, the company can repay the securities,
avoiding unnecessary debt.
6. Employee Stock Options: Convertible securities can also be used for employee stock option plans.
Companies can issue convertible bonds or preferred stock to employees, which can be converted into
common shares at a later date. This helps in retaining and motivating key employees.
7. Stock Price Support: The issuing of convertible securities can sometimes create a support level for the
company's stock price. Investors who purchase these securities with the intention of converting them into
common shares in the future provide a potential demand for the company’s stock.
In summary, issuing convertible securities provides companies with financial flexibility, allows them to attract a
broader range of investors, and can be a strategic tool for future financing and acquisitions. Investors, on the other
hand, are attracted to convertible securities because of the potential for capital appreciation and the ability to
convert the securities into common shares if the company performs well.

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b) Define the straight bond value, conversion value, and conversion premium associated with
a convertible bond. Show the general relationships among them.
1. Straight Bond Value: The straight bond value of a convertible bond refers to the value of the bond if it
were a traditional non-convertible bond. It represents the present value of the bond's coupon payments
and the principal amount (par value) discounted at the prevailing market interest rate for similar non-
convertible bonds. In the context of a convertible bond, this represents the floor value or the minimum
value of the bond if it were never converted into common stock.
2. Conversion Value: The conversion value of a convertible bond is the value of the bond if it were
converted into common stock at the current market price per share. It is calculated by multiplying the
conversion ratio (the number of shares the bond can be converted into) by the market price of the
company's stock. This represents the value that the bondholders would receive if they chose to convert
their bonds into equity.
3. Conversion Premium: The conversion premium is the difference between the market price of the
convertible bond and its conversion value. It is expressed as a percentage and calculated using the
following formula:
Conversion Premium=(Convertible Bond Price−Conversion ValueConversion Value)×100%
Conversion Premium=(Conversion ValueConvertible Bond Price−Conversion Value)×100%
If the conversion premium is positive, it means the convertible bond is trading above its conversion value. If it's
negative, the bond is trading below its conversion value.
The relationships among these values can help investors assess the attractiveness of a convertible bond:
 If the Convertible Bond Price > Conversion Value: This means the bond is trading at a premium to its
conversion value. Investors are paying more than the immediate equity value they would receive upon
conversion. The higher the premium, the less attractive the convertible bond is compared to the common
stock.
 If the Convertible Bond Price < Conversion Value: This indicates the bond is trading at a discount to
its conversion value. Investors can buy the convertible bond at a lower price than the immediate equity
value they would receive upon conversion. A lower conversion premium (or a negative premium) makes
the convertible bond more attractive relative to the common stock.
 If the Convertible Bond Price = Conversion Value: In this scenario, the conversion premium is zero.
The convertible bond is trading at par with its conversion value. Investors are essentially indifferent
between holding the convertible bond and holding the stock directly, assuming no other factors influence
their decision.
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Investors often analyze these relationships to make informed decisions about whether to invest in a convertible
bond based on its potential for capital appreciation and the relative safety provided by its bond-like features.

c) Intel corporation has an outstanding issue of convertible bonds with $1000 par value. These
bonds are convertible Into 20 shares of common stock. They have 10% annual coupon Interest
rates and 20-years maturity. The average interest rate on similar risk straight bonds is 11%.

i.. Calculate the investment value of the bond.

ii. Calculate the conversion value when the market price of common stock is $40, $50, and $55.
iii. Each of the stock price given, at what price would you expect the bond to sell for? And why?
Calculate the investment value of the bond:
The investment value of a convertible bond is the value of the bond as a fixed-income security, ignoring the
conversion option. This can be calculated using the following formula:
Investment value = (Par value * Coupon rate) / (Yield to maturity)
In this case, the par value is $1000, the coupon rate is 10%, and the yield to maturity is 11%. Therefore, the
investment value of the bond is:
Investment value = ($1000 * 10%) / (11%) = $909.09
ii. Calculate the conversion value when the market price of common stock is $40, $50, and $55:
The conversion value of a convertible bond is the value of the bond if it were converted into common stock. This
can be calculated using the following formula:
Conversion value = Number of shares * Market price per share
When the market price of common stock is $40, the conversion value of the bond is:
Conversion value = 20 shares * $40/share = $800
When the market price of common stock is $50, the conversion value of the bond is:
Conversion value = 20 shares * $50/share = $1000
When the market price of common stock is $55, the conversion value of the bond is:
Conversion value = 20 shares * $55/share = $1100
iii. Each of the stock price given, at what price would you expect the bond to sell for? And why?
The price at which a convertible bond sells for is determined by a number of factors, including the investment
value of the bond, the conversion value of the bond, and the market price of the underlying common stock.

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When the market price of the underlying common stock is below the conversion value, the bond is said to be
trading at a discount. This is because investors can get more value by converting the bond into common stock.
When the market price of the underlying common stock is above the conversion value, the bond is said to be
trading at a premium. This is because investors can get more value by selling the bond and buying the common
stock directly.
In this case, the investment value of the bond is $909.09. When the market price of the underlying common stock
is below $45.45 ($909.09 / 20), the bond is expected to sell for a price closer to its investment value.
When the market price of the underlying common stock is above $45.45, the bond is expected to sell for a price
closer to its conversion value.
Therefore, at a market price of $40 per share, the bond is expected to sell for a price closer to $909.09. At a market
price of $50 per share, the bond is expected to sell for a price closer to $1000. At a market price of $55 per share,
the bond is expected to sell for a price closer to $1100.
However, it is important to note that the actual price at which the bond sells for may deviate from the expected
price due to a number of factors, such as the overall market conditions and the creditworthiness of the issuer.

2. a) What are stock purchase warrants? What are the differences between the effects of
warrants and convertibles on the firm's capital structure and the ability to raise new capital?
Stock Purchase Warrants:
Stock purchase warrants are financial instruments that give the holder the right, but not the obligation, to buy a
specific number of shares of a company's stock at a predetermined price within a certain timeframe. Warrants are
often used as sweeteners in conjunction with other securities offerings, such as bonds or preferred stock. They
provide investors with the opportunity to purchase company shares at a fixed price in the future, allowing them
to benefit if the stock price increases beyond the warrant's exercise price.
Differences Between Warrants and Convertibles:
1. Effect on Capital Structure:
 Warrants: Warrants do not immediately impact the company's capital structure when issued.
They become a part of the capital structure only if and when they are exercised. When warrants
are exercised, the company issues new shares, increasing the number of outstanding shares and
potentially diluting existing shareholders.
 Convertibles: Convertible securities, such as convertible bonds, immediately impact the capital
structure when issued. They combine elements of debt and equity, with the potential to be
converted into common stock in the future. This means that the company has both debt and equity
obligations until the convertibles are either converted or mature.
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 2. Dilution Impact:
 Warrants: Warrants can result in dilution if and when they are exercised. When warrant holders
exercise their warrants, they receive new shares, which can dilute the ownership stake of existing
shareholders.
 Convertibles: Convertibles also have the potential to cause dilution, especially if the stock price
appreciates significantly, leading to conversion. When convertibles are converted into common
stock, existing shareholders' ownership percentages are diluted.
3. Ability to Raise New Capital:
 Warrants: Warrants provide companies with an opportunity to raise additional capital in the
future if and when warrant holders choose to exercise their warrants. This allows the company to
generate funds without incurring additional debt.
 Convertibles: Convertible securities allow companies to raise immediate capital at the time of
issuance, as investors are effectively lending money to the company with the potential for
conversion into equity in the future. This immediate infusion of capital can be beneficial for
funding projects or reducing existing debt.
4. Investor Behavior:
 Warrants: Warrant holders have the choice of when to exercise their warrants. They will typically
exercise their warrants if the current market price of the stock is higher than the warrant's exercise
price, allowing them to buy shares at a discount.
 Convertibles: Convertible bondholders may choose to convert their securities into common stock
if the stock price appreciates significantly, giving them the opportunity to benefit from capital
gains.
In summary, warrants and convertibles both provide avenues for companies to raise capital and for investors to
potentially benefit from future stock price appreciation. Warrants offer more flexibility to investors regarding the
timing of their investment, while convertibles have an immediate impact on the company's capital structure and
can provide immediate funding. The choice between warrants and convertibles depends on the company's
financing needs and the preferences of both the company and its investors.

b) What is warrant premium? At what price of common stock the warrant premium would be
the highest? Explain the situation graphically.
The warrant premium is the difference between the current market price of a warrant and its intrinsic value. In
other words, it represents the extra amount investors are willing to pay for the potential future profit that could be
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gained by exercising the warrant and buying the underlying stock at a predetermined price. The warrant premium
is influenced by various factors, including the volatility of the underlying stock, the time remaining until the
warrant's expiration, and the current market interest rates.
To understand at what price of common stock the warrant premium would be the highest, we can consider a
graphical representation using a payoff diagram.
In a payoff diagram, the x-axis represents the price of the underlying common stock, and the y-axis represents the
total value of the investment. For a warrant, the total value is calculated as follows:
Total Value of Warrant=Number of Warrants×(Stock Price−Warrant Strike Price)Total Value of Warrant=Num
ber of Warrants×(Stock Price−Warrant Strike Price)
Let's assume a scenario with the following parameters:
 Number of warrants = 1
 Warrant strike price = $50 (the price at which the warrant holder can buy the stock)
 Warrant premium = $10 (the extra amount investors are willing to pay for the warrant)
 Warrant expiration = 1 year
 Volatility and interest rates are constant
Here's how the payoff diagram would look like:
|
V |
a |
l |
u |
e |
|-----------------
| \
| \
| \
| \
| \
| \
| \
| \
| \
| \

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 | \
| \
| \
| \
| \
| \
|--------------------------------\
| /|
| /|
| / |
| / |
| / |
| / |
| / |
| / |
| / |
| / |
| / |
| / |
| / |
| / |
| / |
| / |
| / |
|--------------/-----------------|--------------
/50
In this diagram, the slope of the line represents the gain (or loss) for the warrant holder based on the price of the
underlying stock. As the price of the stock increases above $50, the value of the warrant (and the warrant
premium) increases linearly, as the warrant holder can buy the stock at a lower price than the market price.

The highest warrant premium occurs when the price of the common stock equals the warrant strike price ($50 in
this case). At this point, the warrant premium would be equal to the difference between the market price and the

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strike price, which is $0 in this scenario. Beyond this point, the warrant premium starts decreasing because the
warrant holder can already buy the stock at a price equal to the market price.

c) An investor is evaluating a company's common stock and warrant to choose the better
investment opportunity. The firm's stock is currently selling for $50 per share. A warrant of
the company to purchase 3 shares of common stock at $45 per share is selling for $20. The
investor has $8000 to invest.

i. Suppose he purchased the stock and then sold it for $60 per share. what percent of gain
would he realize ignoring brokerage fees and taxes?
ii. Suppose he purchased warrants and afterwards the market price of common stock increased
to $60 per share. What percent of gain would he realize from warrants ignoring other fees and
taxes?
iii. Comment on the risks of investing in both investment opportunities.
i)
If the investor purchases the firm's stock and then sells it for $60 per share, he would realize a gain of $10 per
share. This represents a 20% gain on his investment, calculated as follows:
(Gain per share / Purchase price per share) * 100% = 20%
($10 / $50) * 100% = 20%
Therefore, the answer is 20
ii)

If the investor purchases warrants and then the market price of common stock increases to $60 per share, the
warrants will be worth $45 per warrant, as they can be exercised to purchase 3 shares of common stock at $45
per share. This represents a $25 gain per warrant, calculated as follows:
$60 market price per share - $45 strike price per share = $15 gain per share
$15 gain per share * 3 shares per warrant = $45 gain per warrant
As the investor purchased the warrants for $20 each, this represents a 125% gain on his investment, calculated as
follows:
(Gain per warrant / Purchase price per warrant) * 100% = 125%
($45 - $20) / $20 * 100% = 125%

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Therefore, the investor would realize a 125% gain from the warrants.
iii)
Both investing in common stock and investing in warrants carry certain risks.
Common stock
 Market risk: This is the risk that the overall market will decline, which could cause the value of the
investor's stock to decline.
 Company-specific risk: This is the risk that the company itself will perform poorly, which could cause the
value of the investor's stock to decline.
 Liquidity risk: This is the risk that the investor may not be able to sell their stock when they want to, or
may have to sell it at a discounted price.
Warrants
 Expiration risk: Warrants have an expiration date, after which they become worthless. If the investor does
not exercise their warrants before they expire, they will lose their entire investment.
 Exercise price risk: The exercise price of a warrant is the price at which the investor can purchase shares
of common stock. If the market price of the common stock does not rise above the exercise price, the
warrants will be worthless.
 Leverage risk: Warrants are a leveraged investment, meaning that they can amplify both profits and losses.
If the market price of the common stock increases, the value of the warrants will increase at a faster rate.
However, if the market price of the common stock decreases, the value of the warrants will decrease at a
faster rate.

3. a) What is meant by business failure and what are the types of it?
Business Failure refers to a situation in which a business is unable to meet its financial obligations or sustain its
operations. Business failure can occur due to various reasons, both internal and external, and can have significant
consequences for the owners, employees, creditors, and the broader economy. It's a critical event in the business
lifecycle and can lead to closure, bankruptcy, or other forms of insolvency.
Types of Business Failure:
1. Financial Insolvency: This type of failure occurs when a company is unable to pay its debts as they
become due. Financial insolvency can result from mismanagement of funds, poor financial planning, or
economic downturns.
2. Operational Failure: Operational failure happens when a business is not able to efficiently produce goods
or services, leading to increased costs, reduced quality, and customer dissatisfaction. Factors such as

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 ineffective management, outdated technology, or lack of skilled employees can contribute to operational
failure.
3. Strategic Failure: Strategic failure occurs when a company's long-term planning or decision-making is
flawed. This can involve entering the wrong markets, pursuing unprofitable product lines, or failing to
adapt to changing consumer demands or technological advancements.
4. Market Failure: Market failure happens when a company fails to understand or respond to changes in
the market. This could be due to fierce competition, shifts in consumer preferences, or inability to
innovate, leading to declining sales and profitability.
5. Technological Failure: In today's digital age, technological failure is a significant risk. Businesses that
do not adopt relevant technologies or fail to protect their systems adequately can suffer disruptions, data
breaches, or loss of competitiveness.
6. Management Failure: Poor management decisions, lack of leadership, or internal conflicts can lead to
business failure. Ineffective management can result in poor financial management, low employee morale,
and a lack of strategic direction.
7. Regulatory Failure: Non-compliance with legal and regulatory requirements can lead to fines, legal
battles, or even shutdowns. Businesses that fail to adhere to industry standards or government regulations
risk severe consequences.
8. Environmental or Natural Disaster: Unforeseen events such as natural disasters, pandemics, or
geopolitical crises can severely impact businesses. Companies that do not have contingency plans or
appropriate insurance coverage may find it challenging to recover.
9. Human Factors: Human factors such as fraud, embezzlement, or unethical behavior can lead to financial
losses and reputational damage. Lack of ethics and integrity within the organization can erode trust and
lead to failure.

b) Discuss the major causes of business failure.

Business failure can result from a variety of factors, and often it is a combination of issues rather than a single
cause. Here are some major causes of business failure:
1. Poor Management: Incompetence, lack of experience, and poor decision-making by company leaders
can lead to disastrous outcomes. Management should have a clear vision, effective planning, and the
ability to adapt to changing market conditions.
2. Insufficient Capital: Inadequate funding or poor financial management can lead to cash flow problems.
Without enough capital to cover operating expenses, businesses may struggle to pay suppliers, employees,
or creditors, leading to financial insolvency.

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 3. Lack of Planning: Businesses without a solid business plan or strategic direction lack a roadmap for
success. A well-thought-out plan is crucial for setting goals, allocating resources, and navigating
challenges.
4. Market Misalignment: Failing to understand the target market, customer needs, or competitive landscape
can result in products or services that do not meet market demands. Businesses need to conduct market
research and adapt their offerings accordingly.
5. Ineffective Marketing: Poor marketing strategies or ineffective promotion can lead to low sales and
revenue. Effective marketing is essential for attracting customers and building brand awareness.
6. Failure to Innovate: Businesses that do not invest in research and development or fail to innovate can
become obsolete. Technological advancements and changing consumer preferences require businesses to
adapt and introduce new products or services.
7. Overexpansion: Rapid or uncontrolled growth can strain resources and management capabilities.
Overexpansion, whether in terms of locations, products, or services, can lead to a lack of focus and
increased operational complexities.
8. High Operational Costs: Inefficient operations, high overhead, or excessive spending can erode profits.
Cost management is critical to maintaining healthy profit margins.
9. Poor Employee Management: Inadequate training, lack of motivation, or high employee turnover can
negatively impact productivity and customer service. A skilled, motivated, and satisfied workforce is
essential for business success.
10. Economic Factors: Economic downturns, recessions, inflation, or changes in interest rates can affect
consumer spending, business investments, and access to credit, making it challenging for businesses to
operate profitably.
11. Legal and Regulatory Issues: Non-compliance with laws and regulations can lead to fines, lawsuits, or
business closure. Businesses need to stay updated on legal requirements relevant to their industry.
12. Supply Chain Disruptions: Events such as natural disasters, geopolitical conflicts, or global pandemics
can disrupt supply chains, leading to production delays and inventory shortages.
13. Technological Challenges: Failure to adopt relevant technologies or protect against cyber threats can
impact efficiency and data security.
14. Lack of Adaptability: Businesses that are resistant to change or fail to adapt to evolving market trends
and customer preferences risk becoming irrelevant.

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c) What is meant by voluntary settlement? Discuss the strategies under the voluntary settlement
to sustain the firm?
Voluntary Settlement:
Voluntary settlement refers to a situation in which a financially distressed business proactively takes steps to
negotiate with its creditors and stakeholders to restructure its debts, operations, or ownership in order to avoid
bankruptcy or liquidation. It is a voluntary arrangement between the business and its creditors, often overseen by
a mediator or financial advisor, to find mutually beneficial solutions that allow the business to continue its
operations while addressing its financial challenges.
Strategies under Voluntary Settlement to Sustain the Firm:
1. Debt Restructuring: Businesses can negotiate with creditors to extend the repayment period, reduce
interest rates, or even forgive a portion of the debt. Debt restructuring can provide immediate relief on
cash flow, making it easier for the business to meet its financial obligations.
2. Asset Sales: Selling non-core or underperforming assets can generate funds to pay off debts or invest in
core business operations. Businesses can focus on their core strengths and assets, which often leads to
increased efficiency and profitability.
3. Equity Investment: Bringing in new equity investors or partners can inject fresh capital into the business.
This infusion of funds can be used to pay off debts, invest in growth initiatives, or improve the overall
financial health of the company.
4. Operational Efficiency Improvement: Businesses can implement cost-cutting measures, improve
operational efficiency, and streamline processes to reduce expenses. This can involve renegotiating
contracts, optimizing supply chains, or implementing new technologies to increase productivity.
5. Customer and Market Focus: By understanding customer needs and market trends, businesses can tailor
their products or services to better meet demands. Satisfied customers are more likely to generate revenue
through repeat business and positive referrals.
6. Employee Engagement and Training: Engaged and well-trained employees tend to be more productive
and loyal. Investing in employee training and creating a positive work environment can lead to increased
efficiency and innovation.
7. Diversification: Diversifying product lines, services, or customer segments can spread risk and reduce
dependency on a single revenue source. Businesses can explore new markets or create complementary
products to enhance overall revenue streams.
8. Strategic Partnerships and Alliances: Collaborating with other businesses or forming strategic
partnerships can provide access to new customers, technologies, or distribution channels. Joint ventures
and alliances can lead to mutually beneficial outcomes for all parties involved.
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 9. Customer Relationship Management: Building strong relationships with customers through
personalized services, feedback mechanisms, and loyalty programs can enhance customer satisfaction and
retention. Satisfied customers are more likely to remain loyal and recommend the business to others.
10. Innovation and Adaptation: Continuous innovation and the ability to adapt to changing market
conditions are crucial. Staying ahead of the competition often requires investing in research and
development, exploring new technologies, and embracing change.
11. Legal and Taxation Strategies: Seeking legal advice for potential tax incentives, credits, or exemptions
can optimize the tax burden. Additionally, resolving legal disputes or regulatory issues promptly can
prevent long-term financial drains.

4. a) What is stock swap transactions? How is ratio of exchange calculated?

Stock Swap Transactions:
A stock swap, also known as a stock-for-stock exchange, is a financial transaction in which an investor or a
company exchanges their existing shares of one stock for shares of another company. Stock swaps are commonly
used in mergers, acquisitions, and other corporate restructuring activities. Instead of using cash to pay for the
acquisition of another company, the acquiring company offers its own shares to the shareholders of the target
company.
In a stock swap transaction, the shareholders of the target company receive shares of the acquiring company's
stock in exchange for their shares in the target company. The value of the shares received in the swap is based on
the exchange ratio, which is determined by the companies involved in the transaction. This ratio specifies how
many shares of the acquiring company will be given for each share of the target company.
Calculation of the Exchange Ratio:
The exchange ratio is calculated to ensure that the value of the shares being exchanged is fair and equitable for
both parties. The ratio is usually determined by considering the relative market prices of the two stocks involved
in the swap. Here's a simplified way to calculate the exchange ratio:
Exchange Ratio=Market Price of Target Company’s Stock/Market Price of Acquiring Company’s Stock
For example, let's say Company A wants to acquire Company B. Company A's stock is trading at $50 per share,
and Company B's stock is trading at $40 per share. The exchange ratio would be:
Exchange Ratio=$50/$40=1.25
In this case, shareholders of Company B would receive 1.25 shares of Company A's stock for each share of
Company B's stock they own.

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b) Discuss the process of merger negotiations. What aspects are usually discussed in the
process?
Mergers are complex transactions that involve negotiations between two or more companies to combine their
operations, assets, and resources. The process of merger negotiations typically follows a structured framework
and involves several key steps and aspects:
**1. Preliminary Discussions:
 Confidentiality Agreements: Before detailed discussions begin, companies often sign confidentiality
agreements to protect sensitive information shared during negotiations.
 Preliminary Proposal: The acquiring company may make an initial non-binding offer expressing interest
in the merger. This proposal outlines the basic terms of the deal, such as the type of consideration (cash,
stock, or a combination), valuation, and other key terms.
2. Due Diligence:
 Financial Due Diligence: Both companies exchange financial information and conduct thorough analyses
of each other's financial statements, assets, liabilities, and cash flow to assess the financial health of the
organizations.
 Legal Due Diligence: Legal experts review contracts, lawsuits, intellectual property rights, regulatory
compliance, and other legal aspects to identify potential risks and liabilities.
 Operational Due Diligence: Operations, IT systems, human resources, and other key operational aspects
are evaluated to identify potential synergies and challenges in integrating the businesses.
3. Definitive Agreement:
 Negotiation of Terms: Detailed negotiations take place regarding the terms of the merger, including the
final price, form of payment, governance structure, management roles, and any special conditions.
 Drafting the Merger Agreement: Lawyers from both parties work together to draft a definitive merger
agreement that outlines all the terms and conditions of the deal. This document is essential for legal clarity
and protection of both parties' interests.
4. Board Approval and Shareholder Consent:
 Board Approval: The boards of directors of both companies review the terms of the merger agreement
and vote to approve the deal.
 Shareholder Approval: Shareholders of the companies involved typically vote on the merger proposal.
Approval requirements vary based on corporate laws and the terms of the merger agreement.
5. Regulatory Approval:

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  Antitrust and Regulatory Clearances: The merger may need approval from antitrust authorities and
regulatory bodies to ensure that the combined entity does not create a monopoly or violate competition
laws.
6. Integration Planning:
 Integration Teams: Teams from both companies collaborate to plan the integration process, addressing
issues such as organizational structure, employee transitions, IT system integration, branding, and cultural
alignment.
 Communication Plans: Clear communication plans are developed for employees, customers, suppliers,
and other stakeholders to address concerns and ensure a smooth transition.
7. Closing the Deal:
 Closing Documents: Legal documents are finalized and signed, including the merger agreement, financial
agreements, and other necessary contracts.
 Transfer of Assets and Shares: The transfer of assets and shares is completed according to the terms of
the agreement, and the merger becomes official.
 Announcement: The merger is publicly announced, and the companies begin operating as a single entity.

c) Briefly explain the takeover defences in case of hostile takeover attempts.

In the context of hostile takeover attempts, companies deploy various strategies and mechanisms, often known as
"takeover defenses," to protect themselves from being acquired or to make the acquisition more difficult and
costly for the hostile bidder. Here are some common takeover defenses:
1. Poison Pill: A poison pill is a shareholder rights plan that allows existing shareholders to buy additional
shares at a discount if a hostile bidder acquires a certain percentage of the company's shares. This
significantly dilutes the hostile bidder's ownership stake, making the takeover financially unattractive.
2. Share Repurchase: The target company buys back its own shares, increasing demand and driving up the
share price. This makes it more expensive for the hostile bidder to acquire a controlling stake.
3. Staggered Board: A staggered board structure ensures that only a fraction of the board members are up
for re-election in any given year. This makes it difficult for a hostile bidder to gain control of the entire
board in a single election cycle.
4. Supermajority Voting Provisions: These provisions require a high percentage of shareholder votes
(beyond a simple majority) to approve certain actions, such as a merger. Hostile bidders may find it
challenging to secure the necessary votes.

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 5. Golden Parachutes: These are provisions in executive contracts that provide substantial financial benefits
to executives if there is a change in control of the company. Golden parachutes can make acquisitions
more expensive for the hostile bidder.
6. Crown Jewel Defense: The target company sells its most valuable assets to make itself less attractive to
the hostile bidder. This strategy reduces the value of the acquisition and can deter potential acquirers.
7. White Knight: The target company seeks out a friendly third-party acquirer (the white knight) as an
alternative to the hostile bidder. This strategy provides shareholders with a more appealing option and
discourages the hostile takeover attempt.
8. Litigation: The target company may initiate legal action against the hostile bidder, alleging securities
fraud, antitrust violations, or other legal violations. Legal battles can create uncertainties and delays,
discouraging the hostile bidder.
9. Pac-Man Defense: The target company turns the tables by making a counter-bid for the hostile bidder.
This unexpected move can deter the initial acquirer and create a more complex and competitive situation.
10. Crown Jewel Lock-Up: The target company may enter into agreements to sell its valuable assets to
friendly third parties if a hostile takeover occurs. These agreements become active upon the change of
control, making the acquisition less attractive to the hostile bidder.
It's important to note that the effectiveness of these defenses varies, and they often require careful planning and
consideration of legal and regulatory constraints. Additionally, shareholder reactions and public opinion can
influence the outcome of hostile takeover attempts and the implementation of these defenses.

d) Explain the concepts of Leveraged Buyouts (LBOs) and Divestitures.

Leveraged Buyouts (LBOs):
A Leveraged Buyout (LBO) is a financial transaction in which a company, investment group, or private equity
firm acquires another company using a significant amount of borrowed money (debt) to meet the cost of
acquisition. In an LBO, the assets of the target company are often used as collateral for the debt, and the acquiring
entity uses the cash flows of the acquired company to repay the debt over time. The goal of an LBO is to use the
target company's assets and cash flows to finance the acquisition, generate returns for the investors, and improve
the financial performance of the acquired business through restructuring, cost-cutting, and operational
improvements.
LBOs are typically executed by private equity firms and involve taking a public company private or acquiring a
private company. The acquired company's existing management might be retained or replaced, depending on the
objectives of the acquirer.
Divestitures:

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Divestiture refers to the process of selling, liquidating, or otherwise disposing of a portion of a company's assets,
subsidiaries, divisions, or business units. Companies often divest assets or divisions to streamline operations,
focus on core competencies, reduce debt, generate cash, or comply with regulatory requirements. Divestitures can
take various forms, including asset sales, spin-offs, carve-outs, and equity carve-outs:
1. Asset Sale: The company sells specific assets or business units to another company. The buyer acquires
the assets but not the entire company.
2. Spin-off: The company creates a new, independent company by separating a portion of its business
operations. Shareholders of the parent company often receive shares in the newly formed entity.
3. Carve-out: A division or business unit is separated from the parent company and operates as an
independent entity. The parent company retains a significant stake in the carved-out business.
4. Equity Carve-out: The parent company sells a minority stake in a subsidiary by offering shares to the
public while retaining control. The subsidiary becomes a separate, publicly traded company.

5. a) Define merger, consolidation and holding company. Point out the competitive advantages
of these forms of business combinations.
Merger: A merger is a business combination in which two or more companies agree to combine their operations
and become a single entity. In a merger, one company typically absorbs the assets and liabilities of another
company, and the merged entities continue their operations under a new or existing name. Mergers can be friendly
(mutually agreed upon) or hostile (opposed by the target company's management).
Consolidation: Consolidation, similar to a merger, is a corporate restructuring strategy where two or more
companies combine their operations and assets to form a new legal entity. Unlike a merger, where one company
absorbs the other(s), in a consolidation, a completely new company is formed, and the existing companies cease
to exist as independent entities. Consolidation often occurs when the combining entities believe that creating an
entirely new company will yield synergistic benefits and efficiencies.
Holding Company: A holding company is a corporation that owns a controlling interest in one or more subsidiary
companies but does not engage in the day-to-day operations of those subsidiaries. Instead, it exists primarily to
manage its investments in other companies, providing governance and oversight while allowing subsidiaries to
operate independently under their own management teams.
Competitive Advantages of Business Combinations:
1. Economies of Scale: Mergers and consolidations often result in larger entities, which can lead to
economies of scale. Larger companies can negotiate better deals with suppliers, reduce per-unit production
costs, and streamline administrative processes, leading to cost savings.
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 2. Diversification: Merging with or acquiring companies in different markets or industries can diversify a
business's revenue streams. Diversification can help mitigate risks associated with fluctuations in specific
markets or economic downturns.
3. Synergy: Business combinations can create synergies, where the merged entity's overall performance is
greater than the sum of its individual parts. Synergies can result from cost savings, improved operational
efficiency, increased market power, or complementary product offerings.
4. Market Power: Larger, consolidated entities often have increased market power and negotiating leverage.
This can lead to better terms with suppliers, higher bargaining power with customers, and the ability to
influence market trends.
5. Resource Sharing: Merged entities can share resources such as research and development capabilities,
distribution networks, manufacturing facilities, and expertise, leading to enhanced innovation and
efficiency.
6. Global Expansion: Mergers and consolidations can facilitate global expansion by leveraging the
combined strengths of the entities involved, allowing them to enter new markets or expand existing ones
more effectively.
7. Enhanced Competitive Position: Business combinations can create companies with stronger competitive
positions, enabling them to compete more effectively against rivals. This increased competitiveness can
result from improved product offerings, broader geographic coverage, or superior operational efficiency.

b) Discuss in brief the motives for business combinations.

Business combinations, such as mergers, acquisitions, and joint ventures, can be motivated by various strategic
objectives. These motives can vary based on the companies involved and the specific circumstances, but some
common motives include:
1. Economies of Scale: Combining operations can lead to economies of scale, reducing average costs by
spreading fixed costs over a larger production output. This can result in cost savings and improved
profitability.
2. Synergy: Business combinations can create synergies, where the joint entity's value and performance are
greater than the sum of its parts. Synergies can arise from cost reductions, revenue enhancements,
improved operational efficiency, or shared resources.
3. Market Power: Larger entities often have increased market power, allowing them to negotiate better
deals with suppliers and exert greater influence over distribution channels. Enhanced market power can
lead to favorable terms, increased profitability, and a competitive advantage.

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 4. Diversification: Companies may seek to diversify their product or service offerings, customer base, or
geographic reach through business combinations. Diversification can reduce risks associated with reliance
on a single market or product line.
5. Access to New Markets: Business combinations can provide access to new markets, allowing companies
to expand their geographic footprint and tap into new customer segments. This can facilitate growth and
increase revenue streams.
6. Acquiring Technology or Intellectual Property: Companies may acquire other firms to gain access to
proprietary technologies, patents, copyrights, or other intellectual property assets. This can enhance
innovation capabilities and strengthen the competitive position.
7. Vertical Integration: Firms may vertically integrate by acquiring businesses in their supply chain
(backward integration) or distribution channels (forward integration). Vertical integration can improve
control over costs, quality, and delivery schedules.
8. Financial Synergy: Strong companies may acquire weaker firms with valuable assets but financial
challenges, aiming to improve the financial health of the combined entity. This can involve restructuring
debt, optimizing capital structures, or improving cash flows.
9. Talent Acquisition: Acquiring companies with skilled employees, experienced management teams, or
unique talents can enhance the human capital of the merged entity, contributing to innovation and
operational excellence.
10. Competitive Positioning: Business combinations can help companies strengthen their competitive
positioning by consolidating market share, enhancing brand recognition, or offering a more
comprehensive range of products and services.
11. Rapid Growth: Companies may pursue acquisitions to achieve rapid growth, especially if organic growth
opportunities are limited. Acquiring established businesses allows for quicker market entry and revenue
generation.
12. Regulatory Compliance: In certain industries, mergers and acquisitions can help companies comply with
regulatory requirements, such as environmental standards, by consolidating resources and expertise.

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c) Differentiate between the following terms:

Strategic and financial merger

Horizontal and vertical merger
Congeneric and conglomerate merger
1. Strategic Merger vs. Financial Merger:
 Strategic Merger: A strategic merger is a business combination driven by long-term goals and the desire
to achieve specific strategic objectives. These objectives could include gaining access to new markets,
diversifying product offerings, leveraging synergies, enhancing operational efficiency, or acquiring
valuable intellectual property. Strategic mergers focus on creating value through the synergy of combined
resources and capabilities, aiming for sustainable competitive advantages.
 Financial Merger: A financial merger, on the other hand, is primarily motivated by financial
considerations such as increasing shareholder value, optimizing capital structure, improving financial
performance ratios, or achieving tax efficiencies. Financial mergers are often driven by financial
engineering and cost-saving measures, aiming to enhance short-term profitability and financial metrics.
Unlike strategic mergers, they may not always result in long-term operational synergies.
2. Horizontal Merger vs. Vertical Merger:
 Horizontal Merger: A horizontal merger occurs when two companies that operate in the same or similar
industry and produce similar goods or services combine their operations. Horizontal mergers are aimed at
consolidating market share, reducing competition, and achieving economies of scale. These mergers often
raise antitrust concerns since they can reduce market competition.
 Vertical Merger: A vertical merger takes place between companies operating at different stages of the
production or supply chain. In a vertical merger, a company merges with either a supplier (backward
integration) or a distributor (forward integration). Vertical mergers aim to improve supply chain
coordination, reduce costs, and secure a stable supply of inputs or outlets for the products or services.
3. Congeneric Merger vs. Conglomerate Merger:
 Congeneric Merger: A congeneric merger involves companies that are in related but not directly
competing industries. These companies may share some similarities in terms of technologies, distribution
channels, or customer bases. Congeneric mergers often occur to diversify product offerings, achieve
economies of scale in research and development, or enhance cross-selling opportunities.
 Conglomerate Merger: A conglomerate merger occurs between companies operating in entirely different
industries or businesses with no obvious similarities. Conglomerate mergers are driven by the desire to

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 diversify risk, enter new markets, or take advantage of profitable investment opportunities in unrelated
sectors. These mergers aim to create a balanced portfolio of businesses across different industries.
Conglomerate mergers are further classified into pure conglomerate mergers (no common business lines)
and mixed conglomerate mergers (limited commonality in business activities).

6. a) Define call and put options. When do the values of call and put exist? How do the
minimum values of put and call calculated?
Call Option: A call option is a financial contract that gives the holder the right, but not the obligation, to buy a
specific quantity of an underlying asset (such as stocks, commodities, or currencies) from the option seller at a
predetermined price (the strike price) within a specified period of time. Call options are typically used by investors
who anticipate that the price of the underlying asset will rise. The buyer of a call option pays a premium to the
seller for this right.
Put Option: A put option is a financial contract that gives the holder the right, but not the obligation, to sell a
specific quantity of an underlying asset at the strike price within a specified period of time. Put options are
commonly used as a hedge against a decline in the price of the underlying asset. Similar to call options, put options
buyers pay a premium to the sellers.
Existence of Call and Put Options: Call and put options exist in the financial markets as tradable securities.
Investors buy and sell these options on exchanges or in over-the-counter (OTC) markets. They serve as important
risk management tools for investors and are widely used for speculative purposes as well.
Minimum Values of Put and Call Options: The minimum value of a put option is the greater of two values:
either zero (if the option is out-of-the-money and not yet expired, meaning the strike price is higher than the
current market price of the underlying asset) or the difference between the strike price and the market price of the
underlying asset (if the option is in-the-money and not yet expired).
Similarly, the minimum value of a call option is also the greater of two values: either zero (if the option is out-of-
the-money and not yet expired, meaning the strike price is lower than the current market price of the underlying
asset) or the difference between the market price of the underlying asset and the strike price (if the option is in-
the-money and not yet expired).
These minimum values occur because options have intrinsic value, which is the value an option would have if it
were exercised immediately. For call options, intrinsic value is calculated as the difference between the market
price of the underlying asset and the strike price (S - K, where S is the market price and K is the strike price). For
put options, intrinsic value is calculated as the difference between the strike price and the market price of the
underlying asset (K - S). If the intrinsic value is negative (meaning the option is out-of-the-money), the minimum
value is zero. If it's positive (meaning the option is in-the-money), the minimum value is the intrinsic value.
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b) Explain in brief the put-call parity equation.
The put-call parity is a fundamental principle in options pricing theory, stating that the price of a European call
option and a European put option with the same strike price and expiration date should be related in a specific
way. The put-call parity equation helps ensure that options in the same market with the same underlying asset and
the same exercise price and maturity are correctly priced relative to each other.

In practical terms, the put-call parity equation implies that if there is any deviation between the prices of a call
option and a put option with the same strike price and expiration date, arbitrage opportunities could arise. Traders
can take advantage of these opportunities by creating a portfolio that includes options and the underlying stock,
ensuring that the put-call parity equation holds, and making a risk-free profit.
The put-call parity equation is crucial for options traders and market participants as it provides a relationship
between call and put options, helping to validate the pricing of these financial instruments in the market. Any
deviations from put-call parity can lead to arbitrage opportunities, which, in an efficient market, are quickly
exploited by traders, helping to maintain the parity relationship.

c) What factors do usually affect the value of option?

The value of an option, whether it's a call option or a put option, is influenced by several key factors. These factors
are commonly referred to as the "Greeks" in options trading. Here's a brief overview of the factors that affect the
value of an option:
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 1. Underlying Asset Price (S): The current market price of the underlying asset (e.g., stock, index,
commodity) has a direct impact on the value of both call and put options. For call options, as the underlying
price increases, the option becomes more valuable. For put options, as the underlying price decreases, the
option becomes more valuable.
2. Strike Price (K): The strike price is the price at which the option holder can buy (for call options) or sell
(for put options) the underlying asset. The relationship between the strike price and the current market
price affects the option's value. In general, a smaller difference between the strike price and the underlying
price increases the option's value.
3. Time to Expiration (T): The amount of time remaining until the option's expiration date is a critical
factor. Generally, options lose value as they approach expiration. This phenomenon is known as time
decay or theta decay. The longer the time to expiration, the higher the option premium, especially for
options that are in-the-money or have a higher volatility.
4. Volatility (σ): Volatility represents the degree of variation of an asset's price over time. Higher volatility
increases the potential price swings of the underlying asset, making it more likely for the option to expire
in-the-money. Consequently, options tend to have higher premiums when the underlying asset is more
volatile.
5. Interest Rates (r): Interest rates, specifically risk-free interest rates, also influence option prices. Higher
interest rates generally lead to higher call option premiums and lower put option premiums because the
cost of carrying the underlying asset is higher.
6. Dividends (for Stocks): For stock options, dividends can impact the option prices. Typically, when a
company pays dividends, the stock price decreases by the dividend amount, which can affect the value of
both call and put options.
7. Market Conditions and Sentiment: Current market conditions, economic news, geopolitical events, and
investor sentiment can influence option prices. For example, unexpected news about a company's earnings
can lead to significant changes in the prices of its options.
Options pricing models, such as the Black-Scholes model, take these factors into account to estimate the fair
market value of options. Traders and investors analyze these variables to make informed decisions about buying
or selling options contracts.

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d) How can options be used in the stock market to protect the value of investment? Explain
with an example.
Options can be used in the stock market to protect the value of investments through a strategy called a "protective
put." A protective put involves purchasing a put option for an existing stock position. This put option acts as a
form of insurance, providing downside protection to the investor in case the stock price declines.
Here's how a protective put works with an example:
Let's say you own 100 shares of ABC Company, which is currently trading at $50 per share. You are concerned
that the stock price might drop, but you want to hold onto your shares in case the price goes up later. To protect
your investment, you decide to buy a put option with a strike price of $45 and an expiration date three months
from now. The put option costs you $3 per share.
Now, there are two possible scenarios:
Scenario 1: Stock Price Increases or Remains Stable If the stock price of ABC Company increases or remains
above $45 until the expiration date, you can still sell your shares in the open market at the higher price. In this
case, you let the put option expire worthless, losing the premium you paid for it ($3 per share). However, the
increase in the stock price compensates for the cost of the put option, and you benefit from the rise in the stock's
value.
Scenario 2: Stock Price Decreases If the stock price of ABC Company drops below $45, your put option comes
into play. You have the right to sell your shares at the higher strike price of $45, regardless of the current market
price. For example, if the stock price falls to $40, you can exercise your put option, selling your shares for $45
each, limiting your losses. The put option helps protect your investment by providing a floor price for selling the
stock.
In this protective put strategy, you've limited your potential losses to the difference between the stock's current
price and the put option's strike price, plus the premium paid for the put option. However, you still benefit from
any potential gains in the stock's price above the total cost of the protective put strategy.
It's essential to carefully consider the costs of purchasing the put option (the premium) and the level of protection
it provides, balancing the potential losses against the premium paid. This strategy allows investors to participate
in potential gains while protecting against significant losses in a declining market.

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