MBA 4th Semester

SIKKIM MANIPAL UNIVERSITY DEPARTMENT OF DISTANCE EDUCATION ASSIGNMENTSEMESTER 4

NAME ROLL NUMBER LEARNING CENTRE PRADESH ASSIGNMENT SET No. COURSE NAME

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SUNIL KUMAR GUPTA : : : 511029827 RAEBARELI-UTTAR 1 (One)

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MBA - FINANCE

Master of Business Administration - MBA Semester 4 MF0015 - International Financial Management Assignment Set- 1 Q1. What is meant by BOP? How are capital account convertibility and current account convertibility different? What is the current scenario in India? Ans:- The balance of payments (or BOP) of a country is a record of international transactions between residents of one country and the rest of the world over a specified period, usually a year. Thus, Indias balance of payments accounts record transactions between Indian residents and the rest of the world. International transactions include exchanges of goods, services or assets. The term residents means businesses, individuals and government agencies and includes citizens temporarily living abroad but excludes local subsidiaries of foreign corporations. The balance of payments is a sources-and-uses-of-funds statement. Transactions such as exports of goods and services that earn foreign exchange are recorded as credit, plus, or cash inflows (sources). Transactions such as imports of goods and services that expend foreign exchange are recorded as debit, minus, or cash outflows (uses). The Balance of Payments for a country is the sum of the Current Account, the Capital Account and the change in Official Reserves. The current account is that balance of payments account in which all short-term flows of payments are listed. It is the sum of net sales from trade in goods and services, net investment income (interest and dividend), and net unilateral transfers (private transfer payments and government transfers) from abroad. Investment income for a country is the payment made to its residents who are holders of foreign financial assets (includes interest on bonds and loans, dividends and other claims on profits) and payments made to its citizens who are temporary workers abroad. Unilateral transfers are official government grants-in-aid to foreign governments, charitable giving (e.g., famine relief) and migrant workers transfers to families in their home countries. Net investment income and net transfers are small relative to imports and exports. Therefore a current account surplus indicates positive net exports or a trade surplus and a current account deficit indicates negative net exports or a trade deficit. The capital (or financial) account is that balance of payments account in which all cross-border transactions involving financial assets are listed. All purchases or sales of assets, including direct investment (FDI) securities (portfolio investment) and bank claims and liabilities are listed in the capital account. When Indian citizens buy foreign securities or when foreigners buy Indian securities, they are listed here as outflows and inflows, respectively. When domestic residents purchase more financial assets in foreign economies than what foreigners purchase of domestic assets, there is a net capital outflow. If foreigners purchase more Indian financial assets than domestic residents spend on foreign financial assets, then there will be

a net capital inflow. A capital account surplus indicates net capital inflows or negative net foreign investment. A capital account deficit indicates net capital outflows or positive net foreign investment. Current scenario in India The official reserves account (ORA) records the total reserves held by the official monetary authorities (central banks) within the country. These reserves are normally composed of the major currencies used in international trade and financial transactions. The reserves consist of hard currencies (such as US dollar, British Pound, Euro, Yen), official gold reserve and IMF Special Drawing Rights (SDR). The reserves are held by central banks to cushion against instability in international markets. The level of reserves changes because of the central banks intervention in the foreign exchange markets. Countries that try to control the price of their currency (set the exchange rate) have large net changes in their Official Reserve Accounts. In general, a net decrease in the Official Reserve Account indicates that a country is buying its currency in exchange for foreign exchange reserves, to try to keep the value of the domestic currency high with respect to foreign currencies. Countries with net increases in the Official Reserve Account are usually attempting to keep the price of the domestic currency cheap relative to foreign currencies, by selling their currencies and buying the foreign exchange reserves. When a central bank sells its reserves (foreign currencies) for the domestic currency in the foreign exchange market, it is a credit item in the balance of payment accounts as it makes available foreign currencies. Similarly, when a central bank buys reserves (foreign currency), it is a debit item in the balance of payment accounts. The Balance of Payments identity states that: Current Account + Capital Account = Change in Official Reserve Account. If a country runs a current account deficit and it does not run down its official reserve to cover this deficit (there is no change in official reserve), then the current account deficit must be balanced by a capital account surplus. Typically, in countries with floating exchange rate system, the change in official reserves in a given year is small relative to the Current Account and the Capital Account. Therefore, it can be approximated by zero. Thus, such a country can only consume more than it produces (or imports are greater than exports; a current account deficit) only if it has a capital account surplus (foreign residents are willing to invest in the country). Even in a fixed exchange rate system, the size of the official reserve account is small compared to the transactions in the current and capital account. Thus the residents of a country cannot have a current account deficit (imports exceeding exports) unless the foreigners are willing to invest in that country (capital account surplus). Q2. What is arbitrage? Explain with the help of suitable example a towway and a three-way arbitrage. Ans:- Arbitrage is the activity of exploiting imbalances between two or more markets. Foreign money exchangers operate their entire businesses on this principle. They find tourists who need the convenience of a quick cash exchange. Tourists exchange cash for less than the market rate and then the money exchanger converts those foreign funds into the local currency at a higher rate. The difference between the two rates is the spread or profit.

There are plenty of other instances where one can engage in the practice arbitrage. In some cases, one market does not know about or have access to the other market. Alternatively, arbitrageurs can take advantage of varying liquidities between markets. The term 'arbitrage' is usually reserved for money and other investments as opposed to imbalances in the price of goods. The presence of arbitrageurs typically causes the prices in different markets to converge: the prices in the more expensive market will tend to decline and the opposite will ensue for the cheaper market. The the efficiency of the market refers to the speed at which the disparate prices converge. Engaging in arbitrage can be lucrative, but it does not come without risk. Perhaps the biggest risk is the potential for rapid fluctuations in market prices. For example, the spread between two markets can fluctuate during the time required for the transactions themselves. In cases where prices fluctuate rapidly, would-be arbitrageurs can actually lose money. There are basically two types of arbitrage. One is two-way arbitrage and the other is three-way arbitrage. The more popular of the two is the two-way forex arbitrage. In the international market the currency is expressed in the form AAA/BBB. AAA denotes the price of one unit of the currency which the trader wishes to trade and it refers the base currency. While BBB is international three-letter code 0f the counter currency. For instance, when the value of EUR/USD is 1.4015, it means 1 euro = 1.4015 dollar. If the speculator is shrewd and has a deeper understanding of the forex market, then he can make use of this opportunity to make big profits. Forex arbitrage transactions are quite easy once you understand the method by which the business is conducted. For instance, the exchange rates of EUR/USD = 0.652, EUR/GBP = 1.312 and USD/GBP = 2.012. You can buy around 326100 Euros with $500,000. Using the Euros you buy approximately 248420 Pounds which is sold for approximately $500,043 and thereby earning a small profit of $43. To make a large profit on triangular arbitrage you should be ready to invest a large amount and deal with trustworthy brokers. Arbitrage is one of the strategies of forex trading. To make a substantial income out of this strategy you need to make an enormous amount of investment. Though theoretically it is considered to be risk free, in reality it is not the case. You should enter into this transaction only if you have deeper understanding of forex market. Hence, it would be wise not to devote much time in looking out for arbitrage opportunities. However, forex arbitrage is a rare opportunity and if it comes your way, then grab it without any hesitation. Three Way (Triangular) Arbitrage

The three way arbitrate inefficiency now arises when we consider a case in which the EUR/JPY exchange rate is NOT equivalent to the EUR/USD/USD/JPY case so there must be something going on in the market that is causing a temporary inconsistency. If this inconsistency becomes large enough one can enter trades on the cross and the other pairs in opposite directions so that the discrepancy is corrected. Let us consider the following example : EUR/JPY=107.86 EUR/USD=1.2713 USD/JPY = 84.75 The exchange rate inferred from the above would be 1.2713*84.75 which would be 107.74 and the actual rate is 107.86. What we can do now is short the EUR/JPY and go long EUR/USD and USD/JPY until the correlation is reestablished. Sounds easy, right ? The fact is that there are many important problems that make the exploitation of this three way arbitrage almost impossible. Q3. You are given the following information: Spot EUR/US: 0.7940/0.8007 Spot USD/GBP:1.8215/1.8240 Three months swap: 25/35 Calculate three month EUR/USD rate. Ans:1st Method : Forward Points = ((Spot * (1 + (OCR rate * n/360))) / (1 + (BCR rate * n/360))) Spot OCR = Other Currency Rate BCR = Base Currency Rate Forward points = ((0.07940 * (1 + (0.018215 * 90/360))) / (1 + (0.08007 * 90/360))) 0.07940 SWAP = -0.00120 Forward rate = 0.07940 - 0.00120 = 0.0782 Customer sells EUR 3 Mio against USD at 0.0782 at 3 month (0.07940 - 0.00120). Customer wants to Buy EUR 3 Mio against USD 3 months forward. Q.4 Explain various methods of Capital budgeting of MNCs. Ans:- Methods of Capital Budgeting Discounted Cash Flow Analysis (DCF) DCF technique involves the use of the time-value of money principle to project evaluation. The two most widely used criteria of the DCF technique are the Net Present Value (NPV) and the Internal Rate of Return (IRR). Both the techniques

discount the projects cash flow at an appropriate discount rate. The results are then used to evaluate the projects based on the acceptance/rejection criteria developed by management. NPV is the most popular method and is defined as the present value of future cash flows discounted at an appropriate rate minus the initial net cash outlay for the projects. The discount rate used here is known as the cost of capital. The decision criteria is to accept projects with a positive NPV and reject projects which have a negative NPV. The NPV can be defined as follows:

NPV = Where, I0 = initial cash investment CFt = expected after-tax cash flows in year t. k = the weighted average cost of capital n = the life span of the project. The NPV of a project is the present value of all cash inflows, including those at the end of the projects life, minus the present value of all cash outflows. The decision criteria is to accept a project if NPV o and to reject if NPV < o. IRR is calculated by solving for r in the following equation.

where r is the internal rate of return of the project. The IRR method finds the discount rate which equates the present value of the cash flows generated by the project with the initial investment or the rate which would equate the present value of all cash flows to zero. Adjusted Present Value Approach (APV) A DCF technique that can be adapted to the unique aspect of evaluating foreign projects is the Adjusted Present Value approach. The APV format allows different components of the projects cash flow to be discounted separately. This allows the required flexibility, to be accommodated in the analysis of the foreign project. The

APV approach uses different discount rates for different segments of the total cash flows depending upon the degree of certainty attached with each cash flow. In addition, the APV format helps the analyst to test the basic viability of the foreign project before accounting for all the complexities. If the project is acceptable in this scenario, no further evaluation based on accounting for other cash flows is done. If not, then an additional evaluation is done taking into account the other complexities. As mentioned earlier, foreign projects face a number of complexities not encountered in domestic capital budgeting, for example, the issue of remittance, foreign exchange regulation, lost exports, restriction on transfer of cash flows, blocked funds, etc. The APV model is a value additivity approach to capital budgeting, i.e., each cash flow as a source of value is considered individually. Also, in the APV approach each cash flow is discounted at a rate of discount consistent with the risk inherent in that cash flow. In equation form the APV approach can be written as:

APV =

Where the term Io = Present value of investment outlay

= Present value of operating cash flows

= Present value of interest tax shields

= Present value of interest subsidies The various symbols denote Tt = Tax savings in year t due to the financial mix adopted St = Before-tax value of interest subsidies (on the home currency) in year t due to project specific financing id = Before-tax cost of dollar debt (home currency)

The last two terms in the APV equation are discounted at the before-tax cost of dollar debt to reflect the relative certain value of the cash flows due to tax savings and interest savings. Q.5 a. What are depository receipts? Ans:- Depository Receipt (DR) is a negotiable certificate that usually represents a companys publicly traded equity or debt. When companies make a public offering in a market other than their home market, they must launch a depository receipt program. Depository receipts represent shares of company held in a depository in the issuing companys country. They are quoted in the host country currency and treated in the same way as host country shares for clearance, settlement, transfer and ownership purposes. These features make it easier for international investors to evaluate the shares than if they were traded in the issuers home market. There are two types of depository receipts GDRs and ADRs. Both ADRs and GDRs have to meet the listing requirements of the exchange on which they are traded. Q.5 b. Boeing commercial Airplane Co. manufactures all its planes in United States and prices them in dollars, even the 50% of its sales destined for overseas markets. Assess Boeings currency risk. How can it cope with this risk? Ans:- Boeing faces foreign exchange risk for two reasons: (1) It sells half its planes overseas and the demand for these planes depends on the foreign exchange value of the dollar, and (2) Boeing faces stiff competition from Airbus Industrie, a European consortium of companies that builds the Airbus. As the dollar appreciates, Boeing is likely to lose both foreign and domestic sales to Airbus unless it cuts its dollar prices. One way to hedge this operating risk is for Boeing to finance a portion of its assets in foreign currencies in proportion to its sales in those countries. However, this tactic ignores the fact that Boeing is competing with Airbus. Absent a more detailed analysis, another suggestion is for Boeing to finance at least half of its assets with ECU bonds as a hedge against depreciation of the currencies of its European competitors. ECU bonds would also provide a hedge against appreciation of the dollar against the yen and other Asian currencies since European and Asian currencies tend to move up and down together against the dollar (albeit imperfectly). Q6. Distinguish between Eurobond and foreign bonds? What are the unique characteristics of Eurobond markets? Ans:- A Eurobond is underwritten by an international syndicate of banks and other securities firms, and is sold exclusively in countries other than the country in whose currency the issue is denominated. For example, a bond issued by a U.S. corporation, denominated in U.S. dollars, but sold to investors in Europe and Japan (not to investors in the United States), would be a Eurobond. Eurobonds are issued by multinational corporations, large domestic corporations, sovereign governments, governmental enterprises, and international institutions. They are offered

simultaneously in a number of different national capital markets, but not in the capital market of the country, nor to residents of the country, in whose currency the bond is denominated. Almost all Eurobonds are in bearer form with call provisions and sinking funds. A foreign bond is underwritten by a syndicate composed of members from a single country, sold principally within that country, and denominated in the currency of that country. The issuer, however, is from another country. A bond issued by a Swedish corporation, denominated in dollars, and sold in the U.S. to U.S. investors by U.S. investment bankers, would be a foreign bond. Foreign bonds have nicknames: foreign bonds sold in the U.S. are "Yankee bonds"; those sold in Japan are "Samurai bonds"; and foreign bonds sold in the United Kingdom are "Bulldogs." Figure 4 specifically reclassifies foreign bonds from a U.S. investor`s perspective. FIGURE 4 FOREIGN BONDS TO U.S. INVESTORS

Foreign currency bonds are issued by foreign governments and foreign corporations, denominated in their own currency. As with domestic bonds, such bonds are priced inversely to movements in the interest rate of the country in whose currency the issue is denominated. For example, the values of German bonds fall if German interest rates rise. In addition, values of bonds denominated in foreign currencies will fall (or rise) if the dollar appreciates (or depreciates) relative to the denominated currency. Indeed, investing in foreign currency bonds is really a play on the dollar. If the dollar and foreign interest rates fall, investors in foreign currency bonds could make a nice return. It should be pointed out, however, that if both the dollar and foreign interest rates rise, the investors will be hit with a double whammy. Characteristics of Eurobond markets1. Currency denomination: The generic, plain vanilla Eurobond pays an

annual fixed interest and has a long-term maturity. There are a number of different currencies in which Eurobonds are sold. The major currency denominations are the U.S. dollar, yen, and euro. (70 to 75 percent of Eurobonds are denominated in the U.S. dollar.) The central bank of a country can protect its currency from being used. Japan, for example, prohibited the yen from being used for Eurobond issues of its corporations until 1984.

2. Non-registered: Eurobonds are usually issued in countries in which there is

little regulation. As a result, many Eurobonds are unregistered, issued as bearer bonds. (Bearer form means that the bond is unregistered, there is no record to identify the owners, and these bonds are usually kept on deposit at depository institution). While this feature provides confidentiality, it has created some problems in countries such as the U.S., where regulations require that security owners be registered on the books of issuer. 3. Credit risk: Compared to domestic corporate bonds, Eurobonds have fewer protective covenants, making them an attractive financing instrument to corporations, but riskier to bond investors. Eurobonds differ in term of their default risk and are rated in terms of quality ratings. 4. Maturities: The maturities on Eurobonds vary. Many have intermediate terms (2 to 10 years), referred to as Euronotes, and long terms (10-30 years), and called Eurobonds. There are also short-term Europaper and Euro Medium-term notes. 5. Other features: Like many securities issued today, Eurobonds often are sold with many innovative features. For example: principal in another.b) Option currency Eurobond offers investors a choice of currency. For

a) Dual-currency Eurobonds pay coupon interest in one currency and

instance, a sterling/Canadian dollar bond gives the holder the right to receive interest and principal in either currency.1. A number of Eurobonds have special conversion features. One

type of convertible Eurobond is a dual-currency bond that allows the holder to convert the bond into stock or another bond that is denominated in another currency. 2. A number of Eurobonds have special warrants attached to them. Some of the warrants sold with Eurobonds include those giving the holder the right to buy stock, additional bonds, currency, or gold.

Master of Business Administration - MBA Semester 4 MF0016 Treasury Management Assignment Set- 1 Q.1 Explain how organization structure of commercial bank treasury facilitates in handling various treasury operations. Ans:- The treasury organisation deals with analysing, planning, and implementing treasury functions. It deals with issues of profit centre, cost centre etc. The organisations managing interfaces with treasury functions include intragroup communications, taxation, recharging, measurement and cultural aspects. Structure of treasury organisation Figure 1.2 depicts the structure of treasury organisation which is divided into five groups.

Figure 1.2: Treasury Organisations Fiscal This group includes budget policy planning division, industrial and environmental division, common wealth state relationships, and social policy division. Macroeconomic This group deals with economic sector of the organisation. It includes domestic and international economic divisions, macroeconomic policy and modeling division. Revenue This group is concerned with the taxes in an organisation. It includes business tax division, indirect tax, international and treaties division, personal and income division, tax analysis and tax design division. Markets This group mainly deals with selling of products in the competitive market. It includes competition and consumer policy, corporations and financial services policy, foreign investments and trade policy division. Corporate services This group deals with overall management of the treasury organisation. It includes financial and facilities division, human resource division, business solutions and information management division.

Treasury management in banks In recent days, most of the Indian banks have classified their business into two primary business segments like treasury operations (investments) and banking operations (excluding treasury). The treasury operations in banks are divided into: Rupee treasury The rupee treasury carries out various rupee based treasury functions like asset liability management, investments and trading. It helps in managing the banks position in terms of statutory requirements like cash reserve ratio, statutory liquidity ratio according to the norms of the Reserve Bank of India (RBI). The various products in rupee treasury are:

1. Money market instruments Call, term, and notice money, commercial papers, treasury bonds, repo, reverse repo and interbank participation etc. 2. Bonds Government securities, debentures etc 3. Equities Foreign exchange treasury The banks provide trading of currencies across the globe. It deals with buying and selling currencies. Derivatives The banks make foundation for Over the Counter (OTC). It helps in developing new products, trading in order to lay off risks and form apparatus for much of the industrys self-regulation.

The role of policies in strategic management was described in this section. The next section deals with inter-dependency between policy and strategy. Q.2 Bring out in a table format the features of certificate of deposits and commercial papers. Ans:Features of commercial papers CPs is an unsecured promissory note. CPs can be issued for a maturity period of 15 days to less than one year. CPs is issued in the denomination of Rs.5 lakh. The minimum size of the issu e is Rs. 25 lakh. The ceiling amount of CPs should not exceed the working capital of th e issuing company. The investors in CPs market are banks, individuals, business organisations and the corporate units registered in India an d incorporated units. Features of CDs in Indian market Schedule banks are eligible to issue CDs Maturity period varies from three months to one year Banks are not permitted to buy back their CDs before the maturity CDs are subjected to CRR and Statutory Liquidity Ratio (SLR) requirements

They are freely transferable by endorsement and delivery. They have no lock-in period.

The interest rate of CPs depends on the prevailing interest rate on CPs market, forex market and call money market. The attractive rate of interest In any of these markets, affects the deman d of CPs. The eligibility criteria for the companies to issue CPs are as follows: The tangible worth of the issuing company should not be less than Rs . 4.5 Crores. The company should have a minimum credit rating of P2 and A2 obtained from Credit Rating Information Service of India (CRISIL) and Investment Information and Credit Ratin g Agency of India Limited. (ICRA) respectively The current ratio of the issuing company should be 1.33:1. The issuing company has to be listed on stock exchange.

CDs have to bear stamp duty at the prevailing rate in the markets

The NRIs can subscribe to CDs on repatriation basis

Q.3 Critically evaluate participatory notes. Detail the regulatory aspects on it. Ans:- The participants in forex market are the RBI at the apex, authorised dealers (ADs) licensed by forex market, exporters, importers, companies and individuals. The major participants of foreign exchange market are: Corporates They mainly include business houses, international investors, and multinational corporations. They operate in market by buying or selling currencies within the framework of exchange control regulations. It deals with banks and their clients to form retail segment of forex market. Commercial banks They play an important role in forex market. They operate in market by trading currencies for their clients. Large volume of transactions consists of banks dealing directly among themselves and smaller transactions usually consists of intermediary foreign exchange brokers. Central bank It plays a vital role in the countrys economy by controlling money supply. Central banks get involved in forex market to regain price

stability of exchange rate, protect certain levels of price in exchange rate, and support economic goals like inflation and growth. Exchange brokers They ensure the most favourable quotations between the banks at a low cost in terms of time and money. Banks provide opportunities to brokers in order to increase or decrease the rate of buying or selling foreign currencies. Exchange brokers have a tendency to specialise in unusual currencies but also manage major currencies. In India, many banks deal through recognised exchange brokers or may deal directly among themselves.

The other participants include RBI and its authorised dealers, exporters, importers, companies and individuals. Q.4 What is capital account convertibility? What are the implications on implementing CAC? Ans:- Capital Account Convertibility (CAC) refers to relaxing controls on capital account transactions. It means freedom of currency conversion in terms of inflow and outflows with respect to capital account transaction. Most of the countries have liberalised their capital account by having an open account, but they do retain some regulations for influencing inward and outward capital flow. Due to global integration, both in trade and finance, CAC enhances growth and welfare of country. The perception of CAC has undergone some changes following the events of emerging market economies (EMEs) in Asia and Latin America, which went through currency and banking crises in 1990s. A few counties backtracked and re-imposed capital controls as part of crisis resolution. Crisis such as economic, social, human cost and even extensive presence of capital controls creates distortions, making CAC either ineffective or unsustainable. The cost and benefits from capital account liberalisation is still being debated among academics and policy makers. These developments have led to considerable caution being exercised by EMEs in opening up capital account. The Committee on Capital Account Convertibility (Chairman: Shri. S.S. Tarapore) which submitted its report in 1997 highlighted the benefits of a more open capital account but at the same time cautioned that CAC could pose tremendous pressures on the financial system. India has cautiously opened its capital account and the state of capital control in India is considered as the most liberalised it had been since late 1950s. The different ways of implementing CAC are as follows: Open the capital account for residents and non-residents. Initially open the inflow account and later liberalise the outflow account. Approach to simultaneously liberalise control of inflow and outflow account.

Q.5 Detail domestic and international cash management system Ans;- The strategy of a company which has its businesses in many nations and efficiently manages its cash and liquidity is called multinational cash management programme. The main goal of multinational cash management is the utilisation of local banking and cash management services.

Multinational companies are those that operate in two or more countries. Decision making within the corporation is centralised in the home country or decentralised across the countries where the organisation does its business. The reasons for which the firms expand into other countries are as follows: Seeking new markets and raw materials Seeking new technology and product efficiency. Preventing the regulatory obstacles. Retaining customers and protecting its processes Expanding its business.

Several factors which distinguish multinational cash management from domestic cash management are as follows: Different currency denominations Political risk and other risk. Economic and legal complications. Role of governments Language and cultural differences. Difference in tax rates, import duties.

The principle objective of multinational cash management programme is to maximise a companys financial resources by taking benefits from all liability provisions, payable periods. The multinational cash management programme effectively achieve its goals by using excess cash flow from some units across the globe to extend cash needs in other units which is called in-house banking and by relocating funds for tax and foreign exchange management through repricing and invoicing. During multinational cash management system payments by customers to companys branches are basically handled through a local bank. The payments between the branches and the parent company are managed through the branches, correspondents or associates of the parent company. Through the use of electronic reporting systems a parent company observes cash balances in its foreign local banks. Multinational cash management programme specifically evaluate its techniques by timing of billing, use of lockboxes or intercept points, negotiated value range. The multinational cash management system involves exchange rate risk which occurs when the cash flow of one currency during transformation to another currency the cash value gets declined. It occurs due to the change in exchange rates. The exchange rates are determined by a structure which is called the international monetary system. For example, Wincor Nixdorf played an innovative role in enhancing cash handling between various countries. Wincors focus was on the entire process chain which started from head office to stores, crediting to the retail companys account, head

office to branches and so on. Wincor Nixdorfs served several countries with its innovative hardware and software elements, IT services to side operations and consulting services to develop custom optimised solutions. Q.6 Distinguish between CRR and SLR Ans:- Cash Reserve Ratio Cash Reserve Ratio (CRR) is a countrys central bank regulation that sets the minimum reserves for banks to hold for their customer deposits and notes. These reserves are considered to meet the withdrawal demands of the customers. The reserves are in the form of authorised currency stored in a bank treasury (vault cash) or with the central bank. CRR is also called liquidity ratio as it controls money supply in the economy. CRR is occasionally used as a tool in monetary policies that influence the countrys economy. CRR in India is the amount of funds that a bank has to keep with the RBI which is the central bank of the country. If RBI decides to increase CRR, then the banks available cash drops. RBI practices this method, that is, increases CRR rate to drain out excessive money from banks. The CRR in the economy as declared by RBI in September 2010 is 6 percent. An organisation that holds reserves in excess amount is said to hold excess reserves. The following are the effects of CRR on economy: CRR influences an economys money supply by effecting the potential of banks CRR influences inflation in an organization CRR stimulates higher economic activity by influencing the liquidity

Statutory Liquidity Ratio Statutory Liquidity Ratio (SLR) is the percentage of total deposits that banks have to invest in government bonds and other approved securities. It means the percentage of demand and time maturities that banks need to have in forms of cash, gold and securities like Government Securities (G-Secs). As gold and government securities are highly liquid and safe assets they are included along with cash. In India, RBI determines the percentage of SLR. There are some statutory requirements for placing the money in the government bonds. After following the requirements, the RBI arranges the level of SLR. The maximum limit of SLR is 40 percent and minimum limit of SLR is 25 percent. The RBI increases the SLR to control inflation, extract liquidity in the market and protects customers money. Increase in SLR also limits the banks leverage position to drive more money into the economy.

If any Indian bank fails to maintain the required level of SLR, then it is penalized by RBI. The nonpayer bank pays an interest as penalty which is above the actual bank rate. The main objectives for maintaining SLR are the following: By changing the SLR level, the RBI increases or decreases banks credit expansion Ensures the comfort of commercial banks Forces the commercial banks to invest in government securities like government bonds

Master of Business Administration - MBA Semester 4 MF0017 Merchant Banking and Financial Services Assignment Set- 1 Q.1 What do you understand by insider trading. What are the SEBI rules and regulations to prevent insider trading. Ans:- "Insider trading" is a term subject to many definitions and connotations and it encompasses both legal and prohibited activity. Insider trading takes place legally every day, when corporate insiders officers, directors or employees buy or sell stock in their own companies within the confines of company policy and the regulations governing this trading. It is the trading that takes place when those privileged with confidential information about important events use the special advantage of that knowledge to reap profits or avoid losses on the stock market, to the detriment of the source of the information and to the typical investors who buy or sell their stock without the advantage of "inside" information. Almost eight years ago, India's capital markets watchdog the Securities and Exchange Board of India organised an international seminar on capital market regulations. Among others issues, it had invited senior officials of the Securities and Exchange Commission to tell us how it tackled the menace of insider trading. SEBI rules and regulations to prevent insider trading. SEBI had amended the Insider Trading Regulations 1992 vide a Notification dated November 19, 2008 which I had discussed it here and here. SEBI has now released a set of "Clarifications" on 24th July 2009 on certain issues arising out of the amendments made. I had opined on some of these issues in my earlier posts referred to above and hence me update on what are the clarifications so given. Curiously, the "clarifications" have no formal standing or reference. It is neither a circular, nor a notification, nor even a press release. It is neither signed nor dated. But it seeks to "clarify" and giving meaning to the Regulations that have legal standing and where such "meaning" is quite contrary - as we will see - to the plain reading of the text. Having said that, the "clarifications" mostly relaxes the requirements and hence, being gift horses, one should not examine them in the mouth too closely! Let us see the clarifications given. Recollect that specified persons were banned from carrying out opposite transactions "(banned transactions") for six months of original buy/sale ("original transactions"). The question was whether acquisition of shares under ESOPs scheme and sale of such shares would be considered as transactions that trigger off such ban and whether these themselves are banned.

It is clarified that exercise of ESOPs will neither be deemed to be "original transaction" nor "banned transaction". Thus, by acquiring shares under ESOPs, you don't trigger a ban and if you are banned for six months, you can still exercise ESOPs. The reasoning given is that the ban is only on transactions in secondary market.(Incidentally, I had felt that "However, taking all things into account, perhaps the intention is not to cover shares acquired under ESOPs Schemes. "). But sale of shares acquired through ESOPs is covered but it will only be deemed to be a "original transaction" and not a "banned transaction". In other words, even if you are under a ban, you can still sell shares acquired under ESOPs but once you sell such shares, you have triggered a ban of six months. On this aspect, I do not understand the basis of clarifying that the sale of shares acquired under ESOPs scheme will not be an "original transaction" - the logic of covering secondary market transactions should apply here also. Then, it is clarified that every later transaction triggers a fresh six month ban. A purchase on 1st February results in ban till 1st August. However, if there is a fresh purchase on 15th March, there is a ban now till 15th September. Effectively, this means that the ban period is from 2nd Febuary till 15th September. What about transactions before this amendment - will the amendment create ban in respect of them too - this is an academic issue now at least as the six month period is now complete. It is clarified though that the transactions before the amendment are not to be considered. On a similar note, unwinding of positions in derivatives held on the date of this amendment is possible. A crucial clarification is that the ban on "sale" of shares for personal emergencies is permisible by waiver by the Compliance Officer. This is not evident from a plain reading of the provision and I had opined that "This bar on such transactions is total. There are no circumstances whether of urgent need or otherwise under which the bar can be lifted. There is also no provision under which even SEBI could grant exemption.". But SEBI thinks it is so evident and hence let us accept this gift without creating legal niceties! Note that this clarification applies only to sales and there can be no purchases within these six month ban period - obviously there cannot be any personal emergency to purchase shares! Q.2 What is the provision of green shoe option and how is it used by companies to stabilize prices. Ans:- Green Shoe Option (GSO) is an option where a company can retain a part of the over-subscribed capital by issuing additional shares. Oversubscription is a situation when a new stock issue has more buyers than shares to meet their orders. This excess demand over supply increases the share price. There is another situation called undersubscription. In undersubscription, a new stock issue has fewer buyers than the shares available. An issuing company appoints a stabilizing agent, which is usually an underwriter or a lead manager, to purchase shares from the open market using the funds collected from the over-subscription of shares. The stabilizing agent stabilizes the price for a period of 30 days from the date of listing as authorised by the SEBI. Green shoe option agreement allows the underwriters to

sell 15 percent more shares to the investors than planned by the issuer in an underwriting. Some issuers do not include green shoe options in their underwriting contracts under certain circumstances where the issuer funds a particular project with a fixed amount of price and does not require more funds than quoted earlier. The green shoe option is also known as over-allotment option. The over-allotment refers to allocation of shares in excess of the size of the public issue made by the stabilizing agent out of shares borrowed from the promoters in pursuance of a GSO exercised by the issuing company. The greenshoe option is popular because it is the only SEC-permitted means for an underwriter to stabilize the price of a new issue post-pricing. Issuers will sometimes not permit a greenshoe on a transaction when they have a specific objective for the offering and do not want the possibility of raising more money than planned. The term comes from the first company, Green Shoe Manufacturing now called Stride Rite Corporation, to permit underwriters to use this practice in its offering. The mechanism by which the greenshoe option works to provide stability and liquidity to a public offering is described in the following example: A company intends to sell 1 million shares of its stock in a public offering through an investment banking firm (or group of firms which are known as the syndicate) whom the company has chosen to be the offering's underwriter(s). When the stock offering is the first time the stock is available for public trading, it is called an IPO (initial public offering). When there is already an established market and the company is simply selling more of their non-publicly traded stock, it is called a follow-on offering. The underwriters function as the broker of these shares and find buyers among their clients. A price for the shares is determined by agreement between the company and the buyers. One responsibility of the lead underwriter in a successful offering is to help ensure that once the shares begin to publicly trade, they do not trade below the offering price. When a public offering trades below its offering price, the offering is said to have "broke issue" or "broke syndicate bid". This creates the perception of an unstable or undesirable offering, which can lead to further selling and hesitant buying of the shares. To manage this possible situation, the underwriter initially oversells ("shorts") to their clients the offering by an additional 15% of the offering size. In this example the underwriter would sell 1.15 million shares of stock to its clients. When the offering is priced and those 1.15 million shares are "effective" (become eligible for public trading), the underwriter is able to support and stabilize the offering price bid (which is also known as the "syndicate bid") by buying back the extra 15% of shares (150,000 shares in this example) in the market at or below the offer price. They can do this without the market risk of being "long" this extra 15% of shares in their own account, as they are simply "covering" (closing out) their 15% oversell short. If the offering is successful and in strong demand such that the price of the stock immediately goes up and stays above the offering price, then the underwriter has oversold the offering by 15% and is now technically short those shares. If they were

to go into the open market to buy back that 15% of shares, the underwriter would be buying back those shares at a higher price than it sold them at, and would incur a loss on the transaction. This is where the over-allotment (greenshoe) option comes into play: the company grants the underwriters the option to take from the company up to 15% more shares than the original offering size at the offering price. If the underwriters were able to buy back all of its oversold shares at the offering price in support of the deal, they would not need to exercise any of the greenshoe. But if they were only able to buy back some of the shares before the stock went higher, then they would exercise a partial greenshoe for the rest of the shares. If they were not able to buy back any of the oversold 15% of shares at the offering price ("syndicate bid") because the stock immediately went and stayed up, then they would be able to completely cover their 15% short position by exercising the full greenshoe. Q.3 Discuss the proportionate allotment procedure followed by the lead banker to allot shares. Ans:- The post-issue Lead Merchant Banker shall ensure that moneys received pursuant to the issue and kept in a separate bank (i.e. Bankers to an Issue), as per the provisions of section 73(3) of the Companies Act 1956, is released by the said bank only after the listing permission under the said Section has been obtained from all the stock exchanges where the securities were proposed to be listed as per the offer document. Post-issue Advertisements -(Clause 7.5) Post-issue Lead Merchant Banker shall ensure that in all issues, advertisement giving details relating to over-subscription, basis of allotment, number, value and percentage of applications received along with stockinvest, number, value and percentage of successful allottees who have applied through stockinvest, date of completion of despatch of refund orders, date of despatch of certificates and date of filing of listing application is released within 10 days from the date of completion of the various activities at least in an English National Daily with wide circulation, one Hindi National Paper and a Regional language daily circulated at the place where registered office of the issuer company is situated. Post-issue Lead Merchant Banker shall ensure that issuer company / advisors / brokers or any other agencies connected with the issue do not publish any advertisement stating that issue has been over-subscribed or indicating investors' response to the issue, during the period when the public issue is still open for subscription by the public. Advertisement stating that "the subscription to the issue has been closed" may be issued after the actual closure of the issue. Basis of Allotment -(Clause 7.6)

In a public issue of securities, the Executive Director/Managing Director of the Designated Stock Exchange along with the post issue Lead Merchant Banker and the Registrars to the Issue shall be responsible to ensure that the basis of allotment is finalised in a fair and proper manner in accordance with the following guidelines:. Provided, in the book building portion of a book built public issue notwithstanding the above clause, Clause 11.3.5 of Chapter XI of these Guidelines shall be applicable. Proportionate Allotment Procedure The allotment shall be subject to allotment in marketable lots, on a proportionate basis as explained below: a. Applicants shall be categorised according to the number of shares applied for. b. The total number of shares to be allotted to each category as a whole shall be arrived at on a proportionate basis i.e. the total number of shares applied for in that category (number of applicants in the category x number of shares applied for) multiplied by the inverse of the over-subscription ratio as illustrated below: Total number of applicants in category of 100s - 1,500 Total number of shares applied for - 1,50,000 Number of times over-subscribed - 3 Proportionate allotment to category - 1,50,000 x 1/3 = 50,000 c. Number of the shares to be allotted to the successful allottees shall be arrived at on a proportionate basis i.e. total number of shares applied for by each applicant in that category multiplied by the inverse of the oversubscription ratio. Schedule XVIII of basis of allotment procedure may be referred to. Number of shares applied for by 100 each applicant Number of times oversubscribed 3 Proportionate allotment to each successful applicant - 100 x 1/3 = 33 (to be rounded off to 100) d. All the applications where the proportionate allotment works out to less than 100 shares per applicant, the allotment shall be made as follows: i. Each successful applicant shall be allotted a minimum of 100 securities; and ii. The successful applicants out of the total applicants for that category shall be determined by drawal of lots in such a manner that the total number of shares allotted in that category is equal to the number of shares worked out as per (ii) above.

e. If the proportionate allotment to an applicant works out to a number that is more than 100 but is not a multiple of 100 (which is the marketable lot), the number in excess of the multiple of 100 shall be rounded off to the higher multiple of 100 if that number is 50 or higher. f. If that number is lower than 50, it shall be rounded off to the lower multiple of 100. As an illustration, if the proportionate allotment works out to 250, the applicant would be allotted 300 shares. g. If however the proportionate allotment works out to 240, the applicant shall be allotted 200 shares. All applicants in such categories shall be allotted shares arrived at after such rounding off. h. If the shares allocated on a proportionate basis to any category is more than the shares allotted to the applicants in that category, the balance available shares for allotment shall be first adjusted against any other category, where the allocated shares are not sufficient for proportionate allotment to the successful applicants in that category. i. The balance shares if any, remaining after such adjustment shall be added to the category comprising applicants applying for minimum number of shares. j. As the process of rounding off to the nearer multiple of 100 may result in the actual allocation being higher than the shares offered, it may be necessary to allow a 10% margin i.e. the final allotment may be higher by 10 % of the net offer to public.

Q.4 What are the advantages of leasing to a company. Ans:- Leasing has many advantages for the lessee as well as for the lessor. Lease financing offers the following benefits to the lessee: One hundred percent finance without immediate down payment for huge investments, except for his margin money investment. Facilitates the availability and use of equipments without the necessary blocking of capital funds. Acts as a less costly financing alternative as compared to other source of finance. Offers restriction free financing without any unduly restrictive covenants. Enhances the working capital position. Provides finance without diluting the ownership or control of the lessor. Offers tax benefits which depend on the structure of the lease. Enables lessee to pay rentals from the funds generated from operations as lease structure can be made flexible to suit the cash flow. When compared to term loan and institutional financing, lease finance can be arranged fast and documentation is simple and without much formalities. The lessor being the owner of the asset bears the risk of obsolescence and the lessee is free on this score. This gives the option to the lessee to replace the equipment with latest technology

The following are the benefits offered by lease financing to the lessor: The lessors ownership is fully secured as he is the owner and can always take possession in case of default by the lessee. Tax benefits are provided on the depreciation value and there is a scope for him to avail more depreciation benefits by tax planning. High profit is expected as the rate of return increases Return on equity is elevated by leveraging results in low equity base which enhance the earnings per share. High growth potential is maintained even during periods of depression.

Q.5 Discuss Accounting standard 19 for lease based on operating lease. Ans:- Accounting Standard (AS)-19, Leases, is issued by the Council of the Institute of Chartered Accountants of India. This standard comes into force with respect of all assets leased during accounting periods commencing on or after 1.4.2001 and is mandatory in nature from that date. Accordingly, the Guidance Note on Accounting for Leases issued by the Institute in 1995, is not applicable in respect of such assets. Earlier application of this Standard is, however, encouraged. Scope The right accounting policies and disclosures in relation to finance leases and operating leases should be applied in accounting for all leases other than the following: Lease agreements to explore or to use natural resources, such as oil, gas , timber, metals and other mineral rights; and Licensing agreements for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights; and Lease agreements to use property such as lands.

Related definitions The following terms are used in this statement:

Lease A lease is an agreement calling for the lessee (user) to pay the lessor (owner) for use of an asset for an agreed period of time. A rental agreement is a lease in which the asset is a substantial property. Finance lease A lease which transfers all the risks and rewards incident to ownership of an asset. Operating lease A lease for which the lessee acquires the property for only a small portion of its useful life. Non-cancellable lease A non-cancellable lease is a lease that can be abandoned only:

Inception of lease The inception of lease is the former date of the lease agreement and the commitment date by the parties to the principal provisions of the lease. Lease term The lease term is the non cancellable period for which the lessee has agreed to take on lease asset together with future periods. Minimum lease payments It is the regular rental payments excluding executory costs to be paid by the lessee to the lessor in a capital lease. The lessee informs that an asset and liability at the discounted value of the future minimum lease payments. Fair value The expected value of all assets and liabilities of a owned company used to combine the financial statements of both companies. Economic life The outstanding period of time for which real estate improvements are expected to generate more income than operating expenses cost. Useful life Useful life of a leased asset is either the period over which leased asset is expected to be useful by the lessee or the number of production units expected to be gained from the use of the asset by the lessee. Residual value The value of a leased asset is the estimated fair value of the asset at the end of the lease term. Guaranteed residual value It is guaranteed by the lessee or by a party on behalf of the lessee to pay the maximum amount of the guarantee; and in the case of the lessor, the part of the residual value which is guaranteed by the lessee or on behalf of the lessee, or an independent third party who is financially able of discharging the obligations under the guarantee. Unguaranteed residual valued of a lease asset It is the value of a leased asset that is the total amount by which the residual value of the asset exceeds its guaranteed residual value. Gross investment in the lease It is the sum of the minimum lease payments within a finance lease from the lessors view and any unguaranteed residual value accumulating to the lessor. Unearned finance income Any income that comes from investments and other sources unrelated to employment services. Net investment in the lease Net investment in the lease is the gross investment in the lease less unearned finance income. Implicit interest An interest rate that is not explicitly stated, but the implicit rate can be determined by use of present value factors. Contingent rent It is the portion of the lease payments that is not permanent in amount but is based on a factor other than just the passage of time. For example, percentage of sales.

Classification of leases The lease can be classified as either a finance lease or an operating lease based on different accounting treatments as required for the different types of lease. This classification is based on the extent to which risks and rewards of ownership of leased asset are transferred to the lessee or remain with the lessor. Risks include

loss from idle capacity, technological obsolescence, and variations in return. Rewards include the rights to sell the asset and gain from its capital value. Leases are classified as a finance lease if it transfers considerably all the risks and rewards of ownership to the lessee; else if it does not then it is an operating lease. While classifying a lease, it is important to recognize the essence of the agreement and not just its legal form. The commercial reality is always important. Conditions in the lease may specify that an entity has only a limited disclosure to the risks and benefits of the leased asset. The following are some of the situations where an individual or in combination, would usually direct to a lease being a finance lease: Transfer of ownership to the lessee by the end of the lease term. The lessee has the choice to purchase the asset at a cost that is expected to be lower than its fair value and such that the option is likely to be exercised. The lease term is for a key part of the financial life of the asset, even if title to the asset is not transferred. The current value of the least lease payments is equal to substantially all of the fair value of the asset. The leased resources are of a specialized nature such that only the lessee can use them without significant modification. Losses or gains from changes in the fair value of the residual value of the asset add to the lessee. The lessee has the option to continue the lease for a secondary term at significantly below market rent.

The following are some of the situations where an individual or in combination, would usually direct to a lease being an operating lease: If the lessor experiences the risk associated with a movement in the market value of the asset or the use of the asset. If there is an option to cancel, and the lessee is likely to exercise such an option. Leases of land, if title is not transferred. If the title to the land is not likely to pass to the lessee, then the rewards and risks of ownership has not substantially passed.

The lowest lease payments need to be allocated between the land and the building component in proportion to their relative fair values of the lease holding interests at the beginning of the lease. If the allocation is not be made reliably, then both leases are treated as finance leases or as operating leases. Leases in the financial statements of lessees Let us now discuss about leases in the financial statement of lessees. Operating lease

In an operating lease, the lease payments are recognised as an expenditure on a straight-line basis over the lease term, unless another organised basis is more representative of the pattern of the users benefit. The incentives in operating leases will be in the form of up-front payments and rent-free periods. These need to be properly noticed over the lease term from its commencement. Finance lease At the initiation of the lease term, lessees identify finance leases as assets and liabilities in their balance sheets on sum equal to the value of the leased asset or, if lower, on the current value of the minimum lease payments. The discount rate in calculating the current value of the minimum lease payments is the interest rate contained in the lease, if this is possible to determine. Else, the lessees incremental borrowing rate can be used. Any initial direct costs of the lessee are included to the amount identified as an asset. After the initial recognition, the lease payments are assigned between the repayment of the outstanding liability and the finance charge in order to reflect a constant periodic rate of interest on the liability. The asset needs to be depreciated over its expected useful life under IAS 16, using rates for similar assets. If there is no reasonable certainty that ownership will transfer to the lessee, then the shorter of the lease term and the useful life must be used. Leases in the financial statements of lessors This section analyses leases in the financial statement of lessors. Operating lease Lessors present assets under operating leases in their balance sheets based on the nature of the asset. The depreciation policy for depreciable leased assets will be consistent with the lessors normal depreciation policy for related assets, and depreciation is calculated in accordance with International Accounting Standard (IAS 16 and IAS 38). Lease income from operating leases is identified in income on a straight-line basis over the lease term, unless another organised basis is more representative of the pattern in which user benefit derived from the leased asset is reduced. Finance lease Lessors recognise assets held under a finance lease in their balance sheets and present them as a receivable on an amount equal to the net investment in the lease. The identification of finance income is based on a pattern showing a periodic rate of return on the lessors net investment in the finance lease. The dealer lessors recognise selling profit or loss in the period, based on the policy followed by the entity for outright sales. If low rates of interest are quoted, selling profit will be restricted which would apply if a market rate of interest were charged. Costs incurred by manufacturer or dealer lessors associated with negotiating and

arranging a lease will be recognised as an expense when the selling profit is identified. Q.6 Given the various types of mutual funds, take any two schemes and discuss the performance of the schemes.

Ans:- Different types of mutual fund schemes Schemes according to Maturity Period: A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period. Open-ended Fund/ Scheme An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity. Close-ended Fund/ Scheme A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund is open for subscription only during a specified period at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual funds schemes disclose NAV generally on weekly basis. Schemes according to Investment Objective: A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows: Growth / Equity Oriented Scheme The aim of growth funds is to provide capital appreciation over the medium to longterm. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the

investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a longterm outlook seeking appreciation over a period of time. Income / Debt Oriented Scheme The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations. Balanced Fund The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds. Money Market or Liquid Fund These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods. Gilt Fund These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes. Index Funds

Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme. There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges. How to know the performance of a mutual fund scheme? The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on daily basis in case of open-ended schemes and on weekly basis in case of close-ended schemes. The NAVs of mutual funds are required to be published in newspapers. The NAVs are also available on the web sites of mutual funds. All mutual funds are also required to put their NAVs on the web site of Association of Mutual Funds in India (AMFI) www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place The mutual funds are also required to publish their performance in the form of halfyearly results which also include their returns/yields over a period of time i.e. last six months, 1 year, 3 years, 5 years and since inception of schemes. Investors can also look into other details like percentage of expenses of total assets as these have an affect on the yield and other useful information in the same half-yearly format. The mutual funds are also required to send annual report or abridged annual report to the unitholders at the end of the year. Various studies on mutual fund schemes including yields of different schemes are being published by the financial newspapers on a weekly basis. Apart from these, many research agencies also publish research reports on performance of mutual funds including the ranking of various schemes in terms of their performance. Investors should study these reports and keep themselves informed about the performance of various schemes of different mutual funds. Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity oriented schemes with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc. On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme.

Master of Business Administration - MBA Semester 4 MF0018 Insurance and Risk Management Assignment Set- 1 Q.1 Explain chance of loss and degree of risk with examples Ans:- Chance of loss Loss is the injury or damage borne by the insured in consequence of the happening of one or more of the accidents or misfortunes against which the insurer, in consideration of the premium, has undertaken to assure the insured. Chance of loss

is defined as the probability that an event that causes a loss will occur. The chance of loss is a result of two factors, namely peril and hazard. Hazards are further classified into the following four types:

Physical hazard This is a danger likely to happen due to the physical characteristics of an object, which increases the chance of loss. For example defective wiring in a building which enhances the chance of fire. Moral hazard It is an increase in the probability of loss due to dishonesty or character defects of an insured person. For example, Burning of unsold goods that are insured in order to increase the amount of claim is a moral hazard. Morale hazard It is an attitude of carelessness or indifference to losses, because the losses were insured. For example, careless acts like leaving a door unlocked which makes it easy for a burglar to enter, or leaving car keys in an unlocked car increase the chance of loss. Legal hazard It is the severity of loss which is increased because of the regulatory framework or the legal system. For example actions by government departments restricting the ability of insurers to withdraw due to poor underwriting results or a new environment law that alters the risk liability of an organisation.

Degree of risk Degree of risk refers to the intensity of objective risk, which is the amount of uncertainty in a given situation. It can be assessed by finding the difference between expected loss and actual loss. The formula used is Degree of risk = Degree of risk is measured by the probability of adverse deviation. If the probability of the occurrence of an event is high, then greater is the likelihood of deviation from the outcome that is hoped for and greater the risk, as long as the probability of loss is less than one. In the case of exposures in large numbers, estimates are made based on the likelihood of the number of losses that will occur. With regard to aggregate exposures the degree of risk is not the probability of a single occurrence but it is the probability of an outcome which is different from that expected or predicted. Therefore insurance companies make predictions about the losses that are expected to occur and formulate a premium based on that. Q.2 Explain in detail Malhotra Committee recommendations Ans:- Recommendations of Malhotra committee The major reforms in Indian industry started when the Malhotra committee was formed in 1993 headed by R. N. Malhotra (former Finance Secretary and RBI Governor). This was formed to analyse the Indian insurance industry and propose the future course of the industry. It modified the financial sector to design a system appropriate for the changing economical structures in India. The committee

recognised the importance of insurance in financial systems and designed suitable insurance programs. The report submitted by the committee in 1994 is given below: Structure Government risk in the insurance Companies to be decreased to 50%. GIC must be taken under the government so that the GIC subsidiaries can work independently. Better freedom of operation for insurance companies.

Competition Private companies who have initial capital of Rs 1 billion must be permitted to work in the insurance industry. Companies should not use a single entity to deal with life and general Insurance. Foreign companies may be permitted to work in the Indian insurance industry only as partners of some domestic company. Postal life insurance must be permitted to work in the rural market. Every state must have only one state level life insurance company.

Regulatory body The Insurance Act must be changed. An Insurance Regulatory body must be formed. Insurance controller, which was a part of finance ministry, should be allowed to work independently.

Investments The mandatory investments given to government securities from the LIC Life Fund must be reduced from 75% to 50%. GIC and its subsidiaries should not be allowed to hold more than 5% in any company.

Customer service LIC must pay interest if it delays any payments beyond 30 days. All insurance companies should be encouraged to create unit linked pension plans. The insurance industry should be computerised and the technologies must be updated. The insurance companies should promote and fulfil customer services. They should also extend the insurance coverage areas to various sectors.

The committee allowed only a limited competition in this sector as any failure on the part of new players could ruin the confidence of the public to associate with this

industry. Every insurance company with an initial capital of Rs.100 crores can act as an independent company with economic motives. Since then there is a competition between the private and public sectors of insurance, the Insurance Regulatory and Development Authority Act, 1999 (IRDA Act) was formed to control, support and ensure a structured growth of the insurance industry. The private sector insurance companies were allowed to work along with the public sector, but had to follow the conditions given below: The company must be registered under the Companies Act, 1956. The total capital share by a foreign company held by itself or by through sub sectors of the company should not exceed 26% of the capital paid to the Indian insurance industry. The company should only provide life, general insurance or reinsurance. The company should have an initial paid capital of at least Rs.100 crores to provide life insurance. The company should have an initial paid capital of at least Rs.200 crores to provide reinsurance.

Later in 2008, further reforms were made by introducing the plan for Insurance (Laws) Amendment Bill - 2008 and The LIC (Amendment) Bill - 2009. These amendments influenced the Indian insurance industry in a huge way. The Insurance (Laws) Amendment Bill - 2008 amended three other acts namely, Insurance Act 1938, General Insurance Business (Nationalisation) Act 1972 (GIBNA) and Insurance Regulatory and Development Authority Act 1999. Q.3 What is the procedure to determine the value of various investments? Ans:Q.4 Discuss the guidelines for settlement of claims by Insurance company Ans:- General guidelines for claims settlement There are some guidelines that must be followed while settling the claims. These guidelines are general in nature, and are not compiled to be the same always. Therefore, the claim settling authority uses discretion and records reasons. Appointment of surveyor The Insurance Act states that surveyor should survey claims above Rs. 20,000. The surveyors appointment should be based on the following points: The surveyor should have a valid license. The surveyor selected should consider the type of loss and nature of the claims. Depending on the situation, if technical expertise is required, a consultant having technical expertise assists the surveyor.

One surveyor can be used for various jobs, if the surveyors competence is good for both.

Appointment of investigator Depending on circumstances, it is necessary to appoint an investigator for verifying the claim version of loss. The appointing letter of the investigator o mentions all the reference terms to perform. Q.5 What is facultative reinsurance and treaty reinsurance? Ans:- The two different types of reinsurances are: Facultative reinsurance. Treaty reinsurance.

Facultative reinsurance It is a type of reinsurance that is optional; it is a case-by-case method that is used when the ceding company receives an application for insurance that exceeds its retention limit. It is based on the individual agreements that help to cover specific losses. When any primary insurer wants reinsurance for a specific coverage, it enters the market, and bargains with different reinsurance companies for the amount of coverage and premium, looking out for a better value. According to most of the contracts, the reinsurer pays a ceding commission to the insurer to pay for purchase expenses. Before issuing the insurance policy the insurer looks for reinsurance and speaks to many reinsurers. The insurance company does not have any commitments to cede insurance and also the reinsurer has no commitments to accept the insurance. However if the insurance company find a reinsurer who is willing to take the insurance policy then they can enter into a contract. Facultative reinsurance is used when a huge amount of insurance is preferred and while considering a specific risk involved in an individual contract. Facultative reinsurance is the reinsurance of a part of a single policy or the entire policy after negotiating the terms and conditions. It reduces the risk exposure of the ceding company against a particular policy. Facultative reinsurance is not mandatory. One advantage of facultative reinsurance is it is flexible as a reinsurance contract is arranged to fit any kind of cases. It helps the insurance companies in writing large amount of insurance policies. Reinsurance moves the huge losses of the insurers to the reinsurer and thus helps the insurer. One main disadvantage of facultative reinsurance is that it is not reliable. The ceding insurer will not know in advance whether a reinsurer will agree to pay any part of the insurance. The other disadvantage of this kind of reinsurance is the delay in issuing the policy as it cannot be issued until the reinsurance is got for that policy.

Treaty reinsurance Treaty reinsurance is one in which the primary insurer agrees to cede the insurance policy to the reinsurer and the reinsurer has to accept it. It includes a standing agreement with a specific reinsurer. The amount of insurance that the primary insurer sells and those policies where both the parties provide the service is specified in the contract. All the business that comes under the contract is automatically reinsured according to the conditions of the treaty. Treaty reinsurance needs the reinsurer to assume the entire responsibility of the ceding company or a part of it for some particular sections of the business with respect to the terms of the policy. The contract is a compulsory contract because according to the treaty the ceding company has to cede the business and the reinsurer is compelled to assume the business. It is a type of reinsurance that is preferred while considering the groups of homogenous risks. The treaty reinsurance provides many advantages to the primary insurance company. It is automatic, more reliable, and there is no delay in issuing the policy. It is also more cost effective as there is no need to shop around for reinsurers before writing the policy. The treaty reinsurance is not advantageous to the reinsurer. Usually the reinsure does not know about the individual applicant of the policy and has to depend on the underwriting judgment that the primary insurer gives. It may be so that the primary insurer can show bad business like more losses and get reinsured for it as the reinsurer does not know the real fact. The primary insurer may pay insufficient premium to the reinsurer. Therefore the reinsurer undergoes a loss if the risk selection of the primary insurer is not good and they charge insufficient rates. There are different types of treaty reinsurance arrangements which may differ according to the liability of the reinsurer. They are: Quotashare treaty. Surplusshare treaty. Excessofloss treaty. Reinsurance pool.

Q.6 What is the role of information technology in promoting insurance products Ans:-The rapid developments in information technology are posing serious challenges for insurance organisations. The use of information technology in insurance industry has an impact on the efficiency of the organisation as it reduces the operational costs. After many private players entered the insurance industry, the competition in the insurance sector has become immense. Information technology has helped in enhancing the insurance business. Insurance industry uses information technology for internal administration, accounting, financial management, reports, and so on.

Indian insurance organisations are rapidly growing as technology-driven organisations, by replacing billions of files with folders of information. Insurers are heading towards the technological enhancements, in order to focus on the key areas of insurance business. The role of IT in different fields of insurance like:

Actuarial investigation - Insurers depend on the rates of actuarial models to decide the quantity of risks which create loss. Insurance organisations are using new technologies, to analyse the claims and policyholders data for providing connection between risk characteristics and claims. Developments in technology allow actuaries to examine risks more precisely. Policy management - Most of the insurance policies are printed and conveyed to policy owners through mail every year. The method of creating documents is accomplished by technicians and typists. In most of the cases, this task is generally completed by using new technology. Customer data is accessed by computer systems, and maintained in huge folders, in order to renew each policy. To assemble the policies, complex software packages are used, and to print the policies high speed printers are utilised. Underwriting Underwriters can use knowledge based expert systems to make underwriting decisions. By using automated systems, underwriters can compare an individuals risk profile with their data and customise policies according to the individuals risk profile. Front end operations: CRM (Customer Relationship Management) packages are used to integrate the different functional processes of the insurance company and provide information to the personnel dealing with the front end operations. CRM facilitates easy retrieval of customer data. LIC is using CRM packages to handle its front end operations.

Master of Business Administration-MBA Semester 4 MB0052 Strategic Management and Business Policy - 4 Credits Assignment Set- 1 (60 Marks) Note: Each question carries 10 Marks. Answer all the questions.

Q.1 What similarities and differences do you find in BCG business portfolio matrix, Ansoff growth matrix and GE growth pyramid. (10 marks) Ans. The BCG matrix is a portfolio management tool used in product life cycle. BCG matrix is often used to highlight the products which get more funding and attention within the company. During a products life cycle, it is categorised into one of four types for the purpose of funding decisions. Figure 3.5 below depicts the BCG matrix.

Figure 3.5 BCG Growth Share Matrix Question Marks (high growth, low market share) are new products with potential success, but they need a lot of cash for development. If such a product gains enough market shares to become a market leader, which is categorised under

Stars, the organisation takes money from more mature products and spends it on Question Marks. Stars (high growth, high market share) are products at the peak of their product life cycle and they are in a growing market. When their market rate grows, they become Cash Cows. Cash Cows (low growth, high market share) are typically products that bring in far more money than is needed to maintain their market share. In this declining stage of their life cycle, these products are milked for cash that can be invested in new Question Marks. Dogs (low growth, low market share) are products that have low market share and do not have the potential to bring in much cash. According to BCG matrix, Dogs have to be sold off or be managed carefully for the small amount of cash they guarantee. The key to success is assumed to be the market share. Firms with the highest market share tend to have a cost leadership position based on economies of scale among other things. If a company is able to apply the experience curve to its advantage, it should able to produce and sell new products at low price, enough to garner early market share leadership. Limitations of BCG matrix: The use of highs and lows to form four categories is too simple The correlation between market share and profitability is questionable. Low share business can also be profitable. Product lines or business are considered only in relation to one competitor: the market leader. Small competitors with fast growing shares are ignored. Growth rate is the only aspect of industry attractiveness Market share is the only aspect of overall competitive position 3.4.2 Igor Ansoff growth matrix The Ansoff Growth matrix is a tool that helps organisations to decide about their product and market growth strategy. Growth matrix suggests that an organisations attempts to grow depend on whether it markets new or existing products in new or existing markets. Ansoffs matrix suggests strategic choices to achieve the objectives. Figure 3.6 depicts Ansoff growth matrix.

Figure 3.6 Ansoff Growth Matrix Market penetration Market penetration is a strategy where the business focuses on selling existing products into existing markets. This increases the revenue of the organisation. Market development Market development is a growth strategy where the business seeks to sell its existing products into new markets. This means that the product is the same, but it is marketed to a new audience. Product development Product development is a growth strategy where a business aims to introduce new products into existing markets. This strategy may need the development of new competencies and requires the business to revise products to appeal to existing markets. Diversification Diversification is the growth strategy where a business markets new products in new markets. This is an intrinsically riskier strategy because the business is moving into markets in which it has little or no experience. For a business to adopt a diversification strategy, it should have a clear idea about what it expects to gain from the strategy and an honest assessment of the risks. 3.4.3 McKinsey/GE growth pyramid The McKinsey/GE matrix is a tool that performs a business portfolio analysis on the Strategic Business units in an organisation. It is more sophisticated than BCG matrix in the following three aspects: Industry (market) attractiveness Industry attractiveness replaces market growth. It includes market growth, industry profitability, size and pricing practices, among other possible opportunities and threats.

Competitive strength Competitive strength replaces market share. It includes market share as well as technological positions, profitability, size, among other possible strengths and weaknesses. McKinsey/GE growth pyramid matrix works with 3*3 grids while BCG matrix is 2*2 matrixes. External factors that determine market attractivene