Eravandi

Mutual Funds

2011-01-23T15:25:00.001+05:30

MUTUAL FUNDS

Mutual Fund is an investment company that pools money from shareholders / unitholders and invests in a variety of securities, such as stocks, bonds and money market instruments. Most open-end mutual funds stand ready to buy back (redeem) its shares at their current net asset value, which depends on the total market value of the fund's investment portfolio at the time of redemption. Most open-end mutual funds continuously offer new shares also to investors.

In Simple Words, Mutual fund is a mechanism for pooling the resources by issuing units to the investors and investing funds in securities in accordance with objectives as disclosed in offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unitholders.

The profits or losses are shared by the investors in proportion to their investments. The mutual funds normally come out with a number of schemes with different investment objectives which are launched from time to time. In India, a mutual fund is required to be registered with Securities and Exchange Board of India (SEBI), which regulates securities markets, before it can collect funds from the public.

In Short, a mutual fund is a common pool of money in to which investors with common investment objective place their contributions that are to be invested in accordance with the stated investment objective of the scheme. The investment manager would invest the money collected from the investor in to assets that are defined/ permitted by the stated objective of the scheme. For example, an equity fund would invest equity and equity related instruments and a debt fund would invest in bonds, debentures, gilts etc.

Sponsor:

A sponsor is an entity responsible for laying the foundation stone of a fund. In real sense, it puts in the seed money in fund’s set up. Any registered company, a scheduled bank or financial institution can act as sponsor. As per SEBI norms it must possess a prerequisite and good financial record in past. AMC and custodian are appointed by sponsor but once AMC is constituted, sponsor is just the stakeholder of fund and is not liable for making up any operational losses of the fund. For example, SBI is the sponsor of SBI Mutual Fund.

Board of trustees:

Mutual funds in India are constituted as trusts and have a board of trustees to run the fund. AMC is a third party appointed by trustees for managing the money but the real power lies with the trust that is accountable for investor’s money held in the fund. They can even sack the AMC if it is found doing unethical practices or underperforming.

Custodian:

It is an independent entity appointed for holding and safekeeping of the fund’s assets. As the portfolio of securities for a mutual fund is so big, they need a third party for receipt, delivery of securities and keeping an account of the same. Most of the funds use banks as their custodians but one bank can act as custodian of multiple funds. On a broader side, when instead of common public, bigger players like FIIs are the investors, the concept of domestic and global custodian comes into picture.

AMC:
Asset Management Company (AMC) can be considered as the heart of any fund. It manages the investments you have made. At the core are fund managers or portfolio managers taking investment decisions on your behalf. They have access to critical market data that helps them analyze the market conditions and explore investing opportunity to meet their financial objectives. In addition, it is responsible for maintaining a record of pricing and accounting data. It also calculates NAV of the fund that is mandated by SEBI to be disclosed publicly on daily basis. The fund charges investors a fee, called management fees for the services offered by AMC.

The ultimate aim of any fund is the benefit to investors and SEBI is keeping an eye on above entities to ensure compliance of rules and regulations set for the investor’s benefit. The fund regulations in India are considered the best in the world and one major strength lies in well coordinated structure with defined roles of sponsor, trustee, AMC that tend to protect investor’s from risk of default.

8.1 History of Mutual Funds in India

Unit Trust of India (UTI) was the first mutual fund set up in India in the year 1963. In early 1990s, Government allowed public sector banks and institutions to set up mutual funds.

In the year 1992, Securities and exchange Board of India (SEBI) Act was passed. The objectives of SEBI are – to protect the interest of investors in securities and to promote the development of and to regulate the securities market.

In 1995, the RBI permitted private sector institutions to set up Money Market Mutual Funds (MMMFs). They can invest in treasury bills, call and notice money, commercial paper, commercial bills accepted/co-accepted by banks, certificates of deposit and dated government securities having unexpired maturity of upto one year.

As far as mutual funds are concerned, SEBI formulates policies and regulates the mutual funds to protect the interest of the investors. SEBI notified regulations for the mutual funds in 1993. Thereafter, mutual funds sponsored by private sector entities were allowed to enter the capital market. The regulations were fully revised in 1996 and have been amended thereafter from time to time. SEBI issues guidelines to the mutual funds from time to time to protect the interests of investors.

All mutual funds, whether promoted by public sector or private sector entities including those promoted by foreign entities, are governed by the same set of Regulations. There is no distinction in regulatory requirements for these mutual funds and all are subject to monitoring and inspections by SEBI. The risks associated with the schemes launched by the mutual funds sponsored by these entities are of similar type.

8.2 Types of Mutual Funds

a) 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.

(i) Open-ended Fund

An open-ended Mutual fund is one that is available for subscription and repurchase on a continuous basis. These Funds 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.

(ii) Close-ended Fund

A close-ended Mutual fund 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.

b) Schemes according to Investment Objective:

A scheme can also be classified as growth fund, income fund, or balanced fund 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:

(i) Growth / Equity Oriented Scheme

The aim of growth funds is to provide capital appreciation over the medium to long- term. 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 long-term outlook seeking appreciation over a period of time.

(ii) 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.

(iii) 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.

(iv) 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.

(v) Gilt Fund

These funds invest exclusively in government securities. Government securities have negligible or nil 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.

c) Other schemes

(i) 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 composition 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.

(ii) Tax Saving Schemes

In India, Tax Saving Schemes schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues, for e.g. Equity Linked Savings Schemes (ELSS).

(iii) Sector Specific Schemes

These have caught the fancy of investors in the recent times. These schemes invest only in stocks of a particular sector alone, for example, Banking, Pharmaceuticals, Infrastructure etc.

8.3 What is NET ASSET VALUE ?

The Term Net Asset Value (NAV) is used by investment companies to measure net assets. It is calculated by subtracting liabilities from the value of a fund's securities and other items of value and dividing this by the number of outstanding shares. Net asset value is popularly used in newspaper mutual fund tables to designate the price per share for the fund.

The value of a collective investment fund based on the market price of securities held in its portfolio is first calculated. Units in open ended funds are valued using this measure. Closed ended investment trusts have a net asset value but have a separate market value (if listed on stock exchange). Such closed ended Schemes can trade at net asset value or their price can be at a premium or discount to NAV. NAV is calculated each day by taking the closing market value of all securities owned plus all other assets such as cash, subtracting all liabilities, then dividing the result (total net assets) by the total number of shares outstanding.

Calculating NAVs - Calculating mutual fund net asset values is easy. The current market value of the fund's net assets (securities held by the fund minus any liabilities) is found and then divided by the number of units outstanding. So if a fund had net assets of Rs.50 lakh and there are one lakh units of the fund, then the price per unit (or NAV) is Rs.50.00.

The NAV has significance, apart from knowing one’s value of investment at a particular time. The AMC fixes the sale and repurchase price of open-ended schemes at NAV (or around it, in case of entry / exit load is applicable).

Factoring

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What is factoring?

Factoring is a service that covers the financing and collection of account receivables in domestic and international trade. It is a cash management tool for companies where long receivables are a part of business cycle. It is the conversion of credit sales into cash.

In factoring, a financial institution (factor) buys the accounts receivable of a company (Client) and pays up to 80% of the amount immediately on agreement. Factoring company pays the remaining amount (Balance 20%-finance cost-operating cost) to the client when the customer pays the debt. Collection of debt from the customer is done either by the factor or the client depending upon the type of factoring. The account receivable in factoring can either be for a product or service.

Examples are factoring against goods purchased, factoring for construction services (usually for government contracts), factoring against medical insurance etc. Let us see how factoring is done against an invoice of goods purchased.

Characteristics of factoring

Usually period for factoring is 90 to 150 days. Sometimes more than 150 days.
Costly source of finance compared to other sources of short term borrowings.
Credit worthiness is evaluated based on financial strength of customer (debtor). Therefore ideal for new and emerging firms without strong financials.
Bad debts are considered for factoring.
Credit rating is not mandatory. But factoring companies usually carries out credit risk analysis before entering into agreement.
Method of off balance sheet financing.
Cost of factoring=finance cost + operating cost. Factoring cost depends on transaction size, financial strength of the customer etc. varies from 1.5% to 3% per month depending upon the financial strength of client's customer.
Indian firms offer factoring for invoices as low as 1000Rs
For delayed payments beyond the approved credit period, penal charge of around 1-2% per month over and above normal cost is charged.

How is factoring different from a bank loan?

1. Credit decision in factoring is based on receivables rather than other factors like how long the company has been in business, working capital and personal credit score.

2. Factoring is not a loan; it is the purchase of financial asset.

3. Bank loan involves two parties whereas factoring involves three-buyer, exporter and factor.

**There is some misconception regarding factoring like people believe factors are a lender of last resort but that is not true because exporters seeking out factoring are often in the beginning stages of growth. At first glance, factoring appears to be expensive but does a lot more; in essence, factoring replaces the accounts receivables and credit department.

Advantages

turns receivables instantly into cash
provides credit protection for receivables
helps meet increasing sales demand and expand
Saves time as invoice financing company collects money itself

Disadvantages

may lead to ruined relations with customers if factor engages in aggressive or unprofessional practices when collecting accounts.
cost involved in factoring agreement may be more than cost of other methods of financing

Different types of Factoring

Disclosed and Undisclosed
Recourse and Non recourse

A single factoring company may not offer all these services.

Disclosed

o Client's customers are notified of factoring agreement. Can either be recourse or non recourse.

o factor may or may not be responsible for the collection of debts depending on whether it is recourse or non recourse.

Undisclosed

client's customers are not notified of the factoring arrangement. Sales ledger administration and collection of debts are undertaken by client himself. Client has to pay the amount to the factor irrespective of whether customer has paid or not.

Recourse

client undertakes to collect debts from customer. If customer dosent pay amount on maturity, factor will recover it from client. Offered at lower interest rate since risk by factor is low. Balance amount is paid to client when customer pays factor.

Non recourse

factor undertakes to collect debts from customer. Balance amount is paid to client at the end of credit period or when the customer pays factor whichever comes first. advantage is that continuous factoring will eliminate need for credit and collection departments.

Factoring companies in India

· Canbank Factors Limited

· SBI Factors and Commercial Services Pvt. Ltd

· The Hongkong and Shanghai Banking Corporation Ltd

· Foremost Factors Limited

· Global Trade Finance Limited

· Export Credit Guarantee Corporation of India Ltd

· Citibank NA, India

· Small Industries Development Bank of India (SIDBI)

· Standard Chartered Bank

What is forfeiting?

The forfeiting owes its origin to a French term ‘a forfait’ which means to forfeit (or surrender) ones’ rights on something to someone else. It is a mechanism of financing exports:

a. by discounting export receivables

b. evidenced by bills of exchanges or promissory notes

c. without recourse to seller (viz; exporter)

d. carrying medium to long-term maturities

e. on a fixed rate basis upto 100% of contract value.

In other words, it is trade finance extended by a forfaiter to an exporter seller for an export/sale transaction involving deferred payment terms over a long period at a firm rate of discount. Forfaiting is generally extended for export of capital goods, commodities and services where importer insists on supplies on credit terms. Recourse to forfaiting usually takes place where the credit is for long date maturities and there is no prohibition for extending the facility where the credits are maturing in periods less than one year.

Parties to Forfaiting

There are five parties in a transaction of forfaiting.

i. Exporter

ii. Importer

iii. Exporter’s bank

iv. Importer’s bank

v. The forfaiter.

Mechanism

1. exporter and importer negotiate proposed export sale contract. Then exporter approaches forfaiter to ascertain terms of forfaiting.

forfaiter collects details about importer, supply and credit terms, documentation etc.

· ascertains country and credit risk involved.

· quotes discount rate.

5. exporter then quotes a contract price to overseas buyer by loading discount rate, commitment fee etc. On the sale price of goods to be exported.

6. exporter and forfaiter sign a contract.

7. Export takes place against documents guaranteed by importer’s bank.

8. exporter discounts bill with forfaiter and latter presents the same to importer for payment on due date or even sell it in secondary market.

Documentation

1. Forfaiting transaction is usually covered either by a promissory note or bills of exchange & are guaranteed by a bank.

3. Bills of exchange may be ‘availed by’ importer’s bank. ‘Aval’ is an endorsement made on bills of exchange or promissory note by the guaranteeing bank by writing ‘per aval’ on these documents under proper authentication.

Costs of forfaiting

1. Commitment fee, payable by exporter to forfeiter ‘for latter’s’ commitment to execute a specific forfeiting transaction at a firm discount rate with in a specified time.

2. Discount fee, interest payable by exporter for entire period of credit involved and deducted by forfaiter from amount paid to exporter against availised promissory notes or bills of exchange.

3. Documentation fee.

Benefits of forfaiting

1. frees exporter from political or commercial risks from abroad.

2. offers ‘without recourse’ finance to an exporter. does not effect exporter’s borrowing limits/capacity.

3. relieves exporter from botheration of credit administration and collection problems.

4. Forfaiting is specific to a transaction. It does not require long term banking relationship with forfaiter.

5. Exporter saves money on insurance costs because forfeiting eliminates need for export credit insurance.

Advantages

· Firms resorting to factoring have added attraction of ready source of short-term funds. This improves cash flow and is invaluable as it leads to a higher level of activity resulting in increased profitability.

· By offloading the sales accounting and administration, management has more time for planning, running and improving the business, and exploiting opportunities, The reduction in overheads brought about by factor’s administration of sales ledger result in interest savings and contribute towards cost savings.

Disadvantages

· costlier to in-house management of receivables, specially for large firms which have access to similar sources of funds as the factors themselves and which on account of their size have well organised credit and receivable management.

· perceived as an expensive form of financing and also as finance of the last resort. This tends to have a deleterious effect on the creditworthiness of the company in the market.

Major players in India

The first factoring company was started by the SBI in 1991 namely Factors and Commercial Ltd. (SBI FACS) followed by Canara Bank and PNB, setting the subsidiaries for the purpose. While the SBI would provide such services in the Western region, the RBI has permitted the Canara Bank and PNB to concentrate on the Southern and Northern regions of the country, for providing such services for the customers. The major players since 1991 are Canbank Factors, SBI Factors and later Foremost Factors. The new entrants in the market include ICICI, HSBC and Global Trade Finance. Canback Factors leads in the domestic market with about 65%-70% of the share.

The factoring service has not developed to any significant extent in India.

Bill Discounting

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Bill discounting as a fund-based activity emerged as a profitable business in the early nineties – However post scam its importance has declined (restrictions by RBI)

DEF

Bank takes the bill drawn by borrower on his(borrower's) customer and pay him immediately deducting some amount as discount/commission. The Bank then presents the Bill to the borrower's customer on the due date of the Bill and collect the total amount. If the bill is delayed, the borrower or his customer pay the Bank a pre-determined interest depending upon the terms of transaction.

TYPES OF BILLS

Demand Bill: Payable immediately “at sight” or “on presentment” to the drawee. Bill on which no “due date” is specified is also termed as a demand bill.

Usance Bill: (time Bill) - Bill of exchange drawn on a term governed by the usage in that trade. Usance refers to the time period recognized by custom or usage for payment of bills.

Documentary Bills: B/Es that are accompanied by documents that confirm that a trade has taken place. documents include the invoices and other documents of title such as railway receipts, lorry receipts and bills of lading.

Further classified as:

(i) Documents against acceptance (D/A) bills - documentary evidence accompanying B/E is deliverable against acceptance by drawee.

(ii) Documents against payment (D/P) bills - In case a bill is a “documents against payment” bill and has been accepted by the drawee, documents of title will be held by bank till maturity of B/E.

Clean Bills: not accompanied by any documents that show that a trade has taken place. Thus interest rate charged on such bills is higher than rate charged on documentary bills.

CREATION OF A B/E:

Suppose a seller sells goods to a buyer. In most cases, the seller would like to purchase on credit. To solve this problem, the seller draws a B/E of a given maturity on the buyer.

Seller (creditor) ---Drawer of bill

Buyer(debtor)----Drawee.

seller then sends the bill to the buyer who acknowledges his responsibility for the payment of the amount by writing his acceptance on the bill.

DISCOUNTING OF A B/E:

The seller, who is the holder of an accepted B/E has two options:

1. Hold on to the B/E till maturity and then take the payment from the buyer.

2. Discount the B/E with a discounting agency. (more attractive)

The seller can take over the accepted B/E to a discounting agency and obtain ready cash.

(known as discounting the B/E)

The margin between the ready money paid and the face value of the bill is called the discount and is calculated at a rate percentage per annum on the maturity value.

The maturity a B/E is defined as the date on which payment will fall due.

TYPES OF BILL DISCOUNTING:

Bills discounting is of two types

1. Purchase bills discounting - investor discounts the purchase bill of the company and pays the company, who in turn pay their supplier. investor gets his money back from the company at the end of the discounting period.

2. Sales bill discounting - investor discounts the sales bill of the company and pays directly to the company. The investor gets his return from the company at the end of the discounting period.

Procedure

Broker will contact you with proposals to discount bills of different companies at different rates. better companies command discounting rates of 13% to 15%,while lesser known have to pay discounting rates of 17% - 28%.

On agreement of particular bill discounting transaction company gives to the investor the following:

ü The original copies of bills to be discounted;

ü hundi / promissory note; Post dated cheque.

The investor simply has to issue a cheque - amount arrived at after deducting the discount rate.

EX. Company A wants to discount its purchase bill of Rs200,000 for three months. Investor P agrees to do so at a discount rate of 21%.

Investor will issue a cheque of Rs189, 500. (200,000 x 21% x 3/12)

company on its part will issue a post-dated cheque of Rs200,000 for three months period.

He gets the interest element at the first day of issuing the cheque. i.e. he does not include that part in his cheque amount. Thus he can earn interest on this interest for a three-month period. Even a simple bank fixed deposit on it will earn @5% p.a. By investing Rs189,500 for three months, the investor earns Rs10,500 on it. A return of 22.16%.

Discount Rates The rates depend on the following factors:

Broker - His relations with the company and the investor do make a difference of a couple of percentage point in discounting rates.

Liquidity - Liquidity crunch in the market tends to hike up the rates even in the best of the companies.

Volume/Value of Discounting - When the volume/value of discounting done by the investor is high, he is looking at security more than returns. The company on its part is looking at savings by way of reduced legal paper work and a higher amount of dedicated funds .

Frequency - regular bills discounter may get upto 1% to1.5% points higher interest rates than a new investor. investor trying out with a new company and will agree to a lesser rate to ensure safety.

ADR/GDR

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AMERICAN DEPOSITORY RECEIPTS (ADR) & GLOBAL DEPOSITORY RECEIPTS (GDR)

Depository Receipts :

Depository Receipts are a type of negotiable (transferable) financial security, representing a security, usually in the form of equity, issued by a foreign publicly-listed company. However, DRs are traded on a local stock exchange though the foreign public listed company is not traded on the local exchange.

Thus, the DRs are physical certificates, which allow investors to hold shares in equity of other countries. . This type of instruments first started in USA in late 1920s and are commonly known as American depository receipt (ADR). Later on these have become popular in other parts of the world also in the form of Global Depository Receipts (GDRs). Some other common type of DRs are European DRs and International DRs.

In nut shell we can say ADRs are typically traded on a US national stock exchange, such as the New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated in US dollars, but these can also be denominated in Euros.

How do Depository Receipts Created?

When a foreign company wants to list its securities on another country’s stock exchange, it can do so through Depository Receipts (DR) mode. . To allow creation of DRs, the shares of the foreign company, which the DRs represent, are first of all delivered and deposited with the custodian bank of the depository through which they intend to create the DR. On receipt of the delivery of shares, the custodial bank creates DRs and issues the same to investors in the country where the DRs are intended to be listed. These DRs are then listed and traded in the local stock exchanges of that country.

What are ADRs :

American Depository Receipts popularly known as ADRs were introduced in the American market in 1927. ADR is a security issued by a company outside the U.S. which physically remains in the country of issue, usually in the custody of a bank, but is traded on U.S. stock exchanges. In other words, ADR is a stock that trades in the United States but represents a specified number of shares in a foreign corporation.

Thus, we can say ADRs are one or more units of a foreign security traded in American market. They are traded just like regular stocks of other corporate but are issued / sponsored in the U.S. by a bank or brokerage.

ADRs were introduced with a view to simplify the physical handling and legal technicalities governing foreign securities as a result of the complexities involved in buying shares in foreign countries. Trading in foreign securities is prone to number of difficulties like different prices and in different currency values, which keep in changing almost on daily basis. In view of such problems, U.S. banks found a simple methodology wherein they purchase a bulk lot of shares from foreign company and then bundle these shares into groups, and reissue them and get these quoted on American stock markets.

For the American public ADRs simplify investing. So when Americans purchase Infy (the Infosys Technologies ADR) stocks listed on Nasdaq, they do so directly in dollars, without converting them from rupees. Such companies are required to declqare financial results according to a standard accounting principle, thus, making their earnings more transparent. An American investor holding an ADR does not have voting rights in the company.

The above indicates that ADRs are issued to offer investment routes that avoid the expensive and cumbersome laws that apply sometimes to non-citizens buying shares on local exchanges. ADRs are listed on the NYSE, AMEX, or NASDAQ.

Global Depository Receipt (GDR): These are similar to the ADR but are usually listed on exchanges outside the U.S., such as Luxembourg or London. Dividends are usually paid in U.S. dollars. The first GDR was issued in 1990.

ADVANTAGES OF ADRs:

There are many advantages of ADRs. For individuals, ADRs are an easy and cost effective way to buy shares of a foreign company. The individuals are able to save considerable money and energy by trading in ADRs, as it reduces administrative costs and avoids foreign taxes on each transaction. Foreign entities prefer ADRs, because they get more U.S. exposure and it allows them to tap the American equity markets. .

The shares represented by ADRs are without voting rights. However, any foreigner can purchase these securities whereas shares in India can be purchased on Indian Stock Exchanges only by NRIs or PIOs or FIIs. The purchaser has a theoretical right to exchange the receipt without voting rights for the shares with voting rights (RBI permission required) but in practice, no one appears to be interested in exercising this right.

How ADR Operates

Indian companies have direct access to raise funds from Indian public by way of issuing Shares, Debentures etc. However Indian companies cannot do so, in such a direct manner, when it comes to raising funds from American people. That would entail the Indian companies to adopt US Accounting Norms which is also called as GAAP, maintain accounting practices as per American Financial Year (Which starts in January and ends in December of any particular year), as also follow variety of stringent standards as per American norms. Effectively, it would mean that the Indian company would have to follow two different set of rules simultaneously, one to comply with the laws of Indian Companies Act, and the other to comply with the American Laws.

The method to circumvent the American norms, but still raise funds from American people is available by way of ADR or American Depository Receipts. In this system, the Indian company deposits certain amount of its Indian shares with designated American Banks. The banks, in turn, issues receipts that are equivalent in values (And also based on the intrinsic value the Indian Company’s shares would fetch in the American market) to the Indian Company. These receipts essentially would be in number of receipts. Then these Indian Companies can trade these ADRs or American Depository Receipts with the American public. These ADRs can be purchased and traded freely without any encumbrances in the American Stocks and Shares Market. This way the Indian company is able to enter into the American Stocks and Shares market, and raise funds from the American public.

The role of the American bank which has issued these receipts is very crucial, since it is they who stand guarantee to the issued receipts. Hence they do exhaustive study of the Indian company from all perspectives, and only then issue the ADR to the Indian company.

Some Major ADRs issued by Indian Companies :

Among the Indian ADRs listed on the US markets, are Infy (the Infosys Technologies ADR), WIT (the Wipro ADR), Rdy(the Dr Reddy’s Lab ADR), and Say (the Satyam Computer ADS)

What are Indian Depository Receipts (IDR) :

Recently SEBI has issued guidelines for foreign companies who wish to raise capital in India by issuing Indian Depository Receipts. Thus, IDRs will be transferable securities to be listed on Indian stock exchanges in the form of depository receipts. Such IDRs will be created by a Domestic Depositories in India against the underlying equity shares of the issuing company which is incorporated outside India.

Though IDRs will be freely priced., yet in the prospectus the issue price has to be justified. Each IDR will represent a certain number of shares of the foreign company. The shares will not be listed in India , but have to be listed in the home country.

The IDRs will allow the Indian investors to tap the opportunities in stocks of foreign companies and that too without the risk of investing directly which may not be too friendly. Thus, now Indian investors will have easy access to international capital market.

Normally, the DR are allowed to be exchanged for the underlying shares held by the custodian and sold in the home country and vice-versa. However, in the case of IDRs, automatic fungibility is not permitted.

SEBI has issued guidelines for issuance of IDRs in April, 2006, Some of the major norms for issuance of IDRs are as follows. SEBI has set Rs 50 crore as the lower limit for the IDRs to be issued by the Indian companies. Moreover, the minimum investment required in the IDR issue by the investors has been fixed at Rs two lakh. Non-Resident Indians and Foreign Institutional Investors (FIIs) have not been allowed to purchase or possess IDRs without special permission from the Reserve Bank of India (RBI). Also, the IDR issuing company should have good track record with respect to securities market regulations and companies not meeting the criteria will not be allowed to raise funds from the domestic market If the IDR issuer fails to receive minimum 90 per cent subscription on the date of closure of the issue, or the subscription level later falls below 90 per cent due to cheques not being honoured or withdrawal of applications, the company has to refund the entire subscription amount received, SEBI said. Also, in case of delay beyond eight days after the company becomes liable to pay the amount, the company shall pay interest at the rate of 15 per cent per annum for the period of delay.

VOTING RIGHTS ON DRs IN PRACTICE - ANALYSIS OF SOME RECENT DR ISSUES IN INDIA AND ABROAD

It is understood that in case of issue of DRs, as a business arrangement, domesticcustodian bank exercises the voting rights on the shares underlying such DRs, asper the instructions of the Overseas Depository Bank which in turn is governed bythe terms of the depositary agreement / terms of issue of the DRs. Such terms ofagreement / issue of DRs vary from issuer to issuer with respect to the right of DRHolders to instruct the custodian on exercise of voting rights.

The “terms of issue” in some of the recent GDR / ADR issues in India as well as in some foreign jurisdictions were perused. It was observed that in some of thecases, the right to give instructions to the custodian bank for exercise of votingrights is vested with the Board of Directors of the issuer company. In certain othercases, the said right is vested with the DR holders. In some cases, a combinationof the above is also used, viz. in the first instance the right to instruct is providedto the holders of DRs and in the event of their failure to exercise the said right, itis deemed to have been vested with the Board of Directors of the issuer company.It is also noted that invariably it is stated that the Depositary will not exercise any voting rights in respect of the underlying shares unless required to do so by law.

Guidelines for ADR/GDR issues by the Indian Companies -Disinvestment of shares by the Indian companies in theOverseas market through issue of ADRs/GDRs

(i) Divestment by shareholders of their holdings of Indian companies, in the overseas markets would be allowed through the mechanism of Sponsored ADR/GDR issuein respect of:-

(a) Divestment by shareholders of their holdings of Indian companies listed in India;

(b) Divestment by shareholders of their holdings of Indian companies not listed in India but which are listed overseas.

(ii) The process of divestment would be initiated by such Indian companies whose shares are being offered for divestment in the overseas market by sponsoringADR/GDR issues against the block of existing shares offered by the shareholdersunder the provisions of these guidelines.

(iii) Such a facility would be available pari-passu to all categories of shareholders, ofthe company whose shares are being sold in the ADR/GDR markets overseas.This would ensure that no class of shareholders gets a special dispensation.

(iv) The sponsoring company, whose shareholders propose to divest existing shares in the overseas market through issue of ADRs/GDRs will give an option to all itsshareholders indicating the number of shares to be divested and the mechanismhow the price will be determined under the ADR/GDR norms. If the sharesoffered for divestment are more than the pre-specified number to be divested,shares would be accepted for divestment in proportion to existing holdings.

(v) The proposal for divestment of the existing shares in the ADR/GDR market would have to be approved by a special resolution of the company whose shares are beingdivested.

(vi) The proceeds of the ADR/GDR issue raised abroad shall be repatriated into India within a period of one month of the closure of the issue.

(vii) Such ADR/GDR issues against existing shares arising out of the divestment would also come within the purview of the existing SEBI Takeover Code if theADRs/GDRs are cancelled and the underlying shares are to be registered with thecompany as shareholders.

(viii) Divestment of existing shares of Indian companies in the overseas markets for issue of ADRs/GDRs would be reckoned as FDI. Such proposals would requireFIPB approval as also other approvals, if any, under the FDI policy.

(ix) Such divestment inducting foreign equity would also need to conform to the FDI sectoral policy and the prescribed sectoral cap as applicable. Accordingly thefacility would not be available where the company whose shares are to be divestedis engaged in an activity where FDI is not permitted.

(x) Each case would require the approval of FIPB for foreign equity induction through offer of existing shares under the ADR/GDR route.

(xi) Other mandatory approvals such as those under the Companies Act, etc. as applicable would have to be obtained by the company prior to the ADR/GDRissue.

(xii) The issue related expenses (covering both fixed expenses like underwriting commissions, leadmanagers charges, legal expenses and reimbursable expenses) for public issue shall be subject to a ceiling of 4% in the case of GDRs and 7% inthe case of ADRs and 2% in case of private placements of ADRs/GDRs. Issue expenses beyond the ceiling would need the approval of RBI. The issue expensesshall be passed onto the shareholders participating in the sponsored issue on a prorate basis.

(xiii) The shares earmarked for the sponsored ADR/GDR issue may be kept in an escrow account created for this purpose and in any case, the retention of shares insuch escrow account shall not exceed 3 months.

(xiv) If the issues of ADR/GDR are made in more than one tranche, each tranche would have to be treated as a separate transaction.

(xv) After completing the transactions, the companies would need to furnish full particulars thereof including amount raised through ADRs/GDRs, number ofADRs/GDRs issued and the underlying shares offered, percentage of foreignequity level in the Indian company on account of issue of ADRs/GDRs, details ofissue parameters, details of repatriation, and other details to the Exchange ControlDepartment of the Reserve Bank of India, Central Office, Mumbai within 30 daysof completion of such transactions.

(xvi) The tax provision under Section 115 AC of the Income Tax Act 1961, which is applicable to non-resident investors for ADR/GDR offering against issue of freshunderlying shares would extend to non-resident investors investing in foreignexchange in ADRs/GDRs issued against disinvested existing shares, in terms of therelevant provisions of the Income Tax Act, 1961

(xvii) Resident shareholders divesting their holdings will be subject to Capital Gain tax provisions applicable under the Income Tax Act 1961 i.e. Section 115 AC applicable for non-residents would not extend to them.

Original DTC was pro-middle class. Now it is Pro-rich. Do you agree?

2010-09-24T22:03:00.001+05:30

“Old wine in a new bottle”

This is centered around expectations to minimize tax exemptions, but widen tax slab on personal finances.

The government is quite confident of replacing archaic Income Tax Act with DTC from April 1, 2011
THE DIRECT TAXES CODE PROPOSES TO introduce considerable novelty like reduction in corporate tax rate and widening of personal income tax slabs. They can give a new direction to taxation system. However, there is a little bit of uncertainty on them at this stage, following changes proposed in the original taxes code. The DTC has tinkered with the short-term capital gain tax charged from investors. Individual investors will now have to pay tax on 50% of the gains earned. The rate of short-term capital gain tax would be according to the income tax slab of that individual. For corporates, the short-term capital gain tax would be calculated at 30% after deducting 50% from the overall gains. In an overall positive reaction to the DTC Bill, the Dalal Street experts said that the new code is in favour of the common man and can even boost retail participation in stock market. On the long-term basis, the move will give a big push to the inclusive growth agenda. Retail investors will get a big booster from the proposal,” CNI Research CMD Kishore P Ostwal said. The DTC Bill seeks to increase tax exemption on income from Rs 1.6 lakh to Rs 2 lakh and fix the corporate tax at a flat 30%. Echoing a similar view, Geojit BNP Paribas Assistant vice-president Gaurang Shah said, “On long-term basis it is a healthy and a positive move for retail investors, who will have more money to invest in the market.” On the Distribution Dividend Tax, which will be at 15%, Ostwal said, “It will slightly affect the cash proportion of smaller companies. THE PROPOSED NEW DIRECT TAXES LAW will take away the special treatment that women have so far enjoyed and force individuals to overhaul the way in which they plan their savings.
Women will be put on the same footing as men. Tax-free savings schemes will be fewer, with the government knocking off many from among the 16 odd available now. DTC has been cleverly packaged. The total amount of amount of tax deduction that will be available to individuals, including interest on housing loans will be around 3 lakh, roughly the same as now.

The new Bill has only tinkered at the fringes, with no significant benefits for the aam admi. The re-packaging of the savings schemes will significantly lower the savings potential”, said Sandip Mukherjee, executive director, PwC. “The exemption of 2 lakhs is four time the per capita income, which is a generous limit,” countered a senior tax department official. The maximum a person can save on her tax burden is 24,000 and that too if she earns more than 8 lakh a year.

Why?

The potential revenue loss from exemptions has forced the government to scrimp on the hikes in the threshold levels of personal income tax.

DTC Bill is good for the market but not for the ordinary man. One of the highlights of the DTC was the introduction of the Exempt Exempt Taxation (EET) system of taxation on savings schemes as against the prevailing Exempt-Exempt-Exempt (EEE) system. Under the EET system of taxation of savings, a tax payer would get a tax breakon contributions to specified saving schemes (eg Public Provident Fund) as well as on any accretion/ accumulation of income in such account. However, any withdrawals would be taxed at the time of withdrawal or receipt. This would lead to drain in the savings of the tax payer when it would be required the most (eg after retirement). The DTC bill also proposes to retain corporate tax at 30 per cent, but without surcharge and cess. With them, the current tax liability on corporates comes to over 33 per cent. The government also conceded to the industry demand not to levy minimum alternate tax (MAT) on assets but book profits of the companies. So, it had to dilute earlier proposal of cutting corporate tax to 25 per cent, sources said. Tax experts said this proposal will provide much needed relief to the industry and bring the levy on par with global standards, though the industry wanted it to be reduced to 25 per cent. However, the government raised MAT to 20 per cent from 18 per cent, but it should not make much of a difference since with surcharge and cesses, MAT currently comes to 19.33 per cent.

Is GST VAT? What are the hurdles involved in implementing it?

2010-09-24T22:01:00.001+05:30

Everybody is keenly awaiting for the proposed GST draft which will replace the existing system of VAT in India. VAT is value added tax (on products). GST is like VAT but applies to Services also (apart from products). In India, we have VAT and Service Tax whereas in many countries you have only GST. VAT and GST is a tax on consumer expenditures and in theory should not fall on business activities. When a business operating in a VAT/GST country buys goods or services it pays tax to the supplier, which is called an input tax. When the same business sells goods or services, whether to another business or to a final consumer, it is required to charge tax, which is called an output tax. The business then must periodically total the input tax and deduct it from the output tax, paying the excess to the government agency responsible for collecting it.
GST is India’s most ambitious indirect tax reform, which seeks to stitch together a common market and reduce costs to replace the current fragmented regime. In India Dual GST would be implemented 20% & 12% split evenly between state and center. CST (Central Sales Tax) would be scrapped in a GST regime.
Hurdles:
I am opposed to it...it is unethical to tax luxury cars & sugar at the same rate says kerela FM.
1. Opposition from states: At present, the states are opposing the 12% single GST. Arriving at an acceptable GST rate has been bogged down by differences among the states and also between states and other entities like the TFC task force on GST architecture. Thumb rule is that larger the number of taxes subsumed in GST, lower will be the revenue neutral rate. The states have been reluctant to subsume all taxes into GST as it would mean loss of power to unilaterally change some taxes. Two drafts of the proposed new tax regime failed to find acceptability by states and the third has been referred to empowered committee of state finance ministers.
2. Improper Structure: There is much debate on the likely aggregate rate of the GST. It is also possible that several other design elements of the GST can undergo changes.
3. GST requires constitutional amendments currently the Centre cannot impose tax beyond manufacturing and states cannot levy service tax. Unlike Direct Tax Code (DTC), GST is a transaction-based tax and hence can be introduced any time.

RBI – Sole Objective – to control Inflation

2010-09-24T21:59:00.001+05:30

Overview:
The Preamble of RBI describes its function as to regulate issue of Bank Notes and keeping of reserves with a view to securing monetary stability in the country.
Role of RBI
1. Bank of Issue: Issues Bank notes of all denominations
2. Acts as Government banker & advisor, agent to Central and State Governments.
3. Controller of Credit
4. Custodian of Foreign Reserves
5. Supervisory functions : settles disputes arising among other banks under its ambit.
Inflation – A concern
Inflation is a grave concern, given the vast disparity between the rich and poor. Skyrocketing inflation robs the poor, and hurts others.
RBI follows a multiple indicator approach to arrive at its goals of growth, price and financial stability- rather than targeting inflation alone. Rbis OBJECTIVES R often conflicting with each other>>> It looks confused, ineffective and does not effectively tackle inflation but effectively stunts the growth pattern of the economy.
RBI should clear itself from this confusion and control inflation while maintaining growth. It should be reactive rather than proactive, as monetary policy is most effective when it is forward-looking. RBI’s autonomy should not be compromised either in fact or in perception
Why it is not possible?
Constraints imposed by the political system pulls down autonomy of RBI. Transparency is the best example.
RBI’s decision to strip Dr KC Chakrabarty of important portfolios. Monetary policy being dictated by a powerful governor/finance ministry & Subbaraos decision to reverse an increase in pension for RBI retirees.
Some have even mockingly dubbed RBI as the finance ministry’s ‘department of monetary policy execution’.
Solution: Operational Independence
1. RBI should seek government approval only on matters where the RBI Act (1934) calls for such approval. It should articulate need for changes in the Act. Autonomy is never given, it is earned and taken.
2. There should be a clear paradigm to adopt. By all means, let the RBI's fight against inflation continue. The US Fed Reserve, which is the RBI's model, does not have to resort to CRR. control is through the price of money i.e, interest rate and not the quantity. The Fed does not sequester resources of the banking system by raising CRR for it has zero CRR. Even if the Fed's monetarist model is followed, one has to allow borrowers to get credit at least at a price. Both quantity and price cannot be controlled at the same time, which is what the RBI is doing.

FDI In Education

2010-09-24T21:58:00.000+05:30

India’s education sector has become a prized one with the UPA mulling over issues like opening up the sector for foreign participation. Moreover the foreign education Institutions Bill which was earlier withdrawn after strong protests from the left parties now finally sees the light of day- however several universities have indicated that they will not be setting campuses in India.

But the ministry says that it is working on several ways to increase FDI participation, which will not just be restricted to setting a base. One must understand that “FDI encompasses a whole range of initiatives in the education sector- from JVs, twinning arrangements, skill developments, and universities.

PROS OF FDI

1. FDI would solve problem of lack of funding- resulting in expansion.

2. Quality education would prevent outflow of Indian students and $4 billion spent by them- thus less expensive and retention of domestic talent achieved.

3. Increased competition leading to - international competitiveness, change of curricula, increased responsiveness to students needs, technological Innovation, improved infrastructure.

4. Degrees offered to be internationally comparable and acceptable.

5. Creation of new institutions to generate employment.

CONS OF FDI

1. Money power of foreign institutions would attract best teachers and students from local institutions.

2. Main motive is profit making.

3. Since competition entails cost reduction, infrastructure, would find least investment and also teachers and non-teaching staff being appointed without necessary qualifications.

4. These institutes charge high fees resulting in local private institutions raising their fee to establish competitiveness– end burned on students

5. These institutes would tend to repatriate as much profit as possible back home - accelerating outflow of foreign exchange.

Looking at both the pros & cons its clear that if implementation as well as elimination of the drawbacks is achieved FDI can work wonders. One must understand that the industry is presently facing a dearth of skilled manpower that may hit its competitiveness. Opening up the sector seems like the only way out.

One must understand that FDI is not just restricted to universities. Its slated that primary and secondary education will attract that largest FDI. At the end of the day “FDI is not about universities alone. It’s about empowerment of 220 million children who will not be going to universities,”

“FDI in education sector is a channel of international benchmarking and should be welcome. But it should be monitored and regulated well, keeping in mind the national interest.”

Sumitomo Corporation

2010-09-01T19:07:00.000+05:30

Sumitomo Corporation – The story of Copper derivatives

Incident:

This study is a classic example of – ‘Running on the top of the tiger not knowing how to get off without being eaten.’

Yasuo Hamanaka, the chief copper trader at Japan's Sumitomo Corporation caused $2.6 billion losses to the company through his unauthorized trading activities in the physical and futures market in copper at the London Metal Exchange. It was the largest unauthorized trading-related loss incurred by any Japanese company during that time.

Analysis:

Initial Profits – Result of Manipulation

Yasuo Hamanaka the head trader of Sumitomo Corporation manipulated the world copper prices through his operations on the LME (London Metal Exchange) copper futures market over the period of 1991-95. This artificial increase in copper price resulted in increased profits for Sumitomo Corporation from selling copper. Moreover Hamanaka was reporting inflated trading profits to the top management by showing invoices of fictitious option trades, which he had created through a nexus with some brokers. Whenever any hedge fund or speculator who was aware of manipulation tried to take short positions, Hamanaka invested more money into his positions thus sustaining the high price. However despite these faulty practices no action was taken against Hamanaka because of the profits he generated for the company.

Lack Of Transparency

Successful manipulation of the copper prices was possible due to lack of transparency in the reporting positions of large clients at LME.

Action Taken Too Late

During late 1995, due to increased copper production facilities particularly in China, copper prices started declining. This was ominous for Sumitomo as they had long positions in the futures market. Hamanaka failed to get rid of his positions. He tried to recover the losses by taking huge positions in copper commodity futures on the London Metal Exchange. However the huge volume of trading attracted the attention of the exchange and it gave a warning to Hamanaka. Hamanaka then struck a deal with Merrill Lynch for US $150 Mn, which enabled him to trade via Merrill at LME. Later however when LME started investigating on the alleged manipulation of copper prices Hamanaka was taken off from his position of head trader. This brought the short traders and hedge funds into the act causing the copper prices to fall further on LME.

Lack of Proper Managerial Supervision and Operational Control Systems

Transactions were made solely by Yasuo Hamanaka himself. He abused Sumitomo's name, and continued on with unauthorized trading and even borrowed money from several banks without any authorization from his seniors. Hamanaka a middle-level manager got so much power only because of the fact that he had helped Sumitomo garner a lot of profits in the past. He was given a great deal of responsibility by the company, a star trader status and his only regulators were overseas, far from Tokyo.

Lack of Monitoring

Trading in commodities and financial instruments was not being properly monitored by the government regulatory agencies and by the companies undertaking these transactions. This conclusion can be derived from the fact that in a short span of 16 months three major derivative disasters were seen:

· UK's 233-year-old Barings Bank, which lost $ 1.4 bn in February 1995 due to Nick Leeson's unauthorized trading activities in the Singapore futures market

· Japanese bank Daiwa which lost $1.1 bn in America's Treasury bond market in September 1995 due to the unauthorized trading activities of Toshihide Iguchi.

· Japan's Sumitomo Corporation $2.6 billion losses due to unauthorized trading activities in the physical and futures market in copper at the London Metal Exchange.

The debacle was the result of Sumitomo's poor managerial, financial and operational control systems. Due to this, Hamanaka was able to carry on unauthorized trading activities undetected by the top management. The vesting of excessive decision power on a single employee and failure to implement the job rotation policy were the other reasons cited.

Damage Control Measures

In order to control mounting losses, Sumitomo began aggressive liquidation of its uncovered positions in the copper physical and futures market under its new president Kenji Miyahara. It cancelled its plans to buy back 20 million of its shares and award Yen 120 million ($1.1 million) of bonuses to its senior managers. Sumitomo was able to overcome the losses since it had a net worth of $6 bn and another $8 bn in hidden reserves. The losses estimated to be $2.6 bn amounted to only 10 per cent of Sumitomo's annual sales.

Conclusion & lessons learnt from derivatives

“Derivatives” are complex bank creations that are very hard to understand, but the basic idea is that you can insure an investment you want to go up by betting it will go down. The simplest form of derivative is a short sale: you can place a bet that some asset you own will go down, so that you are covered whichever way the asset moves.

Particularly, the Sumitomo case resulted in tighter internal supervision and control procedures by trading firms and financial institutions the world over. Disclosure must lead to a serious introspection among various financial regulators and trading firms to improve the existing regulation and supervision procedures.

Regulators have now become more aware and proactive than ever before as the possibilities to manipulate the markets have become more practical with the advent of complex and high leveraged instruments like derivatives. Prevention here is always better than prosecution. Companies should also restrain themselves from vesting too much power on a single employee and follow a job rotation policy. By entering into fictitious trades and manipulating accounts, Hamanaka successfully misled the management to believe that he was making huge profits. Sound operational and monitoring system need to be in place to keep track of activities of traders. Successful traders might require more, not less, scrutiny.

What needs to be done in the future?

1. Resolving and Prosecuting Insider Crimes

2. Reducing False Positives

3. Protecting Customer Data

4. Investigate irrational spurts in revenue as much as drop in profitability.

5. Fix the remuneration and fix the bonus as a fixed percentage of the CEO’s salary

6. Create policies and procedures on risk management and educate the employees regarding the same.

“Major crises are major opportunities for change”

The Derivatives Chernobyl

2010-09-01T18:59:00.001+05:30

The Derivatives Chernobyl - Collapse of Bear Stearns on March 16, 2008
Incident:
The latest jolt to the massive derivatives edifice came with the collapse of Bear Stearns on March 16, 2008. Bear Stearns helped fuel the explosive growth in the credit derivative market, where banks, hedge funds and other investors have engaged in $45 trillion worth of bets on the credit-worthiness of companies and countries. Before it collapsed, Bear was the counterparty to $13 trillion in derivative trades. On March 14, 2008, Bear's ratings were downgraded by Moody's, a major rating agency; and on March 16, the brokerage was bought by JPMorgan for pennies on the dollar, a token buyout designed to avoid the legal complications of bankruptcy. The deal was backed by a $29 billion “non-recourse” loan from the Federal Reserve. “Non-recourse” meant that the Fed got only Bear's shaky paper assets as collateral. If those proved to be worthless, JPM was off the hook. It was an unprecedented move, of questionable legality; but it was said to be justified because, as one headline put it, “Fed's Rescue of Bear Halted Derivatives Chernobyl.” The notion either that Bear was “rescued” or that the Chernobyl was halted, however, was grossly misleading. The CEOs managed to salvage their enormous bonuses, but it was a “bailout” only for JPM and Bear's creditors. For the shareholders, it was a wipeout. Their stock initially dropped from $156 to $2, and 30 percent of it was held by the employees. Another big chunk was held by the pension funds of teachers and other public servants. The share price was later raised to $10 a share in response to shareholder outrage, but the shareholders were still essentially wiped out; and the fact that one Wall Street bank had to be fed to the lions to rescue the others hardly inspires a feeling of confidence. Neutron bombs are not so easily contained.
The Bear Stearns hit from the derivatives iceberg followed an earlier one in January, when global markets took their worst tumble since September 11, 2001. Commentators were asking if this was “the big one” - a 1929-style crash; and it probably would have been if deft market manipulations had not swiftly covered over the approaching catastrophe. The precipitous drop was blamed on the threat of downgrades in the ratings of two major monoline insurers, Ambac and MBIA, followed by a $7.2 billion loss in derivative trades by Societe Generale, France's second-largest bank.

Analysis:
The Monolines serve as counterparties in a web of credit default swaps, and a downgrade in their ratings would jeopardize the whole shaky derivatives edifice. Without the Monoline insurers' AAA seal, billions of dollars worth of AAA investments would revert to junk bonds. Many institutional have a fiduciary duty to invest in only the “safest” triple-A bonds. Downgraded bonds therefore get dumped on the market, jeopardizing the banks that are still holding billions of dollars worth of these bonds. In this case, AMBAC was being used as a "cover" by the banks which originated these bundles of mortgages to get their mispriced ratings. Ambac Financial Group, Inc. is a holding company whose affiliates provide financial guarantees and financial services to clients in both the public and private sectors around the world. Ambac's principal operating subsidiary, Ambac Assurance Corporation, is a guarantor of public finance and structured finance obligations. The downgrade of AMBAC in January signaled a simultaneous downgrade of bonds from over 100,000 municipalities and institutions, totaling more than $500 billion.
Now that the mortgages were failing and the banks were stuck with them, AMBAC couldn’t possibly pay; they could not cover the debt. And the banks don't wish to mark these CDOs to market [downgrade them to their real market value] because they are probably at best worth 60 cents on the dollar, but are being held by the banks on balance at roughly par. The banks would therefore no doubt need one bailout after another from the only pocket deeper than their own, the U.S. government's. But the federal government's AAA rating is already in jeopardy, due to its gargantuan $9 trillion debt.

The Societe Generale Fraud

2010-09-01T18:55:00.001+05:30

The Societe Generale fraud: An example of poor risk management

Incident:

The 2nd largest bank of France, Societe Generale, was struggling to square up the huge $ 7.2 billion loss it incurred on account of the biggest fraud committed by its young equity dealer -- the biggest loss an individual has inflicted on a bank. 31-year-old Jerome Kerviel put the survival of Societe Generale at stake. Kerviel took positions in the derivatives trade far beyond what the bank permitted. He took positions to the extent of 50 billion Euros plus, which is much more than the market value of Societe Generale. To cover up the positions in the market and avoid any takeover attempts, the bank was forced to mop up funds worth billions of dollars from the market. It is estimated that Societe Generale’s loss was to the tune of 5 Billion Euro ($7 Billion). Incidentally the biggest fraud in banking industry was announced on the day the US Central Bank announced its biggest rate cut (since 1990) of 75 basis points. A few even wonder whether there is any link between the Fed’s announcement of rate cut and the fraud in Societe Generale. By December 2007, he had made gains of over € 1.4 billion through such positions. By mid-January 2008, the compliance officers at Société Generale found abnormalities pertaining to the trades carried out by Kerviel and they informed the authorities. Kerviel admitted to the Head of Société Generale’s investment banking division that he had committed unauthorized trades and fictitious transactions. The CEO of the bank, its board, and the Central Bank of France were informed about these transactions and they decided to close the trading positions that Kerviel had created. However, by that time, the markets were falling sharply, and Société Generale had to incur a loss of € 6.3 billion on unwinding these positions.

Analysis:

1. When a bank creates policies and procedures for Risk Management it should also make sure that the employees are trained on these procedures and should be well aware of the Risk Management systems. In the case of Societe Generale the bank was not able to educate its employees about the needs to ensure the secrecy of the password.

It was like installing a huge ultra modern alarm in a building but with its window wide open so the thief can conduct his overnight raid.

2. In the trading business every trader is assigned some limit within which he can trade. The traders are assigned day limit or overall limit of trade and at any point of time they cannot exceed that limit. But in practice traders cross their limits in an attempt to make more profit for their bank and pocket fat incentives for themselves. In an attempt to earn a huge profit for Societe Generale, Kerviel booked deals in excess of Euro 50 billion.

3. Usually forward contracts are off-balance sheet items, which are regarded as “not so important” by banks. Keeping this in mind Kerviel used a fine mix of equity trading, futures and forward contracts. On behalf of Societe Generale, Kerviel used to bet on the movement of the stock market index. Whenever he booked a genuine transaction, he used to book the other leg of the transaction in the form of fictitious forward contracts (an agreement to buy or sell any commodity at an agreed time in future for an agreed price), with his supervisors finding the books tallied and he appearing to be trading within the limit assigned to him. To reflect several of the booked contracts as genuine he would use his colleagues’ systems. Thus he managed to convince his auditors / bosses about the authenticity of the transactions, since the transactions ostensibly were entered by another employee. For doing so, he made use of the passwords of several of his colleagues.

4. An independent verification was not carried out on traders' positions and trade cancellations. The fictitious transactions were not monitored and reconciliations were not carried out.

5. Kerviel's main responsibilities included handling proprietary deals in the futures market. He was required to purchase a portfolio of stock index futures and at the same time, sell a similar mix of futures, with slightly different value. His main job was to hedge the funds. By purchasing a stock and at the same time selling the stock at a higher price the person is actually hedging his position. His job was to take bets on small price differences between futures contracts and not to place directional bets. The idea was to take a long position by purchasing certain stocks and at the same time take a short position by short-selling other stocks. The combined positioned balanced or hedged the investment fund against changes in the overall level of the market, and allowed him to profit from a change in the relative price of the two positions. Today, this is known as a "relative value" investment strategy. Thus the original meaning of the term "hedge fund" does not mean that the investment is completely hedged, but rather that it is hedged against the risk of a change in direction of the overall market. However, instead of maintaining a hedged position, Kerviel began placing unauthorized trades by taking directional bets, which were initially in small amounts. The investment strategy that he followed was Macro or Global hedge. These funds take directional bets on market prices of securities, foreign currencies, commodities and derivatives. Global funds investment in emerging market economies and macro funds seek to profit from changes in interest rates and prices based on changes in a country’s macroeconomic prospects. An example of directional bet is one instance the person shorts the 30-year bond and long the 29-year bond in the expectation of profiting from a fall in the spread between their yields. In order to execute this strategy he makes extensive use of leverage in the repurchase agreement or "repo" market by financing about 99% of their purchase of the 29-year bond and borrowing the 30-year bond in order to sell it short.

6. Unauthorized trading of this scale may have gone unnoticed initially due to the high volume in low-risk trades normally conducted by his department.

The Cause for the disaster:

1. Lack of automated process: Ignored Trader Limits - Societe Generale only paid attention to net limits (difference between long and short trades). By ignoring the gross trading numbers, Societe Generale failed to detect huge anomalies in the long and short positions. Failure to scrutinize Margin Calls - Societe Generale failed to scrutinize the breakdown of the margin calls and pinpoint the calls attributed to one trader.

2. Lack of Internal Controls Culture: Trusted Insider- The trader previously worked with SocGen’s middle office. He exploited his knowledge of controls and segmented his trades in order to ensure interaction with a different controller. Unverified Emails - SocGen failed to verify the trader’s fake emails provided as proof of hedging positions.

3. Lack of Strong Access Controls: Lax Access Security- The trader used other staff’s access credentials (username & password) to gain privileged access into the bank’s systems.

How directional bets using hedge funds affect the market:

1. Although they have a small proportion of the capital in financial markets, they use leverage to take significantly large size positions in those markets. In addition, their market reputation creates followers and induces trend investors to take the same bets so that the combined effect is often the self-fulfilling investment strategy against the value of a nation’s currency.

2. Their use of direct credit from banks and broker-dealers to financial their trading operations, and the use of indirect credit through repurchase agreement and securities lending markets to take highly leveraged positions in securities and derivatives markets is another big issue. These credit relationships mean that a failure of a hedge fund could undermine the solvency of banks which hold government insured deposits and money centered banks which also serve critical roles in the economy’s cash payment and securities clearing systems.

What needs to be done in the future?

The incident is an eye-opener; financial institutions and banks should first remind themselves to stick to the basics. While chasing money and business if we do not stick to the basics (like ensuring the secrecy of the password), in this super computer age where practically everything is possible online, we are risking our future as well as that of our organizations.

An effective program of governance and employee surveillance must focus on the four greatest practical threats to a financial institution in order to provide a business case for developing and extending an employee surveillance program, in order to align that program with a enterprise-wide process of corporate governance, to achieve regulatory compliance, and ultimately to reduce fraud losses. By connecting the risk analysis done across different silos of the institution, whether in risk management, operations, trading compliance, and corporate/IT security as well as putting in place a thin layer of analytics to spot specific anomalies characteristic of rogue trading schemes, an institution can take a practical approach to employee surveillance across the enterprise that positions it well to spot rogue traders early on.

Is there Need for a Super Regulator

2010-08-08T14:56:00.001+05:30

Recently an ordinance was promulgated that spoke of a statutory joint committee, headed by Union finance minister being set up.

PURPOSE - Resolve disputes among any of the financial sector regulators in India.

Unlike the existing high-level coordination committee on financial markets (HLCCFM – which is an informal forum), the decisions of a statutory panel are binding. To that extent, the finance ministry becomes the super regulator—and erodes RBI’s autonomy.

It’s time however that RBI too took a close look at itself. For instance, financial inclusion, financial literacy and consumer protection functions can be handled by FSDC; micro regulations part of its job must be taken away and it should get out of its role as the government’s debt manager when India’s fiscal deficit comes down. RBI can concentrate on monetary policy, exchange rate management, payments and settlements and the macro regulations for the financial system as a whole. It also needs to disclose more in its balance sheet. Overall, the regulator needs to reinvent itself.

Consider, what happened to the US and the UK during the financial crisis, the former with a plethora of regulators, the latter with a single super regulator

Neither of these regulatory models was able to save the financial systems in their respective countries from imploding. The one lesson that the crisis has unequivocally taught us is that it doesn’t really matter what kind of regulator you have—it’s the financial system that’s key.

That said, there’s certainly a case for a body that will oversee financial stability. However making the finance ministry the final authority in the financial sector is fraught with risk: consider the numerous handouts to lobby groups in the Union Budget, the large fiscal deficit and the tendency to use banks for political objectives, eg) farm loan waiver. The government already has too much influence over financial regulators and we cannot let it grow any further.

RBI governor D. Subbarao’s recent letter to finance minister Pranab Mukherjee sums up my views on the issue, “the appearance of autonomy is as important as the actual autonomy itself” and “the very existence of a joint committee will sow seeds of doubt in public mind about the independence of regulators.”

Training and Development

2010-04-10T18:14:00.000+05:30

Training is an event. Development is a process.

Training is a process of learning a sequence of programmed behavior. The focus is on immediate improvement of the employee, in order to make him more effective in his current role. More often at lower levels.

Eg Classroom instruction, OJT, Apprenticeships.

Development not only improves job performance but also brings about the growth of the personality. The focus is on making them efficient enough to handle critical situations in the future. More often with managers.

Egs Varied Work Experiences, Formal Education

Training usually refers to some kind of organized event that has a specific beginning an end. Employee development, however, is a much bigger, inclusive "thing".

When we train people, we focus on the job. When we develop people, we focus on the person. When we train people, we’re adding value to specific things, such as what their job description is. When we develop people, we add value to everything.

Training:

· Focuses on technical concepts.

· Focus is on immediate improvement of the employee, in order to make him more effective in his current role.

· Focuses on short term gains.

· Reward the company immediately in terms of better productivity of employee.

· Is concerned with the teaching of specific subject matter and skills.

· Formal classroom learning activities

· Vocational in nature.

Development:

· Focuses on theoretical skills & conceptual ideas.

· Focus is on making them efficient enough to handle critical situations in the future.

· Focuses on long-term accruals.

· Does not lead to any immediate and tangible benefits to the company.

· Is concerned with a broader subject matter.

· Learning experiences, both on and off the job, including formal, classroom training.

· General In nature.

Employee training is a necessity for any business that wants to remain competitive in today’s marketplace. But if you want to make a lasting difference training by itself is not enough development is a must.

“Training changes performance, development changes lives”

As a manager not knowing the exact definitions may cause problems as if you will not be able to match training or development objectives with the right programme as a result u not only will wasting valuable time but also wasting money and undermining your credibility in the eyes of your employees.

Expected MH-CET Cutoffs 2010

2010-04-10T11:02:00.003+05:30

Institute Home University Mah State All India
OPEN OPEN OMS
JBIMS -Mumbai 185+ 184+ 192+

K J SOMAIYA -Mumbai 175+ 166+ 187+

SYDENHAM -Mumbai 175+ 174+ 182+

WELINGKAR -Mumbai 172+ 166+ 179+

PUMBA (Pune) 147+ 161+ 174+

N L DALMIA -Mumbai 168+ 155+ 173+

ST. XAVIER -Mumbai 162+ 145+ 173+

RIZVI -Mumbai 150+ 140+ 172+

CHETANA -Mumbai 158+ 150+ 169+

MET-Mumbai 162+ 150+ 169+

SIES -Mumbai 175+ 159+ 166+

LALA LAJPATRAI-Mumbai 156+ 140+ 163+

IES -Mumbai 157+ 145+ 162+

VIVEKANAND-Mumbai 149+ 138+ 159+

SINHGAD (Pune) 138+ 142+ 159+

MIT (Pune) 137+ 143+ 155+

INDIRA (Pune) 125+ 140+ 152+

WADIA (Pune) 131+ 135+ 151+

BVP, NAVI MUMBAI 140+ 132+ 149+

DY PATIL (PIMPRI, Pune) 125+ 127+ 137+

Shree C. E. Society's Indira Institute of Management, Pune 138+ 145+ 163+

St. Francis Institute of Management & Research, Mumbai 155+ 136+ 159+

M.E.S. Pillai's Instt of Managnt Stds & Research,New Panvel 137+ 128+ 150+

Rocket Singh

2010-04-08T18:17:00.001+05:30

Corporate Lessons from Movie "Rocket Singh"

Lesson # 1 : Not everyone gets motivated equally by money

People cannot get convinced by money always. As managers, we need to persuade, converse, negotiate and engage our team members. A person can get motivated by monetary as well as non-monetary items too. Some people just need sweet words and recognition for the work done. Hence, money should be used only where required.

Lesson # 2 : The right attitude is required to thrive sales

Just having bookish knowledge does not make a great salesperson (an influencer, a persuader and negotiator). To be a great salesperson, he needs to have right aptitude-an aptitude of empathy, an aptitude to see beyond the obvious.

Lesson # 3 : “Disturbing” others is pre-requisite to be salesperson

Asking (or disturbing people) is pre-requisite to become a great salesperson. He should be an extrovert. If he is hesitant to break the ice, start conversations and ask for help and guidance and engage people in discussions, he then needs to cultivate people skills. Great salespeople come one step forward, after saying hello, they confidently say, “Can you please help me”?

Lesson # 4 : The greatest secret of success in business - Satisfied Clients

In today’s era, providing customer Service 24/7 is very essential. In order to thrive and excel in the business, organizations need to cultivate a service culture across the board. A customer is a King. Delighted and satisfied customers are your ambassadors and their referral can generate more business. A company incurs 5-6 times the cost to gain a new customer.

Lesson # 5 : Encourage Participative Management

If associates are treated like partners, they will own the organization. Allow them to grow as the company grows. If humans are treated as Resources and Capital meant to be consumed and used, they will act like leaches sucking away the vital veins of the organization and reaching out to the bone marrows. Sales & Marketing people employed on fixed salary work from 9 to 5. If they are partners in the profitability, they will sell even in dreams and will become killer sales machines……timeless and spaceless. Mediocres become Masterminds when they are involved.

Lesson # 6 : Everyone is born with potential of ‘vice & virtue’

Every employee has both the qualities……the qualities of Rising & Falling in career. Which quality is dominant, determines your destiny. Certain attitudes will put a gravitational pull on you while others will make you ‘sky’s the beginning’ type.

Lesson # 7 : Higher the risk, higher the profits

Jumping out of comfort zones, taking initiatives and playing with risks is what makes the difference. If you are stuck in the grooves of ‘safety’, you end up nowhere. The road from Good to Great is paved with taking initiatives. The biggest risk in life is to avoid the risk. No profit can be made without taking risk. All successful people like Sir Richard Branson, Mr.Ratan Tata, Mr.L.N.Mittal – all have a great appetite for risk.

Lesson # 8 : A Great Team leads to a Successful Organization

Great organizations are built by great teams and not by accident. Teams are built by reinforced trust, mutual respect, sharing and caring. The trust deficit among the team members erodes the team spirit. Build a great team; build a great organization.

XAT 2010 Expected Cut- offs

2010-01-24T19:01:00.004+05:30

Institute	Expected Cut-off	Flagship Program	Number of Seats Overall	Cut-off in 2009 (Percentile)
XLRI - BM	34+	BM & PMIR	120	98.03
XLRI - PMIR	31+	BM & PMIR	120	95
XIM-B	31+	PGDM	120	96.21 (89.55 for Orissa Quota)
SP Jain	23+	PGDM	120	85
IFMR	22+	PGDM	60	85.29
GIM	26+	PGDM	120	93
LIBA	24+	PGDBM	120	91.5
KIAMS	20+	PGDM	60	72 (Girls); 79 (Boys)
XIME	23+	PGDM	120	90
XISS	15+	PGDPM	75	55