vol UME4.07

ISSUE 69

JULY 1st, 2010

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5

12

17

19

21

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Commodities Article

Investors check

Buzzword

Did You Know

Debate

Alumni Speak

Quiz & Crossword

RepoReverse RepoCall rateInflation (as on 14th June)Forex Reserve (as on 25th June)91day T-BillIIP (as on 11th June)6.90 GS 2019

5.25 %3.75 %3.50 - 5.50 %+ 10.16 % $ 275.969 billion 5.3653 %17.6 %8.0907 %

1

CONTENTS

QUOTES

Rates

GRaPHs

Well, you know, I was a human being before I became a businessman -GEORGE SOROS

It’s not your salary that makes you rich,

it’s your spending habits.

-CHARLES JAFFE

44

44.4

44.8

45.2

45.6

46

31-Mar 1-Apr 5-Apr 6-Apr 7-Apr 8-Apr 9-Apr 12-Apr 13-Apr

Rs/$

Rs/$

15000

15200

15400

15600

15800

16000

31-Mar 01-Apr 05-Apr 06-Apr 07-Apr 08-Apr 09-Apr 12-Apr 13-Apr

Gold(per 10 gram)

Gold(per 10 gram)

80

82

84

86

88

90

31-Mar 01-Apr 05-Apr 06-Apr 07-Apr 08-Apr 09-Apr 12-Apr 13-Apr

Oil(per bbl)

Oil(per bbl)

10000000

15000000

20000000

25000000

30000000

5100

5200

5300

5400

5500

31-Mar

01-Apr 05-Apr 06-Apr 07-Apr 08-Apr 09-Apr 12-Apr 13-Aprfuture ratesopen interest

5,000.00

5,100.00

5,200.00

5,300.00

5,400.00

5,500.00

16,500.00

17,000.00

17,500.00

18,000.00

18,500.00

31-Mar 1-Apr 5-Apr 6-Apr 7-Apr 8-Apr 9-Apr 12-Apr 13-Apr

sensex nifty

15000

15200

15400

15600

15800

16000

15-Apr 16-Apr 19-Apr 20-Apr 21-Apr 22-Apr 23-Apr 26-Apr 27-Apr 28-Apr 29-Apr

Gold(per 10 gram)Gold(per 10 gram)

80

82

84

86

88

90

15-Apr 16-Apr 19-Apr 20-Apr 21-Apr 22-Apr 23-Apr 26-Apr 27-Apr 28-Apr 29-Apr

Oil(per bbl)

Oil(per bbl)

16000

16500

17000

17500

18000

17-May 20-May 25-May 28-May

Gold(per 10 gram)

Gold(per 10 gram)

68

70

72

74

76

78

17-May 20-May 25-May 28-May

Oil(per bbl)

Oil(per bbl)

17200

17400

17600

17800

18000

15-Jun 17-Jun 21-Jun 23-Jun 25-Jun 29-Jun

Gold(per 10 gram)

Gold(per 10 gram)

72

74

76

78

80

15-Jun 17-Jun 21-Jun 23-Jun 25-Jun 29-Jun

Oil(per bbl)

Oil(per bbl)

45

45.4

45.8

46.2

46.6

47

15-Jun 17-Jun 21-Jun 23-Jun 25-Jun 29-Jun

Rs/$

Rs/$

8000000

14000000

20000000

26000000

32000000

5100

5200

5300

5400

5500

15-Jun 17-Jun 21-Jun 23-Jun 25-Jun 29-Jun

future ratesopen interest

5,100.00

5,200.00

5,300.00

5,400.00

5,500.00

17,200.00

17,400.00

17,600.00

17,800.00

18,000.00

15-Jun 17-Jun 21-Jun 23-Jun 25-Jun 29-Jun

sensex nifty

Student Cartoon

inteRnational news

Leaders at the G20 summit in Canada have agreed to cut national budget deficits by •

2013 while endeavouring to promote economic growth.

Japan’s new government has pledged to slash corporation tax from 40% to nearer •

25% and beat deflation to achieve stable economic growth of 2% a year.

China’s pledge for a more flexible Yuan will slow nation’s exports this year, adding to •

difficulties that include the European Debt crisis and rising costs.

Volcker rule provision of Wall Street reform legislation being finalised by congress •

would put a lid on domestic mergers and acquisitions by the largest US banks.

Finance Minister Pranab Mukherjee asked the central and western states and public •

sector banks to extend mainstream banking facilities to the poor, small farmers and

micro-entrepreneurs.

RIL, RNRL sign revised new gas supply master agreement which would pave the •

way for gas allocation to power plants being set up by Anil’s group company - Reli-

ance Power Ltd.

As Reserve Bank of India (RBI) has set July 1 as the date from which the base rate •

regime will come into effect, the country’s largest lender State Bank of India (SBI) has

hinted that the bank’s base rate would be around 7.5 per cent.

The World Bank is committed to supporting India’s development agenda through the •

record annual lending of 9.3 billion dollars for the current financial year.

Insurance Regulatory and Development Authority (IRDA) announced drastic chang• •

es to Unit Linked Insurance Plans (ULIPS) cutting agent commissions, increasing

the lock-in period and making it a more risk-based product and also harmonise the

character of these popular investment schemes with that of designated long-term

savings schemes like provident funds which are eligible for tax exemption at the time

of withdrawal.

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national news

By Elezabeth Merin Mathew, MBA-L

By Elezabeth Merin Mathew, MBA-L

Globally commodities derivatives exchanges have existed for a long time. The CBOT and CME are two of the oldest derivatives exchanges in the world. The CBOT was established in 1848 to bring farmers and merchants together. Initially, its main task was to standardise the quantities and qualities of the grains that were traded. Within a few years, the first futures-type contract was developed.

Speculators soon became interested in the contract and found trading in the contract to be an attractive alternative to trading the underlying grain itself. In 1919, another exchange, the CME was established. Now futures exchanges exist all over the world. On these ex-changes, a wide range of commodities and financial assets formed the underlying assets in various contracts. The commodities included pork bellies, live cattle, sugar, wool, lumber, Copper, aluminium, gold and tin.

The few most popular and heavily traded are the:• London Metals Exchange (LME), London• New York Mercantile Exchange (NYME), New York• Chicago Mercantile Exchange (CME), Chicago• Chicago Board Of Trade (CBOT), Chicago • London International Financial Futures And Op-tions Exchange (LIFFE), London • Tokyo Commodity Exchange (TOCOM), Tokyo• Winnipeg Commodity Exchange, Canada.

TOP 5 MOST TRADED COMMODITY EXCHANGES

Commodity markets are varied around the World but all trade in similar commodities. The top 5 commodity markets (according to volumes) around the World include:• New York Mercantile Exchange USA • Tokyo Commodity Exchange Japan • NYSE Euro next EU • Dalian Commodity Exchange China • Multi Commodity Exchange India

NEWYORK MERCANTILE EXCHANGE

The New York Mercantile Exchange (NYMEX) is the world’s largest physical commodity futures exchange, located in New York City. It is a primary trading forum for energy prod-ucts and precious metals. The exchange is in existence since last 132 years and performs trades trough two divisions, the NYMEX division, which deals in energy and platinum and the COMEX division, which trades in all the other metals.

The New York Mercantile Exchange handles billions of dollars worth of energy products, metals, and other commodities being bought and sold on the trading floor and the overnight

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By Mookambigai, MBA-N

Commodity eXCHanGes oF tHe woRld

electronic trading computer systems. The prices quoted for transactions on the exchange are the basis for prices that people pay for various commodities throughout the world.

Trading hours are in U.S. Central Time, the time in Chi-cago, where CME Group is headquartered, with one exception: hours for Euro zone HICP futures and op-tions are in London time. The trading hours differ from commodity to commodity and it opens at 9:05 to 13:45 and for some it starts at 7:55 A.M.

Commodities traded: Light sweet crude oil, Natural Gas, Heating Oil, Gasoline, RBOB Gasoline, Electric-ity Propane, Gold, Silver, Copper, Aluminium, Platinum, Palladium, etc.

TOKYO COMMODITY EXCHANGE

The Tokyo Commodity Exchange (TOCOM) is the second largest commodity futures ex-change in the world. It trades in to metals and energy contracts. It has made rapid advance-ment in commodity trading globally since its inception 20 years back. One of the biggest reasons for that is the initiative TOCOM took towards establishing Asia as the benchmark for price discovery and risk management in commodities like the Middle East Crude Oil.

TOCOM’s recent tie up with the MCX to explore cooperation and business opportunities is seen as one of the steps towards providing platform for futures price discovery in Asia for Asian players in Crude Oil since the demand-supply situation in U.S. that drives NYMEX is different from demand-supply situation in Asia. In Jan 2003, in a major overhaul of its com-puterized trading system, TOCOM fortified its clearing system in June by being first com-modity exchange in Japan to introduce an in-house clearing system. TOCOM launched options on gold futures, the first option contract in Japanese market, in May 2004.

Commodities traded: - Gasoline, Kerosene, Crude Oil, Gold, Silver, Platinum, Aluminium, Rubber, etc.

LONDON METAL EXCHANGE

The London Metal Exchange (LME) is the world’s premier non-ferrous market, with highly liquid contracts. The exchange was formed in 1877 as a direct consequence of the in-dustrial revolution witnessed in the 19th century. The primary focus of LME is in provid-ing a market for participants from non-ferrous based metals related industry to safeguard against risk due to movement in base metal prices and also arrive at a price that sets the benchmark globally. The exchange trades 24 hours a day through an inter office telephone market and also through an electronic trading platform. It is famous for its open-outcry trad-ing between ring dealing members that takes place on the market floor.

Commodities traded: Aluminium, Copper, Nickel, Lead, Tin, Zinc,Aluminium Alloy, North American Special Aluminium Alloy (NASAAC), Polypropylene, Linear Low Density Poly-ethylene, etc.

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yUan ReValUation

5

Yuan revaluation: Meaning & Implication

Introduction:

Latest news in the financial papers was about China revaluing Yuan. So, let us try and understand what it actually means and the economic and financial implications of it.Before understanding the implications, let us first understand the two important terms which is necessary to answer the questions that follow.

What is Currency Revaluation? A deliberate upward adjustment in the official exchange rate established, or pegged, by government against a specified standard, such as another currency or gold. Revaluation occurs exclusively in fixed currencies, when the currency in question is pegged to another currency. A government generally revalue’s its own currency when it wishes to make ad-justments to its peg to another currency.

What is Currency Devaluation? It is the active decision of a government to reduce the value of its own currency vis-a-vis other currencies. Currency devaluation occurs exclusively for fixed currencies, or a curren-cy that is pegged to another currency. Governments often devalue their own currencies to make their exports less expensive in foreign markets. If a company exports its products for the same price in the local (devalued) currency, it is cheaper for consumers to buy those products in their own currency. If the currency is devalued it makes the country’s exports less expensive in foreign markets.

China’s Previous and current Move:

During the previous decade, China’s Currency was pegged to the U.S. dollar at 8.28 RMB. On July 21, 2005, it was revalued to 8.11 per U.S. dollar, following the removal of the peg to the U.S. dollar. The revaluation resulted from pressure from the United Stated and the World Economic Council.The People’s Bank of China also announced that the Renminbi would be pegged to a basket of foreign currencies, rather than being strictly tied to the U.S. dollar, and would trade within a narrow 0.3 percent band against this basket of curren-cies. China has stated that the basket is dominated by a group of international currencies including the U.S. dollar, euro, Japanese yen and South Korean won, with a smaller pro-portion made up of the British pound, Thai baht and Russian ruble.Last week the Chinese allowed the Yuan to float a little vis-a-vis the dollar. The currency did move from that 6.82 rate that it had remained for the last 23 months.

History of China’s Currency:

The Renminbi was first issued shortly before the takeover of the mainland by the Com-munists in 1949. One of the first tasks of the new communist government was to end the hyperinflation that had plagued China near the end of the Kuomintang era.

By Niveditha Tiwary, MBA-M

6

During the era of the command economy, the value of the RMB was set to unrealistic val-ues in exchange with western currency and severe currency exchange rules were put in place. With the opening of the mainland Chinese economy in 1978, a dual track currency system was instituted, with Renminbi usable only domestically, and with foreigners forced to use foreign exchange certificates. The unrealistic lev-els at which exchange rates were pegged led to a strong black market in currency transactions.

In the late 1980s and early 1990s, the PRC worked to make the RMB more convertible. Through the use of swap centres, the exchange rate was brought to realis-tic levels and the dual track currency system was abol-ished. The RMB is convertible on current accounts, but not capital accounts. The ultimate goal has been to make the RMB fully convertible. However, partly in response to the Asian Fi-nancial Crisis of 1998, the PRC has been concerned that the mainland Chinese financial system would not be able to handle the potential rapid cross border movements of hot money, and as a result, as of 2003, full convertibility remains a distant goal.

Exchange Rate of the American Dollar vs. China’s currency (Renminbi):

China’s view:

The decision over Yuan revaluation becomes more political when some “external” pres-sures from the USA, Japan and Europe have intensified over the last two years, the Chi-nese authorities, nevertheless, are still reluctant to revalue the Yuan further. They insist that China’s banking system and financial institutions must be improved before floating the Yuan is considered. This may also be due to a fear of los-ing further competitiveness in China’s exports following a de facto appreciation of the Yuan since 1997. The ex-port sector has become more significant in keeping the economy to grow, particularly when the unemployment created by widespread layoffs from state owned enter-prises and sustained deflation continue to develop.

National sovereignty is another concern that the Chi-nese authorities have to consider, since conventionally they believe that the value of a country’s currency is an internal issue so it should not be intervened by exter-nal pressures. A case against the Yuan revaluation has also emerged, particularly from the Chinese side. The Chinese authorities have argued that firstly the country’s foreign reserves are largely a result of the “hot money”, inflows of foreign capital hoping to instantaneously capitalize on a Yuan revaluation, rather than long term foreign direct investment in capital projects. In addition, China believes that trade surplus is increasingly due to slowing imports, rather than growing exports. As investment in fixed capacity has declined, so has the demand for equipment and machinery, much of which is imported.

7

In addition, while China’s trade surplus with the US exceeded $200 Billion in 2005, China runs a deficit with most other countries it trades with. Should the Yuan be significantly revalued, China will face stronger competition from its Asian developing economies in the markets of North America, Europe and Japan, as well as in these economies them-selves.

United States’ view:

Within the United States, the issue of appreciating the RMB is controversial. Manufactur-ers and textile producers are in favour of appreciating the RMB. However, many American companies that depend on mainland Chinese factories to supply inexpensive products and components, such as aerospace companies, computer manufacturers, discount retailers, and other companies are against appreciating the RMB. Furthermore, many economists have pointed out that manufacturing jobs have been declining in the United States for decades. Some people have suggested that blaming the lack of job growth on the value of the RMB is merely a convenient misdirection on the part of the vested interests. Many people in US feel that the large trade deficit is due to the China.

Financial Consequences of revaluating or floating China’s currency:

The financial consequences of free valuation are complicated. Many economists believe that appreciation of the Yuan would cause the PRC government to buy fewer United States treasury bonds, causing bond prices to fall and bond yields to rise, hampering improve-ment in the U.S. economy. The ensuing depreciation of the US dollar might price oil out of the reach of the American economy, causing stagflation, a collapse of US oil dependant industries, massive unemployment and other dire economic consequences.

The Chinese economy is not growth driven and thus is not able to drive the world growth even with it’s own higher growth rate. There are other problems with this government in-vestment and export driven economy such as fear of overheating and property bubble. The depegging of Yuan will help focus the Chinese economy on domestic demand and balance it. If the domestic demand in China improves and other currencies are competitive with Yuan then China can be able to drive the world economy.

Conclusion:

Thus the current Chinese move to revalue its currency and float it partially against the dol-lar seems to be a smart and rather diplomatic move just before the G20 meeting in Toronto but it did add some optimism in Washington that Beijing may be getting closer to allow the Yuan appreciate amid intensifying pressure to make a move.

As far as India is concerned there wouldn’t be any major impact on India of the Yuan’s revaluation. Indian exporters see only small immediate gains from the marginal 2.1% re-valuation of Yuan, but hope that if the Chinese authorities allow the Yuan to float against the dollar even within the tight 0.3% daily band, there could be some respite from the low prices at which Chinese exporters virtually dump their products in the global market. Thus a strong Yuan would benefit Indian exports as it would make prices of Chinese goods more “realistic”.

ABSTRACT:

Enron’s collapse is generally viewed as a morality tale - the natural result of managerial greed, a clueless board, and feckless gatekeepers. But none of these aspects of the story clearly distinguishes Enron from other major firms during the bubble era of the late 90s. This material identifies certain economic facts from the many moving parts that was Enron, and organizes them along two main threads. The first describes Enron’s major businesses, and the incentives and constraints under which the managers of those businesses operated.

The second thread describes the basic financial engineering tools developed by Enron’s finance department. These threads are then woven into the timeline of Enron’s ultimate collapse. What emerges is a tale of how bad bets that resulted in good outcomes came to be viewed by top management and the board as bets worth repeating on an ever-larger scale. Early success in highly risky ventures were ramped up and duplicated, under perverse incentives, into a financial disaster. The firm then doubled down on that disaster with non-economic hedges developed by the finance group.

The CFO, in a wholesale breach of his fiduciary responsibilities, including corruption of various gatekeepers, managed to cloak the poor quality of his hedges and his motivation in creating them. This duplicity prevented top management or the board from fully recognizing or acting upon the danger that those hedges posed to Enron’s survival, until it was too late. The political and economic reactions to Enron are usefully viewed in terms of these distinguishing elements of its failure.

Some facts and figure about company:-1.Enron, the 7th largest U.S. company in 2001,filed for bankruptcy in December 2001.2.Enron investors and retirees were left with worthless stock.3.Enron was charged with securities fraud (fraudulent manipulation of publicly reported)4.On October 16, 2001, in the first major public sign of trouble, Enron announces a huge third-quarter loss of $618 million.5.On October 22, 2001, the Securities and Exchange Commission (SEC) begins an inquiry into Enron’s accounting practices.6. On December 2, 2001, Enron files for bankruptcy.

How did the scandal happen?Enron was formed in 1985 by Kenneth Lay after merging Houston natural gas and Inter North. Several years later, when Jeffrey Skilling was hired, he developed a staff of executives that, through the use of accounting loopholes, special purpose entities and

8

tHe enRon sCandal

poor financial reporting, were able to hide billions in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives were able to mislead Enron’s board of directors and audit committee of high-risk accounting issues as well as pressure Andersen to ignore the issues.

Enron’s stock price, which hit a high of US$90 per share in mid-2000, caused shareholders to lose nearly $11 billion when it plummeted to less than $1 by the end of November 2001. The U.S. Securities and Exchange Commission (SEC) began an investigation, and Dynegy offered to purchase the company at a fire sale price. When the deal fell through, Enron filed for bankruptcy on December 2, 2001 under Chapter 11 of the United States Bankruptcy Code, and with assets of $63.4 billion, it was one of the largest corporate bankruptcy in U.S. history.

Many executives at Enron were indicted for a variety of charges and were later sentenced to prison. Enron’s auditor, Arthur Andersen, was found guilty in a United States District Court, but by the time the ruling was overturned at the U.S. Supreme Court, the firm had lost the majority of its customers and had shut. Employees and shareholders received limited returns in lawsuits, despite losing billions in pensions and stock prices.

As a consequence of the scandal, new regulations and legislation were enacted to expand the reliability of financial reporting for public companies. One piece of legislation, the Sarbanes-Oxley Act, expanded repercussions for destroying, altering, or fabricating records in federal investigations or for attempting to defraud shareholders. The act also increased the accountability of auditing firms to remain objective and independent of their clients

Base rate implementation by Banks and its Impact on Borrowers

The RBI announced the guidelines on the new base rate system for banks which will replace the existing system of Benchmark Prime Lending Rates (BPLR) effective from 1st July. This system was supposed to come in effect on 1st April but was deferred on banker’s request.“The base rate system will replace the BPLR system with effect from July 1… In order to give banks some time to stabilize the system of base rate calculation, banks are permitted to change the benchmark and methodology any time during the initial six month period i.e. end-December 2010″ --RBI

Benchmark Prime Lending Rates (BPLR) -The Existing system

It is the interest rate that commercial banks charge their most credit worthy customers. According to RBI, banks are free to fix the BPLR with the approval of their respective boards. Banks are free to decide the BPLR but their interest rates have to have a reference to the BPLR fixed.

9

Base Rate imPlementationBy Emili Mathew, MBA-N

10

New Base rate system

This system sets a limit for the banks, below which no banks would be allowed to give commercial loans. Base rate will be fixed on the basis of cost of funds and other expenses to service the customers. Benchmark base rates will be reviewed every 3 months.

The proposed replacement of the current BPLR with base rate system came as many banks abused the current BPLR and provided loans to corporate below this rate. The problem in the case of BPLR is that when the interest rate falls, banks do not cut the PLR and therefore the borrowers do not get the benefit of fall in the interest rates. But when interest rates rises, they increase the PLR which lead to rise in variable rates also.

The replacement of BPLR with new base rate system will-• Increase the transparency in lending• It will force the banks to cut their base rates automatically if the interest rate in the market falls.• It will benefit the borrowers who borrow at variable rate which is pegged against the benchmark rate.

Impact of the Base Rate implementation on Borrowers

In case banks choose the external market benchmark rate instead of the base rate as their benchmark rate, the borrower benefits from any of the lower market interest rates. But to be on the safer side, borrowers should not expect that the interest rates will come down as the new system is implemented. This might not happen as there are several factors that determine the actual rate offered.

Actual rate charged will be base rate plus borrower specific charges including product specific operating cost, credit risk premium and tenure premium. Just because the base rate is lower than the previously used prime lending rate does not mean the borrowing cost for individuals will come down. Banks have full freedom to use any methodology to compute the base rate or the minimum below which they will not be permitted to lend money. So, one cannot be sure of how beneficial this system can be.

Benefits that borrowers can get after implementing the base rate system are:

• Transparency: In this new system, it will be clear to individuals what rate is being charged which will increase transparency and bring additional clarity.• More choices available: If there are difference in bank base rates and borrower specific rates then there will be a choice available to the clients.

The base rate will impact the variable loans on consistent basis. This will happen because at present the interest rate on loans is linked to other rates like PLR or BPLR. The interest rate on loans will be linked to the new base rate and hence a change in this rate will impact the loan seeker.

The base rate system would be applicable for all new loans and for those old loans that come for renewal. In case existing borrowers want to switch to the new system, the RBI guidelines said an option should be given to them before expiry on mutually agreed terms with zero charge. Ultimately, the base rate system can benefit the borrowers only if banks compute the base rates appropriately keeping in mind the interests of the borrowers.

11

new UliPs noRms issUed By iRda

Introduction:

On 18th June 2010, Government of India settled the two-month long tussle between IRDA and SEBI by ruling that Unit-linked Insurance Products (ULIPS) will be governed by the Insurance Regulatory and Development Authority (IRDA). The law ministry issued an or-dinance amending the RBI Act 1934, Insurance Act 1938, SEBI Act 1992 and Securities Contract Regulations Act 1956, clarifying that life insurance business will include any unit-linked insurance policy or scripts or any such instruments.ULIPs are those insurance products the value of which is linked to market price of the stocks in which a part of the money is invested.

New ULIPs Norms:

The Finance Ministry while ruling in favor of IRDA had recommended certain changes to make the product more investor friendly. Some of the changes in the investment-cum-insurance products were, increased minimum insurance cover, capping of overall and surrender charges and a minimum guaranteed return for pension plans.Consequently, IRDA has brought about certain changes in the structure of ULIPs which will be effective from 1st September, 2010.

They are as follows:• Minimum guaranteed annual return of 4.5% on pension plans.• Increased lock in period to five years. • Minimum insurance cover increase to ten times the annual premium for people below the age of 45 years.• Even distribution of charges across the lock in period.• A ceiling on maximum reduction in yield (the difference between gross and net yields) after the lock in period.• A minimum mortality or health cover provided by all ULIPs other than pension and annu-ity products.

Implications:

1. Increased lock in period from three years to five years, including the top up premiums, will make UILP a long term instrument with better risk protection. 2. Elimination of high front ending of expenses; all the charges will have to be evenly divided across the lock in period. During this period, no residuary payments on policies which have lapsed, been surrendered or discontinued will be made.3. Capping of overall and surrender charges (IRDA has already capped the overall charge on ULIPs from January 1) will reduce costs; caps have been applied on the difference from the fifth year to the end of the policy term (3 per cent for a 10-year policy and 2.25 per cent for a 15-year policy).

By Sanjeeb Saha MBA-K

Gargee Mukherjee, MBA-L

4. Stringent guidelines for capping expenses; small regular premium policies might become unviable. Thus, a large proportion of people who pay premium of less than Rs15,000 or so a year (constitute about 35-40% of total policies sold by life insurance companies) will suffer. Again, the commission structure may not sustain an agent’s income which in turn may affect the sales of the product.

The increased lock in period will reduce the flexibility of the product; this issue has been ad-dressed by allowing loans on ULIP. The loan amount will not exceed 40% of the net asset value (NAV) where equity instruments > 60% of the total share and 50% of NAV where debt instruments > 60 % of the total share.

Conclusion:

Apparently the new circular benefits the investors. The measures taken by IRDA will add more value to the policy holder and make the products more transparent. This will also im-prove persistency and provide long term and sustainable income streams for distributors. The full impact of these steps on the industry players is yet to be ascertained as further clari-fications on certain clauses have to be made.

BUZZwoRds

Baby Bills

A nickname given to the hypothetical companies that would have formed if the Justice Department had broken up Microsoft Corporation.

Bo Derek

A slang term used to describe a perfect stock or investment. In 1979 hit movie “10”, ac-tress Bo Derek portrayed the “perfect woman”, or “the perfect 10”.

Stabilizer

An economic policy or program that increases or decreases automatically to offset the cur-rent economic trend without government assistance.

Chastity Bond

A bond designed to prevent unwanted takeovers by having a maturity that is activated once a takeover is complete.

Aunt Millie

A slang term for an uneducated or unsophisticated investor. The term is considered a de-rogatory remark in the financial sector, often used to refer to poor investment choices.

12

Food inFlation By Gaurav Jain , MBA-K Shekhar Gupta, MBA-K

“For every percentage increase in food prices, an additional 16 million people are threatened with hunger.” - P. Chidambaram, Home Minister.

India uses the Wholesale Price Index (WPI) to calculate and then decide the inflation rate in the economy. Most developed countries use the Consumer Price Index (CPI) to calculate inflation. The set of 435 commodities and their price changes are used for the calculation. The selected commodities are supposed to represent various strata of the economy and are supposed to give a comprehensive WPI value for the economy. Individual WPI values for all the 435 commodities are calculated and then the weighted average of individual WPI figures are computed to arrive at the overall WPI.

Commodities are given weightage depending upon their influence in the economy. The WPI is calculated on a weekly basis and the CPI is on a monthly basis. This is the reason why India uses the WPI system.Government claimed that the food inflation was the result of three forces that are completely out of the government’s control—the cost and push effect, the de-mand and pull effect and the control over stock supply. All the three factors causes the food inflation to rise and the government can only take steps to ensure it is under control.

Why food prices are soaring in India?

1. The Ration shops/ Supply company markets are not supplying the grains and sugar given by the government to the common man. “Holding” is a common phenomenon seen in ration shops/petrol pumps, and those materials are then sold to other shops through “Black”.2. The main cause is, nowadays people are not cultivating vegetables because now they are practicing Flat culture -- farmers sell their lands to Landlords, who in turn make Flats/malls, so agriculture land is converted to commercial land.3. The profit margin in cultivation is less for the farmer; actually heavy margin is there for suppliers /middle distributors; thus actual farmer is getting only 4 rupees, even if a vegetable is selling in a vegetable stall for 16 rupees.4. Prices of most pulses too, are high due to a supply-demand mismatch. Currently, there is a shortage of 4 million tonnes of pulses in India and the impact of late monsoon on the plant-ing of Kharif pulses is also weighing on the prices.5. Climate-related changes do affect the availability of food items, but the current rise in the food bill is too steep to attribute only to the weather.6. With the government affecting a hike in fuel prices, food prices have shot up even fur-ther.

What can be done?

1. Overhaul institutions like the Indian Council of Agriculture Research (ICAR), Agriculture Universities and the food distribution systems.

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2. Stringent punishment for Black hoarders. 3. Address Global Warming and Climate Change.4. Conserve every drop of water. 5. Universal consensus on Genetically Modified food. 6. Connect farmer and the end user.7. Proper enactment of the Rural Employment Guarantee Act. 8. Special Agricultural Zones (SAZ) in line with Special Economic Zones (SEZ).9. Control population, in turn to control the future demand.10. Small and marginal farmers should have equal access to credit, fertilizer, improved seeds, pesticides, electricity, and water.

The extraction of liquidity from the economy due to the 3G Spectrum has forced the Govern-ment to bring in more liquidity in the means of Government Securities buy back and similar methods which further causes the food inflation to rise.

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Goldman saCHs and tHe GReeK deBt CRisis

By Samson Sujinder, MBA-K

In the previous issue of Chaanakya, we got a clear understanding of the ongoing European debt crisis. This particular article throws the spotlight on the role of Wall Street giant Gold-man Sachs in the events that led to the bankruptcy of Greece.

The euro membership rules place strict caps on the size of government deficits relative to a national economy as part of its EU Maastricht framework. The Eurozone rules dictate that governments must keep a country’s deficit below 3 per cent of its GDP and must have a total debt of not more than 60 per cent of GDP - rules that Greece did not keep to, even during the economic boom!

Goldman Sachs has been the most important of more than a dozen banks used by the Greek government to manage its national debt using derivatives. The bank’s traders cre-ated a number of financial deals that allowed the country to raise money to cut its budget deficit now, in return for repayments over time or at a later date, thereby masking the true extent of the nation’s off-balance sheet debt figures by pushing part of their liabilities into the future.

A deal struck between Goldman Sachs and the Greek government in early 2002 involved cross currency swaps in which government debt issued in dollars and yen were swapped for euro debt for a certain period to be exchanged back for their original currencies at a later date. Such cross currency swaps are commonplace in the finance world, but in the Greek case Goldman Sachs devised a special kind of swap with ‘fictional exchange rates’ (artifi-cially low rate) which enabled the Greeks to receive a far higher sum than the actual euro market value of the 10 billion dollars/yen transacted thereby arranging additional credit to the tune of 1 billion dollars which was an up-front payment of Goldman Sachs to Greece. This credit wasn’t disclosed in the country’s financials and hidden from Eurostat (the EUs official statistics agency). While it arranged the swap, Goldman also sought to buy insur-

ance on Greek debt and engage in other trades to protect itself against the risk of a default on those swaps! Goldman Sachs meanwhile made a unique profit by charging a mammoth commission for the deal ($ 300 million) and then proceeded to cunningly sell the swap to the National Bank of Greece for even higher profit in 2005 thereby ridding itself of all net exposure to a default on Greek debt.

Post the swap deal that allowed the government to hide its deficit, Goldman Sachs earned $24 million dollars by underwriting bonds sales to raise $15 billion for Greece. These bonds in turn were used as collateral for further borrowings from the European Central bank (ECB). No mention was made about the swaps in the sales prospectus documents of the 10 bond sales the bank arranged thereby hiding the inherent risks involved from investors and regulators.

Moreover the swap deals were hidden from public view and were undisclosed in the country’s financials as they weren’t considered as loan entries. In all its efforts to obscure Greece’s debt, the rules were circumvented legally hence punitive action against the savvy bank is doubtful despite the long term damage it afflicted on a nation for the sake of profit.These revelations have thrown more bad light on the investment bank that is already being criticized for its role in the recent sub-prime mortgage crisis and its controversial financial products such as CDOs (Collateralized debt obligations) and CDS (Credit default swaps).

How did Goldman Sachs manage to arrange the deal, make substantial profit margin from it, hedge the whole credit exposure (by buying insurance on the default of Greece) and eventually underwrite Greek debt issues without revealing the deal to investors and get away scot free? This scandal highlights once more the conflicts of interest which still have not been resolved in the financial system. More investigations are required to know what exactly happened, but, if suspicions are confirmed, this kind of attitude from investment banks like Goldman Sachs represents a problem in terms of ethics and poses a threat to the trust needed for the functioning of financial markets.

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PaRtial deReGUlation oF FUel PRiCes By Sanjeeb Saha, MBA-K Gargee Mukherjee, MBA-L

Introduction:

On 25th June 2010, in a major decision to bring petroleum products in line with market rates, the government freed petrol from all pricing controls. Diesel prices have been par-tially deregulated in the sense that further increases will be made by the public sector oil marketing companies (OMCs) only in consultation with the Ministry of Petroleum and Natu-ral Gas. As of now petrol price has been hiked by Rs 3.5/liter and diesel price by Rs 2/liter, households will have to pay an additional Rs 35 per cylinder and cooking fuel kerosene will be dearer by Rs 3/liter. This hike was necessitated by the rising gulf between the cost of production and the retail prices

State oil firms currently lose about Rs 215 crore per day on selling fuel below the imported

cost. At present, petrol is being sold at Rs 3.73/liter below its cost, diesel at a loss of Rs 3.80/liter, kerosene at Rs 18.82/liter and domestic LPG at a discount of Rs 261.90 on every 14.2-kg cylinder.

Such decontrol first happened in April 2002 ,when the NDA government was in power but was later rolled back - partly by the NDA and then fully by the UPA - when oil prices started rising.

Implications:

Petrol & Diesel:

• The partial implementation of Kirit Parikh Committee recommendation will improve the cash flow for OMCs and reduce their borrowings. This, in turn, will greatly reduce their inter-est burden and increase net profit.

• Decontrolling will entail a greater role for the private sector — with the government forcing its PSUs to sell at below cost prices, private firms like Reliance stopped retail sales several years ago. Now that prices are getting back to free market levels, these firms are likely to be back in business. In 2006, Reliance had a 13-14% market share in diesel sales. Getting back that market share and more could take just a couple of years, maybe less.

• PSU oil firms have about half the gross refinery margins that RIL has, as they have much older and smaller refineries. If they still lose Rs 15000-20000 crore this year, in addition to the Rs 55000 crore they already lost over the previous five years, there will probably be no hope for modernization. But still it would benefit the PSUs as they had projected to lose Rs 74300 crore in revenues in 2010-11 fiscal and after the hikes, they will be saddled with Rs 53000 crore of losses instead.

• The three OMCs namely, Indian Oil, BPCL and HPCL will now be able to compete freely. On the combined turnover of Rs 530,000 crore, if they can generate even 5% net profit, all three companies could figure in the list of India’s top 10 profit making companies. This will boost their share prices and benefit retail investors by way of attractive dividends.

Kerosene & LPG:

• The government would continue to heavily subsidize both kerosene and LPG. Kerosene rates went up by Rs 3/liter, the first increase in the “poor man’s cooking fuel” in more than 8 years to cut government subsidies. But basically it is a waste of money because, only 1.3% of all rural households use kerosene for cooking. Interestingly, while the number of house-holds using kerosene fall a third between 1999 and 2005, the government cut the kerosene allocations under the PDS by just 13%.

Economy:

• Fuel accounts for a quarter of India’s estimated $25.6 billion subsidy bill.The oil industry’s deregulation is essential to maintain the fiscal health of the country, which has a deficit target of 5.5% of GDP for FY11.

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• In the short term, concerns on inflationary pressures caused by the fuel price hikes could be deterring. It is anticipated that such price hike may increase the inflation rate by 0.9 - 1%.•RBI may be prompted to monetary tightening by increasing policy rates before a policy review on July 27 in order to control inflationary pressure and if that does not happen, we may see a 50 basis points increase in both policy rates.

Conclusion:

Increase in fuel prices generally has a depressing effect on the economy. But as fuel has a very low elasticity of demand, it tends to pull out resources from other forms of expendi-ture to compensate the extra outflow. Despite the hike, retail fuel prices in India continue to remain lower than those in most European and South Asian countries. Pricing of fuel has traditionally been a highly politicized issue because of its direct impact on the public transportation cost and food inflation. Probably, this was a much needed bold measure and the government has taken the first step in the right direction.

did U Know

History of Taxation

The history of taxation can be traced back to time immemorial and it is not a recent devel-opment by any means. A thorough research on the history of taxation system shows that taxes were levied on either on sale or purchase of merchandise/livestock.

Further, the history of taxation suggests that the process of levying and the manner of tax collection were not or-ganized. But it suggests that all historical leaders and head countrymen collected taxes to run its authority. In other words taxes on income, sale, purchase and prop-erties were collected to run the ruling Government ma-chineries.

Further, these taxes were collected to meet their mili-tary and civil expenditure and also to meet the common needs of the subjects like maintenance of roads, drain-age system, government buildings, administration and other functions of the region. This laid the foundation for the Indian Tax machinery.

There were no homogeneous tax rate structures. It depended on the production capacity and the type/ nature of the commodities. The tax rates varied according to the quantum of annual production. These taxes were collected in cash or in kind and it entirely depended on the type of commodity or service on which it was levied upon.

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For example, there was a very common practice of selling food crops and cash crops to government machineries against no money.

The history of taxation suggests that these were done to store government buffer stocks to meet emergencies. Taxes were levied on all classes of citizens, like actors, dancers, singers and even dancing girls.

Taxes were paid in the form of gold-coins, cattle, grains, raw-materials and even by rendering personal service.

In India, the tradition of taxation has been in force since ancient times. It finds its references in many ancient books like ‘Manu Smriti’ and ‘Arthasastra’. There has been a perfect mixture of direct taxes and indirect taxes. India’s history of taxation suggests existence of a large and composite taxable popula-tion. With the advent of the moguls in India, the country witnessed a sea of change in the taxation system.

Although, they also practiced the same norm of taxation, it was more homogeneous in its structure and mode of collection. The period of British rule in India witnessed some remarkable changes in the whole taxation system.

Even though it was highly in favour of the British government and its exchequer, it incor-porated modern and scientific method of taxation tools and systems. In 1922, the country witnessed a paradigm shift in the overall system. An administration and taxation system was set up. The Indian taxation system thereafter witnessed rapid growth and modern-ization.

The financial capital is being concentrated by corporations, institutional investors, and even our pension funds, and being reinvested in companies that repeat this process because it provides the highest return on that financial capital.

- PAUL HAWKEN

A person’s credit report is one of the most important tools consumers can use to maintain their financial security and credit rating, but for so long many did not know how to obtain one, or what to do with the information it provided.

- RUBEN HINOJOSA

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19

deBate

By Paul george, MBA-N

FOR / YES

How much debt does Greece owe?$367 billion to other European countries.

How much does Ireland owe?$865 billion.

How much does Spain and Italy owe?$1 trillion each (mainly to France Britain and Germany).

How will France, Britain and Germany recover this money?They have to be bailed out but the question is who would bail them out.

How serious is the Euro crisis for the rest of the world? The initial con-cern when the Greece crisis erupted per-tained to the financial mar-kets and sov-ereign credibility. These are still serious is-sues as there are apprehensions of other countries joining the fray, with Spain now becoming the epicentre of the crisis.

But the real concern is, how will growth in the real sector be affected? The EC says that there has been positive growth in this region in the first quarter, thus dispelling the fear of a recession. The IMF has projected

AGAINST / NO

When the RBI Governor was confronted with a similar question last week, he quoted “Problem is in Europe, not in US”; this is an example to show how confident the global markets are to tackle this as a minor issue.

To support this statement there are five euro zone countries in the top 10 GDPs of the world, but still all five GDPs put together is not more than the GDP of USA alone.At first glance it’s not obvious that there should be a crisis in Europe at all. Even if Greece were to default on its debt and this would most likely be a rescheduling or a restructuring rather than a large-scale cancellation of the bulk of Greece’s debt.

This would involve a relatively small amount of money compared to the resources that the EU has available to bail out any affected banks.And Spain’s debt is much smaller, relative to its economy, than that of Greece: it’s about 60% of GDP, well below the EU average of 80%

As the origin of the problem lies in fiscal pol-icy, confidence needs to be re-established there. Strong and coordinated signals must be sent out to the public about the ability of the weak states in the Euro zone to put their fiscal situation in order, accepting the impo-sition of strong monitoring and discipline on fiscal policy by the Union’s institutions. That is exactly what the ECB is doing by conduct-ing the “Stress Tests” to their prime banks and ensuring the confidence is restored.Moreover sovereign debt crisis has been

WILL EURO CRISIS LEAD TO GLOBAL RECESSION?

By Bhargav K, MBA-J Rajdeep Rathi, MBA-J Anvin Allen , MBA-N

Caroline jacob , MBA-N

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a growth of 1% for the year after a negative growth number last year. However, all the bailout packages for these countries, starting with Greece (bailout package of €140 billion, of which €40 billion came from the Interna-tional Monetary Fund, and the rest from the other euro-zone countries) have a commitment of fiscal tighten-ing. A rollback in spending levels will have an im-pact on demand.

The rest of the world will feel the effects of the Euro crisis via these important channels:

• The crisis will lower growth in Europe, a market toward which about a quarter of world exports are destined. • It will lead to further Euro depreciation, sharply reducing profits from exports to Eu-rope while also increasing competition from the continent.• The crisis will add greatly to the volatil-ity of financial markets and will lead to bouts of risk aversion.• Another important point here is that the crisis could deal a mortal blow to many fragile financial institutions.• A failure to contain the crisis will raise the alarm on sovereign debt in other indus-trial countries and inevitably in any exposed emerging market.

The collapse of the financial system as we know it is real, and the crisis is far from over. The flaws in the euro have the potential to destroy the 27-nation European Union. A re-cession next year is almost inevitable given the current policies.

with Greece for many years. There is noth-ing intrinsic about such crisis, that they need to become important shocks to the broader global economies.

European Union was formed with the mo-tive of doing trade within its group in a profit-able manner and help each other during the crisis situation. Its motive is well served dur-ing this current crisis through the $ 1 trillion bailout package for the Greece government. The European Union is similar in nature to that of India in the way of its structure. In-dia constitutes of 29 states and Euro zone constitutes 27 countries, some are poor and some are rich, so any weakness in one state can be set off against the strengths of the other state. Similarly, in Europe the crisis of PIIGS country can be made better by the performing economies like Germany, France and Britain among others.

Inflation, which is the major indicator of eco-nomic well being, is at moderate levels of 1.4% to 1.6% in the Euro zone. The exports of Euro zone has reached to high of 3% af-ter 44 months during the month of May. Euro Central Bank has reduced the interest rates to a record low of 1% to reduce the burden on the euro zone governments. Euro zone GDP is still projected to grow at a rate of 1.2% for the current financial year.

United States of America which is the major economy in the world constitutes only 13% of its GDP as exports, of this only 20% is exported to Europe. The dollar has been strengthening off late. These facts stress more on the healthiness of the global econ-omy leader and its rippling effect. So,It will take some time to cross this bad time in its economic cycle but will surely emerge as a stronger union.

By SMITHA JOSEPH CLIFFORD CARDOZA MOHIL KAPOOR

alUmni sPeaK

In this edition, we have Mr. MAHIDHARA DAVANGERE to give us insights on corporate life.

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Chaanakya: What does your job involve?A) Pramartha Investment Partners is a Boutique Investment Bank. As an Investment Consultant, my job involves identifying investment opportunities to our clients - both insti-tutional and Private.

Chaanakya: As an investment consultant what are the various factors you take into con-sideration before you offer your service?A) Understanding the client’s requirement becomes the foundation on which we custom build our services. We build a Risk matrix of every client. Each case is different and the clients financial risk appetite keeps constantly changing.

Chaanakya: Can you share your experience about how it has been in the corporate world initially and the changes those you underwent?A) I started off as an Officer in Citi financials where I did Credit analysis which involved qualifying a customer for his eligibility to avail a personal loan. From there I moved to Oc-wen and joined the company as an Underwriting Analyst. Here my role involved dealing with US Mortgage Underwriting and Due Diligence process, particularly w.r.t. Post Clos-ing Analysis of Mortgage Loans before they enter the Secondary Market In My last job I worked as a Senior Equity Analyst in Indian Ocean Rim Asset Manage-ment analysing Australian Small Cap Stocks, building Financial Models ( including Ratio Analysis, Forecasting, Quantitative Research, compliance research etc), building com-plex excels models (using VBA Macros) to forecast and analyze the Stock Market.My stint as an Equity Analyst gave me immense exposure to the world of Investments and it paved the way to open my own firm.

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Chaanakya: What can you suggest to the students who are looking for a job profile as you are into now?

A) To work or to start an Investment Consultancy you need to start thinking about building your knowledge base and your own brand. Don’t just think MBA is the end of the world and that it will take you places. You have to constantly upgrade your skills. You have to come out of the traditional paradigms of studying a particular subject, rather you should think of knowledge as inter-disciplinary. Keep your minds open to learning.

Chaanakya: What has made you to take up many other courses after MBA? What other certifications or add on courses have you done and how have they helped you in getting a job or retaining one?A) Updating one’s knowledge is paramount, especially given the fact that the factors that affect markets keep changing and there is simply too much information to process. Most of the courses I pursued after my MBA were correspondence courses mainly to supplement my knowledge at work and also to increase my credibility in the market. I did MFC (Master of Finance and Control) to understand Accounting in a better fashion. Mathematics was always my passion and having strong mathematical background is a plus point in invest-ment field. Keeping this in mind I completed my MSc (Maths) simultaneously.I am currently pursuing Actuarial studies from Institute of Actuaries, UK leading to Fellow-ship in Actuaries (At present. there are only about 200+ Actuaries in India). I am also a candidate member in the CFA (Chartered Financial Analyst) program of the CFA Institute (US) which is considered Gold Standard in investment profession. This will lead me to be one of the very few Investment Actuaries in the country which will in turn help me the edge to run my Investment Firm.

Chaanakya: The placements for the senior students start a few months from now. How do you think should the students start preparing themselves for the placements?A) If you already have work experience I don’t need to tell you much on how you need to prepare for your interview. However for both Freshers and experienced candidates it is extremely important that you know about yourself and your goals clearly. Get acquainted with current affairs and know your subject matter very well. Read about the company for which you are attending for interview, if it was in news recently and also have a look at their website and their products and services. It is always better to prepare a write up about yourself and get yourself ready with possible interview questions before hand as it will add to your confidence.

Chaanakya: As a recruiter what are the qualities, qualifications, additional certifications that you would look for as a minimum criteria?A) This is a very subjective question. I only try to see if the candidate is right person for the job, irrespective of the qualification he or she has. Nevertheless, don’t stop learning and upgrading your skill. Otherwise, you may get your first job and move on. But you may soon become ‘stagnated’, once another new generation takes over! Thank you and all the best

Quiz

Across

5. GIC special investments,the private equity arm of Singapore Government’s GIC has an-nounced a 380 crore infusion in which Healthcare6. Allows issuer to extinguish the note at a pre-determined time.

Down

1. Credit Default Swaps are usually measured as the cost incurred to insure how many dollars against the risk of de-fualt.2. Temporary reduction in the selling price of an item to stimulate demand or to drive a competitor out of the market.3. Among the Euro zone countries,which country’s bond spread has remained stable and low within the bloc during June2010.4. A member of a stock exchange who was ‘hammered’ and expelled from the membership for being unable to meet financial or contractual obligation.

Identify The Logos.

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Crossword

1 2 3

4 5

answers

Quiz

Crossword

Manesh Paul Mani Editor-in-Chief

Sachin Cartoon

Amutha Priya D News

Nivedita Tiwary Investors check

Poornima Sasikumar Student Article

Nithya Prakash Scam

Mookambigai Commodities Market

Niveditha S Debate

Clifford Cardoza

Smitha Joseph &

Mohil Kapoor Alumni Speak

Amar G M Quiz & Did You Know

Mantri Ankit Atul Quotes & Buzz Words

Pottim Sahiti Reddy Crosswords

Vipul Jain Graph, Rates

Bhargav K Design and Editing

Pradeep Thangavel Compiling and Editing

Dhanya Anna Kurian

Resmy Sebastian Review Committee

1. Grameen Bank

2. NABARD

3. Bank of Japan

4. IndusInd Bank

5 BNP Paribas

team

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Please mail your valuable feedbacks, reviews at chaanakya@mba.christuniversity.in

Please mail your valuable feedbacks, reviews at chaanakya@mba.christuniversity.in