Arbitrage Magazine - DECEMBER 2018 - Finance & Investment Club | IIM Rohtak

ARBITRAGE DEC 2018

VOL. 3 ISSUE 1

ARTICLE OF THE MONTH:

INDEPENDENCE VS OBEDIENCE: The RBI vs Indian Government Deadlock

FINANCE AND INVESTMENT CLUB

Editor's Note We are pleased to publish the twenty-third issue of ‘Arbitrage’ – Finance and Investment Club’s monthly magazine. Arbitrage aims to cover a diverse range of topics under the wide domain of Finance and Economics. Our goal is to ensure that we provide significant value to the readers through informative articles and articles on current affairs. We would like to thank all the authors for contributing their articles for Arbitrage.

In the Article of the Month – "Independence vs Obedience: The RBI vs Indian Government Deadlock”, the author Mr. Rohit Kumar Choubey from IIM Ranchi has talked about recent instances where the differences between the RBI and the Central Government have gotten apparent and visible, and how these contradictions would pan out in the future.

We hope for the continuous support of our authors and readers to make this magazine a success.

-Finance and Investment Club, IIM Rohtak Parag Nawani Siddhesh S Salkar Vineeth Harikumar Naveen Kumar Sankalp Jain Pavankumar S Bibekjyoti Roy Nandi Aditi Patil

Index S.No.

Article

Pg. No.

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INDEPENDENCE VS OBEDIENCE: THE RBI VS INDIAN GOVERNMENT DEADLOCK

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AMERICAN PLAYBOY AND THE BIG SHORT: SHORTING THE CULTURE AND THE MARKET

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END OF GREAT COMMODITY CYCLE

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4

WHY ARE RECESSIONS ALWAYS A SHOCK?

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5

DERIVATIVES

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EMERGING TREND IN REAL ESTATE FINANCING: REIT & ITS PROSPECTIVE IMPLICATION IN INDIA

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THE GROWTH AND WORKING OF FLEXIBLE INFLATION TARGETING (FIT) IN INDIA

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MACHINE LEARNING: INVESTMENT BANKING

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A NEW TAX BRACKET?

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BREXIT: PAST, PRESENT & FUTURE

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BOOK REVIEW:COMMON STOCK AND UNCOMMON PROFITS

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INDEPENDENCE VS OBEDIENCE: THE RBI VS INDIAN GOVERNMENT DEADLOCK Rohit Kumar Choubey IIM Ranchi

ARTICLE OF THE MONTH

India has grabbed headlines amongst countries around the world on account of the recent occurrences surrounding friction between the Indian Government and the RBI. The speculation became public knowledge with the strongly worded speech given by the RBI deputy governor Viral Acharya emphasizing the importance of maintaining the Central Bank’s independence and the adverse consequences that could befall an economy if the Centre subverts the Central Bank’s authority.

Points of contention There are several areas where the government and the RBI have a difference in opinion. Firstly, there always has been some sort of subjectivity regarding the appropriate amount of capital that the RBI needs to hold in its balance sheet. Usually, this figure is assumed to be close to 20% of the country’s GDP. However, the government feels that the RBI is overly capitalized at the moment and that it should free up some capital to fund the government’s fiscal deficit which, in turn, could stimulate the economy. As per the government, this excess amount of capital is nearly 3.6 lakh crores. Also, RBI is being pressed to inject liquidity into weak banks and NBFCs which needs to regain investor confidence after the IL&FS default. Lastly, the Prompt Corrective Action framework which was developed to prevent banks with already weak balance sheets from getting weaker through indiscriminate lending was revisited, with more stringent benchmarks introduced for these banks. The government, however, wants RBI to follow a more relaxed approach towards dealing with such banks and loosen lending norms.

To understand this problem, we must first know as to why the RBI, which is wholly owned by the Indian Government, needs to be given its fair share of

autonomy in determining the course of monetary policies. If the government were to influence monetary policies, it could be tempted to use short-term liquidity improvement tactics to spur growth. This could lead to inflation via an increase in nominal interest rates and would ultimately decrease potential growth and decrease investor confidence in the economy. As opined by the Deputy Governor of RBI, the Government and the RBI are playing two different forms of the game. The Government is playing a T20 cricket match where the game needs to be won within a limited period, often overlooking the longterm consequences. On the other hand, the RBI is playing a Test match where it needs to focus not on only on winning every session but also on survival so that the entire game could be won.

The approaching elections, coupled with the government’s continual emphasis on fiscal spending has fueled further speculation that the Centre’s actions are more concentrated towards garnering votes from the masses by providing them with short-term relief. The government went so far as to mention Section 7 of the RBI Act, which is basically meant to be an instrument through which it can force decisions upon the Central Bank if it deems necessary for the public interest. The Section has never been used before in the history of independent India.

The pressure from the Centre upon the RBI because of the aforementioned reasons has allegedly led to the resignation of the RBI Governor Urjit Patel, a few months after the resignation of RBI’s Chief Economic Advisor Arvind Subramaniam, which is an indication that the government will not shy away from exerting its influence over the Central Bank.

What to expect in the future?

The Reserve Bank of India, in earlier decades, had had its fair share of leaders who had a political inclination which eventually led to a substantial increase in inflation figures, especially before Congress brought in former IMF chief economist Raghuram Rajan at the

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helm of the RBI. Under his presence, RBI was able to put a halt to the spurring inflation figures and declining rupee value. Subsequently, under Urjit Patel, RBI imposed restrictions on the amount that banks in poor condition could lend until they cleared their balance sheets and held a firm stance against practices that led to the persisting problem of increased bad loans which PSU banks are currently struggling to cope up with.

Das is a veteran who was at the forefront in defending government actions like demonetization in the year 2016 and is still a strong supporter of the move. However, according to critics, policies like demonetization has delivered a substantial blow to the Indian economy, especially the manufacturing sector which it is still struggling to recover from the setback. Also, facts support the conclusion that demonetization has had Also, as per the credit rating agency Moody, India’s little to offer to the common population up until sovereign credit rating is Baa2, which barely cuts an now. With major wins for the opposition in state investment grade economy. According to the former elections in BJP dominated states recently, the Governor of RBI Raghuram Rajan, if the excess desire for RBI’s excess reserves by the reserves of RBI are transferred to the Centre, it could government ahead of the forthcoming elections lead to a rating downgrade which eventually would is only going to escalate. Therefore, it would be result in increased cost of borrowings. Also, these crucial to watch whether the new governor reserves are earmarked for contingencies, and a would continue to build the legacy put forward reduction in this amount could potentially increase by his competent predecessors like Rajan and the exposure of the Indian economy to downside risk Patel and maintain the sanctity of the of increased market fluctuations. The newly independence of RBI, or would just be there appointed RBI governor Shaktikanta perform the government’s bidding.

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AMERICAN PLAYBOY AND THE BIG SHORT: SHORTING THE CULTURE AND THE MARKET Himanshu IIM Rohtak

Those of you who know about this would be

thinking how both of them are correlated, a web

for civil rights. They build playboy clubs even at a point of time they were too diversified, they were

series and a movie that too of a different genre, and into music, television channels, luxurious cab I am not saying that it is, but they have a thing in

services, resorts, and many more things and it all

led them to make a massive fortune and both of

company, but he builds the Playboy brand. Those

common, both of them ride an early wave which them betted against the masses. Oops, I forget to introduce it for the crowd which doesn’t know

what these words are. The first one is American

playboy ummm It's little controversial when most of the people hear this name, Playboy, all they

started from a magazine. He not only build a

who are interested in marketing, brand building and are reading heavy books like Kotler and others

should watch this series, the way he built this brand against the odds is exceptional.

think is about sex, lust, bunnies, parties all the sins

And now we will talk about the second name on the

dream which Hugh Hefner built, lived and gifted to

movie will be so exciting and knowledgeable to

this humankind have made, but it is not, it is a

humanity. Here, I will talk about a web-series on

Amazon Prime which is American playboy which

clearly shows the journey of Hugh Hefner building his empire all across the globe riding against the

mainstream culture. Yes, you read it right against the prevailing culture and reading or creating the new upcoming culture and helping it to grow. In our business schools, all we have taught by our professors is to go with the culture, study the

culture and how firms who don’t understand the

prevailing culture dies. But this guy went against

the culture that was prevailing in the 1950s where you could not possibly talk against the

government, existing racism, gender inequality,

civil rights, and sex. He filled the void in the market of magazines there were none for men’s lifestyle and built it from his kitchen. This series unfolds

list which is The big short. I had zero ideas that this watch. It revived my interest in finance, yes I was

kind of depressed after seeing and studying finance for real in my life for the first time in MBA course and marketing was too lucrative as much as the

beautiful actresses which advertise the products.

But there was something because of that I was interested in finance that was capital market,

especially the stock and bond markets. This movie clearly explains some of the basic concepts of

financial markets and the picture of the financial

crisis of the year 2008 that washed away the world

economy into a sea of garbage. They clearly showed what led to this crisis, how corrupt are these rating

agencies, banking institutes, and some big names in trading industries. But in this crisis, some people

managed to make a lot of money who identified it very early and correctly. People called them mad

every event which took place in his journey step by and did not believe in them. If you are a finance step. How they had the idea of a ‘centerfold’ and

enthusiast and in some point of your life looking

issues which no one in the media dared to speak

indirectly, you must watch this epic piece of drama

‘the girl next door,’ how they spoke about social

on. It’s not the sex which made playboy famous or

on which they were based. They gave a platform to cultural leaders to discuss pressing social issues and published many controversial interviews

which left an impact on society. They even fought

forward to investing in the market directly or

which would give you a chance to learn a lot in just 2 hours. In the end, you will be able to correlate it

with recent IL & FS crisis in India. If you watch both

of these, you will also be able to say that both of the protagonists in these shorted something

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against the majority sentiments one shorted theÂ

market and other shorted the culture and make it big.

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END OF GREAT COMMODITY CYCLE Arush Sharma MDI Gurgaon THE COMMODITY SUPERCYCLE: HOW IT BECAME

may take a decade to happen. This production cut

followed a great price depression in 1980-2000. The

causes demand to exceed supply, and the

SO LARGE. The current commodity supercycle

secular Bull Run which started around 2000 – 02

coincided with the spectacular rise of the emerging nations, the housing bubble and the

unconventional monetary policy. Meanwhile, it did suffer a huge setback in 2007 during the great

recession. Moreover, it is not having the greatest of times today. But even with the occasional rough patches, commodities have generated mind-

boggling returns in the past decade. IT’S JUST

SUPPLY AND DEMAND The prices of commodities are driven by the factors of supply and demand.

Prices rise when demand exceeds supply and

(and possibly demand to increase simultaneously) producers start again with their capex cycle.

However, mine production requires a lot of time

due to capital intensity and legal proceedings which result in a lag. This causes a sudden rise in prices.

This attracts further investment, and the process continues. The above explanation is extremely simple but only looks at the producers of

commodities. However, in reality, there are

numerous other factors like interest rates, supply shocks, new technology, etc. that determine the prices.

prices fall when the opposite happens. Hence, the

But all of them can be classified as altering the

analysis of the forces behind supply and demand.

the opinion of several investors the current bull

study of commodity prices is essentially the

Producers of commodities are profit-seeking entities and will boost or cut production to

maximize profits. To understand their incentives very simply, consider the case of the 1970s. The

commodities prices were on a continuous rise. This incentivized the producers to increase the capital expenditure (CapEx) to develop mines and wells.

This caused supply to increase. The period of

supplies exceeding demand is particularly long in the commodity business because these are

extremely capital-intensive industries. Mines

continue their production even when they make losses. As long as they cover their fixed cost

operating a mine is justified. Eventually, a time

comes when supply outstrips demand, and the prices begin to fall. This can be due to a rise in supply, a fall in demand or growth in supplies

exceeding the growth in demand. As a result of

falling prices, the producers begin to invest lesser

in mines. This occurs because excess inventory has associated cost. It has deterioration risk, hedging risk, warehouse, and insurance charge and

opportunity cost. In fact, in extreme cases, mines

are shut completely. This entire cycle is slow and

forces of supply or demand only. 2002 - 07 ERA In market originated around 2000. However, in my

opinion, it truly began in 2002 when the price on the CRB commodity index broke past its all-time high.

This period coincided with the low-interest rate regime followed by the Fed post the dot-com bubble burst and the rise in demand from the emerging nations. The ultra-low interest rate

regime that followed caused the world interest

rates to drop. Anyone could borrow and lend at the very low-interest rates in the open economy.

Countries and companies all around the world

started borrowing and investing at a rapid pace.

Countries like India, China, Brazil, etc. started

consuming humongous amounts of commodities

to satisfy their growth trajectory. This resulted in a sudden growth in the demand for commodities.

However, during the 1990s the investment into

commodities had died. When there was a sudden spike in demand, the supply side did not have adequate inventory to satisfy the demand.

Furthermore, as already explained the capex starts generating result only after a considerable lag.

Hence, supply growth lagged demand growth for a considerable period. Additionally, there was

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another major development that was going on in the

futures markets gained volume, their prices became

prices picked up massively till 2007. This resulted in

regarding investing in commodities. Many index

advanced economies of the world. The housing

the wealth effect propping up consumption. As the

economy started heating up, Fed started hiking the interest rates from 2005. When the Fed started

raising the rates, the producers started monetizing

more of their stock. By monetizing their stocks, they

the primary determinant of all the decisions

funds were opened, and investors poured into the cheap money aggressively. Studies have shown a strong correlation between funds inflow in index funds and futures prices.

were locking in higher interest rates rather than

Additionally, as the prices of commodities rose more

inherent risk in such businesses as already

activities. This is in sharp contrast to the fact that had

reinvesting in their business. This occurs due to the mentioned. Producers are always worried about excess inventories. This aggravated the supply

crunch post-2005 and resulted in a huge run up in commodity prices till 2007. Then came the great

recession. Housing prices fell, and so did the interest rates, stock markets, and the commodities markets.

This caused a huge shock in the economy. Wealth got destroyed in nightmarish proportions.

As expectations about the future state of the

economy turned gloomy, financial markets tanked.

This was the first major pause in the secular Bull Run of the commodities market. THE QE ARRIVES TO SAVE THE WORLD The Fed started its

unconventional monetary policy, quantitative easing (QE), in 2008 whereby it printed money and bought toxic assets, primarily Mortgage-backed securities

(MBS). QE pumped in a vast quantity of money into the global money supply. This raised the inflation expectation which never actually materialized.

Nevertheless, the easy money led to a rally in global markets. One of the major cause that has been attributed to this rally is the financialization of

commodities. In 2000, the commodities futures

market was deregulated, and speculative position limits were relaxed substantially.

As a consequence, the futures options trading

volume rose five times from 630 million contracts in 1998 to 3.2 bn contracts in 2007.

Further, commodities became favorite among

investors due to their low correlation with other

markets. This idea and its strong correlation with

inflation were sold aggressively among the clients by brokerages, banks, and hedge funds. Also, as theÂ

funds got invested due to momentum trading

most of it been a part of the consumption basket; its demand would have decreased. This gives some

strength to the hypothesis that financialization of

commodities might have resulted in commodities

prices boom. This argument is further strengthened

by the fact that commodities like oil, gold, etc., which could be easily invested in through the futures

market gained much more than the markets like iron ore, coal, etc. which lack a developed financial

market. SUPPLY SHOCKS Like the previous Bull

market; this one also witnessed a supply shock. But the only major one was the 2013 agriculture market shock. This was the result of one of the worst

drought in the past 70 years in the US. Although

many attribute the 2007 run-up in oil price to supply

shock from turmoil in Nigeria, strife in Iraq, etc. data proves that the world supply of crude oil was quite

stable in the 2000s. In fact, it had more to do with the lack in an increase in production in 2005-07, which was primarily due to extraction from older wells

whose efficiency decrease when the pressure falls.

CURRENT SCENARIO The commodity supercycle might have ended according to many. But at the

same time, many veteran investors believe that it is

just a major correction. Every commodity is off its alltime highs, and equity markets are gaining strength

around the world. Many path-breaking technologies like fracking, cheaper alternative energy, etc. are altering the supply-demand scenario for commodities.

The emergence of the technology sector seems

much stronger than a decade ago. Sentiments and

optimism all around the world are improving. China

and India have slowed down considerably comparedÂ

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to the previous decade. Moreover, the key selling

the commodity bulls right now. But it is near

Further, the commodities financial market has

We were almost on the verge of a political crisis

point for commodities, the QE, is off the way.

become much more mature and price manipulation can be expected to become all the more difficult.

Many large banks have shut down their commodity businesses. The factors seem to be aligned against

impossible to predict the future with accuracy. in Ukraine. There can be many others to come.

History tells us that the last major commodity bull market high made during the much unexpected Iranian revolution.

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WHY ARE RECESSIONS ALWAYS A SHOCK? Ayesha Aggarwal IIFT Delhi Financial models that are widely used by various

example, the 2008 crisis, the Asian currency crisis,

across the world have their foundation in economic

this crisis happened almost a decade ago and the

analysts, investors and hedge fund managers theories. But the real question that arises

concerning these models that are so relied upon by people to help them make their investment

decisions, that tell them where to invest their

millions of dollars, is how sound are they? A few

years before the financial crisis of 2008, Raghuram Rajan said in an address ‘financial innovation has

introduced new risks into the system’ why is it then people continue to rely on these models for predicting the future?

Financial models are used to predict risks, the user

punches in certain numbers, and the model churns out a number. Judging by this you can like a

financial model similar to the models based on principles of physics that help NASA scientists

determine with unbelievable accuracy the speed of the rocket at a particular height. But physics and

finance are not the same. Models of physics deal

with highly quantifiable parameters like the weight

of an atom, velocity, etc. Economists over the years have aspired to develop models that accurately predict the macro and micro indicators. But

financial models are far more complex and often

have parameters that are not easily quantifiable for instance human behavior. One cannot always

assume humans to act rationally, in fact, humans

have biases and are complex emotional beings: all these attributes are extremely hard to quantify. A rational investor has been assumed as a

fundamental assumption in many of the financial

theories that we come across daily. How then can

we trust models that have their very fundamentals being questioned?

It is astonishing how through the years big firms have continued hiring mathematicians and

statisticians to develop quantitative models that

predict the market movement. Why then did these models fail to predict the various financial

breakdowns that have happened in the past, for

etc. to name a few. Of course, it can be argued that models must have evolved over the years, but it is safe to say that the fundamentals on which these

models were built are still the same. The problem remains the same.

People are trying to figure out the market which is filled with information asymmetry, herd mentality and cognitive biases of humans based on models

that are purely quantitative, models which cannot

work without quantifying all the parameters and the moment you quantify something you are forced to render a certain degree of stability to that

parameter whereas markets are ever changing.

Such a dynamic phenomenon cannot be captured by models that have been forcefully fitted to

frameworks that were not meant for them in the first place.

Another example to drive home my point would be the models used by the Federal Reserve to forecast where the economy is heading. The two models used by it are Statistical and DSGE (Dynamic

stochastic general equilibrium). Both these models

failed to give any kind of hint regarding the financial crisis that wreaked havoc in 2008 for a simple

reason that both these models work on a simple

basis of economic equilibrium. But the economy as we know is never in equilibrium it is in a continuously evolving state.

Majority of the models that are in function today are quite old like the DSGE model for example which is based on the Philips Curve: a concept that was first introduced in the 1950s. How suitable are these models to function in an economy of the 21st

century where concepts like cryptocurrency and big data exist? How can these models help us in

predicting stock movements of an exchange that is and will be driven by tech companies? (I would like

to digress here by pointing out that tech companies fail to follow the traditional demand and supply

curve, unlike companies, are driven by tangible

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products.)

account the different factors that affect its behavior.

economic and financial models that are more

come together. A synergy that can help build an

What the future demands and deserves are

suitable to adjust to the ever-changing nature of the economy we live in — models that can aptly reflect the vagaries of the economic system and take intoÂ

Maybe this is where technology and economics

evolving rather than a static simulation of the world we live in to help us better predict the future and avert the crisis to come.

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DERIVATIVES Parag Nawani IIM Rohtak Let’s Swap the Options of moving Forwards with

default risk.

The heading of this article might not mean

It is similar to a forward contract. The difference is

better Futures.!

anything, but it contains those financial products which belong to the magical world of

DERIVATIVES. Yes, I am talking about Forwards,

Futures, Options, and Swaps. In this article, I have tried to provide insights into these products and their applications.

Hedgers, Speculators, and Arbitrageurs

A hedger is a person who wants to mitigate his business risk. For example- an electric wiring

company uses copper in its production and sets

prices based on its cost. The cost of copper might

increase in the future, so the company would like to protect its business from the increased cost. A

speculator attempts to predict price changes and

extract profit from the price moves in an asset. He may utilize leverage to magnify returns and has a

shorter investing period than that of investors. An arbitrageur is an investor who endeavors to profit from price inefficiencies in the market by making synchronized trades that offset each other to

capture risk-free profits. He would seek out price

inconsistencies between stocks listed on more than one exchange by buying the undervalued shares on one exchange while selling on another exchange,

thus capturing risk-free profits as the prices on the two exchanges converge. These are the THREE

main categories of investors who trade derivatives in the market.

Forwards

A forward is a derivative contract between two

parties to buy or sell an asset at a definite price on a future date. It can be used for both hedging or

speculation, though its non-standardized nature

makes it particularly suitable for hedging. It can be tailored to any commodity, amount and delivery

date. A forward contract settlement can take place

on cash or a delivery basis. They trade as over-the-

counter (OTC) instruments and not on a centralized exchange, which gives rise to a higher degree ofÂ

Futures

that they are standardized to facilitate trading on a futures exchange. The futures markets are

characterized by the capacity to use very high

leverage comparative to stock markets. They can be used to hedge or speculate on the price movement of the underlying asset. For example, a corn

producer could use futures to lock in a certain price

and mitigate risk, or a speculator could profit on the price movement of corn using futures by going either long or short.

The futures market is different from that of forwards market in that they are settled daily (known as Mark to Market) as compared to settlement on delivery

date in forwards market. Also delivery takes place in most of the cases in the forwards market, whereas

most contracts are closed out before maturity in the futures market.

Cross-hedging

One of the use cases of the futures market is known as Cross-hedging. This refers to the case when there is no futures contract on the asset being

hedged, and we choose a contract whose futures

price is most highly correlated with the asset price.

For example, an airline plans to purchase a million

gallons of jet fuel in one month, but jet fuel futures contracts are unavailable in the market. Its prices are highly correlated with that of heating oil, and hence the company decides to use heating oil futures for hedging.

Strip and Stack & Roll

These are the two common trading strategies in the futures market. A Futures Strip is the sale or buying of futures contracts in successive delivery months

in a single security. In Stack and Roll, we enter into a futures contract to hedge exposures up to a time

horizon, and then close them out and reflect new exposure.

Options

This class of derivatives gives the buyer the right,Â

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but not the obligation to buy or sell the underlying

options. Some of them are Bull spread; Bear spread,

an asset at a specified price (known as Strike price)

Strip. Their payoffs are shown below.

asset. A Call option provides its buyer a right to buy before the expiration date of the call option. A Put

Butterfly spread, Straddle & Strangle, and Strap &

option, on the other hand, provides its buyer a right to sell an asset at the Strike price. Suppose, an investor expects the stock price of a particular

company would rise in the future, then he would buy a Call option to protect himself from buying the

stock at a higher price. Similarly, he would go for a

Put option if he has an opposite view of that stock. A long position is being on the buying side. A short

position is being on the selling side. Figure 1 shows the payoffs from different option positions.

American and European options

This classification is based on the time-difference in

cash flows from the options. A European option can be exercised only on its expiration date, whereas an

American option can be exercised at any time before its expiration date. Â Put call parity

This rule holds that the put and call options on a

particular asset with the same strike price and same expiry date are fairly priced.

C and P are the call and put option prices

respectively. K is the strike price for both options. R is the risk-free interest rate. T is time to expiry for both options. So is the current price of the asset.

Trading strategies

There are many creative strategies, either to

maximize profits or to minimize losses, usingÂ

Binomial option pricing model

This model is used to calculate the price of an option by using the probability of future prices of an asset.

Black-Scholes-Merton Model

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This model is useful to calculate the option prices, taking into account various critical factors.

Forward Rate Agreement (FRA).

Currency Swaps

It involves the exchange of interest and principal in one currency for the same in another currency.

Interest payments are exchanged at fixed dates

through the life of the contract. They are done most commonly to hedge long-term investments and to change the interest rate exposure of the two parties.

In an Interest Rate Swap, the principal is not

C and P are call and put option prices, respectively. exchanged, while in a currency swap, it is generally Swaps

exchanged at the beginning and the end of the

exchange the cash flows or liabilities from two

So we see that the derivatives are some of the most

It is a derivative contract by which two parties

different financial instruments. The swap contracts are used to transform a liability or an asset.

Interest Rate Swaps

Suppose Microsoft Inc. has taken a loan at a fixed interest rate, and it wants to change its fixed

liability into a floating one, whereas Google Inc. wants to convert its floating liability into a fixed

swap’s life.

interesting products of financial engineering. They

are excessively used in the present time for various purposes. According to the recent data from the Bank for International Settlements, the gross market value of all derivative contracts is

approximately $12.7 trillion, and the total notional amount outstanding for these contracts is an

one, both these parties can come in a contract with estimated $542.4 trillion. each other to exchange their liabilities, which will

I hope this article has provided you with a brief

are valued generally in two ways-

applications. Read more about these products and

constitute an Interest rate swap. These contracts Valuation regarding bonds and Valuation as a

overview of the various derivative products and their get mesmerized by the world of Derivatives!

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EMERGING TREND IN REAL ESTATE FINANCING: REIT & ITS PROSPECTIVE IMPLICATION IN INDIA Rohit Khanna IMI New Delhi Suppose you don’t want to buy physical real estate or don’t want to deal with developer but want to

invest in real estate, what are the options you have?

The answer to above question lies primarily in three choices of financial products. Firstly, one can invest

in listed entities in Indian stock market of developer of his/her choice. The second financial product is the private equity which usually comes out with

different schemes. In case of listed entities, one can enter or exit anytime, but in the case of private

equity, the investor is locked – in for a particular period. The third financial tool is Real Estate

Investment Trust (REIT) which combines private

equity and listed entity. REITs are listed on the stock exchange, and returns are directly dependent on how the asset or group of assets is performing

rather than corporate management issues or any other issues.

REIT gives opportunity to benefit from earnings

generating real estate. The shareholders of REIT benefits by owning stocks and earning dividend based incomes on them without owning and

managing the property. So it is very feasible option for the individuals who are short on funds to

purchase real estate property but eager to invest in

it. REITs permit people to invest in portfolios of real estate belongings by purchase of individual

company stock or through a mutual fund or exchange-traded fund (ETF).

REIT generates money from individual investors, institutional investors or companies that want to

invest the same. Once REIT collects funds, it uses

that money to purchase commercial property which might be office space, hotels, shopping malls, etc.

Then, REIT rent or lease out those properties and

start receiving rents, or they might also earn profit by selling some units. The profits earned from

renting and selling properties is distributed back to investors in the form of dividends.

There are fundamentally two types of REITs – Equity REITs and Mortgage REITs. Equity REITs spend and

own properties which also help them to gain from any appreciation in those properties. The revenue earned by them primarily comes from their

properties' rents. These kinds of REITs generally own apartments, office buildings, retail malls, or hotels. Mortgage REITs deal in investment and

possession of property mortgages. These REITs

credit funds for mortgages to holder of real estate property, or acquire prevailing mortgages or

mortgage-backed securities. Their earnings are

produced essentially by the interest that they earn on the mortgage loans. The combination of both types of REITs is known as Hybrid REITs.

In 2014, SEBI came up with REIT regulations under which REIT can be set up only as Trust, but not a

company or LLP. It is mandatory to register them with SEBI, and these can only be traded on stock exchanges. For listing, total asset value of REIT must be greater than Rs. 500 crores along with

minimum public float of 25%. Further, REIT can invest in commercial real estate assets, either

directly or through Special Purpose Vehicle (SPVs) which invests more than 80% of its assets in

properties. If REIT is investing through an SPV, REIT has to hold controlling interest with at least 50% of the equity share capital or interest in SPV. In India, REITs are prohibited from investing in any kind of

agricultural or vacant land. It is mandatory to return at least 90% of cash flows from dividends to investors in the form of dividends.

There are multiple benefits of investing in REITs.

Firstly, just like mutual funds one can sell or buy any number of units with minimum initial investment of Rs 2 lakhs. One does not need to search for buyers or sellers as there is high liquidity in the market.

There is high-risk exposure in stocks as compared to REIT, and there is less volatility in REIT

investments as rental returns are stable and

constant. Real Investment trust generally invests in multiple locations and in multiple types of properties which helps in diversification.

13

These are managed by professionals who rely

thoroughly on market research before making any

investment which might not be the case when one attempts to invest by purchasing properties. As

compared to under construction properties, there is no risk of delay in case of REIT. Also, these are more

transparent regarding occupancy levels, buying and selling rates, average rent, etc.

According to 2016 EY report, global REIT industry

values to $1.7 trillion. With India moving away from traditional assets like gold, silver, etc. towards

financial instruments, it might witness huge domestic demand for REIT as seen for mutual funds. However, India is yet to witness its first listing for REITs. SEBI

has already given consent to six institutional investors

including US’ North Carolina Fund and Canada-based Â

Sentry Global to infuse in India as developers and

real estate investors under REITS. Blackstone and local partner Embassy Group are in process of

filing prospectus for an initial public offering (IPO) of the REIT in next few months which might raise as much as $1 billion.

However, there are some barriers for REITS in India as there is little unpredictability for adoption of same in the country. The high risk in equity

markets is also complemented by high returns in

long-term which are around 9-10% whereas yield

from residential property and commercial property

are only about 3% and 8% respectively. However, if investors look at both, annual yield and capital

appreciation, it can prove to be attractive for them.

With first listing of REIT is just few quarters away, it will be real test case for the Indian market.

14

THE GROWTH AND WORKING OF FLEXIBLE INFLATION TARGETING (FIT) IN INDIA Rujuta Wani SIMSREE Introduction:

Inflation Targeting is a monetary policy implemented by the central banks of the economy for maintaining inflation at a certain predefined level or within a specific range. Generally, the main target of the

central bank is to keep the inflation level sufficiently low. However, in Inflation Targeting, there is a

publicly declared and agreed upon target. The

central bank then tries to keep inflation below this

targeted level, and penalties are faced by the central bank in case of missing the targets. This policy was

first adopted by New Zealand in 1990, a post which it was soon accepted by many economies. India adopted it in 2016 under the Monetary Policy Committee (MPC) of Governor Urjit Patel.

History:

In India, in the past, a monetarist approach was used which used to consider a supply-side approach to determine the growth of the economy and the

demand affected only the inflation, not the output.

The inflation targeting, however, focuses on the demand side approach which emphasis that the demand plays a major role in economic

development. The advantage of this policy is that it

brings transparency, accountability and it also gives the central bank a wide control spectrum over the

Analysis of FIT:

The Monetary Policy Committee (MPC) has targeted FIT to be at 4 percent with +/ 2 percent. It has

helped to reduce the inflation of 2011 which was around 11 percent. FIT has consistently kept the

inflation low except the phases of Demonetization (2016) and GST (2017). Impact Analysis can be described as below [1] -

• Repo Rate– From the time this policy was

implemented until today, RBI has made almost

eight changes to the policy. The repo rate in July 2014 was 8 percent and has been reducing

consistently. At present, it is 6.5 percent. This repo rate helps to maintain the inflation at a specified

level. In the case of increasing inflation, there are

contractionary policies implemented by the RBI economy. So generally the central bank forecasts the and government to control inflation. In the case of future path of inflation and compares it with the the lower inflation rate, the expansionary policy is targeted inflation rate. Further, the difference

between the forecast and the target determines how much the monetary policy needs to be adjusted [2]

Below graph shows the Inflation rates of India in the

implemented by the government and RBI to

increase the purchasing power of the people thus sending out money into the economy.

past and how the implementation of Inflation

targeting has helped to reduce the inflation level which was approximately 11% in 2011.

However, what is really remarkable is the growth of ‘Battle Royale’ games. Battle Royale genre, which

involves gamers fighting in a shrinking playground to be the last player standing, has seen tremendous

• Consumer Price Index (CPI) – In India, CPI is used

revenue this year, up from just about $1.7 billion in

inflationary pressures, CPI is seen to be increasing.

success and estimated to generate $12.6 billion in 2017.

as a key index for measuring inflation. Due to

It was 3.6 percent in October 2017 and then rose to

15

5.21 percent in December 2017. This rise was marked due to the rise in food inflation

Challenges in India and Conclusion: Implementing FIT in a developing economy like India holds some challenges like below [2]:

• Importance of Food Prices to the changes in CPI –

In Indian CPI, food constitutes around 46 percent of the CPI basket, and this poses a high risk in the implementation of FIT. Food prices are highly susceptible to supply stocks while the FIT is

focused on demand side leading to output. These

food prices are mainly derived from the agricultural outputs which are highly dependent on

environmental factors like adequate rainfall, less

soil erosion, the absence of natural calamities, etc.

• GDP – GDP growth under this policy is marked

well so far. However, GDP went down in 2016 and

2017 due to Demonetization and GST respectively.

However, from 2014 to 2016, the GDP of the

economy was good. At present GDP growth is 7.1 percent for the second half of 2018.

Hence having an inflation target based on CPI is

risky. However, a well-drafted FIT policy will be able to nullify the food price sensitive effect by

implementing effective strategies. Firstly, there is a need to have a long run inflation target which will anchor to the expectations. Secondly, the central • Merits - It brings in transparency in the economy.

Adds accountability to the central bank. Narasimha

committee (2000) and Rajan committee( 2007) once stated that such a policy provides more room for the policy makers to respond to large shocks.

• Demerits - A successful implementation of this policy needs a lot of parameters like - Independence of the Central Bank

- Developed technical infrastructure for forecasting and modeling - Data availability

- An economy with fully deregulated prices not sensitive to commodity prices

- A healthy economy with the sound banking system and well-developed capital markets

Hence for India, some economists view the flexible policy as predatory for the economy.

bank reinforces the anchor by publishing forecast that shows a medium duration path back to the

target along with the assessment of the channels through which the inflation adjusts itself back to the target taking into account all types of lags or

delays. Because of this the FIT will gain credibility and will win the public confidence and will get in price stability into the economy.

• Building Credibility – Before FIT came into

existence, the RBI did not have any explicit price stability which could judge or predict whether

long-run inflation target will be achieved or not.

Hence with the FIT in place, the most important

thing for RBI is to gain the consumer credibility.

This can be achieved through transparent

communications ( like monthly or annual reports), announced objectives and goals, etc.

16

• Technological Infrastructure – [3]For future

inflation forecasting an advanced technological, infrastructural base is needed. Most of the

developed countries already have this in place.

India being a developing nation needs to work on this because at present also we are not able to The above shows how expectations can amplify or absorb in case of inflation shock. Like when the

central bank raises the policy rates the effect on the economy depends on how the people of the economy interpret the action.

forecast for 8-12 quarters future data as this

requires highly sophisticated instruments. Hence we must aim to build a strong technological

infrastructure base for long future forecasting of inflation.

17

MACHINE LEARNING: INVESTMENT BANKING Deepak Rawtani KJ SIMSR

There are two reasons for this transition. First, the tools used earlier were more straightforward in

approach and secondly, from 1995-2005, the focus was on the search, natural language, and

information retrieval. This combined with Human Capital development and investment in basic Most of you might be familiar with the company

infrastructure helped in the evolution of ML.

name Ola! In marketing words, it is now regarded as the top-of-the-mind recall. What attracts in the

picture is the brand positioning “Reach on time or

get your money back” along with the estimated ride

time. Ever wondered how your ride’s estimated time and arrival time is measured? Well take your time

and think something related to Industrial Revolution 4.0. The answer to my very own is MACHINE

LEARNING. In layman terms, Machine Learning or

In layman terms, Investment Banking or IB is a

applications to act, learn and improve without being

organizations or individuals to raise capital or

ML is a category of an algorithm that allows software special branch of banking operation that helps monitored.

provide financial consultancy to them.

An investment Bank helps its client perform the following main things:-

A) Buy or sell assets or companies – Mergers and Acquisitions

B) Raise capital from Equity Capital Markets (ECM) C) Providing financial services such as trading

securities, derivatives trading, and FICC (Fixed Income Instruments, Currencies, and Commodities)

D) Raise Capital from Debt Capital Markets (DCM) E) Restructuring to improve the efficiency of business

The journey of ML started in 1952 when it was still

Apart from the above core competencies of IB, it

the 1980s. Initially started with developing a

Coverage

the stuff of science fiction but gathered pace after computer learning program based on the game of

checkers, the journey’s critical moment was in 2016 when an algorithm developed by Google managed to win five games out of five in a Chinese board game! A big achievement is the world of technology.

covers two types of groups, i.e. Product and

In simple terms, Product means working in a group that specifically does a transaction in one the

following platforms (M&A, DCM, and ECM) while on the other hand coverage means you focus on a

particular industry ranging from consumer retail to heavy industry and Telecom to Textiles.

18

Machine Learning in Investment Banking: Current Applications

Despite IB being slow to catch up with ML, a lot of

knowledge to make data-driven decisions that are leaner and faster than traditional approaches.

Below are some common classes of ML problems

current applications have been outsourced to ML. All

A) Lack of Skilled Resources

into three groups-

ML is a new technology, and there is a shortage of

the current application of ML in IB has been clubbed A) Trade processing Its core application revolves around identifying

systematic investment strategies and automatically executing trades over several global financial

markets. Apart from this, identifying patterns in the trade that can lead to failure. In layman terms,

Machine Learning optimizes trade execution from

The backbone of any economy is its skilled labor. skilled labor to develop and manage analytical

content for ML. The problem gets aggravated when Data Scientists an organization hires lacks how financial markets work. Understanding the

economics of data is key for successful correlation of ML and IB.

different channels. These channels can be external

B) Classifying the areas that need Automation

the firm’s trading desk. Thus, not only efficient but

For organizations and enterprises, it is increasingly

dealer algorithms, internal execution algorithms or also cost optimization.

B) Predictive Analytics

The core competency of Predictive Analytics to help and guide traders make a better and faster decision by deciding what price to quote when buying and

selling bonds for their clients based on real-time and historical data. A recent tool called Katana was

launched by ING is based on Predictive Analytics.

becoming difficult to separate facts from fiction of

ML today. Before one decides which AI platform to use, one needs toevaluate which areas of

Investment Banking one is looking to solve. Areas like current financial positions, research, issuance history, market conditions, and historical data are

up for grab for Automation. However, not all areas need automation. It is for the organization to

decide which area is to be automated. Anyways,

the easiest process to automate is the one that can be carried out manually with no output while on

the other hand, the complicated process requires in-depth introspection before going for automation.

C) Commencing without good data C) Automated Market Data Collection

ML can be helpful to detect certain changes in the

The first and foremost problem faced by ML is the

market information from different sources by

data are the biggest obstacles of an ideal machine

to filter out the most relevant information for

of services from underwriting, trading, financial

collection procedure.

bonds, research, to the advisory on mergers and

Challenges

get is not suitable for ML. The solution to this

market without any human intervention. Obtaining

quality of good data. Noisy, incomplete and, dirty

automating the process and then using algorithms

learning. IB is a division where data from the range

clients is the brain behind this Automated Market

advisory, raising capital, issuance of shares and

Machine Learning in Investment Banking:

acquisitions colludes. However, all the data one

Machine learning provides organizations with the

problem is in-depth analysis and separation of

19

healthy and useful data for ML processes.

Conclusion

D) Inadequate Infrastructure

number crunching, Machine Learning can come

ML requires a vast amount of data processing

capabilities. This coupled with the complexity

associated with Investment Banking, and lack of

financial market knowledge of Data Scientists takes

a toll on already built infrastructure. The potential is up-gradation of infrastructure and financial market training of Data Scientist.

With the IB industry becoming data heavy and handy in coming years. The core concept of

Automation is the brain behind the early success of ML in IB. However, a few roadblocks like lack of

skilled manpower, inadequate infrastructure, and classification of data are minor hiccups, but they

too will become a thing of past if the ML moves with an upward trajectory in coming years.

20

A NEW TAX BRACKET? Ria Bajaj Vishal Mahajan IMI New Delhi

With a few days left for the next budget, this would

Many tax experts have given conflicting views

which presents a new dimension of Indian taxation

introduced for Individuals or HUF’s. The focus has

be the best time to highlight a significant issue system. Even though the preparations for the

budget starts months before the actual date, still

this issue will be relevant for the current budget as well as the upcoming budgets.

Terms used:

regarding the fact that a new tax bracket should be been on these two categories because progressive system of tax applies to mostly these categories of taxpayers and not firms or companies.

Former finance minister P Chidambaram had once

raised this concern in 2013 that when the economy requires and when the government requires more

resources, taxing the very rich “a little more” should be considered. But the statement never took the Tax brackets or Tax Slabs

Tax slab or a tax bracket is a range of income which is taxed at a given rate. Indian system of taxation is

governed by Income Tax Act 1961. India introduced the Income Tax Act in 1961 which regulates the

taxation system in India along with the Finance Acts passed in the parliament each year in the budget sessions. The tax slabs in 1961 were as follows:

shape of reality because of the then 2014 general elections.

Considering the current economic situation of the

country, even after introduction of the much talked about GST, government seems to be far away from

achieving its pegged target to keep the fiscal deficit at 3.3 percent of GDP by March 2019. The

government budgeted a fiscal deficit of INR 6.24 lakh crore for FY19 or 3.3% of the GDP. Fiscal deficit at the end of October was INR 6.49 lakh crore.

Therefore, a new tax bracket for Individuals and

HUF’s might be a prospect in curbing this situation 57 years after the introduction of the IT Act,

currently, the tax slabs for Individual (resident or non-resident), HUF, AOP, BOI are:

but only after considering all its pros and cons.

Country by Country comparison

Let us understand how individuals are taxed in the other countries.

Why there are Tax Slabs or Brackets?

India has a progressive system of taxation just like

many other countries, which entails that the burden of tax increases with an increase in income, thereby ensuring that the poor and rich are taxed accordingly.

Why a new tax bracket?

21

For the above calculations, tax slabs more than ten lacs have been considered because before that the tax rates are different depending upon the types of assessees and their age groups. Secondly, To conclude, In USA, an individual has to give up 35%

AOP/BOI have been considered separate because a

INR to 3.5 crores INR, and above that the remaining

Problems with the Indian Tax Regime

income between 5.5 Crores INR and eight crores INR

are exploited when they pay a hefty portion of their

In UK, income above INR 40 lacs will invite a tax

concern here is that majority of the taxpayers

exceeding 1.4 crores INR.

to file a return but are instead automatically taxed

top marginal effective income tax rate is 60.4 percent.

the small segment of actual taxpayers.

rate is 39 percent.

5,08,74,369 (5 crores approximately) out of a

India’s population was 44 crores as of 1961 and

% of the total crowd. If we look at other countries,

USD in 1961 which increased to 1940 in 2017. It

taxes leaving very little scope of tax evasion or tax

population figure and approximately 2300% increase

to keep the tax rates low. But the reality is even

Importance of Direct Taxes

these countries have kept the tax rates very high

as tax amount with income ranging from 1.5 crore

flat rate of tax is applicable on those assessees.

income is charged at 37%. In China, similarly, an

Currently, the Indian Taxpayers believe that they

will attract 35% tax rate and above that 45% tax rate.

hard-earned income by way of taxes. The point of

bracket of 40% and 45% tax rate for income

belong to the salary class who don’t have a choice

Talking about the Scandinavian countries, Denmark's

under TDS system. The burden, therefore, shifts to

Sweden's is 56.4 percent. Norway's top marginal tax

The returns filed during AY 2017-18 were

What does population and income figures say?

population of 128 crores which accounts for only 4

around 128 crores in 2017. Per capita GDP was 81

majority of the population is subject to payment of

implies there has been an increase of 191% in the

avoidance which is why some countries can afford

in the per capita income figures.

after a tight control over their taxation regimes,

The direct tax collected contributes to more than

indeed.

government. Around five crore individuals filed tax

The new tax bracket

was around seven crores in 2017.

for Individuals or HUF, it will certainly have many

Taxpayers is significant for our hypothesis using

Considering the tax slabs of other countries, and

department of India.

bracket can be aptly applied with an upper

50% of the total tax revenues for the Indian

returns in 2017 whereas the no of individual taxpayers

If Indian government introduces a new tax bracket

Let us understand how the segmentation of

implications both positive and negative.

some data from the official website of the Income Tax

the wealth of individuals in India, the new tax

threshold of 5 crores. Hence if we make a tax slab of 10 lacs to 5 crores with an effective tax rate of 30% and remaining income over and above five

crores being charged at 40%, the results obtained would be as follows:

22

The difference of 4200 crores INR would significantly

would find that the solution is feasible because

may be not now but in the future as well.

shifted to the untaxed population bringing more

cover deficit of INR 25000 crores to meet the target The Way Ahead

The proposed tax bracket might appear difficult to some because of the current situation, but if the government can fix the loopholes in its taxation

system at the earliest, even the contradicting parties

then the burden of tax would be considerably

transparency. The need is not to focus on just one

part of taxation regime, i.e., GST right now but also consider other ways to boost revenues for the government in the long run.

23

BREXIT: PAST, PRESENT & FUTURE Yash Jalan Himanshu IM Rohtak An entire country headed into unchartered territory

vehemently campaigned for the remaining side

individuals in the United Kingdom cast a ballot to

him out to push for Brexit.

on June 23rd, 2016. That is the day 17.4 million

leave the European Union as the first country.

Around 60 years ago after world wars I & II had

brought unparalleled devastation to the European

continent, a simple idea gained traction: if countries form stronger economic ties, they'll be much less likely to go to war. Therefore, in the year 1957, the

European Economic Community was established by 6 countries of which the UK was not a part of. It tried to become a member two times. However, the

move was blocked by French president Charles de Gaulle. After the end of his power, UK became a

member in the year 1973. Surprisingly, not everyone was happy about it and so two years down the line; the UK held its first-ever national referendum to

decide whether it should turn around and leave. The vote was far off. Approximately 67% of the electorate chose to stay.

Over the years the EU became more and more

consolidated as its members acceded to give up

more and more autonomy; contrarily, the UK tried

to keep itself independent for many aspects such as it did not change its currency from pound to euros,

it did not open its borders for free movement within the Union and so on.

The Lisbon Treaty was adopted in 2009, and it not only made the EU more efficient and more

powerful, but for the first time, it gave its members an official mechanism to leave called article 50.

As a result of The Great Recession that struck

Greece and affected the world economy, the Union was plagued by a migrant crisis from the Middle

East and North Africa. Immigration rates rose across Germany, France, and the UK. There was high

pressure on Europe’s leaders to stop the flow of immigrants. Facing tough re-election, David

Cameron promised a public referendum on whether the UK should leave the EU. After win, the

referendum was scheduled. However, Cameron

which gave extra incentive for his rivals who wanted One of the primary leave arguments was that the UK was contributing too much money to the EU as it was one of the wealthiest countries in the Union.

Terrorism was on the rise. Europe suffered a string of attacks, some of which were carried out by

immigrants. Immigrants was a key issue as the UK had the highest population density. The US is 6 times less than the UK.

Finally, the UK chose to leave by a narrow vote of

51.9 to 48.1. The repercussions led to the resignation of Cameron. The British Pound depreciated and it remains 15% lower against the dollar.

Teresa May succeeded and her government had a 2year time period to negotiate through a long list of key points which include whether the European

Court of Justice will continue to have jurisdiction over the UK, whether the UK will reject the EU

Human Rights Act in favor of writing their own

British Bill of Rights, how the security and crime-

fighting relationship will work, how much the UK will pay for EU projects and programs that it

committed to before Brexit, what the rights are for

EU citizens living in the UK and vice versa for Britons living in the EU, what will happen along the land

border between Northern Ireland of the UK and the Republic of Ireland an EU member state.

Over the last 2 years, Theresa May has been trying to negotiate a Brexit deal with the EU and now 29th March 2019 approaches when things have to be finalized. There are 2 parts to the Brexit deal:

1. UK’s withdrawal from the EU and what happens in the days straight after.

2. Then there’s about what happens about the future long-term relations.

Theresa May’s deal contains a backstop plan which

is like a safety net in case the first part is agreed upon and the second part isn’t. In such a case,

controversial border checks wouldn’t be needed

24

between Northern Ireland and the Republic of

referendum forecast for 13% growth. However,

would be treated slightly different than the rest of the

do nothing, the Bank of England’s Monetary Policy

Ireland, and for that to happen, Northern Ireland

UK, which wouldn’t be surprising. Many are upset with this as they believe that it would make the

United Kingdom less united. Moreover, for this

backstop to end, both the UK and the EU would have to agree, and therefore the UK could be at the mercy of the EU. May does need the support of the MPs to make the deal see the light of the day.

Accepting the deal would still be a better alternative, else the UK would crash out of the EU which would

cause economic disaster both for the UK and the EU. Postponing the Brexit would invite further criticism and delay. So would conducting a second

referendum. Some believe getting rid of Teresa

would make things easier. However, it might delay everything by weeks and cause several more disagreements. The reality is yet to unfold.

EFFECTS

The UK’s exit from EU will surely have an economic impact on both of them.The UK will be looking for

the opportunity to negotiate trade deals directly with non-EU countries.

households have carried on spending. Rather than Committee stepped in after the referendum to

increase liquidity by purchasing government, cut interest rates, and corporate debt, and provide

banks with access to cheap finance to help support lending to businesses and households.

Meanwhile, the new Chancellor allowed fiscal policy to support the economy, rather than

depressing growth by raising taxes and cutting

spending. After the referendum, there is evidence

that economic performance has been weaker than

it probably would have been, had the Brexit did not happen. The pound has gone down by 11% against other major currencies– that indicates lower

confidence in the UK’s economic prospects. UK

economic growth has been weaker since 2016 than pre-referendum forecasts suggested, while all

other major economies have experienced stronger than expected growth. The Centre for European

Reform has estimated that the UK economy was

around 2.5% smaller by the end of June 2018 than it

would have been, had the vote gone the other way.

The analysis suggests that sectors who will get

Trade

manufacturing and high tech industries such as

are most likely going to increase because

profoundly affected by Brexit are clothing,

aerospace or who import their parts from outside to assemble and depends on EU.

Some sectors have a possibility to get benefits such as agriculture and food processing from any new

trade barriers that may arise between the UK and the EU. The impact across the income distribution

suggests that all income groups will be hit similarly

hard by any negative effects of Brexit. Lower-income households are likely to get negatively affected by

The transport cost, tariffs and non tariffs barriers previously when UK was part of EU there were no

tariffs on goods movement between the countries within EU, and non tariffs barriers such as custom checks and paper work will increase that will increase cost and time.

As trade with the EU accounts for around half of UK imports and exports, any increase in barriers to

trade with it would have a more negative impact on UK growth in the short- and medium-term than

increases in the price of goods (like food), but higher- any positive impact from reducing barriers to trade income households are likely to get affected through with China. decreased wages, as they most likely work for export-oriented businesses.

Foreign direct investment

Business investment growth has slowed after the

investment from EU countries. Exit from the EU

The immediate economic impact of Brexit

referendum. Business investment in the 1st quarter of 2018 was 2.3% higher than at the time of the

referendum, compared to the Bank of England’s pre-

The UK gets about two-fifths of the foreign

could affect the UK’s attractiveness to foreign

investors. There are minimum three reasons why FDI into the UK might have been boosted by

25

being a member of the EU and could get affected as a

certain specified standards.

of Brexit:

Many of these regulations have been set at the EU

a member of the EU and could get affected as a result 1. Free movement of capital.

level, meaning that Brexit will give the opportunity

2. EU Single Market makes the UK an attractive export to tailor them to suit the UK’s needs. Reducing platform for multinationals. They can take advantage of the UK’s attractive business environment, while

also being able to enjoy smooth trade with the rest of

regulatory costs could increase overall output and productivity of businesses.

the EU.

Productivity

which have complicated supply chains or networks

the decades before the financial crisis – but since

3. Operating from an EU country is attractive for MNC

Productivity in the UK grew around 2% a year in

of subsidiaries across many countries within the bloc. 2007, productivity in the UK has stagnated. The The EU Single Market – including common

reasons are still not clear.

between countries – reduces coordination costs for

migration, Brexit could affect the level and growth

regulations and the ability to move staff freely these kinds of companies.

Number and type of workers

The quantity and quality of available labor also

depend on a number of migrants come to the country

By having an effect on levels of trade, FDI and

rate of productivity in the UK for several theoretical reasons. Maybe Brexit would lead to an overall

increase in trade barriers between the UK and other countries of EU.

for work.The UK as a member of the EU is limited in

Value of sterling

states from coming to the country to work if they

vote is indicating that the vote caused the market

its ability to prevent nationals of other EU member

have a job to go to in the UK. Therefore, Brexit may

have an impact on economic growth is by changes to immigration policy. This could become targeted at attracting certain types of migrants

Existing evidence by the Migration Advisory

Committee suggests that increases in immigration

have a negligible impact on the overall employment and earnings of UK-born workers. So, the UK’s past experience has been that migrants produce

additional economic output, rather than taking jobs of native-born workers.

Regulations

UK’s departure from the EU will remove restrictions on the use of state aid, opening the Government up to new pressure from domestic interest groups to

implement policies that could distort competition.

Businesses are restricted to pollute the environment, and have the compulsion to contribute towards the Government’s objectives for renewable energy

generation; regulations are also in place to promote

judicious behavior in the financial sector. Companies

are required to ensure their goods and services meet

The sterling is being deteriorated since the Brexit to take a negative view of the UK’s economic.

This fluctuation of currency has a different effect on

the different region of the country. A weaker pound will raise the price of imports, which results into higher prices for consumers – particularly for products that are imported and which UK

businesses would struggle to produce. This will raise costs for inputs used which at some point have come from overseas.

After the Brexit voter, the depreciation of sterling has increased inflation by 1.7 percentage points according to some estimates.

Conversely, and all else being equal, the

depreciation of sterling provides a boost to

businesses which sell their products abroad. This is because a UK-produced good or service will

become cheaper to foreign buyers. However, while the depreciation of sterling in the early 1990s (when the UK government stopped trying to defend sterling’s peg to the Deutschmark)

provided a significant boost to the economy, more recent experience suggests that currency depreciations have done little to help

26

exporters.

would be witness to such a historical event that

This was the entire account of the story of Brexit

generations to come. The impact of Brexit would be

that has happened till date and what is likely to

happen in the near future. It is important to account for the gravity of the situation as our generationÂ

would be taken up as studies by the future

many folds, some of which would be unraveled

once the UK actually leaves the EU. Only time can tell us what really happens.

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BOOK REVIEW

Common Stocks and Uncommon Profits Warren Buffett, the ingenious investor and world’s 3rd richest man, started off under the aegis of the ideology of Benjamin Graham, investing in dirt cheap stocks, expecting some stocks to progressively compound well enough to compensate for the losses in the rest. Well, this was until he came across the investment approach of Philip A. Fisher, the author behind the book under review.

Fisher believes in shelling out money in high-quality growth stocks even if it means paying out a fairer value for the share, and retaining the same over the years, and decades to benefit from the compounding of capital. Buffett eventually resorted to a mix of both Fisher and Graham.

- suppliers, consumers, shareholders, employees, and competitors before coming to a decision. Fisher believes in not depending entirely on the quantitative data which is available in loads to investors, but being on the field to carry out discussions.

The author has highlighted 15 questions which a quality investor ought to answer before investing — some of the questions being whether the commodity which the company offers has enough market potential to increase sales and whether the profit margin is wide enough to provide sufficient cushion.

All said Fisher doesn't discount the necessity of selling a stock if need be, under exceptional circumstances and has highlighted In Common Stocks and Uncommon the situations where it may be Profits, Fishers explains how to go essential to do so. The success of about looking for quality stocks by a such an investment approach can be method which he calls “scuttlebutt.” gauged from the fact that though Scuttlebutt means holding published in 1958, the contents of detailed discussions with all the book are relevant and used relevant shareholders today as well.

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