Finly oct 2016 by FINLY

FINLY| October 2016 | Finstreet | SIMSR

Contents

SIMSR

Cover Story

Introduction: Everyone is aware of the stock market i.e. equity market for investing purposes and also how the equities are one of the few assets that can consistently outpace the long term ravages of inflation. So, now the question arises why a long term investor especially young one like us with a time horizon of potentially more than few decades for investing even need to consider the fixed income securities for investing? The answer is really simple: Long term gains are not the only measure of investing success. What good is it for an investor to achieve success only at the tail end of an investing carrier while living through losses during his/her working life? So, people like us need to put some of our money in a

more reliable and stable assets class like bonds, if only to safeguard a portion of the overall assets for immediate goals. What's a Bond? Now that we are clear about why we need to invest in a bond let us see what a bond is. Bonds are basically a loan that you provide to a government entity or corporation. It's just like any loan secured as a borrower and comes with contractual obligations that are clearly defined for both the parties. That contract- which is the bond itself - specifically states what annual interest rate you are to expect as compensation for the loan, how long the loan will last, and the exact date upon which you will receive your original loan principal back in full.

FINLY| October 2016 | Finstreet | SIMSR

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SIMSR

Unlike stocks, where the investor is part owner of the business, the relationship here, as a bond investor is that of a lender and a borrower. Like the equity investors, bond investor should also consider the financial strengths and weakness of the underlying debtor if dealing with corporate bond and the industry the firm is in. Now, let's look at some general terms which are used for bonds: Par value: This simply refers to the face value of each bond. Maturity: This refers to the date at which the bond issuer agrees to redeem the bondholder. This is also the date at which the loan contract itself- the bondexpires, so interest payments and benefits would also end at this time. However some bonds may be called prior to maturity, known as callable bonds. A callable bond gives the right to the issuer under certain circumstances to end the life of the contract sooner than expected. Coupon Rate: The coupon rate represents the annual interest rate paid on a bond, expressed as a percentage of the face value of the bond. Yield: The yield is nothing but the interest collected on investment. When you buy a bond at par, yield is equal to the interest rate. When the price

changes, so does the yield. Bond rating system: The bond rating system helps investors determine a company's credit risk. Think of a bond rating as the report card for a company's credit rating. Blue-chip firms, which are safer investments, have a high rating, while risky companies have a low rating. The chart below illustrates the different bond rating scales from the major rating agencies in the U.S.: Moody's, Standard and Poor's and Fitch Ratings. Types of Bonds: Long term vs. Short term: Long term bonds are those that mature in 10 years or more while intermediate term bonds mature in two to 10 years, and short term bonds come due in around two years or less. Government Vs. Corporate: Government bonds are issued by the government of various countries and depending on the country ratings they are usually safer for long term investment needs. Corporate bonds are issued by the companies which are trying to raise capital for expansion and allied activities. Corporate bonds are characterized by higher yields because there is a higher risk of a company defaulting than a government. The

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FINLY| September 2016 | Finstreet | SIMSR

upside is that they can also be the most rewarding fixed-income investments because of the risk the investor must take on. The company's credit quality is very important: the higher the quality, the lower the interest rate the investor receives. Zero Coupon bond: This is a type of bond that makes no coupon payments but instead is issued at a considerable discount to par value. Masala bond: Masala bond is a type of bond through which Indian entities can raise money from overseas markets in rupees and not in foreign currency. These are Indian rupee denominated bonds issued in offshore capital markets. The rupee denominated bond is an attempt to shield issuers from currency risk and instead transfer the risk to investors buying these bonds. Recently, HDFC raised Rs. 500 Crore through masala bonds carrying a coupon rate of 7.25 per cent per annum payable semiannually. Now that we are familiar with the basics of bonds, let's take a brief look at

the participants in the bond market. The participants are as follows: ● Government and Corporations: The Governments and Corporations are the issuers of bonds in the market. ● Commercial banks: The commercial banks are usually the main subscribers of the bonds in the market. ●Investment managers/Mutual funds: These also act as the subscribers for the bonds. ● Depository agency and clearing corporation: Depository agencies are the vaults where the electronic records are stored i.e. certificates, whereas the clearing corporation works with exchanges to handle confirmation, delivery and settlement of transactions. ● Retail Investors: The retail investors are also subscribers of the bonds though in limited numbers, they usually buy through the mutual funds. Now that we have taken a look at the full functioning let's now compare the Asian bond market with the Indian bond market. International vs. Indian bond market: The bond market has a large footprint in the developed countries in general compared to the developing countries.

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SIMSR Table: Government vs. Corporate India

Going with this norm, in India, it remains small despite a string of measures taken over many years now. As we can see from the below table the penetration i.e. outstanding debt to GDP ratio for the Indian G-secs is only 40% and for the corporate bonds only 17% compared to 81% for G-secs and 120% for corporate bonds for the developed market like USA. Overall penetration of the debt market in India, as measured by the amount outstanding to GDP, increased from 10.31% to ~17% between 2010 and 2015. However, the growth is pale in comparison with other developed and emerging Asian markets.

Indian Primary market scenario:

Table: Global scenario

Table: Issuance rate

For almost all the countries, the bond m a r ke t i s d o m i n a t e d b y t h e government sector. This is necessary since a developed government bond market is often considered to be essential for the development of the corporate bond market where interest rate benchmarks of G-secs are used to reckon the spreads. Now, let's take a look at the total outstanding corporate and sovereign debt in India.

As we can see from the above table, the Sovereign bond consists of about 72% of the total bonds issued in the country compared to a paltry 28% which comprises of the corporate bond issues.

As we can see from the above table the Indian primary market saw a healthy growth in the last five years, at a 19% CAGR for the issuance of fresh bonds. Also, from the above table we can say that, the issuance of new bonds in the Indian market was concentrated towards the top end, with AAA and AA category rated accounting for almost 80% of the total, mainly due to the restrictive investment policies of key investors such as pension funds and insurance companies in the sector. Indian Secondary market scenario: The secondary market is also quite liquid compared to global peers as shown in

FINLY| October 2016 | Finstreet | SIMSR

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Table: Rating wise decomposition

the table below. The numbers are quite dismal for the corporate bonds as compared to G-Sec.

rated issues are mostly held till maturity. Table: Rating wise trading in secondary market

Table: Secondary market liquidity comparison

The liquidity in the secondary market for corporate bonds has improved if we see the figure for the daily average trading in the table given below by approximately 11% annually over five years. Table: Average Daily trading (Rs. Crore)

Also, as in case of the primary bond market the secondary bond market trading is also mostly concentrated towards top-rated securities with AAA and AA category ratings accounting for almost 96% of the trades, while low

So, after getting a detailed perception of the Indian and the world bond market coupled with the distribution of the primary and secondary bond market of India, let's now take a look at the measures that RBI has brought about in the market to help in development of the instrument. RBI's new measures in bond market and its Implications The three main pillars of bond market are regulator, participants and instruments. For bond market to grow in India, the regulator must take appropriate actions and avoid congestion due to multiple regulatory bodies. The participants both supply side (corporate) as well as buyer side(investors) must stick to the bond market for considerable period of time and the instruments provided must have different variety to cater different needs of investors. For corporate it's

FINLY| October 2016 | Finstreet | SIMSR

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SIMSR

important to have a sturdy working capital to run the business effectively. The cash flow of business like infrastructure or metal industry may be uneven. So it becomes very essential for such companies to raise money from capital market or debt market. In debt market the money is raised by borrowing from bank or by issuing bonds to public. Debt market does involve risk. The company issuing bonds may go bankrupt and therefore may not be able to pay back to the investor. In US during housing bubble the mortgage backed bond instruments were purchased in large numbers and when the market crashed, investors had to take the hit. Investors must be fully aware of the instruments they are investing in. Bond price is driven by supply and demand. As demand for a bond increases its price will increase which in turn will give low yield. In JAN '16 report from Goldman Sachs, its estimated that, should the yield on US Treasuries increase just 1%, it could cost investors as much as $1 trillion dollars in losses. To put that into context, that is more than the entire losses seen in the mortgagebacked bond market, which was the ultimate trigger for the most recent financial crisis. RBI and SEBI keep a close eye on bond market in India. Recently RBI has brought some changes to boost bond market. The main focus of the changes brought by RBI was to address liquidity issue in bond market, bring more investor participation and make raising of funds for corporate as well as banks easy. RBI's new measures are to help corporate raise good amount of money

via bonds. Some of the measures taken up by RBI are. PCE ceiling raised to 50% Partial credit enhancement was given by banks to corporate in order to improve the credit of the company which in turn will decide the credit of bonds. Previously only 20 % of bond size was provided by banks now the limit has been raised to 50%. Only condition is single bank cannot raise pce beyond 20%. This rule has made sure there is enough backing to a bond from reputed banks and improves the credibility of bond. Masala Bonds for Tier - I, II capital Banks can now raise tier1 and tier2 capital by issuing masala bonds. Tier 1 capital is the working capital needed by banks, it can be shareholder's equity and retained earnings and tier 2 capital is known a supplementary capital, it includes revaluation reserves, hybrid capital instruments and subordinated term debt, general loan-loss reserves, and undisclosed reserves. Banks' total capital is sum of tier1 and tier2 capital. Rate of return in masala bond will determine the investment by foreign investors. Money raised by masala bonds will also be used mainly to fund infrastructure projects. Infrastructure projects are on a halt for a long time due to unavailability of funds and now banks can pump in more money to boost infrastructure sector. Brokers in repo corporate bonds Banks dealt with repo market but RBI's new measure has given some power to brokers in the market In order to encourage activity in the corporate bond market, brokers authorized as market makers will be allowed to participate in the corporate bond repo market. Market makers, apart from assuming risk also add diversity to the markets. Therefore, we need to develop

Cover Story

a class of market makers in corporate debt bonds similar to Primary Dealers in the government securities market. This measure is expected to meet their funding and securities requirement arising out of market making activities. Direct trade in corporate bonds for FPIs FPI's getting direct access to bond market is a biggest boost to the bond market. FPI's can buy bonds directly without any hassle can bring a good amount of liquidity in the bond market. There are two kinds of participants in NDS-OM â&#x20AC;&#x201C; direct and indirect. Direct members have current and SGL accounts with the Reserve Bank and can directly settle their trades on NDS-OM. Indirect members don't have current and SGL accounts with the Reserve Bank and therefore have to trade on NDS-OM through members who have these accounts with the Reserve Bank. FPIs despite being indirect participants have given special privilege to trade on NDSOM. Retail participation in treasuries Retail investors normally invest in liquid mutual fund or park their money in banks as deposits. But now RBI has opened doors for retail investor to buy Treasury bills which are short term bond(less than one year period). This move will increase the demand of g-sec bonds since the participation will be improved. The banks may improve the interest rate on FD to attract investors to deposit their money in banks. Corp bonds for LAF To promote development of the corporate bond market, following emerging international practice, RBI is actively considering corporate bonds as eligible collateral for liquidity operations. Banks and companies can keep corporate bonds as collateral and raise money from RBI to cater its need of working capital. This system is followed in some emerging international market will be followed in India as well. This needs amendments in RBI Act and the

work has already started in that direction. Removing 7-day restriction Currently, listed companies can lend through repos in G-sec for a minimum tenor of seven days to banks and PDs, which constrains their participation. It is proposed to allow such companies to lend through the repo market, without any tenor or counter party restrictions. Conclusion The investor base in corporate debt market is small. It is confined to banks, insurance companies, PFs, pension funds and primary dealers. Retail participation remains low due to absence of knowledge and understanding of bonds as an asset class. It is imperative to consider innovative ways for expanding the investor base. More policies which make the bond market transparent and an attractive destination to park money is required. Investors come from different background and thus a need for variety of investment instruments to meet diverse requirements of its participants. There is lack of these in the Indian debt market which in turn inhibits development of these markets. There are very few liquidity bonds or very short term bonds. Securitization of the corporate debt instruments would provide a big fillip to the market as it would improve risk transference and diversification and provide liquidity to the issuers. Bond issuances which are viewed as being costly and cumbersome must be made simpler. For cooperates raising debt funds bond market should be the first choice over bank borrowing. RBI's measures are in the direction of making bond market competitive and of global standards. Country's debt market has to be robust for the faster development of the country. Industries can take advantage of such a market for their money requirement.

Article of the Month - Winner

THE PRELUDE: Clutched under the chains of colonialism, India's independence brought with itself a sea of hopes, ambitions and opportunities to bring back its lost glory and to be an epitome of growth and development, by doing away with the archaic British rules and policies and carving its own identity on the map of the world. The 70 years of post-independence has seen the country rise from being buried under the remains of backwardness, poverty and lack of governance to being the 2nd most developing country in the world and a future superpower in the making. Such a progress has come by the implementation of judicious policies forming a part of the overall general budget which acts as a fillip to the overall economy, and to continue this bandwagon of change, the cabinet approved advancing the railway budget by a month, letting go of a 92 year old tradition of having a separate railway budget and removed classification for

expenditure to make this exercise simpler. The budget session will see an early presentation of the union and the railway budget combined before 28th Jan, a month ahead of the current practice, resulting in the entire budgetary formalities to be over by the end of the financial year ,i.e., 31st March. Such a step will automatically make the tax proposals and expenditure policies to come into effect from the new fiscal year for better implementation. WHY? Hands down the largest public sector in the country and employing almost 1.3 million employees carrying over 13 million passengers and 1.3 million tons of freight, the railways are the lifeline of this country in its truest sense, and the decision to scrap away with almost a century old practice must have a substantial weight of reason attached with it. Fortunately, this merger makes no exception. During the pre-

Article of the Month - Winner

independence rule, the rail budget was separated from the main budget, following recommendation of a panel headed by British railway economist William Acworth, and every year after 1924, rail budget was presented ahead of the general budget in the parliament. Recommended solely for the purpose of b ette r p o l i c y fo r m u l at i o n a n d implementation, a separate railway budget made sense as the larger part of the country's GDP depended on railway revenue's as the railways took up nearly 85% of the yearly budget. But, According to a report by Mr. Bibek Debroy, member of the NITI Aayog; with decreasing percentages of railways' share in the economy, dwindling down to as low as a meagre 15 % of the union budget, no constitutional or legal requirement for a separate rail budget and countries which incorporated the same Acworth committee recommendations doing away with the ritual, railways will work well according to the commercial principles only when the sole discretion is left to the railway board and not the Parliament. Furthermore, down the years, demarcated budget presentations served no purpose while politicising the whole process, making it an avenue for populism with MP's demanding new trains and stops for existing ones. It made fares impossible to raise and railways as a vehicle to dispense patronage. Pros: ! This would lead to the presentation of a single appropriation bill including the estimates of the railway ministry, thereby saving

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Parliament's crucial time of having to hold two separate sessions No drawbacks and hindrances faced by the railways in the implementation of new policies and reforms, saving time and money Less political pressure of demands by regional and state ministers for new trains and stoppages as now, the centre will hold the key Railways will get rid of annual budgetary dividend of over 10,000 crore and make judicious use of this f u n d fo r d e v e l o p m e n t a n d expansion Being under the umbrella of the finance ministry will mean a more commercialised distribution of railway resources Part of the capital expenditure will be borne by the main budget helping railways peg up spending worth Rs.1.21 lakh crores.

Cons: Decisions related to the distribution and allocation of funds to various departments might take place according to the rise and the fall of the budget ! Depleting conditions of various departments under the government with lesser attention towards responsibilities and more towards sorting their own means ! Such a step would mean shutting off of doors for privatization in the railways framework ! Price hikes may became a tricky issue to deal with as the party in command will not want irk the common people and lose its voter bank !

FINLY|October 2016 | Finstreet | SIMSR

Article of the Month - Winner

SIMSR

THE ROAD AHEAD: With only 11,000 kms being build from the overall 66,000 kms network of railways post- independence and the ministry facing a burden of Rs. 4.83 lakh crores towards completion of 458 unfinished and ongoing projects, such a calculated policy decision comes a welcome step to breath liberalisation and eventual modernisation into the railway network. According to the experts, although advancing and merging of the budget is an idea that they deemed inevitable in the present economic scenario, but there are certain vital issues that still require attention at the nascent stages. The autonomy and the transparency of the railways and its accounts and performance needs to be maintained, with no endeavours to micro-manage the railways. it will also need to confine the passion on of deficit, subsidy burden and capex smoothly to the general budget. True reformation can only come if the railways can be converted into a commercial enterprise capable to raise resources from the market on its own financial strength and credit worthiness. Only then can we see a new dawn rise with the Indian railways soaring along its tracks towards the journey of progress and development

Does Pose a Global Financial Crisis? Article of the Month - Runner Up

Bhagyashree Kulkarni IMI, New Delhi

In the year 2008, Lehman Brothers- one of the largest bankers- with assets of $639.4 billion and shareholders' equity base of $26.3 billion- went down and the fall of the giant triggered the great financial crisis. Now, once again similar threat is looming over Deutsche Bank with its $1.8 trillion valued assets with shareholders' equity base of $ 66.5 billion. It highlights the failure of the regulators and their oversight of irresponsible lending. Some people attribute the crisis to the practice of shoving debt down the throat of the financial system, each time the economy failed by mode of adjustment for inflation and changes in rates in the name of elastic response. On June 29, 2016, the International Monetary Fund stated that Deutsche Bank has become another threat to the world's financial system. “Deutsche Bank appears to be the most important contributor to systemic risks, followed by HSBC and Credit Suisse.” the Washington-based IMF said in a report. They also said that

if it fails, it will take along with it at least 15 other banks and the overall impact will be five times the Lehman Brothers Crisis. The shares of the Bank are traded at 20% of Book value which is even less than its liquidation value. The modus operandi was- A banker would go to the bank for say $ 2.5 million to make it go away. Bank would pay off the debt and the banker in turn would make a SWAP transaction of $2.5 million in favor of the Bank. The banker would be happy because bad debts went out of books and Bank would be happy to have a chunk of SWAP transaction. Jim Willie, leading experts on the gold and silver market says“They have converted fraud and criminal activity into a small cost of doing business.” Interpol has raided the office of the CEO of Deutsche Bank and other banks and arrested those who have cracked under pressure and come out with confessions of involvement in criminal activities.

Article of the Month - Runner Up

SIMSR The causes of the crisis are: ! Aggressive risk taking in LIBOR and FOREX derivative trading ! Poor performance of core business ! Lack of capital ! Tier I equity well below the standards set by Basel III norms ! The bank has a massive notional exposure in derivative contracts of over $ 73 trillion which is 13% of the total global exposure ! Excessive leverage on its Balance Sheet ! The bank faces an illiquid market and thereby limiting its ability to deliver which impaired its profitability ! In April, May and June, 2016, 5,000 tons of gold were taken out of branches in London to be leased and re- hypothecated in European Banks as securities and as equity for futures contracts that went bad. The resultant effect will be: ! Shareholders will be paid less dividends. ! The Bank will have to cut the number of employees. ! Unprofitable business will have to be hived out. ! The Bank will have to raise new capital by issuing fresh shares or bonds but the bank has gathered such equity worth 21.7 billion Euros - three times before. ! Mortgaged backed securities will have to be liquidated which might result into a loss of ! 4.5 billion. This will have a chain effect in the world market and

there is a threat of collapse of the world financial system. This crisis will be triple the size of the crisis faced by the world in the year 2008- 2009. There might be a run over by the depositors to take out their savings. It is predicted that all the money coming out of the banks will go in gold and silver and their prices will shoot to $ 2,000/oz and $ 100/ kg respectively.

The billion dollar question is- Will the great wall of Berlin fall? Will the history repeat itself? Will the strongest economy of European Union come down and bring all the economies of Europe & the world on the knees? Free Market economy is where the strongest survive and the weaker parish. In the year 1974, Herstatt Bank of Germany was liquidated by the German regulators, due to the similar cavalier banking practices of getting overextended without having any regard for liquidity. The bank of this size is not built overnight and without creating enemies. The large sharks of the world are waiting patiently to grab the opportunity. When stocks of a great company are quoted at a valuation less than its intrinsic value one should act decisively. Given its size, nobody will let Deutsche Bank fall. Being the largest bank of Germany, the pride of the Germans and their economy are tightly interwoven with it. It is likely that a bailout operation by the

Article of the Month - Runner Up

FINLY| October 2016 | Finstreet | SIMSR

German Government may happen in the form of Nationalization of the bank. There are high chances that even after the dilution of equity, the s l i d e m ay n o t st o p a s t h e deflationary conditions are not going away. `

ECO Section

FINLY| August 2016 | Finstreet | SIMSR

Indo-US relations have always followed a wiggling course exhibiting mutual agreement in some fields and striking differences in others. The political structure of the United States; owing to its superior position among all other economies of the world, has and will always impact the Indian economy. The presidential election in November this year would also attribute to a new chapter of Indo-US relations. The two strong contestants Donald Trump and

Hillary Clinton are receiving mixed responses from the fastest growing economy of India. Hilary Clinton, leading the stage from Democrats side, has impeccable credentials and experience. She has been the only former resident of the White House in contention, and may even be the only one ever in history. On the other hand Donald Trump, the vocal Republican is an relatively not a known

FINLY| September 2016 | Finstreet | SIMSR

ECO Section

entity and therefore his foreign policies and capabilities are yet to be seen. There are some major economic key points that need consideration. If we look at the below chart

We can easily see that the USA has been the most major trading partner of India. Moreover the two countries are deliberating on augmenting the prevalent two way trade from USD 100 billion to USD 500 billion which is a lofty target to achieve thus a lot lies on the election.

In this context Trump had often taken a shrill tone to the issues like TPP (Trans Pacific Partnership) and some other rhetoric like Mexico and other Asian nations like China taking away American jobs and running trade surplus with USA. This is a regressive approach to liberal and forward looking trade regime and can impact negatively to the Indian counterparts. While Hillary on the other hand has been much supportive of the Indian trade engagements with USA, also she supported Indian aspirations for NSG and MTCR.

Moreover, as per former banker, Meera Sanyal who once worked with Hillary Clinton on her council for women empowerment endorsed her by citing reasons on why she could make a supporter for India. For trade, she postulates that while there will be US pressure to open up markets. Next up is the USA visa regime, it is of the prime importance to India, the population of Indian immigrants in USA are at around 2 million, 3rd Highest in USA. In view of this the Democrats have been liberal and if we look at the Obama regime expanded the legal immigration

of skilled workers. Hillary is expected to continue with the same suit. However, if Trump has often accused other nations particularly, Asian countries and Mexico for the 5 million manufacturing job losses over the past 15 years. He aims to reduce H1 B visas and to ensure minimum wage for H1B workers this would lead to the government prioritize US workers over Indians. This will impact the Indian GNP figures directly. However, in this game of Asian powers, China's loss is India's gain and China stands to lose big under a President Trump. Talking about the Foreign Policies and issues related to the Global Security. Trump, unlike than any of his predecessor, openly speaks about Pakistan being a problem nation and advocates India as a solution for this problem. He has already threatened to influence Pakistan's policy of US to cut off aid provided to Pakistan. The prospect of Trump Presidency is certain to rattle nerves among the generals of Rawalpindi and the Communist Party leaders of Beijing. Hillary on the other hand with the Democratic mentality is expected to continue to play safe bet on Pakistan. Trump had openly given out the antiMuslim statements and has not criticised Pakistan of playing a dual game of taking aid and breeding terror groups. In this context India stands to gain relatively more under Trump regime. However, looking at the larger scheme of the things Hillary is more preferred to Trump.

ECO Section

SIMSR

Y T I D O M M OC TIONS PO Faculty Section

Aparna Bhat Asst. Professor-Finance KJ SIMSR

The Securities and Exchange Board of India (SEBI) recently announced that commodity derivatives exchanges would now be permitted to introduce trading in options on commodities. Erstwhile regulations had restricted trading to commodity futures alone. The introduction of options, according to SEBI, would be conducive for the overall development and deepening of the market for commodity derivatives, encourage broad-based participation, enhance liquidity and facilitate hedging. The share price of MCX, the only listed commodity exchange, shot up by 5 per cent on the back of the announcement by SEBI. Commodity options are contracts traded on consumption assets such as metals, energy, agri-commodities and livestock. These options may be structured as contracts on the spot commodity. Usually, however, the underlying is a futures contract on the underlying commodity rather than the

commodity itself. The commodity options traded on the Chicago Mercantile Exchange (CME) â&#x20AC;&#x201C; which is the world's leading derivatives exchange - are options on futures. Thus, a November 2016 call (put) option on soybeans gives the option buyer the right to enter into a long (short) position in the November 2016 soybean futures contract. Similarly, a call (put) option on Light Sweet Crude Oil is a right to assume a long (short) position in the underlying Light Sweet Crude Oil futures traded on the CME. While most of these options are American style (meaning that the option buyer may exercise them on any day till the expiry date) and are settled by delivery of the underlying futures contract, some options such as the Natural Gas options are European style (can be exercised only on their expiry date) and are settled in cash.

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Finly | July 2016 | Finstreet | SIMSR

Faculty Section

SIMSR

Table 1 shows the hedging alternatives available to a farmer sowing wheat in the month of August. He may either short wheat futures for the month of November (harvest month) or simply purchase a November put option on the wheat. Sell futures August - planting November â&#x20AC;&#x201C; harvesting Scenario I

Sell futures @ Rs.336

Buy put Buy put for strike price of 340 @ Rs.10

Price falls to 300

Buy back futures @305

Put pay-off = 340-300 = 40

Sell in spot market

Rs. 300

Effective sale price

300+(336-305) = Rs.331

300+40 = Rs. 340

Price rises to 400

Buy back futures @405

Put expires worthless

Sell in spot market

Rs. 400

Effective sale price

400+(336-405) = Rs. 331

400-10 = Rs. 390

Scenario II

Commodity options are better suited for hedging than commodity futures as the latter involve daily mark-to-market of the futures position. This can impose a crippling financial burden on the hedger in the event of an unexpected movement in the price of the hedged commodity. For instance, the price of cotton touched one dollar in 2010 for the first time in forty years. A number of American cotton growers who had hedged their produce by shorting cotton futures lost heavily because of the sudden surge in cotton prices. A hedger who uses commodity options for hedging his exposure, on the other hand, is not liable for any further payments once the upfront option premium has been paid. Commodities have certain unique features which mark commodity options as distinct from options on regular, financial assets. First, the pricing of all derivatives is based on the principle of 'no-arbitrage'. The forward price is simply the spot price compounded at the cost of carry over

the maturity of the forward contract. This relationship holds because of the arbitrageur's ability to execute cashcarry arbitrage (which involves buying the asset in the spot market using borrowed funds and simultaneously shorting the asset in the forward market) or reverse cash-carry arbitrage (which envisages short-selling the asset in the spot market and going long in the forward market). The no-arbitrage argument does not hold in case of certain commodities. For instance, perishable commodities such as eggs or butter cannot be stored for long periods while commodities such as electricity may experience shrinkage in quantity during storage. In case of livestock, the forward may not be born yet. Thus arbitrage becomes difficult, if not impossible, in case of some commodities. The second problem with commodity options is that of delivery. Commodity option contracts on most global exchanges require physical delivery and therefore, a call buyer must

Faculty Section

arrange for a warehouse for receiving delivery while a put buyer needs to have the commodity transported to the designated location of delivery. The third important problem with commodity options is that of dynamic hedging. An equity options trader with a short position in a put option would hedge the same by selling deltaequivalent number of the underlying shares. But a trader selling put options on a rare-earth metal or livestock could face problems in borrowing the underlying commodity, due to illiquidity or regulatory constraints on shorting. Huge transaction costs would i m p a i r t h e t ra d e r ' s a b i l i t y to dynamically hedge the short option position.

India. It is argued that physically settled options would meet the genuine hedging demand. But the trading community might be more comfortable with financially-settled options in line with the existing stock, index and currency options. Again, it remains to be seen whether the proposed options are launched on spot commodities or as options on futures. In any case, some interesting times are in store for the Indian derivatives market with the birth of commodity options.

Commodity options on spot commodities are priced with the familiar Black-Scholes-Merton model while the Black (1976) formula is applied in case of commodity options that are traded as options on futures. The notation is similar to the formula used for equity options except that the formula includes a continuous convenience yield 'y' in the place of a continuous dividend yield 'q'. A negative convenience yield implies a strong contango market for the commodity and hence a higher premium for call options. A positive convenience yield that is greater than the risk-free rate implies a commodity market in backwardation and hence a lower call premium. SEBI will have to decide upon the exercise style as well as mode of settlement of commodity options in

Finly | July 2016 | Finstreet | SIMSR

Finance Leadership Trainee @

Alumni Section

Lokesh Dash (PGDM-Finance) (2014-2016) KJSIMSR

I am overwhelmed to write for FINLY and contribute to FINSTREET in the capacity of an alumnus. Hindustan Unilever Limited (HUL) visited the campus as the first company in dream status on 22nd Sept, 2015. HUL is the market leader in FMCG sector in India with more than a third of the total market share in the said space. It has 48 brands spread across four major categories namely Food and Drinks, Home care, Personal care and Water. It's a company that wants you to showcase your finance acumen and understanding in various sub domains and commands you to deliver on all necessary KPIs. Additionally, the competition offered from within the firm cannot be ignored especially when the resources you are competing with, are mostly IIM graduates or CA rankers. So, there is a dire need to be on your toes adhering to deadlines while handling multiple projects in different

departments. I am in my second stint in HUL, and within these five months I have seen a fair amount of diversification in the work that I have been assigned to. From Customer Development Finance to Supply Chain Finance, from Trial Balance Reviews to Automations, from contract agreements to taxation. I have anchored projects in areas like Receivables, Supply chain and Process Automation and Simplification. Currently I am posted at a factory doing business partnering with the factory manager to drive savings agenda, factory budget, cost control and generation of cash for the business. I am also responsible for evaluation of business cases/capex proposals for all tea units across India along with central technology & innovation team partners and ensuring compliance, control and financial hygiene at individual units.

Alumni Section

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The general perception is working for a startup is difficult while that for an MNC is relatively easy owing to tried and tested policies and processes. However, working at HUL is no smooth sailing either. Every firm faces a lot of competition in the present world and hence there is a need to constantly reinvent ourselves in everything that we do and come out with more efficient ways to be in business. Lastly I would like to thank FINSTREET, FINLY team and Shreya for giving me an opportunity to write and get in touch with you all. All I want to say is accept things with an open mind as and when they come and give your best into that. There is never a right or wrong decision. It's simply a decision and your actions make it seem right or wrong. Feel free to get in touch with me on lokeshdash1@gmail.com

Article by FInacue 25

The need to promote export trade goes beyond industrial and economic development. Revenue from exports can make Indian Rupee a prominent currency in Asia Pacific region to begin with, and hence boost India's position in global diplomatic outcomes. But the plans of Government of India (Govt. henceforth) in this aspect, last decade was limited to erratic promotion expenditure, and bilateral trade promotion arrangements. Direct financial aid in export promotional activities to encourage exporters was completely absent. In this light a necessary action from the GOVT. would

be steady growth in promotion related expenditure which will boost India's exports multifold. Govt. Trade Promotion Expenditure Government spending over the last decade has been very unpredictable. In 2005 Govt. spend Rs. 1003 Crore under Foreign Trade and Export Promotion. This increased to 17 per cent year -onyear growth to Rs 1174 Crore as in Fig.3 below. In the year 2007 India witnessed incremental FDI inflows and hence rejoiced an appreciating Rupee value. During this time the Govt. increased the export promotion expenditure to 48%.

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Due to the drastic aftermath of the Global credit crisis which took place in 2008 the Govt continued to support. with 43 percent year-on-year growth in export promotion. The promotion expenditure remained above 40 percent year-on-year growth for 2009. India's overall export also grew during this phase with 14.7 percent increase in 2008 and 28.19 percent increase in 2009 (Fig. 1 above) 2010 saw a negative growth of 33 percent in export promotion expenditure and overall export grew by 0.57 percent only (refer Fig.1). In the year 2011 the Govt. came up with New Manufacturing Policy. It had long been the need to make India's manufacturing Industry robust to generate more employment opportunity as well as contribute significantly to the GDP. The export promotion expenditure of the Govt. surged to a 50 percent year -onyear growth with Rs.3728 Crore (refer Fig. 2). With the start of the Twelfth Five Year Plan the Govt continued focus on

Manufacturing sector and MSME Exports and export promotion was on the agenda. The Planning Commission also issued various guidelines for revamping the operative structure of Export Promotion Councils in the country. However an outlay of only Rs 2500 Crore (detailed breakup in Fig.3 below) was proposed for a total of five export related schemes including an Establishment of Export Promotion Fund . A budgetary provision of Rs.1000 Crore was recommended for refund of costs incurred due to export promotion and brand building activities of MSME. Despite such focused recommendations the Govt export promotion expenditure during 2012 declined with a negative year-on year growth of 25 percent. In 2013 it only rose by 8 percent with a total sum of Rs. 3044 Crore. Once again incremental Govt spending on promotion, FDI flows and focus on the manufacturing sector yielded results in 2014. The overall exports had a year-on year growth of 16 percent the same year. In 2015 Govt

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export promotion was Rs 3980 Crore with the declining growth rate of 10 percent compared to 19 percent previous year. Merging the growth in exports and export promotion spending (Fig 4above) it is observed that the two respective factors are directly. This is also strongly evident as one sees the growth in Indian export continued in the difficult year of 2009 (after effects of global credit crisis) with the increase in Govt. expenditure increased year-on year basis. Further is observed that growth in exports dipped in the following year in 2010 as the Govt. spending also plummeted. Finacue offers multiple related projects in the area of telecom equity research â&#x20AC;&#x201C; such as 'the Data Opportunity in India.' Team Finacue - Finacue offers rolespecific industry projects in Finance, allowing B-school students to hone their skills in the subject of their choice.

Sector Analysis

Introduction: Indian Telecom Sector is one of the topperforming sectors in India. Today, India is the second largest telecom industry in the world. The Indian mobile economy has shown steady growth over past one and half decade and is expected to contribute substantially to India's GDP. This rapid growth is driven by strong consumer demand and reformist policies by Govt. of India leading to a competitive business environment. Easy market access and a fair and proactive regulatory framework have facilitated telecom services reaching consumers at affordable prices. The deregulation of Foreign Direct Investment (FDI) norms has fuelled faster growth of the sector. It is currently one of the top five employment opportunity generator in the country. It is expected that the sector will create about 4 million direct and indirect jobs over next five years. The sector is strongly driven by

increasing data consumption on handheld devices. With the launch of Reliance Jio, the total revenue from mobile services market is expected to touch $ 37 billion mark in 2017, thereby registering a Compound Annual Growth Rate (CAGR) of 5.2 % between 2014 and 2017. India is also expected to have over 180 million smart phones by 2019, contributing around 13.5% of the global smart phone market, based on rising affordability and lower prices for data services. According to Ericsson Mobility Report India, smart phone subscriptions in India is expected to increase four-fold to 810 million by 2021, while the total smart phone traffic is expected to grow seventeenfold to 4.2 Exabytes (EB) per month by 2021. The industry has attracted FDI worth US$ 18.38 billion during the period April 2000 to March 2016, according to Department of Industrial Policy and Promotion (DIPP).

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Sector Analysis

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Various business models adopted by telecom players in India are mainly focused on below 3 parameters. 1.Rural reach considering expansion 2.Revenue per minute concept considering sustainability 3.Retention of customers in order to have an edge over customers With mobile number portability coming into the picture, the competition has turned fiercer. This has provided a gaining ground for big players like Airtel, Vodafone and Idea as compared to other players. Also, technology has shifted from CDMA to GSM which made TATA and Reliance to lose some extent of market.

telecom sector such as Vodafone, Idea and BSNL. Including other rivals and recently launched Jio, this figure jumps over ten. Most of these companies possess strong capability of providing services similar to that of Airtel. 2.Bargaining power of Buyer: Medium Bharti Airtel is leading operator in terms of no. of subscribers. The company experiences medium bargaining power from consumer end as there not much difference among services offered and ease in switching operators.

Let us analyze Business Model adopted by Airtel in brief: Porter's five forces analysis for Airtel:

3.Bargaining power of Suppliers: Low Telecom industry has large number of supplier, which gives them option to choose from a bulk. In addition to that, they use shared resources such as tower infrastructure. Also, switching cost due to hardware change is also low.

1.Intensity of competition: High Bharati Airtel has strong rivals in

4.Threats of substitutes: High No severe threat as the

Sector Analysis

c o m p a ny h a s m a i n t a i n e d a n d expanded its customer base over the years. However, telecom industry faces threat from cable TV and satellite operators and wireless phones. 5.Threats from new entrants: Low Due to high investment and cut throat competition, chances of new entrants succeeding in this sector are very less. Airtel's business model: Business model adopted by Bharti Airtel mainly focuses on diversification of services in order to be a leading global player. The company has a dedicated Enterprise division unit which focuses on diverse portfolio of services to the customer. It is further divided into Carrier Business Unit and Corporate Business Unit. Airtel operates in 23-circles all over India with GSM service offered. Also, it provides landline services in 93 cities across India. They have adopted cost responsiveness and local responsiveness strategy in all circles where customer charges varies from state to state depending upon the needs of customers. Airtel has effectively used operational similarity among the services it offers in delivering the value to the customer. Objectives here are cost optimization through resources sharing. For example, cables provided from telephone connection by Airtel can also be used for broadband usage without much infrastructure change and skill utilization. This helps the company to achieve economies of scale.

Major developments in recent past are listed below: ! LeEco, a Chinese technology company, has invested $ 7 million into a manufacturing facility at Greater Noida for manufacturing of Le2 smartphones. The company has entered into a partnership with Compal Technologies for the same. ! Huawei, a Chinese Telecom gear maker, has set up its largest global service centre (GSC) at Bengaluru , with an initial investment of Rs 136 crore (US$ 20.28 million), which will extend its support to Huawei's domestic and international telecom carrier customers in about 30 markets across Asia, Middle East and Africa. ! Gionee, a Chinese smartphone maker, which currently assembles smartphones in partnerships with Foxconn and Dixon, plans to invest Rs 500 crore (US$ 74.56 million) to set up a manufacturing facility in India. ! Singapore Telecommunications Limited (Singtel), the major shareholder in Bharti Airtel, announced that it has signed an agreement with its majority owner Temasek Holdings Private Limited to purchase a 7.39 per cent stake in Bharti Telecom Limited, the parent company of Bharti Airtel Limited, in a deal worth US$ 659.51 million. ! OnePlus, a Chinese smartphone giant, is to start manufacturing in India in partnership with Foxconn. The organization plans to have 90 per cent of the devices sold in India to be manufactured locally.

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Sector Analysis

Reliance Communications Ltd has agreed to acquire Sistema Shyam TeleServices Ltd (SSTL), a local unit of Russian company Sistema JSFC. The deal is valued at Rs 4,500 crore (US$ 671.01 million) including payments to the government for spectrum allocation.

Government Initiatives: Govt. of India has undertaken various initiatives in order to boost growth in Telecom Industry in India. Some of the other major initiatives are listed below: ! The Ministry of Communications & Information Technology has recently launched Twitter Sewa. It is an online communications platform facilitating users for registration and resolution complaints in the telecommunications sectors. ! The Telecom Regulatory Authority of India (TRAI) is taking initiatives in order to boost internet penetration across the country. It has released a consultation paper which aims at offering consumers free Internet services, within the framework of net neutrality. TRAI has also proposed three models for free data delivery to customers without violating any of the regulations. ! The Government of India has now allowed two options of payments for telecom players as a part of liberalizing the payment terms for spectrum auctions. Two options include upfront payment and payment in installments. ! The Telecom Regulatory Authority of India (TRAI) has recommended a Public-Private Partnership (PPP) model for BharatNet, an ambitious

project planned by Govt. of India in order to expand broadband network in rural India. Centre and State governments will serve as main clients in this project. ! The Ministry of Skill Development and Entrepreneurship (MSDE) has signed a Memorandum of Understanding (MoU) with Department of Telecommunication (DoT) in order to develop and implement a National Action Plan for Skill Development. The objective of the program is fulfilling skilled manpower requirement, along with provision of employment and entrepreneurship opportunities in the sector ! . Major challenges faced by Telecom sector: Huge industry debts can be listed as the major issue being faced by Indian Telecom Industry. The sector is struggling to control over its debts as gross industry debt has reached Rs. 3.8 crore, significantly more than annual revenues. Further challenges lie in form o f f l atte n e d g ro w t h a n d st i ff competitions. Entry of Reliance Jio has made all the major players to revise over current pricing models and it may result into price cuts. Even though urban market has reached maturity level, Telecom industries still have a large portion of rural market to penetrate into. Rural market bears a teledensity is only 50%, with 70% of the population residing. The tapping of rural market may require high capital expenditures to set up infrastructure supporting new generation services.

News Buzz

Ĺ¸The newly constituted Monetary Policy committee slashed the repo rate by 25 basis point to 6.25% in the fourth bi-monthly monetary policy review of RBI. This was also the newly appointed RBI Governor Urjit Patel's first monetary policy announcement. All the 6 members of the Monetary Policy Committee unanimously voted for a rate cut with an aim of boosting credit lending and off take growth while also keeping an eye on Inflation. RBI is trying to bring down Inflation to a targeted rate of 4%. The latest

policy rates are: Repo Rate: 6.25%

SLR: 20.75%

Reverse repo rate: 5.75%

Marginal standing Facility: 6.75%

CRR: 4%

In the GST council meeting headed by the finance minister Arun Jaitley on 18 October government proposed to have a four-slab rate structure for the new indirect tax regime i.e. Goods & Services Tax ranging from 0 to 26%. For calculating the revenue of each state a secular growth rate of 14% will be taken into consideration with 201516 as the base year. The entire structure will be kept revenue neutral so there is no burden on customers. States getting lower taxes after the implementation of GST will be compensated by the Centre. The GST is proposed to be levied at 6% (lower rate), 12% (Standard 1 rate), 18% (Standard 2 rate) and 26% (Higher rates) on the goods and services. It will be 0% on goods and services related to food, health and education and 26% luxury goods. The government is committed to implement GST as per the expected deadline of 1 April 2017. Russian consortium led by Rosneft Oil Company is ready to acquire the India's second largest private oil company Essar Oil in an all cash deal valued at $ 13 billion. Apart from the Russian company the consortium includes Netherlandsbased commodities trader Trafigura and private investment group United Capital Partners.This deal has the potential to redraw Indiaâ&#x20AC;&#x2122;s oil routes.

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Trivia

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Masala bonds are bonds issued outside India but denominated in Indian Rupees, rather than the local currency. International Finance Corporation used this term to evoke the culture and cuisine of India. Unlike dollar bonds where the borrower takes the currency risk, masala bond investors will bear the risk. The first Masala bond was issued by the World Bank backed IFC in November 2014 when it raised 1,000 crore bond to fund infrastructure projects in India. Later in August 2015 International Financial Corporation for the first time issued green masala bonds and raised Rupees 3.15 Billion to be used for private In July 2016 HDFC raised 3,000 crore rupees from Masala bonds and thereby became the first Indian company to issue masala bonds In the month of August 2016 public sector unit NTPC issued first corporate green masala bonds worth 2,000 crore rupees. Bitcoin Bitcoins is a form of virtual currencymeaning, if you have bitcoins (we will get to how you obtain bitcoins later), you do not physically purchase goods by handing notes or tokens to the seller. Bitcoins are used for electronic purchases and transfers Every single purchase is immediately logged digitally (on computers) on a transaction log that tracks the time of purchase and who owns how many bitcoins. Think of this transaction log as an audit trail: it contains every single piece of information of every bitcoin transaction. This digital transaction log is called 'blockchain'. The greatest advantage, however, is that all necessary information is public and transparent. Without revealing the identities of the buyer and seller, the entire bitcoin network is made aware of each and every transaction. This gives a tremendous amount of comfort to both parties of the transaction. Since Bitcoin is not a fiat currency with legal tender status under any jurisdiction, but the tax liability comes regardless of the medium used for transaction.

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