Niveshak January 12 by Zigu MBA

Niveshak THE INVESTOR

VOLUME 5 ISSUE 1

January 2012

AUDITORS

WATCH DOGS

Will the yen dream run come to an end?>> Pg. 08

BLOOD HOUNDS

is gold an investor’s paradise? pg. 20

FROM EDITOR’S DESK Dear Niveshaks,

Niveshak Volume V ISSUE I January 2012 Faculty Mentor Prof. N. Sivasankaran

THE TEAM Editorial Team Akanksha Behl Akhil Tandon Chandan Gupta Harshali Damle Kailash V. Madan Nilkesh Patra Rakesh Agarwal Creative Team Anuroop Bhanu Venkata Abhiram M.

All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

2011 has not been very pleasant for the business world, as majority of both the developed and the developing nations have failed to experience rampant growth. Come 2012, we are again heading for a bumpy economy, and the harbingers of growth seem to be miles away. The Euro Zone occupied the center-stage in the geo politics arena for almost the entire year. The repercussions of the debt of these countries have been felt by economies all across the globe. While the depth and duration of the slowdown in the European union being difficult to be quantifiable, a continued credit crunch, sovereign-debt problems, lack of competitiveness, and fiscal austerity imply serious problems. The United States, which was on the brink of another major slowdown in 2011, has of late shown signs of recovery, both in terms of output and employment. The outlook for the developing economies doesn’t seem to be very encouraging. The South East Asian giants- India and china have been revising its growth objective from time to time, and growth in china has been curtailed to a single figure level. India has been battling with a low Industrial production and inflation in the latter half of the year, and the depreciation of the home currency has been a major concern. However, with a spur in NRI deposits, owing to deregulation of NRI deposit rates, and the hefty selling of dollars by the reserve bank, the rupee has become is emerging…revise this sentence. The Industrial production data for the month of November has provided a ray of hope, and all the efforts of the government in combating inflation are finally bearing fruit. Amidst such a situation, the World Bank has slashed the world GDP growth forecast for 2012 to a paltry 2.50%, and 3.40% for 2013. Given the uncertainty prevailing, and importance of euro zone in international business, the future of euro will play be a major role in determining how the world economy will shape up in this year. Thus, the coming year will yet again test the mettle of our economists, financial analysts and business tycoons. This issue brings to you an exclusive view on the credibility of accountants in the contemporary world. This issue also features an exclusive interview with Mr. Swapnil Dakshindas, a Senior Manager at one of the Big Four Audit firms. The article of the month throws light on the appreciation of yen, and this issue also features other articles on Gold as a lucrative investment, commodity markets and the viability of ‘Real Estate Investment Trusts’ as an investment avenue. The classroom section explains the concept of ‘Insider Trading’. We would like to thank all the readers for their valuable articles, crossword entries and appreciation e-mails. It is only because of readers’ constant support and encouragement that Niveshak has been such a great success. On these closing thoughts, I on behalf of the entire team of Niveshak would like to wish you all a happy and unforgettable 2012. Please send in your suggestions and feedback at niveshak.iims@gmail.com and as always, stay invested.

Team Niveshak Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

CONTENTS Niveshak Times

Cover Story

04 The Month That Was Article of the month

Will the Yen dream run come to an end?

He speaketh

14 Mr. Swapnil Dakshindas

Auditors - Watchdogs or Bloodhounds?

Perspective 18

Commodity market: Prove your ‘metal’

Fingyaan

16 Assessing Real Estate

Investment Trusts (REITs) as an investment

Finsight 20 Is Gold an Investor’s paradise?

CLASSROOM

23 Insider Trading

NIVESHAK

The Month That Was

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The Niveshak Times Team NIVESHAK

IIM, Shillong

FDI up by 56% and Indirect taxes collection rises by 16.1% FDI in country went up to $2.53 billion in November 2011 showing an impressive growth of around 56%. The cumulative flows for the AprilNovember period reached $22.83 billion up by 62.81 per cent from $14.02 billion a year ago. The FDI for the current financial year is expected to cross the mark of $30 billion, far ahead of the $19.43 billion of FDI inflow for the last fiscal year. Services, housing and real estate, construction activities, computers and hardware, power and telecom are some of the sectors that see the maximum inflow of funds during this period. Another good news came for the struggling Indian Economy when the Chairman of Central Board of Excise and Customs ( CBEC) S K Goel announced an impressive 16.1% growth in Indirect tax collection to Rs 2,85,787 crore during AprilDecember against the collection of Rs 2,46,168 crore in the same period last year. The indirect tax collection in three quarters of 2011-12 is about 72.7 per cent of the Budget Estimates of Rs 3,92,908 crore, showing CBEC is well on track to meet the budget estimates this financial year. Government modifies import duty structure of gold and silver

As per notification by Government of India the import duty structure of gold and silver has been changed from specific to ad valorem with effect from 17th January,2012. The import duty on gold has been pegged at 2% on the value of gold as against the existing charge of Rs 300 per 10 grams while the same on silver has been changed to 6% of the value from the prevailing Rs 1500 a kg. The move is likely to curb exorbitant import of precious metals which has resulted in huge outflow of dollar outside India. The

January 2012

change is expected to rake in an additional Rs 600 crore for the exchequer during the remaining months of the fiscal as per Finance Ministry estimates. “The old rates were fixed 4-5 years ago. In the last few years, prices have increased substantially so the change has been made to bring duties in line with market prices,” said Central Board of Excise and Customs (CBEC) Chairman S K Goel. The decision is expected to fuel the prices of gold and silver in the market. The diamonds also will now attract an import duty of 2% on the value. Reliance Communications gets into $1.18 billion refinance deal with Chinese banks Reliance Communications said on 17-jan-2012 that it has secured loans from a host of Chinese banks including Industrial and Commercial Bank of China , China Development Bank Corp, Export Import Bank of China and other banks to refinance $1.18 billion worth of outstanding foreign currency convertible bonds of Rs 654 conversion price due for redemption on March 1. The maturity period of loan would be of seven years at interest cost of about 5 percent. The news has come as a relief to the Reliance Communications that has reported falling profits for eight straight quarters. The company is also in talks with various international giants to strike a deal for its tower business so as to repay its huge debt of around $ 6.5 billion. China’s economy down to single digit growth China’s economy has registered a single digit growth rate of 9.2 % as compared with the 10.4% growth in 2010. However it beats the government target of 8% growth rate. According to official projections the growth of economy is further expected to come down to around 8.5 per cent in 2012. Ma Jiantang, Chief of China National Bureau of Statistics (NBS), told the media that as per the preliminary statistics, China’s GDP reached 47.16 trillion yuan ($ 7.26 trillion) in 2011.

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Aviation Ministry to initiate the process of allowing foreign airlines to invest in the local aviation industry Aviation Ministry said in a statement that it would soon initiate the process of opening up the Indian aviation sector for investment by the foreign airlines up to a stake of 49%.The foreign investors are allowed to invest up to 49% in the domestic airlines but foreign airlines are barred from the same. A meeting between Finance Minister Pranab Mukherjee and Civil Aviation Minister Ajit Singh in this regard also decided to release Rs 150 crore for payment of portion of pending salaries and allowances of Air India employees, including pilots. The decision brings a relief to the cash strapping Indian airlines which are already under a huge debt and are expected to lose up to $3 billion in the fiscal year that ends in March. Citigroup’s profits up by 6% from the previous year Citigroup posted a profit of $11.3 billion in 2011, 6% more than the previous year. The CEO of the company, Mr. Vikram Pandit, is very happy with the solid performance of the company in 2011 and stated that the company has reached its key benchmarks in the consumer business segment. However, there was a sharp fall of 33% in the revenues of Citi’s asset management and brokerage business to $6.4 billion. The firm also reported fourth quarter earnings, which fell to $1.16 billion, down from $1.2 billion in the same period in 2010. France Downgraded by S&P, Gold to strengthen there after France, the second-biggest economy of the Eurozone, can no longer boast about the AAA credit rating like Germany, which still retains it. S&P downgraded France’s credit rating by one notch to AA+. It stated that France’s unemployment rate was high, around 9%, due to its high government debt and a rigid labor market. There is a possibility of another downgrade this year

or next if efforts at budget consolidation policy and organizational restructurings falter. France is trying to reduce around 1.7 trillion euros of debt. However, this downgrade would raise its borrowing costs at such a time. Higher costs could make the EFSF, which i s meant to prevent t h e credit contagion, less effective in stemming the euro crisis. However, there is a possibility that this downgrade of France may make people rush to the yellow metal again which could lead to higher prices of Gold. Financial planners have recommend investors hold 5-10% of their portfolio in gold as part of their asset allocation. Investment proposals in India plunged 45% Investment proposals in India plunged 45 per cent to a five-year low in 2011 as companies ceased projects citing administrative disturbances, a move which could deteriorate the growth in 2012. In 2011, the new investment proposals in the country stood at 10.46 trillion rupees as compared to 18.88 trillion rupees in 2010. According to Prime Minister Manmohan Singh, India’s economy is likely to grow at about 7 per cent this fiscal year, lower than the 7.5 per cent growth the government forecasted last month. 3rd consecutive week for negative food inflation Food inflation in India stood at – 0.42 per cent for the week ended January 7, 2012, remaining negative for the third consecutive week. This was mainly due to fall in prices of onion and vegetables. Onion prices fell by 75.42 per cent while potato prices were down by 23.48 per cent. Overall vegetables’ prices went down by 45.81 per cent compare to the same period last year. However, other food products became more expensive. Price of pulses went up by 14.27 per cent while for milk it grew by 11.48 per cent. Fruits and cereals also became more expensive on an annual basis. According to experts, the decline in food inflation will be a major incentive for the RBI to resort to the option of cutting key interest rates in the future.

The Month That Was

The Niveshak Times

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NIVESHAK

Article Market of Snapshot the Month Cover Story

Market Snapshot

Source: www.bseindia.com www.nseindia.com

MARKET CAP (IN RS. CR) BSE Mkt. Cap Index Full Mkt. Cap Index Free Float Mkt. Cap

58,91,508 28,31,879 13,86,220

LENDING / DEPOSIT RATES Base rate Deposit rate

10%-10.75% 8.5% - 9.25%

Source: www.bseindia.com

CURRENCY RATES INR / 1 USD INR / 1 Euro INR / 100 Jap. YEN INR / 1 Pound Sterling

50.39 65.31 65.27 77.97

CURRENCY MOVEMENTS

RESERVE RATIOS CRR SLR

6% 24%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

6% 8.50% 7.50%

Source: www.bseindia.com 22nd December 2011 to 20th January 2012 Data as on 20th January 2012

January 2012

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NIVESHAK

BSE Index Sensex

Open 15,546

Close 16,739

% Change 7.67%

MIDCAP Smallcap AUTO BANKEX CD CG FMCG Healthcare IT METAL OIL&GAS POWER PSU REALTY TECK

5,141 5,517 8,019 9,353 5,293 7,974 4,056 5,822 5,652 9,457 7,879 1,776 6,345 1,375 3,328

5,680 6,277 8,819 10,912 5,801 9,807 4,035 6,169 5,500 11,198 8,325 2,078 7,227 1,708 3,293

10.48% 13.78% 9.98% 16.67% 9.60% 22.99% -0.52% 5.96% -2.69% 18.41% 5.66% 17.00% 13.90% 24.22% -1.05%

% CHANGE

Article Market of Snapshot the Month Cover Story

Market Snapshot

NIVESHAK

Article of the the Month Article of Month Cover Story

Will the

dream run

come to an end? Akanksha Kumar & Jaideep Singh Gaur

Welingkar institute of Management,Mumbai Will the Japanese Yen dream run come to an end? Here we talk of the most developed and the third largest economy of the world - Japan. There are various factors that govern the valuation of a currency ranging from the economic outlook, macroeconomic conditions and trade relations to political stability. The Japanese Yen has enjoyed a dream run from the period between mid 2007 to where the currency appreciated in general despite volatility in the process. Even though the economic indicators in were not in its favor ,from a low of around 120 , Yen has stabilized to about 78 at present(Fig. 1). Since the past 6 months, there has been speculation in the market that the Yen has reached its peak and owing to the grim economic conditions, the currency is bound to depreciate. Japan is basically an export driven economy and hence due to the global financial crisis (2008), there was an overall drop in demand for the Japanese goods and the appreciated Yen made the exports too dear for the consumers abroad. This led to a

steep fall in the growth rate which went down to a low of -5% in the year 2010, indicating that the gross domestic output was shrinking (Fig. 2) .The fall in the growth rate led to a decrease in inflation (Fig. 3) which should have been a positive sign for a growing economy but not so in the case of Japan as the currency deflated by 2-3 % in the 2009-10 and the economy contracted. Till now, Japan had enjoyed a positive balance of trade but the appreciated Yen ensured that the Japanese exports plummeted as compared to the imports leading to an overall negative balance of trade of -684 Billion Yen ($8.7 billion) in 2011. The overall contraction is also aided by the fact that the local manufacturers are setting up production plants outside for cheaper labor and lower costs of production. The industrial output was predicted to be â&#x20AC;&#x201C;13% for the previous quarter and it was actually -7 %. The outwardly movement of the production houses aided the problem of high unemployment and low exports.

Fig. 1: Relationship between yen and dollar (Jan 2007 to present)

January 2012

NIVESHAK

Article of Month Article of the the Month Cover Story

Fig. 2: GDP growth rate of Japan from 1970 to present

The natural rate of unemployment in Japan is 2.6% but it never went below 4 % in the previous years. To add to its woes, Japan has one of the world’s oldest populations and the working population of the country is predicted to decline over the next few decades. A continuously increasing population in the

which could be attributed to the fact that US economy suffered a severe recession post 2007 when its sub-prime crisis went to an unsustainable level. On the other hand, the Japanese Yen was perceived as a stable currency and became a safe haven for investors, triggering its rise .The further appreciation

Fig. 3: The decreasing inflation rate from July 2008 onwards

age bracket of 55-64 is all set to enjoy pension and medical benefits leaving a huge void in the work force that cannot be sustained by the younger work force. Such a scenario also leads to a decrease in the domestic consumption and an increase in the government expenditure. In such a grim economic outlook it was quite strange that the appreciation of Yen in the Forex markets continued unabated .A major reason could be that around the same time, the dollar was weakening

of the currency led to more investment in Yen by investors and speculators as it continued to yield positive results. Hence the appreciation of the Yen was more due to financial and speculative reasons than the country’s own economic outlook leading to the formation of a bubble around it. Time seems to be literally running out for Japan as the debt to GDP ratio stands at 492%. Out of this, the sovereign debt contributes approximately 213% which is the highest in the world. The tax revenues

Fig. 4: Relationship between trade balance and current account

Fig. 5: Ratios of overseas production

NIVESHAK

Article of the the Month Article of Month Cover Story

Fig. 6: Unemployment rate in Japan

generated by the government have been declining constantly in relation to the ever-increasing budget deficit .The reduction in revenue generation can be attributed to the rise of unemployment which is coupled by a variety of factors and the increase in the budget deficit is largely due to an increase in the government spending. The Tsunami on March 11, 2011 hit a massive blow to the already crippling economy, adding huge expenses for the government for the redevelopment work. The Japanese government also borrowed close to $2.87 billion from the Eurozone for the same. Japan is already sitting on a pile of huge debts and the maturity amount for none of them is less than 40000 billion Yen ($512 billion) for the next 4 years till 2015.The biggest chunk of debts have to be paid in the year of 2011 amounting to 120000 yen ($1538 billion). Considering the huge foreign reserves of Japan ($1.3 trillion) the repayment of the debt should not be a problem but at this stage the economy is sliding and the government is not able to generate more revenues due to factors ranging from unemployment, reduction in workforce, contracting exports to increasing expenses and so on. If the similar situation continues and the gap between the budget deficit and revenues increases, the economy will keep becoming shakier. High debt is good for positive economic times but when the economy takes a downturn the same is bound to turn into a major sore point.

The Japanese government has tried to intervene in the Forex markets to help the Yen depreciate but the effects were short lived. Hence the Bank of Japan recently announced an expanded asset purchase program (aka quantitative easing) that could raise the eyebrows of even the most liberal proponents of QE. The expanded program includes purchase of real estate investment trusts, exchange-traded funds and lower quality corporate bonds in order to facilitate some depreciation. Thus, we see that the Japanese Yen has enjoyed an appreciated value for quite some time due to market and speculator sentiments in a volatile global situation. Since the appreciation was not due to the high growth of the economy it was unnatural for the currency to appreciate so strongly. All the above data strongly indicates that Japan is touted to face some tough economic times ahead and it really needs some real out of the box solutions in order to get out of this quagmire. The stabilization of the Yen shows that it has reached its peak and the speculators do not see any reason for further investment as they do not see the gains any further. Moreover, the strengthening of the dollar can accelerate Yenâ&#x20AC;&#x2122;s fall as the speculators would like to once again move to a safe haven. The depreciation of Yen would be a blessing for Japan as it is the only way it can expand its economy.

Fig. 7: Japan debt maturity timeline

January 2012

NIVESHAK

WATCHDOGS

BLOODHOUNDS

Rakesh Agarwal & Harshali Damle

Team Niveshak

Auditing is an important tool that the shareholders use to evaluate the operations and ensure the safety of their investment in a particular company. However, in the recent past, the effectiveness of this tool has been highly questioned. There is a need to understand the importance and limitations of auditing to better appreciate its requirement in the current scenario. Auditing is the independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size or legal form, when such an examination is conducted with a view to expressing an opinion thereon. Audit can be of various kinds. Some of them are 1)Internal Audit 2)External Audit 3)Tax Audit There is a significant difference between Internal and External Audit. Internal Auditors •Internal Audit is conducted to add value and improve the organization’s operations •Internal Auditors report to the Audit Committee formed by the Board of Directors or the management •They are usually the employees of the organization, though the internal audit function can be outsourced too. There are limitations on the independence of the internal auditors

External Auditors •External Audit enables an auditor to express an opinion about the financial statements of the organization •They report to the Shareholders of the organization •They are independent from the management of the organization Need for an audit Audit helps the shareholders to understand if their investment is in safe hands. Not all investors are financially literate and they need help to have a check on the financial performance of the company and hence arises the need for an audit. All companies are statutorily required to prepare and maintain accounts which are then scrutinized by the auditor who certifies them. The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. In the case of most general purpose frameworks, that opinion is based on whether the financial statements are presented fairly, in all material respects, or give a true and fair view in accordance with the framework. The Audit report includes a paragraph mentioning the management responsibilities. The standard

Cover Story Article of the Month Cover Story

AUDITORS:

NIVESHAK

Article Cover of the Story Month Cover Story

content of an audit is: “Management is responsible for the preparation of these financial statements that give a true and fair view of the financial position, financial performance and cash flows of the Company”. This responsibility includes the design, implementation and maintenance of internal control relevant to the preparation and presentation of the financial statements that give a true and fair view and are free from material misstatement, whether due to fraud or error. Auditors’ responsibility is to express an opinion on these financial statements based on their audit. The key points to be noted here are: 1)Auditors give an opinion and no guarantee on the financial soundness of the company. The auditor is not an advisor to the company or to the shareholders of the company. 2)Materiality is an important consideration in the opinion. This means that the auditors can choose to ignore immaterial facts. Materiality will be defined as something that will have an impact on the decision making of the users of the financial statements. 3)The opinion is on the true and fair view. This can be clearly differentiated from the correctness element. 4)Reasonable assurance is not an absolute level of assurance, because there are inherent limitations of an audit which result in most of the audit evidence on which the auditor draws conclusions and bases the auditor’s opinion being persuasive rather than conclusive. Inherent Limitations of an Audit The auditor is not expected to, and cannot, reduce audit risk to zero and cannot therefore obtain absolute assurance that the financial statements are free from material misstatement due to fraud or error. This is because there are inherent limitations of an audit. Most of the audit evidence which the auditor draws conclusions and bases the auditor’s opinion on is persuasive rather than conclusive. The inherent limitations of an audit arise from • The nature of financial reporting • The nature of audit procedures and • The need for the audit to be conducted within a reasonable period of time and at a reasonable cost.

Some examples of these limitations can be: Use of sampling techniques by the auditor, controls being circumvented by collusion or inappropriate management override. Also auditors cannot comment on the propriety of the decisions taken by the management. Duties of an auditor An auditor is appointed by the shareholders of the company. Hence the auditor is liable to report to them in the form of an audit report. For this, it is the duty of the auditor to exercise adequate skills and competence and ensure independence during the process. An auditor is required to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error. However, currently, the function and need of an audit is being questioned by investors. This is due to a rise in high profile scams in various companies. The Indian Enron The Satyam scam perpetrated by B. Ramalinga Raju and his affiliates in January 2009 is considered the biggest Indian corporate scandal till date. It has recently come into the lime-light after the new owners of Satyam Computer Services, the Mahindra’s, have decided to file a suit against its former board of directors, employees and also the audit arm of PricewaterhouseCoopers in a Hyderabad court seeking damages for perpetrating the fraud. This brings into question the fiduciary responsibilities, obligations and responsibilities in performance of duties of the auditors. Both Satyam and PricewaterhouseCoopers are globally reputed firms. The auditors cannot hide under the standard clause “auditors can be watchdogs and not bloodhounds” especially when cash and bank balances have been overstated in such a large company. A company is considered an entity distinct from its promoters. So, there is no reason why it cannot sue its promoter for perpetrating a fraud and letting the company bleed. The same holds true for the management team or even auditors who either collude with promoters, breach their fiduciary responsibility or are negligent in their duties. The

It took nearly three years for the Institute of Chartered Accountants of India (ICAI) to finally come out with its findings on those guilty of perpetrating the Satyam scam

January 2012

NIVESHAK

of not conducting proper due diligence while Talluri Srinivas, former partner of PricewaterhouseCoopers (PwC), then statutory auditors of Satyam has been held guilty for not complying with professional standards. The role of Satyam internal auditor Prabhakar Gupta and S Gopalakrishnan, former partner of PwC, is still under scrutiny while two chartered accountants of Lovelock & Lewes have been charged with a Rs 5 lakh penalty each for gross negligence in carrying out the statutory audit of Satyam and have been barred permanently from the register of members. Roles For a publicly listed firm, the shareholders of a company place very high reliance on the auditor’s report, which apparently shows the true and fair view of the accounts of a company. Hence, it is of utmost importance that the auditors perform their duties with care and vigilance to ensure that there are no illegal or improper transactions; and any wrong-doing is transparently reported to the people at large who have invested their hard earned money to become a part of the company. Conclusion In scams like this, all the parties involved invariably suffer incredible loss in terms of losses in customers as well as significant reputational loss. Hence, it becomes the responsibility of both the auditors and the company management to ensure that the audit protocols and guidance lines are followed diligently without fail. The role of the ICAI and other regulatory bodies should not be confined to just punishing auditors in case they fail to discharge their duty, but they should also re-examine the present system to strengthen and intensify the internal audit system. There is a need to maintain high standards of integrity to ensure safeguarding the interests of the investors. Also it is the need of the hour to strengthen the regulatory framework of the operations of the companies.

The role of the ICAI and other regulatory bodies should not be confined to just punishing auditors in case they fail to discharge their duty, but they should also re-examine the present system to strengthen and intensify the internal audit system

Article of the Month Cover Story

culpability of the audit firm, as opposed to that of the partner in charge of the audit, is far less obvious. Despite this, the image of Satyam’s statutory auditors, PricewaterhouseCoopers has been tarnished, as voices are being raised at the possibility that the auditors were complicit with the conspirators in the multi-crore scam. On the other hand, the auditors feel that the case filed by Mahindra Satyam is merely an attempt to shift the responsibility of the fraud that was deliberately concealed under the direction of Satyam’s own management to the auditors. So, Price Waterhouse has also filed a case against Mahindra Satyam, countering the latter’s charges. Agreed, it has the right to seek legal remedy and has several precedents in the West. An example is Arthur Andersen that agreed, without accepting any wrongdoing on its part, to pay damages to Enron Corp creditors to settle charges that the accounting firm was negligent in auditing and advising the energy trader that became bankrupt in 2001. Specific Penalties US regulators actions A joint penalty of USD 17.5 billion was imposed by US regulator Securities Exchange Commission in April, 2011 on Satyam Computers, PriceWaterhouse India and affiliated auditors for manipulating accounts for several years. Satyam agreed to pay a fine of USD 10 million towards settlement of charges while PriceWaterhouse India settled its charges of conducting “deficient audits of the company’s financial statements and enabling a massive accounting fraud to go undetected for several years” by paying USD 6 million. For violations of PCAOB rules and standards in relation to the Satyam audit engagement, Lovelock & Lewes and Price Waterhouse Bangalore agreed to pay the Public Company Accounting Oversight Board (PCAOB) a USD 1.5 million penalty in settlement of the charges. Indian regulators actions It took nearly three years for the Institute of Chartered Accountants of India (ICAI) to finally come out with its findings on those guilty of perpetrating the Satyam scam. According to the findings of ICAI, Vadlamani Srinivas, erstwhile chief financial officer (CFO) of Satyam Computers has been found guilty

NIVESHAK

He Speaketh

Mr. Swapnil Dakshindas

Senior Manager in one of the Big 4 Audit Firms Mr. Swapnil Dakshindas is a Senior Manager at one of the Big Four Audit firms in the Audit and Assurance Department. He is a Chartered Accountant with over 10 years of work experience in the field of auditing. He has worked as an auditor of both public and private companies across various sectors.

Niveshak: As

an auditor with an ex-

perience in auditing for

Mr. Swapnil Dakshindas, Chartered Accountant, in a candid discussion with Team Niveshak talks about the regulatory framework, current audit procedures, impact of IFRS and the changes required

years, do

you think the current regulations are sufficient with regards the safeguarding the interests of the investors?

Mr. Dakshindas: Regulations will only be effective if they are implemented in the letter and spirit. If we see the history of frauds / scams, we can note that it was not insufficient regulations which were solely responsible. Regulations on its own cannot ensure fair reporting from corporates, fraudsters find a way around the regulations and would continue to do so. To safeguard the interests of investors an orchestrated effort is required from the management and the auditors. Changes to legislations would continue to be made as they are an effort to improve the legislation and incorporate the changing environment. In my opinion, the current regulations are sufficient to safeguard the interests of the investors if followed in the right spirit. Niveshak: What

are your suggestions

for improving the regulatory framework to increase the efficiency and effectiveness of audits?

Mr. Dakshindas: I feel that one of the most important improvement opportunity is that the regulations should ensure that the auditors are acting

January 2012

independently and without any pressure in performing their duties effectively. The current Companies Bill proposes rotation of Auditors after certain period of time. I feel that this change is a good move towards increasing the efficiency and effectiveness of audits. Also regulations have to keep pace with the changing business environment. Legislators have to play an active role in understanding the way in which corporates operate. In order to improve efficiency and effectiveness of audits, the auditors too are required to keep up with the changes in business by adopting more robust audit procedures. Auditors have to gear themselves up with the necessary tools in order to perform an effective audit. Niveshak: What will be your advice to investors investing based on the auditors opinion of the company? Mr. Dakshindas: In todayâ&#x20AC;&#x2122;s era, investors have to look further than only the financial statements. There is no denial that the financial statements reflect on the position of the company, but investors are impacted by the future performance of the company which is based on an array of factors. But it does not mean that the investors shy away from the auditorâ&#x20AC;&#x2122;s report and the financial statements. One bad apple should not deter us from having apples at all!

NIVESHAK

you think high level management

agement of a company?

frauds can be detected using the normal audit pro-

Mr. Dakshindas: Manipulation is possible where there is a judgment involved. Hence, Management Mr. Dakshindas: Statutory audits were not designed Estimates is one of the financial statement areas in a manner to detect frauds. Auditors were al- which is most prone to manipulation. ways considered as a watch dog and not a bloodhound. But this perception is fast changing now Niveshak: What are the indicators that one must and the investors expect a lot more from the audi- look out for to identify such potential manipulators. An auditor is expected to perform assess- tions? ment of existence of frauds based on a variety Mr. Dakshindas: Indicators can be: excessive presof factors. In case, the auditor comes across in- sures on management from sources outside or dicators of frauds, the audit procedures are then inside the entity to achieve an expected and designed to cover these fraud risks. In order to perhaps unrealistic earnings target or financial detect high level management frauds, the audi- outcome- particularly when the consequences to tors are expected to exercise a high level of pro- management for failing to meet these goals can fessional skepticism. Performing normal audit be significant, history of the management, unusuprocedure help in identifying indicators of fraud, al changes to such estimates, aggressive use of but do not detect fraud in itself. estimates, etc. cedures?

Niveshak: How

do you rate the effectiveness of

internal audits in companies?

Mr. Dakshindas: Internal Audit is an independent agency that can be engaged by the management /Board of Directors to ensure safeguarding of assets, improve efficiency/effectiveness of operations and ensure compliance for the applicable statutes/policies developed by the company. Internal auditors do a more focused audit on the operations and processes of a company. But in India, Internal audits reap little results, as the Internal Auditor reports to the management only. So, if the management does not take appropriate action on matters highlighted by internal auditor, then it loses its effectiveness. So again, internal audit in itself cannot said to be effective or ineffective. It is the joint effort of the internal auditor and the management which results in an efficient and effective audit. Niveshak: Do you think an increase in the scope of the audit will increase its effectiveness? (eg. Comment on propriety of management decisions, etc.)

Niveshak: How

will the implementation of

impact financial statements?

the profit

figures and other financial statement elements be affected very significantly from it?

Mr. Dakshindas: The implementation of IFRS will involve a new way of thinking about accounting and financial reporting. This new way of thinking places greater emphasis on interpretation and application of principles- with a particular focus on the substance and underlying economics of a transaction, and on transparency of financial information. Adopting IFRS is not simply a policy change; it is a business change. These standards bring about many new accounting concepts and requirements that will significantly affect the way entities account for and report their results. For e.g. Financial instruments which were reported as off Balance Sheet items will now have to be fair valued at each reporting date and accounted for based on their classification.

Mr. Dakshindas: Increasing scope is not the answer to increasing effectiveness of audits. The current scope of audits are robust enough to ensure efficient audit. The only need is to get equipped adequately and follow the required procedures diligently. Niveshak: What

Would

IFRS

are the financial statement areas

that are most prone to manipulation by the man-

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Article FinGyaan of the Month Cover Story

ASSESSING REAL ESTATE INVESTMENT TRUSTS (REITs) AS AN INVESTMENT Abishek Sharma & Amit Sharma

SCHMRD Pune

Alpha is a measure of an assets risk relative to the overall market. It reflects the difference between an assets actual performance and the performance expected based on risk level taken by the fundâ&#x20AC;&#x2122;s manager. A fund that produced the expected return for the level of risk assumed has an Alpha of zero. A positive Alpha shows that the manager produced a return greater than expected for the risk taken. A negative Alpha indicates that the manager has produced a return smaller than expected relative to the risk taken. In the last decade, the market for real estate investment trusts (REITS) has shown substantial growth rates. REITS were originally a tax design for corporations investing in real estate assets in order to reduce or eliminate the corporate income tax. Overall, the REIT structure was designed to provide a somehow similar vehicle for investments in real estate markets as mutual funds provide for investments in stocks. For instance, Australian real estate investment trusts (AREITS) are a unitized portfolio of property assets, listed on the Australian stock exchange, which allow investors to purchase a share in a diversified and professionally managed portfolio of real estate. According to 2011 Australian REIT Survey conducted by (BDO Corporate Finance) the top 40 REITs in Australia had assets of $148 billion as of June 30, 2011. It excluded entities with a market capitalisation less than $10 million. In the US, REITs gained 28.0% on a total-return basis during 2010 much higher than the S&P 500 (+14.8%). Fundamentals are clearly improving across the space, and REIT displayed high positive alpha. Also,

Fig. 1: REITs, S&P 500, NASDAQ future predictions

January 2012

the perception that REITs could serve as a hedge in the event of either an economic crisis or inflation makes REIT an excellent opportunity to invest. Overall, the market can be classified by offering four different types of REITs: 1)Equity trusts where the assets are invested in ownerships claims to various types of properties like, e.g. residential, commercial or industrial property 2)Mortgage trusts where the assets are invested in claims where interest is the main source of income like for example mortgages 3)Hybrid trusts that invest in both equity and mortgages, offering the advantage of offsetting interest income against depreciation of the property 4)Specialized trusts that invest for example in development and construction or are involved in sale and lease-back arrangements Past studies have presented mixed evidence on the relationship between stock returns and REIT returns. Studying the magnitudes simultaneously would enable us to draw inferences for both private and public policy purposes. For instance, private portfolio managers would be interested in learning how sensitive REIT returns are to stock market movements in order to improve the risk management of their real estate portfolios and/or also see whether mixing real estate assets with a general market portfolio would offer better risk/return opportunities. Also, official policymakers (i.e. monetary authorities) would be interested in seeing how changes in interest rates affect REIT performance. Over the last few years the real estate sector has had an excellent performance. Fuelled by increasing prices, higher rents and government spending more on infrastructure projects the real estate industry has been delivering very high returns, outperforming global equity markets most of the time. In 2008-2009, the sub-prime crisis had a significant impact on REITs but as soon as global market recovered, REITs again yielded significant returns over equity and other investment options. In addition, REITs are an attractive option for both institutional and private investors. REITs not only provide access to the real estate market, but are also a liquid investment alternative.

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Regression statistics

Double-Dip Recession: If in future the economy slows down rapidly and GDP growth turns negative again, the capital markets could become more volatile, and valuations could fall. In particular, a double-dip recession driven by weakness in the housing market (particularly in the US) could raise questions again about the financial system and shut off capital availability for the REIT sector, resulting in a selloff. Tail Risks: There are currently a number of tail risks—outcomes that rarely can happen but that may have strong negative effects were they to occur—facing the capital markets as we look out into 2011. Generally macro in nature, these could still end up impacting the REIT space via fund flows, macro-economic changes, or monetary policy. Methodology and data S&P 500 Index is a barometer to measure the US stock market health and growth. Also, the REIT index gives us data on returns through investment in real estate. We have compared percentage changes of respective indices with each other by forming a regression model based on recent data. Data for both the indices has been collected for the last year on a daily basis. The regression model provides us with mathematical evidence proving that REIT retains a positive alpha against stock indices. A similar approach has been applied for the Australian REIT. Data and preliminary statistical results The data sample contains daily observations that combine the following variables. For the four categories of REITs namely equity, mortgage, hybrid and composite we obtained the total index return. The sample’s period is from December 2010 to December 2011 and the main source is Bloomberg. The other variables are the S&P 500 continuously compounded returns and the growth rate of industrial production. Industrial production is a proxy for real economic activity. Regression statistics Multiple R

0.745

R square

0.559

Adjusted R square

0.557

Standard Error

0.789

Observations

251

Multiple R

0.905

R square

0.820

Adjusted R square

0.820

Standard Error

0.795

Observations

255 Y=0.034+1.17X coefficients

Intercept

0.034

X Variable 1

1.17

Table 2: Results for regression analysis - REIT index (US) & S&P500 stock index. (daily percentage change)

As there are different REIT structures in different economies, we have performed regression on last one year data of both Australia and the US. To validate our research that REIT seeks positive alpha against the S&P500 index, we collected data for REIT index and S&P500 for the past year on a daily basis. Thereafter, daily percentage change for each of the two indices was calculated. Then, regression was performed on the collected data using Excel 2007. Results showed that the two indices share a good correlation. The regression model explains 99% of the deviation in the data. Further, regression model shows that returns on REIT are over and above S&P500 index (positive Alpha) which implies that gains over and above natural returns on REIT are higher as compared to S&P500. Herein is a great investment opportunity. However in this case, Alpha is considerably too small as we are focussing on return on daily basis. If on such a short term REIT can give a positive Alpha over and access of returns, it gives investors better portfolio option if they invest on REITs. Further if we find out Alpha for long term, it is significant enough to attract the investors over equity market. With the calculations and empirical data, we have reached to calculation that REIT can yield much higher returns in this economic scenario where nations are spending hugely on their infrastructure. Hence, we conclude that REIT’s all over the world have performed well even in the face economic adversity which makes it a high gain proposition for investors.

Y=0.0213+.73X coefficients Intercept

0.021

X Variable 1

0.727

Table 1: Results for regression analysis - REIT (Australia) & S&P500 stock index. (daily percentage change)

Article FinGyaan of the Month Cover Story

Risks Related to REITS

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Article Perspective of the Month Cover Story

Commodity

Prove

market:

your â&#x20AC;&#x2DC;metalâ&#x20AC;&#x2122; Ashish Kumar & Tejas Ghargec

SIBM Bangalore

Trading in commodities has been an attractive investing medium for many people in recent past. Commodities on MCX, NCDEX and other trading platform have seen a tremendous increase in trading volume. The items that are being traded in commodity market varies from oil seeds to food grains to metals and Iron & steel. We have concentrated on metals as it seems to be more promising and lucrative in commodity market. The metal section in commodities especially has outperformed the market. The metal index value can be compared through following table. Current Scenario It is evident from the table below that the future price of MCXMETAL index raised very sharply every year from 2008 till date. The future price increase shows that the there has been a trend of more trading in metals in commodity market in particular. As the volume traded increased every year so did the spot price of the metal index. This trend clearly indicates a sign of higher interest of traders in commodity market and that too in metals. The return has been huge on the investments made in metal section in commodity market. This trend also indicates that the demand of metals has increased significantly in recent past and is likely to continue in future. The four most traded metals on MCX are Copper, Zinc, Lead, and Aluminium. The table below shows the volume traded from March 2008 to March 2011. The CAGR shown is the compounded annual growth in volume traded. Copper has a CAGR of 32.67%. Aluminium is 16.99% and Lead is 57.46% Year(As on 1st June)

Future price(Rs.)(MCXMETAL)

2008-09

2185.3

2009-10

3260

2010-11

4266

2011-12

4733 Table 1:Metal index value table (Future price)

January 2012

The increase in traded volume shows that the general demand for these metals has increased. These metals have a growth because its utility as a product has increased. For example there has been a high demand in industries like batteries and infrastructure. These industries depend on the general demand and availability of these metals. So as these industries prosper so does the metals. Comparison of price movement of few metals vis-a-vis Sensex:

As graph shows Sensex is fairly negatively correlated with Lead and Zinc. It offers option to diversify the portfolio besides bullion. Future Prospects As we have seen that these metals have attracted a lot of investors to bet on them. The Metal index has risen up to the historical high. There is lot more to come for the metals in particular for the commodity market which will lure more investors to invest in commodity market as the liquidity of commodity market has increased. The higher liquidity resembles higher opportunity to make money in market. The commodity market will bring about a new change in investors thinking. Government plays a major role in this market. As some of the government policies and regulations bring about a whole new prospect to the industry, so does it affects the commodity market. Few regulations and projects such as National Highway Authority of India have lead to an immense rise in the metal demands. When such

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2008-09 (30th march)

2009-10 (30th march)

2010-11 (30th march)

2011-12 (30th march)

CAGR

Copper

1007753

2175657

2706875

3122346

32.67%

Aluminium

13706

12510

16547

25678

16.99%

Zinc

323656

208772

257899

273429

-4.12%

Lead

110436

130344

578649

678937

57.46%

Table 2:Metal index value table (Volume traded & CAGR)

projects are undertaken, there is rise in demand of metals which leads to rise in the prices of metals as such. Such type of scenarios will attract investors because they know that the fluctuations of the spot prices of these metals will be high. The liquidity will also increase which again will give a positive vibe to the investors to make money by investing in commodity market. The rural electrification corporation limited has shown an increase in the demand of copper tubes for electrification purposes and which will grow as the day passes. There are certain areas where government has taken steps to improve the existing conditions, few of them being infrastructure, electricity, automobiles etc. As an investor one needs to understand that as long as India grows, so will the need for infrastructure and automobiles. The future demand for the metals will obviously increase which will give a boost in trading of metals in commodity market. Analysis of important metals: Zinc: About 47 % of Zinc produced worldwide is consumed by Galvanizing industry. Galvanizing industry is located mainly in China. Since China has the largest manufacturing sector in world. Galvanizing is complementing industry to manufacturing. Due to low demand worldwide, Zinc prices have declined from $2500/ton to $1900/ton. The International Lead and Zinc Study Group (ILZSG) reported that Zinc markets were in a 308000 tonne surplus in the first eight months of 2011, primarily due to increased mine production. Since supply exceeding demand Zinc prices are likely to remain weak in 2012. Aluminum: Total Aluminum Industrial consumption data shows that Transport, Packaging and construction industry account for 26%, 22% and 22% of total consumption respectively. Transport contributes nearly to 6% of India’s GDP. India is sixth largest vehicle manufacturer of world. The industry grows at 16-18 %. With 7 million units, it is projected to overtake Japan,

Germany and Korea by 2017. Construction industry contributes nearly about 8 % of GDP. This industry is growing at the CAGR of 20% for the last 5 years. Indian packaging industry is growing 15 % year on year. Copper: Copper is mainly used in electrical/electronics industry (42%) followed by construction (28%) and transportation (12%). Worldwide electricity is not penetrated in developing and under developed nations. There is large scale electrification programmes carried out by nations including India. India wants to increase electricity capacity addition by 100 GW from 2012 to 2017 which is half of the present electricity capacity of nation. Thus copper and Aluminium prices will be rising in coming years. Lead: Batteries are the main driver of lead worldwide demand. About 71% of lead produced is consumed by battery production. Lead acid battery is used in automobiles, inverters and UPS. Therefore the lead demand depends heavily on Automobile, computer and domestic inverter industry. Demand in automobile, inverter and UPS is dwindling due to global slowdown. Lead seems to show decline in prices for short term, but it has boom for long term. Conclusion According to recent analysis and reports, shareholders in equity market have eroded their wealth by more than 20% in last one year. As the Indian market for equities has taken a major hit due to European woes and unstable US economies, people are reluctant to invest in equities. The much safer and profitable investment ahead lies in commodity market because of the ease of monetary policies in some major economies like China and regulations by Indian government. Moreover being a developing and emerging market in infrastructure, FIIs see India as a lucrative market. Their investment will surge the demand for metals which in turn will lead to better liquidity and better ROI for investors. Hence, it’s time for Indian investors to be metalistic !!.

Article Perspective of the Month Cover Story

Volume traded

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Article of the Month Cover Story Finsight

Is Gold an Investor’s paradise? Harsh Bhatia

IIFT, New Delhi

Gold has emerged as one of the most reliable and stable Investment avenue for most of the investors who otherwise are finding it difficult to save themselves from huge losses because of the falling stock markets, rising unemployment and falling GDP’s, Low correlation with other asset classes like equity and debt makes it less volatile than other commodity prices and thus a good asset to diversify the overall portfolio. However investors must be very careful while parking their funds in Gold because as the world economy turns stable, gold prices languish, as happened in the 1980s to 1990s.

Hats off to the little yellow metal which has managed to outshine the millions of other investment options available today. With global economy downsizing and inflation rising, unemployment reaching the maximum level, and stock markets putting all their efforts to terrorize the investors, gold appears to be the “The Silver Lining” to the millions of investors around the world, be it in the form of bullion, gold certificates, miningshares, derivatives, ETFs or even jewellery. Gold has emerged as one of the most liquid and stable assets for investment purposes. During last two years, when all the asset classes have failed to perform, gold is the only investible asset that has remained upbeat. Gold is a hedge against the dollar and inflation. It has a very low correlation

with other asset classes like equity and debt thereby a good asset to diversify the overall portfolio. If had invested $10,000 in January 2001, your 37.81 ounces of the precious metal would have been worth more than $69,000 by September 1, 2011. As per the current status (January 18, 2012) the price of gold is Rs 27584/10g. The centre has raised import and excise duties on gold and silver hoping to mop up Rs 600 Cr more and contain current account deficit. Raising import duty on gold to 2% of value from Rs 300 per 10 grams to Rs 540 per 10 grams as per the current price. It could slow imports thus reducing dollar demand and strengthening the rupee. As it is clearly visible from the chart, there has been a considerable increase in the prices of gold over the

Fig. 1: Gold vs. Stocks since 1998

January 2012

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Article of the Month Cover Story Finsight

Table. 1: 10 gms of GOLD PRICE History for the last 86 years

last 15 years (from 1996-2011). Last 2 years have shown an increase of more than 100%! Such trends fuel more demand for gold, which, combined with limited production and supply, drive prices even higher in a kind of cycle. E-gold on the Financial Technologies-promoted National Spot Exchange (NSEL) outperformed other gold investment avenues in 2010, due to the least transaction, brokerage and delivery costs compared to other options. Spot gold gave slightly higher returns, but given the risk involved in holding physical gold, many investors preferred to invest in e-gold. E-gold has offered 23.64 per cent return since its launch in March last year. Other options, including MCX Gold Futures, have offered comparatively less, with Gold BeES and Reliance Gold ETF posting 17.98 per cent and 17.82 per cent returns, respectively. E-gold was launched in April 2010 for investment by small investors who could not buy in bulk. It also helps in diversifying an investor’s portfolio as it usually tends to progress opposite the stock market. Traditional options, such as bonds, property and hedge funds often fail to handle the market panic, and may sell off with equities in times of uncertainty. Gold is subject to market risk, but many of the downside risks associated with its price is different to the risks associated with other assets. This enhances gold’s attractiveness as a portfolio diversifier. The more volatile an asset, usually the riskier it is. The gold price is typically less volatile than other commodity prices. Portfolios consisting of gold may leverage this uncertainty and would

be able to with-stand catastrophic economic situations. Gold also enjoys a tax-free life in countries such as UK, where gold coins like Sovereigns and Britannia’s are viewed as currency and so are exempted from VAT. Plus, since the increase in value of gold has not been derived by work, it is not an income, thus there is no income tax either. Silver & other precious metals do not enjoy the same luxury. Gold enjoys psychological appeal. 4000 years after its discovery, it is still perceived as one of the most precious metals. This means that even during times of crisis, market failures and government defaults, gold is likely to retain its value unlike other investment options. This makes gold one of the safest collaterals for the financers to count upon, enabling them to lend money without much hesitation. Also it is not tied to any issuer’s liability unlike bonds, but is entirely the investor’s asset. Gold is perceived as “The World’s Frightened Bunny”. Whenever the economy signals signs of depression and downturn, the demand for gold has increased. During crisis, people fear that their investment options would be negatively influenced and would not provide them with necessary funds hence they see gold as an asset which will always buy bread. When Lehman Brothers declared bankruptcy in September 2008, the prices of Gold rose by 27% from $728 per ounce to $922 in a matter of three days. Gold is also used to protect the economy from rising inflation by controlling the country’s cur-

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Article of the Month Cover Story Finsight

rency against fluctuating dollar. It is inversely related with dollar, i.e. when the dollar weakens, the price of gold will rise. Many currency traders treat gold as the 4th global currency, after Dollar, Yen and Euro. The European demand for gold comes mainly from German and Swiss investors because of concerns over public debt in the Euro zone and the potential inflationary impact of the European Central Bank’s announcement of the $1 trillion rescue package to purchase Euro zone government bonds to address the Greek debt crisis. Although gold is a great hedge in this risky time, the problem is that it is just – a hedge – and so when times are good for the economy, investments in gold can take a downhill path. Gold is today viewed as a safety-net against political and economic uncertainties, and its demand is high today only in such circumstances. But when world economy turns stable, gold prices languish, as it happened in the 1980s to 1990s. This is why it has been suggested that “investors should hold no more than 15% of their assets in gold, and they should buy only when the price dips because the price of the metal is historically high.” Gold has the advantage of being the most easily comprehensible investment to the average investor, considering that its value is set on an open market. As Market watch noted, “Gold is what a real bull market looks like”. Gold is under-valued, under-owned and under-appreciated. The supply/demand balance in gold is becoming increasingly tight. And although interim volatility cannot be ruled out, gold prices are likely to trade higher. It is most assuredly not well understood by most investors. At the beginning of the 1970’s when gold was about to undertake its historic move from $35 to $800 per ounce in the succeeding ten years, the same observations would have been valid. The only difference this time is that the fundamentals for gold are actually better. Under such circumstances, the future of gold seems quite ‘golden’ indeed. Thus, holding Gold in your portfolio isn’t advisable...it’s a must!!! Long live the king of all investments!

FIN-Q Solutions December 2011 1. Operation Twist 2. 159th meeting of OPEC 3. Cuba 4. UTI 5. Pranab Mukharjee, Subbarao 6. Cost per click 7. Dual Aspect Concept 8. Parimal D. Nathwani 9. Sage Peachtree Complete Accounting

10. Round trip trading

January 2012

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INSIDER TRADING Rameswar Misra

IIM Shillong

this information Galleon group and Gupta benefitted, which was a loss for other investors. I got it, but can insider trading be legal? Sir, is insider trading a serious offence for which Rajat Gupta, the 1st Indian born global CEO of an MNC, is charged by Securities Exchange Commission (SEC)? Yes, because he used information to make money that should have been kept confidential, i.e insider trading. Sir, Can you tell me more about insider trading? Insider trading is trading in stocks, bonds or securities of a corporation by an individual who has non-public information about the corporation. The insider here is an individual who can be company’s director, officer, large shareholder, etc. In USA and Germany, it is required that these insiders report their trading to the regulator or disclose it publicly, within a few days of business trading cycle. So, how can it be illegal? It can be illegal, if the insider uses the material information that is still not disclosed to the public. If he shares this information with anybody, who can use this to an advantage over other investors and thus makes profits, or saves himself from losses, then it’s illegal. Sir, can you give an example? When Rajat Gupta gave information to Raj Rajaratnam, the founder of Galleon funds, about Berkshire Hathaway’s investment of $5 billion in Goldman Sachs, just after attending the board meeting of Goldman Sachs(which was a day before it was made public), it was illegal. From

It is legal, if insiders will trade after the material information is public or as per SEC in USA. If insiders have a legal contract that allows them to trade in future, than it’s not illegal and is called affirmative defence. In this scenario, the insider has no direct advantage over other investors. Still regulatory bodies want such insider trading to be reported. Then, we should always invest or trade following the trading patterns of insiders. Yes, to some extent we may, as insiders know about their company’s position better than what has been disclosed to public. For example, a Chief Financial Officer knows the financial health of his company better that what is being reported to public. So to follow the CFO’s footsteps will be wiser. But, if insiders are using it as a strategy to trap investors, even though they know company in future will not do as expected, then you are in a problem because you stand a chance of losing your investment. Oh I see. Just one last question sir. In India if I adopt such unethical ways to create money, can I be traced? Definitely yes. SEBI is a vigilant watchdog. It compares the financial reports of corporates with that of auditors like PwC, E&Y, etc. and in case of collusion of reports strict action is initiated. Thank you, Sir. Now, I have some idea about insider trading.

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CLASSROOM FinFunda of the Month

FIN-Q 1. Pachmarhi, located in X District of Madhya Pradesh is the only hill station in the state. X is very important with regards to the Indian Financial System. Identify X’s claim to fame. 2. This term is used extensively in newspaper reports today. It shot into prominence after X (newspaper) published it after the Watergate scandal in 1973. Identify the term and X. 3. X is a non-tradable, non interest paying financial instrument which protects employers against fraudulent actions of their employees. Identify X. 4. Company X founded by Y got its fourth round of funding recently from General Atlantic and Sequoia Capital. This funding is one of the biggest in pure-play analytics. Identify X and Y. 5. . X was set up with the help of Y and presently has 2 stocks listed in it with a total market capitalization of $0.7bn. Identify X and Y. 6. DSP Merill Lynch has a very important first to its name in the Indian Context. Name it. 7. Some of the tactics used in XY, also known as Z are closed-door meetings with bank directors, increased severity of inspections, appeals to community spirit, or vague threats. It is usually done by an authority like the Federal Reserve. Identify X, Y and Z. 8. Connect. (Hint: International trade term)

9. X publicly listed its shares in 2005 through an IPO and immediately spun off X Capital Markets and X Alternative Investments. X is presently one of the advisors of Y, which recently filed for bankruptcy protection. Identify X and Y. 10. Some of the stocks in this investor’s portfolio include Aptech, Lupin, Nagarjuna Construction and Karur Vysya Bank. He recently exited Pantaloon Retail completely. He is sometimes referred to as India’s Warren Buffett. Identify him.

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January 2012

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Prize - INR 1000/-

Akanksha Kumar & Jaideep Singh Gaur Welingkar institute of Management, Mumbai

FIN - Q

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Prashanta Khaitan

Jamnalal Bajaj Institute of Management Studies , Mumbai

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