Professional Documents
Culture Documents
Bulls Eye: Financial Concepts
Bulls Eye: Financial Concepts
1
www.hitbullseye.com Financial Concepts
Financial Concepts
The banks in India are free to decide interest rates on term deposits and loans. Yet the RBI needs to control
interest rates as it is an important tool to check inflation, one of its prime concerns. So the RBI continues to
referee and provide a direction to interest rates. The Bank Rate is one of the tools used by RBI for this purpose
as it refinances banks at this rate. In other words, the Bank Rate is the rate at which the banks borrow from
the RBI.
Second, banks are still the main source of funds for the government, which means despite a lower SLR
requirement, banks’ investment in government securities will go up as government borrowing rises.
Consequently, bank investment in gilts continues to be higher than 30 % despite RBI bringing down the
minimum SLR to 25 % a couple of years ago.
Therefore, to determine the interest rates, what matters is not the SLR requirement but the size of the
government borrowing programme. As government borrowing increases, interest rates, too, look up.
However, there are some loans to which PLR do not apply - like some priority sectors, which are at directed
and sub-PLR rates. At the same time, banks can charge higher rates on consumer loans such as car loans
which are governed by their PLR.
Besides working capital loans, banks provide term loans to companies for new projects, for which they
announce a separate medium-term prime lending rate (MTPLR). A cut in PLR means money is available at
cheaper rates, thereby giving a fillip to new projects, encouraging new investments and stimulating demand.
Bulls Eye Learning Curve
2
www.hitbullseye.com Financial Concepts
Pioneered in France to eliminate the cascading effect of several levies from the stage of raw material to final
product, it is now levied in more than 40 countries. The advantage of VAT over any other indirect tax is that it
shifts the tax base towards the point of final consumption rather than first point sale thereby ensuring `tax
neutrality' of production decisions. Since each producer up the value chain would like to claim the benefit of
set-off, there is automatic pressure on the producers down the value chain to pay their tax. Moreover, since
tax collection takes place in stages, evasion at any one stage is automatically compensated at a later stage.
The money collected by the fund allows it to hire such staff at very low costs. In effect, the mutual fund vehicle
exploits economies of scale and all three areas – research, investing and transaction.
A sponsor then hires an Asset Management Company (AMC) to invest the funds according to the investment
objective. It also hires a custodian and perhaps a third one to handle registry (unitholders’) work. In the Indian
context, the sponsor promotes the AMC also in which it holds a majority stake.
The AMC has to hire an outside custodian responsible for the custody of the fund assets. The custodian is also
responsible for the receipt of all kinds of cash and non-cash benefits such as bonus, dividends, rights etc. The
custodian is usually a bank/ financially sound institution. The AMC receives a fee for its services. In addition
SEBI also permits AMCs to charge expenses for the management of the fund upto certain limits.
Bulls Eye Learning Curve
4
www.hitbullseye.com Financial Concepts
Sub-Standard Assets: Non-performing assets for not more than two years. Also, in cases where the loan
repayment is rescheduled, RBI has asked banks to recognize the loans as sub-standard at least for a year.
Doubtful Assets: Loans which have remained non-performing for a period exceeding two years and which are
not considered as loss assets. A major portion of assets under this category are `sick' companies referred to
the B.I.F.R. and awaiting finalization of rehabilitation packages.
Loss Assets: Are one where the loss has been identified but the amount has not been written off wholly or
partly. In other words, such an asset is considered uncollectible.
How to solve the NPA problem? What steps have been taken so far?
Banks need better credit appraisal systems so as to prevent NPAs from happening. However, once NPAs
happen, the problem can be solved only if there is enabling legal structure, since NPA recovery requires court
orders. With judicial delays, debt recovery takes a very long time.
Banks are now working on Debt Recovery Tribunals to solve this problem. An Asset Reconstruction Company,
has also been mooted for rehabilitating revivable NPAs and recovering funds out of unrevivable NPAs (gone
cases).
Experts have also suggested the concept of narrow banking, where only strong and efficient banks will be
allowed to give commercial loans, while the weak banks will take positions in less risky assets such as
government securities and inter-bank lending.
Bulls Eye Learning Curve
5
www.hitbullseye.com Financial Concepts
What is Venture Capital?
Venture Capital is the capital provided by firms of professionals who invest alongside management in young,
rapidly growing companies have the potential for high growth. Thus a Venture Capitalist (VC) may provide the
seed capital for unproven ideas, products or technology-oriented firms. The VC may also invest in a firm unable
to raise finance through conventional means.
VC subsidiaries are established by major companies and financial institutions. The primary institutional source
of VC is a VC firm. VCs take higher risks by investing in an early-stage company with little history, and expect
a higher return for their high-risk investment.
In calculating returns, many VCs end up owning substantial company stock, which sometimes gives them
equity control. The professional investor will look at company value before investment and the investor's
financial contribution when determining how much equity is necessary for the fund to get adequate return on
investment. This issue is often the largest financing hurdle for VCs and owners to work through.
Let's take Zee Telefilms (ZTL), which considered criteria like length of service, performance and the seniority.
ZTL issued 4.60 lakh ESOPs convertible into equity shares of Rs 10 each, to about 70 employees of ZTL and its
associate companies. Each employee was eligible to apply for between 3,000 shares and 10,000 shares at Rs
212 per share when the share traded at the time was at Rs 4,255 on the BSE. The shares consisted of three
equal parts, issuable to employees with a minimum of two years’ continuous service. One-third of the shares
allotted were freely transferable, another third were locked in for one year from the date of allotment and the
balance was locked in for two years after allotment. Many companies are now flashing ESOPs to attract the
best of talents from big B-school campuses offering ESOPs to graduates at the entry level. This includes
companies like Infosys, Wipro, Microsoft, HCL Technologies and HCL Infosystems.
What is a vote-on-account?
The demand for grants takes time, and the government cannot wait for Parliament to clear the expenditure
proposals before meeting its expenses from April 1. The Constitution, therefore, empowers the Lok Sabha to
grant a Vote-on-Account so that the government can continue with the necessary expenditure in the new fiscal,
before the Budget proposals actually get passed.
The vote-on-account normally covers the expenditure requirement of the government for two months, during
which the government is expected to continue spending proportionately on its ongoing expenditure items.
Today, currencies aren’t weighed against each other and valued according to the amount of gold or silver
contained in them, though done long ago to price different currencies. Now, a subtler method values
currencies. Nations which attract more foreign exchange than they lose, see their currencies appreciate; those
that lose more forex than they earn, see their currencies drop in value. The valuation is done by the
marketplace — through the relentless buying and selling of different currencies.
Today, the volume of foreign exchange worldwide tops $1 trillion a day. Nations that run persistent trade
surpluses or have huge capital inflows by way of foreign direct investment or stock market investment see their
currencies appreciate since these inflows raise the stock of foreign currencies against the local one.
On the other hand, trade deficits and capital flight trigger depreciation. In currency markets, the relative
strengths of economies, policies and expectations determine exchange rates.
Policy matters a lot. Greater openness exposes nations to overseas trade and investment flows. This can cut
both ways. Countries with good fundamentals do well; however, open economy policies also expose
fundamental weaknesses rapidly. Perhaps the most important job for policymakers in economies trying to open
up is to align domestic policies to global standards. Countries like India, having rickety economic foundations,
are cautious and retain controls on overseas trade and investment.
A phenomenon known as Sunspots syndromes — when expectations become self fulfilling and trigger actual
changes — is common in forex markets. Eventually fundamentals, which depend on polices, influence interest
rates, prices and eventually exchange rates. But forex markets move much faster than the government
policies. Often movements are caused by simple rumours about policy changes.
However, large sea-saws in relatively short time are not desirable. One, they make it tough for people to
reckon what a reasonable rate is.
Bulls Eye Learning Curve
9
www.hitbullseye.com Financial Concepts
What is poverty line?
Poverty line is a construct essential to measure how poor a country is, which is useful in making policies for
development. Behind statements like "40 % Indians are poor" there is an implicit poverty line.
A common way to define the poverty line is a broad income-based level, say, 60 per cent of a country’s
average income per head.
The average Indian earns about $ 440, or Re 19800 per year. Going by the 60 % of income rule, a poor Indian
has an annual income of Rs 11800 or Rs 990 a month. We draw a poverty line by calculating the `minimum’
cost of living that can sustain people. For very poor countries like ours, this boils down to a nutritional
requirement: the cost of minimum calories needed to keep people alive. This looks like a fairly foolproof
method, but has some built in glitches. For example, calorie needs vary across genders and age. A rough
average is 3,000 calories daily for working men; about 2,900 for working women.
Consequently, the government can show large poverty declines by spending just enough on the least-poor to
drag them above the poverty line, spending nothing on the poorer folk. Despite that, the HCR is India’s official
method to estimate poverty.
That’s why the IGR is a more useful measure than a simple roll call. Now, if you took something away from
someone who is acutely poor and gave it to someone less poor, it is obvious that the degree of poverty will
rise. But neither HCR nor IGR can account for this. Neither reflects changes in poverty brought about by
transfers between the poor.
Bulls Eye Learning Curve
10
www.hitbullseye.com Financial Concepts
What is securitisation?
Securitisation is a process by which the forecast future income of an entity is transformed and sold as debt
instruments such as bonds. This allows the company to get cash upfront, which can be productively used. It is
done by suitably “repackaging” the cash flows or the free cash generated by the firm issuing these bonds.
A finance company with car loans can raise funds by selling these loans to another entity. But this sale can also
be done by “securitising” its car loans portfolio into instruments with a fixed return based on the maturity
profile. If the company has Re. 100 crore worth of car loans and is due to earn 17% income on them, it can
securitise them into instruments with 16% return with safeguards against defaults. These could be sold by the
co. to another if it needs funds before these repayments are due. The principal and interest repayment on the
securitised instruments are met from the securitized assets.
Selling these securities will not only provide the co with cash before maturity, but also the assets (loans) will
go out of the books of the finance co once they are securitised, a good thing as all risk is gone.
It works well if the securitised asset is homogenous w.r.t credit risk and maturity. Ideally, there should be
historical data on the portfolio performance and the issuing company on credit quality and repayment speed.
How does it differ from financing through a straight bond or debenture issue?
Unlike a traditional bond issue, the repayment of funds raised through securitisation is not an obligation of the
originator, or the finance company issuing the securitised instrument. In a straight bond or debenture issue, if
the company goes bust, the investors would have a tough time getting their funds back. However, if one
invests in a securitised instrument, investors are assured of interest payments even if the finance company
goes bust, as the securitised loans are separated from the finance company’s books through a special purpose
vehicle which holds these assets. At the same time, as securitised instruments can be traded, the investor has
liquidity as the securitised bond can be sold in the market.
The rating is also not a recommendation to buy, hold or sell an instrument. This means that before deciding to
purchase an instrument, you have to ensure the suitability of the investment to your risk profile.
Besides, since ratings change, it is always better to ask for the latest rating outstanding on the instrument,
available on web-sites of CRISIL, CARE and ICRA.
However, a rating once accepted can be downgraded or upgraded by the CRA with prior notice to the issuer. In
this case the issuer does not have the right to request that the downgrade or upgrade not be made public.
Bulls Eye Learning Curve
12
www.hitbullseye.com Financial Concepts
What is BPO all about?
BPO (Business Process Outsourcing) is the contractual service to completely manage, deliver and operate one
or more (typically IT-intensive) business processes or functions. This could include processing to contact
centre operations to payroll processing, among others. A simpler way to think of BPO is to compare it to the
functions most organisations include in the general and administrative category. Some key business processes
that are outsourced and form a large part of the BPO market are administration, finance and accounting,
human resource, payment services, manufacturing services, distribution, logistics, sales and marketing,
customer care among others.
At present, the US comprises 50 % of the global BPO market. Of the various BPO areas, Customer Relationship
Management (CRM) is expected to undergo most rapid growth projected at over 20 p.a. Within CRM BPO, more
specifically, call centre outsourcing is expected to grow at 29 p. a. over the next five years.
How is the price policy responsible for huge stocks of food grain?
The misuse of the price policy has created a huge food management problem. Procurement prices for wheat
and paddy have been rising every year, creating a distorted incentive for farmers to switch to rice and wheat
cultivation.
Price policy has an impact on the cost of procurement operations and ultimately on distribution costs, both on
the open market and on the PDS. Food Corporations India (FCI) is the central agency responsible for
procurement, transportation and storage operations and rising procurement prices raise economic costs of its
operations.
To cover part of the costs, PDS prices have been raised throughout the nineties, especially after 1997-98. This
turned away most PDS customers, since market prices were below PDS prices. So, while rising prices have led
to a huge supply response form farmers, PDS offtake has fallen. As result, grain stocks have ballooned over the
past few years.
These, as the name suggests, are cooperative banks at the district level and at the state level. Each district will
have not more than one DCCB with a number of DCCBs reporting to the SCB. Earlier these two tiers were also
under RBI supervision. However, following the establishment of the National Bank of Agriculture and
Development (NABARD) in 1982, the supervisory function of these banks has been passed on to NABARD.
As against inflation, we have deflation, a situation when prices take a tumble. This is a theoretical concept and
something that rarely occurs in developing countries.
Also, prices go up whenever there is a hike in petro prices. Inflation here is due to cost push factors. This is
because petroleum is a vital input in many items and as an essential fuel for road transport, it adds to the
transportation costs and so prices in general tend to rise.
Therefore, it is felt that it is important to give a more representative picture true for the entire nation.
Therefore, the government sticks to trends in wholesale prices when it talks of inflation.
Bulls Eye Learning Curve
16
www.hitbullseye.com Financial Concepts
What is the canalized list?
Several items like urea are canalized — they can be imported only by designated agencies like MMTC and STC,
the government's trading arms. Gold in bulk, for example, can be imported only by specified banks. Earlier,
items like sugar, edible oil, wheat and rice were imported by the government through canalizing agencies.
However, ongoing liberalization has led to many of them becoming freely importable.
What is EPCG?
The EPCG scheme allows exporters to import machinery duty free or at concessional duty if the importer
agrees to achieve a fixed export target within a specified time. The scheme was very popular when customs
duty on capital goods was high. Currently under the EPCG scheme, import of capital goods carry 10% customs
duty though duty free imports are also permitted, subject to a minimum import volume. Exemptions are
available for certain sectors like farming and garments even if the minimum threshold is not met.
First, the scheme of Export & Trading Houses. These are units recognized by the office of the DGFT (Director
General of Foreign Trade) on the basis of their export performance. The second scheme covers exporters who
have directly exported goods worth Rs 5 crore and above during the preceding licensing year or an average of
Rs 2 crore and above during each of the preceding three licensing years.
While Export & Trading Houses are entitled for a SIL ranging between 6 per cent and 12 per cent on FOB (free
on board, or cost of the goods at the point of shipment) basis and 7.5 per cent and 15 per cent on NFE (net
foreign exchange earning) basis, the other exporters are issued SIL at the rate of 4 per cent.
The objective of the DEPB is to neutralize the incidence of basic customs duty on the import content of export
products. This neutralization is provided by way of grant of duty credit against the export products at rates
announced by the DGFT from time to time. The DEPB licence is issued on both post and pre-export basis. The
DEPB licence is transferable, and all items except those appearing in the negative list of imports are allowed to
be imported. Credits earned under the DEPB can be utilized for payment of customs duty on any item imported
under SIL.
An Advance Licence is granted to a merchant or a manufacturer exporter for duty-free supply of domestic as
well as imported inputs required for the manufacture of export goods without payment of basic customs duty.
However, such inputs are subject to payment of additional customs duty equal to the excise duty at the time of
import.
Advance licences are issued on the basis of production programmes of regular exporters and also on specific
export order subject to fulfillment of a time-bound export obligation both in terms of quantity as well as value.
The licence is issued on the basis of a minimum value of 33 per cent, which may be reduced up to 25 per cent
in exceptional cases.
The negative list contains items not allowed to be imported or exported. However, some of these are allowed to
be imported and exported through canalizing agencies.
Bulls Eye Learning Curve
18
www.hitbullseye.com Financial Concepts
What is a Debit card? How does it work?
A Debit Card combines the functions of an ATM card and a cheque. When you pay with your Debit Card, the
shopkeeper swipes your card through an electronic point of sale (EOS) terminal, directly linked with the issuing
bank. When this is done, the cardholder’s account immediately gets debited. So, let’s say you spend Re. 520 at
a shop, your account instantly gets debited accordingly. Debit cards are issued by banks, but are used at
stores.
What is the difference between credit and debit cards? If you have both, when
will you use the credit card and when the debit card?
A credit card offers you credit for a given period, usually about 45 days. With a debit card, there’s no interest
or bill to be settled separately, as your bank account is immediately debited. Also, when you apply for a debit
card, you do not need to go through a credit check.
All you need is a bank account. A debit cardholder cannot spend on his card if he lacks sufficient balance in his
account. Customers tend to use credit cards in high value transactions and debit cards for lower value goods or
services.
Does a debit card holder have to pay if there’s a mistake in his debit card
statement?
Although the chances of errors in a debit card statement are remote, mistakes can still occur. If you find an
error in your statement, notify your bank immediately. Normally, a bank has 10 business days from the date of
your notification to investigate the problem. If the bank needs more time, it can take up to 45 days, but only if
it deposits the amount in dispute into your account. If the bank later determines that there was no error, it can
take the money back, but it must first send you a written explanation.
Bulls Eye Learning Curve
19
www.hitbullseye.com Financial Concepts
What’s monetary policy?
Monetary and credit policy is the policy statement, traditionally bi-annual, through which the RBI targets a key
set of indicators to ensure price stability in the economy. These factors include:
a) Money supply, commonly referred to as M3 — which indicates the stock of legal currency in the economy
b) Interest rates
c) Inflation
Besides, the RBI gets a platform to announce norms for financial bodies such as banks, financial institutions,
NBFCs, nidhis, primary dealers in the money markets and foreign exchange market dealers. It also gets an an
opportunity to spell out its overview on the economy, and an occasion for it to indicate deposit and advance
targets for banks in the half-year.
How does the monetary policy affect the domestic industry and exporters in
particular?
Exporters keenly look forward to the monetary policy since the central bank always makes an announcement
on export refinance, or the rate at which the RBI will lend to banks, which have advanced pre-shipment credit
to exporters. A lowering of these rates would mean lower borrowing costs for the exporter. The most important
issue that the monetary policy has addressed till now has been that of interest rates. And since the interest
rates affect the borrowing costs of corporates and as a result, their bottomlines, the monetary policy is very
important to them.
Bulls Eye Learning Curve
20
www.hitbullseye.com Financial Concepts
What is the US GAAP?
GAAP or “Generally Accepted Accounting Principles” are the basis for preparation of accounts by US companies.
GAAP is considered to be among the toughest and most conservative accounting standards in the world. As a
result, accounts prepared under US GAAP are considered more trustworthy and transparent than many others.
Recent scandals involving Enron and WorldCom, have however, severely dented confidence on this score.
It has an open decision making process, which is open to public observation and participation. It receives many
requests for actions on various financial accounting and reporting topics.
1. improve the usefulness of financial reporting by focusing on primary characteristics of relevance and
reliability
2. keep standards current to reflect changes
3. consider promptly any significant areas of deficiency
4. promote international convergence of accounting standards
Is It A New Phenomenon?
No. It is no different from ‘kerb’ deals of the 1990s, which disappeared with the advent of screen-based
trading.
Would a uniform code affect the personal laws of only one community?
Not at all. The perception that a uniform civil code would necessitate changes in only Muslim personal law is
incorrect. As women’s organizations and others have repeatedly pointed out, personal laws governing different
communities in India have a common feature – they are all gender-biased. For instance, the law pertaining to
succession among Hindus is unequal in the way it treats men and women. A truly modern and progressive code
would, therefore, mean changes in all personal laws. The concept of the “Hindu Undivided Family”, so far as it
pertains to succession, would also obviously have to undergo a change under a uniform civil code. Similarly,
Muslim, Christian and other personal laws too would have to change. This also explains why historically
changes in personal law have been resisted not just by one community, but by the ruling orthodoxy in all of
them.