Name of Project

Names of Participants

References

Index
What is Risk and importance of measuring risk

Risk is gauging of probability of an adverse event happening and in business terms it is

expected magnitude of loss in case such an event occurs. The preparedness and the
measures to mitigate risk as adopted by a firm or as attained by a firm during its
various business transactions are determined by combined impact of not only the
probability or Magnitude of loss but also by operational practices and market
understanding followed by a firm.

This means in simpler terms, the magnitude of risk may be same but the strategies of
risk management may differ. In Business enterprises, the management of risk is mainly
confined to situations of high probability of small losses. It is mainly managed by
evaluating certain operational and financial parameters of firm. However, the
management of large risks due to act of nature or other uncontrollable circumastnces is
done by strategic decisions like Capital budgeting decisions.

In this project report on Risk Ananlysis, we are focussing on the management of risk
that emanate from conduct of normal day to day operations of the business.

Types of Risk

Market Risk
Liquidity Risk
Currency ( Fluctuation) Risk
Credit Risk
Hedging Risk
Operational risk

However, the broad understanding of particularly three types of risks i.e Market Risk
( vide study of Share Price indices, Earnings per share, etc), Credit Risk ( vide study of
Debt to Equity Ratio, Interest coverage ratio, etc) and Operational Risk ( by study of
Operating leverage, Financial leverage ratio, etc) gives an overall picture on
performance of a firm and its management of mitigation of all the types of risks. Thus,
understanding of Market Risk, Credit Risk and Operational Risk gives broad
understanding of Credit Worthiness of a business firm.
Definitions:

Market Risk: It is the risk of losses due to movement in financial market prices or
volatilites.

Credit Risk : It is the risk of losses due to the fact that counterparties may be
unwilling or unable to fulfil their contractual obligations.

Operational Risk: It is the risk of loss resulting from failed or internal processes,
systems and people or from external events.

However, often these three categories interact with each other in determining and
understanding overall risk category of a firm. Thus, understanding of Market Risk,
Credit Risk and Operational Risk gives broad understanding of Credit Worthiness of a
business firm.

Approach : Risk Analysis

We have selected Automobile sector in India including some of the leading Four
wheeler and Two wheeler manufacturers in order to understand their business practices
and management of risk. This sector is selected as it is one of the most flourishing
business sector bringing significant growth in the economy and this sector is also driver
of several allied industries.

The companies selected for analysis are:

Maruti Suzuki India Ltd.

Tata Motors Ltd.
Mahindra and Mahindra Ltd.
Hero Honda Motors Ltd.
Bajaj Auto Ltd.

The financial performance for last five financial years ( 2005-06 to 2009-10) is studied
in order to analyse risk management of these companies as detailed in this report.
 Financial Parameters and Ratios in Risk Measurement.

1) Market Risk

The tools employed in analysis of Market Risk: Share Price indices, EPS and Bet values.

2) Credit Risk

The measurement of credit risk is done by analysis of Debt to Equity Ratio, Interest
Coverage Ratio and Debt service coverage ratio.

DEBT EQUITY RATIO

A measure of a company's financial leverage calculated by dividing its total

liabilities by stockholders' equity. It indicates what proportion of equity and debt the
company is using to finance its assets.

This ratio is computes as :

It signifies what proportion of debt a company has relative to its assets. The measure
gives an idea to the leverage of the company along with the potential risks the
company faces in terms of its debt-load.

INTEREST COVERAGE RATIO

A ratio used to determine how easily a company can pay interest on outstanding debt.
The interest coverage ratio is calculated by dividing a company's earnings before
interest and taxes (EBIT) of one period by the company's interest expenses of the same
period:

 
The lower the ratio, the more the company is burdened by debt expense. When a
company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses
may be questionable. An interest coverage ratio below 1 indicates the company is not
generating sufficient revenues to satisfy interest expenses.

Borrowing money is one of the most effective things a company can do to build its
business. But, of course, borrowing comes with a cost: the interest that is payable
month after month, year after year. These interest payments directly affect the
company's profitability. For this reason, a company's ability to meet its interest
obligations, an aspect of its solvency, is arguably one of the most important factors in
the return to shareholders.

Interest coverage is a financial ratio that provides a quick picture of a company's ability
to pay the interest charges on its debt. The "coverage" aspect of the ratio indicates how
many times the interest could be paid from available earnings, thereby providing a
sense of the safety margin a company has for paying its interest for any period.

A company that sustains earnings well above its interest requirements is in an excellent
position to weather possible financial storms. The interest-coverage ratio below 1 is an
immediate indication that the company, regardless of its industry, is not generating
sufficient cash to cover its interest payments. That said, an interest-coverage ratio of
1.5 is generally considered the bare minimum level of comfort for any company in any
industry.

For example, for an established utility company - a provider of power or water - an

interest-coverage ratio of 2 is an acceptable standard. For more volatile industries, such
as automobile manufacturing or steel production, an acceptable minimum for interest
coverage is 3. Industrial companies such as these see more fluctuations in their
production and consumption patterns from year to year. A greater margin of safety is
therefore required to ensure the company can cover interest charges.

DEBT SERVICE COVERAGE RATIO (DSCR):

In corporate finance, it is the amount of cash flow available to meet annual interest and
principal payments on debt, including sinking fund payments.

In government finance, it is the amount of export earnings needed to meet annual
interest and principal payments on a country's external debts.
In personal finance, it is a ratio used by bank loan officers in determining income
property loans. This ratio should ideally be over 1. That would mean the property is
generating enough income to pay its debt obligations.

In general, it is calculated as:

The debt service coverage ratio provides a way to assess the financial strength and the
associated risk level, of a pool of loans. A DSCR of less than 1 would mean a negative
cash flow. A DSCR of less than 1, say 0.95,  would mean that there is only enough net
operating income to cover 95% of annual debt payments. For example, in the context
of personal finance, this would mean that the borrower would have to delve into his or
her personal funds every month to keep the project afloat. Generally, lenders frown on
a negative cash flow, but some allow it if the borrower has strong outside income.

3) Operational Risk.

The Measurement of operational risk is studied vide Degree of Operating Leverage,

Financial Leverage and Combined leverage ratio.

OPERATING LEVERAGE RATIO

Contribution margin is a measure of operating leverage: the higher the contribution

margin is (the lower variable costs are as a percentage of total costs), faster the profits
increase with sales. Note that unlike other measures of operating leverage, in the linear
Cost-Volume-Profit Analysis Model, contribution margin is a fixed quantity, and does not
change with Sales. Contribution = Sales - Variable Cost.

DOL and Operating income

The Degree of Operating Leverage (DOL) can be computed in a number of

equivalent ways; one way it is defined as the ratio of the percentage change in
Operating Income for a given percentage change in Sales.
Companies with high fixed costs, after reaching the breakeven point, see a greater
increase in operating revenue when output is increased compared to companies with
high variable costs. The reason for this is that the costs have already been incurred, so
every sale after the breakeven transfers to the operating income. On the other hand, a
high variable cost company sees little increase in operating income with additional
output, because costs continue to be imputed into the outputs. The degree of operating
leverage is the ratio used to calculate this mix and its effects on operating income.

FINANCIAL LEVERAGE RATIO

A measure of a company's financial leverage calculated by dividing its total

liabilities by stockholders' equity. It indicates what proportion of equity and debt the
company is using to finance its assets.

Degree Of Combined Leverage - DCL

A leverage ratio that summarizes the combined effect the degree of operating leverage
(DOL), and the degree of financial leverage has on earnings per share (EPS), given a
particular change in sales. This ratio can be used to help determine the most optimal
level of financial and operating leverage to use in any firm. For illustration,

DCL = % Change in EPS / % Change in Sales

This ratio can be very useful, as it summarizes the effects of combining both financial
and operating leverage, and what effect this combination, or variations of this
combination, has on the corporation's earnings. It is worth noting that a firm with a
relatively high level of combined leverage is seen as riskier than a firm with less
combined leverage, as the high leverage means more fixed costs to the firm.
 s
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The Model Formulated for Risk Analysis for all the five firms is:

DCL

companies in view of the above model.

DFL
DOL

The Values of Ratios / DOL,DFL,DCL/ Beta/ Share Indices compliation for individual

The same is already prepared in excel sheet.