ISSUE 3

IIM K ’S FINA N CI A L
NEW SL E T T ER
5TH JULY, 2008

FROM FY DESK
INSIDE THIS
ISSUE:
We, Team FY, welcome you to The crude oil prices have risen incorporate the same in our
the third issue of the FY News- to $142 per barrel and also further editions.
VOLATILITY- letter. the inflation has reached a 13
STOCK MAR- 1
KETS year high to 11.63%. As per
Firstly, we welcome PGP 12 to
the experts view, the inflation
FIN GYAAN - IIMK and wish them all the
M&AS
2 would continue to rise in the
best for the coming two years.
future till it reaches 13% after
FIN-TERVIEN This issue is a further attempt
WITH PROF 2 which it would subsequently
to make the learning of fi-
NAIR subside.
nance more interesting and
FOOD FOR simpler.
2 We shall also look at the vari-
THOUGHT
ous aspects of mergers and
STOCK MAR-
Continuing from the previous
acquisitions and briefly de-
KETS- edition, we take you on a jour-
TECHNICALS 3 scribe the various defensive
VS FUNDA- ney of the Stock Markets. The
MENTALS strategies. The historic merger
markets are highly volatile with
between AOL and Time Warner
FIN- the indices fluctuating on a
TERESTING is the event for this issue from
PAST - AOL- 3 daily basis. We make an at-
the fin-teresting past.
TIME WARNER tempt to know the reasons
behind the same. Also we try
FIN-CTIONARY 3 Lastly, we thank you for all the
to throw light on the difference
suggestions and critics for the
between technical and funda-
FIN-TRIVIA 4 newsletter and we shall try to
mental analysis.

FIN WATCH VOLATILITY—STOCK MARKETS - ASHISH A.(PGP11)

The bourses across the globe
 1$ = Rs. 43.30 are so much more volatile this
year. Is it just the investor ex-
 Inflation 11.63%
pectations that are causing this
or are there much deeper rea-
 BSE –2.44% (30 Jun
sons? Let‟s try and dissect a
to 4 Jul)
few of the reasons which have
MARKET WATCH led to this phenomenon
1. The FIIs reallocating their
funds from risky emerging mar-
kets to more stable developed
markets; US recession and sub
prime crisis being some of the
major reasons triggering this
2. Increased event related vola-
tility due to movement of capital
across the markets
3. The commodity market vola-
tility is affecting the equity mar-
kets in a much greater fashion
now
4. A very few Indian companies
have a hedging strategy to
address the issues of currency
fluctuations leading to one
more source of market volatil-
ity
5. The local political risk preva-
lent due to the general elec-
tions scheduled in 2009
6. International crude oil prices
and domestic inflation going up
are some of the other major
reasons causing volatility in the
markets
Looking at all of the above
cited reasons it looks that the
Indian markets success story is
going to end. But as per the
recent world report, the GDP of
India is continuously growing
at a rate higher than the world
average; which in addition to
instilling confidence in an in-
vestor is a good sign for the
markets. So people looking for
longer term investments, India
is definitely the place to be in.
 IIMK’S FINANCIAL NEWSLETTER
FIN GYAAN - MERGERS & ACQUISTIONS
Definition: M&A is a general term used to
refer to the consolidation of companies.
The key rationale behind an M&A is 1+1 =
3 i.e. the combined entity creates greater
value for the shareholders than separate
entities.
Classification: An acquisition can be either
by another firm or its own management. In
a merger, the target firm is merged with
the acquiring company and the sharehold-
ers receive its shares. In a consolidation,
the 2 entities combine to form a new entity
which issues shares to its shareholders. In
a tender offer, the acquiring company ac-
FIN-TERVIEW WITH PROF. ABHILASH NAIR
What are the major / macro factors that
have the potential to significantly affect the
Stock Market?
1. Inflation
2. Index of Industrial Product: A business
indicator which helps the analyst to identify
the economic turning points
3. Term Premium Rates: The interest rates
for a particular term
4. Exchange rates are the major factors
which affect the Stock market significantly.
Changes in any of these factors can cause
a huge impact to the market. In addition to
these factors, companies use financial
ratios such as Book Equity to market eq-
uity, etc to understand where they stand in
the market.
How important is Behavioral Finance to
predict the market?
Behaviorists formulate the Fund managers.
The science opens the eyes of hard core
rationalists. But the market actually works
FOOD FOR THOUGHT
Stock Market
1> London Stock Exhange - AIM
2> Does Plunging Stock Market Show Danger of
Private Social Security Accounts? - AARP Bulletin
Today
3> Stock Market Crash of 1929
4> Calculating the Dow Jones Industrial Average
5> Active Trading terms
6> Movies centered around Stock Market
Page 2
quires the outstanding stock of the target
to bypass the management which can also ated from increase in operating income
lead to a hostile takeover. In a manage- whereas in financial synergy the value is
ment buyout, the company‟s own manage- created from higher cash flows or lower cost
ment acquires the company and the com- of capital. Operating synergies can result
pany can cease to exist as a public traded from economies of scale, geographical diver-
company and become a private business. sification, and combination of different func-
If this buyout is done with the help of debt,tions in a business. Financial synergies can
it is known as leverage buyout. result from added debt capacity if the cash
flows of the new entity are more stable and
Synergy: Synergy is the potential additional predictable, and tax benefits by showing
value from combining two firms and is the losses of the acquired firm thus reducing the
main driver for M&A. It can be classified taxable income and thus the tax burden.
into Operating & Financial synergies. Oper-
ating synergy is the additional value cre- Contd Pg4
-RESHMA U. (PGP11)
on the Herd mentality. Behavioral Finance The Stock market players can be divided into
speaks more about the behavior of a ra- Individuals and Institutions. Both these play-
ers work slightly different because of differ-
tionalist. It speaks of various types of in-
ent risk taking abilities. The disposition /
vestors who have different risk taking abil-
ity. However, the hedging manager is more loss aversion in the market is practically the
like a Fund manager. The performance of a reason for the volatility of the market. For an
fund manager is linked to the performance individual, when the stocks the individual is
of the fund. The person has to make maxi- dealing with starts making losses, the indi-
mum money out of the market during his viduals will not sell the stocks immediately.
tenure. His performance is directly propor-They expect the stocks to rise later on.
tional to the profits / money made. How- Hence the individuals have IARA i.e. In-
ever, even if Behavioral Finance tells the creased Absolute Risk Aversion. However, for
Fund manager to invest in a particular an institution, the mentality is to sell the
stock, wherein the market is offloading stocks fast if they are falling. This is because
that stock because of Herd mentality, the for an institution the performance of the
Fund manager, with all the analysis, might Fund managers is directly proportional to the
not want to go ahead and invest. The rea- performance of the Funds. Hence, the insti-
tutions have DARA i.e. Decreasing Absolute
soning behind this is, "since others are not
Risk Aversion. The risk Aversion function can
doing it why should I do it". Hence, the fund
manager also ends up being a part of the be defined as the second order derivative of
herd mentality. Hence, Behavioral Finance the utility function divided by the first order
cannot be used directly during Hedging. derivative of the utility function. The utility
function is that most people are Risk Averse
Can you explain the way Stock markets are i.e. as the risk increases, the expected re-
looked at by Individuals and Institutions? turns increase. It will be a quadratic utility
function. Contd. Pg. 4
Inflation
“It's only when the 1> Business Mergers and Acquisitions in India -
tide goes out that Mint, Corporate News
2> Stock Market Volatility
you learn who's 3> Indian mergers and Acquisitions
4> Planning for a successful M&A
been swimming
5> Grandfather inflation Report
naked.”
-Warren Buffett
 ISSUE 3
STOCK MARKETS – TECHNICALS VS FUNDAMENTALS
The Stock Market has been
highly volatile for the past few
months and the reasons given
are varied. However, let us see
on what basis are the stock
trading decisions made. The two
possible approaches of making
an investment decision: Techni-
cal and Fundamental Analysis.
Technical Analysis – This analy-
sis makes you invest as per the
market sentiments and get
maximum returns. The price
discovery of a script is based on
the demand supply model.
Higher the demand more will be
the supply price. The technical
analyst studies the market
trend and makes the decision of
buying/selling. He feels that the
historical performances are an
indication of the future prices.
The key requirements are the
traded volume and price data of
the script. Historical prices are
FIN-TERESTING PAST
AOL-Time Warner -> Merger takes a brief look at what went Another reason was that after
between equals??!!! wrong.
Year 1999: Companies ac- One of the main reasons was
quired – Netscape, Moviefone, that America Online was never
Nullsoft, Gateway.Net
Year 2000: Shocks the world by analysts criticize that at the
announcing its intention to ac- time of the merger the AOL
quire Time Warner
AOL and Time Warner finally
merged into a new entity, AOL-
Time Warner, which was worth
almost $US 350 billion (The
official merger took place in
2001). On one hand there was
the largest Internet Service Pro-
vider then and on the other was
the largest media company. The
management popped open the
champagne bottles. The cus-
tomers cheered. The stocks of
both the companies shot
through the roof. But what was
touted as “the merger of cen-
tury” soon became derided as
“the worst merger in history”.
This article, like many before it,
Page 3
FIN—CTIONARY
the indicators for technicals.
DEFENSIVE STRATEGIES
Technical analysis is done more To support this with an example
on a short term basis. – If a person wants to buy a TV,
Dawn Raid: Like the dawn raid
there are two approaches. A in war, the corporate dawn
Fundamental Analysis – A fun- technical analyst would just
raid is done early in the morn-
damental analyst makes his analyze the past sales of all the
ing, so by the time the tar-
decision based on the current TV products in the market.
get realizes it's being at-
and future earning capacity of Based on the trends, he would
tacked, it's too late - the inves-
the company. This analysis is make the purchase without
tor has already scooped up
carried out by studying the com- knowing the intrinsic value of
some controlling interest .
pany financial documents like the product. On the other hand,
the auditor‟s report, profit and a fundamental analyst would Greenmail: Company has to
loss statements, quarterly bal- make a detailed study of all the buy its shares at a significant
ance sheets, dividend records products, study its features, premium from another com-
and policies of the companies. It analyse the characteristics and pany, which holds substantial
also includes the study of pro- then make a buy decision. shares, to prevent hostile
duction indices, price statistics takeover. Also known as a
and crop forecasts to gauge the Most investors would advise “Good Bye Kiss”.
state of economy. After the combining both the schools of
evaluation if one feels that the thought, where one approach is Lady Macbeth strategy: Third
used to strengthen the signal by
stock is underpriced then we party poses as a white knight
the other approach. However,
buy. Market price is the indica- the success of investors like to gain trust, but then turns
tor for fundamentals. Funda- Warren Buffet opens up a differ- around and joins with un-
mental analysis is done, more- ent stream of thought. friendly bidders.
over, on a long term basis.
Macaroni defense: The target
company issues a large num-
ber of bonds with the condi-
tion they must be redeemed
the merger the entity failed to at a high price if the company
implement their vision and is taken over.
strategies. They lacked the abil-
ity to discover new trends in the Pac-man defense: The target
as big as Time Warner. Most industry, because of which their firm turns around and tries to
acquire the other company
competitors surged ahead. For
eg: AOL failed to offer broad- that has made the hostile
stocks were overvalued be- band access as soon as possi- takeover attempt.
cause of the Internet bubble. ble.
Poison Pill: Target company
The assumptions of a 25% su-
makes its stock less attrac-
pernormal growth rate and a 5% Furthermore, the primary rea-
tive by selling more of its
terminal period growth rate put son for the merger, according to
shares to existing sharehold-
the valuation of the company at company executives, was for
ers at discount .
US$ 93 per share. The valuation AOL to get access to Time War-
made sense considering the ner‟s vast cable network and for
White Knight: A company that
environment at that time but it Time Warner to be able to pub-
makes a friendly takeover
was clearly not realistic and lish their vast sources of infor-
offer to a target company that
sustainable. But since AOL was mation online. But this accord-
is being faced with a hostile
worth as much as Time Warner ing to some critics could have
takeover from a separate
was, they got the same voting been achieved through licensing
party.
rights and power. Yet, two years agreements and joint ventures,
after the merger the stock price keeping the companies sepa-
of the new entity fell to a new rate. This would have avoided
low – a decrease of over 90%. corporate culture clash that the
In January of 2002, it an- companies faced.
nounced a staggering loss of
around US$100 billion.
 Page 4

Mail us at fy@iimk.ac.in Financially Yours (FY) is the

FIN-TERVIEW
In case of Mergers and Acquisi-
tions, it is seen that the acquirer
company's stocks experience a
dip immediately after the acqui-
sition. However, since the Ac-
quirer company has actually
acquired a new company, it has
expanded its horizon and in-
creased the probability of book-
ing higher profits. Then why is
there a dip in the Acquirer com-
pany's stocks?
Consider the TATA Corus deal.
The deal propelled TATA into
international market and in-
creased the expected profits.
However, the stock price of
TATA experienced a fall immedi-
ately after it acquired Corus.
The investors expected TATA to
book higher margins of profits
at a later stage. However, there
is a large gestation period be-
fore the TATA actually books
profits. The longer the gestation
period, the higher the risk asso-
ciated with investing in the
stocks. With increase in risk, the
expected returns of the inves-
tors also increase. When the
analysts determine the Current
Stock price, they have to divide
the predicted Cash flows with
-CONTD FROM PG2
the Expected returns which are
very high. Hence, the current
Stock price falls and the Stocks
experience the Dip.
We express our special thanks
to Prof. Abhilash Nair for having
taken out time for the interview
and sharing his opinions.
finance interest group of IIMK.
The prime objective of FY is to
promote and develop an inter-
est in the field of finance.
Through a variety of activities
all round the year like holding
sessions, competitions, orga-
nizing seminars for Horizons
and management events for
Backwaters, FY facilitates the
learning process and encour-
ages friendly competition
among fin enthusiasts.
However, being an „interest‟
group our efficient working
depends on the enthusiastic
participation from the stu-
dents.

FIN - GYAAN -CONTD FROM PG 2

Process: When executing an M&A, the ac- the acquiring company needs to develop
quiring company can first develop an ac- ways to raise the finances to fund the ac-
quiring strategy which forms the underlying quisition. This could 100% stock, 100%
motive of the acquisition. This would re- cash or a mix of both. The company can
quire the company to understand the use its own finances or borrow debt de-
emerging trends in the particular sector pending upon the future financial implica-
and based on these trends, the company tions. Finally, the negotiation and execu-
needs to find a target which forms in line tion of the deal consummates an M&A. Mridul M 9946103226
with the strategy. Once the target is identi- Rohit J 9946102149
fied, its valuation along with premiums like Saurabh K 9946102142
control premium gives the acquiring com-
Viral S 9946660709
panies an idea of how much to pay. Next,

We invite articles/interesting facts/write-ups from the readers, this being a platform of sharing knowledge amongst all the fin enthusi-
asts. Also, we further look forward for suggestions and ideas for the coming academic year so that we can plan accordingly. Kindly get
in touch with any of the FY coordinators for further details.

FIN TRIVIA 3 -RESHMA UMBARJE(PGP 11)

1. 3. 7.
Across: Down:
2. 4.
1. The lowest price the investor demands for 1. Annuity for full payment for full period
selling of stocks (3) (Abbrv.) (2) 5. 6.
2. Measure of risk of MF's as compared to 3. Estimated Transaction cost - Actual Trans- 9.
Market (5) action cost (8)
8. 11.
5. The points delivered by the Futures ex- 4. Whole-dollar price of offer (6)
change at the fulfillment of futures contract 10.

(Abbrv.) (2) 7. Dollar Price change / Price change of

option ) to 1% change in volatility (5) Solutions for Fin Trivia 2
6. GDP + residents income from outside - non-
residents income from inside (Abbrv.) (3) 8. Rule of Senior creditors paid before junior 1. A 3. C I D
creditors during bankruptcy (Abbrv.) (2) 2. C A L L
8. Federal Tax liability of person (Abbrv.) (3) T C
11. Stock price rise by following the dividend
O 8.B
9. Pre-tax profit / no. of shares (Abbrv.) (3) signal (Abbrv.) (2) 4. F 6. A T E
10. High risk-adjusted returns exhibited by low 5. G I L T

P/E stocks (Abbrv.) (3) O T A

7. D C B