2008

Quest
ion1: NovRTP
Whataret
hei
nvest
ors’r
ight
s& obl
i
gat
ionsundert
heMut
ualFund
Regul
ati
ons?
Ans:
I
nvest
ors’
right
sandobl
i
gat
ionsundert
heMut
ual
FundRegul
ati
ons:
I
mport
antaspectofthemutualf
undregul
ati
onsandoper
ati
onsisthe
i
nvestor
s’pr
otecti
onanddiscl
osurenor
ms.Itservesthev
erypurposeof
mutualf
undguidel
ines.
Duetothesenor
msi ti
sver
ynecessar
yforthei
nvest
ort
oremainvi
gil
ant
.
I
nvest
orshoul
dconti
nuousl
yeval
uat
etheperfor
manceofmutual
fund.
Fol
lowi
ng ar
et he st
eps t
aken f
ori
mpr
ovementand compl
i
ance of
st
andar
dsofmutual
fund:
1. Allmutualfundsshoulddiscl
oseful
lport
fol
ioofthei
rschemesi nthe
annualreportwit
hinonemont hofthecloseofeachf inanci
alyear
.
Mutualfundshoul
deithersenditt
oeachunithol
derorpubli
shitbyway
ofanadv er
ti
sementinoneEngli
shdai
lyandoneinregi
onall
anguage.
(
1)
2. TheAssetManagementCompanymustprepar
eacompl i
ancemanual
anddesi
gninternalaudi
tsy
stemsi
ncl
udi
ngauditsy
stemsbefor
ethe
l
aunchofanyschemes.
Thet r
ust
eesar ealsorequir
edt oconsti
tut
eanaudi tcommi t
teeofthe
trustees which wi l
lr evi
ew t he i
nter
nal audit systems and the
recommendat ionoft heint
ernalandstatut
oryaudi
tr eport
sandensure
theirrect
if
icat
ion.
3. TheAMCshal lconstit
uteanin-houseval
uationcommitteeconsi
sti
ngof
seni
orexecuti
vesincludi
ngpersonnelfr
om accounts,f
undmanagement
andcompliancedepar t
ments.Thecommi tteewouldonar egul
arbasi
s
revi
ewthesystem practi
ceofvaluat
ionofsecuri
ti
es.
4. Thet r
usteesshallreview allt
ransact
ionsoft
hemut
ualf
undwi
tht
he
associ
atesonar egularbasis.
I
nvest
ors’
Right
s:
1. Unithol
derhav
epropor
ti
onat
eri
ghtint
hebenef
ici
alownershi
poft
he
schemesasset
saswellasanydi
vi
dendori
ncomedeclar
edundert
he
scheme.
2. Recei
vedi
vi
dendwar
rantwi
thi
n42day
s.
3. AMCcanbet
ermi
nat
edby75%oft
heuni
thol
der
s.
 CAFi
nal-SFM

4. Ri
ghttoinspectmaj
ordocument si.
e.mat
eri
alcont
ract
s,Memor
andum
ofAssoci
ati
onandArti
clesofAssoci
ati
on(
M.A.&A.A)oftheAMC,Of
fer
documentetc.
5. 75% oft
heunitholder
shav
ether
ightt
oappr
oveanychangesi
nthe
cl
oseendedscheme.
6. Ev
eryuni
thol
derhav
eri
ghtt
orecei
vecopyoft
heannual
stat
ement
.
Legal
li
mit
ati
onst
oinv
est
ors’
right
s:
1. Unitholder
scannotsue the t
rustbuttheycan i
nit
iat
e pr
oceedi
ngs
againstt
hetrust
ees,
ift
heyf
eelt
hattheyar
ebei
ngcheated.
2. Excepti
ncert
ainci
rcumstancesAMCcannotassur
easpeci
fi
edl
evelof
ret
urntothei
nvest
ors.AMCcannotbesuedtomakegoodanyshort
fal
l
i
nsuchschemes.
I
nvest
ors’
Obl
igat
ions:
1. Aninvest
orshoul
dcar ef
ull
ystudytheriskf
actor
sandotheri
nfor
mati
on
prov
idedintheofferdocument.Fail
uretostudywi
llnotent
it
lehi
mfor
anyri
ghtsther
eaf
ter.
2. I
tist
heresponsi
bil
i
tyoftheinvest
ort
omonit
orhi
sschemesbyst
udy
ing
t
herepor
tsandotherf
inanci
alstat
ement
softhef
unds.
Quest
ion2
Di
sti
ngui
shbet
ween:
(
a) Ev
ent
-Descr
ibedandAct
ivi
ty-
Descr
ibedNet
wor
k
(
b) Pr
imar
yMar
ketandSecondar
yMar
ket
(
c) Caps&Fl
oor
sVs.Swapt
ions
Ans:
(
a) Dist
incti
onbetweenEv ent-Descri
bedorAct i
vi
ty-
Descr i
bedNetwor kOft
en,
anet workisdescribedbyst ati
ngtheev ent
s,i.
e.,thestartandfini
shof
acti
viti
es.Usuall
y,t hePERTnet workisdescribedbyev ent
s,because
acti
viti
esconsumi ngt i
mear econsidereduncer tai
nandapr obabil
i
sti
c
approachisresort
edt o.Intheso-cal
ledCPM net work,act
ivi
ti
esbetween
two nodes,i.e.,the ar c elements,are stat
ed.Her e,the nodes ar
e
dependentont hedet erminist
icassessmentofact iv
iti
es.
However,t
his disti
ncti
on based on descr i
bing the pr
ocedur
e ei
ther
thr
oughnodesorbyact i
vit
iesisf astdi
sappearingandbothPERTand
CPM canbedescr i
bedi nterchangeablybyeitheroftheabovemethods.
Butiti
simportantthataconsi stentconvent
ionisadheredtothr
oughout
thenet
worklogic.

2 Rahul
Mal
kan
 CAFi
nal-SFM

(
b) Di
sti
nct
ionbet
weenpr
imar
yandsecondar
ymar
ket
s
(
1) Nat ureofSecurit
ies:Thepr imarymar ketsdeal swit
hnewsecur iti
es,that
i
s,secur it
ies,whi chwer enotpr eviouslyav ai
labl
eandar e,t heref
or e,
offeredtot heinvest i
ngpubl i
cf ort hef ir
sttime.Themar ket
,t heref
or e,
derivesitsnamef rom thefactt hati tmakesav ail
abl
eanew bl ockof
secur i
ti
esforpublicsubscr i
ption.Thest ockmar ket
,ontheotherhand, i
s
amar ketforoldsecur i
ti
es,whi chmaybedef inedassecuri
ties,whi ch
hav ebeeni ssuedal r
eadyandgr antedst ockexchangequot ation.The
stockexchanges,t heref
ore,providear egularandconti
nuousmar ketfor
buy i
ngandsel l
ingofsecur i
ti
es.
(
2) Nat ur eofFi nancing:Anot heraspectr el
atedt ot hesepar atef unct i
onsof
these t wo par t
s of t he secur i
ti
es mar keti st he nat ure of t heir
cont ribution toi ndust ri
alf inancing.Si nce t he pr i
mar y mar ket i s
concer nedwi thnewsecur ities,itprov i
desaddi ti
onalf undst ot hei ssui ng
compani esei t
herf orst artinganew ent erpriseorf ortheexpansi onor
diver sif
ication oft he exist i
ng one and,t her efore,i t
s cont ribution t o
companyf i
nancingi sdi r
ect .Incont rast,thesecondar ymar ketscani nno
cir
cumst ancesuppl yaddi ti
onalf undssi ncet hecompanyi snoti nv olved
i
nt het ransaction.Thi s,howev er,doesnotmeant hatthest ockmar kets
donothav er el
ev ancei nt hepr ocessoft ransf erofr esour cesf rom
sav er stoi nvestors.Thei rrol er egardingt hesuppl yofcapi tali sindi r
ect.
Theusualcour seint hedev elopmentofi ndust r
ialenterpriseseemst obe
thatt hosewhobeart heinitialbur denoff inanci nganewent erprisepass
i
ton t o ot herswhen t he ent erpr
ise becomeswel lest ablished.The
exist enceofsecondar ymar ketswhi chpr ovidei nsti
tutionalf acili
tiesf or
thecont inuouspur chaseandsal eofsecur i
ti
esand,t othatext ent,lend
l
iqui dityandmar ket abil
it
y ,playani mportantpar tinthepr ocess.
(
3) Organizational Differences: The st ock exchanges hav e phy sical
exi
stenceandar el ocatedinapar ticulargeographicalarea.Thepr i
mar y
marketi snotr ootedi nanypar t
icularspotandhasnogeogr aphical
exi
stence.The pr i
mar y mar kethas nei t
herany t angi
blef orm any
admi ni
strati
veor ganizati
onalsetupl i
ket hatofstockexchanges, norisit
subjected t o any cent r
ali
zed cont roland admi nist
rati
on f or t he
consummat ionofi tsbusiness.Iti
sr ecogni zedonlybyt heservicest hat
i
trender stot helendersandbor rower sofcapi t
alfundsatt heti
meofany
part
icularoper at
ion.
(
c) Di
sti
nct
ionbet
weenCaps&f
loor
svs.Swapt
ions
Forcaps/
floor
s,ther
elevantst
ochasti
cv ar
iableistheimpli
edf or
ward
rat
ef oreach ti
me bucket.Comparati
vely
,t he under
lyi
ng st
ochast
ic

3 Rahul
Mal
kan
 CAFi
nal-SFM

vari
ableforswapt ionswoul dbet hef orward-
starti
ngswap.I tisal so
i
mpor tanttonot et hataswapt i
onwi l
lactual
lyonl yhasonedat eof
exerci
secompar edt oacap( whichisessent i
all
yaser iesofseparatecall
opti
onsonf or
war dr ates).Althought hecashf low dat eswil
lbesi milar
,
eachcapletinacapshoul dbet r
eatedindependent l
y.Onceaswapt ionis
exerci
sed,allthecashf lowsont heunder l
yi
ngI RSoft heswaptionwi l
l
occur.Thereisconsequent lyquiteabi gdiff
erencebet weena2- yearcap
on3- monthinstr
ument( at otalof7opt i
ons)anda3- mont hswaptionon
an18- monthforwar d-startIRS( onlyasi ngleoption).Thisdiff
erencei s
ref
lectedi
nt hefactthatswapt ionsattractalowerpr emi um.
Wher eswapt ionsareusedt ohedgeabor rowing,i twoul dappearatf i
rst
glancet hatt hecostoft hepr emi um ofswapt ionswoul dcancelany
benef i
t.Thiswouldbet hecasei ft hehedgewer epr i
cedentir
elyofft he
forwardcur ve,asisthecasewhencapsar eused.Thev ol
ati
li
tyelement
i
nt he cap pr emium i s det ermi ned by t aking i nto account t he
considerati
onofeacht i
mebucket .Aspoi nt edout ,aswapt i
onishowev er
anopt iononaf orwardstartIRS.Thev olatil
it
ycur veistheref
oredr awn
aroundt heswapandnott hef orwar dcurv e.Theswapcur vewi l
lalway s
bebel owt hef or
wardcur v
easl ongast het wocur vesarepositi
ve.Thi s
relat
ionshipresult
sf r
om thef actt hattheswapr atei stheonef i
xedr ate
thatcausest hesum oft henetpr esentv aluesoft hef i
xedcashf l
owst o
equal t
hesum oft henetpr esentv aluesoft hef loatingflows.
Anotherdi ff
erencebet ween theinst
rument
si st hefactthatoncea
swaptionisexer ci
sed,thehol
derhasenter
edintoaswap.Thi sswapwil
l
havebeenent er
edi nt
oataf av our
abl
erat
e,buttheholdercansti
lll
ose
moneyi ftheratesmov eagainsthim.Whenacapi sexer
cised,t
hehol
der
cannev erlosemoney .
Quest
ion3: NovPaper
Wr
it
eshor
tnot
esonanyf
ouroft
hef
oll
owi
ng:
(
a) Fi
nanci
alr
est
ruct
uri
ng
(
b) Cr
ossbor
derl
easi
ng
(
c) Embeddedder
ivat
ives
(
d) Ar
bit
rageoper
ati
ons
(
e) Rol
l
ingset
tl
ement
.
Answer
(
a) Financi
alRestr
uctur
ing:Fi
nanci
alr
estructuri
ng,i
scarri
edoutint
ernall
yin
the fir
m wi t
ht he consent of i
tsv ari
ous stakehol
ders.Financi
al
restr
uctur
ingi
sasui tabl
emodeofr estructur
ingofcorporat
efi
rmst hat

4 Rahul
Mal
kan
 CAFi
nal-SFM

havei ncurredaccumul atedsizablelossesf or/ov eranumberofy ears.

As a sequel ,the shar e capit
alofsuch f i
rms,i n manycases,get s
subst anti
all
yer oded/l ost
;inf act,i
nsomecases,accumul atedlosses
overt hey earsmaybemor et hanshar ecapi tal
,causi ngnegat iv
enet
wor t
h.Gi vensuchadi smalst ateoff inancialaf f
air
s,av astmaj ori
tyof
suchf i
rmsar el i
kelytohav eadubi ouspot enti
alf orl i
quidati
on.Can
someoft heseFi rmsber evi
ved?Fi nanci alrestr
ucturi
ngi sonesucha
measur eforther evivalofonlyt hosef i
rmst hatholdpromi se/ pr
ospects
forbet terfinancialperformancei nthey earst ocome.Toachi evethe
desired objective,'suchf ir
mswar r
ant/mer i
tar est
ar twi thaf resh
balancesheet ,whi chdoesnotcont ainpastaccumul atedl ossesand
fi
ctit
iousasset sandshowsshar ecapitalatitsreal/t
ruewor t
h.
(
b) Cross-Bor derLeasi ng:Cr oss-borderl easing i sal easing agr eement
wherel essorandl esseear esituatedi ndi fferentcount ri
es.Thi sr aises
si
gnificantaddi t
ionali ssuesr elati
ngt ot axav oi
danceandt axshel ter
s.It
hasbeen wi delyused i n someEur opean count ries,t o arbitr
aget he
di
fferencei nt het axl awsofdi fferentcount r
ies.Cr oss- borderl easing
have been i n pr actice as a means of f inanci ng infrastructure
devel
opmenti n emer ging nat i
ons.Cr oss-bor derl easing may hav e
si
gnificant appl i
cat i
ons i nf inancing i nfrastruct ure dev elopment i n
emergi ngnat ions-suchasr ailandai rt r
anspor tequi pment ,telephone
andtel ecommuni cations, equipment ,andasset si ncor poratedintopower
generat ion and di stri
but ion systems and ot herpr oj
ectst hathav e
predi
ct ablerev enuest reams.
Amaj orobjecti
veofcr oss-
borderleasesist oreducetheov er
allcostof
fi
nancingthroughuti
lizat
ionbyt helessoroftaxdepreciationall
owances
toreduceitstaxabl
ei ncome,Thet axsav i
ngsar epassedt hr
ought othe
l
esseeasal owercostoff i
nance.Thebasi cpr er
equi
sitesar erelat
ivel
y
hightaxratesinthelessor'
scount r
y,li
beraldepreci
ati
onr ulesandei t
her
veryfl
exi
bleorv er
yfor mali
sti
crulesgoverningtaxowner ship.
(
c) Embedded Der i
vati
ves: An embedded der i
vat
ive is a deriv
ati
ve
i
nstrumentt hati
sembeddedi nanothercontr
act-thehostcont
ract
.The
hostcontractmightbeadebtorequi t
yinstr
ument,alease,
aninsur
ance
contractorasaleorpurchasecont
ract.
Der i
vat
ives requi
re bei ng mar ked-t
o-market thr ough the income
statement,ot
herthanqual i
fyi
nghedgingInstrument s.Thisrequi
rement
onembeddedder ivat
ivesi sdesignedt oensuret hatmar ket-
to-
mar ket
through the income st at
ement cannot be av oided by including
embeddi ng-aderivat
ivei nanothercontr
actorf i
nanci ali
nst
rumentt hat
i
snotmar ket
-t
omar ketthroughtheincomest atement .

5 Rahul
Mal
kan
 CAFi
nal-SFM

Anembeddedder ivati
vecanar isef rom del
iberatefinanci
alengineeri
ng
andint
entionalshi
ftingofcert
ainr isksbetweenpar ti
es.Manyembedded
deri
vat
ives,howev er,ari
seinadv ertentl
ythroughmar ketpract
icesand
commoncont ract
ingar r
angement s.Evenpur chaseandsal econt ract
s
thatquali
fyf orexecutorycont ractt r
eatmentmaycont ai
nembedded
deri
vat
ives.Anembeddedder ivativecausesmodi f
icati
ont oacont r
act'
s
cashfl
ow, basedonchangesi naspeci fi
edvariable
(
d) ArbitrageOper ations:Ar bi
tr
agei sthebuy ingandsel l
ingoft hesame
commodi t
yindi f
ferentmar kets.Anumberofpr ici
ngrelati
onshipsexist
i
nt he f orei
gn exchange mar ket,whose v i
olati
on woul dimpl yt he
existenceofar bitrageoppor tuniti
es-t heoppor t
unit
yt omakeapr ofi
t
withoutr i
sk ori nvestment.These t ransact ions referto adv ant
age
derivedi nthetransact i
onsoffor ei
gncur r
enci esbyt aki
ngt hebenefit
sof
dif
ferencei nratesbet weent wocur renciesatt wodi f
ferentcenter
satt he
samet imeorofdi ff
erencebetweencr ossr atesandact ual r
ates.
Forexample,acustomercangainf r
om arbi
tr
ageoper ati
onbypur chase
ofdoll
arsinthel
ocalmarketatcheaperpr
iceprevail
ingatapointofti
me
andsellt
hesamef orst
erli
ngintheLondonmar ket.TheSter
li
ngwi l
lthen
beusedf ormeeti
nghiscommi t
mentt opaythei mportobl
igati
onf r
om
London.
(
e) Rol l
ingSettl
ement:SEBIi ntr
oducedanew set tlementcy cleknownas
the' roll
i
ngsettl
ementcycl
e' .Thiscycl
est artsandendsont hesameday
andt hesett
lementtakeplaceont he'T+5' day ,whichis5busi nessdays
from t hedat
eoft hetr
ansact i
on.Hence, t
het ransact i
ondoneonMonday
wi l
lbeset tl
edont hefol
lowi ngMondayandt het r
ansactiondoneon
Tuesdaywi l
lbeset tl
edont hefoll
owing- Tuesdayandsoon.Hence
unl i
keaBSEorNSEweekl ysettl
ementcy cle,int herol
li
ngset tl
ement
cy cl
e,t hedecisi
onhast obemadeatt heconcl usi
onoft hetradi
ng
sessi on,onthesameday ,Rol l
i
ngset t
lementcy cleswerei ntr
oducedin
bot hexchangesonJanuar y12, 2000.
I
nternat
ional
ly,mostdev el
opedcount
riesfol
low therol
li
ngset
tl
ement
system.ForinstanceboththeUSandtheUKf oll
owar oi
li
ngset
tl
ement
(T+3)sy st
em,whi l
et he Ger
man stock exchanges f
oll
ow a (
T+2)
sett
lementcycle.
2009
Quest
ion4: MayRTP
Wri
teShor
tNoteona)DebtSecuri
ti
zat
ionb)I
nsi
derTr
adi
ngc)REPOand
REVERSEREPOd)For
eignExchangeRateRi
sk

6 Rahul
Mal
kan
 CAFi
nal-SFM

Ans:
(
a) DebtSecur
it
izat
ion
DebtSecur iti
zat
ion isa pr ocessbywhi ch fi
nanci alassetsl ikel oan
recei
vables,mor tgage backed receivables,cr editcard balances,hi r
e
purchasedebt or
s,leaser ecei
vables,tradedebt orsetcaretr ansformed
i
ntosecur it
ies.Itisbasicallyamet hodofr ecy cl
ingoff unds.Asset s
generati
ngst eadycashf low arepackagedt ogetherandagai nstt hi
s
assetpool smar ketsecur i
ti
esar eissues.Thepr ocessi nvolvedt hree
functi
ons:
(
i) Origi
nat
ion:Againstal oan,securi
tyofthi
skindofsetofasset sare
placedtot hefinancingcompany .Howev er
,creditwort
hinessof
repaymentofloanov eritsl
if
ear etobestruct
ureddependi
ngont he
varyi
ngvolumeofeachi ngr
edientsint
hepool ofasset
.
(
ii
) Pooling:Simil
arloansorreceivabl
esareclubbedtogethertocreate
anunder ly
ingpoolofasset s.Thispoolistransf
err
edi nfavourof
SPV (Speci alpur posevehicl
e),whichactsasat rusteefort he
i
nv estor
.Once,t he assets ar
et ransf
err
ed theyare heldi nt he
organizer
sportf
olio.
(
ii
i)Securit
izat
ion:Itisj obofSPVt ost r
uctureandissuethesecuri
ti
es
on the basis ofassetpool .The secur i
ti
es carr
y coupon and
expectedmat uri
tywhi chcanbeassetbasedormor t
gagebased.
Thesear egener all
ysol dtoinvestorst hr
oughmer chantbankers.
The investor
si nterested i
nt hi
st ype ofsecurit
iesare gener
ally
i
nstit
utionali
nvestorslikemutualfund,i
nsurancecompaniesetc.
(
b) I
nsiderTr adi
ng :I nsidertrading is buyi
ng orsel l
i
ng ordealing in
securi
ti
esofal i
stedcompany ,byadirector
,memberofmanagement ,
an
employeeoranyot herpersonsuchasi nt
ernalorst
atutor
yaudi
tor,
agent,
analy
st consultant et c who hav e knowl edge of materi
al,insi
de
i
nformationnotavailablet
ogener alpubli
c.
Theinsi dertr
adingi sill
egalast hepersonconcern,bydintofhisaccess
toinsideinformat i
onaboutt hecompanybecauseofhi sdirectori
ndi r
ect
i
nvolvementi ntheaf fairsofthecompanyei t
heratoper ati
onlev elor
analysislevel
,makespr ofi
tindeal
ingwithsharesandothersecurit
ieson
thebasi sofsecr etinfor mati
on.Thisprofi
tisconsi
deredt obeill
egalas
thesamei satt hecostofgener ali
nvestor
si nthesecur i
ti
esoft he
companyandt heper sonsi nvol
vedinthi
skindofpracti
ceispunishable.
Thi
s unethi
calpr
act
ice has caused seri
ous concer
ni nIndia and
el
sewhereinthewor
ldfortheinvestor
sast hesamer esul
tsinhuge
l
ossestocommoninvest
orsanddrivi
ngthem awayfrom capi
talmarket
.

7 Rahul
Mal
kan
 CAFi
nal-SFM

I
notherwor
ds,lossofconf
idenceofi
nvestor
scausedbyinsi
dert
rading
hasadamagingeff
ectoncreati
onofcapi
talfort
hegrowt
hofcorporate
worl
d.
(
c) REPOandREVERSEREPO
Ther earemoneymar kettransact
ionsent eredi ntobypl ayer
si nt he
moneymar ketsuchascommer ci
albanks,f i
nancialinst
ituti
ons,l arge
playersli
kemut ualf undbutar einr estr
ictedusebecauseofpol icy
guideli
nesofRBI .Thewor dREPOi sabbr ev
iationofar epurchaseopt i
on.
Anagr eementbywhi chabor r
owersel l
scer t
ainaccept abl
esecur itiest o
al enderagainstfundr eceiv
edandagr eest or ev
erset hetransactionat
anagr eedfut ur
edatei stheessent ialf
eatureofaREPOt ransact ion.I n
essenceitisacont r
actofl endinganddi ff
erencebet weent hepricesof
securit
ies on two dat es willrepresentthe costoff und whi ch t he
bor r
oweragr eestobear .
Asi ngletransact
ionasdescr i
bedabov eisa‘ REPO’transacti
onwhen
viewedf rom thepointoft heborrower-
sell
erofsecuriti
es;t hesame
transact i
on when v i
ewed from the pointofv i
ew ofl ender-
buy
eris
under stood as a ‘REVERSE REPO’ .Hence,essent i
all
y,t her
eis no
differencebet ween“ r
epo”and‘ REVERSEREPO’t ransacti
onexcepti
ng
thatt hei denti
fi
cati
oni sfr
om adi ff
erentpointofview.Theessential
featur eofRepot r
ansacti
onare:
(
i) Afi
nanciali
nst
it
uti
onpl
acescer
tai
nsecur
iti
es(
present
lyr
est
ri
cted
t
oTreasurybil
l
s)witht
hebuyerandborr
owsacer t
ainamountof
money.
(
ii
) Onagivendatespeci
fi
edinadvance(
bet
ween14day
sto1y
ear
)
t
heent
ir
etransact
ioni
srev
ersed.
(
ii
i)Thedi f
ferencebetweenthepur
chaseandsal
epri
ceist
heinter
est
orgaint ot hebuyer.Somet
imesthesel
lermayal
sogainfrom a
tr
ansaction.Thisiswhent hebuyeri
sinneedofsecuri
ti
esand
i
niti
atesthet r
ansact
ion.
(
d) For
eignExchangeRat eRisk:Thisri
skr
elatestotheuncert
aint
yat t
ached
tot
heexchanger atesbetweent wocur
rencies.Forexample,t
heamount
bor
rowedinf or
eigncurrencyi stoberepaidinthesamecur rencyorin
someotheracceptablecurrency.
Thusiftheforei
gncur r
encybecomesst rongerthan(say)Indianrupees,
theIndi
anborrowerhast orepaytheloani ntermsofmor er upeesthan
therupeesheobt ai
nedbywayofl oan.Theext r
arupeeshepay sisnot
duetoanincreaseininter
estrat
ebutbecauseofunf avourableexchange
rat
e.Converselyhewi l
lgaini
fther upeeisst r
onger
.Thef l
uctuati
onin

8 Rahul
Mal
kan
 CAFi
nal-SFM

theexchangeratecausesuncer
tai
ntyandt
hisuncer
tai
ntygi
vesr
iset
o
exchangerat
erisk.
Thef
oll
owi
ngt
ool
sar
eav
ail
abl
etocov
erexchanger
ater
isk:
(
i) Spotcont
ract
s.
(
ii
) Rupeef
orwar
dcont
ract
.
(
ii
i)Rupeer
oll
overcont
ract
.
(
iv)Cr
oss-
cur
rencyf
orwar
dcont
ract
.
(
v) Cr
osscur
rencyr
oll
overcont
ract
.
(
vi)Cr
osscur
rencyopt
ions.
(
vii
)Cur
rencyf
utur
es.
(
vii
i
)Cur
rencyandi
nter
estr
ateswaps.
(
ix)Ar
bit
rage.
Quest
ion5: NOVRTP
Wr
it
eadet
ail
ednot
eont
heFor
war
dRat
eAgr
eement(
FRA)
.
Ans:
Aforwar
dr ateagr eement(FRA)isanov er-
the-counterversionofashor t
i
nter
estratefuture.Pri
maril
yusedasani nter-
bankhedgi nginstrumentin
theear
ly1980s,i tsusehassi ncespreadtoanumberofcor poratesas
well
.Although,as an ov er-
the-
counter,offbalance-sheeti nstrument
,
vol
umef i
gurescanonl ybeguessedat ,theFRAi sverypopul armet hod
ofhedgi
ngi nterestrat
erisk,andvolumei nvar i
ouscur renciesmustr un
tomanybill
ionsofUSdol larsannual
ly.
Af orwardr at
e agreementi san agreementbetween two parti
est o
protectthemselvesagainstfuturemovementsininter
estrates.Under
thecont r
act,t
het wopar t
iesagreetoaninter
estrat
et hatappli
estoa
notionall
oanordeposi tofanagr eedamount,whichistobedr awnor
placedonanagr eedfut
uredat eforaspeci
fi
edter
m.
I
naf orwardr ateagreement ,thebankquot i
ngpr i
cesagr eest opayi t
s
customer( acor porateoranot herbank)thediff
erenceresul t
ingfrom a
changei nLI BOR ( oranot herreferencerat
e)i naspeci fieddi r
ecti
on
compar ed witht he agreed FRA r ate,based on a notionalpr i
ncipal
amountl oanedf oranot i
onalperiodoft i
me.Not ethatthiscani nvolv
e
LIBORei t
herr isi
ngorf all
ing,ast hebankwi l
lquoteat wo- waypr i
ceto
caterforeitherr equi
rement .I
fLI BORshouldmov etheot herway sthe
customermustpayt hebank.Thepay mentt
obemadei neithercaseis
the presentv alue oft he dif
ference inthe two inter
estr ates.Itis

9 Rahul
Mal
kan
 CAFi
nal-SFM

unfor
tunat
elyr atherconfusi
ngthatahedgerwhobuy saf ut
urei
s,i
n
theor
y,agreei
ngt olendcashatthespeci
fi
edrat
e,whereasifhebuy
san
FRAhei sagreeing(inef
fect)t
oborr
owcashatthespecif
iedrat
e.
UnderanFRA
• Thebuyer(bor
rower
)ist
hepar
tyseeki
ngt
opr
otecti
tsel
fagai
nsta
ri
sei
ninter
estrat
es.
• Thesel
ler(
lender
)ist
hepar
tyseeki
ngt
opr
otecti
tsel
fagai
nstaf
all
i
nint
erestr
ates.
I
nAugust1985,t heBr i
tishBanker sAssociati
onissuedstandar
dterms
andcondi t
ionswhi chnow f ormt heusualbasisfordealsinUSdollars,
sterl
ing,Deut schemar ks,Swi ssfrancsandy en.TheAust r
ali
anBankers
Associationhasal sopr oducedasepar at
esetoft er
msandconditions
fordomest i
cAust r
ali
anFRAsr ef
lecti
ngthedomi nanceofbankbill
s( a
discounti nstrument )as t he prevail
i
ng funding arr
angementinthei r
mar ket.
Byconv
enti
on,
FRArat
esar
equotedinter
msoftheti
metot
hest
artand
thet
imetot
heendoft
henot
ional
loanper
iod,
asofnow.
Themai
nfeat
uresoft
heFRAasf
oll
ows:
• AnFRA i
sasi mpleagr
eementbetweent
wopar
ti
es,wi
thdet
ail
s
conf
ir
meddi
rect
lybet
weenthemsel
ves.
• An FRA achi ev es approxi
matelythe same resul
tas f ut
ures or
for
war dcont racts,butof f
ersmuchgr eat
erflexi
bil
i
ty.Star
tdates,
i
nterestperiodsandnot ionalpr
inci
palamountareagreedbythetwo
part
iestot hecont ract
.AnFRAcant heref
orebeexact l
ytai
lor
edt o
sui
tacust omer ’sspecif
icrequi
rements.
Thecustomeragr eesaf uturerat
ewi thabankandatt hebegi
nni
ngof
the specifi
c period (value date),r ecei
ves or pays a cash sum
repr
esentingtheinter
estdifferent
ialbetweentheagreedrat
eandLI
BOR.
Noinit
ialorvari
ati
onmar ginsar einvol
ved.
• I
ft hecustomer’
sv i
ewoft hemarketchanges,hecancl
oseouthis
FRAbyt akingoutar ev
ersi
ngFRA( anequalandopposi
teFRAata
newpr i
ce)
.Thepr i
ceoftherever
singFRAwillr
efl
ectt
hemarketr
ate
fortheper
iodatthetimeofclosi
ngthehedge.
FRAsar ewidelyusedbycor porates,especial
l
yinhi st
or i
call
yhi ghand
volat
il
eint
erestrat
ecountries,suchast heUKandAust rali
a,wher eFRAs
arecommonl yusedtohedgeagai nsttheriskofri
singinterestratesbya
companywi thabor r
owing.Ingener al,FRAsar eusedbycor poratesfor
thefol
lowi
ngbr oadpurposes:

10 Rahul
Mal
kan
 CAFi
nal-SFM

• Tol
ocki
nthecostofbor
rowi
ngonanexi
sti
ngf
loat
ing-
rat
eloan.
• Toguar
ant
eether
ateofi
nter
estacompanyhast
opayonf
utur
e
dr
awdowns.
• To guar
ant
eet
hei
nter
estr
ateear
nedonsur
plusf
undsf
orany
per
iod.
FRAsar eav ai
labl
ei nanyamount ,generall
yfrom ￡ 500,000 orthe
equiv
alentupwards,andarenowavail
ableinabroadrangeofcurr
encies,
i
ncluding US doll
ars,st
erli
ng,Swiss Francs,Deut
schemarks,French
fr
ancs, y
en,gui
lder
sandAust ral
i
andoll
ars.
FRAsar ewidelyquotedouttotwoy earsinEur opeandUS.Customers
cant ransactforanyperiodoveronemont h,incl
udi
ng‘br
oken’ornon-
standarddates.Howev er
,acustomermayhav etopayawiderspr
eadfor
abr oken-dat
eFRA( suchas11/2on41/ 2).UsersofFRAs
1. FRAsar efarmor ewidelyusedthanf uturesbycorporat es.Usuall
y,thi
sis
becausecor porat
es,beinglessinter
est -
ratesensit
iveont hewhol ethan
fi
nancialinstit
uti
ons,do notpl acesuch ahi gh valueon t hef acil
it
y
fut
uresof f
erofbei nginandoutoft hemar ketinmi nutes.Thef orward
rat
eagr eementpr ov
idescor porat
et r
easurerswithappr oximatel
yt he
samehedgi ngbenef it
soff ut
ures,butwi t
hnoneoft het echni
caland
administr
ati
v edif
fi
cult
ies.
2. Banksar ealsoheav yusersoft heFRAmar ket.Themostcommonuseof
FRAsbybanksi stoironoutmi smat chesi nt heshor t-
term st
ructur eof
theirassetsandl i
abil
i
ties.Forexampl e,let’
ssupposeabankf oundt hat
i
thas￡100m ofl endi
ngatsi xmont hs( sayatanav er ageof14%)v ersus
￡100m oft hree-monthdeposi ts(sayatanav erageof12%) .Thatbank
woul dber unni ngther i
skt hatitsheal thy2% pr ofitmar ginont hef ir
st
threemont hsmi ghtbeer odedov erthesecondt hreebyagener alrisein
i
nter estrates,whi chwoul dforceittor oll
overi t
sbor rowingatahi gher
rate.Itmi ghtt hereforeconsi deritprudentt omat chi tsexposur esbut
woul dnotwi sh(orbeabl e)todosobyact ual l
yr est ructur
ingitsl oans
anddeposi ts.Instead,i
tcoul dbuyat hr ee-on-
sixFRAwhi chwoul dlocki n
the r eturni t wouldr ecei
ve ov er t he second t hree mont hs,and
syntheticall
ycr eateamor eprecisemat chofmat urities.
Bankquoti
ngFRApri
cesalluset
hefuturesmar
kettohedgethemsel
ves,
cal
cul
ati
ngwhatproport
ionsoft
henearbyandsucceedingcontr
act
sto
buyorsel
ltomat
cht hei
rFRAposi
ti
ons.Therei
s,asaresul
t,aver
ycl
ose
l
inkbet
weenthefut
uresandFRAmar ket
s.
Quest
ion

11 Rahul
Mal
kan
 CAFi
nal-SFM

Wr
it
eShor
tNot
eson
(
i) Dr
awbacksofi
nvest
ment
sinMut
ual
Funds
(
ii
) ESOSandESPS
(
ii
i)Fact
ori
ngandBi
l
ldi
scount
ing
Ans.
(
i) Dr
awbacksofi
nvest
menti
nmut
ual
funds
(
a) Therei s no guar
antee ofr et
urn as some MutualFunds may
underperf
orm andMut ualFundInv
estmentmaydepreciat
einval
ue
whichmayev eneffecterosi
on/Deplet
ionofpr
inci
palamount
(
b) Diver
sif
icat
ionmaymi
nimi
zer
iskbutdoesnotguar
ant
eehi
gher
ret
urn.
(
c) Mutualfunds perfor
mance isj udged on t he basi
s of past
per
formancerecor
dofv ar
iouscompanies.Butt
hiscannott
akecare
oforguar
anteefut
ureperf
ormance.
(
d) MutualFundcosti
sinvol
vedli
keent
ryl
oad,exi
tload,f
eespai
dto
AssetManagementCompanyetc.
(
e) Ther
emaybeunet hi
calPr
act
icese.g.di
ver
sionofMut
ualFund
amountsbyMutualFund/
stot hei
rsist
erconcer
nsf
ormaking
gai
nsfort
hem.
(
f) MFs,sy
stemsdonotmai
ntai
ntheki
ndoft
ranspar
ency
,theyshoul
d
mai
ntai
n
(
g) ManyMFschemeare,att
imes,subj
ectt
olocki
nper
iod,t
her
efor
e,
denyt
hemar
ketdr
awnbenefi
ts
(
h) Atti
mes,t
hei
nvest
ment
sar
esubj
ectt
odi
ff
erentki
ndofhi
dden
cost
s.
(
i) Redr
essal
ofgr
iev
ances,
ifany,
isnoteasy
(
ii
) ESOSandESPS
ESOS
1. Meani
ng
Employ
ee St
ock Opt
ion Scheme means a scheme underwhi
ch t
he
companygr
ant
sopti
ontoemployees
2. Audi
tor
s’Cer
ti
fi
cat
e
Audit
ors’Cert
if
icat
etobepl
acedateachAGM stat
ingt
hatthescheme
hasbeeni mpl ementedaspert
heguidel
inesandinaccor
dancewiththe
speci
alresolut
ionpassed.

12 Rahul
Mal
kan
 CAFi
nal-SFM

3. Tr
ansf
erabi
l
ity
I
tisnott
ransf
erabl
e.
4. Consequencesoff
ail
ure
Theamountpayablemaybeforfei
ted.I
ftheopt
ionsar
enotvest
eddue
t
onon-f
ulf
il
lmentofcondi
ti
onrel
ati
ngt ovesti
ngofopti
onthent
heamount
mayberef
undedtotheemploy
ees.
5. Locki
nper
iod
Mini
mum peri
odof1yearshal
lbet
herebetweenthegr
antandvest
ingof
opt
ions.Companyisfreet
ospecif
ythelockinperi
odfortheshar
esissued
pur
suanttoexer
ciseofopt
ion.
ESPS
1. Meani
ng
Employ
eeStockPurchaseSchememeansaschemeunderwhi
cht
he
companyof
fer
sshar
estoemployeesasapar
tofpubl
i
cissue.
2. Tr
ansf
erabi
l
ity
I
tist
ransf
erabl
eaf
terl
ocki
nper
iod.
3. Locki
nper
iod
Oney earfr
om thedateofall
otment.IftheESPSi
spartofpubli
cissue
andtheshar esareissuedtoemployeesatt hesamepri
ceasi nthepubli
c
i
ssue,thesharesissuedtoemployeespursuantt
oESPSshallnotbesubj
ect
toanylockin.
(
ii
i)Fact
ori
ngandBilldi
scount
ing:Themai
ndi
ff
erencesbet
weenFact
ori
ng
andBil
ldi
scount
ingar
e:
(
1) Whil
efact
ori
ngismanagementofbook-debt
s,bi
l
ldi
scount
ingi
sa
sor
tofbor
rowingf
rom commer
cial
banks.
(
2) I
nf act
ori
ngnogr
aceper
iodi
sgi
ven,wher
easi
nbi
l
ldi
scount
ing
gr
aceperi
odi
s3days.
(
3) Forfact
ori
ng ther
eis no Speci
fi
c Act,wher
eas i
n case ofbi
l
l
di
scount
ingNegoti
abl
eInst
rumentsActappl
i
es.
(
4) Fact
oring i
s a portfol
i
o of complementar
yf i
nanci
alser
vices
whereasbi
lldi
scount
ingisusual
l
yoncasetocasebasi
s.
(
5) I
nf actor
ing t
he basi
s off i
nancing i
st urnover.Whereas i
n bil
l
di
scounti
ngitist
hesecurit
yprovisionaswel lasther
equirementof
fi
nancewhichdet
erminetheamountoff inancing.
(
6) I
nfact
ori
ngt
her
iskofbaddebt
sispassedont
othef
act
or,
wher
eas

13 Rahul
Mal
kan
 CAFi
nal-SFM

i
nbi
l
ldi
scount
ingi
tisst
il
lret
ainedbyt
hebusi
ness
Quest
ion6: NovPaper
Whati
sthei
mpactofGDRsonI
ndi
anCapi
tal
Mar
ket
?
Ans:
I
mpactofGl
obalDeposi
tor
yRecei
pts(
GDRs)onI
ndi
anCapi
talMar
ket
Aftert he gl obali
zat
ion oft he I
ndian economy ,accessi bil
i
tyt ov ast
amountofr esour ceswasav ai
labletot hedomest iccor poratesect or
.One
suchaccessi bil
itywasi nt er
msofr ai
sing financialresour cesabr oad by
i
nternationally prudentcompani es.Among ot her
s,GDRs wer et he most
i
mpor tantsour ce off i
nance f rom abr oad atcompet i
ti
ve cost.Gl obal
depositoryr eceiptsarebasi cal
lynegot i
abl ecerti
fi
catesdenomi natedi nUS
doll
ars,t hatrepr esentanon-UScompany ’spubliclytradedl ocalcur r
ency
(I
ndian r upee)equi t
yshar es.Compani es inI ndia,through t he issue of
depositoryr eceipts,havebeenabl et ot ap globalequi tymar kett or aise
for
eigncur rencyf undsbywayofequi ty.
Si
ncetheincept
ionofGDRs,aremarkabl
echangei
nIndi
ancapi
talmar
ket
hasbeenobserv
ed.Someofthechangesar
easf
oll
ows:
(
i) Indi
ancapi
talmarkettosomeext entisshif
ti
ngf
rom Bombayt
o
Luxembur
gandotherfor
eignf
inanci
alcent
res.
(
ii
) Therei sar bi
tr
agepossi bili
tyin GDR i ssues.SincemanyI ndian
compani esareact i
v el
ytradingont heLondonandt heNew Yor k
Exchangesandduet otheexi stenceoft i
medi ff
erences,mar ket
news,sentimentset c.atti
mest hepricesoft hedeposit
oryreceipts
aretradedatdi scountsorpr emi umst ot heunderl
yingstock.Thi s
presents an arbit
rage oppor t
unity whereint he r
eceipts can be
boughtabr oadandsol dinIndiaatahi gherpri
ce.
(
ii
i)I
ndi
ancapitalmar
keti
snol ongerindependentfrom t
herestoft
he
wor
ld.Thi
sputsaddi
ti
onalstrai
nont heinvest
orsastheynowneed
t
okeepupdatedwit
hworldwideeconomicev ent
s.
(
iv)I
ndian ret
ailinvestor
s are compl etel
y sidel
i
ned. Due t o the
pl
acementsofGDRswi t
h Foreign Inst
it
uti
onalInvestor
’son the
basi
sfreepri
cing,theret
aili
nvestor
scannow nol ongerexpectto
makeeasymoneyonheav i
lydi
scountedr i
ght
/publi
cissues.
(
v) Aconsi
der
abl
eamountofforei
gninv
estmenthasfoundit
swayin
t
heIndi
anmar
ketwhi
chhasimprov
edliqui
dit
yint
hecapi
talmar
ket
.
(
vi)Indi
ancapit
almar
kethasst
art
edt
orev
erber
atebywor
ldeconomi
c
changes,
goodorbad.

14 Rahul
Mal
kan
 CAFi
nal-SFM

(
vii
)Indi
ancapi
talmar
kethasnotonl
ybeenwi
denedbutdeepenedas
wel
l
.
(
vii
i
)Ithasnow becomenecessaryforI
ndi
ancapi
talmarkett
oadopt
i
nter
nat
ional
pract
icesi
nit
sworki
ngi
ncl
udi
ngfi
nanci
ali
nnovat
ions.
Quest
ion7
Whatar
ethel
i
mit
ati
onsofCr
edi
tRat
ing?
Ans:
Li
mit
ati
onsofCr
edi
tRat
ing
Credi
trat
ingisav er
yimpor
tantindi
cat
orforpr
udencebuti
tsuf
fer
sfr
om
cer
tainli
mitat
ions.Someofthel
imitati
onsar
e:
(
i) Confli
ctofInterest–Therati
ngagencycoll
ectsf
eesfrom theenti
tyit
rat
esl eadi
ngt oaconfli
ctofinter
est
.Sincetherat
ingmar ketisver
y
compet i
ti
ve,t
her eisadi
stantpossi
bil
i
tyofsuchconfl
ictenter
ingint
o
therat
ingsyst
em.
(
ii
)Indust r
ySpeci ficrathert han CompanySpeci fi
c – Downgr ades are
l
inked toi ndustr
yr athert han companyper formance.Agencies give
i
mpor tance to macro aspect s and nott
o mi cro ones;overr
eactt o
exi
sting condit
ionswhi ch come f r
om opti
mistic/pessi misti
cv i
ews
ari
singoutofup/downt ur ns.Atti
mes,valuejudgment sar
enotr uled
out.
(
ii
i)Rati
ngChanges–Rati
ngsgi
ventoinst
rumentscanchangeoveraperi
od
ofti
me.Theyhavet
obekeptunderconstantwatch.Downgr
adingofan
i
nstr
umentmaynotbet i
melyenought okeepinvest
orseducatedover
suchmatt
ers.
(
iv)Cor
por
ateGov
ernanceI
ssues–Speci
alat
tent
ioni
spai
dto:
(
a) Rati
ngagenci
esget
ti
ngmor
eoft
hei
rrev
enuesf
rom asi
ngl
eser
vice
orgroup.
(
b) Rati
ngagenci esenjoyingadomi nantmar ketposi
ti
on.Theymay
engagei naggressi
vecompetiti
vepr act
icesbyr ef
usi
ngtoratea
col
later
ali
zed/securit
izedi
nst
rumentorcompel ani
ssuert
opayfor
servi
cesrendered.
(
c) Great
ert
ransparencyi
ntherat
ingprocessviz.i
nthedi
scl
osur
eof
assumpt
ionsleadi
ngtoaspeci
fi
cpubli
crati
ng.
(
v) BasisofRati
ng– Rat i
ngsar
ebasedon‘ poi
ntoft
ime’concept
rat
herthanon‘per
iodofti
me’conceptandthusdonotpr
ovidea
dynami
cassessment.

15 Rahul
Mal
kan
 CAFi
nal-SFM

(
vi)CostBenef i
tAnaly si
s– Sincerati
ng i
smandator
y,itbecomes
essent
ialf
orentit
iest ogetthemsel
vesrat
edwi
thoutcar
ryi
ngout
costbenef
itanal
ysis.
2010
Quest
ion8: MayRTP
Expl
aint
hev
ari
oust
ypesofr
iskst
owhi
cht
heSwapDeal
eri
sexposedt
o.
Ans:
I
nt hepr ocessofswap, t
her oleofswapdeal erissignifi
cantinsof arasi t
bringst ogethert wocount er-partieswhosei nterestsarecompl ement aryt o
eachot her.Fort hisrole,ittakesasmal lpar toft heinterestpay mentf l
ow.
Sincet hepr incipalamounti sl arge,evenasmal lpercentageoft hei nterest
pay mentaddsconsi der abl
yt oi tspr ofi
t.But ,ont heot herhand,t heswap
deal erhast of aceav ar i
etyofr isks.I
tisaf actt hattheswapdeal ersar e
prof essionalbodi esandt heyant i
cipatealmostwi t
hcer tai
ntyt hechangesi n
i
nt erestr ateort heexchanger ate.Butt herei sev erypossi bil
i
tyt hatt heir
ant i
cipat i
onpr oveswr ong.I nt hatcase,t heyhav etobeart hei nterestrat e
exposur eort heexchanger at eexposur e.Inaddi tiontot heset wof ormsof
ri
sk,t herear esomeot herfor msofr iskt hattheyar eexposedt o.These
differentf ormsofr i
sksasf ollows:
(
a) I
nterest-r
ateRi sk:Interest-
rateri
skar i
seswhent hei nt
erestrat
eona
part
icul
arl oanf ai
lst okeepabr eastoft hemov ementoft hemar ket
i
nterestrate.Thusi tcanbesai dthatthef i
xedl oansundert heswap
carr
yhi gherrisk.Ont hecont rar
y,fl
oati
ngi nter
estr ateshouldnotbe
ri
skybecausei tchangeswi t
hthechangingpr ofi
l
eoft hemoneymar ket.
Butitdoescar ryriskatl eastbetweentwor esetdateswhent heinter
est
rat
eofapar ti
cularloanmaynotber esetdespitechangesi nthemar ket
i
nterestrates.
Theswapdeal erisfacedwi ththei nt
erest-
rat
er i
sk,especial
lywheni t
hasanakedposi ti
oni ntheswap.Supposet heswapdeal erpaysfixed-
rateinter
esttotheend- userortot hecounter-
party;andinexchangei t
recei
v esLIBOR.I
fLIBORmov estotheswapdeal er
’sdisadvant
age,i
twi l
l
havet opaymor einf orm ofint
erest.Buttheriskcanber educedift he
swapdeal erdoesnothav eanakedposi t
ionandpassesont heriskt o
anothercounter-
part
y.
(
b) Exchange-rat
eRi sk:Changesi ntheexchanger ateareacommonaf fai
r
i
nt hef or
eignexchangemar ket
.Iftheswapdeal erpaysfixedrateof
i
nterestonaloandenomi natedinacurrencywhichisgoingtodepreci
ate,
i
twi l
lhavet opayagr eateramountofi nter
esttot heend-user.Her
eit
maybenot edt hatift
heswapdeal erf
acesbot htheint
erest
-rateri
skand

16 Rahul
Mal
kan
 CAFi
nal-SFM

theexchange-r
ateri
sksimult
aneously
,thequantum ofri
skwil
lbev er
y
l
arge.Ifthet
wor i
sksareposi
tiv
elycorr
elat
ed,t
heriskwil
lbest
il
lhi
gher.
Butiftheyarenegati
vel
ycorrel
atedoruncorr
elat
ed,theri
skwil
lnotbe
sohigh.
(
c) Credi
tRisk:Creditr
iskariseswhenacount er-
partydefaul
tspaymentto
theswapdeal er.Insuchcases,t hecontractist er
minated.However,
ter
minati
onoft hecontractdoesnotprotecttheswapdeal erfr
om loss.
Thisi
sbecauset hecontractist
erminat
edonl ywi t
honecount er
-par
ty.
Theotherneedspay mentwhi cht
heswapdeal erhastomake.
(
d) MismatchRi sk:Thereareoccasionswheni tisdiff
icul
tf ort heswap
dealert
of indaper f
ectmatchforacount er
-party
.Whenaper fectmatch
i
snotav ail
able,t
heswapdeal eroffersconcessionst oattractsuitable
counter
-par t
y.Anysuchconcessioncausesl osst oit.Somet imesaf ter
giv
ingconcessi ons,perf
ectmatchi snotav ai
lableondi f
ferentcount s,
suchasnot i
onalprinci
pal
,maturi
ty,swapcoupon,r esetdat es,etc.The
swapdeal ermayhav et
opaymor einter
est.
(
e) SovereignRisk:Sov erei
gnriskar
iseswhenthegover
nmentofacount r y
towhi choneoft hetwocount er
-part
ybel
ongs,put
srestri
cti
onsont he
fl
ow off oreignexchange.Thi sentai
l
suponpay ment
sr ecei
vedbyt he
swapdeal er.Itshouldnotbecalledtodef
aul
tri
skorcreditri
skbecause
thecount er-
partyiswi ll
i
ngt omakepay ment
s.Itisthegov er
nment al
rest
ri
ct i
onthatcomesi ntheway.
(
f) Del
iv
eryRi sk:Deli
veryri
skarises when t
he two counter
-par
ti
es ar
e
l
ocatedint
wodi f
ferentt
imezonessothatthedateofmaturi
tydif
fer
sby
oneday.However,t
heswapdealeri
snotv er
ymuchaf f
ectedbyit.
Quest
ion9
Wr
it
eShor
tNot
eson
(
i) Enumerat
ethe basi
c di
ff
erences bet
ween cash and der
ivat
ives
market
.
(
ii
) Appli
cati
onofDoubl
etaxat
ionagr
eement
sonGl
obaldeposi
tor
y
recei
pts.
(
ii
i)RepoandaRev
erseRepo.
Ans:
(
i) The basi
c di
ff
erences bet
ween Cash and t
he Der
ivat
ive mar
ketar
e
enumerat
edbelow:-
(
a) I
ncashmar kettangi
bleasset
sar etr
adedwher easinderi
vati
ve
mar
ketcont
ract
sbasedont angi
bleori
ntangi
blesasset
sli
keindex

17 Rahul
Mal
kan
 CAFi
nal-SFM

orr
atesar
etr
aded.
(
b) Incashmarket
,wecanpurchaseevenoneshar
ewher
easi
nFut
ures
andOpti
onsminimum l
otsarefi
xed.
(
c) Cash marketi
s moreriskythan Futur
es and Opt
ions segment
becausei
n“Fut
uresandOpti
ons”r
iskisli
mit
edupto20%.
(
d) Cash assets may be meantfor consumpt
ion or invest
ment
.
Deri
vat
ivecont
ract
saref
orhedgi
ng,
ar bi
tr
ageorspecul
ation.
(
e) Thevalueofder
ivati
vecontr
actisal
waysbasedonandl
inkedtothe
under
lyi
ngsecur
ity.Thoughthi
sli
nkagemaynotbeonpoint
-t
o-poi
nt
basi
s.
(
f)Int he cash mar
ket
,a customermustopen securit
ies t
radi
ng
accountwi t
hasecurit
iesdeposi
tor
ywher eastot
radefuturesa
customermustopen af utur
et r
adi
ng accountwi
th aderivat
ive
broker
.
(
g) Buyi
ngsecur
iti
esincashmar keti
nvolv
esput
ti
ngupallthemoney
upf
rontwhereas buy
ing f
utures si
mplyi
nvol
ves put
ti
ng up t
he
margi
nmoney .
(
h) Withthepurchaseofshar
esofthecompanyincashmarket
,the
hol
derbecomespartowneroft
hecompany.Whi
leinf
utur
eitdoes
nothappen.
(
ii
)(a)Dur i
ngtheper iodofj udi
ciar
yowner shipofsharesinthehandsoft he
overseasdepositorybank, theprovisi
onsofav oidanceofdoubletaxat
ion
agreementent eredintobyt heGov ernmentofI ndiawit
ht hecountryof
resi
denceoft heov erseasdeposi torybankwi l
lbeappl icabl
eint he
mat t
eroft axati
onofi ncomef rom dividendsfrom theunderli
neshares
andt heint
erestonf oreigncurrencyconv ert
ibl
ebounds.
(
b) Duri
ngt heperi
odi fany,whentheredeemedunder li
nesharesar eheldby
thenon-resi
dencei nvest
orsont r
ansferfrom j udici
aryowner shipofthe
overseasdepositorybank,beforetheyaresol dt oresidentpurchasers,
the avoidance ofdoubl et axat
ion agreementent ered into by the
governmentofI ndiawi t
ht hecountryofr esidenceoft henon- r
esi
dent
i
nvestorwi l
lbeappl icableinthemat teroft axat
ionofi ncomef r
om
div
idendsf rom theunder li
neshares,ori nt
er eston f or
eign curr
ency
converti
blebondsoranycapi t
algainsari
si ngoutoft hetransferofthe
underli
neshares.
(
ii
i)ARepodealisonewher eeli
giblepar
ti
esenteri
ntoacontractanot
herto
borr
ow moneyatapr edeter
mi nedrat
eagainstthecol
l
ateralofeli
gibl
e
secur
it
yforaspeci
fi
edperiodoft i
me.Thelegalt
itl
eofthesecuri
tydoes

18 Rahul
Mal
kan
 CAFi
nal-SFM

changes.Themot iv eoft hedeali st ofund apositi

on.Though t he
mechanics essent
iall
yr emains the same and the contr
actv i
rt
ual l
y
remainsthesame,incaseofr everseRepodealtheunderly
ingmot i
veof
thedealistomeett hesecur it
y/i
nstrumentspeci
fi
cneedsort olendt he
money .I
ndianRepomar ketisgov ernedbyReserveBankofI ndia.At
presentRepoispermi t
tedbet ween64pl ayer
sagainstCentr
alandSt ate
Gov er
nmentSecuri
ties(includi
ngT- Bi
ll
s)atMumbai.

Quest
ion10: Maypaper
Br
ief
lyexpl
ainwhati
sanexchanget
radedf
und.
Ans:
ExchangeTr adedFunds(ETFs)wereintr
oducedinUSi n1993andcame
toIndi
aar ound2002.ETFi sahy br
idproductthatcombinesthefeaturesof
anindexmut ualfundandstockandhence, i
salsocall
edindexshares.These
fundsar eli
stedont hestockexchangesandt hei
rpri
cesarelinkedt othe
underl
yingindex.Theauthor
izedpart
ici
pantsactasmarketmakersforETFs.
ETFcanbeboughtandsol dl i
keanyotherst
ockonst ockexchange.I
n
ot
herwor ds,theycanbeboughtorsol danytimeduri
ngthemar kethour
sat
pr
icesthatareexpect edtobeclosertotheNAVattheendoft heday.NAVof
anETFi sthev al
ueoft heunderl
yingcomponentofthebenchmarkindexhel
d
bytheETFpl usallaccrueddi
videndslessaccr
uedmanagementf ees.
Therei
snopaperworkinvolvedfori
nvesti
nginanETF.Thesecanbe
boughtli
keanyot
herst
ockbyjustplaci
nganorderwi
thabr
oker
.
Someot
heri
mpor
tantf
eat
uresofETFar
easf
oll
ows:
1. I
tgivesaninvest
orthebenef
itofinvest
inginacommodi tywi
thout
phy
sical
l
ypur
chasingt
hecommodit
ylikegold,
sil
ver
,sugaret
c.
2. I
tisl
aunchedbyanassetmanagementcompanyorot
herent
it
y.
3. Theinv
est
ordoesnotneedt
ophysi
cal
l
ystor
et hecommodi
tyorbearthe
cost
sofupkeepwhi
chispar
toft
headmini
str
ativ
ecost
softhefund.
Quest
ion11:
Li
standbr
ief
lyexpl
aint
hemai
nfunct
ionsofani
nvest
mentbank
Ans:
Mai
nFunct
ionsofanI
nvest
mentBank

19 Rahul
Mal
kan
 CAFi
nal-SFM

Thef
oll
owi
ngar
e,br
ief
ly,
asummar
yofi
nvest
mentbanki
ngf
unct
ions:
-Managi
ng an I
PO (Ini
ti
alPublic Of
feri
ng)
:Thi sincl
udes hi
ri
ng
manager
stothei
ssue,duedi
l
igenceandmarket
ingt
heissue.
-I
ssueofdebt
:Whenacompanyrequi
rescapi
tal
,i
tsomet
imeschooses
toi
ssuepubl
i
cdebti
nst
eadofequi
ty.
-Merger
sandAcqui si
ti
ons:Act
ingasi
nter
medi
arybet
weenAcqui
rer
andtar
getcompany
-Pr
ivat
ePl acement
:A privat
eplacementdif
fer
sl i
tt
lefr
om apubli
c
off
eri
ngasidefr
om thefactt
hatapri
vat
eplacementi
nvol
vesaf
ir
m
sel
li
ngst ockorequit
yt opri
vat
einvest
orsrathert
hantopubli
c
i
nvestor
s.
-Fi
nanci
alRestructur
ing:When a company cannotpay its cash
obli
gati
ons–i tgoesbankr
upt.Inthi
ssit
uati
on,acompanycan,of
course,
choosetosi mpl
yshutdownoperati
onsandwal
kawayor ,i
t
canalsorest
ruct
ureandremaininbusi
ness.
Quest
ion12: NovRTP-si
mil
art
oquest
ionsal
readydi
scussedNovPaper
Quest
ion13
(
a) (
i) Whati
sthemeani
ngofNBFC?
(
ii
) Whatar
ethedi
ff
erentcat
egor
iesofNBFCs?
(
ii
i) Expl
ainbr
ief
lyt
her
egul
ati
onofNBFCsunderRBIAct
.
(
b) Expl
aint
heconcept‘
Zer
odat
eofaPr
oject
’inpr
ojectmanagement
.
(
c) Gi
vet
hemeani
ngof‘
Caps,
Floor
sandCol
l
ars’
opt
ions.
(
d) Di
sti
ngui
shbet
weenOpen-
endedandCl
ose-
endedSchemes.
(
e) Expl
ainCAMELmodel
incr
edi
trat
ing.
Ans:
(
a)(
i) Meani ngofNBFC( NonBankingFi nancialCompanies)NBFCst ands
forNon-Bankingf i
nanci
alinst
it
ut i
ons,andt hesearer egul
atedbyt he
ReserveBankofI ndiaunderRBIAct ,1934.NBFC’spri
ncipalbusi
nessis
recei
vingofdepositsunderanyschmeorar r
angementori nanyother
manner or lending on any ot her manner .They nor mall
y provi
de
supplementar
yfinancetothecorporatesector.
(
ii
) Di
ff
erentcat
egor
iesofNBFCar
e
1. Loancompani
es
2. I
nvest
mentCompani
es.

20 Rahul
Mal
kan
 CAFi
nal-SFM

3. Hi
rePur
chaseFi
nanceCompani
es.
4. Equi
pmentLeasi
ngCompani
es.
5. Mut
ual
Benef
itFi
nanceCompani
es.
6. Housi
ngFi
nanceCompani
es
7. Mi
scel
l
aneousFi
nanceCompani
es
(
ii
i)Regul
ati
onofNBFCs-
RBIAct
RBIr
egul
atest
heNBFCt
hrought
hef
oll
owi
ngmeasur
es:
(
a) Mandat
oryRegi
str
ati
on.
(
b) Mi
nimum ownedf
unds.
(
c) Onl
yRBIaut
hor
izedNBFCscanacceptpubl
i
cdeposi
ts.
(
d) RBIpr
escr
ibest
hecei
l
ingofi
nter
estr
ate.
(
e) RBIpr
escr
ibest
heper
iodofdeposi
t.
(
f) RBIpr
escr
ibest
hepr
udent
ial
nor
msr
egar
dingut
il
izat
ionoff
unds.
(
g) RBIdi
rect
sthei
rinv
est
mentpol
i
cies.
(
h) RBIi
nspect
orsconducti
nspect
ionsofsuchcompani
es.
(
i) RBIprescri
besthepoi
ntswhi
chshoul
dbeexami
nedandr
epor
tedby
theaudit
orsofsuchcompani
es.
(
j) RBIpr
escri
besthenormsf orprepar
ati
onofAccount
spar
ti
cul
arl
y
pr
ovi
sioni
ngofpossi
blel
osses.
(
k) I
fanyofint
erestorpri
nci
palorbothi
s/areduefrom anycustomer
formorethan 6 months,the amountisrecei
vabl
e( int
erestor
pri
nci
pal
orboth)ist
ermedasnon-perf
ormi
ngasset.
(
b) ZeroDateofaProjectmeansadat ei
sf i
xedfr
om whi chimplementat i
on
oftheproj
ectbegi
ns.I ti
sast arti
ngpointofi
ncurri
ngcost .Thepr oj
ect
complet
ionperi
odi scountedf rom t
hezerodat e.Pre-
projectacti
v i
ti
es
shoul
dbecompl etedbef or
ezer odat
e.Thepr e-
proj
ectact i
vit
iesshould
becompletedbef
orez erodate.Thepre-
proj
ectacti
vi
ti
esar e:
a. I
dent
if
icat
ionofpr
oject
/pr
oduct
b. Det
ermi
nat
ionofpl
antcapaci
ty
c. Sel
ect
ionoft
echni
cal
hel
p/col
l
abor
ati
on
d. Sel
ect
ionofsi
te.
e. Sel
ect
ionofsur
veyofsoi
l
/pl
otet
c.
f
. Manpowerpl
anni
ngandr
ecr
uit
ingkeyper
sonnel

21 Rahul
Mal
kan
 CAFi
nal-SFM

g. Costandf
inanceschedul
i
ng.
(
c) ‘
CapFl
oor
s&Col
lar
s’opt
ions
Cap: Iti
saseriesofcallopt
ionsoninterestr
atecoveri
ngamedium-
to-
longter
mf l
oati
ngrat
eliabi
li
ty.Pur
chaseofaCapenabl estheaborr
owers
tofixi
nadvanceamaximum bor rowi
ngr at
eforaspeci f
iedamountandfora
specif
ieddur
ati
on,whil
eallowinghimt oavailbenefi
tofaf alli
nrat
es.The
buyerofCappaysapremium tothesell
erofCap.
Floor
: I tisaputopt i
ononi nt
erestr
ate.PurchaseofaFloorenablesa
l
endert ofi
xinadv ance,ami ni
malrateforplaci
ngaspecifi
edamountf ora
specif
ieddurat
ion,whileal
lowinghimt oavailbenefi
tofariseinrates.The
buyerofthefl
oorpay sthepremium t
othesell
er.
Col
lars: ItisacombinationofaCapandFl oor.Thepurchaserofa
Col
larbuysaCapandsi multaneousl
ysell
saFl
oor.ACol larhast
heef f
ectof
l
ockingitspurchasesi
ntoaf l
oati
ngrat
eofint
erestthatisboundedonbot h
hi
ghsideandt helowsi
de.
(
d) OpenEndedandCl
oseEndedSchemes
OpenEndedSchemedonothav ematur
it
yperiod.Theseschemesar e
avai
lableforsubscr
ipt
ionandr epurchaseonaconti
nuousbasis.Invest
orcan
conv eni
entl
ybuyandsel luni
t.Thepr i
ceiscal
cul
atedanddeclaredondai l
y
basis.Thecalculat
edpriceist er
medasNAV.Thebuy i
ngpri
ceandsel li
ng
pri
cei scalcul
atedwithcer t
ainadj ustmenttoNAV.Thekeyf utureofthe
schemei sli
quidi
ty.
CloseEndedSchemehasast ipulat
edmat uri
typeri
odnormall
y5t o10
years.TheSchemei sopenforsubscripti
ononlyduri
ngthespeci
fi
edperi
odat
thet i
meofl aunceoft hescheme.I nvestorcaninvestatt
het i
meofinitial
i
ssueandt hereaf
tertheycanbuyorsel lfr
om stockexchangewheret he
schemei sli
sted.Toprovideanexitroutsomecl oseendedschemesgivean
opti
onofsel l
ingbank(repur
chase)ont hebasisofNAV.TheNAVi sgenerally
decl
ar edonweeklybasis.
(
e) CAMELModeli
nCr
edi
tRat
ing
Camelst
andsf
orCapit
al,Assets,Management,Earni
ngsandLi
quidit
y.
TheCAMELmodeladoptedbytheratingagenci
esdeserv
esspeci
alat
tenti
on,
i
tfocusesont
hefol
l
owingaspects-
(
i) Capital
-Composi
tionofext
ernalfundsraisedandret
ainedear
nings,
fi
xeddi vi
dendscomponentforpr efer
enceshar esandf l
uct
uating
divi
dendscomponentforequit
yshar esandadequacyofl ongterm
fundsadj ust
edt
ogear i
nglevels,abil
it
yofi ssuert
or ai
sefurther
borrowings.

22 Rahul
Mal
kan
 CAFi
nal-SFM

(
ii
) Assets-Revenuegenerat
ingcapacit
yofexisting/pr
oposedasset s,
fai
rv al
ues,technol
ogi
cal
/physi
calobsol
escence,l i
nkageofasset
values t
ot urnover
,consist
ency,appropri
at i
on of met hods of
depreci
ati
onandadequacyofchar getorevenues,size,agei
ngand
recover
abil
i
tyofmonet aryasset
sl i
kereceivablesandi t
sl i
nkage
withtur
nover.
(
ii
i)Management -Extentofi nvol
vementofmanagementper sonnel
,
team-work,aut
hori
ty,t
imeli
ness,ef
fect
ivenessandappr
opri
ateness
ofdecisi
onmaki ngal ongwi t
hdirect
ingmanagementt oachieve
corpor
ategoals.
(
iv)Earni
ngs-Absolutelev
els,t
rends,st
abi
l
ity
,adapt
abi
l
ityt
ocycli
cal
fl
uctuat
ions,abi
li
tyoftheentit
ytoserv
iceexi
sti
ngandaddi
ti
onal
debtsproposed.
(
v) Li
quidi
ty-Effecti
venessofwor ki
ngcapi
talmanagement
,corpor
ate
pol
ici
esf orstockandcr edi
tor
s,managementandtheabi
li
tyofthe
cor
poratetomeett heircommitmenti
ntheshor
trun.
These fi
ve aspectsf or
m the fiv
e core bases f
orestimati
ng cr
edit
worthi
nessofani ssuerwhichl
eadst otheratingofaninstr
ument.Rati
ng
agenci
esdet er
mi net hepre-
dominanceofposi ti
ve/
negat
iveaspect
sunder
eachofthesefivecategori
esandthesearefactoredinf
ormakingtheover
all
rat
ingdeci
sion
2011
Quest
ion14: MayRTP
Di
sti
ngui
shbet
ween
(
a) CashandDer
ivat
iveMar
ket
(
b) Sy
stemat
icRi
skandUnsy
stemat
icRi
sk
(
c) For
fei
ti
ngandFact
ori
ng
(
d) For
war
dandFut
ureCont
ract
s
Ans:
a) Fol
l
owing ar
emai
ndi
ff
erencesbet
weenCashMar
ketand Der
ivat
ive
Market
.
(
i) I
ncashmar kett angi
bleasset
sar etr
adedwher easinderi
vati
ve
marketcont
ractsbasedont angi
bleori
ntangi
blesasset
sli
keindex
orr
atesaretraded.
(
ii
)I ncashmarket
,wecanpurchaseevenoneshar
ewher
easi
nFut
ures
andOpti
onsminimum l
otsarefi
xed.

23 Rahul
Mal
kan
 CAFi
nal-SFM

(
ii
i)Cash marketi
s moreriskythan Futur
es and Opt
ions segment
becausei
n“Fut
uresandOpti
ons”r
iskisli
mit
edupto20%.
(
iv)Cash asset
s may be meantf
or consumpt
ion or i
nvest
ment
.
Deri
vat
ive
cont
ract
sar
eforhedgi
ng,
arbi
tr
ageorspecul
ati
on.
(
v) Thevalueofder
ivati
vecontr
actisal
waysbasedonandl
inkedtothe
under
lyi
ngsecur
ity.Thoughthi
sli
nkagemaynotbeonpoint
-t
o-poi
nt
basi
s.
(
vi)Int he cash mar
ket
,a customermustopen securit
ies t
radi
ng
accountwi t
hasecurit
iesdeposi
tor
ywher eastot
radefuturesa
customermustopen af utur
et r
adi
ng accountwi
th aderivat
ive
broker
.
(
vii
)Buy i
ngsecur
iti
esincashmar keti
nvolv
esput
ti
ngupallthemoney
upf
rontwhereas buy
ing f
utures si
mplyi
nvol
ves put
ti
ng up t
he
margi
nmoney .
(
vii
i
)Wi ththepurchaseofshar
esofthecompanyincashmarket
,the
hol
derbecomespartowneroft
hecompany.Whi
leinf
utur
eitdoes
nothappen.
(
b) Systemat icriskr eferst ot hev ariabili
t yofr eturnonst ocksorpor tf
olio
associ at
edwi t hchangesi nretur nont hemar ketasawhol e.Itar i
sesdue
tor iskfactorst hataf f
ectt heov erallmar ketsuchaschangesi nt he
nations’economy ,taxr eform byt heGov ernmentorachangei nt he
wor l
dener gysi tuati
on.Thesear er iskst hataf fectsecur i
ti
esov eralland,
consequent ly,cannotbe di versified away .Thi sist he r i
sk whi ch is
common t o an ent i
re cl ass ofasset s orl i
abili
ti
es.The v alue of
i
nv estment smaydecl i
neov eragi vent i
meper i
odsi mpl ybecauseof
economi cchangesorot herev ent st hati mpactl ar gepor tionsoft he
mar ket. Asset al l
ocat i
on and di ver sif
icat i
on can pr otect agai nst
systemat i
cr isk because di f
fer entpor t
ions oft he mar kett end t o
under perf
orm atdi fferentt i
mes.Thi si s al so called mar ketr i
sk.
Unsy stematicr iskhowev er,referst or iskuni quet oapar t
icularcompany
orindustry.Itisav oidablet hroughdi ver sif
icat i
on.Thisist her iskofpr ice
change due t ot he uni que ci rcumst ances ofa speci fic secur i
t yas
opposedt otheov erallmar ket.Thi sr iskcanbev i
rtuall
yel i
mi natedf rom
apor t
fol
iothroughdi v
er sifi
cation.
(
c) Forf
eit
ingwasdev el
opedt ofinancemedi
um tolongterm contr
actsfor
fi
nancingcapi
talgoods.Forf
eiti
ngisamechanism offi
nancingexports.
Thisisaform offixedrat
ef i
nancewhichinv
olvesthepurchasebyt he
for
fei
tureoftrader ecei
vabl
esnor mal
lyinthef orm oftradebill
sof

24 Rahul
Mal
kan
 CAFi
nal-SFM

exchange or promi
ssor
y not
es,accept
ed by t
he buyer wi
tht
he
endorsementorguar
ant
eeofabanki
nthebuy
er’
scount
ry.
Thebenef i
tsar
et hatt
heexport
ercanobt ainful
lval
ueofhisexpor
t
contractonornearshipmentwit
houtrecourse.Theimport
eronthe
otherhandhasext
endedpaymentt
ermsatfixedrat
efi
nance.
Theforf
eit
uretakesovert
hebuyerandcountr
yri
sks.For
fei
ti
ngprov
ides
arealal
ter
nati
vetothegover
nmentbackedexpor
tfi
nanceschemes.
Fact oringcanhowev er,broadl ybedef inedasanagr eementi nwhi ch
receiv ablesar isi
ngoutofsal eofgoods/ servi
cesar esol dbya“ fi
rm”
(cl
ient )t othe“ factor”(af i
nancialinter
medi ary)asar esultofwhi cht he
ti
tlet ot hegoods/ servi
cesr epresentedbyt hesaidr eceivablespasseson
tot hef actor.Hencef orth,thef act
orbecomesr esponsi bleforallcredit
cont rol,salesaccount i
nganddebtcol l
ect i
onf r
om t hebuy er(s)
.Inaf ul
l
servicef actori
ngconcept( withoutrecour sefacil
ity
)i fanyoft hedebt ors
fai
lst opayt heduesasar esul tofhisfinancialinstabil
ity/insolvency/
bankr upt cy,thef actorhastoabsor bt helosses.

(
d) Di
sti
nct
ionbet
weenf
orwar
dandf
utur
escont
ract
s
1. Tradi
ng:Forwardcont
ract
saretr
adedonpersonalbasi
sorontel
ephone
orother
wise.Futur
escont
ract
saretr
adedi
nacompet i
ti
vear
ena.
2. Si
zeofcont r
act:For
wardcontr
act
sareindiv
iduall
ytail
oredandhaveno
standardi
sed si
ze.Futur
es cont
ract
s are standar
dised i
nt er
ms of
quantit
yoramountasthecasemaybe.
3. Organised exchanges:For ward cont
ract
s aret
raded i
n an overthe
countermar ket.Fut
ur escontract
saret r
adedonorgani
sedexchanges
withadesignatedphy sical
locati
on.
4. Sett
lement
:For
war dcontr
actssett
lementtakespl
aceonthedat
eagr
eed
uponbetweentheparti
es.Futur
escontractsset
tl
ement
saremadedail
y
vi
aexchange’
scleari
nghouse.
5. Deli
ver
ydate:Forwardcont r
actsmaybedel iv
eredonthedat esagreed
uponandintermsofact ualdeli
ver
y.Fut
urescontr
act
sdeliver
ydatesare
fi
xedoncycli
calbasisandhar dl
ytakespl
ace.However
,itdoesnotmean
thatt
herei
snoact ualdeli
ver
y.
6. Transacti
oncosts:Costoffor
wardcontr
act
si sbasedonbi d– ask
spread.Futur
escont
ract
sent
ail
broker
agef
eesforbuyandsel
lorder
s.
7. Mar
kingtomar ket
:Forwar
dcontract
sarenotsubj
ecttomarkingto
mar
ket.Fut
urescontr
act
saresubj
ecttomar
kingt
omarketi
nwhichthe

25 Rahul
Mal
kan
 CAFi
nal-SFM

l
osspr
ofi
tisdebit
edorcr
edi
tedi
nthemar
ginaccountondai
l
ybasi
sdue
t
ochangei
nprice.
8. Margins:Margins are notrequi
red i
nfor
ward cont
ract
.Inf
utur
es
contr
actsever
ypar t
ici
pantissubj
ecttomai
ntai
nmargi
nasdeci
dedby
theexchangeauthor
iti
es.
9. Credi
tRi sk:I
nforwar
dcont
ractscredi
tri
skisbornebyeachpart
yand,
ther
efore,everypart
yhast o bot
herforthe cr
edit
wor
thinessoft
he
counter–party.
I
nfutur
escontr
actsthet
ransact
ionisat wowayt r
ansact
ion,hencet
he
par
ti
esneednott
obot
herforthecr
edi
twor
thi
nessofeachpart
y.
10.Li
abil
it
yext
ent:Infor
wardcont
ract
sthel
iabi
l
ityhappenst
obeunl
i
mit
ed
becausemarketfl
uct
uat
ionmaybewide.
I
nFut
uresContracttheext
entofl
oss/pr
ofi
tisknowneverynextdayand
dependingont heri
sktaki
ngcapaci
tyofthepar
ty,exposur
emaybe
li
mited.
Quest
ion15: Maypaper
(
a) Zer
ocouponbonds
(
b) I
nter
estswap
(
c) I
nter
-BankPar
ti
cipat
ionCer
ti
fi
cat
e
(
d) Meani
ngandAdv
ant
agesofNet
ti
ng
(
e) Nost
ro,
Vost
roandLor
oAccount
s
Ans:
(
a) Asnamei ndicatest hesebondsdonotpayi nterestdur i
ngt hel i
feofthe
bonds.I nstead,zer ocouponbondsar ei ssuedatdi scountedpr i
cet o
thei
rf acev alue,whi chi st heamountabondwi l
lbewor thwheni t
mat uresorcomesdue.Whenazer ocouponbondmat ur
es,t heinvestor
willrecei v
eonel umpsum ( f
acev alue)equal tothei nit
ialinvestmentplus
i
nterestt hathasbeenaccr uedont hei nv estmentmade.Themat ur
ity
datesonzer ocouponbondsar eusuallylongt erm.Thesemat ur i
tydat
es
all
owani nvest orforal ongr angepl anning.Zer ocouponbondsi ssuedby
banks,gov ernmentand pr ivate sectorcompani es.Howev er,bonds
i
ssued bycor por atesect orcar ryapot entiall
yhi gherdegr eeofr i
sk,
dependi ngont hef i
nancialst rengthoft hei ssuerandl ongermat ur
ity
peri
od, buttheyal soprovideanoppor t
unityt oachi eveahi gherr etur
n.
(
b) Aswapi sacontract
ualagreementbet
weentwoparti
estoexchange,or
"swap,
"fut
urepay mentstr
eamsbasedondi f
fer
encesintheretur
nst o
dif
fer
entsecur
it
iesorchangesi nt hepr
iceofsomeunder l
yingitem.

26 Rahul
Mal
kan
 CAFi
nal-SFM

Interest r ate swaps const itutethe most common t ype of swap

agr eement .Inaninterestrateswap, t
hepar t
iestot heagr eement ,t
ermed
theswapcount er
par t
ies,agreet oexchangepay ment si ndexedt ot wo
differentinterestrates.Totalpay mentsaredet er
mi nedbyt hespeci fi
ed
not i
onal princi
palamountoft heswap, whichi snev eractuallyexchanged.
Financi alintermediari
es,suchasbanks,pensi onf unds,andi nsurance
compani es,aswel lasnon- financi
alfir
msusei nterestr ateswapst o
effectivelychanget hemat uri
tyofout st
andi ngdebtort hatofani nterest-
bear i
ngasset .Swapsgr ew outofpar allelloanagr eement si nwhi ch
fir
msexchangedl oansdenomi natedindif
fer entcur r
encies.
(
c) TheIBPCsar eshor t-
terminst r
ument stoeven-
outtheshort-t
erml i
quidit
y
withi
nthebanki ngsy stem.Thepr i
maryobject
iveist oprov i
desome
degreeoff l
exibil
it
yint hecreditpor t
fol
i
oofbanksandt osmoot hent he
consort
ium ar rangement s.The I BPC can be issued by schedul ed
commer cialbankandcanbesubscr i
bedtobyanycommer ci
albank.The
IBPCisi ssuedagai nstanunder ly
ingadvance,classi
fi
edst andardand
theaggregateamountofpar ti
cipati
oninanyaccountt i
mei ssue.During
thecurrencyoft hepar ti
cipati
on,theaggregateamountofpar ti
cipat
ion
shouldbecov eredbyt heout st
andingbalanceinaccount.
Thepart i
cipat
ioncanbei ssuedi ntwot ypes, vi
z.withandwi thoutr
iskto
thelender.Whi l
ethepar t
ici
pationwi t
houti tcanbei ssuedf oraper i
od
notexceedi ng 90 days.Par ti
cipation is now wi thr i
sk fora per i
od
between91day sand180day s.Thei nterestrateonI BPC isfreel
y
determinedi nthemar ket.Thecer tifi
catesar eneithertransfer
abl
enor
prematurelyredeemablebyt hei ssuingbank.I nthecaseoft hebank
i
ssuingI BPCwi thri
sk,theaggr egateamountofpar t
ici
pationwouldbe
reducedf r
om theaggregateadv anceout standing.
Theschemei sbenefi
cialbotht otheissui
ngandpar tici
patingbanks.The
i
ssuingbankcansecur efundsagai nstadvanceswi t
houtact uall
ydilut
ing
i
tsasset-mix.Abankhav ingthehi ghestloanst ototalassetr at
ioand
l
iqui
ditybi
ndcansquar et hesituati
onbyi ssuingIBPCs.Tot helender,i
t
provi
desanoppor t
unityt o depl
oyt heshor t-t
erm surplusf undsi na
securedandprof
itabl
emanner .
(
d) I
tisat echni
queofopt i
mi singcashfl
owmov ementswiththecombi ned
efforts of the subsidiaries ther
eby reducing administrati
ve and
tr
ansact i
oncost sresulti
ngf rom curr
encyconv er
sion.Ther ei saco-
ordinatedint
ernati
onalinterchangeofmat er
ial
s,fi
nishedpr oductsand
partsamongt hediff
erentuni t
sofMNCwi thmanysubsi diariesbuy i
ng
/sell
ingfrom/toeachot her.Netti
nghel
psinmi nimi
singthetot alvol
ume
ofintercompanyfundflow.

27 Rahul
Mal
kan
 CAFi
nal-SFM

Adv
ant
agesder
ivedf
rom net
ti
ngsy
stem i
ncl
udes:
1) Reducest henumberofcross-
bordert
ransact
ionsbetweensubsi
diar
ies
thereby decr
easi
ng the over
alladminist
rat
ive cost
s ofsuch cash
transfer
s
2) Reducestheneedforfor
eignexchangeconversi
onandhencedecr
eases
tr
ansact
ioncostsassoci
atedwit
hf or
eignexchangeconv
ersi
on.
3) I
mprovescashfl
owfor
ecast
ingsi
ncenetcasht
ransf
ersar
emadeatt
he
endofeachper
iod
4) Gi
vesan accur
ater eportand set
tl
esaccount
sthr
ough co-
ordi
nat
ed
ef
for
tsamongallsubsidi
ari
es.
(
e) I
ni nterbank t r
ansact i
ons,f orei
gn exchange i st ransfer
red from one
accountt o anotheraccountandf r
om onecent ret o anothercent re.
Ther efore,thebanksmai ntainthreetypesofcur rentaccountsinor derto
facil
itatequi cktransferoff undsindi fferentcurrencies.Theseaccount s
areNost ro,Vost r
oandLor oaccount smeani ng“our”,“your
”and“ thei
r”.A
bank’ sf orei
gncur r
encyaccountmai ntainedbyt hebanki naf or
eign
count ryandi nt hehomecur r
encyoft hatcount r
yi sknownasNost r
o
Accountor“ ouraccountwi t
hy ou”.Forexampl e,AnI ndianbank’sSwi ss
francaccountwi t
habanki nSwi tzerland.Vost roaccounti st helocal
currencyaccountmai ntainedbyaf orei gnbank/ branch.Itisalsocalled
“youraccountwi thus”.Forexampl e,Indi anrupeeaccountmai ntai
nedby
abanki nSwi tzerl
andwi t
habanki nI ndi
a.TheLor oaccounti san
accountwher ei
nabankr emi tsfundsinf orei
gncur rencytoanotherbank
forcr edittoanaccountofat hir
dbank.
Quest
ion16: NovRTP
Wr
it
eashor
tnot
eon
(
a) Random Wal
kTheor
y
(
b) Thr
eef
ormsofEf
fi
cientMar
ketHy
pot
hesi
s
(
c) Gr
eenShoeOpt
ion
(
d) Funct
ionsofMer
chantBanker
s
(
e) Sensi
ti
vi
tyanal
ysi
sinCapi
tal
Budget
ing
Ans:
(
a) Manyinvest
mentmanagersandstockmarketanalyst
sbeli
evethatstock
marketpri
cescanneverbepredict
edbecauset heyarenotar esultof
anyunderly
ingfact
orsbutaremer estati
sti
calupsanddowns.Thi s
hypot
hesisisknownasRandom Wal khy
pothesiswhichstat
est hatthe
behavi
ourofstockmarketpr
icesisunpredi
ctabl
eandt hatthereisno

28 Rahul
Mal
kan
 CAFi
nal-SFM

rel
ationshipbet weent hepr esentpri
cesoft heshar esandt heirfuture
pri
ces.Pr oponent softhishy pot
hesi
sar guethatstockmar ketpricesar e
i
ndependent .ABr it
ishstat
istici
an,M.G.Kendel l
,f oundthatchangesi n
securit
ypr i
cesbehav enear lyasiftheyar egener atedbyasui tably
designed r oulet
t e wheelf or whi
ch each out come i s st ati
sticall
y
i
ndependentoft hepasthi story
.Inotherwor ds,thef actthatt herear e
peaks and t roughs i n st
ock exchange pr i
ces i s a mer e statisti
cal
happening– successi vepeaksandt roughsar eunconnect ed.Int he
l
ayman' sl anguagei tmaybesai dthatpr i
cesont hestockexchange
behav eexact lyt hewayadr unkwouldbehav ewhi l
ewal kinginabl ind
l
ane,i .
e.,upanddown,wi thanunst eadywaygoi ngi nanydi recti
onhe
l
ikes,bendi ngont hesideonceandont heothersidet hesecondt i
me.
Thesuppor
ter
soft
hist
heor
yputoutasi
mpl
ear
gument
.Itf
oll
owst
hat
:
(
i) Pricesofsharesinstockmar ketcannev erbepredi
cted.Thereasonis
thatthepri
cetrendsarenotther esul
tofanyunderly
ingfact
ors,butt
hat
theyrepr
esentastati
sti
calexpressionofpastdat
a.
(
ii
) Ther
emaybeper i
odicalupsordownsinsharepri
ces,butnoconnection
canbeestabl
i
shedbetweent wosuccessi
vepeaks(hi
ghpriceofstocks)
andtr
oughs(l
owpriceofstocks)
.
(
b) TheEMHt heoryisconcer nedwithspeedwi thwhichinfor
mat i
oneffects
thepri
cesofsecuri
ties.Aspert hestudycar ri
edouttechnicalanal
ystit
wasobservedthatinformat i
onisslowlyincorpor
atedinthepr i
ceandi t
prov
ides an opport
uni t
yt o earn excess profi
t.Howev er,once t he
i
nformati
onisincor
por at
edt heni
nvestorcannotear nthi
sexcessprofit.
LevelofMar ketEff
ici
ency:Thatpr iceref
lect
sallav
ail
abl
einf
ormat
ion,
thehighestorderofmar keteffi
ciency.Accordi
ngtoFAMA,ther
eexist
thr
eelevelsofmarketeff
iciency
:-
Weakform ef
fi
ciency–Pri
cer
efl
ectal
li
nfor
mat
ionf
oundi
nther
ecor
dof
pastpr
icesandvolumes.
Semi–Strongef
fi
ciency–Pri
cerefl
ectnotonl
yallinf
ormati
onfoundin
ther
ecor
dofpastpricesandv
olumesbutalsoal
lotherpubl
i
clyavai
labl
e
i
nfor
mati
on.
St
rongfor
m eff
ici
ency–Pr
icer
efl
ectal
lav
ail
abl
einf
ormat
ionpubl
i
cas
wel
laspri
vat
e.
(
c) I
tisanopt i
onthatal l
owst heunderwrit
ingofanIPOt osel
ladditi
onal
sharesi
fthedemandi shi gh.I
tcanbeunder st
oodasanopt i
ont hat
al
lowstheunder
wr i
terforanewi ssuetobuyandresel
laddi
ti
onalshares
uptoacert
ainpr
e-determinedquantit
y.

29 Rahul
Mal
kan
 CAFi
nal-SFM

Looking tot he excepti

onali nter
estofi nvestor
si nt erms ofov er
-
subscri
ptionoftheissue,certai
npr ovisi
onsaremadet oi ssueaddit
ional
sharesorbondst ounderwr i
tersfordi st
ri
bution.Thei ssuerauthorises
foraddi
tionalsharesorbonds.I ncommonpar l
ance,itistheretent
ionof
over-
subscripti
ontoacer t
ainextent.Itisaspecialfeatureofeuro-i
ssues.
Ineuro-
issuestheinter
nationalpracti
cesar ef
ol l
owed.
I
nt heIndi
ancont ext
,greenshoeopt i
onhasal i
mi t
edconnotati
on.SEBI
guidel
i
nesgov erningpublicissuescontainappropri
ateprovi
sionsfor
accepti
ngover-
subscr i
pti
ons,subj
ecttoaceil
ing,say,15percentofthe
off
ermadet opubl i
c.Incertai
nsituati
ons,t
hegr een-shoeopti
oncan
evenbemor ethan15percent .
Exampl
es:
• I
DBIhadcome–upear l
ierwi
ththeirFl
exi
bonds(Ser
ies4and5).Thi
sisa
debtinst
rument
.Eachoftheserieswasini
ti
all
yfl
oatedf
or`750crores.
SEBIhadpermit
tedIDBItor
etai
nanexcessofanequalamountof`750
cror
es.
• I
CICIhadlaunchedthei
rfi
rstt
rancheofsaf
etybondsthr
oughunsecur
ed
r
edeemabledebenturesof`200cr or
es,wi
thagreenshoeopti
onforan
i
denti
calamount.
• I
nfosysTechnol ogi
eshasexercisedthegr eenshoeoptiontopurchase
upto7,82,000additi
onalADSsrepresent
ing3,91,
000equityshar
es.This
off
erinit
iall
yinvolv
ed5. 22mil
l
iondeposi t
oryshares,r
epresent
ing2.61
mil
li
ondomest i
cequityshar
es.
(
d) The basi cf uncti
on of mer chantbanker or i nvestmentbanker i s
mar keti
ngofcor porateandot hersecur i
ti
es.I nthepr ocess,heper forms
anumberofser vi
cesconcer ning v
ar i
ousaspect sofmar ket i
ng,v iz.
,
originat
ion,under wr i
ti
ng,and di st
ributi
on,ofsecur iti
es.Dur ing the
regimeofer stwhil
eCont rol
lerofCapi talIssuesi nIndia,whennewi ssues
wer epricedatasi gnifi
cantdi scountt otheirmar ketpr i
ces,themer chant
banker ’
sj obwasl imitedtoensur i
ngpr esscov erageanddi spatching
subscr i
ption forms t o every cor neroft he country.Now,mer chant
banker sar edesigninginnov ativeinstrument sandper form anumberof
otherser vicesbothf orthei ssui ngcompani esaswel lasthei nvestors.
Theact ivi
tiesorser vi
cesper for medbymer chantbanker s,i
nI ndia,today
i
ncl ude:
(
a) Pr
ojectpr
omot
ionser
vices.
(
b) Pr
ojectf
inance.
(
c) Managementandmar
ket
ingofnewi
ssues.

30 Rahul
Mal
kan
 CAFi
nal-SFM

(
d) Under
wri
ti
ngofnewi
ssues.
(
e) Sy
ndi
cat
ionofcr
edi
t.
(
f) Leasi
ngser
vices.
(
g) Cor
por
ateadv
isor
yser
vices.
(
h) Pr
ovi
dingv
ent
urecapi
tal
.
(
i) Oper
ati
ngmut
ual
fundsandof
fshor
efunds.
(
j) I
nvest
mentmanagementorpor
tfol
i
omanagementser
vices.
(
k) Boughtoutdeal
s.
(
l) Pr
ov i
dingassi
stancef
ort
echni
calandf
inanci
alcol
l
abor
ati
onsand
j
ointvent
ures.
(
m)Managementofanddeal
i
ngi
ncommer
cial
paper
.
(
n) I
nvest
mentser
vicesf
ornon-
resi
dentI
ndi
ans.
(
e) Sensiti
vityanal y
si si s used i n Capi talbudget i
ng f ormor e precisely
measur ingther i
sk.I thel psinassessi nginformat ionast ohowsensi tiv
e
aretheest imat edpar amet ersoft hepr ojectsuchascashf lows, di
scount
rate,andt hepr ojectl ifetot heest i
mat i
oner rors.Fut ur
ebei ngal ways
uncer t
ainandest imat ionsar ealway ssubj ecttoer ror,sensiti
vityanalysi
s
takescar eofest i
mat ioner r
orsbyusi nganumberofpossi bl
eout comes
i
nev al
uat i
ngapr oject.Themet hodol ogyadopt edi nsensi ti
vi
tyanal ysi
s
i
st oev aluateapr ojectbyusi nganumberofest imat edcashf lowssoas
toprov i
det ot hedeci si onmakerani nsightintot hev ariabi
lit
yofout come.
Thus,iti sat echni queofr i
skanal y
si swhi chstudi est her esponsiveness
ofacr i
teri
onofmer itl i
keNPVorI RRt ov ari
at i
oni nunder l
yingfact or
s
l
ikesel l
ingprice, quant i
tysold,returnsf rom ani nvest mentet c.
Sensi
ti
vi
tyanal
ysi
sanswer
squest
ionsl
i
ke,
(
i) Whathappenst
othepresentvalue(orsomeot hercr
it
eri
onofmer
it
)if
f
lowsare,
say`50,
000t
hant heexpected`80,
000?
(
ii
) Whatwil
lhappent
oNPVift
heeconomi
cli
feoft
hepr
ojecti
sonl
y3y
ear
s
r
athert
hanexpect
ed5y
ears?
Therefore,wherevert hereis an uncertai
nty,ofwhat evertype,the
sensiti
vit
yanal
ysispl ay
sacr ucialr
ole.However,i
tshouldnotbeviewed
ast hemet hodt or emov ether i
skoruncer t
aint
y ,i
tisonlyat oolto
analyse and measur et he ri
sk and uncer
taint
y.I nterms ofcapital
budgetingthepossiblecashflowsarebasedont hreeassumpti
ons:
(
a) Cashf
lowsmaybewor
st(
pessi
mist
ic)

31 Rahul
Mal
kan
 CAFi
nal-SFM

(
b) Cashf
lowsmaybemostl
i
kel
y.
(
c) Cashf
lowsmaybemostopt
imi
sti
c.
Sensi
ti
vi
tyanal
ysi
sinv
olv
est
hreest
eps
(
1) I
dent
if
icat
ionofal
lthosev
ari
abl
eshav
ingani
nfl
uenceont
hepr
oject
’s
NPVorIRR.
(
2) Def
ini
ti
onoft
heunder
lyi
ngquant
it
ati
ver
elat
ionshi
pamongt
hev
ari
abl
es.
(
3) Anal
ysi
softheimpactoft
hechangesi
neachoft
hev
ari
abl
esont
he
NPVofthepr
oject
.
Thedeci
sionmaker
,insensi
ti
vi
tyanal
ysi
sal
way
saskshi
msel
fthequest
ion–
whatif?
Quest
ion17: NovPaper
Wr
it
eshor
tnot
esonoft
hef
oll
owi
ngs:
(
a) Capi
tal
Rat
ioni
ng
(
b) Embeddedder
ivat
ives
(
c) Deposi
tor
ypar
ti
cipant
(
d) Moneymar
ketmut
ual
fund
(
e) Leadi
ngandl
aggi
ng
(
f) Takeov
erbyr
ever
sebi
d
Ans:
(
a) CapitalRationing:Whent hereisascar cit
yoff unds,capitalrati
oningis
resortedto.Capi talrati
oningmeanst heut i
lizat i
onofexi st
ingfundsi n
mostpr ofi
tabl
e mannerbysel ecti
ng the accept able projectsint he
descendingor derorr ankingwi t
hl i
mitedav ailablefunds.Thef ir
m must
be abl eto maxi mi ze the profi
ts bycombi ning the mostpr ofitabl
e
proposals.Capi t
alrationi
ngmayar i
seduet o( i)externalfactorssuchas
highbor r
owingr ateornon- avai
labil
i
tyofloanf undsduet oconst r
aintsof
Debt -
Equit
yRat io;and( ii
)Int
ernalConstrai
nt sI mposedbymanagement .
Projectshouldbeaccept edasawhol eorreject ed.Itcannotbeaccept ed
andexecut edinpi ecemeal .
I
RRorNPVar ethebestbasi sofev aluationev enunderCapit
alRati
oning
si
tuati
ons.The obj ectiveist o selectt hose proj
ects whi
ch hav e
maximum and posi ti
ve NPV. Pr eference should be gi ven t o
i
nterdependentprojects.Projectsaret ober ankedintheorderofNPV.
Wher et her
ei s mul t
i-peri
od CapitalRat i
oning,LinearProgrammi ng
Technique should be used t o maxi mize NPV.I nt imes ofCapi tal
Rati
oning,theinvestmentpol i
cyoft hecompanymaynotbet heoptimal

32 Rahul
Mal
kan
 CAFi
nal-SFM

one.
(
b) A deri
vat
ivei s defined as a contractthathas allthe f
oll
owing
char
acter
ist
ics:I
tsv aluechangesinresponsetoaspeci
fi
edunderl
yi
ng,
e.
g.anexchangerate, i
nter
estrat
eorsharepri
ce;
I
trequi
resl
i
ttl
eornoi
nit
ial
neti
nvest
ment
;
I
tisset
tl
edataf
utur
edat
e;
Themostcommonder
ivat
ivesar
ecur
rencyf
orwar
ds,f
utur
es,opt
ions,
i
nter
estr
ateswapset
c.
Anembeddedder ivati
veisader iv
at iv
ei nst r
umentt hatisembeddedi n
anothercontract–t hehostcont ract.Thehostcont ractmi ghtbeadebtor
equit
yi nstr
ument ,a lease,an i nsurancecont ractora sal eorpur chase
contract
.Der i
vativesr equi
ret o bemar ked-to-mar kett hr
ough t heincome
stat
ement ,othert hanqual i
fyi
nghedgi ngi nstrument s.Thisr equi
rementon
embeddedder i
vativesar edesignedt oensur et hatmar k-
to-marketthrough
the i
ncome st atementcannotbe av oided byi ncluding -embeddi ng -a
deri
vativ
ei nanot hercont r
actorf inanciali nstrumentt hatisnotmar ked-
to
marketthroughthei ncomest atement .
Anembeddedder i
vativecanar i
sef r
om deliber
atefi
nancialengi
neeri
ng
andintenti
onalshift
ingofcer t
ainri
sksbet weenpar ti
es.Manyembedded
deri
vati
ves,howev er,ar i
se inadver
tentl
yt hrough mar ketpracti
ces and
commoncont r
acti
ngar rangements.Ev enpurchaseandsal econtract
sthat
qual
ifyforexecut
orycont racttr
eatmentmaycont ai
nembeddedder i
vat
ives.
Anembeddedder ivati
vecausesmodi ficat
iontoacont r
act'scashfl
ow,based
onchangesinaspeci fi
edv ari
abl
e.
(
c) Deposi tory Parti
cipant s:Undert his sy st em,t he secur i
ties ( shares,
debent ures,bonds,Gov ernmentSecur iti
es,MFuni tset c.)ar ehel di n
electronicformjustl i
kecashi nabankaccount .Tospeedupt het ransfer
mechani sm of secur i
t i
es f rom sal e,pur chase,t ransmi ssi on,SEBI
i
nt r
oducedDeposi torySer vicesal soknownasDemat eri
alizationofl isted
secur it
ies.Iti
st hepr ocessbywhi chcer tif
icateshel dbyi nvestorsi n
phy sicalform areconv er
tedt oanequi val entnumberofsecur it
iesi n
electronicform.Thesecur iti
esar ecr edit edt ot hei nvest or ’
saccount
mai ntainedthroughani ntermedi arycal ledDeposi t
or yPar ticipant( DP).
Shar es/Securi
ti
esoncedemat eri
al i
zedl oset heirindependenti dentiti
es.
Separ ate number s ar e al lot
t ed f orsuch demat eri
alized secur iti
es.
Organi zati
onholdingsecur iti
esofi nvestor si nel ectr
oni cf orm andwhi ch
render s servi
ces r elated t ot r
ansact ions i n secur it
ies i s cal led a
Deposi tory.A deposi tory hol ds secur ities i n an account ,t ransfers
secur it
iesfrom oneaccounthol dert o anot herwi thoutt hei nvestors

33 Rahul
Mal
kan
 CAFi
nal-SFM

havingtohandl
etheseintheirphysi
calform.Thedeposi t
oryisasaf e
keeperofsecuri
ti
esforandonbehal fofthei nvestors.Allcor
porate
benefi
tssuchasDi vi
dends,Bonus,Rightsetc.ar eissuedt osecuri
ty
holder
saswereusedtobei ssuedi
ncaseofphy sicalf
orm.
(
d) Animpor tantpar
toffinanci
almar keti
sMoneymar ket
.Itisamarketfor
short
-ter
m money .Itplaysacruci alr
oleinmai nt
aini
ngtheequil
ibr
ium
betweent heshort-
ter
m demandandsuppl yofmoney .Suchschemes
i
nvesti nsafehighl
yl i
quidinst
rument sincl
udedincommer ci
alpapers
cert
if
icatesofdeposit
sandgov ernmentsecurit
ies.
Accordi
ngly,t
heMoneyMar ketMut ualFund( MMMF)schemesgener all
y
provi
dehighreturnsandhi ghestsaf et
yt otheordinar yinvestor
s.MMMF
schemesar eactiveplayersoft hemoneymar ket.Theychannal li
zet he
i
dleshortfunds,par ti
cular
lyofcor porateworld,tot hosewhor equire
suchfunds.Thisprocesshel pst hosewhohav eidlef undst oearnsome
i
ncomewi t
houttakinganyr i
skandwi t
hsuretythatwhenev ertheywi l
l
needthei
rfunds,theywi l
lget( generallyinmaximum t hreehoursoft i
me)
thesame.Shor t
-t
erm/ emergencyr equirementsofv ariousfir
msar emet
bysuchMut ualFunds.Par t
icipati
onofsuchMut ualFundspr ovi
dea
boosttomoneymar ketandhel pi ncont rol
l
ingthev olatil
it
y.
(
e) Leadi
ngmeansadv anci
ngapay menti
.e.maki
ngapay mentbefor
eitis
due.Lagging i
nvol
ves postponi
ng a paymenti
.e.delay
ing payment
beyonditsduedate.I
nf or
exmar ketLeadi
ngandlaggi
ngareusedf or
twopurposes:
-
(
1) Hedgingf or
eignexchangerisk:Acompanycanl eadpay mentsrequir
ed
tobemadei nacur rencythati slikel
ytoappreci
ate.Forexampl e,a
companyhast opay$100000af teronemonthf r
om today.Thecompany
apprehends the USD to appreciate.Itcan make the paymentnow.
Leadinginvol
v esafi
nancecosti .e.onemonth’sint
erestcostofmoney
usedf orpur
chasing$100000.
Acompanymayl agt hepaymentthati
tneedstomakeinacur r
encyt
hat
i
ti sli
kel
yt odepr eciat
e,provi
dedthereceiv
ingpartyagreesforthi
s
proposi
ti
on.Ther eceivi
ngpartymaydemandi nt
erestf
orthisdel
ayand
thatwoul
dbet hecostofl aggi
ng.
Deci
sionr
egar
dingl
eadi
ngandlaggingshoul
dbemadeaf t
erconsider
ing
(i
)li
kel
ymovementi
nexchangerate(i
i)i
nter
estcostand(
ii
i)di
scount(i
f
any)
.
(
2) Shi
fti
ngtheli
qui
dit
ybymodi fyi
ngthecredi
tter
msbet weeninter
-gr
oup
ent
iti
es:Forexample,A Holdi
ng Companysells goods t
oi t
s 100%
Subsi
diar
y.Nor
malcredi
tter
mi s90days.Supposecostoffundsis12%

34 Rahul
Mal
kan
 CAFi
nal-SFM

forHol dingand15% forSubsidiary.Int hi

scaset heHol dingmaygr ant
creditforlongerperi
odt oSubsidiaryt ogett hebestadv antageforthe
groupasawhol e.I
fcostoff undsi s15% f orHoldingand12% f or
Subsidiary,theSubsi
diarymayleadt hepay mentf orthebestadv antage
oft hegr oupasawhol e.Thedeci sionr egardingleadingandl agging
shouldbet akenonthebasisofcostoff undst obothpay i
ngentit
yand
receivi
ngent i
ty.I
fpay i
ngandr eceivingent i
tieshav edi ff
erenthome
currencies,l
ikel
ymovement si
nexchanger ateshouldalsobeconsi dered.
(
f) General
l
y,abi gcompanytakesoverasmallcompany .Whenthesmal l
er
companygai nscontr
olofal ar
geronet henitiscal l
ed“Take-ov
erby
rever
sebid”.Incaseofrev
ersetake-
over
,asmal lcompanytakesov era
bigcompany .Thi
sconcepthasbeensuccessful
l
yf ol
lowedforrevi
valof
sicki
ndustr
ies.
Theacquir
edcompanyi ssai
dtobebi
gifanyoneoft
hef
oll
owi
ng
condi
ti
onsissat
isf
ied:
(
i) The asset
s of the t
ransf
eror company ar
e gr
eat
er t
han t
he
tr
ansf
ereecompany;
(
ii
) Equit
ycapit
altobei ssuedbythetransf
ereecompanypur
suantt
o
theacqui
sit
ionexceedsit
sori
ginal
issuedcapi
tal
,and
(
ii
i)Thechangeofcont
rolinthetransf
ereecompanywi
llbet
hrought
he
i
ntr
oducti
onofminori
tyholderorgroupofhol
der
s.
Rev
erset
akeov
ert
akespl
acei
nthef
oll
owi
ngcases:
(
1) When the acqui
red company (
big company
)isaf
inanci
all
y weak
company
(
2) When t
he acqui
rer(t
he smallcompany)alr
eadyhol
ds a si
gni
fi
cant
pr
opor
ti
onofsharesoftheacqui
redcompany(
small
company
)
(
3) When thepeopl
eholdi
ng t
op managementpositi
onsint
heacqui
rer
companywanttober
eli
vedof
foft
heirr
esponsi
bil
i
ties.
Theconceptoft ake-overbyrev
ersebid,
orofrever
semer ger
,isthusnot
theusualcaseofamal gamationofasi ckunitwhichisnon-vi
ablewitha
heal
thyorprosper
ousuni tbutisacasewherebytheenti
reundert
akingofthe
heal
thyandpr osper
ouscompanyi st obemer gedandv estedint hesick
companywhi chi
snon-viable.

2012
Quest
ion18: MayRTP

35 Rahul
Mal
kan
 CAFi
nal-SFM

Wr
it
eashor
tnot
eon
(
a) Fi
nanci
alLease
(
b) Di
ff
erencebet
weenSt
ockI
ndexFut
ureandEqui
tyOpt
ion
(
c) EmbeddedDer
ivat
ives
(
d) 100%BookBui
l
dingPr
ocess
(
e) Fact
orsaf
fect
ingEconomi
cAnal
ysi
s
Ans:
(
a) Financi alLease:Fi nanci alleaseagr eementi sal ong-term ar r
angement ,
whi chi si rr
ev ocabledur i
ngt hepr imar yleaseper i
odwhi chi sgener all
y
thef ulleconomi cl
ifeoft hel easedasset .Undert hisarrangementl essor
i
sassur edt or eal
izet hecostofpur chasingt hel easedasset ,costof
fi
nanci ngi tandot heradmi nist
r ativeexpensesaswel lashi spr ofitby
wayofl easer entdur ingt hei nitial( pri
mar y)per i
odofl easi
ngi t self
.
Financi alleasei nvolvest ransfer ri
ngal mostal lther i
sksi nci
dent alt o
owner shi pandbenef itsar i
singt her ef r
om exceptt hel egalt i
tl
et ot he
l
essee agai nst hi si rrev ocable under taking to make uncondi tional
pay ment st ot helessorasperagr eedschedul e.Thisi sacl osedend
arrangementwi thnoopt iont olesseet oterminatet hel easeagr eement
subsequent l
y.I n such l ease,t he l essee has t o bear i nsurance,
mai ntenance and ot herr elated cost s.The choi ce ofassetand i ts
suppl i
eri sgener al
lyleftt ot hel esseei nsucht ransact i
ons.Thev ari
ant s
underf i
nanci al l
easear easunder :
• Lease wit
h purchase opt
ion-
wherethe l
essee has t
he r
ightto
purchaset
heleasedassetsaftert
heexpi
ryofini
ti
all
easeperi
odat
anagreedpri
ce.
• Leasewi
thlesseehavi
ngr esi
dualbenef
it
s-wher
ethelesseehasthe
ri
ghttosharethesaleproceedsoft heassetaft
erexpir
yofinit
ial
l
easeperi
odand/ortorenewtheleaseagreementatalowerr
ental
.
(
b) Di
ffer
encebetweenStockIndexFutur
eandEquityOpti
on:I
nvest
ingin
st
ockfutur
esdif
fer
sfr
om invest
ingi
nequi
tyopt
ionscont
ract
sinsever
al
ways:
• I
nal ongopti
onspositi
on,thei nvest
orhastheri
ghtbutnotthe
obl
igati
ontopurchaseordeli
verstock.Inal
ongfut
ureposi
ti
on,
the
i
nvestorisobl
i
gatedtodel
iverthestock.
• Opti
onstrader
suseamat hemat
icalf
actor
,thedel
tathatmeasures
therel
ati
onshi
pbetweentheopt
ionspremium andthepri
ceoft he
underl
yi
ngstock.Att
imes,
anopti
onscontract
'
svaluemayfl
uctuate

36 Rahul
Mal
kan
 CAFi
nal-SFM

i
ndependent
lyoft
hestockpri
ce.Bycontr
ast
,thef
utur
econt
ractwi
l
l
muchmor ecl
osel
yfol
l
owt hemov ementoft
heunderl
yi
ngst
ock.
(
c) Embedded Der i
vati
ves: An embedded der i
vat
ive is a deriv
ati
ve
i
nstrumentt hati
sembeddedi nanothercont
ract–thehostcont
ract
.The
hostcontractmightbeadebtorequi tyi
nstr
ument,alease,
aninsur
ance
contractorasaleorpurchasecontr
act.
Der i
vat
ives requir
e t o be mar ked-to-
market through the i ncome
statement,otherthanqual i
fyi
nghedgi nginst
rument s.Thisrequir
ement
onembeddedder ivativ
esar edesi gnedt oensuret hatmark-to-market
through the income st atementcannotbe av oided by including -
embeddi ng-ader iv
at i
vei nanothercont r
actorfi
nanci ali
nst
rumentt hat
i
snotmar ked-t
omar ketthroughtheincomest at
ement .
Anembeddedder ivati
vecanar isef rom del
iberatefinanci
alengineeri
ng
andint
entionalshi
ftingofcert
ainr isksbetweenpar ti
es.Manyembedded
deri
vat
ives,howev er,ari
seinadv ertentl
ythroughmar ketpract
icesand
commoncont ract
ingar r
angement s.Evenpur chaseandsal econt ract
s
thatquali
fyf orexecutorycont ractt r
eatmentmaycont ai
nembedded
deri
vat
ives.Anembeddedder ivativecausesmodi fi
cati
ont oacont r
act'
s
cashfl
ow, basedonchangesi naspeci fi
edvariable.
(
d) 100% BookBui l
dingPr ocess:Inanissueofsecurit
iestot
hepublic
thr
oughapr ospectus,t
heopt i
onfor100%bookbuildi
ngisavai
l
abl
et o
anyissuercompany .Theissueofcapi
talshoul
dbe`25cror
eandabove.
Reservati
onforfi
rm all
otmenttot heextentofthepercentagespecified
i
nt he rel
evantSEBIgui del
ines can be made onl yt o promot ers,
‘
per manentemployeesoft heissuercompanyandi nthecaseofnew
companyt othepermanentempl oyeesoft hepr
omoti
ngcompany ’
.I
tcan
alsobemadet osharehol
dersoft hepromot i
ngcompani es,i
nt hecase
ofnew companyandshar eholder
sofgr oupcompaniesi nthecaseof
existi
ngcompanyei t
heronacompet i
ti
vebasi soronaf i
rm allot
ment
basis.
(
e) Factor
s aff
ecti
ng Economic Anal
ysi
s:Some oft
he economy wi
de
fact
orsar
ediscussedasunder
:
(
i) Growt hRatesofNat i
onalI ncomeandRel atedMeasures:Formost
purposes,whati simportantist hediff
erencebetweent henomi nal
growthr ate quoted by GDP and t he ‘r
eal’growth aft
ert aki
ng
i
nflati
oni nt
oaccount .Theest imatedgr owthr at
eoft heeconomy
woul dbeapoi nt
ertot hepr ospectsfort heindust
ri
alsector,and
therefor
et other et
urnsi nvestorscanexpectf r
om investmentin
shares.

37 Rahul
Mal
kan
 CAFi
nal-SFM

(
ii
) GrowthRatesofIndust
rialSector:Thiscanbef urt
herbrokendown
i
ntogr owthratesofvariousi ndustr
iesorgr oupsofindustri
esif
requi
red.Thegrowthr
atesi nvari
ousi ndust
ri
esareesti
mat edbased
ontheestimateddemandf ori
tspr oducts.
(
ii
i)Infl
ati
on:Infl
ati
oni smeasuredintermsofeitherwholesal
eprices
(theWholesalePr i
ceIndexorWPI)orret
ailpr
ices(ConsumerPr i
ce
IndexorCPI ).The demand in some i
ndustri
es,parti
cul
arl
yt he
consumerpr oductsindust
ri
es,i
s signi
fi
cant
lyinfl
uenced byt he
i
nf l
ati
onrate.
Therefor
e,fir
msi nt hesei ndustri
esmakecont i
nuousassessment
abouti
nflati
onratesli
kel
ytopr evaili
nt henearfut
uresoastofi
ne-
tunethei
r
pri
ci
ng,di st
ri
buti
on and promot ion poli
cies t
othe ant
ici
pat
ed i
mpactof
i
nfl
ati
onondemandf orthei
rpr oducts.
(
iv)Monsoon:Becauseoft hestr
ongf or
wardandbackwar
dl i
nkages,
monsoonisofgreatconcer
ntoinv
estorsi
nthest
ockmarkett
oo.
Quest
ion19: Maypaper
Wr
it
eshor
tnot
esonanyf
ouroft
hef
oll
owi
ng:
(
a) Zer
ocouponbonds
(
b) I
nter
estswap
(
c) I
nter
-BankPar
ti
cipat
ionCer
ti
fi
cat
e
(
d) Meani
ngandAdv
ant
agesofNet
ti
ng
(
e) Nost
ro,
Vost
roandLor
oAccount
s
Ans:
(
a) Asnamei ndi catesthesebondsdonotpayi nterestdur ingthel i
feoft he
bonds.I nstead,zer ocouponbondsar ei ssuedatdi scountedpr i
cet o
theirfacev alue,whichi st heamountabondwi llbewor thwheni t
mat uresorcomesdue.Whenazmat ures,t hei nvest orwillreceiveone
l
umpsum ( facev al
ue)equalt ot heiniti
alinv estmentpl usinterestthat
hasbeenaccr uedont heinvestmentmade.Themat uritydatesonzer o
couponbondsar eusuall
yl ongt er
m.Thesemat ur i
t ydatesal l
ow an
i
nv estorforal ongrangepl anning.Zerocouponbondsi ssuedbybanks,
gov er
nmentandpr i
vatesect orcompani es.Howev er ,bondsi ssuedby
corporatesect orcarr
yapot ential
lyhigherdegr eeofr i
sk,dependi ngon
thef i
nancialst rengt
hoft hei ssuerandl ongermat urityperiod,butt hey
alsopr ovi
deanoppor tunit
yt oachieveahi gherr et ur
n.
(
b) Aswapisacontr
act
ualagreementbet
weent
wopar ti
estoexchange,or
"
swap,
"fut
urepaymentstr
eamsbasedondiff
erencesintheretur
nst o

38 Rahul
Mal
kan
 CAFi
nal-SFM

differentsecur it
iesorchangesi nthepr iceofsomeunder lyi
ngi tem.
Interest r ate swaps const itutethe most common t ype of swap
agr eement .Inani nterestrateswap, t
hepar t
iestot heagr eement ,t
ermed
theswapcount erpar t
ies,agreet oexchangepay ment si ndexedt ot wo
differentinterestr ates.Totalpay mentsaredet er
mi nedbyt hespeci fi
ed
not i
onal princi
pal amountoft heswap, whichi snev eractuallyexchanged.
Financi alintermedi ari
es,suchasbanks,pensi onf unds,andi nsurance
compani es,aswel lasnon- financi
alfir
msusei nterestr ateswapst o
effectivelychanget hemat uri
tyofout st
andi ngdebtort hatofani nterest-
bear i
ngasset .Swapsgr ew outofpar allelloanagr eement si nwhi ch
fir
msexchangedl oansdenomi natedindif
fer entcur r
encies.
(
c) TheIBPCsar eshor t-
terminst r
ument stoeven-
outtheshort-t
erml i
quidit
y
withi
nthebanki ngsy stem.Thepr i
maryobject
iveist oprov i
desome
degreeoff l
exibil
it
yint hecreditpor t
fol
i
oofbanksandt osmoot hent he
consort
ium ar rangement s.The I BPC can be issued by schedul ed
commer cialbankandcanbesubscr i
bedtobyanycommer ci
albank.The
IBPCisi ssuedagai nstanunder ly
ingadvance,classi
fi
edst andardand
theaggregateamountofpar ti
cipati
oninanyaccountt i
mei ssue.During
thecurrencyoft hepar ti
cipati
on,theaggregateamountofpar ti
cipat
ion
shouldbecov eredbyt heout st
andingbalanceinaccount.
Thepartici
pat
ioncanbeissuedi ntwotypes,vi
z.wi
thandwithoutr
iskto
thelender.Whil
ethepart
ici
pationwi t
houtitcanbeissuedforaperiod
notexceeding 90 day
s.Par t
icipati
on i
s now withrisk f
ora period
between91day sand180days.
The interestrat
e on I BPC i sfreel
ydeter
mi ned int he mar
ket.The
cert
ifi
catesarenei t
hert r
ansferabl
enorpremat ur
elyredeemablebyt he
i
ssuing bank.I nt he case oft he bank i
ssuing IBPC withrisk,t he
aggregateamountofpar ti
cipat
ionwouldbereducedf rom t
heaggr egate
advanceout st
anding.
Theschemei sbenefi
cialbotht otheissui
ngandpar tici
patingbanks.The
i
ssuingbankcansecur efundsagai nstadvanceswi t
houtact uall
ydilut
ing
i
tsasset-mix.Abankhav ingthehi ghestloanst ototalassetr at
ioand
l
iqui
ditybi
ndcansquar et hesituati
onbyi ssuingIBPCs.Tot helender,i
t
provi
desanoppor t
unityt o depl
oyt heshor t-t
erm surplusf undsi na
securedandprof
itabl
emanner .
(
d) I
tisat echni
queofopt i
mi si
ngcashfl
owmov ementswiththecombined
effort
s of t he subsidiari
es ther
eby reducing administ
rat
ive and
tr
ansact i
oncost sresul
tingf r
om curr
encyconv er
sion.Thereisaco-
ordinat
edi nt
ernati
onalinter
changeofmat er
ial
s,fi
nishedproductsand

39 Rahul
Mal
kan
 CAFi
nal-SFM

partsamongthedif
fer
entuni
tsofMNCwithmanysubsi
diar
iesbuyi
ng
/sell
i
ngf r
om/t
oeachother
.Net
ti
nghel
psi
nmini
misi
ngthetotalv
olume
ofinter
companyf
undfl
ow.
Adv
ant
agesder
ivedf
rom net
ti
ngsy
stem i
ncl
udes:
1) Reduces the number of cross-
bor
der transacti
ons between
subsi
diar
iesther
ebydecr
easi
ngtheoveral
ladmi ni
str
ati
vecostsof
suchcashtransf
ers.
2) Reduces the need forforei
gn exchange conv
ersi
on and hence
decr
eases transact
ion costs associ
ated wi
thf or
eign exchange
conver
sion.
3)I
mprovescashfl
owforecast
ingsi
ncenetcasht
ransf
ersar
emadeat
theendofeachper
iod.
4) Gi
vesanaccur
atereportandsett
lesaccount
sthr
oughco-
ordi
nat
ed
ef
for
tsamongall
subsidiar
ies.
(
e) I
ni nterbank t r
ansact i
ons,f orei
gn exchange i st ransfer
red from one
accountt o anotheraccountandf r
om onecent ret o anothercent re.
Ther efore,thebanksmai ntainthreetypesofcur rentaccountsinor derto
facil
itatequi cktransferoff undsindi fferentcurrencies.Theseaccount s
areNost ro,Vost r
oandLor oaccount smeani ng“our”,“your
”and“ thei
r”.A
bank’ sf orei
gncur r
encyaccountmai ntainedbyt hebanki naf or
eign
count ryandi nt hehomecur r
encyoft hatcount r
yi sknownasNost r
o
Accountor“ ouraccountwi t
hy ou”.Forexampl e,AnI ndianbank’sSwi ss
francaccountwi t
habanki nSwi tzerland.Vost roaccounti st helocal
currencyaccountmai ntainedbyaf orei gnbank/ branch.Itisalsocalled
“youraccountwi thus”.Forexampl e,Indi anrupeeaccountmai ntai
nedby
abanki nSwi tzerl
andwi t
habanki nI ndi
a.TheLor oaccounti san
accountwher ei
nabankr emi tsfundsinf orei
gncur rencytoanotherbank
forcr edittoanaccountofat hir
dbanker ocouponbond.
Quest
ion20: NovRTP
Wr
it
eashor
tnot
eon
(
a) Li
nkbet
weenFi
nanci
alPol
i
cyandSt
rat
egi
cManagement
(
b) Zer
oDat
eofaPr
ojecti
nPr
ojectManagement
(
c) Ti
mingofI
nvest
mentDeci
sionsont
hebasi
sofDowJonesTheor
y
(
d) Mai
nFunct
ionsofI
nvest
mentBanki
ng
(
e) Di
sti
nct
ionbet
weenCapi
tal
andMoneyMar
ket
Ans:

40 Rahul
Mal
kan
 CAFi
nal-SFM

(
a) Thesuccessofanybusi nessi smeasur edinf i
nanci
alterms.Maxi misi
ng
valuetotheshar ehol
dersist heul t
imat
eobj ecti
ve.Forthi
st ohappen,at
everystageofitsoper ati
onsi ncludi
ngpol i
cy-maki
ng,thef i
rm shoul
dbe
taking st
rategi
cst epswi thv al
ue-maximizati
on object
ive.Thisi sthe
basisoffinanci
al pol
icybeinglinkedtostrategi
cmanagement .
Thel
inkagecanbecl
ear
lyseeni
nrespectofmanybusi
nessdeci
sions.
Forexample:
(
i) Mannerofr
aisi
ngcapi
talassourceoff
inanceandcapi
talst
ruct
ure
ar
ethemostimpor
tantdimensi
onsofst
rategi
cplan.
(
ii
) Cut
-of
frate(
oppor
tuni
ty cost of capi
tal
)for accept
ance of
i
nvest
ment
deci
sions.
(
ii
i)I
nvestmentandf undal
locati
onisanot
herimportantdi
mensi
onof
i
nter
faceofstr
ategicmanagementandf
inanci
alpoli
cy.
(
iv)For
eignExchangeexposur
eandr
iskmanagement
.
(
v) Li
qui
dit
ymanagement
(
vi)Adi vi
dendpol
icydeci
siondealswiththeext
entofearni
ngstobe
dist
ri
butedandaclosei nt
erf
aceisneededtoframethepoli
cyso
thatthepol
i
cyshoul
dbebenef i
cial
foral
l.
(
vii
)Issueofbonusshar
eisanot
herdi
mensi
oni
nvol
vi
ngt
hest
rat
egi
c
deci
sion.
Thusfrom abovediscussi
onsitcanbesai dt hatfi
nancialpoli
cyofa
companycannotbewor kedoutini
solat
iontootherfuncti
onalpoli
cies.I
thas
awiderappealandcl
oserli
nkwiththeover
allor
ganizati
onalper
f or
manceand
di
recti
onofgrowth.
(
b) ZeroDateofaProjectmeansadat ei
sf i
xedfr
om whi chimplementat i
on
oftheproj
ectbegi
ns.I ti
sast arti
ngpointofi
ncurri
ngcost .Thepr oj
ect
complet
ionperi
odi scountedf rom t
hezerodat e.Pre-
projectacti
v i
ti
es
shoul
dbecompl etedbef or
ezer odat
e.Thepr e-
proj
ectact i
vit
iesshould
becompletedbef
orez erodate.Thepre-
proj
ectacti
vi
ti
esar e:
a. I
dent
if
icat
ionofpr
oject
/pr
oduct
b. Det
ermi
nat
ionofpl
antcapaci
ty
c. Sel
ect
ionoft
echni
cal
hel
p/col
l
abor
ati
on
d. Sel
ect
ionofsi
te.
e. Sel
ect
ionofsur
veyofsoi
l
/pl
otet
c.

41 Rahul
Mal
kan
 CAFi
nal-SFM

f
. Manpowerpl
anni
ngandr
ecr
uit
ingkeyper
sonnel
g. Costandf
inanceschedul
i
ng.
(
c) I
deal
l
yspeaking,thei
nvest
mentmanagerwouldliket
opurchaseshares
atati
mewhent heyhaver
eachedthelowestt
roughandsellthem ata
ti
mewhentheyreachthehi
ghestpeak.
However,in pr
acti
ce,this seldom happens.Ev en t
he mostastute
i
nvest
mentmanagercan nev erknow when t hehighestpeakort he
l
owesttroughhasbeenreached.Ther efor
e,hehastoti
mehisdeci
sionin
suchamannert hathebuy stheshar eswhent heyareontheri
seand
sel
lst
hem whent heyar
eont hef all
.Itmeansthatheshoul
dbeabl eto
i
denti
fyexact
lywhenthefall
i
ngort herisi
ngtr
endhasbegun.
Thisist echnicall
yknownasi dentifi
cati
onoft heturninthesharemarket
prices.Identi
f i
cati
onoft hi
st urni sdiff
icul
tinpr act
icebecauseoft he
factthat ,ev
eni nar i
singmar ket,pri
ceskeeponf all
ingasapar tofthe
secondar ymov ement .Simi
larlyev eninaf al
lingmar ketpri
ceskeepon
ri
singt empor ari
ly.Howt obecer tainthatther i
seinpr i
cesorfal
linthe
samei sduet oar ealtur
ninpr icesf r
om abul li
shtoabear ishphaseor
vicev er
saort hatitisdueonl ytoshor t-
runspeculati
vetrends?
Dow Jonestheoryidenti
fi
esthet ur
ni nthemarketpr
icesbyseei
ng
whetherthesuccessiv
epeaksandt roughsar
ehigherorlowert
han
ear
li
er.Consi
dert
hef ol
lowi
nggraph:
According t
ot he t
heory
,t he inv
est
mentmanagershoul d pur
chase
i
nv estment
swhent hepricesareatT1.Att hi
spoint,hecanascer t
ain
thatthebul
ltrendhasstarted,
sinceT2ishi
gherthanT1andP2i shigher
thanP1.
Simi
l
arly
,whenpr icesreachP7heshoul
dmakesal es.Att
hispoi
nthe
canascert
ainthatthebeari
shtr
endhasstar
ted,si
nceP9islowert
han
P8andT8i slowerthanT7.
(
d) Thef
oll
owi
ngar
e,br
ief
ly,
asummar
yofi
nvest
mentbanki
ngf
unct
ions:
♦ Managi
ng an IPO (Ini
ti
alPubli
c Offer
ing)
:Thisincl
udes hi
ri
ng
manager
stotheissue,duedi
l
igenceandmarket
ingt
heissue.
♦ Issue ofdebt:When a companyrequi
res capi
tal
,itsomet
imes
choosestoissuepubl
i
cdebtinst
eadofequi
ty.
♦ Merger
sandAcquisi
ti
ons:Act
ingasi
nter
medi
arybet
weenAcqui
rer
andtar
getcompany
♦ Pr
ivat
ePlacement:Apr
ivat
eplacementdi
ffer
sli
ttl
ef r
om apubli
c
of
feri
ngasi
defrom t
hef
actthatapri
vat
eplacementinvol
vesaf
ir
m

42 Rahul
Mal
kan
 CAFi
nal-SFM

sel
l
ingstockorequi
tyt
opr
ivat
einv
est
orsr
athert
hant
opubl
i
c
i
nvest
ors.
♦ Financi
alRest ruct
uring:When a company cannotpay i
ts cash
obli
gati
ons–i tgoesbankrupt.Inthi
ssit
uati
on,acompanycan,of
course,chooset osimplyshutdownoperati
onsandwal
kawayor ,i
t
canalsor est
ructur
eandr emaininbusi
ness.
(
e) Thecapit
almar ketdealsinf inanci
alassets.Fi
nanci
alassetscompr i
ses
ofshares,debentures,mut ualfundset c.Thecapitalmar ketisalso
knownasst ockmar ket.St ockmar ketandmoneymar ketar
et wobasic
componentsofI ndi
anf inancialsystem.Capitalmarketdealswi t
hlong
andmedi um terminstrument soff i
nanci
ngwhi l
emoneymar ketdeal
s
wit
hshortterminstr
ument s.
Quest
ion21: NovPaper
Answeranyf
ourf
rom t
hef
oll
owi
ng-:
(
a) I
nter
faceofFi
nanci
alPol
i
cyandSt
rat
egi
cManagement
(
b) Commer
cial
Paper
(
c) Amer
icanDeposi
tor
yRecei
pt
(
c) Adv
ant
agesofhol
dingsecur
it
iesi
n'Demat
'for
m
(
e) Sy
ner
gyi
nthecont
extofMer
ger
sandAcqui
sit
ions
Ans:
(
a) Theinterfaceofstr
ategicmanagementandf inanci
alpoli
cywillbecl
earl
y
understood ifwe appr eci
atethe factt hatt he st
arti
ng pointofan
organizati
oni smoneyandt heendpoi ntoft hatorganizat
ionisalso
money .Noor gani
zati
oncanr unanexisti
ngbusi nessandpr omoteanew
expansionpr oj
ectwithoutasuitabl
ei nt
ernallymobili
zedf i
nanci
albase
orbothi nter
nal
lyandexternal
lymobil
izedfinancial
base.
Sources offi
nance and capitalstructure ar
et he mosti mport
ant
dimensi
onsofast r
ategi
cplan.Thegener ati
onoffundsmayar i
seoutof
ownershi
pcapit
alandorbor r
owedcapi tal.Acompanymayi ssueequi
ty
sharesand/orpref
erencesharesformobi li
zi
ngownershi
pcapital
.
Alongwi t
hthemobi l
izationoffunds,poli
cymaker sshoulddecideonthe
capitalstructur
etoi ndicatethedesiredmi xofequi tycapi
talanddebt
capital.Therearesomenor msf ordebtequityrat
io.Howeverthisr
ati
oin
i
tsi dealf or
mv ar
iesfrom industrytoindust r
y.Italsodependsont he
planningmodeoft heorganizati
onunderst udy.
Anotheri
mport
antdi
mensionofstr
ategi
cmanagementand f i
nancial
pol
icyint
erf
ace i
sthe i
nvest
mentand fund al
l
ocat
ion deci
sions.A

43 Rahul
Mal
kan
 CAFi
nal-SFM

pl
annerhast oframepol i
ciesforr
egulat
inginvest
mentsinf i
xedasset s
andf orrestr
ainingofcurrentasset
s.Investmentproposal
smoot edby
di
fferentbusinessunit
smaybeaddi t
ionofanewpr oduct,i
ncreasi
ngt he
l
evelofoper ati
onofanexi sti
ngproductandcostreducti
onandef fici
ent
uti
l
izationofresourcesthroughanewappr oachandorclosermonitoring
ofthedi f
fer
entcr i
ti
calact
ivi
ti
es.
Now,giventhesethr
eet y
pesofpr
oposal
saplannershoul
deval
uat
e
eachoneoft hem bymakingwi
thi
ngroupcompari
soninthel
i
ghtof
capi
tal
budgeti
ngexer
cise.
Divi
dendpoli
cyisy etanot
herareaformaki ngfi
nanci
alpol i
cydecisi
ons
aff
ecti
ngthestrat
egicperf
ormanceoft hecompany .Aclosei nt
erf
aceis
needed t
of rame the pol
icyto be benef i
cialforall
.Di vi
dend poli
cy
deci
siondealswiththeextentofearningst obedistr
ibutedasdi vi
dend
andtheextentofearni
ngstober et
ainedf orfut
ureexpansionschemeof
thefi
rm.
I
tmaybenot edf r
om t heabov ediscussionst hatf inancialpol icyofa
companycannotbewor kedouti nisolat
ionofot herf unctionalpol icies.It
has a wi derappealand cl oserl i
nk witht he ov erallor ganizat ional
performanceanddi rectionofgr owth.Thesepol iciesbei ngr elatedt o
externalawar eness aboutt he fir
m,speci al
lyt he awar eness oft he
i
nv estorsaboutthef i
rm,i nr espectofi tsinter
nalper formance.Ther ei s
alway sapr ocessofev aluationact iv
ei nt hemi ndsoft hecur r
entand
future stake holders oft he company .As a r esul tpr eference and
patronagef orthecompanydependssi gni
ficantl
yont hef i
nanci alpol icy
framewor k.And henceat tention oft hecor poratepl anner smustbe
drawnwhi l
eframingt hef i
nanci alpoli
ciesnotatal aterstagebutdur i
ng
thest ageofcorporateplanni ngi t
self
.
(
b) Acommer ci
alpaperi
sanunsecuredmoneymar ketinst
rumentissuedin
thef or
m ofapr omissor
ynote.Sincet heCPr epr
esentsanunsecur ed
borrowinginthemoneymar ket,t
her egulat
ionofCPcomesundert he
purviewoftheReserveBankofIndiawhi chi
ssuedguidel
inesin1990on
thebasisoftherecommendationsoft heVaghulWor ki
ngGr oup.These
guideli
neswereaimedat:
(
i) Enabli
ng the hi
ghlyrated cor
porat
e bor
rower
sto di
ver
sif
ythei
r
sourcesofshortt
erm borr
owings,
and
(
ii
) Topr
ovi
deanaddi
ti
onal
inst
rumentt
otheshor
tter
minv
est
ors.
I
tcanbei
ssuedformaturit
iesbet
ween7day sandamaximum uptooneyear
fr
om t
hedateofissue.Thesecanbeissuedi
ndenominat
ionsof`5l
akh
ormult
ipl
esther
efore.Allel
i
gibl
eissuer
sarerequi
redtogetthecr
edit

44 Rahul
Mal
kan
 CAFi
nal-SFM

r
ati
ngf
rom cr
edi
trat
ingagenci
es.
El
i
gibi
l
itycr
it
eri
afori
ssuerofcommer
cial
paper
Thecompaniessati
sfy
ingt
hef
oll
owi
ngcondi
ti
onsar
eel
i
gibl
etoi
ssue
commerci
alpaper
.
• Thetangi
blenetwort
hofthecompanyis`5cr
oresormor
easper
audi
tedbal
ancesheetoft
hecompany.
• Thef
undbasewor
kingcapi
tal
li
miti
snotl
esst
han`5cr
ores.
• Thecompanyisrequi
redt
oobtai
nthenecessar
ycr
edi
trat
ingf
rom
ther
ati
ngagenci
essuchasCRI
SIL,I
CRAetc.
• Theissuer
sshould ensur
ethatt
hecredi
trat
ing atthet
imeof
appl
yi
ngtoRBIshoul
dnotbemorethant
womont hsol
d.
• Theminimum curr
entr
ati
oshouldbe1.
33:
1basedoncl
assi
fi
cat
ion
ofcur
rentasset
sandli
abi
li
ti
es.
• Forpubl
i
csectorcompani
estherearenoli
sti
ngr
equi
rementbutf
or
compani
esotherthanpubl
icsector
,thesameshoul
dbel i
stedon
oneormorest
ockexchanges.
• Alli
ssue expenses shal
lbe bor
ne by t
he company i
ssui
ng
commerci
alpaper.
(
c) Adeposi toryreceiptisbasi
call
yanegot iabl
ecert
if
icatedenomi natedin
US dol l
arst hatrepresentanon-US Company ’spubl i
clytradedl ocal
currency(INR)equi t
yshares/securi
ti
es.Whilet
het ermr efertothem is
globaldeposi tor
yr eceipt
s howev er
,when such r ecei
pts arei ssued
outsidetheUS, butissuedfortr
adingintheUStheyar ecall
edADRs.
AnADRi sgener all
ycr eatedbydepositingthesecur i
ti
esofanI ndi
an
companywi thacust odianbank.I
narrangementwi ththecust odianbank,
adeposit
oryint heUSi ssuestheADRs.TheADRsubscr iber/holderi
nthe
USisenti
tledt otradetheADRandgener all
yenjoyri
ghtsasowneroft he
underl
yi
ngI ndiansecur i
ty.ADRswit
hspeci al/
uniquefeatureshav ebeen
devel
opedov eraper iodoft i
meandt hepr acti
ceofi ssuingADRsby
Indi
anCompani esiscatchingup.
OnlysuchIndiancompani esthatcanst akeacl aimf orint
ernat
ional
recogni
ti
on can av ai
lt he opport
unityt oi ssue ADRs.The l i
sti
ng
requi
rement
sinUSandt heUSGAAPr equir
ement sar efai
rl
ysevereand
willhaveto be adhered.Howev erifsuch condi ti
ons are metADR
becomesanexcellentsourcesofcapit
albri
nginginf orei
gnexchange.
Thesearedeposi
tor
yr ecei
ptsi
ssuedbyacompanyi nUSA andare
gover
nedbytheprovi
sionsofSecur
it
iesandExchangeCommi
ssionof

45 Rahul
Mal
kan
 CAFi
nal-SFM

USA.Ast heregul
ati
onsaresevere,I
ndi
ancompani
estaptheAmeri
can
marketthroughpri
vatedebtplacementofGDRSli
stedinLondonand
Luxemburgstockexchanges.
Apartfrom l
egali
mpedi
ments,ADRSarecostli
erthanGl
obalDeposi
tory
Receipts(GDRS).Legalfees ar
e consider
ably hi
gh f
orUS l i
sti
ng.
Registr
ati
onfeeinUSAisal
sosubstant
ial
.Hence,ADRSarel
esspopular
thanGDRS.
(
d) From anindi
vi
dualinv
estorpointofvi
ew,thefol
l
owi
ngar
eimpor
tant
advant
agesofhol
dingsecur
it
iesindematf
orm:
• I
tisspeedi
erandav
oidsdel
ayi
ntr
ansf
ers.
• I
tav
oidsl
otofpaperwor
k.
• I
tsav
esonst
ampdut
y.
Fr
om the i
ssuer
-company poi
ntofvi
ew also,t
her
e ar
e si
gni
fi
cant
adv
ant
agesduet
odemat t
ing,
someofwhi
chare:
• Sav
ingsi
npr
int
ingcer
ti
fi
cat
es,
post
ageexpenses.
• St
ampdut
ywai
ver
.
• Easymoni
tori
ngofbuying/sel
l
ingpat
ternsi
nsecuri
ti
es,increasi
ng
abi
li
tyt
ospottakeov
eratt
emptsandattempt
satpri
cerigging.
(
e) Sy
ner
gyMaybedef
inedasf
oll
ows:
V(
AB)>V(
A)+V(
B).
I
not herwor dsthecombi nedval
ueoft
wof i
rmsorcompaniesshal
lbe
morethant hei
rindiv
idual
v al
ue.Thi
smayberesul
tofcompl
i
mentaryser
vices
economicsofscal eorboth.
Agoodexampl eofcompl i
mentar
yacti
vi
ti
escanacompanymayhav ea
good networ ki
ng ofbranches and ot
hercompany may hav
e ef f
ici
ent
producti
onsy st
em.Thusthemer gedcompanieswi
llbemor
eeffi
cientthan
i
ndividualcompani
es.
OnSimi l
arlines,economicsoflargescaleisalsooneofthereasonf or
synergybenefit
s.Themai nreasonisthat,t
helargescal
eproduct
ionresults
i
nl owerav eragecostofpr oducti
one. g.reducti
oninoverheadcostson
accountofshar ingofcent r
alservi
cessuchasaccount i
ngandf inances,
Offi
ce executives,t op lev
elmanagement ,legal,sal
es promoti
on and
adverti
sementet c.
Theseeconomicscanbe“real
”ari
singoutofr
educti
oni
nfact
ori
nputper
uni
tofout put
,whereaspecuni
aryeconomicsarereal
i
zedfr
om payi
nglower
pri
cesforfact
orinput
stobulkt
ransact
ions.

46 Rahul
Mal
kan
 CAFi
nal-SFM

2013
Quest
ion22: MayRTP-si
mil
art
oquest
ionsal
readydi
scussed
Quest
ion23: Maypaper
Wr
it
eshor
tnot
esonanyf
ouroft
hef
oll
owi
ng:
(
a) Cr
edi
tRat
ing
(
b) AssetSecur
it
izat
ion
(
c) Cal
lMoney
(
d) Eur
oConv
ert
ibl
eBonds
(
e) Fi
nanci
alRest
ruct
uri
ng(
4x4=16Mar
ks)

Answer
(
a) Creditrati
ng:Cr editr
atingisasy mboli
cindicationofthecurr
entopinion
regardi
ngt her elat
ivecapabili
tyofacor porateentit
ytoservi
ceitsdebt
obli
gations int ime wi t
hr efer
ence tot he instr
umentbeing rated.It
enablesthei nvestortodiff
erenti
atebet
weeni nst r
umentsonthebasi sof
their under l
yi
ng cr edit quali
ty. To f aci
lit
ate simple and easy
understanding, cr edit rati
ng i s expr essed i n alphabet
ical or
alphanumer i
cal symbols.
ThusCr
edi
tRat
ingi
s:
1) Anexpr
essi
onofopi
nionofar
ati
ngagency
.
2) Theopi
nioni
sinr
egar
dtoadebti
nst
rument
.
3) Theopi
nioni
sasonaspeci
fi
cdat
e.
4) Theopi
nioni
sdependentonr
iskev
aluat
ion.
5) The opini
on depends on the pr
obabi
l
ity ofi
nter
estand pr
inci
pal
obl
i
gationsbei
ngmettimely
.
Cr
edi
trat
ingai
mst
o
(
i) pr
ovi
desuper
iori
nfor
mat
iont
othei
nvest
orsatal
owcost
;
(
ii
) pr
ovi
deasoundbasi
sforpr
operr
isk-
ret
urnst
ruct
ure;
(
ii
i)subj
ectbor
rower
stoaheal
thydi
sci
pli
neand
(
iv)assi
stinthef
rami
ng ofpubl
i
cpol
i
cygui
del
i
nesoni
nst
it
uti
onal
i
nvestment
.
I
nIndi
ather
ati
ngcov
eragei
soff
air
lyr
ecentor
igi
n,begi
nni
ng1988when

47 Rahul
Mal
kan
 CAFi
nal-SFM

t
hefir
str
ati
ngagencyCRI
SILwasest
abl
i
shed.Atpr
esentt
her
ear
efewot
her
r
ati
ngagenci
esl
ike:
(
i) Cr
edi
tRat
ingI
nfor
mat
ionSer
vicesofI
ndi
aLt
d.(
CRI
SIL)
.
(
ii
)Inv
est
mentI
nfor
mat
ionandCr
edi
tRat
ingAgencyofI
ndi
a(I
CRA)
.
(
ii
i)Cr
edi
tAnal
ysi
sandResear
chLi
mit
ed(
CARE)
.
(
iv)Duf
f&Phel
psCr
edi
tRat
ingI
ndi
aPv
t.Lt
d.(
DCRI
)
(
v) ONI
CRACr
edi
tRat
ingAgencyofI
ndi
aLt
d.
(
vi)Fi
tchRat
ingsI
ndi
a(P)Lt
d.
(
b) AssetSecurit
isati
on:Iti
samet hodofr ecycl
ingoffunds.I tisespeci
all
y
benefi
cialtofinanci
alinter
medi ar
iestosuppor tthel endingv ol
umes.
Assetsgenerati
ngsteadycashf l
owsar epackagedt ogetherandagainst
thisassetspoolmar ketsecuri
ti
escanbei ssued.Thepr ocesscanbe
classi
fi
edinthefoll
owingthreefuncti
ons.
1. Theoriginat
ionf uncti
on:Aborr
owerseeksaloanfrom f
inancecompany
,
bankorhousi ngcompany .Onthebasisofcr
editwort
hinessrepay
ment
scheduleisstructuredovert
heli
feofthel
oan.
2. Thepoolingfunct
ion:Simil
arloansorrecei
vabl
esareclubbedtogetherto
creat
eanunder ly
ingpoolofasset s.Thi
spoolistr
ansferr
edinf av
ourof
aSPV( Speci
alPur poseVehicle)
,whichactsasatr
usteefortheinvestor.
Once,theassetsaretransf
erredtheyareheldi
ntheor
ganizersportfol
ios.
3. Thesecur i
ti
sationfunction:I
tistheSPV’sj
obt ostructur eandissuethe
securi
tiesont hebasi sofassetpool.Thesecuri
ti
escar rycouponandan
expectedmat urit
y,whichcanbeassetbasedormor t
gagebased.These
aregener all
ysol dtoinvestorsthr
oughmerchantbanker s.Theinvest
ors
i
nterestedi nt histypeofsecur i
ti
esaregeneral
lyinstitutionali
nvest
ors
l
ikemut ualfund,insurancecompaniesetc.Theoriginatorusuallykeeps
thespread.
General
l
y,t he process ofsecuri
tisat
ion i
s withoutrecourse i
.e.the
i
nvestorbearsthecr edi
triskofdefaul
tandt heissuerisunderanobligat
ion
topayt oinvestor
sonl yift hecashflowsar ereceivedbyissuerfrom the
col
later
al.
(
c) Cal
lMoney :TheCallMoneyisapartoft
hemoneymar ketwhere,dayto
daysurplusfunds,mostl
yofbanks,ar
etr
aded.Moreover
,thecallmoney
marketismostl i
qui
dofallshor
t-
ter
m moneymarketsegments.
Thematur
it
yperi
odofcallloansvaryf
rom 1to14day
s.Themoneyt hat
i
slentforonedayi ncallmoneymar ketisal
soknownas‘ over
night
money’
.Theint
erestpai
doncal ll
oansareknownasthecal
lrat
es.The

48 Rahul
Mal
kan
 CAFi
nal-SFM

callr
ateisexpect edtofreelyr
efl
ectt heday-to-daylackoff unds.These
rat
esv aryfrom day -
to-
dayandwi t
hintheday ,oft
enf rom hour -
to-
hour.
Highratesindicatetheti
ghtnessofliquidi
tyint hefi
nancialsystem whil
e
l
owr atesindicateaneasyliqui
dit
yposi t
ioninthemar ket
.
I
nIndia,callmoneyi slentmainl
ytoev enouttheshort
-t
erm mismatches
ofasset sandl i
abili
tiesandt omeetCRR r equir
ementofbanks.The
short
-t
er m mismat ches ari
se due t ovari
ati
on in matur
it
ies i
.e.the
depositsmobil
izedar edeployedbyt hebankatalongermaturi
tytoearn
morer etur
nsanddur ati
onofwi t
hdrawalofdeposi
tsbycustomersv ary
.
Thus,thebanksbor row fr
om cal lmoneymar ket
st omeetshor t-
ter
m
maturi
tymi smatches.
Moreover,thebanksborr
ow fr
om callmoneymarkett
omeetthecash
Reserv
eRat i
o(CRR)requi
rement
st hatt
heyshouldmaint
ainwi
thRBI
ever
yf or
tnightandiscomputedasaper cent
ageofNetDemandand
Ti
meLi abil
i
t i
es(
NDTL).
(
d) EuroConverti
bleBonds:TheyarebondsissuedbyIndiancompaniesin
for
eign marketwit
ht heopt i
on t
o conver
tt hem i
nto pr
e-deter
mined
numberofequitysharesofthecompany.Usuallypr
iceofequit
yshares
atthetimeofconversi
onwillf
etchpr
emium.TheBondscar ryfi
xedrate
ofi
nterest
.
Thei
ssueofbondsmaycar
ryt
woopt
ions:
Calloption:Undert histhei ssuercancal lthebondsf orredempt ion
beforet he date ofmat urit
y.Wher ethe i ssuer’
s shar e price has
appreci
at edsubstanti
all
y,i
.e.,farinexcessoft her edempt i
onv alueof
bonds,thei ssuercompanycanexer ci
setheopt ion.Thi scallopt ion
for
cest hei nvest
orst oconv ertthebondsi ntoequi t
y.Usually,sucha
caseariseswhent hesharepr i
cesr eachast agenear130%t o150%of
theconv ersi
onpr i
ce.Putoption:Itenabl
esthebuy eroft hebondar ight
tosellhisbondst otheissuercompanyatapr e-determinedpr iceand
date.Thepay mentofinterestandt heredempt ionoft hebondswi l
lbe
madebyt heissuer-
companyi nUSdol lar
s.
(
e) Fi
nancialr estructuri
ng:Itiscarri
edouti nternall
yint hef i
rm wi ththe
consentofi tsv ari
ousstakeholders.Financi alrest
ructuri
ngi sasui tabl
e
modeofr estr
uct uri
ngofcorporatefir
mst hathav eincurredaccumul ated
si
zablelossesf or/ov eranumberofy ears.Asasequel ,theshar ecapital
ofsuchf irms,inmanycases,get ssubst ant ial
lyeroded/l ost;infact,i
n
somecases, accumul at
edlossesov erthey earsmaybemor et hanshare
capi
tal,causi ng negativ
e networ th.Gi ven such a di smalst ate of
fi
nancialaffai
rs, avastmajori
tyofsuchf irmsar eli
kelytohav eadubi ous

49 Rahul
Mal
kan
 CAFi
nal-SFM

potent i
alforli
quidati
on.Cansomeoft heseFirmsber evi
ved?Financial
restructuri
ngisonesuchameasur efort herevi
valofonlythosef i
rms
thatholdpr omise/prospectsforbet
terfi
nancialper
formanceinthey ear
s
tocome.Toachi evethedesiredobjecti
v e,'
suchfi
rmswar r
ant/mer i
ta
restartwi thaf resh balance sheet,whi ch does notcont ai
n past
accumul at
edlossesandf i
cti
ti
ousasset sandshowsshar ecapitalatit
s
real
/ tr
uewor t
h.
Quest
ion24: NovRTP-si
mil
art
oquest
ionsal
readydi
scussed
Quest
ion25
Wr
it
enot
esonanyf
ouroft
hef
oll
owi
ng:
(
a) Expl
aint
heconcept
,‘
Zer
odat
eofaPr
oject
’inpr
ojectmanagement
.
(
b) XYZ Bank,Amster
dam,wantstopurchase`25mill
i
onagainst£for
fundi
ngthei
rNostr
oaccountandt
heyhavecr
edi
tedLOROaccountwi
th
BankofLondon,
London.
Cal
cul
atetheamountof£’
scredi
ted.Ongoi
ngi
nter
-bankr
atesar
eper$,
`
61.
3625/3700&per£,$1.
5260/70.
(
c) Whati
sanExchangeTr
adedFund?Whatar
eit
skeyf
eat
ures?
(
d) Whati
sanequi
tycur
veout
?Howdoesi
tdi
ff
erf
rom aspi
nof
f?
(
e) Whatismoneymar
ket?Whatar
eit
sfeat
ures?Whatki
ndofi
nef
fi
cienci
es
i
tissuff
eri
ngf
rom?(4x4=16Marks)
Answer
(
a) ZeroDateofaProjectmeansadat ei
sf i
xedfr
om whi chimplementat i
on
oftheproj
ectbegi
ns.I ti
sast arti
ngpointofi
ncurri
ngcost .Thepr oj
ect
complet
ionperi
odi scountedf rom t
hezerodat e.Pre-
projectacti
v i
ti
es
shoul
dbecompl etedbef or
ezer odat
e.Thepr e-
proj
ectact i
vit
iesshould
becompletedbef
orez erodate.Thepre-
proj
ectacti
vi
ti
esar e:
(
1) I
dent
if
icat
ionofpr
oject
/pr
oduct
(
2) Det
ermi
nat
ionofpl
antcapaci
ty
(
3) Sel
ect
ionoft
echni
cal
hel
p/col
l
abor
ati
on
(
4) Sel
ect
ionofsi
te.
(
5) Sel
ect
ionofsur
veyofsoi
l
/pl
otet
c.
(
6) Manpowerpl
anni
ngandr
ecr
uit
ingkeyper
sonnel
(
7) Costandf
inanceschedul
i
ng.
(
b) Topur
chaseRupee,XYZBankshal lfi
rstsel
l£andpurchase$andthen
sel
l$t
opurchaseRupee.Accor
dingly
,foll
owingr
ateshal
lbeused:

50 Rahul
Mal
kan
 CAFi
nal-SFM

(
£/`
)ask
Theav
ail
abl
erat
esar
easf
oll
ows:
(
$/£)bi
d=$1.
5260
(
$/£)ask=$1.
5270
(
`/$)bi
d=`61.
3625
(
`/$)ask=`61.
3700
Fr
om abov
eav
ail
abl
erat
eswecancomput
erequi
redr
ateasf
oll
ows:
(
£/`
)ask=(
£/$)
askx(
$/`
)ask
=(
1/1.
5260)x(
1/61.
3625)
=£0.
01068or£0.
0107
Thusamountof£t
obecr
edi
ted
=`25,
000,
000x£0.
0107
=£267,
500
(
c) ExchangeTr adedFunds( ETFs)wereintr
oducedi nUSi n1993andcame
toIndi
aar ound2002.ETFi sahy bri
dproductthatcombi nesthefeat
ur es
ofanindexmut ualf
undandst ockandhence,isalsocalledindexshares.
Thesefundsar elist
edont hestockexchangesandt hei
rpr i
cesareli
nked
tot he underl
ying index
.The aut hori
zed part
icipant
s actas mar ket
makersf orETFs.
ETFcanbeboughtandsol dl i
keanyotherst
ockonst ockexchange.I
n
ot
herwor ds,theycanbeboughtorsol danytimeduri
ngthemar kethour
sat
pr
icesthatareexpect edtobeclosertotheNAVattheendoft heday.NAVof
anETFi sthev al
ueoft heunderl
yingcomponentofthebenchmarkindexhel
d
bytheETFpl usallaccrueddi
videndslessaccr
uedmanagementf ees.
Therei
snopaperworkinvolvedfori
nvesti
nginanETF.Thesecanbe
boughtli
keanyot
herst
ockbyjustplaci
nganorderwi
thabr
oker
.
Someot
heri
mpor
tantf
eat
uresofETFar
easf
oll
ows:
1. I
tgivesaninvest
orthebenef
itofinvest
inginacommodi tywi
thout
phy
sical
l
ypur
chasingt
hecommodit
ylikegold,
sil
ver
,sugaret
c.
2. I
tisl
aunchedbyanassetmanagementcompanyorot
herent
it
y.
3. Theinv
est
ordoesnotneedt
ophysi
cal
l
ystor
et hecommodi
tyorbearthe
cost
sofupkeepwhi
chispar
toft
headmini
str
ativ
ecost
softhefund.
4. An ETF combines the v
aluat
ion featur
e ofa mutualfund oruni t
i
nvestmentt
rust,
whichcanbeboughtorsol dattheendofeachtradi
ng
dayforit
snetassetv al
ue,wit
ht hetradabi
li
tyf
eatur
eofacl osed-
end

51 Rahul
Mal
kan
 CAFi
nal-SFM

fund,whicht
radesthr
oughoutt
het
radi
ngdayatpr
icest
hatmaybemor
e
orlessthani
tsnetassetval
ue.
(
d) Equit
yCurveoutcanbedefinedasparti
alspi
noffinwhichacompany
creat
esit
sownnew subsidiaryandsubsequent
lybringouti
tsIPO.I
t
shouldbehowevernotedthatparentcompanyret
ainsit
scontr
oland
onlyapar
tofnewsharesar
ei ssuedt
opubli
c.
OntheotherhandinSpinoffparentcompanydoesnotr ecei
veanycash
assharesofsubsidiar
ycompanyar eissuedtoexist
ingsharehol
derin
thefor
m ofdividend.Thus,shareholder
si nnew companyremaint he
samebutnotincaseofEquitycurveout.
(
e) I
nawi derspect
rum,amoneymar ketcanbedefi
nedasamar ketf
or
shor
t-
ter
m moneyand f i
nanci
alassetsthatar
enearsubst
it
utesfor
moneywithmini
mum t
ransacti
oncost.
Feat
ures:
• Thet erm short
-t
erm meansgeneral
lyaper
ioduptooney earandnear
substit
utestomoneyi susedtodenot
eanyfi
nanci
alassetwhichcanbe
quickl
yconv er
tedint
omoney .
• Lowcost
.
• I
tprovi
desanavenueforequi
li
brat
ingt
heshor
t-
ter
m sur
plusf
undsof
l
ender
sandther
equir
ementsofborr
ower
s.
• I
t,t
hus,prov
idesar easonabl
eaccesst
ot heuser
sofshor
tter
m money
t
omeett hei
rrequi
rementsatreal
i
sti
cpri
ces.
• Themoneymar ketcanal
sobedefi
nedasacentr
einwhi
chfinanci
al
i
nsti
tut
ions congregat
efort
he pur
pose ofdeal
i
ng i
mper
sonall
yin
monetaryasset
s.
I
nef
fi
cienci
es:
(
i) Mar
ket
snoti
ntegr
ated,
(
ii
) Hi
ghv
olat
il
it
y,
(
ii
i)I
nter
estr
atesnotpr
oper
lyal
i
gned,
(
iv)Pl
ayer
srest
ri
cted,
(
v) Suppl
ybased-
sour
cesi
nfl
uenceuses,
(
vi)Notmanyi
nst
rument
s,
(
vii
)Pl
ayer
sdonotal
ter
nat
ebet
weenbor
rowi
ngandl
endi
ng,
(
vii
i
)Reser
ver
equi
rement
s,
(
ix)Lackoft
ranspar
ency
,

52 Rahul
Mal
kan
 CAFi
nal-SFM

(
x) I
nef
fi
cientPay
mentSy
stems,
(
xi)Seasonal
shor
tageoff
unds,
(
xii
)Commer
cial
transact
ionsar
emai
nlyi
ncash,
and
(
xii
i
)Heav
ySt
ampdut
yli
mit
inguseofexchangebi
l
ls
2014
Quest
ion26: MayRTP
Wr
it
eashor
tnot
eon
(
a) Leadi
ngandLaggi
ng
(
b) Soci
alCostBenef
itAnal
ysi
s
(
c) Det
ermi
nant
sofDi
vi
dendPol
i
cy
(
d) Si
gni
fi
canceofanunder
lyi
ngi
nrel
ati
ont
oDer
ivat
iveI
nst
rument
s
(
e) Zer
oCouponBonds
Ans:
(
a) Leadi
ngmeansadv anci
ngapay menti
.e.maki
ngapay mentbefor
eitis
due.Lagging i
nvol
ves postponi
ng a paymenti
.e.delay
ing payment
beyonditsduedate.I
nf or
exmar ketLeadi
ngandlaggi
ngareusedf or
twopurposes:
-
(
1) Hedging f or
eign exchange r i
sk:A companycan l ead pay ments
requi
redt obemadei nacur r
encyt hati sl i
kelytoappr eciate.For
exampl e,acompanyhast opay$100000af teronemont hf r
om
today.Thecompanyappr ehendst heUSDt oappr eciate.I
tcanmake
thepay mentnow.Leadi nginvolvesaf i
nancecosti .e.onemont h’
s
i
nterestcostofmoneyusedf orpur chasing$100000.Acompany
mayl agt hepay mentt hatitneedst omakei nacur rencyt hatitis
l
ikelyto depr eci
ate,prov i
ded ther eceivi
ng par tyagr eesf orthis
propositi
on.Ther eceivi
ngpar t
ymaydemandi nterestfort hisdelay
andt hatwoul dbet hecostofl agging.Deci sionr egardingl eading
andlaggingshoul dbemadeaf t
erconsi dering(i)li
kelymov ementi n
exchanger ate(ii
)int
erestcostand( ii
i)discount( i
fany ).
(
2) Shif
ti
ngthel i
qui
dit
ybymodi
fyi
ngt
hecr
edi
tter
msbet
weeni
nter
-
groupent
it
ies:
Forexampl e,A HoldingCompanysel lsgoodst oi t
s100% Subsi di
ary.
Normalcredittermis90day s.Supposecostoff undsis12%f orHoldingand
15%f orSubsidi
ary.I
nt hi
scasetheHol di
ngmaygr antcreditforlongerperi
od
toSubsidiar
yt ogetthebestadv antageforthegroupasawhol e.Ifcostof
fundsis15%f orHoldingand12%f orSubsi
diar
y,theSubsidiarymayl eadthe

53 Rahul
Mal
kan
 CAFi
nal-SFM

paymentf orthebestadvantageoft hegr oup asawhol e.Thedeci si

on
regardingleadi
ngandlaggi
ngshouldbet akenont hebasisofcostoff unds
tobot hpayingent
it
yandreceivi
ngenti
ty.I
fpay i
ngandrecei
vingent
it
ieshav e
diff
erenthomecur r
enci
es,l
ikel
ymov ementsinexchangerateshoul
dal sobe
considered.
(
b) I
ti sincr easi ngl yrealisedt hatcommer cialev aluat ionofpr oject si snot
enought oj ust ifycommi tmentoff undst oapr oj ectespeci allywhent he
projectbel ongst opubl icut i
lit
yandi r
respectiveofi tsfinanci alv iabili
tyit
needst obei mpl ement edi nt hei nterestoft hesoci etyasawhol e.Huge
amountoff undsar ecommi tt
edev er
yy eartov ar i
ouspubl icpr ojectsof
allt
y pes–i ndust ri
al,commer cialandt hosepr ov i
di ngbasi ci nfrast ructure
facil
iti
es.Anal ysisofsuchpr oj ect shast obedonewi thr efer encet ot he
socialcost sandbenef itssi ncet heycannotbeexpect edt oy i
eldan
adequat ecommer cialr ateofr etur nont hef undsempl oyedatl east
duringt heshor tperiod.Asoci alr ateofr etur ni smor ei mpor tant .The
actualcost s orr evenues do notnecessar i
lyr ef l
ectt he monet ary
measur ementofcost sorbenef itst ot hesoci ety .Thi si sbecauset he
mar ketpr iceofgoodsandser vicesar eoftengr ossl ydi stor t
edduet o
vari
ous ar tificialrest ri
ctions and cont rol
sf rom aut hor it
ies,hence a
diff
erenty ar dst ickhast obeadopt edf orevaluat ingapar t
icul arpr ojectof
socialimpor tanceandi tscost sandbenef it
sar ev aluedat' oppor t
uni t
y
cost' orshadowpr icest ojudget her ealimpactoft heirbur denascost s
tothesoci ety .Thus,soci alcostbenef i
tanal ysisconduct samonet ary
assessmentoft het ot alcostandr evenuesorbenef i
tsofapr oject,
payingpar ticularat tentiont ot hesoci alcostsandbenef i
tswhi chdonot
normal lyfeat ur einconv entional cost i
ng.
Unit
ed Nat i
ons Industri
alDev el
opment Or gani sati
on ( UNIDO) and
Organi
sati
onofEconomi cCooper ati
onandDev elopment( OECD)hav e
done much wor k on SocialCostBenef i
tanal ysis.A gr eatdealof
i
mpor t
ance is attached tot he socialdesi rabilit
y of pr oj
ectsl ike
employmentgener ation potenti
al,val ue addition,f orei
gn exchange
benefi
t,l
iv
ingstandar di
mpr ovementet c.UNI DOandOECDappr oaches
needaser i
ousconsi der
ati
oni nthecal cul
ationofbenef itsandcost st o
thesociet
y.Thistechniquehasgotmor er elevancei nt hedev eloping
countr
ieswherepubliccapit
alneedspr ecedenceov erpri
vatecapital.
(
c) Manyfact
orsdet
erminet
hedi v
idendpol
icyofacompany
.Someoft
he
f
actor
sdeter
mini
ngthedi
videndpoli
cyar
e:
(
i) Div
idendPayoutr at
io:Acert
ainshareofear ni
ngstobedistr
ibut
ed
asdivi
dendhast obewor kedout.Thisinv
olvesthedeci
siontopay
outortoret
ain.Thepaymentofdividendsresul
tsint
hereducti
onof

54 Rahul
Mal
kan
 CAFi
nal-SFM

cashand,t herefor
e,deplet
ionofasset
s.Inor dertomai nt ainthe
desi
red l
ev elofasset s as wellas tofinance t he i
nvest ment
opport
uni
ties, t
hecompanyhast odeci
deupont hepayoutratio.D/P
rat
ioshouldbedet er
minedwithtwoboldobj ecti
ves–maxi mi si
ng
thewealt
hoft hefir
ms’ownersandpr ov
idingsuf f
ici
entf undst o
fi
nancegrowt h.
(
ii
) Stabili
tyofDi v
idends:Gener al
lyinv estor
sf av ourast abl
edividend
policy.Thepol i
cyshoul dbeconsi st entandt her eshouldbeacer tai
n
mini mum di vi
dendt hatshoul dbepai dr egul arly
.Thel i
abil
i
tycan
takeanyf orm,namel y,
constantdiv idendpershar e;st
ableD/Pr ati
o
andconst antdivi
dendpershar epl ussomet hingext r
a.Becauset hi
s
entails– t heinv estor’
sdesir eforcur renti ncome,i tcontai
nst he
i
nf ormationcont entaboutt heprofitabili
tyoref fici
entworki
ngoft he
company ;creati
ngi nterestf
orinsti
t uti
onalinv estor’
setc.
(
ii
i)Legal ,Cont r
act ualandI nternalConst r
aintsandRest ricti
on:Legal
andCont ractualr equirement shav et obef oll
owed.Al lrequirements
ofCompani esAct ,SEBIgui delines,capi talimpai rmentgui deli
nes,
netpr ofi
tand i nsol vency et c.,hav et o be kepti n mi nd whi l
e
declaringdi vidend.Forexampl e,i nsolventfirmi spr ohibi
tedf rom
payingdi vidends;bef orepay i
ngdi vi
dendaccumul atedl osseshav e
tobesetof f,howev er,thedi videndscanbepai doutofcur r
entor
previous y ear s’pr ofit.Al so t here may be some cont r
actual
requirement swhi char etobehonour ed.Mai ntenanceofcer tai
n
debtequi tyr atiomaybesuchr equirement s.Inaddi ti
on,t heremay
be cer tai
ni nt er
nalconst raints whi ch ar e unique t ot he f i
rm
concer ned.Ther emaybegr owt hpr ospects,financialr equir
ement s,
avail
abi l
it
yoff unds,ear ni
ngst abi li
tyandcont r
ol etc.
(
iv)Owner’s Consi
derat
ions:This may i
ncl
ude t
he t
ax status of
shar
eholder
s, thei
r opport
unit
ies f
or inv
est
ment di
luti
on of
ownershi
petc.
(
v) Capi t
alMar ketCondi tionsandI nfl
ation:Capitalmar ketcondi tions
andr ateofi nflational sopl ayadomi nantrol
ei ndet ermini ngt he
divi
dendpol icy.Theext entt owhichaf i
rm hasaccesst ocapi tal
mar ket,alsoaf fect sthedi v
idendpoli
cy .Afi
rm hav i
ngeasyaccess
tocapi t
almar ketwi l
lfoll
owal i
ber
aldividendpolicyascompar edt o
thef i
rm havingl imi tedaccess.Somet imedi v
idendsar epai dt okeep
thef i
rms‘ el
igible’ forcertainthi
ngsinthecapitalmar ket.Ininf l
ation,
ri
singpr iceseati ntothev al
ueofmoneyofi nvestorswhi cht heyar e
receivi
ngasdi vidends.Goodcompani eswi l
ltrytocompensat ef or
rateofi nfl
ati
onbypay i
nghi gherdi
vidends.Replacementdeci sionof

55 Rahul
Mal
kan
 CAFi
nal-SFM

t
hecompani
esal
soaf
fect
sthedi
vi
dendpol
i
cy.
(
d) Theunderlyi
ngmaybeashar e,acommodityoranyot herassetwhich
hasamar ketabl
evaluewhichissubj
ectt
omarketr
isks.Theimportance
ofunder
lyi
ngi nder
ivat
ivei
nstr
umentsisasf
oll
ows:
• Allderi
vat
ivei
nst
rument
sar
edependentonanunder
lyi
ngt
ohav
e
value.
• Thechangei
nvaluei
naf orwar
dcont
racti
sbr
oadl
yequalt
othe
changei
nval
uei
ntheunder
lyi
ng.
• I
nt he absence ofa v
aluabl
e under
lyi
ng assett
he der
ivat
ive
i
nst
rumentwill
hav
enov
alue.
• Onmat ur
ity
,thepositi
onofprof
it/
lossi
sdetermi
nedbythepriceof
underl
yi
nginstr
ument s.I
fthepri
ceoftheunderl
yi
ngishighert han
thecontr
actpri
cet hebuyermakesaprofi
t.I
fthepr
icei
slower ,the
buyersuf
fersaloss.
(
e) Asnamei ndicatest hesebondsdonotpayi nterestdur i
ngt hel i
feofthe
bonds.I nstead,zer ocouponbondsar ei ssuedatdi scountedpr i
cet o
thei
rf acev alue,whi chi st heamountabondwi l
lbewor thwheni t
mat uresorcomesdue.Whenazer ocouponbondmat ur
es,t heinvestor
willrecei v
eonel umpsum ( f
acev alue)equal tothei nit
ialinvestmentplus
i
nterestt hathasbeenaccr uedont hei nv estmentmade.Themat ur
ity
datesonzer ocouponbondsar eusuallylongt erm.Thesemat ur i
tydat
es
all
owani nvest orforal ongr angepl anning.Zer ocouponbondsi ssuedby
banks,gov ernmentand pr ivate sectorcompani es.Howev er,bonds
i
ssued bycor por atesect orcar ryapot entiall
yhi gherdegr eeofr i
sk,
dependi ngont hef i
nancialst rengthoft hei ssuerandl ongermat ur
ity
peri
od, buttheyal soprovideanoppor t
unityt oachi eveahi gherr etur
n.
Quest
ion27: Maypaper
(
a) Tr
adi
ti
onal
&Wal
terAppr
oacht
oDi
vi
dendPol
i
cy
(
b) Fact
orsaf
fect
ingv
alueofanopt
ion
(
c) For
war
dRat
eAgr
eement
s
(
d) Amer
icanDeposi
tor
yRecei
pts
(
e) Bal
anci
ngFi
nanci
alGoal
svi
s-a-
visSust
ainabl
eGr
owt
h
Ans:
(
a) Accor
dingt
ot hetr
adit
ionalposi
ti
onexpoundedbyGr aham andDodd,
thest
ockmarketpl
acesconsider
ablymoreweightondivi
dendst
hanon

56 Rahul
Mal
kan
 CAFi
nal-SFM

ret
ained ear
nings.Fort hem,the st
ockmar keti
s overwhelmingl
yin
favourofli
beraldiv
idendsasagainstni
ggardl
ydiv
idends.Theirvi
ew i
s
expressedquanti
tat
ivel
yinthef
oll
owingval
uati
onmodel:
P =m (
D+E/
3)
Wher
e,
P =Mar
ketPr
icepershar
e
D =Di
vi
dendpershar
e
E =Ear
ningspershar
e
m =aMul
ti
pli
er.
Aspert
hismodel,intheval
uat
ionofshar
est hewei
ghtatt
achedtodivi
dends
isequaltofourtimestheweightat
tachedtoret
ainedearni
ngs.Inthe
modelprescr
ibed,Ei
srepl
acedby(D+R)sothat
P =m {
D+(
D+R)
/3}
=m (
4D/
3)+m (
R/3)
Thewei ghtspr
ovi
dedbyGr aham andDoddar ebasedont heirsubj
ecti
ve
j
udgment s and not der i
ved f r
om obj ecti
ve empi ri
cal anal ysis.
Notwithstandi
ngthesubject
ivi
tyoftheseweights,
themaj orcont enti
onofthe
tr
aditi
onalpositi
onisthataliberalpayoutpol
i
cyhasaf avourableimpacton
stockprices.
Theformulagi venbyPr of.JamesE.Wal t
ershowshowdi vi
dendcanbe
usedtomaxi misetheweal thposi ti
onofequityholders.Hearguest hati nthe
l
ongr un,sharepricesreflectonl ythepresentv al
ueofexpect eddi vidends.
Retenti
ons inf
luence stock pr ices onl
yt hrough t hei
ref f
ecton f urt
her
di
vidends.Itcan env i
sage di f
ferentpossible mar ketpri
ces in di ffer
ent
si
tuati
onsandconsi dersinternalrateofret
urn,mar ketcapi
tal
isati
onr ateand
di
videndpayoutratiointhedet er
mi nat
ionofmar ketvalueofshares.
Wal
terModel
focusesont
wof
act
orswhi
chi
nfl
uencesMar
ketPr
ice
(
i) Di
vi
dendPerShar
e.
(
ii
) Rel
ationshi
p bet
ween I nt
ernalRate ofRetur
n( IRR)on r
etai
ned
ear
ningsandmar ketexpectat
ions(
costofcapi
tal
).
IfI
RR>CostofCapi tal
,Shar
epr
icecanbeevenhi
gheri
nspit
eoflow
di
vi
dend.Ther
elati
onshi
pbetweendi
vi
dendandshar
epri
ceonthebasi
sof
Walt
er’
sfor
mul
ai sshownbelow:
Vc=
a

57 Rahul
Mal
kan
 CAFi
nal-SFM

c
c
DR(
E-D)
R
R
+
Wher
e,
Vc =Mar
ketv
alueoft
heor
dinar
yshar
esoft
hecompany
Ra =Retur
noni
nter
nalr
etent
ion,i
.e.
,ther
atecompanyear
nsonr
etai
ned
pr
ofi
ts
Rc =CostofCapi
tal
E =Ear
ningspershar
e
D =Di
vi
dendpershar
e.
(
b) Thereareanumberofdi ffer
entmat hemat i
calf ormulae,ormodels,that
aredesignedtocomputethef ai
rvalueofanopt i
on.Yousimplyinputall
the var
iables (
stockpr
ice,ti
me,i nterestr ates,divi
dends and future
vol
atil
it
y),andyougetananswert hattell
sy ouwhatanopt ionshouldbe
worth.Her earethegeneraleff
ectst hev ariableshav eonanopt ion's
pri
ce:
(
a) Pri
ceoftheUnderlyi
ng:Thev al
ueofcallsandput sareaffectedby
changesintheunderly
ingstockpri
ceinar el
ativ
elystrai
ghtf
or ward
manner.Whent hestockpr i
cegoesup,cal l
sshoul dgaininv alue
andputsshoulddecrease.Putopti
onsshouldincreaseinvalueand
cal
lsshoul
ddropast hestockpri
cefal
ls.
(
b) Time:Theopt ion'sf utur
eexpiry,atwhich t
imei tmaybecome
worthl
ess,i
sani mpor t
antandkeyf act
orofev eryopt
ionst r
ategy.
Ult
imatel
y,t i
me can det er
mine whether your opti
on t radi
ng
deci
sionsarepr ofi
table.Tomakemoneyi nopt i
onsov erthelong
ter
m,y ouneedt ounder standtheimpactoft i
meonst ockand
opti
onposit
ions.
With stocks,t i
me isat rader'
s all
y as the stocks ofqual it
y
compani estendt ori
seov erlongperiodsoft ime.Butti
mei st he
enemyoft heopt i
onsbuy er.Ifdayspasswi thoutanysi gni
fi
cant
changeint hestockpr
ice,t
hereisadecl i
nei
nt hevalueoftheopti
on.
Also,thev alueofanopt iondeclinesmorer api
dlyastheopt ion
approachest heexpir
ationday .Thatisgoodnewsf ort
heopt ion

58 Rahul
Mal
kan
 CAFi
nal-SFM

sel
ler
,whotr
iest
obenef i
tfr
om ti
medecay
,especi
all
ydur
ingt
hat
fi
nalmont
hwhenitoccur
smostrapi
dly
.
(
c) Vol
ati
li
ty:The beginning pointofunder st
anding volati
l
ityisa
measurecal
ledstat
isti
cal(somet i
mescall
edhistor
ical)vol
atil
i
ty,or
SV forshort.SV i s a statist
icalmeasure oft he pastpr ice
movementsoft hest ock;ittell
sy ouhow vol
atil
et hest ockhas
act
uall
ybeenoveragiv enperi
odoft i
me.
(
d) I
nterestRate-Anot
herfeat
urewhichaffect
st heval
ueofanOpt i
on
i
st het i
mev al
ueofmoney .Thegr eaterthei nt
erestr
ates,t
he
pr
esentv al
ueofthefut
ureexer
cisepr
iceisless.
(
c) A Forwar dRat
eAgr eement( FRA)isanagr eementbet weentwo
parti
est hr
oughwhichabor rower/lenderpr
otect
si tsel
ffrom t
he
unfavourabl
echangestothei nter
estrat
e.Unli
kefuturesFRAsare
nottradedonanexchangethusar ecal
ledOTCproduct.
Fol
l
owi
ngar
emai
nfeat
uresofFRA.
♦ Normal
lyitisusedbybankstof i
xint
erestcostsonanti
cipat
ed
f
uturedeposi
tsori
nter
estr
evenuesonvariabl
e-r
atel
oansi
ndexed
t
oLIBOR.
♦ I
tisanof
fBal
anceSheeti
nst
rument
.
♦ Itdoesnoti
nvol
veanytr
ansferofpr i
ncipal
.Thepri
ncipalamountof
theagreementi
ster
med" noti
onal"because,whi
l
eitdet er
minesthe
amountofthepayment
,actualexchangeofthepri
ncipalnevert
akes
place.
♦ Iti
ssettledatmat uri
tyincashr epresenti
ngt heprofitorl
oss.Abank
thatsell
sanFRAagr eestopayt hebuy ertheincreasedinterestcost
onsome" not
ional"pri
ncipalamounti fsomespeci fi
edmat ur
it
yof
LIBORi saboveast i
pulat
ed" forwardr ate"ont hecontractmat urit
y
orsettl
ementdat e.Conversely,thebuy eragr eest opayt hesel l
er
anydecr easeininterestcostifmar ketinterestratesfallbelowt he
forwardrate.
♦ Fi
nalsett
lementoftheamount
sowedbyt
hepar
ti
est
oanFRAi
s
det
erminedbythef
ormula
Pay
ment=×100
[
1+RR(
dtm/
DY)
]
(
N)(
RR-FR)
(dt
m/DY)
Wher
e,

59 Rahul
Mal
kan
 CAFi
nal-SFM

N =t
henot
ional
pri
nci
pal
amountoft
heagr
eement
;
RR = Ref
erence Rat
efort he matur
it
y speci
fied by t
he contr
act
pr
evai
l
ingonthecont
ractset
tl
ementdat
e;ty
pical
lyLI
BORorMI BOR
FR =Agr
eed-
uponFor
war
dRat
e;and
dt
m =mat
uri
tyoft
hef
orwar
drat
e,speci
fi
edi
nday
s(FRADay
s)
DY =Daycountbasi
sappl
icabl
etomoneymar
kett
ransact
ionswhi
ch
coul
dbe360or365day
s.
I
fLI
BOR>FRt hesel
lerowesthepaymenttothebuy
er,andi
fLIBOR<FR
thebuyerowesthesell
ertheabsol
uteval
ueofthepaymentamount
deter
minedbytheaboveformula.
♦ The di
ff
erent
ialamountis di
scount
ed atpostchange (
actual
)
i
nter
estrat
easi ti
sset
tl
edinthebegi
nni
ngoftheper
iodnotatthe
end.
Thus,buy
inganFRAiscomparabl
etosel
l
ing,
orgoi
ngshor
t,aEur
odol
l
ar
orLI
BORfut
urescont
ract
.
(
d) Amer i
canDeposi t
oryReceipt s(
ADRs) :Adepositoryrecei
ptisbasi
call
ya
negoti
ablecert
if
icatedenomi natedinUSdol l
arsthatrepresentanon-US
Company ’
spublicl
yt radedlocalcurrency(I
NR)equi tyshares/
securi
ti
es.
Whilethetermrefertot hem isglobaldeposi
toryreceipt
showev er
,when
suchreceipt
sarei ssuedout si
det heUS,butissuedf ortr
adingintheUS
theyarecall
edADRs.
AnADRi sgener all
ycr eatedbydepositingthesecur i
ti
esofanI ndi
an
companywi thacust odianbank.I
narrangementwi ththecust odianbank,
adeposit
oryint heUSi ssuestheADRs.TheADRsubscr iber/holderi
nthe
USisenti
tledt otradetheADRandgener all
yenjoyri
ghtsasowneroft he
underl
yi
ngI ndiansecur i
ty.ADRswit
hspeci al/
uniquefeatureshav ebeen
devel
opedov eraper iodoft i
meandt hepr acti
ceofi ssuingADRsby
Indi
anCompani esiscatchingup.
OnlysuchI ndiancompani est hatcanst akeacl aimf orint
ernational
recogniti
on can av ailt he oppor tunit
yt oissue ADRs.The l ist i
ng
requirementsinUSandt heUSGAAPr equi r
ementsar ef ai
rl
ysev er
eand
willhav et o be adhered.Howev eri fsuch condi ti
ons ar e metADR
becomesanexcel l
entsour cesofcapi t
albr i
ngi
ngi nf orei
gnexchange.
Thesear edeposi toryreceiptsi ssuedbyacompanyi nUSA andar e
governedbyt heprovisi
onsofSecur i
ti
esandExchangeCommi ssi
onof
USA.Ast heregulati
onsar esev ere,Indiancompani est aptheAmer ican
mar ketthroughpr i
vatedebtpl acementofGDRsl istedi nLondonand
Luxembur gstockexchanges.

60 Rahul
Mal
kan
 CAFi
nal-SFM

Apartfrom l
egali
mpediments,ADRsarecostli
erthanGl
obalDeposi
tory
Receipts(GDRs).Legalfees are consider
ably hi
gh f
orUS l i
sti
ng.
Registr
ati
onfeeinUSAisalsosubst
anti
al.Hence,ADRsarel
esspopular
thanGDRs.
(
e) Theconceptofsust ainablegr owt hcanbehel pfulforplanni ngheal thy
corporate gr owt h.Thi s conceptf orces manager st o consi dert he
fi
nancialconsequencesofsal esincr easesandt osetsal esgr owt hgoal s
thatareconsi stentwi tht heoper atingandf i
nanci alpol
ici
esoft hef i
rm.
Often,aconf li
ctcanar i
sei fgrowt hobj ectiv
esar enotconsi stentwi ththe
valueoft heor gani zati
on' ssustainablegr owt h.Quest i
onconcer ningr i
ght
distr
ibution ofr esourcesmayt akeadi f
ficultshapei fwet akei nt o
considerationt her i
ghtnessnotf ort hecur r
entst akeholder sbutf orthe
futur
est akeholder sal so.To t akeani ll
ust r
ation,letusr efert of uel
i
ndust rywher er esour cesar eli
mi t
edi nquant i
tyandaj udi cialuseof
resourcesi sneededt ocat ert otheneedoft hef uturecust omer salong
withtheneedoft hepr esentcust omer s.Onemayhav enot icedt hesav e
fuelcampai gn,ademar ketingcampai gnt hatdev i
atesfrom t heusual
approachofsal esgr owt hst r
ategyandpr eachesf orconser v ationoff uel
fortheiruseacr ossgener ati
on.Thi si sanexampl eofst abl egr owt h
strat
egy adopt ed by t he oi lindust ry as a whol e underr esource
constraintsandt hel ongr unobj ecti
v eofsur vi
valov eryears.I ncr ement al
growt hst r
ategy ,profitst r
ategyandpausest r
ategyar eotherv ariantsof
stablegrowt hst rategy.
Sustainabl
egrowthisi mpor t
anttoent er
priselong- t
erm dev el
opment .
Too f astortoo sl
ow gr owth wil
lgo agai nstent erpr
isegr owth and
development,so fi
nancialshoul d play i
mpor t
antr ol
ei n ent
erpri
se
development,adoptsuitablef i
nancialpoli
cyi ni
tiati
v et o make sure
enterpri
segrowthspeedcl oseto sustai
nablegr owt hr ati
o and have
sustainabl
eheal
thydevelopment.
Thesust ainablegr owt hr ate( SGR) ,conceptbyRober tC.Hi ggins,ofa
fi
rmi st hemaxi mum r ateofgr owthi nsal esthatcanbeachi eved,gi v
en
thefirm'spr ofi
tabil
ity,assetut ili
zation,anddesi reddi vi
dendpay outand
debt(financi all
ev erage)r at
ios.Thesust ainabl
egr owthrat eisameasur e
ofhowmuchaf i
rm cangr owwi t
houtbor rowingmor emoney .Afterthe
fi
rm haspassedt hisr ate,itmustbor rowf undsf rom anot hersour cet o
facil
i
tategr owth.Var i
ablest ypi
cal l
yi ncludethenetpr ofi
tmar ginonnew
andexi stingr evenues; theassett urnov errati
o,whi chisther ati
oofsal es
revenuest ot otalasset s;theasset st obegi nningofper iodequi tyr atio;
and ther et ent
ion r ate,whi ch isdef ined ast hef racti
on ofear nings
retai
nedi nt hebusi ness.

61 Rahul
Mal
kan
 CAFi
nal-SFM

SGR=ROEx(
1-Di
vi
dendpay
mentr
ati
o)
Sustai
nable growt h model s assume t hatthe business want st o:1)
maintainat argetcapi talst r
ucture withoutissuing new equi ty;2)
maintainatargetdividendpay mentr at
io;and3)increasesalesasr apidly
asmar ketconditi
onsal l
ow.Si ncet heassettobeginningofper iodequi ty
rati
oisconst antandt hef i
rm'
sonl ysour ceofnew equi tyi sret ai
ned
earni
ngs,salesandasset scannotgr ow anyf asterthant heret ai
ned
earni
ngsplust headdi ti
onaldebtt hattheretai
nedear ni
ngscansuppor t.
Thesust ai
nablegr owt hr ateisconsistentwiththeobser vedev idence
thatmostcor porati
onsar er el
uctanttoissuenewequi ty.If
,howev er,
the
fi
rmi swill
i
ngt oi ssueaddi ti
onalequity,t
hereisinpr i
ncipl
enof inancial
constrai
ntoni t
sgr owthrat e.
Quest
ion28: NovRTP
Wr
it
eashor
tnot
eon
(
a) I
mpactofGDRsonI
ndi
anCapi
tal
Mar
ket
(
b) Ty
pesofr
isksf
orei
gnexchangedeal
i
ngsar
eexposedt
o
(
c) Const
rai
ntsonpay
ingDi
vi
dend
(
d) Ty
pes/For
msofFact
ori
ng
(
e) Tr
easur
ybi
l
ls
Ans:
(
a) Af t
ert he gl obal i
zat i
on oft he I ndian economy ,accessi bi
li
tyt ov ast
amountofr esour ceswasav ail
abl et ot hedomest iccor poratesect or.
Onesuchaccessi bil
it
ywasi nter msofr aisi
ngfinancialresourcesabr oad
byi nternationallypr udentcompani es.Amongot hers,GDRswer et he
mosti mpor tantsour ceoff inancef r
om abr oad atcompet it
ivecost .
Global deposi tor y receipts ar e basi cal
ly negot iable cer ti
ficates
denomi natedi nUSdol l
ars,thatr epr esentanon-UScompany ’spubl icly
tradedl ocalcur rency( I
ndianr upee)equi tyshares.Compani esi nI ndia,
throught hei ssueofdeposi tor yr eceipts,havebeenabl et ot apgl obal
equitymar kett or aiseforeigncur r encyf undsbywayofequi t
y .Sincet he
i
ncept ionofGDRs,ar emar kabl echangei nIndiancapi talmar kethas
beenobser ved.Someoft hechangesar easf ol
l
ows:
(
i) Indi
ancapi
talmarkettosomeext entisshif
ti
ngf
rom Bombayt
o
Luxembur
gandotherfor
eignf
inanci
alcent
res.
(
ii
) Thereisarbi
tragepossi
bil
it
yin GDR i
ssues.Si
ncemanyI ndian
companiesareacti
vel
ytradi
ngont heLondonandtheNew Yor k
Exchangesandduet otheexist
enceoftimedif
fer
ences,market

62 Rahul
Mal
kan
 CAFi
nal-SFM

news,sentimentset c.atti
mesthepri
cesofthedepositor
yr ecei
pts
aretradedatdi scountsorpremiumstot heunderl
yingstock.This
presents an arbit
rage oppor
tuni
ty wher
eint he r
eceipt
s can be
boughtabr oadandsol dinI
ndi
aatahigherpri
ce.
(
ii
i)I
ndi
ancapitalmar
keti
snol ongerindependentfrom t
herestoft
he
wor
ld.Thi
sputsaddi
ti
onalstrai
nont heinvest
orsastheynowneed
t
okeepupdatedwit
hworldwideeconomicev ent
s.
(
iv)I
ndian ret
ailinvestor
s are compl etel
y sidel
i
ned. Due t o the
pl
acementsofGDRswi t
h Foreign Inst
it
uti
onalInvestor
’son the
basi
sfreepri
cing,theret
aili
nvestor
scannow nol ongerexpectto
makeeasymoneyonheav i
lydi
scountedr i
ght
/publi
cissues.
(
v) Aconsi
der
abl
eamountofforei
gninv
estmenthasfoundit
swayin
t
heIndi
anmar
ketwhi
chhasimprov
edliqui
dit
yint
hecapi
talmar
ket
.
(
vi)Indi
ancapit
almar
kethasst
art
edt
orev
erber
atebywor
ldeconomi
c
changes,
goodorbad.
(
vii
)Indi
ancapi
talmar
kethasnotonl
ybeenwi
denedbutdeepenedas
wel
l
.
(
vii
i
)Ithasnow becomenecessaryforI
ndi
ancapi
talmarkett
oadopt
i
nter
nat
ional
pract
icesi
nit
sworki
ngi
ncl
udi
ngfi
nanci
ali
nnovat
ions.
(
b) Afirm deali
ngwi t
hf or
eignexchangemaybeexposedt oforeigncur
rency
exposures.Theexposur eist her esultofpossessi on ofassetsand
l
iabil
i
ties and transactions denomi nated i nf or
eign currency.When
exchanger atef
luctuates,assets,
li
abi l
i
ties,revenues,expensesthathave
beenexpr essedinf or
eigncur r
encywi llresultineit
herforei
gnexchange
gainorloss.Af i
rm dealingwithforeignexchangemaybeexposedt othe
fol
lowingtypesofr i
sks:
(
i) Transact i
onExposur e:Af i
rm mayhav esomecont ractuall
yfixed
payment sandr eceiptsinforei
gncur r
ency,suchas,importpay ables,
exportreceivables,inter
estpay abl
eonf oreigncurrencyl oanset c.
Allsuchi temsar et obeset tl
edi naf or
eigncurrency.Unexpect ed
fl
uctuationinexchanger atewil
lhav efavourabl
eoradv ersei mpact
on its cash fl
ows.Such exposur es ar
et ermed as t r
ansactions
exposures.
(
ii
) Transl
ati
on Exposure:The transl
ati
on exposurei s al
so called
account
ingexposureorbalancesheetexposure.Itisbasical
l
yt he
exposur
eont heasset sandli
abil
it
iesshownint hebalancesheet
andwhicharenotgoi ngtobeli
quidat
edinthenearf ut
ure.Itr
efers
totheprobabi
l
ityoflossthatt
hef i
rm mayhavetof acebecauseof

63 Rahul
Mal
kan
 CAFi
nal-SFM

decreaseinvalueofasset
sduetodev
aluati
onofaforei
gncur r
ency
despit
et hef actt
hattherewasnof or
eignexchangetransacti
on
duri
ngt heyear.
(
ii
i)Economi cExposur e:Economicexposuremeasur esthepr obabil
it
y
thatfluctuati
onsinf or
eignexchangerat
ewi l
laffectt
hev al
ueoft he
fi
rm.Thei ntri
nsi
cv al
ueofaf ir
mi scalcul
atedbydi scounti
ngt he
expect edfuturecashf lowswithappropri
atediscounti
ngr ate.The
ri
ski nv ol
vedi neconomi cexposurerequir
esmeasur ementoft he
effectoff l
uctuat
ionsinexchangerateondiff
erentfut
urecashf lows.
(
c) Const
rai
ntsonpay
ingDi
vi
dedends
(
i) Legal:UnderSect i
on205(1)oftheCompaniesAct1956,di
v i
dendi s
tobepai doutofcur r
entprofi
tsorpastprof
it
safterdepreciati
on.
TheCent ralGovernmentcanal l
ow acompanyt opaydivi
dendf or
anyfinancialyearoutofpr of
it
softhecompanywi thoutprov i
ding
fordepreciat
ionifi
tisint
hepublici
nter
est
.
Divi
dendistobepai dincashbutacompanyi sall
owedt ocapi
tal
ise
prof
itsorreserves(ret
ainedear
nings)forissui
ngfull
ypaidbonus
shares.Capi
talprof
itmayalsobedistr
ibut
edasdi v
idendsifar
ti
cles
permit.
(
ii
) Li
quidit
y:Paymentofdividendsmeansout fl
ow ofcash.Abi l
it
yt o
paydivi
dendsdependsoncashandl i
quidi
typosit
ionofthef i
rm.A
maturecompanydoesnothav emuchi nvestmentoppor
tunit
ies,nor
arefundsti
edupi npermanentwor ki
ngcapi t
aland,t
herefor
ehasa
soundcashposi ti
on.Foragr owt
hor i
ent
edcompanyi nspiteof
good profi
ts,itwi l
lneed f unds forexpanding activ
iti
es and
permanentworkingcapit
alandt hereforeitisnotinaposi ti
ont o
decl
aredivi
dends.
(
ii
i)Access tot he CapitalMarket
:Bypay ing large di
vi
dends,cash
posi
ti
oni saffect
ed.I fnewshareshav et
obei ssuedtorai
sef unds
for fi
nancing i nvestment pr
ogr ammes and i ft he existi
ng
shar
eholders cannotbuy addi ti
onalshar es,cont r
olis diluted.
Paymentofdi vi
dendsmaybewi t
hheldandear ningsareut
il
isedf or
fi
nanci
ngf i
rm’sinvestmentopportuni
ti
es.
(
iv)I
nvestment Oppor tunit
ies: I
f investment oppor
tuni
ti
es are
i
nadequate,i
tisbet tertopaydivi
dendsandraiseexter
nalf
unds
whenevernecessar
yf orsuchoppor
tuni
ti
es.
(
d) Dependingupont hefeatur
esbuil
tintothef act
ori
ngar
rangementto
cat
ertot hevar
yingneedsoftr
ade/ci
ti
zens,t
herecanbedi
ffer
entki
nds
offact
oring:

64 Rahul
Mal
kan
 CAFi
nal-SFM

Recour se and Non- r

ecourse Factoring:Undera r ecourse f actor
ing
arrangement ,thef actorhasr ecourset ot heclient(fir
m)i ft hedebt
purchased/ r
eceivablef act
oredturnsoutt obei rr
ecoverable.Inot her
wor ds,thef actordoesnotassumecr editri
sksassoci ated wi t
ht he
receivables.Thef actordoesnothav et herightt
or ecourseint hecaseof
non- r
ecour sefactoring.Thelossarisingoutofi rr
ecoverabler ecei
vables
i
sbor nebyhi m,asacompensat i
onf orwhichhechar gesahi gher
commi ssion.
Adv anceandMat urit
yf actoring:Thef actorpai dapr especi f
iedpor ti
on,
rangingbet weent hree-fourthst oninet enths,ofthef actoredreceivables
i
nadv ance,t hebal ancebei ngpai duponcol lect
ion/ ontheguar ant
eed
pay mentdat e.Adr awingl imit,asapr e-pay ment,ismadeav ail
ableby
thef actortot heclientassoonast hef actoreddebt sar eappr oved/t
he
i
nv oicesareaccount edf or.Thecl ienthast opayi nterest(discount)on
theadv ance/repay mentbet weent hedat eofsuchpay mentandt hedat e
ofact ualcoll
ectionf r
om t hecust omer s/ortheguar anteedpay mentdat e,
determi nedont hebasi soft hepr evail
ingshor t-
termr ate,thef i
nanci al
standingoft hecl i
entandt hev ol
umeoft het urnover.
Ful
lf actor
ing:Thi
si st he mostcompr ehensi
veform off act
ori
ng
combiningt hef
eat
uresofal lthefact
ori
ngservi
cesspeci
all
ythoseof
non-
recourseandadvancefactori
ng.I
tisal
soknownasoldl
inefact
ori
ng.
Disclosedandundi sclosedFactoring:Indiscl
osedf actori
ng,t hename
ofthef actorisdisclosedint heinvoicebythesuppl i
er-manuf acturerof
thegoodsaski ngt hebuy ertomakepay menttot hefactor,thenameof
the factori s notdi scl
osed int he invoi
ce in undisclosed f act
oring
alt
hough t he f act
or mai ntains the sales ledger of t he suppl ier
-
manuf acturer
.Theent i
rereal
izat
ionoft hebusinesstransactioni sdone
i
nt henameoft hesuppl i
ercompanybutal lcontrolremai nswi t
ht he
factor.
Domest i
c and expor t/Cross BorderFactori
ng:I ft he three parti
es
i
nv ol
ved,namel y
,cust omer( buyer)
,cli
ent,(
sell
er-supplier
)andf actor
(f
inanci
alintermediary)aredomi cil
edint hesamecount ryt heniti s
knownasdomest icfactor
ing.Thereareusual
l
yf ourpar t
iesinvolvedtoa
crossborderfact
oringtransacti
on.Theyare:
1. Expor
ter(
cli
ent
)
2. I
mpor
ter(
cust
omer
)
3. Expor
tfact
or
4. I
mpor
tFact
or

65 Rahul
Mal
kan
 CAFi
nal-SFM

I
tisal
soknownast
wo-
fact
orsy
stem.
(
e) Treasurybi
ll
sareshort-
term debtinst
rument softheCent ralGov er
nment,
mat ur
inginaperiodofl essthanoney ear.Treasurybil
lsar eissuedby
RBIonbehal foftheGov er
nmentofI ndi
af orperiodsr angingf r
om 14
dayst o 364 dayst hr
ough r egularauct i
ons.They ar e hi ghlyli
qui
d
i
nstrumentsandissuedtot i
deov ershort-
termliqui
dityshortf
al l
s.
Treasurybi llsar esol dthr oughanauct ionpr ocessaccor dingt oaf i
xed
aucti
oncal endarannouncedbyt heRBI .Banksandpr i
mar ydeal ersar e
themaj orbi ddersi nt hecompet i
t i
v eauct i
onpr ocess.Pr ovidentFunds
and ot her i nv estors can make non- compet i
tive bids.RBImakes
all
ocationt onon- compet i
tivebidder satawei ght edav eragey ieldarri
v ed
atont hebasi soft hey ieldsquot edbyaccept edcompet it
ivebi ds.These
dayst het reasur ybillsar ebecomi ngv erypopul aronaccountoff al
ling
i
nterestr ates.Tr easur ybi ll
sar ei ssuedatadi scountandr edeemedat
par.Hence, thei mplici
ty ieldonat reasurybillisaf unctionoft hesizeof
thediscountandt heper i
odofmat urit
y.Now,t hesebi ll
sar ebecomi ng
partofdebtmar ket.InI ndia,thelar gesthol der soft het reasur ybill
sar e
commer cialbanks, t
rust, mut ualfundsandpr ov i
dentf unds.Al thought he
degreeofl iquidityoft reasur ybill
sar egr eatert hant radebi lls,theyar e
notselfliquidat i
ngast hegenui net radebillsar e.T-bill
sar eclai m against
thegov ernmentanddonotr equireanygr adingorf urtherendor sement
oraccept ance.
Quest
ion29 NovPaper:
simi
lart
oquest
ionsal
readydi
scussed
2015
Quest
ion30: MayRTP
Wr
it
eashor
tnot
eon
(
a) Ar
bit
ragePr
ici
ngTheor
y
(
b) Congl
omer
ateMer
ger
(
c) Takeov
erSt
rat
egi
es
(
d) Fact
orsaf
fect
ingi
nvest
mentdeci
sioni
npor
tfol
i
omanagement
(
e) Rol
eofI
nvest
mentBanksi
nPr
ivat
ePl
acement
Ans:
(
a) Unli
ketheCAPM whi chisasingl
ef act
ormodel ,
theAPTi samul tif
actor
modelhav i
ngawhol esetofBetaValues–onef oreachf actor.Arbi
trage
Pri
cing Theorystatesthatthe expected r
eturn on an investmenti s
dependentuponhowt hatinv
estmentreactstoasetofi ndivi
dualmacr o-
economicf act
ors(degr
eeofr eacti
onmeasur edbyt heBet as)andt he

66 Rahul
Mal
kan
 CAFi
nal-SFM

ri
skpremi um associatedwit
heachoft hosemacr o–economicfactors.
TheAPTdev el
opedbyRoss( 1976)holdsthatther
earefourf act
or s
which explaint heriskpremium relat
ionshi
p ofaparti
cul
arsecur it
y.
Sever
alfact orsbeingident
if
iede.g.i
nflat
ionandmoneysupply
,interest
rat
e,industrialproducti
onandper sonalconsumpti
onhaveaspect sof
bei
ngi nt
er-relat
ed.
Accor
dingt
oCAPM,
E(Ri
)=Rf+λβi
Wher
e,λi
stheav
erager
iskpr
emi
um [
E(Rm)–Rf
]
I
nAPT,
E(Ri
)=Rf+λ1βi
1λ2βi
2λ3βi
3λ4βi
4+++
Where,λ1,λ2,λ3,λ4ar eaver
ageriskpremium f
oreachoft hefour
f
actorsinthemodelandβi
1βi2βi
3βi4,,,aremeasuresofsensi
ti
vi
tyof
t
hepar t
icul
arsecur
it
yit
oeachofthef
ourfactor
s.
(
b) Such mer gersi nvolvef irms engaged i n unr el
ated t ype ofbusi ness
oper ati
ons.Inot herwor ds,t hebusinessact i
vit
iesofacqui r
erandt he
targetar enei therr el
atedt oeachot herhor izontall
y( i.
e.,producingt he
same orcompet i
ti
ng pr oducts)norv ert
icall
y( having r elat
ionship of
buy erand suppl i
er)
.I
n a pur e conglomer ate mer ger,t here are no
i
mpor tantcommon f act or
s between t he compani es in pr oduction,
mar keting,r esear ch and dev el
opmentand t echnol ogy.Ther e may
howev erbe some degr ee ofov erl
apping i n one ormor e oft hese
commonf act ors.Suchmer gersareinf act
,uni fi
cati
onofdi fferentkinds
ofbusi nessesunderonef l
agship company .Thepur poseofmer ger
remai nsut il
i
zat ionoff inancialresources,enl argeddebtcapaci tyand
alsosy nergyofmanager i
al f
uncti
ons.
(
c) Normal l
yacquisit
ionsar emadef riendl
y,howeverwhent hepr ocessof
acquisi
ti
oni sunfriendly(i
.e.
,hostil
e)suchacquisi
ti
oni sreferredt oas
‘
takeover’).Hosti
l
et akeoverari
seswhent heBoardofDi rectorsoft he
acquiri
ngcompanydeci detoappr oachtheshareholder
soft het arget
companydi r
ectl
ythroughaPubl icAnnouncement( TenderOf f
er )t
obuy
thei
rshar esconsequentt otherejecti
onoftheoffermadet ot heBoar d
ofDirectorsofthetargetcompany.
TakeOverSt
rat
egi
es:Othert hanTenderOf
fert
heacqui
ri
ngcompany
canal
souset
hefol
lowi
ngt echniques:
• Str
eetSweep:Thisrefer
st othet
echniquewheretheacqui
ri
ngcompany
accumulatesl
argernumberofsharesinat ar
getbef
oremakinganopen
off
er.Theadvantageisthatt
hetar
getcompanyi sl
eftwi
thnochoi
cebut
toagreetotheproposal
ofacquir
erfortakeov
er.
• BearHug:Whent
heacqui
rert
hreat
enst
het
argett
omakeanopenof
fer
,

67 Rahul
Mal
kan
 CAFi
nal-SFM

theboar
doft ar
getcompanyagr
eest
oaset
tl
ementwi
tht
heacqui
rerf
or
changeofcontr
ol.
• Str
ategi
cAl l
i
ance:Thisinvolvesdisar
mi ngtheacqui
rerbyoffer
inga
part
nershi
prathert
hanabuy out.Theacquir
ershoul
dasser
tcont
rolfr
om
wit
hinandtakeoverthet
argetcompany .
• Br
and Power:Thisrefer
sto enter
ing i
nto an al
l
iance wit
h power
ful
br
ands to di
spl
ace t
he tar
get
’s br
ands and as a resul
t,buyoutt
he
weakenedcompany.
(
d) Fact
orsaf
fect
ingI
nvest
mentDeci
sionsi
nPor
tfol
ioManagement
(
i) Object
ivesofi nvest
mentport
fol
io:Ther
ecanbemanyobj ecti
vesof
makingani nvestment.Themanagerofapr ovi
dentfundpor tf
oli
o
hastolookf orsecuri
ty(l
owri
sk)andmaybesat isf
iedwit
hnonet oo
hi
gherreturn.Anaggr essi
vei
nvestmentcompanymay ,howev er
,be
wil
l
ingtot akeahi ghri
skinor
dertohavehighcapit
alappr
eciat
ion.
(
ii
) Sel
ect
ionofi
nvest
ment
(
a) Whattypesofsecuri
ti
estobuyorinvestin?Thereisawi devariet
yof
i
nvest
mentsopportuni
ti
esavai
labl
ei.
e.debentures,convert
ibl
ebonds,
pr
efer
ence shar
es,equit
yshares,governmentsecurit
ies and bonds,
i
ncomeunits,
capit
aluni
tset
c.
(
b) Whatshouldbetheproport
ionofinvest
mentinfixedint
erest
/di
vi
dend
secur
it
iesandv
ari
abl
einter
est/di
vi
dendbear
ingsecuri
ti
es?
(
c) I
ncasei nv
estment
sar etobemadei nt hesharesordebent
uresof
compani
es,whi
chpart
icul
ari
ndust
ri
esshowpotent
ialofgr
owt
h?
(
d) Oncei
ndust
ri
eswithhi
ghgrowthpot
enti
alhav
ebeenident
if
ied,t
henext
st
epistosel
ectt
heparti
cul
arcompani
es,i
nwhosesharesorsecur
it
ies
i
nvest
mentsar
etobemade.
(
ii
i)Timingofpur chase:Atwhatpr i
cetheshareisacquiredfort
he
portf
oli
odependsent ir
elyont heti
mingdeci
sion.I
tisobviousi
fa
personwi shestomakeanygai ns,heshoul
d“ buycheapandsell
dear”i.e.buywhent hesharesar esel
li
ngatal ow pri
ceandsell
whent heyareatahighprice.
(
e) Thei nv
estmentbanker'
swor kinvol
vedi napriv
atepl
acementisqui
te
si
mi l
artosell
sideM&Ar epresentat
ion.Thebankersat
tempttofi
nda
buyerbywr i
ti
ngt hepri
vatePl acementMemor andum (
PPM)andt hen
contact
ingpotent
ial
str
ategicorf i
nancial
buyer
softhecl
ient
.
Becausepr
ivateplacementsinvol
vesell
ingequi
tyanddebttoasingl
e
buyer
,thei
nv est
orandt hesell
er(thecompany)ty
pical
l
ynegot
iat
ethe

68 Rahul
Mal
kan
 CAFi
nal-SFM

termsofthedeal.Investmentbankersf unct
ionasnegoti
ator
sf orthe
company,helpi
ngtoconv i
ncetheinvest
oroft heval
ueofthefir
m.Fees
i
nv ol
vedi
nprivat
eplacementsworkli
ket hoseinpubl
icoff
eri
ngs.Usuall
y
theyareafi
xedpercentageoft
hesizeoft hetr
ansact
ion.
Questi
on31: Maypaper
(
a) Explai
nt hemeani ngofthefol
lowingrel
ati
ngt
oSwapt r
ansacti
ons:
(
i) PlainVani l
aSwaps
(
ii
) BasisRat eSwaps
(
ii
i)AssetSwaps
(
iv)Amor ti
singSwaps
(
b) Disti
nct i
onbetweenOpenendedschemesandCl osedendedschemes
(
c) Stateanyf ourassumptionsofBlackSchol
esModel
(
d) Givet hemeani ngofCaps,Fl oorsandColl
aropt
ionswi t
hr espectt
o
I
nter
est .
(
e) Global deposi
toryrecei
pts
Ans:
(
a)(
i) Plai
n Vani
l
la Swap:Also cal
l
ed generi
c swap and i
tinv
olves t
he
exchangeofafi
xedrateloantoafloat
ingrat
eloan.Fl
oati
ngrat
ebasis
canbeLIBOR,MIBOR,Pr
imeLendingRateetc.
(
ii
) Basi
s Rate Swap:Si mi
l
art o pl
ainvanil
l
a swap withthe dif
fer
ence
paymentsbasedont hedif
fer
encebetweentwodif
ferentvar
iabl
erates.
Forexampleoneratemaybe1mont hLIBORandothermaybe3- month
LI
BOR.I notherwor dstwo legsofswap arefl
oating butmeasured
agai
nstdif
fer
entbenchmarks.
(
ii
i)AssetSwap:Si mil
artopl
ainvani
l
laswapswi t
hthedif
fer
encethati
tis
the exchange fi
xed r
ateinv
estments such as bonds whi
ch pay a
guaranteedcouponrat
ewit
hfl
oati
ngrateinvestment
ssuchasanindex.
(
iv)Amor ti
singSwap:Ani nterestrat
eswapi nwhi cht
henoti
onalprinci
pal
forthei nter
estpay
ment sdecli
nesdur i
ngthelif
eoftheswap.Theyar e
part
icularlyusef
ulforborrowerswhohav eissuedr
edeemabl
ebondsor
debentur es.I
tenablesthem toi nt
erestr
atehedgingwit
hr edempti
on
prof
ileofbondsordebent ures.
(
b) OpenEndedSchemedonothav emat ur
it
yperiod.Theseschemesar e
avai
labl
ef orsubscri
pti
onandr epurchaseonacont i
nuousbasi
s.Inv
estor
canconv enientl
ybuyandsel lunit
.Thepr icei
scalculat
edanddeclar
ed
ondailybasi s.Thecalculat
edpr i
cei stermedasNAV.Thebuy i
ngpri
ce
andselli
ngpr i
ceiscalculat
edwi thcer t
ainadj
ustmenttoNAV.Thekey
fut
ureoft heschemei sliqui
dity.

69 Rahul
Mal
kan
 CAFi
nal-SFM

CloseEndedSchemehasast i
pulatedmat ur
it
yper i
odnor mal l
y5t o10
years.TheSchemei sopenf orsubscr ipt
iononl yduringthespecifi
ed
periodattheti
meofl aunchoft hescheme.I nvest
orcani nv
estatthe
timeofi ni
ti
alissueand thereaf
tert heycan buyorsel lfr
om stock
exchangewheretheschemei sli
sted.Topr ov
ideanexi troutsomeclose
-endedschemesgiveanoptionofsel l
i
ngbank( r
epurchase)ont hebasi
s
ofNAV.TheNAVi sgener
all
ydeclaredonweekl ybasis.
(
c) Themodelisbasedonanormaldist
ri
buti
onofunder
lyi
ngassetr
etur
ns.
Thef
oll
owingassumpti
onsaccompanythemodel
:
1. Eur
opeanOpt
ionsar
econsi
der
ed,
2. Not
ransact
ioncost
s,
3. Shor
tter
mint
erestr
atesar
eknownandar
econst
ant
,
4. St
ocksdonotpaydi
vi
dend,
5. St
ockpr
icemov
ementi
ssi
mil
art
oar
andom wal
k,
6. St
ockr
etur
nsar
enor
mal
l
ydi
str
ibut
edov
eraper
iodoft
ime,
and
7. Thev
ari
anceoft
her
etur
nisconst
antov
ert
hel
i
feofanOpt
ion.
(
d) CapOpt ion:Itisaser i
esofcal lopti
onsoni nterestratecoveri
nga
medi
um- to-l
ongtermfloati
ngratel
iabi
li
ty.PurchaseofaCapenabl esthe
aborrowerstof i
xinadvanceamaxi mum bor rowingrateforaspecifi
ed
amountandf oraspecif
ieddurati
on,whileall
owinghi mt oavai
lbenefi
t
ofafall
inrates.ThebuyerofCappay sapr emium tothesell
erofCap.
Fl
oorOpt i
on:I ti
saputopt iononi nt
erestrate.PurchaseofaFl oor
enabl
esal endert
of ixi
nadvance,ami ni
malr at
ef orpl
acingaspeci f
ied
amountforaspeci f
ieddurat
ion,whil
eallowi
nghi mt oavailbenefi
tofa
ri
seinrat
es.Thebuy eroft
hef l
oorpaysthepremium totheseller
.
Coll
arsOpt
ion:I
tisacombi nati
onofaCapandFl oor.Thepurchaserofa
Coll
arbuysaCapandsi multaneousl
ysellsaFloor.A Col
larhast he
eff
ectoflocki
ngi t
spur chasesi nt
oaf loat
ingr
ateofi nt
erestthatis
boundonbothhighsideandt helowside.
(
e) GlobalDeposi toryRecei pt:Iti
saninstrumenti nthef orm ofadepository
receiptorcer t
ificatecreatedbyt heOv erseasDeposi toryBankout side
Indiadenomi natedi ndol l
arandissuedt onon- r
esidenti nvest
orsagainst
thei ssueofor dinaryshar esorFCCBsoft hei ssuingcompany .Itis
tradedi nstockex changei nEuropeorUSA orbot h.A GDR usual l
y
representsoneormor eshar esorconv er
ti
blebondsoft he i
ssuing
company .Ahol derofaGDRi sgiv
enanopt i
ontoconv ertiti
ntonumber
ofshar es/bonds t hati tr epr
esents after45 day sf rom the date of

70 Rahul
Mal
kan
 CAFi
nal-SFM

al
lotment.Thesharesorbondswhi chahol derofGDRi sent
it
ledt
oget
aretradedinIndi
anStockExchanges.Tillconversi
on,t
heGDRdoesnot
carr
yanyv oti
ngri
ght.Ther
eisnolock-i
n-periodforGDR.
Quest
ion32: NovRTP
Wr
it
eashor
tnot
eon
(
a) Nost
ro,
Vost
roandLor
oAccount
s
(
b) Char
act
eri
sti
csofFi
nanci
alLeasi
ng
(
c) Mar
kingt
oMar
ket
(
d) Rel
evantassumpt
ionsofCAPM
(
e) ExchangeTr
adedFunds
Ans:
(
a) I
ni nterbank t r
ansact i
ons,f orei
gn exchange i st ransfer
red from one
accountt o anotheraccountandf r
om onecent ret o anothercent re.
Ther efore,thebanksmai ntainthreetypesofcur rentaccountsinor derto
facil
itatequi cktransferoff undsindi fferentcurrencies.Theseaccount s
areNost ro,Vost r
oandLor oaccount smeani ng“our”,“your
”and“ thei
r”.A
bank’ sf orei
gncur r
encyaccountmai ntainedbyt hebanki naf or
eign
count ryandi nt hehomecur r
encyoft hatcount r
yi sknownasNost r
o
Accountor“ ouraccountwi t
hy ou”.Forexampl e,AnI ndianbank’sSwi ss
francaccountwi t
habanki nSwi tzerland.Vost roaccounti st helocal
currencyaccountmai ntainedbyaf orei gnbank/ branch.Itisalsocalled
“youraccountwi thus”.Forexampl e,Indi anrupeeaccountmai ntai
nedby
abanki nSwi tzerl
andwi t
habanki nI ndi
a.TheLor oaccounti san
accountwher ei
nabankr emi tsfundsinf orei
gncur rencytoanotherbank
forcr edittoanaccountofat hir
dbank.
(
b) Sal
i
entf
eat
uresofFi
nanci
alLease
(
i) I
tisani
nter
medi
atet
ermt
olong-
ter
m ar
rangement
.
(
ii
) Dur
ingt
hepr
imar
yleaseper
iod,
thel
easecannotbecancel
l
ed.
(
ii
i)Theleasei
smor
eorl
essf
ull
yamor
ti
zeddur
ingt
hepr
imar
ylease
per
iod.
(
iv)Thecostsofmaint
enance,t
axes,i
nsuranceetc.,aretobei
ncur
red
bythel
esseeunl
essthecont
ractpr
ovidesotherwise.
(
v) Thel
esseei
srequi
redt
otaket
her
iskofobsol
escence.
(
vi)Thel
essori
sonl
ytheFi
nanci
erandi
snoti
nter
est
edi
ntheasset
.
(
c) I
timpl
iest
heprocessofrecordi
ngt
heinvest
mentsi
ntradedsecur
it
ies
(
shar
es,debt
-i
nst
rument
s,et c.
)atavalue,whi
chrefl
ect
st hemarket

71 Rahul
Mal
kan
 CAFi
nal-SFM

valueofsecur it
iesont her eporti
ngdat e.I nt hecont extofder ivati
ves
tradi
ng, t
hef uturescont ractsar emar kedt omar ketonper iodic(ordaily)
basis.Mar kingtomar ketessent i
all
ymeanst hatatt heendofat rading
session,alloutstandingcont ractsarerepr i
cedatt heset t
lementpr iceof
thatsessi on.Unl ike the f orward cont r
act s,t he future cont r
acts are
repri
cedev eryday .Anyl ossorpr ofi
tr esultingf rom repricingwoul dbe
debitedorcr edit
edt ot hemar ginaccountoft hebr oker .It
,therefore,
providesanoppor tunit
yt ocal culatet
heext entofl i
abil
ityont hebasi sof
repri
cing.Thus,t hefut urescont r
actspr ovidebet terr i
skmanagement
measur eascompar edtof orwardcont r
acts.
Supposeon1stdaywet akeal ongposi t
ion,sayatapr iceof`100t obe
mat uredon7t hday .Now on2nddayi ft hepricegoesupt o`105,t he
contractwi llberepr icedat`105att heendoft hetradingsessionand
profitof`5wi l
lbecr edit
edt otheaccountoft hebuy er.Thisprofitof`5
maybedr awnandt huscashf l
owal soincreases.Thi smar ki
ngt omar ket
willresultinthreet hings–one,y ouwi l
lgetacashpr ofitof`5;second,
theexi sti
ngcont ractatapr i
ceof`100woul dst andcancel l
ed;andt hird
youwi llreceiveanewf utur
escont ractat`105.I nessence,t hemar king
tomar ketfeatureimpl iesthatthev alueoft hefut ur
escont ractissett o
zeroatt heendofeacht r
adingday .
(
d) RelevantAssumpt i
onsofCAPM
(i
) Thei nvestor’sobjectiveist omaxi mizet heut i
li
tyoft ermi nalwealt
h;
(i
i
)I nvestorsmakechoi cesont hebasisofr iskandr et
urn;
(i
i
i)I nvestorshav eidentical t
imehor i
zon;
(i
v)I nvestorshav ehomogeneousexpect ationsofr iskandr eturn;
(v
)I nf
ormat i
oni sfr
eelyandsi mul t
aneouslyav ailabl et
oi nvestors;
(v
i)Ther ei srisk-fr
eeasset ,andi nvestorcanbor rowandl endunl i
mit
ed
amount satther i
sk-freer ate;
(v
ii
)Ther ear enot axes,transact ioncosts,r estr
ictionsonshor trat
esor
othermar ketimperfections;
(v
ii
i)Totalassetquant i
tyi sf i
xed,andal lasset sar emar ketableand
divi
sible.
(
e) ExchangeTr adedFunds( ETFs)wereintr
oducedi nUSi n1993andcame
toIndi
aar ound2002.ETFi sahy bri
dproductthatcombi nesthefeat
ur es
ofanindexmut ualf
undandst ockandhence,isalsocalledindexshares.
Thesefundsar elist
edont hestockexchangesandt hei
rpr i
cesareli
nked
tot he underl
ying index
.The aut hori
zed part
icipant
s actas mar ket
makersf orETFs.
ETFcanbeboughtandsol
dli
keanyot
herst
ockonst
ockexchange.I
n

72 Rahul
Mal
kan
 CAFi
nal-SFM

otherwords,theycanbeboughtorsol danyt i
medur ingthemar ket
hoursatpri
cest hatar
eexpectedtobecl osertotheNAVatt heendof
theday.NAVofanETFi sthev al
ueoftheunder l
yi
ngcomponentoft he
benchmarkindexheldbytheETFpl usal
laccrueddiv
idendslessaccr
ued
managementf ees.
Thereisnopaperwor kinvol
vedforinvesti
ngi
nanETF.Thesecanbe
boughtli
keanyotherstockbyjustpl
acinganorderwi
thabr
oker
.Some
otheri
mport
antfeatur
esofETFar easfoll
ows:
1. I
tgivesaninvest
orthebenef
itofinvest
inginacommodi tywi
thout
phy
sical
l
ypur
chasingt
hecommodit
ylikegold,
sil
ver
,sugaret
c.
2. I
tisl
aunchedbyanassetmanagementcompanyorot
herent
it
y.
3. Theinv
est
ordoesnotneedt
ophysi
cal
l
ystor
et hecommodi
tyorbearthe
cost
sofupkeepwhi
chispar
toft
headmini
str
ativ
ecost
softhefund.
4. An ETF combi nes the valuat
ion feat ur
e ofa mut ualfund orunit
i
nv estmentt
rust,
whichcanbeboughtorsol dattheendofeacht r
ading
dayf orit
snetassetv alue,wit
ht hetr adabi
li
tyf
eatureofaclosed-end
fund,whicht
radesthroughoutthetradingdayatpricesthatmaybemor e
orlessthani
tsnetassetv al
ue.
NovPaper
Quest
ion33si
mil
art
oquest
ionsal
readydi
scussed


73 Rahul
Mal
kan