INDIAN INSTITUTE OF PLANNING AND MANAGEMENT

NEW NON METRO CITY

SUBJECT

AN EMPIRICAL STUDY ON MORTGAGE STRUCTURE IN INDIA - A CASE

OF HDFC BANK

SUBMITTED BY:
BATCH:
PHONE NO.:
E-MAIL:
SECTION:
 ABSTRACT

Despite its recognized economic and social importance, housing finance has remained
under-developed in India. The proportion of households living in permanent structures in
India rose from 41.7% in 1991 to 51.8% in 2001, but a high proportion of 38.5% of
households still lives in one-room structures in 2001, which was 40.5% in 1991. A
vibrant secondary market will be an efficient, low cost and stable way of raising money
and managing cash flows in the overall mortgages market. This will be achieved due to
economies of scale in raising money, in processing the purchase and servicing of large
numbers of mortgage loans, and in managing risks through diversification. We have
analyzed several mortgage refinancing models, and have strongly recommended capital
market based models, as the same minimize agency costs, integrate capital markets and
mortgage markets, and over long run will reduce the cost of mortgage lending.
 ACKNOWLEDGEMENT

Through this acknowledgement I express my sincere gratitude towards all those people
who helped me in this project, which has been a learning experience.

I appreciate the co-ordination extended by my friends and also express my sincere

thankfulness to the entire faculty members of Indian Institute of Planning &
Management, Non metro city, giving me the opportunity to do this project/study and also
assisting me for the same.
 TABLE OF CONTENTS

Topic Page No.

1. Abstract 1

2. Acknowledgment 2

3. Introduction 4

4. Theoretical Review/Perspective 6

5. Review and Research 20

6. New Developments in the Research Area 37

7. Topics for further research 38

8. Recommendations 39

9. Conclusion 41

10. Bibliography 44
 INTRODUCTION TO THE TOPIC

Till October 2004, National Housing Bank has made 10 MBS issues in the secondary
market with total issue size of INR 512.27 crores and comprising of 35,116 housing
loans. But the mortgages that are securitized annually account for only 0.5% of the
amount that is disbursed in the primary mortgages market. We have estimated the size of
secondary mortgages market in India using various methodologies. The estimate using
housing data of India and Malaysian ratio of housing loans securitized for 2008-2009
comes to INR 6682.27 crores. If the funds required in the housing sector are taken into
account, then the mortgage securities that can be issued per year can be INR 14272
crores. Also, assuming the present CAGR of 24.42% in disbursals to continue till 2010
and if 15.9% (Malaysian ratio) of the amount disbursed is securitized, then the amount
corresponding to mortgage securities issued in 2010 would be INR 32625 crores.
From the perspective of the long term debt market and using the ratio of MBS to
government debt in Malaysia, the total mortgage securities that could have been issued in
India in the year 2008-2009 would have been INR 18091 crores. With the average loan
size in India of INR 2 lakhs, this extra liquidity of INR 18091 crores, would have
facilitated housing finance to around 904550 people in India.

The potential for secondary mortgages market in India is huge even when we take the
most conservative ratios (of the Malaysian market), which are lowest among the
developed and semi-developed secondary mortgages market of the world. If like in US,
the two-third of our home loans are securitized and based on the disbursals figure of
2008-2009, the MBS issued in 2008-2009 would have been of INR 28017.91 crores. We
have elaborately discussed the reasons why securitisation should bring down the cost of
funding for the mortgage originator. In India, inefficiency is breeding inefficiency and the
cost of securitisation remains high due to either rating agencies exaggerating the credit
enhancements or the investors demanding high premiums for risks they have not properly
appreciated. Therefore, Indian housing finance companies regard the gain-on-sale
booking as one of the prime motivators for securitisation, which, as we have
demonstrated, is quite misplaced. We have made significant recommendations for an
institutional framework for development of the securitisation market. NHB, in our
recommendation, should play an increased role in securitisations in at least two ways that
it does not currently do:

 NHB credit-enhanced securitisations

 Pool-of-pools transactions

A strong legal framework is essential for the establishment of securitisation market in the
country. We have tried to identify the problems in the legal system that stifle the growth
of securitisation. Laws relating to mortgages date back to the 19 th century and obviously
cannot be expected to be securitisation-friendly. We have suggested simple amendments
that would take RMBS paper from the fold of Transfer of Property law, a 19 th century
enactment, and would avoid the need to have a conveyance for transfer of mortgage debt,
thereby eliminating the stamp duty issue.

The primary mortgages market should be developed through standardization of

documents and underwriting practices, and by using professional standards of property
appraisal. We have also made comprehensive analysis of the risks underlying investment
in RMBS, and made a case that the credit and prepayment risks in MBS investing are
quite often misunderstood and are exaggerated. There are significant differences between
market practices in the US market and those in the Indian market – so the US-style
prepayment risks are not relevant to the Indian marke

RESEARCH OBJECTIVES & METHODOLOGY

• Providing stability to the mortgages market
• Responding to the changing capital markets
• Assisting the secondary markets including the support of these markets for
affordable housing
• Promoting access to credit throughout the country by increasing liquidity and
improving distribution of investment capital for residential mortgages market
• Secondary market investor buys mortgages within their guidelines and limits,
which are revised from time to time depending upon the market
considerations

LITERATURE REVIEW
The housing finance sector in India has undergone unprecedented change over the past
five years. The importance of the housing sector in India can be judged by the estimate
that for every Indian rupee (INR) invested in the construction of houses, INR 0.78 is
added to the gross domestic product of the country . The housing sector is also
subservient to the development of 269 other industries . Also the development of robust
housing finance is important to cope with population growth and rapid urbanization in the
country.

Despite its recognized economic and social importance, housing finance has remained
under-developed in India. The role of efficient housing finance system in the provision of
housing cannot be over-emphasized, and is too obvious a need to demand an explanation.

The dismal state of the Indian housing finance can be gauged from the fact that the
mortgage to GDP ratio stood at an abysmal 3% in India in 2001 when compared to 57%
in UK, 54% in USA, 40% in EU, 7% in China, 17% in Thailand and 34% in Malaysia .

2 HOUSING FINANCE SYSTEMS

Broadly speaking, housing finance is delivered, at the house-owner level, by housing

finance companies or banks (say, mortgage financiers). This is by and large common in
every country. The secondary market in residential mortgages refers to the manner in
which these mortgage financiers raise their own funding. On this front, there are several
models, which may broadly be classed into (a) depository banking model; (b) refinancing
body model; or (c) capital market model.

No country in the world works exclusively on any one of the models – there are
combinations in various proportions. In the first system, the mortgage financiers are
depository institutions who are allowed access to public savings – for example, banks
typically raise public deposits; building societies in the UK having been depending on
public savings in form of deposits. The second system has some form of refinancing
body, say, National Housing Bank in India, that raises resources at a central level on its
own balance sheet, and then provides refinance to the mortgage financiers. In the third
model, the mortgage financiers have their mortgage originations funded by capital
market. Here again, there are two possible models – the covered bond or pfandbriefe
model as it prevails in Germany, and the mortgage pass through model or securitisation
model that originated in the USA and then spread all over the World.

Each model has its own merits and demerits. The first model has existed through
centuries, and its biggest advantage is its simplicity. The public needs some saving option
-mortgage financiers provide an easy mode of pooling public savings. However, the first
model has shown grave potential for problems over time. The biggest problem is the huge
asset liability mismatch (ALM) problem that it necessarily implies – the retail deposits
are either contractually or behaviorally short-term, while mortgage finance is long term.
In addition, retail delivery requirements necessitate presence of a large number of
mortgage financiers in every country, and if they are allowed access to public deposits,
there is a huge requirement of regulatory surveillance on a large number of depository
entities. Not only their capital adequacy needs to be monitored, there is a need to ensure
there are no unfair or unhealthy practices in place – a goal which is more often observed
in breach than in compliance. The debacle of savings and loans associations in the USA
proves the point that a large number of entities with depository access can pose a threat to
the system.

The refinancing model is cost and inefficiency-ridden. More intermediaries imply more
costs, and if the apex refinancing body is a publicly-owned entity, it may also carry sloth
which percolates down. That apart, such larger apex bodies are not immune from
financial problems - on the contrary, their large size only means any probability of
demise of the institution may too strong a shock for the system to tolerate. Alan
Greenspan was recently critical of the behemoth-sized Fannie Mae and Ginnie Mae.

The capital market model has one notable difficulty – it is not easy, particularly for
regular requirements of small amounts of funding. On the other hand, it has several
merits. Eventually, in either model, the funding comes from the capital market – so the
capital market model only integrates the primary mortgage market with the ultimate
provider of funding. It is a sort of a disintermediation model, as the role of the mortgage
financier is reduced to mortgage originator and servicer. If the integration is efficient, the
capital market model brings down the cost of funding , and resolves several problems
such as ALM, interest rate mismatch, etc. The capital market model cannot replace the
other models, but to the extent it can be exploited, it brings efficiency and makes housing
finance both cheaper as also more easily accessible.

We later revert to the example of the US government-supported entities (GSEs) in

promoting house finance, but it is clear from history that in both the capital market
models – the European covered bonds or pfandbriefe model and the US mortgage pass-
through model - the mortgage-backed capital market securities have proved to be
extremely safe and sound means of investment for the investing public. In the European
covered bonds case, for example, there is reportedly no default over the last 200 years. In
the US mortgage pass throughs, to the extent they are backed by the GSEs, there is no
question of a default as the GSEs bear the implicit support of the US government, and
even in the non-agency or private label market, defaults have been very scanty, with very
high recovery rates . In addition, the level of secondary market activity in the GSE
securities is only next to government treasuries – as reflected by the graphics below.

We find that global financial institutions tend to trade more heavily than their local
counterparts in the liquid (active) portion of the bond market. Chowdhry and Nanda
(1991) suggest that informed investors tend to trade in more liquid assets, presumably to
camouflage their information advantage. Our finding on the different trading patterns
across global and local financial institutions is consistent with the view that global
financial institutions may have an information advantage and strategically use the more
liquid bonds to conceal their superior information.

Our empirical analysis also uncovers that the average delayed price impact of trades
initiated by global financial institutions is consistently larger than that initiated by local
counterparts (both large and small). Specifically, for every one million Turkish Lira (TL)
traded by global financial institutions, the price changes TL 0.09 or 6 U.S. cents more in
a 10-minute interval than if the TL 1 million were traded by a typical large financial
institution. This represents a price advantage of 11 basis points. As argued in Hasbrouck
(1991), the delayed price impact of a trade measures the informativeness of the trader.
This finding lends support to the conjecture that global financial institutions have an
information advantage, as it suggests that global financial institutions can consistently
buy at a lower (or sell at a higher) price than their local counterpart. These results are
robust to excluding foreign financial institutions from our analysis and/or limiting
attention to the subsample of liquid bonds. This suggests that our findings go beyond the
usual foreign versus domestic dichotomy and are unlikely to be attributed to liquidity.

Building upon the findings on the informativeness of trades for different financial
institutions, we find that global financial institutions earn higher profits on informed
trades than their local counterparts. Specifically, global financial institutions earn 0.006
percentage point higher day-trading profit per trading cycle on informed trades than
typical large financial institutions which in turn earn 0.008 percentage point higher profit
per trading cycle than local financial institutions. This is consistent with the prediction
that financial institutions with an information advantage are likely to perform better on
asset trading than others. We also find that day-trading profitability exhibits some
persistence for all financial institutions. High interest rate volatility reduces day-trading
profitability and investor participation in day-trading.

Finally, we find the price impact of trades by global financial institutions declined over
time. Consistent with the declined price impact of these trades, while global financial
institutions still perform better on informed trades in bond day-trading than their local
counterparts, the outperformance has declined over the same time period. This may
suggest possible learning by local financial institutions as a result of repeated trading
with global financial institutions. Using the approach introduced in Seru, Shumway, and
Stoffman (2009), we identify statistically significant learning effect by local financial
institutions, in particular local small financial institutions, as they accumulate more
experience trading with other informed financial institutions.
We organize the remainder of our paper as follows. Section 2 describes the Turkish
government bond market and trading system, and Section 3 defines our classification of
traders as global versus local financial institutions and presents summary statistics on our
data. In Section 4, we provide empirical analysis and discuss our results. Finally, we
make concluding remarks in Section 5.
2. The Bonds and Bills Market
2.1 The Market

Turkey’s public debt market, the Bonds and Bills Market, is an important investment and
trading venue for financial institutions. Using total market capitalization standardized by
GDP as a measure of importance, according to World Bank Database on Financial
Development and Structure, Turkey ranked 9th out of 30 major world bond markets, with
its bond market being 2.3 times as large as its equity market (see Beck et al., 2000 for
details).

Almost every month, the Turkish Treasury auctions bonds with maturities ranging from
one month to 10 years. After the primary market allocation, these bonds are traded on an
automated secondary market, the Bonds and Bills Market. The institutions that are
authorized to trade on the Bonds and Bills Market are Istanbul Stock Exchange (ISE)
member banks and member brokerage houses. These financial institutions typically trade
on their own accounts. Sometimes they fill retail buy orders from their inventory, but if
their inventory is insufficient they may go to market to meet demand.

Each institution employs multiple traders who form an information network. They are in
constant contact with each other throughout the trading day, permitting them to be better
informed of the local buy and sell order flow. For instance, it is common for traders to
inform the participants in their network that they have learned that a particular financial
institution is a net buyer today or that another financial institution is trying to liquidate a
sizeable position. Some institutions have home offices in multiple markets while others
have branches; such organizational structures create multi-market trader networks that
facilitate the transmission of information relevant to the local market.

Bond market participants are a diverse mix of small and large Turkish financial
institutions and large international financial institutions. These institutions have different
arrangements to disseminate information. International banks, for instance, have their
bond trading floors connected by a “hoot”. Nowadays a “hoot” refers to an electronic
communication system, but originally it was a device devoted to a single trading floor.
“Hoot” transmissions tend to flow from New York and London to other markets. In
contrast, bond traders of Turkish banks (especially large Turkish banks) gather
information by making phone calls to fellow bond traders in overseas financial centers.
Of course, information is also available to all traders whose firms have access to public
information networks such as Reuters, Bloomberg, and similar providers. Different
financial institutions, however, may still have different information processing
capabilities, which may lead to differences in interpretation of publicly released
information and in turn trading performance. For example, Lyons (1995) and Love and
Payne (2008) show that information publicly and simultaneously released to all market
participants is partially impounded into prices through order flows in exchange rate
determination.
2.2 The Trading System

The Bonds and Bills Market is a limit order book market that uses an electronic system to
match, administer, and report transactions. The market operates in two sessions: from
9:30 a.m. to 12:00 noon, and from 1:00 p.m. to 5:00 p.m. Bonds with same-day and next-
day settlement trade until 2:00 p.m., which is the settlement time for the day; between
2:00 p.m. and closing, only bonds with next-day settlement trade. Thus, the number of
transactions declines noticeably after 2:00 p.m.

Orders are processed and executed according to price and time priority. The ISE uses an
order-driven electronic continuous market with no intermediary such as a market maker
and no floor brokers. The majority of the orders are routed electronically via member
firms to the central limit order book through an order processing system that does not
require any re-entry by the member firms. In very rare cases, member firms call
representatives at the exchange to have their orders entered for them. Member firms can
execute market orders and limit orders, as well as orders that require further conditions
for execution (e.g., fill-or-kill and stop-loss). Member firms are not allowed to enter
orders when the market is closed; however, they are allowed to withdraw their existing
orders. It is not unusual to see traders filling out their order screen prior to opening time
and submitting multiple orders at the open.

Price information on the 20 best bids and offers is continuously available to member
firms. The system does not display quantity demanded or offered at each of these prices
and nor does it reveal the identity of the traders submitted the orders. However, past
transactions can be viewed by all members. The most recently issued bond is designated
as the active (or benchmark) bond. The tick size is one Turkish lira (TL) for a 100,000
TL face value bond, with minimum (maximum) order size set to 100,000 TL (10 million
TL); no formal upstairs market exists for block trades. An incoming market order is
executed automatically against the best limit orders in the book. Execution within the
inside quotes is allowed.

Once a transaction takes place, a confirmation notice is sent to the parties involved in the
transaction. The other market participants do not learn the identities of the parties, but
they do observe that a transaction took place at a specific price and quantity. All
information pertaining to price, yield, and volume of best orders as well as details of the
last transaction and a summary of all transactions are disseminated to data vendors,
including Bloomberg, Reuters, and some local firms, immediately after each transaction.
In addition, all trades are reported to the clearing organization, the ISE Settlement and
Custody Bank Inc. (Takas Bank), at the end of the day to facilitate bookkeeping. We do
not have information on what percentage of the transactions take place in ISE; however,
anecdotal evidence suggests that ISE consolidates more than 97% of the turnover value
of the Bonds and Bills Market’s transactions. The remaining portion is captured by over-
the-counter markets.
The Turkish government typically plays a minimal role in the Bonds and Mills Market.
Nevertheless, after the 2001 banking crisis, the Undersecretariat of the Treasury initiated
a primary dealer system that requires some members that participate in the primary
market auction to provide liquidity by quoting a bid and an ask (not necessarily the best
bid or ask) in the secondary market. The quotes are identified as being given by a primary
dealer. The rationale for this innovation is that these members would accommodate
liquidity needs that may arise during times of crisis, although anecdotal evidence
indicates that such action by the primary dealers has yet to occur. The number of primary
dealer members (typically between eight and 14) and its composition (foreign or
domestic) is determined by the Undersecretariat. In 2006, there were 12 primary dealers.
3. Data and Summary Statistics

Our sample consists of 1,716,917 tick-by-tick time-stamped transactions beginning May

1, 2001 and ending June 15, 2005 (1,039 trading days) for 177 Turkish lira-denominated
Treasury bills and notes. For each transaction, we have detailed information on the time
of order placed and filled, transaction price, and trade size. More importantly, our data
set also contains the identities of the traders on both sides of a transaction from their
unique identification code. The starting date of the sample is two months after the
Turkish financial crisis attributed to liquidity shortages in the banking system that ended
in February 2001. Data availability dictates the sample’s ending date.

One hundred seventy distinct financial institutions participated in the Bonds and Bills
Market. We classify these as either local or global financial institutions. Specifically, a
financial institution is classified as “global” if it has branches or offices in major financial
markets outside Turkey; otherwise, it is classified as “local”. Based on information
collected from the ISE and data from the Turkish Bank Association
(http://www.tbb.org.tr/net/subeler) on overseas branches and offices, we classify 146 as
local financial institutions and 24 as global financial institutions. We use the ISE asset
size categories to divide local financial institutions into 116 small and 30 large financial
institutions.
The roster of global financial institutions includes large foreign banks such as Deutsche
Bank, Citibank, and JP Morgan Chase as well as large domestic financial institutions
such as Yapı Kredi Bankası A.Ş., Vakıflar Bankası A.Ş., and Akbank A.Ş. The foreign
global financial institutions have home offices in New York and throughout Europe, with
the latter including offices in London, Amsterdam, Paris, and Frankfurt to name but a
few. Six of the global financial institutions are Turkish and together account for more
than 22% of the global financial institutions’ participation in the Turkish market. These
financial institutions have branch and liaison offices not only in New York and Europe
but also in Bahrain, Tokyo, and Moscow.

Using the trader identification code, our global/local classification scheme, and ISE asset
size categories, we classify each transaction as being made by a local small, local large,
or global financial institution. Table 1 reports selective summary statistics for our data.
Panel A shows the average daily trading volume in U.S. dollars (USD) of the local small,
local large, and global financial institutions sorted by seller- and buyer-initiated trades
and their counterparties. Of the USD 640 million of total daily volume, trading between
local large and global financial institutions is the highest, with average daily trading
volume reaching USD 133.8 million for seller-initiated trades and USD 139 million for
buyer-initiated trades. Trading among global financial institutions is the second highest,
with seller- and buyer-initiated daily trading volume of USD 76.5 million and USD 95.6
million, respectively.

Because of the large difference in the number of global and local financial institutions,
the total trading volume/number of transactions may not be the best way to show the
trading activities by different financial institutions. Consequently, we normalize the
trading volume/number of transactions by the number of financial institutions involved in
the trades. Panel B shows the average daily trading volume in U.S. dollars (USD) per
local small, local large, and global financial institutions. Our results suggest that trading
among global financial institutions is the highest, with average daily trading volume
reaching USD 3.2 million per financial institution for seller-initiated trades and USD 4.0
million for buyer-initiated trades. Trading between local large and global financial
institutions is the second highest, with average daily trading volume per financial
institution reaching USD 2.5 million for seller-initiated trades and USD 2.6 million for
buyer-initiated trades, respectively.

In Panel C, we report the average size of tick-by-tick transactions for local small, local
large, and global financial institutions without reference to the initiator. The average
volume per transaction is highest, at USD 0.65 million among global financial
institutions, followed by trading between local large and global financial institutions at
USD 0.45 million, while trades among local large financial institutions rank third.What
has now happened is that the daily traffic of the customers gets divided between the two,
but since the business flows every single day, instead of half of the days in the earlier
situation, the annual income for both remains the same. The biggest benefit of such an
arrangement is that they have got rid of the daily uncertainty on account of the weather
condition.
This is a very simplified example of what diversification can achieve. Pardon me for the
extra dose of simplicity through such a fictional example. Life is not so simple.
Incidentally, to make another point using the same example, let us add a new dimension:
our fictional hill station is in a high risk seismic zone, or is in a troubled order area. The
ice cream parlor and the coffee shop now face another risk, which they need to tackle.
While considering diversification, the word 'unrelated' is of critical importance. Just
because one has invested in thirty stocks or ten mutual funds does not necessarily mean
that one has diversified one's portfolio. In the example of our hill station, both the
businesses have exactly opposite effect of the changing weather.
Similarly, when one is investing in various businesses either through profession, or
through stocks or through growth mutual funds, one needs to be careful in ensuring that
the underlying businesses do not have the same impact of various changes that happen in
the environment.
Assume an investor invests in bank fixed deposits as well as equity mutual funds. An
equity mutual fund portfolio may have stocks from various industries, e.g.,
petrochemicals, FMCG, pharmaceuticals, automobiles, information technology, banking,
etc.
When the Governor of Reserve Bank of India makes some policy announcement, the
same may have an impact (either positive or negative) on stocks of banks, but may not
have any impact on the stocks of IT or pharma companies.
Similarly, when the exchange rate between the Indian rupee and the US dollar fluctuate,
it may have an impact on the export oriented companies (These companies export their
goods or services and earn in foreign currency) and an exactly opposite impact on the
companies dependent on imported raw materials (These import goods or services and
thus spend foreign currency).
Thus, the equity investments are considered to be properly diversified. However, when
the overall preference of investors shifts towards or against the stock markets, the stock
prices of almost all the companies across the stock market fluctuate together, in spite of
having different businesses.
The fluctuations in the stock market prices cause the NAVs of the mutual funds to
fluctuate, but the same has no impact on the value or the interest on the fixed deposits.
Thus, we can safely say that the investor has invested in two unrelated asset classes - a
very important thing to keep in mind while building a diversified portfolio.
As can be understood from the above discussion, the fluctuation in the values of
individual components is unchanged, but the changes in the value of the portfolio of the
investor are moderated. At the same time, the returns from the portfolio would be a
weighted average of the returns from the individual components. Thus, through
diversification, the returns got averaged but the risk got cancelled partially.
So whether you follow the adage "Do not put all your eggs in one basket" or the exact
opposite of the same "Put all your eggs in one basket and watch the basket carefully"
depends on your strengths or the lack of the same in the respective areas - and this is
especially true in case of investments.
There are many things in life where one can find various alternatives, but investment is
an area where one can choose from different options but 'not investing' is not an option.
Globalization has thrown up many challenges and it has become increasingly complex to
do business in the wired village of the next millennium. There is a bewildering collection
of securities, markets and financial institutions. Investors, today, are being loaded with
information, thanks to the Internet and the growing number of websites that are devoted
to investing information. Hence, it is necessary for them to sift through and evaluate this
information. For this it is necessary to understand the fundamentals of investment. While
terminology and trading mechanisms may change, learning to carefully analyze and
evaluate investment opportunities will pay off under any circumstances. The economic
well being of an investor in the long run depends significantly on how wisely he invests.
Investments in securities in the capital markets are a key factor for the economic growth
of the country. If the economic environment is ripe and the corporate management
expectations are optimistic a firm normally wishes to expand in order to increase their
earnings. The expansions can be financed by gaining access to the capital markets i.e.
through the sale of stocks and bonds. The investors who have earned profits on previous
investments in securities or have observed others doing this will be ready to provide fund
for the expansions. Thus firms grow, jobs are provided, families prosper and eventually,
the economy grows.
DEFINING INVESTMENT
The dictionary meaning of investment is to commit money in order to earn a financial
return or to make use of the money for future benefits or advantages. People commit
money to investments with an expectation to increase their future wealth by investing
money to spend in future years. For example, if you invest Rs. 1000 today and earn 10
%over the next year, you will have Rs.1100 one year from today.
Investment benefits both economy and the society. It is an outgrowth of economic
development and the maturation of modern capitalism. For the economy as a whole,
aggregate investment sanctioned in the current period is a major factor in determining
aggregate demand and, hence, the level of employment. In the long term, current
investment determines the economy’s future productive capacity and, ultimately, a
growth in the standard of living. By increasing personal wealth, investing can contribute
to higher overall economic growth and prosperity. The process of investing helps to
create financial markets where companies can raise capital. This too, contributes to
greater economic growth and prosperity. Specific types of investments provide other
benefits to society as well. For instance, common stocks provide a mechanism for
stockholders to monitor the performance of company management. At the same time,
municipal bonds provide capital for valuable public projects such as schools and roads.
Although, the rewards of investing are obvious, investing is not without risk. However,
over the long run, the rewards of investing outweigh the risks.
Investment teaches how we can use our accumulated assets to earn a monetary return
instead of waiting to spend those assets on consumption. Thus investment can be defined
as the purchase of an asset to produce a return. Therefore, before investing, one must
accumulate some assets, which is done through the process of saving, or spending less
than our incomes. This applies to all financial entities, be it a household, business or a
unit of government. Assets that are accumulated by saving may or may not earn a return.
However, the overall return that an investor may realize depends upon a number of things
such as amount of money available for investment; the degree of risk that the investor is
willing to take; the amount of immediate income that is needed; the degree of liquidity
that is required; the intelligence and knowledge that the investor processes; and sheer
luck.
An investment is a commitment of funds made in the expectation of some positive rate of
return. If the investment is done properly, the return will be commensurate with the risk
the investor assumes. It is the employment of funds with the aim of achieving additional
income. It involves the commitment of resources, which have been saved away from
current consumption in the hope that some benefit will accrue in future.
Investment involves the use of current funds of a purpose other than to satisfy the
immediate consumption need of the owner. Therefore, the application of money to a
purpose , which does not involve immediate use on the part of the owner, is known as
investment of money. It is an operation that involves the transfer of money or title to
money into the hands of others, who in return, agree to return them with interest or
dividend.
 FINDINGS & ANALYSIS
 HDFC bank is the second largest private banking sector in India having 2,201
branches and 7,110 ATM’s

 HDFC bank is located in 1,174 cities in India and has more than 800 locations to
serve customers through Telephone banking

 The bank’s ATM card is compatible with all domestic and international
Visa/Master card, Visa Electron/ Maestro, Plus/cirus and American Express. This
is one reason for HDFC cards to be the most preferred card for shopping and
online transactions

 HDFC bank has the high degree of customer satisfaction when compared to other
private banks

 The attrition rate in HDFC is low and it is one of the best places to work in private
banking sector

 HDFC has lots of awards and recognition, it has received ‘Best Bank’ award from
various financial rating institutions like Dun and Bradstreet, Financial express,
Euromoney awards for excellence, Finance Asia country awards etc
  HDFC has good financial advisors in terms of guiding customers towards right
investments 

Weakness

 HDFC bank doesn’t have strong presence in Rural areas, where as ICICI bank its
direct competitor is expanding in rural market

 HDFC cannot enjoy first mover advantage in rural areas. Rural people are hard
core loyals in terms of banking services.

 HDFC lacks in aggressive marketing strategies like ICICI

 The bank focuses mostly on high end clients

 Some of the bank’s product categories lack in performance and doesn’t have
reach in the market

 The share prices of HDFC are often fluctuating causing uncertainty for the
investors

Opportunities

 HDFC bank has better asset quality parameters over government banks, hence the
profit growth is likely to increase

 The companies in large and SME are growing at very fast pace. HDFC has good
reputation in terms of maintaining corporate salary accounts

 HDFC bank has improved it’s bad debts portfolio and the recovery of bad debts
are high when compared to government banks

 HDFC has very good opportunities in abroad

 Greater scope for acquisitions and strategic alliances due to strong financial
position

Threats

 HDFC’s nonperforming assets (NPA) increased from 0.18 % to 0.20%. Though it

is a slight variation it’s not a good sign for the financial health of the bank

 The non banking financial companies and new age banks are increasing in India
  The HDFC is not able to expand its market share as ICICI imposes major threat

 The government banks are trying to modernize to compete with private banks

 RBI has opened up to 74% for  foreign banks to invest in Indian market

The immediate cause or trigger of the crisis was the bursting of the United States housing
bubble which peaked in approximately 2005–2006. High default rates on "sub prime" and
Adjustable Rate Mortgages (ARM), began to increase quickly thereafter. An increase in
loan incentives such as easy initial terms and a long-term trend of rising housing prices
had encouraged borrowers to assume difficult mortgages in the belief they would be able
to quickly refinance at more favorable terms. However, once interest rates began to rise
and housing prices started to drop moderately in 2006–2007 in many parts of the U.S.,
refinancing became more difficult. Defaults and foreclosure activity increased
dramatically as easy initial terms expired, home prices failed to go up as anticipated, and
ARM interest rates reset higher.

Share in GDP of U.S. financial sector since 1860.

In the years leading up to the start of the crisis in 2007, significant amounts of foreign
money flowed into the U.S. from fast-growing economies in Asia and oil-producing
countries. This inflow of funds made it easier for the Federal Reserve to keep interest
rates in the United States too low (by the Taylor rule) from 2002–2006 which contributed
to easy credit conditions, leading to the United States housing bubble. Loans of various
types (e.g., mortgage, credit card, and auto) were easy to obtain and consumers assumed
an unprecedented debt load. As part of the housing and credit booms, the amount of
financial agreements called mortgage-backed securities (MBS), which derive their value
from mortgage payments and housing prices, greatly increased. Such financial innovation
enabled institutions and investors around the world to invest in the U.S. housing market.
As housing prices declined, major global financial institutions that had borrowed and
invested heavily in sub prime MBS reported significant losses. Falling prices also
resulted in homes worth less than the mortgage loan, providing a financial incentive to
enter foreclosure. The ongoing foreclosure epidemic that began in late 2006 in the U.S.
continues to drain wealth from consumers and erodes the financial strength of banking
institutions. Defaults and losses on other loan types also increased significantly as the
crisis expanded from the housing market to other parts of the economy. Total losses are
estimated in the trillions of U.S. dollars globally

While the housing and credit bubbles built, a series of factors caused the financial system
to both expand and become increasingly fragile. Policymakers did not recognize the
increasingly important role played by financial institutions such as investment banks and
hedge funds, also known as the shadow banking system. Some experts believe these
institutions had become as important as commercial (depository) banks in providing
credit to the U.S. economy, but they were not subject to the same regulations. These
institutions as well as certain regulated banks had also assumed significant debt burdens
while providing the loans described above and did not have a financial cushion sufficient
to absorb large loan defaults or MBS losses. These losses impacted the ability of financial
institutions to lend, slowing economic activity. Concerns regarding the stability of key
financial institutions drove central banks to provide funds to encourage lending and
restore faith in the Governments also bailed out key financial institutions and
implemented key financial institutions and implemented economic stimulus programs,
assuming significant additional financial commitments.

The Crash of 1929 and the ensuing Great Depression has always been a subject of
interest and fascination for many of us. Most of us grew up understanding that such a
financial calamity could never happen again. The history books tell us rules and
regulations were created to prevent this type thing from happening again. These
regulations were contained in the Glass-St ea gall Act of 1933 and the Banking Act of
1933.

Some of the new conditions created in the 1930s included the creation of the FDIC to
give bank customers confidence that their deposits in banks would be safe. Also included
were rules to prevent banks from owning other financial institutions such as insurance
companies, and vice versa, in order to prevent financial institutions from becoming so big
and intertwined, that the failure of one huge company could bring down the entire
financial system. By the way, this particular provision of Glass-Seagull was repealed with
the passage of the Gramm-Leach-Bliley Act of 1999. Another aspect of Glass-Steagall
sought to control speculation. There was more too.

In the post-Depression and post-World War II era, the economy and the markets
performed well. There were periods of normal business cycle recessions and expansions
and there were bull and bear markets with an occasional crash mixed in, like in 1987, but
nothing that threatened the entire financial system. As scary of the crash of 1987 was, it
had more to do with specifics to computerized program trading than anything that was
happening in the economy as a whole. The financial system was not in jeopardy in 1987.

So how did we go from fairly normal, cyclical ups and downs to the disaster that
culminated in the collapse or near collapse of the entire financial system of the whole
western world in 2008?

Here is one of the biggest culprits: in addition to stripping away the Glass-Steagall
protections throughout the 1980s and 1990s, the biggest factor laying the foundation for
our recent financial meltdown was the ridiculously low level of interest rates from 2000
to 2008.

After the crash of 1987, the Federal Reserve, under the then new Fed chairman, Alan
Greenspan, lowered interest rates, not to pump up the economy, but to help Wall Street
pump up stock prices. This was not a traditional role for the Fed. The Fed took on a new
role with this move and, more and more, become a protector of asset prices. They would
step in time and again whenever there would be a big sell-off on Wall Street.
In January 2001, the Fed under Greenspan started cutting rates at an unprecedented pace.
By the summer of 2001, the Fed lowered the Fed Funds Rate from 6% to 3.5%. After
September 11th 2001, the interest rate cuts began in earnest. By December of 2001, they
moved the Fed Funds rate down to 1.75%. By 2003, they brought it down to 1%. This
was the lowest Fed Funds rate since 1962.

From December of 2001 to September of 2004 Greenspan kept the Fed Funds rate at no
higher than 1.75% for a total of 33 months. In November of 2002, this key rate was
moved to 1.25% and it was kept it there for 21 months. In June 2003, the rate was moved
to 1.00% kept there for over 12 months.

So in 2000, the Fed Funds Rate was 6.5% but it was ultimately moved down to 1.75%
where it stayed for 33 months. It was then moved lower still to 1.25% where it stayed for
21 months. It went all the way to 1.00% where it stayed for 12 months. Anyone who had
money in a money market fund during this period remembers it well.

The bottom line is that never before in our history had the fed funds rate been this low for
this long. There were significant ramifications resulting from these extremely low interest
rates. One ramification was that ultra low interest rates caused speculation, including
speculation in housing prices, mortgage backed securities, derivatives and more.

If Greenspan hadn't keep interest rates so low for so long there would not have been a
housing bubble. Without a housing bubble, there would have been fewer mortgage-
backed securities, fewer derivatives and no sub-prime crisis. You get the idea. The
collapse was caused by mistakes that were made by so-called experts who should have
known better.

Causes

The immediate cause of the global financial crisis was the massive growth and then
collapse of a new asset class securitized sub prime mortgages. On one level, sub prime
montages have a positive social role.-helping people with relatively poor credit ratings to
own their own homes. However, the scale of lending, the way these mortgages were sold
and how they were developed into huge complex financial instruments that many do not
understand led to a led to a shock to confidence in the global financial system not seen
since the Depression of the 1930s.

Probably the weakest link in sub prime mortgage assets as they developed was
that they depended on US house prices continuing to rise. Sub prime mortgages were
structured typically with either the first two or three years of a 30 year mortgage at a
fixed interest rate, and the remainder of the loan at a variable rate. Borrowers had two
reasons to refinance their loans with the same lender at the end of the fixed rate period.
First, the variable rate was usually very high (and higher than the fixed rate), and second,
there were usually high penalties for paying out the loan early. As long as the value of
houses continued to rise, sub prime borrowers could easily refinance their loans every
two or three years. But when house prices began to slow and then fall, the whole process
began to quickly unwind.

At the big end of town, the rapidly growing sub prime mortgages were being repackaged
and sold to banks and other financial institutions. The amounts of money involved were
staggering. In 2000, sub prime and the similar Alt‐ A mortgages totaled USD 125bn or
4% of the US mortgage market. By the first quarter of 2007, they amounted to USD
1,495 billion or 25% of the mortgage market. When these mortgages were repackaged,
the new asset was divided into various segments or ‘tranches’, each with a different level
of security (up to AAA). The security allegedly reflected the exposure to default of the
underlying mortgage, but did not really reflect the true risk. Once defaults gained
momentum, all the various tranches began to fall like dominoes, making the assets
unsaleable.

As it became apparent that the assets of some major US financial institutions were
worthless, confidence in the financial system as a whole rapidly deteriorated, to the point
where banks were reluctant to lend to each other, except at very high interest rates (as
shown by the sharp rise in LIBOR – the London inter‐bank offer rate). If banks were
reluctant to lend to other banks, they were even less willing to lend to non‐banks. And
those with funds outside the banking sector were unwilling to lend to banks. The result
was a sharp fall in the availability of credit. This became the basis for transmitting the
crisis from the financial sector to the rest of the US and other developed
country economies. In order to reduce the impact of the crisis on the real economy, first
the US government and then governments in numerous developed produced massive
assistance packages to inject liquidity into their financial systems and to restore business
and consumer confidence. Confidence in many countries, however, remains low, as
evidenced by the dramatic drop in US consumer spending.

Beyond the immediate sub prime mortgage cause, however, are larger and more basic
forces. An extended period of excessively easy credit in the US encouraged many to
increase their consumption and more importantly their debt. Many (both borrowers and
lenders) gave little thought to the possibility of interest rates rising; leaving them highly
vulnerable when higher rates eventually arrived. As well, greed and even criminal
behavior was evident among some of the organizations selling sub prime mortgages.
People who did not understand the loans or did not have sufficient income to support
them were convinced to take on what quickly proved to be crippling levels of debt.

3. Describe in brief the terms Ledger, daybook and journal

A ledger (also known as a book of final entry) is a record of accounts, each recorded
individually (on a separate page) with its balance. Unlike the journal listing
chronologically all financial transactions without balances, the ledger summarizes values
of one type of financial transactions per account, which constitute the basis for the
balance sheet and income statement

. Ledgers include:

 Customer ledger, for financial transactions with a customer (sometimes called a

sales ledger).

 Supplier ledger, for financial transactions with a supplier (sometimes called a

purchase ledger).

 General (nominal) ledger representing assets, liabilities ,income and expenses.

The general ledger is the main accounting record of a business which uses double entry
bookkeeping it usually includes accounts for such items as current assets, fixed assets,
liabilities, revenue and expense items, gains and losses. The general ledger is also known
as nominal ledger

The general ledger is a collection of the group of accounts that supports the items shown
in the major financial statements. It is built up by posting transactions recorded in the
sales daybook, purchases daybook, cash book and general journals daybook. The general
ledger can be supported by one or more subsidiary ledgers that provide details for
accounts provided in the general ledger.

The balance sheet and income statement are both derived from the general ledger. Each
account in the general ledger consists of one or more pages. The general ledger is is
where posting to the accounts occurs. Posting is the process of recording amounts as
credits (right side) and debits (left side) in the pages of the ledger.

The listing of account names is known as chart of accounts. The extraction of account
balances is called trial balance. The general ledger should include the date, description
and balance or total amount for each account. It is usually divided into at least seven
main categories. These categories include assets, liabilities, owner’s equity, revenue,
expenses, gains and losses. The main categories of the general ledger may be further
subdivided into sub ledgers to include additional details of such amounts as cash,
accounts receivable, accounts payable etc.

Because each bookkeeping entry debit one account and credits another account in an
equal amount thus, the double-entry bookkeeping system helps ensure that the general
ledger is always in balance, thus maintaining the equation

Assets= Liabilities + Shareholders Equity

A daybook is an account book in which merchants and others make entries of their daily
transactions. This is generally a book of original entries and as such may be given in
evidence to prove the sale and delivery of merchandise or of work done

. A journal is a daily record of events or business or it is a book in which the transactions

are entered the first time they are processed. It is a book in which an account of
transactions is kept prior to a transfer to the ledger in the process of book keeping
In the foregoing numerous academic definitions of investment, speculation and gambling,
it can be observed that most of them are framed around the following three differentiating
factors:

(a) What is the motive of the buyer? The investor presumably buys to procure an annual
return under conditions of safety, whereas others buy for appreciation.

(b) What type of security is bought-high grade or low grade? The investor presumably
buys high-grade securities, the others low grade.

(c) How long is the security held? The investor presumably holds for the long-term, the
speculator for the short-term.

FEATURES OF INVESTMENT

Investment needs of different investors don’t have any standard pattern. They differ from
investor to investor. However, all investors have four tasks in common. First, they must
determine their investment objectives clearly. Secondly, they must decide upon the types
of investments to be used and the proportions of each to be acquired. Thirdly, they select
investments of the desired types. And finally, they should study the long run values of
suitable investments and time their purchase and sales accordingly. This four-fold task is
the essence of successful investment management for an investor. India's second-largest
private housing finance company, Dewan Housing Finance Corporation Limited (DHFL),
is the first off the block In India with a reverse mortgage scheme.

The scheme, called 'Saksham' is targeted at retired senior citizens above 60 years of age.
The scheme is similar to a housing loan except that in a home loan the borrower pays a
fixed EMI to the lending institution, while in reverse mortgage the lender pays the
borrower a fixed sum of money on a monthly (or quarterly) basis, the total payment being
equal to the value of the property and the interest on the loaned amount.

After the death of the borrower and the borrower's spouse, the housing company sells the
property to recover the amount paid out along with interest at a rate similar to interest on
housing loans.
The scheme is designed to supplement the monthly income of senior citizens. This
scheme is offered to retired people above the age of 60 years who own property and have
been living in it for at least one year.

The loan amount is sanctioned based on the:

 Age of the borrower

 Average value of the property

 Rate of interest on the loan

 The payment method chosen by the borrower

The eligibility for a reverse mortgage loan is simple. The borrower should be 60 years of
age, living in self-owned property, which is free of any other encumbrances, and is an
approved construction. The amount loaned would depend on the estimated value of the
property (minus the interest cost) its condition and life. The loan does not apply to
ancestral property.

Saksham allows customers and their spouses to live in the property as long as they are
alive, without the fear of eviction even after the tenure expires. The surplus amount is
then paid to the legal heirs of the borrower. The legal heirs also have the option to re-
possess the property after the demise of both customers and their spouses.

According to Shivkumar Mani, head, marketing, DHFL, "As per the guidelines laid down
by NHB, DHFL is the first company to launch this scheme in India. This unique scheme
is designed to help senior citizens to sustain their lifestyle and also help them maintain
their monthly expenditure without being dependent on anyone. It is a social security
scheme designed to benefit the senior citizens post retirement."

DHFL will first launch Saksham in Mumbai and its adjoining areas before making it
available nationally.

Reverse Mortgage by Union Bank

Union Bank of India on 4 April, 2008 launched its "Union Reverse Mortgage Scheme", a
loan product designed exclusively for the benefit of senior citizens.
The bank is the fourth in the country to launch the scheme through which the loan seeker
need not worry about re-payment and be assured of monthly income; the Bank's
Bangalore Zone Field General Manager L N V Rao

The loan will be available to homeowners who are 60 years of age or more and can be
availed jointly with the spouse, provided he or she is more than 55 years old, he said.

Unlike other loan products, there is no income criteria to be met for availing loan. On the
demise of the last surviving owner, the legal heirs have the right to repay. If they do not
wish to do so, the bank will sell the property, set off the loan outstanding

The surplus, if any, will be given to legal heirs. The minimum loan amount that can be
availed is Rs one lakh and maximum Rs 50 lakh, Rao said. Seventy per cent of the
assessed value of the building would be the loan amount.

The maximum tenor of a loan under this scheme is 15 years. The loan carries a fixed
interest of 10 per cent per annum.

Typically, for a loan of Rs 10 lakh, the monthly pay off to the owner on ten year loan will
be Rs 4880 and on a 15 year loan, it will be Rs 2410, Rao said.

The property is revalued every five years and adjustments will be made to the monthly
payments accordingly, he said.

Rao said the borrower has to comply with certain conditions which include that he bear
the cost of property insured against fire, earthquake and other calamities.

If the borrower ceases to stay in the house which has been mortgaged, the loan will be
cancelled.

LIC Housing to combine reverse mortgage with insurance plan

LIC Housing Finance is looking to combine its reverse mortgage plan with a whole-life
annuity provided by a life insurer. This will allow home owners to use their property to
generate income for life as against for only 15 years as provided under the present reverse
mortgage schemes.

The housing finance arm of the Life Insurance Corporation on Thursday announced the
launch of its reverse mortgage scheme. This product is available across the country for
senior citizens above 60 years. The loan can be availed of either singly or jointly with a
spouse, if the spouse is also above 60.

The shortcoming of most reverse mortgage schemes is that it is available only for 15
years. With the increased life expectancy, most borrowers are expected to outlive the
term of their reverse mortgage. Under present schemes while income from the reverse
mortgage dries up after 15 years, the borrowers end up with the lender having a lien on
their property.

LIC Housing Finance chief executive SK Mitter told ET that the company was in talks
with insurance companies to work out a scheme where home equity could be used to buy
an annuity that provides income for the entire life span of the borrower. “We are working
out how to merge an annuity plan with this product” said Mr Mitter.

The reverse mortgage loan by LICHF will be offered at a fixed interest rate, subject to
reset every five years. Under the scheme, senior citizens can avail of the loan either on a
monthly payment or on a lump sum payment or a combination of both. The property
evaluated for the loan should have at least 20 years of residual life. The maximum loan
balance shall be 90% of the value of the property and the loan balance will include
interest till maturity.

The amount of the loan will take into consideration the property value, age of the
borrower, and the rate of interest. The loan will become due and payable only when the
last surviving borrower dies or opts to sell the home, or permanently moves out of the
home.

Risks to RM Lenders

Szymanoski is a good starting point to appreciate the risks faced by an RM lender. These
risks are at the heart of the reluctance of lenders to get into RM lending, in the absence of
public policy support. The principal and unique problem facing the lender is that of
predicting accumulated future loan balances under an RM, at the time of origination. The
uniqueness is because RM is a ‘rising debt’ instrument. Since RM is a non-recourse loan,
the lender has no access to other properties, if any, of the borrower. Even if the collateral
property appreciates in value, it might still be lower than the loan balance at the time of
disposal of the property. There are three basic sources of this risk:

Mortality Risks

This is the risk that an RM borrower lives longer than anticipated. The lender might get
hit both ways: he has to make annuity payments for a longer period; and the eventual
value realized might decline. However, this risk is usually ‘diversifiable’, if the RM
lender has a large pool of such borrowers. Possibility of adverse selection (of
predominance of relatively healthier borrowers) is counterbalanced by the possibility that
even borrowers with poor health may be attracted by RM’s credit line or lump sum
options.

However, there is no literature on one possible source of systematic risk. Since RM is

projected to substantially improve the monthly income and/ or liquid funds of the RM
borrowers, would it not itself result in a systematically higher life expectancy amongst
them than otherwise? Perhaps this lacuna is due to the relatively short experience with
RM so far.

Interest Rate Risks

Given that the typical RM borrower is elderly and is looking for predictable sources of
income/ liquidity, RM loans promise a fixed monthly payment / lump sum / credit line
entitlement. However, for the lender, this is a long-term commitment with significant
interest rate risks.

While fixing the above, the lender has to account for a risk premium and thus can offer
only a conservative deal to the borrower. This interest rate risk is not fully diversifiable
within the RM portfolio.

Most of the RM loans accumulate interest on a floating rate basis to minimize interest
rate risks to the lender. However, since there are no actual periodic interest payments
from the borrower, these can be realized only at the time of disposal of the house, if at all.

Property Market Risk

This risk may be partly diversifiable by geographical diversification of RM loans.

However, property values may be a non-stationary time series.

Others have pointed out additional aspects of these risks:

 RM can be considered as a package loan with a ‘crossover’ put option to the

borrower to sell his house at the accumulated value of the RM loan at the
(uncertain) time of repayment. If this option can be valued, it can be suitably
priced and sold in the market. However, unlike in the case of forward mortgages,
markets for resale, securitization and derivatives based on RMs are non-existent
or non-competitive. Small market size and predominance of government backed
 RM insurance may dissuade potential entrants. This impedes the flow of funds to
finance RM loans.

 For the lender, both the interest and any shared appreciation component added to
the loan balance are taxable as current income even though there is no cash
inflow.

 RM loans found takers amongst lenders only after the availability of default
insurance under the HECM programme. Even then, in most of the RM loans,
interest accumulates at a floating rate linked to one-year treasury rates. Boehm
and Ehrhardt illustrate why. Basically they demonstrate that

 A fixed interest rate RM carries an interest rate risk several orders of

magnitude higher than a conventional coupon bond or regular mortgage. It
could be especially high at origination (as many as 100 times) and
continues to be higher throughout.

 The small initial investment under an RM is very deceptive. RM creates

very large off-balance sheet liabilities, if market rates rise above the rate
assumed under RM.

 If interest rate risk is also incorporated into capital adequacy norms, this
will mean disproportionate (to current asset value) additional capital
commitments to support RM lending

 This is because the typically small RM loan value at origination is

essentially the difference between the value of a relatively long duration
asset (loan repayment) and a relatively shorter duration annuity liability.
  Compared to a fixed interest RM that is non-callable by the borrower, a
callable RM carries very high risks for the lender. The fact that most of the
RMs accumulate at floating rates and that fresh RM loans involve
significant upfront costs mitigate this risk considerably .

Moral Hazard Risk

Once an RM loan is taken, the homeowners may have no incentive to maintain the house
so as to preserve or enhance market value. This might be especially true when the loan
balance is more or less sure to cross the sale value. Since the benefit would accrue mainly
to the lenders and the cost borne by the homeowner, it is perhaps not sensible to assume
otherwise. Miceli and Sirmans model this risk. They conclude that in a competitive
market, the lenders will respond by either reducing the loan amount or by charging a risk
premium in interest or both. However this fear of moral hazard in maintenance does not
square with the findings of Leviton discussed earlier, on the intensity of the attachment of
the elderly to their homes.

The more important point is that some time during the tenure of an RM, an elderly
borrower may simply be physically incapable of maintaining the home as per loan
requirements. Though the RM loan contract provides for foreclosure under such
conditions, this seems to be impractical and sure to result in litigation and bad publicity
for the lender. These problems have begun to crop up already.

Shiller and Weiss broaden the scope in two dimensions:

 In addition to RM, a range of home equity conversion products

 Beyond mere maintenance, they consider incentives to improve home values, to

drive a hard bargain at the time of sale, and cheat the lender at the time of
 appraisal before granting the loan (adverse selection) or through disguised or
complex sale arrangements to achieve undeclared gains at the cost of the lender.

They advice caution:

 Experience to date may not be a reliable guide to the future as most of the
experimental schemes are in their infancy

 Losses due to moral hazard may take many years to develop

 Competitive pressures for achieving volumes in future may increase this risk

Liquidity Risks

In RM loans where the borrower draws down on his loan through a credit line, there is a
risk of sudden withdrawals.

Considerations in Product Design

In this section, we focus on aspects of product design likely to be attractive from the
perspective of a potential RM customer and a lender.

Customer Perspective

 Empathetic counseling from professionally competent and independent

counselors- NGOs like Help Age, Dignity Foundation, Indian Association of
Retired Persons (IARP) etc., may be interested in providing such services
 Ratio of RM Loan limit to current market value of property: This will be a
function of borrower’s age, projected long term interest rates and property
appreciation rates

 Flexibility in draw downs: The line of credit with interest credit for unutilized
portion is the most popular choice in the U.S context. The same might be true in
India too. Cash may be withdrawn as and when needed, especially large amounts
to meet medical and other emergencies, in contrast to a regular monthly amount.
However this is vulnerable to myopic withdrawals or under pressure from
relatives.

 Minimum possible RM closure costs

 Clarity in borrower’s responsibility for property maintenance and paying

property taxes, insurance etc. Strong legal protection against foreclosure and/ or
forcible eviction based on fine print may be desirable. Alternatively, the RM
lender should be willing to take over such a responsibility against deduction from
RM loan limit/ annuity.

 Clarity in tax treatment of RM receipts, accrued interest, capital gains etc.

 Option to refinance in case interest rates decline substantially

 Protection against lender defaults- though not very critical.

Lender Perspective

The major concern is with respect to the risks of mortality (longevity), interest rates and
property appreciation rates. There is no simple way to explore these except through
financial modeling. Some alternatives for limiting risks in the learning phase have been
suggested:

 Purchasing a life annuity through an insurance tie-up so that a part of the

mortality risk is transferred to the insurer with the necessary core competence.
Their expertise may also be used to decide on the lump sum RM loan.

 Based on the U.S experience so far, it seems better for the lender to assume
responsibility for property maintenance/ taxes against deduction from RM loan
limits/ annuity payments.

 Though insurance against default risk is unlikely in India, an RM lender has to

charge an equivalent additional interest spread of 2-2.5%, if not more, as a default
risk premium

 It seems worthwhile to explore and lobby for concessional refinance for RM loans
from agencies like the National Housing Bank and for lower RM related
transaction taxes.

 Given the requirement of property market related expertise at the micro-level, it

might be worthwhile to focus on only one or two cities in the initial phase.

 There might be a need for tie-ups with agencies for various services- property
valuation, title search, property maintenance and so on.
Welfare from Reverse Mortgage

Comparison of welfare provided by reverse mortgage over the last ten years of life with
the option of no Reverse mortgage (selling and renting or buying another house) shows
that a reverse mortgage is a better solution than the other two scenarios considered.

Comparison of Welfare Functions

20

15
Welfare

10

15

21
11

13

17

19
1

Number of case s
Average Welfare in the last ten years of life with RM
Average Welfare in last ten years of life without RM

We perform 20,000 simulations and finally, we calculate the mean and standard error

and confidence intervals of over all the iterations

Across income groups, the welfare gain remains similar, but the difference between the
welfare with and without RM is different. Lower income quartiles seem to benefit more
from the reverse mortgage than higher income quartiles, as has also been shown in
various other studies by Venti
Average and Wise
Welfare for theetc. (1991)
Highest Income Quartile
20

15
W e lfa re

10

0
1 2 3 4 5 6 7 8 9
No of Cases
Average Welfare for the last ten years of life with RM
Average Welfare for the last ten years of life without RM
 Average Welfare for Lowest Quartile Income Levels
20

15
W elfa re

10

0
1 2 3 4 5 6 7
Number of Cases
Average Welfare in last ten years of life with RM
Average Welfare in last ten years of life with RM

Welfare Gains by introducing Reverse Mortgage to smooth consumption fluctuation

Percentile  = 10 =5  =1

100% 0.068 0.039 0.023

70% 0.062 0.034 0.020

 50% 0.059 0.028 0.018

30% 0.043 0.019 0.013

10% 0.020 0.012 0.004

Note: Return on Stocks is 10%, bonds is 5%, home appreciation at 10%, personal
discount rate of 10%.

Looking at the data, one can conclude that unlocking housing equity does have a
substantial impact on the income levels of individuals. However, there are some
limitations to this study, which are discussed below.

The true cost (ex post) of obtaining funds from a reverse mortgage will depend on the
timing of the borrower’s death—if the borrower lives well past his life expectancy then a
reverse mortgage will have low costs but if he dies sooner than expected then a reverse
mortgage will be expensive.

While making an investment decision, the investors should consider a number of features
which their portfolios should posses. Thus, a successful investor should take into account
the following twelve features in- order to choose specific investments.

1. Safety of Principal

One of the investment objectives is safety of principal though the safety is not absolute or
complete. An investor should carefully review the economic and industry trends before
choosing the type of investment or the time of investment or the time of investment to
ascertain safety of principal. He should avoid unsound and profit-less risks. Since errors
are unavoidable, to ensure safety of principal, an investor should go for extensive
diversification of assets.

Diversification can be vertical or horizontal. Vertical diversification occurs when

securities of various companies engaged in different phases of production, from raw
material to finished goods, are held in the portfolio. Whereas, horizontal diversification
occurs when the portfolio contains the securities of various companies, which are in the
same stage of production. Another way to diversify securities is to classify then according
to bonds and stocks. These can, again, be classified according to issuers, dividend or
interest earned, products of a firm, etc.

Adequate diversification means assortment of investment commitments in different ways

such as by industry, geographically, by management personnel, by financial types or by
maturities. A proper combination of these factors will reduce losses due to the decline of
any company or industry, disaster in any geographic region such as, storm, flood or
drought, defalcation by any management group, changes in price-level and interest rates.

But, diversification, if carried to extremes, is wasteful. Holding too many securities is

undesirable as it is too hard for the investor to monitor them. Similarly, too small
commitments in securities are uneconomic because of excessive commission charges and
other costs in transaction. Probably the simplest and the most effective diversification is
accomplished by holding different securities at the same time having reasonable
concentration in each.

2. Liquidity and collateral value

Every investor requires a minimum fund to meet emergencies. To have assure and quick
availability of fund an investor should have a sound portfolio with adequate liquidity. For
an investment to be liquid, it must be reversible (i.e. the transaction can be reversed or
terminated) and marketable (i.e. the investment can be sold in the market for cash).
Whether the fund, that may be needed foe business opportunities, is to be raised by sale
or borrowing, it will be easier if the portfolio contains a planned proportion of high grade
and readily saleable investment.

3. Stability of Income
Stability of income is an important factor for those investors who depend closely on
income. Emphasis on income stability may not always be consistent with other
investment principles. Income stability helps in stabilizing the prices of corporate stocks.
But it is restricted to certain industries only. Thus insistence upon income stability leads
to limitation in capital growth and diversification.

4. Purchasing power stability

An investor should maintain a stable purchasing power in order to balance his portfolio.
For this, he should carefully study the degree of price level inflation expected, the
possibilities of gain and loss in the investment available and the limitations imposed by
personal considerations.

5. Adequacy of income after tax

An investor faces two problems while making an investment decision, one concerned
with the amount of income paid by the investment and the other with the burden of
income taxes upon that income. An investment programme, should therefore, be planned
taking into consideration the tax status of the investor. It is very important to see that the
income is adequate after paying taxes. An investor is always eager to obtain maximum
cash returns on their investments and are prone to take excessive risks an immediate
dividend is always preferred which may be beneficial at a later date. It is very difficult on
the part of an investor to make a choice between adequate income and adequate security
but it is possible to find out some goods stocks, which pay all their earnings in dividends.

6. Capital Growths

Growing rate of capital formation is a primary condition for rapid economic

development. Investment is an essential ingredient in the capital growth of an economy.
Investors are therefore constantly seeking for “growth stocks”. An ideal “growth stocks”
is the right issue in the right industry, bought at the right time.

7. Legality

The legal aspects of property ownership often, affect investment plans and decisions. So,
law should approve all investments. Illegal securities may bring out many problems for
the investors. Identification of legal securities and investing in such securities will help
the investor in avoiding such problems.

8. Possible Appreciation

Stock, bond and real estate markets are all highly irregular. The investors should try to
forecast which securities will possibly appreciate. This should be done carefully and not
in a manner of speculation or gamble. An investor can make profit by choosing carefully,
buying at the right time and switching from overpriced to under-priced items.

9. Freedom from care or paying attention

Investments are always accompanied by risks. So it is not advisable to make investment

and then forget. Constant supervision is necessary to avoid losses and to obtain good
returns. One can minimize the attention required by their investments by employing
professional investments counselor. Another way of being free from care or paying
attention to the investments made is to invest in securities like UTI or LIC or any savings
certificate. Here, the management of securities is lift to the care of the investment
management services of the trust.

10. Tangibility

Due to price-level inflation, confiscatory laws, or social collapse, intangible securities

such as bank deposits, stocks or bonds have lost their value. So, some investors prefer to
invest part of their wealth in tangible properties such as building, land, gold, etc. It may,
however, be considered that tangible property yield no income apart from the direct
satisfactions to their owners obtain from their use or possession.

11. Concealability

All properties, tangible or intangible, must be concealable in order to be safe from social
disorders, government confiscation, or unacceptable levels of taxation. This
concealment may be in the form of ownership abroad or ready transferability. For
example, many hold secret title to gold or foreign money accounts in Swiss and other
foreign banks. Gold and precious stones have long been esteemed as they combine high
value with small bulk and are readily transferable.

THE INVESTMENT PROCESS

Viewing investment as a process, which goes on in every society, one may ask exactly
what that process consists of and what limits it. The investment process is a complex
activity that describes the steps of decision-making followed by an investor regarding the
appropriate time to invest in. Traditionally, securities are analyzed and managed using a
broad two-step process - Security analyses and Portfolio management. This two-step
process may be broken down into the following steps:

1. Setting Investment Policy:

The initial step of the investment process involves specification of investment objectives,
investment constraints, determination of invest-able wealth, identification of potential
investment assets, tax status of the investor, considering attributes of investment assets.
Investment objectives should be stated in terms of both risk and return. In other words,
the objective of an investor is to make a lot of money accepting the fact losses may be
incurred. The typical objectives of investors are current income, capital appreciation, and
safety of principal. Moreover, constraints arising due to liquidity, the time horizon, tax
and other special circumstances, if any, must be identified. This step of investment
process also identifies the potential financial assets that may be included in the portfolio
basing on the investment objectives, amount of invest-able wealth and tax status of the
investor.

2. Asset-mix decision

An investor has to decide the proportions of stocks and bonds to be included in the
portfolio. An appropriate stock-bond mix depends mainly on the risk tolerance nature of
the investor.

3. Formulation of portfolio strategy

After the choice of asset mix, the very next step is to formulate an appropriate portfolio
strategy. Broadly, there are two choices available – an active portfolio strategy and a
passive portfolio strategy. An active portfolio strategy focuses primarily on earning
superior risk adjusted returns. This strategy seeks to change the proportions chosen in the
asset-mix expecting to earn more profit. While, a passive portfolio strategy involves
holding a diversified portfolio that maintains a predetermined legal risk. This strategy
determines the desired investment proportions and assets in a portfolio and maintains
these, making a few changes over time, if necessary.

4. Perform Security analysis

This step involves valuation and analysis of the securities available for investment
regarding their future behaviour, expected return and associated risk. For valuation of
securities., first of all, it is necessary to understand the characteristics of the various
securities to estimate their. Secondly, a valuation model is to be applied to these
securities to estimate their value (or price). The relative attractiveness of the security can
be determined by comparing the estimated value with the current market price of the
security. Basically, there are two approaches to security analysis – Technical Analysis
and Fundamental analysis. Technical Analysis involves the study of stock market prices
of a firm in order to predict the future price movements. By identifying an emerging trend
or pattern in rice movements of a stock, the technical analyst hopes to predict accurately
the future price movements of that particular stock. On the other hand, fundamental
analysts, past price movements have no effect on the future prices of a stock. They say
that the intrinsic (or true) value of an asset is equal to the present value of cash flows or
earnings that the asset holder is expected to receive. To determine the intrinsic value of
an equity stock, the security analyst must forecast the earnings and dividends expected
from the stock and then convert to their equivalent present value by using an appropriate
discount rate that reflects the riskiness of the stock. Once the intrinsic value of the
common stock has been determined, it is compared to the current market price of the
stock. Stocks that have an intrinsic value more than the current market price are said to be
under-valued or under priced and should be purchased whereas those that have an
intrinsic value less than the current market price are said to be over-valued or over

Priced and should be sold out. However, fundamental analysts believe that the market
will correct this mis-pricing of securities in future. In other words, undervalued stock
prices will show unusual appreciation where as prices of overvalued stock will show
unusual depreciation.

5. Portfolio construction and execution

After securities have been evaluated, the next step is construction and execution of the
portfolio. This is the phase that is concerned with the implementation of portfolio
strategy. This involves identification of the specific assets in which the investor should
invest and determination of the proportions of investors wealth to be invested in each of
the assets. An investor makes two types of decisions while constructing portfolios – the
asset allocation decision and the security selection decision. The asset allocation
decision is the choice among broad asset classes, while the security selection decision is
the choice of particular securities to be held within each asset classes. Accordingly there
are two approaches to portfolio construction – top down and bottom up. Top down
portfolio construction starts with asset allocation and only after that, the investor decides
on the particular securities to be held. On the other hand, in the bottom up approach, the
portfolio is constructed from the securities that appear to be attractively priced without
concerning about asset allocation. Thus, the main features of portfolio construction and
execution are – determination of diversification level, consideration of investment timing,
selection of investment assets and allocation of invest-able wealth to investment assets.

Example of Investment Portfolio

Cash 10

Income Stocks 20

Growth Stocks 38

Treasury Bills 17

Corporate Bonds 15
6. Portfolio Revision

Having built a portfolio, an investor must consider when and how to revise it. Portfolio
revision involves the periodic repetition of the above steps. The investment objectives of
an investor may change over time and the current portfolio may no longer be optimal for
him. So the investor may form a new portfolio by selling certain securities and
purchasing others that are not held in the current portfolio. Moreover, the value of a
portfolio as well as its composition (i.e. the relative proportions of stock and bond
components) may change over time as stocks and bonds tend to fluctuate. As a result,
some securities that were not attractive initially may become attractive and vice- versa. In
response to such changes, the investors may like to revise and rebalance his existing
portfolio.

7. Performance Evaluation

The final step in the investment process is the performance evaluation of the portfolio.
Investments are always made under conditions of uncertainty and it is necessary to
evaluate periodically how the investment (portfolio) performed so that, if necessary, the
investor may consider switching over to alternate proposals. The performance of
evaluation of a portfolio is done in terms of risk and return. The key issue is whether the
portfolio return is commensurate with its risk exposure. This may provide useful
feedback to improve the quality of the portfolio management process.

Risk Management

Since the occurrence of these incidents, the importance of risk management has
been extensively recognized by banks and securities firms when deciding the amount of
risk they are willing to take.

Moreover, bank regulators now put an emphasis on risk management practices in

attempting to reduce the fragility of financial and banking system.

Setting up of risk management cell is been practiced by various banks, brokerage

houses and other financial firms. Basic objective of this department was to eliminate risk
exposure to the firm and the client’s portfolio as much as possible.

In volatile financial markets, both market participants and market regulators need
models for measuring, managing and containing risks. Market participants need risk
management models to manage the risks involved in their open positions. Market
regulators on the other hand must ensure the financial integrity of the stock exchanges
and the clearing houses by appropriate margining and risk containment systems.

The successful use of risk management models is critically dependent upon

estimates of thevolatility of underlying prices. The principal difficulty is that the
volatility is not constant overtime - if it were, it could be estimated with very high
accuracy by using a sufficiently long sample of data. Thus models of time varying
volatility become very important. Practitioners and econometricians have developed a
variety of different models for this purpose. Whatever intuitive or theoretical merits any
such model may have, the ultimate test of its usability is how well it holds up against
actual data. Empirical tests of risk management models in the Indian stock market are
therefore of great importance in the context of the likely introduction of index futures
trading in India.

TOPICS FOR FURTHER RESEARCH

Some of the topics for further research would be

1. How would finance sector cutting there advertisement cost to increase

profitability bracket
2. Customer satisfaction will be the key participant for the success of HDFC new
launched product.
 RECOMMENDATIONS

Monopoly can be considered as the polar opposite of perfect competition. It is a market

form in which there is only one seller. While, at first glance, a monopolistic form may
appear to be rarely found market structure, several industries in the United States have
monopolies. Local electricity companies provide an example of a monopolist.

There are many factors that give rise to a monopoly. Patents can give rise to a monopoly
situation, as can ownership of critical raw materials (to produce a good) by a single firm.
A monopoly, however, can also be legally created by a government agency when it sells
a market franchise to sell a particular product or to provide a particular service. Often a
monopoly so established is also regulated by the appropriate government agency.
Provision of local telephone services in the United States provides an example of such a
monopoly. Finally, a monopoly may arise due to declining cost of production for a
particular product. In such a case the average cost of production keeps falling and reaches
a minimum at an output level that is sufficient to satisfy the entire market. In such an
industry, rival firms will be eliminated until only the strongest firm (now the monopolist)
is left in the market. Such an industry is popularly dubbed as the case of a natural
monopoly. A good example of a natural monopoly is the electricity industry, which reaps
the benefits of economies of scale and yields decreasing average cost. Natural
monopolies are usually regulated by the government.

Generally speaking, price and output decisions of a monopolist are similar to a

monopolistically competitive firm, with the major distinction that there are a large
number of firms under monopolistic competition and only one firm under monopoly.
Nevertheless, at any output level, the price charged by a monopolist is higher than the
marginal revenue. As a result, a monopolist also does not produce to the point where
price equals marginal cost (a condition met under a perfectly competitive market
structure).
 CONCLUSION
Profit maximization refers to the process of determining the price and the total output
level that can ensure a firm the maximum profit. There are many strategies and ways by
which this issue can be approached. According to some people, profit equals the
difference between the total revenue and the total cost. This is better known as total
revenue-total cost method. Another method called the marginal revenue-marginal cost
stresses on the fact that profit in a competitive and non-monopolized market reaches the
maximum point where the marginal revenue is equal to the marginal cost. The cost
incurred by a firm are of two types namely fixed cost and variable cost. Fixed cost refers
to those cost that have to be incurred by the firms even during the times of no output. The
examples of fixed costs are wages, rent, upkeep charges, maintenance charges etc.
Variable cost refers to those cost which increase as more and more output is produced.
The summation of these two costs gives the total cost. Marginal cost is the change in cost
as more and more output is produced -- in economical terms, it is the derivative of cost
with respect to the output quantity. The marginal cost may vary accordingly if the
calculus approach is taken.
Profit optimization refers to the processes that look to cut down unnecessary costs in the
production. It is much different from profit maximization. Here, if a firm is already
running in profit, it can look to optimize the profit even more so as to consolidate its own
market in the globalized world. The profit is optimized by means like cutting down on the
wages, cost of finished product from small manufacturers. Cost-cutting can be, in a way
related to profit optimization.
 BIBLIOGRAPHY

 Global Entertainment and Media Outlook: 2006–2010, a report issued by global

accounting firm PricewaterhouseCoopers

 Bhatia (2000). Advertising in Rural India: Language, Marketing Communication, and

Consumerism, 62+68

 Eskilson, Stephen J. (2007). Graphic Design: A New History. New Haven,

Connecticut: Yale University Press. pp. 58. ISBN 978-0-300-12011-0.

 Advertising Slogans, Woodbury Soap Company, "The skin you love to touch", J.
Walter Thompson Co., 1911

 McChesney, Robert, Educators and the Battle for Control of U.S. Broadcasting, 1928-
35, Rich Media, Poor Democracy, ISBN 0-252-02448-6 (1999)
 http://www.canwestmediaworks.com/television/nontraditional/opportunities/
virtual_advertising/

 Advertising's Twilight Zone: That Signpost Up Ahead May Be a Virtual Product -

New York Times

 Lasch, Christopher. The Culture of Narcissism: American Life in an Age of

Diminishing Expectations. pp. 302. ISBN 978-0393307382.