Niveshak_May12

THE INVESTOR VOLUME 5 ISSUE 5 May 2012

Discrediting or Crediting Credit : Trends Worldwide, Pg. 08

Rupee depreciation and its im-pact on Indian economy, pg. 18

Niveshak

India Vision 2020

IS IT ACHIEVABLE?

Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

F R O M E D I T O R ’ S D E S K

NiveshakVolume VISSUE V

May 2012

Faculty MentorProf. N. Sivasankaran

Editorial TeamAkanksha BehlAkhil Tandon

Chandan GuptaHarshali Damle

Kailash V. MadanNilkesh Patra

Rakesh Agarwal

Creative TeamAnuroop Bhanu

Venkata Abhiram M.

All images, design and artwork are copyright of

IIM Shillong Finance Club

©Finance ClubIndian Institute of Management

Shillong

www.iims-niveshak.com

THE TEAM

Dear Niveshaks,

This month brought a lot of political turmoil in the European Union Nations starting with Netherlands and then France. Also the economic indicators exhibited by most of the countries like Spain, United Kingdom, Australia, Chain, Singapore, Japan, etc. were not very encouraging. This has led to a rising negative market sentiment that has been reflected in the markets worldwide.

Speaking of India, the statements issued by RBI and discussions of the impact of the growing uncertainty on Indian economy have not been very encouraging. Also the downgrades by S & P and IMF have led to doubt the growth potential of the country in the coming year.

In the light of this situation we present the May 2012 issue of Niveshak with the cover story on: Is India Vision 2020 achievable?

Also this month, many companies reported their earnings. While most of them

have performed at par with market expectations, there were a few positive signs too with companies like Nissan overcoming the impact of Japan nuclear disaster and re-porting 22% year on year growth in revenues. Also, thanks to rising oil prices, Exxon Mobil replaced Wal-Mart from first place among the Fortune 500 top revenue-gener-ating United States companies.

The article of the month on- Discrediting or Crediting Credit Trends World-wide, explains the trends in credit industry and its importance. The issue also features interesting reads on Rupee depreciation and its impact on Indian economy, Basel III Framework Origins & Implications and Relevance of Laissez Faire Economy in current scenario. This month’s classroom section explains to you the concept of Book Building.

With final calls being declared for most of the Management Institutes, Team Niveshak would like to extend their heartiest congratulations to all those who have made it through and achieved what they had worked hard for. We hope that you have a fulfilling and enlightening journey ahead.

We would also like to thank our readers for their constant support through won-derful articles and appreciation. It is your endless encouragement and enthusiasm that keeps us going.

Kindly send in your suggestions and feedback to [email protected] and as always,

Stay invested.

Team Niveshak

C O N T E N T S

Niveshak Times04 The Month That Was

Article of the month 08 Discrediting or Crediting Credit - Trend World Wide

Cover Story

11 Is India Vision 2020 achiev-able?

Perspective 14 Relevance of Laissez Faire Economy in the Present Sce-nario

FinGyaan

16 Basel III Framework Origins & Implications

Finsight18 Rupee depreciation and its impact on Indian economy

CLASSROOM21 Book Building

May 2012

Facebook IPO: The biggest investing story-line of the year The much awaited initial public offering of Face-book Inc. did not go as anticipated. The huge valuation by the social networking company combined with a 30 minute delay in the opening of trade and trading glitches due to high volume of orders resulted in the stock pricing staying sticky to its offering price of $38 at the close of the market. The Facebook share opened 11% higher than the offering price but after the high-est point of $45 fell rapidly to close at $38.23. This IPO was the t h i r d la rges t in the history of US, a f t e r V i s a a n d General Motors and resulted in $104 billion valu-ation of the eight year old company. This un-expected scenario led to a setback for the lead underwriter on the deal, Morgan Stanley. It had to buy shares on the open market to secure the $38 price level. The company was, however, val-ued at $32 a share by Morningstar but Krapfel expects Facebook shares to trade over $50. FB’s Chief Executive Mark Zuckerberg, who founded the company from his Harvard dorm room in 2004, is now worth $19.25 billion.

India received maximum ever inflow of FDI in March

In spite of the ruckus over the Rs 11000 crore tax dispute with Vodafone, which was expected to severely affect the Foreign Direct Investment attracted by the country, India received FDI of US $8.1 billion in March this year. This is the highest ever monthly inflows by India. There was an 8 fold increase in the FDI attracted from March last year where in the FDI inflows were US $ 1.07 billion. In the past, the highest FDI was of $5.65 billion and was received in June 2011. The total inflow in 2010-11 was $19.42 billion which was lower by $6.41 billion from the inflow in 2009-10. The major contributor to the inflow was the $ 7.2 billion deal between

Reliance Industries and British Petroleum. Phar-maceuticals, telecom, construction, power and metallurgical industries were amongst the sec-tors to receive large FDI inflows during the fi-nancial year 2011-12. The highest FDI source for the country was Mauritius.S&P downgrade’s the country’s economy to negative

In the cue of slow progress on India’s fiscal con-dition along with worsening economic indica-tors, Standard & Poor’s, on 23rd April, revised its stance for the country’s economy to negative and gave it a rating of BBB - from BBB + (sta-ble). BBB - is the lowest investment grade rat-ing. Moreover, S&P has threatened to lower the country’s rating in the coming two years if there isn’t any improvement in the fiscal and political health of the nation. However, S&P expects only a meek advancement in the fiscal reforms. To add to the already bad situation, the rating out-look of the top 10 banks of the country including State Bank of India, ICICI Bank, HDFC Bank to name some, were also lowered. Other banks like Axis Bank, IDBI Bank, Bank of India, Indian Bank, Indian Overseas Bank, Syndicate Bank and Union Bank of India are also expected to suffer collateral injury.No likelihood of a further reduction by RBI during monetary policy review

Any further rate cut by RBI after the reduction in repo rate by 50 basis points in the mid-mon-etary policy review to boost growth is unlike-ly due to many factors, one of them being retail inflation (CPI) touching a double digit in April, 10.36%, as against 9.38% in March. This was primarily due to rising prices of vegetables. However, core inflation remained stable, in line with the trend of wholesale infla-tion. This shows that food items have a higher

The Niveshak Times


IIM, ShillongTeam NIVESHAK

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weightage in CPI (47.6%) than in WPI which rose to 7.32% in April from 6.95% in March. Falling rupee and chances of increase in fuel prices can strengthen inflation further. More-over, disappointing fall in industrial output by 3.5% in March, slowing deposits growth, strong demand for loans, have erased the hope of a cut on June 18 when the RBI will review its mon-etary policy. Greek parties fail to form government af-ter recent elections

As a result of the severe austerity measures imposed over the past two years to secure vital interna-

tional bailouts and keep away bankruptcy, the furious

Greeks retaliated by abandon-ing the two pillars of Greek politics

and heading towards a bunch of smaller parties on both the left and right. This move exhibited widespread anger of the people of Greece. No party was left with enough seats in the Parlia-ment to govern alone. The President appealed for a formation of a coalition government to avoid a repeat election. However, ignorance of the same has pushed the debt-stricken country closer to insolvency and a likely departure from the euro zone as the political instability has wor-ried Greece’s international creditors who have asserted that the country must stick to its cost-cutting bailout terms. However, new austerity measures worth $18.9 billion and implementa-tion of other reforms have been assured to be passed by Athens in June. Based on the review of these, the creditors would determine whether or not to carry on with the issue of rescue loans because of which Greece is still in the chips. Investors pacified by announcement of defferal of GAAR by a year The General Anti Avoidance Rule, or GAAR, which was proposed on 16th March as a part of the budget for fiscal 2013, was formed with the objective of denying tax advantage to agree-

ments that have been entered into with the sole aim of evading tax disbursement. This will be done somewhat by preventing investors from routing investments via Mauritius or other tax havens. This increases the threat of tax on in-vestments in Indian market. This, along with the unexpected onset of the provisions which lack complete detail, have been major reasons for dis-turbing foreign investors. However, the Finance Minister Pranab Mukherjee has now planned to defer the applicability of GAAR provisions by a year in order to give more time to both the tax payers and the tax department to address all re-lated concerns. However, no changes proposed would supersede the provisions of double-tax avoidance treaties that India has with 82 coun-tries. Moreover, a reduction in the long term capital gain tax has been proposed from 20% to 10% along with a reduction in the withholding tax to 5% from 20% in the present. India’s top three private banks down-graded by Moody’s

There has been a mounting concern over India’s sovereign debt ratings. This has been a cause for the downgrade of the country’s top three pri-vate banks – ICICI, HDFC and Axis Bank by Moody’s from C- to D+. This now maps to a baseline credit of baa3 from baa2. These banks had their standalone ratings higher than the rat-ing of the country as a whole. This move by Moody’s has made it clear that the creditwor-thiness of the banks is highly correlated with the credit strength of the country’s government. Moreover, the three banks have substantial di-rect exposure to the Indian government securi-ties when compared with their capital bases and have relatively low level of cross-border expan-sion of their operations. In addition to this, these banks are predominantly domestic establish-ments which have been facing similar exposures at the macroeconomic and financial environment as the sovereign government. Also, there is lack of funding from foreign ownership.

The Niveshak Times

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© FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

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MARKET CAP (IN RS. CR)BSE Mkt. Cap 57,41,522Index Full Mkt. Cap 26,89,547Index Free Float Mkt. Cap 13,44,871

CURRENCY RATESINR / 1 USD 54.88INR / 1 Euro 70.21INR / 100 Jap. YEN 69.08INR / 1 Pound Sterling 86.84

POLICY RATESBank Rate 9.00%Repo rate 8.00%Reverse Repo rate 7.00%

Market Snapshotwww.iims-niveshak.com

RESERVE RATIOSCRR 4.75%SLR 24%

LENDING / DEPOSIT RATESBase rate 10%-10.75%Deposit rate 8.5% - 9.25%

Source: www.bseindia.com www.nseindia.com

Source: www.bseindia.com

Source: www.bseindia.com29th March to 22nd May 2012

Data as on 22nd May 2012

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CURRENCY MOVEMENTS

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arket Snapshot

BSEIndex Open Close % ChangeSensex 17,039 16,026 -5.95%

MIDCAP 6170.24 5854.18 -5.12%Smallcap 6459.04 6274.69 -2.85%AUTO 9768.15 9202.5 -5.79%BANKEX 11355.63 10678.79 -5.96%CD 6214.64 6428.93 3.45%CG 9887.35 8780.95 -11.19%FMCG 4459.03 4601.48 3.19%Healthcare 6447.59 6602.37 2.40%IT 5976.93 5471.24 -8.46%METAL 10899.51 9933.71 -8.86%OIL&GAS 7810.52 7462.24 -4.46%POWER 2047.46 1777.5 -13.19%PSU 7100.41 6616.05 -6.82%REALTY 1696.02 1566.66 -7.63%TECK 3501.37 3175.89 -9.30%


Market Snapshot

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The Global Financial Crisis 2008 left the world in a lurch. Just when everything seemed to be getting better, the US market was up for a rude shock. The subprime mortgage crisis increased the TED spread to a region of 150-200 bps. On September 17, 2008, the TED spread exceeded 300 bps breaking the previous record set after the Black Monday crash of 1987. You can’t have your cake and eat it too. Ironies of our time and times to come, the financial crisis taught the world how far credit has distanced the common man from reality and the banking industry from solvency. The housing bubble got the US financial indus-try to deliver on its accounts receivables. Sub-prime and Adjustable Rate Mortgages combined in complex MBS (Mortgage Backed Securities), failed to solve the market problems. The direct impact of the crisis can be measured in terms of declines in various stock indices and large re-ductions in the market value of equities (stocks) and commodities worldwide. TED spread spiked to a record 465 bps on October 10, 2008. Dow Industrials dropped 504.48 points; Standard & Poor’s 500 Index lost more than 4.5% and the Nasdaq composite index lost more than 3.5%. Were there lessons for the common man and the industry?

International trade saw a significant downturn during this phase. Between 1982 and 2008, the world saw high debt financed consumption. So what if your granny told you: Cut your coat ac-

cording to your cloth. Uncle Sam was there to prove everybody wrong. The US economy awak-ened to tighter regulations in the form of Dodd Frank Wall Street Reform and Consumer Protec-tion Act of 2010 in order to rein in the crisis set forth. Shadow banking system gained promi-nence. American International Group (AIG) was saved by an $85 billion capital injection by the government. The benchmark index for finance around the world strengthens these derivatives. Not taking into account market expectations, the money market interest rates showed a steep rise during the financial crisis which affected the transmission mechanism of monetary policy to the economy. Monetary policies were affected to reduce the difference in market expectations and LIBOR. Research showed that the financial crisis was governed by risk rather than liquidity. The fig. 1 (Source: FRB) elucidates the trends in consumer credit so far.To put things in perspective, let’s view the world economy from the viewpoint of US, UK, Europe (excluding UK) and Asia. How has the financial crisis impacted the role of these powerhouses? The spiral/domino effect of the financial crisis 2008 crashed many financial markets world-wide. A depreciating dollar further aggravated the situation and forced leading nations’ gov-ernments to respond in a proactive and aggres-sive manner.US: The Economic Stimulus Act of 2008 was en-acted to increase consumption. A sharp reduc-

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Discrediting or Crediting Credit - Trends world wide

The financial crisis taught the world how far credit has distanced the common man from reality and the banking industry from solvency


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tion in federal funds rate during the initial half of the crisis reduced the size of the re-set of adjustable rate mortgages. A $700 billion asset purchase program was created through Emer-gency Economic Stabilization Act of 2008. Some of the largest financial institutions were forced to accept government equity of $125 billion. The global markets were infused with liquidity. UK: Britain’s leading share index, the FTSE100, recorded its largest single day point’s fall since 1987. A bank rescue package of GBP 500 billion was announced by the British government on 8 October 2008. HSBC Group issued a statement announcing a GBP 750 million capital injection into the Bank of England. Royal Bank of Scot-land Group raised GBP 20 billion from the Bank Recapitalisation Fund.Europe: More trade dependent nations like Ger-many saw sharper declines in output during the crisis than other less open economies. European Economic Recovery Plan 2008 aimed to restart lending and stimulate investment in the EU’s economies. ECOFIN Council provided BOP assis-tance of up to Euro 6.5 billion to Hungary. Efforts were made to restore market confidence and minimize any risks of a future crisis.

Asia: Asian equity markets began to fall and there was widening of credit spreads. There was a sharp decline in the demand for durable goods and thus in trade volumes. Manufacturing was scaled back sharply. Producers, concerned about credit availability, tried to preserve work-ing capital. Financial institutions were carefully regulated, made transparent and sufficiently well capitalized and liquid to withstand large shocks. China and India emerged as financial powerhouses. In response to the global financial crisis 2008, Basel III norms (third in a series of Basel Ac-cords) were introduced. The norms require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets (RWA). How does the credit card industry scenario look like at present in the given context? Is there a decline in consumer credit or an ever growing appetite for more risk and more rewards? The world is still recovering from the aftershocks of the crisis and the financial markets are re-sponding wisely. Many financial institutions had to shut shop but there were many who evolved. Banks have become more regulated and the

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Fig. 1 Percentage change of total consumer credit, seasonally adjusted at an annual rate(Source: Federal Reserve Board 2012)

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The spiral/domino effect of the fi-nancial crisis 2008 crashed many

financial markets worldwide

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governments have become much more wary of the credit industry. The credit lending institu-tions on the other hand, are busy reducing their non-performing assets.August 2011 saw S&P’s downgrading of the USA’s long term federal debt from AAA to AA+, suggesting US treasuries are no longer risk free assets. The government’s budget deficit has increased from US$403 billion (3.2% of GDP) in 2005 to US$1.6 trillion (10.6% of GDP) in 2010.

There were some financial institutions which played a key role in the recovery of the US econ-omy after the financial crisis of 2008. For ex-ample, Bank of America acquired Merrill Lynch and JP Morgan bought Bear Sterns for $10 per share & Washington Mutual (WaMu) for $1.9 bil-lion during difficult times. Another good example is Amex Travel Related Services. The credit industry earns revenues mainly from three sources: annual fees, inter-est on outstanding loans/balances and discount revenues from retailers/merchants on each transaction (2.89%). Amex follows the policy of writing off loans no later than 180 days past due. Of particular interest is Amex’s membership re-wards program which strives to get customer hooked on to consumer credit. Bonus points are provided for certain high value purchases.

The fig. 3 clearly shows the after-effects of the financial crisis in 2008 and the sharp recovery thereafter. The turnaround is highly significant in the current context of recovering markets around the world. What has led to this vast growth in revenues? Have the number of con-sumers increased? The change in total number of cards in force was 7% as compared to the change in revenues which was 19.27%.Sources suggest that consumer credit is on the rise despite financial recession. The number of swipes or transactions per card has increased. There has been an increase in number of mer-chants accepting cards. Business and consumer spending in the US has propelled the growth. Revolving credit has been going up. Consum-ers are spending across all categories including travel and entertainment.

The above figure shows the market shares of the three biggest credit card companies in the world.

There have been many initiatives so far by the governments around the world to contain the damage done to the economies due to finan-cial crisis 2008. Prominent among them are the Basel III norms and bank rescue packages to restore market confidence. Infusion of liquidity and minimization of risks are some of the other initiatives. There has been a steady growth in consumer spending habits with the markets showing a positive recovery. Thus, despite fi-nancial stress and erosion of vast amount of reserves, the credit industry is booming and shows no signs of slowing down.

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Fig. 2 Pubic & Budget Deficit (% of GDP)

Fig. 3 Net Income in $ millions

Fig. 4 Credit Purchase Volume (Dollars)


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requisite will and effort required. However, con-sidering the current situation and prospects for the coming years, the achievement of this vi-sion is questionable.

In recent months, Europe has entered a reces-sion again, with the fall in production and po-litical turmoil. This has led to fall in investor confidence. In a statement issued by the RBI in April, going into 2012, the global economy ap-pears to be in a continuing phase of multi-speed growth. Most recent assessments indicate that the euro area is entering into a mild recession, while growth and employment conditions in the US are improving. Growth in emerging markets, especially China and India, is slowing beyond what was anticipated but these two economies are still likely to provide some support for global recovery.

The balance of payments (BoP) came under significant stress during Q3 of 2011-12 as the current account deficit (CAD) widened sub-

Cover Story

TeaM nIveshak

Harshali Damle

Every country needs a vision statement which stirs the imagination and motivates all seg-ments of society towards making greater ef-fort. India Vision 2020 was originally a paper prepared by TIFAC under the chairmanship of Dr. APJ Abdul Kalam and a team of 500 experts. Dr. Kalam, along with Dr. YS Rajan, shaped this concept through his seminal work - 2020 India: prospects for the new millennium of transform-ing the nation into a developed country through focus on their core competencies:

• Agriculture and food processing

• Infrastructure

• Education and Health

• Information Technology and Communication

• Critical technologies and strategic industries

It is a statement of what our nation can achieve, provided we are able to fully mobilize all available resources - human, organization-al, technological and financial, to generate the

Is India Vision 2020 achievable?

Fig. 1 Trade Balance (USD bn)

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population is below poverty line. The bulk of the population below the rating curve in fig. 3 also points to a disturbing inequality in in-come, something that should concern planners as the government seeks to target benefits to those in need through initiatives such as the food security and employment guarantees.Depreciating INRThe Indian rupee has depreciated by 6.86 percent (fig. 4) and was the worst performer amongst the major Asian currencies. It lost nearly 12 percent of its value since touching a peak of 43.85 against dollar on July 27 2011. Rupee depreciation not only has an impact on the import bill but also seri-ously affects the cost of borrowing for the corpo-rate sector.The Indian rupee has depreciated sharply against the dollar despite slower U.S. growth. The main reasons for it are:1. Inflation has remained at around 9-10% for nearly two years.2. Fiscal deficits remain high.3. There have been significant reforms in the past few years in the economy of India.4. The world economy has remained highly uncer-tain. This has led to pressure on most currencies against the U.S. dollar.Inflation accelerated in April to 7.23 percent, pres-sures on prices of food, fuel and manufactured

stantially and capital inflows declined.

Another major concern for India is the fall in the FDI due to political uncertainties and the global recession.

Study by London Business School

A recent study at the London Business School pointed out 7 reasons why India is unlikely to be a superpower. The reasons stated are: The chal-lenge of the Naxalites; the insidious presence of the Hindutvawadis; the degradation of the once liberal and upright Centre; the increasing gap be-tween the rich and the poor; the trivialisation of the media; the unsustainability, in an environmen-tal sense, of present patterns of resource consump-tion; the instability and policy incoherence caused by multi-party coalition governments.India, as the participants in the LSE study say, should strive to become a more inclusive and ef-ficient society, rebuild its broken institutions and engage with the egregious problem of state cor-ruption.Falling GDP and GDP per Capita

Another major problem faced in India is increas-ing inequality and the decline in GDP per capita.If the monthly average consumption expenditure is taken as a benchmark for what an individual needs to survive, the revised poverty line would be Rs 66.10 for urban areas and Rs 35.10 for rural regions. This would mean that about 65% of the

Fig. 3 GDP Growth and GDP Per Capita Growth

Fig. 2 FDI inflow (USD bn)


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including the Export-Import Bank of India, Infra-structure Finance Co. of India, the Indian Railway Finance Corp., and Power Finance Corp.What can be done to revive the economy?

Although the current situation does not seem very favourable, India is still better, compared to other developing nations. The fact that India is an open economy stresses that it will be affected by global economies. So this is the time to take some con-structive steps to channel our resources in the right direction. Some of the suggestions in this regard are:• Oil import demand could be phased along with coordinating purchases so that at no time there is a cluster of excessive imports• The government can take initiatives to promote and increase the flow of foreign investment in In-dia. Three recent steps taken by the government include increasing the pension fund FDI limit or the investment limit in government security and corporate bonds. Some of these steps are heading in the right direction.• The government can make attractive investments and invite long-term funds in the form of FDI in the infrastructure sector.• The Government may consider reducing tempo-rary imports.• FDI in the aviation industry, retail trade may also attract foreign investors.Effective policies and strong measures will un-doubtedly go a long way in reviving the economy and directing it towards progress.

goods all collected, adding to the struggle of the RBI to control inflation when economic growth has slumped to about three year low according to a statement issued by the Ministry of Commerce. Inflation has cooled from 2011, when it was above 9 percent for most of the year. But it is still higher amongst its BRICS counterparts that are Brazil, Russia, China and South Africa. Many central banks have recently reduced inter-est rates more than what market participants had anticipated. This was the case of Brazil, India and, outside of MS Australia.It is true that all emerging market currencies have fallen, as they do in the deteriorating global confi-dence, but the rupee has a higher burden of a ris-ing current account deficit and the perception of politics is extremely negative. Both factors were instrumental in putting credit rating of India on the clock.Falling Credit Ratings

The International Monetary Fund (IMF) has slightly lowered growth forecast for India to 6.9 percent in 2012 from an earlier forecast of 7 per-cent on weak global and domestic demand. Standard & Poor’s also announced that it has re-vised its outlook about India’s long-term rating, which has become negative from stable. Accord-ing to S & P, there is a possibility that one in three of the ratings will downgrade India’s BBB- sover-eign credit. Threats to the status of India include a weakening global economy, the decline in growth prospects for India’s gross domestic product, and the political paralysis that threatens fiscal reforms. At the same time, S & P revised its outlook to negative for seven “government-related entities,”

Although the current situation does not seem very favourable, India is still better, compared to

other developing nations.

Fig. 4 INR / USD

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main Irish banks that financed the real estate bubble. Had it just allowed the investors to bear the brunt then all the citizens wouldn’t have suffered.

We call this bad capitalism because the politician and wealthy corporations tie up in a mutually beneficial fashion and abuse power and wealth for their own mo-tives. This has led to rising inequality around the world and protests like Occupy Wall Street. Here also we can see that the involvement of government has created problems. For example, the bailing out of failing banks with taxpayer’s money in the US and rising income dis-parity among citizens there, the CEO of Enron still not being punished for the crime he committed because of the relationship he had with the administration. These are the outcomes of crony capitalism. As the banks have closer ties with the politicians, they are rescued with taxpayers’ money instead of them facing the lashing. This can be seen in the movie ‘Too big to fail’ also. Now, had the government not intervened the taxpay-ers money would’ve been saved and the real culprits, the top management of banks who earn huge bonuses, would have suffered. This is a more desirable situation and this can be reached with minimal interference of the government or laissez faire economy. Yes, the short term effects of this would be harsh. But the long term would be more secure. Income inequalities would also decrease as the government would be able to direct

Laissez faire is defined as the theory or system of gov-ernment that upholds the autonomous character of the economic order, believing that government should intervene as little as possible in the direction of eco-nomic affairs. In simpler words, laissez-faire is an envi-ronment in which transactions between private parties are free from state intervention, including restrictive regulation, taxes, tariffs and enforced monopolies.

In the current scenario of financial crisis that the glob-al economy is witnessing, the concept of a laissez faire economy has come under lot of criticism. We can see a lot of government interference in the form of bailout packages to the banks, examples of crony capitalism in various parts of the world. Newspapers are flooded with articles blaming capitalism for anything and ev-erything that has gone wrong in the world. This makes one think upon the point that laissez faire economy is good as a concept but is it really relevant in today’s global settings.

I put forward my argument that it would be immature to write this off as an end point of capitalism and that assume the laissez faire economy would not work. Taking a look at economies around none of them is a perfect example of a laissez faire economy. First let us look at the US economy, though it is dominated by the private sector, the role of the state cannot be under-mined. This can be seen by looking at the government spending which is more than 40% of the national in-come. There is economic interference by the govern-ment in the form of more than 100 federal agencies and commission like IRS, FRB, FDIC, FBI etc. Under lais-sez faire capitalism all these agencies would be done away with.

Talking about the euro zone we can see that it also has not been free from government interference. Greece, the worst affected of the Eurozone countries, is in such a position because of the government’s decision to run high fiscal deficits. In Ireland we can see that the government decided to finance the bad loans of 6

Relevance of Laissez Faire Economy in the Present Scenario

sIBM Pune

Mohil Poojara

In the current scenario of financial crisis that that the

global economy is witnessing,the concept of a laissez faire

economy has come under a lot of criticism


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money towards subsidies, tax rebates, special licens-es and favourable policies. A class of economists say that without government intervention there will be lots of problems and the economies might collapse. But, such a situation would pave way for a better economy in the future and the probability of such crisis will come down. So situations like the double dip recession the world is witnessing at the moment would not be prevalent in the future.

Now that we’ve seen the negative effects the non laissez faire economy has caused, let us take a look at how a laissez faire system would benefit the economy. Such a economy rewards entrepreneur-ship, risk taking and innovation, and provides ac-cess to all economic activities to the citizens. There are enough evidences to suggest that private owner-ship without much interference of the government does well. Even though India is not a laissez faire economy, the benefits of the 1991 Privatization pol-icy can be witnessed. The growth of India comes from the private sector and the government is not as efficient as the private sector. It has also reduced inequality and has brought to the disposal a vari-ety of public and private means of transportation (almost unlimited mobility for the common man), housing filled with convenience and appliances for almost every chore, entertainment at every corner, luxurious dining-out facilities, and the availability of a huge variety of quality and tasty foods. These were simply not available to the average person, seventy years ago.

Conclusion

In conclusion, is laissez faire economic policy a thing of the past? No. Laissez faire economy still has im-mense potential to generate wealth and reduce in-equalities. Is constant intervention by governments and fiscal stimulus a necessity now? No. In fact, as discussed above, it is one of the major reasons be-hind the present financial crisis.

FIN-Q SolutionsApril 2012

1. Bank for Interna-tional Settlements in Ba-sel

2. Dutch auction

3. Australian Dollar

4. Bank of Italy Build-ing

5. Its symbol is printed on the notes

6. R K Shanmukhan Chetty

7. Pac-man defense

8. Money Laundering

9. Berkshire Hathaway

10. Bourse

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The Basel III framework is the regulatory response to the causes and consequences of the global finan-cial crisis. The objective of the reforms is to improve the banking sector’s ability to absorb shocks arising from financial and economic stress by prescribing more stringent capital and liquidity requirements. It raises the core capital required, introduces counter cyclical measures and enhances a banks’ ability to conserve core capital during periods of stress via a conservation capital buffer.

Origins

The Basel III framework has originated in the wake of 2008 global financial crisis. From a macroeco-nomic perspective, the crisis was the result of sustained global imbalances and a breakdown of trust. It is said that the solution of the preceding crisis becomes the cause of the next one. The last major financial crisis was the Asian crisis of 1997-98 and the lesson learnt was to maintain a large war chest of foreign exchange reserves to protect against an attack on the country’s currency. China and other emerging economies did exactly did this as they followed an export led growth strategy. The huge amount of capital accumulated by the emerg-ing economies was then invested in the advanced economies. This depressed yields in the financial markets of the advanced economies. In search of higher yields to improve return on investment, the market players started the process of financial en-gineering and innovation. Out of this emerged new structured financial products like collateralised debt obligations, mortgage backed securities and credit default swaps, which increased market complexity and illiquidity. Along with rise in the shadow bank-ing system, the financial sector became too big in relation of the real economy. There was a supervi-sory and regulatory failure as the proper authorities failed to recognise the inherent risk in these new fi-nancial products. These issues were compounded by political issues and real wage stagnation in the US.

Ultimately, banks simply entered the crisis with in-sufficient capital. The Basel requirement of common equity was as low as 2% of risk weighted assets. However, even then, banks did not calculate risk base properly. They indulged in capital arbitrage, utilising a loophole which favoured lower capital re-quirement for the trading book and higher capital for the banking book. They securitized mortgage loans

through special investment vehicles, thereby artifi-cially enhancing credit rating and liquidity support.

Post Crisis: Basel II.5

Global initiatives to strengthen the financial system were spearheaded by the political leadership of the G20, Financial Stability Board (FSB) and the Basel Committee on Banking Supervision. In July 2009, the Basel Committee came out with some measures, dubbed Basel II.5 to plug the loopholes in the sys-tem, especially with regards to capital arbitrage. In-cremental risk charge for specific risk or credit risk in trading book was introduced and capital require-ments for the trading book were increased approxi-mately threefold. Steps were also taken to manage liquidity and reputation risk, along with new disclo-sure practices.

The Basel III Framework

The Basel Committee published Basel III rules in De-cember 2010. The objectives of Basel III are

• To minimise risk of recurrence of a crisis of the magnitude of 2008 financial crisis

• Introduce micro prudential elements so that risk is contained in individual institutions

• Improve risk management and governance

• Strengthen banks’ transparency and disclosures

Micro Prudential Elements

Capital Adequacy Norms: In attempt to increase high quality capital in banks, Tier 1 capital will be have to a minimum of 6% of risk weighted assets (RWA), compared to the 4% required currently. Tier 3 capi-tal has been completely abolished and innovative features in non-equity capital instruments are not acceptable.

Enhancing Risk Coverage of Capital: The Basel III framework aims to provide enhanced risk coverage. Banks will be subject to a Credit Valuation Adjust-ment capital charge to protect themselves against mark to market losses related to deterioration in creditworthiness of the counterparty. Measures have been introduced to strengthen capital requirements for counterparty exposures and securities financing activities.

International Liquidity Framework: Basel III introduc-es two new liquidity standards, Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) to improve banks’ resilience to liquidity shocks. The

MdI, GurGaon

Raghav Pandey & Keyur Vinchhi

Basel III Framework : Origins & Implications


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LCR will require banks to maintain a buffer of highly liquid securities over a 30 day horizon, while the NSFR requires a minimum amount of stable sources of funding at a bank relative to the liquidity profiles of the assets, as well as the potential for contingent liquidity needs arising from off-balance sheet com-mitments, over a one-year horizon.

Macro Prudential Elements

Capital Conversation Buffer: Basel III prescribes a capital conversation buffer of 2.5 of RWAs, compris-ing of Tier 1 common equity capital be built in ad-dition to 8% total capital requirement. This is to be done outside periods of stress and banks will be draw upon this as losses are incurred during periods of stress.

Countercyclical Capital Buffer: The countercyclical buffer aims to ensure that banking sector capital requirements take into consideration the macro fi-nancial environment it is operating in. Credit growth and factors will signal a system wide risk build up which will be monitored by national authorities and a countercyclical capital requirement will be en-forced as per the prevailing conditions.

Pro-Cyclicality of Provisioning Requirements: During lean periods, banks’ profits decline but they are re-quired to make higher provisions for NPAs. To ad-dress the pro-cyclicality issue, the Basel Committee is working with the International Accounting Stan-dard Board towards an expected loss approach to provisioning as opposed to the current practice of an incurred loss approach.

Countercyclical Capital Buffer: The countercyclical buffer aims to ensure that banking sector capital re-quirements take into consideration the macro finan-cial environment it is operating in. Credit growth and factors will signal a system wide risk build up will be monitored by national authorities and a countercy-clical capital requirement will be enforced as per the prevailing conditions.

Interconnectedness: Through enhanced regulatory framework for global systemic important banks (G-SIBs), the issue of interconnectedness among large banks is trying to be address.

Too Big to Fail Problem: The G-SIBs will be grouped into different categories of systemic importance by the Basel Committee, with varying level of additional loss absorbency requirements. This will range from

1% to 3.5% of risk weighted assets. This additional requirement is to be met through common equity (Tier 1 capital).

Reliance on External Credit Ratings: It has been pro-posed that banks must perform their own internal credit rating of externally rated securitization expo-sures in attempt to reduce excessive dependence on external credit rating.

Macroeconomic Impact

The increase in equity capital requirement is likely going to result in an increase of the weighted aver-age cost of capital. Banks are likely going to pass on the higher cost of capital to borrowers via higher lending rates. It is safe to assume that equilibrium lending rates are going to increase marginally and result in slower credit growth.

The Macroeconomic Assessment Group set up by the FSB and the Basel Committee estimate a maximum decline in GDP of 0.22% (relative to the baseline forecasts) at the end of Basel III implementation pe-riod. However, the International Institute of Finance estimates that GDP will be 3.2% lower that it would be otherwise after 5 years.

Liquidity & Profitability of Banks

Indian banks are required to maintain minimum re-serves of high quality liquid assets via the statu-tory liquidity ratio (SLR). The SLR is currently at 24%. However, the RBI has not yet clarified whether these reserves would count towards to the LCR. If they do not, the proportion of liquid assets with banks will increase dramatically and will have a significant ad-verse effect on bank earnings.

Regardless, studies have indicated Basel III require-ments will have a substantial impact on profitability internationally. A study by McKinsey & Co indicates that, holding all other factors constant, return on equity is going to fall by 400 basis points in Europe and 300 basis points in the US.

Implications

It is clear that implementation of the Basel III frame-work would involve some costs. However, the frame-work would address the weakness in measurement of risk in Basel II along with the loopholes. Ultimate-ly, it would also ensure a much safer financial sys-tem with a reduced risk of a banking crisis.

Fig. 1: Capital Adequacy of Public Sector Banks - Ind (Median) Fig. 2: Capital Adequacy of Private Sector Banks - Ind (Median)

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Indian economy, grow-ing at the decent pace of 7-8%, has been bad-ly hurt by the constant depreciation of rupee against the dollar. Glob-al economic crisis along with rising current ac-count deficit, falling FDI and an unstable Indian political scenario has played a pivotal role in this downward trend of Indian currency. Rupee depreciation has re-sulted in high inflation & high interest rates and has posed a serious challenge to the target of double digit GDP growth. However, experts believe that this depreciation is short term and transient and rupee is bound to bounce back to its nor-mal level once the global economic condition re-covers for good.

est rates and high GDP growth rate. One common element which is in-volved in all the above is the currency and its intrinsic value.

FactorsHaving known the importance of the rupee from the macro-level perspec-tive, rupee depreciation or for that matter, currency movements cannot occur without any rational stimuli. These stimuli or factors, that could change an entire dimension of a country, could be external or internal. Some of these factors are briefed be-low.

Current account deficit: CAD of one’s country implies that the imports of the country are more than its exports. In other words one can say that the country is having an outflow of dol-lars thus creating a local demand for the foreign currency (USD). This demand appreciates the foreign cur-rency (USD) and depreciates the (INR) local currency. As in the case of India, the current account deficit which was 2.6% of GDP in 2010/11 is expected to touch 4% in 2011/12, pulling down

Everybody is talking about the emer-gence of third world and India being one of the active players in the futur-istic scenario. But is it true to claim these urgings, considering the pres-ent situation of the Indian Economy?The Indian Economy has been grow-ing moderately at 7-8 % annually and it’s pegged as one of the fastest grow-ing economies in the world. But will the fluctuations in its currency pose a threat to its growth? Well the answers are brought forward in this article.Depreciation of currencyThe decline or in loss of value of the domestic currency with respect to the foreign currency is called deprecia-tion, which is typical in a floating ex-change rate system. Rupee’s value is depreciating against dollar and as of 18th April 2012, it stands at 51.80 Rs for each dollar. Does this mean it is adverse to the Indian Economy? Well, no. Apprecia-tion or depreciation has its own ad-vantages and disadvantages. As ap-preciation is out of equation in this article, the plausible impact of cur-rency depreciation on the economy is depicted in the pages to come. Indian macro-economic dynamics is ruled by different entities, like ex-porters, importers, foreign investors, speculators, exchange rates, purchas-ing power, interest rates and policies – fiscal and monetary. These play an important role in maintaining an ideal economy with low inflation, low inter-

IIFT kolkaTa

S Raj Sharan

RupeedepReciation

its impact on Indian economy


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rupee well below the tolerable levels. Inflow of capital: The current account deficit mentioned in the above can also imply that there is a current account surplus in foreign countries. These surpluses from the other coun-tries are supposed to cycle back to our Indian depositories in the form of FDIs to maintain the currency fluctuations on an even keel. However, in the event of lack lustre response from other countries in terms of FDI, which might be due to a variety of reasons (political, tactical), there would be depreciating pressure on the local cur-rency (INR).

Global economic crisis: Global economic condi-tions like Euro Zone, subprime bubble and other turmoil have a depreciating effect on INR as USD is considered to be a safe haven currency in all the aspects of foreign transactions. In addition to this, the risk of bankruptcy that threatens the companies fuels the withdrawal of FIIs from the Indian stock markets contributing to the cur-rency depreciation even further.

Indian political situation: Though Indian politics has been stable over the past years, the present GOI have had a substantial problems in dealing with many political bottlenecks. These bottle-necks like corruption scandals (2G, CWG), dis-satisfaction among allies, war of words between prominent politicians, loomed large over the recent past and impregnated the UPA II govern-ment with numerous uncertainties over their fu-ture. This has resulted in loss of FIIs from Indian stocks, further factoring the downfall of Indian Rupees.

ImpactRupee is the most depreciated currency in the Asian continent and considering this present trend, India has been preventing rupee from de-preciating any further. To pave justice for the actions undertaken by the government to pre-vent the crisis, the implications of rupee depre-ciation on our growing economy are unfolded in the next few paragraphs.

Boost for exporters: The falling rupee value against the dollar results in exports becoming cheaper in the International markets. In other words, for every dollar, the amount of the local currency equivalent is higher and thus the In-dian goods and services are cheaper for foreign buyers. Apparently, this results in the demand for Indian products and services, generating rev-enue and providing foreign exchange reserves for the country.

Tragic for importers: Here the imports become expensive in the foreign markets. For every unit of dollar there is a greater sum of rupees tal-lied, wherein the importers have to pay more than before for the goods and services provided to them. As India imports oil, base metals and food grains, to meet the increasing demand of the growing population, the importing costs in-curred rises. With the import costs in upswing mood, the current account deficit is liable to go up as well. According to recent data, the Indi-an current account deficit is $19.6 billion for FY 2012 which is the worst in at least eight years and this shows that it’s an area to be looked

into by the Government of India.

High Inflation: The high import cost to the im-porters is reflected in the goods’ prices as they try to shift the burden of the cost onto the shoul-ders of the consumers. This increases the prices of the goods at the consumer’s end. In normal case, this high price reduces the demand caus-ing a reduction of prices. But in India, as the disposable income rises due to the burgeoning of the middle class, the supply to meet this de-mand is realized by loans. Hence the financial system is infused with more money supply. This excess money is used to buy high priced goods contributing again to the increase of prices. This leads to high inflation which is detrimental to any growing economy.

Burden on borrowers: A killer effect from rupee depreciation is that the Indian borrowers have the liability to repay more debt. Indian corpo-rates who have borrowed money from foreign banks (ADB) and other international players are subjected to this throbbing task of repaying even higher debt as the skewness increases in the $/INR parity. In the macro level, the Government of India is strained heavily to repay the foreign and dollar denominated debts and the pain is even more in the case of short term debts.

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High Fiscal Deficit: As India has a growing popu-lation with moderate income, GOI has an im-portant role to play in financing their obligatory needs like petrol, cooking gas, etc. So on behalf of the people, GOI gives subsidies to the oil mar-keting companies like IOCL, HPCL, BPCL, under-writing the fiscal deficit. As rupee depreciates, these compensations become huge as the oil prices are driven by internationally driven dol-lar prices. Thus the depreciation of INR further heightens these huge debt repayments piling up the fiscal deficit.Loss of FII inflows: Due to the depreciation of the currency FIIs have the tendency to dissuade from investing in the country. The withdrawal of funds takes place in the event of a follow-ing situation. For instance, a FII invests on $10 worth of stock for Rs 500 at the current mar-ket price. Consider a scenario wherein after 1 year, the stock of FII made no loss, no profit and rupee depreciated to 60 against dollar. On the stock sale the FII would get Rs 500, but while converting to dollars, it ends up in loss. These withdrawals of funds could lead to a collapse in

the stock markets, posing serious concerns to the Indian economic status.High Interest Rates: The high inflation risks are effectively fought with the increase in interest rates by RBI. These interest rates include not only reverse Repo and the Repo rates but also the money market rates. This is mainly done for sucking out the liquidity from the financial system. As the money supply decreases, the consumption pattern also decreases, resulting in low and deferred investments impeding the growth output.Attraction of FDI: As rupee’s value is in a down-ward trend against the strong currencies of the world (USD, Euro, Yen, Pounds), India becomes a favourable destination for FDI. The setting up of plants, machineries, and campuses now be-

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comes cheaper and this cost factor proves to be a decisive factor for potential markets.Pain for Indian students going abroad: Rupee depreciation pinches hard on the students go-ing abroad for studies as it now costs more for meeting expenses like fees, stay and other mis-cellaneous expenses because of the scale up of the rupee equivalent to dollar.Global outlook of Indian rupeeHaving discussed about the causes and im-plications of Indian rupee, one can come to a conclusion that the current situation is “multi centric” in origin. The present global conditions has been so overwhelming that India and other emerging markets are unlikely to remain im-mune especially in today’s world of global inter-dependence. However, experts believe that this depreciation is short term and transient and it’s bound to bounce back to its normal level once the global economic condition recovers for good. Since India has strong growth fundamen-tals the tide over the depreciation of rupee has not been anticipated to last for a long time and this present rupee crisis is not a reflection of the fundamentals of the Indian economy.ConclusionThe above insights implicate that the rupee de-preciation is one of the major platforms upon which the Indian economy treads along. The In-dian rupee is under a great stress as overseas investors cut back their exposure to the Asia’s third-largest economy amid international uncer-tainty and mounting worries over the domes-tic economy. The above listed impacts give us a roadmap on what India should expect from this currency fall. Having this in mind, the task of reaching double digit growth rates and India playing as a front runner in the world arena, remains a challenge and the answers to these queries lie in a Pandora’s Box which I will leave for the readers to unravel.


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Hello students today we shall talk about the Book Building process related to issue of securities. So tell me what do you know of them?

As far as I know Sir, it is a method of issue of shares based on floor price which is indicated before the opening of the bid-ding process. The issue price is fixed after the bid closing date. It is a process which

is compulsory for companies for IPO’s which do not have specified track record of profits. But, what does price discovery through book building process imply?

The price of the securities under this method is determined on the basis of the bids obtained for the quantum of securities offered for subscription. Thus providing an

opportunity to discover the prices.

Is there any minimum number days for which the bid needs to be open?

Yes, there does exist a minimum num-ber of days. As per SEBI guidelines the book building should remain open for a minimum of three working days.

Sir, is there a difference between of-fer of shares through book building and offer of shares through public issue?

When shares are offered as part of the book-building process the price at which the securities are allotted is not known as opposed to when they are offered through

normal public issue. Further it is easier to gauge the demand in case of shares being issued under book-building since records are maintained. Whereas in case of public issue of shares demand is known only when the issue closes.

Sir I have heard that there are cat-egories of investors involved in book building process. Is it really true?

Yes this is absolutely true. Briefly speaking there are three kinds of inves-tors involved. They are RII (Retail Individ-ual Investor), QIB (Qualified Institutional Buyers) and the NII (Non-Institutional

Buyers). RII are investors that invest for an amount less than Rs 100000. As the bid amount exceeds Rs 100000 they are referred to as the high net worth NII’s. QIB’s are institutional investors who possess the expertise to invest in securities.

Sir what is the Red Herring Pro-spectus issued in case of book building?

A Red Herring prospectus is similar to a prospectus in all respects except for the fact that it does not contain details about the price or the number of shares to be issued or the total amount of the issue.

However the upper and lower band of price may be disclosed or the floor price is mentioned.

Sir I am getting confused. What is the difference between IPO and book building ?

Do not get confused. See IPO is where it is the lead managers who decide the price of the issue. In a book build-ing process the syndicate members decide the indicative price range and investors

decide the price of the issue through tender.

Sir then what are the advantages of opting for the book building process? Why should any company go for book building process?

Basically book building saves a lot of resources in terms of cost and time as it curtails the lengthy allotment procedure, the duration between allotment and list-ing, and curtails grey market operations.

Again as the prices are fixed on the basis of bids there is very little scope for manipulating the price before listing. It also helps discover the demand and price of the shares since books are maintained on a daily basis.

CLASSROOMFinFunda

of the Month

BOOK BUILDING

NIVESHAK 21C

lassroomIIM Shillong Ankita shah

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F I N - Q1. X follows a geometric Brownian motion with constant drift and volatility. It is

very popular with options. Identify X.

2. Connect:

3. What is the technique used to estimate the portfolio losses and is commonly used by energy trading companies?

4. Morgan Stanley’s _________ Curse?

5. “This is the root of all evils”. Why is this famous in Vatican City?

6. X is used to refer to a situation where the firm’s actual bank balance is greater than what is shown on its books. Identify X.

7. West Germany, France, Italy and a few other European nations agreed to keep their currency at the same exchange rate relative to each other in 1972. What is this mechanism called?

8. Connect:

9. X is an interim financial arrangement until a stable long term money arrange-ment is made. It is an asset on the balance sheet of banks. Identify X.

10. Offering maximum incentives to induce an employee to take voluntary retire-ment is loosely called, being given the XY. Identify X and Y.

All entries should be mailed at [email protected] by 12th June, 2012 23:59 hrs One lucky winner will receive cash prize of Rs. 500/-

Article of the MonthPrize - INR 1000/-

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W I N N E R S

A N N O U N C E M E N T SALL ARE INVITED

Team Niveshak invite articles from B-Schools all across India. We are looking for original articles related to finance & economics. Students can also contribute puz-zles and jokes related to finance & economics. References should be cited wherever necessary. The best article will be featured as the “Article of the Month” and would be awarded cash prize of Rs.1000/-

Instructions » Please email your article with the file name and the subject as <Title of the

Article>_<Institute Name>_<Author’s name/Group’s name> by 12 June 2012. » Article must be sent in Microsoft Word Document (doc/docx), Font: Times New

Roman, Font Size: 12, Line spacing: 1.5 » Please ensure that the entire document has a wordcount between 1200 - 1500 » The cover page of the article should only contain the Title of the Article, the Au-

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