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FROM THE EDITOR’S DESK AUG 2010 MONEY MANAGER

From The Editor’s Desk

When the entire world was engulfed in the economic crisis, there was still some hope in certain
quarters. The hope that the growth in a select few markets could still compensate for the downturn
witnessed in the developed economies. One of those rays of hope was India: the silver lining in this
cloud of recession.

India has been the talk of the town for the past few decades as it has amazed the pundits around the
world through its growth rate, its presence at global forums as well as robustness of its financial set
up. The investors around the world through their investment patterns have given the Indian markets a
literal “thumbs up”. This can be witnessed through the large amount of capital inflows in the recent
past. At the same time, the Indian economic policies have been appreciated by one and all because of
it inherent strengths as well as strong fundamentals. If the ability of the Indian markets to successfully
tackle a downturn of such magnitude surprised everyone, its high rates of growth after just a year of
the crisis has left everybody spellbound. But it doesn‟t mean that there are no cynics. Some have
downplayed India‟s successful recovery as fallout of its relative detachment from the global economy
whereas some feel that India escaped as its population has inadequate access to credit thus lower
exposure to risk. So, whatever may be the reason, there is little doubt that story of Indian financial
markets is not just interesting but it‟s also captivating.

Money Manager 8 with its theme, “Unleashing India: The Story of Indian Financial Markets” is a
humble attempt on our part to narrate this story through the prism of industry as well as academia.

This edition has tried to capture views from different quarters that more than just influence the way
the market behaves. The interviews present international outlook on the Indian market and provide
macroeconomic insights on the government policies. The articles from the academia give financial as
well as regulatory view of the Indian financial developments. The student articles through its variety
and conceptual clarity have touched down upon different aspects of Indian economy. We have also
incorporated articles that relate finance with our day-to-day activities be it poker or relationships.

On behalf of the Money Manager team, I would like to express our deepest gratitude to the eminent
personalities who shared their views and perspectives on this theme, the distinguished faculty who
kindly agreed to judge the student entries and our sponsors of this edition, UBS AG Hong Kong. We
thank you, our discerning and ever supportive readers, for the encouragement and succour you have
provided us. We hope that this edition of Money Manager will add value through its variety of
offerings.

Please send in your valuable suggestions to finclub@email.iimcal.ac.in.

Happy reading!

Saket Saurabh (IIM-C)

 MONEY MANAGER AUG 2010 ACKNOWLEDGEMENTS

Acknowledgements
We at The Finance & Investments Club, IIM
Calcutta would like to sincerely thank all those
who have been instrumental in helping us
release this edition of „The Money Manager‟.
THE
We‟d like to thank our sponsors, UBS for their
support and encouragement. Their patronage
MONEY
and contributions have helped create a much
richer and more appealing Money Manager, one MANAGER
that we hope the readers will enjoy.

The Money Manager team would like to express

Editor-in-Chief
its deepest gratitude to the leading luminaries
from the industry and academia for their Saket Saurabh
contributions through insightful articles and
thought provoking interviews. We would like to Editorial Board
thank UBS for their cover interview, Dr. Golaka Aditya Damani
C. Nath for his interview, Prof. Asish K. Ashish Agarwal
Bhattacharyya and Prof. V.K. Unni for their Pavan Adarsh
articles. Rahul Singh Thakur
Sethu Chidambaram
We were quite overwhelmed by the phenomenal Smitalee Prusty
response from the student community across the
country – the broad range of topics covered and Coordinating Committee
analytical depth of the articles was Priyesh Jaipuriar
extraordinary. A big thank you to all those who Anindya Dutta (IIM-A)
sent in articles for this issue – we hope to have Priyank Patwari (IIM-B)
your continued support in forthcoming editions
as well.
Design
Abhishek Verma
We would like to express our gratitude to all the
members of FinClub for their valuable inputs Nitin Sahai
and feedbacks. Last, but by no means least, we
would like to thank you, our readers, whose Feedback/ Queries
unstinting support has helped the Money finclub@email.iimcal.ac.in
Manager grow to the national presence it enjoys http://www.iimc-finclub.com/
today. We hope you will enjoy reading this
edition as much as we enjoyed putting it
together!
 AUG 2010 MONEY MANAGER

Contents 
Cover Article : Indian Fi‐ 56  Arm Chair Investing on Nifty: A P/E 
Based Approach. 
nancial Markets  60  Why the Indian Markets Will Not Fail 
 
Expert Opinion 
The Lighter Side of Fi‐
6  An Outlook on Indian Markets    nance 
UBS 
65  On Bonds and Bondings 
9  The Changing Face of Indian Markets 
Dr. Golaka C. Nath  
67  Great Poker Players Make Great Trad‐
12  IFRS : Internationalizing Indian Accounts    ers, Or Do They?   
Prof. Asish K. Bhattacharyya  
Financial Crossword 
14  Viewing Reforms Through The Regulatory 
Prism  
Prof. V.K. Unni 

Editorial Articles 
17  The Basics of Base Rate  
20  ULIPs: Whose Product Is It Anyway?   
23  Financial Inclusion in India   
27  What Drives Indian Equity Markets? 
31  Oil Price Deregulation 

Student Articles 
36  Exchange Traded Funds (ETF) : Opportuni‐
ties to Deepen 
41  Mutual Funds Industry in India 
45  Developed Corporate Bond Market in  
India  
51  Capital Accounting Convertibility: Is India 
Ready? 
 MONEY MANAGER AUG 2010 PREFACE

Preface 
The Money Manager was started with an aim to collect
the views of students, practitioners and academicians on
the current developments and most relevant issues in
finance. Its stated objective was to provide a platform
for management students to express their views on all
areas of finance from private equity to capital markets,
corporate finance to insurance.

The Money Manager is not a “research journal”; rather,

it is a collection of interesting and current ideas in
finance. It is the first of its kind, a joint endeavor of the
finance clubs of IIM Ahmedabad, Bangalore and
Calcutta. To provide not just an Indian perspective, but
a truly global one, we try and get contributions from
professionals and academicians from across the world.

Interviews with professors in world-renowned institutes

and practitioners in the highest echelons of the world of
finance feature in the pages that follow. Student articles
are solicited from reputed institutions around the world.
The articles are then screened for originality and then
judged by an elite panel of professors from IIM A, B
and C. The winning articles are tested on originality,
depth of analysis, relevance of topic and presentation
style. We hope to include eminent industry persons in
the panel of judges for future editions.

Seven editions of the Money Manager have been

published before this and we hope to continue to
provide relevant and thought-provoking articles to read
for anyone who is interested in finance. To enable the
Money Manager to reach an even wider audience, it will
be available for download online. All current and past
editions are available on our websites, including http://
iimc-finclub.com/, the website of Finance &
Investments Club of IIM Calcutta. These will be
updated regularly, so do keep checking in!

- Finance Clubs of IIM A, B & C 

1
COVER ARTICLE
Cover Article : Indian Financial Markets 
Since the beginning of this decade the Indian
capital markets have been receiving global at-
tention due to the improving macroeconomic
fundamentals. The presence of a great pool of
talent, rapid integration with the world economy
and liberalization measures taken by the govern-
ment have increased India’s global competitive-
ness and have helped the capital markets grow
by leaps and bounds. In this issue we take a look
at the major turning points and focus on the
most recent developments in the markets.
The major revolution in the capital markets
started with the establishment of the Securities
and Exchange Board of India (SEBI), the regu-
latory authority for Indian securities market in
1992. It aimed at protecting the investors and
improving the infrastructure of capital markets
in India. Since then a flurry of improvements
have been initiated by the Government of India
and the SEBI which has resulted in transition of
exchanges to screen-based order matching sys-
tems for better transparency, dematerialization
of shares, online trading facility and adoption of
market oriented economic policies. This led to
faster and cheaper transactions, and increased
the volumes traded by many folds. This along
with the liberalization measures undertaken by
government since 1993 has helped deliver India
on the global platform. This decade has also
seen the rise of the derivatives markets which
are now being used by many Indian corporations
for hedging their risks. Mobile phone banking
being implemented around the country indicates
that much of the system is at the Internet age
and beyond. However despite these efforts our
markets have not been able to reach the levels
desired. Even now less than 1 per cent of our
population invests directly in the equity market.
In terms of depth, participation and geographical
spread, Indian capital markets are nowhere close
to the developed nations; not even close to their
Asian counterparts.
2
AUG 2010 MONEY MANAGER
A multitude of reasons surface when we probe
these shortcomings of the Indian Capital mar-
kets. The primary market which used to be the
retail investors’ favorite investment avenue and
an entry point till a few years ago, has been
dwindling of late. This was reflected in the re-
cent IPO’s of some public-sector firms, which
have traditionally enjoyed a sound and safe in-
vestment image among public investors. Retail
Investor participation in the market remains dis-
mal even in the secondary market. To put the
picture in perspective, the Indian retail investor
saves over $300 billion but allocates less than 5
per cent to financial market instruments other
than low return bank deposits. Even in terms of
geographical spread, more than 90 per cent of
exchange trade is largely confined to 10 cities
and 100 companies.
The biggest reason for this lackluster allocation
to capital markets remains lack of confidence
and limited financial literacy. In the last two
decades, India has seen scams and frauds which
has left the investor nervous. The allocation
fraud of Yes bank IPO where multitude of retail
accounts were opened by a single investor to get
maximum allocation through retail route rather
than HNI route is one such example. It repre-
sented not only the pervasiveness of the menace
 MONEY MANAGER AUG 2010
but also the inability of our legal and financial
control systems in dealing with it. It takes an era
to uncover a scam of this magnitude in any
country. To punish the perpetrators takes even
longer in India! Compensation if any is hard to
come by. Several such scams have left the Indi-
an investor suspicious of the capital markets and
those with weaker hearts have instead chosen to
invest in the low return fixed deposit schemes.
Regaining their confidence will require speedy
indictments and compensation for which an
overhaul of the legal system is required. There
has been some good news on that front with the
recent disgorgement of undue profits from the
IPO scam and compensation to the wronged in-
vestors. Whether it will be enough to entice the
retail investor, only time will tell.
The Government and SEBI have been doing
their part by spreading investor education and
using product innovation and technology to
bridge the urban-rural divide for a more equita-
ble and inclusive growth. The dwindling interest
in the primary markets can also be rejuvenated
by allocating higher retail portion in the IPO and
simplifying the procedures and cost of opening
Demat accounts to encourage people beyond the
top 10 centers to invest directly in equities. Cur-
rently, the application forms being used for bid-
3
COVER ARTICLE
ding in initial and follow-on public offers are
unnecessarily long and enquire redundant data
which can be done away with. There are various
proposals currently being discussed by SEBI’s
Primary Market Advisory Committee to remove
these details from the forms and make them
more investor friendly.
The SEBI in its role of protector of investors and
capital market regulator recently got into a battle
with the IRDA over regulation of ULIPs. Earlier
last year, SEBI had banned entry loads on Mutu-
al funds which made the product unprofitable
for the insurance agents. They focused their at-
tention on the new product called ULIPs which
still had entry loads ranging from 15-20%. Dur-
ing the last year, the premium collected from
these products was a total 20 billion dollars
which is about 60% of the net FII inflows of the
previous year. This huge amount of money,
most of which is invested in the capital markets,
was not under the purview of the SEBI. This
prompted SEBI to ban 14 private insurers from
selling any new ULIP product without register-
ing with SEBI. Although the verdict has ended
with the court siding with the IRDA and ULIPS
still remain under its purview, it has helped be-
ing the truth about this product in front of inves-
tors who would now think twice before invest-
ing in them. An overhaul in the nature of these
products is being contemplated without which
the product may die a natural death due to all the
bad publicity it has gathered during this battle.
For more information on the battle between
SEBI and IRDA do check out the article
‘ULIPS: Whose product is it anyway?’ in the
current issue.
Indian debt market
Debt Market plays a very critical role for any
growing economy which need to employ a large
amount of capital and resources for achieving
the desired industrial and financial growth. The
Indian debt market is today one of the largest in
Asia which includes government securities, pub-
lic sector undertakings, other government bod-
COVER ARTICLE
ies, financial institutions, banks and corporate.
In most of the economies of the world the debt
markets have been more popular than the equity
markets. However in India the reverse remains
true. The debt markets had been plagued by ex-
cessive controls and administered rates to pave
way for any development. Before1992, only a
handful of institutions participated in the gov-
ernment bond market with no trading activity on
any exchange and a system of administered
rates. Money was lent according to the plan pre-
pared by the government of India and any fall-
out of the plan was funded by issuance of more
government bonds.
The exponential growth of India’s government
bond market during last decade can be attributed
mainly to structural changes pioneered by the
Government and the Reserve Bank of India to
improve transparency in market dealings, meth-
od of primary auctions, deepening the market
with new market participants like Primary Deal-
ers, borrowings at market determined rates, and
creating technology platforms like NDS to rec-
ognize the institutional characteristics of the
market. In the wake of deregulation of interest
rates as part of financial sector reforms, there
was a need for introducing hedging instruments
to manage interest rate risks. RBI introduced
Over the Counter hedging instruments like Inter-
est Rate Swaps (IRS), Forward Rate Agreements
(FRA), Interest Rate futures(IRF), zero coupon
bonds, convertible bonds, callable (put-able)
bonds and step-redemption bonds over the years.
However the same kind of impetus has been
lacking in the corporate bond markets in India.
As a result this, major source of corporate fund-
ing is all but non-existent. The corporate in India
still prefer to borrow on loans from financial
institutions which they can keep on their books
at book value rather than by bonds which need
be marked to market. These financial institutions
divert the huge domestic savings which never
find way into the equities market, for corporate
consumption. Even the foreign currency borrow-
ings by way of FCCB’s and ECB’s are favorites
4
AUG 2010 MONEY MANAGER
among the Indian corporations rather than the
domestic corporate bonds. A slew of reasons
have been cited for this, most notably, the
lengthy issuance procedure for public issues, the
information disclosure requirements, higher
costs of public issues and inability of the public
segment in handling larger issues. However, the
most important factor remains that the corporate
bond market remains a cheap source of funds
only for AAA rated paper. This limits the num-
ber of entities which would find it profitable and
cheaper to raise money by this route. As a result,
the corporate bond segment is dominated only
by very credit worthy PSU’s. The biggest inves-
tors in this segment of the market, namely LIC,
GIC and UTI prefer to hold the instruments to
maturity, thereby truncating the supply of paper
in the market. If there ever was a need to devel-
op the corporate bond market, its time has quite
definitely come.
Indian authorities are targeting an increase in
infrastructure spending of some $500 billion
during the current five-year plan which cannot
be financed through the usual bank loan route.
Most of the resources raised by banks are by
way of deposits, which are short-term in nature,
while infrastructure projects have a long-
gestation period creating an asset liability mis-
match. This kind of financing can only be ar-
ranged by the bond market.
Going forward the emphasis in the debt market
shall remain on financial innovation by means of
newer products within a sound regulatory and
supervisory framework. In 2010, India has pro-
posed to introduce exchange-traded rupee op-
tions and interest-rate futures based on a wider
range of debt securities and step up efforts to
further develop a derivatives market that can
help investors guard against financial risk.
Bourses will be permitted to introduce dollar-
rupee options and futures based on two- and five
-year government bonds and 91- day treasury
bills. The Reserve Bank of India also plans to
finalize regulations for customized foreign-
exchange derivatives.
 MONEY MANAGER AUG 2010
The Reserve bank of India (RBI) has also pro-
posed to introduce credit default swaps, or CDS,
in Indian markets to enable firms to hedge
against any possible default by a bond issuer.
Although such a proposal has been drafted twice
before, the introduction of CDS remained stalled
in the wake of the financial crisis of 2008. At a
time when the entire world is shying away from
CDS, its introduction in Indian markets is trig-
gered more by necessity than by anything else,
especially for infrastructure bonds to fund In-
dia’s growth story. However caution will have
to be observed knowing the explosive nature of
this product.
If there is anything that we have learnt from the
last crisis it’s that maintaining adequate capital,
avoiding excessive reliance on short term fund-
About the Author :  
Smitalee Prusty is a 2nd year PGP student at IIM Calcutta. She holds a masters degree in Mathematics and
Computing from Indian Institute of Technology Kharagpur. She can be reached at smitalee@gmail.com
5
COVER ARTICLE
ing, maintaining proper loan underwriting and
following sound risk management policies is a
must. Thankfully we have the SEBI and RBI
which quite skillfully handled this during the
crisis keeping India somewhat protected from
the magnitude of turmoil in the west. However
there have been criticisms of excessive control
which have hampered product innovation. India
still has significant opportunities for productive
and prudent financial innovation, leaving it in
the enviable position of learning from the expe-
rience of others. Product innovation in multiple
asset classes such as bonds, interest rate futures,
equity and SME will surely bring about the
much-needed multifold capital formation and a
scope for huge employment generation in India.
EXPERT OPINION
An Outlook On Indian Markets 
An interview with UBS 
SEBI has proposed new takeover norms.
According to you what are the likely
implications of its introduction on the capital
market activity in the Indian Equity
markets?
We believe that by increasing the trigger point
for making an open offer 15% to 25% will help
Indian companies to get meaningful funding
with out worrying about hitting the open offer
limit..
 Also, many strategic investors such as PE,
overseas corporate will be able to increase
their existing stake in Indian companies to
25% with out reaching the open offer
limit.
 The proposal to increase the open offer
size to 100% from current minimum 20%
will only bring serious players to the table.
 Another positive outcome of the 100%
open offer size means that it is easier for
the company to delist instead of the
cumbersome process of reverse book
building.
 We believe use of volume weighted
average price (VWAP) and the inclusion
6
AUG 2010 MONEY MANAGER
of non-compete fee for determining the
final offer price are welcome steps as
these would lead to better price discovery
for minority shareholders and ensure
equitable treatment for all shareholders
Will the new takeover norms affect the
attractiveness of the Indian firms as takeover
targets or will it prevent sham bids? Which of
the two seems more probable?
We view the new proposed take over norms as
progressive and inline with international
standards. We do not think these norms will
impact the attractiveness of Indian firms as take
over targets. Rather, we think that the
attractiveness will be determined by the
domestic market growth story and the
company’s fundamentals.
Also, as mentioned above, we think that
provisions such as open offer size of 100% will
only solicit interest from serious players who
will be attracted by domestic market
fundamentals.
With Coal India IPO expected to hit the
markets by October, and the Government
making it mandatory for listed companies to
raise public shareholding to 25%, how well
 MONEY MANAGER AUG 2010
do you think the markets are prepared to
handle so much weight on market liquidity?
The minimum 25% public shareholding rule
primarily impacts public sector enterprises
(PSUs) as our analysis of BSE 500 companies
suggests that out of the total amount needs to be
raised to comply with the rule, ~86% will have
to be raised by PSUs.
 We believe that PSU divestment in FY11
either through complying by 25% public
shareholding rule or through other primary
sector offerings (IPOs) will not hamper
stock market momentum because of the
following factors:
 We believe Indian stocks will continue to
attract flows from FIIs and domestic
insurance companies, driven by positive
momentum in data points such as quarterly
GDP, earnings growth, good monsoon,
government policies, and better fiscal
situation.
 We expect domestic institutional investors
to continue to support public sector
divestment in FY11. Domestic investor
demand (including insurance companies)
contributed 63% to PSU divestment
proceeds in FY10.
 There was significant FII interest (more
than 30% of total subscriptions) in four of
the six PSU public offerings in FY10. FIIs
invested 16.6% in total PSU offerings in
FY10.
 Non-institutional investors (retail,
employees and high net worth individuals)
have also shown significant interest in
PSU divestment in FY10 provided the
valuations are reasonable (as was evident
by non-institutional investors’
participation in NMDC’s and NTPO’s
FPO).
7
EXPERT OPINION
How big of a concern is the uptrend in
inflation in India. Do you think that RBI has
been proactive enough in controlling inflation
or do you think it needs to hike rates again?
Inflation is one of the primary concerns for
Indian capital markets. Foreign institutional
investors are looking at inflation figures very
closely. We expect WPI inflation rate to decline
towards 5-6% levels by fiscal year-end. Our
India Economist, Philip Wyatt, in his report in
his note India: Inflation Zenith dated 2 July
2010 looked at 4 main angles - aggregate
demand, WPI measurement, global price
pressures and re-pricing of oil & food – and
concluded that:
 India is at or close to the peak in headline
inflation and over the next 12 months the
rate should drop.
 If oil prices turn out to stabilise, then fuel
price deregulation is a distraction. The real
issue is that high food price inflation
should drop lower because it simply
mirrors oil inflation trends with a lag.
 Absent fuel price deregulation distortions
and new official indices we would expect
WPI inflation rate to decline towards 5-6%
by fiscal year-end.
 But in reality the 1-2% impact of the jump
-up due to deregulation could be partly
offset by a drop-down due to the
introduction of a new index, otherwise the
new WPI should be little different.
 More importantly, global disinflation/
deflation pressures could also push it
lower still, conceivably to under 5%.
We think RBI has been proactive enough in
dealing with inflation when compared to other
central banks. The central bank (RBI) has
started tightening by hiking reserve requirement
EXPERT OPINION AUG 2010 MONEY MANAGER

ratio (CRR) by 100bp to 6% and the policy
interest rate corridor, repo rate and reverse repo
rate, by 100bp and 125bp respectively (repo and
reverse repo at 5.75% & 4.50%). The recent
hike of repo and reverse repo rates on 27 July
2010 also again shows RBI’s resoluteness to
fight inflation proactively.
But it has much further to go to wind back its
easy money of 2008-09. Market yields have
risen to reflect this situation and upward
pressure on local rates should persist, 3m t-bill
yields have risen from 3-3.5% at the low to 5-
5.5% today. We expect monetary tightening to
continue in FY11 till nominal rates move up and
more in line with inflation trends.
There have been big concerns on the credit
quality with regards to the funds raised by
the telecom sector in India, especially after
the mega spending in the 3G auctions. Do you
think such concerns are warranted?
would be a good investing strategy in today's
markets?
We remain bullish on India stocks with Mar11
Sensex target of 22,000. We believe that the
combination of several positive factors such as a
good monsoon, government policies, a better
fiscal situation, lower inflation outlook, and
earnings growth will enable Indian stock
markets to re-rate further from current levels.
Our key overweight sectors are banks,
infrastructure, power and real estate while our
key underweight sectors are consumer goods, IT
services and Telecom.

As per inputs from banks, part of 3G lending is

expected to be refinanced via external
commercial borrowings (ECBs) which will
result in shifting some of the credit risks
externally.

Also we understand that banks are comfortable

with their lending to incumbents (Bharti, Idea,
Vodafone) as compared to new operators (STel,
Tata DoCoMo). However, some mid cap banks
have supported new operators with stricter
underwriting standards.

According to media reports, telecom exposure as

a percentage of overall bank lending is estimated
to be 5%. We believe that telecom exposure is
well diversified among large operators
mitigating the credit quality risk to an extent, in
our view.

What are your top picks in this

market environment and what do you think

8
 MONEY MANAGER AUG 2010 EXPERT OPINION

The Changing Face Of Indian Markets  
An interview with Dr. G. C. Nath 
Dr. Golaka C Nath is a Senior Vice President at the Clearing Corporation of India Ltd.
(CCIL). He has over 21 years of experience in the banking and financial sector, having
previously worked with the National Stock Exchange of India Ltd. and Vijaya Bank. In
the past, he has worked on a World Bank Project on “Developing Bond Market in
South Asia”. He has also provided secretarial service to the High Powered Committee
on “Corporate Bonds and Securitization” appointed by the Ministry of Finance,
Government of India.

Inflation has become the biggest challenge for
the Indian economy right now. Where do you
see the inflation rate going in the next few
months?
It is, no doubt, a very important negative factor
for the economy which has the potential for
destabilising growth expectations. It is a
challenge to control inflation with the present
policy prescription. We have to understand that
initially inflation started with supply side
constraints and mostly in food but later
percolated to other non-food sector. Today fuel
accounts for a large part of the inflation. Both
food and fuel inflation are difficult to control
unlesss and until we take some structural
decisions to augment the supplies. A good
monsoon may bring some respite. However,
monetarily speaking, you can not control
inflation with unlimited supply of liquidity at
5%-6% repo rate when inflation is more than
10%. More monetary tightening is required if
we have to monetarily control inflation.
It has been witnessed especially in the Indian
context that the high growth period is
followed by a period of high inflation. Do you
think that we should compromise our growth
to rein in inflation? If yes then should it take
place because the Indian growth is
inequitable in nature but the inflation
pervasive? What impact could it have on the
economic recovery?
Yes high inflation is not sustainable for high
growth as equilibrium will break as per
economic theory. Spiralling inflation will
destabilize growth in the long run and the cost
will be castratropic at times. We have seen in
Latin American countries - It took a very long
time for these economies to come back on the
growth trail with lot of pain and support from
US due to political reasons. We can not expect
such kind of assurance. Our infrastructure can
not sustain growth rate of 9% in the long run. In
my opinion, if we can achieve an 8% long term
growth with this infrastructure, it should be
good enough. Given the non-equitable
distribution of development, we should do better
to control inflationary pressure as it wipes out
wealth from poor faster than the rich.
In the recent past we witnessed an
unprecedented liquidity crunch due to 3G
and Wireless broadband auction. But even
this development didn't result in any change
in spending cycle of the government. Do you
think that there should be a change in the
current spending policy?
Spending policy is well defined for the
government and it is desirable that Govt.
maintains the planned expenditure schedules.
Liquidity crunch is a temporary problem and it
will change as government pays out salaries,
funding for various departments. However,
government should restrain its non-plan

9
EXPERT OPINION
expenditure so that it will not have an impact on
the market. Money goes out and comes back. As
the auction of 3G and BWA was not a routine
inflow, Government took its time to allocate
funds in excess of their budgeted figures from
such auctions. In the long run, the auction
proceeds will be helpful to reduce our fiscal
deficit.
After the base rate system, there are now
talks of freeing up of interest rates of savings
account. Do you think that it is really needed
and what could be its probable implications?
Yes, freeing of SB interest rate is required. It
will create competition and customers will have
better resouces. However, as it is, banks provide
swipe–in facility to most of their customers and
hene SB accounts earn better return. Changing
SB interest rate will further this process.
Do you see the setting up of the Financial
Stability and Development Council (FSDC) as
a threat to the autonomy of the financial
sector regulators?
The scope is not properly defined and it is
going to create a lot of confusion in future. The
autonomy of the regulators will be questioned. I
personally do not agree with the proposal. To
my mind FSDC will be a political intereference
in the working of independent regulators as
Finance Ministry will be putting its hand
everywhere and at times will interefere in day to
day workings of the regulators.
Even though bond markets are not as easily
and frequently manipulated as equity
markets but still the possibilities of
misconduct remain. Can you tell us the
probable ways in which manipulation occurs
and what are the steps that the regulators
intend to take in order to avoid them?
Manipulation can happen in many ways,
specifically in less liquid markets like India.
However, due to the surveillance system, it can
10
AUG 2010 MONEY MANAGER
be easily traced today and provides a negative
incentive for traders to do that. In illiquid stocks,
the order book is very thin. Hence traders can
talk to each other and execute a deal at an
agreed price which may be away from the
market. However, with the MTM system in
place for centralised settlement, this can be
controlled to a large extent. But pricing an
illquid security away from the curve will finally
go the the books even if you charge margins. It
is a longer call. But given the systems in palce
today in India, it is extremely difficult to
manipulate the market without the regulator
knowing it.
The foreign banks have a dominant market
share in the bond markets as well. Do you see
this as an outcome of existing regulations
being too stringent for the national banks or
it is due to the local banks lacking the
required capabilities? Should their
participation be encouraged even if it
requires comprising with the existing
regulations?
It is the strategy and policy of a bank that drives
its participation in the market. If you have a buy
and hold policy, you will rarely trade, you will
dump at least 25% of NDTL in HTM category.
Foreign banks follow their parent system which
is generally a mark to market kind of system for
all portfolio. Hence there is an incentive for
trading. Further, the compensation structure also
is responsible for trading. More I trade, more
profit I possibly generate which increases by
bonus. Given the current US legislation putting
lots of restriction on proprietary trading, things
will change so some extent. However, we have
to also acknowledge, the skillset in foreign
banks will be far better in quality than the public
banks. Most of the students from top institutes
like IIMs amd IITs will surely not look at public
banks as a career but they will jump to join a
foreign bank irrespective of its global reputation.
So PSU banks have to manage with what ever
skill set they get with their limited resource
allocation for compensation.
 MONEY MANAGER AUG 2010 EXPERT OPINION

What are the steps that are needed to
encourage the participation of retail investors
in the debt markets or you are happy with the
status quo i.e. limited participation of retail
investors?
Retail investors do not come to this market very
easily. Education is very important for retail
investors. Given many competing products, few
investors will be willing to put their money in a
30 year bond with 8.32%. Globally, you hardly
find retail investors in this market, the way you
find them in Mutual funds or equity market. I do
not see Indian retail investors coming to this
market in next 10 years or so.
The major chunk of Indian bond market is
comprised of government bonds. What have
been the main hurdles in developing an
equally liquid corporate bond market? What
can be done to develop the corporate bond
market?
of the guys buy and hold. So STRIPS will take
time to pick up. We have to understand that a
STRIP is more risky than a bond of similar
maturity due to interest rate sensitivity. Products
like CDS will come at some point in time.
However, it will be difficult to have successful
market for these products. In a plain vanila OTC
derivatives product where banks are allowed to
participate, PSU banks have negligible market
share (less than 0.5%) while they hold about
65% of the total banking assets in the country.
When they are reluctant to come to this simple
plain vanilla product, I do not expect them to
come to more complicated markets like CDS
immediately. It may go the OTC derivatives
way – concentration of few banks.
Disclaimer: The views presented here are solely
of Dr. Golaka C. Nath and have no relation to
CCIL.

Corporate bonds have been a good topic for

conferences and seminars for last 10 years or
more. A good deal of things have been
suggested by Dr. R H Patil committee report.
We have to follow those steps. The cost of
issuance including creating charge is
prohibitive. This must change if you want
corporate debt to improve. Debenture trustees
must work with responsibility.

RBI has been pretty cautious in introducing

new products in the Fixed Income Markets
with the US financial crisis further adding to
the aversion of the central bank. Now that we
are recovering from the pangs of the crisis, do
you see a push for introduction of
instruments like CDS in the Indian markets?
Further, do you see the market for products
like STRIPS which was recently introduced,
growing in India?

The new products like STRIPS are more suitable

for trading in a kind of market where churning
portfolio is regualar. In our kind of market, most

11
EXPERT OPINION AUG 2010 MONEY MANAGER

IFRS : Internationalizing Indian Accounts 
An article by Prof. Asish K. Bhattacharyya 
Asish K. Bhattacharyya, D.Phil., is Professor, Finance and Control,
Indian Institute of Management Calcutta (IIM-C). Prior to joining
IIM-C, he was the Technical Director, Institute of Chartered
Accountants of India, and a senior faculty member at the S.P. Jain
Institute of Management and Research, Mumbai. Besides, he has
about 20 years experience in the industry. A Fellow of the Institute
of Chartered Accountants of India, Professor Bhattacharya is a
member of the accounting committee of IRDA.

International Financial Reporting Standards
(IFRS) are issued by International Accounting
Standards Board (IASB), which is an arm of
IFRS Foundation, a global body headquartered
in London. Earlier it was known as International
Accounting Standards Committee (IASC). IASC
was formed in 1973. IASC was dissolved in the
year 2001 to form IFRS Foundation. Accounting
standards issued by IASB are called IFRS.
Accounting standards issued by IASC are called
International Accounting Standards (IAS). IFRS
refers to the complete set of IFRSs issued by
IASB, IASs issued by IASC and not withdrawn
by IASB and interpretations issued by the
Interpretation Committee of IASB and
interpretations issued by the Interpretation
Committee of IASC and not withdrawn by
IASB.
With the globalization of capital markets, the
need of a single set of high quality,
understandable, enforceable and globally
accepted international financial reporting
standards was felt. Accordingly, a movement for
convergence of national accounting standards
with IFRS began. The movement gained
momentum in the year 2000, when the Internal
Organisation of Securities Commission
(IOSCO) assessed and approved the Core
Standards issued by IASC. More than 100
countries (including European Union) have
adopted accounting standards, which are fully
converged with IFRS. India is committed to
implement accounting standards fully
convergent with IFRS by April 1, 2011. As per
the road map issued by the Ministry of
Corporate Affairs, NIFTY 50 companies,
SENSEX 30 companies and companies whose
net worth was more than INR 10,000 million
will apply accounting standards fully convergent
with IFRS. For convenience, in subsequent
paragraphs we shall refer those standards as
INFRS.
Convergence
Convergence gives flexibility to carve out of
IFRS some accounting principles, methods and
disclosures and also to carve in some accounting
principles, methods and disclosures to address
unique requirements of the country and to

12
 MONEY MANAGER AUG 2010
address special concerns expressed by regulators
and users. However, this flexibility is used
judiciously to ensure that the objective of
convergence is not lost. Therefore, INFRS are
expected to be substantially same as IFRS.
Fair value
IFRS uses fair value, as measurement basis,
much more extensively that the extant Indian
GAAP. For example, ESOPs issued to
employees are recognised at fair value; revenue
is measured at the fair value of the consideration
received; financial assets and financial liabilities
are initially measured at fair value; Financial
instruments, except a few exceptions are
measured at fair value; intangible assets
acquired in a business combination are initially
measured at fair value; and biological assets are
measured at fair value. In some cases, the
change in the fair value between two balance
sheet dates is recognised as profit or loss in the
profit and loss account for the period. It is a
myth that IFRS requires fair value measurement
of all assets and liabilities in the balance sheet.
Intensive use of fair value as measurement
attribute is debated across the globe. In India,
many accountants believe that the adoption of
fair value measurement will lead to accounting
fraud. The concern is triggered by the fact that
in absence of an active market for an asset or a
liability, fair value is determined using
economic models. Fair value determined using
an economic model is an opinion because the
value reflects large number of assumptions
made by the valuer. Therefore, there is ample
scope for engineering the fair value. Moreover,
valuation is more an art than a science.
Therefore, valuation skills can be developed
only by practicing valuation. In absence of wide
spread use of fair value in India, there is
shortage of valuation experts. These concerns
can be addressed by the government by
developing a well regulated profession of
valuers at an accelerated speed.
13
EXPERT OPINION
Relevance and reliability
Standard setters always endeavor to establish a
balance between relevance and reliability in
formulating accounting standards. Earlier the
emphasis was on reliability. Now the emphasis
has been shifted to relevance. Users of financial
statements find fair value measurement of
certain assets and liabilities (e.g. financial
instruments) more relevant (in decision making)
than the historical cost measurement.
Accountants and auditors are more comfortable
with historical cost measurement because they
are comfortable with estimates that are
auditable. Therefore, they oppose fair value
measurement of assets and liabilities. But IFRS
is using fair value measurement intensively
because ‘decision usefulness’ is the overriding
principle for the preparation and presentation of
financial statements.
Conclusion
It is a huge challenge for all stake holders to
successfully manage the transition from the
Indian GAAP to INFRS. The present discomfort
is similar to the discomfort of the Indian
corporate sector when India opened up the
economy in early 1990. But, Indian companies
have taken the challenge and have emerged
stronger and more resilient and many of them
are now global players. Let us hope that Indian
managers and accountants will manage the
transition successfully.
EXPERT OPINION AUG 2010 MONEY MANAGER

Viewing Reforms Through The Regulatory Prism 
An article by Prof. V. K. Unni 
Dr. V.K. Unni, faculty member of IIM Calcutta, currently holds the Max
Planck Fellowship instituted by Max Planck Society Germany. He also has the
rare distinction of serving in the Fulbright Fellowship Selection Panel for three
consecutive terms. He has been consulted on various projects/initiatives
undertaken by Columbia University, European Commission, German Ministry
of Research, IIT Bombay, IIT Kharagpur, Microsoft Corporation, Herbert
Smith LLP, UNCTAD, etc. He is an alumnus of the prestigious International
Visitor Leadership Program established by US Department of State.

India which got its independence from Great
Britain in 1947 used an economic model of self
reliance which continued for almost 45 years.
During this period India, tried to put certain
barriers on foreign trade, which also included a
ban on foreign investment. During those days
the fundamental policy objective for the
government was to have economic self-reliance
whereby the country’s economy was supported
by domestic resources rather than international
investments.
The common perception at that time was that
public ownership of basic industries was very
crucial to ensure development in the interest of
the whole nation. Since it was believed that
global trade was biased towards developing
countries, the policy of the government was
aimed at self-sufficiency in most products
through import substitution. The government
made sure that the role of Foreign Direct
Investment (FDI) in the country would be a
marginal one by enacting laws like Foreign
Exchange Regulations Act (FERA) and
Monopolies and Restrictive Trade Practice Act
(MRTP). FERA limited foreign equity
participation at forty percent so as to restrict
foreign exchange outflows arising out of
dividend and royalty payments. MRTP Act
prevented large enterprises from being
developed which eventually disallowed the
companies from reaping the benefits associated
with economies of scale. The Constitution of
India also played a major role in forcing the
policymakers to subscribe to laws like MRTP.
The Indian Constitution has a chapter dealing
with directive principles that provides overall
guidance in state policymaking and this includes
the concept that the economic system should
function in a manner that does not lead to the
concentration of wealth in the hands of a select
few.
During the initial decades, India’s economic
development strategy was inward-looking and
there were numerous industrial licensing
requirements, widespread public ownership of
heavy industry, very high tariff barriers, tight
restriction on the operations of foreign firms and
on imports and exports through laws like FERA
and excessive bureaucratic control.
In the year 1991 India was forced to make many
major changes in its earlier approach because of
the grave balance of payment crisis which it had
to face. Thus India slowly began to embrace the
globalization model which essentially was
premised on the idea that national economies
were intertwined and any barriers imposed on
trade would stifle national development. In the
years which followed after 1991 the government
continued with the process of systematic
economic reforms, which marked a clear
departure from the four decades of planning

14
 MONEY MANAGER AUG 2010
based on self-reliance. As a result of this policy
change, the Indian government was compelled
to make laws and regulations which reflected the
new economic model. The history behind the
new economic regulations in India has a strong
relationship to the process of liberalization,
privatization, and globalization which was kick-
started in 1991.
Major Regulatory Changes Post 1991
After 1991 India witnessed some major changes
with respect to regulation of capital markets,
foreign exchange markets as well as monopolies
and restrictive trade practices. Even prior to
1991 India had laws dealing with the
establishment of companies and the existing law
i.e, the Companies Act 1956 specified the
general legal framework for setting up,
functioning, and closing down of Indian
companies. All registered companies in India,
public as well as private, are governed by the
Companies Act. While setting in motion the
plans for India's economic liberalization and
development of domestic capital markets, the
central government set up Securities and
Exchange Board of India (SEBI) to exercise
regulatory control over the stock markets. In the
year 1988 SEBI was established as an advisory
body, but in 1992 it was empowered to regulate
the securities market under the Securities and
Exchange Board of India Act of 1992 (SEBI
Act).
However it should be noted that there were
several laws enacted prior to 1992 that
established a foundation for securities
regulation. The Capital Issues (Control) Act
1947 regulated the manner in which a company
may issue debt and equity. Under the said law
companies needed approval from the Controller
of Capital Issues (CCI) for raising capital and
there existed some stringent pricing norms. This
law was abolished in 1992. The Securities
Contract Regulation Act of 1956 empowered the
Central Government to protect investor interest
15
EXPERT OPINION
by following a system of self-regulation where
the stock exchanges would supervise
transactions involving securities. But the
absence of a central regulator was badly felt
when self regulating organisations like stock
exchanges could not create a fair and efficient
system of trade. All these factors led to the
establishment of SEBI as the market regulator in
1992.
Since its inception SEBI has been very active in
framing legal provisions dealing with
fundamental market problems such as insider
trading. The SEBI (Insider Trading) Regulations
prohibit "insiders" from dealing in exchange-
traded securities on his or another's behalf based
on unpublished price sensitive information.
SEBI has drafted various regulations which are
intended to protect the rights of ordinary
investors/share-holders and notable amongst
them are SEBI (Merchant Bankers) Regulations
1992, SEBI (Mutual Funds) Regulations 1996,
SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations 1997, SEBI (Delisting
of Equity Shares) Regulations 2009, SEBI
(Issue of Capital and Disclosure Requirements)
Regulations 2009 etc.
Amongst the regulations mentioned above the
one dealing with takeovers popularly known as
the Takeover Code and the provisions dealing
with public issues called as the ICDR
EXPERT OPINION AUG 2010 MONEY MANAGER

regulations always attract significant attention
from the business community. To SEBI’s credit
it has been trying to innovate with various new
regulations and have introduced fresh avenues
for raising capital like Qualified Institutional
Placements (QIP) and Indian Depository
Receipts (IDR).
With regard to the regulations affecting the
foreign exchange market there has been
significant changes post 1991. Foreign
Exchange Management Act (FEMA) has
replaced the draconian FERA. Reserve Bank of
India (RBI) has been given to mandate to
regulate the capital account foreign exchange
transactions done by any person resident in India
and any person resident outside India. Thus RBI
has issued numerous regulations in the field of
foreign investments and this broadly covers
areas like FDI, investments made by foreign
institutional investors under the portfolio
investment scheme, investments made by Non
Resident Indians under the portfolio investment
scheme, investments by venture capital funds
etc. Similar regulations have been framed to
deal with overseas investments made by Indian
companies in joint ventures and subsidiary
companies. Regulations framed under FEMA
have been highly successful in bringing foreign
investment to the country and it has also played
a significant role in facilitating the overseas
investments made by Indian companies.
effect on competition. However the provisions
in the law dealing with combinations are yet to
be notified
Conclusion
Needless to mention, the economic liberalization
has triggered the need to have a set of new
regulations which can match the spirit of free
enterprise, entrepreneurship and risk taking. It is
quite evident that the policy makers are trying
hard to make many of the laws consistent with
this objective. India has undoubtedly done
reasonably well in the last two decades on this
front. However with one-third of the world's
poor and one billion people, India desperately
needs rapid growth and employment
opportunities to eliminate poverty further and
sustain the recent income increases. For India to
achieve its realistic rate of growth, the
government needs to implement regulations
which correctly embody its potential. Till then
India the sleeping giant will have its existence in
a near somnolent state.

Another important area of law which has

witnessed a major revamp is the MRTP Act. The
said law has been repealed and has been
substituted with a brand new Competition Act.
The new law dealing with competition has been
framed after considering the present day market
conditions and it fully reflects the sentiments of
the various stakeholders. Thus there are
provisions dealing with anti-competitive
agreements, abuse of dominant position and
combinations involving mergers and
acquisitions. Unlike its predecessor the
Competition Act will only target the conduct of
parties which are having an appreciable adverse

16
 MONEY MANAGER AUG 2010
The Basics Of Base Rate 
There hardly is an adult nowadays who hasn't
felt the need or has gone ahead to avail a loan.
You can blame it on the increasing consumerism
or the inflationary forces. Anyways, I am not
going to discuss the rate of inflation or
conspicuous consumption rather I will focus on
the rate of interest on these loans. These rates
were affected by a major change that took place
on the 1st of July, 2010. This happening was;
"coming into effect of Base Rate System".
So, the first question that would come to our
minds would be, why was a new system needed?
To answer this, I will first explain the old
regime. The rate that took the centre stage in the
previous era was Base Prime Lending Rate
(BPLR). BPLR indicated the rate of interest at
which banks lent to favoured customers, i.e.,
those with high credibility. So, one might be
tempted to say that it was the best available rate
of interest. BPLR of SBI was 11.75% in Jun'10.
But unfortunately almost 70% of the loans
carried an interest rate below BPLR. So what
was so unfortunate about it? The disturbing
aspect was cross-subsidization. The blue chip
companies walked away with lowest of rates
whereas the SME compensated for them by
17
EDITORIAL ARTICLES
paying a higher rate. This was because there was
no transparency involved in the process of
arriving at BPLR and the large firms could arm-
twist their way to lower rates.
So let me now define Base Rate System (BRS)
in a little detail. BRS is a system to fix interest
rates for borrowers which will serve as the
minimum rate for all loans i.e. a bank can't lend
below the base rate. As was the case with BPLR,
each bank can have its own Base Rate. Its basis
of calculation will mainly include cost of
deposits, profit margin etc.
This is the illustrative methodology released by
RBI for computation of Base Rate:
Base Rate=a+b+c+d
a - Cost of Deposits=Dcost
b - Negative Carry on CRR and SLR= [{(Dcost−
SLR*Tr)/ (1− CRR+SLR)} *100– Dcost]
c - Unallocatable Overhead Cost= (Uc / Dply)
100
d - Average Return on Net Worth= [(NP/NW) *
(NW/TL)] 100
Where:
Dcost Cost of Deposits
D: Total Deposits= Time Deposits + Current
Deposits + Saving Deposits
Dply: Deployable Deposits =Total deposits less
share of deposits locked as CRR and SLR
balances,.e. =D* (1− CRR+SL )
CRR: Cash Reserve Ratio
SLR: Statutory Liquidity Ratio
Tr: 364 T-Bill Rate
Uc Unallocatable Overhead Cost
NP : Net Profit
NW : Net Worth = Capital + Free Reserves
TL : Total Liabilities
Negative carry on CRR and SLR balances arises
because the return on CRR balances is nil, while
EDITORIAL ARTICLES
the return on SLR balances (proxied using the
364-day Treasury bill rate) is lower than the cost
of deposits.
Unallocatable overhead cost for banks could
include aggregate employee compensation
relating to administrative functions in corporate
office, directors' and auditors' fees, legal and
premises expenses, depreciation, cost of printing
and stationery, expenses incurred on
communication and advertising, IT spending
and cost incurred towards deposit insurance.
The Base Rate has to be revised every quarter.
Though so far an option is available to the
existing borrowers to move to the BRS price
from the BPLR one, but in near future a sunset
clause from RBI might make the transfer
mandatory. Most of the PSB (public sector
banks) have announced their base rate as 8%
whereas SBI has declared 7.5% as its rate. On
the other hand private banks like ICICI have
pegged it at 7.5% and HDFC has fixed it at
7.25%.
So, let's point out some of the advantages of this
new system:
 This could usher into a era of interest rates
that are set by scientific methods which was not
the case with BPLR
 An effort has been made towards
transparency in the interest rate calculation for
the loans i.e. the credit spread above the Base
Rate which could be different for different types
of customers will have to be calculated in a
transparent manner.
 Cross-subsidization as evidenced from the
SMEs paying higher interest rates to compensate
for the low rates of blue chip firms has finally
caught the attention of the policy makers.
 It could lead to a "rate war" thus lowered
cost of borrowings esp. for SME can't be ruled
out.
 A transparent regime will result in credit
worthy customers availing loan at suitable rate
who may have been refused loan in the past
regime.
18
AUG 2010 MONEY MANAGER
 BPLR as the ceiling rate for loans up to Rs.
2 lakh has been withdrawn which reinforces the
third point.
It could prove to be a blessing in disguise
for alternative short term debt instruments like
Commercial Papers (CP) or non-convertible
debentures (NCD) or Certificate of deposit
(CD). This system can also lead to innovation in
the fixed income markets with products being
designed to suit the needs of the lenders and
borrowers
But even BRS has its share of doubts and
concerns:
 The banks can still provide benefits to the
large borrowers by say paying higher interest
rates on their deposits though large borrowers
would normally not keep high deposits as loan
interest rate will always be higher than deposit
rates.
 Why quarterly revision, why not daily even
when computerization (of above 85%) is the
norm at the Indian banks?
 It could lead to banks shying away from
lending (with low interest rates) rather they
might prefer investing in CP or CDs.
 Segments which are perceived as more risky
may see their effective lending rates going up.
 Excluding the agri-loans, loans to banks’
own employees, loans against deposits from the
purview of BRS is a dampener
The announced base rates expose the
cartelization of banks else how come most banks
have the exactly same base rates or the
difference being in multiples of 25 basis points?
So, the road ahead for the Base Rate would be to
link it apart from the fully covered cost plus
rate, to a benchmark rate like 5YR sovereign
Bond Rate. Now, both will be dynamic as the
rates would be monthly reset and it would take
into account all possible costs a Bank can incur
for running its business. This would be a big
improvement from the past regime as BPLR did
nothing of the sort and the method was also not
 MONEY MANAGER AUG 2010
known to public. This would make the system
scientific. As macroeconomic indicators could
have a more pronounced and immediate impacts
on the lending rates now so dynamic regulations
would be the need of the hour.
As Mr. G.C. Nath, Sr. V.P., CCIL (Clearing
Corporation of India) while sharing his insights
on BRS says, “Daily revision of Base rates is
not advised because the regulatory cost will
drastically increase by doing the same. And you
do not get much benefit as we do not expect
banks to increase their deposit rates on daily
basis - neither other cost increase on daily basis.
So, quarterly reset is fine as it maps with the
policy announcements." So we may continue
with quarterly revision of Base Rates in near
future as well. Though the trade-off remains as a
one-year cost might not have reflected the
current cost while a three-month cost may not
reflect the historic cost.
Mr. Nath adds that roll over (reinvesting funds
from a mature security into a new issue of the
About the Author : 
Saket Saurabh is a 2nd year PGP student at IIM Calcutta. He holds a bachelors degree in Electronics and
Communication Engineering from National Institute of Technology, Patna. He can be reached at
ss.nitp@gmail.com. He maintains a blog at http://saketvaani.blogspot.com
19
EDITORIAL ARTICLES
same or a similar security) cost of average CP/
CD could be very high as they have a life cycle
of 3 months. So, a banker has to find a loan
customer if it wants to survive competition."
With banking having an oligopolistic structure
and their business dealing in homogeneous
products, most banks offer the same kind of
rates for deposits - a few bps here and there.
Also due to competition, banks also try to keep
the customers with them. The customers
compare rates across banks and then bargain
with banks for the best rate. So, cartelizations of
banks say they forming groups like PSU banks,
foreign banks, private banks, co-op banks, etc.
and developing some kind of informal structure
to deal with various issues could still be the
norm.
So whether BRS will be the dawn of a new era
or will it prove to be an exercise in futility? For
now it would be safe to say that “Only time will
tell.
EDITORIAL ARTICLES
ULIPs : Whose Product Is It Anyway ? 
Earlier this summer, when IPL frenzy had cov-
ered the cricket fanatic nation, teams were bat-
tling to win yet another T20 championship, it’s
organizers and team owners fighting legal bat-
tles off the field, there was another battle unfold-
ing in the financial circles: the tussle between
SEBI (Securities and Exchange Board of India)
and IRDA (Insurance Regulatory and Develop-
ment Authority) for the right to regulate ULIPs
(Unit Linked Insurance Plans). This episode has
brought to fore various issues surrounding this
product. The size of the market for life insurance
products in India, estimated to be the fifth larg-
est in the world, is over $40 billion and growing
at a rapid pace of over 30% per annum. ULIPs
account for over 80% of the business in this
market. Through this article we will give an
overview of ULIPs, the much publicized tussle
between the two regulators over this, the recent
changes brought about by IRDA and its impact
on the life insurance industry and the investors.
So what are ULIPS? ULIPs or Unit Linked In-
surance Plans as the name suggests, are insur-
ance plans linked to investment units. It is a fi-
nancial product that offers you life insurance as
well as an investment like a mutual fund. Part of
the premium you pay goes towards the sum as-
sured (amount you get in a life insurance policy)
and the balance is invested in whichever invest-
ments you desire - equity, fixed-return or a mix-
ture of both.
Why are ULIPS in news now? In April 2010,
SEBI issued a notice asking all insurers to stop
the sale of ULIPs, which according to SEBI,
should come under its regulations. Insurance
regulator IRDA immediately struck down on
this call and asked insurance companies to ig-
nore SEBI's order. What followed was a bitter
public spat between the two regulators with the
Finance Minister intervening and calling for a
joint application before the judiciary.
20
AUG 2010 MONEY MANAGER
So why was SEBI, the capital market regulator
so concerned about regulating an insurance
product – in this case ULIPs. Well, the genesis
of this issue lies in an August 2009 verdict by
SEBI which banned the entry loads on Mutual
Funds. Entry load is the commission that an in-
vestor has to pay while purchasing units of a
mutual fund. After this verdict, entry loads on
Mutual Funds had to be cut down to as low as
0.5-1%. In contrast, ULIPs had entry loads rang-
ing from 15-20%. One of the biggest assets of
MFs is their wide distribution network which
can reach out to a large number of investors.
However, with the reduction in the upfront com-
missions, selling Mutual Fund units was no
longer a very attractive proposition for the
agents in this distribution network. This is where
ULIPs came into the picture. As these products
still continued to have large upfront commis-
sions, most distributors shifted their attention
from selling MFs to selling ULIPs.
Just to give you a sense of how every distributor
jumped on to the ULIP bandwagon, fathom this:
during the previous financial year, over 1.6 mil-
lion ULIP policies were sold, with the total pre-
mium involved in these products amounting to
over $20 billion. Most of these funds are invest-
ed in the capital market. To put this figure in
 MONEY MANAGER AUG 2010
perspective, the net FII inflow in the previous
fiscal was around $32 billion. The effect that
FIIs can have on the movement in the Indian
markets has been well documented. So, the bur-
geoning size of the ULIP products meant that
SEBI essentially had no control over a major
investor segment in the capital markets. This
finally culminated in SEBI’s April 10 order ban-
ning 14 private insurers from selling any new
ULIP product without registering with SEBI.
Was SEBI justified in putting in place this ban?
The main contention by SEBI was that ULIPs
ultimately are investment products. As men-
tioned earlier, they have a very significant in-
vestment in the capital markets. So, it does make
sense to bring such products under the purview
of the capital market regulator. But a couple of
things regarding SEBI’s ban order stuck out.
Firstly, it quite conspicuously left out the public
sector insurers (read LIC) from the ambit of the
ban. Given the size of these insurers, it’s hard to
explain why they were treated differentially than
the private insurers. Secondly, the manner in
which it placed the ban. It should never have
been a unilateral decision. The insurance regula-
tor IRDA was not kept in the loop while taking
this drastic step which ultimately gave rise to the
bitter public dispute between the two regulators.
The central government had to finally step in to
resolve this turf war between the regulators. The
verdict was finally ruled in favor of IRDA with
the government promulgating an ordinance to
amend existing laws to include ULIPs under the
life insurance business. So what next for ULIPs?
This highly publicized tussle brought various
aspects of ULIPs into limelight. There already
were a number of concerns being raised by vari-
ous stakeholders regarding some of the prob-
lems this product had. First of all, it had a signif-
icant entry load – as high as 30% in some cases.
This encouraged distributors to push the product
to the investors and often led to misrepresenta-
tion of information related to the product in or-
der to sell more and more of them. Secondly, the
surrender charges, imposed on premature en-
21
EDITORIAL ARTICLES
cashment of investment units, were exorbitant.
In some cases, surrender charges went up to as
high as 90% if the policy was surrendered in the
first three years. IRDA had already started the
process of instituting more stringent rules to
overcome these aspects of ULIPs. However, the
events over the past few months precipitated in
some sweeping changes being suggested by the
regulator. Let’s analyze some of the new guide-
lines it has provided on the product and its pos-
sible impacts on the insurers and the investors:
 Increasing the Lock-in Period to five years
from the current three.
 To spread out the front end expense over
the lock-in period. This is good news for
the investors as it would insure that the
insurance seller is not ‘mis-selling’ the
product to realize short term gains.
 Capping the surrender charges to 15% of
fund value as well as in absolute terms.
Again, this would be beneficial for the in-
vestors as they would now incur a smaller
cost while switching from one policy to
another. However, this would mean a big
loss in revenues for the insurers. Accord-
ing to estimates, around 25-30% of the
policies lapse within the current lock-in
period of three years with surrender charg-
es ranging from 50%-90%. This combined
with the spreading out of the entry load
would mean a significant reduction in the
revenues of the insurers as well as an in-
crease in their time to break even.
 The risk cover has been increased to at
least 10 times the annual premium being
paid. This would mean that the insurers
would have to set aside larger capital
which would dampen their profitability. It
would also deter marginal companies from
entering in this segment.
So it is quite evident that the new regulations,
which the insurance companies are required to
comply with by September 1st, would serve to
reduce the attractiveness of ULIPs for these
companies. However, looking on the positive
EDITORIAL ARTICLES AUG 2010 MONEY MANAGER

other products like Mutual Funds whose popu-
larity had waned significantly over the past year.
And most importantly, the investors will most
certainly be better off with these changes. On
how the insurance companies would deal with
these changes, only time will tell. But I have a
strong feeling that after MFs and ULIPs, it’s
time for another new kid on the block. An year
from now, the dialectic may shift to yet another
product. But again, only time will tell.

References 
http://economictimes.indiatimes.com/articleshow/6069224.cms 
http://economictimes.indiatimes.com/personal‐finance/insurance/analysis/Ulip‐norms‐Insurers‐may‐
have‐a‐long‐wait‐to‐break‐even/articleshow/6116820.cms 
http://www.journaloffinance.in/?p=806

About the Authors 
Aditya Damani is a 2nd year PGP student at IIM Calcutta. He holds a masters degree (Integrated) in Mathe-
matics and Scientific Computing from Indian Institute of Technology Kanpur. He can be reached at ad-
ityad2011@email.iimcal.ac.in.

Priyesh Jaipuriar is a 2nd year PGP student at IIM Calcutta. He holds a bachelors degree in Computer Sci-
ence and Engineering from Indian Institute of Technology Kharagpur. He can be reached at priyeshjaipuri-
ar@gmail.com

22
 MONEY MANAGER AUG 2010
Financial Inclusion in India: A myth or possibility  
Financial inclusion, one of the cornerstones of
inclusive growth, aims at the extension of bank-
ing services to the deprived and marginalized
sections of society, who have so far been denied
access to credit facilities by banks. It is to be
achieved by ensuring timely availability of
cheap credit to the needy, particularly those be-
low poverty line. Other aspects are likely to in-
clude extension of banking services such as
bank accounts (savings, checking), insurance,
mortgages and financial planning.
Indian economy has been growing at a rapid
pace. It witnessed a GDP growth rate of 7.4% in
2009-10 [1], the second highest among sizeable
economies of the world in that fiscal year, and
was only marginally affected by the recession-
ary trends in the developed world. To make the
growth more equitable and to ensure that the
benefits of economic growth trickle down to the
deprived sections of society, the Government of
India has adopted a multi-pronged approach to
facilitate inclusive development. Various
schemes targeting rural employment, education,
access to information, financial inclusion, rural
electrification, healthcare and sanitation, rural
infrastructure and food security have been
launched to enable the masses, especially those
below poverty line, to empower themselves and
become both a beneficiary of and a contributor
to the Indian growth story.
Currently, approximately ten percent of Indians
hold ninety percent of the resources. While
loans are easily available to the affluent, banks
are generally unwilling to give loans to the poor
because of the costs and risks associated with
the recovery of debt. Thus, the poor have no oth-
er option than to knock at the doors of unscrupu-
lous local money lenders, who charge exorbitant
interest rates. Unable to service the interest, they
lose all their possessions, fall into a debt trap,
and at times end up working as bonded labor or
even committing suicides. Lack of education &
23
EDITORIAL ARTICLES
general financial awareness exacerbates their
condition.
Credit might be needed either to meet some exi-
gencies or to pursue entrepreneurial ideas. In the
latter case, many enterprising individuals, with
viable entrepreneurial ideas, are unduly denied
opportunities to pursue their dreams for lack of
funds.
Several questions need to be addressed to identi-
fy the scope of financial inclusion in India:
a) How much is the Government of India, with a
fiscal deficit of 6.6% [2] in 2009-10, willing to
invest in this initiative? What should be its role?
b) What should be the criteria for loan approval
or rejection?
c) Is financial inclusion through business corre-
spondence model, as proposed in the Union
Budget, a viable idea and what is the profit po-
tential?
d) Should there be some laws and regulations?
Or can banks be incentivized into lending?
e) Who bears the responsibility for bad debt, the
bank or the government of India?
f) What infrastructure, technology, and supple-
mentary changes are needed to support this initi-
ative?
g) What should be the mode of development?
Should it be public led, private led or through
PPP?
The 2010-2011 Government of India budget
provides for recapitalization of regional rural
banks, increased targeted agricultural credit
flow, allowing people affected by natural calam-
ities more time to pay their debt off, extension
of banking facilities to habitations having popu-
lation of more than 2000 by 2012, insurance and
other services to be provided through Business
Correspondence model, and augmentation of
Financial Inclusion Fund and Financial Inclu-
sion Technology fund [3].
EDITORIAL ARTICLES AUG 2010 MONEY MANAGER

Therefore, the government, despite its current charge a commission fee from the bank for each
focus on reducing fiscal deficit, looks committed new account opened and for each transaction
to the cause of promoting balanced growth. It (deposit) that takes place. They can start doling
should develop plans to monitor the implemen- out credit to the needy after a thorough inspec-
tation of the schemes so that corruption is mini- tion and interrogation into the potential use of
mized and taxpayers' money is well utilized. The funds. They will need to periodically monitor
UIDs could be used to introduce greater trans- any misappropriation of funds and the recovera-
parency in the overall lending process. bility of the loans. The agents of the BC (if the
BC is not an individual), trained not harass the
Generally, the person seeking loan is too poor to poor for debt recovery, will be paid a fraction of
offer anything as a collateral. Also, the interest the revenue earned by the BC from the bank,
rate has to be low, unlike in the subprime loans based on the services they render. The BCs must
provided in the US at high interest rates. There- actively pursue only those cases where the loss
fore, banks should base their lending criteria on
the viability or sustainability of the proposed
utilization of funds and not on the basis of per-
sonal wealth of the individual seeking loan. A
delicate balance has to be struck between easy
approval process of the loans without much red
tape and examination of the potential of credit
recovery. Single window clearance facility for
loan approval should be setup. The banks must
be friendly and flexible even if an idea is not
viable to be supported, and must encourage the
loan seeker to come up with more viable alterna-
tives, instead of discouraging him/her by out
rightly rejecting the loan. Banks should also be
flexible to extending the deadlines for paying off
the debt on a case to case basis.

The Business Correspondence model ([3], [6])

has the potential to be viable in the long term.
The model will work through a local financial
services provider, called the Business Corre-
spondent (BC), who will have a tie-up with a
regional unit of a bank. According to the current
RBI guidelines, NGOs, mutual fund institutions,
companies, post offices, retired bank employees,
ex-servicemen and retired government employ-
ees can act as BCs of banks [7]. Thus, through
the BC model, the loan seekers can have easy
access to financial services with the bank not
having to invest in infrastructure to reach the un-
banked areas [5]. The bank will provide the ini-
tial capital to the BCs. The BCs will need to ed-
ucate the target masses and incentivize them to
save by opening bank accounts. The BCs can
potential is substantial, more than the costs in-
curred in ensuring recoverability of loans.
Since this is a high risk and low profit business,
private players will be initially reluctant to enter
this field. Therefore, regulatory bodies such as
the RBI, banks such as NABARD, and public
sector banks such as the SBI and the PNB will
have to take lead. The RBI could formulate laws
mandating all the banks operating in India,
whether public or private, to allocate small per-
centage of their capital to this initiative. This
will nullify any initial competitive advantage
any bank might have by not entering the micro-
credit business. The government could fund pi-

24
 MONEY MANAGER AUG 2010
lot projects to assess the effectiveness of the ide-
as aimed at promoting financial inclusion. It also
has a role in making the environment more con-
ducive for lending by providing tax subsidies to
BCs and banks involved in the business. Initial
profits generated by banks and BCs, if any, and
the interest expense on loans taken by the poor
should be exempt from tax. The government
should underwrite to cover some percentage of
the debt recovery losses incurred by the banks
and BCs by providing them government bonds
(GSecs). Outstanding banks and BCs who pro-
vide exemplary service and deliver excellent
results and individuals who utilize the loans for
constructive purposes should be identified and
rewarded.
Gradual proliferation of technology such as
ATMs, internet infrastructure for online banking
and facilities such as mobile banking to reach
out to those who live in far flung areas is needed
to make the financial services accessible to all.
The Government of India set up two funds [3]
dedicated to this cause:
Financial Inclusion Fund, for capitalizing the
BCs, imparting financial education and literacy,
supporting pilot projects aimed at achieving fi-
nancial inclusion.
Financial Technology Inclusion Fund, for set-
ting up banking technology infrastructure, such
as ATMs & Kiosks, mobile banking facilities
and IT infrastructure for internet based banking
in backward areas.
These funds should be utilized judiciously and
voluntary tax-free donations and anonymous
donations, with no upper limit, should be sought
from well-off people for augmenting the funds.
All the aspects of inclusive growth are mutually
reinforcing and should not be viewed in isola-
tion. For example, working under NREGS
would provide the much needed finances to the
rural people. Some of them would deposit these
funds in banks and these funds would eventually
be used to provide credit to the needy. Introduc-
25
EDITORIAL ARTICLES
tion of UID would eliminate corruption occur-
ring through fake job cards in NREGS. A
NREGS worker might work on digging ponds or
wells to promote water harvesting, which in turn
will help to reduce dependence on monsoons.
Reduced dependence on monsoons will lead to
stability in food production, thereby boosting
rural economy. Better rural economy would ena-
ble the rural youth to invest further in their edu-
cation and computer literacy. Greater percola-
tion of IT will empower the masses and help
them seek better price for their produce. Better
education would help them understand the im-
portance of saving. They would also be able to
use RTI to enquire into the utilization of funds
allocated for their respective villages and high-
light any irregularities. It would also help in re-
ducing class differences, prejudices and biases
prevalent in our society. Better living standards
in rural areas would also help prevent mass exo-
dus of rural population into cities in search of
better means of livelihood.
The recent success of microcredit and micro-
finance, pioneered by Mohammad Yunus of No-
bel Prize fame, in Bangladesh, gives us hope.
Micro-insurance also presents a big opportunity,
where the farmers could insure their losses in
case of crop failure. India has close to six lakh
villages [4]. The rural economy presents a low
profit, but a largely untapped mass market.
Therefore, if the concept is successful in the ini-
tial phases, private players would also gradually
enter. A more prosperous rural India is a win-
win situation for all.
However, banks and bank correspondents must
be cautious to guard against complacency and
negative practices. The whole concept of finan-
cial inclusion will be defeated if the banks don’t
act in good faith. They should treat everyone
equal and not give preferential access to funds to
the rich farmers and rural corporate households.
Also, private banks entering this business should
be monitored closely as they might tend to devi-
ate from the social equity aspect and focus more
on the profits. Therefore, public private partner-
EDITORIAL ARTICLES AUG 2010 MONEY MANAGER

ship model could also be pursued, with in-
creased responsibility of oversight on the public
agency. Therefore, even though the idea is risky,
the government must make all efforts to see it
through despite some initial losses. Several hier-
archical monitoring levels must be set up, start-
ing from villages, blocks, and going up to dis-
tricts, states and center where the potential and
actual losses could be periodically monitored at
each level through reports generated using data
warehousing and MIS technologies, the problem
areas identified and corrective steps taken. Once
the rural economy could be put on the platform
of growth, it would prove to be a self-
perpetuating engine. All it needs is a helping
hand.

References : 
 
http://economictimes.indiatimes.com/news/economy/indicators/Manufacturing-helps-GDP-grow-74-in-FY10/
articleshow/5996613.cms
http://www.business-standard.com/india/news/2009-10-fiscal-deficit-stands-at-66gdp/396788/
http://indiabudget.nic.in/ub2010-11/bh/bh1.pdf
http://www.financialexpress.com/news/The-disappearing-Indian-village/660376/
http://www.fino.co.in/news-pdf/Performance%20Of%20The%20Business%20Model%20-%20A%20Mixed%
20Bag%20Aug%2028.pdf
http://rbi.org.in/scripts/BS_CircularIndexDisplay.aspx?Id=2718
http://www.deccanherald.com/content/20513/campus-corner.html

About the Author : 
Vipul Singh is a 1st year PGP student at IIM Calcutta. He holds a bachelors degree in Computer Science and
Engineering from Indian Institute of Technology Kanpur. He can be reached at sinvipul@gmail.com

26
 MONEY MANAGER AUG 2010 EDITORIAL ARTICLES

What Drives Indian Equity Markets ? 
Introduction
agricultural products will go up and affect the
consumers drastically. It might lead to a condi-
India's equity markets hold one of the keys, if
tion of drought in several states of India which
not the key, to the country's future growth trajec-
forces the government to drop import tax on a
tory. A growing and increasingly complex mar-
number of commodities. It also causes shortage
ket-oriented economy, and its rising integration
of water supply for production of power and
with global trade and finance, require deeper,
electricity. Electricity shortage has a strong ef-
more efficient and well-regulated financial mar-
fect on almost all sectors, which also causes de-
kets. The Indian Equity Market is the third big-
lay in productions or increase in costing of prod-
gest market in Asia after China and Hong Kong.
ucts. Less rain affects the purchasing power in
As of March 2009, the market capitalization was
the rural areas and contract demand for products
around $598.3 billion (Rs 30.13 lakh crore) [1]
and services. This is not good news for FMCG
which is one-tenth of the combined valuation of
companies which depend on agricultural and
the Asia region.
rural market.
Today, Indian stock markets have become in-
Inflation and Interest Rates: Although higher
tensely technology and process driven, giving
inflation rates spur higher growth rates but the
little scope for manipulation. Electronic trading,
vast disparity of income in Indian population
digital certification, straight through processing,
makes it impossible for the poorest in India to
electronic contract notes, online broking have
buy basic commodities. In times of raging infla-
emerged as major trends in technology. Risk
tion, by increasing the base interest rate, RBI
management has become robust thus reducing
attempts to lower the supply of money by mak-
the recurrence of payment defaults. Product ex-
ing it more expensive to obtain. This reduces the
pansion taken place in a speedy manner. Indian
amount of money in circulation, which works
equity markets now offer, in addition to trading
to keep inflation low. It makes borrowing mon-
in equities, opportunities in trading of deriva-
ey more expensive, which affects how consum-
tives in futures and options in index and stocks.
ers and businesses spend their money; for busi-
In this article, we will look at what are the major
nesses, this leads to higher interest expenses (for
factors that affect the Indian equity markets and
those with a debt to pay) & lower earnings from
how do they do so. These can be broadly classi-
their consumers & hence lower profits. Since a
fied into 2 categories: Internal & External
stock price represents the sum of all the ex-
pected future cash flows from that company dis-
Internal Factors
counted back to the present, the stock price falls.
Monsoons: In India, agriculture provides
Government Policy and Political Factors: The
around 70% of employment either directly or
political situation, stability & commitment of the
indirectly. This is the major reason for the eco-
government to structural reforms in the econo-
nomic growth of India to depend on Monsoon
my greatly affect the market sentiments. Dereg-
season. Monsoon season in India starts from
ulating an industrial sector will have a positive
June and continue till September. A good mon-
impact on the stock market. War periods and
soon means government can ease restrictions on
periods of a stagflation and unemployment are
the export of wheat and rice, boost output of
likely to have telling effects on the stock market
grain and oil seeds and help calm inflation. On
performance and the economy may be headed
the other hand, scarce rainfall implies prices of
towards a recession.

27
EDITORIAL ARTICLES AUG 2010 MONEY MANAGER

Elections affect the Indian equity market in a

huge way. In the 2004 general elections, the Na-
tional Democratic Alliance led by BJP, unsuc-
cessfully tried to ride on the market sentiments
to power. When NDA was voted out of power,
the sensex recorded the biggest fall in a day
amidst fears that the Congress-Communist coali-
tion would stall economic reforms. Later Prime
Minister Manmohan Singh's assurance of
'reforms with a human face' cast off the fears
and market reacted sharply to touch 8500 which
was the highest ever mark then.

SEBI: Securities Exchange Board of India

(SEBI) supervises the functions of the Equity
Market in India. It provides major guidelines to
who can operate in the market and how. For ex-
ample: It decides which investors can comprise
a QIB (Qualified Institutional Buyer). Then it
specifies that QIBs shall not be promoters or
related to promoters of the issuer, either directly
or indirectly. Besides, QIBs cannot have either
veto rights or the right to appoint any nominee
director to the board because that would also be
considered to be related to the promoter. Hence,
policies of SEBI have a huge role to play in In-
dian Equity markets.
Investor sentiments at different price levels
investors expect downward price movement.
Traders monitor market sentiment since it is
known that investors follow a buy high, sell
low strategy. Therefore, according to traders,
"fading" the investors' movements will eventual-
ly lead to taking money from them [2].
The following figure demonstrates how all the
factors mentioned in the article affected the Indi-
an stock market in 2002.

Market Sentiments, news & market shocks:

Stock market performance is largely seen as an
indicator of the development of a particular
country and over expectations about its perfor-
mance could lead to stock market bubbles which
might burst any time.

Market sentiment is the general prevailing atti-

tude or consensus of the investment community
as to the anticipated price development in a mar-
ket. This attitude is the accumulation of a variety
of fundamental and technical factors, including
How various internal factors affected movement of
price history, economic reports, seasonal factors, stock market in 2002 [3].
and national and world events. If the investors External Factors
expect upward price movement in the stock mar-
ket, the sentiment is said to be bullish. On the Global Economic Outlook: In the present eco-
contrary, if the market sentiment is bearish, most nomic scenario, where the countries are highly

28
 MONEY MANAGER AUG 2010
reliant on Foreign Trade & Foreign Investors,
the impact of a recession in one country perco-
lates down to all the linked industries. As we
saw recently, due to fears of Greece defaulting
on its loans, there was a huge FII/FDI withdraw-
al from the Indian Equity Market as well. In
2008, the collapse of one bank in US led to a
“Liquidity Crunch” all over the world. We were
slightly better protected from the recent finan-
cial meltdown, largely because of the still large
role of the nationalized banks and other controls
on domestic finance. But this is likely to change
in the near future.
Most global economies go through unending cycles of
Booms and Glooms
FDI/FIIs: An important feature of the develop-
ment of stock market in India in the last 15 years
has been the growing participation of Institu-
tional Investors, both foreign institutional inves-
tors and the Indian mutual funds.
Foreign Direct Investment (FDI) comes in the
form of involvement in direct production activi-
ties and is of a medium-long term nature. The
investor acquires the ownership of assets for the
purpose of controlling the production, distribu-
tion and other activities of the firm. FDIs facili-
tate international trade and transfer of
knowledge.
A Foreign Institutional Investment (FII) is any
investment fund that is registered in a country
29
EDITORIAL ARTICLES
outside of the one in which it is currently invest-
ing [4]. These include hedge funds, insurance
companies, pension funds and mutual funds.
The growing Indian economy has resulted in
several FIIs to invest in Indian equity markets.
FIIs are, however, a short term investment and
can have bidirectional causation with the returns
of other domestic financial markets such as
money markets, stock markets, and foreign ex-
change markets. Hence understanding the dy-
namics of FII is very important for any emerg-
ing economy. A sudden withdrawal by FIIs
leads to a sharp depreciation of the rupee. FDI
and FIIs are generally preferred over other forms
of external finance, because they do not create
any debt, they are non-volatile and their returns
depend upon the projects financed by the inves-
tor [5].
FII Investment in Indian equity markets in last 10
years [6]
Policies of Other countries: Any decision taken
by other countries that affects the amount of in-
vestment that will be done in India will definite-
ly affect the Indian equity market. For example,
when US Senate ratified the Indo-US Civil Nu-
clear Deal, the Indian equity market jumped as it
expected more and more investments coming to
India. Another example is that recently, Chinese
news of Yuan free float had its affect on crude
oil as well and it started rising but fell later on
EDITORIAL ARTICLES
Movement of Sensex in last 10 years [7]
when it was realized that the impact of this
would be very limited.
Exchange Rates: The performance of exchange
rate markets also plays a role in the determina-
tion of the financial market. When the Indian
rupee had appreciated to about Rs. 41 against
the US dollar, it lowered the country's import
prices but it also hit the exporters hard thus driv-
ing down their equity. A sharp depreciation of
the rupee may be good for India’s exports that
were adversely affected by the slowdown in
global markets; it is not so good for those who
have accumulated foreign exchange payment
commitments. Moreover, a depreciating rupee
doesn’t help the Government to rein in inflation.
Crude Oil Price Shocks: When international
References :‐
http://en.wikipedia.org/wiki/List_of_stock_exchanges
http://en.wikipedia.org/wiki/Market_sentiment
BSE Annual Capital Market Review Report 2003
http://www.investopedia.com/
Role of Institutional Investors in Indian Stock Markets, S.S.S. Kumar
Statistics released by SEBI (http://www.sebi.gov.in/)
About the Author :  
Mayank Mishra is a 1st year PGP student at IIM Calcutta. He holds a bachelors degree in Mechanical Engi-
neering from Indian Institute of Technology Bombay. He can be reached at mayank06.iitb@gmail.com
30
AUG 2010 MONEY MANAGER
crude oil prices rise suddenly, the stock markets
around the world tend to fall. The main reason
behind this is the fear of the investors that the
profit margin of the companies will decrease
because of an increase in the operational cost,
fuel cost, and transportation cost of the compa-
nies. This is the reason that the buyers become
susceptible about the future of the companies
that are hugely dependent on oil. Also, there is
more pressure on the government to raise do-
mestic petrol/diesel prices. If the government
does that, stock prices of oil majors like IOC,
BPCL, HPCL and other related oil and gas com-
panies like Reliance petrol, Essar oil, RNRL go
up. However, such a step increases inflation &
more importantly food inflation which has fur-
ther implications on the economy.
Conclusion and Future Outlook
The prevailing economic conditions, both do-
mestic and global, suggest the Indian stock mar-
ket is poised to continue to rally in 2010, with a
minimum 12-15% average ROI per annum for
next 5 years [8]. Key factor remains the impact of
Q4 results and strong GDP growth of around
8%. However point of caution needs to be the
phase wise withdrawal of financial support giv-
en by Indian government to the market. So far,
the recovery in India has been driven by domes-
tic consumption and government expenditure.
However, corporate investment is expected to
surge in 2010 due to the strong GDP growth
which will increase capacity utilization.
 MONEY MANAGER AUG 2010
Oil Price Deregulation: What it entails for the Indian Economy?
Oil price regulation has been a hotly debated
and contentious issue that the Government has
faced over the last many months. Oil Price de-
regulation, proposed by the Empowered Group
of Ministers (EGoM) on the recommendations
of the Kirit Parikh Panel, is not something that
has suddenly occurred to the current establish-
ment. The BJP-led NDA government had decon-
trolled petrol and diesel prices on April 1, 2002,
and they were being revised every fortnight for
nearly 21 months. However, political compul-
sions forced the then establishment to abandon
the practice just a few months before the general
elections in May 2004. Subsequently the NDA
was voted out of power and the Congress led
UPA, propped by the Left emerged as the ruling
combination. Suddenly, no one seemed interest-
ed in talking about price deregulation anymore.
A ten-worded anti-disinvestment statement
clearly stated the intentions of the Left – that as
long as the government had their backing, eco-
nomic reforms were an anathema. With a reas-
suring victory of the Congress in 2009 and the
near annihilation of the Left, things looked set to
change – reforms that had been earlier put on the
backburner were expected to be carried out. Ma-
jor reforms were expected in a number of sec-
tors including oil and gas. The government did
not disappoint India Inc. and promptly set up the
Kirit Parikh Panel which advocated the follow-
ing in its report:
 Total decontrol of oil prices (both diesel
and petrol), and
 Immediate increase in prices of kerosene
by Rs 6 per litre and LPG rates by Rs 100
a cylinder.
The committee headed by economist Kirit
Parikh [1], [7] also pegged the losses of state-
run oil marketing companies at Rs 40,000 crores
(approx $8.4 bn) on account of having to sell
transport fuels at below cost. Also, concern was
raised over the Standard & Poor’s decision to
cut Indian Oil’s credit rating on account of
31
EDITORIAL ARTICLES
   
shrinking profits and declining cash flows
caused by delays in government compensation
for selling fuels below cost. The subsidies were
creating a fiscal deficit to the tune of $25.6 bn.
The step was therefore natural for the govern-
ment if it intended to aggressively pursue its
agenda of “inclusive development” for all sec-
tions of the society. Schemes like the NREGA
were suffering as a substantial amount of budget
allocation had been earmarked for oil subsidies.
In view of all these factors the government de-
cided to go ahead with the deregulation of petrol
and diesel prices, the outcome of which was an
increase of Rs 3.50 a litre for petrol and Rs. 2.50
a litre for diesel. Before revision, oil marketing
companies (OMCs) were making under-
recoveries of Rs.3.73 a litre on petrol, Rs.3.80
on diesel, Rs.17.92 on kerosene, and Rs.261.90
a cylinder on domestic LPG [2]. Post-revision
there would be almost no under-recovery on pet-
rol, but the OMCs will still incur a loss of
Rs.1.50 and Rs.15 a litre on sale of diesel and
kerosene respectively, and Rs. 227 on a cylinder
of LPG. However, even the existing changes in
prices will go a long way in improving the con-
fidence of an already bleeding oil industry.
The impact of price revision for the Indian
Economy can be enumerated as:
 One of the foremost impacts, as has been
EDITORIAL ARTICLES
briefly mentioned above, will be on the
fiscal deficit of India – it currently stands
at Rs. 4.34 lakh crores (around $90.4 bn)
[3]. India’s reliance on oil imports stands
roughly at 75% its energy needs and the
government sets fuel prices to cushion the
poor from inflation. The decision to dereg-
ulate will help mobilise an amount of
around Rs. 1.3 lakh crores (around $27 bn)
which is close to 30 % of total deficit. Al-
so, in the last fiscal year ended March 31,
India spent 149.5 billion rupees (3.35 bil-
lion U.S. dollars), or nearly 1.5 percent of
all public expenditure in subsidies to oil,
compared with initial estimates of 31.1
billion rupees. This is a substantial ex-
penditure and will be written off as a result
of this price increase.
 As already mentioned, increased availabil-
ity of funds for its social policies is going
to be a major impact – the NREGA and
the Right to Education Bill, to just men-
tion a few, need a substantial inflow of
funds for their continued sustenance.
 Deregulating prices will cut down revenue
losses in public sector oil companies –
both upstream and downstream. Also, the
move will improve cash flows of the pub-
lic oil marketing companies (OMCs), and
the private companies can now expect a
level playing field to compete with their
public counterparts. Private refiners and
marketers like Reliance and Essar Oil are
already considering and evaluating options
to restart their petrol pump stations and
improve on existing distribution infra-
structure to cater to a larger market. Also,
the improved cash flows will have a direct
bearing on the credit ratings of PSUs.
 International OMCs, which are currently
represented in India through the limited
presence of Shell, will be following this
keenly since it has the potential to open
the doors for them to enter the retail mar-
32
AUG 2010 MONEY MANAGER
ket in India, which is growing in terms of
the quantity of oil products sold annually.
 Increased competition in this sector is ex-
pected to lead to greater efficiency. Previ-
ous precedence is available in the form of
reforms in telecom sector. Telecom re-
forms led to increased competition and
market efficiency with the end consumer
being the ultimate beneficiary.
 Newer technologies of alternate fuel
source cars may get a fillip owing to in-
creasing fuel prices and the need for
cheaper transportation solutions.
However some negatives will also result out of
this, chief among them being:
 The change in oil prices will have a trickle
-down effect on the whole economy in
general. As a result, inflation figures are
going to be affected unless price pressure
of essential commodities ease from the
supply side. At a time when the govern-
ment is already battling double-digit food
inflation and a fuel inflation of almost
20% in the week ended June 26, 2010, in-
creasing fuel prices will only add to the
burden of the people. Headline inflation in
June was 10.55%, and this can be ex-
pected to go up in the near future. Also an
upward movement of 90 to 100 basis
points on the wholesale price index is ex-
pected.
 Industries that will bear a direct impact of
this will be sectors such as
Auto
Transportation
Crude oil based input industries such
as chemicals, manmade textiles
(polyester) and pharma companies
 Distribution based businesses such as
FMCG and cement would also bear the
brunt as high speed diesel has also seen a
 MONEY MANAGER AUG 2010
price revision. [4]
 Cost of infrastructure is expected to go up.
The upmove will affect India Inc. with a
lag of three months and the overall impact
on the cost structure is expected to be
around 4 to 5%. Quarter results (July –
Sep) are therefore expected to be signifi-
cantly poor. So even though the oil com-
panies will remain optimistic, in the short
run, other sectors may be forced to take
some beating in their earnings. Since
transportation costs are expected to go up,
the end consumers will end up paying a
higher cost for the oil not only directly but
also indirectly through other products.
 Railways, serve an excellent case in point.
The railway minister in her budget speech
had already mentioned no upward revision
in ticket prices with an eye on the upcom-
ing polls in her home state. As a result of
this, revenues of the railways can be ex-
pected to come down. Since the price of
ATF had already been decontrolled as ear-
ly as 2002, airlines industry should not be
affected.
Clearly, the effect of this major policy reform is
going to have far-reaching consequences. De-
spite being an important step in the reforms pro-
cess of India, this new policy has faced criticism
for a variety of reasons.
 First, experts are questioning whether the
government really has its heart in decon-
trolling prices of fuels with its recent deci-
sion of not to decontrol diesel prices.
 Secondly, genuine concerns exist as to
what will happen when crude shoots past
$100. Price bands of petrol price may then
severely restrict options to increase fuel
prices. An international crisis in an oil pro-
ducing nation cannot be ruled out at this
particular point of time with tensions ex-
isting Iran and the US and Israel on the
33
EDITORIAL ARTICLES
other side. Under such circumstances, In-
dia may be forced to undergo a situation
similar to the US oil regulation of 1973.
Also any subsequent deregulation may pan
out the way it did in the US in 1979 after
deregulation of gas prices.
 Thirdly, hoarders are another source of
concern. History has time and again
proved that when essential products are
scarce and have high prices, it results in
stocking to create an artificial demand.
Although onions and sugar are not nearly
the same as oil but the crisis in onion pric-
es and more recently in the prices of sugar
show that high prices may lead to creation
of hoarding.
 Fourthly, adulteration of fuel is another
major concern. Instead of going for fuel
efficient vehicles, consumers may go over
to the adulterated oil market. This black
market will result in substantial losses to
the exchequer.
 Fifth, political pressures cannot be dis-
counted. Trinamool Congress with its 19
MPs is a key government ally. Mamata
Banerjee, the Trinamool chief, is facing
elections in her home state of West Bengal
next year. She has already expressed her
displeasure by skipping cabinet meetings
on this issue. She would not prefer risking
her constituency to the Left on this issue.
Besides the Congress at present is not hav-
ing a comfortable majority. With a thread-
bare majority of 278 members, in the
worst case scenario, this policy may be
forced out for political compulsions.
 Sixthly, Also, with mounting opposition
pressure, it is not known how the govern-
ment will react to the flak it will receive
from all parties including many sections of
the Congress who have serious misgivings
about this policy decision. Also, the cru-
cial state of Bihar is going to polls soon
EDITORIAL ARTICLES AUG 2010 MONEY MANAGER

and a lot may depend on the performance

of the Congress in that state.
 Seventhly, the government has been lucky
in the sense that so far a normal monsoon
is on the cards. If per chance the situation
worsens, it will drive food inflation north-
wards with the result that the ultimate los-
er will be the oil companies with the re-
peal of this policy.
 Concerns also exist about the speculation
in prices as a result international oil fu-
tures and options.
In spite of all the criticisms, oil price regulation
remain an important step in the introduction of
next generation reforms in India which will have
far reaching consequences in not only helping
the bleeding oil companies but also the general
economy in the long run. It is interesting to note
that on the 6th of July after the revision in prices
the bourses saw positive trends driven by strong
openings by oil companies. At the current stage,
even with rising costs in the near future of es-
sential commodities, it can be safely concluded
that on the whole deregulation is going to have a
positive impact on the overall economy of India.

References : 
 
http://economictimes.indiatimes.com/news/news-by-industry/energy/oil-gas/Kirit-Parikh-panel-for-freeing-
petrol-diesel-prices/articleshow/5531478.cms
http://www.hindu.com/2010/06/27/stories/2010062763900800.htm
http://beta.profit.ndtv.com/news/show/apr-jan-fiscal-deficit-soars-34-to-rs-3-5-lakh-cr-28299
http://www.thehindubusinessline.com/2010/07/01/stories/2010070152241000.htm
http://www.stockmarketsreview.com/recommendations/
oil_price_deregulation_report_on_the_path_of_reforms_20100701_18642/
http://radicalnotes.com/journal/2010/07/13/the-political-economy-of-oil-prices-in-india/
http://petroleum.nic.in/reportprice.pdf
http://www.deccanchronicle.com/business/diesel-price-won%E2%80%99t-be-deregulated-centre-009
http://marketpublishers.com/lists/7603/news.html
http://www.dnaindia.com/money/report_deregulation-of-oil-likely-to-improve-price-stability_1401308
http://economictimes.indiatimes.com/articleshow/5533705.cms

About the Author : 
 
Abhinav Gupta is a 1st year PGP student at IIM Calcutta. He holds a bachelors degree in Computer Science
and Engineering from Indian Institute of Technology Kharagpur. He can be reached at
guptaabhinav94@gmail.com

34
Student Articles 
Winning Articles 
1st Prize 
Exchange Traded Funds (ETF): Opportunities to Deepen
Akshay Mishra (LSE), Sailesh Pati (IIM-A) & Tuhin Chatterjee (IIM-B)

2nd Prize 
Mutual Funds Industry in India
Abhishek Rawale & Saurabh Rai (IIM-B)

3rd Prize 
Developing Corporate Bond Market in India
Jaideep Singh, Ritambara Vasudeva & Shefali Omer (MDI Gurgaon)
STUDENT ARTICLES AUG 2010 MONEY MANAGER

Exchange Traded Funds (ETF): Opportunities to Deepen   

Introduction to Current Structure  What are ETFs 
of Indian Capital Markets    
An ETF is an investment fund that tracks a bas-
Post Liberalization in 1990s, India’s capital mar- ket of assets. These could be an index, a com-
kets have transformed themselves with SEBI modity or a basket of commodities. ETFs are
being established in 1992. With establishment of essentially chunks or pieces of portfolios that
NSE in 1994, competition in the markets in- investors trade in instead of stocks.
creased and the volume of transactions increased Tracking is achieved by holding all the securi-
significantly and new instruments emerged. ties which make up the class, and in the same
For over a century, India’s capital markets, proportions. ETFs can be traded like a stock
which consist primarily of debt and equity mar- wherein prices experience changes throughout
kets, have increasingly played a significant role the day as they can be bought and sold almost
in mobilising funds to meet public and private anytime during the day.
entities’ financing requirements. The advent of  
exchange-traded derivative instruments in 2000, Figure 1 - Global ETF asset growth, as at end of Aug
such as options and futures, has enabled inves- 2009
Source: ETF Research and Implementation Strategy
tors to better hedge their positions and reduce Team, Barclays Global Investors, Bloomberg
risks
Essentially India’s capital markets deal with
three types of Instrument
1. Debt
2. Equity
3. Derivatives (Exchange traded derivatives
started in 2000)
In the Debt market, government bonds dominate
due to high fiscal deficit which has crowded out
the corporate bonds which are still small in size.
India’s Equity markets in India are vibrant and
broad based. However there is a need to broaden
the shareholder pattern and bring in more insti-
tutional investors. Second, Participation in Indi-
an markets by retail investors is also low. Indian
households are ultra conservative with about
50% of savings deposited in banks and 18% in
provision and pension funds. A mere 5% are in-
ETFs were first introduced in 1989 but its
vested in stock exchange. A joint survey by the
growth has picked up only in the last 10 years
Securities and Exchange Board of India and Na-
wherein the assets under management in ETFs
tional Council for Applied Economics Research
in Europe and the US have grown at an average
(SEBI-NCAER) in March 2003 estimated that
annual rate of 40% over the last decade. Figure
only 13 million households out of the total 177
1 shows the growth in global ETF assets since
million surveyed have investments in the capital
the start of the decade. Global ETF assets
markets.
reached $725 billion by end 2008. Morgan Stan-
Exchange Traded Funds (ETF) ‐  ley estimates, global ETF assets should be worth

36
 MONEY MANAGER AUG 2010
$2 trillion by 2012.
Creation of ETFs    Silver, Wheat Sugar or even currencies
The creation of ETFs is initiated by an institu-
tional investor depositing a specified block of
shares with the ETF to get a fixed amount of
ETF shares. These blocks are called creation
units. The institutional investor then can sell all
or a part of these ETFs in an exchange where in
retail investors can trade such ETFs like they
would buy or sell any equity stock. To redeem
the ETF, the institutional investor will have to
deposit all the ETF shares that he received while
depositing the block of shares .
Passive Management versus Active Manage-
ment
The philosophy of managing an ETF is what is
known as passive management where in the
fund manager makes minor and periodic adjust-
ments to keep the ETF in line with the underly-
ing which it is tracking. The principle of an ETF
is to match an index or a commodity instead of
beating that index.
Hence, an investor one harnesses the benefits of
the market, the country, the sector etc. They help
the investor focus on what is most important-
choice of asset classes.
This is in contrast with the mutual funds concept
where the fund manager actively tries to beat the
market.
Types of ETFs  market inefficiencies through intraday
1. Based on Market Capitalization: ETFs
can be tracking a pool of companies segre-
gated based on their market capitalization
2. Based on Emerging and Developed
Markets: ETFs formed to track emerging
economies like BRIC countries or devel-
oped companies.
3. Industry Based: ETFs track the trends in
prices of stocks of a particular industry
37
STUDENT ARTICLES
like real estate, biotechnology etc.
4. Commodity / Currency Based: Gold,
5. Index Based: Companies like S&P and
Dow Jones, issue indexes comprised of
stocks related to a particular industry, or
shares representing the stock markets
Advantages of ETFs 
 
ETFs provide investors with an easy mechanism
for diversification, which is also provided by
mutual and index funds. In comparison, ETFs
provide some additional benefits which are men-
tioned below.
1. Low Cost: The expense ratio (fund operat-
ing costs as a percentage of assets under
management) of ETFs is lower than ac-
tively managed funds due to lower man-
agement fees. This is due to the passive
management philosophy of ETFs which
does not require continuous monitoring
and rebalancing of the fund’s portfolio.
ETF’s management expense is 18% lower
than the same for mutual funds. The cost
benefits would be negated by the broker-
age charges during trading, but the net
benefit can be increased by balancing in-
vestment size with trading frequency.
2. Trading Flexibility: Since ETFs are trad-
ed like stocks, their prices are continuous-
ly updated as trades occur unlike mutual
funds which are revalued only at the end
of the day. Thus ETFs permit an active
investor to make money out of possible
trading. Unlike index and mutual funds,
short selling in ETFs is permitted which
implies that an investor could make money
even when the market is falling. Since
ETFs could be designed to track different
indices, commodities and any desirable
portfolio combination in the capital mar-
ket, they provide investors with plenty of
trading options.
STUDENT ARTICLES AUG 2010 MONEY MANAGER

3. Tax efficiency: ETFs are more tax- Figure 2 - Investment Preferences of Indian Investor
efficient than mutual and index funds due
to their transaction structure. During ETF
creation, there are no tax-implications as
all transactions are in kind (no cash trans-
fer takes place). The institutional investor
deposits a block of securities in exchange
for ETF shares which are then sold in the
market. During redemption of large hold-
ings, ETF shares are redeemed with shares
having the lowest cost basis in the fund,
thereby minimizing capital gains tax for
the ETF. In contrast mutual and index
funds may have to sell securities they hold
for redemption claims, which results in
capital gain tax. Thus existing investors
are affected due to tax implications from
the ones exiting the fund, which is not the Source: Sebi Handbook of Statistics, 2008
case in ETFs.
Figure 3: Mutual Funds - NAV in Rs. Cr
Transparency: ETFs provide transparency to
investors by disclosing their holdings on a daily
basis. The transparency prevents price manipu-
lations and help investors make informed deci-
sions.

Opportunities in Indian Market 
Traditionally Indian investors have been con-
servative with over 50% preferring to keep their
savings in bank deposits as shown in Figure 2.
In the last five years, mutual funds have grown
at a CAGR of 35% indicating that this is the pre-
ferred medium for Indians investing in capital
markets (Figure 3). Despite this rapid growth,
penetration of mutual funds among retail inves- Source: Sebi
tors has been quite low. In a recent survey by
KPMG, this has been mainly attributed to lack In this scenario, ETFs provide a much simpler
of knowledge among investors in understanding and hassle-free medium for Indian investors to
and selecting from various complicated schemes obtain the same benefits which they would get
(Figure 4). in a mutual fund. Considering the low trading
volumes of ETFs in India relative to their for-
eign counterparts, the first step needed to make
this happen is to create awareness about ETFs
among retail investors. Secondly, investors need
to be provided with more portfolio choices when

38
 MONEY MANAGER AUG 2010
investing in ETFs. Currently there are about on-
ly 16 ETFs traded in India. This is in sharp con-
trast to developed capital markets like US and
Europe which have 706 and 753 listed ETFs re-
spectively. A good starting point would be the
portfolio allocation of MSCI India relative to
MSCI World (Figure 5). Sectors like IT and En-
ergy which have relatively higher weightage in
the index should be given higher priority by in-
stitutional investors while developing sector spe-
cific ETFs.
Figure 4 - KPMG survey
Source: KPMG
Challenges of implementing ETFs  that is, by using derivatives to replicate the un-
in India   errors which can be attributed to: (1) differences
There are various issues that have restricted
growth of ETFs in India and have not allowed
them to sprout as freely as they have in more
developed markets such as the US. The main
amongst those can be narrowed down to:
Management Challenges: Most traditional
ETFs are passively managed. This works in the
39
STUDENT ARTICLES
case of major index trackers and actively traded
commodities. But tracking small-cap stocks or
corporate bonds which are thinly traded be-
comes infeasible for passive strategies as the
number of securities required to replicate the
sector/index becomes too low and requires arti-
ficial structuring. In such cases, active manage-
ment of the fund remains the only viable solu-
tion. This is also the prime reason why many
product categories in India are under-
represented in terms of ETF availability. There
are issues, however, with active management.
“Active” management, by its very nature, would
require a higher fund management fee from in-
vestors – thus making it unattractive for them.
Also, the real-time nature of ETFs is affected if
the security-selection strategies are intended to
be applied during intra-day trading. It remains to
be seen whether a trade-off between letting go
of some of the inherent advantages of ETFs and
having a more diversified set of ETFs which
represent most sectors in India is feasible or not.
Structuring Issues: Management of ETFs not
only involves picking of the securities that repli-
cate a sector or an index but also replicating the
underlying asset even if those securities are not
physically available. Most commodity indices
are tracked in this way by using say, crude oil
call options along with a bond of appropriate
maturity such that the payoffs are similar to
those of the underlying asset. Equity tracking for
sectors that do not allow for direct equity owner-
ship (maybe due to less common stock being
available) can also be performed in this way –
derlying stocks. This, however, leads to tracking
in liquidity between the derivatives and the un-
derlying markets which leads to failure of arbi-
trage pricing and (2) most derivatives engi-
neered using options are susceptible to be priced
according to their implied volatilities rather than
the price of the underlying. Thus, although,
ETFs are claimed to “replicate” an index –
tracking errors are always present due to ineffi-
cient markets and different pricing models. To
STUDENT ARTICLES AUG 2010 MONEY MANAGER

remedy this issue, it requires an increase in the
number of ETFs operating in India – which can
lead to standardization of the financial structures
being used to replicate individual securities.
Fragmentation of equity markets: The tradi-
tional stronghold of ETFs has been the equity
markets. However, the equity markets in India
are extremely fragmented – the stocks compris-
ing the popular indices such as the BSE30 and
the S&P CNX Nifty are heavily traded while the
small-caps are thinly traded leading to ineffi-
cient tracking. This is a problem encountered in
the developed markets as well. However, in
those markets, the extreme liquidity of the deriv-
atives market allows for efficient replication.
Therefore, unless the exchange-based deriva-
tives market in India itself matures to allow hy-
brid securities to be traded, there will always be
a challenge for ETF managers
to represent all the sectors of the equity markets.
Exchange capabilities: As mentioned earlier,
ETF replication may require, at times, innova-
tive financial engineering. This requires multiple
capabilities of the exchanges the ETFs are being
traded on: (1) All the constituent products mak-
ing up an ETF structure must have a significant
volume-base on the exchange, (2) the exchange
should allow the decomposition of a unit ETF
order into its constituent products automatically
– which will lead to reduced transaction costs,
more efficient straight-through processing and
less redundant margin account maintenance.
Most exchanges in India are not sophisticated
enough to allow such features. In the absence of
these, active management of ETFs and higher
fees remain the only option to replicate com-
plex/thinly-traded securities.

References 
www.world-exchanges.org
http://www.nseindia.com/content/products/etfmktwtch_All.htm

About the Authors 
Akshay Mishra is a graduate student in the Department of Finance at the London School of Economics
and Political Science. He completed his B.Tech and M.Tech in Mechanical Engineering from IIT
Kharagpur and can be contacted at A.Mishra2@lse.ac.uk
Sailesh Pati is a second year MBA student at IIM Ahmedabad. He completed his B.Tech and M.Tech in
Electronics Engineering from IIT Kharagpur and can be contacted at saileshp@iimahd.ernet.in

Tuhin Chatterjee is a second year MBA student at IIM Bangalore. He completed his B.Tech and M.Tech
in Chemical Engineering from IIT Kharagpur and can be contacted at tuhin.chatterjee08@iimb.ernet.in

40
 MONEY MANAGER AUG 2010
Mutual Funds Industry in India 
Abstract  could be channelized in the mutual
Mutual funds in India now have the flexibility to
invest in derivatives and foreign securities. But
do such investment strategies benefit the mutual
fund performance? This article answers the
question through an empirical study of equity
diversified mutual funds. We find that most In-
dian mutual fund managers do not employ de-
rivatives in their portfolios. The decision to use
derivatives is associated with fund size and
number of fund managed by Asset Management
Company. Also, the extent of derivative usage
was found to be solely dependent on fund size.
It was found that use of derivatives did not im-
prove the performance of funds significantly.
Mutual Fund Industry in India  has been little participation of institutional in-
The Mutual Funds industry is considered as one
of the most dominant players in the world econ-
omy and is an important constituent of the finan-
cial sector. It has witnessed startling growth in
terms of the products and services offered, re-
turns churned, volumes generated and the num-
ber of international players. The market has
graduated from offering plain vanilla and equity
debt products to an array of diverse products
such as gold funds, exchange traded funds
(ETF’s), and capital protection oriented funds.
The major benefits of investing in a mutual fund
are to capitalize on the opportunity of a profes-
sionally managed fund by a set of fund manag-
ers who apply their expertise in investment. It
also gives the investors an opportunity to invest
in a variety of stocks without incurring high
transactional costs.
With India being one of the fastest growing
economies in the world, the mutual funds sector
is expected to have huge growth potential. With
a saving rate of more than 35% of GDP and
80% of the population who save, these savings
41
STUDENT ARTICLES
funds sector as it offers a wide investment op-
tion. The rapid growth of tier I and tier II cities
in India augurs well for this sector. India has
been amongst the fastest growing markets
for mutual funds since 2004, witnessing a
CAGR of 29 percent in the five-year period
from 2004 to 2008 as against the global
average of 4 percent.
Usage of Derivatives in India 
The last decade has witnessed a significant
growth in the number and the variety of deriva-
tive instruments available to investors in India.
The options available for investors in India are
Equity derivatives, fixed income derivatives and
foreign currency derivatives. Nevertheless, there
vestors in derivatives market even though mutu-
al funds have been allowed to invest in deriva-
tives by SEBI since 2006. The intensity of deriv-
atives usage by any institutional investor is a
function of its ability and willingness to use de-
rivatives for either risk mitigation or for risk
trading. A study of derivatives usage by mutual
funds in India throws up some interesting ques-
tions like - do the funds that use derivatives have
returns better than those funds that do not? What
factors influence the ‘decision to use deriva-
tives’ and the 'extent of usage’? Does derivative
usage have a positive impact on selectivity and
timing skills of mutual funds?
The article reports the findings of our empirical
study aimed at answering the above questions
and compares the return characteristics of funds
that use derivatives to those that do not. Our fo-
cus is on three alternative ways such investment
strategies by fund managers may affect the dis-
tribution of a mutual fund’s returns:
Funds that invest in derivatives may have higher
or lower risk than funds that do not invest in de-
rivatives.
STUDENT ARTICLES
Managers investing in derivatives may improve
net portfolio performance, either due to lower
transaction costs or because managers better uti-
lize information.
Managers may use derivatives to affect inter-
temporal changes in the fund’s risk exposure.
Sample data for the study  pendent variables and a binary flag (0 or 1) as
We perform a comparative study of the risk and
performance of users vs. non users of deriva-
tives. We focused on typical mean-variance and
market model related performance measures and
we also tested for selectivity and timing skills.
For the study, 273 equity diversified mutual
funds were chosen. In the mutual funds studied
the instruments used were Options, Futures and
Warrants. The time period used for analysis is 1
year. The Mutual Funds studied belonged to 35
different fund houses (AMCs), with each fund
house having 1 to 24 MF schemes. Out of the
273 MFs, 45 (19.3%) had exposure to deriva-
tives, the extent of exposure ranging from 0.03%
to 77.29% of total portfolio size. The fund size
of the MFs studied ranged from INR 11.16
crores to INR 3662.65 crores. None of the funds
had an Entry load, although the exit load ranged
from 0 to 5%, with typical value of exit load be-
ing 1% for a period of less than 1 year. Out of
the 35 fund houses, 13 had exposure in the de-
rivative markets through one or more MF
schemes. Whether this increased exposure modi-
fied the funds’ performance or risk profiles is
the main objective of this study.
Factors  affecting  the  decision  to 
use derivatives  For identifying factors influencing the extent of
Based on the findings of similar empirical stud-
ies for the US, Italian and Spanish mutual funds
markets, following factors were chosen for the
study –
 Fund size(Assets under management)
 Fund age (Inception year of fund)
 Management experience (presence of oth-
er users of derivatives in same fund fami-
42
AUG 2010 MONEY MANAGER
ly)
 Cash management (entry and exit load)
The brackets indicate the mutual fund attributes
identified to act as surrogate for the chosen fac-
tors.
With the variables defined above, a Logit model
was formulated with above variables as inde-
the dependent variable to indicate whether or not
the fund invests in derivatives.
This model indicates whether or not one of the
aforementioned factors has an influence on the
decision to invest in derivatives. We found that
only the variables fund size and management
experience are significant and rest of the varia-
bles are not useful in explaining the derivative
usage. This implies that the probability of using
derivatives increases with the number of funds
in the family and with the size of the fund. The-
se results highlight the key role of economies of
scales in the decision to use derivatives. The sig-
nificance of size also supports the idea that larg-
er funds are more willing to use derivatives to
manage their positions. The variables that do not
affect the decision to use derivatives are the
fund’s age, the load fees and the presence of
other funds in the family using derivatives.
Factors affecting the  
extent of derivative usage 
derivative exposure, we again chose the same
explanatory variables. The dependent variable
this time was the percentage exposure of the
fund to derivatives i.e. ratio of investment in de-
rivatives to total assets under management. A
linear regression equation was formulated for
this purpose.
The study showed that the extent of derivative
 MONEY MANAGER AUG 2010
usage is independent of the number of funds in
the family also. It depends only on the size of
the fund. Again, economies of scale play a sig-
nificant role. The fund size plays a significant
role in deciding the extent of derivative expo-
sure. So, we can conclude that the decision to
use derivatives and extent of usage is related to
economies of scale and users are more likely to
be funds that belong to a large family of funds
having a large fund size.
Risk return profile  tures market increases. This factor is defined as
To assess the risk return profile of users versus
non-users, the returns of the mutual funds over
past one year were compared with the market
returns. The performance of users and non-users
were compared on parameters like Sharpe ratio,
Treynor ratio and Jensen alpha. The risk free
rates used were the Government of India 91 day
T-bill rates. Market rate used is the monthly re-
turn on Nifty over past one year.
If we look at the returns of the funds and com-
pare the key ratios, following results were ob-
tained:
It can be observed that there is no significant
difference between the Sharpe ratio for users
and non-users of derivatives indicating that ex-
posure to derivative does not lead to superior
performance in terms of volatility adjusted re-
Performance Criteria Users Non-users
Beta 0.831 0.903
Jenson’s Alpha 0.556 0.203
Sharpe Ratio 0.402 0.377
Treynor Index 4.338 4.566
turns. The Jensen’s alpha is the measure of per-
formance of interest for well diversified inves-
tors. Both users and non-users of derivatives in-
dicate a positive alpha, indicating that they per-
form better than the market owing to their diver-
sified portfolios. A positive alpha for users of
derivative funds indicates is evidence of superi-
or performance. The Treynor Index indicates if
the fund outperforms the risk free rate and if the
43
STUDENT ARTICLES
performance is achieved with lower market ex-
posure. Again, there is no significant difference
in the performance of users and non-users of
funds.
Selectivity and timing skills 
To establish the hypothesis that the usage of de-
rivatives had any substantial effect on the timing
of investments by mutual fund, we extended the
CAPM model by incorporating a factor that cap-
the square of the market excess return.
This model allows for separation of timing skills
in fund management.
Both users and non-users of derivatives show a
negative timing coefficient indicating that they
did not time the market efficiently. The timing
skill of users of derivatives was found to be
worse than that of non-users.
Conclusion 
We find that most Indian mutual fund managers
do not employ derivatives in their portfolios.
Only 19.3% of the 273 funds in our sample use
derivatives. The results are generally consistent
with the findings in Koski and Pontiff (1999),
who report that 20.8% of US equity fund man-
agers employ derivatives in their funds. We also
find that, for funds that invest in derivatives, the
use of derivatives as a percentage of a fund’s
total holdings are moderate, with averages of
8.4%.
We find some evidence that the decision to use
derivatives is associated with fund size and
number of fund in the fund family. The extent of
STUDENT ARTICLES AUG 2010 MONEY MANAGER

derivative use was found to be solely dependent
on fund size. Surprisingly, in terms of returns -
the use of derivatives did not improve the per-
formance of funds. Users of derivatives did not
exhibit superior timing skills when compared to
non-users.
We view our results as evidence that the inci-
dence and extent of derivatives usage by Indian
mutual funds are modest and the use of deriva-
tives does not adversely affect fund return and
risk profiles. Our findings are of particular im-
portance to regulatory agencies as well as mutu-
al funds investors. We believe that the evidence
presented herein can lessen regulators’ concern
about the abuse of derivatives by mutual funds
in India.

References 
Koski Jennifer Lynch, Pontiff Jeffrey, 1996, How Are Derivatives Used? Evidence from the Mutual Fund In-
dustry, Financial Institutions Centre 96-27
Delib Daniel N., Vermaa Raj, 2000: Contracting in the investment management industry: evidence from mutual
funds, Journal of Financial Economics 63 (2002) 79–98
Emilia Garcia-Appendini and Thomas A. Rangel-Hilt, 2009, Do derivatives enhance or deter mutual fund risk-
return profiles? Evidence from Italy, CAREFIN Research Paper No. 7/09

About the Authors 
Abhishek Rawale: The author is a Second Year student of Post Graduate Program in Management at
Indian Institute of Management, Bangalore. After completing his Bachelor of Engineering (Computer
Science) from Netaji Subhas Institute of Technology (NSIT), New Delhi, he worked in the Semiconductor
Industry for three years. He can be reached at abhishek.rawale08@iimb.ernet.in.

Saurabh Rai: The author is a Second Year student of Post Graduate Program in Management at Indian
Institute of Management, Bangalore. Prior to this he completed his Bachelor of Technology (Mechanical
Engineering) from Institute of Technology, BHU. He did his summer internship at ICICI Bank. He can be
reached at saurabh.rai08@iimb.ernet.in.

44
 MONEY MANAGER AUG 2010 STUDENT ARTICLES

Developing Corporate Bond Market in India 
Abstract  banking system can be gauged from the fact that
For developing countries like India, a liquid cor-
porate bond market can play a crucial role in
supporting economic development. Despite ex-
istence of a support structure necessary develop-
ment of Corporate bond market, the market in
India cripples due to lack of a well structured
primary and secondary market, issuers and well
defined regulations. In the paper we intend to
cover these problems and the correctives
measures that have been taken till date and les-
sons that can be learnt from countries like Aus-
tralia and Korea.
govt securities. The dominance of equities and
since 1996, India's stock market capitalisation as
a percentage of GDP has increased to 108%
from 32.1%, while the banking sector's ratio to
GDP has risen from 46.3% to 78.2% in 2008. In
contrast, the bond markets grew to a modest
43.4 percent of GDP from 21.3 percent. Of this
corporate bonds account for around 3.2% of
GDP and government bond market accounts for
38.3% of GDP. (Figure 1)
Source: RBI
India’s government bond market stands ahead of

Introduction 
Capital market in any country consists of equity
and the debt markets. Within the debt market
there are govt securities and the corporate bond
market. For developing countries, a liquid cor-
porate bond market can play a critical role in
supporting economic development as

 It supplements the banking system to meet

Figure 1
corporate sector’ requirements for long-
term capital investment and asset creation. most East-Asian emerging markets but most of
it is used as a source of financing the deficit.
 It provides a stable source of finance in The size of the Indian corporate debt market is
case of volatile equity market. minuscule in comparison with not only the de-
veloped markets, but also some of the emerging
 A well structured corporate bond market
economies in Asia like Thailand, Malaysia and
can have implications on monetary policy
China (Figure 2)
of a country as bond markets can provide
relevant information about risks to price
Characteristics and features  
stability
 Innovation and a Plethora of options:
Despite rapidly transforming financial sector
and a fast growing economy India's corporate
Over time great innovations have been wit-
bond market remains underdeveloped. It is still
dominated by the plain vanilla bank loans and nessed in the corporate bond issuances, like

45
STUDENT ARTICLES AUG 2010 MONEY MANAGER

floating rate instruments, convertible bonds,
callable (put-able) bonds, zero coupon bonds
and step-redemption bonds. This has brought a
variety that caters to a wider customer base and
helps them maintain strike a risk-return balance.
the companies can avoid the lengthy issuance
procedure for public issues. Second is the low
cost of private placement. Third, the amounts
that can be raised through private placements are
typically larger. Fourth, the structure of debt can
be negotiated according to the needs of the issu-
er. Finally, a corporate can expect to raise debt
from the market at finer rates than the PLR of
banks and financial institutions only with an
AAA rated paper. This limits the number of en-
tities that would find it profitable to enter the
market directly. Even though the listing of pri-
vately placed bonds has been made mandatory, a
proper screening mechanism is missing to take
care of the quality and transparency issues of
private placement deals.

Figure 3: Resource mobilization through debt

Figure 2

Over time great innovations have been wit-

nessed in the corporate bond issuances, like
floating rate instruments, convertible bonds,
callable (put-able) bonds, zero coupon bonds
and step-redemption bonds. This has brought a
variety that caters to a wider customer base and
helps them maintain strike a risk-return balance.

 Preference for private placement:

In India, issuers tend to prefer Private Placement

over public issue as against USA where majority
Source: Equity and corporate debt report: RBI
of corporate bonds are publically issued.

In India while private placement grew 6.23

times to Rs. 62461.80 crores in 2000-01 since
1995-96, the corresponding increase in public
issues of debt has been merely 40.95 percent
from the 1995-96 levels. (Figure 3).This leads to
a crunch in market liquidity. A number of fac-
tors are responsible for such preference. First,

Figure 4
Source: RBI

46
 MONEY MANAGER AUG 2010 STUDENT ARTICLES

 Dominance of financial institutions:

corporations with an AAA rating.
The public issues market has over the years
been dominated by financial institutions. The (Table 1)
issuers who are the main participants in other
 Non-existent repo market for corporate
corporate bond markets (that is, private sector,
non-financial), represent only a small proportion bonds unlike the government bonds where
of the corporate debt issues in the Indian market. there is an active repo market.
Most of the privately placed bonds (which are
about 90% of the total issue of corporate bonds)  Complicated and slow issuance procedure.
are issued by the financial and the public sector.
(Figure 4)  Regulators in India are reactive rather than
proactive.
 Inefficient secondary market:
Further the secondary market for non-sovereign  Illiquid secondary market- part of it is due
debt, especially corporate paper still remains
to the fact that the number of issuers is
plagued by inefficiencies. The primary problem
is the total lack of market making in these secu- low and part of it is due to the fact that the
rities, which consequently leads to poor liquidi- large investors prefer to hold these securi-
ty. The biggest investors in this segment of the ties till maturity.
market, namely LIC, UTI prefer to hold these
instruments to maturity, thereby holding the sup-  Lack of formal market makers
ply of paper in the market.
The listed corporate bonds also trade on the  Limited demand for bond financing. The
Wholesale Debt Segment of NSE. But the per- corporate debt market in India continues to
centage of the bonds trading on the exchange is be dominated by banks
small. Number of trades in debt compared to
equity on an average for August 2007 is only  Limited investor base. A successful corpo-
0.003%. rate bond market requires non banking in-
vestors which are limited and restricted in
case of India.

 Inadequate credit assessment skills cou-

pled with lack of transparency in trades

 There is a lot of confusion in the market

regarding both regulations and the trading
Figure 5 floors.
Figures are turnover on the wholesale debt market segment of NSE.
Source: NSE To sum up, corporate bond the market in India
suffers from deficiencies of participants, prod-
Challenges and issues  ucts and a comprehensive institutional frame-
work.
 Dominance of private placements
 Dominance of large corporations. The Recent developments 
credit rating system encourages only the large

47
STUDENT ARTICLES
Given the importance of a well developed cor-
porate bond market, the government, the RBI
and SEBI have initiated measure to develop the
corporate bond market in India. Most measures
were aimed at improving the disclosure norms.
The corporate bond market got its due attention
by the government in the Union Budget of 2004-
05where in the High Level Expert Committee on
Corporate Bonds and Securitisation, chaired by
Dr. R. H. Patil, was set up to look into the regu-
latory, legal, tax and mortgage design issues for
the development of the corporate bond markets.
The suggestions made by the committee were to
develop the market infrastructure. Some of the
suggestions made in the report include the re-
moving the stamp duty, simplifying the issuance
and disclosure norms, to bring the cost of corpo-
rate bonds at par with those of government secu-
rities by having similar TDS norms, enhance the
investor base by encouraging participation of
mutual funds, pension funds, insurance compa-
nies and gratuity funds and also retail participa-
tion through better primary and secondary mar-
kets. It also suggested a regulatory framework
for a transparent and efficient secondary market
for corporate bonds should be put in place by
SEBI in a phased manner. It also recommended
having a trade reporting system, introduction of
repo in corporate bonds and better clearing and
settlement system.
Both RBI and SEBI have fundamentally agreed
to these recommendations and steps are being
taken to implement the same. Some of the steps
include:
Dematerialization of holdings, as required by
SEBI since 2002; increased trading transparency
from compulsory reporting of trades, linking
48
AUG 2010 MONEY MANAGER
local rating agencies to international rating
agencies. In January 2007 SEBI was declared as
the sole body responsible for regulating and co-
ordinating the primary and secondary corporate
bond market. It was a major step in remove the
lack of coordination that existed due to two reg-
ulators (SEBI and RBI). In April 2007, SEBI
permitted both BSE and NSE to set up trading
platforms. In April 2007, SEBI reduced the shut
period in corporate bonds, to align it with that
applicable for Government Securities, and trada-
ble lots in corporate bonds. In December 2007
SEBI made further amendments in issuance pro-
cedures to reduce the cost and ease issuance. It
also gave green signal to FMMIDA to start trade
reporting platform for CBs. Moreover, the gov-
ernment has made changes in the Companies
Act and on simplification and reduction in the
stamp duty w.e.f. 2007. From December 1,
2009 all corporate bonds traded OTC or on the
debt segment of the stock exchanges will have
to be cleared and settled through the National
Securities Clearing Corporation Ltd (NSCCL) or
the Indian Clearing Corporation Ltd (ICCL). It
will help in eliminating the counter party risk in
trade settlement and ensure a smooth receipt and
payment system. In June 2008, the investment
limit for FIIs in corporate debt was increased
from $1.5 billion to $3 billion and further to $15
billion in January 2009. Ministry of Finance has
hinted towards corporate market becoming Repo
-able from 2010.
India’s learning from the Australi‐
an corporate bond market 
Australian economy has been very much regu-
lated before 1980 like Indian economy. In Aus-
tralia, too, government bond market was devel-
oped much before the development of the corpo-
rate bond market through deregulation. Thus a
deregulation will help the Indian market. Moreo-
ver the following reforms can also be imple-
mented.
 The secondary market has to be developed
for the bonds.
 MONEY MANAGER AUG 2010
Like in Australia, GOI bonds in India are
also purchased by insurance companies
and gratuity funds. They hold these bonds
till maturity. As such there is no secondary
market for these bonds.
 The Forex market in India is to be deregu-
lated to attract foreign investors. As of
now the forex market is highly regulated
by RBI. India needs to develop cross cur-
rency swap market so that the foreign in-
vestors can hedge their investment. How-
ever this will bring instability to the Indian
currency in the beginning.
 India can also construct Bond Indices to
provide a benchmark for investment. This
will also make the bonds acceptable
among the retail investors.
Policy  lessons  from  the  Korean  ket, Korean Government took real steps to
corporate bond market  promote electronic trading. It introduced
Unlike, many developing economies including
India, corporate bond were lot more popular in
Korea, basically because of the reluctance of the
government of Korea to issue government
bonds. Moreover, the bonds issued by compa-
nies were guaranteed by government as such
they were risk free. Corporate bond market in
Korea has weathered crisis in late 1990s and
early 2000s but has recovered afresh from each
crisis, stronger. Korean bond market grew both
in quality and size due to various government
reforms even in the midst of various crisis. Es-
tablishment of market infrastructure and en-
hancement of overall liquidity and transparency
of the primary and secondary market has helped
in the long run.
 Corporate bonds were first introduced in
1972. But the real development of these
bonds was seen after the development of
49
STUDENT ARTICLES
an efficient government bond market.
Thus its development is the first step in
developing corporate bonds.
 Essential market infrastructure and institu-
tional arrangements are the basic require-
ment for the development of efficient bond
markets. Korea introduced many systems
such as a Dutch auction system, a reopen-
ing and marked-to-market system and a
primary dealer system. Moreover it also
took steps to develop the futures repur-
chase market for government bonds. These
institutional and legal infrastructures and
framework in a very short period were
able to induce liquidity in the market.
 Instead of being satisfied with OTC mar-
ETS (electronic trading system) for the
government bond market. It was mandato-
ry to trade in benchmark issues using the
system. This has not only improved trans-
parency but also liquidity in the market.
 Many companies in India are not able to
issue bonds because of low rating. Korea
also faced the same problem after the IMF
Crisis. To overcome this problem it used
securitization and credit guarantee meth-
ods. This helped even small companies to
raise funds not only from domestic market
but also from the international market.
STUDENT ARTICLES AUG 2010 MONEY MANAGER

References 
Asia Bond Monitor- ADB, April 2008
Bank for International Settlements. 2006. ‘‘Developing Corporate Bond Markets in Asia.’’ BIS Papers No.26,
February.
India’s Bond Market-Development and Challenges Ahead, Stephen Wells and Lotte Schou-Zibell, Working
paper series on regional economic integration no.22, ADB, December 2008.
CS Update, august 2008, ICSI
Equity and corporate debt report 2007, RBI
An overview of the Australian corporate bond market by Ric Battellino and Mark Chambers, Reserve Bank of
Australia

About the Authors 
Jaideep Singh has done his mechanical engineering from Delhi College of Engineering, Delhi. He is
currently pursuing his MBA from Management Development Institute, Gurgaon. He has consistently been
among top students and has also won prizes in various inter B-school competition

Ritambara Vasudeva after graduating in Eco.(Hons) from Indraprastha College, Delhi University, is
pursuing her MBA from Management Development Institute, Gurgaon. She is a member of Monetrix,
Economics and Finance club of MDI.

Shefali Omer has done her B.Com from Kanpur University. She also secured an A.I.R. 28 in CA-CPT
and has cleared CA-PCE. She is currently pursuing MBA from Management Development Institute,
Gurgaon. She is a member of Monetrix, Economics and Finance club of MDI, Gurgaon

50
 MONEY MANAGER AUG 2010
Capital Account Convertibility: Is India Ready? 
Abstract:  flows. Thus, CAC for Indian economy refers to
Background
Capital Account Convertibility for the Indian
economy refers to the abolition of all re-
strictions with respect to movement of capital
from India to different countries across the
globe and vice versa. The Reserve Bank of In-
dia, in consultation with the Government of In-
dia, appointed a committee chaired by S.S. Tar-
apore to set out a roadmap towards adopting full
CAC. This article, while evaluating India’s
readiness towards capital account liberalization,
examines India’s performance on the precondi-
tions laid down by the Tarapore committee [1]
in 1997 and the feasibility of the Tarapore Com-
mittee [2] recommendations. The article also
attempts to analyse the effect of CAC on the
Indian economy in the backdrop of the financial
crisis.
Conclusions
India has not met most of the prerequisites set
by the Tarapore committee. India is not yet
ready for full Capital Account Convertibility but
it should prepare a robust roadmap for adopting
CAC in future. Adoption of the second Tarapore
committee recommendations still remains infea-
sible as the preconditions set by the committee
in the prior period itself have not been met.
Even as moving to fuller convertibility of cur-
rency may benefit the capital markets, the possi-
bility of a financial/currency crisis cannot be
completely ruled out since India’s financial inte-
gration is still in its nascent stage.
Overview  of  Full  Capital  Account 
Convertibility:  Objectives of CAC in the Indian Context:
 
Full Capital Account Convertibility implies free-
dom of currency conversion in relation to capital
transactions in terms of both inflows and out-
51
STUDENT ARTICLES
the abolition of all restrictions with respect to
movement of capital from India to different
countries across the globe and vice versa. Move-
ment towards FCAC will ensure that all non-
residents i.e. corporate and individuals would be
treated equally. This would mean removal of the
tax benefits accorded to NRIs via special bank
deposit schemes.
Evolution  of  Capital  Account  Con‐
vertibility in India: 
In 1994 August, the Indian economy had to
adopt the present form of Current Account Con-
vertibility, on account of compulsions by the
International Monetary Fund (IMF) Article No.
VII. The primary objective behind the adoption
of CAC in India was to make the movement of
capital and the capital markets open and inde-
pendent so that it would exert less pressure on
the Indian financial markets. The proposal for
the introduction of CAC was present in the rec-
ommendations suggested by the Tarapore Com-
mittee appointed by the Reserve Bank of India
in 1997.
The status of Capital Account Convertibility in
India for various non residents is as follows:
For Foreign Corporate and Institutions, there is
reasonable amount of convertibility
For non-resident Indians, there is approximately
an equal convertibility, but one accompanied by
procedural and regulatory impediments
For individuals, foreigners other than PIOs,
there is near zero convertibility
 To facilitate growth in the economy by
minimising the cost of equity and debt
capital
 To improve the efficiency of the Indian
STUDENT ARTICLES AUG 2010 MONEY MANAGER

financial sector through greater compe- India’s Performance on the above criteria post-
tition, thereby minimising the interme- 2000:
diation costs
The fiscal deficit to GDP ratio came below the
 To provide opportunities for diversifi-
4% mark only in 2006-07 followed by 3.3% in
cation of investments by residents 2007-08. However, due to the fiscal stimulus
measures adopted by the Government of India in
Concomitants  for  a  move  to  Full  2008-09, the fiscal deficit to GDP ratio in-
creased to 6.8%, the highest since 1998-99. This
Capital Account Convertibility:  indicates that India has performed poorly on the
fiscal front. Considering that the target of 3.5%
The fiscal-monetary policies, exchange rate deficit set out by the Tarapore committee has
management, prudential, regulatory and supervi- only been accomplished once, this criterion
would not be a stable one in judging India’s
sory safeguards and measures for development
readiness to adopting Full Capital Account Con-
of financial markets, all assume importance. The vertibility.
implementation of these measures and the pace
of liberalisation are a simultaneous process. Three Years’ Average Inflation Rate
Pre-Conditions of Full CAC in India: Tarapore
Committee Recommendations (I) During 1997-2000, the average inflation rate
The 1997 committee had laid down the follow- decreased continuously from 5.6% to 4.5%.
However, since 1999-2000, the average inflation
ing preconditions to be satisfied before India
rate has hovered above the 5% limit, which is
adopted CAC gradually (over a period of 3 years above the recommended band set by the Tara-
from 1997-2000) pore Committee.
a. Gross Fiscal Deficit/GDP ratio to come
down to 3.5%
b. The annual average rate of inflation for the
previous 3 years to lie between 3-5%
c. Gross Non-Performing Assets of public
sector banks to come down to 5% in 2000
from 13.7% in 1997
d. Average Cash Reserve Ratio should come
down to 3%

The gross NPAs of public sector banks have been

on a decline. The NPAs came below the 5% mark
only in 2004-05 as opposed to the target of 2000-
2001. However, the gross NPAs of these banks
have come down remarkably since 2000-01.

52
 MONEY MANAGER AUG 2010
Average Effective Cash Reserve Ratio
The lowest level of average CRR has been in the
year 2003-04, at 4.5%. The average CRR is well
above the Tarapore committee’s prescribed limit
of 3%. It is only in the year 2009-10, that the
CRR has come down drastically due to fears of
the slowdown, but it still remains higher than the
floor. Hence, this criterion is not met while eval-
uating India’s readiness to adopting full Capital
Account Convertibility.
Debt-Servicing Ratio
The panels indicate that the debt servicing ratio has never
touched the required 20% limit set by the Tarapore com-
mittee.
53
STUDENT ARTICLES
Thus, India has not met most of the prerequisites
set by the Tarapore committee for moving to-
wards full Capital Account Convertibility. Bar-
ring the NPAs of the Public Sector Banks which
have come down drastically, India has per-
formed poorly on other fronts, including on the
fiscal front. The Fiscal Responsibility and Budg-
et Management Act (FRBM) was enacted to
eliminate the revenue deficit and to reduce the
central fiscal deficit to 3% by March 31, 2009.
However, due to the economic stimulus package
unveiled by the government in response to the
acute economic slowdown, there has been a
sharp increase in the central fiscal deficit and as
a result, the FRBM Act has been temporarily
suspended.
Adequacy of Reserves: 
The adequacy of reserves is considered an im-
portant parameter for capital account liberaliza-
tion as it helps in gauging an economy’s ability
to withstand external shocks. The RBI has been
pursuing a policy of maintaining an adequate
level of foreign exchange reserves to meet In-
dia’s import requirements, unforeseen contin-
gencies and liquidity risks. Compared to US
$5.8 billion in the financial year 1990-91, India
now has a foreign reserve base of $283.6 billion
(as on December 18, 2009). Thus, from an im-
port cover of just 2 months in 1990-91, India
now has an import cover of more than 14
months, which is way above the prescribed
‘safe’ level of 6 months. The Reserves/Debt-
Service ratio has also shot up from 0.5 to 7.2
over the period, which indicates a comfortable
level of debt servicing using the foreign reserves
during periods of exigency. India’s total foreign
reserves well exceed India’s overall external
debt.
STUDENT ARTICLES
Tarapore  Committee  II:  Recom‐
mendations  The DTAA is needed to promote International
 
The second round of Tarapore committee set up
to suggest a roadmap for full Capital Account
Convertibility came out with the following set of
recommendations:
a. The sequential full Capital Account Con-
vertibility to be adopted in three phases:
2006-07 (Phase-I), 2007-09 (Phase-II) and
2009-10 and 2010-11 (Phase-III)
b. FIIs to be banned from investing fresh
capital through the issue of fresh Participa-
tory Notes; PNs to be gradually phased out
c. Industrial houses to be allowed and en-
couraged to set up banks
d. Discriminatory tax treaties (such as Dou-
ble Tax Avoidance Treaty or DTAA) to be
abolished, since they are incompatible
with the concept of capital Account Con-
vertibility
e. For resident corporates, the ceiling for fi-
nancial capital transfer abroad to be re-
laxed from 25% of their net worth
f. External Commercial Borrowing limit per
annum to be increased
g. Ceiling for loans and borrowings by resi-
dent banks from overseas banks to be re-
laxed from 25% of their unimpaired tier-I
capital
Why  Tarapore  Committee  II  rec‐
ommendations remain infeasible?  
 
Even as the government attempted a move to-
wards phasing out Participatory Notes, a mere
rumour of the news resulted in a stock market
crash. (P-notes formed approximately over 55%
component of FIIs in 2007. It is only recently,
54
AUG 2010 MONEY MANAGER
amid global turmoil, that share of P-notes has
fallen to 15.55%)
trade. Hence, it can only be abolished if full cap-
ital account convertibility is implemented simul-
taneously, else there are expected to be serious
repercussions in term of our exports
The ECB limit was increased to $500 million
but that was more in response to the liquidity
crunch rather than moving towards capital ac-
count convertibility. The present government
has been thinking of rolling back this increased
ceiling.
Possible Hiccups:
a. The effect of a financial crisis on the Indi-
an economy with full capital account con-
vertibility is difficult to predict. Other
economies with full capital account con-
vertibility are highly coupled with the
world economy. This means that global
problems directly impacted these domestic
economies as well. The recent examples of
Ireland and Iceland are not very encourag-
ing.
b. There is no clarity regarding the regulatory
measures required to prevent abuse of cap-
ital account convertibility. Speculators are
known to move markets recklessly and
increase the risk for common investors.
Conclusion: 
 
Accordingly, it can be concluded that the issue
of India adopting full Capital Account Converti-
bility still remains questionable. Many require-
ments of first Tarapore committee recommenda-
tions were relaxed in the second Tarapore com-
mittee recommendations; however, the move
 MONEY MANAGER AUG 2010 STUDENT ARTICLES

towards full account convertibility still seems
infeasible. Even as advancing to fuller converti-
bility of currency may benefit the capital mar-
kets by bringing in cheaper capital, the possibil-
ity of a financial/currency crisis cannot be com-
pletely ruled out since India’s financial integra-
tion is still in its nascent stage. The recent global
meltdown hasn’t helped either. As of now, India
needs a rigorous regulatory and monitoring body
which would have an effective system for inter-
vening at the right time to ensure domestic sta-
bility and prevention of disruption in the Indian
capital markets. It can be concluded that India is
not yet ready for full Capital Account Converti-
bility, but it should prepare a robust roadmap for
adopting CAC in future.
Exhaustive studies conducted by international
rating agencies prove the point that full capital
account convertibility by itself does not make a
country a more attractive investment destination.
More important parameters in this respect are a
strong financial sector and fiscal rectitude. The-
se are exactly the signposts that the Tarapore
committee has advocated. With many signposts
that are difficult to reach, it is unlikely that India
will move towards fuller convertibility by adher-
ing to the path and the timelines set out. In that
respect, the value of the Tarapore committee
report might well lie in its emphasis on crucial
procedural and macroeconomic issues rather
than Full Capital Account Convertibility per se.

References 
http://dbie.rbi.org.in
Indiastat.com/banksandfinancialinstitutions/3/stats.aspx
rbi.org.in
Indiastat.com/economy
Tarapore Committee Report on Capital Account Convertibility in India, 2006
“Why capital Account Convertibility in India is Premature” Williamson (2006)
“Capital Account Convertibility and Risk management in India”, Amadou N.R.Sy, IMF Working Paper
WP/07/251

About the Authors 
Gaurav Anand is presently pursuing Post Graduate Diploma in Management from Management
Development Institute, Gurgaon. He can be reached at pg09gaurav_anand@mdi.ac.in

Hitesh Seth is presently pursuing Post Graduate Diploma in Management from Management
Development Institute, Gurgaon. He can be reached at pg09hitesh_s@mdi.ac.in

Srikanth Rayasam is presently pursuing Post Graduate Diploma in Management from Management
Development Institute, Gurgaon. He can be reached at pg09srikanth_r@mdi.ac.in

55
STUDENT ARTICLES AUG 2010 MONEY MANAGER

Arm‐chair Investing on Nifty: A P/E based approach 
  
Introduction  EPS is 12% and the current EPS is 100, then it is
estimated that the EPS at the end of five years
  from now will be 176. Also, assume that the cur-
If you’re a Warren Buffet or a Rakesh Jhunjhun- rent stock price is 1500 (PE of 15).
wala, or any experienced investor with both the
knowledge and time to study the market, you Then we examine the average Price-Earnings
would be better off handpicking stocks and Ratio (PE) of the stock over the last 10 years.
monitoring them. But what if you wanted the We assume that this average will be sustained
thrill of investing in the stock market, and yet over the next few years. Based on this assump-
not spending too much time pouring over the tion, we estimate the future price of the stock (in
business pages each day? This P/E based ap- our case five years from now) by multiplying
proach to investing in Exchange traded funds the future EPS with the historical average PE
hopes to achieve that. It does not claim it can ratio. If the historical average PE of the stock in
beat the returns of careful handpicking. It’s a our example is 18, then the future price of the
method for the busy executive, with better than stock is expected to be 3168 (176X18). Of
SIP returns. course, there are no guarantees but past record
demonstrates that for high quality stocks, this is
Conceptual Framework  usually the case.
  The next step is to estimate the expected return
on our investment. In our example, we have the
This is inspired by an excellent book
option to buy the stock at current market price of
“Buffetology” written by Mary Buffet, the
Rs. 1500 with an expectation that the stock price
daughter-in-law of the legendry investor Warren
at the end of five years will be Rs. 3168. The
Buffet. Mary Buffet explains that Warren Buffet
rate of return on this investment works out to
views stocks as bonds with variable rate of inter-
16.12% per annum.
est (returns). The main difference between a
Finally, we compare the expected rate of return
fixed income instrument (e.g. fixed deposits or
on the stock with the risk free return available in
bonds) and stocks is that while fixed income in-
the market over the same period. Let us assume
struments offer a fixed rate of return, the stocks
that the rate of return on five year fixed deposits
offer variable returns. However, the returns from
is 7%. We can now see that the investment in
high quality, well established stocks can be pre-
stock is expected to yield much higher return
dicted with a fair degree of certainty. The proce-
(16.12%) than the return on fixed deposit. In
dure for calculating the expected returns from
such a situation, it is better to invest in stock ra-
high quality stocks with established track record
ther than fixed deposit. So our decision is made!
is described below:
We will invest in stock.
Firstly, we need to examine the average growth
However, what happens if the current market
of the earning per share (EPS) of the stock over
price of the stock is 2200 (PE of 22)? In that
a long period (usually 10 years). It is assumed
case, the expected rate of return from investment
that the average growth in EPS over the last 10
in stock will yield only 7.56% per annum, just a
years will be sustained over the next few years
shade higher than the 7% return on fixed depos-
(5 to 10 years). Based on this, we estimate the
it. Now we are not sure whether we should in-
future EPS of a stock by compounding the cur-
vest in stock or fixed deposit. Is it worth taking
rent EPS at the average EPS growth rate. For
the risk of investing in stock if we are getting
example, if the 10 years average growth rate of
only 0.56% % higher return but with uncertainty

56
 MONEY MANAGER AUG 2010
that we may even lose a part of our capital. Per-
haps not. Therefore, we would invest in stock
only if the expected return from the stock is sig-
nificantly higher than the return on fixed depos-
it. In our case, we have assumed that we would
not invest unless the expected return from the
stock is at least 10% per annum. The example
above shows that if invest when the PE levels
are low, then we get higher returns. Also, it fol-
lows that when the PE levels are high, it makes
sense for us to sell the stock and book profits, as
the expected return from that point onwards are
likely to be lower and we are better off switch-
ing to investment in risk free instruments i.e.
fixed deposit.
Our methodology is based on the above ap-
proach. We have replaced individual stocks with
an exchange traded fund (NIFTY Bees), also
called ETFs. An index fund offers better diversi-
fication and therefore reduces the risk of invest-
ment. The index fund represents investment in
high quality and large mid cap stocks with ex-
cellent liquidity. The ETF has very low expense
ratio and can be easily bought and sold over in-
ternet, which makes it very easy for a busy exec-
utive to invest in. The research has shown that
over a long period of time, most other types of
funds (diversified equity funds or sectoral funds)
are not able to beat the performance of
Exhibit 1
57
STUDENT ARTICLES
the index funds. For all these reasons, we
decided to invest in NIFTY Bees.
We examined the last 10 years data and came up
with following facts:
1. Average growth rate of the EPS of NIFTY
over the last 10 years is 13 % per annum. For
future, we have assumed 12% per annum, to be
on conservative side.
2. Average PE over last 10 years has been
around 18.
3. The highest level of PE is just over 28 and
lowest level is just over 10. Only twice in the
last 10 years, have these levels been reached.
Most of the time, PE hovers in the range of 15-
20, with sporadic upwards and downwards
Figure 1 below shows this more clearly.
As mentioned earlier, we decided that we will
not invest in stock (NIFTY BeeS in our case)
unless the expected rate of return is at least 10%.
Based on above historical data, the investment
in NIFTY BeeS is expected to yield 10% or
more return, if we invest when the PE levels are
19.75 or less. Therefore, we decided that we will
invest in stock if the PE is 19.75 or less. If PE is
higher, then we are better off keeping money in
a cash fund, which gives low returns (we have
assumed 4%) but does not suffer from the risk of
loss of capital. We chose cash fund over fixed
deposits because it is much easier to get in and
out of cash funds. Also, the after tax return on
cash fund is quite similar to return on fixed de-
posits.
STUDENT ARTICLES
The Methodology  This is achieved by selling excess equity and
 
Let us briefly describe how the method works.
Basically, we start off with a sum of money (say
Rs. 30,000) and allocate it for investing in the
Nifty Bees. Part of it is directly put into buying
the equity, part left in Cash that may in future be
used to buy equity, but for the time being earns
interest for you. So how much in equity, and
how much in cash? It depends on the P/E of the
benchmark at that time. Every decision in this
model, for that matter, will depend on P/E.
Based on the frequency distribution of the NIF-
TY PE curve, we decided to use the following
model for allocation of investible funds between
cash fund and NIFTY Bees.
So what now once we’ve committed our initial
capital? Now we follow a monthly systematic
invest plan, by putting in Rs 1,000 at the begin-
ning of every month. But unlike a Passive SIP,
where we blindly invest every month, here we
again turn to our indicator, the P/E. Economic
Times publishes daily, the P/E of the Nifty
Benchmark, else it is available online. At the
beginning of each month we make a note of the
P/E and recalculate the percentage of our invest-
ment that should be in equity and the percentage
that should be in cash based on the above table.
So if we now find the P/E to be 24, we would
rather keep only 10% in equity. So we calculate
the value of our current portfolio (equity +cash
+ Rs. 1000 to deployed for the month) and take
10% of that and keep it in equity while keeping
the rest in cash.
PE Range
<14
14<PE<16
16<PE<18
18<PE<20
20<PE<22
22<PE<23
23<PE<24
PE>24
Exhibit 2
58
AUG 2010 MONEY MANAGER
parking the sale proceeds in cash fund. Then we
set the portfolio aside till next month. And re-
peat the same again. Thus, what is clear is that
we’re spending minimal time (once a month) on
managing the investment and putting in minimal
analysis (just tracking the P/E). But are we actu-
a l l y m a k i n g m o n e y ?
The Results 
We did a simulation of this exercise over a 10
year period (31 May 1999 to 01 June 2009). We
find that if we had followed our method over
this period, we would have earned a compound-
ed rate of return of 20.7% per annum! Compare
this to a simple SIP plan, which would have
fetched a return of 13.7% per annum. We have
earned about 7 % higher return over simple SIP.
By any standards, this kind of return over a 10
year period is superb. What is more, we didn’t
spend any time in researching and tracking
stocks. All we needed was one simple decision
one day in a month. Finally, the risks assumed
are very low as we stay invested only when the
market is cheap and there is higher margin of
safety. As market starts getting overvalued we
start selling and hold larger and larger propor-
tion of portfolio in cash fund, which is risk free.
In a SIP you would be invested fully even dur-
ing the time when markets are overvalued and
hence risky. Finally, we also computed 5 year
rolling returns under our methodology and under
traditional SIP methodology to check the con-
sistency of returns under our methodology. Un-
% of funds in equity
at least 90%
at least 80%
at least 70%
at least 60%
no buying/no selling . SIP amount to be invested in cash
fund.
Not more than 50%
Not more than 25%
Not more than 10
 MONEY MANAGER AUG 2010 STUDENT ARTICLES

der SIP, we sometimes got returns as high as
41%, but then sometimes as low as 6%, with a
standard deviation of 0.11. With our method we
had a narrower range, in between 11 and 38%,
with a standard deviation of 0.08. Our returns
were more consistent and predictable and still
gave a higher overall return over a 10 year peri-
od. What more do we want?
There exist funds like FT India Dynamic PE Ra-
tio Fund of Funds (FTDPEF), which follow a
similar methodology.
However, the differences and some advantages
of the above discussed method are 1) Use of
cash while not invested in stock, instead of fixed
deposits, which have their own inherent risks 2)
Entry/Exit loads of a managed fund 3) No flexi-
bility in adjusting PE trigger values to suit an
individual’s personal risk propensity 4) last but
not the least, the thrill of doing it yourself!
*A P/E of 19.75 means that at current market price, the
stock is giving a return of 5.06%. However, the EPS, gets
compounded at the rate of 12% per annum (historical),
thus giving us an average return of 10% over a 5 year pe-
riod.

About the Author 
Puneet Gupta is presently pursuing Post Graduate Diploma in Management from Indian Institute of
Management Bangalore. He can be reached at puneet.gupta09@iimb.ernet.in

59
STUDENT ARTICLES
Why the Indian Markets Will Not Fail 
Abstract: The paper tries to understand the In-
dian Financial markets with respect to the Indi-
an people. It explores the risk assuming tenden-
cy of Indians and links it to their investment and
saving patterns and behavior. This along with
the history of the markets is used to analyze a
linkage between the two. Finally, it brings out
that inherent nature of the Indian markets and its
constituents which will keep the market afloat
despite the volatility and cyclicity.
Introduction  brokers in 1839 to more a million brokers today.
A market, as defined by the Merriam Webster
dictionary, is “a meeting together of people for
the purpose of trade by private purchase and sale
and usually not by auction”1. Extending the def-
inition, a financial market can thus be defined as
a market for the exchange of capital and credit2
that helps businesses grow and also helps inves-
tors make money3. The financial market com-
prises of all vehicles of investment – the stock
market, the bond market, the commodities mar-
ket and the foreign exchange market. They can
also be classified into money markets (which
include short term financial instruments) and
capital markets (which include long term finan-
cial instruments)
The Indian financial market – A brief history
Sl.No. As on 31st 1946 1961 1971
December
1 No. of 7 7 8 8
Stock Exchanges
2 No. of 1125 1203 1599
Listed Cos.
3 No. of Stock 1506 2111 2838
Issues of
Listed Cos.
60
AUG 2010 MONEY MANAGER
Indian financial history dates back to the days of
Arthshastra who developed a sophisticated taxa-
tion system and laid the foundations of what we
call today a sophisticated financial system.
James Wilson is considered as the father of the
Indian Financial system whose roots originate
from the British Empire. He gave India its first
ever Budget that brought stabilization amidst the
chaos. His other pioneering works include cen-
tralization of the financial control and creation
of a system of taxes. The Indian financial Mar-
ket has evolved since then from half a dozen
The early nineties’ financial market was domi-
nated by commodities trading and cities like Ah-
medabad and Bombay gained commercial im-
portance.
As industrialization proliferated, the need for
official trading houses developed and this gave
birth to various regional stock markets during
the 1940s. At present there are 21 stock ex-
changes in India excluding the NSE and OTCEI.
The evolution and current state 
There have been much turbulence in the Indian
markets like the various scams, world economic
recessions but Indian economy has evolved a
long way due to the various reforms and prudent
policy moves.
The financial market today provides the much
1975 1980 1985 1991 1995
9 14 20 22
1552 2265 4344 6229 8593
3230 3697 6174 8967 11784
 MONEY MANAGER AUG 2010 STUDENT ARTICLES

4 Capital of Listed 270 753 1812 2614 3973 9723 32041 59583
Cos. (Cr. Rs.)
5 Market value of 971 1292 2675 3273 6750 25302 110279 478121
Capital of Listed
Cos. (Cr. Rs.)
6 Capital per 24 63 113 168 175 224 514 693
Listed Cos. (4/2)
(Lakh Rs.)
7 Market Value of 86 107 167 211 298 582 1770 5564
Capital per Listed
Cos. (Lakh Rs.)
(5/2)
8 Appreciated value 358 170 148 126 170 260 344 803
of Capital per
Listed Cos. (Lak Rs.)

needed fuel for growth of the Indian economy. considerable amount of change in India. On
Our regulatory framework has strengthened as proper observation of the saving trend in India
the financial system has become more and more we can see that in the earlier years, household
complex. savings in the physical assets used to dominate
the domestic saving in the country. But slowly
A peep into the Indian mind  the saving trend in India changed.

The current increase in the saving rate in India is

Let us try to understand the mindset of Indians.
Why is it important? It is because a market
thrives on people and their investments/buying
and on what they think 4. And the people in In-
dia believe in bargaining and saving intelligently
i.e. frugality in general5. The savings rate in In-
dia when compared to others is in general high-
er.
As the stage for achieving an astounding growth
has been set, the onus is on the financial market,
to provide the much needed stimulus to the Indi-
an Growth story. The ultimate aim of the Indian
Financial market remains to empower every In-
dian to achieve his dream by enabling him with
judicious credit flows, astute financial guidance
and an efficient investment mechanism.
India's saving rate has been uneven over the past
four decades but has still shown substantial
growth. Table 2 gives the domestic savings rate
from year 2000. Just as the savings rate, the
composition in the saving too has undergone a
mainly driven by the savings made by the finan-
cial household. Financial institutions in India are
currently making inroads into the rural areas and
also there is an increase in the trend of easy ac-
cessibility to other investment opportunities
which is actually increasing the saving trend of
India6. The knowledge of an average Indian re-
garding the various tools of investment has in-
creased in the past few decades, still the central
and the most popular investment tool remains
the fixed deposit schemes, insurance and postal
deposits. A look at table 3 shows that Financial
Saving in Indian households is predominated by
Deposits with banks, followed by claims on
Government and Insurance Funds. Moreover, an
Indian average investor invests a lot more than
what his American counterpart who would pre-
fer to invest in various short term investment
schemes than going for fixed returns scheme.

61
STUDENT ARTICLES AUG 2010 MONEY MANAGER

Period 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07

Savings rate 24.80% 23.70% 23.50% 26.40% 29.80% 31.80% 34.30% 34.80%

Table 2: Gross domestic savings rate

(Rs. in Crore)
Item 2003- 2004- 2005- 2006- 2007- 2008-
04(P) 05(P) 06(P) 07 08(P) 09#
Financial Saving (Gross) 380090 435706 588656 650412 715994 746865
a) Currency 42675 36977 51954 66274 81278 93056
b) Deposits 145657 161416 278985 319385 374088 436710
i) With Banks 141973 158393 274704 311215 360727 409678
ii) With Non-banking Compa- 3803 3370 4567 1516 3751 13453
nies
iii) With Cooperative Banks and -6 -134 -64 131 266 133
Societies
iv) Trade Debt (Net) -114 -213 -222 6523 9345 13446
c) Shares and Debentures 492 4967 29008 58598 89134 19349
i) Private Corporate Business 4275 6124 7851 23755 31565 31124
ii) Banking 111 263 290 206 766 995
iii) Units of Unit Trust of India -8586 -3146 -444 -310 -324 -2737
iv) Bonds of Public Sector un- 173 176 172 237 328 446
dertakings
v) Mutual Funds (Other than 4519 1550 21139 34709 56799 -10478
UTI)
d) Claims on Government 87372 106420 86755 19198 -28315 -23479
i) Investment in Government 28469 21313 14390 1654 -14714 -33879
securities
ii) Investment in Small Savings, 58903 85106 72364 17544 -13601 10400
etc.
e) Insurance Funds 52240 69572 83340 114851 128930 150337
i) Life Insurance Funds 49427 65577 79426 110965 124422 145876
ii) Postal Insurance 1098 1414 1215 2200 2729 2594
iii) State Insurance 1715 2581 2699 1686 1779 1868
f) Provident and Pension Funds 51655 56354 58615 72106 70878 70891
Memo:
GDP at Market Prices (at cur- 2760224 3121414 3531451 4129173 4723400 5321753
rent prices)
Source: Economic Survey 2007-08

Table 3: Financial Saving of Household Sector (Gross) in India (2003-2004 to 2008-2009)

Risk and No risk  changed. The table below shows the change in

savings in the three tiers of the total savings.
India’s saving rate has grown substantially in the
last few decades and its composition has also

62
 MONEY MANAGER AUG 2010
Saving Mode
1980-81
Household saving 75.9
Private saving 8 11.5
Public Saving 16.2
Source: Economic Survey 1999-2000
It can be seen from the above data that house-
hold savings (individual, non-corporate business
and private collectives) and private savings
(joint stock companies and cooperative institu-
tions) have increased at the expense of public
savings which have declined by almost 109
times in percentage terms over a period of two
decades. This has been aided by growth in con-
sumerism and a liberalized environment
(increased internal and foreign competition as
well as FDI in various sectors).
Over a period of rising savings rate in the econo-
my and household savings constituting more and
more of the total pie, it is an obvious disad-
vantage for a growing economy like India. In
light of a further rise in savings rate caused by
multiple factors in future, an obvious risk for the
financial markets is apparent. More so, with the
Indian psyche which is slightly risk averse and
tends to favor savings as per the above distribu-
tion, the apparent risk seems greater.
But, over the years, the composition of house-
hold savings has undergone a transition. Earlier,
savings in financial instruments dominated the
savings in financial assets but at present, the
trend has reversed and almost 52% of the house-
hold savings are in physical properties as com-
pared to 44% around the 1990s. But as the sav-
ings rate has risen substantially, a fall of a few
percentage points does not mean much of a re-
duction. Infact, with an increase in household
savings which may be held either in the form of
liquid assets like currency bank deposits and
gold or financial assets like shares, securities or
policies, it indirectly helps as savings in these
63
STUDENT ARTICLES
Percentage
1990-91 1998-99
84.4 82.7
17.2
4.2 0.15
modes finally find their way into the financial
markets by investment bankers and traders.
Thus, a part of the risk by higher savings is done
away with.
Indian markets are thriving well because of the
ability to mitigate the above risk by modes of
savings which aid in doing so. This also forms
the basis for optimism in future where a growing
savings rate may prove to be a blessing in dis-
guise: it fulfills the purpose of financial invest-
ment prudence and also satisfies the investment
needs of the economy.
So Why the Indian markets will not 
Fail 
Indian investor population consists of a con-
servative mix of people, dominated by risk
averse individuals. Our financial institutions like
RBI are known to be conservative amongst the
various economies of the world. Although stock
market is an important part of our financial sys-
tem, the volatility does not truly reflect the fi-
nancial soundness of the system. This can be
inferred because of the observations which show
that these short term investments are just a part
of their robust and versatile project portfolio.
According to Clarence Wong (Head- economic
research and consulting, Asia at Swiss Re), “The
fact that only around 10 per cent of Indians are
covered by any form of pension scheme helps us
understand the low financial risk tolerance of
Indian respondents.”
These risk averse individuals along with a small-
er percentage of risk lover population constitutes
STUDENT ARTICLES AUG 2010 MONEY MANAGER

a healthy mix of investors for the country. The ulators, Indian financial markets did not suc-
strength of well balanced investor population cumb to the global recessionary waves and will
was tested during the recession and it is because continue to thrive successfully.
of the prudence shown by the investors and reg-

References 
1. http://www.merriam-webster.com/netdict/market
2. https://www.rbfcu.org/NB/html/Investments/Dictionary_F.htm
3. http://useconomy.about.com/od/themarkets/a/capital_markets.htm
4. http://toostep.com/trends/investment-trends-in-india
5. http://www.nytimes.com/2008/12/18/world/asia/18iht-letter.html?_r=1
6. http:// finance. mapsofworld. Com / savings /india/rate.html
7. Salam, M. A., & Kulsum, U. (2000). Savings Behaviour in India: An Empirical Study.
8. Binswanger, H. P. (1980). Attitudes toward Risk: Experimental Measurement in Rural India. American
Journal of Agricultural Economics,Vol. 62, No. 3 , 395-407.
9. Shetty, S. L., & Menon, K. A. (1980). Savings and Investment without Growth. Economic and Political
Weekly, Vol. 15, No. 21 , 927-936
10. Ferrari, A., & Dhingra, I. S. (2008). India's Investment Climate : Voices of Indian Business. The World
Bank
11. BUREAU, E. E. (2006, Feb 28). Story behind India’s savings, investment boom. Retrieved Jan 29, 2010,
from The Indian Express: http://www.indianexpress.com/res/web/pIe/full_story.php?content_id=88731
12. Spastic Markets. (2005, July). Shareowner, 18(6), 5,22. Retrieved January 30, 2010, from ABI/INFORM
Global. (Document ID: 865581741)
13. Berg, W. (2006). The Indian Stock Market. Retrieved Jan 29, 2010, from Ezine Articles: http://
ezinearticles.com/?The-Indian-Stock-Market&id=118673
14. Vadlamannati, K. C. (2009). Indian Economic Reforms and Foreign Direct Investment: How Much Differ-
ence Do they Make to Neighbours? South Asia Economic Journal 2009; 10; 31 , 31-59.

About the Authors 
Akanksha Verma is a Comp. Sc. Gold Medalist from SGSITS Indore. She has rich experience in the
financial services division of USA. She has cleared the Level 1 FLMI Insurance certification. She is a
writer and a poetess.
Shalin Gupta a Mech Engg Silver Medalist from Pantnagar Univ. possesses in-depth problem solving and
quantitative skills. His stint with Maruti exposed him to operational and financial linkages. He is a
guitarist and an active member of SPIC MACAY.

Udayan Bhattacharya is an IT Engg from BMSCE Bangalore. He has worked with reputed clients
across the world. He has a knack in financial modeling and has handled various aspects of project
management. He is a ‘Sangeet Visharad’ and an excellent badminton player.

64
 MONEY MANAGER AUG 2010
On Bonds And Bondings   
Have you ever tried to find out what similarities
do the financial instruments have with our day-
to-day activities? Some might be wondering for
the logic behind this question whereas some
might say that it’s too obvious as the instru-
ments are meant to take care of our day-to-day
financial needs depending upon our incomes and
risk taking capabilities. Let me put a more spe-
cific question; what are the similarities between
Fixed Income instruments and relationships in
real life? Before you start guessing let me sim-
plify the task by defining the two terms. By
fixed income instruments, I mean those financial
instruments that help you earn low but fixed re-
turns on your investments thereby reducing your
risk. The most well known example is bond. On
the other hand by relationships, I mean those
existing between a boy and a girl or a man and a
woman. I am counting out relationships arising
out of family ties, friendships or those existing
between same sexes. In better words let’s limit
ourselves to those relations that might culminate
into marriages.
65
THE LIGHTER SIDE OF FINANCE
Any fin guy would tell you that fixed income is
one of the most specific areas of finance. So, if
you don’t aim to be an I-banker and thus intend
to turn the page over, I would still request you to
join me in this exploration.
First of all, why the need for fixed income mar-
ket exists? The answer is the need an alternative
to the volatile equity markets. Aren’t relation-
ships too aimed at helping you counter the va-
garies of loneliness? They help in sharing happi-
ness as well as sorrows thereby mitigating the
upheavals in life thus mirroring the impact of
debt markets on your returns. Let’s us now focus
on the characteristics of a debt instrument say
bond. The longer the maturity of the bond the
more risks it entails so greater are our expecta-
tions in terms of yields. On the same lines, a
long-term relationship is much more demanding.
If you still doubt me, ask any husband who has
forgot his anniversary or wife’s birthday. On the
other hand a short duration instrument like T-bill
finds many takers even at low yields as in short
term relationships that prosper because of low
level of commitments.
While looking for an analogy between source of
bonds and motive behind relationships, on the
basis of issuer, we can broadly classify bonds
into two types; corporate and government with
the offerings being named corporate bonds and
G-Sec (government securities) respectively.
Buying a G-Sec is like having a relationship
with a guy or a girl whom you love as a person.
Nothing else matters. The emotional security is
valued more even if it comes at the cost of eco-
nomic benefits akin to sovereign bonds where
the government guarantee outscores low returns.
On the other hand having a corporate bond in
your portfolio is a sign that one is hoping to earn
a little more than a normal debt instrument and
so he is guided by the fundamentals of the issu-
ing firm. At the same time, there are occasions
THE LIGHTER SIDE OF FINANCE AUG 2010 MONEY MANAGER

when you find a man or a woman falling for a
partner because of features like his/her attractive
looks or his/her bank balance. Though one bene-
fits materialistically but they result in frequent
break-ups due to incompatibilities as is the case
with corporate bonds which have much higher
rate of defaults.
Some of you who have a Facebook (social net-
working site) account would have come across
the option of “it’s complicated” while filling
your relationship status. In such complex rela-
tionships one isn’t sure of the future prospects of
the companionship. In short, they are indecisive
and thus face a lot of anxiety. Similar is the case
with complex instruments in debt market that
enhance the risk attached to your investments as
outcomes are very unpredictable. The advent of
technology has impacted the markets as well as
relationships. On one side virtual platforms like
social networking sites, chat rooms etc. facilitate
real life relationships and on the other hand we
have dematerialised securities being traded on
electronic avatars like NDS-OM (negotiated
dealing systems-order matching) which is an
electronic, screen based, anonymous, order driv-
en trading system for dealing in G-Secs. Though
NDS-OM brings transparency to the trading sys-
tem but same can’t be said of the online relation-
ships.
the CRR (credit reserve ratio) and SLR (statuary
liquidity ratio) requirements? Can we find an
analogy in the money markets for the disco-
theque where guys and girls are desperate to let
their hair down after a tiring day with a few
dance rounds sometimes resulting in a few casu-
al or serious relationships? I think we can. With
DJ controlling the Disco through his set, it’s the
RBI who makes the market participants dance to
its tune in the money markets.
And if you thought that only the fixed income
market allows you to diversify through instru-
ments of varying maturity and returns, think
again. The Casanovas and the playboys have
mastered the art long ago by romancing multiple
beauties at a given time.
By the way, aren’t relationships also known as
bonds?

How about money markets where banks trade

with compatible lenders or borrowers in repo
and call market to meet their short duration fi-
nancing needs? Aren’t they desperate to meet

About the Author : 
 
Saket Saurabh is a 2nd year PGP student at IIM Calcutta. He holds a bachelors degree in Electronics and
Communication Engineering from National Institute of Technology, Patna. He can be reached at
ss.nitp@gmail.com. He maintains a blog at http://saketvaani.blogspot.com

66
 MONEY MANAGER AUG 2010 THE LIGHTER SIDE OF FINANCE

Great Poker Players Make Great Traders, Or Do They? 
Poker is a microcosm of all we admire and dis-
dain about capitalism and democracy. It can be
rough-hewn or polished, warm or cold, charita-
ble and caring, or hard and impersonal, fickle
and elusive, but ultimately it is fair, and right,
and just. - Lou Krieger
Have you ever had a chance to play a hand of
poker? Did you ever think poker can be one of
the best training grounds for wannabe traders?
Increasing number of hedge funds and broker-
age houses are looking to recruit from the most
unusual of a talent pool – the poker players.
There is a growing awareness that a great poker
player has all the requisite skills that a success-
ful financial trader needs: a calculated and ra-
tional approach to risk, ability to take quick de-
cisions under intense pressure, discipline and a
good memory.
Before we get into the litany of how poker helps
in honing your skills as a trader, here is a quick
snapshot of what poker is. Poker is a set of card
games of which the most famous is the No-
Limit Texas Hold ‘Em where each player is
dealt two cards initially and a set of five
‘community’ cards is dealt on the table which is
common to all the players. There are four rounds
of betting – first, immediately after you are dealt
the first two cards (called the pre-flop), second –
after the first three community cards (called the
flop) are dealt and the final two rounds of bet-
ting after each of the fourth and the fifth card are
dealt (called the turn and the river respectively).
You can either check or bet or raise or call or
fold at any point in the game.
Information Asymmetry
There is a substantial element of information
asymmetry in a poker game. And that’s precise-
ly the reason why poker is so hugely popular.
You have a bit of information on the current
hand and you need to solicit or deduce informa-
tion about your opponents’ hands. The more the
information, the more the chances you will win.
There are two ways to do it: You calculate the
odds, the implied odds, and the probability of
making your hand and go about in a logical and
scientific manner as to how you play a given
hand. The other is deducing information about
your opponents – through his playing style, his
betting pattern, his body language and the myri-
ad other signals which he might be giving out
even without his knowledge – and controlling
your emotions. These two ways of eliciting in-
formation and taking a decision are never re-
warding, when practiced in isolation.
In fact, it would suffice to say, you will never
make money in the long run if you are extraordi-
nary in one and come a cropper in the other.
This article delves into the psychological issues
involved in playing poker and likens it to the
real-world trading decisions.
As Frank Murtha, a behavioral finance consult-
ant puts it point-blank, “The stock market and
Texas Hold ‘em are games of investing based on
incomplete and unfolding information. The goal
of each is to accumulate wealth by making deci-
sions based on that information.”
The best way to play a game of poker is to

67
THE LIGHTER SIDE OF FINANCE
weigh the marginal cost and benefit, without
considering past losses and gains and to treat
each hand independently. In reality, past results
do matter because players reassess the percep-
tions of their skill levels and outcomes do have
lasting psychological effects.
There are five common psychological errors –
Greed, Over-confidence, Regret, Seeing pat-
terns, Holding on to losers.
Greed
The best cards to be dealt before the flop in pok-
er are bullets (Two Aces). Probabilistically, this
hand will win the most no. of times than any
other two cards. The problem arises when you
start counting the chickens even before they are
hatched. Sure, a pocket aces is a great way to
start a hand with. But there are so many ways
your bullets could be busted as the hand pro-
gresses. A typical instance is when three cards
of the same suit, which is not of the suit of one
of your aces, open on the flop, and the turn card
also is of the same suit as the flop. The chances
of a flush busting your bullets are extremely
high. But you still keep betting or calling, at a
point when you should be folding.
The same happens so often in our portfolio
when we bet and bet big on a stock which we
think is a sure winner in the hope of a massive
kill in a short time period. When there is unex-
pected negative news about the company, we
tend to remain rigid and not change our initial
perceptions, popularly referred to as Bayesian
Rigidity in behavioral finance parlance. The
probability of winning big, even if the chances
are ridiculously small, blinds us from the fact
that this is the opportune time to quit.
If only that one minute of rationality prevailed,
you would have known the most obvious deci-
sion in almost all the cases would be to quit. Or
rather to fold and look for the next hand. If only,
that is.
68
AUG 2010 MONEY MANAGER
Over Confidence
Over-confidence – Oh, that most ruining of feel-
ings. Let’s say, you win a series of hands in your
table, partly due to your adeptness and partly
due to all your lucky stars in place. That’s when
most, if not all, players tend to start ‘thinking’
they are better than what they ‘thought’ they
were just a few hands earlier. That’s precisely
the point when all hell starts breaking loose and
you start playing rashly than you would normal-
ly. What could have been a great killing, swiftly
results in a position where your stack might
even become smaller than it initially was. Not
letting your emotions take control of you, and
steadily playing the subsequent hands based
solely on the merit of that individual hand is the
blatantly evident ploy that should be employed.
But trust me it’s infinitely more difficult to fol-
low that day in and day out. Therein lies the dif-
ference between a good player and a truly great
player.
In real world, overconfidence results in two tan-
gible implications: Traders tend to make un-
called for and unjustified bets based on their
perceived ability to interpret information, when
in actuality they do not have all the information
to form unbiased projections. Secondly, traders
tend to trade more frequently than can be justi-
fied by the information.
Regret Minimization
In an investment framework, regret is the feeling
in hindsight of making a bad decision. It is that
“If only I had done that…” feeling that we get
once in every while. In poker, there will be
many a hand which you will feel, in hindsight,
you should never have got in. You have a mar-
ginal hand right from pre-flop and you keep on
calling all your opponent’s bet till the river, only
to find out to your dismay that he had, as ex-
pected, a far better hand from the beginning and
you had lost quite a bit of your chip stack in the
process. The other case is when you had the best
hand from the pre-flop stages till the turn, but
 MONEY MANAGER AUG 2010
your opponent forms a better hand right at the
river. You curse yourself, if only I had bet a lit-
tle more, he would have folded earlier.
Many poker pros concede that the most difficult
thing to master is the art of folding in poker. To
call it quits when it ought to be quit. When fac-
ing themselves in a situation where they have a
feeling of regret, a large majority of players do
either of the following two: They bet large even
on very weak hands else they play so tightly that
they don’t win as much as they could have, even
on very good hands.
Contrast this to the real world. In behavioral fi-
nance, regret minimization framework states
that investors, in order to avoid the feeling of
regret, tend to be too risk averse and stay put in
safe instruments like bonds and bills leading to a
lack of diversity in their portfolio. They also
tend to stick on to profitable investments rather
than sell it. Diametrically opposite is the case of
an investor who, in order to reduce his regret
levels, harps on to very risky investments hop-
ing that the windfall from the new investments
will offset his previous losses.
Seeing patterns
69
THE LIGHTER SIDE OF FINANCE
Seeing patterns where none exists is another of
the major emotional errors. A famous study by
two professors – Werner DeBondt of DePaul
University and Richard Thaler of the University
of Chicago – showed that investors relying on
past information and market return patterns be-
came over-optimistic about past winners and
over-pessimistic about past losers. But in reality
the stock returns patterns never repeated.
Holding onto losers
According to behavioral finance, loss aversion
refers to the individual’s reluctance to accept a
loss. And when seen from the loss aversion
framework, even though a stock might have
come down considerably from its cost price, in-
vestors tend to hold it, hoping that it will recov-
er. Relate this to a poker player, who, even
though on a losing spree, keeps taking re-buyins
and keeps on playing hoping that he will win
one big hand which will make up his losses.
And, so goes on the search for that one elusive
hand like those French searching eternally for
that elusive Scarlet Pimpernel.
Another instance in poker is when, even though
you know you have a very weak hand, you still
call your opponent’s bet for the sole reason that
you have already invested so much in the pot in
that particular hand. Whereas the logic of eco-
nomics and sunk cost tells you that you need to
fold, that god-forsaken ego of yours doesn’t al-
low you to admit that you have taken a bad deci-
sion and that you are losing. So what ensues? In
majority cases, you refuse to accept that you are
holding on to a losing hand and you keep on
calling.
Conclusion
As poker pros often tell you, you should reward
yourself on taking good decisions and not on
winning huge pots. There will be times when the
pot’s outcome is out of your control. As Stephen
Covey would tell you, the pot’s outcome is your
circle of concern, but taking good decisions and
THE LIGHTER SIDE OF FINANCE AUG 2010 MONEY MANAGER

playing good poker is in your circle of control.
‘Bad beats’ are a way of life. You can’t pick
winners all your life. But if your decisions are
based on solid research, then you are bound to
make money in the long run.
Any smart player will know – the short run nev-
er matters. It’s the long run which determines
how good a player or trader you are. And re-
member, in the long run, the theory of probabil-
ity is always true. Always. And as your Strategy
Professor would have it, “Hope is never a strate-
gy.”

References : 
 
http://economics-files.pomona.edu/GarySmith/PokerPlayers.pdf
http://articles.chicagotribune.com/2010-01-31/news/1001280626_1_professional-poker-players-poker-face-
poker-table
http://www.kiplinger.com/features/archives/how-texas-hold-em-simulates-investing.htmlhttp://
www.bloomberg.com/apps/news?pid=newsarchive&sid=alximP6.Eta8

About the Author : 
 
Sethu Chidambaram is a 2nd year PGP student at IIM Calcutta. He can be reached at csethu@gmail.com

70
 MONEY MANAGER AUG 2010
Financial Crossword 
Across
2.To assume financial responsibility for or guarantee
against failure
6.A writedown in the valuation or return of an asset to
partially forgive a debt
11.A psychological phenomenon whereby people do
something primarily because other people are doing it
12.Recurring stream of fixed payments over a specified
period of time
13.A trade where you borrow and pay interest in order to
buy something else that has higher interest
14.To pledge securities as collateral for a loan when the
same securities have already been pledged for another
loan
16.A measurement of the income distribution of a coun-
try's residents, helps define the gap between the rich and
the poor
17.The gradual elimination of a liability, such as a mort-
gage, in regular payments over a specified period of time
18.The synthetic collateralized debt obligation at the heart
of SEC charges against Goldman Sachs
20.Degree of similarity between a given time series and a
lagged version of itself over successive time intervals
21.An option with a built in mechanism to expire worth-
less should a specified price level be exceeded
Down
1.A derivative security issued by the company that gives
the holder the right to purchase securities from the issuer
at a specific price within a certain time frame
3.When a parent company sells a portion or all of its inter-
est in a subsidiary to the public in an IPO
4.A fund that tracks an index, but can be traded like a
stock
5.A condition of slow economic growth and relatively
high unemployment
7.The process of removing coupons from a bond and then
selling the separate parts as a zero coupon bond and inter-
est paying coupons
8.A procedure used to calculate the zero-coupon yield
curve from market figures
9.The amount of benefit that is associated with physically
owning a particular good, rather than owning a futures
contract for that good
10.Instruments used by foreign investors or hedge funds
that are not registered with the SEBI
15.A condition in which distant delivery prices for futures
exceed spot prices
19."A financial product that offers you life insurance as
well as an investment like a mutual fund "
 AUG 2010 MONEY MANAGER

Financial Crossword 
Send in your entries for the Financial Crossword to
moneymanager.abc@gmail.com. Cash prizes worth
INR 5000 await the top three entries!

The winners will be announced next week on our

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