FINANCE GUIDEBOOK

The Finance Club

Contents
Accounting ............................................................................................................................................ 3
Financial Markets ................................................................................................................................ 18
Banking................................................................................................................................................ 31
Economics ........................................................................................................................................... 33
Recent Developments ......................................................................................................................... 45
Historical Events.................................................................................................................................. 49
Careers in Finance ............................................................................................................................... 57

Accountancy
What is Accounting?
Accounting is the guide-post for management. It points out the problems faced or likely to be faced by
the firm. A firm should know the financial implications of its operations. The financial score of the firm is
kept by the accounting system. Accounting is the medium through which business organizations
communicate their financial performance and financial position to the outside world. Accounting is the
process of identifying, measuring and communicating economic information to permit informed
judgements and decisions by users of the information. Accounting is defined as the systematic and
comprehensive recording of financial transactions pertaining to a business. Accounting also refers to the
process of summarizing, analyzing and reporting these transactions.
Who are the users of accounting information?
The accounting information is used by both internal and external stakeholders. The most predominant
group of external stakeholders includes the suppliers of capital which includes shareholders, lending
banks and financial institutions, bond holders and other lenders, etc. These stakeholders have financial
interest in the business and therefore are interested in knowing about the financial performance and
health of the organization. These groups have a direct stake in the financial health of the organization.
They use the accounting information to access the risk return profile of the company. The information
contained in the financial statements helps them to judge the return they expect from their investment
as well as the risk they are exposed to by investing and lending to the organization.
Tax authorities are also interested in the accounting information. As business units are liable to pay tax
on their taxable income, accounting information is used to ascertain the same.
What is meant by Accounting Cycle?
The accounting cycle involves:1. IDENTIFYING THE BUSINESS TRANSACTIONS : All business transactions carried out by the firm are
identified. Business activities are separated from the non-business activities.
2. CLASSIFYING THE BUSINESS TRANSACTION: The business activities are then classified according to
their nature and recording in the financial statements.
3. RECORDING THE BUSINESS TRANSACTION: The identified business transactions are recorded for
maintaining proper records of firms activities. Journals, ledgers and Trial Balance are used for
recording transactions.
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4. SUMMARIZING THE BUSINESS TRANSACTIONS : The business transactions are summarized on

periodical basis to interpret the firms profitability and performance. Profit and Loss account,
Balance Sheet, and Cash Flow statements are use for summarizing.
5. INTERPRETING THE BUSINESS TRANSACTIONS: The financial performance of the firm is interpreted to
arrive at the profitability position of the firm. Trend Analysis, Common Size, Ratio Analysis are
used for the interpretation amongst others available.
What is the role of various agencies and government agencies?
The accounting practices are greatly influenced by the regulatory requirements prescribed. As the
financial statements are used by the external users, suitable provisions should be made in applicable acts
to ensure comparability of information.
COMPANIES ACT, 1956: It governs the creation, continuation and winding up of companies and also the
relationships between the shareholders, the company, the public, and the government. The act also has
provisions regarding the books of accounts to be kept by companies, format of financial statements and
authentication of financial statements. Companies Bill 2012 has been passed by both the houses and is
awaiting Presidents assent. Once approved by the President, it will be called The Companies Act 2013.
MINISTRY OF CORPORATE AFFAIRS: It is primarily responsible for the administration of the companies act,
1956. In addition it also supervises three professional accounting bodies namely the Institute of Chartered
Accountant of India (ICAI), the Institute of Cost and Works Accountants of India (ICWAI) and the Institute
of Company Secretaries of India (ICSI).
RESERVE BANK OF INDIA: The Reserve bank of India is the central bank of India and was set up in 1935 to
regulate the business of banking in India. RBI also supervises the banking companies and issues circulars
relating to disclosures in the notes of accounts to the financial statements.
BANKING REGULATIONS ACT, 1949: It states that every banking company incorporated in India is required
to prepare a Balance Sheet and a Profit and Loss account for each accounting period and these financial
statements of banking companies must be prepared in the format prescribed in the Third Schedule of
banking Regulations Act 1949.
INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY: IRDA was established in 1999 to protect the
interests of holders of insurance policies, to regulate, to promote and ensure orderly growth of the
insurance industry in India. The financial statements of insurance companies must be prepared in the
format prescribed by IRDA regulations.
SECURITIES AND EXCHANGE BOARD OF INDIA: SEBI was established by an act of parliament in the year 1992
to protect the interests of investors in securities and to promote the development of, and to regulate,
the securities market. The act gives SEBI powers to specify the requirements of listing of securities.
INCOME TAX ACT, 1961: Financial accounting and tax accounting are two distinct branches of accounting.
The taxable income is computed as per the provisions of Income Tax Act, 1961 whereas reported profits
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for financial accounting is determined based upon the applicable accounting standards and requirements
of the Companies Act, 1956.
CONFEDERATION OF ASIAN AND PACIFIC ACCOUNTANTS : The Confederation of Asian and Pacific Accountants
(CAPA) represent national professional accounting organisations in the Asia-Pacific region.
INTERNATIONAL FEDERATION OF ACCOUNTANTS: International Federation of Accountants (IFAC) is the global
organization for the accountancy profession.
What are the different types of accounts?
For the usage in Accounting, Accounts are classified into:
1. REAL ACCOUNTS: Real Accounts are accounts relating to assets owned by the enterprise. For Excash, machinery, etc.
2. PERSONAL ACCOUNTS : Personal Accounts are accounts relating to the persons, both natural and
legal, with whom the enterprise has business transactions. They represent the amount
receivables and payable by the enterprise. For Ex- Capital Account, Loan from Banks, etc.
3. NOMINAL ACCOUNTS: Nominal Accounts are accounts relating to income and expenses. For Exsales, rent earned and paid, etc.
What do you mean by journal entry?
Journal entry is the beginning of the accounting cycle. Journal entries are the logging of business
transactions and their monetary value into the t-accounts of the accounting journal as either debits or
credits. Journal entries are usually backed up with a piece of paper; a receipt, a bill, an invoice, or some
other direct record of the transaction. Easy to record and to maintain traceability for each transaction
What is a Ledger?
Ledger is a book of accounts in which data from transactions recorded in journals are posted and thereby
classified and summarized. It is typically used by businesses that employ the double-entry bookkeeping
method - where each financial transaction is posted twice, as both a debit and a credit, and where each
account has two columns.
What is a Trial Balance?
Trial Balance is the aggregate of all debits and credit balances at the end of an accounting period. It shows
if the general ledger is in balance (total debits equal total credits) before making closing entries and serves
as a worksheet for making closing entries. It provides the basis for making draft financial statements.

What do you mean by financial statement and explain types of financial statements and their
functions?
Financial statements can be referred to as representation of the financial status of a company in a
systematically documented form. These written reports help to quantify the financial strength,
performance and liquidity of a company.
There are three different types of financial statements. The different types of financial statements indicate
the different activities occurring in a particular business house.

Balance Sheet
Income statement
Cash flow statement

What is a Balance Sheet?

Balance Sheet presents the financial position of an entity at a given date. It is comprised of the following
three elements:

ASSETS : Something a business owns or controls (e.g. cash, inventory, plant and machinery,
etc)
LIABILITIES: Something a business owes to someone (e.g. creditors, bank loans, etc)
EQUITY (CAPITAL ): What the business owes to its owners. This represents the amount of capital
that remains in the business after its assets are used to pay off its outstanding liabilities. Equity
therefore represents the difference between the assets and liabilities.

What is meant by Income Statement?

Also known as the P&L statement or the Profit And Loss Statement, this statement ascertains the profit
and loss of any business. Income Statement is composed of the following two elements:

Income: What the business has earned over a period (e.g. sales revenue, dividend income,
etc)
Expense: The cost incurred by the business over a period (e.g. salaries and wages,
depreciation, rental charges, etc)

Net profit or loss is arrived by deducting expenses from income.

What is a Cash Flow Statement?
Cash Flow Statement, presents the movement in cash and bank balances over a period. The movement in
cash flows is classified into the following segments:

Operating Activities: Represents the cash flow from primary activities of a business.
Investing Activities: Represents cash flow from the purchase and sale of assets other than
inventories (e.g. purchase of a factory plant)
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Financing Activities: Represents cash flow generated or spent on raising and repaying share
capital and debt together with the payments of interest and dividends.

Which are the twelve generally accepted accounting principles? Explain.

Separate Entity Concept
The business entity concept provides that the accounting for a business or organization be kept separate
from the personal affairs of its owner, or from any other business or organization. The balance sheet of
the business must reflect the financial position of the business alone. Also, when transactions of the
business are recorded, any personal expenditures of the owner are charged to the owner and are not
allowed to affect the operating results of the business.
The Going Concern Concept
The going concern concept assumes that a business will continue to operate, unless it is known that such
is not the case. This concept has strong implication on the valuation of assets of the business. For example,
a supply of envelopes with the company's name printed on them would be valued at their cost. This would
not be the case if the company were going out of business. In that case, the envelopes would be difficult
to sell because the company's name is on them. When a company is going out of business, the values of
the assets usually suffer because they have to be sold under unfavourable circumstances. The values of
such assets often cannot be determined until they are actually sold.
The Principle of Conservatism
The principle of conservatism provides that accounting for a business should be fair and reasonable. It is
better to understate the financial position of the business rather than overstate. Probable gains should
be ignored but account for probable losses should be made.
The Objectivity Principle
The objectivity principle states that accounting will be recorded on the basis of objective evidence.
Objective evidence means that different people looking at the evidence will arrive at the same values for
the transaction. Simply put, this means that accounting entries will be based on fact and not on personal
opinion or feelings.
The source document for a transaction is almost always the best objective evidence available. The source
document shows the amount agreed to by the buyer and the seller, who are usually independent and
unrelated to each other.
Accounting Period Concept
This concept provides that accounting to take place over specific time periods known as fiscal periods. It
is usually of 12 months. These fiscal periods are of equal length, and are used when measuring the
financial progress of a business.
The Accrual Basis of accounting concept
Cash basis- transactions are recorded on receipt and payment of cash.

Accrual basis- revenue is recorded when earned while expenses are recorded when incurred irrespective
of when received or paid.
Example - Think of the building of a large project such as a dam. It takes a construction company a number
of years to complete such a project. The company does not wait until the project is entirely completed
before it sends its bill. Periodically, it bills for the amount of work completed and receives payments as
the work progresses. Revenue is taken into the accounts on this periodic basis.
The Matching Principle
The matching principle states that each expense item related to revenue earned must be recorded in the
same accounting period as the revenue it helped to earn. If this is not done, the financial statements will
not measure the results of operations fairly.
The Cost Concept
The cost principle states that the accounting for purchases must be at their cost price. This is the figure
that appears on the source document for the transaction in almost all cases. The value recorded in the
accounts for an asset is not changed until later if the market value of the asset changes. It would take an
entirely new transaction based on new objective evidence to change the original value of an asset.
The Consistency Principle
The consistency principle requires accountants to apply the same methods and procedures from period
to period. When they change a method from one period to another they must explain the change clearly
on the financial statements. The consistency principle prevents people from changing methods for the
sole purpose of manipulating figures on the financial statements.
The Materiality Principle
The materiality principle states that all information that affects the full understanding of a company's
financial statements must be include with the financial statements provide but unnecessary details should
be avoided.
The Dual Concept
Every transaction affects at least two accounts in such a way that the below equation would always be
balanced.
Assets= Capital + Liabilities
Money Measurement Concept
It states that all the events and transactions should be converted and expressed in money terms are
subject matter of accounting. If business units earn revenue in different currencies then the financial
statements are prepared using a uniform currency called reporting currency.

What do you mean by accounting standards? Name all the accounting standards.
Accounting standards translate general accounting principle to specific accounting principles to specific
accounting rules and are mandatory to be followed. While 32 Accounting Standards have been issued by
ICAI, the following 29 are mandatory:
AS 1
AS 2
AS 3
AS 4
AS 5
AS 6
AS 7
AS 9
AS 10
AS 11
AS 12
AS 13
AS 14
AS 15
AS 16
AS 17
AS 18
AS 19
AS 20
AS 21
AS 22
AS 23
AS 24
AS 25
AS 26
AS 27
AS 28
AS 29

Disclosure of Accounting Policies

Valuation of Inventories
Cash Flow Statements
Contingencies and Events Occurring after the Balance Sheet Date
Net Profit or Loss for the period, Prior Period Items and Changes in Accounting Policies
Depreciation Accounting
Construction Contracts (revised 2002)
Revenue Recognition
Accounting for Fixed Assets
The Effects of Changes in Foreign Exchange Rates (revised 2003),
Accounting for Government Grants
Accounting for Investments
Accounting for Amalgamations
Employee Benefits (revised 2005)
Borrowing Costs
Segment Reporting
Related Party Disclosures
Leases
Earnings per Share
Consolidated Financial Statements
Accounting for Taxes on Income.
Accounting for Investments in Associates in Consolidated Financial Statements
Discontinuing Operations
Interim Financial Reporting
Intangible Assets
Financial Reporting of Interests in Joint Ventures
Impairment of Assets
Provisions, Contingent Liabilities and Contingent Assets

What is IFRS?
International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the
International Accounting Standards Board (IASB), which is an independent accounting standard-setting
body consisting of 14 members from nine countries and is based in London. IFRS are becoming the global
standard for the preparation of public company financial statements.

What is meant by convergence with IFRS?

Convergence means that the Indian Accounting Standards (AS) and the International Financial Reporting
Standards (IFRS) would, over time, continue working together to develop high quality, compatible
accounting standards. As per the notification of the Ministry of Corporate Affairs, convergence of Indian
Accounting Standards (AS) with International Financial Reporting Standards (IFRS) will take place in
phases. The first phase commenced on 1st April 2011 and is expected to be over by 2014.
What is an asset in financial accounting?
Any item of economic value owned by an individual or corporation, especially that which could be
converted to cash. E.g.: land, buildings, furniture, patent, etc.
What are the different types of assets?
Assets can be classified into 2 types:
1. TANGIBLE ASSETS : Assets that have a physical substance such as currencies, buildings, real estate,
vehicles, inventories, equipment, and precious metals are called tangible assets. They can be
further classified into current assets and fixed assets.
2. INTANGIBLE ASSETS: They lack of physical substance and usually are very hard to evaluate which
includes patents, copyrights, franchises, goodwill, trademarks, trade names, etc.
What are current assets and different types of it?
Current assets are cash and other assets which can be converted to cash or consumed either in a year or
in the operating cycle (whichever is longer), without disturbing the normal operations of a business. There
are 5 major items which can be included into current assets:
1. CASH AND CASH EQUIVALENTS: This includes currency and other assets such as deposit accounts,
money orders, cheque, bank drafts which can be converted to cash immediately.
2. SHORT- TERM INVESTMENTS : They include securities bought and held for sale in the near future to
generate income on short-term price differences (trading securities).
3. ACCOUNT RECEIVABLES: They represent money owed by entities to the firm on the sale of products
or services on credit. They are shown in the balance sheet as an asset. To record a journal entry
for a sale on account, one must debit a receivable and credit a revenue account. When the
customer pays off their accounts, one debits cash and credits the receivable in the journal entry.
The ending balance on the trial balance sheet for accounts receivable is usually a debit.
4. INVENTORY: It is commonly used to describe the goods and materials that a business holds for the
ultimate purpose of resale (or repair).The inventory of a manufacturer should report the cost of
its raw materials, work-in-process, and finished goods. The cost of inventory should include all
costs necessary to acquire the items and to get them ready for sale.
5. PRE-PAID EXPENSES : They arise as a result of business making payments for goods and services to
be received in the near future. While prepaid expenses are initially recorded as assets, their value

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is expensed over time as the benefit is received onto the income statement, because unlike
conventional expenses, the business will receive something of value in the near future.
What are fixed assets?
Fixed assets are tangible assets held by an entity for the production or supply of goods and services, for
rentals to others, or for administrative purposes. These assets are expected to be used for more than one
accounting period. They are generally not considered to be a liquid form of assets unlike current assets.
They include buildings, land, furniture and fixtures, machines and vehicles.
E.g.: If a company is in the business of selling cars, it must not account for cars held for resale as fixed
assets but instead as inventory assets. However, any vehicles other than those held for the purpose of
resale may be classified as fixed assets such as delivery trucks and employee cars.
What is a liability?
A liability is commonly defined as an obligation of an entity arising from past transactions or events. They
are reported on a balance sheet and are usually divided into two categories:
1. CURRENT LIABILITIES : These liabilities are reasonably expected to be liquidated within a year. They
usually include payables such as wages, accounts, taxes, and accounts payable, unearned revenue
when adjusting entries, portions of long-term bonds to be paid this year, short-term obligations
(e.g. from purchase of equipment).
2. LONG-TERM LIABILITIES : These liabilities are reasonably expected not to be liquidated within a year.
They usually include issued long-term bonds, notes payables, long-term leases, pension
obligations, and long-term product warranties. The balance sheet is based upon the following
equation:
ASSETS = LIABILITIES + OWNER'S E QUITY
What is Owner's equity?
Owner's equity is an individual or company's net worth. This is calculated by taking the value of all assets
and subtracting the value of all liabilities. Owner's equity is used in determining an individual's or
company's creditworthiness, and can be used in determining the value of a business when its owner or
shareholders want to sell. It also includes the value of intangible assets and liabilities. It is sometimes
referred to as the book value of the company.
What is Shareholders Fund?
It represents the actual amount put in the business by the owners and the amount raised by issuance of
shares and earnings retained. Shareholders fund is generally divided into two parts- share capital and
reserves and surplus.

SHARE CAPITAL : It represents the amount raised by issuance of shares at the face value.
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RESERVE AND SURPLUS : It represents the part of profit that has been retained by the company after
paying out the dividends. It is also called as retained earnings.

E.g.: you have started a business by investing Rs. 100,000. After an year, the business have earned a profit
of Rs 50,000 out of which you decided to keep Rs. 10,000 to yourself and the remaining amount to be
reused in future of the business. In this case, Rs. 40,000 will be the retained earnings while Rs. 100,000
will be the owners share in the business. After few years, you have decided to raise investments in your
business by issuing 10,000 shares at a face value of Rs 10. The amount of Rs. 100,000 raised will be the
share capital.
What are dividends?
It represents a part of the profit that is distributed to the shareholders. The final dividend is proposed by
the directors of the company. The dividends released attract a tax called as dividend distribution tax or
corporate distribution tax and is deducted from the profit made by the company.
Continuing with the above example, your business have earned a profit of Rs. 100,000 and you being the
Director of your business have decided to give out 10% dividend to your shareholders. The dividend
released has attracted the dividend distribution tax of 10% on the amount of dividend issued. As a result
an amount of Rs. 10,000 will be issued for the dividends and Rs 1,000 will be the dividend distribution tax
and the profit will be apportioned accordingly.
What is the distinction between debtor and creditor?
A DEBTOR is a person or enterprise that owes money to another party. (The party to whom the money is
owed is often a supplier or bank that will be referred to as the creditor.)
CREDITORS are the entities which give some type of credit to a borrower or debtor. A creditor could a
company, person, organization, government, a bank, a corporation or a credit card issuer. They look at
financial information before giving out money (for a loan) to businesses.
E.g.: If Company X borrowed money from its bank, Company X is the debtor and the bank is the creditor.
If Supplier A sold merchandise to Retailer B, then Supplier A is the creditor and Retailer B is the debtor.
What are the different types of credits?

SECURED LOAN OR CREDIT: Loan will be given only if there is some kind of asset or property offered by
the borrower. This approach helps to reduce the risk to the entity or individual which is providing the
credit or loan, because there is always the choice of laying claim to the pledged asset during the time
that the borrower fails to pay the loan amount according to the loan agreement or contract.
UNSECURED LOAN OR CREDIT: Some creditors prefer to not entail the pledging of some kind of asset in
exchange for giving a credit or loan to the borrower. In this situation, the creditor has a lot of details
in order to indicate there is an adequate amount of confidence which the debtor would repay the full
amount of the debt in an appropriate manner.

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What are trade payables?

Liabilities owed to suppliers for purchases or services rendered. They are also referred as accounts payable
or as sundry creditors. For example, when any goods are purchased on credit from the vendor then that
amount is included under the head trade payables.
What is depreciation?
The process of appropriating the cost of a fixed asset over its useful life is called depreciation. The term
depreciation is associated with tangible assets such as plant machinery, furniture, building and vehicles.
E.g.: If a company buys a piece of equipment for $1 million and expects it to have a useful life of 10 years,
it will be depreciated over 10 years. Every accounting year, the company will expense $100,000 (assuming
straight-line depreciation), which will be matched with the money that the equipment helps to make each
year.
What are the various methods of computing depreciation?
1. STRAIGHT LINE METHOD : This method depreciates cost evenly throughout the useful life of the fixed
asset.
Depreciation per annum = (Cost - Residual Value) / Useful Life
2. DECLINING BALANCE METHOD: This method charges depreciation at a higher rate in the earlier years
of an asset. The amount of depreciation reduces as the life of the asset progresses.
Depreciation per annum = (Net Book Value - Residual Value) x Rate%
Where, Net Book Value is the asset's net value at the start of an accounting period. It is calculated
by deducting the accumulated (total) depreciation from the cost of the fixed asset. Residual Value
is the estimated scrap value at the end of the useful life of the asset. As the residual value is
expected to be recovered at the end of an asset's useful life, there is no need to charge the portion
of cost, equaling the residual value. Rate of depreciation is defined according to the estimated
pattern of an asset's use over its life term.
3. SUM-OF-THE-YEARS '-DIGITS METHOD: This is one of the accelerated depreciation techniques which
are based on the assumption that assets are generally more productive when they are new and
their productivity decreases as they become old.
SYD Depreciation = (Depreciable Base Remaining Useful Life)/Sum of the Years' Digits
Where, depreciable base is the difference between cost and salvage value of the asset.

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What is amortization?
It is defined as the deduction of capital expenses over a specific period of time (usually over the asset's
life). More specifically, this method measures the consumption of the value of intangible assets, such as
a patent or a copyright.
E.g.: Suppose XYZ Biotech spent $30 million dollars on a piece of medical equipment and that the patent
on the equipment lasts 15 years, this would mean that $2 million would be recorded each year as an
amortization expense.
What is Inventory?
It includes the raw materials, work-in-progress goods and finished goods that are ready or will be ready for sale
and are considered as assets to any business. The composition of inventories will depend upon the nature of
business of the organization. A manufacturing company will have all the above components, a trading company
will have only finished goods and a service company may not have any inventory at all. Inventory is always
valued at lower of cost or net realizable value. First-in-First-Out (FIFO), Last-in-Last-Out (LIFO), specific
identification method and average cost method are the methods used for evaluating the inventory. As per AS
2 the cost of inventories should be assigned by using either FIFO or weighted average method.

What is a ratio? What are the different kinds of financial ratios?

Ratios express one item in relation to other and draw inference of this expression. Ratios are very
important as they help to analyze the financial statements of a company or a firm.
Ratios are of following types:
1.
2.
3.
4.
5.
6.
7.
8.
9.

Profitability Ratios
Growth Ratios.
Dividend policy ratios
Short-term liquidity ratio
Capital structure ratio
Asset utilization ratio
Return ratio
Market Ratio
Price to book value ratio

What is profitability ratio? What are the different kinds of profitability ratios?
A class of financial metrics that are used to assess a business's ability to generate earnings as compared
to its expenses and other relevant costs incurred during a specific period of time.
Following are the different profitability ratios:
Gross Profit Ratio =

Sales Cost of Goods Sold

Sales

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EBITDA
Sales

Cash Operating Margin =

Operating Margin =
Net Profit Ratio =

EBIT
Sales

PAT
Sales

Operating Expenses Ratio =

Earnings per Share =

Operating Expenses
Sales

PAT Dividend on Preference Shares (if any)

No. of Equity Shares

What is growth ratio? What are the different kinds of growth ratios?
Growth ratio indicates the growth of the company based on its historical performance.
Following are the different growth ratios:
COMPOUND ANNUAL GROWTH RATIO (CAGR) indicates average annual growth achieved by an enterprise
during a given period of time.
= (1 + )
Where
A = current value
P = base value
g = CAGR
n = difference between current year and base year.
YEAR ON YEAR GROWTH RATIO (Y-O-Y) gives the long term average growth of key financial variables.
Year on Year growth =

Current Year Sales Previous Year Sales

Previous Year Sales

What is dividend policy ratio? What are the different kinds of dividend policy ratios?
Dividend policy ratios measure how much a company pays out in dividends relative to its earnings and
market value of its shares. These ratios provide insights into the dividend policy of a company.
Dividend Rate =

Total Dividend
No. of Shares

Dividend Payout Ratio =

Dividends + Dividend Distribution Tax

PAT

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Dividend Yield =

Dividend per Share

Current Market Price

What is Short-term Liquidity ratio? What are the different kinds of Short-term Liquidity
ratios?
Short-term liquidity ratios indicate the adequacy of the companys current assets to meet its current
obligations.
Current Ratio =
Quick Ratio =

Current Assets
Current Liabilities

Current Assets Inventories

Current Liabilities

What is Capital Structure ratio? What are the different kinds of Capital Structure ratios?
Capital Structure ratios indicate the proportion of borrowed funds and share holders fund in total capital
employed.
Debt Equity Ratio =

Long term Debts

Shareholders Fund

Fixed Assets to Long term Debt =

Interest Coverage Ratio =

Fixed Assets
Long term Debts

EBIT
Interest

Debt Service Coverage Ratio =

EBIT + Depreciation + Other Non Cash Expenses

Loan Installment
Interest +
(1 Tax Rate)

What is Asset Utilization ratio? What are the different kinds of Asset Utilization ratios?
The asset utilization ratio measures management's ability to make the best use of its assets to generate
revenue. This is particularly meaningful in a manufacturing, where fewer capital assets are used to
produce products.
Total Assets Turnover Ratio =

Sales
Total Assets

Fixed Assets Turnover Ratio =

Sales
Fixed Assets

Current Assets Turnover Ratio =

Inventory Turnover Ratio =

Sales
Current Assets

Cost of Goods Sold

Average Inventories
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Average Holding Period =

365
Inventory Turnover Ratio

Debtors Turnover Ratio =

Sales
Average Debtors

Days of Sales Outstanding =

365
Debtors Turnover Ratio
365 Creditors
Purchases

Average Payment Period =

Length of Cash Conversion Cycle = Average Holding Period + Days of Sales Outstanding + Average Payment Period

What is Return ratio? What are the different kinds of Return ratios?
Return ratios indicate the returns earned by a company with respect to its assets, equity, capital employed
etc.
Return of Assets (ROA) =

EBIT(1 Tax Rate)

Total Assets

Return on Capital Employed (ROCE) =

Return on Equity (ROE) =

EBIT(1 Tax Rate)

Capital Employed

PAT
Shareholders Funds

DuPont Analysis
Return on Equity (ROE) =

PAT
Sales
Total Assets

Sales Total Assets Shareholders Funds

What is Price-to-Book Value ratio? What are the different kinds of Price-to-Book Value ratios?
Price to Book Value Ratio =

Current Market Price

Book Value per Share

P
Current Market Price
Price Earnings ( ) Ratio =
E
Earnings per Share
Price Earnings to Growth Ratio =

Price Earnings Ratio

Growth Rate

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Financial Markets
What is a Share?
Total equity capital of a company is divided into equal units of small denominations, each called a share.
Each share forms a unit of ownership of a company and is offered for sale so as to raise capital for the
company. For example, in a company the total equity capital of Rs 2,00,00,000 is divided into 20,00,000
units of Rs 10 each. Each such unit of Rs 10 is called a Share. Thus, the company then is 12 said to have
20,00,000 equity shares of Rs 10 each. The holders of such shares are members of the company and have
voting rights.
Shares can be broadly divided into two categories - equity and preference shares.
EQUITY SHARES give their holders the power to share the earnings/profits in the company as well as a
vote in the AGMs of the company. Such a shareholder has to share the profits and also bear the losses
incurred by the company.
PREFERENCE SHARES earn their holders only dividends, which are fixed, giving no voting rights.
What is a Debt Instrument?
Debt instrument represents a contract whereby one party lends money to another on pre-determined
terms with regards to rate and periodicity of interest, repayment of principal amount by the borrower to
the lender.
In the Indian securities markets, the term bond is used for debt instruments issued by the Central and
State governments and public sector organizations and the term debenture is used for instruments
issued by private corporate sector.
What is a Derivative?
A derivative is a product whose value is derived from the value of one or more underlying variables or
assets in a contractual manner. The underlying asset can be equity, Forex, commodity or any other asset.
For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change
in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven
by the spot price of wheat which is the "underlying".
Some commonly used FINANCIAL DERIVATIVES are:
FORWARDS: A forward contract is a customized contract between two entities, where settlement takes
place at a specific date in the future at todays predetermined price.
E.g.: On 1st June, X enters into an agreement to buy 50 bales of cotton for 1st December at Rs.1000
per bale from Y, a cotton dealer. It is a case of a forward contract where X has to pay Rs.50000 on 1st
December to Y and Y has to supply 50 bales of cotton.
FUTURES: A futures contract is an agreement between two parties to buy or sell the underlying asset
at a future date at today's future price. Futures contracts differ from forward contracts in the sense
18

that they are standardized and exchange traded. To facilitate liquidity in the futures contracts, the
exchange specifies certain standard quantity and quality of the underlying instrument that can be
delivered, and a standard time for such a settlement.
OPTIONS : An Option is a contract which gives the right, but not an obligation, to buy or sell the
underlying at a stated date and at a stated price. While a buyer of an option pays the premium and
buys the right to exercise his option, the writer of an option is the one who receives the option
premium and therefore obliged to sell/buy the asset if the buyer exercises it on him.
Options are of two types - CALL and PUT options:
CALLS give the buyer the right but not the obligation to buy a given quantity of the underlying
asset, at a given price on or before a given future dates.
Puts give the buyer the right, but not the obligation to sell a given quantity of underlying asset
at a given price on or before a given future date.
Presently, at NSE, futures and options are traded on the Nifty, CNX IT, BANK Nifty and 116 single
stocks.
WARRANTS: Options generally have lives of up to one year. The majority of options traded on
exchanges have maximum maturity of nine months. Longer dated options are called Warrants and
are generally traded over-the-counter.

Define Commodity Derivatives market.

Commodity derivatives market trade contracts for which the underlying asset is commodity. It can be an
agricultural commodity like wheat, soybeans, rapeseed, cotton, etc. or precious metals like gold, silver,
etc.
What is the difference between Commodity and Financial Derivatives
The basic concept of a derivative contract remains the same whether the underlying happens to be a
commodity or a financial asset. However there are some features which are very peculiar to commodity
derivative markets. In the case of financial derivatives, most of these contracts are cash settled. Even in
the case of physical settlement, financial assets are not bulky and do not need special facility for storage.
Due to the bulky nature of the underlying assets, physical settlement in commodity derivatives creates
the need for warehousing. Similarly, the concept of varying quality of asset does not really exist as far as
financial underlying is concerned. However in the case of commodities, the quality of the asset underlying
a contract can vary at times.
What is a Mutual Fund?
A Mutual Fund is a corporate body registered with SEBI that pools money from individuals/corporate
investors and invests the same in a variety of different financial instruments or securities such as equity
shares, Government securities, Bonds, debentures etc. Mutual funds can thus be considered as financial
intermediaries in the investment business that collect funds from the public and invest on behalf of the
investors. Mutual funds issue units to the investors. The appreciation of the portfolio or securities in which

19

the mutual fund has invested the money leads to an appreciation in the value of the units held by
investors.
The investment objectives outlined by a Mutual Fund in its prospectus are binding on the Mutual Fund
scheme. The investment objectives specify the class of securities a Mutual Fund can invest in. The schemes
offered by mutual funds vary from fund to fund. Some are pure equity schemes; others are a mix of equity
and bonds. Investors are also given the option of getting dividends, which are declared periodically by the
mutual fund, or to participate only in the capital appreciation of the scheme.
What is an Exchange Traded Fund?
An ETF represents a basket of stocks that reflect an index such as the Nifty. An ETF trades just like any
other company on a stock exchange. Unlike a mutual fund that has its net-asset value (NAV) calculated at
the end of each trading day, an ETF's price changes throughout the day, fluctuating with supply and
demand. By owning an ETF, you get the diversification of an index fund plus the flexibility of a stock.
Because, ETFs trade like stocks, you can short sell them, buy them on margin and purchase as little as one
share. Another advantage is that the expense ratios of most ETFs are lower than that of the average
mutual fund. When buying and selling ETFs, you pay your broker the same commission that you'd pay on
any regular trade.
What is an Index?
An Index shows how a specified portfolio of share prices is moving in order to give an indication of market
trends. It is a basket of securities and the average price movement of the basket of securities indicates
the index movement, whether upwards or downwards.

NIFTY INDEX
S&P CNX Nifty (Nifty), is a scientifically developed, 50 stock index, reflecting accurately the market
movement of the Indian markets. It comprises of some of the largest and most liquid stocks traded
on the NSE. It is maintained by India Index Services & Products Ltd. (IISL), which is a joint venture
between NSE and CRISIL. The index has been co-branded by Standard & Poors (S&P). Nifty is the
barometer of the Indian markets.
SENSEX INDEX
S&P BSE SENSEX (S&P Bombay Stock Exchange Sensitive Index), also-called the BSE 30 or simply
the SENSEX, is a free-float market capitalization-weighted stock market index of 30 well-established
and financially sound companies listed on BSE Ltd.

What is a Depository?
A depository is like a bank wherein the deposits are securities (viz. shares, debentures, bonds, government
securities, units etc.) in electronic form.
There are two depositories in India which provide dematerialization of securities. The National Securities
Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL).
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The benefits of participation in a depository are:

Immediate transfer of securities
No stamp duty on transfer of securities
Elimination of risks associated with physical certificates such as bad delivery, fake securities, etc.
Reduction in paperwork involved in transfer of securities
Reduction in transaction cost
What is Dematerialization?
Dematerialization is the process by which physical certificates of an investor are converted to an
equivalent number of securities in electronic form and credited to the investors account with his
Depository Participant (DP).
Define Securities.
Securities includes instruments such as shares, bonds, stocks or other marketable securities of similar
nature in or of any incorporate company or body corporate, government securities, derivatives of
securities, units of collective investment scheme, interest and rights in securities, security receipt or any
other instruments so declared by the Central Government.
What is the function of Securities Market?
Securities Markets is a place where buyers and sellers of securities can enter into transactions to purchase
and sell shares, bonds, debentures etc. Further, it performs an important role of enabling corporate and
entrepreneurs to raise resources for their companies and business ventures through public issues.
Transfer of resources from those having idle resources (investors) to others who have a need for them
(corporate) is most efficiently achieved through the securities market. Stated formally, securities markets
provide channels for reallocation of savings to investments and entrepreneurship.
Savings are linked to investments by a variety of intermediaries, through a range of financial products,
called Securities.
Which are the securities one can invest in?

Shares
Government Securities
Derivative products
Units of Mutual Funds

Who regulates the Securities Market?

The responsibility for regulating the securities market is shared by Department of Economic Affairs (DEA),
Department of Company Affairs (DCA), Reserve Bank of India (RBI) and Securities and Exchange Board of
India (SEBI).

21

What is SEBI and what is its role?

The Securities and Exchange Board of India (SEBI) is the regulatory authority in India established under
SEBI Act, 1992. Its role includes:
Regulating the business in stock exchanges and any other securities markets
Registering and regulating the working of stock brokers, subbrokers etc.
Promoting and regulating self-regulatory organizations
Prohibiting fraudulent and unfair trade practices
Calling for information from, undertaking inspection, conducting inquiries and audits of the stock
exchanges, intermediaries, self regulatory organizations, mutual funds and other persons associated
with the securities market.
What are the different segments of Securities Market?
The securities market has two interdependent segments: the primary (new issues) market and the
secondary market. The primary market provides the channel for sale of new securities while the secondary
market deals in securities previously issued.
Define Primary Markets.
The primary market provides the channel for sale of new securities. Primary market provides opportunity
to issuers of securities; Government as well as corporates, to raise resources to meet their requirements
of investment and/or discharge some obligation.
They may issue the securities at face value, or at a discount/premium and these securities may take a
variety of forms such as equity, debt etc. They may issue the securities in domestic market and/or
international market.
Define Secondary Markets.
Secondary market refers to a market where securities are traded after being initially offered to the public
in the primary market and/or listed on the Stock Exchange. Majority of the trading is done in the secondary
market. Secondary market comprises of equity markets and the debt markets.
What is meant by Face Value of a share?
The nominal or stated amount assigned to a security by the issuer. For shares, it is the original cost of the
stock shown on the certificate; for bonds, it is the amount paid to the holder at maturity. It is also known
as par value or simply par. For an equity share, the face value is usually a very small amount (Rs. 5, Rs. 10)
and does not have much bearing on the price of the share, which may quote higher in the market, at Rs.
100 or Rs. 1000 or any other price.
When a security is sold above its face value, it is said to be issued at a Premium and if it is sold at less than
its face value, then it is said to be issued at a Discount.

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Why do companies need to issue shares to the public?

Most companies are usually started privately by their promoter(s). However, the promoters capital and
the borrowings from banks and financial institutions may not be sufficient for setting up or running the
business over a long term. So companies invite the public to contribute towards the equity and issue
shares to individual investors. The way to invite share capital from the public is through a Public Issue.
Simply stated, a public issue is an offer to the public to subscribe to the share capital of a company. Once
this is done, the company allots shares to the applicants as per the prescribed rules and regulations laid
down by SEBI.
What are the different kinds of issues?
Primarily, issues can be classified as a Public, Rights or Preferential issues (also known as private
placements). While public and rights issues involve a detailed procedure, private placements or
preferential issues are relatively simpler. The classification of issues is illustrated below:
INITIAL PUBLIC OFFERING (IPO)
IPO is when an unlisted company makes either a fresh issue of securities or an offer for sale of its
existing securities or both for the first time to the public. This paves way for listing and trading of
the issuers securities.
A FOLLOW ON PUBLIC OFFERING (FPO)
FPO is when an already listed company makes either a fresh issue of securities to the public or an
offer for sale to the public, through an offer document.
RIGHTS ISSUE
It is issued when a listed company which proposes to issue fresh securities to its existing
shareholders as on a record date. The rights are normally offered in a particular ratio to the
number of securities held prior to the issue. This route is best suited for companies who would
like to raise capital without diluting stake of its existing shareholders.
PREFERENTIAL ISSUE
Refers to the issue of shares or convertible securities by listed companies to a select group of
persons. This is a faster way for a company to raise equity capital.
What is meant by Market Capitalization?
The market value of a quoted company, which is calculated by multiplying its current share price (market
price) by the number of shares in an issue, is called as market capitalization. E.g. Company A has 120
million shares in issue. The current market price is Rs. 100. The market capitalization of company A is Rs.
12000 million.
How are companies classified on the basis of Market Capitalization?
BSEs classifies companies according to their Market Capitalization by using the 80-15-5 method. Heres
how this method works:
1. Arrange all the companies in descending order of their Market Capitalization.

23

2. The group of companies from the top, which together contribute 80% of the total Market
Capitalization are Large-cap Companies,
3. The next group of companies contributing 15% (80-95%) of Market capitalization are Mid-cap
companies, and
4. The remaining companies which contribute 5% of Market Capitalization are Small-cap companies.
Thus, the Large-cap companies, Mid-cap companies and Small-cap companies contribute 80%, 15% and
5% of the total Market Capitalization of the market respectively. This is known as the 80-15-5 method.
Alternatively, if we want to categories companies according to market capitalization, then in terms of
numbers companies can be categorized as:
TYPE
MARKET CAP RANGE
COMPANIES
LARGE-CAP
ABOVE RS 10,000 CRORES
TCS, AXIS BANK, MARUTI SUZUKI
INDIA
MID-CAP
2,000 TO 10,000 CRORES
APOLLO TYRES, CRISIL LTD.,
BRITANNIA INDUSTRIES LTD.
SMALL-CAP
UP TO 2,000 CRORES
ANDHRA
BANK,
BAJAJ
ELECTRICALS LTD
What is a Bond?
Bond is a negotiable certificate evidencing indebtedness. It is normally unsecured. A debt security is
generally issued by a company, municipality or government agency. A bond investor lends money to the
issuer and in exchange, the issuer promises to repay the loan amount on a specified maturity date. The
issuer usually pays the bond holder periodic interest payments over the life of the loan. The various types
of Bonds are as follows:
ZERO COUPON BOND: Bond issued at a discount and repaid at a face value. No periodic interest is
paid. The difference between the issue price and redemption price represents the return to the
holder. The buyer of these bonds receives only one payment, at the maturity of the bond.
CONVERTIBLE BOND: A bond giving the investor the option to convert the bond into equity at a
fixed conversion price.
TREASURY BILLS: Short-term (up to one year) bearer discount security issued by government as a
means of financing their cash requirements.
What is an ESOP?
An EMPLOYEE STOCK OWNERSHIP PLAN (ESOP) is an employee-owner scheme that provides a company's
workforce with an ownership interest in the company. In an ESOP, companies provide their employees
with stock ownership, often at no up-front cost to the employees. ESOP shares, however, are part of
employees' compensation for work performed. Shares are allocated to employees and may be held in an
ESOP trust until the employee retires or leaves the company. The shares are then sold.
Define Bull Market.
A bull market is when everything in the economy is great, people are finding jobs, gross domestic product
(GDP) is growing, and stocks are rising. Picking stocks during a bull market is easier because everything is
24

going up. Bull markets cannot last forever though, and sometimes they can lead to dangerous situations
if stocks become overvalued. If a person is optimistic and believes that stocks will go up, he or she is called
a "bull" and is said to have a "bullish outlook".
Define Bear Market.
A bear market is when the economy is bad, recession is looming and stock prices are falling. Bear markets
make it tough for investors to pick profitable stocks. One solution to this is to make money when stocks
are falling using a technique called short selling. Another strategy is to wait on the side-lines until you feel
that the bear market is nearing its end, only starting to buy in anticipation of a bull market. If a person is
pessimistic, believing that stocks are going to drop, he or she is called a "bear" and said to have a "bearish
outlook".
Define Short Selling.
Selling short is the sale of a stock that you don't own. More specifically, a short sale is the sale of a security
that isn't owned by the seller, but that is promised to be delivered. Short sellers assume that they will be
able to buy the stock at a lower amount than the price at which they sold short. Selling short is the
opposite of going long. That is, short sellers make money if the stock goes down in price.
This is an advanced trading strategy with many unique risks and pitfalls. Novice investors are advised to
avoid short sales.
What is a Stock Exchange?
The stock exchanges in India, under the overall supervision of the regulatory authority, the Securities and
Exchange Board of India (SEBI), provide a trading platform, where buyers and sellers can meet to transact
in securities. These days, the trading platforms provided by exchanges are electronic and there is no need
for buyers and sellers to meet at a physical location to trade.
Who is a Broker?
A broker is an individual or party (brokerage firm) that arranges transactions between a buyer and
a seller for a commission when the deal is executed. A stockbroker is a regulated professional individual,
usually associated with a brokerage firm or broker dealer, who buys and sells stocks and other
securities for both retail and institutional clients, through a stock exchange or over the counter, in return
for a fee or commission. Stockbrokers are known by numerous professional designations, depending on
the license they hold, the type of securities they sell, or the services they provide.
What is a Portfolio?
A Portfolio is a combination of different investment assets mixed and matched for the purpose of
achieving an investor's goal(s). Items that are considered a part of your portfolio can include any asset
you own-from shares, debentures, bonds, mutual fund units to items such as gold, art and even real estate

25

etc. However, for most investors a portfolio has come to signify an investment in financial instruments
like shares, debentures, fixed deposits, mutual fund units.
A good investment portfolio is a mix of a wide range of asset class. Different securities perform differently
at any point in time, so with a mix of asset types, your entire portfolio does not suffer the impact of a
decline of any one security. When your stocks go down, you may still have the stability of the bonds in
your portfolio.
What is meant by Dividends declared by a Company?
Returns received by investors in equities come in two forms
a. Growth in the value (market price) of the share
b. Dividends
Dividend is distribution of part of a company's earnings to shareholders, usually twice a year in the form
of a final dividend and an interim dividend. Dividend is therefore a source of income for the shareholder.
Normally, the dividend is expressed on a 'per share' basis, for instance Rs. 3 per share. This makes it easy
to see how much of the company's profits are being paid out, and how much are being retained by the
company to plough back into the business. So a company that has earnings per share in the year of Rs. 6
and pays out Rs. 3 per share as a dividend is passing half of its profits on to shareholders and retaining the
other half. Directors of a company have discretion as to how much of a dividend to declare or whether
they should pay any dividend at all.
What is a Stock Split?
A stock split is a corporate action which splits the existing shares of a particular face value into smaller
denominations so that the number of shares increase, however, the market capitalization or the value of
shares held by the investors post-split remains the same as that before the split.
E.g.: If a company has issued 1,00,00,000 shares with a face value of Rs.10 and the current market price
being Rs. 100, a 2-for-1 stock split would reduce the face value of the shares to 5 and increase the number
of the companys outstanding shares to 2,00,00,000, (1,00,00,000*(10/5)). Consequently, the share price
would also halve to Rs. 50 so that the market capitalization or the value shares held by an investor remains
unchanged. It is the same thing as exchanging a Rs. 100 note for two Rs. 50 notes; the value remains the
same.
Why do companies announce Stock Split?
Though there are no theoretical reasons in financial literature to indicate the need for a stock split,
generally, there are mainly two important reasons. As the price of a security gets higher and higher, some
investors may feel the price is too high for them to buy, or small investors may feel it is unaffordable.
Splitting the stock brings the share price down to a more "attractive" level. In our earlier example to buy
1 share of company ABC you need Rs. 40 pre-split, but after the stock split the same number of shares can
be bought for Rs.10, making it attractive for more investors to buy the share. This leads us to the second

26

reason. Splitting a stock may lead to increase in the stock's liquidity, since more investors are able to afford
the share and the total outstanding shares of the company have also increased in the market.
What is meant by Buy Back of Shares?
A buyback can be seen as a method for company to invest in itself by buying shares from other investors
in the market. Buybacks reduce the number of shares outstanding in the market. Buy back is done by the
company with the purpose to improve the liquidity in its shares and enhance the shareholders wealth.
Under the SEBI (Buy Back of Securities) Regulation, 1998, a company is permitted to buy back its share
from:
a. Existing shareholders on a proportionate basis through the offer document.
b. Open market through stock exchanges using book building process.
c. Shareholders holding odd lot shares.
What is meant by Investment?
The money you earn is partly spent and the rest saved for meeting future expenses. Instead of keeping
the savings idle you may like to use savings in order to get return on it in the future. This is called
Investment.
What are various Short-term financial options available for investment?
Broadly speaking, savings bank account, money market/liquid funds and fixed deposits with banks may
be considered as short-term financial investment options:
SAVINGS BANK ACCOUNT is often the first banking product people use, which offers low interest
(4%-5% p.a.), making them only marginally better than fixed deposits.
MONEY MARKET OR LIQUID FUNDS are a specialized form of mutual funds that invest in extremely
short-term fixed income instruments and thereby provide easy liquidity. Unlike most mutual
funds, money market funds are primarily oriented towards protecting your capital and then, aim
to maximize returns. Money market funds usually yield better returns than savings accounts, but
lower than bank fixed deposits.
FIXED DEPOSITS WITH BANKS are also referred to as term deposits and minimum investment period
for bank FDs is 30 days. Fixed Deposits with banks are for investors with low risk appetite, and
may be considered for 6-12 months investment period as normally interest on less than 6 months
bank FDs is likely to be lower than money market fund returns.
What are various Long-term financial options available for investment?

POST O FFICE MONTHLY INCOME SCHEME is a low risk saving instrument, which can be availed
through any post office. It provides an interest rate of around 8% per annum, which is paid
monthly. Minimum amount, which can be invested, is Rs. 1,000/- and additional investment in
multiples of 1,000/-.
PUBLIC PROVIDENT FUNDS are long term savings instrument with a maturity of 15 years and interest
payable at 8% per annum compounded annually. A PPF account can be opened through a
27

nationalized bank at any time during the year and is open all through the year for depositing
money. Tax benefits can be availed for the amount invested and interest accrued is tax-free.
COMPANY FIXED DEPOSITS are short-term (six months) to medium-term (three to five years)
borrowings by companies at a fixed rate of interest which is payable monthly, quarterly, semiannually or annually. They can also be cumulative fixed deposits where the entire principal along
with the interest is paid at the end of the loan period. The rate of interest varies between 6-9%
per annum for company FDs. The interest received is after deduction of taxes.
BONDS are fixed income (debt) instrument issued for a period of more than one year with the
purpose of raising capital. The central or state government, corporations and similar institutions
sell bonds. A bond is generally a promise to repay the principal along with a fixed rate of interest
on a specified date, called the Maturity Date.
MUTUAL FUNDS are funds operated by an investment company which raises money from the public
and invests in a group of assets (shares, debentures etc.), in accordance with a stated set of
objectives. It is a substitute for those who are unable to invest directly in equities or debt because
of resource, time or knowledge constraints. Benefits include professional money management,
buying in small amounts and diversification. Mutual fund units are issued and redeemed by the
FUND MANAGEMENT COMPANY based on the fund's NET ASSET VALUE (NAV), which is determined
at the end of each trading session. NAV is calculated as the value of all the shares held by the
fund, minus expenses, divided by the number of units issued. Mutual Funds are usually long term
investment vehicle though there some categories of mutual funds, such as money market mutual
funds which are short term instruments.

What is meant by Trading?

Trading means performing a transaction that involves the buying and selling of a security. It involves
multiple parties participating in the voluntary negotiation and then the exchange of one's goods and
services for desired goods and services that someone else possesses.
What are the various factors considered while investing in a company?
Invest in companies which have:

BUSINESS CONTINUITY
First, look at continuity of business. Take the instance of a company in the electronics sector. The
Indian government-owned ECTV closed down operations when it failed to take advantage of other
business opportunities. It was once the largest seller of television sets in the country. Another
example in this industry was Videocon VCR, which was set up as a stand-alone manufacturer of
VCRs. The company failed to be alert to technological advancements, which sounded the death
knell for the outdated VCR and obviously for the company too!
ADEQUATE CAPACITY
Second, look at capacity. How big is beautiful? Size brings in economies of scale all rightcost is
spread over a larger output, bringing down the overall cost. But bigger isn't necessarily better in
this case. Companies can grow out of control. Arvind Mills built 10% of the global denim capacity,
28

creating an oversupply situation. When these capacities went on stream, prices of denim dropped
and the infrastructure costs just killed the company. Arvind Mills couldn't go close to achieving
full capacity in its manufacturing, which it needed to do to be viable.
SURVIVAL ABILITY
Competition kills and this is one major cause of failure. Hindustan Unilever has over the years
taken the competition to its rivals and expanded its portfolio. When growth from its bread and
butter business of detergents and soap was plateauing, the company found new outlets to grow.
In the last three decades, this survival skill transformed the company into an FMCG conglomerate
with powerful cash flows. The survival factors here are more to do with the ability of the
management to see future trends in their business.
APPROPRIATE INFRASTRUCTURE
The infrastructure should complement the market where it sells its product or where it procures
its raw material. You can't have a cement plant in Karnataka and try to service the Delhi market.
It would be far more expensive just to transport goods that far, thus spiraling costs.
NEW CAPACITY CREATIONS:
Most capacities in any business come in at the peak of the business cycle. This generally leads to
a drop in selling prices as new capacities mean more supply. And a demand drop would hurt the
players in that field.
COST MANAGEMENT
The company should have a suitable cost structure for the business. Lower costs enable the
company to survive in a down phase well. In an upward business cycle, good cost management
implies higher profitability.
PRODUCTS WITH STAMINA
Look out for opportunistic businesses. There have been small niche players who have tried to
identify and milk insubstantial opportunities. For instance, a small company, India Food
Fermentations, tried to market the concept of dosas as fast food through a vending machine, Dosa
King. This company went bankrupt.

What are the different types of Investors in the market?

AGGRESSIVE : They adopt a method of portfolio management and asset allocation that attempts to
achieve maximum return. An aggressive investment strategy attempts to grow an investment at
an above-average rate compared to its industry or the overall market, but usually take on
additional risk. They place a higher percentage of their assets in equities rather than in safer debt
securities.
MODERATELY AGGRESSIVE : These investors seek longer term investment gains through a mix of
equity investments. While many of the investments are the same, the overall portfolio contains
some more conservative investments, creating a portfolio that builds wealth with less annual
swings in the portfolio's performance. An investor with a time frame of between 6-10+ years is
most appropriate for this type of portfolio and the average level of return that an investor can
expect to receive is between 10-11% annually. This annual investment return represents the stock
market's long term average growth over the past several decades.
29

MODERATELY CONSERVATIVE : They are much less willing to accept variations in their portfolio's
balance. Individuals that are going to need their money within 3-6 years are most suitable for this
investment strategy, or those looking for a regular income stream. A moderately conservative
portfolio is often more weighted to individual bonds or bond mutual funds, and can expect to
earn between 6-8% in annual growth. Moderately Conservative investors also typically receive
income from dividends on a quarterly or annual basis from their investments.
CONSERVATIVE : Typically those investors with either a short term goal (less than 3 years), or those
who are in retirement seeking a regular income stream. These portfolios tilt away from equity
investments into more preservation investments, like individual bonds, bond funds, municipal
bonds and annuities. These assets are not intended to provide great growth within the portfolio,
but are designed to provide income and preserve the principal balance over the investor's
estimated lifespan.

What is the difference between a Shareholder and Stakeholder?

Shareholders are stakeholders in a corporation, but stakeholders are not always shareholders. A
shareholder owns part of a company through stock ownership, while a stakeholder is interested in the
performance of a company for reasons other than just stock appreciation.
Stakeholders could be:
employees who, without the company, would not have jobs
bondholders who would like a solid performance from the company and, therefore, a reduced
risk of default
customers who may rely on the company to provide a particular good or service
suppliers who may rely on the company to provide a consistent revenue stream

Banking
30

What is a Bank and what are its functions?

The term bank is used generically to refer to any financial institution that is licensed to accept deposits
that are repayable on demand, and lends money.
A bank makes money via Net Interest Income
Net Interest Income (NII) = Interest Earned on Loans Interest Paid on Deposits
What are the different services offered by a bank to a corporate?

LOANS: Banks provide short and long-term funds to businesses.

CASH DEPOSITS: Corporate deposit surplus funds in a bank.
FOREIGN EXCHANGE TRANSACTIONS: Banks act as authorized dealers to facilitate foreign exchange
transactions.
ADVISORY SERVICES: Banks provide financial advisory services such as valuations, issue
management, mergers & acquisitions, etc. to corporate.
TRADE SERVICES : Banks play the role of the trusted intermediary between parties involved in trade
and facilitate trade and commerce.

What are the different Types of Bank Accounts?

SAVINGS ACCOUNTS

These accounts are meant for individuals. It pays interest. The interest is calculated on the daily
balance in the account. The interest is credited to the accounts on a monthly or quarterly basis.
There is some restriction on the number of times a customer may withdraw or deposit funds.
CURRENT ACCOUNTS

They are held mainly by businesses. These are accounts primarily meant for transacting, and
hence have no restrictions on the number of transactions. Banks do not pay any interest on
current accounts.
TERM/TIME/FIXED DEPOSITS

These are deposits with a fixed maturity, hence also called Fixed Deposits (FDs). The customer
cannot add to, or withdraw from, this deposit till maturity i.e. transactions are not allowed on
an FD. FDs earn higher interest than savings deposits, and banks are free to fix the interest rates.
RECURRING DEPOSITS

These are a fixed deposit variant. The only difference being that, the customer has the flexibility
to deposit the amount in installments. No withdrawals are allowed. One can however, avail a loan
against the deposit.
PUBLIC PROVIDENT FUND ACCOUNTS
These are accounts meant for retirement savings. In India, they are fully tax exempt you pay no
tax on the principal or interest earned.

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What are the different categories of banks?

SCHEDULED BANKS : Banks which have deposits>INR 200 crores are Scheduled Banks E.g.: SBI, ICICI
NON-SCHEDULED BANKS: Banks which have deposits<=INR 200 crores are Non-scheduled Banks E.g.:
Sawai Madhopur Urban Co-operative Bank Ltd, City Co-operative Bank Ltd., Mysore
PUBLIC SECTOR BANKS: PSBs are those banks where the government holds a majority (>50%)
ownership. E.g.: SBI, Bank of India
PRIVATE BANKS: Banks which are owned by private Indian entities such as corporate or individuals.
E.g.: ICICI, Axis Bank
FOREIGN BANKS: Banks owned by Multinational/non-Indian entities. E.g.: HSBC, Deutsche bank,
JPMC
URBAN CO-OPERATIVE BANK: These banks are formed by a group of members and their main focus
is to mobilize savings from low income and middle income groups to ensure credit availability to
its members.

What are NBFCs?

Non-Banking Finance Companies (NBFCs) are financial institutions that provide services, similar to banks,
but they do not hold a banking license. The main difference is that NBFCs cannot accept deposits
repayable on demand. All NBFCs are not entitled to accept public deposits. Only those NBFCs to which the
Bank had given a specific authorization are allowed to accept/hold public deposits. Motilal Oswal, Tata
Capital, Reliance Capital are some of the NBFCs in India.
Some of their services include:
1) Providing loans and credit facilities
2) Leasing and Hire purchase
3) Lending
4) Investment services (Asset Management, underwriting)

Economics
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What is GDP?
GDP is the total value of products & Services produced within the territorial boundary of a country. It is
calculated using the formula provided below:
GDP = Private Consumption + Investment + Government Spending + Net exports
Where,

Net Exports = Exports Imports

Private Consumption here refers to the household consumption expenditure which will fall
under one of the three categories durable goods, non-durable goods and services.
Investment here refers to business investment in buying new equipment like purchase of
software, buying of machinery, etc. and does not include exchange of assets. This should not be
confused with financial investment in purchase of financial products.
Government Spending is the expenditure of government on final goods and services. It is
inclusive of salaries of public servants and purchase of military equipment but excludes social
security and unemployment benefits.
APPLICATION: To see the strength of a countrys local economy. GDP is considered to be an indicator of
standard of living of a country. Countries with higher GDP are considered to have better standard of
living.
What is GNP?
Total value of Goods and Services produced by all nationals of a country (whether within or outside the
country).
GNP = GDP + NR (Net income inflow from assets abroad or Net Income Receipts) - NP (Net payment
outflow to foreign assets)
Net income receipt is arrived at by summing the income from overseas investment and subtracting from
the sum the income earned by foreign nationals and companies domestically. Let us consider an example
for further clarification. Suppose the GDP and GNP of India are to be calculated, now if an Indian company
has a plant in China then the profit made by that plant will not be included in GDP but will be included in
GNP. Similarly if a Chinese firm has a plant in India then the plants income will be accounted for in GDP
but will be subtracted from GNP value. To summarize the basis of production allocation is geographical
location and ownership for GDP and GNP respectively.
APPLICATION: To see how the nationals of a country are doing economically.
What is PPP?
Purchasing power parity is based on the assumption that in absence of duties, transaction costs and other
curbs, identical goods should have the same price in different countries when expressed in same currency.
In other words, how much money would be needed to purchase same amount of goods and services in
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two different markets. This allows for calculating PPP exchange rates that can be used to convert gross
national income of countries in terms of a single currency, usually the US dollar, to facilitate meaningful
comparisons after adjusting for prices.
For example, suppose that Japan has a higher GDP per capita, ($18) than the US ($16). That means that
Japanese on average make $2 more than normal Americans. However, they are not necessarily richer.
Suppose that one gallon of orange juice costs $6 in Japan and only $2 in the US. The Japanese can only
buy 3 gallons while the Americans can buy 8 gallons. Therefore, in terms of orange juice, the Americans
are richer
Now apply this to daily life. The orange juice represents the previously mentioned "basket of goods" which
represents the cost of living in a country. Therefore, even if a country has a higher GDP per capita
(individual income), that country's people may still live poorer if the cost of living is more expensive
What is Inflation?
Inflation means that the general level of prices is going up i.e. more money is needed to get the same
amount of a good or service, or the same amount of money will get a lower amount of a good or service.
Let us take an example suppose one week earlier you went to have breakfast in a nearby restaurant and
you have taken a 50 rupee note with you. If the price a piece of sandwich was Rs. 10 price then with you
could buy 5 sandwich pieces. Now over the week the prices of bread and vegetables have gone up on
account of inflation and as a result the restaurant has increased the price of a piece of sandwich to Rs.12.5.
Now you can only buy 4 sandwich pieces with the same 50 rupee note today. Now you may be thinking
as to how one can measure inflation. The answer to your question is inflation rate, the measure of rise in
price level of goods and services. It indicates the rate of rise in price level of goods and services.
What are the causes of inflation?
When the total money in an economy (the money supply) increases too rapidly, the quality of the
money (the currency value) often decreases.
Demand-Pull inflation
The Demand-Pull inflation theory can be said simply as "too much money chasing too few goods." In
other words, if the will of buying goods is growing faster than amount of goods that have been made,
then prices will go up. This most likely happens in economies that are growing fast.
Cost-Push inflation
The Cost-Push inflation theory says that when the cost of making goods (which are paid by the company)
go up, they have to make prices higher to still make profit out of selling that very product. The higher costs
of making goods can include things like workers' wages, taxes to be paid to the government or bigger
costs of getting raw materials from other countries.

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What is Deflation?
A general decline in prices, often caused by a reduction in the supply of money or credit is called deflation.
Deflation can be caused also by a decrease in government, personal or investment spending. The opposite
of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand
in the economy, which can lead to an economic depression. Central banks attempt to stop severe
deflation, along with severe inflation, in an attempt to keep the excessive drop in prices to a minimum.
The decline in prices of assets is often known as Asset Deflation.
What is Stagflation?
When inflation is accompanied by an increase in unemployment rate then the situation is called
stagflation. The term stagflation is combination of two terms stagnation and inflation.
Therefore it is a situation in which there is almost no growth in production (total amount
of goods and services produced), there is high inflation, and unemployment is higher than normal. This
situation usually begins with things beginning to cost more while fewer of the things are being made.
Because fewer things are being made, fewer people are needed to make them. This causes unemployment
to increase.
What is Hyperinflation?
In economics, hyperinflation is inflation that is "out of control," when prices increase very fast
as money loses its value. One example of hyperinflation is in Germany in the 1920s. In 1922, the largest
banknote was 50,000 Mark. These banknotes were so worthless that people would burn them in fires to
keep them warm. The notes would burn longer than the amount of wood you could buy with them. In
Zimbabwe, the inflation rate was 231,150,888.87 % in July 2008.
What are the effects of inflation?
The effect of inflation is not distributed evenly in the economy, and as a consequence there are hidden
costs to some and benefits to others from this decrease in the purchasing power of money. For example,
with inflation, those segments in society which own physical assets, such as property, stock etc., benefit
from the price/value of their holdings going up, while those who seek to acquire them will need to pay
more for them. However in general high or unpredictable inflation rates are regarded as harmful to an
overall economy. They add inefficiencies in the market, and make it difficult for companies to budget or
plan long-term. Uncertainty about the future purchasing power of money discourages investment and
saving. And inflation can impose hidden tax increases, as inflated earnings push taxpayers into higher
income tax rates unless the tax brackets are indexed to inflation. Where fixed exchange rates are imposed,
higher inflation in one economy than another will cause the first economy's exports to become more
expensive and affect the balance of trade.
But yes, moderate inflation is good for developing economies like ours.

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Some of the effects are explained below:

Inflation cycle
High inflation can prompt employees to demand rapid wage increases, rising wages in turn can help fuel
inflation. In the case of collective bargaining, wage growth will be set as a function of inflationary
expectations, which will be higher when inflation is high. This can cause a wage spiral. In a sense, inflation
begets further inflationary expectations, which beget further inflation.
Hoarding
People buy durable and/or non-perishable commodities and other goods as stores of wealth, to avoid the
losses expected from the declining purchasing power of money, creating shortages of the hoarded goods.
Social Unrest and Revolts
Inflation can lead to massive demonstrations and revolutions. For example, inflation and in particular food
inflation is considered as one of the main reasons that caused the 20102011 Tunisian revolution and
the 2011 Egyptian revolution,
Allocative Efficiency
But when prices are constantly changing due to inflation, price changes due to genuine relative price
signals are difficult to distinguish from price changes due to general inflation, so agents are slow to
respond to them. The result is a loss of allocative efficiency.
Cost involved in changing
With high inflation, firms must change their prices often in order to keep up with economy-wide changes.
But often changing prices is itself a costly activity whether explicitly, as with the need to print new menus,
or implicitly, as with the extra time and effort needed to change prices constantly.
What are WPI, CPI and PPI?
Inflation in an economy can be measured based on 3 indexes.
WPI Wholesale price index
Wholesale Price Index (WPI) is a price index which represents the wholesale prices of a basket of goods
over time. In simple words, WPI is an indicator of price changes in the wholesale market. WPI measures
the changes in the prices charged by manufacturers and wholesalers. WPI measure the changes in
commodity prices at a selected stages before goods reaches to the retail level.
For example in India about 435 items were used for calculating the WPI in base year 1993-94 while the
advanced base year 2004-05 and which has now been changed to 2010-2011; uses 676 items
1. Primary Articles: consist of food grains, fruits and vegetables, milk, eggs, meats and fishes,
condiments and spices, fibers, oil seeds and minerals. Their weight age is 22.02 %.
2. Fuel, Power, and Light & Lubricants: consist of coal and petroleum related products, lubricants,
electricity etc. Their weight age is 14.23%.
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3. Manufactured Products: consist of dairy products, atta, biscuits, edible oils, liquors, cloth,
toothpaste, batteries, automobiles etc. Their weight age is 63.75%.
Shortcomings
Not globally comparable as countries either have a producer price index or a consumer price
index, that is used by central bank.
Only has goods, and excludes services (contributes 56% to Indias GDP), a huge part of the
economy, which directly affect prices of all other things
These rates do not reflect the prices consumers pay for goods
CPI Consumer price index
Consumer Price Index (CPI) is a price index which represents the average price of a basket of goods over
time. In simple words, CPI is based on changes in prices at the retail level. CPI measures the average prices
of goods and services that we, the consumers, have paid for. Education, apparel, foods and beverages,
communication, transportation, recreation, housing, and medical care are the 8 groups for which the CPI
is set
India currently has four indices that measure changes in prices of goods and services paid by the final
consumer
1.
2.
3.
4.

CPI Industrial Workers;

CPI Urban Non-Manual Employees;
CPI Agricultural laborers;
CPI Rural labor.

Shortcomings
The all-India CPI, which has been divided between urban and rural areas, gives the most accurate
picture of prices but has very limited history as it was started in January last year
PPI focuses on prices of goods and services that are received by the producer. This is different
from the retail prices, which include shipping costs, taxes and other levies
Why 3 different indexes?
1. WPI Does not include service industry which contributes 56% to the GDP
2. CPI Helps to measure the price of goods and services at a retail level/last stage
3. PPI It completes the loop by also measuring the prices of goods and services at the first stage
Who proposed PPI in India?
Former Reserve Bank governor D Subbarao has said India needs a new gauge of inflation the producer
price index. According to Subbarao, the most widely watched measure of inflation in India, the wholesale
price index (WPI), does not include services, which forms a big part of economic activity (contributes 56%
to Indias GDP)

37

The market basket for CPI is determined and maintained by United States Bureau of Labor Statistics.
Another minor point of difference between the two indexes is that WPI is generally calculated and
reported on a weekly basis while CPI follows a monthly calculation and reporting procedure. At present
most of the countries including USA, UK, Japan and China use CPI for inflation rate calculation.
What is Human Development Index?
The Human Development Index (HDI) is a number from 0 to 1 (higher is better) used
to compare different countries. It is published by United Nations Development Program. It is used to rank
countries into different groups for example developed and developing countries.
The Human Development Index uses different measurements of a population:

LIFE EXPECTANCY AT BIRTH: This is used to see how healthy the people in one country are.
It assumes that healthier people live longer on average.
LITERACY is used to look at how educated people are, for example how many adults can read and
write. One third of this is the gross enrollment ratio, which measures how many of children of
schooling age attend school.
STANDARD OF LIVING : This is measured by calculating the gross domestic product with the total
population so that it becomes comparable.

In another sign that India has much catching up to do, the Human Development Report 2013 released by
the United Nations Development Program (UNDP), ranked the country at a low 136 among 186 countries
on its human development index (HDI) a composite measure of life expectancy, access to education
and income levels.
What do you mean by monetary policy?
Monetary policy is the process by which the monetary authority (RBI in India) of a country controls
the supply of money, availability of money, and cost of money or rate of interest for the purpose of
achieving the following

Economic growth
Economic stability
Relatively stable prices
Low unemployment.
Exchange rates with other currencies

Within almost all modern nations, special institution generally called central banks has responsibility of
formulating monetary policy and supervising the smooth operation of the financial system
Monetary policy can
either being expansionary or contractionary, where an expansionary policy
increases the total supply of money in the economy more rapidly than usual, this form policy is
traditionally used to try to combat unemployment in a recession by making easy credit available in the
hope that easy credit will entice businesses to expand. On the other hand contractionary policy expands
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the money supply more slowly than usual or even shrinks it by making credit dearer to discourage
borrowing, which is intended to slow inflation in order to avoid the resulting distortions and deterioration
of asset values.
Monetary base
The first tactic manages the money supply. This mainly involves buying government bonds for expanding
the money supply or selling them for contracting the money supply, these are known as open market
operations, because the central bank buys and sells government bonds in public market. When the
central bank disburses or collects payment for these bonds, it alters the amount of money in the economy
.The change in the amount of money in the economy that is monetary base.
Interest rates
The second tactic manages money demand. Demand for money, like demand for most things, is sensitive
to price. For money, the price is the interest rates charged to borrowers. Setting banking-system lending
or interest rates in order to manage money demand is a major tool used by central banks. Ordinarily, a
central bank conducts monetary policy by raising or lowering its interest rate target for the interbank
interest rate.
Reserve requirements
The monetary authoritys third tactic exerts regulatory control over banks. Monetary policy can be
implemented by changing the proportion of total assets that banks must hold in reserve with the central
bank. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the
rest is invested in illiquid assets like mortgages and loans. By changing the proportion of total assets to be
held as liquid cash, the central bank changes the availability of loanable funds. This acts as a change in the
money supply. Example - alteration in cash reserve ratio and statutory liquidity ratio.
Discount window lending
Central banks normally offer a discount window, where commercial banks are able to borrow reserves
from the Central Bank to meet temporary shortages Under this discount window ,the interest rate charged
(called the 'discount rate') is usually set below short term interbank market rates. Accessing the discount
window allows institutions to vary credit conditions (i.e., the amount of money they have to loan out),
thereby affecting the money supply. E.g. - alteration in bank rates, repo rates and reverse repo rate.

What are Policy Rates?

At first let us consider two similar rates bank rate and repo rate.
BANK RATE is the rate of interest that commercial banks and other financial intermediaries have to pay on
the loan that they take from countrys central or federal bank. REPO RATE is similar to bank rate except
that it is applicable to short term loans while bank rate is applicable to long term loans. In India Reserve
Bank of India (RBI) is central bank. Suppose that bank rate in India is 5% which means that if a commercial
39

bank takes a loan of 1 million rupees from central bank then it has pay 5% of 1 million i.e. Rs. 50,000 as
the interest. REVERSE REPO RATE is the counterpart of repo rate. It is the rate of interest commercial banks
and other financial intermediaries receive on excess funds they deposit with the central bank. Now
suppose the commercial bank deposits 1 million rupees in central bank with reverse repo rate being 5%
then the commercial bank will receive Rs. 50,000 as interest on their deposit. The three above mentioned
rates are also referred to as POLICY RATES.
What are Reserve Ratios?
CASH RESERVE RATIO (CRR) and STATUTORY LIQUIDITY RATIO (SLR) are reserve ratios which put a limit on the
minimum amount of reserve that commercial banks and other financial intermediaries are required to
keep in central bank. CRR is the percentage of their total deposits that the commercial banks have to keep
in central bank in form of cash. SLR is similar to CRR except that apart from cash other liquid assets like
precious metals such as gold and approved short term securities like treasury bills may be used to meet
the reserve requirements. A better understanding of reserve ratio will be possible after going through the
example provided below. Assume that the CRR and SLR are 4% and 22% respectively and a commercial
bank has a total deposit of 10 million rupees with itself. Now the bank has to keep 0.4 million rupees in
cash as a deposit with central bank and make a net deposit of 2.2 million rupees in form of liquid assets
with the central bank. The latest ratios and rates can be checked on
(http://www.rbi.org.in/scripts/WSSViewDetail.aspx?TYPE=Section&PARAM1=4%0A)
The RBI reviews these rates and ratios on a monthly basis with intent to keep a check on money supply
and inflation rate in economy. In order to increase the supply of money in economy RBI may decrease its
policy rates and reserve ratios. The decrease will have the combined effect of increasing the deposits
available with the commercial banks which may be offered as loans to general public thereby pumping
money into the economy.
What is Marginal Standing Facility (MSF)?
MSF rate is the rate at which banks borrow funds overnight from the Reserve Bank of India (RBI) against
approved government securities. This came into effect in May 2011. Under the Marginal Standing Facility
(MSF), currently banks avail funds from the RBI on overnight basis against their excess statutory liquidity
ratio (SLR) holdings.
What is the current MSF rate?
Under this scheme, Banks are able to borrow up to 2% of their respective Net Demand and Time
Liabilities outstanding at the end of the second preceding fortnight. The rate of interest on the amount
accessed from this facility w.e.f. 5th September, 2014, has been fixed at 9.00%. This scheme is likely to
reduce volatility in the overnight rates and improve monetary transmission. RBI is expected to reduce the
difference as the currency begins to show signs of greater stability.

40

What is the difference between Liquidity Adjustment Facility - Repo Rate and Marginal
Standing Facility rate?
Banks can borrow from the Reserve Bank of India under LAF - repo rate, which stands at 8.00%, by pledging
government securities over and above the statutory liquidity requirement of 22%. Though in case of
borrowing from the Marginal Standing Facility, banks can borrow funds up to one percentage of their net
demand and time liabilities, at 9.00%. However, it can be within the statutory liquidity ratio of 22%.
What is Balance of Payment?
Balance of Payments (BoP) accounts are an accounting record of all monetary transactions between a
country and the rest of the world. These transactions include payments for the country's exports and
imports of goods, services, financial capital, and financial transfers. The BoP accounts summarize
international transactions for a specific period, usually a year and follows the principles of double entry
accounting.
Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as
positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded
as negative or deficit items.
The two principal parts of the BOP accounts are the current account and the capital account. The basic
difference between both being that the current account reflects a nation's net income from abroad and
the capital account reflects net change in ownership of foreign assets.
What is current account?
Current account is one of two primary components of the balance of payments. It is called
the current account as it covers transactions in the "here and now" those that don't give rise to future
claims. It is the sum of the international transactions under the following 4 heads

GOODS- net earnings on exports minus payments for imports of visible items i.e. Goods
SERVICES- Net income from the intangible service (e.g. tourism) is taken into account
INCOME- earnings on foreign investments minus payments made to foreign investors
CURRENT TRANSFERS- Current transfers take place when a certain foreign country simply provides
currency to another country with nothing received as a return. Typically, such transfers are done
in the form of donations, aids, or official assistance any receipt is added and vice versa.

Current account shows the net amount a country is earning if it is in surplus, or spending if it is in deficit
What is Current account deficit (CAD)?
Occurs when a country's total imports of goods, services and transfers are greater than the country's total
export of goods, services and transfers. This situation makes a country a net debtor to the rest of the
world.

41

The current account is a section in a country's balance of payments (BOP) that records its current
transactions. When a current transaction enters the account, it is recorded as a credit; when a value leaves
the account, it is marked as a debit. Basically, a current account deficit occurs when more money is being
paid out than brought into a country.
What does a Deficit imply?
When a current account is in deficit, it usually means that a country is investing more abroad than it is
saving at home. Often, the logic dictating a country's investment decisions is that it takes money to make
money. In order to try and boost its gross domestic production (GDP) and future growth, a country may
go into debt, taking on liabilities to other countries. It then becomes what is termed as a "net debtor" to
the world. However, a problematic deficit can result if a government has not planned out a sound
economic policy and used its debts for consumption purposes, not future growth.
India's current account deficit stood at 1.7% of GDP ($32.4 billion) for FY2014 against 4.7% of GDP ($87.8
billion) in FY2013.
How can current account deficit be reduced?
Action to reduce a substantial current account deficit usually involves

Increasing exports through subsidies, custom duty exemptions and adjusting government
spending to favor domestic suppliers is also effective
Decreasing imports, this is generally accomplished directly through import restrictions, quotas, or
duties.
Influencing the exchange rate to make exports cheaper for foreign buyers will indirectly make the
current account positive by ensuring export competitiveness.
Includes measures that increase domestic savings (or reduced domestic borrowing), including a
reduction in borrowing by the national government

What is Capital Account?

The Capital Account records the net change in ownership of foreign assets. It includes the reserve
account (the foreign exchange market operations of a nation's central bank), along with loans and
investments between the country and the rest of world. The term "capital account" is also used in the
narrower sense that excludes central bank foreign exchange market operations.
A surplus in the capital account means money is flowing into the country; it will effectively represent
borrowings or sales of assets. A deficit in the capital account means money is flowing out the country, and
it suggests the nation is increasing its ownership of foreign assets.
It is an aggregate of following items

FOREIGN DIRECT INVESTMENT - Net FDI that is long term capital investment coming from abroad
minus investment made by the citizen of the country in other nation.
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PORTFOLIO INVESTMENT - Refers to the purchase of shares and bonds, the capital account entry will
just be for any buying or selling of the portfolio assets in the international capital markets.
OTHER INVESTMENT - includes capital flows into bank accounts or provided as loans
RESERVE ACCOUNT - The reserve account is operated by a nation's central bank to buy and sell
foreign currencies

What is meant by Foreign Institutional Investors (FII)?

An investor or investment fund that is from or registered in a country outside of the one in which it is
currently investing. Institutional investors include hedge funds, insurance companies, pension funds and
mutual funds. These investors invest in the country indirectly by purchasing stocks of the companies listed
on the stock exchanges. The FII money inflows or outflows are also called hot money flows.
The term is used most commonly in India to refer to outside companies investing in the financial markets
of India. International institutional investors must register with the Securities and Exchange Board of India
to participate in the market. One of the major market regulations pertaining to FIIs involves placing limits
on FII ownership in Indian companies.
What is meant by Foreign Direct Investment (FDI)?
FDI is defined as an investment made to acquire lasting (business) interest in enterprises operating outside
of the investors economy. For instance, if a company registered in the United States of America buys a
stake in an Indian company, such an investment is termed FDI. This type of investment is more involved
with the management, technology transfer and other field expertise and knowhow in the project. Some
of the sectors that attract high FDI are services, computer software and hardware, telecommunications,
construction, housing & real estate, automobile, power, chemicals, and drugs & pharmaceuticals.
Mauritius, Singapore, U.S. and UK are among the major sources of FDI.
FDI is better than FII it is non-debt creating, non-volatile, and its returns depend on the performance of
the projects financed by the investors. FDI facilitates international trade by promoting transfer of
knowledge, skills, and technology.
What is meant by Brown Field Investment?
When a company or government entity purchases or leases existing production facilities to launch a new
production activity, it is known as Brown Field investment. This is one strategy used in foreign-direct
investment. Ex: Jet-Etihad deal
What is meant by Green Field Investment?
A form of foreign direct investment where a parent company starts a new venture in a foreign country by
constructing new operational facilities from the ground up. In addition to building new facilities, most
parent companies also create new long-term jobs in the foreign country by hiring new employees. This is
opposite to a brown field investment.
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Green field investments occur when multinational corporations enter into developing countries to build
new factories and/or stores. Developing countries often offer prospective companies tax-breaks,
subsidies and other types of incentives to set up green field investments. Governments often see that
losing corporate tax revenue is a small price to pay if jobs are created and knowledge and technology is
gained to boost the country's human capital. Ex: FDI in retail
What is a Depository Receipt?
Depository receipt is a generic term that includes American Depository Receipts (ADRs) and Global
Depository Receipts (GDRs). Indian companies are permitted to access the international capital markets
through issue of ADRs / GDRs.
ADR or American Depository Receipt is a non-American stock that trades in American stock exchanges. It
is valued in dollars, and each ADR represents a specific number of shares (one or more) in a non-American
corporation. GDR or Global Depository Receipt is used to offer Indian shares in any other country other
than the US. Foreign companies who wish to raise capital in India can do so by issuing Indian Depository
Receipts (IDR).
Examples of ADR issues by Indian Companies: ICICI Bank Ltd, Infosys Ltd, Wipro Ltd
Examples of GDR issues by Indian Companies: Axis Bank Ltd, Gail (India) Ltd
What are external commercial borrowings?
Money that has been borrowed from foreign sources for financing the commercial activities in India is
called external commercial borrowings. ECBs include commercial bank loans, buyers' credit, suppliers'
credit, and credit from official export credit agencies and commercial borrowings from the private sector
window of multilateral financial Institutions such as International Finance Corporation (Washington), ADB.
It is different from FDI in that ECB means any kind of funding other than Equity. If foreign money is used
to finance foreign capital it is termed as FDI.

Recent Developments

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Securities Laws (Amendment) Act, 2014

What is Securities Laws (Amendment) Act?
An Act of Parliament which empowers the capital market regulator (SEBI) to search premises and seize
assets of securities law offenders. It also gives SEBI the power to take on promoters who raise funds
through Ponzi schemes.
Why was this act in news recently?
The Securities Laws (Amendment) Act 2014 was passed on 25 August 2014 with the approval of both the
houses.
In January 2013, SEBI had to battle the Subrata Roy-led group in the Supreme Court for the right to oversee
the Lucknow-based group's fund-raising through optionally convertible debentures.
In April 2013, the Saradha Group financial scam broke out in West Bengal, leading to the collapse of the
company's ponzi scheme and lakhs of investors losing their money. To respond to market needs, it became
necessary to enhance SEBI's powers.
What are the key highlights of the Securities Laws (Amendment) Act?

The Act empowers the Securities Exchange Board of India (SEBI) to clamp down on illicit moneypooling schemes, arrest of defaulters, to access call data records and other frauds.
It is a part of the government and regulators efforts to tighten noose around fraudsters in the wake
of several cases of illicit money-polling activities that includes ponzi operators.
It would also facilitate setting up of a special SEBI court to fast-track the investigation and prosecution
process.
It also grants approval for search and seizure operations in suspected cases of frauds.
It has as many as 57 clauses to amend various sections of the SEBI Act and two other related
legislations.

Goods and Services Tax

What is Goods and Services Tax (GST)?
Goods and Services Tax is a Value Added Tax (VAT) which is to be implemented in India, the decision on
which is pending. The proposed GST will replace several existing taxes, including the central level excise
tax and service tax, and state level VAT, entertainment tax, lottery tax and electricity duty, with one single
tax, thus facilitating the consolidation of a single market across the country and allowing for greater supply

45

chain efficiency and economies of scale, GST has been decided to be implemented using a dual GST model
Central GST and State GST.
The proposal is expected to be implemented by the government by April 2016.
Expected rates
World over GST rates are typically between 16-20%, which is likely to be the same for India.
Prospects
Full implementation of GST could raise Indias GDP growth by 0.9 to 1.7 percent, according to the National
Council of Applied Economic Research (NCAER).

Two-part levy: Central GST and State GST;

Common threshold for the levy of GST: All businesses with annual turnover of more than Rs 10
lakh for general states and Rs 5 lakh for special-category and north-eastern states;

Harmonize GST exemption lists nationwide: 96 items exempted by States and 243 items by the
Center.

Issues

Differences remain over the degree of control between states and the Center over central GST.
Below the Rs 1.5 crore limit, the Center wants to keep legal control and give states
administrative control, but states are asking for both. Above the limit, dual-control is agreed
upon.

States are also pushing for high-tax products such as petroleum, alcohol and tobacco out of the
GST purview.

Some are also concerned that the proposed GST structure will infringe on states financial
autonomy by removing a large portion of their own revenue source.

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PJ Nayak Committee on Governance in Public Sector Banks

On 20th January 2014, Reserve Bank of India (RBI) constituted an Expert Committee, under the
Chairmanship of Shri P. J. Nayak, Ex-Chairman of Axis Bank, to review Governance of the Boards of Banks
in India. The objective was to improve the governance structure of the State owned banks and also to
help private sector banks attract more capital.

What are the key recommendations of the PJ Nayak Committee?

Given poor asset quality and low productivity, either privatize PSU banks or transform
governance structure to make them efficient.

Reduce government stake in PSU banks to less than 50 percent

Remove dual structure of both Finance Ministry and RBI regulating PSU banks. Give all
regulatory authority to RBI

Improve quality of PSU bank board discussions; focus on key areas like business strategy,
financial reports, risk, and compliance.

The government should transfer its stake in PSU banks to a holding company termed Bank
Investment Company

Government should reduce its stake in BIC to under 50 percent and appoint a professional
management for BIC

Have uniform bank licensing regime across all broad-based banks, and niche licenses for banks
with more narrowly defined businesses

Allow mutual funds, pension funds, PE funds to hold 20 percent in private sector banks, without
having to take RBI approval

Ensure a minimum of five-year tenure for bank Chairmen and a minimum of three year tenure for
Executive Directors

Union Budget 2014

The Union Budget announced a roadmap of policy initiatives that could lead the economy back to 7-8%
growth levels in the next 3-4 years. The government also aims to stabilize the macro-economy with lower
levels of inflation, narrow fiscal deficit and a manageable current account deficit.

47

Key Proposals

5 New IITs and IIMs in India

Budget proposes Plan expenditure of Rs 5,75,000 crores for current fiscal.

All future indirect transfers under the retrospective tax regime will be scrutinized by a high level
committee of CBDT before action is taken

Vision of creating of 100 smart cities as satellite towns. For this purpose, the minister allocated
Rs 7,060 crore in the Budget.

To improve access to irrigation, an amount of Rs 1,000 crore under the scheme Pradhan Mantri
Krishi Sinchayee Yojana, has been set aside.

20 new industrial corridors to be set up

To increase the road network National Highways Authority of India and State Roads will invest
an amount of Rs 37,880 crores, which includes Rs 3,000 crores for the North Eastern states.

Introduction of uniform KYC norms across financial sector

Insurance sector-- composite FDI cap raised to 49% from 26%

Under the Section 80C of the Income Tax Act, the limit has been increased to Rs 1.5 lakh from Rs
1 lakh earlier.

Increase in the minimum taxable income to Rs 2.5 lakh from Rs 2 lakh earlier & the same
threshold for senior citizens has also been hiked by Rs 50,000 to Rs 3 lakh from Rs 2.5 lakh
earlier.

The budget set a target of 4.1% of the GDP for the current fiscal deficit. The target for the next
financial years has been estimated to be 3.6% for 2015-16 and 3% of the GDP for 2016-17. This
indicates the governments focus on fiscal consolidation.

FDI in Defence sector raised to 49 per cent

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Historical Events
Subprime Mortgage Crisis
What is a subprime loan?
A subprime mortgage loan is designed for people who cannot get approved for a standard, prime loan.
Subprime borrowers typically have weakened credit histories and reduced repayment capacity. Subprime
loans have a higher risk of default than loans to prime borrowers and carry relatively high interest rate.
What is U.S. subprime loan crisis of 2008?
The U.S. subprime mortgage crisis was a set of events and conditions that led to a financial crisis and
subsequent recession that began in 2008. It was characterized by a rise in subprime mortgage
delinquencies and foreclosures, and the resulting decline of securities backed by said mortgages.
What led to subprime loan crisis?
1.
2.
3.

4.

5.

The economy was at risk of a deep recession after the dotcom bubble burst in early 2000; this
situation was compounded by the September 11 terrorist attacks that followed in 2001.
In response, US government tried to stimulate the economy by encouraging US banks to lend
money to people to encourage spending and investing mainly for the purpose of buying houses.
Banks created capital liquidity through a reduction in interest rates. In turn, investors sought
higher returns through riskier investments. Lenders took on greater risks too, and approved
subprime mortgage loans to borrowers with poor credit ratings.
A silent storm brewed in financial markets with origins in the US housing market which witnessed
an unprecedented growth. The boom was led by high housing prices (due to increased demand)
and low interest rates.
Finally the Housing Bubble burst in 2006. Housing prices began to drop. Rising interest rates and
falling housing prices led to rise in subprime mortgage delinquencies and resultant foreclosure.

What was the impact of subprime crisis?

1.

2.
3.
4.

Subprime Loan crisis led to the financial crisis of 2007-08 and a global recession. Many investment
banks got bankrupt and many were acquired by other banks. For e.g. Investment Bank Bear Sterns
was acquired by JP Morgan Chase, a commercial bank.
Another investment bank, Lehman Brothers declared bankruptcy on Sep 15, 2008, facing a refusal
by the federal government to bail it out.
Washington Mutual was closed and its assets were sold to JP Morgan Chase.
Merrill Lynch was acquired by Bank of America.

49

5.

US Federal Reserves helped several banks like AIG (by providing them loan of $75b), and granted
approval to Goldman Sachs and Morgan Stanley to convert themselves into a commercial bank.

What was its impact on India?

1.

2.

Immediate or Direct impact: The US meltdown which shook the world had little immediate impact
on India, because of Indias strong fundamental and less exposure of Indian financial sector with
the global financial market. Perhaps this has saved Indian economy from being swayed over
instantly. Unlike in US where capitalism rules, in India, market is closely regulated by the
government.
Indirect Impact: The indirect impact or the second round impact of the crisis affected India quite
significantly.
a.
Decline in FII (More pressure on domestic market): The liquidity squeeze in global markets
following the collapse of Lehman Brothers had serious implications for India: it not only
led to massive outflows of foreign institutional investment (FII) but also compelled Indian
banks and corporations to shift their credit demand from external sources to the domestic
banking sector. These events put considerable pressure on liquidity in the domestic
market and consequently provoked a credit crunch. This credit crunch, coupled with a
general loss of confidence, increased the risk aversion of Indian banks, which eventually
hurt credit expansion in the domestic market.
b.
Impact on Indias export: With the US and several European countries slipping under the
full blown recession, Indian exports have run into difficult times, since October.
Manufacturing sectors like leather, textile, gems and jewellery have been hit hard
because of the slump in the demand in the US and Europe. Around 50,000 artisans
employed in jewellery industry have lost their jobs as a result of the global economic
meltdown
c.
Exchange rate depreciation: With the outflow of FIIs, Indias rupee depreciated
approximately by 20 per cent against US dollar and stood at Rs. 49 per dollar at some
point, creating panic among the importers.

Euro zone Crisis (2009-present)

What is European Union (EU) and Euro Zone?
The European Union (EU) is an economic and political union of 28 member states that are located primarily
in Europe. The EU operates through a system of supranational independent institutions and
intergovernmental negotiated decisions by the member states. Institutions of the EU include the
European Commission, the Council of the European Union, the European Council, the Court of Justice of
the European Union, the European Central Bank, the Court of Auditors, and the European Parliament.

50

The euro zone officially called the euro area, is an economic and monetary union (EMU) of 17 European
Union (EU) member states that have adopted the euro () as their common currency and sole legal tender.
The euro zone currently consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece,
Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. Other EU
states (except for the United Kingdom and Denmark) are obliged to join once they meet the criteria to do
so. Also free mobility of Human Resource is promoted within Euro zone.
What is the European Debt Crisis?
The European debt crisis is the shorthand term for Europes struggle to pay the debts it has built up in
recent decades. Five of the regions countries Greece, Portugal, Ireland, Italy, and Spain have, to
varying degrees, failed to generate enough economic growth to make their ability to pay back
bondholders the guarantee it was intended to be. Although these five were seen as being the countries
in immediate danger of a possible default, the crisis has far-reaching consequences that extend beyond
their borders to the world as a whole.
What led to European Debt Crisis?
Greece

Greece, which spent heartily for years and failed to undertake fiscal reforms, was one of the first
to feel the pinch of weaker growth.

In January 2001, Greece drops its currency, the drachma, to join the European Union "euro zone."
Greece is the 12th country to adopt the currency. In order to meet the EU's standards, Greece
makes deep cuts in public spending but still spending around $11b in Athens Olympics in 2004.

Underreporting the budget deficit: In Nov 2004, Greece admits that it gave misleading
information to gain admittance to the euro zone. One of the EU's requirements for euro zone
member countries is deficits below 3% of GDP. Greece had not met those criteria since 1999.

In late 2009 George Papandreou won the elections as Prime minister and was forced to announce
that previous governments had failed to reveal the size of the nations deficits. In truth, Greeces
debts were so large that they actually exceed the size of the nations entire economy, and the
country could no longer hide the problem.

Prime Minister Papandreou announced plans to cut public sector employment, reduce military
spending, and cut government spending in other areas.

Thousands of union workers went on strike to protest cuts in government spending

Ireland

The Irish sovereign debt crisis was not based on government over-spending, but from the state
guaranteeing the six main Irish-based banks who had financed a property bubble.

Irish banks had lost an estimated 100 billion Euros, much of it related to defaulted loans to
property developers and homeowners made in the midst of the property bubble, which burst
around 2007. The economy collapsed during 2008. Unemployment rose from 4% in 2006 to 14%
by 2010, while the national budget went from a surplus in 2007 to a deficit of 32% GDP in 2010

51

With Ireland's credit rating falling rapidly in the face of mounting estimates of the banking losses,
guaranteed depositors and bondholders cashed in during 200910, and especially after August
2010.
The Irish government was forced to nationalize Anglo Irish Bank to keep it from collapsing. The
government takes a 36% direct stake in Bank of Ireland, and 93% in Anglo Irish Bank
In 2009, Ireland outlined 15 billion in spending cuts and tax increases. It refused to raise its low
tax on corporations. This plan is intended to reduce the budget deficit to 9.1% of GDP in 2011.
Thousands rally in Dublin, protesting the bailout and budget cuts.

Portugal

Portugal had allowed considerable slippage in state-managed public works and inflated top
management and head officer bonuses and wages in the period between the Carnation
Revolution in 1974 and 2010. Persistent and lasting recruitment policies boosted the number of
redundant public servants.

Risky credit, public debt creation, and European structural and cohesion funds were mismanaged
across almost four decades.

When the global crisis disrupted the markets and the world economy, together with the US credit
crunch and the Euro zone crisis, Portugal was one of the first and most affected economies to
succumb.

In January, 2010 - The government announced that it was freezing government wages and
reducing the number of government workers through attrition. The government also announced
new austerity measures, including more privatization, caps on wages and tax increases. Tens of
thousands of public workers strike.
Spain

Spain had a comparatively low debt level among advanced economies prior to the crisis. Its public
debt relative to GDP in 2010 was only 60%, more than 20 points less than Germany, France or the
US, and more than 60 points less than Italy, Ireland or Greece. Debt was largely avoided by the
ballooning tax revenue from the housing bubble, which helped accommodate a decade of
increased government spending without debt accumulation. When the bubble burst, Spain spent
large amounts of money on bank bailouts.

Although Crisis did cause unrest among people, large protests erupted when the government
announces planned to raise the retirement age.

The government wins approval of its 15 billion austerity plan. The plan includes cutting public
employees' wages and cutting welfare benefits. Parliament passes a law that makes it easier for
companies to fire workers.

General strike called by unions to oppose the spending cuts. But in January 2011 - The government
and unions reach an agreement over pension reform. The retirement age is raised from 65 to 67.

In May, 2011 Young people protest unemployment in Madrid, Barcelona and Valencia. The
unemployment rate among young people has reached 50% in some areas.

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Mention the main reasons in brief.

VIOLATION OF EU RULES: According to EU, its member nations must not have national debt of more
than 3% of GDP. But it was not followed by Greece and Cyprus as they did not give real data.
BANKING SECTOR PROBLEM : The European banking sector appeared to be vulnerable as it has
showed a dramatic collapse since it got involved in the global financial chain that was dragged
down in the 2007 financial crisis, which was buoyed by the burst of the mortgage bubble in the
United States.
POLITICAL CONFLICT: The role of politics in the debt dilemma cannot be ignored as the different
political perspectives between parties having different ideologies have created a kind of conflict
between European decision makers as Germany and other rich nations were on one hand refusing
to let taxpayers pay for the crisis and have refused any decisive methods including violation to
their sovereignty while the other camp, which is so-called peripheral nations, have been asking
for more flexibility.
SLOW AND INDECISIVE ACTIONS F ROM EUROPEAN O FFICIALS: The debt crisis which was triggered by
Greece did not remain only in the Hellenic country but transferred from one country to another
due to the slow response from European leaders to solving the problem as their actions were
always late and not decisive.

What are the measures being taken by ECB to tackle the crisis?

Countries got huge bailout in order to help them come out the crisis. Greece got a huge bailout
of 245 billion Euros whereas Spain got 41.6b Euros, Portugal got 78b Euros, Ireland got 67.5b
Euros as bailout majorly from ECB and IMF. They are still getting financial help.
European Financial Stability Facility (EFSF): On 9 May 2010, the 27 EU member states agreed to
create the European Financial Stability Facility, a legal instrument aiming at preserving financial
stability in Europe by providing financial assistance to euro zone states in difficulty. Stocks surged
worldwide after the EU announced the EFSF's creation. The facility eased fears that the Greek
debt crisis would spread.
European Financial Stabilization Mechanism (EFSM): On 5 January 2011, the European Union
created the European Financial Stabilization Mechanism (EFSM), an emergency funding
programme reliant upon funds raised on the financial markets and guaranteed by the European
Commission using the budget of the European Union as collateral. It runs under the supervision
of the Commission and aims at preserving financial stability in Europe by providing financial
assistance to EU member states in economic difficulty.

What are the learnings from Euro Debt Crisis?

The first is that economic (monetary) integration without political (fiscal) integration is a flawed union.
A second lesson is that countries that use a stateless currency such as the euro have limited ability to
respond to economic troubles. They have no independent monetary policy, nor a currency that can
plunge to make their economies more competitive. Their governments only levers are fiscal policy

53

and any powers that can help deflate their economies, the recourse known as an internal
devaluation
Another lesson is that austerity programs kill sick, and even not-so-sick, economies. They thereby
worsen, rather than fix, government finances.
Immoral/unethical practices can make your debt even worse.

What was the Impact of Euro Debt Crisis on India?

If the euro zone crisis is not averted, India which has about a sixth of its total exports to the
European Union will face unemployment in the lower income category, such as textiles, one of
the biggest employers. Textiles, including readymade garments, account for about a fifth of the
total exports to Europe.
The slump in spending by the Europeans will aggravate the Indian economic slowdown where
growth rate has already dipped
Capital flows into the economy and exports are likely to take a slump. The sudden surge in Foreign
Institutional Investor (FII) has left India grappling with high inflation.
Opportunity: Crisis in Europe should be seen as an opportunity for India to break into the markets
where they export.

1991 Reforms- Liberalization Privatization Globalization

In June 1991, Indian economic policy embarked on a definite change in direction. Jettisoning the planned
economic development model that had been followed since the 1950s which was marked by the state
micro-managing the economy, oppressive controls on the private sector and over-reliance on the public
sector the state decided to play a facilitating and regulatory role, giving more freedom to entrepreneurs
and the private sector and opening up the economy. The era of planned economic development had been
based on the belief that it would lead the country out of poverty to prosperity. Unfortunately, the
paraphernalia of a closed economy only stifled growth. The Indian economy grew at an annual average
rate of 3.5 per cent in the first three decades.
The realization of the need for easing the controls on the economy came in the 1980s. However, this only
resulted in some tinkering with the controls mechanism and there was no attempt at a fundamental
restructuring of the economy. Though growth picked up, this was on the back of heavy public spending,
which only led to huge fiscal deficits and increasing external debt. This finally culminated in a full-blown
crisis in 1990-91 when the rise in oil prices due to the Gulf War put a tremendous strain on Indias balance
of payments position. Foreign exchange reserves plummeted to being enough for just two weeks of
imports and India was in serious danger of defaulting on its external debts.
The IMF came up with a bailout but there was no escaping the fact that the Indian economy needed drastic
reforms. These were undertaken with a major delicensing exercise in 1991. Industrial licensing was
scrapped, imports liberalized, foreign investment levels hiked. Over the years, sector after sector was
slowly opened up to competition domestic and foreign.

54

Industry
The industrial sector has been the focus of much of the economic reforms. In 1991, industrial licensing
was abolished for all but 18 industries; the number of sectors reserved for the public sector was reduced
from 12 to 8; imports were liberalized; the Monopolies and Restrictive Trade Practices (MRTP) Act
relaxed. Besides, certain sectoral measures were also taken. The 1991 Automobile Policy opened up
the auto sector to foreign manufacturers and the New Power Policy allowed private participation in power
generation. Since then the process of delicensing continued. In 1993, the telecom sector was thrown open to
the private sector. Even defence equipment has been opened up to the private sector. Small scale sector
reservation, which had discouraged industrial units from achieving economies of scale and becoming
efficient, remains, but for a very few industries.
Services
The services sector, which has largely escaped the governments heavy-handed regulation and micromanagement, has flourished after liberalization, benefiting from the freeing of controls on industry and
the financial sector. With the liberalization process throwing up new opportunities, a host of new services
emerged offered by imaginative and resourceful entrepreneurs. India has also been a major exporter of
services, especially in the information technology and information technology-enabled services. The
Indian IT and ITES sectors are seen as a threat to companies in more advanced economies. Indias share
in world service exports has increased more than six times from 0.5 per cent in 1990 to 3.3 per cent in
2010. India, which plays the protectionist card at the World Trade Organization (WTO) on industry and
agriculture, is aggressive in demanding more openness by advanced economies in the service sector
negotiations. At the same time, it continues to be protectionist and closed when it comes to opening up
some sectors like law and education.
Financial Sector
Banking sector reforms were kicked off in 1992 and have been continuing since then. Private Banks,
including foreign banks, have been allowed to operate and their reach is now extensive. This has ushered in
much-needed competition into the sector, improving services in public sector banks as well. Interest
rates have been decontrolled. Both deposit rates and lending rates have been deregulated. Banks
are being given greater operational freedom than before and mandatory requirements on investment in
government securities, priority sector lending etc have been eased.
However, public sector banks are still not completely free of government control and political interference.
A Bill on reducing government stake in public sector banks to 33 per cent was tabled in 1999 but nothing
came of it.
The public sector monopoly in the insurance industry finally came to an end in 1999. Apart from the six public
sectors insurance companies that were the only insurers in 2000 when the sector was opened up, there are
now close to 50 insurance firms and the stiff competition among them has been a boon for consumers. A
strong regulator - the Insurance Regulatory and Development Authority - has set strict guidelines for
insurance firms. However, there are still restrictions on the extent of foreign investment in insurance firms.
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Telecommunications
The telecom sector has been a success story of private sector involvement in infrastructure and testimony
to how free competition ultimately benefits the consumer. Starting with opening up email, voice mail and
cellular services to the private sector in 1991, competition has now been allowed in basic services and
national and international long distance services as well. All this has led to a tremendous increase in
connectivity. Tele-density, which was less than 1 per cent in March 1991, is now over 70 per cent. Cellular
phones, once considered a luxury, are now a lifeline for service providers like electricians, plumbers,
food hawkers, roadside tailors the very section the market was not expected to cater to. There are over
650 million mobile phone connections across the country now.
Impact of Liberalization
Has the economic reforms process had the effect it was supposed to - a more robust economy,
increased prosperity and a reduction in poverty?
Macro Economic Stability
The reforms that were kicked off in 1991 did have an impact on the economy. Growth of gross domestic
product (GDP) spurted from 0.8 per cent in 1991-92 to 5.3 per cent in 1992-93. GDP growth kept up this
upward spiral and averaged 5.5 per cent in the 1990s. Inflation, which had soared to 13.7 per cent prior
soon came down to single digits and has remained at that level since then, even going down to 2 per cent
at several points of time. The reforms also strengthened Indias external sector substantially. The share of
both exports and imports in GDP rose. This was prompted by liberalization and decline in real exchange
rate in the case of exports and strong domestic demand and lowering of tariff and non tariff barriers in
the case of imports. From a current account deficit of 3.1 per cent of GDP in 1990-91, India had a current
account surplus of 0.8 percent of GDP in 2001-02, for the first time in 23 years, though current account
deficit levels are now at worrying levels. India is now the worlds fourth largest economy in PPP terms and
is also among the fastest growing economies. Its share in world GDP is 5.5 per cent, against 3.2 per cent
in 1990.
Poverty
The structural adjustment programme has often been criticized for being anti-poor. But there is enough
statistical evidence that poverty has been declining steadily, and since 1991 at a faster pace than before.
The latest figures put out by the Planning Commission shows that the percentage of people below the
poverty line has fallen to 29.8 per cent in 2009-10 from 37.2 per cent in 2004-05
Public Finances
Public finances continue to be a major source of worry. The fiscal crisis of 1991 was in no small measure
due to the high fiscal deficits of the 1980s, caused by huge public spending. The combined fiscal deficit of
the Centre and the states touched 10 per cent in the crisis year. Fiscal consolidation, therefore, became a
crucial element of the reforms process. Initially, the fiscal deficit at the Centre did fall from 8.3 percent of

56

GDP in 1990-91 to 5.9 per cent in 1991-92 but increased to 7.4 per cent in 1993-94. Since then it hovered
around the 5 percent mark for several years but started going up again since 2008-09.
A major step in the direction of fiscal reform was taken when the National Democratic Alliance
government tabled the Fiscal Responsibility and Budget Management Bill in 2000. It was enacted in 2003
and the FRBM Rules notified in 2004. Under the Act, the central government was to reduce its revenue
deficit by 0.5 per cent of GDP every year from 2003 and eliminate it entirely by 31 March 2008. The fiscal
deficit was to be reduced to 3 per cent of GDP by 31 March 2008, with an annual reduction of 0.3 per cent
of GDP from 2003.
Employment
The other criticism leveled against the reforms process is that it has led to jobless growth. Indeed,
employment seems to be a mixed bag of achievements. At 2.62 per cent in 2004-05, growth in
employment has been less than the growth in the labor force (2.84 per cent), which has been the general
trend in employment in India. The unemployment rate has also increased - from 6.06 in 1993-94 to 6.6
per cent in 2009-10, spiking to 7.3 per cent and 8.2 per cent in 1999-2000 and 2004-05 respectively.
Non-agricultural employment grew faster than agricultural sector employment between 1993-94 and
2004-05 (3.49 per cent and 0.40 per cent respectively).
In the organized sector, which employs 287 lakh persons as of 2010, employment growth has been largely
stagnant since 2001, barring a few years when it exhibited a 1 per cent or 2 per cent growth. Within the
organized sector, however, it is the private sector that is contributing to employment growth at an average
annual rate of around 2 per cent since 2001. After negative growth between 2002 and 2004, the annual
growth has ranged between 2.4 per cent and 6.4 per cent. Growth in public sector employment has been
stagnant.

Careers in Finance
What are the various career options available in the field of finance?
Following are the different career paths available in the field of finance:
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1. CORPORATE FINANCE
Corporate Finance helps a company to help it find various sources to raise finance, grow the
business, make acquisitions, plan for its financial future, manage cash in hand and ensure future
economic viability. The different options available for professionals seeking a career in corporate
finance include treasurer, credit manager, investor relations officer and controller. In India,
companies like CRISIL, KPMG, and Deloitte are involved in corporate finance advisory activities.
2. INVESTMENT BANKING
An investment bank is a financial institution that assists individuals, corporations and
governments in raising capital by underwriting and/or acting as the clients agent in the issuance
of securities e.g.: IPO/ FPO work is handled by investment banks. An investment bank also assist
companies in mergers and acquisitions, and provide ancillary services such as market making,
trading of derivatives, fixed income instruments, foreign exchange, commodities, and equity
securities. At the entry level, an analyst would be responsible for writing reports, maintaining
spreadsheets, trading stock options, research, etc. Investment Banking aspirants need to have an
in- depth knowledge of money markets, the state of the economy and business and industry in
general. They are expected to be continuously involved in extensive research on these subjects,
and be up-to-date with the latest information. Avendus, Bajaj Capital and SBI capital markets are
few of the prominent Investment Banking firms in India.
3. COMMERCIAL BANKING
A commercial bank is one primarily engaged in deposit and lending activities to private and
corporate clients in wholesale and retail banking. Other services typically include bank and credit
cards, private banking, custody and guarantees, cash management and settlement as well as trade
finance. Commercial banks make their profits by taking small, short-term, relatively liquid
deposits and transforming these into larger, longer maturity loans. This process of asset
transformation generates net income for the commercial bank. State Bank of India, ICICI and HDFC
banks are some of the major players in Commercial Banking in India.
4. FOREX MANAGEMENT:
The foreign exchange market refers to the network of individuals, banks and organized financial
exchanges that trade global currencies. Foreign exchange management requires its participants
to enter the market to deliver and accept currencies at fluctuating exchange rates. Foreign
exchange management requires you to follow current events that translate into fluctuating
exchange rates for a particular country. Several companies are looking for professionals who
understand the nuances of international finance, international capital markets and risk
management. Management graduates may seek careers in areas of overseas fund mobilization,
risk management, Forex dealing or Forex consultancy.
5. FINANCIAL PLANNING
Financial planning helps people make advance provision for financial needs that may arise in
future. On the technical side, strong attention to detail is required to analyze all types of financial
options, including their tax implications and legal restrictions. Financial computing skills are
58

recommended for performing the mathematical calculations quickly and accurately. Good
communication skills is a plus as planners have to communicate complex financial concepts and
strategies to clients in non-technical, easy-to understand terms.
6. TRADING
Trading is a global phenomenon and offers tremendous potential to market participants for both
profit taking on small price corrections as well as to hedgers looking at managing price risk on
account of price fluctuations. The market can be classified into equities (stocks and shares) and
fixed income, currencies and commodities (corporate credit, government debt, currencies,
commodities and interest rate products). Traders track the markets and buy and sell products at
the touch of a button. Your career will be defined both by what you trade (e.g. equities, foreign
exchange, or commodities) and by the kind of trader you are. The ability to multi-task, to work
under pressure in a fast-moving environment, to assimilate information quickly in order to react
fast to market changes, sharp attention to detail, and strong risk management skills are a must
for a successful career in trading. Futures First and Jaypee Capital are some of the prominent
trading companies in India.
7. INSURANCE
Indian insurance sector is poised to mark great progress in the years the come. Over the past few
years, many foreign insurance companies have ventured into the Indian landscape in order to
harness the immense untapped latent potential of this industry. Moreover, the favorable
regulatory environment ensures stability and fair play in the entire market. The different career
paths under insurance include underwriting, actuarial and broking. Good analytical skills,
attention to detail and a strong results orientation are the skills required to excel in this sector.
LIC, SBI Life Insurance, Birla Sunlife and ICICI Prudential are some of the major players in this
sector.

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CONTRIBUTORS
(BATCH OF 2013-15)
ADITI TRIPATHI
AKANKSHA GUPTA
ANKIT SEHGAL
ANKUSH ARYA
ASHISH JAIN
CHETAN SANJIV MARWAHA
DHANENDAR DUGAR
JEWEL VARUGHESE
LIPI SINGAL
MEHER DIVYA KOLLI
SAURABH CHAWLA
SHIKHA AGRAWAL
SURBHI GOYAL
SURBHI R ATHI
YASWANTH REDDY KALUSANI
(BATCH OF 2014-16)
SHRIRAM RAJASEKARAN

COMPILED BY

THE FINANCE CLUB

E-mail : finalyze.j@imi.edu

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