Finshastra January 2011 Volume 1

8/8/2019 Finshastra January 2011 Volume 1

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Information Technology SolutionsFINS hastraNews letter of finance cell , Master of International Business

Volume VIII |ssue I

an 15 ,2011

Team FinshastraAnuratn

Saurabh

Sunita

Kamal

For any query or suggestion email us at [email protected]

f fffdgf Your gateway to the world of finance

Your Finance Vocab

What Does NINJA Loan Mean? A slang term for a loan extended to a borrower with "no income, no job and no assets".Whereas most lenders require the borrower to show a stable stream of income orsufficient collateral, a NINJA loan ignores the verification process. What Does Bespoke CDO Mean? A type of collateralized debt obligation (CDO) that a dealer creates for a specific groupof investors. The CDO is structured according to the investors' needs. The investorgroup then typically buys a single tranche of the bespoke CDO. The remaining tranchesare then held by the dealer, who will usually attempt to hedge against losses. Bespoke CDOs are a relatively new instrument in the financial world. They allowinvestors to target very specific risk/return profiles for their investment strategies orhedging requirements

Financial covenants

Part of the conditions of a loan agreement, these covenants are the promises by themanagement of the borrowing firm to adhere to certain limits in the firm's operations.For example, not to allow certain balance sheet items or ratios to fall below or go overan agreed upon limit

What Does Credit Default Swap (CDS) Mean? A swap designed to transfer the credit exposure of fixed income products betweenparties. Explains Credit Default Swap (CDS) The buyer of a credit swap receives credit protection, whereas the seller of the swapguarantees the credit worthiness of the product. By doing this, the risk of default istransferred from the holder of the fixed income security to the seller of the swap. For example, the buyer of a credit swap will be entitled to the par value of the bond bythe seller of the swap, should the bond default in its coupon payments.


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What Does North American Loan Credit Default Swap Index - LCDX Mean? A specialized index of loan-only credit default swaps (CDS) covering 100 individualcompanies that have unsecured debt trading in the broad secondary markets. The LCDXis traded over the counter and is managed by a consortium of large investment banks,which provide liquidity and assist in pricing the individual credit default swaps.

The index begins with a fixed coupon rate (225 bps); trading moves the price andchanges the yield, much like a standard bond. The index rolls every six months. Buyersof the index pay the coupon rate (and purchase the protection against credit events),while sellers receive the coupon and sell the protection. What is being protected is a"credit event" at the company, such as defaulting on a loan or declaring bankruptcy.

What Does Globally Floored Contract Mean? A guarantee found in structured investment products that provides a minimum payoff at maturity. A globally floored contract will protect the investor or minimize his loss incase the underlying investment loses its value. Globally Floored Contract With principal-protected notes, an investor receives a guarantee providing downsideprotection on the investment. A cost of this downside protection is that the investor willnot participate in the full upside potential of the underlying investment.


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Toxic Security is the name applied during the aftermath of the subprime meltdown tofinancial instruments which cannot be readily identified as an asset or a liability.According to George Soros, "the toxic securities in question are not homogeneous.". Oneexample would be a credit default swap that entitles the holder to a regular stream of small payments but obliges the holder to make a large payment if a specified event occurs. John Gapper describes one such instrument, a "tail risk" swap:

Cash CDOs involve a portfolio of cash assets, such as loans, corporate bonds,asset-backed securities or mortgage-backed securities. Ownership of the assetsis transferred to the legal entity (known as a special purpose vehicle) issuing theCDOs tranches. The risk of loss on the assets is divided among tranches inreverse order of seniority. Cash CDO issuance exceeded $400 billion in 2006.

Synthetic CDOs do not own cash assets like bonds or loans. Instead, syntheticCDOs gain credit exposure to a portfolio of fixed income assets without owningthose assets through the use of credit default swaps, a derivatives instrument.(Under such a swap, the credit protection seller, the CDO, receives periodic cashpayments, called premiums, in exchange for agreeing to assume the risk of loss

on a specific asset in the event that asset experiences a default or other credit event.) Like a cash CDO, the risk of loss on the CDO's portfolio is divided intotranches. Losses will first affect the equity tranche, next the mezzanine tranches,and finally the senior tranche. Each tranche receives a periodic payment (theswap premium), with the junior tranches offering higher premiums.

Distressed securities are securities of companies or government entities that areeither already in default, under bankruptcy protection, or in distress and headingtoward such a condition. The most common distressed securities are bonds and bankdebt. While there is no precise definition, fixed income instruments with a yield to

maturity in excess of 1000 basis points over the risk-free rate of return (e.g. Treasuries)are commonly thought of as being distressed.

compiled by Kamal


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TimeLine Of The US SubprimeCrisis

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TIMELINE OF THE US SUBPRIME CRISIS

The subprime crisis mainly refers to the glitches in America's subprime mortgagemarket, which consists of loans to individuals with weak credit histories and whichultimately led to the collapse of US economy with wide ranging repercussions on worldeconomy.

The inception of the crisis can be traced back to 2001 when the Federal Reservelowered the interest rates 11 times on the back of the dot.com bust and 9/11 andhousing bubble started taking shape. The next significant event was the Feds attempttocombat inflation when 16 consecutive interest rate hikes followed the first on 30th June2004, affecting American borrowers. Thereafter in 2005-06 house prices in the USbegan to fall, accompanied by increasing defaults on subprime mortgages and that ishow property bubble began to unwind.

March 2007: The landmark problem began when New Century Financial, the second

largest subprime lender, stopped lending, and its shares got suspended.

April 2007: New Century Financial filed for bankruptcy .Though it wasnot the first of subprime lenders to take this path, but it was the most high-profile victim of the crisistill then.

October 2007: Merrill Lynch announcedUS$7.9 billion writedown . After announcing aworst-case scenario US$7 billion hit due to the falling prices of mortgage-backedinvestments just a month before, Merrill Lynch surprised the Wall Street.

November 2007: Other bulge bracket banks took a hit . Morgan Stanley announced aUS$ 3.7 billion writedown due to its mortgage-related exposure. Citigroup announced awrite down of US$ 8 to 11 billion.

March 2008: JP Morgan Chase & Co. acquired troubled Wall Street firm Bear Stearns, ina deal engineered by the Federal Reserve, which agreed to provide up to $29 billion infinancing to cover potential Bear Stearns losses that JPMorgan agreed to assume.


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July 2008: The FDIC took over IndyMac, a California bank that had been one of theleading lenders who made home loans to people who did not provide proof of theirincome. FDIC warned that more bank failures lay ahead.

September 2008: Treasury Secretary Henry Paulson announced a takeover of FannieMae and Freddie Mac, putting the government in charge of the twin mortgage giantsthat own or back more than $5 trillion in mortgages. The Treasury Department agreedto provide up to $200 billion in loans to the cash-starved firms that were crucial sourcesof mortgage funding for banks and other home lenders.

Bank of America agreed to acquire Merrill Lynch, in a deal joining one of the nation'slargest banks with one of the its largest brokerage firms, for up to $50 billion. Deal cameafter talks to have Bank of America buy Lehman Brothers, another money-losing WallStreet firm, fall through. Unable to find a buyer, Lehman Brothers filed for bankruptcycourt protection.

October 2008: President George W. Bush signed the Emergency Economic StabilizationAct, creating a $700 billion Troubled Assets Relief Program to purchase failing bankassets. It also contained easing of the accounting rules that forced companies to collapsebecause of the existence of toxic mortgage-related investments.

The year 2009 and 2010 have been majorly gone into worldwide measures to mitigatethe adverse impacts of the crisis with various scams unfolding accompanied with blamegame.


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Life Post Crises : Will The WorldEconom(ies) Review

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by Saurabh Chopra and Kamal Girdhar

Have you ever heard about any of these - Tequila crisis , Asian Flu or the Russian virus ?What is single most underlying common factor in them ? Each of these propagated like acontagious disease , quickly effecting not only neighbouring but also distant markets. Asthese crisis made into the breaking news of media , the word contagion began tofrequently appear in the financial literature.

So on and so forth , there is still no consensus on the definition of financial contagionbut according to very popular Forbes and Rigobons 2002 , definition of financialcontagion is a significant increase in cross market linkages after a shock to onecountry (or a group of countries)

The United State Subprime mortgage crisis of 2007 although originated in a veryspecific and relatively small segment of the US mortgage market, it has spread well

across the US Borders.. Results suggests that the contagion exists and not only on eachof the registered stock exchange in the world but also post subprime the spread wasseen in the macroeconomic environment and industrial sectors around the world .

Ben Bernanke, the chairman of the US Federal Reserve, stated in a speech delivered on15 October 2007, that the developments of the relatively small US subprime market were having a large impact upon the global financial system. In fact, the first lossesassociated with the subprime crisis were then reported in the media by a number of institutions, including the Citigroup, in the US, the Crdit Agricole, in France,the HSBC,in the United Kingdom, the CIBC, in Canada, or the DeutscheBank, in Germany


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The results suggest that markets in Canada, Italy, France and the United Kingdomdisplay significant levels of contagion, which are less relevant in Germany. Canadaappears to be the country where the highest intensity of contagion is observed. TheSubprimecrisis rapidly developed and spread into a global economic shock, resulting ina number of European bank failures, declines in various stock indexes, and largereductions in the market value of equities and commodities.

Bleeding Euro !!!

One of the long-term worldwide consequences of the economic breakdown is the 2010European sovereign debt crisis. This crisis primarily impacted five countries: Greece,Ireland, Portugal, Italy, and Spain. The governments of these nations habitually runlarge government budget deficits. Other Eurozone countries include: France, Belgium,The Netherlands, Luxembourg, Germany, Finland, Slovenia and Austria. Greece, which at the time of the crisis also suffered from bad governing with widespread corruptionand tax evasion, was hit the hardest and was thus targeted by credit ratingagencies as the weak link of the Eurozone. Fear that Greece's debt problems wouldcause lenders to stop lending to it, with the result that Greece would default on itssovereign debt, sparked speculation that such a default would cause lenders to stoploaning money to the other PIGS (Portugal, Ireland/Italy, Greece and Spain) as well,with the result that they would also eventually default on their sovereign debt.A sovereign default by Spain, Portugal, Italy and Greece would result in bank losses so


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so large that almost every bank in Europe would become insolvent due to the now uncollectible outstanding loans to those four countries.

Some developing countries that had seen strong economic growth saw significant slowdowns. According to the research by the Overseas Development Institute,reductions in growth can be attributed to falls in trade, commodity prices, investment and remittances sent from migrant workers (which reached a record $251 billion in2007, but have fallen in many countries since).This has stark implications and has led toa dramatic rise in the number of households living below the poverty line, be it 300,000

in Bangladesh or 230,000 in Ghana.In Nov 2010 , Federal Reserve announced it would embark on a second round of quantitative easing, or QE2 which has had severe repercussions on Inflation in developingworld. In today's world of financial globalisation , the implications of QE2 go farbeyond the US. Lowering rates in the US will accentuate the "carry trade"whereinvestors borrow cheaply in the US and park their money in developing countries whereinterest rates are relatively higher: private speculators reap profits on the interest ratespread and the appreciation of developing country currencies.Such massive inflows of hot money into emerging markets will have the destabilising effects of rapid currencyappreciation and asset bubbles ! Asian super powers India and China remains in grave

danger of higher inflation due to ever increasing food price rises.

INFLATION : OUT OF HAND ??


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CURRENCY WARS : WILL CHINA BUDGE ??

Currency war, also known as competitive devaluation, is a condition ininternational affairs where countries compete against each other to achieve arelatively low for their home , so as to help their domesticindustry.According to Brazil's finance minister, , and to severalfinancial journalists, a global currency war has broken out in 2010. In generalsenior policy makers and journalists have suggested the phrase "currency war"overstates the extent of hostility, though there is a risk of further escalation. Whilemany states have experienced undesirable upwards pressure on their exchangerates and taken part in the on-going arguments, the most notable dimension hasbeen the rhetorical conflict between the United States and China over the valuation

of the . For much of 2009 and 2010, China has been under pressure from theUS to allow the yuan to appreciate. Between June and October 2010, Chinaallowed a 2% appreciation of the yuan, but there are concerns from Westernobservers that China only relaxes her intervention when under heavy pressure.The fixed peg was not abandoned until just before the June G20 meeting, afterwhich the yuan appreciated by about 1%, only to slowly devalue again untilfurther US pressure in September when the yuan again began relatively steepappreciation, with the imminent September US Congressional hearings to discussmeasures to force a revaluation.

Lastly , since subprime crisis broke out in August 2007, there have been other

developments in the economy that affected stock prices. Most prominently, theU.S. dollar depreciated against the euro and the Japanese yen by 15 percent and18 percent, respectively, during July 31, 2007March 31, 2008; the world oil priceincreased by close to 40 percent during the same period..Hence as pointed out invery first lines of this article US Subprime crisis of 2008 was contagious just likeMexican Tequila of 1994 , or Asian flu of 1997 or Russian Virus of 1998 .

Saurabh Chopra Kamal Girdhar

Kamal Girdhar is an alumnus of Shri Ram College Of Commerce , University Of Delhiand is currently a final year student at Dept. Of Commerce , Delhi School Of Economics. He is placed at ICICI and his work commences from May 2011 onwards.

exchange rate currencyGuido Mantega

yuan

[email protected]@gmail.com
mailto:[email protected]:[email protected]://en.wikipedia.org/wiki/Chinese_yuanhttp://en.wikipedia.org/wiki/Guido_Mantegahttp://en.wikipedia.org/wiki/Currencyhttp://en.wikipedia.org/wiki/Exchange_rate


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CEO Corner

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Mr. Jaspal Singh Bindra serves as the Chief Executive - Asia of StandardChartered Bank Singapore. Mr. Bindra serves as the Chief Executive Officer of Asia for Standard Chartered PLC. Mr. Bindra Chief Executive of Asian Regionfor Standard Chartered Bank and Standard Chartered Bank (Taiwan) Limitedat Standard Chartered Bank (Hong Kong) Limited. He serves as Chief Executive Officer and General Manager of Standard Chartered Bank India andalso serves as its General Manager ... of South Asia.He is a qualifiedChartered Accountant and has an MBA from Xavier Labor Relations Institute,Jamshedpur.

iHere is an interview conducted by India Knowledge@Wharton

Is your appointment to Standard Chartered's board an indication of a power shift toward Asia -- not just in the bank, but in the global environment as well?

Jaspal Bindra : I believe that my elevation to Standard Chartered's board isrecognition of the significance of our Asian operations. Our Asia business, as aproportion of the total, is roughly two-thirds. Whether you look at it by balancesheet, profitability or number of people, Asia accounts for about 60% to 70%. Out

of 11, [there] are two Asians on the board, which is still a bit lopsided. But it is adifference from about two decades ago, when a lot of our international cadreofficers were non-Asians. If you look at the pipeline, the board is going to get more diverse, which is a reflection of the power shift toward Asia in general.

Q: You are planning a listing in India through Indian Depository Receipts. How bigwill this issue be, and when are you planning it? How much of the bank's equitywill it represent?

Bindra : We are very interested in floating an IDR issue, which will be India's first,and we are actively pursuing this. We haven't decided on the exact time and size,though we hope to do it in the second quarter of this year, subject to market

conditions.Q: What is the objective of the issue? Why did you opt for an IDR as opposed toother instruments?

Bindra : We aren't really looking at the IDR for capital-raising reasons. If it wasjust for capital, we could have raised it from anywhere. This is more of a strategicstep given India's growing importance in the Standard Chartered network, as webelieve that listing in India will go a long way [toward] increasing our visibilityand profile in the market. We have been working very closely with the Indianregulators for the last 18 months to make this happen, and their support has beencommendable. India is the second-largest market now for Standard Chartered,and it is very quickly catching up with Hong Kong. Hence, we believe now is theright time to list here.


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Second, we believe we will be among the first in what will become a trend. Weexpect to see quite a few companies with an interest in India to list in the localmarket. We've been trendsetters on several other counts. We've [held] our globalPLC board meeting here in India since the 1980s. Now, it is fashionable for othersto do [the same]. When we set up our global processing house in India in 2000,we were the first foreign bank to do so. Now everybody else is clamoring to do thesame. So, we believe listing is going to be something that will happen for most companies with longer-term interests and scale of operations here.

Moreover, we also want to raise capital. I believe that India, in times to come, willbecome a very big source of capital for international issuers. It is one of theaspiring financial centers of the world. With a view on the longer term, we want

to have the advantage of being the first mover in an emerging internationalfinancial center.

Q: This is the first IDR in Indian history. Do you see problems in explaining theconcept to investors or selling it?

Bindra : There will be challenges, because this will be the first IDR to hit themarket. Clearly, there will be questions in investors' minds about the structure of the instrument, how one trades in it, what kind of returns can be made on theinstrument, and what are the risks involved given that our shares aresimultaneously trading in London and Hong Kong. Moreover, investors will alsowant to understand more about our business. Steps are being taken to giveadequate information to investors through various channels, including themedia.... We have also had tremendous support from the authorities and weexpect this will continue as we bring the instrument to the market.

Q: You see an era of outbound M&A ahead. But for Indian companies to go on asuccessful takeover trail, they need the currency of acquisitions, principallyequity. Most Indian promoters are, however, unwilling to dilute their holdings.How do you see takeovers happening in this environment?

Bindra : By and large, most Indian promoters doing transactions restrict theiroutbound ambitions to companies that they can finance with a mix of theirinternal resources and leverage. However, it is not that Indian promoters arealways unwilling to dilute. For example, both Hindalco's acquisition of Novelisand Tata Steel's acquisition of Corus did indeed involve raising equity, albeit as asecond step of financing -- that is, equity raised for taking out a bridge facility. Infact, several outbound acquisitions by Indian companies involved financingthrough convertible bonds, which can -- and did -- convert to equity.

Logically speaking, outbound M&A is here to stay and grow. India has been a net importer of capital for a long time. That must change, especially as Indiancompanies have scale and competitive strength to compete in internationalmarkets.

Q: You say that two of the greenfield areas in India are education and themarriage market. You see the latter as a US$20 billion business opportunity. But,


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Bindra : Education is an important sunrise sector in India, and we could see a lot of inbound M&A activity in [it]. The majority of Indians are young, and it is in thenational interest to have a literate population in place. Today, every individual,whatever the means, wants his or her kids to be educated. It is a mega-aspiration.And with rising wealth, it is possible to back the aspiration with resources. Theonly gap is availability of the facility. The demand-supply gap is so obvious that every business house wants to [get into education]. We hope policy makersfacilitate this. The big growth is going to come in places like hotel management [training], vocational courses, design institutes, fashion institutes ....

Another industry with strong potential is the marriage market, which is one of the biggest markets we will have. As a rough estimate, there are about 10 million

marriages in India every year -- a number that is going to grow as the youngpopulation grows. If you take an average spend of US$2,000 [for a wedding],which is on the lower side, [marriage] is a US$20 billion-a-year industry. If youhad any other economic activity of US$20 billion, that would be fantastic.... [We]feel very bullish on India on so many counts.

Q: How has Standard Chartered fared during the global financial crisis? Has it escaped damage because it is essentially a conservative bank?

Bindra : To the extent that we can speak as of today, we have come out well as anorganization. We say "well" and not "fantastic" or "excellent" as it is such anuncertain world, and you have to be cautious about what might happen in thefuture. But [based] on a day-to-day analysis, when we compare where we werebefore the 2008 crisis with where we are today, we can say we are far strongernow. We are one of few institutions that can say that.

We had record performances in 2008 and the first half of 2009. To have recordperformances at a time that has seen the worst crisis in our living memory issomething. But I don't think we are out of the woods. More recently, we have seen[financial problems in] Greece and Dubai. So I don't think the ride ahead iscompletely smooth. There will be bumps along the way. But we feel quite certainof our business model, our strategy for emerging markets and our credit portfolio, which looks good. We've stuck to what we know and what we do well.

Most of our business is pretty boring, but in exciting markets. People who havesuffered are those who did exciting business in boring markets, such as the U.S.

[As long as] the fundamentals don't balance out -- that is, the East saving toomuch and West still highly leveraged -- there will be concerns over currency,volatility [and] prices; [there will be] concerns over what happens if someone,say, moves from U.S. Treasuries to gold. We can't be sure another Dubai story willnot surface.


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Q: The bank has some sort of a presence in all continents. But this is limited.Doesn't the future belong to banks with a global footprint?Bindra : We have chosen to focus on a few key markets, and that strategy has paidoff very well. We will stay with it.

Q: What are the lessons the bank and you yourself have drawn from the financialcrisis?

Bindra : A key takeaway from the crisis for the financial sector as a whole is theimportance of adhering to the basics of good banking. There cannot be enoughemphasis on exercising prudence and adhering to robust risk management practices. There is a need for strengthening customer relationships to better

understand the customer and his or her risk profile, [and] to sell the right kind of products to the customer. The business must be built along sustainable lines.

Q: Where do you see Standard Chartered going in the future?

Bindra : Standard Chartered is not driven by size, and in that way we are different from other institutions. We want to be the best at what we do, which is a highaspiration. We do want to continue to grow market share, build a market presence and go from one record performance to another. That is there, but it isnot with the aim of being the largest distributor or even among the top 10 inIndia or China. But we have no difficulty in living with the situation. We are not going to work toward buying up stuff just to get the distribution, etc., which

doesn't make sense.On the other hand, we can have a leading edge in product innovation. There areareas of huge strength, learning, experience of other markets, etc. We can partnerwith governments or regulators in policy formation, as we have done in Nepal orAfghanistan, where we framed the entire Banking Act. It is such achievementsthat we are very proud of.

compiled by

Anuratn

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Finshastra January 2011 Volume 1