MB0036

– Strategic Management & Business Policy

Assignment Set- 1

1. Explain the different circumstances under which a suitable growth strategy should be selected
by any company to improve its performance (i.e., intensive, integrative or diversification growth). You
may select an example of your choice to substantiate your views.

Answer :

Strategies to Improve Sales

There are three alternatives to improve the sales performance of a business unit, to fill the gap between
actual sales and targeted sales:
a) Intensive growth
b) Integrative growth
c) Diversification growth
a) Intensive Growth:
It refers to the process of identifying opportunities to achieve further growth within the company’s current
businesses. To achieve intensive growth, the management should first evaluate the available opportunities
to improve the performance of its existing current businesses.
It may find three options:
· To penetrate into existing markets
· To develop new markets
· To develop new products
At times, it may be possible to gain more market share with the current products in their current markets
through a market penetration strategy. For instance, SONY introduced TV sets with Trinitron picture
tubes into the market in 1996 priced at a premium of Rs.10,000 and above over the market through a
niche market capture strategy. They gradually lowered the prices to market levels. However, it also
simultaneously launched higher-end products (high-technology products) to maintain its global image as a
technology leader. By lowering the prices of TVs with Trinitron picture tubes, the company could
successfully penetrate into the markets to add new customers to its customer base.
Market Development Strategy is to explore the possibility to find or develop new markets for its current
products (from the northern region to the eastern region etc.). Most multinational companies have been
entering Indian markets with this strategy, to develop markets globally. However, care should be taken to
ensure that these new markets are not low density or saturated markets, which could lead to price
pressures.
Product Development Strategy involves consideration of new products of potential interest to its current
markets (e.g. Gramaphone Records to Musical Productions to CDs)– as part of a Diversification strategy.

Study the following example to understand what Product Development Strategy is.
MICROSOFT’s New Strategy
It is called PC-plus. It has three elements:
a) Providing computer power to the most commonly used devices such as cell phone, personal
computer, toaster oven, dishwasher, refrigerator, washing machines and so on.
b) Developing software to allow these devices to communicate.
c) Investing heavily to help build wireless and high-speed internet access throughout the world to
link it all together.
 Microsoft envisions a home where everyday appliances and electronics are smart. According to Bill
Gates, ‘In the near future, PC-based networks will help us control many of our domestic matters
with devices that cost no more than $ 100 each ‘.
It is also said at Microsoft that VCRs can be programmed via e-mail, laundry washers can be
designed to send an instant message to the home computer when the load is done and refrigerators
can be made to send an e-mail when there’s no more milk. Microsoft plans to give these appliances
‘brains‘ and provide them the means to talk to each other through their Windows CE Operating
System.

b) Integrative Growth:
It refers to the process of identifying opportunities to develop or acquire businesses that are related to the
company’s current businesses. More often, the business processes have to be integrated for linear growth
in the profits. The corporate plan may be designed to undertake backward, forward or horizontal
integration within the industry.
If a company operating in music systems takes over the manufacturing business of its plastic material
supplier, it would be able to gain more control over the market or generate more profit. (Backward
Integration)
Alternatively, if this company acquires some of its most profitably operating intermediaries such as
wholesalers or retailers, it is forward integration. If the company legally takes over or acquires the
business of any of its leading competitors, it is called horizontal integration (however, if this competitor is
weak, it might be counter-productive due to dilution of brand image).
c) Diversification Growth:
It refers to the process of identifying opportunities to develop or acquire businesses that are not related to
the company’s current businesses. This makes sense when such opportunities outside the present
businesses are identified with attractive returns and that industry has business strengths to be successful.
In most cases, this is planned with new products that have technological or marketing synergies with
existing businesses to cater to a different group of customers (Concentric Diversification).
A printing press might shift over to offset printing with computerised content generation to appeal to
higher-end customers and also add new application areas ( Horizontal Diversification ) – or even sell
stationery.
Alternatively, the company might choose new businesses that have nothing to do with the current
technology, products or markets (Conglomerate Diversification).
The classic examples for this would be engineering and textile firms setting up software development
centres or Call Centres with new service clients.
Situation Analysis
Sales Improvement Strategies:
a) A supplier of computer stationery invests in a computer stationery manufacturing unit.
b) A vendor supplying engine boxes to Maruti decides to supply the same with modifications to
Hyundai.
c) A company dealing in computer floppies plans to set up a Software Technology Park.

2. What are the components of a good Business Plan and briefly explain the importance of each.

Answer :
 The format of a Business Plan is something that has been developed and refined over the years and is
something that should not be changed. Like a good recipe, a business plan needs to include certain
ingredients to make it work.
When you create a business plan, don't attempt to recreate its format. Those reviewing this type of
document have expectations you must meet. If they do not see those crucial decision-making
components, they'll see no reason to proceed with their review of your business plan, no matter how great
your business idea.
Executive Summary Section
Every business plan must begin with an Executive Summary section. A well-written Executive Summary
is critical to the success of the rest of the document. Here is where you need to capture the attention of
your audience so that they will be compelled to read on. Remember, it's a summary, so each and every
word must be carefully selected and presented.
Use the Executive Summary section of your business plan to accurately describe the nature of your
business venture including the need that you plan to fill. Show the reasons why people need
your product or service. Show this by including a brief analysis of the characteristics of your potential
market.
Describe the organization of your business including your management team. Also, briefly describe your
sales and marketing plan or approach. Finally include the numbers that those
reviewing your business plan want to see - the amount of capital you seek, the carefully calculated sales
projections and your plan to repay the loan.
If you've captured your audience so far they'll read on. Otherwise, they'll close the document and add your
business plan to the heap of other rejected ideas.
Devote the balance of your business plan to providing details of the items outlined in the Executive
Summary.
The Business Section
Be sure to include the legal name, physical address and detailed description of the nature of your business.
It's important to keep the description easy to read using common terminology. Never
assume that those reading your business plan have the same level of technical knowledge that you do.
Describe how you plan to better serve your market than your competition is currently
doing.
Market Analysis Section
An analysis of the market shows that you have done your homework. This section is basically a summary of
your Marketing Plan. It needs to show the demand for your product or service, the
proposed market, trends within the industry, a description of your pricing plan and packaging and a
description of your company policies.
Financing Section
The Financing section must show that you are as committed to your business venture as you expect those
reading your business plan to be. Show the amount of personal funds you are contributing and their source.
Also include the amount of capital you need and your plan to repay this debt. Include all pertinent financial
worksheets in this section: annual income projections, a break-even worksheet, projected cash flow statements
and a balance sheet.
Management Section
Outline your organizational structure and management team here. Include the legal structure of your business
whether it is a partnership, corporation or limited liability corporation.
Include resumes and biographies of key players on your management team. Show staffing projection data for
the next few years.
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 2. You wish to start a new venture to manufacture auto components. Explain different
stages in the process of starting this new business.

Sol.
Every business starts out as an idea. This idea usually involves the invention of a new product, or
revolves around a better way of making and marketing an existing one. While many would argue that
the idea stage is not a stage at all, it is actually a turning point, as business adviser Mike Pendrith
points out. After this, you as a business builder must refine this idea into a money-making reality.
Here in this case supposing we are to start a new venture of manufacturing auto components and also
to market them. We will see here in the following paragraphs different stages of achieving the same
goal.

1. Idea Researching
In this stage, you are researching your idea. The object of your research is to find out who is
marketing the same product or service in your area, and how successful the marketer has been.
You can accomplish this by a Google search on the Internet, launching a test-marketing
campaign, or conducting surveys. Also, you are attempting to find what the level of interest is
in the products (or services) you wish to market.
Here as the main goal is to start a company that manufactures the auto components, we are to
make a research on all the auto companies which are procuring the spares from the outside
vendors. And also the competitors who are all marketing that, their existence and also how
successful they are.
As part of the initial research process, it is important to consider the legal requirements of
selling your product or service. According to the Biz Ed website, examine the legal
ramifications of your business. Know the tax laws governing your business. If insurance is a
requirement, prepare to budget for it. Also, be aware of any safety laws governing you as an
employer. Hence we are also to make a research on the feasible area where we can start our
organization and licenses that we need to take keeping in mind the environmental factors as
well.
2. Business Plan Formulation
You must write a business plan. As Pendrith points out, this is crucial if you want funding,
such as a small business loan or grant, or if you wish to lease a building. At this stage, Pendrith
advises, you need to consult with an attorney or business adviser for assistance.
In the business plan you typically include following heads:

i) Executive Summary
ii) Company and Product Description
iii) Market Description
iv) Equipment and Materials
v) Operations
vi) Management and Ownership
vii) Financial Information and Start-Up Timeline
viii) Risks and Their Mitigation

3. Financial Planning
Financial planning involves thinking about the financial costs of starting and maintaining your
business. According to the Biz Ed website, you should consider such issues as the costs of
 running the business; the prices you wish to charge your customers; cash flow control; and
how you wish to set up financial reserves in case of an emergency or an event causing
significant loss to the business. This includes the planning of whether to take any loans or
make personal investments in the company.
4. Advertising Campaign
Decide how you will market your product. Consider your budget and your target audience.
Make up business cards with your logo on it, your name and the name of your business. Make
sure that they are of the most professional quality. Utilizing print, the newspaper, the Internet,
radio or TV is also wise, considering, of course, the size of your advertising budget.
Here in this case more than TV, a better advertising media will be road side sign boards placed
close to the auto companies for getting the deals to manufacture their spares. As TV is useful
only to reach the common man and he is not our target customer. Hence sign boards is the
feasible solution and also pamphlets circulated across the pioneers. This apart personal
marketing is much more suggested.
5. Preparing for Launch
Advertise for employees. This also requires adequate planning. Think about what you look for
in an employee. Be specific about the requisite skills and experience you are seeking. Then
begin requesting resumes and setting up interviews, making hiring decisions based on the
standards you have set.
In this case we will be looking for a few candidates in managerial position who must be good
in managing things apart from minimal technical knowledge.
Lower level people at the shopfloor people. They need to have real time experience in the
shop floor activities.
The employees apart, one needs to plan on the plant and machinery as well.
Thus these are all the stages that I would consider performing if incase I plan to start a
manufacturing unit producing automobile components.

3. Explain the process of due Diligence and why it is necessary.

Sol.

Due diligence
Of course, your commercial partner will need some reassurance about the quality of the offer you are
making to them. If you are involved in licensing technology or seeking commercial support for your
research you are likely to hear of ‘due diligence.’ When a future partner is considering whether or not to
license technology, to buy a share of patent rights, or to support your research, they will need to satisfy
themselves that it is a viable proposition. The process of assessing the viability, risk, potential liabilities
and commercial prospects of a project is known as ‘due diligence.’ Indeed, if a potential partner seems not
to be interested in this kind of issues, it may actually raise questions about their commitment to the project
or the credibility of their business plan, particularly if the relationship assumes some degree of risk and
investment on their part.
Generally, due diligence will involve assessing the overall commercial operations, cash flow, assets and
liabilities of a business that is being purchased or otherwise financially supported. You would think twice
about purchasing a business if you found that it was burdened with debts, or was about to be involved in
difficult litigation, or if there were doubts about whether it really owned its assets. The same applies to a
potential investment involving intellectual property. For instance, a potential commercial partner would
not want to invest in patented technology only to find out that patent renewal fees have not been paid and
the patent has lapsed, or to find out that the patent was being opposed by another company, or to find that
there is prior art available that calls into question its validity. It may transpire that a student, a contractor
 or a visiting researcher could actually be legally entitled to some or all of the patent rights. Even a serious
level of uncertainty or doubt could be enough to deter a potential partner, especially if they have run into
this kind of difficulty before.
Due diligence may also involve searching for information about the full range of IP rights that might
impact on the relevant technology – for instance, to check whether you have later filed patent applications
on improvements to the original patented technology, that may limit the value of their investment in the
original technology. Other intellectual property rights – such as related trade mark or design registrations,
or key trade secrets or copyright material (such as manuals or software) – may also need to be identified
or located, as these may also affect the commercial partner’s interests in the technology. For example,
they may be unwilling to take out a licence for your patent without getting access to the software you have
developed for a related process. They may want the right to use your trade mark in association with the
patented technology.
So in a due diligence process, your commercial partner may undertake a range of checks and need various
forms of information. These may include:
· Checks on external records, such as patent registers and patent databases, including foreign patents;
· Searches of patent databases for conflicting technology;
· Independent advice from patent attorneys on issues such as patent ownership, patent validity and scope
of patent claims;
· Checks on employment contracts, confidentiality arrangements, and contracts with other parties that may
interfere with the exercise of IP rights;
· Details of the patent prosecution such as examiners’ reports and other opinions;
· Details of any legal challenges to the patent, and the way the proceedings were resolved;
· Checks on laboratory notebooks in the event that the validity of US patents is of concern to the
commercial partner (this also provides reassurance as to claims of ownership of the patent);
· Surveys of the activity of competitors and owners of competing technology, and possibilities of conflict;
and
· Analysis of freedom to operate issues.
In preparing to licence your technology, you should consider in advance these kind of due diligence
issues. If you can anticipate and provide comprehensive answers to these questions, you will be able more
effectively to reassure your commercial partner, and you will be in a stronger negotiating position in
negotiating licence terms. It should also speed up the licensing negotiations, and ultimately the
commercialization of your intellectual property.

4. Is Corporate Social Responsibility necessary and how does it benefit a company and its
shareholders?

Sol.

Corporate social responsibility (CSR), also known as corporate responsibility, corporate citizenship,
responsible business, sustainable responsible business (SRB), or corporate social performance,[1] is a
form of corporate self-regulation integrated into a business model. Ideally, CSR policy would function as
a built-in, self-regulating mechanism whereby business would monitor and ensure its support to law,
ethical standards, and international norms. Consequently, business would embrace responsibility for the
impact of its activities on the environment, consumers, employees, communities, stakeholders and all
other members of the public sphere. Furthermore, CSR-focused businesses would proactively promote the
public interest by encouraging community growth and development, and voluntarily eliminating practices
that harm the public sphere, regardless of legality. Essentially, CSR is the deliberate inclusion of public
interest into corporate decision-making, and the honoring of a triple bottom line: people, planet, profit.
The practice of CSR is much debated and criticized. Proponents argue that there is a strong business case
for CSR, in that corporations benefit in multiple ways by operating with a perspective broader and longer
than their own immediate, short-term profits. Critics argue that CSR distracts from the fundamental
economic role of businesses; others argue that it is nothing more than superficial window-dressing; others
yet argue that it is an attempt to pre-empt the role of governments as a watchdog over powerful
multinational corporations. Corporate Social Responsibility has been redefined throughout the years.
However, it essentially is titled to aid to an organization's mission as well as a guide to what the company
stands for and will uphold to its consumers.
Development business ethics is one of the forms of applied ethics that examines ethical principles and
moral or ethical problems that can arise in a business environment.
In the increasingly conscience-focused marketplaces of the 21st century, the demand for more ethical
business processes and actions (known as ethicism) is increasing. Simultaneously, pressure is applied on
industry to improve business ethics through new public initiatives and laws (e.g. higher UK road tax for
higher-emission vehicles).
Business ethics can be both a normative and a descriptive discipline. As a corporate practice and a career
specialization, the field is primarily normative. In academia, descriptive approaches are also taken. The
range and quantity of business ethical issues reflects the degree to which business is perceived to be at
odds with non-economic social values. Historically, interest in business ethics accelerated dramatically
during the 1980s and 1990s, both within major corporations and within academia. For example, today
most major corporate websites lay emphasis on commitment to promoting non-economic social values
under a variety of headings (e.g. ethics codes, social responsibility charters). In some cases, corporations
have re-branded their core values in the light of business ethical considerations (e.g. BP's "beyond
petroleum" environmental tilt).
The term "CSR" came in to common use in the early 1970s, after many multinational corporations
formed, although it was seldom abbreviated. The term stakeholder, meaning those on whom an
organization's activities have an impact, was used to describe corporate owners beyond shareholders as a
result of an influential book by R Freeman in 1984.[2]
ISO 26000 is the recognized international standard for CSR (currently a Draft International Standard).
Public sector organizations (the United Nations for example) adhere to the triple bottom line (TBL). It is
widely accepted that CSR adheres to similar principles but with no formal act of legislation. The UN has
developed the Principles for Responsible Investment as guidelines for investing entities.
Potential business benefits
The scale and nature of the benefits of CSR for an organization can vary depending on the nature of the
enterprise, and are difficult to quantify, though there is a large body of literature exhorting business to
adopt measures beyond financial ones (e.g., Deming's Fourteen Points, balanced scorecards). Orlitzky,
Schmidt, and Rynes found a correlation between social/environmental performance and financial
performance. However, businesses may not be looking at short-run financial returns when developing
their CSR strategy.
The definition of CSR used within an organization can vary from the strict "stakeholder impacts"
definition used by many CSR advocates and will often include charitable efforts and volunteering. CSR
may be based within the human resources, business development or public relations departments of an
organization,[11] or may be given a separate unit reporting to the CEO or in some cases directly to the
board. Some companies may implement CSR-type values without a clearly defined team or program.
The business case for CSR within a company will likely rest on one or more of these arguments:
Human resources
A CSR program can be an aid to recruitment and retention,[12] particularly within the competitive graduate
student market. Potential recruits often ask about a firm's CSR policy during an interview, and having a
comprehensive policy can give an advantage. CSR can also help improve the perception of a company
among its staff, particularly when staff can become involved through payroll giving, fundraising activities
or community volunteering. See also Corporate Social Entrepreneurship, whereby CSR can also be driven
by employees' personal values, in addition to the more obvious economic and governmental drivers.
Risk management
 Managing risk is a central part of many corporate strategies. Reputations that take decades to build up can
be ruined in hours through incidents such as corruption scandals or environmental accidents. These can
also draw unwanted attention from regulators, courts, governments and media. Building a genuine culture
of 'doing the right thing' within a corporation can offset these risks.[13]
Brand differentiation
In crowded marketplaces, companies strive for a unique selling proposition that can separate them from
the competition in the minds of consumers. CSR can play a role in building customer loyalty based on
distinctive ethical values.[14] Several major brands, such as The Co-operative Group, The Body Shop and
American Apparel[15] are built on ethical values. Business service organizations can benefit too from
building a reputation for integrity and best practice.
License to operate
Corporations are keen to avoid interference in their business through taxation or regulations. By taking
substantive voluntary steps, they can persuade governments and the wider public that they are taking
issues such as health and safety, diversity, or the environment seriously as good corporate citizens with
respect to labour standards and impacts on the environment
Stakeholder priorities
Increasingly, corporations are motivated to become more socially responsible because their most
important stakeholders expect them to understand and address the social and community issues that are
relevant to them. Understanding what causes are important to employees is usually the first priority
because of the many interrelated business benefits that can be derived from increased employee
engagement (i.e. more loyalty, improved recruitment, increased retention, higher productivity, and so on).
Key external stakeholders include customers, consumers, investors (particularly institutional investors),
communities in the areas where the corporation operates its facilities, regulators, academics, and the
media.

5. Distinguish between a Financial Investor and a Strategic Investor explaining the role they
play in a Company.

Sol.

In the not so distant past, there was little difference between financial and strategic investors. Investors of
all colors sought to safeguard their investment by taking over as many management functions as they
could. Additionally, investments were small and shareholders few. A firm resembled a household and the
number of people involved – in ownership and in management – was correspondingly limited. People
invested in industries they were acquainted with first hand.
As markets grew, the scales of industrial production (and of service provision) expanded. A single
investor (or a small group of investors) could no longer accommodate the needs even of a single firm. As
knowledge increased and specialization ensued – it was no longer feasible or possible to micro-manage a
firm one invested in. Actually, separate businesses of money making and business management emerged.
An investor was expected to excel in obtaining high yields on his capital – not in industrial management
or in marketing. A manager was expected to manage, not to be capable of personally tackling the various
and varying tasks of the business that he managed.
Thus, two classes of investors emerged. One type supplied firms with capital. The other type supplied
them with know-how, technology, management skills, marketing techniques, intellectual property,
clientele and a vision, a sense of direction.
In many cases, the strategic investor also provided the necessary funding. But, more and more, a
separation was maintained. Venture capital and risk capital funds, for instance, are purely financial
investors. So are, to a growing extent, investment banks and other financial institutions.
The financial investor represents the past. Its money is the result of past - right and wrong - decisions. Its
orientation is short term: an "exit strategy" is sought as soon as feasible. For "exit strategy" read quick
profits. The financial investor is always on the lookout, searching for willing buyers for his stake. The
stock exchange is a popular exit strategy. The financial investor has little interest in the company's
management. Optimally, his money buys for him not only a good product and a good market, but also a
good management. But his interpretation of the rolls and functions of "good management" are very
different to that offered by the strategic investor. The financial investor is satisfied with a management
team which maximizes value. The price of his shares is the most important indication of success. This is
"bottom line" short termism which also characterizes operators in the capital markets. Invested in so many
ventures and companies, the financial investor has no interest, nor the resources to get seriously involved
in any one of them. Micro-management is left to others - but, in many cases, so is macro-management.
The financial investor participates in quarterly or annual general shareholders meetings. This is the extent
of its involvement.
The strategic investor, on the other hand, represents the real long term accumulator of value.
Paradoxically, it is the strategic investor that has the greater influence on the value of the company's
shares. The quality of management, the rate of the introduction of new products, the success or failure of
marketing strategies, the level of customer satisfaction, the education of the workforce - all depend on the
strategic investor. That there is a strong relationship between the quality and decisions of the strategic
investor and the share price is small wonder. The strategic investor represents a discounted future in the
same manner that shares do. Indeed, gradually, the balance between financial investors and strategic
investors is shifting in favour of the latter. People understand that money is abundant and what is in short
supply is good management. Given the ability to create a brand, to generate profits, to issue new products
and to acquire new clients - money is abundant.

These are the functions normally reserved to financial investors:

Financial Management
The financial investor is expected to take over the financial management of the firm and to directly
appoint the senior management and, especially, the management echelons, which directly deal with the
finances of the firm.
1. To regulate, supervise and implement a timely, full and accurate set of accounting books of the
firm reflecting all its activities in a manner commensurate with the relevant legislation and
regulation in the territories of operations of the firm and with internal guidelines set from time to
time by the Board of Directors of the firm. This is usually achieved both during a Due Diligence
process and later, as financial management is implemented.
2. To implement continuous financial audit and control systems to monitor the performance of
the firm, its flow of funds, the adherence to the budget, the expenditures, the income, the cost of
sales and other budgetary items.
3. To timely, regularly and duly prepare and present to the Board of Directors financial
statements and reports as required by all pertinent laws and regulations in the territories of the
operations of the firm and as deemed necessary and demanded from time to time by the Board of
Directors of the Firm.
4. To comply with all reporting, accounting and audit requirements imposed by the capital
markets or regulatory bodies of capital markets in which the securities of the firm are traded or are
about to be traded or otherwise listed.
5. To prepare and present for the approval of the Board of Directors an annual budget, other
budgets, financial plans, business plans, feasibility studies, investment memoranda and all other
financial and business documents as may be required from time to time by the Board of Directors
of the Firm.
6. To alert the Board of Directors and to warn it regarding any irregularity, lack of compliance,
lack of adherence, lacunas and problems whether actual or potential concerning the financial
systems, the financial operations, the financing plans, the accounting, the audits, the budgets and
any other matter of a financial nature or which could or does have a financial implication.
 7. To collaborate and coordinate the activities of outside suppliers of financial services hired or
contracted by the firm, including accountants, auditors, financial consultants, underwriters and
brokers, the banking system and other financial venues.
8. To maintain a working relationship and to develop additional relationships with banks,
financial institutions and capital markets with the aim of securing the funds necessary for the
operations of the firm, the attainment of its development plans and its investments.
9. To fully computerize all the above activities in a combined hardware-software and
communications system which will integrate into the systems of other members of the group of
companies.
10. Otherwise, to initiate and engage in all manner of activities, whether financial or of other
nature, conducive to the financial health, the growth prospects and the fulfillment of investment
plans of the firm to the best of his ability and with the appropriate dedication of the time and
efforts required.

Collection and Credit Assessment

1. To construct and implement credit risk assessment tools, questionnaires, quantitative methods,
data gathering methods and venues in order to properly evaluate and predict the credit risk rating
of a client, distributor, or supplier.
2. To constantly monitor and analyse the payment morale, regularity, non-payment and non-
performance events, etc. – in order to determine the changes in the credit risk rating of said factors.
3. To analyse receivables and collectibles on a regular and timely basis.
4. To improve the collection methods in order to reduce the amounts of arrears and overdue
payments, or the average period of such arrears and overdue payments.
5. To collaborate with legal institutions, law enforcement agencies and private collection firms in
assuring the timely flow and payment of all due payments, arrears and overdue payments and other
collectibles.
6. To coordinate an educational campaign to ensure the voluntary collaboration of the clients,
distributors and other debtors in the timely and orderly payment of their dues.
The strategic investor is, usually, put in charge of the following:

Project Planning and Project Management

The strategic investor is uniquely positioned to plan the technical side of the project and to implement it.
He is, therefore, put in charge of:
1. The selection of infrastructure, equipment, raw materials, industrial processes, etc.;
2. Negotiations and agreements with providers and suppliers;
3. Minimizing the costs of infrastructure by deploying proprietary components and planning;
4. The provision of corporate guarantees and letters of comfort to suppliers;
5. The planning and erecting of the various sites, structures, buildings, premises, factories, etc.;
6. The planning and implementation of line connections, computer network connections,
protocols, solving issues of compatibility (hardware and software, etc.);
7. Project planning, implementation and supervision.

Marketing and Sales

1. The presentation to the Board an annual plan of sales and marketing including: market
penetration targets, profiles of potential social and economic categories of clients, sales promotion
methods, advertising campaigns, image, public relations and other media campaigns. The strategic
investor also implements these plans or supervises their implementation.
2. The strategic investor is usually possessed of a brandname recognized in many countries. It is
the market leaders in certain territories. It has been providing goods and services to users for a
long period of time, reliably. This is an important asset, which, if properly used, can attract users.
 The enhancement of the brandname, its recognition and market awareness, market penetration, co-
branding, collaboration with other suppliers – are all the responsibilities of the strategic investor.
3. The dissemination of the product as a preferred choice among vendors, distributors, individual
users and businesses in the territory.
4. Special events, sponsorships, collaboration with businesses.
5. The planning and implementation of incentive systems (e.g., points, vouchers).
6. The strategic investor usually organizes a distribution and dealership network, a franchising
network, or a sales network (retail chains) including: training, pricing, pecuniary and quality
supervision, network control, inventory and accounting controls, advertising, local marketing and
sales promotion and other network management functions.
7. The strategic investor is also in charge of "vision thinking": new methods of operation, new
marketing ploys, new market niches, predicting the future trends and market needs, market
analyses and research, etc.
The strategic investor typically brings to the firm valuable experience in marketing and sales. It has
numerous off the shelf marketing plans and drawer sales promotion campaigns. It developed software and
personnel capable of analysing any market into effective niches and of creating the right media (image and
PR), advertising and sales promotion drives best suited for it. It has built large databases with multi-year
profiles of the purchasing patterns and demographic data related to thousands of clients in many countries.
It owns libraries of material, images, sounds, paper clippings, articles, PR and image materials, and
proprietary trademarks and brand names. Above all, it accumulated years of marketing and sales
promotion ideas which crystallized into a new conception of the business.

Technology
1. The planning and implementation of new technological systems up to their fully operational
phase. The strategic partner's engineers are available to plan, implement and supervise all the
stages of the technological side of the business.
2. The planning and implementation of a fully operative computer system (hardware, software,
communication, intranet) to deal with all the aspects of the structure and the operation of the firm.
The strategic investor puts at the disposal of the firm proprietary software developed by it and
specifically tailored to the needs of companies operating in the firm's market.
3. The encouragement of the development of in-house, proprietary, technological solutions to the
needs of the firm, its clients and suppliers.
4. The planning and the execution of an integration program with new technologies in the field,
in collaboration with other suppliers or market technological leaders.
Education and Training
The strategic investor is responsible to train all the personnel in the firm: operators, customer services,
distributors, vendors, sales personnel. The training is conducted at its sole expense and includes tours of its
facilities abroad.
The entrepreneurs – who sought to introduce the two types of investors, in the first place – are usually left
with the following functions:
Administration and Control
1. To structure the firm in an optimal manner, most conducive to the conduct of its business and
to present the new structure for the Board's approval within 30 days from the date of the GM's
appointment.
2. To run the day to day business of the firm.
3. To oversee the personnel of the firm and to resolve all the personnel issues.
4. To secure the unobstructed flow of relevant information and the protection of confidential
organization.
5. To represent the firm in its contacts, representations and negotiations with other firms,
authorities, or persons.
This is why entrepreneurs find it very hard to cohabitate with investors of any kind. Entrepreneurs are
excellent at identifying the needs of the market and at introducing technological or service solutions to satisfy
such needs. But the very personality traits which qualify them to become entrepreneurs – also hinder the
future development of their firms. Only the introduction of outside investors can resolve the dilemma. Outside
investors are not emotionally involved. They may be less visionary – but also more experienced.
They are more interested in business results than in dreams. And – being well acquainted with entrepreneurs –
they insist on having unmitigated control of the business, for fear of losing all their money. These things
antagonize the entrepreneurs. They feel that they are losing their creation to cold-hearted, mean spirited,
corporate predators. They rebel and prefer to remain small or even to close shop than to give up their
cherished freedoms. This is where nine out of ten entrepreneurs fail - in knowing when to let go.
 MB0037 – International Business Management
Assignment Set- 1

Q.1 a. How has liberalizing trade helped international business?

Sol.

The Benefits of Trade Liberalization

Policies that make an economy open to trade and investment with the rest of the world are needed for
sustained economic growth. The evidence on this is clear. No country in recent decades has achieved
economic success, in terms of substantial increases in living standards for its people, without being open
to the rest of the world. In contrast, trade opening (along with opening to foreign direct investment) has
been an important element in the economic success of East Asia, where the average import tariff has
fallen from 30 percent to 10 percent over the past 20 years.
Opening up their economies to the global economy has been essential in enabling many developing
countries to develop competitive advantages in the manufacture of certain products. In these countries,
defined by the World Bank as the "new globalizers," the number of people in absolute poverty declined
by over 120 million (14 percent) between 1993 and 1998.
There is considerable evidence that more outward-oriented countries tend consistently to grow faster than
ones that are inward-looking. Indeed, one finding is that the benefits of trade liberalization can exceed the
costs by more than a factor of 10. Countries that have opened their economies in recent years, including
India, Vietnam, and Uganda, have experienced faster growth and more poverty reduction. On average,
those developing countries that lowered tariffs sharply in the 1980s grew more quickly in the 1990s than
those that did not.
Freeing trade frequently benefits the poor especially. Developing countries can ill-afford the large
implicit subsidies, often channeled to narrow privileged interests that trade protection provides.
Moreover, the increased growth that results from free trade itself tends to increase the incomes of the
poor in roughly the same proportion as those of the population as a whole. New jobs are created for
unskilled workers, raising them into the middle class. Overall, inequality among countries has been on
the decline since 1990, reflecting more rapid economic growth in developing countries, in part the result
of trade liberalization.
The potential gains from eliminating remaining trade barriers are considerable. Estimate of the gains
from eliminating all barriers to merchandise trade range from US$250 billion to US$680 billion per year.
About two-thirds of these gains would accrue to industrial countries. But the amount accruing to
developing countries would still be more than twice the level of aid they currently receive. Moreover,
developing countries would gain more from global trade liberalization as a percentage of their GDP than
industrial countries, because their economies are more highly protected and because they face higher
barriers.
Although there are benefits from improved access to other countries’ markets, countries benefit most
from liberalizing their own markets. The main benefits for industrial countries would come from the
liberalization of their agricultural markets. Developing countries would gain about equally from
 liberalization of manufacturing and agriculture. The group of low-income countries, however, would gain
most from agricultural liberalization in industrial countries because of the greater relative importance of
agriculture in their economies.

b. What are the merits and demerits of international trade? (4 marks)

Sol.
Advantages and Disadvantages of International Trade
Advantages to consider:
• Enhance your domestic competitiveness
• Increase sales and profits
• Gain your global market share
• Reduce dependence on existing markets
• Exploit international trade technology
• Extend sales potential of existing products
• Stabilize seasonal market fluctuations
• Enhance potential for expansion of your business
• Sell excess production capacity
• Maintain cost competitiveness in your domestic market

Disadvantages to keep in mind:

• You may need to wait for long-term gains
• Hire staff to launch international trading
• Modify your product or packaging
• Develop new promotional material
• Incur added administrative costs
• Dedicate personnel for traveling
• Wait long for payments
• Apply for additional financing
• Deal with special licenses and regulations
Q. 2 Discuss the impact of culture on International Business.

Sol.

The following can be looked as the various aspects of the cultural dichotomies.

Table 2.1: Cultural Dichotomies

In this new millennium, few executives can afford to turn a blind eye to global business opportunities.
Japanese auto-executives monitor carefully what their European and Korean competitors are up to in
getting a bigger slice of the Chinese auto-market. Executives of Hollywood movie studios need to weigh
the appeal of an expensive movie in Europe and Asia as much as in the US before a firm commitment.
The globalizing wind has broadened the mindsets of executives, extended the geographical reach of
firms, and nudged international business (IB) research into some new trajectories. One such new
trajectory is the concern with national culture. Whereas traditional IB research has been concerned with
economic/ legal issues and organizational forms and structures, the importance of national culture –
broadly defined as values, beliefs, norms, and behavioural patterns of a national group – has become
increasingly important in the last two decades, largely as a result of the classic work of Hofstede (1980).
National culture has been shown to impact on major business activities, from capital structure (Chui et
al., 2002) to group performance (Gibson, 1999). For reviews, see’ Boyacigiller and Adler’ (1991) and
‘Earley and Gibson’ (2002).
The purpose of this Unit is to provide a state-of-the-art review of several recent advances in culture and
IB research, with an eye toward productive avenues for future research. It is not our purpose to be
comprehensive; our goal is to spotlight a few highly promising areas for leapfrogging the field in an
increasingly boundary-less business world. We first review the issues surrounding cultural convergence
and divergence, and the processes underlying cultural changes. We then examine novel constructs for
characterizing cultures, and how to enhance the precision of cultural models by pinpointing when the
effects of culture are important. Finally, we examine the usefulness of experimental methods, which are
rarely employed in the field of culture and IB. A schematic summary of our coverage is given in Table
2.1, which suggests that the topics reviewed are loosely related, and that their juxtaposition in the present
paper represents our attempt to highlight their importance rather than their coherence as elements of an
integrative framework.

1 Cultural change, convergence and divergence in an era of partial globalization

An issue of considerable theoretical significance is concerned with cultural changes and transformations
taking place in different parts of the world. In fact, since the landmark study of Haire et al. (1966) and the
publication of Industrialism and Industrial Man by Kerr et al. (1960), researchers have continued to
search for similarities in culture-specific beliefs and attitudes in various aspects of work related attitudes
and behaviours, consumption patterns, and the like. If cultures of the various locales of the world are
indeed converging (e.g., Heuer et al., 1999), IB-related practices would indeed become increasingly
similar. Standard, culture-free business practices would eventually emerge, and inefficiencies and
complexities associated with divergent beliefs and practices in the past era would disappear. In the
following section, we review the evidence on the issue and conclude that such an outlook pertaining to
the convergence of various IB practices is overly optimistic.
2 Evolution of partial globalization
Globalization refers to a ‘growing economic interdependence among countries, as reflected in the
increased cross-border flow of three types of entities: goods and services, capital, and know-how’
(Govindarajan and Gupta, 2001, 4). Few spoke of ‘world economy’ 25 years ago, and the prevalent term
was ‘international trade’ (Drucker, 1995). However today, international trade has culminated in the
emergence of a global economy, consisting of flows of information, technology, money, and people, and
is conducted via government international organizations such as the North American Free Trade
Agreement (NAFTA) and the European Community; global organizations such as the International
Organization for Standardization (ISO); multinational companies (MNCs); and cross – border alliances in
the form of joint ventures, international mergers, and acquisitions. These inter – relationships have
enhanced participation in the world economy, and have become a key to domestic economic growth and
prosperity (Drucker, 1995, 153).
Yet, globalization is not without its misgivings and discontents (Sassan, 1998). A vivid image associated
with the G8 summits is the fervent protests against globalization in many parts of the world, as shown in
television and reported in the popular media. Strong opposition to globalization usually originates from
developing countries that have been hurt by the destabilizing effects of globalization, but in recent times
we have also seen heated debates in Western economies triggered by significant loss of professional jobs
as a result of off shoring to low – wage countries. Indeed, workers in manufacturing and farming in
advanced economies are becoming increasingly wary of globalization, as their income continues to
decline significantly. In parallel to the angry protests against globalization, the flow of goods, services,
and investments across national borders has continued to fall after the rapid gains of the 1990s.
Furthermore, the creation of regional trade blocs, such as NAFTA, the European Union, and the
Association of Southeast Asian Nations, have stimulated discussions about creating other trade zones
involving countries in South Asia, Africa, and other parts of the world. Although it is often assumed that
countries belonging to the World Trade Organization (WTO) have embraced globalization, the fact is
that the world is only partially globalized, at best (Schaeffer, 2003). Many parts of Central Asia and
Eastern Europe, including the former republics of the Soviet Union, parts of Latin America, Africa, and
parts of South Asia, have been sceptical of globalization (Greider, 1997). In fact, less than 10% of the
world’s population is fully globalized (i.e., being active participants in the consumption of global
products and services) (Schaeffer, 2003). Therefore, it is imperative that we analyze the issues of cultural
convergence and divergence in this partially globalized world.
‘Universal culture’ often refers to the assumptions, values, and practices of people in the West and some
elites in non-Western cultures. Huntington (1996) suggested that it originates from the intellectual elites
from a selected group of countries who meet annually in the World Economic Forum in Davos,
Switzerland. These individuals are highly educated, work with symbols and numbers, are fluent in
English, are extensively involved with international commitments, and travel frequently outside their
country. They share the cultural value of individualism, and believe strongly in market economics and
political democracy. Although those belonging to the Davos group control virtually all of the world’s
important international institutions, many of the world’s governments, and a great majority of the world’s
economic and military capabilities, the cultural values of the Davos group are probably embraced by only
a small fraction of the six billion people of the world.
Popular culture, again mostly Western European and American in origin, also contributes to a
convergence of consumption patterns and leisure activities around the world. However, the convergence
may be superficial, and have only a small influence on fundamental issues such as beliefs, norms, and
ideas about how individuals, groups, institutions, and other important social agencies ought to function.
In fact, Huntington (1996, 58) noted that ‘The essence of Western civilization is the Magna Carta, not the
Magna Mac. The fact that non-Westerners may bite into the latter has no implications for their accepting
the former’. This argument is obvious if we reverse the typical situation and put Western Europeans and
Americans in the shoes of recipients of cultural influence. For instance, while Chinese Kung Fu
dominates fight scenes in Hollywood movies such as Matrix Reloaded, and Chinese restaurants abound
in the West, it seems implausible that Americans and Europeans have espoused more Chinese values
because of their fondness of Chinese Kung Fu and food. A major argument against cultural convergence
is that traditionalism and modernity may be unrelated (Smith and Bond, 1998). Strong traditional values,
such as group solidarity, interpersonal harmony, paternalism, and feminism, can co-exist with modern
values of individual achievement and competition. A case in point is the findings that Chinese in
Singapore and China indeed endorsed both traditional and modern values (Chang et al., 2003; Zhang et
al., 2003). It is also conceivable that, just as we talk about Westernization of cultural values around the
world, we may also talk about Easternization of values in response to forces of modernity and
consumption values imposed by globalization (Marsella and Choi, 1993).
Although the argument that the world is becoming one culture seems untenable, there are some areas that
do show signs of convergence. We explore in the following the roles of several factors that
simultaneously cause cultures of the world to either converge or diverge, in an attempt to identify several
productive avenues for future research.

3 Role of multiculturalism and cultural identity

The broad ideological framework of a country, corporation, or situation is the most important
determinant of the cultural identity that people develop in a given locale (Triandis, 1994). The ‘melting
pot’ ideology suggests that each cultural group loses some of its dominant characteristics in order to
become the mainstream: this is assimilation, or what Triandis (1994) calls subtractive multiculturalism.
In contrast, when people from a cultural group add appropriate skills and characteristics of other groups,
it may be called integration, or additive multiculturalism. Both of these processes are essential for
cultural convergence to proceed. However, if there is a significant history of conflict between the cultural
groups, it is hard to initiate these processes, as in the case of Israelis and Palestinians. In general,
although there has been some research on the typology of animosity against other nations (e.g., Jung et
al., 2002), we do not know much about how emotional antagonism against other cultural groups affects
trade patterns and intercultural cooperation in a business context. The issues of cultural identity and
emotional reactions to other cultural groups in an IB context constitute a significant gap in our research
effort in this area.

4 Implications of convergence and divergence issues

One message is clear: while convergence in some domains of IB activity is easily noticeable, especially
in consumer values and lifestyles, significant divergence of cultures persists. In fact, Hofstede (2001)
asserts that mental programs of people around the world do not change rapidly, but remain rather
consistent over time. His findings indicate that cultural shifts are relative as opposed to absolute.
Although clusters of some countries in given geographical locales (e.g., Argentina, Brazil, Chile) might
indicate significant culture shifts towards embracing Anglo values, the changes do not diminish the
absolute differences between such countries and those of the Anglo countries (i.e., US, Canada, UK).
Huntington, in his ‘The Clash of Civilizations’ (1996), presents the view that there is indeed a resurgence
of non-Western cultures around the world, which could result in the redistribution of national power in
the conduct of international affairs. The attempt by the Davos group to bring about uniform practices in
various aspects of IB and work culture, thereby sustaining the forces of globalization, is certainly
worthwhile. However, our analysis suggests that there is no guarantee that such convergence will come
about easily, or without long periods of resistance.
IB scholars need to understand that although some countries might exhibit strong tendencies toward
cultural convergence, as is found in Western countries, there are countries that will reject globalization,
not only because of its adverse economic impacts (Greider, 1997) but also because globalization tends to
introduce distortions (in their view) in profound cultural syndromes that characterize their national
character.
Furthermore, reactions to globalization may take other forms. Bhagat et al. (2003) have recently argued
that adaptation is another approach that could characterize the tendencies of some cultures in the face of
mounting pressures to globalize. Other approaches are rejection, creative synthesis, and innovation
(Bhagat et al., 2003). These different approaches highlight once again the complex dynamics that
underlie cultural convergence and divergence in a partially globalized world. Also, in discussing issues of
convergence and divergence, it is necessary to recognize that the shift in values is not always from
Western society to others, but can result in the change of Western cultural values as well. For example,
the emphasis on quality and teamwork in the West is partly a result of the popularity of Japanese
management two decades ago.
Scholars of IB should recognize that the issue of convergence and divergence in this era of partial
globalization will remain as a persistent and complex issue whose direction might only be assessed on a
region-by-region basis. It is also wise to adopt an interdisciplinary perspective in understanding the
forces that create both convergence and divergence of cultures in different parts of the world. For
instance, in Understanding Globalization, Schaeffer (2003) has provided an insightful discussion of the
social consequences of political, economic and other changes, which have significant implications for IB.
The cause-effect relationships of globalization and its various outcomes, especially the cultural outcomes,
are not only characterized by bi-directional arrows, but are embedded in a complex web of relationships.
How these complex relationships and processes play out on the stage of IB remains to be uncovered by
IB researchers.

5 Processes of cultural changes

In the previous section, we make the point that, through the process of globalization, cultures influence
each other and change, but whether or not these changes will bring about cultural convergence is yet to
be seen. In this section, we delineate a general model that describes and explains the complex processes
underlying cultural changes. As explained before, IB is both an agent and a recipient of cultural change,
and for international business to flourish it is important to understand its complex, reciprocal
relationships with cultural change.
In line with the view of Hofstede (2001) that culture changes very slowly, culture has been treated as a
relatively stable characteristic, reflecting a shared knowledge structure that attenuates variability in
values, behavioral norms, and patterns of behaviours (Erez and Earley, 1993). Cultural stability helps to
reduce ambiguity, and leads to more control over expected behavioural outcomes (Weick and Quinn,
1999; Leana and Barry, 2000). For instance, most existing models of culture and work behaviour assume
cultural stability and emphasize the fit between a given culture and certain managerial and motivational
practices (Erez and Earley, 1993). High fit means high adaptation of managerial practices to a given
culture and, therefore, high effectiveness. The assumption of cultural stability is valid as long as there are
no environmental changes that precipitate adaptation and cultural change. Yet, the end of the 20th century
and the beginning of the new millennium have been characterized by turbulent political and economical
changes, which instigate cultural changes. In line with this argument, Lewin and Kim (2004), in their
comprehensive chapter on adaptation and selection in strategy and change, distinguished between
theories driven by the underlying assumption that adaptation is the mechanism to cope with change, and
theories driven by the underlying assumption of selection and the survival of the fittest, suggesting that
ineffective forms of organization disappear, and new forms emerge. However, although organizational
changes as a reaction to environmental changes have been subjected to considerable conceptual analyses,
the issue of cultural change at the national level has rarely been addressed.
There are relatively few theories of culture that pertain to the dynamic aspect of culture. One exception is
the eco-cultural model by Berry et al. (2002), which views culture as evolving adaptations to ecological
and socio-political influences, and views individual psychological characteristics in a population as
adaptive to their cultural context, as well as to the broader ecological and socio-political influences.
Similarly, Kitayama (2002) proposes a system view to understanding the dynamic nature of culture, as
opposed to the entity view that sees culture as a static entity. This system view suggests that each
person’s psychological processes are organized through the active effort to coordinate one’s behaviours
with the pertinent cultural systems of practices and public meanings. Yet, concurrently, many aspects of
the psychological systems develop rather flexibly as they are attuned to the surrounding socio-cultural
environment, and are likely to be configured in different ways across different socio-cultural groups.
These adaptive views of culture are supported by empirical evidence. For example, Van de Vliert et al.
(1999) identified curvilinear relationships between temperature, masculinity and domestic political
violence across 53 countries. Their findings showed that masculinity and domestic violence are higher in
moderately warm countries than in countries with extreme temperatures. Inglehart and Baker (2000)
examined cultural change as reflected by changes in basic values in three waves of the World Values
Surveys, which included 65 societies and 75% of the world’s population. Their analysis showed that
economic development was associated with shifts away from traditional norms and values toward values
that are increasingly rational, tolerant, trusting, and participatory. However, the data also showed that the
broad cultural heritage of a society, whether it is Protestant, Roman Catholic, Orthodox, Confucian, or
Communist, leaves an enduring imprint on traditional values despite the forces of modernization.
The process of globalization described before has introduced the most significant change in IB, with its
effects filtering down to the national, organizational, group and individual levels. Reciprocally, changes
at micro-levels of culture, when shared by the members of the society, culminate into macro level
phenomena and change the macro-levels of culture. In the absence of research models that can shed light
on this complex process of cultural change, Erez and Gati (2004) proposed that the general model of
multi-level analysis (Klein and Kozlowski, 2000) could be adopted for understanding the dynamics of
culture and cultural change.
6 The dynamics of culture as a multi-level, multi-layer construct
The proposed model consists of two building blocks. One is a multi-level approach, viewing culture as a
multi-level construct that consists of various levels nested within each other from the most macro-level of
a global culture, through national cultures, organizational cultures, group cultures, and cultural values
that are represented in the self at the individual level, as portrayed in Figure 2.1. The second is based on
Schein’s (1992) model viewing culture as a multi – layer construct consisting of the most external layer
of observed artefacts and behaviours, the deeper level of values, which is testable by social consensus,
and the deepest level of basic assumption, which is invisible and taken for granted. The present model
proposes that culture as a multi – layer construct exists at all levels – from the global to the individual –
and that at each level change first occurs at the most external layer of behaviour, and then, when shared
by individuals who belong to the same cultural context, it becomes a shared value that characterizes the
aggregated unit (group, organizations, or nations).
In the model, the most macro-level is that of a global culture being created by global networks and global
institutions that cross national and cultural borders. As exemplified by the effort of the Davos group
discussed earlier, global organizational structures need to adopt common rules and procedures in order to
have a common ‘language’ for communicating across cultural borders (Kostova, 1999; Kostova and
Roth, 2003; Gupta and Govindarajan, 2000).

Figure 2.1: The dynamic of top-down–bottom-up processes across

levels of culture.
Given the dominance of Western MNCs, the values that dominate the global context are often based on a
free market economy, democracy, acceptance and tolerance of diversity, respect of freedom of choice,
individual rights, and openness to change (Gupta and Govindarajan, 2000).
Below the global level are nested organizations and networks at the national level with their local
cultures varying from one nation or network to another. Further down are local organizations, and
although all of them share some common values of their national culture, they vary in their local
organizational cultures, which are also shaped by the type of industry that they represent, the type of
ownership, the values of the founders, etc. Within each organization are sub-units and groups that share
the common national and organizational culture, but that differ from each other in their unit culture on
the basis of the differences in their functions (e.g., R&D vs manufacturing), their leaders’ values, and the
professional and educational level of their members. At the bottom of this structure are individuals who
through the process of socialization acquire the cultural values transmitted to them from higher levels of
culture. Individuals who belong to the same group share the same values that differentiate them from
other groups and create a group – level culture through a bottom-up process of aggregation of shared
values. For example, employees of an R&D unit are selected into the unit because of their creative
cognitive style and professional expertise. Their leader also typically facilitates the display of these
personal characteristics because they are crucial for developing innovative products. Thus, all members
of this unit share similar core values, which differentiate them from other organizational units. Groups
that share similar values create the organizational culture through a process of aggregation, and local
organizations that share similar values create the national culture that is different from other national
cultures.
Both top-down and bottom-up processes reflect the dynamic nature of culture, and explain how culture at
different levels is being shaped and reshaped by changes that occur at other levels, either above it through
top-down processes or below it through bottom-up processes. Similarly, changes at each level affect
lower levels through a top-down process, and upper levels through a bottom-up process of aggregation.
The changes in national cultures observed by Inglehart and Baker (2000) could serve as an example for
top-down effects of economic growth, enhanced by globalization, on a cultural shift from traditional
values to modernization. However, in line with Schein (1992), the deep basic assumptions still reflect the
traditional values shaped by the broad cultural heritage of a society.
Global organizations and networks are being formed by having local-level organizations join the global
arena. That means that there is a continuous reciprocal process of shaping and reshaping organizations at
both levels. For example, multinational companies that operate in the global market develop common
rules and cultural values that enable them to create a synergy between the various regions, and different
parts of the multinational company. These global rules and values filter down to the local organizations
that constitute the global company, and, over time, they shape the local organizations. Reciprocally,
having local organizations join a global company may introduce changes into the global company
because of its need to function effectively across different cultural boarders. A study by Erez-Rein et al.
(2004) demonstrated how a multinational company that acquired an Israeli company that develops and
produces medical instruments changed the organizational culture of the acquired company. The study
identified a cultural gap between the two companies, with the Israeli company being higher on the
cultural dimension of innovation and lower on the cultural dimension of attention to detail and
conformity to rules and standards as compared with the acquiring company. The latter insisted on
sending the Israeli managers to intensive courses in Six – Sigma, which is an advanced method of quality
improvement, and a managerial philosophy that encompasses all organizational functions. Upon
returning to their company, these managers introduced quality improvement work methods and
procedures to the local company, and caused behavioural changes, followed by the internalization of
quality – oriented values. Thus, a top-down process of training and education led to changes in work
behaviour and work values. Sharing common behaviours and values by all employees of the local
company then shaped the organizational culture through bottom–up processes. The case of cultural
change via international acquisitions demonstrated the two building blocks of our dynamic model of
culture: the multi-level structure explains how a lower-level culture is being shaped by top-down effects,
and that the cultural layer that changes first is the most external layer of behaviour. In the long run,
bottom – up processes of shared behaviours and norms shape the local organizational culture.

7 Factors that facilitate cultural change

Culture itself influences the level of resistance or acceptance of change. Harzing and Hofstede (1996)
proposed that certain cultural values facilitate change, whereas others hinder it. The values of low power
distance, low uncertainty avoidance, and individualism facilitate change. Change threatens stability, and
introduces uncertainty, and resistance to change will therefore be higher in cultures of high rather than
 low uncertainty avoidance (Steensma et al., 2000). Change also threatens the power structure, and
therefore will be avoided in high power distance cultures. Finally, change breaks the existing harmony,
which is highly valued in collectivistic cultures, and therefore will not be easily accepted by collectivists
(Levine and Norenzayan, 1999).
A recent study by Erez and Gati (2004) examined the effects of three factors on the change process and
its outcomes:
· the cultural value of individualism – collectivism;
· the reward structure and its congruence with the underlying cultural values; and
· the degree of ambiguity in the reward structure.
The change process examined was a shift from choosing to work alone to a behavioural choice of
working as part of a team, and vice versa. Working alone is more prevalent in individualistic cultures,
whereas working in teams dominates the collectivistic ones.

8 Understanding when culture matters: increasing the precision of cultural models

Beyond exploring new cultural constructs and the dynamic nature of culture, we also argue for the
importance of examining contingency factors that enhance or mitigate the effect of national culture.
Consider the following scenario. A senior human resource manager in a multinational firm is charged
with implementing an integrative training program in several of the firm’s subsidiaries around the globe.
Over the term of her career, the manager has been educated about differences in national culture and is
sensitive to intercultural opportunities and challenges. At the same time, she understands the strategic
need to create a unified global program that serves to further integrate the firm’s basic processes, creating
efficiencies and synergies across the remote sites. She approaches the implementation with trepidation. A
key challenge is to determine whether the program should be implemented in the same manner in each
subsidiary or modified according to the local culture at each site. Put another way, in this complex
circumstance, does culture matter?

Q.3. a. Explain the brief structure of WTO.

Sol.

Structure of World Trade Organization (WTO)

The WTO’s overriding objective is to help trade flow smoothly, freely, fairly and predictably.
It does this by:
· Administering trade agreements
· Acting as a forum for trade negotiations
· Settling trade disputes
· Reviewing national trade policies
· Assisting developing countries in trade policy issues, through technical assistance and training programs
· Cooperating with other international organizations

Structure
The WTO has nearly 150 members, accounting for over 97% of world trade. Around 30 others are
negotiating membership.
Decisions are made by the entire membership. This is typically by consensus. A majority vote is also
possible but it has never been used in the WTO, and was extremely rare under the WTO’s predecessor,
GATT. The WTO’s agreements have been ratified in all members’ parliaments.
The WTO’s top level decision-making body is the Ministerial Conference which meets at least once
every two years.
Below this is the General Council (normally ambassadors and heads of delegation in Geneva, but
sometimes officials sent from members’ capitals) which meets several times a year in the Geneva
headquarters. The General Council also meets as the Trade Policy Review Body and the Dispute
Settlement Body.
At the next level, the Goods Council, Services Council and Intellectual Property (TRIPS) Council
report to the General Council.
Numerous specialized committees, working groups and working parties deal with the individual
agreements and other areas such as the environment, development, membership applications and regional
trade agreements.
Secretariat
The WTO Secretariat, based in Geneva, has around 600 staff and is headed by a director-general. Its
annual budget is roughly 160 million Swiss francs. It does not have branch offices outside Geneva. Since
decisions are taken by the members themselves, the Secretariat does not have the decision-making role
that other international bureaucracies are given with. The Secretariat’s main duties are to supply technical
support for the various councils and committees and the ministerial conferences, to provide technical
assistance for developing countries, to analyze world trade, and to explain WTO affairs to the public and
media.
The Secretariat also provides some forms of legal assistance in the dispute settlement process and advises
governments wishing to become members of the WTO.
 Figure 5.1: Structure of WTO

The WTO is ‘member-driven’, with decisions taken by consensus among all member governments.
The WTO is run by its member governments. All major decisions are made by the membership as a
whole, either by ministers (who meet at least once every two years) or by their ambassadors or delegates
(who meet regularly in Geneva). Decisions are normally taken by consensus.
In this respect, the WTO is different from some other international organizations such as the World Bank
and International Monetary Fund. In the WTO, power is not delegated to a board of directors or the
organization’s head.
When WTO rules impose disciplines on countries’ policies, that is the outcome of negotiations among
WTO members, the rules are enforced by the members themselves under agreed procedures that they
negotiated, including the possibility of trade sanctions. But those sanctions are imposed by member
countries, and authorized by the membership as a whole. This is quite different from other agencies whose
bureaucracies can, for example, influence a country’s policy by threatening to withhold credit.
Reaching decisions by consensus among some 150 members can be difficult. Its main advantage is that
decisions made this way are more acceptable to all members. And despite the difficulty, some remarkable
agreements have been reached. Nevertheless, proposals for the creation of a smaller executive body –
perhaps like a board of directors each representing different groups of countries – are heard periodically.
But for now, the WTO is a member-driven, consensus-based organization.
Highest authority: the Ministerial Conference
So, the WTO belongs to its members. The countries make their decisions through various councils and
committees, whose membership consists of all WTO members. Topmost is the ministerial conference
which has to meet at least once every two years. The Ministerial Conference can take decisions on all
matters under any of the multilateral trade agreements.
Second level: General Council in three guises
Day-to-day work in between the ministerial conferences is handled by three bodies:
· The General Council
· The Dispute Settlement Body
· The Trade Policy Review Body
All three are in fact the same – the Agreement Establishing the WTO states they are all the General
Council, although they meet under different terms of reference. Again, all three consist of all WTO
members. They report to the Ministerial Conference.
The General Council acts on behalf of the Ministerial Conference on all WTO affairs. It meets as the
Dispute Settlement Body and the Trade Policy Review Body to oversee procedures for settling disputes
between members and to analyze members’ trade policies.
Third level: councils for each broad area of trade, and more back to top
Three more councils, each handling a different broad area of trade, report to the General Council:
· The Council for Trade in Goods (Goods Council)
· The Council for Trade in Services (Services Council)
· The Council for Trade – Related Aspects of Intellectual Property Rights (TRIPS Council)
As their names indicate, the three are responsible for the workings of the WTO agreements dealing with
their respective areas of trade. Again they consist of all WTO members. These three also have the
subsidiary bodies.
Six other bodies report to the General Council. The scope of their coverage is smaller, so they are
“committees”. But they still consist of all WTO members. They cover issues such as trade and
development, the environment, regional trading arrangements, and administrative issues. The Singapore
Ministerial Conference in December 1996 decided to create new working groups to look at investment
and competition policy, transparency in government procurement, and trade facilitation.
Two more subsidiary bodies dealing with the plural-lateral agreements (which are not signed by all
WTO members) keep the General Council informed of their activities regularly.
Fourth level: down to the nitty-gritty
Each of the higher level councils has subsidiary bodies. The Goods Council has 11 committees dealing
with specific subjects (such as agriculture, market access, subsidies, anti-dumping measures and so on).
Again, these consist of all member countries. Also reporting to the Goods Council is the Textiles
Monitoring Body, which consists of a chairman and 10 members acting in their personal capacities, and
groups dealing with notifications (governments informing the WTO about current and new policies or
measures) and state trading enterprises.
The Services Council’s subsidiary bodies deal with financial services, domestic regulations, GATS rules
and specific commitments.
At the General Council level, the Dispute Settlement Body also has two subsidiaries: the dispute
settlement “panels” of experts appointed to adjudicate on unresolved disputes, and the Appellate Body
that deals with appeals.
Heads of Delegations and other boards: the need for informality
Important breakthroughs are rarely made in formal meetings of these bodies, least of all in the higher level
councils. Since decisions are made by consensus, without voting, informal consultations within the WTO
play a vital role in bringing a vastly diverse membership round to an agreement.
One step away from the formal meetings is informal meetings that still include the full membership, such
as those of the Heads of Delegations (HOD). More difficult issues have to be thrashed out in smaller
groups. A common recent practice is for the chairperson of a negotiating group to attempt to forge a
compromise by holding consultations with delegations individually, in twos or threes, or in groups of 20 –
30 of the most interested delegations.
These smaller meetings have to be handled sensitively. The key is to ensure that everyone is kept
informed about what is going on (the process must be “transparent”) even if they are not in a particular
consultation or meeting, and that they have an opportunity to participate or provide input (it must be
“inclusive”).
One term has become controversial, but more among some outside observers than among delegations. The
“Green Room” is a phrase taken from the informal name of the director-general’s conference room. It is
used to refer to meetings of 20 – 40 delegations, usually at the level of heads of delegations. These
meetings can take place elsewhere, such as at Ministerial Conferences, and can be called by the minister
chairing the conference as well as the director-general. Similar smaller group consultations can be
organized by the chairs of committees negotiating individual subjects, although the term Green Room is
not usually used for these.
In the past delegations have sometimes felt that Green Room meetings could lead to compromises being
struck behind their backs. So, extra efforts are made to ensure that the process is handled correctly, with
regular reports back to the full membership.
The way countries now negotiate has helped somewhat. In order to increase their bargaining power,
countries have formed coalitions. In some subjects such as agriculture virtually all countries are members
of at least one coalition – and in many cases, several coalitions. This means that all countries can be
represented in the process if the coordinators and other key players are present. The coordinators also take
responsibility for both “transparency” and “inclusiveness” by keeping their coalitions informed and by
taking the positions negotiated within their alliances.
In the end, decisions have to be taken by all members and by consensus. The membership as a whole
would resist attempts to impose the will of a small group. No one has been able to find an alternative way
of achieving consensus on difficult issues, because it is virtually impossible for members to change their
positions voluntarily in meetings of the full membership.
Market access negotiations also involve small groups, but for a completely different reason. The final
outcome is a multilateral package of individual countries’ commitments, but those commitments are the
result of numerous bilateral, informal bargaining sessions, which depend on individual countries’
interests. (Examples include the traditional tariff negotiations, and market access talks in services.)
So, informal consultations in various forms play a vital role in allowing consensus to be reached, but they
do not appear in organization charts, precisely because they are informal.
They are not separate from the formal meetings, however. They are necessary for making formal decisions
in the councils and committees. Nor are the formal meetings unimportant. They are the forums for
exchanging views, putting countries’ positions on the record, and ultimately for confirming decisions. The
art of achieving agreement among all WTO members is to strike an appropriate balance, so that a
breakthrough achieved among only a few countries can be acceptable to the rest of the membership.

b. Highlight the drawbacks of GATT.

Sol.

Given its provisional nature and limited field of action, the success of GATT in promoting and securing
the liberalization of much of world trade over 47 years is incontestable. Continual reductions in tariffs
alone helped spur very high rates of world trade growth – around 8 per cent a year on average during the
1950s and 1960s. And the momentum of trade liberalization helped ensure that trade growth consistently
out-paced production growth throughout the GATT era. The rush of new members during the Uruguay
Round demonstrated that the multilateral trading system, as then represented by GATT, was recognized as
an anchor for development and an instrument of economic and trade reform.
The limited achievement of the Tokyo Round, outside the tariff reduction results, was a sign of difficult
times to come. GATT’s success in reducing tariffs to such a low level, combined with a series of
economic recessions in the 1970s and early 1980s, drove governments to devise other forms of protection
for sectors facing increased overseas competition. High rates of unemployment and constant factory
closures led governments in Europe and North America to seek bilateral market-sharing arrangements
with competitors and to embark on a subsidies race to maintain their holds on agricultural trade. Both
these changes undermined the credibility and effectiveness of GATT.
Apart from the deterioration in the trade policy environment, it also became apparent by the early 1980s
that the General Agreement was no longer as relevant to the realities of world trade as it had been in the
1940s. For a start, world trade had become far more complex and important than 40 years before: the
globalization of the world economy was underway, international investment was exploding and trade in
services – not covered by the rules of GATT – was of major interest to more and more countries and, at
the same time, closely tied to further increases in world merchandise trade. In other respects, the GATT
had been found wanting: for instance, with respect to agriculture where loopholes in the multilateral
system were heavily exploited – and efforts at liberalizing agricultural trade met with little success – and
in the textiles and clothing sector where an exception to the normal disciplines of GATT was negotiated in
the form of the Multi-fibre Arrangement. Even the institutional structure of GATT and its dispute
settlement system were giving cause for concern.
Together, these and other factors convinced GATT members that a new effort to reinforce and extend the
multilateral system should be attempted. That effort resulted in the Uruguay Round.

Q.4. a. Give a short note on the regional economic integration.

Sol.

Regional Economic Integration

Regional integration can take many forms, and nowhere is this more evident than in the vastly different
integration processes taking place in the regions of Europe and East Asia. The subject of this paper is
regional integration as it has developed in East Asia with a focus on the drivers of that integration. While
the paper is not intended as a direct comparison of integration in East Asia and Europe, it will include
some comparisons between the two regions.
Integration in East Asia has progressed very slowly and is still in an early stage despite that the process
has continued for decades. In fact, it could be said that the process began centuries ago – even as far back
as the 15th century. By comparison, European integration has progressed steadily and has gradually
deepened over the last 50 years to reach an advanced stage today with a common currency and well-
developed regional institutions. Thus, the speed of progression and the level of integration attained in the
two regions are quite dissimilar.
In addition to these differences, the drivers behind the integration process in each region are different. In
Europe, the origins of integration have been institutional in nature, and the development of institutions has
been prominent throughout the process. Thus, regional institutions have been the driving force behind
integration in Europe. In East Asia, the development of regional institutions has also occurred; however,
progress in this area has been slow and the few existing institutions are fairly weak and ineffective.
Nevertheless, regional integration is taking place in East Asia, but the driving force is the market rather
than policy or institutions. Corporations and the production networks they have established are driving
integration in East Asia.

b. Mention the benefits of WTO.

Sol.
Ten Benefits of WTO
1. The system helps to keep the peace
2. The system allows disputes to be handled constructively
3. A system based on rules rather than power makes life easier for all
4. Freer trade cuts the cost of living
5. It gives consumers more choice and a broader range of qualities to choose from
6. Trade raises incomes
7. Trade stimulates economic growth and that can be good news for employment
8. The basic principles make the system economically more efficient, and they cut costs
9. The system shields governments from narrow interests
10. The system encourages good government

Q. 5 a. Explain five-element product wave model.

Sol.

The Five-Element Product Wave

As illustrated in Figure 4.5, the wave model employs design engineering, process engineering, product
marketing, production, and end-of-life activities as elements. The first wave is associated with the "A"
version of a product or service, and survives through the traditional PLC introduction and growth phases.
A second wave begins with the "B" version, the markedly improved second model. It starts just before the
traditional life cycle maturity stage and lives until sales decline to a point at which an EOL decision must
be made.
Note that design engineering has a peak of activity level at each upgrade. Process engineering activity
shadows that of design engineering, as system changes will be contemplated and made to facilitate the
changes made in the product or service. Product marketing also has activity level spikes that closely match
engineering design activity, lagged somewhat for product introduction. Production has one activity peak
that results from demand management and production planning through master production scheduling.
Finally, the EOL curve peaks at each redesign. The last wave begins shortly before original production
ceases and ends when the product is no longer manufactured or supported by the EOL Company or
division. The EOL element requires that a decision be made about the preceding version at each major
redesign: continue production, make a short-term run of spares, keep blueprints active so that parts can be
made as ordered, enter into a manufacturing and support agreement with another entity, or discontinue
production.
For the sake of parsimony, Figure 4.5 shows only a two-product model ("A" and "B" versions). In reality,
there may be hundreds of significant redesigns. The wave effect comes from the fact that the process
repeats for the successful firm, forming swells in design engineering, process engineering, product
marketing, and manufacturing curves before the final crest at EOL activity.
The five-element product wave, or FPW, uses trigger points, rather than time, as the horizon over which
the element curves vary. Changes in magnitude, represented by the vertical axis, result from differing
activity levels within the five elements. Simple changes in levels of dollar or unit product sales, in and of
themselves, do not necessarily determine the trigger points. Rather, the varying activity levels are a direct
result of product introductions and redesigns that, from the outset, must take into account company
strategy, core capabilities, and the state of the competitive environment. For example, a product with
strong sales may be redesigned in a preemptive strike against competitors, further distancing that product
from the competition, such as with Caterpillar’s innovative high-drive bulldozers.
That the five-element wave is grounded in reality becomes apparent when considering the recent research
that suggests product introduction cycles are being compressed. Bayus (1994) claims that knowledge is
being applied faster, resulting in increasing levels of new product introductions. Yet since product
removals are not keeping pace with introductions, there are an increasing number of product variations on
the market. Slater (1993) observes that product life cycles are growing shorter and shorter. Vesey (1992)
reports that the strategy for the 1990s is speed to market and discusses the pressures the market is exerting
to shorten product introduction lead times.
Regardless of whether life cycles are actually being compressed or knowledge is simply being applied
faster, it is apparent that firms are increasing the speed with which they bring their products to market.
The effect of this is a compression of the design engineering, process engineering, production, and
product marketing elements of the wave model. (The EOL curve may remain unchanged because
accelerated introductions do not necessarily affect EOL efforts.) The five-element wave clearly shows the
inefficiency of traditional "over-the-wall" systems as speed to market increases. As the elements
compress, more and more information is thrown over the wall. Recipients find themselves with less and
less time to take action. Taken to the extreme, in-baskets, phone lines, conference rooms, desks, and floors
are soon gridlocked and littered with unanswered correspondence and things to do. Forget quality;
production itself grinds to a halt.
The solution is to maximize the advantage of the relationships within the five-element wave and work in
concurrent teams, as illustrated in Figure 6. That way, responsibility is shared throughout the system.
Members from each discipline optimize the system. The method tears down barriers between departments
and speeds the introduction process, thus decreasing costs. The focal point becomes the customer, rather
than the task. The system is totally interactive and bound together. Each element is connected to all of the
others and is focused on the customer. (Note that the authors have taken a great deal of artistic license
here! No meaning should be attached to the actual measure of overlap area in Figure 4.6.)
What is the recent experience with teams? There is evidence that using concurrent design teams speeds the
product to market and provides substantial savings. Boeing expects that concurrent design will save some
$4 billion in the development of its 777 airliner. Westinghouse recently suggested that concurrent
engineering would eliminate 200 duplicate processes in a project that consisted of 600 using traditional
over-the-wall approaches. Ford’s Team Taurus was able to cut a full year out of model turnaround. In
addition, design changes required after initial production began were reduced by some 76 percent.
The strength of the five-element product wave is the fact that it illuminates critical decision points in the
life of a product or service. The interrelationships of the elements clearly illustrate the benefit of working
product introductions, design changes, and end-of-life decisions in teams. This is particularly true in
today’s rapidly compressing environment of speeding products to market. Furthermore, the model is
flexible and may be expanded or contracted to include those functional areas relevant to the production
team. Thus, whether a given firm’s product is a service or a manufactured good, the five-element wave is
a powerful tool that can be deployed to accelerate effective decision making in markets demanding ever-
increasing levels of speed and agility.

b. What do you mean by globalization?

Sol.

Economic "globalization" is a historical process, the result of human innovation and technological
progress. It refers to the increasing integration of economies around the world, particularly through trade
and financial flows. The term sometimes also refers to the movement of people (labor) and knowledge
(technology) across international borders. There are also broader cultural, political and environmental
dimensions of globalization that are not covered here.
At its most basic, there is nothing mysterious about globalization. The term has come into common usage
since the 1980s, reflecting technological advances that have made it easier and quicker to complete
international transactions – both trade and financial flows. It refers to an extension beyond national
borders of the same market forces that have operated for centuries at all levels of human economic activity
– village markets, urban industries, or financial centers.
Markets promote efficiency through competition and the division of labor – the specialization that allows
people and economies to focus on what they do best. Global markets offer greater opportunity for people
to tap into more and larger markets around the world. It means that they can have access to more capital
flows, technology, cheaper imports, and larger export markets. But markets do not necessarily ensure that
the benefits of increased efficiency are shared by all. Countries must be prepared to embrace the policies
needed, and in the case of the poorest countries may need the support of the international community as
they do so.

Q. 6. Give some examples of companies doing international business and discuss how they have they
have managed their business in the international markets.

Sol.

A PERSPECTIVE OF THE NORTHEN ISLAND SOFTWARE COMPANIES, RAPD M–UP

Within six months of announcing it would invest $4.5 million to establish its new software development
center in Northern Ireland, IMR was up and running with more than one-third its target staff.
"The fast start-up of the Belfast facility reaffirms our confidence to locate in Northern Ireland," said
Sanan. "The success to date in building a quality work force has surpassed our expectations and opens up
new ambitions for our interests in Northern Ireland."
According to Arthur "Bro" McFerran, president of IMR (NI) Ltd., the company is hiring 12 to 18
programmers a month in Northern Ireland and is well on its way to meeting its staffing goal of 300 by
1999. McFerran credited Northern Ireland’s Training & Employment Agency (T&EA) with helping place
the company’s staffing on the fast track.
"The T&EA not only has helped us to identify and recruit qualified software graduates from Northern
Ireland’s universities, it is also assisting us with a unique initiative to bring additional sources of high
quality talent to the company," McFerran said.
Innovation In Training
Impressed by the number and quality of information technology graduates from the region’s universities,
IMR recognized an untapped resource in the well-educated, versatile graduates of other fields in Northern
Ireland. Working with the T&EA, IMR developed "IMR Academy," an intensive
20-week training program at the Belfast Institute of Further and Higher Education, to expand the skills of
qualified applicants who are not computer software graduates, but who are equally well-educated in other
Disciplines and who have demonstrated aptitude for learning computer software programming.
Tom Scott of the T&EA said IMR applicants are assessed throughout the program and those who
successfully complete the course are awarded a National Computing Certificate and full-time employment
with IMR. Approximately 40 trainees have already participated in the program.
"IMR is extremely pleased with the T&EAs ability to design and deliver a training program customized to
our needs, and one that is delivering us an impressive pool of incremental programming talent," McFerran
said.
Smart And Available
"The recent software investments by IMR and other companies provide a new opportunity for Northern
Ireland’s computer graduates," McFerrin said. Recruitment research by IMR indicates that traditionally,
nearly half of the region’s computer graduates have been forced to seek jobs outside Northern Ireland due
to the lack of available information technology positions.
Now IT graduates have the chance to find good jobs in Northern Ireland, and graduates from other fields
can take advantage of the IMR Academy training program to get a head start on a career in the growing
software sector.
McFerrin said. Recruitment research by IMR indicates that traditionally, nearly half of the region’s
computer graduates have been forced to seek jobs outside Northern Ireland due to the lack of available
information technology positions.

Competitive Advantage
Northern Ireland recently has attracted information technology – based investments from other
multinational companies such as BT, Fujitsu, Liberty Mutual Group, Seagate Technology, STB Systems
and UniComp. These companies cite Northern Ireland’s work force and favorable cost base in their
decisions to locate in the region.
"The availability of high-quality graduates combined with the region’s competitive operating costs and
attractive incentives made Northern Ireland the best possible location for STB," said Richard W. Cooke,
STB’s director of engineering operations.
With salaries and fringe costs for well trained software engineers in Northern Ireland approximately 50
percent lower than costs for US engineers, and low employee turnover and favorable rates for office
space, the overall annual per capita operational costs to develop high quality software can be significantly
less compared with these same costs in the United States.
Typical starting salaries for IT graduates in Northern Ireland are $22,000 to $25,000 annually. At less than
three percent annually, Northern Ireland’s employee turnover rate is a fraction of the rates typically
experienced in other parts of Europe and the United States. Annual costs per square foot for office space,
exclusive of property taxes and service charges, range from as low as $5 per square foot in some
development areas, to approximately $14 in Belfast. These costs can be as much as 50 percent lower than
office space costs in other European cities.
 MF0006 – International Financial Management
Assignment Set-1

Q.1 Give possible reasons by which the companies are encouraged to be an MNC?

Answer :

A firm that is engaged in cross-border business is defined as a Multinational Corporation (MNC).

An MNC is a corporation with substantial direct investments in foreign countries (it is not just an
export business) and is engaged in the active management of these off-shore assets (it is not just
holding a passive financial portfolio).

Some of the possible reasons are:

• To broaden markets: Saturated home markets ask for market development abroad (Coca Cola,
Mac Donald’s etc.). Multinationals seek new markets to fill product gaps in foreign markets where
excess returns can be earned.

• To seek raw materials: Multinationals secure the necessary raw materials required to sustain
primary business line (Exxon; Wal Mart). Multinationals also seek to obtain easy access to oil
exploration, mining, and manufacturing in many developing nations.

• To seek new technologies: Multinationals seek leading scientific and design ideas.

• To seek production efficiencies by shifting to low cost regions (GE).

• To avoid political hurdles such as import quota, regulatory measures of governments, trade
barriers, etc.

• To diversify i.e. to cushion the impact of adverse economic events.

• To postpone payment of domestic taxes.

• To counter foreign investments by competitors.

Q.2 What do you mean by International Trade Flows? Also explain various factors
affecting international trade flows.

Answer :

International Trade Flows

International trade is the exchange of goods and services across international boundaries. The
world trade in goods and services has grown much faster than world GDP since 1960. Since 1960,
global trade has grown twice as fast as the global GDP. The share of international trade in national
economies has, in most cases, increased dramatically over the past few decades. In most countries,
international trade represents a significant share of GDP.

Factors Affecting International Trade Flows

• Impact of Inflation: A relative increase in a country’s inflation rate will decrease its current
account, as imports increase and exports decrease.

• Impact of National Income: A relative increase in a country’s income level will decrease its
current account, as imports increase.

• Impact of Government Restrictions: A government may reduce its country’s imports by

imposing a tariff on imported goods, or by enforcing a quota. Some trade restrictions may be
imposed on certain products for health and safety reasons.

• Impact of Exchange Rates: If a country’s currency begins to rise in value, its current account
balance will decrease as imports increase and exports decrease.

The factors interact, such that their simultaneous influence on the balance of trade is complex.
Q.3 (a) Define Swaps. Also explain various types of swaps.

Answer :

Swaps

A swap is an agreement to exchange cash flows at specified future times according to certain
specified rules. The two counterparties in a swap agree to exchange or swap cash flows at
periodic intervals.

The different kinds of swaps are:

1. Interest Rate Swap – An exchange of fixed-rate interest payments for floating-rate interest
payments.
2. Currency Swap – An exchange of interest payments and principal in one currency for interest
payments and principal in another currency.
3. Cross Currency Interest Rate Swap- An exchange of floating rate interest payments and
principal in one currency for fixed rate interest payments and principal in another currency.

The above mentioned three kinds of swaps can be explained as follows :

1. Interest Rate Swap

A standard fixed-to-floating interest rate swap (also referred to as "exchange of borrowings") is an

agreement between two parties, in which each contracts to make payments to the other on
particular dates in the future till a specified termination date. One party, known as the fixed rate
payer, makes fixed payments all of which are determined at the outset. The other party known as
the floating rate payer will make payments the size of which depends upon the future evolution of
a specified interest rate index (such as the 6-month LIBOR). The floating "leg" is typically
periodically reset. The fixed and floating payments are calculated as if they were interest payments
on a specified amount borrowed or lent. It is notional because the parties do not exchange this
amount at any time; it is only used to compute the sequence of payments. In a standard swap, the
notional principal remains constant through the life of the swap. An agreement by a company to
receive 6-month LIBOR & pay a fixed rate of 5% per annum every 6 months for 3 years on a
notional principal of $100 million is an example of an interest rate swap.

2. Currency Swaps

In an interest rate swap the principal is not exchanged. In a currency swap the principal is
exchanged at the beginning and the end of the swap. A currency swap is an agreement between
two parties in which one party promises to make payments in one currency and the other promises
to make payments in another currency.

An example would be a U.S. company needing Euros to fund a project in Germany. It has a choice
to either issue a fixed-rate bond in Euros or issue a fixed-rate bond in dollars and convert those
dollars to Euros. It may be much easier for the company to raise funds in dollars in USA where it
is well-known, than to raise funds in Euros in Germany where it may not be so well-known.
Therefore, the company chooses to issue a fixed rate bond in dollars and convert them to Euros.
One way to convert the dollars to Euros is to construct a dollar/Euro currency swap. And one of
the simplest ways to do this is at the beginning of the transaction, the company takes the dollars
received from the issue of the dollar denominated bond and pays them up front to a swap dealer
who pays the company an equivalent amount in Euros. The swap dealer pays interest payments in
dollars to the company which it can use to pay the dollar coupon interest to the bondholders in
USA from whom it has raised money. At the same time, the company pays an agreed-upon amount
of Euros to the swap dealer. At maturity the company and the swap dealer re-exchange the
principal; the company pays the same amount of euros to the swap dealer as it had received at the
initiation of the swap and receives the same amount of dollars it had given to the swap dollar in
exchange. Thus, upon maturity, the company pays back the principal to its bondholders in dollars.
As a result of this swap, the company has converted a dollar-denominated loan into a Euro-
denominated loan.

3. Cross Currency Interest Rate Swap

A fixed-to-floating currency swap also known as cross-currency swap will have one payment
calculated at a floating interest rate while the other is at a fixed interest rate. It is a combination of
a fixed-to-fixed currency swap and a fixed-to-floating interest rate swap. Each counterparty to a
currency swap can be described in terms of the type of interest (fixed or floating), and the currency
that he pays and also the type of interest and the currency that he receives. For example, in a cross
 currency interest rate swap, one of the counterparties may be a payer of a six month dollar LIBOR
and a receiver of a five year sterling fixed interest. (The other counterparty therefore will pay a
five year sterling fixed interest and receive six month dollar LIBOR).

Cross-currency interest rate swaps allow a company to switch from one currency to another. For
example, a French company wishing to start operations in the USA can tap a source of fixed rate
funds in the euro market, where its name may be well-known and its credit well-perceived, and
swap it into floating rate dollars, to achieve funding at a level significantly better than what a
direct issue in floating rate dollar market would offer.

(b) Define foreign bonds with their salient features.

Answer :

Foreign Bonds

A country’s foreign bond market is that market in which the bonds of issuers not domiciled in that
country are sold and traded. For example, the bonds of a German company issued in the U.S. or
traded on the U.S. secondary markets would be part of the U.S. foreign bond market. The
definition of "foreign" refers to the nationality of the issuer in relation to the market place. For
example, a US dollar bond sold in the United States by the Swedish car producer Volvo is
classified as a foreign bond while one issued by General Motors is a domestic bond.

Features of the Foreign Bonds:

1. Foreign bonds are sold in the currency of the local economy.

2. Foreign bonds are subject to the regulations governing all securities traded in the national
market and sometimes special regulations governing foreign borrowers (e.g., additional
registration).

3. Foreign bonds provide foreign companies access to funds they often use to finance their
operations in the country where they sell the bonds.

4. Foreign bonds are regulated by the domestic market authorities. The issuer must satisfy all
regulations of the country in which it issues the bonds.
The difference between a domestic and a foreign bond is that the issuer of the latter is a foreign
entity which may be beyond investors’ legal reach in the event of default. However, since
investors in foreign bonds are usually the residents of the domestic country, investors find them
attractive because they can add foreign content to their portfolios without the added exchange rate
exposure.

Foreign bonds are known by different names in different countries. They are called Yankee bond,
Samurai bonds, Matador bonds, Bulldog bonds and Rembrandt bonds in USA, Japan, Spain, UK
and Netherlands respectively.
 MF0007 – Treasury Management
Assignment Set-1

Q.1 Describe all the tasks of Treasury Management in large Company.

Answer :

The tasks of Treasury Management vary depending upon the nature of the organisation, operation,
quality of management etc. However, the following functions are generally attributable to Treasury
management.

(1) Framing Treasury Policies: Policies are to be framed regarding borrowing, investment,
payment of expenses like salary, purchase of raw materials. Many areas regarding cash sales,
receipts from debtors etc., are also to be considered and suitable policies are framed. Policies
regarding cash sale and the terms of cash sale are to be framed. Borrowing long-term funds to meet
the capital expenditure also needs framing policies. These policies relate to deciding about the
borrowers and the nature of instrument of borrowing. Policy regarding the source of finance and the
instruments used to borrow for the capital expenditure will make a severe impact on the future cash
flows of the corporate for a long time to come. Therefore, the policies are to be framed carefully.

(2) Establishing a Treasury System: A suitable system should be established to account for all the
income, expenses, payments and receipts. These are necessary, not only to avoid misuse of funds,
but also to ensure a proper system of accountability. In addition, the increasing powers of regulatory
agencies both in India and abroad call for maintenance of a system that will stand the scrutiny of any
governmental agencies like Securities & Exchange Commission in the USA. In the wake of
accounting scandals of Enron and WorldCom, Sarbanes-Oxley Act was passed in the USA, giving
greater powers to the regulator, SEC. In India, Securities Exchange Board of India (SEBI) is also
vested with a lot of powers regarding the financial intermediaries and listed companies. Where the
institution involved is a banking institution, it should be able to stand the scrutiny of the Reserve
Bank of India. If it is operating in the financial market, the bank is subject to the scrutiny of SEBI,
apart from the scrutiny of the RBI.

(3) Liquidity Planning: The size of modern corporations has gone up either due to persistent
capacity expansion, international operations or mergers and acquisitions. This brings about acute
problems of cash flow. At every point of time, sufficient liquidity is to be ensured so that the
corporate does not run into the problem of shortage of liquidity. To achieve this without sacrificing
profitability, corporates are relying on investment in money market instruments more and more. For
large-scale operations, the problem is always temporary shortages of cash and its surplus. Temporary
shortages are to be met through additional sourcing of cash. Temporary surplus of cash has to be
invested in order to avoid the presence of idle funds.
(4) Portfolio Management: As the corporates are investing heavily in the capital market securities
like equity shares, preference shares, bonds or debentures, portfolio management also becomes an
important function of the Treasury. Right from the selection of the portfolio, its designing,
continuous monitoring and constant churning for an active investment strategy, it is the Treasury that
plays a vital role. Various risk management products in the form of derivatives are available in every
type of organised market. In currency markets, stock markets, foreign exchange markets and also in
credit markets, sophisticated techniques are available to manage the risk. These derivatives can also
be used to increase the profit from operations in these organised markets.

(5) Identification of Funding Agencies: With Liberalisation, funds are moving globally. The skill
and the comprehensive effort in tapping the source of finance and funding agencies will bring down
the cost of capital considerably. The Treasury Manager must work out various scenarios and the
suitable fund-agency matrix. In the future, this will reduce the time involved in the research in order
to tap the source. Apart from the traditional sources like banks and international monetary
organisations, there is a new breed of financiers in the form of venture capitalists, private equity
partners, High Networth Individuals, Hedge Funds etc. The Treasury Manager has to establish and
maintain contacts with every type of financiers in order to raise the funds readily and at a cheap cost.

(6) Foreign Exchange Dealings: Certain industries like the Indian software industry, engineering
industry, textiles and a host of others may be dependent upon exports. There are manufacturing
industries, which are dependent upon import of raw materials like petroleum refineries, thermal
power stations, and industries using base metals for their operations. There are also industries, which
are dependent upon both exports and imports, as in the case of polished diamonds industry. It
involves both the receipts and payments only in foreign currencies. The values of the currencies are
volatile. After liberalization of most of the economies, funds are moving very quickly from one set
of countries to the other. In such a scenario, it is the functions of the Treasury to see that such
fluctuations contribute to the profits of the corporate rather than becoming a loss. Unexpected
fluctuations will make the firms to incur losses. Well-planned operations will provide for taking
hedge against a possible loss in the future.

(7) Planning for Organic & Inorganic Growth: It has become quite common that successful
corporates are going on a global level expansion. They do it by way of organic growth (which is
called Greenfield Project) in the form of capacity expansion. They may also do it by way of
inorganic growth (known as Brownfield Project) through mergers and acquisitions. Both the routes
call for mobilizing huge funds. Unlike in the normal operations, funds needed for organic and
inorganic growth are required on a mammoth scale. There is also a trend with Indian companies like
Tata Steel and Tata Tea taking over companies that are larger than the acquirers. Corus taken over
by Tata Steel is bigger than the latter many times. The funds needed naturally are very huge in size.
It may be on an unprecedented scale in the history of the company. The Treasury Manager must gear
up for such challenges. The Treasury has to be ready with the funds as and when such an organic or
inorganic growth takes place. In certain organisations, it takes place continuously and the Treasury
must always be planning for raising resources again and again.

(8) Risk Management for Derivatives: Many corporates cover every type of risk they are exposed
to. Depending upon the nature of the organisation like banking, manufacturing, security trading etc,
risks exist in most of the operations. As long as the financial markets remained underdeveloped, the
corporates had to bear the loss. With the International Organisation of Securities Commissions
(IOSCO) bringing about uniformity in practices in financial markets and accounting practices, the
facility is provided to the corporates to cover their risks through hedging and forward dealings.
Treasury has the important task of such risk management. However, derivatives are not everyone’s
cup of tea. It involves quite a lot of complicated computations and also a good amount of gut feeling.
Otherwise, derivatives may contribute to heavy losses being incurred by the organisation.
Q.2 What is Qualified Institutional Placement? Do you think it is injustice on retail
investors of the Company?
Answer :

Qualified Institutions and Placement (QIP) and Preferential Allotment are quickest, easiest and cost
effective ways of raising capital, and therefore, the promoters prefer these routes over the time
consuming rights issues or follow-on offers.

Rights issue and follow-on issues are mainly bogged down by lengthy, tedious and time consuming
procedures, while QIP and preferential allotment are less time consuming as that do not require
submitting and seeking approval of issue prospectus as in the case of right issue. A placement
document is required to be submitted with stock exchanges were shares are to be listed against full
fledged issue prospectus for right issues.

In QIP, no prior regulatory approval is required for issue document placed with QIBs, which are
basically institutional investors. The assumption is that institutional investors, to whom the shares
are offered, are supposed to be well informed investors and a detailed prospectus approved by the
regulators is not needed.

Besides QIP, many companies have raised money in the recent past through Preferential Allotment
of shares to promoters and strategic investors as well. The purpose of allotting preferential shares to
promoters is to maintain promoters stake at a comfortable level post equity dilution through QIP
issue.

One of the reasons for introducing QIP was to invite risk takers to the market. A company that
wants to come out with an IPO and list has to fulfill certain basic criteria such as profitability track
record, net worth and so on. Companies in certain industries such as direct-to-home and airlines
where gestation period is long, will not able to float an IPO due to the non-fulfillment of the
eligibility conditions. To allow such companies to raise money from the stock market, the
Disclosure and Investor Protection Guidelines allowed them to float IPO provided 50% of shares are
reserved and allotted to Qualified Institutional Buyers.

It is not only promoters, but even institutional investors prefer QIP and Preferential Allotment. This
is because if institutional investors decide to buy shares from the open market in bulk, the price of
the stock shoots up. They are saved from this possible impact cost when he buys a stake through QIP
or Preferential Allotment.

QIPs & Preferential issues have flexible structure. QIP is popular because the issuer can use other
financial instruments convertible into equity shares, except warrants. Preferential issues allow
companies to allot optional convertible warrants. Optionally convertible warrants are not available
to QIBs. However, preferential issues come with a lock-in period, while QIP has no lock-in, with
the only condition that shares should be sold through the recognized stock exchanges.

With companies favoring QIP and preferential allotment, small and retail investors are being
deprived of opportunities to invest in such companies. Suppose retail investor is holding
shares of a company about whom he is confident. He is convinced about its future prospectus
and would like to hold these shares for long term. Now if the company wants to raise
additional equity capital the retail investor is on losing side. This is because, he is being
 deprived of the investment opportunity in favor of a handful of institutional investors and
promoters.

Q.3 What is risk involved in investment in debt funds where more than 90% investment
is in Government bonds? Which short term option (90days) you will choose for your
Company for investment of liquid surplus and why

Answer :

Debt funds by nature, bond funds like all mutual funds, are investment vehicles. They are meant
especially for investors with relatively less appetite for risk and having an intention to earn returns
higher than what are possible to earn from other avenues like Fixed Deposits that are considered as
safe. So, safety and return both are of equal concern for those investing in Bond Funds. Most bond
funds pay income regularly and their NAVs tend to fluctuate less than an equity fund.

Where do they invest?

In order to successfully achieve the goals of the fund, they invest in a multiplicity of debt
instruments such as Corporate pares, papers issued by GOI etc. with different maturities and
qualities. In order to balance the liquidity needs of investors who might want to redeem their funds
any time, they also have exposure to money market instruments and call papers. Generally, mutual
funds invest in bonds issued by different issuers such as government, corporate houses etc. Bonds
can be classified on the basis of their issuer as:

1. Government Bonds

The Government Treasury and its agencies issue these bonds. Treasury bonds are considered
the highest quality of all bonds because the credit of the government backs them and so the
payment upon maturity is more or less guaranteed. In exchange for this very high margin of
credit safety, they have the lowest yields.

2. Corporate Bonds

These are issued by various companies to finance their operations, expansion activities etc.
Credit rating agencies such as CRISIL, CARE, ICRA rate these instruments in India on the
basis of their degree of safety, which is defined as their ability to pay the amount on maturity.
The risk-return trade off is witnessed here as well, for companies with good rating offer less
yield.

3. Municipal bonds

These bonds are issued by governments and municipalities. Considered as reasonably safe,
these bonds provide varying returns depending upon their maturities.

The returns from a bond fund are essentially the weighted average of the returns on each of its
investment. So if a fund has invested in bonds of different maturities and yields, the yield from the
fund will be the weighted average of the yields on different securities, weighted by the proportion
of invested sum. The quality of papers and average duration of the portfolio are some of the factors
that determine the returns one can earn from the fund. However, the prices and yields of bonds can
fluctuate like other investments and so there is some risk inherent even in bond funds and they are
not absolutely risk-free as they are often made out to be.

What are the risks associated?

Bond funds invest in bonds and like any investment are affected by some risks. There are several
risks associated with bonds and so they also affect the funds that invest in bonds. They are:

Interest-rate risk

Unlike stock market where an upward movement of market leads to upward movement in stock
prices, it is a fall in the market yield that pushes up the prices of debt securities. This happens
because there exists an inverse relationship between the yield and the price of a bond. So, if there
is an upward movement of interest rates after one has invested in a bond fund, the prices of bonds
will go down leading to a corresponding fall in the NAVs of the bond funds. Let us take an
example:

Suppose a person buys a bond for Rs. 100 with a coupon rate of 10 percent. In other terms the
person should get Rs. 110 at the end of the year. If the RBI announces a hike in the bank rate and
the market yield for the duration of the bond increased, say to 11 percent, the prices of the bond
will fall around to Rs. 90.91 in order to adjust to the market yield. This is termed as interest rate
risk in financial jargon and is precisely what happened in 2000 when RBI had hiked the interest
rates.

An investor stands to benefit in the opposite scenario, when the interest rates are cut as then the
prices go up leading to better returns from the fund. If the interest rate in the above example falls
to 9 percent, a person still gets Rs. 10 in interest but in order to align the amount received to the
prevailing market yield, the price of the bond adjusts to Rs. 111.11. In this case, the investor is
better of by selling it at Rs. 111.11 than holding it to its maturity, as then he will only get Rs. 110.

This risk is also dependent upon the maturity and duration of the bond and generally, the longer a
fund's duration or average maturity, the higher its interest-rate risk, or the more sensitive the NAV
of the fund will be to changes in interest rates. One can reduce the interest rate risk by choosing a
bond fund with a shorter duration or average maturity.

Credit risk

Just like shares where the performance of the company has some bearing on the stock prices,
credibility of the issuer is of importance in debt instruments. The risk of the issuer not being able
to make payments on his liabilities (debt instrument) is termed as default risk or credit risk. This is
of special concern to the investor if the fund is investing into junk bonds or lower quality bonds.
Bond funds offer professional management and a range of quality ratings to help lower this risk
and so investors stand to benefit by the expertise of fund to pick good papers only.

Delay Risk

Cash flows are estimated on the basis of the pattern of income distribution. For example, a bond
can pay interest half yearly, on fixed dates and so if there is any delay in receiving payments from
the issuer, there is bound to be a mismatch between the cash flows. This can be termed as the delay
risk. Mutual funds too can miss out on the interest due on an investment and have to show it as
accrued but not received. This also affects the time value of the money due. A continuation of this
trend may lead to a re-rating of the paper and add to the non-performing assets of the fund.

Balancing Risk vs. Reward

As with any investment in any category, there is always a trade-off between the risks taken and
returns generated. The greater the risk of a bond fund (dependent on the quality and duration of
papers), the higher is the potential reward, or return. With a bond fund, the risk that prices may
fluctuate and the value of your investment may increase or decrease is not eliminated and so one
must choose funds based on his risk tolerance.

Short term option (90days) Company for investment of liquid surplus :

Certificate of Deposit (CD) is a negotiable certificate issued by a bank on the receipt of a large
deposit. It is like a fixed deposit receipt issued by the bank on the receipt of a deposit. The
ordinary FD Receipt is neither negotiable nor transferable. It is only assignable. FD is not subject
to restrictions like minimum amount, tenure etc. CD is a negotiable certificate payable to bearer.
CDs appeared in the U.S.A., in 1961.

In India, the RBI permitted banks to issue CDs from June 1989. CDs are meant for large deposits
so that administrative expenses of the bank and the depositor are reduced. CD is a short term
security while the ordinary FD can be of either short-term or long-term security.

Features of Certificate of Deposit:

1) Borrower: Borrower is any scheduled bank other than RRBs for raising large funds. On
receiving the deposit, the banks issue the negotiable receipt which can be transferred or sold in the
secondary market.

2) Investors: The investors are generally Joint Stock Companies, institutions, High Networth
Individuals or any other funds. The purpose is to park the funds generally for a period of three
months.

3) Tenure: The tenure is usually between three months to one year. The common tenure is three
months.

4) Denomination of CD: Originally, the minimum denomination was Rs. 1 crore and in multiples
of Rs. 5 lakh thereafter. Later on, it was modified as a minimum denomination of Rs. 10 lakh and
in multiples of Rs. 5 lakh thereafter.

5) Negotiable Instrument: It is negotiable so that it can be transferred by delivery &

endorsement. In many case, it is payable to the order of the depositor or to the bearer of the
instrument. However, there is an initial lock in period of 30 days during which it cannot be
transferred.

6) Issue price: The face value of the CD is its maturity value. It is issued at a discount to the face
value. The discount is decided by market forces of demand and supply.

Most of the CDs are held by the depositor until maturity. As a result, a secondary market has not
developed yet. DFHI has started buying the CDs. To create a secondary market, it should also sell
them. However, it is not able to accumulate enough CDs due to the tendency of the depositor to
 hold it until maturity. As a result, the secondary market has not developed due to lack of adequate
supply.

MF0008 – Merchant Banking & Financial Services

Assignment Set-1

Q.1 Bring out an overview of Indian financial system post 1950 period.

Answer :

The financial system or the financial sector of a country consists of:-

(a) specialized & non specialized financial institution
(b) organized &unorganized financial markets and
(c) Financial instruments & services which facilitate transfer of funds.

Procedure & practices adopted in the markets, and financial inter relationships are also the parts of
the system. These parts are not always mutually exclusive. For example, the financial institution
operate in financial market and are, therefore a part of such market. The word system in the term
financial system implies a set of complex and closely connected or inters mixed institution, agents
practices, markets, transactions, claims, & liabilities in the economy. The financial system is
concerned about money, credit, & finance – the terms intimately related yet some what different from
each other. Money refers to the current medium of exchange or means of payment. Credit or Loan is
a sum of money to be returned normally with Interest it refers to a debt of economic unit. Finance is
a monetary resources comprising debt & ownership fund of the state, company or person.

Features of financial system -:

1. It provides an Ideal linkage between depositors savers and Investors Therefore it encourages
savings and investment.
2. Financial system facilitates expansion of financial markets over a period of time.
3. Financial system should promote deficient allocation of financial resources of socially
desirable and economically productive purpose.
4. Financial system influence both quality and the pace of economic development.

Role of financial system:

 The role of the financial system is to promote savings & investments in the economy. It has a vital
role to play in the productive process and in the mobilization of savings and their distribution among
the various productive activities. Savings are the excess of current expenditure over income. The
domestic savings has been categorized into three sectors, household, government & private sectors.
The savings from household sector dominates the domestic savings component. The savings will be
in the form of currency, bank deposits, non bank deposits, life insurance funds, provident funds,
pension funds, shares, debentures, bonds, units & trade debts. All of these currency & deposits are
voluntary transactions & precautionary measures. The savings in the household sector are mobilized
directly in the form of units, premium, provident fund, and pension fund. These are the contractual
forms of savings. Financial actively deals with the production, distribution & consumption of goods
and services. The financial system will provide inputs to productive activity. Financial sector
provides inputs in the form of cash credit & assets in financial for production activities.
The function of a financial system is to establish a bridge between the savers and investors. It helps in
mobilization of savings to materialize investment ideas into realities. It helps to increase the output
towards the existing production frontier. The growth of the banking habit helps to activate saving and
undertake fresh saving. The financial system encourages investment activity by reducing the cost of
finance risk. It helps to make investment decisions regarding projects by sponsoring, encouraging,
export project appraisal, feasibility studies, monitoring & execution of the projects.

Financial System of any country consists of financial markets, financial intermediation and financial
instruments or financial products. This paper discusses the meaning of finance and Indian Financial
System and focus on the financial markets, financial intermediaries and financial instruments. The
brief review on various money market instruments are also covered in this study.

The term "finance" in our simple understanding it is perceived as equivalent to 'Money'. We read
about Money and banking in Economics, about Monetary Theory and Practice and about "Public
Finance". But finance exactly is not money, it is the source of providing funds for a particular
activity. Thus public finance does not mean the money with the Government, but it refers to sources
of raising revenue for the activities and functions of a Government. Here some of the definitions of
the word 'finance', both as a source and as an activity i.e. as a noun and a verb.

INDIAN FINANCIAL SYSTEM FROM 1950 TO 1980 –

Indian Financial System During this period evolved in response to the objective of planned economic
development. With the adoption of mixed economy as a pattern of industrial development, a
complimentary role was conceived for public and private sector. There was a need to align financial
system with government economic policies. At that time there was government control over
distribution of credit and finance. The main elements of financial organization in planned economic
development are as follows:-

1. Public ownership of financial institutions –

The nationalization of RBI was in 1948, SBI was set up in 1956, LIC came in to existence in 1956 by
merging 245 life insurance companies in 1969, 14 major private banks were brought under the direct
control of Government of India. In 1972, GIC was set up and in 1980; six more commercial banks
were brought under public ownership. Some institutions were also set up during this period like
development banks, term lending institutions, UTI was set up in public sector in 1964, provident
fund, pension fund was set up. In this way public sector occupied commanding position in Indian
Financial System.

2. Fortification Of Institutional structure –

Financial institutions should stimulate / encourage capital formation in the economy. The important
feature of well developed financial system is strengthening of institutional structures. Development
banks was set up with this objective like industrial finance corporation of India (IFCI) was set up in
1948, state financial corporation (SFCs) were set up in 1951, Industrial credit and Investment
corporation of India Ltd (ICICI)was set up in 1955. It was pioneer in many respects like underwriting
of issue of capital, channelisation of foreign currency loans from World Bank to private industry. In
1964, Industrial Development of India (IDBI).

3. Protection of Investors –
Lot many acts were passed during this period for protection of investors in financial markets. The
various acts Companies Act, 1956 ; Capital Issues Control Act, 1947 ; Securities Contract Regulation
Act, 1956 ; Monopolies and Restrictive Trade Practices Act, 1970 ; Foreign Exchange Regulation
Act, 1973 ; Securities & Exchange Board of India, 1988.

4. Participation in Corporate Management –

As participation were made by large companies and financial instruments it leads to accumulation of
voting power in hands of institutional investors in several big companies financial instruments
particularly LIC and UTI were able to put considerable pressure on management by virtual of their
voting power. The Indian Financial System between 1951 and mid80’s was broad based number of
institutions came up. The system was characterized by diversifying organizations which used to
perform number of functions. The Financial structure with considerable strength and capability of
supplying industrial capital to various enterprises was gradually built up the whole financial system
came under the ownership and control of public authorities in this manner public sector occupy a
commanding position in the industrial enterprises. Such control was viewed as integral part of the
strategy of planned economy development.

INDIAN FINANCIAL SYSTEM POST 1990’S

The organizations of Indian Financial system witnessed transformation after launching of new
economic policy 1991. The development process shifted from controlled economy to free market for
these changes were made in the economic policy. The role of government in business was reduced
the measure trust of the government should be on development of infrastructure, public welfare and
equity. The capital market an important role in allocation of resources. The major development
during this phase are:-
 1. Privatisation of Financial Institutions –
At this time many institutions were converted in to public company and number of private players
were allowed to enter in to various sectors:
a) Industrial Finance Corporation on India (IFCI): The pioneer development finance institution was
converted in to a public company.
b) Industrial Development Bank of India & Industrial Finance Corporation of India (IDBI & IFCI):
IDBI & IFCI ltd offers their equity capital to private investors.
c) Private Mutual Funds have been set up under the guidelines prescribed by SEBI.
d) Number of private banks and foreign banks came up under the RBI guidelines. Private institution
companies emerged and work under the guidelines of IRDA, 1999.
e) In this manner government monopoly over financial institutions has been dismantled in phased
manner. IT was done by converting public financial institutions in joint stock companies and permitting
to sell equity capital to the government.

2. Reorganization of Institutional Structure –

The importance of development financial institutions decline with shift to capital market for raising
finance commercial banks were give more funds to investment in capital market for this. SLR and
CRR were produced; SLR earlier @ 38.5% was reduced to 25% and CRR which used to be 25% is at
present 5%. Permission was also given to banks to directly undertake leasing, hire-purchase and
factoring business. There was trust on development of primary market, secondary market and money
market.
3. Investors Protection –
SEBI is given power to regulate financial markets and the various intermediaries in the financial
markets.

INDIAN FINANCIAL SYSTEM

The economic development of a nation is reflected by the progress of the various economic units,
broadly classified into corporate sector, government and household sector. While performing their
activities these units will be placed in a surplus/deficit/balanced budgetary situations.

There are areas or people with surplus funds and there are those with a deficit. A financial system or
financial sector functions as an intermediary and facilitates the flow of funds from the areas of
surplus to the areas of deficit. A Financial System is a composition of various institutions, markets,
regulations and laws, practices, money manager, analysts, transactions and claims and liabilities.

Financial System;
The word "system", in the term "financial system", implies a set of complex and closely connected or
interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy.
The financial system is concerned about money, credit and finance-the three terms are intimately
related yet are somewhat different from each other. Indian financial system consists of financial
market, financial instruments and financial intermediation. These are briefly discussed below;

FINANCIAL MARKETS

A Financial Market can be defined as the market in which financial assets are created or transferred.
As against a real transaction that involves exchange of money for real goods or services, a financial
transaction involves creation or transfer of a financial asset. Financial Assets or Financial Instruments
represents a claim to the payment of a sum of money sometime in the future and /or periodic payment
in the form of interest or dividend.

Money Market- The money market ifs a wholesale debt market for low-risk, highly-liquid, short-
term instrument. Funds are available in this market for periods ranging from a single day up to a
year. This market is dominated mostly by government, banks and financial institutions.

Capital Market - The capital market is designed to finance the long-term investments. The
transactions taking place in this market will be for periods over a year.

Forex Market - The Forex market deals with the multicurrency requirements, which are met by the
exchange of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes
place in this market. This is one of the most developed and integrated market across the globe.

Credit Market- Credit market is a place where banks, FIs and NBFCs purvey short, medium and
long-term loans to corporate and individuals.

Constituents of a Financial System

FINANCIAL INTERMEDIATION
Having designed the instrument, the issuer should then ensure that these financial assets reach the
ultimate investor in order to garner the requisite amount. When the borrower of funds approaches the
financial market to raise funds, mere issue of securities will not suffice. Adequate information of the
issue, issuer and the security should be passed on to take place. There should be a proper channel
within the financial system to ensure such transfer. To serve this purpose, Financial intermediaries
came into existence. Financial intermediation in the organized sector is conducted by a widerange of
institutions functioning under the overall surveillance of the Reserve Bank of India. In the initial
stages, the role of the intermediary was mostly related to ensure transfer of funds from the lender to
the borrower. This service was offered by banks, FIs, brokers, and dealers. However, as the financial
system widened along with the developments taking place in the financial markets, the scope of its
operations also widened. Some of the important intermediaries operating ink the financial markets
include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians,
portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite
dealers, self regulatory organizations, etc. Though the markets are different, there may be a few
intermediaries offering their services in move than one market e.g. underwriter. However, the
services offered by them vary from one market to another.

Intermediary Market Role

Stock Exchange Capital Market Secondary Market to securities
Investment Capital Market, Corporate advisory services, Issue of securities
Bankers Credit Market
Underwriters Capital Market, Subscribe to unsubscribed portion of securities
Money Market
Registrars, Capital Market Issue securities to the investors on behalf of the
Depositories, company and handle share transfer activity
Custodians
Primary Dealers Money Market Market making in government securities
Satellite Dealers
Forex Dealers Forex Market Ensure exchange ink currencies

FINANCIAL INSTRUMENTS

Money Market Instruments

The money market can be defined as a market for short-term money and financial assets that are near
substitutes for money. The term short-term means generally a period upto one year and near
substitutes to money is used to denote any financial asset which can be quickly converted into money
with minimum transaction cost.

Some of the important money market instruments are briefly discussed below;

1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers

1. Call /Notice-Money Market

Call/Notice money is the money borrowed or lent on demand for a very short period. When money is
borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or
Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next
working day, (irrespective of the number of intervening holidays) is "Call Money". When money is
borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security
is required to cover these transactions.

2. Inter-Bank Term Money

Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money market.
The entry restrictions are the same as those for Call/Notice Money except that, as per existing
regulations, the specified entities are not allowed to lend beyond 14 days.

3. Treasury Bills.

Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is an
IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the
stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a
discount to the face value, and on maturity the face value is paid to the holder. The rate of discount
and the corresponding issue price are determined at each auction.

4. Certificate of Deposits

Certificates of Deposit (CDs) is a negotiable money market instrument nd issued in dematerialised

form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial
institution for a specified time period. Guidelines for issue of CDs are presently governed by various
directives issued by the Reserve Bank of India, as amended from time to time. CDs can be issued by
(i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks
(LABs); and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short-
term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs
depending on their requirements. An FI may issue CDs within the overall umbrella limit fixed by
RBI, i.e., issue of CD together with other instruments viz., term money, term deposits, commercial
papers and intercorporate deposits should not exceed 100 per cent of its net owned funds, as per the
latest audited balance sheet.

5. Commercial Paper

CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper the debt
obligation is transformed into an instrument. CP is thus an unsecured promissory note privately
placed with investors at a discount rate to face value determined by market forces. CP is freely
negotiable by endorsement and delivery. A company shall be eligible to issue CP provided - (a) the
tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore;
(b) the working capital (fund-based) limit of the company from the banking system is not less than
Rs.4 crore and (c) the borrowal account of the company is classified as a Standard Asset by the
financing bank/s. The minimum maturity period of CP is 7 days. The minimum credit rating shall be
P-2 of CRISIL or such equivalent rating by other agencies.

Capital Market Instruments

The capital market generally consists of the following long term period i.e., more than one year
period, financial instruments; In the equity segment Equity shares, preference shares, convertible
preference shares, non-convertible preference shares etc and in the debt segment debentures, zero
coupon bonds, deep discount bonds etc.
 Hybrid Instruments

Hybrid instruments have both the features of equity and debenture. This kind of instruments is called
as hybrid instruments. Examples are convertible debentures, warrants etc.

Conclusion

In India money market is regulated by Reserve bank of India (www.rbi.org.in) and Securities
Exchange Board of India (SEBI) [www.sebi.gov.in ] regulates capital market. Capital market consists
of primary market and secondary market. All Initial Public Offerings comes under the primary
market and all secondary market transactions deals in secondary market. 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. Secondary market comprises of equity markets and the debt
markets. In the secondary market transactions BSE and NSE plays a great role in exchange of capital
market instruments. (visit www.bseindia.com and www.nseindia.com ).

Q.2 Explain latest monetary policy of RBI.

Answer :

In its annual monetary policy review for 2010-11, RBI increased its policy rates.

• Repo rate and Reverse repo rate increased by 25 bps to 5.25% and 3.75% respectively, with
immediate effect. Impact: Repo is the rate at which banks borrow from RBI and Reverse Repo is the rate
at which banks deploy their surplus funds with RBI. Both these rates are used by financial system for
overnight lending and borrowing purposes. An increase in these policy rates imply borrowing and
lending costs for banks would increase and this should lead to overall increase in interest rates like credit,
deposit etc. The higher interest rates will in turn lead to lower demand and thereby lower inflation. The
move was in line with market expectations
• Cash reserve ratio (CRR) increased by 25 bps to 6.00%, to apply from fortnight beginning from
24 April 2010. Impact: When banks raise demand and time deposits, they are required to keep a certain
percent with RBI. This percent is called CRR. An increase in CRR implies banks would be required to
keep higher percentage of fresh deposits with RBI. This will lead to lower liquidity in the system. Higher
liquidity leads to asset price inflation and also leads to build up of inflationary expectations.Before the
policy, market participants were divided over CRR. Some felt CRR should not be raised as liquidity
would be needed to manage the government borrowing program, 3-G auctions and credit growth. Others
felt CRR should be increased to check excess liquidity into the system which was feeding into asset price
inflation and general inflationary expectations. Some in the second group even advocated a 50 bps hike
in CRR.

By increasing the rate by 25 bps, RBI has signalled that though it wants to tighten liquidity it also
wants to keep ample liquidity to meet the outflows. Governor’s statement added that in 2010-11,
despite lower budgeted borrowings, fresh issuance will be around Rs 342300 cr compared to Rs
251000 cr last year.

RBI’s Domestic Outlook for 2010-11

 Table 1: RBI’s Indicative Projections (All Fig In %, YoY)
2009-10 targets 2009-10 2010-11 targets
(Jan 10 Policy) Actual (Apr 10 Policy)
Numbers
GDP 7.5 Expected at 8 with an upward
7.2 by CSO bias
Inflation (based on WPI, for 8.5 9.9 5.5
March end)
Money Supply (March end) 16.5 17.3 17
Credit (March end) 16 17 20
Deposit (March end) 17 17.1 18
Source: RBI

• Growth: RBI revised its growth forecast upwards for 2010-11 at 8% with an upward bias
compared to 2009-10 figure of 7.5%. It said “Indian economy is firmly on the recovery path.” RBI’s
business outlook survey shows corporates are optimistic over the business environment. Growth in
industrial sector and services has picked up in second half of 2009-10 and is expected to continue. The
exports and import sector has also registered a strong growth. It is important to note that RBI has placed
the growth under the assumption of a normal monsoon. India could have achieved a near 8% growth in
2009-10 itself, if monsoons were better. Table 2 looks at growth forecasts of Indian economy for 2010-11
by various agencies.

Table 2:Projections of GDP Growth by various agencies for 2010-11 (in %,

YoY)
2009-10 2010-11
RBI 7.5 with an upward bias 8 with an upward bias
PM’s Economic Advisory 7.2 8.2
Council
Ministry of Finance 7.2 8.5 (+/- 0.25)
IMF 6.7 8
Asian Development Bank 7.2 8.2
OECD 6.1 7.3
RBI’s Survey of Professional 7.2 8.5
Forecasters

• Inflation: RBI’s inflation projection for March – 11 is at 5.5% compared to FY March-10

estimate of 8.5% with an upward bias (the final figure was at 9.9%). RBI said inflation is no longer
driven by supply side factors alone. First WPI non-food manufactured products (weight: 52.2 per cent)
inflation, increased sharply from (-) 0.4%in November 2009, to 4.7% in March 2010. Fuel price inflation
also surged from (-) 0.7 per cent in November 2009 to 12.7% in March 2010. Further, contribution of
non-food items to overall WPI inflation, which was negative at (-) 0.4% in November 2009 rose sharply
to 53.3% by March 2010. So, overall demand pressures on inflation are also beginning to show signs.
These movements were visible in March 2010 itself, pushing RBI to increase rates before the official
policy in April 2010.
• Monetary Aggregates: RBI has increased the projections of all three monetary aggregates for
2010-11. These projections have been made consistent with higher expected growth in 2010-11. Higher
growth will lead to more demand for credit. Then management of government borrowing program will
remain a challenge as well. High growth coupled with the borrowing program will need higher financial
resources. Therefore, projections for money supply, credit and deposit are raised to 17%, 20% and 18%
respectively.However, higher growth in money supply would also lead to build up of higher inflation and
inflationary expectations. In an interesting article, Renu Kohli said growth in M1 is greater than M3.

There are various measures to calculate money supply. Each measure can be classified by
placing it along a spectrum between narrow and broad monetary aggregates. Narrow money
includes most acceptable and liquid forms of payment like currency and bank demand
deposits. Broad money includes narrow money and other kinds of bank deposits like time
deposits, post office savings account etc.

These different types of money are typically classified as Ms. The number of Ms usually range
from M0 (narrowest) to M3 (broadest) but which Ms are actually used depends on the system.
There are four Ms in India:

o M1: Currency with the public + Demand Deposits + Other deposits with the RBI.
o M2: M1 + Savings deposits with Post office savings banks.
o M3: M1+ Time deposits with the banking system
o M4: M3 + All deposits with post office savings banks (excluding National Savings
Certificates).

Growth in M3 is higher than M1 between April- November 2009. From Dec-2009 onwards,
the growth rate in M1 is higher than M3. The difference in M1 and M3 comes from the growth
rate in time and demand deposits. Growth in Time deposits is higher than demand deposits
between April-November 2009. From December 2009, onwards growth in demand deposits
picks up. This in turn reflects in differences in growth rate of M1 and M3. The growth rate in
currency is volatile. It declines 15% in August 2009 and then again increases to 17.9% in
December 2009. It then declines to 15.6% in March 2010. Hence, the difference between M1
and M3 comes from surge in growth of demand deposits and decline in growth of time
deposits.

So, this just confirmed what Kohli said. She added this could be interpreted in two ways. First,
spending on consumption and production is increasing as economy has recovered from
recession. Second, it could be people are spending now as they expect higher inflation in
future. Higher inflation in future could also lead to higher returns on assets and property in
future, therefore people are preferring to spend now.

It will be interesting to watch trends in M1 and M3 from now on as well.

RBI also outlined downside risks with its projections:

• First, there is still substantial uncertainty about the pace and shape of global recovery
• Second, if the global recovery does gain momentum, commodity and energy prices, which
have been on the rise during the last one year, may harden further. This could put upwards
pressure on inflation
• Third, monsoon will continue to play a vital role both from domestic demand and inflation
perspective.
 • Fourth, policies in advanced economies are likely to remain highly expansionary. High
liquidity in global markets coupled with higher growth in emerging economies foreign capital
flows are expected to remain higher. This will put pressure on exchange rate policy. RBI
usually does not comment on its exchange rate policy. As the economic situation is
exceptional, RBI also commented on India’s exchange rate policy.

Our exchange rate policy is not guided by a fixed or pre-announced target or band. Our policy has
been to retain the flexibility to intervene in the market to manage excessive volatility and disruptions
to the macroeconomic situation. Recent experience has underscored the issue of large and often
volatile capital flows influencing exchange rate movements against the grain of economic
fundamentals and current account balances. There is, therefore, a need to be vigilant against the
build-up of sharp and volatile exchange rate movements and its potentially harmful impact on the real
economy.

Policy Stance

The policy stance remains unchanged from January 2010 policy.

Table 3: Comparing RBI’s Policy Stance

October 2009 Policy January 2010 Policy April 2010 Policy
• Watch inflation trend • Anchor inflation • Anchor inflation
and be prepared to expectations, while being expectations, while
respond swiftly and prepared to respond being prepared to
effectively appropriately, swiftly and respond
• Monitor liquidity to effectively to further appropriately, swiftly
meet credit demands build-up of inflationary and effectively to
of productive sectors pressures. further build-up of
while securing price • Actively manage inflationary
and financial stability liquidity to ensure that pressures.
• Maintain monetary the growth in demand for • Actively manage
and interest rate credit by both the private liquidity to ensure
regime consistent and public sectors is that the growth in
with price and satisfied in a non- demand for credit by
financial stability, and disruptive way. both the private and
supportive of the • Maintain an interest rate public sectors is
growth process regime consistent with satisfied in a non-
price, output and disruptive way.
financial stability. • Maintain an interest
rate regime
consistent with price,
output and financial
stability.

Source: RBI

Summary: Given the economic outlook, policy ahead is going to remain challenging. There are
many trade-offs RBI has to manage. It needs to manage high inflation without impacting the growth
process. The recent inflation numbers show rising demand side pressures on inflation. The market
participants are already looking at an increase of around 100-150 bps by March 2011 end. The higher
interest rates would make it difficult to manage the government borrowing program and also invite
 more capital flows. High interest rates could also lead to higher lending costs for the corporate sector.
The challenges are not limited to domestic factors alone. The concerns remain on future outlook of
advanced economies which complicates the policy process further.

Other Development and Regulatory Policies

In its Annual (in April) and Mid-term review (in October) of monetary policy, RBI also covers
developments and proposed policy changes in financial system.

Some of the developments announced in this policy are:

New Products/Changes in guidelines

• Currently, Interest rate futures contract is for 10 year security. RBI has proposed to introduce
Interest rate futures for 2 year and 5 year maturities as well.
• RBI has permitted recognised stock exchanges to introduce plain vanilla currency options on
spot US Dollar/Rupee exchange rate for residents
• Final guidelines for regulation of non- convertible debentures of maturity less than one year by
end-June 2010
• RBI had proposed to introduce plain vanilla Credit Default Swaps in October 2009 policy. RBI
would place a draft report on the same by end- July 2010
• Earlier, banks could hold infrastructure bonds in either held for trading or available for sale
category. This was subject to mark to market requirements. However, most banks hold these
bonds for a long period and are not traded. From now on, banks can classify such investments
having a minimum maturity of seven years under held to maturity category. This should lead
banks to buy higher amount of infrastructure bonds and push infrastructure activity.
• The activity in Commercial Papers and Certificates of deposit market is high but there is little
transparency. FIMMDA has been asked to develop a reporting platform for Commercial
Papers and Certificates of deposit.

Setting up New Banks

• Finance Minister, in his budget speech on February 26, 2010 announced that RBI was considering
giving some additional banking licenses to private sector players. NBFCs could also be considered, if
they meet the Reserve Bank’s eligibility criteria. In line with the above announcement, RBI has decided
to prepare a discussion paper on the issues by end-July 2010 for wider comments and feedback.
• In 2004 seeing the financial health of urban cooperative banks, it was decided not to set up any
new UCBs. Since then the performance of these banks has improved. It has been decided to set up a
committee to study whether licences for opening new UCBS can be done.
• In February 2005, the Reserve Bank had released the ‘roadmap for presence of foreign banks in
India’. The roadmap laid out a two-phase, gradualist approach to increase presence of foreign banks in
India. The first phase was between the period March 2005 – March 2009, and the second phase after a
review of the experience gained in the first phase. In the first phase, foreign banks wishing to establish
presence in India for the first time could either choose to operate through branch presence or set up a
100% wholly-owned subsidiary (WOS), following the one-mode presence criterion. Foreign banks
already operating in India were also allowed to convert their existing branches to WOS while following
the one-mode presence criterion.However, because of the global crisis the second phase which was due
in April 2009, could not be started. The global financial crisis has also thrown some lessons for
policymakers. Drawing these lessons RBI would put up a discussion paper on the mode of presence of
foreign banks through branch or WOS by September 2010.
Q.3 Explain the recent SEBI guidelines for merchant bankers.

Answer :

SEBI Guidelines for Merchant Bankers

It should be clearly noted that merchant banking has been statutorily brought within the framework of
the Securities and Exchange Board of India under SEBI (Merchant Bankers) Regulations, 1992.

1) In terms of guidelines issued during April 1990, all merchant bankers will require authorization by
SEBI to carry out business.

The Criteria for Authorization Includes:

(a) Professional qualification in finance, law or business management;

(b) Infrastructure like adequate office space, equipment and manpower;

(c) Employment of two persons who have the experience to conduct business of merchant bankers;

(d) Capital adequacy;

(e) Past track record, experience, general expectation and fairness in all transactions.

2) SEBI issued further guidelines classifying the merchant bankers in four categories based on the
nature and range of activities and their responsibilities to SEBI investors and issue of securities. SEBI
has issued revised guidelines on December 22, 1992 classifying the activities of merchant bankers as
follows:

· The first category consists of merchant bankers who carry on any activity of issue management
which will inter alia consists of preparation of prospects and other information relating to the issue,
determining financial structuring tie-up of financiers and final allotment and refined of subscription
and to act in the capacity of managers, advisor or consultant to an issue, portfolio manager and
underwriter.

· The second category consists of those authorized to act in the capacity of co-manager/ advisor,
consultant underwriter to an issue or portfolio manager.

· The third category consists of those authorized to act as underwriter, advisor or consultant to an
issue.

· The fourth category consists of merchant bankers who act as advisor or consultant to an issue.

· Minimum net worth for first category is Rs.1crore, second category Rs.50 lakhs, third category
Rs.20 lakhs.

(3) As initial authorization fee, an annual fee and renewal fee may be collected by SEBI.

(4) All issues must be managed at least at one authorized banker, functioning as the sole manager or
the Lead Managers. But for issue over Rs. 100 cr. and above, the number of Lead Managers may go
up to a maximum of four; the specific responsibilities of each Lead Manager must be submitted to
SEBI prior to the issue.

(5) The lead merchant banker holding a certificate under category I shall accept a minimum
underwriting obligation of 5% of the total underwriting commitment or Rs.25 lakhs whichever is less.

(6) Each merchant banker is required to furnish to the SEBI half yearly unaudited financial results
when required by it with a view to monitor the capital adequacy of the merchant banker.

(7) SEBI has prescribed a code of conduct to the merchant bankers. The bankers must perform his
duties with highest standards of integrity and fairness in all his dealings. He will render at all times
high standards of service, exercise due diligence, ensure proper care and exercise independent
professional judgment. The merchant banker and his personnel will act in an ethic manner in all
dealings with the investors, clients and fellow bankers. All merchant bankers must adhere to the code
of conduct.

(8) The above guidelines will be administered by SEBI and it will supervise the activities of merchant
bankers.

(9) SEBI has been vested with power to suspend or cancel the authorization in case of violation of the
guidelines.

(10) To ensure transparency and accountability in the operation of merchant banker and to protect the
investors, a number of obligations and responsibilities have been imposed on them. It has been
decided to ask merchant bankers to enter into agreement with corporate body setting out their mutual
right, liabilities and obligations relating to an issue particularly on disclosure, allotment and refund,
maintenance of books of accounts and submission of half yearly reports to SEBI.

(11) Inspections shall be conducted by SEBI to ensure that provisions of the regulations are properly
complied with and to investigate complaints from customers. It is obligatory on the part of merchant
bankers to furnish all the details bought by the investigating team.

The regulations, however, indicate that the Board would give reasonable notice to merchant bankers
before undertaking inspection. On the basis of inspection report, the Board will communicate the
contents of the report to concerned merchant banker to give him/her an opportunity to put forth his or
her submissions. On receipt of the explanations, if any of the merchant bankers the SEBI would
advise merchant bankers to take any measures that it may deem fit and to comply with the provisions
of the regulations.

The notification procedure relating to the action to be initiated against merchant banks in case of
difficulty has been detailed out. The regulations empower SEBI to take action against defaulting
bankers such as suspension/ cancellation of registration. In case of deliberate manipulation or price
rigging or cornering activities or deterioration in the financial position, the Board is empowered to
cancel the registration of the merchant banker. Under the regulation, the SEBI is empowered to
suspend a registration of a member banker in case the merchant banker furnishes wrong or false
information, fails to resolve the complaints of the investors etc. The penalty of suspension or
cancellation of registration can be imposed by SEBI only after holding an enquiry and giving
sufficient opportunity to the merchant banker being heard. Any merchant banker aggrieved by an
order of SEBI can however, appeal to the Union Government.
In September, 1997, SEBI brought about some major changes in SEBI (Merchant Bankers) Rules and
Regulations, 1992. Accordingly, only corporate bodies will be allowed to function as merchant
bankers. Moreover, the multiple categories of merchant bankers shall be abolished and there will be
just one entity viz. Merchant Banker.

The merchant bankers presently functioning as Merchant Bankers Category II, III and IV shall have
an option to either upgrade themselves as Merchant Bankers (Presently Merchant Banker Category I)
or seek separate registration as underwriters or Portfolio Managers. Under respective regulations, the
merchant bankers will be prohibited from carrying out fund- based activity other than those related
exclusively to capital markets. In effect, the activities undertaken by NBFCS such as accepting
deposits, leasing and bill discounting would not be allowed to be undertaken by a merchant banker.

So far, we dealt with the general outline of merchant banking and SEBI guidelines for the functioning
of merchant bankers in India. Now let us turn our attention to the study of Public Issue Management.
 MF0009 – Insurance & Risk Management
Assignment Set – 1

Q1 Risk can be classified into several distinct categories”. Explain.

Answer :

Some of the definitions of risks are as follows :

· Risk is the possibility of an unfortunate occurrence.

· Risk is a combination of hazards.

· Risk is unpredictability – the tendency that actual results may differ from predicted results.

· Risk is uncertainty of loss.

· Risk is the possibility of loss.

However, looking at the definitions there seems to emerge some kind of common thread running
through each of them. Firstly, there is the underlying idea of uncertainty, what we have referred to
as doubt about the future. Secondly, there is the implication that there are differing levels or
degrees of risk. The use of words such as possibility and unpredictability does seem to indicate
some measure of variability in the effect of this doubt. Thirdly, there is the idea of a result having
been brought about by a cause or causes. This does seem to tie in nicely with the working
definition we used earlier of uncertainty about the outcome in a given situation.

Risk can be classified into several distinct categories which re as follows :

Risks may be classified in many ways; however, there are certain distinctions that are particularly
important. These include the following:

(a) Financial and Non-financial Risks

In its broadest context, risk includes all situations in which there is an exposure to adversity. In
some cases, this adversity involves financial loss while in others it does not. There is some element
of risk in every aspect of human endeavour, and many of these risks have no (or only incidental)
financial consequences.
Financial risk involves the relationship between an individual (or an organisation) and an asset or
expectation of income that may be lost or damaged. Thus, financial risk involves three elements:
(i) the individual or organization that is exposed to loss, (ii) the asset or income whose destruction
or dispossession will cause financial loss, and (iii) a peril that can cause the loss.

The first element in financial risk is that someone will be affected by the occurrence of an event.
During the devastating floods, a considerably large area of farmland is damaged by flood waters,
causing a financial loss to the tune of several billions to the owners.

The second and third elements are the thing of value and the peril that can cause the loss of the
thing of value. The individual who owns nothing of value and who has no prospects for improving
that situation faces no financial risk. Further, if nothing could happen to the individual’s assets or
expected income, there is no risk.

b) Static and Dynamic Risk

A second important distinction is between static and dynamic risks. Dynamic risks are those
resulting from changes in the economy. Changes in the price level, consumer tastes, income and
output, and technology may cause financial loss to members of the economy. These dynamic risks
normally benefit society over the long run, since they are the result of adjustments to misallocation
of resources. Although these dynamic risks may affect a large number of individuals, they are
generally considered less predictable than static risks, since they do not occur with any precise
degree of regularity.

Static risks involve those losses that would occur even if there were no changes in the economy. If
we could hold consumer tastes, output and income, and the level of technology constant, some
individuals would still suffer financial loss. These losses arise from causes other than the changes
in the economy, such as the perils of nature and the dishonesty of other individuals. Unlike
dynamic risks, static risks are not a source of gain to society. Static losses involve either the
destruction of the asset or a change in its possession as a result of dishonesty or human failure.
Static losses tend to occur with a degree of regularity over time and, as a result, are generally
predictable. Because they are predictable, static risks are more suited to treatment by insurance
than are dynamic risks.

c) Acceptable and Unacceptable Risk

There are two elements of uncertainty in most types of events that are handled by risk managers –
the likelihood of the event occurring, and the size of the ensuing loss. Generally, the degree of risk
aversion displayed by individuals acting in either a private or managerial capacity tends to increase
with the potential size of loss. Some loss potentials are so small that an individual or organization
is prepared to accept the risk and assume any loss that does occur. Beyond a certain size, the risk
becomes unacceptable and ways will be sought to avoid, reduce or transfer that risk. Of course, the
maximum size of loss that can be tolerated depends on the status of the individual or organisation,
and so the division between acceptable and unacceptable risks is not entirely clear-cut for two
reasons.

First, it depends partly on time. The size of loss that could be absorbed by, say, one year’s profits
would normally be far larger than could be accommodated within one month’s operating budget.
Secondly, there will be a range of potential losses where the occurrence of the loss could strain the
individual’s or an organization’s finances but it could be overcome (perhaps by resort to
borrowing or raising additional capital). Then, whether the risk of incurring a loss of any size will
be regarded as acceptable or unacceptable will depend upon the cost of handling the risk relative to
the benefits thereof. For example, if loss reduction measures would greatly exceed the expected
reduction in losses; or if the premium required by insurers is deemed high relative to the risk that
would be transferred, then no attempt may be made to reduce the risk or insure it.

The division between acceptable and unacceptable risk will always be influenced even if it is not
fully determined by such financial considerations. Furthermore it will be influenced by the
allocation of the costs and benefits of those risks and methods of handling them between persons
who may be affected. In the case of industrial accidents, for instance, according to the rules laid
down by law, the employer will be liable to compensate employees for injuries sustained as the
result of accidents at work, though whether the size of award determined according to those rules
represents adequate compensation for the pain, suffering, loss of amenity and loss of an injured
employee’s present and future earnings is a matter of judgement. The cost of reducing the
probability and/or severity of such accidents will fall directly upon the employer, though some or
all of that cost may ultimately be passed on to the employees through a reduction in earnings due
to a cut in the risk premium element of wages. Because perceived costs and benefits may differ,
employees (or their trade union representatives) may have a different view as to what constituted
an unacceptable risk to that held by the employer.

d) Fundamental and Particular Risks

A fundamental risk is a risk that affects the entire economy or large numbers of persons or groups
within the economy. Examples include rapid inflation, cyclical unemployment and war because
large numbers of individuals are affected. The risk of a natural disaster is another important type of
fundamental risk. Hurricanes, tornadoes, earthquakes, floods, and forest and grass fires can result
in damage to billions of dollars worth property and cause numerous deaths.

In contrast to a fundamental risk, a particular risk is a risk that affects only individuals and not the
entire community, Examples include car thefts, bank robberies, and dwelling fires. Only
individuals experiencing such losses are affected, not the entire economy.

The distinction between a fundamental and a particular risk is important because Government
assistance may be necessary to insure a fundamental risk. Social insurance and Government
insurance programmes, as well as government guarantees and subsidies, may be necessary to
insure certain fundamental risks. For example, the risk of unemployment generally is not insurable
by private insurers but can be insured publicly by state unemployment compensation programmes.

e) Pure and Speculative Risks

Pure risk is defined as a situation in which there are only the possibilities of loss or no loss. The
only possible outcomes are adverse (loss) and neutral (no loss). Examples of pure risks include
premature death, job-related accidents, catastrophic medical expenses, and damage to property
from fire, lighting, flood, or earthquake.

Speculative risk is defined as a situation in which either profit or loss is possible. For example, if
you purchase 100 shares, you would profit if the price of the shares increases but would lose if the
price declines. Other examples of speculative risk include betting on a horse race, investing in real
estate, and going into business for self. In these situations, both profit and loss are possible.

It is important to distinguish between pure and speculative risks for three easons. First, private
insurers generally insure only pure risks. With certain exceptions, speculative risks are not
considered insurable, and other techniques for coping with risk must be used. (One exception is
that some insurers will insure institutional portfolio investments and municipal bonds against loss).
 Second, the law of large numbers can be applied more easily to pure risks than speculative risks.
The law of large numbers is important because it enables insurers to predict future loss experience.
In contrast, it is generally more difficult to apply the law of large numbers to speculative risks to
predict future loss experience. An exception is the speculative risk of gambling, where casino
operators can apply the law of large numbers in a most efficient manner.

Finally, society may benefit from a speculative risk even though a loss occurs, but it is harmed if a
pure risk is present and a loss occurs. For example, a firm may develop new technology for
producing inexpensive computers. As a result, some competitors may be forced into bankruptcy.
Despite the bankruptcy, society benefits because the computers are made available at a lower cost.
However, society normally does not benefit when a loss from a pure risk occurs, such as a flood or
earthquake that devastates an area.

Q2 Identify common misconceptions about risk management and explain why these
misconceptions are developed.

Answer :

Misconceptions about Risk Management

While risk management has become a popular topic of discussion, some of what is discussed
reflects a misunderstanding of risk management. Some of these misconceptions reflect a
misreading of the literature, while others reflect defects in the literature itself. The first
misconception is that the risk management concept is principally applicable to large organizations.
The second is that the risk management approach to dealing with pure risks seeks to minimize the
role of insurance.

a) Universal Applicability

If one were to judge on the basis of much of the literature dealing with the concept of risk
management, it would be easy to conclude that risk management has no useful application except
with respect to the problems facing a large industrial complex. This misconception can easily
result from the fact that many of the techniques with which writers have been preoccupied (e.g.,
self-insurance plans, captive insurers, etc.) do apply primarily to giant organizations. Most of the
articles on risk management have been written by practicing professional Risk Mangers. It is
natural that they would write about the techniques they use in their own companies, and virtually
all professional Risk Managers are employed by large organizations. But it cannot be
overemphasized that the risk management philosophy and approach applies to organizations of all
sizes (and to individuals as well for that matter), even though some of the more esoteric techniques
may have limited application in the case of an average organization.

As the Risk Manager’s position has increased within the corporate framework and risk
management has become a recognized term in business jargon, the interest in risk management has
increased in businesses of all sizes. While it is obvious that the small firm cannot afford a full-time
professional Risk Manager, the principles of risk management are as applicable to the small
organization as to the giant international firm. The principles of risk management are nothing more
than common sense applied to the management of pure risks facing an individual or organization.
 The principles are applicable to organizations of all sizes, as well as to individuals and families.
While the techniques may differ in scope and complexity, the same risk management tools are
used in either case.

b) Anti-Insurance Bias?

The second misconception about risk management that it is anti-insurance in its orientation and
that it seeks to minimize the role of insurance in dealing with risk also stems from risk
management literature. Much of the literature on risk management has also been preoccupied with
topics related to risk retention, self-insurance programmes, and captive insurance companies.
Indeed, if one were to ask practitioners in the insurance field to describe the essence of risk
management that is, its philosophy – many would respond that the major emphasis of risk
management is on the retention of risk and on the use of deductibles. While it is true that retention
is an important technique for dealing with risks, it is not what risk management is all about.

The essence of risk management is not in the retention of exposures. Rather it is in dealing with
risks by whatever mechanism is most appropriate. In many instances, commercial insurance will
be the only acceptable approach. While the risk management philosophy suggests that there are
some risks that should be retained, it also dictates that there are some risks that must be
transferred. The primary focus of the Risk Manager should be on the identification of the risks that
must be transferred to achieve the primary risk management objective. Only after this
determination has been made does the question of which risks should be retained arise. More often
than not, determining which risks should be transferred also determines which risks will be
retained; the residual class that does not need to be transferred.

Q3 What are the social values of insurance? What are the social costs? Explain.

Answer :

There are many social and economic values of insurance, which are as follows:

1. Reduced Reserve Requirements

Perhaps the greatest social value – indeed, the central economic function – of insurance is to obtain
the advantages that flow from the reduction of risk. One of the chief economic burdens of risk is
the necessity of accumulating funds to meet possible losses, and one of the greatest advantages of
the insurance mechanism is that it greatly reduces the total of such reserves necessary for a given
economy. Because the insurer can predict losses in advance, it needs to keep readily available only
enough funds to meet those losses and to cover expenses. If each insured has to set aside such
funds, there would be need for a far greater amount. For example, in many localities, a Rs. 100,000
building can be insured against fire and other physical perils for about Rs. 500 a year. If insurance
is not available, the insured would probably feel a need to set aside funds at a much higher rate
than Rs. 500 a year.

2. Capital Freed for Investment

Another aspect of the advantage just described is the fact that the cash reserves that insurers
accumulate are made available for investment. Insurers as a group, and life insurance firms in
particular, are among the largest and most important institutions collecting and distributing the
nation’s savings. From the viewpoint of the individual, the insurance mechanism enables renting
an insurer’s assets to cover uncertain losses rather than providing this capital internally, much like
renting a building instead of owning one. Capital that is thereby released frees funds for
investment purposes. Thus, the insurance mechanism encourages new investment. For example, if
an individual knows that his or her family will be protected by life insurance in the event of
premature death, the insured may be more willing to invest savings in a long-desired project such
as a business venture, without feeling that the family is being robbed of its basic income security.
In this way, a better allocation of economic resources is achieved.

3. Reduced Cost of Capital

Because the supply of funds that can be invested is greater than it would be without insurance,
capital is available at a lower cost than would otherwise be possible. This result brings about a
higher standard of living because increased investment itself will raise production and cause lower
prices than would otherwise be the case. Also, because insurance is an efficient device to reduce
risks, investors may be willing to enter fields they would otherwise reject as too risky. Thus,
society benefits from increased services and new products, the hallmarks of increased living
standards.

4. Reduced Credit Risk

Another advantage of insurance lies in its importance to credit. Insurance has been called the basis
of the nation’s credit system. It follows logically that if insurance reduces the risk of loss from
certain sources, it should mean that an entrepreneur is a better credit risk if adequate insurance is
carried. Today it would be nearly impossible to borrow money for many business purposes without
insurance protection that meets the requirements of the lender.

5. Loss Control Activities

Another social and economic value of insurance lies in its loss control or loss prevention activities.
Although the main function of insurance is not to reduce loss but merely to spread losses among
members of the insured group, insurers are nevertheless vitally interested in keeping losses at a
minimum. Insurers know that if no effort is made in this regard, losses and premiums would have a
tendency to rise. It is human nature to relax vigilance when it is known that the loss will be fully
paid by the insurer. Furthermore, in any given year, a rise in loss payment reduces the profit to the
insurer, and so loss prevention provides a direct avenue of increased profit.

6. Business and Social Stability

Finally, the existence and availability of insurance can lead to increased business and social
stability. Several illustrations may be helpful in envisioning this point. For example, if adequately
protected, a business need not face the grim prospect of liquidation following a loss. Similarly, a
family need not break up following the death or permanent disability of one or more income
producers. A business venture can be continued without interruption even though a key person or
the sole proprietor dies. A family need not lose its life’s savings following a bank failure. Old-age
dependency can be avoided. Loss of a firm’s assets by theft can be reimbursed. Whole cities
ruined by a hurricane can be rebuilt from the proceeds of insurance.

Social Costs of insurance :

No institution can operate without certain costs. The costs for an insurance institution include
operating the insurance business, losses that are caused intentionally, and losses that are
aggregated.

1. Operating the Insurance Business

The main social cost of insurance lies in the use of economic resources, mainly labour, to operate
the business. The average annual overhead of property insurers accounts for about 25 per cent of
their earned premiums but ranges widely, depending on the type of insurance. In life insurance, an
average of 20 per cent of the premium rupee is absorbed in expenses. In other words, the
advantages of insurance should be weighed against the cost of obtaining the service.

2. Losses that are Intentionally Caused

A second social cost of insurance is attributed to the fact that if it were not insurance, certain losses
would not occur – losses that are caused intentionally by people in order to collect on their
policies. Although there are no reliable estimates as to the extent of such losses, it is likely they are
only a small fraction of total payments. Insurers are well aware of this danger, however, and take
numerous steps to keep it to a minimum.

3. Losses that are Exaggerated

Related to the cost of intentional losses is the tendency of some insured to exaggerate the extent of
damage that results from purely unintentional losses. For example, Company ABC has an old
photocopy machine that does not work well. When a small fire in ABC building causes some
smoke damage throughout the building, ABC may be tempted to claim that its fire insurance
should pay for a new photocopy machine. The old machine has likely been affected by smoke, but
in reality, the machine did not work well before the fire and probably would have been replaced
soon anyway. The existence of insurance tempts ABC to exaggerate its loss in this situation.
Similarly, health expenses for families that have health insurance may be higher than the expenses
for uninsured families. Once an accident or sickness has occurred, an individual may decide to
undergo more expensive medical treatment, or the physician may prescribe it if it is known that an
insurer will bear most or all of the cost.