SIKKIM MANIPAL UNIVERSITY

DEPARTMENT OF DISTANCE EDUCATION

ASSIGNMENT
SEMESTER 4

NAME : SUNIL KUMAR GUPTA

ROLL NUMBER : 511029827

LEARNING CENTRE : RAEBARELI-UTTAR

PRADESH

ASSIGNMENT SET No. : 1 (One)

COURSE NAME : MBA - FINANCE

 Master of Business Administration - MBA Semester 4
MF0015 - International Financial Management
Assignment Set- 1

Q1. What is meant by BOP? How are capital account convertibility and
current account convertibility different? What is the current scenario in
India?

Ans:- The balance of payments (or BOP) of a country is a record of international

transactions between residents of one country and the rest of the world over a
specified period, usually a year. Thus, India’s balance of payments accounts record
transactions between Indian residents and the rest of the world. International
transactions include exchanges of goods, services or assets. The term “residents”
means businesses, individuals and government agencies and includes citizens
temporarily living abroad but excludes local subsidiaries of foreign corporations.

The balance of payments is a sources-and-uses-of-funds statement. Transactions

such as exports of goods and services that earn foreign exchange are recorded as
credit, plus, or cash inflows (sources). Transactions such as imports of goods and
services that expend foreign exchange are recorded as debit, minus, or cash
outflows (uses).

The Balance of Payments for a country is the sum of the Current Account, the
Capital Account and the change in Official Reserves.

The current account is that balance of payments account in which all short-term
flows of payments are listed. It is the sum of net sales from trade in goods and
services, net investment income (interest and dividend), and net unilateral transfers
(private transfer payments and government transfers) from abroad. Investment
income for a country is the payment made to its residents who are holders of
foreign financial assets (includes interest on bonds and loans, dividends and other
claims on profits) and payments made to its citizens who are temporary workers
abroad. Unilateral transfers are official government grants-in-aid to foreign
governments, charitable giving (e.g., famine relief) and migrant workers’ transfers
to families in their home countries. Net investment income and net transfers are
small relative to imports and exports. Therefore a current account surplus
indicates positive net exports or a trade surplus and a current account deficit
indicates negative net exports or a trade deficit.

The capital (or financial) account is that balance of payments account in which all
cross-border transactions involving financial assets are listed. All purchases or sales
of assets, including direct investment (FDI) securities (portfolio investment) and
bank claims and liabilities are listed in the capital account. When Indian citizens buy
foreign securities or when foreigners buy Indian securities, they are listed here as
outflows and inflows, respectively. When domestic residents purchase more
financial assets in foreign economies than what foreigners purchase of domestic
assets, there is a net capital outflow. If foreigners purchase more Indian financial
assets than domestic residents spend on foreign financial assets, then there will be
a net capital inflow. A capital account surplus indicates net capital inflows or
negative net foreign investment. A capital account deficit indicates net capital
outflows or positive net foreign investment.

Current scenario in India

The official reserves account (ORA) records the total reserves held by the
official monetary authorities (central banks) within the country. These reserves are
normally composed of the major currencies used in international trade and financial
transactions. The reserves consist of “hard” currencies (such as US dollar, British
Pound, Euro, Yen), official gold reserve and IMF Special Drawing Rights (SDR). The
reserves are held by central banks to cushion against instability in international
markets. The level of reserves changes because of the central bank’s intervention in
the foreign exchange markets. Countries that try to control the price of their
currency (set the exchange rate) have large net changes in their Official Reserve
Accounts. In general, a net decrease in the Official Reserve Account indicates that a
country is buying its currency in exchange for foreign exchange reserves, to try to
keep the value of the domestic currency high with respect to foreign currencies.
Countries with net increases in the Official Reserve Account are usually attempting
to keep the price of the domestic currency cheap relative to foreign currencies, by
selling their currencies and buying the foreign exchange reserves. When a central
bank sells its reserves (foreign currencies) for the domestic currency in the foreign
exchange market, it is a credit item in the balance of payment accounts as it makes
available foreign currencies. Similarly, when a central bank buys reserves (foreign
currency), it is a debit item in the balance of payment accounts.

The Balance of Payments identity states that: Current Account + Capital

Account = Change in Official Reserve Account. If a country runs a current
account deficit and it does not run down its official reserve to cover this deficit
(there is no change in official reserve), then the current account deficit must be
balanced by a capital account surplus. Typically, in countries with floating exchange
rate system, the change in official reserves in a given year is small relative to the
Current Account and the Capital Account. Therefore, it can be approximated by
zero. Thus, such a country can only consume more than it produces (or imports are
greater than exports; a current account deficit) only if it has a capital account
surplus (foreign residents are willing to invest in the country). Even in a fixed
exchange rate system, the size of the official reserve account is small compared to
the transactions in the current and capital account. Thus the residents of a country
cannot have a current account deficit (imports exceeding exports) unless the
foreigners are willing to invest in that country (capital account surplus).

Q2. What is arbitrage? Explain with the help of suitable example a tow-
way and a three-way arbitrage.

Ans:- Arbitrage is the activity of exploiting imbalances between two or more

markets. Foreign money exchangers operate their entire businesses on this
principle. They find tourists who need the convenience of a quick cash exchange.
Tourists exchange cash for less than the market rate and then the money
exchanger converts those foreign funds into the local currency at a higher rate. The
difference between the two rates is the spread or profit.
There are plenty of other instances where one can engage in the practice arbitrage.
In some cases, one market does not know about or have access to the other
market. Alternatively, arbitrageurs can take advantage of varying liquidities
between markets.

The term 'arbitrage' is usually reserved for money and other investments as
opposed to imbalances in the price of goods. The presence of arbitrageurs typically
causes the prices in different markets to converge: the prices in the more expensive
market will tend to decline and the opposite will ensue for the cheaper market. The
the efficiency of the market refers to the speed at which the disparate prices
converge.

Engaging in arbitrage can be lucrative, but it does not come without risk. Perhaps
the biggest risk is the potential for rapid fluctuations in market prices. For example,
the spread between two markets can fluctuate during the time required for the
transactions themselves. In cases where prices fluctuate rapidly, would-be
arbitrageurs can actually lose money.

There are basically two types of arbitrage. One is two-way arbitrage and the
other is three-way arbitrage. The more popular of the two is the two-way forex
arbitrage.

In the international market the currency is expressed in the form AAA/BBB. AAA
denotes the price of one unit of the currency which the trader wishes to trade and it
refers the base currency. While BBB is international three-letter code 0f the counter
currency. For instance, when the value of EUR/USD is 1.4015, it means 1 euro =
1.4015 dollar.

If the speculator is shrewd and has a deeper understanding of the forex market,
then he can make use of this opportunity to make big profits. Forex arbitrage
transactions are quite easy once you understand the method by which the business
is conducted.

For instance, the exchange rates of EUR/USD = 0.652, EUR/GBP = 1.312 and
USD/GBP = 2.012. You can buy around 326100 Euros with $500,000. Using the
Euros you buy approximately 248420 Pounds which is sold for approximately
$500,043 and thereby earning a small profit of $43.

To make a large profit on triangular arbitrage you should be ready to invest a large
amount and deal with trustworthy brokers.

Arbitrage is one of the strategies of forex trading. To make a substantial income out
of this strategy you need to make an enormous amount of investment. Though
theoretically it is considered to be risk free, in reality it is not the case. You should
enter into this transaction only if you have deeper understanding of forex market.
Hence, it would be wise not to devote much time in looking out for arbitrage
opportunities. However, forex arbitrage is a rare opportunity and if it comes your
way, then grab it without any hesitation.

Three Way (Triangular) Arbitrage

The three way arbitrate inefficiency now arises when we consider a case in which
the EUR/JPY exchange rate is NOT equivalent to the EUR/USD/USD/JPY case so there
must be something going on in the market that is causing a temporary
inconsistency. If this inconsistency becomes large enough one can enter trades on
the cross and the other pairs in opposite directions so that the discrepancy is
corrected. Let us consider the following example :

EUR/JPY=107.86
EUR/USD=1.2713
USD/JPY = 84.75

The exchange rate inferred from the above would be 1.2713*84.75 which would be
107.74 and the actual rate is 107.86. What we can do now is short the EUR/JPY and
go long EUR/USD and USD/JPY until the correlation is reestablished. Sounds easy,
right ? The fact is that there are many important problems that make the
exploitation of this three way arbitrage almost impossible.

Q3. You are given the following information:

Spot EUR/US: 0.7940/0.8007

Spot USD/GBP:1.8215/1.8240
Three months swap: 25/35
Calculate three month EUR/USD rate.

Ans:-

1st Method :
Forward Points = ((Spot * (1 + (OCR rate * n/360))) / (1 + (BCR rate * n/360))) -
Spot

OCR = Other Currency Rate

BCR = Base Currency Rate
Forward points = ((0.07940 * (1 + (0.018215 * 90/360))) / (1 + (0.08007 *
90/360))) – 0.07940
SWAP = -0.00120
Forward rate = 0.07940 - 0.00120 = 0.0782

Customer sells EUR 3 Mio against USD at 0.0782 at 3 month (0.07940 - 0.00120).

Customer wants to Buy EUR 3 Mio against USD 3 months forward.

Q.4 Explain various methods of Capital budgeting of MNCs.

Ans:- Methods of Capital Budgeting

Discounted Cash Flow Analysis (DCF)

DCF technique involves the use of the time-value of money principle to project
evaluation. The two most widely used criteria of the DCF technique are the Net
Present Value (NPV) and the Internal Rate of Return (IRR). Both the techniques
discount the projects’ cash flow at an appropriate discount rate. The results are
then used to evaluate the projects based on the acceptance/rejection criteria
developed by management.

NPV is the most popular method and is defined as the present value of future cash
flows discounted at an appropriate rate minus the initial net cash outlay for the
projects. The discount rate used here is known as the cost of capital. The decision
criteria is to accept projects with a positive NPV and reject projects which have a
negative NPV.

The NPV can be defined as follows:

NPV =

Where,

I0 = initial cash investment

CFt = expected after-tax cash flows in year t.

k = the weighted average cost of capital

n = the life span of the project.

The NPV of a project is the present value of all cash inflows, including those at the
end of the project’s life, minus the present value of all cash outflows.

The decision criteria is to accept a project if NPV ≥ o and to reject if

NPV < o.

IRR is calculated by solving for r in the following equation.

where r is the internal rate of return of the project.

The IRR method finds the discount rate which equates the present value of the cash
flows generated by the project with the initial investment or the rate which would
equate the present value of all cash flows to zero.

Adjusted Present Value Approach (APV)

A DCF technique that can be adapted to the unique aspect of evaluating foreign
projects is the Adjusted Present Value approach. The APV format allows different
components of the project’s cash flow to be discounted separately. This allows the
required flexibility, to be accommodated in the analysis of the foreign project. The
APV approach uses different discount rates for different segments of the total cash
flows depending upon the degree of certainty attached with each cash flow. In
addition, the APV format helps the analyst to test the basic viability of the foreign
project before accounting for all the complexities. If the project is acceptable in this
scenario, no further evaluation based on accounting for other cash flows is done. If
not, then an additional evaluation is done taking into account the other
complexities.

As mentioned earlier, foreign projects face a number of complexities not

encountered in domestic capital budgeting, for example, the issue of remittance,
foreign exchange regulation, lost exports, restriction on transfer of cash flows,
blocked funds, etc.

The APV model is a value additivity approach to capital budgeting, i.e., each cash
flow as a source of value is considered individually. Also, in the APV approach each
cash flow is discounted at a rate of discount consistent with the risk inherent in that
cash flow. In equation form the APV approach can be written as:

APV =

Where the term Io = Present value of investment outlay

= Present value of operating cash flows

= Present value of interest tax shields

= Present value of interest subsidies

The various symbols denote

Tt = Tax savings in year t due to the financial mix adopted

St = Before-tax value of interest subsidies (on the home currency) in year t due to
project specific financing

id = Before-tax cost of dollar debt (home currency)

The last two terms in the APV equation are discounted at the before-tax cost of
dollar debt to reflect the relative certain value of the cash flows due to tax savings
and interest savings.

Q.5 a. What are depository receipts?

Ans:- Depository Receipt (DR) is a negotiable certificate that usually represents a

company’s publicly traded equity or debt. When companies make a public offering
in a market other than their home market, they must launch a depository receipt
program. Depository receipts represent shares of company held in a depository in
the issuing company’s country. They are quoted in the host country currency and
treated in the same way as host country shares for clearance, settlement, transfer
and ownership purposes. These features make it easier for international investors to
evaluate the shares than if they were traded in the issuer’s home market.

There are two types of depository receipts – GDRs and ADRs. Both ADRs and GDRs
have to meet the listing requirements of the exchange on which they are traded.

Q.5 b. Boeing commercial Airplane Co. manufactures all its planes in

United States and prices them in dollars, even the 50% of its sales
destined for overseas markets. Assess Boeing’s currency risk. How can it
cope with this risk?

Ans:- Boeing faces foreign exchange risk for two reasons: (1) It sells half its planes
overseas and the demand for these planes depends on the foreign exchange value
of the dollar, and (2) Boeing faces stiff competition from

Airbus Industrie, a European consortium of companies that builds the Airbus. As the
dollar appreciates, Boeing is likely to lose both foreign and domestic sales to Airbus
unless it cuts its dollar prices. One way to hedge this operating risk is for Boeing to
finance a portion of its assets in foreign currencies in proportion to its sales in those
countries. However, this tactic ignores the fact that Boeing is competing with
Airbus. Absent a more detailed analysis, another suggestion is for Boeing to finance
at least half of its assets with ECU bonds as a hedge against depreciation of the
currencies of its European competitors. ECU bonds would also provide a hedge
against appreciation of the dollar against the yen and other Asian currencies since
European and Asian currencies tend to move up and down together against the
dollar (albeit imperfectly).

Q6. Distinguish between Eurobond and foreign bonds? What are the
unique characteristics of Eurobond markets?

Ans:- A Eurobond is underwritten by an international syndicate of banks and other

securities firms, and is sold exclusively in countries other than the country in whose
currency the issue is denominated. For example, a bond issued by a U.S.
corporation, denominated in U.S. dollars, but sold to investors in Europe and Japan
(not to investors in the United States), would be a Eurobond. Eurobonds are issued
by multinational corporations, large domestic corporations, sovereign governments,
governmental enterprises, and international institutions. They are offered
simultaneously in a number of different national capital markets, but not in the
capital market of the country, nor to residents of the country, in whose currency the
bond is denominated. Almost all Eurobonds are in bearer form with call provisions
and sinking funds.

A foreign bond is underwritten by a syndicate composed of members from a

single country, sold principally within that country, and denominated in the currency
of that country. The issuer, however, is from another country. A bond issued by a
Swedish corporation, denominated in dollars, and sold in the U.S. to U.S. investors
by U.S. investment bankers, would be a foreign bond. Foreign bonds have
nicknames: foreign bonds sold in the U.S. are "Yankee bonds"; those sold in Japan
are "Samurai bonds"; and foreign bonds sold in the United Kingdom are "Bulldogs."

Figure 4 specifically reclassifies foreign bonds from a U.S. investor`s perspective.

FIGURE 4
FOREIGN BONDS TO U.S. INVESTORS

Foreign currency bonds are issued by foreign governments and foreign

corporations, denominated in their own currency. As with domestic bonds, such
bonds are priced inversely to movements in the interest rate of the country in
whose currency the issue is denominated. For example, the values of German bonds
fall if German interest rates rise. In addition, values of bonds denominated in foreign
currencies will fall (or rise) if the dollar appreciates (or depreciates) relative to the
denominated currency. Indeed, investing in foreign currency bonds is really a play
on the dollar. If the dollar and foreign interest rates fall, investors in foreign
currency bonds could make a nice return. It should be pointed out, however, that if
both the dollar and foreign interest rates rise, the investors will be hit with a double
whammy.

Characteristics of Eurobond markets

1. Currency denomination: The generic, plain vanilla Eurobond pays an

annual fixed interest and has a long-term maturity. There are a number of
different currencies in which Eurobonds are sold. The major currency
denominations are the U.S. dollar, yen, and euro. (70 to 75 percent of
Eurobonds are denominated in the U.S. dollar.) The central bank of a country
can protect its currency from being used. Japan, for example, prohibited the
yen from being used for Eurobond issues of its corporations until 1984.
2. Non-registered: Eurobonds are usually issued in countries in which there is
little regulation. As a result, many Eurobonds are unregistered, issued as
bearer bonds. (Bearer form means that the bond is unregistered, there is no
record to identify the owners, and these bonds are usually kept on deposit at
depository institution). While this feature provides confidentiality, it has
created some problems in countries such as the U.S., where regulations
require that security owners be registered on the books of issuer.
3. Credit risk: Compared to domestic corporate bonds, Eurobonds have fewer
protective covenants, making them an attractive financing instrument to
corporations, but riskier to bond investors. Eurobonds differ in term of their
default risk and are rated in terms of quality ratings.
4. Maturities: The maturities on Eurobonds vary. Many have intermediate
terms (2 to 10 years), referred to as Euronotes, and long terms (10-30 years),
and called Eurobonds. There are also short-term Europaper and Euro
Medium-term notes.
5. Other features:

• Like many securities issued today, Eurobonds often are sold with many
innovative features. For example:

a) Dual-currency Eurobonds pay coupon interest in one currency and

principal in another.
b) Option currency Eurobond offers investors a choice of currency. For
instance, a sterling/Canadian dollar bond gives the holder the right to
receive interest and principal in either currency.

1. A number of Eurobonds have special conversion features. One

type of convertible Eurobond is a dual-currency bond that allows
the holder to convert the bond into stock or another bond that is
denominated in another currency.
2. A number of Eurobonds have special warrants attached to them.
Some of the warrants sold with Eurobonds include those giving
the holder the right to buy stock, additional bonds, currency, or
gold.
 Master of Business Administration - MBA Semester 4
MF0016 – Treasury Management
Assignment Set- 1

Q.1 Explain how organization structure of commercial bank treasury

facilitates in handling various treasury operations.

Ans:- The treasury organisation deals with analysing, planning, and implementing
treasury functions. It deals with issues of profit centre, cost centre etc. The
organisations managing interfaces with treasury functions include intragroup
communications, taxation, recharging, measurement and cultural aspects.

Structure of treasury organisation

Figure 1.2 depicts the structure of treasury organisation which is divided into five
groups.
Figure 1.2: Treasury Organisations

• Fiscal – This group includes budget policy planning division, industrial and
environmental division, common wealth state relationships, and social policy
division.
• Macroeconomic – This group deals with economic sector of the organisation.
It includes domestic and international economic divisions, macroeconomic
policy and modeling division.
• Revenue – This group is concerned with the taxes in an organisation. It
includes business tax division, indirect tax, international and treaties division,
personal and income division, tax analysis and tax design division.
• Markets – This group mainly deals with selling of products in the competitive
market. It includes competition and consumer policy, corporations and
financial services policy, foreign investments and trade policy division.
• Corporate services – This group deals with overall management of the
treasury organisation. It includes financial and facilities division, human
resource division, business solutions and information management division.

Treasury management in banks

In recent days, most of the Indian banks have classified their business into two
primary business segments like treasury operations (investments) and banking
operations (excluding treasury).

The treasury operations in banks are divided into:

• Rupee treasury – The rupee treasury carries out various rupee based treasury
functions like asset liability management, investments and trading. It helps in
managing the bank’s position in terms of statutory requirements like cash
reserve ratio, statutory liquidity ratio according to the norms of the Reserve
Bank of India (RBI). The various products in rupee treasury are:
 1. Money market instruments – Call, term, and notice money, commercial
papers, treasury bonds, repo, reverse repo and interbank participation
etc.
2. Bonds – Government securities, debentures etc
3. Equities

• Foreign exchange treasury – The banks provide trading of currencies across

the globe. It deals with buying and selling currencies.
• Derivatives – The banks make foundation for Over the Counter (OTC). It helps
in developing new products, trading in order to lay off risks and form
apparatus for much of the industry’s self-regulation.

The role of policies in strategic management was described in this section. The next
section deals with inter-dependency between policy and strategy.

Q.2 Bring out in a table format the features of certificate of deposits and
commercial papers.

Ans:-

Features of commercial Features of CDs in Indian

papers
CPs is an unsecured promissory
note.
CPs can be issued for a maturity
period
of 15 days to less than one year.
CPs is issued in the
denomination of
Rs.5 lakh. The minimum size of
the issu
e is Rs. 25 lakh.
The ceiling amount of CPs should
not exceed the working capital of
th
e issuing company.
The investors in CPs market are
banks,
individuals, business
organisations and
the corporate units registered in
India an
d incorporated units.
market
Schedule banks are eligible to
issue CDs
Maturity period varies from three
months
to one year
Banks are not permitted to buy
back
their CDs before the maturity
CDs are subjected to CRR and
Statutory
Liquidity Ratio (SLR)
requirements
They are freely transferable by
endorsement and delivery.
They have no lock-in period.
The interest rate of CPs depends
on
the prevailing interest rate on
CPs
market, forex market and call CDs have to bear stamp duty at
money the
market. The attractive rate of prevailing rate in the markets
interest
In any of these markets, affects
the deman
d of CPs.
The eligibility criteria for the The NRIs can subscribe to CDs
companies on
to issue CPs are as follows: repatriation basis
The tangible worth of the issuing
company should not be less than
Rs
. 4.5 Crores.
The company should have a
minimum credit rating of P2 and
A2 obtained from Credit Rating
Information Service of India
(CRISIL) and
Investment Information and
Credit Ratin
g Agency of India Limited. (ICRA)

respectively
The current ratio of the issuing
company should be 1.33:1.
The issuing company has to be
listed on stock exchange.

Q.3 Critically evaluate participatory notes. Detail the regulatory aspects

on it.

Ans:- The participants in forex market are the RBI at the apex, authorised dealers
(ADs) licensed by forex market, exporters, importers, companies and individuals.
The major participants of foreign exchange market are:

• Corporates – They mainly include business houses, international investors,

and multinational corporations. They operate in market by buying or selling
currencies within the framework of exchange control regulations. It deals with
banks and their clients to form retail segment of forex market.
• Commercial banks – They play an important role in forex market. They
operate in market by trading currencies for their clients. Large volume of
transactions consists of banks dealing directly among themselves and smaller
transactions usually consists of intermediary foreign exchange brokers.
• Central bank – It plays a vital role in the country’s economy by controlling
money supply. Central banks get involved in forex market to regain price
 stability of exchange rate, protect certain levels of price in exchange rate,
and support economic goals like inflation and growth.
• Exchange brokers – They ensure the most favourable quotations between the
banks at a low cost in terms of time and money. Banks provide opportunities
to brokers in order to increase or decrease the rate of buying or selling
foreign currencies. Exchange brokers have a tendency to specialise in
unusual currencies but also manage major currencies. In India, many banks
deal through recognised exchange brokers or may deal directly among
themselves.

The other participants include RBI and its authorised dealers, exporters, importers,
companies and individuals.

Q.4 What is capital account convertibility? What are the implications on

implementing CAC?

Ans:- Capital Account Convertibility (CAC) refers to relaxing controls on capital

account transactions. It means freedom of currency conversion in terms of inflow
and outflows with respect to capital account transaction. Most of the countries have
liberalised their capital account by having an open account, but they do retain some
regulations for influencing inward and outward capital flow. Due to global
integration, both in trade and finance, CAC enhances growth and welfare of country.

The perception of CAC has undergone some changes following the events of
emerging market economies (EMEs) in Asia and Latin America, which went through
currency and banking crises in 1990’s. A few counties backtracked and re-imposed
capital controls as part of crisis resolution. Crisis such as economic, social, human
cost and even extensive presence of capital controls creates distortions, making
CAC either ineffective or unsustainable. The cost and benefits from capital account
liberalisation is still being debated among academics and policy makers. These
developments have led to considerable caution being exercised by EMEs in opening
up capital account. The Committee on Capital Account Convertibility (Chairman:
Shri. S.S. Tarapore) which submitted its report in 1997 highlighted the benefits of a
more open capital account but at the same time cautioned that CAC could pose
tremendous pressures on the financial system. India has cautiously opened its
capital account and the state of capital control in India is considered as the most
liberalised it had been since late 1950’s. The different ways of implementing CAC
are as follows:

• Open the capital account for residents and non-residents.

• Initially open the inflow account and later liberalise the outflow account.
• Approach to simultaneously liberalise control of inflow and outflow account.

Q.5 Detail domestic and international cash management system

Ans;- The strategy of a company which has its businesses in many nations and
efficiently manages its cash and liquidity is called multinational cash management
programme. The main goal of multinational cash management is the utilisation of
local banking and cash management services.
Multinational companies are those that operate in two or more countries. Decision
making within the corporation is centralised in the home country or decentralised
across the countries where the organisation does its business.

The reasons for which the firms expand into other countries are as follows:

• Seeking new markets and raw materials

• Seeking new technology and product efficiency.
• Preventing the regulatory obstacles.
• Retaining customers and protecting its processes
• Expanding its business.

Several factors which distinguish multinational cash management from domestic

cash management are as follows:

• Different currency denominations

• Political risk and other risk.
• Economic and legal complications.
• Role of governments
• Language and cultural differences.
• Difference in tax rates, import duties.

The principle objective of multinational cash management programme is to

maximise a company’s financial resources by taking benefits from all liability
provisions, payable periods. The multinational cash management programme
effectively achieve its goals by using excess cash flow from some units across the
globe to extend cash needs in other units which is called in-house banking and by
relocating funds for tax and foreign exchange management through repricing and
invoicing.

During multinational cash management system payments by customers to

company’s branches are basically handled through a local bank. The payments
between the branches and the parent company are managed through the branches,
correspondents or associates of the parent company. Through the use of electronic
reporting systems a parent company observes cash balances in its foreign local
banks.

Multinational cash management programme specifically evaluate its techniques by

timing of billing, use of lockboxes or intercept points, negotiated value range.

The multinational cash management system involves exchange rate risk which
occurs when the cash flow of one currency during transformation to another
currency the cash value gets declined. It occurs due to the change in exchange
rates. The exchange rates are determined by a structure which is called the
international monetary system.

For example, Wincor Nixdorf played an innovative role in enhancing cash handling
between various countries. Wincor’s focus was on the entire process chain which
started from head office to stores, crediting to the retail company’s account, head
office to branches and so on. Wincor Nixdorf’s served several countries with its
innovative hardware and software elements, IT services to side operations and
consulting services to develop custom optimised solutions.

Q.6 Distinguish between CRR and SLR

Ans:- Cash Reserve Ratio

Cash Reserve Ratio (CRR) is a country’s central bank regulation that sets the
minimum reserves for banks to hold for their customer deposits and notes. These
reserves are considered to meet the withdrawal demands of the customers. The
reserves are in the form of authorised currency stored in a bank treasury (vault
cash) or with the central bank. CRR is also called liquidity ratio as it controls money
supply in the economy. CRR is occasionally used as a tool in monetary policies that
influence the country’s economy.

CRR in India is the amount of funds that a bank has to keep with the RBI which is
the central bank of the country. If RBI decides to increase CRR, then the banks’
available cash drops. RBI practices this method, that is, increases CRR rate to drain
out excessive money from banks. The CRR in the economy as declared by RBI in
September 2010 is 6 percent.

An organisation that holds reserves in excess amount is said to hold excess

reserves.

The following are the effects of CRR on economy:

• CRR influences an economy’s money supply by effecting the potential of

banks
• CRR influences inflation in an organization
• CRR stimulates higher economic activity by influencing the liquidity

Statutory Liquidity Ratio

Statutory Liquidity Ratio (SLR) is the percentage of total deposits that banks have to
invest in government bonds and other approved securities. It means the percentage
of demand and time maturities that banks need to have in forms of cash, gold and
securities like Government Securities (G-Secs). As gold and government securities
are highly liquid and safe assets they are included along with cash.

In India, RBI determines the percentage of SLR. There are some statutory
requirements for placing the money in the government bonds. After following the
requirements, the RBI arranges the level of SLR. The maximum limit of SLR is 40
percent and minimum limit of SLR is 25 percent.

The RBI increases the SLR to control inflation, extract liquidity in the market and
protects customers’ money. Increase in SLR also limits the bank’s leverage position
to drive more money into the economy.
If any Indian bank fails to maintain the required level of SLR, then it is penalized by
RBI. The nonpayer bank pays an interest as penalty which is above the actual bank
rate.

The main objectives for maintaining SLR are the following:

• By changing the SLR level, the RBI increases or decreases banks’ credit
expansion
• Ensures the comfort of commercial banks
• Forces the commercial banks to invest in government securities like
government bonds
 Master of Business Administration - MBA Semester 4
MF0017 – Merchant Banking and Financial Services
Assignment Set- 1

Q.1 What do you understand by insider trading. What are the SEBI rules
and regulations to prevent insider trading.

Ans:- "Insider trading" is a term subject to many definitions and connotations and it
encompasses both legal and prohibited activity. Insider trading takes place legally
every day, when corporate insiders – officers, directors or employees – buy or sell
stock in their own companies within the confines of company policy and the
regulations governing this trading. It is the trading that takes place when those
privileged with confidential information about important events use the special
advantage of that knowledge to reap profits or avoid losses on the stock market, to
the detriment of the source of the information and to the typical investors who buy
or sell their stock without the advantage of "inside" information. Almost eight years
ago, India's capital markets watchdog – the Securities and Exchange Board of India
organised an international seminar on capital market regulations. Among others
issues, it had invited senior officials of the Securities and Exchange Commission to
tell us how it tackled the menace of insider trading.

SEBI rules and regulations to prevent insider trading.

SEBI had amended the Insider Trading Regulations 1992 vide a Notification dated
November 19, 2008 which I had discussed it here and here. SEBI has now released a
set of "Clarifications" on 24th July 2009 on certain issues arising out of the
amendments made. I had opined on some of these issues in my earlier posts
referred to above and hence me update on what are the clarifications so given.

Curiously, the "clarifications" have no formal standing or reference. It is neither a

circular, nor a notification, nor even a press release. It is neither signed nor dated.
But it seeks to "clarify" and giving meaning to the Regulations that have legal
standing and where such "meaning" is quite contrary - as we will see - to the plain
reading of the text. Having said that, the "clarifications" mostly relaxes the
requirements and hence, being gift horses, one should not examine them in the
mouth too closely!

Let us see the clarifications given.

Recollect that specified persons were banned from carrying out opposite
transactions "(banned transactions") for six months of original buy/sale ("original
transactions"). The question was whether acquisition of shares under ESOPs scheme
and sale of such shares would be considered as transactions that trigger off such
ban and whether these themselves are banned.
It is clarified that exercise of ESOPs will neither be deemed to be "original
transaction" nor "banned transaction". Thus, by acquiring shares under ESOPs, you
don't trigger a ban and if you are banned for six months, you can still exercise
ESOPs. The reasoning given is that the ban is only on transactions in secondary
market.(Incidentally, I had felt that "However, taking all things into account,
perhaps the intention is not to cover shares acquired under ESOPs Schemes. ").

But sale of shares acquired through ESOPs is covered but it will only be deemed to
be a "original transaction" and not a "banned transaction". In other words, even if
you are under a ban, you can still sell shares acquired under ESOPs but once you
sell such shares, you have triggered a ban of six months. On this aspect, I do not
understand the basis of clarifying that the sale of shares acquired under ESOPs
scheme will not be an "original transaction" - the logic of covering secondary
market transactions should apply here also.

Then, it is clarified that every later transaction triggers a fresh six month ban. A
purchase on 1st February results in ban till 1st August. However, if there is a fresh
purchase on 15th March, there is a ban now till 15th September. Effectively, this
means that the ban period is from 2nd Febuary till 15th September.

What about transactions before this amendment - will the amendment create ban in
respect of them too - this is an academic issue now at least as the six month period
is now complete. It is clarified though that the transactions before the amendment
are not to be considered. On a similar note, unwinding of positions in derivatives
held on the date of this amendment is possible.

A crucial clarification is that the ban on "sale" of shares for personal emergencies is
permisible by waiver by the Compliance Officer. This is not evident from a plain
reading of the provision and I had opined that "This bar on such transactions is
total. There are no circumstances – whether of urgent need or otherwise – under
which the bar can be lifted. There is also no provision under which even SEBI could
grant exemption.". But SEBI thinks it is so evident and hence let us accept this gift
without creating legal niceties! Note that this clarification applies only to sales and
there can be no purchases within these six month ban period - obviously there
cannot be any personal emergency to purchase shares!

Q.2 What is the provision of green shoe option and how is it used by
companies to stabilize prices.

Ans:- Green Shoe Option (GSO) is an option where a company can retain a part
of the over-subscribed capital by issuing additional shares. Oversubscription is a
situation when a new stock issue has more buyers than shares to meet their orders.
This excess demand over supply increases the share price. There is another
situation called undersubscription. In undersubscription, a new stock issue has
fewer buyers than the shares available. An issuing company appoints a stabilizing
agent, which is usually an underwriter or a lead manager, to purchase shares from
the open market using the funds collected from the over-subscription of shares. The
stabilizing agent stabilizes the price for a period of 30 days from the date of listing
as authorised by the SEBI. Green shoe option agreement allows the underwriters to
sell 15 percent more shares to the investors than planned by the issuer in an
underwriting. Some issuers do not include green shoe options in their underwriting
contracts under certain circumstances where the issuer funds a particular project
with a fixed amount of price and does not require more funds than quoted earlier.
The green shoe option is also known as over-allotment option. The over-allotment
refers to allocation of shares in excess of the size of the public issue made by the
stabilizing agent out of shares borrowed from the promoters in pursuance of a GSO
exercised by the issuing company.

The greenshoe option is popular because it is the only SEC-permitted means for an
underwriter to stabilize the price of a new issue post-pricing. Issuers will sometimes
not permit a greenshoe on a transaction when they have a specific objective for the
offering and do not want the possibility of raising more money than planned. The
term comes from the first company, Green Shoe Manufacturing now called Stride
Rite Corporation, to permit underwriters to use this practice in its offering.

The mechanism by which the greenshoe option works to provide stability and
liquidity to a public offering is described in the following example:

A company intends to sell 1 million shares of its stock in a public offering through an
investment banking firm (or group of firms which are known as the syndicate) whom
the company has chosen to be the offering's underwriter(s). When the stock offering
is the first time the stock is available for public trading, it is called an IPO (initial
public offering). When there is already an established market and the company is
simply selling more of their non-publicly traded stock, it is called a follow-on
offering.

The underwriters function as the broker of these shares and find buyers among
their clients. A price for the shares is determined by agreement between the
company and the buyers. One responsibility of the lead underwriter in a successful
offering is to help ensure that once the shares begin to publicly trade, they do not
trade below the offering price.

When a public offering trades below its offering price, the offering is said to have
"broke issue" or "broke syndicate bid". This creates the perception of an unstable or
undesirable offering, which can lead to further selling and hesitant buying of the
shares. To manage this possible situation, the underwriter initially oversells
("shorts") to their clients the offering by an additional 15% of the offering size. In
this example the underwriter would sell 1.15 million shares of stock to its clients.
When the offering is priced and those 1.15 million shares are "effective" (become
eligible for public trading), the underwriter is able to support and stabilize the
offering price bid (which is also known as the "syndicate bid") by buying back the
extra 15% of shares (150,000 shares in this example) in the market at or below the
offer price. They can do this without the market risk of being "long" this extra 15%
of shares in their own account, as they are simply "covering" (closing out) their 15%
oversell short.

If the offering is successful and in strong demand such that the price of the stock
immediately goes up and stays above the offering price, then the underwriter has
oversold the offering by 15% and is now technically short those shares. If they were
to go into the open market to buy back that 15% of shares, the underwriter would
be buying back those shares at a higher price than it sold them at, and would incur
a loss on the transaction.

This is where the over-allotment (greenshoe) option comes into play: the company
grants the underwriters the option to take from the company up to 15% more
shares than the original offering size at the offering price. If the underwriters were
able to buy back all of its oversold shares at the offering price in support of the
deal, they would not need to exercise any of the greenshoe. But if they were only
able to buy back some of the shares before the stock went higher, then they would
exercise a partial greenshoe for the rest of the shares. If they were not able to buy
back any of the oversold 15% of shares at the offering price ("syndicate bid")
because the stock immediately went and stayed up, then they would be able to
completely cover their 15% short position by exercising the full greenshoe.

Q.3 Discuss the proportionate allotment procedure followed by the lead

banker to allot shares.

Ans:- The post-issue Lead Merchant Banker shall ensure that moneys received
pursuant to the issue and kept in a separate bank (i.e. Bankers to an Issue), as per
the provisions of section 73(3) of the Companies Act 1956, is released by the said
bank only after the listing permission under the said Section has been obtained
from all the stock exchanges where the securities were proposed to be listed as per
the offer document.

Post-issue Advertisements -(Clause 7.5)

Post-issue Lead Merchant Banker shall ensure that in all issues, advertisement
giving details relating to over-subscription, basis of allotment, number, value and
percentage of applications received along with stockinvest, number, value and
percentage of successful allottees who have applied through stockinvest, date of
completion of despatch of refund orders, date of despatch of certificates and date of
filing of listing application is released within 10 days from the date of completion of
the various activities at least in an English National Daily with wide circulation, one
Hindi National Paper and a Regional language daily circulated at the place where
registered office of the issuer company is situated.

Post-issue Lead Merchant Banker shall ensure that issuer company / advisors /
brokers or any other agencies connected with the issue do not publish any
advertisement stating that issue has been over-subscribed or indicating investors'
response to the issue, during the period when the public issue is still open for
subscription by the public.

Advertisement stating that "the subscription to the issue has been closed" may be
issued after the actual closure of the issue.

Basis of Allotment -(Clause 7.6)

In a public issue of securities, the Executive Director/Managing Director of the
Designated Stock Exchange along with the post issue Lead Merchant Banker and
the Registrars to the Issue shall be responsible to ensure that the basis of allotment
is finalised in a fair and proper manner in accordance with the following guidelines:.
Provided, in the book building portion of a book built public issue notwithstanding
the above clause, Clause 11.3.5 of Chapter XI of these Guidelines shall be
applicable.

Proportionate Allotment Procedure

The allotment shall be subject to allotment in marketable lots, on a proportionate

basis as explained below:

a. Applicants shall be categorised according to the number of shares applied

for.
b. The total number of shares to be allotted to each category as a whole shall
be arrived at on a proportionate basis i.e. the total number of shares applied
for in that category (number of applicants in the category x number of shares
applied for) multiplied by the inverse of the over-subscription ratio as
illustrated below:

Total number of applicants in category of 100s - 1,500

Total number of shares applied for - 1,50,000

Number of times over-subscribed - 3

Proportionate allotment to category - 1,50,000 x 1/3 = 50,000

c. Number of the shares to be allotted to the successful allottees shall be

arrived at on a proportionate basis i.e. total number of shares applied for by
each applicant in that category multiplied by the inverse of the over-
subscription ratio. Schedule XVIII of basis of allotment procedure may be
referred to.

Number of shares applied for by – 100 each applicant

Number of times oversubscribed – 3

Proportionate allotment to each successful applicant - 100 x 1/3 = 33

(to be rounded off to 100)

d. All the applications where the proportionate allotment works out to less than
100 shares per applicant, the allotment shall be made as follows:
i. Each successful applicant shall be allotted a minimum of 100
securities; and
ii. The successful applicants out of the total applicants for that category
shall be determined by drawal of lots in such a manner that the total
number of shares allotted in that category is equal to the number of
shares worked out as per (ii) above.
 e. If the proportionate allotment to an applicant works out to a number that is
more than 100 but is not a multiple of 100 (which is the marketable lot), the
number in excess of the multiple of 100 shall be rounded off to the higher
multiple of 100 if that number is 50 or higher.
f. If that number is lower than 50, it shall be rounded off to the lower multiple of
100. As an illustration, if the proportionate allotment works out to 250, the
applicant would be allotted 300 shares.
g. If however the proportionate allotment works out to 240, the applicant shall
be allotted 200 shares. All applicants in such categories shall be allotted
shares arrived at after such rounding off.
h. If the shares allocated on a proportionate basis to any category is more than
the shares allotted to the applicants in that category, the balance available
shares for allotment shall be first adjusted against any other category, where
the allocated shares are not sufficient for proportionate allotment to the
successful applicants in that category.
i. The balance shares if any, remaining after such adjustment shall be added to
the category comprising applicants applying for minimum number of shares.
j. As the process of rounding off to the nearer multiple of 100 may result in the
actual allocation being higher than the shares offered, it may be necessary to
allow a 10% margin i.e. the final allotment may be higher by 10 % of the net
offer to public.

Q.4 What are the advantages of leasing to a company.

Ans:- Leasing has many advantages for the lessee as well as for the lessor. Lease
financing offers the following benefits to the lessee:

• One hundred percent finance without immediate down payment for huge
investments, except for his margin money investment.
• Facilitates the availability and use of equipments without the necessary
blocking of capital funds.
• Acts as a less costly financing alternative as compared to other source of
finance.
• Offers restriction free financing without any unduly restrictive covenants.
• Enhances the working capital position.
• Provides finance without diluting the ownership or control of the lessor.
• Offers tax benefits which depend on the structure of the lease.
• Enables lessee to pay rentals from the funds generated from operations as
lease structure can be made flexible to suit the cash flow.
• When compared to term loan and institutional financing, lease finance can be
arranged fast and documentation is simple and without much formalities.
• The lessor being the owner of the asset bears the risk of obsolescence and
the lessee is free on this score. This gives the option to the lessee to replace
the equipment with latest technology
The following are the benefits offered by lease financing to the lessor:

• The lessor’s ownership is fully secured as he is the owner and can always
take possession in case of default by the lessee.
• Tax benefits are provided on the depreciation value and there is a scope for
him to avail more depreciation benefits by tax planning.
• High profit is expected as the rate of return increases
• Return on equity is elevated by leveraging results in low equity base which
enhance the earnings per share.
• High growth potential is maintained even during periods of depression.

Q.5 Discuss Accounting standard 19 for lease based on operating lease.

Ans:- Accounting Standard (AS)-19, Leases, is issued by the Council of the Institute
of Chartered Accountants of India. This standard comes into force with respect of all
assets leased during accounting periods commencing on or after 1.4.2001 and is
mandatory in nature from that date. Accordingly, the ‘Guidance Note on Accounting
for Leases’ issued by the Institute in 1995, is not applicable in respect of such
assets. Earlier application of this Standard is, however, encouraged.

Scope

The right accounting policies and disclosures in relation to finance leases and
operating leases should be applied in accounting for all leases other than the
following:

• Lease agreements to explore or to use natural resources, such as oil, gas ,

timber, metals and other mineral rights; and
• Licensing agreements for items such as motion picture films, video
recordings, plays, manuscripts, patents and copyrights; and
• Lease agreements to use property such as lands.

Related definitions

The following terms are used in this statement:

• Lease – A lease is an agreement calling for the lessee (user) to pay the
lessor (owner) for use of an asset for an agreed period of time. A rental
agreement is a lease in which the asset is a substantial property.
• Finance lease – A lease which transfers all the risks and rewards incident to
ownership of an asset.
• Operating lease – A lease for which the lessee acquires the property for
only a small portion of its useful life.
• Non-cancellable lease – A non-cancellable lease is a lease that can be
abandoned only:
 • Inception of lease – The inception of lease is the former date of the lease
agreement and the commitment date by the parties to the principal
provisions of the lease.
• Lease term – The lease term is the non cancellable period for which the
lessee has agreed to take on lease asset together with future periods.
• Minimum lease payments – It is the regular rental payments excluding
executory costs to be paid by the lessee to the lessor in a capital lease. The
lessee informs that an asset and liability at the discounted value of the future
minimum lease payments.
• Fair value – The expected value of all assets and liabilities of a owned
company used to combine the financial statements of both companies.
• Economic life – The outstanding period of time for which real estate
improvements are expected to generate more income than operating
expenses cost.
• Useful life – Useful life of a leased asset is either the period over which
leased asset is expected to be useful by the lessee or the number of
production units expected to be gained from the use of the asset by the
lessee.
• Residual value – The value of a leased asset is the estimated fair value of
the asset at the end of the lease term.
• Guaranteed residual value – It is guaranteed by the lessee or by a party
on behalf of the lessee to pay the maximum amount of the guarantee; and in
the case of the lessor, the part of the residual value which is guaranteed by
the lessee or on behalf of the lessee, or an independent third party who is
financially able of discharging the obligations under the guarantee.
• Unguaranteed residual valued of a lease asset – It is the value of a
leased asset that is the total amount by which the residual value of the asset
exceeds its guaranteed residual value.
• Gross investment in the lease – It is the sum of the minimum lease
payments within a finance lease from the lessors’ view and any
unguaranteed residual value accumulating to the lessor.
• Unearned finance income – Any income that comes from investments and
other sources unrelated to employment services.
• Net investment in the lease – Net investment in the lease is the gross
investment in the lease less unearned finance income.
• Implicit interest – An interest rate that is not explicitly stated, but the
implicit rate can be determined by use of present value factors.
• Contingent rent – It is the portion of the lease payments that is not
permanent in amount but is based on a factor other than just the passage of
time. For example, percentage of sales.

Classification of leases

The lease can be classified as either a finance lease or an operating lease based on
different accounting treatments as required for the different types of lease. This
classification is based on the extent to which risks and rewards of ownership of
leased asset are transferred to the lessee or remain with the lessor. Risks include
loss from idle capacity, technological obsolescence, and variations in return.
Rewards include the rights to sell the asset and gain from its capital value.

Leases are classified as a finance lease if it transfers considerably all the risks and
rewards of ownership to the lessee; else if it does not then it is an operating lease.
While classifying a lease, it is important to recognize the essence of the agreement
and not just its legal form. The commercial reality is always important. Conditions in
the lease may specify that an entity has only a limited disclosure to the risks and
benefits of the leased asset.

The following are some of the situations where an individual or in combination,

would usually direct to a lease being a finance lease:

• Transfer of ownership to the lessee by the end of the lease term.

• The lessee has the choice to purchase the asset at a cost that is expected to
be lower than its fair value and such that the option is likely to be exercised.
• The lease term is for a key part of the financial life of the asset, even if title to
the asset is not transferred.
• The current value of the least lease payments is equal to substantially all of
the fair value of the asset.
• The leased resources are of a specialized nature such that only the lessee
can use them without significant modification.
• Losses or gains from changes in the fair value of the residual value of the
asset add to the lessee.
• The lessee has the option to continue the lease for a secondary term at
significantly below market rent.

The following are some of the situations where an individual or in combination,

would usually direct to a lease being an operating lease:

• If the lessor experiences the risk associated with a movement in the market
value of the asset or the use of the asset.
• If there is an option to cancel, and the lessee is likely to exercise such an
option.
• Leases of land, if title is not transferred.
• If the title to the land is not likely to pass to the lessee, then the rewards and
risks of ownership has not substantially passed.

The lowest lease payments need to be allocated between the land and the building
component in proportion to their relative fair values of the lease holding interests at
the beginning of the lease. If the allocation is not be made reliably, then both leases
are treated as finance leases or as operating leases.

Leases in the financial statements of lessees

Let us now discuss about leases in the financial statement of lessees.

Operating lease
In an operating lease, the lease payments are recognised as an expenditure on a
straight-line basis over the lease term, unless another organised basis is more
representative of the pattern of the user’s benefit. The incentives in operating
leases will be in the form of up-front payments and rent-free periods. These need to
be properly noticed over the lease term from its commencement.

Finance lease

At the initiation of the lease term, lessees identify finance leases as assets and
liabilities in their balance sheets on sum equal to the value of the leased asset or, if
lower, on the current value of the minimum lease payments. The discount rate in
calculating the current value of the minimum lease payments is the interest rate
contained in the lease, if this is possible to determine. Else, the lessee’s incremental
borrowing rate can be used. Any initial direct costs of the lessee are included to the
amount identified as an asset. After the initial recognition, the lease payments are
assigned between the repayment of the outstanding liability and the finance charge
in order to reflect a constant periodic rate of interest on the liability.

The asset needs to be depreciated over its expected useful life under IAS 16, using
rates for similar assets. If there is no reasonable certainty that ownership will
transfer to the lessee, then the shorter of the lease term and the useful life must be
used.

Leases in the financial statements of lessors

This section analyses leases in the financial statement of lessors.

Operating lease

Lessors present assets under operating leases in their balance sheets based on the
nature of the asset. The depreciation policy for depreciable leased assets will be
consistent with the lessor’s normal depreciation policy for related assets, and
depreciation is calculated in accordance with International Accounting Standard (IAS
16 and IAS 38). Lease income from operating leases is identified in income on a
straight-line basis over the lease term, unless another organised basis is more
representative of the pattern in which user benefit derived from the leased asset is
reduced.

Finance lease

Lessors recognise assets held under a finance lease in their balance sheets and
present them as a receivable on an amount equal to the net investment in the
lease. The identification of finance income is based on a pattern showing a periodic
rate of return on the lessor’s net investment in the finance lease.

The dealer lessors recognise selling profit or loss in the period, based on the policy
followed by the entity for outright sales. If low rates of interest are quoted, selling
profit will be restricted which would apply if a market rate of interest were charged.
Costs incurred by manufacturer or dealer lessors associated with negotiating and
arranging a lease will be recognised as an expense when the selling profit is
identified.

Q.6 Given the various types of mutual funds, take any two schemes and
discuss the performance of the schemes.

Ans:- Different types of mutual fund schemes

Schemes according to Maturity Period:

A mutual fund scheme can be classified into open-ended scheme or close-ended

scheme depending on its maturity period.

Open-ended Fund/ Scheme

An open-ended fund or scheme is one that is available for subscription and

repurchase on a continuous basis. These schemes do not have a fixed maturity
period. Investors can conveniently buy and sell units at Net Asset Value (NAV)
related prices which are declared on a daily basis. The key feature of open-end
schemes is liquidity.

Close-ended Fund/ Scheme

A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The
fund is open for subscription only during a specified period at the time of launch of
the scheme. Investors can invest in the scheme at the time of the initial public issue
and thereafter they can buy or sell the units of the scheme on the stock exchanges
where the units are listed. In order to provide an exit route to the investors, some
close-ended funds give an option of selling back the units to the mutual fund
through periodic repurchase at NAV related prices. SEBI Regulations stipulate that
at least one of the two exit routes is provided to the investor i.e. either repurchase
facility or through listing on stock exchanges. These mutual funds schemes disclose
NAV generally on weekly basis.

Schemes according to Investment Objective:

A scheme can also be classified as growth scheme, income scheme, or balanced

scheme considering its investment objective. Such schemes may be open-ended or
close-ended schemes as described earlier. Such schemes may be classified mainly
as follows:

Growth / Equity Oriented Scheme

The aim of growth funds is to provide capital appreciation over the medium to long-
term. Such schemes normally invest a major part of their corpus in equities. Such
funds have comparatively high risks. These schemes provide different options to the
investors like dividend option, capital appreciation, etc. and the investors may
choose an option depending on their preferences. The investors must indicate the
option in the application form. The mutual funds also allow the investors to change
the options at a later date. Growth schemes are good for investors having a long-
term outlook seeking appreciation over a period of time.

Income / Debt Oriented Scheme

The aim of income funds is to provide regular and steady income to investors. Such
schemes generally invest in fixed income securities such as bonds, corporate
debentures, Government securities and money market instruments. Such funds are
less risky compared to equity schemes. These funds are not affected because of
fluctuations in equity markets. However, opportunities of capital appreciation are
also limited in such funds. The NAVs of such funds are affected because of change
in interest rates in the country. If the interest rates fall, NAVs of such funds are
likely to increase in the short run and vice versa. However, long term investors may
not bother about these fluctuations.

Balanced Fund

The aim of balanced funds is to provide both growth and regular income as such
schemes invest both in equities and fixed income securities in the proportion
indicated in their offer documents. These are appropriate for investors looking for
moderate growth. They generally invest 40-60% in equity and debt instruments.
These funds are also affected because of fluctuations in share prices in the stock
markets. However, NAVs of such funds are likely to be less volatile compared to
pure equity funds.

Money Market or Liquid Fund

These funds are also income funds and their aim is to provide easy liquidity,
preservation of capital and moderate income. These schemes invest exclusively in
safer short-term instruments such as treasury bills, certificates of deposit,
commercial paper and inter-bank call money, government securities, etc. Returns
on these schemes fluctuate much less compared to other funds. These funds are
appropriate for corporate and individual investors as a means to park their surplus
funds for short periods.

Gilt Fund

These funds invest exclusively in government securities. Government securities

have no default risk. NAVs of these schemes also fluctuate due to change in interest
rates and other economic factors as is the case with income or debt oriented
schemes.

Index Funds
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive
index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the
same weightage comprising of an index. NAVs of such schemes would rise or fall in
accordance with the rise or fall in the index, though not exactly by the same
percentage due to some factors known as "tracking error" in technical terms.
Necessary disclosures in this regard are made in the offer document of the mutual
fund scheme.

There are also exchange traded index funds launched by the mutual funds which
are traded on the stock exchanges.

How to know the performance of a mutual fund scheme?

The performance of a scheme is reflected in its net asset value (NAV) which is
disclosed on daily basis in case of open-ended schemes and on weekly basis in case
of close-ended schemes. The NAVs of mutual funds are required to be published in
newspapers. The NAVs are also available on the web sites of mutual funds. All
mutual funds are also required to put their NAVs on the web site of Association of
Mutual Funds in India (AMFI) www.amfiindia.com and thus the investors can access
NAVs of all mutual funds at one place

The mutual funds are also required to publish their performance in the form of half-
yearly results which also include their returns/yields over a period of time i.e. last
six months, 1 year, 3 years, 5 years and since inception of schemes. Investors can
also look into other details like percentage of expenses of total assets as these have
an affect on the yield and other useful information in the same half-yearly format.

The mutual funds are also required to send annual report or abridged annual report
to the unitholders at the end of the year.

Various studies on mutual fund schemes including yields of different schemes are
being published by the financial newspapers on a weekly basis. Apart from these,
many research agencies also publish research reports on performance of mutual
funds including the ranking of various schemes in terms of their performance.
Investors should study these reports and keep themselves informed about the
performance of various schemes of different mutual funds.

Investors can compare the performance of their schemes with those of other mutual
funds under the same category. They can also compare the performance of equity
oriented schemes with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc.

On the basis of performance of the mutual funds, the investors should decide when
to enter or exit from a mutual fund scheme.
 Master of Business Administration - MBA Semester 4
MF0018 – Insurance and Risk Management
Assignment Set- 1

Q.1 Explain chance of loss and degree of risk with examples

Ans:- Chance of loss

Loss is the injury or damage borne by the insured in consequence of the happening
of one or more of the accidents or misfortunes against which the insurer, in
consideration of the premium, has undertaken to assure the insured. Chance of loss
is defined as the probability that an event that causes a loss will occur. The chance
of loss is a result of two factors, namely peril and hazard. Hazards are further
classified into the following four types:

• Physical hazard – This is a danger likely to happen due to the physical

characteristics of an object, which increases the chance of loss. For example
defective wiring in a building which enhances the chance of fire.
• Moral hazard – It is an increase in the probability of loss due to dishonesty
or character defects of an insured person. For example, Burning of unsold
goods that are insured in order to increase the amount of claim is a moral
hazard.
• Morale hazard – It is an attitude of carelessness or indifference to losses,
because the losses were insured. For example, careless acts like leaving a
door unlocked which makes it easy for a burglar to enter, or leaving car keys
in an unlocked car increase the chance of loss.
• Legal hazard – It is the severity of loss which is increased because of the
regulatory framework or the legal system. For example actions by
government departments restricting the ability of insurers to withdraw due to
poor underwriting results or a new environment law that alters the risk
liability of an organisation.

Degree of risk

Degree of risk refers to the intensity of objective risk, which is the amount of
uncertainty in a given situation. It can be assessed by finding the difference
between expected loss and actual loss. The formula used is

Degree of risk =

Degree of risk is measured by the probability of adverse deviation. If the probability

of the occurrence of an event is high, then greater is the likelihood of deviation from
the outcome that is hoped for and greater the risk, as long as the probability of loss
is less than one. In the case of exposures in large numbers, estimates are made
based on the likelihood of the number of losses that will occur. With regard to
aggregate exposures the degree of risk is not the probability of a single occurrence
but it is the probability of an outcome which is different from that expected or
predicted. Therefore insurance companies make predictions about the losses that
are expected to occur and formulate a premium based on that.

Q.2 Explain in detail Malhotra Committee recommendations

Ans:- Recommendations of Malhotra committee

The major reforms in Indian industry started when the Malhotra committee was
formed in 1993 headed by R. N. Malhotra (former Finance Secretary and RBI
Governor). This was formed to analyse the Indian insurance industry and propose
the future course of the industry. It modified the financial sector to design a system
appropriate for the changing economical structures in India. The committee
recognised the importance of insurance in financial systems and designed suitable
insurance programs. The report submitted by the committee in 1994 is given below:

Structure

• Government risk in the insurance Companies to be decreased to 50%.

• GIC must be taken under the government so that the GIC subsidiaries can
work independently.
• Better freedom of operation for insurance companies.

Competition

• Private companies who have initial capital of Rs 1 billion must be permitted to

work in the insurance industry.
• Companies should not use a single entity to deal with life and general
Insurance.
• Foreign companies may be permitted to work in the Indian insurance industry
only as partners of some domestic company.
• Postal life insurance must be permitted to work in the rural market.
• Every state must have only one state level life insurance company.

Regulatory body

• The Insurance Act must be changed.

• An Insurance Regulatory body must be formed.
• Insurance controller, which was a part of finance ministry, should be allowed
to work independently.

Investments

• The mandatory investments given to government securities from the LIC Life
Fund must be reduced from 75% to 50%.
• GIC and its subsidiaries should not be allowed to hold more than 5% in any
company.

Customer service

• LIC must pay interest if it delays any payments beyond 30 days.

• All insurance companies should be encouraged to create unit linked pension
plans.
• The insurance industry should be computerised and the technologies must be
updated. The insurance companies should promote and fulfil customer
services. They should also extend the insurance coverage areas to various
sectors.

The committee allowed only a limited competition in this sector as any failure on
the part of new players could ruin the confidence of the public to associate with this
industry. Every insurance company with an initial capital of Rs.100 crores can act as
an independent company with economic motives.

Since then there is a competition between the private and public sectors of
insurance, the Insurance Regulatory and Development Authority Act, 1999 (IRDA
Act) was formed to control, support and ensure a structured growth of the insurance
industry. The private sector insurance companies were allowed to work along with
the public sector, but had to follow the conditions given below:

• The company must be registered under the Companies Act, 1956.

• The total capital share by a foreign company held by itself or by through sub
sectors of the company should not exceed 26% of the capital paid to the
Indian insurance industry.
• The company should only provide life, general insurance or reinsurance.
• The company should have an initial paid capital of at least Rs.100 crores to
provide life insurance.
• The company should have an initial paid capital of at least Rs.200 crores to
provide reinsurance.

Later in 2008, further reforms were made by introducing the plan for Insurance
(Laws) Amendment Bill - 2008 and The LIC (Amendment) Bill - 2009. These
amendments influenced the Indian insurance industry in a huge way.

The Insurance (Laws) Amendment Bill - 2008 amended three other acts namely,
Insurance Act 1938, General Insurance Business (Nationalisation) Act 1972 (GIBNA)
and Insurance Regulatory and Development Authority Act 1999.

Q.3 What is the procedure to determine the value of various investments?

Ans:-
Q.4 Discuss the guidelines for settlement of claims by Insurance company

Ans:- General guidelines for claims’ settlement

There are some guidelines that must be followed while settling the claims. These
guidelines are general in nature, and are not compiled to be the same always.
Therefore, the claim settling authority uses discretion and records reasons.

Appointment of surveyor

The Insurance Act states that surveyor should survey claims above Rs. 20,000. The
surveyor’s appointment should be based on the following points:

• The surveyor should have a valid license.

• The surveyor selected should consider the type of loss and nature of the
claims.
• Depending on the situation, if technical expertise is required, a consultant
having technical expertise assists the surveyor.
 • One surveyor can be used for various jobs, if the surveyor’s competence is
good for both.

Appointment of investigator

Depending on circumstances, it is necessary to appoint an investigator for verifying

the claim version of loss. The appointing letter of the investigator o mentions all the
reference terms to perform.

Q.5 What is facultative reinsurance and treaty reinsurance?

Ans:- The two different types of reinsurances are:

• Facultative reinsurance.
• Treaty reinsurance.

Facultative reinsurance

It is a type of reinsurance that is optional; it is a case-by-case method that is used

when the ceding company receives an application for insurance that exceeds its
retention limit. It is based on the individual agreements that help to cover specific
losses. When any primary insurer wants reinsurance for a specific coverage, it
enters the market, and bargains with different reinsurance companies for the
amount of coverage and premium, looking out for a better value. According to most
of the contracts, the reinsurer pays a ceding commission to the insurer to pay for
purchase expenses.

Before issuing the insurance policy the insurer looks for reinsurance and speaks to
many reinsurers. The insurance company does not have any commitments to cede
insurance and also the reinsurer has no commitments to accept the insurance.
However if the insurance company find a reinsurer who is willing to take the
insurance policy then they can enter into a contract.

Facultative reinsurance is used when a huge amount of insurance is preferred and

while considering a specific risk involved in an individual contract. Facultative
reinsurance is the reinsurance of a part of a single policy or the entire policy after
negotiating the terms and conditions. It reduces the risk exposure of the ceding
company against a particular policy. Facultative reinsurance is not mandatory.

One advantage of facultative reinsurance is it is flexible as a reinsurance contract is

arranged to fit any kind of cases. It helps the insurance companies in writing large
amount of insurance policies. Reinsurance moves the huge losses of the insurers to
the reinsurer and thus helps the insurer.

One main disadvantage of facultative reinsurance is that it is not reliable. The

ceding insurer will not know in advance whether a reinsurer will agree to pay any
part of the insurance. The other disadvantage of this kind of reinsurance is the
delay in issuing the policy as it cannot be issued until the reinsurance is got for that
policy.
Treaty reinsurance

Treaty reinsurance is one in which the primary insurer agrees to cede the insurance
policy to the reinsurer and the reinsurer has to accept it. It includes a standing
agreement with a specific reinsurer. The amount of insurance that the primary
insurer sells and those policies where both the parties provide the service is
specified in the contract. All the business that comes under the contract is
automatically reinsured according to the conditions of the treaty.

Treaty reinsurance needs the reinsurer to assume the entire responsibility of the
ceding company or a part of it for some particular sections of the business with
respect to the terms of the policy. The contract is a compulsory contract because
according to the treaty the ceding company has to cede the business and the
reinsurer is compelled to assume the business. It is a type of reinsurance that is
preferred while considering the groups of homogenous risks.

The treaty reinsurance provides many advantages to the primary insurance

company. It is automatic, more reliable, and there is no delay in issuing the policy.
It is also more cost effective as there is no need to shop around for reinsurers
before writing the policy.

The treaty reinsurance is not advantageous to the reinsurer. Usually the reinsure
does not know about the individual applicant of the policy and has to depend on the
underwriting judgment that the primary insurer gives. It may be so that the primary
insurer can show bad business like more losses and get reinsured for it as the
reinsurer does not know the real fact. The primary insurer may pay insufficient
premium to the reinsurer. Therefore the reinsurer undergoes a loss if the risk
selection of the primary insurer is not good and they charge insufficient rates.

There are different types of treaty reinsurance arrangements which may differ
according to the liability of the reinsurer. They are:

• Quota–share treaty.
• Surplus–share treaty.
• Excess–of–loss treaty.
• Reinsurance pool.

Q.6 What is the role of information technology in promoting insurance

products

Ans:-The rapid developments in information technology are posing serious

challenges for insurance organisations. The use of information technology in
insurance industry has an impact on the efficiency of the organisation as it reduces
the operational costs. After many private players entered the insurance industry,
the competition in the insurance sector has become immense. Information
technology has helped in enhancing the insurance business. Insurance industry
uses information technology for internal administration, accounting, financial
management, reports, and so on.
Indian insurance organisations are rapidly growing as ‘technology-driven’
organisations, by replacing billions of files with folders of information. Insurers are
heading towards the technological enhancements, in order to focus on the key
areas of insurance business.

The role of IT in different fields of insurance like:

• Actuarial investigation - Insurers depend on the rates of actuarial models

to decide the quantity of risks which create loss. Insurance organisations are
using new technologies, to analyse the claims and policyholder’s data for
providing connection between risk characteristics and claims. Developments
in technology allow actuaries to examine risks more precisely.
• Policy management - Most of the insurance policies are printed and
conveyed to policy owners through mail every year. The method of creating
documents is accomplished by technicians and typists. In most of the cases,
this task is generally completed by using new technology. Customer data is
accessed by computer systems, and maintained in huge folders, in order to
renew each policy. To assemble the policies, complex software packages are
used, and to print the policies high speed printers are utilised.
• Underwriting – Underwriters can use knowledge based expert systems to
make underwriting decisions. By using automated systems, underwriters can
compare an individual’s risk profile with their data and customise policies
according to the individual’s risk profile.
• Front end operations: CRM (Customer Relationship Management)
packages are used to integrate the different functional processes of the
insurance company and provide information to the personnel dealing with the
front end operations. CRM facilitates easy retrieval of customer data. LIC is
using CRM packages to handle its front end operations.
 Master of Business Administration-MBA Semester 4
MB0052 – Strategic Management and Business Policy - 4 Credits
Assignment Set- 1 (60 Marks)

Note: Each question carries 10 Marks. Answer all the questions.

Q.1 What similarities and differences do you find in BCG business portfolio
matrix, Ansoff growth matrix and GE growth pyramid. (10 marks)

Ans. The BCG matrix is a portfolio management tool used in product life
cycle. BCG matrix is often used to highlight the products which get more funding
and attention within the company. During a product’s life cycle, it is categorised
into one of four types for the purpose of funding decisions. Figure 3.5 below depicts
the BCG matrix.

Figure 3.5 BCG Growth Share Matrix

Question Marks (high growth, low market share) are new products with potential
success, but they need a lot of cash for development. If such a product gains
enough market shares to become a market leader, which is categorised under
Stars, the organisation takes money from more mature products and spends it on
Question Marks.

Stars (high growth, high market share) are products at the peak of their product life
cycle and they are in a growing market. When their market rate grows, they
become Cash Cows.

Cash Cows (low growth, high market share) are typically products that bring in far
more money than is needed to maintain their market share. In this declining stage
of their life cycle, these products are milked for cash that can be invested in new
Question Marks.

Dogs (low growth, low market share) are products that have low market share and
do not have the potential to bring in much cash. According to BCG matrix, Dogs
have to be sold off or be managed carefully for the small amount of cash they
guarantee.

The key to success is assumed to be the market share. Firms with the highest
market share tend to have a cost leadership position based on economies of scale
among other things. If a company is able to apply the experience curve to its
advantage, it should able to produce and sell new products at low price, enough to
garner early market share leadership.

Limitations of BCG matrix:

— The use of highs and lows to form four categories is too simple

— The correlation between market share and profitability is questionable. Low share
business can also be profitable.

— Product lines or business are considered only in relation to one competitor: the
market leader. Small competitors with fast growing shares are ignored.

— Growth rate is the only aspect of industry attractiveness

— Market share is the only aspect of overall competitive position

3.4.2 Igor Ansoff growth matrix

The Ansoff Growth matrix is a tool that helps organisations to decide about their
product and market growth strategy. Growth matrix suggests that an organisation’s
attempts to grow depend on whether it markets new or existing products in new or
existing markets. Ansoff’s matrix suggests strategic choices to achieve the
objectives. Figure 3.6 depicts Ansoff growth matrix.
Figure 3.6 Ansoff Growth Matrix

Market penetration – Market penetration is a strategy where the business focuses

on selling existing products into existing markets. This increases the revenue of the
organisation.

Market development – Market development is a growth strategy where the business

seeks to sell its existing products into new markets. This means that the product is
the same, but it is marketed to a new audience.

Product development – Product development is a growth strategy where a business

aims to introduce new products into existing markets. This strategy may need the
development of new competencies and requires the business to revise products to
appeal to existing markets.

Diversification – Diversification is the growth strategy where a business markets

new products in new markets. This is an intrinsically riskier strategy because the
business is moving into markets in which it has little or no experience.

For a business to adopt a diversification strategy, it should have a clear idea about
what it expects to gain from the strategy and an honest assessment of the risks.

3.4.3 McKinsey/GE growth pyramid

The McKinsey/GE matrix is a tool that performs a business portfolio analysis on the
Strategic Business units in an organisation. It is more sophisticated than BCG matrix
in the following three aspects:

— Industry (market) attractiveness – Industry attractiveness replaces market

growth. It includes market growth, industry profitability, size and pricing practices,
among other possible opportunities and threats.
— Competitive strength – Competitive strength replaces market share. It includes
market share as well as technological positions, profitability, size, among other
possible strengths and weaknesses.

— McKinsey/GE growth pyramid matrix works with 3*3 grids while BCG matrix is 2*2
matrixes.

External factors that determine market attractiveness are the following:

— Market size

— Market growth

— Market profitability

— Pricing trends

— Competitive intensity/rivalry

— Overall risk of returns in the industry

— Opportunity to differentiate products and services

— Segmentation

— Distribution structure (e.g., retail, direct, wholesale)

Internal factors that affect competitive strength are the following:

— Strength of assets and competencies

— Relative brand strength

— Market share

— Customer loyalty

— Relative cost position (cost structure compared to competitors)

— Distribution strength

— Record of technological or other innovation

— Access to financial and other investment resources

Figure 3.7 McKinsey/GE Growth Pyramid

Q.2 Discuss the investment strategies applicable for businesses and

methods to rectify faulty investment strategies. (10 marks)

Ans. An investment strategy is a key component of every conceivable business

type, and it's critical to ensuring the success of the business. Entire college
programs have been designed specifically to teach business investment strategies,
but a few key tips can help lay groundwork for effective investing.

Use Income to Eliminate Debt

o While the pay-down of outstanding debt may not seem like business
investment on the surface, debt elimination can equate to a financial
return that outpaces even the best investments. If a business has
outstanding debt financed at a given interest rate, paying off that debt
guarantees an instant return of that percentage. Because business
debt often reaches into double digit interest rates, paying off this debt
can provide an instant, guaranteed return that is significantly higher
than usual returns on other investments.

Reinvest Funds to Nurture the Business

o Perhaps one of the most common ways businesses invest their funds
involves purchasing additional equipment, remodeling customer-facing
 environments or opening additional locations. By reinvesting profits
back into the business for expansion or improvement, the business
stands to gain additional profits as a result of the expansion. As an
added bonus, a guaranteed return on the investment will come in the
form of tax not assessed on the reinvested funds.

Invest in Other Businesses

o Some businesses find success in investing their profits in other

noncompeting businesses. These investments may be made as
traditional cash investments, as loans or by purchasing securities
issued to business start-ups. Investing in other businesses can be an
especially wise move for companies in shaky industries, as spreading
investments into other types of operations can help diversify a
business's holdings and reduce the risk of a complete business loss.

Or

— Use of income to eliminate debt

— Reinvestment of funds to nurture the business

— Investment in other businesses

Investment is defined as the commitment of money or capital (e.g. purchasing

assets, keeping funds in a bank account etc) to generate future returns. A proper
understanding of the investment strategies and a thorough analysis of the options
helps an investor to create a portfolio that maximises returns and minimises
exposure to risks.

Following are the ways to invest successfully:

— Leave a margin of safety – Always leave a margin of safety in your investments

to protect your portfolio. The following are the two ways to incorporate the above
principle in your investment selection process.

° Be conservative in your valuation assumptions

° Only buy assets dealing at substantial discounts to your conservative estimate.

— Invest in business which you understand – Invest in a business in which you have
a thorough understanding of the customers, products/services etc.

— Make assumptions – Make assumptions about your future performance by

recognising your own limitations. Never purchase the stock until you understand the
industrial economy and able to forecast the future of the company with certainty.

— Measure your success – Evaluate your performance by the underlying measures

in business.
— Have a clear disposition towards price – The more you pay for an asset in relation
to its earnings, the lesser is your return value. So have a clear outlook towards the
price.

— Allocate capital by opportunity cost – Allocate investments/assets to the choice

which has been opted as the best among several mutually exclusive choices.

Internal methods to rectify faulty investment strategies

In this section we will explain the methods to rectify faulty investment strategies.
Some of the methods are as follows:

— Internal transformation

— Corporate restructuring and reorganisation

— Financial restructuring

— Divestment strategy

— Expansion strategy

— Diversification strategy

— Vertical and horizontal integration strategy

— Building core competencies and critical success factors

Frequent assessment report assists in detecting the problems associated with faulty
investment strategies in an organisation.

Internal transformation

Internal transformation takes place in an organisation to sustain constant growth,

survival and maintain profitability. It includes corporate restructuring, downsizing of
employees etc. The following are the reasons for internal transformation of a
company:

— Pressure on owner to decrease costs

— Overstaffing

— Large and complicated company structure

— Low flexibility of staff

— Financial instability
The main objective of a company which adopts internal transformation is to
increase efficiency by reaching the standards in the global market. This is achieved
by holding high quality level of productivity.

The essential components of a successful business transformation are as follows:

— Achievement

° A new level of sustainably high performance emerges

° Extraordinary and unexpected results appear throughout

— Improved synergy

° Collaboration naturally occurs across all levels

° Creativity and innovation flourishes

— Aliveness

° Employees flourish as they openly express their passion, commitment and

creativity towards work.

° Growth and development occurs both personally and professionally

— Shared future

° The entire organisation unites to accomplish the future and live consistently with
core values

We will now discuss the two internal transformation processes in the following
section.

— Corporate restructuring and re-organisation

— Layoffs and employee termination

Q.3. a. Distinguish policy, procedure and programmes with examples. (5

marks)
b. Give a short note on synergy. (5 marks)

Differences between policy, procedure, process and programmes

In the previous topic we discussed the definition and meaning of policy, procedure,
process and programmes. Now we will analyze how each concept is different from
the other.
1. Policy is Procedure Process is a set of Programme is
general in identifies the activities a concrete
nature and specific actions conducted by scheme of
identifies the and explains people to achieve activities
company when an action organizational designed to
rules. needs to be goals. accomplish a
2. Policy taken. specific
explains the Process defines objective.
reason for It describes the method in
existence of emergency which the work is It provides
an procedures which done. step by step
organisation. include warnings approach to
3. Policy shows and cautions. It is a long term the activities
how rules rule that drives an taken to
are enforced It is systematic organization. achieve the
and way of handling goals.
describes its routine actions.
consequenc Programming
es. Procedure defines helps in
4. It defines an the means to developing an
outcome or achieve the goals. economical
a goal. way of doing
5. They are Procedures are things in a
described by written in an systematic
using simple outline format. manner.
sentences.
6. Policies are
It is generally
guidelines
detailed and rigid.
for
It is a part of
managerial
tactical tools.
actions.
7. It is a
planned way
to handle
certain
issues in the
organization.
8. It is framed
by the top
level
managemen
t.

9. Policies are
a part of the
strategies of
the
organization.
 Ans. b. Synergy is the energy or force created by the working together of various
parts or processes.
Synergy in business is the benefit derived from combining two or more elements
(or businesses) so that the performance of the combination is higher than that of
the sum of the individual elements (or businesses).

Organizations strive to achieve positive synergy or strategic fit by combining

multiple products, business lines, or markets. One way to achieve positive synergy
is by acquiring related products, so that sales representatives can sell numerous
products during one sales call. Rather than having two representatives make two
sales calls to a potential customer, one sales representative can offer the broader
mix of products.

Mergers and acquisitions are corporate-level strategies designed to achieve positive

synergy. The 2004 acquisition of AT&T Wireless by Cingular was an effort to create
customer benefits and growth prospects that neither company could have achieved
on its own—offering better coverage, improved quality and reliability, and a wide
array of innovative services for consumers.

Negative synergy is also possible at the corporate level. Downsizing and the
divestiture of businesses is in part the result of negative synergy. For instance,
Kimberly-Clark Corporation set out to sharpen its emphasis on consumer and health
care products by divesting its tiny interests in business paper and pulp production.
According to the company, the removal of the pulp mill will enhance operational
flexibility and eliminate distraction on periphery units, thus allowing the corporation
to concentrate on a single, core business activity.

The intended result of many business decisions is positive synergy. Managers

expect that combining employees into teams or broadening the firm's product or
market mix will result in a higher level of performance. However, the mere
combination of people or business elements does not necessarily lead to better
outcomes, and the resulting lack of harmony or coordination can lead to negative
synergy.

Q.4. Select any established Indian company and analyse the different
types of strategies taken up by the company over the last few years. (10
marks)

Cadbury plc, formerly known as Cadbury-Schweppes plc, before it demerged from

its Americas Beverages manufacturing business in 2008 (Peston, 2008), is the
world’s leading confectionery manufacturer and distributor. Cadbury plc “operates
in over 60 countries, works with over 35,000 direct and indirect suppliers and
employs around 50,000 people” (Cadbury India Ltd., 2008).

Cadbury stresses the importance that it places on quality. Apart from its mission
statement, it also references the slogan, “Cadbury means quality” as an integral
part of its business’s activities (Superbrands, 2008).
Lastly, Cadbury also aims to put “A Cadbury in every pocket” (Karvy Research, n.d.)
by targeting current consumers and encouraging them to make impulse purchases
and by maintaining a superior marketing mix (Karvy Research, n.d.).

Cadbury India Ltd, as the Indian subsidiary of this confectionery giant, also utilizes
the same mission and vision statements of its parent firm when operating in the
Indian market, albeit with different business strategies and approaches. Since
Cadbury’s activities vary from country to country, this report will simply examine
the activities of Cadbury India Ltd in the Indian market, one of the fastest growing
confectioneries markets in the world (Financial Express, 2008).
Products offered by Cadbury India Ltd.

Cadbury plc manufactures and sells three different kinds of confectionery:

chocolate, candy and chewing gum (Cadbury India Ltd., 2008), but in the Indian
market, its product line is split up into the chocolate confectionery, milk food drinks,
candy and gums categories (Cadbury India Ltd., 2008).

This report will examine two different products offered to the Indian market by
Cadbury India: Cadbury Dairy Milk (chocolate category) and Cadbury Bournvita
(milk drinks category).

(a) Cadbury Dairy Milk

(i) Pricing

Cadbury India enjoys controlling 70% of the confectionery market in India, of which
30% is directly due to the success of its Dairy Milk product, which averages sales of
around 1 million bars per day (Cadbury Dairy Milk, 2008; Marketing
Communications, 2008). Cadbury Dairy Milk bars are Cadbury India’s cash cow in
the country’s 4000 tonne, Rs. 6.50 billion (around 1.6 billion CAD) chocolate market
(Gupta, 2003), as such, has been designated its flagship brand (Cadbury India Ltd.,
2008; Chatterjee, 2000).

Part of Cadbury Dairy Milk’s success lies in its shared history with India’s identity (it
was first sold in 1948, one year after the country was made independent from the
British Empire) (Cadbury Dairy Milk, 2008) but also in the fact that it is priced
relatively cheaply (Chatterjee, 2006) and is relatively affordable by the Indian
masses. Even its smallest Dairy Milk bar, the 13 gram version, is priced at Rs. 5
(about 0.13 CAD), affordable by many middle-class Indians as an occasional treat,
but not affordable for those who buy from the less-then-3-rupee (Rs. 3) segment of
the market (Chatterjee, 2006). Its history of operating in the country and its
average level pricing of chocolate bars, has made the Cadbury dairy Milk bar
synonymous with high quality, affordable pure milk chocolate for many Indian
customers (Cadbury Dairy Milk, 2008).

(ii) Consumer segments served and advertising/promotional strategies

used

Cadbury India Ltd continuously markets Dairy Milk as a relatively inexpensive treat,
towards market segments divided by age, income, technological knowledge and
health-consciousness.
In the 1990’s, the company stated promoting the chocolate for “the kid in
everyone”, in an attempt to appeal to adults as well as children (Cadbury Dairy Milk,
2008).

In order to appeal to potential lower-income customers in the villages of India,

further marketing in the form of the “Real taste of life” campaign (Cadbury Dairy
Milk, 2008) attempted to absorb these customers into its market share. By using
opinion leaders from Bollywood and using extensive advertising in newspapers,
television, magazines and massive billboards across the country, Cadbury managed
to capture the attention of the nation and cement its market share superiority in
India (Cadbury Dairy Milk, 2008; Marketing Communications, 2008).

Nowadays, Cadbury’s is trying to tap into the potential market of younger

generation Internet users by offering contests and hosting competitions online, the
most notable being its “Pappu Pass Ho Gaya” (Pappu Passed!) joint venture
operation with Reliance India Mobile, a branch of India’s largest network service
provider, which allowed students across the country to check their examination
grades online and celebrate with Cadbury’s Dairy Milk if they did well (Cadbury
Dairy Milk, 2008).

Furthermore, Cadbury India continuously develops new versions of its Dairy Milk
brand in order to keep its adult and children consumers satisfied and interested.
Variations include the Fruit & Nut and Crackle & Roast Almond variations (Cadbury
Dairy Milk, 2008) which are meant for snacking, as well as the Cadbury Dairy Milk
Desserts, “to cater to the urge for ‘something sweet’ after meals” (Cadbury Dairy
Milk, 2008). The Cadbury Bournville Dark Chocolate bar, similar to the Dairy Milk
bar, targets the health-conscious market segment of the chocolate market, who
wish to enjoy the taste of dark chocolate but also its health benefits (Financial
Express, 2008). Lastly, Cadbury Dairy Milk Wowie, with Disney characters embossed
on each chocolate square (Cadbury Dairy Milk, 2008) clearly targets the child
segment of its market. Cadbury’s market segmentation is quite effective because it
allows them to target all three major market segments: children, adults and
technologically-savvy consumers, but it does not serve those segments of the
market that have been divided by income levels. Although Dairy Milk is affordable
to the upper and middle-income consumers who view it as a mid-priced item
(Kochhar, 2007), lower income consumers who buy from the less-than-3-rupee
range of chocolate cannot afford to buy Cadbury Dairy Milk regularly. Cadbury will
need to address the needs of this market segment in order to boost its sales of
Dairy Milk.

Indian consumers seem to be satisfied with Cadbury Dairy Milk as its marketing
promotes it as an occasional indulgence, despite popular opinion that it is a
relatively expensive luxury product (Cadbury India Ltd. Analysts Meet, 1999). This
restrained marketing has allowed the chocolate to slowly become a measure of
quality for many Indians, as Cadbury Dairy Milk is their “Gold Standard” for
chocolate, where the “pure taste of Cadbury Dairy Milk defines the chocolate taste
for the Indian consumer” (Cadbury India Ltd., 2008). In fact, Cadbury Dairy Milk was
voted one of the India’s most trusted brands in a poll conducted in 2005 (Cadbury
Dairy Milk, 2008).
(iii) Product Positioning

Cadbury India Ltd’s main sources of competition come from Amul, India’s own dairy
company and Nestle India, Nestle’s subsidiary in India. As seen in Appendix B,
Cadbury India controls around 70% (Cadbury India Ltd., 2008) of the chocolate
market, whereas Amul controls around 2% (Dobhal, n.d.) and Nestle India around
27% (Nestle to expand, 2008).

As mentioned earlier, Cadbury’s main strength comes from it ability to market Dairy
Milk products “through altering the theme and functionality of the product as the
time demands” (Cadbury India Ltd Analysts Meet, 1999). Although this has allowed
it to control more of the market than its closest competitors, the reasons for its
success may also lie in the fact that many Indians still view its chocolates as luxury
products (Cadbury India Ltd Analysts Meet, 1999) and not as household goods. This
contradicts Cadbury’s assertion that its leadership is maintained by a “superior
marketing mix” (Karvy Research, n.d.). Cadbury India may have misinterpreted the
popularity of Dairy Milk as a sign that the Indian public has accepted it as a
household product. In fact, the booming economy and the increasing affluence of
the burgeoning middle class (Basu, 2004) has promoted the use of status symbols,
where the regular consumption of so-called luxury chocolates such as Cadbury
Dairy Milk is viewed as fashionable (Kochhar, 2007). Despite Amul’s longer history
in India, its chocolates are viewed as being local and not luxurious, justifying a lower
price tag (Chansarkar et al., 2006). Cadbury India must maintain its current
marketing strategy but slowly start to promote Dairy Milk as a household good so
that consumers spend their rising disposable incomes on it and boost its sales (Rai,
2006).

Amul’s origins as a community welfare program in Gujarat, one of India’s most

industrialized states, to becoming a national enterprise (Amul, 2008) spanned the
decades during which newly-independent India forged its identity, thus becoming an
integral part of India’s identity and giving its marketing strategy a new source of
authority. Cadbury simply cannot match this kind of national endorsement, so by at
least promoting the fact that it has been operating in India for almost as long as
Amul, it can try to be “Indian” too. This, in combination with the longest running
advertising campaign that Amul is famous for gives it a brand awareness boost.

Moreover, Amul’s reputation for credibility, safety and consumer satisfaction was
only reinforced when Cadbury India’s Chinese-made products were found to be
contaminated with worms and melamine (Sinn and Karimi, 2008). The “Gold
Standard” (Cadbury Dairy Milk, 2008) was no longer gold, nor was it a standard
anymore, as people’s confidence in its safety was shattered. In order to position its
products as safe and affordable treats once again, Cadbury India should make
attempts to be even more sensitive to consumer demands. Customer satisfaction
must be given the utmost importance, even if the company has to run at a loss for a
few months, as this will eventually allow it to negate some of the extensive damage
that this negative publicity has to the firm’s reputation. The new extra-layer
packaging of chocolate that is now being used in the manufacture of Dairy Milk is a
good first step to take in reclaiming some of the public’s trust (Vivek, 2004).
Lastly, Amul’s innovative ideas will be the bane of Cadbury. Their release of diabetic
friendly chocolate and chocolates catering to different ethnic flavours (Janve and
Dogra, 2007) as well as chocolates for festive seasons allow them to rapidly sway
consumers over to their products. This accounts for their soaring annual market
growth rates of 18% annually (Indian Express, 1999).

In comparison to Nestle India however, Cadbury India’s longer track history gives it
a competitive edge. Cadbury has more of a brand recognition power than Nestle
has, and it uses this extensively to promote Cadbury Dairy Milk all over the country.
Nestle still has to break into the Indian market; one way to do this would be to
follow Amul’s lead and develop and market products that meet specific ethnic
needs, such as chocolates for Diwali and Rakshabandan (two different Indian
festivals) (Kochhar, 2007) , concepts that Cadbury India has yet to explore.

Cadbury India must counter this threat that Nestle and Amul pose, namely, the
production of chocolates specifically for the festive seasons of India. By doing so,
Cadbury will be able to position its chocolates as chocolate specifically designed for
India, endearing it to the consumers and boosting its sales.

(a) Cadbury Bournvita

(i) Pricing

Cadbury Bournvita was first sold on the Indian markets in 1948, soon after Cadbury
India Ltd (then known as Cadbury-Fry) was incorporated (Cadbury Bournvita, 2008).
As a result of being one of the first products offered on the Indian market by
Cadbury, combined with successful marketing strategies and promotional offers,
Cadbury Bournvita enjoys a 17% market share of the malt-based food drink market
(Cadbury Bournvita, 2008). India alone accounts for 22% of the world’s malt-food
milk drink retail sales (BeverageDaily, 2004), but unlike Cadbury Dairy Milk,
Cadbury Bournvita does not control a large share of India’s malt-based food drinks
market.

Bournvita is largely sold in 500 gram bottles for around Rs. 95 (2.35 CAD) a piece
despite other sizes being available, and is perceived to be quite expensive (Hawa,
2002). However, due to its long history with India, and the fact that it is used a
staple source of nourishment by Indian mothers for their children, Bournvita’s still
remains popular (Hawa, 2002).

(ii) Consumer segments served and advertising/promotional strategies

used

Cadbury markets its Bournvita product in diverse market segments. Bournvita has
been marketed mainly towards children, but also finds followers amongst elderly
people, pregnant women and athletes (Hawa, 2002; Cadbury Bournvita, 2008).
Continuous brand re-invention, a “rich brand heritage” and complete overhauls in
packaging, product design, promotion and distribution have allowed Cadbury
Bournvita to maintain its 17% market share over the years in India’s 220,000 tonne
malt-food market (Cadbury Bournvita, 2008; BeverageDaily, 2004).
Over the years, Cadbury has marketed Bournvita in order to appeal to the change in
perceptions and tastes of its consumers. It focused on the “Good Upbringing,
Goodness that grows with you” campaign to promote Bournvita as an essential
health drink for children (Cadbury Bournvita, 2008). This campaign was conducted
mainly on the radio, the primary medium of communication for many Indians at the
time (Ranjan, 2007). This campaign was followed by the massively successful
“Brought up right, Bournvita bright” television, newspaper and magazine campaign
(Cadbury Bournvita, 2008) to reach out to more children and promote the link
between intelligence and Bournvita, a concept that appealed to many children. In
order to cement their consumer base and ensure brand loyalty, in the 1990s,
Bournvita challenged the public by promising complete physical and mental
development for its consumers (Cadbury Bournvita, 2008), where the subsequent
television marketing campaign secured Cadbury Bournvita’s place in the Indian
market. The most recent marketing campaign undertaken by Cadbury Bournvita is
the one specially designed to harness consumers’ uncertainty about the challenges
of the new millennium. The “Real Achievers who have grown up on Bournvita”
campaign focused on preparing consumers with the health, vitality and nutrition
necessary for facing the challenges of the new millennium (Cadbury Bournvita,
2008) and allowed Cadbury Bournvita to keep “pace with the evolving mindsets of
the new age consumers” (Cadbury Bournvita, 2008). This marketing campaign was
broadcast on television and published in newspapers in an effort to recruit
contestants (Kapoor, 2007).

The release of new versions of the original Bournvita such as Bournvita 5-Star,
combining the flavour of the original chocolate Bournvita with the flavor of Cadbury
5-Star (Cadbury Bournvita, 2008), one of its caramel chocolates helps maintain
consumer interest. The new product is being aimed at the segment of children who
want nutrition but also taste (Cadbury Bournvita, 2008).

By also sponsoring the Indian Olympic team to the Moscow Olympics of 1980
(Cadbury Bournvita, 2008), Cadbury Bournvita has managed to appeal to an athletic
market segment as well. Recently, by supporting sports competitions and
sponsoring athletes across the country, Cadbury Bournvita has managed to
promote itself as a sports drink for athletes (Kapoor, 2007).

Furthermore, one of the most famous Indian examples of Cadbury Bournvita’s

ingenious marketing is its sponsorship of the Bournvita Quiz Contest. The Bournvita
Quiz Contest is the longest running quiz show in India, having first been aired in
1972. The Contest spans 7 countries, has involved more than 4000 schools and
more than 1 million students, making it one of the most popular high school
contests (Cadbury Bournvita, 2008), as well as one of Cadbury’s most successful
marketing ventures till date.

However, despite Cadbury Bournvita’s history of serving consumers in the Indian

market, and amidst allegations of declining quality and taste of the Bournvita brand
(Hawa, 2002), many customers still feel that Bournvita does not have the appeal
that other brands, such as Horlicks do (refer to Appendix C) and thus the market is
slowly switiching over to white malt-based food drinks such as Horlicks (Karvy
Research, n.d.; Cadbury India Ltd Analysts Meet, 1999).
(iii) Product Positioning

The malt-based food drinks market in India is divided into brown drinks and white
drinks categories (Cadbury India Ltd Analysts Meet, 1999; Karvy Research, n.d.),
with white drinks being popular in the southern and eastern parts of the country,
and the brown drinks being popular in the northern and western parts of the
country (Karvy Research, n.d.).

Cadbury Bournvita’s major source of competition comes from GlaxoSmithKline’s

Horlicks and Heinz Food’s Complan. As seen in Appendix C, Horlicks is the market
leader with a 44% market share (Chatterjee, 2006), followed by Cadbury Bournvita
with its 17% market share (Chatterjee, 2006) and then Complan with its 13%
market share (Samajdar, 2006).

As mentioned earlier, the malt-drinks market is split up into the white and brown
drinks categories. The white drinks category is mainly led by Horlicks whereas the
brown drinks category is led by Bournvita (Karvy Research, n.d.). Lately, more
consumers have started switching over to consuming white drinks than brown
drinks, thereby giving Horlicks a larger market share than Bournvita (Karvy
Research, n.d.).

When competing with Horlicks, Cadbury Bournvita’s current marketing strategy is

simply not enough. Given than Horlicks has been operating in the Indian market for
longer than Cadbury (Horlicks, 2008), this larger market share may be explained by
more consumer familiarity with Horlicks than with Bournvita, however, Horlicks’
extensive marketing campaigns may also have played a part.

Horlicks has always marketed itself as a “Great Family Nourisher” with products
such as Mother’s Horlicks designed for different members of the family (Horlicks,
2008), which makes it more appealing to a wider section of the market, with
products designed for different members of the family, such as Mother’s Horlicks
(Horlicks, 2008), than Bournvita’s mainly child-oriented approach. Thus, even
elderly and convalescent consumers can consume the product without feeling
conscious of consuming a child-only product. Even the Bournvita Quiz Contest,
effectively Bournvita’s longest running marketing campaign, mainly attracts more
child consumers to its product (Radakrishnan, 2002), and thus cannot compete with
Horlicks’ wider appeal. Thus, the solution lies in Cadbury India marketing Bournvita
as an adult drink as well. Only then will it be able to compete effectively with
Horlicks.

Meanwhile, Complan’s market share of 13% (Samajdar, 2006), is less than

Bournvita’s. Although both products are targeted at children, Complan has
marketed itself as a “perfect nutritional supplement” (Complan, n.d.) rather than as
a healthy drink for children, which is Bournvita’s approach. Since the words
‘nutritional supplement’ connote a need for extra nourishment, this may possibly
work against Complan as many families may feel that their child receives enough
nourishment and does not require more. Although Cadbury Bournvita currently has
a larger market share of the two, it must continue to market itself as a child-friendly
drink, and not as a nutritional supplement, in order to maintain its superiority.
Delivering Cadbury products to customers

India’s 300 billion USD retail market is growing at a rate of 30% per annum (Rai,
2006). In a country where half a billion people are under the age of 25, disposable
incomes are on the rise and the economy is growing at a rate of 8% annually (Rai,
2006), selling treats such as Cadbury Dairy Milk bars and Cadbury Bournvita powder
will generate massive returns. However, in order to be able to sell these products to
customers, proper distribution channels must be identified. The Indian retail sector
is composed of 97% “family-run, street corner stores” (Rai, 2006) and the remaining
3% consisting of malls and shopping complexes.

Therefore, Cadbury India Ltd. produces its products in factories spread

geographically across India, but also sells its products through a chain of over
300,000 retailers spread across India (Cadbury India Ltd Analysts Meet, 1999). The
efforts of these retailers are augmented by the support of 1900 distributor locations
and 27 depots (Cadbury India Ltd Analysts Meet, 1999). Furthermore, of a total of
3600 locations that sell Cadbury products, almost 3100 locations are directly
supplied by Cadbury India Ltd distributors at least thrice a month (Cadbury India Ltd
Analysts Meet, 1999).

These distribution networks give Cadbury India its competitive edge in India’s
massive consumer market.

SWOT Analysis of Cadbury India Ltd.

Cadbury India Ltd’s objective of putting a “Cadbury in every pocket” (Karvy

Research, n.d.) can only be done if the company markets its Cadbury Dairy Milk as a
household good and its Bournvita as a family-friendly drink. Until then, its Cadbury
Dairy Milk success will only be short-term in nature and Bournvita will not be able to
reverse the trend towards the consumption of white malted drinks (Cadbury India
Ltd Analysts Meet, 1999) and compete with Horlicks. As seen in Appendix D, if
Cadbury Dairy Milk can be marketed extensively enough to break the ‘luxury’
perception that consumers have of it currently (Cadbury India Ltd Analysts Meet,
1999), it can benefit from inelastic demand as a household product, thus generating
a constant stream of revenue and cementing the Dairy Milk brand as a cash cow
product. This objective can be accomplished by simply building on the good
reputation and trust that it has earned, and by listening to the needs of its
consumers. Bournvita meanwhile needs to be extensively marketed in order to
reduce the damaging effect that Horlicks’ family-friendly marketing mix is having on
its market share. Furthermore, the key threat that can affect Cadbury India Ltd’s
success in India is Amul’s innovative marketing strategy. As a result of its witty
marketing strategies, length of time serving India and its ability to develop and
market products specifically tailored for Indian consumers, Amul’s yearly growth
rate of 18% may slowly start to eat away at Cadbury’s success (Indian Express,
1999).

Conclusion

Cadbury India Ltd’s position in India is relatively strong. In order to maintain its lead
in such a large market, it must learn to address the specific needs of its consumers
and continue to maintain their goodwill, while also analyzing its competitors’
marketing strategies. By doing so, it will be able to isolate the benefits and
drawbacks of its competitors’ marketing mix and use those to its own advantage.

Cadbury must also appreciate the advantages of a positive reputation and always
stress consumer satisfaction. One key aspect of this lies in maintaining the safety of
its products so that the name of Cadbury is always synonymous with high quality
safe products. Repeats of the recent melamine and worms issues cannot be allowed
to happen as once consumer confidence in its brand name is shattered, Cadbury
India’s brand recognition aspect will immediately work against it by highlighting the
link between its name and contaminated food products. This will cripple sales and
reverse the fruits of 70 years of hard work in the country, leaving the path open for
more efficient local companies like Amul to learn from Cadbury India’s mistakes and
take over its market share.

Future Strategy
In the branded impulse market, the share of chocolate in 6.6% and Cadbury’s share
in the impulse segment is 4.8% factor like changing attitude, higher disposable
income, a large youth population, and low penetration of chocolate (22% of urban
population) point towards a big opportunity of increasing the share of chocolate in
the branded impulse among the costly alternative in the branded impulse market.
It appears that company is likely to play the value game to expand the market
encouraged by the recent success of its low priced ‘value for many packs’.
Various measures are undertaken in all areas of operation to create value for the
future.
New channel of marketing such as gifting and child connectivity and low end value
for money product for expanding the consumer base have been identified.
In terms of manufacturing management focus is on optimizing manufacturing
efficiencies and creating a world class manufacturing location for CDM and Éclairs.
The company is today the second best manufacturing location of Cadbury’s
Schweppes in the world.
Efficient sourcing of key raw material i.e. coca through forward purchase of imports,
higher local consumption by entering long term contract with farmer and
undertaking efforts in expanding local coca area development. The initiatives in the
terms of development a long term domestic coca a sourcing base would field
maximum gains when commodity prices start moving up.
• Use of it to improve logistic and distribution competitiveness
• Utilizing mass media to create and maintain brands.
• Expand the consumer base. The company has added 8 million new consumer in
the current year and how has consumer base of 60 million although the growth in
absolute numbers is lower than targeted, the company has been able to increase
the width of its consumer base through launch of low priced products.
• Improving distribution quality by addressing issues of product stability by
installation of visi coolers at several outlets. This would be really effective in
maintaining consumption in summer, when sales usually dip due to the fact that the
heat effects product quality and thereby consumption.
• The above are some steps being taken internally to improve future operation and
profitability. At the same time the management is also aware of external changes
taking place in the competitive environment and is taking steps to remain
competitive in the future environment of free imports, lower barrier to trade and the
advent of all global players in to the country. The management is not unduly
concerned about the huge deluge of imported chocolate brands in the market place.
It is of the view that size of this imported premium market is small to threaten its
own volumes or sales in fact, the company looks at the tree important as an
opportunity, where it could optimally use the global Cadbury Schweppes portfolio.
The company would be able to not only provide greater variety, but it would also be
more cost effective to test market new product as well as improve speed of
response to change in consumer preference through imports. The only concerns
that the company has in this regard is the current high level of duties, which limit
the opportunity to launch value for money products.

Q. 5 Why do you think it is necessary for organisations to have vision and

mission statements and also core competencies? Support your answer
with relevant examples. (10 marks)

Ans. Vision and Mission statements

A well-articulated strategic intent guides the development of goals and helps in

inspiring the employees to achieve targets. It also facilitates in utilising the intent to
allocate resources and in encouraging team participation. It comprises of the vision
and mission statements.

Vision statement

A vision statement defines the purpose and principles of an organisation in terms of

the values of the organisation. It is a concise and motivating statement that guides
the employees to select the procedures to attain the goals. Vision statement is the
framework of strategic planning. A vision statement describes the future ambition of
an organisation. A vision is the ability to view what the organisation wants to be in
future. It is prepared for the organisation and its employees. It should be implanted
in the organisation being collectively shared by everyone in the organisation. It
conveys an effective business plan. It integrates an understanding about the nature
and aspirations of the organisation and develops this conception to lead the
organisation towards a better objective. It must synchronise with the organisation’s
principles. The ambition should be rational and achievable.

Example - Wal-Mart’s vision is to become worldwide leader in retailing.

Vision statement of L&T

L&T employees shall be innovative and the empowered team will constantly create
values and attain global benchmarks.

L&T shall promote a culture of trust and continuous learning. It shall meet the
expectations of employees, stakeholders and society.

(i) Cadbury’s Vision Statement

Our objective is to deliver superior shareholder returns by realizing our vision to the
be
the world’s biggest and best confectionery company. We are currently the biggest,
and
we have an enduring commitment to become the undisputed best. At the heart of
our plan
is our performance scorecard, delivered through our priorities, sustainability
commitments and culture

Cadbury plans to “deliver superior shareholder returns” (Cadbury plc, 2008) by

measuring its financial progress in the areas of growth, efficiency, capabilities and
sustainability from 2008 to 2011 (Cadbury plc, 2008).

Mission statement

A mission statement is the extensive definition of the mission of an organisation. It

is a concise description of the existence and fundamental purpose of an
organisation. It describes the present potentials and activities of the organisation. It
conveys the purpose of the organisation to its employees and the public. It is vital
for the development and growth of the organisation.

Mission statement is the responsibility by which an organisation aims to serve its

stakeholders. It gives a framework on the operations of the organisation within
which the strategies are devised. It describes the present capabilities, the
stakeholders and the reason for existence of an organisation. The statement
distinguishes an organisation from its other competitors by explaining its scope of
activities, technologies, its products and services used to achieve the goals and
objectives. It should be practical and achievable. It should be clear and precise so
that the actions can be taken based on it. It should be unique and different to leave
an impact on everyone. It should be credible so that the stakeholders accept it.

Example -Wal-Mart’s mission is to provide ordinary customers the chance to buy the
same thing as rich people.

Mission statement of IBM

“At IBM, we strive to be the forerunner in inventing, developing and manufacturing
most advanced information technologies, including computer systems, software,
storage systems and microelectronics.”

The distinction between mission statement and vision statement is that the mission
statement focuses on the present position of the organisation and the vision
statement focuses on the future of the organisation.

(ii) Cadbury’s Mission Statement

Cadbury’s mission statement outlines its overall business objective and its
commitment to its customers.

Our core purpose “Working together to create brands people love” captures the
spirit of what we are trying to achieve as a business. We collaborate and work as
teams to convert products into brands.

Core competencies are those skills that are critical for a business to achieve
competitive advantage. These skills enable a business to deliver essential customer
benefit like the selection of a product or service by a customer. Core competency is
the key strength of business because it comprises the essential skills. These are the
central areas of expertise of the company where maximum value is added to its
services or products. Example – Infosys has a core competency in information
technology.

It is a unique skill or technology that establishes a distinct customer value. As the

organisation progresses and adapts to the new environment, the core competencies
also adjust to the change. They are not rigid but flexible to advancing time. The
organisation makes the maximum utilisation of the competencies and correlates
them to new opportunities in the market. Resources and capabilities are the
building blocks on which an organisation builds and executes a value-added
strategy. The strategy is devised in a manner that an organisation can receive
reasonable profit and attain strategic competitiveness.

Core Competencies are not fixed. They change in response to the transformation in
the environment of the company. They are adaptable and advance over time. As an
organisation progresses and adapts to new circumstances, the core competencies
also adapt to the transformation.
Q. 6. What is SBU? Explain its features, functions and roles. Mention some
of the successful SBU of MNC’s. (10 marks)

Incompelete

Ans. Strategic Business Unit or SBU is understood as a business unit within the
overall corporate identity which is distinguishable from other business because it
serves a defined external market where management can conduct strategic
planning in relation to products and markets. The unique small business unit
benefits that a firm aggressively promotes in a consistent manner. When companies
become really large, they are best thought of as being composed of a number of
businesses (or SBUs).Strategic Business Unit (SBU) is necessary when corporation
starts to provide different products and hence, need to follow different
strategies.SBUs are also known as strategy centers, Independent Business Unit or
even Strategic Planning Centers.

Strategic Business Unit (SBUs) is necessary when corporation starts to provide

different products and hence, need to follow different strategies. To ease its
operation, corporate set different groups of product/product line regarding the
strategy to follow (in terms of competition, prices, substitutability, style/ quality,
and impact of product withdrawal). These strategic groups are called Strategic
Business Units (SBUs).

Each Business Unit must meet the following criteria:

1. Have a unique business mission, independent from other SBUs.

2. Have clearly definable set of competitors.
3. Is able to carry out integrative planning relatively independently of other
SBUs.

Should have a Manager authorized and responsible for its operation.

 Master of Business Administration-MBA Semester 4
International Business Management – MB0053
Assignment Set - 1

Q.1 What is globalization? What are its benefits? How does globalization help in
international business? Give some instances?

Ans : Globalization (or globalization) describes the process by which regional

economies, societies, and cultures have become integrated through a global
network of political ideas through communication, transportation, and trade. The
term is most closely associated with the term economic globalization: the
integration of national economies into the international economy through trade,
foreign direct investment, capital flows, migration, the spread of technology, and
military presence. However, globalization is usually recognized as being driven by a
combination of economic, technological, sociocultural, political, and biological
factors. The term can also refer to the transnational circulation of ideas, languages,
or popular culture through acculturation. An aspect of the world which has gone
through the process can be said to be globalized.
Against this view, an alternative approach stresses how globalization has actually
decreased inter-cultural contacts while increasing the possibility of international and
intra-national conflict.[3]

Globalization has various aspects which affect the world in several different ways

 Industrial - emergence of worldwide production markets and broader access to

a range of foreign products for consumers and companies. Particularly movement of
material and goods between and within national boundaries. International trade in
manufactured goods increased more than 100 times (from $95 billion to $12 trillion)
in the 50 years since 1955.China's trade with Africa rose sevenfold during 2000-07
alone.

 Financial - emergence of worldwide financial markets and better access to

external financing for borrowers. By the early part of the 21st century more than
$1.5 trillion in national currencies were traded daily to support the expanded levels
of trade and investment

 Economic - realization of a global common market, based on the freedom of

exchange of goods and capital

 Job Market- competition in a global job market. In the past, the economic fate of
workers was tied to the fate of national economies. With the advent of the
information age and improvements in communication, this is no longer the case.
Because workers compete in a global market, wages are less dependent on the
success or failure of individual economies. This has had a major effect on wages and
income distribution

 Political - some use "globalization" to mean the creation of a world government

which regulates the relationships among governments and guarantees the rights
arising from social and economic globalization. Politically, the United States has
enjoyed a position of power among the world powers, in part because of its strong
and wealthy economy. With the influence of globalization and with the help of the
United States’ own economy, the People's Republic of China has experienced some
tremendous growth within the past decade. If China continues to grow at the rate
projected by the trends, then it is very likely that in the next twenty years, there will
be a major reallocation of power among the world leaders. China will have enough
wealth, industry, and technology to rival the United States for the position of
leading world power.

Most of us assume that international and global business are the same and that any
company that deals with another country for its business is an international or
global company. In fact, there is a considerable difference between the two terms.

International companies – Companies that deal with foreign companies for their
business are considered as international companies. They can be exporters or
importers who may not have any investments in any other country, apart from their
home country.
Global companies – Companies, which invest in other countries for business and
also operate from other countries, are considered as global companies. They have
multiple manufacturing plants across the globe, catering to multiple markets.

The transformation of a company from domestic to international is by entering just

one market or a few selected foreign markets as an exporter or importer.
Competing on a truly global scale comes later, after the company has established
operations in several countries across continents and is racing against rivals for
global market leadership. Thus, there is a meaningful distinction between a
company that operates in few selected foreign countries and a company that
operates and markets its products across several countries and continents with
manufacturing capabilities in several of these countries.
Companies can also be differentiated by the kind of competitive strategy they adopt
while dealing internationally. Multinational strategy and global competitive strategy
are the two types of competitive strategy.

 Multinational strategy – Companies adopt this strategy when each country’s

market needs to be treated as self contained. It can be for the following reasons:
o Customers from different countries have different preferences and expectations
about a product or a service.
o Competition in each national market is essentially independent of competition in
other national markets, and the set of competitors also differ from country to
country.
o A company’s reputation, customer base, and competitive position in one nation
have little or no bearing on its ability to successfully compete in another nation.
o Some of the industry examples for multinational competition include beer, life
insurance, and food products.

 Global competitive strategy – Companies adopt this strategy when prices and
competitive conditions across the different country markets are strongly linked
together and have common synergies. In a globally competitive industry, a
company’s business gets affected by the changing environments in different
countries. The same set of competitors may compete against each other in several
countries. In a global scenario, a company’s overall competitive advantage is
gauged by the cumulative efforts of its domestic operations and the international
operations worldwide.

A good example to illustrate is Sony Ericsson, which has its headquarters in

Sweden, Research and Development setup in USA and India, manufacturing and
assembly plants in low wage countries like China, and sales and marketing
worldwide. This is made possible because of the ease in transferring technology and
expertise from country to country.
Industries that have a global competition are automobiles, consumer electronics
(like televisions, mobile phone), watches, and commercial aircraft and so on.
Table 1 portrays the differences in strategies adopted by companies in international
and global operations.
Strategy International Global
Location Selected target countries Most global businesses
and trading areas operate in North America,
 Europe, Asia Pacific, and
Latin America
Business Custom strategies to fit the Same basic strategy
circumstances of each host worldwide with minor
country situation country customisation where
necessary
Product-line Adopted to local culture and Mostly standardised
particular needs and products sold worldwide,
expectations of local buyers moderate customisation
depending on the regulatory
framework
Production Plants scattered across Plants located on the basis
many host countries, each of maximum competitive
producing versions suitable advantage (in low cost
for the surrounding countries close to major
environment markets, geographically
scattered to minimise
shipping costs, or use of a
few world scale plants to
maximise economies of
scale)
Source of supply of raw Suppliers in host country Attractive suppliers from
materials preferred across the world
Marketing and distribution Adapted to practices and Much more worldwide
culture of each host country coordination; minor
adaptation to host country
situations if required
Cross country connections Efforts made to transfer Efforts made to use almost
ideas, technologies, the same technologies,
competencies and competencies, and
capabilities that work capabilities in all country
successfully in one country markets (to promote use of
to another country a mostly standard strategy),
whenever such a transfer new successful competitive
appears advantageous capabilities are transferred
to different country markets
Company organisation Form subsidiary companies All major strategic decisions
to handle operations in each closely coordinated at global
host headquarters; a global
country; each subsidiary organisational
operates more or less structure is used to unify the
autonomously to fit host operations in each country
country conditions

Benefits of globalisation
We have moved from a world where the big eat the small to a world where the fast
eat the slow", as observed by Klaus Schwab of the Davos World Economic Forum.
All economic analysts must agree that the living standards of people have
considerably improved through the market growth. With the development in
technology and their introduction in the global markets, there is not only a steady
increase in the demand for commodities but has also led to greater utilization.
Investment sector is witnessing high infusions by more and more people connected
to the world's trade happenings with the help of computers. As per statistics,
everyday more than $1.5 trillion is now swapped in the world's currency markets
and around one-fifth of products and services are generated per year are bought
and sold.
Buyers of products and services in all nations comprise one huge group who gain
from world trade for reasons encompassing opportunity charge, comparative
benefit, economical to purchase than to produce, trade's guidelines, stable business
and alterations in consumption and production. Compared to others, consumers are
likely to profit less from globalization.
Another factor which is often considered as a positive outcome of globalization is
the lower inflation. This is because the market rivalry stops the businesses from
increasing prices unless guaranteed by steady productivity. Technological
advancement and productivity expansion are the other benefits of globalization
because since 1970s growing international rivalry has triggered the industries to
improvise increasingly.
Globalization can be described as a process by which the people of the world are
unified into a single society and functioning together. This process is a combination
of economic, technological, sociocultural and political forces. Globalization, as a
term, is very often used to refer to economic globalization, that is integration of
national economies into the international economy through trade, foreign direct
investment, capital flows, migration, and spread of technology. The word
globalization is also used, in a doctrinal sense to describe the neoliberal form of
economic globalization.Globalization is also defined as internationalism, however
such usage is typically incorrect as "global" implies "one world" as a single unit,
while "international" (between nations) recognizes that different peoples, cultures,
languages, nations, borders, economies, and ecosystems
exist(http://en.wikipedia.org/). Globalization has two components: the globalization
of market and globalization of production....
Some other benefits of globalization as per statistics
 Commerce as a percentage of gross world product has increased in 1986 from
15% to nearly 27% in recent years.
 The stock of foreign direct investment resources has increased rapidly as a
percentage of gross world product in the past twenty years.
 For the purpose of commerce and pleasure, more and more people are crossing
national borders. Globally, on average nations in 1950 witnessed just one overseas
visitor for every 100 citizens. By the mid-1980s it increased to six and ever since
the number has doubled to 12.
 Worldwide telephone traffic has tripled since 1991. The number of mobile
subscribers has elevated from almost zero to 1.8 billion indicating around 30% of
the world population. Internet users will quickly touch 1 billion.
o Promotes foreign trade and liberalisation of economies.
o Increases the living standards of people in several developing countries through
capital investments in developing countries by developed countries.
o Benefits customers as companies outsource to low wage countries. Outsourcing
helps the companies to be competitive by keeping the cost low, with increased
productivity.
o Promotes better education and jobs.
o Leads to free flow of information and wide acceptance of foreign products, ideas,
ethics, best practices, and culture.
o Provides better quality of products, customer services, and standardised delivery
models across countries.
o Gives better access to finance for corporate and sovereign borrowers.
o Increases business travel, which in turn leads to a flourishing travel and
hospitality industry across the world.
o Increases sales as the availability of cutting edge technologies and production
techniques decrease the cost of production.
o Provides several platforms for international dispute resolutions in business, which
facilitates international trade.
Some of the ill-effects of globalisation are as follows:
 Leads to exploitation of labour in several cases.
 Causes unemployment in the developed countries due to outsourcing.
 Leads to the misuse of IPR, copyrights and so on due to the easy availability of
technology, digital communication, travel and so on.
 Influences political decisions in foreign countries. The MNCs increasingly use their
economical powers to influence political decisions.
 Causes ecological damage as the companies set up polluting production plants in
countries with limited or no regulations on pollution.
 Harms the local businesses of a country due to dumping of cheaper foreign
goods.
 Leads to adverse health issues due to rapid expansion of fast food chains and
increased consumption of junk food.
 Causes destruction of ethnicity and culture of several regions worldwide in favour
of more accepted western culture.

In spite of its disadvantages, globalisation has improved our lives in various fields
like communication, transportation, healthcare, and education.
Q.2 What is culture and in the context of international business
environment how does it impact international business decisions?
Ans: Culture is defined as the art and other signs or demonstrations of human
customs, civilisation, and the way of life of a specific society or group. Culture
determines every aspect that is from birth to death and everything in between it. It
is the duty of people to respect other cultures, other than their culture. Research
shows that national ‘‘cultures’’ generally characterise the dominant groups’ values
and practices in society, and not of the marginalised groups, even though the
marginalised groups represent a majority or a minority in the society.
Culture is very important to understand international business. Culture is the part of
environment, which human has created, it is the total sum of knowledge, arts,
beliefs, laws, morals, customs, and other abilities and habits gained by people as
part of society.
Culture is an important factor for practising international business. Culture affects
all the business functions ranging from accounting to finance and from production
to service. This shows a close relation between culture and international business.
The following are the four factors that question assumptions regarding the impact of
global business in culture:
 National cultures are not homogeneous and the impact of globalisation on
heterogeneous cultures is not easily predicted.
 Culture is not similar to cultural practice.
 Globalisation does not characterise a rupture with the past but is a continuation
of prior trends.
 Globalisation is only one of many processes involved in cultural change.

Cultural differences affect the success or failure of multinational firms in many

ways. The company must modify the product to meet the demand of the customers
in a specific location and use different marketing strategy to advertise their product
to the customers. Adaptations must be made to the product where there is demand
or the message must be advertised by the company. The following are the factors
which a company must consider while dealing with international business:
 The consumers across the world do not use same products. This is due to varied
preferences and tastes. Before manufacturing any product, the organisation has to
be aware of the customer choice or preferences.
 The organisation must manage and motivate people with broad different cultural
values and attitudes. Hence the management style, practices, and systems must be
modified.
 The organisation must identify candidates and train them to work in other
countries as the cultural and corporate environment differs. The training may
include language training, corporate training, training them on the technology and
so on, which help the candidate to work in a foreign environment.

 The organisation must consider the concept of international business and

construct guidelines that help them to take business decisions, and perform
activities as they are different in different nations. The following are the two main
tasks that a company must perform:
o Product differentiation and marketing – As there are differences in consumer
tastes and preferences across nations; product differentiation has become business
strategy all over the world. The kinds of products and services that consumers can
afford are determined by the level of per capita income. For example, in
underdeveloped countries, the demand for luxury products is limited.
o Manage employees – It is said that employees in Japan were normally not satisfied
with their work as compared with employees of North America and European
countries; however the production levels stayed high. To motivate employees in
North America, they have come up with models. These models show that there is a
relation between job satisfaction and production. This study showed the fact that it
is tough for Japanese workers to change jobs. While this trend is changing, the fact
that job turnover among Japanese workers is still lower than the American workers
is true. Also, even if a worker can go to another Japanese entity, they know that the
management style and practices will be quite alike to those found in their present
firm. Thus, even if Japanese workers were not satisfied with the specific aspects of
their work, they know that the conditions may not change considerably at another
place. As such, discontent might not impact their level of production.
The following are the three mega trends in world cultures:
 The reverse culture influence on modern Western cultures from growing
economies, particularly those with an ancient cultural heritage.
 The trend is Asia centric and not European or American centric, because of the
growing economic and political power of China, India, South Korea, and Japan and
also the ASEAN.
 The increased diversity within cultures and geographies.
 The following are the necessary implications in international business:
 Avoid self reference criterion such as, one’s own upbringing, values and
viewpoints.
 Follow a philosophical viewpoint that considers that many perspectives of a
single observation or phenomenon can be true.
 Discover and identify global segments and global niche markets, as national
markets are diverse with growing mobility of products, people, capital, and culture.
 Grow the total share market by innovating affordable products and services, and
making them accessible so that, they are affordable for even subsistence level
consumers rather than fighting for market share.
 Organise global enterprises around global centres of excellence.

Hofstede’s cultural dimensions

According to Dr. Geert Hofstede, ‘Culture is more often a source of conflict than of
synergy. Cultural differences are a trouble and always a disaster.’
Professor Hofstede carried out a detailed study of how values in the workplace are
influenced by culture. He worked as a psychologist in IBM from 1967 to 1973. At
that time he gathered and analysed data from many people from several countries.
Professor Hofstede established a model using the results of the study which
identifies four dimensions to differentiate cultures. Later, a fifth dimension called
‘long-term outlook’ was added.
The following are the five cultural dimensions:
 Power Distance Index (PDI) – This focuses on the level of equality or
inequality, between individuals in the nation’s society. A country with high power
distance ranking depicts that inequality of power and wealth has been allowed to
grow within the society. These societies follow caste system that does not allow
large upward mobility of its people. A country with low power distance ranking
depicts the society and de-emphasises the differences between its people’s power
and wealth. In these societies equality and opportunity is stressed for everyone.
 Individualism – This dimension focuses on the extent to which the society
reinforces individual or collective achievement and interpersonal relationships. A
high individualism ranking depicts that individuality and individual rights are
dominant within the society. Individuals in these societies form a larger number of
looser relationships. A low individualism ranking characterises societies of a more
collective nature with close links between individuals. These cultures support
extended families and collectives where everyone takes responsibility for fellow
members of their group.
 Masculinity – This focuses on the extent to which the society supports or
discourages the traditional masculine work role model of male achievement, power,
and control. A country with high masculinity ranking shows the country experiences
high level of gender differentiation. In
these cultures, men dominate a major part of the society and power structure, with
women being controlled and dominated by men. A country with low masculinity
ranking shows the country, having a low level of differentiation and discrimination
between genders. In low masculinity cultures, women are treated equal to men in
all aspects of the society.
 Uncertainty Avoidance Index (UAI) – This focuses on the degree of tolerance
for uncertainty and ambiguity within the society that is unstructured situations. A
country with high uncertainty avoidance ranking shows that the country has low
tolerance for uncertainty and ambiguity. A rule-oriented society that incorporates
rules, regulations, laws, and controls is created to minimise the amount of
uncertainty. A country with low uncertainty avoidance ranking shows that the
country has less concern about ambiguity and uncertainty and has high tolerance
for a variety of opinions. A society which is less rule-oriented, readily agrees to
changes, and takes greater risks reflects a low uncertainty avoidance ranking.
 Long-Term Orientation (LTO) – Describes the range at which a society
illustrates a pragmatic future oriented perspective instead of a conventional historic
or short term point of view. The Asian countries are scoring high on this dimension.
These countries have a long term orientation, believe in many truths, accept
change easily, and have thrift for investment. Cultures recording little on this
dimension, trust in absolute truth is conventional and traditional. They have a small
term orientation and a concern for stability. Many western cultures score
considerably low on this dimension.
In India, PDI is the highest Hofstede dimension for culture with a rank of 77, LTO
dimension rank is 61, and masculinity dimension rank is 62.
Every society has its own unique culture. Culture must not be imposed on
individuals of different culture. For example, the Cadbury Kraft Acquisition, 2009
was a landmark international deal, in which a U.S. based company Kraft acquired
the British chocolate giant, Cadbury which were in complete extremes in terms of
culture. Let us discuss the major cultural elements that are related to business.
Cultural elements that relate business
The most important cultural components of a country which relate business
transactions are:
 Language.
 Religion.
 Conflicting attitudes.

Cross cultural management is defined as the development and application of

knowledge about cultures in the practice of international management, when
people involved have diverse cultural identities.
International managers in senior positions do not have direct interaction that is
face-to-face with other culture workforce, but several home based managers handle
immigrant groups adjusted into a workforce that offers domestic markets.
The factors to be considered in cross cultural management are:
Cross cultural management skills
The ability to demonstrate a series of behaviour is called skill. It is functionally
linked to achieving a performance goal.
The most important aspect to qualify as a manager for positions of international
responsibility is communication skills. The managers must adapt to other culture
and have the ability to lead its members.
The managers cannot expect to force members of other culture to fit into their
cultural customs, which is the main assumption of cross cultural skills learning. Any
organisation that tries to enforce its behavioural customs on unwilling workers from
another culture faces conflict. The manager has to possess the skills linked with the
following:
 Providing inspiration and appraisal systems.
 Establishing and applying formal structures.
 Identifying the importance of informal structures.
 Formulating and applying plans for modification.
 Identifying and solving disagreements.
Handling cultural diversity
Cultural diversity in a work group offers opportunities and difficulties. Economy is
benefited when the work groups are managed successfully. The organisation’s
capability to draw, save, and inspire people from diverse cultures can give the
organisation spirited advantages in structures of cost, creativity, problem solving,
and adjusting to change.
Cultural diversity offers key chances for joint work and co-operative action. Group
work is a joint venture where, the production of two or more individuals or groups
working in cooperation is larger than the combined production of their individual
work.
Factors controlling group creativity
On complicated problem solving jobs diverse groups do better than identical
groups. Diverse groups require time to solve issues of working together. In diverse
groups, over time, the work experience helps to overcome gender, racial, and
organisational and functional discriminations. But the impact cannot be evaluated
and there is always risk in creating a diverse group. A successful group is profitable
with respect to quick results and the creation of concern for the future. Negative
stereotypes are emphasised if it fails.
Factors related with the industry and company culture are also important. Diverse
groups do well when the members:
o Assist to make group decisions.
o Value the exchange of different points of view.
o Respect each other’s skills and share their own.
o Value the chance for cross-cultural learning.
o Tolerate uncertainty and try to triumph over the inefficiencies that occur when
members of diverse cultures work together.

A diverse group is known to be more creative, where the members are tolerant of
differences. The top management level provides its moral and administrative
support, and gives time for the group to overcome the usual process difficulties.
They also provide diversity training, and the group members are rewarded for their
commitment.
Ignore diversity
It may be difficult to manage diversity. It is better to ignore, which is an alternative.
The management must:
o Ignore cultural diversity within the employees.
o Down-play the importance of cultural diversity.

This rejection to identify diversity happens when management:

o Fails to have sufficient awareness and skills to identify diversity.
o Identifies diversity but does not have the skill to manage the diversity.
o Recognises the negative consequences of identifying diversity probably cause
greater issues than ignoring it.
o Thinks the likely benefits of identifying and managing diversity do not validate the
expected expenses.
o Identifies that the job provides no chances for drawing advantages from diversity.

Strategies to ignore diversity may be possible when culture groups are given
various jobs, and sharing required resources are independent in the workplace.
Groups and group members are equally incorporated and work together. In such
cases, confusion occurs when the diverse value systems are not identified that are
held by different staff groups.
Q3. Cosmos Limited wants to enter international markets. Will country risk
analysis help Cosmos Limited to take correct decisions? Substantiate your
answer
Ans: Country risk analysis is the evaluation of possible risks and rewards from
business experiences in a country. It is used to survey countries where the firm is
engaged in international business, and avoids countries with excessive risk. With
globalisation, country risk analysis has become essential for the international
creditors and investors
Overview of Country Risk Analysis
Country Risk Analysis (CRA) identifies imbalances that increase the risks in a cross-
border investment. CRA represents the potentially adverse impact of a country’s
environment on the multinational corporation’s cash flows and is the probability of
loss due to exposure to the political, economic, and social upheavals in a foreign
country. All business dealings involve risks. An increasing number of companies
involving in external trade indicate huge business opportunities and promising
markets. Since the 1980s, the financial markets are being refined with the
introduction of new products.
When business transactions occur across international borders, they bring
additional risks compared to those in domestic transactions. These additional risks
are called country risks which include risks arising from national differences in
socio-political institutions, economic structures, policies, currencies, and geography.
The CRA monitors the potential for these risks to decrease the expected return of a
cross-border investment. For example, a multinational enterprise (MNE) that sets up
a plant in a foreign country faces different risks compared to bank lending to a
foreign government. The MNE must consider the risks from a broader spectrum of
country characteristics. Some categories relevant to a plant investment contain a
much higher degree of risk because the MNE remains exposed to risk for a longer
period of time.
Analysts have categorised country risk into following groups:
 Economic risk – This type of risk is the important change in the economic
structure that produces a change in the expected return of an investment. Risk
arises from the negative changes in fundamental economic policy goals (fiscal,
monetary, international, or wealth distribution or creation).
 Transfer risk – Transfer risk arises from a decision by a foreign government to
restrict capital movements. It is analysed as a function of a country’s ability to earn
foreign currency. Therefore, it implies that effort in earning foreign currency
increases the possibility of capital controls.
 Exchange risk – This risk occurs due to an unfavourable movement in the
exchange rate. Exchange risk can be defined as a form of risk that arises from the
change in price of one currency against another. Whenever investors or companies
have assets or business operations across national borders, they face currency risk
if their positions are not hedged.
 Location risk – This type of risk is also referred to as neighborhood risk. It
includes effects caused by problems in a region or in countries with similar
characteristics. Location risk includes effects caused by troubles in a region, in
trading partner of a country, or in countries with similar perceived characteristics.
 Sovereign risk – This risk is based on a government’s inability to meet its loan
obligations. Sovereign risk is closely linked to transfer risk in which a government
may run out of foreign exchange due to adverse developments in its balance of
payments. It also relates to political risk in which a government may decide not to
honor its commitments for political reasons.
 Political risk – This is the risk of loss that is caused due to change in the political
structure or in the politics of country where the investment is made. For example,
tax laws, expropriation of assets, tariffs, or restriction in repatriation of profits, war,
corruption and bureaucracy also contribute to the element of political risk.

Risk assessment requires analysis of many factors, including the decision-making

process in the government, relationships of various groups in a country and the
history of the country. Country risk is due to unpredicted events in a foreign country
affecting the value of international assets, investment projects and their cash flows.
The analysis of country risks distinguishes between the ability to pay and the
willingness to pay. It is essential to analyse the sustainable amount of funds a
country can borrow. Country risk is determined by the costs and benefits of a
country’s repayment and default strategies. The ways of evaluating country risks by
different firms and financial institutions differ from each other. The international
trade growth and the financial programs development demand periodical
improvement of risk methodology and analysis of country risks.
Purpose of Country Risk Analysis
Risk arises because of uncertainty and uncertainty occurs due to the lack of reliable
information. Country risk is composed of all the uncertainty that defines the risk of
country exposure. The assessment of country risk is used to incorporate country
risk in capital budgeting and modify the discount rate.
CRA regulates the estimated cash flows and explores the main techniques used to
measure a country’s overall riskiness. It is mainly used by MNCs, in order to avoid
countries with excessive risk. It can be used to monitor countries where the MNC is
engaged in international business. Analysing the country risk helps in evaluating the
risk for a planned project considered for a foreign country and assesses gain and
loss possibility outcomes of cross-border investment or export strategy.
Country detailed risk refers to the unpredictability of returns on international
business transactions in view of information associated with a particular country.
The techniques used by the banks and other agencies for country risk analysis can
be classified as qualitative or quantitative. Many agencies merge both qualitative
and quantitative information into a single rating. A survey conducted by the US
EXIM bank classified the various methods of country risk assessment used by the
banks into four types. They are:
 Fully qualitative method – The fully qualitative method involves a detailed
analysis of a country. It includes general discussion of a country’s economic,
political, and social conditions and prediction. Fully qualitative method can be
adapted to the unique strengths and problems of the country undergoing
evaluation.
 Structured qualitative method – The structured method uses a uniform
format with predetermined scope. In structured qualitative method, it is easier to
make comparisons between countries as it
follows a specific format across countries. This technique was the most popular
among the banks during the late seventies.
 Checklist method – The checklist method involves scoring the country based on
specific variables that can be either quantitative, in which the scoring does not need
personal judgment of the country being scored or qualitative, in which the scoring
needs subjective determinations. All items are scaled from the lowest to the highest
score. The sum of scores is then used to determine the country risk.
 Delphi technique – The technique involves a set of independent opinions
without group discussion. As applied to country risk analysis, the MNC can assess
definite employees who have the capability to evaluate the risk characteristics of a
particular country. The MNC gets responses from its evaluation and then may
determine some opinions about the risk of the country.
 Inspection visits – Involves travelling to a country and conducting meeting with
government officials, business executives, and consumers. These meetings clarify
any vague opinions the firm has about the country.
 Other quantitative methods – The quantitative models used in statistical
studies of country risk analysis can be classified as discriminant analysis, principal
component analysis, logit analysis and classification and regression tree method
Data sourcing
The basic data is important to analyse a country. The economic, financial and
currency risk components are based on the variables (quantitative and qualitative
variables). The variables must consider the particularities of each country and the
needs of the model used. The standard variables are used to maintain the regular
analysis comparable with similar works of other countries. Therefore, the first step
is to make sure that the historical series of official data are reliable, consistent and
comparable. The standard economic variables that are found mainly in the varied
approach adopted by financial institutions and rating agencies, are associated with
the country’s real ability to repay its commitments. The balance of payments
(summary account of economic transactions among a country and the others
nations of the world, during a period) and its evolution through the years means a
strong source of data. The exchange rate (currency risk) is another important
variable considered, as it balances the transactions (balances the prices of goods,
services, and capital) between residents and non-residents. The analysis must
consider the historical behavior of the exchange rate and the policy which made
clear whether the country follows a rational economics approach or it uses the
exchange rate as a tool to maintain a forced macroeconomic equilibrium.
Apart from the macroeconomic variables which deal with the external sector of the
economy, there are some other relevant variables such as the interest rate, level of
investments, public debt and its service, internal savings, consumption, GDP or
GNP, money supply, inflation rate and so on.
The analysis must be accomplished with qualitative variables, which consider social
aspects as population, life expectancy, rate of birthday, rate of unemployment, level
of literacy and so on. The social-political aspects are necessary for all kind of
analysis as they describe the whole setting of the running economy.
Tools
The risk management demands a regular follow up regarding governmental
policies, external and internal environment, outlook provided by rating agencies,
and so on. Following are the tools recommended:
 Chain of value – Includes the main countries that sustain trade relationships
with the nation, broken by sectors and products.
 Strength and weakness chart – Focus the key aspects that warn the country.
 Table of financial markets performance – Follow up the behavior of bonds
and stocks already issued and to be issued.
 Table of macroeconomic variables – Provides alert signals when the behavior
of any ratio presents a relevant change.
The content of country risk analysis mainly involves country history, corporate
risk, dependency level, external environment, domestic financial system,
ratios for economic risk evaluation and strength and weakness chart.
Country history
The historical brief helps to identify aspects that interfere in the future behavior of
the country, reducing the ability to payback any external commitment. The main
historical data provides a good understanding of the key factors which draw the
behaviour of the society, the government, the private sector, the legal environment,
the economical, political, and the relationships to neighbour nations and the world
as a whole.

Corporate risk
Both country risk studies and business risk analysis enhances wealth from the
available resources, in terms of capital, natural resources, technology and labour
forces. This clarifies that those kind of analysis procures extensive knowledge from
the business approach for companies, including financial theory.
Dependency level
The next step after the history in brief, is a clear definition about how the country is
positioned in the world in terms of its wide relationships, economic block in which it
belongs to, importance of international trade and so on. All these aspects are
significant to identify the dependency level of the country. The financial
dependency to meet the needs of a country is also a strong concern for the analyst.
In this case, the maturity of debts (internal and external) and the available sources
of financing also help to measure the freedom grades of the country.
External environment
The external trade is an important factor to the development of societies.
Globalisation has brought international business to the center of the discussions
and the external environment has become vital for all countries.
Thus, a complete vision on economic trends, the behavior of financial markets, the
forecasts for conflicts among nations, the improvement of the economic blocks, the
level of openness of the world economy, financial crisis and international liquidity is
a framework over which the analysis must start.
Domestic financial system
The banking sector has implemented many actions to avoid losses, after the
international crisis. Basel Committee has defined some strong measures to be
followed by the financial houses and Central Banks are trying to monitor their
jurisdictions. Apart from those procedures, recently Asia and Turkey crisis have
shown that the inspection is not enough to keep the reliability of some domestic
system. The international banks had developed many tools to deal with
international crisis. When domestic banks do not have a consistent risk
management policies and adequate provisions to theirs credits, the country risk
happens to be the worst. Therefore, the analysis must consider the health of the
domestic financial system, by evaluating information provided by the Central Banks
and, from the principal banks of the country. Accessing Centrals Bank policies and
supervising procedures also help to evaluate the health of the financial system.
Ratios for economic risk evaluation
Cross-border economic risk analysis evaluates the probable macroeconomic ratios
among some variables. They can be separated into two groups such as domestic
and external. The figures must be presented in historic series (at least five years) to
provide information about its progress, which can be real values, percentages, or
relations. The mainly used ratios and variables in case of domestic economy are the
following:
· Gross domestic product (GDP) –· GDP per capita –· GDP growth rate –·
Unemployment rate –· Internal savings or GDP –· Investment or GDP –·
Gross domestic fixed investment or variation of GDP – Gini Index –· Growth
domestic fixed investment or gross domestic savings –.· Budget deficit or
GDP –· Internal debt or GDP –
The monetary policy is essential as it deals with the price stability. An economy
which presents less instability in its prices of goods and services, provides huge
facilities to decision makers based on their predictions to expected returns of
investments and a firm social, economical and political environment. All these
aspects request a systematic approach over price indicators such as the following:
· Real interest rate –· Percentage increase in the money supply The mainly
used ratios and variables in case of external economy are the following:
· External debt or GDP –· Short term debts and reserves –· Exchange currency rate –
· External debt services and exports –.
Strength and weakness chart
In order to explain the significant aspects provided by the analysis, the strength and
weakness chart can be used to merge each strength and weakness with the related
scenario. is a model of relationships among several variables (quantitative and
qualitative) to show their interdependency and the complexity of analysis.
Q4. How can managers in international companies adjust to the ethical
factors influencing countries? Is it possible to establish international
ethical codes? Briefly explain?
Ans: Ethics can be defined as the evaluation of moral values, principles, and
standards of human conduct and its application in daily life to determine acceptable
human behaviour.
Business ethics pertains to the application of ethics to business, and is a matter of
concern in the corporate world. Business ethics is almost similar to the generally
accepted norms and principles. Behaviour that is considered unethical and immoral
in society, for example dishonesty, applies to business as well.
Managers are influenced by three factors affecting ethical values. These factors
have unique value systems that have varying degrees of control over managers.
Religion – Religion is one of the oldest factors affecting ethics. Despite the
differences in religious teachings, religions agree on the fundamental principles and
ethics. All major religions preach the need for high ethical standards, an orderly
social system, and stress on social responsibility as contributing factors to general
well-being.
Culture – Culture refers to a set of values and standards that defines acceptable
behaviour passed on to generations. These values and standards are important
because the code of conduct of people reflects on the culture they belong to.
Civilisation is the collective experience that people have passed on through three
distinct phases: the hunting and gathering phase, agriculture phase, and the
industrial phase. These phases reflect the changing economic and social
arrangements in human history.
Law – Law refers to the rules of conduct, approved by the legal system of a country
or state that guides human behaviour. Laws change and evolve with emerging and
changing issues. Every organisation is expected to abide the law, but in the pursuit
of profit, laws are frequently violated. The most common breach of law in business
is tax evasion, producing inferior quality goods, and disregard for environmental
protection laws.
Ethics is significant in all areas of business and plays an important role in ensuring a
successful business. The role of business ethics is evident from the conception of an
idea to the sale of a product. In an organisation, every division such as sales and
marketing, customer service, finance, and accounting and taxation has to follow
certain ethics.
Public image – In order to gain public confidence and respect, organisations must
ascertain that they are honest in their transactions. The services or products of a
business affect the lives of thousands of people. It is important for the top
management to impart high ethical standards to their employees, who develop
these services or products.
A company that is ethically and socially responsible has a better public image.
People tend to favour the products and services of such organisations. Investors’
trust is just as important as public image for any business. A company that
practices good ethical creates a positive impression among its stakeholders.
Management’s credibility with employees – Common goals and values are
developed when employees feel that the management is ethical and genuine.
Management’s credibility with employees and the public are intertwined. Employees
feel proud to be a part of an organisation that is respected by the public. Generous
compensations and effective business strategies do not always guarantee employee
loyalty; organisation ethics is equally significant. Thus, companies benefit from
being ethical because they attract and retain good and loyal employees.
Better decision-making – Decisions made by an ethical management are in the
best interests of the organisation, its employees, and the public. Ethical decisions
take into account various social, economic and ethical factors.
Profit maximisation – Companies that emphasise on ethical conduct are
successful in the long run, even though they lose money in the short run. Hence, a
business that is inspired by ethics is a profitable business. Costs of audit and
investigation are lower in an ethical company.
Protection of society – In the absence of proper enforcement, organisations are
responsible to practice ethics and ensure mechanisms to prevent unlawful events.
Thus, by propagating ethical values, a business organisation can save government
resources and protect the society from exploitation.
Most countries have similar ethical values, but are practiced differently. This section
deals with the way individuals in different countries approach ethical issues, and
their ethically acceptable behaviour. With the rise in global firms, issues related to
ethical values and traditions become more common. These ethical issues create
complications to Multi-National Companies (MNCs) while dealing with other
countries for business. Hence, many companies have formulated well-designed
codes of conduct to help their employees.
Two of the most prominent issues that managers in MNCs operating in foreign
countries face are bribery and corruption and worker compensation.
Bribery and corruption – Bribery can be defined as the act of offering, accepting,
or soliciting something of value for the purpose of influencing the action of officials
in the discharge of their duties. Corruption is the abuse of public office for personal
gain. The issue arises when there are differences in perception in different
countries. For example, in the Middle East, it is perfectly acceptable to offer an
official a gift. In Britain it is considered as an attempt to bribe the official, and
hence, considered unlawful.
Worker compensation – Businesses invest in production facilities abroad because
of the availability of low-cost labour, which enables them to offer goods and
services at a lower price than their competitors. The issue arises when workers are
exploited and are underpaid compared to the workers in the parent country who are
paid more for the same job. The disparity arises due to the differences in the
regulatory standards in the two countries.
Earlier, we believed that ethics is a prerogative of individuals, but now this
perception has immensely changed. Many companies use management techniques
to encourage ethical behaviour at an organisational level.
Code of conduct for MNCs
The code of conduct for MNCs refers to a set of rules that guides corporate
behaviour. These rules prescribe the duties and limitations of a manager. The top
management must communicate the code of conduct to all members of the
organisation along with their commitment in enforcing the code.
Some of the ethical requirements for international companies are as follows:
o Respect basic human rights.
o Minimise any negative impact on local economic policies.
o Maintain high standards of local political involvement.
o Transfer technology.
o Protect the environment.
o Protect the consumer.
o Employ labour practices that are not exploitative.

When a manager of an international firm faces an ethical problem, certain models

help in solving these ethical issues
Culture is a major factor which influences marketing decisions and practices in a
foreign country. For example, in the middle-eastern countries the prior approval of
the governing authorities should be taken if a firm plans to advertise a product
related to women’s apparel, as showcasing some aspects of women clothing is
considered immodest and immoral.
Q.5 Discuss the international marketing strategies. How is it different
from domestic marketing strategies?
Ans: International marketing refers to marketing of goods and products by
companies overseas or across national borderlines. The techniques used while
dealing overseas is an extension of the techniques used in the home country by the
company.
Taking into account the various conditions on which markets vary and depend,
appropriate marketing strategies should be devised and adopted. Like, some
countries prevent foreign firms from entering into its market space through
protective legislation. Protectionism on the long run results in inefficiency of local
firms as it is inept towards competition from foreign firms and other technological
advancements. It also increases the living costs and protects inefficient domestic
firms.
To counter this scenario firms must learn how to enter foreign markets and increase
their global competitiveness. Firms that plan to do business in foreign land find the
marketplace different from the domestic one. Market sizes, customer preferences,
and marketing practices all vary; therefore the firms planning to venture abroad
must analyse all segments of the market in which they expect to compete.
The decision of a firm to compete internationally is strategic; it will have an effect
on the firm, including its management and operations locally. The decision of a firm
to compete in foreign markets has many reasons. Some firms go abroad as the
result of potential opportunities to exploit the market and to grow globally. And for
some it is a policy driven decision to globalise and to take advantage by
pressurising competitors.
But, the decision to compete abroad is always a strategic down to business decision
rather than simply a reaction. Strategic reasons for global expansion are:
o Diversifying markets that provide opportunistic global market development.

o Following customers abroad (customer satisfaction).

o Exploiting different economic growth rates.
o Pursuing a global logic or imperative to harvest new markets and profits.
o Pursuing geographic diversification.
o Globalising for defensive reasons.
o Exploiting product life cycle differences (technology).
o Pursuing potential abroad.
Likewise, there can be other reasons like competition at home, tax structures,
comparative advantage, economic trends, demographic conditions, and the stage in
the product life cycle. In order to succeed, a firm should carefully look at their
geographic expansion and global marketing strategy. To a certain extent, a firm
makes a decision about its extent of globalisation by taking a stance that may span
from entirely domestic to a global reach where the company devotes its entire
marketing strategy to global competition. In the process of developing an
international marketing strategy, the firm may decide to do business in its home-
country (domestic operations) only or host-country (foreign country) only.
Segmentation
Firms that serve global markets can be segregated into several clusters based on
their similarities. Each such cluster is termed as a segment. Segmentation helps the
firms to serve the markets in an improved way. Markets can be segmented into nine
categories, but the most common method of segmentation is on the basis of
individual characteristics, which include the behavioural, psychographic, and
demographic segmentations. The basis of behavioural segmentation is the general
behavioural aspects of the customers. Demographic segmentation considers the
factors like age, culture, income, education and gender. Psychographic
segmentation takes into account: beliefs, values, attitudes, personalities, opinions,
lifestyles and so on.
Market positioning
The next step in the marketing process is, the firms should position their product in
the global market. Product positioning is the process of creating a favourable image
of the product against the competitor’s products. In global markets product
positioning is categorised as high-tech or high–touch positioning.
One challenge that firms face is to make a trade-off between adjusting their
products to the specific demands of a country and gaining advantage of
standardisation such as the maintenance of a consistent global brand image and
cost savings. This is task is not easy.
International product policy
Some thinkers of the industry tend to draw a distinction between conventional
products and services, stressing on service characteristics such as heterogeneity
(variation in standards among providers, frequently even among different locations
of the same firm), inseparability from consumption, intangibility, and perishability.
Typically, products are composed of some service component like, documentation,
a warranty, and distribution. These service components are an integral part of the
product and its positioning.
Firms have a choice in marketing their products across markets. Many a times,
firms opt for a strategy which involves customisation, through which the firm
introduces a unique product in each country, believing that tastes differ so much
between countries that it is necessary to create a new product for each market. On
the other hand, standardisation proposes the marketing of one global product, with
the belief that the same product can be sold in different countries without
significant changes. For example, Intel microprocessors are the same irrespective of
the country in which they are sold.
Finally, in most cases firms will go for some kind of adaptation. Here, when moving
a product between markets minor modifications are made to the product. For
example, in U.S. fuel is relatively cheap, therefore cars have larger engines than the
cars in Asia and Europe; and then again, much of the design is identical or similar.
International pricing decisions
Pricing is the process of ascertaining the value for the product or service that will be
offered for sale.
In international markets, making pricing decisions is entangled in difficulties as it
involves trade barriers, multiple currencies, additional cost considerations, and
longer distribution channels. Before establishing the prices, the firm must know its
target market well because when the firm is clear about the market it is serving,
then it can determine the price appropriately. The pricing policy must be consistent
with the firms overall objectives. Some common pricing objectives are: profit, return
on investment, survival, market share, status quo, and product quality.
The strategies for international pricing can be classified into the following three
types:
· Market penetration· Market holding: · Market skimming:
The factors that influence pricing decisions are inflation, devaluation and
revaluation, nature of product or industry and competitive behaviour, market
demand, and transfer pricing.
The approach taken by company towards pricing when operating in international
markets are ethnocentric, polycentric, and geocentric.
Price can be defined by the following equation:
The pricing decision enables us to change the price in many ways, some of them
are:
· “Sticker” price changes –. · Change quantity –· Change quality –· Change
terms –
Transfer pricing
Transfer pricing is the process of setting a price that will be charged by a subsidiary
(unit) of a multi-unit firm to another unit for goods and services, which are sold
between such related units.
Transfer pricing is determined in three ways: market based pricing, transfer at cost
and cost-plus pricing. The Arm’s Length pricing rule is used to establish the price to
be charged to the subsidiary.
Many managers consider transfer pricing as non-market based. The reason for
transfer pricing may be internal or external. Internal transfer pricing include
motivating managers and monitoring performance. External factors include taxes,
tariffs, and other charges.
Transfer Pricing Manipulation (TPM) is used to overcome these reasons.
Governments usually discourage TPM since it is against transfer pricing, where
transfer pricing is the act of pricing commodities or services. However, in common
terminology, transfer pricing generally refers TPM.
International advertising
International advertising is usually associated with using the same brand name all
over the world. However, a firm can use different brand names for historic reasons.
The acquisition of local firms by global players has resulted in a number of local
brands. A firm may find it unfavourable to change those names as these local
brands have their own distinctive market.
The purpose of international advertising is to reach and communicate to target
audiences in more than one country. The target audience differ from country to
country in terms of the response towards humour or emotional appeals, perception
or interpretation of symbols and stimuli and level of literacy. Sometimes, globalised
firms use the same advertising agencies and centralise the advertising decisions
and budgets. In other cases, local subsidiaries handle their budget, resulting in
greater use of local advertising agencies.
International advertising can be thought of as a communication process that
transpires in multiple cultures that vary in terms of communication styles, values,
and consumption patterns. International advertising is a business activity and not
just a communication process. It involves advertisers and advertising agencies that
create ads and buy media in different countries. This industry is growing worldwide.
International advertising is also reckoned as a major force that mirrors both social
values, and propagates certain values worldwide.
International promotion and distribution
Distribution of goods from manufacturer to the end user is an important aspect of
business. Companies have their own ways of distribution. Some companies directly
perform the distribution service by contacting others whereas a few companies take
help from other companies who perform the distribution services. The distribution
services include:
 The purchase of goods.
 The assembly of an attractive assortment of goods.
 Holding stocks.
 Promoting sale of goods to the customer.
 The physical movement of goods.

In international marketing, companies usually take the advantage of other countries

for the distribution of their products. The selection of distribution channel is helpful
to gain the competitive advantage. The distribution channel is also dependent on
the way to manage and control the channel. Selecting the distribution channel is
very important for agents and distributors.
Domestic vs. International marketing
Domestic marketing refers to the practice of marketing within a firm’s home
country. Whereas International or foreign marketing is the practice of marketing in
a foreign country; the marketing is for the domestic operations of the firm in that
country.
Domestic marketing finds the "how" and "why" a product succeeds or fails within
the firm’s home country and how the marketing activity affects the outcome.
Whereas, foreign marketing deals with these questions and tries to find answers
according to the foreign market conditions and it provides a micro view of the
market at the firm’s level.
In domestic marketing a firm has insight of the marketing practices, culture,
customer preferences, climate and so on of its home country, while it is not totally
aware of the policies and the market conditions of the foreign country.
The stages that have led to achieve global marketing are:
 Domestic marketing – Firms manufacture and sell products within the country.
Hence, there is no international phenomenon.
 Export marketing – Firms start exporting products to other countries. This is a
very basic stage of global marketing. Here, the products are developed based on
the company’s domestic market although the goods are exported to foreign
countries.
 International marketing – Now, Firms start to sell products to various countries
and the approach is ‘polycentric’, that is, making different products for different
countries.
 Multinational marketing – In this stage, the number of countries in which the
firm is doing business gets bigger than that in the earlier stage. And hence, the
company identifies the regions to which the company can deliver same product
instead of producing different goods for different countries. For example, a firm may
decide to sell same products in India, Sri lanka and Pakistan, assuming that the
people living in this region have similar choice and at the same time offering
different product for American countries. This approach is termed ‘regiocentric
approach’.
 Global marketing – Company operating in various countries opts for a common
single product in order to achieve cost efficiencies. This is achieved by analysing the
requirements and the choice of the customers in those countries. This approach is
called ‘Geocentric approach’.

The practice of marketing at the international stage does not designate any country
as domestic or foreign. The firm is not considered as the corporate citizen of the
world as it has a home base.
The firm must not have a ’single marketing plan’, because there are differences
between the target markets (that is domestic or international markets). There
should never be a rigid marketing campaign. A firm that is successful internationally
first obtains success locally.
Few approaches that you can consider for an international marketing are:
 Advertise as a foreign product – By doing so, the product will be considered
as genuine and original in some countries.
 Joint partnership with a local firm – finding a firm that has already
established credibility will benefit a lot. The product will be considered as a local
product by following this marketing approach.
 Licensing – You can sell the rights of your product to a foreign firm. Here the
problem is that the firm may not maintain the quality standard and therefore may
hurt the image of the brand.

Culture is a major factor which influences marketing decisions and practices in a

foreign country. For example, in the middle-eastern countries the prior approval of
the governing authorities should be taken if a firm plans to advertise a product
related to women’s apparel, as showcasing some aspects of women clothing is
considered immodest and immoral.
Q.6 Explain briefly the international financial management components
with examples and applicability
Ans: The term ‘Financial Management’ refers to the proper maintenance of all the
monetary transactions of the organisation. It also means recording of transactions
in a standard manner that will show the financial position and performance of the
organisation. The Financial Management can be categorised into domestic and
international financial management.
The domestic financial management refers to managing financial services within the
country. International financial management refers to managing finance and share
between the countries.
The main aim of international finance management is to maximise the
organisation’s value that in turn will increase the impact on the wealth of the
stockholders. When the doors of liberalisation opened, entrepreneurs capitalised the
opportunity to step their foot to conduct business in different parts of the world.
International trade gave way for the growth of international business. For a
corporation to be successful, it is vital to manage the finance and business accounts
appropriately. The rise in significance and complexity of financial administration in a
global environment creates a great challenge for financial managers. The
contributions of different financial innovations like currency derivative, international
stock listing, and multicurrency bonds have necessitated the accurate management
of the flow of international funds through the study of international financial
management.
The International Financial Management (IFM) came to its existence when the
countries all over the world started opening their doors for each other. This
phenomenon is also called as liberalisation. But after the end of the Second World
War, the integration in terms of foreign activities has grown substantially. The firms
of all types are now opting to operate their business and deploy their resources
abroad. Furthermore, the differences between the countries have persisted that has
given rise to the prevalence of market imperfections
Components of International Financial Management
Foreign exchange market
The Foreign exchange or the forex markets facilitates the participants to obtain,
trade, exchange and speculate foreign currency. The foreign exchange market
consists of banks, central banks, commercial companies, hedge funds, investment
management firms and retail foreign exchange brokers and investors. It is
considered to be the leading financial market in the world. It is vital to realise that
the foreign exchange is not a single exchange, but is created from a global network
of computers that connects the participants from all over the world.
The foreign exchange market is immense in size and survives to serve a number of
functions ranging from the funding of cross-border investment, loans, trade in
goods, trade in services and currency speculation. The participant in a foreign
exchange market will normally ask for a price.
The trading in the foreign exchange market may take place in the following forms:
 Outright cash or ready – foreign exchange currency deals that take place on
the date of the deal.
 Next day – foreign exchange currency deals that take place on the next working
day.
 Swap – Simultaneous sale and purchase of identical amounts of currency for
different maturities.
 “Spot” and “Forward” contracts – A Spot contract is a binding obligation to
buy or sell a definite amount of foreign currency at the existing or spot market rate.
A forward contract is a binding obligation to buy or sell a definite amount of foreign
currency at the pre-agreed rate of exchange, on or before a certain date.

The advantage of spot dealing has resulted in a simplest way to deal with all foreign
currency requirements. It carries the greatest risk of exchange rate fluctuations due
to lack of certainty of the rate until the deal is carried out. The spot rate that is
intended to receive will be set by current market conditions, the demand and supply
of currency being traded and the amount to be dealt. In general, a better spot rate
can be received if the amount of dealing is high. The spot deal will come to an end
in two working days after the deal is struck.
A forward market needs a more complex calculation. A forward rate is based on the
existing spot rate plus a premium or discounts which are determined by the interest
rate connecting the two currencies that are involved. For example, the interest
rates of UK are higher than that of US and therefore a modification is made to the
spot rate to reflect the financial effect of this differential over the period of the
forward contract. The duration will be up to two years for a forward contract. A
variation in foreign exchange markets can be affected to any company whether or
not they are directly involved in the international trade or not. This is often referred
to as ‘Economic’ foreign exchange and most difficult to protect a business.
The three ways of managing risks are as follows:
 Choosing to manage risk by dealing with the spot market whenever the need of
cash flow rises. This will result in a high risk and speculative strategy since one will
not know the rate at which a transaction is dealt until the day and time it occurs.
Managing the business becomes difficult if it depends on the selling or buying the
currency in the spot market.
 The decision must be made to book a foreign exchange contract with the bank
whenever the foreign exchange risk is likely to occur. This will help to fix the
exchange rate immediately and will give a clear idea of knowing the exact cost of
foreign currency and the amount to be received at the time of settlement whenever
this due occurs.
 A currency option will prevent unfavourable exchange rate movements in the
similar way as a forward contract does. It will permit gains if the markets move as
per the expectations. For this base, a currency option is often demonstrated as a
forward contract that can be left if it is not followed. Often banks provide currency
options which will ensure protection and flexibility, but the likely problem to arise is
the involvement of premium of particular kind. The premium involved might be a
cash amount or it could also influence into the charge of the transaction.

Foreign currency derivatives

Currency derivative is defined as a financial contract in order to swap two
currencies at a predestined rate. It can also be termed as the agreement where the
value can be determined from the rate of exchange of two currencies at the spot.
Hence, the spot market exposures can be enclosed with the currency derivatives.
The main advantage from derivative hedging is the basket of currency available.
Figure 1 describes the examples of currency derivatives. The derivatives can be
hedged with other derivatives. In the foreign exchange market, currency derivatives
like the currency features, currency options and currency swaps are usually traded.
The agreement undertaken to exchange cash flow streams in one currency for cash
flow streams in another currency in future is provided by currency swaps. These will
help to increase the funds of foreign currency from the cheapest sources.
 Figure 1: Example for Foreign Currency Derivatives

Some of the risks associated with currency derivatives are:

 Credit risk takes place, arising from the parties involved in a contract.
 Market risk occurs due to adverse moves in the overall market.
 Liquidity risks occur due to the requirement of available counterparties to take
the other side of the trade.
 Settlement risks similar to the credit risks occur when the parties involved in the
contract fail to provide the currency at the agreed time.
 Operational risks are one of the biggest risks that occur in trading derivatives due
to human error.
 Legal risks pertain to the counterparties of currency swaps that go into
receivership while the swap is taking place.

International monetary systems

The international monetary systems represent the set of rules that are agreed
internationally along with its conventions. It also consists of set of rules that govern
international scenario, supporting institutions which will facilitate the worldwide
trade, the investment across cross-borders and the reallocation of capital between
the states.
International monetary systems provide the mode of payment acceptable between
buyers and sellers of different nationality, with addition to deferred payment. The
global balance can be corrected by providing sufficient liquidity for the variations
occurring in trade. Thereby it can be operated successfully.
The gold and gold bullion standards
The gold standard was the first modern international system. It was operating
during the late 19th and early 20th centuries, the standard provided for the free
circulation between nations of gold coins of standard specification. The gold
happened to be the only standard of value under the system. The advantages of
this system depend in its stabilising influence. Any nation which exports more than
its import would receive gold in payment of the balance. This in turn has resulted in
the lowered value of domestic currency. The higher prices lead to the decreased
demands for exports. The sudden increase in the supply of gold may be due to the
discovery of rich deposit, which in turn will result in the increase of price abruptly.
This standard was substituted by the gold bullion standard during the 1920s;
thereby the nations no longer minted gold coins. Instead, reversed their currencies
with gold bullion and determined to buy and sell the bullion at a fixed cost. This
system was also discarded in the 1930s.
The gold-exchange system
Trading was conducted internationally with respect to the gold-exchange standard
following World War II. In this system, the value of the currency is fixed by the
nations with respect to some foreign currency but not with respect to gold. Most of
the nations fixed their currency to the US dollar funds in the United States. With a
view to maintain a stable exchange rate at the global level, the International
Monetary Fund (IMF) was created at the ‘Bretton Woods international Conference’
held in 1944. The drain on the US gold reserves continued up to the 1970s. Later in
1971, the gold convertibility was abandoned by the United States leaving the world
without a single international monetary system.
Floating exchange rates and recent development
After the abundance of the gold convertibility by the US, the IMF in 1976 decided to
be in agreement on the float exchange rates. The gold standard was suspended and
the values of different currencies were determined in the market. The ‘Japanese
yen’ and the ‘German Deutschmark’ strengthened and turned out to be increasingly
important in international financial market, at the same time the US dollar
diminished its significance. The Euro was set up in financial market in 1999 as a
replacement for the currencies. Hence, it became the second most commonly used
currency after the dollar in the international market. Many large companies opt to
use euro rather than the dollar in bond trading with a goal to receive better
exchange rates. Very recently the some of the members of Organisation of
Petroleum Exporting Countries (OPEC) such as Saudi Arabia, Iraq have opted to
trade petroleum in Euro than in Dollar.
International financial markets
International foreign markets provide links connecting the financial markets of each
country and independent markets external to the authority of any one country. The
heart of the international financial market is being governed by the market of
currency where the foreign currency is denominated by the international trade and
investment. Hence the purchase of goods and services is preceded by the purchase
of currency.
The purpose of the foreign currency markets, international money markets,
international capital markets and international securities markets are as follows:
 The foreign currency markets – The foreign currency market is an
international market that is familiar in structure. This means that there exists no
central place where the trading can take place. The ’market’ is actually the
telecommunications like among financial institutions around the globe and opens
for business at any time. The greater part of the worlds that deal in foreign
currencies is still taking position in the cities where international financial activity is
centred.
 International money markets – A money market can be conventionally
defined as a market for accounts, deposits or deposits that include maturities of one
year or less. This is also termed as the Euro currency markets which constitute an
enormous financial market that is beyond the influence and supervision of world
financial and government authorities. The Euro currency market is a money market
for depositing and borrowing money located outside the country where that money
is officially permitted tender. Also, Euro currencies are bank deposits and loans
existing outside any particular country.
 International capital markets – The international capital provides links among
the capital markets of individual countries. It also comprises a separate market of
their own, the capital market that flows in to the Euro markets. The firms enjoy the
freedom to raise capital, debit, fixed or floating interest rates and maturities varying
from one month to thirty years in an international capital markets.
 International security markets – The banks have experienced the greatest
growth in the past decade because of the continuity in providing large portion of the
international financial needs of the government and business. The private
placements, bonds and equities are included in the international security market.

The following are the reasons given for the enormous growth in the trading of
foreign currency:
 Deregulation of international capital flows – Without the major government
restrictions, it is extremely simple to move the currencies and capital around the
globe. The majority of the deregulation that has differentiated government policy
over the past 10 to 15 years.
 Gain in technology and transaction cost efficiency – The advancements in
technology is not only taking place in the distribution of information, in addition to
the performance of exchange or trading. This has resulted greatly to the capacity of
individuals on these markets to accomplish instantaneous arbitrage.
 Market upwings – The financial markets have become increasingly unstable
over recent years. There are faster swings in the stock values and interest rates,
adding to the enthusiasm for moving further capital at faster rates.