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Executive Summary

Financial risk is the prospect of financial loss or gain due to unforeseen changes in the
underlying risk factors market risk, credit risk, operational risk.
Market Risk
Market Risk is the risk of loss or gain arising from unexpected changes in market
prices such as security prices) or market rates (such as interest rates or exchange
Credit risk
The risk of loss arising from failure of counterparty to make a promised payment.
Operational Risk
Risk of loss arising from failure of internal systems or people who operate in them.
n this study emphasis is laid on one particular form of financial risk namely market
risk, or the risk of loss or gain arising from unexpected changes in market prices such
as security prices) or market rates (such as interest rates or exchange rates)
The theory and practice of risk management! and included within that risk
measurement ha"e de"eloped enormously since the pioneering work of #arry
Markowit$ in the %&'(s. The theory has attracted a huge amount of intellectual energy
from specialists and the theory has de"eloped to an extent that where risk
measurement is regarded as a distinct su)!field of finance.
*ne factor )ehind the rapid de"elopment of risk management was the high le"el of
insta)ility in the economic en"ironment within which firms operated. + "olatile
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en"ironment exposes firms to greater financial risks and therefore pro"ides an
incenti"e for firms to find new and )etter way of managing this risk7 the "olatility in
the economic en"ironment is reflected in the "arious factors8
Stock market Volatility
,tock markets ha"e always )een "olatile, )ut sometimes extremely so8 for example.
*n *cto)er %&,%&93 the 4ow :ones fell 0;< and in the process knocked off o"er = %
trillion in e>uity capital8 and from :uly 0%, through +ugust ;%, %&&9. The 4ow :ones
lost %9< of its "alue . *ther western stock markets ha"e experienced similar falls and
some +sian ones ha"e experienced much worse ones (the ,outh ?orean stock markets
lost o"er half of its "alue during %&&3).
Exchange rate Volatility
6xchange rates ha"e )een "olatile e"er since the )reakdown of the 5retton @oods
system of fixed exchange rates. n the early %&3(s occasional exchange rate crisis
ha"e also led to sudden and significant exchange rate changes, including! among
many others the 6RM de"aluations of ,ept %&&0, the pro)lem of the -eso in %&&1, the
6ast asian currency pro)lems of %&&3!%&&9, the Rou)le crisis of %&&9 and 5ra$il in
Interest rate Volatility
There ha"e )een maAor fluctuations in interest rates, with their attendant effects on the
funding costs, corporate cash flows and asset "alues , for example, the Fed Funds rate,
a good indicator of short term market rates in the B,, approximately dou)led o"er
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Commodity market Volatility
Commodity markets are notoriously "olatile and commodity prices often go through
long periods of apparent sta)ility and then suddenly Aump )y enormous amounts8 for
instance in %&&(, the price of @est Texas intermediate crude oil rose from a little o"er
=%' a )arrel to round =1( a )arrel. ,ome commodity prices also show extremely
pronounced day!to!day and e"en hour!to hour "olatility.
+nother factor contri)uting to the transformation of risk management is the huge
increase in trading acti"ity since the late %&D(s. There ha"e )een massi"e increases in
the range of instruments traded o"er the past two or three decades, and trading
"olumes in these new instruments ha"e new instruments ha"e also grown rapidly.
+ third contri)uting factor to the de"elopment of risk management was the rapid
ad"ance in the state of information technology impro"ements in T ha"e made
possi)le huge increase in )oth computational power and the speed with which
calculations can )e carried out. mpro"ements in computing power, increase in
computing speed and reductions in the computing costs ha"e thus come together to
transform the technology a"aila)le for risk management.
1. Introduction
The concept of Ealue at Risk has emerged as the centerpiece of the trend towards the
measurement and management of market risk in financial transactions.
Market risk has )een present in the process of financial intermediation all along.
,e"eral factors ha"e contri)uted to the increased focus on risk management8 the
deregulation of financial markets7 the increase in risk profile of organi$ations, with
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increased emphasis on acti"ities that re>uire the deli)erate assumption of risk7 the
"olatility of markets and its impact on financial institutions7 the pressure from capital
market in"estors for returns related to the relati"e riskiness of their in"estments7 and
the regulatory pressures on a risk management framework
The concept of risk has assumed a new paradigm. That is, the nature of risk!taking has
changed. Traditional risk!taking was confined to )alance!sheet!oriented interest rate
risk created )y deli)erate maturity mismatches. ,upplementary risk!taking may ha"e
)een present in areas such as currency or securities trading.
Modern risk!taking, howe"er, is more di"erse in nature. t encompasses traditional
forms of risk!taking and increased trading in other asset classes. This increased
trading focus is dri"en )y )oth client demands in terms of market making, and
proprietary or own!account trading, in search of return. This change reflects in no
small part the increasing di"ersity of the acti"ities undertaken )y financial institutions,
including acti"ities in all asset classes (de)t, currency, e>uity and commodities) and in
)usinesses ranging from )alance!sheet!dri"en acti"ities (such as lending), off!)alance!
sheet acti"ities (such as underwriting and securities distri)ution and risk management
instruments), to pure fee!)ased acti"ities (such as in"estment management, custody
ser"ices and cash!management ser"ices).
The remainder of the report has )een organi$ed as follows.
,ection 0 outlines the o)Aecti"es of the study. ,ection ; gi"es a )rief o"er"iew of
literature on Ealue at Risk. Further, ,ection 1 discusses the e"olution of Ealue at Risk
and the increasing importance of risk management )y taking cues from the financial
disasters of yesteryears, thus highlighting the importance of measuring and
monitoring such risks. ,ection ' gi"es a )rief introduction to the concept of Ealue at
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Risk (EaR). ,ection D descri)es the application of Ealue at Risk to "arious financial
instruments. ,ection 3 descri)es the three methods used for computation of Ealue at
Risk (EaR). ,ection 9 highlights the empirical work. ,ection & highlights the findings.
,ection %( tests the "alidity of the model. ,ection %% pro"ides the scope for further
research. ,ection %0 gi"es the limitation of the study and section %; concludes the
2. Objectives of the study
This study explores the possi)ility of using Ealue at Risk (EaR) approach to >uantify
the risk associated with a trading portfolio. The EaR )ased margin will )e large
enough to co"er a one!day loss that can )e encountered on &&< of the days. t
computes the Ealue at Risk figure using the historical simulation and "ariance!
co"ariance method for a forex portfolio and tests the "alidity of the model to draw
specific conclusions.
3. Literature Review
The literature on EaR has de"eloped greatly in the last few years. Recent work that
has )een concluded on EaR is8
,unil ?umar and M. :ayade"
(0((1) computed the margin re>uirements )ased on
daily EaR for %'!sample commodity futures contracts from four exchanges and
compared them with margin computation traditionally used )y these exchanges.
CF+ :ournal of +pplied Finance
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/angadhar 4ar)ha
compute the EaR for a set of fixed income securities )ased on
extreme "alue theory. t compares the estimates of EaR for a portfolio of fixed income
securities across three methods8 Eariance!Co"ariance method, #istorical ,imulation
method and 6xtreme Ealue method and finds that extreme "alue method pro"ides the
accurate EaR estimator in terms of correct failure ratio and the si$e of EaR.
. !he evo"ution of #a"ue at Ris$
.1 Ris$ mana%ement before #a"ue at Ris$
/ap analysis
*ne common approach was gap analysis. /ap analysis )egins with determination of
an appropriate holding period and then determine how much of the asset or lia)ility
will re!price during this period and the amounts in"ol"ed gi"e us our rate!sensiti"e
assets and rate!sensiti"e lia)ilities. The gap is the difference )etween rate!sensiti"e
assets and rate!sensiti"e lia)ilities and the interest rate exposure is taken to )e the
change in net interest income that occurs in response to a change in interest rates. This
inturn is assumed to )e e>ual to the gap times the interest!rate change.
/ap analysis is simple to carry out, )ut has its limitations8 it only applies to on!
)alance sheet interest!rate risk, and e"en then only crudely7 it looks at the impact of
interest rates on income, rather than on asset or lia)ility "alues7 and results can )e
sensiti"e to the choice of hori$on period.
4uration +nalysis
4uration +nalysis is another method traditionally used )y financial institutions for
measuring interest!rate risks. The (MacaulayFs) duration 4 of a )ond (or any other
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fixed!income security) can )e defined as the weighted a"erage term to maturity of the
)ondFs cash flows, where the weights are the present "alue of each cash flow relati"e
to the present "alue of all cash flows.
The duration measure is useful )ecause it gi"es an approximate indication of the
sensiti"ity of a )ond price to a change in yield8
< Change in )ond price G4
HI y2(l J y)
where y is the yield and Iy is the change in yield. The )igger the duration, the more
the )ond price changes in response to a change in yield. The duration approach is "ery
con"enient )ecause duration measures are easy to calculate and the duration of a )ond
portfolio is a simple weighted a"erage of the durations of the indi"idual )onds in that
portfolio. t is also )etter than gap analysis )ecause it looks at changes in asset (or
lia)ility) "alues, rather than Aust changes in net income.
#owe"er, duration approaches ha"e similar limitations to gap analysis8 they ignore
risks other than interest!rate risk7 they are crude, and e"en with "arious refinements to
impro"e accuracy, duration!)ased approaches are still inaccurate relati"e to more
recent approaches to fixed!income analysis. Moreo"er, the main reason for using
duration approaches in the past G their (comparati"e) ease of calculation G is no
longer of much significance, since more sophisticated models can now )e
programmed to gi"e their users more accurate answers rapidly.
,cenario +nalysis
+ third approach is scenario analysis (or Kwhat ifF analysis), in which we set out
different scenarios and in"estigate what we stand to gain or lose under them. To carry
out scenario analysis, we select a set of scenarios G or paths descri)ing how rele"ant
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"aria)les (e.g., stock prices, interest rates, exchange rates, etc.) might e"ol"e o"er a
hori$on period. @e then postulate the cash flows and2or accounting "alues of assets
and lia)ilities, as they would de"elop under each scenario, and use the results to come
to a "iew a)out our exposure.
,cenario analysis is complex to carry out. + lot hinges on oneFs a)ility to identify the
KrightF scenarios, and there are relati"ely few rules to guide us when selecting them.
,cenario analysis also does not tell us anything a)out the likelihood of different
scenarios, so we need to use our Audgement when assessing the practical significance
of different scenarios. Thus, the results of scenario analyses are highly su)Aecti"e and
depend to a "ery large extent on the skill or otherwise of the analyst.

-ortfolio Theory
+ somewhat different approach to risk measurement is pro"ided )y portfolio theory.
-ortfolio theory starts from the premise that in"estors choose )etween portfolios on
the )asis of their expected return, on the one hand, and the standard de"iation (or
"ariance) of their return, on the other. The standard de"iation of the portfolio return
can )e regarded as a measure of the portfolioFs risk. *ther things )eing e>ual, an
in"estor wants a portfolio whose return has a high expected "alue and a low standard
de"iation. These o)Aecti"es imply that the in"estor should choose a portfolio that
maximises expected return for any gi"en portfolio standard de"iation or, alternati"ely,
minimises standard de"iation for any gi"en expected return.
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4.2 The origin and development of Value at Risk
n the late %&3(s and %&9(s, a num)er of maAor financial institutions started work on
internal models to measure and aggregate risks across the institution as a whole. They
started work on these models in the first instance for their own internal risk
management purpose!as firms )ecame more complex, it was )ecoming increasingly
difficult, )ut also increasingly important, to )e a)le to aggregate their risks taking
account of how they interact with each other, and firms lacked the methodology to do
The )est known of these systems is the RiskMetrics system de"eloped )y :- Morgan.
+ccording to industry legend, this system is said to ha"e originated when the
chairman of :- Morgan, 4ennis @eatherstone, asked his staff to gi"e his a daily one!
page report indicating risk and potential losses o"er the next 01 hours, across the
)ankFs entire trading portfolio. This report!the famous K18%' reportF was to )e gi"en
to him at 18%' each day, after the close of trading. n order to meet this demand, the
Morgan staff had to de"elop a system to measure risks across different trading
positions, across the whole institution, and also aggregate these risks into a single risk
measure. The measure used was "alue at risk (or EaR), or the maximum likely loss
o"er the next trading day, and the EaR was estimated from a system )ased on standard
portfolio theory, using estimates of the standard de"iations and correlations )etween
the returns to different traded instruments. @hile the theory was straightforward,
making this system operational in"ol"ed a huge amount of work8 measurement
con"entions had to )e chosen data sets constructed, statistical assumptions agreed,
procedures determined to estimate "olatilities and correlations, computing systems
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esta)lished to carry out estimations, and many other practical pro)lems resol"ed.
4e"eloping this methodology took a long time, )ut )y around %&&(, the main
elements! the data systems, the risk measurement methodology and the )asic
mechanics!were all in place and working reasona)ly well. +t that point it was decided
to start using the K18%' reportF, and it was soon found that the new risk management
system had a maAor positi"e effect. n particular, it Ksensitised senior management to
risk!return trade!offs and led o"er time to a much more efficient allocation of risks
across the trading )usinessesF (/uldimann (0(((, p. '3). The new risk system was
highlighted in :- MorganFs %&&; research conference and aroused a great deal of
interest from potential clients who wished to )uy or lease it for their own purposes.
Meanwhile, other financial institutions had )een working on their own internal
models, and EaR software systems were also )eing de"eloped )y specialist companies
that concentrated on software systems were also )eing de"eloped )y specialist
companies that concentrated on software )ut were not in a position to pro"ide data.
The resulting systems differed >uite considera)ly from each other. 6"en where they
were )ased on )roadly similar theoretical ideas, there were still considera)le
differences in terms of su)sidiary assumptions, use of data, procedures to estimate
"olatility and correlation, and many other KdetailsF. 5esides, not all EaR systems were
)ased on portfolio theory8 some Ksystems were )uilt using historical simulation
approaches that estimate EaR from histograms of past profit and loss data and other
systems were de"eloped using Monte Carlo ,imulation techni>ues.
These firms were keen to encourage their management consultancy )usinesses, )ut at
the same time they were conscious of the limitations of their own models and wary
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a)out gi"ing too many secrets away. @hilst most firms kept their models secret, :-
Morgan decided to make its data and )asic methodology a"aila)le so that outside
parties could use them to write their own risk management software. 6arly in %&&1,
Morgan set up the Risk Metrics unit to do this and the Risk Metrics model!a
simplified "ersion of the firmFs own internal model!was completed in eight months. n
*cto)er that year, Morgan then made its Risk Metrics system and the necessary data
freely a"aila)le on the internet8 outside users could now access the Risk Metrics
model and plug their own position data into it.
This )old mo"e attracted a lot of attention, and the resulting pu)lic de)ate a)out the
merits of Risk Metrics was useful in raising awareness of EaR and of the issues
in"ol"ed in esta)lishing and operating EaR systems. n +ddition, making the Risk
Metrics data a"aila)le ga"e a maAor )oost to the spread of EaR systems )y gi"ing
software pro"iders and their clients access to data sets that they were often una)le to
construct themsel"es. t also encouraged many of the smaller software pro"iders to
adopt the Risk Metrics approach or make their own ,ystems compati)le with it.
The ,u)se>uent adoption of EaR systems was "ery rapid, first among securities
houses and in"estment )anks, and then among commercial )anks, pension funds and
other financial institutions, and non financial corporates. .eedless to say, the state of
the art also impro"ed rapidly. 4e"elopers and users )ecame more experienced7 the
com)ination of plummeting T costs and continuing software de"elopment meant that
systems )ecame more powerful and much faster, and a)le to perform tasks that were
pre"iously not feasi)le7 EaR systems were extended to co"er more types of
instruments7 and the EaR methodology itself was extended to deal with other types of
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risk )esides the market risks for which EaR systems were first de"eloped, including
credit risks, li>uidity risks and cash!flow risks.
n the modern day risk management systems, Ealue!at!Risk (EaR) has )een widely
promoted )y regulatory groups and em)raced )y financial institutions as a way of
monitoring and managing market risk ! the risk of loss due to ad"erse mo"ements in
interest rate, exchange rate, e>uity and commodity exposures ! and as a )asis for
setting regulatory minimum capital standards. The re"ised 5asle +ccord, implemented
in :anuary %&&9, allows )anks to use EaR as a )asis for determining how much
additional capital must )e set aside to co"er market risk )eyond that re>uired for
credit risk. Market related risk has )ecome more rele"ant and important due to the
trading acti"ities and market positions taken )y large )anks. +nother impetus for such
a measure has come from the numerous and su)stantial losses that ha"e arisen due to
shortcomings in risk management procedures that failed to detect errors in deri"ati"es
pricing (.atwest, B5,), excessi"e risk taking (*range County, -roctor and /am)le),
as well as fraudulent )eha"ior (5arings and ,umitomo).
The Ealue!at!Risk (EaR) is now a widely used measure of market risk in finance and
economics literature. Following the recommendations of the 5asle Committee on
5anking ,uper"ision (5asle Committee, %&&Da) of the 5ank for nternational
,ettlement (5,), central )anks in almost all countries re>uire their super"ised )anks
to measure market risk with EaR. n principle, not only )anks )ut any in"estor also
can use EaR to assess the extent of possi)le loss in their portfolios due to market
fluctuations. ,o, today, EaR is perhaps the most common measure of a portfolioFs
exposure to loss (Chow and ?irt$man, 0((0).
The )road categories of risk in financial markets are )usiness risk, strategic risk and financial risk. The financial
risks are of different type,like, credit risk, li>uidity risk, operational risk and market risk. The concept of EaR is
mainly concerned with market risk ("an den /oor)ergh and Elaar, %&&&7 Tsay, 0((0).
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.3 Lessons from &inancia" 'isasters
.3.1 Oran%e )ounty )ase
The purpose of this case is to explain how a municipality can lose =%.D )illion in
financial markets. The case also introduces the concept of LEalue at RiskL (E+R),
which is a simple method to express the risk of a portfolio. +fter the string of recent
deri"ati"es disasters, financial institutions, end!users, regulators, and central )ankers
are now turning to E+R as a method to foster sta)ility in financial markets. The case
illustrates how E+R could ha"e )een applied to the *range County portfolio to warn
in"estors of the risks they were incurring.
n 4ecem)er %&&1, *range County stunned the markets )y announcing that its
in"estment pool had suffered a loss of =%.D )illion. This was the largest loss e"er
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recorded )y a local go"ernment in"estment pool, and led to the )ankruptcy of the
county shortly thereafter.
This loss was the result of unsuper"ised in"estment acti"ity of 5o) Citron, the County
Treasurer, who was entrusted with a =3.' )illion portfolio )elonging to county
schools, cities, special districts and the county itself. n times of fiscal restraints,
Citron was "iewed as a wi$ard who could painlessly deli"er greater returns to
in"estors. ndeed, Citron deli"ered returns a)out 0< higher than the compara)le ,tate
Citron was a)le to increase returns on the pool )y in"esting in deri"ati"es securities
and le"eraging the portfolio to the hilt. The pool was in such demand due to its track
record that Citron had to turn down in"estments )y agencies outside *range County.
,ome local school districts and cities e"en issued short!term taxa)le notes to rein"est
in the pool (there)y increasing their le"erage e"en further).
The in"estment strategy worked excellently until %&&1, when the Fed started a series
of interest rate hikes that caused se"ere losses to the pool. nitially, this was
announced as a MMpaperNN loss. ,hortly thereafter, the county declared )ankruptcy and
decided to li>uidate the portfolio, there)y reali$ing the paper loss.
5o) Citron was implementing a )ig )et that interest rates would fall or stay low. The
=3.' )illion of in"estor e>uity was le"eraged into a =0(.' )illion portfolio. Through
reverse repurchase agreements, Citron pledged his securities as collateral and
rein"ested the cash in new securities, mostly '!year notes issued )y go"ernment!
sponsored agencies..
The portfolio le"erage magnified the effect of mo"ements in interest rates. CitronFs
main purpose was to increase current income )y exploiting the fact that medium!term
maturities had higher yields than short!term in"estments. *n 4ecem)er %&&;, for
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instance, short!term yields were less than ;<, while '!year yields were around '.0<.
@ith such a positi"ely sloped term structure of interest rates, the tendency may )e to
increase the duration of the in"estment to pick up an extra yield. This )oost, of course,
comes at the expense of greater risk.
The strategy worked fine as long as interest rates went down. n Fe)ruary %&&1,
howe"er, the Federal Reser"e 5ank started a series of six consecuti"e interest rates
increase, which led to a )lood)ath in the )ond market. The large duration led to a =%.D
)illion loss.
.3.2 *arin%s *an$ co""a+se
The collapse of 5arings )ank can )e traced to a trader, .ick Oeeson who )rought
5arings )ank to its knees with losses of more that % )illion pounds sterling.
.ick Oeeson was the Chief 4eri"ati"es trader on the ,ingapore 4eri"ati"es Market
for 5arings )ut in charge of ,ettlements at the same time. +s part of the settlement
duties, he arranged the payments to the stock exchange to co"er 5arings trading at the
end of each day.
Therefore, when he made a loss he was a)le to transfer it into another internal hidden
account, then keep on trading showing no loss, whilst regularly making up excuses to
his superiors a)out why he re>uired more cash to )e wired from Oondon to co"er his
trading. #e was in fact trading with 5arings money, not their clients.
6"entually, he had so much money at the mercy of the market, that any swing
downward (for the .ikkei :apanese index) would result in huge losses for 5arings.
Bnfortunately, for him and all his colleagues, there was an earth>uake in :apan and
the Market crashed and didnNt )ounce as heNd hoped.
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-erhaps one reason for the pro)lem was the lack of understanding of market risk and
risk management. Market Risk monitoring would ha"e shown his managers how risky
their trading methods were )efore.
.3.3 ,eta""%ese""schaft

Metallgesellschaft +/, or M/, a /erman conglomerate, owned largely )y 4eutsche

5ank +/, the 4resdner 5ank +/, 4aimler!5en$, +llian$, and the ?uwait n"estment
+uthority. M/, a traditional metal company, was engaged in pro"iding risk
management ser"ices. *ne of their su)sidiaries in its L6nergy /roupL, was M/
Refining and Marketing nc. (M/RM) in charge of refining and marketing petroleum
products in the B.,.
n 4ecem)er %&&;, Metallgescellschaft +/ re"ealed pu)licly that its L6nergy /roupL
was responsi)le for losses of approximately =%.' )illion, due mainly to cash flow
pro)lems resulting from large oil forward contracts it had written.
M/RM committed to sell, at prices fixed in %&&0, certain amounts of petroleum e"ery
month for up to %( years with profit margins was as much as =' per )arrel. 5y
,eptem)er of %&&;, M/RM had sold forward contracts amounting to the e>ui"alent
of %D( million )arrels. These contracts contained an LoptionL clause that ena)led the
counterparties to terminate the contracts early if the front!month .ew Pork Mercantile
6xchange (.PM6Q) futures contract was greater than the fixed price at which
M/RM was selling the oil product. f the )uyer exercised this option, M/RM would
)e re>uired to pay in cash one!half of the difference )etween the futures price and the
fixed prices times the total "olume remaining to )e deli"ered on the contract.
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M/RM went long in the futures and entered into *TC energy swap agreements to
recei"e floating and pay fixed energy prices. +ccording to the .PM6Q, M/RM held
the futures position e>ui"alent of '' million )arrels of gasoline and heating oil. 5y
deduction, their swap positions may ha"e accounted for as much as %%( million
)arrels to completely hedge their forward contracts. The swap positions introduced
credit risk for M/RM.
.3. 'aiwa *an$
The executi"e "ice!president guchi, 4aiwa )ank, exploited his dual roles as )oth
trader and )ack!office record keeper. #e incurred the original loss of =0((,((( as a
neophyte in %&91. Trying to recoup it )y aggressi"e trading, he only made the hole
)igger. guchi fooled his superiors )y forging documents. #is losses totaled =%.%
)illion o"er %% years, =0(( million less than what Oeeson lost 5arings.
-. #a"ue at Ris$. the conce+t
-.1 'e/nition
VaR is the maximum loss over a target horizon such that there is a low, prespecified
proailit! that the actual loss will e larger"# $hilippe %orion
The predicted worst#case loss at a specific confidence level &e.g., '()* over a
certain period of timeR.
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For example, a )ank might say that the daily EaR of its trading portfolio is =% million
at the && percent confidence le"el. n other words, under normal market conditions,
only one percent of the time, the daily loss will exceed =% million.R (:orion 0((%)
To understand the concept of "alue at risk, we consider a simple example in"ol"ing an
Foreign 6xchange forward contract entered into )y a )ank ,uppose that the current
date is 1
+pril 0((', and the contract has &% days remaining until the deli"ery date
on 1
:uly 0(('. The ; month B, and ndian interest rates are r
e>ual to 1.09< and
S '.01<, respecti"ely and the spot exchange rate is 13.0(Rs2=. *n the deli"ery date
the company will deli"er Rs 13 million and recei"e =% million. The ndian Rupee
mark to market "alue of the forward contract can )e computed using the interest and
exchange rates pre"ailing on 1
+pril. ,pecifically,
ndian Rupee Mark to Market "alue
S T(6xchange rate in .R2B,4) H B,4 % millionU - .R 13million
%J r
%J r
S T(13.1( .R2B,4)H B,4 % millionU ! .R 13million
%J. (109 %J. ('01
S Rs 3&130(.0&.
*n the next day, '
+pril it is likely that interest rates, exchange rates, and thus the
"alue of the forward contract ha"e all changed. ,uppose we assume that the
pro)a)ility that the loss will exceed Rs 01(,((( is ' percent. f we use this ' percent
pro)a)ility as the cutoff to define a loss due to normal market mo"ements, then Rs
01(,((( is the (approximate) Ealue at Risk.
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Ealue at Risk measures are used to estimate the pro)a)ility of a portfolio of assets
losing more than a specified amount o"er a specified time period due to ad"erse
mo"ements in the underlying market factors of a portfolio. t pro"ides an estimate of
the potential loss on a portfolio that would occur gi"en relati"ely large ad"erse price
+ssuming that o"er a gi"en time period, the composition of portfolio remains
unchanged, the E+R statistic is a one!sided confidence inter"al on portfolio losses,
such that8
Prob [ P ! x" t#$ % V&R '
This states that the pro)a)ility that the change in the "alue of the portfolio, I-, (which
is a function of the holding period It, and changes in the prices of assets held in the
portfolio, I x) is less than the Ealue at Risk and e>ual to the significance le"el . +
well!specified E+R model should produce statistically meaningful E+R forecasts.
The )asic feature of a &&< E+R is that it should exceed %< of the time, and that the
pro)a)ility of the E+R )eing exceeded at time tJ% remains %< e"en after
conditioning on all information known at time t. This implies that the E+R should )e
small in times of low "olatility and high in times of high "olatility, so that the e"ents
where the loss exceeds the forecasted E+R measure are spread o"er the entire sample
period and do not come in clusters (,arma et al, 0((%)
6stimation of EaR in"ol"es the following steps8
%. 4etermination of time hori$on for estimating a potential loss.
0. ,election of degree of certainty re>uired, i.e. confidence inter"al for the
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-age %&
;. dentification of pro)a)ility distri)ution of likely returns for the instrument or
portfolio under consideration.
1. nterpretation of EaR estimate.
-.2 0ra+hica" re+resentation of #a"ue at Ris$
+ portfolio whose one!day &'< EaR is =%( million, would )e expected to lose less
than =%( million during &' days out of %((, )ased on its current composition and
recent market )eha"ior. n other words, the portfolio is expected to lose at least =%(
million in ' days out of %((.
The portfolioNs one!day &'< EaR is found )y locating that point on the x!axis such
that &'< of the pro)a)ility falls to the right of the point. This represents the upper
)ound on a &'< confidence inter"al for the amount that the portfolio might lose.
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!he %ra+hica" re+resentation of #aR.
-.2.1 #a"ue at Ris$ across business units
-.2.2 #a"ue at Ris$ across &inancia" 1arameters
-.2.3 #a"ue at Ris$ across /nancia" +roducts
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-.2. #a"ue at Ris$ across %eo%ra+hic re%ions
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-.2.- #a"ue at Ris$ across counter+arties
-.3 Im+ortance of #a"ue at Ris$
EaR primarily )egan in the in"estment departments of commercial and in"estment
)anks as a result of the risks in deri"ati"es products.
Technical descriptions of risk such as delta and gamma may ha"e )een helpful to
traders, )ut users of deri"ati"es products were fre>uently unsure of the relati"e risk of
the securities.
n addition, during the late %&9(s and early %&&(s, there was an explosion of exotic
and specialty deri"ati"es products. n"estors and company executi"es found them
difficult to analy$e and were unac>uainted with the risks in these new products.
This necessitated the de"elopment of a tool that would allow technical users to
communicate risks easily and accurately to other interested parties. Thus led to the
de"elopment of Ealue at risk model.
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EaR results can )e presented in a hierarchical manner )oth aggregate and drilled
down in se"eral ways depending on the purpose. This facilitates monitoring credit risk
and market risk at different le"els. The concept can )e percolated to "arious le"els and
+dvantages of Value at Risk over other methods
%. ,ince EaR gi"es a ,ingle measure to depict risk of a portfolio, it makes
reporting and reporting of risk easier.
0. +nother measure of EaR
-. #a"ue at Ris$. 1arameters
2a3 #o"ati"ity
2b3 )on/dence Leve"
+ confidence le"el is pro)a)ility of loss associated with EaR measurement. The
higher the confidence le"el c the greater the EaR measure. 5ut as c increases, the
num)er of occurrences )elow EaR shrinks, leading to poorer measures of large )ut
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unlikely losses. @ith %((( o)ser"ations, for example, EaR is taken as %(
o)ser"ation for a &&< confidence le"el.

,ovin% from one con/dence Leve" to other
From standard normal ta)les, &'< one!tailed EaR corresponds to %.D1' times and
&&< EaR corresponds to 0.;0D times the standard de"iation.
Therefore, to con"ert from &&< EaR to &'< EaR.
EaR (&'<) S EaR (&&<) x %.D1'20.;0D
2b3 4o"din% +eriod or time hori5on
The time hori$on used to calculate EaR should depend on the li>uidity of the
securities in the portfolio and how fre>uently they are traded. Oess li>uid securities
call for a longer time hori$on. The most common time hori$ons used )y commercial
and in"estment )anks to calculate EaRs of their trading rooms are one day, one week,
5ankers Trust uses a && percent le"el7 Chemical and Chase, a &3.' percent le"el7 Citi)ank a &'.1< le"el7 5ank
+merica and :.-.Morgan a &' percent le"el. For internal models of capital allocation, the 5asle Committee
recommends a multiple of three (with an additional factor depending on the failure rate of the EaR limit in the
past) of the EaR, calculated using %( day holding period and && percent le"el of confidence.
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and two weeks. The 5asle Committee on 5anking ,uper"ision
mandates that )anks
using EaR models to set aside capital for market risk of their trading operations use a
holding period of two weeks and a confidence le"el of && percent. n contrast if the
EaR num)er is )eing used to decide how much capital to set aside to a"oid
)ankruptcy, then a long hori$on is desira)le.
,imilarly, insurance companies are typically )ound to hold their portfolio of claims
for one year7 in this time they can neither alter the portfolio )y a su)stantial amount
nor renegotiate the premiums they recei"e. #ence in firm wide risk management one
year is the appropriate hori$on for measuring the market risk of the in"estment
portfolio of these companies.
n practice, the hori$on cannot )e less than the fre>uency of reporting of profits and
losses. Typically, )anks measure -V O on a daily )asis, and corporates on a longer
inter"al (ranging from daily to monthly). This inter"al is the minimum hori$on for
+nother criteria relates to the )acktesting issue. ,horter time inter"als create more
data points matching the forecast EaR with the actual, su)se>uent -V O. +s the power
of the statistical tests increases with the num)er of o)ser"ations, it is ad"isa)le to take
a hori$on as short as possi)le. For all these reasons, the usual recommendation is to
pick a hori$on that is as short as feasi)le, for instance % day for trading desks. The
hori$on needs to )e appropriate to the asset classes and the purpose of risk
management. For institutions such as pension funds, for instance, a %!month hori$on
may )e more appropriate. For capital ade>uacy purposes, institutions should select a
high confidence le"el and a long hori$on. There is a trade!off howe"er, )etween these
two parameters. ncreasing one or the other will increase EaR.
5ank of nternational ,ettlements
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,ovin% from one time hori5on to the other
+ssuming a normal distri)ution for the portfolio returns, the "ariance of a T!day
return should )e NTN times the "ariance of a %!day return.
For example, if %!day EaR is = %(,((( and if EaR for %( days ha"e to )e calculated,
then EaR can )e calculated as8
VaR (or ) day holding period ' *aily VaR + S,R) !)#-
&c* ,ase currenc!
The )ase currency for calculating EaR is typically the currency of e>uity capital and
reporting currency of a company. For example, 5ank of +merica would use B,4 to
calculate and report its worldwide risks, while the Bnited 5ank of ,wit$erland would
use ,wiss francs.
-.- Re%u"atory &ramewor$ for va" ris$
The 5asle committee on )anking super"ision has stipulated the following regulations
with respect to "alue at Risk.
5asel Committee on 5anking ,uper"ision
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%. Time horizon
Ealue!at!risk must )e computed on a daily )asis.
0. -onfidence level
n calculating the "alue!at!risk, a &&th percentile, one!tailed confidence
inter"al is to )e used.
;. .olding $eriod
The minimum Lholding periodL shall )e ten trading days. 5anks shall use
"alue!at!risk num)ers calculated according to shorter holding periods scaled
up to ten days )y the s>uare root of time.
1. $eriod of /ample
The choice of historical o)ser"ation period (sample period) for calculating
"alue!at!risk will )e constrained to a minimum length of one year. The
super"isory authority may also re>uire a )ank to calculate its "alue!at!risk
using a shorter o)ser"ation period if, in the super"isorNs Audgment7 this is
Austified )y a significant upsurge in price "olatility.
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'. 0pdated data
5anks should update their data sets no less fre>uently than once e"ery three
months and should also reassess them whene"er market prices are su)Aect to
material changes.
D. -hoice of method
.o particular type of model is prescri)ed. ,o long as each model used captures
all the material risks run )y the )ank, )anks will )e free to use models )ased,
for example, on "ariance!co"ariance matrices, historical simulations, or Monte
Carlo simulations.
9. -apital re1uirements
6ach )ank must meet, on a daily )asis, a capital re>uirement expressed as the
higher of its pre"ious dayNs "alue!at!risk num)er measured according to the
parameters specified in this section and an a"erage of the daily "alue!at!risk
measures on each of the preceding sixty )usiness days, multiplied )y a
multiplication factor.
The multiplication factor will )e set )y indi"idual super"isory authorities on the )asis
of their assessment of the >uality of the )ankNs risk management system, su)Aect to an
a)solute minimum of ;. 5anks will )e re>uired to add to this factor a LplusL directly
related to the ex!post performance of the model, there)y introducing a )uilt!in
positi"e incenti"e to maintain the predicti"e >uality of the model. The plus will range
from ( to % )ased on the outcome of L)acktestingL, if the )acktesting results are
satisfactory and the )ank meets all of the >ualitati"e standards as set out.
The Market risk Charge (MRC) is measured as follows8
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-age 0&
S Max (k.% H E+R
t! ,
) J ,RC
D( iS%
which in"ol"es the a"erage of the market EaR o"er the last D( days , times a
super"isor determined multiplier k ( with a minimum "alue of ;) , as well as the
pre"ious dayFs EaR and a specific risk charge ,RC.
/enerally, acti"e financial institutions (e.g., )anks, hedge funds) consistently use a
%!day forecast hori$on for EaR analysis of all market risk positions since it is not
feasi)le to proAect market risks much further )ecause trading positions can change
dynamically from one day to the next. *n the other hand, in"estment managers often
use a %!month forecast window, while corporations may apply >uarterly or e"en
annual proAections of risk.

7. #aR a++"ied to #arious &inancia" instruments
7.1 #aR a++"ied to E8uity Stoc$s
National Stock Exchange Guidelines with respect to Margin requirements
These guidelines places stocks on different categories for imposition of margins.
The ,tocks which ha"e traded atleast 9(< of the days for the pre"ious %9
months shall constitute the /roup and /roup .
*ut of the scrips identified a)o"e, the scrips ha"ing mean impact cost of less
than or e>ual to %< shall )e categori$ed under /roup and the scrips where
the impact cost is more than %, shall )e categori$ed under /roup .
The remaining stocks shall )e classified into /roup .
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The impact cost shall )e calculated at %'th of each month on a rolling )asis
considering the order )ook snapshots of the pre"ious six months. *n the )asis
of the impact cost so calculated, the scrips shall mo"e from one group to
another group from the %st of the next month.
-alculation of mean impact cost
The mean impact cost for the purposes of classification of the scrips in the two
/roups "i$. /roup V would )e calculated in the following manner8
i. mpact cost shall )e calculated )y taking four snapshots in a day from the
order )ook in the past six months. These four snapshots shall )e randomly
chosen from within four fixed ten! minutes windows spread through the day.
ii. The impact cost shall )e the percentage price mo"ement caused )y an order
si$e of Rs.% Oakh from the a"erage of the )est )id and offer price in the order
)ook snapshot. The impact cost shall )e calculated for )oth, the )uy and the
sell side in each order )ook snapshot.
iii. The computation of the impact cost adopted )y the 6xchange would )e
disseminated on the we)site of the exchange.
i". The 6xchanges shall use a common methodology for carrying out the
calculations for mean impact cost. The details of calculation methodology and
rele"ant data shall )e made a"aila)le to the pu)lic at large through the we)site
of the 6xchanges. +ny change in the methodology for the computation of
impact cost would also )e disseminated )y the 6xchange
4aily margins paya)le )y mem)ers consists of the following8
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%. Ealue at Risk Margin
0. Mark to Market Margin
4aily margin, comprising of the sum of EaR margin and mark to market margin is
Value at Risk Margin
EaR margin is applica)le for all securities in rolling settlement. +ll securities are
classified into three groups for the purpose of EaR margin.
For the securities listed in /roup , ,crip wise daily "olatility calculated using the
exponentially weighted mo"ing a"erage methodology that is used in the index futures
market and the scrip wise daily EaR would )e ;.' times the "olatility so calculated.
For the securities listed in /roup the EaR margin shall )e higher of scrip EaR (;.'
sigma) or three times the index EaR, and it shall )e scaled up )y root ;.
For the securities listed in /roup , the EaR margin would )e e>ual to fi"e times the
index EaR and scaled up )y root ;.
EaR margin rate for a security constitutes the following8
%. Ealue at Risk (EaR) )ased margin, which is arri"ed at, )ased on the methods
stated a)o"e. The index EaR, for the purpose, would )e the higher of the daily
ndex EaR )ased on ,V- C.Q .FTP or 5,6 ,6.,6Q. The index EaR
would )e su)Aect to a minimum of '<.
0. +dditional E+R Margin 8 D< as specified )y ,65.
;. ,ecurity specific Margin 8 .ational ,ecurities Clearing Corporation of ndia
Otd. may stipulate security specific margins for the securities from time to
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The EaR )ased margin would )e rounded off to the next higher integer (For eg8 if the
EaR )ased Margin rate is %(.(%, it would )e rounded off to %%.(() and capped at
The EaR margin rate computed as mentioned a)o"e will )e charged on the net
outstanding position ()uy "alue!sell "alue) of the respecti"e clients on the respecti"e
securities across all open settlements. The net position at a client le"el for a mem)er
are arri"ed at and thereafter, it is grossed across all the clients for a mem)er to
compute gross exposure for margin calculation.
For example, in case of a mem)er, if client + has a )uy position of %((( in a security
and client 5 has a sell position of %((( in the same security, the net position of the
mem)er in the security would )e taken as 0(((. The )uy position of client + and sell
position of client 5 in the same security would not )e netted. t would )e summed up
to arri"e at the mem)erFs exposure for the purpose of margin calculation.
Mark to Market Margin
Mark to market margin is computed on the )asis of mark to market loss of a mem)er.
Mark to market loss is the notional loss which the mem)er would incur in case the
cumulati"e net outstanding position of the mem)er in all securities, at the end of the
rele"ant day were closed out at the closing price of the securities as announced at the
end of the day )y the .,6. Mark to market margin is calculated )y marking each
transaction in a scrip to the closing price of the scrip at the end of trading. n case the
security has not )een traded on a particular day, the latest a"aila)le closing price at the
.,6 is considered as the closing price.
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n the e"ent of the net outstanding position of a mem)er in any security )eing nil, the
difference )etween the )uy and sell "alues would )e considered as notional loss for
the purpose of calculating the mark to market margin paya)le.
MTM profit2loss across different securities within the same settlement is set off to
determine the MTM loss for a settlement. ,uch MTM losses for settlements are
computed at client le"el.
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Additional Base Capital
Mem)ers may pro"ide additional margin2collateral deposit (additional )ase capital) to
.,CCO, o"er and a)o"e their minimum deposit re>uirements ()ase capital), towards
margins and2 or exposure 2 turno"er limits.
Mem)ers may su)mit such deposits in any one form or com)ination of the following
%. Cash
0. Fixed 4eposit Receipts (F4Rs) issued )y appro"ed )anks and deposited with
appro"ed Custodians or .,CCO
;. 5ank /uarantee in fa"our of .,CCO from appro"ed )anks in the specified
format. f a 5ank guarantee is su)mitted from )ank, whose networth is a)o"e
Rs.'(( crores, then the same is considered as cash component and all other
5ank guarantees will )e considered as non!cash component as per past
1. +ppro"ed securities in demat form deposited with appro"ed Custodians.
'. /o"ernment ,ecurities .The haircut for the /o"ernment ,ecurities shall )e
D. Bnits of the schemes of li>uid mutual funds or go"ernment securities mutual
funds. The haircuts for units of li>uid funds or go"ernment securities mutual
funds shall )e %(< of .et +sset Ealue (.+E). Bnits of all Mutual Funds
schemes except Oi>uid Mutual Funds and /o"ernment ,ecurities Mutual
Funds (in demat) shall )e eligi)le security for the purpose of non!cash
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component of additional capital and margin su)Aect to a haircut e>ui"alent to
the EaR of the unitNs .+E plus any exit load charged )y the mutual fund.
+ll +dditional 5ase Capital gi"en in the form of cash 2 F4R25/Fs from appro"ed
5anks whose networth is a)o"e '(( crores, (hereinafter referred to as NCash
ComponentN) should )e atleast '(< of the total +dditional 5ase Capital and Cash
Margins in respect of e"ery trading mem)er. ncase where non ! cash component is
more than '( < of the total additional )ase capital, the excess non!cash component is
ignored for the purpose of exposure limits re>uirements and2or margins re>uirements.
issemination to the market
The EaR calculations will )e )ased either on 5,6 ,ensex or , V - C.Q .ifty and
would )e disseminated )y the 5,6 and .,6 daily on their we)sites )y D8;( pm in a
downloada)le format.
7.2 #aR a++"ied to &ixed Income Securities
The computation of EaR for a fixed income portfolio differs in important ways from
that of an e>uity portfolio. First, unlike in the case of an e>uity portfolio where
o)ser"ed prices can )e directly used for the computation of EaR, the price of each
fixed income instrument in a portfolio is an outcome of many security!specific
attri)utes, in addition to the fundamental factor, the underlying term structure. This
rules out the use of prices directly for the computation of EaR if the o)Aecti"e is to
measure the interest rate risk that the portfolio is su)Aect to. Bse of a $ero coupon
yield cur"e (WCPC) is central to the exercise, as yield!to!maturity (PTM) )ased
approaches are also su)Aect to the same pro)lem as with use of o)ser"ed prices.
Mo"ements of the WCPC, inasmuch as they depict the changes in the interest rate
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structure, are reflecti"e of changes in the "alue of the portfolio occurring on account
of interest rate changes alone.
6stimation of EaR for a portfolio of fixed income securities is complicated )y two
reasons8 *ne, the changes in market "alues of the securities are non!linearly related to
changes in spot interest rates leading to difficulties in making simple assumptions
a)out the distri)ution of the portfolio returns. + related point is that since one needs to
know the entire term structure of interest rates to "alue a fixed income security (up to
the rele"ant maturity) and to study the EaR of the security we need to model the
distri)ution of a great num)er of interest rates. The popular practice of cash!flow
mapping considers a selected set of interest rates and maps the cash flow timings to
that of the tenor of the selected interest rates through linear interpolations. n addition,
the cash!flow interpolations may also lead to significant approximation errors. +
)etter strategy would )e to generate KreturnsF on (a portfolio of) fixed income
instruments at the first stage )y "aluing the said portfolio on o)ser"ed yield cur"es,
and estimate the EaR directly from the returns on the )ond portfolio. + maAor
ad"antage of this approach is that it does not re>uire an assumption a)out the interest
rates. ,ince the EaR is estimated )ased on )ond portfolio returns, this approach has
the disad"antage of )eing portfolio specific there)y necessitating the model
parametri$ation, and estimation to )e done for each portfolio separately. The .,6!
EaR system follows the latter approach of generating returns "ia historical simulation
and fitting a model of EaR to the return series.
7.3 #aR a++"ied to o+tions
,atyaAit 4as, ,waps2 Financial 4eri"ati"es
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EaR techni>ues are well suited to measurement of risk on asset and linear deri"ati"e
(forward, future or swaps) positions. The application of "ar techni>ue to >uantify the
risk of options or portfolios containing options presents difficulties. These difficulties
arises from a num)er of sources8
%. -rice mo"ements of options are non linear this means that for gi"en changes in
the asset price the price change of the option is not constant. This potential
acceleration or deceleration of the market risk (which is e>ui"alent to the
gamma risk of an option) creates difficulties in modelling the exposure of
0. mpact of changes in "olatility on the price of options ( Eega risk )
;. mpact of time decay on the price of the options (theta risk).
n effect the non!linearity of option price function means that the sensiti"ity of the
position to a change in the rele"ant risk factor is not constant. This means the EaR
estimates may o"er or underestimate the market risk, as it assumes the parameter is
constant. The effect of changes in "olatility and time decay impacts the final term of
the EaR calculation, as they are additional terms that may impact upon the price of the
option. Therefore, they must )e incorporated )y forecasting potential changes in these
factors to deri"e an accurate measure of risk. Eolatility is not a factor in the pricing of
assets and forwards. Conse>uently they are irrele"ant to the >uantification of risk of
these linear price. Theta in contrast is not uni>ue to options the "alue of )oth assets
(for example de)t instruments and forwards change as a function of time howe"er the
degree of change is smaller and the impact on risk less significant
7. #aR for &orei%n )urrency S+ot 1ositions
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The calculation of EaR for foreign currency spot position is explained using an open
long position.

+ long position of X%(( million
6xchange rate8 X%S=%.'
+nnuali$ed "olatility8 %(<
@orking days in a year8 0'(

Therefore, with the gi"en exchange rate, the "alue of a long position of X%(( million
is e>ui"alent to =%'( million.
S %( S (.D;0'<
4aily Eolatility S (.D;0'<
$otential 2luctuations in 3xchange Rates

The next step, after calculating daily "olatility is to calculate the possi)le fluctuations in the
X2B,= rate, for one and two standard de"iations.

The X2B,= rate at one standard de"iation7 will fluctuate )etween =%.'(&199 and
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+t two standard de"iations, the rate will fluctuate )etween =%.'%9&3' and =%.19%(0'.
-otential /ain2Ooss
The potential gain2loss on the foreign currency spot position for one and two standard
de"iations are calculated.
From the calculations, it can )e concluded that8

%. @ithin one standard de"iation, the X2B,= rate can fluctuate )etween
=%.'(&199 and =%.1&('%;.
0. D9< of the "alues are contained within this range and ;0< are outside this
;. +lso, it can )e stated with D9< confidence that the loss2gain will not exceed
=(.&193' million.
1. &'< of the "alues are contained within this range and only '< are outside this
7.- #aR for &orei%n )urrency O+tions
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,imilarly, the calculation of EaR for foreign currency options is explained using a
long call option as an example.
Oong call option of X%(( million
*ption premium paid8 X0 million S =; million
4elta of the option8 (.'.
Eolatility is %(< annuali$ed
0'( working days in a year are assumed
From the a)o"e details, the call option position delta is calculated as X%(( million H
(.' S X'( million. The position has the same risk as X'( million in spot.
Calculation of 4aily Eolatility
+s a first step, daily "olatility is calculated from annuali$ed "olatility as it was done
for EaR of foreign currency spot.
S %( S (.D;0'<
4aily Eolatility S (.D;0'<
-otential /ain2Ooss on the -osition
Ealue at Risk, for )oth one and two standard de"iations, is calculated )elow
Ealue at risk S [Market .al/e o( Position in I0R
+Val/e o( 1 at the con(idence le.el
+*aily .olatility or standard de.iation$
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From the calculations it can )e concluded that with one standard de"iation, the EaR
on the option position will )e =(.131;9 million and with two standard de"iations, it
will )e =(.&193' million.
2oreign -urrenc! /pot vis#4#vis 5ption
The ta)le shows that =; million position in pound call option has half as much risk as
=%'( million position in Xspot2forward.
+lternati"ely, the =D million position in call option on pound has the same risk as
=%'( million position in X. Thus, the le"erage of options is % in 0'.
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7.7 ;++"ications Of #a"ue at Ris$ in the Indian Scenario
Ealue!at!Risk (EaR) is )een widely promoted )y regulatory authorities in ndia as a
way of monitoring and managing market risk and as a )asis for setting regulatory
minimum capital standards. The 5asel +ccord, implemented in :anuary %&&9, uses
EaR as a )asis for determining the amount of regulatory capital ade>uate for co"ering
market risk )eyond that re>uired for credit risk The guidelines of the 5asel
Committee call for linking of each entityFs market risk capital charge to the riskiness
of its assets as measured )y the chosen EaR model. +ccuracy of measurement would
pro"e critical as regulation would not specify KaF single model for measurement of
risk7 the choice of model would )e left to market participants who would also )e
re>uired to furnish details of )ack!testing for the chosen EaR model. @hile a
conser"ati"e estimate of risk would lead to "ery large capital holdings, a li)eral
estimate would result in inade>uate co"erage of loss and excessi"e num)er of model
failures historically, which would in turn attract penalties from the regulator. t would
therefore )e in the interest of market participants to de"elop models that accurately
measure the riskiness of their portfolios and furnish estimates of capital charge that
would pro"ide ade>uate co"er. +n important consideration in this context is the
setting up of risk measurement systems )y each indi"idual participant for estimating
portfolio risk under alternati"e models and scenarios would also in"ol"e significant
n the ndian financial sector EaR has till now )een applied to the Capital Markets
(,tock 6xchanges) for margin calculations as well as for capital ade>uacy
re>uirements of -rimary 4ealers. The K/uidelines on Capital +de>uacy ,tandards for
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-rimary 4ealersF were issued )y the Reser"e 5ank of ndia on 4ecem)er %%, 0(((
mandate the -rimary 4ealers (-4s) to work out the market risk )ased on EaR model .
EaR has also )een applied to measure the market risk associated with forward
exposures. The 5asel +ccord, implemented in :anuary %&&9, uses EaR as a )asis for
determining the amount of regulatory capital ade>uate for co"ering market risk
)eyond that re>uired for credit risk
The R5 in its guidelines has asked ndian )anks to use traditional techni>ues like
/ap +nalysis for monitoring interest rate and li>uidity risk. #owe"er R5 is
expecting ndian )anks to mo"e towards sophisticated techni>ues like 4uration,
,imulation, EaR in the future. +s regards the trading portfolio all foreign )anks and
most ndian -ri"ate sector )anks use /ap analysis, )ut are gradually mo"ing towards
duration analysis. Most of the foreign )anks use duration analysis and are expected to
mo"e towards ad"anced methods like Ealue at Risk for the entire )alance sheet. ,ome
foreign )anks are already using EaR for the entire )alance sheet.

The )anks ha"e )een gi"en flexi)ility to use in!house models )ased on EaR for
measuring market risk as an alternati"e to a standardised measurement framework
suggested )y 5asle Committee. The internal models should, howe"er, comply with
>uantitati"e and >ualitati"e criteria prescri)ed )y 5asle Committee.
The nternal Models +pproach was adopted )y the 5asle Committee in its amendment
to capital accord in %&&D to incorporate the market capital charges which was now
)ased on market risk estimates from )anksF internal risk measurement models. The
)ank would use its proprietary risk measurement model to estimate its trading risk
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exposure which, when multiplied )y a certain scaling factor as a measure of
regulatorFs conser"atism, would )ecome the )asis for the regulatory capital charge for
market risk. Regulators would also impose a num)er of standardi$ing restrictions on
)anksF internal models, in order to ensure rough compara)ility across )anks that use
this approach.

@hile the small )anks operating predominantly in ndia could adopt the standardised
methodology, large )anks and those )anks operating in international markets should
de"elop expertise in e"ol"ing internal models for measurement of market risk.
The ,ecurities and 6xchange )oard of ndia in an attempt to reform the ndian ,tock
markets and make them more competiti"e stipulated in the year 0((% that the margin
re>uirements for securities in the compulsory rolling settlement mode would )e
determined )ased the Ealue at!Risk (EaR) model. Further it pro"ided that
%. ,cripwise EaR to )e computed using a confidence le"el of &&<.
0. The daily "olatility of each scrip shall )e ;.' times
;. The method to )e used is 6xponentially weighted mo"ing a"erage method
1. The exchanges are expected to calculate and display the scrip!wise margins on
a daily )asis.
The idea of linking the margin re>uirements to that of the "olatility of stock prices
would lead to a more efficient risk management system wherein "olatile stocks are
inade>uately co"ered and less "olatile stocks are handicapped )y more than
re>uired margins.
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6. ,ethods of ca"cu"atin% #a"ue at Ris$
The EaR model is )ased on three main approaches8
%. #istorical simulation7
0. The "ariance!co"ariance method7
;. Monte Carlo simulations.
n all the methods EaR is calculated on the same schematic )asis8 first, )asic
parameters, such as the period of the sample, the holding period, and the confidence
le"el, are set7 then the rele"ant risk factors are selected and risk mapping is
undertaken7 finally, EaR is calculated.
The methods for calculating EaR can )e )roadly di"ided into two categories.
%. -arametric (Eariance!co"ariance method)
0. .onparametric (#istorical simulations and Monte Carlo simulations).
6.1 4istorica" Simu"ation
This is the simplest of the non!parametric methods as it is not make any assumptions
a)out the distri)ution of changes in risk factors, the structure of the markets, and the
interrelation )etween them. +t the first stage of this system the daily changes in the
"arious risk factors are calculated for the holding period. Then the effect of the change
"aria)les on the current "alue of the trading )ook, i.e., the profit or loss that would
result if past changes were to occur today, is examined.
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;dvanta%es of 4istorica" Simu"ation ,ethod
%. This method is relati"ely simple in application and does not make any
assumptions a)out the distri)utions of the "arious risk factors and the
correlations )etween them.
0. n addition, it can incorporate non!linear positions, such as deri"ati"e
positions, in a natural way, a property that is useful in the context of fixed
income portfolios.
'rawbac$s of 4istorica" Simu"ation ,ethod
%. ts main disad"antage is the lack of data, due to the trade!off )etween a wide
and a narrow sample. *n the one hand, the wider the sample (a larger
window), the greater the pro)a)ility that it will incorporate data a)out more
extreme e"ents (changes). *n the other, a wider sample also includes data
from the distant past that are irrele"ant to the present situation.
0. +nother draw)ack is that it is "ery sensiti"e to the particular data window,
which the 5asle committee has chosen to )e at least one year of past returns.
n other words, whether returns from a highly "olatile or a crash period is
included or not makes a huge difference for the "alue!at!risk predicted. #ence
EaR predictions )ased on #istorical ,imulation exhi)it high "aria)ility.
;. +nother disad"antage is the lack of sta)ility in the results of the simulation,
reflected in daily fluctuations in EaR. f we assume, for example, that the
sample used for the simulation is )ased on three years )ack from the day of
calculation, and that the greatest loss in the portfolio is incurred (through the
simulation) as a result of changes that occurred exactly three years ago, the
EaR on the day of calculation will )e significantly different from that on the
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next day, as the latter is )ased on a sample that does not include the day of the
large loss.
6.2 #ariance.)ovariance method
5oth ad"antages and draw)acks of the "ariance!co"ariance matrix analytic method
are conse>uences of the underlying assumptions in which it is )ased. ts maAor
draw)ack is the assumption that financial market returns are normally distri)uted, an
assumption that has )een shown to )e in"alid in thousands of empirical studies on
asset returns. Financial returns are typically characteri$ed )y fat!tails and "olatility
clustering. Fat!tail property of asset returns implies that losses are much more
fre>uent than predicted )y the "ariance!co"ariance analysis. The "ariance!co"ariance
analysis is particularly weak where the demands from a EaR model for regulatory
purposes and risk control are strong, i.e. in the prediction of extreme >uantiles or large
+nother "ariant of "ariance!co"ariance analysis is the 6xponential weighting
approach. This approach applies exponentially declining weights to past returns to
calculate conditional "olatilities. This techni>ue is Austified )y the presence of
conditional heteroskedasticity or "olatility clustering in the data, meaning that a
"olatile day is typically followed )y "olatile days. The exponential approach also has
the draw)ack that a conditional normality assumption needs to )e made to calculate
the EaR of a portfolio from its conditional "olatility, an assumption that, more often
than not, is not satisfied )y financial data. +lthough the exponential smoothing
approach addresses the issue of non!normality in the (unconditional) distri)ution of
returns, it may not )e applica)le for regulatory EaR purposes on three grounds. First,
while daily returns reflect strong "olatility clustering, they can hardly )e detected in
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)i!weekly returns such as the regulatory %(!day holding period. ,econd, the "olatility
clustering o)ser"ed in the data largely emanates from medium and small range
"olatility periods. 6xtreme e"ents, such as losses at or )eyond &&< confidence
inter"al scatter rather independently o"er time. Finally, as has )een esta)lished )y the
theoretical and empirical literature, interest rate and )ond return processes typically
display a complicated dependence structure in )oth mean and "ariance, there)y
making simple exponential weighting schemes ! so often used in computing the e>uity
EaR ! inapplica)le
The strength lies in the assumption a)out the Aoint normal distri)ution of the portfolio
returns and the assumption a)out the linear relationship (or >uadratic at the most)
among market risk factors (or independent "aria)les) and the portfolio "alue.
Eariance!co"ariance analysis relies on the assumption that financial returns are
normally distri)uted.
;dvanta%es of #ariance.)ovariance ,ethod(
%. t facilitates EaR calculations" making this method easily understanda)le.
0. Rapidity in such calculations, a "ery important feature when working in real time.
'rawbac$s of #ariance.)ovariance ,ethod(
%. The EaR estimation through the "ariance!co"ariance matrix approach gi"es
EaR o"erestimates for small confidence le"els and EaR underestimates for )ig
le"els of pro)a)ility. +s a result, it causes excesses or lacks in the re>uired
)ank capital in order to face the market risk )y the super"isor authorities, with
the resulting repercussions in the )ank sol"ency. This draw)ack comes from
assuming normality in the portfolio returns.
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0. The linearity assumption makes this method only applica)le, theoretically, to
linear portfolios7 not a "ery useful feature, considering the great and growing
use of non!linear assets (especially options) in portfolios.
;. 6"en )y increasing the portfolio "alue approximation to a >uadratic one
(deltagamma methods), success would not )e guaranteed since an accurate
EaR estimate of the non!linear portfolios is not feasi)le.
These two last draw)acks are particularly pertinent regarding options near the money
and close to expiration.

6.3 ,onte.)ar"o Simu"ation
ortfoli o's val ue in each market scenari
Monte Carlo simulation can )e "iewed as a hy)rid of the parametric approach and the
historical simulation approach (it is technically a parametric approach). Bnlike the
"ariance!co"ariance approach, the Monte Carlo approach does not make any
assumptions a)out the model of changes in risk factors7 thus, it can )e applied to all
kinds of positions, )oth linear and nonlinear.
The Monte Carlo simulation methodology has a num)er of similarities to historical
simulation. The main difference is that rather than carrying out simulation using the
o)ser"ed changes in the market factors o"er the last . periods to generate .
hypothetical profit and losses, we take a statistical distri)ution that is )elie"ed to
ade>uately capture or approximate the possi)le changes in the market factors. Then, a
pseudo random num)er generator is used to generate hypothetical changes in market
factors. These are then used to construct hypothetical portfolio profit and losses on the
current portfolio, and the distri)ution of possi)le portfolio profit and loss. Finally, the
"alue at risk is then determined from this distri)ution.
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For linear instruments, the results of the Monte Carlo will )e almost exactly the same
as those of the historical simulation if the "ariance2co"ariance matrix dri"ing the
Monte Carlo was created from the same historical period that is used in the historical
simulation. #owe"er, for instruments that display non!linear )eha"ior (optionality),
the Monte Carlo approach will )e an appropriate measure of the em)edded risk while
the parametric approach will not.
Monte Carlo simulations entail the following steps8
%. + set of random draws of new market data is generated.
0. The current portfolio is re"alued )ased on new market data.
;. The process is repeated to produce a distri)ution of future "alues of the
1. EaR and other risk estimates are generated from the distri)ution.
'rawbac$s of ,onte )ar"o Simu"ation techni8ues inc"ude(
%. Monte Carlo simulation may underestimate the pro)a)ility of large changes in
the underlying "aria)les where the underlying distri)ution and "olatility is
incorrectly specified.
0. The process is expensi"e and slow. Monte Carlo processes are
computationally demanding.
6. <hich method to use=
The different methods of calculating EaR ha"e "arying a)ilities to handle optionality
(non!linear relations), stress testing, complex fixed income and deri"ati"e structures,
risk causality, fat tails, non!symmetrical distri)utions, aggregation of risk from
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multiple systems, etc. Furthermore, some of the solutions are more difficult to
understand and explain. The three methodologies are discussed )elow8
1arametric a++roach
@hen EaR was first de"eloped o"er a decade ago, the parametric approach was the
standard )ecause it was computationally extremely efficient. The efficiency results
from the fact that this is an ZanalyticR approach, which directly calculates a solution,
rather than the alternati"e approaches that determine a solution )y iterati"ely
simulating potential scenarios.
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4istorica" Simu"ation
The historical simulation methodology repeatedly "alues current holdings )ased on
the market conditions that existed o"er a specific historical period of time. This has
the ad"antage of )eing "ery intuiti"e. Bnlike the parametric and Monte Carlo
simulation methodologies, no assumption on the distri)ution of changes in market
factors is re>uired (the other two assume normally distri)uted market returns and
therefore historical simulation )etter handles fat tails (kurtosis), i.e., extreme e"ent
risk, and asymmetric distri)utions (skewness), as are experienced in relati"ely illi>uid
markets such as emerging markets. Furthermore, the historical simulation
methodology explicitly understands the characteristics of instruments with non!linear
)eha"ior and analy$es )ased on historic market performance.
6.- #aR )aveats
EaR is a summary measure of risk. ts application, howe"er is su)Aect to some
#aR does not describe the worst +ossib"e "oss
Ear is not aimed at pro"iding a measure of the a)solute worst loss. EaR only pro"ides
an estimate of the losses at some confidence le"el. #ence ther will )e instances where
EaR will )e exceeded. The lower the confidence le"el, the lower is the EaR measure,
)ut the more fre>uently we should o)ser"e exceptions. This is why )acktesting is an
essential component of EaR systems. t ser"es as a reminder that exceptions are
expected to occur, hopefully at a rate that corresponds to the selected confidence
Estimation ris$
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6stimation risk is the risk that some of the parameters of our model ha"e )een
estimated falsely, perhaps due to an insufficient amount of data a"aila)le in
cali)rating the model. For instance, we might )e working with a "alue for, which is
too low, and hence underestimate the Ealue!at!Risk of our portfolio.
)han%in% +osition ris$s
EaR assumes that the position is fixed o"er the time hori$on. This also explains why
the typical adAustment from %!day to multiple day hori$ons uses the s>uare root of
time factor. t ignores the possi)ility that the trading positions may change o"er time
in response to changing market conditions. Eolatility may not )e sta)le and may "ary
o"er time. +s it "aries o"er time it re>uires the "olatility changes to )e put into a
model. -rices may respond in a non!linear fashion to changes in market "aria)les. n
such cases, non!standard adaptation of EaR is needed. 6xample of such a position is
con"exity in mortgage!)acked securities
Event and Stabi"ity ris$s
t assumes that the recent past is a good proAection of future randomness. There is no
guarantee that the future will not hide surprises!either one!time e"ents(such as
de"aluation) or structural changes (such as going from fixed to floating exchange
,ta)ility risk can )e e"aluated )y stress testing, which aims at addressing the effects
of drastic changes on portfolio risk.
!ransition ris$
@hene"er there is a maAor change, a potential exists for errors. This applies for
instance to organi$ational changes, expansion into new markets or products,
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implementation of a new system, or new regulations. ,ince existing controls deal with
existing risks, they may )e less effecti"e in the transition.
Transition risk is difficult to deal with )ecause it cannot )e modeled explicitly. The
only safeguard is increased "igilance in times of transition.
,ode" ris$s
Model risk can )e defined as the risk of loss occurring from use of inaapropriate
models for "aluing securities. This can result in mis"aluation of the portfolio and
hence of its risks. Model risk usually falls under the um)rella of operational risks.
Models can fail owing to a num)er of reasons8
%) input data can )e wrong
0) parameters of the model can )e incorrectly estimated
;) the model can )e incorrect
1) model can )e incorrectly implemented.
6.7 Limitations of #a"ue at Ris$
EaR also has its draw)acks as a risk measure. ,ome of these are fairly o)"ious that
EaR estimates can )e su)Aect to error, that EaR system can )e su)Aect to model risk
(i.e., the risk of errors arising from inappropriate assumption on which models are
)ased) implementation risk (i.e., the risk of errors arising from the way in which
systems are implemented). #owe"er, such pro)lems are common to all risk
measurement systems, and are not uni>ue to EaR.
1. #aR >ninformative of !ai" Losses
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EaR does ha"e its own distincti"e limitations. *ne of these is that the EaR only tells
us the most we can lose if a tail e"ent does not occur it tells us the most we can lose
&'< of the time, or whate"er! )ut tells us nothing a)out what we can lose on the
remaining '< of occasions. f a tail e"ent (i.e., a loss in excess of EaR )does occur,
we can expect to lose more than the EaR )ut the EaR figure itself gi"es us no
indication of how much that might )e.
This can lead to some awkward conse>uences. + trader or asset manager might Kspike
K his firm )y entering into deals that produce small gains under most circumstances
and the occasional "ery large loss. f the pro)a)ility of loss is low enough, then this
position would ha"e a low EaR and so appear to ha"e little risk, and yet the firm
would now )e exposed to the danger of a "ery large loss. + single EaR figure can also
gi"e a misleading impression of relati"e riskiness might ha"e two positions with e>ual
EaR at some gi"en confidence le"el and holding period, and yet one position might
in"ol"e much hea"ier tail losses than the other.
2. #aR can discoura%e 'iversi/cation
+nother draw)ack ids that EaR can discourage di"ersification. ,uppose there are %((
possi)le future states of the world, each with same pro)a)ility. There are %(( different
assets, each earning reasona)le money in && sates, )ut suffering a )ig loss in one state.
each of these assets loses in a different state, so it is certain that on eof them will
suffer a large loss. f we in"est in one of these assets only, then our EaR will )e
negati"e at say, the &'< confidence le"el, )ecause the pro)a)ility of incurring a loss
is %<. #owe"er, if we di"ersify our in"estments and in"est in all assets, then we are
certain to incur a )ig loss. The EaR of a di"ersified portfolio is therefore much larger
than the EaR of the undi"ersified one. ,o, a EaR measure can discourage
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di"ersification of risks )ecause it fails to take into account the magnitude of losses in
excess of EaR.
!" Em+irica" study( )om+arin% di?erent #aR Estimation
methods with a +ortfo"io 2"inear3 of forei%n currency units.
@e compare, the two EaR estimation methodologies in existence8
the historical simulation and the "ariance!co"ariance matrix .
The daily exchange rates for each of the currencies! 6uro, /5-, B,4ollar and Rupee
ha"e )een used to undertake the study. The data has )een collected from secondary
sources, R5 Reference Rate archi"es for the period from %3.(&20((; to 32%20((;.
6.1 4istorica" Simu"ation method(
n the study an attempt has )een made to >uantify the foreign exchange risk position
of a trading portfolio.
Ste+ 1
The portfolio is assumed to exist of %(( units each of 6BR*, 5ritish -ound (/5-),
B, 4ollar (B,4).
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Ste+ 2
The mo"ement in the exchange rates! Re2B,4, Re26uro and R62/5- for a)out ;00
data points, that is, ;00 alternati"e scenarios for what can happen )etween today and
Ste+ 3 Rate of )han%e 2Rc3
@e then arri"e at the rate of change in the "alue of the portfolio using the following
S T(-t ! -
) 2 -
UH %((
@here R
S daily rate of change
- S exchange rate of the currency i.e Re2B,4, Re26uro or R62/5-, as the case
This defines a pro)a)ility distri)ution for daily changes in the "alue of the portfolio.
+ssuming a &&< confidence le"el, the estimate of EaR is the first percentile of the
distri)ution. Therefore, in case of ;00 data points the third! worst daily change is the
first percentile of the distri)ution.
For instance in the gi"en ta)le, the market "alue of the portfolio is Rs. %9;9&.9.@e
can calculate the change in the "alue of portfolio )etween today and tomorrow for all
different scenarios. For scenario %, it is Rs. %910'.007 for scenario 0 it is Rs.
%9;30.%&.then changes in the "alue are arranged in ascending order and the third!
worst daily change is the one!day &&< EaR.
6.2 #ariance.)ovariance method(
6.2. 1 )om+utation of #aR in a sin%"e.asset case 2 >ndiversi/ed #aR3
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+ssuming that the forex portfolio consists of only one currency we can calculate the
undi"ersified EaR for each of the currency.
f these returns are go"erned )y normal distri)ution, then &&< of all returns will fall
within 0.'9 standard de"iation of the mean return (one tail approach), we thus
compute the mean and standard distri)utions of daily returns.
Finally, *aily VaR
' [Market .al/e o( Position in I0R
+Val/e o( 1 at the con(idence le.el
+*aily .olatility or standard de.iation$
VaR (or n day holding period ' *aily VaR + S,R) !n#-
9.2. 1 )om+utation of #aR in a mu"ti.asset case 2'iversi/ed #;R3(
+ssuming the portfolio consists of %(( units of each currency, B,4, 6uro and /5-
we can calculate the 4i"ersified EaR using the correlations )etween the currency .
Ste+ 1(
2oldings 3 Market Val/e o( the position
6uro /5- B,4 Total
#olding in units %(( %(( %((
Market Ealue in .R 1;9; 900'.9 '39% %9;9&.9
ME -roportion 0;.9;< 11.3;< ;%.11< %((.((<
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-age '&
Ste+ 2(
@e work out the correlations )etween the currencies.
Correlation Matrix
Correlation Matrix
30R#67R 8,$ 67R 0/9#67R
6BR!.R % (.90&1&'D;9 (.3;&;%1399
/5- .R (.90&1&'D;9 % (.&'01'0%09
B,4!.R (.3;&;%1399 (.&'01'0%09 %
Ste+ 3(
Variance-Co.ariance Matrix 4eights Matrix
30R#67R 8,$ 67R 0/9#67R
6BR!.R (.((((1 (.((((1 (.((((1
/5- .R (.((((1 (.((((' (.(((('
B,4!.R (.((((1 (.((((' (.((((D
Ste+ (
-ortfolio EarianceS@eights H T(Eariance!Co"ariance matrix)H weights matrixU.
-ortfolio ,tandard 4e"iation S -ortfolio Eariance[ (.'
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
6uro 0;.9;<
/5- 11.3;<
B,4 ;%.11<
)otal %((.((<
-age D(
*i.ersi(ied VaR
&'< hp % day 0(1.9'&01D&
&&< hp % day 09&.3;'3%0%
&'< hp ' days 1'9.(3&0(%&
&&< ho ' days D13.9D93139
4i"ersified EaR for . days S [Market .al/e o( Position in o( 1 at the
con(idence le.el+ or standard de.iation $ + S,R!0#-
)he 5ene(its o( *i.ersi(ication
Comparison o( 6ndi.ersi(ied 3 *i.ersi(ied V&Rs
6ndi.ersi(ied *i.ersi(ied *i((erence
&'< hp % day 0%1.11%( 0(1.9'&0 &.'9%3
&&< hp % day ;(;.093; 09&.3;'3 %;.''%D
&'< hp ' days 13&.'(1D 1'9.(3&0 0%.10'1
&&< hp ' days D39.%3%( D13.9D93 ;(.;(0;
The %!day &'< EaR for the portfolio containing %(( units of 6uro is Rs.13.&%;&, %((
units of /5- is &%.&;D and %(( units of B,4 is 31.'&( is Rs. 0%1.11% indi"idually.
The %!day &'< EaR for the portfolio containing %(( units of 6uro, B,4, /5- is
The amount 0%1.11%( less 0(1.9'&0 indicates the )enefits of di"ersification. f 6uro,
/5-, B,4 had )een perfectly correlated then EaR for the portfolio would )e e>ual to
the sum of EaR of ndi"idual portfolios. Oess than perfect correlation leads to some
risk )eing Zdi"ersified awayR.
:. &indin%s(
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From the analysis of the results of the empirical study, we arri"e at the following
%. The differences )etween the EaR estimations o)tained with each one of the
methods are much larger in the case of the di"ersified portfolio than in the
undi"ersified one. This is so for all the confidence le"els, periods of time and
num)er of iterations.
0. The largest differences )etween methods (in )oth di"ersified and undi"ersified
portfolios) are o)tained for the EaR calculated with a &&< of confidence.
;. n the case of the di"ersified portfolio, the )iggest difference )etween )oth
methods is o)tained for the EaR with a confidence of &&< and for any period
of time and the difference declines as the confidence le"el rises. The
importance of this conclusion can )e traced to the )ank capital re>uirements
gi"en )y 5asle committee for their market risk (pro)a)ility of &&< and %(
days)7 precisely where the differences are largest. 5ut, )earing in mind that the
EaR calculated with the "ariance!co"ariance approach is higher than the EaR
calculated with the historical method, the )ank will ha"e a tendency to use the
historical one. This is )ecause a smaller amount of capital is re>uired,
)enefiting its profita)ility7 )ut it would not )e controlling the sol"ency of that
)ank in a correct way.
1. @ith )oth methods, the longer the period of time and2or the higher the
confidence le"el, the larger the EaR estimates o)tained.
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'. Oogically, the EaR amounts o)tained with )oth methods (and for all
confidence le"els, periods of time and num)er of iterations), are much )igger
in the undi"ersified portfolio than in the di"ersified one. This re"eals the delta
hedging effect in the reduction of the entire portfolio risk.
For instance, the % day analytic EaR with &&< of confidence, amounts to Rs.
;(;.9;3; in the di"ersified portfolio and to Rs.09&.3;'3 million in the undi"ersified
D. The differences )etween methods )ecome smaller as the num)er of iterations
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1@. !estin% the mode". *ac$testin%
1@.1 *ac$testin%
5acktesting is a method of "erification that checks whether the model is ade>uate.
Eerification can )e made with a set of tools, including )acktesting, stress!testing and
independent re"iew and o"ersight. This section focuses on )acktesting techni>ues for
"erifying the accuracy of EaR models. 5acktesting is statistical framework that
consists of checking whether actual trading losses are in line with EaR forecasts. 6ach
exceedence is called a "iolation.
The key steps in )acktesting are as follows8
EaR estimates using the rele"ant EaR model are generated.
+ctual portfolio profits and losses are calculated .
The actual daily gain or loss is compared to the daily EaR measures
The error fraction (termed as "iolation) is then calculated as the num)er of
occasions on which the actual trading result exceeded the EaR risk measure.
The EaR estimates should )e significantly larger than the trading outcomes for all )ut
small num)er of days (for example, at a confidence le"el of &&<, using a test sample
of 0'( days, the error fraction should )e around 0!; i.e %<. n other words, the actual
profit or loss should not exceed EaR forecast for more than ; days o"er a hori$on of
0'( days at a confidence le"el of &&<.
,easurin% vio"ations
Models are designed to reflect reality. 5acktests compare reali$ed trading results with
model generated risk measures, )oth to e"aluate a new model and to reassess the
accuracy of existing models. +lthough no single methodology for )acktesting has
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)een esta)lished, )anks using internal EaR models for market risk capital
re>uirements must )acktest their models on a regular )asis. The 5, imposes a
penalty on institutions whose EaR models perform poorly.
5anks generally )acktest risk models on a monthly or >uarterly )asis to "erify
accuracy. n these tests, they o)ser"e whether trading results fall within pre!specified
con(idence bands as predicted )y EaR models. f the model performs poorly, they
pro)e further to find the cause (e.g., check integrity of position and market data,
model parameters, methodology).
Risk measurement can always )e impro"ed. The pragmatic >uestion is whether the
impro"ement in performance is worth the in"estment. 5acktesting can help in this
cost )enefit analysis.
*ac$testin% #aR
The Risk Management di"ision should keep a data)ase of daily EaR and mark!to!
market trading re"enues for all trading desks and )usiness units. Trading re"enues
should )e defined as the change in mark! to! market in positions, plus any trading!
related interest income or other re"enue. The most straightforward way to )acktesting
is to plot daily -VO against predicted EaR and to monitor the num)er of "iolations, or
departures, from the confidence )ands. -refera)ly, &( days or more of history should
)e a"aila)le for )acktesting. +ccording to the 5,, national regulators should use the
num)er of excessions o"er the most recent %0 months of data (or 0'( trading days) as
the )asis for super"isory response. 6xcessions should )e within confidence le"el
expectations8 if we ha"e a %!day &'< confidence EaR, we should expect a)out '<
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downside excessions o"er time. f actual excessions are significantly different, steps
should )e taken to track down the source of error.
1@.2 Stress testin%
,tress testing can )e used to define a set of techni>ues that are used to examine the
potential effect on the firmFs financial decision of exceptional )ut not impossi)le
changes in market price2rates or com)ination of such changes.
Stress testin%. the Rationa"e
The demand for stress testing is dri"en )y two factors8
nherent weaknesses in EaR as a risk measure.
The need to ensure the sol"ency of the institution where unlikely extreme
price2rate changes are experienced.
Stress testin%. the )once+t
VaR versus /tress Testing
The critical differences )etween EaR and stress testing are8
EaR is the static >uantification of exposures and rate of change of exposure at
current le"els.
,tress Testing represents the dynamic >uantification of exposure )ased on an
assumed e"olution of prices.
VaR #ersus Stress $esting
Factor E+R ,tress Testing
,ee ,atyaAit 4as, Z ,waps2Fianacial deri"ati"es product, -ricing ,applications and Risk ManagementR
6dition Eolume 1
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Technical )asis ,tatistical or historical Bser defined
.ormal market conditions Crisis, market )reakdowns
or extreme conditions
+ssumptions .ormal assumptions used
in E+R
Eolatility ,ta)le conditions assumed .one
4ata source #istorical data Bser defined ()ased on
historical or assumed
extreme market conditions)
Stress testin%. the 1rocess
The key elements in stress testing include8
Test conditions
This is focused on the extreme conditions the portfolio is to )e tested against. This
will entail decisions regarding the market "aria)les to )e stressed. The indi"idual
"aria)les (interest rates2yield cur"es, currency prices, e>uity prices, commodity
prices, "olatility and correlations) to )e stressed and identified. This may also entail
identifying com)inations or "aria)les to )e stressed. The selection of test conditions
may )e influenced )y nature of the portfolio, the assumed "ulnera)ility of the
portfolio to certain types of price mo"ements and Audgements regarding the )eha"ior
of market "aria)les.
Test assumptions
This is focused on identifying the detailed )asis of the stress test. @here the test
conditions ha"e )een esta)lished, selection of test assumptions focuses on the
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%. :uantum the degree of extreme price mo"ement must )e nominated.
This represents a )alance )etween too small a change and too large a
0. -orrelations ! The historical correlations should )e re"iewed to
determine the likely )eha"ior of relati"e price mo"ements under
extreme market conditions
;. ;i1uidit! conditions! This is concerned with trading li>uidity. 6xtreme
market conditions are assumed to )e associated with decreases in
trading li>uidity. The test assumptions may seek to reflect these )y
increasing the holding period or risk hori$on.
1. Transaction costs extreme market conditions are associated with
increases in trading costs. The test assumptions may incorporate
increased )id!offer spreads.
'. <arket /tructure consideration will ha"e to )e gi"en to the possi)le
changes in market regimes under stress conditions. These may include
possi)le changes in regulatory en"ironment (imposition of trading
controls, foreign exchange controls, position si$e limits), changes in
market )eha"iour (changes in traditional relationships )etween
"aria)les) or )eha"iour of market participants (reduction in credit
limits, withdrawal from or curtailing of trading acti"ity )y market
Re"aluation of the portfolio
,tress Testing necessitates re"aluation of portfolios to esta)lish likely changes in
"alue as a mechanism for esta)lishing risk.
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The re"aluation can )e done in the following ways8
%. 4elta!)ased ! this uses the delta of the positions to deri"e changes in "alue.
0. Full Re"aluation this uses normal pricing models to completely re"alue the
portfolio to deri"e the new "alue. The new "alue is then compared to the
current "alue to deri"e the change in "alue (the potential profit or loss)
4elta!)ased re"aluation is typically >uicker and cheaper. #owe"er, it may )e
inaccurate for non!linear products (particularly, option portfolios). Full re"aluation
will generally )e more accurate, )ut will )e slower and more expensi"e.
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;++"ication of Stress !estin% outcomes8
The stress testing process will pro"ide estimates of profit or losses on the portfolio
for the nominated stress conditions.
The results are then used to re"iew the portfolio. ?ey aspects of the application of
stress testing include8
%. Risk limits To ensure compliance, there may )e specific risk limits for stress
tests that the results will )e compared to. @here no formal stress test risk
limits exists, the results of stress test may )e compared to existing risk limits
to esta)lish the extent of risk )eing carried.
0. -apital +llocation! The stress results may )e used to re"iew the ade>uacy of
capital deployed against trading risks.
;. <odel Validit! The stress tests may pro"ide useful information of
pro)lems2weaknesses in portfolio "aluations and pricing models. This
typically arises )ecause stress test will generally show large swings in profit
and loss. The changes can often highlight model risks and pro)lems in pricing
1. +d=usting $ositions The stress test results may re"eal unaccepta)le risks or
com)ination of risks that may dictate adAustments to trading positions within
the portfolio. The o)Aecti"e of the portfolio is to reduce the "ulnera)ility of the
portfolio to large losses in the e"ent of stress conditions2 assumptions actually
occurring. +dAustment of positions will usually focus on not only the >uantum
of potential risk, )ut also the possi)ility of stress conditions occurring.
!y+es of Stress testin%
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,tress testing is a generic term that encompasses a "ariety of methods of examining
the performance of a portfolio under extreme conditions.
The maAor types of stress testing include8
>. /ensitivit! +nal!sis this determines the impact (in profit or loss terms) of a
large specified change in a single market risk factor on the portfolio at a gi"en
point in time. + large or extreme change in price2rate, "olatility or correlation
is assumed. The portfolio is re"alued to identify the likely change in "alue.
The process is repeated for all market risk factors considered important to the
"alue of the portfolio. 6ach sensiti"ity test is to a single market risk factor, and
conducted on a ceterus pari)us )asis (that is, all other factors are held
constant). + "ariation of this approach is the maximum loss approach. This
consolidates the worst!case market mo"es that ha"e the )iggest ad"erse impact
on the "alue of the portfolio. The maximum loss is e>ual top the effect of the
com)ination of the changes in risk factors. This allows estimation of the
com)ination of changes in market risk factors that would inflict the largest
loss on the portfolio.
2. /cenario +nal!sis this analyses the )eha"iour of the portfolio and its change
in "alue for a com)ination of extreme changes in risk factors. Bnlike
,ensiti"ity +nalysis, the identified risk factors are assumed to simultaneously
change in an ad"erse manner.
There are two types of scenarios8
Fixed ,cenarios This entails construction of hypothetical
com)inations of e"ents that are extreme, )ut not impossi)le, to
esta)lish the )eha"ior of thee portfolio.
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#istorical ,cenarios this uses actual historical e"ents to deri"e
price2rate, "olatility data and correlations to esta)lish the performance
of the current portfolio if the historical e"ent is repeated.
?. /imulation +nal!sis This uses simulations to model the portfolio o"er time.
t will typically take the form of Monte Carlo ,imulations to esta)lish a series
of paths for market risk factors ()ased on parametric criteria or history), and
model the )eha"ior of the portfolio o"er time. The essential differentiating
feature of simulations is the a)ility to randomly generate the changes in risk
factors (within nominated criteria) and through the use of acti"e Monte Carlo
processes to dynamically model the portfolio incorporating trader inter"ention
*ther Techni>ues a num)er of other types of stress modelling ha"e emerged. These
%. 6xtreme "alue theory (Z6ETR)! this uses statistical theory concerned with the
)eha"ior of the ZtailsR or extreme changes in a distri)ution of market returns
to model the )eha"ior of market risk factors.
0. Crash Modelling This uses modeling techni>ues (deri"ed from option
pricing and Aump diffusion theory) to model the "alue change in the portfolio
for a ZcrashR (large price change) in a market risk factor (typically, the asset
11. Sco+e for further Research
*ne of the areas in which Ealue at Risk can )e applied is to compute the mark!to
market margin re>uirements of mem)ers with the stock exchanges on the )asis of
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Ealue at Risk. This would pro"ide for a single num)er for risk of any trading mem)er
and thus ensure )etter risk management systems.
EaR can )e a "ery handy tool in the area of credit risk management which in"ol"es
estimating the risk of a loan portfolio )y looking at "aria)les such as pro)a)ility of
default )y an in"estor, loss on default etc.
The most widely used application for EaR is to determine the daily maximum
pro)a)ility of loss across all trading desks forex, )onds, deri"ati"es etc. to gi"e a
more holistic "iew of the o"erall risk that a )ank or financial institution shall )e
exposed to.
12. Limitations of the study
4ue to the complexity of computation in"ol"ed in the method of Monte Carlo
,imulation, only two methods! #istorical ,imulation and Eariance!Co"ariance
method ha"e )een applied to the empirical data.
n the present day scenario of glo)alisation and li)erali$ation, )anks are exposed to
greater risks than )efore. n "iew of the a)o"e, the 5asle Committee on 5anking
,uper"ision (5C5,) has proposed the .ew Capital +de>uacy +ccord, which not only
endea"ors )anks to hold higher le"els of capital, )ut also en"isages a greater role for
the market. +n increased emphasis is going to )e placed on market risks, newer
models of measurement of market risks "i$., Ealue at Risk (EaR) etc. nternationally,
these models are )eing applied extensi"ely in sectors ranging from )anks, insurance
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companies, primary dealers and mutual funds etc. -resently in ndia, the )anks are
re>uired to adopt Ealue at Risk (EaR) approach to measure the risk associated with
forward exposures and in addition some primary dealers and mutual funds are also
applying this concept.
n this report an attempt has )een made to understand the concept of Ealue at Risk and
discuss its applica)ility in the financial markets. @ith the increasing thrust on risk
management and effecti"e managing of risk , it is imperati"e that financial institutions
shall ha"e to apply the new era risk >uantification models like Ealue at Risk to
manage their portfolio.
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Z+mendment to the Capital +ccord to ncorporate Market Risks,R ,ank for
6nternational /ettlements, :anuary.
2. DOWD, KEVIN (%&&9), 5eyond Ealue at Risk The .ew ,cience of Risk
Management, :ohn @iley V ,ons
3. GUJARATI, DAMODAR N. (%&&') 5asic 6conometrics, Third 6dition,
Mc/raw!#ill nternational 6ditions, 6conomic ,eries, Mc/raw!#ill, nc.
4. HULL, J. C. and WHITE, A. (1998): Value at Risk when Daily
Chanes in !a"ket Va"ia#les a"e n$t %$"&ally
Dist"i#uted. Journal of Derivatives, V$l. ', % 3, (()"in), )).
'. HENDRICKS, Da""yll (199+): ,-aluati$n $. Value*at*Risk
!$dels /sin 0ist$"i1al Data. Economic Policy Review,
Federal Reserve Bank of New York, (A)"il), )). 39*23.
+. JACKSON, 4.5 et al. (1992a): 6ank Ca)ital and Value at Risk.
The Journal of Derivatives, V$l.4, (()"in), )). 23*89
2. JORION, 7inan1ial "isk &anae", (e1$nd ,diti$n.
8. LONGERSTAY, J et al. (199+): Risketrics!. Technical
Document. !$"an 8ua"anty 9"ust C$&)any, 7$u"th ,diti$n,
%ew :$"k (De1e&#e" 12).
9. MARSHALL, C and SIEGEL, !. (1992): Value at Risk:
;&)le&entin a Risk
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-age 3'
!easu"e&ent (tanda"d. The Journal of Derivatives, V$l. 4,
(()"in), )). 91*113.
Techni>ues for using Monte Carlo in EaR estimationR! Research paper,
.ational ,tock 6xchange of ndia.
11. VENKATARAMAN, (. (1992): Value at Risk .$" a
!i<tu"e $. %$"&al Dist"i#uti$ns: 9he /se $. =uasi*6ayesian
,sti&ati$n 9e1hni>ues. Economic Pers"ectives, Federal
Reserve Bank of #hica$o, V$l. 21, %? 2, (!a"1h*A)"il), )). 2*
12. Crnko"ic, C. and :. 4rachman (%&&D). Z+ Bni"ersal Tool to
4iscriminate +mong Risk Measurement Techni>ues,R @orking paper, :. -.
Morgan, Corp
13. J.P.MORGAN BANK (%&&D), RiskMetrics Technical 4ocument,
.ew Pork, :. -. Morgan 5ank.
14. JORION, P. (%&&D). Value at RiskA The 7ew ,enchmark for
-ontrolling <arket Risk, Chicago8 rwin.
ZAKEN@ The mplementation *f Ealue +t Risk (EaR) n sraelFs 5anking
,ystem 5ank of srael 5anking Re"iew .o. 3 (%&&&), D%93
1+. SATYAJIT DAS, ,waps2 Financial 4eri"ati"es Eolume .
12. SUNIL KUMAR AND M. JAYADEV (0((1), CF+ :ournal
of Finance , .o"em)er 0((1
18. VERMA committee Report on Risk Containment in the deri"ati"es
market pu)lished )y ,65.
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List of websites visited
%. www.)
0. www.r)
1. (/lo)al +ssociation of Risk -rofessionals)
3. www.appliedderi"ati"
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&6)OMO5I7E I0*6S)R8
The a/tomobile ind/stry in IndiaGthe tenth largest in the world with an annual
production of approximately 0 million unitsGis expected to )ecome one of the maAor
glo)al automoti"e industries in the coming years. + num)er of domestic companies
produce automo)iles in ndia and the growing presence of multinational in"estment,
too, has led to an increase in o"erall growth. Following the economic reforms of %&&%
the ndian automoti"e industry has demonstrated sustained growth as a result of
increased competiti"eness and relaxed restrictions. The monthly sales of passenger
cars in ndia exceed %((,((( units
Tata Motors launches its first truck in colla)oration with Mercedes!5en$.
In 1953, the government of India and the Indian private sector initiated
manufacturing processes to help develop the automobile industry, which
had emerged by the 1940s in a nascent form. etween 19!0 to the
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economic liberali"ation of 1991, the automobile industry continued to
grow at a slow pace due to the many government restrictions. # number
of Indian manufactures appeared between 19!0$19%0.&apanese
manufacturers entered the Indian mar'et ultimately leading to the
establishment of (aruti )dyog. # number of foreign firms initiated *oint
ventures with Indian companies.
Challenges (aced by Indian &/tomoti.e Ind/stry in the ne9 age
+he Indian automotive industry has been facing new challenges due to the
rapid changes ta'ing place during the last decade. +his article discusses
those challenges and initiatives ta'en by the government to overcome
+he Indian auto industry is changing rapidly. ,uring the last decade, many
international auto manufacturers, either by themselves or in partnership
with Indian companies, have started manufacturing activities in India. +he
ancillary industries have also grown in tandem. +he -uality of production
in small$ and medium$scale industries has improved to such an e.tent
that they started e.porting products to international manufacturers. +he
ma*or brea'through of recent years is the unveiling of /0ano/ by +ata
(otors during the auto e.po 100!. +his has received worldwide attention
and proved that India can not only design an automobile of international
standards but also e.ecute the pro*ect at a much lower cost through
innovative choice of components, materials, engine design etc.
+hese developments in the auto sector have given new confidence to
everyone related to the auto industry and specifically to the government
which resulted in the announcement of the #uto 2olicy 1003$1013 by the
(inistry of 4eavy Industries. #ccording to the #uto 2olicy, the Indian auto
sector is e.pected to grow to )56 113 billion by 1013 and add 1.5 million
new *obs to the economy. 7very year two to three million people are
e.pected to purchase new vehicles. 5everal million vehicles and
components are e.pected to be e.ported to both developed and
developing nations. +o achieve these goals, it is important that the
present 8,2 growth rate, which is more than % per cent, continues to
remain at the same level for the ne.t %$10 years. +he government is also
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giving some concessions to the auto industry. +o reali"e the above growth
predictions, it is important to overcome various challenges the industry is
facing currently. +wo of the foremost challenges are the spiraling cost of
fuel and the paucity of highly s'illed manpower.
Risin% oi" +rice
International price of crude oil has crossed )56 110 per barrel and is
rising at an alarming rate. +he forecast of mar'et e.perts that the crude
oil price will plateau around )56 100 per barrel has been proved wrong.
+he s'yroc'eting crude oil price rise will affect the economic growth of
most of the nations of the world including India. +he prospects of India
and 9hina of becoming economic superpower will be seriously affected.
#lso, the rise in oil prices will impact the growth of global automotive
industry. )nless the use of alternative fuels increases, it is very unli'ely
that the situation will change for the better.
+his necessarily means that more and more investments should be
directed towards :;,, establishing mechanisms to translate :;, results
into products and their efficient manufacturing. +his will also re-uire
radical redesigning of engines.
4uman resources
+he second ma*or challenge is the creation of highly s'illed human
resource re-uired for the auto industry. #uto industry, li'e many other
industries is facing severe shortage of s'illed technical as well as
managerial manpower. +his challenge becomes all the more daunting
because faults lie at a more fundamental level of training infrastructure
and the social perception.
+he growth of auto industry in India will be contingent not *ust on
domestic demand, but also e-ually on e.ports. +herefore, the present
pro*ections will become a reality if thrust is given to original research that
will yield brea'through results. +hese results help in addressing the
current global concerns such as environment, fuel efficiency, need for
alternate and renewable fuels and materials etc. +his can happen only
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through a consortium approach where various auto companies and
academic institutions wor' together as in the case of I+ hardware
industry. +he consortium approach should be e.tended to address the
trained human resource shortage as well. +he government should act as a
facilitator by bringing about necessary changes in the current laws that
will encourage private participation. <inally, there should be mechanisms
in place that will ensure that there is a balance in the pool of human
resources comprising research scientists, managers, engineers, designers,
technicians, and s'illed and semis'illed wor'ers.
The Indian Automobile Industry manufactures over 11 million vehicles and exports
about 1.5 million each year.
The dominant products of the industry are two-wheelers with a market share of over
75 and passen!er cars with a market share of about 1".
#ommercial vehicles and three-wheelers share about $ of the market between them.
About $1 of the vehicles sold are used by households and only about $ for
commercial purposes.
The industry has a turnover of more than %&' ()5 billion and provides direct and
indirect employment to over 1) million people.
The supply chain is similar to the supply chain of the automotive industry in *urope and
Interestin!ly+ the level of trade exports in this sector in India has been medium and
imports have been low. ,owever+ this is rapidly chan!in! and both exports and imports
are increasin!.
-ith a hi!h cost of developin! production facilities+ limited accessibility to new
technolo!y+ and increasin! competition+ the barriers to enter the Indian Automotive
sector are hi!h.
India has a well-developed tax structure. The power to levy taxes and duties is
distributed amon! the three tiers of .overnment. The cost structure of the industry is
fairly traditional+ but the profitability of motor vehicle manufacturers has been risin!
over the past five years.
Tata /otors is leadin! the commercial vehicle se!ment with a market share of about
"0. /aruti &u1uki is leadin! the passen!er vehicle se!ment with a market share of
0". ,yundai /otor India 2imited and /ahindra and /ahindra are focusin! expandin!
their footprint in the overseas market. ,ero /oto#orp is occupyin! over 01 and
sharin! 3" of the two-wheeler market in India with 4a5a5 Auto. 4a5a5 Auto in itself is
occupyin! about 56 of the three-wheeler market.
7ver the past few years+ the industry has been volatile. #urrently+ India8s increasin! per
capita disposable income which is expected to rise by 19" by 3915

and !rowth in
exports is playin! a ma5or role in the rise and competitiveness of the industry.
The level of technolo!y chan!e in the /otor vehicle Industry has been hi!h but+ the rate
of chan!e in technolo!y has been medium. Investment in the technolo!y by the
producers has been hi!h.
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Automo$ile In%ustr& is a s&m$ol of technical marvel $& humankin%. Automo$ile in%ustr& is consi%ere% to
$e one of the fastest 'ro(in' sectors in an& %evelo)in' an% even in a %evelo)e% countr&. Due to its
%ee) for(ar% an% $ack(ar% linka'es (ith several ke& se'ments of the econom&* the automo$ile
in%ustr& is havin' a stron' multi)lier effect on the 'ro(th of a countr& an% hence is ca)a$le of $ein' the
%river of economic 'ro(th. Even automo$ile in%ustr& )la&s a ma+or role as a catal&st in %evelo)in' the
trans)ort sector in one han% an% hel)s in%ustrial sector on the other there$& even facilitates in the
'ro(th of the econom& an% increases the em)lo&ment o))ortunities. The risk an% return anal&sis linke%
(ith an& in%ustr& reveals the intricacies involve% (ith the )articular in%ustr&. A close (atch on these
values thro(s li'ht on a clear un%erstan%in' an% facilitates in %ecision makin' a$out the investment in
securities. ,hile makin' the %ecisions re'ar%in' investment an% financin'* one seeks to achieve the
ri'ht $alance $et(een risk an% return* in or%er to o)timi-e the value of the firm. isk an% return 'o
to'ether in investments. Ever&thin' an investor .$e it the firm or the investor in the firm/ %oes is tie%
%irectl& or in%irectl& to return an% risk. The o$+ective of an& investor is to ma0imi-e e0)ecte% returns
from his investments* su$+ect to various constraints* )rimar& risk. eturn is the motivatin' force*
ins)irin' the investor in the form of re(ar%s* for un%ertakin' the investment. The im)ortance of returns
in an& investment %ecision can $e trace% to the factors1 it ena$les investors to com)are alternative
investments in terms of (hat the& have to offer the investor* it hel)s in measurin' of historical returns
(hich ena$les the investors to assess ho( (ell the& have %one* it facilitates in measurin' of the
historical returns also hel)s in estimation of future returns.
To I%entif& the isk an% eturn involve% in the investment of securities in the market s)ecificall&
(ith the In%ian automo$ile in%ustr&
A ke& criticism of the e0istin' em)irical literature on the risk2return relation relates to the relativel& small
amount of con%itionin' information use% to mo%el the con%itional mean an% con%itional volatilit& o0
e0cess stock market returns. To the e0tent that financial market )artici)ants have information not
reflecte% in the chosen con%itionin' varia$les* measures of con%itional mean an% con%itional volatilit& 2
an% ultimatel& the risk2return relation itself 2 (ill $e mis2s)ecifie% an% )ossi$l& hi'hl& mislea%in'. ,e
consi%er one reme%& to these )ro$lems usin' the metho%olo'& of %&namic factor anal&sis for lar'e
%atasets* (here$& a lar'e amount of economic information can $e summari-e% $& a fe( estimate%
factors. ,e fin% that three ne( factors* a 3volatilit&4* 3risk )remium4* an% 3real4 factor* contain im)ortant
information a$out one25uarter ahea% e0cess returns an% volatilit& that is not containe% on commonl&
use% )re%ictor varia$les. Moreover* the factor au'mente% s)ecifications (e e0amine )re%ict an%
unusual 67289 )ercent of the one25uarter ahea% variation in e0cess stock market returns* an% e0hi$it
remarka$l& sta$le an% stron'l& statisticall& si'nificant out2of2sam)le forecastin' )o(er. :inall&* in
contrast to several )re2e0istin' stu%ies that rel& on a small num$er of con%itionin' varia$les* (e fin% a
)ositive con%itional correlation $et(een risk an% return that is stron'l& statisticall& si'nificant* (hereas
the uncon%itional correlation is (eakl& ne'ative an% statisticall& insi'nificant.
The evi%ence from this stu%& sho(s that the 3accruals anomal&4 an% the 3ca)ital investment anomal&4
are %istinct* even thou'h ca)ital investments an% accruals ma& $e relate% in a certain (a&. The results
also in%icate that* after a%+ustment for the :ama;:rench three risk factors* investors earn su$stantiall&
hi'her returns $& usin' a strate'& that e0)loits $oth anomalies at the same time than $& e0)loitin' either
anomal& alone. Usin' current accruals as the measure of accruals )ro%uce% similar results to usin' total
accruals* an% the results are ro$ust to various measures of return. The evi%ence su''ests that
mana'ers in com)anies ranke% hi'hest in $oth accruals an% ca)ital investments ma& $e overl&
o)timistic a$out future %eman% for their )ro%ucts
Diversification in )ortfolios of in%ivi%ual stocks1
Stan%ar% investment metho%olo'& su''ests much of the $enefit from %iversification is achieve% (ith a )ortfolio
of $et(een < an% 89 stocks. Investors (ith a lon'2term investment hori-on* ho(ever* mi'ht $e concerne% (ith
shortfall risk that coul% result in en%in' (ealth levels si'nificantl& $elo( tar'et. Usin' a 892&ear return series
for 6*999 lar'e common stocks an% a Safet& :irst criterion* the authors conclu%e that even 699 stocks ma& not
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$e enou'h to alleviate si'nificant levels of shortfall risk. Althou'h )ortfolios (ith a small num$er of stocks can
:esearch /ethodolo!y
:esearch 'esi!n
This research article stu%& has a%o)te% %escri)tive research %esi'n.
These %ata (ere %ra(n from the historic %ata from the NSE .National Stock E0chan'e/ ;
$oth the S=> ?N@ NI:T! an% the Stock eturn of the in%ivi%ual firms
.TATA* M=M* AINDUSTAN* ASAO" LE!LAND = MAUTAI/. Internet is use% as the )rimar& source to
%ra( the %ata for the anal&sis of the risk in the securities of these firms in the automo$ile in%ustr&.
;ormulas used
S&stematic isk B
Uns&stematic isk B
Market return <
Stock return B
The outcome of the calculations for the Al)ha .the return In%icator/ an% the Beta .S&stematic risk/ of the
C %ifferent firms %urin' the )erio% of Dan 899E
; Dec 899F is as follo(s1
Indian automobile industry comparison
=ear TATA />/ ,industan Ashok leyland /aruthi
899E 9.98 9.6C E.7C 29.EG 9.97
899C 29.9E 9.9G 9.H< 9.99 9.98
8997 9.98 9.87 9.89 9.9G 9.98
A2?,A 899F 29.8E 29.98 29.9E 29.97 29.6E
899E 6.8F 9.GE 6.88 9.<7 6.89
899C 6.6G 9.6F 29.8C 6.9H 6.69
8997 6.6F 9.69 29.98 6.9H 6.6H
899F 9.<H 29.96 9.9C 9.<G 9.H<
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Base% on the Al)ha .eturn in%icator/ an% the Beta .S&stematic isk/ for the ma+or )la&ers in
the In%ian automo$ile in%ustr& the anal&sis coul% $e ma%e on the %e'ree of risk involve% in
the investment of the securities of these firms. This (ill further enhance the anal&sis to
calculate the E0)ecte% return* E IrJ for the investors on these firms in future.
The *xpected :eturn and the *xpected :isk durin! the period of 3990-3997
*xpected return *xpected risk
TATA 2<.79 TATA 66H.HH
Ain%ustan 68<.8H Ain%ustan 89H8.FH
Ashok le&lan% 26G.<E Ashok le&lan% 899.F6
Maruthi 6.97 Maruthi 7C.6H
?robability of :eturn
=ear TATA ?rob />/ ?rob ,I@'% ?rob A&,7 ?rob /A:% ?rob
&TA@ A 2*= T,I
899E 9.98 89.99 9.6C 89.99 E.7C 89.99 29.EG G9.99 9.97 GC.99
899C 29.9E 8C.99 9.9G GC.99 9.H< GC.99 9.99 GC.99 9.98 8C.99
8997 9.98 89.99 9.87 6C.99 9.89 6C.99 9.9G 6C.99 9.98 8C.99
899F 29.8E GC.99 29.98 G9.99 29.9E G9.99 29.97 89.99 29.6E 6C.99
>ro$a$ilit& of eturn K is allocate% )urel& $ase% on the kno(le%'e of the in%ustr& an% e0)erience
Base% on the calculate% values of Al)ha .the return In%icator/ an% the Beta .S&stematic risk/ for the five
%ifferent firms $et(een the )erio%s of 899E2 899F the E0)ecte% eturn an% risk involve% in the
investments ma%e in these firms have $een foun%. These calculations can hel) in certain anal&sis that
coul% $e ma%e for a clear un%erstan%in' a$out the investment %ecisions on these firms.
*xpected :eturn
:rom the calculate% values of E0)ecte% eturn* E IrJ it is clear that AINDUSTAN MOTOS has 'iven
)henomenal return of 68<.8HK com)are% to other firms in the same in%ustr&. :ollo(in' that is the MAAINDA
= MAAINDA is (ith F.CK. The ne'ative result of ASAO" LE!LAND an% TATA motors )roves that these
firms faile% to 'ive the )ossi$le )ositive outcome %urin' the )erio% of 899E2899F.
*xpected :isk
Usin' the e0)ecte% return values* the )ossi$le outcome coul% $e )re%icte%. The chance of the actual
outcome from an investment (ill var&. The (i%th of a )ro$a$ilit& %istri$ution of rates of return is a
measure of risk. The (i%er the )ro$a$ilit& %istri$ution* the 'reater the risk or 'reater the varia$ilit& of
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return the 'reater is the variance. Aere* amon' the five lea%in' automo$ile )la&ers in In%ia MAUTAI
offers a lesser varia$ilit& of risk i.e. 7C.6HK follo(in' (hich is MAAINDA = MAAINDA (ith a risk of
Ealuation8 Maruti ,u$uki Otd.
Company 2istory
Maruti ,u$uki ndia Otd (formerly Maruti Bdyog Otd) is ndiaNs largest passenger car
company, accounting for a)out 1& per cent of the domestic car market. The company
offers full range of cars from entry le"el Maruti 9(( V +lto to stylish hatch)ack Rit$,
+!star, ,wift, @agon R, 6stillo and sedans 4Wire, ,Q1 and ,ports Btility "ehicle
/rand Eitara. The company is a su)sidiary of ,u$uki Motor Corporation of :apan.
The company is engaged in the )usiness of manufacturing, purchase and sale of
motor "ehicles and spare parts (automo)iles). The other acti"ities of the company
include facilitation of pre!owned car sales, fleet management and car financing. They
ha"e four plants, three located at -alam /urgaon Road, /urgaon, #aryana and one
located at Manesar ndustrial Town, /urgaon, #aryana.
The company has se"en su)sidiary companies, namely Maruti nsurance 5usiness
+gency Otd, Maruti nsurance 4istri)ution ,er"ices Otd, Maruti nsurance +gency
,olutions Otd, Maruti nsurance +gency .etwork Otd, Maruti nsurance +gency
,er"ices Otd Maruti nsurance +gency Oogistics Otd and True Ealue ,olutions Otd.
The first six su)sidiaries are engaged in the )usiness of selling motor insurance
policies to owners of Maruti ,u$uki "ehicles and se"enth su)sidiary, True Ealue
,olutions Otd is engaged in the )usiness of sale of certified pre!owned cars under the
)rand NMaruti True EalueN
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Shareholding Pattern
CompanyFs maAor stake of o"er '1< is held )y foreign promoter group namely
,u$uki group. nstitution holding in Maruti is little less than ;9< which also suggests
the low risk and high potential of this stock and after that a)out 9< of the companyFs
stock is held )y general pu)lic.
Maruti ,u$uki is a market leader in the domestic passenger car market with a market
share of '%.0< in FP%(. The company has a strong product portfolio spanning across
"arious price points. Maruti has made significant in"estments in )uilding an ela)orate
distri)ution network with 9(0 sales and 013( ser"ice outlets, which in our "iew
remains a competiti"e edge for the company. n FP%(, the company achie"ed a key
milestone of "ehicle sales in excess of % million units.
*"er the last six months Maruti has underperformed the 5,6 +uto ndex )y 0'< on
the )ack of heightened concerns regarding market share erosion and margin pressure
on account of commodity cost increases and ad"erse currency mo"ements. +lthough
market share loss is a gi"en in light of competiti"e launches (.ano will surely erode
some of its market share). t can )e expected that MarutiFs domestic "olume growth in
the passenger car segment o"er the next few years should remain good at a)out %(<
PoP reasons for that )eing8
:- ;ood .ol/me gro9th despite market share loss
4espite se"eral new launches in the compact car segment, we )elie"e "olume
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ramp up for the new entrants would take a few years. MarutiFs strong distri)ution
reach of 9(0 sales outlets and 013( ser"ice stations remains a competiti"e edge. The
company plans to focus on the largely under!penetrated rural markets, which currently
contri)ute %D.'< of its domestic "olumes (& < in FP(&). Furthermore, we note that
MarutiFs current product portfolio is fairly di"ersified with the re"enue share from the
compact car segment accounting for 'D< of total sales.
<- Margin le.ers to partially o((set inp/t cost press/re
MarutiFs cali)rated capacity expansion would ensure high utili$ation le"els
o"er the next two years. The company has completed its platform rationali$ation and
up gradation efforts in \1FP%(, which we feel could )ring in cost efficiencies in the
su)se>uent period. Further with the recent price hike of ] %< on )lended )asis, it
would )e a)le to partially offset some
portion of commodity cost increase. +d"erse forex mo"ement is likely to impact
operating profits )y ]0< in FP%%6 and FP%06, )ased on MarutiFs unhedged
=- Expect (re>/ency o( ne9 la/nches to accelerate
Maruti has )een consistently launching one new model e"ery year in addition
to refreshers of its existing models. n the context of emission norms change, the
company has upgraded most of its existing models to 5,!E emission standards. n
addition to one new model launch, Maruti will also undertake model face!lifts at
regular inter"als.
1. Ind/stry o/tlook remains positi.e.
-assenger car demand in ndia is on an up mo"e following the growing
demand for cars led )y impro"ing income and consumption le"els. Fa"ora)le
domestic story coupled with low penetration le"els pro"ides a huge upside
opportunity for the passenger car players in the domestic market. ncreasing
competition will lead to an o"erall )roadening of the car market in ndia. 4omestic
passenger "ehicle segment in ndia ha"e registered a %'< C+/R growth in the past 1
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?- Mar/ti@s c/rrent per(ormance
MarutiFs total sales grew )y 0;< to 99%1( units in May 0(%( on ro)ust
demand. The domestic sales recorded its highest monthly sales at 3D%0( units, up
)y 0%< in May 0(%(. The pre"ious domestic monthly sales high was in Fe) 0(%(.
,egment wise, +0 and +; registered highest domestic monthly sales. The +0
segment that comprises of compact car )rands grew )y %3< to D0D3& units while
the +; segment i.e. sedan models grew )y impressi"e D%< to %(99; units in May
0(%(. ,urprisingly the M9(( sales grew )y %(< to 0''9 units in May 0(%(. The
exports of MarutiNs passenger cars grew )y healthy ;;< to %0(0( units on ro)ust
demand, howe"er its market shares slipped )y %(( )ps to 1&< in May 0(%(. *n
o"erall )asis, MarutiNs total sales crossed o"er %!lakh units (on including its
multipurpose and utility "ehicle sales).
Aey Ratios
Ratios to meas/re BShort )erm Sol.ency@
The "alue of current ratio is %.399 is fairly good, its "alue is greater than % which
suggests that after a period of % year when these assets will )e con"erted into cash
Maruti will end up getting cash instead of paying and its "alue is not so high that it
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may suggest some inefficient use of its current assets. The "alue of cash ratio is .D;0
which is on the higher side and tells us that the company is currently ha"ing enough
cash to pay of D;.0< of its current lia)ilities.
)/ Meas/res
The turno"er figures are extremely good the in"entory turno"er ratio of 03.9D
suggests that the in"entory is turned o"er 03.9D times e"ery year and the ratio of 4ays
,ales in in"entory of %;.% days tells us that Maruti holds %;.% days of in"entory with
Recei.ables )/
0et Sales
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MarutiFs .et ,ales has grown at a C+/R of a)out %1.'< for %1 years and for the last
' years the C+/R for growth in .et sales has )een %3.DD<. This trend might get
dampened )y recession )ut Maruti is still likely to continue a moderate growth of
a)out %(<.
;ro9th rates in P5I) and 0et Pro(it
MarutiFs last %1 year C+/R for -5T is &.9< and ' year C+/R is %D<. For .et
-rofit the %1 year C+/R has )een %%.%< and ' year C+/R has )een %%.(%<.
Ret/rn on 0et-4orth
MarutiFs +"erage Return on net worth for the last %1 years has )een %9.3D<. This is
extremely good, since a"erage return on .FTP for the last %( years has )een
*i.idend Pay-o/t ratio
MarutiFs a"erage di"idend payout for the last %1 years in comparison to its net
profit is a)out %(.91<. This is similar to its peers.
Rein.estment Rate
MarutiFs a"erage rein"estment rate for the last %1 years has )een &'.;< and for the
last ' years it has )een extraordinarily high at %%&.D1<.
Ret/rn on Capital
MarutiFs a"erage return on capital for the last %1 years has )een %3.10<, and for the
last ' years it a"erages out at %3.39<.
;ro9th Rate
/rowth rate is nothing )ut multiplication of KReturn on CapitalF and KRein"estment RateF.
Growth rate=return on capital x reinvestment rate
+"erage /rowth Rate for the last %1 years has )een %9.9;< and for the last ' years it
has )een %&.00<.
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Ealuation method used here to "alue Maruti is KFree Cash Flow To FirmF or FCFF.
+ll the rates used here are )ased on historical data and "ariations are made in them
after discussions. Following are assumptions and rates used for "aluation.
Operating MarginC Oast %1 yearFs a"erage operating margin is %1.D&<, last %(
yearFs a"erage operating margin is %0.'D<, last ' yearFs a"erage operating margin
is %D.10< )ut operating margin for 0((& was "ery low compared to these at %0.(D.
For calculation purposes we ha"e taken operating margin to )e at %'< for the first
0(%% to 0(%; and after that at %1< since there will )e pressure on it due to
increased competition.
Rein.estment RateC Rein"estment rate used for 0(%( is kept at 3'< due ama$ing
results shown )y the company a good part of this growth came from decreased raw
material prices and low )ase effect. 5ut it can )e safely assumed this growth will )e
"ery difficult to maintain. #ence the Rein"estment rate is assumed to )e 3'< for
0(%( and for later years it is assumed to )e D(<.
Ret/rn on CapitalC Oast ' years a"erage return on capital was a"eraging at
%9< and this )elie"e Maruti will )e a)le to maintain.
*ebt to E>/ityC Current 4e)t to 6>uity ratio is &< )ut since Maruti will not )e a)le
to maintain its rein"estment rates there will )e a su)stantial decrease in cash outflows
hence Maruti will decrease its 4e)t to 6>uity ratio to '<.
*i.idendC Company will increase the di"idend ratio to ;0< of its net e"entually.
Other IncomeC *ther ncome will grow at a constant rate of %0< gi"en the steady
increase in cash.
4orking CapitalC CompanyFs working capital currently is negati"e )ut as its
growth will slow down it will )ecome difficult to maintain a negati"e working
capital so excess cash i.e. remainder of net profits after paying di"idends and
*epreciationC Oast %1 year a"erage depreciation is at a)out 9.'< this is taken as
;ro9th RateC ,ince 0(%( was an exceptional year growth rate for 0(%% will )e
%;.'< )ut for the consecuti"e 1 years high growth rate period is taken at %(.9<.
)erminal ;ro9th RateC Terminal /rowth Rate is taken same as Risk Free Rate
#ere 4efault ,pread is dependent upon ndiaFs currency risk which according to
MoodyFs Rating is K5a0F which when con"erted into default spread comes out to )e
e>ual to ;<
. %( year 5ond rate is on :une D was at 3.'9<. Risk Free Rate comes out
to )e at 1.'9<.
C 5eta of Maruti comes out to )e K.9(D9F after normali$ing it with industry.
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Dree Cash Dlo9 to Dirm
Partic/lars <E:F <E:= <E:< <E::E <E:E
65T(%!t) ;(1&.901 ;(0(.%;' 03;D.0'9 019(.(%1 010&.&&D
.et Capital 6xpenditureTCapital
6xpenditure! 4epreciationU ;&%.01 ;D3.01 ;1D.19 999.01 !%1.;&
Change in @orking Capital
Calc/lation o( ;ro9th Rate!R-R+ROC# :E-GEH :E-GEH :E-GEH :E-GEH :?-E?H
%) R*C %9.((< %9.((< %9.((< %9.((< 0(.(3<
65T(%!T) ;(1&.90 ;(0(.%1 03;D.0D 019(.(% 01;(
5ook Ealue of 6>uity V 4e)t %9D&0.%& %D3;0.0% %'0%D.'1 %;391.0& %0%(3.%9
0) Rein"estment Rate (.D (.D (.D (.D (.3'
Cap ex %39&.(9 %D%;.(% %1''.%' %93;.00 !%1.;&
Change in @C ( ( ( ( (
65T(%!T) ;(1&.90 ;(0(.%1 03;D.0D 019(.(% 01;(
FCFF ;11%.(D ;;93.;9 ;(90.31 ;;D9.0' 01%'.D%
@+CC (.%0 (.%0 (.%0 (.%0 (.%0
-resent "alue 00(1.0; 010'.10 00%0.;& 03(;.&' 0%D1.;;
Terminal Ealue ( 1 years high growth) ;(D0(.01
Firm Ealue 10;;(.'3
6>uity Ealue 10;;(.'3
Face Ealue '
.o of ,hares 099&%((D(
-rice -er ,hare %1D'.%9%133
5alance Sheet &bstract
<E:F <E:= <E:< <E:: <E:E
,*BRC6, *F FB.4, 8
,hare Capital %11.' %11.' %11.' %11.' %11.'
Reser"es Total %3D'3.'& %'3&(.&1 %1(3D.'3 %0'(%.D1 %(;9;.19
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age &0
6>uity ,hare @arrants ( ( ( ( (
6>uity +pplication Money ( ( ( ( (
Total ,hareholdersF Funds %39(0.(& %'&;'.11 %100%.(3 %0D1D.%1 %('03.&9
Total 4e)t 9&(.% 3&D.33 &&'.13 %%;9.%' %'3&.0
Total Oia)ilities %9D&0.%& %D3;0.0% %'0%D.'1 %;391.0& %0%(3.%9
+--OC+T*. *F FB.4, 8
/ross 5lock %D11'.%9 %1D'D.% %;(1;.(& %%'93.&' &3%1.3;
Oess8 +ccumulated 4epreciation %(0'(.(3 99'0.0; 3D(D.1D D1&3.9 ''%0.90
Oess8 mpairment of +ssets
.et 5lock D%&'.%% '9(;.99 '1;D.D; '(&(.%' 10(%.&%
Total +ssets %9D&0.%& %D3;0.0% %'0%D.'1 %;391.0& %0%(3.%9
Pro(it and 7oss &cco/nt &bstract
<E:F <E:= <E:< <E:: <E:E
.C*M6 8
1&&&9.1 1'%01.& ;D3'D.3 ;%&13.D
,ales Turno"er D 3 1(30D.' 3 9
6xcise 4uty 31&&.33 D3D9.31 D%(9.&9 ''%;.'0 0919
101&9.D ;9;'D.0 ;1D%3.' ;%01;.0 0&(&&.D
.et ,ales & 0 ; D 9
*ther ncome %D(D.11 %1;1.;0 %09(.D1 %%1;.1; %(0(.&0
,tock +dAustments ( ( ( ( (
11%('.% ;&3&(.' ;'9&9.% ;0;9D.D
Total ncome ; 1 3 & ;(%0(.D
;D'19.9 ;0D(0.3 0D''D.3 0'DD9.3
Total 6xpenditure 9 & 0&101.& 3 0
*perating -rofit '&1&.90 '3';.1; '%&0.D; 1D9D.1& 11'%.99
nterest D;.&; '3.0; 3%.' 9%.3' ;;.'
/ross -rofit '99'.9& 'D&D.0% '%0%.%; 1D(1.31 11%9.;9
4epreciation %;&3.91 %01'.33 %%(9.DD &91.&9 90'.(0
Minority nterest ()efore tax) ( ( ( ( (
-rofit 5efore Tax 1199.(' 11'(.11 1(%0.13 ;D%&.33 ;'&;.;D
Tax %19%.(D %1D9.D1 %;01.%% %%&1.'0 %(&1
Fringe 5enefit Tax
4eferred Tax
.et -rofit ;((D.&& 0&9%.3& 0D99.;' 010'.01 01&3.D0
Minority nterest (after tax) (
-rofit2Ooss of +ssociate Company
.et -rofit after Minority nterest V -2O +sso.Co. ;((D.&& 0&9%.3& 0D99.;' 010'.01 01&3.D0
6xtraordinary tems (
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age &;
+dAusted .et -rofit ;((D.&& 0&9%.3& 0D99.;' 010'.01 01&3.D0
+dAst. )elow .et -rofit ;((D.&& 0&9%.3& 0D99.;' 010'.01 01&3.D0
%;D09.1 %%&%1.( %(;;&.%
- V O 5alance )rought forward %'1&'.% ' 9 ' 900%
,tatutory +ppropriations (
+ppropriations %%01.'3 %%%'.%1 &3;.&9 9'(.;% ;3&.13
%3;33.' %;D09.1 %%&%1.( %(;;&.%
- V O 5alance carried down ; %'1&'.% ' 9 '
4i"idend &D0.01 &'1.%3 9;;.;& 303.'3 ;01.D&
-reference 4i"idend
6>uity 4i"idend (<) DD'.&%< DD(.;;< '3D.31< '(;.'%< 001.3(<
4i"idend Tax ^ %D.93< %D0.;; %D(.&3 %1(.'& %00.31 '1.39
6-, )efore Minority nterest (Bnit Curr.) %(1.(9 %(;.0% &;.(' 9;.&1 9D.1'
6-, )efore Minority nterest (+dA) (Bnit Curr.) %(1.(9 %(;.0% &;.(' 9;.&1 9D.1'
6-, after Minority nterest (Bnit Curr.) %(1.(9 %(;.0% &;.(' 9;.&1 9D.1'
6-, after Minority nterest (+dA) (Bnit Curr.) %(1.(9 %(;.0% &;.(' 9;.&1 9D.1'
,ales Trends in +utomo)ile
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age &1
ndian +utomo)ile ndustry is se"enth largest in the world total production for 0((&
)eing 0D,;0,D&1
units. ndia also is the fourth largest automo)ile exporter of
automo)iles. The performance figures for ndian +utomo)ile industry ha"e )een
exceptional, o"er the past %( years from 0((1 to 0((& the net production of
automo)iles in ndia has grown at a C+/R of %0.1(< (' year C+/R for passenger
Cars has )een %'.('<). The importance of these figures increases e"en more if we
consider the total unit increase in world automo)ile production has )een at a %( year
C+/R of (.9%<.
n the last %( years in terms of growth ndian +utomo)ile ndustry has clearly
outperformed the world a"erage )y a gigantic margin )ut it is not the point where we
consider automo)ile industry in ndia to )e a mature one, in!fact it is not showing any
signs of maturing. 0((& was marked as a negati"e year for most world automo)ile
industry, showing a negati"e growth )y a whopping %;.'<. @hereas ndian
+utomo)ile ndustry showed a completely re"erse trend and registered a growth of
%0.&(<. This comes to pro"e that +utomo)ile markets for de"eloped countries may
)e saturated or e"en shrinking in face of recession )ut ndian automo)ile market
remains up)eat.
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age &'
6"en though growth of ndian +utomo)ile ndustry has )een spectacular, it still
remains a fraction of world automo)ile market with Aust 1.;< in terms of total "olume
in units produced and figure )ecomes e"en lower if we consider the share in terms of
currency. +utomo)ile penetration (cars) is still "ery low in ndia a little o"er %( cars
per %((( people (optimistic figure7
-age _ 09
planning commission report
this num)er is 3). -roAections
for car penetration for
ndia are extremely good at ;90 per %((( people )y 0(0'. +utomo)ile industry is
)ound to )oom.

ndia is fast )ecoming a production hu) for maAor automo)ile manufacturers who
want to manufacture to cars so as to export. t is estimated that within next 1 years
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age &D
ndian auto players alone will in"estment =;( 5illion
. This in"estment discussed
suggests the industryFs self perspecti"e which and the likely trend for auto industry for
this decade. This in"estment is aimed at not only satisfying domestic demand )ut also
to support the export demand which ha"e grown at a fantastic D year C+/R of
Economy as a Dactor
,ale of Commercial Eehicles is )acked )y strong - num)ers (%3.D< PoP). This has
created high growth expectations. Oot of new launches are expected this season with
support of strong economic indicators growth seems certain. Margins which were
under pressure due to strong steel prices will also impro"e as the steel prices ha"e
started to soften.
There are some concerns on the possi)ility rising material prices and also there is a
strong likelihood of a hike in interest rates. /i"en the increased competition in the
small car segment it would )ecome "ery difficult for players to pass this increased
cost on to the consumers.
,@*T! +nalysis
%. ndian +utomo)ile ndustry is glo)ally cost competiti"e8 t is possi)le )ecause of
cheap la)or a"aila)ility and tax holidays pro"ided )y ,6Ws.
0. /o"ernment support8 ndian go"ernment has also put +uto among its priorities
0(%0 target to )ecome %(< of our /4-.
;. ndian +utomoti"e ndustry is following glo)al accepted >uality measures at a lower
cost. This makes it a perfect destination for production!outsourcing of automo)iles.
1. The a"aila)ility large talent pool at cheap prices.
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age &3
'. +"aila)ility of cheap RV47 1 Ts )e deemed as centers of excellence for automo)ile
research and access to latest technology.
The )iggest and pro)a)ly the only weakness of ndian automo)ile ndustry is its
slow growth in Research and 4e"elopment most companies ()arring T+T+ and
MVM) do not ha"e ade>uate spending on RV4 in comparison to their turno"er.
Maruti for instance is completely dependent upon ,u$uki for any new technology
all of the successful cars sold )y it were de"eloped )y ,u$uki7 ,wift, +!,tar
(which replaced alto in other markets as .ew +lto), ,Q1, Rit$ etc. This weakness
will soon )ecome history as ndian companies are catching fast in RV4 and are
showing strong signs of success e.g.8 MVM ,corpio #y)rid, T+T+ .ano.
5esides RV4 the other weakness is political hostility (T+T+ .ano ,ingur plant)
)ut is only a regional pro)lem of less de"eloped states or pro!communist states,
states like /uAarat, Maharashtra are pro"ing to )e a ha"en for ndustries.
%. ndia has a large pool of cheap talent which can )e utili$ed in decreasing the RV4
0. ndia has potential to )ecome manufacturing and export hu) with it cheap la)or
;. ndia has "ery low car penetration a)out %( per %((( this num)er expected )ecome
;90 )y 0(0', this means that there is plenty of room for new entrants to enter and
grow with the market without ha"ing others existing competitors ha"ing to suffer a
market loss.
%. ndian markets ha"e always suffered from duplicate products and cheap counterfeits
this puts pressure on original e>uipment manufacturers to reduce the prices and
compete with cheaper counterfeits.
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age &9
0. ndia shares a )order with china which presents it with a uni>ue pro)lem of cheaper
counterfeits in a "ery huge manner through illegal imports and dumping.
;. @ith li)erali$ation and foreign players entering ndian markets there is intense
pressure on local players to impro"e and upgrade their products and if they donFt they
might )ecome extinct.
1. Certain component imports from FT+ regime countries are )ecoming a threat existing
-*RT6RN, FE6 F*RC6,
+.+OP,, *F +BT*M*5O6
-orterNs Fi"e Forces is a way of examining the attracti"eness of an industry. t does so
)y looking at fi"e forces which act on that industry. These forces are determinants of
that industryNs profita)ility.
The fi"e forces are8
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age &&
:- )2E )2RE&) OD 0E4 E0)R&0)SC
n the automo)ile (car) sector, the threat of new entrants is generally "ery low. The
industry is "ery mature and it has successfully reached economies of scale. n order to
compete in this industry a manufacture must )e a)le to achie"e economies of scale.
For this to occur,
-age _ ;;
manufacturers must mass!produce the automo)iles so that they are afforda)le to the
consumer. The huge amount of capital re>uirement, large distri)ution networks and
)rand image constitutes to other factors that restrict the entry of new )arriers. The
existing loyalty to maAor )rands, incenti"es for using a particular )uyer, higher fixed
costs, scarcity of resources, high costs of switching companies, and go"ernment
regulations constituted the )arriers to entry which in turn reduced the competition in
auto industry. t costs a lot to set up a car manufacturing facility, a new firm may
usually ha"e a "ery low )rand e>uity, legislation and go"ernment policy such as
safety, 6-+ and emissions are "ery rigid and it takes >uite a lot of time to esta)lish a
strong distri)ution network.
<- )2E 5&R;&I0I0; PO4ER OD 568ERSIC6S)OMERSC
n the automo)ile sector, the )uyers wield considera)le power. The manufacturers
depend on them to stay in )usiness. f they cannot keep their )uyers happy then they
risk losing them to their competitors. The )uyers ha"e low switching cost if they are
not happy. The automo)ile manufacturers are competing against each other on "alue,
features, >uality, style and customi$ation to appeal to their customers. n the past
when the economy was not li)erali$ed, the car manufacturers themsel"es had much of
the power, )ut with the entry of foreign companies after li)erali$ation the power
switched from ,6OO6R, to 5BP6R, as the foreign manufacturers offered
alternati"es to domestic "ehicles.
#owe"er, the )argaining power with the )uyers is M*46R+T6OP high V not
completely high, the reason )eing that the )uyers are not large )ut few in num)er.
,econd, the )uyers do not ha"e the a)ility to integrate )ackwards into the industry, if
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %((
they want a car then they ha"e to purchase it from a car dealer only, they themsel"es
wonFt manufacture a car.
=- )2E 5&R;&I0I0; PO4ER OD S6PP7IERSC
n the automo)ile industry this refers to all the suppliers of parts, tires, components,
electronics, and e"en the assem)ly line workers. To manufacture a car lots of different
parts are re>uired V to accomplish this there exist many suppliers. These suppliers
rely on one or two automakers to )uy a maAority of their products. f an automaker
decided to switch suppliers, it could )e
-age _ ;1
de"astating to the pre"ious supplierNs )usiness. +s a result, suppliers are extremely
suscepti)le to the demands and re>uirements of the automo)ile manufacturer and hold
"ery little power.
F- )2RE&) OD S65S)I)6)E PRO*6C)SC
The threat of su)stitutes to the automo)ile sector is fairly mild. There a"ail many
other mode of transportation such as walking, cycling, taking a )us, train, rickshaw
and to a larger extent an airplane or helicopter )ut none offer the utility, con"enience,
independence, and "alue afforded )y automo)iles. The switching costs associated
with using a different mode of transportation, such as train, may )e high in terms of
personal time, con"enience, and utility, )ut not necessarily monetarily the cost of fuel
consumed on a similar round trip, daily parking, car insurance, and maintenance).
,u)stitutes products all depend on the geographic location of the consumer. n places
with high population densities (eg Mum)ai), people prefer walking or cycling or
taking a train, more rather than owing a car V keep waiting at signals for 0!long
hours. *n the contrary, there are people who would prefer to ha"e at least one car for
the ZstatusR title in the society.
Ri"alry among the competitors is "ery strong is this industry. Tit!for!tat price slashes,
ad campaigns, and product de"elopments keep them on the edge of inno"ation and
profita)ility. *ne of the reasons for such high ri"alry is the lack of differentiation
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %(%
opportunities. +ll the companies make cars (,edans, #atch)acks, and ,BEFs). 5efore
making any purchases the competitors are compared to one another constantly.
+s per me I0)E0SI)8 OD RIV&7R8 &MO0; COMPE)I)ORS is the most
important (orce in a/tomobile ind/stry- The price, >uality, dura)ility, and many
other aspects of different manufacturers are greatly taken into consideration when
deciding which 5rand to purchase. For instance, in ndia market for sedans V coupe,
companies like 5M@, +udi V Mercedes are into fierce competition. The price V the
features offered )y 5M@ for its ;!series model are often compared to the price V the
features of +B4 +!1 model V Mercedes C!class models. ,imilarly ,koda Fa)ia,
#onda :a$$ V Eolkswagen -olo are )eing highly compared on features, performance
V prices. +lso the newly launched T+T+ .+.* (the lowest price car) is
extensi"ely competing in price with Maruti!9((, which was the lowest price a"aila)le
car )efore the launch of .ano.
AE8 CER)&I0I)8
n auto sector, the "ery re>uirement of a company for its sur"i"al is RE;67&R
)EC20O7O;8 6P ;R&*&)IO0. For instance in the past we had Aust -6TR*O
cars, then with the gradual hike in petrol prices, cars using diesel V C.//as as fuel
were manufacture V now, "ery recently, the renowned car companies are coming up
with #P5R4 cars due to the concerns regarding the /lo)al @arming. Thus, it is
"ery possi)le that in future also technological changes would )e taking place keeping
in "iew the customerFs re>uirement V en"ironmental scenario.
AE8 60CER)&I0I)88
+ "ery "ital uncertainty in +uto sector is the PRICE OD )2E R&4-M&)ERI&7
(,teel, +luminum etc.). Changes in the cost of raw!material ha"e a direct impact on
the price of the cars, which further affect the demand of the car. Thus, if in future the
price of steel increases, the sale price of car would increase, this will ha"e a negati"e
impact on its demand V "ise!a!"ersa.
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %(0
6ntering of glo)al )rands into the market pro"iding the "ariety of cars with wide
ranges in the prices, which ga"e li)erty to the customers to choose as per their need.
.ew designs, fuel efficient engines and "arious offers throughout the year resulted in
the growth of re"enues for the automo)ile sector.
ndustry 5reakup
ndian +utomo)ile ndustry can )e )roken up into four categories8
4omestic Market ,hare for 0((&!%(
-assenger Eehicles %'.9D %'.9D
Commercial Eehicles 1.;0 1.;0
Three @heelers ;.'9 ;.'9
Two @heelers 3D.0; 3D.0;
)9o 4heelers Segment
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %(;
Two wheeler sales are )ack on dou)le digit growth path )acked )y ro)ust economic
growth and a"aila)ility of finances translating which ha"e translated into this increase
in demand. The two!wheeler sales grew at a healthy rate of ;%< which resulted into a
unit sold reach %('333; units in May 0(%( and se>uentially it grew )y 3< from
&99%09 units in +pril 0(%(. *f the %('333; domestic sales accounted for &;D'''
units and exports accounted for %0%0%9 units with a growth rate of 0&< and '%<
ndian Metrological department has predicted normal ,outh @est Monsoons, which
can help impro"e rural income, and there )y rural demand for automo)iles in general,
and two wheelers in particular. Thus the near term outlook is positi"e.
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %(1
,cooters segment has gi"en a come)ack and this segment is pro"ing to )e the )iggest
thri"ing and up)eat two!wheeler segment. ts total sales grew )y ro)ust 1D< to
%D(3'; units in May 0(%(. The domestic sales grew )y 1'< to %'3'(& units and the
exports $oomed ahead )y whopping %('< to ;011 units in May 0(%(.
The scooter segment was the sole segment in two wheeler industry to remain
unaffected )y the sudden recession in 0((9. t has )een on healthy growth trail
especially from .o"em)er 0((D with few occasional hiccups. Cashing on the trend,
-iaggio would )e re!entering the scooter segment )eginning with Eespa OQ %0'
model. The )oard of -iaggio V Co has okayed a plan to in"est nearly 6uro ;( million
o"er two years to esta)lish a %.'!lakh capacity plant that will produce a model
specially de"eloped for ndia, the worldNs second!largest two!wheeler market. The
first scooter is expected to roll out )y the end of 0(%0.
+lso #onda MotorcycleNs (#onda) total scooter sales grew )y 09< to 33D&' units in
May 0(%( on demand. ts domestic sales grew )y 09< to 3D&9( units while the
exports grew )y whopping %('< to 3%' units in May 0(%(. #owe"er its market share
slipped to 19< in May 0(%( from ''< in May 0((&.
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %('

The motorcycle sales grew )y 0&< to 910%1; units in May 0(%( )acked )y demand
in domestic as well as export markets. The domestic sales grew )y 0D< to 30';%%
units while the exports grew )y ro)ust 1&< to %%D9;0 units partly lifted )y low )ase
5aAaA +utoNs total sales grew )y impressi"e D;< to 0D&199 units in May 0(%( partly
lifted )y demand and low )ase effect. The domestic sales grew )y nota)le D&< to
%&%30D units while the exports grew )y ro)ust '%< to 333D0 units in May 0(%(. ts
market share impro"ed to ;0< in May 0(%( from 0'< in May 0((&.
)hree 4heeler Segment
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %(D
Three wheeler segment has grown at a rate of a)out &.3< yearly in the last six years if
calculated geometrically. @hile the domestic sales grew at a C+/R of a)out 3.D<
and exports grew at a C+/R of %D.9<.
n three wheeler segment 99< of the market share is held )y three players namely
5aAaA +uto, -iaggio, and MVM.
Passenger Vehicles Segment
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %(3
Total passenger "ehicles segment has grown at a rate of little o"er %'< in the last D
years with domestic sales growing at a rate of a)out %;.3< and exports growing at a
rate of 00.&< D year C+/R. 4omestic sales were had to face some )eating in 0((&
)ut the industry showed allo"er marginal growth )ecause of exports growth was o"er
';<.For the current year, the passenger "ehicle industry continued on its ro)ust
growth trail with ;%< growth in May 0(%( to 00;D93 units )acked )y demand and
partly low )ase. The domestic sales grew )y ;'< to %&('3' units on demand and low
)ase while the exports grew )y %%< to ;;%%0 units despite healthy )ase. 4espite the
series of price hikes in span of four months in passenger "ehicle industry as well as
fuel price hike, the passenger "ehicle demand is undeterred owing to increased
purchasing power gi"en to consumers with change in tax sla)s, healthy economic
growth and specially the launches of new2"ariants of small cars such as E@ -olo, /M
5eat, Ford Figo and Maruti ,u$ukiNs new @agon R and 6eco at attracti"e prices.
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %(9
The compact car segment is a)out to see some increased competition with the launch
of .issanFs KMade in ndiaN car Micra. This compact car would )e hitting the ndian
stands from :uly 0(%(. .issan has commenced the production of first Micra at its
Chennai plant in May 0(%(. The car has )een displayed in showroom from May 0'
0(%( and would hit the ndian market in :uly 0(%(. ts exports are expected to )egin
from ,eptem)er 0(%(. .issan is looking at exporting to more than %(( countries
including 6urope, Middle 6ast and +frica.
-age _ 11
Passenger Cars
The passenger carNs total sales grew )y 0D< to %9%%;( units in May 0(%( largely
on demand. The domestic sales grew )y healthy ;(< to %1919% units on low )ase
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %(&
and demand while the growth in exports were restricted to %(< to ;0D1& units on
account of high )ase.
6tility Vehicle
The utility "ehicle sales grew )y impressi"e '9< to 0'39; units in May 0(%( on
demand and steep low )ase effect. ts domestic sales grew )y impressi"e 'D< to
0'1;0 units while the exports grew )y whopping 1(&< to ;'% units in May 0(%(.
M/lti P/rpose Vehicle !MPV#
The M-E sales grew )y ro)ust '%< to %D331 units in May 0(%( on healthy demand.
ts domestic sales grew )y ro)ust '%< to %DDD0 units while the exports grew )y
nota)le 1&< to %%0 units in May 0(%(.
5aJaJ &/to 7td-
,ales .et -rofit
) CM- '0@!#igh '0@!Oow Mkt. Cap -26
%%'(9.' %9%1.(0 %%3.'% 00&0 0;(& &91.& ;;%D%.D% %&.'
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%(
L For May F%(, 5aAaA +uto reported sturdy D%.D< yoy "olume growth (though 1.'<
lower mom), led )y ro)ust motorcycle and three!wheeler "olumes.
L Motorcycles posted ro)ust D0.&< yoy "olume growth (though 0.D< lower mom), to
0D9,91( units. The newly!launched 4isco"er!%'( sold %0,;33 units, -ulsar (3',&31
units) and 4isco"er (%(3,(3D units) made up D9< of motorcycle sales.
L n May F%(, export growth was D;.'< yoy (though %'.9< lower mom), to &',&D1
L For \1FP%(8 9(.'< growth in net sales to ;;&&.' crores and 1 fold rise in net profit
to ';0 crores.
L FP%( sales grew o"er ;'< to %%'(9 crores while net profit showed a %D(< growth to
all time high at %3(0 crores.
L 65T4+ margin for the >uarter was the highest e"er at 00.&< and 0%.3< for \1FP%(
and FP%(.
L There are many strategic launches planned for FP%% such as 4isco"er %((cc, -ulsar
%;'cc and -latina %0'cc all these com)ined with already launched 4isco"er %'(cc
would expand "olume )ased growth.
L FP%( PoP units growth in 0@hFs for 5+O has )een ;%< and for ;@hFs has )een
01<. This was a result of strong domestic demand.
2ero 2onda
,ales .et -rofit 6-,(TTM) CM- '0@!#igh '0@!Oow Mkt. Cap -26
%'3'9.%9 00;%.9; %%%.9 %&91.;' 0(&1 %;%%.3 ;&D0' %3.3'
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%%
L #ero #ondaNs total scooter sales grew )y impressi"e D1< to 0131D units in May 0(%(
despite high )ase. ts domestic sales grew )y ro)ust D%< to 0;3;9 units while the
exports surged )y significant 0((< to %((9 units in May 0(%(. ts market share grew
)y %(( )ps to %'< in Ma y 0(%(.
L #ero #ondaNs total sales grew )y %0< to 1%%%93 units in May 0(%( purely on
demand. The domestic sales grew )y %0< to 1(%;0( units while the exports grew )y
%D< to &9D3 units in May 0(%(. #owe"er its market shares slipped )y 3(( )ps to
1&< in May 0(%(. The company raised prices of its products )y up to Rs %,((( with
immediate effect in :une 0(%( due to rising input costs.
L #ero #onda introduced two new models in +pril the refreshed /lamour and
/lamour F. t plans to continue to )uild on its strategy of inno"ation and technology
focus )y introducing new products and product refreshes.
L #ero #onda recently crossed a significant milestone )y co"ering %((,((( "illages
under its rural initiati" 8aaon .ar +ngan". This um)rella platform for all
rural initiati"es has helped in steadily widening its presence in rural and upcountry
markets, taking its contri)ution to sales to 10< of the total.
)VS Motor Co-
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%0
,ales .et -rofit
) CM- '0@!#igh '0@!Oow Mkt. Cap -26
1;'D.(3 %;0.D& ;.D1 &3.% %(9.9 1(.' 0;(D.'' 0D.D9
L TE, MotorNs scooter sales grew )y ro)ust 10< to ;%991 units in May 0(%( though
partly dri"en )y demand and partly low )ase effect. The domestic sales grew )y
ro)ust 1(< to ;('D3 units while the exports grew )y whopping %(%< to %;%3 units in
May 0(%(. The market share was intact at 0(< in May 0(%(.
L TE,Ns total sales grew )y 03< to D3&(D units in May 0(%( on demand as well as low
)ase. ts domestic sales grew )y 0%< to '0;%& units while the exports grew )y ro)ust
'%< to %''93 units in May 0(%(. ts market share was intact at 9< in May 0(%(.
L The moped segmentNs total sales grew )y 0&< to '1933 units in May 0(%( on healthy
demand. t solely represents TE, motor. ts domestic sales grew )y 03< to ';3;'
units. ts exports grew )y outstanding DD%< to %%10 units in May 0(%( lifted )y )oth
ro)ust demand and low )ase.
L Motorcycle "olumes increased 0D.&< yoy and 0.&< mom, marking the sixth
consecuti"e month of mom "olume growth. n Fe) F%(, TE, introduced the auto!
clutch motorcycle :i"e in Tamil .adu and +ndhra -radesh, with the countrywide
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%;
launch coming in Mar and +pr. This has contri)uted to TE,F motorcycle growth.
L Three!wheeler "olumes increased 0%3.;< year on year ()ut lower 9'.9< month on
month) to 0,;%; units. 6xports increased D0.%< year on year (though D.%< lower
mom), to %9,(1D units, marking the sixth consecuti"e month of year on year "olume
growth for TE,F exports.
&shok 7eyland
,ales .et -rofit
- '0@!#igh '0@!Oow Mkt. Cap -26
% 10D.0%
0 D0.' 3(.;'
% 9;0%.03 %&.D3
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%1
L The +shok Oeyland!.issan Aoint "entures for OCE will the roll!out of the first wa"e
of products next year with a capacity of %.'Oac units.
L t is expected the :E will launch ; new "ehicles in next ; years.
L Total "ehicle sales more than tre)led to D,'(0 units (009.&< P*P) in May. 4omestic
sales surged to ',&3; units compared with %,D&3 in May 0((& while exports nearly
dou)led to '0& units.
L The MV#CE passenger and goods segment were the main dri"ers of "olumes, which
increased %(;.%< and ;%'.0< PoP to %,1;D units and 1,&'9 units, respecti"ely.
L The OCE segment recorded strong growth of 10.%< PoP and %%%.9< MoM though
the )ase is "ery low. /oing forward, with the -antnagar plant reaching full capacity
utili$ation we expect larger OCE sales in the northern region.
L 6xports impro"ed in "olume terms )y 99.&< PoP and ;.3< MoM to '0& units though
according to contri)ution to total sales the segment declined slightly on PoP )asis.
-age _ ';
Mahindra and Mahindra
-rofit 6-,(TTM) CM-
Oow Mkt. Cap -26
%9D(0.%% 0(93.3' ;D.9& D;%.D' D1%.9 ;13 ;'31'.(3 %3.%0
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%'
L Mahindra V MahindraNs (MVM) total scooter sales grew )y whopping 0D(< to 90(D
units in May 0(%(. The ro)ust growth is partly dri"en )y fact that MVM entered the
scooter space only in +pril 0((& thus dri"en )y low )ase. ts domestic sales grew )y
whopping 0D3< to 9(1D units while the exports grew )y impressi"e 90< to %D( units
in May 0(%(. ts market share grew )y ;(( )ps to '< in May 0(%(
L 4omestic BE sales grew '(< yoy, while exports grew 03'< yoy (from a low )ase),
dri"ing o"erall BE growth to ''<.
L 4omestic tractor "olumes rose 0&< yoy, while export growth was Aust ;< yoy.
*"erall tractor growth came in at 03.9< yoy and '.9< mom. The launch of an ultra!
cheap entry!le"el tractor aimed at small and marginal farmers could pro"ide the
necessary impetus to MVMFs tractor "olumes
-age _ '1
L Three!wheeler "olumes too were ro)ust, at %1'.3< yoy and %;< mom. This growth is
attri)uta)le to good demand for /io and Maxximo
L OCE "olumes grew 0%.0< yoy, while Oogan sales shot up &1.9< (primarily on the
export of ;'( units).
)&)& Motors
,ales .et -rofit 6-,(TTM) CM- '0@!#igh '0@!Oow Mkt. Cap -26
9 ;&.0D 9((
0 0D&.' 1'D19 0(.;9
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%D
L Tata MotorsN (Tata) total sales grew )y ro)ust 1'< to %&%0' units in May 0(%(
gaining from demand and low )ase effect. The domestic sales grew )y ro)ust 1'< to
%9D%9 units. t included .ano sales of ;''( units.
L 5rand wise, the ndica range sales were lower )y %'< to 91D9 units while the ndigo
range grew )y whopping %;;< to DD(( units in May 0(%(.
L The exports impro"ed )y ro)ust 'D< to '(3 units in May 0(%(. ts market share
impro"ed to %%< in May 0(%( from &< in May 0((&.
L Tata Motors commenced the commercial operations of peopleNs car .ano at its mother
plant in ,anand, /uAarat. The companyNs initial capacity of 0.' lakh cars per annum
would )e achie"ed in phases while with some )alancing could )e expanded to ;.'
lakh units per annum.
+utomo)ile sector after a strong run of o"er %( years showed a strong
decline in growth for the years 0((3!0((&. That was )ecause of the
recession which affected entire world economies )ut as the economy is
)ouncing )ack the sale of automo)iles ha"e picked up and that too with a
)ang, growth rates e"en higher of what they were for the years prior to
recession. ndia is )ack to )ecoming one of the fastest growing
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%3
automo)ile markets in the word and many reports suggesting that ndia
will surpass china in the a"erage automo)ile (-assenger Eehicle
,egment) )y 0(0' there is tremendous potential in automo)ile industry
and the recent growth figures )y all the automo)ile maAors pro"e this
point that ndian automo)ile industry is )ack on track.
.ow the competition will not )e limited to Aust the existing players in the
market i.e. Maruti, #yundai, T+T+, /M, #onda and ,koda. Competition
will now )e much higher with all the auto maAors lining up for entry into
ndia either to market their cars here or to manufacture, )ut all the auto
maAors seem to )e coming to ndia.
Automobile Export Trends
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%9
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %%&
&/tomobile Exports )rends !0/mber
Category EF E? EM <EEM-EK
Passenger %,0&,0& %,DD,1( %,3','3
Vehicles % 0 0 %,&9,1'0 0,%9,1(% ;,;',30& 1,1D,%1D 00.&;<
al Vehicles %3,1;0 0&,&1( 1(,D(( 1&,';3 '9,&&1 10,D0' 1',((3 %3.%;<
4heelers D9,%11 DD,3&' 3D,99% %,1;,9&D %,1%,00' %,19,(DD %,3;,090 %D.9;<
)9o 0,D',(' ;,DD,1( ',%;,%D
4heelers 0 3 & D,%&,D11 9,%&,3%; %(,(1,%31 %%,1(,%91 03.';<
;rand 1,3&,&% D,0&,'1 9,(D,00 %(,%%,'0
)otal & 1 0 & %0,;9,;;; %',;(,'&1 %9,(1,D%& 01.3(<
Passenger Vehicles Monthly *omestic Sales *ata
Category2 ,ales
,egment2,u) segment
Manufacturer For The Month *f Cumulati"e
May +pr ! May
< <
Chang 0(%( ! 0((& !
0(%( 0((& 6 %% %( e
-assenger Eehicles
-Passenger Cars
!!5M@ ndia -"t. Otd. 01' %D& 1' '%3 ;D3 1%
!!Mercedes!5en$ ndia -"t Otd ;9' %9% %%; D90 ;'& &(
!!Eolkswagen ndia -"t Otd %&3& ;(% ''3 ;3;; D%1 '(9
!!.issan Motor ndia -"t Otd %1 %& !0D ;9 ;( 03
!!#ind.Motors 3(% D%' %1 %13( %%0; ;%
!!Mahindra V Mahindra 1'( 103 ' 3'; &33 !0;
!!Tata Motors %9D%9 %09;9 1' ;9;9( 01(1( D(
!!Maruti Bdyog 3D%0( D0939 0% %11399 %%&%(D 00
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-age %0(
!!/en Motors ndia D3%0 ;9&( 3; %'D%D 3;&' %%%
!!Ford ndia 390( %&91 0&1 %'(1D ;9%3 0&1
!!#onda ,iel Cars 1(;0 1(3; !% 3';& 330& !0
!!#yundai Motor 03%'% 0;'(% %D ''D'0 1'310 00
!!Fiat +uto ndia 0%D; %%3' 91 ;&D; 0;9( D3
!!Toyota ?irloskar 3%( D&3 0 %D%1 %019 0&
!!,koda +uto ndia %;9% %(D0 ;( 0DDD 0%%( 0D
%1919 %%;9%
!Total *f -assenger Cars % ( ;( 0&01'3 0%3(;3 ;'
-6tility Vehicles
!!5M@ ndia -"t. Otd. 0D '3 !'1 D% && !;9
!!Mercedes!5en$ ndia -"t Otd 0' %0 %(9 1& %0 ;(9
!!nternational Cars V Motors Otd. &' D9 1( %1& 00% !;;
!!.issan Motor ndia -"t Otd 10 0 0((( D' 1
!!Force Motors D00 11; 1( %%33 &%; 0&
!!#ind.Motors %90 %;; ;3 ;(9 0(1 '%
!!Mahindra V Mahindra %;13D 9(;; D9 0D(&( 0%&11 %&
!!Tata Motors 09'& 0D0% & D'(3 '(1& 0&
!!Maruti Bdyog &D9 099 0;D %D9( %%&; 1%
!!/en Motors ndia %'(0 %%&9 0' ;%1' 01&' 0D
!!Ford ndia 0D( %91 1% '1; ;9' 1%
!!#onda ,iel Cars ;' ( !! %(D ( !!
!!#yundai Motor ( 0 !! ( 9 !!
!!Toyota ?irloskar ';1( ;003 D' %(1;& D(D0 30
!Total *f Btility Eehicles 0'1;0 %D0D9 'D '(;%& ;9'9& ;(
-M/lti P/rpose Vehicles
!!Tata Motors ;3(& ;119 9 D;3; D0(0 ;
!!Maruti Bdyog %0&'; 3D%& 3( 0;D(3 %';1; '1
!Total *f Multi -urpose Eehicles %DDD0 %%(D3 '% 0&&9( 0%'1' ;&
%&('3 %1%%1
Total *f8 -assenger Eehicles ' ' ;' ;303'D 033%3% ;1
Passenger Vehicles Monthly Export *ata
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %0%
Category2 6xport
,egment2,u) segment
Manufacturer For The Month *f Cumulati"e
May +pr ! May
< <
0(%( 0((& Change 0(%( ! %% 0((& ! %(
-assenger Eehicles
-Passenger Cars
!!5M@ ndia -"t. Otd. ( ( !! ( ( !!
!!Mercedes!5en$ ndia -"t Otd ( ( !! ( ( !!
!!Eolkswagen ndia -"t Otd ( ( !! ( ( !!
!!.issan Motor ndia -"t Otd ( ( !! ( ( !!
!!#ind.Motors ( ( !! ( ( !!
!!Mahindra V Mahindra ;90 ( !! ';0 ( !!
!!Tata Motors '(3 ;01 'D &;% '1( 30
!!Maruti Bdyog %0(0( &(%0 ;; 01&'3 %'9;3 '9
!!/en Motors ndia %% 0% !19 D1 1% 'D
!!Ford ndia ( 9; !! %30 %0% 10
!!#onda ,iel Cars ( 0 !! 0 0 (
!!#yundai Motor %&D'3 0(%0' !0 1;%3D 1001& 0
!!Fiat +uto ndia 30 '0 ;9 0&1 %;D %%D
!!Toyota ?irloskar ( ( !! ( ( !!
!!,koda +uto ndia ( ( !! ( ( !!
!Total *f -assenger Cars ;0D1& 0&D%& %( 3(%09 '9&0D %&
-6tility Vehicles
!!5M@ ndia -"t. Otd. ( ( !! ( ( !!
!!Mercedes!5en$ ndia -"t Otd ( ( !! ( ( !!
!!nternational Cars V Motors Otd. ( ( !! ( ( !!
!!.issan Motor ndia -"t Otd ( ( !! ( ( !!
!!Force Motors ( ( !! ( ( !!
!!#ind. Motors ( ( !! ( ( !!
!!Mahindra V Mahindra 0D9 '& ;'1 'D3 %;3
!!Tata Motors 9% %( 3%( %(9 %3
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %00
!!Maruti Bdyog 0 ( !! 0 %( !9(
!!/en Motors ndia ( ( !! % % (
!!Ford ndia ( ( !! ( ( !!
!!#onda ,iel Cars ( ( !! ( ( !!
!!#yundai Motor ( ( !! ( ( !!
!!Toyota ?irloskar ( ( !! ( ( !!
!Total *f Btility Eehicles ;'% D& 1(& D39 %D'
-M/lti P/rpose Vehicles
!!Tata Motors ( ( !! ( ( !!
!!Maruti Bdyog %%0 3' 1& %&& %;% '0
!Total *f Multi -urpose Eehicles %%0 3' 1& %&& %;% '0
Total *f8 -assenger Eehicles ;;%%0 0&3D; %% 3%((' '&000 0(
5eta Calc/lation
Total Market Risk -reimum for ndia &.((<
4efault ,pread 1.'(<
Company .ame 5eta 426 Corrected 5eta
Maruti ,u$uki (.3&0 (.(& (.9(D9;D
Tata Motors %.1;' (.&3 %.0''1&;
#ero #onda Motor (.D;0& (.(; (.33D01D
M V M %.000' (.D& %.%%03;9
5aAaA +uto (.3%%& ( (.3D(&'%
+shok Oeyland %.0001 (.D3 %.%(0'10
TE, Motor Co. %.(19' (.&D %.0'(;&1
+"erage %.((&;%1 (.193%1;
56T+ (+E/) Oe"ered %.((&;%1
426 (+E/) (.193%1;
Tax ;;.((<
56T+ (+E/) Bnle"ered (.3D(&'%
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %0;
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %01
,-R./ 0(%0!0(%1 ,,2%0!%12F!'324elhi2,56
-age %0'