To study the investment environment would be of importance to the investor, as it would also

encompass the demand supply match and mismatch.

Let us visualize the world and its economy. There are many countries
with their many economies in this environment. We see the interaction
between countries at different stages in their development. We see the
many markets to enable this interaction between the various
countries. Each of these markets has its regulator, the trading platform and its system, its agents (or
brokers), and the participants.

Here it is a question of demand and supply of

various commodities, products & services and trading instruments. And

the analysis would encompass the demand-supply match/mismatch.
In this global environment, we have India with its economy and its own
many markets.
Among these markets we have the securities market, with its regulator
(SEBI), the trading platform and its systems (stock exchanges), its
agents (brokers) and its many participants (including corporate, financial
institutions both domestic and foreign, mutual funds, insurance
companies, banks and individual investors).

Here again it is a question of demand

and supply of various commodities, products & services and trading instruments.

And the analysis

would encompass the demand-supply match and mismatch.

It would be advisable to note at this stage, that due to the liberalization

process undertaken by India over the last 18 years,

we are today in an

environment where events that take place in other parts of the world have a direct or indirect effect on our
economy.

This would further effect the specific market and finally would

have an effect on the equity market.

Let us visualize a scenario of an industrial slowdown in the U.S.
Amongst other things, this would have a direct bearing (i.e. a reduction)
on the demand of steel. To protect its own domestic steel industry, the
U.S. government would temporarily introduce trade barriers on steel
imports. This in turn would cause a reduced export of steel from India to
the U.S., causing a temporary over supply of steel in the domestic
market. The steel manufacturers would have to tackle the higher levels
of inventory and its associated costs. In the domestic steel market, even
if the demand were constant, the excess supply would cause a reduction
in the price realization per marketable ton of steel. This in turn would
directly effect the incomes and profit margins of the steel manufacturers.
Such a situation would temporarily cause a drop in the share prices of
steel stocks in the equity market.
This example is to describe to you how logical the sequence of events is
and what the end result would be. However, this sequence does take a
long duration of time to unfold, sometimes may even take years.
Chapter One: The Investment Environment I. Real assets versus financial
assets 1. The material wealth of a society is determined ultimately by the

productive capacity of its economy, which is a function of the real assets of

the economy: the land, buildings, knowledge, and machines that are used
to produce goods and the workers whose skills are necessary to use those
resources. 2. Financial assets, like stocks or bonds, contribute to the
productive capacity of the economy indirectly, because they allow for
separation of the ownership and management of the firm and facilitate the
transfer of funds to enterprise with attractive investment opportunities.
Financial assets are claims to the income generated by real assets. 3. Real
vs. Financial assets: a. Real assets produce goods and services, whereas
financial assets define the allocation of income or wealth among investors.
b. They are distinguished operationally by the balance sheets of individuals
and firms in the economy. Whereas real assets appear only on the asset
side of the balance sheet, financial assets always appear on both sides of
the balance sheet. Your financial claim on a firm is an asset, but the firms
issuance of that claim is the firms liability. When we aggregate over all
balance sheets, financial assets will cancel out, leaving only the sum of real
assets as the net wealth of the aggregate economy. c. Financial assets are
created and destroyed in the ordinary course of doing business. E.g. when
a loan is paid off, both the creditors claim and the debtors obligation cease
to exist. In contrast, real assets are destroyed only by accident or by
wearing out over time. II. Financial markets and the economy 1. Smoothing
consumption: Store (e.g. by stocks or bonds) your wealth in financial
assets in high earnings periods, sell these assets to provide funds for your
consumption in low earnings periods (say, after retirement). 2. Allocation of
risk: virtually all real assets involve some risk (so do financial assets). If a
person is uncertain about the future of GM, he can choose to buy GMs
stock if he is more risk-tolerant, or he can buy GMs bonds, if he is more
conservative. 3. Separation of ownership and management: Let
professional managers manage the firm. Owners can easily sell the stocks
of the firm if they dont like the incumbent management team or police the
managers through board of directors (stick) or use compensation plans tie
the income of managers to the success of the firm (carrot). In some
cases, other firms may acquire the firm if they observe the firm is
underperforming (market discipline). III. Clients of the financial system 1.
Household sector: a. Tax concerns: people in different tax brackets need

different financial assets with different tax characteristics. - 2 - Study notes

of Bodie, Kane & Marcus By Zhipeng Yan b. Risk concerns: Differences in
risk tolerance create demand for assets with a variety of risk-return
combination. 2. Business sector: business is more concerned about how to
finance their investments, through debt or equity either privately or publicly.
Business issuing securities to the public have several objectives. First, they
want to get the best price possible for their securities. Second, they want to
market the issues to the public at the lowest possible cost. This has two
implications. First, business may hire specialists to market their securities.
Second, most business will prefer to issue fairly simple securities that
require the least extensive incremental analysis and, correspondingly, are
the least expensive to arrange. Such a demand for simplicity or uniformity
by business-sector issuers is likely to be at odds with the household
sectors demand for a wide variety of risk-specific securities. This mismatch
of objectives gives rise to an industry of middlemen who act as
intermediaries between the two sectors, specializing in transforming simple
securities into complex issues that suit particular market niches. 3.
Government sector: Governments cannot sell equity shares. They are
restricted to borrowing to raise funds when tax revenues are not sufficient
to cover expenditures. A special role of the government is in regulating the
financial environment. IV. The environment responds to clientele demands:
The smallness of households creates a market niche for financial
intermediaries, mutual funds, and investment companies. Economies of
scale and specialization are factors supporting the investment banking
industry. V. Markets and market structure 1. Direct search market: buyers
and sellers must seek each other out directly. 2. Brokered market: e.g. real
estate market, primary market and block transactions. 3. Dealer markets:
dealers trade assets for their own accounts. Their profit margin is the bidasked spread. 4. Auction market: all transactors in a good converge at one
place to bid on or offer a good. If all participants converge, they can arrive
at mutually agreeable prices and thus save the bid-asked spread. VI.
Ongoing trends 1. Globalization: U.S. investors can participate in foreign
investment opportunities in several ways: a. purchase foreign securities
using American Depository Receipts (ADRs), which are domestically traded
securities that represent claims to shares of foreign stocks. b. purchase

foreign securities that are offered in dollars. c. Buy mutual funds that invest
internationally. d. buy derivative securities with payoffs that depend on
prices in foreign security markets. - 3 - Study notes of Bodie, Kane &
Marcus By Zhipeng Yan 2. Securitization: the biggest asset-backed
securities are for credit card debt, car loans, home equity loans, student
loans and debt of firms. Pools of loans typically are aggregated into passthrough securities. The transformation of these pools into standardized
securities enables issuers to deal in a volume large enough that they can
bypass intermediaries. 3. Financial engineering: the process of bundling
and unbundling of an asset.

Improving The Business Climate And

Encouraging Investment

A vibrant private sector is the main engine of sustainable

economic growth and employment and an important pathway
out of poverty. But governments establish the climate in which
businesses operate. Business regulations that create a level
playing field and provide strong property and investor

protections are essential to a thriving private sector.

Productive private sector investment is an important

component of competitiveness and growth strategies for
developing countries. Attracting foreign direct investment, in
particular, helps to link a countrys domestic economy to
global value chains in key sectors.

The World Bank Group is a global expert in reforms to

improve the business climate in developing countries and
foster investment growth. The Bank Groups work focuses on

reforms to address factors underlying client performance in

global benchmarking products like Doing Business and on
improving overall regulatory quality and effectiveness.

Investment climate teams of the Bank Groups Trade and

Competitiveness Global Practice provide advice and technical
assistance to governments seeking to generate private sector
cost savings, investment, trade flows, and jobs. This work helps
governments implement reforms to improve their business
environments and encourage and retain investment, thus
fostering competitive markets, growth, and job creation. An
increasing focus of investment climate work is the imperative to
connect local businesses to global markets and multinational
enterprises where new technologies, innovation, and managerial
practices are exchanged. The emerging importance of global
value chains in explaining international trade and investment
points to the need for an increased emphasis on sector-specific
reforms to support greater outcomes in terms of investment and
enterprise growth.
Five key objectives define the effort to help developing countries
improve their investment climate:

Opening and promoting effective markets.

Improving government-to-business service delivery.

Reducing business costs and risks.

Enhancing regulatory transparency and implementation.

Fostering business growth and upgrading.

Expanding the Impact of Effective Regulatory Reform

All investment climate work includes cross-cutting elements that
focus on economic integration, jobs, information and
communications technology, inclusiveness and gender, and
business growth and small and medium enterprises. Work with
client governments is based on five key operating principles:
benchmarks and analytics to spur reform; responsiveness;
enabling and connecting integrated solutions; incubation and
innovation of ideas; and making impact.
Business regulatory reform can have maximum impact when
reform is undertaken in a coordinated manner. For example,
encouraging new firm formation depends on business entry
regulations and related factors, including land regulation, taxation,
and labor regulations. Government regulations play a decisive
role in creating a predictable, safe enabling framework for firms
while efficiently protecting consumers, public health, and safety.

Good regulatory practice focuses on the systematic application of

tools, institutions, and procedures which governments can
mobilize to ensure that regulatory outcomes are effective,
transparent, and inclusive. These can include ensuring that
businesses and entrepreneurs can gain easy access to the
provisions of those laws and regulations that are in force, and that
they receive timely notification of new and proposed regulatory
measures. A key aim of reforms is to reduce the burden of starting
and licensing a business. Relevant tools may include:

Diagnostic assessments and development of reform

recommendations, such as inventories of business regulations

and procedures, stakeholder consultations, legal review, and
mapping of business processes.

Institutional reform, for example, the establishment of clear

and transparent legal mandates for regulatory agencies, and

improved coordination across regulatory agencies.

Deployment of risk assessment and risk classification tools

to focus regulatory oversight.

Provision of regulatory information that is accessible,

reliable, and timely.

Promotion of regulatory compliance through incentives,

guidance, and strategic communications campaigns.

Development of e-registries and transactional portals for

regulatory service delivery.

Attracting Foreign Direct Investment and Maximizing Impact
for Local Economies
FDI brings not only investment and jobs but also increased
exports, supply chain spillovers, and new technologies and
business practices. Realizing these benefits requires clear and
effective implementation of investment strategies and policies that
respond to the realities and aspirations of a particular country. As
a critical part of this, countries need to define their value
proposition as an attractive investment location and to proactively
market investment opportunities to investors in sectors and
subsectors, highlighting their comparative advantages relative to
other locations. Clear strategies and effective marketing are
particularly important for countries with little track record of
attracting FDI, or a reputation as difficult places to invest.
Support to client governments focuses on improving their
investment policy framework, and maximizing the effectiveness of
investment promotion efforts. This includes setting priorities to
design coherent and concrete investment policy and promotion
reform agendas at both economy-wide and sector levels; helping
attract, facilitate, retain, and maximize positive spillovers of FDI
into the domestic economy. Investment climate teams work with

client governments to improve the effectiveness of policies aimed

at attracting FDI. This work includes streamlining investment
procedures, reducing risk through measures to prohibit unlawful
expropriation and arbitrary actions, and implementing
nondiscriminatory treatment of foreign and domestic investors.
Recent Projects
Costa Rica was a top 10 reformer in Doing Business 2013, with
reforms delivered through partnership with the Bank Group.
Innovations have included the launch of an online one-stop shop
for starting a business and an electronic platform for construction
permitting. A new secured transactions law has been enacted to
facilitate access to credit. Cte dIvoire has been ranked as a top
10 reformer inDoing Business for two consecutive years. Working
with the Bank Group, the government has implemented 16
reforms in business start-up, registering property, enforcing
contracts, and other areas. It also has adopted regulations to
reduce explicit or implicit discrimination against female
entrepreneurs.
Investment climate teams have worked with the state of
Rajasthan, India, to streamline business regulations and simplify
regulatory requirements for businesses in the region. On the basis
of recommendations presented to the government, new
regulations were adopted providing for self-certification for annual

inspections, extending the expiration of business licenses from

five to ten years, and eliminating mandatory annual license
renewals. The Bank Group also helped define Rajasthans
competitive proposition in the automotive, solar power
manufacturing and IT-enabled services sectors, reforming the
investment environment to make each sector more attractive, and
undertaking targeted sector outreach. This helped create a
pipeline of approximately $2 billion in investment in these sectors.
In Turkey, reform of FDI policy and legislation led to the removal
of minimum investment requirements and elimination of screening
for FDI approvals. A simple registration system was established
instead. Three years after the reform FDI inflows increased by a
factor of 10. In Mongolia, development of a new investment law
entailed the elimination of screening for FDI approvals. The
introduction of good practices in investor protection boosted
investor confidence by protecting more than $10 billion of existing
FDI stock from being subject to expropriation.
Regional projects can have a powerful leveraging effect on the
benefits of reform. In the East African Community (EAC), a
scorecard assessing compliance with regional obligations boosted
national reform efforts. For example, in Tanzania the scorecard
triggered the liberalization of regulations that had restricted the
movement of capital.

By helping to bring together private sector investors with

governments seeking to promote growth, the Bank Group has
played a direct role in helping to generate investment and create
jobs. In Brazil, the Bank Group helped build the capacity of APEX
(Brazils investment promotion intermediary) and two state
investment promotion intermediaries in Para and Pernambuco,
northern frontier states, to undertake targeted investor outreach.
This led to the attraction of over $1.3 billion of new investment, of
which some 70 percent went to the two frontier states.