You are on page 1of 60

Q.

1Explain the different circumstances under which a suitable growth strategy


should be selected by any company to improve its performance (i.e., intensive,
integrative or diversification growth). You may select an example of your choice
to substantiate your views

Answer :-

1. Intensive Growth:

It refers to the process of identifying opportunities to achieve further growth within the
company’s current businesses. To achieve intensive growth, the management should first
evaluate the available opportunities to improve the performance of its existing current
businesses.

It may find three options:

• To penetrate into existing markets


• To develop new markets
• To develop new products

At times, it may be possible to gain more market share with the current products in their
current markets through a market penetration strategy. For instance, SONY introduced TV
sets with Trinitron picture tubes into the market in 1996 priced at a premium of Rs.10,000
and above over the market through a niche market capture strategy. They gradually
lowered the prices to market levels. However, it also simultaneously launched higher-end
products (high-technology products) to maintain its global image as a technology leader. By
lowering the prices of TVs with Trinitron picture tubes, the company could successfully
penetrate into the markets to add new customers to its customer base.

Market Development Strategy is to explore the possibility to find or develop new markets for
its current products (from the northern region to the eastern region etc.). Most multinational
companies have been entering Indian markets with this strategy, to develop markets
globally. However, care should be taken to ensure that these new markets are not low
density or saturated markets, which could lead to price pressures.

Product Development Strategy involves consideration of new products of potential interest


to its current markets (e.g. Gramaphone Records to Musical Productions to CDs)– as part
of a Diversification strategy.

2. Integrative Growth:

It refers to the process of identifying opportunities to develop or acquire businesses that are
related to the company’s current businesses. More often, the business processes have to
be integrated for linear growth in the profits. The corporate plan may be designed to
undertake backward, forward or horizontal integration within the industry.

If a company operating in music systems takes over the manufacturing business of its
plastic material supplier, it would be able to gain more control over the market or generate
more profit. (Backward Integration)
Alternatively, if this company acquires some of its most profitably operating intermediaries
such as wholesalers or retailers, it is forward integration. If the company legally takes over
or acquires the business of any of its leading competitors, it is called horizontal integration
(however, if this competitor is weak, it might be counter-productive due to dilution of brand
image).

3. Diversification Growth:

It refers to the process of identifying opportunities to develop or acquire businesses that are
not related to the company’s current businesses. This makes sense when such
opportunities outside the present businesses are identified with attractive returns and that
industry has business strengths to be successful. In most cases, this is planned with new
products that have technological or marketing synergies with existing businesses to cater to
a different group of customers (Concentric Diversification).

A printing press might shift over to offset printing with computerised content generation to
appeal to higher-end customers and also add new application areas ( Horizontal
Diversification ) – or even sell stationery.

Alternatively, the company might choose new businesses that have nothing to do with the
current technology, products or markets (Conglomerate Diversification).

The classic examples for this would be engineering and textile firms setting up software
development centres or Call Centres with new service clients.

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

Answer :-

A business plan is a detailed description of how an organization intends to produce, market


and sell a product or service. Whether the business is housing, commercial or some you
own board of directors, management and staff the details of how you intend to operate and
expand your busniness.

A solid business plan describes who you are, what you do, how you will do it, your capacity
to do it, what financial resources are necessary to carry it out, and how you intend to secure
those resources. A well-written plan will serve as a guide through the start-up phase of the
business. It can also establish benchmarks to measure the performance of your business
venture in comparison with expectations and industry standards. And most important, a
good business plan will help to attract necessary financing by demonstrating the feasibility
of your venture and the level of thought and professionalism you bring to the task.

Establish Goals

Once you have identified goals for a new business venture, the next step in the business
planning process is to identify and select the right business. Many organizations may find
themselves starting at this point in the process. Business opportunities may have been
dropped at your doorstep. Perhaps an entrepreneurial member of the board of directors or
a community resident has approached your organization with an idea for a new business, or
a neighborhood business has closed or moved out of the area, taking jobs and leaving a
vacant facility behind. Even if this is the case, we recommend that you take a step back and
set goals. Failing to do so could result in a waste of valuable time and resources pursuing
an idea that may seem feasible, but fails to accomplish important goals or to meet the
mission of your organization.Depending on the goals you have set, you might take several
approaches to identify potential business opportunities.

Local Market Study: Whether your goal is to revitalize or fill space in a neighborhood
commercial district or to rehabilitate vacant housing stock, you should conduct a local
market study. A good market study will measure the level of existing goods and services
provided in the area, and assess the capacity of the area to support existing and additional
commercial or home-ownership activity. This assessment is based on the shopping and
traffic patterns of the area and the demographic and socio-economic characteristics of the
community. A bad or insufficient market study could encourage your organization to pursue
a business destined to fail, with potentially disastrous results for the organization as a
whole. Through a market study you will be able to identify gaps in existing products and
services and unsatisfied demand for additional or expanded products and services. If your
organization does not have staff capacity to conduct a market study, you might hire a
consultant or solicit the assistance of business administration students from a local college
or university. Conducting a solid and thorough market study up front will provide essential
information for your final business plan.

Analysis of Local and Regional Industry Trends: Another method of investigating


potential business opportunities is to research local and regional business and industry
trends. You may be able to identify which business or industrial sectors are growing or
declining in your city, metropolitan area or region. The regional or metropolitan area
planning agency for your area is a good source of data on industry trends.

Internal Capacity: The board, staff or membership of your organization may possess
knowledge and skills in a particular business sector or industry. Your organization may wish
to draw upon this internal expertise in selecting potential business opportunities.

Internal Purchasing Needs / Collaborative Procurement: Perhaps, your organization


frequently purchases a particular service or product. If nearby affiliate organizations also
use this service or product, this may present a business opportunity. Examples of such
products or services include printing or copying services, travel services, transportation
services, property management services, office supplies, catering services, and other
products. You will still need to conduct a complete market study to determine the demand
for this product or service beyond your internal needs or the needs of your partners or
affiliates.

Identify Business Opportunities

Buying an Existing Business: Rather than starting a new business, you may wish to
consider purchasing an existing business. Perhaps a local retail or small light
manufacturing business that has been an anchor to the local retail area or a much-needed
source of jobs in the neighborhood is for sale. Its closure would mean the loss of jobs and
services for your neighborhood. Your organization might consider purchasing and taking
over the enterprise instead of starting a new business. If you decide to pursue this option,
you still need to go through the steps of creating a business plan. However, before moving
ahead, these are just a few important areas to research in assessing the business you plan
to purchase:Be sure to conduct a thorough review of the financial statements for the past
three to five years to determine the current fiscal status and recent financial trends, the
validity of the accounts receivable and the status of the accounts payable. Are all the
required licenses and permits in place and can they be transferred to a new owner?

Also look at the quality of key employees who, because of their expertise, may need to
remain with the business.You will also need to assess the customer or client base and
determine whether its members will remain loyal to the business after it changes hands.

Another area to evaluate is the perception or image of the business. Inspect the facilities
and talk to suppliers, customers and other businesses in the area to learn more about the
reputation of the business.

At this early stage of your planning process, be sure to consult an attorney experienced in
corporation law. As a non-profit corporation, engaging in income-generating activities not
related to your mission may affect your tax-exempt status. You may also wish to protect
your organization from any liability issues connected with the proposed business activity.
After you have decided on a particular business activity, have a qualified attorney advise
you on the proper corporate structure for your new venture. In addition to qualified legal
counsel, seek the expertise of an experienced professional in that particular industry. He or
she will bring valuable knowledge and insights regarding the industry that will prove
extremely useful during the business planning process.

Advisory

You have decided on a business opportunity that meets the goals of your organization. Now
you are ready to test the feasibility of the venture and to present your business concept to
the world. A solid business plan will clearly explain the business concept, describe the
market for your product or service, attract investment, and establish operating goals and
guidelines.

The first step in writing your business plan is to identify your target audience. Will this be an
internal plan the board will use to assess the feasibility and appropriateness of the
business? Or will this plan be distributed to a larger external audience such as funding
sources, commercial lenders or the community to gain financial backing and political
support for the proposed venture? The content and emphasis of the plan will shift according
to the audience.

Q.3You wish to start a new venture to manufacture auto components. Explain


Different stages in the process of starting this new business.

Answer :-

Every business starts out as an idea. This idea usually involves the invention of a new
product, or revolves around a better way of making and marketing an existing one. While
many would argue that the idea stage is not a stage at all, it is actually a turning point, as
business adviser Mike Pendrith points out. After this, you as a business builder must refine
this idea into a money-making reality. Here in this case supposing we are to start a new
venture of manufacturing auto components and also to market them. We will see here in
the following paragraphs different stages of achieving the same goal.
1. Idea Researching
In this stage, you are researching your idea. The object of your research is to find out who
is marketing the same product or service in your area, and how successful the marketer
has been. You can accomplish this by a Google search on the Internet, launching a test-
marketing campaign, or conducting surveys. Also, you are attempting to find what the level
of interest is in the products (or services) you wish to market.
Here as the main goal is to start a company that manufactures the auto components, we
are to make a research on all the auto companies which are procuring the spares from the
outside vendors. And also the competitors who are all marketing that, their existence and
also how successful they are.
As part of the initial research process, it is important to consider the legal requirements of
selling your product or service. According to the Biz Ed website, examine the legal
ramifications of your business. Know the tax laws governing your business. If insurance is a
requirement, prepare to budget for it. Also, be aware of any safety laws governing you as
an employer. Hence we are also to make a research on the feasible area where we can
start our organization and licenses that we need to take keeping in mind the environmental
factors as well.

2. Business Plan Formulation

You must write a business plan. As Pendrith points out, this is crucial if you want funding,
such as a small business loan or grant, or if you wish to lease a building. At this stage,
Pendrith advises, you need to consult with an attorney or business adviser for assistance.
In the business plan you typically include following heads:

ι ) Executive Summary
ιι) Company and Product Description
ιι ι) Market Description
ιϖ) Equipment and Materials
ϖ) Operations
ϖι) Management and Ownership
ϖι ι) Financial Information and Start-Up Timeline
ϖ ι ι ι ) Risks and Their Mitigation

3. Financial Planning
Financial planning involves thinking about the financial costs of starting and maintaining
your business. According to the Biz Ed website, you should consider such issues as the
costs of running the business; the prices you wish to charge your customers; cash flow
control; and how you wish to set up financial reserves in case of an emergency or an event
causing significant loss to the business. This includes the planning of whether to take any
loans or make personal investments in the company.
4. Advertising Campaign
Decide how you will market your product. Consider your budget and your target audience.
Make up business cards with your logo on it, your name and the name of your business.
Make sure that they are of the most professional quality. Utilizing print, the newspaper, the
Internet, radio or TV is also wise, considering, of course, the size of your advertising
budget.
Here in this case more than TV, a better advertising media will be road side sign boards
placed close to the auto companies for getting the deals to manufacture their spares. As
TV is useful only to reach the common man and he is not our target customer. Hence sign
boards is the feasible solution and also pamphlets circulated across the pioneers. This
apart personal marketing is much more suggested.

5. Preparing for Launch

Advertise for employees. This also requires adequate planning. Think about what you look
for in an employee. Be specific about the requisite skills and experience you are seeking.
Then begin requesting resumes and setting up interviews, making hiring decisions based
on the standards you have set. In this case we will be looking for a few candidates in
managerial position who must be good in managing things apart from minimal technical
knowledge.
Lower level people at the shopfloor people. They need to have real time experience in the
shop floor activities. The employees apart, one needs to plan on the plant and machinery
as well. Thus these are all the stages that I would consider performing if incase I plan to
start a manufacturing unit producing automobile components.

Q.4Explain the process of due Diligence and why it is necessary.

Answer :-

A business which wants to attract foreign investments must present a business plan. But a
business plan is the equivalent of a visit card. The introduction is very important – but, once
the foreign investor has expressed interest, a second, more serious, more onerous and
more tedious process commences: Due Diligence.

"Due Diligence" is a legal term (borrowed from the securities industry). It means,
essentially, to make sure that all the facts regarding the firm are available and have been
independently verified. In some respects, it is very similar to an audit. All the documents of
the firm are assembled and reviewed, the management is interviewed and a team of
financial experts, lawyers and accountants descends on the firm to analyze it.

First Rule:

The firm must appoint ONE due diligence coordinator. This person interfaces with all
outside due diligence teams. He collects all the materials requested and oversees all the
activities which make up the due diligence process. The firm must have ONE VOICE. Only
one person represents the company, answers questions, makes presentations and serves
as a coordinator when the DD teams wish to interview people connected to the firm.

Second Rule:

Brief your workers. Give them the big picture. Why is the company raising funds, who are
the investors, how will the future of the firm (and their personal future) look if the investor
comes in. Both employees and management must realize that this is a top priority. They
must be instructed not to lie. They must know the DD coordinator and the company’s
spokesman in the DD process. The DD is a process which is more structured than the
preparation of a Business Plan. It is confined both in time and in subjects: Legal, Financial,
Technical, Marketing, Controls.
Q.5Is Corporate Social Responsibility necessary and how does it benefit a Company
and its shareholders?

Answer :-

The main function of an enterprise is to create value through producing goods and services
that society demands, thereby generating profit for its owners and shareholders as well as
welfare for society, particularly through an ongoing process of job creation. However, new
social and market pressures are gradually leading to a change in the values and in the
horizon of business activity.

CSR is a concept whereby companies integrate social and environmental concerns in their
business operations and in their interaction with their stakeholders on a voluntary basis.

There is today a growing perception among enterprises that sustainable business success
and shareholder value cannot be achieved solely through maximising short-term profits, but
instead through market-oriented, yet responsible behaviour. Companies are aware that they
can contribute to sustainable development by managing their operations in such a way as
to enhance economic growth and increase competitiveness whilst ensuring environmental
protection and promoting social responsibility, including consumer interests.In this context,
an increasing number of firms have embraced a culture of CSR. Despite the wide spectrum
of approaches to CSR, there is large consensus on its main features:

• CSR is behaviour by businesses over and above legal requirements, voluntarily adopted
because businesses deem it to be in their long-term interest;
• CSR is intrinsically linked to the concept of sustainable development: businesses need
to integrate the economic, social and environmental impact in their operations;
• CSR is not an optional "add-on" to business core activities – but about the way in which
businesses are managed.

Socially responsible initiatives by entrepreneurs have a long tradition in Europe. What


distinguishes today’s understanding of CSR from the initiatives of the past is the attempt to
manage it strategically and to develop instruments for this. It means a business approach,
which puts stakeholder’s expectations and the principle of continuous improvement and
innovation at the heart of business strategies. What constitutes CSR depends on the
particular situation of individual enterprises and on the specific context in which they
operate, be it in Europe or elsewhere. In view of the EU enlargement, it is however
important to enhance common understanding both in Member States and candidate
countries.

There are various theoretical perspectives on the concept of Corporate Responsibility:


ranging from a traditional view of the firm (e.g. Friedman, 1962; Walley and Whitehead,
1994) to a call for a complete paradigm shift in business practice (e.g. Dyllick and Hockerts,
2002; Gladwin et al, 1995). However, all views on corporate responsibility are based on the
same premise: that there is a corporate strategic approach to environmental and social
issues (c.f. Banerjee et al, 2003; Lyon, 2004). Hence, it contains both corporate
environmentalism and corporate social responsibility (Dyllick and Hockerts, 2002), leading
to the current construct that Corporate Responsibility includes any initiative that reduces the
environmental impact and/or contributes to the improvement of the social conditions beyond
the firm’s legal obligations (Roome, 2006). As such, it is considered a key development in
connecting corporate practices with the societal goal of sustainable development, as firms
can “contribute to more sustainable patterns of production and consumption within society”

Corporate Responsibility can be considered as encompassing two components (Banerjee,


2002; Bansal and Roth, 2000; van Marrewijk, 2004): a strategy focus (i.e. how strategically
important environmental and social issues are perceived by management), and an
orientation aspect (i.e. a set of underlying corporate values that provide an internal
‘compass’ to which the company can orient its environmental and social actions). The
orientation of an organisation has significant strategic power in terms of shaping the
organisational direction (Chen et al, 1997; Keogh and Polonsky, 1998; Shrivastava, 1995c).
As such, the ‘responsible’ orientation not only influences the overall responsibility of a firm,
it also affects the extent and form that actual responsible strategies will take, as well as the
ethical behaviour standards and the environmental protection commitment of the
organisation (Shrivastava, 1995b). Therefore, the responsible orientation within a firm
needs to be studied in more detail to provide additional insights into organisational attitudes
towards the environment and society.

Various researchers (e.g. Bansal and Roth, 2000; McKay, 2001; Prakash, 2001) found that
a multi-theoretical perspective explained some organisational responses to a greater extent
than single theories in isolation, and could explain the seemingly ad hoc choices of firms to
go beyond legal compliance. Since this paper aims to propose two complementary
multidisciplinary approaches, none of the existing theories is judged or favoured above
others. Instead, the different theories are used in combination to draw out more
comprehensive notions of the role of values in corporate responsibility.

Assuming that organisations are open systems (Katz and Kahn, 1966), and as such
become interdependent with those elements of the environment with which they transact
(Pfeffer, 1982), organisations work within such interdependencies to reduce uncertainty and
ensure survival (DiMaggio, 1988; McKay, 2001). Based on this, the central premise of
resource dependence is that power relations among actors are commonly asymmetrical
and that organisations strive to obtain power, maintain autonomy, and reduce uncertainty in
the context of external pressures and demands. Control over resources is critical in
maintaining power and is therefore pursued by organisations (McKay, 2001). As such, an
organisation-wide dedication to a compelling long-range vision (a shared vision) is the key
to generating the internal pressure and enthusiasm needed for [responsible] innovation and
change (Hamel and Prahalad, 1989; Hart, 1995). Given the difficulty of generating a
consensus about a purpose, shared vision is a rare (firm-specific) resource, and few
companies have been able to establish or maintain a widely shared or enduring sense of
mission (Hamel and Prahalad, 1989). Starik and Rands (1995) extended this idea to include
values, as these act as a mechanism to unify and orient organisational units toward
sustainability. Norms and shared values are essential to understand the sustainability of
organisations, and provide links between the organisation and the environment and society
(Starik and Rands, 1995).

Institutional theory is also based on the open systems assumption as described above.
However, the central premise of institutional theory is that survival arises out of conformity
to external rules and norms. Thus, the theory examines how external social and regulatory
pressures influence organisational actions (Scott 1987). Due to the powerful nature of
environmental influences, organisations seek to conform to environmental pressures as a
way to secure stability, legitimacy and access to resources. Those organisations that are
responsive to such institutional pressures are assumed to be more likely to survive
(DiMaggio and Powell, 1983; McKay, 2001). In setting environmental strategy and
structure,

firms may choose action from a repertoire of possible options. However, the internal
structure and culture of the firm reflect the dominant institutions of the organisational field,
hence the range of that repertoire is bound by the rules, norms, and beliefs of the
organisational field (Hoffman, 1997).

Based on the ‘systems’ view of organisations, the central premise of stakeholder theory is
that there are specific interest groups in the outside environment, which have a stake in the
behaviour and effectiveness of that organisation (Freeman, 1984). Although stakeholder
theory shares notions of power with both previously discussed theories, neither resource
dependence theory nor institutional theory appears to suffice to explain the full range of
stakeholder power. Both theories offer explanations of reactions to economic or formal/legal
pressures, but fail to account for political pressures (Jonker and Foster, 2002): where
environmental or social stakeholders are involved, there is neither resource dependency
nor formal/legal pressure to conform (Frooman, 1999). The perception of the responsible
managers influences the approach to stakeholders
(e.g. Collison et al, 2003; Cormier et al, 2004; Sharma and Henriques, 2005), and it is
argued that “responses to environmental pressures can vary widely among firms depending
on managerial perceptions of environmental risks and opportunities … on their
interpretation of the importance and relationship of the natural environment to their
business activity” (Banerjee, 1998: p. 148). In explicitly describing the values and
responsibilities of a firm, business codes can help by providing a framework for managers
to guide their decisions, and simultaneously informing external stakeholders (Kaptein,
2004).

A number of scholars argue that current research and practice in corporate environ-
mentalism may be limited by the assumptions under which much is carried out (Porter,
2005). These authors therefore call for a revolutionary way of thinking about business
regarding environment and society (e.g. Dyllick and Hockerts, 2002; Gladwin et al, 1995;
Peattie, 2000; Shrivastava (1995a); Stern et al. (1995)). A variety of authors (e.g. Banerjee,
2001; Gladwin et al. 1995; Hoffman, 2000) have demonstrated how using traditional
management theories (in particular institutional theory, strategic choice, transformational
leadership) can hinder efforts to change to a more ‘green’ state of doing business at the
institutional as well as the organisational level. Therefore, new perspectives, preferably
from new domains, are required to challenge current assumptions and facilitate the
transition of developing appropriate organisational values (Starkey and Crane, 2003).

From the above, we could conclude that shared values are a key component in attaining a
shared vision of the Corporate Responsibility of an organisation and to guide interactions
with stakeholders, and are formed by rules, norms and ethical behaviour standards from
both inside and outside of the organisation.

However, there is academic and anecdotal evidence that the integration of corporate
responsibility throughout the hierarchy of organisations is marginal, and even absent in
some cases (e.g. Barakat, 2006b; Knox et al, 2005). A recent study by Barakat (2006b)
suggested that among employees in three UK case studies there was a general absence of
shared meaning with regards to key environmental themes and issues (although smaller
clusters around hierarchical levels and some functional groups shared some experiences
on some issues). There was no system for the identification and definition of environmental
concepts, no explicit means by which concepts could be shared and discussed, and no
mechanism to indicate to employees the concepts and definitions that would be acceptable
and those that would not. Hence, employees experienced their firm’s corporate
environmentalism predominantly in an individual manner. The perceived corporate
orientation towards environmentalism followed this, and this study therefore offers some
evidence that corporate environmental orientation can be perceived and experienced
differently within the same organisation.

Furthermore, many researchers and practitioners in the Corporate Responsibility field (e.g.
Banerjee et al, 2003; Juholin, 2004; Murphy, 1988) have argued (or assumed) that the
vision and commitment of senior management is communicated clearly, and understood
and incorporated by all staff within the organisation in the manner as it was initially intended
(Preston, 2001; Ramus, 2001). Yet, there is little evidence that this assumption is grounded
in practice (Barakat, 2006a; Knox et al, 1995). Even more so, there is evidence that (mainly
lower-level) employees do not perceive their firm to be pro-active in its environmental and
social responsibilities (e.g. Barakat, 2006a; Lingard et al, 2000; Ramasamy and Woan-Ting,
2004). Research suggests that since employees are not oblivious to the ethical climate of
the company, this interaction affects the trust that employees have of their organisations
and affects their commitment to it (Van Dyne et al, 1994; Fritz et al, 1999; Gross and
Etzioni, 1985). Also, the employees’ experience of Corporate Responsibility appears to be
significantly affected by their perception of the behaviours and attitudes of management,
especially if an employee perceives an inconsistency between the immediate manager and
the corporate policy (Ramus, 2001). The resultant dissatisfaction and lack of engagement
could potentially impact the success of responsible initiatives (e.g. Preston, 2001; Ramus,
2001). Hence, it has become important to understand how Corporate Responsibility is
interpreted by decision-makers (Banerjee, 2002) and decision implementers.

Q.6Distinguish between a Financial Investor and a Strategic Investor explaining the


role they play in A Company.

Answer :-

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

These are the functions normally reserved to financial investors:

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

Collection and Credit Assessment

1. To construct and implement credit risk assessment tools, questionnaires, quantitative


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

Project Planning and Project Management

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

Marketing and Sales

1. The presentation to the Board an annual plan of sales and marketing including: market
penetration targets, profiles of potential social and economic categories of clients, sales
promotion methods, advertising campaigns, image, public relations and other media
campaigns. The strategic investor also implements these plans or supervises their
implementation.
2. The strategic investor is usually possessed of a brandname recognized in many countries.
It is the market leaders in certain territories. It has been providing goods and services to
users for a long period of time, reliably. This is an important asset, which, if properly used,
can attract users. The enhancement of the brandname, its recognition and market
awareness, market penetration, co-branding, collaboration with other suppliers – are all the
responsibilities of the strategic investor.
3. The dissemination of the product as a preferred choice among vendors, distributors,
individual users and businesses in the territory.
4. Special events, sponsorships, collaboration with businesses.
5. The planning and implementation of incentive systems (e.g., points, vouchers).
6. The strategic investor usually organizes a distribution and dealership network, a franchising
network, or a sales network (retail chains) including: training, pricing, pecuniary and quality
supervision, network control, inventory and accounting controls, advertising, local marketing
and sales promotion and other network management functions.
7. The strategic investor is also in charge of "vision thinking": new methods of operation, new
marketing ploys, new market niches, predicting the future trends and market needs, market
analyses and research, etc.

The strategic investor typically brings to the firm valuable experience in marketing and
sales. It has numerous off the shelf marketing plans and drawer sales promotion
campaigns. It developed software and personnel capable of analysing any market into
effective niches and of creating the right media (image and PR), advertising and sales
promotion drives best suited for it. It has built large databases with multi-year profiles of the
purchasing patterns and demographic data related to thousands of clients in many
countries. It owns libraries of material, images, sounds, paper clippings, articles, PR and
image materials, and proprietary trademarks and brand names. Above all, it accumulated
years of marketing and sales promotion ideas which crystallized into a new conception of
the business.

Technology

1. The planning and implementation of new technological systems up to their fully operational
phase. The strategic partner's engineers are available to plan, implement and supervise all
the stages of the technological side of the business.
2. The planning and implementation of a fully operative computer system (hardware, software,
communication, intranet) to deal with all the aspects of the structure and the operation of
the firm. The strategic investor puts at the disposal of the firm proprietary software
developed by it and specifically tailored to the needs of companies operating in the firm's
market.
3. The encouragement of the development of in-house, proprietary, technological solutions to
the needs of the firm, its clients and suppliers.
4. The planning and the execution of an integration program with new technologies in the field,
in collaboration with other suppliers or market technological leaders.

Education and Training

The strategic investor is responsible to train all the personnel in the firm: operators,
customer services, distributors, vendors, sales personnel. The training is conducted at its
sole expense and includes tours of its facilities abroad.
The entrepreneurs – who sought to introduce the two types of investors, in the first place –
are usually left with the following functions:

Administration and Control

1. To structure the firm in an optimal manner, most conducive to the conduct of its business
and to present the new structure for the Board's approval within 30 days from the date of
the GM's appointment.
2. To run the day to day business of the firm.
3. To oversee the personnel of the firm and to resolve all the personnel issues.
4. To secure the unobstructed flow of relevant information and the protection of confidential
organization.
5. To represent the firm in its contacts, representations and negotiations with other firms,
authorities, or persons.

This is why entrepreneurs find it very hard to cohabitate with investors of any kind.
Entrepreneurs are excellent at identifying the needs of the market and at introducing
technological or service solutions to satisfy such needs. But the very personality traits which
qualify them to become entrepreneurs – also hinder the future development of their firms.
Only the introduction of outside investors can resolve the dilemma. Outside investors are
not emotionally involved. They may be less visionary – but also more experienced.
They are more interested in business results than in dreams. And – being well acquainted
with entrepreneurs – they insist on having unmitigated control of the business, for fear of
losing all their money. These things antagonize the entrepreneurs. They feel that they are
losing their creation to cold-hearted, mean spirited, corporate predators. They rebel and
prefer to remain small or even to close shop than to give up their cherished freedoms. This
is where nine out of ten entrepreneurs fail - in knowing when to let go.
Q.1(a)How has liberalizing trade helped international business?

Answer :-

The Benefits of Trade Liberalization

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

Although there are benefits from improved access to other countries’ markets, countries
benefit most from liberalizing their own markets. The main benefits for industrial countries
would come from the liberalization of their agricultural markets. Developing countries would
gain about equally from liberalization of manufacturing and agriculture. The group of low-
income countries, however, would gain most from agricultural liberalization in industrial
countries because of the greater relative importance of agriculture in their economies.
Q1(b). What are the merits and demerits of international trade?

Answer :-

Merits:

• Enhance your domestic competitiveness


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

Demerits:

• You may need to wait for long-term gains


• Hire staff to launch international trading
• Modify your product or packaging
• Develop new promotional material
• Incur added administrative costs
• Dedicate personnel for travelling
• Wait long for payments
• Apply for additional financing
• Deal with special licenses and regulations

Q.2Discuss the impact of culture on International Business.

Answer :-

• Cultural Influences

There are some obvious ways culture influences an international business;


The way how we present ourselves
How we express opinions
• Assumptions based on the environment and context
• Perceptions of voice, and other personal physical details
It is essential to adapt to these cultural differences. They stop interfering with
communication.

When the two aspects of human society, culture and business, interact with each other. It
leads to the development of interesting conditions or scenarios. When different cultures
converge at a common point with business as the platform, the clashes are bound to take
place. But most importantly, such a scenario helps us adapt to challenging situations.

Different communities or countries in the follow different mannerisms and etiquette. The
way or view to see a problem might change from country to country, across the globe.

The international business culture, as a whole, is a congregation of various business


practices, cultural influences and the thought processes followed in different nations. The
various things that impact an international business are mannerisms, communication, time,
etc.

• Body Language

Every nation has a separate culture; a part of which is reflected in the behavior and the
body language of the people. In an international business, understanding the undercurrents
beneath the mannerisms or gestures becomes necessary. There are changes that behavior
might get misinterpreted by people from different Cultures. Thus, it requires a skilled
coordinator to handle challenging situations during meetings.

• Communication

The way of communicating could be different in different cultures. The terms used by some
might sound harsh to others. The way in which words are pronounced to impact the
intercultural communication in the corporate houses. In fact, it is one of the major
hindrances in the proofs business communication.

• Time

People from Britain and Germany are keen on following the time-bound schedules. The
different ‘Time-Cultures’ might be the reason behind clashes, between people from diverse
cultures.

The way in which the boardroom meetings are handled, is also a reason behind differences
in opinions. Corporate houses from western countries stick to the schedules during
meetings. They get down to business in an outright manner. Other cultures may differ in
this aspect of business.

The marketing executives sent for international assignments, are bound to face problems in
dealing with the corporate culture of that particular country. Understanding a foreign market
and formulating the company policies to cater to the need of international clients is a
challenging job. Skilled professionals possessing the quality called ‘empathy’ are able to
deliver the goods in stores.

With today’s business entering a ‘globalize’ world. The interaction between different
cultures is bound to happen. Merely learning different languages won’t be enough. It is
necessary for corporate houses to understand the social conditions of different countries, to
successfully tap the respective markets. Being sensitive to the values and beliefs of
different cultures of the world is necessary.

International businesses are not only a way of marking profits by the exploitation of
international talent, but also a bridge between different nations of the world. Tomorrow’s
world will rely more on a symbiotic relationship between international businesses and
cultures as a whole.

• Values and Attitudes

Values and attitudes vary between nations, and even vary within nations. So if you are
planning to take a product or service overseas make sure that you have a good grasp the
locality before you enter the market. This could mean altering promotional material or subtle
branding messages. There may also be an issue when managing local employees. For
example, in France workers tend to take vacations for the whole of august, whilst in the
United States employees may only take a couple of week’s vacation in an entire year.

• Education

The level and nature of education in each international market will vary. This may impact
the type of message or even the medium that you employ. For example, in countries with
low literacy levels, advertisers would avoid communications which depended upon written
copy, and would favour radio advertising with an audio message or visual media such as
billboards. The labeling of products may also be an issue.

• Social Organizations
This aspect of cultural framework relates to how a national society is organized. For
example, what is the role of women in a society? How is the country governed – centralized
or devolved? The level influence of class system. So social mobility could be restricted
where caste and class system are in place. Whether or not there are strong trade unions
will impact upon management decisions if you employ local workers.

• Technology and Material Culture

Technology is a term that includes many other elements. It includes questions such as is
their energy to power our products? Is there a transport infrastructure to distribute our
goods to consumers? Does the local port have large enough cranes to offload containers
from ship? How quickly dose innovations diffuse? Also of key importance, do consumers
actually buy material goods i.e. are they materialistic?

• Law and Politics

The underpinning social culture will drive the political and legal landscape. The political
ideology on which the society is based will impact upon your decision to market there. For
example, the United Kingdom has a largely market-driven, democratic society with laws
based upon precedent and legislation, whilst lran has a political and legal system based
upon the teachings and principles lslam and a Sharia tradition.

• Aesthetics

Aesthetics relate to your senses, and the appreciation of the artistic nature of something,
including its smell, taste or ambience. For example, is something beautiful? Does it have a
fashionable design? Was an advert delivered in good taste? Do you find the color, music or
architecture relating to an experience pleasing? Is everything relating to branding
aesthetically pleasing?
• Cross Cultural Marketing Blunders

Although cruel, cross cultural marketing mistakes are a humorous means of understanding
the impact poor cultural awareness or translations can have on a product or company when
selling abroad.

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

Answer :-

Brief Structure of WTO.

WTO structure: all WTO members may participate in all councils, committees, etc, except
Appellate Body, Dispute Settlement panels, and plurilateral committees.

Structure of the World Trade Organization The World Trade Organization came into
force on January 1, 1995, fully replacing the previous GATT Secretariat as the organization
responsible for administering the international trade regime. The basic structure of the WTO
includes the following bodies.

• The Ministerial Conference, which is composed of international trade ministers from


all member countries. This is the governing and body of the WTO, responsible for
setting the strategic direction of the organization and making all final decisions on
agreement under its wings. The ministerial Conference meets at least once every two
years. Although voting can take place, decisions are generally taken by consensus, a
process that can at time be difficult, particularly in a body composed of 136 very
different members.

• The General Council composed of senior representatives (usually ambassador level) of


all members. It is responsible for overseeing the day-to-day business and management
of the WTO, and is based at the WTO headquarters in Geneva. In practice, this is the
key secession-making arm of the WTO for most issues. Several of the bodies described
below report directly to the General Council.

• The Trade Policy Review Body is also composed of all the WTO members, and
oversees the Trade Policy Review Mechanism, a product of the Uruguay Round. It
periodically review the trade policies and practices of all member states. These reviews
are intended to provide a general indication of how states. These reviews are
implementing their obligations, and to contribute to improved adherence by the WTO
parties to their obligations.

• The Dispute Settlement Body is also composed of all the WTO members. It oversees
the implementation and effectiveness of the dispute resolution process for all WTO
agreement, and the implementation of the decision on WTO dispute. Disputes are heard
and ruled on by dispute resolution panels chosen individually for each case, and the
permanent Appellate Body that was established in 1994. Dispute resolution is
mandatory and binding on all members. A final decision of the Appellate Body can only
be reversed by a full consensus of the Dispute Settlement Body.

• The Councils on Trade in Goods and Trade in Service operates under the mandate
of the General Council and are composed of all members. They provide a mechanism to
oversees the details of the general and specific agreement on trade-in services. There is
also a Council for the Agreement on Trade-Related Aspect of Intellectual Property
Rights, dealing with just that agreement and subject area.

• The Secretariat and Director General of the WTO reside in Geneva, in the old
home of GATT. The Secretariat now numbers just under 550 people, and undertakes
the administrative functions of running all aspects but provides vital services, and often
advice, to those who do. The Secretariat is headed by the Director General, who is
elected by the members.

• The Committee on Trade And Development and Committee on Trade and


Environment are two of the several committees continued or established under the
Marrakech Agreement in 1994. They have specific mandates to focus on these
relationships, which are especially relevant to how the WTO deals with sustainable
development issues. The Committee on Trade and Development was established in
1965. The forunner to the Committee on Trade and Environment (the Group on
Environment Measures and International trade) was establish in 1971, but did not meet
until 1992. Both Committees are now active as discussion grounds but do not actually
negotiate trade rules.

Q3(b) Highlight the drawbacks of GATT.

Answer :-

Given its provisional nature and limited field of action, the success of GATT in promoting
and securing the liberalization of much of world trade over 47 years is incontestable.
Continual reductions in tariffs a lone helped spur very high rates of world trade growth –
around 8% a year on average during the 1950s and 1960s. And the momentum of trade
liberalization helped ensure that trade growth consistently out-paced production growth
throughout the GATT era. The rush of new members during the Uruguay round
demonstrated that the multilateral trading system, as then represented by GATT, was
recognized as an anchor for development and an instrument of economic and trade reform.

The limited achievement of the Tokyo Round, outside the tariff reduction results, was a sign
of difficult times to come. GATT’s success in reducing tariffs to such a low level, combined
with a series of economic recessions in the 1970s and early 1980s, drove governments to
devise other forms of protection for sectors facing increased overseas competition. High
rates of unemployment and constant factory closures led governments in Europe and North
America to seek bilateral market-sharing arrangements with competitors and to embark on
a subsidies race to maintain their holds on agricultural trade. Both these changes
undermined the credibility and effectiveness of GATT.

Apart from the deterioration in the trade policy environment, it also became apparent by the
early 1980s that the General Agreement was no longer as relevant to the realities of world
trade as it had been in the 1940s. For a start, world trade had become far more complex
and important than 40 years before; the globalization of the world economy was underway,
international investment was exploding and trade in services – not covered by the rules of
GATT – was of major interest to more and more countries and, at the same time, closely
tied to further increases in world merchandise trade. In other respect, the GATT had been
found wanting: for instance, with respect to agricultural where loopholes in the multilateral
system were heavily exploited – and efforts at liberalizing agricultural trade met with little
success – and in the textiles and clothing sector where an exception to the normal
disciplines of GATT was negotiated in the form of the Multi-fiber Arrangement. Even the
institutional structure of GATT and its dispute settlement system were giving cause for
concern.

Together, these and other factors convinced GATT members that a new effort to reinforce
and extend the multilateral system should be attempted. That effort resulted in the Uruguay
Round.

Q4(a) Give a short note on the regional economic integration

Answer :-

The regional economic integration.

Regional economic integration is an agreement among countries in a geographic region to


reduce and ultimately remove, tariff and non tariff barriers to the free flow of goods or
services and factors of production among each others. It can be also refers as any type of
arrangement in which countries agree to coordinate their trade, fiscal, and/or monetary
policies are referred to as economic integration. Obviously, there are many different levels
of integration. Free trade Area; A free area occurs when a group of countries agree to
eliminate tariff between themselves, but maintain their own external tariff on imports from
the rest of the world.

Regional integration has been defined as an association of states based upon location in a
given geographical area, for the safeguarding or promotion of the participants, an
association whose terms are fixed by a treaty or other arrangements. Philippe De
Lombaerde and Luk Van Langenhove define regional integration as a worldwide
phenomenon of territorial systems that increase the interactions between their components
and create new forms of organization, co-existing with traditional forms of state-led
organization at the national level. According to Hans Van Ginkel, regional integration refers
to the process by which states within a particular region increase their level of interaction
with regard to economic, security, political, and also social and cultural issues in short;
regional integration is the joining of individual states within a region into a larger whole. The
degree of integration depends upon the willingness and commitment of independent
sovereign states to share their sovereignty. Regional integration initiatives should fulfill at
least eight important functions:

• The strengthening of trade integration in the region


• The creation of an appropriate enabling environment for private sector
development
• The development of infrastructure programmes in support of economic growth
and regional integration
• The development of strong public sector institutions and good governance;
• The reduction of social exclusion and the development of an inclusive civil society
• Contribution to peace and security in the region
• The building of environment programmes at the regional level
• The strengthening of the region’s interaction with other regions of the world.[3]

The crisis of the post-war order led to the emergence of a new global political structure.
This new global political structure made obsolete the classical West phalian concept of a
system of sovereign states to conceptualize world politics. The concept of sovereignty
becomes looser and the old legal definitions of an ultimate and fully autonomous power of a
nation-state are no longer meaningful. Sovereignty, which gained meaning as an affirmation
of cultural identity, has lost meaning as power over the economy. All regional integration
projects during the cold War were built on the West phalian state system and were to serve
economic growth as well as security motives in their assistance to state building goals.
Regional integration and globalization are the two phenomena challenging the existing
global order based upon sovereign states at the beginning of the twenty-first century. The
two processes deeply affect the stability of the west phalian state system, thus contributing
to both disorder and a new global order.
Closer integration of neighboring economies is seen as a first step in creating a larger
regional market for trade and investment. This works as a spur to greater efficiency,
productivity gain and competitiveness, not just by lowering border barriers, but by reducing
other costs and risks of trade and investment. Bilateral and sub-regional trading
arrangements are advocated as development tools as they encourage a shift towards
greater market openness. Such agreements can also reduce the risk of reversion towards
protectionism, locking in reforms already made and encouraging further structural
adjustment.

In broad terms, the desire for closer integration is usually related to a larger desire for
opening to the outside world. Regional economics cooperation is being pursued as a
means of promoting development through grater efficiency, rather than as a means of
disadvantaging others. Most of the members of these arrangements are genuinely hoping
that they will succeed as building blocks for progress with a growing range of partners and
towards a generally freer and open global environment for trade and investment. Integration
is not an end in itself, but a process to support economic growth strategies, greater social
equality and democratization.

Regional integration arrangements are a part and parcel of the present global economic
order and this trend is now an acknowledged future of the international scene. It has
achieved a new meaning and new significance. Regional integration arrangement are
mainly the outcome of necessity felt by nation-states to integrate their economies in order to
achieve rapid economic development, decrease conflict, and build mutual trusts between
the integrated units. The nation-state system, which has been the predominant pattem of
international relations since the peace of Westphalia in 1648 is evolving towards a system
in which regional groupings of states is becoming more important than sovereign states.
There is a powerful perception that the idea of the state and its sovereignty has been made
irrelevant by processes that are taking place at both the global and local level. Walter
Lippmann believes that, the true constituent members of the international order of the future
are communities of states.
Q4(b). Mention the benefits of WTO

Answer :-

1. The system helps to keep the peace

Peace is partly an outcome of two of the most fundamental principles of the trading system:
helping trade to flow smoothly and providing countries with a constructive and fair outlet for
dealing with disputes over trade issues. It is also an outcome of the international confidence
and cooperation that the system creates and reinforces.

2. The system allows disputes to be handled constructively

As trade expands in volume, in the number of products traded, and in the numbers of
countries and companies trading, there is a greater chance that disputes will arise. The
WTO system helps resolve these disputes peacefully and constructively. If this could be left
to the member states, the dispute may lead to serious conflict, but lot of trade tension is
reduced by organization such as WTO.

3. A system based on rules rather than power makes life easier for all

WTO system is based on rules rather than power and this makes life easier for all trading
nations. WTO reduces some inequalities giving smaller countries more voice, and at the
same time freeing the major powers from the complexity of having to negotiate trade
agreements with each of the member states.

4. Freer trade cuts the cost of living

Protectionism is expensive: it raises prices. The WTO’s global system lowers trade barriers
through negotiation and applies the principle of non-discrimination. The result is reduced
costs of production (because imports used in production are cheaper) and reduced prices
of finished goods and services, and ultimately a lower cost of living.

5.It provides more choice of product of products and qualities:

It gives consumers more choice and a broader range of qualities to choose from

6. Trade raises incomes

Through WTO trade barriers are lowered and this increases imports and exports thus
earing the country foreign exchange thus raising the country’s income..

7. Trade stimulates economic growth :

With upward trend economics groth, jobs can be created and this can be enhanced by
WTO through careful policy making and powers of free trade.

8. Basic principles make life more efficient:


The basic principles make the system economically more efficient and the cut costs. Many
benefits of the trading system are as a result of essential principle at the heart of the WTO
system and they make life simpler for the enterprises directly involved in international trade
and for the producers of goods.

9. Governments are shielded from lobbying:

WTO system shields the government from narrow interest. Government is better placed to
defend themselves against lobbying from narrow interest groups by focusing on trade-offs
that are made in the interests of everyone in the economy.

10. The system encourages good government

The WTO system encourages good government. The WTO rules discourage a range of
unwise policies and the commitment made to liberalize a sector of trade becomes difficult to
reverse. These rules reduce opportunities for corruption.

Q5 (a) Explain five-element product wave model.

Answer :-

The wave model employs design engineering, process engineering, product marketing,
production, and end-of-life activities as elements. The first wave is associated with the "A"
version of a product or service, and survives through the traditional PLC introduction and
growth phases. A second wave begins with the "B" version, the markedly improved second
model. It starts just before the traditional life cycle maturity stage and lives until sales decline
to a point at which an EOL decision must be made.

Note that design engineering has a peak of activity level at each upgrade. Process
engineering activity shadows that of design engineering, as system changes will be
contemplated and made to facilitate the changes made in the product or service. Product
marketing also has activity level spikes that closely match engineering design activity, lagged
somewhat for product introduction. Production has one activity peak that results from demand
management and production planning through master production scheduling.
Finally, the EOL curve peaks at each redesign. The last wave begins shortly before original
production ceases and ends when the product is no longer manufactured or supported by the
EOL Company or division. The EOL element requires that a decision be made about the
preceding version at each major redesign: continue production, make a short-term run of
spares, keep blueprints active so that parts can be made as ordered, enter into a
manufacturing and support agreement with another entity, or discontinue production.

For the sake of parsimony, Figure shows only a two-product model ("A" and "B" versions). In
reality, there may be hundreds of significant redesigns. The wave effect comes from the fact
that the process repeats for the successful firm, forming swells in design engineering,
process engineering, product marketing, and manufacturing curves before the final crest at
EOL activity.

The five-element product wave, or FPW, uses trigger points, rather than time, as the horizon
over which the element curves vary. Changes in magnitude, represented by the vertical axis,
result from differing activity levels within the five elements. Simple changes in levels of dollar
or unit product sales, in and of themselves, do not necessarily determine the trigger points.
Rather, the varying activity levels are a direct result of product introductions and redesigns
that, from the outset, must take into account company strategy, core capabilities, and the
state of the competitive environment. For example, a product with strong sales may be
redesigned in a preemptive strike against competitors, further distancing that product from
the competition, such as with Caterpillar’s innovative high-drive bulldozers.

That the five-element wave is grounded in reality becomes apparent when considering the
recent research that suggests product introduction cycles are being compressed. Bayus
(1994) claims that knowledge is being applied faster, resulting in increasing levels of new
product introductions. Yet since product removals are not keeping pace with introductions,
there are an increasing number of product variations on the market. Slater (1993) observes
that product life cycles are growing shorter and shorter. Vesey (1992) reports that the
strategy for the 1990s is speed to market and discusses the pressures the market is exerting
to shorten product introduction lead times.

Regardless of whether life cycles are actually being compressed or knowledge is simply
being applied faster, it is apparent that firms are increasing the speed with which they bring
their products to market. The effect of this is a compression of the design engineering,
process engineering, production, and product marketing elements of the wave model. (The
EOL curve may remain unchanged because accelerated introductions do not necessarily
affect EOL efforts.) The five-element wave clearly shows the inefficiency of traditional "over-
the-wall" systems as speed to market increases. As the elements compress, more and more
information is thrown over the wall. Recipients find themselves with less and less time to take
action. Taken to the extreme, in-baskets, phone lines, conference rooms, desks, and floors
are soon gridlocked and littered with unanswered correspondence and things to do. Forget
quality; production itself grinds to a halt.

The solution is to maximize the advantage of the relationships within the five-element wave
and work in concurrent teams, . That way, responsibility is shared throughout the system.
Members from each discipline optimize the system. The method tears down barriers between
departments and speeds the introduction process, thus decreasing costs. The focal point
becomes the customer, rather than the task. The system is totally interactive and bound
together. Each element is connected to all of the others and is focused on the customer.
(Note that the authors have taken a great deal of artistic license here! No meaning should be
attached to the actual measure of overlap area )

What is the recent experience with teams? There is evidence that using concurrent design
teams speeds the product to market and provides substantial savings. Boeing expects that
concurrent design will save some $4 billion in the development of its 777 airliner.
Westinghouse recently suggested that concurrent engineering would eliminate 200 duplicate
processes in a project that consisted of 600 using traditional over-the-wall approaches. Ford’s
Team Taurus was able to cut a full year out of model turnaround. In addition, design changes
required after initial production began were reduced by some 76 percent.

The strength of the five-element product wave is the fact that it illuminates critical decision
points in the life of a product or service. The interrelationships of the elements clearly
illustrate the benefit of working product introductions, design changes, and end-of-life
decisions in teams. This is particularly true in today’s rapidly compressing environment of
speeding products to market. Furthermore, the model is flexible and may be expanded or
contracted to include those functional areas relevant to the production team. Thus, whether a
given firm’s product is a service or a manufactured good, the five-element wave is a powerful
tool that can be deployed to accelerate effective decision making in markets demanding ever-
increasing levels of speed and agility.
Q5(b) What do you mean by globalization?

Answer :-

• Globalization:

Globalization is the system of interaction among countries of the world in order to develop
the global economy. Globalization refers to the integration of economics and societies all
over the world. Globalization involves technological, economical, political, and cultural
exchanges made possible largely by advances in communication, transportation, and
infrastructure.

Liberalization is another aspect of globalization. Both are two faces of one coin.
Liberalization is known for free trade and business. In the global era, liberalization has a
grater positive aspect for trade and business. Liberalization gives a policy to make an
economy open to trade and invest across the world with suitable growth. In the capitalist
and imperialist era, no country has achieved economic success and substantial increases
in living stands for its people without being open to the rest of world. Liberalization
advocates the aspect of free trades. In the recent era, free trade has given so many befits
for the poor especially. Liberalization has created many new jobs for unskilled workers also.

Free trade has been the most successful aspect for developing countries and industries. It
has changed culture and society also with new working culture. Developing countries would
gain more from global trade liberalization as a percentage of their GDP than industrial
countries, because their economies are more highly protected and because they face
higher barriers.

To open up economy to the global economy, a country has developed competitive


advantages in the manufacture of certain products in the global world of market. For
examples, we can take some countries that have opened their economies in recent years
such as – India, Vietnam and Uganda, have experienced faster growth and more poverty
reduction.
Although, there are only benefits from improved access to other countries markets,
countries benefits most from liberalizing their own markets. The main benefits for industrial
countries would gain about equally from liberalization of manufacturing and agriculture. The
group of low-income countries because of the grater relative importance of agriculture in
their economies.
Globalization is a historical process rather than political or economical. It is the result of
human innovation and technological progress. Globalization has shown the increasing
integration of economics around the world. It has taken a greater aspect in the world
particularly, through trade and financial flows. Globalization has covered the broader
culture, politics and environmental dimensions of globalization. There are two types of
integration-negative and positive.

• Negative Integration is the breaking down of trade barriers or protective barriers such
as tariffs and quotas. In the previous chapter, trade protectionism and its policies were
discussed.

You must remember that the removal of barriers can be beneficial for a country if it allows
for products that are importance or essential to the economy. For example, by eliminating
barriers, the costs of imported raw materials will go down and the supply will increase,
making it cheaper to produce the final products for export (like electronics, car parts, and
clothes).

• Positive Integration on the other hand aims at standardizing international economic


laws and policies. For example, a country which has its own policies on taxation trades with
a country with its own set of policies on tariffs. Likewise, these countries have their own
policies on tariffs. With positive integration (and the continuing growth of the influence of
globalization), these countries will work on having similar or identical policies on tariffs.

• Effect of Globalization

According to economists, there are a lot of global events connected with globalization and
integration. It is easy to identify the changes brought by globalization.

1. Improvement of International Trade: Because of the globalization, the number of


countries where products can be sold or purchased has increased dramatically.

2. Technological Progress: Because of the need to compete and be competitive globally,


governments have upgraded their level of technology.

3. Increasing Influence of Multinational Companies: A company that has subsidiaries in


various countries is called a multinational. Often, the head office is found in the country
where the company was established.

Q6.Give some examples of companies doing international business and discuss how
they have they have managed their business in the international markets

Answer :-

Multinational companies may pursue policies that are home country – oriented or host
country – oriented or world – oriented. Perl mutter uses such terms as ethnocentric,
polycentric. However, “ethnocentric” is misleading because if focuses on race or ethnicity.
Especially when the home country itself it populated by many different races. Whereas
“polycentric” loses its meaning when the MNCs operate only in one or two foreign countries.
According to Franklin Root (1994). An MNC is a parent company that

1. Engages in foreign production through its affiliates located in several countries.


2. Exercises direct control over the policies of its affiliates.
3. Implements business strategies in production, marketing, finance and staffing that
transcend national boundaries.

*Howard V. Perl mutter, “The Tortuous Evolution of the Multinational Corporation.”

Three Stages of Evolution:


1. Export Stage:
• Initial inquiries & firms rely on export agents.
• Expansion of export sales.
• Further expansion & foreign sales branch or assembly operations (to save transport
cost)

2. Foreign Production Stage:


There is a limit to foreign sales (tariffs, NTBs)
• DFI Versus Licensing
Once the firm chooses foreign production as a method of delivering goods to foreign
markets, it must decide whether to establish a foreign production subsidiary or license the
technology to a foreign firm.
• Licensing Is usually first experience (because it is easy)
e.g.: Kentucky Fried Chicken in the U.K.
 It does not require any capital expenditure
 It is not risky
 Payment = a fixed% of salesProblem0 the mother form cannot exercise any
managerial control over the licensee (it is independent) The licensee may transfer
industrial secrets to another independent firm, thereby creating a rival.
 Direct Investment It requires the decision of top management because it is a critical
step.
 It is risky (lack of information) (US firms tend to established subsidiaries in Canada first.
Singer Manufacturing Company established its foreign plants in Scotland and Australia
in the 1850s)
 Plants are established in several countries
 Licensing is switched from independent producers to its subsidiaries.
 Export continues

3. Multinational Stage:
The company becomes a multinational enterprise when it begins to plan, organize and
coordinate production, marketing, R&D, financing, and staffing. For each of these
operations, the firm must find the best location.

Motives for Foreign Direct Investment (FDI)

A company whose foreign sales are 25% or more of total sales. This ratio is high for small
countries, but low for large countries, e.g. Nestle (98% Dutch), Phillips (94% Swiss).

Examples0 Manufacturing MNCs


24 of top fifty firms are located in the U.S.
9 in Japan
6 in Germany
Petroleum companies: 6/10 located in the U.S.
Food / Restaurant Chains, 10/10 in the U.S.
US Multinational Corporations Exxon, GM, Ford, etc.
New MNCs do not pop up randomly in foreign nations. It is the result of conscious

Planning by corporate managers. Investment flows from regions of low anticipated profits to
those of high returns.
1. Growth motive: A company may have reached a plateau satisfying domestic demand.
Which is not growing? Looking for new markets.

2. Protection in the importing countries: Foreign direct investment is one way to expand.
FDI is a means to bypassing protective instruments in the importing country.
 European Community: Imposed common external tariff against outsiders. US
companies circumvented these barriers by setting up subsidiaries.
 Japanese corporations located auto assembly plants in the US, to bypass VERs.

3. High Transportation Costs: Transportation costs are like tariffs in that they are barriers
which raise consumer prices. When transportation costs are high, multinational firms want
to build production plants close to the market in order to save transportation costs.
Multinational firms that invested and built production plants in the United States are better
off than the exporting firms that utilized New Orleans port to ship and distribute products
through New Orleans, provided that they built plants in a safe area.

4. Exchange Rate Fluctuations: Japanese firms invest here to produce heavy construction
machines to avoid excessive exchange rate fluctuations. Also, Japanese automobile firms
have plants to produce automobile parts. For instance, Toyota imports engines and
transmissions from Japanese plants, and produce the rest in the U.S.

5. Market Competition: The most certain method of preventing actual or potential


competition is to acquire foreign businesses.
GM purchased Monarch (GM Canada) and Opal (GM Germany). It did not buy Toyota,
Datsun (Nissan) and Volkswagen, They Later become competitors.

6. Cost Reduction: United Fruit has established banana-producing facilities in Honduras.


Cheap foreign labor. Labor costs tend to differ among nations. MNCs can hold down costs
by locating part of all their productive facilities abroad. (Maquildoras)

Supplying Products to Foreign Buyers


Export versus Direct Foreign Investment0 Foreign production is not always an answer.
Foreign markets can be better served by exporting, rather than by creating a foreign
subsidiary if there are economies of scale. If large scale production reduces unit cost, it is
better to concentrate production in one place. MES is the minimum rate of output at which
average Cost (AC) is minimized. If minimum efficient scale (MES) is not achieved, then
export.
In other words, if there is excess capacity, why not utilize that and export outputs to other
countries? There is no point in creating another plant overseas when domestic capacity is
not fully utilized.
If the foreign demand exceeds the minimum efficient scale, then FDI.
Minimum efficient scale and FDI
International Joint Ventures

JV is a business organization established by two or more companies that combines their


skills and assets.

1. A JV is formed by two businesses that conduct business in a third country. (US firm +
British firm jointly operate in the Middle East)
2. Joint venture with a local firm (GM + Shanghai Automobile Company)
3. Joint venture includes local government.
Bechtel Company, US
Messerschmitt – Boelkow – Blom, Germany  Iran Oil Investment Company
National Iranian Oil Company

Why9
 Large capital costs – costs are tool large for a single company
 Protection – LDC governments close their borders to foreign companies
 Bypass Protectionism.

Problems
Control is divided. The venture serves “two masters”

Welfare Effects
The new venture increases production, lowers price to consumers.
The new business is able to enter the market that neither parent could have entered
singly.
Cost reductions (otherwise, no joint ventures will be formed) increased market power 
not necessarily well.
Q.1 Give possible reasons by which the companies are encouraged to be an MNC?

Answer :-

There is an enormous influence of global brands like “Coca-Cola,” “Canon,” or “BMW”


across the world. These are multinational brands. A Multinational Corporation (MNC) is a
company that has been incorporated in one country and has production and sales
operations in other countries. Often 30% or more of sales and profits of multinationals are
generated outside national borders. A typical multinational company consists of a parent
company located in the home country and at least five or six foreign subsidiaries, with a
high degree of strategic interaction among them.

Firms can be defined as “multinational” on many dimensions, including the following:


• The degree of foreign sales
• The degree of foreign assets
• Source of labour and production
• Source of capital funding

An MNC is a corporation with substantial direct investments in foreign countries (it is not
just an export business) and is engaged in the active management of these off-shore
assets (it is not just holding a passive financial portfolio).
MNCs are a recent phenomenon (mainly after World War II) and they affect all the sectors
of activity (even the service sector). There are about 60,000 MNCs in the world. While not
all MNCs are large, most large companies are MNCs. Multinationals now account for
about 10% of world GDP.

Why do companies expand into other countries and become


multinationals? Some of the possible reasons are:

• To broaden markets: Saturated home markets ask for market development abroad
(Coca Cola, Mac Donald’s etc.). Multinationals seek new markets to fill product gaps in
foreign markets where excess returns can be earned.
• To seek raw materials: Multinationals secure the necessary raw materials required to
sustain primary business line (Exxon; Wal Mart). Multinationals also seek to obtain easy
access to oil exploration, mining, and manufacturing in many developing nations.
• To seek new technologies: Multinationals seek leading scientific and design ideas.
• To seek production efficiencies by shifting to low cost regions (GE).
• To avoid political hurdles such as import quota, regulatory measures of governments,
trade barriers, etc.
• To diversify i.e. to cushion the impact of adverse economic events.
• To postpone payment of domestic taxes.
• To counter foreign investments by competitors.
Q.2What do you mean by International Trade Flows? Also explain various factors
affecting international trade flows.

Answer :-

International trade is the exchange of goods and services across international


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

Factors Affecting International Trade Flows

• Impact of Inflation: A relative increase in a country’s inflation rate will decrease its current
account, as imports increase and exports decrease.
• Impact of National Income: A relative increase in a country’s income level will decrease
its current account, as imports increase.
• Impact of Government Restrictions: A government may reduce its country’s imports by
imposing a tariff on imported goods, or by enforcing a quota. Some trade restrictions may
be imposed on certain products for health and safety reasons.
• Impact of Exchange Rates: If a country’s currency begins to rise in value, its current
account balance will decrease as imports increase and exports decrease.

The factors interact, such that their simultaneous influence on the balance of trade is
complex.

Q.3 (a) Define Swaps. Also explain various types of swaps.

Answer :-

A swap is an agreement to exchange cash flows at specified future times according to


certain specified rules. The two counterparties in a swap agree to exchange or swap cash
flows at periodic intervals.

The different kinds of swaps are:

• Interest Rate Swap – An exchange of fixed-rate interest payments for floating-rate interest
payments.

• Currency Swap – An exchange of interest payments and principal in one currency for
interest payments and principal in another currency.

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

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


borrowings") is an agreement between two parties, in which each contracts to make
payments to the other on particular

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

2. Currency Swaps

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

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

3. Cross Currency Interest Rate Swap

A fixed-to-floating currency swap also known as cross-currency swap will have one
payment calculated at a floating interest rate while the other is at a fixed interest rate. It is a
combination of a fixed-to-fixed currency swap and a fixed-to-floating interest rate swap.
Each counterparty to a currency swap can be described in terms of the type of interest
(fixed or

floating), and the currency that he pays and also the type of interest and the currency that
he receives. For example, in a cross currency interest rate swap, one of the counterparties
may be a payer of a six month dollar LIBOR and a receiver of a five year sterling fixed
interest. (The other counterparty therefore will pay a five year sterling fixed interest and
receive six month dollar LIBOR).

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

Q.3 (b) Define foreign bonds with their salient features.

Answer :-

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

Features of the Foreign Bonds:

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


2. Foreign bonds are subject to the regulations governing all securities traded in the national
market and sometimes special regulations governing foreign borrowers (e.g., additional
registration).
3. Foreign bonds provide foreign companies access to funds they often use to finance their
operations in the country where they sell the bonds.
4. Foreign bonds are regulated by the domestic market authorities. The issuer must satisfy all
regulations of the country in which it issues the bonds.

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

Foreign bonds are known by different names in different countries. They are called Yankee
bond, Samurai bonds, Matador bonds, Bulldog bonds and Rembrandt bonds in USA,
Japan, Spain, UK and Netherlands respectively.
Q.1 Describe all the tasks of Treasury Management in large Company.

Answer :-

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

1. Framing Treasury Policies: Policies are to be framed regarding borrowing, investment,


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

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

3. Liquidity Planning: The size of modern corporations has gone up either due to persistent
capacity expansion, international operations or mergers and acquisitions. This brings about
acute problems of cash flow. At every point of time, sufficient liquidity is to be ensured so
that the corporate does not run into the problem of shortage of liquidity. To achieve this
without sacrificing profitability, corporates are relying on investment in money market
instruments more and more. For large-scale operations, the problem is always temporary
shortages of cash and its surplus. Temporary shortages are to be met through additional
sourcing of cash. Temporary surplus of cash has to be invested in order to avoid the
presence of idle funds.

4. Portfolio Management: As the corporates are investing heavily in the capital market
securities like equity shares, preference shares, bonds or debentures, portfolio
management also becomes an important function of the Treasury. Right from the selection
of the portfolio, its designing, continuous monitoring and constant churning for an active
investment strategy, it is the Treasury that plays a vital role. Various risk management
products in the form of derivatives are available in every type of organised market. In
currency markets, stock markets, foreign exchange markets and also in credit markets,
sophisticated techniques are available to managethe risk. These derivatives can also be
used to increase the profit from operations in these organised markets.

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

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

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

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

Q.2What is Qualified Institutional Placement? Do you think it is injustice on retail


investors of the Company?

Answer :-

Qualified institutional placement (QIP) is a capital raising tool, whereby a listed


company can issue equity shares,fully and partly convertible debentures, or any securities
other than warrants, which are convertible into equity shares, to a qualified institutional
buyer (QIB). Apart from preferential allotment, this is the only other speedymethod of
private placement for companies to raise money. It scores over other methods, as it does
not involvemany of the common procedural requirements, such as the submission of pre-
issue filings to the market regulator.

To enable listed companies raise money from domestic markets in a short span of time,
market regulator Sebiintroduced the concept of QIP in 2006. This was also done to prevent
listed companies in India from developing anexcessive dependence on foreign capital. Prior
to introduction of QIPs, the complications associated with raisingcapital in the domestic
markets had led many companies to look at tapping overseas markets via foreign
currencyconvertible bonds (FCCB) and global depository receipts (GDR). This has also
helped issuing companies price theirissues closer to the prevailing market price.

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

Answer :-

Investors constantly look for alternative avenues to complete their investment requirements.
Debt is one area where there is a lot of action as a significant portion of investors’ portfolios
is invested in this asset class. A number of options are available in this segment. One of
these is debt mutual fund. There are several factors that distinguish this product from other
debt instruments.

Nature of risk: One major factor that differentiates a debt fund from other debt instruments
is the nature of risk. A normal debt investment that most people are comfortable with, such
as bank fixed deposits or other small savings options, will have a fixed rate of interest and a
fixed tenure for which the investment will be held.

But when one invests in an open-ended debt scheme, the situation changes, as there is no
compulsory end period to the investment and returns earned will not be fixed in nature. The
call on the tenure of investment is entirely investor’s in this case. One needs to ensure that
the decision on this aspect is taken considering various factors affecting them. There is a
new risk in this kind of investment, not present in traditional debt products, the interest rate
risk. It arises from the fact that there can be a movement in interest rates against the
expectation of a fund manager.

There are also other ris-ks, such as credit risk, which arises if the fund is unable to recover
the money invested in a particular instrument. There is also a risk that ear-nings can be less
than inflation, which may leave the investor with lesser purchasing power.

Volatility: With the recent regulatory changes, there is another risk of higher volatility (than
what is seen at present). This can be the case with short-term debt-oriented funds. This will
occur as these funds will now require to mark to market all money market and debt
securities with a maturity period of over 90 days.

This means a large majority of short-term debt funds may have a large percentage of their
portfolios marked to market. However, it’s important to take note of two things at this stage.
One is that volatility in debt funds will always be far less compared with equity funds.
Secondly, funds can choose to have very short-term instruments in their portfolios, but this
will be at the cost of returns. This kind of a portfolio will also not be suitable for all funds.

Most investors equate a debt investment with stability and it is often a tough task to get
them to understand that unlike traditional debt instruments, debt funds can see a rise or fall
in their net asset values (NAV).

Time matters: There are several ways to tackle an increased volatility in a debt fund. One of
them is related to the time period available for investment. The moment there is mark to
market for the portfolio of a fund, some amount of volatility is bound to creep in. One option
is to go for those funds that do not have such a portfolio, and this will have lesser volatility.
The other way the impact of this factor can be reduced is by attuning the portfolio to a
specific time period.

For example, if your investment horizon is 15 days, you can choose a liquid scheme to
invest you money. If the investment horizon is six months, you will need to select a fund
that has a portfolio matching this duration.

This will result in a situation where the former will give lower returns and the latter will still
retain some volatility. But it will at least eliminate the worry of any mismatch with the
investment process. On the other hand, matching a 15-day investment requirement with
another type of fund can be a disaster as during this time if the interest rate movement is
against the fund,it could lead to a loss of capital.

Impact on returns: Problems may also arise when an investor is caught on the wrong foot in
a debt fund investment. This happens when a sudden change leads to a fall in
performance.

The option here is to evaluate an investment to see whether a recent impact was a one-
time problem and if it can have any impact on the performance in future. If the investment is
expected to do well as the situation improves or the condition that led to the impact
reverses, then the wise thing to do will be to continue with the investment. At the same
time, if it appears that it will take a long time to recover from the hit, then it may be a better
idea to exit the investment and look for better opportunities elsewhere.
Short-term investment options

I.Short-term FDs:

Nothing beats short term FDs when it comes to security and liquidity. It is better to opt for
bank deposits over company deposits, which do offer high returns but are risky. The
advantage with Short-term FDs is that it provides higher interest rate than saving accounts
and it is as safe also. If you think that you are going to need this money at a particular time
in future, it is better to shift that money from your saving account to short-term fixed deposit.

II.Short-term floating rate funds:

The major drawback of an FD is that your money is locked in at a particular interest rate.
So if the interest rate increases after opening a deposit account, you won’t be eligible to
benefit from this rate hike. E.g. if your FD carries an interest rate of 6 per cent and if the
new interest rate become 6.25 per cent, you will still earn 6 per cent on your deposit. If you
try to liquidate this deposit, you will end up losing interest for premature withdrawal.

To overcome this drawback of the FD, you can opt for floating rate funds. The interest rate
here varies in accordance with the change in their benchmark index rate. So when the
benchmark interest rate increases, the returns from these funds increase and vice versa.
However these returns come at a price. They are riskier than a traditional FD. Moreover,
not all these funds are available to small investors as they require very high investment.

III.Liquid Funds

A good avenue to invest for a short term and earn reasonable returns is a liquid fund.
Liquidfunds invest in short-term debt instruments with maturities of less than one year.
Therefore, they invest in money market instruments, short-term corporate deposits and
treasury. The maturity of instruments held is between three and six months. A liquid fund
provides good liquidity, low interest rate risk and the prevailing yield in the market. Liquid
funds have the restriction that they can only have 10 per cent or less mark-to-market
component, indicating a lower interest rate risk.They invest in money market instruments
such as certificate of deposits, commercial paper and treasury bills, either on an overnight
basis, for 10 days or a month. These funds can be used to park cash for a short term.
These funds are used to earn a definite amount in less than a year.

Liquid funds are used primarily as an alternative to short-term fix deposits. Liquid funds
invest with minimal risk (like money market funds). The minimum investment size in a liquid
fund varies from Rs. 25,000 to Rs 1 lakh.

Liquid funds have an exit load if the investor redeems before the lock-in period. But in most
cases, the lock-in period is quite low – varying from 7 to 10 days. Liquid funds score over
short term fix deposits. Banks give a fixed rate in the range 5%-5.5% p.a. for a term of 15-30
days. Returns from deposits are taxable depending on the tax bracket of the investor, which
considerably pulls down the actual return. Dividends from liquid funds are tax-free in the
hands of investor, which is why they are more attractive than deposits. The sole
disadvantage of liquid fund is that investors cannot take the advantage of higher returns
being offered by long-term instruments.
IV.Saving Account

Savings Bank Accounts are meant to promote the habit of saving among the citizens while
allowing them to use their funds when required. The main advantage of Savings Bank
Account is its high liquidity and safety. On top of that Savings Bank Account earns moderate
interest too. The rate of interest is decided and periodically reviewed by the Government of
India.

Savings Bank Account can be opened in the name of an individual or in joint names of the
depositors. Savings Bank Accounts can also be opened and operated by the minors
provided they have completed ten years of age. Accounts by Hindu Undivided Families
(HUF) not engaged in any trading or business activity can be opened in the name of the
Karta of the HUF. The minimum balance to be maintained in an ordinary savings bank
account varies from bank to bank. It is less in case of public sector banks and comparatively
higher in case of private banks

It is advisable to seek the following information from bank before opening the account:

• Minimum balance requirements.

• Penal provisions in case the balance falls below the minimum stipulated amount

• Penalty in case of return of cheques issued or instruments sent on collection.

• Collection facilities etc. offered and charges applicableDetails of charges, if any for issue
of cheque books and limits fixed on number of withdrawals, cash drawings, etc.
Q1.Bring out an overview of Indian financial system post 1950 period .

Answer :-

Financial System of any country consists of financial markets, financial intermediation


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

The term "finance" in our simple understanding it is perceived as equivalent to 'Money'.


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

The American Heritage® Dictionary of the English Language, Fourth Edition defines the
term as under-

1:"The science of the management of money and other assets.";


2: "The management of money, banking, investments, and credit. ";
3: "finances Monetary resources; funds, especially those of a government or corporate
body"
4: "The supplying of funds or capital."

Finance as a function (i.e. verb) is defined by the same dictionary as under-

1:"To provide or raise the funds or capital for": financed a new car
2: "To supply funds to": financing a daughter through law school.
3: "To furnish credit to".

Another English Dictionary, "WordNet ® 1.6, © 1997Princeton University " defines the
term as under-

1:"the commercial activity of providing funds and capital"


2: "the branch of economics that studies the management of money and other assets"
3: "the management of money and credit and banking and investments"

The same dictionary also defines the term as a function in similar words as under-

1: "obtain or provide money for;" " Can we finance the addition to our home?"
2:"sell or provide on credit "

All definitions listed above refer to finance as a source of funding an activity. In this
respect providing or securing finance by itself is a distinct activity or function, which
results in Financial Management, Financial Services and Financial Institutions. Finance
therefore represents the resources by way funds needed for a particular activity. We thus
speak of 'finance' only in relation to a proposed activity. Finance goes with commerce,
business, banking etc. Finance is also referred to as "Funds" or "Capital", when referring
to the financial needs of a corporate body. When we study finance as a subject for
generalising its profile and attributes, we distinguish between 'personal finance" and
"corporate finance" i.e. resources needed personally by an individual for his family and
individual needs and resources needed by a business organization to carry on its
functions intended for the achievement of its corporate goals.

INDIAN FINANCIAL SYSTEM

The economic development of a nation is reflected by the progress of the various


economic units, broadly classified into corporate sector, government and household
sector. While performing their activities these units will be placed in a
surplus/deficit/balanced budgetary situations.

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

Financial System;

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

FINANCIAL MARKETS

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

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

Capital Market - The capital market is designed to finance the long-term investments.
The transactions taking place in this market will be for periods over a year.
Forex Market - The Forex market deals with the multicurrency requirements, which are
met by the exchange of currencies. Depending on the exchange rate that is applicable,
the transfer of funds takes place in this market. This is one of the most developed and
integrated market across the globe.

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

Constituents of a Financial System


FINANCIAL INTERMEDIATION

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

FINANCIAL INSTRUMENTS

Money Market Instruments

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

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

Call/Notice Money
Treasury Bills
Term Money
Certificate of Deposit
Commercial Papers

• Call /Notice-Money Market

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

• Inter-Bank Term Money

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

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

• Certificate of Deposits

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


dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or
other eligible financial institution for a specified time period. Guidelines for issue of CDs
are presently governed by various directives issued by the Reserve Bank of India, as
amended from time to time. CDs can be issued by (i) scheduled commercial banks
excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select
all- India Financial Institutions that have been permitted by RBI to raise short-term
resources within the umbrella limit fixed by RBI. Banks have the freedom to issue
CDs depending on their requirements. An FI may issue CDs within the overall
umbrella limit fixed by RBI, i.e., issue

• Money Market

• Forex Market
of CD together with other instruments viz., term money, term deposits, commercial
papers and intercorporate deposits should not exceed 100 per cent of its net owned
funds, as per the latest audited balance sheet.

• Commercial Paper

CP is a note in evidence of the debt obligation of the issuer. On issuing commercial


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

Capital Market Instruments

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

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

Q2. Explain latest monetary policy of RBI

Answer :-

Repo rate and Reverse repo rate increased by 25 bps to 5.25% and 3.75% respectively,
with immediate effect. Impact: Repo is the rate at which banks borrow from RBI
and Reverse Repo is the rate at which banks deploy their surplus funds with RBI. Both
these rates are used by financial system for overnight lending and borrowing
purposes. An increase in these policy rates imply borrowing and lending costs for
banks would increase and this should lead to overall increase in interest rates like
credit, deposit etc. The higher interest rates will in turn lead to lower demand and
thereby lower inflation. The move was Cash reserve ratio (CRR) increased by 25 bps
to 6.00%, to apply from fortnight beginning from 24 April 2010. Impact: When banks
raise demand and time deposits, they are required to keep a certain percent
with RBI. This percent is called CRR. An increase in CRR implies banks would
be required to keep higher percentage of fresh deposits to asset price inflation
and also leads to build up of inflationary expectations.Before the policy,
market participants were divided over CRR. Some felt CRR should not be raised
as liquidity would be needed to manage the government borrowing program, 3-G
auctions and credit growth. Others felt CRR should be increased to check excess
liquidity into the system which was feeding into asset price inflation and
general inflationary expectations. Some in the second group even advocated a 50 bps
hike in CRR.
Growth: RBI revised its growth forecast upwards for 2010-11 at 8% with an
upward bias compared to 2009-10 figure of 7.5%. It said “Indian economy is
firmly on the recovery path.” RBI’s business outlook survey shows corporates are
optimistic over the business environment. Growth in industrial sector and
services has picked up in second half of 2009-10 and is expected to continue.
The exports and import sector has also registered a strong growth. It is
important to note that RBI has placed the growth under in 2009-10 itself, if
monsoons were better. Table 2 looks at growth forecasts of Indian economy for
2010-11 by various agencies.Other Development and Regulatory Policies In
developments and proposed policy changes in financial system.

Some of the developments announced in this policy are:

New Products/Changes in guidelines

• Currently, Interest rate futures contract is for 10 year security. RBI has proposed
to introduce Interest rate futures for 2 year and 5 year maturities as well.

• RBI has permitted recognised stock exchanges to introduce plain vanilla currency
options
on spot US Dollar/Rupee exchange rate for residents

• Final guidelines for regulation of non- convertible debentures of maturity less


than one year by end-June 2010 RBI had proposed to introduce plain vanilla Credit
Default Swaps in October 2009 policy.
• Earlier, banks could hold infrastructure bonds in either held for trading or available for
sale category. This was subject to mark to market requirements. However, most
banks hold such investments having a minimum maturity of seven years under
held to maturity category. infrastructure activity.

• The activity in Commercial Papers and Certificates of deposit market is high but
there is little transparency. FIMMDA has been asked to develop a reporting
platform for Commercial Papers and Certificates of deposit.

Setting up New Banks

• Finance Minister, in his budget speech on February 26, 2010 announced that
RBI was considering giving some additional banking licenses to private sector
players. NBFCs could also be considered, if they meet the Reserve Bank’s eligibility
criteria. In line with the above announcement, RBI has decided to prepare a discussion
paper on the issues by end-July 2010 for wider comments and feedback.

• Inup decided done.

• In February 2005, the Reserve Bank had released the ‘roadmap for presence of
foreign banks in India’. The roadmap laid out a two-phase, gradualist approach to
increase presence–phase. In the first phase, foreign banks wishing to establish
presence in India for the first time could either choose to operate through branch
presence or set up a 100% wholly-owned subsidiary (WOS), following the one-
mode presence criterion. Foreign banks already while following the one-mode
presence criterion.However, because of the global crisis the crisis put up a
discussion paper on the mode of presence of foreign banks through branch or
WOS

Q3. Explain the recent SEBI guidelines for merchant bankers

Answer :-

SEBI Guidelines for Merchant Bankers

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

The Criteria for Authorization Includes:

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

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

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

(d) Capital adequacy;


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

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

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

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

The third category consists of those authorized to act as underwriter, advisor or


consultant to an issue.

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

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

• As initial authorization fee, an annual fee and renewal fee may be collected by SEBI.

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

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

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

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

• The above guidelines will be administered by SEBI and it will supervise the activities of
merchant bankers.
• SEBI has been vested with power to suspend or cancel the authorization in case of
violation of the guidelines.

• To ensure transparency and accountability in the operation of merchant banker and to


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

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

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

The notification procedure relating to the action to be initiated against merchant banks in
case of difficulty has been detailed out. The regulations empower SEBI to take action
against defaulting bankers such as suspension/ cancellation of registration. In case of
deliberate manipulation or price rigging or cornering activities or deterioration in the
financial position, the Board is empowered to cancel the registration of the merchant
banker. Under the regulation, the SEBI is empowered to suspend a registration of a
member banker in case the merchant banker furnishes wrong or false information, fails
to resolve the complaints of the investors etc. The penalty of suspension or cancellation
of registration can be imposed by SEBI only after holding an enquiry and giving
sufficient opportunity to the merchant banker being heard. Any merchant banker
aggrieved by an order of SEBI can however, appeal to the Union Government.

In September, 1997, SEBI brought about some major changes in SEBI (Merchant
Bankers) Rules and Regulations, 1992. Accordingly, only corporate bodies will be
allowed to function as merchant bankers. Moreover, the multiple categories of merchant
bankers shall be abolished and there will be just one entity viz. Merchant Banker.

The merchant bankers presently functioning as Merchant Bankers Category II, III and IV
shall have an option to either upgrade themselves as Merchant Bankers (Presently
Merchant Banker Category I) or seek separate registration as underwriters or Portfolio
Managers.
Q1“Risk can be classified into several distinct categories”. Explain.

Answer :-

Classification of Risk

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

• Financial and Non-financial Risks

some cases, this adversity involves financial loss while in others it does not. There is
some element of risk in every aspect of human endeavour, and many of these risks
have no (or only In its broadest context, risk includes all situations in which there is an
exposure to adversity. In incidental) financial consequences.

Financial risk involves the relationship between an individual (or an organisation) and an
asset or expectation of income that may be lost or damaged. Thus, financial risk
involves three elements: (i) the individual or organization that is exposed to loss, (ii) the
asset or income whose destruction or dispossession will cause financial loss, and (iii) a
peril that can cause the loss.

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

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

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

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

• Acceptable and Unacceptable Risk

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

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

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

• Fundamental and Particular Risks

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

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

The distinction between a fundamental and a particular risk is important because


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

• Pure and Speculative Risks

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

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

It is important to distinguish between pure and speculative risks for three easons. First,
private insurers generally insure only pure risks. With certain exceptions, speculative
risks are not considered insurable, and other techniques for coping with risk must be
used. (One exception is that some insurers will insure institutional portfolio investments
and municipal bonds against loss).

Second, the law of large numbers can be applied more easily to pure risks than
speculative risks. The law of large numbers is important because it enables insurers to
predict future loss experience. In contrast, it is generally more difficult to apply the law of
large numbers to speculative risks to predict future loss experience. An exception is the
speculative risk of gambling, where casino operators can apply the law of large numbers
in a most efficient manner.

Finally, society may benefit from a speculative risk even though a loss occurs, but it is
harmed if a pure risk is present and a loss occurs. For example, a firm may develop new
technology for producing inexpensive computers. As a result, some competitors may be
forced into bankruptcy. Despite the bankruptcy, society benefits because the computers
are made available at a lower cost. However, society normally does not benefit when a
loss from a pure risk occurs, such as a flood or earthquake that devastates an area.
Q2. Identify common misconceptions about risk management and explain why
these misconceptions are developed.

Answer :-

Misconceptions about Risk Management

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

a) Universal Applicability

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

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

b) Anti-Insurance Bias?

The second misconception about risk management that it is anti-insurance in its


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

The essence of risk management is not in the retention of exposures. Rather it is in


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

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

Answer :-

Principles of Social Insurance

Social insurance is offered through some form of government, usually on a compulsory


basis. It is designed to benefit persons whose income is interrupted by an economic or
social condition that society as a whole finds undesirable and for which a solution is
generally beyond the control of the individual. Social insurance plans are usually
introduced when a social problem exists that requires government action for solution
and where the insurance method is deemed most appropriate. Examples are the
problems of crime, poverty, unemployment, mental disease, ill health, dependency of
children or aged persons, drug addiction, industrial accidents, divorce, and economic
privation of a certain class, such as agricultural workers. Insurance is not an
appropriate method of solution for many of these problems because the peril is not
accidental, fortuitous, or predictable. In other instances, insurance is perhaps feasible,
but due to the catastrophic nature of the event (as in unemployment), private insurers
cannot undertake the underwriting task because of lack of financial capacity. This
means that if the insurance method is to be used as a solution to certain problems,
government agencies must either administer or finance the insurance plan. An
understanding of social insurance can be facilitated by an appreciation of the basic
differences between these and privately sponsored insurance devices.

(a) Compulsion: Most social insurance plans are characterized by an element of


compulsion. Because social insurance plans are designed to solve some social
problem, it is necessary that everyone involved must co-operate. This principle is in
sharp contrast to private insurance, which has very few compulsory features.

(b) Set Level of Benefits: In social insurance plans, little choice is usually given as to what
level of benefits is provided. Further, all persons covered under the plan are subject to
the same benefit schedules, which may vary according to the amount of average wage,
length of service, or job status. In private, individual insurance, of course, one may
usually buy any amount of coverage desired.
(c) Floor of Protection: A basic principle of social insurance in a system of private enterprise
is that it aims to provide a minimum level of economic security against perils that may
interrupt income. The purpose of social insurance plans is to give all qualified persons a
certain minimum protection, with the idea that more adequate protection can and should
be provided through individual initiative. The incentive to help oneself, a vital element of
the free-enterprise system, is thus preserved.

(d) Subsidy: All insurance devices have an element of subsidy in that the losses of the
unfortunate few are shared with the fortunate many who escape loss. In social
insurance, it is anticipated that an insured group may not pay its own way but will be
subsidized either by other insured groups or by tax-payers. Some social insurance
plans have access to general tax revenues if the contributions from covered workers
are inadequate.

(e) Unpredictability of Loss: For several reasons, the cost of benefits under social insurance
cannot usually be predicted with great accuracy. Therefore, the cost of some types of
social insurance is unstable. For example, in a general depression, unemployment may
rise to unusual heights, causing tremendous outlays in benefits that may threaten the
solvency of the Unemployment Compensation Fund.

(f) Conditional Benefits: In social insurance, benefits are often conditional. For example, if
one earns more than a specified amount, various social insurance benefits may be lost.
One might argue that it is wrong to attach conditions to recovery in social
insurance,under the theory that one should receive benefits as a matter of right.
However, as insured worker has no particular inalienable right, except the right given by
the social insurance law under which the worker is protected. The employee’s right can
and probably be conditional. To have it otherwise would mean that some would be
receiving payments not really needed, and either the costs would rise or others would
be deprived of income that is their sole source of support.

(g) Contributions Required: In order to qualify as social insurance, a public programme


should require a contribution, directly or indirectly, from the person covered, the
employer, or both. Thus, social insurance does not include public assistance
programmes wherein the needy person receives outright gifts and must generally prove
inability to pay for the costs involved. This does not mean that the beneficiary in social
insurance must pay all of the costs, but the beneficiary must make some contribution
or else the programme is not really an insurance programme but rather a form of public
charity.

(h) Attachment to the Labour Force: Although it is not a necessary principle of social
insurance, most social insurance plans cover only groups that are or have attached to
the labour force. The basic reason for this is that nearly all such plans are directed at
those perils that interrupt income. Private insurance contracts, of course, are issued to
individuals regardless of employment status. The requirement of attachment to the
labour force has been a subject of frequent criticism by those who want a greater
expansion of social insurance.
Social and Economic Values

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

1. Reduced Reserve Requirements

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

2. Capital Freed for Investment

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

3. Reduced Cost of Capital

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

4. Reduced Credit Risk

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

5. Loss Control Activities

Another social and economic value of insurance lies in its loss control or loss prevention
activities. Although the main function of insurance is not to reduce loss but merely to
spread losses among members of the insured group, insurers are nevertheless vitally

interested in keeping losses at a minimum. Insurers know that if no effort is made in this
regard, losses and premiums would have a tendency to rise. It is human nature to relax
vigilance when it is known that the loss will be fully paid by the insurer. Furthermore, in
any given year, a rise in loss payment reduces the profit to the insurer, and so loss
prevention provides a direct avenue of increased profit.

6. Business and Social Stability

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

Social Costs of insurance

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

1. Operating the Insurance Business

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

2. Losses that are Intentionally Caused

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

Related to the cost of intentional losses is the tendency of some insured to exaggerate
the extent of damage that results from purely unintentional losses. For example,
Company ABC has an old photocopy machine that does not work well. When a small
fire in ABC building causes some smoke damage throughout the building, ABC may be
tempted to claim that its fire insurance should pay for a new photocopy machine. The
old machine has likely been affected by smoke, but in reality, the machine did not work
well before the fire and probably would have been replaced soon anyway.

The existence of insurance tempts ABC to exaggerate its loss in this


situation.Similarly,health expenses for families that have health insurance may be higher
than the expenses for uninsured families. Once an accident or sickness has occurred,
anindividual may decide to undergo more expensive medical treatment, or the physician
may prescribe it if it is known that an insurer will bear most or all of the cost.