FINSIGHT

FINOPSIS (FINANCE CLUB), IIM RANCHI

MARCH 2020

STANDOFF BETWEEN THE HOLY TRINITY OF OIL-

OPEC, MEXICO AND RUSSIA

The essence of every article this month in Economy

Finsights is how the novel CoronaVirus has There have been constant cold skirmishes
plummeted and disrupted the entire global between the Arabs and Russia. The reason is
economy. We have elaborated on the fact that simple, with falling demand and a constant
global supply chains are bust, businesses are supply of oil, prices are falling. Simple demand
on the verge of collapse and economies are and supply economics. Now both the Arabs
falling. Amidst this there is little hope for oil and Russia want to boost up supply, just to out
importing countries like India, the prices of compete each other. This has led to falling oil
prices. To put things into context, Oil prices
oil are falling and they are falling fast.
were in the upwards of $60 per barrel in the
Although the Indian government has decided
beginning of March, 2020. With sudden
not to pass all the benefits of falling oil prices
demand shocks and excess supply of oil they
to the consumers by raising taxes on this
can go down to as low as $20 per barrel. This
essential commodity, maybe because they
sudden fall will disrupt the already grieving oil
want to create a cushion of funds to fight the
industry. Automobile industry was already a
economic losses caused by the COVID-19 mess in the pre- COVID-19 era. It is now a
havoc, but that is a story for another day. disaster for the industry.
Coming back to our story, in order to improve
the situation, the US president decided to
intervene. He struck a deal that said to cut
global oil production by 10 mn barrels per day.
That meant that both Russia and the Arabs had
to cut production rate by 2.5 mn barrels per day
and Mexico had to cut their share by 4 lakh
barrels. Mexico decided to not go through the
deal. They instead made a counter offer to cut
the production by only 1 lakh barrels a day. The
US decided to fill the buffer by further reducing
their production by 2.5 lakh barrels a day.

The reason behind the standoff was very simple.

The Mexican Central Bank owns exotic put options
in lieu of falling oil prices. Mexico’s economy is
heavily dependent on the production of oil. The
largest state owned company is Pemex. Now the
Mexicans are not concerned about falling oil prices
because they have already mitigated their price
risk by owning exotic put options. This means that
if the prices go too low they can exercise their
right to sell oil at the $40 per barrel. This gives
them an edge in the negotiations. They did the
same thing during the 2008 financial crisis, which
led to crumbling oil prices. They have been paying
premiums in the upwards of $1 bn to attain this
right for the past several years and it is paying out
now.
 FinTech in times of Corona
In the times of social distancing, lockdown,
and mass quarantine, the world economies
are shattering. There is a worldwide
economic slowdown that is haunting all
the countries and is creating stress about
the future.In the midst of all this madness,
Financial Technologies (FinTech) has seen
an open opportunity in the market. While
people are avoiding any kind of contact
with one another, online is the solution.
FinTech has gained the limelight like never
before. But is the reality the same as what
it looks like or is there more to the picture
creating even bigger hurdles? Let’s have a
look.Despite all the heat faced by the
startups after the start of lockdown, there
has been a 72% increase in the usage of
fintech apps in Europe. Various digital
buying and selling platforms are seeing an
exponential rise in the traffic, which is
merely hinting towards a changed buying
behavior of the customers. In a country like
India also, fintech apps will play a crucial
role in these times of crisis since India has
shown the highest Fintech adoption rate
globally at 87 percent as compared to the
global average of 64 percent. The finTech
industry has mostly thrived upon services
like Online aggregators, utility payments,
and transfer payments, booking portals.
But since the lockdown, there has been a
surge in demand for card-based and digital
payments, worldwide. Big companies are
trying to follow the trend by innovating
and providing the best possible solutions
they can. For example, Mastercard is
revising its transaction limits, and ICICI
Bank is providing services on Whatsapp.
The Government of India also has a major
role to play in this surge of digital
payments. The government has announced
that it will transfer around $22.5 billion to
help the most impoverished sections, who
are losing daily wages because of the
lockdown, sustain. This money will help
farmers, underprivileged pensioners, the
disabled, and the like. All these transfers
will be made through a digital means,
which is also an effort to send a message to
the masses to do the same.
However, the picture is not all glorious,
especially for startups and fintech lenders.
Despite the initial surge in demand, the
companies are losing money as the number
of transactions reduces due to decreased
spending. This will affect the fintechs that
majorly relied upon small profit margins on
money transfers and online bookings. Even
the big brands like Visa and MasterCard
have reported and expected downfall in
the deals by 2% to 4%. This will lead to
even lower funding by fintech lenders and
most of the small businesses will be on the
verge of shut down. In situations like this,
even the government injected money will
not be much of a help to these companies,
given the lack of infrastructure that India
has, but this also provides the country with
an opportunity to improve on it and make
better use of it.

The expected spending downfall is also

pushing fintech companies towards
innovation. Following are a few examples:
Instamojo, A Bengaluru-based company,
has introduced Priority KYC, which will help
the essential businesses to go online in as
little as five minutes.
Razorpay, in partnership with Rentile, is
providing office furniture on rent to enable
them to work from home.
Paytm has collaborated with Reliance
General Insurance to introduce a COVID-19
insurance policy with a cover ranging from
Rs 25,000 to Rs 2 lakh.
PhonePe (owned by Walmart), in
partnership with Bajaj Allianz General
Insurance, has also launched an insurance
policy called Corona Care, which will be
priced at Rs 156 and will provide a cover of
Rs 50000 to any person under the age of 55
years but will be only applicable to
hospitals providing coronavirus treatment.
Despite all the hurdles, it is clear that
Fintech is going to be one of those
industries that will get a boost from the
coronavirus crisis, at least in the longer run.
The fintech industry has proved to be the
most useful in these times of social
distancing and with the advent of
upcoming economic downfall, fintech is
going to be the future. It is about time that
investors start investing in this industry and
understand its importance.
Global Recession Expected: Introducing
Coronavirus Economic Scenarios
The expansion of the Coronavirus (COVID-
19) outbreak into a global pandemic in
March 2020 has shifted the global
economic outlook into a recession. At the
beginning of April, Euromonitor
International downgraded the baseline
global real GDP growth forecast for 2020 to
a range of -1.5% to 0.0% (compared to 2.6-
3.4% growth forecast in January
2020).China’s real GDP growth forecast has
been cut to just 1.0% in 2020, while the US
economy is expected to contract by 3.0%.
The Eurozone economy is forecast to
contract by 4.4% in 2020, with Italian real
GDP declining by 7.0%. The size of the
downgrades due to the COVID-19 pandemic
reflect the strong impact of social
distancing measures on economic activity.
Each month of strict quarantine/lockdown
is expected to reduce annual output growth
in advanced economies by around three
percentage points.
COVID-19 scenarios predict a worse impact
than the Global Financial CrisisIn addition
to updating the baseline forecast, we have
introduced three adverse global scenarios
to capture the major downside risks related
to the COVID-19 pandemic. In our baseline
forecast, the size of the contraction in
economic activity is comparable to that
during the 2008-2009 Global Financial
Crisis. The projected world real GDP growth
rate for 2020 is lower than in 2009, but
trend growth was faster in the 2000s, so
the deviation from trend growth is similar
at around 4 percentage points below the
prepandemic forecast. Our adverse
downside risks scenarios are worse than the
2008-2009 financial crisis.The baseline
forecasts assume that strict social
distancing measures successfully flatten
infection rate curves over 1-2 quarters, with
infection rates below 10% in key economies
and case mortality rates that are less than
1% on average (accounting for a large
number of mild or asymptomatic
infections). Risks of health crisis is turning
into a longer-term financial crisis
The pandemic is causing severe financial
strains in many sectors of the economy, as
businesses are forced to shut down and
employees lose work shifts or are laid off.
The hit to business revenues and household
incomes risks turning a health crisis and
temporary cuts in economic activity into a
longer-term financial crisis.Governments in
advanced economies have reacted to the
COVID-19 pandemic with unprecedented
fiscal and credit stimulus measures,
exceeding 10% of pre-pandemic output in
some cases. The baseline outlook assumes
these measures are enough to avoid
massive business liquidations and eliminate
most of the losses in disposable income for
workers. As a result, the economy rebounds
relatively quickly once social distancing
measures are relaxed. Global real GDP
growth is expected to improve to 3.75.7% in
2021.However, the level of uncertainty
around baseline forecasts is now
unprecedented in the last 30 years. There is
epidemiological uncertainty about the
spread of COVID-19 and its death rate, as
well as the length of strict social distancing
measures. There is economic uncertainty
about the ability of government credit and
fiscal stimulus measures to counter
negative financial amplification effects.
Adverse COVID-19 scenarios are as important as the baseline outlookTo account for all
this uncertainty, we have introduced three adverse COVID-19 economic scenarios, ranging
from a deep recession all the way to economic crisis scenarios: The baseline forecast is
assigned around a 40% probability, with around a 30% probability assigned to a deep
recession scenario, in which global economic activity contracts by 1.5% to 3.5%. We assign
around a 27% probability to our economic crisis scenarios, combining the direct
economic costs of social distancing and pandemic-related supply constraints with a
financial crisis. The economic crisis scenarios would cause global output to contract by
3.5% to 9.0% in 2020. These crisis scenarios also imply a delayed economic recovery with
global output growth in 2021 ranging from -2.0% to 3.0%, compared to 3.7-5.7% growth in
the baseline forecast (leaving around 3% probability on a more optimistic faster global
recovery scenario).

Source : https://blog.euromonitor.com/introducing-euromonitors-coronavirus-global-economic-scenarios/
 NEWS Snippets
World economy faces the worst performance
since the past decade: Bank of America
Corporation (BofA) economists stated that the
world economy is heading for its worst
performance since the 2009 financial crisis. The
decline is due to the increasing spread of
coronavirus across the world. The economists
stated that they are expecting 2.8% global
growth in 2020, which is the weakest since 2009.
The forecast did not include a global pandemic
that would basically shut down economic activity
in many major cities
DBS Bank, Bharti AXA join hands
insurance plan covering Covid-19: DBS Bank
India tied-up with Bharti AXA to roll out a
complimentary insurance plan covering
medical conditions. The plan would cover all
medical conditions, including Covid-19, and up
to 10 days of hospitalization, with a cover of Rs
5,000 per day, for 30 days, DBS Bank India said
in a release.
ADB to invest $100 mn in NIIF FOF: Asian
Development Bank (ADB) has joined the
Government of India (GOI) and Asian
Infrastructure Investment Bank (AIIB) as an
investor under the instruments of the National
Investment and Infrastructure Fund (NIIF) of India.
Under the move, ADB will invest $100 million
equivalent in the NIIF Fund of Funds (FOF).
RBI revised exposure limits for UCBs: Reserve Bank
of India (RBI) revised exposure limits for urban
cooperative banks (UCBs) to a single borrower and a
group of borrowers to 15% and 25%, respectively, of
tier-I capital.
RBI to implement Mega Bank Consolidation
Plan on 1 April: The Reserve Bank of India
(RBI) stated that the schemes for the merger
of 10 state-run banks into four lenders will
come into force from 1 April. RBI also stated
that the branches of merging banks will
operate as of the banks in which the banks
have been amalgamated.The banks sought to
defer the merger schemes of lenders due to
the lockdown triggered by coronavirus
outbreak. Union Finance Minister Nirmala
Sitharaman announced that the megabank
consolidation plan would take effect from 1
April 2020 despite the COVID-19 pandemic.
The banks include: (i) amalgamation of
Oriental Bank of Commerce (OBC) and United
Bank of India into Punjab National Bank (PNB)
for
(ii) amalgamation of Syndicate Bank into
Canara Bank (iii) amalgamation of Andhra
Bank and Corporation Bank into Union Bank
all of India (iv) amalgamation of Allahabad Bank
into Indian Bank
RBI chalks out contingency plan for
smooth functioning of services: Reserve
Bank of India (RBI) put in place a contingency
plan to ensure that crucial information
technology (IT) services for the delivery of
digital banking, treasury services.It includes
measures to prepare for anticipated
disruptions, ensure smooth flow of operations
and staffing, identify critical resources, and
form crisis management groups while
keeping all staff insulated from exposure to
the virus.
 ECONOMY WATCH
Growth: Where due to the novel
coronavirus adversely affecting the global
economy is bound to contract by a
whooping 3% in the month of April 2020,
Indian economy saw a fall in growth
estimated from 5% to 2%. Many credit
rating agencies like Moody’s, Standard &
Fitch further deteriorates the Indian
growth story to 1.6%. This can further result
in economic loss due to flight of foriegn
Inflation: The total inflation has fallen by capital from the economy. India attracts
170 bps: RBI. This is due to supply chain capital due to extensive growth portrayed
disruptions caused by extensive lockdowns by the economy. However, it will be the
initiated by the current regime. Also, it only economy along with China to manifest
seems that the Indian consumers have
a positive growth in the FY 2020-21: IMF.
delayed their non-essential consumption
decisions. This is not a positive outlook for
an economy which depends fairly 60% on
consumption to contribute to the GDP. in
this light, the food inflation is at a
whooping level of 8.8%. This is still a
respite from the previous month’s figure of
10%. Apparently, the price level of essential
products are rising sharply in the Indian
economy.
Fiscal performance: The gross revenue of
the government has fallen by 0.8%. When
the businesses are unable to operate, the
government can not expect a high tax Trade: Due to the covid-19 pandemic, the
collection. A falling revenue is countries have become skeptical to trade
accompanied by a 12.6% increase in the with each other. Trade has been massively
total expenditure. It will be interesting to
hit. Exports have fallen by approximately
see the impact on fiscal deficit and further
35%. This is accompanied by a fall in
crowding out of debt from the Indian
imports to the tune of 29%. With falling oil
economy. This is bound to dry up debt for
prices in the midst can offer the
the private players. Government has already
government a little respite. However, there
introduced a stimulus package of INR 1.7
is negligible demand for oil. This view has
lakh crores to combat the coronavirus
been explained in one of the
impact. It has been called inadequate by
accompanying articles. In a nutshell, the
many renowned economists and another
balance of payment stands at 0.2 percent
package is underway.
of the GDP, a fall from 2.7 percent on a Y-o-
Y basis.
Currency Rate: The forex reserves have
risen from US$ 413 bn to US$ 475 bn. The
rupee depreciated against the US dollar,
Japanese Yen and Euro by 3.85 per cent,
6.12 percent and 5.18 per cent respectively
in March 2020. However, it appreciated
against Poundsterling by 0.79 per cent in
March 2020
 HISTORY OF DERIVATIVES
As much as we one might think that derivatives
are a modern concept of trading, they have a
fairly rich history, around 10,000 years old.
However, it was only during the 1970s when
derivatives actually became more prevalent, but
their past is worth knowing. Let’s take a look at
its timeline:
8000 BC:   Clay tokens were baked into
envelopes, which acted as a confirmation and
proof to pay or make a delivery on time. It
served as a forward contract.
1700 BC:   The contracts of buying and selling
became more organized as the rulers like
Hammurabi of Babylon also came into the
picture to roll out rules and regulations on
contracts.
500 BC:  One of the first proper put options was
negotiated for an olive field when Greek
philosopher Thales forecasted a high yield of
olives. He made a cash deposit to buy the right
(but not the obligation) to sell the yield, and
when the outcome was in his favor, he made
huge profits.
13th Century:   Montis, a derivative contract
between government and people, came into
the picture in Italy. It was a way to raise money
by the government but later on, came to be
used as a sort of currency by the people.
15th Century:   Over-the-counter markets for
derivative trading came into the picture, and
the market evolved more into trade fairs and
the like to facilitate the process of buying and
selling easier. One such market society was
formed in Belgium called the Bourse, where
traders from all over Europe came together to
sell their products but not directly. They sold
the rights and hence eliminated the
transportation risk.
17th Century:   While the derivatives market
was taking shape in Europe, Japan established
its own Dolma Rice Exchange in 1730, which
facilitated the exchange of Japan’s biggest
commodity, i.e., rice. The exchange was
further bifurcated into two types – Shomia and
Choaimai, for which Japan even ended up
having a clearinghouse and making one of the
first centralized futures markets.
18th Century:   The United States also joined
the party when agricultural demand rose, and
there was a need for some centralized system
to hold the market together. This was when
the Chicago Board of Trade came into the
picture. It started with agricultural products
but later on included dairy and foreign food
grains. Today, the Chicago Board of Trade is
known as the CME group.
19th Century:   It was during the 1970s when
derivatives trading started to take off, getting
more popularized and easily accessible with
the start of the computer era. In 1992, trading
became electronic, and price listing and
clearing houses facilitated the world to trade
over the internet.
Today:   The derivatives market is still in a
growth phase; however, with the advent of
technology and better regulations, we have
come a long way. Those clay tokens are now
electronic tokens, which include a myriad of
commodities under the purview of derivatives.
Technologies like crypto-currencies show that
there is a much wider scope in this area still to
be discovered.
 STRATEGY OVERVIEW
Long Straddle

Surrounded by the uncertainties in the global financial markets due to COVID-19 pandemic
traders are concerned regarding the swings in the markets. We have seen a bear phase in
the market and sharp recoveries as well. It’s more risky to keep a long/short positions
overnight due to high volatility. A long Straddle strategy helps traders profit from huge
swings in both the directions (North or South). It involves the following trades to be
executed.

Buy an ATM strike Call option

Buy an ATM strike Put option (Both Call and Put options must be of the strike price and
expiry)

If markets sharply go north then on expiry the Put options will be worthless while profiting
from the Call option. If markets sharply go south then on expiry the Call options will be
worthless while profiting form the Put option. Kindly note this strategy is profitable only
when markets movement is greater than the sum of premiums paid for buying the ATM
options.
Crossword

Source:CrosswordWeaver.com
 Answers
(Crossword - February Edition)