Professional Documents
Culture Documents
BUDGET 2011
THE
balancing act
Housing MFI PG.08 Facebook valuation PG.16
FROM EDITOR’S DESK Dear Niveshaks,
The last few months have been bad for the world economy in gen-
eral. The Libyan Crisis, high oil prices, European debt woes and now the
Tsunami in Japan, there seems to be no respite for the global markets. The
Niveshak latest natural calamity in Japan sent shock waves across the global mar-
Volume IV kets and pounded commodities and equity markets worldwide. Japan, the
ISSUE III world’s third largest economy is also the world’s third largest energy con-
sumers and imports almost all its energy needs. As a result, the rally in the
March 2011 oil market came to a halt and the crude slid below $100 for the first time
ever since the beginning of political unrest in the oil-rich Middle East and
North African regions. As far as the equities markets are concerned, the
MSCI’s entire country world index fell to a five week low and most of the
Faculty Mentor Asian markets tumbled including Sensex which fell by 154 points on back
Prof. N. Sivasankaran of the Japanese disaster. The IIP numbers for the month of January that
came on March 11 also didn’t present a rosy picture. The industrial growth
was a meagre 3.7% as compared to a robust 16.8% in the same month last
year. The sectors mainly responsible for the tepid overall growth, as mea-
THE TEAM sured by IIP, were manufacturing and mining which witnessed significant
deceleration in output. One of the reasons for the dismal IIP numbers over
the last few months has been the tight monetary policy of RBI to curb infla-
Editor tion. Against a slowing industrial growth, it would be interesting to see the
Rajat Sethia policy measures taken up by RBI in its upcoming policy review meeting on
March 17.
The other big story this month has been our Union budget. The three
Sub-Editors key macroeconomic concerns before the Union Budget 2011-12 were high
Alok Agrawal inflation, high current account deficit, and fiscal consolidation. Additionally,
Deep Mehta there was an expectation that the government would restart the reform
Jayant Kejriwal process. The Budget has made an attempt to address all these issues. By
Mrityunjay Choudhary and large, the budget was a balancing act. It ventured little and gained little.
Sawan Singamsetty As far as the market reaction was concerned, no bad news was good news
and the markets saw a short lived rally post budget. The three key themes
Shashank Jain
of this year’s budget were fiscal consolidation, inclusive growth and focus
Tejas Vijay Pradhan on agriculture and infrastructure financing. The greater outlay and liberal-
ization of FDI/FII in infrastructure is an example of Government’s renewed
focus on infrastructure sector. Social sector spending too remained one of
Creative Team the top priorities of the government. However, refraining from announcing
Vishal Goel new schemes, the budget laid stress on providing reasonable allocation to
Vivek Priyadarshi the existing schemes, in order to curb fiscal deficit and provide room for the
already committed Right to Food Act.
The month’s cover story on ‘Union Budget’ delves further into various
All images, design and artwork aspects related to the budget and the impact it will have on various industri-
are copyright of al sectors. Given the focus of the budget on inclusive growth and infrastruc-
IIM Shillong Finance Club ture, the ‘Article of Month’ explores the topic of Housing Microfinance and
its role in supporting affordable houses for masses in India. The other big
news this month was about General Atlantic buying a tenth of Facebook
and valuing the company at $65 billion. Earlier in January, Goldman Sachs
©Finance Club had valued the company at $50 billion. The present issue features an article
Indian Institute of Management on the Facebook valuation and digs into whether the high numbers truly
Shillong reflects Facebook’s value. The issue also features an article on the ‘Jasmine
Revolution’ in the Middle East and its impact on the inward remittances to
www.iims-niveshak.com India. Lastly, the month’s classroom focuses on the option trading strategy
‘Dividend Arbitrage’ and the type of securities it is best suited for.
Stay invested.
Rajat Sethia
(Editor -Niveshak)
Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears
no responsibility whatsoever.
CONTENTS
Niveshak Times finsight
04 The Month That Was 16 Facebook Valuation
Cover Story
12 BUDGET 2011
PERSPECTIVE
19 Jasmine Revolution - Impact
on Inward Remittances
FINLOUNGE
22 Fin-Q
www.iims-niveshak.com
TEAM NIVESHAK
IIM, Shillong
ONGC’s Navaratna status in danger exercise is believed to be a part of the larger Hin-
Oil and Natural Gas Corp (ONGC), India’s most prof- duja Group corporate branding exercise which is
itable firm, will lose the coveted Navaratna status underway. London-based firm Wolff Olins is said
and the accompanying financial autonomy in its to be working on the rebranding and category
rush to the Rs 11,500 crore share sales scheduled segmentation exercise for Ashok Leyland. Ashok
next month. The govern- Leyland is segmenting and branding the different
ment plans to withdraw product categories it will now inhabit thanks to its
both of its directors on tie-up with Nissan and other global alliances. The
the ONGC board to meet Hinduja group is also working on a strategy to give
the capital market regula- a common corporate and brand identity to all the
tor SEBI’s listing norm of companies in the group.
having equal number of Buffet makes entry into India through in-
functional and indepen- surance business
dent directors to allow Warren Buffett’s Berkshire Hathaway has made an
Rs 11,500 crore public offering ( FPO) on April 5, entry into India through the insurance distribu-
sources said. The move would, however, lead to tion business. Berkshire
ONGC losing its Navaratna status that gives the will directly market motor
The Month That Was
er companies. For instance, LLPs are not subjected a $2-billion deal with Saudi Telecom Company, in
to minimum alternate tax (MAT), surcharge or divi- which the global outsourcing services company
dend distribution tax. The passage of the budget will manage the customer care operations of the
in Parliament will change this. The tax imposed largest telecom operator in the Kingdom of Saudi
on LLPs may, therefore, impact 27 companies con- Arabia. The joint venture, Contact Centre Company,
trolled by Mukesh Ambani and family, which hold will be near-equally owned by the two arms, with
the 35% promoters’ stake in Reliance Industries 50% plus one share being held by STC and the rest
(RIL). Last year 35% of the promoters holding in under Aegis, which will have operational control
RIL, currently worth about Rs 1.2 lakh crore, were and responsibilities.
transferred to these LLPs for tax advantage. Face book valuation up to $65 billion: Gen-
SBI bond issue witnesses 4.5 times retail eral Atlantic is expected to
oversubscription: Retail investors have lapped buy a 0.1% stake in Face
up the Rs 1,000-crore State Bank of India bond is- book, an investment which
sue 4.5 times taking the overall subscription to a will value the social net-
full 8.5 times. Retail investors have put in bids for working site at $65 billion.
Rs 4,500 crore, against the The General Atlantic invest-
Market Snapshot
AoM Perspective
Source: www.bseindia.com
as
www.nseindia.com
Month That W
Market Snapshot
RESERVE RATIOS
CRR 6%
SLR 24%
AoM
LENDING / DEPOSIT RATES POLICY RATES
Base rate 7.6% - 8.5% Bank Rate 6%
Savings Bank rate 3.50% Repo rate 6.75%
Deposit rate 7% - 8% Reverse Repo rate 5.75%
Perspective
Gold INR 20871.00 / 10 grams
Silver 53620.00 / kg
The
WPI 8.31%
Crude Oil $99.07
Month
Index of Industrial Production (IIP) 3.70%
FinGyaan
That Was
FinSight
“While finance companies say ‘We’ll provide the credit, but who’ll construct?’, developers say
‘We’ll construct, but who’ll provide the buyers credit?’. This is a situation that needs to change.”
- R.V.Verma (NHB Chairman)
AoM
1. A significant proportion of finances in
Housing Industry are used for Upper Income Hous-
ing needs.
2. By and large, the Low Income Housing is
not the primary focus of Micro Finance firms.
CHANGING ENVIRONMENT Figure 2: Housing Finance Institution Hierarchy in India
The Government of India has drawn its atten-
tion into the low income housing issue since 2000s. The most important public player in housing
The support comes in the combination of subsidies finance in India is the National Housing Bank (NHB).
and new housing construction and through the NHB was set up on July 9, 1988 under the National
slum up gradation and redevelopment programmes Housing Bank Act, 1987. It is the regulatory body
in the urban areas. Such programmes frame the for housing finance institutions and principally
environment within which any financing institution promotes housing finance institutions at regional
in the low income housing sector would have to levels. Both provide loans to housing finance insti-
function. tutions which are then lent to low-income house-
Following graph displays the rising invest- holds. They also refinance these housing finance
ments in the housing sector: institutions.
on financial performance, SAHF tends to have larger an average micro loans of INR 50000 is provided to
loan amount used for longer tenure. a single party. Another example is the tie up of NHB
Micro-Credit to Housing Finance (MCHF): It has with REPCO bank in 2008 to cover 10,000 members
evolved naturally out of conventional micro-credit in 5 years with an outlay of Rs.100 Crore under rural
programmes, as over the time MFIs realized that housing Microfinance scheme.
a sizable portion of loan is used by their clients 2. Collaboration of Commercial banks with
towards their home improvement. The financial per- NGOs
formance and parameters are of prime importance The low income housing is not an attractive
in this case. proposition for commercial banks. However, col-
HMF MODEL: KEY FEATURES laborating with NGOs and other such organizations
A housing micro loan generally ranges from allows them to lend in bulk and reap benefits for
INR 50,000 to INR 600,000 and the tenure may ex- themselves. In such an arrangement the organiza-
tend from 5 years to 15 years. Although the interest tion acts as the bridge between the bank and the
rates are high (12%-18%) and are mostly unsecured, actual borrowers. For instance in the SEWA Project,
these loans do not require any official statements of HDFC disbursed a cumulative amount of Rs. 4.37
income for loan sanctioning. The non requirement crores to the SEWA Bank, Ahmadabad. A significant
of such documents and near to zero collateral is the portion of this fund was used by SEWA to address
key to target the EWG and LIG sector. Such loans are the housing needs of its women members.
sometimes accompanied by land acquisition, land 3. Entry of Private Micro financing firms
registration and construction (including self-help Realising that the major portion of credit is
building techniques) being used to meet the housing needs of the poor,
The following illustration shows the feasibility MFIs have started coming out with separate hous-
of such loans: ing products for borrowers with good credit history.
AoM
support the finances, such measures perpetuate a
nel. Apart from NGOs, the SHGs give a substantial
culture of non-repayment on part of the borrowers.
opportunity to the financing institutions to not only
reach out to the poor but also to identify the right In spite of the presence of such challenges,
individuals for granting loans based on their credit the road lies ahead for the HMF. The concept is
worthiness. NHB has undertaken a pilot project in still in its nascent stage and it is hoped that with
this direction called as PHIRA (Productive Housing the passing time, it can overcome such obstacles.
in Rural Areas). The project has planned to cover Few ramifications measures can be in the form of
10,000 members in 5 years with an outlay of $25 deployment of Hidden subsidies, mortgaging legal
million. titles wherever possible and creating awareness for
‘progressive building’ in the construction arena.
THE SUCCESS STORY
CONCLUSION
HMF v/s MFI
HMF is one of the growing portfolios of MFIs
Though the MFI model addresses the credit
worldwide. Researches done by international agen-
concern of LIG, certain characteristics were re-
cy USAID in various countries have revealed the
quired to be tweaked in order that it works in the
immense potential of HMF. In China, the housing
housing domain. As one of the portfolios of the
market was liberalized only during the late nine-
MFI, the HMF model has following advantages over
ties by allowing a ‘one-time’ equity grants based
tradition MFI:
on the market value of their existing housing are
• Larger and longer loans given to enable them to access mortgage instru-
• Unlike MFI where the repayment capacity ments The success of subsidy program in Chile and
is measured in terms of loan usage to generate fu- social housing program in South Africa are other
ture income, in HMF this capacity is based only on major success stories and these have been pos-
current income and future income as the housing sible through government establishing partnership
asset does not directly generate income with housing institutions, communities, the private
• It removes the social collateral inherent in sector and NGOs. Since market forces will generally
MFI model which is very important as the housing not provide housing that the poor can afford, and
loans should target to the individuals further market forces will never have the ability to
HMF is a non-subsidized, sustainable ap- do so until these masses cease being poor, it is up
proach tailored to meet the housing needs of the to government to take the initiative.
entrepreneurial and working poor. Hence it results Looking at the success of the MHF models al-
in asset creation for the poor at the needed scale ready implemented coupled with the government’s
as demand for social housing continues to grow. In reforms in (i) the land (grant of land security to
the times when commercial banks and MFI models poor, reduced government interventions in land
have not been very successful, the housing micro market), (ii) finance (down marketing housing fi-
finance or the micro housing model has supported nance, fiscal incentives to the private sector devel-
mass housing and reaffirmed as the centrepiece opers, micro-finance institutions) and (iii) capital
program of government in poverty alleviation. subsidies, we believe the model is here to stay and
FEW BOTTLENECKS is the potential answer to India’s housing problem.
The volatile income of low-income groups and
the vulnerability of these small economic shocks
in absence of appropriate collateral can adversely
Cover Story
Allocation of Rs. 60bn for re-capitalization of 7.5% to 5%. One major benefit to FMCG companies
banks is less than the figure in FY11 but will still in short term would be the increase in allocation
have a POSITIVE impact on SBI, IDBI, Canara bank and under Rashtriya Krishi Vikas Yojana – a rural initia-
Central Bank. tive on income generation. Allocation of Rs. 3 bn
for improved production of pulses will be beneficial
Market expected some decision on the gov-
to companies such as HUL, Marico and Godrej Con-
ernment subsidy or concession on interest rates to
sumer Products Ltd. This is because this allocation
be provided on lending to State Electricity Boards
will bring 60k hectares more in edible oil plantations
(SEBs) given their poor financial health. But NO AN-
and the above companies are exposed to edible oil
NOUNCEMENT regarding the same was mentioned in
imports since palm oil is a major input material for
the budget. Same holds true for wishlist regarding
them. Classification of cold storage projects as infra-
tax break on longer tenure deposits.
structure ones will be POSITIVE for FMCG companies
Issue of banking license guidelines before the in Food sector.
end of this fiscal will provide some clarity as to who
One other factor that will be POSITIVE for com-
will be eligible for the same. Additional tax deduc-
panies is the linking of NREGA to CPI. This will drive
tion of up to Rs. 20,000 for investments in long-term
income levels of rural consumers. This is because
infrastructure bonds for individual taxpayers contin-
allocation to NREGA will increase by approx. 20-25%
ues for one more year. This is definitely a POSITIVE
as compared to FY11 i.e Rs. 100bn and thus drive
for PFC, REC and IDFC.
consumption of products for rural consumers.
Decision to move legislations in the financial
Thus, we see that the overall impact can be
sector like The Insurance Laws (Amendment) Bill,
classified as NEUTRAL for FMCG sector with no major
2008; The Life Insurance Corporation (Amendment)
impact on any particular company.
Bill, 2009; Banking Laws Amendment Bill, 2011;etc
will be POSITIVE as it will open up the sector by Agriculture Sector
bringing in more capital and create more value. It Budget 2011 has given a major uplift to the ag-
will also clarify the accounting policies to be fol- ricultural sector. Especially in view of the upcoming
lowed. elections, the finance minister has tried his best to
One NEGATIVE we see is the increase in target appease the farmers. The target for credit flow for
credit flow to farmers from Rs.3750bn to Rs.4750bn. the year 2011-12 has been increased by Rs. 1, 00, 000
This will put pressure on SBI, ICICI, BoB, PNB and crore from Rs.3, 75,000 crores to Rs.4, 75,000 crores.
other banks as this will expose them more to direct Banks have been asked to step up direct lending for
agri lending and increase the subvention burden. agriculture to small and marginal farmers. The inter-
est subvention scheme will continue during 2011-12
FMCG
of providing short term crop loans to farmers at 7
It has been a mixed budget for this sector with per cent interest. A 3 per cent interest subvention
no clear majority in favor of a thumbs UP or DOWN. is proposed for those farmers who repay their crop
The increase in tax exemption limit from 1.6 loans on time in 2011-12. The total allocation under
lakhs to 1.8 lakhs as mentioned earlier will give Rashtriya Krishi Vikas Yojana (RKVY) has been in-
more disposable income in the hands of the con- creased from Rs.6, 755 crore in 2010-11 to Rs.7, 860
sumer and hence POSITIVE for FMCG companies. Ex- crore in 2011-12 mainly to check the smooth flow of
cise duty was expected to increase by approx. 10% distribution of the major commodities in the market
for cigarettes but budget gave them a surprise by and to control prices. The NABARD’s (National Bank
NO CHANGE in duty which greatly pleased companies for Agriculture and Rural Development) capital base
such as ITC, Godfrey Phillips. But companies such as would be strengthened by infusing Rs.3000 crore, in
Britannia, Parle were not impressed by a 100bps rise a phased manner. Approval is being given to set up
in excise on biscuits. Increase in excise in certain 15 more Mega Food Parks (15 already sanctioned)
consumer categories also impacted HUL, Nestle, Col- to ensure smooth flow of fruits & vegetable at com-
Infrastructure investments
have been allocated Rs.
2,14,000 crores, 23.3% higher
than the previous budget.
provision of Rs.300 crore is being made. An amount fied rate of 10% could increase the prices for brand-
of Rs.300 crore has been proposed to bring 60,000 ed garments. Nominal excise duty of 1% on branded
hectares under oil palm plantation, by integrating gold/ silver jewellery and articles could hurt branded
the farmers with the markets. This is to reduce the jewellery retailers. The marginally higher income tax
dependency on import as the domestic production exemption limit could be a positive for the sector in
of edible oil meets only about 50 per cent demand. terms of higher disposable income.
An amount of Rs.300 crore has been proposed to Infrastructure, Construction and Power
promote 60,000 pulses villages in rain fed areas for sector
increasing crop productivity and strengthening mar-
The most notable point in favour of this sec-
ket linkages. Continuing with last budget’s allocation
tor is that this time infrastructure investments have
of Rs. 400 crore to extend the green revolution to the
been allocated 2,14,000 crores which is 23.3% higher
eastern region of the country, another Rs. 400 crore
than the previous budget. This will certainly give a
has been allocated for the same.
positive outlook since many investments would be
Fertilizer Industry channelized into this sector and will benefit many
Fertilizer Industry as usual remained promi- Infra companies like L&T, Hindustan Construction,
nent in Budget 2011 as well. As the sector has con- Nagarjuna Construction as new projects would be
tinuously demanded higher capital, government launched. Further, increase in limit of FII invest-
proposed to include capital investment in fertilizer ments in corporate infrastructure bonds to US$25 bil-
production as an infrastructure sub-sector. This move lion would increase the flow of funds into this sector
will help fertilizer companies in accessing cheaper and reduce the funding constraints that were faced
financing and tax breaks. The government also pro- previously. However, there has been a small increase
poses that it will move towards direct transfer of in MAT rates from 18 to 18.5% which can have a
cash subsidy to people living below poverty line in a mild negative impact on Infra companies because
phased manner in order to ensure greater efficiency, this move will result in excessive cash outflow. Hav-
cost effectiveness and better delivery for fertilizers. ing said that, there has been a reduction in corpo-
This move is seen as positive for the sector as the rate surcharge from 7.5% to 5%. The tax benefits
domestic industry has suffered from under-recovery of section 80-IA have been extended for one more
of cost and delay in disbursement of subsidy for year which is beneficial for power companies and
long. Urea is the key focus in the industry, which road developers. The exemption on excise duty of
represents around 50% or 27mt of total fertilizer con- 10% for equipment required for expansion of exist-
sumption per annum. There is a proposal for active ing mega or ultra-mega power projects will help the
consideration of the Urea under the extension of the power utilities to lower their capital expenditures.
Nutrient Based Subsidy (NBS) regime. This move is Other measures that can improve the funding in
expected to be positive and will benefit both farmers the sector are the Tax free bonds of Rs 30,000 crore
and companies in the industry. Also the reduction of that would be issued by government undertakings
interest rates and allocation of higher credit to the to boost the infrastructure development. Budget al-
agricultural sector is likely to benefit the fertilizer location to major schemes include Rs 58,000 crore
industry as a whole. (increase of 21%) to Bharat Nirman, Rs 8000 crore
Retail Sector (Increase of 48%) to North Eastern Region and 10,300
crore (increase of 9%) to NHDP. Allocation for urban
The budget proved to be a disappointment for
infrastructure increased by 52.5% to Rs 8050 crore.
Mini Cement Plants
EXISTING REVISED
Upto MRP of Rs190/bag Rs 185/mt 10% ad valorem
Above MRP of Rs190/bag Rs 315/mt 10% + Rs 30/mt
Other Than Mini Cement Plants
EXISTING REVISED
Upto MRP of Rs190/bag Rs 290/mt 10% + Rs 80/mt
Above MRP of Rs190/bag 10% 10% + Rs 160/mt
Cover Story
Cement increase of the wages in the National Rural Employ-
The Excise duty structure on cement has been ment Guarantee Scheme. An extension on the ex-
revised as shown in the table below. emption of the countervailing duty of the parts of
mobile handsets is expected to keep their prices
With this new structure, the negative impact
low. This would to some extent help in increasing
is expected to be about Rs 8 – Rs 10 per bag. This is
the subscriber base of the companies. However their
marginally negative for the cement manufacturers,
potential in terms of revenues is doubtful. However
since it is likely that this excess cost will be pushed
an increase in the MAT and surcharge would impact
to the consumers and hence price hikes are expect-
the bottom lines of the companies. Also the gov-
ed very soon. There has been a reduction in custom
ernment’s plan to charge extra licence fees has put
duty on pet coke and gypsum to 2.5%. This means
extra stress on the sector already burdened by the
that raw material needed for manufacturing would
3G spectrum auction.
be cheaper in general. This measure is specifically
very beneficial for Shree Cement which relies highly Thus overall the telecom industry has been dis-
(reliance of nearly 60%) on pet coke. The increase in appointed with the budget proposals.
allocation for infrastructure by 23% would certainly Pharma
create more demand for cement which is positive The allocation made to the ministry of Health
for sector. Overall, the Budget 2011-12 would have a and Family welfare has been increased by 20%
neutral impact on the cement sector. which would help the pharmaceutical companies.
Real Estate An increase in the MAT on the developers of SEZs
There has been an increase in the existing may indirectly affect the companies operating from
home loan limit from 20 lakhs to 25 lakhs for dwell- these zones. Another disappointment for the compa-
ing units under priority sector lending. This move nies involved in R&D is the decision of not allowing
is seen to boost demand among the lower income an extension in the weighted deduction on in-house
group of buyers who plan to buy a home by tak- R&D expenditures. Thus overall the budget has been
ing home loans. This increase would also be ben- neutral on the R&D sector.
eficial for the key players like Purvavankara, HDIL Conclusion
etc. in affordable segment in urban areas. The exist- To conclude, the budget has done what was in
ing scheme of interest subvention of 1% on hous- its control to alleviate pressures on interest rate and
ing loan has been extended for further 1 year. This, inflation. Secondly, despite 4 major state elections
again, would be beneficial for developers present in due and inflationary fears, the Government has re-
low-cost/affordable housing present in tier 2 and 3 frained from a populist budget and kept its commit-
cities. The imposition of MAT of 18.5% on developers ment on fiscal consolidation. As far as the markets
of SEZs would have an adverse impact in the form of are concerned, no bad news was good news and
increased tax liability, which earlier was an incentive the Sensex shot up by 400 points and Nifty by 100
for SEZs developers. The allocation for Rural Hous- points on budget announcements. However, looking
ing fund has been increased to Rs 3000 crores and forward, the market will be governed more by inter-
HUDCO has been allowed to raise funds by issuance national cues and macroeconomic factors.
of tax free bonds worth Rs 5000 crores. Both these
moves are positive for real estate sector. Overall, the
Budget 2011-12 would have a marginally positive im-
pact on the realty sector.
Telecom
The companies were expecting clarity from the
government on the treatment of the 3G spectrum
outflows. Also in lieu of the large expenses made in
Perspective
“Jasmine Revolution” started from
ferred form of foreign exchange. The India which have
Tunisia and resulted in the capsiz-
flow of remittances is the least in- been focussed upon
ing of local government few weeks
fluenced by economic downturn and
remains a stable source of income
back. Unemployment and corruption in this article
are being considered as the main
which can be seen from the follow-
reason behind these uprisings. It
ing graph.
also spread across Egypt resulting
Inward remittances are the in stepping down of President Hosni
remittances received from Indians Mubarak and protests in Jordan, Ye-
working abroad. These remittances men, Bahrain, Morocco and to an ex-
result in flow of foreign currency into tent to China also.
the country. The foreign funds get
This unrest in West Asia may
accumulated with the Indian banks
widen India’s current account defi-
that pay out equivalent Indian ru-
cit further which was last recorded
pees to the beneficiaries of the re-
as $16 billion in the quarter of July
mittances in India.
–Sept 2010. The region accounts for
Banks having surplus for- remittances worth $26 billion or 48
eign currency funds sell the funds per cent of India’s total remittance
to other Indian banks in exchange inflow of $55 billion. In addition, it
Classroom
tions and an equivalent amount of underlying stock
Let’s elaborate the above concept
before the ex-dividend date and then exercising the
with the help of an example. Suppose that
put after collecting the dividend. Hence, it will give
stock XYZ is trading at $100 and is paying
you an opportunity to earn a small amount of gain
a $2 dividend in one week’s time. A put option with
in small period of time.
expiry three weeks from now and a strike price of
$110 is selling for $11. A trader wishing to structure
Sir! Though your definition is mak- a dividend arbitrage can purchase one contract for
ing some sense to me but I am slightly $1,100 and 100 shares for $10,000, for a total cost of
confused about the Put options. Can you $11,100. In one week’s time, the trader will collect
please elaborate on it a bit? the $200 in dividends and the put option to sell the
stock for $11,000. The total earned from the dividend
and stock sale is $11,200, for a profit of $100.
Put option is basically a contract
giving the owner the right, but not the
obligation, to sell a specified amount One last question, what type of
of an underlying security at a specified securities are best suited to adopt such
price within a specified time. This is the opposite options strategy and create dividend ar-
of a call option, which gives the holder the right to bitrage opportunity.
buy shares.
Good question. Generally, this
Yes Sir! I can recollect it now, But strategy is best when used on a security
can you please give some example to with low volatility (causing lower options
explain it in detail? premiums) and a high dividend. Hence,
it creates an opportunity to create profits while as-
suming very low to no risk.
Yes sure, here is an example. Sup-
pose you have one Mar 10 HUL 10 put,
you have the right to sell 100 shares of
HUL at $10 until March 2010 (usually the
third Friday of the month). If shares of HUL fall to
$5 and you exercise the option, you can purchase
100 shares of HUL for $5 in the market and sell the
shares to the option’s writer for $10 each, which
means you make $500 (100 x ($10-$5)) on the put
option. Note that the maximum amount of potential
profit in this example ignores the premium paid to
2. A strategy often used by hedge funds which involves purchase of a convert-
ible security and simultaneously shorting the same company’s common stock.
3. This entrepreneur took his company to an IPO while still being a teenager. He
was later found guilty of a massive accounting fraud worth $100 million. Name the
person.
FinLounge
5. This Princeton graduate started the first Index Mutual fund which tracked the
S&P 500. Who is he?
All entries should be mailed at niveshak.iims@gmail.com by 25th March, 2011 23:59 hrs
One lucky winner will receive cash prize of Rs. 500/-
Crossword Winner
The Crossword Winner for the month February 2011 is
Rajesh Beriwal
of IIFT Delhi
He receives a cash prize of Rs.500/-
CONGRATULATIONS!!
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