SMU's Semester v assignment for Finance option

7/29/2019 SMU's Semester v assignment for Finance option

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Name: Dromor Tackie-Yaoboi

Roll Number: 531110332

Learning Centre: 02544

Course & Semester: MBA Semester IV

Subject: MB0052 Strategic Management and Business Policy

Assignment No.: 1

Subject Code: MB0052

Date of Submission at the Learning Centre: 27 February, 2013


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Q. 1What do you understand by the term Strategyin the context of BusinessManagement and Policy? And what are the stages in the formulation of a Strategy?

Answer:

Businesses have to respond to a dynamic and often hostile environment for pursuit of their mission.

Strategies provide an integral framework for management and negotiate their way

through a complex and turbulent external environment. Strategy seeks to relate the goals of

the organisation to the means of achieving them.

A companys strategy is the game plan management is using to stake out market position and

conduct its operations. A companys strategy consists of the combination of competitive

moves and business approaches that managers employ to please customers, compete

successfully and achieve organisational objectives.

Strategy may be defined as a long range blueprint of an organisation's desired image,

direction and destination what it wants to be, what it wants to do and where it wants to go.

Strategy is meant to fill in the need of organisations for a sense of dynamic direction, focus

and cohesiveness.

Strategy is a well defined roadmap of an organization. It defines the overall mission, vision and

direction of an organization. The objective of a strategy is to maximize an organizations strengths

and to minimize the strengths of the competitors. Strategy, in short, bridges the gap between where

we are and where we want to be.

Features of Strategy

1. Strategy is Significant because it is not possible to foresee the future. Without a perfect

foresight, the firms must be ready to deal with the uncertain events which constitute the

business environment.

2. Strategy deals with long term developments rather than routine operations, i.e. it deals with

probability of innovations or new products, new methods of productions, or new markets to

be developed in future.

3. Strategy is created to take into account the probable behavior of customers and competitors.

Strategies dealing with employees will predict the employee behavior.


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The overall objective of a strategy is twofold:

To create competitive advantage, so that the company can outperform the

competitors in order to have dominance over the market.

To guide the company successfully through all changes in the environment

The Generic Strategies

According to Glueck and Jauch there are four generic ways in which strategic alternatives can

be considered. These are stability, expansion, retrenchment and combinations.

(i) Stability strategies: One of the important goals of a business enterprise is stability to

safeguard its existing interests and strengths, to pursue well established and tested

objectives, to continue in the chosen business path, to maintain operational efficiency on

a sustained basis, to consolidate the commanding position already reached, and to

optimise returns on the resources committed in the business.

(ii) Expansion Strategy: Expansion strategy is implemented by redefining the business by

adding the scope of business substantially increasing the efforts of the current business.

Expansion is a promising and popular strategy that tends to be equated with dynamism,

vigor, promise and success. It is often characterised by significant reformulation of goals

and directions, major initiatives and moves involving investments, exploration and

onslaught into new products, new technology and new markets, innovative decisions and

action programmes and so on. Expansion include diversifying, acquiring and merging

businesses.

(iii) Retrenchment Strategy:A business organisation can redefine its business by divesting

a major product line or market. Retrenchment or retreat becomes necessary or expedient

for coping with particularly hostile and adverse situations in the environment and when

any other strategy is likely to be suicidal. In business parlance also, retreat is not always

a bad proposition to save the enterprise's vital interests, to minimise the adverse environmental

effects, or even to regroup and recoup the resources before a fresh

assault and ascent on the growth ladder is launched.(iv) Combination Strategies: Stability, expansion or retrenchment strategies are not

mutually exclusive. It is possible to adopt a mix to suit particular situations. An enterprise

may seek stability in some areas of activity, expansion in some and retrenchment in the

others. Retrenchment of ailing products followed by stability and capped by expansion in

some situations may be thought of. For some organisations, a strategy by diversification


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and/or acquisition may call for a retrenchment in some obsolete product lines, production

facilities and plant locations.

B. Strategy Formulation Process

Strategy formulation refers to the process of choosing the most appropriate course of action for

the realization of organizational goals and objectives and thereby achieving the organizational

vision.The process of strategy formulation basically involves six main steps. Though

these steps do not follow a rigid chronological order, however they are very rational and can be

easily followed in this order.

1. Setting Organizations objectives - The key component of any strategy statement is to

set the long-term objectives of the organization. It is known that strategy is generally a

medium for realization of organizational objectives. Objectives stress the state of being

there whereas Strategy stresses upon the process of reaching there. Strategy includes

both the fixation of objectives as well the medium to be used to realize those objectives.

Thus, strategy is a wider term which believes in the manner of deployment of resources

so as to achieve the objectives.

While fixing the organizational objectives, it is essential that the factors which influence the

selection of objectives must be analyzed before the selection of objectives. Once the

objectives and the factors influencing strategic decisions have been determined, it is easy to

take strategic decisions.

2. Evaluating the Organizational Environment - The next step is to evaluate the general

economic and industrial environment in which the organization operates. This includes a

review of the organizations competitive position. It is essential to conduct a qualitative and

quantitative review of an organizations existing product line. The purpose of such a review is

to make sure that the factors important for competitive success in the market can be

discovered so that the management can identify their own strengths and weaknesses as well

as their competitors strengths and weaknesses.

After identifying its strengths and weaknesses, an organization must keep a track of


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competitors moves and actions so as to discover probable opportunities of threats to its

market or supply sources.

3. Setting Quantitative Targets - In this step, an organization must practically fix the

quantitative target values for some of the organizational objectives. The idea behind this is to

compare with long term customers, so as to evaluate the contribution that might be made by

various product zones or operating departments.

4. Aiming in context with the divisional plans - In this step, the contributions made by each

department or division or product category within the organization is identified and

accordingly strategic planning is done for each sub-unit. This requires a careful analysis of

macroeconomic trends.

5. Performance Analysis - Performance analysis includes discovering and analyzing the gap

between the planned or desired performance. A critical evaluation of the organizations past

performance, present condition and the desired future conditions must be done by the

organization. This critical evaluation identifies the degree of gap that persists between the

actual reality and the long-term aspirations of the organization. An attempt is made by the

organization to estimate its probable future condition if the current trends persist.

6. Choice of Strategy - This is the ultimate step in Strategy Formulation. The best course of

action is actually chosen after considering organizational goals, organizational strengths,

potential and limitations as well as the external opportunities.


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Q.2. What, in brief, are the types of Strategic Alliances and the purpose of each?Supplement your answer with one real life example of each

Answer:Strategic alliances constitute a viable alternative in addition to Strategic Alternatives.

Companies can develop alliances with the members of the strategic group and performmore effectively. These alliances may take any of the following forms. Following are the

different types of strategic Alliances:

1. Product and/or service alliance:Two or more companies may get together to

synergise their operations, seeking alliance for their products and/or services. A

manufacturing company may grant license to another company to produce its

products. The necessary market and product support, including technical know-how,

is provided as part of the alliance. Example :- Coca-cola initially provided such

support to Thums Up.

Two companies may jointly market their products which are complementary in nature.

Example :- 1) Chocolate companies more often tie up with toy companies. 2) TV

Channels tie-up with Cricket boards to telecast entire series of cricket matches live.

Two companies, who come together in such an alliance, may produce a new product

altogether. Example :- Sony Music created a retail corner for itself in the ice-cream

parlours of Baskin-Robbins.

2. Promotional alliance:Two or more companies may come together to promote theirproducts and services. A company may agree to carry out a promotion campaign

during a given period for the products and/or services of another company. Example

:- The Cricket Board may permit Cokes products to be displayed during the cricket

matches for a period of one year.

3. Logistic alliance: Here the focus is on developing or extending logistics support.

One company extends logistics support for another companys products and services.

Example:- The outlets of Pizza Hut, Kolkata entered into a logistic alliance with TDK

Logistics Ltd., Hyderabad, to outsource the requirements of these outlets from morethan 30 vendors all over Indiafor instance, meat and eggs from Hyderabad etc.

4. Pricing collaborations: Companies may join together for special pricing

collaborations. Example :- It is customary to find that hardware and software

companies in information technology sector offer each other price discounts.

Companies should be very careful in selecting strategic partners. The strategy should


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be to select such a partner who has complementary strengths and who can offset the

present weaknesses.


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Q. 3 What is a Business Plan? What purpose does it serve? (10 marks)

Ans:

A business plan is a map for where the company is heading. The New World Encyclopedia defines a

business plan as "a formal, written statement of a set of business goals, the financial background andnature of the business, and the strategy for reaching those goals." It therefore defines much about

the company for outsiders and those who have or plan to have a stake in the company.

Purpose

1.Viability.

The exercise of writing a plan can help you decide whether or not the business is viable. Its much

easier to stop moving forward with an idea when you have invested little time or money. Once the

business has started youre more likely to keep pouring your money and your efforts into trying to

make it succeed.

2. Direction.

When researching your industry, competitors, and current market opportunities you may find that

you see the business moving in a different direction than you first anticipated. As an example, Bill

was interested in opening up a boutique grocery store. He wrote a full business plan with two of his

friends. They were really excited about starting the new venture. However, their timing was a little

off. Boutique grocery stores started popping up on every corner of the neighborhoods theyconsidered opening their store. In addition, these stores were backed by large chains. They decided

to forgo the idea. A few years later, Bill wrote another business plan for a different business. Within

6 months of completing the plan he opened up his wholesale business and was exceeding revenue

projections.

3. Clarity.

The outline of a business plan is fairly structured. Youll be challenged to write a Mission Statement,

a Vision Statement, establish your staffing plans, determine your break even point and much more.

Youll be much more confident about the purpose of the business and how internal and external

factors will impact your success.

4. Road map.

The business plan is a template to follow for both the start-up phase as well as execution of daily

operations. Following the tasks youve established in the business plan will help you get up and


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running sooner with fewer mishaps. And it provides a base line for which to compare your results.

Without a road map, how are you going to know what steps to take or when you need to make

adjustments to the business? The plan can be adapted as any aspect of your business changes, such

as product or service offerings, the entry of a new competitor, a recession, a economic boom, etc.

5. Commitment.

The most important benefit, other than determining viability, is commitment. Writing the business

plan is a level of commitment. If you dont have the time to write the plan, then how do you think

you are going to find time to operate your new business? If you are truly committed to your business

idea, you will take the time to create a business plan.

6. Reviewing your business idea

Business plans are often used for raising finance for the business as they are generally a requirement

of lenders or investors. Although even if you do not intend to raise finance you should still prepare aplan to help focus your thoughts, check your calculations, help you monitor results and enable

communication of your ideas.

7. Communicating your business idea with a financier

The lender, such as a bank, will be looking to see how you propose to handle risks that your

company may encounter. They are concerned about the security of the repayment of the money they

have loaned to you and sowant to ensure that you will be managing the companys risk wisely. As

well as checking your credit rating a bank manager may ask you a number of questions which you

will need to be able to answer, such as:

1. Why do you need the amount requested?

2. What will you do with it?

3. How do you know its enough?

4. How much less can the company survive on?

5. What other sources of finance do you have or who else are you borrowing from?

6. How are you going to pay it back?

7. What collateral or guarantee do you have?You need to ensure that the first 6 questions are already answered in your business plan as it is much

harder to change the managers mind in your interview with them. The bank will look for collateral

and cash flow within your plan.

Professional Investorsaccept risk, although they will try to limit their exposure to it.The questions

they may be asking themselves while reading your business plan are:


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- How much can I make?They are usually looking to make around 30-50% annual compound

growth on their investment

- How much can I lose?What is the risk of losing their investment?

- How can I get my money back or out of the company?

- Who else is investing in this company?


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Q. 4 What is the chief purpose of a Business Continuity Plan and what are itscomponents for effective implementation. Explain in a sentence or two as to how it isdifferent from a Business Plan (10 marks)Answer:

Business continuity planning (BCP) "identifies an organization's exposure to internal and externalthreats and synthesizes hard and soft assets to provide effective prevention and recovery for the

organization, while maintaining competitive advantage and value system integrity. It is also called

business continuity and resiliency planning(BCRP). A business continuity plan is a roadmap for continuing

operations under adverse conditions such as a storm or a crime. In the US, governmental entities

refer to the process as continuity of operations planning(COOP).

Personnel

Human resources represent one of most critical BCP components, and often, personnel issues are

not fully integrated into the enterprise-wide plan. Based on the BIA, the BCP should assign

responsibilities to management, specific personnel, teams, and service providers. The planning group

should comprise representatives from all departments or organizational units, and the BCP should

be prepared by the individuals responsible for carrying out the assigned tasks. In addition, the plan

should specifically identify the integral personnel that are needed for successful implementation of

the BCP, and succession plans should assign responsibilities to back-up personnel in the event

integral employees are not available. Additionally, vendor support needs should be identified. The

BCP should address:

How will management prepare employees for a disaster, reduce the overall risks, and shorten

the recovery window?

How will decision-making succession be determined in the event management personnel are

unavailable?

How will management continue operations if employees are unable or unwilling to return to

work due to personal losses, closed roads, or unavailable transportation?

How will management contact employees in the event personnel are required to evacuate to

another area during non-business hours?

Will the financial institution have the resources necessary to transport personnel to an offsite

facility that is located a significant distance from their residence?


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Who will be responsible for contacting employees and directing them to their alternate

locations?

Who will be responsible for leading the various BCP Teams (e.g., Crisis/Emergency,

Recovery, Technology, Communications, Facilities, Human Resources, Business Units and

Processes, Customer Service)?

Who will be the primary contact with critical vendors, suppliers, and service providers?

Who will be responsible for security (information and physical)?

Personnel Needs

One of the first things that many financial institutions realize during a disaster is that recovery

cannot take place without adequate personnel. Recovery efforts are typically more successful when

management attempts to solicit and meet the immediate needs of their employees. Ideally, advance

plans should be established regarding living arrangements for displaced employees and their families,

such as securing blocks of hotel rooms or maintaining rental contracts for small homes, within and

outside the local area. If an emergency lodging program is offered by the financial institution,

management should be aware of the business needs of each employee to ensure that proper

communication channels and alternative telecommunications options are available, particularly if

employees are required to work at their hotel or at an alternate location.

Management should plan for basic necessities and services for its staff members who have been

displaced during a disaster. If possible, management should establish plans to obtain water, food,

clothing, child care, medical supplies, and transportation prior to the disruptive event. On-site

medical support, mobile command centers, and access to company vehicles and other modes of

transportation should also be provided, if available. Management's efforts to maintain good

employee relations will likely contribute to the commitment and loyalty of financial institution

personnel and their desire to assist with the timely recovery of operations.

Emergency Training

Since personnel are critical to the recovery of the financial institution, business continuity training

should be an integral part of the BCP. During a disaster, a well-trained staff will more likely remain

calm during an emergency, realize the potential threats that may affect the financial institution, and


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be able to safely implement required procedures without endangering their lives or the lives of

others. A comprehensive training program should be developed for all employees, conducted at least

annually, and kept up-to-date to ensure that everyone understands their current role in the overall

recovery process. In addition, an audit trail should be maintained to document management's

training efforts.

Cross Training and Succession Planning

Cross-training of personnel and succession planning is also an important element of the business

continuity planning process. Management should cross train employees throughout the organization

and assign back-up personnel for key operational positions. The financial institution should also plan

to shift employees to other corporate sites, branches, back-up locations, or service provider facilities

outside of the disaster area and prior to the development of transportation problems, if possible.

To ensure adequate staffing at the alternate site, financial institutions may decide to locate staff at

the back-up facility on a permanent basis or hire employees who live outside the primary business

area and closer to the alternate facility. If employees are unable to return to work, management may

use formal agreements with temporary agencies and headhunting services to provide temporary

staffing solutions.

BCP Team Assignments

Planning should also consider human resources necessary for decision making and staffing at

alternate facilities under various scenarios. Typically, a recovery team is established to perform this

function, and their primary responsibility is to recover predefined critical business functions at the

alternate back-up site. They will be responsible for retrieving materials from the off-site storage

location, such as data files, supplies, equipment, and software. Once these materials have been

obtained, the recovery team will install the necessary hardware, software, telecommunications

equipment, and data files required for recovery.

Key personnel should also be identified to make decisions regarding the renovation or rebuilding of

the primary facility after the immediate disaster has ended. These tasks usually require personnel

beyond what is necessary for ongoing business continuity efforts. Personnel responsible for

returning the primary facility to normal operations are usually designated to a salvage team, which


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should be separate from the recovery team. The salvage team must be certain that all pending danger

is over, and employees can safely return to the primary facility. Once personal security is ascertained,

the salvage team will be responsible for supervising the retrieval and cleaning of equipment, the

removal of debris, and the recovery of spoiled media and reports. The salvage team is also given the

authority to resume normal operations at the primary facility, which is a significant task since

numerous areas must be closely reviewed to ensure that operations will function properly.

Once the salvage team approves the resumption of normal operations, the recovery team is assigned

the responsibility of returning production to the primary facility. However, before restoration tasks

can be performed and employees return to the primary facility, the salvage team should perform an

inventory of all property and ensure that the on-site investigation is complete. The BCP should

address guidelines for transferring operations from the back-up site to the primary facility with

minimum disruption. In addition, records should be maintained detailing associated costs and

property valuations for documenting budgetary changes, general ledger records, and insurance

claims.

Finally, the business continuity planning coordinator or planning committee should be given

responsibility for regularly conducting employee awareness training and performing annual tests of

the BCP. In addition, the BCP should be updated at least annually, or more frequently, after

significant changes to business operations, or if training and testing reveal gaps in the policy

guidelines.

Communication

Communication is a critical aspect of a BCP and should include communication with employees,

emergency personnel, regulators, vendors/suppliers (detailed contact information), customers

(notification procedures), and the media (designated media spokesperson). Alternate

telecommunications capabilities should be implemented to prevent any single point of failure that

could disrupt operations. Policy guidelines should also address alternate methods of

telecommunications in the event primary providers are unable to supply necessary services, and

regular audits should confirm the adequacy of these diverse systems.


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Communicating With Employees

One of the most important activities of business continuity planning involves communicating with

employees. Employees should be promptly notified of a pending disaster, and specific evacuation

instructions should be provided and included in the BCP. Management must be able to

communicate with personnel located in isolated areas or dispersed across multiple locations, and

management should be aware of each employee's evacuation plans to ensure that they can be

contacted in a timely manner during a disaster. While manually dialed telephone call trees may be a

viable communication tool in some instances, emergency notification systems should be evaluated to

determine their cost effectiveness. With either method, management should ensure that contact

information is current and easily accessible. Synchronization with human resource departments and

company mail systems may prove helpful in maintaining the currency of contact information.

Employee notification solutions may also include the following:

An in-bound hotline number for employees to retrieve up-to-date voice messages from any

location or a website accessible only by employees that provides important information

regarding the operational status of the financial institution and contact numbers for financial

institution personnel;

A two-way polling phone system that confirms all employees have been contacted, with

confirmed delivery of messages;

Remote access provided to employees through the use of laptops, software, and Internet

based solutions by utilizing dial-up connections, cable modems, virtual private networks

(VPNs), integrated services digital networks (ISDNs), digital subscriber lines (DSLs), or

wireless capabilities;

Ultra forward service, which allows incoming calls to be rerouted to a pre-determined

alternate location;

Custom redirect service, which allows management to determine where incoming calls are

answered and redirect calls to various locations or pre-established phone numbers;

Provisioning local phone services to one office from two different telecommunications

provider locations to provide phone system redundancy; and

Adding a back-up Internet Service Provider (ISP) and balancing the traffic between the two

ISPs over separate communication paths.


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Interfacing With External Groups

Financial institutions often forget about the need to include BCP guidelines regarding their

interaction with external groups such as local and state municipal employees and city officials.

Management should implement BCP guidelines addressing escalation procedures and include

contact information for communicating with these various groups. Consideration should be given to

the proximity of the financial institution to police, fire, and medical facilities, and the timeliness of

their response should be factored into BCP recovery strategies.

Given the importance of the on-going operation of the financial system, financial institutions should

be able to communicate with their industry counterparts. Current contact information should be

maintained and should be easily accessible to facilitate conference calls and meetings between

financial sector trade associations, financial authority working groups, emergency response groups,

and international exchange organizations. These groups should assess the potential impact of major

operational disruptions, coordinate recovery efforts, and promptly respond to failures in critical

communication systems.

Media Relations

A significant part of any BCP and related test plan should involve dealing with the media. When a

disruptive event occurs that could affect the financial institution's ability to continue operations, the

public must be informed. Before a disaster strikes, management should prepare a response that has

been approved by the board and the shareholders. In addition, employees should be instructed to

refer any questions to the financial institution's media contact. The chosen spokesperson should be

adequately informed, credible, have strong communication skills, and be accessible to the media so

that inaccurate information is not broadcast to the public, which could potentially harm the

reputation of the financial institution. Only confirmed information should be provided, and the

spokesperson should discuss what the financial institution is doing to mitigate any potential threats.

In order to ease customer's concerns regarding the security of their deposit funds, it is a good idea to

conduct regular media briefings until the emergency has ended.

Technology Issues

The technology issues that should be addressed in an effective BCP include:


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Hardware - mainframe, mid-range, servers, network, end-user;

Software - applications, operating systems, utilities;

Communications (network and telecommunications);

Data files and vital records;

Operations processing equipment; and

Office equipment.

These technology issues play a critical role in the recovery process; therefore, comprehensive

inventories should be maintained to ensure that all applicable components are considered during

plan development. Planning should include identifying critical business unit data that may only

reside on individual workstations, which may or may not adhere to proper back-up schedules.

Additionally, the plan should address vital records, necessary back-up methods, and appropriate

back-up schedules for these records.

The BCP team or coordinator should also identify and document end-user requirements. For

example, employees may be able to work on a stand-alone personal computer (PC) to complete

most of their daily tasks, but they may require a network connection to fulfill other critical duties.

Consequently, management should consider providing employees with laptops and remote access

capabilities using software or a VPN connection.

When developing the BCP, institutions should exercise caution when identifying non-critical assets.

An institution's telephone banking, Internet banking, or automated teller machine (ATM) systems

may not seem mission critical when systems are operating normally. However, these systems may

play a critical role in the BCP and be a primary delivery channel to service customers during a

disruption. Similarly, an institution's electronic mail system may not appear to be mission critical, but

may be the only system available for employee or external communication in the event of a

disruption.

Data Center Recovery Alternatives

Financial institutions should make formal arrangements for alternate processing capability in the

event their data processing site becomes inoperable or inaccessible. The type of recovery alternative

selected will vary depending on the criticality of the processes being recovered and the recovery time


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objectives (RTOs). For example, financial industry participants whose operations are critical to the

functioning of the overall financial system and other financial industry participants should establish

high recovery objectives, such as same-day business resumption. Conversely, less stringent recovery

objectives may be acceptable for other entities. Considerations such as the increased risk of failed

transactions, liquidity concerns, solvency, and reputation risks should be factored into the decision

making process. The scope of the recovery plan should address alternate measures for core

operations, facilities, infrastructure systems, suppliers, utilities, interdependent business partners, and

key personnel. Recovery plan alternatives may take several forms and involve the use of another data

center or a third-party service provider. A legal contract or agreement should evidence recovery

arrangements with a third-party vendor. The following are acceptable alternatives for data center

recovery. However, institutions will be expected to describe their reasons for choosing a particular

alternative and why it is adequate based on their size and complexity.

Difference between A business Plan and Business Continuity Plan

A business plan is the guiding document stating a business's goals, operations, key personnel, SWOT

(Strengths, Weaknesses, Opportunities, & Threats) and PEST (Political, Economic, Sociocultural

and Technology) analysis, startup costs, budget, and expected profitability.

Business continuity plans are the guidelines for continuing business operations in the event of a

disaster (but is not a disaster recovery plan). For example - a hurricane wipes out a server farm. Thedisaster recovery plan focuses on the technological aspect of getting the business up and running.


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Q. 5 Take any three examples of the components of a Decision Support System and

explain how they help decision making (10 marks)

Ans. Following are the three examples of the components of a Decision Support System

1.Annual Budget: It is really a business plan. The budget allocates amounts of money toevery activity and/or department of the firm. As time passes, the actual expenditures are

compared to the budget in a feedback loop. During the year, or at the end of the fiscal

year, the firm generates its financial statements: the income statement, the balance sheet,

the cash flow statement. When putting together, these four documents are the formal

edifice of the firms finances. However, they can not serve as day-to-day guides to the

General Manager.

2. Daily Financial Statements:The Manager should have access to continuously updated

statements of income, cash flow, and a balance sheet. The most important statement is

that of the cash flow. The manager should be able to know, at each and every stage,

what his real cash situation is as opposed to the theoretical cash situation which

includes accounts payable and account receivable in the form of expenses and income.

3.The Daily Ratios Report: This is the most important part of the decision support

system. It enables the Manager to instantly analyse dozens of important aspects of the

functioning of his company. It allows him to compare the behaviour of these parameters

to historical data and to simulate the future functioning of his company under different

scenarios. It also allows him to compare the performance of his company to the

performance of his competitors, other firms in his branch and to the overall

performance of the industry that he is operating in.

The Manager can review these financial and production ratios. Where there is a strong

deviation from historical patterns, or where the ratios warn about problems in the future

management intervention may be required.

Examples of the Ratios to be Included in the Decision System

SUE measuredeviation of actual profits from expected profits

ROEthe return on the adjusted equity capital

Debt to equity ratios

ROAthe return on the assets

The financial average

ROSthe profit margin on the sales


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ATOasset turnover, how efficiently assets are used

Tax burden and interest burden ratios

Compounded leverage

Sales to fixed assets ratios

Inventory turnover ratios

Days receivable and days payable

Current ratio, quick ratio, interest coverage ratio and other liquidity and coverage

ratios

Valuation price ratios

And many others

A decision system has great impact on the profits of the company. It forces the

management to rationalize the depreciation, inventory and inflation policies. It warns themanagement against impending crises and problems in the company. It specially helps in

following areas:

a.The management knows exactly how much credit it could take, for how long (for which

maturities) and in which interest rate. It has been proven that without proper feedback,

managers tend to take too much credit and burden the cash flow of their companies.

b.A decision system allows for careful financial planning and tax planning. Profits go up,

non cash outlays are controlled, tax liabilities are minimized and cash flows are

maintained positive throughout.

The decision system is an integral part of financial management in the West. It is completely

compatible with western accounting methods and derives all the data that it needs from

information extant in the company.

So, the establishment of a decision system does not hinder the functioning of the company

in any way and does not interfere with the authority and functioning of the financial

department, but infact helps the manager to take quick decisions and make profit to the

company.


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Q.6 Name and explain any three ways in which a Companys CSR can be expressed

Ans. 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 as

they are increasingly aware that responsible behaviour leads to sustainable business success.

CSR is also about managing change at company level in a socially responsible manner. This

happens when a company seeks to set the trade-offs between the requirements and the

needs of the various stakeholders into a balance, which is acceptable to all parties. If

companies succeed in managing change in a socially responsible manner, this will have a

positive impact at the macro-economic level.

Following are the different ways in which company's CSR can be expressed.

1. Employment and Social Affairs Policy

Within a business CSR relates to quality employment, life-long learning, information,

consultation and participation of workers, equal opportunities, integration of people with

disabilities anticipation of industrial change and restructuring. Social dialogue is seen as a

powerful instrument to address employment-related issues.

Employment and social policy integrates the principles of CSR, in particular, through the

European Employment Strategy, an initiative on socially responsible restructuring, the

European Social Inclusion Strategy, initiatives to promote equality and diversity in the

workplace, the EU Disability Strategy and the Health and Safety Strategy.

In its document "Anticipating and managing change: a dynamic approach to the social

aspects of corporate restructuring", the Commission has stressed that properly taking into

account and addressing the social impact of restructuring contributes to its acceptance and

to enhance its positive potential. The Commission has called upon the social partners to

give their opinion in relation to the usefulness of establishing at Community level a number

of principles for action, which would support business good practice in restructuring

situations.

Deeply rooted societal changes such as increasing participation of women in the labour

market should be reflected in CSR, adapting structural changes and changing the work

environment in order to create more balanced conditions for both genders acknowledging

the valuable contribution of women as strategies which will benefit the society as well as the

enterprise itself.


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2. Enterprise policy

Only competitive and profitable enterprises are able to make a long-term contribution to

sustainable development by generating wealth and jobs without compromising the social

and environmental needs of society. In fact, only profitable firms are sustainable and have

better chances to adopt/develop responsible practices.

The role of enterprise policy is to help create a business environment, which supports the

Lisbon objective of becoming the worlds most dynamic knowledge-driven economy,

supports entrepreneurship and a sustainable economic growth. Its objective is to ensure a

balanced approach to sustainable development, which maximises synergies between its

economic, social and environmental dimensions.

3. Consumer Policy

CSR has partly evolved in response to consumer demands and expectations. Consumers, in

their purchasing behaviour, increasingly require information and reassurance that their

wider interests, such as environmental and social concerns, are being taken into account.

Consumers and their representative organisations have an important role to play in the

evolution of CSR. If CSR is therefore to continue to serve its purpose, strong lines of

communication between enterprises and consumers need to be created.


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Reference:

http://www.managementstudyguide.com/strategy-definition.htm

http://www.wisteria.co.uk/?q=business-plans

http://pros-per.com/98/business-plan-its-real-purpose/

http://www.newworldencyclopedia.org/entry/Business_plan

Elliot, D.; Swartz, E.; Herbane, B. (1999) Just waiting for the next big bang: business continuity

planning in the UK finance sector. Journal of Applied Management Studies, Vol. 8, No, pp. 4360.

Here: p. 48.

SMU Manual on Strategic Management and Business Policy(Book ID: B1314)
http://www.wisteria.co.uk/?q=business-planshttp://www.wisteria.co.uk/?q=business-planshttp://www.wisteria.co.uk/?q=business-plans


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Subject: International Business Management

Assignment No.: 1

Subject Code: MB0053



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Q.1 Write a short note on Globalization.

Ans. The term "globalization" has acquired considerable emotive force. Some view it as a

process that is beneficial a key to future world economic development and also

inevitable and irreversible. Others regard it with hostility, even fear, believing that it

increases inequality within and between nations, threatens employment and livingstandards and thwarts social progress. This brief offers an overview of some aspects of

globalization and aims to identify ways in which countries can tap the gains of this

process, while remaining realistic about its potential and its risks.

Globalization offers extensive opportunities for truly worldwide development but it is not

progressing evenly. Some countries are becoming integrated into the global economy

more quickly than others. Countries that have been able to integrate are seeing faster

growth and reduced poverty.

Economic "globalization" is a historical process, the result of human innovation andtechnological progress. It refers to the increasing integration of economies around the

world, particularly through trade and financial flows. The term sometimes also refers to

the movement of people (labor) and knowledge (technology) across international

borders. There are also broader cultural, political and environmental dimensions of

globalization that are not covered here.

At its most basic, there is nothing mysterious about globalization. The term has come

into common usage since the 1980s, reflecting technological advances that have made

it easier and quicker to complete international transactions both trade and financial

flows. It refers to an extension beyond national borders of the same market forces that

have operated for centuries at all levels of human economic activity village markets,

urban industries, or financial centers.

Globalization is not just a recent phenomenon. Some analysts have argued that the

world economy was just as globalized 100 years ago as it is today. But today commerce

and financial services are far more developed and deeply integrated than they were at

that time. The most striking aspect of this has been the integration of financial markets

made possible by modern electronic communication.

There are four aspects of globalization:

1. Trade: Developing countries as a whole have increased their share of world trade

from 19 percent in 1971 to 29 percent in 1999. For instance, the newly industrialized

economies (NIEs) of Asia have done well, while Africa as a whole has fared poorly.

The composition of what countries export is also important. The strongest rise by far

has been in the export of manufactured goods. The share of primary commodities in


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world exports such as food and raw materials that are often produced by the

poorest countries, has declined.

2. Capital movements: Globalization sharply increased private capital flows to

developing countries during much of the 1990s. It also shows that:

the increase followed a particularly "dry" period in the 1980s;

net official flows of "aid" or development assistance have fallen significantly

since the early 1980s; and

the composition of private flows has changed dramatically. Direct foreign

investment has become the most important category. Both portfolio investment

and bank credit rose but they have been more volatile, falling sharply in the

wake of the financial crises of the late 1990s.

3. Movement of people: Workers move from one country to another partly to find

better employment opportunities. The numbers involved are still quite small, but in

the period 1965-90, the proportion of labor forces round the world that was foreign

born increased by about one-half. Most migration occurs between developing

countries. But the flow of migrants to advanced economies is likely to provide a

means through which global wages converge. There is also the potential for skills to

be transferred back to the developing countries and for wages in those countries to

rise.

4. Spread of knowledge (and technology): Information exchange is an integral, oftenoverlooked, aspect of globalization. For instance, direct foreign investment brings not

only an expansion of the physical capital stock, but also technical innovation. More

generally, knowledge about production methods, management techniques, export

markets and economic policies is available at very low cost, and it represents a

highly valuable resource for the developing countries.


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Q.2 Describe the positives of trade liberalization.

Ans. 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.

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 consistentlyto 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.

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. Developingcountries 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.

Further liberalization by both industrial and developing countries will be needed to


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realize trades potential as a driving force for economic growth and development.

Greater efforts by industrial countries and the international community more broadly, are

called for to remove the trade barriers facing developing countries, particularly the

poorest countries. Although quotas under the so-called Multi-fibre Agreement are due to

be phased out by 2005, speedier liberalization of textiles and clothing and of agriculture

is particularly important. Similarly, the elimination of tariff peaks and escalation in

agriculture and manufacturing also needs to be pursued. In turn, developing countries

would strengthen their own economies (and their trading partners) if they made a

sustained effort to reduce their own trade barriers further.

Enhanced market access for the poorest developing countries would provide them with

the means to harness trade for development and poverty reduction. Offering the poorest

countries duty and quota free access to world markets would greatly benefit these

countries at little cost to the rest of the world. The recent market-opening initiatives of

the EU and some other countries are important steps in this regard. To be completelyeffective, such access should be made permanent, extended to all goods, and

accompanied by simple, transparent rules of origin. This would give the poorest

countries the confidence to persist with difficult domestic reforms and ensure effective

use of debt relief and aid flows.


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Q.3 Write a short note on GATT and WTO, highlighting the difference between the

two.

Ans. General Agreement on Tariff and Trade(GATT):

The GATT, was established on a provisional basis after the Second World War in thewake of other new multilateral institutions dedicated to international economic

cooperation notably the "Britton Woods" institutions now known as the World Bank

and the International Monetary Fund.

The original 23 GATT countries were among over 50 which agreed a draft Charter for

an International Trade Organization (ITO) a new specialized agency of the United

Nations. The Charter was intended to provide not only world trade disciplines but also

contained rules relating to employment, commodity agreements, restrictive business

practices, international investment and services.

In an effort to give an early boost to trade liberalization after the Second World War and

to begin to correct the large overhang of protectionist measures which remained in

place from the early 1930s-tariff negotiations were opened among the 23 founding

GATT "contracting parties" in 1946. This first round of negotiations resulted in 45,000

tariff concessions affecting $10 billion or about one-fifth of world trade. It was also

agreed that the value of these concessions should be protected by early and largely

"provisional" acceptance of some of the trade rules in the draft ITO Charter. The tariff

concessions and rules together became known as the General Agreement on Tariffs

and Trade and entered into force in January 1948.

Although the ITO Charter was finally agreed at a UN Conference on Trade and

Employment in Havana in March 1948, ratification in national legislatures proved

impossible in some cases. When the United States government announced, in 1950,

that it would not seek Congressional ratification of the Havana Charter, the ITO was

effectively dead. Despite its provisional nature, the GATT remained the only multilateral

instrument governing international trade from 1948 until the establishment of the WTO.

Although, in its 47 years, the basic legal text of the GATT remained much as it was in

1948, there were additions in the form of "plural-lateral voluntary membership

agreements and continual efforts to reduce tariffs. Much of this was achieved through a

series of "trade rounds".

The biggest leaps forward in international trade liberalization have come through

multilateral trade negotiations, or "trade rounds", under the auspices of GATT the

Uruguay Round was the latest and most extensive.


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The limited achievement of the Tokyo Round, outside the tariff reduction results, was a

sign of difficult times to come. GATTs 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.

WTO

World Trade Organization came into existence in 1995 after the desolation of General

Agreement on Tariff and Trade (GATT).

The WTOs overriding objective is to help trade flow smoothly, freely, fairly andpredictably. It does this by:

Administering trade agreements

Acting as a forum for trade negotiations

Settling trade disputes

Reviewing national trade policies

Assisting developing countries in trade policy issues, through technical

assistance and training programs

Cooperating with other international organizations

The WTO has nearly 150 members, accounting for over 97% of world trade. Around 30

others are negotiating membership. Decisions are made by the entire membership. This

is typically by consensus. A majority vote is also possible but it has never been used in

the WTO, and was extremely rare under the WTOs predecessor, GATT. The WTOs

agreements have been ratified in all members parliaments.

The WTOs top level decision-making body is the Ministerial Conference which meets

at least once every two years. Below this is the General Council which meets several

times a year in the Geneva headquarters. The General Council also meets as the TradePolicy Review Body and the Dispute Settlement Body. At the next level, the Goods

Council, Services Council and Intellectual Property (TRIPS) Council report to the

General Council.

Numerous specialized committees, working groups and working parties deal with

the individual agreements and other areas such as the environment, development,


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membership applications and regional trade agreements.

The WTO Secretariat, based in Geneva, has around 600 staff and is headed by a

director-general. Its annual budget is roughly 160 million Swiss francs. It does not have

branch offices outside Geneva. Since decisions are taken by the members themselves,

the Secretariat does not have the decision-making role that other internationalbureaucracies are given with.

The WTO is run by its member governments. All major decisions are made by the

membership as a whole, either by ministers (who meet at least once every two years) or

by their ambassadors or delegates (who meet regularly in Geneva). Decisions are

normally taken by consensus.

Difference between WTO and GATT:-

The World Trade Organization is not a simple extension of GATT; on the contrary, it

completely replaces its predecessor and has a very different character. Among the

principal differences are the following:

a. The GATT was a set of rules, a multilateral agreement, with no institutional

foundation, only a small associated secretariat which had its origins in the attempt

to establish an International Trade Organization in the 1940s. The WTO is a

permanent institution with its own secretariat.

b. The GATT was applied on a "provisional basis" even if, after more than forty years,

governments chose to treat it as a permanent commitment. The WTO

commitments are full and permanent.

c. The GATT rules applied to trade in merchandise goods. In addition to goods, the

WTO covers trade in services and trade-related aspects of intellectual property.

d. While GATT was a multilateral instrument, by the 1980s many new agreements

had been added of a plural-lateral, and therefore selective, nature. The agreements

which constitute the WTO are almost all multilateral and, thus, involve

commitments for the entire membership.

e. The WTO dispute settlement system is faster, more automatic, and thus much lesssusceptible to blockages, than the old GATT system. The implementation of WTO

dispute findings will also be more easily assured.


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Q.4 Think of any MNC and analyze its business strategy orientation.

Ans. Multinational companies (MNC) may pursue business strategies that are home country

oriented orhost country oriented orworld oriented.

Perlmutter uses such terms as ethnocentric, polycentric and geocentric. However,"ethnocentric" is misleading because it focuses on race or ethnicity, especially when the

home country itself is 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

a. engages in foreign production through its affiliates located in several countries,

b. exercises direct control over the policies of its affiliates,

c. implements business strategies in production, marketing, finance and staffing that

transcend national boundaries.

Business strategy of a MNC can be analyzed with the help of 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).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)

it does not require any capital expenditure

it is not risky

payment = a fixed % of sales

e.g.: Kentucky Fried Chicken in the U.K.

Problem that may arise while following a particular business strategy: The

mother firm may find it difficult in exercise of any managerial control over the

licensee (as it is independent).


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Secondly, the licensee may transfer industrial secrets to another independent firm,

thereby creating a rival.

The next stage for supplementing any particular business strategy is

Investments involved.

It requires the decision of top management because it is a critical step.

it is risky (lack of information) (for example-US firms tend to establish

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 itbegins to plan, organize and coordinate production, marketing, R&D, financing, and

staffing. For each of these operations, the firm must find the best location.

This is how a MNC decides its business strategy orientation.


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Q.5 What does FDI stand for? Why do MNCs opt for FDI to enter international market?

Ans. FDI stands for Foreign Direct Investment. 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. When MNC

incorporated in one country, invests in another country, it is said that the FDI has flowedinto the other country from some foreign origin.

The main reasons for MNCs to opt for FDI to enter international market is stated as

follows:

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 theybuilt 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 Opel (GM Germany). It did not buy Toyota, Datsun (Nissan) and Volkswagen.

They later became competitors.

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

Cheap foreign labour. Labour costs tend to differ among nations. MNCs can hold


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down costs by locating part of all their productive facilities abroad. (Maquildoras)


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Q.6 Viewing culture as a multi-level construct, describe various levels it consists of.

Ans. There are two kinds of approach construct of culture. One is a multi-level approach,

viewing culture as a multi-level construct that consists of various levels nested within

each other from the most macro-level of a global culture, through national cultures,

organizational cultures, group cultures, and cultural values that are represented in theself at the individual level.

The second is based on Scheins (1992) model viewing culture as a multi layer

construct consisting of the most external layer of observed artifacts and behaviours,

the deeper level of values, which is testable by social consensus, and the deepest level

of basic assumption, which is invisible and taken for granted.

The present model proposes that culture as a multi layer construct exists at all levels

from the global to the individual and that at each level change first occurs at the

most external layer of behaviour, and then, when shared by individuals who belong tothe same cultural context, it becomes a shared value that characterizes the aggregated

unit (group, organizations, or nations).

In the model, the most macro-level is that of a global culture being created by global

networks and global institutions that cross national and cultural borders.

Figure-1: The dynamic of top-downbottom-up processes across levels of culture.

Given the dominance of Western MNCs, the values that dominate the global context are

often based on a free market economy, democracy, acceptance and tolerance of

diversity, respect of freedom of choice, individual rights, and openness to change.

Below the global level are nested organizations and networks at the national level with

their local cultures varying from one nation or network to another. Further down are
http://resources.smude.edu.in/slm/wp-content/uploads/2009/06/clip-image00457.gif


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local organizations, and although all of them share some common values of their

national culture, they vary in their local organizational cultures, which are also shaped

by the type of industry that they represent, the type of ownership, the values of the

founders, etc. Within each organization are sub-units and groups that share the

common national and organizational culture, but that differ from each other in their unit

culture on the basis of the differences in their functions (e.g., R&D vs manufacturing),

their leaders values, and the professional and educational level of their members. At

the bottom of this structure are individuals who through the process of socialization

acquire the cultural values transmitted to them from higher levels of culture. Individuals

who belong to the same group share the same values that differentiate them from other

groups and create a group level culture through a bottom-up process of aggregation

of shared values. For example, employees of an R&D unit are selected into the unit

because of their creative cognitive style and professional expertise. Their leader also

typically facilitates the display of these personal characteristics because they are crucial

for developing innovative products. Thus, all members of this unit share similar core

values, which differentiate them from other organizational units. Groups that share

similar values create the organizational culture through a process of aggregation, and

local organizations that share similar values create the national culture that is different

from other national cultures.

Both top-down and bottom-up processes reflect the dynamic nature of culture, and

explain how culture at different levels is being shaped and reshaped by changes that

occur at other levels, either above it through top-down processes or below it through

bottom-up processes. Similarly, changes at each level affect lower levels through a top-

down process, and upper levels through a bottom-up process of aggregation.

Global organizations and networks are being formed by having local-level organizations

join the global arena. That means that there is a continuous reciprocal process of

shaping and reshaping organizations at both levels. For example, multinational

companies that operate in the global market develop common rules and cultural values

that enable them to create a synergy between the various regions, and different parts of

the multinational company. These global rules and values filter down to the local

organizations that constitute the global company, and, over time, they shape the local

organizations. Reciprocally, having local organizations join a global company mayintroduce changes into the global company because of its need to function effectively

across different cultural boarders.


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Reference:

http://ie.technion.ac.il/~merez/papers/jibs_culture_Intern_B.pdf

http://www.going-global.com/articles/understanding_foreign_direct_investment.htm

www.persianholdings.com/UsersFiles/admin/files/article-en/.../52.pdf

SMU Manual on International Business Management (Book ID: B1315)


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Subject: International Financial Management

Assignment No.: 1

Subject Code: Mf0015



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1. What is meant by BOP? How are capital account convertibility and current account

convertibility different? What is the current scenario in India?

Ans: The balance of payments (orBOP) of a country is a record of international transactions

between residents of one country and the rest of the world over a specified period, usually a year.

Thus, Indias balance of payments accounts record transactions between Indian residents and the

rest of the world. International transactions include exchanges of goods, services or assets. The

term residents means businesses, individuals and government agencies and includes citizens

temporarily living abroad but excludes local subsidiaries of foreign corporations.

The balance of payments is a sources-and-uses-of-funds statement. Transactions such as exports

of goods and services that earn foreign exchange are recorded as credit, plus, or cash inflows

(sources). Transactions such as imports of goods and services that expend foreign exchange are

recorded as debit, minus, or cash outflows (uses).

The Balance of Payments for a country is the sum of the Current Account, the Capital

Account and the change in Official Reserves.

The current account is that balance of payments account in which all short-term flows of

payments are listed. It is the sum of net sales from trade in goods and services, net investment

income (interest and dividend), and net unilateral transfers (private transfer payments and

government transfers) from abroad. Investment income for a country is the payment made to its

residents who are holders of foreign financial assets (includes interest on bonds and loans,

dividends and other claims on profits) and payments made to its citizens who are temporary

workers abroad. Unilateral transfers are official government grants-in-aid to foreign

governments, charitable giving (e.g., famine relief) and migrant workers transfers to families in

their home countries. Net investment income and net transfers are small relative to imports and

exports. Therefore a current account surplus indicates positive net exports or a trade surplus

and a current account deficit indicates negative net exports or a trade deficit.

The capital (or financial) account is that balance of payments account in which all cross-border

transactions involving financial assets are listed. All purchases or sales of assets, including direct

investment (FDI) securities (portfolio investment) and bank claims and liabilities are listed in the


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capital account. When Indian citizens buy foreign securities or when foreigners buy Indian

securities, they are listed here as outflows and inflows, respectively. When domestic residents

purchase more financial assets in foreign economies than what foreigners purchase of domestic

assets, there is a net capital outflow. If foreigners purchase more Indian financial assets than

domestic residents spend on foreign financial assets, then there will be a net capital inflow. A

capital account surplus indicates net capital inflows or negative net foreign investment. A

capital account deficit indicates net capital outflows or positive net foreign investment.

Current scenario in India

The official reserves account (ORA) records the total reserves held by the official monetary

authorities (central banks) within the country. These reserves are normally composed of the

major currencies used in international trade and financial transactions. The reserves consist of

hard currencies (such as US dollar, British Pound, Euro, Yen), official gold reserve and IMF

Special Drawing Rights (SDR). The reserves are held by central banks to cushion against

instability in international markets. The level of reserves changes because of the central banks

intervention in the foreign exchange markets. Countries that try to control the price of their

currency (set the exchange rate) have large net changes in their Official Reserve Accounts. In

general, a net decrease in the Official Reserve Account indicates that a country is buying its

currency in exchange for foreign exchange reserves, to try to keep the value of the domestic

currency high with respect to foreign currencies. Countries with net increases in the Official

Reserve Account are usually attempting to keep the price of the domestic currency cheap relative

to foreign currencies, by selling their currencies and buying the foreign exchange reserves. When

a central bank sells its reserves (foreign currencies) for the domestic currency in the foreign

exchange market, it is a credit item in the balance of payment accounts as it makes available

foreign currencies. Similarly, when a central bank buys reserves (foreign currency), it is a debit

item in the balance of payment accounts.

The Balance of Payments identity states that: Current Account + Capital Account = Change

in Official Reserve Account. If a country runs a current account deficit and it does not run down

its official reserve to cover this deficit (there is no change in official reserve), then the current

account deficit must be balanced by a capital account surplus. Typically, in countries with


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floating exchange rate system, the change in official reserves in a given year is small relative to

the Current Account and the Capital Account. Therefore, it can be approximated by zero. Thus,

such a country can only consume more than it produces (or imports are greater than exports; a

current account deficit) only if it has a capital account surplus (foreign residents are willing to

invest in the country). Even in a fixed exchange rate system, the size of the official reserve

account is small compared to the transactions in the current and capital account. Thus the

residents of a country cannot have a current account deficit (imports exceeding exports) unless

the foreigners are willing to invest in that country (capital account surplus).


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Q.2 What is arbitrage? Explain with the help of suitable example a two-way and a three wayarbitrage.

Answer:

Arbitrage is the activity of exploiting imbalances between two or more markets. Foreign money

exchangers operate their entire businesses on this principle. They find tourists who need the

convenience of a quick cash exchange. Tourists exchange cash for less than the market rate and then

the money exchanger converts those foreign funds into the local currency at a higher rate. The

difference between the two rates is the spread or profit. There are plenty of other instances where

one can engage in the practice arbitrage. In some cases, one market does not know about or have

access to the other market. Alternatively, arbitrageurs can take advantage of varying liquidities

between markets. The term 'arbitrage' is usually reserved for money and other investments as

opposed to imbalances in the price of goods. The presence of arbitrageurs typically causes the prices

indifferent markets to converge: the prices in the more expensive market will tend to decline and the

opposite will ensue for the cheaper market. The

efficiency of the market refers to the speed at which the disparate prices converge. Engaging in

arbitrage can be lucrative, but it does not come without risk. Perhaps the biggest risk is the potential

for rapid fluctuations in market prices. For example, the spread between two markets can fluctuate

during the time required for the transactions themselves. In cases where prices fluctuate rapidly,

would-be arbitrageurs can actually lose money.

There are basically two types of arbitrage

. One is two-way arbitrage and the other is three-way arbitrage. The more popular of the two is the

two-way forex arbitrage. In the international market the currency is expressed in the form

AAA/BBB. AAA denotes the price of one unit of the currency which the trader wishes to trade and

it refers the base currency. While BBB is international three-letter code 0f the counter currency. For

instance, when the value of EUR/USD is 1.4015, it means 1 euro = 1.4015 dollar. If the speculator

is shrewd and has a deeper understanding of the forex market, then he can make use of this

opportunity to make big profits. Forex arbitrage transactions are quite easy once you understand the

method by which the business is conducted.

For instance, the exchange rates of EUR/USD = 0.652, EUR/GBP = 1.312 and USD/GBP

=2.012. You can buy around 326100 Euros with $500,000. Using the Euros you buy approximately

248420 Pounds which is sold for approximately $500,043 and thereby earning a small profit of

$43.To make a large profit on triangular arbitrage you should be ready to invest a large amount and


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deal with trustworthy brokers. Arbitrage is one of the strategies of forex trading. To make a

substantial income out of this strategy you need to make an enormous amount of investment.

Though theoretically it is considered to be risk free, in reality it is not the case. You should enter into

this transaction only if you have deeper understanding of forex market. Hence, it would be wise not

to devote much time in looking out for arbitrage opportunities. However, forex arbitrage is a rare

opportunity and if it comes your way, then grab it without any hesitation.

Three Way (Triangular) Arbitrage

The three way arbitrate inefficiency now arises when we consider a case in which the EUR/JPY

exchange rate is NOT equivalent to the EUR/USD/USD/JPY case so there must be something

going on in the market that is causing a temporary inconsistency. If this inconsistency becomes large

enough one can enter trades on the cross and the other pairs in opposite directions so that the

discrepancy is corrected. Let us consider the followingexample :

EUR/JPY=107.86EUR/USD=1.2713USD/JPY = 84.75 The exchange rate inferred from the

above would be 1.2713*84.75 which would be 107.74 and the actual rate is 107.86. What we can do

now is short the EUR/JPY and go long EUR/USD and USD/JPY until the correlation is

reestablished. Sounds easy, right ? The fact is that there are many important problems that make the

exploitation of this three way arbitrage almost impossible.


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Q.3 You are given the following information:

Spot EUR/USD : 0.7940/0.8007 Spot USD/GBP: 1.8215/1.8240

Three months swap: 25/35Calculate three month EUR/USD rate.

Solution:Spot Rate EUR/USD: 0.7940/0.8007Forward Outright (if Premium)

3 months swap: 25/35=0.0025/0.0035

3 months EUR/USD rate= (0.7940+0.0025)/(0.8007+0.0035)=0.7965/0.8042Forward Outright (if Discounted)

3 months swap: -25/-35=-0.0025/-0.0035

3 months EUR/USD rate= (0.7940-0.0025)/(0.8007-0.0035)=0.7915/0.7972


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Q.4 Explain various methods of Capital budgeting of MNCs.

Ans:- Methods of Capital Budgeting

Discounted Cash Flow Analysis (DCF)

DCF technique involves the use of the time-value of money principle to project evaluation. The two

most widely used criteria of the DCF technique are the Net Present Value (NPV) and the Internal

Rate of Return (IRR). Both the techniques discount the projects cash flow at an appropriate

discount rate. The results are then used to evaluate the projects based on the acceptance/rejection

criteria developed by management.

NPV is the most popular method and is defined as the present value of future cash flows discounted

at an appropriate rate minus the initial net cash outlay for the projects. The discount rate used here

is known as the cost of capital. The decision criteria is to accept projects with a positive NPV andreject projects which have a negative NPV.

The NPV can be defined as follows:

NPV =

Where,

I0 = initial cash investment

CFt = expected after-tax cash flows in year t.

k = the weighted average cost of capital

n = the life span of the project.

The NPV of a project is the present value of all cash inflows, including those at the end of the

projects life, minus the present value of all cash outflows.

The decision criteria is to accept a project if NPV o and to reject if

NPV < o.

IRR is calculated by solving for r in the following equation.

where r is the internal rate of return of the project.

The IRR method finds the discount rate which equates the present value of the cash flows generated

by the project with the initial investment or the rate which

SMU's Semester v assignment for Finance option

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