Capitalism is the Mother of Reinvention

For so long we have been discussing about the economic recession and its impacts.

Every now and then we witness such a correction, we consistently speculate the "End of Capitalism is here". I used to consistently disagree with this approach. Because according to me

"Capitalism Re-invents Itself"

According to me, at this moment all the companies are back to the place where they were during their formation. This is the place where Capitalism starts to grow but with a different approach.

Initially in 90s companies used Mass Production mechanisms, this mechanism got huge responses and companies upgraded their methodology to this kind of manufacturing.

But as we know world is ever changing and improving in all aspects of life which get explored from time to time, Sakichi Toyoda, Founder of Toyota Motors along with Ohno, invented a new methodology named as Lean Manufacturing(Also known as Toyota Production System).

This technology was better than its rivals and hence got immediate recognition. This mechanism is based on elimination of waste in mass methodology.

New companies which came up after Lean was invented used it.

We can see GM and Ford used Mass Production and hence are today Bailed-out, but Toyota still is standing firm.

So in the post what I meant to say is that, after this recession the companies require a revival of their internal structure and various other processing mechanisms which they are using at this moment.

Doing this, it would revive the definition of modern day capitalism and make it more modern and immune to previous mishaps.......................

The worst is yet to come

Dow Jones Industrial Average slid to its lowest layers in the last 6 years.

This came due to the speculation of Banks edging Bankruptcy and the deepening of the Recession in the economy of USA.

Exerts have oft-quoted:
"the worse is yet to come!!"

The impact of this hit can bring many more hostilities and can ruin the economy all-together leading to a metaphorical review of what was witnessed in 1930s.

According to reports, the 30-stock blue-chip gauge fell as to 7,447.55, breaking through the November 21 Bear Market low to levels not seen since March 2003.

GDP of Japan fell to its lowest in the last 35 yrs. A clear cut of 12% in GDP was observed giving a clear indication of big economies becoming cost ridden.

In order to prevent total collapse of the world's 2nd richest economy IMF has signed a $100 Billion contract so that the economic stability can once again be restored.

In my recent posts I have been expressing my views about the downturn and many of them have been proved with a much stronger impact..
But who knows this is a moving market and the impact of this can be anything worse than what I or any other person can view.......................

India: A Rising Tide Of RED Ink!!

The Interim budget announced by Pranab Mukherjee shows a red ink slashing the Indian Economy. The next Government will either have to

"Get this sea to recede or build dykes to protect the land".

So says this web-link, and I so agree with it!

The next couple of years won't be easy to digest and are likely to be tough ones for the world economy and for India.
But according to me, India has been highly insulated from Economic recession(oot Cause is Subprime Crisis), but this storm will show its effect and will be a sustained phenomena for the upcoming one and a half year or so.
It could be said that India is observing a growth recession, which usually means an economy growing at such a low pace that more jobs are been shed then been added.


Governments are expected to heavily influx market during such growth recessions even though tax collections are anaemic. They have to run in heavy fiscal deficits. The main problem is that the entrant political government will have very little power to attack this problem and would again add up to fiscal and other deficits, again drowning economy back to '91 kind of situations.

The Indian Fiscal Deficit including Budget Bond Issuance is now at a record high. This situation for India is ironical. Manmohan Singh took the first stab at bringing down the deficits in the early '90s. Then P Chidambaram tried to cut the deficit during his reign as Finance Minister in mid '90s.

Statistics

The stand-in Finance Minister candidly admitted that a record slippage was likely to push the fiscal deficit or external borrowings, in 2008-09 to three times the value of its initial target of 2.5% of GDP after taking into account all off-budget bonds.

The Stock Market reacted negatively and BSE's benchmark index ended at days low.

According to FinMin there can be a deviation of upto 20% from the projected values in the budget.

Tax collections, which contributes nearly 90% of revenue to government will be on a low air this fiscal year.

In case of 3G spectrum(non-tax receipts), the government will raise approx. 20,000 crore RS in 2009-10(which is nearly half of what was estimated and is expected by the Telecom ministry's projections).

The strain is to show upto 164% increase in the total fiscal deficit.

The fiscal deficit is expected to be about 5.5% of the total GDP(excluding crude).

It is estimated that average price of crude wil be below 70$ a barrel.

In all seeing a drop of nearly 12% GDP in Japan(worst in last 35 yrs), India is still fairly insulated nut the this is just the start of recession India will have to manage and keep up the pace of Growth so that the next fiscal year can be handled easily and without any strain..

But I would like to raise the point which I always use to ask-
The last five years were the one long clash between politics and economics. And there are no prizes for guessin which side did win......................

Enron Scandal

Enron Corporation has been one of the biggies in the field of Power and Electricity Generation.

The Company traces its roots to the Northern Natural Gas Company formed in 1932. But the company got a stand-alone reputation in 1979, by buying a lower rated Houston Natural Gas Group, and establishing Enron Corporation.

The Company had a good hold on American Power Business and was presented the best Power firm for 6 consecutive years. With a capital of above 100bn$, the company was strongly steering to become the ultimate in Power Business.

Company having more than 50% hold on American Market, was seen to be the next big thing in Global Economy.

But the company was caught in a fierce scandal when many revelations about financing and accounting reports came up. The Company's Auditor Firm, Arthur Anderson, was responsible for irregular accounting procedures conducted throughout the decade on 1990.

Company was on the verge of Bankruptcy within 6 months of the disclosure of the scandal.A White knight rescue attempt by a similar, smaller energy company, Dynegy, was not viable. Enron filed for bankruptcy on December 2, 2001.

The basis of scandal was the revelation that maximum part of profits and revenue of the company were due to the Special Purpose Entity.

Enron was using SPE's appropriately by placing non energy related business into separate legal entities. What they did wrong was that they apparently tried to manufacture earnings by manipulating the capital structure of the SPEs; hide their losses; did not have independent outside partners that prevented full disclosure and did not disclose the risks in their financial statements.

So the financial debts and the losses that it reported were not reported in the financial statements. This scandal caused dissolution of one of the largest firm Arthur Anderson.

As the news of scandal was on air many of speculations were made for the dissolution of the company, this lead to decrease in the faith of investors in the company. This lead to the downfall of the shares of the company from somewhere about 100$ to about 50 cents. This was the basic reason that the company was on the verge of bankruptcy.

Financial Instruments of the Company dragged down to such an extent that the market capitalization decreased to about 1% of what it had before the scandal.

Enron planned to retain their three cross pipeline business and also some external invested assets. Post Bankruptcy the company had to sell-off all its pipelines business to make a new entity CrossCountry Energy, making the Company a small shell with limited scope of development.

So as to pay the debts to the investors and to pay all the outstanding in the market the company resolved into a Enron Creditors Group Corporation. Its goal is to pay off the old Enron's remaining creditors and wind up Enron's affairs.........................

Derivatives- Means To Mass Destruction!!!

In Capital Markets, there have been many ways to multiply your profit, in recent times the craving in this direction has increased heavily.

Derivatives have been in the industry for almost 3 centuries. The financial derivatives came into spotlight in post-1970 period due to growing instability in the financial markets.

Derivative is a product whose value is derived from the value of one or more basic variables, called underlying. The underlying asset can be equity, index, foreign exchange (forex), commodity or any other asset.
Derivatives can be essentially used to diminish or tone down the risk of economic loss arising from the changes in the value of the underlying.

Because the value of a derivative is contingent on the value of the underlying, the notional value of derivatives is recorded off the balance sheet of an institution, although the market value of derivatives is recorded on the balance sheet.

Uses of Derivatives are in Hedging and Speculation and Arbitrage.

Hedging

Derivatives allow risk incurred in the value of the underlying asset to be transferred from one party to another. Such a mechanism is know as Hedging.
We can say a buyer and seller can sign a contract about a particular value of an asset in future(The value is speculated for future value on the basis of the market and demand forecasting in future).

Hedging also occurs when an individual or institution buys an asset (like a commodity, a bond that has coupon payments, a stock that pays dividends, and so on) and sells it using a futures contract.

Speculation and Arbitrage

Derivatives can be used to acquire risk, rather than to insure or hedge against risk.
Speculation means Implied Gambling(Gambling with some results favoring it). Individuals and Institutions enter into a derivative contract to speculate on the value of the underlying asset, betting that the party seeking insurance will be wrong about the future value of the underlying asset.

Individuals and institutions may also look for arbitrage opportunities, as when the current buying price of an asset falls below the price specified in a futures contract to sell the asset.
Arbitrage means Intermediate Market conditions.
An example can be-
There is always a difference in price of Shares in NSE and BSE. Some people may buy Shares in NSE and sell them in BSE if the value is more(earning profit excluding minor transaction charges).
Arbitrage is no loss work which has become a famous undertaking in recent times.

Criticism

Warren Buffet once said "Derivatives are a means of Mass Destruction", clearly the saying goes with the happening. The Tornado of Economic Recession which is DESTRUCTIVE and still going on has been the, u can say "EYE WITNESS", of the above saying.

Derivatives massively leverage the debt in an economy, making it ever more difficult for the underlying real economy to service its debt obligations and curtailing real economic activity, which can cause a recession or even depression.

The use of derivatives can result in large losses due to the use of leverage, or borrowing. Derivatives allow investors to earn large returns from small movements in the underlying asset's price. However, investors could lose large amounts if the price of the underlying moves against them significantly.

There have been instances of massive losses in derivative markets such as-
1. The need to recapitalize insurer American International Group(AIG) with $85 billion of debt provided by the US federal . An AIG subsidiary had lost more than $18 billion over the previous three quarters on Credit Default Swaps (CDS) it had written. It was reported that the recapitalization was necessary because further losses were foreseeable over the next few quarters.

2. The bankruptcy of Orange County, CA in 1994, the largest municipal bankruptcy in U.S. history. On December 6, 1994, Orange County declared Chapter 9 bankruptcy, from which it emerged in June 1995. The county lost about $1.6 billion through derivatives trading.(Courtesy: Economic Times) Orange County was neither bankrupt nor insolvent at the time; however, because of the strategy the county employed it was unable to generate the cash flows needed to maintain services. Orange County is a good example of what happens when derivatives are used incorrectly and positions liquidated in an unplanned manner; had they not liquidated they would not have lost any money as their positions rebounded. Potentially problematic use of interest-rate derivatives by US municipalities has continued in recent years..................

Instruments in Capital Markets

The changes in the regulatory framework of the capital market and fiscal policies have resulted in newer kinds of financial instruments (securities) being introduced in the market.

The variations in all the instruments depend on the tenure, the nature of security, the interest rate, the collateral security offered and the trading features, etc.

Debentures

These are issued by companies and regulated under the SEBI guideline. The rights of investors as debenture holders are governed by the Companies Act, which prohibits the issue of debentures with voting rights.
There are many types of Debentures like Participating debentures, Convertible debentures with options, Third party convertible debentures and many more.


Bonds

Indian Development Financial Institutions (DFIs) in India, like IDBI, ICICI and IFCI have been raising capital for their operations by issuing bonds like Income Bonds, Tax-free bonds, Capital Bonds etc.
In addition to the interest rates and maturity profiles of these instruments, the issuer institutions have been including a put/call option.


Preference Shares

Owners of preference shares enjoy a preferential treatment with regard to corporate actions like dividend. They also have a higher right of repayment in case of winding up of a company.
The various types of Preference Shares are:
• Cumulative and non-cumulative
• Participating
• Cumulative & Redeemable fully convertible to preference shares
• Cumulative & Redeemable fully convertible to equity shares.


Equity Shares

These represent the proportionate ownership of the company. This right is expressed in the form of participation in the profits of the company. Some hybrid securities like equity shares with detachable warrants are also available.

Some other Variants are Derivatives and Hedging.


Dematerialisation of securities occurs when securities issued in physical form are destroyed and an equivalent number of securities are credited into the beneficiary owner's account.
India has adopted dematerialisation route to depository. In a depository system, the investors stand to gain by way of efficient settlements, lower costs and lower risks of theft or forgery, etc....................