Niveshak May, 2014 Issue

THE INVESTOR
VOLUME 7 ISSUE 5
May 2014
The Chinese Debt BOMB

Ticks
FROM EDITORS DESK

Dear Niveshaks,
Niveshak
Volume VII
ISSUE V
May 2014
Faculty Chairman
Prof. P. Saravanan
THE TEAM
Akanksha Gupta
Apoorva Sharma
Gaurav Bhardwaj
Jatin Sethi
Kocherlakota Tarun
Mohit Gupta
Mohnish Khiani
Priyadarshi Agarwal
S C Chakravarthi V
All images, design and artwork
are copyright of
IIM Shillong Finance Club
Finance Club
Indian Institute of Management
Shillong
We hope that the month of May calmed down all the anxieties pertaining to new government and the higher market expectations related to the same. The month of May began
with twin blasts in Chennai Central which have shaken the entire country. In these blasts,
one person was reported to be killed and 14 other injured and the investigation is still
on. The very next was a historic one in the Indian elections where Narendra Modi gave a
thumping victory to BJP and there by the party was able make a simple majority in the
Lok Sabha, which was only witnessed in 1984 elections (25 years before!!). Creating history, BSE Sensex and NSE Nifty touched all their time highs of 25000 and 7500 within
a very short span of time. The 30 share index had a solid run for some few days during
which it has surged 1470 points to hit a new life-time high of 25373.63 points. Owing to
the huge loss in the Lok-Sabha elections, Bihar Chief Minister resigned from his post taking up full responsibility for the loss. Similar circumstances took place in the Congress
party when both the president and vice-president of the party (Sonia Gandhi and Rahul
Gandhi) offered to resign from their party post in lieu of the humiliating defeat faced
by them. Before the swearing in of Narendra Modi as the 14th Prime Minister of India,
another tragic event took place where in there was an attack on Indian Embassy in Herat,
Afghanistan. On the business side, the major breakthrough this month was the merger
of e-commerce majors of India Flipkart and Myntra. This merger is done in the expectation that their combined might can place them in a better position to take on Amazon
which has been aggressively making its presence felt in the Indian online retail. On the
international front, a nation- wide curfew had been imposed by Thailands military by
dissolving the government and constitution because of six-month long anti-government
protests. Credit Suisse agreed to pay a hefty fine of $196 million to settle charges that it
violated federal security laws by providing cross-border brokerage without registering
with the Securities and Exchange Commission.
In this May edition of Niveshak, our editors have covered the story about the Chinese
Debt Bomb, a major economic event that has recently gone almost unnoticed. The Article
of the month this time is Warren Buffet: Can his success be replicated? which explains
how Warren Buffet has become a successful investor and what are the key insights to
be learnt. FinGyan section covers recent challenges in Liqidity management India by
explaining the steps taken by RBI pertaining to Liquidity Adjustment Facility. Finsight
article Goldfinger gives a good insight about the gold prices. The FinPact section discusses Energy Future Holdings buyout, which was a failed decision. Finview has the excerpts from Mr.Rajesh Gupta, senior manager from one of the leading private banks.
Classroom section shares knowledge on prospectus.
We would like to thank our readers for their immense support and encouragement. You
remain our prime motivation factor that keeps our spirits high and give us the vigor and
vitality to keep working hard. Thank you.
Stay invested!

Team Niveshak
www.iims-niveshak.com
Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears
no responsibility whatsoever.
CONTENTS
Cover Story
Niveshak Times
04 The Month That Was
Article of the month
14
The Chinese Debt Bomb

10 Warren Buffet: Can His Suc- Ticks
cess Be Replicated?
FinGyaan
18
Recent Challenges in Liquidity Management in India
Finsight
26 Goldfinger
FinPact
22 Energy Future Holdings Buy- 29 Mr. Rajesh Gupta,

out
FINVIEW
Senior Manager, Leading Private

Bank
CLASSROOM
31 Prospectus
The Month That Was
NIVESHAK
The Niveshak Times

Team NIVESHAK
IIM Shillong
RBI Eased Gold Import Norms Under 20:80
Scheme
Under the 20:80 Scheme, Star trading houses and
premier trading houses, which are registered as
nominated agencies by the Directorate General of
Foreign Trade(DGFT) now can import gold. With this
move the number of institutions that import gold
will go up and will increase supply of gold. Besides,
it will also lead to fall in the prices of gold. The RBI
had imposed severe restrictions on gold imports to
combat the Current Account Deficit (CAD) and sliding
rupee in July 2013. RBI prescribed a 20:80 formula,
which tied imports with exports of gold. Under
the 20:80 Scheme, an importer has to ensure that
at least 20 percent of every lot of imported gold is
exclusively made available for exports as finished
good and the balance for domestic use. The facility
was available to the selected banks only and other
entities were barred from imports of gold. Welcoming
Reserve Banks this decision; the World Gold Council
(WGC) said this would help in increasing the official
supplies.
Flipkart India Pvt. Ltds Acquisition of
Myntra.com
Flipkart India Pvt. Ltds acquisition of Myntra.com
will help add scale and gain share in the key fashion
segment. This will help when the company plans an
initial public offering (IPO) of shares, which is on
the cards. Myntras chief executive officer Mukesh
Bansal said that it aims to achieve sales worth
Rs.20,000 crore by 2020, for which it needs to make
a cash investment of $200 million (Rs.1,172 crore).
Flipkart said it will invest $100 million in the fashion
business after the deal.
Both companies are running heavy losses and have
had to repeatedly dilute equity to raise funds.
Valuations of the companies are already absurdly
high. Valuations of the companies are already
absurdly high, with both being valued at about 1.6
times the value of annualized monthly sales. Sales
here refers to gross merchandise value (GMV), of
which the companys revenue is likely to be only
a fraction (the commission it earns on the sale).
Competition is just picking up, with Amazon.com
Inc. increasing its presence in India. Whats more,
wiser from the experience in western markets,
traditional retailers are increasingly offering online
MAY 2014
retail options for customers. Pure online retailers

such as Flipkart and Myntra have little option but to
continue offering discounts to attract traffic.
Dell Regains Top Spot In Domestic PC Market
In Q1
PC maker Dell grew 25% in the first quarter amid
a declining Indian PC market that saw shipments
fall 25.2% year on year owing to poor end-user
demand. The overall Consumer PC shipments stood
at 1.01 million units in Q1 2014, a drop of 4.3%
sequentially over Q4 2013. Consumers sentiments
plummeted further due to high inflation and soaring
prices owing to rupee fluctuations. Concerns over
the economic conditions remained a key drag and
Q1 was no different HP, which dominated the India
PC market in 2013 across all product categories,
took the second place with a share of 20.4% in Q1
2014. Pricing, widespread retail presence, and strong
support from channel partners ensured their lead in
the consumer market, according to IDC. Lenovo, with
14.9% market share, took the third spot.
NSEL Commences Remittance Of Payout To
Unit-Holders Of E-Gold
As a part of the financial closure of gold e-series
contracts, National Spot Exchange Ltd (NSEL) today
started making direct payments to over 21,000
unit-holders at the average rate of Rs 2,935.9925
per gram. NSEL had a total of 617.5 kgs of gold
eligible for rematerialisation and financial closure.
Pursuant to FMC issuing the NOC, the exchange had
issued the circular on April 4 for rematerialisation/
financial closure of e-series settlement. NSEL
went into trouble in July last year after two dozen
counterparties declared their inability to settle
payments amounting to Rs 5,600 crore to more than
13,000 investors. A total of 85.5 kgs of gold were
released to the unit holders in the rematerialisation
process. The remaining 532 Kgs of gold that were
held by NSEL on behalf of unit holders were taken
up for financial closure starting May 8. Of this, 477
kgs of gold was sold through auction which is 89.70
per cent of the stock available for financial closure, a
statement issued here said. All eligible unit-holders
of e-gold will get remittance to the tune of 89.70 per
cent against their each unit of holding, while the
remittance for their remaining 10.30 per cent will
be given once NSEL auctions the remaining stock.
NIVESHAK
For other metals, the auction is in progress and the

direct payout will be released to eligible unit holders
as per the circular issued by NSEL.
Sensex Breaks All Barriers
The BSE Sensex, which was range bound for most of
the past 3 years, tore through all expectations and
price targets set by brokerage houses and touched
25,000 on 16th May, when it was announces that the
people of India have given Narendra Modi a clear
mandate to run the country for the next 5 years.
Narendra Modi, seen as a pro-business leader, who
can quick and smart actions to heal the countrys
economic issues and bring back the country to its
high growth rates. A lot of money that was waiting
on the side-lines to come into India gushed into
the markets in hope of a stable government in
India, which would kick-start the investment cycle
in India. The wave has created such a positive
sentiment that, a few brokerages who were still a
bit sceptical of India have raised their targets on
Sensex to 28,000 immediately after the Sensex hit
25,000. What remains to be seen now is how the
BJP-led government would act in the coming months
and the steps that they would take to make India
one of the most preferred destinations for foreigners
to invest in.
Swiss Banking Giant Credit Suisse Pleads
Guilty
Credit Suisse has pleaded guilty to helping tax
cheats i.e. thousands of US clients, to evade paying
taxes to the US government. It has agreed to pay
a $2.6bn (1.5bn) fine. As per US Attorney, Credit
Swiss conspired to help US citizens hide assets in
offshore accounts in order to evade paying taxes.
It is the biggest bank to plead guilty to criminal
charges in the US in more than 20 years. The bank
said the settlement would reduce its second-quarter
net profit by 1.6bn Swiss Francs ($1.8bn; 1bn). The
$2.6bn payment is the highest in a US criminal tax
investigation to date, according to US authorities.
However, as part of the agreement with US regulators,
the bank will not lose its banking licence in the US.
Mahindra
Considering
$684
Million
Investment In New India Plant
Infrastructure Mahindra and Mahindra Ltd is
considering investing about 40 billion rupees
($684 million) in a new factory, as it readies new
models for an anticipated pickup in sales. Pawan
Goenka, president of Mahindras automotive and
farm equipment sectors, said the proposed new

plant would have capacity to make 400,000 vehicles
annually, and an announcement on its development
would be made soon. Goenka said another option
on the table was expanding Mahindras Chakan
plant in western India.
The company, Indias largest SUV maker, last year
said it would invest 100 billion rupees over the
next three years to increase production and boost
research and development. The landslide victory
last week of the pro-business Bharatiya Janata Party
in the general elections have further raised hopes
among auto executives that the new government will
initiate reforms to kick-start the sluggish economy.
Automakers in India have been battling two years of
slumping sales as a slowing economy kept a lid on
consumer spending, which was further burdened by
high interest rates and fuel costs. Hindu nationalist
Narendra Modis new government is expected to
push ahead with major reforms to revive growth
amid the countrys worst economic slowdown since
the 1980s.The company is expected to roll out two
new compact SUVs in 2015.
Thailand In The Hands Of Its Army
Two days after Thaialands army chief declared
martial law, the country was seized by the army and
rival protest camps were asked to disperse. The main
reason for the protests was the tussle between the
supporters of the former premier Thaksin Shinawatra
and the opponents who are backed by the royal
establishment. In order to bring back the situation to
normalcy, the army has taken the control of power.
This announcement of army control was made after
the General summoning the rival factions to to find
a compromise to end six months of anti-government
protest. Unfortunately, the talks were failed and the
army had to take over the country.
In the history, the Thai armed forces have intervened
in the politics of the nation for 18 times since the
time the country became a constitutional monarchy
in 1932. Hundreds of soldiers surrounded Bangkoks
army club hours before the coup announcement and
the leader of the protest Suthep Thaugsuban was
taken away. Till now, 28 people were killed and 700
were injured since the protests have begun.
FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG
The Month That Was
The Niveshak Times
NIVESHAK
Article ofSnapshot
Market the Month
Cover Story
Market Snapshot
Source: www.bseindia.com
www.nseindia.com
MARKET CAP (IN RS. CR)

BSE Mkt. Cap
85,93,245.88
CURRENCY RATES
INR/1USD
INR/1Euro
INR/100Jap.YEN
INR/1PoundSterling
INR/ 1 SGD
LENDING / DEPOSIT RATES

Base rate
Deposit rate
10.00%-10.25%
8.00% - 9.05%
RESERVE RATIOS
58.483
79.8058
57.57
98.6725
46.73
CURRENCY MOVEMENTS
CRR
SLR
4.00%
23%
POLICY RATES
Bank Rate
Repo rate
Reverse Repo rate
9.00%
8.00%
7.00%
26th April 2014 to 25th May 2014
Data as on 25th May 2014
MAY 2014
NIVESHAK
BSE
Index
Sensex
MIDCAP
Smallcap
AUTO
BANKEX
CD
CG
FMCG
Healthcare
IT
METAL
OIL&GAS
POWER
PSU
REALTY
TECK
Open
Close
% change
22688.07
7373.64
7597.34
13615.96
14910.3
6633.02
12589.52
6837.11
10619.78
8786.98
10432.38
9605.77
1741.18
6561.7
1472.17
4929.63
24693.35
8668.32
9128.04
14580.74
17523.13
8235.58
14775.05
6794.28
10073.03
8440.06
12538.05
11545.47
2287.46
8614.28
1976.96
4832.03
8.84%
17.56%
20.15%
7.09%
17.52%
24.16%
17.36%
-0.63%
-5.15%
-3.95%
20.18%
20.19%
31.37%
31.28%
34.29%
-1.98%
% CHANGE
FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG
Article of Snapshot
Market the Month
Cover Story
Cover Story
Market Snapshot
10
Article of the Month

Cover Story
NIVESHAK
Warren Buffett: Can his

success be replicated?
Yamini Sandeep
All the people in the world of finance must have

had come across the legendary investor of all
time, Warren Edward Buffett, at some point in
time. His unmatched investment ability coupled
with astute abilities of a turn-around CEO has
earned him disciples all over the world. From
becoming one of the top ten richest persons in
the world to the top philanthropist in the world,
his success is quite unprecedented and his road
to success is indeed less travelled by.
The purpose of this article is not just to eulogize
the Oracle of Omaha, as he is fondly called,
but to understand whether his success can be
replicated by an ordinary human being and
draw out key learnings from his exemplary life.
Humble Origins
Born to a US congressman Howard Buffett in the
year 1930, Warren Buffett displayed interest in
making and saving money even as a child. He
went door to door selling chewing gum, CocaCola, weekly magazines etc. He spent $25 and
purchased a pin ball machine which he placed
in a local barber shop. It became so successful
that he installed several machines in different
shops within no time. He filed his own income
MAY 2014
IIM Lucknow
tax return in the year 1944.

He graduated from the Columbia Business School
where he learnt the basics of investing, which
later became famous as Value Investing, from
his teacher Benjamin Graham. Benjamin Graham
was the author of The intelligent Investor, a
treatise on the philosophy of value investing.
He started purchasing shares of a textile
manufacturing firm called Berkshire Hathaway in
the year 1962, and later took control of the firm.
He used it as a vehicle for future investments in

companies all across the US. He owns companies
which deal in insurance, candies, newspapers,
NIVESHAK
11

Cover Story
Fig 1: Warren Buffet Sector Holdings
rail roads, etc. and holds stakes in blue chip

companies such as Coca-Cola, IBM, Goldman
Sachs, American Express etc.
He was placed in the Forbes 400 list for the first
time in the year 1979 when his net worth was
$620 million.
Buffett, The Investor
An investor who bought one share of Berkshire
Hathaway at just over $11 when Buffett took
control of the company 50 years ago, would
have seen it soared to $190,000 in recent days,
an annual return of 21% (Refer Fig 1). This
performance is phenomenal especially when
it has been replicated over such a long period
of time. He thus stands as a living testament
to contradict one of the guiding principles of
finance, Efficient Market Hypothesis (EMH). EMH
states that stock price of a company reflects all
the available information and it is not possible
to consistently achieve returns in excess of
average market returns on a risk-adjusted basis.
Berkshire is into all manner of business, from
insurance to ice-cream parlors. Normally, such
diverse groups suffer from Conglomerate
discount; but Berkshires shares trade at a 40%
premium to its book value.
He outperformed the broader markets by
investing in good quality-low risk stocks at a
price lesser than its fair value, what he calls as
intrinsic value. He invests only in the businesses
he understands and calls it as his circle of
competence, usually companies with stable
earnings and hard-to-replicate business models.
He followed the same approach even when the
entire market is against his philosophy during
the dot-com bubble. He has never invested in

any technology company for his belief that their
earnings are difficult to be estimated (however,
he invested in the tech giant IBM due to the
unavailability of the companies that match his
stringent criteria at a point in time). He also
favors firms with good management and solid
business model, although not currently making
money. An Example of such an investment was
Coca-Cola (after the New Coke failure) when
he acquired around 7% stake in the company
for a very low price, which later turn out to be
the most successful investment of his career.
Buffett, The CEO
Buffett has become famous not just as an
investor in many companies but also for his
shrewd abilities of a turnaround CEO. He bought
companies with inefficient management but
distinct competitive business model and turned
them profitable by his efficient capital allocation
abilities. He gives complete freedom to the
managers of the firms he owns. Such is the
low-key profile maintained by Buffett that not
many people in the US are aware of the holding
company name Berkshire Hathaway, though it
has around 80 companies under its wings.
Can His Success Be Replicated?
After feeling awe struck at the phenomenal
success achieved by Buffett, let me try to answer
the question posed by the title of this article.
Can the success of Mr. Buffett be replicated?
Many academicians and investors have dismissed
Buffetts success contrary to the efficient market
hypothesis as statistical outlier. Some of them
have attributed his success simply to luck,
Buffet outperformed the broader markets by investing in

good quality-low risk stocks at a price lesser than its fair
value, what he calls as intrinsic value.
12

Cover Story
NIVESHAK
Fig 2: Warren Buffet Style Portfolio Performance
the happy winner of a coin-flipping contest.

However, the paper Buffetts Alpha by the
trio of Andrea Frazzini, David Kabiller, and Lasse
Heje Padersen presents a lucid explanation to
this important question. This paper showed
that a Buffett-style portfolio can be designed
and put into practice with sheer discipline.
Buffetts success appears neither to be magic nor
luck but primarily due to his strict adherence to
cheap, safe and high quality stocks combined
with the shrewd use of leverage. He achieved
a Sharpe ratio of 0.76, higher than any other
mutual fund or stock with a history of more
than 30 years. Sharpe Ratio is a measure of
risk adjusted performance. It is calculated by
subtracting the risk-free rate from the portfolio
return and dividing it by the standard deviation
of the portfolio returns.
Although his Sharpe ratio is good, it is not
super human. So how did he achieve such a
phenomenal success? The answer lies in the
use of leverage. He applied 1.6 to 1 leverage
financed partly by the float received from his
insurance business, GEICO. Because of the fact
that an insurance company gets the capital
upfront and pays claims later, he ventured into

insurance business and used the proceeds from
it to finance his investments. Thus he could get
capital at a very low rate of interest, around 3
percentage points less than that of the treasury
rate.
So how does Buffett select stocks to achieve
such an attractive return over a long period of
time? The answer lies in his selection of safe
(with low beta and low volatility), cheap
(stocks with low price-to-book ratios), and
high-quality (stocks with profitable, stable,
growing, and with high payout ratios) stocks.
This philosophy is put succinctly in one of letters
to the shareholders of Berkshire Hathaway:
Whether were talking about socks or stocks,
I like buying quality merchandise when it is
marked down
To understand whether his success is due
to the rare combination of a CEO and an
investor, his returns are further decomposed
into returns due to investments in public
companies and returns due to investments in
private companies. It turns out that the returns
in public companies are higher which indicates
Buffetts success appears neither to be magic nor luck but

primarily due to his strict adherence to cheap, safe and high
quality stocks combined with the shrewd use of leverage.
MAY 2014
NIVESHAK
to prove that the stock markets are efficient

and it is impossible to beat the broader markets
consistently. He thus stood as the living proof to
contradict the Efficient Market Hypothesis hands
down.
Importance of the competitive advantage of a
business: Buffett puts so much emphasis on the
margin of safety whereby he states that he takes
care of his down side first and then thinks about
the upside on the stocks he wants to purchase.
His famous quote on the irrelevance of the
management reads as
I try to buy stock in businesses that are so
wonderful that an idiot can run them. Because
sooner or later, one will
More than anything else, he is probably the
only person in the world to put the meaning
of investment in stock markets in two simple
statements.
Rule No 1: never lose money; Rule No 2: dont
forget the Rule No.1
Happy Investing!!

Cover Story
that Buffetts skill is mostly in stock selection.

In summary, Buffett has gained a unique access
to leverage which he has invested in safe,
cheap and high-quality stocks. He kept himself
aloof from the clutter of the Wall Street and
kept on investing in stocks with his conviction
in Value investing. Thus, his success does not
appear as luck, but an expression that value
and quality investing can be implemented in an
actual portfolio.
What Are The Key Learnings For Us?
Having understood that the stupendous
performance of Buffetts investments is not due
to the perceived luck factor, lets understand
the key learnings from his life as a successful
investor and CEO.
Invest in Yourself: He was not very confident
in public speaking during his initial days as an
investor. Having understood the importance of
speaking skills, he enrolled for Dale Carnegie
public speaking course. Using what he learned,
he taught a class on investment principles
at University of Nebraska-Omaha where the
average of the students enrolled for the course
was twice his own age. His persuasion skills
have helped him very much later in his days as
an investor.
He found the importance of something that he
lacks at a very early age and invested in a course
to master it. Very few of us feel the importance
of soft skills and those who mastered those
skills have achieved phenomenal success
compared to those who have not even though
they may have the same technical knowledge.
Investing in yourself is the best thing you can
do. Anything that improves your own talents;
nobody can tax it or take it away from you.
They can run up huge deficits and the dollar
can become far worth less. You can have all
kinds of things happen. But if youve got talent
yourself, and youve maximized your talent,
youve got a tremendous asset that can return
ten-fold Warren Buffett
Power of Simplicity: Buffett still lives in the
same 3-bed room flat that he bought 50 years
ago in mid-town Omaha. He says that he has
everything that he needs in that house. His
house does not have a wall or a fence.
Dont buy more than what you really need and
encourage your children to do and think the
same - Warren Buffett
Dont remain an Orthodox: Warren Buffett kept
his cool and followed what he believed in even
when the stalwarts of finance have been trying
13
Cover Story
14
NIVESHAK
The Chinese Debt Bomb Ticks
Mohnish Khiani
IIM Shillong
A major economic event that has recently gone
almost unnoticed is Chinas first corporatebond default. The company was a solar-energyequipment firm called Shanghai Chaori, a
small, private, highly leveraged and not very
important company. But its debt default draws
our attention towards the state of the worlds
2nd largest economy. The Chinese economy is in
the middle of a debt crisis, which is comparable
to the likes of the one we saw during the fall
of Lehman Brothers. The default of Shanghai
Chaori was tiny by comparison as it could not
make an interest payment on a $163 million
bond outstanding, whereas Lehman Brothers
owed nearly $613 billion when it collapsed. But
this is just the tip of an iceberg that is currently
about double the size of Chinas GDP. By allowing
Shanghai Chaori to go bust, the Chinese have
signalled that they are no longer in denial about
the debt crisis they are facing. This certainly
matters in a country in which data and statistics
are precooked and every economic move, which
includes the run-up in debt itself, is planned.
And this problem is fast approaching, as only
last year Chinese banks wrote off more than
twice the level of bad loans than they did in
2012.
China, for years now, has been the driver of global
growth. Its consumption and infrastructure
booms have kept afloat thousands of mines,
Chinese consumers have poured billions into the
MAY 2014
pockets of consumer goods companies around

the world, and its state-owned enterprises
have become the default bankers for energy,
agricultural and other development around the
world. China also holds more U.S. Treasuries
than any other nation+ outside the U.S. itself. It
currently consumes around 46% of the worlds
steel and 47% of the worlds copper. In 2010,
its export and import oriented banks had
already surpassed the World Bank in lending
to developed countries. In 2013 alone, Chinese
companies made $90-billion non-financial
overseas investments. If China catches a cold,
the rest of the world wont be sneezing, it would
be headed for the emergency room.
In the past few years, there have been many
predictions that the Chinese real estate sector
was about to implode at any moment. But these
predictions have not borne out, but now is the
time for the world to pay attention. Real estate
activity indicators have been trending lower, and
the downturn in the sector now threatens to
turn into a bust. The default risks in the weakly
regulated shadow banking sector and the rise
in local governments debt levels are alarming
and real. Yet the government and the central
bank have tools to limit the negative short-term
consequences of these conditions. They have
already deployed debt rollovers, bank bailouts
and recapitalisations. Over a year ago, the head of
emerging markets at Morgan Stanley Investment
NIVESHAK
not know exactly what theyre buying into.

The greater risk to China lies in the consequences
of any mortgage bust. Real Estate investment
has grown on to account for about 13 per cent
of the GDP, roughly double the share in USs
GDP at the height of the bubble in 2007. After
adding related sectors, such as cement, steel
and other construction materials, the figure
stands closer to 16%. The broadly defined
property sector accounts for about a third
of the fixed-asset investments in China and
accounts for about a fifth of commercial bank
loans but is used as collateral in at least twofifths of total lending in China. The booming
property market has also produced huge
revenues from land sales, which has fuelled
of the shadow banking units in China, which

consists of leasing companies, trust companies,
insurance firms and other types of non-bank
financial institutions. The growth of Chinas
shadow banking system has been stupendous.
In the year 2000, about 80% of all credit was
supplied by the traditional banks, with shadow
banks supplying a small portion of the rest. But
by last year, the split between traditional banks
and shadow banks was roughly 50-50. Chinas
debt to GDP ratio has also risen accordingly
to over 200% currently. Such shadow banks
typically lend money to industries by raising
capital from wealth management products sold
via traditional banks to retail investors who may
much of the local governments infrastructure

spending. The reason that things look different
today is the realisation of a chronic oversupply.
As the property slowdown has started to kick
in, housing starts, completions and sales have
turned significantly lower, especially outside
the principal cities. Idle Inventories of unsold
homes in Beijing are reported to have risen
from seven to 12 months supply. But when it
comes to homes under construction and total
sales in tier 2 cities, the inventories of unsold
homes has risen to about 15 months; and in
tier three and four cities, it is about 24 months.
The tightening of credit terms, which includes
funding costs for property developers, especially
Cover Story
Management, Mr Ruchir Sharma, pointed out

that China was pumping out credit faster than
any other country in the world. That is not the
real problem, but the problem is that much of
it went into dubious public-sector investments
rather than productive private enterprises. 5
years ago it took just over a dollar of marginal
debt to create a dollar of economic growth in
China, but today it takes about four dollars of
debt to create a dollar of growth. At this rate, it
takes a greater than 20-per-cent annual growth
in debt levels to sustain Chinas targeted 7.5 %
economic growth. These are crisis numbers by
any standard.
Much of the credit expansion in the recent
years has taken place due to the explosion
15
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16
NIVESHAK
in the vulnerable shadow banking sector, is

taking its toll. Rates of return on infrastructure
and commercial property, and cash flows for
developers and local government, have been
continuously deteriorating. The crunch in the
real estate market, and the economy, will come
when land and property prices fall more broadly
across the country. If activity levels and prices
weaken further, Beijings resolution to not to
respond with traditional stimulus programmes
is unlikely to hold for a longer time. Some steps
may provide financial markets and the economy
with some short-term relief. But if the Chinese
government goes too far with its temporary
adjustments, it will underestimate the essential
strategy of rebalancing the economy, in which
case the negative economic impact would be
larger and would last longer.
In the meantime, this easily borrowed money is
finding ever-more creative ways to flow through
China, through a gamut of complex schemes.
Under one increasingly popular financing
structure, called the trust beneficial rights or
TBRs, banks are allowed to buy only the cash
flow of a particular asset. Its a complicated
structure, with a simple, yet dangerous result:
Using this, a bank can effectively lend to
companies, but book the loan as an interbank
asset, which is an investment, that allows the
bank to assign a far lower risk weighting than
in case of traditional loans. That, in turn, allows
the bank to apply a lower capital adequacy ratio
rating, which means that it has lesser money on
hand to stop loans from going bad. Now, this is
a perfect recipe for banking instability.
But, a financial crisis in China isnt the same
as the one in the U.S. For one, Chinese debt is
almost completely China-owned. A large chunk
of it is in the public sector and the central
government, which holds some $4 trillion in
reserves can bail out firms at its will. Indeed,
theyve done that more than 20 times in the
past two years, which shows how long the crisis
has been brewing.
In the near term China can let its debt crisis
fester. That will only make things worse in
the long run, as it would increase the moral
hazards and slow down the economic growth,
which may be as low as 5% this year, down
from double digit figures seen a few years back.
Even worse, the government is already using
those figures as a reason to backtrack on its
recent promises to reform the economy. Beijing
is now talking about pumping more stimulus
to keep the countrys growth rate around the
7% level, which it says is needed to keep the
MAY 2014
unemployment from reaching dangerous levels.

Chinese authorities have allowed the countrys
first corporate bond default, inflicting losses
on small investors in a painful step towards
making its financial system more marketoriented. Until now, Beijing had bailed out
troubled companies to preserve confidence in
its credit markets. But the ruling Communist
Party has pledged to make the economy more
productive by allowing market forces to play a
much bigger role. A dangerous build-up of debt
and the explosion of risky and poorly regulated
shadow banking have raised serious concerns
about the health of Chinas economy. Thats
why the Shanghai Chaoris default has sparked
fears that the country could be headed for a
full-blown economic crisis like the one that
slammed Wall Street in 2008. The concern is that
the Chaoris default will be the tip-off point for
the unravelling of the Chinese financial system.
The default could stoke fear in the minds of
investors and bankers and make them believe
that the companies they thought were safe
bets could potentially turn out to be risky, and
they could begin to reassess other loans and
investments in other corporations also. In other
words, they might start redefining what is and
is not risky and be very fearful in lending out
new loans. That could then lead to a credit
crunch, when nervous bankers would become
wary of lending money, or lending at affordable
interest rates. More bankruptcies would result,
if this happens. This would eventually cause the
financial markets to freeze and this would end
up transitioning from a Bear Stearns moment in
China to a Lehman Brothers moment in China,
when the entire financial sector melts down.
Yes, it could be a Lehman Brothers moment
for China, and since the global financial system
is highly interconnected today, this fear would
spread soon and that would be very bad news
for the United States as well. Since the 2008
crash, the level of private domestic credit in
China has risen from $9 trillion to an astounding
level of $23 trillion. This is an increase of $14
trillion in about 5 years. Much of this hot
money has flowed into bonds, stocks and real
estate investments in the United States.
This bubble of private debt that we have seen
inflate in China since the Lehman crisis is
unlike anything that the world has ever seen.
Never before has so much private debt been
accumulated in such a short period of time. In
the recent past, all of this debt has helped China
fuel its tremendous economic growth, but now a
whole bunch of Chinese companies are realizing
NIVESHAK
its quite evident that China has less room to

manoeuvre now than it did 20 years ago.
It is true that Chinas closed capital and
current account as well as the governments
tight control over the financial system makes
Chinas situation fundamentally different from
that of countries with open capital and current
accounts from where foreign investors can flee
at any time if they get a cold feet over an overextended bubble. The great degree of central
control over the economy which the Chinese
government enjoys makes it inherently more
difficult to predict the quantum of losses the
demise of the credit bubble in China can bring
about and such things arent easy to time to
begin with. Will China be a drag or a boon to the
global economy, remains to be seen?
Cover Story
that they have got over leveraged. The situation

is so grave that, it is being projected that
Chinese companies will pay out the equivalent
of a trillion dollars in interest payments this
year alone. That number is more than twice the
amount that the U.S. government would pay as
interest in 2014.
Trouble is, the Chinese governments argument
that more debt is needed to keep unemployment
down, which no longer holds. As Ruchir Sharma
points out, every percentage point of GDP
growth currently creates around 1.7 million
new jobs, up from 1.2 million jobs a decade
ago. That means even 5% GDP growth would be
able to keep the Chinese economy stable. So
why isnt the country putting in more efforts to
deflate its debt bubble and change its economic
model? The answer remains the same. As in
the U.S., the political and economic elite have
little impetus to change a system that has made
them fantastically wealthy.
While Beijing may allow firms like Shanghai
Chaori, which are not systemically important,
to default in order to convince people that
its grappling with the debt issues, sate-level
governments and public sector companies are
still too big to fail. This is why it may not result
in a Lehman Brothers moment. But it will make
it much harder for the country to move to its
next stage of economic development, given the
fact that China has represented about a third of
global growth since the 2008 financial crisis, has
implications for all of us.
But, history offers some reason to distrust
the doomsayers. In the 1990s, amid another
credit explosion, Chinese banks saw their nonperforming loans rise to at least 25 per cent of
their portfolios some believe the real number
was as high as 40 per cent. In early 1999, GITIC
(Guangdong International Trust & Investment
Corp), went bankrupt, leaving investors with
$4.4-billion in unpaid loans. Worried investors
called Chinas financial system among the worst
on earth and predicted a severe economic
collapse. It didnt happen. Banks were
recapitalized with $32.5-billion through bond
sales, and some of the bad debts were tossed
into a series of state-owned asset management
companies. Growth slowed from 13.1% in 1994
to 7.6% in 1999 but by 2003, the economy was
roaring on, at 10% again. The current situation is
nonetheless a bit different. In the 1990s, Chinas
debt-to-GDP ratio stood at 25 per cent, which
was far lower than most developed countries.
But today, its far higher. By how much is very
hazy, given the lack of solid official numbers
and a vast deviation in external estimates. But
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18
NIVESHAK
FinGyaan
FinGyaan
RECENT CHALLENGES
IN LIQUIDITY
MANAGEMENT IN INDIA
Rajiv S Rao & Sandeep Ramesh
SPJIMR, Mumbai
In the case of India, the ultimate goals of

monetary policy, i.e., price stability and growth,
have remained unchanged over the years.
In the recent years, financial stability has
been considered as an additional objective of
monetary policy. The development of the money
market over the years and relative stability in
the call money market enabled the Reserve Bank
to move away from quantity-based instruments
to price-based instruments under its multiple
indicators approach adopted since 1998. In June
2000, RBI introduced the Liquidity Adjustment
Facility (LAF) and from November 2004 onwards,
LAF was operated through fixed rate repo and
reverse repo. This helped to develop interest
rate as an important instrument of monetary
transmission.
In recent times however, two major weaknesses
in LAF came to the fore. First was the lack of a
single policy rate, as the operating policy rate
alternated between repo during deficit liquidity
situation and reverse repo rate during surplus
MAY 2014
liquidity condition. Second was the lack of a

firm corridor, as the effective overnight interest
rates dipped (rose) below (above) the reverse
repo (repo) rate in extreme surplus (deficit)
conditions.
Recognising these shortcomings, a new
operating procedure was put in place in May
2011. As per the new operating procedure, the
weighted average overnight call money rate was
explicitly recognised as the operating target of
monetary policy. The repo rate was made the
only one independently varying policy rate.
A new Marginal Standing Facility (MSF) was
instituted under which scheduled commercial
banks (SCBs) could borrow overnight at 100
basis points above the repo rate up to one per
cent of their respective net demand and time
liabilities (NDTL). This limit was subsequently
raised to two per cent of NDTL and in addition,
SCBs were allowed to borrow funds under MSF
on overnight basis against their excess SLR
holdings as well. Moreover, the Bank Rate being
the discount rate was aligned to the MSF rate.

The revised corridor was defined with a fixed
width of 200 basis points. The repo rate was
placed in the middle of the corridor, with the
reverse repo rate at 100 basis points below it
and the MSF rate as well as the Bank Rate at 100
basis points above it.
The recent challenges in liquidity management
have been analysed
across four periods
viz. 1) November
2011 to June 2012
which saw the
easing of liquidity
conditions
after
sharp depreciation
in the rupee value,
2) July 2012 to
April 2013 when
liquidity conditions
eased temporarily
and
tightened
again
despite
large injection of
liquidity by RBI,
3) July 2013 to
September
2013
when US Federal Reserve announced its
intention to start tapering of the quantitative
easing program (QE3) and 4) September 2013
to December 2013 when RBI rolled back the
exceptional liquidity measures after volatility in
foreign exchange markets decreased.
November 2011 to June 2012: The liquidity deficit
crossed the one per cent of NDTL level. This
deficit was largely structural and caused in part
by foreign exchange intervention that became
necessary in the face of the sharp 19 per cent
depreciation of the rupee between end-July and

mid-December of 2011. This sharp depreciation
forced the RBI into sterilisation operations
to stabilize the rupee. Increasing divergence
between deposits mobilised and credit extended
by commercial banks also contributed to the
deficit situation. Finally, the deficit conditions
were further aggravated by frictional factors
like the build-up of
government
cash
balances
(especially
advance tax) with the
Reserve Bank that
persisted longer than
anticipated. RBI had
to actively manage
liquidity
without
compromising
on
the
anti-inflationary
stance through 1)
Injection of liquidity
by way of open market
operations
(OMOs),
2) Cut in cash reserve
ratio (CRR) of banks
and 3) a decline in
currency in circulation
and a reduction in government cash balances
with the Reserve Bank.
The overnight rates did not spike as in the past
episodes of large liquidity deficits. They remained
range bound within the formal corridor defined
by the LAF reverse repo rate and the MSF rate.
Despite the significant tightening of liquidity
conditions, on-tap availability of emergency
liquidity through the MSF window capped the
Reserve Banks operating target, viz., weighted
average overnight call money market rate, and
Fig 1: Revised LAF Framework
19
FinGyaan
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FinGyaan
NIVESHAK
20

FinGyaan
Cover Story
NIVESHAK
Fig 2: Current Dividend Yields of Major Markets
facilitated its range- bound movement. Monetary

transmission, therefore, remained effective.
July 2012 to April 2013: RBI undertook the
second phase of the liquidity management
when, consequent upon these policy measures,
the liquidity deficit declined and returned to
the Reserve Banks comfort level and remained
mostly there until the beginning of November
2012. To pre-empt any prospective tightening
of liquidity conditions arising out of frictional
factors such as advance tax outflows, festive
season currency demand and increase in the
wedge between the growth rate of credit and
deposit, the Reserve Bank reduced the CRR by
25 bps in September 2012 in addition to the 100
bps SLR cut effective from August 2012. Since
November 2012, the inter-bank market again
witnessed a tightening of liquidity conditions
mainly due to the build-up of government cash
balances and rise in currency in circulation with
the liquidity deficit crossing the Reserve Banks
comfort level of (-1) per cent of net demand and
time liabilities (NDTL). The significant squeeze
on liquidity creation and large build-up of
government cash balances, the Reserve Bank
resumed open market purchase auctions of
government securities in early September 2013.
RBI injected around 1.5 trillion rupees into the
system, but large and persistent build-ups in
government cash balances counterbalanced the
measures to an extent.
July 2013 to September 2013: A new challenge
presented itself in the form of sharp depreciation
MAY 2014
of the rupee consequent to the sudden surge in

capital outflows following indications of tapering
of the US Feds quantitative easing programme
(QE3). RBI resorted to an unconventional but
effective approach through these measures 1)
Hiked short-term interest rates and compressed
domestic money market liquidity as a first line
of defence. The measures taken included a 200
basis points (bps) hike in the marginal standing
facility (MSF) rate to 10.25 per cent 2) Cap on
daily LAF borrowing to 0.5 per cent of NDTL of
respective banks as against the earlier practice
of unlimited access against excess SLR holdings.
3) A hike in the minimum daily cash reserve
ratio (CRR) requirement to 99 per cent from 70
per cent of the requirement 4) weekly auctions
of cash management bills (CMBs) were also
conducted to drain out the liquidity.
September 2013 to December 2013: Taking
into account the easing of the exchange
rate pressures and evolving macroeconomic
conditions, the Reserve Bank in its Mid-Quarter
Monetary Policy Review (September 20, 2013)
moved towards normalising monetary measures
by implementing the following measures 1)
Reduced the MSF rate by 75 bps to 9.5 per cent
in September 2013 to reduce cost of funds. MSF
was further reduced by 50 bps in October 2013.
2) The minimum daily CRR balance maintained
by the banks was reduced to 95 per cent of
the requirement from 99 per cent to provide
banks with the flexibility to better manage their
liquidity situation. 3) Considering inflation risks,
NIVESHAK
policy would need to be carefully calibrated

to balance price stability, growth and financial
stability.
policy and to revert to the LAF repo rate as the

operational policy interest rate.
The constant vigilance by the RBI on liquidity
management has returned some normality to
the system. Credit growth has accelerated since
mid-July 2013, partly due to the substitution of
costlier money market sources of finance by
corporates with bank credit. This has reduced
the divergent trend between deposits mobilized
and credit extended. While the RBI was able
to effectively manage the volatility in foreign
exchange markets through effective monetary
policy transmission, it is confronted with three
issues that need to be addressed: 1) decelerating
growth, 2) comparatively high consumer price
inflation and 3) external vulnerability. While
managing the liquidity deficit conditions, RBI
had to ensure that it does not deviate from
its anti-inflationary stance. The double digit
CPI index has been posing a challenge to
the implementation of monetary policy. The
significant wedge between wholesale price
and consumer price inflation exacerbated the
challenge for monetary management in anchoring
inflationary expectations. It is important for
the RBI to avoid financial disintermediation or
financial repression if growth is to be revived on
a sustainable footing. In a period of economic
slowdown, a pro-growth monetary policy may
push the interest rate down, but if the internal
rate of return (IRR) falls at a faster rate due
to depressed expected returns on investment,
monetary policy stimulus may have limited
effect. Factoring in these limitations and the
three challenges enumerated above, monetary
FinGyaan
Cover Story
the repo rate was increased by 25 bps to 7.5 per

cent.
Finally, RBI signalled its intention to normalise
the conduct and operations of monetary
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Cover Story
NIVESHAK
Energy Future Holdings Buyout: A

failed investment decision
Dwaipayan Chakraborty
IIM Shillong
Whats an LBO?
Leverage BuyOut is a mechanism to buy
a company partially or completely through
borrowed sources of fundsE.g. If Nestle wants
to buy Amul, but do not have required funds,
it can raise debt from the market and later sell
assets of Amul to pay-off the debt it cannot pay
through the cash flows generated by both the
companies.
What is Private Equity?
Private Equity consists of investors contributing
funds tomake direct investments into private
companies or buys majority shares of public
companies eventually resulting in delisting of
the public company. Capital for private equity
is raised from retail and institutional investors,
and can be used to fund new expansion and
growth strategies or to strengthen its balance
sheet.
Once a balance sheet is strengthened, the
Private Equity players exits from the company
selling its assets and pocketing the profits.
There is no emotion involved, no buzzwords
like consumer-focus or brand equity, it is pure
MAY 2014
capitalism.
What is the Difference between Buyout
and Leveraged Buyout?
In the case of a buyout or a management
buyout, the management of the company
retains its control and takes it away from the
public. They usually do this when they see that
the stock market is not doing enough justice
to the fundamentals of the company and thus
consolidates their control over the company
In the case of a leveraged buyout, the PE firm
that arranges the funds also aims to take
control of the company. While a MBO is done
to rejuvenate the company, LBO deal is done
with the relentless pursuit of profit and can
even mean liquidation of the company to pay
off the debt obligations that were procured
during the buyout. Most PE investments are
highly leveraged and raise money from high risk
instruments and junk bonds.
Major players in the PE business
Private equity companies hire the best brains
and continue to attract the best talents. They
hire fresh graduates from top B-Schools and
NIVESHAK
penny for bailing TXU out.

In 2007 TXU was again faced with a crisis
keeping the companies financials in place and
thus stuck the LBO deal under which the CEO
of the company John C. Wilder will continue to
manage the company. Although TXU Corp had a
problem with managing its finances, its overall
business prospect was good. Not many healthy
companies want to sell themselves; most
would prefer to use their capital to buy other
companies. However, in TXUs case, CEO John
Wilders compensation package increased if the
company shares were acquired at premium.
Moreover at the time of buyout the market cap
of TXU Corp. was $27.5billion with $12.3 billion
in debt. A $47billion bid for the company was
nothing but a money machine for the existing
shareholders.
Why Goldman Sachs came into the
picture?
The size of the deal for leverage buyout of TXU Corp
was around $47billion. It is nearly impossible for
any individual player to arrange for such a huge
amount. Thus most LBO deals is initiated by a
PE player and backed by an investment bank. In
this case it was collaboratively initiated by KKR
and TPG the PE players and Goldman Sachs as
Fig 1: A SPELT Analysis of the deal

FinPact
Cover Story
experienced professionals from top investment

banks.
The biggest players in the PE market are,
Kohlberg Kravis and Roberts (KKR); Blackstone;
TPG Capital and Carlyle Group.
The Deal: Leveraged buyout of Energy
future holdings
What is TXU Corp.?
TXU Corp or Energy Future Holdings as it is
known today is an energy utility company,
headquartered in Texas. The company derives
bulk of its profits from coal and nuclear power
plants and was instrumental in pegging the
utility prices to the natural gas prices.
Why TXU Corp. went for a LBO?
TXU Corp. carved out its main energy producing
subsidiary, TXU Energy back in 2002. After a
series of deals in Europe that did not pan out,
TXU Energy and its parent company found it
difficult to carry their debt. DLJ merchant banking
came in with a $750 million investment in TXU
Energy. A few months after the transaction,
Warren Buffet bought one-third of DLJs stake
for $250 million, a clear testament to the value
proposition in the energy sector. At some point,
DLJ exited this investment and earned a pretty
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24

FinPact
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NIVESHAK
the investment bank. LBO deals require a lot of

hedge funds and junk bonds and Goldman Sachs
was the leader in hedge funds in general and
fuel-price hedging in particular.
The deal also indirectly involved Citi Bank,
JPMorgan Chase and Credit Suisse who sold loans
of TXU corp. to help finance the private equity.
Thus in a way the deal involved the very best
and brightest of Corporate America.
Why KKR and TPG were interested in
buying TXU?
Energy is a classic buyout category and being
highly value driven has always attracted the eyes
of investors. (Repetitive line)Although TXU Corp
had a problem with managing its finances its
overall business prospect was fine, the generation
business of TXU was highly promising and under
the leadership of its CEO the stock prices moved
from $5.44 in Oct 2002 to $60 in 2007. Thus it
proved to be a sound investment plan for a
PE firm. These firms usually stay invested in
highly volatile securities thus having a low-risk
profitable firm like TXU would only hedge them
against bad times. This motivated them to pay
such a huge amount for the company and go
ahead with the deal. TXU Corp was bought at
15% premium above its share price and 8.5 times
EBITDA (earnings before interest, tax, depreciation
and amortization). The deal was blessed by the
regulators
TXU Corp. had plans to go ahead with opening
of 11 new coal plants to meet the growing needs
of power and this decision faced huge backlash
from the environmental activists as well as
regulators. The LBO deal promised to close
down eight of these plants and supported the
mandatory emission and production limits as per
environmental safeguard thereby environmental
activists pushed and even lobbied for the deal.
The deal also proposed to reduce the utility
charges by 10% thus earning the blessings of the
regulators as well who saw high value in public
cost saving.
Never before had an LBO earned so much support
from the government that it appointed James
Baker III, the former secretary of State as the
advisory chairman.
As the saga unfolded
The deal agreed to split the original company into
three units, power generation to be handled by
Luminant Energy, transmission and distribution
to be developed by Oncor Electric delivery and
MAY 2014
TXU Energy would manage the companys retail

electric business.
The structure of the deal includes a $33billion
buyout of TXU equity and $12 billion in existing
debts. To finance the same the buyers contributed
$8.5billion in equity and $24.5 billion in debt
thus the deal had around 80% in debt and 20%
in equity.
Although this kind of structure is very common
in a LBO and even in some cases the debt-equity
share is 90%-10%; for a company like TXU Corp.
which was already operating at 0.85 debt to
equity ratio, such a move raised questions like
where these loans will be placed in a company
that is already overleveraged.
How the credit rating agencies viewed
the deal?
Immediately after announcement of the deal
the credit rating agency S&P downgraded the
TXU debts to below investment grade expressing
concerns over the highly leveraged structure.
It also put it on a credit watch with negative
implication.
The primary reasons cited were the promise by
the buyers to reduce prices which would reduce
cash flow and exposure to huge amounts
associated with the plan to drop eight coalpowered plants and along with it a declining
customer base of TXU.
Moody argued, citing compromise on
bondholders interest and found the deal risky
and viewed it with scepticism.
Fitch argued that that resulting company
would cause a substantial indebtedness and
also questioned the strategic direction of
the company as well as likely changes in the
corporate structure and how the firm would
continue its financial practices after the deal.
Usually PE firms employ a massive cost cutting
strategy after acquiring a company, in the energy
utility sector however such a strategy may imply
a compromise on safety and dependability of
the delivery.
Investment objectives of all PE firms are with an
objective to maximise the investment and profit
from the company and is believed to have no
respect for values. Even the cost saving to the
customer which was promised was required till
2008 after which the firms were free to raise the
prices, many saw it as a ploy by the buyers to
increase the customer base and the hiking the
prices. The electrical utility industry is crucial to
NIVESHAK
its profits
In most of the cases however PE firms exit the
company before the repayment period is reached
and thus save themselves from the burden of
paying the returns to the bondholders.
This entire junk bond thus places the LBO market
on a morally wrong footing.
The giant deal as it stands today:
Unfortunately the deal materialised in Oct 2007
and in the very next year the world was to
see the greatest financial crisis after the Great
Depression of 1929.
Despite involving the best brains of corporate
America, KKR, TPG and Goldman Sachs could
only recover 3% of their investments and the
company as it stands today would file for
bankruptcy next month.
The deal was primarily based on rising gas prices
instead the gas prices fell post 2008 crisis and
a hydraulic fracturing created a surge in US Gas
supplies. The company registered 10 straight
quarterly losses since 2011 and Warrant Buffet
was to quote the investment as one the biggest
mistakes of his company. The bankruptcy
filing would be the fifth biggest non-financial
bankruptcy in the world.
What is the insight from here?
The best brains of corporate America took a
company that was started in 1882, soon after
the invention of incandescent light bulb to a
bankruptcy. It is a lesson for all of us as budding
managers to see where our goal lies in striking
an investment deal. There was no question
on the planning and execution of the deal but
what it lacked was care for the society and was
thus not sustainable. Sustainable leadership in
the world of Finance is hard to learn given the
models and case studies we learn are mainly
developed out of the Game of Greed practiced in
Corporate America. But as Dylan said the times
they are a changing, there will be a change
where Finance caters not only to the 1% but to
the whole 100% of the Globe.

FinPact
Cover Story
the growth of an economy and thus operating it

on a soul motive to drive profits can have major
repercussions on the society, thus the regulators
should have been prudent in ensuring that such
a play not only benefits the buyers but is in the
interest of societys long term interest.
Because of the sheer size of the deal, the
largest PE buyout in history the deal should
have involved a lot of other stakeholders who
should approved agreements reached between
the Commission and the buyers.
In order to ensure that the buyers actually
delivered on their promise, it was mandated
to remain under the public utility company of
Texas.
What drew Warrant Buffet into the
deal?
As stated earlier, despite the size of the deal
investors saw the company as an extremely
good investment option. Berkshire Hathway had
earlier purchase stocks in TXU when it appeared
close to bankruptcy and the sold it at hefty
profits in 2004.
This time Buffet was offered two bond issues,
one was $1.1 billion purchase of 10.5% bonds
at 95 cents on the dollar and another $1 billion
of PIK-Bonds for 93 cents on the dollar. The
drawing of Berkshire Hathway generated huge
confidence among the investors and helped in
further procuring of cheap debt.
Whats so much about these Junk Bonds?
Junk bonds are bonds issued by companies
whose ratings are lower than BB, the high return is
attributed to the weak underlying fundamentals
of the company that makes it highly susceptible
to defaults and hence investing in bonds is
referred as junk investment and the bonds as
junk bonds.
LBOs use junk bonds as a cheap source of
raising capital and especifically because of the
high exposure to junk bonds that acquisition by
a PE player is viewed with great scepticism and
caution.
Raising money through junk bonds means::
1)
The company is highly risky and can
default on its bond payments , thus at the
outset of the purchase the PE firms project the
company as risky
2)
Even if the PE firms are able to turn
around the company they need to pay big
interest amount from the cash flow of the
company to its bondholders thereby lowering
25
26

Finsight
Cover Story
NIVESHAK
Goldfinger
Ronak Ravindran
Bangalore University
For over four thousand years, it served as a

symbol of power, glory, greatness, grandeur
and status. Civilizations and empires lusted
after it, even as it ignited wars and destroyed
cities. It embellished the walls of palaces
and tombs alike and its lustre drew men
towards it like moths to a candle flame. Over
the last century, gold has been hailed as the
asset class of the highest echelon. Corporate
prophets even went as far as calling it the
ultimate bubble. Alas, no longer.
In 2013, that dream run came to a
resounding end. Gold, which has rivalled
equities over the past 3 decades as the bestperforming asset class, plunged close to 30%,
wiping out the gains that it had notched up
in the past 2 years. The global crash of gold
prices was eerily similar to the fate that
silver suffered in the 1980s, following the
devious trades of the Hunt brothers, who
tried to corner and monopolize the silver
market. Ever since the US went off the Gold
Standard in 1971, gold has virtually seen an
unstoppable rally but the asset class, which
has always been perceived by governments
as a natural hedge against inflation, saw
its prices tumble from over $1900/oz to a
MAY 2014
little over $1300/oz, in the short span of a

week. That crash, however, is not devoid
of explanation and a multitude of factors
snowballed into the terrifying tumble of gold
prices worldwide.
With Europe still suffering from the
effects of a crushing recession, the deficits
of some of member nations of the European
Union have spiralled out of control, even as
austerity measures struggle to kick in with
full force. For now, the Scandinavian countries
are in a safe spot and economic giants like
Germany and France are managing to keep
their heads above water. The PIIGS (Portugal,
Italy, Ireland, Greece and Spain), however,
havent been that lucky and now, Cyprus
has joined the party. With a major banking
crisis and a crippling deficit, the Cyprian
Government is mulling over the possibility
of dumping its gold reserves in the open
market. This would potentially create a glut
of over half a billion dollars worth of gold
in the global bullion market. The Cyprian
Parliament will take a decision on the matter
soon but considering Cyprus financial
health, the move to dump gold is virtually
sure-fire. If or when Cyprus does pull the
NIVESHAK
27
Finsight
Classroom
Cover Story
plug on its gold, the other PIIGS, with their

ballooning deficits, are sure to follow suit,
which would lead to a much larger crash in
gold prices. Spain, for instance, has a trillion
dollar deficit to rein in and it would certainly
use its gold reserves to ease the strain on
its economy. Cyprus, however, is a nation in
its own right and the Cypriot crisis unfolded
only in March. After all, nations can and
sometimes do topple markets by themselves.
However, when it comes to the crash in gold
prices, the trail leads to a certain individual,
who had a major role to play. But that said
individual is no ordinary man. The subject
in question actually managed to break the
Bank of England in 1992.
In 1992, the world began to recognize
the financial insight and might of George
Soros. Soros, one of the worlds greatest
investors and the founder of the Quantum
Fund, took a sizeable position against the
British Pound. When the British Government
refused to raise interest rates or let their
currency float in the same manner as other
European countries, the British Pound
crumbled and Soros made a fortune of over
a billion dollars. His contrarian call against
the British Pound worked wonders and this
time around, Soros has zeroed in on the
ultimate asset.
Soros, who has always declared that
he invests wherever he sees a bubble,
was bullish on gold for the past 12 years
and he built up a sizeable position in the
worlds largest gold exchange traded fund
(ETF), SPDR. However, in the closing quarter

of 2012, Soros liquidated over half of his
holdings in SPDR and declared his bearish
outlook on the asset. Moreover, Soros
position on gold, which was valued at a few
billion dollars, was no meagre one. When
investors and fund managers learnt that
Soros had cashed in, herd mentality set in
and gold ETFs worldwide witnessed massive
selling. The Cypriot banking crisis and the
fiscal deficit troubles in the Eurozone, of
course, compounded the problem. Several
ETFs even had a problem delivering physical
gold against the widespread redemptions.
And it wasnt just Soros who was at
the centre of all the mayhem. PIMCO or
Pacific Investment Management Company,
the worlds largest bond fund, has also
turned negative on bullion and this stance
would have surely manifested itself in
the liquidation of some its sizeable gold
holdings. Sadly, the global bullion market,
as large as it may be, is certainly not strong
enough to withstand the combined financial
might of a pair of punters like George Soros
and PIMCO.
After crumbling all the way to a level of
a little over $1300/oz, gold managed to find
some support and it has crossed the $1400/
oz barrier, even as value buying sets in.
Gold, which normally moves in the opposite
direction as crude oil, seems to have
mirrored the fall in crude prices this time
around. This may just be an aberration or it
may be an omen for a much larger and more
28

Finsight
Cover Story
NIVESHAK
Fig 1: Gold Prices Stabilizes While Gold ETF Selling Continues
catastrophic double dip recession on a global

scale. After all, gold and crude oil plunged
hand-in-hand in 2008, in the 1980s and in
1929, just before recession and depression
descended on the global economy. Gold
prices may have stabilized for now but if the
European PIIGS and Cyprus choose to dump
their gold, all hell will certainly break loose
and economic gloom and doom will surely
become the order of the day.
In the eponymous 1964 flick, Auric
Goldfinger intended to radioactively
contaminate the United States gold reserves
at Fort Knox. This would have triggered a
surge in gold prices worldwide, leading to
a multi-fold increase in Goldfingers wealth,
which was largely denominated in gold.
However, before he could succeed with his
devious plan, Goldfinger was vanquished by
Sir Sean Connery, in the avatar of a certain
Bond. James Bond.
But that was back in 1964. This time
around, in 2013, Goldfinger, having cashed
out of his gold holdings just before the
horrendous crash in which played no small
role, seems to have come out on top. Just
like in 1992, the financial world is in awe of
Goldfingers timing and his contrarian call on
the asset on which he had a bullish stance
for well over a decade. And Goldfinger,
MAY 2014
obviously, is laughing all the way to the

bank. Oh wait. Did I say Goldfinger? I meant
Soros. George Soros.
MR. RAJESH GUPTA

Senior Manager, Leading Private Bank
coming out with new guidelines/circulars and

making them effective immediately. To read the
conscience of the new guidelines/stipulations is
imperative to ensure smooth compliance.
Liquidity Adjustment Facility (LAF) is a tool
used in monetary policy that allows banks to
borrow money through repurchase agreements.
This arrangement allows banks to respond to
liquidity pressures and is used by governments
to assure basic stability in the financial markets.
Priority sector refers to those sectors of the
economy which may not get timely and
adequate credit in the absence of this special
dispensation. Typically, these are small value
loans to farmers for agriculture and allied
activities, micro and small enterprises, poor
people for housing, students for education and
other low income groups and weaker sections.
Banks have mandate for providing a specified
portion of the bank lending to these specific
sectors. Issuance of two new banking licenses
How do you think that the banking goes with the RBI philosophy of rural growth.
industry will evolve with the issuance of
new banking licenses by RBI to two other
Inclusive growth is the trending word
companies?
RBI has issued two new banking licenses in in current economics of growth and
April 2014 to IDFC (Infrastructure Development development. According to you, what
Finance Company), a financial services firm with is the role of one of the Indias leading
special focus on infrastructure financing, and bank in promoting inclusive growth in
Bandhan Financial Services, large micro lender. India?
These institutions have strong presence in the The Indian economy has moved on a high
under-banked regions of India which will help growth path for past two decades. Despite the
in financial inclusion. The move is expected high growth, concerns have been raised over
to enhance service delivery especially in rural the growth not being equally distributed. Here
areas. Reportedly, they have been given a year comes the concept of Inclusive growth. It implies
and a half to begin operations. The move will advancing equitable opportunities for economic
participants during the process of economic
also boost job creation in banking sector.
growth which benefits every section of society.
What would be the impact of number As a leading private sector player, promoting
of regulations imposed by RBI on banks inclusive growth has been a priority area from
related to LAF facilities, PSLs, expansion both a social and business perspective. The Bank
in rural areas etc. And how as a banker strives to make a difference to its customers,
you deal with such stipulations imposed to the society and to the nations development
by RBI?
through its products and services, as well as
RBI has become very active these days in through development initiatives and community
What are your views on the new
government and how do you think it
would impact the banking industry in
general?
Sensex hitting 25K mark and rupee getting
stronger itself defines the expectations of
market from the new govt. Moreover, stable govt
is viewed as Dawn of a new era. Also, the new
PMs priorities for next 100 days viz. education,
health; infrastructure and investment reforms
etc is a welcome move.
I believe it would give banking industry the
much needed strategic direction. New Finance
Minister has signaled that it would take steps
to make India an investment destination where
there is stability of policy, taxation and fiscal
measures. This implies that interest rates are
expected to come down in order to make the
economy competitive.
29
FinView
Cover Story
FinGyaan
NIVESHAK
NIVESHAK
outreach. Key focus areas are: primary health,

elementary education, skill development &
sustainable livelihoods and expanding access to
financial services.
FinGyaan
FinView
30
You must have made various strategic

decisions in your careerfor example,
about how to reallocate the business
portfolio, where you might have
tried your own tricks against the
conventional way of doing things and
the recommendation by your team. How
do you do that?
Although I have not taken any major strategic
decision yet, I would like to highlight few key
success factors in this industry. One has to be
vigilant and updated with all the guidelines/
circulars associated with his/her profile and
internal guidelines of the organization. The spirit
of these guidelines should also be looked into.
One should be aware of various products and
services offered and terminologies used in the
sector. Knowledge of market and economy is a
must. In this industry, Service is a key deliverable.
Quality service leads to customer satisfaction and
one should in fact strive for customer delight.
Customers want convenience in banking, hence
latest technology plays very significant role. It
also helps in lowering transaction costs and
improving the quality of products. This is the
reason why mobile banking and online banking
are gaining momentum. Product innovation is
another yardstick in banking industry. How to
structure the products in a way that best suits
clients requirements/needs is essential. Last
but not the least, the industry is experiencing
competitive environment these days. One has
to be aware of products offered by other Banks
and their pricing & terms to remain competitive.
According to you what are the qualities
of an Ace Banker?
Apart from above, a banker needs to be wellinformed with current events and stock market,
articulate, possess presentation skills. He/she
should possess analytical skills and attention to
detail.
According to you where the Indian
economy heading and what are the
sectors that would steer the Indian
growth story?
Prospects of Indian economy are bright. India
would see the growth story with revival of
MAY 2014
investment and business confidence. Three

major constraints are: persistent food price
inflation, financial distress of most infrastructure
companies, and lack of jobs for young people
entering the workforce. Improvement in these
should be the priority and key agenda of
new govt. New govt has clubbed together few
separate ministries which will improve coordination, effectiveness and speed of decisionmaking. I expect that economic momentum will
be back through decisiveness and improved
confidence overall.
Key sectors are: Food and Agribusiness,
Healthcare, Life Sciences, Media and
Entertainment, Telecommunications, Information
Technology, Infrastructure. These are future
businesses of India. Growth and development
of these sectors would facilitate the overall
development of the country.
31
NIVESHAK
prospectus
FinFunda
of the
Month
Gaurav bharadwaj
IIM Shillong
Sir yesterday my father brought a

document file which he named as a prospectus.
What does that mean sir?
Prospectus is an invitation for investors
to subscribe to shares issued by the concerned
company. It contains all the information
regarding companys key personnel, profitability,
pro-forma statements etc. It also tells investors about the
number of shares that the company would offer and the
price at which shares would be issued.
But sir when I saw the document, it
stated that you can subscribe to the companys
shares within a price band of Rs.45- Rs.60. If
issue price is already disclosed by the company
than, what does this statement mean?
See, prospectus is not of one type.
There are different types of prospectus like
Shelf prospectus, red herring prospectus and
abridged prospectus. So different prospectus
quote prices differently. Some gives a price band and
issue shares through book building and others quote a
single price and issue shares on pro rata basis in case of
over subscription.
Can you please explain different types of
prospectus?
A red herring prospectus does not have
complete particulars on the price of the
securities offered and quantum of securities
to be issued. The front page of the prospectus
displays a bold red disclaimer stating that information in
the prospectus is not complete, and may be changed if
required.
Shelf prospectus is generally issued by banks and
financial institutions for a certain time period mostly 1
year, and it ensures that such financial institutions does

not have to wait for regulatory approvals to raise capital
within stipulated time period.
Abridged Prospectus is a shorter version of the
Prospectus and contains all the salient features of a
Prospectus. It accompanies the application form of public
issues.
Sir! You talked about book building above.
What is it? When is it used?
Book building is a process of price
discovery of shares depending upon the capital
that company wants to raise, and the amount at
which investors bid for the companys shares.
The process is directed towards both the institutional as
well as the retail investors. The issue price is determined
after the bid closure based on the demand generated in
the process.
Sir, institutional investors are so big
and they make bulk purchases of shares of
a company. Dont they get any bulk discount
compared to retail investors who subscribe to
company shares in very small numbers?
No, in case of an IPO or an FPO, everyone
is issued shares of the company at the same
price disregarding the quantity of purchase or
the type on investor. But when a company goes
for an acquisition of equity stake of another
company, than they can get discount on such bulk
purchase of equity.
Thank you so much for all the information
Sir!!!
Classroom
Cover Story
CLASSROOM
32
FIN-Q
1. After PwC acquired Booz and Co, what is its new name?
2. The first commercial cellphone Motorola Dynatac went for sale on March 13, 1984. What
was its price then?
3. X is a metric that comprises of the stocks of the companies associated with a famous
personality Y. Due to the power and influence of this celebrity Y, it is believed by some
analysts that the stocks of index will always outperform their competition. Y also formerly
held a position at the UNHCR. Identify X and Y.
4. This rule prohibits banks from proprietary trading and restricts investment in hedge
funds and private equity by commercial banks and their affiliates. Which rule are we talking about? Name the act which the rule is a part of.
5. Mulberry raised prices of one of its luxury handbags range by 10 per cent. Interestingly,
the demand for this range of handbags doubled. How would you classify this product in
terms of economics?
6. Which countrys foreign market is known as Rembrandt Market?
7. Identify the person and the company he founded

8. Question (Connect the dots)
9. Question (Connect the dots)
All entries should be mailed at niveshak.iims@gmail.com by 10th June, 2014 23:59 hrs One
lucky winner will receive cash prize of Rs. 500/-
33
WINNERS
Prize - INR 1500/-
Yamini Sandeep
IIM Lucknow
FIN - Q
Prize - INR 500/-
Swati Pamnani
IIM Shillong
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Shillong- 793014

Niveshak May, 2014 Issue

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Niveshak May, 2014 Issue

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THE INVESTOR

The Chinese Debt BOMB

FROM EDITORS DESK

04 The Month That Was

Article of the month

The Chinese Debt Bomb

Recent Challenges in Liquidity Management in India

22 Energy Future Holdings Buy- 29 Mr. Rajesh Gupta,

Senior Manager, Leading Private

The Month That Was

The Niveshak Times

retail options for customers. Pure online retailers

For other metals, the auction is in progress and the

farm equipment sectors, said the proposed new

FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

The Month That Was

The Niveshak Times

MARKET CAP (IN RS. CR)

LENDING / DEPOSIT RATES

FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month

Warren Buffett: Can his

All the people in the world of finance must have

tax return in the year 1944.

He used it as a vehicle for future investments in

Article of the Month

Fig 1: Warren Buffet Sector Holdings

rail roads, etc. and holds stakes in blue chip

the dot-com bubble. He has never invested in

Buffet outperformed the broader markets by investing in

Article of the Month

Fig 2: Warren Buffet Style Portfolio Performance

the happy winner of a coin-flipping contest.

upfront and pays claims later, he ventured into

Buffetts success appears neither to be magic nor luck but

to prove that the stock markets are efficient

FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month

that Buffetts skill is mostly in stock selection.

The Chinese Debt Bomb Ticks

pockets of consumer goods companies around

not know exactly what theyre buying into.

of the shadow banking units in China, which

much of the local governments infrastructure

FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

Management, Mr Ruchir Sharma, pointed out

in the vulnerable shadow banking sector, is

unemployment from reaching dangerous levels.

its quite evident that China has less room to

FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

that they have got over leveraged. The situation

In the case of India, the ultimate goals of

liquidity condition. Second was the lack of a

the discount rate was aligned to the MSF rate.

depreciation of the rupee between end-July and

Fig 1: Revised LAF Framework

FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

Article of the Month

Fig 2: Current Dividend Yields of Major Markets

facilitated its range- bound movement. Monetary

of the rupee consequent to the sudden surge in

policy would need to be carefully calibrated

policy and to revert to the LAF repo rate as the

the repo rate was increased by 25 bps to 7.5 per