Assignment Lot Alpha

Team- KATHA
Date: 4th October 2015

Exercise 1:
As per the Serendip Bank, a Secunderabad Product criterion that fits the bill perfectly will be as
follows.
The deposit product name is Easy save-fix-withdraw Product.
The following are the characteristics of the product:
1) The account will be a saving-cum-fixed deposit account.
2) Fixed character A certain amount from the account will be saved as fixed deposit and will
pay interest on that amount. The amount will be fixed according to the customers choice, i.e.
same amount per month or every month it would be different.
3) Saving character- un-fixed amount in the account will be offered a reduced rate of interest.
4) The saving amount can be withdrawn by cheque as per the need of the customer.
5) If fixed amount has to be withdrawn then a certain charges will be charged.
6) A minimum of Rs.1500 should be deposited from which Rs.1000 as fixed deposit and Rs.500
as saving deposit in the account.
7) Interest will be calculated on yearly based.

Exercise 2:
As per the Serendip Bank, Secunderabad Product criteria that fits the bill perfectly for the Nonresident Indian will be as follows.
The deposit product name is Easy save-fix-withdraw- NRI Product.
The following are the characteristics of the product:
1) The account will be a saving-cum-fixed deposit account.
2) Fixed character A certain amount from the account will be saved as fixed deposit and will
pay interest on that amount. The amount will be fixed according to the customers choice, i.e.
same amount per month or every month it would be different (decided at the start of the year)
3) Saving character- Un-fixed amount in the account will be offered a reduced rate of interest.
4) The saving amount can be withdrawn by cheque as per the need of the customer.
5) If fixed amount has to be withdrawn then a certain charges will be charged.
6) A minimum of 5500 should be deposited from which Rs.3000 as fixed deposit and Rs.2500 as
saving deposit in the account.
7) Interest will be calculated on yearly based.
8) The currency will be in Indian Rupees.
9) The account can be maintained by the account individually (NRI) or jointly by a resident.

Exercise 3:
Foreign Currency Non Resident (Bank) Account FCNR (B) Account is the most appropriate bank account for
any NRI. As account can be held in any convertible currency.
As per the Scenario A, B, C, D, E and F we observe that appreciation/ depreciation of Rupees against

Dollar and the confused Anirvan on whether to return to India or not, FCNR is the best option.
According to FCNR:
1) Account holder will be allowed to make a deposit for the period of 1 to 5 years.

2) Account can be held in any convertible currency (USD as per Anirvan) and not necessary in
Indian rupees as in NRE (Non- Resident Rupee) Account.
3) Interest rates:
a. Deposits of maturities, 1 year to less than 3 years, interest shall be paid within the ceiling
rate of LIBOR/ SWAP rates plus 200 basis points for the respective currency/
corresponding maturity.
b. Deposits with maturity of 3-5 years interest shall be paid within the ceiling rate of
LIBOR/ SWAP rates plus 300 basis points.
c. On floating rate deposits, interest shall be paid within the ceiling of SWAP rates for the
respective currency/ maturity plus 200 bps/ 300 bps, as the case may be. For floating rate
deposits, the interest reset period shall be six months.
4) If NRI turns to be a resident, deposits may be allowed to continue till maturity at the
contracted rate of interest, if so desired by him.
Interest type c is a good option for all scenarios as interest reset is six months.
Scenario A & B: Interest rate a is appropriate as tenure is short.
Scenario C & D: interest type b is better as its longer term
Scenario E & F: interest type c only or use combination of interest rate type a and type b.

Exercise 4:
Current account: Its meant for businessmen. These are liquid deposits with no limits in number of
transactions or amount of transaction per day. Bank charges service charges on the account holder. It
needs to have higher minimum balance to be maintained or else penalty. The transaction can be made
in any form i.e. cash, Demand draft, pay order, cheques, internet banking etc. It allows deposit,
withdrawal, transfer of money at any location. Account holding period may be continuous or fixed.
Saving account: There is a limit of number of transactions and amount of transactions on a period,
increase in any of these charges are added. The bank pays the holder a certain amount of interest
every month i.e. 4% to 6% or more depending on the bank. Withdrawal is possible by cheques and
withdrawal slip. Account has no maximum holding period. Loan facility is not allowed but EMI can
be paid.
Term deposit: Its period is fixed (15 days to 10 years) and no transactions can be made. In case of
emergency fixed account can be closed before maturity by deduction of some amount from interest.
Account holders earn higher interest rates. Loan facility is allowed.

Exercise 5:
To hedge against the exchange rate risk, Khazana bank can enter into a FCNR Swap deal with the
RBI. The RBI will accept dollar deposits during the swap window and give Khazana bank the rupee
equivalent. When the swap is unwound, RBI will accept the rupee amount back plus 3.5% interest p.a.
The premium for getting into a currency forward contract is higher than the FCNR swap deal. So, this
will increase the banks margin.

Exercise 6:
a) In the first situation where the interest rate is expected to come down by a minimum of 3% in the
next 3-4 years and remain at that rate for the decades to come I would advise Samrat to go for the

floating rate loan which is indexed to the banks base rate. He can go for the collar which comes at no
additional cost since, interest rates are not going to increase in the near future.
b) In the second situation where the interest rates are expected to very volatile it is better for Samrat to
go for a fixed rate loan of 10.5%. The benefit will be that interest rate will be fixed irrespective of the
market conditions and cash outflow will be steady and certain.

Exercise 7:
To predict credit card defaulters most banks only concentrate on the customer level and product level
characteristics such as the size of the credit, payment history, outstanding balances, etc. In order to
increase the level of prediction other macro factors should also be considered such as national
unemployment rate, performance of the stock market, the type of industry the customer is employed
in.
The model will also allow changes in variables as new information comes into make the model more
dynamic and to improve the accuracy of the model. Some of the change inputs can be,
Partial payment based on the amount received by the bank, the customers likelihood of
future payment can be predicted
ii.
Unanswered calls as the number increases, his willingness to pay back decreases
iii.
Additionally his account can be monitored constantly for the level of stress
If the model predicts a high probability of default, further credit can be declined and the person has to
followed-up regularly to make sure that he pays back the outstanding amount before proving new
credit.
i.

Exercise 8:
Statistics plays a very important role in predicting the financial distress and also the factors which
leads to it. Predictive models can be used to decide who is eligible for credit and on what terms. This
will reduce the credit default risk.
It is very hard to device a mechanism which guarantees zero default because not all inputs can be
captured with 100% accuracy. Also, the variables considered for the model need not be the only ones
leading to default.

Exercise 9:
Maybe youve heard the expression money makes the world go round? Well, that pretty much
describes the way money moves in society sort of in a circle. Money gets to the bank from lots of
sources. First, we know it starts at the Treasury, which keeps banks supplied with the money they
need for their customers. But then theres also money thats already in the economy you know
money from other sources, such as individuals and businesses. That money also goes to banks. So you
see how money gets to the bank, leaves the bank, goes through the economy, and then returns again to
the bank. Money recycles!
Hey Sachin!! Please read how your credit card functions!
1. Merchant(Walmart) calculates the amount of purchase and asks you for payment
2. You present Walmart with your credit card, issued by your company GE

3. Walmart runs credit card through the point of sale unit. The amount of the sale is either handentered or transmitted by the cash register.
4. Walmart transmits the credit card data and sales amount with a request for authorization of
the sale to their acquiring bank (A bank that has a business relationship with a merchant and
receives all credit card transactions from that merchant)
Point of sale units are usually set to request authorization at the time of sale, and then
actually capture the sales draft at a later time.
5. The acquiring bank that processes the transaction, routes the authorization request to the cardissuing bank. The credit card number identifies type of card, issuing bank, and the
cardholder's account.
6. If the cardholder (you-Sachin) has enough credit in their account to cover the sale, the issuing
bank authorizes the transaction and generates an authorization code. This code is sent back to
the acquiring bank.
The issuing bank puts a hold on the cardholder's account for the amount of the sale.
Note that the cardholder's account(your account) has not been actually charged yet.
7. The acquiring bank processing the transaction, and then sends the approval or denial code to
Walmarts point of sale unit. Each point of sale device has a separate terminal ID for credit
card processors to be able to route data back to that particular unit.
8. A sale draft, or slip, is printed out by the point of sale unit or cash register. Walmart asks you
to sign the sale draft, which obligates them to reimburse the card-issuing bank for the amount
of the sale.
9. At a later time, probably that night when the store is closing up, Walmart reviews all the
authorizations stored in the point of sale unit against the signed sales drafts. When all the
credit card authorizations have been verified to match the actual sales drafts, Walmart will
capture, or transmit, the data on each authorized credit card transaction to the acquiring bank
for deposit.
10. The acquiring bank performs what is called an interchange for each sales draft, with the
appropriate card-issuing bank. The card-issuing bank transfers the amount of the sales draft,
minus an interchange fee to the acquiring bank
11. The acquiring bank then deposits the amount of the all the sales drafts submitted by Walmart,
less a discount fee, into Walmarts bank account.

Exercise 10:

Issuing Bank- Jupiter

Advising and Confirming Bank- Vanguard

By confirming a credit at the request or upon the instructions of the issuing bank, the advising bank
becomes liable on the credit as if it had issued it (while of course acquiring rights against the issuing
bank) and it is then known as "the confirming bank".
The judicial system protects the confirming bank against defaults. Vanguard definitely shouldnt
confirm more letters of credit issued by Jupiter!!
Under documentary credit transaction, the main obligation that the issuing bank owned to the
beneficiary is to receive, examine the required documents and make payment

The terms of credit bind both the issuing bank and the advising bank. If case of irrevocable credit, the
issuing bank is obligated to reimburse the relevant bank which has paid or undertaken to pay the
beneficiary. If case of revocable credit, the issuing bank may revoke the credit without incurring an
obligation to notify the beneficiary of the revocation. However, it cannot be revoked after the advising
bank has made the payment or has accepted the documents from the beneficiary in accordance with
the terms of the credit. In such situation, the issuing bank is also obligated to pay.
The issuing bank also has an obligation to reimburse correspondent bank which has made the payment
pursuant to the instructions or the terms of credit.

Exercise 11:
1. A bid bond is often a condition for the consideration of a bid. A bid bond (also called a
tender bond) is issued to ensure that the exporter submits realistic bids under the tender
process and to protect the importer for any loss that might occur if the exporter fails to sign
the contract. A bid bond also assures the importer that the exporter will comply with the terms
of the contract in the event that the tender is accepted. Bid bonds are usually issued for 2% to
5% of the tender amount.
2. An advance payment bond ensures repayment to the importer of an agreed percentage of the
contract amount (typically 10%-30% of the contract amount) if the exporter does not fulfil its
contractual obligations.
3. A performance bond safeguards the importer, should the exporter fail to meet its contractual
obligations. Performance bonds are usually issued for 10% to 20% of the contract amount but
may be fixed by the local law of the importer's country. Obligations under a performance
bond could concern supply obligations or obligations concerning function and quality during
the agreed period of the guarantee.
4. With the supply of factory plant, machinery and other capital goods, it is often agreed that the
buyer may withhold 5%-10% of the contract amount for a guarantee period, for example 12
months after the plant or machine(s) are up and running. The exporter may wish to receive the
full contract amount before the end of the contract period (in the example given above, 12
months) by issuing a retention bond that covers the amount that would otherwise be
withheld. The exporter will request its bank to issue a retention bond in favour of the buyer.
Once the buyer receives the retention bond he will transfer the amount of the bond value
direct to the exporter by international money transfer.

Exercise 12:
Consequences of Exchange Rate risk in the following cases:
i.
ii.
iii.
iv.

Discounting of an export bill not backed by LC

Purchasing of an export bill not backed by LC
Negotiation of a bill drawn under an LC
Overdraft/Working Capital Demand Loan in INR

- Exporter & Importer

- Exporter & Importer
- Exporters Bank
- Exporter

Exercise 13:

Mumbai Electric manufactures should ask for Single letter of credit or revolving letter of
credit from the importers to trade off the credit risk exposure. The revolving letter of credit is
same as the letter of credit, only differs in the payment method.
We will suggest Mumbai Electric to ask for Single letter of credit from the importers. The
importers bank will issue the Single letter of credit or revolving letter of credit on behalf of
importers as a commitment of series of payment by importers. So, the importers will pay the
total amount of shipment in fixed annual instalments for five years once all conditions are
met. If importers default, the importers banks will compensate the Mumbai Electric
manufactures.

Exercise 14:

Performance bank guarantee is also known as performance bond. It is a bank guarantee for
satisfactorily completion of project by contractor issued in the favour of beneficiary and if the
contract party failed to perform the agreed tasks, the beneficiary will get the compensation of
remaining amount by the bank.
In this case, Meta Mart ltd. is beneficiary, while M/s. Ashiyana Constructions a contract party
that goes bankrupt.
In such scenario, Meta Mart can invoke the performance guarantee and will get compensation
of monetary loss incur up to the sum of Rs 25crores (bank guarantee amount)
If invoked, Duniya Bank is obliged to compensate the Meta Mart Ltd. for the loss incur as per
the performance guarantee issued in favour of beneficiary by the contract party.

Exercise 15:

Letter of credit is a type of commitment issued by a bank on behalf of the importer to the
exporter or exports bank for payments assurance if the specified conditions are met by the
exporter. If defaults occurs (importer is unable to pay), the importers bank will recover the
remaining sum of money. While Bank guarantee is an agreement stating that if the buyer is
unable to pay to the seller, the bank will pay the buyers debt to the seller.
Both are almost similar. The key point is that in letter of credit, the issuing bank doesnt wait
for the buyer to default while in bank guarantee, it came into function only when the buyer
defaults or failed to pay.
Difference in the undertaking, in case of letter of credit, the banks undertaking to the
exporter while in Bank guarantee, undertaking on behalf of banks customer.
The difference in undertaking of rupee note & letter of credit is that the rupee note is a
promise to pay cash immediately, while latter is a contract, less liquid & cash will sanction in
the case of default

Exercise 16:

Demand Loan is a type of loan in which the sum of money can be called for complete
repayment without giving any prior warning to the borrower. While the Letter of credit is a
type of commitment issued by a bank on behalf of the importer to the exporter for payments
assurance if the specified conditions are met & if not, the importers bank will recover it.
In the given case, the credit risk exposure to bank is less in letter of credit as compared to
demand loan.
As it is mentioned in the case that the tenor is 1 year. So, if beta defaults, the bank has to
compensate the remaining amount while in case of alpha, if bank feels that alpha is about to
face any downturn then bank can ask for the repayment of remaining instalments but bank has
already sanctioned the loan amount. So, more amount of credit loss in case of alpha.

Exercise 17:

A cash credit working capital facility is a secured option. It allows the option to draw an
amount without having enough credit balance. The amount that can be withdrawn is
determined by the working capital gap and the drawing power of the client.
Working capital demand loan requires a minimum cash credit limit based on the working
capital cycle estimate. The interest on the facility is comparatively lower.
Since the turnover of Tirupathi Textiles is volatile, it is better to take Option Beta which will
be more secure than Option Alpha.
In case of no volatility, it is better to take Option Alpha as the interest rate (calculated as
(0.13*0.5)+(0.09*0.5)) is 11% which is lower than that of Option Beta which is 14%.

Exercise 18:

The term loan requires to be paid within a particular period of time and has a fixed rate.
Whereas, the working capital demand loan has a floating rate and no fixed payment period.
As such, the term loan would require more scrutiny at the time of sanction to know whether
the company can pay the debt within the time. The demand loan would require a continuous
monitoring of the working capital after the issue of credit.
Hence, the demand loan would also carry more credit exposure at a later stage.

Exercise 19:
To address the problem of liquidity requirements in RTGS the banks need to have sufficient balances
in their central bank accounts throughout the day of processing. Gridlock occurs in the event of failure
of execution of certain transfer instructions which causes a delay in other transactions as well. To
avoid such a situation, it is important that transactions are executed simultaneously. The free riding
of cover at the cost of other transactions can also be reduced by having intraday repo agreements with
central banks so that the bank can have enough liquidity for RTGS and then repurchase the securities
at a higher rate on the next day.

Exercise 20:

The hidden dynamite in net settlement system is that in case of a default, the entire payment
system is affected and normal settlement becomes impossible.
If the sender of a payment has low liquidity to settle his balances, the netting of his payments
has to be unwound. This can affect the receivers liquidity which might in turn affect his
receivers liquidity. This can cause a domino effect affecting several banks across the banking
sector.
To stop the domino effect, in case of a default, the banks transactions are removed from the
days transaction and the net positions of other banks are calculated and settled. Banks must
also post collateral for participation and share the losses of the default of at least any single
member.

Exercise 21

Janus Joints makes the RTGS transaction for Rs. 120 Lakhs towards Dimension traders. The
remitting bank, BSB, should be able to transfer the money to the beneficiary bank, Bank of
Kochi, Kannur. And remitting bank BSB goes bankrupt, because of lack or inadequacy of
funds.
BSB, can use its balance maintained under cash reserve ratio maintained with central bank.
Also they could use the intra-day liquidity (IDL), supplied by the Central Bank for RTGS
transactions. The RBI has fixed the IDL limit to three times their net owned fund. The BSB
will be able to make the transfer but will be bankrupt and is liable to pay heavy penalties if
unable to pay the IDC to the central bank. The beneficiary bank will transfer the money
within 30 minutes of receiving the money to Dimension Traders and RBI will have to come
up with a way to either save the BSB or let it collapse depending upon the reason for
bankruptcy.
Also, BSB has enough collateral and the value of each security will not decimate immediately
and BSB could complete the transaction.

Exercise 22

Currency options and forward is both derivative contracts they derive their values from the
underlying asset -- in this case, currency pairs. Currencies always trade in pairs. For example,
the euro/U.S. dollar pair is denoted as EUR/USD
Currency forward obliges the contract buyer to purchase the long currency and pay for it with
the short currency. And in Forwards there is an obligation to full fill the contract on the date
of expiry. But in case of option there is no obligation to full fill the contract, it depends upon
the person who is holding the long position to exercise the right and for person holding short
position has the obligation if other party (long) exercise the right.
Currency option preferred choice because in a long call, the upside potential is higher
(explained by payoff diagram for long option) as the party who has the long position will
have potential of making unlimited profit as the value of underlying increases.
In Currency option the long party pays a premium to the short party buy the option, premium
is the cost of buying right to exercise contract and capping the downward risk. So at
expiration, if the value of the spot value of the underlying is less that its strike price (OTM
option- Out of Money) the long party will not exercise the option and loses the premium to
the short party.

In case of forward contract both long and short party will have an obligation to full fill the
contracts either through cash settlement or delivery mechanism. The only advantage with the
forward contract is that the long party does not have to pay any premium to the short to enter
into a contract but the downside risk is not capped.

Exercise 23
CASE A
As a CEO of Bank Khazana, most preferred target for take-over would be Bank Kalpataru as
its Return on Assets (ROA) and Return on Equity (ROE) of 1.55 and 16.30% respectively is
highest among the peers. ROA of 1.55 means that for every 1% increase in Assets the return
on net income will increase by 55%, operations and management of assets is efficient with
respect to peers. ROE of 16.30% means will provide good returns to bank Khazana
shareholders. Capital adequacy ratio is also highest of 17% which means that Value at risk
(VaR) is minimum among its peers. Also degree of automation is very high which signifies
that high synergies post-merger due to less time taken in transaction process and low cost of
operations.
Case B
Preferred target for Merger/Acquisition Bank Kalpataru
Reasons for Merger:

Diversification entry into the corporate segment

Expanding reach in South India
CRAR is 17% - has a high capital adequacy ratio and is considered safer. Even if unexpected
losses occurs, it is less likely to become insolvent
Return on Assets & ROE are higher compared to other banks
Average age of employees are close to each other easier to integrate & collaborate
Challenges Post-Merger:

No prior experience of handling the corporate segment

CASA ratio is the lowest among the banks sources of funds are costly