acceptance the drawee

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Acceptance The drawee's acknowledgement of the LIABILITY on a BILL OFEXCHANGE, in writing on the instrument itself. A bill may also bear the co-acceptance by a bank, which is a guarantee to honour the instrument in theevent of default by the drawee.

acid test

A stern measure of a company's ability to pay its short term debts, in thatstock is excluded from asset value. (liquid assets/current liabilities) Alsoreferred to as the Quick Ratio.

Accommodation Bill A BILL OF EXCHANGE without any consideration, orquid pro quo. In this case, a person signs a bill and makes himself liable,without receiving any value in return, such as, an advantage or a benefit.

The purpose of accepting such a bill is to accommodate the drawer who istemporarily in need of funds. The acceptance enhances the LIQUIDITY of theinstrument, which can be discounted by the drawer with a bank.

Accrual Basis A method of accounting that recognizes revenues andexpenses as they accrue, even though cash would not have been received orpaid during the accrual period.

ADR An acronym for American Depository Receipt. It is an instrument tradedat U.S. exchanges representing a fixed number of shares of a foreigncompany that is traded in the foreign country. By trading in ADRs, U.S.investors manage to avoid some of the problems of dealing in foreignsecurities markets. The ADR route enables companies to raise funds in theU.S. financial markets, provided they meet the stringent regulatory norms fordisclosure and accounting. (See also GDR.)

Allotment The acceptance of an application subscribing to the shares orother securities of a company. Such allotment establishes the contractualrelationship that underlies an investment through public subscription.

Amortization The reduction of an amount at regular intervals over a certaintime period. This term is used to refer to the reduction of debt by regularpayment of loan installments during the life of a loan. It is also used todescribed the accounting process of writing off an intangible ASSET.

Annual Report A yearly publication that contains particulars relating to the


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operating data of a company, and which is published and distributed by thecompany to its share-holders, as per the requirement of the Companies Act.

The important contents are the profit and loss statement and the BALANCESHEET. These statements show a company's performance in terms of salesand earnings during a financial year, and also its year-end financial positionin terms of ASSETS and LIABILITIES. It also contains the directors' report, anotice to the shareholders about the proposed business agenda of theannual general meeting and the auditor's report.

Arbitrage The simultaneous purchase and sale transactions in a security ora commodity, undertaken in different markets to profit from pricedifferences. For example, an arbitrageur may find that the share of The TataIron and Steel Company (TISCO) is trading at a lower price, at the VadodaraStock Exchange compared to the exchange at Bombay. Hence, he may

simultaneously purchase TISCO stock in Vadodara at, say Rs.250, and sell inBombay at a higher price, say Rs.256, making a profit of Rs.6 per share lessexpenses.

Asset Management Company (AMC) A company set up for floating andmanaging schemes of a MUTUAL FUND. An AMC earns fees by acting as thePORTFOLIO manager of a fund. The AMC is appointed by the Board of

Trustees, which oversees its activities. Thus, a mutual fund is generallyestablished as a trust by a SPONSOR, which could be a registered company,bank or FINANCIAL INSTITUTION. Also, a custodian and a registrar areappointed to ensure safe keeping of the fund's securities and to deal withinvestors' applications, correspondence, etc.

assets

Anything owned by the company having a monetary value; eg, 'fixed' assetslike buildings, plant and machinery, vehicles (these are not assets if rentedand not owned) and potentially including intangibles like trade marksand brand names, and 'current' assets, such as stock, debtors and cash.

asset turnover

Measure of operational efficiency - shows how much revenue is produced per of assets available to the business. (sales revenue/total assets less currentliabilities)


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At-the-Money The term relates to trading in listed OPTIONS. An option issaid to be trading "at-the-money" when the STRIKING PRICE and the marketprice of the underlying share are equal. (See OPTIONS as well as AppendixII).

Badla System An Indian term for a trading system with a mechanism fordeferring either payment for shares purchased or delivery of shares sold. Thesystem, discontinued by the Securities and Exchange Board of India (SEBI),from March 1994, was applicable to A group or 'Specified' shares. Forcarrying forward a purchase transaction from one settlement period to thenext, the buyer normally paid the seller a charge termed badla or'Contango'. This consideration would be fixed in the badla session. Whenbuyers could not take delivery, badla financiers would step in and help outthe buyers. In the reverse but abnormal situation, when the market was in anoversold position and a buyer demanded delivery but the seller could notrespond even by borrowing shares, the buyer would be paid a'Backwardation charge', also known as undha badla. However the buyercould insist on delivery, instead of accepting deferment charges, leading toan auction of the shares in question. The contango or backwardation chargedepended on various factors including the extent of outstanding position,short sales, floating stocks, and the prevailing interest rate. The criticismagainst the badla system has essentially been on two counts: equity andtransparency. The system was slanted in favour of short sellers who could, ina normal market situation, earn interest even without owning the shares sold(it has been argued though, that such short selling helps to checkspeculative and frenzied buying). Also, it was suspected that the contangoand backwardation charges reportedly decided at the badla sessions wereoften untrue. Besides, it appears that the limit of 90 days within which thecarryovers were to be settled, was often exceeded.

Some features of the new system of CARRY FORWARD (CF), introduced atthe Bombay Stock Exchange in January 1996, are :

1. Sale or purchase of transactions may be carried forward up to 75 days.2. Brokers are to classify the transactions, as to whether for delivery or

CF, and report daily.3. Badla sessions will be screen-based.4. Strict monitoring of brokers' positions with the imposition of various

margins: daily, mark-to-market and CF.

A more liberal Modified Carry Forward System based on therecommendations of the J. S. Varma committee was introduced in 1997.Salient features of the new system include an increase in the overall carry


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forward limit per broker, reduction in daily margin and removal of the limiton financiers.

Balance of Payments A statement that contains details of all the economictransactions of a country with the rest of the world, for a given time period,

usually one year. The statement has two parts: the Current Account and theCapital Account.

The 'Current Account' gives a record of a country's: (a) Trade Balance whichshows the difference of exports and imports of physical goods such asmachinery, textiles, chemicals and tea, (b) 'Invisibles' that comprise services(rendered and received) such as transportation and insurance and certainother flows, notably private transfers by individuals. When imports of goodsexceed exports, it is referred to as a 'Trade Deficit'. However, the overallcurrent account position depends on both the trade balance and theperformance of 'Invisibles'.

The 'Capital Account' contains details of the inward and outward flows of capital and international grants and loans. Examples of such flows areexternal assistance, foreign (direct and PORTFOLIO) investments,subscription to Global Depository Receipts or EUROCONVERTIBLE BONDS anddeposits of non-residents. Inflows on the capital account are helpful infinancing a current account DEFICIT. Any gap that remains is covered bydrawing on exchange or gold reserves, or by credit from the InternationalMonetary Fund. Depending on the nature of imports, a deficit on the currentaccount indicates an excess of investment over domestic saving in aneconomy. So long as this deficit is kept in check (evaluated as a percentage

of the CROSS DOMESTIC PRODUCT), the DEBT SERVICE RATIO would remainwithin manageable limits.

A challenge posed to India some years ago was the upward pressure on theRupee's exchange rate in the wake of large capital account inflows. So, tomaintain the competitiveness of India's exports, the Reserve Bank of India(RBI) resorted to purchases of foreign exchange. However, this has alsocaused money supply to increase, and the RBI has had to 'sterilize' suchmonetization by raising the CASH RESERVE RATIO or by engaging in OPENMARKET OPERATIONS.

Balance Sheet A statement of the financial position of an enterprise, as ona certain date, and in a certain format showing the type and amounts of thevarious ASSETS owned, LIABILITIES owed, and shareholder's funds.

balance sheet


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The Balance Sheet is one of the three essential measurement reports for theperformance and health of a company along with the Profit and Loss Accountand the Cashflow Statement. The Balance Sheet is a 'snapshot' in time of who owns what in the company, and what assets and debts represent thevalue of the company. (It can only ever nbe a snapshot because the picture

is always changing.) The Balance Sheet is where to look for informationabout short-term and long-term debts, gearing (the ratio of debt to equity),reserves, stock values (materials and finsished goods), capital assets, cashon hand, along with the value of shareholders' funds. The term 'balancesheet' is derived from the simple purpose of detailing where the moneycame from, and where it is now. The balance sheet equation isfundamentally: (where the money came from) Capital + Liabilities = Assets(where the money is now). Hence the term 'double entry' - for every changeon one side of the balance sheet, so there must be a corresponding changeon the other side - it must always balance. The Balance Sheet does not showhow much profit the company is making (the P&L does this), although

pervious years' retained profits will add to the company's reserves, which areshown in the balance sheet.

Bank Guarantee The financial guarantees and performance guaranteesissued by banks on behalf of their clients. A financial guarantee assuresrepayment of money. (e.g. an advance received on an electrificationcontract), in the event of non-completion of the contract by the client. Aperformance guarantee provides an assurance of compensation in the eventof inadequate or delayed performance on a contract. A deferred paymentguarantee promises payment of installments due to a supplier of machinery

or equipment.Bank Rate The rate of interest charged by the Reserve Bank of India (RBI)on financial accommodation extended to banks and FINANCIALINSTITUTIONS. The support is provided in the form of a bills rediscountingfacility and advances or REFINANCE against specified ASSETS (e.g.

TREASURY BILLS and DATED SECURITIES) or PROMISSORY NOTES.

The intent behind changing the Bank Rate at certain junctures is to raise orlower the cost of funds that banks obtain from the RBI. This, in turn, wouldalter the structure of banks' interest rates and thereby serve to curb orencourage the use of credit. However, the Bank Rate is a relatively passiveinstrument of credit control. In the wake of the East Asian currency crisis, theRBI used the Bank Rate in conjunction with the CASH RESERVE RATIO andother measures to stabilize the exchange rate of the Rupee.

In recent times, it has been RBI's endeavor to make the Bank Rae andeffective signaling device as well as a reference rate. However, sincefrequent changes in the Bank Rate may be undesirable, the short-term


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REPOS interest rate seems to be a useful supplement in influencing the flowand cost of funds in the short term.

Bear A person who expects share prices in general to decline and who islikely to indulge in SHORT SALES.

Bear Market A long period of declining security prices. Widespreadexpectations of a fall in corporate profits or a slowdown in general economicactivity can bring about a bear market.

Beta (b) A measure of the volatility of a stock in relation to the market. Morespecifically, it is the index of SYSTEMATIC RISK, indicating the sensitivity of return on a security or a PORTFOLIO to return from the market. It is the slopeof the regression line, known as the CHARACTERISTIC LINE, which shows therelationship of an ASSET with the market. For measuring market returns, aproxy such as a broad-based index is used. Thus, if b exceeds 1, the security

is more volatile than the market, and is termed an 'Aggressive Security'. Forexample, a beta of 1.3 implies that a security's return will increase by 13percent when the return from the market goes up by 10 percent. An assetwhose beta is less than 1 is termed a 'defensive security'. Based on this, anaggressive growth strategy would be to invest in high beta stocks when themarket is poised for an upswing; similarly, a switchover to low beta stocks isrecommended when a downswing is imminent.

Bills of Exchange A credit instrument that originates from the creditor(drawer) on which the DEBTOR (drawee) acknowledges his LIABILITY; aftersuch acceptance, the drawer may get the bill discounted, so as to realize theproceeds immediately. As an illustration, consider the following :

Hindustan Rasayan, a supplier of chemicals, draws a 90- day bill of Rs.6,20,000 on Indian Parma Corporation (drawee) directing the drawee tomake payment at the end of 90 days to or to the order of Pyramid FinanceLimited (payee).

After the drawee accepts the bill, it is discounted with Pyramid Finance at aDISCOUNT RATE of 20 percent per annum. Hindustan Rasayan thus receives

$6,20,000 x (1 (90/365 x 20/100)) = Rs.5,89,425

The effective interest rate works out to 21 percent :

6,20,000 5,89,425 365

-------------------------------5,89,425 90

Blue Chip A share of a company that is financially very sound, with an


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impressive track record of earnings and DIVIDENDS, and which is highlyregarded for its competent management, quality products and/or services.Examples in India are Hindustan Lever, Gujarat Ambuja Cements, and Reckitt& Colman among others.

Bond A long-term debt instrument on which the issuer pays interestperiodically, known as 'Coupon'. Bonds are secured by COLLATERAL in theform of immovable property. While generally, bonds have a definiteMATURITY, 'Perpetual Bonds' are securities without any maturity. In the U.S.,the term DEBENTURES refers to long-term debt instruments which are notsecured by specific collateral, so as to distinguish them from bonds.

Bond Insurance A form for credit enhancement, which provides a financialguarantee on the obligations of a debt instrument. The purpose of creditenhancement is to increase the safety of debt securities. Apart from financialguarantees, other forms of credit enhancement include letter of credit,

overcollateralization, etc. Overcollateralization involves the provision of additional assets as security.

Bonus Shares The issue of shares to the shareholders of a company, bycapitalizing a part of the company's reserves. The decision to issue bonusshares, or stock DIVIDEND as in the U.S., may be in response to the need tosignal an affirmation to the expectations of shareholders that the prospectsof the company are bright; or it may be with the motive of bringing down theshare price in absolute terms, in order to ensure continuing investor interest.Following a bonus issue, though the number of total shares increases, theproportional ownership of shareholders does not change. The magnitude of abonus issue is determined by taking into account certain rules, laid down forthe purpose. For example, the issue can be made out of free reservescreated by genuine profits or by share PREMIUM collected in cash only. Also,the residual reserves, after the proposed capitalization, must be at least 40percent of the increased PAID-UP CAPITAL. These and other guidelines mustbe satisfied by a company that is considering a bonus issue. )See alsoMARKET CAPITALIZATION.)

Book Building A process used to ascertain and record the indicativesubscription bids of interested investors to a planned issue of securities. The

advantages of this technique of obtaining advance feedback, are that itresults in optimal pricing and removes uncertainty regarding mobilization of funds.

The concept of book building is alien to India's PRIMARY MARKET; so, towardsthe end of 1995, efforts were under way, to introduce this mechanism as anoption in the case of large issues (minimum size: Rs.100 crore). An issue wasdivided into a 'Placement Portion' and another termed 'Net Offer to the


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Public'. For the Placement Portion, the exercise of book building enables theissuing company to interact with institutional and individual investors, andcollect particulars of the number of shares they would buy at various prices.

The procedure is carried out by a lead manager to the issue, called the 'BookRunner'. It commences with the circulation of a preliminary PROSPECTUS and

an indicative price band, for the purpose of forming a syndicate of underwriters, comprising FINANCIAL INSTITUTIONS, MUTUAL FUNDS andothers. This syndicate, in turn, contacts prospective investors in order toelicit their quotes. These quotes are forwarded to the book runner, whoprepares a schedule of the size of orders at different prices. After receiving asufficient number of orders, the company and the merchant bankers decidethe issue price and underwriting particulars. There are some other aspects of book building arising from the guidelines issued by the Securities andExchange Board of India. A change brought about in 1997 was that the bookbuilding process could be applied to the extent of 100 percent of the issuesize, for large issues as defined above. Interestingly, the process has been

used in India to place debt securities as well.Book Value It is the amount of NET ASSETS that would be available perEUQUITY SHARE, after a company pays off all LIABILITES includingPREFERENCE SHARES from the sale proceeds of all its ASSETS liquidated atBALANCE SHEE values.

Bought-out Deal The sale of securities under a negotiated agreementbetween an issuer and the investing institution, as an alternative to a PUBLICISSUE. The intent on the part of the buyer is to offload the securities later in

the market at a profit. Bought-out deals are commonplace in issues of theOver the Counter Exchange of India (OTCEI). The advantage to the issuingcompany is the saving in time and cost that a public issue would entail. It is abig help to unlisted companies and projects, which must see through agestation period before tapping the PRIMARY MARKET. For institutions andMUTUAL FUNDS, the route is another avenue for investing funds. However,there could be some disadvantages to the issuer such as interference by theINSTITUTIONAL INVESTOR or restrictive CONVENANTS in the initialsubscription agreement. On the other hand, the institutional investor or thesponsor in OTCEI deals, bears the risk of capital loss due to a fall in the priceof the securities.

Break-even Point The point where the revenues from a business operationequal the total costs (FIXED COSTS = VARIABLE COSTS). Thus, a profitaccrues when revenues exceed the break-even point. The break-evenvolume is computed by dividing the fixed costs (FC) by the differencebetween the selling price per unit (SP) and variable cost per unit (VC). Forinstance, if FC is Rs.4,000, VC is Rs.60 and SP is Rs.85, the break-evenvolume is 4,000/(85-60) = 160 units of output.


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The break-even point in terms of revenues can be determined by dividingthe fixed costs by the contribution margin ((SP-VC)/SP). Thus.

4000 =Rs.13,600

((85-60)/85)

which equals the revenues at 160 units.

Bridge Loan A short-term loan granted to a borrower to tide over atemporary funds shortage. Such an accommodation is usually arranged atthe time of a PUBLIC ISSUE, when expenditures on a project lead to aDEFICIT, thereby necessitating a bridge loan.

Budget A financial plan that projects receipts and payments of an entitycovering a specific period of time, usually one year. Its primary purpose is toachieve financial control. Budgets could be distinguished on the basis of timespan, function and flexibility. For instance, budgets may be short-term orlong-term; similarly, there are Sales Budgets, Cash Budgets, CapitalExpenditure Budgets and other to cover different functions.

Budget

In a financial planning context the word 'budget' (as a noun) strictly speakingmeans an amount of money that is planned to spend on a particularlyactivity or resource, usually over a trading year, although budgets apply toshorter and longer periods. An overall organizational plan therefore containsthe budgets within it for all the different departments and costs held bythem. The verb 'to budget' means to calculate and set a budget, although ina looser context it also means to be careful with money and find reductions(effectively by setting a lower budgeted level of expenditure). The wordbudget is also more loosely used by many people to mean the whole plan. Inwhich context a budget means the same as a plan. For example in the UK the Government's annual plan is called 'The Budget'. A 'forecast' in certaincontexts means the same as a budget - either a planned individualactivity/resource cost, or a whole business/ corporate/organizational plan. A'forecast' more commonly (and precisely in my view) means a prediction of performance - costs and/or revenues, or other data such as headcount, %performance, etc., especially when the 'forecast' is made during the tradingperiod, and normally after the plan or 'budget' has been approved. In simpleterms: budget = plan or a cost element within a plan; forecast = updated


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budget or plan. The verb forms are also used, meaning the act of calculatingthe budget or forecast.

Bull A person who expects share prices in general to move up and who islikely to take a long position in the stock market.

Business Risk The risk of business failure, which stems from factors such asthe cost structure of a venture (i.e., FIXED COST versus VARIABLE COST),intra-industry competition, and government policies. It is reflected in thevariability of profits before interest and taxes.

Call Money A term used for funds borrowed and lent mainly by banks for

overnight use. This is a market, which banks access in order to meet theirreserve requirements or to cover a sudden shortfall in funds and the interestrate is determined by supply and demand conditions. The situation ariseswhen banks face an unforeseen shortfall in funds, perhaps because theyhave invested a large amount in other ASSETS, e.g., GOVERNMENTSECURITIES and loans or due to heavy withdrawals by depositors for differentreasons. High call money rates are an indication of such a mismatch or of adeliberate policy to substantially borrow short-term and lend long-term. Themore stringent requirements relating to the Cash Reserve Ratio from January1995, particularly the severe penalty for default, has also forced banks toborrow short-term; this explains the sudden but short-lived jumps in the callmoney rate.

An alternative source for banks would be to do REPOS deals with theDiscount and Finance House of India (DFHI) or Securities Trading Corporationof India (STCI), using the excess security holdings. Incidentally, DFHI is alsoan active intermediary in the call money market. Besides, certain FINANCIALINSTITUTIONS and corporate entities (through PRIMARY DEALERS) have alsobeen permitted to participate as lenders. The announcement by the ReserveBank of India (RBI) in April, 1995 to permit private sector MUTUAL FUNDS tolend in the call money/NOTICE MONEY/BILL REDISCOUNTING market mayalleviate the situation considerably. Incidentally, this measure also provides

these entities a facility for parking short-term funds. Ultimately, though, theRBI intends to make the call money/notice money/term money market into apurely inter-bank market, with the additional involvement of PrimaryDealers. Accordingly, the REPOS market is being widened and developed forthe benefit of non-bank participants, who may be permitted to do reposdeals (i.e., borrowing funds) as well. Further, the underlying eligiblesecurities will include PSU BONDS, corporate BONDS, and others indematerialized form. Moreover, the participation of non-banks in the


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call/notice money market is to cease by the end of 1999.

Capital Adequacy Ratio A requirement imposed on banks to have a certainamount of capital in relation to their ASSETS, i.e., loans and investments as acushion against probable losses in investments and loans. In simple terms,

this means that for every Rs.100 of risk-weighted assets, a bank must haveRs. X in the form of capital. Capital is classified into Tier I or Tier II. Tier Icomprises share capital and disclosed reserves, whereas Tier II includesrevaluation reserves, hybrid capital and subordinated debt. Further, Tier IIcapital should not exceed Tier I capital. The risk weightage depends upon thetype of assets. For example, it is zero on government guaranteed assets, 20percent on short-term bank claims on 100 percent on private sector loans.(Risk weights on GOVERNMENT SECURITIES are being introduced.) Thecapital adequacy ratio is percentage of total capital funds to the total risk-weighted assets.

The capital risk-weighted assets ratio system introduced by the ReserveBank of India (RBI) in 1992, in accordance with the standards of the Bank forInternational Settlements (BIS), had set the deadlines indicated below.Subsequently, RBI had to extend the deadline in some cases up to March1997.Institutions Norm DateForeign banks operating in India 8% 31-Mar-93Indian banks with branches abroad 8% 31-Mar-95All other banks 8% 31-Mar-96

The ratio is being raised to 9%, to take effect from March 31, 2000.

The impact of this system on Indian banks was reflected in the increaseddemand for capital and changes in the composition of assets. The trend of fund-raising by banks through equity and other issues, as well as theaccumulation of GOVERNMENT SECURITIES should be seen in thisperspective.

To shore up the capital position of public sector banks, the Government of India has injected several thousand crore rupees in the last few years. Thisinfusion is reflected in the banks' investment in Government BONDS knownas 'Recapitalization Bonds'. Incidentally, capital adequacy norms have alsobeen announced for term-lending institutions and NON-BANKING FINANCIALCOMPANIES. See also NARASIMHAM COMMITTEE (1998).

Capital Asset Pricing Model (CAPM) A theoretical construct, developed byWilliam Sharpe and John Lintner, according to which, a security's return isdirectly related to its SYSTEMATIC RISK, that is, the component of risk which


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cannot be neutralized through DIVERSIFICATION. This can be expressed as :

Expected rate of return Risk-free rate of return + Risk premium

Further, the model suggests that the prices of ASSETS are determined insuch a way that the RISK PREMIUMS or excess returns are proportional tosystematic risk, which is indicated by the BETA coefficient. Accordingly, therelationship

Risk Return on Risk-free (Beta of premium market portfolio return security)

Determines the risk premium. Thus, according to the model, the expectedrate of return is related to the beta coefficient. This relation is portrayed bythe SECURITY MARKET LINE.

Capital Market Line This is a graphical line which represents a linearrelationship between the expected return and the total risk (standarddeviation) for efficient PORTFOLIOS of risky and riskless securities. Whenlending and borrowing possibilities are considered, the capital market linebecomes the EFFICIENT FRONTIER starting from the riskless rate for the pointof tangency on the efficient frontier of portfolios.

capital employed

The value of all resources available to the company, typically comprisingshare capital, retained profits and reserves, long-term loans and deferredtaxation. Viewed from the other side of the balance sheet, capital employedcomprises fixed assets, investments and the net investment in workingcapital (current assets less current liabilities). In other words: the total long-term funds invested in or lent to the business and used by it in carrying outits operations.

cashflow

The movement of cash in and out of a business from day-to-day direct

trading and other non-trading or indirect effects, such as capital expenditure,tax and dividend payments.

cashflow statement

One of the three essential reporting and measurement systems for anycompany. The cashflow statement provides a third perspective alongside theProfit and Loss account and Balance Sheet. The Cashflow statement shows


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the movement and availability of cash through and to the business over agiven period, certainly for a trading year, and often also monthly andcumulatively. The availability of cash in a company that is necessary to meetpayments to suppliers, staff and other creditors is essential for any businessto survive, and so the reliable forecasting and reporting of cash movement

and availability is crucial.

Capital Reserves The reserves created in certain ways, that include thesale of FIXED ASSETS at a profit. These amounts are regarded as notavailable for distribution as DIVIDENDS.

Cash Reserve Ratio (CRR) A legal obligation on all SCHEDULED COMMERCIALbanks excluding REGIONAL RURAL BANKS to maintain certain reserves in theform of cash with the Reserve Bank of India (RBI). The reserves, to bemaintained over a fortnight, are computed as a percentage of a bank's netdemand and time LIABILITIES. Banks earn interest on eligible cash balancesthus maintained and it contributes to their profitability. However, suchinterest payment tends to attenuate monetary control, and hence theseoutflows need to be moderated if the situation so demands. An alternativethat has been suggested is to fix a lower level of reserves and pay a modestinterest.

Central Bank The premier bank in a country that discharges theresponsibilities of issuing currency, managing MONEY SUPPLY by appropriatemeasures in order to maintain price stability and economic growth,maintaining the exchange value of the domestic currency, superintendenceand regulation of the commercial banks, etc. In India, the Reserve Bank of India (RBI) is the Central Bank. RBI, therefore, carries out the dutiesmentioned above, and also acts as a banker to the Central and StateGovernments. Besides this, it also manages the public debt, i.e., fund-raisingprogrammes of the government.

Chakravarty Committee A committee set up by the Reserve Bank of India(RBI), under the chairmanship of S. Chakravarty to appraise the working of the monetary system and suggest measure for improving the effectivenessfo monetary policy in promoting economic development. In its reportsubmitted in April 1985, the committee made several recommendations toreform the financial system including :

1. MONETARY TARGETING as a policy tool, that is, controlled increase inmoney supply to maintain price stability while facilitating increase inreal output.

2. Removal of ceilings on interest rates on bank loans to the non-prioritysectors and on call loans.


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3. Upward revision on interest rates on TREASURY BILLS andGOVERNMENT SECURITIES. Selling marketable securities to the public(instead of the RBI) at attractive YIELDS would avoid the excessivecreation of money.

Chelliah Committee A committee on tax reforms constituted by theGovernment of India in 1991, under the chairmanship of Raja Chelliah. Itsrecommendations encompass the areas of corporate taxes, customs andexcise duties, and personal income taxes. Among its numerous suggestionsaimed at improving revenue buoyancy and simplicity are the following :

1. Reduction of the corporate tax rate on domestic companiesprogressively to 40 percent.

2. Introducing of the system of 'Presumptive Taxation' for groups such assmall traders, contractors, transport operators and others.

3. Simplification of the excise duty structure and a move towards a Value

Added Tax (VAT) system covering commodities and services.4. Substantial reductions in import tariffs and excise duties in a phasedmanner.

5. Levying taxes on the service sector to cover stock-brokers, telephoneservices and insurance contracts among others.

Chore Committee A working group appointed by the Reserve Bank of India(RBI), in 1979, to review the operation of the CASH CREDIT SYSTEM, tosuggest improvements in the same, as well as to propose alternative typesof credit facilities in order to ensure greater discipline and a more productiveuse of credit. The group headed by K. B. Chore of the RBI made several

recommendations including :

1. To administer lending under method II of the TANDON COMMITTEEnorms.

2. In assessing credit requirements, banks should appraise and fixseparate limits for the normal level and for peak level needs.

3. Simplification of the Quarterly Information System (QIS) and penaltyfor delay in submitting the reports.

4. Establishment of a discount house in India.

Chit Fund This is a non-banking financial intermediary. A chit fund scheme

typically involves the collection of periodic subscriptions from enrolledmembers, which is then disbursed as a loan to a member. The member isselected either by lot or through an auction. The promoter is also called the'Foreman' and the capital given out is called 'Prize Money'.

Closed-end Fund A scheme of an investment company in which a fixednumber of shares are issued. The funds so mobilized are invested in avariety of vehicles including shares and DEBENTURES, to achieve the stated


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objective, e.g., capital appreciation for a GROWTH FUND or current incomefor an INCOME FUND. After the issue, investors may buy shares of the fundfrom the secondary market. The value of these shares depends on the NETASSET VALUE of the fund, as well as supply and demand for the fund'sshares. Examples are Mastershare and Ind Ratna.

Commercial Paper (CP) A short-term, unsecured PROMISSORY NOTE issuedby BLUE CHIP companies. Like other MONEY MARKET instruments, it is issuedat a DISCOUNT on the FACE VALUE and is freely marketable. CommercialPaper may be issued to any person including individuals, banks andcompanies. The Reserve Bank of India (RBI) has laid down certain conditionsregarding issue of CPs. The issuing company must have a certain minimumtangible NET WORTH, working capital limit, asset classification, etc. and thepaper must have a CREDIT RATING of P2, A2 or PR-2. Moreover, the ratingmust not be over two months old at the time of issue. From November 1996,the extent of CP that can be issued by all eligible corporates has been raised

to 100 percent of the working capital credit limit. As for restoration of thelimit consequent on redemption of CP, banks have been given freedom todecide on the manner of doing so.

Commodity Futures A standardized contract guaranteeing delivery of acertain quantity of a commodity (such as wheat, soybeans, sugar or copper)on a specified future date, at a price agreed to, at the time of thetransaction. These contracts are standardized in terms of quantity, qualityand delivery months for different commodities. Contracts on certaincommodities such as pepper and coffee are already traded in India.Moreover, the Kabra Committee in 1994 recommended that futures trading

be permitted in several other commodities including rice, cotton, Soya beanand castor oil. Further, in an interesting development, a committeeappointed by the Reserve Bank of India under the chairmanship of R.V.Gupta has recommended that Indian corporates be allowed to hedge inoffshore futures and OPTIONS markets in a phased manner. The committeesubmitted its report in November 1997. (See also Appendix II).

Consortium A term generally used in banking: it refers to a group of banksassociating for the purpose of meeting the financial requirements of aborrower, such as WORKING CAPITAL or a term loan. In business, the termapplies to a group of companies, national or international, working together

as a joint venture, sharing resources and having interlocking financialagreements.

Contingent Liabilities The liabilities that may arise as a result of somefuture event which, though possible, is deemed unlikely; for example, a court

judgement on a pending lawsuit may impose a financial payment on acompany.


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Corporate Governance The manner in which a company is managed. Theterm, Corporate Governance connotes the importance of responsibility andaccountability of a company's management to its shareholders and otherstakeholders, viz., employees, suppliers, customers and the local community.Hence it calls for ethics, morals and good practices in running a company.

Good corporate governance would be reflected in generally goodperformance, clean business practices, improved disclosure and soundpolicies relating to capital expenditure, financing and dividend payment,which will enhance shareholders' wealth.

Cost of Capital The weighted average cost for long-term funds raised by acompany from different sources such as term loans, DEBENTURES/BONDS,PREFERENCE SHARES, EQUITY SHARES and retained earnings.

Cost of Goods Sold Alternatively called the Cost of Sales, it is the sum of total input costs associated with a certain quantity of goods sold. The total

input costs include materials used, direct and indirect labour, utilities, andother manufacturing expenses including DEPRECIATION.

cost of debt ratio (average cost of debt ratio)

Despite the different variations used for this term (cost of debt, cost of debtratio, average cost of debt ratio, etc) the term normally and simply refers tothe interest expense over a given period as a percentage of the averageoutstanding debt over the same period, ie., cost of interest divided byaverage outstanding debt.

cost of sales (COS)

Commonly arrived at via the formula: opening stock + stock purchased -closing stock.

Cost of sales is the value, at cost, of the goods or services sold during theperiod in question, usually the financial year, as shown in a Profit and LossAccount (P&L). In all accounts, particularly the P&L (trading account) it'simportant that costs are attributed reliably to the relevant revenues, or thereport is distorted and potentially meaningless. To use simply the total valueof stock purchases during the period in question would not produce the

correct and relevant figure, as some product sold was already held in stockbefore the period began, and some product bought during the periodremains unsold at the end of it. Some stock held before the period oftenremains unsold at the end of it too. The formula is the most logical way of calculating the value at cost of all goods sold, irrespective of when the stockwas purchased. The value of the stock attributable to the sales in the period(cost of sales) is the total of what we started with in stock (opening stock),


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and what we purchased (stock purchases), minus what stock we have leftover at the end of the period (closing stock).

current assets

Cash and anything that is expected to be converted into cash within twelvemonths of the balance sheet date.

current ratio

The relationship between current assets and current liabilities, indicating theliquidity of a business, ie its ability to meet its short-term obligations. Alsoreferred to as the Liquidity Ratio.

current liabilities

Money owed by the business that is generally due for payment within 12months of balance sheet date. Examples: creditors, bank overdraft, taxation.

Coupon Rate It is the rate of annual interest on the PAR VALUE of DEBENTURES or BONDS that an issuer promises to pay. In India, till a fewyears ago, coupon rates were subject to a ceiling stipulated by the Controllerof Capital Issues. With the removal of the ceiling, issuers have fixed theircoupon rates by taking into consideration, market perceptions andexpectations. The rate may be fixed or it may be floating in relation to somebenchmark.

Credit Rating The exercise of assessing the credit record, integrity andcapability of a prospective borrower to meet debt obligations. Credit ratingrelates to companies, individuals and even countries. In the case of acompany's debt instrument, such formal evaluation with the aid of quantitative and qualitative criteria, culminates in the assignment of a letterrating to the security. The instrument could be a DEBENTURE, FIXEDDEPOSIT OR COMMERCIAL PAPER. The rating represents in rating agency'sopinion at that time on the relative safety of timely payment of interest andprincipal associated with the particular debt obligation. This opinion rests onthe agency's assessment of the willingness and capability of the issuer tomeet the debt obligations. The methodology is to examine key factors likethe business, the management, regulatory environment, competition andfundamental aspects including the financial position. A high credit rating canhelp in reducing the interest cost and also facilitate placement of the debtsecurity. The rating agencies in India are Credit Rating and InformationServices of India Limited (CRISIL), ICRA, and Credit Analysis and Research


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(CARE).

A recent development in India is the rating of fixed deposits of banks,STRUCTURED DEBT OBLIGATIONS and securitized debts. Moreover,performance ratings can now be obtained by real estate developers and LPGbottlers. It is expected that ratings will soon be extended to chit funds andMUTUAL FUNDS, Besides, a general credit rating service not linked to anydebt issue may be availed of by a company. This service is already offeredby Indian rating firms. CIRSIL, for example, calls it Credit Assessment. Thisrating can be used in negotiations with new bankers, for performanceguarantees, etc. International rating agencies also undertake sovereignrating, i.e. of countries.

Credit appraisal also covers individuals. This type of information is useful to

consumer credit firms

Cross Currency Option An instrument that confers a contractual right onthe purchaser of the OPTION to buy (call) or sell (put) a currency againstanother currency, e.g., Yen for U.S. dollar. For this privilege, the purchaserpays a cost termed PREMIUM. Incidentally, the terminology applicable tocross currency options is similar to the one for stock options. For instance,the STRIKE PRICE is the contracted exchange rate at which the option buyerbuys or sells a currency. The advantages with a cross currency option,(introduced in India in January 1994) as compared to forward and futuresdeals are that the option buyer is under no obligation to exercise the right;moreover, the maximum possible loss, it at all, becomes known to the optionbuyer at the outset. Thus, when the direction of a currency's movement isuncertain, a cross currency option may be preferable to a FORWARDCONTRACT.

Current Assets The assets which are expected to be converted into cash orconsumed during the 'Operating Cycle' of a business. The operating cycle isthe time taken for the sequence of events from the purchase of raw

materials to the collection of cash from customers for goods sold. Hence, it isalso known as the 'Cash Conversion Cycle'. However, if raw materials arebought on credit, then the cash conversion cycle is shorter than theoperating cycle by the period of credit available. Examples of current assetsare cash, short-term investments particularly MONEY MARKET securities, rawmaterials, work-in-process, finished goods, and ACCOUNTS RECEIVABLE.


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Current Liabilities The claims against a company that will become duewithin a year. These are mainly LIABILITIES on account of purchase of materials or services rendered to the firm. Examples include accounts andPROMISSORY NOTES payable, as well as taxes and loan repayments fallingdue within the year. Current Ratio This ratio is a measure of a company'sability to pay its short-term debts as they become due. It is computed from aBALANCE SHEET by dividing CURRENT ASSETS by CURRENT LIABILITIES. InIndia, the general norms for this liquidity ratio is 1.33

Debenture A debt security issued by companies, having a certain MATURITYand bearing a stated COUPON RATE. Debentures may be unsecured orsecured by ASSETS such as land and building of the issuing company.Debenture holders have a prior claim on the earnings (coupon) and ASSETS

in the event of liquidation, as compared to PREFERENCE and equityshareholders. (See also BOND, DEBENTURE REDEMPTION RESERVE andDEBENTURE TRUSTEE.)

Debenture Redemption Reserve (DRR) The term is given to thereserves that are to be compulsorily created by companies for the expresspurpose of retiring DEBENTURES issued by them whose MATURITY exceeds18 months. Before redemption commences, the reserves (DRR) mustcumulate to 50 percent of the amount of debentures issued.

Debenture Trustee The third party to a DEBENTURE issue, with whom the

TRUST DEED is executed and who must ensure that the issuer abides by thepromises, pledges and restrictions relating to the DEBENTURE issue. The roleof the trustee is that of a watchdog who acts on behalf of the debentureholders. (See also TRUST DEED.)

Debt Service Coverage Ratio (DSCR) A ratio used to assess the financialability of a borrower to meet debt obligations. While appraising loandrequests, lending institutions ascertain the debt servicing capacity fromfinancial projections submitted, by computing the ratio of cash accruals plusinterest payments (on term loans) to the sum of interest and loanrepayments :

DSCR = Profits after taxes DEPRECIATION + InterestchargesInterest charges + Loan repayments

The figures in the numerator and denominator are typically aggregated for10 years in working out the DSCR.

Debt-Equity Ratio This ratio is used to analyze FINANCIAL LEVERAGE. It is astructural ratio that gauges the level of debt financing, and is worked out by


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dividing total debt, short-term and long-term, by NET WORTH. Thedenominator would comprise total equity of common stockholders andPREFERENCE capital.

Deficit In general, it connotes a shortfall. In the context of a BUDGET, it

refers to the excess of expenditure over revenues during a certain period.However, there are specific measures of deficit used in India for a financialyear, as described below :

Revenue Deficit The excess of expenditure over receipts in the revenueaccount fo the Government of India. Receipts include taxes and non-taxrevenues such as interest and DIVIDENDS and also grants. Some fo theexpenditure items are interest, SUBSIDIES, certain defense outflows,salaries, pensions etc. Thus, the revenue deficit is a good indicator of whether the government is living within its means. The recent phenomenonof high levels of revenue deficit financed by borrowings to meet consumption

expenditure has ominous implications. Whereas outflows on account of interest charges and loan repayments will go up, the creation of productiveASSETS decelerates, as funds are diverted to current expenditure.

In the Union Budget 1996-97, it was proposed that a high-level, 'ExpenditureManagement and Reforms Commission', be appointed to tackle the issue of public expenditure management and control concerning the CentralGovernment.

Budget Deficit The figure that results by subtracting the total expenditures(on revenue and capital accounts) from the total receipts (on revenue and

capital accounts) of the Government of India. The budget deficit is financedthrough the issue of Ad hoc TREASURY BILLS and/or by drawing down cashbalances with the Reserve Bank of India. As mentioned above, revenuereceipts include tax and non-tax revenues. Capital receipts compriserecovery of loans, proceeds from the sale of government assets andborrowings other than through Treasury Bills. Capital expenditure includesloans and advances to states and public sector units, and capital outlay.

Deflation A phenomenon of falling prices in an economy, which may be dueto a contraction in MONEY SUPPLY.

Depository A system of computerized book-entry of securities. Thisarrangement enables a transfer of shares through a mere book-entry ratherthan the physical movement of certificates. This is because the scrips are'dematerialized' or alternatively, 'immobilized' under the system.

A depository performs the functions of holding, transferring and allowingwithdrawal of securities through its agents viz., depository participants. Forsettlement of trades done at an exchange, the depository interacts with a


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clearing corporation which oversees the payment of funds and delivery of securities.

Under dematerialization, securities in physical form are destroyed, whereasunder immobilization, the securities are stored away in vaults. Further,

rematerialization is possible, so as to restore securities to physical form. The system of maintaining ownership records in the form of electronicholdings will help to eliminate problems that are associated with physicalcertificates such as fake/torn certificates and loss in transit.

Depreciation An accounting process by which the cost of a FIXED ASSET,such as a building or machinery, is allocated as a periodic expense, spreadover the depreciable life of the ASSET. The term also means the amount of expense determined by such a process. Sometimes, it is calledAMORTIZATION when the ASSET is intangible or 'depletion' when the asset is

a natural resource, such as minerals. There are different methods of depreciation such as the Straight Line Method and the Written Down Value(WDV) method.

In the context of international finance, depreciation refers to the decline inthe market value of a currency in relation to another currency. For example,if one U.S. dollar could be bought in the market for Rs.40 as against Rs.41.50earlier, it means that the dollar has depreciated vis--vis the Indian rupee.

This would result in American goods and services becoming cheaper toIndians and Indian goods and services becoming more expensive toAmericans.

Or

The apportionment of cost of a (usually large) capital item over an agreedperiod, (based on life expectancy or obsolescence), for example, a piece of equipment costing 10k having a life of five years might be depreciated overfive years at a cost of 2k per year. (In which case the P&L would show adepreciation cost of 2k per year; the balance sheet would show an assetvalue of 8k at the end of year one, reducing by 2k per year; and thecashflow statement would show all 10k being used to pay for it in year one.)

Depression An economic condition that is characterized by a severecontraction in economic activity, which is manifested. In numerous businessshut-downs, widespread unemployment, and declining investment in plantand equipment on account of falling sales.

Derivative A financial contract that derives its value from another ASSET oran index of asset values. These underlying assets maybe foreign exchange,


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BONDS, equities or commodities. For example, FORWARD CONTRACTS relateto foreign exchange; futures to commodities, debt instruments, currencies orstock indices; and OPTIONS to equities. Derivatives are traded at organizedexchanges and in the over-the-counter (OTC) market.

Derivatives traded at exchanges are standardized contracts having standarddelivery dates and trading units. OTC derivatives are customized contractsthat enable the parties to select the trading units and delivery dates to suittheir requirements. Moreover, there are fewer regulatory restrictions and thisfacilitates innovation. A major difference between the two is that of counterparty risk the risk of default by either party. With exchange-tradedderivatives, the risk is controlled by exchanges through clearing-houseswhich act as a contractual intermediary and impose margin requirements. Incontrast, OTC derivatives signify greater vulnerability. OPTIONS derive theirvalues from shares or stock market indices; an option confers the rightwithout any obligation to buy or sell an asset at a predetermined price on or

before a stipulated EXPIRATION DATE. Interest-rate futures are tied to debtinstruments. This contract binds the parties to exchange a debt securityagainst payment e.g., TREASURY BILL, on a future date at a predeterminedprice. The value of the futures contract is governed by the value of theunderlying Treasury Bill. If yields decline, the value of the futures contractwill rise because the buyer has locked in a higher interest rate. SWAPS areagreements between two parties to exchange cash flows in the futureaccording to a predetermined formula.

With their universal recognition as risk-management tools, trading inderivatives has registered a phenomenal growth in the Western financial

markets. The relationship with other assets and certain other features makesderivatives useful for SPECULATION, HEADGING, ARBITRAGE and PORTFOLIOadjustments.

India may soon see the introduction of exchange-traded derivatives on stockindices and other financial assets if the recommendations of the L.C. GUPTACOMMITTEE are implemented shortly.

Devaluation The lowering of a country's official exchange rate in relation toa foreign currency (or to gold), so that exports compete more favorably inthe overseas markets. Devaluation is the opposite of REVALUATION. (See

also DEPRECIATION)

dividend

A dividend is a payment made per share, to a company's shareholders by acompany, based on the profits of the year, but not necessarily all of theprofits, arrived at by the directors and voted at the company's annual


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general meeting. A company can choose to pay a dividend from reservesfollowing a loss-making year, and conversely a company can choose to payno dividend after a profit-making year, depending on what is believed to bein the best interests of the company. Keeping shareholders happy andcommitted to their investment is always an issue in deciding dividend

payments. Along with the increase in value of a stock or share, the annualdividend provides the shareholder with a return on the shareholdinginvestment.

Dhanuka Committee A committee headed by Justice D. R. Dhanuka toreview securities related Acts, regulations and rules, set up by the Securitiesand Exchange Board of Indian (SEBI) in March 1997. Some of itsrecommendations as gleaned from press reports are :

1. The MUTUAL FUND and collective schemes of the Unit Trust of India(UTI) must come under the purview of SEBI.

2. In case of differences, the SEBI Act must prevail over the UTI Act.3. Self-regulatory organizations in the financial sector such as AMBI andAMFI must register with SEBI.

4. The exemption from payment of stamp duty that is available tobeneficial owners of dematerialized shares should also be extended totransfer of shares in physical form.

5. Companies making a public issue of over Rs.10 crore should use theDEPOSITORY option.

Direct Taxes Taxes whose impact and incidence are on the same person. The taxes levied on income, and wealth tax are instances of direct taxes.

Discount This refers to :

1. The margin by which a security's market price is lower than its facevalue.

2. In security analysis, it means the adjustment in security pricesconsequent to the assimilation of new information about a company, ornews in general. An illustration is the increase in the price of a stockfollowing the news of the company bagging big sale orders.

3. Reduction in the sale price of goods.

Discount Rate The interest rate used in calculating the PRESENT VALUE of future cash flows.

Disinvestments The sale of shareholding by an individual or institution inorder to raise cash.


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Diversification The process of spreading out investments so as to limitexposure and reduce risk. Individuals do this by investing in shares of different companies or by combining stocks with DEBENTURES, MUTUALFUND shares, FIXED DEPOSITS and other investment vehicles. Companiesachieve diversification by venturing into new and unrelated business areas.

Dividend The payment made by a company to its shareholders. Legal andfinancial considerations have a bearing on the level of dividend to be paid.For instance, dividends may be paid out of profits alone; so also, a growingcompany needs funds to finance its expansion and hence may pay only amodest dividend, in order to conserve resources.

Dow Theory A theory to ascertain the emergence of a primary trend (a

trend which indicates either a bullish or bearish phase) in the stock market.It seeks confirmation of whether a long-term market advance or decline isunder way, by examining the movement of the Dow Jones Industrial Averagein conjunction with the Dow Jones Transportation Average. These averagesare summary measures of stock prices in the U.S.

Dumping The sale of goods in a foreign market at a price that is below theprice realized in the home country, after allowing for all costs of transferincluding transportation charges and duties. The motive may be to enhancerevenues, offload surplus stocks or a predatory intent of killing foreigncompetition.

Earnings Per Share (EPS) The net profits of a company expressed on a per(EQUITY) SHARE basis. It is arrived at by dividing the figure of profits aftertaxes and DIVIDENDS paid on PREFERENCE SHARES, if any, by the number of equity shares outstanding. Therefore, it does not reveal the potential impactof dilution in earnings on account of securities such as convertibles orwarrants that may be outstanding. Moreover, an improvement in EPS doesnot necessarily indicate a more productive use of the total amount of fundsavailable with a firm.

Economic Value Added (EVA) A tool for evaluating and selecting stocks forinvestment, and also used as a measure of managerial performance. AnAmerican consultancy firm, Stern Stewart is credited with the developmentof this tool in the late eighties. It is calculated by subtracting the total cost of


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capital from the after-tax operating profits of a company.

EVA = After-tax Operating Profits Total cost of capital

Operating profits simply mean earnings before interest and taxes. The cost

of capital is the composite cost of total equity and debt, which together aredeployed in various ASSETS such as land, buildings, machines, INVENTORIES,receivables and cash. Total equity includes reserves and shares PREMIUM,for which an appropriate OPPORTUNITY COST must be considered. A positiveEVA is deemed to be a good sign and the higher it is, the better. EVAexpressed on a per share basis facilitates comparison between companies.

EEFC Account This refers to the Exchange Earners' Foreign CurrencyAccount, a scheme introduced in 1992 for exporters and residents receivingforeign exchange. A certain percentage of the earnings may be maintainedin this account in order to limit exchange rate risk in case of future imports

or for other specified purposes.

Efficient Portfolio A diversified selection of stocks resulting in a least riskPORTFOLIO for a given rate of return. At that level of RISK, no other portfolioprovides superior returns. Combining shares from different unrelatedindustries helps to neutralize the UNSYSTEMATIC RISK inherent in eachsecurity. (See also MARKOWITZ MODEL.)

EOQ The acronym for Economic Order Quantity, a term that relates toINVENTORY management. It is the optimum size of order which minimizesthe cost of purchasing and holding inventories.

Equity Grading A service offered by the credit rating agency, ICRA Limited,under which the agency assigns a grade to an equity issue, at the request of the prospective issuer. This symbolic indicator conveys the agency's opinionon the relative quality of equity being offered, on the basis of its in-depthstudy of the company and all relevant factors. It takes into account theearning prospects, risk and financial strength associated with the issuer,which reflect its managerial competence, industry outlook, competition, etc.credit rating agency, ICRA Limited, under which the agency assigns a gradeto an equity issue, at the request of the prospective issuer. This symbolicindicator conveys the agency's opinion on the relative quality of equity being

offered, on the basis of its in-depth study of the company and all relevantfactors. It takes into account the earning prospects, risk and financialstrength associated with the issuer, which reflect its managerialcompetence, industry outlook, competition, etc. There are 12 grades startingwith ERAI (signifying excellent earning prospects with low risk) and endingwith ERD3 (representing poor earning prospects and high risk). The agencyalso offers the service of Equity Assessment, which is at the request of aninvestor. This appraisal is a one-time exercise and is in the form of a report


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that is intended to help investors in their investment decisions.

Equity Share A security that represents ownership interest in a company. Itis issued to those who have contributed capital in setting up an enterprise.Apart from a PUBLIC ISSUE, equity shares may originate through an issue of

BONUS SHARES, CONVERTIBLE securities, WARRANTS, GDRS, etc. Analternative term that is sometimes used is 'COMMON STOCK' or simply,'STOCK'.

The share of a public limited company can be subsequently sold throughstock exchanges or other forums. The claim of equity shareholders onearnings and on ASSETS in the event of liquidation, follows all others. Forexample, DIVIDEND on equity shares is paid after meeting interestobligations and dividends to PREFERENCE shareholders. Hence, they are alsoknown as 'residual owners'. For bearing such risk, equity shareholders expecthandsome returns by way of DIVIDENDS and price appreciation of the share,

when their enterprise performs well.

Escrow Cash , securities or other valuable instruments that are held by athird party to ensure that the obligations under a contract are discharged.

The escrow mechanism is a technique of mitigating the risk to lenders and itis used typically in infrastructure projects such as power, roads or telecom.For example, an escrow account can be set up at a bank for depositing thepayments of electricity bills.

Euro The common European currency that will come into being with theformation of the European Union. This economic union has given birth to the

European Monetary Union tht will be characterized by a common CENTRALBANK and MONETARY POLICY, besides the common currency. Elimination of exchange rate risk and reduction of transaction costs between members areseen as major benefits of the common currency. The circulation of the Eurois slated to take place in 2002 and it is expected to emerge as an importantinternational currency. More specifically, it will compete with the US dollar asa reserve currency.

Euro Issue An issue of securities to raise funds outside the domesticmarket. Euro issues by Indian companies have been by way of GDRS orEUROCONVERTIBLE BONDS. The advantages associated with Euro issues

are :

1. Reduced cost of capital owing to lower interest rates and floatationcosts.

2. Efficient pricing that maximizes mobilization.3. No immediate dilution of voting control.4. Greater visibility due to international exposure.5. Inflow of foreign currency funds.


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Euro issues must conform to the guidelines issued by the CentralGovernment. Among other thing, prior permission for an issue must beobtained from the Ministry of Finance. (See GDR and FOREIGN CURRENCYCONVERTIBLE BOND).

Eurobond A bond denominated in a currency different from that of thecountry in which it is sold.

Extraordinary Item An accounting term in the U.S. for a profit or loss to acompany resulting from an unusual and rare occurrence or event. Examplesinclude expropriation of properties by a foreign government or gains fromrefunding a BOND issue.

earnings before..

There are several 'Earnings Before..' ratios and acronyms: EBT = EarningsBefore Taxes; EBIT = Earnings Before Interest and Taxes; EBIAT = EarningsBefore Interest after Taxes; EBITD = Earnings Before Interest, Taxes andDepreciation; and EBITDA = Earnings Before Interest, Taxes, Depreciation,and Amortization. (Earnings = operating and non-operating profits (eginterest, dividends received from other investments). Depreciation is thenon-cash charge to the balance sheet which is made in writing off an assetover a period. Amortisation is the payment of a loan in instalments.

Factoring An arrangement for obtaining funds by selling receivables to aspecialized financing agency (the factor), generally without recourse. Whenfactoring is contemplated, a firm's sales to different customers must haveprior approval of the factor. Typically, a factor pays up to 80 percent of theinvoice value to its client (firm) upon receipt of the copy of the invoicerelating to goods delivered. The balance is paid after receiving the amountdue from the firm's customer. In order to ensure timely collection, the factormay follow up with the customer after furnishing the details of receivables.

The agency, i.e., the factor, bears the responsibility and attendant RISK of collecting the dues from the company's customers.

There are two basic components to the charges levied by a factor:interest or DISCOUNT charge and service fee. Whereas the interest ratedepends on the cost of money and competition among factors, the servicecommission is for bearing risk, processing and collecting the receivables andhandling the book-keeping. Factoring is thus a financial package of credit,


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debt collection and sales ledger administration resulting in regular cash flowsto companies whose credit sales comprise a significant portion of the totalsales. The main drawback with factoring is that it is usually very expensive.

Among the reasons why factoring has not caught on in India are competitionfrom alternative sources of financing particularly bill DISCOUNTING as well asfunds constraint and lack of credit information. The task of debt collection isalso considered to be a major impediment.

Financial Futures These are contracts guaranteeing delivery of specifiedfinancial instruments on a future date, at a predetermined price. Thefinancial instruments traded in the U.S. futures markets consist of foreigncurrencies and debt securities e.g., TREASURY BILLS, long-term U.S. TreasuryBONDS, COMMERCIAL PAPER, etc. The futures contracts on debt securities

are commonly known as interest-rate futures. They offer companies, banksand institutions a means to insulate themselves from adverse interest ratemovements through HEADING. The objective behind hedging is to establishin advance, a certain rate of interest for a given time period. That apart,financial futures offer considerable profit potential which attracts speculatorsand individual investors too.

Financial Institution A non-banking financial intermediary (companycorporation or co-operative society) carrying on any of the activities specifiedin the relevant section of the Reserve Bank of India Act. These activitiesinclude lending, investing in shares and other securities, HIRE-PURCHASE,

insurance and CHIT FUNDS.In general, this term refers to the Development Finance Institutions such asIDBI and IFCI, as well as the Unit Trust of India (UTI) and the Life InsuranceCorporation of India (LIC). However, a more specific classification could be asshown below :

SIDBI : Small Industries Development Bank of India.SCICI : SCICI Ltd.


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SFCs: State Financial Corporations. TFCI: Tourism Finance Corporation of India Ltd. TDICI : Technology Development and Information Company of India Ltd.RCTD : Risk Capital and Technology Finance Corporation Limited.

Financial Leverage The ability to magnify earnings available to equityshareholders, by the use of debt or fixed-charge securities. Generally, thehigher the amount of debt in relation to total financing, the greater will bethe impact on profits available to equity shareholders, other things beingequal. A simple illustration is shown below.

The Sparking Water Company has total assets of Rs.3,00,000. The impact of the use of debt becomes evident by comparing the EARNINGS PER SHARE(EPS) under different financing alternatives as shown below.

The effect of financial leverage is that an increase in the firm's PBIT results in

a greater than proportionate increase in its EPS. For instance, in Plan B, a 50percent increase in PBIT (from Rs.1,20,000 to 1,80,000) results in a 56percent increase in EPS. Hence DFL, the degree of financial leverage, at agiven PBIT can be measured by the formula:

DFL =Percentage change in EPSPercentage change inPBIT

At PBIT Rs. 1,20,000, DFL = 56/50 = 1.12.

Though debt finance is tax-deductible, and hence an attractive source of funds, leverage is a double-edged sword, since the firm using leverageattracts not only higher returns but a risk as well. This is because an increasein debt raises fixed interest expenses and, thereby, the chances of financialfailure.

Plan A : 0% debt; equity Rs.3,00,000 (3,000 equity shares of Rs.100par)Profits before interest andtaxes (PBIT) Interest

Profits beforetaxes(PBT) Taxes-50% EPS

1,200,000 0 1,20,000 60,000 20

1,80,000 0 1,80,000 90,000 302,40,000 0 2,40,000 1,20,000 40Plan B : 30% debt at 15% interest per annum (2,100 shares atRs.100 par)

PBIT Interest PBT Taxes(50%) EPS


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1,20,000 13,500 1,06,500 53,250 25361,80,000 13,500 1,66,500 83,250 39.642,40,000 13,500 2,26,500 1,13,250 53,93

Financial Markets The transactions which result in the creation or transferof financial ASSETS and LIABILITIES, mostly in the form of tradeablesecurities. The term connotes a vast forum rather than a specific physicallocation for trading activity. The constituents of financial markets are shownbelow :

The Money Market is that segment of the financial markets whereinfinancial instruments having maturities of less than one year are traded. These different instruments are listed below :Instrument Typical MATURITY (in days)CALL MONEY and NOTICE MONEY 1 and up to 14REPOS 14INTER-BANK TERM MONEY 15 TO 90BILL OF EXCHANGE 90

TREASURE BILL 91 AND 364

INTER-BANK PARTICIPATIONCERTIFICATE 91 TO 180CERTIFICATE OF DEPOSIT 90 TO 364COMMERCIAL PAPER 30 TO 364INTERCORPORATE DEPOSIT 90


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The money market is useful to any entity, whether a government, bank,business or wealthy individuals having a temporary surplus or DEFICIT.Hence, it may be viewed as a forum for adjusting their short-term LIQUIDITYpositions. The open money market does not have any physical tradinglocations. It is essentially a network of the major players and intermediaries

linked by telephones and other media. However, the Reserve Bank of Indiaplans to introduce screen-based trading system for this segment. TheDISCOUNT AND FINANCE HOUSE OF INDIA LIMITED (DFHI) plays an importantrole as a MARKET MAKER in money market securities.

The Capital Market is that segment of the financial markets in whichsecurities having maturities exceeding one year are traded. Examplesinclude DEBENTURES, PREFERENCE shares and EQUITY SHARES.

Over-the-Country Exchange of India (OCTEI) offerings may originate as apublic issue or a BOUGHT-OUT DEAL. EURO ISSUES and overseas offerings

include GDRs, FOREIGN CURRENCY CONVERTIBLE BONDS, ADRs, FOREIGNBONDS and private placement with Foreign Institutional Investors (FIIs), all of which bring inflow of foreign exchange.

Over-the-counter transactions refer to the trading in securities includingshares, that goes on at places other than exchanges, e.g., KERB DEALS ortransactions at investors' clubs.

Fiscal Policy The use of tax and expenditure powers by a government.Government all over the world, are vested with the task of creatinginfrastructure (e.g., roads, ports, power plants, etc.) and are also required to

ensure internal and external security. These responsibilities entailgovernment expenditures on various fronts capital outlays, the defenseforces, police, the administrative services and others. Taxes are a majorsource of revenue to meet these outflows. Thus, the Union Governmentcollects income tax, EXCISE DUTY, customs duty, etc., through its differentarms.

An increase in government spending without a matching increase in inflowsmay cause or exacerbate a DEFICIT. But, government spending alsocontributes to aggregate demand for goods and services directly, andindirectly by increasing private incomes which stimulates private demand.

Float The interval between the issuance of a cheque and its payment by thedrawer's bank, through the clearing system. The time involved in clearingcheques through the banking system allows greater flexibility in cashmanagement funds need not be deposited in an account as soon as acheque is issued.

Floating Exchange Rate The exchange rate of a currency that is allowed to


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float, either within a narrow specified band around a reference rate, or totallyfreely according to market forces. These forces of demand and supply areinfluenced by factors, such as, a nation's economic health, tradeperformance and BALANCE OF PAYMENTS position, interest rates andINFLATION.

Floating Rate Bond A debt security whose COUPON RATE is periodicallyadjusted upwards or downwards, usually within a specified band, on thebasis of a benchmark interest rate or an index. These securities, also termed'Indexed Bonds', were introduced to offer investors protection fromINFLATION and INTEREST RATE RISK that are inherent in a DEBENTURE orBOND bearing a fixed coupon. When interest rates and bond YIELDS go up,the coupon is raised as indicated by the issuer. The disadvantage is whenrtes fall, because the bondholder's coupon receipts will fall. Moreover, thedownward revision of the coupon would also preclude any CAPITAL GAINS byway of price appreciation, accruing to the holder. In India e.g., the first such

instrument was introduced by the State Bank of India in December 1993. Thebonds carry a floating rate of interest for 3 percent over the bank'smaximum term deposit rate, with a minimum coupon rate of 12 percent perannum; the coupon rate will be adjusted at regular intervals of six months on

January 1 and July 1 throughout the tenure of the instrument. (See alsoGOVERNMENT SECURITIES.)

In December 1997, Capital Indexed Bonds of the Government of India wereintroduced. These bonds provide investors a complete hedge againstinflation for the principal amount of investment, on the basis of theWholesale Price Index.

fixed assets

Assets held for use by the business rather than for sale or conversion intocash, eg, fixtures and fittings, equipment, buildings.

fixed cost

A cost which does not vary with changing sales or production volumes, eg,building lease costs, permanent staff wages, rates, depreciation of capitalitems.

FOB - 'free on board'

The FOB (Free On Board) abbreviation is an import/export term relating tothe point at which responsibility for goods passes from seller (exporter) tobuyer (importer). It's in this listing because it's commonly misunderstood andalso has potentially significant financial implications. FOB meant originally(and depending on the context stills generally means) that the seller is liable


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for the goods and is responsible for all costs of transport, insurance, etc.,until and including the goods being loaded at the (nominated FOB) port. Animporting buyer would typically ask for the FOB price, (which is now nowoften linked to a port name, eg., FOB Hamburg or FOB Vancouver), knowingthat this price is 'free' or inclusive of all costs and liabilities of getting the

goods from the seller to the port and on board the craft or vessel. LogicallyFOB also meant and still means that the seller is liable for any loss ordamage up to the point that the goods are loaded onto the vessel at the FOBport, and that thereafter the buyer assumes responsibility for the goods andthe costs of transport and the liability. From the seller's point of view an FOBprice must therefore include/recover his costs of transport from factory orwarehouse, insurance and loading, because the seller is unable to chargethese costs as extras once the FOB price has been stated. The FOBexpression originates particularly from the meaning that the buyer is free of liability and costs of transport up to the point that the goods are loaded onboard the ship. In modern times FOB also applies to freight for export by

aircraft from airports. In recent years the term has come to be used inslightly different ways, even to the extent that other interpretations areplaced on the acronym, most commonly 'Freight On Board', which istechnically incorrect. While technically incorrect also, terms such as 'FOBDestination' have entered into common use, meaning that the insuranceliability and costs of transportation and responsibility for the goods are theseller's until the goods are delivered to the buyer's stipulated deliverydestination. If in doubt ask exactly what the other person means by FOBbecause the applications have broadened. While liability and responsibilityfor goods passes from seller to buyer at the point that goods are agreed tobe FOB, the FOB principle does not correlate to payment terms, which is a

matter for separate negotiation. FOB is a mechanism for agreeing price andtransport responsibility, not for agreeing payment terms. In summary: FOB(Free On Board), used alone, originally meant that the transportation costand liability for exported goods was with the seller until the goods wereloaded onto the ship (at the port of exportation); nowadays FOB (Free OnBoard or the distorted interpretation 'Freight On Board') has a wider usage -the principle is the same, ie., seller has liability for goods, insurance andcosts of transport until the goods are loaded (or delivered), but the point atwhich goods are 'FOB' is no longer likely to be just the port of export - it canbe any place that it suits the buyer to stipulate. So, if you are an exporter,beware of buyers stipulating 'FOB destination' - it means the exporter is

liable for the goods and pays transport costs up until delivery to thecustomer.

Foreign Currency Convertible Bond (FCCB) An unsecured debtinstrument denominated in a foreign-currency and issued by an Indiancompany which is convertible into shares, or in some cases into GDRs, at a


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predetermined rate. That is, the CONVERSION PRICE and the exchange rateare fixed. The BOND which bears a certain coupon enables the issuingcompany to economize on interest cost by tapping foreign markets and alsoto postpone a DILUTION in the EARNINGS PER SHARE. The advantage to theinvestor is the option of retaining the security as a bond till REDEMPTION, if the stock does not rise to the desired level. Moreover, the interest rate onthe security is higher as compared to bonds of foreign companies. Subject tothe rules prevailing, put and call OPTIONS may be attached to theinstrument. The put enables investors to sell their bonds back to the issuer.

The call allows the issuer to undertake REFINANCING or to force conversion.Incidentally, one dimension of FCCBs is that they add to India's externaldebt. Moreover, until conversion, the interest is paid in foreign currency. If the option to convert is not exercised, redemption too will entail an outflowof foreign currency. Therefore, the exchange risk, i.e., the depreciation cost,

must be taken into consideration. In some respects, an 'Alpine Convertible'bond (issued to Swiss investors) scores over others; the issue costs are lowerand the placement process is shorter. (See also EURO ISSUES and GDR.)

Forfeiting This refers to the sale of export receivables. It amounts toDISCOUNTING receivables by a forfeiting company, but without recourse tothe exporter. Therefore, it serves to convert as sale of goods on credit into acash sale. Under this arrangement, the exporter receives the proceeds onsurrendering to the forfeiter, the endorsed debt instrument duly accepted bythe importer and co-accepted by his bank. Unless otherwise specified, theforfeiter bears the risk of default in payment by the importer. So, theforfeiter's fee depends on the country of the importer apart from the duedate of payment. For instance, the fee for forfeiting bills accepted by animporter in Uganda could be higher than for an importer in U.K. in India, theEXIM BANK introduced forfeiting in 1992. Authorized Dealers in foreignexchange may also enter this business.

Forfeiture It means the deprivation of shares held by an investor, usually asa consequence of default in paying money, called upon allotment, to the

company. As a result of a forfeiture, the investor ceases to be a shareholderinsofar as the forfeited shares are concerned; however, he remains liable forthe sum due.

Formula Plans These are mechanistic methods of timing decisions relatingto the buying and selling of securities. There are different formula plans thatinclude the Constant Dollar Plan and the Constant and Variable Ratio Plans.


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These methods are for the patient, conservative investor who seeksprotection from large losses and is not confident of timing his decisionscorrectly. (See DOLLAR COST AVERAGING).

Forward Contract A transaction which binds a seller to deliver at a futuredate and the buyer to correspondingly accept a certain quantity of aspecified commodity at the price agreed upon, which is known as the'Forward Rate'. A forward contract is distinct from a futures contract becausethe terms of the former can be tailored to one's needs whereas, the latter isstandardized in terms of quantity, quality and delivery month for differentcommodities. In other words, forward contracts are customized contractsthat enable the parties to choose delivery dates and trading units to suittheir requirements. (See also COMMODITY FUTURES.)

Forward Discount The differential by which a currency is less expensive inthe forward market as compared to the SPOT MARKET.

Forward Premium The amount by which a currency's forward rate exceedsthe spot market rate. (See INTEREST RATE PARITY THEOREM).

Fund-based This term is used to describe financial assistance that involvesdisbursement of funds. Examples include the CASH CREDIT facility, billDISCOUNTING, equipment leasing, HIRE-PURCHASE and FACTORING. Incontrast, non-fund based services involve the issuance of LETTERS OFCREDIT, BANK GUARANTEES, ACCEPTANCE and fee-based services such assecurity issues management, LOAN SYNDICATION and advisory assistance.

Funding The technique of extending the MATURITY of debt by substitutinglong-term debt instruments for short-term securities through REFINANCINGoperations. Sometimes, this is also referred to as 'debt roll-over' or'conversion'. In India, funding has been applied to Ad hoc TREASURY BILLSheld by the Reserve Bank of India. Subsequently, it has been extended to364-day and 91-day auctioned bills. The consequence of such substitution of

'floating debt' (TREASURY BILLS or WAYS and MEANS ADVANCES) by 'fundeddebt' (LONG-DATED or undated GOVERNMENT SECURITIES) is an increase inthe interest burden as a result of the longer maturity of government debt,even though the quantum has not changed. Funding operations also result inreplenishment of the floating stock of Government Securities, whichfacilitates OPEN MARKET OPERATIONS and statutory investment by banks.


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This practice of debt roll-over may be employed during tight LIQUIDITYconditions in the financial markets or alter-natively with the objective of matching outflows to receipts. However, such a change in the MATURITYprofile of debt that causes the interest obligations to become more onerous,as stated above, may aggravate the repayment situation. The lattercontingency can, however, be overcome if the Government's coffers getfilled due to a growing economy, (See also STATUTORY LIQUIDITY RATIO.)

Futures Market A market in which contracts for future delivery of certaincommodities or securities are traded. (See also COMMODITY FUTURES andFINANCIAL FUTURES.)

GDR An acronym for Global Depository Receipt. It is an instrumentdenominated in foreign currency that enables foreign investors to trade in

securities of alien companies not listed at their exchanges. So, e.g., a dollar-denominated GDR issued on behalf of an Indian company represents acertain number of rupee-denominated equity shares, which are issued by thecompany to an intermediary termed the 'Overseas Depository Bank' (ODB),in whose name the shares are registered. The shares, however, rest with thelocal custodian bank. The GDR which is issued by the ODB may trade freelyin the security markets overseas; e.g., DGRs of Indian companies are listedon the Luxembourg Stock Exchange and some on the London StockExchange. Also, a GDR holder, not wanting a continue holding theinstrument, may opt for cancellation of the same after the specified periodby approaching the ODB and having the underlying shares released by thecustodian in India for sale. The proceeds, adjusted for taxes, and convertedinto foreign currency will be remitted to the foreign investor subsequently.As an example, the GDR of G.E. Shipping issued in February 1994 at a priceof U.S. $ 15.94 has five underlying shares. GDRs are generally issued at amodest DISCOUNT to the prevailing market price. A bigger discount maytrigger off widespread ARBITRAGE trading.

The advantage of an issuing company is the inflow of foreign currency funds.

Further, DIVIDEND payments are in rupees and, therefore, there is noexchange risk. Moreover, the increase in equity is clearly known unlike withFOREIGN CURRENCY CONVERTIBLE BONDS. Administratively too, in mattersregarding dividends, company meetings, etc. it becomes easier for thecompany to interact with the single ODB that accounts for a largeshar

acceptance the drawee

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