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GST

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MCQ on GST

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FORMS OF BUSINESS ORGANISATION

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MARKETING BASICS

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Role of Commercial Banks in the Economy

Role of Commercial Banks in the Economy

As we know that main objectives of a commercial bank is to earn profit by the process of accepting of deposits and advancing loans through different methods. Although these functions are the basic function of commercial banks, but there are a lot more functions which enhances the importance of banks today.

1. Acceptance of deposits, by opening different kinds of bank accounts
2. Advancing of loans to needy persons through different methods and requirements
3. Provisions of agency and general utility services to his customers
4. Making new investments in different organizations and increasing the productive capacity of the country
5. Promote capital formation in the country by mobilizing and collection of savings for the purpose of investments
6. Development of industries in the country according to the requirements of the economy
7. A balanced development in the economy is achieved in different sectors & regions through the resources of bank funds
8. Development in agricultural production is made possible by providing different kinds of loans
9. These banks help in reducing reliance in foreign assistance by their efforts in the mobilization of domestic savings
10. These banks help in the implementation of an effective monetary policy according to the objective to central bank.
11. Commercial banks also help in the creation and distribution of money through the sales and purchase of securities.
12. Commercial banks are the custodian and distributor of liquid capital of the country, which is the life blood of all commercial and economic activities of a country.

role of banking to business

1. Collections of Savings and Advancing Loans

Acceptance of deposit and advancing the loans is the basic function of commercial banks. On this function, all other functions depend accordingly. Bank operates different types of accounts for their customers.

2. Money Transfer

Banks have facilitated the making of payments from one place or persons to another by means of cheques, bill of exchange and drafts, instead of cash. Payment though cheques, draft is more safe and convenient, especially in case of huge payments, this facility is a great help for traders and businessmen. It really enhances the importance of banks for business community.

3. Encourages Savings

Banks perform an invaluable service by encouraging savings among the people. They induce them to save for profitable investment for themselves and for national interest. These savings help in capital formation.

4. Transfer Savings into Investment

Bank transfer the savings collected from the people into investment and thus increase the amount of effective capital, which helps the process of economic growth.

5. Overdraft Facilities

The banks allow the overdraft facilities to their trusted customers and thus help them in overcoming of temporary financial difficulties.

6. Discounting Bill of Exchange

Importance of banks can be seen through the facility of discounting bill of exchange. Banks discount their bill of exchange of consumers and help them in the financial difficulties. By discounting bill of exchange, they able to get the desire amount for investment they want.

7. Financing Internal & External Trade

Banks help merchants and traders in financing internal and external trade by discounting foreign bill of exchange, issuing of letter of credit and other guarantees for their customers.

8. Act as an Agent

The bank act as a agent and help their customers in the purchase and sales of shares, provision of lockers payment of monthly and dividends on stock.

9. Issue of Traveler’s Cheques

For the convenience and security of money for travelers and tourists, bank provides the facility of traveler’s cheques. These cheques enable the travelers and tourists to meet their expenses during their journey, as these are accepted by issuing bankers, restaurants, and other businessmen both at home and abroad. No doubt, this is also one of the great functions of banks and shows the importance of banks for us in more precise ways.

10. General Utility Services

Existence of commercial banks is essential for contribution to general prosperity. Banks are the main factors in raising the level of economic development of the world. In addition to above-cited advantages, banks also provide many services of general utilities to the customers and the general public.

Importance of Insurance to a Business

Six Importance of Insurance to a Business

Insurance is a form of risk management primarily used to hedge against the risk of potential financial loss. Again insurance is defined as the equitable transfers of the risk of a potential loss, from one entity to another, in exchange for a premium and duty of care.

The insurance has been useful to the business society also. Some of the uses are discussed below:

1. Uncertainty of Business Losses is Reduced

In world of business, commerce and industry a huge number of properties are employed. With a slight slackness or negligence, the property may be turned into ashes. The accident may be fatal not only to the individual or property but to the third party also.

New construction and new establishment are possible only with the help of insurance, in absence of it, uncertainty will be to the maximum level and nobody would like to invest a huge amount in the business or industry.

A person may not be sure of his life and health and cannot continue the business up to longer period to support his dependents. By purchasing policy, he can be sure of his earning because the insurer will pay a fed amount at the time of death.

Again, the owner of a business might foresee contingencies that would bring great loss. To meet such situations they might decide to set aside annually a reserve, but it could not be accumulated due to death. However, by making an annual payment, to secure immediately, insure policy can be taken.

2. Business Efficiency is Increased with Insurance

When the owner of a business is free from the botheration of losses, he will certainly devote much time to the business. The carefree owner can work better for the maximization of the profit.

The new, as well as old businessmen, are guaranteed payment of a certain amount with the insurance policies at the death of the person; at the damage, destruction or disappearance of the property or goods.

The uncertainty of loss may affect the mind of the businessmen adversely. The insurance, removing the uncertainty, stimulates the businessmen to work hard.

3. Key Man Indemnification

Key man is that particular man whose capital, expertise, experience, energy, ability to control, goodwill and dutifulness make him the most valuable asset in the business and whose absence will reduce the income of the employer tremendously and up to that time when such employee is not substituted.

The death or disability of such valuable lives will, in many instances, prove a more serious loss than that by fire or any hazard.

The potential loss to be suffered and the compensation to the dependents of such employee require an adequate provision which is met by purchasing adequate life-policies.

The amount of loss may be up to the amount of reduced profit, expenses involved in appointing of such persons and payment to the dependents of the key man. The Term Insurance Policy or Convertible Term Insurance Policy is more suitable in this case.

4. Enhancement of Credit

The business can obtain loan by pledging the policy as collateral for the loan. The insured persons are getting more loans due to certainty of payment at their deaths.

The amount of loan that can be obtained with such pledging of policy, with interest, thereon will not exceed the cash value of the policy.

In the case of death, this value can be utilized for setting of the loan along with the interest. If the borrower is unwilling to repay the interest, the lender can surrender the policy and get the amount of loan and interest thereon paid.

The redeemable debentures can be issued on the collateral of capital redemption policies. The insured properties are the best collateral and adequate loans are granted by the lenders.

5. Business Continuation

!n any business particularly partnership business may discontinue at the death of any partner although the surviving partners can restart the business, but in both the cases the business and die partners will suffer economically.

The insurance policies provide adequate funds at the time of death. Each partner may be insured for the amount of his interest in the partnership and his dependents may get that amount at the death of the partner.

With the help of property insurance, the property of the business is protected against disasters and the chance of disclosure of the business due to the tremendous waste or loss.

6. Welfare of Employees

The welfare of employees is the responsibility of the employer. The former are working for the latter. Therefore, the latter has to look after the welfare of the former which can be provision for early death, provision for disability and provision for old age.

These requirements are easily met by the life insurance, accident and sickness benefit, pensions which are generally provided by group insurance.

The premium for group insurance is generally paid by the employer. This plan is the cheapest form of insurance for employers to fulfill their responsibilities.

The employees will devote their maximum capacities to complete their jobs when they are assured of the above benefits. The struggle and strife between employees and employer can be minimized easily with the help of such schemes.

foreign exchange risk management and techniques to reduce risk

Foreign Exchange Risk Management

Many firms are exposed to foreign exchange risk - i.e. their wealth is affected by movements in exchange rates - and will seek to manage their risk exposure. This page looks at the different types of foreign exchange risk and introduces methods for hedging that risk

Types of foreign exchange risk

·        Transaction risk

This is the risk of an exchange rate changing between the transaction date and the subsequent settlement date, i.e. it is the gain or loss arising on conversion.

This type of risk is primarily associated with imports and exports. If a company exports goods on credit then it has a figure for debtors in its accounts. The amount it will finally receive depends on the foreign exchange movement from the transaction date to the settlement date.

As transaction risk has a potential impact on the cash flows of a company, most companies choose to hedge against such exposure. Measuring and monitoring transaction risk is normally an important component of treasury risk management.

The degree of exposure is dependent on:

(a) The size of the transaction, is it material?

(b) The hedge period, the time period before the expected cash flows occurs.

(c) The anticipated volatility of the exchange rates during the hedge period.

The corporate risk management policy should state what degree of exposure is acceptable. This will probably be dependent on whether the Treasury Department is been established as a cost or profit centre.

·        Economic risk

Transaction exposure focuses on relatively short-term cash flows effects; economic exposure encompasses these plus the longer-term affects of changes in exchange rates on the market value of a company. Basically this means a change in the present value of the future after tax cash flows due to changes in exchange rates.

There are two ways in which a company is exposed to economic risk.

Directly: If your firm's home currency strengthens then foreign competitors are able to gain sales at your expense because your products have become more expensive (or you have reduced your margins) in the eyes of customers both abroad and at home.

If your firm's home currency strengthens then foreign competitors are able to gain sales at your expense because your products have become more expensive (or you have reduced your margins) in the eyes of customers both abroad and at home.

Indirectly: Even if your home currency does not move vis-a -vis your customer's currency you may lose competitive position. For example suppose a South African firm is selling into Hong Kong and its main competitor is a New Zealand firm. If the New Zealand dollar weakens against the Hong Kong dollar the South African firm has lost some competitive position.

Even if your home currency does not move vis-a -vis your customer's currency you may lose competitive position. For example suppose a South African firm is selling into Hong Kong and its main competitor is a New Zealand firm. If the New Zealand dollar weakens against the Hong Kong dollar the South African firm has lost some competitive position.

Economic risk is difficult to quantify but a favoured strategy to manage it is to diversify internationally, in terms of sales, location of production facilities, raw materials and financing. Such diversification is likely to significantly reduce the impact of economic exposure relative to a purely domestic company, and provide much greater flexibility to react to real exchange rate changes.

·        Translation risk

The financial statements of overseas subsidiaries are usually translated into the home currency in order that they can be consolidated into the group's financial statements. Note that this is purely a paper-based exercise - it is the translation not the conversion of real money from one currency to another.

The reported performance of an overseas subsidiary in home-based currency terms can be severely distorted if there has been a significant foreign exchange movement.

If initially the exchange rate is given by $/£1.00 and an American subsidiary is worth $500,000, then the UK parent company will anticipate a balance sheet value of £500,000 for the subsidiary. A depreciation of the US dollar to $/£2.00 would result in only £250,000 being translated.

Unless managers believe that the company's share price will fall as a result of showing a translation exposure loss in the company's accounts, translation exposure will not normally be hedged. The company's share price, in an efficient market, should only react to exposure that is likely to have an impact on cash flows.

Hedging transaction risk - the internal techniques

Internal techniques to manage/reduce forex exposure should always be considered before external methods on cost grounds. Internal techniques include the following:

Invoice in home currency

One easy way is to insist that all foreign customers pay in your home currency and that your company pays for all imports in your home currency.

However the exchange-rate risk has not gone away, it has just been passed onto the customer. Your customer may not be too happy with your strategy and simply look for an alternative supplier.

Achievable if you are in a monopoly position, however in a competitive environment this is an unrealistic approach.

Leading and lagging

If an importer (payment) expects that the currency it is due to pay will depreciate, it may attempt to delay payment. This may be achieved by agreement or by exceeding credit terms.

If an exporter (receipt) expects that the currency it is due to receive will depreciate over the next three months it may try to obtain payment immediately. This may be achieved by offering a discount for immediate payment.

The problem lies in guessing which way the exchange rate will move.

Matching

When a company has receipts and payments in the same foreign currency due at the same time, it can simply match them against each other.

It is then only necessary to deal on the forex markets for the unmatched portion of the total transactions.

An extension of the matching idea is setting up a foreign currency bank account.

Decide to do nothing?

The company would "win some, lose some".

Theory suggests that, in the long run, gains and losses net off to leave a similar result to that if hedged.

In the short run, however, losses may be significant.

One additional advantage of this policy is the savings in transaction costs.

Hedging transaction risk - the external techniques

Transaction risk can also be hedged using a range of financial products. These are introduced below with links to more detailed pages.

Forward contracts

The forward market is where you can buy and sell a currency, at a fixed future date for a predetermined rate, i.e. the forward rate of exchange. This effectively fixes the future rate.

Money market hedges

The basic idea is to avoid future exchange rate uncertainty by making the exchange at today's spot rate instead. This is achieved by depositing/borrowing the foreign currency until the actual commercial transaction cash flows occur. This effectively fixes the future rate.

Futures contracts

Futures contracts are standard sized, traded hedging instruments.

The aim of a currency futures contract is to fix an exchange rate at some future date, subject to basis risk.

Options

A currency option is a right, but not an obligation, to buy or sell a currency at an exercise price on a future date. If there is a favourable movement in rates the company will allow the option to lapse, to take advantage of the favourable movement. The right will only be exercised to protect against an adverse movement, i.e. the worst-case scenario.

A call option gives the holder the right to buy the underlying currency.

A put option gives the holder the right to sell the underlying currency.

Options are more expensive than the forward contracts and futures but result in an asymmetric risk exposure.

Forex swaps

In a forex swap, the parties agree to swap equivalent amounts of currency for a period and then re-swap them at the end of the period at an agreed swap rate. The swap rate and amount of currency is agreed between the parties in advance. Thus it is called a fixed rate/fixed rate swap.

The main objectives of a forex swap are:

To hedge against forex risk, possibly for a longer period than is possible on the forward market.

Access to capital markets, in which it may be impossible to borrow directly.

Forex swaps are especially useful when dealing with countries that have exchange controls and/or volatile exchange rates.

Currency swaps

A currency swap allows the two counter parties to swap interest rate commitments on borrowings in different currencies.

In effect a currency swap has two elements:

An exchange of principal in different currencies, which are swapped back at the original spot rate - just like a forex swap.

An exchange of interest rates - the timing of these depends on the individual contract.

The swap of interest rates could be fixed for fixed or fixed for variable.

SWAPS. ITS FEATURES AND TYPES

swaps

swaps are a primary element in the derivatives markets, and one of the most active financial sector (represents 61% of the OTC market in 2001).

swaps are OTC instruments which means they traded in context other than a formal exchanges so it's falls under the forward contracts, in fact we can consider swaps as a series of forward contracts due to the substantial similarity between their characteristics as we will below.

Before we cross to the characteristics, let's take a look to the definition of swaps: swaps are contract between two parties to exchange a series of cash flows  based on notional principles at a specified dates.

Characteristics: 

1- as mentioned the swaps are an OTC instruments.

2- at initiation neither party pays any amount to other, so swap has a zero value at the start. except currency swap which the parties exchange amounts denominated in two different currencies but equal in value.

3- with different titles but same concept, swaps has a two important dates as all derivatives instruments, the first one is a settlement date which refer to each date the parties exchange the payments, the time between two settlement dates call as a settlement period, the second date is the termination period and it's refer to the date of final payment between the parties.

4- the payment between the parties is based on net owed amount, for example if I owes you $10 and you owes me $8, simply I will pay you $2, also this point is excluded from currency swap.

of course as all OTC instruments, swaps subject to the default risk, the risk of the counterparty fault to pay the his obligation, that's why before entering to any contract swap, one must to make a enough analysis to assess the credit quality of the counterparty.

Types of Swap:

there are various types of swap, but the most important are

1-currency swap

2-interest rates swap

3-equity swap

Currency Swap:

remember the two swap characteristics which are excluded from the currency swap 1- no notional principle exchange at initiation, 2- the payment make based on netting.

the general definition of the swap currency is: exchange of interest payments between two parties in different currencies.

for example if Apple corporation seeks to expands it's operations in Europe and need a € 1 million, Apple has a three choices as follows:

1- issue a fixed-rate euro denominated bond: which is required a well knowledge in a European bonds market (suppose Apple lacks this feature)

2-borrowing a €1 million from a bank at floating rate which subject apple to the risk of interest rates increases. for sure Apple will not prefer this type of finance.

3- is to issue a fixed-rate dollar denominated bond and swap it with a fixed-rate euro denominated bond, which represents a perfect solution for Apple in this scenario, please remember that even the both bonds denominated in the different currencies, but the bonds value are equal

to progress in the third solution, simply apple send to the best credit quality  European financial brokers or investment banks, ask them to quote such bond, suppose that Apple chose ABC investment bank for their good offer  to make the transaction with. 

suppose Apple issues a 3 years $1.5 million bond at rate of 5.5% semiannually, then enters into a swap with ABC which issues a €1 million at a rate of  4.9% semiannually (note that the $1.5 million and €1 million are equal in value if the exchange rate $1=€0.667).

now Apple will exchanges it's dollar denominated bond at rate 5.5% with the ABC's euro denominated bond at rate of 4.9%, so apple will pay the principle amount of it's bond to the ABC, and receive the principle amount of the ABC's bond, practically this operation equal to Apple has issued euro denominated bond at 4.9% interest rate and this bond purchased by ABC which will receive semiannually interest payments in euro, and the same for ABC prospective.

now lets continue our example to discover how this transaction will running during the life of transaction and how it will be terminated.

suppose the settlements dates (the dates of payments occurrence) are 1st of June and 1st of December of each 3 years. 

at the initiation (1st June 2012), Apple will pay $1.5 million to the ABC, and ABC will pay €1 million to the Apple.

at the 2nd settlement date (1st Dec 2012), apple will pay interest payment =

€1 million *0.049*0.49315068= €24,164.68

and ABC will pay interest payment =

$1.5 million * 0.055*0.9315068= $40,684.931

this interest payments will be the same, until the 5th  settlement date 

 (1st June 2014), in the final interest payments (termination date 1st Dec 2014) both parties are pays the interest payment plus the bond's amount, that means the final payment of Apple = €24,164.68 + €1 million= €1,024,164.68 and for ABC= 40,684.931+ $1.5 million= $1,50,684.931.

I used the bonds here for simplicity, but actually neither Apple or ABC issued any bond, simply they exchange the amounts they need at a different denominated currencies and the interest payments at a rates and dates they agreed in advanced.

Interest Rate Swaps:

the definition of interest rate swaps are: the exchange a series of cash flows in the same currency between two parties based on a notional principle amount, one party pay at a fixed interest rate, and the other at a floating interest rate (most often LIBOR), this  called as plain vanilla swap.

Characteristics:

1- as mentioned in the swaps characteristics the interest rate swaps no exchange of any payment between the parties at initiation(except the fools), because the both side will pay the same amounts in the same currency.

2- the interest payments always netted ( I owes you $10 you owes me $8, I pay you only $2).

3- interest rate swaps one party pay fixed rate, while the other party pay floating, or both pay floating (different rates)m but never both pays fixed rates.

4-the floating rate always determined at the beginning of the settlement period, which means the floating payer know the amount will pay only if the new settlement period has started.

note: always remember that the floating interest rates  will be made based on 30 days in month and 360 days in year, and for the fixed interest rates 30 days in month 365 days in year.

let's take an example on interest rate swaps

suppose that on 1st Jan 2012 Apple borrowed $1 million from ABC bank, at a LIBOR + 25 points on a quarterly basis on the 1st March, 1st June,                           1st September and 1st December at the end of the year Apple will return the principle amount they borrowed.

Apple fears from the increasing in LIBOR rate, and prefer to pay a fixed rate, so the management call for their broker XYZ ask him to make an interest rate swap, the broker  quote the transaction and give Apple a fixed rate of  5.8% on the same settlement dates of the loan payment.

suppose the current LIBOR is 6.1% , so the first payment which apple make to the XYZ = $1 million * 0.058* 0.24657s= $14,301.35 and this amount is constant during the swap's life, and the amount will pay to the Apple = $1 million*0.061*0.25= $15,250 and this amount is flactuates in respones to the LIBOR, we can note that XYZ is owes the greater amount, and the difference between the two amounts = $948.65 this amount will pay by the XYZ to the Apple.

we cant determine the next payments of the XYZ before we reach to the end of the next settlement period.

now apple is pay a fixed rate of 5.8% and receive the LIBOR rate, also Apple pay a 0.25 of LIBOR to the ABC bank, so the total interest rate Apple pays = 5.8% + 0.25%= 6.5%.

Equity Swaps

equity swaps are same the other types there's a party pay at a fixed rate while the other party pays at floating rate, but instead of a interest rates, the floating payer pays based on the return on stock or stock index (S&P500, NASDAQ indices).

There's a two points distinguishes equity swap than the currency and interest rate swaps.

First one is the fixed payer could also pay a variable amount, when the equity return of the index declined, suppose Apple enters into equity swap with XYZ broker, Apple promised to pay the return on the NASDAQ while XYZ promised to pay a fixed rate of 8% and the specified notional principle amount is $1 million, if the current return on the NASDAQ is 1287.23, after few days it became 1280.00, payments make on a quarterly basis.

It's obvious that the return is negative by 3197/3287.23-1= -0.02744, now the XYZ must to pay the fixed payment which = $1 million*0.08*0.24657= $19,725.6 + $1 million (-0.02744)= $47,165.6.

If the current return on NASDAQ is 3237 and became 3350, the return is positive and apple must to pay 3350.23/3237-1* $1 million = $34,908.86 (this payment will be paid by Apple to XYZ).

XYZ will pay $1 million *0.08*0.24657= $19,724.6, so Apple owes the great amount, so apple must pay $34,908.86 - $19,724.6.

Yasser Almansoor

https://www.linkedin.com/pulse/swaps-definition-types-characteristics-calculations-yasser-almansoor