Economic Overhaul or Economic Downturn - 2 August 2011 THE 'D-DAY'

Alright, 2nd August 2011 is definitely going to be remembered as either the day that marked the downfall of a colossal economy like the USA or the reference day that saved the world from a massive economic recession.
Whichever be the reason, one thing's for sure; the world's trust on an economy which maintained a 'AAA' rating ever since its constitution and an economy that has so long acted as the beacon of world trade; the economy that gave the world the priceless DOLLAR; UNCLE SAM'S UNITED STATES OF AMERICA , is surely going to weaken.

The hyper links regarding the reason for this debt crisis have already been given in my previous post. But to briefly explain the "hows and whys"..let's take this example :

Your parents have set a certain limit within which you can borrow money from them as and when needed in a month, and of-course this money you refer to as the palatable pocket money. Let's imagine that that you spend all the money and are about to exceed your limit ; what are your options now ?

• Ask your parents to increase your pocket money limit or "CEILING".
• Cut down on your expenditures and save more money to never exceed the set limit.

The above example when considered keeping in mind the state of affairs in the US has given rise to a DEBT CRISIS. 

USA had a fixed debt ceiling and when the ceiling was reached things started getting murky. The govt's vault has little money left to pay back the debts, to pay the dues and to run the economy.

SOLUTION : Well the Republicans and Democrats of the US Senate are not ready to arrive at a common consensus.

The Republicans want Obama's government to cut their expenditures to pay back the debts.

Whereas the Obama administration thinks that increasing the debt ceiling is the only viable option out.

RESULT : 2 August 2011 has been predicted as the day when USA will face default ( inability to pay back debts); leading to grave outcomes for both the US and the world economy.

To wind up, the internal commotion in the US Senate has jeopardized the world economy. with half the world economies losing faith in the state of affairs of the US.  

Just 2 more days and the result will be in front of us. 

Vive la WORLD ECONOMY !!

PS : Being a 4th year engineering student, the placement season for me is just about to begin. And frankly if at all the world enters the gloomy recession, I'll cuss MR. OBAMA for the rest of my  life.

Debt Crisis : THE WEEPING GREEKS & THE SMUG UNCLE SAM

With the world economy in a state of shock or perhaps a state of mutely heading into a state of the "Stygian Recession", yet again...
Here are the 2 most easily understandable articles that can bring things in perspective..perhaps make you understand how we have again reached a stalemate when it comes to saving the world economy :

• GREEK DEBT CRISIS : What led the EU into its current state of economic affairs 
• US DEBT CRISIS : The rise & fall of an economic giant

PS : Sticking to my colloquial approach, I have tried to find the articles that explain the subject matter in the simplest of ways possible.

Debt Instruments

Debt instruments ?! Well if not the same, you all must have heard about BONDS and DEBENTURES !
And that's what will be dealt with here.

Alright..let's suppose a poor yeoman wishes to construct his house in village. His modus operandi would be to first check his pocket and borrow the rest. Upon scrutinization, he realises that he has fallen short of Rs.10K.
So he goes to a nearby moneylender to borrow this sum at a specific interest.

Now in economics terms; the money lent by the lender is an investment for him, because the borrower will return the principal with an additional interest. When this transaction is written on a contract, it becomes a debt instrument, where the lender becomes an "investor" and the borrower becomes the "issuer".

On a gargantuan scale, the term BOND is used for instruments that are issued by state or central governments ( like the ones issued by the GREEK Govt., which has led to the Greece Economic Crisis) or PSUs, while the term DEBENTURE is used for instruments issued by private players.

The written contract will specify 3 key details :

1. Rate of interest : rate @ which money is borrowed

2. Maturity : date on which the principal will be repaid

3. Principal : the money lent

Depending on a person's risk tolerance, a person can decide on what bond or debenture to invest in. The main risk lies in the fact that the company or institution that is the Issuer, becomes bankrupt or shuts down abruptly. Here comes the role of CREDIT RATING COMPANIES like CRISIL ( in India) and STANDARD & POOR'S ( on the global scale). 'AAA' rating means the highest safety and 'D' means that the company is in default ( citing: GREEK ECONOMIC CRISIS).

A general principle in investment: "Higher the risk, higher the interest that the company will pay, on the other hand a safer company will provide a lower rate, but will ensure that your money rests in safe hands." Thus the safest kinds of debt instruments are the ones issued by the state or central govts., because the govt. itself guarantees the returns.

All About Mutual Funds

So..when was the last time you saw a 'disclaimer' crop up in a television commercial quoting a trite statement "Mutual funds are subject to market risk. Please read the offer document carefully before investing." ? Perhaps yesterday..or may be an hour back.

So what does this statement connote ? Well the answer will be dealt with in the next few lines. Read on...

Suppose a middle class service man with a monthly income of around Rs.25K, thinks of investing in the share market, with the inherent fear of the stocks crashing and him losing his hard earned money. Such investors whose "risk tolerance" is low retort back to a well diversified investment portfolio. It is this diversified investment portfolio that brings MUTUAL FUNDS ( also called ASSET MANAGEMENT COMPANY [AMC] ) in the picture.

WHAT IS AN AMC ?

An asset management company pools money from investors and invests it in a portfolio on behalf of the investors. The money pooled in is the "mutual fund", which is invested in various asset classes like equity, bonds, debentures (to be explained in the next few posts).
The AMC is responsible for investing the pooled money into specific securities. The AMC constantly tracks and monitors the market trends and manages the funds, leading to low risk and hopefully quashing the fear of losing ones money in the "not so predictable" market.
ICICI Prudential Asset Management Co. Ltd., is an example of an AMC.

Different kinds of funds are available viz. Hedge funds, sector funds, debt fund etc, the details of which are beyond the colloquial approach that I'm sticking to !!

Understanding FDI & FII

Ever since I started digging deep into the XYZs of understanding the world economics; I felt the urge to at least start reading about the basic terminologies and fundamentals; a plenitude of which was always present in all papers, books, journals et al. One thing that immediately caught my eyes and ears was the frequency of the usage of this "FDI & FII" thing everywhere. So here's a post that will try to keep things in perspective. Read on...

With liberalization of economies of the world and the rapid  globalization, markets are opening up for direct investments from companies and firms of different countries to spur economic growth in the receiving market / economy / nation. And this is what has given rise to the terminologies FDI & FII.

Take for example; a company based in Germany buys a stake in an Indian company leading to a rather fast pace development and revenue generation, benefiting both the organizations. This is what we call FDI or FOREIGN DIRECT INVESTMENT.

Buying stakes doesn't entitle the investing company to take over the parent company; rather the parent enterprise is the plenipotentiary in all matters. And this investment in an aborigine company by a foreign company gave rise to the term Multi-National Company (MNC).

Example of such a collaboration is BAJAJ-ALLIANZ ( Bajaj being the parent company and Allianz being the German financial services giant).

Some of  the primary advantages of FDI are:

• International Trading by transfer of knowledge, expertise & skills.
• Plays a catalytic role in the development of both the enterprises and the parent economy.

Sectors attracting high FDIs are IT, TELECOM, PHARMACY, REAL ESTATE, AUTOMOBILE INDUSTRY etc.

MORE THE FDI, MORE WOULD BE THE SANGUINENESS OF AN ECONOMY.

Coming to FII; the starting 'F' and the ending 'I' connote the same idea as in FDI; the difference being only in the middle 'I', that stands for INSTITUTION, making FII = Foreign Institutional Investment, where the Institution/Investor is a registered operator in a country other than the one in which it is currently investing.

Such investors include Insurance companies, mutual funds etc.

Such companies invest in the parent economy's finance markets; with constant regulation by some regulatory authorities in the receiving end economy. Example of such a body in India is SEBI = Securities & Exchange Board of India.

I hope the next time you witness these words anywhere, you'd be able to construe the ideas more clearly.