PROJECT REPORT TITLED

LIABILITY MANAGEMENT AND DERIVATIVES AS A TOOL OF LIABILITY MANAGEMENT IN FINANCIAL INTERMEDIARIES

SUBMITTED BY: MANISH SAINI ENROLMENT NUMBER # 990046281 STUDY CENTRE # 0712 REGIONAL CENTRE # 029 PROJECT PROPOSAL# 34918

SUBMITTED TO: SCHOOL OF MANAGEMENT STUDIES INDIRA GANDHI NATIONAL OPEN UNIVERSITY MAIDAN GARHI NEW DELHI.

CONTENTS
1.About IDBI 2.Introduction 3.Reasons for ALM Mismatch 4. Sources And Characteristics Of IRR 5.Measurement and management of IRS 6.Regulatory framework 7.ALM constraints 8.What are Derivatives 9. FRAs and IRS 10.What Does IRS Do? 11. Indian Scenario 12. Conclusion 13. References

ABOUT IDBI Industrial Development Bank of India (IDBI) was established in July 1964 by Government of India under an act of Parliament, the Industrial Development Bank of India Act, 1964(the IDBI Act). The IDBI Act governs the functions and working of IDBI. Initially IDBI was set up as a wholly owned subsidiary of the Reserve Bank of India (RBI) to provide credit and other facilities for the development of industry. In 1976,the ownership of IDBI was transferred to the Government of India and it was entrusted with the additional responsibility of acting as the principal financial institution for coordinating the activities of institutions engaged in financing, promotion or development of industry. In 1982, IDBI transferred its International Finance Division to export-import Bank of India, which was established as a wholly owned corporation of the Government of India under the export-import Bank of India Act, 1982. In 1990,IDBI's portfolio relating to the small-scale industrial sector was transferred to the Small Industries (SIDBI), which was established as a wholly owned subsidiary of IDBI under Small Industries Development Bank of India Act, 1989(SIDBI Act, 1989). IDBI provided significant support in the development of the capital market through setting up of Securities & Exchange Board of India, National Stock

Exchange of India LTD, Credit Analysis and Research LTD, Stock Holding Corporation of India LTD, Investor Services of India LTD, National Securities Depository Ltd. In 1999, entered into a JV agreement with the Principal Financial Group, USA for participation in equity and management of IDBI Investment Management Company Ltd., erstwhile a 100% subsidiary of IDBI. In March 2000, set up IDBI Intech Limited as a subsidiary to undertake IT related activities. Functions As a Development Bank, IDBI has financed and nurtured Indian industry through its infancy to fulfill the national dream of a robust industrial and financial structure in the country. Over the last thirty years, IDBI's role as a catalyst to industrial development has encompassed a broad spectrum of activities. IDBI can finance all types of industrial concerns covered under the provisions of the IDBI Act, irrespective of the size or the form of the organization. IDBI primarily provides finance to large and medium industrial enterprises and is authorized to finance all types of industrial concerns engaged in the manufacture, processing of preservation of goods, mining, shipping,

transport, hotel industry, information technology, medical and health services, leasing, generation and distribution of power, maintenance, repair,

testing or servicing of vehicles, vessels and other types of industrial machinery and the setting up of industrial estates. IDBI also assists industrial concerns engaged in research and development of any process or product or in the provision of special technical knowledge or other services for promotion of industrial growth. In addition, floriculture, road construction and the establishment and development of tourism related facilities including amusement parks, cultural centers, restaurants, travel and transport facilities and other tourist services and film industry have been recognized as industrial activities eligible for finance from IDBI. IDBI has been assigned a special role for co-coordinating the activities of institutions engaged in financing, promoting or developing industries as also provision of technical, legal and marketing assistance to industry and undertaking market surveys, investment research as well as technoeconomic studies in connection with development of industries.

"We are envisaging the new Industrial Development Bank of India as a central coordinating agency, which ultimately will be concerned, directly or indirectly, with all the problems or questions relating to the long and medium term financing of industry, and will be in a position, if necessary, to adopt and enforce a system of priorities, in promoting future industrial growth" Extract of the then Union Finance Minister's address

to the Parliament on the setting up of IDBI in 1964

IDBI's future strategy for business growth would be to further build upon its area of core competence viz., project financing complemented with the aggressive entry into other compatible business operations. Asset growth of acceptable quality through client-driven business deals that would help maintain IDBI's market shares along with enhanced profitability would be an integral part of the strategy. IDBI's future strategy would be not only to maintain its premier position in the Indian financial system but also to take a position of prominence among top DFIs of the world. Offices IDBI has its Head Office at Mumbai and has an all India presence through its branch network. It operates through the network of 5 Zonal offices; one each in Calcutta, Chennai, Guwahati, Mumbai and New Delhi. Besides, IDBI has 38 branch offices located in state capitals and major commercial centers in India. Government Holding The IDBI Act was amended in October 1994, which, inter alia, permitted IDBI to raise equity from the public subject to the holding of the Government not falling below 51% of the issued capital. Pursuant to the amendment, in July 1995,IDBI made its first initial public offering of equity shares aggregating RS. 2184 crones. Simultaneously, the Government also offered for sale a part of its holding of equity shares in the capital of IDBI

aggregating Rs.187.5 crores (including premium of RS. 120 per share) to the Indian public. On completion of the allotment of shares offered to the public, the Government's shareholding in IDBI reduced to 72.14%. The Government share holding has further come down to 57.76% with effect from June 5,2000 as, the Government of India converted 24.7 crone equity shares into 24.70 crone fully paid preference shares of Rs.10/- each redeemable within 3 years and carrying a dividend @ 13% pa. However the Government's holding has gone up to 58.5% with effect from August 25,2000. Regulation and Supervision The IDBI Act regulates the functions and business of IDBI. In addition it is a financial institution subject to regulatory supervision by RBI. Section 45L of RBI Act, 1934, empowers RBI, inter alia, to call for certain information relating to the business of IDBI and give directions relating to conduct of its business. RBI has also setup a Board of Financial Supervision under the chairmanship of the Governor of RBI, which carries out periodical supervision of IDBI.RBI also issues detailed guidelines on Asset Classification, Income Recognition and Provisioning, Capital Adequacy, Asset Liability Management etc. from time to time. IDBI adheres to all such guidelines and submits necessary information to RBI as per guidelines.

Corporate Governance Presently corporate governance is administered through the Board and two major committees, i.e. the Executive Committee and the Audit Committee. However the primary responsibility of upholding the high standards of corporate governance in its operations and providing necessary disclosures within the framework of legal provisions and banking conventions with commitment to enhance the shareholder's value, lies with the Board of IDBI. The Board The Board of Directors can have a maximum of 12 directors, consisting of a Chairman and a Managing Director appointed by the Government of India, a fulltime director appointed by the Government on the recommendations of the Board, two Government nominees, three directors having special knowledge in diverse fields nominated by Central Government and four directors elected by the shareholders other than the Government of India. Primary responsibilities of the Board include: Maintaining high standard of corporate governance. Shaping the policies and procedures of the Bank. Monitoring the progress and shaping the future growth strategy.

The Executive Committee All directors of the Board are members of the Executive Committee, with the CMD of IDBI being the committee chairman. This committee deals with sanctions of assistance above certain threshold limits and also decides on matters relating to Business Plans, Resource Mobilization, Investments, Capital Expenditure etc. Audit Committee It comprises of five directors and is headed by an independent professional director. This committee acts an interface between the management and the statutory and internal auditors overseeing internal auditors.

Investor Grievances Committee This committee consists of a Chairman and two members, who are Directors of the Board and the Deputy Managing Director as a member. The committee looks into redressal of shareholders and the investors' complaints mainly relating to transfer of shares/bonds, on-receipt of annual accounts and dividend, interest etc.

OBJECTIVES

RESEARCH METHODOLOGY

LIMITATION

INTRODUCTION
Asset and liability management is the management of total balance sheet dynamics with regards to size and quality. It involves quantification of risks. Asset and Liability Management is the management of the structure of a bank's balance sheet in such a way that interest related earnings are maximized within the overall risk preference of the banks management. Stated in this way, ALM is not new to bank management. No bank could have survived over the years without paying attention to the risk/return characteristics of its balance sheet. Asset and Liability management has grown up as a response to the problem of managing modern banks dealing in a wide range of diversified aspects, liabilities, and contingent liabilities at a time of volatile interest rates, volatile exchange rates and, more generally a continually changing economic environment. Over the last few years the Indian financial markets have witnessed wideranging changes at the fast pace. Intense competition for business involving both the assets and liabilities, together with increasing volatility in the domestic interest rates as well as foreign exchange rates has bought pressure on the management of banks to maintain a good balance among spreads, profitability and long term viability. These pressures call for

structured and comprehensive measures and not just ad hoc action. The management of banks has to base their business decisions on a dynamic and integrated risk management system and process driven by corporate strategy. Banks are exposed to several major risks in the course of their business- credit risk, interest rate risk, foreign exchange risk, equity commodity price risk, liquidity risk and operational risk. The initial focus of the Asset Liability Management (ALM) function would be to enforce the risk management discipline viz. managing business after assessing the risks involved. The objective of good risk management programs should be that these programs would evolve into a strategic tool for bank management.

In the normal course, banks are exposed to credit and market risks in view of the asset-liability transformation. With liberalization in Indian financial markets over the last few years and growing integration of domestic markets and with external markets, the risks associated with banks operations have become complex and large, requiring strategic management. The interest rates on bank investments in government and other securities are also now market related. Intense competition for business involving both the assets and liabilities, together with increasing volatility in the domestic interest rates as well as foreign exchange rates, has brought pressure on the

management of banks to maintain a good balance among spreads, profitability and long-term viability. Imprudent liquidity management can put bank earnings and reputation at great risk. These pressures call for structured and comprehensive measures and not just ad hoc action. The management of banks has to base their business decisions on a dynamic and integrated risk management system and process, driven by corporate strategy. Banks are exposed to several major risks in the course of their businesscredit risk, interest rate risk, foreign exchange risk,

equity/commodity price risk, liquidity risk and operational risk. It is, therefore, important that banks introduce effective risk management systems that address the issues related to interest rate, currency and liquidity risks.

Banks can address these risks in a structured manner by upgrading their risk management and adopting more comprehensive Asset-Liability Management (ALM) practices that has been done hitherto. Asset and Liability Management is the management of the structure of a bank's balance sheet in such a way that interest related earnings are maximized within the overall risk preference of the banks management. Stated in this way, ALM is not new to bank management. No bank could have survived over the years without paying attention to the risk/return

characteristics of its balance sheet. Asset and Liability management has grown up as a response to the problem of managing modern banks dealing in a wide range of diversified aspects, liabilities, and contingent liabilities at a time of volatile interest rates, volatile exchange rates and, more generally a continually changing economic environment.

REASONS FOR ASSET LIABILITY MISMATCH: Prepayment / Payment Delays: The prepayment or payment delay creates mismatch in the Asset - Liability structure when a borrower does not fulfill his obligation or does not do so on time. There is a fundamental connection between this problem and asset and liability management, in that all asset management relies upon asset being of good quality. The most direct influence of asset and liability

management on this problem has been the switch to variable rate lending. This change designed to remove from banks much of the interest rate risk involved in maturity transformation succeeded but shifting the interest rate risk to the borrower, thus making his cash flow less predictable and may be making him a worse credit risk. Of course this will depend upon the variability of rates of interest, a sudden fall in rates of interest will obviously help borrowers on variable rate terms, rise will be to their disadvantage. Bad debts also affects asset and liability management. They freeze assets and convert short-term claims into long-term claims. Cash flows, which were expected, are not received and this impacts on bank liquidity. If bad debts are unusually large they affect outsiders perception of the bank and in all probability reduce its creditworthiness, thereby affecting the ease and/or cost of raising funds. And anything affecting the perceived creditworthiness of a bank affects its ability to manage

liabilities. While it is to be expected that bad debts will rise in time of severe recession, the problems can be exacerbated by insufficient diversification of the loan portfolio. With all lending whether by banks or by financial institutions, concentration on individual lenders, individual groups, and individual economic sectors can increase this problem. Thus measuring and managing liquidity needs are vital activities of commercial banks. By assuring a bank's ability to meet its liabilities as they become due, liquidity management can reduce the probability of an adverse situation developing. In order to overcome this liquidity gap, commercial banks undertake Credit Risk Management, which involves three key principles: selection, limitation and diversification. The choice to whom to lend is a first requirement. However discrimination is a bank's credit management, there remains the risk of unforeseen changes in the economic fortunes of companies, industries, of geographical areas or even of whole countries; hence it is necessary to have a system of limits in different ways and at different levels for amounts to be loaned to any one borrower or group of connected borrower and to any one industry or type of economic activity. The third principle of limitationavoiding concentration of lending. But over and beyond this minimum implied diversification, the more a bank is able to spread its lending over different types of borrower, different economic sectors and

different geographical regions, the less likely is it to encounter credit problems. Large banks are more able to diversify by geography by economic sector than small banks. Vulnerable Exchange Rate Movements: vulnerable exchange rate movements creates Asset- Liability mismatch due to changes in foreign exchange rates. Floating exchange rate arrangement has bought in its wake pronounced volatility adding a new dimension to the risk profile of bank balance sheets. The increased capital flows across free economies following deregulation have contributed to increase in the volume of transactions. Large cross border flows together with the volatility has rendered the banks balance sheets vulnerable to exchange rate movements. Dealing in different

currencies brings opportunities as also risks. If the liabilities in one currency exceed the level of assets in the same currency, then the currency mismatch can add value or erode value depending upon the currency movements. For instance if dollar assets exceed dollar liabilities a bank stands to gain from appreciation of the dollar and to lose from depreciation. Banks undertake operations in foreign

exchange like accepting deposits, making loans and advances and quoting prices for foreign exchange transactions. Irrespective of the strategies adopted, it may not be possible to eliminate currency mismatches altogether. Besides some of the institutions may take

proprietary trading positions as a conscious business strategy. The simplest way to avoid this is to ensure that mismatches, if any are reduced to zero or near zero. The management of currency positions like other aspects of asset and liability management involves both short-run and long run considerations. In the short run banks can transact in a range of markets in orders to alter their asset/liability position in any given currency. In the long run banks can choose to compete more or less aggressively for business in particular currencies and they can vary their long-term borrowing in particular currencies. If it accords with its other long term plans, a bank can seek to develop retail banking operations in other currencies in order to boost its resources in the currencies in question. Balance Sheet Activities: Banks have traditionally stood ready to provide certain types of guarantee which involved underwriting the obligations of a third party and which creates contingent liability for the guarantor banks. In recent years contingent activities have become more important as banks have increased off-balance sheet business in search for fee income or for hedging purposes. The new contingent risk are those arising from commitments to provide funds in the future, from acting as counter party in currency or interest-rate

swaps and from outstanding forward or futures commitment, and from options granted. Contingent activities should be taken seriously because they being contingent as opposed to actual at times could be

underestimated. Interest Rate Mismatches: Whenever rate-of-interest conditions attaching to assets and liabilities diverge, then changes in market interest rates will affect bank earnings. The regulatory restrictions on banks greatly reduced many of the risks in the financial system. The deposits were taken in at mandatory rates and loaned out at legally established rates. Interest rates therefore remained unaffected by market pressures. Deregulation of the financial system in India has put in place a lot of operational freedom to the financial institutions and the pricing of major portion of assets and liabilities have been left to their commercial judgement. The money that savings institutions historically took in was primarily short-term deposit whereas the money they lent out was primarily in the form of long-term loans. They failed in the early 1980's when interest rate on deposit accounts rose sharply. Because the mortgages used to pay interest on these accounts were long-term instruments, the institutions were receiving lower rates than

they were paying. Therefore their cost of funds rose much faster than the yields on their assets. The resulting declines in spread and profitability contributed to many failures. For example, suppose ABC negotiated 10% with the borrower on 48month installment loan and a rate of 6% with the depositor on 90 days CD. The spread would be 4%, which is favorable to ABC. Now the depositor decides to renew the CD at the end of 90 days. If deposit interest rates in ABC's market have risen during the 90 days since the CD originally opened, ABC would be forced to pay higher rate when CD renews. If local rate have risen by 2%, then ABC may be required to pay 8% on renewal of CD. But because the 48-month installment loan is fixed to maturity and 45 installments of the original 48 payments will be still outstanding ABC will have 10% yield on the majority of the loan and cost of fund will be 8%. The spread has dropped to 2% from 4%. As a result less money will be available to cover expenses. This difference occurs because loan and deposit reprice at different times. If rates had fallen during the 90 day period, cost of funds would drop at renewal increasing ABC's profitability. The rapidly climbing cost of funds in contrast to the sluggish movement in yields on earning assets contributed to heavy losses.

The earning of assets and the cost of liabilities are therefore closely related to interest rate volatility. Interest rate refers to potential impact of Net Interest Income (NII) or Market Value of Equity (MVE) caused by unexpected changes in interest rate. This unexpected change in the interest rates gives raise to Interest Rate Risk. While asset and liability management covers a much broader scope than management of interest rate risk, this aspect of risk

management is one of the most important disciplines in asset and liability management.

SOURCES AND CHARACHTERISTIC OF INTEREST RATE RISK The degree of interest rate risk that the institution must manage depends upon the rate sensitivity of the financial instruments it uses to obtain funds (deposits and borrowings) and invest funds (investment and loans). Financial instruments rate sensitivity is the speed at which the interest rate on the instrument responds to a change in market rates. For example, suppose a customer opened a money market deposit account (MMDA) at an interest rate of 5.5%. An MMDA is a saving account that is designed to be directly equivalent to and competitive with money market mutual funds. The institution can establish its own minimum deposit and maintenance balance requirement to open the account to earn interest, the MMDA contract specifies that whenever the institution changes its MMDA rate, all MMDA customers automatically receive the new rate. If the institution changes its rate to 5.75%, the customer who opened the MMDA at 5.5% will immediately receive the higher rate. Because the interest rate on the account might change immediately whenever there is a change in market rates, the MMDA account can be extremely rate-sensitive. On the other hand suppose a customer purchases a 2-year CD at a rate of 6.5%, the CD contract specifies that the interest rate will be in effect for the life of the instrument, 2 years. If the institution raises its rates on 2 years CD to 7%, the customer who already purchased it at 6.5% is locked in the older

rate. Because a considerable length of time will elapse before the CD will react to the change in market rates and because there are penalties for early withdrawal, such CD is not considered to be very rate sensitive.

This shows rate sensitivity of a financial instrument depends upon certain characteristics. These characteristics are: 1. Length of term to maturity - the above example of the 2-year CD showed the effect of maturity on rate sensitivity. Maturity is the point at which an instrument becomes due and payable. The maturity of an instrument represents an occasion to renegotiate the rate on the instrument. Upon maturity of a 2 year CD the customer is free to take the funds and seek the most favorable rate at which to reinvest. Thus, the shorter the term of maturity, the more susceptible borrowers and lenders are to rate sensitivity. Financial institution can replace maturing investments, loan, and deposits on borrowings with other investments, loans, deposits or

borrowings. At the time of reinvestment, the financial institution is vulnerable to the effect of changes in market interest rates. If rates have gone up since the original instrument was first negotiated, the replacement instrument will carry a higher interest rate. If rates have gone down, the opposite occurs.

2. Use of Amortization - an instrument is said to amortize when it calls for payment of a portion of the instruments principal periodically over the life of the instrument. For example, the typical mortgage loan has a 30-year life, but each monthly payment includes interest on the outstanding balance plus a reduction in the outstanding principal. As the institution receives these principal payments it has the opportunity to lend the funds to other customers at current market rates. This shows amortizing instrument is more rate-sensitive than one that calls for a lump-sum payment. This is because the principal payments represent re-pricing opportunities.

3. Prepayment - often a borrower or depositor does not adhere to the principal repayment schedule specified in the contract. When a customer prepays a loan early, the institution has the opportunity to reinvest those funds at current market rates. When the customer negotiates an early withdrawal on a CD, an institution replaces the funds withdrawn with funds obtained at current market rates. Because prepayment causes a loan or CD to reprice earlier than specified in the contract, in institution experiencing frequent payment is more rate sensitive than an instrument that experiences infrequent prepayments. Prepayments on loans vary based on demographic and economic characteristics. E.g. a market with rapidly growing, healthy economy experiences higher turnover in its housing stock than a market that is stagnant, causing more frequent prepayments of mortgage loans. In an

environment of falling rates, borrowers will have greater incentives to refinance loans than when will rates are rising. 4. Contractual Repricing - timing the repricing of a financial instrument by specifying it in the instruments contract is called contractual re pricing. Earlier the timing of the re pricing of an instrument had been directly tied to the timing of its principal flows. The reason re pricing was tied to these cash flows is that until recently most instruments have carried an interest rate that remained fixed until maturity? But then it was discovered that guaranteeing a fixed rate for the term of the instrument could cause considerable difficulty. Making the purchase of certain classes of assets affordable to customers requires that the purchase be financed over relatively long periods of time. Fixed rate term loans are not very rate sensitive, as their balances do react to the changes in market rates. Because customers like to keep their deposits in short term instruments, it is difficult to find a source of deposit with rate sensitivity similar to that of an institutions long-term mortgages. This problem of funding long term assets with short-term liabilities is to separate instruments re pricing from the terms of the contract. E.g. while the typical adjustable rate mortgage has a term of 15 to 30 years, its contract may allow the institution to change its interest rate annually based on movements in market rates. Contractual modification of the re

pricing characteristics affects the rate sensitivity of the instrument. Rather than gradually re pricing over 15 o 30 years through amortization, the instrument can re price annually. Interest rate risk can be basically classified into: Gap or mismatch risk A gap risk arises from holding assets and liabilities with different principal amounts, maturity or re pricing dates thereby creating exposure to unexpected changes in the level of interest rates. The gap is the difference between the amount of assets and liabilities on which the interest rates are reset or re priced during a given period. In other words, when assets and liabilities re price during different periods, they can create a mismatch. Such a gap or mismatch may lead to gain or loss depending upon how interest rates in the market tends to move. For example, if a bank has invested the proceeds of a 91 days, 8% deposits in 91 days treasury bill earning 10% and maturing on the same day as the deposit, the bank will have a matched gap. Here there would be no interest rate risk. If the proceeds of the 91 day deposit are re invested in the floating rate loan (re priced at monthly interval) with an initial rate of 10%, the interest rate charged on the loan will change twice during 91 days, while deposit rate remains unchanged. Since the asset is repriced much more rapidly than the liability during this period, the bank is more asset sensitive. The asset sensitive bank can

produce a large NII if the interest rate rises in the market because interest rate on floating loan moves higher during the 91 days period, while interest rate being paid on the deposit remains at 8%. Conversely, asset sensitive gap position will cause compression in NII as interest rate declines. If bank uses 91 days 8% deposit to fund a 5 year fixed rate govt. stock at 10%, the stock would continue to earn 10% while the deposit gets re priced at every 91 days interval. The bank is more liability sensitive because the interest paid on deposit is reset more rapidly than the fixed coupon earned on the stock. A rise or fall in the interest rate in a liability sensitive situation has the opposite effect on the NII than on an asset sensitive bank. Any increase in the interest rate will cause an erosion in the liability sensitive bank NII. Basis risk In a perfectly matched gap position, there is no timing difference between the repricing dates; the magnitude of change in the deposit rate would be exactly matched by the magnitude of change in the loan rate. However, interest of two different instruments will seldom change by the same degree during the give period of time. The risk that the interest rate of different assets and liabilities may change in different magnitude is called basis risk. The following table shows how the basis risk occurs.

GAP Statement for ABC Bank (Amount in million of Rs) Repricing Assets Call money Cash credit 50 40 90 Saving Bank Time deposits Repricing liabilities 50 50 100

The bank as a negative gap of Rs.10 million. In case the interest rate falls by 1% (assuming that the rates on all assets and liabilities change by 1%) will improve the banks NII by Rs. 1 million.

Net Interest Position Risk The banks net interest position also exposes the bank to an additional interest rate risk. If a bank has more assets on which it earns interest than its liabilities on which it pays interest, interest rate risk arises when interest rate earned on assets changes while the cost of funding of the liabilities remains at 0%. Thus, a bank with positive net interest position will experience a reduction in NII as interest rate declines and expansion in NII as interest rate rises. A large positive net interest position accounts for most of the profit generated by many financial institutions.

Embedded Option Risk Large changes in the level of interest rate create a risk to banks profits by encouraging pre payment of loans and/or withdrawal of deposits before the stated maturity dates. In case where no penalty for pre payment of loans, the borrower have a natural tendency to pay of their loan when a decline in interest rate occurs. In such cases, the bank receive a lower NII for e.g. suppose a bank disbursed a 90 days loan at the rate of 10% which is funded through a 90 days CD at the rate of 8%. In case the rate of interest declines to 9% after 30 days and the borrower repays his loan immediately, the bank receives only 200 basis points NII or 30 days rather than the anticipated 90 days. In the remaining 60 days of the 90 days term, the NII will be only 100 basis points. When the interest rate rises, the NII will be exposed to same embedded option risk in the liability side of the balance sheet. If there are no substantial penalties for pre mature withdrawal, the depositor may withdraw the term deposits before the contracted maturities so that the funds can be re deposited in new deposit accounts at a higher rate of interest. Thus, as interest rate rise and falls, the banks are exposed to some degree of risk as customers exercise the embedded options inherent in their loan and deposit contracts. The faster and higher the magnitude of changes in the interest rate, the greater will be the embedded option risk. Banks impose penalties for pre payment of loans and pre mature withdrawal of deposits. However as customer resist paying large penalties bank have to

reduce penalties to modest level as a competitive strategy to attract additional business. Yield Curve Risk An yield curve is a line on a graph plotting the yield of all maturities of a particular instrument. As the economy moves through business cycle, the yield curve changes rather frequently. To illustrate how a change in the shape of yield curve affects the banks NII, lets us assume that ABC bank use three years floating rate fixed deposits for funding three year floating rate loans (the deposits and loans are re priced at quarterly intervals). If the bank pays 100 basis points above the 8.50%, 91 days treasury bills rate to fixed deposits and basis points is produced. If the yield curve turns inverted during the next repricing date with the 91 days TB's rate increasing to 10% and 364 days TB's rate remaining at 9% and the spread relationship of deposits and loans to TB's remains constant, the NII will be reduced to 100 basis points. Thus banks should base only the rate of single instruments for pricing the assets and liabilities.

Re-investment Risk As one instrument matures and replaced with another, the funds being re invested may bear a different rate than the funds in the initial instrument. The risk that this will occur is called re-investment risk. As replacement instruments take the place of original instrument on an institutions statement of condition, the institutions interest income and interest expense will rise or fall, depending on the whether the replacement bears a higher or lower interest rates than the original instrument. Liquidity Risk Customers look to financial institution as a source of funds and a place to deposit excess funds. A depositor expects to be able to withdraw deposited funds as needed, so a financial institution needs to have funds available when the customer asks for them. Borrower also expects that an institution will be able to supply funds for loans. So, financial institutions seek to have some degree of liquidity. Liquidity is a measure of a business, individual or institution to convert assets into cash at a particular time without significant loss of principal value. In other words liquidity is the ability to meet commitments when due and to undertake new transactions when desirable.

The liquidity of assets varies widely. Assets offering immediate liquidity

include cash or assets that varies widely. Assets offering immediate liquidity include cash or assets that can be converted into cash at least within the next day. Such assets include vault cash, fed funds, securities maturing tomorrow and demand deposits. Assets that offer intermediate liquidity can be converted into cash within a few days or weeks without a significant loss. Scheduled loan repayments due within the next few weeks are a source of intermediate liquidity. Loans that can be securitized and sold in the wholesale markets are considered to be a source of intermediate liquidity. Illiquid assets are those assets that cannot be converted into cash within a few days without incurring substantial loss of principal value.

Measurement and Management of Interest Rate Risk

Before risk can be managed, they must be identified and quantified. Unless we measure the quantum of risk inherent in a bank's balance sheet is measured it is impossible to measure the degree of risk the bank is exposed to. It is equally impossible to develop effective risk management strategies. Without being able to understand the correct risk position of the bank. There are many analytical techniques to measure interest rate risk. The most commonly used techniques are: Maturity Gap Analysis Duration Gap Analysis. Simulation Value At Risk.

While these methods highlight different facets of interest rate risk, banks in combination that combine features of all the techniques can use these. Maturity Gap Analysis Gap analysis is a technique that shows how quickly an individual ratesensitive asset or liability reacts to change in market rate. In addition, gap

analysis compares the rate sensitivity of assets and liabilities making up an institution's portfolio and measures the imbalance between their respective rate sensitivities at a particular time. It does this by breaking down future cash flows by rate-sensitive asset or liability is scheduled to reprice. The gap is the difference between the amounts of assets and liabilities repricing in a rate-sensitivity period. A rate sensitivity is a period of time during which the portion of a rate sensitve asset or liability is scheduled to reprise The mismatch risk can be measured by calculating gaps over different time intervals based on aggregate balance sheet data at a fixed point of time. An institutions interest rate position is the cumulative result of thousands of individual items of deposits, loans, investments etc. Each deposit, advance, investment etc has its own cash flow characteristics. In order to fully comprehend the risk inherent in banks balance sheet, each deposit, borrowing, loan, cash credit etc. should be related to their cash flows and repricing to a given change in general level of interest rate.

The gap report should be generated by grouping rate sensitive liabilities, assets and off balance sheet positions into time buckets according to residual maturity or next repricing period, whichever is earlier. The difficult task in gap analysis is determining rate sensitivity. All investments, advances, deposits, borrowings, purchased funds etc. that mature/re price within a specified timeframe are interest rate sensitive. Similarly any

principal repayment of loan is also rate sensitive if the bank expects to receive within the time horizon. This includes final principal payment and interim installments. Certain assets and liabilities are repriced at predetermined intervals and are rate sensitive at the time of repricing. While the interest rate on term deposits are fixed during their currency the advances portfolio of the banking system is basically floating. The interest rates could be repriced any number of occasions, corresponding to the changes in PLR. Duration Gap Analysis Matching the duration of assets and liabilities instead of matching the time until repricing is another technique for interest rate measurement. Duration gap model focuses on managing NII by recognizing the changes in the market value of the assets and liabilities for a given change in the market interest rate. Duration is the weighted average of the time until expected cash flows from a security will be received, relative to the current price of the security. The weights are the present values of each cash flow divided by the current price. Additional data required to calculate the duration gap are the current market yields/cost of different categories of assets and liabilities.

The difference between duration of the asset structure and the duration of the liability structure is the bank's net duration. If the net duration is

positive (DA>DL), a decrease in market interest rate will increase the market value of the bank. When the duration gap is negative, the market value of the bank increases when rate of interest increases but decreases when rate falls. Simulation Simulation is a technique to measure an institution's interest rate risk by forecasting the effect of an interest rate change on the institution's profitability and market value. All the asset-liability simulation models use a basic three-step approach in running a computer simulation. First, the user provides the computer simulation model with data. Then the computer model uses the data to simulate the effect of the interest rate assumptions and management policies on the institution profitability and market value. Finally the model communicates its result using a variety of reports. Value at Risk VAR is a statistical measure of the risk that estimates the maximum loss that may be experienced on a portfolio with a given level of confidence. VAR always comes with a probability that says how likely it is that losses will be smaller than the amount given. VAR is a monetary amount, which may be lost over a certain specified period of time. The period of time is dependent on the period the portfolio is considered to be held constant. The following is the general formal definition of VAR:

Value at risk is the maximum amount of money that may be lost on a portfolio over a given period of time, with a given level of confidence. VAR is typically calculated for a one-day period - known as the holding period - and is often calculated with 95% confidence. 95% confidence means that there is (on average) a 95% chance of loss on the portfolio being lower than the VAR calculated. Thus the typical definition of VAR becomes the maximum amount of money that may be lost on a portfolio in 24 hours, with 95% confidence. The holding period commonly used is one day. The longer the holding period, the larger is the VAR. The confidence levels will only be true if VAR is compared against the actual loss on the portfolio over a large number of days. It is possible that at some point we will experience several days in a row in which the actual loss on the portfolio is in excess of the var figure

REQUIREMENT OF AN EFFECTIVE ALM FUNCTION - REGULATORY FRAMEWORK. ALM INFORMATION SYSTEM: The information necessary to support ALM decision- making can be from internal and external sources. Internal information should contain all that is necessary to determine the banks position, evaluate results of prior ALM activity and apply the banks expertise. External information should enable ALM to link historical, current and forecast developments in the bank's economic environment (including institutional aspects such as regulation and the structure of financial markets) to the development of desirable strategies for managing the banks position. ALM information requirements can differ enormously between banks. A multi- center, risk-taking institution cannot be successful without a constant stream of internal and external information to feed the decision making process that controls its ALM and trading positions. Such an institution will recognize the critical nature of relevant, reliable and timely information for these processes because of the critical role they play in banks business. A risk avoiding, single center bank on the other hand may approach the subject of ALM information with much less effort and can still have satisfactory process.

The purpose of ALM information is to help ALM function understand the dynamics and trends of the banks net interest income and the potential for favorable and unfavorable change. Information should enable the bank to design attractive strategies. In large banks ALM needs to deal with data belonging to many different systems, often spread over many countries. The ALM function needs to be intelligent and economic user of information, able to improvise, estimate, negotiate access, it should not ask for more than it strictly needs. The basic information below shows a fairly long list of external items. The economic forecast needs to focus on the economic development of the bank service area. In many banking markets, change in transaction balances, business and consumer saving, and borrowing activities are distributed proportional to each banks overall market share. From there fairly accurate and reliable forecast cane be made with regard to changes in many balancesheet item. Also analysis of the short-term flow of funds and the policy alternatives available to the monetary authorities to influence developments often leads to practical results. It may be difficult for many economists, unless they get much exposure to daily financial market activity to develop an operational aspect to their forecasting in the are of interest rates. As an alternative to the fundamental approach traditionally used by economist to forecast interest rates and exchange rates, banks where trends

are interpreted without too much concern about their causes adopt a technical approach. ALM Process gives weight to Risk parameters Risk identification Risk measurement Risk management Risk policies and tolerance levels

We have already seen the different types of risk faced by banks and strategies for measurement and management of interest rate and liquidity risk. ALM Organization For implementing asset and liability management in an organization the following steps need to be taken : Organizing a planning team Developing a strategic plan Establishing an Asset Liability Committee

Developing a process for reviewing performance relative to the institutions profit and strategic plans.

By successfully completing these five steps, the institution builds a foundation for integrating the key components of asset-liability

management. The Planning Team A banks planning team is responsible for developing the banks strategic plan and setting planning process, assigns responsibilities for developing the component parts of the banks overall plan, reviews the components and recommends action regarding the plan to the board of directors. The planning team periodically reviews the institution's performance relative to the plan and recommends modifications. Composition - The composition of the planning committee varies according to the size, level of sophistication and philosophy of the institution. In small institutions, the planning committee combines key managers and board members. In large banks like IDBI, with full time planning staff, the planning committee consists entirely of staff members. In addition the planning team always consist of the chief executive officer of the bank. Team members should include members who have a basic set of skills and knowledge. The key member of the planning committee is the team leader. This person is responsible for scheduling, organizing and conducting the committee

meetings. The Strategic Plan Developing the strategic plan is the most crucial part of the planning process. The strategic plan identifies the bank goals over the next few years, examines the banks present position and determines the action necessary to achieve the goals set forth in the mission statement. A strategic plan has give key components. Mission statement Strategic financial goals Situation analysis SWOT analysis Action plan supported by a financial plan.

Mission Statement The financial institution begins the planning process by developing a basic direction. It does this by preparing a basic mission statement, which identifies the institutions, primary reason for being in business. The mission will vary in accordance with the situation of the bank. The mission statement should retain enough flexibility to allow the institution to react to internal and external change. The economic, regulatory and competitive environment

is certain to change over time, and the mission statement must be flexible enough to that change. It should 1. Define line of business - the mission statement should first define the line of business, its primary focus. By identifying the institutions primary focus in the mission statement, manager can better direct their efforts toward goals compatible with their institutions basic purpose. 2. Differentiates from competition - the mission statement should identify the institutions uniqueness and strengths. One way is to define the qualities that differentiate the institution from its competition. 3. Identify key values - the mission statement should spell out the institutions key values. These might include commitment to community, employees, stockholders and customers. 4. Identify present and prospective customers - the mission statement should identify present and prospective customers. Here in identifying the customers it should specify the institutions market area. 5. Spell out commitment to profitability - it should spell out the profit orientation of the institution and its commitment to achieving its strategic financial goals.

Strategic Financial Goals The mission statement serves as a basis for developing a set of strategic financial goals. The strategic financial goals generally include objectives in each of five crucial areas of financial performance. These areas are: Profitability Growth Capitalization Investor compensation

Situation Analysis The third step in the strategic planning process is to determine the institutions current performance relative to its goals. An analysis of the current situation will help build on institution strengths and correct its weaknesses. Situation analysis begins with internal analysis. Management evaluate financial trends within the institution, as well as its resources and its management policies and procedures. After examining the institution itself external analysis is done. The managers look at the institutions

market, its performance in its market and the regulations that affect its present and future operations. SWOT Analysis Here the most important issues identified in the situation analysis are brought out. SWOT analysis is done in which the institution identifies and sets priorities among its most important strengths, weakness, opportunities and threats. Action Plans In the final step of the strategic planning process, a series of action plan is developed. The action plans will take the institution from its present position, as identified in the situation and SWOT analysis towards achievement of its mission and strategic financial goals. The Asset-Liability Management Committee Once the strategic plan has been developed and is in place, the responsibility for day to day administration of the components that affect financial performance passes to the asset - liability committee (ALCO). While the planning committee has a long-range perspective and meets infrequently the ALCO has a much shorter-range perspective and meets more frequently.

Composition and Responsibilities The size of ALCO would depend on the size of each institution, business mix and organizational complexity. To ensure commitment of the top

management and timely response to market dynamics, the CEO or the ED head the committee. The chiefs of investment, credit, resource management or planning funds management/treasury, international banking and

economic research can be members of the committee. In addition, the head of the technology division should also be invitee for building up of MIS and related computerization. In its pricing role, the committee establishes and modifies on all the rate sensitive assets and liabilities marketed by the institution in the retail market. Pricing changes are designed to react to competitive and market changes and to manipulate customer demand in managing the institutions position with regard to interest rate, credit and liquidity risk.

The Budget or Profit Plan A banks annual budget or profit plan is the tool that keeps the bank on track towards achieving its strategic financial goals. The ALCO oversees the development of the budget, recommends its implementation to the BOD and monitors the banks performances under the plan.

The Review System An established system of reviewing the plan and modifying it where necessary contributes significantly to the plan's success. When the plan is written, the bank determines the frequency of its review, the types of performance reporting and the method to use in modifying the plan. Banks depend on effective plans with realistic targets. These plans enable the managers to take action consistent with the banks short and long-range goals. ALM CONSTRAINS FACED BY BANKS One of the essential requirements of ALM is the timely and accurate collection of data. In India, considering the large network of branches, it becomes difficult to collect and compile reliable data in absence of computerized environment. One of the major problems is the mismatch between relatively shortterm liabilities and the longer maturity assets held, particularly in the SLR proportion of a bank portfolio. The appropriate training of the staff for interpretation of data for ALM is also one of the problems faced by the banks.

In India, the market of off-balance sheet products viz. Swaps, FRA's, option and futures have not been developed. These are not used for hedging interest rate risk.

The deregulation of interest rate, though has made significant impact on the management and performance of the banks, it lacks

professional approach and technique to interest rate forecasting.

Derivatives as a tool of liability management One of the significant approaches used by banks to overcome the problem of asset liability mismatch is to use various derivative instruments like futures, options, swaps etc. all these instruments play a vital role in balancing the balance sheets of the banks in a reasonable manner. Covering all these aspects is one of the basic requirements of the banks. But to cover the interest rate risk, the most effective instrument is Interest Rate Swaps. Following pages of the report give a brief about the derivatives, their presence in international and domestic market. What are Derivatives? Derivatives, the word, originate in mathematics and refers to a variable, which has been derived from some other variable. For example, a measure of weight in pounds can be derived from a measure of weight in kilograms

by

multiplying

by

2.2.

Derivatives are financial contracts of pre-determined fixed duration, whose values are derived from the value of an underlying primary financial instrument, commodity or index, such as interest rates, exchange rates, commodities, and equities. They are also known as contingent claims. Without the underlying product and market it would not have any independent existence. Someone may take an interest in the derivative product without having an interest in the underlying product market; but the two are always related and may therefore interact and affect each other, similar to the way in which coffee prices may affect tea prices because both are beverages. If we look back at the world in the mid-sixties, price risk in financial markets was fairly limited. This was an era when state interventions were much more prevalent, the world over, and many kinds of risk were apparently absent owing to price controls. For example, "interest rate risk" did not appear to be present in India owing to direct state control over interest rates. Ever since the early seventies, governments all over the world have steadily retreated from overt price controls. This has been motivated by an increasing realization that these stabilization programs involve enormous costs, upon governments in particular and upon the economy in general through distortions in resource allocation.

The evolution of the four major financial markets of the economy - equity, debt, foreign exchange, and commodities - has proceeded differently. In the case of equity, direct government interventions have been absent in almost all countries. In the case of foreign exchange, the first phase of elimination of price controls took place in OECD countries in the early seventies, though market interventions continued. From the early nineties onwards, there has been a sense that government intervention in many currencies is infeasible even when it is thought desirable. In the area of interest rates, there has been a significant shift in monetary policy away from targeting nominal interest rates. In the area of commodities, the breakdown of cartels like OPEC, and the steady reduction of controls upon agricultural commodities, has led to an increasing emphasis upon markets in determining commodity prices. The deregulation of these four financial markets has had many

consequences for productivity and economic growth. It has also generated an upsurge of price volatility. The term "risk" is often interpreted, in common parlance, as the probability of encountering losses. In the language of modern economics, however, risk is defined as volatility, where unexpected changes (whether in the positive or negative direction) are viewed symmetrically. Volatility in major financial markets of the world rose sharply in the early seventies. For a simple example, we can think of a

commodity like cement in India, where price controls once existed. Under a regime of price controls, the price apparently stayed constant for many months at a time. However, the "true" price of cement did fluctuate. The inflexibility of a controlled price generated risk for consumer (of shortages) and producers (of gluts). A builder might apparently face no risk through a clearly defined price, but the risk of actually obtaining cement might be quite considerable if shortages exist. A cement manufacturer faced the opposite risks. In an environment without price controls, it is the publicly visible price, which fluctuates, and trading in cement is always possible at the market price. The market-clearing price sends out meaningful signals to influence the behavior of consumers and producers, and the risk is explicitly visible as the volatility of cement prices. Economic agents are uncomfortable when exposed to risk. Risk can inhibit the use of efficient production processes, and hence productivity, in the economy. Hence the management of risk has become important. There are three major `technologies' through which economic agents can reduce the risk that they are exposed to: diversification, insurance and hedging. Diversification It is obtained when economic agents spread their exposure over many imperfectly correlated risks.

Insurance It is obtained by paying a fixed cost (the insurance premium) and eliminating certain kinds of risk.

Hedging Derivatives are risk-shifting instruments. The derivatives can also be compared to an insurance policy. As you pay premium in advance to an insurance company in protection against a specific event, the derivatives products have a payoff contingent upon the occurrence of some event for which you pay premium in advance. Initially, they were used to reduce exposure to changes in foreign exchange rates, interest rates, or stock indexes or commonly known as risk hedging. Hedging is the most important aspect of derivatives and also its basic economic purpose. There has to be counter party to hedgers and they are speculators. Speculators don't look at derivatives as means of reducing risk but it's a business for them. Rather he accepts risks from the hedgers in pursuit of profits. Thus for a sound derivatives market, both hedgers and speculators are essential. Now, derivative market can stand on two pillars, but they will stand better if there were three pillars. The third pillar represents arbitrageurs (judge in French). These market participants look for mispricings and market mistakes, and by taking advantage of them; they disappear and never become too large.

Risk management: Derivatives provide an excellent mechanism to Portfolio Managers for managing the portfolio risk and to Treasury Managers for managing interest rate risk. The importance of index futures & Forward Rate Agreement (FRA) in this process can't be overstated.

Price discovery: These derivative instruments make the spot price discovery more reliable using different models like Normal

Backwardation hypothesis. These instruments will cause any arbitrage opportunities to disappear & will lead to better price discovery. Increasing the depth of financial markets: When a financial market gets such sort of risk-management tools, its depth increases since the Institutional Investors get better ways of hedging their risks against unfavorable market movements. Now these are some of the arguments against: Speculation: Many people fear that these instruments will

unnecessarily increase the speculation in the financial markets, which can have far reaching consequences. The Barrings Bank incident is the classic case in point. Market efficiency: Many people fear that the Indian markets are not mature & efficient enough to introduce these instruments. These

instruments require a well functioning & mature spot market. Like recently The Economic Times reported the strong correlation of Indian equity markets to the NASDAQ. Such type of market imperfections makes the functioning of derivatives market all the more difficult. Volatility: The increased speculation & inefficient market will make the spot market more volatile with the introduction of derivatives. So one can see that the pros of derivatives far outweigh the cons. And moreover, by imposing margin requirements, by limiting the exposure one can take and other measures like that, these vices of derivatives can be controlled. The importance of derivatives for any financial market can't be overstated.

History and Development of Derivative Markets (Instruments): A lot of people have this notion that derivatives are a completely new phenomenon. They may have become popular now but their origin can be traced back to Aristotle's writings. Aristotle tells the story of Thanes; a poor philosopher who developed a financial device, which he said, could be universally applicable. Thanes had great skill in forecasting and predicting how good the harvest would be in the autumn. Confident about his prediction, he made agreements with area olive press owners to deposit what little money he had with them to guarantee him exclusive use of their olive presses when the harvest was ready. Thanes successfully negotiated low prices because the harvest was in future and no one knew whether the harvest would be plentiful or pathetic and because the olive press owners were willing to hedge against the possibility of a poor yield -and these contracts were exercised some 2500 years ago! This indicate that that derivatives are not a new concept at all, although, for India it is still a relatively recent phenomenon. The three modes of trade-spot transactions, forward/futures transactions and options- have existed through the course of history, reaching the high of sophistication in the late twentieth century. The concept of forward delivery,

with contracts stating what is to be delivered for a fixed price at a specified place at a specified date, existed in ancient Greece and Rome. Perhaps the first organized commodity exchange on which forward contracts existed in early 1700s in Japan. The first formal commodity exchange in the United States for spot and forward trading was formed in 1848:the Chicago Board of Trade (CBOT). Futures contracts began trading on CBOT in 1860s.The Chicago Mercantile Exchange (CME) was formed in 1919,though it did exist before that date under other names. Merton Miller, one of the winners of the 1990 Nobel Prize for economics, wrote in 1986,"my nomination for the most significant financial innovation of the last twenty years is financial futuresthe futures exchange style of trading of financial instruments."

Options also have a long history. The concept of options existed in ancient Greece and Rome. Options were used by speculators in the tulip craze of seventeenth century Holland. Unfortunately, there was no mechanism to guarantee the performance of the options' terms, and when the tulip craze collapsed in 1636,many of the speculators were wiped out. In particular, the put writers refused to take delivery of the tulip bulbs and pay high prices they had originally agreed to pay. Puts and calls, mostly on agricultural commodities were traded in nineteenth century England and in the United States. On the basis of underlying assets, derivatives are broadly of three types: Financial Derivatives

Commodity Derivatives Index Derivatives

In commodity derivatives the underlying asset is commodity like gold or could be any other raw material whereas in case of financial derivatives, the underlying asset is some financial instrument like equity etc. In case of Index derivative, the value is derived from the index of securities like S & P 500 or Sensex. Also financial risks can arise due to following: Due to inherent risk associated with each security and systematic risk of the whole market of securities. Due to fluctuations in Interest rates Due to fluctuations in Exchange rates

Thus we can have 3 types of financial derivatives for all the above 3 cases. Equity Derivative Interest Rate Derivative Currency Derivative

In the equity derivatives we can have stock index futures, stock index options, individual stocks options and individual stock futures. Derivative markets in India The Past: It's been fairly long since derivative trading started off on the Indian Indexes. Activity has failed to really take off with low figures being transacted in terms of Value and Volumes. The punters in the capital markets but has not really brought about a wave so as to speak hailed the introduction of derivatives trading. There are several factors, which impede the growth of the derivatives markets in India. Of these factors the absence of clear guidelines on tax-related issues and the high cost of transaction is the most prominent. The Bombay Stock Exchange decided to introduce a new index, which would now substitute the BSE-30 in order to boost derivatives trading. The new Index was to be narrower and more sensitive than the 30-share Sense. The derivatives markets are generally a very volatile market and operators in these markets would prefer a more volatile index than the Sense. It could be said that the interest of the operators in derivatives trading would be directly proportional to the volatility in the underlying security which would mean that more the volatility, more the interest. BSE's developing the new index suits the traders in the derivatives market.

To elaborate more on this special index it needs to be clearly stated that this index included several technology scrips that had not found a place in the existing index. Apart from tracing in index futures, the bourse plans to introduce trading in other products in the derivatives segment such as the trading in stock options and futures. The new index is to be in place by April 2001. Trading in index options would begin with 30-50 scrips. These would include scrips in the current Sensex and also some of the scrips on the Nifty (NSE-50). The criteria for the selection of these scrips would be liquidity and market capitalization. The aspect that rolling settlement has been mandated for nearly all the actively traded stocks, speculative activity is likely to switch to the derivatives market. The derivatives market is expected to see a spurt in activities by the end of this fiscal. The derivatives in India need to catch up with other major bourses the world over wherein the turnover in the derivatives segment far exceeds the cash segment.

The BSE recently introduced limited trading membership to investors in the derivatives segment. This would involve an entrance fee of Rs. 1 lakh. Initiatives have been taken in terms of a nationwide training program to disseminate information on derivatives trading. The CEO of derivatives segment of BSE, Manoj Vaish has stated explicitly that the volume of derivatives trading in India was currently very low compared with the cash volumes. The introduction of the limited trading membership (LTM) would

enable members to taste the flavor of derivatives without having to accept the liability of paying margin money to the exchange. The liability would be borne out by the clearing member who would act on behalf of LTM. However, an LTM would neither be entitled to hold any office of the exchange neither have voting rights. The exchange would charge annually an amount of Rs. 25,000 in addition to an initial fee of Rs. 3 lakh, out of which Rs. 2 lakh would go to the investor protection fund and the balance to trade guarantee fund. The LTM would have all the rights and privileges of a trading member and have to be registered. All guidelines issued by the Stock Exchange Board of India would apply to the LTM.

Other initiatives to spruce up derivatives trading are the plan to develop a retail debt market and also bring about the participation of the bourse in the wholesale debt market. Players in the derivatives markets could expect to see some changes in the future and hope that the Indian derivative markets take off without further snags. Changes in the Market: What will happen to Indian Financial market, when the derivatives will be launched, is yet to be seen, but for the market and it's time now to say good bye to Badla and all such deferral products like ALBM and BLESS. Come July 2, 2001, the Indian bourses will be ushering into an era of options finally. In a move, which is bound to have far reaching implications, the market

regulator SEBI has finally decided to put a ban on Badla and all deferral products, effective July 2, 2001. The regulator has given time till September 3, 2001 to liquidate outstanding deferred positions as of the current settlement worth close to Rs. 2,000 crore. It has said that any additional deferred position taken after May 15 would have to be liquidated by July 2, and no new deferred positions will be allowed from July 2. This gives a breathing space to the players to square up their position and is expected to ease the selling pressure. The fact that market has sustained the upward momentum, post-ban announcement, vindicates that belief.

The regulator has further announced that 251 scrips will be put into rolling settlement mode. This will be in addition to the 163 scrips, which are already in the compulsory-rolling mode. These are the scrips, which form part of the list of scrips where Badla or ALBM was allowed. SEBI has said that all scrips, which do not form part of this list, will be brought within the ambit of rolling settlements from January 2, 2002. In the interim period, however, the regulator has decided to put in place a uniform settlement cycles for stocks, which are not in rolling mode. This cycle would run from Monday to Friday and would be followed across all the stock exchanges. This would effectively lead to the closing of the door on menace of inter-exchange arbitrage, which had been outlined as one of the reasons for the recent stock market scam. In another bold initiative towards bringing the Indian capital market at par with the global practices, SEBI has decided to do away with the price bands

(circuit filters) for all stocks in the rolling mode. It sounds logical to give an adequate exit opportunity to investors once the trading period is reduced to a single day from five days. Though the price bands would continue to be in place for other scrips, 95 percent of all trading volumes would be exempt from any price bands. SEBI has also decided that the global practice of having index-based circuit filters will be introduced. It means that while their will be no price bands on individuals stocks, the market could be frozen if the entire index itself swings sharply. The extent of the circuit filter would be worked out shortly. To keep a check on another malaise, insider trading, the regulator has approved a code of conduct and a preventive framework. The regulator has also paved the way for launch of options trading on individual stocks, though it has deferred the launch of futures on individual stocks.

On this front, the BSE has recently entered into an agreement with Chicago Mercantile Exchange (CME) to adopt its "Standard Portfolio Analysis of Risk" (SPAN) system for calculating margin requirements and managing risk. Introduced by the CME in 1988, SPAN has become an industry-standard, adopted by more than 30 exchanges and clearing organizations worldwide including Tokyo Stock Exchange, Singapore Exchange and Hong Kong Futures Exchange. SPAN was the first futures industry performance bond system ever to calculate requirements exclusively on the basis of overall portfolio risk. SPAN is a portfolio-based system, which comprehensively

evaluates the impact of specified market events on futures and options portfolios. A key element of this process is granting credit for net long option value, and assessing additional charges for net short option value. This long option value credits and short option value charges comprise the premium component of the overall, or "total", performance bond calculation. The requirement assessed upon long options positions is designed to reflect the fact that the holder of these long options may not be able to liquidate them at their current market value. The difference between the current value of a given long option position and its liquidation value under a "worst case scenario" of market movement is derived as part of the scanning risk calculation, and serves as a haircut against the option's full value to reflect potential liquidation losses. The BSE has said that it will adopt CME's standard portfolio analysis of risk management to compute margin

requirements for derivative products like options and futures. The exchange has said that this will also be used for recognizing risk offsets between the cash and the derivatives markets. The market appears to be divided on the issue of ban on Badla. According to one section of the market, as Badla has been around for a long time it should have been allowed to continue, albeit with more stringent risk measures such as upfront payment of margins. Another view is that so long as Badla mechanism is available derivatives will never take off, as given a choice between Badla and other derivatives, players would opt for a

mechanism like Badla, which they have been used to for decades. Not withstanding such never ending debates, the fact of the matter is that, we need a market where rules of game are different for each discipline - be it rugby or football. And, the writing on the wall is clear - it's time to clean one's act or be ready for extinction, which could be just a few strokes away. Financial Derivatives in India Informal options markets As in other countries, informal options markets have existed in India for centuries. Today, they go by names like teji-mandi, bhav-bhav, etc. Lacking formal market institutions, these markets are fairly small. The anachronistic legal prohibition upon derivatives contracts in India has also served to impede Badla On the equity market, many observers have noted that the institution of Badla (on the Bombay Stock Exchange) and derivatives markets are similar insofar as they are both vehicles for leveraged trading. This fact has been widely, and incorrectly, mutated into the notion that "Badla is an indigenous alternative to derivatives". This fact is incorrect insofar as Badla is not indigenous (it has existed in stock markets in London, Paris and Milan). It is also incorrect insofar as Badla does not achieve what either futures or options markets achieve, which is hedging risk. Hence, Badla does not the growth and institutionalization of these markets.

belong in the analysis of derivatives markets in India. (Badla is now scrapped by SEBI since July 2001)

Futures and options markets By May 1996, the National Stock Exchange (NSE) had substantially completed the development of systems and software required to start trading futures and options on the NSE-50 index. The commencement of trading on this market has been awaiting approval from SEBI since then. In November 1996, SEBI created the twenty-member L. C. Gupta Committee in order to draft a policy framework governing derivatives markets. As of early December 1997, the report of this committee is awaited.

Many of the fears about equity index derivatives as "highly leveraged instruments" are essentially misplaced on the equity market. This is because the distorted trading practices presently used on the spot market for equity in India involve more leverage, and much more unsafe leverage, than what is involved in the NSE index derivatives proposal. In this sense, the attempts at formulating a stringent regulatory apparatus to govern the index derivatives market are somewhat misplaced, and risk stifling the market in its formative phase. A superior approach towards regulation would have involved an early onset of equity index derivatives, coupled by a policy initiative to diminish the leveraged trading, which is found on the spot

market.

Currency derivatives In the report on capital account convertibility, the Tarapore Committee has recommended that a dollar-rupee futures market should augment the existing dollar-rupee forward market, and that a currency options market should be created. These initiatives would give improved hedging methods through which economic agents could reduce their exposure to currency fluctuations, and improve market quality on the dollar-rupee spot market. Market structure 3 essential classes of players drive the markets Hedgers: They seek to eliminate or reduce price risk to which they are already exposed. They provide the economic substance to any financial market and without them; markets would lose their very purpose and become mere tools of gambling. Speculators: They willingly take price risks to profit from price changes. Speculators provide the necessary liquidity and depth to the market. Arbitrageurs: They strive to make risk-less profit by simultaneously transacting in two markets to capitalize on the price differential between them.

The derivatives market perform a number of useful economic functions, which include Price discovery Transfer of risk Market completion Trading, settlement and risks.

Derivative Exchange Apex level SEBI regulation is a contentious issue - interestingly in the US, the SEC, in spite of being an extremely efficient regulator, restricts its itself to cash trading in securities and options on securities alone while futures trading falls under the Commodities Futures Trading Commission.

The need for a separate exchange also remains a debatable issue - while the NYSE and NASDAQ are inarguably the largest cash markets for securities in the US, it's future markets like the Chicago Mercantile Exchange and Chicago Board of Trade that walk away with the honors.

Memberships on offer would broadly be of two kinds - clearing members (with discriminating abilities to settle trades on proprietary and client

account)

and

non-clearing

members

(essentially

satellite

dealers).

Trading A trade would bear two flags - a Buy/Sell based on a long / short position being taken and an Open/Close depending on whether a fresh position is being taken or an existing one being squared up. This concept is important because margins are levied on net open positions not on the value of outstanding contracts alone. Clearing House A clearing house performs full novation for all contracts. By acting as a counterparty to each buy or sell, it assumes responsibility for guaranteeing settlement of all open positions. An important function of a clearing house is the fixation and enforcement of margin maintenance and default resolution by "shifting of positions" or "closing out." Margining A margin comprises "Initial" margin (cover against largest potential loss) and "Variation" margin (increase or decrease on margin account arising out of daily mark to market valuation of open positions). The JR Varma Committee has recommended margin fixation based on a 99% Value at Risk model.

Risk Containment Even an accurate 99% VaR model could lead to margin shortfall once in every six months so a payment crisis threat hangs like a Damocles' sword over the exchange. A second level of defense must necessarily be built by means of capital adequacy norms. And the last mechanism is by way of position limits. Opportunities For Brokers, the product presents yet another revenue opportunity as clearing members or non-clearing members (as a network of satellite dealers spread all over the country). With index futures, Mutual Funds could now hedge their portfolios and vary equity exposure freely. Index futures could also help reduce tracking error risk for index funds and mitigate impact cost while fulfilling redemption commitments. Banks: They can operate as clearing banks and carrying large floats in the bargain. Guarantees on behalf of members (in lieu of margins) and extension of lines of credit are good business opportunities, further supplemented by advisory or custodial services. Corporate, Insurers or Institutions: They can take the advantage of calendar spreads, allowing them to earn risk free return with no credit

risk. This promises to be an effective substitute for ICDs. Financial Institutions with large portfolios would be able to insulate their holdings from adverse market movements. A few enablers for the derivatives markets to kick off are needed: Inclusion of "derivatives" under the definition of securities under SCRA. Modification of SEBI (FII) and SEBI (Mutual Fund) Guidelines to permit them to trade in exchange listed derivatives. ICAI guidelines for accounting treatment of derivatives. CBDT guidelines for tax treatment of gains/losses on index futures usage. Exemption from stamps duty.

The Challenges ahead for derivatives to be successful: Broad-basing participation. Acceleration of the dematerialization drives to facilitate arbitrages. Improvement in banking infrastructure and EFT. Buoyancy of money markets. the Carry forward system to allow institutional

Public awareness and education. Political will.

It is necessary to end on a note of caution by continuing Lord Bagri's (Chairman of the London Metal exchange) quote "An attempt to add value to something that is already arbitrarily valued can easily compound a mistake So an instrument, created to control risk can itself turn into a major risk"

FORWARD RATE AGREEMENT AND INTEREST RATE SWAPS A FRA is similar to a forward contract, but this payoff is based on an interest rate, rather than an underlying asset price. For e.g. suppose a financial manager believes that interest were going up and wanted to lock in a specific rate to be paid on a future loan. He could do this by taking a short forward position in a fixed income security like a T-bill or a bond. If the hedge ratio was properly established in the forward contract, it could completely offset the increased cost of borrowing in the future. This was a forward contract in which the pay off is decided by the prices of the fixed income security. In a FRA the payoff is decided directly by the interest rate and so our finance manger would take a long position in a FRA. The contract would specify a notional principal and the terms under which payment would be made. Typically payoffs are based on LIBOR. The Eurodollar interbank rate, at the beginning of a specific period, but the payment is only made at the end of the period. The payment is based on the difference between LIBOR at the beginning of the period and the contract rate, which was agreed on when the contract was taken out. The settlement rate is agreed bench mark/reference rate prevailing on the settlement date.

An interest rate swap (can also be viewed as a series of FRA's) is an agreement between two parties to exchange interest payments on a predetermined amount of principal ("notional principal"). No principal is exchanged; the parties are liable only for the interest payments and

payments are exchanged on a net basis. For example, an interest rate swap allows the member issuing variable rate liabilities to fix the rate paid on these liabilities over some agreed upon time period. To the swap counterparty who pays fixed and receives floating, the swap is like a long position in a series of FRA's, plus one spot transaction. The initial transaction is a spot transaction since the counter parties know the LIBOR at the time of entering the agreement, remaining are FRA's.

WHAT DOES AN IRS DO? It is not an exaggeration to say that the interest rate swap constitutes the most important financial innovation of the last decade. Swaps have proved to be a fundamental and lasting development and are now in general use throughout the international financial sector. A vast and rapidly growing market also supports them. Swaps performed a number of key functions: Arbitrage between markets - between the money market and the capital market, between different sectors of the money market, between different currencies, and with other derivative instruments. By exchanging payments between markets, swaps have played a crucial role in the integration and globalization of the financial market, improving the efficiency of financial intermediation and providing borrowers with cheaper funds and investors with higher returns.

Risk management - the exchange of interest payment through swaps allows the unbundling of the various features of funding and investment instruments and the financial engineering of this features into synthetic instruments often in combination with other derivative instruments.

Gaining access to market - where borrowing or lending is blocked by regulation, in liquidity, general underdevelopment, investors resistance, or any other obstacle, the exchange of payments to swaps provides access to the interest rates and currency of that market without the need to fund or invest in it. Swaps emerged as instruments to exploit new issue arbitrage opportunities between the money and the capital market and they remain a key factor in the primary market in the international bonds. Different types of interest rate swaps The IRS involves the exchange of fixed exchange interest with floating interest rate linked to LIBOR. Such fixed against floating swaps are called coupon swaps. The term reflects the fact that the fixed interest rate used in such swaps reflects the yield on fixed income or coupon-bearing bonds, which pay fixed nominal amounts of interest, often called coupon. Coupon swaps are the most commonly traded swaps.

Generic is the term used to describe the simplest of any type of instrument

(the so-called plain vanilla version). Specifically, a generic IRS has a constant notional principal amount, an exchange of fixed against floating interest. In other words a generic swap is a simple type of coupon swap. It has a constant fixed interest rate and a flat floating interest rate. It also has regular payment of fixed and floating interest.

All the more complex (non generic) types of IRS can be constructed from the generic instrument, by combining generic swaps in complicated structures or by adding other derivatives like future and options.

Diff swaps, also known as quanto swaps, are a combination of a currency and interest rate swap in which one of the parties pays interest at a foreign rate, but the notional principal is still in the user's home currency. For example, one party could pay interest at a Japanese rate on a dollar amount of notional principal. The other party might pay interest at LIBOR on the same notional principal. A diff swap is equivalent to a hedge or speculative position on a foreign interest rate without the currency risk.

In arrears swaps the interest payment is made on the day that the floating rate is determined. For e.g., in each previous swap or FRA we have studied, the payment was made at the end of the period based on LIBOR at the beginning of the period. In an arrears swap, LIBOR is identified on a given day and interest is paid on that day. Such swaps are often executed because of beliefs about how the term structure might change over the life of the swap.

In basis swaps both parties make floating rate payments, with one payment being tied to one floating interest rate and the other tied to another floating interest rate. This is also known as a floating-floating swap. In index swaps one payment is tied to some kind of index. Another type of index swap might involve one payment being tied to an index of returns on mortgage packed securities. Although the mortgage-backed security is a complex instrument, the idea behind such a swap is to obtain returns similar to those held by issuers of mortgages. Thus a party could agree to pay LIBOR and receive the return on a mortgage backed security index. Amortizing swaps are transactions in which the notional principal is reduced through time until it eventually reaches zero. This type of swap is particularly common when one of the parties makes floating payments tied to an index of mortgage backed securities. Since a mortgage is an amortizing instrument, the swap payments should be based on a declining notional principal. The opposite type of swap, an accreting swap, is also used. In this case, the notional principal rises through time.

QUOTATION

AND

PRICING

OF

INTEREST

RATE

SWAPS

QUOTING OF SWAP PRICES: It has become a convention in the international swap market to use LIBOR as the standard index for the floating interest rate in coupon swaps in most

currencies (usually the 6-month LIBOR). Other floating rate indexes are available, but the presumption is that the floating rate is LIBOR, unless specified otherwise. It is therefore possible to discuss the price of a swap in terms of their fixed rate and the swap market is sometimes said to 'talk the fixed rate'. The fixed rate in the swap is called the SWAP RATE/ In the early days of the IRS market, and still in the case of the currencies which have less liquid swap markets, the fixed rate in coupon swaps are quoted in absolute terms, i.e. as the full percentage annual yield. These socalled all in prices are illustrate in the table below of New Zealand dollar swap prices, which are published weekly in the International Financing Review. Example of 'all-in' swap rates for New Zealand dollar swaps: YEAR 1 2 3 4 5 6 SEMI -ANNUAL RATE 8.00 - 7.85 8.25 - 8.05 8.50 - 8.30 8,85 - 8.65 9.05 - 8.85 9.25 - 9.05

Source: International Financing Review, Bankers Trust New Zealand Ltd.

Two- way prices: In the table above, it can be seen that two prices are quoted for each maturity of interest rate swap. These are two - way prices. A 'two-way' price is typically quoted between professional swap dealers and is a dual quotation consisting of a buying and a selling price for each instrument. By paying the lower fixed rate in one swap and receiving the higher fixed rate in the other, the intermediary earns dealing spread between the two rates. For example, in the case of 6-year New Zealand dollar swaps quoted in the table above, the quoting dealer would hope to receive a fixed rate of 9.25% p.a. and pay a fixed rate of 9. 05% earning a spread of 20 basis points p.a. on every matching pair of swaps. In swap markets in certain major currencies such as US dollar, the use of all in terms for quoting the fixed rates in coupon swaps has been replaced by the convention of quoting in two parts; a swap spread and a benchmark interest rate. The bench mark interest rate is usually the yield on the run (most liquid) government bond with a remaining maturity closet to that of the swap. When a coupon swap is agreed, the spread and the benchmark yield are fixed, producing an all in rate, which is used in calculating the fixed interest payments through the swap. Swap spreads therefore, are quoted while negotiating a swap, before it is agreed and implemented.

Pricing a swap The first step towards determination of the value of a swap is to specify the timing of resets and payments, and also the index maturity to which floating payments are linked. Most IRS are know as generic IRS, typically using the 6 month LIBOR as the floating index, so that the index maturity is 6 months. Also in these swaps, the reset date precedes the payment date by exactly the index maturity (6 months). Thus the LIBOR on the reset date is paid/recd after 6 months i.e. the settlement date, which naturally becomes the next reset date. The next step involves determining the fixed rate that is appropriate for the term of the swap; this is called the swap rate. The pricing of a swap can be better understood by identifying the swap as a combination of fixed and floating rate bonds. The fixed payments on a swap are like those on a fixed rate bond, while floating payments are reset at some predetermined date according to the benchmark rate. Since most bonds in the US make semi annual payments, a floating rate bond typically makes semi annual payments, but at a rate determined at the previous coupon date. The rate could be LIBOR, T-Bill rate, commercial paper rate, or any other type that the counterparties agree to. If the coupon on a floating bond is adjusted continuously to new interest rates, its price would be always be at par. So unless the interest changes

drastically b/w coupon payments dates, the price of such a bond will not deviate far from par and then on the coupon payment date, the price will go back to par. This statement assumes that whatever index the coupon is tied to, is an appropriate discount rate (the opportunity cost of the investment) for the bond. Thus we can say that a swap is like a long position in one bond and short position in the other. Since a swap involves no initial exchange of cash, it should have ZERO initial value. Thus to price the swap means to determine the fixed rate that will make the swap have zero initial value.

THE INDIAN SCENARIO

The shift from administered to free market pricing, in the present era of economic liberalization, has made financial engineering an indispensable tool for risk management. This is because liberalization has assured us into a phase of volatility and risk, where the cosy regime of administered prices has given way to an environment of constantly changing prices, interests and exchange rates. However even after 8 yrs of free market economy, risk management in India is still in its infancy and the hedging techniques are limited to the occasional use of forward contracts to cover currency risks and future trading to manage commodity risk. The increasing integration of the Indian money markets with the foreign exchange markets has necessitated the use of rupee-based derivatives like interest rate

swaps/caps/floors/collars/ and futures contracts. Worldwide, there are two types of financial instruments used for risk hedging - cash instruments, used in cash markets. Like zero coupon/deep discount bonds, floating rate notes, debt equity swaps etc. the other hedging tool derivatives, is fare more cost effective, flexible and versatile form of risk management. Since derivatives are linked to the underlying cash

instruments, the exposure risk of loss of principal is not there in these, making them a far more effective tool of risk management.

The RBI has taken bold steps to bring about structural changes to induce

vibrancy in our money markets. With guidelines pertaining to Asset- Liability Management (ALM) already in place, rupee derivatives are the natural next step in protecting banks from interest and liquidity risks. Besides these would also allow the borrower to borrow at favorable terms. With banks having to put the ALM system in place from April 2000, their excessive reliance on call money would reduce, enabling them to borrow for terms longer than overnight money. This would be possible through vibrant market of repos and clean interbank transactions of varying tenors. This would help the development of a term money market that has been eluding our system for ages. With IRS put in place banks would be able to hedge any mismatch on their balance sheets. At the same time, by deploying similar tenor funds into similar tenor assets, banks would be able to match the timings of their inflows and outflows and could also be run hedged mismatches.

However IRS will be meaningful only in an environment of totally deregulated interest rates and the existence of a term money market which would provide an acceptable and standardized rupee yield curve for systematic pricing of swaps. Fixed Income Money Market Dealers Association (FIMMDA) has been working for this purpose. It has been collecting two way quotes on dealt basis from willing banks to come out with the benchmark rates. Not only will the development of a term money market provide benchmark rate, it would also allow banks to put funds for a longer term with other banks and FIS, as

against the current state where they are forced to park their surplus-higher cost term deposits in lower yield call money markets. It has been working on guidelines to promote secondary markets, to give depth to out money markets and help to market determined yield curve to emerge.

CONCLUSION
Asset-Liability Management (ALM) in banks is known as the process of adjusting the liabilities to meet the desired loan demands, liquidity needs and safety requirements. The basic objective is to ensure that the bank's profitability is not unduly exposed to chages in interest rates. The interest rate exposure arises because the maturity patterns of the asset and liabilities differ, they need to be priced at different point of time., and therefore changes in interest rates affect the cost of liabilities and yield on asset and profitability. We have already seen that asset liability management forms an essential tool in the hand of the top management which can be effectively utilised to maintain the right balance between the objective of profit and risk undertaking. Asset and Liabilities management till now may be in infant stage in India. In fact, essential requirement of ALM is the timely and accurate collection of data. With the large network, which the Indian banks have, this is possible only by using information technology. This process of computerisation of the branches of Indian banks has begun just lately in the public sector and private sector banks. On account of the mammoth size, this is a massive task, once this is done, the top management will have access to accurate

information and hence will be in a better position to carry out A/L management. May be till recently many of the banks were not even familiar with the concept. However, it is a task to be accomplished now. All bankers are familiar with this concept and need to take all necessary steps to implement this. Also, the forecasting method (of interest rates) have to be sharpened for this. With the advent of Information Technology and the competition as a result of liberalisation, these concepts of A/L management are bound to be supportive instruments of routine use on daily basis. The techniques that we discussed are among the more common in use but these, and the many others have been devised by individual banks for their own use, remains aid to management. Asset and Liability management like all management depends ultimately on judgement and decision making.

REFERENCES
1. TUCKER ALAN L - Financial Futures Options and Swaps 2. ANDERSEN TORBEN JUUL - Money, Banking and Financial Market 3. JOHN C HULL - Futures, Options and other derivatives 4. COOPERS AND LYBRAND - Interest Rate Swap 5. FRANK J FABOZZI - The handbook of fixed income securities.

ACKNOWLEDGEMENT
It is only when a person is working on a project, that he realizes the amount of difficulties he has to overcome. However, in spite of all the difficulties, he knows help is always near at hand to tackle the problems. The researcher takes a great privilege to express his heartiest gratitude to the Project Guide Mr. Anil Mehta who assisted him a lot by providing detailed and explanatory lessons on how to go about in the project. Special and sincere thanks to all the others who contributed a lot by providing help to the researcher from time to time during the project work.

MANISH SAINI

CERTIFICATE
This is to certify that the project titled Liability Management and Derivatives as a Tool of Liability Management in Financial

Intermediaries is an original work of the Student and is being submitted in partial fulfillment for the award of the Masters Degree in Business Administration of Indira Gandhi National Open University. This report has not been submitted earlier either to this University or to any other University/Institution for the fulfillment of the

requirement of a course of study.

(Signature of Supervisor)

(Signature of Student)