COST OF PROJECT AND MEANS OF FINANCING
A project is concerned finance is the basic prerequisite. Without proper financial arrangement an entrepreneur is finding difficult to go ahead with his project. Funds requirement should be optimum so as to avoid the problems of both under and over capitalisation. So the cost project should be accurately estimated. Once the estimation of cost of project is over, the next step is to find out the sources of financing. After identifying the various available sources, a finance mix should be finalised. The selected finance mix should be optimum from the point of view of cost, control and flexibility.
COST OF PROJECT
The cost of project represents the total of all items of outlay associated with a project which are supported by long-term funds. The major cost elements of a project are the following:
Land and site development
Buildings and civil works
Plant and machinery
Technical know-how and engineering fees
Expenses on foreign technicians and training for Indian technicians abroad.
Miscellaneous fixed assets
Preliminary and capital issue expenses
Margin money for working capital
Initial cash losses
Land and site development
This includes basic cost of land, premium payable on lease hold, cost of levelling and development, cost of laying approach roads, cost of gates, cost of tube wells etc. The cost of land varies considerably from one location to another location. Similarly the expenditure on site development also varies according to topography of the land.
Buildings and civil works
This includes buildings for the main plant and equipment, building for auxiliary services like work shops, laboratory etc., godowns, warehouses, quarters for staff etc. The cost of buildings and civil works depends on the kinds of structures required. Once the kinds of structures required are specified, cost estimates are based on the plinth area and rates for various types of structures.
Plant and machinery
The cost of plant and machinery is the most significant component of the project cost. This includes the cost of imported machinery and its allied cost, cost of indigenous machinery, cost of stores and spares and installation and foundation charges. The cost of the plant and machinery is based on the latest available quotation adjusted for possible escalation.
Technical know-how and Engineering fees
Often it is necessary to engage technical consultants or collaborators from India and/or abroad for advice and help in various technical matters like preparation of the project report, choice of technology, selection of the plant and machinery, and so on. So the amount payable for obtaining the technical know-how and engineering services for setting up the project is an important component of the project cost.
Expenses on foreign technicians and training of Indian technicians abroad
Services of foreign technicians may be required in India for setting up the project and supervising the trial runs. Expenses on their travel, boarding, and lodging along with their salaries and allowances must be shown here. Likewise, expenses on Indian technicians who require training abroad must also be included here.
Miscellaneous fixed assets
Fixed assets which are not part of the direct manufacturing process may be referred to as miscellaneous fixed assets. They include items like furniture, office machinery and equipment, tools, vehicles, railway sidings, diesel generating sets, transformers, boilers, piping systems, laboratory equipments etc. Expenses incurred for the procurement or use of patents, licenses, trade marks, copyrights, etc and deposits made with electricity board may also be included here.
Preliminary and capital issue expenses
Expenses incurred for identifying the project, conducting market survey, preparing feasibility report, drafting memorandum and articles of association and incorporating the company are referred to as preliminary expenses.
Expenses borne in connection with the raising of capital from the public are referred to as capital issue expenses. The major components of capital issue expenses are: underwriting commission, brokerage, fees to managers and registrars, printing and postage expenses, advertising and publicity expenses, listing fees, and stamp duty.
Pre-operative expenses
Some revenue expenses incurred till the commencement of commercial production are referred to as pre-operative expenses. This includes establishment expenses, rent, rates and taxes, travelling expenses, interest and commitment charges on borrowings, insurance charges, mortgage expenses, interest on deferred payments, start-up expenses, and miscellaneous expenses.
Provision for contingencies
A provision for contingencies is made to provide for certain unforeseen expenses and price increases over and above the normal inflation rate which is already incorporated in the cost estimates.
Margin money for working capital
The principal support for working capital is provided by commercial banks and trade creditors. However, a certain part of the working capital requirement has to come from long-term sources of finance. Referred to as the ‘margin money for working capital’, this is an important element of the project cost.
Initial cash losses
Most of the projects incur cash losses in the initial years. Yet, promoters typically do not disclose the initial cash losses because they want the project to appear attractive to the financial institutions and investing public. Failure to make a provision for such cash losses in the project cost generally affects the liquidity position and impairs the operations.
MEANS OF FINANCING
To meet the cost of project the following means of finance are available:
share capital
term loans
debenture capital
deferred credit
incentive sources
miscellaneous sources
Share capital
There are two types of share capital-equity capital and preference capital. Equity capital represents the contribution made by the owners of the business, the equity shareholders, who enjoy the rewards and bear risks of ownership. Equity capital being the risk capital carries no fixed rate of dividend. Preference capital represents the contribution made by preference shareholders and the dividend paid on it is generally fixed.
Term Loans
Term loans are provided by financial institutions and commercial banks represents secured borrowings which are a very important source for financing new projects as well as expansion, modernization, and renovation schemes of existing firms. There are two broad types of term loans available in India: rupee term loans and foreign currency term loans. While the former are given for financing land, building, civil works, indigenous plant and machinery, and so on, the latter are provided for meeting the foreign currency expenditures towards the import of equipment and technical know how.
Debenture capital
Debentures are instruments for raising debt capital. There are two broad types of debentures: convertible debentures and non convertible debentures. Convertible debentures as the name implies, are debentures which are convertible, wholly or partly, in to equity shares. The conversion period and price are announces in advance.
Deferred credit
Many a time the suppliers of plant and machinery offer a deferred credit facility under which payment for the purchase of plant and machinery can be made over a period of time.
Incentive sources
The government and its agencies may provide financial support as inventive to certain types of promoters or for setting up industrial units in certain locations. These incentives may be in the form of seed capital assistance, capital subsidy or tax exemption for a certain period.
Miscellaneous sources: A small portion of project finance may come from miscellaneous sources like unsecured loans, public deposits, and leasing and hire purchase finance. Unsecured loans are typically provided by the promoters to bridge the gap between the promoter’s contribution and the equity capital the promoters can subscribe to. Public deposits represent unsecured borrowings from the public at large. Leasing and hire purchase finance represent a form of borrowing different form the conventional term loans and debenture capital.
Factors affecting selection of means of finance
The selection of means of finance governs the following considerations:
a) Norms of regulatory bodies and financial institutions
b) Key business considerations
Norms of Regulatory bodies and financial institutions
In many countries, including India, the proposed means of financing for a project must be either approved by a regulatory agency or conform to certain norms laid down by the government or financial institutions in this regard. The primary purpose of such regulation is to impart prudence to project financing decisions and provide a measure protection to investors.
Key business considerations
The key business considerations which are relevant for the project financing decision are: cost, risk, control and flexibility.
Cost In general the cost of debt fund is lower than the cost of equity funds. The primary reason is that the interest payable on debt capital is a tax-deductible expense whereas the dividend payable on equity capital is not.
Risk The main sources of risk for a firm are: business risk and financial risk. Business risk refers to the variability of earning before interest and taxes and arises mainly from fluctuations in demand and variability of prices and costs. Financial risk represents the risk arising from financial leverage. It must be emphasized that while debt capital is cheap it is also risky because of the fixed financial burden associated with it.
Control From the point of view of promoters of the project, the issue of control is important. They would ordinarily prefer a scheme of financing which enables them to maximise their control, current as well as potential, over the affairs of the firm, given their commitment of funds to the project.
Flexibility This refers to the ability of a firm to raise further capital from any source it wishes to tap to meet the future financing needs. In most practical situations, flexibility means that the firm does not exhaust fully its debt capacity.
WORKING CAPITAL
Working capital is the amount of money required by an enterprise for carrying out its day to day operations. The money invested in current assets like raw materials, finished products, debtors etc is known as working capital. The current assets in aggregate refer to gross working capital and the excess of current assets over current liabilities are called net working capital. The working capital is of two types: permanent working capital and variable working capital. Usually the permanent working capital is financed by long-term source of finance and variable working capital by short-term sources. The short-term sources of finance primarily include the following:
1.Loans from banks
2.Public deposits
3.Trade credit
4.Pledging and factoring
5.Bank overdraft
6.Cash credit
7.Bills discounting
8.Advances from customers
9.Accruals
PLANNING CAPITAL STRUCTURE
Project financing is usually discussed after project selection. But, in practice project financing is considered from the time of project conception. Indeed project financing is tangled with project planning, analysis, and selection. As the project proposal progresses through the stages of planning, analysis, and selection, the outline of project financing become clearer.
A capital project involves investment in land, plant and machinery, miscellaneous fixed assets, technical know-how, distribution network, and working capital. Hence capital project may be regarded as a mini firm. So the issues to be considered in financing a project are identical to those considered in financing a business firm.
Capital Structure
The two broad sources of finance available to a firm are: shareholder’s funds and loan funds. Shareholder’s funds come mainly in the form of equity capital and retained earnings and secondarily in the form of preference capital. Loan funds come in a variety of ways like debenture capital, term loans, deferred credit, public deposit and working capital advance.
Ignoring the preference capital the basic differences between shareholder’s funds and loan funds are as follows:
Equity
Debt
Equity shareholders have a residual claim on the income and the wealth of the firm
Creditors have a fixed claim in the form of interest and principal payment
Dividend paid to equity shareholders is not a tax deductible payment
Interest paid to creditors is a tax deductible payment
Equity ordinarily has an indefinite life
Debt has a fixed maturity
Equity investors enjoy the exclusive privilege to control the affairs of the firm
Debt investors play a passive role- of course; they impose certain restrictions on the way the firm is run to protect their interest.
Key Factors in Determining the Debt – Equity Ratio
The key factors in determining the debt-equity ratio for a project are:
a)cost
b)nature if assets
c)business risk
d)norms of lenders
e)control consideration and
f)market conditions
Cost
Compared to equity shareholders, lenders require lower rate of return. This advantage gets magnified when the firm pays taxes, because the interest on debt is a tax deductible expense whereas the dividend on equity is not. Even though the cost of debt is low, it is accompanied by a higher rate of risk.
Nature of assets
The nature of firm’s assets has an important bearing on its capital structure. If the assets are primarily tangible, debt finance used is more. On the other hand, if the assets are primarily intangible debt finance used is less. Usually the lenders are more willing to lend against tangible assets and less inclined to lend against intangible assets.
Business risk
Business risk refers to the variability of earning power. Business risk mainly come from demand variability, price variability, variability of input prices and proportion of fixed operating costs. Generally the affairs of the firm should be managed in such a way that the total risk borne by equity shareholders, which consist of business risk and financial risk, is not unduly high. This implies that if the firm is exposed to a high degree of business risk, its financial risk should be kept low.
Norms of Lenders
The norms employed by the lenders have a bearing on the capital structure. Generally the debt-equity ratio norm allowed by financial institutions is 1:1. But for highly capital intensive projects they permit a higher debt-equity ratio.
Control considerations
The extent of equity stake that promoters want to have in a project has an important bearing in its capital structure. So the promoters make a choice between equity and debt in such a way as to not loose their desired control over the project.
Market conditions
If the market is attractive and equity shares can be issued at an attractive premium, the project may rely more on equity. On the other hand, in the equity market is depressed, the project may rely more on debt.
Choice between equity and debt
Use more equity when
Use more debt when
The tax rate applicable is negligible
The tax rate applicable is high
Business risk exposure is high
Business risk exposure is low
Dilution of control is not an important issue
Dilution of control is an issue
The assets of the project are mostly intangible
The assets of the project are mostly tangible
The project has many growth options
The project has few growth options
Monday, September 13, 2010
Monday, September 6, 2010
Project Planning - Project Identification
PROJECT IDENTIFICATION
Project identification is the first step of a new venture. A right direction may enable an entrepreneur to scale new heights. Otherwise, he has to undergo a number of hurdles in his way. It is therefore, very crucial to entrepreneur to identify projects.
Theoretically, an entrepreneur has an infinitively wide choice with respect to his project. The important dimensions of choice are: product/service, market, technology, equipment, scale of production, location, incentives and time phasing. The task of identifying a feasible and promising project is somewhat difficult. Moreover it is interrelated with the government policies, infrastructural development and skills of people.
MEANING AND DEFINITION OF PROJECT
A project or a capital investment involves allocation and consumption of resources in the expected stream of benefits extending far in the future.
The following are the some of the definitions of project.
“An investment project is carried out according to a plan in order to achieve a definite objective within a certain time and which will cease when the objective is achieved” – Dictionary of Management.
“Project is an approval for a capital investment to develop facilities to provide goods and services” – World Bank.
“Any scheme or a part of scheme for investing resources which can be reasonably analysed and evaluated as an independent unit. It may be any item of investment activity which can separately evaluated” – Little and Mirless
Thus, a project may be defined as a scientifically evolved work plan devised to achieve a specific objective with a specified period of time. The three basic attributes are: a course of action, specific objectives and definite time perspective.
CLASSIFICATION OF PROJECTS
Projects have been classified in various ways by different authorities. A classification of project helps to highlight its essential characteristics and feasibility evaluation.
1. Quantifiable project and Non-quantifiable project
Quantifiable projects are those in which a quantifiable assessment of benefit can be made. Non-quantifiable projects are those where such an assessment is not possible. Projects concerned with industrial development, power generation, mineral development fall in the first category while projects involving health, education and defense fall in the second category.
2. Sectoral Projects
The planning commission India accepted sectoral base as the criterion for classification of projects. A project may, under this classification fall in to any one of the following sectors
a)Agriculture and allied sector
b)Irrigation and power sector
c)Industry and mining sector
d)Transport and communication sector
e)Social service sector
f)Miscellaneous
This system of classification has been found useful in resource allocation at macro level
3. Techno-economic Projects
Projects are sometimes classified on the basis of their techno economic characteristics. Three main group of classification can be identified here:
a)Factor intensity-oriented classification: On the basis of this classification, projects may be classified as capital intensive or labour intensive depending upon whether large scale investment in plant and machinery of human resource is involved.
b)Causation – oriented classification: Here projects are classified as demand based or raw materials based projects-depending on the no availability of certain goods or services and consequent demand for such goods and services or the availability of certain raw material, skills or other inputs as the dominant reason for starting the project.
c)Magnitude oriented classification: In this the size of investment forms the basis of classification. Projects may thus be classified as large scale. Medium-scale or small scale projects depending upon the total project investment.
4. Financial Institutions classification
All India and state financial institutions classify the projects according to the purpose for which the project is being taken up. They are:
a)New projects
b)Expansion projects
c)Modernization projects
d)Diversification projects
5. Service projects
The service oriented projects are classified as under:
a)Welfare projects
b)Service projects
c)R & D projects
d)Educational projects.
IMPORTANCE AND DIFFICULTIES OF CAPITAL INVESTMENT
Importance
Capital expenditure decisions often represent the most important decisions taken by a firm. Their importance comes from three inter-related reasons.
Long term effects- The consequences of capital expenditure decisions extend far into the future. The scope of current manufacturing activities of a firm is governed largely by capital expenditure in the past. Likewise, current capital expenditure decisions provide the framework for future activities.
Irreversibility- the market for used capital equipment in general is ill-organised. Further, some type of custom-made equipments, the market may virtually non-existent. Thus, a wrong capital investment decision often cannot be reversed without incurring a substantial loss.
Substantial outlays- Capital expenditures usually involve substantial outlays. Capital costs tend to increase with advanced technology.
Difficulties
While capital expenditure decisions are extremely important, they also pose difficulties which come from three principal sources.
Measurement problems: Identifying and measuring the costs and benefits of a capital expenditure proposal tends to be difficult. This is more so when a capital expenditure has a bearing on some other activities of the firm or has some intangible consequences.
Uncertainty: A capital expenditure decision involves costs and benefits that extend far into the future. It is impossible to predict exactly what will happen in the future. Hence, there is usually a great deal of uncertainty characterizing the costs and benefits of a capital expenditure decision.
Temporal spread: The costs and benefits associated with a capital expenditure decision are spread out over a long period of time, usually 10-20 years for industrial projects and 20-50 years for infrastructural projects. Such a temporal spread creates some problems in estimating discount rates and establishing equivalences.
PROJECT LIFE CYCLE
A project has to pass through different phases, from beginning to its completion. Following are the different phases in the life cycle of a project.
1. Conception: In this phase project idea is conceived. The project ideas come from different sources. These ideas should be shaped to suit for consideration and comparison. The ideas have to be examined in the light of objectives and constraints. The acceptable idea will form the basis of a future project. Conception is an important phase in the life cycle of a project.
2. Development phase: In this phase, the idea generated during the conception phase is developed. This stage comprises of the production of document describing the project in sufficient details covering all the aspects necessary to catch the mind of the customers and/or financial institutions.
3. Planning: Once project proposal is identified, a preliminary analysis should be done. It helps to know whether the project justify a feasibility study. Planning provides the frame work which shapes, guides and confines the identification of individual project opportunities.
4. Analysis: A detailed analysis of the idea is to be done in this phase. Marketing, technical, financial, economic and ecological aspects should be analyzed in detail. The information developed in this analysis will form the basis of designing the cost and benefits associated with the project.
5. Selection: In this phase the worthiness of the project is examined using one or more of the appraisal criteria. These criteria includes pay back period, accounting rate of return, net present value, internal rate of return and cost-benefit ratio. Suitable cutoff values have to be specified to apply the various appraisal criteria.
6. Financing: Once the project is selected the next phase involves making suitable financial arrangements. Equity and debt are the two major source of finance for a project. To decide a suitable financial mix, factors like flexibility, risk, income, control and taxes should be considered.
7. Implementation: This is the phase of setting up manufacturing activities. This includes drawing engineering designs, negotiations and contracting, construction, training and commissioning of plant. Various techniques of project management like CPM, PERT etc can be applied in this phase.
8. Review: Performance review has to be done periodically to compare the actual performance with projected performance. The review is useful in the following ways:
(i) It helps to judge how realistic the assumptions underlying the project are.
(ii) It provides the basis of future decision making.
(iii) It helps in taking corrective action.
Facets of Project Analysis
The important facets of project analysis are:
Market analysis
Technical analysis
Financial analysis
Economic analysis
Ecological analysis
Market analysis: Market analysis is primarily concerned with assessment of aggregate demand of proposed product and market share of the proposed project. For this a wide variety of information such as consumption trends, supply position, imports and exports, structure of competition, cost structure, demand elasticity, consumer behavior, distribution channels etc should be required.
Technical analysis: Technical analysis seeks to determine whether the prerequisites for the successful commissioning of the project have been considered and reasonable good choices have been made with respect to location, size, process, etc.
Financial analysis: Financial analysis seeks to ascertain whether the proposed project will be financially viable in the sense that whether it is able service the debt and meet the return expectations of providers of capital. Cost of project, means of finance, cost of capital, profitability, level of risk, break-even point, etc are the important aspect in this analysis.
Economic analysis: Economic analysis, also known as social cost benefit analysis, is concerned with judging a project from the larger social point of view. In such an evaluation the focus is on the social costs and benefits of a project. Here the direct economic benefits and costs of the project measured in terms of shadow prices not in terms of market prices. It also analyse the impact of proposed project in income distribution, level of savings and investment in the society.
Ecological analysis: This analysis concerned with environmental impact of the proposed project. This analysis is very crucial in the case of environment-polluting industries. The key areas in this analysis are likely environmental damage caused by the project and proposed restoration measures in the project.
GENERATION AND SCREENING OF PROJECT IDEAS
The search of project ideas is the first step towards establishing a successful venture. The key to success lies in getting into the right business at the right time. Identification of good business opportunities requires imagination, sensitivity to environmental changes, and realistic assessment of what the firm can do.
Project identification is concerned with the collection, compilation, and analysis of economic data for eventual purpose of locating possible opportunities for investment and with the development of the characteristics of such opportunities.
The objective of project identification is to find out investment opportunities which are feasible and promising and which merit further examination and appraisal.
The following are the different aspects to be considered for the generation and screening of project ideas.
Generation of Ideas
An entrepreneur or a firm needs to generate a few ideas about the project they can undertake in order to select a most promising one. The project ideas can be discovered from various sources. They include:
a)Knowledge about unmet customer needs.
b)A study of existing industries in terms of their profitability and capacity utilization.
c)Examination of inputs and outputs of various industries.
d)Review of imports and exports.
e)Study of plan outlays and Governmental guidelines.
f)Suggestions of financial institutions and developmental agencies.
g)Investigation of local materials and resources.
h)Analysis of economic and social trends.
i)Study of technological developments.
j)Exploring possibility of reviving sick units.
k)Attending trade fairs.
l)Stimulating creativity for generating new project ideas.
Stimulating the flow of ideas
To stimulate the flow of ideas, the following are helpful:
SWOT Analysis: SWOT analysis represents a conscious, deliberate, and systematic effort by an organization to identify opportunities that can be profitably exploited by it. Periodic SWOT analysis facilitates the generation of idea.
Clear articulation of objectives: The operations objectives of the firm may be one or more of the following:
Cost reduction
Productivity improvement
Increase in capacity utilization
Improvement in contribution margin
Expansion into promising fields.
A clear articulation and prioritization of objectives helps in channelising the efforts of employees and probes them to think imaginatively.
Fostering a conducive climate: To tap the creativity of people and to harness their entrepreneurial urges, a conducive organizational climate has to be fostered. Many organizations successfully used suggestion schemes to motivate employees to think more creatively.
Monitoring Environment
Basically a promising investment idea enables a firm to exploit opportunities in the environment by drawing on its competitive strengths. Hence, the firm must systematically monitor the environment and assess its competitive abilities. The important aspects to be studied in monitoring the key sectors of the environment are as follows:
Economic Sector
State of the economy
Overall rate of growth
Growth rate of primary, secondary and tertiary sectors.
Cyclical fluctuations
Linkage with the world economy
Trade surplus/deficits
Balance of payment situation
Governmental Sector
Industrial policy
Government programmes and policies
Tax framework
Subsidies, incentives, and concessions.
Import and export policies.
Financing norms
Lending conditions of FIs and Banks
Technological Sector
Emergence of new technologies
Access to technical know-how
Receptiveness on the part of industry
Socio-demographic Sector
Population trends
Age shifts in population
Income distribution
Educational profile
Employment of women
Attitude toward consumption and investment
Competition sector
Number of firms in the industry and market share of top few.
Degree of homogeneity and differentiation among products
Entry barriers
Comparison with substitutes in terms of quality, price, appeal and functional performance.
Marketing policies and practices
Supplier Sector
Availability and cost of raw materials and sub-assemblies
Availability and cost of energy
Corporate Appraisal
A realistic appraisal of corporate strengths and weaknesses is essential for identifying investment opportunities which can be profitably exploited. The broad areas of corporate appraisal and the important aspects to be considered under them are as follows:
Marketing and Distribution
Market image
Product line
Market share
Distribution network
Customer loyalty
Marketing and distributions costs
Production and Operations
Condition and capacity of plant and machinery
Availability of raw material, sub-assemblies, and power
Degree of vertical integration
Locational advantage
Cost structure
Research and Development
Research capabilities of the firm
Track record of new products developments
Laboratories and testing facilities
Coordination between research and operations
Corporate Resources and Personnel
Corporate image
Relation with governmental and regulatory agencies
Dynamism of top management
Competence and commitment of employees
State of industrial relations
Finance and Accounting
Financial leverage and borrowing capacity
Cost of capital
Tax situation
Relations with shareholders and creditors
Accounting and control system
Cash flows and liquidity.
TOOLS FOR IDENTIFYING INVESTMENT OPPORTUNITIES
There are several useful tools or frameworks that are helpful in identifying promising investment opportunities. The most popular one is Porter model, which is discussed below.
Porter Model: Profit Potential for Industries
Michael Porter has argued that the profit potential of an industry depends on the combined strength of the following five basic competitive forces:
a)Threat of new entrants
b)Rivalry among existing firms
c)Pressure from substitute products
d)Bargaining power of buyers
e)Bargaining power of sellers
Threat of new entrants: New entrants add capacity, inflate costs, push prices down, and reduce profitability. Hence, if an industry faces the threat of new entrants, its profit potential is limited. The threat from new entrants is low if the entry barriers confer an advantage on existing firms and deter new entrants.
Rivalry between existing firms: Firms in an industry compete on the basis of price, quality, promotion, service, warranties, and so on. Generally, a firm’s attempts to improve its competitive position provoke retaliatory action from others. If the rivalry between the firms in an industry is strong, competitive moves and countermoves dampen the average profitability of the industry.
Pressure from substitute products: All firms in industry face competition from industries producing substitute products. Performing the same function as the original product, substitute products may limit the profit potential of the industry by imposing a ceiling on the prices that can be charged by the firms in the industry.
Bargaining power of Buyers: Buyers are a competitive force. They can bargain for price cut, ask for superior quality and better service, and induce rivalry among competitors. If they are powerful, they can depress profitability of the supplier industry.
Bargaining power of suppliers: suppliers, like buyers, can exert a competitive force in an industry, as they can raise prices, lower quality, and curtail the range of free services that they provide. Powerful suppliers can hurt the profitability of the buyer industry.
PRELIMINARY SCREENING
By environment scanning and corporate appraisal it is possible to develop a long list of project ideas. Before going for detailed analysis some kind of preliminary screening is required to eliminate ideas which are not promising. For this purpose, the following aspects may be looked into:
Compatibility with the promoter
Consistency with governmental priorities
Availability of inputs
Adequacy of market
Reasonableness of cost
Acceptability of risk level
Compatibility with the promoter: The idea must be compatible with the interest, personality, and resources of the entrepreneur. A real opportunity has three characteristics (i) it fits the personality of the entrepreneur, (ii) it is accessible to him and (iii) it offers good prospect on the invested capital.
Consistency with governmental priorities: The project idea must be feasible given the national goals and governmental regulatory framework. There should not be any difficulty in obtaining the license for the project.
Availability of inputs: the resources and inputs required for the project must be reasonably assured. Capital requirements of the project should be in manageable limit. It is ensured that there is no difficulty in obtaining technical know-how. Adequate supply of raw materials and other inputs should also be ensured.
Adequacy of the market: The size of the present market must offer the prospect of adequate sales volume. Further, there should be a potential for growth and a reasonable return on investment. To judge the adequacy of the market the factors like market size, competitors and their market share, export market, distribution system, patent protection etc should be considered.
Reasonableness of cost: The cost structure of the proposed project must enable it to realize an acceptable profit with a price. In this regard the factors such as cost of material inputs, labour costs, factory overheads, administration overheads, selling and distribution costs, service costs, economies of scale etc should be considered.
Acceptability of risk level: The desirability of a project is critically dependent on the risk characterizing it. In the assessment of risk of a project the factors such as business cycles, technological changes, competition from substitutes and imports and governmental control over price and distribution should be analysed.
Project identification is the first step of a new venture. A right direction may enable an entrepreneur to scale new heights. Otherwise, he has to undergo a number of hurdles in his way. It is therefore, very crucial to entrepreneur to identify projects.
Theoretically, an entrepreneur has an infinitively wide choice with respect to his project. The important dimensions of choice are: product/service, market, technology, equipment, scale of production, location, incentives and time phasing. The task of identifying a feasible and promising project is somewhat difficult. Moreover it is interrelated with the government policies, infrastructural development and skills of people.
MEANING AND DEFINITION OF PROJECT
A project or a capital investment involves allocation and consumption of resources in the expected stream of benefits extending far in the future.
The following are the some of the definitions of project.
“An investment project is carried out according to a plan in order to achieve a definite objective within a certain time and which will cease when the objective is achieved” – Dictionary of Management.
“Project is an approval for a capital investment to develop facilities to provide goods and services” – World Bank.
“Any scheme or a part of scheme for investing resources which can be reasonably analysed and evaluated as an independent unit. It may be any item of investment activity which can separately evaluated” – Little and Mirless
Thus, a project may be defined as a scientifically evolved work plan devised to achieve a specific objective with a specified period of time. The three basic attributes are: a course of action, specific objectives and definite time perspective.
CLASSIFICATION OF PROJECTS
Projects have been classified in various ways by different authorities. A classification of project helps to highlight its essential characteristics and feasibility evaluation.
1. Quantifiable project and Non-quantifiable project
Quantifiable projects are those in which a quantifiable assessment of benefit can be made. Non-quantifiable projects are those where such an assessment is not possible. Projects concerned with industrial development, power generation, mineral development fall in the first category while projects involving health, education and defense fall in the second category.
2. Sectoral Projects
The planning commission India accepted sectoral base as the criterion for classification of projects. A project may, under this classification fall in to any one of the following sectors
a)Agriculture and allied sector
b)Irrigation and power sector
c)Industry and mining sector
d)Transport and communication sector
e)Social service sector
f)Miscellaneous
This system of classification has been found useful in resource allocation at macro level
3. Techno-economic Projects
Projects are sometimes classified on the basis of their techno economic characteristics. Three main group of classification can be identified here:
a)Factor intensity-oriented classification: On the basis of this classification, projects may be classified as capital intensive or labour intensive depending upon whether large scale investment in plant and machinery of human resource is involved.
b)Causation – oriented classification: Here projects are classified as demand based or raw materials based projects-depending on the no availability of certain goods or services and consequent demand for such goods and services or the availability of certain raw material, skills or other inputs as the dominant reason for starting the project.
c)Magnitude oriented classification: In this the size of investment forms the basis of classification. Projects may thus be classified as large scale. Medium-scale or small scale projects depending upon the total project investment.
4. Financial Institutions classification
All India and state financial institutions classify the projects according to the purpose for which the project is being taken up. They are:
a)New projects
b)Expansion projects
c)Modernization projects
d)Diversification projects
5. Service projects
The service oriented projects are classified as under:
a)Welfare projects
b)Service projects
c)R & D projects
d)Educational projects.
IMPORTANCE AND DIFFICULTIES OF CAPITAL INVESTMENT
Importance
Capital expenditure decisions often represent the most important decisions taken by a firm. Their importance comes from three inter-related reasons.
Long term effects- The consequences of capital expenditure decisions extend far into the future. The scope of current manufacturing activities of a firm is governed largely by capital expenditure in the past. Likewise, current capital expenditure decisions provide the framework for future activities.
Irreversibility- the market for used capital equipment in general is ill-organised. Further, some type of custom-made equipments, the market may virtually non-existent. Thus, a wrong capital investment decision often cannot be reversed without incurring a substantial loss.
Substantial outlays- Capital expenditures usually involve substantial outlays. Capital costs tend to increase with advanced technology.
Difficulties
While capital expenditure decisions are extremely important, they also pose difficulties which come from three principal sources.
Measurement problems: Identifying and measuring the costs and benefits of a capital expenditure proposal tends to be difficult. This is more so when a capital expenditure has a bearing on some other activities of the firm or has some intangible consequences.
Uncertainty: A capital expenditure decision involves costs and benefits that extend far into the future. It is impossible to predict exactly what will happen in the future. Hence, there is usually a great deal of uncertainty characterizing the costs and benefits of a capital expenditure decision.
Temporal spread: The costs and benefits associated with a capital expenditure decision are spread out over a long period of time, usually 10-20 years for industrial projects and 20-50 years for infrastructural projects. Such a temporal spread creates some problems in estimating discount rates and establishing equivalences.
PROJECT LIFE CYCLE
A project has to pass through different phases, from beginning to its completion. Following are the different phases in the life cycle of a project.
1. Conception: In this phase project idea is conceived. The project ideas come from different sources. These ideas should be shaped to suit for consideration and comparison. The ideas have to be examined in the light of objectives and constraints. The acceptable idea will form the basis of a future project. Conception is an important phase in the life cycle of a project.
2. Development phase: In this phase, the idea generated during the conception phase is developed. This stage comprises of the production of document describing the project in sufficient details covering all the aspects necessary to catch the mind of the customers and/or financial institutions.
3. Planning: Once project proposal is identified, a preliminary analysis should be done. It helps to know whether the project justify a feasibility study. Planning provides the frame work which shapes, guides and confines the identification of individual project opportunities.
4. Analysis: A detailed analysis of the idea is to be done in this phase. Marketing, technical, financial, economic and ecological aspects should be analyzed in detail. The information developed in this analysis will form the basis of designing the cost and benefits associated with the project.
5. Selection: In this phase the worthiness of the project is examined using one or more of the appraisal criteria. These criteria includes pay back period, accounting rate of return, net present value, internal rate of return and cost-benefit ratio. Suitable cutoff values have to be specified to apply the various appraisal criteria.
6. Financing: Once the project is selected the next phase involves making suitable financial arrangements. Equity and debt are the two major source of finance for a project. To decide a suitable financial mix, factors like flexibility, risk, income, control and taxes should be considered.
7. Implementation: This is the phase of setting up manufacturing activities. This includes drawing engineering designs, negotiations and contracting, construction, training and commissioning of plant. Various techniques of project management like CPM, PERT etc can be applied in this phase.
8. Review: Performance review has to be done periodically to compare the actual performance with projected performance. The review is useful in the following ways:
(i) It helps to judge how realistic the assumptions underlying the project are.
(ii) It provides the basis of future decision making.
(iii) It helps in taking corrective action.
Facets of Project Analysis
The important facets of project analysis are:
Market analysis
Technical analysis
Financial analysis
Economic analysis
Ecological analysis
Market analysis: Market analysis is primarily concerned with assessment of aggregate demand of proposed product and market share of the proposed project. For this a wide variety of information such as consumption trends, supply position, imports and exports, structure of competition, cost structure, demand elasticity, consumer behavior, distribution channels etc should be required.
Technical analysis: Technical analysis seeks to determine whether the prerequisites for the successful commissioning of the project have been considered and reasonable good choices have been made with respect to location, size, process, etc.
Financial analysis: Financial analysis seeks to ascertain whether the proposed project will be financially viable in the sense that whether it is able service the debt and meet the return expectations of providers of capital. Cost of project, means of finance, cost of capital, profitability, level of risk, break-even point, etc are the important aspect in this analysis.
Economic analysis: Economic analysis, also known as social cost benefit analysis, is concerned with judging a project from the larger social point of view. In such an evaluation the focus is on the social costs and benefits of a project. Here the direct economic benefits and costs of the project measured in terms of shadow prices not in terms of market prices. It also analyse the impact of proposed project in income distribution, level of savings and investment in the society.
Ecological analysis: This analysis concerned with environmental impact of the proposed project. This analysis is very crucial in the case of environment-polluting industries. The key areas in this analysis are likely environmental damage caused by the project and proposed restoration measures in the project.
GENERATION AND SCREENING OF PROJECT IDEAS
The search of project ideas is the first step towards establishing a successful venture. The key to success lies in getting into the right business at the right time. Identification of good business opportunities requires imagination, sensitivity to environmental changes, and realistic assessment of what the firm can do.
Project identification is concerned with the collection, compilation, and analysis of economic data for eventual purpose of locating possible opportunities for investment and with the development of the characteristics of such opportunities.
The objective of project identification is to find out investment opportunities which are feasible and promising and which merit further examination and appraisal.
The following are the different aspects to be considered for the generation and screening of project ideas.
Generation of Ideas
An entrepreneur or a firm needs to generate a few ideas about the project they can undertake in order to select a most promising one. The project ideas can be discovered from various sources. They include:
a)Knowledge about unmet customer needs.
b)A study of existing industries in terms of their profitability and capacity utilization.
c)Examination of inputs and outputs of various industries.
d)Review of imports and exports.
e)Study of plan outlays and Governmental guidelines.
f)Suggestions of financial institutions and developmental agencies.
g)Investigation of local materials and resources.
h)Analysis of economic and social trends.
i)Study of technological developments.
j)Exploring possibility of reviving sick units.
k)Attending trade fairs.
l)Stimulating creativity for generating new project ideas.
Stimulating the flow of ideas
To stimulate the flow of ideas, the following are helpful:
SWOT Analysis: SWOT analysis represents a conscious, deliberate, and systematic effort by an organization to identify opportunities that can be profitably exploited by it. Periodic SWOT analysis facilitates the generation of idea.
Clear articulation of objectives: The operations objectives of the firm may be one or more of the following:
Cost reduction
Productivity improvement
Increase in capacity utilization
Improvement in contribution margin
Expansion into promising fields.
A clear articulation and prioritization of objectives helps in channelising the efforts of employees and probes them to think imaginatively.
Fostering a conducive climate: To tap the creativity of people and to harness their entrepreneurial urges, a conducive organizational climate has to be fostered. Many organizations successfully used suggestion schemes to motivate employees to think more creatively.
Monitoring Environment
Basically a promising investment idea enables a firm to exploit opportunities in the environment by drawing on its competitive strengths. Hence, the firm must systematically monitor the environment and assess its competitive abilities. The important aspects to be studied in monitoring the key sectors of the environment are as follows:
Economic Sector
State of the economy
Overall rate of growth
Growth rate of primary, secondary and tertiary sectors.
Cyclical fluctuations
Linkage with the world economy
Trade surplus/deficits
Balance of payment situation
Governmental Sector
Industrial policy
Government programmes and policies
Tax framework
Subsidies, incentives, and concessions.
Import and export policies.
Financing norms
Lending conditions of FIs and Banks
Technological Sector
Emergence of new technologies
Access to technical know-how
Receptiveness on the part of industry
Socio-demographic Sector
Population trends
Age shifts in population
Income distribution
Educational profile
Employment of women
Attitude toward consumption and investment
Competition sector
Number of firms in the industry and market share of top few.
Degree of homogeneity and differentiation among products
Entry barriers
Comparison with substitutes in terms of quality, price, appeal and functional performance.
Marketing policies and practices
Supplier Sector
Availability and cost of raw materials and sub-assemblies
Availability and cost of energy
Corporate Appraisal
A realistic appraisal of corporate strengths and weaknesses is essential for identifying investment opportunities which can be profitably exploited. The broad areas of corporate appraisal and the important aspects to be considered under them are as follows:
Marketing and Distribution
Market image
Product line
Market share
Distribution network
Customer loyalty
Marketing and distributions costs
Production and Operations
Condition and capacity of plant and machinery
Availability of raw material, sub-assemblies, and power
Degree of vertical integration
Locational advantage
Cost structure
Research and Development
Research capabilities of the firm
Track record of new products developments
Laboratories and testing facilities
Coordination between research and operations
Corporate Resources and Personnel
Corporate image
Relation with governmental and regulatory agencies
Dynamism of top management
Competence and commitment of employees
State of industrial relations
Finance and Accounting
Financial leverage and borrowing capacity
Cost of capital
Tax situation
Relations with shareholders and creditors
Accounting and control system
Cash flows and liquidity.
TOOLS FOR IDENTIFYING INVESTMENT OPPORTUNITIES
There are several useful tools or frameworks that are helpful in identifying promising investment opportunities. The most popular one is Porter model, which is discussed below.
Porter Model: Profit Potential for Industries
Michael Porter has argued that the profit potential of an industry depends on the combined strength of the following five basic competitive forces:
a)Threat of new entrants
b)Rivalry among existing firms
c)Pressure from substitute products
d)Bargaining power of buyers
e)Bargaining power of sellers
Threat of new entrants: New entrants add capacity, inflate costs, push prices down, and reduce profitability. Hence, if an industry faces the threat of new entrants, its profit potential is limited. The threat from new entrants is low if the entry barriers confer an advantage on existing firms and deter new entrants.
Rivalry between existing firms: Firms in an industry compete on the basis of price, quality, promotion, service, warranties, and so on. Generally, a firm’s attempts to improve its competitive position provoke retaliatory action from others. If the rivalry between the firms in an industry is strong, competitive moves and countermoves dampen the average profitability of the industry.
Pressure from substitute products: All firms in industry face competition from industries producing substitute products. Performing the same function as the original product, substitute products may limit the profit potential of the industry by imposing a ceiling on the prices that can be charged by the firms in the industry.
Bargaining power of Buyers: Buyers are a competitive force. They can bargain for price cut, ask for superior quality and better service, and induce rivalry among competitors. If they are powerful, they can depress profitability of the supplier industry.
Bargaining power of suppliers: suppliers, like buyers, can exert a competitive force in an industry, as they can raise prices, lower quality, and curtail the range of free services that they provide. Powerful suppliers can hurt the profitability of the buyer industry.
PRELIMINARY SCREENING
By environment scanning and corporate appraisal it is possible to develop a long list of project ideas. Before going for detailed analysis some kind of preliminary screening is required to eliminate ideas which are not promising. For this purpose, the following aspects may be looked into:
Compatibility with the promoter
Consistency with governmental priorities
Availability of inputs
Adequacy of market
Reasonableness of cost
Acceptability of risk level
Compatibility with the promoter: The idea must be compatible with the interest, personality, and resources of the entrepreneur. A real opportunity has three characteristics (i) it fits the personality of the entrepreneur, (ii) it is accessible to him and (iii) it offers good prospect on the invested capital.
Consistency with governmental priorities: The project idea must be feasible given the national goals and governmental regulatory framework. There should not be any difficulty in obtaining the license for the project.
Availability of inputs: the resources and inputs required for the project must be reasonably assured. Capital requirements of the project should be in manageable limit. It is ensured that there is no difficulty in obtaining technical know-how. Adequate supply of raw materials and other inputs should also be ensured.
Adequacy of the market: The size of the present market must offer the prospect of adequate sales volume. Further, there should be a potential for growth and a reasonable return on investment. To judge the adequacy of the market the factors like market size, competitors and their market share, export market, distribution system, patent protection etc should be considered.
Reasonableness of cost: The cost structure of the proposed project must enable it to realize an acceptable profit with a price. In this regard the factors such as cost of material inputs, labour costs, factory overheads, administration overheads, selling and distribution costs, service costs, economies of scale etc should be considered.
Acceptability of risk level: The desirability of a project is critically dependent on the risk characterizing it. In the assessment of risk of a project the factors such as business cycles, technological changes, competition from substitutes and imports and governmental control over price and distribution should be analysed.
Monday, August 30, 2010
Steps in Research Process
Research in common parlance refers to a search for knowledge. It aims at discovering the truth. Research is undertaken to discover answers to questions by applying scientific method. Research must be based on some problems or on some facts. Inquisitiveness and dissatisfaction are the two main building rocks of any research. In a progressive science the generalized answers may not hold good beyond a certain time period, with the passage of time the facts may change and the problem itself may undergo change and so also the concept. Therefore, a constant search is become essential to know the exact truths. That constant search or research process consists of a series of closely related activities or steps. Such activities overlap continuously rather than following a strictly prescribed sequence.
However, the following steps are involved in research:
1.Formulating the Research Problem: In a research process the first and foremost steps happens to be that of selecting and properly defining the problem. A research problem in general refers to some difficulty with a researcher experiences in the context of either a theoretical or practical situation and wants to obtain a solution for the same.
While selecting a research problem, at first the researcher selects a discipline and from that a particular subject is chosen. From this a broad area of that particular subject, and then he selects a few topics for problems. At the final stage he selects a single topic after considering several factors.
Following points may be observed by the researcher in selecting a problem:
Over done subject should not be chosen.
Too narrow or too vague problem should be avoided.
The subject selected for research should be familiar and feasible.
The solvability of the problem should be considered.
The importance of the subject, qualification and training of the researcher, ability of the researcher and availability of data should also be considered.
The time available with the researcher and the availability of money with him etc. should also be considered.
The topic may also be based on the special interest and convenience of researcher.
2.Review of Literature: Once the problem is formulated a brief summary of it should be written down. It is compulsory for a research worker writing a thesis fir PhD degree to write a synopsis of the topic to submit it to the necessary committee for obtaining approval. At this juncture the researcher should undertake extensive literature survey connected with the problem. This is essential to know whether the problem has already been investigated before, if so how and what extent etc. For this purpose the abstracting and indexing journals, published and unpublished bibliographies, academic journals, government reports, books etc. must be tapped depending upon the nature of the problem.
3.Fixing the Objectives: After making the extensive literature review, the researcher fixes the objectives of his study with the help of literature review, discussion with experts etc.
4.Development of Working Hypothesis: Working hypothesis is a tentative assumption made in order to draw out and tests its logical or empirical consequences. They affect the manner in which tests must be conducted in the analysis of data and indirectly the quality of data which is required for analysis. The role of hypothesis is to guide the researcher by delimiting the area of research and keep him on the right track.
5.Preparing the Research Design: Research Design is the conceptual framework structure within which the research is conducted. It constitutes the blue print for collection, measurement and analysis of data. In other words it is a plan of the proposed work. There are several designs mainly coming under experimental and non-experimental designs.
6.Determining Sample Design: For conducting research the researcher needs adequate and accurate data. In order to obtain these data a researcher conducts investigation into a given population. Population means aggregate of all elements possessing all the characteristics which the researcher wants to study. In other words the entire group from which a sample is chosen is known as 'Population'. A complete enumeration of all the items in the population is known as 'Census Inquiry'. This type of equity involves great deal of time, money and energy. Besides these census inquiry is not possible in practice under many circumstances.
Selecting a few items from the universe or population is called a 'Sample'. The researcher must decide the way of selecting a sample, popularly known as 'Sample Design'. In other words, the sample design is a definite plan determined before any data are actually collected for obtaining a sample from a given population. Samples can be either Probability Samples or Non – Probability Samples.
7.Collecting the data or Collection of data: There are several ways for collecting the appropriate data which differ considerably in context of money, costs, time and other resources at the disposal of the researcher.
Primary data can be collected wither through experiment or through survey. If the researcher conducts an experiment, he observes some quantitative measurement of the data with the help of which he examines the truth contained in his hypothesis. But in the case of survey the data can be collected by several ways such as observation, personal interviews, telephone interviews, mailing of questionnaires, schedules etc.
8.Analysis of Data: After the data have been collected, the researcher turns to the task of analyzing them. The analysis of data requires a large number of closely related operations such as establishment of categories, the application of these categories to raw data through coding, editing, tabulation and then drawing statistical inferences. Thus the researcher should classify the raw data into some purposeful and usable categories through coding, editing and tabulation, then analyses this with the help of some statistical measurements.
9.Hypothesis Testing: After analyzing the data the researcher is in a position to test the hypothesis if any, he had formulated earlier. For testing the hypothesis various statistical tests such as T-Test, F-Test, Chi-Square Test etc. are applied. Hypothesis testing will result either in accepting or in rejecting the hypothesis. If the researcher had no hypothesis to start with, generalizations established on the basis of the data collected and analyzed.
10.Generalization and Interpretation: If the hypothesis is tested and upheld several times, it may be possible for the researcher to arrive at generalization, ie., to build up a theory. As a matter of facts the real value of research lies in its ability to arrive at certain generalization. If the researcher had no hypothesis to start with, he might seek to explain his findings on the basis of some theory. It is known as 'Interpretation'. The process of interpretation may quite often trigger of new questions which in turn may lead to further research.
11.Preparation of Report: Finally the researcher has to prepare the report of what has been done by him with utmost care.
However, the following steps are involved in research:
1.Formulating the Research Problem: In a research process the first and foremost steps happens to be that of selecting and properly defining the problem. A research problem in general refers to some difficulty with a researcher experiences in the context of either a theoretical or practical situation and wants to obtain a solution for the same.
While selecting a research problem, at first the researcher selects a discipline and from that a particular subject is chosen. From this a broad area of that particular subject, and then he selects a few topics for problems. At the final stage he selects a single topic after considering several factors.
Following points may be observed by the researcher in selecting a problem:
Over done subject should not be chosen.
Too narrow or too vague problem should be avoided.
The subject selected for research should be familiar and feasible.
The solvability of the problem should be considered.
The importance of the subject, qualification and training of the researcher, ability of the researcher and availability of data should also be considered.
The time available with the researcher and the availability of money with him etc. should also be considered.
The topic may also be based on the special interest and convenience of researcher.
2.Review of Literature: Once the problem is formulated a brief summary of it should be written down. It is compulsory for a research worker writing a thesis fir PhD degree to write a synopsis of the topic to submit it to the necessary committee for obtaining approval. At this juncture the researcher should undertake extensive literature survey connected with the problem. This is essential to know whether the problem has already been investigated before, if so how and what extent etc. For this purpose the abstracting and indexing journals, published and unpublished bibliographies, academic journals, government reports, books etc. must be tapped depending upon the nature of the problem.
3.Fixing the Objectives: After making the extensive literature review, the researcher fixes the objectives of his study with the help of literature review, discussion with experts etc.
4.Development of Working Hypothesis: Working hypothesis is a tentative assumption made in order to draw out and tests its logical or empirical consequences. They affect the manner in which tests must be conducted in the analysis of data and indirectly the quality of data which is required for analysis. The role of hypothesis is to guide the researcher by delimiting the area of research and keep him on the right track.
5.Preparing the Research Design: Research Design is the conceptual framework structure within which the research is conducted. It constitutes the blue print for collection, measurement and analysis of data. In other words it is a plan of the proposed work. There are several designs mainly coming under experimental and non-experimental designs.
6.Determining Sample Design: For conducting research the researcher needs adequate and accurate data. In order to obtain these data a researcher conducts investigation into a given population. Population means aggregate of all elements possessing all the characteristics which the researcher wants to study. In other words the entire group from which a sample is chosen is known as 'Population'. A complete enumeration of all the items in the population is known as 'Census Inquiry'. This type of equity involves great deal of time, money and energy. Besides these census inquiry is not possible in practice under many circumstances.
Selecting a few items from the universe or population is called a 'Sample'. The researcher must decide the way of selecting a sample, popularly known as 'Sample Design'. In other words, the sample design is a definite plan determined before any data are actually collected for obtaining a sample from a given population. Samples can be either Probability Samples or Non – Probability Samples.
7.Collecting the data or Collection of data: There are several ways for collecting the appropriate data which differ considerably in context of money, costs, time and other resources at the disposal of the researcher.
Primary data can be collected wither through experiment or through survey. If the researcher conducts an experiment, he observes some quantitative measurement of the data with the help of which he examines the truth contained in his hypothesis. But in the case of survey the data can be collected by several ways such as observation, personal interviews, telephone interviews, mailing of questionnaires, schedules etc.
8.Analysis of Data: After the data have been collected, the researcher turns to the task of analyzing them. The analysis of data requires a large number of closely related operations such as establishment of categories, the application of these categories to raw data through coding, editing, tabulation and then drawing statistical inferences. Thus the researcher should classify the raw data into some purposeful and usable categories through coding, editing and tabulation, then analyses this with the help of some statistical measurements.
9.Hypothesis Testing: After analyzing the data the researcher is in a position to test the hypothesis if any, he had formulated earlier. For testing the hypothesis various statistical tests such as T-Test, F-Test, Chi-Square Test etc. are applied. Hypothesis testing will result either in accepting or in rejecting the hypothesis. If the researcher had no hypothesis to start with, generalizations established on the basis of the data collected and analyzed.
10.Generalization and Interpretation: If the hypothesis is tested and upheld several times, it may be possible for the researcher to arrive at generalization, ie., to build up a theory. As a matter of facts the real value of research lies in its ability to arrive at certain generalization. If the researcher had no hypothesis to start with, he might seek to explain his findings on the basis of some theory. It is known as 'Interpretation'. The process of interpretation may quite often trigger of new questions which in turn may lead to further research.
11.Preparation of Report: Finally the researcher has to prepare the report of what has been done by him with utmost care.
Thursday, August 19, 2010
Research – An introductory approach : What is Research ? Characteristics of research : Classification of social research - motivating factors of social research - importance of social research and limitations of social research.
Introduction
One of the basic desires of man is to know of things around him. Basically man is developing certain inquiry is his mind and wants to get reply for it. He is asking so many questions such as why, how, when etc. of all things. Moreover in the modern complex world man is faced with many problems. He wants to find immediate solution to these problems. His desire to find the solution to the problems is mainly due to his urge to do something better or more efficiently. Problem solving is a technical process which not only require ingenuity but also a fund of accumulated knowledge and wisdom. This accumulation of knowledge is very essential to solve a problem. According to Charls Pierce the American philosopher there are four ways of gaining knowledge.
1.Method of Tenacity : We hold something true because we believe it to be so for a very long time. Old people's tales fall under this category.
2.Method of Authority : Some persons holding position like teachers and religious leaders make statements and which are accepted by us.
3.Method of Intuition : Certain information found reasonable are accepted by us. Men easily guess that women are soft spoken.
4.Method of Science : Under this method ideas are accepted only after they have been vigorously tested.
Scientific Method is defined by Rummel as the systematic and refined use of specialized tools and procedures to obtain a more adequate solution to a problem that would be possible by less discriminatory means. This scientific method of studying a problem is termed as Research. The word meaning of research is to search back.
Research is considered to be the more formal, systematic and intensive process of carrying on the scientific method of analysis. Intensive study, deep analysis and reflective thinking are the basic ingredients of research. Application of scientific tools and accepted steps and procedures are essential for an ideal research.
Social Research
Social Research studies men and his institutions in an empirical way. The relevance of social research is far greater in developing countries like India which are confronted with complex socio-economic problems like poverty, unemployment, illiteracy and the like.
Importance of Social Research
1.Social Research provides the basic data for social planning.
2.Research has a greater role in providing solution to immediate problems faced by the community.
3.It promotes social interest and better understanding in the society.
4.It enables the researcher to have an intimate knowledge of the society and such a knowledge guides social growth on proper lines.
Definition of Social Research
According to P.V Young social Research may be defined as a scientific undertaking which, by means of logical and systematized techniques seeks to :-
1.Discover new facts or verify and test old facts.
2.Analyze the sequences, inter relationships and causal explanations which were derived within an appropriate theoretical frame of reference, and
3.develop new scientific tools, concepts and theories which would facilitate reliable and valid study of human behavior.
Social Research is a systematic method of exploring, analyzing and conceptualizing social life in order to extent, correct or verify knowledge, whether that knowledge aid in the construction of a theory or in the practice of an art.
Characteristics of Research
1.Research is a systematic and accurate investigation : There is no place for approximations and ambiguities in research.
2.Research is directed towards the solution of a problem : It may attempt to answer a question or to determine the relation between two or more variables.
3.Research emphasizes the development of generalizations, principles or theories that will be helpful in predicting future occurrences.
4.Research is based upon observable experience or empirical evidence.
5.Research demands accurate observations and descriptions.
6.Research involves gathering of both primary and secondary data for a new purpose.
7.Research is characterized by patient and unhurried activity.
8.Research requires expertise. The researcher should know what is already known about the problem and how others investigated it.
9.Research should be carefully recorded and reported.
10.Research sometimes require courage.
Objectives of Research
1.Identify the problem to be solved.
2.Describe an institution or a group or a phenomenon.
3.Explain the relationship between variables ie, causal explanation.
4.Discover information that never be discussed in the ordinary course of life.
5.Discover new information and modify the existing information.
Motivations in doing Research
The possible motives for doing research may be either one or more of the following :
1.Desire to get a higher degree with its consequential benefits.
2.Desire to face the challenge in solving unsolved problems.
3.Desire to get intellectual joy of doing some creative work.
4.Desire to be of services to the society.
5.Desire to get respectability.
Types of Research
Social Research has been classified several ways depending on the purpose for which it is undertaken, the extent to which it satisfies the scientific procedure or the methods of data collection or the control factor involved etc. There is no hard and fast rule in the classification. The classification is done more for the sake of promoting better understanding or for the sake of convenience.
On the basis of purpose for which it is conducted, research is mainly classified into four such as Pure Research, Applied Research, Action Research and Evaluation Research.
1. Pure Research
Pure Research or Fundamental (basic) Research is the research that is undertaken for widening the horizon of knowledge, that is just for the purpose of acquiring new knowledge. It is conceived as a search for broad principles without any immediate utilitarian objective. Its essential element is building theories and principles by broad generalization. It is time consuming and involves much costs. A researcher may have to devote his entire life time, out of scientific curiosity, unmindful of immediate rewards.
Eg: Scientific inventions such as steam engine, electricity etc.
2. Applied Research
Applied Research is need based and aims at solving immediate problems or here the researcher is making use of existing knowledge to solve a problem. It is completed in a short span of time and is empirical and men-centered. Its major purpose is to improve the system or practice and the theoretical development is of minor importance.
3. Evaluation Research
This type of research is primarily directed to evaluate the performance of the developmental projects and other economical programmes that have already been implemented. The objective being to realistically assess the impact of any such programme. This is of three types such as Concurrent evaluation, Phasic evaluation and Terminal Evaluation.
a. Concurrent Evaluation :
It is a continuing process of an inspection of the project that has been launched ie. The evaluation goes on side by side with the implementation of the project. It evaluates the performance and gives direction and control as and when possible.
b. Phasic Evaluation
Phasic or Periodic Evaluation takes place at different phases or stages of performance of the project. It enables us to evaluate the performance of the completed phase and make adjustments in the subsequent phases after keeping in view the failures and success of the previous phase.
c.Terminal Evaluation :
It is the evaluation of the project after it is being completed. The main objective is to provide necessary feed back ie. an overall assessment is made to see how the best a project has served the objective for which it was launched.
4. Action Research
The process by which the practitioners attempt to study their problems scientifically in order to guide, correct and evaluate their decisions and actions in called Action Research. In this case the person who faces the problem tries to find out its solution. There is a thin line of difference between applied research and action research, sometimes it may consider one and the same.
On the basis of data collected method research is classified into historical, case study, survey and experimental research.
1.Historical Research or Method:
In this method the research is conducted on the basis of historical data. Historical Research is essential for both basic and applied research in business. Explanations for the present are derived from historical inquiries. Historical Research is concerned with digging up facts. The main sources of historical data are books, documents, newspapers, magazines, diaries, auto-biographies, personal letters, personal agreements, historical paintings etc. The steps involved in this method are selection of the problem, formulation of hypothesis, preparation for collection of data, organization of data, evaluation of data, interpretation and writing the report.
2.Case Study Method
The case study research has been one of the important methods of social research. It is a deep and intensive study of a particular social unit confined to a very small number of cases. It also seeks to determine social process, it reveals the complexity of factors, and indicate their sequences and inter relationships. Social unit may be a person, a family, an institution, a cultural group or even an entire community. It uses of both primary and secondary sources of data. Steps involved in case study are selection of cases, identification of situations, gathering and recording of data, interpretation and reporting of data.
3.Survey Method :
This includes the systematic gathering of data from population by applying personal contact, interviews or other techniques. It is a process by which quantitative facts about a social phenomena are collected to contribute to the solution of immediate problems. Survey technique is used only when the desired information cannot be gathered more easily and less expensively from other sources.
4.Experimental Method :
This approach to research is based on scientific methods in so far as causal relation are studied under controlled conditions. The main aim of this is to identify the variables and the relationship with each other. The variables under this kind of study are termed as independent variable and dependent variable.
Independent Variable and Dependent Variable :
The variable that the researcher wish to explain is the dependent variable. The variable which is expected to explain the changes in the dependent variable is referred to as independent variable. The independent variable is also called Predictor variable, it is the explanatory variable considered to be the presumed cause of change in the value of dependent variable. The dependent variable is the expected outcome of independent variable.
There may be some other kinds of researches such as exploratory research, descriptive research, diagnostic research etc.
Exploratory Research :
When the purpose of research is to gain familiarly with the problem or to achieve new insights into it, in order to formulate a more precise problem the exploratory studies are generally made.
There are 3 approaches to the exploratory study such as :-
1.Survey of literature or literature reviews.
2.Discussion with experts.
3.Case-study or examination of existing records.
Descriptive Research : It is concerned with describing the characteristics of phenomenon and find out the relationship between variables. Descriptive study may employ any or all the methods of data collection such as interviews, questionnaires, observations etc.
Diagnostic Research : It is concerned with finding the real cause of a problem and what can be done to overcome this problem.
Limitations of Social Research :
Social Research deals with social phenomena which is different from physical phenomena. Man has complete control over physical phenomena because it can be put to laboratory test under guided conditions. Because of this fundamental difference there are several difficulties or limitations to social research.
1.Complexity of Social Data: Researches in social sciences are based on human behavior and the behavior of human beings, is influenced by so many factors such as physical, social, psychological, geographical, biological and sociocultural. Because of these factors an observer is generally confused.
2.Problems in interpreting relationship between cause and effect : In case of a social phenomena cause and effect are inter dependent and one stimulates the other. It is very difficult to establish cause-effect relationship in social sciences.
3.Problems of Concepts : Different concepts are used in social research and the same concept may be defined differently in different researches.
4.Dynamic nature of social phenomena : Human society is constantly changing and improving itself by past knowledge. Thus not only the deductions based on past studies, but even the techniques used in past may prove useless for the present and future studies.
5.Problem of maintaining objectivity : The problem of impartiality is in part a problem of objectivity. Any personal bias vitiates the universality criterion of a scientific preposition. To be objective in the conduct of an inquiry one shouldn't let one's belief be influenced by his personal motives, customs and social situations of which he himself is a part.
6.Unpredictability : Predictability is one of the most important characteristics of science. But it is not so in the case of social sciences because of complexity of social data as well as due to the fact that social behavior is sufficiently irregular and unpredictable.
7.Difficulty in the verification of inferences : Verification of the research results obtained is possible in the case of physical sciences but in social sciences it is much more difficult. The events in social sciences are non-repetitive and the social scientists are ill equipped with their tools to verify prediction.
8.Difficulty in the use of experimental method : In the case of social sciences it is not possible to put human beings to laboratory tests. Here the research has to wait for the circumstances to occur in the natural course. They cannot be created artificially.
9.Problem of interdisciplinary approach : Social research in any field are inter related, therefore we cannot draw water tight compartments for each sector of social sciences. The main problem in interdisciplinary research is that every branches of knowledge has its own line of approach and a methodology suited for the purpose. When they are tried to be fitted in a single frame, distortions are bound to take place.
10. Less Finance : Inadequate financing is one of the major problem faced by the social research in modern world.
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One of the basic desires of man is to know of things around him. Basically man is developing certain inquiry is his mind and wants to get reply for it. He is asking so many questions such as why, how, when etc. of all things. Moreover in the modern complex world man is faced with many problems. He wants to find immediate solution to these problems. His desire to find the solution to the problems is mainly due to his urge to do something better or more efficiently. Problem solving is a technical process which not only require ingenuity but also a fund of accumulated knowledge and wisdom. This accumulation of knowledge is very essential to solve a problem. According to Charls Pierce the American philosopher there are four ways of gaining knowledge.
1.Method of Tenacity : We hold something true because we believe it to be so for a very long time. Old people's tales fall under this category.
2.Method of Authority : Some persons holding position like teachers and religious leaders make statements and which are accepted by us.
3.Method of Intuition : Certain information found reasonable are accepted by us. Men easily guess that women are soft spoken.
4.Method of Science : Under this method ideas are accepted only after they have been vigorously tested.
Scientific Method is defined by Rummel as the systematic and refined use of specialized tools and procedures to obtain a more adequate solution to a problem that would be possible by less discriminatory means. This scientific method of studying a problem is termed as Research. The word meaning of research is to search back.
Research is considered to be the more formal, systematic and intensive process of carrying on the scientific method of analysis. Intensive study, deep analysis and reflective thinking are the basic ingredients of research. Application of scientific tools and accepted steps and procedures are essential for an ideal research.
Social Research
Social Research studies men and his institutions in an empirical way. The relevance of social research is far greater in developing countries like India which are confronted with complex socio-economic problems like poverty, unemployment, illiteracy and the like.
Importance of Social Research
1.Social Research provides the basic data for social planning.
2.Research has a greater role in providing solution to immediate problems faced by the community.
3.It promotes social interest and better understanding in the society.
4.It enables the researcher to have an intimate knowledge of the society and such a knowledge guides social growth on proper lines.
Definition of Social Research
According to P.V Young social Research may be defined as a scientific undertaking which, by means of logical and systematized techniques seeks to :-
1.Discover new facts or verify and test old facts.
2.Analyze the sequences, inter relationships and causal explanations which were derived within an appropriate theoretical frame of reference, and
3.develop new scientific tools, concepts and theories which would facilitate reliable and valid study of human behavior.
Social Research is a systematic method of exploring, analyzing and conceptualizing social life in order to extent, correct or verify knowledge, whether that knowledge aid in the construction of a theory or in the practice of an art.
Characteristics of Research
1.Research is a systematic and accurate investigation : There is no place for approximations and ambiguities in research.
2.Research is directed towards the solution of a problem : It may attempt to answer a question or to determine the relation between two or more variables.
3.Research emphasizes the development of generalizations, principles or theories that will be helpful in predicting future occurrences.
4.Research is based upon observable experience or empirical evidence.
5.Research demands accurate observations and descriptions.
6.Research involves gathering of both primary and secondary data for a new purpose.
7.Research is characterized by patient and unhurried activity.
8.Research requires expertise. The researcher should know what is already known about the problem and how others investigated it.
9.Research should be carefully recorded and reported.
10.Research sometimes require courage.
Objectives of Research
1.Identify the problem to be solved.
2.Describe an institution or a group or a phenomenon.
3.Explain the relationship between variables ie, causal explanation.
4.Discover information that never be discussed in the ordinary course of life.
5.Discover new information and modify the existing information.
Motivations in doing Research
The possible motives for doing research may be either one or more of the following :
1.Desire to get a higher degree with its consequential benefits.
2.Desire to face the challenge in solving unsolved problems.
3.Desire to get intellectual joy of doing some creative work.
4.Desire to be of services to the society.
5.Desire to get respectability.
Types of Research
Social Research has been classified several ways depending on the purpose for which it is undertaken, the extent to which it satisfies the scientific procedure or the methods of data collection or the control factor involved etc. There is no hard and fast rule in the classification. The classification is done more for the sake of promoting better understanding or for the sake of convenience.
On the basis of purpose for which it is conducted, research is mainly classified into four such as Pure Research, Applied Research, Action Research and Evaluation Research.
1. Pure Research
Pure Research or Fundamental (basic) Research is the research that is undertaken for widening the horizon of knowledge, that is just for the purpose of acquiring new knowledge. It is conceived as a search for broad principles without any immediate utilitarian objective. Its essential element is building theories and principles by broad generalization. It is time consuming and involves much costs. A researcher may have to devote his entire life time, out of scientific curiosity, unmindful of immediate rewards.
Eg: Scientific inventions such as steam engine, electricity etc.
2. Applied Research
Applied Research is need based and aims at solving immediate problems or here the researcher is making use of existing knowledge to solve a problem. It is completed in a short span of time and is empirical and men-centered. Its major purpose is to improve the system or practice and the theoretical development is of minor importance.
3. Evaluation Research
This type of research is primarily directed to evaluate the performance of the developmental projects and other economical programmes that have already been implemented. The objective being to realistically assess the impact of any such programme. This is of three types such as Concurrent evaluation, Phasic evaluation and Terminal Evaluation.
a. Concurrent Evaluation :
It is a continuing process of an inspection of the project that has been launched ie. The evaluation goes on side by side with the implementation of the project. It evaluates the performance and gives direction and control as and when possible.
b. Phasic Evaluation
Phasic or Periodic Evaluation takes place at different phases or stages of performance of the project. It enables us to evaluate the performance of the completed phase and make adjustments in the subsequent phases after keeping in view the failures and success of the previous phase.
c.Terminal Evaluation :
It is the evaluation of the project after it is being completed. The main objective is to provide necessary feed back ie. an overall assessment is made to see how the best a project has served the objective for which it was launched.
4. Action Research
The process by which the practitioners attempt to study their problems scientifically in order to guide, correct and evaluate their decisions and actions in called Action Research. In this case the person who faces the problem tries to find out its solution. There is a thin line of difference between applied research and action research, sometimes it may consider one and the same.
On the basis of data collected method research is classified into historical, case study, survey and experimental research.
1.Historical Research or Method:
In this method the research is conducted on the basis of historical data. Historical Research is essential for both basic and applied research in business. Explanations for the present are derived from historical inquiries. Historical Research is concerned with digging up facts. The main sources of historical data are books, documents, newspapers, magazines, diaries, auto-biographies, personal letters, personal agreements, historical paintings etc. The steps involved in this method are selection of the problem, formulation of hypothesis, preparation for collection of data, organization of data, evaluation of data, interpretation and writing the report.
2.Case Study Method
The case study research has been one of the important methods of social research. It is a deep and intensive study of a particular social unit confined to a very small number of cases. It also seeks to determine social process, it reveals the complexity of factors, and indicate their sequences and inter relationships. Social unit may be a person, a family, an institution, a cultural group or even an entire community. It uses of both primary and secondary sources of data. Steps involved in case study are selection of cases, identification of situations, gathering and recording of data, interpretation and reporting of data.
3.Survey Method :
This includes the systematic gathering of data from population by applying personal contact, interviews or other techniques. It is a process by which quantitative facts about a social phenomena are collected to contribute to the solution of immediate problems. Survey technique is used only when the desired information cannot be gathered more easily and less expensively from other sources.
4.Experimental Method :
This approach to research is based on scientific methods in so far as causal relation are studied under controlled conditions. The main aim of this is to identify the variables and the relationship with each other. The variables under this kind of study are termed as independent variable and dependent variable.
Independent Variable and Dependent Variable :
The variable that the researcher wish to explain is the dependent variable. The variable which is expected to explain the changes in the dependent variable is referred to as independent variable. The independent variable is also called Predictor variable, it is the explanatory variable considered to be the presumed cause of change in the value of dependent variable. The dependent variable is the expected outcome of independent variable.
There may be some other kinds of researches such as exploratory research, descriptive research, diagnostic research etc.
Exploratory Research :
When the purpose of research is to gain familiarly with the problem or to achieve new insights into it, in order to formulate a more precise problem the exploratory studies are generally made.
There are 3 approaches to the exploratory study such as :-
1.Survey of literature or literature reviews.
2.Discussion with experts.
3.Case-study or examination of existing records.
Descriptive Research : It is concerned with describing the characteristics of phenomenon and find out the relationship between variables. Descriptive study may employ any or all the methods of data collection such as interviews, questionnaires, observations etc.
Diagnostic Research : It is concerned with finding the real cause of a problem and what can be done to overcome this problem.
Limitations of Social Research :
Social Research deals with social phenomena which is different from physical phenomena. Man has complete control over physical phenomena because it can be put to laboratory test under guided conditions. Because of this fundamental difference there are several difficulties or limitations to social research.
1.Complexity of Social Data: Researches in social sciences are based on human behavior and the behavior of human beings, is influenced by so many factors such as physical, social, psychological, geographical, biological and sociocultural. Because of these factors an observer is generally confused.
2.Problems in interpreting relationship between cause and effect : In case of a social phenomena cause and effect are inter dependent and one stimulates the other. It is very difficult to establish cause-effect relationship in social sciences.
3.Problems of Concepts : Different concepts are used in social research and the same concept may be defined differently in different researches.
4.Dynamic nature of social phenomena : Human society is constantly changing and improving itself by past knowledge. Thus not only the deductions based on past studies, but even the techniques used in past may prove useless for the present and future studies.
5.Problem of maintaining objectivity : The problem of impartiality is in part a problem of objectivity. Any personal bias vitiates the universality criterion of a scientific preposition. To be objective in the conduct of an inquiry one shouldn't let one's belief be influenced by his personal motives, customs and social situations of which he himself is a part.
6.Unpredictability : Predictability is one of the most important characteristics of science. But it is not so in the case of social sciences because of complexity of social data as well as due to the fact that social behavior is sufficiently irregular and unpredictable.
7.Difficulty in the verification of inferences : Verification of the research results obtained is possible in the case of physical sciences but in social sciences it is much more difficult. The events in social sciences are non-repetitive and the social scientists are ill equipped with their tools to verify prediction.
8.Difficulty in the use of experimental method : In the case of social sciences it is not possible to put human beings to laboratory tests. Here the research has to wait for the circumstances to occur in the natural course. They cannot be created artificially.
9.Problem of interdisciplinary approach : Social research in any field are inter related, therefore we cannot draw water tight compartments for each sector of social sciences. The main problem in interdisciplinary research is that every branches of knowledge has its own line of approach and a methodology suited for the purpose. When they are tried to be fitted in a single frame, distortions are bound to take place.
10. Less Finance : Inadequate financing is one of the major problem faced by the social research in modern world.
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Monday, August 9, 2010
Census and Sample Investigation - Sample - Sample Design - Sampling Process - Advantages and Limitations of Sampling.
Census and Sample Investigation
All items in any field of inquiry constitute a universe or population. A complete enumeration of all items in the population is known as ‘Census Inquiry’. It can be presumed that in such an inquiry, when all the items are covered, no element of chance is left and highest accuracy is obtained. But in practice this may not be true even the slightest element of bias in such an inquiry will get larger and larger as the number of observations increase.
Census type of inquiry involves a great deal of time, money and energy. When field of inquiry is large this method becomes difficult to adopt because of the resources involved. Moreover, this method is practically beyond the reach of ordinary researchers. Further it is not possible to examine every item in the population sometimes and it is not possible to obtain sufficiently accurate results by studying only a part of total population. When the field of studies or the universe is a small one, it is no use in resorting to a sample survey. When the field studies are undertaken in practical life, considerations of time and cost almost invariably lead to a selection of respondents ie., a selection of only a few items.
Meaning of Sample: A sample is a smaller representation of a large unit or value. In other words a sample is that part of the universe or population which we select for the purpose of investigation. In the ordinary course we make judgment and take decisions on the basis of samples. For example:
When we go to a shop, we examine a handful of rice to find the quality of rice in the whole bag.
A doctor examines only a few drops of blood to draw conclusions about the blood constitution of the body.
Similarly when field studies are undertaken in practical life, considerations of time and costs almost invariably lead to a selection of respondents ie., a selection of only a few items from the population. The respondents selected should be a representative of the total population as possible in order to produce a miniature cross section. The selected respondents constitute what is technically called a sample and the selection process is called ‘Sampling Technique”. The survey so conducted is called as ‘Sample Survey’.
Sample Design: A sample design is a definite plan for obtaining a sample from a given population. It refers to the technique or procedure that enables the researcher for selecting an item for the sample. Researcher must prepare a sample design for the study ie., he must plan how a sample should be selected and of what size such a sample would be. Sample design is determined before data collection.
Steps in Sampling or Sampling Process: Sampling process in research has the following steps:
1.Define the population and determine the sampling unit: The population is the aggregate of all the elements to be studied. When the number of unit belonging to a particular universe is certain, it is called ‘Finite Universe’- example: Number of workers in a factory, area of a town etc. When the number of unit cannot be ascertained, it is called as ‘Infinite Universe’. Example: number of stars in the sky, listeners of a specific radio program etc.
A properly defined population must be defined in terms of Elements, Sampling units, Extend and Time. Suppose the research is conducted on the problem of Indian Cotton Textile Export, the element should be different types of cotton and cotton textile products, sampling unit would be the firm’s exporting these, extend is India and the time may specified by 2009 or so on. The sampling unit should be definite, clear and unambiguous. It may be a geographical one (example- State, District, Village etc.), a social unit (example- a family, school etc.), or it may be an individual.
2.Identify the Sample frame or Source list: It is a list which contains the names of the unit of the population or universe. In the above example the sampling frame would be the lists of the firms that are members of the Council for cotton textile export. If the source list is not available, the researcher has to prepare such a list, which is comprehensive, correct, reliable, appropriate and representative of the population.
3.Determine the Sample Size: It refers to the number of items to be selected from the universe to constitute a sample. The size of the sample shall be optimum while fulfill the requirements of efficiency, representativeness, reliability and flexibility. The size of the sample depends upon a number of factors like:
a)Homogeneity and heterogeneity of the universe: If the items in the universe are homogeneous, a small sample is required and vice-versa.
b)Number of classes: If many classes or groups are to be framed, then a large sample is required so that every class must be of proper size for statistical analysis.
c)Law of statistical regularity: The law indicates that for obtaining accurate results the sample shall be randomly selected and must represent the whole universe.
d)Other considerations: Other factors like type of sampling, size of questionnaire, standard of accuracy, availability of finance, training of investigators and time at the disposal of the researcher etc., shall also be considered.
4.Sampling Procedure: Finally the researcher must decide the type of sample he will use ie, he must decide about the techniques to be used in selecting the items for the sample. There are several sample designs out of which the researcher must choose the best one fit for his study.
Characteristics of a good sample
A good sample must be representative of the universe. It should contain majority of the characteristics of the universe, if not all. In other words, a good sample should posses all the basic characteristics of the universe.
Another requirement pf a good sample is that it is free from bias. Bias may c reap in the selection of the sample for reasons like convenience, substitution, mistake in the adoption of sampling method and failure to cover the whole of the chosen sample.
The third essential of a good sample is its adequacy. Adequacy in the sense that the sampling size must be adequate to yield reasonable conclusions regarding the population from the sample drawn.
The sample must enable the measures of sampling error in fact the representativeness of the sample and the validity of conclusions depend to a large extent on these errors even if a proper selection is employed, a sample may not be exactly representative of the population owing to sampling errors. As such the researcher must be in a position to estimate the influences of these errors and declare to the readers the percentage of accuracy of his survey results.
Finally, the results of a good sample should be applicable to all items of the universe with a reasonable level of confidence. Unless the sample has this characteristic there is no use in conducting a research study.
Advantages of sampling: The sampling technique is used in survey method of data collection. The following are the advantages of sampling techniques:
1.When the size of population or universe is very large, sampling technique is best suited for the collection of data as it economizes money, time and effort.
2.When the lesser percentage of accuracy is sufficient in any study, the sampling technique is much suitable for the collection of data or information through the sample survey. A higher percentage of accuracy can be ensured only through census survey.
3.The sampling technique enables the investigator to collect the required information from relatively a large size of population or the availability of data is unlimited in character.
4.There are certain types of study where census method cannot be adopted at all. For instance, in a study relating to the availability of mineral resources in the country sampling method is used to make an attempt to evaluate its availability below the earth in the country.
5.When the items of universe or population is more homogeneous in nature, sampling technique is more feasible and useful.
6.Sometimes the sampling units are get exploited while making the study. In such situations census study is not possible and thereby sampling study is advantageous. For instance, a study conducted for measuring the life period of electric bulbs produced by an organization.
Limitations of Sampling:
1.The conclusions or generalizations derived from a sample survey are always less accurate and liable for more errors compared to the conclusions arrived through census method.
2.When the various units of the survey population are not alike and liable to change frequently, the sampling technique will be very difficult. The conclusions derived from one set of units are not comparable with another set of units which are frequently liable to change in their nature.
3.If due care is not taken in conducting a sample survey, the conclusions will be much misleading and erroring in nature.
4.The adoption of sampling techniques can be successful only if due care is taken to select the sample by competent persons in the field.
5.When the population is heterogeneous and the time available are very short, it is not possible to make a selection of a best sample. Moreover, if we need 100% accuracy, the sampling techniques cannot be used.
All items in any field of inquiry constitute a universe or population. A complete enumeration of all items in the population is known as ‘Census Inquiry’. It can be presumed that in such an inquiry, when all the items are covered, no element of chance is left and highest accuracy is obtained. But in practice this may not be true even the slightest element of bias in such an inquiry will get larger and larger as the number of observations increase.
Census type of inquiry involves a great deal of time, money and energy. When field of inquiry is large this method becomes difficult to adopt because of the resources involved. Moreover, this method is practically beyond the reach of ordinary researchers. Further it is not possible to examine every item in the population sometimes and it is not possible to obtain sufficiently accurate results by studying only a part of total population. When the field of studies or the universe is a small one, it is no use in resorting to a sample survey. When the field studies are undertaken in practical life, considerations of time and cost almost invariably lead to a selection of respondents ie., a selection of only a few items.
Meaning of Sample: A sample is a smaller representation of a large unit or value. In other words a sample is that part of the universe or population which we select for the purpose of investigation. In the ordinary course we make judgment and take decisions on the basis of samples. For example:
When we go to a shop, we examine a handful of rice to find the quality of rice in the whole bag.
A doctor examines only a few drops of blood to draw conclusions about the blood constitution of the body.
Similarly when field studies are undertaken in practical life, considerations of time and costs almost invariably lead to a selection of respondents ie., a selection of only a few items from the population. The respondents selected should be a representative of the total population as possible in order to produce a miniature cross section. The selected respondents constitute what is technically called a sample and the selection process is called ‘Sampling Technique”. The survey so conducted is called as ‘Sample Survey’.
Sample Design: A sample design is a definite plan for obtaining a sample from a given population. It refers to the technique or procedure that enables the researcher for selecting an item for the sample. Researcher must prepare a sample design for the study ie., he must plan how a sample should be selected and of what size such a sample would be. Sample design is determined before data collection.
Steps in Sampling or Sampling Process: Sampling process in research has the following steps:
1.Define the population and determine the sampling unit: The population is the aggregate of all the elements to be studied. When the number of unit belonging to a particular universe is certain, it is called ‘Finite Universe’- example: Number of workers in a factory, area of a town etc. When the number of unit cannot be ascertained, it is called as ‘Infinite Universe’. Example: number of stars in the sky, listeners of a specific radio program etc.
A properly defined population must be defined in terms of Elements, Sampling units, Extend and Time. Suppose the research is conducted on the problem of Indian Cotton Textile Export, the element should be different types of cotton and cotton textile products, sampling unit would be the firm’s exporting these, extend is India and the time may specified by 2009 or so on. The sampling unit should be definite, clear and unambiguous. It may be a geographical one (example- State, District, Village etc.), a social unit (example- a family, school etc.), or it may be an individual.
2.Identify the Sample frame or Source list: It is a list which contains the names of the unit of the population or universe. In the above example the sampling frame would be the lists of the firms that are members of the Council for cotton textile export. If the source list is not available, the researcher has to prepare such a list, which is comprehensive, correct, reliable, appropriate and representative of the population.
3.Determine the Sample Size: It refers to the number of items to be selected from the universe to constitute a sample. The size of the sample shall be optimum while fulfill the requirements of efficiency, representativeness, reliability and flexibility. The size of the sample depends upon a number of factors like:
a)Homogeneity and heterogeneity of the universe: If the items in the universe are homogeneous, a small sample is required and vice-versa.
b)Number of classes: If many classes or groups are to be framed, then a large sample is required so that every class must be of proper size for statistical analysis.
c)Law of statistical regularity: The law indicates that for obtaining accurate results the sample shall be randomly selected and must represent the whole universe.
d)Other considerations: Other factors like type of sampling, size of questionnaire, standard of accuracy, availability of finance, training of investigators and time at the disposal of the researcher etc., shall also be considered.
4.Sampling Procedure: Finally the researcher must decide the type of sample he will use ie, he must decide about the techniques to be used in selecting the items for the sample. There are several sample designs out of which the researcher must choose the best one fit for his study.
Characteristics of a good sample
A good sample must be representative of the universe. It should contain majority of the characteristics of the universe, if not all. In other words, a good sample should posses all the basic characteristics of the universe.
Another requirement pf a good sample is that it is free from bias. Bias may c reap in the selection of the sample for reasons like convenience, substitution, mistake in the adoption of sampling method and failure to cover the whole of the chosen sample.
The third essential of a good sample is its adequacy. Adequacy in the sense that the sampling size must be adequate to yield reasonable conclusions regarding the population from the sample drawn.
The sample must enable the measures of sampling error in fact the representativeness of the sample and the validity of conclusions depend to a large extent on these errors even if a proper selection is employed, a sample may not be exactly representative of the population owing to sampling errors. As such the researcher must be in a position to estimate the influences of these errors and declare to the readers the percentage of accuracy of his survey results.
Finally, the results of a good sample should be applicable to all items of the universe with a reasonable level of confidence. Unless the sample has this characteristic there is no use in conducting a research study.
Advantages of sampling: The sampling technique is used in survey method of data collection. The following are the advantages of sampling techniques:
1.When the size of population or universe is very large, sampling technique is best suited for the collection of data as it economizes money, time and effort.
2.When the lesser percentage of accuracy is sufficient in any study, the sampling technique is much suitable for the collection of data or information through the sample survey. A higher percentage of accuracy can be ensured only through census survey.
3.The sampling technique enables the investigator to collect the required information from relatively a large size of population or the availability of data is unlimited in character.
4.There are certain types of study where census method cannot be adopted at all. For instance, in a study relating to the availability of mineral resources in the country sampling method is used to make an attempt to evaluate its availability below the earth in the country.
5.When the items of universe or population is more homogeneous in nature, sampling technique is more feasible and useful.
6.Sometimes the sampling units are get exploited while making the study. In such situations census study is not possible and thereby sampling study is advantageous. For instance, a study conducted for measuring the life period of electric bulbs produced by an organization.
Limitations of Sampling:
1.The conclusions or generalizations derived from a sample survey are always less accurate and liable for more errors compared to the conclusions arrived through census method.
2.When the various units of the survey population are not alike and liable to change frequently, the sampling technique will be very difficult. The conclusions derived from one set of units are not comparable with another set of units which are frequently liable to change in their nature.
3.If due care is not taken in conducting a sample survey, the conclusions will be much misleading and erroring in nature.
4.The adoption of sampling techniques can be successful only if due care is taken to select the sample by competent persons in the field.
5.When the population is heterogeneous and the time available are very short, it is not possible to make a selection of a best sample. Moreover, if we need 100% accuracy, the sampling techniques cannot be used.
Thursday, August 5, 2010
Sub Prime Mortgage Crisis (SPMC) in US: An Overview - Crisis in India
The Crisis in India:
After a long spell of growth, the Indian economy is experiencing a downturn. Industrial growth is faltering. The FEX reserves are depleting, the rupee is depreciating and the sensex is shuttling near 10000 marks. The Indian economy, in line with global scenario, commenced groping in the dark.
The immediate effect of the US crisis has been heavy outflow of FIIs from the equity market. Faced with the need to retrench assets to cover the losses in their home countries and seeking havens of safety in a highly volatile environment, FIIs have been major sellers in Indian Markets. A pull out of the FIIs has triggered collapse in Indian Stock Market. The sensex have fallen from its closing peak of 20873 on Jan, 2008 to around 9500 by the beginning of November 2008. Driven the stock indices down, the exit of FIIs has led to a sharp depreciation of the rupees. Going by RBI reference rate, between January 2008 and November 2008, the rupee depreciated by almost 25% with respect to a weak currency like dollar (from Rs.39.20 to Rs.50.20). The depreciation occurred despite having frequent sale of dollars by the RBI.
The second route through the global financial crisis had affected India is through the exposure of Indian Banks situated abroad or banks operating in India to the impaired assets resulting from the sub prime crisis. Unfortunately, there are no clear estimates of the extent of that exposure, giving room for rumour in determining market trends. ICICI Bank was one of the major victims of run on the bank for quite a short period due to rumours that sub prime exposures had badly damaged its Balance Sheet even though RBI claimed that the exposure of Indian Banks to assets impaired by the financial crisis is quite small.
The RBI had estimated that as a result of exposure to Collaterised Debt Obligations (CDO) and Credit Default Swap (CDS), the market losses of Indian Banks at the end of July 2008 was around USD 450 mio including USD 90 mio to Public Sector Banks and USD 360 mio to Private Sector Banks. Though it is a serious concern, RBI opined that even if they are to be provided for, these Banks are well capitalized and can handle the situation. The fears are compounded by the minority in metros and major cities dealing with foreign banks and whose global exposures to toxic assets are substantial. What is disgusting to the investor and depositors are the limited Information available on the risks to which they are exposed.
The fourth indirect fall out of the global crisis and its ripples in India is the losses sustained by NBFCs/Mutual Funds as a result of their exposure to domestic stock market and currency market. The losses would be larger than expected and is resulted in RBI’ s decision to direct Banks to extend loans to MFs against CDs or buy back of their own CDs before maturity- under Liquidity Adjustment Facility (LAF). These losses are bound to render some institution fragile, with implications that will become evident only in the ensuing months,
In the uncertain environment, Banks/FIs are more concerned about their own Balance Sheet and have been cutting back on credit especially the huge volume of housing, automobile and retail loans provided to individuals. The reluctances of lenders to increase their exposures in the market in which they are already overexposed and the fears of increasing payment obligations in an uncertain economic environment are bound to curtail debt financed consumption and infrastructure investments. It is known that credit financed housing investments and credit financed consumption have been important drivers of growth in recent years and underpin the 9% growth trajectory that India have been experiencing.
Finally, the global recession generated by the financial crisis in the developed economies would adversely affect India’s exports especially exports of IT and ITES. More than 60% of IT/ITES are directed to the US international Banks/FIs. The nationalization of many of these Banks/FIs would increase the pressure to cut outsourcing to keep jobs in the developed countries. The reported reduction of capacity utilization, labour retrenchment, contraction of salary structure etc. by major industrial houses engaged in automobiles, textiles, iron and steel, cement, aviation etc. have created much hue and cry among the public. Pursuant to the slowing of growth outside the financial sector would have implications for merchandise and service exports. The net result would be a smaller export stimulus and widening trade deficit.
RBI Measures:
In the developed economies like US and European countries, the Balance Sheet of many Banks/FIs was rotten due to credit defaults and many financial institutions became bankrupt. Even though, the Banks/FIs in India are not that much affected, the withdrawal of FIIs from our stock market generated a threat of instability in our economy. In such a circumstance, the stabilization measures of RBI‘s have aided to avert liquidity squeeze substantially. The major steps initiated by RBI are as follows:
a.
Cash Reserve Ratio (CRR)
August 30, 2008
9%
October 11, 2008
7.50% (Reduced by 150 bps)
October 15, 2008
6.50% (Reduced by 100 bps)
November 1, 2008
5.50% (Reduced by 100 bps)
b.
Repo Rate
July 30, 2008
9%
October 20, 2008
8% (Reduced by 100 bps)
November 1, 2008
7.50% (Reduced by 50 bps)
c.
Statutory Liquidity Ratio (SLR)
November 1, 2005
24% (Reduced by 100 bps)
d.
Introduction of dual repo on September 15, 2008 to increase liquidity
e.
Provision of liquidity support of Rs.60,000 crores to MFs and NBFC ‘ s through commercial banks
f.
Special Refinance facility to Commercial Banks.
g.
Dollar support to Indian Banks with foreign branches
The RBI reiterates that it is confident of managing the situation and minimizing the adverse impact of global crisis to Indian economy. Pursuant to better economic recovery, P. Chidambaram, our Finance Minister, optimistically pointed out
“there is a storm blowing across the world. India will be affected to some extent, although indirectly, but Indian Business and industry have placed India in a situation where we can weather the storm.”
Conclusion:
If we look at the economic scenario prevailing in and around the country, the postulates of globalisation and the aftermath of global villages concept have became more significant. The positive correlated change in national economy in line with global happenings/events is quite visible and challenging. The FIIs/ FDIs have more voice and role in FEX growth. The ups and downs of indices at NASDAQ / NIKKE/ London Stock Exchange will get mechanically reflected in Chinese /Indian Stock Exchanges within seconds. The situation demands improvement in investor confidence. To achieve this objective, the Global economy needs more funds to improve liquidity and wants proper and pragmatic economic restructuring. Our Government is also not in the backstage. Frequent reduction of CRR and repo rates, accompanied by slashing of SLR are clear indication of measures puts forth by RBI to keep up the pace of economic growth and to retain the investor confidence, both domestic and international. The strategies for restructuring, through quite time consuming, demands integration of diverse segments of economy, including financial, manufacturing and service segments, under close supervision and regulation. The repeated measures enforced by RBI coupled with rapport from GOI will definitely rejuvenate Indian economic scenario at the optimal level.
After a long spell of growth, the Indian economy is experiencing a downturn. Industrial growth is faltering. The FEX reserves are depleting, the rupee is depreciating and the sensex is shuttling near 10000 marks. The Indian economy, in line with global scenario, commenced groping in the dark.
The immediate effect of the US crisis has been heavy outflow of FIIs from the equity market. Faced with the need to retrench assets to cover the losses in their home countries and seeking havens of safety in a highly volatile environment, FIIs have been major sellers in Indian Markets. A pull out of the FIIs has triggered collapse in Indian Stock Market. The sensex have fallen from its closing peak of 20873 on Jan, 2008 to around 9500 by the beginning of November 2008. Driven the stock indices down, the exit of FIIs has led to a sharp depreciation of the rupees. Going by RBI reference rate, between January 2008 and November 2008, the rupee depreciated by almost 25% with respect to a weak currency like dollar (from Rs.39.20 to Rs.50.20). The depreciation occurred despite having frequent sale of dollars by the RBI.
The second route through the global financial crisis had affected India is through the exposure of Indian Banks situated abroad or banks operating in India to the impaired assets resulting from the sub prime crisis. Unfortunately, there are no clear estimates of the extent of that exposure, giving room for rumour in determining market trends. ICICI Bank was one of the major victims of run on the bank for quite a short period due to rumours that sub prime exposures had badly damaged its Balance Sheet even though RBI claimed that the exposure of Indian Banks to assets impaired by the financial crisis is quite small.
The RBI had estimated that as a result of exposure to Collaterised Debt Obligations (CDO) and Credit Default Swap (CDS), the market losses of Indian Banks at the end of July 2008 was around USD 450 mio including USD 90 mio to Public Sector Banks and USD 360 mio to Private Sector Banks. Though it is a serious concern, RBI opined that even if they are to be provided for, these Banks are well capitalized and can handle the situation. The fears are compounded by the minority in metros and major cities dealing with foreign banks and whose global exposures to toxic assets are substantial. What is disgusting to the investor and depositors are the limited Information available on the risks to which they are exposed.
The fourth indirect fall out of the global crisis and its ripples in India is the losses sustained by NBFCs/Mutual Funds as a result of their exposure to domestic stock market and currency market. The losses would be larger than expected and is resulted in RBI’ s decision to direct Banks to extend loans to MFs against CDs or buy back of their own CDs before maturity- under Liquidity Adjustment Facility (LAF). These losses are bound to render some institution fragile, with implications that will become evident only in the ensuing months,
In the uncertain environment, Banks/FIs are more concerned about their own Balance Sheet and have been cutting back on credit especially the huge volume of housing, automobile and retail loans provided to individuals. The reluctances of lenders to increase their exposures in the market in which they are already overexposed and the fears of increasing payment obligations in an uncertain economic environment are bound to curtail debt financed consumption and infrastructure investments. It is known that credit financed housing investments and credit financed consumption have been important drivers of growth in recent years and underpin the 9% growth trajectory that India have been experiencing.
Finally, the global recession generated by the financial crisis in the developed economies would adversely affect India’s exports especially exports of IT and ITES. More than 60% of IT/ITES are directed to the US international Banks/FIs. The nationalization of many of these Banks/FIs would increase the pressure to cut outsourcing to keep jobs in the developed countries. The reported reduction of capacity utilization, labour retrenchment, contraction of salary structure etc. by major industrial houses engaged in automobiles, textiles, iron and steel, cement, aviation etc. have created much hue and cry among the public. Pursuant to the slowing of growth outside the financial sector would have implications for merchandise and service exports. The net result would be a smaller export stimulus and widening trade deficit.
RBI Measures:
In the developed economies like US and European countries, the Balance Sheet of many Banks/FIs was rotten due to credit defaults and many financial institutions became bankrupt. Even though, the Banks/FIs in India are not that much affected, the withdrawal of FIIs from our stock market generated a threat of instability in our economy. In such a circumstance, the stabilization measures of RBI‘s have aided to avert liquidity squeeze substantially. The major steps initiated by RBI are as follows:
a.
Cash Reserve Ratio (CRR)
August 30, 2008
9%
October 11, 2008
7.50% (Reduced by 150 bps)
October 15, 2008
6.50% (Reduced by 100 bps)
November 1, 2008
5.50% (Reduced by 100 bps)
b.
Repo Rate
July 30, 2008
9%
October 20, 2008
8% (Reduced by 100 bps)
November 1, 2008
7.50% (Reduced by 50 bps)
c.
Statutory Liquidity Ratio (SLR)
November 1, 2005
24% (Reduced by 100 bps)
d.
Introduction of dual repo on September 15, 2008 to increase liquidity
e.
Provision of liquidity support of Rs.60,000 crores to MFs and NBFC ‘ s through commercial banks
f.
Special Refinance facility to Commercial Banks.
g.
Dollar support to Indian Banks with foreign branches
The RBI reiterates that it is confident of managing the situation and minimizing the adverse impact of global crisis to Indian economy. Pursuant to better economic recovery, P. Chidambaram, our Finance Minister, optimistically pointed out
“there is a storm blowing across the world. India will be affected to some extent, although indirectly, but Indian Business and industry have placed India in a situation where we can weather the storm.”
Conclusion:
If we look at the economic scenario prevailing in and around the country, the postulates of globalisation and the aftermath of global villages concept have became more significant. The positive correlated change in national economy in line with global happenings/events is quite visible and challenging. The FIIs/ FDIs have more voice and role in FEX growth. The ups and downs of indices at NASDAQ / NIKKE/ London Stock Exchange will get mechanically reflected in Chinese /Indian Stock Exchanges within seconds. The situation demands improvement in investor confidence. To achieve this objective, the Global economy needs more funds to improve liquidity and wants proper and pragmatic economic restructuring. Our Government is also not in the backstage. Frequent reduction of CRR and repo rates, accompanied by slashing of SLR are clear indication of measures puts forth by RBI to keep up the pace of economic growth and to retain the investor confidence, both domestic and international. The strategies for restructuring, through quite time consuming, demands integration of diverse segments of economy, including financial, manufacturing and service segments, under close supervision and regulation. The repeated measures enforced by RBI coupled with rapport from GOI will definitely rejuvenate Indian economic scenario at the optimal level.
Sub Prime Mortgage Crisis (SPMC) in US: An Overview:
The heat of economic melt down is spreading slowly across the world for the first time since the Great Depression of 1930s. The fall of some of the giant global Banks/FIs of US/European/Asian countries including Lehman Brothers, Merrill Lynch, Bear Sterns, AIG (US), Dexia (Belgium), Origami Bank, Sumo Bank, Bonsai Bank (Japan) etc. unearth the gravity of the situation. Filing for bankruptcy by Banks/FIs across the US / European countries have become quite common and placed the investor confidence at high alert. Even we noticed with surprise the insolvency of Republic of Iceland a consequence of the adverse economic situation. Ben Bernanke, the Head of Federal Reserve, US has admitted the economic slow down in US and expressed that it would take another two three years to set right the economy and make the situation under control. The reported reduction of capacity utilisation, contraction of labour strength, down ward revision of salary structure etc. by major industrial houses engaged in automobiles, textiles, iron and steel, cement, aviation etc. have created much hue and cry among the public.
Indian economy is also not free from this global phenomenon. Though initially the Government of India have vehemently claimed proper insulation of our economy against any global crisis, of late Mr. Man Mohan Singh, our PM has acknowledged that India is also under the clutches of global melt down. The hectic withdrawal by FIIs has resulted in unparallel crash in sensex, heavy depreciation in rupee value against dollar and significant reduction in FEX reserves. To overcome the situation, RBI has opted for various quantitative measures to infuse liquidity in the financial system. In his strategic meeting with leading industrialists of the country, Mr. Singh sought for their assistance to keep away from employee reduction, contraction of productivity and labour retrenchment. Under such a circumstance, it is quite significant to evaluate the scenario behind the global economic crisis and its aftermath.
I. The US Collapse and its Intensity:
The topography of the Wall Street Banks (WSB) changed radically since September 2008. Bear Sterns, founded in 1923, collapsed and was hastily acquired by J.P. Morgan (JPM). The ailing Bank Washington Mutual was also bought into the fold of JPM. Lehman Brothers, founded in 1850, declared bankruptcy, and was taken over by Barclays Bank. Merrill Lynch, founded in 1914, folded alongside Lehman Brothers, to be picked up by Bank of America. A few days later, American International Group (AIG), founded in 1919, the world’s largest insurance company, went down the slope towards bankruptcy, but was fortunately saved at the eleventh hour by an emergency infusion of $ 85 billion by the US Government. A few weeks later, the Federal Reserve provided an additional loan of almost $ 38 billion to strengthen the ailing insurance giant. The Government sponsored mortgage agencies Fannie Mae and Freddie Mac, created in 1968 and 1970 respectively, retreated from their autonomy in to the embrace of Government. In the mid October 2008, Wells Fargo Bank absorbed Wachovia Bank, founded in 1879. JPM, founded in 1879, and Goldman Sachs, founded in 1869, went from being Investment Banks to become Bank Holding Companies. This turbulence has caused a downward slide and slope for major stock markets across the world and the credit market commenced to seize up. The pulse of electricity now began to make inroads into the confidence of those who hire and fire, who make and break. Things are so bad that General Motors released a statement that “Bankruptcy is not an option” for the Company. The Labour Department, US announced that the country lost 1.59 lacs jobs in September, up from 0.73 lacs jobs lost in August 2008. The Wall Street Journal released its survey of 52 economists who pointed out that things can only go negative. The shifts in US from ardent laizzez faire postulates to nationalization concepts are quite a paradox.
II. SPMC – An Overview:
From late 2002 to mid 2005, the US Federal Reserve funds rate stood at levels that implied that when adjusted for inflation, the real interest rate was negative. Easy access to credit at low interest rates triggered a housing boom, which in turn triggered inflation in housing prices and encouraged more housing investments. From the FY 2001 to FY 2007, the real estate value of households and the corporate sector is estimated to have increased by $ 14.5 trillion.
The SPMC is an ongoing economic problem in US and became more visible during 2007. The situation is characterized by contracted liquidity in the credit market and banking system. Sub prime lending is the practice of extending mortgage loans to borrowers with poor credit history. Higher rate of interest is charged to mitigate the risk factors, viz. poor income level, low credit score, unstable employment status etc. Sensing the opportunity coupled with encouraging interest rate environment, the Banks/FIs expanded the borrower base by inducting sub prime ones or borrowers with low credit ratings and high probability of default, viz. the No Income, No Jobs and Assets (NINJAs). Mortgage borrowers attracted these clients by relaxing income criteria and offered sweeteners like lower interest rate for initial period with reset options. The share of such sub-prime loans in all mortgages rose sharply, from 5% in 2001 to more than 20% by 2007. Borrowers chose to use this “opportunity” because they were not properly informed about their commitments. Also, they were over confident about their ability to meet the repayment obligations.
On the supply side, the complex nature of finance centered on the “Originate and Sell” model. The Banks/FIs discounted the risk because they expected to cash in on large profits even while transferring the risk associated with the investments. The mortgage brokers sought out willing borrowers for a fee, turning to sub prime markets in search of volumes. The Mortgage lenders and Banks financed these mortgages because they wanted to buy the interest and amortization flows associated with such lending. Also, they wanted to sell these instruments too less regulated intermediaries such as the Wall Streets Banks. The Banks, who bought these mortgages, opted to expand their business by bundling assets and sold to institutions, investors, hedge funds and portfolio managers. To suit different tastes for risks, they bundled them into tranches with varying probability of default and differential risk weightage/protection against losses.
The associated risk was rated by approved independent agencies which, not knowing the details of the specific borrowers to whom the original credit was sanctioned, use statistical models to determine which kind of tranche could be rated as being of high, medium or low risk. Once certified, these tranches could be absorbed by Banks, Mutual Funds, pension funds and insurance companies, which could create portfolios involving varying degrees of risk and different streams of future cash flows linked to the original mortgage. Whenever necessary, these institutions could insure against default by turning to the insurance companies and entering into arrangements such as CDSs. Even Government Sponsored Enterprises such as Freddie Mac and Fannie Mae, which were not expected to be involved in or exposed to the sub prime market, had to cave in because they feared they were losing business to new rivals who were tiring to cash in on the boom and poaching on the business of these specialists. Because of this complex chain, institutions at every level assumed that they were not carrying any risk or they were properly insured against.
The problems began with defaults on sub prime loans. In some cases, default occurred before interest rates were reset to higher levels and in others, after the resetting of rates. As the proportion of default grew, the structure gives in and all assets turned illiquid. Rising foreclosures pushed down housing prices as more properties were up for sale. On the other hand, the losses suffered by financial institutions were freezing up credit, resulting in a fall on housing demand. As the housing prices collapsed, the housing equity held by many depreciated and they found themselves paying back loan that were much larger that the value of the assets. Default and foreclosures seemed a better option than remaining trapped in this losing deal.
Since mark to market accounting required taking account of prevailing market prices, many financial firms had to write down the values of the assets they had and take the losses into their balance sheets. But since the market value was unknown, many firms took much smaller write down than warranted. But they could not hold out forever. The extend of the problem was partly revealed when leading Wall Street Bank like Bear Sterns declared that investments in two funds it created linked to Mortgaged Backed Securities (MBS) were worthless. This signaled that many financial institutions were near insolvency. Infact, given the financial integration within and across countries, almost all financial firms in the US and abroad were severely affected. Fear forced firms from lending to each other, affecting their ability to continue with their business to meet short-term cash needs. Insolvency began threatening the best and largest firms. The independent Wall Street investment banks, Bear Sterns, Lehman Brother etc, shut shop or merged into bigger banks or converted themselves into bank holding companies that were subject to stricter regulations. This was seemed as the end of an era in which these independent investment banks epitomized the innovation that financial liberalization had unleashed.
III. SPMC- A Search for Causes:
The Securities and Exchange Commission has conceded that self-regulation of Investment Banks contributed to the crisis. The first thing occurred with the withdrawal of the Glass Steagall Act (GSA), which was passed after the Great Depression in 1930s. The GSA separated the investment activities and commercial banking activities. The Act was repealed in 1999 with the Gramm Leach Bliley Act (GLBA) with liberalization in investment and commercial banking activities. Economist Robert Kuttner has criticized that the repeal of GSA has possibly contributed to the sub prime crisis. Coupled with this, the Community Reinvestment Act (CRA) has encouraged lending to untrustworthy/non creditworthy consumers. It has been stated that the amendments to CRA in the mid 1990s, raised the amount of home loans to otherwise unqualified low income borrowers and allowed for the securitisation of CRA regulated loans containing sub prime mortgages. The US Department of Housing and Urban Development’s mortgage policies fuelled the trend towards issuing risky loans.
Before 1970s, the US financial sector was highly regulated and stable in which Banks were dominated, deposit rates were controlled and small and medium deposits were guaranteed. The Bank profits were determined by the difference between deposit and lending rates, and banks were restrained from straying into areas such as securities trading and insurance. Infact, this was the concept of “the lend and hold model”. The Banks extended their activity beyond conventional commercial banking into merchant banking and insurance through a holding company and transform themselves in to universal banking with multiple services. Within banking, there was a gradual shift in focus from generating net interest margins to earning fees and commissions for various financial services. The “Lend and Hold” model gives way to “Originate and Sell” model. While banks did provide credit and create assets that promised a stream income in the future, they did not hold those assets any more. Rather they structured them into pools, “securitised” those pools and sold them for a fee to institutional investors and portfolio managers. Those who bought the risk looked into the returns they would earn in the long term. That Banks were no longer museums, but parking lots that served as temporary holding spaces to bundle up assets and sell them to investors looking for long term instruments. Many of these structure products were complex derivatives and it was difficult to assess the risks associated with them. The role of assessing risk was given to private rating agencies, which failed to estimate the risk associated.
Also, the financial liberalization increased the number of layers in financial system, with varying degrees of regulations across each layers. In areas where regulations were quite light like investment banks, hedge funds and private equity firms, the FIs could borrow huge amounts against smaller own capital and issued leveraged investments to create complex products that were often traded over the counter rather than through exchanges.
Finally, while the many layers of the financial structure were seen as independent and were differentially regulated depending on how and from whom they obtained their capital (such as small depositors, pension funds or high net worth individuals). They were in the final analysis integrated in ways that were not always transparent. Banks that sold credit assets to investment banks, and claimed to have transferred the risk, lent to or invested in these investment banks to earn higher returns from their less regulated activities.
Indian economy is also not free from this global phenomenon. Though initially the Government of India have vehemently claimed proper insulation of our economy against any global crisis, of late Mr. Man Mohan Singh, our PM has acknowledged that India is also under the clutches of global melt down. The hectic withdrawal by FIIs has resulted in unparallel crash in sensex, heavy depreciation in rupee value against dollar and significant reduction in FEX reserves. To overcome the situation, RBI has opted for various quantitative measures to infuse liquidity in the financial system. In his strategic meeting with leading industrialists of the country, Mr. Singh sought for their assistance to keep away from employee reduction, contraction of productivity and labour retrenchment. Under such a circumstance, it is quite significant to evaluate the scenario behind the global economic crisis and its aftermath.
I. The US Collapse and its Intensity:
The topography of the Wall Street Banks (WSB) changed radically since September 2008. Bear Sterns, founded in 1923, collapsed and was hastily acquired by J.P. Morgan (JPM). The ailing Bank Washington Mutual was also bought into the fold of JPM. Lehman Brothers, founded in 1850, declared bankruptcy, and was taken over by Barclays Bank. Merrill Lynch, founded in 1914, folded alongside Lehman Brothers, to be picked up by Bank of America. A few days later, American International Group (AIG), founded in 1919, the world’s largest insurance company, went down the slope towards bankruptcy, but was fortunately saved at the eleventh hour by an emergency infusion of $ 85 billion by the US Government. A few weeks later, the Federal Reserve provided an additional loan of almost $ 38 billion to strengthen the ailing insurance giant. The Government sponsored mortgage agencies Fannie Mae and Freddie Mac, created in 1968 and 1970 respectively, retreated from their autonomy in to the embrace of Government. In the mid October 2008, Wells Fargo Bank absorbed Wachovia Bank, founded in 1879. JPM, founded in 1879, and Goldman Sachs, founded in 1869, went from being Investment Banks to become Bank Holding Companies. This turbulence has caused a downward slide and slope for major stock markets across the world and the credit market commenced to seize up. The pulse of electricity now began to make inroads into the confidence of those who hire and fire, who make and break. Things are so bad that General Motors released a statement that “Bankruptcy is not an option” for the Company. The Labour Department, US announced that the country lost 1.59 lacs jobs in September, up from 0.73 lacs jobs lost in August 2008. The Wall Street Journal released its survey of 52 economists who pointed out that things can only go negative. The shifts in US from ardent laizzez faire postulates to nationalization concepts are quite a paradox.
II. SPMC – An Overview:
From late 2002 to mid 2005, the US Federal Reserve funds rate stood at levels that implied that when adjusted for inflation, the real interest rate was negative. Easy access to credit at low interest rates triggered a housing boom, which in turn triggered inflation in housing prices and encouraged more housing investments. From the FY 2001 to FY 2007, the real estate value of households and the corporate sector is estimated to have increased by $ 14.5 trillion.
The SPMC is an ongoing economic problem in US and became more visible during 2007. The situation is characterized by contracted liquidity in the credit market and banking system. Sub prime lending is the practice of extending mortgage loans to borrowers with poor credit history. Higher rate of interest is charged to mitigate the risk factors, viz. poor income level, low credit score, unstable employment status etc. Sensing the opportunity coupled with encouraging interest rate environment, the Banks/FIs expanded the borrower base by inducting sub prime ones or borrowers with low credit ratings and high probability of default, viz. the No Income, No Jobs and Assets (NINJAs). Mortgage borrowers attracted these clients by relaxing income criteria and offered sweeteners like lower interest rate for initial period with reset options. The share of such sub-prime loans in all mortgages rose sharply, from 5% in 2001 to more than 20% by 2007. Borrowers chose to use this “opportunity” because they were not properly informed about their commitments. Also, they were over confident about their ability to meet the repayment obligations.
On the supply side, the complex nature of finance centered on the “Originate and Sell” model. The Banks/FIs discounted the risk because they expected to cash in on large profits even while transferring the risk associated with the investments. The mortgage brokers sought out willing borrowers for a fee, turning to sub prime markets in search of volumes. The Mortgage lenders and Banks financed these mortgages because they wanted to buy the interest and amortization flows associated with such lending. Also, they wanted to sell these instruments too less regulated intermediaries such as the Wall Streets Banks. The Banks, who bought these mortgages, opted to expand their business by bundling assets and sold to institutions, investors, hedge funds and portfolio managers. To suit different tastes for risks, they bundled them into tranches with varying probability of default and differential risk weightage/protection against losses.
The associated risk was rated by approved independent agencies which, not knowing the details of the specific borrowers to whom the original credit was sanctioned, use statistical models to determine which kind of tranche could be rated as being of high, medium or low risk. Once certified, these tranches could be absorbed by Banks, Mutual Funds, pension funds and insurance companies, which could create portfolios involving varying degrees of risk and different streams of future cash flows linked to the original mortgage. Whenever necessary, these institutions could insure against default by turning to the insurance companies and entering into arrangements such as CDSs. Even Government Sponsored Enterprises such as Freddie Mac and Fannie Mae, which were not expected to be involved in or exposed to the sub prime market, had to cave in because they feared they were losing business to new rivals who were tiring to cash in on the boom and poaching on the business of these specialists. Because of this complex chain, institutions at every level assumed that they were not carrying any risk or they were properly insured against.
The problems began with defaults on sub prime loans. In some cases, default occurred before interest rates were reset to higher levels and in others, after the resetting of rates. As the proportion of default grew, the structure gives in and all assets turned illiquid. Rising foreclosures pushed down housing prices as more properties were up for sale. On the other hand, the losses suffered by financial institutions were freezing up credit, resulting in a fall on housing demand. As the housing prices collapsed, the housing equity held by many depreciated and they found themselves paying back loan that were much larger that the value of the assets. Default and foreclosures seemed a better option than remaining trapped in this losing deal.
Since mark to market accounting required taking account of prevailing market prices, many financial firms had to write down the values of the assets they had and take the losses into their balance sheets. But since the market value was unknown, many firms took much smaller write down than warranted. But they could not hold out forever. The extend of the problem was partly revealed when leading Wall Street Bank like Bear Sterns declared that investments in two funds it created linked to Mortgaged Backed Securities (MBS) were worthless. This signaled that many financial institutions were near insolvency. Infact, given the financial integration within and across countries, almost all financial firms in the US and abroad were severely affected. Fear forced firms from lending to each other, affecting their ability to continue with their business to meet short-term cash needs. Insolvency began threatening the best and largest firms. The independent Wall Street investment banks, Bear Sterns, Lehman Brother etc, shut shop or merged into bigger banks or converted themselves into bank holding companies that were subject to stricter regulations. This was seemed as the end of an era in which these independent investment banks epitomized the innovation that financial liberalization had unleashed.
III. SPMC- A Search for Causes:
The Securities and Exchange Commission has conceded that self-regulation of Investment Banks contributed to the crisis. The first thing occurred with the withdrawal of the Glass Steagall Act (GSA), which was passed after the Great Depression in 1930s. The GSA separated the investment activities and commercial banking activities. The Act was repealed in 1999 with the Gramm Leach Bliley Act (GLBA) with liberalization in investment and commercial banking activities. Economist Robert Kuttner has criticized that the repeal of GSA has possibly contributed to the sub prime crisis. Coupled with this, the Community Reinvestment Act (CRA) has encouraged lending to untrustworthy/non creditworthy consumers. It has been stated that the amendments to CRA in the mid 1990s, raised the amount of home loans to otherwise unqualified low income borrowers and allowed for the securitisation of CRA regulated loans containing sub prime mortgages. The US Department of Housing and Urban Development’s mortgage policies fuelled the trend towards issuing risky loans.
Before 1970s, the US financial sector was highly regulated and stable in which Banks were dominated, deposit rates were controlled and small and medium deposits were guaranteed. The Bank profits were determined by the difference between deposit and lending rates, and banks were restrained from straying into areas such as securities trading and insurance. Infact, this was the concept of “the lend and hold model”. The Banks extended their activity beyond conventional commercial banking into merchant banking and insurance through a holding company and transform themselves in to universal banking with multiple services. Within banking, there was a gradual shift in focus from generating net interest margins to earning fees and commissions for various financial services. The “Lend and Hold” model gives way to “Originate and Sell” model. While banks did provide credit and create assets that promised a stream income in the future, they did not hold those assets any more. Rather they structured them into pools, “securitised” those pools and sold them for a fee to institutional investors and portfolio managers. Those who bought the risk looked into the returns they would earn in the long term. That Banks were no longer museums, but parking lots that served as temporary holding spaces to bundle up assets and sell them to investors looking for long term instruments. Many of these structure products were complex derivatives and it was difficult to assess the risks associated with them. The role of assessing risk was given to private rating agencies, which failed to estimate the risk associated.
Also, the financial liberalization increased the number of layers in financial system, with varying degrees of regulations across each layers. In areas where regulations were quite light like investment banks, hedge funds and private equity firms, the FIs could borrow huge amounts against smaller own capital and issued leveraged investments to create complex products that were often traded over the counter rather than through exchanges.
Finally, while the many layers of the financial structure were seen as independent and were differentially regulated depending on how and from whom they obtained their capital (such as small depositors, pension funds or high net worth individuals). They were in the final analysis integrated in ways that were not always transparent. Banks that sold credit assets to investment banks, and claimed to have transferred the risk, lent to or invested in these investment banks to earn higher returns from their less regulated activities.
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