IGNOU MBA MS-03 Solved Assignment January 2012

Course Code                                      :           MS-3

Course Title                                       :           Economic and Social Environment

Assignment Code                              :           MS-3/TMA/SEM-I/2012

Coverage                                            :           All Blocks

Note : Answer all the questions and submit this assignment on or before April 30, 2012, to the coordinator of your study center.

                                                                                                    

1. What are the important laws related to the functioning and operation of capital markets in India? Briefly Discuss.

Solution: Laws related to the functioning and operation of capital markets in India

1. Public offerings.

A new regime is being established for IPOs by insurance companies. Rather than issue a new set of guidelines for that industry, SEBI has decided to apply the ICDR Regulations, 2009 along with additional industry-specific disclosures such as specific risk factors, overview of the insurance industry and a glossary of terms. Other changes in public offering norms include enhancement of a maximum application size for retail individual investors to Rs. 2 lakhs across all issues, the introduction of mandatory pro forma financial statements for issuer companies that have undergone a merger or restructuring after the last disclosed financial statements and the removal of a requirement for minimum promoters’ contribution in a further public offering (FPO).

In progressively addressing issues of gun-jumping, SEBI now requires investment banks to submit a compliance certificate “as to whether the contents of the news reports that appear after the filing of the [draft offer document] are supported by disclosures in offer document or not”. An item which is noteworthy is the reference to news reports appearing in media where the issuer has a private treaty with such media group. This will ensure that the securities are sold pursuant to the offer document, which constitutes the single source of information for marketing purpose as also for legal consequences (such as liability of misrepresentation).

2. Preferential Issues

In a measure that tightens restrictions on issue of securities to promoters, SEBI has provided that promoters (or promoter group) are ineligible to receive equity shares, convertible securities or warrants for a period of one year if they have failed to exercise previously issued warrants. This will operate as a disincentive against issue of warrants to promoters and promoter group, and further curb the misuse of warrants. For a previous discussion on regulation of such warrants, see here and here).

3. Rights Issue for IDRs

SEBI has proposed a new framework for rights issues for foreign companies that have outstanding Indian depository receipts (IDRs). Issuers are required to circulate a wrap document that contains information specific to IDR holders. The level disclosures will be similar to that expected in a rights issue by an Indian company. On a related note, the IDR holders of Standard Chartered were faced with certain legal and regulatory issues regarding their ability to participate in the bank’s recent rights offering, and it is hoped that the new regulatory framework will iron out those issues.

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2. Describe the situation in which large and small firms would be more efficient with respect to size of Industrial units.

Solution: Most empirical findings suggest that small and medium-sized firms, rather than

large firms, conduct R&D more efficiently. Also small firms and independent

inventors are disproportionately responsible for significant innovations. This is in close agreement with the conclusion by Vossen (1996) that smaller firms are more profit/cost efficient in innovation. There are however other, complementary explanations for the empirical finding that small firms have much more innovative output than one would expect on the basis of their innovative input. First, small firm R&D tends to be underestimated in many standard surveys, because mainly formal R&D, conducted in separate R&Ddepartments is measured (Kleinknecht and Reijnen, 1991). Moreover, studies of the different components of innovation costs indicate that larger firms have higher7 shares of R&D in total innovation costs than smaller firms (Archibugi, Evangelista and Simonetti, 1995; Felder, Licht, Nerlinger and Stahl, 1996), so that

independently from the way it is measured, R&D would underestimate the

innovative input of smaller firms. Second, the results of Acs, Audretsch and

Feldman (1994) indicate that small firms more effectively take advantage of

knowledge spillovers from corporate R&D laboratories and universities. And third,

the economic value of innovations may differ between smaller and larger firms, as

suggested by Cohen and Klepper (1992), who find theoretically that under certain

stochastic conditions, larger firms will produce fewer innovations per dollar spent

on R&D, but their innovations will be on average of a higher quality.

From the stylized fact that smaller firms produce more innovations than one would

expect on the basis of their input, Zenger (1994) concludes that apparently

organizational diseconomies of scale outweigh the technological economies of

scale in R&D. The aforementioned explanations and the organizational

characteristics related to size mentioned in the last paragraph suggest however, that

it is not either small firms or large firms which are the better innovators per se. Instead, small and large firms are probably good at different types of innovation, or

their roles vary over the industry cycle in a "dynamic complementary" (Cf.

Nooteboom, 1994). Large firms are probably better at the kind of innovations that

make use of economies of scale and scope, or require large teams of specialists,

such as fundamental, science based innovations and large scale applications, which

are probably also the innovations with higher average economic value (Cf. Cohen

& Klepper, 1992). Small firms are likely to be relatively strong in innovations

where effects of scale are not (yet) important and where they can make use of their

flexibility and proximity to market demand, such as new products or productmarket combinations, modifications to existing products for niche markets, and

small-scale applications. Moreover, the small firms' efficiency in producing these

kinds of innovations is enhanced by their ability to take advantage of knowledge

spillovers from large firms' corporate R&D departments (Cf. Acs, Audretsch and

Feldman, 1994).

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3. Assess Industrial Policy of 1956 and explain how Schedule A, B, and C are different from one another.

Solution: Coming soon !!!

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4. Analyze the first three phases of Foreign Trade Regime, in the process of economic development.

Solution: These phases in the  foreign trade regime were designed essentially as a classificatory and descriptive  device to capture meaningfully the evolution of foreign trade regime in terms of its  restrictionist content and the dimensions and patterns of its use of control  and price instruments. There are broadly five phases which are as follows :

Phase I: Characterised by the systematic and significant imposition of quantitative

restrictions (QR). It might start in-response to an unsustainable balance of payments

deficit.  Throughout Phase I, controls are generally maintained and often intensified. 

Phase II: Characterised by continued reliance upon quantitative restrictions and

generally increased restrictiveness of the entire control system.

Phase II is distinguished by two additional and related aspects of the QR system, both relatively  unimportant during Phase I:  The detailed workings of the control system become increasingly complex, and  Price measures are adopted to buttress the functioning of the control system.  Both these characteristics of Phase II arise from dissatisfaction with the results of an  undifferentiated system and are often the result of many small decisions rather than  an overall policy design.  Price measures are introduced to both exports and imports. The continuation or  intensification of foreign exchange shortage leads to the recognition that additional export earnings would be desirable. Rebate schemes, import replenishment schemes,  special credits for exporters, and a variety  of other devices may be instituted that offset part or all the discrimination against exports implicit in an overvalued exchange rate. As for imports, price measures are also adopted to absorb part of the excess demand for imports. Tariffs may be increased or surcharges added to the cost  of importing.  The following aspects of the price situation in Phase II are then evident: (1) the exchange parity is overlaid by tariffs and subsidies, levied in lieu of formal parity change, (2) domestic currency is overvalued at the current parity plus trade tariffs and  subsidies, implying a premium on imports.

Phase III: In this phase, attempts are made to systematize the change introduced

during the previous phase. It may consist of a mere "tidying-up" operation directed at

replacing the diverse import premiums by reasonably uniform tariffs such that the

differential incentive effects caused by diverse premiums on different imports are

greatly reduced or virtually eliminated. Alternatively, the tidying-up operations may replace the existing tariffs and export subsidies with a formal parity change, the result being that the effective exchange rates on exports and imports do not change much but the dispersion of tariffs is replaced by uniform devaluation. On the other hand, Phase III may take the form of a devaluation cum liberalization package. Such a package may have a gross devaluation large enough to leave a net devaluation despite the removal of trade tariffs and subsidies, and measure of import liberalization.

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5. What does the Quantity Theory of Money (QTM) imply? Also identify two principal purposes for holding money.

Solution: The quantity theory of money states that there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold. According to QTM, if the amount of money in an economy doubles, price levels also double, causing inflation (the percentage rate at which the level of prices is rising in an economy). The consumer therefore pays twice as much for the same amount of the good or service.  Another way to understand this theory is to recognize that money is like any other commodity: increases in its supply decrease marginal value (the buying capacity of one unit of currency). So an increase in money supply causes prices to rise (inflation) as they compensate for the decrease in money’s marginal value.

The Theory’s Calculations

In its simplest form, the theory is expressed as:

MV = PT (the Fisher Equation)

Each variable denotes the following:

M = Money Supply

V = Velocity of Circulation (the number of times money changes hands)

P = Average Price Level

T = Volume of Transactions of Goods and Services

The original theory was considered orthodox among 17th century classical economists and was overhauled by 20th-century economists Irving Fisher, who formulated the above equation, and Milton Friedman. (For more on this important economist, see Free Market Maven: Milton Friedman.) It is built on the principle of "equation of exchange":

Amount of Money x Velocity of Circulation = Total Spending

Thus if an economy has US$3, and those $3 were spent five times in a month, total spending for the month would be $15.

*Two Principal Purposes for holding money.

Perhaps the best explanation for holding cash in a portfolio was summarized by John Maynard Keynes, after which Keynesian economics or Keynesian Theory is named.  Keynesian economic theory states that both the state (government) and private sectors play an important role in the health of an economy.  In particular, Keynes also spoke about the importance of cash.

Motives for Holding Money:

In his publication on The General Theory of Employment, Interest, & Money, Keynes outlined three reasons, or motives, for holding money or cash:

Transaction Motive - cash is held to pay for goods or services.  It is useful for conducting our everyday transactions or purchases.

Precautionary Motive - cash is a relatively safe investment.  Cash investments rarely lose value (as can stocks or bonds) and are therefore held for safety reasons in a balanced portfolio.

Asset or Speculative Motive - cash investments provide a return to their holders.

There can be many variations on the reasons mentioned above, but these three reasons are perhaps the best overall explanation as to why cash plays an important role in any investor's portfolio. At a very practical level, we own cash investments to pay for our daily or monthly expenses.  At a more strategic level, cash provides an investor with a way to control risk as well as gain a return on their investment.

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1. Write short  notes on the following:-

a)                  Economic Development

Solution: Economic development generally refers to the sustained, concerted actions of policymakers and communities that promote the standard of living and economic health of a specific area. Such actions can involve multiple areas including development of human capital, critical infrastructure, regional competitiveness, environmental sustainability, social inclusion, health, safety, literacy, and other initiatives. Economic development differs from economic growth. Whereas economic development is a policy intervention endeavor with aims of economic and social well-being of people, economic growth is a phenomenon of market productivity and rise in GDP. Consequently, as economist Amartya Sen points out: “economic growth is one aspect of the process of economic development.

Economic development has evolved into a professional industry of highly specialized practitioners. The practitioners have two key roles: one is to provide leadership in policy-making, and the other is to administer policy, programs, and projects. Economic development practitioners generally work in public offices on the state, regional, or municipal level, or in public-private partnerships organizations that may be partially funded by local, regional, state, or federal tax money. These economic development organizations (EDO's) function as individual entities and in some cases as departments of local governments. Their role is to seek out new economic opportunities and retain their existing business wealth.

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b)     Administered Prices

Solution: An administered price is in general a price which is either set (fixed) by legal statute or by a standard procedure formulated as an official policy, instead of being determined directly by supply costs and market demand. Even if supply and demand conditions change, the administered price may therefore stay the same, or it may change in the opposite direction - if e.g. demand falls, the administered price is kept the same or raised, to subsidize the supplier and protect his income, or alternatively the price is kept constant to protect the consumer/purchaser. Price controls can specify a price ceiling (the upper limit of price) and a price floor (the minimum amount that can be charged for a good or service). Administered prices stabilize the costs of commodities such as sugar, staple foods, goods, and interest rates and fees, according to acceptable standards. When supply and demand for the good change, the administered price may change to subsidize the supplier or protect the consumer.

Examples of administered prices included price controls and rent controls. Administered prices are often imposed to maintain the affordability of certain goods and to prevent price gouging during periods of shortages (such as gas prices). Rent controls are intended to stabilize rent in certain cities, where rents are reviewed by a standard of reasonableness.

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