A Peek into
Volume 3 / Issue 4
An Introduction to Financial
Engineering and Risk Management
Related Party Transactions - Training for CBI Officers on
Cautionary Tales for ‘Investigation of
Investors & Analysts Capital Markets Fraud’
P rogress made in finance theory, applied mathematics and computer
science are acting as drivers for financial engineering - a multidisciplinary
field that fosters financial product innovation. However, if regulation lags
behind financial innovation, which may be possible, there could be risk. We can
neither stifle innovation nor let unbridled innovation hurt the markets. Hence
the policy makers and regulators have a tough job finding the fine balance
between innovation and market safety.
In this Issue of NISM we touch upon this subject starting from the very basic
concept of financial engineering and also draw attention to a specialized
program on financial engineering and risk management offered by NISM.
We also cover two post-event updates:
Related Party Transactions - Cautionary Tales for Investors & Analysts.
An event organized by NISM in association with the CFA Institute, USA and
Indian Association of Investment Professionals (IAIP) on Thursday, October 28,
Training for CBI Officers on ‘Investigation of Capital Markets Fraud’. This was
a two-day training programme (18-19 October, 2010) conducted by NISM for
the officers of CBI.
We have lined up a distinguished set of speakers for the India Investment
Management Conference that will be organized in association with the CFA
Institute-USA and IAIP. The event is scheduled for January 7, 2011 and early
bird registration discount of 20% is available till November 30, 2010.
The first batch of NISM’s one-year, residential, full-time, post-graduate
programme – Certified Securities Markets Professional (CSMP 2010-2011) is
progressing well. We share a short note written by one of the students on life in
and around the NISM Campus at Vashi, Navi Mumbai.
We hope that you find the NISM Update useful and informative. Please send
your feedback and suggestions to firstname.lastname@example.org
NISM UPDATE Team
NATIONAL INSTITUTE OF SECURITIES MARKETS
NISM Bhavan, Plot No. 82, Sector - 17,
Vashi, Navi Mumbai - 400 705
Phone: +91- 022-66735100-106 | Fax: 022-66735110
2 NiSM November 2010
Related Party Transactions - Training for CBI Officers on
Cautionary Tales for Investors & Analysts ‘Investigation of Capital Markets Fraud’
An event titled “Related Party Transactions” was NISM conducted a two-day training programme for CBI
conducted by the CFA Institute, USA, Indian Association of officers on ‘Investigation of Capital Markets Fraud’ at CBI
Investment Professionals (IAIP) and NISM in Mumbai. The Academy, Ghaziabad during 18-19 October, 2010. The
event on Thursday, October 28, 2010 was hosted by the programme was inaugurated by Shri Sujeet Pandey, IPS,
National Stock Exchange in its auditorium at Bandra Kurla DIG (Training) and Prof. G. Sethu, OSD In-Charge of NISM.
Shri Sujeet Pandey, during the inaugural address,
Mr Vidhu Shekhar of NSE, set the ball rolling, followed by emphasized the importance of understanding the
two excellent presentations from Mr. Lee Kah Lun (Head, magnitude and complexity of economic crimes and its
Asia Pacific: Standards and Financial Market Integrity, CFA cascading effect on various intermediaries associated with
Institute) and Mr David Smith (Co-Head, Asia Corporate the securities markets.
Governance Research, Institutional Shareholder Services).
Mr Lee provided glimpses of his vast experience on the Based on a series of discussions with senior officials at SEBI
subject with illustrations from China, Hong Kong, and enforcement agencies, the programme was structured
Malaysia, Indonesia, India and other parts of Asia. Mr to sensitize the participants to various capital markets
Smith explained the technicalities of RPT and how some of operations and issues related to investigation of capital
the transactions are abusive while others are not. Abusive market crimes. During the first day of the programme,
RPTs are the bane of free market enterprise. Mechanisms sessions were arranged to provide an overview of the
for empowering small retail investors were also discussed. financial and regulatory system in the capital markets,
primary and secondary market activities and
This was followed by a panel discussion in which the understanding of the various intermediaries in the
speakers were joined by Ms Fianna Jesover (Corporate securities markets. The second day sessions emphasized
Affairs Division, OECD Directorate for Financial and on the regulatory role of SEBI and the surveillance and risk
Enterprise Affairs). Ms Jessover provided the OECD management practices adopted by SEBI. The sessions
context, and also added to the experience-sharing further highlighted operations by the Stock Exchanges as
discussion. The panel was ably moderated by Mr Navneet first line regulators in the securities markets. Technical
Munot of SBI Mutual Fund. This was followed by a lively sessions on derivatives and the role of FIIs, the activities
question & answer session, where the questions were of and crimes in securities markets were also held.
consistently high quality.
The valedictory session was addressed by Dr. Pradnya
The key takeaway from the event was that fair disclosure in Sarvade, ED, SEBI, who highlighted the role of enforcement
the true spirit of corporate governance and vigilance agencies in preventing securities market crimes and the
exercised by independent directors are the key to road ahead. The programme was well received by 25 CBI
protecting shareholders’ interest. In the long run, well Officers in the rank of Addl. SP, Dy. SP, Inspectors and Bank
governed corporations gain the trust of shareholders and Officers on deputation to CBI.
enjoy access to capital markets to realize their business
November 2010 NiSM 3
Financial Engineering and Risk Management
Prof. G Sethu – Officer on Special Duty, NISM
A financial product is a package of cash flows.
Small pieces of cash flow streams are
assembled together to make a product. Different
time and sought regular assured cash flows by way of
interest payments and principal repayment. The
promoter divided the claims on the future cash flows
ways of packaging creates different financial expected to be generated by the firm into two parts:
products. The art and science of this task is called one, a fixed assured cash flow stream; the other a
financial engineering. residual cash flow stream that could be high if the
firm did well and low or nil if the firm did not do well.
Consider the earliest form of financial engineering. A He sold the first as firm’s debt and the residual cash
promoter wanted to raise money to finance a flow stream as firm’s equity. The firm’s cash flows
business enterprise. He approached people asking were parceled out as two financial products, debt
them to contribute to the firm’s capital. He came and equity. In terms of seniority of claim on the firm’s
across two types of people: one kind who were cash flows, debt came first and equity came next.
prepared to take risk, commit funds forever and This is financial engineering. It was a win-win
sought dividends; the other kind who did not want to situation for the firm, debt holders and equity
take risk, were willing to commit funds for a limited holders. Thus financial engineering created choices
4 NiSM November 2010
that met a wider range of customer choice. When large amounts are
required to be raised, no one segment of investors is adequate. Through
financial engineering, we create layers of claims on the firm’s cash flows,
some senior and some subordinate claims. The game can get quite complex
and some of the subordinate layers can get very risky.
As we are only repackaging a given cash flow stream, the risk of the package
cannot be different from the risk of the underlying cash flow. It is a zero sum
Unless we are able to assess the value of cash flow streams, we would be
unable to create the equivalence between the cash flow streams that are
being exchanged. As finance theory improves, the asset pricing models
(including option pricing models) become better. In certain cases, complex
mathematics and computer programming are required to work out asset
prices. Progress made in finance theory, applied mathematics and computer
science act as drivers for financial engineering. That is why financial
engineering is a multidisciplinary field. Needless to say, financial engineering
fosters financial product innovation.
Modern world offers more choices to people. Awareness and education
equips people to make the right choices from the ever increasing choices.
Would we say that the modern world is risky? We could look at financial
engineering the same way. Is financial engineering adding to the risk of the
financial system? Financial engineering only redistributes the risk while
offering a wider menu of financial choices to investors. Some buyers prefer
more risk and some prefer less risk. The problem arises when the high risk
layer is sold to uninformed persons who aren’t able to evaluate or
understand the high risk they are taking.
It could also be a case that different financial products need to be regulated
differently. If regulation lags behind financial innovation, which may be
possible, there could be risk. The solution is neither to stifle innovation nor
let unbridled innovation hurt the markets. Policy makers and regulators have
a tough job finding the fine balance between innovation and market safety.
NISM, through its School for Securities Education (SSE), offers a certificate
programme in the field of Financial Engineering and Risk Management. It is a
specialized programme that combines the teaching of high-level
quantitative financial economics, advanced mathematics, complex
modelling and computer science. NISM's "Certificate in Financial
Engineering and Risk Management (CFERM)" programme provides the right
blend of theory and applications, addressing context as well as content. The
objective of this Programme is to match the right talent with the experienced
theoreticians and practitioners and serve the financial markets with a batch
of well-trained financial engineers.
November 2010 NiSM 5
CFERM programme is an executive certificate programme in financial
engineering and risk management. It has been designed for working
professionals in treasury and risk management functions who cannot attend
After successful completion of the programme, the participants would have
acquired requisite knowledge to:
Design and understand new financial products and financial solutions
?treasury more effectively
Implement financial solutions for banks, corporate and other entities in
the financial sector
? evaluate the various financial engineering and risk
management solutions offered in the market
?risk management issues at strategic and operational levels
Understand New Manage Treasury
Financial Products more Effectively
Address Risk Implement
Management issues Financial Solutions
at Strategic and for BFSI Sector
For for information on CFERM programme, write to email@example.com
6 NiSM November 2010
Student Life in and around the NISM
Campus at Vashi
Tapabrata Neogi – Student of CSMP 2010-2011
H ome to new age Securities Markets
Professionals, NISM’s Certified Securities
Markets Professional programme focuses on all
the classrooms of the institute. The mundane
necessities that any academic life can bring about is
replaced by no nonsense approach towards
round development of students with focus on professional learning through guidance that is of
surprise quizzes, assignments, and final exams. Life, high standards.
therefore, is focused on meeting assignment
deadlines and being ready for surprise quizzes. The NISM and its hostel are located at a great location in
element of surprise being quite high, there are many Vashi with malls, parks, fitness centers, and host of
sleep-deprived days that develops capability to other facilities around that offer students enough
develop financial solutions and understand financial avenues for recreation. Definitely, there is no time to
markets in a holistic manner. slack-off because the approach of the programme is
nothing less than avant-garde allowing students to
In fact, holidays turn out to be fun-filled days with focus on their career aspirations in a much bigger
movies, cricket, badminton, discussions in the way than might have been possible otherwise.
canteen and trips to places like Pune, Lonavala, or
Khandala. We at NISM manage to get hold of our After so much hard work, the fun simply doubles up
own share of fun celebrating events like during holidays, birthday parties, or festivals as
Independence Day, Ganesh Chaturthi, Navratri, students bring out their distinctive characteristics
Diwali and all other festivals. Rigor of the course and talent to make time more enjoyable for
brings out the best in us as we run around trying to everyone in the batch. The whole programme is
complete tasks given by faculty members and doing enriching with huge amount of opportunity for
our best in the time available. personal growth and career focused initiative.
Birthday parties of batch-mates turn out to be huge In a sense, life at National Institute of Securities
celebrations with entire batch participating in the Markets is a journey of a lifetime, sure to bring out
event to make it memorable as always. Perhaps this well-rounded and competent professionals to face
is what life should be all about with professionalism challenges of Securities Markets in the future.
mixed with equal share of fun. Study trips to places Learning to innovate and living with fun is intimately
like BSE, NSE and MCX provide great exposure that intertwined at NISM.
focuses on strong applications of theories learnt in
November 2010 NiSM 7
2011 India Investment
What's Next after the Recovery?
DATE 7 January 2011 VENUE Grand Hyatt Mumbai
7 Mumbai, India
FEES CFA Institute Members, IAIP Members, NISM
Graduates (CFERM/CSMP program)
Rate: INR 8,400
CFA Institute Candidates /NISM Students
Rate: INR 9,450
Register b r
Non-member Rate: INR 10,500
Save 30 Novem
For Registration, Visit: www.nism.ac.in/cfa
Contact: firstname.lastname@example.org |+91 22 66735100-06