Question bankrupt company. Inability to meet the short-term liabilities

Question 1: What is
liquidity and why is it important?

 

The definition of
liquidity is the company are able to meet up the short-term liability or
obligations. Also, liquidity occur when the company able to convert financial
assets or assets into cash. Financial asset is a tangible liquid asset that evolve value because
of a constitutional claim of what it represents. For example, stocks, bonds,
bank deposits and others. Generally, short-term represent obligations which
mature within one accounting year. The operating cycle which is buying,
manufacturing, selling, and collecting are the reflects of short term. Liquid
assets also those that can access instantaneously. There are some cases cash
can be somewhat illiquid. This somewhat related about a certificate of deposit.
The money is tied up for a set period of time with a certificate
of deposit. This process cannot access it early without obtain burden
penalties.

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A company that
cannot pay its creditors on time and continue not to satisfy its obligations to
the suppliers of credit, services, and goods can be declared a suffering
company or bankrupt company. Inability to meet the short-term liabilities may
affect the company’s operations. Due to this it may affect the company’s
reputation. Shortage of cash or liquid assets on hand may push a company to
miss the encouragement given by the suppliers of credit, services, and goods.
Greater cost of goods which would affect the profitability of the business that
may result from loss of encouragement from the suppliers of
credit, services, and goods. Therefore, there is always essential for the
company to maintain certain level of liquidity. Despite of that, there is no
standard benchmark for liquidity. It depends on the nature of the business,
scale of operations, location of the business and other factors.

Liquidity is also
important because it is attribute of any exchange. Also, by increasing the
stock’s market depth liquidity, it helps in the arrangement of improved prices.
In order to make markets more efficient and to diminish arbitrage
opportunities, liquidity is necessary. When market offered and provide such an
environment, investors able to conduct risks and to make acquainted decisions
for exchange execution. There is a positive relationship between trading
activity and liquidity. Generally, a market with good liquidity develop an
ecosystem where trading activity could embellishment, which could occur only
positive effects. Similarly, high trading costs and took time for order
execution are the lack of liquidity led.

Whenever the
company have liquid assets, it can get to them quickly, and use them easily.
For example, when a company have a portion of emergency fund in a high-yield
savings account that it can access faster, a greater share of emergency assets
is actually in a taxable investment account. The company have the money
invested in Exchange Traded Funds which is the trade like stocks on exchanges
and can be more liquid than mutual funds where it depends on distribution and
other factors. It takes a few days to receive the money in bank account when
the company have to sell something for an emergency purchase. However, the even
more liquid assets the company have can usually cover during the break in time.

The liquidity
position of a company has gain interest from every stakeholder. Also, the
liquidity of the company before selling goods on credit will check by the
supplier of goods. In addition, employees also have interest in the liquidity
to recognize whether the company can meet its employees’ associated obligations
such as salary, pension, provident fund and others. Usually, shareholders are
engrossed in understanding the liquidity due to its greater impact on the
profitability. Shareholders also could dislike greater liquidity as
profitability and liquidity are inversely related. However, shareholders are
also wise that non-liquidity will strip the company from getting encouragement
from the suppliers, creditors, and bankers.

 

Question 2: What factors
affect liquidity?

         

          First of all, Bombay Stock Exchange
(BSE) started publishing the Bombay Stock Exchange Sensitive Index (SENSEX) in
1986. This free-float and market-weighted stock market index included 30
well-established and financially sound companies that are listed on the BSE.
Next, Bombay Stock Exchange was a virtual monopoly until 1992, when the
establishment of the National Stock Exchange of India (NSE) have severely
affected Bombay Stock Exchange’s market share and compelled the introduction of
an electronic trading systemic 1995.

          After that, stock markets had always
played a pivotal role in any economy because they provided a platform for
businesses to raise capital and for investors to trade in financial securities.
For this reason, a country’s stock market needed to be robust and liquid.
Similar to India’s growing economy resulted in an unprecedented increase in the
variety and number of financial products and services in the market.

          Moreover, the National Stock Exchange
(NSE) was established in 1992 and started operations in 1994. Predictably, the
NSE, which had online trading facilities from day one, slowly started reducing
the BSE’s monopoly in the equities segment. Then, as a strategy to innovate and
offer new products, the NSE soon started insisting on the need for derivatives.
Therefore, the BSE was accustomed to badla
trading, and hence, opposed derivatives.

          Furthermore,
the ingenious and innovative badla trading had been introduced to increase liquidity in the
Indian secondary markets. This approach essentially meant that all transactions
would be settled (the delivery of shares and the payment of cash) in the
future, which is similar to a forward or a futures transaction.

          As derivatives were finally introduced in 2000 and in 2001,
following a major scam on the stock exchanges, the badla system was banned. Meanwhile, the BSE had not been prepared
for this move. Although derivatives were introduced simultaneously on both the
NSE and the BSE. As a result, the BSE had clearly missed a big opportunity.
Slowly, the BSE’s market share in the cash segment began to slip away, as most
traders preferred to trade both derivatives and equities on the same exchange.

          Alternatively,
to enable the Indian stock exchanges to improve liquidity in illiquid
securities, the Securities and Exchange Board of India (SEBI) has permitted
stock exchanges to introduce Liquidity Enhancement Schemes for illiquid
securities in their equity derivatives segment, which were similar to the
payments for order-flow arrangements globally. Next, Liquidity Enhancement
Intensive Programmes (LEIPS) also affect the liquidity.

          Lastly, derivatives liquidity enhancement programme takes
toll on BSE profit. However, the scheme still had inflicted a negative impact
on the exchange’s financial performance. Thus, it added that the BSE had
witnessed a sharp decline in its profitability as a quick glance at the BSE’s
quarterly income statements confirmed this decline. Subsequently, market share
or profitability was the dilemma. As a lower market share would mean reduced
liquidity. Reduced liquidity can make the market share decrease.

 

Question 3: Discuss
the impact of Liquidity Enhancement Incentive Programmes (LEIPs) on Bombay Stock
Exchange (BSE) and National Stock Exchange (NSE).

 

In
June 2011, the Securities and Exchange Board of India (SEBI) allows the stock
exchanges to introduced Liquidity Enhancement Incentive Programmes (LEIPs). The
LEIPs will helped to boost their liquidity for illiquid securities in their
equity derivatives segment. Stock exchanges will encourage market contribution
to trade in the illiquid segments with the acceptance of Liquidity Enhancement
Schemes.

For
the Bombay Stock Exchange (BSE), Liquidity Enhancement Schemes indicate that
the stock exchanges could directly pay market contributors to involve in
trading of its equity derivatives segment. With the fact that the liquidity was
an important contributor to any stock market, the BSE response with launching a
series of Liquidity Enhancement Incentive Programmes (LEIPs) to assured its
future. The first series of LEIPs of BSE start with LEIPs-I at Sept. 28, 2011
where the first period only takes 27 days which is end at Oct. 25, 2011. Then
the LEIPs-II start at the next day, Oct. 26, 2011 and remain 6 months. After
that the series continue launching until LEIPs-IX where it ends at July 31,
2013. The period of each series mainly takes 6 months which is the maximum
period of the series. The goal of launching a series of LEIPs is to produce long-term,
self-sustaining liquidity in the Bombay Stock Exchange’s Future and Option
Segment to preserve their liquidity.

The
first series of LEIPs (LEIPs-I) start with maximum 10 contracts. Each member
required to at least pay 5,000 Indian Rupee where half of the payment goes to
future contract and the other contributes in option contracts. After that,
LEIPs-II, they expand the maximum payout to 10 contracts per trade for future
and 200 contracts for option. The total incentives are increasing to 1.02
billion or 170 million every month. Then, to obtain largest participant,
LEIPs-III is introduced as it is focused on options market, SENSEX. The market
shares of LEIPs’ series continue increasing followed with their liquidity as
they focused more on their objectives for every series that they launched.

In
February 2013, the liquidity enhancement schemes issued by Securities and
Exchange Board of India (SEBI) allowed exchanges to introduce this scheme in
the cash segment. By this option, they can achieve market share in the equity
segment as a derivative segment.

From
derivative segment, the Liquidity Enhancement Incentive Programmes (LEIPs) not
only provide an efficient effect towards market but also bring a negative
effect towards Bombay Stock Exchange’s profit. Through all the series of LEIPs
in derivatives segment, it is effectively increase the BSE’s market share.
LEIPs have proof that through LEIPs, BSE succeeded in obtaining a certain of
market share from the NSE through LEIPs-VI. LEIPs-VI is concentrated on BSE-100
index which created to compete against the NSE’s NIFTY 50-company index.
However, owing the incentive paid out, it is decreasing the profitability since
it takes advantage on BSE’s profit. Similar to the LEIPs in the cash segment as
it is increase the market share in the equity segment.

The
liquidity enhancement scheme resulted in impose a bad impact towards the
financial performance of exchange. From The Bombay Stock Exchange quarterly
income statement of June 2011 to September 2012 it is clearly stated a sharp
decrease in the profit. The highest profit they gain is during the first
quarter June 30, 2011 where the profit before tax is 900.19 million Indian
Rupee. The profit start declined from June 30, 2011 until June 30, 2012. The
profit gain during June 20, 2012 shows the lowest profit gain which is 311.80
million Indian Rupee. This is because the expenditure involve under LEIPs is
high during 2012 as stated in BSE’s financial statement. The expenditure under
LEIPs which stated as “Exceptional Items” in the financial statement, reduce
the profit of BSE. It is obviously shows a sharp declined of the BSE’s
profitability.

Hence,
the Liquidity Enhancement Incentive Programmes (LEIPs) gives both positive and
negative impact. The series of LEIPs helped BSE to gain market share by expand
their futures and option contracts and gain some market share from NSE which
resulted in decreasing of NSE. However, LEIPs also ignored the profitability of
the BSE as stated in the quarterly financial statements of the Bombay Stock
Exchange for financial years 2011 until 2013.

 

Question 4: Discuss the
viability of continuing with LEIPs if the BSE were to be publicly listed.

           

            Bombay
Stock Exchange (BSE) has been introduce in the Indian business. Every Indian
corporate worth its salt has tapped the Indian capital market through the
exchange, and every major company has its shares listed on the BSE. A listing
on the BSE was like “holy grail” in the Indian corporate and business world.
BSE has been pioneered various innovations into the Indian capital market. Moreover,
BSE has been introducing transparency and successful-investors friendliness in
the trading of various instruments such as stocks, derivatives and debt
instruments. Besides that, The Bombay Stock Exchange is the oldest stock
exchange in Asia, and monopoly in India until 1994 until National Stock
Exchange was launched. Almost, nine months after the BSE launched a market-
making scheme in the equity derivatives segment, its share in the latter has
growth about 20-22 per cent. This is on the back of a rise in the number of
broker participants trading on the exchange, due to various incentives extended
to them.

It BSE need to be listed they must have some
resources or strategies that can exploit opportunities and defend the company
from major threats. Resources is valuable if they want to increase customer
satisfaction and customer value. But if the company not reach that, the company
may lead to competitive disadvantage. It is necessary to continually review the
Bombay Stock Exchange Liquidity Enhancement Incentive Programmers company’s
activities. It also the opportunities to BSE to increase the value of company
because the Liquidity Enhancement Incentive Programmers company that are not
used by any other company are known as rare because it just introduced. Rare
and valuable resources grant much competitive advantages to the firm, but
create a few companies when they used the same resources and provide competitive
and also as the rare resources. Even, the competitive parity is not desired
position, but the company should not lose its valuable resources to still alive
in industry.

 

Question 5: Compare and contrast LIEPs with
cream-skimming in the United States.

Liquidity Enhancement Incentive Programmes
(LEIPs) and cream-skimming are both involved in trading activity in the market.

LEIPs are launch by Bombay Stock Exchange
(BSE) in order to secure its future with goals of creating lasting and
self-sustaining liquidity in BSE’s Equity Derivatives Segment.

While the cream-skimming is an analogy used
to refer to a situation where the company only entertain the high-value or
low-cost customers and ignore those customers that have low profitability. This
is being practice by the financial industries at over-the-counter (OTC)
markets.

 

 

i)                  
Members
/ participants

The LEIPs program required the members of BSE
to register either as the general market participants (GMPs) or as market
makers (MMs). After they registered, they were required to trade a minimum
number of times to be eligible for the incentive.

While for the cream-skimming, can be done by
any financial industries and normally these cream-skimmers will try to capture
the most profitable portion of the market for a product and may restrict
themselves to large volume customers only because of the transaction costs are
lower than dealing with smaller volume customers or individuals.

ii)                
Items
traded

The LEIPs is the place where enable the BSE
participants to trade in the illiquid segments of their products offering.
Through this, BSE could pay the market participants directly to trade in its
equity derivatives segment.

In the other hand, the cream-skimming which
happen in OTC markets enable the financial industries to trade assets. This
trading required the information about the underlying assets quality and
valuation skills. The informed dealers in the OTC markets are better to be able
to determine the assets value for sale so they can cream-skimmed the most
valuable assets.

iii)              
Incentive

LEIPs provide their participants with four
types of incentives which is volume-based cash incentives, lower transactions fees,
open-interest cash incentives and obligation-based cash incentives. However,
the cream-skimming does not provide any incentive to its participants that
practice it.