Archive for November, 2017

In efficient financial markets, all hedging devices should be perfect substitutes!

In general, alternative hedging devices are reasonably good substitutes for one another. However this statement is not quite true for at least three reasons:

(1) Not all hedging instruments convey the same rights and obligations. For example, a forward contract commits the parties to go through with the transaction while an option gives the choice of whether to proceed to the option holder.

(2) Not all hedging devices are taxed the same way.

(3) Money market hedges appear on the balance sheet as assets and offsetting liabilities while derivative securities do not.

Be the first to comment - What do you think?

How does a derivative security work as a hedging device?

Financial managers can use a derivative security to hedge the asset to which the derivative is connected by creating an opposite exposure to the asset. For example, a food processor could buy futures on the agricultural products it will be purchasing in the next few months. If the cost of the products rises the food processor will have to pay more for them, but the futures contracts will increase in value as well offsetting the extra cost and providing the additional money required. The asset and the derivative position are perfectly negatively correlated in this strategy: any change in value of the asset will be offset by an opposite change in value of the derivative security. In the ideal hedge, the opposite exposure is for the same amount of money as the asset itself, however, since derivative instruments come in fixed sizes for example $10,000 units it is often difficult to construct an opposite position of precisely the needed amount.

Be the first to comment - What do you think?

Strategy

The term strategy has entered the management literature comparatively much later than its use in Military Science. Game theorists have used strategy-in the same sense in which the term policy was used earlier. Therefore, the concept of strategy and various actions involved are quite confusing and, sometimes, even contrasting. At first, the term strategy was used in management in terms of Military Science to mean what a manager does to offset actual or potential actions of competitors. The term is still being used in the same sense though by few only. Originally, the term strategy has been derived from Greek word ‘strategos’ which means general. The word strategy, therefore, means the art of general.

When the term strategy is used in military sense, it refers to actions that can be taken in the light of action taken by opposite party. According to the Oxford Dictionary, ‘military strategy is the art of so moving or disposing the instruments of warfare (troops, ships, aircrafts, missiles, etc.) as to impose upon the enemy the place, time and conditions for fighting by oneself. Strategy ends, or yields to tactics when actual contact with enemy is made.

In management, the concept of strategy is mostly taken in a slightly different form rather than in military form; it is taken more broadly. However, even in this form, various experts of the field do not agree about the precise scope of strategy. In earlier views, strategy was taken in a very comprehensive way.

For example, Chandler, who made a comprehensive analysis of the interrelationship among the environment, strategy, and organization structure has defined the term strategy in 1962 as follows:

“Strategy is the determination of the basic long-term goals and objectives of an enterprise and the adoption of the course of action and the allocation of resources necessary for carrying out these goals.”

Professors at Harvard Business School who have made considerable contributions in the development of strategic management have held similar views. One of them (Andrews) has defined strategy as follows:

Strategy is the pattern of objectives, purpose or goals and major policies and plans for achieving these goals, stated in such a way, so as to define what business the company is in or is to be and the kind of company it is or is to be.

The above two definitions of strategy are quite comprehensive and include objective setting as part of strategy. As against this, Stanford Research Institute, USA takes a different view when it states that strategy is a way in which the firm, reacting to its environment, deploys its principal resources and marshals its main efforts in pursuit of its purpose. Glueck who defines strategy as follows holds almost similar view:

“A strategy is a unified, comprehensive, and integrated plan relating the strategic advantages of the firm to the challenges of the environment. It is designed to ensure that the basic objectives of the enterprise are achieved.

Two approaches of defining strategy, particularly in terms of the actions included in strategy, are different with former approach including objective setting as part of the strategy while latter excluding it. This difference is likely to continue unless we arrive at universally acceptable concept of strategy. For the purpose of this text, strategy is defined as follows:

Strategy is course of action through which an organization relates itself with envi-ronment so as to achieve its objectives.

Be the first to comment - What do you think?

Features of Strategy

1. Strategy relates the firm to its environment, particularly the external environ-ment in all actions whether objective setting, or actions and resources required for its achievement. This definition emphasizes on the systems approach of management and treats an organization as part of the society consequently affected by it.

2. Strategy is the right combination of factors both external and internal. In relating an organization to its environment, the management must also consider the internal factors too, particularly its strengths and weaknesses, to take various courses of action.

3. Strategy is relative combination of actions. The combination is to meet a particular condition, to solve certain problems, or to attain a desirable objective. It may take any form; for every situation varies and, therefore, requires a somewhat different approach.

4. Strategy may even involve contradictory action. Since strategic action depends on environmental variables, a manager may take an action today and revise or reverse his steps tomorrow depending on the situations.

5. Strategy is forward looking. It has orientation towards the future. Strategic ac-tion is required in a new situation. Nothing-new requiring solutions can exist in the past, and so strategy is relevant only to the future.

Be the first to comment - What do you think?

Strategy and Tactics

It is beneficial to make distinction between strategy and tactics so that managers can concentrate themselves on strategic functions rather than engaging in tactical functions. Organizational decisions range across a spectrum, having a broad master strategy at one end and minute tactics at the other. The major difference between strategy and tactics is that strategy determines what major plans are to be undertaken and allocates resources to them, while tactics, in contrast, is means by which previously determined plans are executed. Beyond this major difference, there may be some other differences, which can be understood better by analyzing military use of strategy and tactics.

Carl von Clausewitz, a Prussian army general and military scientist, defines military strategy as ‘making use of battles in the furtherance of the war’ and the tactics as ‘the use of armed forces in battle.’ A successor to Clausewitz, Count von Moltke is more lucid in making distinction between strategy and tactics.

He states that:

‘Strategy is a system of make shifts. It is carried through an originally conceived plan under a constantly shifting set of circumstances. Strategy furnishes tactics with the opportunity to
strike with the prospect of success. It does this through its conduct of the armies and their concentration on the field of battle. On the other hand, however, strategy concept accepts the
results of every single engagement and builds on them. Strategy retires when a tactical victory is in the making in order later to exploit the newly created situation.

The basic goal of strategy accordingly is to break the will of the army, deprive him of the means to fight, occupy his territory, destroy or obtain control of his resources or otherwise make him submit. The goal of tactics is success in a given action which is only one part in a group of related military actions.A further distinction between strategy and tactics as used in Military Science is made on the basis of delegation of decision making authority. Strategic decisions are not delegated too low in the organization. Normally the authority is not delegated below the levels than those, which possess the perspective required for the most effective decisions.

Such a distinction between strategy and tactics is quite sharp. However, business is different from war in its true perspective not only in terms of its objectives vis-a-vis its competitors but also in terms of process of achievement of objectives. In business, there is seldom a win-lose situation as is the case with the war. Therefore, the distinction should be made between strategy and tactics in business terms.

Be the first to comment - What do you think?

Distinction between Strategy and Tactics

1. Level of Conduct . As discussed earlier, strategy is developed at the highest level of management either at the headquarter or at major divisional offices and related exclusively to
decisions in the province of these levels. Tactics is employed at and relates to lower levels of management.

2. Periodicity. The formulation of strategy is both continuous and irregular. The process is continuous but the timing of decision is irregular as it depends on the appearance of opportunities, new ideas, crisis, management initiative, and other non-routine stimuli. Tactics is determined on a periodic basis by various organizations. A fixed timetable may be followed for this purpose, for example, preparation of budgets at regular intervals.

3. Time Horizon. Strategy has a long-term perspective; especially the successful strategies are followed for quite long periods. In occasional cases, it may have short-term duration. Thus, depending on the nature and requirement, its time horizon is flexible, however, emphasis is put on long-term. On the other hand, time horizon of tactics is short-run and definite. The duration is uniform, for example budget preparation.

4. Uncertainty. Element of uncertainty is higher in the case of strategy formulation and its implementation. In fact, strategic decisions are taken under the conditions of partial ignorance. Tactical decisions are more certain as these are taken within the framework set by the strategy. Thus, evaluation of tactics is easier as compared to evaluation of a strategy.

5. Information Needs. The total possible range of alternatives from which a manager can choose his strategic action is greater than tactics. A manager requires more information for arriving at strategic decision. Since an attempt is made to relate the organization to its environment, this requires information about the various aspects of environment. Naturally the collection of such information will be different. Tactical information is generated within the organization particularly from accounting procedures and statistical sources.

6. Subjective Values. The formulation of strategy is affected considerably by the personal values of the person involved in the process. For example, what should be the goals of an organization is affected considerably by the personal values of the persons concerned. On the other hand, tactics is normally free from such values because this is to be taken within the context of strategic decisions.

7. Importance. Strategies are most important factors of organization because they decide the future course of action for the organization as a whole. On the other hand, tactics are of less importance because they are concerned with specific part of the organization. This difference, though seems to be simple, becomes important from managerial action point of view.

8. Type of Personnel Involved in Formulation. Generally separate group of managerial personnel are involved in strategy and tactics formulation and their implementation. As discussed earlier, strategic decisions are never delegated below a certain level m the managerial hierarchy. The basic principle m this context is not to delegate below the levels than those possess the perspective required for most effective strategic decisions. Personnel at lower levels can take tactical decisions because these involve minute implementation of strategic decisions.

Though these differences between strategy and tactics are there, often the lines of demarcation between these two are blurred both conceptually and operationally. At the one extreme end, the differences are crystal clear, as discussed above. But these differences may not always hold true because tactics is generated by strategy and may rightly be called sub-strategy. What is one manager’s strategy is another manager’s tactics and vice-versa. For example, strategies are developed at the headquarters the strategic planning process. Various divisions of the company may then pursue sub strategies within this strategic planning. Thus, what might be considered tactical plans at the headquarters may be termed as strategy at the divisional levels. Thus, depending on the level of the organization, an action may be strategic or tactical.

Be the first to comment - What do you think?

Levels of Strategy

Strategy may operate at different levels of an organization – corporate level, business level, and functional level.

Be the first to comment - What do you think?

Corporate Level Strategy

Corporate level strategy occupies the highest level of strategic decision-making and covers actions dealing with the objective of the firm, acquisition and allocation of resources and coordination of strategies of various SBUs for optimal performance. Top management of the organization makes such decisions. The nature of strategic decisions tends to be value oriented, conceptual and less concrete than decisions at the business or functional level.

Be the first to comment - What do you think?

Business-Level Strategy

Business-level strategy is – applicable in those organizations, which have different businesses-and each business is treated as strategic business unit (SBU). The fundamental concept in SBU is to identify the discrete independent product/market segments served by an organization. Since each product/market segment has a distinct environment, a SBU is created for each such segment.

For example, Reliance Industries Limited operates in textile fabrics, yarns, fibers, and a variety of petrochemical products. For each product group, the nature of market in terms of customers, competition, and marketing channel differs. Therefore, it requires different strategies for its different product groups. Thus, where SBU concept is applied, each SBU sets its own strategies to make the best use of its resources (its strategic advantages) given the environment it faces. At such a level, strategy is a comprehensive plan providing objectives for SBUs, allocation of re-sources among functional areas and coordination between them for making optimal contribution to the achievement of corporate-level objectives.

Such strategies operate within the overall strategies of the organization. The corporate strategy sets the long-term objectives of the firm and the broad constraints and policies within which a SBU operates. The corporate level will help the SBU define its scope of operations and also limit or enhance the SBUs operations by the resources the corporate level assigns to it. There is a difference between corporate-level and business level strategies.

For example, Andrews says that in an organization of any size or diversity, corporate strategy usually applies to the whole enterprise, while business strategy, less comprehensive, defines the choice of product or service and market of individual business within the firm. In other words, business strategy relates to the ‘how’ and corporate strategy to the ‘what’. Corporate strategy defines the business in which a company will compete preferably in a way that focuses resources to convert distinctive competence into competitive advantage.’

Corporate strategy is not the sum total of business strategies of the corporation but it deals with different subject matter. While the corporation is concerned with and has impact on business strategy, the former is concerned with the shape and balancing of growth and renewal rather than in market execution.

Be the first to comment - What do you think?

Functional-Level Strategy

Functional strategy, as is suggested by the title, relates to a single functional operation and the activities involved therein.

Decisions at this level within the organization are often described as tactical. Such decisions are guided and constrained by some overall strategic considerations. Functional strategy deals with relatively restricted plan providing objectives for specific function, allocation of resources among different operations within that functional area and coordination between them for optimal contribution to the achievement of the SBU and corporate-level objectives. Below the functional level strategy, there may be operations-level strategies as each function may be dividend into several sub functions. For example, marketing strategy, a functional strategy, can be subdivided into promotion, sales, distribution, pricing strategies with each sub function strategy contributing to functional strategy.

Strategies at all the three levels are interlinked in which a higher level strategy generates a lower-level strategy and a lower-level strategy contributes to the achievement of the objectives of higher-level strategy.

Be the first to comment - What do you think?

Next Page »