Gold and Central banks

Gold and Central banks

Nithisha CHALLA

In this article, Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024) This article presents a comprehensive understanding of how gold functions within the global economy and central banking strategies, reflecting historical significance, economic impacts, and future potential.

Introduction

Gold’s value as a reserve asset goes beyond its historical significance; today, central banks use it as a vital economic buffer and tool for financial stability. It has played a strategic role in the financial operations of central banks globally, serving as a hedge against inflation, a tool for reserve diversification, and a reliable store of value. This article explores the complex relationship between gold and central banks, highlighting historical significance, reserve strategies, economic impacts, and recent trends.

Historical Significance of Gold and Central banks

Using gold as a currency dates back thousands of years. For much of modern history, gold was the basis of the world’s monetary system, setting the standard for currency value.

Gold Standard

Until the mid-20th century, most major economies adhered to the gold standard, where each currency unit was pegged to a specific amount. Under the Bretton Woods Agreement (1944-1971), the U.S. dollar was directly convertible to gold, while other currencies were pegged to the dollar. This system solidified gold’s role in global monetary stability. However, the Bretton Woods system ended in 1971, transitioning central banks toward a floating exchange rate system.

Shift to Floating Exchange Rates

Although the gold standard was formally abandoned, gold continued to play a central role in monetary reserves for central banks worldwide, driven by its intrinsic value and historic stability in times of financial crisis.

The below figure shows the Top 10 countries with the highest gold reserves (US$ Million) in the second quarter of 2024.

Top 10 countries with highest gold reserves
Top 10 countries with highest Central banks gold reserves
Source: Central Banks, Federal Reserve Bank of St. Louis, International Monetary Fund, World Bank, World Gold Council

Why Central Banks Hold Gold

Gold is a key asset for central banks due to its stability, independence from other economic assets, and ability to hedge against inflation and currency risk.

Diversification of Foreign Reserves

According to the World Gold Council (WGC), central banks hold gold as part of a diversified portfolio that includes foreign currencies, government bonds, and other assets. Gold’s low correlation with other assets helps reduce portfolio risk.

Inflation Hedge and Safe-Haven Asset

Gold’s value often rises in response to inflationary pressures, making it a popular hedge against currency devaluation. For instance, during periods of heightened inflation in the U.S. and Europe, central banks increased their gold reserves to stabilize national reserves.

Global Stability During Crises

Central banks increase gold holdings during geopolitical tensions and economic downturns. For instance, central banks acquired approximately 1,136 metric tons of gold in 2022 alone, marking the largest annual net gold purchases since 1967 (World Gold Council, 2023).

Leading Central Banks and Their Gold Holdings

Many countries prioritize gold in their reserve strategies, with the largest gold holdings concentrated among a few central banks. These top holders collectively hold around 60% of global central bank gold reserves, underscoring gold’s importance among the world’s most prominent economies.

  • United States: The U.S. has the largest gold reserves, totaling 8,133.5 metric tons as of 2023 (World Gold Council). The U.S. Federal Reserve’s substantial gold reserves bolster the dollar’s stability, lending it a “safe-haven” currency status.
  • Germany: The Deutsche Bundesbank holds around 3,355 metric tons of gold, focusing on economic stability and currency confidence.
  • International Reserves: The International Monetary Fund (IMF) holds around 2,814 metric tons of gold, which it maintains as a “safety net” for international economic stability, intervening to support currency values in times of economic crisis.

Emerging Markets and Rising Demand for Gold Reserves

In recent years, emerging economies have increasingly turned to gold to reinforce their economic stability.

  • China: As stated by the People’s Bank of China (PBoC), its gold reserves have rapidly expanded to approximately 2,010 metric tons as of 2023, part of China’s strategy to reduce dependence on the U.S. dollar and enhance the yuan’s position as a global currency.
  • Russia: The Central Bank of Russia actively grew its gold reserves to over 2,298 metric tons by 2022 (World Gold Council), emphasizing the importance of gold amid geopolitical tensions and economic sanctions.
  • India: The Reserve Bank of India (RBI) also expanded its gold holdings, reaching approximately 795 tons in 2023. India uses gold as a hedge against currency volatility, particularly during inflationary cycles, aligning with its long-standing cultural and economic relationship with gold (World Gold Council, 2023).

Economic Impacts of Central Bank Gold Purchases

The actions of central banks significantly influence global gold markets, particularly in times of economic instability.

Price Stability and Market Demand: Central banks collectively account for about 10-20% of annual global gold demand, influencing gold prices and market stability. According to the World Gold Council, central bank purchases accounted for a record-breaking 1,136 metric tons in 2022, pushing global gold prices to multi-year highs.

Strengthening Currency Value: For many emerging markets, holding gold as a reserve asset bolsters currency credibility. Gold reserves help stabilize a nation’s economy by maintaining foreign reserves and serving as a collateralized asset during debt restructuring or financial assistance negotiations.

Inflation Control: Countries with high inflation rates, such as Turkey, have increased their gold reserves to combat domestic inflationary pressures. By 2023, Turkey’s central bank held around 550 tons of gold, partially insulating its economy from severe currency depreciation.

The Future of Gold in Central Bank Reserves

Shift from the Dollar-Centric System

Some central banks, especially in emerging markets, aim to diversify away from the dollar and other Western assets, driven by geopolitical concerns. Gold provides an attractive alternative due to its universal value and liquidity.

Increased Demand for Sustainable Financial Assets

Gold mining and sustainability are increasingly critical issues for central banks. Many central banks, led by European nations, have begun to prioritize sustainably sourced gold for their reserves, aligning with ESG (Environmental, Social, and Governance) commitments.

Potential for Digital Gold Reserves

As digital currencies evolve, some central banks are exploring digital gold or gold-backed digital currencies as potential financial assets. This shift could create new financial instruments, making gold an even more versatile and accessible asset class.

Conclusion

Gold remains a critical element of central bank reserves, valued for its stability, economic security, and inflation-hedging properties. With global gold demand on the rise, central banks are likely to continue viewing gold as an essential reserve asset. As emerging economies strengthen their reserves and geopolitical risks persist, gold’s importance within central banking strategies will only deepen, securing its status as a pillar of global economic stability.

Why should I be interested in this post?

Gold has been a key financial asset for centuries, acting as a store of value, a hedge against inflation, and a safe-haven asset during economic crises. With both developed and emerging economies increasing their gold reserves, understanding its role as a financial cornerstone for central banks helps students grasp fundamental market dynamics and investor behavior, especially during periods of economic uncertainty

Related posts on the SimTrade blog

   ▶ Nithisha CHALLA History of Gold

   ▶ Nithisha CHALLA Gold resources in the world

Useful resources

Academic research

Erb, C.B., and C.R. Harvey (2013) The Golden Dilemma. Financial Analysts Journal 69 (4): 10–42.

Erb, C.B., and C.R. Harvey (2024) Is there still a Golden Dilemma. Working paper.

Bogle, John C. (2007). The Little Book of Common Sense Investing. John Wiley & Sons.

Business

World Gold Council (WGC) Gold Demand Trends Full Year 2023

Federal Reserve System What central bank does?

Mining.com (August 7, 2024) China’s PBOC keeps gold buying on hold as prices hit record

International Monetary Fund (IMF) The role of gold

Other

Wikipedia Gold

About the author

The article was written in October 2024 by Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024).

Gold in India

Gold in India

Nithisha CHALLA

In this article, Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024) explores gold’s multifaceted significance in India, examining its historical roots, economic impact, cultural value, and future potential.

Introduction

India’s association with gold is ancient, with the metal symbolizing prosperity, purity, and wealth. For centuries, gold has been valued as an adornment and a symbol of security and status, affecting both urban and rural economies across the country. With India and China together accounting for over 50 percent of the world’s gold demand, World Gold Council dated October 2024, understanding its importance goes beyond investment; it’s a story of tradition, economic significance, and national pride. As one of the world’s top gold importers, India’s reliance on imported gold introduces opportunities and challenges for its economy.

Historical Significance of Gold in India

This refers to the ancient history, religious and cultural ties, historical trade, and treasure of gold.

Ancient History

India’s relationship with gold dates back to the Indus Valley Civilization (circa 3300–1300 BC), where archeological finds have unearthed gold jewelry, indicating the metal’s early status as a precious material. India was a central hub in ancient trade, exchanging spices, textiles, and precious metals. Gold was both imported and exported, flowing from regions like Persia and Egypt, as traders recognized India as a rich market. This trade bolstered India’s gold reserves and established the metal as a key part of economic and social transactions.

Below figure shows a photograph of a group of goldsmiths (Sonars) seated around a low work table in Bombay, taken by Shivashanker Narayen in c. 1873, from the Archaeological Survey of India Collections.

Photograph of a group of goldsmiths in 1873
 Photograph of a group of goldsmiths in 1873
Source: shoplune

Religious and Cultural Ties

Gold holds divine significance in Hindu mythology. According to legend, the Hindu goddess Lakshmi, the deity of wealth and prosperity, is adorned in gold, symbolizing abundance. This association with divinity makes gold not only valuable but auspicious, embodying good fortune and blessings. Gold has sacred connotations, used extensively in temples, idols, and as offerings to deities. Temples like Tirupati and Padmanabhaswamy house enormous gold reserves, signifying the metal’s spiritual importance.

Below figure shows a picture of the Hindu god Sri Padmanabhaswamy reclining on the serpent Anantha which is one of the golden treasures of India

Sri Padmanabhaswamy reclining on the serpent Anantha
Sri Padmanabhaswamy reclining on the serpent Anantha
Source: Forbes

Cultural and Social Importance of Gold

In many regions, particularly in rural India, gold represents financial stability. It is often considered a “safe asset” that can be sold or pledged in times of need. It is a staple in Indian weddings and festivals like Diwali and Akshaya Tritiya, where it symbolizes luck and prosperity. Families across income levels save and invest in gold, especially for daughters’ weddings.

According to the World Gold Council (WGC), Indian households hold approximately 25,000 metric tons of gold, accounting for nearly 40% of global private gold holdings in the world. Gifting gold remains a widespread tradition in India, passed down through generations as family heirlooms and regarded as wealth that grows with time. WGC expects the average demand to reach around 850 to 950 tonnes per annum by 2020 at an annual growth rate of 35 percent with two-thirds of its market coming from rural markets, that is households.

Because of the emotional value associated with household jewelry, people rarely sell their gold to meet their immediate financial needs, as an alternative people pledge their gold ornaments as short-term loans, such loans are called organized gold loan markets.

Below figure shows, an organized gold loan market projection(as mentioned above), INR 3101 billion by 2020 at a three-year CAGR of 13.17 percent

Gold loan market projection
Gold loan market projection
Source: KPMG

Economic Impact of Gold in India

India’s gold consumption significantly affects its economy, with implications for trade, financial stability, and national savings.

Gold as a Financial Asset, Trade Balance and Foreign Exchange

Inflation Hedge: Gold is traditionally seen as a hedge against inflation, protecting wealth during economic downturns. Its ability to retain value attracts investors during periods of high inflation or currency devaluation. For a rigorous analysis of this question, you can read the academic articles by Erb and Harvey (2013 and 2024) that challenge the traditional view that gold is a hedge against inflation.

Risk Diversification: Investors across India use gold to diversify their portfolios, as gold prices often perform inversely to equity markets. This reduces risk, providing a balance during times of market volatility.

High Import Dependency: India imports over 80% of its gold, making gold purchases a significant contributor to the trade deficit. In 2021, gold imports cost the Indian economy around $55 billion, placing substantial pressure on the country’s current account.

Import Duty Adjustments: To counter rising imports, the government levies an import duty on gold (currently, in 2024, around 6%), aiming to curb demand and balance the trade deficit. However, this often leads to price-sensitive demand fluctuations.

During the July 2024 Union Budget, Finance Minister Nirmala Sitharaman announced a drop in customs duties on the import of gold, silver and platinum. Due to this, the current duties drop from 15% to 6%, a significant cut of 9% in import duty on gold.

Below figure shows, import customs duty on gold, from 15 percent in July 2022, to 6 percent in July 2024.

Gold customs import duty
Gold customs import duty
Source: World Gold Council (WGC)

Contribution to the Indian Economy Through Employment and Taxes

Employment in Jewelry and Trade: India’s gold industry employs millions, from miners and artisans to retail jewelers. Major gold hubs like Mumbai and Jaipur have vibrant trade networks, supporting local economies and artisan crafts. The Federation of Indian Chambers of Commerce & Industry (FICCI) and the World Gold Council (WGC) (September 2022), report that the gold industry contributes over $30 billion to India’s GDP annually, with the jewelry sector alone employing around 4.6 million people, spanning from goldsmiths to retail traders and related support sectors.

Tax Revenue: The gold industry is a source of government revenue through import duties, GST on gold purchases, and income tax from jewelers and traders.

Shift Toward Formal Investments: Younger and urban investors are increasingly investing in structured products like Sovereign Gold Bonds and Gold ETFs, signaling a gradual shift from physical gold to formal investment avenues.

Gold’s Impact on Financial Policies and Regulations

Policy on Import and Consumption: India’s government frequently adjusts gold import policies to control demand and influence economic stability. High demand often prompts higher import duties or restrictions to limit the impact on foreign exchange.

Regulation of Financial Gold Products: To support formal financial growth, the government offers options like Sovereign Gold Bonds, which promote investment without affecting the trade balance. These bonds allow investors to gain from gold’s price appreciation without physical ownership.

Anti-Smuggling Efforts: Due to high import duties, gold smuggling has become an issue. Regulatory efforts focus on reducing smuggling to ensure that the government earns tax revenue from gold imports.

Gold’s Role in Modern India

Gold in Indian Independence

During India’s independence movement, 1857-1947, leaders urged citizens to donate gold for the national cause. This movement emphasized gold’s role as a unifying asset for Indians across social classes.

Continuing Cultural Significance in Post-Independence India

The importance of gold has persisted in modern India, with a large part of household wealth still held in physical gold. Even as digital and financial assets grow, gold remains a stable and respected form of wealth storage.

Evolution with Government Policies

Post-independence, gold import policies, and the introduction of schemes like the Gold Monetization Scheme and Sovereign Gold Bonds have attempted to modernize India’s relationship with gold, encouraging citizens to treat it as an investment rather than simply a family heirloom.

Gold Markets and Demand in India

Based on the data given by Statista, the demand for gold across India was about 747.5 metric tons in 2023. This represented a decrease of three percent in comparison to the previous year, when the gold demand was 774 metric tons.

Below figure shows fluctuations in the annual demand volume of gold across India from 2010 to 2023.

Annual gold demand volume from 2010 to 2013
Annual gold demand volume
Source: Statista

  • Regional Gold Hubs: Cities like Mumbai, Kolkata, and Chennai have bustling gold markets, with jewelry demand highest in Tamil Nadu, Kerala, and Maharashtra.
  • Jewelry vs. Investment Demand: While traditional gold jewelry demand remains high, investment in gold bars, coins, and newer avenues like digital gold is rising.
  • Gold Price Sensitivity: Indian consumers are sensitive to gold price fluctuations, with demand typically increasing during periods of price stability or decline.

Conclusion

Gold remains the top choice for many investors for portfolio diversification or protection against economic instability. This precious metal has held its value over centuries. While market prices fluctuate, many still choose to buy gold to secure their financial future.

Why should I be interested in this post?

Gold has been a key financial asset for centuries, acting as a store of value, a hedge against inflation, and a safe-haven asset during economic crises. Understanding its investment options helps students grasp fundamental market dynamics and investor behavior, especially during periods of economic uncertainty.

Related posts on the SimTrade blog

   ▶ Nithisha CHALLA History of Gold

   ▶ Nithisha CHALLA Gold resources in the world

Useful resources

Academic research

Erb, C.B., and C.R. Harvey (2013) The Golden Dilemma. Financial Analysts Journal 69 (4): 10–42.

Erb, C.B., and C.R. Harvey (2024) Is there still a Golden Dilemma. Working paper.

Bogle, John C. (2007). The Little Book of Common Sense Investing. John Wiley & Sons.

Business

World Gold Council (WGC) India’s gold jewellery market structure

World Gold Council (WGC) Indian gold import duties reduced to the lowest level in over a decade

KPMG (2017) India’s gold loan market: Is it glitter fading?

Shoplune The Story Of India And Gold Through The Ages

Statista Annual demand volume of gold across India from 2010 to 2023

Other

Wikipedia Gold

About the author

The article was written in October 2024 by Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024).

Gig Economy

Gig Economy

Anant Jain

In this article, Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) talks about Gig Economy.

Introduction

The gig economy is defined by a setup where businesses offer freelancers and independent contractors temporary, flexible work in place of typical, full-time employees. In a gig economy, businesses or employers can increase the cost savings on hiring, benefits and payroll costs while a person working in the gig economy benefits from the possibility to earn income from several different sources and complete projects and tasks on a flexible schedule.

In the general setting of a gig economy, freelancers and independent contractors typically find their own jobs by connecting with businesses and clients using an internet platform or smartphone app. With the help of businesses like Airbnb, TaskRabbit, Uber, Lyft, PostMates, DoorDash, and Instacart, the gig economy has grown significantly during the past ten years. In fact, a 2020 report from the ADP Research Institute indicated that from 2010 to 2019, gig employment increased by 15% in the United States. According to a survey by MasterCard and Kaiser Associates, the gross volume of transactions in the gig economy is expected to reach $455 billion by 2023.

The possible benefits of the gig economy may not be reaped by people who don’t use modern technology and services like Internet. Additionally, a person’s geographical location also impacts the possibility of being a part of the gig economy since most cities have more advanced technology and hence having the deepest roots in the gig economy.

Although the gig economy spans a wide range of sectors, the basic idea is the same: gig workers will take on tiny, ad hoc tasks for payment. These tasks can involve creating a website, making food deliveries, walking dogs, or picking up a family and taking them to the airport. The gig worker moves on to the following task after the job is finished.

Although it is typical for businesses to keep working with the same gig worker, neither the business nor the worker are required to make a long-term commitment.

Workers that are interested in engaging in the gig economy often need to join up by submitting an application to their preferred platforms. Once accepted, individuals can select which projects or work shifts to finish. For instance, in order to keep her nights and weekends open, a woman who works for DoorDash can choose to work for two to three hours when her kids are in school. A virtual assistant, on the other hand, could decide to work a standard 9 to 5 job for a business to finish a particular assignment.

While people may question the worth of a gig economy, it is worthwhile to those who operate in the gig economy. According to studies, 79% of people who work in the gig economy are happier than they were when they had regular employment.

Pros Of The Gig Economy

Flexibility

With gig employment, you are effectively your own employer and may decide how, where, and for how long you work. In certain cases, you can even select your clientele and pricing.

Independence

Since gig workers are not directly supervised and are not required to work in an office, they are allowed to do tasks independently, according to their preferences, and on their own schedule.

Scope Of work

The gig economy offers the chance to take on a variety of jobs and projects that may keep you on your toes and exercise your creative and problem-solving abilities in the process, as opposed to working in one 9–5 job for one boss.

Cost Efficient For Businesses

Freelancers can be a less expensive option for firms than hiring full-time workers. They also provide owners the chance to locate new talent and set different charges for different skill levels.

Cons Of The Gig Economy

Income Instability

Having a flexible work schedule has the consequence of bringing with it an unstable source of income. The quantity of labour available determines your revenue from gigs, and you only get paid when you do jobs.

Lack Of Benefits

Gig workers are often ineligible for health insurance, retirement programs, and workers’ compensation or disability insurance if they are injured on the job.

Stress And Burnout

Having a range of jobs might be monetarily advantageous, but it can also cause stress and fatigue. For a delivery driver, for instance, doing numerous jobs might drain your energy, change your way of life, and even damage your car.

Taxes And Expenses

Independent contractors who get payment for gig work may be required to make quarterly anticipated tax payments in addition to being responsible for paying self-employment taxes. By making timely and enough tax payments, you can avoid a fine. Additionally, gig workers are in charge of getting and keeping their work-related gear and supplies, such as smartphones, phone plans, laptops, and automobiles.

Uber’s Business Model: Example For One Of The Leading Company In The Gig Economy

Business Model

Uber operates on a platform-based business model that connects drivers (independent contractors) with riders through a mobile app. The key components of its business model:

  • Ride-Hailing Services: Uber’s core service allows users to request rides via the app, connecting them with nearby drivers. The app calculates fares based on distance, demand, and time.
  • Driver Independence: Drivers are classified as independent contractors, not employees, which means they have the flexibility to choose when and how much they work. Uber retains a percentage of each fare as a commission, typically around 20-30%.
  • Dynamic Pricing: Uber employs a dynamic pricing model (also known as surge pricing) that adjusts fares based on real-time demand and supply. This model incentivizes drivers to work during peak times when prices increase.
  • Expansion of Services: Beyond ride-hailing, Uber has expanded into food delivery (Uber Eats), freight transport (Uber Freight), and even micro-mobility options like scooters and bikes, diversifying its revenue streams.
  • Technology and Data Utilization: The company leverages data analytics and algorithms to optimize routes, enhance user experience, and manage driver-partner supply.

Uber’s Green Initiatives

Uber has made commitments towards sustainability and aims to position itself as a green company through several initiatives:

  • Electric Vehicle (EV) Transition: Uber has pledged to transition to an all-electric fleet by 2030 in major cities and by 2040 globally. This involves encouraging drivers to switch to electric vehicles and providing incentives for doing so.
  • Partnerships: The company collaborates with manufacturers and governments to promote the adoption of EVs and invest in charging infrastructure.
  • Carbon Offset Programs: Uber offers options for riders to contribute to carbon offset projects, aiming to neutralize the emissions generated from their rides.

Pollution and Environmental Concerns

Despite these initiatives, Uber faces critique regarding its environmental impact due to multiple factors:

  • Independent Contractors: Since drivers are independent contractors, Uber does not directly control the vehicles they use or their maintenance. Many drivers still use older, less fuel-efficient vehicles, contributing to greenhouse gas emissions.
  • Increased Vehicle Miles Travelled (VMT): Research indicates that ride-hailing services can lead to increased vehicle miles travelled, as rides may include more deadheading (drivers traveling without passengers) and inefficient routing. This can negate some of the benefits of switching to electric vehicles.
  • Urban Congestion: The rise of ride-hailing has been associated with increased traffic congestion in cities, leading to more emissions and pollution. This situation raises concerns about the overall sustainability of the business model.

Conclusion

Despite its cons, both employees and employers may gain greatly from the gig economy. A employer has access to a diverse pool of talent without out any commitment to permanently hire the person or any repercussions to fire them if their skill set does not match with the required level. An employer may also utilise gig economy during phases when it is difficult to hire full-time employees. Additionally, an employer does not usually incur any costs to cover benefits provided to employees like health insurance, etc. On the contrary, the gig economy provides employees the freedom and ability to undertake multiple jobs, the freedom to choose the place to work depending on the employment and flexibility in their work timings.

Related Posts On The SimTrade Blog

Useful Resources

HBS – The Gig Economy Is Here to Stay

McKinsey – Gig Economy: The Future of Work

Business Cases

Uber’s Commitment to Sustainability

Understanding the Uber Business Model

About The Author

The article was written in October 2024 by Anant JAIN ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

The Ongoing Hyperinflation In Turkey And Its Ripple Effects On European Union

The Ongoing Hyperinflation In Turkey And Its Ripple Effects On European Union

Anant Jain

In this article, Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) talks about the ongoing hyperinflation in Turkey and its ripple effects on European markets.

Introduction

Turkey is facing one of the most severe inflation crises in its modern since 2019. Hyperinflation, marked by an uncontrollable surge in prices, has deeply impacted the Turkish economy and is starting to affect European markets as well. This article delves into the causes behind Turkey’s hyperinflation, its consequences on the Turkish economy, and the broader implications for Europe.

Figure 1. Inflation In Turkey (1960-2024)
Hyperinflation in Turkey
Source: World Bank

You can download the Excel file for the data used for the figure above.

Causes Of Hyperinflation In Turkey

Several factors have contributed to Turkey’s current hyperinflation crisis: monetary policy and Central Bank challenges, depreciation of the Turkish Lira, and political and external pressures.

Monetary Policy and Central Bank Challenges

The Turkish administration, led by President Recep Tayyip Erdoğan, has adopted unconventional monetary policies, including lowering interest rates despite high inflation. Erdoğan’s view that high interest rates lead to inflation contradicts established economic theory, leading to frequent rate cuts.
The Central Bank of Turkey has faced issues with its independence, with frequent changes in leadership and government interference undermining the effectiveness of its monetary policy.

Depreciation Of The Turkish Lira

The Turkish lira has seen a sharp decline in value against major currencies like the U.S. dollar and the euro. This currency depreciation has increased the cost of imports, which drives up prices domestically. Given Turkey’s reliance on imported goods, including energy and raw materials, the weakening lira has significantly contributed to inflation.

Political & External Pressures

Internal political instability and external geopolitical tensions have intensified the economic situation.

  • Political events, including the 2018 presidential elections and subsequent local elections in 2019, have created uncertainty in the markets. The government’s actions, such as arrests of opposition figures and crackdowns on dissent, have raised concerns about the rule of law and investor confidence.
  • The COVID-19 pandemic and the subsequent recovery have affected global supply chains and commodity prices, putting additional pressure on inflation in Turkey. Rising oil prices, in particular, have hurt Turkey due to its dependence on energy imports.

Global issues, such as rising energy costs and disruptions in supply chains, have also worsened Turkey’s inflation crisis.

Effects On Turkey’s Economy

Hyperinflation has had severe consequences for Turkey: Rising Costs and Living Standards, Devaluation Of Savings & Income, and Challenges For Businesses and Investment.

Rising Costs and Living Standards

The prices of everyday goods and services have soared, placing a heavy burden on Turkish citizens. Essential items like food, fuel, and housing have become increasingly expensive, leading to a marked decline in the quality of life for many people.

Official inflation rates are high, but real rates may be even higher. This has resulted in widespread economic difficulty, with many Turks struggling to afford basic necessities.

Devaluation Of Savings & Income

As the lira depreciates, the value of savings held in lira has diminished. Those on fixed incomes or holding substantial savings in lira are experiencing a severe reduction in their purchasing power.
Wage increases have not matched inflation rates, resulting in a decrease in real wages. This reduction in income has led to lower consumer spending, further hurting economic growth.

Challenges For Businesses and Investment

The hyperinflation crisis has created a turbulent environment for businesses. Rising costs and reduced consumer spending are making it challenging for companies to maintain profitability.
Foreign investors are hesitant to engage with the Turkish market due to concerns about the unstable lira and the government’s economic policies.

Consequences For European Markets

The economic turmoil in Turkey is beginning to influence European markets in several ways: Trade and Supply Chain Interruptions, Financial Market Volatility, and Migration & Social Strain.

Trade and Supply Chain Interruptions

  • Impact: Increased costs and disruptions in supply chains are causing delays in production and raising prices for goods in Europe. European companies may either absorb these costs or pass them on to consumers, potentially leading to lower sales and profits.
  • Example: European car manufacturers like Volkswagen and Renault are experiencing increased costs and delays because of issues with their Turkish suppliers. For instance, a Turkish automotive parts supplier reported a 30% rise in costs due to the lira’s devaluation, affecting European manufacturers reliant on these components.

Financial Market Volatility

  • Impact: Turkey’s financial instability has led to increased volatility in European financial markets. Concerns about potential defaults on Turkish debt may result in tighter credit conditions and impact the profitability of European banks.
  • Example: Spanish bank BBVA, which holds a significant investment in Turkey through Garanti BBVA, has been affected by the financial instability in Turkey. The lira’s devaluation and inflation have led to fluctuations in BBVA’s stock price and higher borrowing costs.

Effects On The Euro & Economic Stability

  • Impact: The euro’s depreciation in response to Turkey’s crisis could lead to higher import costs for European countries, particularly those that rely on non-Eurozone imports. This might worsen inflationary pressures in Europe and complicate the European Central Bank’s efforts to manage economic growth.
  • Example: In late 2022, the euro saw a noticeable decline in value against major currencies, partly due to concerns about the effects of Turkey’s economic situation. As the Turkish lira weakened, European investors and businesses faced greater uncertainty, affecting market sentiment and currency exchange rates.

Migration & Social Strain

  • Impact: Increased migration from Turkey could put additional pressure on European social services, such as housing, healthcare, and education. This may heighten political tensions within the EU as member states address how to manage and support the influx of migrants.
  • Example: Turkey has been a significant source of migration to Europe, with many people seeking refuge from economic and political instability. The worsening situation in Turkey could lead to more migration to countries like Greece and Italy, which are already dealing with substantial migration challenges.

Conclusion

The hyperinflation crisis in Turkey is a rapidly evolving issue with wide-ranging consequences. While the primary burden falls on the Turkish economy, the repercussions are starting to be felt across Europe. Trade disruptions, financial instability, and potential migration issues are among the challenges that European markets may face due to Turkey’s economic troubles.

The situation underscores the interconnected nature of global economies and the need for Europe to monitor and prepare for potential economic fallout. European policymakers and businesses must stay alert and adaptable in response to the ongoing developments in Turkey.

Addressing Turkey’s hyperinflation will require substantial economic reforms, including restoring central bank independence, stabilizing the currency, and regaining investor confidence. Until these issues are resolved, the economic and social impacts of Turkey’s crisis will continue to challenge both Turkey and Europe.

Related Posts On The SimTrade Blog

▶ Anant JAIN Understanding Hyperinflation

Useful Resources

Data

World Bank Inflation, consumer prices

Economic Analysis

World Bank Turkey Economic Monitor

Financial Times Turkey’s Economic Crisis

BBC News Turkey’s Inflation Crisis

European Central Bank Economic Bulletin

Council on Foreign Relations Turkey’s Economic Struggles

About The Author

The article was written in October 2024 by Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Understanding Debt Ratio & Its Impact On Company Valuation

Understanding Debt Ratio & Its Impact On Company Valuation

Anant Jain

In this article, Anant JAIN (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022) explain the debt ratio and its importance in firm valuation.

Introduction

In financial analysis, calculating and even evaluating a company’s debt ratio is essential for assessing its financial stability and valuation. The debt ratio provides insights into how a company finances its assets—through debt or equity—and reveals critical information about its risk profile. This article explores the debt ratio in detail, including real-life examples, and discusses its implications for company valuation.

Defining Debt Ratio

The debt ratio is a financial metric that represents the proportion of a company’s assets that are financed by debt.

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  • Total Debt: This includes all short-term and long-term debt/liabilities. Short-term debt includes financial commitments due within one year, such as accounts payable, commercial paper and short-term loans. Long-term debt consists of liabilities such as bank loans and bonds with repayment periods extending beyond one year.
  • Total Assets: This includes all resources owned by the company, such as cash, inventory, property, and equipment.

Sometimes, the debt will include financial debt only (accounts payable being include to the working capital).

Understanding Debt Ratio Values

High Debt Ratio

A high debt ratio indicates that a large portion of a company’s assets is financed through debt. For instance, a debt ratio of 0.70 means that 70% of the company’s assets are debt-financed. High leverage can heighten financial risk, as the probability to repay the capital of the loan and interest is higher, and then the probability of bankruptcy is higher. During economic downturns or revenue drops, companies with high debt ratios might face challenges in maintaining financial stability and avoiding default.

Low Debt Ratio

A low debt ratio suggests that the company relies more on equity financing. For instance, debt ratio of 0.3 implies that 30% of the assets are financed by debt. While this indicates lower financial risk and greater stability, it may also suggest that the company is conservative in leveraging debt (to minimize the cost of bankruptcy).

Implications for Company Valuation

Risk Assessment

The debt ratio can be a valuable metric to assess a company’s risk level. High leverage increases financial risk, which can affect the company’s stock price and valuation. Investors often seek higher returns to compensate for higher risk, potentially leading to a lower stock price if the company is perceived as too risky. This issue has been extensively studied in the academic literature (see the seminal works of Modigliani and Miller (1958 and 1963).

Cost of Capital

WACC (weighted average cost of capital) is the average rate that a business pays to finance its assets. The debt ratio affects a company’s WACC. A higher proportion of debt can reduce the WACC due to the tax benefits associated with interest payments. Lower WACC can increase the company’s valuation by increasing the present value of future cash flows. However, excessive debt might raise the cost of equity as investors demand higher returns to offset increased risk, which could diminish the benefits of a lower WACC.

Figure 2. Calculation Of WACC.
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Creditworthiness and Borrowing Capacity

The debt ratio impacts a company’s credit rating and borrowing ability. High debt levels can lead to lower credit ratings, resulting in higher borrowing costs and reduced financial flexibility. This can negatively affect the company’s valuation due to increased financial costs and operational constraints.

Growth Potential

Companies with manageable debt levels may be better positioned to pursue growth opportunities. Effective use of debt can enable investments in expansion, technology, and acquisitions. A moderate debt ratio can suggest that the company is leveraging debt effectively to drive growth without overextending itself. This positive outlook can boost investor confidence and increase the company’s valuation.

Industry Context

Debt ratios should be assessed within the context of industry standards. Different industries have varying norms for acceptable debt levels based on capital requirements, revenue stability, and growth potential. For example:

  • Capital-Intensive Industries: Sectors such as utilities, telecommunications, and manufacturing often have higher debt ratios due to substantial capital needs for infrastructure and equipment. In these industries, higher leverage is often necessary and accepted.
  • Service and Technology Industries: Companies in service and technology sectors typically have lower capital requirements and may operate with lower debt ratios. High debt levels in these industries could signal potential financial risk or overextension.

Real-Life Examples

Tesla, Inc.

Tesla, renowned for its electric vehicles and energy products, has historically maintained a high debt ratio. For example, Tesla’s debt ratio has been around 0.70 in late 2010s, indicating that 70% of its assets are financed by debt. This high leverage reflects Tesla’s aggressive growth strategy and significant investments in technology and infrastructure. Despite the elevated debt ratio, Tesla’s robust revenue growth and innovative position have led to a high valuation, illustrating that high leverage can be manageable if the company demonstrates strong financial performance and growth potential.

Figure 3. Tesla’s Debt Ratio From 2015 – 2023.
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Apple Inc.

Apple, a leading technology company, has a lower debt ratio compared to Tesla. As of its latest financial disclosures in 2024, Apple’s debt ratio stands at almost 0.40. This lower ratio indicates that Apple relies more on equity financing and has a solid balance sheet. Apple’s cautious approach to debt and substantial cash reserves contribute to its high valuation and perceived financial stability. Investors value Apple’s lower risk profile and consistent cash flow generation, which supports a high valuation.

Figure 4. Apple’s Debt Ratio From 2000 – 2024.
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General Electric (GE)

General Electric, a large multinational conglomerate, has experienced varying debt ratios over time. Historically, GE has had a high debt ratio, such as in 2000 when it was approximately 0.8. As of 2024, it stands at 0.6. This high leverage was partly due to significant capital investments and acquisitions. During its restructuring phase, the high debt ratio contributed to financial difficulties and a lower stock price (cost due to the restructuring). This example underscores how excessive leverage can impact a company’s valuation and financial health.

Figure 5. General Electric’s Debt Ratio From 2000 – 2024.
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Conclusion

The debt ratio is a vital metric for understanding a company’s financial structure and risk profile. Its implications for company valuation are substantial, affecting perceptions of risk, cost of capital, creditworthiness, and growth potential. By analysing the debt ratio alongside other financial indicators and industry benchmarks, investors and analysts can develop a comprehensive understanding of a company’s financial health and make more informed valuation decisions.

Real-world examples, such as Tesla’s high debt ratio versus Apple’s conservative approach, illustrate how different debt levels can influence a company’s valuation and investor perception. A thorough analysis of the debt ratio enables stakeholders to assess a company’s stability, growth prospects, and financial strategy, leading to more accurate and insightful evaluations.

Related Posts On The SimTrade Blog

▶ Rodolphe CHOLLAT-NAMY Why do companies issue debt?

▶ Rodolphe CHOLLAT-NAMY Corporate debt

▶ Rodolphe CHOLLAT-NAMY The rise in corporate debt

▶ Bijal GANDHI Credit Rating

▶ Jayati WALIA Credit risk

▶ Louis DETALLE A quick review of the DCM (Debt Capital Market) analyst’s job…

Useful Resources

Academic references

Modigliani, F., M.H. Miller (1958) “The Cost of Capital, Corporation Finance and the Theory of Investment.” American Economic Review, 48(3), 261-297.

Modigliani, F., M. H. Miller (1963) “Corporate Income Taxes and the Cost of Capital: A Correction.” American Economic Review, 53(3), 433-443.

Business resources

Tesla’s Financial Reports

Analysis on Tesla’s Debt

Apple’s Financial Reports

Analysis on Apple’s Debt

GE’s Financial Reports

Analysis on GE’s Debt

Deloitte – Industry Insights

Bloomberg – Company Profiles

About The Author

The article was written in October 2024 by Anant JAIN (ESSEC Business School, Master in Management, 2019-2022).

The Future Of CleanTech: Innovations Driving A Sustainable World And Their Financial Implications

The Future Of CleanTech: Innovations Driving A Sustainable World And Their Financial Implications

Anant JAIN

In this article, Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) talks about CleanTech.

Introduction

CleanTech, or clean technology, represents a burgeoning field dedicated to creating innovative solutions that minimize environmental impact, enhance energy efficiency, and support sustainable practices. This article examines the current worldwide landscape of CleanTech, highlights key innovations, and explores the potential for shaping a sustainable future.

Understanding CleanTech

CleanTech involves technologies that deliver superior performance while lowering costs compared to traditional methods, all while reducing environmental harm. CleanTech spans various sectors, including energy, water management, transportation, and agriculture, reflecting its extensive potential to address environmental concerns.

Key Innovations In CleanTech

Renewable Energy

Renewable energy sources such as solar, wind, and hydropower are pivotal to CleanTech advancements.

Example: Tesla has made significant strides with its solar roof and solar panels, which have become more efficient and affordable.

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Energy Storage

Effective and efficient energy storage is crucial for balancing the variable output of renewable energy sources.

Example: QuantumScape focuses on developing solid-state batteries, which offer higher energy density and improved safety compared to conventional lithium-ion batteries. These advancements are crucial for electric vehicles and large-scale energy storage.

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Electric Vehicles (EVs)

The shift from thermal engine vehicle towards electric vehicles is transforming traditional medium for transportation and daily travel.

Example: Rivian produces EVs like the R1T pickup truck and R1S SUV offering longer driving capabilities and advanced features showcasing the advancements and diversity in EV sector.

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Smart Grids & Energy Management

Smart grids use digital technology to increase efficient distribution of electricity.

Example: Siemens has developed smart grid solutions that incorporate sensors and data analytics to optimize energy distribution and minimize outages, aiding in the integration of renewable energy sources.

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Water Purification and Conservation

Capable innovations in water management are essential and critical for addressing freshwater scarcity issues across the globe.

Example: Xylem provides advanced water purification technologies and smart irrigation systems, such as the Smart Irrigation Controller, which optimizes water use in agriculture based on real-time data.

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Waste Management and Recycling

New technologies are completely changing the waste management and recycling sector.

Example: TerraCycle specializes in recycling hard-to-process waste, offering innovative methods for recycling and upcycling materials that are typically not handled by conventional waste systems.

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Challenges Ahead

Despite its promise, the CleanTech sector faces several challenges that must be addressed for its full potential to be realized:

High Upfront Costs

Many CleanTech innovations need prominent startup investment. Although these investments often lead to long-term savings and environmental benefits, it can be a barrier to widespread development.

Regulatory Hurdles

The regulatory environment can be complex and vary across regions, impacting the deployment of CleanTech technologies. Different countries may have distinct requirements and approval processes that affect market entry.

Technological Uncertainty

CleanTech encompasses a range of emerging technologies that are still evolving. Long-term performance, reliability, and cost-effectiveness of these technologies are not yet fully established.

Infrastructure Needs

Implementing CleanTech solutions often requires upgrading or developing new infrastructure. For instance, expanding the network of electric vehicle charging stations necessitates significant investment and coordination.

Market Competition

The CleanTech sector is competitive, with numerous companies vying for market share. Ongoing innovation & advancements in the technology are critical for companies to have a competitive edge.

Public Awareness And Acceptance

Overcoming resistance to new technologies and educating the public about their benefits can be challenging. Public awareness campaigns are essential for encouraging adoption and building trust in CleanTech solutions.

Implications For The Stock Market

The CleanTech sector has significant implications for the stock market:

Investment Opportunities

The CleanTech industry attracts investor due to its growth potential and impact. Companies involved in this area are often viewed as high-growth investments. The sector’s expansion is supported by regulatory incentives, technological advancements, and a global focus on sustainability.

Government Policies & Incentives

The government play a critical role in shaping the CleanTech market through their policies and incentives. Supportive regulations, subsidies, and tax credits can enhance the attractiveness of CleanTech investments. Investors should be aware of policy developments that may influence the market.

Market Volatility

CleanTech investments can experience market volatility due to regulatory changes, competition, and shifting consumer preferences. Investors should be ready & prepared for such fluctuations and should conduct in depth research before making investment decisions.

Sustainable Investing

The rise of Environmental, Social, and Governance (ESG) criteria has led to a focus on sustainable investing. CleanTech companies often align with ESG goals, attracting socially conscious investors. Investment funds and indices focused on sustainability offer exposure to the CleanTech sector.

Personal Investing In CleanTech

For individual investors interested in CleanTech, several strategies can be considered:

Direct Investment

Investing directly in CleanTech companies can provide exposure to innovative technologies and growth potential. Stocks of companies involved in solar energy, electric vehicles, or energy storage are popular options.

Exchange-Traded Funds (ETFs) And Mutual Funds

For a diversified investment approach, investors can choose CleanTech-focused ETFs and mutual funds. These funds pool investments in a variety of CleanTech companies, reducing individual risk and providing broad exposure to the sector.

Green Bonds

Investing in green bonds allows individuals to support CleanTech initiatives while earning fixed-income returns since they focus on financing environment friendly projects.

Research And Due Diligence

Conducting thorough research and due diligence is essential for any investment. It is important to evaluate a company’s financial health, technological innovations and roadmap, market potential, and management style to help make informed investment decisions. Staying updated on industry trends and technological advancements is also beneficial.

The Path Forward

The future of CleanTech holds great promise, driven by ongoing research and investment. Collaboration among governments, businesses, and research institutions is key to advancing CleanTech solutions. Supportive policies, financial incentives, and public awareness are crucial for fostering innovation and adoption.

As we confront environmental challenges, CleanTech represents a vital part of the solution. Utilising CleanTech technology and innovation can help us move towards a more sustainable and bright future. For investors, CleanTech offers opportunities to align financial goals with environmental impact, potentially achieving both financial returns and contributing to a greener planet.

In summary, CleanTech is essential to the global effort to create a sustainable world. Through continued innovation and collaborative efforts, we can realize the full potential of these technologies and build a cleaner, greener future. Understanding the financial implications and opportunities within the CleanTech sector can lead to rewarding and impactful investment decisions.

Related Posts On The SimTrade Blog

▶ Akshit GUPTA Green bonds

▶ Anant JAIN Green Investments

Useful Resources

Useful Articles

International Energy Agency (IEA) – CleanTech

International Energy Agency (IEA) – Cleantech

Business Examples

Tesla – Solar Roof and Solar Panels

QuantumScape – Solid-State Batteries

Rivian – Electric Vehicles

Siemens – Smart Grids

Xylem – Water Purification and Smart Irrigation

TerraCycle – Waste Management and Recycling

About The Author

The article was written in October 2024 by Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Milton Friedman VS Archie B. Carroll On CSR

Milton Friedman VS Archie B. Carroll On CSR

Anant Jain

In this article, Anant JAIN (ESSEC Business School, Grande Ecole – Master in Management, 2019-2022) talks about the difference between Milton Friedman and Archie Carroll’s take on corporate social responsibility (CSR).

Introduction

The understanding of CSR has undergone significant transformation over the decades, reflecting a shift in societal values and expectations regarding the role of businesses. Milton Friedman’s influential 1970 article, “The Social Responsibility of Business is to Increase Its Profits,” argues for a profit-centric approach. Conversely, Archie B. Carroll’s 1991 work, “The Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders,” introduces a more nuanced framework that extends beyond mere profit. This analysis delves into the progression from Friedman’s profit-oriented stance to Carroll’s more inclusive approach, highlighting key case studies that illustrate these concepts.

Milton Friedman’s Perspective

A. Core Argument

  • Focus On Shareholder Value
    Friedman posits that the primary duty of business leaders is to maximize shareholder value. He views businesses primarily as economic entities, with profit generation being their principal aim.
  • Scope Of Social Issues
    According to Friedman, addressing societal or environmental concerns falls outside the proper scope of business activities. He argues that these issues should be tackled by governments and non-profits rather than by businesses.

B. Justification For Friedman’s View

  • Agent-Principal Dynamics
    Friedman’s perspective is based on the principle-agent relationship. Executives, as agents, are tasked with prioritizing shareholder returns, provided they operate within legal and ethical boundaries.
  • Legal & Ethical Boundaries
    While Friedman supports profit maximization, he insists that it must be pursued within legal and ethical limits. Nonetheless, he believes these considerations should not detract from the primary goal of profitability.
  • Economic Contribution
    Friedman contends that profit maximization leads to economic efficiency and overall societal benefits, including job creation and innovation, which contribute to general economic growth.

C. Case Study: Enron Corporation

  • Overview: Enron, once a prominent American energy company, exemplified an intense focus on profit maximization. Its aggressive strategies aimed at boosting financial performance were initially lauded.
  • Alignment With Friedman’s View: Enron’s practices were consistent with Friedman’s emphasis on profit. However, the company’s pursuit of financial gains led to severe ethical breaches, including fraudulent accounting practices designed to artificially inflate earnings.
  • Outcome: The exposure of Enron’s fraudulent activities in 2001 led to its collapse, resulting in substantial losses for shareholders and employees. This case underscores the potential dangers of prioritizing profit over ethical standards.

Archie B. Carroll’s Perspective

A. The Pyramid Of Corporate Social Responsibility

  • Economic Responsibility (Base Level)
    Carroll acknowledges the fundamental need for businesses to be profitable, placing this as the foundation of his CSR pyramid. Profitability is crucial for business sustainability.
  • Legal Responsibility (Second Level)
    On top of economic responsibilities, Carroll stresses the importance of adhering to laws and regulations. Businesses are expected to operate within legal boundaries.
  • Ethical Responsibility (Third Level)
    Carroll introduces the concept of ethical responsibility, where businesses must uphold ethical norms that go beyond mere legal compliance. This includes fairness and respect for stakeholders.
  • Philanthropic Responsibility (Top Level)
    At the peak of the pyramid is philanthropic responsibility. Carroll advocates for voluntary efforts by businesses to contribute positively to society through charitable activities and community engagement.

B. Rationale Behind Carroll’s Model

  • Comprehensive Approach
    Carroll’s model marks a shift from a narrow focus on profits to a broader understanding of CSR. By incorporating legal, ethical, and philanthropic responsibilities, it reflects the multifaceted role of businesses in society.
  • Moral Obligations
    Carroll’s framework acknowledges that businesses have moral duties that extend beyond financial performance. This perspective aligns with the growing recognition of businesses’ roles in addressing social and environmental issues.
  • Strategic Integration
    According to Carroll, CSR should be an integral part of business strategy. Companies adopting this comprehensive approach are better equipped to build stakeholder trust and enhance their overall reputation.

C. Case Study: Patagonia

  • Overview: Patagonia, an American outdoor apparel company, is noted for its strong commitment to environmental and social responsibility. The company integrates CSR into its core operations and practices.
  • Alignment With Carroll’s Model: Patagonia’s approach embodies Carroll’s multi-dimensional model of CSR:

1. Economic Responsibility: The company remains profitable and operationally sound.

2. Legal Responsibility: It complies with relevant environmental and labor laws.

3. Ethical Responsibility: Patagonia adheres to high ethical standards, including transparency in its supply chain and fair labor practices.

4. Philanthropic Responsibility: The company actively participates in charitable activities and environmental advocacy, such as its 1% for the Planet initiative, which donates a portion of sales to environmental causes.

  • Outcome: Patagonia’s dedication to a broad CSR approach has strengthened its reputation, fostered customer loyalty, and made a positive impact on environmental and social issues. The company’s practices illustrate the benefits of aligning profit with a commitment to broader societal responsibilities.

Evolution of Thought

A. From Profit Maximization To Broader Responsibility

  • Friedman’s Profit-Centric View: Friedman’s perspective emphasizes profit maximization as the central business objective, with limited consideration for broader social or ethical issues.
  • Carroll’s Comprehensive Model: Carroll’s Pyramid of CSR represents a significant shift, incorporating economic, legal, ethical, and philanthropic responsibilities. This model recognizes the need for businesses to balance profit with social and ethical obligations.

B. Impact On Modern CSR Practices

  • Changing Societal Expectations: The transition from Friedman’s profit-focused approach to Carroll’s broader framework reflects changing expectations, highlighting the importance of businesses contributing positively to society and the environment.
  • Influence OSn Business Behavior: Carroll’s model has influenced contemporary CSR practices by encouraging a more integrated and strategic approach. Companies are increasingly engaging in CSR initiatives that align with their values and address stakeholder concerns.
  • Corporate Governance: The shift towards Carroll’s model has impacted corporate governance by emphasizing ethical leadership, stakeholder engagement, and long-term value creation.

Conclusion

Milton Friedman’s and Archie B. Carroll’s perspectives represent distinct phases in the evolution of corporate social responsibility. While Friedman’s focus on profit maximization underscores a traditional business objective, Carroll’s Pyramid of CSR introduces a comprehensive framework that includes economic, legal, ethical, and philanthropic responsibilities. This evolution highlights a growing recognition of the broader role businesses play in society and the need for a balanced approach to corporate responsibility.

Personal Opinion

The transition from Milton Friedman’s profit-centric view to Archie B. Carroll’s multi-dimensional model of CSR marks a significant shift in how businesses understand their societal role. Friedman’s approach, with its emphasis on profit maximization, represents a traditional view where financial performance is paramount. While this perspective underscores the importance of economic efficiency and shareholder returns, it often overlooks broader social and ethical responsibilities.

In contrast, Carroll’s Pyramid of Corporate Social Responsibility offers a more comprehensive approach. By integrating economic, legal, ethical, and philanthropic responsibilities, Carroll’s model acknowledges that businesses operate within a complex societal framework. This holistic perspective aligns with contemporary values and recognizes that businesses have a crucial role in addressing social and environmental challenges.

From a modern standpoint, Carroll’s model seems more in tune with the needs and expectations of today’s stakeholders. In an era where corporate behavior is under heightened scrutiny, adopting a balanced approach to CSR can enhance a company’s reputation, build stakeholder trust, and ensure long-term success. Companies that embrace Carroll’s framework are better equipped to navigate complex social and ethical landscapes, foster meaningful community relationships, and drive positive change.

In summary, while Friedman’s focus on profit remains a core element of business, Carroll’s expanded view represents a more progressive understanding of CSR. This evolution reflects a necessary and beneficial shift towards more responsible and impactful business practices.

Related Posts On The SimTrade Blog

▶ Anant JAIN Analysis Of “The Social Responsibility Of Business Is To Create Value For Stakeholders” Article By Freeman And Elms

▶ Anant JAIN Analysis Of The Article “The Pyramid Of Corporate Social Responsibility: Toward The Moral Management Of Organizational Stakeholders,” By Archie B. Carroll

▶ Anant JAIN Deep Dive On The Article “The Social Responsibility of Business is to Increase Its Profits” By Milton Friedman

▶ Anant JAIN Stakeholder

▶ Anant JAIN Shareholder

▶ Anant JAIN Mission Statement

▶ Anant JAIN Writing A Mission Statement

Useful Resources

“The Social Responsibility of Business is to Increase Its Profits” by Milton Friedman

“The Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders” by Archie B. Carroll

Investopedia Enron Scandal Explained

Harvard Business Review: How Patagonia Is Leading the Way in Corporate Responsibility

Stanford Social Innovation Review: The Evolution of Corporate Social Responsibility

Business & Society: A Strategic Approach to Corporate Social Responsibility

Bebchuk L, and Tallarita, R. 2020, The illusionary promise of stakeholder governance, Cornell Law Review, 106: 91-177.

About The Author

The article was written in October 2024 by Anant JAIN (ESSEC Business School, Master in Management, 2019-2022).

Understanding Price Elasticity Of Demand

Understanding Price Elasticity Of Demand

Anant JAIN

In this article, Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) introduces the economic concept of price elasticity of demand.

Introduction

Price elasticity of demand (PED) is an important economic concept that measures the impact on the demand of a product or service due to change in the price of that product or service. This concept helps businesses, policymakers, and economists make informed decisions regarding pricing strategies, economic policies, and market analysis.

Definition

Price elasticity of demand measures the degree of change in the quantity demanded of a product or service due to change in the price.

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This ratio reveals the extent to which demand for a product shift in response to price changes. For instance, if a product’s price increases by 10% and the quantity demanded decreases by 20%, the PED would be: -20%/10% = -2

The negative value indicates an inverse relationship between price and demand, consistent with the law of demand i.e. if the price of the product increases, then the demand would decrease and vice versa.

Different Methodologies Of Calculating Price Elasticity Of Demand

Point Method

The point method is more precise method than the percentage method because it calculates price elasticity of a demand curve at a specific point. It includes dividing the change in quantity demanded by the price change at a given price and quantity level. This method’s formula is:

Price elasticity = (change in quantity demanded) / (change in price) * (average price / average quantity)

Example:
A shoe retailer notes that when the price of a specific sneaker increases from $60 to $70, the quantity demanded decreases from 200 to 150 sneakers.

Calculation of Price Elasticity:

Change in quantity demanded:
150−200=−50150 – 200 = -50150−200=−50

Change in price:
70−60=1070 – 60 = 1070−60=10

Average price:
(60+70)/2=65(60 + 70) / 2 = 65(60+70)/2=65

Average quantity:
(200+150)/2=175(200 + 150) / 2 = 175(200+150)/2=175

Price Elasticity:
(−50/10)∗(65/175)=−1.86( -50 / 10 ) * ( 65 / 175 ) = -1.86(−50/10)∗(65/175)=−1.86

This example shows that the demand for the sneakers is elastic since the elasticity is greater than 1.

Arc Method

The arc method is used when there is a significant change in the price or quantity demanded between any two points on the demand curve. It is calculated by dividing the change in quantity demanded by the average of the initial and final prices and then dividing that result by the change in price divided by that average. This method’s formula is:

Price elasticity = (change in quantity demanded / average quantity) / (change in price / average price)

Example:
A airline company raises the price of its ticket from $800 to $1,000, resulting in a drop in quantity demanded from 5,000 units to 3,500 tickets.

Calculation of Price Elasticity:

Change in quantity demanded:
3,500−5,000=−1,5003,500 – 5,000 = -1,5003,500−5,000=−1,500

Average quantity:
(5,000+3,500)/2=4,250(5,000 + 3,500) / 2 = 4,250(5,000+3,500)/2=4,250

Change in price:
1,000−800=2001,000 – 800 = 2001,000−800=200

Average price:
(800+1,000)/2=900(800 + 1,000) / 2 = 900(800+1,000)/2=900

Price Elasticity:
(−1,500/4,250)/(200/900)=−1.88\left( -1,500 / 4,250 \right) / \left( 200 / 900 \right) = -1.88(−1,500/4,250)/(200/900)=−1.88

This example shows that the demand for the tickets is elastic.

Types Of Price Elasticity

Elastic Demand (PED > 1)

  • Definition: An elastic demand is where demand is highly responsive to price changes. A percentage change in price results in a higher percentage change in the quantity demanded of the product.
  • Examples: Non-essential luxury goods such as high-end electronics or designer clothing.
  • Implications: Businesses may lower prices to boost sales volumes, potentially increasing total revenue.
  • Demand Curve: As shown in Figure 1, when the price decrease from 60 to 50 i.e., 17% decrease in price, the demand increases from 70 to 100 i.e., demand increases by 42%. Therefore, a slight percentage increase in price results in greater percentage increase in the quantity demanded of the good or service. As a result, the demand curve slope is flatter and we get the price elasticity as 42%/-17% = -2.47.

Figure 1. Elastic Demand Curve.
Title

Inelastic Demand (PED < 1)

  • Definition: An inelastic demand is where demand is less responsive to price changes. Price increases or decreases have a relatively small effect on the quantity demanded.
  • Examples: Essential goods such as basic food items or essential medicines.
  • Implications: Companies can raise prices with minimal impact on sales volume, which can enhance revenue and profit margins.
  • Demand Curve: As shown in Figure 2, when the price increases from 50 to 70 i.e., 40% increase in price, the demand decreases from 80 to 70 i.e., demand decreases by 12%. Therefore, a slight percentage increase in price results in greater percentage decrease in the quantity demanded of the good or service. As a result, the demand curve slope is stepper and we get the price elasticity as -12%/40% = -0.3.

Figure 2. Inelastic Demand Curve.
Title

Unitary Elasticity (PED = 1)

  • Definition: The percentage change in quantity demanded of a product match to the percentage change in price i.e., total revenue remains constant.
  • Implications: Price adjustments need to be carefully managed to avoid altering total revenue.
  • Demand Curve: As shown in Figure 3, when the price increases from 20 to 30 i.e., 50% increase in price, the demand decreases from 160 to 80 i.e., demand decreases by 50%. Therefore, a slight percentage increase in price results in an equal percentage decrease in the quantity demanded of the good or service. As a result, the price elasticity of demand is -50%/50% = -1.

Figure 3. Unitary Elastic Demand Curve.
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Perfectly Elastic Demand (PED = ∞)

Consumers are only willing to buy at a specific price only; any change from this price will result in no demand for the product. This is a more hypothetical case and would not ideally occur in the real world.

As shown in Figure 4, the price is fixed at 50 and the quantity demanded can increase or decrease at this price only. As soon as the price is changed, the demand would become zero. As a result, the demand curve slope is parallel to the X axis and our price elasticity is equal ∞.

Figure 4. Perfectly Elastic Demand Curve.
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Perfectly Inelastic Demand (PED = 0)

The quantity demanded of a product will not change irrespective of the change in the price of that product. This is a more hypothetical case and would not ideally occur in the real world.

As shown in Figure 5, the quantity is fixed at 80. Any change in price will make the demand remain at the same level at all times. As a result, the demand curve slope is parallel to the Y axis and our price elasticity is 0/ % change in price = 0.

Figure 5. Perfectly Inelastic Demand Curve.
Title

Factors Influencing Price Elasticity Of Demand

Availability Of Substitutes

  • Influence: Products with numerous substitutes tend to have more elastic demand, as consumers can easily switch if prices rise.
  • Examples: Butter versus margarine.

Necessity VS Luxury

  • Influence: Essential goods generally exhibit inelastic demand since they are crucial for consumers, while luxury items show elastic demand as they are non-essential.
  • Examples: Insulin for diabetics (necessity) vs. high-end electronics (luxury).

Proportion Of Income

  • Influence: Products that consume a significant portion of a consumer’s income usually have more elastic demand.
  • Examples: Major appliances versus inexpensive everyday items.

Time Horizon

  • Influence: Demand elasticity can vary over time. In the short term, consumers might not change their purchasing behaviour significantly, but in the long term, they may adjust their habits as alternatives become available.
  • Examples: Buying flight ticket due to an emergency versus buying a flight ticket in advance for a holiday

Brand Loyalty

  • Influence: Strong brand loyalty can make demand more inelastic, as dedicated consumers may be less sensitive to price increases for their preferred brands.
  • Examples: Premium brands like Apple or Rolex.

Implications For Businesses & Policymakers

Pricing Strategies

Businesses use PED to optimize pricing strategies. For products with elastic demand, reducing prices might boost sales volume and total revenue. Conversely, for inelastic products, increasing prices can raise revenue without significantly affecting sales volume.

Taxation & Subsidies

Policymakers consider PED when designing taxes and subsidies. Taxes on inelastic goods, such as cigarettes, may not significantly reduce consumption but can generate substantial revenue. Subsidies on essential goods help make them more affordable and can support sustained demand.

Market Decisions

Understanding PED helps businesses with product pricing, marketing strategies, and inventory management by predicting how changes in price will affect consumer behaviour.

Implications For Financial & Stock Markets

Impact On Company Earnings & Stock Prices

  • Revenue Forecasting
    PED assists investors and analysts in forecasting a company’s revenue based on price changes. Firms with inelastic demand may experience stable revenue with price increases, while those with elastic demand might see increased sales volumes with lower prices.
  • Profit Margins
    Companies with inelastic demand can adjust prices to protect or enhance profit margins. In contrast, firms with elastic demand might face tighter margins if they need to reduce prices to maintain sales.
  • Stock Valuation
    Investors may view companies with inelastic demand as more stable, potentially leading to higher stock valuations. Conversely, companies with elastic demand might be perceived as riskier due to revenue fluctuations.
  • Pricing Power
    Pricing power is a key indicator of a company’s strength and profitability in the market. Firms with high pricing power can better withstand inflation, changes in input costs, or competitive pressures, as they have the flexibility to adjust prices to protect margins. It refers to a company’s ability to raise prices without significantly reducing the demand for its products or services. Companies with strong pricing power can increase prices while maintaining profitability because their customers are willing to pay more without switching to competitors or reducing consumption i.e., the company has a more inelastic demand curve.

For example, PED can help an investor understand the impact of change in price in the quantity demanded for an Airline company versus a pharmaceutical company. Since Pharmaceutical products are more necessary compared to an airline ticket, the Airline company has a more elastic demand compared to a pharmaceutical company. As a result, a change in price in an airline company will impact its revenue more than a pharmaceutical company.

Market Reactions To Economic Changes

  • Economic Downturns
    During recessions, companies offering inelastic products are generally less affected by reduced consumer spending, making their stocks more attractive during economic uncertainty.
  • Inflation
    In inflationary periods, firms with inelastic demand can pass on higher costs with little impact on sales volume, preserving profitability. Companies with elastic demand might face reduced sales as consumers cut back spending.

For example, if we compare a luxury handbag versus milk, hand bag is a luxury item and has a more elastic demand curve compared to milk which is a necessity with a more elastic demand curve. During inflation or recession, consumers will consume milk irrespective of the change in price of the good due to the nature of the product versus consumers may choose to delay or not purchase a handbag because it becomes more of a luxury commodity in such situations.

Investment Strategies & Market Trends

  • Sector Performance
    Knowledge of PED aids in assessing sector performance. Sectors with inelastic demand, such as consumer staples, often perform better during economic fluctuations compared to discretionary sectors with elastic demand.
  • Mergers & Acquisitions
    Companies with inelastic demand are often attractive acquisition targets due to their stable revenue streams, potentially impacting stock prices and market dynamics.

Regulatory & Policy Impacts:

  • Regulatory Changes
    Regulations that impact prices affect companies differently based on their PED. Firms with inelastic demand may absorb or pass on regulatory costs with less effect on demand, influencing market reactions.
  • Subsidies
    Government subsidies for essential goods can benefit companies with inelastic demand by maintaining or increasing sales volumes, positively affecting their financial performance and stock valuations.

For example, suppose government provides subsidies to the housing market versus essential medical goods, the consumers will increase their demand more in the housing market since it will become more affordable for the consumers. On the other hand, just because the medical goods become less expensive, consumers will not start purchasing or consuming more medicines due to the subsidy.

Conclusion

Price elasticity of demand is an essential economic concept that helps in understanding consumer behaviour and market dynamics. By grasping PED, businesses can make informed pricing decisions, and policymakers can craft effective policies. Furthermore, PED has significant implications for financial and stock markets, affecting company valuations, investment strategies, and market responses to economic conditions. A thorough understanding of PED provides valuable insights for navigating both consumer and financial markets effectively.

Related Posts On The SimTrade Blog

Useful Resources

Case Study: The Effect of Price Elasticity on Revenue – Starbucks

Case Study: Price Elasticity and Tobacco Products

Case Study: Elasticity of Demand for Luxury Goods

About The Author

The article was written in October 2024 by Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

My experience as an Accounting Assistant at Dafinity

My experience as an Accounting Assistant at Dafinity

Samia DARMELLAH

In this article, Samia DARMELLAH (ESSEC Business School, Global BBA, 2020-2024) shares her professional experience as an Accounting Assistant at Dafinity.

About Dafinity

Dafinity is a well-established accounting firm in France, dedicated to providing tailored financial services to its clients.

They offer three main services: Part-Time CFO Services, Transaction Advisory Services (TAS), and Digital Transformation Consulting (TD).

Part-Time CFO Services

This means they provide expert financial leadership to companies that may not need a full-time Chief Financial Officer. They help guide these businesses through financial challenges and support their growth.

Transaction Advisory Services (TAS)

This service helps businesses with important financial transactions, like mergers or acquisitions, ensuring everything goes smoothly.

Digital Transformation Consulting (TD)

Dafinity assists companies in automating and optimizing their financial processes, making their operations more efficient.

The firm has worked with several notable clients, including BPI France, Deepki, and Djoko. Its dedication to quality service has made it a trusted partner for many businesses.

During my three-month internship at Dafinity (Spring 2021), I had the chance to work as an Accounting Assistant. In this role, my primary responsibilities included entering accounting entries, preparing tax returns, and assisting in the monthly review of accounts. This experience allowed me to gain valuable insights into the financial processes of a leading accounting firm and sharpen my analytical skills as I learned to assess the financial health of various clients.

Logo of Dafinity.
Logo of Dafinity
Source: Dafinity.

My missions

During my three-month internship as an accounting assistant at Dafinity, I had the opportunity to dive into a variety of tasks that significantly contributed to my professional growth. Each responsibility offered a unique learning experience that enhanced my understanding of the accounting field.

One of my key tasks was entering accounting data into the firm’s systems. This role was crucial because it emphasized the importance of accuracy and attention to detail in financial reporting. I quickly learned that even the smallest error could lead to larger discrepancies down the line.

I also participated in the review of monthly accounts, where I checked financial statements for accuracy. This process provided me with valuable insights into how businesses manage their finances and maintain their financial health. It was fascinating to see firsthand the level of scrutiny that goes into ensuring financial statements are precise and reflective of reality.

Additionally, I contributed to preparing tax returns, including VAT (Value Added Tax) and other corporate taxes. This task introduced me to the complexities of tax regulations and the necessity of compliance, revealing just how critical it is for businesses to stay on top of their tax obligations.

Interacting with clients was another significant aspect of my role. I managed document requests and provided guidance, which greatly improved my communication skills. These interactions taught me the importance of understanding clients’ needs and being able to offer solutions that align with their goals.

Finally, I assisted in the preparation of documents for annual audits. This experience underscored the significance of transparency and accuracy in financial reporting. I realized that thorough preparation is key to a successful audit, reinforcing the importance of diligence in all aspects of accounting.

Required skills and knowledge

During my internship, I learned that several important skills and knowledge areas are essential for success in accounting. First, being comfortable with accounting software, particularly Excel, was crucial for tasks like entering data and analyzing financial information. Understanding basic accounting principles and tax regulations was also necessary to prepare accurate tax returns and ensure compliance with laws.

Additionally, effective communication was important because I frequently interacted with clients. Being able to explain information clearly helped build trust and ensured that clients felt supported. Attention to detail was vital, as even small errors in accounting can lead to significant issues. Finally, being able to think critically and solve problems was important when faced with challenges, like discrepancies in financial records.

Overall, these experiences helped me grow and prepared me for future opportunities in finance.

What This Experience Brought Me

My time at Dafinity has been incredibly rewarding for several reasons:

Skill Development

I gained hands-on experience in accounting and finance, which complements what I’ve learned in school. This practical knowledge will be invaluable as I continue my career.

Understanding the Firm’s Environment

Working at Dafinity gave me a clear picture of how an accounting firm operates. I learned about the services they offer, like part-time CFO support and transaction advisory services, and how these help businesses succeed.

Interpersonal Skills

Working with clients improved my communication skills and taught me how important it is to build good relationships in a professional setting. Understanding client needs and providing solutions is key to success.

Financial concepts related my internship

Cash-flow

Cash flow refers to the movement of money in and out of a business, indicating its liquidity and financial health. It is essential for maintaining operations and meeting obligations. During my internship at Dafinity, I gained insights into how businesses manage their cash flow by monitoring receivables and payables. Understanding cash flow was crucial for helping clients develop strategies to optimize their financial resources, ensuring they have enough liquidity to support their operations and growth initiatives.

Depreciation

Depreciation is the method used to allocate the cost of a tangible asset over its useful life, reflecting the asset’s reduction in value over time. This accounting concept is vital for accurate financial reporting and tax calculations. In my role as an accounting assistant, I was involved in preparing financial statements where I learned how depreciation impacts a company’s profit margins and tax liabilities. Properly accounting for depreciation helps businesses provide a clearer picture of their financial position and comply with accounting standards.

Fixed Assets

Fixed assets refer to the long-term tangible assets that a company owns and uses in its operations, such as buildings, machinery, and equipment. These assets are critical for generating revenue and sustaining operations. During my internship, I analyzed the fixed assets of clients to assess their asset utilization and long-term financial planning. Understanding the implications of fixed assets helped me recognize how investments in these assets can drive growth and efficiency, emphasizing the importance of strategic asset management in financial decision-making

Related posts on the SimTrade blog

   ▶ All posts about Professional experiences

   ▶ Louis DETALLE A quick review of the Accountant job in France…

   ▶ Lou PERRONE Free Cash Flow: A Critical Metric in Finance

Useful resources

Dafinity

About the author

The article was written in October 2024 by Samia DARMELLAH Samia DARMELLAH (ESSEC Business School, Global BBA, 2020-2024).

My Experience as a Credit Risk Portfolio Analyst at Société Générale Private Banking

My Experience as a Credit Risk Portfolio Analyst at Société Générale Private Banking

Samia DARMELLAH

In this article, Samia DARMELLAH (ESSEC Business School, Global BBA, 2020-2024) shares her professional experience as a Credit Risk Portfolio Analyst apprentice within Société Générale Private Banking.

Société Générale

Société Générale is a major player in French banking, established in 1864. According to an Xerfi study (2024), it’s the third-largest bank in France, behind BNP Paribas and Crédit Agricole (in terms of net banking income (NBI)), and plays a crucial role in the financial landscape. It also ranks as the sixth-largest bank in Europe and the twenty-first largest worldwide.

I have the opportunity to work as a Credit Risk Portfolio Analyst apprentice within Société Générale Private Banking for two and a half years (2022-2024). In this role, my primary responsibility was to assess and monitor the risks associated with the loans provided by the private bank.

Logo of Société Générale.
Logo of Société Générale - Credit Risk Portfolio Analyst
Source: Société Générale.

What is a Credit Risk Portfolio Analyst?

A Credit Risk Portfolio Analyst, also called “Credit Risk Analyst,” has the principal task of monitoring the bank’s credit portfolios to ensure that counterparties (borrowers) can repay their debts. In other words, we continuously evaluate the financial health of borrowers, whether companies or individuals, to prevent potential losses for the bank.

In the private banking sector at Société Générale, clients are often wealthy individuals or companies with significant assets. This sometimes complicates risk assessment, as we need to analyze various types of assets used as collateral, such as stocks, bonds, or mutual funds.

My missions

1. Credit Portfolio Monitoring

One of my responsibilities is closely monitoring the bank’s credit portfolio, particularly those of private clients. This involves daily analysis of ongoing loans and assessing potential risks associated with changes in the economic and financial situation of borrowers.

I am also responsible for producing credit risk reports, where I analyze indicators such as Exposure At Default (EAD), Expected Credit Loss (ECL), and Risk-Weighted Assets (RWA). These data points help us identify where the risks lie and how best to respond to them.

2. Credit Provisioning

Another essential part of my job involves credit provisioning. In collaboration with financial and commercial teams, I help identify weakened counterparties—borrowers who may struggle to repay their debts. My role is to determine the necessary level of provisions to cover the risks, a delicate exercise that requires both caution and anticipation.

3. Stress Tests on Financial Assets

Another important mission involves stress tests. These tests simulate adverse economic scenarios to assess how the credit portfolio would react under such conditions. For example, we simulate a sharp drop in financial markets or an economic crisis and analyze the impact on collateralized assets such as stocks, bonds, and mutual funds. These simulations help us prepare for unforeseen events and ensure better risk management.

4. Regulatory Projects

The banking sector is highly regulated, and I am involved in implementing new regulatory projects. This includes, for example, adapting to new European and international standards, such as those set by the Basel Committee, which dictate rules on credit risk management. This work involves a lot of coordination between teams and requires an understanding of the technical implications of these regulations.

Required skills and knowledge

Throughout my apprenticeship, I develop a strong set of skills. Firstly, mastering financial tools specifically, I improve my Excel skills, essential for analyzing and manipulating complex financial data. I also work with specific banking risk management tools to assess credit risk and produce the required reports.

Additionally, risk assessment requires a keen eye for numbers, great rigor, and critical analytical skills. It is crucial to quickly identify warning signs while managing large volumes of data.

Finally, my role involves many interactions with commercial, financial, and regulatory teams. I learn to communicate my analyses clearly and collaborate closely with different stakeholders, which is essential for successfully managing risk projects.

What This Experience Brought Me

Working within the Risk Management department at Société Générale Private Banking has been a particularly enriching experience. I have the opportunity to work on complex topics and gradually gain autonomy. This position allows me to understand all aspects of credit risk management and the strategic implications for a major private bank.

I also have the chance to evolve in an environment that values continuous learning. I was able to train continuously, whether through exchanges with bank experts or internal training sessions. This experience has truly been a steppingstone for my future career, opening up numerous opportunities in the field of risk management and finance.

In conclusion, this apprenticeship as a Credit Risk Portfolio Analyst has been one of the most formative human and professional experiences. It allows me to acquire solid technical and analytical skills while immersing myself in the core issues of risk management for a major banking institution.

Financial concepts related my internship

Probability of Default (PD)

Probability of Default (PD) is a measure of how likely it is that a borrower will fail to repay a loan. It’s essentially an estimate of the probability that a company or individual won’t meet their financial obligations. Banks use this to assess how risky a loan might be before lending money.

Loss Given Default (LGD)

LGD measures the percentage of a loan that a lender expects to lose in case of default, after accounting for recoveries from collateral. It’s a key component in determining credit risk exposure. LGD is often combined with PD to calculate potential credit losses.

Stress Test

A stress test simulates adverse economic conditions to evaluate how a financial institution or portfolio would react to crises. It’s used to identify vulnerabilities and assess the resilience of assets under extreme scenarios. Stress tests are essential for risk management and regulatory compliance.

Why should I be interested in this post?

If you’re interested in the world of finance, the position of Credit Risk Portfolio Analyst offers a valuable opportunity. This role involves assessing and managing credit risk for high-net-worth individuals and large corporations, providing exposure to various areas of finance. You will be responsible for monitoring loan portfolios, conducting financial analysis, and preparing detailed reports, all of which require strong analytical skills and attention to detail.

I highly recommend pursuing this position, especially within a banking institution. Working at a bank allows you to gain essential experience in risk management with less complex credit situations. Once you have a solid foundation, you can consider advancing to roles in investment funds, where the stakes and responsibilities are significantly higher.

Related posts on the SimTrade blog

   ▶ All posts about Professional experiences

   ▶ Jayati WALIA Credit Risk

   ▶ Matthieu MENAGER My professional experience as a credit analyst at Targobank

Useful resources

Presentation of Société Générale

Le risque de crédit – Cairn.info

L’univers des risques en finance – Cairn.info

About the author

The article was written in October 2024 by Samia DARMELLAH Samia DARMELLAH (ESSEC Business School, Global BBA, 2020-2024).

Recent Financial Innovations in China in the 2020s

Recent Financial Innovations in China in the 2020s

Samia DARMELLAH

In this article, Samia DARMELLAH (ESSEC Business School, Global BBA, 2020-2024) present recent financial innovations in China in the 2020s.

Introduction

During my academic exchange at Fudan University in China, I was captivated by the innovation and dynamism of the financial sector. In 2024, China is considerably ahead of other countries in terms of financial progress, reshaping the services landscape with revolutionary technologies. In this article, we will explore some of the most striking developments, including the rise of digital payments, blockchain integration, Intelligence Artificial in China, robo-advisors and the launch of the Digital Yuan.

By diving into these innovations, the aim is to show how they are improving the efficiency of financial services while creating new opportunities for businesses and consumers, providing a glimpse into the trends shaping the future of finance.

Digital Payments via QR Codes

Digital payments have become a revolution in China, especially those made using QR codes. Whether shopping or paying for a cab, scanning a QR code is the most common method. This trend was driven primarily by Covid-19 and has since multiplied across the country. By June 2024, over 969 million users were actively making payments via applications such as WeChat Pay and Alipay, according to Statista’s report on mobile payment users in China, published in 2024. What’s fascinating is the extent to which this practice has become ingrained in everyday life: almost 72% of consumers will regularly use mobile payments by early 2024.

Payment via QR Code.
Payment via QR Code
Source: Google Image.

Although mobile payments in physical stores have fluctuated, reaching almost 84% in the second third quarter of 2024 before dropping and rising again to 72% in the first quarter of 2024 according to Statista. Digital transaction trends remain strong and dominant across China, facilitating billions of transactions seamlessly and securely.

Blockchain for Security and Transparency

Blockchain is a technology that allows a database to be shared in a decentralized manner, that is, between actors who do not necessarily trust each other and without a central controlling entity. In China, blockchain technology has become an essential pillar of financial security and transparency. It has enormous potential, according to a study carried out by Statista between 2017 and 2022, the market size is expected to reach more than 27 billion yuan by 2025 and nearly 69 billion yuan by 2030.

One of the growing sectors that benefits from blockchain in China is logistics. Companies like Alibaba are using this technology to track goods at every stage of their shipment, from manufacturing to delivery. Thanks to blockchain, data on the origin, quality and transport conditions of products are recorded transparently and securely. This not only helps to strengthen consumer confidence, but also to combat counterfeiting, a major challenge for companies operating in China.

AI-Powered Lending

Artificial intelligence (AI) plays a major role in China, with the market reaching around 70 billion yuan in 2020. Forecasts indicate that it could reach nearly 170 billion yuan by 2026. The technology is being integrated into a variety of sectors, including healthcare, financial services, and retail. Companies like Alibaba and Baidu are investing heavily in the development of AI solutions, driving growth, and transforming the way businesses operate. China’s dominance in this field could position it as a global leader in AI in the years to come.

Size of China’s artificial intelligence economy in 2020
 Size of China's artificial intelligence economy in 2020, with forecasts until 2026, by segment (in billion yuan)
Source: Statista.

Size of China’s artificial intelligence economy in 2020, with forecasts until 2026, by segment (in billion yuan)

Robo-Advisors in Wealth Management

In China, innovation in wealth management is booming thanks to robo-advisors. These automated platforms use artificial intelligence to provide personalized investment advice, tailored to each user’s financial goals. The Chinese robo-advisor market is expected to reach $2.67 billion by 2024, with annual growth of 10% to 2027 according to Statista.

According to a BlueWeave Consulting report on artificial intelligence in China in 2024, this expansion is fueled by the growth of the middle class, which will number over 400 million people in 2020. Robo-advisors are making it easier and cheaper to access financial services.

Today, many financial companies are adopting these technologies to attract younger customers. For example, the MyBank platform, a digital bank affiliated to Ant Financial (Alibaba) uses AI algorithms to offer automated, personalized financial services. This model has transformed the way financial services are offered, making wealth management more accessible for the new generation. Robo-advisors are no longer reserved for high-net-worth investors but have also become accessible to ordinary customers. This phenomenon illustrates how China’s innovations are transforming the wealth management landscape.

The Digital Yuan and Cryptocurrencies

The digital yuan, or “e-CNY” as it is also known, is a digital version of China’s currency launched in a test phase in 2020 by the People’s Bank of China. Unlike decentralized crypto-currencies, the digital yuan is fully state-controlled, enabling secure and traceable transactions. It has revolutionized the payments market in China, offering an alternative to platforms such as Alipay and WeChat Pay. By facilitating instant payments, even offline, it has improved financial inclusion, particularly for unbanked populations.

The e-CNY also enables the government to strengthen economic surveillance and stimulate the growth of digital commerce. As the digital yuan develops, it could potentially influence the dynamics of digital currencies worldwide.

Conclusion

In summary, China’s financial sector is evolving rapidly thanks to innovative technologies that are making services more accessible and efficient. The rise of digital payments, the use of blockchain, artificial intelligence, robo-advisors and the launch of the digital yuan show how China is transforming its financial landscape. These changes are opening up new opportunities for consumers and businesses and paving the way for the future of financial services, both in China and internationally.

Related posts on the SimTrade blog

   ▶Nithisha CHALLA Top financial innovations in the 21st century

   ▶Nithisha CHALLA Top 5 companies by market capitalization in China

Useful resources

BlueWeave Consulting (2024) China Artificial Intelligence Market

Fullerton, E. J. (2022) The People’s Republic of China’s Digital Yuan: Its environment, design, and implications. Asian Development Bank

Marin-Dagannaud, G. (2017) Le fonctionnement de la blockchain. Annales Des Mines – Réalités Industrielles

Shen, K., Tong, X., Wu, T., & Zhang, F. (2022) The next frontier for AI in China could add $600 billion to its economy

Statista (2024) Number of mobile payment users in China from 2024 to June 2024

Statista (2018-2024) Mobile payments adoption in POS in China from 2018 to 2024

Statista (2017-2022) Blockchain market size in China from 2017 to 2022

Statista (2019-2026) Scale of AI industry in China by segment from 2019 to 2026

Statista (2017-2027) Robo-advisors market in China from 2017 to 2027

About the author

The article was written in October 2024 by Samia DARMELLAH (ESSEC Business School, Global BBA, 2020-2024).

How to invest in Gold

How to invest in Gold

Nithisha CHALLA

In this article, Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024) provides an overview of types of gold investments, strategies and considerations that follows.

Introduction

There is a saying from ancient times: “There is no better way to increase and preserve your buying power than through ownership of gold and silver”. It could defer from country to country, but gold remains a preferred investment in contemporary financial markets. In this article, we delve a little deeper into types of gold investments such as physical gold investments, gold certificates, mutual funds, alternative gold investments, and investment strategies and considerations.

Physical Gold Investments

This refers to purchasing physical gold through bars, coins, and jewelry.

Bullion (Bars and Coins)

Bullion refers to purchasing physical gold in the form of bars or coins. The value is directly linked to the gold price, but it comes with storage and insurance costs. Popular among collectors and investors, gold coins like the American Eagle and Canadian Maple Leaf are often considered for their liquidity and ease of trade.

Gold Bullion: coins and bars
Gold bullion and coins
Source: US Gold Bureau

Advantages and disadvantages: It is a tangible asset that has no counterparty risk and possesses universally recognized value, but it has high storage costs, insurance and liquidity issues. Larger gold bars are generally more liquid than coins, as they are easier to sell and can be divided into smaller units if needed. Whereas, some coins, especially those with limited mintage (how many were made in the first place), may be less liquid and harder to sell. Current Gold Price as of October 17, 2024, is approximately $1,950 per ounce (USD).

Jewelry

Jewelry refers to purchasing physical gold in the form of ornaments. Most of the countries like China, India, Egypt, etc. have high cultural significance and resale value for these ornaments. Several ancient ornaments are passed on to their heirs in kingdoms that hold high value.

Gold Jewelry
Gold Jewelry
Source: US Gold Bureau

Advantages and disadvantages:Jewelry is valued on its purity, craftsmanship, and market trends, but it has high wastage, and making charges. In countries like India, the wastage and making charges of gold depending on the complexity of the jewelry design could almost cost an extra one-third of the actual gold value in the ornament.

Gold Certificates

Starting in the 17th century, gold certificates were issued by goldsmiths in London and Amsterdam. These gold certificates then acted as proof of gold ownership. In time, the certificates were passed from hand to hand just like cash payments, without the hassle of having to move the gold bullion itself. In early 19th-century, US Treasury began to issue gold certificates which circulated as money until 1933, when the US government banned private gold ownership inside the United States. Today, gold certificates continue to be issued by several German and Swiss banks, as well as by gold pool programs in Australia and the US. These certificates represent ownership of a certain quantity of gold bullion or coins.

Gold Certificates
Gold Certificates width=
Source: Wikipedia

Advantages and disadvantages: Though it avoids physical storage issues and provides easy transferability, there was high counterparty risk and a lack of physical possession.

Paper Gold Investments

Gold Exchange Traded Funds (ETFs)

These funds allow investors to gain exposure to the gold price without owning the physical asset. ETFs like SPDR Gold Shares (GLD) track the gold price closely and are popular among institutional and retail investors.

Advantages and disadvantages: The main advantages of ETF’s are their ease of trading, Liquidity, and lower transaction costs. And the disadvantages are its high management fees and potential tracking errors. Added reference at the end of the article.

Several case studies examining the performance of SPDR Gold Shares (GLD) during economic downturns typically analyze how this gold-backed ETF tends to perform when broader stock markets experience significant declines, highlighting its potential as a “safe haven” asset where investors often flock to preserve wealth during times of uncertainty; this study would likely show that GLD prices often rise or remain relatively stable during economic downturns, demonstrating gold’s historical role as a hedge against market volatility.

Gold Mining Stocks

Gold stocks are shares of companies involved in the gold industry, either a mining corporation, gold Mutual Funds, or Exchange Traded Funds. It means that you own a certain part of the company, and you are entitled to any profit or loss that comes out of your investment in the gold stocks. The ETF’s here are called gold mining ETF’s and an example is VanEck Vectors Gold Miners ETF (GDX).

Advantages and disadvantages: Gold mining stocks can provide significant leverage to gold price movements. A small increase in gold prices can translate into a larger gain for the mining company’s stock.

Gold Mutual Funds

A “gold mutual fund” is a pooled investment that buys a variety of gold mining stocks, allowing you to indirectly gain exposure to the gold mining industry with less individual company risk; essentially, a gold mutual fund is a basket of gold mining stocks managed by a professional fund manager.

Advantages and disadvantages: Though it benefits from professional management and diversification, it has higher fees compared to ETFs, and less direct exposure to gold prices.

Alternative Gold Investments

  • Gold Futures and Options: Derivative contracts based on future gold prices. It has high volatility and, the potential for significant losses.
  • Gold IRAs: Individual Retirement Accounts that include physical gold. It has high tax advantages, and portfolio diversification but also has high custodial fees and storage requirements.
  • Digital Gold: Investing in gold through digital platforms that represent ownership of physical gold. It has high risks in platform reliability and cybersecurity concerns.

General Terminology in Gold Investments

Diversification: How gold can balance a diversified investment portfolio.

Hedging Against Inflation: Gold’s role in protecting against currency devaluation and inflation.

Market Timing: Strategies for buying low and selling high, technical and fundamental analysis.

Risk Management: Setting investment goals, understanding volatility, and managing exposure.

Conclusion

Gold remains the top choice for many investors for portfolio diversification or protection against economic instability. This precious metal has held its value over centuries. While market prices fluctuate, many still choose to buy gold to secure their financial future.

Why should I be interested in this post?

Gold has been a key financial asset for centuries, acting as a store of value, a hedge against inflation, and a safe-haven asset during economic crises. Understanding its investment options helps students grasp fundamental market dynamics and investor behavior, especially during periods of economic uncertainty.

Related posts on the SimTrade blog

   ▶ Nithisha CHALLA History of Gold

   ▶ Nithisha CHALLA Gold resources in the world

Useful resources

Academic research

Bogle, John C. (2007). The Little Book of Common Sense Investing. John Wiley & Sons.

Erb, C.B., and C.R. Harvey (2013) The Golden Dilemma. Financial Analysts Journal 69 (4): 10–42.

Erb, C.B., and C.R. Harvey (2024) Is there still a Golden Dilemma. Working paper.

Business

World Gold Council Gold spot prices

Bloomberg Investing in Gold: Is Gold Still a Good Inflation Hedge in a Recession?

Focus economics Gold: The Most Precious of Metals

Gold Avenue What is a gold ETF?

Seeking Alpha GLD: Why Gold Should Be Your First Portfolio Pick In A Recession

Other

Wikipedia Gold

About the author

The article was written in October 2024 by Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024).

The Price of Gold

The Price of Gold

Nithisha CHALLA

In this article, Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024) explores the complexities behind gold pricing, key external drivers, and historical trends.

Introduction

Gold has been a store of value and medium of exchange for centuries, its price deeply rooted in global economic, political, and financial systems. In modern markets, the price of gold is influenced by a range of factors, from macroeconomic conditions to geopolitical tensions.

What Is the Gold Price?

The gold price is the market value of one troy ounce of gold. It is quoted in terms of various currencies, most notably the U.S. dollar (USD). The price fluctuates based on supply and demand dynamics in international markets, and gold is traded on commodity exchanges such as the London Bullion Market Association (LBMA) and COMEX in the United States.

When studying gold price there are two terms we certainly come across, they are Spot Price and Futures Price. Spot Price is the current market price at which gold can be bought or sold for immediate delivery. The futures price is the agreed-upon price for gold to be delivered at a future date, which can differ from the spot price due to expectations of future market conditions.

Figure 1 below gives the evolution of the gold price over the period January 1971-September 2024.

Figure 1. Evolution of the Gold price
 Gold price chart January 1971-September 2020
Source: Wikipedia

Key factors affecting gold price

Supply and demand dynamics

The fundamental economic principle of supply and demand plays a crucial role in determining the price of gold. However, unlike consumable commodities, the supply of gold remains relatively stable since most of the gold ever mined is still in existence.

  • Global gold production:

    New gold production, primarily from mining, adds a limited amount to the existing gold supply. Countries like China, Australia, and Russia are major gold producers, and changes in production levels can impact prices.
  • Jewelry and industrial demand:

    Jewelry accounts for a significant portion of global gold demand, particularly in countries like India and China. In addition, gold has applications in technology, particularly in electronics and medical devices.
  • Economic Conditions:

    During economic prosperity, people may be more inclined to purchase gold jewelry for personal adornment or as a status symbol. However, during economic downturns, demand for jewelry may decline.
  • Central Banks:

    Central banks can significantly impact gold prices by buying or selling gold reserves. Their actions can influence market sentiment and prices.
  • Technology:

    Gold is used in various industries, including electronics, dentistry, and aerospace. Advancements in technology can drive demand for gold in these sectors.

Inflation and gold as a hedge

Gold is traditionally seen as a hedge against inflation. When inflation rises, the purchasing power of fiat currencies decreases, leading investors to seek refuge in assets like gold, which tend to maintain value over time. During periods of high inflation, such as the 1970s, gold prices surged as investors sought protection against currency devaluation.

Erb and Harvey (2013) observed that a common argument for investing in gold is that it is an inflation hedge, a golden constant. The golden constant can be considered as a collection of statements that assert that over a long time, the purchasing power of gold remains largely the same; in the long run, inflation is a fundamental driver of the price of gold; deviations in the nominal price of gold relative to its inflation-adjusted price will be corrected; and in the long run, the real return from owning gold is zero.

Interest rates and opportunity cost

There is a strong inverse relationship between gold prices and interest rates. When interest rates are low, the opportunity cost of holding non-yielding assets like gold decreases, making gold more attractive to investors. The period of low interest rates following the 2008 financial crisis led to a sharp increase in gold prices as central banks worldwide implemented loose monetary policies.

U.S. dollar strength

Gold is priced in U.S. dollars, so fluctuations in the value of the dollar have a direct impact on gold prices. When the U.S. dollar strengthens, gold becomes more expensive for foreign buyers, potentially reducing demand and lowering prices. In 2014, the strengthening of the U.S. dollar against other major currencies contributed to a decline in gold prices.

Figure 2 below gives the evolution of the gold price against the US dollar.

Gold price vs US dollar
 Gold price vs US dollar
Source: Bloomberg

Central bank policies

Central banks around the world hold substantial gold reserves, and their buying or selling behavior can influence gold prices. In recent years, central banks, particularly in emerging markets, have increased their gold holdings to diversify reserves away from fiat currencies like the U.S. dollar. Russia and China have been among the largest buyers of gold in recent years, which has helped support the price of gold.

Gold as a hedge against global financial crises

  • The role of gold in times of crisis: Gold is widely regarded as a hedge during financial crises. Investors tend to flock to gold during periods of extreme volatility in stock markets or global currency markets. The COVID-19 pandemic is the most recent example, where gold rallied to record highs as economies around the world faced unprecedented challenges. During the 2008 financial crisis, gold prices surged as investors sought alternatives to failing banking institutions and depreciating fiat currencies.
  • Currency devaluation and hyperinflation: In countries facing hyperinflation or severe currency devaluation, such as Venezuela or Zimbabwe, gold has acted as a critical asset to preserve wealth. When a nation’s currency rapidly loses value, gold remains a valuable and stable store of wealth

Gold price and its relationship with other assets

Gold vs stock market

Gold often moves inversely to the stock market. During periods of stock market decline or volatility, investors tend to move funds into gold, leading to price increases. However, in bull markets, gold may lag as investors seek higher returns in equities. For example, during the 2008 financial crisis, while global stock markets crashed, gold prices surged as it became a safe-haven asset.

Gold vs bonds

There is a similar inverse relationship between gold and bond yields, especially U.S. Treasury yields. When bond yields are low, the opportunity cost of holding gold decreases, making it more attractive. Conversely, rising bond yields can lead to lower demand for gold as bonds offer better returns.

Gold vs. cryptocurrencies

The rise of cryptocurrencies like Bitcoin has sparked debate about whether these digital assets could replace gold as a store of value. Although both assets are seen as alternatives to fiat currency, gold has a longer history and is less volatile. Cryptocurrencies offer higher potential for speculative gains, but their price volatility makes gold the preferred haven during financial crises.

The Future of gold prices

Increasing Central Bank Demand: Central banks, particularly in emerging markets, are expected to continue increasing their gold reserves, further supporting demand and prices.

The rise of digital assets such as Bitcoin has led to debates about whether cryptocurrencies could replace gold as a store of value. While some investors are shifting toward crypto, gold remains a trusted asset with thousands of years of history backing its status as a safe haven

Conclusion

The gold price is a reflection of a wide array of global economic and political factors, from inflation and central bank policies to geopolitical risks and financial market stability. While gold’s role as a hedge against inflation and a safe-haven asset remains unchanged, its interactions with modern financial markets, including competition from digital assets like cryptocurrencies, continue to evolve. Investors and central banks alike look to gold as a reliable store of value, particularly in times of uncertainty.

Why should I be interested in this post?

Gold has been a key financial asset for centuries, acting as a store of value, a hedge against inflation, and a safe-haven asset during economic crises. Understanding its investment options helps students grasp fundamental market dynamics and investor behavior, especially during economic uncertainty.

Related posts on the SimTrade blog

   ▶ Nithisha CHALLA History of Gold

   ▶ Nithisha CHALLA Gold resources in the world

Useful resources

Academic research

Erb, C.B., and C.R. Harvey (2013) The Golden Dilemma. Financial Analysts Journal 69 (4): 10–42.

Erb, C.B., and C.R. Harvey (2024) Is there still a Golden Dilemma. Working paper.

Business resources

World Gold Council Gold spot prices

Bloomberg Investing in Gold: Is Gold Still a Good Inflation Hedge in a Recession?

Focus economics Gold: The Most Precious of Metals

Other

Wikipedia Gold

About the author

The article was written in October 2024 by Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024).

Deep Dive On The Article “The Social Responsibility of Business is to Increase Its Profits” By Milton Friedman

Deep Dive On The Article “The Social Responsibility of Business is to Increase Its Profits” By Milton Friedman

Anant Jain

In this article, Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) talks about Friedman’s article on “The Social Responsibility of Business is to Increase Its Profits” published in the New York Times Magazine in 1970.

Introduction

In his article in The New York Times Magazine in 1970, Milton Friedman articulated his viewpoint on the role of businesses in society. He posits that the foremost social responsibility of a business is to maximize profits for its shareholders, provided it operates within the bounds of legal and ethical standards. Friedman’s critique of corporate social responsibility (CSR) reflects the classical economic theory of the time and provides a framework for understanding business operations.

Overview Of Friedman’s Arguments

Here is a detailed summary of his arguments:

1. Central Argument: Profit Maximization

The core opinion of Friedman is that businesses predominantly exist to generate profits. According to Friedman, the essence of a business is to enhance shareholder value by maximizing their financial returns. This perspective is deeply rooted in classical economic theory, which views profit maximization as a key driver of economic efficiency and growth. Friedman argues that corporate executives are fiduciaries who must act in the best interests of shareholders, focusing on strategies that enhance financial performance. He believes that this profit-centered approach not only benefits shareholders but also contributes to broader economic prosperity by promoting investment, innovation, and job creation.

2. Separation Of Business & Government Roles

Friedman emphasizes a clear distinction between the roles of business and government. He argues that businesses should refrain from engaging in social responsibility activities—such as philanthropy or environmental initiatives—because these functions should be managed by governmental institutions and individuals who might in fact be a shareholder of the business in context making an individual choice According to Friedman, when businesses undertake social responsibilities, they are effectively making decisions about how resources should be allocated, a role he believes should be reserved for government and elected officials. He asserts that such overreach by businesses can disrupt democratic processes and undermine the principles of a free market economy.

3. Adherence To Legal & Ethical Standards

While supporting for profit maximization, Friedman underlines that businesses must function within legal and ethical borders. He contends that profit generation should not come at the expense of illegal or unethical behavior. For Friedman, ethical business conduct involves adherence to laws and regulations rather than engaging in socially responsible activities. He argues that businesses should play by the “rules of the game,” which include fair competition and honesty, without diverting resources or attention to social causes.

4. Critique Of Corporate Social Responsibility (CSR)

Friedman is critical of CSR, arguing that it often serves as a facade for executives to pursue personal values or political agendas at the expense of shareholders. He suggests that CSR initiatives can be ambiguous, lack clear accountability, and lead to inefficiencies. According to Friedman, when executives invest in CSR, they are effectively imposing costs on shareholders that could otherwise be distributed as profits. This approach, he argues, can create conflicts of interest and dilute the focus on maximizing shareholder value. Friedman’s critique reflects his belief that CSR is often more about the personal preferences of executives than about genuine social impact.

5. Impact On Business Philosophy

Friedman’s article has been a critical touchstone in discussions about the role of business in society. His argument that businesses should focus solely on profit maximization has been both defended and contested over the years. Supporters of Friedman’s view argue that a singular focus on profit drives economic growth, innovation, and efficiency. Critics, however, argue that this perspective is overly narrow and fails to address the broader social and environmental impacts of business activities.

Implications & Outcome Of Friedman’s Theory

Profit-Oriented Focus

Friedman’s emphasis on profit maximization reinforces the idea that the primary purpose of a business is to generate financial returns for shareholders. This focus is based on the belief that pursuing profits contributes to overall economic efficiency and job creation.

Limitations Of Traditional Responsibility

The article highlights limitations in traditional views of corporate responsibility. Friedman’s stance against business involvement in social issues may overlook the broader impacts of corporate activities on society and the environment.

Shifting Perspectives

The rise of CSR and sustainability practices signifies a shift towards recognizing that businesses have broader responsibilities. Companies are increasingly expected to balance financial success with positive societal contributions, reflecting a growing understanding that business success is intertwined with the well-being of stakeholders and the environment.

Relevance In Today’s Business World

Friedman’s argument, while influential, is increasingly viewed as less applicable in the context of contemporary business practices. Now days, businesses are recognizing that their impact extends beyond financial performance. Here are some examples contrasting Friedman’s views with today’s business practices:

Friedman’s View: Profit-First Approach

Example: Enron’s aggressive pursuit of profits through unethical financial practices exemplifies the risks associated with an exclusive focus on profit maximization. The company’s collapse highlights the potential consequences of prioritizing profit over ethical considerations and legal compliance.

Today’s Business Practices: CSR Integration

Example: Patagonia: Patagonia is a leading example of integrating CSR with its business strategy. The company prioritizes environmental sustainability by using recycled materials and supporting environmental causes. This approach demonstrates how businesses can align profitability with positive social and environmental impact, reflecting a modern understanding of corporate responsibility.

Friedman’s View: Minimal Social Engagement

Example: Historically, tobacco companies focused on profit maximization while downplaying the health risks associated with smoking. This narrow focus on profitability led to significant ethical and legal issues, illustrating the limitations of a profit-only approach.

Today’s Business Practices: Proactive Social Responsibility

Example: Ben & Jerry’s actively engages in social activism and supports various causes, such as racial justice and climate action. The company’s integration of social issues into its business model reflects a modern approach where CSR is an essential component of corporate strategy.

Friedman’s View: Profit Maximization With Potential Ethical Conflicts

Example: Volkswagen’s Emissions Scandal where Volkswagen’s focus on profit maximization led to unethical behavior, including emissions cheating. This scandal highlights the dangers of prioritizing profit over ethical standards and regulatory compliance.

Today’s Business Practices: Ethical & Sustainable Focus

Example: Tesla’s commitment to advancing renewable energy and electric vehicles demonstrates how modern businesses can pursue profitability while addressing environmental concerns. Tesla’s approach reflects a balance between financial success and positive contributions to sustainability.

Conclusion

In my opinion, Friedman’s article represents a seminal viewpoint in the discourse on corporate responsibility, reflecting a classical economic perspective that prioritizes profit and efficiency. While his views were groundbreaking at the time, they have faced considerable scrutiny as the expectations of businesses have evolved. The increasing emphasis on CSR and sustainability reflects a broader understanding of the role businesses play in society, extending beyond mere profit generation to include positive contributions to social and environmental well-being.

Related Posts On The SimTrade Blog

▶ Anant JAIN Analysis Of “The Social Responsibility Of Business Is To Create Value For Stakeholders” Article By Freeman And Elms

▶ Anant JAIN Analysis Of The Article “The Pyramid Of Corporate Social Responsibility: Toward The Moral Management Of Organizational Stakeholders,” By Archie B. Carroll

▶ Anant JAIN Milton Friedman VS Archie B. Carroll On CSR

▶ Anant JAIN Stakeholder

▶ Anant JAIN Shareholder

▶ Anant JAIN Mission Statement

▶ Anant JAIN Writing A Mission Statement

Useful Resources

Milton Friedman (13/09/1970): The Social Responsibility of Business is to Increase Its Profits – The New York Times Magazine

Harvard Business Review – “Friedman vs. Stakeholder Theory: A Comparison”

Patagonia’s Approach to Corporate Social Responsibility

Ben & Jerry’s Social Activism and CSR Practices

Tesla’s Commitment to Sustainability and Innovation

About The Author

The article was written in September 2024 by Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Analysis Of The Article “The Pyramid Of Corporate Social Responsibility: Toward The Moral Management Of Organizational Stakeholders,” By Archie B. Carroll

Analysis Of The Article “The Pyramid Of Corporate Social Responsibility: Toward The Moral Management Of Organizational Stakeholders,” By Archie B. Carroll

Anant Jain

In this article, Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) talks about the article “The Pyramid Of Corporate Social Responsibility: Toward The Moral Management Of Organizational Stakeholders,” by Archie B. Carrol.

Introduction

Archie B. Carroll introduces in this article a structured framework that delineates the various levels of corporate social responsibility (CSR). Carroll’s pyramid framework categorizes CSR into four distinct levels—economic, legal, ethical, and philanthropic responsibilities—providing a comprehensive approach to understanding and implementing CSR. This model aims to help businesses navigate their multifaceted roles and obligations to stakeholders.

This detailed summary will explore each level of Carroll’s pyramid with relevant real-life examples to illustrate how companies address these responsibilities. Additionally, it will critique the model’s applicability and effectiveness in today’s rapidly evolving business environment, considering the complexities and dynamic nature of contemporary CSR practices.

Figure 1. The Pyramid Of Corporate Social Responsibility.
Pyramid Of CSR
Source: Archie B. Carroll

Detailed Summary of Carroll’s Pyramid Model

1. Economic Responsibilities

Definition: Economic responsibilities, at the bottom of Carroll’s pyramid, represent the fundamental duty of businesses to be profitable. This profitability ensures the survival and growth of the organization, allowing it to provide returns to shareholders, create jobs, and contribute to economic development.

Example: Apple’s success in the technology market, driven by its innovative products and strong financial performance, exemplifies how economic viability supports further investment and growth. Apple’s profitability enables it to fund research and development, maintain competitive advantage, and address higher-level CSR responsibilities.

2. Legal Responsibilities

Definition: The second level involves compliance with laws and regulations. Businesses are expected to adhere to legal standards covering labor practices, environmental regulations, health and safety, and other statutory requirements.

Example: Johnson & Johnson has faced various legal challenges, such as lawsuits related to product safety. In response, Johnson & Johnson has strengthened its compliance measures and regulatory practices, including enhanced quality control and transparent reporting, to meet and exceed legal standards.

3. Ethical Responsibilities

Definition: Ethical responsibilities go beyond legal obligations, focusing on doing what is morally right. This includes fairness, transparency, and respect for stakeholder rights, even in the absence of legal requirements.

Example: Ben & Jerry’s is known for its commitment to social justice, Ben & Jerry’s engages in ethical practices by advocating for issues like racial justice and climate change. The company’s initiatives, such as supporting fair trade and environmental sustainability, demonstrate its adherence to ethical standards beyond legal requirements.

4. Philanthropic Responsibilities

Definition: At the top of the pyramid, philanthropic responsibilities involve voluntary actions that benefit society, such as charitable donations and community engagement. These actions are not mandatory but contribute to societal well-being.

Example: Through the Starbucks Foundation and various community initiatives, Starbucks supports causes such as youth empowerment and disaster relief. Its philanthropic efforts enhance community relations and contribute positively to societal development.

Critiques Of Carroll’s Model In Today’s Context

Hierarchical Structure Limitations

Critique: The pyramid’s linear progression may not fully capture the complex and interconnected nature of CSR in today’s business environment. Modern companies often address multiple CSR levels simultaneously rather than sequentially.

Example: Unilever’s Sustainable Living Plan integrates economic, legal, ethical, and philanthropic goals into a cohesive strategy, reflecting a more integrated approach to CSR than the hierarchical model suggests.

Contextual Variability

Critique: The model’s general framework may not account for industry-specific and regional variations in CSR expectations. Different sectors and geographic areas may have unique challenges and standards that are not fully addressed by the pyramid.

Example: In the oil and gas industry, CSR involves addressing environmental impacts and engaging with local communities. Shell’s CSR practices must navigate industry-specific challenges, highlighting the need for tailored strategies beyond the pyramid’s generic levels.

Evolving Stakeholder Expectations

Critique: The pyramid might not exhibit the accelerated evolution of stakeholder’s expectations. Today’s stakeholders demand real-time responsiveness and transparency on social, environmental, and ethical issues, which may not be fully captured by a static model.

Example: Nike’s response to scrutiny over labor practices and environmental impact illustrates the need for agile and responsive CSR strategies that address contemporary stakeholder concerns in real-time.

Integration Of Global & Local Perspectives

Critique: Carroll’s model may overlook the need for integrating global and local CSR perspectives. Multinational companies often need to balance global CSR standards with local expectations and regulations.

Example: McDonald’s adapts its CSR strategies to address regional issues, such as nutrition and community engagement, demonstrating the importance of localized CSR initiatives alongside global commitments.

Future Of Corporate Social Responsibility

Greater Emphasis On Sustainability & Climate Action

Trend: As climate change becomes an increasingly urgent issue, businesses are expected to prioritize sustainability and integrate climate action into their CSR strategies. Companies will likely face growing pressure from consumers, investors, and regulators to adopt environmentally friendly practices and reduce their carbon footprint.

Example: Microsoft has committed to becoming carbon negative by 2030, investing in renewable energy, and enhancing its sustainability initiatives. This commitment reflects the increasing importance of environmental stewardship in modern CSR strategies.

Increased Focus On Social Equity & Inclusion

Trend: Social equity and inclusion are becoming central to CSR efforts. Companies are expected to address issues such as diversity, equity, and inclusion (DEI) and contribute to social justice initiatives. Stakeholders are demanding more transparency and accountability regarding how businesses handle these issues.

Example: Salesforce has made significant strides in promoting DEI through its workforce, policies, and community engagement. The company’s efforts include setting ambitious diversity goals and supporting social justice causes, reflecting the growing emphasis on social equity in CSR.

Integration Of Technology and Innovation

Trend: Technology and innovation are increasingly being integrated into CSR strategies to address social and environmental challenges. Businesses are leveraging digital tools and data to enhance transparency, track progress, and develop innovative solutions for CSR issues.

Example: IBM is utilizing technology to drive CSR efforts, such as using artificial intelligence for environmental monitoring and developing blockchain solutions for supply chain transparency. These innovations support more effective and measurable CSR outcomes.

Enhanced Stakeholder Engagement & Collaboration

Trend: Companies are recognizing the importance of engaging with a broader range of stakeholders, including local communities, NGOs, and industry partners. Collaborative approaches are being emphasized to address complex social and environmental challenges more effectively.

Example: Nestlé engages with various stakeholders through its Creating Shared Value (CSV) program, collaborating with NGOs, governments, and local communities to address issues such as nutrition, water stewardship, and rural development. This collaborative approach enhances the impact of its CSR initiatives.

Conclusion

Carroll’s pyramid model offers a foundational framework for understanding CSR by categorizing economic, legal, ethical, and philanthropic responsibilities. While it provides valuable insights, the model’s hierarchical approach may not fully address the complexities of modern CSR. Companies today often engage in integrated, context-specific, and responsive CSR practices that reflect evolving stakeholder expectations and industry-specific challenges.

The real-life examples illustrate how businesses are adapting their CSR strategies to meet contemporary demands, suggesting the need for a more flexible and nuanced approach to CSR beyond Carroll’s pyramid. Looking to the future, CSR is expected to increasingly focus on sustainability, social equity, technological innovation, and enhanced stakeholder engagement, reflecting the dynamic and evolving nature of corporate responsibility in today’s world.

Related Posts On The SimTrade Blog

▶ Anant JAIN Analysis Of “The Social Responsibility Of Business Is To Create Value For Stakeholders” Article By Freeman And Elms

▶ Anant JAIN Deep Dive On The Article “The Social Responsibility of Business is to Increase Its Profits” By Milton Friedman

▶ Anant JAIN Milton Friedman VS Archie B. Carroll On CSR

▶ Anant JAIN Stakeholder

▶ Anant JAIN Shareholder

▶ Anant JAIN Mission Statement

▶ Anant JAIN Writing A Mission Statement

Useful Resources

Archie B. Carroll “The Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders”

Apple’s Corporate Social Responsibility

Johnson & Johnson Legal Challenges

Ben & Jerry’s Social Justice Initiatives

Starbucks’ Social Impact Report

Unilever’s CSR Strategy

Shell’s CSR and Sustainability

Nike’s Response to Labor Practices

McDonald’s Local Initiatives

About The Author

The article was written in September 2024 by Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

Understanding Hyperinflation: Causes, Effects And Examples

Understanding Hyperinflation: Causes, Effects And Examples

Anant Jain

In this article, Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022) talks about Hyperinflation.

Introduction

Hyperinflation is an extreme economic scenario where prices increase at an incredibly fast rate, far beyond normal inflation. Unlike gradual inflation, where prices rise slowly over time, hyperinflation can cause prices to double in just days or even hours. This article explores the causes and effects of hyperinflation, along with some significant historical examples, to provide a thorough understanding of this severe economic issue.

What Is Hyperinflation?

Hyperinflation is an economic situation when the inflation rates go beyond 50% per month. In such situations, the value of the local currency diminishes rapidly in that country, leading consumers and businesses to reduce their currency holdings. As a result, prices soar while the currency’s value plummets, creating a vicious cycle that exacerbates the economic turmoil.

Causes Of Hyperinflation

Hyperinflation can be triggered by various factors, often working together: excessive money supply, loss of confidence, demand-pull inflation, and cost-push inflation.

Excessive Money Supply

A major cause of hyperinflation is when a central bank excessively prints money without corresponding economic growth. This devalues the currency, as seen in Zimbabwe, where the government printed money to fund a war and other expenditures, leading to runaway inflation.

Loss Of Confidence

When people lose trust in a currency, they rush to spend it, increasing the velocity of money. This quickened circulation of money drives prices up further. In Weimar Germany, the loss of confidence in the mark led to a rapid decline in its value, worsening inflation.

Demand-Pull Inflation

Hyperinflation can also result from demand-pull inflation, where demand for goods and services surpasses supply. If not managed, this can spiral into hyperinflation. For example, during the Yugoslav hyperinflation, economic sanctions and the collapse of the economy led to demand outpacing supply.

Cost-Push Inflation

When production costs rise, businesses pass these costs on to consumers through higher prices. If these cost increases are widespread and persistent, they can contribute to hyperinflation. Hungary experienced this after World War II, when the destruction of infrastructure and the need for rebuilding led to severe cost-push inflation.

Effects of Hyperinflation

Hyperinflation can have destructive impact for an economy: erosion of savings, distorted spending and investment, barter systems, and social and political unrest.

Erosion of Savings

As currency value collapses, savings lose their purchasing power, discouraging saving and leading to reduced investment. In Zimbabwe, many saw their life savings wiped out as the currency’s value plummeted.

Distorted Spending and Investment

People often spend money quickly to avoid holding devalued currency, leading to hoarding and speculative investments, which destabilize the economy further. In Weimar Germany, people bought durable goods like pianos and sewing machines to preserve their wealth.

Barter Systems

In extreme cases, currency becomes so worthless that people revert to barter, exchanging goods and services directly. During the Yugoslav hyperinflation, barter became common as the dinar lost all value.

Social and Political Unrest

Economic instability caused by hyperinflation can lead to social unrest and political instability, as people struggle to afford basic necessities.

Historical & Recent Examples Of Hyperinflation

Numerous countries have experienced hyperinflation, each with its own causes and consequences:

Weimar Germany (1921-1923)

After World War I, Germany experienced one of the most infamous cases of hyperinflation. The Treaty of Versailles imposed heavy reparations on Germany, and to meet these obligations, the government printed vast amounts of money. As a result, prices doubled every few days eventually leading to hyperinflation. Eventually, the government introduced a new currency and implemented fiscal reforms to stabilize the economy.

Hungary (1945-1946)

After World War II, Hungary experienced the worst hyperinflation ever recorded, with prices doubling every 15 hours at its peak. The government introduced the forint as a new currency, alongside economic reforms, to bring hyperinflation under control.

Yugoslavia (1992-1994)

Following the breakup of Yugoslavia, the country faced hyperinflation due to economic mismanagement and excessive money printing to fund the war. Prices doubled every 34 hours at the peak of the crisis, but the introduction of a new currency and international aid eventually stabilized the economy.

Venezuela (2016-Present)

Venezuela has been dealing with hyperinflation since 2016, caused by political instability, economic mismanagement, and a collapse in oil prices. At its worst, the inflation rate reached 10 million percent in 2019, leading to widespread poverty, shortages of basic goods, and a mass exodus of citizens.

Zimbabwe (2017-2020)

Zimbabwe, which previously experienced hyperinflation in the late 2000s, faced another bout starting in 2017. The government again resorted to printing money to cover its expenditures, causing inflation to exceed 500% by 2019. Although the situation has somewhat stabilized, the country still struggles with high inflation rates.

South Sudan (2016-Present)

South Sudan has been grappling with hyperinflation since 2016, exacerbated by ongoing civil conflict and disrupted oil production. The inflation rate peaked at over 800% in 2016, worsening the humanitarian crisis in the country.

Argentina (2018-Present)

Argentina’s inflation crisis worsened in 2018, driven by economic instability, rising debt, and loss of confidence in government policies. The inflation rate exceeded 50% in 2019 and remains high, despite government efforts to control it.

Lebanon (2019-Present)

Lebanon’s hyperinflation, which began in 2019, is fuelled by political instability, economic mismanagement, and a banking crisis. Their currency lost over 90% of its value, causing inflation to exceed 200% in 2020, and as a consequence, worsening the country’s economic and social crisis.

Lessons From Hyperinflation

The experiences of countries that have undergone hyperinflation offer several important lessons:

Monetary Discipline

Controlling the money supply is essential. Central banks must avoid excessive money printing and ensure that any increase in the money supply aligns with economic growth. This requires sound monetary policy and fiscal discipline.

Economic Stability

Maintaining political and economic stability is crucial for sustaining confidence in a currency. Governments should implement responsible fiscal policies, maintain balanced budgets, and avoid excessive debt.

International Support

In certain situations, international aid can help alleviate the hyperinflation and stabilize an economy facing hyperinflation. Adopting foreign currencies or securing international loans can provide temporary relief while domestic reforms are implemented. Organizations like the International Monetary Fund (IMF) can offer financial support and technical expertise.

Conclusion

Hyperinflation is a rare but catastrophic economic event that can have long-lasting impacts on a country’s economy and society. Understanding its causes and effects, and learning from historical examples, can help policymakers and economists prevent and manage such crises in the future. By maintaining monetary discipline, ensuring economic stability, and seeking international support, when necessary, countries can avoid the devastating consequences of hyperinflation.

Related Posts On The SimTrade Blog

▶ Anant JAIN The Ongoing Hyperinflation In Turkey And Its Ripple Effects On European Union

Useful Resources

The Balance What Is Hyperinflation?

BBC What Can We Learn from Past Hyperinflations?

International Monetary Fund (IMF) Hyperinflation Episodes in History

Federal Reserve Bank of St. Louis Understanding Hyperinflation

About The Author

The article was written in September 2024 by Anant JAIN (ESSEC Business School, Grande Ecole Program – Master in Management, 2019-2022).

ETFs on gold

ETFs on gold

Nithisha CHALLA

In this article, Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024) provides an overview of ETFs on gold, the major types gold ETFs in market, and the advantages and disadvantages of investing on gold ETFs.

Introduction

Gold ETFs are financial instruments that track the price of gold and allow investors to buy shares representing a fraction of physical gold holdings. The first gold ETF was launched in March 2003. Later, State Street Corporation launched SPDR Gold Shares (NYSE: GLD) in 2004, which became the largest gold-backed ETF in the world by 2019. In 2020, the Royal Mint issued the first gold ETC issued by HANetf Securities Plc, from a European sovereign entity. And after that, Wilshire Phoenix launched the wShares Enhanced Gold Trust (NYSE: WGLD) in 2021. This ETF tracks the Wilshire Gold Index, which automatically rebalances physical gold and cash based on market conditions.

Types of Gold ETFs

There are two types of gold ETFs, namely Physically Backed Gold ETFs and Synthetic gold ETF’s.

Physically Backed Gold ETFs: These ETFs invest in physical gold, held in a secure vault by the ETF provider. The units of the ETF represent a specific amount of gold. For example, one unit of a physically backed gold ETF might represent 1 gram of gold. Examples include SPDR Gold Shares (GLD) and iShares Gold Trust (IAU).

Synthetic Gold ETFs: These ETFs do not invest in physical gold. Instead, they use financial instruments, such as futures contracts or swaps, to track the price of gold. This means the ETF provider does not need to hold any physical gold.

Major Gold ETFs in the Market

SPDR Gold Shares (GLD)

SPDR offers investors an innovative, relatively cost-efficient, and secure way to access the gold market. Originally listed on the New York Stock Exchange in November of 2004, and traded on NYSE Arca (the top U.S. exchange for the listing and trading of exchange-traded funds (ETFs) ) since December 13, 2007, SPDR Gold Shares is the largest physically backed gold exchange-traded fund (ETF) in the world. SPDR Gold Shares also trade on the Singapore Stock Exchange, the Tokyo Stock Exchange, The Stock Exchange of Hong Kong, and the Mexican Stock Exchange (BMV).

Figure 1 below gives GLD share price dated from January 1, 2024, to October 11, 2024.

Figure 1. SPDR share price
SPDR share price
Source: Yahoo Finance

iShares Gold Trust (IAU)

With a global lineup of 1,400+ Exchange Traded Funds (ETFs), iShares has been a leader in the ETF marketplace for more than two decades, and as a part of BlackRock, their products are engineered by investment professionals with discipline and deep risk management expertise. It has a lower expense ratio (It is the fee that investors pay to own a mutual fund or exchange-traded fund (ETF)) compared to GLD.

Figure 2 below gives the IAU share price dated from January 1, 2024, to October 11, 2024.

Figure 2. SiShares Gold Trust (IAU) share price
SiShares Gold Trust (IAU) share price
Source: Yahoo Finance

Aberdeen Standard Physical Gold Shares ETF (SGOL)

SGOL is designed to track the spot price of gold bullion by holding gold bars in a secure vault in Switzerland. The company also posts the serial numbers of the bars, giving investors further security over the status of their investment. While SGOL isn’t the most liquid way to gain exposure to gold, it could be a solid choice for investors seeking greater peace of mind regarding their precious metals investment.

Now how do we trust the data here? To maintain the authenticity of the gold ETF’s the data is monitored in three ways, independent audits, periodic physical verifications or regulatory oversights. By ensuring the accuracy of the fund’s financial reporting and the security of its gold holdings, audits help to protect investors from fraud, mismanagement, and other risks. For example, SGOL is Audited twice a year.

Figure 3. Aberdeen Standard Physical Gold Shares ETF (SGOL) share price
Aberdeen Standard Physical Gold Shares ETF (SGOL) share price
Source: Yahoo Finance

Comparative Analysis of Gold ETFs

Gold ETFs provide a convenient way to invest in gold without the need to physically own it. They offer benefits like easy trading, lower costs, and the ability to diversify your portfolio. However, not all gold ETFs are created equal. Here’s a comparative analysis of key factors to consider when choosing a gold ETF:

  • Expense Ratios: The annual fee charged to manage the ETF. A lower expense ratio means more of your investment goes towards buying gold, rather than paying fees. Compare the expense ratios of different gold ETFs to find one with the lowest cost.
  • Liquidity and Trading Volume: The ease with which an ETF can be bought or sold at a fair price. High liquidity means you can buy or sell shares quickly without significantly affecting the price. Look for ETFs with high trading volumes to ensure liquidity.
  • Tracking Accuracy: The difference between an ETF’s performance and the performance of its underlying benchmark (usually the spot gold price). A lower tracking error indicates the ETF is more closely following the gold price.
  • Tax Considerations: How efficiently an ETF is taxed, Tax-efficient ETFs can help you minimize your tax burden. So researching the tax implications of different gold ETFs to find one that aligns with your tax strategy is highly beneficial.

The annual management fees are different for different ETFs, which is also a key factor for the investors to choose a certain ETF to invest in. For example, SPDR Gold Shares and iShares Gold Trust charge 0.25%, Invesco Gold ETF charge 0.15% and WisdomTree Physical Gold ETF charge 0.20%.

Advantages and disadvantages of Investing in Gold ETFs

Whether the advantages or disadvantages outweigh each other depends on your circumstances and investment goals.

Advantages of Investing in Gold ETFs

High liquidity: Gold ETFs are easily tradable on stock exchanges, providing investors with quick entry and exit options. They offer a convenient way to invest in gold without the need to physically store or transport the metal.

Low costs: Investors don’t need to worry about storage and security issues associated with physical gold. Additionally, the expense ratios are generally lower than mutual funds.

Diversification: Investing in gold ETFs offers a way to diversify portfolios with exposure to gold prices, often serving as a hedge against inflation and market volatility.

Disadvantages and Risks of Gold ETFs

Counterparty Risk: If the issuer of the ETF becomes insolvent, investors may face losses.

Taxes: Capital gains taxes may apply when you sell your ETF shares.

Volatility: The price of gold can be highly volatile, and gold ETFs are no exception. Investors should be prepared for potential price fluctuations.

Storage: While gold ETFs typically store their gold in secure vaults, there’s always a risk of theft or loss.

Considerations for gold investment strategies

In the end, the best investment strategy for you will depend on your circumstances and risk tolerance. By carefully considering these factors and the potential benefits and risks associated with gold ETFs, you can make informed decisions about how to incorporate them into your investment portfolio.

Portfolio diversification: A common strategy is to add gold ETFs to your investment portfolio for diversification. Gold’s price movements often correlate negatively with stocks and bonds, providing a potential haven during market downturns. By including gold in your portfolio, you can reduce overall risk and potentially improve returns over the long term.

Hedging Against Inflation: One popular strategy is to use gold ETFs as a hedge against inflation, as gold prices tend to rise when inflation is high. This can help protect your portfolio from the eroding purchasing power of your currency. Note that academic studies (see Erb and Harvey, 2013) have shown that gold may not be a good hedge against inflation.

Conclusion

Gold remains the top choice for many investors for portfolio diversification or protection against economic instability. This precious metal has held (more or less) its value over centuries. While market prices fluctuate, many still choose to buy gold to secure their financial future.

Why should I be interested in this post?

Gold has been a key financial asset for centuries, acting as a store of value, a hedge against inflation, and a safe-haven asset during economic crises. Understanding its investment options helps students grasp fundamental market dynamics and investor behavior, especially during periods of economic uncertainty.

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Useful resources

Academic research

Erb, C.B., and C.R. Harvey (2013) The Golden Dilemma. Financial Analysts Journal 69 (4): 10–42. Erb, C.B., and C.R. Harvey (2024) Is there still a Golden Dilemma Working paper.

Business

Gold Avenue What is a gold ETF?

SPDR Gold shares Bringing the gold market to investors

iShares gold trust (IAU) Why IAU?

Other

Wikipedia Gold

About the author

The article was written in October 2024 by Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management (MiM), 2021-2024).

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