Opinion: Are the global risk-free rates actually free of risks?

While I was studying corporate finance few years ago, I encountered the concept of risk-free rates: the theoretical return on an investment with zero risk of financial loss. It plays a foundational role in models such as CAPM and is at the core of how investment banks and corporate finance teams estimate the cost of equity. However, in reality, no asset is truly risk-free

This post will act as a critique to traditional methods used to calculate risk-free rates. This post aims to challenge some of the traditional methods used to estimate risk-free rates, particularly those commonly accepted in academic exercises and early-stage financial analysis. This is not an attempt to label all methodologies as flawed, but rather to shed light on their limitations of academic practices and propose a different perspective.

To frame this critique, let us understand a concept from the military history called the victory disease. Victory disease is a military term used for ancient armies who gain arrogance and complacency due to repeated triumphs, ultimately leading to irreversible downfall. During the French invasion of Russia in 1812, repeated victories convinced Napolean Bonaparte that his army is undefeatable. With this clouded judgement, Napolean sent 610,000 soldiers to annex Russia. However, Russians were well-prepared with superior tactics and weapons, leading to only 10,000 French soldiers returning alive. This is not just a single instance. History is replete with multiple such encounters. However, this is not merely restricted to history. The hubris of being infallible still exists with many developed economies and is often integrated in the way risk-free rates are computed.

The centrality of the risk-free rate is evident in its indispensable role across the most influential models in finance, especially in the Capital Asset Pricing Model (CAPM). Despite its theoretical relevance, every investment, despite being highly secure, carries at least a minuscule amount of risk. This exposes a fundamental void between the excel sheet models and the real world they seek to describe. To bridge this gap, the industry has adopted the use of government-issued securities from stable, developed economies as a proxy for the risk-free rate.  For instance, the yield to maturity on a US Treasury bond, is widely accepted as the proxy for the risk-free rate in US dollars. However, a rigorous examination reveals that these instruments are subject to an array of risks that are overlooked in standard financial analysis.

We have accepted government-issued bonds from “safe” economies as proxies. But there are critiques to it.

1.   United States

Proxy used: 10-year US T note

Critique: Can artificially inflate bond price in case the Fed choose to conduct Quantitative easing programs.

2.  Eurozone

Proxy used: 10-year German bund rate

Critique: In case of an economic crisis in a single country, Germany’s bond yields will be pulled down by safe-haven demand, making them look safer than they are. The idea of uniform economic safety across the Eurozone is not real.

3.  United Kingdom

Proxy used: 10-year gilt

Critique: Yields heavily influenced by the Bank of England's QE programs, making them more reflective of monetary policy, rather than market fundamentals. 

4.  Japan

Proxy used: 10-year Japanese government bond

Critique: Yields have been shaped by decades of extreme monetary policy intervention, including yield curve control, disconnecting them from finance fundamentals. 

5.  China

Proxy used: 10-Year Chinese Government Bond

Critique: China's government bond yields are not purely market-driven as they are managed through central bank guidance and a controlled financial system.

These are politically stable governments but let us not confuse political credibility with economic soundness. Central banks can and do manipulate these yields for monetary or fiscal goals, often distorting them.

Even if default risk is close to zero, several other risks persist

1.    Inflation risks: Nominal yields say nothing about real returns. A government can pay you back in full and still erode your purchasing power through expansionary monetary policy

2.    Reinvestment risks: Most bonds pay coupons. But unless you reinvest those at the same rate, which is highly unlikely in these volatile markets, realized return does deviate from its yield-to-maturity.

With this, investors need to adopt newer methodologies to fix this issue.

Instead of ignoring the risks in the baseline rate, analysts should quantify the potential risks such as default, inflation, liquidity, and policy risks and embed it in a chosen government bond proxy

Furthermore, they can employ a wide range of risk-free rates in their models to conduct sensitivity and scenario analysis across wide spectrum of risk conditions.

With changing dynamics of the financial industry, it becomes imperative for us to rework on the computational mechanisms for risk-free rates by introducing range of risks, which are not yet in everybody’s perception.

 * The opinions expressed in the article are personal and do not represent the opinions of the organization I work for * 

Rise of intangibles: How the future of business growth lies beyond the balance sheets

 The rise of intangible assets in corporate balance sheets marks a sheer redefinition of competitive advantage. Companies no longer win by owning the most physical assets but they win by owning intangibles: ideas, insights, networks, brand and culture.

To attach some numbers to this claim. In 1975, tangible assets (such as factories, land, and equipment) made up ~83–85% of S&P 500 company value. This equation has reversed with intangibles accounting for ~90% of S&P 500 market value.

The liberalization of global trade, deregulation of sectors such as telecom and finance, and the rise of international supply chains forced companies to become leaner and more agile. Capital-intensive operations were outsourced or divested, while firms began investing more heavily in strategic capabilities such as branding, customer relationships, and intellectual property.

Furthermore, the emergence of the internet, software ecosystems, and data analytics fundamentally changed the nature of value creation. The success of companies like Microsoft, Google, and Amazon depended on their ability to scale up their intangible-heavy models.

The COVID-19 pandemic significantly accelerated digital adoption, driving rapid uptake of remote work, e-commerce, and virtual collaboration tools. Digital-native and digitally agile companies outperformed their peers, highlighting the strategic advantage of digital readiness.

Legal and accounting frameworks tried to keep up pace with this changing trend. The TRIPS agreement (1995) established global IP standards, and IAS 38 (2001) set rules for recognizing intangibles. Yet most internally developed assets such as algorithms, proprietary data, culture remain off-balance-sheet, creating a disconnect between financial statements and the actual enterprise value.

Despite their value, most intangible assets such as software, brand, data, culture remain undervalued or unreported. Over 70% of investors believe key corporate assets are missing from balance sheets, hampering strategic planning, investor confidence, and precision in M&A.

Human capital is another critical intangible but often unmanaged. Talent can leave, taking their core competencies along with them. Yet few organizations have systems in place to quantify or strategically manage this risk.

Impairment testing for intangible assets is widely criticized for its lack of transparency and timeliness. While the majority of investors express a preference for impairment over amortization as a valuation approach, 73% report that current practices fail to deliver meaningful insights into the asset performance.

Furthermore, it is imperative for companies to recalibrate their reporting frameworks to accurately capture and value intangible assets. While the 20th century was driven by physical capital, the 21st century is powered by intangible forces, though invisible, are more influential in shaping competitive advantage.

  * The opinions expressed in the article are personal and do not represent the opinions of the organization I work for * 

 

Opinion: Most strategies fail not because they are wrong, but because they overlook risk. Here is how strategy leaders can think more like risk managers

Majority of the strategic failures at the corporate level happen, not only because of a flawed execution or lack of long-term vision but also because of fragile assumptions regarding the risks.

Strategic blind spots have always brought down massive business transformation projects and there have been innumerable statistics to support this

A 2024 study conducted by Bain & Company revealed that 88% of business transformations fail to achieve their original ambitions

A 2024 Forbes article reported that between 60% to 90% of business strategies fail before they are implemented

Research by Bridges Business Consulting in 2024 indicated that only 2% of leaders are confident in achieving 80–100% of their strategic objectives, underscoring difficulties in strategy execution.

Directors and executives will eventually see strong room for improvement in intertwining strategy and risk. While leaders double down on vision and execution, the hidden killer is often a lack of risk integration at the strategy level. In a volatile environment, ignoring risk is extremely expensive.

These outcomes often stem from strategic decisions made on fragile assumptions and blind spots in risk foresight — history proves this time and again

2008: Lehman Brothers' collapse was largely due to its significant exposure to subprime mortgages and complex financial instruments. The firm's failure to adequately assess and mitigate these risks led to its bankruptcy, marking a pivotal moment in the global financial crisis.

2001- Enron's downfall resulted from widespread internal fraud and the use of complex accounting loopholes to hide debt. The company's lack of transparency and poor risk management practices led to its bankruptcy and the dissolution of its auditing firm, Arthur Andersen

2012 - Kodak, once a giant in the photography industry, failed to adapt to the digital revolution. Despite pioneering the first digital camera in 1975, the company was reluctant to shift focus from its profitable film business. This hesitation allowed competitors to dominate the digital market, leading to Kodak filing for bankruptcy in 2012.

2019- PG&E, a major California utility company, filed for bankruptcy due to liabilities exceeding $30 billion from wildfires caused by its equipment. Despite efforts to improve safety, the company failed to adequately address the risks posed by aging infrastructure and environmental changes, leading to devastating fires and financial collapse

Organizations often operate with concurrent tracks: strategy on one side, risk on the other. Strategy focuses on the “what” and “where,” while risk focuses on the “what if.” Without the appropriate integration, strategy becomes like tall building set up on an extremely weak foundation

To future-proof strategy, risk forecasting must be central to strategic planning. Here are four indicative ways to make that happen:

Challenge assumptions early

What foundational assumptions define the contours of the strategic plan, and how are they validated?

What internal and external dependencies are critical to achieving the goals, and what is their reliability?​

Are there any beliefs or expectations which are taken for granted that could pose risks if they prove incorrect?

Quantify the downside

What are the potential worst-case, best-case, and most probable scenarios for the strategy?​

How would each scenario impact the financials, operations, and market position?​

What is the likelihood of each scenario occurring?

Include risk leadership in strategic planning

Are risk management leaders involved from the inception of strategic planning?​

How are risk assessments integrated into the strategic decision-making processes?

Do cross-functional teams include risk professionals to evaluate strategic initiatives?​

How frequently are risk assessments reviewed and updated in alignment with the organization’s strategic objectives?

Design for Adaptability

How quickly can the organization pivot its strategy in response to emerging risks or new opportunities?

What processes are in place to enable continuous monitoring and adaptation of the organization’s strategic plan?

With these key questions being answered, strategic heads will be better equipped with required foresight and vision to implement business transformation at scale. Risks should not be perceived as hurdles but rather as opportunities to course correct and achieve fresh milestones. 

Northvolt’s bankruptcy: Lessons from the fall of a green technology pioneer

Founded in 2016 by former Tesla executives Peter Carlsson and Paolo Cerutti, Northvolt had set out with an ambitious mission to produce the world’s greenest batteries and support the global transition to renewable energy.

Northvolt had sought to disrupt the battery industry and strengthen Europe's energy independence by establishing gigafactories powered by renewable energy and prioritizing the fundamental circular economy principles.

However, despite its innovative vision, Northvolt faced significant operational and financial challenges that snowballed into a bankruptcy filing in the US. This article attempts to unravel crucial insights into the complexities associated with scaling up the green technologies, navigating competitive markets, and driving cost efficiencies.

Since, its inception, Northvolt had devised a robust strategic vision towards green technologies. Its strategic plan included:

·  Focus on producing lithium-ion batteries for electric vehicles (EVs) and energy storage, using renewable energy to minimize environmental impact.

·  Building its first gigafactory, Northvolt Ett, in Skellefteå, Sweden, with an annual capacity target of 60 GWh.

·  Expanding into sodium-ion batteries, diversifying its portfolio to lower costs and reduce dependency on critical minerals.

·  Operating a battery recycling facility to recover valuable materials

However, the company underwent several operational bottlenecks in 2023. This led to the business incurring severe losses and mounting debt, with the company eventually filing for bankruptcy under Chapter 11 in the US.

Some of the challenges that the business grappled with are as follows:

Production issues:

·  By 2023, Northvolt Ett produced less than 1% of its theoretical capacity due to challenges in scaling production processes.

·  Issues observed in achieving consistency across critical steps, such as mixing, coating, and drying, severely hampered productivity.

·  Quality concerns led to the cancellation of high-value contracts, including a €2 billion deal with BMW.

Technological constraints:

·  Focused on nickel manganese cobalt (NMC) cathodes for high-energy density batteries, which became less competitive as lithium iron phosphate (LFP) batteries improved in cost and performance.

Financial woes:

·  Northvolt accrued $5.84 billion (€5.61 billion) in debt while maintaining only $30 million (€28.81 million) in cash reserves by 2023 end

·  Failed to secure a critical $1.5 billion loan guarantee, leading to increase in the liquidity issues.

Increasing competition:

·  Faced stiff competition from Chinese manufacturers like CATL and BYD, which offered batteries at significantly lower costs ($55/kWh compared to $139/kWh for European counterparts).

Consumer sentiment:

·  Consumers, pressured by inflation and rising costs of living, began prioritizing affordability over green premiums.

Key learnings that can be derived through this case are as follows:

·  Sustainability must be complemented by cost-competitiveness, especially in price-sensitive markets like EV batteries.

·  Despite its state-of-the-art facilities, Northvolt struggled to scale production effectively. This highlights the strong imperative to secure technical know-how and quality talent before foraying into large-scale expansion. Investing in expertise and process optimization early on can help curtail risks.

·  The business's high operating leverage and significant fixed cost structure magnified its challenges, converting difficult periods into severe downturns.

   * The opinions expressed in the article are personal and do not represent the opinions of the organization I work for * 

Trump 2.0: What Indian economy can expect from the new US presidency

 

The recent election of Donald Trump as the 47th President of the US has stirred global markets, with far-reaching implications that transcend beyond the American frontiers. As India’s top export destination and a significant economic partner, the US plays a pivotal role in India’s trade, investment landscape, and overall economic trajectory. Trump’s anticipated policies, particularly on tariffs, immigration, tax reforms, and defence, could shape India's economic and geopolitical positioning. This article attempts to delves into the potential impacts of Trump’s presidency on the Indian economy.

1. Tariff implications

The US is India’s largest export destination, constituting 17.41% of India’s total exports in 2023. However, Trump’s proposed imposition of higher tariffs at 10% across all imports could disrupt India’s export market. Trump’s administration is likely to increase tariffs on key Indian goods, including automobiles, textiles, pharmaceuticals, and wines, affecting India’s competitive standing in the U.S. market. According to the Global Trade Research Initiative (GTRI), heightened tariffs on these sectors could compress India’s export revenue, particularly in manufacturing-dependent regions.

However, this scenario presents a different perspective as well. The potential for up to 60% higher tariffs on Chinese imports aligns with the globally relevant China+1 strategy, which encourages diversifying manufacturing dependence away from China. India stands to benefit from this policy shift by effectively positioning itself as an alternative manufacturing hub and unlock increased market share in sectors like electronics, textiles, and semiconductors.

2. H1-B Visa program

Indian IT firms and professionals heavily depend on the H-1B visa program for workforce mobility to the US. In the past, Trump has adopted a restrictive stance toward this program, asserting that it disadvantages American workers. During his first term, stricter visa regulations led to increased denial rates, with the average H-1B denial rate jumping from 6% in 2016 to 24% by 2018. Analysts anticipate similar measures could resurface, potentially complicating the visa process for Indian applicants.

Indian firms that rely on H-1B visas for a skilled workforce in the US may face an imperative to diversify their market focus or boost domestic hiring in India. With 15% of H-1B applicants recently securing visas amidst heightened scrutiny, Indian companies might prioritize alternative hiring practices, which could spur local employment but limit Indian talent's access to US-based opportunities.

3. Corporate tax cuts

Trump’s emphasis on reshoring US manufacturing through a reduced corporate tax rate of 15% for domestic manufacturers could have mixed effects on India. As the US works to reduce its dependence on overseas production, particularly from China, opportunities for Indian manufacturers in sectors like semiconductors and consumer electronics may expand, aligning with India's Make in India campaign. However, this redirection may also heighten competition for Indian exporters in the US market, making the environment more challenging for MSMEs.

4. Strengthening collaborations on defence

Trump’s foreign policy outlook on reducing Chinese influence in Indo-Pacific region places India as its strategic partner. The US is likely to expand defence cooperation with India, focusing on countering China’s regional influence through initiatives like the Quadrilateral Security Dialogue (QUAD), involving the US, India, Japan, and Australia. Enhanced military cooperation could catalyse investments in India’s defence sector, fostering technological advancement, and robust defence spending to enhance its security infrastructure.

5. Potential Rupee Depreciation Against a Strengthening Dollar

The Indian rupee may experience depreciation in light of the strengthening US dollar, with forecasts projecting it to decline to 84.20-84.50 against the dollar in the short term, and potentially reaching 84.50-85 in the first half of 2025. A weaker rupee could increase the cost of imported goods, impacting sectors reliant on dollar-denominated imports. Rising import costs, especially for oil, could contribute to inflationary pressures within the Indian economy, mandating appropriate policy responses from the RBI.

Donald Trump’s presidency presents a barrage of economic challenges and opportunities for India. While increased tariffs and restrictive immigration policies may create hurdles for Indian businesses, opportunities also arise from the China+1 strategy, defence collaborations, and export competitiveness. Indian policymakers and businesses need to navigate these shifts, ensuring India capitalizes on new avenues while mitigating potential adverse impacts.

  * The opinions expressed in the article are personal and do not represent the opinions of the organization I work for * 

The Evolution of the UK's Financial Sector

Over the centuries, the UK has established itself as a financial hub, with London emerging as a centre for international trade in the early 18th century. The Bank of England, established in 1694, played a crucial role in providing greater liquidity in the national marketplace and supporting the growth of foreign trade.

In 1986, the London Stock Exchange underwent significant changes when it was deregulated, an initiative that became known as the "Big Bang". This event marked the introduction of electronic trading, eliminating face-to-face trading mechanisms and resulting in a surge in trading activity. The Big Bang led to the merger of brokers, jobbers, and merchant banks, and created a free-for-all trading environment that attracted several international banks to London. The Big Bang is credited with creating a significant number of millionaires, and it has left a legacy in the form of a robust financial infrastructure that has cemented London's status as a leading global financial hub.

During the same period, the London Interbank Offered Rate (LiBOR) was established as a benchmark interest rate used to set the cost of borrowing for financial institutions around the world. LiBOR was established in 1986 as part of a broader set of reforms known as the "Big Bang" that deregulated financial markets in the UK. The purpose of LiBOR was to serve as a benchmark interest rate that reflected the cost of borrowing for banks in the London interbank market. The rate was determined by a daily survey of a panel of banks, which submitted their estimated borrowing costs for various currencies and maturities. LiBOR quickly became a widely used benchmark rate for financial contracts, including derivatives, loans, and mortgages, and played a key role in facilitating global financial transactions.

The 1990s saw the UK's financial sector continue to grow, with the emergence of hedge funds and private equity firms. By the 2000s, the UK's financial sector had become increasingly globalized, with strong foothold of international banks.

However, the global financial crisis in 2008 led to increased regulation of the financial sector and a renewed focus on risk management. And in 2021, the Financial Conduct Authority (FCA) announced that LiBOR will be phased out by the end of the year, reflecting changing attitudes towards benchmark interest rates. The changing attitude came as a result of several scandals and concerns over the manipulation of these rates. In this context, LiBOR had come under scrutiny after allegations of rate-rigging by several large banks. This resulted in a loss of confidence in the benchmark and a dire need for a replacement.

In conclusion, the UK has a long history as a financial centre, with London establishing itself as a hub for international trade and finance. The development of the Bank of England, the creation of the London Stock Exchange, and the introduction of electronic trading and LiBOR have all contributed to London's status as a leading global financial hub. However, challenges such as the global financial crisis and concerns over benchmark interest rates have also prompted increased regulation and scrutiny of the financial sector.

 * The opinions expressed in the article are personal and do not represent the opinions of the organization I work for * 

Elon Musk’s ‘Twitter’ dream and the measures taken to realize it

 

Elon Musk bought Twitter for cash consideration of US$ 44 billion, paying $54.20 per piece. After months of legal tussles, deal was finally sealed in October 2022. Musk announced that he plans to promote free speech and create open algorithms to showcase transparency. In his investor pitch, he made tall claims to increase annual revenue from US$ 5 billion in 2021 to US$ 26.4 billion in 2028. He further anticipated the user base to grow from 217 million in 2021 to 931 million in 2028. However, to realize his vision, he has resorted to aggressive measures like job cuts and charging customers for verified accounts, attracting a strong public backlash and co-ordinated trolling attacking by resentful users. This post attempts to lay down a summarized view on steps taken by Elon Musk to remodel the business

1)     New appointments and series of layoffs: Musk has handed pink slips to 50% of Twitter’s staff in order to drive cost efficiencies. His acquisition of Twitter has led to interest bill of US$ 1 billion which makes it imperative for him to cut costs on a war footing. Additionally, being the sole director of Twitter, he has also dissolved the board and fired series of leadership including CEO Parag Aggarwal (CEO), Ned Segal (CFO) and Vijaya Gadda (Head of Legal, Policy and Trust). Furthermore, he has also brought in team of associates as enablers to grow the business including his personal attorney and tech investors 

2)     Setting the table for a stream of recurring revenues: The users of verified accounts will have to pay US$ 8 per month to keep the blue tick (sign of a verified account) next to their name. With this, Twitter will attract a slew of recurring revenues of US$ 40.3 million annually and is expected to reach above US$ 400 million as of 2028 (Assumption: 0.2% of total twitter user base consists of verified accounts; This figure is expected to reach 0.5% as of 2028)

3)     Additional features: Musk wants to transform Twitter’s user interface into different customized versions across customer preferences. He has backed a user suggestion wherein one of the versions can include a conducive space for organized debates and spats (only for verified users). Additionally, he also wants to include user feedback to Twitter posts in form of ratings.

4)     Revival of Vine?: Vine was six-second-long video sharing application, which was acquired by Twitter in 2012 and later discontinued in 2016. Elon Musk conducted a Twitter poll for a consumer opinion on whether he should revive Vine or not. The poll results concluded with 70% of respondents in favour of the Vine comeback. However, Musk needs to evaluate this decision, considering a fierce competition from the existing giants: Tiktok and Youtube in this space

5)     Transforming the application into a super app: Lastly, Musk plans to transform the social media platform into a super application. In future, Twitter can also include features like instant messaging and digital wallets (Elon Musk can bring his core expertise from his initial ventures – Paypal, a digital wallet). Furthermore, he also wants the platform’s algorithm to be open source, making way for public review and modification. Furthermore, he desires to chart a blockchain-based future for Twitter wherein users can add their messages to the blockchain for a small fee which can insulate the posts from bots and spams.

* ThThe opinions expressed in the article are personal and do not represent the opinions of the organization I work for *