Yesterday a simple question in the parliment made Icici bank scrip lose about 10% of its value – and recovered 5%. What really happened is a simple accounting necessity for marking down the investment. Let us take an example, I have “bought” a CDO (collatarised debt obligation)- this is  a bunch of borrowers of a bank securitised by the bank and sold to me. Now if the change in interest rates happens, the value of the CDO can fall. HOWEVER, if I am holding a good CDO where i trust the bank and the underlying borrowers – and their ability to pay, I will hold on till maturity I need not worry. Accounting requirements – SAROX – ensures that the short term fall has to be “marked to market” – and that is what ICICI Bank has done. I am not saying this alone. Warren is saying this in his letter….here i bindaas quote him, verbatim…   “Second, accounting rules for our derivative contracts differ from those applying to our investment portfolio. In that portfolio, changes in value are applied to the net worth shown on Berkshire’s balance sheet, but do not affect earnings unless we sell (or write down) a holding. Changes in the value of a derivative contract, however, must be applied each quarter to earnings.

Thus, our derivative positions will sometimes cause large swings in reported earnings, even though Charlie [Munger] and I might believe the intrinsic value of these positions has changed little. He and I will not be bothered by these swings – even though they could easily amount to $1 billion or more in a quarter – and we hope you won’t be either. You will recall that in our catastrophe insurance business, we are always ready to trade increased volatility in reported earnings in the short run for greater gains in net worth in the long run. That is our philosophy in derivatives as well.”

So when Chanda Kochhar says she has only done “mark to market” believe her!

Ps: this is one of my most popular posts. I have no clue whether anybody from Icici has read this post. Posted on 4 june, 2008

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