Sensex crosses 20k and Ambani crosses Gates

Mukesh Ambani, of Reliance Industries Ltd, became the world's richest man on 29 October, overtaking Microsoft's Bill Gates and Mexican Carlos Slim Helu. The feat was achieved because of the strong rally which the stocks of Ambani's Reliance Industries has been witnessing since last month. The Reliance Industries Ltd stock has risen more than 60% in past few months and has helped Bombay Stock Exchange's 50-stock index Sensex to cross 20,000 points and take Mukesh Ambani's net worth to $63.2billion just piping Helu and Gates who are a little behind at around $62.29bn each. Ambani holds more than 50% shares of Reliance Industries.

Estimates of the wealth of the top five richest person of the world are:

Mukesh Ambani - $63.2 billion
Carlos Slim Helu - $62.3 billion
Bill Gates - $62.3 billion
Warren Buffett - $55.9 billion
Lakshmi Mittal - $50.9 billion

Crude oil price scales new heights

Crude oil price crossed $93 (€64) a barrel in New York.
In London, Brent Crude hit an all-time high of $90 a barrel.
In October the price has risen by more than 16%.
In the year 2007 it has increased by more than 50%.
The current price of crude oil is an all time high in nominal dollars. However inflation adjustments make it slightly below the peak touched of $101.7 in April 1980 (Iran cut the exports).

The trend for the crude oil price is shown below:


Reasons for sharp rise:

Mexico shut one-fifth of its production due to bad weather in Gulf of Mexico.
OPEC is not increasing production to compensate for the reduced supply.
Peak demand period because of northern hemisphere winter season.
Tensions between Turkey and Iraq over Kurdish militants.
U.S. sanctions over Iran's nuclear program.
Dollar has touched a record low.
Oil futures are being used as hedge against the weakening dollar.

Re-branding UTI Bank as Axis Bank

UTI Bank is rechristened Axis Bank. Axis Bank is India's third largest private sector bank and fifth largest bank by market capitalization. Ogilvy & Mather India Ltd was given the task of re-branding.

According to the website of Axis Bank:

"Axis Bank was first of the new private banks to have begun operations in 1994, after the Government of India allowed new private banks to be established. The Bank was promoted jointly by the Administrator of the specified undertaking of the Unit Trust of India (UTI - I), Life Insurance Corporation of India (LIC) and General Insurance Corporation Ltd. and other four PSU companies, i.e. National Insurance Company Ltd., The New India Assurance Company, The Oriental Insurance Corporation and United Insurance Company Ltd."

Unit Trust of India (UTI) was a government institution. After the split of UTI in 2002, its subsidaries UTI Securities, UTI MF and UTI Bank were allowed to retain the UTI brand name for five years till January 2008. Due to the maturity of the agreement UTI Bank had decided to shed the UTI brand and went ahead with a much more modern sounding name - Axis Bank.

The new logo has two strokes, the first stroke depicts forward growth while the second stroke signifies a solid support system. The two thick strokes also connote solidity and security, and conveys a sense of authority and credibility.

Moreover, Axis as a brand is suited as a global brand name and can work across geographical boundaries. The choice of the name can be looked as a part of the bank's strategy to mark its presence globally.

Following are some salient points about the bank (as of year 2007):

It has the third largest ATM network in India (2500).
It has the third largest base of debit cards in the country.
It has the third largest EDC network.
It was the first bank in India to adopt Finacle as a core banking software.
It provides Cash Management Services to more than 2300 customers.
It is in the top 3 arrangers of corporate debt in India.
It provides payroll services to over 12,000 corporates.
It is the agency bank for a number of State Governments and Departments of the Central Government.

Merrill Lynch posts record losses in 93 years

The largest US brokerage Merrill Lynch had suffered worst quarter since its inception year 1914. The write-downs across CDOs and U.S. subprime mortgages were close to $7.9 billion. Earlier it had reported that this to be close to $4.5 billion. The net loss for the third quarter was $2.24 billion. Merrill's chief executive Stan O' Neal is under heavy pressure from board of directors over the handling of the crisis and is likely to resign.

This loss has made Merrill Lynch the biggest setback of the sub-prime crisis. Its losses were more than the combined losses of the rest of the US brokerage. Earlier Bear Stearns had to close two of its hedge funds and suffer $1.5 billion loss.

Merrill Lynch's reported a total net revenues of $577 million in the third quarter of 2007 which was down 94 percent from $9664 million in the second quarter of 2007 and $9833 million in the third quarter of 2006.

"Mortgage and leveraged finance-related write-downs in our FICC business depressed our financial performance for the quarter. In light of difficult credit markets and additional analysis by management during our quarter-end closing process, we re-examined our remaining CDO positions with more conservative assumptions. The result is a larger write-down of these assets than initially anticipated," said Stan O'Neal, chairman and chief executive officer. "We expect market conditions for subprime mortgage-related assets to continue to be uncertain and we are working to resolve the remaining impact from our positions," Mr. O'Neal continued. "Away from the mortgage-related areas, we continue to believe that secular trends in the global economy are favorable and that our businesses can perform well, as they have all year."

Source :Merrill Lynch Press Release

Stocks to watch

As long as our money doesn't make money for us, we are dependent on someone for our sustenance. As long as our budget depends upon the month-end salary, we can’t have everything in life. Investment, if done intelligently, can be one of the easiest way to get rich fast. This section of the blog will keep you updated with the crisp news about the companies and help you to take better decision about investing.

This week was quite significant with the clearance from SEBI about the P-notes and the FII bringing dollars back to exchange. BSE's 30-stock index, Sensex, witnessed an all time high till now and closed at 19,243. In the absence of any bad news in coming days the trend is expected to continue. The inflation maintained its 5 years low position at 3.07% in the week ended 26'th October, and that dilutes the prediction of any hike in CRR by RBI in the near future. This helped the banking sector accumulate significant gains and in the outlook in near future is strong.

There are many large cap stocks which are moving the market quite often and always in news, but in this section we will bring to you those stocks which are not heard much, but all set to be future star. The list starts with -

RMTL is a Gujarat based company manufacturing welded and seamless stainless steel(SS) pipes & tubes, carbon steel(CS) LSAW, HSAW and ERW pipes. It is the only company in the industry having presence in both CS and SS pipes. The company has embarked on a growth trajectory with its Greenfield expansion in Kutch, backward integration into Hot SS extruded-mother pipes, addition of spiral SAW and wind power capacity. Sales of the company has grown by hopping 630% in last 5 years. Share price has gone up by 260% in from Nov ’06 to Oct' 07 At the CMP of Rs 1257 (as on 26th October) the stock is trading at 11.75x FY08E and 9.11x FY09E.

At present the outlook of this company remains very strong from the major markets namely Refinery, Petrochemicals, LNG, Capital Goods Industry and Power Plants. With a robust order book position of around Rs.5 bn which will be executed within next 6-8 months, RMTL will continue to get healthy order book in FY08E and FY09E as well mainly because of big capex plans announced by oil and gas industry players. Undoubtfully, the RMTL stock has been performing very well on the bourses and is has more than doubled in a year. Seeing the valuations and current trend it can easily cross Rs 1800, a 54% upside from current level. More information at Rediff Money.

Disclaimer: FINMANAC has taken due care and caution in compilation of data for its blog. The views and investment tips expressed above are the personal view and should not be taken as only base for any investment decision. FINMANAC advises users to check with certified experts before taking any investment decision.

Are Basel norms really complicated?

The core business of banks is to take deposit from public and lend to individuals, industries, business etc. These loans carry risk of becoming bad debt (debtor is unable to return its debt) and hence non-performing. Since the major deposit of bank comes from public, the government and regulatory authorities are worried that the bank might be tempted to operate on thin capital and expose the depositors to undue credit risk. Therefore, banks all over world are required to keep a specified percentage of their loan portfolio as capital and if some loan goes bad, the loss is borne by the capital and not by depositors. Banks hence are required to maintain a capital adequacy ratio specified by the regulatory bodies.

Basel norm is a framework of capital adequacy for banks. These norms set the guidelines to estimate the amount of capital assets of specified kind should bank hold to absorb losses. The assessment of such losses that bank can incur decides the proportion of liquid asset banks must have at hand to meet those losses in case they are incurred. The loss can be based on the risk exposure i.e. credit, operational or market risks etc. The higher the risk of loss associated with an investment, the more of liquid asset will have to be maintained. A 100 percent risk-weight loss implies that the whole of the investment can be lost under certain conditions and a zero percent risk-weight indicates that the concerned asset is risk-free.

The Basel II norms is improvement over the earlier Basel I norms. India had adopted Basel I in 1999 and subsequently based upon recommendation of Steering committee , the Reserve Bank of India (RBI) issued draft guidelines for Basel II in 2005. Three major inadequacy of Basel I norms were –

1. Non-differentiation: The norms treated all borrowers alike.
2. No weightage was given to availability of security for credit facility.
3. It treated loans of varying maturity in the same manner.

Regarding the first issue, in Basel I, banks were required to keep 8 percent of loan as capital, whether the borrower is a first class blue chip company, with little or no risk, or it is a third rate company with poor track record. Basel II introduced the concept of 5 different risk weights, 20%, 30%, 50%, 100% and 150%. For the highest rated borrower, banks need to keep only 20% of 8 percent or 1.6 percent (8x 20%) of the credit exposure as capital. The RBI has retained the higher base level of 9 percent against world level of 8%.

For the second issue, value of security has been given due consideration while computing the capital charge for a loan.

Taking the last point, the Basel I rule prescribed the same amount of capital whether the loan was for a short period or for a very long period. As the period gets longer the risk associated with the loan increases. Basel II has made some distinction between short and long-term loans given by one bank to another.

The “credit worthiness” is to be determined by the rating accorded by independent credit rating agencies. And over a period of time, the credit rating given by banks themselves for borrowers could be adopted.

The operational risk is covered by Basic Indicator Approach which prescribes a capital charge of 15 per cent of the average gross income for the preceding three years to be maintained.

The revised framework of Basel II, consists of three-mutually reinforcing pillars –

1. Minimum capital requirements,
   
2. Supervisory review of capital adequacy and
   
3. Market discipline.

The first pillar offers three distinct options for computing capital requirement for credit risk and three other options for computing capital requirement for operational risk. The different options for credit risk are Standardized approach, Foundation Internal Rating-Based approach and Advanced Internal Rating-Based Approach. The available options for computing capital for operational risk are Basic indicator approach, Standardized approach and Advanced Measurement approach.

The second pillar is concerned with supervisory review process by national regulators for ensuring assessment of risk and associated capital adequacy of banking institutions.

The third pillar provides norms of disclosure by banks of key information regarding their risk exposure & capital positions and hence aims at improving market disciple.

Gyaan on Banking sector

Banks - how they function - they basically take money from people who have money and give to those who need it on a higher interest

First Indian bank was started way back in 1786 around. But that bank is not functioning now

Oldest Indian bank which is functioning now is SBI, established in 1806, which was known at that time as "Bank of Bengal"

Most of the old banks were headquartered at Calcutta, as it was prime centre of trade

After Independence, most of the banks were nationalised. In 1991 private banks were also allowed to function.

Some Public sector banks – SBI and its subsidiaries, Bank of India, Allahabad Bank, Bank of Baroda etc

Some Private owned banks – ICICI, HDFC, UTI Bank etc.

Banking Terminology
CAR – cash adequacy ratio – basically, government wants banks to keep some amount of money in cash.

CRR – cash reserve ratio – presently 6.75% in India – it is the ratio of cash to net demands and time liabilities (NDTL) of bank. RBI asks bank to keep a certain percent of amount of NDTL in form of cash. This ratio varies between 3 to 20%

SLR – statuary liquidity ratio - It is the amount of money that bank has to deposit to RBI. This rate varies from 25% to 40%

FinManAc: Finance Blog

Securitization

This article tries to explain what is securitization. Lets consider what a bank does? A bank gives loans to its borrowers. If it is a small bank we call it as a sub originator and this small bank transfers these loan to a bigger bank which is called as originator. Now, this originator can sell off this loans to a trust and get money. And this trust sells of these loans in form of bonds to various bond holders

Now this trust collects money from the bondholders and gives it to Originator. And now this originator can lend of this money to more borrowers. Selling off the loans to a trust is known as Securitization.

Common cost terms

Many people are confused about what is the difference in terms like cost saving, cost reduction, cost management etc. This article will help you in understanding the differences in these terms.

Cost Cutting - When we reduce the cost which leads to lowering of quality, then it called cost cutting. Some experts also relate it as Cost Saving.

Cost Rationalization - When we reduce the cost while maintaining the same quality of output, but with a short term perspective, then it is known as cost rationalization. i.e. if u reduce the cost while maintaining the same quality for one time, it will be cost rationalization. Example: U r saving money by going through train, and for this travel only, train takes lesser time than flight (due to waiting time at airport) then its cost rationalization.

If it is done with long term perspective, say due to some improvement in technology, we are able to reduce the cost while maintaining the same quality, its called Cost Reduction

Cost Control is dependent on generic strategy of the company. If it reduces cost following the generic strategy of company, its called cost control. Example: Jet Airways wont compromise on quality but Deccan might do so to reduce the cost.

Cost Management is acheived when we improve the value chain. say one company is providing assembled crankshaft to another company. This company again disassembles it and uses it. So, it will be beneficial for both the companies if it is transported in disassembled form.

Comments are most welcome:)

Capital Budgeting : Cash Flow Components

As discussed earlier capital budgeting is identifying, selecting the best of available options and implementing long-term investment project whose returns are positive.
For selecting the best investment option future cash flow from the project are estimated and analyzed.

Relevant Cash Flow:
For decision making only incremental cash flow analysis is sufficient.
Sunk Cost is irrelevant for decision making purposes.
Opportunity Cost is relevant.

The cash flow as a result of undertaking a project can be divided into three components:
Initial Cash Flow
Operating Cash Flow
Terminal Cash Flow

Initial Cash Flow (ICF):
Cash flow in acquiring new assets/ initial investment for project. It includes cost of the machines and its shipping and installation, testing etc. For using an already owned asset the opportunity cost of the asset has to be added to cash outflow.
From this we have to subtract the after tax proceeds from the sale of old assets.
Initial cash flow also includes cash flow due to change in net working capital (NWC). Net Working Capital = Current Assets - Current Liabilities. Increase in NWC means cash outflow. Change in NWC is not tax deductible.
All these cash flows are assumed to be occurring at the beginning of the project.

Operating Cash Flow (OCF):
It is estimated after-tax cash flow due to the project during its operating life-time. These cash flow generally vary from year to year. Conservatively, the operating cash flows are taken at the end of a year. First the accounting income is calculated by subtracting depreciation for tax purposes. Taxes are deducted from this income. Depreciation is added back to get Net Operating Cash Flow for that accounting period. For a replacement project incremental analysis can be done. Everything has to be calculated on an incremental basis.

Terminal Cash Flow (TCF):
It is the cash flow when the project is terminated. The TCF will be the salvage value of the project and the recovery of the working capital employed.

All these cash flows have to be discounted to find out the net present value (NPV).
Cash flows due to financing activities are implicit in the discounting rate used for finding NPV and are not relevant for decision making purposes.

P/E ratio (PE ratio, Price to earnings ratio)

P/E ratio
= Market price of a share / Earnings per share (EPS)

= Market Capitalization / Earnings

where

Market Capitalization = Number of shares outstanding * Market price of a share

For calculating the earnings there are several variations.

1. Following measure of Earnings are generally used

Earnings after tax (EAT) {most commonly used}

Earnings before tax (EBT)

Earnings before interest and tax (EBIT)

Earnings before depreciation interest and tax (EBIDT)

Earnings before depreciation interest tax and amortization (EBIDTA)

2. For which period the earnings should be taken for?

Generally the earnings are for a period of one year. Now since prices change on every trading day and can be tracked the earnings can be measured efficiently only for a larger period of time generally a quarter. Another question which arises is which period should be considered. There are two variations to this:

TTM (trailing twelve months) – for past 4 quarters

Annual – For last financial year

Leading – Using projected EPS

Can P/E ratio be negative?

Sometimes companies earn zero profit or even run into losses. Is the P/E ratio significant there? For knowing this we have to find out the purpose of finding the P/E ratio.

What is the purpose of P/E ratio?

It shows how much the investors are willing to par for one dollar of company’s earnings. When compared with the industry average and leader we can find out the level of confidence that investors have in the company. But P/E ratio alone is not a sufficient measure to arrive at any conclusion about the stock.

What are the limitations of P/E ratio?

Inability to capture non-monetary aspects.

No standard for using a measure of earnings

Doesn’t cover the past growth and the future growth projection

Can be interpreted in different ways

A one period exceptional income can distort the picture

Time Value of Money (Part 2)

Earlier we discussed about compounding by which we found out the future value of an amount deposited now.
Similar is the concept of discounting where we calculate the present value of a cash that is going to come in future.

PV - Present Value of an amount that will be received in the future, calculated after discounting. FV - Future Value of an amount invested now at a given rate of interest.

The rate used for compounding is the interest rate offered by the instrument in which the money is invested.
For discounting rate generally the cost of capital rate is used. This can be the rate which your money can grow with you.

Till now we had considered cash flow at one point of time and discussed ways to find its value at some other point of time. This kind of cash flow is known as lump-sum. What if the cash flow is divided and keeps on coming at different times. Four new terms are introduced for these:

Annuity - It is a regular cash flow for a fixed period of time.
Annuity Due- Cash flow occurs at the start of the period.
Annuity Ordinary- Cash flow occurs at the end of the period.
Perpetuity - It is a regular cash flow for a infinite period of time.

Generally, Annuity and Perpetuity are used for equal cash flows in each period.
If the cash flows are unequal it is called mixed stream.

The formula for future value of an ordinary annuity (FV) is:
where FVA(due) is future value of annuity due, A is equal cash flow per period for n periods compounded at interest rate r.
Similar formulae for present value are:
Present Value of a growing stream of cash flow:
Gordon Growth Model
g is growth rate of cash flow and if g < onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEh7awFDFtnkqy-wTbUDBR2FLJDdcQDpfcIUeReymZnyAO7IqGLC2X9YeJaksDZ10WIrby-Y9zs9Rgzpeg7r-_1rQL8uTAoG2Jl1GS2CeQb6KHWTQuO3Uzu3lf-6ACKTsRaLejJAnCV8Ez0k/s1600-h/AnnuityGrow.jpg">
Change in Compounding interval

Time Value of Money

Like most of the things money also loses its value if kept idle. Its mainly because of inflation, which increases the cost of goods and the purchasing power of money decreases.

Its better to invest money in something which can give an interest which is more than inflation. Generally the safest place to keep your money is the banks. They give an interest on your deposit. Most of the time the interest is compounded. Compounding makes a big difference in the long run. Compounding essentially means that you will get interest on 'interest earned' besides the usual interest on the initial amount (principal). It keeps on accumulating period after period. Generally the interest rates are compounded annually - meaning the interest you will earn after the end of a year will start fetching you more interest from year end onwards.

Power of Compounding
Compounding creates a big difference in long run. The table shows the the Future Value of Rs 100 after several years.
One may ask that who has seen 200 years and from the table it appears that it doesn't make that big a difference during a short span, say of 10 years. But what happens if you get 20% interest rate.
Now certainly the difference cannot be neglected.
The formula used for calculating Future Value (FV) is pretty simple.

where FV is Future Value, PV is Present Value, r is rate of interest compounded periodically (generally compounded annually), n is the number of periods (eg. number of years if interest rate is compounded annually)
Next article we will discuss about Annuities.

Capital Budgeting

This Article tells us about what Capital Budgeting is and what are the various methods used to evaluate projects.

Capital Investment is spending on long-lived assets.
Capital Budgeting is choosing which project to put money. Its not just choosing best project. It involves identifying potential projects, choosing best out of alternatives and implementing it.

Key parameter for decision making:

1. Simplicity of method of arriving at decision
2. Cash Flows from project
3. Accounting for time value of money
4. Risk-return management
5. Stockholder's value

Methods used for decision making:

1) Payback Period: In this method we choose between the projects based on the time taken to recover the initial investment. We choose the project which has the shortest time period.
Limitations with this method is that it does not take into account the time value of money. also, it is not dependent on the initial investment and ignores the cash flow occurring after the payback period

2) Accounting rate of return(ARR): In this method, we find the ratio of accounting profit, i.e. EBIT and average assets. Whichever project has higher ARR, we take that project.
Limitations with this method is that it also ignores time value of money. Moreover, accounting profit is an ambiguous term. It can vary as per the accounting principles followed.

3) Net Present Value(NPV): In this method, we bring all the cash flows to occur in future at the present value.(discounting them using cost of capital) If the net cash flow comes out to be positive, then project is accepted. Project having higher NPV is selected.
Advantage of this method is that it takes into account the time value of money

4) Internal rate of Return(IRR): this is one of the most widely used method. In this we find out the rate or the cost of capital, at which NPV becomes zero. This rate is known as IRR. In normal cases, i.e. positive cash flows occurring in future, if IRR is higher than present cost of capital, project is accepted. Project having higher IRR is selected.
Limitation of this method is that in case, cash flows sign changes, we get multiple values of IRR which creates problem in taking decisions

5) Profitability Index: this is the ratio of present value of cash inflows to cash outflows.

Fisher Equation - Real & Nominal Interest Rate under Inflation

Equation was derived by Irving Fisher
Effect of inflation on interest rates

Let
Rn = Nominal Rate of Interest
Rr = Real Rate of Interest
Ri = Expected Rate of Inflation.
The above rates are in terms of per $ (not %); then according to Fisher

(1+Rn)=(1+Rr)(1+Ri)

which can be approximated as
Rn = Rr + Ri , since interest rates are quite less than 1.