Standard Chartered Bank announces $3 billion rights issue

Standard Chartered Bank has gone ahead with raising capital to weather the economic downturn and take advantage of the opportunities available in current situation. StanChart is listed on London and Hong Kong stock exchanges. StanChart announced that it will raise £1.78bn through rights issue at 390 pence per share, huge discount to its current market price of 760 pence per share. Existing shareholders will have the option of subscribing 30 new shares for every 91 shares held. This step will raise its Tire-1 capital ratio to 7.4% from 6.1%. This is in line with the industry wide shift of Tire-1 capital ratio towards 8%.

Temasek Holdings Pte is currently the biggest shareholder in StanChart with owning about 19% of the company. If Temasek goes ahead with the rights it can increase its stake to 22%. But this will make StanChart lose the right of printing Hong Kong currency. According to Hong Kong Monetary Authority regulations no bank with more than 20% owned by foreign government can issue currency notes in Hong Kong.

Remarkably, StanChart has so far been relatively insulated from the subprime crisis because of its focus on emerging markets like India, Taiwan etc. But now the economic situation spreading, even the emerging economies are not insulated and it is good option to raise capital while you still can.

US' struggle to save financials continues with Citi

The US Treasury (UST) appears to have been haunted by Lehman Brothers woes. UST cannot see Citigroup falling down. It is such a big player in the financial system that its failure can jolt the already feeble banking system. According to an article on BBC news:

"If the bank were to collapse, it could have caused financial havoc around the globe, seizing up fragile lending markets and causing untold losses among institutions holding debt and financial products backed by the company. "

So here comes the biggy-big rescue package for the giant. Some crucial points in the package are:

• A pool of $306 billion assets identified and Citigroup will bear first $29 billion losses on it rest to be absorbed by UST , Federal Reserve (Fed) and Federal Deposit Insurance Corp. (FDIC).
• Treasury department will give $20 billion from the $700 billion package passed for rescuing the entire financial industry. This is under the Troubled Asset Relief Program (TARP).
  
• Govt will get $7 billion of preferred shares with 8% dividends.
  
• Dividends will be limited to $0.01 per share for next 3 years.
  
• 10 year warrants of $2.7 billion to FDIC and Treasury department at strike price of $10.61 per share.
• Citibank to help distressed homeowners.

The Citi's term sheet of agreement is available from Citigroup's website.

The impact of this package will be that Citigroup's capital adequacy will improve with additional $40 billion in capital benefits. This capital infusion will make the Citigroup's Tier-1 capital ratio at 14% well above the mandatory requirement. On the other hand this rescue has increased the burden on the US government and more than trillion dollars of tax-payers money is at stake. With more and more companies lined up for protection the $700 billion may fall well short. Automobile giants like GM and Ford are so close to bankcrupcy and they certainly require some capital infusion to keep them alive.

Despite the lucrative package, investors at Wall Street are still skeptical about the long term outcome of this. But one thing is sure that if this works out well in near future more of such packages will be seen making their way.

A survival question for Citibank

Citigroup is too big to fail, you must be kidding... Not anymore.

Amidst the fray of failing banks Citibank may be the biggest addition. From being the world's biggest bank about a year and a half ago, today Citibank has serious threats of solvency. This is reflected in its stock price which has plummeted from about $30 per share to about $4 per share. Citibank was under the speculators radar since Vikram Pandit had replaced Chuck as the leader. But with the bank losing Wachovia Corp. deal to Wells Fargo & Co., the negatives started outweighing. And with the continuing losses of billions of dollar every quarter, the stock price saw a sharp decline of about 60% in last week amid speculations of a possible takeover or merger.

Citibank is one of the biggest banks of the world and employs more than 350,000 people. It reduced its workforce by 11,000 in the latest quarter ending September 2008. It has a customer base of more than 200 million and operations in close to 140 countries. Citibank's total assets declined by $50 billion in this quarter, thats 13% decline to 2,050 billion dollars. The question is that with accumulated losses every quarter and a large amount of risky assets still in the bank's portfolio, isn't the future shaky for Citi?

Speculation is that US government is working on a plan to rescue the bank. It will be a tough task ahead for the government to bail out the giant (though not so giant anymore).

Can Lehman manage any further blow?

Market has always been flooded with people who look for prudent investment as well as those who look for easy money. While the investors approach is to get consistent return in long term investment with proper risk management, speculators trying making short term profit by betting on the price of the asset.

Speculation brings great volume to the daily trading with high liquidity which indirectly helps the investors in looking for counterparty. With high liquidity, the price discovery becomes easier because of lot of players being available in market. This also brings down the impact cost significantly. But on the other side, when speculators come with negative prediction about a particular company; because of their larger volume, they have great impact on the stock price of such firms. Recently in March, speculation against Bear Stearns Cos. made its clients and creditors stop doing business with this bank and that subsequently led to the collapse of this relatively smaller investment bank.

The most talked about speculation of March this year after the fall of bear Stern, led to spread rumour of Lehman Brothers Holding Inc., once the largest U.S. underwriter of mortgage-backed bonds, facing difficulty in maintaining its’ solvency and struggling for its survival. After that Lehman had to really fight to get back to normal business. But that was not the end; once again as the home-loan financing companies Fannie Mae and Freddie Mac dropped further on credit woes, Lehman stock fell to an eight-year low in New York trading. The stock was further hit by the speculation of its biggest customers avoiding business with this firm. Pacific Investment Management Co. (PIMCO), manager of the world's biggest bond fund, and hedge fund SAC Capital Advisors LLC both had to publically make it clear that they are continuing trade with Lehman and the speculation is unfounded. The constant pounding of company’s stock with one speculation after other, sometime makes the client doubting the performance of the firm and impacts business.

The above chart shows that the March speculation led the stock fall from $45.99 to $31.75 in a span of just 2 days, a plummet of almost 31%. The firm found it really difficult to cope up with such unexpected fall. The financial sector all over the world is in bad shape this year. The credit contraction has forced brokerages and banks to writedown as much as $408 billion this year alone. After the March debacle, it did change its strategy to fight against the odds. Lehman boosted it’s cash holding and reduced dependency on short-term loans. That led to a stable stock price for a few months from then till May, 2008. But by the end of May, with negative news all over the world and high inflation index all over the world came down and Lehman was on target again. With the recent speculation of its client staying away, it further fell by 22% again in just 2 days. At its eight years low current trading price of $17.3 per share, this year alone counts for more than unprecended 72% fall. The market cap of the company has come down from $34.3 billion in the starting of this year to a mere $9.5 billion at present.

Time will decide if this is a concerted effort of bringing Lehman down or is the wrongdoing of business. But if it continues to follow current trend, then it is not far when this will become another Bear Stern.

Stagflation

"At the end of the third century A.D., Roman Emperor Diocletian struggled to contain an inflation that raised prices by more than 300 percent a year! At the end of the twentieth century, Brazil's president, Fernando Henrique Cardoso, struggled to contain inflation that hit a rate of 40% per month or 5600% a year!"

Hard times for Asian politicians and policy makers. The staggering double digit growth rate is now a thing of the past. Now they are worried about inflation combined with slowing growth- stagflation. The best time to learn another concept in economics though. Inflation can result from either an increase in the aggregate demand or a decrease in aggregate supply. What most economies in Asia are facing is a combination of both. In the recent years, the growth story has created wealth and have given people with a double edged sword. They are definitely spending more than last five years back. This is even true amongst the place like Asia where 2/3 of the entire worlds poverty exist. The social impacts of this are seen in many of our lives, including higher crime rate, rich poor divide etc. But the economic impacts are even more striking on our face.
Global food supply shortage, high crude oil prices and fear of recession in U.S economy and the sad story continues. High crude prices and Global food supply takes the other edge of the sword which is the lessing aggregate supply. Clearly economies are pulled by both these factors. High crude prices are attributed to the factors like increase in speculation. There are websites which talks about peak oil in big time. But this claim fails to answer the soaring prices of coal, commodities. Definitely there is much more to this story than just speculation. Remember, if it was just speculation then there is also a forward sell equivalent to the forward buy. And there should be relative increase in the supply of oil. Recently Saudi Arabia increased its production, but still the prices increased. Genuinely there is a demand surge in Asian countries. China is trying to make a coal free zone for the Olympics, which means replacing the entire system with diesel or alternatives. So we can reject the idea of speculation for soaring oil prices. It might be a reason but fails to explain in its full.
Lets address the fear of recession in U.S. . Of course there are signs of slowing economy. The labor market was one figure which was falling in the recent months. But can we say this will be a hint to the recession impending? Basically, according to Philips curve which gives the relationship between the inflation and unemployment holding constant the expected inflation rate, the natural unemployment rate, says there is a negative relationship between the two variables.
There is a rise in inflation rate coupled with slowing growth which has resulted in increasing unemployment rate. " Cash is King this year"

How securities are traded

The involvement of retail investors in capital market has increased significantly. While many of them invest in market passively through mutual funds, there are quite a few who either invest using demat account or get help of the broker for investment. Many might wonder how shares come to their account and money is deducted online? Why the exchange trading in India is termed as T+2? And what do clearing and settlement means?

The whole trading starts with decision to trade, when the investor looks for some script and place order for that. If the order matches with the counter order placed by some other investor, it gets executed. Once the order gets executed, on the next day it goes to the clearing house where all trades are confirmed. Which is shown in the diagram at T+1 days. Then these cleared trades get settled, where pay-in & pay-out of all the securities and funds takes place. This settlement takes place on T+2 days. Such settlement is called rolling settlement.

In India, rolling settlement was first introduced by Over the counter exchange of India (OTCEI). In the year 2000, SEBI made rolling settlement compulsory for 10 selected securities which had volume more than Rs 1 crore. With time by December 2001, other stocks were also included for rolling settlement. SEBI introduced T+5 rolling settlement in equity market from July 2001, which was subsequently shortened to T+3 from April, 2002. To reduce the risks in settlement like counterparty risk and system risk, SEBI mandated rolling settlement of T+2 days for all the scripts from April 1, 2003.

Can Mutual Funds stop the bear run?

The last 6 months have been really troubling for stock market all over the world. While Dow reached it 2 years low, Nifty dipped below its sentimental level of 4000. In such a volatile market investments made for short term made people lose drastically. The recent dip of NIFTY index from 6280 to 3800 made even the value investor worried.

Looking at the major inflow in the market, we see that two major players – Domestic mutual fund (DMF) and Foreign Institutional investors (FII); behaved differently in the market. While FII pulled out money amounting around 25000 Crore, mutual funds cumulatively invested 9000 Crore in the market. More over the pattern shown in the diagram above explains that; at every fall FII were the one who pulled out money while in most of the dips, mutual funds invested in equity. With more than 600 stocks trading at below its’ 52 weeks lows, fund managers find it quite attractive to take position while FII who are there in market for short term took their money out in panic. As discussed in the previous posts, the compounded annual return is more than 30% for NIFTY index; hence such unexpected fall should be taken as an opportunity by both mutual funds and retail investors to invest rather than to stay away from the market. Staying invested for medium to long term will certainly be rewarding.

Looking at the major players in the market, the question arises about the driving players in the market at present? Is it the FIIs who are running away from the market or the Mutual funds who are investing quite cautiously? FIIs’ pull-out of 25000 crore has been really a reason to worry. This exit has been the major factor of indices taking a dip, but with more than 20,000 crore fund and cash equivalent uninvested, asset management companies (AMCs) have the potential to change the sentiments and encourage people for value investing. Surprisingly this time, the retail investors in Mutual funds have not rushed to redeem the allocated units hence fund managers have more flexibility to move their investment into blue chips which are available at quite a reasonable price.

Useful links for investment decisions

Investment is always a factor of information available. The more updated and exhaustive information one has got the better he/she can decide on investing. This article is dedicated to the different websites available to explore mostly the Indian market conditions, to do preliminary research on individual companies and to get help in investing. Though the list is not exhaustive, the team has tried to come with sites available on different information needed for investment related areas. The list will be modified in future as the new sites bring more and more relevant information for the investors.

Websites of the premier stock exchanges in India

www.nseindia.com

www.bseindia.com

Websites for some of the online brokerages in India –

www.icicidirect.com

www.sharekhan.com

www.kotaksecurities.com

www.motilaloswal.com

www.reliancemoney.com

Sites for extensive financial information about the market, company and financial news – Most of these sites not only give the movement of index during market hours, but also updates on the news so that can be related with movement in indices. Its’ also provides information about the companies in terms of current trading price, volume recent news etc. In depth report on financial statements can also be found here.

www.myiris.com

www.finance.yahoo.co.in

www.moneycontrol.com

www.money.rediff.com

www.moneycentral.msn.com

www.valuenotes.com

Comprehensive lists of business managers can be found at- www.ceoexpress.com

A few sites, which give the insight of happening at the international level -

www.bloomberg.com

www.wallpost.com

www.finance.yahoo.com

www.wsj.com

How an amateur can make intelligent investment?

Why this many people lose in market? One obvious reason for that is people seems to be more comfortable in investing in business they are entirely ignorant about. Decision of investing in a particular industry should not be based upon speculation or some ones’ recommendation as long as one can’t see which business company is in.

An individual, who decides to invest on his own, should not listen to the professionals or hot tips, pick of the week etc from the brokerage firms. He should rather invest in the companies whose business he could understand. There is no more scarcity of information about the financial strength and business opportunities for the companies. A personal visit to the factory outlet of Arvind mills – “MegaMart” could give an idea of the business model of the outlets. A further observation and basic calculation about the contribution of the revenue from MegaMart to the Arvind mills can suggest if the recent decision of Arvind mills to come with another 1500 outlets will be a success or not. Another example could be Future Group. Anyone who has visited Big Bazaar and Food Bazaar can experience the operation of the firm and decide whether to invest in such a firm or not. For such an open industry one does not need to seek suggestion of a broker. You know it before the market gets to know it. But how about financial institutions like IFCI, Reliance Capital, India Bulls etc.? These are all public companies and the balance sheets as well as income statements for different periods are publicly available. In a country like India, which has got maximum number of news channels with 3-4 channels dedicated solely to business, it is no more a challenge to get the up-to-date news about any happening in the economy and market.

Before starting investment, the individual should analyse ones’ trust on the economy, the growth, the future prospect and the rampant impact of economic changes on behaviour of market. For example, before investing in infrastructure industry, one will have to understand that the infrastructure industry is closely coupled with the growth trend of the country. One will also have to do self analysis to see how much of risk he is comfortable with, whether he is a short term investor or a long term investor, and how will he react to the sudden, unexpected and severe drops in the prices. The potential market victims are those who invest everything out available with them when market is at its all time high and abandons all hope & reason when market is down and sells out at loss. Almost all of us read the same news paper, listen to the same channels and economists, it is personal preparation as well as knowledge & research that distinguish the successful investors from the chronic losers. Investor should only invest what you could afford to lose without that loss having any effect on daily life in the foreseeable future.

No one can predict market and anticipate recession; hence it is prudent to look for profitable companies with strong fundamentals available at attractive price.

Why many mutual funds fail to perform?

Mutual fund is a wonderful financial instrument for people who have neither time nor the inclination to test their understanding of the stock market. It helps people with a very small amount of money to diversify their portfolio to minimize the risk. But even then quite often amateurs easily outperform many mutual funds. In fact in long run most of the mutual funds underperform in comparison to their respective benchmark index.

As Peter Lynch says, this is not because of the inability of the fund managers, but it is the inherent fear of losing. Success is one thing, but it is more important not to look bad if you fail. Managers are quite aware that if they lose even 20-30% of investors’ money on company like Reliance, people will question Reliance for its failure than the manager to predict such movement. But a 10% loss on IFCI could call for reasoning behind such investment. It is better to fail on conventional stocks to keep the job safe than to try unconventional stocks and brings the job in jeopardy. That is the reason why most of the fund managers keep looking for reasons not to buy exciting stocks.

The other issue with mutual fund is the fee that management charges to their investor for managing their fund. An entry load of 2.25% brings down the returns by a significant level and again the exit load (In case of most of the mutual funds) of 2.25% further takes away return from the investors. According to Buffet, in Wall-Street, such management fund causes mutual funds giving less than 80% of return in comparison to the index funds.

Another hurdle with mutual fund is the regulation imposed by monitoring authority like Security and Exchange Board of India (SEBI). The upper cap of stake on a particular stock forces fund managers to look for some less attractive stocks than to increase stake on stocks which are bound to give better returns. Specially, in case of Small-Cap, size prevents manager to buy in such companies, because it is not possible to buy enough shares to have noticeable improvement in fund’s performance.

In such a situation, one of the alternative investors could think of is putting money in index funds, which do not need any management and hence can save the entry and exit load. Index funds are kind of exchange traded fund, where individuals’ money is put in different constituents on the index in proportion to their weight in the index. For example the index fund of NIFTY consists of 50 stocks which are constituent of S&P CNX NIFTY, and the money invested in this index-fund is proportionally distributed among these 50 stocks. One can also look for funds which have outperformed the index consistently in past 3 to 5 years. There are a few good mutual-funds which have beaten the index by a significant difference and hence preferred even after the management fee. More importantly, an individual needs to look at the fund-managers’ performance rather than the funds’ performance. As change of management could lead to change in ideology and can have impact on returns as well.

Aren’t stocks riskier than other financial instruments?.. and the more after the recent fall?

This is quite common doubt among most of the people who stay away from the market and are satisfied with meager returns from their fixed deposits or bonds. It is quite probable that market condition change with time, causing a great company to lose its business and its stock to fall. But, rarely a stock is priced below its fundamental value and if at all it does, there could not be a better opportunity to buy such strong stocks. A realistic investor will move from stock to stock with the change in market condition hence averting any such loses.


In last 5 years, NIFTY Index has moved from 1051.80 on June 16^th 2003 to 4517.10 on June 13^th 2008. Had someone invested in Index fund 5 years ago would have made an average of more than 60% return at simple interest and more than 30% return even if taken in compounded terms. And all this return would have come without any botheration of switching from one stock to another(except for the fact that constituents of Nifty are changed).A 30% return overshadows all the misgivings about the risk involved with investing in equity. Equity might be riskier in short term but it becomes safer as the duration increases. The graph does reflect unexpected fall in 2004, 2006 and again in 2008, but such negative returns has always remained for short term and a long term investor would not bother for such movement. Such an impressive return even after taking the latest fall into account gives a clear impression that investment in fundamentally sound company would rarely disappoint.

A retail investor is often scared of speculation in market. Speculators are bound to be there, and this in fact helps in increasing the volume of trade. It brings down the impact cost, as a buyer will always find someone available to sell at that price and vice versa. Most of the speculation happens in small-cap companies. But looking at the fundamentals will easily filter out such stocks from investment perspective. Moreover the speculators have also started moving to derivatives from these small-caps, making equity more reliable.

Investor loses when he buys the right stocks at the wrong price and at the wrong time. Recent fall of DLF Limited is an example of such a stock which came below its issue price. A month back buy of this stock could be termed as right pick at wrong time. Though the stock is fundamentally strong, the recent slow down and doubt about the economic growth in coming days brought down the price of infrastructure firms drastically and DLF was no exception.

People start believing stocks to be prudent investment when it is not. Last year was golden year for many people who blindly invested in stocks without looking even at basic fundamentals like balance sheet & income statements and made decent gain. Stock was hyped all the way to be the obvious choice, but the correction taken place this year has made people believe it to be riskier and safe to stay away thing. And this happened when many stocks are available at bargain price which should have been bought.

To sum up – People lose in market because they seem to be more comfortable in investing in business they are entirely ignorant about. The stock becomes riskier for those who get into market without any planning and knowledge. Hence, one needs to do self analysis to see how much of risk he is comfortable with, whether he is a short term investor or a long term investor, and how will he react to the sudden, unexpected and severe drops in the prices.

Derivatives: Basics

Since 'Derivatives' are so much talked about these days and we haven't covered it in this blog, let me talk something basic about Derivatives. As we know, Derivatives are financial instruments which derive its value from one or more underlying asset (from the word 'derived'). Though underlying price is the most dominant factor in the price of a derivative, other things like risk free rate, volatility in the underlying, duration of the contract, kind of settlement, etc. are few other factors that help in determine the price of a derivative instrument.

So, the more important question which arises is why do we need derivatives? Why can't we straight away trade in the underlying? Well, we need derivatives to hedge the risk. In a developed market, everyone wants to hedge his/her risk and derivatives help him/her to do so. An example for this can be a farmer who wants to sell potatoes after two months when he will harvest his produce. He knows that in future, prices may go up or down. He knows the approximate produce that he is going to have but have to wait for two months to get the physical commodity(Potatoes) to sell in the market. What if prices fall by this time? This is a big fear for the farmer. On the other hand lets assume a chips manufacturing company which has secured a huge order for potato chips to be delivered after 3 months and it required potato supply after two months. The company fears the prices may go up and reduce its profitability. Here is a typical situation in which the two complementary parties share a common risk and are willing to reduce it. What if the farmer and the company agrees to have the deal that farmer will sell a fixed quantity of potatoes to the company after two months at some price which is fixed today. So, they enter into an forward contract ( a kind of derivative instrument, since the price at which contract is done is dependent on the price of potato, the underlying commodity). This way, the farmer and the company hedges the risk. (for farmer, risk is of prices going down in future, while for company, the risk is of prices going up).

Now, coming to the types of derivatives, lets start with the forwards contract. In forwards contract, buyer agrees to buy specific quantity of goods from seller at a fixed price (futures price) on a future date. So in the above example, suppose the company agrees to buy 100 kg of potatoes at 10Rs/Kg after 3 months from now, it will be a forwards contract. Now, in these type of contracts the major problem is of default risk. If prices go up then farmer will try to default and if prices go down then company will try to look for other sellers. Hence, futures contracts are used. In futures, contracts are more standardized and are traded on a future exchange. default risk is taken care by margin which is charged by the exchange from both buyer and seller. Most contracts are settled through cash settlement. Margin requirements can be reduced or waived off for those who have physical ownership of the commodity.

Now we come to the question as to how to decide on the futures price. Now the futures price has to be greater than the spot price else, people will make profit. This can be seen from the following example. Say, If spot price is 100 Rs and futures price is also 100 Rs, then a person will buy futures of 100 Rs and sell stock of 100 Rs. He will earn interest on those 100 Rs which will be his profit (arbitrage). So, future price is always higher than spot price. Theoretically future price is calculated by continuous compounding and is given by S * exp(r*t) where S is spot price, r is rate of interest (risk free rate) and t is fraction of time. Now, if theoretical futures price is greater than actual futures price, then the asset is underpriced and we will like to buy futures and sell stock. And if theoretical futures price is lower than actual futures price, then the asset is overpriced and we will like to sell futures and buy stock. Theoretical futures price will eventually tend to be equal to spot price as we approach the maturity date. This is termed as principle of convergence. Difference of spot price and future price is defined as basis (spot price – future price). When difference increases, we say that basis strengthens and is good for short hedger. When difference decreases, we say that basis weakens and is good for long hedger.

Derivative Market - Financial weapons of mass destruction!!

Yesterday I made a decent 40% profit on the CALL option which I had bought a couple of days back. I started getting interest in option trading last year and followed market religiously. Index option of NIFTY has got decent volume and a volatile market like this could get fair return in the derivative side. The foray in derivative market was a good learning for me. Option market is good for those who have fair idea of economics, who do not get tempted and most important who trades in a market which follows logic.

In case of Indian derivative market, the volume is really thin as compared to equity market. The inflation reported to 42 month’s high at 7.61 on May 9th 2008, but the market did not move down for “some time”. Analysts came with opinion that the current inflation figure was expected and already accounted for. The market started falling after that and the opinion changed that the high inflation was causing the mayhem... On May 12th, the Index of industrial Production (IIP) number came, which was lowest in the last 6 years. Markets fell initially, but regained its loss in the second half with no positive trigger. Not only this, it closed surprisingly in green. Next day market fell by around 2% and the IIP number was blamed for such movement... The inflation on May 16th was reported as 7.83, the highest in last 44 months but market went up in spite of low IIP number and such high inflation. Same story gets repeated and market closes in green - about 0.50-1.0% higher than the previous day close. There are many such instances, which indicate that Indian market is rigged, does not follow logic and is well manipulated for the benefit of a few.

In such a scenario, whether derivative trading is sensible investment alternative or not is an issue to be debated. As per the report from Chicago & New York, between 80-95 % of the amateur players lose in the Futures & Option market. And these odds are worse than the worst odds at casino or at the racetrack. The large potential return in this market is attractive to many small investors who are not satisfied with getting rich slowly by investing in stocks for long term. They venture into the derivative market to get rich faster and eventually lose all their saving in a very short span of time. Options are only for certain period and get expired at the end of the period. One has invested in stock and his research suggests that price will come down soon, so he buys PUT option to hedge his losses. But price does not come down in this month. The option expires worthless and he loses all the money he had paid as the premium. To be protected continually, he has to keep buying PUT option every month which he can not afford to do. The worst thing happens when the sure thing proves to be true and the price of the stock comes down the next month. Not only he has lost his money, he has done it while being right about the stock. Instead of being rewarded he is wiped out from the market with very thin saving at hand.

Another sad part of the story is that these options are very expensive. The more volatile the market is and the more time-horizon the option has got, the higher the premium is. The Black-Scholes formula for calculating the premium of option suggests that NIFTY has got roughly 20-35% of volatility (Volatility index), which results in quite higher premium.

Options are zero-sum game, for every Rupee won in the market there is someone who lost a Rupee, and interestingly, minority does all the winning. Buying option has nothing to do with owning a share and it does not make one owner of the dividend paid by the company. One contributes to the growth of the economy of the country when he buys the share of stock even in the secondary market. But in options market, not a bit of money is put to any constructive use.

To sum up, trading in derivative is one of the riskiest investments. While stock itself is highly priced, the derivative trading could lead to major disaster. Warren Buffet referred these volatile, dangerous options as “financial weapons of mass destruction”. Small investors should be cautious of making investment in such financial instruments and should be rationale than being tempted.

Face 2 Face : INFLATION AND MONETARY MEASURES

For

Monetary measures can be effectively used to control the liquidity to regulate the demand. While supply is the core of the problem, there is not much that can be done to in-crease supply in the short term, whereas demand can be directed easily to keep the inflation in the desired range.

An increase in the price leads to price-wage inflationary spiral. A monetary squeeze can stabilize price level and hence the wage. With the lack of a well developed bond market in India, bonds issued by the central bank squeezes money significantly. Further, rise in interest rate not only makes the borrowing costly but also encourages saving and reduces consumption. The recent increase in CRR will eventually bring down the amount available with banks for lending. Moreover, any monetary measure adopted by RBI signals the market about the intention of government and thus checks the price rise. Though restricting credit-availability impacts growth, inflation needs to be curtailed for the survival of the poor.

Therefore, managing liquidity would continue to take priority to push inflation back to around 5.5 percent this fiscal year.

- Kumar Saurav

AGAINST

Although Inflation is a monetary phenomenon and hence monetary policy is most logical tool to correct it; there are various limitations on the effective working of the quantitative measures of credit control adopted by the Central banks which weaken the monetary policy. Moderate monetary measures are relatively ineffective in controlling inflation and drastic monetary measures are not good because they turn economy into a tailspin. More-over, very often monetary policy is so mildly applied that it hardly has any impact on inflation.

In a developing economy like India, there is always an in-creasing need for credit to fuel the growth. However, there is a need to contract credit to curb inflation. Therefore, this conflict leads to dampening of growth if Central Bank resorts to credit control to check inflation.

Also in modern economies, securities, bonds etc. which are known as near money; represent tangible wealth. As they are highly liquid and are very close to being money, they increase the general liquidity of the economy. Therefore, it is not so simple to control the rate of spending merely by controlling the quantity of money.

Thus, there is no immediate; and direct relationship between money supply and the price level.

- Jaspreet Singh Arora

Courtesy - FY Newsletter

Credit Derivatives- Part I

"The news hit stocks and knocked jittery credit markets hard, with the widely watched iTraxx Crossover index breaking above 600 basis points for the first time, a reflection of soaring debt-insurance cost" - Reuters
"Credit risk measure the change in the credit quality that have the potential for creating losses resulting in stress in systemtically important financial institutions". Derivative is a risk shifting agreement, the value of which is derived from the underlying asset. The underlying asset can be anything you value, which could be physical commodity, an interest rate, a company's stock, a stock index, a currency, or virtually any other tradable instrument.
The reason we go about analyzing this is because of the credit concerns now extend beyond the subprime crisis. One way this is becoming increasingly evident is through the pressure on the balance sheets of financial institutions. What began as deterioration in credit quality altered the market liquidity and this altered various credit products valuation as people added more risk component in the short term. The credit worthiness of customers and the lending rates of the financial institutions are under distress. The question is what is the way forward?
Although the economic condition is adding to the distress, most of it is mitigated by the efforts of the central bank to instigate spending. There should be other ways of improving this situation.
This situation is not just for European or American markets, but it extends to markets like India, where we witnessed some adverse fallout since the starting of this year, a spillover effect.
This has lead to tighter economic and monetary policies which could curtail economic activity further. Falling equity prices will exacerbate the reduced consumer spending. And finally, capital spending could be reduced as the cost of capital increases.

What is interesting is the way the emerging markets are responding to these global cues. High inflation which is as high as 7% in India for example will have to go down as the global economy shrinks. What about the equity inflows in India? According to the recent study on equity inflows in emerging markets by Bank of New York goes against conventional wisdom. It find little to no net effect of inflows on equity prices. But definitely there is a significant relation between the inflows and the equity prices in India at least in the short term.

In the subsequent article we will see how credit is managed and what are various credit derivative products that are available.

Common Currency in South Asia

Introduction

The issue of consolidating the South Asian economies, and have stronger economic relations in the region, is not new. However, the idea of having a common currency in South Asia was encouraged after a successful launch of EURO by European Union in 2002. The talks for a common currency in South Asia began in 2004, when then Prime Minister of India Mr. Atal Bihari Vajpayee went to Pakistan for SAARC summit. It was termed by economies as a visionary initiative which would bring businesses in South Asia closer to each other, kick-starting closer economic ties. This was followed up by the commitment towards economic integration through free trade agreement in the Twelfth SAARC Summit, Islamabad. However, not many empirical studies have taken place to suggest the framework for launching a common currency for South Asia.

Many industry stalwarts and economists have put forth the prospective benefits and problems of having a common currency. The aim of this article is to summarize these benefits and problems and to have an introspection of each of these factors in order to have an understanding of the issue.

Economic Structure of South Asian Nations

In order to have economic integration, the potential member nations should have a similar level of economic development. This includes comparable average literacy level, similar work force productivity and working standards, in order to ensure that the flow of manpower across borders is minimal. If this is not the case, it would lead to an increase in the social and fiscal strains on the immigrant country.

In case of South Asian countries, the level of development of individual economies is more or less the same, with countries like India and China leading the way towards becoming developed economies. However, there are a few countries like Bangladesh which still have a long way to go. Looking at the structure of production, it comes out that the level of contribution of the Industrial sector is reasonably similar across the South Asian countries. The Industrial sector constitutes approximately a fourth of the GDP in all the countries. However, the contribution of agriculture varies across countries.

Although this intra-regional disparity is not much, it still makes the case of South Asia different from that of Europe, where the level of development of countries is even more similar. However, few studies claim that the similarity of economic structure may make the countries vulnerable to similar shocks, which could require a similar policy response. This strengthens the case for a common currency on the grounds of similar shocks.

Feasibility of having Common Currency in South Asia

Apart from the point being mentioned regarding the economies being at similar stages of development, there are two other points which strengthen the case for launching a common currency. Most South Asians already use currency called “Rupee”. Sri Lanka, Pakistan, India and Nepal have currency called Rupee. Bhutan has both Indian Rupee and Ngultrum as legal tender. Maldives’ currency is Rufiya. So it should be easy to have a popular consensus for a unified currency. Second point is that under British rule we all had a common currency which extended to Middle East and to South East Asia. Now, Globalization and freer trade is taking South Asia back to its economic history.

But on the other hand, we need to put an emphasis on the fact that Europe emerged as a common currency economic zone after more than half a century following the end of hostilities in 1945 (End of World War-II). It took fifty years of political, economic and social negotiations for it to become a Union. In the given context, if the situation is compared for South Asia, the efforts for consolidation have only been started recently. This presents a pessimistic picture which weakens the prospect of launching a common currency.

Prospective Benefits

The common currency regime, when achieved, will confer substantial benefits to the region. It will remove the uncertainty about exchange rates and reduced transaction cost will result in providing a big boost to trade and investment in the region. Also, there would be better prospects of synchronization of inflation, interest rates and GDP growth by having a centralized control on money creation. This will contribute to accelerated growth and poverty reduction.
Also, from a business perspective, it will lead to reduction in transaction costs as they increasingly trade with each other. It will provide a bigger market for foreigners to invest in and a bigger market for savings will result in lower interest rates for all borrowers, which is beneficial for businesses everywhere.

Looking at it from another angle, this economic cooperation can prove helpful to bridge political differences among a few countries in the region, especially India and Pakistan.

Issues and Problems

One fundamental problem of having common currency is that individual countries do not have their own currency and monetary policy is agreed on regional level with agreement on national component of currency and money creation. Therefore, the system requires surrender of monetary sovereignty and of seigniorage associated with currency creation and monetary expansion.

Conclusion: The way ahead

The objective of common currency can be achieved only in an incremental manner. The Governors of Central Bank of each country should convene to develop a roadmap for currency union. The process has to begin with the initial step to introduce a parallel currency and utilize that instrument to promote regional cooperation in trade and investment. Parallel currency does not require surrender of sovereignty and individual countries retain control on their currencies and monetary policies. In addition, there is a currency created jointly, according to weightage of different currencies in the basket and assigned a value, and allocated among member countries. This common currency can be created for South Asia and will be fully convertible into any international currency. It will be used as a unit of transactions on account of trade and investment in South Asia and will be legal tender for cross-country transactions in the region. Also, South Asian countries can create a pool of forex reserves to meet emergency Balance of Payments needs as well as development needs in the region. Then, each of the Central Banks should eventually merge all their operations relating to the issue of currency, foreign exchange and interest rates. Finally, mutual trust and confidence has to be built in the parallel currency among all partners in the region, so that it becomes integrated in the economic system of the region, in order to ensure its conversion to common currency, over time.

HDFC bank to buy CBoP

One of the largest private sector bank,HDFC is all set to buy Centurion Bank of Punjab in an all stock deal of about Rs 10,000 crore. This is the biggest merger deal in Indian banking history.The swap ratio for the deal is not yet decided. Let us see how will HDFC Bank benefit from this:

1. Centurion has around 170 branches in northern India and 140 branches in Southern India so HDFC’s presence in these parts of the country specifically in states of Punjab, Haryana and Kerala will receive a boost

2. About 2.5 million customers of CBoP will become a part of HDFC Bank

3. Innovative services can be offered to the clients of HDFC post merger

4. HDFC will become the seventh largest bank in the country in terms of assets post merger

A similar merger was thought, about six years back between the two banks but it didn’t materialized due to valuation reasons. But after such a long time this deal is finally getting materialized on account of good understanding between the top management of the two companies.

What is Group A, B1, B2, S, T, TS, & Z classification of BSE?

The Bombay Stock Exchange (BSE), India's leading stock exchange, has classified Equity scrips into categories A, B1, B2, S, T, TS, & Z to provide a guidance to the investors. The classification is on the basis of several factors like market capitalization, trading volumes and numbers, track records, profits, dividends, shareholding patterns, and some qualitative aspects.

As on February 2008 following criterion are used for classifying stocks into various categories by the Bombay Stock Exchange(BSE).

Group A:
It is the most tracked class of scrips consisting of about 200 scrips. Market capitalization is one key factor in deciding which scrip should be classified in Group A.

According to BSE circular dated February 5, 2008 the criterion is:

1. Company must have been listed for minimum period of 3 months.

Exceptions:
* The Company can be directly listed in group 'A' provided the market capitalisation of a company being listed, based on its issue price, is higher than the average market capitalisation of 100th company in the existing group 'A' as per the ranking based on preceding 3 months data.
* Any company permitted to be traded in F&O segment from date of its listing shall be directly listed in group 'A'.
* Companies listed subsequent to any corporate action involving merger/ demerger/ capital restructuring etc.

2. Companies traded for minimum 98% of the trading days in past 3 months shall be considered eligible.

3. Companies with minimum non-promoter holding of 10% as per the shareholding pattern of most recent quarter shall be considered eligible. The criteria of minimum 10% non-promoter holding shall not be applicable to public sector undertakings (PSUs).

4. The weightage of 75% and 25% shall be given to ranking on three monthly average market capitalisation and traded turnover respectively to arrive at the final ranks.

5. The list derived, based on final rank shall be screened for compliance and investigation. Based on this screening, the list of top 200 companies shall constitute group 'A'.

6. The group re-classification shall be reviewed twice in a year i.e. February and August.

7. On inclusion of any new Company in group 'A' based on criteria 1(a) or 1(b) detailed above, the last company in the existing group 'A', based on its final rank calculated on data preceding three months shall be excluded.

At present there are 216 companies in the A group.
We will look into Group B1 & B2 later.

Group T:
"It consists of scrips which are traded on trade to trade basis."

Group S:
"The Exchange has introduced a new segment named “BSE Indonext” w.e.f. January 7, 2005. The “S” Group represent scrips forming part of the “ BSE-Indonext” segment . “S” group consists of scrips from “B1” & “B2” group on BSE and companies exclusively listed on regional stock exchanges having capital of 3 crores to 30 crores. All trades in this segment are done through BOLT system under S group."

Group TS:
"The “TS” Group consist of scrips in the “ BSE-Indonext” segment which are settled on a trade to trade basis as a surveillance measure."

Group Z:
"The 'Z' group was introduced by the Exchange in July 1999 and includes the companies which have failed to comply with the listing requirements of the Exchange and/or have failed to resolve investor complaints or have not made the required arrangements with both the Depositories, viz., Central Depository Services (I) Ltd. (CDSL) and National Securities Depository Ltd. (NSDL) for dematerialization of their securities."

Group B1 & B2:
All companies not included in group 'A', 'S' or 'Z' are clubbed under this category. B1 is ranked higher than B2.
B1 and B2 groups will be merged as a single Group B effective from March 2008.

Besides these equity groups there are two other groups i.e. Fixed Income Securities (Group F) and Government Securities (Group G).

For more details please visit the source: http://www.bseindia.com/about/tradnset.asp

Why do we need Banks?

One question that might pop up in many people’s mind is “Why do we need banks”? Is It just to deposit money and earn some interest or has it got something much more important than this. Well let’s start and try and understand “Why do we need Banks?” I will take an example, suppose we have three entities Party X, Party Y and an organization Z. Now we will take a few scenarios, first of all let us suppose that all three of them know each other, now if anyone wants money for some activity he has the option of borrowing it from the other party which is willing to lend him. Now let us consider the scenario that these three parties don’t know each other, so what can be the possible consequences. One thing that I can think off is a party who needs money for some activity will not be able to get that and hence may not be able to go ahead with the plans it had. These plans can be the expansion of a business which could have helped to generate jobs and pay the taxes to the government. In other words it could have led to the economic development of a country. So to address this important question of letting the parties interact with each other we need an interface. This interface can function as an intermediary and can help in taking money from people who have excess of them and lending it to the one’s who need them. And so here comes the concept of banks into picture.

Banks basically are involved in the task of taking money from people and giving the same money to others who need them to pursue some activity. These needy people can be organizations, students, or other individuals. Organizations in turn use this borrowed money by investing them in their businesses and generate economic activity. The corporates earn returns on their investments and so are able to return the money to banks with interest component and the banks in turn returns them to the depositor with an added interest component. Thus banks solve this basic problem of taking money from someone and giving them to others in a world where people may not know each other. I hope this article has clarified the concept of banks and helped you to understand the importance of banks to generate economic activity and attain sustainable development of a country.

Crude oil crosses $100 mark again

The crude oil prices jumps back over $100 from $97 per bbbls earlier after the news of blast in a Refinery in Texas. This is second time that oil prices have breached the $100 per barrel level. About one month back the oil prices touched the triple digit mark for the first time but soon retreated back. During the recent recession fears the prices fell back to the level of $80s. Some of the retreat was due to better supply over demand. Even though the recession fear is not totally out, and the supply-demand equation in the near future is intact, the oil prices have been rising because of speculation.

Some of the possible triggers for the recent uptrend seen in the oil prices:
OPEC meeting for decreasing production
Political issues between U.S. and Venezuela
Exxon-Venezuela conflict
Political instability in Nigeria
Blast in Texas Refinery

Fraud at Societe Generale: Was this a new lesson for the financial institution?

One more name got added to the list of

rogue traders with the revelation of fraud by Jerome Kerviel at Societe Generale. This seems to be the biggest banking fraud unless a few more traders, who might have taken massive bullish positions in this bearish market, get exposed in near future. A $7.2 billion loss outsmarted all the previous trading losses. Societe Generale is France’s second largest bank and the unauthorized bets on stock-index futures resulted in a loss of euro 4.9 billion.

Jerome Kerviel started increasing the size of his trades in the year 2007 and Bank was informed about that by the authorities of Eurex, but his net position was a profit of $81 million and hence the caution was ignored by the bank. By the end of 2007, Jerome had booked profit of about $2 billion for the bank and this time he was more ambitious. He entered into contract illegally on the name of bank’s clients. His fictitious trades largely involved future contracts on various indices such as Eurostoxx-50, German DAX and FTSE index. Most of these unauthorized contracts were entered in early January 2008 with a bullish view about the market. But marketing started witnessing a downward movement with a negative sentiment about the global slowdown. By then, bank’s client raised the alarm and the senior authority started investigation. Out of surprise, the management found that his market exposure was $50 billion which was even more than the worth of Soc Gen. The news of this isolated fraud of such huge size caused concerned in the market already reeling with the subprime crisis. European market crumbled around 7% on Monday (21’st January 2008) because of the desperate attempt by the bank to clear off the position. Ultimately the virtual loss turned to real loss of $7.2 billion.

One concern arises here about the decision of management to square off the position at the earliest is that why management had to be this hasty? Shouldn’t the bank waited for indices to go up to make huge profit or atleast avoid loss from the bet? Soc Gen., the second largest bank of France, got aware of the gravity of the situation because of such a huge bet on the indices which amounted more than the worth of the bank itself. This news had also reached to the market and the sentiments got further sour in already bearish market. The FTSE100 had fallen from 6456 on January 2’nd to 5901.7 by January 18’th (Fall of more than 8%) from the speculation of global recession. Management had to take the call well in advance to avoid Soc Gen. becoming another Barings. The management claimed that even after losing the $7.2 billion in the market, the bank was going to show profit of euro 800 million for year 2007.

Trading floors all over the world, have witnessed a series of such frauds. But, who should be blamed for such events? The rouge trader, who misuses the information available with him/her or the management, for whom only the gain matters irrespective of source and the means? All such illegal trading had initial clue as well as warning from different internal or external authority, but management has consciously ignored such indication just because the position was bringing money for the company. While traders have been unethical by using fraud accounts of clients without their permission and betting on amount more than the assigned limit; management needs to introspect and reason out their myopic view of such prevailing wrongdoings. A firm regulatory body with close eye on every transaction and proactive decision of management could avoid such event in future.

Biggest Trading Losses by Financial Institution

Derivatives – Boon or Bane

Before analyzing whether Derivative is a boon or bane. Let us start with the definition of Derivatives. Derivatives are financial instruments which derives its value from the underlying. This underlying can be anything as bullion, commodity, stock, or a stock index. Derivatives can be divided into Forwards, Futures, Options and Swaps broadly based on the purpose for which they are going to be used. Derivatives can either be traded over the Counter (OTC) or on an exchange. OTC’s are the one’s which are customized as per the requirements of the two parties and are not tradable in free market while exchange traded are the standardised one’s and are capable of being traded in an exchange. Now let us take an example and look at a simple derivative forward contract.

In this one party is the seller of the contract and the other is the buyer. Let us say the seller is selling gold at a price of Rupees 600. The seller agrees to buy gold 3 months from now at Rupees 610 and both of them get into an agreement. Essentially all the kind of derivatives contract relates to similar kind of agreements between two parties but with slight variations in terms of contract life, tradability and the purpose of the contract. Looking a bit deeper to the above example one can see that the contract is helping the buyer to first of all book an order for a future date by paying a premium to the seller and not the entire money which he would have to pay if he buys the gold today.

The buyer and the seller in a derivatives contract hold the views that the price of the commodity will rise and fall respectively in the future. Now this seems more like a gamble. But people who buy and sell these kinds of contracts do have their sound logic supported by arithmetic and experience. The derivative contracts are widely used to hedge the risk by different institutions or individuals as well.

Using derivative instruments one can earn a huge amount of profit by investing very less money in a very short span of time. But even though people have their logics behind these, one must not discount the fact that derivative is a zero sum game, wherein one person’s lose is another person’s gain. Now people can earn huge amounts of money in a short span of time but they can loose even bigger sums of money. Some of the example’s which can be cited in this regard are:

a. Nick Lesson leading to the downfall of Baring’s bank

b. Jerome Kerviel leading Societe Generale to a loss of $7.2 Billion in futures contract.

Now seeing these examples one can guess the amount of money which one can loose trading in these instruments.

But on the other hand these instruments can help people and organizations make a lot of money, and hedge their risks against the uncertainties, thus helping them to strengthen their financial positions and their bottom lines.

What is going to move the market from here?

The secondary market witnessed a steep downward movement last month. In the period of January 14-22 BSE30 Sensex lost 4100 points incurring a loss of 16,000 billion for the investors. When Nifty futures turned into discount, it created heavy short positions. Investors were not having enough money to meet the margin calls on their future contracts, and brokers were forced to sell in large numbers. The major drain of money from the secondary market happened mainly because of the following reasons-

1. Reliance power IPO, which came with a bid for nearly Rs 11000 Crores and got oversubscribed by 73 times.
   
2. Future Group, which came with IPO to fetch around Rs 490 Crores, got oversubscribed by 133 times.
   
3. FII withdrawal from the market amounted to Rs 13035.7 Crores in the month of January.

Though FII were selling in large volume because of global cues, the major part of domestic money was stuck with the IPO of Reliance and Future Group and no buyer was available in the market.

Now in the month of February, with fed cut in interest rate huge capital inflow is expected through FII’s. Reliance Power has completed the allotment of shares and it has refunded around Rs 1 lakh crores to the bidders. Future Group also refunded the sum for unalloted bids, which is around Rs 50,000 crores. This huge inflow in market is expected to make the market bullish in the short term. But the movement will majorly be decided by the sentiments, and any negative news will turn the market bearish. The concern over the recession in the US economy is going to keep the market volatile and investors need to be cautious about their investment.

Challenges ahead for Indian Monetary Policy

The much expected rate cut by RBI did not happen. In the midst of all the all sorts of speculation, RBI has adopted a policy of wait and watch for the time being. So what’s there left in Indian market in coming days? The impact of differential interest rate is going to have diverse effect. The following heads could be one way to summarize the future move.

More inflow of dollar is expected in the coming months and the huge capital inflow will further complicate the monetary policy. Rupee has already appreciated by almost 12.3% against dollar in last year and further gain could worsen the plight of export industry. Textile industry has already lost more than 50,000 jobs the issue needs to be addressed soon.

We witnessed the lowest inflation of last 5 years in December 2007, but the wholesale price index rose 3.93% in the week ended January 19. This inflation was highest in the last five months. The huge capital inflow in the market from outside is expected to put pressure on inflation. The petroleum price hike also seems imminent and this going to further accelerates inflation. RBI’s stand on keeping the interest rate intact reflects that curbing inflation is of highest priority at this point of time.

Large capital inflow has increased the liquidity in the market and monetary policy has got complicated, RBI needs to be flexible to act on each and every global clue to keep the interest of one and all.

Off Balance Sheet accounting

As an investor we would be looking for information that is from various sources like annual report, news, analysis etc. But truly there are times when we are not sure about how the company is making money. Though one may think of spending more time in knowing exactly what the company is doing. But that may not be true, as managers may choose not to disclose those to the public. Hence there is always a cap on the information available to the public when there is no ceiling set by any governing body.

This is the major reason why stock market are inefficient!. Let us look more closely at specific accounting malfeasance. This will help us see what is the information that we should be looking more closely when evaluating a company? The biggest corporate scandal in U.S happened in the starting of this decade including Enron, WorldCom.

Although Enron was involved in more than one accounting scandals, the important one was the off balance sheet accounting. It is just pure number jugglery. Towards the end of a financial year if Enron notices that there is $3, 00,000 bad debts, it will simply create a Special Purpose Entity to get this huge debt off the record and create revenue! Now you might wonder what this SPE – Special Purpose Entity is? It is another entity set up by the Enron. Now how would this SPE raise money? They would finance it through banks. Isn’t surprising to know which bank would lend money for such bad debts. But much to our surprise it is all the globally reputed banks. Now the real motivation for the banks to lend money is the coveted stocks of Enron which was consistently increasing in value. That is surprising to see, how the market will evaluate a company with such an accounting practice.

The story doesn’t end here as the equivalent stock which was pledged for this bad debt should also have an accounting entry. This is where the Enron were smart in using the loop holes in accounting standards. They booked them under the issue of stock against promise to pay- notes receivable. Although there is a long standing accounting rule that says Notes Receivable created for the issue of stock should not be treated as an asset but as a contra equity- deductions from owners’ equity. But Enron actually treated as an asset. This is the multibillion dollar “mistake” that Enron did. Without any genuine earnings they were able to bloat their balance sheet!
WorldCom story was a little different. It overstated cash flows by booking $3.8 billion in operating expenses as capital expenses. For an exhaustive list of accounting scandals refer to the link below
http://www.forbes.com/2002/07/25/accountingtracker.html

There is a separate area called the forensic accounting which provides report on the insights into this number jugglery. Now as an investor what are the word of caution?
1. Income from unspecified source, that are not revealed or from special purpose entities
2. Loading of inventories to a sister company
3. Income from asset sales or financial transactions
4. Frequent accounting restatements
5. Accrual earnings that run ahead of cash earnings consistently
Although the list is not exhaustive these are the learning from the past. But the most essential thing for any successful investment as Warren Buffet says is to invest in something where you really know and like the business! It is strange though to see the herd mentality.

Microsoft set to leave its debt-free status for acquiring Yahoo!

Microsoft surprised many analysts by announcing acquisition offer for Yahoo! last week. The offer amount is $44.6 billion based on per share offer price of $31. This is at 62% premium to the closing price of Yahoo! stock on January 31, 2008. The offer is funded by 50% equity & 50% debt. The equity is equal to 0.9509 times the Microsoft's stock closing price on January 31, 2008. Chris Liddell, Chief Financial Officer of Microsoft, said that the offer has more than 100% premium over the operating assets of Yahoo!.

If the acquisition is completed, this will be the first time Microsoft will be borrowing money. At present Microsoft is a debt free company. Yes! Microsoft has no long term debt. Surprising, isn't it? Even Yahoo! has very insignificant amount of debt. Its debt to equity ratio in the latest quarter was 0.079.

Microsoft is a cash rich firm with 21 billion USD in cash and short term investments according to their latest balance sheet (December 31, 2007). The total current assets are more than 37 billion USD. This is huge considering the total assets size of about 67 billion USD. Microsoft funds its operations with short term loans. It has 22 billion USD current liabilities. MS is planning to use its available cash and stock to pay the equity part of the acquisition value.

Yahoo! stock price has climbed more than 50% since the offer was announced last week. Google's investors have been shocked by this and the stock fell heavily after the announcement. Currently, Google is the dominant leader of the online advertising market with more than half of total market share. The market is set to grow from 40 billion USD to 80 billion USD by 2010.

Stock Markets Unwinded

Here comes an article which will let you know the basics of a stock market. So let’s straight away start the topic which I think is of interest to everyone in the country.

First of all for those who think that stock markets are the easiest ways to become rich, think twice as it is one of the most troublesome places. It can make one earn a crore a day and loose two the next day. So with this constraint in mind let’s try and know our markets a bit better.

Let’s start with what does bulls and bears mean. Bulls mean people who purchase stocks and bear the one who sells them. All of you must have heard of about market indices as BSE Sensex or Nifty. One see’s the value of indices jumping up and down throughout the day. What does the value mean? If we take example of BSE Sensex it is the weighted average of thirty stocks which are representative of all the sectors of the economy. Thus these indices change with the change in the underlying stock prices. The next question which must be floating in your mind is what causes the change in stock prices. Well there are several factors which can cause a change in the stock price. Some of them are:

1. Recession in the economy or industry
2. Lower than expected performance of the company
3. Getting a new contract
4. News of its merger or its acquisition

Seeing the factors listed above don’t one get a feeling that these factors are transient and one most see the long term growth prospects of the company. Well my friends the stock markets are driven by something known as “Market Sentiments”. Mostly these sentiments don’t take into account long term growth prospects of a company but are driven mostly by the things happening right know in the company or industry or economy of the country or the global economy as a whole.

Further, I would also like to add that demand and supply, which are yet again governed by the market sentiments play a huge part in deciding the price of the stock and in turn the index value.
Now as we have learnt about the stock price movements and index value movements let us move into a bit more detail to understand the kind of markets prevalent in the country. Now the place where shares do get traded are known as Capital Markets. These can further be classified into primary markets and the secondary markets. The primary market is one where the Initial public offer (IPO) of a company i.e. shares for the first time are on offer while secondary market includes the place where day to day trading happens. Now a few of you must be having doubts about how does the price of an IPO is decided as the share is still not out in the market. Well it a complex process and will discuss about it in the next article. So let’s wind up this article now and will be back with more articles related to the vibrant world of stock markets very soon.

Impending recession and the aftermath

The bearish movement in Indian stock market in last couple of weeks draws everyone’s attention towards the world economy again. In the era of globalization, any significant move in the economy of big players is going to have well spread impact (Article on Decoupling theory). And if the movement is there in US economy no country will be left untouched...

The movement in the US economy started in the month of September with the Subprime crisis followed by credit crunch in the US market. All the major banks in US reported huge losses and Federal Reserve had to cut the interest rate first time after 2003 by 50 basis points (0.50%). The complete effect of subprime crisis was yet to be realized and that was evident with further writing off bad debt by major bank in 3^rd quarter of 2007. The economy started slowing down, and financial market came under much stress. Fed had to intervene again within 4 months of earlier cut and the interest rate was dropped by 75 basis points to 3.5%. This was again followed by reduction in benchmark short-term interest rate by 50 basis points to 3% within 9 days of previous cut. This was the most aggressive movement in interest rates since 2001, and is expected to keep the housing slump and the credit crunch brought on by a meltdown in the home-lending market from pushing the broader economy into the red.

But even after all these measures, the consumer spending in the U.S. increased at the slowest pace in last six months. The unemployment insurance jumped, U. S. economic growth slowed to 0.6% annual rate in the 4^th quarter from 4.9% in the prior three quarters. All these facts indicate towards an impending slowdown and countries need to hedge the movement to all possible extent.

Countries like India has got major exports in U.S. and reduced consumption rate will certainly impact the export business heavily. While, the export industries are already suffering with appreciation in Rupees and it will get worsen with any slowdown in demand abroad; the crude oil price had come down after the speculation on reduced demand by the world’s biggest energy consuming country U.S. This will relax the Indian oil companies a bit with reduced subsidy (more about Crude oil price and its impact).

The significant cut in interest rate by Federal Reserve is aimed to avoid any credit crunch and after the RBI (Reserve Bank of India) decision not to cut the interest rate, heavy credit inflow is expected in coming month. The volatility in stock market reflects the suspicious and bearish environment. The GDP in the year 2007 grew by 9.6% and growth is expected to be close to 9% in FY2008. The government needs to be well prepared for any uncertainty and be ready with flexible policy to avoid any major impact.

Economic Fundae -RBI Credit Policy- 2008

Recession waves roaring in U.S and the interest rate cut by the FED is sent as an abatement in response to it. Although it will benefit the recent sub-prime crisis, the impact of this rate cut to 3.0% in interest rate is far fetched.

As a common understanding we all know the interest rate cut will boost borrowing and hence economic activity. On the other hand this rate cut when done in isolation when the central bank in the rest of the world are not in a compulsion to do so, will leave the capital movement out the country. This is surely detrimental to the business in U.S. as the capital formation will be difficult. It also leaves the U.S dollar to loose value becuase of the interest rate differentials.

Largely the credit policy of RBI - the annual report of the policy measures by our central bank has laregly disappointed the Indian Industry which has to keep their investment plans in abeyance. Belying expectations of a softer interest rate regime, the Reserve Bank in its third quarter review of of monetary policy kept banks rate, repo rate, reverse repo rate and cash reserve ratio unchanged in a bid to maintain financial and price stability.

Now this stand by RBI is surely debately particularly given the current rupee strength. But certainly it is going to a be precautionary move against the price rise. Every single conservative policy has its toll in our growth story. One justification for this indifference is the shorter business cycles in India and the growth being fuelled by the capital inflows. As this is policy needs some time test which will be based on the growth in the country.

This particular scenario would have helped any one new to the macroeconomics to sum up all what we have seen so far - inflation, business cycles, interest rates, exchange rates. It may be unfavorable for many Indian Industries, but the current situation has certainly enhanced our learning in macroeconomics favourably!

Domestic Institutional Investors (DII) were the major buyers which held the markets

Domestic Institutional Investors (DII), which includes Mutual Funds, Insurance firms, and Domestic Financial Institutions (DFI) mainly banks etc., were the major buyers in the past week when the FIIs sold away heavily in the equity markets. While the FIIs have taken away Rs. 15,000 crores from the markets, DIIs have put in about Rs. 10,000 crores. Major part of DII money has come from insurance and financial institutions. Government had asked these institutions to place money in bluechip firms to give support to the markets. LIC, the biggest insurance firm of India, alone has been estimated to have put in $1 billion(Rs. 4000 crores) in the last week.
In the year 2008(till January 25, 2008) FIIs have sold worth Rs. 23,000 crores, while DIIs have bought worth Rs. 12,800 crores.

FII sold heavily in mid January crash

While the Mutual Funds started selling in the initial days of the previous week, they started pumping in the money during the fall of the stocks. FIIs on the other hand were about neutral in the week before but they suddenly started selling off heavily each day and even on last few days of the week when the sensex gained significantly, FIIs were net sellers to the extent of more than 1000 crores of rupees. Though the last day selling was very less compared to previous three days in which they sold about 2500 crores worth of stocks each day.