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Equity

Characteristics of equity
Equity is unsecured and a high risk-return investment
When you invest your money in a debt investment such as a bank deposit, bonds, etc., you are promised a fixed amount of interest on your investment and return of capital. This is n't the case with an equity investment. By becoming an owner, you bear the risk of the company not being successful. However, the rewards for bearing this risk are high. You, as an equity shareholder, are entitled to a share in the profits of the company’s business as well as any appreciation in the perceived value of the shares. The risks and rewards of investing in equity are clearly apparent from the Bombay Stock Exchange Sensitive Index (BSE Sensex), which is a popular stock market index. This index reflects the movement of the share prices on the stock markets. The Sensex rises and/or falls continuously during trading hours. Rises indicate gains and falls indicate losses. True equity money is unsecured and directly reflects the faith of the investor in the business, its management and the commitment of its principals to it. Limited liability Another extremely important feature of equity is its limited liability, which means that, as a part-owner of the company, you are not personally liable if the company is not able to pay its debts. In case of other entities such as partnerships, if the partnership goes bankrupt, the partners are personally liable towards the creditors/lenders and they may have to sell off their personal assets like their house, car, furniture, etc., to make good the loss. In case of holding equity shares, the maximum value you can lose is the value of your investment. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.
Equity remains in perpetual existence
The perpetual existence of a company implies that the death, disability, retirement or termination of a shareholder, director or officer, will not affect the existence of the company. For an equity shareholder, this is convenient since he does not need to renew/renegotiate the terms of his investment (like in the case of a fixed tenure debt investment). He also has the option to sell his equity holding through the stock exchange if he no longer wants to remain invested in the company.
Limited liability
Another extremely important feature of equity is its limited liability, which means that, as a part-owner of the company, you are not personally liable if the company is not able to pay its debts. In case of other entities such as partnerships, if the partnership goes bankrupt, the partners are personally liable towards the creditors/lenders and they may have to sell off their personal assets like their house, car, furniture, etc., to make good the loss. In case of holding equity shares, the maximum value you can lose is the value of your investment. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.
About equity
Equity is a share in the ownership of a company. It represents a claim on the company''s assets and earnings. As you acquire more stock, your ownership stake in the company increases. The terms share, equity and stock mean the same thing and can be used interchangeably. Holding a company''s stock means that you are one of the many owners (shareholders) of a company, and, as such, you have a claim (to the extent of your holding) to everything the company owns. Yes, this means that technically, you own a portion of every piece of furniture; every trademark; every contract, etc. of the company. As an owner, you are entitled to your share of the company''s earnings as well as any voting rights attached to the stock.
Income from equity investing capital appreciation
Equity shares of companies are listed and traded on a stock exchange (the Bombay Stock Exchange or the National Stock Exchange). The market prices of these shares are continuously moving up or down depending on the interest in the company’s stock, it’s business potential, etc. As an equity shareholder, you can profit/lose from the market price rise/fall. For instance, if you have purchased the equity shares of Company ABC at Rs 25 per share and the market price of the share rises to Rs 30, you can sell the shares at this price to make a profit. This is called ‘capital appreciation’. However, if the market price falls to below Rs 25, you would lose. This loss would be notional till you actually sell at this price and book the loss. Bonus shares when you purchase shares of a company, you become a shareholder of the company. When the company is doing well, it may declare a ‘bonus issue’. This means that the company will issue fresh equity shares to its existing shareholders, for free. As a shareholder, you will be entitled to receive bonus shares in proportion to your holding in the company. For instance, if the company declares a bonus in the ratio of 1:2 (this means it will issue one share for every two shares you hold) and if you hold 100 shares, you will be entitled to 50 shares as a bonus. When you sell your bonus shares in the stock market, the market price at which you sell your bonus, minus brokerage charges and necessary taxes (Service Tax, Securities Transaction Tax, etc.), will be your profit i.e. capital appreciation. In this case, there will be no cost of purchase since you have received the bonus for free. For instance, if the company declares a ‘bonus issue’ in the ratio of 1:2 (this means it will issue one bonus share for every two shares you hold) and if you hold 100 shares, you will be entitled to 50 shares as a ‘bonus shares’. The cost of these shares will be nil. In this case, if you sell your bonus shares in the market at say, Rs 35, your capital appreciation will be the entire Rs 35 per share minus brokerage, taxes, etc.
Rights shares
Another way a company offers benefits to its shareholders is by offering ‘rights shares’. This means that the company will offer fresh equity shares to its existing shareholders at a price, which is lower than the current market price of the share. For instance, if the current market price of the company’s share is Rs 35, it will offer shares at below this price, say Rs 25. As a shareholder, you will be entitled to receive ‘rights shares’ in proportion to your holding in the company. For instance, if the company declares a ‘rights issue’ in the ratio of 1:2 (this means it will issue one share for every two shares you hold) and if you hold 100 shares, you will be entitled to 50 shares as a ‘rights shares’. This implies that to obtain the ‘rights shares’, you will have to pay Rs 1,250 (50 shares you are entitled to x Rs 25 per share). In this case, if you sell your rights shares in the market at say, Rs 35, your capital appreciation will be Rs 10 per share minus incidental selling costs. However, if you don’t want to subscribe to the rights offered to you, you can sell your rights entitlements. The price that you receive to sell your rights entitlements will depend on the rights offer price, the current market price and the demand for the company’s shares. For instance, taking the above example forward, if you decide to sell your rights entitlements of 50 shares and you receive Rs 2.50 per share, you will get a total of Rs 125. This will be your profit after deducting incidental selling expenses.
Dividend income
Companies report their profits earned on a quarterly basis. Based on the quantum of profits, companies declare dividends to distribute a portion of these profits to their shareholders. Dividends are declared as a percentage of the share’s face value. For instance, if a company declares a dividend of 10 per cent and its share has a face value of Rs 10, it implies that it will pay Re 1 per share as dividend (Rs 10 x 10 per cent). As a shareholder, you will be entitled to dividend to the extent of your share holding. For instance, in this case if you hold 500 shares, you will get a dividend of Rs 500 (500 shares x Re 1 per share). However, dividend income is uncertain. Companies don’t declare dividends regularly. Dividends are declared only when there are profits available for distribution.
Reasons for issuing equity
To expand its business, a company, at some point, needs to raise money. To do this, it can either borrow by taking a loan or raise funds by offering prospective investors a stake in the company --- which is known as issuing stock. A company usually borrows from banks and/or financial institutions. This is called ‘debt financing’. On the other hand, issuing stock is called ‘equity financing’. While raising loans is used for temporary cash requirements (such as borrowing to fund a project), issuing stock is used to raise funds of a permanent nature.

Derivatives

What are derivatives?
The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities. With Securities Laws (Second Amendment) Act,1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, as:- A Derivative includes: - a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security a contract which derives its value from the prices, or index of prices, of underlying securities
What is a futures contract?
Futures Contract means a legally binding agreement to buy or sell the underlying security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract.
On expiry, futures can be settled by delivery of the underlying asset or cash. Cash settlement enables the settlement of obligations arising out of the future/option contract in cash. However so far delivery against future contracts have not been introduced and the future contract is settled by cash settlement only.
What is an option contract?
Options Contract is a type of Derivatives Contract which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period. The buyer / holder of the option purchases the right from the seller/writer for a consideration which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc. Under Securities Contracts (Regulations) Act,1956 options on securities has been defined as "option in securities" means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities;An Option to buy is called Call option and option to sell is called Put option. Further, if an option that is exercisable on or before the expiry date is called American option and one that is exercisable only on expiry date, is called European option. The price at which the option is to be exercised is called Strike price or Exercise price.
Therefore, in the case of American options the buyer has the right to exercise the option at anytime on or before the expiry date. This request for exercise is submitted to the Exchange, which randomly assigns the exercise request to the sellers of the options, who are obligated to settle the terms of the contract within a specified time frame. As in the case of futures contracts, option contracts can also be settled by delivery of the underlying asset or cash. However, unlike futures cash settlement in option contract entails paying/receiving the difference between the strike price/exercise price and the price of the underlying asset either at the time of expiry of the contract or at the time of exercise / assignment of the option contract. However so far delivery against option contracts have not been introduced and the option contract, on exercise or expiry, is settled by cash settlement only.
What are index futures and index option contracts?
Futures contract based on an index i.e. the underlying asset is the index,are known as Index Futures Contracts. For example, futures contract on NIFTY Index and BSE-30 Index. These contracts derive their value from the value of the underlying index. Similarly, the options contracts, which are based on some index, are known as Index options contract. However, unlike Index Futures, the buyer of Index Option Contracts has only the right but not the obligation to buy / sell the underlying index on expiry. Index Option Contracts are generally European Style options i.e. they can be exercised / assigned only on the expiry date. An index, in turn derives its value from the prices of securities that constitute the index and is created to represent the sentiments of the market as a whole or of a particular sector of the economy. Indices that represent the whole market are broad based indices and those that represent a particular sector are sectoral indices.
In the beginning futures and options were permitted only on S&P Nifty and BSE Sensex. Subsequently, sectoral indices were also permitted for derivatives trading subject to fulfilling the eligibility criteria. Derivative contracts may be permitted on an index if 80% of the index constituents are individually eligible for derivatives trading. However, no single ineligible stock in the index shall have a weightage of more than 5% in the index. The index is required to fulfill the eligibility criteria even after derivatives trading on the index has begun. If the index does not fulfill the criteria for 3 consecutive months, then derivative contracts on such index would be discontinued. By its very nature, index cannot be delivered on maturity of the Index futures or Index option contracts therefore, these contracts are essentially cash settled on Expiry. Therefore index options are the European options while stock options are American options.
What is the structure of derivative markets in India?
Derivative trading in India takes can place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative Exchange/Segment function as a Self-Regulatory Organisation (SRO) and SEBI acts as the oversight regulator. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House, which is independent in governance and membership from the Derivative Exchange/Segment.
What is the regulatory framework of derivatives markets in India?
With the amendment in the definition of 'secruities' under SC(R)A (to include derivative contracts in the definition of securities), derivatives trading takes place under the provisions of the Securities Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992.Dr. L.C Gupta Committee constituted by SEBI had laid down the regulatory framework for derivative trading in India. SEBI has also framed suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lay's down the provisions for trading and settlement of derivative contracts. The Rules, Bye-laws & Regulations of the Derivative Segment of the Exchanges and their Clearing Corporation/House have to be framed in line with the suggestive Bye-laws. SEBI has also laid the eligibility conditions for Derivative Exchange/Segment and its Clearing Corporation/House. The eligibility conditions have been framed to ensure that Derivative Exchange/Segment & Clearing Corporation/House provide a transparent trading environment, safety & integrity and provide facilities for redressal of investor grievances. Some of the important eligibility conditions are-
  • Derivative trading to take place through an on-line screen based Trading System.
  • The Derivatives Exchange/Segment shall have on-line surveillance capability to monitor positions, prices, and volumes on a real time basis so as to deter market manipulation.
  • The Derivatives Exchange/ Segment should have arrangements for dissemination of information about trades, quantities and quotes on a real time basis through atleast two information vending networks, which are easily accessible to investors across the country.
  • The Derivatives Exchange/Segment should have arbitration and investor grievances redressal mechanism operative from all the four areas / regions of the country.
  • The Derivatives Exchange/Segment should have satisfactory system of monitoring investor complaints and preventing irregularities in trading.
  • The Derivative Segment of the Exchange would have a separate Investor Protection Fund.
  • The Clearing Corporation/House shall perform full novation, i.e., the Clearing Corporation/House shall interpose itself between both legs of every trade, becoming the legal counterparty to both or alternatively should provide an unconditional guarantee for settlement of all trades.
  • The Clearing Corporation/House shall have the capacity to monitor the overall position of Members across both derivatives market and the underlying securities market for those Members who are participating in both.
  • The level of initial margin on Index Futures Contracts shall be related to the risk of loss on the position. The concept of value-at-risk shall be used in calculating required level of initial margins. The initial margins should be large enough to cover the one-day loss that can be encountered on the position on 99% of the days.
  • The Clearing Corporation/House shall establish facilities for electronic funds transfer (EFT) for swift movement of margin payments.
  • In the event of a Member defaulting in meeting its liabilities, the Clearing Corporation/House shall transfer client positions and assets to another solvent Member or close-out all open positions.
  • The Clearing Corporation/House should have capabilities to segregate initial margins deposited by Clearing Members for trades on their own account and on account of his client. The Clearing Corporation/House shall hold the clients' margin money in trust for the client purposes only and should not allow its diversion for any other purpose.
  • The Clearing Corporation/House shall have a separate Trade Guarantee Fund for the trades executed on Derivative Exchange / Segment. Presently, SEBI has permitted Derivative Trading on the Derivative Segment of BSE and the F & O Segment of NSE.
What derivative contracts are permitted by SEBI?
Derivative products have been introduced in a phased manner starting with Index Futures Contracts in June 2000. Index Options and Stock Options were introduced in June 2001 and July 2001 followed by Stock Futures in November 2001. Sectoral indices were permitted for derivatives trading in December 2002. Interest Rate Futures on a notional bond and T-bill priced off ZCYC have been introduced in June 2003 and exchange traded interest rate futures on a notional bond priced off a basket of Government Securities were permitted for trading in January 2004.
What is the eligibility criteria for stocks on which derivatives trading may be permitted?
A stock on which stock option and single stock future contracts are proposed to be introduced is required to fulfill the following broad eligibility criteria:-
A stock on which stock option and single stock future contracts are proposed to be introduced is required to fulfill the following broad eligibility criteria:-
  • The stock shall be chosen from amongst the top 500 stock in terms of average daily market capitalisation and average daily traded value in the previous six month on a rolling basis.
  • The stock's median quarter-sigma order size over the last six months shall be not less than Rs.1 Lakh. A stock's quarter-sigma order size is the mean order size (in value terms) required to cause a change in the stock price equal to one-quarter of a standard deviation.
  • The market wide position limit in the stock shall not be less than Rs.50 crores.
  • A stock can be included for derivatives trading as soon as it becomes eligible. However, if the stock does not fulfill the eligibility criteria for 3 consecutive months after being admitted to derivatives trading, then derivative contracts on such a stock would be discontinued.
What is minimum contract size?
The Standing Committee on Finance, a Parliamentary Committee, at the time of recommending amendment to Securities Contract (Regulation) Act, 1956 had recommended that the minimum contract size of derivative contracts traded in the Indian Markets should be pegged not below Rs. 2 Lakhs. Based on this recommendation SEBI has specified that the value of a derivative contract should not be less than Rs. 2 Lakh at the time of introducing the contract in the market. In February 2004, the Exchanges were advised to re-align the contracts sizes of existing derivative contracts to Rs. 2 Lakhs. Subsequently, the Exchanges were authorized to align the contracts sizes as and when required in line with the methodology prescribed by SEBI.
What is the lot size of a contract?
Lot size refers to number of underlying securities in one contract. The lot size is determined keeping in mind the minimum contract size requirement at the time of introduction of derivative contracts on a particular underlying. For example, if shares of XYZ Ltd are quoted at Rs.1000 each and the minimum contract size is Rs.2 lacs, then the lot size for that particular scrips stands to be 200000/1000 = 200 shares i.e. one contract in XYZ Ltd. covers 200 shares.
What is corporate adjustment?
The basis for any adjustment for corporate action is such that the value of the position of the market participant on cum and ex-date for corporate action continues to remain the same as far as possible. This will facilitate in retaining the relative status of positions viz. in-the-money, at-the-money and out-of-the-money. Any adjustment for corporate actions is carried out on the last day on which a security is traded on a cum basis in the underlying cash market. Adjustments mean modifications to positions and/or contract specifications as listed below:
  • Strike price
  • Position
  • Market/Lot/ Multiplier
The adjustments are carried out on any or all of the above based on the nature of the corporate action. The adjustments for corporate action are carried out on all open, exercised as well as assigned positions. The corporate actions are broadly classified under stock benefits and cash benefits. The various stock benefits declared by the issuer of capital are:
  • Bonus
  • Rights
  • Merger/ demerger
  • Amalgamation
  • Splits
  • Consolidations
  • Hive-off
  • Warrants, and
  • Secured Premium Notes (SPNs) among others

    • The cash benefit declared by the issuer of capital is cash dividend.
What is the margining system in the derivative markets?
Two type of margins have been specified -Initial Margin - Based on 99% VaR and worst case loss over a specified horizon, which depends on the time in which Mark to Market margin is collected.Mark to Market Margin (MTM) - collected in cash for all Futures contracts and adjusted against the available Liquid Networth for option positions. In the case of Futures Contracts MTM may be considered as Mark to Market Settlement.
Dr. L.C Gupta Committee had recommended that the level of initial margin required on a position should be related to the risk of loss on the position. The concept of value-at-risk should be used in calculating required level of initial margins. The initial margins should be large enough to cover the one day loss that can be encountered on the position on 99% of the days. The recommendations of the Dr. L.C Gupta Committee have been a guiding principle for SEBI in prescribing the margin computation & collection methodology to the Exchanges. With the introduction of various derivative products in the Indian securities Markets, the margin computation methodology, especially for initial margin, has been modified to address the specific risk characteristics of the product. The margining methodology specified is consistent with the margining system used in developed financial & commodity derivative markets worldwide. The exchanges were given the freedom to either develop their own margin computation system or adapt the systems available internationally to the requirements of SEBI. A portfolio based margining approach which takes an integrated view of the risk involved in the portfolio of each individual client comprising of his positions in all Derivative Contracts i.e. Index Futures, Index Option, Stock Options and Single Stock Futures, has been prescribed. The initial margin requirements are required to be based on the worst case loss of a portfolio of an individual client to cover 99% VaR over a specified time horizon.The Initial Margin is Higher of (Worst Scenario Loss +Calendar Spread Charges) Or Short Option Minimum Charge The worst scenario loss are required to be computed for a portfolio of a client and is calculated by valuing the portfolio under 16 scenarios of probable changes in the value and the volatility of the Index/ Individual Stocks. The options and futures positions in a client's portfolio are required to be valued by predicting the price and the volatility of the underlying over a specified horizon so that 99% of times the price and volatility so predicted does not exceed the maximum and minimum price or volatility scenario. In this manner initial margin of 99% VaR is achieved. The specified horizon is dependent on the time of collection of mark to market margin by the exchange. The probable change in the price of the underlying over the specified horizon i.e. 'price scan range', in the case of Index futures and Index option contracts are based on three standard deviation (3s ) where 's ' is the volatility estimate of the Index. The volatility estimate 's ', is computed as per the Exponentially Weighted Moving Average methodology. This methodology has been prescribed by SEBI. In case of option and futures on individual stocks the price scan range is based on three and a half standard deviation (3.5 s) where 's' is the daily volatility estimate of individual stock. If the mean value (taking order book snapshots for past six months) of the impact cost, for an order size of Rs. 0.5 million, exceeds 1%, the price scan range would be scaled up by square root three times to cover the close out risk. This means that stocks with impact cost greater than 1% would now have a price scan range of - Sqrt (3) * 3.5s or approx. 6.06s. For stocks with impact cost of 1% or less, the price scan range would remain at 3.5s.For Index Futures and Stock futures it is specified that a minimum margin of 5% and 7.5% would be charged. This means if for stock futures the 3.5 s value falls below 7.5% then a minimum of 7.5% should be charged. This could be achieved by adjusting the price scan range.The probable change in the volatility of the underlying i.e. 'volatility scan range' is fixed at 4% for Index options and is fixed at 10% for options on Individual stocks. The volatility scan range is applicable only for option products.Calendar spreads are offsetting positions in two contracts in the same underlying across different expiry. In a portfolio based margining approach all calendar-spread positions automatically get a margin offset. However, risk arising due to difference in cost of carry or the 'basis risk' needs to be addressed. It is therefore specified that a calendar spread charge would be added to the worst scenario loss for arriving at the initial margin. For computing calendar spread charge, the system first identifies spread positions and then the spread charge which is 0.5% per month on the far leg of the spread with a minimum of 1% and maximum of 3%. Further, in the last three days of the expiry of the near leg of spread, both the legs of the calendar spread would be treated as separate individual positions. In a portfolio of futures and options, the non-linear nature of options make short option positions most risky. Especially, short deep out of the money options, which are highly susceptible to, changes in prices of the underlying. Therefore a short option minimum charge has been specified. The short option minimum charge is 3% and 7.5 % of the notional value of all short Index option and stock option contracts respectively. The short option minimum charge is the initial margin if the sum of the worst -scenario loss and calendar spread charge is lower than the short option minimum charge. To calculate volatility estimates the exchange are required to uses the methodology specified in the Prof J.R Varma Committee Report on Risk Containment Measures for Index Futures. Further, to calculate the option value the exchanges can use standard option pricing models - Black-Scholes, Binomial, Merton, Adesi-Whaley.The initial margin is required to be computed on a real time basis and has two components:- The first is creation of risk arrays taking prices at discreet times taking latest prices and volatility estimates at the discreet times, which have been specified. The second is the application of the risk arrays on the actual portfolio positions to compute the portfolio values and the initial margin on a real time basis. The initial margin so computed is deducted from the available Liquid Networth on a real time basis. At the end of the day NSE sends a client wise file to all the brokers and this margin is debited to clients. Next day the broker is supposed to report the collection of margin. If the margin is short, a penalty is levied and the outstanding position is liable to be squared up at the cost of the investor.
What are market wide position limits for single stock futures and stock option contracts?
Market wide position limits on Single Stock Derivative Contracts are as follows The market wide limit of open position (in terms of the number of underlying stock) on futures and option contracts on a particular underlying stock is lower of-- 30 times the average number of shares traded daily, during the previous calendar month, in the relevant underlying security in the underlying segment,Or- 20% of the number of shares held by non-promoters in the relevant underlying security i.e. free-float holding.This limit would be applicable on all open positions in all futures and option contracts on a particular underlying stock.
What measures have been specified by SEBI to protect the rights of investor in derivatives market?
The measures specified by SEBI include:
  • Investor's money has to be kept separate at all levels and is permitted to be used only against the liability of the Investor and is not available to the trading member or clearing member or even any other investor.
  • The Trading Member is required to provide every investor with a risk disclosure document which will disclose the risks associated with the derivatives trading so that investors can take a conscious decision to trade in derivatives.
  • Investor would get the contract note duly time stamped for receipt of the order and execution of the order. The order will be executed with the identity of the client and without client ID order will not be accepted by the system. The investor could also demand the trade confirmation slip with his ID in support of the contract note. This will protect him from the risk of price favour, if any, extended by the Member.
  • In the derivative markets all money paid by the Investor towards margins on all open positions is kept in trust with the Clearing House/Clearing corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilised towards the default of the member. However, in the event of a default of a member, losses suffered by the Investor, if any, on settled / closed out position are compensated from the Investor Protection Fund, as per the rules, bye-laws and regulations of the derivative segment of the exchanges.
  • In the derivative markets all money paid by the Investor towards margins on all open positions is kept in trust with the Clearing House/Clearing corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilised towards the default of the member. However, in the event of a default of a member, losses suffered by the Investor, if any, on settled / closed out position are compensated from the Investor Protection Fund, as per the rules, bye-laws and regulations of the derivative segment of the exchanges.
  • The Exchanges are required to set up arbitration and investor grievances redressal mechanism operative from all the four areas / regions of the country.
Remember, Derivatives are tools which can be used for hedging, speculation as well as trading. It is always advisable to take positions in derivatives with caution. Since the trader is required to give only margin, there is a tendency of overtrading which must be avoided. Overtrading may result in failure to pay margin call &/or MTM the outstanding position is liable to be squared up. Before trading it is necessary that the investor should go through the risk disclosure document carefully so that he is aware of the precautions to be taken in derivatives trading

Commodity

What is commodity?
The term 'commodity' includes all kinds of goods. FCRA defines 'goods' as 'every kind of movable property other than actionable claims, money and securities'. Futures' trading is organized in such goods or commodities as are permitted by the Central Government. At present, all goods and products of agricultural (including plantation), mineral and fossil origin is allowed for futures trading under the auspices of the commodity exchanges recognized under the FCRA. The national commodity exchanges have been recognized by the Central Government for organizing trading in all permissible commodities which include precious (gold and silver) and non-ferrous metals; cereals and pulses; raw jute and jute goods; sugar, gur, potatoes, coffee, rubber and spices, etc
What are commodity futures?
Commodity Futures are contracts to buy specific quantity of a particular commodity at a future date. It is similar to the Index futures and Stock futures but the underlying happens to be commodities instead of Stocks and Indices.
Who are the players in the commodity market?
Investors in the commodities market fall into the following categories:
  • Hedgers:

    • Hedgers enter into commodity contracts to be assured access to a commodity, or the ability to sell it, at a guaranteed price. They use futures to protect themselves against unanticipated fluctuations in the commodity's price.

  • Speculators:

    • Speculators are participants who wish to bet on future movements in the price of an asset. Individuals, willing to absorb risk, trade in commodity futures as speculators. Speculating in commodity futures is not for people who are averse to risk. Unforeseen forces like weather can affect supply and demand, and send commodity prices up or down very rapidly. As a result of this leveraged speculative position, they increase the potential for large gains as well as large losses.

  • Arbitrageur:

    • A type of investor who attempts to profit from price inefficiencies in the market by making simultaneous trades that offset each other and capture risk-free profits. Arbitrageurs constitute a group of participants who lock themselves in a risk-less profit by simultaneously entering into transactions in two or more contracts
How do commodity prices move?
The following factors have an impact the commodity prices:
  • Demand & Supply
  • Natural Factors: Soil and climatic conditions, natural calamities etc.
  • Government Policies - e.g. EXIM Policies like tariff rates, minimum support prices
  • Annual production, consumption and carry-over quantity of stocks
  • Economic policies and conditions:
  • Interest Rates - e.g. hike in federal rates bring down the dollar, thereby increasing lucrative-ness of investment in precious metals.
Indian commodity market?
  • Supply – Worlds leading producer of 17 Agri Commodities
  • Demand – Worlds , major market of Bullion, Foodgrains, Edible oils, Fibers, Spicies and plantation crops.
  • GDP Driver – Predominantly an AGRARIAN Economy
  • Captive Market – Agro products produced and consumed locally
  • Width and Spread – Over 30 major markets and 5500 Mandies
  • Waiting to Explode – Value of production around Rs. 3,00,000 crore and expected futures market potential around Rs. 30,00,000 crore.
Who regulates the Indian commodity future market ?
Just as SEBI regulates the stock exchanges, commodity exchanges are regulated by the Forwards Market Commission (FMC), which comes under the purview of the Ministry of Food, Agriculture and Public Distribution
What are the major commodity exchanges?
  • Multi-Commodity Exchange of India Ltd, Mumbai (MCX).
  • National Commodity and Derivatives Exchange of India, Mumbai (NCDEX).
  • National Multi Commodity Exchange, Ahemdabad (NMCE).
What are the commodity derivatives market timings?
Monday to Friday: 10 am to 11.30 pm (Agri-commodities up to 5 p.m. only) Saturday: 10 am to 2 pm
Is delivery of commodities available? Is it compulsory?
Yes, but its not compulsory, buyers and sellers intending to take/give delivery should express their intention to the exchange. The exchange will match delivery randomly and assign it accordingly.

Currency


Currency market basics: how the global currency markets work
The currency market is the largest and most liquid financial market in the world, but also one of the least known. Currencies like the U.S. dollar, the euro and the yen trade in the foreign exchange (FX) market 24 hours a day across national borders.
Overview of the global currency markets
Currency in its simplest form describes the money or official means of payment in a country or region. The best known currencies include the U.S. dollar, euro, yen, British pound and Swiss franc. A commonly used currency symbol exists for many currencies, for example $, £ or €. FX markets, however, use so called ISO codes, for example USD for U.S. dollar, GBP for the British pound and EUR for the euro.
Every day more than U.S. $3 trillion in currencies change hands in a highly professional interbank market, in which electronic trading platforms link currency traders from banks across the world directly. FX markets are effectively open 24 hours a day thanks to global cooperation among currency traders. At the end of each business day in Asia, traders pass their open currency positions on to their colleagues in Europe, who – at the end of their business day – pass their open positions on to American traders, who just begin their working day and pass positions on to Asia at the end of their business day. And there, the circle begins anew. This makes FX truly global and very liquid.
Around the turn of the century, trading volumes increased dramatically, as Chart 1 shows. The Bank for International Settlement (BIS) identified several factors responsible for the increase in currency trading at the time. First, higher volatility and clear trends in FX markets made currency a potentially attractive investment. Second, interest rate differentials between countries were prompting market participants to exploit these differentials with different strategies. The most famous of these strategies has become the Carry trade, which we will explain in more detail later. Third, the global search for yield was boosting interest in FX as an alternative to stocks and bonds.
Exchange rate
The exchange rate is a price - the number of units of one nation’s currency that must be surrendered in order to acquire one unit of another nation’s currency.
A List of factors which determine currency value
What determines the value of a countries currency really comes down to supply and demand of that currency. If a particular country’s currency is in high demand by purchasers such as travelers, governments, and investors, it will increase the value of that country’s currency. The factors that follow may have a positive or negative effect on the demand for a particular currency.
1) Printing of currency
If a country prints an excessive amount of currency, more then what it normally would, this can decrease the value of the currency. A large amount of currency in circulation can lower the value of a currency. A small amount of currency in circulation can result in the value of the currency increasing.
2) Current state of the economy
If a country’s economy is not doing well, this can decrease the demand for that countries currency. Specifically, here we are talking about the degree of unemployment, degree of consumer spending, and extent of business expansion that is taking place in a country. High unemployment, decrease consumer spending, with a decrease in business expansion, means a poor economy and a decrease in currency value.
The potential for economic growth in a country should also be looked at. If the potential is strong, then it's currency value would expect to increase. Also, if a country produces products that other countries want to buy, it can increase the value of that country’s currency.
3) Prices of foreign goods
Prices of foreign goods is related to the economy. If a foreign company sells goods in a country which are cheaper then comparable products produced in that country, it can hurt the economy of that country. A poor economy results in a decrease in demand for that country’s currency, which lowers its value.
4) Political conditions of a country
A country which is known to have corrupt politicians, can result in a lowering of the value of its currency
5) How secretive is a country
A country which operates at a high level of secrecy, atleast as observed by those outside the country, can result in a lowering of the value of their currency.
6) National debt of a country
In a democratic society, national debt must be paid by the taxpayer. If taxes increase, this results in a lowering of the purchasing capability of society, which results in a deleterious effect on the economy. In this case, currency value will decrease.
7) Presidents popularity
If a president is popular, this can increase the demand for a currency. If the president’s popularity is dropping, due to unpopular government policies, this may result in a decrease in demand for a currency and a subsequent lowering of its value.
8) War and terrorists attacks
A terrorists attack can increase the probability of a war. A war or the strong potential for a war can decrease the demand for a currency, simply because a war drains the economy. Wars are expensive and must be paid by the taxpayer. So war lowers the value of a currency.
9) Government growth
Excess government growth can lower the value of a countries currency. Again, the taxpayer will need to pay for the new growth, which for the long run has a negative effect on the economy.
10) Tax cuts for the consumer
Tax cuts can stimulate the economy, as long as the consumer spends the extra money he or she may have. But also, tax cuts which are to large can result in high demand for products, which may raise prices, which can lead to inflation and the desire to purchase cheaper foreign products. But in general, tax cuts historically have been good for the economy, which can result in an increase demand for that countries currency.
11) Interest rates
A higher interest rate means a higher demand for a currency. Foreign investors in a currency prefer a higher interest. This increase in demand for a currency results in an increase in its value.
12) Housing market
If there is a slowing of a housing market, it means that the seller’s asking price will be less, resulting in less consumer spending. This has a negative effect on the economy. Again, poor economic conditions result in a lower demand for the currency, thereby lowering its value.
13) Positive or negative perception
How purchasers of a currency perceive the previous discussed parameters, can determine the degree of demand for a currency. Whether or not the perception is accurate is not as important as what the perception itself is. Perception is what determines if a currency purchaser decides to buy or sell a currency.
To conclude, the factors presented here are determinants of the degree of demand on a currency, and therefore its value. There are other factors such as manufacturing growth, degree of entrepreneurship in a country, employment growth, and even the weather and its effect on the agricultural industry, energy consumption, and local economies. These also can determine the demand for a currency. The factors listed here determine the perception that a potential buyer of currency may have. How a potential buyer of a currency looks at a particular country using these parameters, will determine the demand on the currency, and ultimately its value.
Economic variables which affect foreign exchange market
Interest rates, inflation, and GDP numbers are the main variables; however other economic indicators such as unemployment rate, bop, trade deficit, fiscal deficit, manufacturing indices, consumer prices and retail sales amongst others.
News and information regarding a country's economy can have a direct impact on the direction that the country's currency is heading in much the same way that current events and financial news affect stock prices, hence the importance of economic factors. The following eight economic factors will directly affect a currency's movements in the Forex market.
Interest rates, inflation, and GDP numbers are the main variables; however other economic indicators such as unemployment rate, bop, trade deficit, fiscal deficit, manufacturing indices, consumer prices and retail sales amongst others.
News and information regarding a country's economy can have a direct impact on the direction that the country's currency is heading in much the same way that current events and financial news affect stock prices, hence the importance of economic factors. The following eight economic factors will directly affect a currency's movements in the Forex market.

Factor 1 - employment data

Strong decreases in employment indicate a contracting economy, while strong increases are perceived indicators of a prosperous economy.

Factor 2 - interest rates
This is always a major focus in the forex market. Since the central banks mandate monetary policy and supply, they are the prime focus of investors and the various market participants.

Factor 3 – inflation
This is the measure of increases or decreases in pricing levels over a period of time. Due to the immense number of goods and services available in a country, usually a grouping of these goods and services are used to measure changes in the pricing. Increases in pricing indicate an increase in the inflation rate which in turn can devalue that country's currency.

Factor 4 - gross domestic product is the measurement for goods and services that were finished over a period of time. The GDP is broken down into 4 categories:

  • Business spending
  • Government spending
  • Private consumption
  • Total net exports

Factor 5 - retail sales
The measurement of sales recorded by retailers over a period of time is a reflection of either increased or decreased consumer spending, depending on whether sales are up or down for the comparative period a year ago. This indicator gives market participants an idea as to how strong or weak the economy is.

Factor 6 - durable goods
Goods that have a lifespan of three or more years are considered durable goods and they are measured in quantities that are ordered, shipped, or unfilled over a period of time. These are also an indicator of economic spending or the lack of it.

Factor 7 - trade and capital flows
Currency values can be significantly impacted by monetary flows that result from certain interactions between countries. When imports exceed exports, there is a tendency for the currency value to decline. Increased investments in a country can lead to the opposite result.

Factor 8 - macroeconomic and geopolitical events
Elections, financial crises, monetary policy changes, and wars can influence the biggest changes in the Forex market. These events can either change and/or lead to reshaping of a country's economy.
Currency derivatives
Currency futures: A currency futures contract is an agreement between two parties to buy or sell a currency at a certain time in the future at a certain price. In India, one can trade in USDINR, EUROINR, GBPINR and JPYINR currency futures.

Currency options: Currency Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Currently, currency options are available only for USDINR.
Major market participants
  • Hedgers
  • Speculators
  • Arbitrageurs
Various terminologies in currency market
Spot price: The price at which a currency trades in the spot market. In the case of USD/INR, spot value is T + 2.

Futures price: The price at which the futures contract trades in the futures market.

Contract cycle: The currency futures contracts on the SEBI recognized exchanges have one-month, two-month, and three-month up to twelve-month expiry cycles. Hence, these exchanges will have 12 contracts outstanding at any given point in time.

Final settlement date: The last business day of the month will be termed the Value date/ Final Settlement date of each contract.

Expiry date: It is the date specified in the futures contract. All contracts expire on the last working day (excluding Saturdays) of the contract months. The last day for the trading of the contract shall be two working days prior to the final settlement date or value date.

Contract size: In the case of USD/INR it is USD 1000; EUR/INR it is EUR 1000; GBP/INR it is GBP 1000 and in case of JPY/INR it is JPY 100,000. ( Ref. RBI Circular: RBI/2009-10/290, dated 19th January, by which RBI has allowed trade in EUR/INR, JPY/INR and GBP/INR pairs.)

Basis: Basis can be defined as the futures price minus the spot price. In a normal market, basis will be positive. Futures prices normally exceed spot prices.

Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures (in commodity markets) the storage cost plus the interest that is paid to finance or ‘carry’ the asset till delivery less the income earned on the asset. For currency derivatives carry cost is the rate of interest.

Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.

Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price which is known as marking-to-market.
Advantages of currency futures
  • Transparency and efficient price discovery
  • Elimination of Counterparty credit risk
  • Access to all types of market participants
  • Transparent trading platform
  • Surveillance.
Contract specifications for currency futures
Symbol USDINR
Instrument Type FUTCUR
Unit of trading 1 (1 unit denotes 1000 USD)
Underlying USD
Quotation/Price Quote Rs. per USD
Tick size 0.25 paisa or INR 0.0025
Trading hours Monday to Friday
9:00 a.m. to 5:00 p.m.
Contract trading cycle 12 month trading cycle.
Last trading day Two working days prior to the last business day of the expiry month at 12 noon.
Final settlement day Last working day (excluding Saturdays) of the expiry month.The last working day will be the same as that for Interbank Settlements in Mumbai.
Base price Theoretical price on the 1st day of the contract. On all other days, DSP of the contract.
Price operating range
Tenure upto 6 months Tenure greater than 6 months
+/-3 % of base price      +/- 5% of base price
Position limits
Clients Trading Members Banks
Higher of 6% of total Higher of 15% of the total Higher of 15% of the
open interest or USD 10 million total open interest or total open interest or USD 100 million
Minimum initial margin 1.75% on first day & 1% thereafter.
Extreme loss margin 1% of MTM value of gross open position.
Calendar spreads Rs. 400/- for a spread of 1 month, Rs. 500/- for a spread of 2 months, Rs. 800/- for a spread of 3 months & Rs. 1000/- for a spread of 4 months or more USD
Settlement Daily settlement : T + 1
Final settlement : T + 2
Mode of settlement Cash settled in Indian Rupees
Daily settlement price (DSP) DSP shall be calculated on the basis of the last half an hour weighted average price of such contract or such other price as may be decided by the relevant authority from time to time.
Final settlement price (FSP) RBI reference rate
Hedging
Currency hedge:
In equities, the act of holding a position in a stock denominated in a foreign currency while holding an equal but opposite position in the currency itself. This protects the investor from fluctuations in the value of a currency adversely affecting the stock holdings.

How hedging is useful for an importer:
The importers need to pay for the imports in terms of USD/EURO/GBP/JPY. The risk of importers is the appreciation of USD against INR. In this case they need to shell out more money in terms of INR for the same imports. The importer’s risk can be hedged using currency derivatives by taking LONG positions in the currency futures/options (call option long position) market.

Hedging exposure by an importer through currency derivatives:

Scenario 1: A chemical importer wants to import chemicals worth USD 1000 and places his import order on November 15, 2010, with the delivery being 2 months ahead. At the time when the contract is placed, in the spot market, one USD was worth say INR 45.10. But, suppose the Indian Rupee depreciates to INR 46.75 per USD at time of payment which is due in January 2011. So, the value of the payment for the importer goes up to INR 46,750 rather than INR 45,100. The hedging strategy for the importer, thus, would be:

Using currency futures:
Current Spot Rate (Nov 15 2010) 45.1000
Buy 1 lot USDINR Jan'11 Contract on 15th Nov '10 (1000 * 45.60) * 1 (Assuming the Jan '11 contract is trading at 45.6000 on 15th Nov '10)
Sell 1 lot USDINR Jan '11 Contracts in Jan '11 Profit/Loss (futures market) 46.7500 1000 * (46.75 – 45.60) * 1 = 1150
Purchases in spot market @ 46.75 Total 46.75 * 1000
cost of hedged transaction 1000 * 46.75 – 1150 = INR 45600
So, effectively the importer pays the November price of USDINR January futures which is 45.60.
Using currency options
Buy 1 lot USDINR Jan'11 Call option @ strike 45.25 on 15th Nov '10 by paying a premium of 0.70 per lot of 1000 USD. Therefore in total he pays a premium of INR 700 for the call option. In January 2011, since the spot price of USDINR is 46.75, the call option @ strike 45.25 is deep ITM (in-the-money) so the premium is increased to 1.50 per lot of USDINR. Thus, profit on hedge position is INR 800. So, he makes a total of INR 800 on his hedge. Effectively his cost of import decreases to INR 45950 (46750-800). How hedging is useful for an exporter: The exporters get their export receivables in terms of USD/EURO/GBP/JPY. The risk of exporters is the appreciation of INR against USD. In this case they get less in terms of INR for their exports. The exporter’s risk can be hedged using currency derivatives by taking SHORT positions in the currency futures/options market (put option long position). Hedging exposure by an exporter through currency derivatives:
Scenario 2: A textile exporter wants to export textile goods worth USD 1000 and gets his export order on November 15, 2010, with the delivery being 2 months ahead. At the time when the contract is placed, in the spot market, one USD was worth say INR 45.10. But, suppose the Indian Rupee appreciates to INR 44.25 per USD at the time of receipt of payments which is due in January 2011. So, the value of the receivables for the exporter decreases to INR 44,250 rather than INR 45,100. The hedging strategy for the exporter, thus, would be:

Using currency futures:
Current Spot Rate (Nov 15 2010) 45.1000
Sell 1 lot USDINR Jan'11 Contract on 15th Nov '10 (1000 * 45.60) * 1 (Assuming the Jan '11 contract is trading at 45.6000 on 15th Nov '10)
Buy 1 lot USDINR Jan '11 Contracts in Jan '11 Profit/Loss (futures market) 44.2500 1000 * (45.60 – 44.25) * 1 = 1350
Selling in spot market @ 44.25 Total cost of hedged transaction 44.25 * 1000 1000 * 44.25 + 1350 = INR 45600
So, effectively the exporter gets the November price of USDINR January futures which is 45.60.
Using currency options:
Buy 1 lot USDINR Jan'11 Put option @ strike 45.0 on 15th Nov '10 by paying a premium of 0.45 per lot of 1000 USD. Therefore in total he pays a premium of INR 450 for the put option.
In January 2011, since the spot price of USDINR is 44.25, the put option @ strike 45.0 is deep ITM (in-the-money) so the premium is increased to 0.75 per lot of USDINR. Thus, profit on hedge position is INR 300.
So, he makes a total of INR 300 on his hedge. Effectively his receivables of export increases to INR 44550 (44250+300).
Arbitrage:
Arbitrage means locking in a profit by simultaneously entering into transactions in two or more markets. If the relation between forward prices and futures prices differs, it gives rise to arbitrage opportunities. Difference in the equilibrium prices determined by the demand and supply at two different markets also gives opportunities to arbitrage

Profits through arbitrage:

Scenario 1: Assume the spot rate for USD/INR is quoted @ Rs. 45.20 and three months forward is quoted at 86 paisa premium to spot @ 46.06 while at the same time one month currency futures is trading @ INR 45.80.

An active arbitrager realizes that there is an arbitrage opportunity as the one month futures price is less than the one month forward price. He implements the arbitrage trade where he; Buys in futures @ 45.80 levels (3 months) Sells in forward @ 46.06 (3 months) with the same term period In the process, he makes a Net Gain of 46.06-45.80 = 0.26 i.e. Approx 26 Paisa arbitrage Profit per contract = INR 260 (0.26x1000)
The discrepancies in the prices between the two markets have given an opportunity to implement a lower risk arbitrage. As more and more market players will realize this opportunity, they may also implement the arbitrage strategy and in the process will enable market to come to a level of equilibrium.
Currency trading tools and techniques:
Technical analysis
To develop a strategy, traders use a variety of tools and techniques. Some traders perform Technical Analysis by using Currency Charts to study the market. This technique assumes that past market movements will help predict future activity. The effectiveness of Technical Analysis makes it a very popular trading technique.

Fundamental analysis
Other traders use Fundamental Analysis for their trading strategy. They follow the effect of economic, social and political events on currency prices. Reading specialized Forex News can help keep you in touch with the Forex community to find out how events might affect currency prices.

Practice and familiarize
Every trader makes mistakes, so it's a good idea to familiarize oneself with a trading environment before investing money. To improve trading skills, a free demo trading account can be opened with a Forex company.

Know the risks
Trading foreign exchange on margin carries a high level of risk, and may not be suitable for everyone. Before deciding to trade foreign exchange investment objectives, level of experience, and risk appetite should be carefully considered. Money that one can afford to lose should only be invested.

IPO

What is an IPO?
An initial public offering, or IPO, is the first sale of stock by a company to the public. A company can raise money by issuing either debt or equity. If the company has never issued equity to the public, it's known as an IPO. Companies fall into two broad categories, private and public.
A privately held company has fewer shareholders and its owners don't have to disclose much information about the company. Anybody can go out and incorporate a company, just put in some money, files the right legal documents and follows the reporting rules of your jurisdiction. Most small businesses are privately held. But large companies can be private too. It usually isn't possible to buy shares in a private company. You can approach the owners about investing, but they're not obligated to sell you anything. Public companies, on the other hand, have sold at least a portion of themselves to the public and trade on a stock exchange. This is why doing an IPO is also referred to as "going public."
Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of directors and they must report financial information every quarter. From an investor's standpoint, the most exciting thing about a public company is that the stock is traded in the open market, like any other commodity. If you have the cash, you can invest."
What is an IPO?
Going public raises cash, and usually a lot of it. being publicly traded also opens many financial doors:
  • Because of the increased scrutiny, public companies can usually get better rates when they issue debt.
  • As long as there is market demand, a public company can always issue more stock. Thus, mergers and acquisitions are easier to do because stock can be issued as part of the deal.
  • Trading in the open markets means liquidity. This makes it possible to implement things like employee stock ownership plans, which help to attract top talent.
Being on a major stock exchange carries a considerable amount of prestige. In the past, only private companies with strong fundamentals could qualify for an IPO and it wasn't easy to get listed.
Getting in on an IPO
Getting a piece of a hot IPO is very difficult, if not impossible. To understand why, we need to know how an IPO is done, a process known as underwriting.
When a company wants to go public, the first thing it does is hire an investment bank. A company could theoretically sell its shares on its own, but realistically, an investment bank is required. Underwriting is the process of raising money by either debt or equity (in this case we are referring to equity). You can think of underwriters as middlemen between companies and the investing public. The company and the investment bank will first meet to negotiate the deal. Items usually discussed include the amount of money a company will raise, the type of securities to be issued and all the details in the underwriting agreement. The deal can be structured in a variety of ways. For example, in a firm commitment, the underwriter guarantees that a certain amount will be raised by buying the entire offer and then reselling to the public. In a best efforts agreement, however, the underwriter sells securities for the company but doesn't guarantee the amount raised. Also, investment banks are hesitant to shoulder all the risk of an offering. Instead, they form a syndicate of underwriters. One underwriter leads the syndicate and the others sell a part of the issue.
Once all sides agree to a deal, the investment bank puts together a registration statement to be filed with the SEBI. This document contains information about the offering as well as company info such as financial statements, management background, any legal problems, where the money is to be used and insider holdings. Once SEBI approves the offering, a date (the effective date) is set when the stock will be offered to the public. During the cooling off period the underwriter puts together what is known as the red herring. This is an initial prospectus containing all the information about the company except for the offer price and the effective date, which aren't known at that time. With the red herring in hand, the underwriter and company attempt to hype and build up interest for the issue. As the effective date approaches, the underwriter and company sit down and decide on the price. This isn't an easy decision it depends on the company and most importantly current market conditions. Of course, it's in both parties' interest to get as much as possible.
Finally, the securities are sold on the stock market and the money is collected from investors.
Don't Just Jump In
Let's say you do get in on an IPO. Here are a few things to look out for.
No history
It's hard enough to analyze the stock of an established company. An IPO company is even trickier to analyze since there won't be a lot of historical information. Your main source of data is the red herring, so make sure you examine this document carefully. Look for the usual information, but also pay special attention to the management team and how they plan to use the funds generated from the IPO.
And what about the underwriters? Successful IPOs are typically supported by bigger brokerages that have the ability to promote a new issue well. Be more wary of smaller investment banks because they may be willing to underwrite any company.
The lock-up period
If you look at the charts following many IPOs, you'll notice that after a few months the stock takes a steep downturn. This is often because of the lock-up period. When a company goes public, the underwriters make promoters and employees in case ESOP to sign a lock-up agreement. Lock-up agreements are legally binding contracts between the underwriters and insiders of the company, prohibiting them from selling any shares of stock for a specified period of time. The problem is, when lockups expire all the insiders are permitted to sell their stock. The result is a rush of people trying to sell their stock to realize their profit. This excess supply can put severe downward pressure on the stock price.
IPO basics: conclusion
Let's review the basics of an IPO
  • An initial public offering (IPO) is the first sale of stock by a company to the public.
  • Broadly speaking, companies are either private or public. Going public means a company is switching from private ownership to public ownership
  • Going public raises cash and provides many benefits for a company
  • Getting in on a hot IPO is very difficult, if not impossible.
  • The process of underwriting involves raising money from investors by issuing new securities.
  • Companies hire investment banks to underwrite an IPO.
  • An IPO company is difficult to analyze because there isn't a lot of historical info.
  • Flipping may get you blacklisted from future offerings.
  • Road shows and red herrings are marketing events meant to get as much attention as possible. Don't get sucked in by the hype.

Mutual Funds

Introduction to mutual fund?
Worldwide, the Mutual Fund, or Unit Trust as it is called in some parts of the world, has a long and success fulhistory. The popularity of the Mutual Fund has increased manifold. In developed financial markets, like the United States, Mutual Funds have almost overtaken bank deposits and total assets of insurance funds. As of date, in the US alone there are over 5,000 Mutual Funds with total assets of over US $ 3 trillion (Rs. 100 lakh crores). In India,the Mutual Fund industry started with the setting up of Unit Trust of India in 1964. Public sector banks and financial institutions began to establish Mutual Funds in 1987. The private sector and foreign institutions were allowed to set up Mutual Funds in 1993. Today, there are 36 Mutual Funds and over 200 schemes with total assets of approximately Rs. 81,000 crores. This fast growing industry is regulated by the Securities and Exchange Board of India (SEBI).
What is a mutual fund ?
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. Anybody with an investible surplus of as little as a few thousand rupees can invest in Mutual Funds. These investors buy units of a particular Mutual Fund scheme that has a defined investment objective and strategy The money thus collected is then invested by the fund manager in different types of securities. These could range from shares to debentures to money market instruments, depending upon the scheme's stated objectives. The income earned through these investments and the capital appreciation realised by the scheme are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
What are the types of mutual fund schemes?
There are a wide variety of Mutual Fund schemes that cater to your needs, whatever your age, financial position, risk tolerance and return expectations. Whether as the foundation of your investment programme or as a supplement, Mutual Fund schemes can help you meet your financial goals.
A) By structure
Open-ended schemes
These do not have a fixed maturity. You deal directly with the Mutual Fund for your investments and redemptions. The key feature is liquidity. You can conveniently buy and sell your units at net asset value ("NAV") related prices.
Close-ended schemes
Schemes that have a stipulated maturity period (ranging from 2 to 15 years) are called close-ended schemes. You can invest directly in the scheme at the time of the initial issue and thereafter you can buy or sell the units of the scheme on the stock exchanges where they are listed. The market price at the stock exchange could vary from the scheme's NAV on account of demand and supply situation, unit holders' expectations and other market factors. One of the characteristics of the close-ended schemes is that they are generally traded at a discount to NAV; but closer to maturity, the discount narrows. Some close-ended schemes give you an additional option of selling your units directly to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations ensure that at least one of the two exit routes are provided to the investor.
Interval schemes
These combine the features of open-ended and close- ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices.
(B) By investment objective
Growth schemes
Aim to provide capital appreciation over the medium to long term. These schemes normally invest a majority of their funds in equities and are willing to bear short- term decline in value for possible future appreciation.
These schemes are not for investors seeking regular income or needing their money back in the short-term. Ideal for:
  • Investors in their prime earning years.
  • Investors seeking growth over the long-term
Income schemes
Aim to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures. Capital appreciation in such schemes may be limited. Ideal for:
  • Retired people and others with a need for capital stability and regular income.
  • Investors who need some income to supplement their earnings.
Balanced schemes
Aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. They invest in both shares and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls. Ideal for:
*Investors looking for a combination of income and moderate growth.
Other schemes
Tax saving schemes
These schemes offer tax rebates to the investors under tax laws as prescribed from time to time. This is made possible because the Government offers tax incentives for investment in specified avenues. For example, Equity Linked Savings Schemes (ELSS) and Pension Schemes. Recent amendments to the Income Tax Act provide further opportunities to investors to save capital gains by investing in Mutual Funds. The details of such taxsavings are provided in the relevant offer documents. Ideal for:
* Investors seeking tax rebates.
Special schemes
This category includes index schemes that attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50, or industry specific schemes (which invest in specific industries) or sectoral schemes (which invest exclusively in segments such as 'A' Group shares or initial public offerings). Index fund schemes are ideal for investors who are satisfied with a return approximately equal to that of an index. Sectoral fund schemes are ideal for investors who have already decided to invest in a particular sector or segment. Keep in mind that any one scheme may not meet all your requirements for all time. You need to place your money judiciously in different schemes to be able to get the combination of growth, income and stability that is right for you. Remember, as always, higher the return you seek higher the risk you should be prepared to take. A few frequently used terms are explained here below:
Net asset value ("NAV")
Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date.
Sale price:is the price you pay when you invest in a scheme. also called offer price. it may include a sales load.
Repurchase price: Is the price at which a close-ended scheme repurchases its units and it may include a back-end load. This is also called Bid Price.
Redemption price: Is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related.
Sales load: Is a charge collected by a scheme when it sells the units. Also called, 'Front-end' load. Schemes that do not charge a load are called 'No Load' schemes.
Repurchase or 'back-end' load: Is a charge collected by a scheme when it buys back the units from the unit holders.
Why should you invest in mutual funds ?
The advantages of investing in a mutual fund are:
  • Professional management.You avail of the services of experienced and skilled professionals who are backed by a dedicated investment research team which analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme.
  • Diversification.Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks declare at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own.
  • Convenient administration.Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and unnecessary follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient.
  • Return potential.Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities.
  • Low costs.Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors.
  • Liquidity.In open-ended schemes, you can get your money back promptly at net asset value related prices from the Mutual Fund itself. With close-ended schemes, you can sell your units on a stock exchange at the prevailing market price or avail of the facility ofdirect repurchase at NAV related prices which some close-ended and interval schemes offer you periodically.
  • Transparency.You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook.
  • Flexibility.Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience.
  • Choice of schemes.Mutual Funds offer a family of schemes to suit your varying needs over a lifetime.
  • Well regulated.All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.
How do you understand and manage risk?
All investments whether in shares, debentures or deposits involve risk: share value may go down depending upon the performance of the company, the industry, state of capital markets and the economy; generally, however, longer the term, lesser the risk; companies may default in payment of interest/ principal on their debentures/bonds/deposits; the rate of interest on an investment may fall short of the rate of inflation reducing the purchasing power. While risk cannot be eliminated, skillful management can minimise risk. Mutual Funds help to reduce risk through diversification and professional management. The experience and expertise of Mutual Fund managers in selecting fundamentally sound securities and timing their purchases and sales, help them to build a diversified portfolio that minimises risk and maximises returns.
How to invest in mutual funds?
Step one - identify your investment needs
Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, level of income and expenses among many other factors. Therefore, the first step is to assess your needs. Begin by asking yourself these questions:
  • What are my investment objectives and needs?Probable Answers: I need regular income or need to buy a home or finance a wedding or educate my children or a combination of all these needs.
  • How much risk am I willing to take? Probable Answers: I can only take a minimum amount of risk or I am willing to accept the fact that my investment value may fluctuate or that there may be a short-term loss in order to achieve a long-term potential gain.
  • What are my cash flow requirements? Probable Answers: I need a regular cash flow or I need a lump sum amount to meet a specific need after a certain period or I don't require a current cash flow but I want to build my assets for the future. By going through such an exercise, you will know what you want out of your investment and can set the foundation for a sound Mutual Fund investment strategy.
Step two - choose the right mutual fund.
Once you have a clear strategy in mind, you now have to choose which Mutual Fund and scheme you want to invest in. The offer document of the scheme tells you its objectives and provides supplementary details like the track record of other schemes managed by the same Fund Manager. Some factors to evaluate before choosing a particular Mutual Fund are:
  • the track record of performance over the last few years in relation to the appropriate yardstick and similar funds in the same category.
  • how well the Mutual Fund is organised to provide efficient, prompt and personalised service.
  • degree of transparency as reflected in frequency and quality of their communications.
Step three - select the ideal mix of schemes.
Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals. The charts could prove useful in selecting a combination of schemes that satisfy your needs.

Step four - invest regularly
For most of us, the approach that works best is to invest a fixed amount at specific intervals, say every month. By investing a fixed sum each month, you buy fewer units when the price is higher and more unitswhen the price is low, thus bringing down your average cost per unit. This is called rupee cost averaging and is a disciplined investment strategy followed by investors all over the world. With many open-ended schemes offering systematic investment plans, this regular investing habit is made easy for you.
Step five - keep your taxes in mind
If you are in a high tax bracket and have utilised fully the exemptions under Section 80L of the Income Tax Act, investing in growth funds that do not pay dividends might be more tax efficient and improve your post-tax return. If you are in a low tax bracket and have not utilised fully the exemption available under Section 80L, selecting funds paying regular income could be more tax efficient. Further, there are other benefits available for investment in Mutual Funds under the provisions of the prevailing tax laws. You may therefore consult your tax advisor or Chartered Accountant for specific advice.
Step six - start early
It is desirable to start investing early and stick to a regular investment plan. If you start now, you will make more than if you wait and invest later. The power of compounding lets you earn income on income and your money multiplies at a compounded rate of return.
Step seven - the final step
All you need to do now is to get in touch with a Mutual Fund or your agent/broker and start investing. Reap the rewards in the years to come. Mutual Funds are suitable for every kind of investor-whether starting a career or retiring, conservative or risk taking, growth oriented or income seeking.
Your Rights As A Mutual Fund Unit holder As a unit holder in a Mutual Fund scheme coming under the SEBI (Mutual Funds) Regulations, ("Regulations") you are entitled to:
  • Receive unit certificates or statements of accounts confirming your title within 6 weeks from the date of closure of the subscription or within 6 weeks from the date your request for a unit certificate is received by the Mutual Fund;
  • Receive information about the investment policies,investment objectives, financial position and general affairs of the scheme;
  • Receive dividend within 42 days of their declaration and receive the redemption or repurchase proceeds within 10 days from the date of redemption or repurchase;
  • Vote in accordance with the Regulations to:
    • Either approve or disapprove any change in the fundamental investment policies of the scheme which are likely to modify the scheme or affect your interest in the Mutual Fund; (as a dissenting unit holder, you would have a right to redeem your investments);
    • Change the asset management company;
    • Wind up the schemes.
  • Inspect the documents of the Mutual Funds specified in the scheme's offer document. In addition to your rights, you can expect the following from Mutual Funds:
    • To publish their NAV, in accordance with the regulations: daily, in case of most open ended schemes and periodically, in case of close-ended schemes;
    • To disclose your schemes' portfolio holdings, expenses, policy on asset allocation, the Report of the Trustees on the operations of your schemes and their future outlook through periodic newsletters, half- yearly and annual accounts;
    • To adhere to a Code of Ethics which require that investment decisions are taken in the best interests of the unit holders.

Insurance

What is insurance?
Insurance is the only way to protect the economic value of assets and life. It is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the insurance. A policyholder is the person or entity buying the insurance policy. The insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium.
What is an asset?
Tangible Intangible
Home Earning Power
Car Training
Jewellery Experience
Computer Skills
Business
Collections
Why should you have insurance?
  • Assets can be destroyed by fire, flood, earth quake, etc. Insurance protects the assets.
  • Insurance covers the risk. A risk is the possibility of loss or damage, that may or may not happen. General insurance covers such contingencies that may happen.
  • If there were no uncertainties, there would be no need for insurance.
  • Life of a person is an income generating asset. In case of untimely death of he person, the family is protected by life insurance cover. For the post-retirement period, life insurance helps to ensures a lump sum payment or a regular income.
How will insurance help?
  • Insurance takes care of the unexpected
  • Family is protected from the loss of earnings in case of a crisis/calamity. Insurance takes the financial burden off.
  • The best way to save regularly- at the best rates.
  • Tax free payout on maturity acts as a ‘nest-egg’ for retirement.
  • Loans possible on certain life insurance policies.
  • Tax saving benefits under section 88 of I.T. Act.
  • After only a single premium, you are covered for the full benefit.
  • As a “locked-in savings”, Life Insurance gives you the highest returns.
  • Life Insurance policy can act as collateral when taking a loan.
  • For only a small sum each year, the Insurance company takes the risk.
What kinds of risks are covered under general insurance?
Fire Buildings, machinery,furniture,fittings, stocks, etc. Loss of net profit also covered.
Marine Large cargo/passenger vessels. Cargo handling also covered.
Burglary Stocks,cash,jewellery.
Fidelity Breach of trust by employees.
Personal Accident Accident to human lives.
Medical Medical expenses incurred during illness/hospitalization.
General insurance ~ additional products
  • Shopkeeper Insurance
  • Flood Insurance
  • Travel Insurance
  • Baggage Insurance
  • Engineering Insurance
  • Household Goods Insurance
  • Earthquake Insurance
Insurance for rural markets
  • Crop Insurance
  • Cattle Insurance
  • Pump Insurance
  • Lift Irrigation Insurance
  • Horticulture/Plantation Insurance
Life insurance covers
Family Financial protection on death of an earning member.
Children Savings for education/marriage/start-in life.
Old Age Retirement income.
Special Needs Medical treatment/Loss of income due to disability(accidents/illness).
Life insurance
Life Policy Has two components
1. Risk Cover- Benefit payable in the event of death
2. Savings- Benefit payable on maturity
Term policy Only risk cover for a specific period.
Endowment policy Survival benefit( for a specified period)
Insurance- an asset everyone should have
Our life is uncertain
  • The only certainty is death- everyone dies
  • The question is when?
Our assets are open to risks of all types
  • Natural & Man made.
So, insurance is needed to think ahead & be prepared financially
  • For old age.
  • For sudden death.
  • For assets & business.
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