Credit Derivative

Credit derivative is a financial instrument whose value is determined by the underlying "credit risk" of the financial asset like the bond or loan.

Credit Risk is used to transfer the risk from one party to another in case if a credit event. Let us say that Party A gives loan to party B (reference party). Party A, to secure itself against a default from party B takes insurance from another Paty C.

The most commonly used credit derivative is the 'credit derivate swap' where the credit risk is swapped between 2 parties. Party A makes regular payment (premium) to party C but party C makes no payment unless there is a credit event. In case B is not able to repay the loan, partt C makes payment to A and then the swap terminates. The amount of payment made is generally the decline in the market value of the reference asset.

http://www.finpipe.com/crederiv.htm

chapter 2: DEMAND

1. The demand Curve
2. Diminshing Marginal Benefit
3. How Demand and Income are related
4. Substitutes and Complements
5. Normal vis-a-vis Inferior Products
6. How Demand and Advertising are related
7. Demand for Durable goods
8. Market Demand v/s Individual Demand
9. The Buyer Surplus

Accounting for Inventories - LIFO or FIFO

LIFO = Last in First Out

FIFO = First in First Out

FIFO means that the inventories that are purchased first are the first to be sold.

LIFO means that the inventories that are purchased last are the first units to be sold.

Companies usually shift from FIFO to LIFO to show less taxable income. Since inventories purchased last would cost higher, the net Income ( Revenues - Cost of Goods) would be less and also the taxable income calculated would also be less.

Common Ratios for Financial Analysis - III

Solvency Ratios
A company being solvent means it can meet its financial obligations.
Current Ratio = Total Assets / Total Liabilities
Acid-test Ratio = Quick Assets / Total Liabilities

Debt Ratio = Total Debt / Total Assets
Debt-to-Equity Ratio = Total Liabilities / Owners quity

Time Interest Earned Ratio : This ratio is used by the creditors who lend money to the businesses. This is to make sure if it is safe to lend money to the investors.

Time Interst Earned Ratio = EBIT / Interest Expense

Commmon Ratio for Financial Analysis - II

Activity Ratios

These ratios help in understanding how well the assets are used being utilized. Efficient usage of assets allows for lesser investment by lenders and owners and thus means less risk involved in the business.

1. Days receivables outstanding : This ratio tells about the days required to make collection on the sales. If more days are required to gather sales capital then more working capital is required to run the business.

Days Receivables Outstanding = Account receivables / Average sales in a day

2. Inventory Turnover : This ratio usually tells how quickly the inventory is moving out to earn money for the company

ITR = Cost of goods sold / Average Inventory

Common Ratios for Financial Analysis - I

Return on Assets = Net Income / Total Assets
This ratio usually tells about the utilization of the assets committed to the business.

Return on Equity = Net Income / Shareholder's Equity
This ratio tells about how well the shareholders investment is used in the business.

Return on Investment
This is a very vague term since "investment" is not defined clearly. Investment may be in the form of assets or owners equity or shareholders equity.

EBIT = (Earning before Interest and Taxes) is also known as the operating margin
Operating Margin = EBIT / Net Sales

An operating margin of 0.12 means company is making 0.12 $ on every 1 $ of sales.
EBIT comes after the company has taken into the consideration the wages, the cost of production, cost of raw materials and other things.

Fully Diluted EPS = (Net Income - Preferred stock dividends)/ ( common stock + equivalent)

Profit Margin = Net Income / Net Sales. This is also known as the retun on sales

PLR - affecting the micro economics and the macro economics

Macro Economics

If the prime lending rate is increased, the borrowing cost would increase. This would slow down the production of the companies. This is would result in slower growth of the industry. The GDP would be affected. Because of lesser revenue and lesse profits, the tax to the government would decrease.

This will decrease inflation

Micro Economics

From microeconomics perspective, high PLR will hit the production. High lending rates will also hit the consumer demand. The company may then have to cut down on the production, lay off staff, take care of the inventory and other things in the purview of micro economics.

Greeshoe Option

The explanation for greenshoe option has been taken from investopedia.

Greenshoe option gives the underwriter an option to increase the allotment of shares.

In case the issuer feels there is a need for more capital or even to stabilize the price of the security it may be decided to over-allot the securities.This could also be done in case the demand for the security increases far more than expected.

Greenshoe option may allow the underwriter to issue 15% more shares than the original decided number

Difference between Bonds and Debentures

Bonds and Debentures are very similar to each other in the sense that both are fixed income instruments that offer a very safe route of investment. However there are certain differences between the two which this blog will try to clear

1. The first major difference between the two is that the bonds are secured by some underlying assets. This means that in case a company defaults on the payment of principle and interests, the investor can claim on the asset. In simple terms no collateral is offered for debentures.

2. Bonds are generally issued by the government whereas the debentures are issued by the corporates

3. Because debentures are unsafe compared to bonds, interest rates offered are higher on debentures.

http://www.fimmda.org/useful_links/faq.asp#p3

Participatory Notes

Participatory notes are issued to the foreign investors by the brokerages, fund houses, hedge funds that are not registered with SEBI.

These brokerages buy listed Indian securities and then issue Participatory Notes to foreign investors. This is almost like informal ADRs. Any dividend, capital gains generated on the underlying securities is given to the investors.

Since investing in Indian markets is limited to the registered FIIs, PNs provide the alternative though ineligible route for foreign investors to enter Indian markets.

The hedge funds are not registered directly with the SEBI but can operate through sub-accounts in FIIs. These funds are said to operate through issuance of PNs. SEBI is not happy because it does not know who is the underlying owner of the security.

How the Government bowled SLR to stump SBI

I feel it would be best to explain this story in points.

1. SBI releases a rights issue.
2. Government is interested in buying the issue and makes payment in the form of government bonds (G-Secs)
3. The value of the bonds is 9996 crores.
4. Now these bonds do not enjoy the SLR status, which means as per the Indian banking regulations these cannot be held till maturity.
5. Only the G-Secs that have SLR status can be held till maturity and all the other bonds are callable before their term expires.
6. Since these bonds do not have SLR status, they cannot be held till maturity and there value is assessed using mark-to-market method.
7. For for bonds, the yield and price are inversely related. Due to the tough economic conditions the interest rates of the G-Secs have risen and the price has fallen.
8. So, the bonds that are held by the SBI, according to M-to-M method, have fallen in value.
9. This fall in value is around 700 crore.
10. SBI is now reuqesting government to give these bonds the SLR status so that they are held till maturity and theire value does not fall.

Statutory Liquidity Ratio (SLR)

SLR is the amount of money that the banks need to maintain in the form of cash , gold or other securities. This amount is expresses in the form of percentage and generally depends on the demand and banks liabilities.

SLR is used to help
1) in containing inflation
2) to secure the solvency of banks
3) augment more bank investment in G-Secs' ( by not keeping enough cash at hand)

Fiscal Deficit

Fiscal deficit simply means that government expenditure is more than the earning. Expenditures include the plan expenditures and non-plan expenditures. Plan expenditures can also be said as the capital expenditures and non plan expenditures can be said as the revenue expenditures.

Fiscal expenditure is taken care by either by borrowing or printing money.

When the government borrows money by issuing bonds, in long term, as per the macroeconomic policy, the bond prices fall and interest rates rise. This affects growth.

When the government chooses to print money, it causes inflation.

Current Account - Surplus/Deficit

Current Account is composed of three entities
Current Account = Balance of Trade + Net Payments + Net Transfers

Balance of Trade = Exports - Imports
Net Payments = Money received from investments abroad - remittances
Net Transfers = International Aid (ignore)


Current Account deficit(X) can be said as the function of exchange rate(p), domestin GDP (d), foreign GDP (f). Thus X=f(p,d,f)

P (exchange rate) = current account improves (goes in surplus) if the currency depreciates. This helps in boosting exports.

Domestic GDP = CA improves if the domestic GDP falls. This reduces demand for foreign goods. So less imports.

Foreign GDP = An increase in foreign GDP helps boost domestic exports and improves current account

petro dollars

Petro Dollars refer to the money (dollars) earned by the OPEC countries and then putting this money back in the US banks.

The money that oil exporters receive from selling oil and then deposit into Western banks. Petrodollars are also known as petrocurrency. - investopedia

Right Issue, Open offer, Tender Offer

Right Issue: Here a company would like to raise by issuing more shares in the secondary market. In right issue the company offers additional share to its already existing share holders. The subscription price is usually lower than the market price

http://www.stock-investment-made-easy.com/rights-issue.html

Open Offer: An open offer is similar to the rights issue. What happens in this case is that here a company offers it shares to the existing share holders at a discount. But these share holders cannot sell these shares in the secondary market. This is also known as the entitlement issue.

http://moneyterms.co.uk/open-offer/

Tender Offer: In tender offer, the company (say A) which wants to acquire another company (say B) offers the shareholders of B to buy their shares at a premium. This is done to increase the stake of B in A.

NRO, NRE and FCNR Account

This blog is intended to help differentiate between the above 3 accounts.

NRE and NRO are the rupee accounts whereas FCNR account is maintained in foreign currency.
NRNR - Non Residential Non Repatriable are also rupee accounts

Proceeds from foreign currency notes/TCs can be credited to the NRE accounts. NRE account can be opened by local funds or by foreign funds. NRO account can be opened using either local fund / foreign fund.

NRO/NRE accounts both can be used to make local payments

Balances from NRE account can be repatriated abroad freely. While those from NRO account cannot be sent outside and used only for local payments.

http://www.iic.nic.in/iic5_a02.htm

Euro Zone

Euro Zone is the currency union of all the countries that use EURO. European Central Bank is responsible for monetary policies in the Euro Zone

How higher crude oil prices also increase the price of vegetable oils

Recently a news clip that higher crude oil prices affect the prices of vegetable oils grabbed my attention and I tried get more information on this.

So the reasons why the price of vegetable oil is also rising are:

1. More and more vegetable oil is used as BIO FUEL. Yes so your palm oil, castor oil, soya bean oil which are usually used for cooking is now used as a fuel. So less oil available for cooking -> Price rises

2. More and more crops such as corn are now being used for making bio fuels instead of cooking oil. So less crop for cooking purposes. Price rises.

3. Farmers are realizing more profits by switching to bio fuel crops. Then less crop for vegetable oil -> Price rises

**Interestingly, corn which is used for producing ethanol is not only used in cereal but is also fodder for cattle. So also expect a price hike in meat and milk.

All about NBFCs

Non Banking financial corporations are registered companies that can engage in businesses such as
a.) Loans and advances
b) Insurance
c) acquisition of shares/bonds/debentures/any marketable security

what NBFCs cannot engage in
a) agricultural activity
b) industrial activity
C) Sale purchase of immovable property

How it is different from a bank is that it does provide feature of demand deposits like the bank does.

A NBFC can either be registered with Sebi or RBI. Dual registration is not required.

NBFCs that are registered with RBI are
a) Asset Financing Companies (AFC)
b) Investment Company (IC)
c) Loan Company (LC)

Mind you that all NBFCs cannot hold deposits and those that can hold have a certificate from RBI. The networth of the NBFC should be greater than the deposits held.

Difference between Privatization and Divestment

Privatization is the process of transferring the ownership of a business of a public sector to the private sector. In a broader sense, privatization refers to transfer of any government function to the private sector including governmental functions like revenue collection and law enforcement.

Divestment is said as the opposite of Investment. Investment means acquisition of certain assets; divestment means the release of assets. A business may be that a particular arm of its is not compatible with its core business and hence may decide to shelve or divest this business. Divestment may be done for various economic or social reasons.

Disinvestment: Disinvestment means shrinkage if the capital available or withdrawal of capital from a business.

what is short-covering

Short Covering is best explained with an example.

Supposing a broker has 50 shares of Rs10 of some company. The broker feels that company doesnt have good prospects and sells the share at Rs. 10. Now suddenly in evening or next day, company's prospects may seem good and share price rises to Rs. 15.

At this point broker may like to buy the share and then to avoid further loss buys 50 shares at Rs15. This is known as short covering- where there is no fresh purchase.

how higher interest rates weaken a currency

News that the US fed bank may increase the interest rates caused the dollar to weaken against other currencies.

This can be best explained with the help of an example. Suppose 1 dollar is currently equal to 42 Indian rupees. So now if the fed bank increases interest rates borrowing money will be more expensive. So with say 84 rupees I can borrow 2 dollars currently at the interest rate of 8.5%. If the interest rate is hiked, borrowing dollar becomes more expensive.

At this time the dollar values is then weakened to say Rs 41. In this way I can buy more dollars with the same 84 rupees but will give higher interest rate.

This is all done to even out higher interest rates so the customer borrowing is not affected by much.

Also as a general rule, higher interest rates will create less demand for a currency and hence its value will fall

Repo Rate, Reverse Repo Rate, CRR, Call Rate

Repo rate is the rate at which banks borrow money from RBI. Increase in the repo rate makes borrowing more expensive for the banks

CRR or Cash Reserve Ratio is the amount of money banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down.

http://openlib.org/home/ila/MEDIA/2004/CRR.html

As per RBI rules, certain percentage of deposits with the bank has to be kept as cash with RBI. This ratio (what part of the total deposits is to be held as cash) is stipulated by the RBI and is known as the CRR, the cash reserve ratio. When a bank’s deposits increase by Rs100, and if the cash reserve ratio is 10, banks will hold Rs10 with the RBI and lend Rs 90. The higher this ratio, the lower is the amount that banks can lend out. This makes the CRR an instrument in the hands of a central bank through which it can control the amount by which banks lend.

Reverse Repo Rate is the rate at which banks park their excess liquidity with RBI.

Obviously the reverse repo rate will be less than the repo rate.

Call Rate is also called the overnight rate. This is the rate at which a depository institution (bank) lends money to another depository institution overnight. This rate is a very good indicator of the short term lending rates.

In countries that have central banks, like India, it is the rate at which RBI lends money to banks overnight.

exchange rate or inflation- what the gov should worry about more

For a country like India, today both the exchange rate and inflation are not heading in the right direction. The rupee is weakening against the dollar whereas the inflation is rising. At this time it becomes important to understand whether the government should take measures to control exchange rate or the inflation.

Lets consider that the government gives more priority to exchange rate. The rupee is weakening against the dollar. To strengthen rupee, the government can only sell the dollars it has. This will strengthen rupee. But what will be the repercussions? By selling dollars the dollar reserve with the government will lessen. With less rupees the imports could be hit, which may actually lead to inflation due to less supply!!

The government will then have to resort to borrowing more dollars and weaken the rupee again. Borrowing may hurt the government fiscal more and weaken the economy and rupee even more. Due to weakned economy FIIs will be less interested in investing in India and hence will not infuse more money in the country.
So it makes no sense to manage exchange rate over inflation.

On the other hand, with inflation under control, there is a chance of business growth. Although inflation control measures are always a damp-ner for the businesses, but with inflation under control common man will be more buoyant about the economy. With more business, the economy and thus the rupee is likely to become more strong.

In the view of raghuram rajan, exchange rate should be left upto the market forces and government should take care of inflation.

How Ranbaxy acquisition will affect the stock holders

Now that daiichi sankyo has acquired stake in ranbaxy, there is bound to be change in investor holdings and their profits. To acquire control daiichi needs 51 % stake in company

1. Daiichi buys 35% from singh family. Another 65% is with the preferred and common stock holders.

2. Daiichi can 9.4% in ranbaxy through preferred allotment of shares

3. Daiichi can offer to buy 20% of 65% shares in market.

4. If daiichi still cannot reach 51% , it will get offer to buy another 4.9 % through preferred allotment

Preferred and Common stock

The main reason for having preferred stock and common stock is to differentiate the ownership from management. Now suppose a particular shareholder has 5% stake in a company. This shareholder has a minority yet sizable stake and may use his 5% ownership to force the company to include him in the corporate making. Many companies would not want this. So this shareholder will be given 5% preferred shares but will have limited voting rights in companys' decisions.
**preferred stocks are not traded on the bourse like common stocks.
There are convertible preferred stocks that can be converted to common stocks.
Preferred stocks can also be returned to the company at a fixed price

*preferred stock is generally given to private equity owners who have stake in the company

1. Dividend Payout
Preferred stock holders have a confirmed dividend payout every quarter. Common stock holders may or may not get dividends depending on the company performance.

2. Decision making Rights
Common stock holders have higher priority on corporate decision making than the preferred share holders. For common stock holders generally 1 stock equals 1 vote

3. Liquidation / Bankruptcy
In case a company goes for liquidation or files for bankruptcy, the preferred share holders get preference for getting all company assets before the common stock holders

Effects of raising interest rate by US

Ben bernanke today announced that to control inflation the fed bank will increase the interest rate. To understand what affect this will have we have to look at both the short term and long term perspectives.

First the short term

1. Because Int. rate have been increased to control inflation, the first entities which would be affected are the businesses. As increased interest rate would make borrowing expensive, less number of firms would be interested in going for credit. So, stocks of such companies fell.

2. Obviously the inflation would be controlled

3. For those who invest in dollar securities, their returns would increase. So in a way there is more demand for dollar. Dollar has therefore strengthened against other currencies.

Long term perspective

Impression that inflation will be controlled and business will be secure in the future, the risks have reduced. Due to this price of 10 year bond has reduced

Effect on oil prices

by increasing interest rate, borrowing dollar has become difficult. So demand for the dollar commodity - crude oil has reduced a bit and hence oil prices have fallen

how a weak dollar causes oil price to rise

Oil is dollar commodity

Now due to weak economic condition in US, the dollar is already weak. Now in Europe, also Canada and Japan, their currencies have become stronger as compared to the dollar. So they can buy more dollar-commodities at a cheaper rate.

As a result these countries can afford to buy more oil at a cheaper rate. Hence there is a huge demand for oil from these countries and more the demand, the oil price is going to rise.

In addition to the high demand, such countries are buying more and more oil to hedge against inflation because tomorrow no one knows what the scenario will be!

why the dollar has weakened

obviously because there is a less demand for the US dollar in the forex. But why?

1. Crude Oil is traded in dollars. All developing/developed countries are buying oil in dollars. There is an excessive supply of dollars in the market. The supply here is more than the demand. And hence by supply-demand principle, the dollar is becoming weak.

2.No one wants to buy US dollars. People buy US dollars for investing in treasury bills, US corporate bonds when they know that the economic situation in US is strong.
But currently the economic situation in US is in doldrums. Few people want to invest in US and hence there is a less demand for US dollars.

3. Due to recession, US Fed bank has reduced interest rates. Even greater deterrent for foreign players to invest in US.

4. A bit of higher inflation is causing US goods to be more expensive. Less people are interested in buying US goods because they are expensive. Hence they are not buying the US dollar for purchases.

5. US economy is import based. It currently has a huge trade deficit. Its pumping huge dollar supplies to the world. Due to this there is a great SUPPLY of dollar in the world. Hence value of dollar is falling.

6. Other reason why the dollar is weakening compared to other currencies is that the economic situation in other European countries or Japan or middle east is much better than in US.

why India is opposed to WTO

Why India feels the WTO recommendations are a stymie to its growth

1. The developed countries esp. US want more access to the markets of developing countries like India. India feels this will threated the local farmers and lower competitive prices will take away their livelihood.

2. US wants to give limited access to the developing countries to its markets. It proposes that in case of a) increased supply and b) falling prices of goods - it can levy import duty on the foreign goods which will be higher than the maximum duty permitted by WTO!!

3. US also wants more leeway on NAMA (non-agri market access). Non Agri products compose more than 85% of products under WTO. Having more access to the non agri market in developing countries is also detrimental to Indian manufacturers

4. US and developed countries also want infusion of RE-MANUFACTURED goods in developing countries. Bringing these low cost second hand machines, goods can erode the indian local market..

"these are highly protectionist moves which are against the market forces", India.

what is book value of a share

Total owner's equity = Assets - Liabilities
Book Value of a share = (total owners equity) / No. of outstanding shares

Generally the market value of the share should be and is greater than the book value.

how a weak rupee causes inflation

A weak rupee would always make the exporter happy.

Consider this weak rupee ----> exports profitable -----> more money in market --> inflation

Consider this weak rupee ----> imports not profitable ---> more money goes out ---> have to buy dollars to finance imports ----> rupee weakens more

why you should not drop interest rates (too much )during recession/ slowdown

Even though it may seem logical to reduce the interest rate during a slowdown to attract more investment, it may not be the most prudent decision when it come to foreign investment.

Consider a country say A that invests in America because it gets good rate of return in comparison to its own country. Say the roi in home country is 5% and that in America in 7%. So A would be tempted to invest in America. But if the rate of return fall to 5% in US, it may not be very wise to invest in US.

eg. say A is INDIA. want to invest 10000 Rs. 10000 rs is equal to 250 $ approx.
I invest 250 $ in US at 7% for 1 year. Interest is 17.5 $ = 700 rs.
I invest 10000 in India at 5% for 1 year. Interest is 500 rs. = 12.5 $

So makes more sense in investing in US. So even during the time of recession, to keep the foreign inflows coming should not reduce the interest rates drastically as done by Ben Bernanke.

six steps to create a blue ocean

1. Look across alternatives
2. Look across strategic group across industries - eg. curves health clubs
3. Look across the usual set of buyers
4. Look across functional and emotional appeal or add one in case of its absence
5.Look across complementary product and service offerings
6. Look across time - how a trend will add value to business years down the line if a trend follows its logical conclusion

a. Understand the strategic profile of the industry
b. Understand the strategic profile of the competitors
c. Understand the strategic profile of your own company

alternatives v/s substitutes

Substitutes: Consider object A that performs some task or has some utility. Now objects B,C and D that have different form as compared to A but perform the same function are called substitute

Alternatives: Now objects E,F and G that have different forms and functions compared to A but perform the same purpose are called alternatives.

eg. of substitutes : A washing machine or a dhobi ghat. Different forms but perform the same functions of cleaning clothes. PURPOSE : to give clean clothes. ALTERNATIVE TO THIS: buy new clothes.

eg. of alternatives: a movie and a family dinner. Both have the function of family outing and enjoyment but are in very different forms and do different functions

The Newbies

The spring through summer is the most exciting time for any MBA aspirant. The joys, heartbreak, the waiting are some of the feelings without which an MBA journey is incomplete. To get out that mundane 9 to 5 job and tread onto something new, something exciting, the eagerness in the hearts is definitely palpable. To get your ones hands on the latest management book, to equip yourself with all the financial knowledge, to learn the latest business terminology, you just want to do it all.

On my recent visit to crossword, this is exactly what I saw. Having secured an admission myself, I too was eager to learn the principles of globalization, the effect "the china price" was having on the world; the tarde, the exports, the imports, the foreign exchnage, they all seemed to excite me like never before. But what came as a surprise and a revelation was that I was not alone. Twenty othere mid-twenties like me were flocking the store to get the most read book on financial accounting or the best sellers on leadership or how to be creative!! incredible.. ah! this MBA fever has surely gripped another set of future leaders and I wish all the very best..

MAHA - SANGRAM

The shameful events thet happened in the last one week were truly a blot on the civil society we are part of. But after having gone through the series of events and the defense persented by the two opposing parties it'll be fair to say both were at fault.


Raj Thakrey ( pyar se log mujhe raj kehte hain) was correct when he said that the state cannot keep bearing the burden of hundreds of migrants who flood into the city everyday. And yes there are thousands of poor maharashtrians who are unemployed and are fit enough to replace the north indians who apparently have taken away their jobs ( just as we indians (all alike) bangalore the americans.. nobody talks about that!) To make a comment that northies are spoiling the culture of maharashtra.. no body is going to buy that argument.. to tamper with the auto meters.. to ogle at pretty lass.. thats human!! even an average mumbaiite does that..


And now coming to the other party in contention who was acting equally stupid (amar sing and abu azmi). Instead of pointing fingers they should better look at what they have done for their states. UP, MP, Bihar some one the most third class states ( will continue to remain so) which cannot even generate enough employment in agri business forget the no-agri startups having any hope! I guess we all know what the solution is of this big problem, so I will not delve much into it..