"WHAT IS CURRENCY HEDGING"

CURRENCY HEDGING: There is a village known as Champak. The village is well known for the intelligence of its people. Chameli is one smart girl of the village and Chatur a smart young man, is keen to marry Chameli. However, Chameli is unwilling to commit. She sets her condition that she might consider marrying him but would confirm only after one year. She comes up with an idea and makes an offer to Chatur. She suggests that they draw up a contract which states that at the end of the year she might consider marrying Chatur but there would be no obligation to do so. For signing up the contract, she would pay Chatur a sum of money. As part of the contract, Chatur has to stay within bounds and not persuade her during this period. If one sees this situation from Chameli's perspective, it appears that she is “Hedging” herself or we may say she is “covering her risks” for a sum of money. Chatur on the other hand stands a chance of marrying Chameli after a year and the sum of money that he gets for the contract becomes the icing on the cake. However, let us examine the scenario in the event of Chameli not marrying Chatur. Chameli would use her option of not marrying Chatur if she happens to find a groom more eligible than Chatur. The only price that she would have to bear for this decision is the sum of money that Chatur would get on account of the contract. So by offering this money, she covers her risks by ensuring that she enjoys the option of marrying either Chatur or somebody better. Chatur has a reasonable chance of marrying Chameli at the end of the year, but if that does not occur he at least gets to pocket the money. Hedging of currency risk is similar to this story. Let's say Chameli places an order to buy foreign machinery at a million dollars at the end the year. As per the contract, she will need to make the payment at the end of the year. Now let's say the value of a million dollar is 5 cr. rupees at the time of signing the contract. At the end of the year the value of the dollar rises by 10%. Now she would have to cough up additional Rs. 50 lacs for the machinery (Rs 5.5 cr for a million dollars due to price appreciation). This increase in cost is not good for her business. And she looks for ways of covering such currency risk. Instead of risking what could be Rs 50 lacs, she buys a call option (you always buy a “call” option but sell a “put” option). This option in essence gives her the option of either purchasing a million dollars for Rs 5 cr. or else allowing the option to expire. Logically, if the value of the million dollars falls below Rs 5 cr, she would allow the option to expire. But if the value of the million dollars goes up beyond Rs 5 cr, she would execute the option. For getting the benefit of this protection, which is popularly expressed as hedging in the financial terms, she would naturally have to pay a fee or price. Let's say this is Rs 5 lacs (This is just for the sake of illustration. The exact price of the option etc. is beyond the scope of this lesson). So by risking Rs 5 lacs, she gets the option of purchasing a million dollars either for Rs 5 cr. or less but certainly not more. And for this she would have to pay Rs 5 lacs. If the price of a million dollars were to drop to Rs 4.95 cr. then she would also recover her fee, (Rs 5 lacs) and if the price were to drop to Rs 4.9 cr., she would end up making a profit of Rs 5 lacs. (Her total cost would then be Rs 4.9 cr for a million dollar + Rs 5 lacs as the fee = Rs 4.95 cr. which is Rs 5 lacs less than the agreed price fixed a year ago.) Otherwise she would risk only Rs 5 lacs in the deal for which she would get a peace of mind by ensuring that the exchange rate for her does not change over the year. This is popularly known as covering the currency risk by way of hedging through the purchase of call options. Thanks & Regards, Anand Balaram Investrade, Kayamkulam-690502 Mob# 9388698999.

Underwriting

Understanding Underwriting Rakesh was aware that the students of the city were dying to see the Rock Band, “Spark” perform in Mumbai. So he approached his friend, Rohit, a seasoned businessman with the idea of hosting such an event. Rohit too felt that the idea was good and thought he could make a killing out of this. He decided to market the event. However, when he realized that the cost of marketing such an event was huge, he started getting cold feet. He started to think, “What if he did not get a full house? What if it started raining on the day of the event?” He knew that only a packed house would become “news” that would benefit his interests and would help his reputation. Sensing that indecisiveness was finding its way into Rohit's mind, Rakesh went on an overdrive to ensure that Rohit does not back out. Rakesh was convinced about the success of the idea. He was not besotted with the kind of apprehensions that bothered Rohit. So he walked up to Rohit and proposed that he would buy the unsold tickets, if there would be any. That assurance was good enough for Rohit to make his decision to go all out and invest the money in creating and marketing the event. This assurance of purchasing the unsold tickets is similar to what is popularly known as “Underwriting”. In underwriting, in this context, a company is trying to raise money from the market by issuing shares. The underwriter is the person who helps the promoter in marketing the issue so that it either gets oversubscribed or 100% subscribed. In case of a shortfall, the underwriter purchases the outstanding shares. Thanks & Regards, Anand Balaram Investrade, Kayamkulam-690502 Mob# 9388698999.

Options Pricing

Options are derivative contracts that give the holder the right, but not the obligation, to buy or sell the underlying instrument at a specified price on or before a specified future date. Although the holder (also called the buyer) of the option is not obligated to exercise the option, the option writer (known as the seller) has an obligation to buy or sell the underlying instrument if the option is exercised. Depending on the strategy, option trading can provide a variety of benefits including the security of limited risk and the advantage of leverage. Options can protect or enhance an investor's portfolio in rising, falling and neutral markets. Regardless of the reasons for trading options or the strategy employed, it is important to understand the factors that determine the value of an option. This tutorial will explore the factors that influence option pricing, as well as several popular option pricing models that are used to determine the theoretical value of options. The following is intended as a review of basic option terminology, which can be used as a reference as needed: American Options - An option that can be at any point during the life of the contract. Most exchange-traded options are American. At-the-Money - An option whose strike price is equal to the market price of the underlying security. Call - An option that gives the holder the right to buy the underlying security at a particular price for a specified, fixed period of time. Contract - An option that represents 100 shares of an underlying stock. Covered Call - An option strategy in which the writer of a call option holds a long position in the underlying security on a share-for-share basis. Covered Put - An option in which the writer of a put option holds a short position in the underlying security on a share-for-share basis. Covered Writer - An option seller who owns the option's underlying security as a hedge against the option. Derivative - An investment product that derives its value from an underlying asset. Options are derivatives. Early Exercise - The exercise of an option before its expiration date. Early exercise can occur with American-style options. European Options - An option that can only be exercised during a particular time period just before its expiration. Date - The date that an option becomes void. For listed stock options, it is the Saturday following the third Friday of the expiration month. Holder - An investor who purchases an option and who makes a premium payment to the writer. In-the-Money - An option that has an intrinsic value. A call option is considered in-the-money if the underlying security is higher than the strike price. LEAPS (Long-term Equity Anticipation Securities) - LEAPS are publicly traded options that have expiration dates longer than one year. Listed Option - A put or call option that is traded on an options exchange. The terms of the option, including strike price and expiration dates, are standardized by the exchange. Naked Option - An option position in which the writer of the option does not have an offsetting position in the underlying security, thereby having no protection against adverse prices moves. Open Interest - The total number of outstanding option contracts in the exchange market on a particular day. Option - A financial derivative that gives the holder the right, but not the obligation, to either buy or sell a fixed amount of a security or other financial asset at an agreed-upon price (the strike price) on or before a specified date. Out-of-the-Money - An option with no intrinsic value that would be worthless if it expired on that day. A call option is out-of-the-money when the strike price is higher than the market price of the underlying security. A put option is out-of-the-money when the strike price is lower than the market price of the underlying security. Over-the-Counter - An option that is not traded over an exchange. An over-the-counter option is not subjected to the standardization of terms such as strike prices and expiration dates. Premium - The total cost of the option. An option holder pays a premium to the option writer in exchange for the right, but not the obligation, to exercise the option. In general, the option's premium is its intrinsic value combined with its time value. Put - An option that gives the holder the right to sell the underlying security at a particular price for a specified, fixed period of time. Strike Price - The agreed-upon price at which an option can be exercised. The strike price for a call option is the price at which the security can be bought (prior to the expiration date); the strike price for a put option is the price at which the security can be sold (before the expiration date). The strike price is sometimes called the exercise price. Terms - The collective conditions of an options contract that denote the strike price, expiration date and the underlying security. Underlying Security - The security that is subject to being bought or sold upon the exercise of an option. Writer - An investor who sells an option and who collects the premium payment from the buyer. Writers are obligated to buy or sell if the holder chooses to exercise the option. The price, or cost, of an option is an amount of money known as the premium. The buyer pays this premium to the seller in exchange for the right granted by the option. For example, a buyer might pay a seller for the right to purchase 100 shares of stock XYZ at a strike price of $60 on or before December 22. If the position becomes profitable, the buyer will decide to exercise the option; if it does not become profitable, the buyer will let the option expire worthless. The buyer pays the premium so that he or she has the "option" or the choice to exercise or allow the option to expire worthless. Premiums are priced per share. For example, the premium on an IBM option with a strike price of $205 might be quoted as $5.50. Since equity option contracts are based on 100 stock shares, this particular contract would cost the buyer $5.50 X 100, or $550 dollars. The buyer pays the premium whether or not the option is exercised and the premium is non-refundable. The seller gets to keep the premium whether or not the option is exercised. An option premium is its cost - how much the particular option is worth to the buyer and seller. While supply and demand ultimately determine price, other factors while we discussed, do play a role. he two components of an option premium are the intrinsic value and the time value. The intrinsic value is the difference between the underlying's price and the strike price. Specifically, the intrinsic value for a call option is equal to the underlying price minus the strike price; for a put option, the intrinsic value is the strike price minus the underlying price Intrinsic Value (Call) = Underlying Price – Strike Price Intrinsic Value (Put) = Strike Price – Underlying Price By definition, the only options that have intrinsic value are those that are in-the-money. For calls, in-the-money refers to options where the exercise (or strike) price is less than the current underlying price. A put option is in-the-money if its strike price is greater than the current underlying price. In-the-Money (Call) = Strike Price < Underlying Price In-the-Money (Put) = Strike Price > Underlying Price Any premium that is in excess of the option's intrinsic value is referred to as time value. For example, assume a call option has a total premium of $9.00 (this means that the buyer pays, and the seller receives, $9.00 for each share of stock or $900 for the contract, which is equal to 100 shares). If the option has an intrinsic value of $7.00, its time value would be $2.00 ($9.00 - $7.00 = $2.00). Time Value = Premium – Intrinsic Value In general, the more time to expiration, the greater the time value of the option. It represents the amount of time that the option position has to become more profitable due to a favorable move in the underlying price. In general, investors are willing to pay a higher premium for more time (assuming the different options have the same exercise price), since time increases the likelihood that the position can become profitable. Time value decreases over time and decays to zero at expiration. This phenomenon is known as time decay. An option premium, therefore, is equal to its intrinsic value plus its time value. Option Premium = Intrinsic Value + Time Value

MARKET CAPITALIZATION

UNDERSTANDING MARKET CAPITALIZATION Let's say in a room there are 100 boxes, each priced at Rs 100. What would be the value of all the boxes? It would amount to Rs100 x 100 boxes = Rs 10,000 If we replace the “boxes” with “shares of a company”, then according to the above working, the cost of all the shares of the company would be Rs 10,000, which is nothing but the total value of outstanding shares or market capitalization of the company. However, this brings us to another term, “OUTSTANDING SHARES”. OUTSTANDING SHARES are shares currently held by investors, including restricted shares owned by the company's officers and insiders, as well as those held by the public. However, one should note that shares that have been repurchased by the company are not considered as a part of outstanding shares. Now, if the price of the boxes were to go up due an increase in demand, the total prices of the entire set of boxes would go up. Similarly, when the value of the shares goes up, so does the market capitalization. Now the question is why would the price of the share go up or come down? The price of a share would go up, if the demand for the goods of the company rises. It would also go up if people's expectation from the company goes up on the back of a new management, innovation, expected demand or some recognition won by the company. Companies whose total value of Market Capitalization is above x cr. are called “Large Cap” companies. Companies whose Market Capitalization is between y cr. and z cr are called “Mid-Cap” companies and companies whose market capitalization is below w cr. are called “Small Cap” companies. Large Cap companies are thus large and stable companies in relation to Mid Cap companies, which again are seen as more stable in comparison to Small Cap companies. So in terms of risk, the Large Cap companies are the least risky while the “Small Cap” companies are most risky. However, the probability of growth is more in the “Small Cap” companies followed by the Mid Cap companies and then by the Large Cap companies. Hence investors have to decide the balance between risk and return when making an educated and informed decision. The reason why Small Cap companies have a higher probability is because not only are they small but perhaps early into a business with larger growth opportunities into the future. As the companies grow (issue fresh capital and/or increase in share price) they become mid cap companies at some point in time and eventually large cap companies. The reason why Large Cap companies are less risky is because of their size, better brand value, better credit worthiness and better grip over the industry due to their experience.

IIP, the key tracker of industrial production

IIP, the key tracker of industrial production Just like the body temperature when measured, (in degrees Fahrenheit or degrees Centigrade) gives us an indication of the health of the person, in the same way, the IIP is the number denoting the condition of industrial production during a certain period. These figures are calculated in reference to the figures that existed in the past. Currently the base used for calculating IIP is 1993-1994. Importance of IIP IIP represents the state of health of the industry. If the IIP exhibits an increasing trend, it indicates that industrial production is steadily rising, thus indicating a healthy state of affairs for the economy. Under such conditions, one can expect a growth in the GDP. On the other hand, a decreasing trend of IIP indicates falling industrial production which becomes a cause for concern for economic growth. Today it is important because with the news of recession hovering over the horizon, better IIP figures would bring in hope and optimism among investors and the stock market with regards to the state of the economy. Its relation with stock markets The optimism amongst the stock markets and investors may translate into the markets going up. This is because the markets expect that company profits are set to rise and thereby leading to the growth in the country’s GDP. It could also lead to an improvement in the country’s economy, thus making it an attractive investment destination to foreign investors. Computation of IIP The first time IIP was used with the year 1937 as its reference point. It contained only 15 products. Since then, the criteria for the base year as well as the number of products have been revamped 7 times. Currently, IIP uses 1993-94 as the reference year. The products included are the ones used on consistent basis and can comprise of small scale sector as well as unorganized production sector. They are segregated into 3 parts: 1. Manufacturing 2. Mining 3. Electricity They are also classified on the basis of usage: 1. Capital goods 2. Basic goods 3. Non-basic goods 4. Consumer durables 5. Consumer non-durables The numbers for IIP are released within 6 weeks after the end of the month. This data is collated from 15 different agencies like The Department of Industrial Policy and Promotion, Indian Bureau of Mines, Central Statistical Organization and Central Electricity Authority. But at times, the entire data may not be easily available. Hence, some estimates are done to generate provisional data, which is then used to calculate provisional index. Once the actual data is available, this index is updated subsequently. Though IIP does indicate the condition of the country’s economy, it should not be taken as the sole basis for investment. This is because some sectors may show higher performance on the basis of underlying speculative practices. So one needs to ascertain the reasons behind an increase or decrease in IIP figures, before investing.

HOW TO SPOT A SCAM IN MARKET?

HOW TO SPOT A SCAM IN MARKET? Scams in the stock market are common today. Wondering how you can avoid being affected by them? You must understand the phenomenon and learn to recognize the telltale signs. Read on to know how! With activity in the stock market ever on the rise, scamsters are aware that every investor wants to subscribe to stocks from particular industries, such as software as part of their portfolio because these stocks yield higher returns. Here’s the architecture of a typical scam: Currently, more than 4500 companies are listed in the B2 category on the BSE. The B2 category is a subset of listed shares that have higher market capitalization and liquidity than the rest. Stocks of these companies are hardly traded as these companies are no longer in operation. Scamsters take over and change the entity of such a company to that of a software company. They hire people, install required equipment and claim to process software export orders. In reality, they do not have the requisite infrastructure or personnel to process export orders. Next, they set up a subsidiary abroad by hiring a representative to run operations or by renting a small place. They conduct export transactions using free ports, such as Hong Kong, Singapore, and Dubai. They pay cash in India and obtain dollars from the subsidiary. In the company books, these dollars are reflected as income from exports. The promoters then hire market operators to publish stories indicating huge orders or collaborations and predict excellent profits for the company. This is substantiated by the net profit figure boosted by the forged export income in the company’s books. The Earnings Per Share (EPS) for the company appears healthy and is priced low when compared to other companies, and the stock is deemed to be an excellent buy. A few market operators then start transactions on the stock and increase liquidity for the counter. Consequently, the trade volumes for the share rise. The share price increases 3 to 5 times in a short period of time. The promoters then start taking advantage of this buoyant situation and sell their stocks to investors. The price of the share goes down suddenly and the investors end up with dead stock. The promoters are able to obtain a good price for stocks of their company. Further, they get a tax rebate by converting hoarded cash into export income! So before investing in any stock, do check the company’s background carefully and performance of the stock at least for the past two quarters. It’s best to avoid investing in stocks that show too much fluctuation in prices...............

Difference between Profit and Loss statement and Cash Flow statement

Understanding the difference between P & L statement and Cash Flow statement Let us look at the following examples:- 1) A man trying to swim across a flooded river to grab a huge prize promised to him for doing the feat. 2) A person going hungry for 100 days to win a competition. 3) An employer promising his employee 24 times his monthly salary for a job. But the only catch being that the salary would be paid together at the end of the first year. 4) An organization spends a large sum of money in a brand campaign but does not have enough money left to pay the salaries of the employees. 5) A man buying the best car available but running out of money to buy fuel. 6) A person getting admitted into the best university but having money that would only fund half the course. In the all the above examples, we have seen that somewhere there dangles an appetizing proposition but the path that is drawn up to make it to the goal is fraught with danger. For example, the man who is crossing the river has little probability to survive till the other end. If he cannot make it, then what is the use of the grand prize? Similarly, the person going hungry for 100 days may not live to enjoy the fruits of his perseverance. The employer who promises double salary to the employee takes the thunder away when he places the condition before him that he'll get paid only at the end of the year. How would the employee survive the year without being paid? Likewise, buying a great car but having little left to maintain and run it becomes a futile and meaningless act and so also would be the case when a person goes to the best university only to realize that he does not have enough to fund the entire course. An incomplete course, quite obviously has little value. There is no logical concept like half a doctor or half an engineer or three fourths a lawyer. You are either a professional or you are not. The above examples have been explained to help one understand the difference between the Profit and Loss Statement and Cash Flow statement. While the profit and loss statement gives an indication of the operational efficiency of a business, it does not entirely reflect the cash flow of the business. For example, if you are a sculpture and you invest 10K in materials to sculpt statues. You then sell those to a client for 20K, and make a profit of 10 K. In the P/L statement, you would record this 10 K profit even though you haven't received the money. Now the client may take up to an “X” number of days to pay you. This is one of the main differences between a P/L statement and Cash Flow statement. The P/L statement uses accrual accounting. This is when all revenues are recorded when earned, and expenses when incurred. Now, in your sculpting business, the company may get a huge order and spend a lot of money in supplying the goods on credit, and this as a result would leave the company with inadequate amount of money for salaries. So even if the business opportunity is large, organizations should know how to manage their money. They have to understand that paying employees on time and maintenance of machines need to be given priority over simply chasing orders. This is why the cash flow statement is a reflection of a company's health, whether it is able to pay bills on time and its ability to finance growth. Simply looking at the P/L statement may not give the kind of insights, However, a P/L statement shows a thorough account of revenues and expenses and is helpful for a person to gauge the earnings per share and whether to invest in a company or not. In the end, it is important to look at both of these statements together to get a better understanding of how the business is doing as a whole. Each statement gives vital information, and they work hand in hand. If the net income is low on the P/L statement, then invariably there is a weak cash flow and one will be able to see where the cash is being spent on the cash flow statement. Looking at these statements separately and drawing conclusions will only leave you will half the piece of the pie and leave you in situations like the ones mentioned above.