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Name: Deepak ShenoyLocation: Bangalore, India

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Thursday, December 28, 2006

LinkFest #5 - Myths, advice, caution and all...

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Let your money work for you (Equitymaster)

 The three D's of investment - Diversification, Dollar Cost averaging and Discipline

are touted in this equitymaster article. I beg to differ on a few things: Don't use

"Dollar cost averaging" - Rupees are more likely all that is available to you. Cost

averaging is part of Systematic investments - but average with the right

investments, not dumb ones. Diversify, but not to the extent that your returns

are bad because of diversification - buy good companies or mutual funds. Don't

buy twenty diversified funds! That's way too much diversification for you, plus it

doesn't work really. And disciplined investing - that's very much recommended.

5 common investment myths (Personalfn)

A good article about what people tend to believe and the ground reality. That Rs.

10 is not a better buy than a Rs. 100 fund (I agree), long term is not necessarily

good, investments and risk taking abilities are individually unique, SIPs are not

necessarily good (I agree), and that you can actually diversify too much.

Unshining India, (Dhirendra Kumar, Value Research Online)

A very interesting take on how people are going berserk just led by the "India

shining" story. Everyone and his aunty is buying property because they feel that

the economy cannot go down. Led by the lucre of a booming economy, investors

are putting money down based on future calculations of income, earnings, GDPgrowth, whatever - and additional fuel comes from TV channels, fund managers,

investment advisors and the like. My thumb rule for you is: When people tell you

"if you don't invest now, it'll be too late", that's the time to stop and play some

gully cricket. But read this article - I wish Kumar had expanded a little more, and

pushed his point through rather than sitting on the fence.

MF vs. Sensex, Sensex wins? (Economic Times)

 Turns out mutual funds have underperformed the equity indexes this year. This is

the case with the US over the last few years too. Is India now becoming a mature

market?

Earlier Linkfests: 1, 2, 3, 4 

Labels: Advice, LinkFest, MutualFunds

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Deepak Shenoy 11:18 AM | 0 comments | 

Mutual Fund Identification Number (MIN) now mandatory

AMFI has notified all mutual fund investors that as per enhanced KYC (Know

 Your Customer) norms, a new unique identification number will be issued to

mutual fund investors. This number is called the Mutual fund Identification

Number (MIN).

From January 1 2007, any investment in a mutual fund worth over Rs. 50,000 will

need MIN information of the investors.

Does this apply to me?

If you are a mutual fund investor in Indian Mutual Funds, or will be at some time

in the future, Yes. Currently it is only mandatory for investors that investAct now,

because later when you really want to invest, the lack of a MIN will prove to be a

pain.

 This also applies if you are a company or a non-individual investor (like an HUF).

How do I get this MIN thing?

1. Download the MIN application form, print it out and fill it up.

2. Second, get the following documents ready:

o A passport size photograph.

o An identity proof (PAN card, Passport, Voter ID card etc.)

(Exhaustive list provided in the application form) 

o A copy of your PAN card

o An address proof (Telephone bill, passport, etc)(Exhaustive list 

 provided in the application form) 

3. Paste the photograph on the form and sign across it.

4. Take a copy of all documents above, including the filled up form.

5. Go to an Investor Service Center and submit all these documents with the

originals. Take back the originals and your copy of the filled up form, duly

acknowledged.

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6. You should get a MIN over the counter.

7. The documents will later be scrutinised and if anything is missing your MIN

will be rejected, and you'll get a letter saying so. If a MIN is rejected, any

investment made with that MIN will be cancelled and the money refunded

to you.

8. If everything is ok, you will have a permanent MIN for all future

investments.

Note that if you don't want to give the originals for over-the-counter verification,

you can produce a certified true copy. Get a copy notarised by a registered

notary, a commercial bank manager or a gazetted officer and submit that.

How much does it cost?

Nothing. It's free for now. They might decide to charge later, so it's in your

interest to get your MIN immediately.

Do I have to do this again and again for every single fund?

No. MIN is a single identification number that works with all mutual funds as per

AMFI.

Do Existing investors need to do something? Nothing if you don't plan to

invest more than Rs. 50,000 in a fund after Jan 1, 2007. If you have an SIP that

invests more than Rs. 50K per installment, you'll need a MIN. I suggest you get a

MIN anyway.

Why do I have to do this?

When I was a kid, my parents used to tell me "Don't ask questions, just do it!".

But today it's important to address the question of "Why?". The Government of 

India is very worried about the fact that money laundering is becoming more and

more prevalent. Converting "black" to "white" money without paying any tax is

what many people want to do, but that is cheating the government.

What they want to do is to stop all avenues for this purpose. People have been

using cunning strategies like investing in other people's names, or using fake

names and addresses to avoid the tax man. In order to curb this, the goverment

expects all financial bodies to "know their customers" - meaning, they should

have a photo identification, address proof etc.

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But this is also an inconvenience to an honest tax paying investor. So, given that

frauds happen with large amounts (typically much higher than Rs. 50,000) they

have decided to limit the MIN requirements to only investments above Rs.

50,000. Unfortunately, people are even more cunning and I am sure they will try

to invest Rs. 49,000 instead, to avoid the MIN measures - so I am definite that

the requirement will soon apply to all investors. It is in your interest to get a MIN

fast, and while it is free.

What about Non Resident Indians (NRIs)?

NRIs and Persons of Indian Origin (PIOs) can invest in Indian Mutual Funds. They

also need a MIN. Now, how can you expect NRIs to submit original documents?

And submit forms themselves?

Firstly, original documents are not needed. Get document copies signed by a

notary in your country, including address proof in the country you are in. You'll

need the notary to sign and provide his seal on the document - only registered

notaries will do.

 To submit documents, have distributors in India submit on your behalf. Send the

notarized copies PLUS the filled up form to your distributor and ask them to

submit on your behalf. You don't need to give a power of attorney or any letter

for submission of documents - that can be done by anyone. Ask them to scan a

copy of the MIN document you have received and mail it to you, apart from

sending it back by post. If you need such support, let me know; I can find

someone who'll do this for you.

PIOs must provide a notarized copy of their PIO card as well. Remember to get

back a copy of the acknowledged, filled up MIN form, because you will need to

provide that along with your application for future investment in Indian mutual

funds.

Okay, I'm still confused. What to do?

Read the FAQ, and if you're still confused about something, leave me a comment.

Resources

Frequently Asked Questions (AMFI)

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MIN Application Form (Individual, Non-Individual) (AMFI)

List of Investor Service Centers 

Labels: Commentary, Compliance, MIN, MutualFunds

Deepak Shenoy 9:54 AM | 4 comments |

Monday, December 25, 2006

Futures and Options: An introduction

Futures and Options (F&O) is a famous phrase used by TV channels, web sites

and in conversation nowadays but many of you many not familiar with the

concept. Let me try and explain, in very simple terms.

Firstly, let me confirm what you already know: That you can buy and sell stocks

on an exchange, and prices of stocks vary every day, and perhaps every minute.

 You buy a stock hoping for future appreciation, and sell when you want to exit or

book profits.

 This is called the "cash" or the "spot" market - that means, when you say "I will

buy 100 shares of company X at Rs. 152" on a stock exchange, someone can sell

it to you and you will get the shares "on the spot". (Technically, you'll get

delivery after two days but that is really an administrative lag) You also pay

money "on the spot" - that is, you will need to immediately pay the Rs. 15,200 in

the example above.

Futures

Now, let me talk about the futures markets. A future is a derivative contract in

which two parties agree to buy or sell something to each other on a particular 

 price at a FUTURE date.

 That means delivery is not immediate, it is at a much later date. And payment is

also not immediate, it is at a later date. This kind of contract is also called a

"forward contract".

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Why do people do this? And how is this different from buying today?

No delivery right now

Futures are for different kinds of requirements. For instance you may not have

the money right now to buy, but you believe the price will go up. You just buy aforward contract for a later date, and on that date you buy and IMMEDIATELY

sell, so that you will simply pocket the difference (or lose the difference if the

stock has lost money).

Short Selling

Secondly, futures can be used to "short sell". If you want to sell something you

should own it first, no? But futures are different - since they are for a later date,

you can sell something without owning it, and then buy it later! So if you believe

the price of an item is going down, you can SELL a forward contract. Since you

don't have to deliver it right now, the buyer does not care if you already have it

or not. On the later date, just buy from the market and give it to the buyer,

pocketing (or losing) the difference.

Hedging

Futures are also for "hedging". Let's say you are a rice farmer and have 1000

kilos of rice growing in your farm. You can harvest it only three months later but

right now the price is very good, nearly Rs. 20 per kilo. But you know that this

year, the rains have been kind, so every rice farmer is going to get a good crop.

So there will be too much rice in the market, and prices will come down, even as

low as Rs. 12 per kilo! What can you do?

 You can't sell the rice right now, because then the buyer will say "show me the

rice" and you can't show him because you can't harvest it until three more

months. But if you don't sell right now you will lose Rs.8 per kg!

What you can do is SELL a futures contract for 1000 kilos at today's price for

three months later, Rs. 20 per kilo. Then three months later when you harvest if 

the price has gone down to Rs. 12 per kilo, you sell it in the market for Rs. 12 per

kilo and make Rs. 12,000. Then you also have to sell 1000 kilos in your forward

contract at Rs. 20, but for that you simply buy from the market at Rs. 12 and give

it to the buyer at Rs. 20, making the extra Rs.8 per kilo, totally Rs.8000. Meaning

you have made Rs. 20,000 for your 1000 kilos!

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 You may be thinking: Why doesn't he simply give the 1000 kilos from his farm to

the buyer? Well, the buyer may be in Brazil! Market traders for commodities like

Rice can be anywhere in the world, therefore when you enter into a futures

contract on an exchange, you need not terminate it with delivery. (in India, in

most cases, you can't even if you want to). You buy and sell on the very same

exchange on the "SPOT" price on the date of delivery. Meaning, if you SOLD a

futures contract, then on the future date the exchange will assume that you will

buy at market price (spot price) and give you the difference between your future

contract price (selling price) and the spot price (buying price).

The Underlying

In the example above, what was bought/sold in the future was "RICE". This is the

"underlying" commodity being traded in the futures contract. Rice is also traded

in the "spot" market - which can be your local kirana store, or a wholesale APMC

yard or a commodity exchange (meaning, you pay and you get your goods right

now). The "underlying" can be anything - a commodity like rice, a set of company

shares, an index value, foreign currency etc.

Exchanges

Okay what if I tell you that I will buy rice at Rs.20 and the price falls to Rs. 12? I

can then run away and hide in a corner, and break my promise, because I stand

to lose Rs. 8. This is where exchanges come in.

Exchanges ensure that your contract is executed. They "assure" your contract.

So if I run away, the exchange will still make sure you get your profits. They will

chase me for the losses. (In fact a futures contract must be traded on the

exchange. If it's not, then it's just a "forward" contract)

Contract Values and Margin In order to make sure that I don't run away from

them, exchanges ask for a "margin" - a certain portion of the contract value as a

"deposit" until the contracted date. In India this is between 12 to 50% of thecontract value for shares; so if you buy a future for buying 100 Infosys shares at

Rs. 2200, the contract value is Rs. 220,000. The margin can be 20% (dictated by

your broker or the exchange) so the margin will be Rs. 44,000. You are required

to pay the margin on the day you buy or sell the futures contract. On the

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contracted date (in the future), you will get back your margin plus your profit (or

minus your loss).

Mark to market

Let us assume I bought a forward contract (100 shares of INFY at current futureprice of Rs. 2200 per share, on January 27, 2007) paying a margin of Rs. 44,000.

Now suddenly if there is a crash and the price of INFY in the spot market dipped

to Rs. 1700? Essentially I have lost Rs. 500 per share - which, for 100 shares, is

Rs. 50,000! This is greater than my margin of Rs. 44,000 so the broker or

exchange may still think I can run away and they will be left to cover the loss. So

they can make a "Marked to market" margin call, meaning that they will ask me

to provide the extra Rs. 6,000 as an additional margin (and maybe another

20,000 to cover a FURTHER fall in prices, that they can do).

Usually mark-to-market means the difference between the spot price and the

agreed future price - this can be positive ("Mark-to-market profit") or negative

("MTM Loss"). Futures are actively traded in the market, and the price of the

future is not decided by you - so once you have bought the future, you can SELL

the contract to someone else. Let's say the the contract I bought at Rs. 2,200 is

now trading at Rs. 2,300 instead. I can sell the contract itself, and I make the Rs.

100 as profit per share - for 100 shares, it's a Rs. 10,000 profit. The exchange will

also give me my margin back, and take a margin from the new owner of thecontract.

Square off 

On the agreed date of the contract, the exchange will "square off" all contracts.

Meaning, all buyers and sellers will be paid back their margin including any

marked to market profits or minus any losses as of that date. To avoid arbitrary

dates, stock exchanges in India have only three open (purchaseable) future

contract dates - the last thursday of the current month, the last thursday of next

month and the last thursday of the month after that. These are called near

month, month+1, month+2. The square off happens at the end of that Thursday.

Options

Futures are pre-agreed contracts and the buyer MUST sell and the seller MUST

purchase. They have no choice in the matter at all, once they sign the contract

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the contract has to be marked to market every day, they have to pay the margin

and they have to square off. That means both the buyer and the seller has an

OBLIGATION to square off the deal.

Now futures dealers are also quite smart - they want to make profits but theywant to reduce their losses. So there is a concept of "options" - a kind of 

derivative contract which is slightly different.

 The buyer of an Option has the RIGHT, but not the obligation to exercise the

contract. What does this mean? Let's say I think the Infosys share will go up next

month, but I am not sure.

Instead of buying a future, I can buy a "CALL" option, which is a "right to buy" at

a later date. If on that date the contract is favourable to me (meaning the spot

price of INFY is higher) I will purchase it and square off, resulting in a profit to

me.

If the spot price is lower than my call option price, I will "ditch" the contract, and

not exercise it...meaning I have no losses.

But then the person selling it to me must be really stupid. Because if the price is

higher, he has the OBLIGATION to sell it to me and make a loss, but if the price is

lower I don't exercise the option and he does not make a profit. So why would he

do it? He charges me a "premium" which is the amount I pay to buy the option. It

may be very cheap; about Rs. 20 per share, but that is the money for his trouble

that he gets to keep in case I decide not to exercise the option. If I decide to

exercise, he still keeps the margin, but pays the mark-to-market loss.

Calls and puts

 The right to BUY an underlying stock at a certain price is known as a call option.

 The right to SELL an underlying stock at a certain prices is a PUT option.

It is quite confusing. You can buy a call option, and you can buy a put option. You

have to associate the phrase "call" with "right to buy" and "put" with "right to

sell". (If you are really confused, repeat this mantra 108 times:

CALL is the right to purchase

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PUT is the right to sell

)

Strike price 

Now futures are traded like shares - so the price of the future is readily availablein the market, and goes up and down every day. But an option is slightly

different, because it is a right and not an obligation. You buy a future in the

futures market, based on who is willing to pay how much for a future.

But an option is always at a pre-agreed price. In stock exchanges for stocks and

indices, the exchange allows different strike prices, usually Rs. 10 between each

other, and a new list of tradeable strike prices is released everyday. These will

usually be a few priecs above the current market price, and a few prices below.

Example: If Infosys is trading at Rs. 2172 today, the exchange may allow strike

prices of Rs. 2150, 2160, 2170, 2180, 2190 and 2200. If the price goes up to

2200 the exchange may open up NEW strike prices of 2210, 2220 and 2230 (the

other ones are still available of course).

Writers

If you buy a CALL option then you buy the right to purchase something. But who

sells it to you? This other person does not have the RIGHT to sell it to you, she

has the OBLIGATION of selling it to you if you want it. This person is called a

writer. You can buy an option, but you can also WRITE an option (meaning you

are now obligated to sell it).

If you write an option you will receive the premium that the buyer will pay.

(Minus any brokerage and taxes).

Writers have a problem: They have limited profits (the margin they receive, when

the strike price is not profitable for the buyer) but unlimited risk of loss when the

strike price is profitable. That means for a call option, if the spot price is below

the strike price, the buyer will not exercise the option, therefore you only get the

premium. If the spot price is above, buyer will exercise and you pay the

difference (but keep the margin).

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Let's say you buy a CALL option of 100 INFY shares from me (Rs. 2200 strike

price, Jan 07, Rs.20 premium per share). You pay me Rs. 2000 (Rs. 20 x 100

shares) as premium. If the price goes to Rs. 2,300 you will exercise the option

and I will have to pay the Rs. 100 difference per share, totally Rs. 10,000. My loss

is Rs. 8,000 because I got the 2,000 premium.

If the price goes down to Rs. 2,100, you will not exercise the option, and I will get

only Rs. 2,000, which was the premium.

Why do I write options? Because most options go unexercised! Meaning, I can

write an option today and it is quite likely that the market price will not be within

the premium so I won't have to lose money! And after all, I can write a CALL

option and BUY a future at the same time, ensuring that I make profits in the

difference. (This is also hedging)

In the money, out of the money

If a call option strike price is below the spot price, it is "in the money". Meaning, if 

INFY price is Rs. 2200 and I have bought a call option for Rs. 2100, I am making

profits, so the option is "in the money".

 The reverse is "out of the money" or "OTM". Meaning, if I buy a call option for a

strike price of 2100 but the current price is Rs. 2000, then I am not making

profits right now, so the option is OTM. Writers usually like to make OTM

contracts so that they are not immediately exposed to loss. (In the money

options usually trade for a big premium, so big that when you consider the

premium, you are making losses!)

Conclusion

 This has been a long post and I am also tired, so I will stop here. Please post your

questions and I will try and sort out any other things I may not have mentioned,

or that are not very clear. Thanks for reading!

Labels: Futures, Options

Deepak Shenoy 6:14 PM | 6 comments | 

Thursday, December 21, 2006

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PAN number is now mandatory

SEBI has posted a circular (MRD/DoP/Dep/SE/Cir-13/06, Sep 26 2006) that

makes a PAN card mandatory, from Jan 1, 2007, for all customers who buy or sell

stocks in Indian Stock Exchange. In addition, the PAN card must be verified by

the brokers visually - so they need to see the original PAN card, and you need to

provide them with a copy.

Now even if you don't trade regularly it is necessary for you to go to your

broker's office and provide them with a copy of your PAN card. This applies to

online trading accounts as well.

Failing to do so means you will not be allowed to trade, and your account may be

frozen post Jan 1, 2007. Please do this promptly and enjoy the holidays!

Labels: Commentary, Compliance

Deepak Shenoy 2:32 PM | 3 comments | 

Wednesday, December 20, 2006

Fundas: Long Term Capital Gains

Long term capital gains (LTCG) applies when you profit from a "capital asset",

in this context meaning something that involves a long term investment, sold

after a long period of time. For stocks and mutual funds, the minimum period

between purchase and sale is 1 year. For property or most other asset types it is

three years. (If you buy and sell within this period, SHORT term capital gains

applies, that's a different concept.)

 The government had decided that it will reward you for making long term

investments, so tax on long term gains is generally lower than the regular tax.

Currently long term capital gains tax is 20% or 10% or even 0%, the difference

between the three is explained below.

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Capital gains is the PROFIT obtained when you buy today and sell a while later.

 Therefore LTCG is the difference between the selling price and the buying price.

But you could have bought something for Rs. 10,000 in 1980 and sold today for

rs. 100,000 - have you made a profit? Not really, because Rs. 10,000 in 1980 was

a big amount of money! Inflation has reduced your profit, and in this case you

may have actually made a loss!

So the tax department allows you to "index" your purchase according to

inflation. They release a Cost Inflation Index (CII) table every year containing

an "index" value for each year - 1980 being 100, 1981 being 109, 1990 being

182 and so on. (See: http://incometaxindia.gov.in/ItInformation/CostInflation.asp)

 This means something bought in 1980 for Rs. 10,000 and sold in 1990 for Rs.

20,000 does not mean Rs. 10,000 profit! The CII for 1990 (year of sale) is 182,

and CII for year of purchase is 1980. So real cost of purchase is Rs. 18200,

arrived at like this:

Rs. 10,000 x (182 divided by 100) 

 The real profit therefore is Rs. 1,800, and tax = 20% of that, = Rs. 360.

 This concept is called "Indexation" meaning you are accounting for inflation of 

your purchase value.

So if you index your purchase, government charges you 20% LTCG tax.

But what if you bought in 2003 and sold today? The CII for 2003 is 447 and this

year is 519. So if you bought for Rs. 10,000 in 2003 and sold today for Rs. 20,000

what is your "indexed" purchase value?

Indexed purchase value = Rs. 10,000 x (519 / 447) = Rs. 11,610

So you have still made a profit of approximately Rs. 8,400 and 20% of that is

payable as tax = Rs. 1,680. But there is an alternative:

 The government allows you on extra benefit: If you don't want to index your

purchase, you can pay only 10% of a non indexed purchase - in this case it

means you will use a purchase price of Rs. 10,000 only. So your non indexed

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profit is Rs. 10,000 and therefore LTCG tax @ 10% is Rs. 1,000 - this is a lot

lesser than the indexed gain!

Finally, if you invest in stocks or equity mutual funds, the government deducts a

"securities transaction tax" (STT) from your transaction (about 0.25% of theentire transaction value). If you pay STT, LTCG tax is ZERO.

SO in short:

Indexed profit: 20% LTCG Tax

Non indexed profit: 10% LTCG Tax

Stocks and Equity funds where you pay STT: 0% LTCG Tax.

(Note: Why I say "where you pay STT" is - if you do not sell in an exchange orsurrender stocks in a buy back offer or surrender stocks in an ADR offer like in

Infosys recently , no STT will be paid, and therefore the 20% or 10% taxes will

apply)

Also read: http://theinvestorblog.blogspot.com/2005/11/capital-gains-tax-

primer.html 

Labels: CapitalGains, IncomeTax

Deepak Shenoy 9:52 AM | 1 comments |

Tuesday, December 19, 2006

SIPs are not necessarily less risky, or better for the long

term

Systematic Investment Plans or SIPs are now touted around by mutual fundsand advisors as the best way to invest in a volatile market, and that small

investors must use that approach to enter the market. I don't particularly deny

that statement, but I feel that SIPs need a lot more history to prove themselves

in India.

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Read this personalfn article for an overview of why SIPs are recommended for

investors. Very good points, mind you. But let me try and see if the results show

the same as the theory.

India has very little historical data - since most mutual funds have existed onlysince 92-93. The U.S. has a far longer and perhaps richer history, so I have

chosen to look up SIPs in the U.S. market, and the SIP concept there is called

"Dollar Cost Averaging" (DCA).

Read this research paper on the subject that talks about DCA and how it

compares with three other strategies: Lumpsum investing (putting money

upfront), Buy and Hold (half in equities and half in t-bills) and Value Averaging.

 The results, taken from data from 1970-1999, and also from 1950-1999 yields

interesting results. The DCA strategy performs worse than Lumpsums for both

large caps and small caps. Also, for small cap stocks, it does worse that all other

strategies!

Secondly, look at the "standard deviation", meaning the variation on either side

from the average. This is an indicator of risk, since your returns may be higher or

lower than the average by a big margin (high risk) or very less (smaller risk). The

SD for Lumpsum investing is the highest, obviously, because you are investing in

a high risk avenue (stocks) with upfront money. But DCA has a higher standard

deviation than value averaging or buy and hold too - which means, it has higher

risk than them - this, additionally, indicates that for a lower long term return, you

are taking on a higher risk.

And lastly, the paper states that SIPs are not necessarily less risky. But they may

also not appeal to the "behaviour" of the investor, which is why most SIPs are

advised. Meaning, most advisors feel that you should not attempt to time the

market and go for an SIP regardless of ups and downs, so that you don't feel

really bad if the market goes down since this strategy averages the cost of 

purchase during lows.

But if you look at the returns and the risk you are taking, you may find lower

returns for higher risk using this strategy, which obviously does not help your

mood!

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 There are disadvantages of SIPs that very few people talk about. You need to

provide either cheques or an ECS mandate upfront to transfer a fixed amount per

month to the fund, on a fixed date. Most investors will invest in multiple funds, on

a fixed set of dates (many mutual funds only offer certain dates - 5th, 15th, 25th

etc. - for SIP investments)

 The first disadvantage is that you can't easily stop one intermediate payment. I

usually tend to take holidays that are not inexpensive. So I may need money one

month to spend well, and I don't want to invest that month - stopping SIP

payments is a huge nightmare, especially if you have invested in many mutual

funds. Plus if you did stop one payment, you have to come back and restart all

your SIPs because the fund assumes you have stopped the strategy completely!

Secondly, the amount is fixed. So you can't choose to invest more when you feel

the market is undervalued, or less when you think it's overvalued. This, for an

active investor, is a problem. For instance, I have invested much more in June

2006 than in November, simply because I thought the market was better. I have

not yet invested much this month, but based on how it goes I might put in a lot

more money in the end of December. This is not available in an SIP scenario.

 Thirdly, the fixed dates don't give you much of an advantage. If you are an active

investor you may want to invest ON the last thursday of the month, because that

is the day futures are exercised and you can figure out how much you want to

invest based on the rollover. Nobody offers you that facility.

Finally, there is an issue with cash flow: I personally have committments that are

either sudden or annual. Like taxes, or holidays or emergencies. I need to have

the flexibility to address investments based on my cash flow, which is not very

predictable. SIPs take away that flexibility from me.

In conclusion, I think SIPs are a good investment for many (I will post about that

later) but if you are an active investor you might want to consider some of the

negatives before you plonk a ton of future cash flow into this investment.

Labels: MutualFunds, SIP

Deepak Shenoy 12:30 PM | 7 comments |

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Friday, December 15, 2006

LinkFest #4: Open Letter, Real Estate bubble, Money Today

Open letter to analysts from a harried investor (Author unknown)

A seriously hassled investor telling the TV analyst what he thinks of him. This is

quite applicable to India as well. Eventually I will provide a table of all the

recommendations by various analysts on a shared Google Spreadsheet. We will

then see the date of recommendation and the high/low prices after that -

perhaps we will be able to see if their "predictions" are anywhere close.

A new Insurance and Mutual Fund company: Bharti-AXA

A new entrant to the Indian financial world, Bharti-AXA will set up a mutual fund

AMC and an insurance company. This can result in two things: Fund manager

churn from an existing AMC if they try to grab one, and more NFOs. Let's see how

it goes.

SEBI suspends Reliance Broking arm for four months (Sify)

SEBI has uncovered some broker regulation violations by Reliance Stock and

Share Broking in 1999, when it was part of the RIL group. It has therefore

suspended it from trading for the next four months. This company is now owned

by the Anil Ambani group; and supposedly is not doing all that much business

anyhow.

Money Today: A new magazine

I picked this up at a newsstand recently and was quite surprised to see some

excellent articles. Read about their latest insurance calculator much on the lines

of my article. 

Is there a bubble in real estate? (IndiaEconomy.org)

A very interesting article and discussion around whether the spurt in real estate

prices in India constitutes a bubble. The parallels with Japan, America and

indeed, earlier Indian events are quite revealing. I've commented there too.

Earlier Linkfests: 1, 2, 3 

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Labels: LinkFest, MutualFunds, RealEstate

Deepak Shenoy 4:21 PM | 1 comments | 

Is a Rs. 10 mutual fund better than a Rs. 100 fund?

A number of people think that the unit price of a mutual fund matters when

they purchase; i.e. that a cheaper unit price is better. Why? They say that they

will get more units for the same money, and isn't that better?

"Number of units"

 The "Number of units" does not matter at all. It is all about gain percentages. The

best funds have gained some 750% in five years. What does that mean? That

means if you bought that fund at Rs. 10 in 2001 its NAV will now be Rs.75 .

If you bought it at Rs. 20, NAV will be Rs. 150.

 There are lots of such funds whose NAV is greater than 100 or 150 because they

have performed very well.

What's the NAV? The total NAV, or "Net Asset Value" is a simple concept - First you get the "Net

Assets", which is the sum total of all the assets minus any liabilities of the fund.

Meaning, add the current market value of all the shares, minus any open

redemption requests and any applicable charges (like Daily fund management

fee etc.) and you get the Net Assets. Divide the Net Assets figure by the total

number of outstanding units and you get the unit price (called the "NAV Unit

Price" or simply, the NAV).

Most web sites and newspapers call the unit price "NAV". It's actually the NAV

unit price, so the phrase is confusing. Let me not confuse you any further: I will

call the total assets as the "Net Assets" and unit price as the "NAV".

Now you might think, if you have a 10,000 rupees, is it better to buy 1,000 units

of one fund quoting at Rs. 10 NAV, or 100 or those quoting at hundred? Frankly

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it's dependent on how the fund performs. If the second fund grows at 20%, your

units are worth Rs. 12,000 at an NAV of Rs. 120. If the first one grows at 10%,

your units are worth Rs. 11,000 at Rs. 11 NAV. What is better? Obviously the

second one, but over here the NAVs are still Rs 11 vs. Rs. 120!

Lesser number of units is like small change

But what if you have a 1000 Rs. NAV? That's a problem, you think; if you want

2,500 rupees, you have to sell three units! That means you take out more than

you want, right? Also what if you have 1200 rupees to invest? You can only buy

one unit, right?

Wrong.

In Mutual funds you also get "fractional" units. So if you invest Rs. 1000 in HDFC

 Taxsaver, whose nav is Rs. 149.44, you will get 6.692 units. (Some funds even go

to fourth decimal)

 You can then sell fractional units also, like 1.212 units etc!

Growth is important, not unit price

What you care about is how much your money grows, not the number of units

you have. It is just as difficult for a Rs. 10 fund to move to Rs. 12, as it is for a Rs.

50 fund to move to Rs. 60.

Labels: Commentary, MutualFunds

Deepak Shenoy 10:32 AM | 4 comments | 

Tuesday, December 12, 2006

Markets have crashed, where do we go from here?

 The Sensex is now under 13,000, with the last three days accounting for a

1000 point drop. This is a 7% drop in three days; and with heavy volumes.

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Minor correction?

Markets usually take a breather every now and then. So this could be a minor

correction. If this is the case, the markets will move up as suddenly as they

dropped. But I do not think this is the case, simply because the immediate past

does not show such a trend. Fast drops are followed by slow rises. The big factor

here is that there is a lot of fear and doubt in the minds of people, and it is

reflected in sentiments expressed in TV channels, and the fact that mutual funds

have not been buying heavily (although they have collected tons of money).

Having said that, this may be an opportunity for them to buy. So we must get

mutual fund data over the next few days to see whether they have been buying

or selling, especially the "heavy cash" funds (which have lots of money but not all

of it is invested in the market)

India Inc. slowing down?

 The Central Statistical Organisation has reported that industrial growth in

October has only seen a 6.2% rise over Oct 2005. This is a matter of concern as

the growth is a lot lower than the 8-9% expected. However, the 30 November

2006 estimate still thinks India's GDP growth will be 8.9%, which is good enough.

Global cues

Other cues include the fact that the US Fed has decided to keep rates steady,

meaning they are not hiking or reducing rates. This is probably temporary, as the

recent rate hikes will most likely be compensated by a drop at some point.

 Japan is expected to announce an interest rate change on Friday, and that may

be significant as their phenomenally low interest has caused a lot of institutions

to borrow from Japan and invest in emerging markets like India. If the Japanese

interest rates rise, there will be another drop in India - this will largely be

"perception" that FIIs will pull out. But they won't, because countries like India

are the only places they will get a significantly higher return than average,therefore if anything MORE money will come in.

What should you do? For the confused investor: Hold your horses. A few days

here and there will not make a difference to you. Let this week by, and if the

market has recovered to 13,500 Sensex levels by next week, continue your

normal investment strategy.

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For a value investor: Some stocks especially midcaps are quoting at extremely

low levels. Go ahead and buy them.

For a mutual fund investor: Usually crashes are accompanied by huge

redemptions. Hold for a week, and then think of purchasing new funds.

Regardless of the above, if the crash takes the sensex below 12,000, sell.

Labels: Advice, Commentary, Crash

Deepak Shenoy 10:21 PM | 2 comments |

Friday, December 08, 2006

Tax saving schemes: Wait till March 2007

 The finance ministry is considered changing the tax benefits given to many

tax saving schemes (Check: Personalfn,Economic Times and My Blog)

Next year's budget may remove some of the tax exemptions provided under 80C

and reduce the personal tax rate. Moreover, some of the exemptions provided

may continue, but may be taxed on exit. So if you put in Rs. 100,000 today into atax saving fund, you will save Rs. 30,600 (highest bracket) tax; but if the ministry

has its way, the entire corpus will be fully taxed when you use this money,

usually unlocked three years later.

But this deal may still be worth the effort, versus "ditching" tax saving schemes

completely. Here's the logic:

Assumption 1: You have 1 lakh to invest in some tax saving investment.

Assumption 2: In three years, your money grows by 70%.Assumption 3: FM declares that 80C investments are fully taxable on exit, and

tax rate is down to 25%. No change to Long Term Capital gains etc.

Scenario 1: You invest the 1 lakh in tax saving funds today.

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 Tax today: nil.

Net value after three years: Rs. 170,000 (70% in three years)

 Tax if you exit: Rs. 42,500 (at 25%)

Real value to you : Rs. 127,500.

Scenario 2: You pay your tax today, and invest in a diversified fund instead.

 Tax today: Rs. 30,600 (at 30.6%)

Net value today: Rs. 68,400.

Net value after three years: Rs. 116,280

 Tax if you exit: Nil (no long term capital gains)

Real value to you: Rs. 116,280.

So there is a value is investing, providing the tax rate comes down to 25%.

What if tax rate stays at 30.6%, and the FM still taxes investments on exit?

Net values after three years: 

Scenario 1: Rs. 117,980

Scenario 2: Rs. 116,280 (stays the same)

 The difference is only Rs. 1,600! And for that difference you have to stay

invested for three years, and lock in your money. It's better then to stay away.And as seen lately, diversified funds seem to do a better job of managing money

than tax saving funds, so you might just make this difference by higher returns.

No lock in, same returns, a much better deal in general.

 The budget is usually revealed in the last week of February. You have time till

March 2007 to make your 80C investments. You may have to consider the

budget proposals carefully; Calculate whether it makes sense, and only if there is

a substantial saving, go on.

Labels: Commentary, IncomeTax, MutualFunds

Deepak Shenoy 10:15 AM | 5 comments | 

Thursday, December 07, 2006

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LinkFest #3:Gold, and Mutual funds

India has 0.4% of the Worlds mutual fund assets (Economic Times) With about

3.41 lakh crore in assets, India's just about 0.4% of the world's assets. Less than

2% of our GDP is available in funds, so the opportunity to grow is tremendous! In

fact, just last month, 30,000 crore was invested in mutual funds.

Buy Gold? (Value Research) What's the fuss about gold, and how to invest in it.

Interestingly the author also talks about how he might earn more money if he

talked more about gold investments rather than mutual funds.

 Top 10 Mutual Funds (Outlook Money)

Outlook Money researches and lists the top 10 funds bases on "RaR" - Risk

Adjusted Return. Some very good funds figure here.

Earlier LinkFests: 1, 2

Labels: Gold, LinkFest, MutualFunds

Deepak Shenoy 6:46 PM | 0 comments | 

Closed ended funds: Why they are popular suddenly, and

why they are not really closed ended.

A lot of new fund offers are appearing as "Closed Ended" because of a

notification that SEBI has introduced, saying that open ended equity funds must

not charge "initial expenses" over the first five years, but offset them with entry

loads. (Read "Mutual Funds NFOs have hidden costs")

NFO expenses

What does this initial charge mean? You see all these ads on TV and on billboards

asking you to buy NFOs - these are all paid for by what is called "initial marketing

expenses". Earlier upto 6% of the funds collected could be allocated to such

expenses, but then fund asset management companies (AMCs) started appearing

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with hundreds of new issues, just to get distributors more commissions. (which

are much higher than the 2.25% they get on their existing funds)

SEBI has therefore acted like a good regulator and disallowed open ended funds

from charging NFO marketing charges beyond the entry load. But if AMCs do this,and charge 6% entry load, no one will buy! If they decide to take it up as their

own expense, they lose money. So what to do?

 The best way out, for AMCs, was to use closed ended funds instead. Closed

ended funds, going by the name, are funds that, once subscribed, are closed for

fresh investments and for exits. (These kind of funds are special to India perhaps

- all U.S. funds are open ended) So it's a "closed" fund. SEBI decreed that such

funds could charge initial charges and amortise them over the period of the fund,

meaning that you as the investor pay for those ads over the three-year period of 

a three year closed ended fund.

The cost of an early exit

 The phrase Closed Ended is misleading. What if you invest a huge amount of 

money and want it back desperately? Most closed ended funds allow you to exit

prematurely, somtimes at fixed days of the year like first five days of a calendar

quarter etc., but that exit usually comes with an exit load.

Also, SEBI has said that apart from the exit load, if you exit early, you should pay

the remaining amortised charges on the fund. Let me demonstrate with an

example.

Let's say you put in Rs. 100,000 in a 3 year closed ended NFO, which collects Rs.

100 crores. They charge 6% = 6 crores as marketing expenses. You have

therefore got 0.01% of the fund and therefore your share of the marketing

expense is Rs. 6,000. This is amortized for three years, meaning 2,000 per year.

 This is adjusted, daily, in the NAV so you don't have to physically pay anyone, it

is automatically reflected in the "repurchase price".

After one year, you decide to sell. Now let's say they are very nice and charge

you zero load on exit. Because you were in there for a year, you have paid Rs.

2,000 of the amortised charges. But Rs. 4,000 is remaining! So when you sell,

they will remove Rs. 4,000 and give you the rest back. That 4,000 is 4% of your

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investment! So if the fund had gone up 10%, it has now resulted in only 6% gain

for you. (Note that you can get that if you put the money in a bank deposit)

Not really closed ended

So you can exit early if you want, just that you pay a charge. Which means thesefunds are not really closed ended. What they are really, are Closed Entry.

After the NFO, for the closed period, no fresh investments are allowed in the

fund.

Is "closed entry" bad for me?

What does this mean for you? Every time the market tanks or drops a lot,

investors will try to take out their money, no matter what the exit load. In open

ended funds that is usually balanced by some people trying to BUY the fund,

because they feel it will go back up. This means that some redemptions can be

met with the money coming in, so the fund manager need not sell the

investments.

But in closed ended funds there is no fresh entry, so the fund manager has to

sell. And therefore, when the markets recover, these funds underperform

because they were not able to buy or hold when the market was low!

 You will see this happening with all these funds, unfortunately, and I will show

you the results after a year from today. I know there will be at least one

correction before then (it has to happen) and that will put pressure on these

funds.

Wait and Watch

I do not recommend these NFOs at all. But I think you may be able to get a good

deal when they finish their closed ended period and become open ended instead.

Let's see.

Labels: Commentary, MutualFunds

Deepak Shenoy 6:12 PM | 3 comments | 

Tuesday, December 05, 2006

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SBI One India Fund (NFO): Should you invest?

SBI MF has an new fund offer (NFO) called : SBI One India Fund.[Offer

Document]

Issue Price: Rs. 10

Minimum: Rs. 5,000 per investor.

SIP option: Not available

Entry Load: Nil at NFO, 2.25% after three years.

Exit Load: Nil. (Amortised initial expenses will be charged)

Initial expenses: 5% expected (upto 6% allowed)

 The idea is that they "focus on all four regions of the country". They also invest in

ADR/GDRs and foreign securities.

I find it weird. It invests equally among Indian "regions". Meaning what? Many big

companies have a pan-India presence, but are headquartered in Mumbai or

Delhi. Are they all western companies? And what's the point of investing in a

region specific companies? Is the region a factor in performance at all? I don't

think so. Plus, what do you consider the "region" of a company that is across

India? The headquarters, perhaps?

Lets see the top companies in India and see where they are headquartered:

1. ONGC : Delhi

2. Reliance : Mumbai

3. NTPC : Delhi

4. Infosys: Bangalore

5. Bharti : Delhi

6. TCS: Mumbai

7. Reliance Comm: Mumbai

8. Wipro: Bangalore

9. ICICI Bank: Vadodara, Gujarat

10. ITC: Kolkata

11. SBI: Mumbai

12. BHEL: Delhi

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In this set, 4 are in the north, 5 in the west, 2 in the south and 1 in the east. If 

you take even the top 100, there will be a very uneven trend towards the north

and west. But most of these companies are pan-India companies!

 The offer document says that:Definition of Regions:

Companies of a region will be defined as those having their:

• Registered office; or

• Head Quarters; or

• Major manufacturing facility; or

• Major Revenue generating activity

In the region defined as a group of states and union territories.

 This means Tata Steel can be both in Western region (since HQ is Mumbai) or in

Eastern region (Jamshedpur unit). That confuses the definition and objective of 

the fund, which I think makes it exactly equal to a diversified fund. Honestly,

attempting to invest equally among regions is a ridiculous idea.

 This fund is a lousy diversification concept. I'm not at all impressed, and I will

track the performance of this fund after six months to see if a) they are really

following their strategy and b) is it making better returns.

Also the fund wants to invest in ADRs, GDRs and foreign securities. Why is a "One

India" fund investing in foreign securities?

Fund structure: This is a three year closed end, and initial expenses of 6% are

amortised over the period. There is no additional entry load. You can exit earlier

than three years, but you must pay the remaining amortised value of the initial

expenses. You can't buy after the NFO for three years - I think this is not a closed

"end" fund, but a closed "entry" fund.

Benchmark: The fund benchmarks itself against the BSE 200. This is a fairly lousy

benchmark, because it has underperformed every other benchmark in existence

(BSE 100, Sensex, Nifty, NSE Junior Midcap etc.) I would request that they

compare this fund to the BSE 100 or the NSE 100 instead.

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 The fund house is good: SBI. But this fund adds very little value, really. Their

other funds have done very well- Magnum Global, Magnum Contra, Magnum

 TaxGain - but I think they have pressure from fund management and distributors

to introduce new funds, since the new fund commissions are much more. (nearly

6% vs. 2.25%) But why should you and I pay for that?

Overall I don't see much difference in this fund from their Magnum Global Fund.

Invest in that instead.

Recommendation: Do not subscribe. After three years, you can gauge the

performance and enter when it becomes an open ended fund.

Labels: MutualFunds

Deepak Shenoy 10:54 AM | 0 comments | 

Monday, December 04, 2006

HDFC 1 year 15 day deposit at 8%

I've just noticed that HDFC's Interest rates have changed recently. They offer

7% for a one year deposit, but a special rate applies for a deposit of 1 year and

15 days: 8% per year compounded quarterly.

 This seems to apply only for deposits from 1 year 15 days to 1 year 16 days. If 

you take a deposit of lesser days or more days (1 year 14 days or 1 year 17 days

you get only 7%!)

Labels: Commentary

Deepak Shenoy 8:37 PM | 0 comments | 

 Your savings may be taxed next year

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An Economic Times article states that some of the 80C deductions, those that

helped you make 1 lakh of your income off the taxman's list, may now be

removed as part of the next year's budget.

...[Being reviewed] are a whole lot of tax breaks – bonus from life insurance policies;

payments from a provident fund, other statutory funds, superannuation funds; medical

insurance premia, interest on home loans; capital gains on property transfers invested in

 bonds, gratuity benefits, pension benefits and so on. Sops to software developers, incentives

for backward area development are also in this hit list, though experts reckon that their

phase out is next to impossible.

 The government's reasoning is simple: Make taxation more transparent and

simple, but do not affect collection of tax. This year, a huge amount of taxes

have been collected, which means more people are complying with the taxation

laws. Going forward, the government might want to cut down on the (high) taxrates, and even bring down the highest rates from 30% down to a more

affordable rate.

But doing so means losing revenue, and money is required by the government to

build infrastructure. So a lower tax rate may mean that income tax will apply to a

lot of things that are currently out of the tax bracket. Let us see what may face

the axe, and reasoning.

Insurance premia: The reason this used to be exempt was to promote insurance.But today most of the insurance premiums paid are for investment. Again, the

government wants to promote long term investment as well, so tax benefits were

provided if money was locked in for three years. At this point, the government

might decide to remove the investment from the tax benefit, and only provide

this for the mortality charge premiums. There may be a push to move the

investment to the EET regime (explained later).

ELSS Funds: To encourage long term equity investing and therefore build the

capital markets, tax sops are given to ELSS fund investments under 80C. Given

that there is no shortage of liquidity in either diversified or tax saving funds, or in

the market, the government might remove the ELSS scheme from 80C or make it

EET based.

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Housing loan interest or principal: Interest may still be out of the taxation bracket

(it's separate from 80C) but the principal repayment is an 80C saving. That might

have to go, meaning you save tax on the interest paid but not on the principal.

 This might ease the huge investments in the real estate industry, though I don't

believe tax-on-principal a big factor at the moment.

PPF and Pension plan investments: Chances are that these will stay, since they

are retirement benefits and honestly the government has done nothing to keep

you going after retirement, and has no plans to. That's why it incentivises you to

save for your own retirement, and I don't believe that should be changed.

EET means Exempt-Exempt-Taxed. This means that your investment is exempt

from tax at the point of buying in, exempt at accrual, but taxed at exit. In simple

terms it's like this. If you invest Rs. 10,000 in an 80C investment like ELSS or

Insurance, it is taken of your taxable income in the year you invest (Exempt at

Entry). Then, in the next three years, say it grows to 15,000. The 5,000 Rs.

growth is not taxed. (Exempt at Accrual). Then, if you sell the fund at say Rs.

20,000, then what is taxed is the amount of tax you saved. (Taxed at Exit)

Let's see how it goes. The EET regime was supposed to come in 2006, it's not in.

With 2007 being right in the middle of the Parliament tenure, there may be some

changes without feeling that they will lose a lot of votes (which is what drives

most policy anyhow). I do believe in the rationalisation of tax, and I hope that the

finance ministry will show the courage to reduce tax rates. If in the process we

have to lose out on some confusing tax saving schemes, so be it.

Labels: Commentary

Deepak Shenoy 12:49 PM | 0 comments |

Friday, December 01, 2006

LinkFest #2: Keeping it Simple, NFOs, Gold.

 The Simple Life 

(Dhirendra Kumar,Value Research Online)

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Investments are about simplicity; the simpler the concept, the better it is for

investors. The author talks you through the simplest investments ("piggy banks")

and tells you why it's necessary and preferable to keep things as clear as

possible. Insurance is therefore, he says, an "unhealthy mix of insurance and

investment" - two concepts he advises you to keep separate. I cannot agree

more.

Closed Ended Funds Galore! (Economic Times)

Ever since SEBI has disallowed amortisation of initial expenses by open ended

mutual funds, AMCs have introduced (largely) only closed ended funds. Initial

expenses are chargeable by AMCs upto 6% of assets, now applicable only to

closed ended funds. AMCs are taking the opportunity to take this money

investors and hide it in smoke and mirrors; amortisation allows you to slowly take

money out in a trickle every month, and as an investor you realise only when it's

too late! Luckily SEBI says it's looking into this.

Case in point: Reliance Equity Opportunity fund had 1700+ crores subscribed in

its NFO in March 2005. Current portfolio is 1200 crores. That means 6% initial

expenses (105 cr) are now being paid by a smaller asset base, a hit of nearly 9%

at this point. No wonder the fund's not performed as well as it's peers.

Is "NEW" fashionable? (Personalfn)

 The author is perplexed by the attraction to something "new" in one's portfolio.

 There are good reasons why one should invest in a new fund, but a low NAV is

not one of them - in fact, the unit price should be completely ignored. It

reiterates the problem we see today; of too many similar NFOs and irrational

exuberance in purchasing them.

Should you buy Gold from your bank? (Personalfn)

Some banks seem to be overcharging for gold, and justifying it saying that they

give you a certificate for the purity of gold. But they don't seem to like their owncertificate, for they won't buy back the gold from you at all. Jewellers, branded

and unbranded, will do so and usually charge much lesser charges for the gold

itself.

New funds launched: SBI One India Fund, Reliance LT Equity Fund (review), HSBC

 TaxSaver (review). Previous Linkfests: 1.

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Labels: LinkFest, MutualFunds

Deepak Shenoy 12:36 PM | 0 comments |

Disclaimer: The author of this page is not a registered financial advisor, and you should notconstrue anything written here to be investment advise. You should consult a qualified

 broker or other financial advisor prior to making any actual investment or trading decisions.

 All information is for educational and informational use only. No representation is being

made that any investment made on the basis of data or information on this blog will result in

profits. In short: Apply your own thoughts before investing; I could be wrong. I do not accept

responsibility for any losses incurred by interpretation of content in this blog.

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ICICIdirect University - Equity  Course Map

  Next Module Previous

Module 

Chapter 1

Module 4 - Basics On The stock Market. 

Working of Stock Market.

Indian Stock Market Overview.

Rolling Settlements.

Concept of Buying Limits.

What is Dematerializtion ?

Going Short.

Concept of Margin Trading.

Types of orders.

Circuits Filters & Trading bands.

India's Unique - Badla.

Securities Lending.

Insider Trading.

 

Working of a stock market

To learn more about how you can earn on the stock market, one has to understand how itworks. A person desirous of buying/selling shares in the market has to first place his order with

a broker. When the buy order of the shares is communicated to the broker he routes the order through his system to the exchange. The order stays in the queue exchange's systems andgets executed when the order logs on to the system within buy limit that has been specified.The shares purchased will be sent to the purchaser by the broker either in physical or dematformat

Top

Indian Stock Market Overview.

The Bombay Stock Exchange (BSE) and the National Stock Exchange of India Ltd (NSE) arethe two primary exchanges in India. In addition, there are 22 Regional Stock Exchanges.However, the BSE and NSE have established themselves as the two leading exchanges andaccount for about 80 per cent of the equity volume traded in India. The NSE and BSE are equalin size in terms of daily traded volume. The average daily turnover at the exchanges has

increased from Rs 851 crore in 1997-98 to Rs 1,284 crore in 1998-99 and further to Rs 2,273crore in 1999-2000 (April - August 1999). NSE has around 1500 shares listed with a totalmarket capitalization of around Rs 9,21,500 crore (Rs 9215-bln). The BSE has over 6000stocks listed and has a market capitalization of around Rs 9,68,000 crore (Rs 9680-bln). Mostkey stocks are traded on both the exchanges and hence the investor could buy them on either exchange. Both exchanges have a different settlement cycle, which allows investors to shifttheir positions on the bourses. The primary index of BSE is BSE Sensex comprising 30 stocks.NSE has the S&P NSE 50 Index (Nifty) which consists of fifty stocks. The BSE Sensex is theolder and more widely followed index. Both these indices are calculated on the basis of marketcapitalization and contain the heavily traded shares from key sectors. The markets are closed

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on Saturdays and Sundays. Both the exchanges have switched over from the open outcrytrading system to a fully automated computerized mode of trading known as BOLT (BSE OnLine Trading) and NEAT (National Exchange Automated Trading) System. It facilitates moreefficient processing, automatic order matching, faster execution of trades and transparency.The scrips traded on the BSE have been classified into 'A', 'B1', 'B2', 'C', 'F' and 'Z' groups. The

'A' group shares represent those, which are in the carry forward system (Badla). The 'F' grouprepresents the debt market (fixed income securities) segment. The 'Z' group scrips are theblacklisted companies. The 'C' group covers the odd lot securities in 'A', 'B1' & 'B2' groups andRights renunciations. The key regulator governing Stock Exchanges, Brokers, Depositories,Depository participants, Mutual Funds, FIIs and other participants in Indian secondary andprimary market is the Securities and Exchange Board of India (SEBI) Ltd.

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Rolling Settlement Cycle :

In a rolling settlement, each trading day is considered as a trading period and trades executedduring the day are settled based on the net obligations for the day. At NSE and BSE, trades inrolling settlement are settled on a T+2 basis i.e. on the 2nd working day. For arriving at thesettlement day all intervening holidays, which include bank holidays, NSE/BSE holidays,

Saturdays and Sundays are excluded. Typically trades taking place on Monday are settled onWednesday, Tuesday's trades settled on Thursday and so on. Top

Concept Of Buying Limit

Suppose you have sold some shares on NSE and are trying to figure out that if you can use themoney to buy shares on NSE in a different settlement cycle or say on BSE. To simplify thingsfor ICICI Direct customers, we have introduced the concept of Buying Limit (BL). Buying Limitsimply tells the customer what is his limit for a given settlement for the desired exchange.Assume that you have enrolled for a ICICI Direct account, which requires 100% of the moneyrequired to fund the purchase, be available. Suppose you have Rs 1,00,000 in your Bank A/Cand you set aside Rs 50,000 for which you would like to make some purchase. Your BuyingLimit is Rs 50,000. Assume that you sell shares worth Rs 1,00,000 on the NSE on Monday.

The BL therefore for the NSE at that point of time goes upto Rs 1,50,000. This means you canbuy shares upto Rs 1,50,000 on NSE or BSE. If you buy shares worth Rs 75,000 on Tuesdayon NSE your BL will naturally reduce to Rs 75,000. Hence your BL is simply the amount setaside by you from your bank account and the amount realized from the sale of any shares youhave made less any purchases you have made.

Your BL of Rs 50,000, which is the amount set aside by you from your Bank account for purchase is available for BSE and NSE. As you have made the sale of shares on NSE for Rs.100000, the BL for NSE & BSE rises to 1,50,000. The amount from sale of shares in NSEwill also be available for purchase on BSE. ICICI Direct makes it very easy for its customers toknow their BL on the click of a mouse. You just have to specify the Exchange and settlementcycle and on a click of your mouse, the BL will be known to you.

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What Is Dematerialization?

Dematerialization in short called as 'demat is the process by which an investor can get physicalcertificates converted into electronic form maintained in an account with the DepositoryParticipant. The investors can dematerialize only those share certificates that are alreadyregistered in their name and belong to the list of securities admitted for dematerialization at the

depositories.Depository : The organization responsible to maintain investor's securities in the electronic form iscalled the depository. In other words, a depository can therefore be conceived of as a "Bank" for securities. In India there are two such organizations viz. NSDL and CDSL. The depositoryconcept is similar to the Banking system with the exception that banks handle funds whereas adepository handles securities of the investors. An investor wishing to utilize the services offeredby a depository has to open an account with the depository through a Depository Participant.Depository Participant : The market intermediary through whom the depository services can beavailed by the investors is called a Depository Participant (DP). As per SEBI regulations, DPcould be organizations involved in the business of providing financial services like banks, brokers,custodians and financial institutions. This system of using the existing distribution channel (mainlyconstituting DPs) helps the depository to reach a wide cross section of investors spread across alarge geographical area at a minimum cost. The admission of the DPs involve a detailedevaluation by the depository of their capability to meet with the strict service standards and afurther evaluation and approval from SEBI. Realizing the potential, all the custodians in India anda number of banks, financial institutions and major brokers have already joined as DPs to provideservices in a number of cities.

Advantages of a depository services :Trading in demat segment completely eliminates the risk of bad deliveries. In case of transfer of electronic shares, you save 0.5% in stamp duty. Avoids the cost of courier/ notarization/ the needfor further follow-up with your broker for shares returned for company objection No loss of certificates in transit and saves substantial expenses involved in obtaining duplicate certificates,when the original share certificates become mutilated or misplaced. Increasing liquidity of securities due to immediate transfer & registration Reduction in brokerage for trading indematerialized shares Receive bonuses and rights into the depository account as a direct credit,thus eliminating risk of loss in transit. Lower interest charge for loans taken against demat shares

as compared to the interest for loan against physical shares. RBI has increased the limit of loansavailed against dematerialized securities as collateral to Rs 20 lakh per borrower as against Rs10 lakh per borrower in case of loans against physical securities. RBI has also reduced theminimum margin to 25% for loans against dematerialized securities, as against 50% for loansagainst physical securities. Fill up the account opening form, which is available with the DP. Signthe DP-client agreement, which defines the rights and duties of the DP and the person wishing toopen the account. Receive your client account number (client ID). This client id along with your DP id gives you a unique identification in the depository system. Fill up a dematerializationrequest form, which is available with your DP. Submit your share certificates along with the form;(write "surrendered for demat" on the face of the certificate before submitting it for demat)Receive credit for the dematerialized shares into your account within 15 days.

Procedure of opening a demat account:

Opening a depository account is as simple as opening a bank account. You can open adepository account with any DP convenient to you by following these steps:Fill up the account opening form, which is available with the DP. Sign the DP-client agreement,which defines the rights and duties of the DP and the person wishing to open the account.Receive your client account number (client ID). This client id along with your DP id gives you aunique identification in the depository system.There is no restriction on the number of depository accounts you can open. However, if your existing physical shares are in joint names, be sure to open the account in the same order of names before you submit your share certificates for demat

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Procedure to dematerialize your share certificates:Fill up a dematerialization request form, which is available with your DP. Submit your sharecertificates along with the form; (write "surrendered for demat" on the face of the certificate beforesubmitting it for demat) Receive credit for the dematerialized shares into your account within 15days.

In case of directly purchasing dematerialized shares from the broker, instruct your broker topurchase the dematerialized shares from the stock exchanges linked to the depositories. Oncethe order is executed, you have to instruct your DP to receive securities from your broker'sclearing account. You have to ensure that your broker also gives a matching instruction to his DPto transfer the shares purchased on your behalf into your depository account. You should alsoensure that your broker transfers the shares purchased from his clearing account to your depository account, before the book closure/record date to avail the benefits of corporate action.

Stocks traded under demat:Securities and Exchange Board of India (SEBI) has already specified for settlement only in thedematerialized form in for 761 particular scripts. Investors interested in these stocks receiveshares only in demat form without any instruction to your broker. While SEBI has instructed theinstitutional investors to sell 421 scripts only in the demat form. The shares by non institutionalinvestors can be sold in both physical and demat form. As there is a mix of both form of stocks, itis possible if you have purchased a stock in this category, you may get delivery of both physicaland demat shares.

Opening of a demat account through ICICI Direct :Opening an e-Invest account with ICICI Direct, will enable you to automatically open a demataccount with ICICI, one of the largest DP in India, thereby avoiding the hassles of finding anefficient DP. Since the shares to be bought or sold through ICICI Direct will be only in the dematform, it will avoid the hassles of instructing the broker to buy shares only in demat form. Adding tothis, you will not face problems like checking whether your broker has transferred the shares fromhis clearing account to your demat account.

Top

Going Short:

If you do not have shares and you sell them it is known as going short on a stock. Generally atrader will go short if he expects the price to decline. In a rolling settlement cycle you will have tocover by end of the day on which you had gone short.

Top

Concept Of Margin Trading:

Normally to buy and sell shares, you need to have the money to pay for your purchase andshares in your demat account to deliver for your sale. However as you do not have the fullamount to make good for your purchases or shares to deliver for your sale you have to cover (square) your purchase/sale transaction by a sale/purchase transaction before the close of thesettlement cycle. In case the price during the course of the settlement cycle moves in your favor (risen in case of purchase done earlier and fallen in case of a sale done earlier) you will make aprofit and you receive the payment from the exchange. In case the price movement is adverse,

you will make a loss and you will have to make the payment to the exchange. Margins are thuscollected to safeguard against any adverse price movement. Margins are quoted as a percentageof the value of the transaction.

Important facts for NRI customers:

Buying and selling on margin in India is quite different than what is referred to in US markets.There is no borrowing of money or shares by your broker to make sure that the settlement takesplace as per SE schedule. In Indian context, buying/selling on margin refers to building a

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leveraged position at the beginning of the settlement cycle and squaring off the trade before thesettlement comes to end. As the trade is squared off before the settlement cycle is over, there isno need to borrow money or shares.

Buying On Margin : Suppose you have Rs 1,00,000 with you in your Bank account. You can use

this amount to buy 10 shares of Infosys Ltd. at Rs 10,000. In the normal course, you will pay for the shares on the settlement day to the exchange and receive 10 shares from the exchangewhich will get credited to your demat account. Alternatively you could use this money as marginand suppose the applicable margin rate is 25%. You can now buy upto 40 shares of Infosys Ltd.at Rs 10,000 value Rs 4,00,000, the margin for which at 25% i.e. Rs 1,00,000. Now as you do nothave the money to take delivery of 40 shares of Infosys Ltd. you have to cover (square) your purchase transaction by placing a sell order by end of the settlement cycle. Now suppose theprice of Infosys Ltd rises to Rs. 11000 before end of the settlement cycle. In this case your profitis Rs 40,000 which is much higher than on the 10 shares if you had bought with the intent to takedelivery. The risk is that if the price falls during the settlement cycle, you will still be forced tocover (square) the transaction and the loss would be adjusted against your margin amount.Selling On Margin : You do not have shares in your demat account and you want to sell as youexpect the prices of share to go down. You can sell the shares and give the margin to your broker 

at the applicable rate. As you do not have the shares to deliver you will have to cover (square)your sell transaction by placing a buy order before the end of the settlement cycle. Just likebuying on margin, in case the price moves in your favor (falls) you will make profit. In case price

goes up, you will make loss and it will be adjusted against the margin amount. Top

Types Of Orders:

There are various types of orders, which can be placed on the exchanges:

Limit Order : The order refers to a buy or sell order with a limit price. Suppose, you check thequote of Reliance Industries Ltd.(RIL) as Rs. 251 (Ask). You place a buy order for RIL with a limitprice of Rs 250. This puts a cap on your purchase price. In this case as the current price isgreater than your limit price, order will remain pending and will be executed as soon as the price

falls to Rs. 250 or below. In case the actual price of RIL on the exchange was Rs 248, your order will be executed at the best price offered on the exchange, say Rs 249. Thus you may get anexecution below your limit price but in no case will exceed the limit buy price. Similarly for a limitsell order in no case the execution price will be below the limit sell price. Market Order : Generallya market order is used by investors, who expect the price of share to move sharply and are yetkeen on buying and selling the share regardless of price. Suppose, the last quote of RIL is Rs251 and you place a market buy order. The execution will be at the best offer price on theexchange, which could be above Rs 251 or below Rs 251. The risk is that the execution pricecould be substantially different from the last quote you saw. Please refer to Important Fact for Online Investors. Stop Loss Order : A stop loss order allows the trading member to place an order which gets activated only when the last traded price (LTP) of the Share is reached or crosses athreshold price called as the trigger price. The trigger price will be as on the price mark that youwant it to be. For example, you have a sold position in Reliance Ltd booked at Rs. 345. Later incase the market goes against you i.e. go up, you would not like to buy the scrip for more thanRs.353. Then you would put a SL Buy order with a Limit Price of Rs.353. You may choose to givea trigger price of Rs.351.50 in which case the order will get triggered into the market when thelast traded price hits Rs.351.50 or above. The execution will then be immediate and will be at thebest price between 351.50 and 353. However stock movements can be so violent at times. Theprices can fluctuate from the current level to over and above the SL limit price, you had quoted, atone shot i.e. the LTP can move from 350…351…and directly to 353.50. At this moment your order will immediately be routed to the Exchange because the LTP has crossed the trigger pricespecified by you. However, the trade will not be executed because of the LTP being over andabove the SL limit price that you had specified. In such a case you will not be able to square your 

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position. Again as the market falls, say if the script falls to 353 or below, your order will be bookedon the SL limit price that you have specified i.e. Rs. 353. Even if the script falls from 353.50 to352 your buy order will be booked at Rs. 353 only. Some seller, somewhere will book a profit inthis case form your buy order execution. Hence, an investor will have to understand that one of the foremost parameters in specifying on a stop loss and a trigger price will have to be its

chances of executionability as and when the situation arises. A two rupee band width betweenthe trigger and stop loss might be sufficient for execution for say a script like Reliance, however the same band hold near to impossible chances for a script like Infosys or Wipro. This vitalparameter of volatility bands of scrips will always have to be kept in mind while using the Stop

loss concept.Top

Circuit Filters And Trading Bands:

In order to check the volatility of shares, SEBI has come with a set of rules to determine the fixedprice bands for different securities within which they can move in a day. As per Sebi directive, allsecurities traded at or above Rs.10/- and below Rs.20/- have a daily price band of ±25%. Allsecurities traded below Rs. 10/- have a daily price band of ± 50%. Price band for all securitiestraded at or above Rs. 20/- has a daily price band of ± 8%. However, the now the price bands

have been relaxed to ± 8% ± 8% for select 100 scrips after a cooling period of half an hour. Theprevious day's closing price is taken as the base price for calculating the price. As the closingprice on BSE and NSE can be significantly different, this means that the circuit limit for a share on

BSE and NSE can be different.Top

Badla financing

In common parlance the carry-forward system is known as 'Badla', which means something inreturn. Badla is the charge, which the investor pays for carrying forward his position. It is a hedgetool where an investor can take a position in a scrip without actually taking delivery of the stock.He can carry-forward his position on the payment of small margin. In the case of short-selling thecharge is termed as 'undha badla'. The CF system serves three needs of the stock market :

Quasi-hedging: If an investor feels that the price of a particular share is expected to go up/down,without giving/taking delivery of the stock he can participate in the volatility of the share. ? Stocklending: If he wishes to short sell without owning the underlying security, the stock lender stepsinto the CF system and lends his stock for a charge. ? Financing mechanism: If he wishes to buythe share without paying the full consideration, the financier steps into the CF system andprovides the finance to fund the purchase The scheme is known as "Vyaj Badla" or "Badla"financing. For example, X has bought a stock and does not have the funds to take delivery, hecan arrange a financier through the stock exchange 'badla' mechanism. The financier wouldmake the payment at the prevailing market rate and would take delivery of the shares on X'sbehalf. You will only have to pay interest on the funds you have borrowed. Vis-à-vis, if you have asale position and do not have the shares to deliver you can still arrange through the stockexchange for a lender of securities. An investor can either take the services of a badla financier or can assume the role of a badla financier and lend either his money or securities. On everySaturday a CF system session is held at the BSE. The scrips in which there are outstandingpositions are listed along with the quantities outstanding. Depending on the demand and supplyof money the CF rates are determined. If the market is over bought, there is more demand for funds and the CF rates tend to be high. However, when the market is oversold the CF rates arelow or even reverse i.e. there is a demand for stocks and the person who is ready to lend stocksgets a return for the same. The scrips that have been put in the Carry Forward list are all 'A'group scrips, which have a good dividend paying record, high liquidity, and are actively traded.The scrips are not specified in advance because it is then difficult to get maximum return. Alltransactions are guaranteed by the Trade Guarantee Fund of BSE, hence, there is virtually norisk to the badla financier except for broker defaults. Even in the worst scenario, where the broker 

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through whom you have invested money in badla financing defaults, the title of the shares wouldremain with you and the shares would be lying with the "Clearing house". However, the risk of volatility of the scrip will have to be borne by the investor.

Top

Securities lending

Securties lending program is from the NSE. It is similar to the Badla from the BSE, only differencebeing the carry forward system not being allowed by the NSE. Meaning this is a where in a holder of securities or their agent lends eligible securities to borrowers in return for a fee to cover shortpositions.

Top

Insider trading:

Insider trading is illegal in India. When information, which is sensitive in the form of influencing theprice of a scrip, is procured or/and used from sources other than the normal course of informationoutput for unscrupulous inducement of volatility or personal profits, it is called as Insider trading.Insider trading refers to transactions in securities of some company executed by a companyinsider. Although an insider might theoretically be anyone who knows material financialinformation about the company before it becomes public, in practice, the list of company insiders(on whom newspapers print information) is normally restricted to a moderate-sized list of company officers and other senior executives. Most companies warn employees about insider trading. SEBI has strict rules in place that dictates when company insiders may executetransactions in their company's securities. All transactions that do not conform to these rules are,

in general, prosecutable offenses under the relevant law.Top

 

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Chapter 1:

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Futures and Options

Countering Counterparty risk 

Some time back, we learnt that the futures are traded on a futures exchange,

which works as a guarantor to all trades in futures and therefore take care of allcounter party risk. But isn't it a big risk for exchanges? How does the exchange

take care of this counter party risk?

Default risk can crash the entire system

Futures normally have a maturity period varyingfrom one month to one year. If the futures

exchanges settle these trades on the last day of maturity, then again the default risk becomes high.And suppose Mr XYZ has 40 futures contracts

long and there are 40 investors with short positions in one contract each. Then if 

Mr XYZ defaults, 40 contracts will default and this may crash the systems

completely.

Let's answer this question: which is more risky, a full

 payment of Rs90,000 after 90 days and or a payment of Rs1,000 every day for next 90 days? Of course, the full

 payment after 90 days. The futures exchanges

understand this and therefore instead of a settlement onthe final day of maturity, they have opted for daily

settlement of all the open positions in the futures. Smart fellows!

But if even in this arrangement of daily settlement, Mr XYZ does not pay hisone day loss, what happens to the other investors? How does the futures

exchange take care of this one day default risk?

An initial margin takes care of compulsive defaulters

Future exchanges circumvent the really persistent defaulters using some very

 prudent measures, thus neutralising counter party risk. They require that both the

 parties involved in the future transaction pay an initial margin to the exchange.The margin is fixed based on the maximum historical price movement on the

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.is expected to cover at least one day's price movement in the Sensex or Nifty.

(We will learn about the Sensex and Nifty futures in the following series).

Futures are settled on a daily basis, depending on the market

value of the future's closing price. But how does the daily

settlement take place? Is it a very cumbersome process? In aword, no.

Futures are cash settledThe most beautiful thing about futures is that they are cash settled. There is no

deliver y of asset r equired of a party who shorts the future and vice versa. So if your position in a future makes a profit, then you receive cash.

The daily settlement also takes place through cash. So if you are holding a long

 position in future and today it ended above yesterday's level, then you receive

the difference between yesterday's price and today's closing price. This transfer of funds is also known as daily margin, which is based on mark-to-market basis.

So does one have to take care of daily cash transactions?

Margin account makes it easy

In reality, when you enter into a futures contract, you deposit a certain amount inyour margin account with your broker. Normally, this opening balance is above

the requisite initial margin set by the exchanges. This extra amount is to take

care of losses on your position in futures, if any. But what happens if the amountin the margin account becomes zero?

The margin account can never reach zero level because your broker will not

allow you to carry the position in the futures if the account balance falls below10%. If your position in the futures keeps making losses and the account balance

falls to 10%, then your broker will ask you to refill the margin account to 15%

of the current exposure in the futures. So the losses in the futures have to be paid

as soon your account falls by 5%. But what about the profit on your position inthe futures? Are they being paid to you according to your margin account

 balance?

Yes, the profit on the futures positions are also settled based on the balance in

the margin account. So if your margin account balance goes above 15% of the

current exposure, then you can withdraw this extra money from your marginaccount. But in practice, this is done once a week on a weekend. If your margin

account balance is in excess of 15% of the current exposure on futures on

Friday, then you can withdraw that amount on that day.

Let's take a simple example of a future contract, which you bought at Rs1,000on 3rd January 2000. The future behaved in the following manner for the next10 days.

Date  Futureslevel 

Loss/gain 

Margina/c

% Of exposure 

MarginCall 

Closing Margina/c 

%0f exposure

1000 150.0 150.0 15.0%