Thursday, May 29, 2008

Can Government of India Control Inflation?

The Reserve Bank of India, says that its prime mandate is to contain inflation. RBI had earlier indicated that an inflation rate between 4.5% and 5% was comfortable for the Indian economy. In the last few weeks, inflation has overshot that threshold and is inching towards the double-digit mark. The wholesale price index (WPI) inflation, which was 3.8% in January, rose to7.41% by March 29. It then eased to 7.1% for the week ending April 5 but rose again to 7.33% the following week. In the near future, there is no hope that it will come down. McKinsey & Co, in a recent survey, found that 64% of the Indian executives polled, were apprehensive about the inflation going up in the next six months.

Experts believe that the Government of India (GoI) will resist raising interest rates since the interest rate differential with the U.S. is already quite large, they would not want to widen it any more. To control inflation, one of the things that the GoI is trying to do is set price ceilings and quantitative controls. However, these techniques have historically been unsuccessful not just in India, but elsewhere as well. Not only these are difficult to administer, but also these methods are outdated. Surely, there is a need to curb price rise, as the monetary policy would not be altered at this point in time because of foreign investments, etc. The government is constrained by what is called the impossible trinity of international finance (the perceived irreconcilability of the three objectives – capital freedom, exchange rate maintenance and independence of monetary policy).

The government has been negotiating with cement and steel manufacturers, (almost) forcing them to restrain prices. "It is my view that cement manufacturers and, to some extent, steel producers are behaving like a cartel," Chidambaram told Parliament in late April. Steel companies are also pointing to rising input costs. An uneasy truce has been reached with the manufacturers agreeing to maintain the current level of prices for a few more months. But the truce would collapse if companies see their profits in the red.

The government has implemented several other steps, including various export bans and import duty cuts and revision of the annual export-import policy. For example, this year, cement exports were banned and all incentives on the export of primary steel were withdrawn. The export target for 2008-09 has been revised to $200 billion – an increase of 23% over the $155 billion achieved in 2007-08. This was short of the $160 billion target for the year.

Increase in steel and cement prices results in pressure on user industries. The country’s largest two-wheeler manufacturer, Hero Honda, has hiked prices for its products. The car manufacturers are also being forced to the wall. The Tata Group's Rs. 100,000 ($2,500) Nano, the inexpensive car due to roll off the assembly lines soon, may be impossible to manufacture at such a low price.

Avik Mukherjee

Globsyn Business School

At What Rate Will India's GDP Grow in 2008?

The BSE sensitive index (Sensex) touched an all-time high of 21,207 on 10th January 2008 and our FM Mr. P. Chidambaram said that the outlook was very positive for India and her GDP is all set to grow at 9% this year. The analysts were having a ball and predicted that Sensex would scale 25,000 in no time. The Governor of Reserve Bank of India (RBI), Dr. Y.V. Reddy, it was reported, was considering a cut in the interest rate to boost investment. The stock analysts were rejoicing about the decoupling theory: How the stock markets in rapidly-growing economies like India and China would be unaffected by the imminent slowdown in the U.S. India was living a dream.

The dream was short-lived and much to all’s astonishment, the Indian markets crashed. The first quarter of the calendar year 2008 was the worst since 1992. Market indices have tumbled 28% in dollar terms and some stocks have lost more than 50% of their values.

Now opinions differ widely on GDP growth in 2008-09. The Delhi-based Oxus Research & Investments is the most optimistic and maintains that 9% is still achievable. Deutsche Bank pegs it at 8.4% while UBS does it at 8.2%. In the middle ground are the Asian Development Bank (8.0%), the International Monetary Fund (7.9%, for calendar 2008) and Lehman Brothers (7.6%). HSBC, JP Morgan Chase and Morgan Stanley are among the least optimistic and estimate a growth of 7%. Meanwhile, rating agency CRISIL has made a downward revision of its estimate to 8.1% from an earlier forecast of 8.5%.

Avik Mukherjee

Globsyn Business School

Wednesday, May 28, 2008

Does India measure inflation accurately?

Inflation means a sustained increase in the aggregate or general price level in an economy. In simple words, it means that prices of goods are increasing.

In recent times, the burning issue is inflation, which is (figuratively speaking) making a hole in the consumers’ pockets. The latest figure of inflation, which is released by the government, is 7.83%. However, does India measure inflation accurately?

Of the two accepted methods for calculating inflation viz., Wholesale Price Index (or WPI, i.e., the index that is used to measure the change in the average price level of goods traded in wholesale market) and Consumer Price Index (or CPI, i.e., a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers), India uses WPI to measure inflation, whereas, all the major countries in the world use CPI to measure inflation. Now I am not saying that since many countries use CPI to measure inflation, India should also do the same. However, it is more logical to use CPI to measure inflation. The prime reason is that CPI gives us an idea that how much is the price rise actually affecting the consumers. WPI does not properly measure the exact price rise an end-consumer will experience because, as the same suggests, it is at the wholesale level. Whereas the WPI is supposed to measure impact of prices on business, India uses that to measure the impact on consumers. Another problem with WPI calculation is that more than 100 out of the 435 commodities included in the Index have ceased to be important from the consumption point of view. So, are we right to use WPI to measure inflation?

Avik Mukherjee
Globsyn Business School

Dividend Stripping

Dividend stripping is the purchase of shares just before a dividend is paid, and the sale of those shares after that payment, ie. when they go ex-dividend. This may be done either by an ordinary investor as an investment strategy, or by a company's owners or associates as a tax avoidance strategy.
For an investor, dividend stripping provides dividend income, and a capital loss when the shares fall in value (in normal circumstances) on going ex-dividend. This may be profitable if the income is greater than the loss, or if the tax treatment of the two gives an advantage.
For further reading:
Contributed by:
Veena Vishwanathan
Globsyn Business School

Lady Macbeth Strategy

A corporate-takeover strategy with which a third party poses as a white knight to gain trust, but then turns around and joins with unfriendly bidders. (A white knight is a company that makes a friendly takeover offer to a target company that is being faced with a hostile takeover from a separate party. The knight in shining armor gallops to the rescue!)

Such a strategy is called a Lady Macbeth strategy because Lady Macbeth, one of Shakespeare's most frightful and ambitious characters, devises a cunning plan for her husband, the Scottish general, to kill Duncan, the King of Scotland. The success of Lady Macbeth's scheme lies in her deceptive ability to appear noble and virtuous, and thereby secure Duncan's trust in the Macbeths' false loyalty.
Contributed by:
Veena Vishwanathan
Globsyn Business School

Monday, May 26, 2008

An example of foreign exchange risk

Where some of the assets of an enterprise are not determined in the currency of its home country, foreign exchange risk or exposure risk arises. Owing to the exchange rate fluctuations, loss arises when domestic currency is exchanged for a foreign currency in relation to business proposed to be undertaken. The occurence of exchange risk can be explained as follows:
An Indian entrepreneur enters into a contract for the purchase of machinery with an American supplier, payment to be made after 3 months. Exchange rate at the time of contract was 40.00/$1. Value of machinery is $50,000. The value of Indian rupee declines to $42.00/$1 after 3 months.
Amount paid to US exporter at the time of contract (US $) = $ 50,000
Amount to be paid to US exporter at spot rate (INR) = $50,000*Rs.40 = Rs. 20,00,000
Amount paid to US exporter at future rate (INR) = $50,000*Rs. 42 = Rs.21,00,000
Therefore, loss suffered = Rs. 21,00,000- 20,00,000 = Rs. 1,00,000
Contributed by:
Veena Vishwanathan
Globsyn Business School

Foreign Bonds

A "foreign currency" bond is a bond that is issued by an issuer in a currency other than its national currency. Issuers make bond issues in foreign currencies to make them more attractive to buyers and to take advantage of international interest rate differentials.
Foreign currency bonds have a vocabulary of their own. Bonds issued in foreign currencies are given the names listed beside the currencies below:
  • "Yankee Bonds" for US dollars
  • "Samurai Bonds" for Japanese Yen
  • "Bulldog Bonds" for British pounds
  • "Kiwi Bonds" for New Zealand dollars

Veena Vishwanathan

Globsyn Business School

Triangular Arbitrage

The process of converting one currency to another, converting it again to a third currency and, finally, converting it back to the original currency within a short time span. This opportunity for riskless profit arises when the currency's exchange rates do not exactly match up. Triangular arbitrage opportunities do not happen very often and when they do, they only last for a matter of seconds. Traders that take advantage of this type of arbitrage opportunity usually have advanced computer equipment and/or programs to automate the process.

As an example, suppose you have $1 million and you are provided with the following exchange rates: EUR/USD = 0.8631,
EUR/GBP = 1.4600 and
USD/GBP = 1.6939.
With these exchange rates there is an arbitrage opportunity:
Sell dollars for euros: $1 million x 0.8631 = 863,100 euros.
Sell euros for pounds: 863,100/1.4600 = 591,164.40 pounds.
Sell pounds for dollars: 591,164.40 x 1.6939 = $1,001,373 dollars
$1,001,373 - $1,000,000 = $1,373
From these transactions, you would receive an arbitrage profit of $1,373 (assuming no transaction costs or taxes).
Contributed by:
Veena Vishwanathan
Globsyn Business School

Balance Sheet of Life

Prof. Jayanta Mitra
Globsyn Business School

Understanding some of the rules of Time Value of Money

Rule Of 72

A rule stating that in order to find the number of years required to double your money at a given interest rate, you divide 72 by the compound return . The result is the approximate number of years that it will take for your investment to double. For example, if you want to know how long it will take to double your money at 12% interest, divide 72 by 12 y ou get six years.
Rule of 69
If you are inclined to do a slighly more involved calculation, a more accurate rule of thumb is the rule of 69. According to this rule, the doubling period = 0.35 + 69/ Interest rate
Hence , if the interest rate is 12%, the doubling period = 0.35 + 69/12 = 6.1 years
Contributed by:
Veena Vishwanathan
Globsyn Business School

What is Reverse Mortgage?

In the Union Budget 2007-08, a proposal to introduce 'Reverse Mortgages' was put forth. In a regular mortgage, a borrower mortgages his new/existing house with the lender in return for the loan amount (which in turn he uses to finance the property); the same is charged at a particular interest rate and runs over a predetermined tenure. The borrower then has to repay the loan amount in the form of EMIs , which comprise of both principal and interest amounts. The property is utilised as a security to cover the risk of default on the borrower's part.
In the reverse mortgage, senior citizens (borrowers), who own a house property, but do not have regular income, can mortgage the same with the lender (a scheduled bank or a housing finance company-HFC). In return, the lender makes periodic payment to the borrowers during their lifetime. Inspite of mortgaging the house property, the borrower can continue to stay in it during his entire life span and continue to receive regular flows of income from the lender as well. Also, since the borrower doesn't have to service the loan, he need not bother about repaying the 'borrowed amount' to the lender.
Veena Vishwanathan
Globsyn Business School

How is credit score calculated?

The credit score, commonly referred to as FICO Score is a proprietary tool created by the Fair Isaac Corporation. This is not the only way to get a credit score, but the FICO score is the measure that is most commonly used by lenders to determine the risk involved in a particular loan. Due to the proprietary nature of the FICO score, the Fair Isaac company does not reveal the exact formula it uses to compute this number. However, what is known is that the calculation is broken into five major categories with varying levels of importance. These categories, with weight in brackets, are
  • payment history (35%),
  • amount owed (30%),
  • length of credit history (15%),
  • new credit (10%) and
  • type of credit used (10%).

The payment history category reviews how well one has met one's prior obligations on various account types. It also looks for previous problems in one's payment history such as bankruptcy, collections and delinquency.

The amount one currently owes to lenders - while this category focuses on one's current amount of debt, it also looks at the number of different accounts and the specific types of accounts that one holds. The longer one has a good credit history, the better. Also, people who apply for credit a lot probably already have financial pressures causing them to do so, so each time one applies for credit, one's score gets dinged a little.

It is important to understand that one's credit score only looks at the information contained on one's credit report and does not reflect additional information that one's lender may consider in its appraisal. For example, one's credit report does not include such things as current income and length of employment. However, because one's credit score is a key tool used by lending agencies, it is important that one maintains and improves it periodically.

Contributed by

Veena Vishwanathan

Globsyn Business School

Friday, May 23, 2008

Picking The Right Mutual Fund

Identifying Goals and Risk Tolerance: Are long-term capital gains desired, or is a current income preferred? Will the money be used to pay for college expenses, or to supplement a retirement that is decades away? Identifying a goal is important because it will enable you to dramatically whittle down the list of the more than 8,000 mutual funds in the public domain. In addition, investors must also consider the issue of risk tolerance. Identifying risk tolerance is as important as identifying a goal.
Style and Fund Type: If the investor intends to use the money in the fund for a longer term need and is willing to assume a fair amount of risk and volatility, then the style/objective he or she may be suited for is a long term capital appreciation fund. Conversely, if the investor is in need of current income, he or she should acquire shares in an income fund. Of course, there are times when an investor has a longer term need, but is unwilling or unable to assume substantial risk. In this case, a balanced fund which invests in both stocks and bonds, may be the best alternative.
Charges and Fees: Some funds charge a sales fee known as a load fee, which will either be charged upon initial investment or upon sale of the investment. A front end load/fee is paid out of the initial investment made by the investor while a back end /fee is charged when an investor sells his or her investment, usually prior to a set time period, such as seven years from purchase. The investor should look for the management expense ratio. The ratio is simply the total percentage of fund assets that are being charged to cover fund expenses. The higher the ratio, the lower the investor's return will be at the end of the year.

Evaluating Managers/Past Results: As with all investments, investors should research a fund's past results. To that end, the following is a list of questions that perspective investors should ask themselves when reviewing the historical record:

  • Did the fund manager deliver results that were consistent with general market returns?
  • Was the fund more volatile than the big indexes (meaning did its returns vary dramatically throughout the year)?
  • Was there an unusually high turnover (which can result in larger tax liabilities for the investor)?

This information is important because it will give the investor insight into how the portfolio manager performs under certain conditions, as well as what historically has been the trend in terms of turnover and return. For this reason, prior to buying into a fund, it makes sense to review the investment company's literature to look for information about anticipated trends in the market in the years ahead.

Size of the Fund : However, there are times when a fund can get too big. A perfect example is Fidelity's Magellan Fund. Back in 1999 the fund topped $100 billion in assets, and for the first time, it was forced to change its investment process to accommodate the large daily (money) inflows. Instead of being nimble and buying small and mid cap stocks, it shifted its focus primarily toward larger capitalization growth stocks. As a result, its performance has suffered. It makes the process of buying and selling stocks with any kind of anonymity almost impossible.

Bottom Line: Selecting a mutual fund may seem like a daunting task, but knowing one's objectives and risk tolerance is half the battle. If one follows this bit of due diligence before selecting a fund, one will increase one's chances of success.

Veena Vishwanathan

Globsyn Business School

Tuesday, May 20, 2008

The Wacky World of Mergers & Acquisitions

Mergers, acquisitions and takeovers have been a part of the business world for centuries. In today's dynamic economic environment, companies are often faced with decisions concerning these actions - after all, the job of management is to maximize shareholder value. There are several ways that two or more companies can combine their efforts. They can partner on a project, mutually agree to join forces and merge, or one company can outright acquire another company, taking over all its operations, including its holdings and debt, and sometimes replacing management with their own representatives. It’s this last case of dramatic unfriendly takeovers that is the source of much of M&A’s colorful vocabulary.

Dawn Raid

During a dawn raid, a firm or investor aims to buy a substantial holding in the takeover-target company’s equity by instructing brokers to buy the shares as soon as the stock markets open. By getting the brokers to conduct the buying of shares in the target company (the “victim”), the acquirer (the “predator”) masks its identity and thus its intent. The acquirer then builds up a substantial stake in its target at the current stock market price. Because this is done early in the morning, the target firm usually doesn't get informed about the purchases until it is too late, and the acquirer now has controlling interest.

There are some popular ways by which a company can protect themselves from a predator. These are all types of what is referred to as "shark repellent".

Golden Parachute: This measure discourages an unwanted takeover by offering lucrative benefits to the current top executives, who may lose their job if their company is taken over by another firm. Benefits written into the executives’ contracts include items such as stock options, bonuses, liberal severance pay and so on.

Greenmail: A spin-off of the term "blackmail", greenmail occurs when a large block of stock is held by an unfriendly company or raider, who then forces the target company to repurchase the stock at a substantial premium to destroy any takeover attempt. This is also known as a "bon voyage bonus" or a "goodbye kiss".

Macaroni Defense: This is a tactic by which the target company issues a large number of bonds that come with the guarantee that they will be redeemed at a higher price if the company is taken over. If a company is in danger, the redemption price of the bonds expands, kind of like macaroni in a pot!

People Pill: Here, management threatens that in the event of a takeover, the management team will resign at the same time en masse. This is especially useful if they are a good management team; losing them could seriously harm the company and make the bidder think twice. On the other hand, hostile takeovers often result in the management being fired anyway, so the effectiveness of a people pill defense really depends on the situation.

White Knight: This is a company (the “good guy”) that gallops in to make a friendly takeover offer to a target company that is facing a hostile takeover from another party (a “black knight”). The white knight offers the target firm a way out with a friendly takeover.


Veena Vishwanathan

Globsyn Business School

Thursday, May 15, 2008

Ten golden rules of Dalal Street

Wealth making in the market has more to do with discipline and the power of time to compound growth than being smart at stock picking and timing the markets just right. To help you in your quest to make wealth in our markets, the following 10 golden rules of markets that will virtually ensure reasonable, steady wealth appreciation have been suggested.

Rule No 1: Plan for tomorrow, today. Start saving for it now! Stagger your investments throughout your earning phase. Invest regularly and invest for the long term to buy in at an average price that includes both markets’ up and down ticks.

Rule No 2: Start early so that the power of compounding begins sooner; time is the magic that converts paise into rupees. In exuberant phases, when we have earned good money from our investments, most of us get greedy, and derivatives and futures provide an outlet for the expression of human greed. While such instruments often satisfy the whims of human greed, if taken to unrealistic levels, irresponsible investment in these securities can lead to financial ruin.

Rule No 3: Do not leverage, it is difficult, if not impossible, to predict short-term trends.
Buy markets, not stocks. We all know that our economy is in a secular phase of prosperity and the stock market is the best proxy for the growth of an economy. To benefit from our soaring economy, buy the market as a whole and not any single stock.

Rule No 4: Buy stocks that mirror the broader indexes, but never buy a single, or a handful of stock exposures. This means that you need to spread your risk across various market segments in the event a particular stock does not perform for reasons beyond the company’s control.

Rule No 5: Look at company earnings, not at stock prices. Stock prices may tempt or give the wrong impression of a company’s welfare. But to build real wealth in equities, you must always rely on declared profits and facts, rather than make decisions based on stock movements. We all tend to sell stocks when we have made profits and keep the ones that have not appreciated. Eventually, we end up holding a portfolio of companies that are not performing! It is only human to sell for profits and not to want to take losses.

Rule No 6: Keep the winners, sell the losers. Check constantly for stocks that are not performing and eliminate them from your portfolio if the outlook does not seem promising. This way, you will have all winners left in your portfolio to take you to your goals.

Rule No 7: Buy value and not momentum. When investing in stocks, your head should prevail over your heart. Resist the urge to get consumed by market chatter. Ignore hot tips from dealers and friends. It is advisable to do your own home work.

Rule No 8: Pick stocks with your brain, not your heart. Large-caps are the ones that have already proven themselves over longer periods of time and have the balance sheet acumen, strong cash flow and brains to manage businesses effectively according to prevailing situations and realistic opportunities available.

Rule No 9: Prefer large-cap stocks to small- and medium-caps. Investment in small and mid-cap stocks requires expertise and strong tracking abilities, that without, your portfolio will under-perform. Do not short sell a stock just because it is going up, and thus, one day it must come down. If companies are able to sustain earnings’ growth for long periods, then its stock may go up, up and up, or it can even remain high without any reason for a long period of time.

Rule No 10: Markets can remain irrationally up, or continually climb for the right reasons. Therefore, never go short. It will expose you to unnecessary risks.

Adapted from:
Veena Vishwanathan

Globsyn Business School