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Sunday, March 30, 2008

Hedging practice to protect your portfolio

Hedging is a practice every investor should know about - there is no arguing that portfolio protection is often just as important as portfolio appreciation. Like your neighbor's obsession, however, hedging is talked about more than it is explained, making it seem as though it belongs only to the most esoteric financial realms. Well, even if you are a beginner, you can learn what hedging is, how it works and what hedging techniques investors and companies use to protect themselves.

What Is Hedging?
The best way to understand hedging is to think of it as insurance. When people decide to hedge, they are insuring themselves against a negative event. This doesn't prevent a negative event from happening, but if it does happen and you're properly hedged, the impact of the event is reduced. So, hedging occurs almost everywhere, and we see it everyday.

For example, if you buy house insurance, you are hedging yourself against fires, break-ins or other unforeseen disasters. Portfolio managers, individual investors and corporations use hedging techniques to reduce their exposure to various risks.

In financial markets, however, hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements.

In other words, investors hedge one investment by making another. Technically, to hedge you would invest in two securities with negative correlations. Of course, nothing in this world is free, so you still have to pay for this type of insurance in one form or another. Although some of us may fantasize about a world where profit potentials are limitless but also risk free, hedging can't help us escape the hard reality of the risk-return tradeoff.

A reduction in risk will always mean a reduction in potential profits. So, hedging, for the most part, is a technique not by which you will make money but by which you can reduce potential loss.

If the investment you are hedging against makes money, you will have typically reduced the profit that you could have made, and if the investment loses money, your hedge, if successful, will reduce that loss.

How Do Investors Hedge?
Hedging techniques generally involve the use of complicated financial instruments known as derivatives, the two most common of which are options and futures. We're not going to get into the nitty-gritty of describing how these instruments work, but for now just keep in mind that with these instruments you can develop trading strategies where a loss in one investment is offset by a gain in a derivative.

Let's see how this works with an example. Say you own shares of Reliance Industries Limited (Ticker: RIL). Although you believe in this company for the long run, you are a little worried about some short-term losses in the Reliance Industries . To protect yourself from a fall in RIL you can buy a put option (a derivative) on the company, which gives you the right to sell RIL at a specific price (strike price). If your stock price tumbles below the strike price, these losses will be offset by gains in the put option. (For more information, see options basics article in

The other classic hedging example involves a company that depends on a certain commodity.

Let's say TATA STEEL is worried about the volatility in the price of Iron ore, the plant used to make steel. The company would be in deep trouble if the price of Iron ore were to skyrocket, which would eat into profit margins severely. To protect (hedge) against the uncertainty of Iron ore prices, TATA STEEL can enter into a futures contract (or its less regulated cousin, the foreward contract), which allows the company to buy the Iron ore at a specific price at a set date in the future.

Now TATA STEEL can budget without worrying about the fluctuating commodity. If the Iron ore skyrockets above that price specified by the futures contract, the hedge will have paid off because TATA STEEL will save money by paying the lower price. However, if the price goes down, TATA STEEL is still obligated to pay the price in the contract and actually would have been better off not hedging.

Keep in mind that because there are so many different types of options and futures contracts an investor can hedge against nearly anything, whether a stock, commodity price, interest rate and currency - investors can even hedge against the weather.

The Downside
Every hedge has a cost, so before you decide to use hedging, you must ask yourself if the benefits received from it justify the expense. Remember, the goal of hedging isn't to make money but to protect from losses. The cost of the hedge - whether it is the cost of an option or lost profits from being on the wrong side of a futures contract - cannot be avoided. This is the price you have to pay to avoid uncertainty.

We've been comparing hedging versus insurance, but we should emphasize that insurance is far more precise than hedging. With insurance, you are completely compensated for your loss (usually minus a deductible). Hedging a portfolio isn't a perfect science and things can go wrong. Although risk managers are always aiming for the perfect hedge, it is difficult to achieve in practice.

What Hedging Means to You
The majority of investors will never trade a derivative contract in their life. In fact most buy-and-hold investors ignore short-term fluctuation altogether. For these investors there is little point in engaging in hedging because they let their investments grow with the overall market.

So why learn about hedging?

Even if you never hedge for your own portfolio you should understand how it works because many big companies and investment funds will hedge in some form. Oil companies, for example, might hedge against the price of oil while an international mutual fund might hedge against fluctuations in foreign exchange rates. An understanding of hedging will help you to comprehend and analyze these investments.

Risk is an essential yet precarious element of investing. Regardless of what kind of investor one aims to be, having a basic knowledge of hedging strategies will lead to better awareness of how investors and companies work to protect themselves. Whether or not you decide to start practicing the intricate uses of derivatives, learning about how hedging works will help advance your understanding the market, which will always help you be a better investor.

Monday, March 24, 2008

Systematic investment plan for stocks

There are very few points that everybody in this world agrees upon. And the stock market unpredictability is undoubtedly one of them. Even people with several years of experience are not always able to track the stock market dynamics, thus falling prey to faulty decisions.Watertight Stock market investing strategy is something that people consider to be elusive. It is something that can be chased, but probably can never be achieved.

But is it a correct notion? Are things like fate, luck, chance, etc., are the only deciding factors in the stock market investments? Or is there any way to approach the stock market in a speculative manner? The answer to the above question probably lies in the Systematic Investment Plan or SIP (a.k.a. "Periodic Payment Plan" or "Contractual Plan").

Systematic Investment Plan (SIP)

Unlike the one-time investment plans, SIP entails regular payments for a fixed period. It allows investors to garner shares of a mutual fund by contributing a fixed (which is often small) amount of money on a regular basis. And it offers the following advantages readily attractive to any investor.

Reduced Pressure On Your Purse

Through SIP you can enter the stock market even with a paltry investment. Your inability to invest a more-or-less fat amount might have kept you away from investing in stock market. SIP is an ideal solution for your problem.

Building For The Future

We have certain needs that can be addressed only through long-term investments. Such needs include children’s education, buying a house of your own, post-retirement emergencies, etc. And SIP offers precious help in this regard. It helps you to save a small amount on a regular basis. And in due time it turns into a substantial amount.

Compounds Returns

SIP not only helps you reach a substantial amount after a certain period of time. Rather it helps you to reach that amount at an early age, depending when you start investing. You can amass a notable amount at 70 if you start investing at 35. An earlier start at 25 can enable you achieve the same amount by 60.

Lowering The Average Cost

In SIP you experience low average cost, courtesy dollar-cost average. You invest the same fixed dollar amount in the same investment at regular intervals over an extended period of time. You are buying more shares of an investment when the share price is low. And you are buying fewer shares when the share price is high. And it may result in you paying a lower average price per share.

The dollar-cost averaging strategy does not try to time the market. Rather it reduces the risk of investing a larger amount in an investment at a wrong time. And it does the same by spreading your investments out over a period of months, years, or even decades.

Market Timing Irrelevance

The previous two paragraphs tell you that SIP makes the market timing irrelevant for you. The stock market unpredictability and volatility often play a deterrent for wannabe investors like you. In SIP, you are completely free from this problem of wrong timing.

The SIP’s Mode Of Function

A typical SIP entails monthly investments over a period of 10, 15 or 25 years. You are generally allowed to start your investment with a modest sum.

You do not have direct ownership of the funds. Rather you own an interest in the plan trust. The plan trust invests the investor's regular payments, after deducting applicable fees, in shares of a mutual fund.

Things That You Should Make Clear Before Investing In SIP

You should make certain things clear to yourself before going for an SIP investment. They include the following:

1. You should be confident about continuing to make payments for the term of the plan. Withdrawal in the mid way will almost certainly make you lose your money unless you are eligible for a full refund.

2. Check the fees charged by the plan. Also check the circumstances under which the plan waives or reduces certain fees.

3. Study the plan’s investment objectives. Take a note of the risks of investing in the plan. And check whether you are comfortable with them.

4. Check your statutory rights to a refund in case you cancel your plan. You can post your comments on the articles in this blog.

If you have any queries regarding any thing then reach me at

If you are beginner to stock market the start reading from the first article

Learn the types of stock trading

The stock market is a reliable indicator of the actual value of companies which issue stock. Values of stocks are based on verifiable financial data such as sales figures, assets and growth. This reliability makes the stock market a good choice for long term investing – well-run companies should continue to grow and provide dividends for their stockholders.

The stock market also provides opportunities for short-term investors. Market skittishness can cause prices to fluctuate quite rapidly and investor psychology can cause prices to fall or rise – even if there is no financial basis for these variations.

How does this happen? News reports, government announcements about the economy, and even rumors can cause investors to become nervous or to suspect that a company will increase in value.

When the price starts to fall or rise, other investors will jump on the bandwagon, causing an even faster acceleration in price. Eventually the market will correct itself, but for savvy short-term investors who watch the market closely, these price changes can offer opportunities for profitable trading.

Short term traders are divided into 3 categories: Position Traders, Swing Traders, and Day Traders.

Position Traders
Position trading is the longest term trading style of the three. Stocks could be held for a relatively long period of time compared with the other trading styles. Position traders expect to hold on to their stocks for anywhere from 5 days to 3 or 6 months. Position traders are watching for fundamental changes in value of a stock. This information can be gleaned from financial reports and industry analyses.

Position trading does not require a great deal of time. An examination of daily reports is enough to plan trading strategies. This type of trading is ideal for those who invest in the stock market to supplement their income. The time needed to study the stock market can be as little as 30 minutes a day and can be done after regular work hours.

Swing Traders
Swing traders hold stocks for shorter periods than position traders – generally from one to five days. The swing trader is looking for changes in the market that are driven more by emotion than fundamental value.

This type of trading requires more time than position trading but the payback is often greater. Swing traders usually spend about 2 hours a day researching stocks and executing orders. They need to be able to identify trends and pick out trading opportunities. They usually rely on daily and intraday charts to plot stock movements.

Day Traders
Day trading is commonly thought of as the most risky way to play the stock market. This may be true if the trader is uneducated, but those who know what they are doing know how to limit their risk and maximize their profit potential. Day trading refers to buying and selling stock in very short periods of time – less than a day but often as short as a few minutes.

Day traders rely on information that can influence price moves and have to plot when to get in and out of a position. Day traders need to be rational and analytical. Emotional buyers will quickly lose money in this type of trading. Because of the close attention needed to market conditions, day trading is a full-time profession.

Friday, March 21, 2008

10 Golden Rules for Successful Stock Market Trading

Your stock trading rules are your money. When you follow your rules you make money. However if you break your own stock trading rules the most likely outcome is that you will lose money.

Once you have a reliable set of stock trading rules it is important to keep them in mind. Here is one discipline that can reap rewards. Read these rules before your day starts and also read the rules when your day ends.

Rule 1: I must follow my rules.

Naturally if you develop a set of rules they are to be followed. It is human nature to want to vary or break rules and it takes discipline to continue to act in accordance with the established rules.

Rule 2: I will never risk more than 3% of my total portfolio on any one stock trade.

There are many old traders. There are many bold traders. But there are never any old bold traders. Protecting your capital base is fundamental to successful stock market trading over time.

Rule 3: I will cut my losses at 5% to 15% when I am wrong without question.

Some traders have an even lower tolerance for loss. The key point here is to have set points (stop loss) within the limits of your tolerance for loss. Stay informed about the performance of you stock and stick to your stop loss point.

Rule 4: Never set price targets.

This is a style that will allow me to get the most out of rising stocks. Simply let the profits run. Realistically, I can never pick tops. Never feel a stock has risen too high too quickly. Be willing to give back a good percentage of profits in the hope of much bigger profits.

The big money is made from trading the really BIG moves that I can occasionally catch.

Rule 5: Master one style.

Keep learning and getting better at this one method of trading. Never jump from one trading style to another. Master one style rather than become average at implementing several styles.

Rule 6: Let price and volume be my guides.

Never listen to any opinion about the stock market or individual stocks you are considering trading or are already trading. Everything is reflected in the price and volume.

Rule 7: Take all valid signals that show up.

Don't make excuses. If an entry signal shows up you have no excuse not to take it.

Rule 8: Never trade from intra-day data.

There is always stock price variation within the course of any trading day. Relying on this data for momentum trading can lead to some wrong decisions.

Rule 9: Take time out.

Successful stock trading is not solely about trading. It's also about emotional strength and physical fitness. Reduce the stress every day by taking time off the computer and working on other areas. A stressful trader will not make it in the long term.

Rule 10: Be an above average trader.

In order to succeed in the stock market you don't need to do anything exceptional. You simply need to not do what the average trader does. The average trader is inconsistent and undisciplined. Ask yourself every day, "Did I follow my method today?" If your answer is no then you are in trouble and it's time to recommit yourself to your stock trading rules.

Thursday, March 20, 2008

Is it time to invest in indian markets ?

The Indian stockmarket, along with the world markets, are currently facing challenging times. Worsening subprime crisis, slumping dollar, rising commodity prices especially crude and food and the slowdown of the US economy has led the indices to shed considerable losses and revert to the levels seen last year.

In this article, we shall take a look at how some of the sectoral indices have performed in the last three months.

Company Price on Jan 18,2008 (Rs) Price on Mar18,2008 (Rs) Change
BSE Sensex 19,014 14,995 -21.1%
BSE Bankex 11,372 7,495 -34.1%
BSE Capital 18,334 13,095 -28.6%
BSE Auto 5,148 4,398 -14.6%
BSE IT 3,791 3,370 -11.1%
BSE Healthcare 4,025 3,671 -8.8%
BSE FMCG 2,303 2,142 -7.0%

As seen from the table, the Sensex is down 22% with the BSE Bankex being the worst performer, and BSE FMCG index registering the least losses.

Banking: The ongoing credit crises have impacted the banking sector across the world. The collapse of the subprime mortgage market wiped out almost US$ 100 bn of value from the three biggest US banks in the past six months.

In India, though the banks do not have direct exposure to subprime, they have overseas exposure in credit derivative products through companies and therefore have to bear the brunt of mark to market losses.

ICICI Bank has reported marked-to-market losses of US$ 264 m in its overseas operations on account of its exposure to credit derivatives and investments at the end of January 2008. Even SBI and Bank Of Baroda have some exposure and the stocks have plunged 30% and 45% respectively since Jan 2008. The Rs 600 bn debt relief package announced in the budget was also instrumental in adding fuel to the fire.

Capital goods: There was significant heating up in the sector, leading to overvaluation of stocks in the past one year. Hence, any correction was imminent.

However, with the global liquidity crunch, corporates would find it difficult to raise capital for their execution plans, thereby affecting their performance.

Further, even the recent IIP numbers (2.1% in Apr 07-Jan 08 as against 16.3% in the corresponding period last year) led to the negative sentiments for the sector.

Auto: The sector, whose contribution to employment is among the highest, has not had a good run on the bourses. This can be attributed to the fact that the companies from the sector are facing pressure both on the costs as well as revenues front. The only exception could be passenger cars where volumes have seen a positive growth rate.

However, in the case of two-wheelers and CVs, higher interest rates and lack of adequate credit have meant that buyers have stayed away. Furthermore, spiraling prices of commodities have also impacted cost structures in a big way.

We believe that the sectoral index will have to put up with some more agony in the near term as there seems to be no relief on the horizon either in the form of lower interest rates or softening of commodity prices. The excise duty cuts recommended in the latest budget are also not having the desired impact.

Software: Even before the chaos had started in the Indian markets, the software sector was the worst hit on account of the appreciating rupee. And even now it continues to face pressure. The reason for the same can be attributed to the impending slowdown of the US economy.

The BFS (Banking and Financial Services) sector is the largest spender in IT in the US. With the ongoing credit crisis in the US, the spending on the BFS front is likely to reduce. Also, with the expected slowdown in the US, Indian IT companies have downgraded their volume growth for the coming quarters. Though the rupee has stabilized against the dollar in recent times, the overall scenario looks bleak.

Pharma and FMCG: Both the sectors are of defensive nature. This is because even in times of recession, people would continue to use daily products and medicines. With increasing income, growing consumerism and health awareness, the growth of these two sectors is expected to be robust. Also, given that the budget has been beneficial to these sectors, the outlook looks positive.

Summing it up…
Equities are a risky asset class. The last three months have indicated how volatile stock markets can be. However, as history has shown, while sentiments affect performance over a short period of time, in the long term, it is the fundamentals, which finally gets it going.

Hence, the weakness in the stockmarkets at present should be looked upon as an opportunity to invest in good quality stocks with strong fundamentals, sound managements and reasonable valuations from a long-term perspective.

8 investing tips in equities

The stock market 'meltdown' witnessed since the start of Jan 22nd 2008 (notwithstanding the recent marginal recovery) has once again brought to the forefront an inherent weakness existent in our markets. This is the fact that FIIs, indisputably and almost entirely, dominate the Indian stock market sentiments and consequently the market movements. In this article, we make an attempt to list down a few points that would aid an investor in mitigating the risks and curtailing the losses during times of volatility as large investors (read FIIs) enter and exit stocks.

it is primarily the retail/small investor community, which gets affected the worst as they are generally among the late entrants to a bullrun (i.e. near the peak) and amongst the last to exit in a correction. However, some amount of stock market prudence and a disciplined approach could go a long-way in protecting one's capital. Listed below are a few points.

1. Manage greed/fear: This is an important point, which every investor must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run - control the greed factor, which could entice you, the investor, to compromise with your investment principles.

By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-popping returns, it must be noted that these stocks have the potential to wipe out almost the entire invested capital. Another way greed affects investor behaviour is when they buy/hold stocks above the price justified by its fundamentals.

Similarly, in a vice-versa scenario (bear market), investors must control their fear when stock markets turn unfavourable and stock prices collapse. Panic selling would serve no purpose and if the company has strong fundamentals, the stock is more than likely to bounce back.

It is apt to note here what Warren Buffet, the legendary investor, had to say when he was asked about his abstinence from the software sector during the tech boom, "It means we miss a lot of very big winners but it also means we have very few big losers.... We're perfectly willing to trade away a big payoff for a certain payoff".

2. Avoid trading/timing the market: This is one factor, which many experts/investors claim to have understood but are more often wrong than right. We believe that it is rather impossible to time the market on a day-to-day basis and by adopting such an approach, an investor would most probably be at the losers' end at the end of the day.
In fact, investors should take advantage of the huge volatility that is witnessed in the markets time and again.

In Benjamin Graham's (pioneer of value investing and the person who influenced Warren Buffet) words, "Basically, price fluctuations have only one significant meaning for the 'true' investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market".

3. Avoid actions based on rumours/sentiments: Rumours are a part and parcel of stock markets, which do influence investor sentiments to some extent. However, investing on the basis of this could prove to be detrimental to an investors' portfolio, as these largely originate from sources with vested interests, which more often than not, turn out to be false. This then leads to carnage in the related stock(s) leaving retail investors in the lurch.

However, if we consider this from another point of view, when sentiments turn sour but fundamentals remain intact, investors could take the opportunity to build a fundamentally strong portfolio. This scenario is aptly described by Warren Buffet, "Be fearful when others are greedy and be greedy when others are fearful".

4. Avoid emotional attachment/averaging: It is very much possible that the company you have invested in fails to perform as per your expectations. This consequently gets reflected on the stock price.

However, in such a scenario, it would not be wise to continue to hold onto the stock/buy more at lower levels on the back of expectations that the company's performance may improve for the better and the stock would provide an opportunity to exit at higher levels.

Here it is advisable to switch to some other stock, which has promising prospects. In Warren Buffet's words, "Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks".

5.Avoid over-leveraging: This behaviour is typical in times of a bullrun when investors invest more than what they can manage with the hope of making smart returns on the borrowed money. Though this move may sound intelligent, it is smart only till the time markets display a unidirectional move (i.e. northwards).

However, things take a scary turn when the markets reverse direction or move sideways for a long time. This is because it leads to additional margin calls by the lender, which might force the investor to book losses in order to meet the margin requirements.

In a graver situation, a stock market fall could severely distort the asset allocation scenario of the investor putting his other finances at risk.

6.Keep Margin of Safety: In Benjamin Graham's words, "For ordinary stocks, the margin of safety lies in an expected 'earning power' considerably above the interest rates on debt instruments".

However, having a stock with a high margin of safety is no guarantee that the investor would not face losses in the future.
Businesses are subject to various internal and external risks, which may affect the earnings growth prospects of a company over the long-term.

But if a portfolio of stocks is selected with adequate margin of safety, the chances of losses over the long term are minimised. He further points out, "while losing some money is an inevitable part of investing, to be an 'intelligent investor,' you must take responsibility for ensuring that you never lose most or all of your money."

7.Follow research: The upswing in the stock markets attracts many retail investors into investing into equities. However, picking fundamentally strong stocks is not an easy task.

In fact, it is even more difficult to identify a stock in a bullish market, when much of the positives are already factored into the stock price, making them an expensive buy.

It is very important to understand here that owning a stock is in effect, owning a part of the company. Hence, a detailed and thorough research of the financial and business prospects of the company is a must.

Given the fact that on most occasions, research is influenced by vested interests, the need of the hour is unbiased research. Information is power and investors need to understand that unless impartially represented (in the form of research) it could be misleading and detrimental in the long run.

8.Invest for the long-term: Short-term stock price movements are affected by various factors including rumours, sentiments, market perception, liquidity, etc, however, in the long-term, stock price tends to align themselves with its fundamentals.

Here it must be noted what Benjamin Graham once said, " the short term, the market is a 'voting' machine (whereon countless individuals register choices that are product partly of reason and partly of emotion), however in the long-term, the market is a 'weighing' machine (on which the value of each issue (business) is recorded by an exact and impersonal mechanism)."

Of course, it must be noted that the above list is not exhaustive and there may be many more points that an investor needs to understand and follow in order to be a successful investor.

Further, the above points are not just a read but needs to be practiced on a consistent basis. While making wealth in the stock markets was never an effortless exercise, it becomes all the more difficult when stock markets/stock prices are at newer highs.

Tuesday, March 18, 2008

Top Investment Tenets For Rupee Millionaire

Michael Steinhardt was a prominent hedge fund manager of the 1970s. There were few investment instruments over which he did not wield mastery.

He formed a hedge fund company along with Howard Berkowitz and Jerrold Fine. Under Steinhardt’s direction, the firm was consistently successful in identifying macro market moves and then fitting its securities trading strategies into these situations.

Steinhardt and his partners achieved a performance track record that still stands out on Wall Street: 24 per cent compound average annual returns — more than double the S&P 500 — over a 28-year period.

What is more amazing is that Steinhardt accomplished this record with stocks, bonds, long and short options, currencies and time horizons ranging from 30 minutes to 30 days.

Below are his few quotable quotes:

“One dollar invested with me in 1967 would have been worth $481 on the day I closed the firm in 1995, versus $19 if it had been invested in a Standard & Poor’s index fund.”

“I always used fundamentals. But the fact is that often, the time frame of my investments was short-term.”

“I do an enormous amount of trading, not necessarily just for profit, but also because it opens up other opportunities. I get a chance to smell a lot of things. Trading is a catalyst.”

“One of the advantages of trading the way I do — being a long-term investor, short-term trader, individual stock selector, market timer, sector analyst — is that I have made so many decisions and mistakes that it has made me wise beyond my years as an investor”.

“Anyone who thinks he can formulate a success in this market is deluding himself because it changes too quickly. As soon as a formula is right for any length of time, its own success carries the weight of its inevitable failure.”

Michael Steinhardt’s top investment tenets are:

Make all your mistakes early in life. The more tough lessons early on, the fewer errors you make later.

Always make your living doing something you enjoy.

Be intellectually competitive. The key to research is to assimilate as much data as possible in order to be to the first to sense a major change.

Make good decisions even with incomplete information. You will never have all the information you need. What matters is what you do with the information you have.

Always trust your intuition, which resembles a hidden supercomputer in the mind. It can help you do the right thing at the right time if you give it a chance.

Don’t make small investments. If you’re going to put money at risk, make sure the reward is high enough to justify the time and effort you put into the investment decision.

Sunday, March 16, 2008

8 key ratios for picking good stocks

The following 8 financial ratios offer terrific insights into the financial health of a company -- and the prospects for a rise in its share price.
1. Ploughback and reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts -- dividends and ploughback.
Dividend is that portion of a company's profits which is distributed to its shareholders, whereas ploughback is the portion that the company retains and gets added to its reserves.
The figures for ploughback and reserves of any company can be obtained by a cursory glance at its balance sheet and profit and loss account.
Ploughback is important because it not only increases the reserves of a company but also provides the company with funds required for its growth and expansion. All growth companies maintain a high level of ploughback. So if you are looking for a growth company to invest in, you should examine its ploughback figures.
Companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
Reserves constitute the accumulated retained profits of a company. It is important to compare the size of a company's reserves with the size of its equity capital. This will indicate whether the company is in a position to issue bonus shares.
As a rule-of-thumb, a company whose reserves are double that of its equity capital should be in a position to make a liberal bonus issue.
Retained profits also belong to the shareholders. This is why reserves are often referred to as shareholders' funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price of your shares.
The higher the reserves, the greater will be the value of your shareholding. Retained profits (ploughback) may not come to you in the form of cash, but they benefit you by pushing up the price of your shares.
2. Book value per share
You will come across this term very often in investment discussions. Book value per share indicates what each share of a company is worth according to the company's books of accounts.
The company's books of account maintain a record of what the company owns (assets), and what it owes to its creditors (liabilities). If you subtract the total liabilities of a company from its total assets, then what is left belongs to the shareholders, called the shareholders' funds.
If you divide shareholders' funds by the total number of equity shares issued by the company, the figure that you get will be the book value per share.
Book Value per share = Shareholders' funds / Total number of equity shares issued
The figure for shareholders' funds can also be obtained by adding the equity capital and reserves of the company.
Book value is a historical record based on the original prices at which assets of the company were originally purchased. It doesn't reflect the current market value of the company's assets.
Therefore, book value per share has limited usage as a tool for evaluating the market value or price of a company's shares. It can, at best, give you a rough idea of what a company's shares should at least be worth.
The market prices of shares are generally much higher than what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under-priced. This is one way in which the book value per share ratio can prove useful to you while assessing whether a particular share is over- or under-priced.
3. Earnings per share (EPS)
EPS is a well-known and widely used investment ratio. It is calculated as:
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
This ratio gives the earnings of a company on a per share basis. In order to get a clear idea of what this ratio signifies, let us assume that you possess 100 shares with a face value of Rs 10 each in XYZ Ltd. Suppose the earnings per share of XYZ Ltd. is Rs 6 per share and the dividend declared by it is 20 per cent, or Rs 2 per share. This means that each share of XYZ Ltd. earns Rs 6 every year, even though you receive only Rs 2 out of it as dividend.
The remaining amount, Rs 4 per share, constitutes the ploughback or retained earnings. If you had bought these shares at par, it would mean a 60 per cent return on your investment, out of which you would receive 20 per cent as dividend and 40 per cent would be the ploughback. This ploughback of 40 per cent would benefit you by pushing up the market price of your shares. Ideally speaking, your shares should appreciate by 40 per cent from Rs 10 to Rs 14 per share.
This illustration serves to drive home a basic investment lesson. You should evaluate your investment returns not on the basis of the dividend you receive, but on the basis of the earnings per share. Earnings per share is the true indicator of the returns on your share investments.
Suppose you had bought shares in XYZ Ltd at double their face value, i.e. at Rs 20 per share. Then an EPS of Rs 6 per share would mean a 30 per cent return on your investment, of which 10 per cent (Rs 2 per share) is dividend, and 20 per cent (Rs 4 per share) the ploughback.
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company's shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.
4. Price earnings ratio (P/E)
The price earnings ratio (P/E) expresses the relationship between the market price of a company's share and its earnings per share:
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company's EPS remaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment.
P/E ratio is a reflection of the market's opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios.
For example, blue chip companies often have P/E ratios that are as high as 20 to 60. However, most other companies in India have P/E ratios ranging between 5 and 20.
On the face of it, it would seem that companies with low P/E ratios would offer the most attractive investment opportunities. This is not always true. Companies with high current earnings but dim future prospects often have low P/E ratios.
Obviously such companies are not good investments, notwithstanding their P/E ratios. As an investor your primary concern is with the future prospects of a company and not so much with its present performance. This is the main reason why companies with low current earnings but bright future prospects usually command high P/E ratios.
To a great extent, the present price of a share, discounts, i.e. anticipates, its future earnings.
All this may seem very perplexing to you because it leaves the basic question unanswered: How does one use the P/E ratio for making sound investment decisions?
The answer lies in utilising the P/E ratio in conjunction with your assessment of the future earnings and growth prospects of a company. You have to judge the extent to which its P/E ratio reflects the company's future prospects.
If it is low compared to the future prospects of a company, then the company's shares are good for investment. Therefore, even if you come across a company with a high P/E ratio of 25 or 30 don't summarily reject it because even this level of P/E ratio may actually be low if the company is poised for meteoric future growth. On the other hand, a low P/E ratio of 4 or 5 may actually be high if your assessment of the company's future indicates sharply declining sales and large losses.
5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends -- capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money -- it doesn't really matter whether it comes from capital appreciation or from dividends.
A wise investor is primarily concerned with the total returns on his investment -- he doesn't really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long-term capital appreciation because of tax considerations.
Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth.
On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.
On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends. In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade-off between capital appreciation and income.
Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company's shares. This relationship is best expressed by the ratio called yield or dividend yield:
Yield = (Dividend per share / market price per share) x 100
Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.
Let us suppose you have invested Rs 2,000 in buying 100 shares of XYZ Ltd at Rs 20 per share with a face value of Rs 10 each.
If XYZ announces a dividend of 20 per cent (Rs 2 per share), then you stand to get a total dividend of Rs 200. Since you bought these shares at Rs 20 per share, the yield on your investment is 10 per cent (Yield = 2/20 x 100). Thus, while the dividend was 20 per cent; but your yield is actually 10 per cent.
The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your shares.
Average yield figures in India usually vary around 2 per cent of the market value of the shares. If you have a share portfolio consisting of shares belonging to a large number of both high-growth and high-dividend companies, then on an average your dividend in-come is likely to be around 2 per cent of the total market value of your portfolio.
6. Return on Capital Employed (ROCE), and
7. Return on Net Worth (RONW)
While analysing a company, the most important thing you would like to know is whether the company is efficiently using the capital (shareholders' funds plus borrowed funds) entrusted to it.
While valuing the efficiency and worth of companies, we need to know the return that a company is able to earn on its capital, namely its equity plus debt. A company that earns a higher return on the capital it employs is more valuable than one which earns a lower return on its capital. The tools for measuring these returns are:
1. Return on Capital Employed (ROCE), and
2. Return on Net Worth (RONW).
Return on Capital Employed and Return on Net Worth (shareholders funds) are valuable financial ratios for evaluating a company's efficiency and the quality of its management. The figures for these ratios are commonly available in business magazines, annual reports and economic newspapers and financial Web sites.
Return on capital employed
Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt).
The figure for operating profit is arrived at after adding back taxes paid, depreciation, extraordinary one-time expenses, and deducting extraordinary one-time income and other income (income not earned through mainline operations), to the net profit figure.
The operating profit of a company is a better indicator of the profits earned by it than is the net profit.
ROCE thus reflects the overall earnings performance and operational efficiency of a company's business. It is an important basic ratio that permits an investor to make inter-company comparisons.
Return on net worth
Return on net worth (RONW) is defined as net profit divided by net worth. It is a basic ratio that tells a shareholder what he is getting out of his investment in the company.
ROCE is a better measure to get an idea of the overall profitability of the company's operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.
The use of both these ratios will give you a broad picture of a company's efficiency, financial viability and its ability to earn returns on shareholders' funds and capital employed.
8. PEG ratio
PEG is an important and widely used ratio for forming an estimate of the intrinsic value of a share. It tells you whether the share that you are interested in buying or selling is under-priced, fully priced or over-priced.
For this you need to link the P/E ratio discussed earlier to the future growth rate of the company. This is based on the assumption that the higher the expected growth rate of the company, the higher will be the P/E ratio that the company's share commands in the market.
The reverse is equally true. The P/E ratio cannot be viewed in isolation. It has to be viewed in the context of the company's future growth rate. The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company.
As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter.
The catch here is to accurately calculate the future growth rate of earnings (EPS) of the company. Wide and intensive reading of investment and business news and analysis, combined with experience will certainly help you to make more accurate forecasts of company earnings.

How the sensex is calculated

For the premier Bombay Stock Exchange that pioneered the stock broking activity in India, 128 years of experience seems to be a proud milestone. A lot has changed since 1875 when 318 persons became members of what today is called The Stock Exchange, Mumbai by paying a princely amount of Re 1.

Since then, the country's capital markets have passed through both good and bad periods. The journey in the 20th century has not been an easy one. Till the decade of eighties, there was no scale to measure the ups and downs in the Indian stock market. The Stock Exchange, Mumbai in 1986 came out with a stock index that subsequently became the barometer of the Indian stock market.

Sensex is not only scientifically designed but also based on globally accepted construction and review methodology. First compiled in 1986, Sensex is a basket of 30 constituent stocks representing a sample of large, liquid and representative companies.
The base year of Sensex is 1978-79 and the base value is 100.

The index is widely reported in both domestic and international markets through print as well as electronic media. The Index was initially calculated based on the "Full Market Capitalization" methodology but was shifted to the free-float methodology with effect from September 1, 2003. The "Free-float Market Capitalization" methodology of index construction is regarded as an industry best practice globally. All major index providers like MSCI, FTSE, STOXX, S&P and Dow Jones use the Free-float methodology. (See below: Explanation with an example)

Due to is wide acceptance amongst the Indian investors; Sensex is regarded to be the pulse of the Indian stock market. As the oldest index in the country, it provides the time series data over a fairly long period of time (From 1979 onwards). Small wonder, the Sensex has over the years become one of the most prominent brands in the country.

The growth of equity markets in India has been phenomenal in the decade gone by. Right from early nineties the stock market witnessed heightened activity in terms of various bull and bear runs. The Sensex captured all these events in the most judicial manner. One can identify the booms and busts of the Indian stock market through Sensex.

Sensex Calculation Methodology
Sensex is calculated using the "Free-float Market Capitalization" methodology. As per this methodology, the level of index at any point of time reflects the Free-float market value of 30 component stocks relative to a base period. The market capitalization of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalization is further multiplied by the free-float factor to determine the free-float market capitalization.

The base period of Sensex is 1978-79 and the base value is 100 index points. This is often indicated by the notation 1978-79=100. The calculation of Sensex involves dividing the Free-float market capitalization of 30 companies in the Index by a number called the Index Divisor.
The Divisor is the only link to the original base period value of the Sensex. It keeps the Index comparable over time and is the adjustment point for all Index adjustments arising out of corporate actions, replacement of scrips etc. During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate Sensex every 15 seconds and disseminated in real time.
BSE also calculates a dollar-linked version of Sensex and historical values of this index are available since its inception.

Understanding Free-float Methodology
Free-float Methodology refers to an index construction methodology that takes into consideration only the free-float market capitalisation of a company for the purpose of index calculation and assigning weight to stocks in Index. Free-float market capitalization is defined as that proportion of total shares issued by the company that are readily available for trading in the market.

It generally excludes promoters' holding, government holding, strategic holding and other locked-in shares that will not come to the market for trading in the normal course. In other words, the market capitalization of each company in a Free-float index is reduced to the extent of its readily available shares in the market.

In India, BSE pioneered the concept of Free-float by launching BSE TECk in July 2001 and Bankex in June 2003. While BSE TECk Index is a TMT benchmark, Bankex is positioned as a benchmark for the banking sector stocks. Sensex becomes the third index in India to be based on the globally accepted Free-float Methodology.
Suppose the Index consists of only 2 stocks: Stock A and Stock B.
Suppose company A has 1,000 shares in total, of which 200 are held by the promoters, so that only 800 shares are available for trading to the general public. These 800 shares are the so-called 'free-floating' shares.
Similarly, company B has 2,000 shares in total, of which 1,000 are held by the promoters and the rest 1,000 are free-floating.
Now suppose the current market price of stock A is Rs 120. Thus, the 'total' market capitalisation of company A is Rs 120,000 (1,000 x 120), but its free-float market capitalisation is Rs 96,000 (800 x 120).
Similarly, suppose the current market price of stock B is Rs 200. The total market capitalisation of company B will thus be Rs 400,000 (2,000 x 200), but its free-float market cap is only Rs 200,000 (1,000 x 200).
So as of today the market capitalisation of the index (i.e. stocks A and B) is Rs 520,000 (Rs 120,000 + Rs 400,000); while the free-float market capitalisation of the index is Rs 296,000. (Rs 96,000 + Rs 200,000).
The year 1978-79 is considered the base year of the index with a value set to 100. What this means is that suppose at that time the market capitalisation of the stocks that comprised the index then was, say, 60,000 (remember at that time there may have been some other stocks in the index, not A and B, but that does not matter), then we assume that an index market cap of 60,000 is equal to an index-value of 100.
Thus the value of the index today is = 296,000 x 100/60,000 = 493.33
This is how the Sensex is calculated.
The factor 100/60000 is called index divisor.

The 30 Sensex stocks are:
ACC, Ambuja Cements, Bajaj Auto, BHEL, Bharti Airtel , Cipla, DLF, Grasim Industries, HDFC , HDFC Bank, Hindalco Industries , Hindustan Lever , ICICI Bank , Infosys, ITC, Larsen & Toubro, Mahindra & Mahindra, Maruti Udyog , NTPC, ONGC , Ranbaxy Laboratories, Reliance Communications , Reliance Energy, Reliance Industries , Satyam Computer Services , State Bank of India, Tata Consultancy Services , Tata Motors , Tata Steel , and Wipro .

Mutual funds concepts

Mutual Funds
A mutual fund is a common pool of money into which investors with common investment objectives place their contributions that are to be invested, in accordance with the stated objective of the scheme. The investment manager invests the money collected into assets that are defined by the stated objective of the scheme.
For example, an Equity fund would invest in Equity and Equity related instruments and a Debt fund would invest in Bonds, Debentures, Gilts etc.
What are Mutual Funds
Mutual Funds in India-Growing from very Modest BeginningsThe Indian Mutual fund industry has started opening up many exciting investment opportunities for Indian investors. We have started witnessing the phenomenon of savings now being entrusted to the funds rather than in banks alone.Mutual Funds now represent perhaps one of the most appropriate investment opportunities for most investors. As financial markets become more sophisticated and complex, investors need a financial intermediary who can provide the required knowledge and professional expertise on taking informed decisions.
The Indian Mutual fund industry has passed through three phases:The first phase was between 1964 and 1987 when Unit Trust of India was the only player. By the end of 1988, UTI had total assets worth Rs.6,700 crores.The second phase was between 1987 and 1993, during which period, 8 funds were established (6 by banks and one each by LIC and GIC).
The total number of schemes went up to 167 and Assets Under Management saw the figures improving to over 61,000 crores.The third phase was marked by the entry of private and foreign sectors in the Mutual fund industry in 1993. The first entrant was Kothari Pioneer Mutual fund, launched in association with a foreign fund.

The Securities and Exchange Board of India (SEBI) formulated the Mutual Fund Regulation in 1996, which for the first time established a comprehensive regulatory framework for the mutual fund industry. Since then several mutual funds have been set up by the private and joint sectors. Currently there are 34 Mutual Fund organizations in India. Today the AUM of the Mutual Fund Industry stands at over Rs.2 lakh crores, a growth of over 1 lakh crores since the last 5 years. Also the percentage of Equity assets in the overall AUM has increased from a shade under 5% to over 30% in the same period.

What are the types of Mutual Funds
(I) Mutual Funds Classification based on Investment Objective:
1.Equity Oriented
a. General Purpose
The investment objectives of general-purpose Equity schemes does not restrict these funds from investing only in specific industries or sectors. Hence these funds have a diversified portfolio of companies spread across a vast spectrum of industries. While these schemes are exposed to equity price risks, diversified general-purpose equity funds seek to reduce the sector or stock specific risks through diversification. They mainly have market risk exposure.
b. Sector Specific
These schemes restrict their investing to one or more pre-defined sectors, e.g. technology sector. Since they depend upon the performance of select sectors only, these schemes are inherently more risky than general-purpose schemes. They are best suited for informed investors who wish to take a view and risk on the concerned sector.
c. Special schemes
Index schemes
The primary purpose of an Index is to serve as a measure of the performance of the market as a whole, or a specific sector of the market. An Index also serves as a relevant benchmark to evaluate the performance of Mutual Funds. Some investors are interested in investing in the market in general rather than investing in any specific fund. Such investors are happy to receive the returns posted by the markets. As it is not practical to invest in each and every stock in the market in proportion to its size, these investors are comfortable investing in a fund that they believe is a good representative of the entire market. Index Funds are launched and managed for such investors.
Tax saving schemes
Investors (Individuals and Hindu Undivided Families ("HUFs") are now encouraged to invest in Equity markets through Equity Linked Savings Scheme (ELSS) by offering them a tax rebate. Units purchased cannot be assigned / transferred/ pledged / redeemed / switched - out until completion of 3 years from the date of allotment of the respective Units.The Scheme is subject to Securities & Exchange Board of India (Mutual Funds) Regulations, 1996 and the notifications issued by the Ministry of Finance (Department of Economic Affairs), Government of India regarding ELSS.Investments in ELSS schemes are eligible for deduction under Sec 80C.An example of ELSS scheme is the Kotak ELSS scheme.

Real Estate Funds
Specialized real estate funds would invest in real estates directly, or may fund real estate developers or lend to them directly or buy shares of housing finance companies or may even buy their securitized assets.
2. Debt Based
These schemes, (also commonly referred to as Income Schemes), invest in debt securities such as corporate bonds, debentures and government securities. The prices of these schemes tend to be more stable as compared to Equity schemes. Most of the returns to the investors are generated through dividends or steady capital appreciation in these schemes. These schemes are ideal for conservative investors or those not in a position to take higher Equity risks, such as retired individuals. However, when compared to the money market schemes they do have a higher price fluctuation risk.
a. Income Schemes
These schemes invest in money markets, bonds and debentures of corporates with medium and long-term maturities. These schemes primarily target current income instead of capital appreciation. Hence they distribute a substantial part of their distributable surplus to the investor by way of dividend distribution. Such schemes usually declare quarterly dividends and are suitable for conservative investors who have medium to long-term investment horizon and are looking for regular income through dividend or steady capital appreciation.
b. Liquid Income Schemes
Liquid Income Schemes are similar to the Income schemes but have a shorter maturity period.
c. Money Market Schemes
These schemes invest in short term instruments such as commercial paper ("CP"), certificates of deposit ("CD"), treasury bills ("T-Bill") and overnight money ("Call"). The schemes are the least volatile of all the types of schemes because of their investments in money market instruments with short-term maturities. These schemes have become popular with institutional investors and high net worth individuals having short-term surplus funds.
d. Gilt Funds
These schemes primarily invest in Government securities. Hence the investor usually does not have to worry about credit risk since Government Debt is generally credit risk free.
3. Hybrid Scheme
These schemes are commonly known as balanced schemes and invest in both equities as well as debt. By investing in a mix of this nature, balanced schemes seek to attain the objective of income and moderate capital appreciation and are ideal for investors with a conservative, long-term orientation.
(II) Mutual Fund Investment Based on Constitution:
1. Open-ended schemes
Open-ended schemes do not have a fixed maturity period. Investors can buy or sell units at NAV-related prices from and to the mutual fund, on any business day. These schemes have unlimited capitalization, do not have a fixed maturity date, there is no cap on the amount you can buy from the fund and the unit capital can keep growing. These funds are not generally listed on any exchange.
Open-ended schemes are preferred for their liquidity. Such funds can issue and redeem units any time during the life of a scheme. Hence, unit capital of open-ended funds can fluctuate on a daily basis. The advantages of open-ended funds over close-ended are as follows:

Ø An any time exit option, the issuing company directly takes the responsibility of providing an entry and an exit. This provides ready liquidity to the investors and avoids reliance on transfer deeds, signature verifications and bad deliveries.
Ø An any time entry option, an open-ended fund allows one to enter the fund at any time and even to invest at regular intervals.
2. Close-ended schemes
Close-ended schemes have fixed maturity periods. Investors can buy into these funds during the period when these funds are open in the initial issue. After that, such schemes cannot issue new units except in case of bonus or rights issue. However, after the initial issue, you can buy or sell units of the scheme on the stock exchanges where they are listed. The market price of the units could vary from the NAV of the scheme due to demand and supply factors, investors' expectations and other market factors.

3. Interval schemes
These schemes combine the features of open-ended and closed-ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV based prices.
Who can invest in Mutual Funds
Mutual Funds in India are open to investment by
1. Residents including
a. Resident Indian Individuals
b. Indian Companies
c. Indian Trusts / Charitable Institutions
d. Banks
e. Non-Banking Finance Companies
f. Insurance Companies
g. Provident Funds
2. Non-Residents including
a. Non-resident Indians, and
b. Other Corporate Bodies
3. Foreign entities, viz.
a. Foreign Institutional Investors (FIIs) registered with SEBI.

However some category of investors are not allowed to invest in particular schemes of certain funds. Besides the investors who are eligible to invest may still need to follow different procedures.

CHOOSING THE RIGHT MUTUAL FUND: is your one-stop investment destination, offering you investment opportunities in a host of financial instruments; with products like Easy IPO, Easy Derivatives, Easy Equity, Easy Mutual Fund. Further more, our offerings are customized to suit your investment profile, hence you can meet your investment objectives.Added to this our , extensive research and wide range of products would cater to your needs and objectives.
1. Past performance
While past performance is not an indicator of the future it does throw some light on the investment philosophies of the fund, how it has performed in the past and the kind of returns it is offering to the investor over a period of time. It would also make sense to check out the two-year and one-year returns for consistency. Statistics such as how 'these funds had performed in the bull and bear markets of the immediate past?' would shed light on the strength of a fund. Tracking the fund's performance in the bear market is particularly important because the true test of a portfolio is often revealed in how little it falls during a bearish phase.
2. Know your fund manager
The success of a fund to a great extent, depends on the fund manager. Some of the most successful Funds are run by the same fund managers. It would be sensible to always ask about the fund manager before investing, knowing about changes in the Fund Manager's strategy or any other significant developments that an AMC may have undergone. For instance, if the portfolio manager who generated the fund's successful performance is No longer managing that particular fund, one would do well to look into the implications and analyze what the pros and cons of investing in that fund.
3. Does the scheme suit your risk profile?
Certain sector-specific schemes come with a high-risk high-return tag. Such plans are suspect to crashes in case the industry/sector loses the market's fancy. If the investor is totally risk averse, he can opt for pure debt schemes with little or no risk. Most investors prefer the balanced schemes, which invest in a combination of equities and debts. Growth and pure equity plans give greater returns than pure debt plans, but their risks are higher.

4. Read the prospectus
The prospectus says a lot about the fund. Reading the fund's prospectus is a must to learn about its investment strategy and the risk that it is prone to. Funds with higher rates of return may carry a higher element of risk. Hence, it is of utmost importance that an investor always chooses a particular scheme after considering his financial goals and weighs them against the risk that a Mutual Fund may take while investing in a particular sector. However, all funds carry some level of risk. Just because a fund invests in Government or Corporate bonds does not mean that it does not have significant risk.

5. Fund Diversification
While choosing a mutual fund, one should always consider factors like the extent of diversification that a Mutual Fund offers. Maintaining a diversified and balanced portfolio is a key to maintaining an acceptable level of risk. Generally the more diversified a fund; the lesser is its susceptibility to get affected by one particular sector/industry's fall.
6. Costs
A fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over a period of time. Finally, an investor must be careful not to pick a fund simply because it has shown a spurt in value in the current rally. It would be advisable to ferret out information regarding a fund for at least three years. The one thing to remember while investing in Equity funds is that it makes no sense to get in and out of a fund with each turn of the market. Like stocks, the right Equity Mutual Fund will pay off big -- if you have the patience. Similarly, it makes little sense to hold on to a fund that lags behind the total market year after year.
What is NAV
Net Asset Value (NAV) denotes the performance of a particular scheme of a mutual fund.Mutual funds invest the money collected from the investors in the securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on day-to-day basis.
NAV= The market value of securities of a scheme / Total number of units of the scheme on any particular date.
For example, if the market value of securities of a Mutual Fund scheme is Rs.200 lakhs and it has issued 10 lakh units of Rs.10 each, to the investors, then the NAV per unit of the fund is Rs.20. NAV is required to be disclosed by the Mutual Funds on a regular basis - daily or weekly - depending on the type of scheme.
Tax Aspects of Mutual funds
Tax Implications of Dividend Income
Equity Schemes
Equity Schemes are schemes, which have more than 50 per cent investments in Equity shares of domestic companies.As far as Equity Schemes are concerned, no Distribution Tax is payable on dividend. In the hands of the investors, dividend is tax-free.
Other Schemes
For schemes other than Equity, in the hands of the investors, dividend is tax-free.However, Distribution Tax on dividend @ 12.81% is to be paid by Mutual Funds.
Tax Implications of Capital Gains
The difference between the sale consideration (selling price) and the cost of acquisition (purchase price) of the asset is called capital gain. If the investor sells his units and earns capital gains, he is liable to pay capital gains tax.Capital gains are of two types: Short Term and Long Term Capital Gains.
Short Term Capital Gains
If the holding period of the Mutual Fund units is less than or equal to 12 months from the date of allotment of units, then short term capital gains is applicable.On Short Term capital gains, no Indexation benefit is applicable.
Tax and TDS Rate (excluding surcharge)
Resident Indians and Domestic Companies
The Gain will be added to the total income of the Investor and taxed at the marginal rate of tax. No TDS.
For NRIs: 10% TDS from the gain for equity schemes and 30% for debt schemes.
Long Term Capital Gains
The holding period of Mutual Fund units is more than 12 months, from the date of allotment of units.On Long Term capital gains Indexation benefit is applicable.
Tax and TDS Rate (excluding surcharge)
Resident Indians and Domestic Companies
The Gain will be taxed
A) At 20% with indexation benefit for debt funds
At 10% without indexation benefit, whichever is lower for debt funds. This does not include TDS.

B) No Long-term Capital Gain tax on equity funds.
A) 20% TDS from the Gain only for debt funds.
B) No tax on Long-term Capital Gains for equity funds
Surcharge applicable
Resident Indians: If the Gain exceeds Rs.8.5 lakhs, surcharge is payable by investors @ 10%. Domestic Companies: Payable by the investor @ 2.5%.
NRIs: If the Gain from the Fund exceeds Rs 8.5 lakhs, surcharge is deducted at source @ 2.5%

Risk Vs Reward
Having understood the basics of Mutual Funds, the next step is to build a successful investment portfolio. Before one begins to build a portfolio, one should understand some other elements of Mutual Fund investing and how they can affect the potential value of investments over the years. The first thing that has to be kept in mind while investing, is that there is no guarantee that one will end up with more money while withdrawing. In other words, the potential of loss is always there. The loss of value in investments, is what is considered risk in investing.

At the cornerstone of investing is the basic principal that the greater the risk you take, the greater the potential reward.
Risk then, refers to the volatility - the up and down activity in the markets and individual issues that occur constantly over a period of time. This volatility can be caused by a number of factors - interest rate changes, inflation or general economic conditions. It is this variability, uncertainty and potential for loss, that causes investors to worry. We all fear the possibility that a stock we invest in will fall substantially. But it is this very volatility that earns higher long-term returns from these investments, than from a savings account.

Different types of mutual funds have different levels of volatility or potential price, and those with the greater chance of losing value are also the funds that can produce the greater returns for you over time. So risk has two sides: it causes the value of your investments to fluctuate, but it is precisely the reason you can expect to earn higher returns.

One might find it helpful to remember that all financial investments will fluctuate. There are very few perfectly safe havens and those simply don't pay enough to beat inflation over the long run.
Types of risks
All investments involve some form of risk. Mentioned below are the common types of risks. An investor would do well to evaluate them against potential rewards while selecting an investment. Market Risk
At times, the prices or yields of all the securities in a particular market rise or fall due to broad outside influences. When this happens, the stock prices of both an outstanding, highly profitable company and a fledgling corporation may be affected. This change in price is due to "market risk". It is also known as systematic risk.
Inflation Risk
Sometimes referred to as "loss of purchasing power." Whenever inflation rises forward faster than the earnings on your investment, one runs the risk of actually being able to buy less, not more. Inflation risk also occurs when prices rise faster than returns.
Credit Risk
In short, how stable is the company or entity to which one lends his/her money while investing? How certain are you that it will be able to pay the interest you are promised, or repay your principal when the investment matures?
Interest Rate Risk
Changing interest rates affect both Equities and bonds in many ways. Investors are reminded that "predicting" which way rates will go, is rarely successful. A diversified portfolio can help in offsetting these changes.
Exchange risk
A number of companies generate revenues in foreign currencies and may have investments or expenses also denominated in foreign currencies. Changes in exchange rates may, therefore, have a positive or negative impact on companies which in turn would have an effect on the investment of the fund.
Investment Risks
In sectoral fund schemes, investments will be predominantly in Equities of select companies in the particular sectors. Accordingly, the NAV of the schemes are linked to the equity performance of such companies and may be more volatile than a more diversified portfolio of Equities.

What are Futures & Options (Derivatives)?

What are Derivatives?
A derivative is a financial instrument whose value depends on the values of other underlying variables. As the name suggests it derives its value from an underlying asset. For Ex-a derivative, may be created for a share, or any material object. The most common underlying assets include stocks, bonds, commodities etc.
Let us try and understand a Derivatives contract with an example:
Anil buys a futures contract in the scrip "Satyam Computers". He will make a profit of Rs.500 if the price of Satyam Computers rises by Rs 500. If the price remains unchanged Anil will receive nothing. If the stock price of Satyam Computers falls by Rs 800 he will lose Rs 800.

As we can see, the above contract depends upon the price of the Satyam Computers scrip, which is the underlying security. Similarly, futures trading can be done on the indices also. Nifty futures is a very commonly traded derivatives contract in the stock markets. The underlying security in the case of a Nifty Futures contract would be the Index-Nifty.

What are the different types of Derivatives?
Derivatives are basically classified into the following:
Futures /Forwards
What are Futures?
A futures contract is a type of derivative instrument, or financial contract where two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price.
The example stated below will simplify the concept:
Ravi wants to buy a Laptop, which costs Rs 50,000 but owing to cash shortage at the moment, he decides to buy it at a later period say 2 months from today.However,he feels that after 2 months the prices of Lap tops may increase due to increase in input/Manufacturing costs .To be on the safer side, Ravi enters into a contract with the Laptop Manufacturer stating that 2 months from now he will buy the Laptop for Rs 50,000. In other words he is being cautious and agrees to buy the Laptop at today's price 2 months from now.The forward contract thus entered into will be settled at maturity. The manufacturer will deliver the asset to Ravi at the end of two months and Ravi in turn will pay cash delivery.
Thus a forward contract is the simplest mode of a derivative transaction. It is an agreement to buy or sell a specific quantity of an asset at a certain future time for a specified price. No cash is exchanged when the contract is entered into.

What are Index Futures?
As Stated above, Futures are derivatives where two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. Index futures are futures contracts where the underlying is a stock index (Nifty or Sensex) and helps a trader to take a view on the market as a whole.

What is meant by Lot size?
Lot size refers to the quantity in which an investor in the markets can trade in a derivative of a particular scrip.For Ex-Nifty Futures have a lot size of 100 or multiples of 100.Hence if a person were to buy 1 lot of Nifty Futures , the value would be 100*Nifty Index Value at that point of time.
Similarly lots of other scrips such as Infosys, reliance etc can be bought and each may have a different lot size. NSE has fixed the minimum value as two lakhs for an Futures and Options contract. Lot sizes are fixed accordingly which will be the minimum shares on which a trader can hold positions.

What is meant by expiry period in Futures?
Each contract entered into has an expiry period. This refers to the period within which the futures contract must be fulfilled. Futures contracts may have durations of 1 month,2 months or at the most 3 months. Each contract expires on the last Thursday of the expiry month and simultaneously a new contract is introduced for trading after expiry of a contract.

What are options?
Before you begin options trading it is critical to have a clear idea of what you hope to accomplish. Only then will you be able to narrow down on an options trading strategy. Let us first understand the concept of options.
An option is part of a class of securities called derivatives.
The concept of options can be explained with this example. For instance, when you are planning to buy some property you might have placed a nonrefundable deposit to hold it for a short time while you evaluate other options. That is an example of a type of option.

Similarly, you have probably heard about Bollywood buying an option on a novel. In 'optioning the novel,' the director has bought the right to make the novel into a movie before a specified date. In both cases, with the house and the script, somebody put down some money for the right to buy a product at a specific price before a specific date.

Buying a stock option is quite similar. Options are contracts that give the holder the right to buy or sell a fixed amount of a certain stock at a specified price within a specified time. A put option gives the holder the right to sell the security, a call option gives the right to buy the security. However, this type of contract gives the holder the right, but not the obligation to trade stock at a specific price before a specific date.

Several individual investors find options useful tools because they can be used either as:
A) A type of leverage or
B) A type of insurance.
Trading in options lets you benefit from a change in the price of the share without having to pay the full price of the share. They provide you with limited control over the shares of a stock with substantially less capital than would be required to buy the shares outright.

When used as insurance, options can partially protect you from the specific security's price fluctuations by granting you the right to buy or sell shares at a fixed price for a limited amount of time.

Options are inherently risky investment vehicles and are suitable only for experienced and knowledgeable investors who are prepared to closely monitor market conditions and are financially prepared to assume potentially substantial losses.

What are the different types of Options? How can Options be used as a strategic measure to make profits/reduce losses?
Options may be classified into the following types:
a) Call Option
b) Put Option

As mentioned before, there are two types of options, calls and puts. A call option gives the holder the right to buy the underlying stock at the strike price anytime before the expiration date. Generally Call options increase in value as the value of the underlying instrument increases.

By contrast, the put option gives the holder the right to sell shares of the underlying stock at the strike price on or before the expiry date. The put option gains in value as the value of the underlying instrument decreases. A put option is one where one can insure a stock against subsequent price fall. If the value of your stocks goes down, you can exercise your put option and sell it at the price level decided upon earlier. If in case the stock price moves higher, all you lose is just the premium amount that was paid.
Note that in newspaper and online quotes you will see calls abbreviated as C and puts abbreviated as P.

The examples stated below will explain the use of Put options clearly:

Case 1:
Rajesh purchases 1 lot of Infosys Technologies MAY 3000 Put and pays a premium of 250 This contract allows Rajesh to sell 100 shares of Infosys at Rs 3000 per share at any time between the current date and the end of May.Inorder to avail this privilege, all Rajesh has to do is pay a premium of Rs 25,000 (Rs 250 a share for 100 shares).
The buyer of a put has purchased a right to sell. The owner of a put option has the right to sell.

Case 2:
If you are of the opinion that a particular stock say "Ray Technologies" is currently overpriced in the month of February and hence expect that there will be price corrections in the future. However you don't want to take a chance , just in case the prices rise. So here your best option would be to take a Put option on the stock.

Lets assume the quotes for the stock are as under:
Spot Rs 1040
May Put at 1050 Rs 10
May Put at 1070 Rs 30
So you purchase 1000 "Ray Technologies" Put at strike price 1070 and Put price of Rs 30/-. You pay Rs 30,000/- as Put premium.

Your position in two different scenarios have been discussed below:
1. May Spot price of Ray Technologies = 1020
2. May Spot price of Ray Technologies = 1080

In the first situation you have the right to sell 1000 "Ray Technologies" shares at Rs 1,070/- the price of which is Rs 1020/-. By exercising the option you earn Rs (1070-1020) = Rs 50 per Put, which amounts to Rs 50,000/-. Your net income in this case is Rs (50000-30000) = Rs 20,000.

In the second price situation, the price is more in the spot market, so you will not sell at a lower price by exercising the Put. You will have to allow the Put option to expire unexercised. In the process you only lose the premium paid which is Rs 30,000.

what is open interest?
The total number of option contracts and/or futures contracts that are not closed or delivered on a particular day and hence remain to be exercised, expired or fulfilled through delivery is called open interest.

What are Index Futures?
As Stated above, Futures are derivatives where two parties agree to transact a set of financial instruments or physical commodities for future delivery at a particular price. Index futures are futures contracts where the underlying is a stock Index (Nifty or Sensex) and helps a trader to take a view on the market as a whole.

What is meant by the terms Option Premium, strike price and spot price?
The price that a person pays for a call option/Put Option is called the Option Premium. It secures the right to buy/sell that particular stock at a specified price called the strike price. In other words the strike price is the specified price at which the holder of a stock option may purchase the stock. If you decide not to use the option to buy the stock, and you are not obligated to, your only cost is the option premium. Premium of an option = Option's intrinsic value + Options time value The stated price per share for which underlying stock may be purchased (for a call) or sold (for a put) by the option holder upon exercise of the option contract is called the Strike price. Spot Price is the current price at which a particular commodity can be bought or sold at a specified time and place.

What is meant by settlement price?
The last price paid for a contract on any trading day. Settlement prices are used to determine open trade equity, margin calls and invoice prices for deliveries.

How does one determine the price of an option?
A variety of factors determine the price of an option.

The behavior of the underlying stock considerably affects the value of an option. Investors have different opinions about how a particular stock will behave in the future and hence may disagree about the value of any given option.

In addition, the value of an option decreases as its expiration date approaches. Thus, its value is also highly dependent on the amount of time left before the option expires.

Intrinsic & Time Value
An options price is composed of its intrinsic value and time value.

What a particular option contract is worth to a buyer or seller is measured by how likely it is to meet their expectations. In the language of options, that's determined by whether or not the option is, or is likely to be, in the money or out-of-the-money at expiration. Intrinsic value is how far an option is 'in-the-money.' Thus, the phrase is an adjective used to describe an option with an intrinsic value. A call option is in- the-money if the spot price is above the strike price. A put option is in the money if the spot price is below the strike price.

It is calculated by subtracting the options strike price from the spot price. An out-of-the-money option has an intrinsic value of zero.

For example if XYZ is trading at Rs 58 and the June 55 call is trading at Rs 4, to calculate the intrinsic value subtract Rs 55 from 58, leaving you with Rs 3 of intrinsic value. The remaining Rs 1 is known as extrinsic or time value.

Time value is the amount over intrinsic value that a buyer pays for the option. While buying time value, an options purchaser assumes that the option will increase in value before it expires. As the option nears expiration, its time value starts decreasing toward zero.
Theoretical Value
Theoretical value is the objective value of an option. It shows how much time-value is left in an option. The most commonly used formula to calculate the theoretical value of an option is known as the Black-Scholes model.
This model considers the price of the stock, the options strike price, the time remaining before expiration, the volatility of the underlying stock, the stock's dividends and the current interest rate while arriving at the theoretical value of the option.
Although an option may trade for more or less than its theoretical value, the market views the theoretical value as the objective standard of an option's value. This makes the price of all options tilt toward their theoretical value over time.

The Components of Theoretical Value
The volatility of the underlying stock is one of the key factors in determining the value of an option. Often, the options price increases as the volatility of the stock increases. The difficulty in predicting the behavior of a volatile stock permits the option seller to command a higher price for the additional risk.
There are two types of volatility, historical and implied. As the term suggests, historical volatility is a measurement of the stocks movement based on its past behavior.
By contrast, implied volatility is calculated using option prices. It is a measurement of the stocks movement as implied by how the market is currently valuing options.
As an owner of a call option you can always exercise your right to the stock and receive any dividend it might pay.
Interest Rate
If you buy an option rather than a stock, you invest less money upfront.
Days Until Expiration
An option, being a wasted asset; wastes a little as each day lapses. Thus its value is calculated in accordance to the amount of days left in its life.

What are swaptions?
A swaption is an option on an interest rate swap. Swaptions are options contracts, which give you the right to enter into a swap agreement at the option expiration, in return for a one-off premium payment.
What is meant by Covered Call, Covered Put, In the Money, Out Of the Money, At the Money?Ø In-the-money
A call option is in the money if the strike price is less than the market price of the underlying security. A put option is in-the-money if the strike price is greater than the market price of the underlying security.
Ø Out of the money
A call option is out-of-the-money if the price of the underlying instrument is lower than the exercise/strike price. A put option is out-of-the-money if the price of the underlying instrument is above the exercise/strike price.
Ø At-the-money
At the money is a condition in which the strike price of an option is equal to (or nearly equal to) the market price of the underlying security.
Ø Covered Call
You can take a covered call if you take a long position in an asset combined with a short position in a call option on the same underlying asset.
Ø Covered Put
The selling of a put option while being short for an equivalent amount in the underlying security.
What are the uses of Derivatives? What are the various derivative strategies that I can use?Derivatives have a multitude of uses namely:
a) Hedging
b) Speculation &
c) Arbitrage

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