Basics Of Derivatives

Basics Of Derivatives:

When people think of stocks, bonds or Treasury bills, they can usually come up with a clear picture in their minds, and probably some examples as well. When the word is "derivatives", most people are lucky if they can conjure up anything but an indistinct fog.

Derivatives are generally placed in the realm of advanced or technical investing, but there is no reason why they should remain a mystery to common investors. This article will use a simple story of a fictional farm to explore the mechanics of derivatives.

The Definition
Derivatives are financial products with value that stems from an underlying asset or set of assets. These can be stocks, debt issues, or almost anything. A derivative's value is based on an asset, but ownership of a derivative doesn't mean ownership of the asset.

We will look at some examples.

The Future of Healthy Hen Farms
Gail, the owner of Healthy Hen Farms, is worried about the volatility of the chicken market with all the sporadic reports of bird flu coming out of the east. Gail wants a way to protect her business against another spell of bad news. Gail meets with an investor who enters into a futures contract with her.

The investor agrees to pay $30 per bird when the birds are ready for slaughter, say, in six months time, regardless of the market price. If, at that time, the price is above $30, the investor will get the benefit as he or she will be able to buy the birds for less than market cost and sell them onto the market at a higher price for a gain.

If the price goes below $30, then Gail will be receiving the benefit because she will be able to sell her birds for more than the current market price, or what she would have gotten for the birds in the open market.

By entering into a futures contract, Gail is protected from price changes in the market, as she has locked in a price of $30 per bird. She may lose out if the price flies up to $50 per bird on a mad cow scare, but she will be protected if the price falls to $10 on news of a bird flu outbreak.

By hedging with a futures contract, Gail is able to focus on her business and limit her worry about price fluctuations.

Swapping
Gail has decided that it's time to take Healthy Hen Farms to the next level. She has already acquired all the smaller farms near her and is looking at opening her own processing plant. She tries to get more financing, but the lender, Lenny, rejects her.

The reason is that Gail financed her takeovers of the other farms through a massive variable-rate loan and the lender is worried that, if interest rates rise, Gail won't be able to pay her debts. He tells Gail that he will only lend to her if she can convert the loan to a fixed-rate. Unfortunately, her other lenders refuse to change her current loan terms because they are hoping interest rates will increase too.

Gail gets a lucky break when she meets Sam, the owner of a chain of restaurants. Sam has a fixed-rate loan about the same size as Gail's and he wants to convert it to a variable-rate loan because he hopes interest rates will decline in the future.

For similar reasons, Sam's lenders won't change the terms of the loan. Gail and Sam decide to swap loans. They work out a deal by which Gail's payments go toward Sam's loan and his go toward Gail's loan. Although the names on the loans haven't changed, their contract allows them both to get the type of loan they want.

This is a bit risky for both of them because if one of them defaults or goes bankrupt, the other will be snapped back into his or her old loan, which may require a payment for which either Gail of Sam may be unprepared. But it allows for them to modify their loans to meet their individual needs.

Buying Debt
Lenny, Gail's financier, ponies up the additional capital at a favorable interest rate and Gail goes away happy. Lenny is pleased as well because his money is out there getting a return, but he is also a little worried that Sam or Gail may fail in their business.

To make matters worse, Lenny's friend Dale comes to him asking for money to start his own film company. Lenny knows Dale has a lot of collateral and that the loan would be at a higher interest rate because of the more volatile nature of the movie industry, so he's kicking himself for loaning all his capital to Gail.

Fortunately for Lenny, derivatives offer another solution. Lenny spins Gail's loan into a credit derivative and sells it to a speculator at a discount to the true value. Although Lenny doesn't see the full return on the loan, he gets his capital back and can issue it out again to his friend Dale.

Lenny likes this system so much that he continues to spin out his loans as credit derivatives, taking modest returns in exchange for less risk of default and more liquidity.

Options
Years later, Healthy Hen Farms is a publicly traded corporation (the ticker symbol is (obviously) HEN) and is America's largest poultry producer. Gail and Sam are both looking forward to retirement.

Over the years, Sam bought quite a few shares of HEN. In fact, he has more than $100,000 invested in the company. Sam is getting nervous because he is worried that some shock, another case of bird flu for example, might wipe out a huge chunk of his retirement money. Sam starts looking for someone to take the risk off his shoulders. Lenny, financier extraordinaire and an active writer of options, agrees to give him a hand.

Lenny outlines a deal in which Sam pays Lenny a fee to for the right (but not the obligation) to sell Lenny the HEN shares in a year's time at their current price of $25 per share. If the share prices plummet, Lenny protects Sam from the loss of his retirement savings.

Lenny is OK because he has been collecting the fees and can handle the risk. This is called a put option, but it can be done in reverse by someone agreeing to buy a stock in the future at a fixed price (called a call option).

The Happy Ending
Healthy Hen Farms remains stable until Sam and Gail have both pulled their money out for retirement. Lenny profits from the fees and his booming trade as a financier.

In this ideal tale, you can see how derivatives can move risk (and the accompanying rewards) from the risk averse to the risk seekers . Although Warren Buffett once called derivatives, "financial weapons of mass destruction", derivatives can be very useful tools, provided they are used properly. Like all other financial instruments, derivatives have their own set of pros and cons, but they also hold unique potential to enhance the functionality of the the overall financial system.

Posted by: Srikanthbabu Kaliki
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Getting Prepared for the Trading Day

Getting Prepared for the Trading Day

With the great challenge of facing the stock market each day and the hope of pulling money out of it on a regular basis, a trader can do few things more important than prepare adequately. It should be no secret that many of the brightest minds in the world are at work to make their living in the stock market, and such competition cannot be taken lightly! Furthermore, while traders should not be in the prediction business, we must certainly have a game plan.

As time progresses, a trader will inevitably learn from his mistakes. This experience is the foundation for laying out a game plan in preparation for the trading day. Merely being a student of the market and of one’s own results will teach a trader to react certain ways to market conditions or events. It is this foundation which should be built upon in order for the trader to elevate his game to the next level (and it IS a game).

In order to develop a trading plan, a trader must begin with his personal style in mind. Swing trading involves a plan that may evolve over the course of a few days to a few weeks, while day trading can be faster-paced and more spontaneous. Personality, patience, and profit objectives will play a large role in which style of trading one may wish to employ, but the trader should choose his method as he plans for success.

Once the trading style is known, the trader must take into account current market conditions. Are recent days or weeks characterized by lasting trends, or by narrow ranges and choppy action? Knowing the answer to this question will put you miles ahead of many other traders who walk in each morning without taking current conditions into consideration. The market will catch you off guard as it changes its rhythm or volatility, but recent history serves as a guide until things change. This means choppy, low-volume, range-bound markets should likely be approached with smaller positions and the expectation of taking profit more quickly and in one piece. A trending market with larger range days and greater volume allow the trader to take bigger positions in hopes of scaling out in pieces as the market moves in the trader’s profitable direction.

Whether after the market closes or early in the day prior to the market’s open, some time should be spent determining an IF/THEN strategy for the upcoming session. By screening for a handful of potential trades, the decision-making process is simplified and a plan is easier to carry out.

Consider finding a list of trade candidates for both the long and short side of the market, setting specific entry and exit prices, and then simply execute that plan. IF the long candidates rise to your entry prices, THEN purchase them. IF the short candidates break the levels of support you see, THEN short-sell them. IF none of your trade candidates trigger their entry prices, THEN do nothing! This kind of game plan will allow you to effectively respond to market conditions without having to predict direction or hope to be bailed out of losing positions. Approaching the market with the IF/THEN mentality also will help the trader to execute a plan, rather than fight the emotional urges to find excitement or force trades. Sometimes things will work exactly as planned and other times the market will whipsaw you right out of positions. Meeting the market with a game plan and sticking with it will undoubtedly allow the trader to work with less stress and emotion, which are two of the worst negative forces that traders face.

Feeling well physically is a very important trait which must be present for a trader to profit. Staying healthy and rested allows the trader to work with a clear mind and focus on the task at hand. Additionally, personal relationships can play a large role in a trader’s effectiveness. When life is rocky away from the trading screens, the successful trader must be willing to cut back on trading size or even back away from the market entirely. A prideful ego will not only cause rough waters on the home front with relationships, but it will also damage the trading account! A clear conscience allows quality rest and a fresh start each morning for returning to the market sharp and ready. Make the most of your weekends to catch up on personal to-do’s and relaxation. When Monday arrives, if you aren’t at your best, don’t expect your trading to be!

Finally, as the morning breaks and the market’s opening nears, follow a routine to get into the proper state of mind for following your plan. This may include reading up on current events, reviewing your charts one final time, grabbing your morning caffeine, or listening to your favorite song. Whatever it is, find what works for you when it comes to getting into the best mindset to extract profits from the market. Remember, the competition is serious and fierce, sharp-minded, and most of all, prepared. You should be too!"

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Trading Rules for Swing Trading

These trading rules below should help your swing trading efforts yield more profits. By following some trading rules, your trading approach will be far superior to any trading method without rules. The objective for all of us is to maximize gains while minimizing losses along the way. Successful trading requires discipline, and these guidelines will help you in your quest for profitability.

1. Emotional control is at the heart of good trading.
Controlling yourself allows the ability to think clearly at each moment, resulting in success as a trader.

2. Cut losses with the most strict discipline.
We must preserve capital at all times. Losing is part of trading, but opportunity cost is to be considered when hoping for a losing position to reverse course. If your trade reverses and violates support, get out and be willing to re-enter. This will save you from big losses and you can always re-enter if the stock crosses the entry price again.

3. Make good decisions and winning will take care of itself.
Focus on how you play the game and not on the scoreboard. Trade with discipline and follow your game plan.

4. When you lose, don't lose the lesson!
Forget the names but remember the events. Those who don't remember the past are doomed to repeat it. Make mistakes with composure and character, without blaming others, and don't dwell on mistakes.

5. When in doubt, get out.
Scrutinize your positions at all times, each day, and you will not be left holding a stock without reason. Be willing to change direction at any time, because your flexibility as an individual investor is a big advantage which should be embraced!

6. Keep your risk/reward profile in check.
Profits can exceed losses even if the number of losing trades is greater than the number of winning trades. Always properly manage money, size positions accordingly, obey stops, and protect profits. This will keep you in the game!

7. Avoid scheduled news.
We are unable to foresee breaking news, but scheduled news we can step aside from. Scheduled news includes interest rate announcements, corporate earnings announcements, and various daily economic releases. Remember to trade only when you've got the best of conditions.

8. Consider your account size for appropriate trading.
An account that is too small magnifies the effects of each trade, which keeps us from thinking rationally. Trade with the attitude that the next trade will simply be 1 of the next 1000 trades you will make.

9. Get a charting program that allows you to build watch lists, sort stocks, and draw trend lines
This is essential to learning. Price action and volume are vitally important in finding good chart patterns.

10. Scale out of winning positions as they work for you.
This achieves two goals: taking some off the table and keeping you in the game. If your trade reverses, you took some profit at good spots. If the move continues, you are still on board for the ride.

11. Don't dig yourself into a hole early in the day or in your career.
Be willing to observe the market and make an informed decision. Missed money is better than lost money, so wait patiently for the best opportunities to arrive.

12. Trade with a blend of anticipation and confirmation.
Balancing these two will mean that you adopt a system of "if this happens, I will do that." Wait for your pitch!

13. Beware of your trading process following a winning streak.
After a win streak, be extra disciplined! Many will make money in the market, but discipline is required to KEEP it. Stay on your guard at all times!

14. Evaluate your results at least monthly.
Monitor your P&L, your win/loss ratio, and the relationship between your biggest wins and worst losses. Reviewing these results helps you continually improve your understanding of the markets and yourself.

15. Finally (perhaps most important), always be patient.
Long-term patience will keep your confidence and optimism high, and short-term patience will help you wait for the best trades. Success doesn't come easy, and rarely are fortunes made overnight. Be willing to pay your dues and put in the work in order to achieve your goals.

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.

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.
Dollex-30
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.
Example
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:
Kotaksecurities.com 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
Or
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.
NRIs:
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
Options
Swaps
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:
Case1:
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
Volatility
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.
Dividends
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

stock market technical & fundamental analysis

What is Technical Analysis?
Technical Analysis is a method where one studies the market statistics to evaluate the worth of a company. Instead of assessing the health of the company by relying on its financial statements, it relies upon market trends to predict how a security will perform.

It is a method of evaluating stocks by analyzing stock market related activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value, but instead use charts to identify patterns that can suggest future activity. They believe in the momentum that the scrips/markets gather over a period of time and cashing in on the same. Technical analysts believe that the historical performance of stocks and markets are indications of future performance.

This method enables 'short-term' investors to gauge companies who have very good potential to gather increased earnings in the near future.

What is a Fundamental Analysis?
A method of evaluating a stock by attempting to measure its intrinsic value. Fundamental analysts study everything from the overall economy and industry conditions, to the financial condition and management of companies. A fundamental analyst would most definitely look into the details regarding the balance sheets, profit loss statements, ratios and other data that could be used to predict the future of a company.

In other words, fundamental analysis is about using real data to evaluate a stock's value. The method uses revenues, earnings, future growth, return on equity, profit margins and other data to determine a company's underlying value and potential for future growth.

What is an Overvalued Stock or an Undervalued Stock?
An overvalued stock can be understood as an inflated hope that a company will do well. Thus, a stock is overvalued if its current price exceeds the intrinsic value of the stock. The market may temporarily price stocks too high or too low and that's how investors determine whether stocks are being overvalued or undervalued. If a stock is overvalued, the current price of the stock exceeds its earnings ratio (PE ratio*) and hence investors expect the price of the stock to drop. A high PE in relation to the past PE ratio of the same stock may indicate an overvalued condition, or a high PE in relation to peer stocks may also indicate an overvalued stock.

Thus the PE ratio is one of the many ways to determine whether a stock is overvalued. *A company's P/E ratio is computed by dividing the current market price of one share of a company's stock by that company's per-share earnings.

For example, a P/E ratio of 10 means that the company has Rs1 of annual, per-share earnings for every Rs10 in share price.

A stock is undervalued when,if is selling at a much lower price than what it is actually worth.This can be determined based on fundamentals like earnings and growth prospects. One of the best-known measures for finding an undervalued stock is the price earnings ratio (P/E).

Consider Colgate and Pepsodent, which are in the same industry and have similar fundamentals. If Colgate has a P/E of 15 and Pepsodent's is 20, Colgate could be an undervalued stock.

What does Value Investing mean?
Value investing is an investment style, which favors good stocks at great prices over great stocks at good prices. Hence it is often referred to as "price driven investing". A value investor will buy stocks he believes the market is undervaluing, and avoid stocks that he believes the market is overvaluing. Warren Buffet, one of the world's best-known investment experts believes in Value investing.

Value investors see the potential in the stocks of companies with sound financial statements that they believe the market has undervalued; as they believe the market always overreacts to good and bad news, causing stock price movements that do not correspond with their long-term fundamentals. Value investors profit by taking a position on an undervalued stock (at a deflated price) and then profit by selling the stock when the market corrects its price later.

Value investors don't try to predict which way interest rates are heading or the direction of the market and the economy in the short term, but only look at a stock's current valuation ratios and compare them to their historical range. In other words they pick up the stocks as fledglings and cash in on them when they are valued right in the markets.

For example, say a particular stock's P/E ratio has ranged between a low of 20 and a high of 60 over the past five years, value investors would consider buying the stock if it's current P/E is around 30 or less. Once purchased, they would hold the stock until its P/E rose to the 50-60 ranges before they consider selling it or even higher if they see further potential for growth in the future.

What is Contrarian Philosophy?
Investing with a value philosophy can be considered as one form of contrarian investing. Buying stocks that are out of favor in the marketplace, and avoiding stocks that are the latest market fad is a contrarian investing strategy. Thus it is an investment style that goes against prevailing market trends, where investors buy scrips that are performing poorly now and sell them in future when they perform well. Contrarians believe in taking advantages that arise out of temporary set backs or other such reasons that have caused a stocks price to decline at the moment.

A simple example of Contrarian Philosophy would be buying umbrellas in winter season at a cheap rate and selling them during rainy days.