The memory of May 2004 is very sharply etched in our minds- when the
markets fell by almost 25 percent. We all expect the same to happen to
this time around too.
In 2004, none of us were prepared for it. In 2009, all of us are
prepared for it. Just as we were prepared for the Sensex to go to
10000 points in 2001, and to 25000 points in 2008 (and to 6500 points
in March 2009!).
Bulls and bears have never been known to be very well behaved animals.
So are markets. Unipolar views are very risky.
Let us look at our options rationally – the elections can have three
possible outcomes. A Congress-led coalition coming to power will give
a sigh of relief to the markets and if we are able to sustain this
synchronized global rally in equities till then, we will rally some
more in salutation.
If a BJP-led NDA coalition comes to power, the entire broking
community will be highly enthused and we will rally even more.
It is the Third front that we are most worried about. The initial
reaction will be very sharp, but may be very short. Mayawati is known
to be a good administrator and always in a hurry to get things done.
After 58 years of planned development leaving a lot to be desired, we
may be better off with an impatient person at the helm.
To sum up, the sum total of our fears do not add up to much. So did we
miss out on something good that is just about beginning to build up?
Maybe not. We need to get over our obsession with timing the market
and focus more on prudent asset allocation.
If we are focused on long term wealth creation, Election 2009 will
just be a blip on the charts that came and went.
The larger issue that we should we worried about at this point of time
is whether the “green shoots of recovery” that the global markets are
rejoicing about will grow and not wither away. It is naïve to expect
the global economy to start bouncing, but at least the rate of fall in
economic indicators should subside.
This will restore risk appetite and encourage orderly flow of credit
and maybe risk capital and portfolio flows too. Once that happens,
India will get its natural share.
Tuesday, April 28, 2009
Friday, April 10, 2009
Results Calendar
Results Calendar
ACC 31-Mar-09
Areva T&D 31-Mar-09
Blue Dart 31-Mar-09
Infosys 15-Apr-09
Megasoft 31-Mar-09
Mysore Cement 31-Mar-09
SKF India 31-Mar-09
ACC 31-Mar-09
Areva T&D 31-Mar-09
Blue Dart 31-Mar-09
Infosys 15-Apr-09
Megasoft 31-Mar-09
Mysore Cement 31-Mar-09
SKF India 31-Mar-09
Wednesday, April 8, 2009
Financial Markets Overview
Here is summary of all about financial markets from various products to participants and much more to give some insight into financial markets and the structure.
Financial Markets
• A marketplace where financial products can be bought and sold
• Financial Products
– Securities
• Stocks, bonds
– Commodities
– Derivatives
• Equity derivatives, credit derivatives etc
– Currencies
– Insurance etc.
Market Types by Product
• Capital Markets / Securities Markets
– Raise capital
– Trade Securities
• Commodities Markets
– Trade commodities (metals, grains etc)
• Derivatives Markets
– Trade Derivatives
• Money Markets
– Trade short-term Debt instruments
• Foreign Exchange Markets /FOREX
– Trade Currencies
• Insurance Markets
– Trade Insurance products
Market Players
• Borrowers
• Lenders / Investors
• Brokerage/Intermediary Firms
• Banks
• Exchanges
Borrowers
• Individuals
– Personal loans
– Mortgages etc
• Corporations – private and public
– Capital for business expansion
– Cash flows etc
• Governments – federal, municipalities,
foreign
– Bonds
Lenders or Investors
• Individuals
– Savings accounts, Pension Accounts
– Securities, mutual funds, hedge funds
– Insurance etc
• Large Corporations
– Stock buy back
– Money Market
– Hedging etc
• Professional Institutions, Hedge Funds
– Asset Management etc
Banks
• Mostly provide loans etc
• Play key role in Money Markets
• Serve Individuals and Corporations
• Individuals
– Savings Accounts
– Pension Accounts
– Investment Account
• Corporations
– Money Lending, etc
Exchanges
• Organizations that facilitate trading
• Provide Trading Floor that allows face-to-face trading
• Also provide Electronic Crossing Engines
Marketplace
• Trading Venues
• Exchange Markets
– Physical facilities that facilitate trading
– Face to face trading
– Only members can trade
– Only listed products trade
– NYSE, ASE, NYFE, NYMEX etc
• OTC (Over-the-counter) Markets
– No physical locations, mostly electronic
– Facilitate direct trade between two parties
– Firms Trade as Market Makers
– Market Makers, Broker-Dealers are players
Exchange Markets
• Trade Listed Products only
– Company stock listed with certain exchange
• Only registered members are allowed to trade
• Specialist – facilitates the trade for specific product
• Floor Brokers – represent firms and their clients
• Traders – trade their own accounts
• Commission Brokers – trade for commission
Popular Exchanges
• New York Stock Exchange (NYSE)
• American Stock Exchange
• Boston Stock Exchange
• Chicago Board Options Exchange
• Chicago Stock Exchange
• Philadelphia Stock Exchange etc.
OTC Markets
• Mostly Electronic Markets
• Virtual Exchanges
• OTC Bulletin Board – US quotation service that lists quotes from Market Makers
• Regulated by appropriate agencies
• Products
– Stocks, Bonds, Municipal Securities, US Gov Securities, etc
• Participants
– Market Makers
– Brokers
Market Makers / Broker-Dealer
• Financial Institution or Individual willing to BUY and SELL instrument at the same time
• Provide continuous quotes for instruments
• Profit or lose money from the bid/offer SPREAD (difference b/w buy and sell price)
• Trade for their own accounts
• Risk their own money
• Same security can be traded by multiple Market makers at different prices
Capital Markets
• Raise Long-term capital
– To expand business
– For additional Cash flow
– Reduce holdings
– Private use
• Long-term debt obligation products
– More than one year debt
• Products
– Securities
• Regulated by SEC and related SROs under the guidance of SEC
– FINRA, MSRB
• Also knows as Securities Market
Security
• Kind of interest or note that has some financial value
• Tradable/Transferable
• Types of products
– Equity Securities – Stocks
– Debt Securities – Bonds
• Stock
– Value may increase or decrease, may return dividend
– Trade in Stock Market
• Debt/Bond
– Produce fixed interest income
– Trade in Bond Market
Stock Market
• Stock (also referred as Share)
– Equity in Corporation
• Types of Stock
– Common Stock
– Preferred Stock etc
• Stock Derivatives
– Contract with or without obligation
• Types of Equity Derivatives
– Futures
– Options
Common Stock
• Also referred to as
– Just Stock
– Share
– Common Share
– Ordinary Share
• Least preferred stock among others
• Holders have the right to vote in certain corporate decision making
• When corporation liquidated may or may not get any money
• Riskier than other securities
Preferred Stock
• Has priority over Common Stock
• Special voting right on some key decisions
– Acquisition and Mergers
– Issuing new Equity
• May get some money when corporation liquidated
• Less riskier than Common Stock
Hybrid Securities
• Products defined with selected characteristics from both Debt and Equity securities
• Some examples
• Preferred Stock
– Have right to collect interest/capital prior to common stock holders when corporation is liquidated
• Convertibles
– Bond/Preferred Stock that can be converted into a common stock after certain period
Securities Markets
• Primary Market
– Trades Initial Offerings
– Allows to raise capital for corporations
– NYSE, NASDAQ etc
– Syndicate – work on release of IPOs (usually Brokerage Firms)
• Secondary Market
– Trades already owned securities
– Exchanges, OTC
Bond Markets
Debt Products
• Debt Products are two types
– Short-term debt – Money Markets
– Long-term debt – Bond Markets
• Debt – investor or lender loans the money to borrower for a certain period of time. In return he expects the fixed amount of interest amount in periodic intervals and principle amount at the end.
• Key terms
– Principal amount – Amount loaned
– Coupon rate – interest rate
– Maturity date – Date on which principal amount is
due
• Periodic interest amount
– Coupon rate * principal amount
• Since these products return fixed amount they are referred to as FIXED INCOME products
• Less riskier than Stock
• In case of liquidation, debt holder may get full or partial principal amount before stock holders
Money Markets
• Short-term debt obligations
• Less than a YEAR maturity
• Very low risk
• Instruments are
– US Treasury Bills (T-Bills)
– US Gov Agency Notes (Notes)
– Municipal Notes
– Bank Certificate of Deposit (CDs)
• Long-term debt obligations
• More than a year maturity (may go up to 30 to 50yrs)
• Fixed flow of returns
• Instruments
– US Treasury Bonds
– Municipal Bonds
– Corporate Bonds
FX Markets
• No Physical Exchanges
• Traded mostly using Telephonic and Electronic Communication (OTC – Over-the-counter)
• Mainly Traded between Financial Institutions
• 24-hour Market
• Quoted on Dealing System (FX Trading Systems)
– Reuters and Bloomberg are popular
• World’s average DAILY FX Trading volume is more than $1800 billions
• Also referred to as Currency Markets
• London, New York and Tokyo are popular FX Markets
• London is the largest in the World
FX Market Players
• Large Banks
• Central Banks (from various countries)
• Investment Management Firms
• Retail FX Brokers (FOREX Brokers)
• Hedge Funds
• Large Corporations
• Governments
• Individuals can trade FX through any FX Brokers
Most Traded Currencies
• USD
• EUR
• JPY
• GBP
• CHF (Swiss Frank)
• AUD
FX Trade Types
• Spot Trades
– Immediate needs
– Usually delivered in 2 business days (settlement time)
• Forwards Trades (Derivative)
– Future date settlement (delivered in future on some date)
Derivatives Market
• Derivative
– Instrument whose value derived from the underlying asset
• Example - Equity Option
– Option is not a security by itself
– It is right (agreement/contract) to sell or buy an underlying security
– Only premium is paid to buy an option NOT the price of the underlying equity
• Traded on Exchanges as well as OTC Markets
• Main Categories are
– Options
• Eg: equity options, bond options
– Futures
• Eg: index futures, commodity futures
– Forwards
• Eg: FX forwards
– Swaps
• Eg: interest rate swaps, currency swaps
Option
• Right to buy or sell an underlying instrument
• Just premium is paid to buy the option not the value of the underlying asset
• It is just a RIGHT not an OBLIGATION
– Holder may not execute his right at all
• Popular Options
– Stock option
– Bond option
– Commodity option
– Interest Rate option
– FX option etc.
Future
• Standard contract to buy or sell an underlying instrument on some future date
• Traded on Futures Exchanges
• Contract is an obligation, holder must exercise
• On delivery date, holder may actually deliver the instrument or pay the price difference
• Popular Futures Contracts
– Commodity
– FX etc
Forward
• Similar to Futures Contract but not Standard
• Traded between two private parties (usually in OTC Markets)
• On delivery date, holder may actually deliver the instrument or pay the price difference
• Riskier than Futures
SWAP
• Is an agreement between two parties to swap one set of CASH FLOW with another set
• For example, holder of Fixed interest rate loan may exchange his cash flow (return stream) with a party who holds Variable rate loan cash flow
• Traded in OTC Derivatives Markets
• Various SWAPs
– Interest Rate Swap
– Currency Swap etc
Why Derivatives?
• Hedging / Insurance
– Transfer the RISK
– Ex: Farmer selling a crop before its harvest to protect from any future fluctuations in prices
• Arbitrage
– Buying an instrument in one market and selling in another and profiting from the difference
• Speculation
– Speculating the price variation in instrument and buying futures or options of that instrument
Brokerage Firms
• Intermediary institution in financial markets
• Provide various different services
• Primary objective is to channel the funds between lenders and borrowers
• Firms specialize intermediary (brokerage) services in various different areas
– Banking
– Capital Markets
– Wealth Management
– Insurance etc.
• Large firms serve in multiple areas
• Brokerage services may also be provided by
– Banks
– Insurance Companies
– Mutual Funds
– Credit Unions etc
• Individuals can also be Brokers, but may have to obtain appropriate licenses
– Financial Advisor
– Insurance Agent etc.
Services
• Investment Banking
• Wealth Management
• Asset/Investment Management
• Banking
• Insurance
• Trading etc
Investment Banking
• Help private and public corporations to raise funds
– Capital Markets
– Equity and Debt
• Advise in mergers and acquisitions (M&A)
– Strategic Partners
• Corporate Finance
– Loans to corporation
Wealth Management
• Beyond basic Financial Planning
• Serving high net worth clients
– Asset Management
– Investment Advisory
– Portfolio management (distribution of investment products)
– Insurance
– Banking Services
• Simpler versions of Wealth Management are
– Portfolio Management
– Private Banking
– Asset Management /Investment Management
Prime Brokerage
• Services to Hedge Funds
• Collective Services
– Custodial Services (clearing, custody etc)
– Financing
– Securities Lending
– Technology Services (Trading/portfolio apps)
– Operational Services (facilities etc)
• Full Service to startup hedge funds
• Other Services
– Risk analytics
– Advisory Services etc
Capital Markets
• Primary Markets
– Work as Syndicate in releasing IPOs
• Secondary Markets
– Provide Trading Services
– Usually hold memberships on most of the exchanges
– Trade instruments for commission
– Trade instruments for their own accounts to profit from market movements
Insurance Services
• Insurance helps individual and corporations in managing the risk
• Some brokerage firms provide insurance for corporations
Research
• Some firms provide research services as well
• Evaluation of Financial Information of Corporations
• Securities Price Evaluations
• Market research and predictions
• Rating Stock and Bonds etc
Large Brokerage Firms
• Goldman Sachs
• Citi
• JPMorganChase
• Merrill Lynch
• Lehman Brothers
• Bear Sterns
• Morgan Stanley
• UBS
• Bank of America
• Barclays Capital
• ABN AMRO
• Deutche Bank
• CSFB and many more….
Regulatory Agencies
SEC
• US Securities and Exchange Commission
• Founded in 1934
• Objective is to protect the public investment
• Regulates Stock Market and Corporate Reporting
• Independent and US Government Agency
• Has power to license and regulate Stock Exchanges
• Agency to enforce Federal Securities Laws
• Has authority to impose fines and take legal actions against the non-complying corporations
• All Public companies must submit quarterly and annual reports to SEC
• Works with SROs and other federal state agencies in implementing and enforcing regulations
• Run by five commissioners appointed by US President
FINRA
• FINRA - Financial Industry Regulatory Authority
• The largest non-governmental regulatory agency
• Regulates all securities firms doing business in the United States
• FINRA oversees nearly 5,000 brokerage firms
• Has approximately 665,000 registered securities representatives
• Founded in 2007 consolidating NASD and some functions of NYSE
• Follows and enforces SEC regulations
• SRO – Self Regulatory Organization
– Holds an authority to introduce its own regulations
– Adds its own regulations or clarifies SEC regulations
– Usually done to complete the missing items in SEC regulations
• Regulates the Trading and Brokerage practices
– Equities
– Bonds
– Securities Futures
– Options
• Every Firm dealing in securities must be a member of some SRO or Regulatory Agency
• Member Types are
– Brokerage Firms
– Securities Representatives / Independent Brokers
• Primary Functions
– Define Regulatory Rules
– Impose Rules
– Audit and monitor member firms and individuals involved in markets
• Can even impose fines or take legal action against non-complying corporations
• Primarily funded by
– Member firms
– Membership fees
– Fines
NYSE
• New York Stock Exchange
• Owned by NYSE Euronext
• NYSE initially started in 1792, operated as not-for profit organization until 2006
• Went public in 2006 as NYSE Group, Inc. after purchase of ARCA ECN
• Turned into NYSE Euronext in 2006 after merger with Euronext
• Euronext – European Stock Exchange based in Paris
• Nation’s largest Stock Exchange
• Also known as BIG BOARD
• Lists/trades more than 2000 companies stock
• NYSE has capitalization of $23+ trillion
– Capitalization: stock worth
• NYSE Composite Index
– Benchmark index that reflects the performance of all the stocks traded on NYSE Exchange
• NYSE Exchange is located on Wall Street in New York City
• Provides Physical Floor for Trading
• Uses popular Continuous Open Outcry Auction Format
• Only Exchange Members are licensed to trade on the Floor
• Individuals known as Specialists act as AUCTIONEERs (middleman)
• Specialist is not an employee of NYSE
• Each listed stock trades at one specialist
• Buyers and Sellers of the stock are gathered at Specialist
Indices
• Index
– Single statistical number that is calculated for a group of components
• Used to measure the overall performance of the components involved
• Example - Stock Market Index
– DJIA – Dow Jones Industrial Average
– Single number that reflects the overall performance of Industrial Stocks
• Indices are available for all different markets and products
Indices – Benchmark Indices
• Benchmark indices are used to measure performance of major markets
• DJIA – Dow Jones Industrial Average
– Performance of major Industrial stock listed on NYSE
– Include companies like GE, IBM, MSFT etc
• S&P 500
– Performance of 500 Large-Cap stocks
• FTSE 100 (Futsie 100)
– 100 Large companies listed on LSE
• Nikkei 225
– 225 Large corporations listed on TSE
• Hang Seng
– Major companies listed on Hong Kong Stock Exchange
Indices - Specialized
• iShares MSCI EAFE
– Index of selected foreign stock
• Morgan Stanley Biotech
– Index of selected biotech companies
• Interest Rate Indices
• Consumer Price Index (CPI)
• Many more…
Financial Markets
• A marketplace where financial products can be bought and sold
• Financial Products
– Securities
• Stocks, bonds
– Commodities
– Derivatives
• Equity derivatives, credit derivatives etc
– Currencies
– Insurance etc.
Market Types by Product
• Capital Markets / Securities Markets
– Raise capital
– Trade Securities
• Commodities Markets
– Trade commodities (metals, grains etc)
• Derivatives Markets
– Trade Derivatives
• Money Markets
– Trade short-term Debt instruments
• Foreign Exchange Markets /FOREX
– Trade Currencies
• Insurance Markets
– Trade Insurance products
Market Players
• Borrowers
• Lenders / Investors
• Brokerage/Intermediary Firms
• Banks
• Exchanges
Borrowers
• Individuals
– Personal loans
– Mortgages etc
• Corporations – private and public
– Capital for business expansion
– Cash flows etc
• Governments – federal, municipalities,
foreign
– Bonds
Lenders or Investors
• Individuals
– Savings accounts, Pension Accounts
– Securities, mutual funds, hedge funds
– Insurance etc
• Large Corporations
– Stock buy back
– Money Market
– Hedging etc
• Professional Institutions, Hedge Funds
– Asset Management etc
Banks
• Mostly provide loans etc
• Play key role in Money Markets
• Serve Individuals and Corporations
• Individuals
– Savings Accounts
– Pension Accounts
– Investment Account
• Corporations
– Money Lending, etc
Exchanges
• Organizations that facilitate trading
• Provide Trading Floor that allows face-to-face trading
• Also provide Electronic Crossing Engines
Marketplace
• Trading Venues
• Exchange Markets
– Physical facilities that facilitate trading
– Face to face trading
– Only members can trade
– Only listed products trade
– NYSE, ASE, NYFE, NYMEX etc
• OTC (Over-the-counter) Markets
– No physical locations, mostly electronic
– Facilitate direct trade between two parties
– Firms Trade as Market Makers
– Market Makers, Broker-Dealers are players
Exchange Markets
• Trade Listed Products only
– Company stock listed with certain exchange
• Only registered members are allowed to trade
• Specialist – facilitates the trade for specific product
• Floor Brokers – represent firms and their clients
• Traders – trade their own accounts
• Commission Brokers – trade for commission
Popular Exchanges
• New York Stock Exchange (NYSE)
• American Stock Exchange
• Boston Stock Exchange
• Chicago Board Options Exchange
• Chicago Stock Exchange
• Philadelphia Stock Exchange etc.
OTC Markets
• Mostly Electronic Markets
• Virtual Exchanges
• OTC Bulletin Board – US quotation service that lists quotes from Market Makers
• Regulated by appropriate agencies
• Products
– Stocks, Bonds, Municipal Securities, US Gov Securities, etc
• Participants
– Market Makers
– Brokers
Market Makers / Broker-Dealer
• Financial Institution or Individual willing to BUY and SELL instrument at the same time
• Provide continuous quotes for instruments
• Profit or lose money from the bid/offer SPREAD (difference b/w buy and sell price)
• Trade for their own accounts
• Risk their own money
• Same security can be traded by multiple Market makers at different prices
Capital Markets
• Raise Long-term capital
– To expand business
– For additional Cash flow
– Reduce holdings
– Private use
• Long-term debt obligation products
– More than one year debt
• Products
– Securities
• Regulated by SEC and related SROs under the guidance of SEC
– FINRA, MSRB
• Also knows as Securities Market
Security
• Kind of interest or note that has some financial value
• Tradable/Transferable
• Types of products
– Equity Securities – Stocks
– Debt Securities – Bonds
• Stock
– Value may increase or decrease, may return dividend
– Trade in Stock Market
• Debt/Bond
– Produce fixed interest income
– Trade in Bond Market
Stock Market
• Stock (also referred as Share)
– Equity in Corporation
• Types of Stock
– Common Stock
– Preferred Stock etc
• Stock Derivatives
– Contract with or without obligation
• Types of Equity Derivatives
– Futures
– Options
Common Stock
• Also referred to as
– Just Stock
– Share
– Common Share
– Ordinary Share
• Least preferred stock among others
• Holders have the right to vote in certain corporate decision making
• When corporation liquidated may or may not get any money
• Riskier than other securities
Preferred Stock
• Has priority over Common Stock
• Special voting right on some key decisions
– Acquisition and Mergers
– Issuing new Equity
• May get some money when corporation liquidated
• Less riskier than Common Stock
Hybrid Securities
• Products defined with selected characteristics from both Debt and Equity securities
• Some examples
• Preferred Stock
– Have right to collect interest/capital prior to common stock holders when corporation is liquidated
• Convertibles
– Bond/Preferred Stock that can be converted into a common stock after certain period
Securities Markets
• Primary Market
– Trades Initial Offerings
– Allows to raise capital for corporations
– NYSE, NASDAQ etc
– Syndicate – work on release of IPOs (usually Brokerage Firms)
• Secondary Market
– Trades already owned securities
– Exchanges, OTC
Bond Markets
Debt Products
• Debt Products are two types
– Short-term debt – Money Markets
– Long-term debt – Bond Markets
• Debt – investor or lender loans the money to borrower for a certain period of time. In return he expects the fixed amount of interest amount in periodic intervals and principle amount at the end.
• Key terms
– Principal amount – Amount loaned
– Coupon rate – interest rate
– Maturity date – Date on which principal amount is
due
• Periodic interest amount
– Coupon rate * principal amount
• Since these products return fixed amount they are referred to as FIXED INCOME products
• Less riskier than Stock
• In case of liquidation, debt holder may get full or partial principal amount before stock holders
Money Markets
• Short-term debt obligations
• Less than a YEAR maturity
• Very low risk
• Instruments are
– US Treasury Bills (T-Bills)
– US Gov Agency Notes (Notes)
– Municipal Notes
– Bank Certificate of Deposit (CDs)
• Long-term debt obligations
• More than a year maturity (may go up to 30 to 50yrs)
• Fixed flow of returns
• Instruments
– US Treasury Bonds
– Municipal Bonds
– Corporate Bonds
FX Markets
• No Physical Exchanges
• Traded mostly using Telephonic and Electronic Communication (OTC – Over-the-counter)
• Mainly Traded between Financial Institutions
• 24-hour Market
• Quoted on Dealing System (FX Trading Systems)
– Reuters and Bloomberg are popular
• World’s average DAILY FX Trading volume is more than $1800 billions
• Also referred to as Currency Markets
• London, New York and Tokyo are popular FX Markets
• London is the largest in the World
FX Market Players
• Large Banks
• Central Banks (from various countries)
• Investment Management Firms
• Retail FX Brokers (FOREX Brokers)
• Hedge Funds
• Large Corporations
• Governments
• Individuals can trade FX through any FX Brokers
Most Traded Currencies
• USD
• EUR
• JPY
• GBP
• CHF (Swiss Frank)
• AUD
FX Trade Types
• Spot Trades
– Immediate needs
– Usually delivered in 2 business days (settlement time)
• Forwards Trades (Derivative)
– Future date settlement (delivered in future on some date)
Derivatives Market
• Derivative
– Instrument whose value derived from the underlying asset
• Example - Equity Option
– Option is not a security by itself
– It is right (agreement/contract) to sell or buy an underlying security
– Only premium is paid to buy an option NOT the price of the underlying equity
• Traded on Exchanges as well as OTC Markets
• Main Categories are
– Options
• Eg: equity options, bond options
– Futures
• Eg: index futures, commodity futures
– Forwards
• Eg: FX forwards
– Swaps
• Eg: interest rate swaps, currency swaps
Option
• Right to buy or sell an underlying instrument
• Just premium is paid to buy the option not the value of the underlying asset
• It is just a RIGHT not an OBLIGATION
– Holder may not execute his right at all
• Popular Options
– Stock option
– Bond option
– Commodity option
– Interest Rate option
– FX option etc.
Future
• Standard contract to buy or sell an underlying instrument on some future date
• Traded on Futures Exchanges
• Contract is an obligation, holder must exercise
• On delivery date, holder may actually deliver the instrument or pay the price difference
• Popular Futures Contracts
– Commodity
– FX etc
Forward
• Similar to Futures Contract but not Standard
• Traded between two private parties (usually in OTC Markets)
• On delivery date, holder may actually deliver the instrument or pay the price difference
• Riskier than Futures
SWAP
• Is an agreement between two parties to swap one set of CASH FLOW with another set
• For example, holder of Fixed interest rate loan may exchange his cash flow (return stream) with a party who holds Variable rate loan cash flow
• Traded in OTC Derivatives Markets
• Various SWAPs
– Interest Rate Swap
– Currency Swap etc
Why Derivatives?
• Hedging / Insurance
– Transfer the RISK
– Ex: Farmer selling a crop before its harvest to protect from any future fluctuations in prices
• Arbitrage
– Buying an instrument in one market and selling in another and profiting from the difference
• Speculation
– Speculating the price variation in instrument and buying futures or options of that instrument
Brokerage Firms
• Intermediary institution in financial markets
• Provide various different services
• Primary objective is to channel the funds between lenders and borrowers
• Firms specialize intermediary (brokerage) services in various different areas
– Banking
– Capital Markets
– Wealth Management
– Insurance etc.
• Large firms serve in multiple areas
• Brokerage services may also be provided by
– Banks
– Insurance Companies
– Mutual Funds
– Credit Unions etc
• Individuals can also be Brokers, but may have to obtain appropriate licenses
– Financial Advisor
– Insurance Agent etc.
Services
• Investment Banking
• Wealth Management
• Asset/Investment Management
• Banking
• Insurance
• Trading etc
Investment Banking
• Help private and public corporations to raise funds
– Capital Markets
– Equity and Debt
• Advise in mergers and acquisitions (M&A)
– Strategic Partners
• Corporate Finance
– Loans to corporation
Wealth Management
• Beyond basic Financial Planning
• Serving high net worth clients
– Asset Management
– Investment Advisory
– Portfolio management (distribution of investment products)
– Insurance
– Banking Services
• Simpler versions of Wealth Management are
– Portfolio Management
– Private Banking
– Asset Management /Investment Management
Prime Brokerage
• Services to Hedge Funds
• Collective Services
– Custodial Services (clearing, custody etc)
– Financing
– Securities Lending
– Technology Services (Trading/portfolio apps)
– Operational Services (facilities etc)
• Full Service to startup hedge funds
• Other Services
– Risk analytics
– Advisory Services etc
Capital Markets
• Primary Markets
– Work as Syndicate in releasing IPOs
• Secondary Markets
– Provide Trading Services
– Usually hold memberships on most of the exchanges
– Trade instruments for commission
– Trade instruments for their own accounts to profit from market movements
Insurance Services
• Insurance helps individual and corporations in managing the risk
• Some brokerage firms provide insurance for corporations
Research
• Some firms provide research services as well
• Evaluation of Financial Information of Corporations
• Securities Price Evaluations
• Market research and predictions
• Rating Stock and Bonds etc
Large Brokerage Firms
• Goldman Sachs
• Citi
• JPMorganChase
• Merrill Lynch
• Lehman Brothers
• Bear Sterns
• Morgan Stanley
• UBS
• Bank of America
• Barclays Capital
• ABN AMRO
• Deutche Bank
• CSFB and many more….
Regulatory Agencies
SEC
• US Securities and Exchange Commission
• Founded in 1934
• Objective is to protect the public investment
• Regulates Stock Market and Corporate Reporting
• Independent and US Government Agency
• Has power to license and regulate Stock Exchanges
• Agency to enforce Federal Securities Laws
• Has authority to impose fines and take legal actions against the non-complying corporations
• All Public companies must submit quarterly and annual reports to SEC
• Works with SROs and other federal state agencies in implementing and enforcing regulations
• Run by five commissioners appointed by US President
FINRA
• FINRA - Financial Industry Regulatory Authority
• The largest non-governmental regulatory agency
• Regulates all securities firms doing business in the United States
• FINRA oversees nearly 5,000 brokerage firms
• Has approximately 665,000 registered securities representatives
• Founded in 2007 consolidating NASD and some functions of NYSE
• Follows and enforces SEC regulations
• SRO – Self Regulatory Organization
– Holds an authority to introduce its own regulations
– Adds its own regulations or clarifies SEC regulations
– Usually done to complete the missing items in SEC regulations
• Regulates the Trading and Brokerage practices
– Equities
– Bonds
– Securities Futures
– Options
• Every Firm dealing in securities must be a member of some SRO or Regulatory Agency
• Member Types are
– Brokerage Firms
– Securities Representatives / Independent Brokers
• Primary Functions
– Define Regulatory Rules
– Impose Rules
– Audit and monitor member firms and individuals involved in markets
• Can even impose fines or take legal action against non-complying corporations
• Primarily funded by
– Member firms
– Membership fees
– Fines
NYSE
• New York Stock Exchange
• Owned by NYSE Euronext
• NYSE initially started in 1792, operated as not-for profit organization until 2006
• Went public in 2006 as NYSE Group, Inc. after purchase of ARCA ECN
• Turned into NYSE Euronext in 2006 after merger with Euronext
• Euronext – European Stock Exchange based in Paris
• Nation’s largest Stock Exchange
• Also known as BIG BOARD
• Lists/trades more than 2000 companies stock
• NYSE has capitalization of $23+ trillion
– Capitalization: stock worth
• NYSE Composite Index
– Benchmark index that reflects the performance of all the stocks traded on NYSE Exchange
• NYSE Exchange is located on Wall Street in New York City
• Provides Physical Floor for Trading
• Uses popular Continuous Open Outcry Auction Format
• Only Exchange Members are licensed to trade on the Floor
• Individuals known as Specialists act as AUCTIONEERs (middleman)
• Specialist is not an employee of NYSE
• Each listed stock trades at one specialist
• Buyers and Sellers of the stock are gathered at Specialist
Indices
• Index
– Single statistical number that is calculated for a group of components
• Used to measure the overall performance of the components involved
• Example - Stock Market Index
– DJIA – Dow Jones Industrial Average
– Single number that reflects the overall performance of Industrial Stocks
• Indices are available for all different markets and products
Indices – Benchmark Indices
• Benchmark indices are used to measure performance of major markets
• DJIA – Dow Jones Industrial Average
– Performance of major Industrial stock listed on NYSE
– Include companies like GE, IBM, MSFT etc
• S&P 500
– Performance of 500 Large-Cap stocks
• FTSE 100 (Futsie 100)
– 100 Large companies listed on LSE
• Nikkei 225
– 225 Large corporations listed on TSE
• Hang Seng
– Major companies listed on Hong Kong Stock Exchange
Indices - Specialized
• iShares MSCI EAFE
– Index of selected foreign stock
• Morgan Stanley Biotech
– Index of selected biotech companies
• Interest Rate Indices
• Consumer Price Index (CPI)
• Many more…
Monday, April 6, 2009
The Learning Curve
This blog is made to track financial market news. Before starting that, the basics of financial markets will be dealt with in detail. From basic definitions to the entire functioning of markets, everything will be focused on from scratch. Some of the information and basic definitions are collected from various researches and trusted websites on markets.
The Learning Curve
What are stocks? Definition: Plain and simple, a “stock” is a share in the ownership of a company. A stock represents a claim on the company's assets and earnings. As you acquire more stocks, your ownership stake in the company becomes greater. Some times different words like shares, equity, stocks etc. are used. All these words mean the same thing.
So what does ownership of a company give you?
Holding a company's stock means that you are one of the many owners (shareholders) of a company and, as such, you have a claim to everything the company owns. This means that technically you own a tiny little piece of all the furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company's earnings as well. These earnings will be given to you. These earnings are called “dividends” and are given to the shareholders from time to time.
A stock is represented by a "stock certificate". This is a piece of paper that is proof of your ownership. However, now-a-days you could also have a “demat” account. This means that there will be no “stock certificates”. Everything will be done though the computer electronically. Selling and buying stocks can be done just by a few clicks.
Being a shareholder of a public company does not mean you have a say in the day-to-day running of the business. Instead, “one vote per share” to elect the board of directors of the company at annual meetings is all you can do. For instance, being a Microsoft shareholder doesn't mean you can call up Bill Gates and tell him how you think the company should be run.
The management of the company is supposed to increase the value of the firm for shareholders. If this doesn't happen, the shareholders can vote to have the management removed. In reality, individual investors like you and I don't own enough shares to have a material influence on the company. It's really the big boys like large institutional investors and billionaire entrepreneurs who make the decisions.
For ordinary shareholders, not being able to manage the company isn't such a big deal. After all, the idea is that you don't want to have to work to make money, right? The importance of being a shareholder is that you are entitled to a portion of the company’s profits and have a claim on assets.
Profits are sometimes paid out in the form of dividends as mentioned earlier. The more shares you own, the larger the portion of the profits you get. Your claim on assets is only relevant if a company goes bankrupt. In case of liquidation, you'll receive what's left after all the creditors have been paid. Another extremely important feature of stock is "limited liability", which means that, as an owner of a stock, you are "not personally liable" if the company is not able to pay its debts.
In other legal structures such as partnerships, if the partnership firm goes bankrupt the creditors can come after the partners “personally” and sell off their house, car, furniture, etc. Owning stock means that, no matter what happens to the company, the maximum value you can lose is the value of your stocks. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.
Why does a company issue stocks?
Why would the founders share the profits with thousands of people when they could keep profits to themselves? The reason is that at some point every company needs to "raise money". To do this, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock.
A company can borrow by taking a loan from a bank or by issuing bonds. Both methods come under "debt financing". On the other hand, issuing stock is called “equity financing”. Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way.
All that the shareholders get in return for their money is the hope that the shares will someday be worth more than what they paid for them. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO).
It is important that you understand the distinction between a company financing through debt and financing through equity. When you buy a debt investment such as a bond, you are guaranteed the return of your money (the principal) along with promised interest payments.
This isn't the case with an equity investment. By becoming an owner, you assume the risk of the company not being successful - just as a small business owner isn't guaranteed a return, neither is a shareholder. Shareholders earn a lot if a company is successful, but they also stand to lose their entire investment if the company isn't successful.
It’s a tricky game!
There are no guarantees when it comes to individual stocks. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends. Without dividends, an investor can make money on a stock only through its appreciation of the stock price in the open market. On the downside, any stock may go bankrupt, in which case your investment is worth nothing.
What makes stock prices go "up" and "down"?
Stock prices change every day because of market forces. By this we mean that stock prices change because of “supply and demand”. If more people want to buy a stock (demand) than sell it (supply), then the price moves up!
Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall. (Basics of economics!) Understanding supply and demand is easy. What is difficult to understand is what makes people like a particular stock and dislike another stock. If you understand this, you will know what people are buying and what people are selling. If you know this you will know what prices go up and what prices go down!
To figure out the likes and dislikes of people, you have to figure out what news is positive for a company and what news is negative and how any news about a company will be interpreted by the people.
The most important factor that affects the value of a company is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. It makes sense when you think about it. If a company never makes money, it isn't going to stay in business. Public companies are required to report their earnings four times a year (once each quarter).
Dalal Street watches with great attention at these times, which are referred to as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection.
If a company's results are better than expected, the price jumps up. If a company's results disappoint and are worse than expected, then the price will fall.
Of course, it's not just earnings that can change the feeling people have about a stock. It would be a rather simple world if this were the case! During the “dotcom bubble”, for example, the stock price of dozens of internet companies rose without ever making even the smallest profit. As we all know, these high stock prices did not hold, and most internet companies saw their values shrink to a fraction of their highs. Still, this fact demonstrates that there are factors other than current earnings that influence stocks.
So, what are "all the factors" that affect the stocks price? The best answer is that nobody really knows for sure. Some believe that it isn't possible to predict how stock prices will change, while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. The only thing we do know is that stocks are volatile and can change in price very very rapidly.
Just remember this: At the most fundamental level, supply and demand in the market determines stock price. There are many types of techniques and methods that investors use to figure out whether a stock price will go up or down! We will try to give you an introduction to these techniques in this article.
What are the Sensex & the Nifty?
The Sensex is an "index". What is an index? An index is basically an indicator. It gives you a general idea about whether most of the stocks have gone up or most of the stocks have gone down.
The Sensex is an indicator of all the major companies of the BSE.
The Nifty is an indicator of all the major companies of the NSE.
If the Sensex goes up, it means that the prices of the stocks of most of the major companies on the BSE have gone up. If the Sensex goes down, this tells you that the stock price of most of the major stocks on the BSE have gone down.
Just like the Sensex represents the top stocks of the BSE, the Nifty represents the top stocks of the NSE.
The BSE, is the Bombay Stock Exchange and the NSE is the National Stock Exchange. The BSE is situated at Bombay and the NSE is situated at Delhi. These are the major stock exchanges in the country. There are other stock exchanges like the Calcutta Stock Exchange etc. but they are not as popular as the BSE and the NSE.Most of the stock trading in the country is done though the BSE & the NSE.
Besides Sensex and the Nifty there are many other indexes. There is an index that gives you an idea about whether the mid-cap stocks go up and down. This is called the “BSE Mid-cap Index”. There are many other types of indexes.
There is an index for the metal stocks. There is an index for the FMCG stocks. There is an index for the automobile stocks etc.
Stock Picking - Which stocks to buy?
Having understood all the basics of the stock market and the risk involved, now we will go into stock picking and how to pick the right stock. Before picking the right stock you need to do some analysis.
There are two major types of analysis:
1. Fundamental Analysis
2. Technical Analysis
Fundamental analysis is the analysis of a stock on the basis of core financial and economic analysis to predict the movement of stocks price.
On the other hand, technical analysis is the study of prices and volume, for forecasting of future stock price or financial price movements.
Simply put, fundamental analysis looks at the actual company and tries to figure out what the company price is going to be like in the future. On the other hand, technical analysis look at the stocks chart, peoples buying behavior etc. to try and figure out what the stock price is going to be like in the future.
The Basics of Fundamental Analysis
Fundamental Analysis Definition: Fundamental analysis is a stock valuation method that uses financial and economic analysis to predict the movement of stock prices.
The fundamental information that is analyzed can include a company's financial reports, and non-financial information such as estimates of the growth of demand for products sold by the company, industry comparisons, and economy-wide changes, changes in government policies etc..
General Strategy
To a fundamentalist, the market price of a stock tends to move towards it's “real value” or “intrinsic value”. If the “intrinsic/real value” of a stock is above the current market price, the investor would purchase the stock because he knows that the stock price would rise and move towards its “intrinsic or real value”
If the intrinsic value of a stock was below the market price, the investor would sell the stock because he knows that the stock price is going to fall and come closer to its intrinsic value.
How do you find out what the intrinsic value of a company is? Once you know this, you will be able to compare this price to the market price of the company and decide whether you want to buy it (or sell it if you already own that stock). To start finding out the intrinsic value, the fundamentalist analyzer makes an examination of the current and future overall health of the economy as a whole.
After you analyzed the overall economy, you have to analyze firm you are interested in. You should analyze factors that give the firm a competitive advantage in it’s sector such as management experience, history of performance, growth potential, low cost producer, brand name etc. Find out as much as possible about the company and their products. Do they have any “core competency” or “fundamental strength” that puts them ahead of all the other competing firms? What advantage do they have over their competing firms? Do they have a strong market presence and market share? Or do they constantly have to employ a large part of their profits and resources in marketing and finding new customers and fighting for market share?
After you understand the company & what they do, how they relate to the market and their customers, you will be in a much better position to decide whether the price of the companies stock is going to go up or down.
How do you compare two companies that are in different fields and different industries? How do you know which one is fundamentally strong and which one is week? If you try to compare two companies in different industries and different customers it is like comparing apples and elephants. There is no way to compare them! So fundamental analysts use different tools and ratios to compare all sorts of companies no matter what business they are in or what they do!
Earnings per share (EPS) ratio & what it means!
Even comparing the earnings of one company to another really doesn’t make any sense, if you think about it. Earnings will tell you nothing about how many shares the company has. Because you do not know how many shares a company has, you do not know how many parts that companies earnings have to be divided into. If the company has more shares, the earnings will be divided into more parts.
For example, companies A and B both earn Rs.100, but company A has 10 shares outstanding, so each share holder has in effect earned Rs.10. On the other hand, if company B has 50 shares outstanding and they too have earned Rs.100 then each shareholder has earned Rs.2. So you see it is important to know what is the total number of outstanding shares are as well as the earnings.
Thus it makes more sense to look at earnings per share (EPS), as a comparison tool. You calculate earnings per share by taking the net earnings and divide by the outstanding shares.
EPS = Net Earnings / Outstanding Shares
There are three types of EPS numbers:
Trailing EPS – last year’s numbers and the only actual EPS
Current EPS – this year’s numbers, which are still projections
Forward EPS – future numbers, which are obviously projections
Price to earning (P/E) ratio & what it means?
If there is one number that people look at than more any other number, it is the “Price to Earning Ratio (P/E)”. The P/E looks at the relationship between the stock price and the company’s earnings. The P/E is the most popular stock analysis ratio, although it is not the only one you should consider.
You calculate the P/E by taking the share price and dividing it by the company’s EPS (Earnings Per Share)
P/E = Stock Price / EPS
For example: A company with a share price of Rs.40 and an EPS of 8 would have a P/E of: (40 / 8) = 5
What does P/E tell you?
Some investors read a high P/E as an “overpriced stock”.
However, it can also indicate the market has high hopes for this stock’s future and has bid up the price.
Conversely, a low P/E may indicate a “vote of no confidence” by the market or it could mean that the market has just overlooked the stock. Many investors made their fortunes spotting these overlooked but fundamentally strong stocks before the rest of the market discovered their true worth.
In conclusion, the P/E tells you what the market thinks of a stock. It tells you whether the market likes or dislikes the stock. If things are vague and unclear to you, do not worry.
PEG (Price to future growth ratio!)
The market is usually more concerned about the future than the present, it is always looking for some way to figure out what is going to happen in the companies future. A ratio that will help you look at future earnings growth is called the PEG ratio.
You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings.
PEG = (P/E) / (projected growth in earnings)
For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 30 / 15 = 2.
What does the “2” mean?
Technically speaking: The lower the PEG number, the less you pay for each unit of future earnings growth. So even a stock with a high P/E, but high projected earning growth may be a good value.
So, to put it very simply, we are interested in stocks with a low PEG value.
Just for the sake of understanding, consider this situation, you have a stock with a low P/E. Since the stock has a low P/E, you start do wonder why the stock has a low P/E. Is it that the stock market does not like the stock? Or is it that the stock market has overlooked a stock that is actually fundamentally very strong and of good value?
To figure this out, you look at the PEG ratio. Now, if the PEG ratio is big (or close to the P/E ratio), you can understand that this is probably because the “projected growth earnings” are low. This is the kind of stock that the stock market thinks is of not much value.
On the other hand, if the PEG ratio is small (or very small as compared to the P/E ratio, then you know that it is a valuable stock) you know that the projected earnings must be high. You know that this is the kind of fundamentally strong stock that the market has overlooked for some reason.
PEG ratio relies on the projected % earnings. These earnings are not always accurate and so the PEG ratio is not always accurate.
The Learning Curve
What are stocks? Definition: Plain and simple, a “stock” is a share in the ownership of a company. A stock represents a claim on the company's assets and earnings. As you acquire more stocks, your ownership stake in the company becomes greater. Some times different words like shares, equity, stocks etc. are used. All these words mean the same thing.
So what does ownership of a company give you?
Holding a company's stock means that you are one of the many owners (shareholders) of a company and, as such, you have a claim to everything the company owns. This means that technically you own a tiny little piece of all the furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company's earnings as well. These earnings will be given to you. These earnings are called “dividends” and are given to the shareholders from time to time.
A stock is represented by a "stock certificate". This is a piece of paper that is proof of your ownership. However, now-a-days you could also have a “demat” account. This means that there will be no “stock certificates”. Everything will be done though the computer electronically. Selling and buying stocks can be done just by a few clicks.
Being a shareholder of a public company does not mean you have a say in the day-to-day running of the business. Instead, “one vote per share” to elect the board of directors of the company at annual meetings is all you can do. For instance, being a Microsoft shareholder doesn't mean you can call up Bill Gates and tell him how you think the company should be run.
The management of the company is supposed to increase the value of the firm for shareholders. If this doesn't happen, the shareholders can vote to have the management removed. In reality, individual investors like you and I don't own enough shares to have a material influence on the company. It's really the big boys like large institutional investors and billionaire entrepreneurs who make the decisions.
For ordinary shareholders, not being able to manage the company isn't such a big deal. After all, the idea is that you don't want to have to work to make money, right? The importance of being a shareholder is that you are entitled to a portion of the company’s profits and have a claim on assets.
Profits are sometimes paid out in the form of dividends as mentioned earlier. The more shares you own, the larger the portion of the profits you get. Your claim on assets is only relevant if a company goes bankrupt. In case of liquidation, you'll receive what's left after all the creditors have been paid. Another extremely important feature of stock is "limited liability", which means that, as an owner of a stock, you are "not personally liable" if the company is not able to pay its debts.
In other legal structures such as partnerships, if the partnership firm goes bankrupt the creditors can come after the partners “personally” and sell off their house, car, furniture, etc. Owning stock means that, no matter what happens to the company, the maximum value you can lose is the value of your stocks. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.
Why does a company issue stocks?
Why would the founders share the profits with thousands of people when they could keep profits to themselves? The reason is that at some point every company needs to "raise money". To do this, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock.
A company can borrow by taking a loan from a bank or by issuing bonds. Both methods come under "debt financing". On the other hand, issuing stock is called “equity financing”. Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way.
All that the shareholders get in return for their money is the hope that the shares will someday be worth more than what they paid for them. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO).
It is important that you understand the distinction between a company financing through debt and financing through equity. When you buy a debt investment such as a bond, you are guaranteed the return of your money (the principal) along with promised interest payments.
This isn't the case with an equity investment. By becoming an owner, you assume the risk of the company not being successful - just as a small business owner isn't guaranteed a return, neither is a shareholder. Shareholders earn a lot if a company is successful, but they also stand to lose their entire investment if the company isn't successful.
It’s a tricky game!
There are no guarantees when it comes to individual stocks. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends. Without dividends, an investor can make money on a stock only through its appreciation of the stock price in the open market. On the downside, any stock may go bankrupt, in which case your investment is worth nothing.
What makes stock prices go "up" and "down"?
Stock prices change every day because of market forces. By this we mean that stock prices change because of “supply and demand”. If more people want to buy a stock (demand) than sell it (supply), then the price moves up!
Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall. (Basics of economics!) Understanding supply and demand is easy. What is difficult to understand is what makes people like a particular stock and dislike another stock. If you understand this, you will know what people are buying and what people are selling. If you know this you will know what prices go up and what prices go down!
To figure out the likes and dislikes of people, you have to figure out what news is positive for a company and what news is negative and how any news about a company will be interpreted by the people.
The most important factor that affects the value of a company is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. It makes sense when you think about it. If a company never makes money, it isn't going to stay in business. Public companies are required to report their earnings four times a year (once each quarter).
Dalal Street watches with great attention at these times, which are referred to as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection.
If a company's results are better than expected, the price jumps up. If a company's results disappoint and are worse than expected, then the price will fall.
Of course, it's not just earnings that can change the feeling people have about a stock. It would be a rather simple world if this were the case! During the “dotcom bubble”, for example, the stock price of dozens of internet companies rose without ever making even the smallest profit. As we all know, these high stock prices did not hold, and most internet companies saw their values shrink to a fraction of their highs. Still, this fact demonstrates that there are factors other than current earnings that influence stocks.
So, what are "all the factors" that affect the stocks price? The best answer is that nobody really knows for sure. Some believe that it isn't possible to predict how stock prices will change, while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. The only thing we do know is that stocks are volatile and can change in price very very rapidly.
Just remember this: At the most fundamental level, supply and demand in the market determines stock price. There are many types of techniques and methods that investors use to figure out whether a stock price will go up or down! We will try to give you an introduction to these techniques in this article.
What are the Sensex & the Nifty?
The Sensex is an "index". What is an index? An index is basically an indicator. It gives you a general idea about whether most of the stocks have gone up or most of the stocks have gone down.
The Sensex is an indicator of all the major companies of the BSE.
The Nifty is an indicator of all the major companies of the NSE.
If the Sensex goes up, it means that the prices of the stocks of most of the major companies on the BSE have gone up. If the Sensex goes down, this tells you that the stock price of most of the major stocks on the BSE have gone down.
Just like the Sensex represents the top stocks of the BSE, the Nifty represents the top stocks of the NSE.
The BSE, is the Bombay Stock Exchange and the NSE is the National Stock Exchange. The BSE is situated at Bombay and the NSE is situated at Delhi. These are the major stock exchanges in the country. There are other stock exchanges like the Calcutta Stock Exchange etc. but they are not as popular as the BSE and the NSE.Most of the stock trading in the country is done though the BSE & the NSE.
Besides Sensex and the Nifty there are many other indexes. There is an index that gives you an idea about whether the mid-cap stocks go up and down. This is called the “BSE Mid-cap Index”. There are many other types of indexes.
There is an index for the metal stocks. There is an index for the FMCG stocks. There is an index for the automobile stocks etc.
Stock Picking - Which stocks to buy?
Having understood all the basics of the stock market and the risk involved, now we will go into stock picking and how to pick the right stock. Before picking the right stock you need to do some analysis.
There are two major types of analysis:
1. Fundamental Analysis
2. Technical Analysis
Fundamental analysis is the analysis of a stock on the basis of core financial and economic analysis to predict the movement of stocks price.
On the other hand, technical analysis is the study of prices and volume, for forecasting of future stock price or financial price movements.
Simply put, fundamental analysis looks at the actual company and tries to figure out what the company price is going to be like in the future. On the other hand, technical analysis look at the stocks chart, peoples buying behavior etc. to try and figure out what the stock price is going to be like in the future.
The Basics of Fundamental Analysis
Fundamental Analysis Definition: Fundamental analysis is a stock valuation method that uses financial and economic analysis to predict the movement of stock prices.
The fundamental information that is analyzed can include a company's financial reports, and non-financial information such as estimates of the growth of demand for products sold by the company, industry comparisons, and economy-wide changes, changes in government policies etc..
General Strategy
To a fundamentalist, the market price of a stock tends to move towards it's “real value” or “intrinsic value”. If the “intrinsic/real value” of a stock is above the current market price, the investor would purchase the stock because he knows that the stock price would rise and move towards its “intrinsic or real value”
If the intrinsic value of a stock was below the market price, the investor would sell the stock because he knows that the stock price is going to fall and come closer to its intrinsic value.
How do you find out what the intrinsic value of a company is? Once you know this, you will be able to compare this price to the market price of the company and decide whether you want to buy it (or sell it if you already own that stock). To start finding out the intrinsic value, the fundamentalist analyzer makes an examination of the current and future overall health of the economy as a whole.
After you analyzed the overall economy, you have to analyze firm you are interested in. You should analyze factors that give the firm a competitive advantage in it’s sector such as management experience, history of performance, growth potential, low cost producer, brand name etc. Find out as much as possible about the company and their products. Do they have any “core competency” or “fundamental strength” that puts them ahead of all the other competing firms? What advantage do they have over their competing firms? Do they have a strong market presence and market share? Or do they constantly have to employ a large part of their profits and resources in marketing and finding new customers and fighting for market share?
After you understand the company & what they do, how they relate to the market and their customers, you will be in a much better position to decide whether the price of the companies stock is going to go up or down.
How do you compare two companies that are in different fields and different industries? How do you know which one is fundamentally strong and which one is week? If you try to compare two companies in different industries and different customers it is like comparing apples and elephants. There is no way to compare them! So fundamental analysts use different tools and ratios to compare all sorts of companies no matter what business they are in or what they do!
Earnings per share (EPS) ratio & what it means!
Even comparing the earnings of one company to another really doesn’t make any sense, if you think about it. Earnings will tell you nothing about how many shares the company has. Because you do not know how many shares a company has, you do not know how many parts that companies earnings have to be divided into. If the company has more shares, the earnings will be divided into more parts.
For example, companies A and B both earn Rs.100, but company A has 10 shares outstanding, so each share holder has in effect earned Rs.10. On the other hand, if company B has 50 shares outstanding and they too have earned Rs.100 then each shareholder has earned Rs.2. So you see it is important to know what is the total number of outstanding shares are as well as the earnings.
Thus it makes more sense to look at earnings per share (EPS), as a comparison tool. You calculate earnings per share by taking the net earnings and divide by the outstanding shares.
EPS = Net Earnings / Outstanding Shares
There are three types of EPS numbers:
Trailing EPS – last year’s numbers and the only actual EPS
Current EPS – this year’s numbers, which are still projections
Forward EPS – future numbers, which are obviously projections
Price to earning (P/E) ratio & what it means?
If there is one number that people look at than more any other number, it is the “Price to Earning Ratio (P/E)”. The P/E looks at the relationship between the stock price and the company’s earnings. The P/E is the most popular stock analysis ratio, although it is not the only one you should consider.
You calculate the P/E by taking the share price and dividing it by the company’s EPS (Earnings Per Share)
P/E = Stock Price / EPS
For example: A company with a share price of Rs.40 and an EPS of 8 would have a P/E of: (40 / 8) = 5
What does P/E tell you?
Some investors read a high P/E as an “overpriced stock”.
However, it can also indicate the market has high hopes for this stock’s future and has bid up the price.
Conversely, a low P/E may indicate a “vote of no confidence” by the market or it could mean that the market has just overlooked the stock. Many investors made their fortunes spotting these overlooked but fundamentally strong stocks before the rest of the market discovered their true worth.
In conclusion, the P/E tells you what the market thinks of a stock. It tells you whether the market likes or dislikes the stock. If things are vague and unclear to you, do not worry.
PEG (Price to future growth ratio!)
The market is usually more concerned about the future than the present, it is always looking for some way to figure out what is going to happen in the companies future. A ratio that will help you look at future earnings growth is called the PEG ratio.
You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings.
PEG = (P/E) / (projected growth in earnings)
For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 30 / 15 = 2.
What does the “2” mean?
Technically speaking: The lower the PEG number, the less you pay for each unit of future earnings growth. So even a stock with a high P/E, but high projected earning growth may be a good value.
So, to put it very simply, we are interested in stocks with a low PEG value.
Just for the sake of understanding, consider this situation, you have a stock with a low P/E. Since the stock has a low P/E, you start do wonder why the stock has a low P/E. Is it that the stock market does not like the stock? Or is it that the stock market has overlooked a stock that is actually fundamentally very strong and of good value?
To figure this out, you look at the PEG ratio. Now, if the PEG ratio is big (or close to the P/E ratio), you can understand that this is probably because the “projected growth earnings” are low. This is the kind of stock that the stock market thinks is of not much value.
On the other hand, if the PEG ratio is small (or very small as compared to the P/E ratio, then you know that it is a valuable stock) you know that the projected earnings must be high. You know that this is the kind of fundamentally strong stock that the market has overlooked for some reason.
PEG ratio relies on the projected % earnings. These earnings are not always accurate and so the PEG ratio is not always accurate.
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