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Futures and Options Trading Strategies

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Futures & Options Trading Strategies

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Mutual Fund overview

MUTUAL FUND OVERVIEW
What is a Mutual Fund?
A mutual fund is a pool of money that is professionally managed for the benefit of all shareholders. As an investor in a mutual fund, you own a portion of the fund, sharing in any increases or decreases in the value of the fund. A mutual fund may focus on stocks, bonds, cash, derivatives or a combination of these asset classes.
There are different types of mutual funds. Some mutual funds are riskier than others. For example, it is unlikely that you will lose money in a mutual fund that buys money market instruments, such as treasury bills. Risk can sometimes work in your favor: the higher the risk, the bigger the potential return (and the bigger the potential loss); the lower the risk, the smaller the potential return (and the smaller the potential loss). To reduce your overall risk and enhance potential returns, you should invest in a diversified portfolio of mutual funds which have different risk characteristics. An investment in a Fund is a convenient method to achieve that diversification.

Advantages of Mutual Fund:
Mutual funds offer a number of advantages, including diversification, professional management, cost efficiency and liquidity.
*Diversification. A mutual fund spreads your investment dollars around better than you could do by yourself. This diversification tends to lower the risk of losing money. Diversification usually results in lower volatility, because when some investments are doing poorly, others may be doing well.
*Professional management. Many people don't have the time or expertise to make investment decisions. A mutual fund's investment managers, however, are trained to search out the best possible returns, consistent with the fund's strategies and goals.
*Cost efficiency. Putting your money together with other investors creates collective buying power that may help you achieve more than you could on your own. As a group, mutual fund investors can buy a large variety and number of specific investments. They can also afford to pay for professional money managers and fund operating expenses, where they wouldn't be able to afford it on their own. *Liquidity. With most funds, you can easily sell your fund shares for cash. Some mutual fund shares are traded only once a day at a fixed price, while stocks and bonds can be bought or sold any time the markets are open at whatever price is then available.

Buying shares (Investment Procedure)
You can buy shares a few different ways, depending on the rules of the particular fund. Funds are often described as either being "no-load" or "load" funds, depending on whether or not they charge a sales commission.
No-load funds: Many funds are no-load funds that charge no (or a very low) sales fee or commission. Financial companies typically sell no-load funds directly to investors in places like newspapers and magazines. In this case, you complete all the paperwork yourself.
Load funds: These funds charge a sales fee or commission for purchases. Some funds charge the fee when you buy shares; others charge when you sell them. Brokerage firms and banks often sell load funds, and will help process any paperwork.
There are reputable, high-performing funds in both categories. Because sales charges reduce your return, we believe that investors should consider no-load funds whenever possible.
Funds typically give you two ways in which to invest:
Lump sum. You can invest any amount you want at one time, as long as you meet the minimum requirements of that fund. Some funds have no minimum for opening an account or no minimum for additional share purchases, while others do.
Automatic investment. Most funds offer plans that allow you to transfer set amounts on a regular basis automatically from your bank account or paycheck.
With automatic investing, you get the benefits of dollar cost averaging. That is, when you make regular investments in a mutual fund, such as investing $100 every month, you can take advantage of both the ups and downs of the market. When the market is down, your monthly investment typically buys you more shares of the fund, helping to increase your ownership in the fund. When the market is up, your monthly investment typically buys you fewer shares of the fund, helping you avoid buying too many shares at higher prices. Over a long period of time, the end result is that the average cost of your fund shares is lower than the average price of the fund shares during the same period.
Exchanging and selling shares
Many funds allow you to make free exchanges of your shares for shares of another fund owned by the same fund company. Typically, there is a limit to the number of free exchanges you can make. Be aware that even though an exchange may be free, there may be tax consequences associated with it.
To sell shares, you either call the fund directly if you have a no-load fund, or have your broker or bank officer do it if you have a load fund. Typically, you are given the option to have the proceeds deposited into your account or sent directly to you by check or wire. Some funds will charge you a fee if you don't keep the fund shares for a minimum amount of time (e.g., 90 or 180 days).

Pricing Methodology:
The value of a mutual fund share is calculated based on the value of the assets owned by the fund at the end of every trading day. Here is how it works:
The fund calculates the value: A share's value is called the Net Asset Value (NAV). The fund calculates the NAV by adding up the total value of all of the securities it owns, subtracting the expenses of the fund, and then dividing by the number of shares owned by shareholders like you.
Value changes daily: Since the value of the stocks or bonds owned by the fund can change daily, the value of the fund can also change daily. Therefore, a fund is required by law to adjust its price once every trading day to provide investors with the most current NAV.
How many shares you own: To see the value of your investment, you take the value of one share and multiply it by the number of shares you have in the fund. While you cannot buy a fraction of a share of stock, you can own a fraction of a mutual fund share, if the amount you invest does not divide evenly by the NAV.

Earnings:
Once your money is in a fund, it can provide you with earnings in three ways.
Appreciation: The value of a fund share can appreciate or go up in value. (Of course, it can also go down in value.) When the total value of the securities owned by the fund rises, the value of your fund shares rises with it. Again, the reverse is also true.
Dividends: If the fund receives dividends from stocks, interest from bonds, or other investment income, it distributes those earnings to shareholders as a dividend according to the terms outlined in its prospectus. Depending on the fund, these distributions can be monthly, quarterly, or annually.
Capital gain distributions: Every time the fund manager sells securities at a profit, the fund earns capital gains. Funds are required to distribute these gains to the shareholders at regular intervals, typically once or twice a year

Choosing a Mutual Fund
Choosing the right funds—and trusting your decisions enough to back them with your money—is challenging. Factors to be considered while investing in Mutual Fund are enumerated below:
Look at the fund prospectus.The prospectus is essentially the user's manual for a mutual fund. The SEC requires every fund to publish a prospectus and update it annually. It covers all of the important elements, such as the history, management, financial condition, performance, expenses, goals, strategies, types of allowable investments, and policies.

Performance. Each fund must tell you how much it has increased or decreased in value in each of the past 10 years (or for every year of its existence, if shorter). This is labeled in the prospectus as "performance" or as "annual total return." Fund performance is required to be shown against a relevant industry benchmark.

Average annual return. While every fund has to show its annual performance, every fund also must tell you its average return on a yearly basis. Average annual return is important because it keeps funds from promoting their best years and ignoring their worst years. It takes the total returns for each year and averages them across the number of years the fund has been in existence.

Fees and expenses. The prospectus will tell you if a fund charges a sales charge or is a "no-load" fund. All funds charge management fees and expenses, which will be described in the prospectus.

Use independent rating services. Independent rating services, such as Morningstar, Lipper and Barrons, often provide a convenient way to find out information about a fund very quickly. These services typically provide you with a rating or ranking of a fund based on its performance relative to its broader peer group, as well an opinion about a fund's management team and operations.

Risks
You could lose money
It's the most obvious and feared risk of investing. There are, however, many strategies for managing this risk, particularly over the long term.
Your money may lose buying power
This risk is also known as inflation risk: as prices increase, your investments must increase in value at least at the same pace, or you'll lose purchasing power.
You may not achieve your goal
Probably the biggest, yet most overlooked risk of investing, is the risk of not achieving your goal. It's probably overlooked so often because so few investors actually set goals, and many others set unrealistic goals. Furthermore, many investors don't buy the right investments to help them achieve their goals. This type of risk is often called shortfall risk (falling short of your goal).
Your investment may rise and fall in value
Almost all investments have the potential to gain and lose value. This is known as market risk. Seasoned investors tend to ignore the relatively small price movements in their investments, preferring to try and capture the more significant fluctuations they can better anticipate. If you invest for longer periods of time, market risk may become less dangerous to you. That's because, over the long-term, most investments tend to rise in price. Market risk, however, can place investors at a significant disadvantage if they are forced to sell at a time when prices happen to be down.
Foreign exchange or currency risk
If you invest overseas, the exchange rate between your home currency and the foreign currency adds an extra layer of risk to your investment. The stock or bond you buy may go up, but the exchange rate may go down so far that it wipes out your gain.
The halo effect
When something wonderful happens to one stock in an industry, many of the others in that industry may also enjoy a rise. This is known as the Halo Effect. But it also occurs in reverse, taking value out of perfectly good investments just because they are linked in the minds of investors to another investment that is experiencing a problem.

Different Types of Funds
Mutual funds come in a wide variety of investment styles. The most common are money market funds, stock funds, bond funds and mixed asset funds.
Money market funds
Aiming for protection, money market funds are considered the safest place to invest money in mutual funds. They do not provide much potential for income or growth. However, they do seek to generate a small amount of return by loaning money on a short-term basis, anywhere from one day to up to a year. These loans are considered low-risk because they are such short-term. On the other hand, they are also typically the class of fund that earns the least for investors. Money market funds charge low interest rates for the loans, thus earning you small amounts on your investment. Money market funds try to maintain a consistent share price of $1 by paying out all of the earnings to shareholders and by avoiding securities that can rise and fall in price (so there are no capital gains to distribute).
You have a choice of varieties of money market funds:
Taxable: These are simply called "money market funds" if offered by a mutual fund company; or "money market accounts" if offered by a bank. Both make short-term loans, but those offered by a bank are FDIC (Federal Deposit Insurance Corporation) insured. Those offered by mutual funds are insured by the private insurer, SIPC (Securities Investors Protection Corporation).
Government: These funds only make loans to national governments or agencies of those governments. Earnings are free from federal taxation.
Municipal: These funds only make loans to various state and local governments and their agencies. The income from these funds is free from federal taxation, and any portion of the income that comes from the state in which you live is also free from state taxation.

Bond Funds.

Aiming for income, bond funds loan money to corporations and/or government agencies. Bond funds are typically for earning a somewhat predictable amount of income. In times of falling interest rates, however, a bond fund could increase in value, growing your money through capital appreciation, as stock funds are meant to do. The opposite is also true; in times of rising interest rates, the bonds in your fund may lose value and cause you to lose money, even while you're earning income from interest.
The different types of Bond Funds available are as follows:
Corporate bonds: a corporation is the borrower
Government bonds: the national government or its agency is the borrower
Municipal bonds: a state or local government or its agency is the borrower
Short-term bond funds: bonds typically maturing in less than five years
Intermediate bond funds: bonds typically maturing in five to ten years
Long-term bond funds: bonds typically maturing in ten to thirty years

Stock Funds
Stock funds generally aim for growth, income or a combination of both. A stock fund invests mainly in stocks and may focus on a particular type of stock or segment of the stock market, depending on its goal and strategy.
Various Stock Funds available are as follows:
Aggressive growth. These are the start-up, or relatively new companies who have not yet established themselves in their product or service market. They may also be companies in high risk businesses, such as the Internet, biotechnology, and a number of other highly competitive and money-intensive industries.
Growth. These are companies that have moved beyond the phase of uncertainty but still have a lot of room to grow.
Value. These are well-established companies with histories of consistent earnings and growth, whose stock prices are viewed by the portfolio manager as being an attractive value.
Industry and sector. Some industries will do well while others will do poorly. The companies in the software business are in the same industry; while others in the high tech hardware business are in a different industry. All of these companies, however, would be grouped into the high tech sector.
Country or region. The economies of different countries act differently at different times. So there are mutual funds, for instance, that invest in specific countries or regions. The term "emerging growth fund," describes a fund that invests in countries that have small but growing economies.

Balanced funds
Balanced funds aim for the best of both stocks and bonds. These funds mix stocks and bonds to give you a mixture of growth potential and income potential, as well as a little more protection during periods of dropping prices. The stocks are typically meant to provid price appreciation potential, while the bonds are meant to provide income and a measure of price stability.Balanced funds may either keep their ratio of stocks to bonds fairly constant or switch the ratio of stocks to bonds depending on market conditions.

Asset allocation funds
Asset allocation funds can invest in a mixture of stocks, bonds and cash equivalents. The ratio of each asset class is typically based on investor risk profiles, such as conservative, moderate and aggressive.


Index funds
Index funds are low-cost mutual funds that seek to mirror the performance of the broader markets they represent.

Lifestyle Funds
These funds aim to provide all the diversification that you need in a single fund. They are designed for consumers who don’t have much time or knowledge to make investment decisions. They can go by a number of different names, such as retirement, target date (e.g., target date 2040), life-cycle or asset allocation funds.

Exchange traded funds (ETFs)
Exchange Traded Funds are baskets of stocks, somewhat like mutual funds, that are traded on the stock market. The fees may be even lower than mutual funds, and the tax consequences more favorable.But you pay a commission to buy them, just like when you buy stocks. So, if you want to invest on a regular basis, ETFs can get very expensive because you pay a commission every time you buy more shares.

Open-ended and Closed-ended fund
The term mutual fund is the common name for an open-end investment company. Being open-ended means that, at the end of every day, the fund issues new shares to investors and buys back shares from investors wishing to leave the fund. Mutual funds may be legally structured as corporations or business trusts but in either instance are classed as open-end investment companies by the SEC. Closed end funds are generally listed funds and can be traded on exchanges just like shares. However, they can be issued and redeemed on specific dates only, and thus the name 'closed end'. The ownership of closed ended funds can transferred from one holder to another.

How to tackle the bear run

Nothing is going good for the economy (whether India or the world). The markets are down and no one knows where it is heading. But there is one common view. The markets have bottomed out and there is little downside from here. However, no one knows when is it going to revive. The levels of 21000 seems fantasy at this point.

Analysts are jobless and are considered a liability to the erstwhile employers who used to flaunt a research division not more than 4 months ago.

But it is said that if there is anything that comes for free in India, it is advise. So here I am, giving free advise. I know I wont be paid foir it anyways ;-)

Seven ways to tackle the bear run

• Stick to stocks of large companies
• Look for debt free companies
• Search for businesses that are insulated (well, relatively) from the slowdown
• Look for companies that largely depend on domestic revenues
• Search for value stocks (generally cash-rich companies)
• Have an investment horizon for at least 2-3 years
• In case of mid-cap stocks, choose companies that are market leaders, are niche players and possibly belong to sunrise sectors

-adapted from the Businessworld, 17-nov-08 issue
You may also apply a set of financial filters:

• PE Ratios below 16
• Debt-Equity Ratio below 1
• Net profit growth and operating margins of over 10% in the last three financial years as well as in the 1st half of FY 09
• Average 3 year return on equities above 20%

So you may follow the advise and invest based on this. But standard disclaimers apply. You wont give me a share if you profit, dont blame me if you lose either.

RBI Bulletin Nov 2008

"India, with its strong internal drivers for growth, may escape the worst consequences of the global financial crisis. Indian banks have very limited exposure to the US mortgage market,
directly or through derivatives, and to the failed and stressed financial institutions. The equity and the forex markets provide the channels through which the global crisis can spread to the Indian system. The other three segments of the financial markets - money, debt and credit markets could be impacted indirectly. Risk aversion, deleveraging and frozen money markets have not only raised the cost of funds for Indian corporates but also its availability in the international markets.
This will mean additional demand for domestic bank credit in the near term. Reduced investor interest in emerging economies could impact capital flows significantly. The impending recession
will also impact on Indian exports.

Even EMEs which do not have direct or significant exposure to stressed financial instruments and troubled financial institutions are
experiencing the indirect impact of the financial crisis, and this impact is by no means insignificant or trivial. Indeed, it could intensify in the months ahead".

- Extract from RBI Bulletin November 2008 ["Lessons from the Global Financial Crisis with Special Reference to Emerging Market Economies and India" - D. Subbarao, Governor, Reserve Bank of India]

Click the links below for the entire bulletin and/or segment breakdown

RBI Statistics
Click here to downLoad: Reserve Bank of India - Bulletin (November 2008) (full bulletin 17.26MB)

Click here to downLoad: Contents

Click here to downLoad: Editorial Committee

Click here to downLoad: Statement by Dr. D. Subbarao, Governor, Reserve Bank of India on the Mid-Term Review of Annual Policy for the Year 2008-09

Click here to downLoad: I. The Real Economy

Click here to downLoad: II. Fiscal Situation

Click here to downLoad: III. Monetary and Liquidity Conditions

Click here to downLoad: IV. Price Situation

Click here to downLoad: V. Financial Markets

Click here to downLoad: VI. The External Economy

Click here to downLoad: Lessons from the Global Financial Crisis with Special Reference to Emerging Market Economies and India* D. Subbarao

IMF on Emerging Markets

Until recently, emerging markets were one of the few bright spots left in a world economy hit by massive deleveraging, failing banks, and corporate profit warnings. But now, the crisis is spreading beyond the advanced economies where it originated, with emerging markets all over the world suffering from the squeeze in global financial markets.

In terms of equity prices too, after more than a year of relatively small spillovers from the financial turmoil in advanced economies, equity prices in emerging markets succumbed to the dramatic worsening of financial distress in mid-September 2008.
Still, in early October, despite their steep and abrupt declines, emerging equity prices as a group were still well above their level at the beginning of their rally in the early part of this decade.

Moreover, unlike in past crises, the size of the spillover has not been uniform, reflecting the deepening of these markets, the different economic fundamentals among emerging market economies, and the growth of South-South cross-border investment, which helps insulate them from investor concerns in mature economies. The equity price declines, however, are likely not over.

IMF has projected that world growth is projected to slow from 5 percent in 2007 to 3¾ percent in 2008 and to just over 2 percent in 2009, with the downturn led by advanced economies. IMF has already trimmed the growth projections of India from 7.9% to 7.8% in 2008 and 6.9% to 6.3% in 2009.

Equity prices affect growth
Such global spillovers on emerging equity prices can, in turn, affect domestic private consumption and investment, although the links between financial markets and the real economy tend to play out more gradually than those within financial markets. The IMF analysis found increasing evidence of the so-called "wealth effect" of equity prices in emerging market economies, although not as pronounced as in mature market economies, where consumption and investment have long been affected by changes in equity prices.

Building resilience
To help withstand abrupt price fluctuations, emerging markets could help build and sustain resilient capital markets. Specifically, the policies that could help to make markets more resilient in the long run include:

• Fostering a broader and more diversified investor base to help deepen markets. Encourage a variety of investors, including institutional investors, such as pension funds and insurance companies, which tend to have long-term investment horizons. Longer-horizon investors can provide a buffer against any reversal of foreign equity inflows.

• Aiding price discovery. Remove impediments to price discovery by avoiding artificial delays in revealing prices or limiting price movements.

• Supporting financial infrastructure development. Adopt legal, regulatory, and prudential rules that conform with international best practice.

• Developing stock exchanges. A well-functioning exchange environment and supporting financial infrastructure for trading equities and new financial instruments can help price discovery, foster liquidity, and generally improve efficiency. Careful implementation, however, is important at every stage. Enhancements and financial innovation need to be properly timed and sequenced, with appropriate oversight in place, so as to reap the full benefits of innovation, while managing the risks to financial stability and ensuring the proper functioning of markets.

“Sail with the tide” is the apt phrase for those who talk about the economy, markets you name it. Except for those who did not invest in India, every one talked about the fundamentals and the growth rate projections for India’s GDP went as high as 15% by some eminent global analysts. Now when the markets have come down, every one has become an astrologer in retrospect. Every one is saying that India was overvalued and this downfall was obvious et al.

India’s GDP growth accelerated to an average of 9.3% during the three years ending March 2008 compared with an average of 6.6% and 6.0% in the preceding three and five years, respectively. “The most important driver for this acceleration in growth above potential was the sharp rise in capital inflows” – believes Chetan Ahya, Managing Director, Morgan Stanley.

Capital inflows have risen dramatically over the past five years. India received an average of $10 billion per annum between 2000 and 2002. During 2003-2005, capital inflows jumped more than two times to an average of $21.3 billion, followed by an increase to $38.5 billion in 2006 and to $98.3 billion in 2007.

Contrary to general belief, the direction and magnitude of capital inflows have been highly influenced by global macro environment rather than emerging markets’ long-term fundamentals. Very often we hear the argument from investors that capital inflows were drawn into India because of attractive growth opportunities and, therefore, this trend will continue unabated. However, trend for capital inflows into emerging markets have been dependent on global risk appetite, which has been driven by liquidity and growth environment in the developed economies.

During 12 months ending March 2008, India received $108 billion in capital inflows. Of this, $29 billion were portfolio equity inflows, $42 billion were debt borrowings, $15.5 billion were net FDI, and the balance was other inflows. Over the last few months, with the reversal in global risk appetite, we are seeing a sharp fall in capital inflows into India and emerging markets. As estimates of Morgan Stanley, capital inflows into India have on an annualised basis slowed to $30-35 billion in April-August 2008. India has seen portfolio equity outflows of $4.3 billion from April to August 2008, in line with the emerging markets.

It has been observed in the past that FDI inflows into emerging markets and India tend to lag the portfolio inflows by a year. A large part of the rise in FDI inflows into India was in the form of private equity inflows, real estate, and acquisition of stakes in Indian companies by multinationals. There has not been any significant increase in FDI into green-field manufacturing activities in India. Hence, a large part of the FDI inflows will likely follow the mood of the capital markets.

“In the current global financial market environment, countries with the twin macro-problems of high current account deficit and tight banking sector liquidity is likely to suffer a major deceleration in growth”, says Chetan. He believes India will be the most affected after Australia. First, unlike the rest of the region, India runs a large current account deficit, and its balance of payments surplus has been driven by capital inflows. Most other countries in the region have large current account surpluses. Second, India has had a strong credit cycle over the last four years. It has been a beneficiary of a virtuous cycle of large capital inflows — major liquidity infusion — pushing up domestic demand. India’s credit growth has averaged 28% over the last three years.

There is not much scope for a quick policy response to a further slowdown in domestic demand. The government has already been running a pro-cyclical fiscal policy stance. Indeed the burden of higher oil prices, the government’s announcement of a wage hike for its employees, and write-off of farm loans have pushed government’s deficit, including off-budget items to 10.2% of GDP in year ended March 2009.

Analysts don’t expect a quick monetary policy response either. It is believed the RBI is unlikely to cut policy rate again until the March-April 2009. The RBI will hesitate to cut policy rate until we see deceleration in WPI inflation closer to RBI’s comfort levels of 5% from the current double digit levels. Moreover, the RBI’s policy rate decision is also likely to be weighed against the weakening exchange rate.

Further domestic demand growth deceleration is inevitable. Over the last 12 months, aggressive tightening in India’s monetary conditions has already slowed credit-funded consumption significantly. The increased tightening in the global and domestic financial markets is expected to further slow investment growth sharply.

With nothing going well for the global economy, one can just sit and watch what the global leaders do to rescue the global economies from the ongoing crisis.

References: The Economic Times Nov 10, 08 [Interview with Chetan Ahya, Managing Director, Morgan Stanley]

Obama, the new face of America

History has already been made by Barack Obama becoming President of the United States. The man of mixed ethnicity is considered to be the utterly representative of the 21st century America. He is expected to reverse (for the better, of course) the image of America abroad and refresh the spirits back home.

But we all saw that this was amongst the most sought after elections in the US. The passion of the elections in the US is understood, but why are we all here in India too were so curious about the elections in the US. One would say that we have become more globalised. Sure we have. But I guess there’s more to it. Our economy has developed deeper linkages with the US around increased trade, currency and investment. India Inc is one of the largest employers in the US as was pointed out in a recent FICCI report, on the back of recent acquisitions and investments by a large number of Indian companies like Wockhardt, TCS, etc. All this has significantly increased the risks and impacts of a US recession on our economy.

We just benefited for years due to the recession in the US economy. The corporates there outsourced their jobs to India leading to the Service sector being the highest contributor to our GDP growth. But now the biggest expectation for India from the new US President is the reversal of the decline of the US economy. He ha stalked about pumping in billions of dollars and tax breaks to the middle class to ‘kickstart the US Economy’. Our exporters should be preparing to take advantage of this coming resurgence of US demand and the government must ensure that our exporters are enabled to benefit from this opportunity.

“Indian businesses can look to broad changes in the outsourcing structure — with more emphasis on on-shore projects and investments by Indian companies with tax and other incentives to encourage this” says Rajeev Chandrasekhar, Member of Parliament and president of FICCI.

Obama has repeatedly talked about making the US economy competitive. This will redefine the strength of the dollar, which is currently at its strongest levels on back of flight to safety of the currency back to the US from across the globe. The US is also expected to be more aggressive in trade negotiations as he has also said “US will fight for a trade policy that opens up foreign markets to support good American jobs.”
India specially needs to be careful on this front. It is believed that Obama is anti-outsourcing but in order to “build a close strategic partnership” between US and India as he had pledged it would be difficult to take a call against outsourcing. Besides, he is not expected to come in the bad books of the corporates in the US who have been benefiting from outsourcing as a result of low costs. To keep his word, he may discourage the issue of H1B visa to Indians (outsiders for that matter).

The global slowdown is already being tagged as “Made in America”. One of the biggest negatives dragging down the world economy has been this growing sense of hopelessness and the vacuum of credible international leadership. Barack Obama has demonstrated both intellectual leadership and temperament that could turn this hopelessness into a positive view of the future. He is seen as the leader who is attuned to temperamentally, intellectually and emotionally lead the nation which leads (well, almost) the globe.

BT

I used to work for BT for 22 years and still feel quite loyal to them, though increasingly frustrated at the apparent determination to die. BT is a good company in many ways, dumb in others. But overall, it has missed out on the IT boom, and the share price has tumbled in recent years, so many of us loyal shareholders have lost a lot of money by staying optimistic about its future. In an industry packed with potential, it has consistently avoided capitalising on the many opportunities it has had.

BT has had a lot of CEOs over the years, and most have missed their main opportunities. Though I am sure some people would disagree, here is my take: Michael Heiffer came from the finance industry but completely failed to understand BT's potential to use its transaction management capabilities in the banking market. Peter Bonfield came in from the computing industry, but totally failed to understand the potential from telecomms-computing convergence, passing over lucrative opportunities worth tens of billions, while wasting tens of billions instead on 3g licenses and incomprehensible company purchases that almost took the company into bankruptcy. The less said about Cockburn the better. Finally, Ben Verwaayen was at least competent. He stopped the fall for a few years by selling off much of the company's most valuable assets, although he failed to dump the network when given the chance, which would have liberated the company to concentrate on what it does best. But although he was good at stopping the rot for a while against tough odds, he was never the right manager to capitalise on growth opportunities. But at least he had the good sense to go when he'd done his bit, to let someone else take BT into the growth phase. But once Ian Livingston was identified as the man likely to take over, there was never any prospect other than doom.

I believe the main problem in BT is accountancy drive. Accountants dominate many blue chip companies because the perception is that since the company exists to make money, people who can manage money ought to be able to run the company better than others, such as engineers. In some industries, perhaps that is true, I won't comment here. But in a high technology company such as BT, it is not at all appropriate. So I warned my friends to sell their BT shares when Ian Livingston was marked to take over. Since then, the price has fallen by about two thirds, proving I was right.

Accountants count beans, but usually only some of the beans. They look at those things that appear on the balance sheet, such as costs, and income, but don't look properly at things that are hard to measure, such as engineer productivity, creativity, or staff loyalty, and rarely look at potential revenue. So they put in place micromanagement systems that greatly reduce productivity by using up staff time to get small quantities of useful information worth a fraction of the costs of acquisition, but since those costs are not directly measured, they are ignored. The result is a very precise but very inaccurate figure for the numbers of beans.

They also have much less understanding than engineers of what it is that the company actually could do, what its skills are, or what the industry could offer. So while BT sits in a field full of promise, surrounded by gold, its focuses on headline cost reduction as the main route to profits, while splashing out heavily on low-potential investments such as BT Vision. Ignoring enormous revenue sources while putting too much effort into cost reduction is folly, but it is sadly a problem that has affected BT for many years. Its single strategy has been hiding in the corner, leaving new opportunities to other companies, while technology progress erodes the potential income from traditional sources, and then trying to stay in business by reducing costs.
This strategy hasn't worked so far and it won't start working in the future. It is long overdue for the scrapheap.

BT has a network that is very expensive to maintain, and is wholly inadequate to run modern services. Its strategy director was quoted in the weekend papers saying that she can't see why anyone would need more than 20Mbit/s to the home. Such comments will go down in the infamous quotation books alongside Bill Gates' comment than no-one could ever need more than 600k of memory in a computer.

The company must start to explore the modern telecoms and IT marketplaces, look around the find the services it could offer, quickly develop them, and then sell them at a reasonable price without its usual confusion marketing. This will cost money, but it will be a sound investment. Saving money ad-infinitum will eventually lead to a tiny company with tiny value. Investing heavily to create adventurous new products and services would create new income streams that will take the company to its full potential.

BT still has a lot of high quality staff, though many have left in recent years in management -induced despair, having offered the company the ideas it needed and having them rejected by accountants and managers with little or no real understanding of telecoms or IT. It is not too late yet, but it soon will be. Identifying key technology-enabled opportunities and financing them will lead to recovery. Counting beans will lead to oblivion. Livingston has to go, and go soon. In my opinion, he just doesn't understand the business he is in, and should never have been at board level, let alone CEO. Francois Barrault has gone as a scapegoat, but I think he had a far better understanding of BT's business than Livingston ever will. BT was once a great company and could be one again with the right policies. Sacking good people and over-promoting fools will not help. Nor will counting only a selection of the beans.

But I haven't sold my shares. I am hoping in spite of everything that one day, BT will appoint a CEO who understands the business, who is prepared to take risk and invest heavily in the right areas, with huge injection into R&D. With the courage to identify and remove some of the thoroughly incompetent managers dotted here and there, and to reward the better ones, BT could once again be a world leading company. But BT can only be a good investment in the long term, and it might not survive that long.

Very risky, but potentially a good buy for the long term.

Marks and Spencer share price decline

M&S used to offer the kind of clothes I would wear. I have no fashion knowledge, and effectively used to outsource that to M&S. I buy whatever shirt they have in stock, knowing I can go out in public wearing it without looking daft.

They seem to be in trouble with declining share prices and I wondered why. I hadn't been clothes shopping for a few months since my wardrobe was stuffed. But when we recently got a black tie dinner invitation, I took my wife there to get a new dress. We couldn't find one. We weren't being fussy, it's just that they only had three, all pretty similar. We searched the whole shop assuming we must have missed the appropriate section, but eventually gave up and went elsewhere. And come to think of it, I had the same trouble last year when I bought a new dinner suit, it took ages to find the right section because the layout had all changed, and when I did, there were very few choices. And I couldn't find the shirts I like either.

I think if this problem is a common one for their regular and loyal customers, it would explain why they are suffering. They have simply lost touch with what their customers want to buy, a potentially fatal problem if it continues. Too much trying to invent new styles and cater for new markets has left them alienating many of their existing customers, who want to spend money there, but can't.

Too bad. I'd like to help by buying stuff there, but they'll have to stock it first. My needs are simple - I just want ordinary everyday clothes that are reasonable quality, look OK, feel OK and don't cost a fortune. I suspect that's what the rest of their traditional customer base also wants.

Back to basics then.

Bankruptcy

We all usually get a lot of mails (junk ones), not all of them are junk though.
I got a forwarded mail from a friend.... I found it interesting.. so here it is.

If you could read patiently and understand, its a great knowledge !
　
Once there was a little island country. The land of this country was the tiny island itself. The total money in circulation was 2 dollars as there were only two pieces of 1 dollar coins circulating around.
　
There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.
B decided to purchase the land from A for 1 dollar. So, now A and C own 1 dollar each while B owned a piece of land that is worth 1 dollar.
* The net asset of the country now = 3 dollars.
　
Now C thought that since there is only one piece of land in the country, and land is non producible asset, its value must definitely go up. So, he borrowed 1 dollar from A, and together with his own 1 dollar, he bought the land from B for 2 dollars.
*A has a loan to C of 1 dollar, so his net asset is 1 dollar.
* B sold his land and got 2 dollars, so his net asset is 2 dollars.
* C owned the piece of land worth 2 dollars but with his 1 dollar debt to A, his net residual asset is 1 dollar.
* Thus, the net asset of the country = 4 dollars.
　
A saw that the land he once owned has risen in value. He regretted having sold it. Luckily, he has a 1 dollar loan to C. He then borrowed 2 dollars from B and acquired the land back from C for 3 dollars. The payment is by 2 dollars cash (which he borrowed) and cancellation of the 1 dollar loan to C. As a result, A now owned a piece of land that is worth 3 dollars. But since he owed B 2 dollars, his net asset is 1 dollar.
* B loaned 2 dollars to A. So his net asset is 2 dollars.
* C now has the 2 coins. His net asset is also 2 dollars.
* The net asset of the country = 5 dollars. A bubble is building up.
　
B saw that the value of land kept rising. He also wanted to own the land. So he bought the land from A for 4 dollars. The payment is by borrowing 2 dollars from C, and cancellation of his 2 dollars loan to A.
* As a result, A has got his debt cleared and he got the 2 coins. His net asset is 2 dollars.
* B owned a piece of land that is worth 4 dollars, but since he has a debt of 2 dollars with C, his net Asset is 2 dollars.
* C loaned 2 dollars to B, so his net asset is 2 dollars.
* The net asset of the country = 6 dollars; even though, the country has only one piece of land and 2 Dollars in circulation.
　
Everybody has made money and everybody felt happy and prosperous.
　
One day an evil wind blew, and an evil thought came to C's mind. "Hey, what if the land price stop going up, how could B repay my loan. There is only 2 dollars in circulation, and, I think after all the land that B owns is worth at most only 1 dollar, and no more."
　
A also thought the same way.
Nobody wanted to buy land anymore.
* So, in the end, A owns the 2 dollar coins, his net asset is 2 dollars.
* B owed C 2 dollars and the land he owned which he thought worth 4 dollars is now 1 dollar. So his net asset is only 1 dollar.
* C has a loan of 2 dollars to B. But it is a bad debt. Although his net asset is still 2 dollars, his Heart is palpitating.
* The net asset of the country = 3 dollars again.
　
So, who has stolen the 3 dollars from the country ? Of course, before the bubble burst B thought his land was worth 4 dollars. Actually, right before the collapse, the net asset of the country was 6 dollars on paper. B's net asset is still 2 dollars, his heart is palpitating.
　
B had no choice but to declare bankruptcy. C as to relinquish his 2 dollars bad debt to B, but in return he acquired the land which is worth 1 dollar now.
* A owns the 2 coins, his net asset is 2 dollars.
* B is bankrupt, his net asset is 0 dollar. ( he lost everything )
* C got no choice but end up with a land worth only 1 dollar
* The net asset of the country = 3 dollars.
　
****** End of the story ******
BUT......
There is however a redistribution of wealth.
A is the winner, B is the loser, C is lucky that he is spared.
A few points worth noting -
(1) When a bubble is building up, the debt of individuals to one another in a country is also building up.
(2) This story of the island is a closed system whereby there is no other country and hence no foreign debt. The worth of the asset can only be calculated using the island's own currency. Hence, there is no net loss.
(3) An over-damped system is assumed when the bubble burst, meaning the land's value did not go down to below 1 dollar.
(4) When the bubble burst, the fellow with cash is the winner. The fellows having the land or extending loan to others are the losers. The asset could shrink or in worst case, they go bankrupt.
(5) If there is another citizen D either holding a dollar or another piece of land but refrains from taking part in the game, he will neither win nor lose. But he will see the value of his money or land go up and down like a see saw.
(6) When the bubble was in the growing phase, everybody made money.
(7) If you are smart and know that you are living in a growing bubble, it is worthwhile to borrow money (like A ) and take part in the game. But you must know when you should change everything back to cash.
(8) As in the case of land, the above phenomenon applies to stocks as well.
(9) The actual worth of land or stocks depend largely on psychology

Where is the money going?

Its Global Liquidity Crisis ! We all have been listening to this for a while now and are adversely affected by this. the global markets are down and money is flowing out of the emerging economies.
I am being asked a very valid question time and again. If money is flowing out of (say) India, it must be going somewhere. For every outflow of money, there must be a corresponding inflow somewhere. But that's not the case. the whole world is facing this liquidity crisis. A gentleman (he invested a lot in the equities and has lost millions due to fall in the market; "the FIs are selling") came up with an answer that the FIs are sitting on cash. OK! lets take this for a while. But are they hold currency notes. Nopes. This money shud then be deposited in the bank accounts. But again this liquidity crisis is most faced by banks. the banks dont have money to lend, the interest rates are shooting up. So is it that the banks are holding money with themselves are not willing to lend. Nopes; not possible.

First let me tell you the cause of liquidity crisis. Liquidity crisis occurs when the borrowers fail to repay. Remember the subprime crisis last year? The banks and other financial institutions lent to low-creditworthy borrowers huge sums of money and they defaulted. It all started from here.

Now let me explain how this non-payment of loan affects liquidity.
Lets go back to the basics of economics that we read in high school. the process of creating money by banks. We read that banks create money using the deposits it gets from the account holders. We know the concept Cash Reserve Ratio [CRR] (known by different but similar names in different countries). Central banks require banks to maintain a minimum percentage of deposit as reserve to meet withdrawal needs. This minimum percentage is called Cash Reserve Ratio. The banks lend the balance of the deposit to borrowers.
I'll explain in detail.
Assume that the CRR is 9% (as was in India about 15 days ago)
Mr. A deposits Rs 100000 into his bank account (Bank A). Based on the liquidity requirement, Bank A is required to hold 9% of 100000 = 9000 and lend the balance Rs 91000.
The bank lends this Rs 91000 to Mr B who deposits this money in say Bank B (even if he uses for any purpose, it ultimately goes to a bank account). Bank B again holds 9% i.e. 8190 and lends the balance (i.e. Rs 82810) to C Ltd and the money goes to Bank C and the process continues.
So we see that Rs 100000 deposited by Mr A in Bank A has already created (or circulated) money worth Rs 100000+91000+82810 = 273810. Mind you, the process continues and there is more money that is generated with this Rs 100000.
Mathematically, Maximum money that is generated with this Rs 100000 given 9% CRR is;
1 / CRR x Initial Money Deposited i.e.
1/0.09 x 100,000 = 1,111,111

Though there were various other related factors, the subprime itself let to writedowns of $501 billion in the US. Assuming a 10% reserve requirement, the banks lost $5010 billion of money creation.
Since there has been huge defaults, the banks are unable to generate money and are thus unable to lend too. Again, the increased demand for loans (and short supply) has led to increase in Interest rates as well.

This is indeed the main reason why the RBI has been trimming the CRR rates (6.5% from 9% in a matter of 10 days).

The policies are being put in place. Lets hope things shape up well !!!
As for the people who are wondering where has the money gone; I hope I have answered to an extent.

Banking Industry - Reasons to smile amidst challenges

The statements issued by the Prime Minister, Finance Minister, RBI Chief and Bank chairmen have at least some truth in it. This is seconded by the recent Crisil report. But again, there are two sides of a coin. The report says that the global crisis is not responsible for the challenges faced by the Indian Banks; but at the same time, there are a lot of internal factors that are responsible for the same.

Contrary to the stance taken by authorities, ratings major Crisil has said domestic, not global factors are responsible for the current challenges facing the banking sector. In a statement issued on Tuesday, the ratings agency has said: “Crisil believes that the Indian banking system is relatively insulated from factors leading to the turmoil in the global banking industry.” The statement goes on to add that the recent tight liquidity in the Indian market is also qualitatively different from the global liquidity crunch, which was caused by a crisis of confidence in banks lending to each other.

Crisil managing director and chief executive officer Roopa Kudva said: “While the main causes of global stress are less relevant here, Indian banks do face increased challenges due to domestic factors.

The banking sector faces profitability pressures due to

• higher funding costs,
• mark-to-market requirements on investment portfolios, and
• asset quality pressures due to a slowing economy.”

But the strong capitalisation of Indian banks is a positive feature in the current environment. Problems of global banks arose, mainly due to exposure to subprime mortgage lending and investments in complex collateralised debt obligations whose values have eroded sharply over the past few months. Globally, the crisis of confidence among banks that has also been affected by the freeze in the inter-bank lending market.

Reasons to smile

Indian banks have limited vulnerability. Indian banks’ global exposure is relatively small, with international assets at about 6% of total assets. Even banks with international operations have less than 11% of their total assets outside India.

The reported investment exposure of Indian banks to distressed international financial institutions of about $1 billion is also very small.

The mark-to-market losses on this investment portfolio, will, therefore, have only a limited financial impact.

Indian banks’ dependence on international funding is also low.

The reasons for tight liquidity conditions in the Indian market in recent weeks are quite different from the factors driving the global liquidity crisis. Some reasons include

• large selling by foreign institutional investors (FIIs),
• subsequent Reserve Bank of India (RBI) interventions in the foreign currency market,
• continuing growth in advances,
• earlier increases in cash reserve ratio (CRR) to contain inflation.

RBI’s recent initiatives, including the reduction in CRR by 150 basis points from October 11, 2008, cancellation of two auctions of government securities, and confidence-building communication, have already begun easing liquidity pressures.

Being an optimist citizen and a strong believer in the government policies, I hope things should turn out well and investors should gein confidence in the Indian Banks soon.

EVA revisited

Economic value Added


INTRODUCTION
Economic Value Added™ is the financial performance measure that comes closer than any other to capturing the true economic profit of an enterprise. EVA also is the performance measure most directly linked to the creation of shareholder wealth over time.

EVA = Net operating Profit After tax – (Capital Employed x Cost of Capital)

Net Operating Profit After Tax (NOPAT): A company's potential cash earnings if its capitalization were unleveraged (that is, if it had no debt). NOPAT is frequently used in economic value added (EVA) calculations.
Calculated as:
NOPAT = Operating Income x (1 - Tax Rate)

Put most simply, EVA is net operating profit minus an appropriate charge for the opportunity cost of all capital invested in an enterprise. As such, EVA is an estimate of true "economic" profit, or the amount by which earnings exceed or fall short of the required minimum rate of return that shareholders and lenders could get by investing in other securities of comparable risk.

Profits the way shareholders count them
The capital charge is the most distinctive and important aspect of EVA. Under conventional accounting, most companies appear profitable but many in fact are not. As Peter Drucker put the matter in a Harvard Business Review article, "Until a business returns a profit that is greater than its cost of capital, it operates at a loss. Never mind that it pays taxes as if it had a genuine profit. The enterprise still returns less to the economy than it devours in resources…Until then it does not create wealth; it destroys it." EVA corrects this error by explicitly recognizing that when managers employ capital they must pay for it, just as if it were a wage.
By taking all capital costs into account, including the cost of equity, EVA shows the cash wealth a business has created or destroyed in each reporting period. In other words, EVA is profit the way shareholders define it. If the shareholders expect, say, a 10% return on their investment, they "make money" only to the extent that their share of after-tax operating profits exceeds 10% of equity capital. Everything before that is just building up to the minimum acceptable compensation for investing in a risky enterprise.

Aligning decisions with shareholder wealth
EVA has been developed to help managers incorporate two basic principles of finance into their decision making. The first is that the primary financial objective of any company should be to maximize the wealth of its shareholders. The second is that the value of a company depends on the extent to which investors expect future profits to exceed or fall short of the cost of capital. By definition, a sustained increase in EVA will bring an increase in the market value of a company. This approach has proved effective in virtually all types of organizations, from emerging growth companies to turnarounds. This is because the level of EVA isn't what really matters. Current performance already is reflected in share prices. It is the continuous improvement in EVA that brings continuous increases in shareholder wealth.

A financial measure line managers understand
EVA has the advantage of being conceptually simple and easy to explain to non-financial managers, since it starts with familiar operating profits and simply deducts a charge for the capital invested in the company as a whole, in a business unit, or even in a single plant, office or assembly line. By assessing a charge for using capital, EVA makes managers care about managing assets as well as income, and helps them properly assess the tradeoffs between the two. This broader, more complete view of the economics of a business can make dramatic differences.

Ending the confusion of multiple goals
Most companies use a numbing array of measures to express financial goals and objectives. Strategic plans often are based on growth in revenues or market share. Companies may evaluate individual products or lines of business on the basis of gross margins or cash flow. Business units may be evaluated in terms of return on assets or against a budgeted profit level. Finance departments usually analyze capital investments in terms of net present value, but weigh prospective acquisitions against the likely contribution to earnings growth. And bonuses for line managers and business-unit heads typically are negotiated annually and are based on a profit plan. The result of the inconsistent standards, goals, and terminology usually is incohesive planning, operating strategy, and decision making.

EVA compared with MVA
Unlike Market based measurements like MVA[Market Value Added is the difference between the equity market valuation of a listed company and the sum of the adjusted book value of debt and equity invested in the company. In other words, it is the sum of all capital claims held against the company; the market value of debt and the market value of equity], EVA can be calculated for a divisional (strategic Business Unit) level. Unlike equities measurements, EVA is a flow and can be used for performance evaluation over time.

EVA compared with EBIT and EPS
Unlike accounting profit such as EBIT, PAT and EPS, EVA is economic and is based on the idea that a company must cover both the operating costs and capital costs.

Usage of EVA:
EVA can be used for the following purposes:
Ø Setting organizational goals
Ø Performance measurement
Ø Determing bonuses
Ø Communication with shareholders and investors
Ø Motivation of managers
Ø Capital budgeting
Ø Corporate valuation
Ø Analyzing equity securities.

Source:
http://www.sternstewart.com/evaabout/whatis.php
http://www.valuebasedmanagement.net/methods_eva.html
http://www.12manage.com/methods_eva.html

National Express

Poor management and lack of investment in new technology. Sell.

US Govt- Different strokes for different folks?

The US Government, through the US Treasury and Federal Reserve, stepped in to save the Fannie Mae and Freddie Mac; refused to do anything about Lehman Brothers, let Bank of America help Merrill Lynch save itself and threw AIG a lifeline. Why this partiality? There’s reason ! Lets see why!

The Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA), and the Federal Home Loan Mortgage Corporation (FHLMC) all are Government Sponsored Entities (GSEs) and they are known by the names Ginnie Mae, Fannie Mae, and Freddie Mac. Each purchases mortgages from lenders to provide funds for mortgage loans.
The agencies issue three types of mortgage-backed securities: mortgage Pass-through securities and collateralized mortgage obligations. and stripped mortgage-backed-securities. This process of combining many similar debt obligations as the collateral for issuing securities is called securitization. The primary reason for mortgage securitization is to increase the debt's attractiveness to investors and to decrease investor required rates of return, increasing the availability of funds for home mortgages.

Ginnie Mae, Fannie Mae, and Freddie Mac all guarantee the timely payment of scheduled interest and principal payments from their mortgage-backed securities. They are able to do this because they only purchase or underwrite loans that conform to certain standards regarding borrower credit ratings, loan size, and the ratio of each loan to the value of the property securing it.

The US Government, through the US Treasury and Federal Reserve, stepped in to save the Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac account for almost half of the $12 trillion mortgage market. By law, they are not allowed to hold sub-prime mortgages or refinance them. But they are listed companies and when the market value of their capital base falls below the mandated capital adequacy levels, how good the assets are is irrelevant.

As GSEs, many foreign central banks (including Japan, China, India) have invested their reserves in the bonds of these agencies. So it was very unlikely that the US govt was going to let its own GSEs go bankrupt.

Reference: Businessworld, CFA Institute Level 1 curriculum

environmental waste

A brilliant piece in today's times by Bjorn Lomborg, one of my favourite environmentalists. While the world goes mad jumping on every passing bandwagon with a climate change banner, there is precious little common sense being applied. Lomborg's simple case that we should cost actions in seems to be ignored by the vast majority of environmentalists. His calculations suggest that for every pound the UK is spending, we will receive roughly 4p worth of good. The money could and should be spent elsewhere.

I can't disagree with a thing he says. His analysis is spot on.

What irritates me more than anything about the whole climate change debate is the almost total ignoring of the effects of future technology with its consequences for business and social change.
All the projections of doom and gloom rely on technology staying similar to today, yet the assumption is that we will still consume more and more. So environmentalists take full account of increasing wealth and consumption, without taking any account of what we will actually be consuming, or how it is made or used. We still see lots of ads telling us how important it is to switch off TVs and other IT and not to leave them on standby. The fact is that these devices don't use 30W on standby any more, it is now more like 0.1W. Recent rises in oil prices have already led to car manufacturers accelerating their plans for electric cars, and caused hundreds of entrepreneurs to get into new energy technology. Panic is not required, solutions are being developed and will be delivered. Not tomorrow, but easily early enough to prevent anything like the doom and gloom being forecast for the long term.

In this light of rapid technology development and the mid term solving of climate change, and the certain aversion of long term doom, Lomborg's criticism of the extreme waste of money on reducing CO2 emissions becomes even more appropriate. Governments are spending extreme amounts of money on very little gain, whereas if they spent much less in the right areas, such as technology R&D, they would accomplish much more.

So why is this in my finance blog rather than my grumpy old man rant? One day, in the not too distant future, the tide will turn, and it will be obvious to everyone that the money has been misdirected. Companies that are developing genuinely useful technologies will flourish, whiloe those sustained by the financial fallout of environmental hype will suffer and most will die.

Time to start looking at your portfolio and weeding out shares in so-called ethical companies, and any that spend a lot of effort to tell everyone how environmentally sound they are. I'd rather have sound financial and business management any day than a CEO whose main effort is to appease the stupid end of environmentalism. The day of reckoning will come sooner than you think.

bank collapses and the suspension of logic

I have been asked several times recently to comment on the economic collapse and have refused to do radio shows because I know too little about economics to make any sensible comment. Or so I thought. But the decisions our leaders have been making in response suggest I am not the only one who knows nothing. I am astonished at how much absolutely obvious sense has been thrown away in the panic. Our UK treasurer has responded to the collapse of Bradford and Bingley by selling much of the bank to the Spanish Santander, while keeping most of the debt. Fair enough if the deal was sound, except that the price he sold it at was only sensible if Santander also took on most of the debt. As far as I can tell from the figures in the morning papers, he effectively sold £21Bn of safe cash for £610M, while the UK taxpayer kept all the debt. Sure, the bank shares were worthless, but cash is cash, and debt is debt, and even if the overall sum is low, the cash bit is still cash, bank branches are still branches, and still worth just as much. Banco Santander must be laughing themselves silly at the stupidity of the UK treasury. I am feeling rather let down, having had a large chunk of my hard earned money given away to a bank for no good reason. Along with every other UK taxpayer. Why is our government so panicked into doing something that they will do anything, regardless of whether it makes any sense? Surely in time of crisis, actions need more than ever to be thought through sensibly.

In any case, I am rather puzzled by this whole thing, and I am not alone. Why is it such a big problem if some banks go under? They can't all fail. The world economy is perfectly sound. People are working, generating wealth. Some people have surplus, others want to borrow. If every bank went broke, new ones would spring up on the internet tomorrow to ensure that borrowers are put in contact with savers, for a cut. As it is, some banks have overstretched, and bought bad risks from other banks, and they deserve to suffer the consequences of their own bad decisions. Other banks who haven't done so will survive, since their assets outweigh their bad risks.

Of course, the situation has created an atmosphere of distrust, and slowed liquidity, but throwing away good money at people who have already proven should not be allowed to manage it does not seem a good idea. Capitalism hasn't failed, the companies failed, that's all. If they are allowed to die, no big deal. Life, business, and the flow of money, will quickly return to normal. The real problem is if taxpayers' money is thrown away, taxes increased, and people can't afford to live well. That will certainly collapse economies.

So, I don't get it. Perhaps I am missing something, but I suspect not. I suspect the real problem is that our leaders don't get it, and are far too willing to listen to bad advice from people who stand to gain a great deal of money from it. If I were in power, I would leave the market alone. It will be very turbulent, lots of people will lose money, and lots will gain. And the banks that survive might be a little more sensible in future. Bail them out, and the pain will affect everyone for a very long time, and the banks will still take bad risks, because that is how their executives are incentivised.

Why is Rupee depreciating then?

The US Economy is weakening, why is Rupee depreciating (as compared to dollar) then?

The rupee slumped to a five-year low of 47.10 in spite of the slowdown in the US Economy. Ideally when a country is in the slowdown the currency of that country should depreciate. Fine that India is slowing down too but is still growing at a rate more than the US. But why is the Rupee depreciating then.

There is heavy dollar-demand from oil refiners and importers.
Sentiment for the local currency was further dampened by losses on the stock markets on Monday (29-Sep-08). But the central bank intervened by selling up to $1 billion which helped prop up the rupee.
We have the inflation climbing the ladder very fast with remote signs of coming down. The crude oil prices are extremely volatile. The GDP forecast is also trimmed every now and then. The current account deficit is widening.

With not many positives in sight, traders see the rupee trading in the 47-per dollar range for the next few days. At the current levels, the rupee is still the second worst performing major Asian currency against the US dollar as it has dipped by 18% since January after the South Korean Won which dipped by about 23% in the same period. Though many other competing Asian currencies, like the Malaysian Ringgit and Thai Baht, have also depreciated against the dollar, they have still fared better than the rupee while the Chinese yuan has actually strengthened against the dollar.
The central bank is not protecting any level as such. It is just protecting the market from excess volatility. At the moment, there are a number of underlying negatives, with constant dollar-outflows from the markets and a widening current account deficit. Given that the central bank is not proactively supporting any particular level, traders are not ruling out possibilities of the rupee depreciating beyond the 47-mark in the next few weeks either.
In the domestic market, the rupee touched a low of 47.10/11 against the dollar during early trade on Monday, a level last seen in June 2003. However, its slide was halted by heavy central-bank intervention, following which the rupee ended the day at 46.96/98 levels against the dollar, weakening from its previous close of 46.54/55. Cash conditions also went through a major squeeze, with banks collectively borrowing a record Rs 90,075 crore from the central bank, over both its daily liquidity adjustment windows.
RBI has been intervening heavily in the forex markets for the past couple of weeks, with nationalised banks selling dollars on its behalf. The RBI is estimated to have sold up to $2 billion in its intervention on Monday, in an attempt to shield the rupee from a steep fall. Also, dollar demand was enhanced on Monday, since the currency and bond markets will be shut on Tuesday for the half-yearly book-closing of banks.

Yield on the 10-year benchmark bond, the 8.24% bond maturing in 2018, rose to a high of 8.73% during early trade. It finally ended the day at 8.62%, three basis points above Friday’s close of 8.59%. According to a dealer with a private bank, some banks picked up positions in the 10-year bond, in an attempt to artificially bring the yield down, so that they wouldn’t incur mark-to-market losses in their half-year closing.
[Remember, yield is inversely related to the price; so when the yield comes down, the prices go up and thus the mark-to-market losses come down] Inter-bank call rates also remained high and touched a high of 16% during the day.
I am not really sure if I have answered the question myself that why is rupee depreciating as compared to the dollar. But yes, there are enough reasons for the rupee to depreciate.

Any better answers? Please post !!

source: extracts from The Economic Times (30-sep-08)

Accounting Impact - SOX

Accounting Impact
From an accounting perspective, the focus in the United States has been on:
• Convergence
• Moving from rules-based standards to principles-based standards
• Trending away from recording assets and liabilities at historical cost and moving to fair value.

Convergence
With the global environment in which companies operate, the FASB and the International Accounting Standards Board ("IASB") have dedicated themselves to improve financial reporting by evaluating the differences between US GAAP and IFRS and reducing those differences where possible. The two bodies are currently in the short-term phase of a longer-term convergence project. The goal of the short-term project is to reduce a variety of differences between US GAAP and IFRS.
The short-term projects are those where significant differences do not exist and the Boards believe that they can reach agreement without a major overhaul of the current requirements.
In addition to the convergence project, the FASB and IASB have joint projects where, from the beginning, they are working together to find the best accounting answer. One such project is business combinations.

Rules-based standards to Principles-based standards
Historically, the accounting standards in the US have been very detailed and rules-based; sometimes to the detriment of properly reflecting the economics of the transaction. Consequently, businesses have sometimes structured transactions to achieve a desired accounting treatment.
A study performed by the SEC entitled, Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-Based Accounting System (dated 25/7/2003) indicated that principles-based standards would result in more transparent information for financial statement users, and provide information that conforms to the spirit or objective of the accounting standard versus meeting detailed rules.
Principles-based standards, however, will require company management and auditors to use more judgement in applying a standard as there will no longer be a list of rules to check-off, but the spirit of the standard and the economics of the transaction must be reflected appropriately.

Historical Cost to Fair Value
A trend in US standard setting has been a move to recording transactions at fair value versus historical cost. While this determination is currently being made on a standard-by-standard basis, the FASB has found that more frequently, fair value is proving to be the most relevant and reliable measure of financial value.
The trend toward fair value is not isolated to standard setters in the US. The IASB has also been trending toward fair value and seeing the benefit of recording financial statement items at fair value.
Fair value versus historical cost is causing quite a bit of debate within the financial community. Some question the reliability of fair value as often it is the result of management's estimate and judgment versus an observable market transaction or contract price. Others question the cost/benefit of providing such information. Determining fair value can be more costly and time consuming for companies than determining historical cost.
Regardless of the debate, standard setters are seeing the benefit of fair value accounting and many new standards are requiring its use.

SOX - International Impact

International Impact of SOX
Foreign Private Issuers ("FPIs") registered on US Exchanges must comply with the Act in the same manner in which a US company does, with limited exceptions. The Act introduced additional requirements that many foreign companies did not anticipate when first deciding to enter US capital markets. As a result of these and other environmental changes, the direct and indirect costs of being an SEC registrant have increased and some foreign companies are reconsidering the US capital markets as a place to raise capital. Additionally, the PCAOB regulates the non-US auditors who have clients that are listed on an exchange in the US and registered with the SEC. This makes the non- US audit firms subject to the regulatory requirements, inspection process, and penalties dictated by the PCAOB.

In response to the increase compliance costs, in March 2007, the SEC finalized rules allowing Foreign Private Issuers to deregister with the SEC if they meet certain requirements.

A link to the final rules is provided (http://www.sec.gov/rules/final/2007/34-55540.pdf)

Although many countries or territories do not have a Sarbanes-Oxley equivalent, many regulatory bodies and Exchanges are expanding their accounting, regulatory, and corporate governance standards in order to prevent large scale corporate scandals as those experienced in the US.

As a result of increased scrutiny by the regulators and investing public, company officials of multinational entities have stated that much of their time has been redirected from strategic business initiatives to matters of compliance. The amount of time and money spent globally on regulatory compliance has increased dramatically in recent years. The increased costs, however, have not gone without benefits. Companies have identified and corrected weaknesses in their internal controls over financial reporting which should improve the quality of the information they are providing to the market. This translates into more informed investors and increased trust in the capital markets

Sarbones Oxley - Overview

Sarbonex Oxley Act (SOX) or Investor Protection Act 2002

The Act was written by Senator Paul Sarbanes and Congressman Michael Oxley and enacted by the Congress of the United States in response to corporate management, accounting, and reporting scandals.
The Act has heightened the role of regulation within the accounting industry and with it the role of the US Securities and Exchange Commission ("SEC") and the newly created Public Company Accounting Oversight Board ("PCAOB") in that regulatory process.
The Act represents the biggest change in the US corporate governance and reporting since the federal securities laws were first enacted in 1933 and 1934. The Act has required the SEC to issue more regulations within six months than the SEC had ever issued before in a similar period.
Among other things, the Sarbanes-Oxley Act establishes new or enhanced standards for corporate accountability and has increased penalties for corporate wrongdoing for SEC registrants.

The Sarbanes-Oxley Act was enacted in an effort to prevent accounting scandals and other reporting problems from recurring, and to rebuild public trust in US corporate business practices, financial reporting, and in the capital markets.

The Act created a new oversight organisation, PCAOB, which now regulates the auditors of US public companies; the SEC continues to regulate the public companies.

The Act requires the PCAOB to establish:

• auditing and related attestation standards
• quality control standards
• ethics standards
• professional standards on the independent auditors’ attestation report on management’s assessment of the effectiveness of internal controls

The Act also authorises the PCAOB to establish rules to implement and enforce auditor independence requirements. Previously, independence rules were established and enforced by the SEC for auditors of public companies and the American Institute of Certified Public Accountants ("AICPA") for auditors of private entities.

The Act gives the PCAOB authority on how it will develop and adopt its standards. The Act does recommend that the PCAOB gather input from outside experts during its standard setting process. The PCAOB agrees with the Act's recommendation and, consequently, develops its standards in an open, public process in which investors, the accounting profession, the preparers of financial statements, and others have the opportunity to participate. In order for a PCAOB standard to become final, however, it must be ratified by the SEC.
The purpose of the Sarbanes-Oxley Act is to protect investors through:

• Disclosures that are more:
• Accurate
• Timely
• Comprehensive
• Understandable

• Enhanced Corporate Governance rules

• Stricter enforcement of the auditing profession by creating the PCAOB

• Improved internal controls over financial reporting

Section 404 of the Sarbanes-Oxley Act requires the annual report (Form 10-K or Form 20-F) of each US SEC registrant (except a registered investment company) to include a report addressing the following:
• A statement of management’s responsibility for establishing and maintaining adequate internal control over financial reporting for the company
• A statement identifying the framework used by management to conduct the required evaluation of the effectiveness of the company’s internal control over financial reporting
• Management’s assessment of the effectiveness of the company’s internal control over financial reporting as of the end of the company’s most recent fiscal year, including a statement as to whether or not the company’s internal control over financial reporting is effective
• A statement that the registered public accounting firm that audited the financial statements included in the annual report has issued an attestation report on management’s assessment of the registrant’s internal control over financial reporting

The cost of compliance with the Sarbanes-Oxley Act, both in dollars and hours, has been a source of debate within the US. So much so that the SEC, with the PCAOB, held and will hold public roundtables to discuss the Act with constituents. The result of such roundtables has been further interpretive guidance from the PCAOB, including the June 2007 release of Auditing Standard No. 5, An Audit of Internal Control Over Financial Reporting that is Integrated with an Audit of Financial Statements to assist in the most effective and efficient implementation of the Act's requirements.

Valuation in Mergers & Acquisitions

Valuation is a critical part of the merger process. A deal that may be sound from a business standpoint may be unsound from a financial standpoint if the bidder firm pays too much. The purpose of a valuation analysis is to provide a disciplined procedure for arriving at a price. If the buyer offers too little, the target may resist and, since it is in play, seek to interest other bidders. If the price is too high, the premium may never be recovered from postmerger synergies. These general principles are illustrated by the following simple model.

ANALYSIS
Mergers increase value when the value of the combined firm is greater than the sum of the premerger values of the independent entities.

NVI = VBT – (VB - VT)

where NVI = net value increase
VB = value of bidder alone
VT = value of target alone
VBT = value of firms combined

A simple example will illustrate.
Company B (the bidder) has a current market value of Rs.40mn. Company T (the target) has a current market value of Rs.40mn. [Please note that this assumption of same market value for both the companies is rarely found]. The sum of the values as independent firms is therefore Rs.80mn. Assume that as a combined company synergies will increase the value to Rs.100mn. The amount of value created is Rs.20mn.

How will the increase in value be divided? Targets always (usually) receive a premium. What about the bidders? If the bidder pays a premium of less than Rs.20mn, it will share in the value increase. If B pays a premium larger than Rs.20mn, the value of the bidder will decline.

If the Bidder pays Rs 50mn the value of the bidder is (40+10) = 50mn implying that the values are shared equally.

If the Bidder pays Rs 60mn the value of the bidder is Rs (100 - 60) = 40mn implying that all synergies go to the target, the bidder gets no incentive to buy the target.

If the Bidder pays Rs 70mn, the value of the bidder is (100 - 70) = 30mn. This is dangerous. It implies that the value of bidder declines and the acquisition is not advised.
On the contrary, if the Bidder pays less Than 50 mn the value of the Bidder may be higher (100 – amount paid) but in this case the target does not accept the acquisition. As already said, the target always receives a premium.

Suppose B exchanges 1.0 of its shares for 1.0 share of T. Since the combined firm is valued at Rs.100mn, T will receive .5 X 100mn, which equals 50mn. The premium paid is 25 percent. Based on their previous 40mn values, B and T each owned 50 percent of the pre-merger combined values. Post-merger, the percentages of ownership will remain 50–50.
If B exchanges 1.5 of its own shares per share of T, this is equivalent to paying Rs.60mn in value for the target. Company T shareholders will own 60 percent of the combined company. None of the synergy gains will be received by the bidder shareholders.

Also note that the target shareholders will have 1.5 shares in the new company for every 1.0 share held by the bidder shareholders. The situation is even worse if B pays more than Rs.60mn for the target. Assume B pays Rs.70mn for the target (1.75 to 1 shares). Since the combined company has a value of Rs.100mn, the value of the bidder shares must decline to Rs.36.36mn. The consequences are terrible. The shares of the bidder will decline in value by Rs.3.64mn, or 9.1 percent. Furthermore, the B shareholders will own only 36.36 percent of the combined company; for every 1.0 share that they own, the target shareholders will own 1.75 shares.

Valuation Methods

The leading methods used in the valuation of a firm for merger analysis are the comparable companies or comparable transactions approach, the spreadsheet approach, and the formula approach.

In the comparable companies or comparable transactions approach, key relationships are calculated for a group of similar companies or similar transactions as a basis for the valuation of companies involved in a merger or takeover. It is a commonsense approach that says that similar companies should sell for similar prices.

Let’s look at an example. We need to value Potential Target (PT) Ltd. and we have three comparable companies. Potential Bidder1 (PB1), Potential Bidder2 (PB2) and Potential Bidder3 (PB3).

We take three ratios into account for simplicity purposes,
Enterprise Value / Revenues (EV/R) - 1.4, 1.2 and 1.0 for PB1, PB2 and PB3 respectively. Thus the average comes to 1.2

Enterprise Value / EBITDA (EV/EBITDA) - 15, 14 and 22 for PB1, PB2 and PB3 respectively. Thus the average comes to 17

Enterprise Value / Free Cash Flow (EV/FCF) - 25, 20 and 27 for PB1, PB2 and PB3 respectively. Thus the average comes to 24.

Next we need to apply these ratios to PT Ltd. Lets assume that Revenues, EBITDA and FCF of PT are 100mn, 7mn and 5 mn respectively.

Applying the respective averages we get Enterprise value in each case

EV based on Revenue = 100 x 1.2 = 120mn

EV based on EBITDA = 7 x 17 = 119 mn

EV based on FCF = 5 x 24 = 120 mn

The average EV would thus be (120 + 119 + 120) / 3 = 120 mn

Wow! pretty close huh? I doubt how often would you find such close figures from the three given methods. But still you now know just one of the methods of valuing a company in case of mergers / acquistions.

One of the advantages of the comparable companies approach is that it can be used to establish valuation relationships for a company that is not publicly traded. This is a method of predicting what its publicly traded price is likely to be. The methodology is applicable in testing for the soundness of valuations in mergers also. Both the buyer and the seller in a merger seek confirmation that the price is fair compared to the values placed on the other companies. For public companies, the courts will require such a demonstration if a suit is filed by an
aggrieved shareholder.
Typically, merger transactions involve a premium as high as 30 percent to 40 percent over the prevailing market price (before news of the merger transaction has leaked out). The relevant valuation for a subsequent merger transaction would be the transaction enterprise prices for comparable deals. The result would be a higher indicated price. We will use 30 percent as the premium factor. The indicated enterprise market value of company PT would be 156 million.

If there had been no comparable companies to be considered, we would go by the valued arrived at by comparable companies approach. But that is just the starting point. Mergers generally involve a lot of negotiations and PT would always seek high premium over its current market price.

We have used three ratios in case of comparable companies approach. In some situations, other ratios might be employed in the comparable companies or comparable transactions approach. Additional ratios could include sales or revenue per employee, net income per employee, or assets needed to produce Re. 1 of sales or revenue. Note that market values are not included in the ratios just listed and in the practical scenarios a veriety of methods are used to come to a Price.