SOME BASIC IMPORTANT CONCEPTS
1. definition of accounting:
“the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of a financial character and interpreting the results there of”.
2. book keeping:
“It is mainly concerned with recording of financial data relating to the business operations in a significant and orderly manner.”
3. Branches of accounting
A. Financial Accounting
B. Management Accounting
4. Concepts of accounting:
A. Separate Entity Concept
B. Going Concern Concept
C. Money Measurement Concept
D. Cost Concept
E. Dual Aspect Concept
F. Accounting period Concept
G. Matching Concept (Periodic matching of costs and Revenue)
H. Realization Concept.
5 Conventions of accounting
A. Conservatism
B. Full disclosure
C. Consistency
D Materiality.
6. Systems of book keeping:
A. Single Entry System
B. Double Entry System
7. Systems of accounting
A. Cash System Accounting
B. Mercantile System of Accounting.
8. Principles of accounting
A. Personal a/c : Debit the receiver
Credit the giver
B. Real a/c : Debit what comes in
Credit what goes out
C. Nominal a/c : Debit all expenses and losses
Credit all gains and incomes
9. Meaning of journal: Journal means chronological record of transactions.
10. Meaning of ledger: ledger is a set of accounts. It contains all accounts of the business enterprise whether real, nominal, personal.
11. Posting: it means transferring the debit and credit items from the journal to their respective accounts in the ledger.
12. Trial balance: Trial balance is a statement containing the various ledger balances on a particular date.
13. Credit note: the customer when returns the goods get credit for the value of the goods returned. A credit note is sent to him intimating that his a/c has been credited with the value of the goods returned.
14. Debit note: when the goods are returned to the supplier, a debit note is sent to him indicating that his a/c has been debited with the amount mentioned in the debit note.
15. Contra entry: which accounting entry is recorded on both the debit and credit side of the cash book is known as the contra entry.
16. Petty cash book: petty cash is maintained by business to record petty cash expenses of the business, such as postage, cartage, stationery, etc.
17. Promissory Note: an instrument in writing containing an unconditional undertaking signed by the maker, to pay certain sum of money only to or to the order of a certain person or to the barer of the instrument.
18. Cheque: a bill of exchange drawn on a specified banker and payable on demand.
19. Stale Cheque: a stale cheque means not valid of cheque that means more than six months the cheque is not valid.
20. Bank reconciliation statement: it is a statement reconciling the balance as shown by the bank pass book and the balance as shown by the Cash Book.
Objective: to know the difference & pass necessary correcting, adjusting entries in the books.
21. Matching concept: matching means requires proper matching of expense with the revenue.
22. Capital income: the term capital income means an income which does not grow out of or pertain to the running of the business proper.
23. Revenue income: the income which arises out of and in the course of the regular business transactions of a concern.
24. Capital expenditure: it means an expenditure which has been incurred for the purpose of obtaining a long term advantage for the business.
25. Revenue expenditure: an expenditure that incurred in the course of regular business transactions of a concern.
26. Differed revenue expenditure: an expenditure which is incurred during an accounting period but is applicable further periods also. Eg: heavy advertisement.
27. Bad debts: bad debts denote the amount lost from debtors to whom the goods were sold on credit.
28. Depreciation: depreciation denotes gradually and permanent decrease in the value of asset due to wear and tear, technology changes, laps of time and accident.
29. Fictitious assets: These are assets not represented by tangible possession or property. Examples of preliminary expenses, discount on issue of shares, debit balance in the profit and loss account when shown on the assets side in the balance sheet.
30. Intangilbe Assets: Intangible assets mean the asset which is not having the physical appearance and it’s have the real value, it shown on the assets side of the balance sheet.
31. Accrued Income: Accrued income means income which has been earned by the business during the accounting year but which has not yet been due and, therefore, has not been received.
32. Outstanding Income : Outstanding Income means income which has become due during the accounting year but which has not so far been received by the firm.
33. Suspense account: the suspense account is an account to which the difference in the trial balance has been put temporarily.
34. Depletion: it implies removal of an available but not replaceable source, Such as extracting coal from a coal mine.
35. Amortization: the process of writing of intangible assets is term as amortization.
36. Dilapidations: the term dilapidations to damage done to a building or other property during tenancy.
37. Capital employed: the term capital employed means sum of total long term funds employed in the business. i.e.
[Share capital+ reserves & surplus +long term loans – (non business assets + fictitious assets)]
38. Equity shares: those shares which are not having preference rights are called equity shares.
39. Pref.shares: Those shares which are carrying the preference rights is called pref. shares
1 Pref.rights in respect of fixed dividend.
2 Pref.right to repayment of capital in the event of company winding up.
40. Leverage: It is a force applied at a particular point to get the desired result.
41. Operating leverage: the operating leverage takes place when a changes in revenue greater changes in EBIT.
42. Financial leverage: it is nothing but a process of using debt capital to increase the rate of return on equity
43. Combine leverage: it is used to measure of the total risk of the firm = operating risk + financial risk.
44. Joint venture: A joint venture is an association of two or more the persons who combined for the execution of a specific transaction and divide the profit or loss their of an agreed ratio.
45. Partnership: partnership is the relation between the persons who have agreed to share the profits of business carried on by all or any of them acting for all.
46. Factoring: It is an arrangement under which a firm (called borrower) receives advances against its receivables, from a financial institutions (called factor)
47. Capital reserve: The reserve which transferred from the capital gains is called capital reserve.
48. General reserve: the reserve which is transferred from normal profits of the firm is called general reserve
49. Free Cash: The cash not for any specific purpose free from any encumbrance like surplus cash.
50. Minority Interest: minority interest refers to the equity of the minority shareholders in a subsidiary company.
51. Capital receipts: capital receipts may be defined as “non-recurring receipts from the owner of the business or lender of the money crating a liability to either of them.
52. Revenue receipts: Revenue receipts may defined as “A recurring receipts against sale of goods in the normal course of business and which generally the result of the trading activities”.
53. Meaning of Company: A company is an association of many persons who contribute money or money’s worth to common stock and employs it for a common purpose. The common stock so contributed is denoted in money and is the capital of the company.
54. Types of a Company:
1. Statutory Companies
2. Government Company
3. Foreign Company
4. Registered Companies:
A. Companies limited by shares
B. Companies limited by guarantee
C. Unlimited companies
D. Private Company
E. Public Company
55. Private company: A private company is which by its AOA:
1 Restricts the right of the members to transfer of shares
2 Limits the no. of members to 50.
3 Prohibits any Invitation to the public to subscribe for its shares or debentures.
56. Public company: A company, the articles of association of which does not contain the requisite restrictions to make it a private limited company, is called a public company.
57. Characteristics of a company:
1 Voluntary association
2 Separate legal entity
3 Free transfer of shares
4 Limited liability
5 Common seal
6 Perpetual existence
58. Formation of company:
1 Promotion
2 Incorporation
3 Commencement of business
59. Equity share capital: The total sum of equity shares is called equity share capital.
60. Authorized share capital: it is the maximum amount of the share capital which a company can raise for the time being.
61. Issued capital: It is that part of the authorized capital which has been allotted to the public for subscriptions.
62. Subscribed capital: it is the part of the issued capital which has been allotted to the public
63. Called up capital: It has been portion of the subscribed capital which has been called up by the company.
64. Paid up capital: It is the portion of the called up capital against which payment has been received.
65. Debentures: Debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its holder.
66. Cash profit: cash profit is the profit it is occurred from the cash sales.
67. Deemed public Ltd. Company: A private company is a subsidiary company to public company it satisfies the following terms/conditions Sec 3(1)3:
1. having minimum share capital 5 lakhs
2. accepting investments from the public
3. no restriction of the transferable of shares
4. No restriction of no. of members.
5. accepting deposits from the investors
68. Secret reserves: secret reserves are reserves the existence of which does not appear on the face of balance sheet. In such a situation, net assets position of the business is stronger than that disclosed by the balance sheet.
These reserves are created by:
1. Excessive depreciation of an asset, excessive over-valuation of a liability.
2. Complete elimination of an asset, or under valuation of an asset.
69. Provision: provision usually means any amount written off or retained by way of providing depreciation, renewals or diminutions in the value of assets or retained by way of providing for any known liability of which the amount can not be determined with substantial accuracy.
70. Reserve: The provision in excess of the amount considered necessary for the purpose it was originally made is also considered as reserve
1 Provision is charge against profits while reserves is an appropriation of profits
2 Creation of reserve increase proprietor’s fund while creation of provisions decreases his funds in the business.
71. Reserve fund: the term reserve fund means such reserve against which clearly investment etc.,
72. Undisclosed reserves: Sometimes a reserve is created but its identity is merged with some other a/c or group of accounts so that the existence of the reserve is not known such reserve is called an undisclosed reserve.
73. Finance Management: financial management deals with procurement of funds and their effective utilization in business.
74. Objectives of Financial Management: financial management having two objectives that Is:
A. Profit maximization: the finance manager has to make his decisions in a manner so that the profits of the concern are maximized.
B. Wealth maximization: wealth maximization means the objective of a firm should be to maximize its value or wealth, or value of a firm is represented by the market price of its common stock.
75. Functions of financial manager:
1 Investment Decision
2 Dividend Decision
3 Finance Decision
4 Cash Management Decisions
5 Performance Evaluation
6 Market Impact Analysis
76. Time value of money: the time value of money means that worth of a rupee received today is different from the worth of a rupee to be received in future.
77. Capital Structure: it refers to the mix of sources from where the long-term funds required in a business may be raised; in other words, it refers to the proportion of debt, preference capital and equity capital.
78. Optimum Capital Structure: capital structure is optimum when the firm has a combination of equity and debt so that the wealth of the firm is maximized.
79. WACC: it denotes weighted average cost of capital. It is defined as the overall cost of capital computed by reference to the proportion of each component of capital as weights.
80. Financial break even point: it denotes the level at which a firm’s EBIT is just sufficient to cover interest and preference dividend.
81. Capital Budgeting: capital budgeting involves the process of decision making with regard to investment in fixed assets. Or decision making with regard to investment of money in long term projects.
82. Pay back period: payback period represents the time period required for complete recovery of the initial investment in the project.
83. ARR: accounting or average rate of return means the average annual yield on the project.
84. NPV: the net present value of an investment proposal is defined as the sum of the present values of all future cash in flows less the sum of the present values of all cash out flows associated with the proposal. (Present value of Cash inflows-Outflows)
85. Profitability Index: where different investment proposal each involving different initial investments and cash inflows are to be compared.
86. IRR: internal rate of return is the rate at which the sum total of discounted cash inflows equals the discounted cash out flow.
87. Treasury management: it means it is defined as the efficient management of liquidity and financial risk in business.
88. Concentration banking: it means identify locations or places where customers are placed and open a local bank a/c in each of these locations and open local collection centre.
89. Marketable Securities: Surplus cash can be invested in short term instruments in order to earn interest.
90. Ageing schedule: in a ageing schedule the receivables are classified according to their age.
91. Maximum permissible bank finance (MPBF): it is the maximum amount that banks can lend a borrower towards his working capital requirements.
92. Commercial paper: a CP is a short term promissory note issued by a company, negotiable by endorsement and delivery, issued at a discount on face value as may be determined by the issuing company.
93. Bridge Finance: It refers to the loans taken by the company normally from commercial banks for a short period pending disbursement of loans sanctioned by the financial institutions.
94. Venture Capital: It refers to the financing of high risk ventures promoted by new qualified entrepreneurs who require funds to give shape to their ideas.
95. Debt Securitization: It is a mode of financing, where in securities are issued on the basis of a package of assets (called asset pool).
96. Lease Financing: Leasing is a contract where one party (owner) purchases assets and permits its views by another party (lessee) over a specified period
97. Trade Credit: It represents credit granted by suppliers of goods, in the normal course of business.
98. Over draft: Under this facility a fixed limit is granted within which the borrower allowed to overdraw from his account.
99. Cash credit: It is an arrangement under which a customer is allowed an advance up to certain limit against credit granted by bank.
100. Clean overdraft: It refers to an advance by way of overdraft facility, but not back by any tangible security.
101. Share Capital: The sum total of the nominal value of the shares of a company is called share capital.
102. Funds Flow Statement: It is the statement deals with the financial resources for running business activities. It explains how the funds obtained and how they used.
103. Sources of funds: There are two sources of funds internal sources and external sources.
Internal source: Funds from operations is the only internal sources of funds and some important points add to it they do not result in the outflow of funds
(a)Depreciation on fixed assets (b) Preliminary expenses or goodwill written off, Loss on sale of fixed assets
Deduct the following items as they do not increase the funds:
Profit on sale of fixed assets, profit on revaluation of fixed assets
External sources: (a) Funds from long term loans (b) Sale of fixed assets (c) Funds from increase in share capital
104. Application of funds: (a) Purchase of fixed assets (b) Payment of dividend (c) Payment of tax liability (d) Payment of fixed liability
105. ICD (Inter corporate deposits): Companies can borrow funds for a short period. For example 6 months or less from another company which have surplus liquidity, such deposits made by one company in another company are called ICD.
106. Certificate of deposits: The CD is a document of title similar to a fixed deposit receipt issued by banks there is no prescribed interest rate on such CDs it is based on the prevailing market conditions.
107. Public deposits: It is very important source of short term and medium term finance. The company can accept PD from members of the public and shareholders. It has the maturity period of 6 months to 3 years.
108. Euro issues: The euro issues means that the issues are listed on a European stock Exchange. The subscription can come from any part of the world except India.
109. GDR (Global depository receipts): A depository receipt is basically a negotiable certificate, dominated in US-dollars that represent a non-US company publicly traded in local currency equity shares.
110. ADR (American depository receipts): Depository receipts issued by a company in the USA are known as ADRs. Such receipts are to be issued in accordance with the provisions stipulated by the securities Exchange commission (SEC) of USA like SEBI in India.
111. Commercial banks: Commercial banks extend foreign currency loans for international operations, just like rupee loans. The banks also provided overdraft.
112. Development Banks: It offers long-term and medium term loans including foreign currency loans
113. International agencies: International agencies like the IFC, IBRD, ADB, IMF etc. provide indirect assistance for obtaining foreign currency.
114. Seed Capital Assistance: The seed capital assistance scheme is desired by the IDBI for professionally or technically qualified entrepreneurs and persons possessing relevant experience and skills and entrepreneur traits.
115. Unsecured Loans: It constitutes a significant part of long-term finance available to an enterprise.
116. Cash Flow Statement: It is a statement depicting change in cash position from one period to another.
117. Sources of cash:
Internal sources: - (a) Depreciation (b) Amortization (c) Loss on sale of fixed assets (d) Gains from sale of fixed assets (e) Creation of reserves
External sources: - (a) Issue of new shares (b) Raising long term loans (c) Short-term borrowings (d) Sale of fixed assets, investments
118. Application of cash: (a) Purchase of fixed assets (b) Payment of long-term loans (c) Decrease in deferred payment liabilities (d) Payment of tax, dividend (e) Decrease in unsecured loans and deposits
119. Budget: It is a detailed plan of operations for some specific future period. It is an estimate prepared in advance of the period to which it applies.
120. Budgetary Control: It is the system of management control and accounting in which all operations are forecasted and so for as possible planned ahead, and the actual results compared with the forecasted and planned ones.
121. Cash budget: It is a summary statement of firm’s expected cash inflow and outflow over a specified time period.
122. Master budget: A summary of budget schedules in capsule form made for the purpose of presenting in one report the highlights of the budget forecast.
123. Fixed budget: It is a budget which is designed to remain unchanged irrespective of the level of activity actually attained.
124. Zero- base- budgeting: It is a management tool which provides a systematic method for evaluating all operations and programs, current of new allows for budget reductions and expansions in a rational manner and allows reallocation of source from low to high priority programs.
125. Goodwill: The present value of firm’s anticipated excess earnings.
126. BRS: It is a statement reconciling the balance as shown by the bank pass book and balance shown by the cash book.
127. Objective of BRS: The objective of preparing such a statement is to know the causes of difference between the two balances and pass necessary correcting or adjusting entries in the books of the firm.
128. Responsibilities of Accounting: It is a system of control by delegating and locating the responsibilities for costs.
129. Profit Centre: A centre whose Performance is measured in terms of both the expense incurs and revenue it earns.
130. Cost Centre: A location, person or item of equipment for which cost may be ascertained and used for the purpose of cost control.
131. Cost: The amount of expenditure incurred on to a given thing.
132. Cost Accounting: It is thus concerned with recording, classifying, and summarizing costs for determination of costs of products or services. planning, controlling and reducing such costs and furnishing of information management for decision making.
133. Elements of cost: (A) Material (B) Labour (C) Expenses (D) Overheads
134. Components of total costs: (A) Prime cost (B) Factory cost (C) Cost of production
(D) Total cost
135. Prime Cost: It consists of direct material direct labour and direct expenses. It is also known as basic or first or flat cost.
136. Factory cost: It comprises prime cost, in addition factory overheads which include cost of indirect material indirect labour and indirect expenses incurred in factory. This cost is also known as works cost or production cost or manufacturing cost.
137. Cost of production: In office and administration overheads are added to factory cost, office cost is arrived at.
138. Total cost: Selling and distribution overheads are added to total cost of production to get the total cost or cost of sales.
139. Cost Unit: A unit of quantity of a product, service or time in relation to which costs may be ascertained or expressed.
140. Methods of Costing: (A) Job costing (B) Contract costing (C) Process costing
(D) Operation costing (E) operating costing (F) Unit costing (G) Batch costing.
141. Techniques of costing: (a) Marginal Costing (b) Direct Costing (c) Absorption costing
(d) Uniform Costing.
142. Standard Costing: standard costing is a system under which the cost of the product is determined in advance on certain predetermined standards.
143. Marginal Costing: it is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, i.e., materials, labour, direct expenses and variable overheads.
144. Derivative: derivative is product whose value is derived from the value of one or more basic variables of underlying asset.
145. Forwards: a forward contract is customized contracts between two entities were settlement takes place on a specific date in the future at today’s pre agreed price.
146. Futures: a future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Future contracts are standardized exchange traded contracts.
147. Options: an option gives the holder of the option the right to do something. The option holder option may exercise or not.
148. Call option: a call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.
149. Put option: a put option gives the holder the right but not obligation to sell an asset by a certain date for a certain price.
150. Option price: option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.
151. Expiration date: the date which is specified in the option contract is called expiration date.
152. European Option: it is the option at exercised only on expiration date itself.
153. Basis: basis means future price minus spot price.
154. Cost of carry: the relation between future prices and spot prices can be summarized in terms of what is known as cost of carry.
155. Initial margin: the amount that must be deposited in the margin a/c at the time of first entered into future contract is known as initial margin.
156. Maintenance margin: this is some what lower than initial margin.
157. Mark to Market: in future market, at the end of the each trading day, the margin a/c is adjusted to reflect the investors’ gains or loss depending upon the futures selling price. This is called mark to market.
158. Baskets: basket options are options on portfolio of underlying asset.
159. Swaps: swaps are private agreements between two parties to exchange cash flows in the future according to a pre agreed formula.
160. Impact cost: impact cost is cost it is measure of liquidity of the market. It reflects the costs faced when actually trading in index.
161. Hedging: hedging means minimize the risk.
162. Capital market: capital market is the market it deals with the long term investment funds. It consists of two markets 1. Primary Market 2. Secondary Market
163. Primary market: those companies which are issuing new shares in this market. It is also called new issue market.(IPO)
164. Secondary Market: secondary market is the market where shares buying and selling. In India secondary market is called stock exchange.
165. Arbitrage: it means purchase and sale of securities in different markets in order to profit from price discrepancies. In other words arbitrage is a way of reducing risk of loss caused by price fluctuations of securities held in a portfolio.
166. Meaning of ratio: Ratios are relationships expressed in mathematical terms between figures which are connected with each other in same manner.
167. Activity ratio: it is a measure of the level of activity attained over a period.
168. Mutual Fund: a mutual fund is a pool of money, collected from investors, and is invested according to certain investment objectives.
169. Characteristics of Mutual Fund:
1 Ownership of the MF is in the hands of the of the investors
2 MF managed by investment professionals
3 The value of portfolio is updated every day
170. Advantage of MF to investors:
1 Portfolio diversification
2 Professional management
3 Reduction in risk
4 Reduction of transaction casts
5 Liquidity
6 Convenience and flexibility
171. Net asset value: the value of one unit of investment is called as the Net Asset Value
172. Open-ended fund: open ended funds means investors can buy and sell units of fund, at NAV related prices at any time, directly from the fund this is called open ended fund.
For ex; unit 64
173. Close ended funds: close ended funds means it is open for sale to investors for a specific period, after which further sales are closed. Any further transaction for buying the units or repurchasing them, happen, in the secondary markets.
174. Dividend option: Investors, who choose a dividend on their investments, will receive dividends from the MF, as when such dividends are declared.
175. Growth option: investors who do not require periodic income distributions can be choose the growth option.
176. Equity Funds: equity funds are those that invest pre-dominantly in equity shares of company.
177. Types of equity funds:
1 Simple equity funds
2 Primary market funds
3 Sectoral funds
4 Index funds
178. Sectoral funds: sectoral funds choose to invest in one or more chosen sectors of the equity markets.
179. Index Funds: the fund manager takes a view on companies that are expected to perform well, and invests in these companies
.
180. Debt Funds: the debt funds are those that are pre-dominantly invest in debt securities.
181. Liquid Funds: the debt funds invest only in instruments with maturities less than one year.
182. Gilt Funds: gilt funds invests only in securities that are issued by the GOVT. and therefore does not carry any credit risk.
183. Balanced funds: funds that invest both in debt and equity markets are called balanced funds.
184. Sponsor: sponsor is the promoter of the MF and appoints trustees, custodians and the AMC with prior approval of SEBI .
185. Trustee: trustee is responsible to the investors in the MF and appoint the AMC for managing the investment portfolio.
186. AMC: the AMC describes Asset Management Company, it is the business face of the MF, as it manages all the affairs of the MF.
187. R & T Agents: the R&T agents are responsible for the investor servicing functions, as they maintain the records of investors in MF.
188. Custodians: custodians are responsible for the securities held in the mutual fund’s portfolio.
189. Scheme take over: if an existing MF scheme is taken over by the another AMC, it is called as scheme take over.
190. Meaning of load: load is the factor that is applied to the NAV of a scheme to arrive at the price.
192. Market Capitalization: market capitalization means number of shares issued multiplied with market price per share.
193. Price Earning ratio: the ratio between the share price and the post tax earnings of company is called as price earning ratio.
194. Dividend yield: the dividend paid out by the company, is usually a percentage of the face value of a share.
195. Market Risk: it refers to the risk which the investor is exposed to as a result of adverse movements in the interest rates. It also referred to as the interest rate risk.
196. Re-investment risk: it the risk which an investor has to face as a result of a fall in the interest rates at the time of reinvesting the interest income flows from the fixed income security.
197. Call risk: call risk is associated with bonds have an embedded call option in them. This option haves the issuer the right to call back the bonds prior to maturity.
198. Credit risk: credit risk refers to the probability that a borrower could default on a commitment to repay debt or band loans
199. Inflation Risk: inflation risk reflects the changes in the purchasing power of the cash flows resulting from the fixed income security.
200. Liquid risk: it is also called market risk, it refers to the ease with which bonds could be traded in the market.
201. Drawings: drawings denotes the money withdrawn by the proprietor from the business for his personal use.
202. Outstanding Income: Outstanding Income means income which has become due during the accounting year but which has not so far been received by the firm.
203. Outstanding Expenses: Outstanding Expenses refer to those expenses which have become due during the accounting period for which the Final Accounts have been prepared but have not yet been paid.
204. Closing Stock: The term closing stock means goods lying unsold with the businessman at the end of the accounting year.
205. Methods of depreciation:
1. Uniform charge methods:
a. Fixed installment method
b. Depletion method
c. Machine hour rate method.
2. Declining charge methods:
a. Diminishing balance method
b. Sum of years digits method
c. Double declining method
3. Other methods:
a. Group depreciation method
b. Inventory system of depreciation
c. Annuity method
d. Depreciation fund method
e. Insurance policy method.
206. Accrued Income: Accrued Income means income which has been earned by the business during the accounting year but which has not yet become due and, therefore, has not been received.
207. Gross profit ratio: it indicates the efficiency of the production/trading operations.
Formula: Gross profit X 100
Net sales
208. Net profit ratio: it indicates net margin on sales
Formula: Net profit X 100
Net sales
209. Return on share holders’ funds: it indicates measures earning power of equity capital.
Formula: profits available for Equity shareholders X 100
Average Equity Shareholders Funds
210. Earning per Equity share (EPS): it shows the amount of earnings attributable to each equity share.
Formula: profits available for Equity shareholders
Number of Equity shares
211. Dividend yield ratio: it shows the rate of return to shareholders in the form of dividends based in the market price of the share
Formula: Dividend per share X 100
Market price per share
212. Price earning ratio: it a measure for determining the value of a share. May also be used to measure the rate of return expected by investors.
Formula: Market price of share (MPS) X 100
Earning per share (EPS)
213. Current ratio: it measures short-term debt paying ability.
Formula: Current Assets
Current Liabilities
214. Debt-Equity Ratio: it indicates the percentage of funds being financed through borrowings; a measure of the extent of trading on equity.
Formula: Total Long-term Debt
Shareholder’s funds
215. Fixed Assets ratio: This ratio explains whether the firm has raised adequate long-term funds to meet its fixed assets requirements.
Formula: Fixed Assets
Long-term Funds
216. Quick Ratios: The ratio termed as ‘liquidity ratio’. The ratio is ascertained y comparing the liquid assets to current liabilities.
Formula: Liquid Assets
Current Liabilities
217. Stock turnover Ratio: the ratio indicates whether investment in inventory in efficiently used or not. It, therefore explains whether investment in inventory within proper limits or not.
Formula: Cost of goods sold
Average stock
218. Debtors Turnover Ratio: the ratio the better it is, since it would indicate that debts are being collected more promptly. The ration helps in cash budgeting since the flow of cash from customers can be worked out on the basis of sales.
Formula: Credit sales
Average Accounts Receivable
219. Creditors Turnover Ratio: it indicates the speed with which the payments for credit purchases are made to the creditors.
Formula: Credit Purchases
Average Accounts Payable
220. Working capital turnover ratio: it is also known as Working Capital Leverage Ratio. This ratio indicates whether or not working capital has been effectively utilized in making sales.
Formula: Net Sales
Working Capital
221.Fixed Assets Turnover ratio : This ratio indicates the extent to which the investments in fixed assets contributes towards sales.
Formula: Net Sales
Fixed Assets
222. Pay-out Ratio: This ratio indicates what proportion of earning per share has been used for paying dividend.
Formula: Dividend per Equity Share X 100
Earning per Equity share
223. Overall Profitability Ratio : It is also called as “ Return on Investment” (ROI) or Return on Capital Employed (ROCE) . It indicates the percentage of return on the total capital employed in the business.
Formula: Operating profit X 100
Capital employed
The term capital employed has been given different meanings
a. sum total of all assets whether fixed or current
b. sum total of fixed assets,
c. sum total of long-term funds employed in the business, i.e.,
Share capital +reserves &surplus +long term loans – (non business assets + fictitious assets).
Operating profit means ‘profit before interest and tax’
224. Fixed Interest Cover ratio : the ratio is very important from the lender’s point of view. It indicates whether the business would earn sufficient profits to pay periodically the interest charges.
Formula : Income before interest and Tax
Interest Charges
225 . Fixed Dividend Cover ratio : This ratio is important for preference shareholders entitled to get dividend at a fixed rate in priority to other shareholders.
Formula : Net Profit after Interest and Tax
Preference Dividend
226. Debt Service Coverage ratio : This ratio is explained ability of a company to make payment of principal amounts also on time.
Formula : Net profit before interest and tax
Interest + Principal payment installment
1 Tax rate
227. Proprietary ratio : It is a variant of debt-equity ratio . It establishes relationship between the proprietor’s funds and the total tangible assets.
Formula : Shareholders funds
Total tangible assets
228.Difference between joint venture and partner ship :
1 In joint venture the business is carried on without using a firm name,
In the partnership, the business is carried on under a firm name.
2 In the joint venture, the business transactions are recorded under cash system
In the partnership, the business transactions are recorded under mercantile system.
3 In the joint venture, profit and loss is ascertained on completion of the venture
In the partner ship , profit and loss is ascertained at the end of each year.
4 In the joint venture, it is confined to a particular operation and it is temporary.
In the partnership, it is confined to a particular operation and it is permanent
.
229.Meaning of Working capital
:
The funds available for conducting day to day operations of an enterprise. Also represented by the excess of current assets over current liabilities .
230.concepts of accounting :
1. Business entity concepts :- According to this concept, the business is treated as a separate entity distinct from its owners and others.
2. Going concern concept :- According to this concept, it is assumed that a business has a reasonable expectation of continuing business at a profit for an indefinite period of time.
3. Money measurement concept :- This concept says that the accounting records only those transactions which can be expressed in terms of money only.
4. Cost concept :-According to this concept, an asset is recorded in the books at the price paid to acquire it and that this cost is the basis for all subsequent accounting for the asset.
5. Dual aspect concept :- In every transaction, there will be two aspects – the receiving aspect and the giving aspect; both are recorded by debiting one accounts and crediting another account. This is called double entry.
6. Accounting period concept :- It means the final accounts must be prepared on a periodic basis. Normally accounting period adopted is one year, more than this period reduces the utility of accounting data.
7. Realization concept :- According to this concepts, revenue is considered as being earned on the data which it is realized, i.e., the date when the property in goods passes the buyer and he become legally liable to pay.
8. Materiality concepts :- It is a one of the accounting principle, as per only important information will be taken, and un important information will be ignored in the preparation of the financial statement.
9. Matching concepts :- The cost or expenses of a business of a particular period are compared with the revenue of the period in order to ascertain the net profit and loss.
10. Accrual concept :- The profit arises only when there is an increase in owners capital, which is a result of excess of revenue over expenses and loss.
231. Financial analysis :The process of interpreting the past, present, and future financial condition of a company.
232. Income statement : An accounting statement which shows the level of revenues, expenses and profit occurring for a given accounting period.
233.Annual report : The report issued annually by a company, to its share holders. it containing financial statement like, trading and profit & lose account and balance sheet.
234. Bankrupt : A statement in which a firm is unable to meets its obligations and hence, it is assets are surrendered to court for administration
235 . Lease : Lease is a contract between to parties under the contract, the owner of the asset gives the right to use the asset to the user over an agreed period of the time for a consideration
236.Opportunity cost : The cost associated with not doing something.
237. Budgeting : The term budgeting is used for preparing budgets and other producer for planning, co-ordination, and control of business enterprise
.
238.Capital : The term capital refers to the total investment of company in money, tangible and intangible assets. It is the total wealth of a company.
239.Capitalization : It is the sum of the par value of stocks and bonds out standings.
240. Over capitalization : When a business is unable to earn fair rate on its outstanding securities.
241. Under capitalization : When a business is able to earn fair rate or over rate on it is outstanding securities.
242. Capital gearing : The term capital gearing refers to the relationship between equity and long term debt.
243.Cost of capital : It means the minimum rate of return expected by its investment.
244.Cash dividend : The payment of dividend in cash
245.Define the term accrual : Recognition of revenues and costs as they are earned or incurred . it includes recognition of transaction relating to assets and liabilities as they occur irrespective of the actual receipts or payments.
245. accrued expenses : An expense which has been incurred in an accounting period but for which no enforceable claim has become due in what period against the enterprises.
246.Accrued revenue : Revenue which has been earned is an earned is an accounting period but in respect of which no enforceable claim has become due to in that period by the enterprise.
247.Accrued liability : A developing but not yet enforceable claim by an another person which accumulates with the passage of time or the receipt of service or otherwise. it may rise from the purchase of services which at the date of accounting have been only partly performed and are not yet billable.
248.Convention of Full disclosure : According to this convention, all accounting statements should be honestly prepared and to that end full disclosure of all significant information will be made.
249.Convention of consistency : According to this convention it is essential that accounting practices and methods remain unchanged from one year to another.
250. Define the term preliminary expenses : Expenditure relating to the formation of an enterprise. There include legal accounting and share issue expenses incurred for formation of the enterprise.
251. Meaning of Charge: charge means it is a obligation to secure an indebt ness. It may be fixed charge and floating charge.
252. Appropriation: It is application of profit towards Reserves and Dividends.
253.Absorption costing : A method where by the cost is determine so as to include the appropriate share of both variable and fixed costs.
254.Marginal Cost : Marginal cost is the additional cost to produce an additional unit of a product. It is also called variable cost.
255. What are the ex-ordinary items in the P&L a/c : The transaction which are not related to the business is termed as ex-ordinary transactions or ex-ordinary items. Egg:- profit or losses on the sale of fixed assets, interest received from other company investments, profit or loss on foreign exchange, unexpected dividend received.
256. Share premium: The excess of issue of price of shares over their face value. It will be showed with the allotment entry in the journal, it will be adjusted in the balance sheet on the liabilities side under the head of “reserves & surplus”.
257.Accumulated Depreciation : The total to date of the periodic depreciation charges on depreciable assets.
258. Investment: Expenditure on assets held to earn interest, income, profit or other benefits.
259.Capital : Generally refers to the amount invested in an enterprise by its owner. Ex; paid up share capital in corporate enterprise.
260. Capital Work In Progress : Expenditure on capital assets which are in the process of construction as completion.
261. Convertible Debenture : A debenture which gives the holder a right to conversion wholly or partly in shares in accordance with term of issues.
262.Redeemable Preference Share : The preference share that is repayable either after a fixed (or) determinable period (or) at any time dividend by the management.
263. Cumulative preference shares : A class of preference shares entitled to payment of cumulates dividends. Preference shares are always deemed to be cumulative unless they are expressly made non-cumulative preference shares.
264.Debenture redemption reserve : A reserve created for the redemption of debentures at a future date.
265. Cumulative dividend : A dividend payable as cumulative preference shares which it unpaid cumulates as a claim against the earnings of a corporate before any distribution is made to the other shareholders.
266. Dividend Equalization reserve : A reserve created to maintain the rate of dividend in future years.
267. Opening Stock : The term ‘opening stock’ means goods lying unsold with the businessman in the beginning of the accounting year. This is shown on the debit side of the trading account.
268.Closing Stock : The term ‘Closing Stock’ includes goods lying unsold with the businessman at the end of the accounting year. The amount of closing stock is shown on the credit side of the trading account and as an asset in the balance sheet.
269.Valuation of closing stock : The closing stock is valued on the basis of “Cost or Market price whichever is less” principle.
272. Contingency : A condition (or) situation the ultimate out come of which gain or loss will be known as determined only as the occurrence or non occurrence of one or more uncertain future events.
273.Contingent Asset : An asset the existence ownership or value of which may be known or determined only on the occurrence or non occurrence of one more uncertain future events.
274. Contingent liability : An obligation to an existing condition or situation which may arise in future depending on the occurrence of one or more uncertain future events.
275. Deficiency : the excess of liabilities over assets of an enterprise at a given date is called deficiency.
276.Deficit : The debit balance in the profit and loss a/c is called deficit.
277.Surplus : Credit balance in the profit & loss statement after providing for proposed appropriation & dividend , reserves.
278.Appropriation Assets : An account sometimes included as a separate section of the profit and loss statement showing application of profits towards dividends, reserves.
279. Capital redemption reserve : A reserve created on redemption of the average cost:- the cost of an item at a point of time as determined by applying an average of the cost of all items of the same nature over a period. When weights are also applied in the computation it is termed as weight average cost.
280.Floating Change : Assume change on some or all assets of an enterprise which are not attached to specific assets and are given as security against debt.
281. Difference between Funds flow and Cash flow statement :
5 A Cash flow statement is concerned only with the change in cash position while a funds flow analysis is concerned with change in working capital position between two balance sheet dates.
6 A cash flow statement is merely a record of cash receipts and disbursements. While studying the short-term solvency of a business one is interested not only in cash balance but also in the assets which are easily convertible into cash.
282. Difference Between the Funds flow and Income statement :
7 A funds flow statement deals with the financial resource required for running the business activities. It explains how were the funds obtained and how were they used,
Whereas an income statement discloses the results of the business activities, i.e., how much has been earned and how it has been spent.
8 A funds flow statement matches the “funds raised” and “funds applied” during a particular period. The source and application of funds may be of capital as well as of revenue nature.
An income statement matches the incomes of a period with the expenditure of that period, which are both of a revenue nature.
Stock
A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings. Also known as "shares" or "equity".
In other words, a shareholder is an owner of a company.. For example, if a company has 1,000 shares of stock outstanding and one person owns 100 shares, that person would own and have claim to 10% of the company's assets. Stocks are the foundation of nearly every portfolio
There are two main types of stock: common and preferred.
Common stock usually entitles the owner to vote at shareholders' meetings and to receive dividends.
Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares. For example, owners of preferred stock receive dividends before common shareholders and have priority in the event that a company goes bankrupt and is liquidated. . However, the best way to think of preferred stock is as a financial instrument that has characteristics of both debt (fixed dividends) and equity (potential appreciation). Also known as "preferred shares.
Penny Stock
A stock that sells for less than $1 per share but may also rise to as much as $10 per share as a result of heavy promotion. All penny stocks are traded over the counter (OTC) or on the pink sheets.
The pink sheets
A daily publication compiled by the National Quotation Bureau with bid and ask prices of OTC stocks, including the market makers who trade them. Unlike companies on a stock exchange, companies quoted on the pink sheets system do not need to meet minimum requirements or file with the SEC. Pink sheets also refers to OTC trading. The pink sheets got their name because they were actually printed on pink paper.
Yellow Sheets
A U.S. bulletin that gives updated bid and ask prices as well as other information on OTC bonds
Similar to the pink sheets that track non-exchange traded OTC micro-cap stocks, the yellow sheets are a primary source of information for investors who track OTC bonds or fixed income securities
What is treasury stock?
Every company has an authorized amount of stock it can issue legally. Of this amount, the total number of shares owned by investors, including the company's officers and insiders (the owners of restricted stock), is known as the shares outstanding. The number available only to the public to buy and sell is known as the float.
Treasury stocks are shares that were once a part of the float and shares outstanding but were subsequently repurchased by the company and decommissioned. These stocks do not have voting rights and do not pay any distributions. A company can decide to hold onto treasury stocks indefinitely, reissue them to the public, or even cancel them.
Investment Bank
A financial intermediary that performs a variety of services. This includes underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients.
Iinvestment banker means A person representing a financial institution that is in the business of raising capital for corporations and municipalities. An investment banker may not accept deposits or make commercial loans. Investment bankers are the people who do the grunt work for IPOs and bond issues.
Capital Markets:-Markets where capital, such as stocks and bonds, are traded.
Capital:-Capital is an extremely vague term whose specific definition depends on the context in which it is used. In general, it refers to financial resources available for use (or)
1. Financial assets or the financial value of assets such as cash.
2. The factories, machinery and equipment owned by a business.
Capital Asset:-A long-term asset that is not bought or sold in the regular course of business.ex: land, buildings, machinery,
Stock Split
The dividing of a company's existing stock into multiple shares. In a 2-for-1 split, each stockholder receives an additional share for each share he or she holds.
In the U.K., a stock split is referred to as a "scrip issue", "bonus issue", "capitalization issue" or "free issue".
This is usually a good indicator that a company's share price is doing well. However, a stock split doesn't give you any more value, just twice as many shares
Stock Pick
A situation in which an analyst or investor uses a systematic form of analysis to conclude that a particular stock will make a good investment and, therefore, should be added to his or her portfolio. The position can be either long or short and will depend on the analyst or investor's outlook for the particular stock's price.
Stock picking can be a very difficult process because there is never a foolproof way to determine what a stock's price will do in the future. However, by examining numerous factors, an investor may be able to get a better sense of future stock prices than by relying on guesswork. Because forecasting is not an exact science, an investor or analyst who uses any forecasting technique should include a margin of error in the calculations.
Scrip
1. A written document that acknowledges a debt.
2. A temporary document representing a fraction of a share resulting from a split or spin-off. Scrips may be applied to the purchase of full shares.
3. Currency issued by a private corporation
1. Historically, companies short of cash have paid scrip dividends instead of cash dividends.
3. An example would be frequent flier miles
U.S. Savings Bonds
A U.S. government savings bond that offers a fixed rate of interest over a fixed period of time. Many people find these bonds attractive because they are not subject to state or local income taxes. These bonds cannot be easily transferred and are non-negotiable.
U.S. savings bonds are one of the safest types of investments because they are endorsed by the federal government and, therefore, are virtually risk free. Although these bonds do not earn much interest compared to the stock market, they do offer a less volatile source of income.
BOND
A debt investment with which the investor loans money to an entity (company or government) that borrows the funds for a defined period of time at a specified interest rate.
The indebted entity issues investors a certificate, or bond, that states the interest rate (coupon rate) that will be paid and when the loaned funds are to be returned (maturity date). Interest on bonds is usually paid every six months (semiannually). The main types of bonds are the corporate bond, the municipal bond, the Treasury bond, the Treasury note, the Treasury bill and the zero-coupon bond.
Treasury Bill - T-Bill
A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks).
T-bills are issued through a competitive bidding process at a discount from par, which means that rather than paying fixed interest payments like conventional bonds, the appreciation of the bond provides the return to the holder.
-For example, let's say you buy a 13-week T-bill priced at $9,800. Essentially, the U.S. government (and its nearly bulletproof credit rating) writes you an IOU for $10,000 that it agrees to pay back in three months. You will not receive regular payments as you would with a coupon bond, for example. Instead, the appreciation - and, therefore, the value to you - comes from the difference between the discounted value you originally paid and the amount you receive back ($10,000). In this case, the T-bill pays a 2.04% interest rate ($200/$9,800 = 2.04%) over a three-month period.
Treasury Bond - T-Bond
marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. The bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.
Treasury bonds are issued with a minimum denomination of $1,000. The bonds are initially sold through auction in which the maximum purchase amount is $5 million if the bid is non-competitive or 35% of the offering if the bid is competitive. A competitive bid states the rate that the bidder is willing to accept; it will be accepted depending on how it compares to the set rate of the bond. A non-competitive bid ensures that the bidder will get the bond but he or she will have to accept the set rate. After the auction, the bonds can be sold in the secondary market
Treasury Note
A marketable, U.S. government debt security with a fixed interest rate and a maturity between one and 10 years. T-notes can be bought either directly from the U.S. government or through a bank. When buying from the government you can either put in a competitive or noncompetitive bid. With a competitive bid you specify the yield you want; however, this does not mean your bid
will be approved. With a noncompetitive bid is one where you accept whatever yield is determined at auction.
T-notes are extremely popular investments as there is a large secondary market that adds to their liquidity. Interest payments on the notes are made every six months until maturity. The income for interest payments are not taxable on a municipal or state level but are federally taxed.
Off-The-Run Treasuries
All Treasury bonds and notes issued before the most recently issued bond or note of a particular maturity. These are the opposite of "on-the-run treasuries".
-Once a new Treasury security of any maturity is issued, the previously issued security with the same maturity becomes the off-the-run bond or note.
Because off-the-run securities are less frequently traded, they typically are less expensive and therefore carry a slightly greater yield.
On-The-Run Treasuries
The most recently issued U.S. Treasury bond or note of a particular maturity. These are the opposite of "off-the-run treasuries".
When quoting the price or yield of a Treasury, all market commentary refers to the on-the-run issue.
The on-the-run bond or note is the most frequently traded Treasury security of its maturity. Because on-the-run issues are the most liquid, they typically are a little bit more expensive and, therefore, yield less than their off-the-run counterparts.
Banker's Acceptance – BA
A short-term credit investment created by a non-financial firm and guaranteed by a bank
-Acceptances are traded at a discount from face value on the secondary market. Banker's acceptances are very similar to T-bills and are often used in money market funds.
BAX Contract
A BAX contract is a short-term investment instrument that uses a Canadian banker's acceptance (BA) as its underlying security. The specific BA underlying the contract has a nominal value of C$1 million and a maturity of three months. The contracts are traded on the Montreal Derivatives Exchange.
Also known as a "banker's acceptance contract".
These contracts are great way for a company to hedge against a rise in interest rates. BAX contracts are becoming increasingly popular because they are a less expensive hedge than their over-the-counter competition, forward rate agreements. BAX contracts are also very liquid, flexible, and do not tie up credit lines.
Hedge
Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.
An example of a hedge would be if you owned a stock, then sold a futures contract stating that you will sell your stock at a set price, therefore avoiding market fluctuations.
Investors use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the hedge).
HedgeStreet
An internet-based, government-regulated market that allows traders to perform hedging activities or speculate on specific economic events. Binaries and futures contracts are provided on different markets including commodities, currencies, employment, inflation and other economic indicators.
HedgeStreet was developed to give the average investor the ability to profit from the outcomes of certain economic events. HedgeStreet benefits small investors by having small contract sizes at low prices. HedgeStreet is regulated by the Commodity Futures Trading Commission.
Delta Hedging
An options strategy that aims to reduce (hedge) the risk associated with price movements in the underlying asset by offsetting long and short positions. For example, a long call position may be delta hedged by shorting the underlying stock. This strategy is based on the change in premium (price of option) caused by a change in the price of the underlying security. The change in premium for each basis-point change in price of the underlying is the delta and the relationship between the two movements is the hedge ratio.
For example, the price of a call option with a hedge ratio of 40 will rise 40% (of the stock-price move) if the price of the underlying stock increases. Typically, options with high hedge ratios are usually more profitable to buy rather than write since the greater the percentage movement - relative to the underlying's price and the corresponding little time-value erosion - the greater the leverage. The opposite is true for options with a low hedge ratio.
Hedge Fund
An aggressively managed portfolio of investments that uses advanced investment strategies such as leverage, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).
Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investments in hedge funds are liquid as they often require investors keep their money in the fund for a minimum period of at least one year.
For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of over $1 million, along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds for the super-rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies.
It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market with their ability to short the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk". In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.
According to SEC
Hedge fund" is a general, non-legal term used to describe private, unregistered investment pools that traditionally have been limited to sophisticated, wealthy investors. Hedge funds are not mutual funds and, as such, are not subject to the numerous regulations that apply to mutual funds for the protection of investors — including regulations requiring a certain degree of liquidity, regulations requiring that mutual fund shares be redeemable at any time, regulations protecting against conflicts of interest, regulations to assure fairness in the pricing of fund shares, disclosure regulations, regulations limiting the use of leverage, and more.
Hedged Tender
A strategy in a tender offer where an investor short sells a portion of the shares he or she owns. This strategy is used to protect against the risk of loss in the event that the tender offer does not go through
For example, imagine a stock was trading at $30, and there was a tender offer for $40 per share. A hedged tender would attempt to lock in the $40 per share even if the offer does not go through.
Hedgelet
A simplified derivative instrument that allows investors to hedge or speculate on economic events such as housing prices, commodity prices, interest rates, currencies and economic indicators.
The price for a hedgelet contract is based on the prevailing market price determined by participants in the market. Every contract has the same defined payout scheme: $10 for a correct contract and $0 for an incorrect one. Each hedgelet contract is set so that investors must make a decision on whether an economic event will occur or not occur.
-For example, on a "Crude Oil > $64" contract an investor can either choose Yes (oil will be more than $64 at expiration) or No (oil will be less than $64 at expiration). If the investor purchases one Yes "Crude Oil > $64" contract for $2, and crude oil ends at $80 when the contract expires, the investor will receive $10 - an $8 profit. However, if the price of crude oil ends at less than $64, the contract will be worthless and the investor will lose the initial $2 investment.
Hedge Ratio
1. A ratio comparing the value of a position protected via a hedge with the size of the entire position itself.
2. A ratio comparing the value of futures contracts purchased or sold to the value of the cash commodity being hedged
1. Say you are holding $10,000 in foreign equity, which exposes you to currency risk. If you hedge $5,000 worth of the equity with a currency position, your hedge ratio is 0.5 (50 / 100). This means that 50% of your equity position is sheltered from exchange rate risk.
2. The hedge ratio is important for investors in futures contracts, as it will help to identify and minimize basis risk
Naked Position
A securities position that is not hedged from market risk. Both the potential gain and the potential risk are greater when a position is naked instead of covered (a covered position is hedged from market risk).
If an investor simply holds 500 shares of Ford, he or she has a naked position in Ford. If the investor wanted to cover this position, he or she could buy put option contracts, which would help protect against downward movements in the price of Ford shares.
Whether to have a naked position is rarely a concern for most small investors, but it is a concern for large investment holders and institutions.
Cramer Bounce
The sudden overnight appreciation of a stock's price following it being recommended by Jim Cramer on his CNBC show, "Mad Money". This increase in price can be attributed to investors who buy stocks after seeing Cramer's recommendations.
This price increase is named due to the nature of how a stock's price can "bounce up" following Jim Cramer's recommendation.
This effect is fairly significant in certain classes of stock. For example, one study entitled, "Is the Market Mad? Evidence from Mad Money". released by Northwestern University in March 2006 showed that for smaller stocks the overnight increase can be over 5%.
This abnormal increase lasts only for about 12 days, where upon the stock's price retreats back to its pre-recommended price; assuming no other news has been released.
This is one instance where it can be argued that irrational investors can cause a significant effect upon a stock's price.
Real Estate Investment Trust - REITA security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages.
REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
Equity REITs: Equity REITs invest in and own properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties' rents.
Mortgage REITs: Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans.
Hybrid REITs: Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.
Individuals can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate. An additional benefit to investing in REITs is the fact that many are accompanied by dividend reinvestment plans (DRIPs). Among other things, REITs invest in shopping malls, office buildings, apartments, warehouses and hotels. Some REITs will invest specifically in one area of real estate - shopping malls, for example - or in one specific region, state or country. Investing in REITs is a liquid, dividend-paying means of participating in the real estate market.
Share Capital
Funds raised by issuing shares in return for cash or other considerations. The amount of share capital a company has can change over time because each time a business sells new shares to the public in exchange for cash, the amount of share capital will increase. Share capital can be composed of both common and preferred shares.
Also known as "equity financing".
The amount of share capital a company reports on its balance sheet only accounts for the initial amount for which the original shareholders purchased the shares from the issuing company. Any price differences arising from price appreciation/depreciation as a result of transactions in the secondary market are not included.
For example, suppose ABC Inc. raised $2 billion from its initial public offering. Over the next year, the total value of its shares increases to $5 billion. In this case, the value of the share capital is still only $2 billion because ABC Inc. had received only $2 billion from the sale of its securities to the investing public.
Swing Trading
A style of trading that attempts to capture gains in a stock within one to four days
2.IP--To find situations in which a stock has this extraordinary potential to move in such a short time frame, the trader must act quickly. This is mainly used by at-home and day traders. Large institutions trade in sizes too big to move in and out of stocks quickly. The individual trader is able to exploit the short-term stock movements without the competition of major traders. Swing traders use technical analysis to look for stocks with short-term price momentum. These traders aren't interested in the fundamental or intrinsic value of stocks but rather in their price trends and patterns.
Tick Index
The number of stocks trading on an uptick minus the number of stocks trading on a downtick
2.IP--This is a very short-term indicator. A positive tick index is good (the higher the better).
Stock Screener
A tool investors can use to filter stocks given certain criteria of their choice.
2.IP__By using a stock screening tool an investor is able to follow a strict set of criteria that he or she requires prior to investing in a company. For example, an investor could screen stocks by entering the following criteria: "listed on the NYSE", "in the telecommunications industry", "has a P/E ratio between 15-25", and "has an annual EPS growth of at least 15% for the past three years". The screener would then produce a list of stocks that displayed all of these attributes. In this example stocks are screened by using only four criteria; however, you can screen stocks by as many criteria as the particular screener you are using will allow.
The stock screener has replaced many days' worth of research with a few clicks of a mouse.
Corporation
A legal entity that is separate and distinct from its owners. Corporations enjoy most of the rights and responsibilities that an individual possesses; that is, a corporation has the right to enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets and pay taxes.
The most important aspect of a corporation is limited liability. That is, shareholders have the right to participate in the profits, through dividends and/or the appreciation of stock, but are not held personally liable for the company's debts.
Corporations are often called "C Corporations".
2.IP-- A corporation is created (incorporated) by a group of shareholders who have ownership of the corporation, represented by their holding of common stock. Shareholders elect a board of directors (generally receiving one vote per share) who appoint and oversee management of the corporation. Although a corporation does not necessarily have to be for profit, the vast majority of corporations are setup with the goal of providing a return for its shareholders. When you purchase stock you are becoming part owner in a corporation.
DERIVATIVES
What are Derivatives ?
The term “Derivative” indicates that it has no independent value, i.e. its value is entirely “derived” from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else.
In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities.
A derivative is a financial instrument that derives its value from the value of another financial instrument (called the underlying). The underlying instrument could be an asset, an interest rate, an exchange rate, or a commodity or any other event or thing specified in advance by the contracting parties. A derivative is a contract between two parties that specifies conditions, in particular, dates and the resulting values of underlying variables, under which settlements or payoffs are to be made between the parties. A derivative therefore has the following features:
• It is a contract between two parties
• It has specified conditions as to settlement
• It derives its value from the value of another instrument called the underlying
With Securities Laws (Second Amendment) At,1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, as:-
A Derivative includes:
(a) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;
(b) a contract which derives its value from the prices, or index of prices, of underlying
securities;
Types of derivatives
Theoretically, since a derivative is a contract between two parties, there can be an infinite number of derivatives possible depending on the terms of contract between the parties. However, in general, the following are the basic types of derivatives:
Forwards
A forward contract is an agreement to buy or sell an asset at a certain time in the future for a certain price (the delivery price). It can be contrasted with a spot contract, which is an agreement to buy or sell immediately. The typical usage of a forward would be to hedge the value of foreign currency denominated assets and liabilities. However, forwards can also be used for speculation. The following terms are commonly associated with forward contracts: (refer Ex:-1)
Futures
A legally binding agreement to buy or sell the underlying security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract. On expiry, futures can be settled by delivery of the underlying asset or cash. Cash settlement entails paying/receiving the difference between the price at which the contract was entered and the price of the underlying asset at the time of expiry of the contract.(refer Ex:-2)
Difference between Forwards and Futures
Futures are more standardized forms of forward contracts and mostly operate in organized markets. While it is possible to have a forward contract for any commercial transaction, futures are normally exchange-traded. Futures contracts are highly uniform contracts that specify the quantity and quality of the good that can be delivered, the delivery date(s), the method for closing the contract, and the permissible minimum and maximum price fluctuations permitted in a trading day.
The basic nature of a forward and future, in a strict legal sense, is the same, with the difference that futures are market-driven organized transactions. As they are exchange-traded, the counter party in a futures transaction is the exchange. On the other hand, a forward is mostly an over-the-counter transaction (OTC) and the counter party is the contracting party. Futures market are normally marked to market on a settlement day, which could even be daily, whereas forward contracts are settled only at the end of the contract. So the element of credit risk is far higher in case of forward contracts.
Option
Option Contract
A type of Derivatives Contract which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a pecified period.
The buyer / holder of the option purchases the right from the seller/writer for a consideration Which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc.
Securities Contracts (Regulations) Act,1956 ‘options in securities’ has been defined as “option in securities” means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities;
An Option to buy is called Call option and option to sell is called Put option. Further, if an option that is exercisable on or before the expiry date(at anytime) is called American option and one that is exercisable only on expiry date, is called European option. The price at which the option is to be exercised is called Strike price or Exercise price.
(Refer for Ex:-3)
Swaps
In a swap, both the parties exchange recurring payments with the idea of exchanging one stream of payments for another. A typical usage is a swap of fixed interest rates with floating rates, or rates floating with reference to one basis to another basis. The basic types of swaps are interest rate swaps, currency swaps, basis swaps, credit swaps etc.
a) Interest rate swap
A plain-vanilla interest rate swap is an exchange of a series of fixed interest payments for a series of floating interest payments, fluctuating with LIBOR (London inter bank offer rate). The fixed rate of interest is often quoted as a spread over the current US Treasury security of the desired maturity and is called the swap rate. Normally, the floating rate paid at the end of each period is based on LIBOR at the beginning of the period. The times at which the floating rates are established are called the reset dates. The two sides of the swap are called the fixed leg and floating leg; and the life of a swap is called its tenor. In this case, only the cash flows, not the principals, of the two types of debt are exchanged. So it is notional principal that measures the size of the swap.
For example, for five years, one counter-party (the buyer) agrees to pay a fixed rate of interest, say the coupons that would be received on $1,000,000 of principal of the current five-year Treasury note plus 65 basis points (.65%) in exchange (from the seller) for five years of semiannual floating rate payments equal to $1,000,000 paying LIBOR with six-month resets. Here, the notional principal is $1,000,000 and the tenor of the swap is five years.
b) Currency swap
In contrast to a plain-vanilla interest rate swap, a currency swap typically not only involves an exchange of coupon payments but also an exchange of principal. As an example of a typical situation, American Firm A would like to borrow pounds, and British Firm B wants to borrow dollars. Because it is better known in the US, Firm A can borrow dollars at a lower interest rate than Firm B, while Firm B, because it is better known in the UK, can borrow pounds at a lower interest rate than Firm A. So if Firm A borrows dollars in the US and Firm B borrows pounds in the UK, but then they swap their obligations, each firm can benefit from the other firm's superior borrowing rate in its domestic currency.
To be more specific, say Firm A wants to borrow £10,000,000 for two years, Firm B wants to borrow $16,000,000 for two years, and the current ($/£) pound exchange rate is 1.6. Assume that Firm A can borrow dollars at 8%, and Firm B can borrow pounds at 10%. The swap transactions that accomplish this are:
Firm A borrows $16m in its domestic US market and Firm B borrows 10m pounds in UK market. Firm A pays $16m to Firm B; and Firm B pays £10,000,000 to Firm A. At the end of first year, Firm A pays £10,000,000 X 0.1 = £1,000,000 to Firm B which Firm B in turn pays to its domestic lender and Firm B pays $16,000,000 x 0.08 = $1,280,000 to Firm A which in turn pays to its domestic lender. At the end of second year, Firm A pays £10,000,000 x .1 = £1,000,000 to Firm B which Firm B in turn pays to its domestic lender and Firm B pays $16,000,000 x .08 = $1,280,000 to Firm A which in turn pays to its domestic lender. Also at the end of second year, Firm A repays £10,000,000 to Firm B; Firm B repays $16,000,000 to Firm B and each firm in turn uses this to repay its domestic lenders.
Typically, the swap is set up so that its value, based on the current exchange rate is zero. Indeed, in our example, the initial value of the swap in dollars is $16,000,000 - 1.6 £10,000,000 = 0. Nonetheless, both counter-parties benefit from the swap because they end up borrowing at lower foreign interest rates than they could have on their own.
c) Credit swaps
Corporate bonds trade at a premium to the risk-free yield curve in the same currency. US Corporate Bonds trade at a premium (called a credit spread) to the US Treasury curve. The credit spread is volatile in and of itself and it may be correlated with the level of interest rates. For example, in a declining, low interest rate environment combined with strong domestic growth, we might expect corporate bond spreads to be smaller than their historical average. The corporate that has issued the bond will find it easier to service the cash flows of the corporate bond and investors will be hungry for any kind of premium they can add to the risk-free rate.
Imagine a fund manager who specializes in corporate bonds who has a view on the direction of credit spreads on which he would like to act without taking a specific position in an individual corporate bond or a corporate bond index. One way for the fund manager to take advantage of this view is to enter into a credit swap. Let's say that the fund manager believes that credit spreads are going to tighten and that interest rates are going to continue to decline.
He would then want to enter into a swap in which he paid the corporate yield at six-month intervals against receiving a fixed yield equal to the inception Treasury yield plus the corporate credit spread. That is to say, at the six-month reset for the tenor of the swap, the fund manager agrees to pay a cash flow determined to be equal to the current annual yield on some benchmark corporate bond or corporate bond index in consideration for receiving a fixed cash flow. This is an off-balance sheet transaction and the swap will typically have zero value at inception.
If corporate yields continue to fall (i.e. through a combination of a lower risk-free rate and a lower corporate credit spread than the one he locked in with the swap), he will make money. If corporate yields rise, he will lose money.
Caps, Floor and Collars
Caps, floors and collars are essentially options designed to shift the risk of an upward and/or downward movement in variables such as interest rates. These are normally linked to a notional amount and a reference rate.
For example, if some one wants to transfer the risk of interest rates going up, one will enter into a cap on a notional amount of say, USD 100 million, with the interest rate of 5.5%. Now if the interest rate increases to 6%, the cap holder will be able to claim a settlement from the cap seller, for the differential rate of 0.5% on the notional amount. If the interest does not go up, or rather declines, the option holder would have paid the premium, and there is no settlement. On the other hand, if some one expects the interest rate to go down which spells a risk to him, he would enter into a floor, which would allow him to claim a settlement if the interest rate falls below a particular strike rate.
Interest rate collar is the fixation of both a cap and floor, so that the payment will be triggered if the rate goes above the collar and below the floor.
Swaption
A swaption is an option on a swap. The option provides the holder with the right to enter into a swap at a specified future date at specified terms. This derivative has characteristics of an option and a swap. These types of derivatives are called multiple derivatives
What are Index Futures and Index Option Contracts ?
Futures contract based on an index i.e. the underlying asset is the index, are known as Index Futures Contracts. For example, futures contract on NIFTY Index and BSE-30 Index. These contracts derive their value from the value of the underlying index. Similarly, the options contracts, which are based on some index, are known as Index options contract. However, unlike Index Futures, the buyer of Index Option Contracts has only the right but not the obligation to buy / sell the underlying index on expiry. Index Option Contracts are generally European Style options i.e. they can be exercised / assigned only on the expiry date. An index, in turn derives its value from the prices of securities that constitute the index and is created to represent the sentiments of the market as a whole or of a particular sector of the economy (Sectoral Index).
By its very nature, index cannot be delivered on maturity of the Index futures or Index option contracts therefore, these contracts are essentially cash settled on Expiry.
What is the structure of Derivative Markets in India ?
Derivative trading in India can take place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative exchange/Segment function as a Self-Regulatory Organisation (SRO) and SEBI acts as the oversight regulator. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House, which is independent in governance and membership from the Derivative Exchange/Segment.
What is the regulatory framework of Derivatives markets in India ?
With the amendment in the definition of ‘securities’ under SC(R)A (to include derivative contracts in the definition of securities), derivatives trading takes place under the provisions of the S C (R) Act, 1956 and S EBI Act, 1992. Dr. L.C Gupta Committee constituted by SEBI had laid down the regulatory framework for derivative trading in India. SEBI has also framed suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lays down the provisions for trading and settlement of derivative contracts. The Rules, Bye-laws & Regulations of the Derivative Segment of the Exchanges and their Clearing Corporation/ House have to be framed in line with the suggestive Bye-laws. SEBI has also laid the eligibility conditions for Derivative Exchange/Segment and its Clearing Corporation/Hou se. The eligibility conditions have been framed to ensure that Derivative Exchange/Segment & Clearing Corporation/House provide a transparent trading environment, safety & integrity and provide facilities for redressal of investor grievances. Some of the important eligibility conditions are :
1 Derivative trading to take place through an on-line screen based Trading System.
2 The Derivatives Exchange/Segment shall have on-line surveillance capability to monitor positions, prices, and volumes on a real time basis so as to determarket manipulation.
3 The Derivatives Exchange/ Segment should have arrangements for dissemination of information about trades, quantities and quotes on a real time basis through atleast two information vending networks, which are easily accessible to investors across the country.
4 The Derivatives Exchange/Segment should have arbitration and investor grievances redressal mechanism operative from all the four areas / regions of the country.
5 The Derivatives Exchange/Segment should have satisfactory system of monitoring investor complaints and preventing irregularities in trading.
6 The Derivative Segment of the Exchange would have a separate Investor Protection Fund.
7 The Clearing Corporation/House shall perform full novation, i.e., the Clearing Corporation/House shall interpose itself between both legs of every trade, becoming the legal counterparty to both or alternatively should provide an unconditional guarantee for settlement of all trades.
8 The Clearing Corporation/House shall have the capacity to monitor the overall position of Members across both derivatives market and the underlying securities market for those Members who are participating in both.
9 The level of initial margin on Index Futures Contracts shall be related to the risk of loss on the position. The concept of value-at-risk shall be used in calculating required level of initial margins. The initial margins should be large enough to cover the one-day loss that can be encountered on the position on 99% of the days.
10 The Clearing Corporation/House shall establish facilities for electronic funds transfer (EFT) for swift movement of margin payments.
11 In the event of a Member defaulting in meeting its liabilities, the Clearing Corporation/House shall transfer client positions and assets to another solvent Member or close-out all open positions.
12 The Clearing Corporation/House should have capabilities to segregate initial margins deposited by Clearing Members for trades on their own account and on account of his client. The Clearing Corporation/House shall hold the clients’ margin money in trust for the client purposes only and should not allow its diversion for any other purpose.
13 The Clearing Corporation/House shall have a separate Trade Guarantee Fund for the trades executed on Derivative Exchange / Segment. Presently, SEBI has permitted Derivative Trading on the Derivative Segment of BSE and the F&O Segment of NSE.
What is minimum contract size ?
The Standing Committee on Finance, a Parliamentary Committee, at the time of recommending amendment to Securities Contract (Regulation) Act, 1956 had recommended that the minimum contract size of derivative contracts traded in the Indian Markets should be pegged not below Rs. 2 Lakhs. Based on this recommendation SEBI has specified that the value of a derivative contract should not be less than Rs. 2 Lakh at the time of introducing the contract in the market.
What is the lot size of a contract ?
Lot size refers to number of underlying securities in one contract. Additionally, for stock specific derivative contracts SEBI has specified that the lot size of the underlying individual security should be in multiples of 100 and fractions, if any, should be rounded of to the next higher multiple of 100. This requirement of SEBI coupled with the requirement of minimum contract size forms the basis of arriving at the lot size of a contract. For example, if shares of XYZ Ltd are quoted at Rs.1000 each and the minimum contract size is Rs.2 lacs, then the lot size for that particular scrips stands to be 200000/ 1000 = 200 shares i.e. one contract in XYZ Ltd. covers 200 shares. What is the margining system in the derivative markets ?
Two type of margins have been specified :
1 Initial Margin — Based on 99% VaR and worst case loss over a specified horizon, which depends on the time in which Mark to Market margin is collected.
2 Mark to Market Margin (MTM) — collected in cash for all Futures contracts and adjusted against the available Liquid Networth for option positions. In the case of Futures Contracts MTM may be considered as Mark to Market Settlement.
Dr. L.C Gupta Committee had recommended that the level of initial margin required on a position should be related to the risk of loss on the position. The concept of valueat- risk should be used in calculating required level of initial margins. The initial margins should be large enough to cover
the one day loss that can be encountered on the position on 99% of the days.
The recommendations of the Dr. L.C Gupta have been a guiding principle for SEBI in prescribing the margin computation & collection methodology to the Exchanges. With the introduction of various derivative products in the Indian securities Markets, the margin computation methodology, especially for initial margin, has been modified to address the specific risk characteristics of the product. The margining methodology specified is consistent with the margining system used in
developed financial & commodity derivative markets worldwide. The exchanges were given the freedom to either develop their own margin computation system or adapt the systems available internationally to the requirements of SEBI. A portfolio based margining approach which takes an integrated view of the risk involved in the portfolio of each individual client comprising of his positions in all Derivative Contracts i.e. Index Futures, Index Option, Stock Options and Single Stock Futures, has been prescribed. The initial margin requirements are required to be based on the worst case loss of a portfolio of an individual client to cover 99% VaR over a specified time horizon.
The Initial Margin is Higher of (Worst Scenario Loss +Calendar Spread Charges) or
Short Option Minimum Charge
The worst scenario loss are required to be computed for a portfolio of a client and is calculated by valuing the portfolio under 16 scenarios of probable changes in the value and the volatility of the Index/ Individual Stocks. The options and futures positions in a client’s portfolio are required to be valued by predicting the price and the volatility of the underlying over a specified horizon so that 99% of times the price and volatility so predicted does not exceed the maximum and minimum price or volatility scenario. In this manner initial margin of 99% VaR is achieved. The specified horizon is dependent on the time of collection of mark to market margin by the exchange. The probable change in the price of the underlying over the specified horizon i.e. ‘price scan range’, in the case of Index futures and Index option contracts are based on three standard deviation (3s ) where ‘s ’ is the volatility estimate of the Index. The volatility estimate ‘s ’, is computed as per the Exponentially Weighted Moving Average methodology. This methodology has been prescribed by SEBI. In case of option and futures on individual stocks the price scan range is based on three and a half standard deviation (3.5s ) where ‘s ’ is the daily volatility estimate of individual stock. For Index Futures and Stock futures it is specified that a minimum margin of 5% and 7.5% would be charged. This means if for stock futures the 3.5s value falls below 7.5% then a minimum of 7.5% should be charged. This could be achieved by adjusting
the price scan range.
The probable change in the volatility of the underlying i.e. ‘volatility scan range’ is fixed at 4% for Index options and is fixed at 10% for options on Individual stocks. The volatility scan range is applicable only for option products. Calendar spreads are offsetting positions in two contracts in the same underlying across different expiry. In a portfolio based margining approach all calendar-spread positions automatically get a margin offset. However, risk arising due to difference in cost of carry or the ‘basis risk’ needs to be addressed. It is therefore specified that a SUPPLEMENT FOR SECURITIES LAWS & REGULATION OF FINANCIAL MARKETS 61 calendar spread charge would be added to the worst scenario loss for arriving at the initial margin. For computing calendar spread charge, the system first identifies spread positions and then the spread charge which is 0.5% per month on the far leg of the spread with a minimum of 1% and maximum of 3%. Further, in the last three days of the expiry of the near leg of spread, both the legs of the calendar spread would be treated as separate individual positions.
In a portfolio of futures and options, the non-linear nature of options make short option positions most risky. Especially, short deep out of the money options, which are highly susceptible to, changes in prices of the underlying. Therefore a short option minimum charge has been specified. The short option minimum charge is 5% and 7.5% of the notional value of all short Index option and stock option contracts respectively. The short option minimum charge is the initial margin if the sum of the worst –scenario loss and calendar spread charge is lower than the short option minimum charge. To calculate volatility estimates the exchange are required to use the methodology specified in the Prof J.R Varma Committee Report on Risk Containment Measures for Index Futures. Further, to calculated the option value the exchanges can use standard option pricing models - Black-Scholes, Binomial, Merton, Adesi-Whaley. The initial margin is required to be computed on a real time basis and has two components:-
1 The first is creation of risk arrays taking prices at discreet times taking latest prices and volatility estimates at the discreet times, which have been specified.
2 The second is the application of the risk arrays on the actual portfolio positions to compute the portfolio values and the initial margin on a real time basis. The initial margin so computed is deducted form the available Liquid Networth on a real time basis.
Mark to Market Margin
Options – The value of the option are calculated as the theoretical value of the option times the number of option contracts (positive for long options and negative for short options). This Net Option Value is added to the Liquid Networth of the Clearing member. Thus MTM gains and losses on options are adjusted against the available liquid networth. The net option value is computed using the closing price of the option and are applied the next day.
Futures – The system computes the closing price of each series, which is used for computing mark to market settlement for cumulative net position. This margin is collected on T+1 in cash. Therefore, the exchange charges a higher initial margin by multiplying the price scan range of 3s & 3.5s with square root of 2, so that the initial margin is adequate to cover 99% VaR over a two days horizon.
MARGIN COLLECTION
Initial Margin –
is adjusted from the available Liquid Networth of the Clearing Member on an online real time basis.
Marked to Market Margins--
Futures contracts : The open positions (gross against clients and net of proprietary/ self trading) in the futures contracts for each member is marked to market to the 62 SUPPLEMENT FOR SECURITIES LAWS & REGULATION OF FINANCIAL MARKETS daily settlement price of the Futures contracts at the end of each trading day. The daily settlement price at the end of each day is the weighted average price of the last half an hour of the futures contract. The profits / losses arising from the difference between the trading price and the settlement price are collected / given to all the clearing members.
Option Contracts : The marked to market for Option contracts is computed and collected as part of the SPAN Margin in the form of Net Option Value. The SPAN Margin is collected on an online real time basis based on the data feeds given to the system at discrete time intervals.
Client Margins
Clearing Members and Trading Members are required to collect initial margins from all their clients. The collection of margins at client level in the derivative markets is essential as derivatives are leveraged products and non-collection of margins at the client level would provided zero cost leverage. In the derivative markets all money paid by the client towards margins is kept in trust with the Clearing House/ Clearing corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilised towards the default of the member. Therefore, Clearing members are required to report on a daily basis details in respect of such margin amounts due and collected from their Trading members / clients clearing and settling through them. Trading members are also required to report on a daily basis details of the amount due and collected from their clients. The reporting of the collection of the margins by the clients is done electronically through the system at the end of each trading day. The reporting of collection of client level margins plays a crucial role not only in ensuring that members collect margin from clients but it also provides the clearing corporation with a record of the quantum of funds it has to keep in trust for the clients.
What are the position limits in Derivative Products ?
The position limits specified are as under –
Client / Customer level position limits :
For index based products there is a disclosure requirement for clients whose position exceeds 15% of the open interest of the market in index products. For stock specific products the gross open position across all derivative contracts on a particular underlying of a customer/client should not exceed the higher of –
1 1% of the free float market capitalisation (in terms of number of shares).
or
2 5% of the open interest in the derivative contracts on a particular underlying stock (in terms of number of contracts).
This position limits are applicable on the combine position in all derivative contracts on an underlying stock at an exchange. The exchanges are required to achieve client level position monitoring in stages. SUPPLEMENT FOR SECURITIES LAWS & REGULATION OF FINANCIAL MARKETS 63
Trading Member Level Position Limits:
For Index products Higher of the following :
The Trading Member position limits are Rs. 100 crore ( or ) 15% of the open interest.
For stock specific products Higher of the following :
The trading member position limit are at 7.5% of the open interest ( or ) Rs 50 crore
for derivative contract in a particular underlying at an exchange.
It is also specified that once a member reaches the position limit in a particular underlying then the member shall be permitted to take only offsetting positions (which result in lowering the open position of the member) in derivative contracts on that underlying. In the event that the position limit is breached due to the reduction in the overall open interest in the market, the member shall be permitted to take only offsetting positions (which result in lowering the open position of the member) in derivative contract in that underlying and no fresh positions shall be permitted. The position limit at trading member level are required to be be computed on a gross basis across all clients of the Trading member.
Market wide limits
There are no market wide limits for index products. However for stock specific products the market wide limit of open positions (in terms of the number of underlying stock) on an option and futures contract on a particular underlying stock would be lower of –
3 30 times the average number of shares traded daily, during the previous calendar month, in the cash segment of the Exchange,
(or )
4 10% of the number of shares held by non-promoters i.e. 10% of the free float, in terms of number of shares of a company.
It is further specified that when the total open interest in a contract reaches 80% of the market wide limit in that contract, the exchanges would double the price scan range and volatility scan range specified. The exchanges are required to continuously review the impact of this measure and take further proactive risk containment measures as may be appropriate, including, further increases in the scan ranges and levying additional margins.
What measures have been specified by SEBI to protect the rights of investor in the Derivative Market ?
The measures specified by SEBI include:
1. Investor’s money has to be kept separate at all levels and is permitted to be used only against the liability of the Investor and is not available to the trading member or clearing member or even any other investor.
2. The Trading Member is required to provide every investor with a risk disclosure document which will disclose the risks associated with the derivatives trading so that investors can take a conscious decision to trade in derivatives
3. Investor would get the contract note duly time stamped for receipt of the order and execution of the order. The order will be executed with the identity of the client and without client ID order will not be accepted by the system. The investor could also demand the trade confirmation slip with his ID in support of the contract note. This will protect him from the risk of price favour, if any, extended by the Member.
4. In the derivative markets all money paid by the Investor towards margins on all open positions is kept in trust with the Clearing House/ Clearing corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilised towards the default of the member. However, in the event of a default of a member, losses suffered by the Investor, if any, on settled / closed out position are compensated from the Investor Protection Fund, as per the rules, bye-laws and regulations of the
derivative segment of the exchanges.
* Reproduced from the website of SEBI (www.sebi.gov.in)
EXAMPLES:
Ex:- 1. Forward
Spot price: Present price of the commodity (underlying).
Forward price: Future price of the commodity (underlying) as quoted today
(The forward price is usually more than the spot price)
Trade date: Date of entering into the forward contract.
Settlement date: Date on which the contract has to be settled by making payment of cash or delivery of asset/underlying
(The forward price is usually more than the spot price)
Forward premium/discount: Forward premium/discount is the excess/shortfall of the forward price over the spot price expressed as a percentage of the spot price over the period of the forward contract. Forward premium/discount is calculated as
P/D = {(Forward rate – Spot rate)/Spot rate}*(360/days to maturity)*100.
= {(F-S)/S}*}*(360/days to maturity)*100
Forward contracts are generally quoted for 1, 3 or 6 month durations in which case the days to maturity would be 30, 90 and 180 respectively. If the above result is negative, then obviously the forward price is quoting at a discount to the spot price.
If a three month forward contract for $ is trading at 48.50 and the spot rate is 48.10, then the premium is
= {(48.50 – 48.10)/48.10}*(360/90)*100. = 3.32%
.
Ex:- 2. Futures
Let us consider the following example of a futures contract
A farmer estimates in November that he will need 5,000 bales of cotton in February. The finished product is not sold forward. He buys futures contracts for delivery in February. Assuming that each contract is for 1,000 bales of cotton, he buys 5 contracts at $3 per bale. Assume the closing price of cotton futures (Feb series) was $2.8 in December, which is also the financial year close for the farmer. Further, in February, the farmer purchased his bales at spot and closed his futures contracts at $3.10 per bale.
The change in value of his futures contracts in December was
=(2.8-3.0)*1,000*5 = $1,000 loss
The change in value in February would be: =(3.1-2.8)*1,000*5 = $1,500 gain
Note that this is an example of a hedge on an anticipated future transaction. There was no existing asset or liability to be hedged. If the transaction qualifies as a hedge, then for the year ended December, the loss of $1,000 would not be recognized in current income. Rather it would be shown in other comprehensive income and taken to income when the transaction actually occurs, that is in February when the cotton is actually bought. In February, therefore, if the transaction takes place as anticipated, the net gain of $500 would be reduced from the cost of the cotton purchased.
Ex:- 3. Options
Consider a simple example of an option contract between two persons, A and B. A buys a call option written by B to acquire 100 shares of Microsoft at a strike price of $50/share, Therefore A has a right but not an obligation to buy shares of Microsoft from B at the price of $50/share. Further, the option can be exercised at any time on or prior to the expiration date (American style option). A pays B a premium of $1,000 for acquiring the option. This is A’s cost of the option. The different pay-offs based on market price of the Microsoft share on the date of exercise are summarized below. For the sake of simplicity, we assume the exercise date to be the expiration date of the contract.
Scenario 1
Market price on expiration $50, A will not exercise the option since the market price and strike price are equal. A loses the premium he paid and B pockets the premium received by him.
Scenario 2
Market price on expiration $55, A will exercise the option, buy the shares from B at $50 and sell them in the market for $55. Note that he still makes a loss since the excess of market price over strike price does not cover the premium he has paid for the option fully. B has to buy from the market at $55 and sell to A at $50, thereby partly losing the premium he received on writing the option.
Scenario 3
Market price on expiration $60, A will exercise the option, buy the shares from B at $50 and sell them in the market for $60. At this point A breaks even since the excess of market price over strike price exactly equals the premium paid by him for acquiring the option. B also breaks even at this point.
Scenario 4
Market price on expiration $65, A will exercise the option, buy the shares from B at $50 and sell them in the market for $65. At this point A makes a profit of $500 after meeting his premium cost. B makes a loss equal to A’s gain.
Inferences:
An option is a zero sum game, i.e. the gain of one player is exactly equal to the loss of the other player. An option holder exercises the option only when the option is in the money i.e. he will make a profit. At the money is a break-even position and out of the money is a loss position in an option.
The option buyer’s gain is unlimited and his loss is limited, the reverse is the position of the option writer or seller.
When you buy a call, you acquire the right but not the obligation to purchase, when you buy a put, you acquire the right but not the obligation to sell. Conversely, when you sell a call, you incur an obligation to sell and when you sell a put, you incur an obligation to buy if the buyer of the option exercises the option.
Exotic options
The above example was of a so-called "plain vanilla options", the simple puts and calls that are priced in the exchange-traded markets and the over-the-counter markets for equities, fixed income, foreign exchange and commodities. Exotic options are either variations on the payoff profiles of the plain vanilla options or they are wholly different kinds of products with optionality embedded in them. We shall discuss below some types of exotic options.
Barrier Options
A barrier option is like a plain vanilla option but with one exception: the presence of one or two trigger prices. If the trigger price is touched at any time before maturity, it causes an option with pre-determined characteristics to come into existence (in the case of a knock-in option) or it will cause an existing option to cease to exist (in the case of a knock-out option).
There are single barrier options and double barrier options. A double barrier option has barriers on either side of the strike (i.e. one trigger price is greater than the strike and the other trigger price is less than the strike). A single barrier option has one barrier that may be either greater than or less than the strike price. Why would we ever buy an option with a barrier on it? Because it is cheaper than buying the plain vanilla option and we have a specific view about the path that spot will take over the lifetime of the structure.
Intuitively, barrier options should be cheaper than their plain vanilla counterparts because they risk either not being knocked in or being knocked out. A double knockout option is cheaper than a single knockout option because the double knockout has two trigger prices either of which could knock the option out of existence. How much cheaper a barrier option is compared to the plain vanilla option depends on the location of the trigger.
Look back options
A look back call gives the owner the right to buy the underlying at expiry at a strike price equal to the lowest price that spot traded over the life of the option. A look back put gives the owner the right to sell the underlying at expiry at a strike price equal to the highest price that spot traded over the life of the option. Look backs are expensive. Anything that gives you the right to pick the top or the bottom is going to be costly. As a general rule of thumb, some people like to think that look back prices are in the ballpark if they are roughly twice the price of an at-the-money straddle.
Compound Options
A compound option is an option-on-an-option. It could be a call-on-a-call giving the owner the right to buy in 1 month's time a 6 month 1.55 US dollar call/Canadian dollar put expiring 7 months from today (or 6 months from the expiry of the compound). It could be a put-on-a-call giving the owner the right to sell in 1 month's time a 6 month 1.55 US dollar call/Canadian dollar put expiring 7 months from today.
DERIVATIVES ;
HISTORY ;
Exchange traded financial derivatives were introduced in India in june 2000 at the two major stock exchanges,NSE and bse. There are various contracts currently traded on these exchanges.
National commodity & derivatives exchange limted (ncdex)started its operation s in December 2003 to provide a platform for commodities trading
The derivatives market in india has grown exponentially,especially at nSE.Nse has around 99.5%OF THER MARKET share of “exchange traded financial derivatives “ market in India.
MEANING ;
IN finance a security whose price Is dependent upon or derived from one or more underlying assets is called a derivative. The derivatives itself is merely a contract between two or more parties.its value is determined by fluctuations in ther underlying assets . ther morst common underlying assets include stock, bonds, commodities. Currencies , interest rates and market indexes.
Futures contracts,forward contracts,options and swaps are the most common types of derivatives. Because derivatives are just contracts just about anything can be used as an underlying asset. There are even derivatives based on weather data, suchn as the amount of rain or the number of sunny days in a particular region
Ex ; forwards, futures, options swaps
FEATURES :
1 A derivative does not have any physical existence but emerges out of a contract between two parties
2 It does not have any value of it own but its value in turn depends on the value of other physical assets which are called ther underlying assets
3 These underlying assets may be shares,debentures,commodities,currencies or short term or long term securities etc
4 The current price of an assets is detemined by the market demand for and supply of the assets however the future price of an asset typically remains unkown.
PURPOSE ;
The principal reasons why derivatives are used are ;
1 To hedge risks.
2 To reflects a view on the future direction of the market
3 To lock in an arbitrage profit
FORWARD CONTRACT ;
A forward contract is an agreement between two parties whereby one party agrees to buy from or sell to, the other party an asset at a future time for an agreed price (usually to as delivery price ). the parties to forward contracts may be individuals, corporates or finanacial institutions. At maturity, a forward contract is settled by delivery of the assets by the seller to the buyer in return for payment of delivery price.
FEATURES :
1 A forward contract is for an agreed amount between the parties to the contract.
2 The price of the commodity is fixed on the date of contract itself.
3 The delivery of the goods has to be made on a certain date in future
FUTURE CONTRACT ;
A future contract , like a forward contract, is an agreement between two parties to buy or sell an assets at a certain date in future for an agreed price. Future contact are normally traded on an exchange. To make trading possible, the exchange specifies certain standardized features of the contract. The exchange may also provide for guarantee mechanism to ensure that eack party to the contract meets its obligations and, consequently, risk from default by parties is minimized.
FEATURES ;
1 The future contract is a standard contract. It is done in contract size, multiples of which are specified by the stock exchange.
2 The future contract has a standard maturity date. It matures on specified day of a particular month. For example, last thursday of marchm, june, September.
FUTURE CONTRACT TRADING
The two types of futures traded in India are Equity Index Futures and Equity Stock Futurers. The following table summarizes about them:
EQUITY INDEX FUTURE :
Meaning:- It is a contract to busy or sell an equity index at an agreed amount on a specified future date.
Underlying asset:- Equity Index Ex – S & PCNX Nifty or BSE Sensex
Mode of settlement:- No physical delivery of equity index. Payment in cash for the difference between the price agreed in the contract and the value of the index on the maturity date.
EQUITY STOCK FUTURE :
Meaning:- It is a contract to buy or sell a security at an agreed amount on a specified future date.
Underlying asset:- Security Ex – Equity Shares
Mode of settlement:- Either physical delivery of shares or payment in cash for the difference between the contract price & the value of security at the time of settlement.
MARGIN
Margin refers to the money which is paid by clearing or trading members to the clearing corporation who in turn collect margin from their respective obligations under the contract. Margins can be paid by cash or be provided by way of a bank guarantee.
AT the time of entering into a contract every client is required to pay an initial margin to the clearing members. This initial margin is ‘marked to market’ on a daily basis in cash i.e., clients pay the deficit margin to or receive the excess margin from the clearing member on daily basis.
OPTION
Option is a contract, which gives the buyer/holder the right, but not obligation to buy or sell a specified underlying asset at a pre-determined price.
CALL-OPTION
Call option is an option to buy the specified underlying asset on or before the expiry date.
PUT –OPTION
Put option is an option to sell the specified underlying asset on or before the expiry date.
OPTION TRADING
EQUITY INDEX OPTION
Meaning :- It is a type of derivative instrument whereby a person gets the right to buy or sell an agreed number of Units of equity index on a specified future date.
Underlying asset:- Equity Index Ex – S & P CNX Nifty or BSE sensex
Time of settlement :- Buyer can exercise his right on the day on which the option expires.
Mode of settlement :- No physical delivery of equity index. Payment in cash of the difference between the strike price and the value of index on the maturity date.
EQUITY STOCK OPTION
Meaning :- It is a type of derivative instrument whereby a person gets the right to buy or sell an agreed number of units of a security on or before specified date.
Underlying asset:- Shares of a company. Ex – Securities listed on stock exchange
Time of settlement :- Buyer can exercise his right at any time before or on the date on which option expires.
Mode of settlement :- Either physical delivery of shares or payment in cash for the difference between the strike price and the value of shares at the time of settlement.
STRATEGIES:
i. Straddle : Simultaneous purchase or sale of options with same expiry date & same strike price.
a) Long straddle : Purcahse of call & put option with same strike price & maturity period.
b) Short straddle : Sale of call & put option with same strike price & maturity period.
ii. Strangle : Simultaneous purchase or sale of options with same expiry date & different strike price.
a) Long strangle : Purchase of call & put option with different strike price & maturity period.
b) Short strangle : Sale of call & put option with different strike price & maturity period.
III . spread ; simultaneous buying of an option & selling of another in respect of same underlying assets.
a) vertical spread ; puchase of call option and sellof call option with same maturity period but with different strike prices
b) horizontical spread : purchase of call option and sale of call option with different maturity periods but with same strike price
c) diagonal spread ; purchase of call option and sale of call option with different maturity periods but and defferent strike prices
d) bullish spread : purchase of one call option with low strike price and sale of another call option with high strike price
e) bearish spread : purchase of one call option with high strike price and sale of another call option with low strike price
f) butterfly spread :
1 Long butterfly : purchase of 2 call options with average strike price, but sale of one call option with low strike price and another with high strike price.
2 Short butterfly : sale of 2 call options with average strike price, but purchase of one call option with low strike price and another with high strike price
IV . STRIP : puchase of one call option and two put opions with same maturity period and strike price.
(opted when prices are likely to be decreased)
V . strap : purchase of one put option and two call options with same maturity period and strike price.
(opted when prices are likely to be increased)
swaps :
swaps is the act of exchanging or substituting . a financial contractual agreement between two parties to exchange (swap) a set of payment that one party owns for a set of payments owned by the party. In general the exchange of one asset or liabilities for a similar asset or liability for the purpose of lengthening or shortening maturities, or raising or lowering coupon rates, to maximize revenue or minimize financing cost.
INTEREST RATE SWAP : AN interest rate swap (irs) is a contractual arrangement between two counter partner who agree to exchange interest payments on a defined principal amount for a fixed period of time. In an IRS, the principal amount is never exchanged and therefore is reffered to as a “notional” principal amount. The most popular interest rate swaps are fixed-for-floating swaps under which cash flows of a fixed rate loan are exchanged for those of a floating rate loan .
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1.Production:
1-From annual reports, there is lot of information available of parent and child companies and consolidated financial statements. Finding the correct one to process and to useful for the analysis. Mostly always we prefer consolidated financial statements for measuring the overall financial position and profits of the company or group.
2.For analysis, the statements may b given in horizontal or vertical analysis or both.based on that we can compare the figures of last base year and can evaluate the performance.
3. In the part of analysis we mostly use some tools which are useful as
comparative, common-size, trend analysis and funds flow statements, and Ratio Analysis.
4. We do the Interpretation and analysis based on the information available from the above tools useful for decision making.
5. We give the more importance for the latest information For Example, It is better to analyse the statements of 2007 or 2006 compare to other old reports like 1999,2000 etc.
6. We also work with the reports which are in other than English language by using some translation tools recommended by the company. For us,it is systran clients server.
7. We also have some special attention of IPO s and client request we do the all processes from all department and we update in website within 24 hours.
8. The reports are captured from SEC,SEDAR,GLOBAL and other stock exchanges of related countries.
9. We also use some separate software for the annual reports which are in image format. These softwares are Abby 8.0 and 7.0 and Omni professional reader and rediaries tools.
10. We also work with access tables which are useful for maintaining the data in table format and to avoid the repeatations.
1. definition of accounting:
“the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of a financial character and interpreting the results there of”.
2. book keeping:
“It is mainly concerned with recording of financial data relating to the business operations in a significant and orderly manner.”
3. Branches of accounting
A. Financial Accounting
B. Management Accounting
4. Concepts of accounting:
A. Separate Entity Concept
B. Going Concern Concept
C. Money Measurement Concept
D. Cost Concept
E. Dual Aspect Concept
F. Accounting period Concept
G. Matching Concept (Periodic matching of costs and Revenue)
H. Realization Concept.
5 Conventions of accounting
A. Conservatism
B. Full disclosure
C. Consistency
D Materiality.
6. Systems of book keeping:
A. Single Entry System
B. Double Entry System
7. Systems of accounting
A. Cash System Accounting
B. Mercantile System of Accounting.
8. Principles of accounting
A. Personal a/c : Debit the receiver
Credit the giver
B. Real a/c : Debit what comes in
Credit what goes out
C. Nominal a/c : Debit all expenses and losses
Credit all gains and incomes
9. Meaning of journal: Journal means chronological record of transactions.
10. Meaning of ledger: ledger is a set of accounts. It contains all accounts of the business enterprise whether real, nominal, personal.
11. Posting: it means transferring the debit and credit items from the journal to their respective accounts in the ledger.
12. Trial balance: Trial balance is a statement containing the various ledger balances on a particular date.
13. Credit note: the customer when returns the goods get credit for the value of the goods returned. A credit note is sent to him intimating that his a/c has been credited with the value of the goods returned.
14. Debit note: when the goods are returned to the supplier, a debit note is sent to him indicating that his a/c has been debited with the amount mentioned in the debit note.
15. Contra entry: which accounting entry is recorded on both the debit and credit side of the cash book is known as the contra entry.
16. Petty cash book: petty cash is maintained by business to record petty cash expenses of the business, such as postage, cartage, stationery, etc.
17. Promissory Note: an instrument in writing containing an unconditional undertaking signed by the maker, to pay certain sum of money only to or to the order of a certain person or to the barer of the instrument.
18. Cheque: a bill of exchange drawn on a specified banker and payable on demand.
19. Stale Cheque: a stale cheque means not valid of cheque that means more than six months the cheque is not valid.
20. Bank reconciliation statement: it is a statement reconciling the balance as shown by the bank pass book and the balance as shown by the Cash Book.
Objective: to know the difference & pass necessary correcting, adjusting entries in the books.
21. Matching concept: matching means requires proper matching of expense with the revenue.
22. Capital income: the term capital income means an income which does not grow out of or pertain to the running of the business proper.
23. Revenue income: the income which arises out of and in the course of the regular business transactions of a concern.
24. Capital expenditure: it means an expenditure which has been incurred for the purpose of obtaining a long term advantage for the business.
25. Revenue expenditure: an expenditure that incurred in the course of regular business transactions of a concern.
26. Differed revenue expenditure: an expenditure which is incurred during an accounting period but is applicable further periods also. Eg: heavy advertisement.
27. Bad debts: bad debts denote the amount lost from debtors to whom the goods were sold on credit.
28. Depreciation: depreciation denotes gradually and permanent decrease in the value of asset due to wear and tear, technology changes, laps of time and accident.
29. Fictitious assets: These are assets not represented by tangible possession or property. Examples of preliminary expenses, discount on issue of shares, debit balance in the profit and loss account when shown on the assets side in the balance sheet.
30. Intangilbe Assets: Intangible assets mean the asset which is not having the physical appearance and it’s have the real value, it shown on the assets side of the balance sheet.
31. Accrued Income: Accrued income means income which has been earned by the business during the accounting year but which has not yet been due and, therefore, has not been received.
32. Outstanding Income : Outstanding Income means income which has become due during the accounting year but which has not so far been received by the firm.
33. Suspense account: the suspense account is an account to which the difference in the trial balance has been put temporarily.
34. Depletion: it implies removal of an available but not replaceable source, Such as extracting coal from a coal mine.
35. Amortization: the process of writing of intangible assets is term as amortization.
36. Dilapidations: the term dilapidations to damage done to a building or other property during tenancy.
37. Capital employed: the term capital employed means sum of total long term funds employed in the business. i.e.
[Share capital+ reserves & surplus +long term loans – (non business assets + fictitious assets)]
38. Equity shares: those shares which are not having preference rights are called equity shares.
39. Pref.shares: Those shares which are carrying the preference rights is called pref. shares
1 Pref.rights in respect of fixed dividend.
2 Pref.right to repayment of capital in the event of company winding up.
40. Leverage: It is a force applied at a particular point to get the desired result.
41. Operating leverage: the operating leverage takes place when a changes in revenue greater changes in EBIT.
42. Financial leverage: it is nothing but a process of using debt capital to increase the rate of return on equity
43. Combine leverage: it is used to measure of the total risk of the firm = operating risk + financial risk.
44. Joint venture: A joint venture is an association of two or more the persons who combined for the execution of a specific transaction and divide the profit or loss their of an agreed ratio.
45. Partnership: partnership is the relation between the persons who have agreed to share the profits of business carried on by all or any of them acting for all.
46. Factoring: It is an arrangement under which a firm (called borrower) receives advances against its receivables, from a financial institutions (called factor)
47. Capital reserve: The reserve which transferred from the capital gains is called capital reserve.
48. General reserve: the reserve which is transferred from normal profits of the firm is called general reserve
49. Free Cash: The cash not for any specific purpose free from any encumbrance like surplus cash.
50. Minority Interest: minority interest refers to the equity of the minority shareholders in a subsidiary company.
51. Capital receipts: capital receipts may be defined as “non-recurring receipts from the owner of the business or lender of the money crating a liability to either of them.
52. Revenue receipts: Revenue receipts may defined as “A recurring receipts against sale of goods in the normal course of business and which generally the result of the trading activities”.
53. Meaning of Company: A company is an association of many persons who contribute money or money’s worth to common stock and employs it for a common purpose. The common stock so contributed is denoted in money and is the capital of the company.
54. Types of a Company:
1. Statutory Companies
2. Government Company
3. Foreign Company
4. Registered Companies:
A. Companies limited by shares
B. Companies limited by guarantee
C. Unlimited companies
D. Private Company
E. Public Company
55. Private company: A private company is which by its AOA:
1 Restricts the right of the members to transfer of shares
2 Limits the no. of members to 50.
3 Prohibits any Invitation to the public to subscribe for its shares or debentures.
56. Public company: A company, the articles of association of which does not contain the requisite restrictions to make it a private limited company, is called a public company.
57. Characteristics of a company:
1 Voluntary association
2 Separate legal entity
3 Free transfer of shares
4 Limited liability
5 Common seal
6 Perpetual existence
58. Formation of company:
1 Promotion
2 Incorporation
3 Commencement of business
59. Equity share capital: The total sum of equity shares is called equity share capital.
60. Authorized share capital: it is the maximum amount of the share capital which a company can raise for the time being.
61. Issued capital: It is that part of the authorized capital which has been allotted to the public for subscriptions.
62. Subscribed capital: it is the part of the issued capital which has been allotted to the public
63. Called up capital: It has been portion of the subscribed capital which has been called up by the company.
64. Paid up capital: It is the portion of the called up capital against which payment has been received.
65. Debentures: Debenture is a certificate issued by a company under its seal acknowledging a debt due by it to its holder.
66. Cash profit: cash profit is the profit it is occurred from the cash sales.
67. Deemed public Ltd. Company: A private company is a subsidiary company to public company it satisfies the following terms/conditions Sec 3(1)3:
1. having minimum share capital 5 lakhs
2. accepting investments from the public
3. no restriction of the transferable of shares
4. No restriction of no. of members.
5. accepting deposits from the investors
68. Secret reserves: secret reserves are reserves the existence of which does not appear on the face of balance sheet. In such a situation, net assets position of the business is stronger than that disclosed by the balance sheet.
These reserves are created by:
1. Excessive depreciation of an asset, excessive over-valuation of a liability.
2. Complete elimination of an asset, or under valuation of an asset.
69. Provision: provision usually means any amount written off or retained by way of providing depreciation, renewals or diminutions in the value of assets or retained by way of providing for any known liability of which the amount can not be determined with substantial accuracy.
70. Reserve: The provision in excess of the amount considered necessary for the purpose it was originally made is also considered as reserve
1 Provision is charge against profits while reserves is an appropriation of profits
2 Creation of reserve increase proprietor’s fund while creation of provisions decreases his funds in the business.
71. Reserve fund: the term reserve fund means such reserve against which clearly investment etc.,
72. Undisclosed reserves: Sometimes a reserve is created but its identity is merged with some other a/c or group of accounts so that the existence of the reserve is not known such reserve is called an undisclosed reserve.
73. Finance Management: financial management deals with procurement of funds and their effective utilization in business.
74. Objectives of Financial Management: financial management having two objectives that Is:
A. Profit maximization: the finance manager has to make his decisions in a manner so that the profits of the concern are maximized.
B. Wealth maximization: wealth maximization means the objective of a firm should be to maximize its value or wealth, or value of a firm is represented by the market price of its common stock.
75. Functions of financial manager:
1 Investment Decision
2 Dividend Decision
3 Finance Decision
4 Cash Management Decisions
5 Performance Evaluation
6 Market Impact Analysis
76. Time value of money: the time value of money means that worth of a rupee received today is different from the worth of a rupee to be received in future.
77. Capital Structure: it refers to the mix of sources from where the long-term funds required in a business may be raised; in other words, it refers to the proportion of debt, preference capital and equity capital.
78. Optimum Capital Structure: capital structure is optimum when the firm has a combination of equity and debt so that the wealth of the firm is maximized.
79. WACC: it denotes weighted average cost of capital. It is defined as the overall cost of capital computed by reference to the proportion of each component of capital as weights.
80. Financial break even point: it denotes the level at which a firm’s EBIT is just sufficient to cover interest and preference dividend.
81. Capital Budgeting: capital budgeting involves the process of decision making with regard to investment in fixed assets. Or decision making with regard to investment of money in long term projects.
82. Pay back period: payback period represents the time period required for complete recovery of the initial investment in the project.
83. ARR: accounting or average rate of return means the average annual yield on the project.
84. NPV: the net present value of an investment proposal is defined as the sum of the present values of all future cash in flows less the sum of the present values of all cash out flows associated with the proposal. (Present value of Cash inflows-Outflows)
85. Profitability Index: where different investment proposal each involving different initial investments and cash inflows are to be compared.
86. IRR: internal rate of return is the rate at which the sum total of discounted cash inflows equals the discounted cash out flow.
87. Treasury management: it means it is defined as the efficient management of liquidity and financial risk in business.
88. Concentration banking: it means identify locations or places where customers are placed and open a local bank a/c in each of these locations and open local collection centre.
89. Marketable Securities: Surplus cash can be invested in short term instruments in order to earn interest.
90. Ageing schedule: in a ageing schedule the receivables are classified according to their age.
91. Maximum permissible bank finance (MPBF): it is the maximum amount that banks can lend a borrower towards his working capital requirements.
92. Commercial paper: a CP is a short term promissory note issued by a company, negotiable by endorsement and delivery, issued at a discount on face value as may be determined by the issuing company.
93. Bridge Finance: It refers to the loans taken by the company normally from commercial banks for a short period pending disbursement of loans sanctioned by the financial institutions.
94. Venture Capital: It refers to the financing of high risk ventures promoted by new qualified entrepreneurs who require funds to give shape to their ideas.
95. Debt Securitization: It is a mode of financing, where in securities are issued on the basis of a package of assets (called asset pool).
96. Lease Financing: Leasing is a contract where one party (owner) purchases assets and permits its views by another party (lessee) over a specified period
97. Trade Credit: It represents credit granted by suppliers of goods, in the normal course of business.
98. Over draft: Under this facility a fixed limit is granted within which the borrower allowed to overdraw from his account.
99. Cash credit: It is an arrangement under which a customer is allowed an advance up to certain limit against credit granted by bank.
100. Clean overdraft: It refers to an advance by way of overdraft facility, but not back by any tangible security.
101. Share Capital: The sum total of the nominal value of the shares of a company is called share capital.
102. Funds Flow Statement: It is the statement deals with the financial resources for running business activities. It explains how the funds obtained and how they used.
103. Sources of funds: There are two sources of funds internal sources and external sources.
Internal source: Funds from operations is the only internal sources of funds and some important points add to it they do not result in the outflow of funds
(a)Depreciation on fixed assets (b) Preliminary expenses or goodwill written off, Loss on sale of fixed assets
Deduct the following items as they do not increase the funds:
Profit on sale of fixed assets, profit on revaluation of fixed assets
External sources: (a) Funds from long term loans (b) Sale of fixed assets (c) Funds from increase in share capital
104. Application of funds: (a) Purchase of fixed assets (b) Payment of dividend (c) Payment of tax liability (d) Payment of fixed liability
105. ICD (Inter corporate deposits): Companies can borrow funds for a short period. For example 6 months or less from another company which have surplus liquidity, such deposits made by one company in another company are called ICD.
106. Certificate of deposits: The CD is a document of title similar to a fixed deposit receipt issued by banks there is no prescribed interest rate on such CDs it is based on the prevailing market conditions.
107. Public deposits: It is very important source of short term and medium term finance. The company can accept PD from members of the public and shareholders. It has the maturity period of 6 months to 3 years.
108. Euro issues: The euro issues means that the issues are listed on a European stock Exchange. The subscription can come from any part of the world except India.
109. GDR (Global depository receipts): A depository receipt is basically a negotiable certificate, dominated in US-dollars that represent a non-US company publicly traded in local currency equity shares.
110. ADR (American depository receipts): Depository receipts issued by a company in the USA are known as ADRs. Such receipts are to be issued in accordance with the provisions stipulated by the securities Exchange commission (SEC) of USA like SEBI in India.
111. Commercial banks: Commercial banks extend foreign currency loans for international operations, just like rupee loans. The banks also provided overdraft.
112. Development Banks: It offers long-term and medium term loans including foreign currency loans
113. International agencies: International agencies like the IFC, IBRD, ADB, IMF etc. provide indirect assistance for obtaining foreign currency.
114. Seed Capital Assistance: The seed capital assistance scheme is desired by the IDBI for professionally or technically qualified entrepreneurs and persons possessing relevant experience and skills and entrepreneur traits.
115. Unsecured Loans: It constitutes a significant part of long-term finance available to an enterprise.
116. Cash Flow Statement: It is a statement depicting change in cash position from one period to another.
117. Sources of cash:
Internal sources: - (a) Depreciation (b) Amortization (c) Loss on sale of fixed assets (d) Gains from sale of fixed assets (e) Creation of reserves
External sources: - (a) Issue of new shares (b) Raising long term loans (c) Short-term borrowings (d) Sale of fixed assets, investments
118. Application of cash: (a) Purchase of fixed assets (b) Payment of long-term loans (c) Decrease in deferred payment liabilities (d) Payment of tax, dividend (e) Decrease in unsecured loans and deposits
119. Budget: It is a detailed plan of operations for some specific future period. It is an estimate prepared in advance of the period to which it applies.
120. Budgetary Control: It is the system of management control and accounting in which all operations are forecasted and so for as possible planned ahead, and the actual results compared with the forecasted and planned ones.
121. Cash budget: It is a summary statement of firm’s expected cash inflow and outflow over a specified time period.
122. Master budget: A summary of budget schedules in capsule form made for the purpose of presenting in one report the highlights of the budget forecast.
123. Fixed budget: It is a budget which is designed to remain unchanged irrespective of the level of activity actually attained.
124. Zero- base- budgeting: It is a management tool which provides a systematic method for evaluating all operations and programs, current of new allows for budget reductions and expansions in a rational manner and allows reallocation of source from low to high priority programs.
125. Goodwill: The present value of firm’s anticipated excess earnings.
126. BRS: It is a statement reconciling the balance as shown by the bank pass book and balance shown by the cash book.
127. Objective of BRS: The objective of preparing such a statement is to know the causes of difference between the two balances and pass necessary correcting or adjusting entries in the books of the firm.
128. Responsibilities of Accounting: It is a system of control by delegating and locating the responsibilities for costs.
129. Profit Centre: A centre whose Performance is measured in terms of both the expense incurs and revenue it earns.
130. Cost Centre: A location, person or item of equipment for which cost may be ascertained and used for the purpose of cost control.
131. Cost: The amount of expenditure incurred on to a given thing.
132. Cost Accounting: It is thus concerned with recording, classifying, and summarizing costs for determination of costs of products or services. planning, controlling and reducing such costs and furnishing of information management for decision making.
133. Elements of cost: (A) Material (B) Labour (C) Expenses (D) Overheads
134. Components of total costs: (A) Prime cost (B) Factory cost (C) Cost of production
(D) Total cost
135. Prime Cost: It consists of direct material direct labour and direct expenses. It is also known as basic or first or flat cost.
136. Factory cost: It comprises prime cost, in addition factory overheads which include cost of indirect material indirect labour and indirect expenses incurred in factory. This cost is also known as works cost or production cost or manufacturing cost.
137. Cost of production: In office and administration overheads are added to factory cost, office cost is arrived at.
138. Total cost: Selling and distribution overheads are added to total cost of production to get the total cost or cost of sales.
139. Cost Unit: A unit of quantity of a product, service or time in relation to which costs may be ascertained or expressed.
140. Methods of Costing: (A) Job costing (B) Contract costing (C) Process costing
(D) Operation costing (E) operating costing (F) Unit costing (G) Batch costing.
141. Techniques of costing: (a) Marginal Costing (b) Direct Costing (c) Absorption costing
(d) Uniform Costing.
142. Standard Costing: standard costing is a system under which the cost of the product is determined in advance on certain predetermined standards.
143. Marginal Costing: it is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, i.e., materials, labour, direct expenses and variable overheads.
144. Derivative: derivative is product whose value is derived from the value of one or more basic variables of underlying asset.
145. Forwards: a forward contract is customized contracts between two entities were settlement takes place on a specific date in the future at today’s pre agreed price.
146. Futures: a future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Future contracts are standardized exchange traded contracts.
147. Options: an option gives the holder of the option the right to do something. The option holder option may exercise or not.
148. Call option: a call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.
149. Put option: a put option gives the holder the right but not obligation to sell an asset by a certain date for a certain price.
150. Option price: option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.
151. Expiration date: the date which is specified in the option contract is called expiration date.
152. European Option: it is the option at exercised only on expiration date itself.
153. Basis: basis means future price minus spot price.
154. Cost of carry: the relation between future prices and spot prices can be summarized in terms of what is known as cost of carry.
155. Initial margin: the amount that must be deposited in the margin a/c at the time of first entered into future contract is known as initial margin.
156. Maintenance margin: this is some what lower than initial margin.
157. Mark to Market: in future market, at the end of the each trading day, the margin a/c is adjusted to reflect the investors’ gains or loss depending upon the futures selling price. This is called mark to market.
158. Baskets: basket options are options on portfolio of underlying asset.
159. Swaps: swaps are private agreements between two parties to exchange cash flows in the future according to a pre agreed formula.
160. Impact cost: impact cost is cost it is measure of liquidity of the market. It reflects the costs faced when actually trading in index.
161. Hedging: hedging means minimize the risk.
162. Capital market: capital market is the market it deals with the long term investment funds. It consists of two markets 1. Primary Market 2. Secondary Market
163. Primary market: those companies which are issuing new shares in this market. It is also called new issue market.(IPO)
164. Secondary Market: secondary market is the market where shares buying and selling. In India secondary market is called stock exchange.
165. Arbitrage: it means purchase and sale of securities in different markets in order to profit from price discrepancies. In other words arbitrage is a way of reducing risk of loss caused by price fluctuations of securities held in a portfolio.
166. Meaning of ratio: Ratios are relationships expressed in mathematical terms between figures which are connected with each other in same manner.
167. Activity ratio: it is a measure of the level of activity attained over a period.
168. Mutual Fund: a mutual fund is a pool of money, collected from investors, and is invested according to certain investment objectives.
169. Characteristics of Mutual Fund:
1 Ownership of the MF is in the hands of the of the investors
2 MF managed by investment professionals
3 The value of portfolio is updated every day
170. Advantage of MF to investors:
1 Portfolio diversification
2 Professional management
3 Reduction in risk
4 Reduction of transaction casts
5 Liquidity
6 Convenience and flexibility
171. Net asset value: the value of one unit of investment is called as the Net Asset Value
172. Open-ended fund: open ended funds means investors can buy and sell units of fund, at NAV related prices at any time, directly from the fund this is called open ended fund.
For ex; unit 64
173. Close ended funds: close ended funds means it is open for sale to investors for a specific period, after which further sales are closed. Any further transaction for buying the units or repurchasing them, happen, in the secondary markets.
174. Dividend option: Investors, who choose a dividend on their investments, will receive dividends from the MF, as when such dividends are declared.
175. Growth option: investors who do not require periodic income distributions can be choose the growth option.
176. Equity Funds: equity funds are those that invest pre-dominantly in equity shares of company.
177. Types of equity funds:
1 Simple equity funds
2 Primary market funds
3 Sectoral funds
4 Index funds
178. Sectoral funds: sectoral funds choose to invest in one or more chosen sectors of the equity markets.
179. Index Funds: the fund manager takes a view on companies that are expected to perform well, and invests in these companies
.
180. Debt Funds: the debt funds are those that are pre-dominantly invest in debt securities.
181. Liquid Funds: the debt funds invest only in instruments with maturities less than one year.
182. Gilt Funds: gilt funds invests only in securities that are issued by the GOVT. and therefore does not carry any credit risk.
183. Balanced funds: funds that invest both in debt and equity markets are called balanced funds.
184. Sponsor: sponsor is the promoter of the MF and appoints trustees, custodians and the AMC with prior approval of SEBI .
185. Trustee: trustee is responsible to the investors in the MF and appoint the AMC for managing the investment portfolio.
186. AMC: the AMC describes Asset Management Company, it is the business face of the MF, as it manages all the affairs of the MF.
187. R & T Agents: the R&T agents are responsible for the investor servicing functions, as they maintain the records of investors in MF.
188. Custodians: custodians are responsible for the securities held in the mutual fund’s portfolio.
189. Scheme take over: if an existing MF scheme is taken over by the another AMC, it is called as scheme take over.
190. Meaning of load: load is the factor that is applied to the NAV of a scheme to arrive at the price.
192. Market Capitalization: market capitalization means number of shares issued multiplied with market price per share.
193. Price Earning ratio: the ratio between the share price and the post tax earnings of company is called as price earning ratio.
194. Dividend yield: the dividend paid out by the company, is usually a percentage of the face value of a share.
195. Market Risk: it refers to the risk which the investor is exposed to as a result of adverse movements in the interest rates. It also referred to as the interest rate risk.
196. Re-investment risk: it the risk which an investor has to face as a result of a fall in the interest rates at the time of reinvesting the interest income flows from the fixed income security.
197. Call risk: call risk is associated with bonds have an embedded call option in them. This option haves the issuer the right to call back the bonds prior to maturity.
198. Credit risk: credit risk refers to the probability that a borrower could default on a commitment to repay debt or band loans
199. Inflation Risk: inflation risk reflects the changes in the purchasing power of the cash flows resulting from the fixed income security.
200. Liquid risk: it is also called market risk, it refers to the ease with which bonds could be traded in the market.
201. Drawings: drawings denotes the money withdrawn by the proprietor from the business for his personal use.
202. Outstanding Income: Outstanding Income means income which has become due during the accounting year but which has not so far been received by the firm.
203. Outstanding Expenses: Outstanding Expenses refer to those expenses which have become due during the accounting period for which the Final Accounts have been prepared but have not yet been paid.
204. Closing Stock: The term closing stock means goods lying unsold with the businessman at the end of the accounting year.
205. Methods of depreciation:
1. Uniform charge methods:
a. Fixed installment method
b. Depletion method
c. Machine hour rate method.
2. Declining charge methods:
a. Diminishing balance method
b. Sum of years digits method
c. Double declining method
3. Other methods:
a. Group depreciation method
b. Inventory system of depreciation
c. Annuity method
d. Depreciation fund method
e. Insurance policy method.
206. Accrued Income: Accrued Income means income which has been earned by the business during the accounting year but which has not yet become due and, therefore, has not been received.
207. Gross profit ratio: it indicates the efficiency of the production/trading operations.
Formula: Gross profit X 100
Net sales
208. Net profit ratio: it indicates net margin on sales
Formula: Net profit X 100
Net sales
209. Return on share holders’ funds: it indicates measures earning power of equity capital.
Formula: profits available for Equity shareholders X 100
Average Equity Shareholders Funds
210. Earning per Equity share (EPS): it shows the amount of earnings attributable to each equity share.
Formula: profits available for Equity shareholders
Number of Equity shares
211. Dividend yield ratio: it shows the rate of return to shareholders in the form of dividends based in the market price of the share
Formula: Dividend per share X 100
Market price per share
212. Price earning ratio: it a measure for determining the value of a share. May also be used to measure the rate of return expected by investors.
Formula: Market price of share (MPS) X 100
Earning per share (EPS)
213. Current ratio: it measures short-term debt paying ability.
Formula: Current Assets
Current Liabilities
214. Debt-Equity Ratio: it indicates the percentage of funds being financed through borrowings; a measure of the extent of trading on equity.
Formula: Total Long-term Debt
Shareholder’s funds
215. Fixed Assets ratio: This ratio explains whether the firm has raised adequate long-term funds to meet its fixed assets requirements.
Formula: Fixed Assets
Long-term Funds
216. Quick Ratios: The ratio termed as ‘liquidity ratio’. The ratio is ascertained y comparing the liquid assets to current liabilities.
Formula: Liquid Assets
Current Liabilities
217. Stock turnover Ratio: the ratio indicates whether investment in inventory in efficiently used or not. It, therefore explains whether investment in inventory within proper limits or not.
Formula: Cost of goods sold
Average stock
218. Debtors Turnover Ratio: the ratio the better it is, since it would indicate that debts are being collected more promptly. The ration helps in cash budgeting since the flow of cash from customers can be worked out on the basis of sales.
Formula: Credit sales
Average Accounts Receivable
219. Creditors Turnover Ratio: it indicates the speed with which the payments for credit purchases are made to the creditors.
Formula: Credit Purchases
Average Accounts Payable
220. Working capital turnover ratio: it is also known as Working Capital Leverage Ratio. This ratio indicates whether or not working capital has been effectively utilized in making sales.
Formula: Net Sales
Working Capital
221.Fixed Assets Turnover ratio : This ratio indicates the extent to which the investments in fixed assets contributes towards sales.
Formula: Net Sales
Fixed Assets
222. Pay-out Ratio: This ratio indicates what proportion of earning per share has been used for paying dividend.
Formula: Dividend per Equity Share X 100
Earning per Equity share
223. Overall Profitability Ratio : It is also called as “ Return on Investment” (ROI) or Return on Capital Employed (ROCE) . It indicates the percentage of return on the total capital employed in the business.
Formula: Operating profit X 100
Capital employed
The term capital employed has been given different meanings
a. sum total of all assets whether fixed or current
b. sum total of fixed assets,
c. sum total of long-term funds employed in the business, i.e.,
Share capital +reserves &surplus +long term loans – (non business assets + fictitious assets).
Operating profit means ‘profit before interest and tax’
224. Fixed Interest Cover ratio : the ratio is very important from the lender’s point of view. It indicates whether the business would earn sufficient profits to pay periodically the interest charges.
Formula : Income before interest and Tax
Interest Charges
225 . Fixed Dividend Cover ratio : This ratio is important for preference shareholders entitled to get dividend at a fixed rate in priority to other shareholders.
Formula : Net Profit after Interest and Tax
Preference Dividend
226. Debt Service Coverage ratio : This ratio is explained ability of a company to make payment of principal amounts also on time.
Formula : Net profit before interest and tax
Interest + Principal payment installment
1 Tax rate
227. Proprietary ratio : It is a variant of debt-equity ratio . It establishes relationship between the proprietor’s funds and the total tangible assets.
Formula : Shareholders funds
Total tangible assets
228.Difference between joint venture and partner ship :
1 In joint venture the business is carried on without using a firm name,
In the partnership, the business is carried on under a firm name.
2 In the joint venture, the business transactions are recorded under cash system
In the partnership, the business transactions are recorded under mercantile system.
3 In the joint venture, profit and loss is ascertained on completion of the venture
In the partner ship , profit and loss is ascertained at the end of each year.
4 In the joint venture, it is confined to a particular operation and it is temporary.
In the partnership, it is confined to a particular operation and it is permanent
.
229.Meaning of Working capital
:
The funds available for conducting day to day operations of an enterprise. Also represented by the excess of current assets over current liabilities .
230.concepts of accounting :
1. Business entity concepts :- According to this concept, the business is treated as a separate entity distinct from its owners and others.
2. Going concern concept :- According to this concept, it is assumed that a business has a reasonable expectation of continuing business at a profit for an indefinite period of time.
3. Money measurement concept :- This concept says that the accounting records only those transactions which can be expressed in terms of money only.
4. Cost concept :-According to this concept, an asset is recorded in the books at the price paid to acquire it and that this cost is the basis for all subsequent accounting for the asset.
5. Dual aspect concept :- In every transaction, there will be two aspects – the receiving aspect and the giving aspect; both are recorded by debiting one accounts and crediting another account. This is called double entry.
6. Accounting period concept :- It means the final accounts must be prepared on a periodic basis. Normally accounting period adopted is one year, more than this period reduces the utility of accounting data.
7. Realization concept :- According to this concepts, revenue is considered as being earned on the data which it is realized, i.e., the date when the property in goods passes the buyer and he become legally liable to pay.
8. Materiality concepts :- It is a one of the accounting principle, as per only important information will be taken, and un important information will be ignored in the preparation of the financial statement.
9. Matching concepts :- The cost or expenses of a business of a particular period are compared with the revenue of the period in order to ascertain the net profit and loss.
10. Accrual concept :- The profit arises only when there is an increase in owners capital, which is a result of excess of revenue over expenses and loss.
231. Financial analysis :The process of interpreting the past, present, and future financial condition of a company.
232. Income statement : An accounting statement which shows the level of revenues, expenses and profit occurring for a given accounting period.
233.Annual report : The report issued annually by a company, to its share holders. it containing financial statement like, trading and profit & lose account and balance sheet.
234. Bankrupt : A statement in which a firm is unable to meets its obligations and hence, it is assets are surrendered to court for administration
235 . Lease : Lease is a contract between to parties under the contract, the owner of the asset gives the right to use the asset to the user over an agreed period of the time for a consideration
236.Opportunity cost : The cost associated with not doing something.
237. Budgeting : The term budgeting is used for preparing budgets and other producer for planning, co-ordination, and control of business enterprise
.
238.Capital : The term capital refers to the total investment of company in money, tangible and intangible assets. It is the total wealth of a company.
239.Capitalization : It is the sum of the par value of stocks and bonds out standings.
240. Over capitalization : When a business is unable to earn fair rate on its outstanding securities.
241. Under capitalization : When a business is able to earn fair rate or over rate on it is outstanding securities.
242. Capital gearing : The term capital gearing refers to the relationship between equity and long term debt.
243.Cost of capital : It means the minimum rate of return expected by its investment.
244.Cash dividend : The payment of dividend in cash
245.Define the term accrual : Recognition of revenues and costs as they are earned or incurred . it includes recognition of transaction relating to assets and liabilities as they occur irrespective of the actual receipts or payments.
245. accrued expenses : An expense which has been incurred in an accounting period but for which no enforceable claim has become due in what period against the enterprises.
246.Accrued revenue : Revenue which has been earned is an earned is an accounting period but in respect of which no enforceable claim has become due to in that period by the enterprise.
247.Accrued liability : A developing but not yet enforceable claim by an another person which accumulates with the passage of time or the receipt of service or otherwise. it may rise from the purchase of services which at the date of accounting have been only partly performed and are not yet billable.
248.Convention of Full disclosure : According to this convention, all accounting statements should be honestly prepared and to that end full disclosure of all significant information will be made.
249.Convention of consistency : According to this convention it is essential that accounting practices and methods remain unchanged from one year to another.
250. Define the term preliminary expenses : Expenditure relating to the formation of an enterprise. There include legal accounting and share issue expenses incurred for formation of the enterprise.
251. Meaning of Charge: charge means it is a obligation to secure an indebt ness. It may be fixed charge and floating charge.
252. Appropriation: It is application of profit towards Reserves and Dividends.
253.Absorption costing : A method where by the cost is determine so as to include the appropriate share of both variable and fixed costs.
254.Marginal Cost : Marginal cost is the additional cost to produce an additional unit of a product. It is also called variable cost.
255. What are the ex-ordinary items in the P&L a/c : The transaction which are not related to the business is termed as ex-ordinary transactions or ex-ordinary items. Egg:- profit or losses on the sale of fixed assets, interest received from other company investments, profit or loss on foreign exchange, unexpected dividend received.
256. Share premium: The excess of issue of price of shares over their face value. It will be showed with the allotment entry in the journal, it will be adjusted in the balance sheet on the liabilities side under the head of “reserves & surplus”.
257.Accumulated Depreciation : The total to date of the periodic depreciation charges on depreciable assets.
258. Investment: Expenditure on assets held to earn interest, income, profit or other benefits.
259.Capital : Generally refers to the amount invested in an enterprise by its owner. Ex; paid up share capital in corporate enterprise.
260. Capital Work In Progress : Expenditure on capital assets which are in the process of construction as completion.
261. Convertible Debenture : A debenture which gives the holder a right to conversion wholly or partly in shares in accordance with term of issues.
262.Redeemable Preference Share : The preference share that is repayable either after a fixed (or) determinable period (or) at any time dividend by the management.
263. Cumulative preference shares : A class of preference shares entitled to payment of cumulates dividends. Preference shares are always deemed to be cumulative unless they are expressly made non-cumulative preference shares.
264.Debenture redemption reserve : A reserve created for the redemption of debentures at a future date.
265. Cumulative dividend : A dividend payable as cumulative preference shares which it unpaid cumulates as a claim against the earnings of a corporate before any distribution is made to the other shareholders.
266. Dividend Equalization reserve : A reserve created to maintain the rate of dividend in future years.
267. Opening Stock : The term ‘opening stock’ means goods lying unsold with the businessman in the beginning of the accounting year. This is shown on the debit side of the trading account.
268.Closing Stock : The term ‘Closing Stock’ includes goods lying unsold with the businessman at the end of the accounting year. The amount of closing stock is shown on the credit side of the trading account and as an asset in the balance sheet.
269.Valuation of closing stock : The closing stock is valued on the basis of “Cost or Market price whichever is less” principle.
272. Contingency : A condition (or) situation the ultimate out come of which gain or loss will be known as determined only as the occurrence or non occurrence of one or more uncertain future events.
273.Contingent Asset : An asset the existence ownership or value of which may be known or determined only on the occurrence or non occurrence of one more uncertain future events.
274. Contingent liability : An obligation to an existing condition or situation which may arise in future depending on the occurrence of one or more uncertain future events.
275. Deficiency : the excess of liabilities over assets of an enterprise at a given date is called deficiency.
276.Deficit : The debit balance in the profit and loss a/c is called deficit.
277.Surplus : Credit balance in the profit & loss statement after providing for proposed appropriation & dividend , reserves.
278.Appropriation Assets : An account sometimes included as a separate section of the profit and loss statement showing application of profits towards dividends, reserves.
279. Capital redemption reserve : A reserve created on redemption of the average cost:- the cost of an item at a point of time as determined by applying an average of the cost of all items of the same nature over a period. When weights are also applied in the computation it is termed as weight average cost.
280.Floating Change : Assume change on some or all assets of an enterprise which are not attached to specific assets and are given as security against debt.
281. Difference between Funds flow and Cash flow statement :
5 A Cash flow statement is concerned only with the change in cash position while a funds flow analysis is concerned with change in working capital position between two balance sheet dates.
6 A cash flow statement is merely a record of cash receipts and disbursements. While studying the short-term solvency of a business one is interested not only in cash balance but also in the assets which are easily convertible into cash.
282. Difference Between the Funds flow and Income statement :
7 A funds flow statement deals with the financial resource required for running the business activities. It explains how were the funds obtained and how were they used,
Whereas an income statement discloses the results of the business activities, i.e., how much has been earned and how it has been spent.
8 A funds flow statement matches the “funds raised” and “funds applied” during a particular period. The source and application of funds may be of capital as well as of revenue nature.
An income statement matches the incomes of a period with the expenditure of that period, which are both of a revenue nature.
Stock
A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings. Also known as "shares" or "equity".
In other words, a shareholder is an owner of a company.. For example, if a company has 1,000 shares of stock outstanding and one person owns 100 shares, that person would own and have claim to 10% of the company's assets. Stocks are the foundation of nearly every portfolio
There are two main types of stock: common and preferred.
Common stock usually entitles the owner to vote at shareholders' meetings and to receive dividends.
Preferred stock generally does not have voting rights, but has a higher claim on assets and earnings than the common shares. For example, owners of preferred stock receive dividends before common shareholders and have priority in the event that a company goes bankrupt and is liquidated. . However, the best way to think of preferred stock is as a financial instrument that has characteristics of both debt (fixed dividends) and equity (potential appreciation). Also known as "preferred shares.
Penny Stock
A stock that sells for less than $1 per share but may also rise to as much as $10 per share as a result of heavy promotion. All penny stocks are traded over the counter (OTC) or on the pink sheets.
The pink sheets
A daily publication compiled by the National Quotation Bureau with bid and ask prices of OTC stocks, including the market makers who trade them. Unlike companies on a stock exchange, companies quoted on the pink sheets system do not need to meet minimum requirements or file with the SEC. Pink sheets also refers to OTC trading. The pink sheets got their name because they were actually printed on pink paper.
Yellow Sheets
A U.S. bulletin that gives updated bid and ask prices as well as other information on OTC bonds
Similar to the pink sheets that track non-exchange traded OTC micro-cap stocks, the yellow sheets are a primary source of information for investors who track OTC bonds or fixed income securities
What is treasury stock?
Every company has an authorized amount of stock it can issue legally. Of this amount, the total number of shares owned by investors, including the company's officers and insiders (the owners of restricted stock), is known as the shares outstanding. The number available only to the public to buy and sell is known as the float.
Treasury stocks are shares that were once a part of the float and shares outstanding but were subsequently repurchased by the company and decommissioned. These stocks do not have voting rights and do not pay any distributions. A company can decide to hold onto treasury stocks indefinitely, reissue them to the public, or even cancel them.
Investment Bank
A financial intermediary that performs a variety of services. This includes underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients.
Iinvestment banker means A person representing a financial institution that is in the business of raising capital for corporations and municipalities. An investment banker may not accept deposits or make commercial loans. Investment bankers are the people who do the grunt work for IPOs and bond issues.
Capital Markets:-Markets where capital, such as stocks and bonds, are traded.
Capital:-Capital is an extremely vague term whose specific definition depends on the context in which it is used. In general, it refers to financial resources available for use (or)
1. Financial assets or the financial value of assets such as cash.
2. The factories, machinery and equipment owned by a business.
Capital Asset:-A long-term asset that is not bought or sold in the regular course of business.ex: land, buildings, machinery,
Stock Split
The dividing of a company's existing stock into multiple shares. In a 2-for-1 split, each stockholder receives an additional share for each share he or she holds.
In the U.K., a stock split is referred to as a "scrip issue", "bonus issue", "capitalization issue" or "free issue".
This is usually a good indicator that a company's share price is doing well. However, a stock split doesn't give you any more value, just twice as many shares
Stock Pick
A situation in which an analyst or investor uses a systematic form of analysis to conclude that a particular stock will make a good investment and, therefore, should be added to his or her portfolio. The position can be either long or short and will depend on the analyst or investor's outlook for the particular stock's price.
Stock picking can be a very difficult process because there is never a foolproof way to determine what a stock's price will do in the future. However, by examining numerous factors, an investor may be able to get a better sense of future stock prices than by relying on guesswork. Because forecasting is not an exact science, an investor or analyst who uses any forecasting technique should include a margin of error in the calculations.
Scrip
1. A written document that acknowledges a debt.
2. A temporary document representing a fraction of a share resulting from a split or spin-off. Scrips may be applied to the purchase of full shares.
3. Currency issued by a private corporation
1. Historically, companies short of cash have paid scrip dividends instead of cash dividends.
3. An example would be frequent flier miles
U.S. Savings Bonds
A U.S. government savings bond that offers a fixed rate of interest over a fixed period of time. Many people find these bonds attractive because they are not subject to state or local income taxes. These bonds cannot be easily transferred and are non-negotiable.
U.S. savings bonds are one of the safest types of investments because they are endorsed by the federal government and, therefore, are virtually risk free. Although these bonds do not earn much interest compared to the stock market, they do offer a less volatile source of income.
BOND
A debt investment with which the investor loans money to an entity (company or government) that borrows the funds for a defined period of time at a specified interest rate.
The indebted entity issues investors a certificate, or bond, that states the interest rate (coupon rate) that will be paid and when the loaned funds are to be returned (maturity date). Interest on bonds is usually paid every six months (semiannually). The main types of bonds are the corporate bond, the municipal bond, the Treasury bond, the Treasury note, the Treasury bill and the zero-coupon bond.
Treasury Bill - T-Bill
A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturities of one month (four weeks), three months (13 weeks) or six months (26 weeks).
T-bills are issued through a competitive bidding process at a discount from par, which means that rather than paying fixed interest payments like conventional bonds, the appreciation of the bond provides the return to the holder.
-For example, let's say you buy a 13-week T-bill priced at $9,800. Essentially, the U.S. government (and its nearly bulletproof credit rating) writes you an IOU for $10,000 that it agrees to pay back in three months. You will not receive regular payments as you would with a coupon bond, for example. Instead, the appreciation - and, therefore, the value to you - comes from the difference between the discounted value you originally paid and the amount you receive back ($10,000). In this case, the T-bill pays a 2.04% interest rate ($200/$9,800 = 2.04%) over a three-month period.
Treasury Bond - T-Bond
marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. The bonds make interest payments semi-annually and the income that holders receive is only taxed at the federal level.
Treasury bonds are issued with a minimum denomination of $1,000. The bonds are initially sold through auction in which the maximum purchase amount is $5 million if the bid is non-competitive or 35% of the offering if the bid is competitive. A competitive bid states the rate that the bidder is willing to accept; it will be accepted depending on how it compares to the set rate of the bond. A non-competitive bid ensures that the bidder will get the bond but he or she will have to accept the set rate. After the auction, the bonds can be sold in the secondary market
Treasury Note
A marketable, U.S. government debt security with a fixed interest rate and a maturity between one and 10 years. T-notes can be bought either directly from the U.S. government or through a bank. When buying from the government you can either put in a competitive or noncompetitive bid. With a competitive bid you specify the yield you want; however, this does not mean your bid
will be approved. With a noncompetitive bid is one where you accept whatever yield is determined at auction.
T-notes are extremely popular investments as there is a large secondary market that adds to their liquidity. Interest payments on the notes are made every six months until maturity. The income for interest payments are not taxable on a municipal or state level but are federally taxed.
Off-The-Run Treasuries
All Treasury bonds and notes issued before the most recently issued bond or note of a particular maturity. These are the opposite of "on-the-run treasuries".
-Once a new Treasury security of any maturity is issued, the previously issued security with the same maturity becomes the off-the-run bond or note.
Because off-the-run securities are less frequently traded, they typically are less expensive and therefore carry a slightly greater yield.
On-The-Run Treasuries
The most recently issued U.S. Treasury bond or note of a particular maturity. These are the opposite of "off-the-run treasuries".
When quoting the price or yield of a Treasury, all market commentary refers to the on-the-run issue.
The on-the-run bond or note is the most frequently traded Treasury security of its maturity. Because on-the-run issues are the most liquid, they typically are a little bit more expensive and, therefore, yield less than their off-the-run counterparts.
Banker's Acceptance – BA
A short-term credit investment created by a non-financial firm and guaranteed by a bank
-Acceptances are traded at a discount from face value on the secondary market. Banker's acceptances are very similar to T-bills and are often used in money market funds.
BAX Contract
A BAX contract is a short-term investment instrument that uses a Canadian banker's acceptance (BA) as its underlying security. The specific BA underlying the contract has a nominal value of C$1 million and a maturity of three months. The contracts are traded on the Montreal Derivatives Exchange.
Also known as a "banker's acceptance contract".
These contracts are great way for a company to hedge against a rise in interest rates. BAX contracts are becoming increasingly popular because they are a less expensive hedge than their over-the-counter competition, forward rate agreements. BAX contracts are also very liquid, flexible, and do not tie up credit lines.
Hedge
Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.
An example of a hedge would be if you owned a stock, then sold a futures contract stating that you will sell your stock at a set price, therefore avoiding market fluctuations.
Investors use this strategy when they are unsure of what the market will do. A perfect hedge reduces your risk to nothing (except for the cost of the hedge).
HedgeStreet
An internet-based, government-regulated market that allows traders to perform hedging activities or speculate on specific economic events. Binaries and futures contracts are provided on different markets including commodities, currencies, employment, inflation and other economic indicators.
HedgeStreet was developed to give the average investor the ability to profit from the outcomes of certain economic events. HedgeStreet benefits small investors by having small contract sizes at low prices. HedgeStreet is regulated by the Commodity Futures Trading Commission.
Delta Hedging
An options strategy that aims to reduce (hedge) the risk associated with price movements in the underlying asset by offsetting long and short positions. For example, a long call position may be delta hedged by shorting the underlying stock. This strategy is based on the change in premium (price of option) caused by a change in the price of the underlying security. The change in premium for each basis-point change in price of the underlying is the delta and the relationship between the two movements is the hedge ratio.
For example, the price of a call option with a hedge ratio of 40 will rise 40% (of the stock-price move) if the price of the underlying stock increases. Typically, options with high hedge ratios are usually more profitable to buy rather than write since the greater the percentage movement - relative to the underlying's price and the corresponding little time-value erosion - the greater the leverage. The opposite is true for options with a low hedge ratio.
Hedge Fund
An aggressively managed portfolio of investments that uses advanced investment strategies such as leverage, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark).
Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investments in hedge funds are liquid as they often require investors keep their money in the fund for a minimum period of at least one year.
For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is, they must earn a minimum amount of money annually and have a net worth of over $1 million, along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds for the super-rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies.
It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market with their ability to short the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk". In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.
According to SEC
Hedge fund" is a general, non-legal term used to describe private, unregistered investment pools that traditionally have been limited to sophisticated, wealthy investors. Hedge funds are not mutual funds and, as such, are not subject to the numerous regulations that apply to mutual funds for the protection of investors — including regulations requiring a certain degree of liquidity, regulations requiring that mutual fund shares be redeemable at any time, regulations protecting against conflicts of interest, regulations to assure fairness in the pricing of fund shares, disclosure regulations, regulations limiting the use of leverage, and more.
Hedged Tender
A strategy in a tender offer where an investor short sells a portion of the shares he or she owns. This strategy is used to protect against the risk of loss in the event that the tender offer does not go through
For example, imagine a stock was trading at $30, and there was a tender offer for $40 per share. A hedged tender would attempt to lock in the $40 per share even if the offer does not go through.
Hedgelet
A simplified derivative instrument that allows investors to hedge or speculate on economic events such as housing prices, commodity prices, interest rates, currencies and economic indicators.
The price for a hedgelet contract is based on the prevailing market price determined by participants in the market. Every contract has the same defined payout scheme: $10 for a correct contract and $0 for an incorrect one. Each hedgelet contract is set so that investors must make a decision on whether an economic event will occur or not occur.
-For example, on a "Crude Oil > $64" contract an investor can either choose Yes (oil will be more than $64 at expiration) or No (oil will be less than $64 at expiration). If the investor purchases one Yes "Crude Oil > $64" contract for $2, and crude oil ends at $80 when the contract expires, the investor will receive $10 - an $8 profit. However, if the price of crude oil ends at less than $64, the contract will be worthless and the investor will lose the initial $2 investment.
Hedge Ratio
1. A ratio comparing the value of a position protected via a hedge with the size of the entire position itself.
2. A ratio comparing the value of futures contracts purchased or sold to the value of the cash commodity being hedged
1. Say you are holding $10,000 in foreign equity, which exposes you to currency risk. If you hedge $5,000 worth of the equity with a currency position, your hedge ratio is 0.5 (50 / 100). This means that 50% of your equity position is sheltered from exchange rate risk.
2. The hedge ratio is important for investors in futures contracts, as it will help to identify and minimize basis risk
Naked Position
A securities position that is not hedged from market risk. Both the potential gain and the potential risk are greater when a position is naked instead of covered (a covered position is hedged from market risk).
If an investor simply holds 500 shares of Ford, he or she has a naked position in Ford. If the investor wanted to cover this position, he or she could buy put option contracts, which would help protect against downward movements in the price of Ford shares.
Whether to have a naked position is rarely a concern for most small investors, but it is a concern for large investment holders and institutions.
Cramer Bounce
The sudden overnight appreciation of a stock's price following it being recommended by Jim Cramer on his CNBC show, "Mad Money". This increase in price can be attributed to investors who buy stocks after seeing Cramer's recommendations.
This price increase is named due to the nature of how a stock's price can "bounce up" following Jim Cramer's recommendation.
This effect is fairly significant in certain classes of stock. For example, one study entitled, "Is the Market Mad? Evidence from Mad Money". released by Northwestern University in March 2006 showed that for smaller stocks the overnight increase can be over 5%.
This abnormal increase lasts only for about 12 days, where upon the stock's price retreats back to its pre-recommended price; assuming no other news has been released.
This is one instance where it can be argued that irrational investors can cause a significant effect upon a stock's price.
Real Estate Investment Trust - REITA security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages.
REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
Equity REITs: Equity REITs invest in and own properties (thus responsible for the equity or value of their real estate assets). Their revenues come principally from their properties' rents.
Mortgage REITs: Mortgage REITs deal in investment and ownership of property mortgages. These REITs loan money for mortgages to owners of real estate, or purchase existing mortgages or mortgage-backed securities. Their revenues are generated primarily by the interest that they earn on the mortgage loans.
Hybrid REITs: Hybrid REITs combine the investment strategies of equity REITs and mortgage REITs by investing in both properties and mortgages.
Individuals can invest in REITs either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specializes in public real estate. An additional benefit to investing in REITs is the fact that many are accompanied by dividend reinvestment plans (DRIPs). Among other things, REITs invest in shopping malls, office buildings, apartments, warehouses and hotels. Some REITs will invest specifically in one area of real estate - shopping malls, for example - or in one specific region, state or country. Investing in REITs is a liquid, dividend-paying means of participating in the real estate market.
Share Capital
Funds raised by issuing shares in return for cash or other considerations. The amount of share capital a company has can change over time because each time a business sells new shares to the public in exchange for cash, the amount of share capital will increase. Share capital can be composed of both common and preferred shares.
Also known as "equity financing".
The amount of share capital a company reports on its balance sheet only accounts for the initial amount for which the original shareholders purchased the shares from the issuing company. Any price differences arising from price appreciation/depreciation as a result of transactions in the secondary market are not included.
For example, suppose ABC Inc. raised $2 billion from its initial public offering. Over the next year, the total value of its shares increases to $5 billion. In this case, the value of the share capital is still only $2 billion because ABC Inc. had received only $2 billion from the sale of its securities to the investing public.
Swing Trading
A style of trading that attempts to capture gains in a stock within one to four days
2.IP--To find situations in which a stock has this extraordinary potential to move in such a short time frame, the trader must act quickly. This is mainly used by at-home and day traders. Large institutions trade in sizes too big to move in and out of stocks quickly. The individual trader is able to exploit the short-term stock movements without the competition of major traders. Swing traders use technical analysis to look for stocks with short-term price momentum. These traders aren't interested in the fundamental or intrinsic value of stocks but rather in their price trends and patterns.
Tick Index
The number of stocks trading on an uptick minus the number of stocks trading on a downtick
2.IP--This is a very short-term indicator. A positive tick index is good (the higher the better).
Stock Screener
A tool investors can use to filter stocks given certain criteria of their choice.
2.IP__By using a stock screening tool an investor is able to follow a strict set of criteria that he or she requires prior to investing in a company. For example, an investor could screen stocks by entering the following criteria: "listed on the NYSE", "in the telecommunications industry", "has a P/E ratio between 15-25", and "has an annual EPS growth of at least 15% for the past three years". The screener would then produce a list of stocks that displayed all of these attributes. In this example stocks are screened by using only four criteria; however, you can screen stocks by as many criteria as the particular screener you are using will allow.
The stock screener has replaced many days' worth of research with a few clicks of a mouse.
Corporation
A legal entity that is separate and distinct from its owners. Corporations enjoy most of the rights and responsibilities that an individual possesses; that is, a corporation has the right to enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets and pay taxes.
The most important aspect of a corporation is limited liability. That is, shareholders have the right to participate in the profits, through dividends and/or the appreciation of stock, but are not held personally liable for the company's debts.
Corporations are often called "C Corporations".
2.IP-- A corporation is created (incorporated) by a group of shareholders who have ownership of the corporation, represented by their holding of common stock. Shareholders elect a board of directors (generally receiving one vote per share) who appoint and oversee management of the corporation. Although a corporation does not necessarily have to be for profit, the vast majority of corporations are setup with the goal of providing a return for its shareholders. When you purchase stock you are becoming part owner in a corporation.
DERIVATIVES
What are Derivatives ?
The term “Derivative” indicates that it has no independent value, i.e. its value is entirely “derived” from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else.
In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities.
A derivative is a financial instrument that derives its value from the value of another financial instrument (called the underlying). The underlying instrument could be an asset, an interest rate, an exchange rate, or a commodity or any other event or thing specified in advance by the contracting parties. A derivative is a contract between two parties that specifies conditions, in particular, dates and the resulting values of underlying variables, under which settlements or payoffs are to be made between the parties. A derivative therefore has the following features:
• It is a contract between two parties
• It has specified conditions as to settlement
• It derives its value from the value of another instrument called the underlying
With Securities Laws (Second Amendment) At,1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, as:-
A Derivative includes:
(a) a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;
(b) a contract which derives its value from the prices, or index of prices, of underlying
securities;
Types of derivatives
Theoretically, since a derivative is a contract between two parties, there can be an infinite number of derivatives possible depending on the terms of contract between the parties. However, in general, the following are the basic types of derivatives:
Forwards
A forward contract is an agreement to buy or sell an asset at a certain time in the future for a certain price (the delivery price). It can be contrasted with a spot contract, which is an agreement to buy or sell immediately. The typical usage of a forward would be to hedge the value of foreign currency denominated assets and liabilities. However, forwards can also be used for speculation. The following terms are commonly associated with forward contracts: (refer Ex:-1)
Futures
A legally binding agreement to buy or sell the underlying security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract. On expiry, futures can be settled by delivery of the underlying asset or cash. Cash settlement entails paying/receiving the difference between the price at which the contract was entered and the price of the underlying asset at the time of expiry of the contract.(refer Ex:-2)
Difference between Forwards and Futures
Futures are more standardized forms of forward contracts and mostly operate in organized markets. While it is possible to have a forward contract for any commercial transaction, futures are normally exchange-traded. Futures contracts are highly uniform contracts that specify the quantity and quality of the good that can be delivered, the delivery date(s), the method for closing the contract, and the permissible minimum and maximum price fluctuations permitted in a trading day.
The basic nature of a forward and future, in a strict legal sense, is the same, with the difference that futures are market-driven organized transactions. As they are exchange-traded, the counter party in a futures transaction is the exchange. On the other hand, a forward is mostly an over-the-counter transaction (OTC) and the counter party is the contracting party. Futures market are normally marked to market on a settlement day, which could even be daily, whereas forward contracts are settled only at the end of the contract. So the element of credit risk is far higher in case of forward contracts.
Option
Option Contract
A type of Derivatives Contract which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a pecified period.
The buyer / holder of the option purchases the right from the seller/writer for a consideration Which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc.
Securities Contracts (Regulations) Act,1956 ‘options in securities’ has been defined as “option in securities” means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities;
An Option to buy is called Call option and option to sell is called Put option. Further, if an option that is exercisable on or before the expiry date(at anytime) is called American option and one that is exercisable only on expiry date, is called European option. The price at which the option is to be exercised is called Strike price or Exercise price.
(Refer for Ex:-3)
Swaps
In a swap, both the parties exchange recurring payments with the idea of exchanging one stream of payments for another. A typical usage is a swap of fixed interest rates with floating rates, or rates floating with reference to one basis to another basis. The basic types of swaps are interest rate swaps, currency swaps, basis swaps, credit swaps etc.
a) Interest rate swap
A plain-vanilla interest rate swap is an exchange of a series of fixed interest payments for a series of floating interest payments, fluctuating with LIBOR (London inter bank offer rate). The fixed rate of interest is often quoted as a spread over the current US Treasury security of the desired maturity and is called the swap rate. Normally, the floating rate paid at the end of each period is based on LIBOR at the beginning of the period. The times at which the floating rates are established are called the reset dates. The two sides of the swap are called the fixed leg and floating leg; and the life of a swap is called its tenor. In this case, only the cash flows, not the principals, of the two types of debt are exchanged. So it is notional principal that measures the size of the swap.
For example, for five years, one counter-party (the buyer) agrees to pay a fixed rate of interest, say the coupons that would be received on $1,000,000 of principal of the current five-year Treasury note plus 65 basis points (.65%) in exchange (from the seller) for five years of semiannual floating rate payments equal to $1,000,000 paying LIBOR with six-month resets. Here, the notional principal is $1,000,000 and the tenor of the swap is five years.
b) Currency swap
In contrast to a plain-vanilla interest rate swap, a currency swap typically not only involves an exchange of coupon payments but also an exchange of principal. As an example of a typical situation, American Firm A would like to borrow pounds, and British Firm B wants to borrow dollars. Because it is better known in the US, Firm A can borrow dollars at a lower interest rate than Firm B, while Firm B, because it is better known in the UK, can borrow pounds at a lower interest rate than Firm A. So if Firm A borrows dollars in the US and Firm B borrows pounds in the UK, but then they swap their obligations, each firm can benefit from the other firm's superior borrowing rate in its domestic currency.
To be more specific, say Firm A wants to borrow £10,000,000 for two years, Firm B wants to borrow $16,000,000 for two years, and the current ($/£) pound exchange rate is 1.6. Assume that Firm A can borrow dollars at 8%, and Firm B can borrow pounds at 10%. The swap transactions that accomplish this are:
Firm A borrows $16m in its domestic US market and Firm B borrows 10m pounds in UK market. Firm A pays $16m to Firm B; and Firm B pays £10,000,000 to Firm A. At the end of first year, Firm A pays £10,000,000 X 0.1 = £1,000,000 to Firm B which Firm B in turn pays to its domestic lender and Firm B pays $16,000,000 x 0.08 = $1,280,000 to Firm A which in turn pays to its domestic lender. At the end of second year, Firm A pays £10,000,000 x .1 = £1,000,000 to Firm B which Firm B in turn pays to its domestic lender and Firm B pays $16,000,000 x .08 = $1,280,000 to Firm A which in turn pays to its domestic lender. Also at the end of second year, Firm A repays £10,000,000 to Firm B; Firm B repays $16,000,000 to Firm B and each firm in turn uses this to repay its domestic lenders.
Typically, the swap is set up so that its value, based on the current exchange rate is zero. Indeed, in our example, the initial value of the swap in dollars is $16,000,000 - 1.6 £10,000,000 = 0. Nonetheless, both counter-parties benefit from the swap because they end up borrowing at lower foreign interest rates than they could have on their own.
c) Credit swaps
Corporate bonds trade at a premium to the risk-free yield curve in the same currency. US Corporate Bonds trade at a premium (called a credit spread) to the US Treasury curve. The credit spread is volatile in and of itself and it may be correlated with the level of interest rates. For example, in a declining, low interest rate environment combined with strong domestic growth, we might expect corporate bond spreads to be smaller than their historical average. The corporate that has issued the bond will find it easier to service the cash flows of the corporate bond and investors will be hungry for any kind of premium they can add to the risk-free rate.
Imagine a fund manager who specializes in corporate bonds who has a view on the direction of credit spreads on which he would like to act without taking a specific position in an individual corporate bond or a corporate bond index. One way for the fund manager to take advantage of this view is to enter into a credit swap. Let's say that the fund manager believes that credit spreads are going to tighten and that interest rates are going to continue to decline.
He would then want to enter into a swap in which he paid the corporate yield at six-month intervals against receiving a fixed yield equal to the inception Treasury yield plus the corporate credit spread. That is to say, at the six-month reset for the tenor of the swap, the fund manager agrees to pay a cash flow determined to be equal to the current annual yield on some benchmark corporate bond or corporate bond index in consideration for receiving a fixed cash flow. This is an off-balance sheet transaction and the swap will typically have zero value at inception.
If corporate yields continue to fall (i.e. through a combination of a lower risk-free rate and a lower corporate credit spread than the one he locked in with the swap), he will make money. If corporate yields rise, he will lose money.
Caps, Floor and Collars
Caps, floors and collars are essentially options designed to shift the risk of an upward and/or downward movement in variables such as interest rates. These are normally linked to a notional amount and a reference rate.
For example, if some one wants to transfer the risk of interest rates going up, one will enter into a cap on a notional amount of say, USD 100 million, with the interest rate of 5.5%. Now if the interest rate increases to 6%, the cap holder will be able to claim a settlement from the cap seller, for the differential rate of 0.5% on the notional amount. If the interest does not go up, or rather declines, the option holder would have paid the premium, and there is no settlement. On the other hand, if some one expects the interest rate to go down which spells a risk to him, he would enter into a floor, which would allow him to claim a settlement if the interest rate falls below a particular strike rate.
Interest rate collar is the fixation of both a cap and floor, so that the payment will be triggered if the rate goes above the collar and below the floor.
Swaption
A swaption is an option on a swap. The option provides the holder with the right to enter into a swap at a specified future date at specified terms. This derivative has characteristics of an option and a swap. These types of derivatives are called multiple derivatives
What are Index Futures and Index Option Contracts ?
Futures contract based on an index i.e. the underlying asset is the index, are known as Index Futures Contracts. For example, futures contract on NIFTY Index and BSE-30 Index. These contracts derive their value from the value of the underlying index. Similarly, the options contracts, which are based on some index, are known as Index options contract. However, unlike Index Futures, the buyer of Index Option Contracts has only the right but not the obligation to buy / sell the underlying index on expiry. Index Option Contracts are generally European Style options i.e. they can be exercised / assigned only on the expiry date. An index, in turn derives its value from the prices of securities that constitute the index and is created to represent the sentiments of the market as a whole or of a particular sector of the economy (Sectoral Index).
By its very nature, index cannot be delivered on maturity of the Index futures or Index option contracts therefore, these contracts are essentially cash settled on Expiry.
What is the structure of Derivative Markets in India ?
Derivative trading in India can take place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative exchange/Segment function as a Self-Regulatory Organisation (SRO) and SEBI acts as the oversight regulator. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House, which is independent in governance and membership from the Derivative Exchange/Segment.
What is the regulatory framework of Derivatives markets in India ?
With the amendment in the definition of ‘securities’ under SC(R)A (to include derivative contracts in the definition of securities), derivatives trading takes place under the provisions of the S C (R) Act, 1956 and S EBI Act, 1992. Dr. L.C Gupta Committee constituted by SEBI had laid down the regulatory framework for derivative trading in India. SEBI has also framed suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lays down the provisions for trading and settlement of derivative contracts. The Rules, Bye-laws & Regulations of the Derivative Segment of the Exchanges and their Clearing Corporation/ House have to be framed in line with the suggestive Bye-laws. SEBI has also laid the eligibility conditions for Derivative Exchange/Segment and its Clearing Corporation/Hou se. The eligibility conditions have been framed to ensure that Derivative Exchange/Segment & Clearing Corporation/House provide a transparent trading environment, safety & integrity and provide facilities for redressal of investor grievances. Some of the important eligibility conditions are :
1 Derivative trading to take place through an on-line screen based Trading System.
2 The Derivatives Exchange/Segment shall have on-line surveillance capability to monitor positions, prices, and volumes on a real time basis so as to determarket manipulation.
3 The Derivatives Exchange/ Segment should have arrangements for dissemination of information about trades, quantities and quotes on a real time basis through atleast two information vending networks, which are easily accessible to investors across the country.
4 The Derivatives Exchange/Segment should have arbitration and investor grievances redressal mechanism operative from all the four areas / regions of the country.
5 The Derivatives Exchange/Segment should have satisfactory system of monitoring investor complaints and preventing irregularities in trading.
6 The Derivative Segment of the Exchange would have a separate Investor Protection Fund.
7 The Clearing Corporation/House shall perform full novation, i.e., the Clearing Corporation/House shall interpose itself between both legs of every trade, becoming the legal counterparty to both or alternatively should provide an unconditional guarantee for settlement of all trades.
8 The Clearing Corporation/House shall have the capacity to monitor the overall position of Members across both derivatives market and the underlying securities market for those Members who are participating in both.
9 The level of initial margin on Index Futures Contracts shall be related to the risk of loss on the position. The concept of value-at-risk shall be used in calculating required level of initial margins. The initial margins should be large enough to cover the one-day loss that can be encountered on the position on 99% of the days.
10 The Clearing Corporation/House shall establish facilities for electronic funds transfer (EFT) for swift movement of margin payments.
11 In the event of a Member defaulting in meeting its liabilities, the Clearing Corporation/House shall transfer client positions and assets to another solvent Member or close-out all open positions.
12 The Clearing Corporation/House should have capabilities to segregate initial margins deposited by Clearing Members for trades on their own account and on account of his client. The Clearing Corporation/House shall hold the clients’ margin money in trust for the client purposes only and should not allow its diversion for any other purpose.
13 The Clearing Corporation/House shall have a separate Trade Guarantee Fund for the trades executed on Derivative Exchange / Segment. Presently, SEBI has permitted Derivative Trading on the Derivative Segment of BSE and the F&O Segment of NSE.
What is minimum contract size ?
The Standing Committee on Finance, a Parliamentary Committee, at the time of recommending amendment to Securities Contract (Regulation) Act, 1956 had recommended that the minimum contract size of derivative contracts traded in the Indian Markets should be pegged not below Rs. 2 Lakhs. Based on this recommendation SEBI has specified that the value of a derivative contract should not be less than Rs. 2 Lakh at the time of introducing the contract in the market.
What is the lot size of a contract ?
Lot size refers to number of underlying securities in one contract. Additionally, for stock specific derivative contracts SEBI has specified that the lot size of the underlying individual security should be in multiples of 100 and fractions, if any, should be rounded of to the next higher multiple of 100. This requirement of SEBI coupled with the requirement of minimum contract size forms the basis of arriving at the lot size of a contract. For example, if shares of XYZ Ltd are quoted at Rs.1000 each and the minimum contract size is Rs.2 lacs, then the lot size for that particular scrips stands to be 200000/ 1000 = 200 shares i.e. one contract in XYZ Ltd. covers 200 shares. What is the margining system in the derivative markets ?
Two type of margins have been specified :
1 Initial Margin — Based on 99% VaR and worst case loss over a specified horizon, which depends on the time in which Mark to Market margin is collected.
2 Mark to Market Margin (MTM) — collected in cash for all Futures contracts and adjusted against the available Liquid Networth for option positions. In the case of Futures Contracts MTM may be considered as Mark to Market Settlement.
Dr. L.C Gupta Committee had recommended that the level of initial margin required on a position should be related to the risk of loss on the position. The concept of valueat- risk should be used in calculating required level of initial margins. The initial margins should be large enough to cover
the one day loss that can be encountered on the position on 99% of the days.
The recommendations of the Dr. L.C Gupta have been a guiding principle for SEBI in prescribing the margin computation & collection methodology to the Exchanges. With the introduction of various derivative products in the Indian securities Markets, the margin computation methodology, especially for initial margin, has been modified to address the specific risk characteristics of the product. The margining methodology specified is consistent with the margining system used in
developed financial & commodity derivative markets worldwide. The exchanges were given the freedom to either develop their own margin computation system or adapt the systems available internationally to the requirements of SEBI. A portfolio based margining approach which takes an integrated view of the risk involved in the portfolio of each individual client comprising of his positions in all Derivative Contracts i.e. Index Futures, Index Option, Stock Options and Single Stock Futures, has been prescribed. The initial margin requirements are required to be based on the worst case loss of a portfolio of an individual client to cover 99% VaR over a specified time horizon.
The Initial Margin is Higher of (Worst Scenario Loss +Calendar Spread Charges) or
Short Option Minimum Charge
The worst scenario loss are required to be computed for a portfolio of a client and is calculated by valuing the portfolio under 16 scenarios of probable changes in the value and the volatility of the Index/ Individual Stocks. The options and futures positions in a client’s portfolio are required to be valued by predicting the price and the volatility of the underlying over a specified horizon so that 99% of times the price and volatility so predicted does not exceed the maximum and minimum price or volatility scenario. In this manner initial margin of 99% VaR is achieved. The specified horizon is dependent on the time of collection of mark to market margin by the exchange. The probable change in the price of the underlying over the specified horizon i.e. ‘price scan range’, in the case of Index futures and Index option contracts are based on three standard deviation (3s ) where ‘s ’ is the volatility estimate of the Index. The volatility estimate ‘s ’, is computed as per the Exponentially Weighted Moving Average methodology. This methodology has been prescribed by SEBI. In case of option and futures on individual stocks the price scan range is based on three and a half standard deviation (3.5s ) where ‘s ’ is the daily volatility estimate of individual stock. For Index Futures and Stock futures it is specified that a minimum margin of 5% and 7.5% would be charged. This means if for stock futures the 3.5s value falls below 7.5% then a minimum of 7.5% should be charged. This could be achieved by adjusting
the price scan range.
The probable change in the volatility of the underlying i.e. ‘volatility scan range’ is fixed at 4% for Index options and is fixed at 10% for options on Individual stocks. The volatility scan range is applicable only for option products. Calendar spreads are offsetting positions in two contracts in the same underlying across different expiry. In a portfolio based margining approach all calendar-spread positions automatically get a margin offset. However, risk arising due to difference in cost of carry or the ‘basis risk’ needs to be addressed. It is therefore specified that a SUPPLEMENT FOR SECURITIES LAWS & REGULATION OF FINANCIAL MARKETS 61 calendar spread charge would be added to the worst scenario loss for arriving at the initial margin. For computing calendar spread charge, the system first identifies spread positions and then the spread charge which is 0.5% per month on the far leg of the spread with a minimum of 1% and maximum of 3%. Further, in the last three days of the expiry of the near leg of spread, both the legs of the calendar spread would be treated as separate individual positions.
In a portfolio of futures and options, the non-linear nature of options make short option positions most risky. Especially, short deep out of the money options, which are highly susceptible to, changes in prices of the underlying. Therefore a short option minimum charge has been specified. The short option minimum charge is 5% and 7.5% of the notional value of all short Index option and stock option contracts respectively. The short option minimum charge is the initial margin if the sum of the worst –scenario loss and calendar spread charge is lower than the short option minimum charge. To calculate volatility estimates the exchange are required to use the methodology specified in the Prof J.R Varma Committee Report on Risk Containment Measures for Index Futures. Further, to calculated the option value the exchanges can use standard option pricing models - Black-Scholes, Binomial, Merton, Adesi-Whaley. The initial margin is required to be computed on a real time basis and has two components:-
1 The first is creation of risk arrays taking prices at discreet times taking latest prices and volatility estimates at the discreet times, which have been specified.
2 The second is the application of the risk arrays on the actual portfolio positions to compute the portfolio values and the initial margin on a real time basis. The initial margin so computed is deducted form the available Liquid Networth on a real time basis.
Mark to Market Margin
Options – The value of the option are calculated as the theoretical value of the option times the number of option contracts (positive for long options and negative for short options). This Net Option Value is added to the Liquid Networth of the Clearing member. Thus MTM gains and losses on options are adjusted against the available liquid networth. The net option value is computed using the closing price of the option and are applied the next day.
Futures – The system computes the closing price of each series, which is used for computing mark to market settlement for cumulative net position. This margin is collected on T+1 in cash. Therefore, the exchange charges a higher initial margin by multiplying the price scan range of 3s & 3.5s with square root of 2, so that the initial margin is adequate to cover 99% VaR over a two days horizon.
MARGIN COLLECTION
Initial Margin –
is adjusted from the available Liquid Networth of the Clearing Member on an online real time basis.
Marked to Market Margins--
Futures contracts : The open positions (gross against clients and net of proprietary/ self trading) in the futures contracts for each member is marked to market to the 62 SUPPLEMENT FOR SECURITIES LAWS & REGULATION OF FINANCIAL MARKETS daily settlement price of the Futures contracts at the end of each trading day. The daily settlement price at the end of each day is the weighted average price of the last half an hour of the futures contract. The profits / losses arising from the difference between the trading price and the settlement price are collected / given to all the clearing members.
Option Contracts : The marked to market for Option contracts is computed and collected as part of the SPAN Margin in the form of Net Option Value. The SPAN Margin is collected on an online real time basis based on the data feeds given to the system at discrete time intervals.
Client Margins
Clearing Members and Trading Members are required to collect initial margins from all their clients. The collection of margins at client level in the derivative markets is essential as derivatives are leveraged products and non-collection of margins at the client level would provided zero cost leverage. In the derivative markets all money paid by the client towards margins is kept in trust with the Clearing House/ Clearing corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilised towards the default of the member. Therefore, Clearing members are required to report on a daily basis details in respect of such margin amounts due and collected from their Trading members / clients clearing and settling through them. Trading members are also required to report on a daily basis details of the amount due and collected from their clients. The reporting of the collection of the margins by the clients is done electronically through the system at the end of each trading day. The reporting of collection of client level margins plays a crucial role not only in ensuring that members collect margin from clients but it also provides the clearing corporation with a record of the quantum of funds it has to keep in trust for the clients.
What are the position limits in Derivative Products ?
The position limits specified are as under –
Client / Customer level position limits :
For index based products there is a disclosure requirement for clients whose position exceeds 15% of the open interest of the market in index products. For stock specific products the gross open position across all derivative contracts on a particular underlying of a customer/client should not exceed the higher of –
1 1% of the free float market capitalisation (in terms of number of shares).
or
2 5% of the open interest in the derivative contracts on a particular underlying stock (in terms of number of contracts).
This position limits are applicable on the combine position in all derivative contracts on an underlying stock at an exchange. The exchanges are required to achieve client level position monitoring in stages. SUPPLEMENT FOR SECURITIES LAWS & REGULATION OF FINANCIAL MARKETS 63
Trading Member Level Position Limits:
For Index products Higher of the following :
The Trading Member position limits are Rs. 100 crore ( or ) 15% of the open interest.
For stock specific products Higher of the following :
The trading member position limit are at 7.5% of the open interest ( or ) Rs 50 crore
for derivative contract in a particular underlying at an exchange.
It is also specified that once a member reaches the position limit in a particular underlying then the member shall be permitted to take only offsetting positions (which result in lowering the open position of the member) in derivative contracts on that underlying. In the event that the position limit is breached due to the reduction in the overall open interest in the market, the member shall be permitted to take only offsetting positions (which result in lowering the open position of the member) in derivative contract in that underlying and no fresh positions shall be permitted. The position limit at trading member level are required to be be computed on a gross basis across all clients of the Trading member.
Market wide limits
There are no market wide limits for index products. However for stock specific products the market wide limit of open positions (in terms of the number of underlying stock) on an option and futures contract on a particular underlying stock would be lower of –
3 30 times the average number of shares traded daily, during the previous calendar month, in the cash segment of the Exchange,
(or )
4 10% of the number of shares held by non-promoters i.e. 10% of the free float, in terms of number of shares of a company.
It is further specified that when the total open interest in a contract reaches 80% of the market wide limit in that contract, the exchanges would double the price scan range and volatility scan range specified. The exchanges are required to continuously review the impact of this measure and take further proactive risk containment measures as may be appropriate, including, further increases in the scan ranges and levying additional margins.
What measures have been specified by SEBI to protect the rights of investor in the Derivative Market ?
The measures specified by SEBI include:
1. Investor’s money has to be kept separate at all levels and is permitted to be used only against the liability of the Investor and is not available to the trading member or clearing member or even any other investor.
2. The Trading Member is required to provide every investor with a risk disclosure document which will disclose the risks associated with the derivatives trading so that investors can take a conscious decision to trade in derivatives
3. Investor would get the contract note duly time stamped for receipt of the order and execution of the order. The order will be executed with the identity of the client and without client ID order will not be accepted by the system. The investor could also demand the trade confirmation slip with his ID in support of the contract note. This will protect him from the risk of price favour, if any, extended by the Member.
4. In the derivative markets all money paid by the Investor towards margins on all open positions is kept in trust with the Clearing House/ Clearing corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilised towards the default of the member. However, in the event of a default of a member, losses suffered by the Investor, if any, on settled / closed out position are compensated from the Investor Protection Fund, as per the rules, bye-laws and regulations of the
derivative segment of the exchanges.
* Reproduced from the website of SEBI (www.sebi.gov.in)
EXAMPLES:
Ex:- 1. Forward
Spot price: Present price of the commodity (underlying).
Forward price: Future price of the commodity (underlying) as quoted today
(The forward price is usually more than the spot price)
Trade date: Date of entering into the forward contract.
Settlement date: Date on which the contract has to be settled by making payment of cash or delivery of asset/underlying
(The forward price is usually more than the spot price)
Forward premium/discount: Forward premium/discount is the excess/shortfall of the forward price over the spot price expressed as a percentage of the spot price over the period of the forward contract. Forward premium/discount is calculated as
P/D = {(Forward rate – Spot rate)/Spot rate}*(360/days to maturity)*100.
= {(F-S)/S}*}*(360/days to maturity)*100
Forward contracts are generally quoted for 1, 3 or 6 month durations in which case the days to maturity would be 30, 90 and 180 respectively. If the above result is negative, then obviously the forward price is quoting at a discount to the spot price.
If a three month forward contract for $ is trading at 48.50 and the spot rate is 48.10, then the premium is
= {(48.50 – 48.10)/48.10}*(360/90)*100. = 3.32%
.
Ex:- 2. Futures
Let us consider the following example of a futures contract
A farmer estimates in November that he will need 5,000 bales of cotton in February. The finished product is not sold forward. He buys futures contracts for delivery in February. Assuming that each contract is for 1,000 bales of cotton, he buys 5 contracts at $3 per bale. Assume the closing price of cotton futures (Feb series) was $2.8 in December, which is also the financial year close for the farmer. Further, in February, the farmer purchased his bales at spot and closed his futures contracts at $3.10 per bale.
The change in value of his futures contracts in December was
=(2.8-3.0)*1,000*5 = $1,000 loss
The change in value in February would be: =(3.1-2.8)*1,000*5 = $1,500 gain
Note that this is an example of a hedge on an anticipated future transaction. There was no existing asset or liability to be hedged. If the transaction qualifies as a hedge, then for the year ended December, the loss of $1,000 would not be recognized in current income. Rather it would be shown in other comprehensive income and taken to income when the transaction actually occurs, that is in February when the cotton is actually bought. In February, therefore, if the transaction takes place as anticipated, the net gain of $500 would be reduced from the cost of the cotton purchased.
Ex:- 3. Options
Consider a simple example of an option contract between two persons, A and B. A buys a call option written by B to acquire 100 shares of Microsoft at a strike price of $50/share, Therefore A has a right but not an obligation to buy shares of Microsoft from B at the price of $50/share. Further, the option can be exercised at any time on or prior to the expiration date (American style option). A pays B a premium of $1,000 for acquiring the option. This is A’s cost of the option. The different pay-offs based on market price of the Microsoft share on the date of exercise are summarized below. For the sake of simplicity, we assume the exercise date to be the expiration date of the contract.
Scenario 1
Market price on expiration $50, A will not exercise the option since the market price and strike price are equal. A loses the premium he paid and B pockets the premium received by him.
Scenario 2
Market price on expiration $55, A will exercise the option, buy the shares from B at $50 and sell them in the market for $55. Note that he still makes a loss since the excess of market price over strike price does not cover the premium he has paid for the option fully. B has to buy from the market at $55 and sell to A at $50, thereby partly losing the premium he received on writing the option.
Scenario 3
Market price on expiration $60, A will exercise the option, buy the shares from B at $50 and sell them in the market for $60. At this point A breaks even since the excess of market price over strike price exactly equals the premium paid by him for acquiring the option. B also breaks even at this point.
Scenario 4
Market price on expiration $65, A will exercise the option, buy the shares from B at $50 and sell them in the market for $65. At this point A makes a profit of $500 after meeting his premium cost. B makes a loss equal to A’s gain.
Inferences:
An option is a zero sum game, i.e. the gain of one player is exactly equal to the loss of the other player. An option holder exercises the option only when the option is in the money i.e. he will make a profit. At the money is a break-even position and out of the money is a loss position in an option.
The option buyer’s gain is unlimited and his loss is limited, the reverse is the position of the option writer or seller.
When you buy a call, you acquire the right but not the obligation to purchase, when you buy a put, you acquire the right but not the obligation to sell. Conversely, when you sell a call, you incur an obligation to sell and when you sell a put, you incur an obligation to buy if the buyer of the option exercises the option.
Exotic options
The above example was of a so-called "plain vanilla options", the simple puts and calls that are priced in the exchange-traded markets and the over-the-counter markets for equities, fixed income, foreign exchange and commodities. Exotic options are either variations on the payoff profiles of the plain vanilla options or they are wholly different kinds of products with optionality embedded in them. We shall discuss below some types of exotic options.
Barrier Options
A barrier option is like a plain vanilla option but with one exception: the presence of one or two trigger prices. If the trigger price is touched at any time before maturity, it causes an option with pre-determined characteristics to come into existence (in the case of a knock-in option) or it will cause an existing option to cease to exist (in the case of a knock-out option).
There are single barrier options and double barrier options. A double barrier option has barriers on either side of the strike (i.e. one trigger price is greater than the strike and the other trigger price is less than the strike). A single barrier option has one barrier that may be either greater than or less than the strike price. Why would we ever buy an option with a barrier on it? Because it is cheaper than buying the plain vanilla option and we have a specific view about the path that spot will take over the lifetime of the structure.
Intuitively, barrier options should be cheaper than their plain vanilla counterparts because they risk either not being knocked in or being knocked out. A double knockout option is cheaper than a single knockout option because the double knockout has two trigger prices either of which could knock the option out of existence. How much cheaper a barrier option is compared to the plain vanilla option depends on the location of the trigger.
Look back options
A look back call gives the owner the right to buy the underlying at expiry at a strike price equal to the lowest price that spot traded over the life of the option. A look back put gives the owner the right to sell the underlying at expiry at a strike price equal to the highest price that spot traded over the life of the option. Look backs are expensive. Anything that gives you the right to pick the top or the bottom is going to be costly. As a general rule of thumb, some people like to think that look back prices are in the ballpark if they are roughly twice the price of an at-the-money straddle.
Compound Options
A compound option is an option-on-an-option. It could be a call-on-a-call giving the owner the right to buy in 1 month's time a 6 month 1.55 US dollar call/Canadian dollar put expiring 7 months from today (or 6 months from the expiry of the compound). It could be a put-on-a-call giving the owner the right to sell in 1 month's time a 6 month 1.55 US dollar call/Canadian dollar put expiring 7 months from today.
DERIVATIVES ;
HISTORY ;
Exchange traded financial derivatives were introduced in India in june 2000 at the two major stock exchanges,NSE and bse. There are various contracts currently traded on these exchanges.
National commodity & derivatives exchange limted (ncdex)started its operation s in December 2003 to provide a platform for commodities trading
The derivatives market in india has grown exponentially,especially at nSE.Nse has around 99.5%OF THER MARKET share of “exchange traded financial derivatives “ market in India.
MEANING ;
IN finance a security whose price Is dependent upon or derived from one or more underlying assets is called a derivative. The derivatives itself is merely a contract between two or more parties.its value is determined by fluctuations in ther underlying assets . ther morst common underlying assets include stock, bonds, commodities. Currencies , interest rates and market indexes.
Futures contracts,forward contracts,options and swaps are the most common types of derivatives. Because derivatives are just contracts just about anything can be used as an underlying asset. There are even derivatives based on weather data, suchn as the amount of rain or the number of sunny days in a particular region
Ex ; forwards, futures, options swaps
FEATURES :
1 A derivative does not have any physical existence but emerges out of a contract between two parties
2 It does not have any value of it own but its value in turn depends on the value of other physical assets which are called ther underlying assets
3 These underlying assets may be shares,debentures,commodities,currencies or short term or long term securities etc
4 The current price of an assets is detemined by the market demand for and supply of the assets however the future price of an asset typically remains unkown.
PURPOSE ;
The principal reasons why derivatives are used are ;
1 To hedge risks.
2 To reflects a view on the future direction of the market
3 To lock in an arbitrage profit
FORWARD CONTRACT ;
A forward contract is an agreement between two parties whereby one party agrees to buy from or sell to, the other party an asset at a future time for an agreed price (usually to as delivery price ). the parties to forward contracts may be individuals, corporates or finanacial institutions. At maturity, a forward contract is settled by delivery of the assets by the seller to the buyer in return for payment of delivery price.
FEATURES :
1 A forward contract is for an agreed amount between the parties to the contract.
2 The price of the commodity is fixed on the date of contract itself.
3 The delivery of the goods has to be made on a certain date in future
FUTURE CONTRACT ;
A future contract , like a forward contract, is an agreement between two parties to buy or sell an assets at a certain date in future for an agreed price. Future contact are normally traded on an exchange. To make trading possible, the exchange specifies certain standardized features of the contract. The exchange may also provide for guarantee mechanism to ensure that eack party to the contract meets its obligations and, consequently, risk from default by parties is minimized.
FEATURES ;
1 The future contract is a standard contract. It is done in contract size, multiples of which are specified by the stock exchange.
2 The future contract has a standard maturity date. It matures on specified day of a particular month. For example, last thursday of marchm, june, September.
FUTURE CONTRACT TRADING
The two types of futures traded in India are Equity Index Futures and Equity Stock Futurers. The following table summarizes about them:
EQUITY INDEX FUTURE :
Meaning:- It is a contract to busy or sell an equity index at an agreed amount on a specified future date.
Underlying asset:- Equity Index Ex – S & PCNX Nifty or BSE Sensex
Mode of settlement:- No physical delivery of equity index. Payment in cash for the difference between the price agreed in the contract and the value of the index on the maturity date.
EQUITY STOCK FUTURE :
Meaning:- It is a contract to buy or sell a security at an agreed amount on a specified future date.
Underlying asset:- Security Ex – Equity Shares
Mode of settlement:- Either physical delivery of shares or payment in cash for the difference between the contract price & the value of security at the time of settlement.
MARGIN
Margin refers to the money which is paid by clearing or trading members to the clearing corporation who in turn collect margin from their respective obligations under the contract. Margins can be paid by cash or be provided by way of a bank guarantee.
AT the time of entering into a contract every client is required to pay an initial margin to the clearing members. This initial margin is ‘marked to market’ on a daily basis in cash i.e., clients pay the deficit margin to or receive the excess margin from the clearing member on daily basis.
OPTION
Option is a contract, which gives the buyer/holder the right, but not obligation to buy or sell a specified underlying asset at a pre-determined price.
CALL-OPTION
Call option is an option to buy the specified underlying asset on or before the expiry date.
PUT –OPTION
Put option is an option to sell the specified underlying asset on or before the expiry date.
OPTION TRADING
EQUITY INDEX OPTION
Meaning :- It is a type of derivative instrument whereby a person gets the right to buy or sell an agreed number of Units of equity index on a specified future date.
Underlying asset:- Equity Index Ex – S & P CNX Nifty or BSE sensex
Time of settlement :- Buyer can exercise his right on the day on which the option expires.
Mode of settlement :- No physical delivery of equity index. Payment in cash of the difference between the strike price and the value of index on the maturity date.
EQUITY STOCK OPTION
Meaning :- It is a type of derivative instrument whereby a person gets the right to buy or sell an agreed number of units of a security on or before specified date.
Underlying asset:- Shares of a company. Ex – Securities listed on stock exchange
Time of settlement :- Buyer can exercise his right at any time before or on the date on which option expires.
Mode of settlement :- Either physical delivery of shares or payment in cash for the difference between the strike price and the value of shares at the time of settlement.
STRATEGIES:
i. Straddle : Simultaneous purchase or sale of options with same expiry date & same strike price.
a) Long straddle : Purcahse of call & put option with same strike price & maturity period.
b) Short straddle : Sale of call & put option with same strike price & maturity period.
ii. Strangle : Simultaneous purchase or sale of options with same expiry date & different strike price.
a) Long strangle : Purchase of call & put option with different strike price & maturity period.
b) Short strangle : Sale of call & put option with different strike price & maturity period.
III . spread ; simultaneous buying of an option & selling of another in respect of same underlying assets.
a) vertical spread ; puchase of call option and sellof call option with same maturity period but with different strike prices
b) horizontical spread : purchase of call option and sale of call option with different maturity periods but with same strike price
c) diagonal spread ; purchase of call option and sale of call option with different maturity periods but and defferent strike prices
d) bullish spread : purchase of one call option with low strike price and sale of another call option with high strike price
e) bearish spread : purchase of one call option with high strike price and sale of another call option with low strike price
f) butterfly spread :
1 Long butterfly : purchase of 2 call options with average strike price, but sale of one call option with low strike price and another with high strike price.
2 Short butterfly : sale of 2 call options with average strike price, but purchase of one call option with low strike price and another with high strike price
IV . STRIP : puchase of one call option and two put opions with same maturity period and strike price.
(opted when prices are likely to be decreased)
V . strap : purchase of one put option and two call options with same maturity period and strike price.
(opted when prices are likely to be increased)
swaps :
swaps is the act of exchanging or substituting . a financial contractual agreement between two parties to exchange (swap) a set of payment that one party owns for a set of payments owned by the party. In general the exchange of one asset or liabilities for a similar asset or liability for the purpose of lengthening or shortening maturities, or raising or lowering coupon rates, to maximize revenue or minimize financing cost.
INTEREST RATE SWAP : AN interest rate swap (irs) is a contractual arrangement between two counter partner who agree to exchange interest payments on a defined principal amount for a fixed period of time. In an IRS, the principal amount is never exchanged and therefore is reffered to as a “notional” principal amount. The most popular interest rate swaps are fixed-for-floating swaps under which cash flows of a fixed rate loan are exchanged for those of a floating rate loan .
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1.Production:
1-From annual reports, there is lot of information available of parent and child companies and consolidated financial statements. Finding the correct one to process and to useful for the analysis. Mostly always we prefer consolidated financial statements for measuring the overall financial position and profits of the company or group.
2.For analysis, the statements may b given in horizontal or vertical analysis or both.based on that we can compare the figures of last base year and can evaluate the performance.
3. In the part of analysis we mostly use some tools which are useful as
comparative, common-size, trend analysis and funds flow statements, and Ratio Analysis.
4. We do the Interpretation and analysis based on the information available from the above tools useful for decision making.
5. We give the more importance for the latest information For Example, It is better to analyse the statements of 2007 or 2006 compare to other old reports like 1999,2000 etc.
6. We also work with the reports which are in other than English language by using some translation tools recommended by the company. For us,it is systran clients server.
7. We also have some special attention of IPO s and client request we do the all processes from all department and we update in website within 24 hours.
8. The reports are captured from SEC,SEDAR,GLOBAL and other stock exchanges of related countries.
9. We also use some separate software for the annual reports which are in image format. These softwares are Abby 8.0 and 7.0 and Omni professional reader and rediaries tools.
10. We also work with access tables which are useful for maintaining the data in table format and to avoid the repeatations.
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