Important terms (shares and trading): Part 2

In this post, some of the other important terms related to shares and the stock exchange have been taken up for discussion.

Derivatives

A derivative is a contract whose value depends on the underlying asset. Futures, forwards and options are all of derivatives. Now, let us briefly understand them

Forwards and futures

A forward contract is a customised agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. For example, A and B enter into an agreement on 1/06/2011 under which A will buy from B 12 mangoes on 1/07/2011 at Rs. 5 each.

Futures are nothing but a special type of forward contracts because they are standardised in nature and are traded in stock exchanges.

Options

An Option is a contract which gives the buyer the right, but not an obligation, to buy or sell the underlying at a stated date and at a stated price (also called Strike Price). The buyer of an option pays the “option premium” to the seller of the option to get the right to exercise his option. The writer of an option is obliged to sell/buy the asset if the buyer exercises it on him. It should be noted that the option premium is forfeited in case the option is not exercised and is adjusted in the price initially decided if the option is exercised.

Options can be classified as American options and European options. In the former case the option can be exercised on any day up to the expiry date, whereas in the latter case it can be exercised only on the expiry date. The options traded in India are all American options.

Options are of two types - Calls and Puts options:

‘Calls’ give the buyer the right to buy a given quantity of the underlying asset; and ‘Puts’ give the buyer the right to sell a given quantity of underlying asset (at a given price on or before a given future date).

A call option is exercised if the market value of the asset is more than the price agreed upon. On the other hand a put option is exercised if the market value of the asset is less that the price agreed upon (adjusted for the premium in both cases).

The concept of leverage

Time and again we come across the term leverage in newspapers and magazines (with respect to shareholders). Leverage is the benefit that the shareholders get due to the loan taken by the company in the form of debentures, bonds, etc.

We shall understand the concept of leverage with the help of the following example:

There are two companies A and B, which have a profit of Rs 100,000 each. Both the companies required Rs 100000 for expansion. Company A raises the required amount by issuing 10000 shares worth Rs 10 each. Company B on the other hand issues 5000 shares worth Rs 10 each and issued 5000 10% debentures worth Rs 10 Each . Now, let us compare the Earnings per share (EPS) of the two companies:

COMPANY A	COMPANY B
Profit  before interest     Rs 100000	Profit before interest     Rs 100000
Interest                        (Rs 0)	Interest                 (Rs 5000)
PBT                              Rs100000	PBT                       Rs 95000
Tax                              (Rs 50000)	Tax                       (Rs 47500)
PAT                              Rs 50000	PAT                       Rs 47500
EPS                              Rs 5	EPS                       Rs 9.5

 (PBT= Profit before Tax, PAT= Profit after Tax, EPS= PAT/(number of shares) Figures in brackets mean an expense and the tax rate is 50%)

From the above example it is clear that the EPS is higher in case of the company that has taken a loan.

With this post, I come to an end of the series of articles pertaining to the stock exchange and shares. I have purposefully kept mutual funds out of the discussion because I would later come up with an entire post related to mutual funds. I hope that the readers found the posts useful. Feedback, suggestions and comments are welcome.

------------

Important terms (shares and trading): Part 1

In the last few posts I had attempted to introduce to my readers the basic concepts of shares and the stock exchange. In this post, some more commonly used terms– Book Building, Dual Listing and Preferential issue have been taken up for discussion.

Book Building

According to SEBI Guidelines 2000, Book Building means a process undertaken by which demand for the securities proposed to be issued by a body corporate is elicited and built up, and the price for such securities assessed, for the determination of the quantum of such securities to be issued by means of a notice, circular, advertisement, document or information memorandum or offer document.

In case of book building, the investors place their bids at different prices and finally the price at which there is maximum demand is selected. The prospectus generally contains a base price and a maximum price between which the bids are made for the securities. The spread between the base price and the maximum price cannot be more than 20%. For example, of a company issues n number of securities with a base price of Rs 100, the maximum price cannot exceed Rs 120 (Rs 100 + 20% of Rs 100)

Difference between book building and fixed issue:

In case of a fixed issue, the price of the issue is fixed first and then the securities are offered to the investors. However, in case of book building, the price is determined on the basis of the demand.

The demand for securities in case of a fixed is known only at the close of the issue, whereas the demand is know on a regular basis in case of book building.

Dual listing

Dual listing is a process that allows a company to be listed on the stock exchanges of two different countries and hence the shares of the company are traded in both the stock exchanges. Dual listing generally takes place when companies belonging to two different companies enter into an equity alliance. Royal Dutch Shell (UK/ Netherlands) and Unilever (UK / Netherlands) are examples of companies which have their shares .

Dual listing is not allowed in India and it will need major amendments to key corporate laws of the country to allow dual listing. The Foreign Exchange Management Act (FEMA) too would need to be amended because case of a dual listed company, an investor can buy shares in one country and sell it in an overseas market and this would require the Indian rupee to be fully convertible. Also, it should be noted that domestic trading in shares denominated in foreign currency cannot take place without the permission of the Reserve Bank of India. It should be noted that the dual listing was one of the prime reasons for failure of the Bharti-MTN deal in the year 2009.

Preferential issue

A preferential issue is an issue of shares or of convertible securities by listed companies to a select group of persons under. The issuer company has to comply with Section 81 of the Companies Act, 1956 and to the guidelines laid down by SEBI. A preferential issue is neither a rights issue nor a public issue, and is a faster way to issue shares.

I hope that the readers will come up with questions and feedback. In the next post, some other important terms like futures, options and leverage would be taken up.

-----------------------

The Stock Exchange: An Overview

The stock exchange is often termed as the barometer of the economy. In this post, an attempt has been made to briefly discuss some of the terms related to the stock exchange.

As per the definition given by The Securities Contract (Regulation) Act, 1956 a Stock Exchange is a body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.

The stock exchanges in India are under the overall supervision of the regulatory authority, the Securities and Exchange Board of India (SEBI). These exchanges provide a trading platform, where buyers and sellers can transact in securities. At present there are 21 recognised stock exchanges in India. To see the list of stock exchanges in India, click here.

Thus, to be precise, it is a regulated market for the buyers and sellers of securities.

Demutualised and mutual stock exchange

In a mutual exchange, the functions of ownership, management and trading are concentrated into a single Group. Here, the broker members of the exchange are both the owners and the traders on the exchange and they further manage the exchange as well. This at times can lead to conflicts of interest in decision making. A demutualised exchange, on the other hand, has all these three functions clearly segregated, i.e. the ownership, management and trading are in separate hands. NSE is an example of a demutualised stock exchange.

Listing of shares in a stock exchange

The shares of a company can be listed on a particular stock exchange (or exchanges) after fulfilling the conditions laid down by that particular stock exchange. It should be noted that all stock exchanges do not have a unique set of prerequisites for listing.

****

BSE and the NSE

The history of the Bombay Stock Exchange (BSE) dates back to the year 1875, when 318 persons who had contributed a sum of Re. 1 each to become a member of the exchange. It is the oldest stock exchange in Asia. The BSE came up with the BSE SENSEX in the year 1986. The base value of the SENSEX is taken as 100 on April 1, 1979, and its base year as 1978-79. In 1995, the BSE successfully moved to electronic trading from the open-cry system of trading. The BSE has the largest number of listed companies in the world. Please click here to know the listing criteria of listing requirements of the BSE. The BSE SENSEX is made up of 30 companies.

The National Stock Exchange (NSE) is a stock exchange located at Mumbai, India. It was incorporated in the year 1992. It is the 9th largest stock exchange in the world by market capitalization and largest in India by daily turnover and number of trades. The index S&P CNX Nifty was launched in the year 1995. The base period for the S&P CNX Nifty index is November 3, 1995. The base value of the index has been taken as 1000. In the year 2000, the NSE became the first exchange in India to started trading of stocks on the Internet. To know the listing criteria of the NSE, click here. The Nifty index is made up of 50 companies.

What is an Index?

An index is a basket of securities that is used to track the changes in the stock market. Securities from various sectors of the industry form a part of the index. Weights are assigned to the securities on parameters like market capitalisation, share price, etc. The securities that form a part of the index are from different sectors; hence they reflect the changes in the entire economy. For example, S&P CNX Nifty is an index that is composed of 50 stocks of various companies belonging to more than 20 different sectors of the economy. An index is revised regularly by varying the companies that form a part of the index. For e.g. if in a particular market scenario, assigning higher weights to petroleum companies can lead to distortion of figures, the weights will be adjusted to depict a more realistic figure.

To illustrate the working of an Index in a Stock exchange, suppose we have an Index named S&P ABC Swifty which indicates the performance of stocks at ABC Stock Exchange. ABC Exchange has in total 100 company’s shares listed on it (from varied sectors of the economy), out of which stocks (and not shares) of 5 companies have been chosen (assume the economy has only 3 notable sectors) to formulate the S&P ABC Swifty. These 5 company stocks are such that they provide an overview of the entire economy.

Now, let’s assume the weights are assigned on the market capitalization of the company.

Company	Market Capitalization (in Rs. Lakhs)	Weight
A	1	0.1%
B	2	0.2.%
C	3	0.3%
D	4	0.4%
E	5	0.5%

Thus total value of S&P ABC Swifty is 5500 points, as of the closing day for, say, 13.05.2011

If the same value falls to, say, 5450 as on the closing day 14.05.2011, we’ll say Swifty has fallen by 0.91% (Bad news for the economy and the investors).

Hope this gives you a rough idea of how the index works. Remember, the actuals are much complex and boggling but you may still draw some parlance with the example.

We hope that the readers were able to understand the basic terms related to the stock exchange. Suggestions, feedback and comments are welcome.

(Co-authored with Dola Halder, B. Com. (Honours), SRCC)

-----------

Shares: An overview

In the last post, some common terms related to shares were discussed.  Now, we would get an overview of some common types of shares and differences between shares and debentures.

Shares: As mentioned in the previous post, a share represents a faction of an individual’s ownership in the company. For example, if the equity share capital of a company is Rs 500000, and it is divided into 5000 shares, the value of one share is Rs500000/Rs 5000 = Rs100. Thus, an individual holding 1000 shares has a 25% ownership in the company.

Equity shares and Preference shares are the two most common types of shares. The primary difference between equity shares and preference shares is that in the latter case the shareholders are entitled to receive  a fixed rate of dividend which is to be paid before dividend can be paid in respect of equity shares. Another important difference is that the preference shareholders enjoy priority over the equity shareholders in payment of surplus and on liquidation of the company. There are several types of preference shares, two of the most common ones are:

·        Cumulative preference shares: In this case the accrued dividend keeps on accumulating till paid.

·        Convertible preference shares: Here the preference shares are converted to equity shares after a stipulated time period or after certain conditions are fulfilled.

Rights Shares: These are those shares that are issued to existing shareholders at a certain price in proportion to the shares held by them. For example, if a company comes up with a rights issue in the ratio of 1:5, each shareholder who currently has five shares is offered one share at a definite price. The shareholder is free to accept or reject the offer.

A rights issue should not be confused with a bonus issue. In the latter case, the shares are distributed in a particular ratio among the existing shareholders free of cost. The issue of bonus shares does not bring money into the company, whereas an issue of rights shares does.

Debentures: A debenture is a certificate of acknowledgement of debt. When a company issues debentures, it raises money in the form of loan, and hence the debenture holders are creditors to the company. Debenture holders are entitled to receive a fixed rate of interest, irrespective of the profit or loss of the company. Convertible debentures are the most common types of debentures. Here, the debentures are convertible to shares after a stipulated time period or after fulfilling certain conditions.

Difference between shares and debentures

The shareholders of a company are owners of the company, whereas the debenture holders are creditors of the company. The dividend payable to shareholders varies with profit (in most cases, when there is no profit, no dividend is paid). On the other hand, a fixed rate of interest is payable to the debenture holders irrespective of the profit or loss. Debenture holders are exposed to less risks as compared to the shareholders because in the former case, the income is regular in nature. It should be noted that at the time of liquidation of the company, the claims of the debenture holders are settled before the claims of the preference and equity shareholders.

In the next post, the basics of stock exchanges and trading would be taken up. I request the readers to come up with questions, comments and suggestions.

-----------

Shares: Basic concepts and terminology

We often come across terms related to shares and stock markets in the newspapers, and many a times we are not very clear with the meanings of these terms. In this post, an attempt has been made to explain the basic terms related to shares. In some of the following posts; the types of shares, terms related to the stock exchange, derivatives and trading will be discussed.

Share: A share represents a faction of an individual’s ownership in the company. For example, if the equity share capital of a company is Rs 500000, and it is divided into 5000 shares, the value of one share is Rs500000/Rs 5000 = Rs100. Thus, an individual holding 1000 shares has a 20% ownership in the company. There are several types of shares, equity and preference shares being the most common ones.

Face value: The face value of a share means the price of the share. For example, if a company has total equity share capital of Rs 500,000, and the number of shares are 5000, then the face value of each share is Rs 500,000/5000=Rs100.

Issue price: Issue price refers to the price at which the shares are offered to the public. Issue price of a share may be more or less than the face value. If the shares are offered at a price that is greater than the face value, it is said to be issued at a premium. On the other hand, if a share is offered for share at a price less than its face value, it is said to be issued at a discount.

Market Price: Market Price of a share is the price at which the shares are being currently changes.

Now, a trick question: Which amongst the following will be WOW choice:

1. A Rs.9 of XYZ and Co. share with face value Rs.1; or
2. A Rs.99 of XYZ and Co. share with face value Rs.1?

Well, as long as you have the same amount of money to invest, it doesn’t make a pinch of difference. You will end up with the same amount of percentage holding with XYZ and Co. folks.

Market Capitalisation: The term Market Capitalisation refers to the total value of all shares of a company. For example, if the number of shares are 100 and the market price of each share is Rs 50, the market capitalisation is Rs50*100=Rs 50000. It should be noted that the market capitalisation is not calculated taking into account the face value of a share.

Stock: A stock refers to a bundle of shares. It should be noted that unlike a share, a stock can be expressed in fractional terms. For example, if 1 stock=100 shares, 25% of the stock would mean     (25 %)*(100 shares) = 25 shares

Dividend: Dividend refers to that portion of the earnings of the company that are distributed between the shareholders. The dividend is always calculated on the face value of a share.

Divided per share: It is calculated by the formula-(Face value)*(%age divided declared). For example, if a company has declared a dividend of 10%, and if the face value of one share is Rs10, the dividend a person who holds 10 shares of the company is (Rs10*10%)*10= Rs10.

Bonus shares: Bonus refers to those shares that are issued by companies free of cost to the existing shareholders, generally on a pro-rata basis. For example, if a company declares a bonus issue in the ratio of 1:5, each shareholder who has five shares is entitled to receive one bonus share.

Price-Earnings Ratio: It is the ratio of the Market price per share and the Earnings per share. For example, if the market price is Rs10, and the earnings per share is Rs2, the Price Earnings Ratio is    Rs 10/ Rs2 = 5. (Earnings per share is calculated by the formula- Profit/Number of shares)

We hope were able to explain clearly the meaning of some frequently used terms. Please feel free to revert back with queries and comments. That’s our dividend for this share of information investment.

(Co-authored with Dola Halder, B. Com. (Honours), SRCC)

-----

Zero Base Budgeting - An overview

Zero Base Budgeting may be defined a planning and budgeting process which requires each manager to justify his entire budget in detail from scratch (hence zero base). Each manager justifies why he should spend any money at all. The approach followed Zero Base Budgeting requires that all activities be identified as decision packages which will be evaluated by a systematic analysis ranked in order of importance.

Zero Base Budgeting and Incremental Budgeting

—  In case of Zero Base Budgeting, all figures are developed with zero as the base, however; in case of incremental budgeting, the current year’s budget is taken as the base for the next year’s budget.

—  The process of preparation of a Zero Base Budget is a costly and complicated process as compared to incremental budgeting, and is suitable mostly for big organisations. However, it should be noted that though preparation of an Incremental Budget is much easier comparatively, it is not as effective as ZBB because past inefficiencies are not accounted for in an incremental budget.

Main features of Zero Base Budgeting:

—  All proposals are considered totally afresh.

—  All amounts are to be justified.

—  A cost benefit analysis of each programme is undertaken.

—  The stress is not on “how much” but on “why”.

—  Departmental objectives are linked to corporate goals.

Merits of Zero Base Budgeting:

•        Effective allocation of resources.

•        Identification of ineffective units.

•        Increase in accountability

•        Cost behaviour analysis.

•        Adds a psychological push to reduce expenditure.

Demerits of Zero Base Budgeting:

•        Increase in paperwork and cost of budget preparation.

•        Danger of emphasising on short term goals instead of long term goals.

•        Proper training and education is required.

•        Not easy to rank decision packages, hence giving rise to conflicts.

It should be noted that the merits outweigh the demerits, and more and more organisations these days are following the Zero Base Budgeting approach. This approach has also been implemented time and again by the government of several countries, including India.

 -----

Market segmentation of computers

Having taken look at the segmentation of the automobile market in the last post, we shall now take a look at the segmentation of the computer market; which is one of the fastest growing markets globally.

·        Geographic segmentation

In the segmentation of computers, geographical segmentation yet again plays a very important role. This is because the demands of people would vary according to their regions. A very good example of this is the computer market in India. Few years ago, laptops were not at all popular in the Indian computer market which was dominated by desktops, despite the fact that laptops were very popular in the world market. Then arrived the LCD screen desktops and later the desktops gave way to laptops.

This happened because the laptops were very expensive for the Indian customer as compared with desktops. So, a global computer manufacturer would have after geographical segmentation, focussed more on the sale of computers as compared to laptops. This is not the case with India in isolation, and is common to most of the developing nations.

Even in India, further geographic segmentation would show that laptops are still not too popular in small cities and towns, where it’s still quite an expensive item for the potential buyers.

·        Demographic segmentation

Demographic segmentation plays a very important role in the computer market. It has been seen recently that most of the laptop manufacturers are coming with more and more coloured laptops in contrast to the black or silver coloured laptops. This has been done to attract the young customers towards the product.

Based on demographic segmentation, manufacturers have come up with different configuration of their product models. For example, a student may not necessarily require a computer with a very large memory space, which would definitely be the case of a professional photographer.

Also, based on demographic segmentation, manufacturers are coming up with small laptops or “net-books”, which are around 40% less expensive than the normal laptops. These having a surprisingly long power back up and are much smaller in size. These have been very popular in the corporate sector, where people like to work in cars and flights, and definitely like to be hassle free from the charger, sockets, etc.

·        Psychological segmentation

Based on the psychological segmentation, manufacturers of computers come up with different variants in the same model, which have different prices, features and configurations. Sony Vaio laptops are an example of this. More recently, the manufacturers of Sony Vaio have come up with less expensive laptops because of the brand popularity and the perception that a Vaio laptop is technologically more advanced and expensive than its competitors. More and more people would thus be attracted towards it due to its affordability.

·        Behavioural  segmentation

Behavioural segmentation is done on the basis of user status, requirements, etc. This is another important basis of segmentation of computers. Now more and more computer manufacturers are coming up with customised laptops. A very good example of this is “Dell”, where one has the option to customise his/her laptop. The customer places the order on the net stating the configuration he requires and the laptop is customised and delivered to the customer’s doorstep within a week.

Having seen the basis of segmentation of computers too, it should be noted that in most cases if a product falls under the low price range, an organisation resorts to mass marketing. However in case of products lying in the premium price category, an organisation on most occasions opts for multi-segment, single segment and micro marketing.

----

Market segmentation for automobiles

In today’s times, the automobile sector is robust with growth and more and more players are entering the automobile industry. The meaning of market segmentation was discussed in the last post and here an attempt has been made to get an overview of the market segmentation of automobiles.

·        Geographic segmentation

Geographical segmentation is one of the most important basis of segmentation of the automobile sector, especially in large sized countries like India, where the conditions in different regions.

Taking the segmentation in India itself, we find that manufactures of tractors would focus only on those areas where agriculture is of prime importance and would target those agriculturists who have sizeable land holdings and have the resources to buy a tractor.

On the other hand, commercial vehicle companies would segment the market on the basis of concentration of industries in different regions.

Luxury car makers would definitely target the metropolitan regions for the sale of their cars, whereas small car makers would also take into account developing cities and townships into account during the process of segmentation of their products. 

·        Demographic segmentation

Another important basis for segmentation of the automobile sector is demographic segmentation. Demographic segmentation provides a base marketing of products according to the income, status, age, etc.

Manufactures of small cars like Nano would primarily focus on the segment of the people belonging to the middle class and here comes lies the demographic segmentation. On the other hand, luxury car manufacturers would focus more on the high income segment.

Similarly, demographic segmentation plays an important role in the two wheeler market. Bike manufacturers generally target young to middle aged people. More and more manufactures are coming with automobiles for women, which have special features and are easy to use.

According to the age of the target market group, automobile manufacturers would come up with different colour variants, for instance bright and flashy colours for the young and vice versa.

·        Psychological segmentation

Based on psychological segmentation, automobile manufacturers come up with different variant of the models of their products. This has been largely seen in the case of cars, where companies generally come up with two or three variants of the same model, and it has been observed by industry analysts that the variant of the medium variant of the model sells the most.

Tag-lines such as “Men are Back” (used by Maruti Suzuki for the launch of a new car) and “Definitely Male” (used by Bajaj for a popular bike) target a particular category of individuals and help to increase sales and popularity in that segment.

Manufacturers of luxury cars like Ferrari, Porsche, etc target the section of the society with a large disposable income and high status, and this can be achieved by psychological segmentation.

·        Behavioural  segmentation

As mentioned earlier, behavioural segmentation is done on the basis of the benefits sought, loyalty status, etc.

This is another important means for segmentation in the automobile sector, and taking yet again the example of a car, Daimler, the manufacturer of luxury car Maybach, customises the cars according to the needs and requirements of the products.

Thus, through some examples, we have seen how the market for automobiles is segmented.

-----