Derivatives : Future

Future

A future contract is an agreement between two parties to buy or sell an asset at a certain time in future at a certain price. It is a special type of forward where date and contract size are specified by third party (i.e. Exchange in case of capital market)

Example

I am Buying 2000 kg Wheat (means 2 lots as one lot carries 100 kg of Wheat) from Farmer through NCDEX (National Commodity and Derivative Exchange)

Features of Future Contract

1. Highly Standardised :- Futures are standardize and legally enforceable. They are standardize for Size, Expiry date (Delivery Date), Quality and place of delivery (in case of commodity)
2. Down payment :- Both parties have to keep margin (Specified % of contract value) with Exchange till the contract gets over or traded.
3. Settlement :- Though the physical settlement of such contract is done at maturity only but profit or loss is calculated and debited and credited on daily bases (Mark to market).
4. Linearity :- It means symmetrical gain or loss due to price fluctuation of underlying.
5. Secondary Market :- As contract is specified by Exchange and hence is having secondary market
6. Non-delivery of asset :- Generally in future contract underlying are not delivered in physical form. Settlement takes place in monetary only as a profit or loss.
   

Advantages of Future Contract

1. Protection against price fluctuation :- Parties to these contract can protect themselves against risk of adverse fluctuation in the price of assets.
2. Proper planning for buying and selling :- As dates for settlement is specified it will help in planning about buying and selling in time
3. Proper portfolio management
4. Proper cash management
5. Flexibility :- These contract are flexible as party in contract wants to wind up its position, they can do it by paying loss or getting profit from other party. It means trouble of exchanging the assets physically is not there.
6. Boon to Financial Intermediaries :- Such contract are beneficial to financial intermediaries because if two major reason
   

• (1) As such contract incurs huge profit or loss, importance of proper guidance and advice increases
  
• (2) Contract value is very high hence financial intermediaries can earn handsome brokerages

Example of Settlement

For example, I had purchased future to buy 200 kg Wheat today and settlement date is after 10 days. Today price was Rs. 7 when I had purchased contract. Suppose at the end of day closing price was Rs. 7.20. It means I am earning Rs. 0.20 per kg. Let’s put it in table form

Date Buying/Opening Price Selling/Closing Price Profit/Loss Net Profit/Loss(Mark to Market)
20/2 7.0 7.20 0.2 (2000*0.2) = 400
21/2 7.20 8.10 0.9 1800
22/2 8.10 7.40 0.7 - 1400
23/2 7.40 7.90 0.5 1000

If we take total of last column, it is Rs. 1800 which is equal to product of difference of buying price (Rs. 7.0) and Selling price (Rs. 7.90) and total quantity { 0.9* 2000} = Rs. 1800

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Derivatives : Forward Contract

Forward :-

A forward contract is a customized contract between two entities where settlement takes place at specific date in future at today’s pre-agreed price.

• The underlying asset can be stocks, bond, currency, commodity etc.
• For Example :- I am buying 1500 kg Wheat from farmer after 25 days from the day of contract at say Rs. 8 per kg.
• The Buyer (Myself) who promises to buy Wheat is said to be in the “Long Position”
• The Seller (Farmer) who promises to sell Wheat is said to be in the “Short Position”
  

Features of Forward Contract

1. Over the Counter (OTC) Trading :- The contract is privately arranged agreement and hence they are not at all standardize in terms of size, exercise date, exercise place etc. They are traded on OTC not on exchanges
2. No down payment :- As there is no third party involvement and hence no down payment is paid by any party
3. Settlement at maturity only :- It means that profit or loss are calculated on the maturity date only
4. Linearity :- It means symmetrical gain or loss due to price fluctuation of underlying.
5. No secondary market :- It is a private contract and hence hardly it is traded (It means I had made contract with farmer to buy 1500 kg wheat as per my requirement. Now if I don’t want to buy then there should be one party who is having the same requirement then only I can sell my contract to him.)
6. Delivery :- Place of delivery is specified in contract itself.
7. No third party involvement :- As no third party involves in such contract, there is always risk of default exists.
   

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Financial Derivatives

Definition

Derivatives are defined as a product whose value is derived from the value of one or more basic variables called bases or underlying (underlying assets, stocks, commodity etc.)

Features of Derivatives are :-

1. It is designed in a way to fulfill the requirement of the users
2. They can be designed and traded on the basis of the expectations regarding future price movement of underlying
3. They are off- balance sheet instrument
4. They are used as a device for reducing risks of fluctuations in asset values
   

Types of Financial Derivatives

1. Forward
2. Future
3. Option
4. Swaps
   

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Types of Speculative Transactions

1. Option Dealing for hedging

Options are used for hedging purpose to limit the loss in portfolio. Thus hedging is a device which protects against losses due to price fluctuation.

2. Wash Sales

It is a device by which a speculator is able to reap huge profits by creating misleading pictures in the market. Actually it’s a fictitious transaction in which member sells huge quantity and buy the same from other brokers.

3. Cornering

It refers to the process of holding the entire supply of a particular security by an individual or a group of individuals with a view to dictate the short-seller and earn profits by catching short seller.

4. Rigging the market

It refers to the process of creating an artificial condition in the market, whereby, the market value of a particular security is pushed up. It is due to strong Bull Run created by such members. They initially buy the securities in bulk at higher prices which shows picture like that the security is in Bull Run.

5. Blank Transfer

It facilitates speculative activities through carry-over or Badla transaction. When the transferor (Seller) simply signs the transfer form without specifying the name of the transferee (Buyer) is called blank transfer.

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Types of Speculators

1. Stags
These are those members who are neither but or sell securities in secondary market. They simply apply for subscription to new issues expecting to sell them at a higher price later when such issues are quoted on the stock exchange. They might sell security even before listing in GRAY market.

2. Wolves
These are those members who are very fast speculators and quickly perceives the trend of market. They trade in bulk and for small price difference.

3. Lame ducks
These are bear member who sell ultimately short by making wrong moves. Generally they sell securities without having it and hence caught in the wrong foot.

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Kinds of Brokers

Client Brokers
These brokers do simple broking business and works as an intermediary in case of buying or selling. They earn only brokerage.

Floor Brokers
It refers to those authorized clerks and sub-brokers who enter the trading floor and execute orders for their clients or members.

Jobbers/Taravaniwalas
These are those brokers who specialize in selected scrips. They buy or sell in bulk in selected scrips only. They earn profit through the margin between buying and selling rates.

Badla Financiers/Badliwalas
These are those members whose main function is to give finance for Badla transaction in specified scrips and earn interest for that finance. The interest is known as Badla rate. They also lend securities to brokers at the time of overselling.

Arbitragers
They are buying and selling securities simultaneously but in different market. (For Example :- Buy in BSE and sell in NSE). Thus they deal in inter-market transaction and earn difference in prices between different markets.

Bulls / Tejiwalas
These are those brokers who are having bullish view (means price is going to increase) on securities

Bears / Mandiwalas
These are those brokers who are having Bearish view (means price is going to decrease) on securities

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Carry over or Badla Transaction

• It refers to postponement of the settlement of a transaction till the next settlement period. Its nothing but facility to carry forward the transaction from one settlement period to another.
• It involves payment of some charges known as “BADLA CHARGES” by the speculator. Badla charges are fixed based on demand and supply conditions in the market.
• To effect Badla transaction, two bargains have to be made.
  

1. First is to cancel out the original transaction by squaring it up. This cancellation is affected at making up price which is decided by exchange.
2. The second is to reopen the original bargain for next settlement period.

• If Buyer has bought XYZ Co’s share in Febuary contract and wants to carry forward his position say to next month (March). So he has to first sell the same share in February contract before the expiry date and second he has to create fresh buying (Long) position in March contract.
• If Seller has sold ABC Co’s share in Febuary contract and wants to carry forward his position say to next month (March). So he has to first buy the same share in February contract before the expiry date and second he has to create fresh selling (Short) position in March contract
  

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Short Selling

Short selling means selling of securities without owning it.

For spot market, when one short sell shares he has to repurchase the same before the end of trading session. In case if one fails to repurchase the shares then he has to pay penalty of 20% of price of the share calculated on the highest price of the next three trading days.

For Example if one has sold GSPL for Rs. 105 on Monday and unable to repurchase before closing of market on that day. For Tuesday and Wednesday highest price of GSPL is 108, 103. Then one has to pay auction penalty equals to 108*0.20 = Rs. 21.6 per share.

- Short selling is allowed in future market or carry over market. Here the short seller can keep his position open till the end of contract. Anytime during the expiry he can repurchase shares. In case if in the same expiry, he want get his expected price, he might carry his trade forward to next contract and will be allowed to wait till the next expiry.

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Margin Trading

• Margin trading is carried on by the clients with borrowed fund from their brokers. It is a popular method of speculative trading.

• Under this method, client opens account with brokers and deposits cash or securities in this account. He agrees to keep minimum amount with the broker. Then he can give order to buy or sell securities for more amounts then what he has deposited.

• In case it falls short of the minimum agreed amount, the client has to deposit further securities into his account. If client fails to do so then his securities are sold out by the brokers after informing to client.

• If the market is favorable, then client may sell his shares and book profit. When such securities are sold, his account will be credited.

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Types of transaction

There are certain types of transactions, which are allowed on the stock exchanges.

1. Transactions for Spot delivery :- The delivery and payment is effected within the time or on the date stipulated when entering into the transaction or within fourteen days, whichever is shorter.
2. Transaction for Hand delivery :- These transactions also referred to as the transaction for "the account", are cleared and settled through the clearing house.
3. Transactions for special delivery :- The delivery and payment is effected within any time exceeding fourteen days following the date of the contact as may be stipulated when entering into the transaction, provided the same is permitted by the governing board or the president of the exchange.
4. Transaction for Clearing settlement delivery :- Under this method, the transactions are cleared and settled through the clearing house. Usually those securities are frequently traded and are usually in demand are cleared through the clearing house.
   

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Types of Order

There are various types of orders, which can be placed by the buyer or seller. They are:

1. Market Order :- A market order is to be executed as soon as possible at the best prevailing price in the market.
2. Limit order :- A limit order is constrained by the price limits specified by the investor. The seller specifies the minimum price that the security must fetch, and the buyer specifies the maximum price that he is willing to pay.
3. Day order :- A day order remains valid only for the day when it is placed. If the order is not executed on that day, it automatically lapses.
4. Week order :- A week order is one, which is active for a week
5. Month order :- A month order is an order, which is valid for one month.
6. Open order :- An open order remains in effect until it is executed or cancelled. It is also known as Good Till Cancel (GTC) order.
   

Some modern types of orders are:

1. Immediate Or Cancel (IOC) order :- When trader enters order with this option and a part of which trades then immediately the remaining part gets cancelled. For Example IOC buy order for 400 shares of XYZ co. ltd. is entered in system and will get 250 shares immediately then remaining order for 150 gets cancelled.
2. All Or None (AON) order :- In this case, wither all the orders entered by trades execute or None of the order executes. For trading purpose AON order executes only when other opposites AON order is matched.
3. Good Till Date (GTD) order :- This order remains in effect until the specific date.
4. Stop Loss order :- In order to sell as soon as price falls below particular level or to buy when the price rises up to a specific level. This is mainly to protect clients against heavy fall or rise so as to limit the amount of loss. Such orders required one more price known as “trigger price” at which it enters into ORDER BOOK.
   

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Types of Shares by Group

1. GROUP "A" SHARES

These are referred to as “Cleaned Securities” or “Specified shares". The facility for carrying forward a transaction from one account period to another is available for these shares. Group "A" shares represent companies, with huge amount of capital, and equally a large scope for investment. These shares are frequently traded and command higher price earning multiples.

2. GROUP "B" SHARES

These are referred to as “Non cleaned securities” or “Non-specified shares”. For these groups facility of carrying forward is not available. Whenever a share is moved from Group "B" to Group "A" its market price rises; likewise, when a share is shifted from Group "A" to Group "B", its market price declines. There are some criteria and guide lines, laid down by stock exchange, for shifting stocks from the non-specified list to the specified list.

3. GROUP “C” SHARES

Under group “C”, only odd lots and permitted securities are included. A number of shares that are less then the market lot are known as odd lots. Old lots have settlement once in a fortnight.

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SENSEX & the NIFTY Index

The Sensex and Nifty are an "index".
So before you go to understanding Sensex & the Nifty you needs to understand Index.

An Index is a comprehensive measure of market trends, intended for investors who are concerned with general stock market price movements. An Index comprises stocks that have large liquidity and market capitalization. Each stock is given a weighted in the Index equivalent to its market capitalization. At the NSE, the capitalization of NIFTY (fifty selected stocks) is taken as a base capitalization, with the value set at 1000. Similarly, BSE Sensitive Index or Sensex comprises 30 selected stocks. The Index value compares the day's market capitalization vis-à-vis base capitalization and indicates how prices in general have moved over a period of time.

The Sensex is an index of all the major companies of the BSE.

The Nifty is an index of all the major companies of the NSE. Just like the Sensex represents the top stocks of the BSE, the Nifty represents the top stocks of the NSE.

The BSE is the Bombay Stock Exchange and the NSE is the National Stock Exchange. The BSE is situated at Bombay and the NSE is situated at Delhi. These are the two major stock exchanges in the country. There are other stock exchanges like the Calcutta Stock Exchange etc. but BSE and the NSE are the most popular. Most of the stock trading in the India is done though the BSE & the NSE.

Besides Sensex and the Nifty there are many other indexes. BSE Mid-cap Index, BSE Small-cap Index, Index by industries like IT, FMCG, Power, Infrastructure, Metal, Automobile, are few of the examples of other Index.

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Satyam Today

Do you know meaning of Satyam?
Satyam = Truth. & What Satyam Done!!

Today, Satyam Computer Services's chairman and founder B Ramalinga Raju admit to fraud and blatant manipulation of accounts. After this news satyam stock fell to Rs.39.95 from Rs.179 of previous close. that shows 77% of decline. at one time it was trading at Rs.30.70. Its todays close is about one third of 52 week low!! Everybodu socked with data given by Mr. Raju. Check the letter of raju here Letter of Raju (To Satyam Board, SEBI & SE)

After this issue SEBI indicate that Satyam may be removed from BSE, NSE.

As an step, Satyam appoint Ram Mynampati to Satyam's interim CEO. He wrote an impassioned letter to all the employees to the company, asking them to stand together in these turbulent times. Also Satyam disclose that Satyam will call press conferance in 24 Hrs. and the bord meeting of 10-Jan will be held without change.

As a result of the event the BSE and NSE Index fall about 7% today.

Hopping for some good outcome after this issue!

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Letter of Raju (To Satyam Board, SEBI & SE)

Following is the text of the letter Raju wrote to the Satyam board and Copy to SEBI and Stock Exchanges.

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Dear Board Members,

It is with deep regret and tremendous burden that I am carrying on my conscience, that I would like to bring the following facts to your notice:

1. The Balance Sheet carries as of September 30, 2008,
a) Inflated (non-existent) cash and bank balances of
Rs 5,040 crore (as against Rs 5,361 crore reflected in the books);
b) An accrued interest of Rs 376 crore, which is non-existent
c) An understated liability of Rs 1,230 crore on account of funds arranged by me;
d) An overstated debtors' position of Rs 490 crore (as against Rs 2,651 reflected in the books);

2. For the September quarter(Q2) we reported a revenue of Rs 2,700 crore and an operating margin of Rs 649 crore(24 per cent of revenue) as against the actual revenues of Rs 2,112 crore and an actual operating margin of Rs 61 crore (3 per cent of revenues). This has resulted in artificial cash and bank balances going up by Rs 588 crore in Q2 alone.

The gap in the balance sheet has arisen purely on account of inflated profits over several years (limited only to Satyam standalone, books of subsidiaries reflecting true performance). What started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of the company operations grew significantly (annualised revenue run rate of Rs 11,276 crore in the September quarter, 2008, and official reserves of Rs 8,392 crore). The differential in the real profits and the one reflected in the books was further accentuated by the fact that the company had to carry additional resources and assets to justify a higher level of operations thereby significantly increasing the costs.

Every attempt made to eliminate the gap failed. As the promoters held a small percentage of equity, the concern was that poor performance would result in the takeover, thereby exposing the gap. It was like riding a tiger, not knowing how to get off without being eaten.

The aborted Maytas acquisition deal was the last attempt to fill the fictitious assets with real ones. Maytas' investors were convinced that this is a good divestment opportunity and a strategic fit. One Satyam's problem was solved, it was hoped that Maytas' payments can be delayed. But that was not to be. What followed in the last several days is common knowledge.

I would like the board to know:

1. That neither myself, nor the Managing Director (including our spouses) sold any shares in the last eight years - excepting for a small proportion declared and sold for philanthropic purposes.
2. That in the last two years a net amount of Rs 1,230 crore was arranged to Satyam (not reflected in the books of Satyam) to keep the operations going by resorting to pledging all the promoter shares and raising funds from known sources by giving all kinds of assurances (statement enclosed only to the members of the board). Significant dividend payments, acquisitions, capital expenditure to provide for growth did not help matters. Every attempt was made to keep the wheel moving and to ensure prompt payment of salaries to the associates. The last straw was the selling of most of the pledged shares by the lenders on account of margin triggers.
3. That neither me nor the managing director took even one rupee/dollar from the company and have not benefited in financial terms on account of the inflated results.
4. None of the board members, past or present, had any knowledge of the situation in which the company is placed. Even business leaders and senior executives in the company, such as, Ram Mynampati, Subu D, T R Anand, Keshab Panda, Virender Agarwal, A S Murthy, Hari T, S V Krishnan, Vijay Prasad, Manish Mehta, Murli V, Shriram Papani, Kiran Kavale, Joe Lagioia, Ravindra Penumetsa, Jayaraman and Prabhakar Gupta are unaware of the real situation as against the books of accounts. None of my or managing directors' immediate or extended family members has any idea about these issues.
   

Having put these facts before you, I leave it to the wisdom of the board to take the matters forward. However, I am also taking the liberty to recommend the following steps:

1. A task force has been formed in the last few days to address the situation arising out of the failed Maytas acquisition attempt. This consists of some of the most accomplished leaders of Satyam: Subu D, T.R. Anand, Keshab Panda and Virendra Agarwal, representing business functions, and A S Murthy, Hari T and Murali V representing support functions. I suggest that Ram Mynampati be made the chairman of this Task Force to immediately address some of the operational matters on hand. Ram can also act as an interim CEO reporting to the board.
2. Merrill Lynch can be entrusted with the task of quickly exploring some merger opportunities.
3. You may have a 'restatement of accounts' prepared by the auditors in light of the facts that I have placed before you.
   

I have promoted and have been associated with Satyam for well over 20 years now. I have seen it grow from few people to 53,000 people, with 185 Fortune 500 companies as customers and operations in 66 countries. Satyam has established an excellent leadership and competency base at all levels. I sincerely apologise to all Satyamites and stakeholders, who have made Satyam a special organisation, for the current situation. I am confident they will stand by the company in this hour of crisis.

In light of the above, I fervently appeal to the board to hold together to take some important steps. TR Prasad is well placed to mobilise a support from the government at this crucial time.

With the hope that members of the Task Force and the financial advisor, Merrill Lynch (now Bank of America), will stand by the company at this crucial hour, I am marking copies of the statement to them as well.

Under the circumstances, I am tendering the resignation as the chairman of Satyam and shall continue in this position only till such time the current board is expanded. My continuance is just to ensure enhancement of the board over the next several days or as early as possible.

I am now prepared to subject myself to the laws of the land and face the consequences thereof.

(B Ramalinga Raju)

Copies marked to:
1. Chairman SEBI
2. Stock Exchanges....

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Note that : - The text is received form news portal and may not verified.

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Stock Market Ratios – EPS, PE, PEG

After Fundamental most analysts use different tools and ratios like EPS, PE, PEG etc. those are described in detail below.

EPS

Only base on earning of company, we cannot select a stock for but or sell. We must consider total shares issued that company. Because on that base total earning of the company is divided. For example if companies A and B both earning 500, but company A has 50 shares issued and B has 100 shares issued. Then shareholder of company A will have earning effect of 10. While shareholder of company B will have earning effect of 5 only. So the point to concentrate is the Earning per share shortly known as EPS. Which is used as a comparison tool.

Simply, an earnings per share is the net earnings and divide by the outstanding shares.

EPS = Net Earnings / Outstanding Shares.

Note that there are three types of EPS numbers:

1. Trailing EPS – last year’s numbers and the only actual EPS.
2. Current EPS – this year’s numbers, which are still projections.
3. Forward EPS – future numbers, which are obviously projections

EPS doesn’t tell you whether it’s a good stock to buy or what the market thinks of it. Also when comparing many companies the burden of calculation is boring. For reducing that, we need to look at some other ratio that is called P/E or PE ratio.

Price to earning (P/E) ratio

The P/E looks at the relationship between the stock price and the company’s earnings. The P/E is the most popular stock analysis ratio, although it is not the only one you should consider.
You calculate the P/E by taking the share price and dividing it by the company’s EPS (Earnings Per Share that we see above)

P/E = Stock Price / EPS

For example: A company with a share price of Rs.50 and an EPS of 10 would have a P/E of: (50 / 10) = 5.

What this 5 says. It says that if you invest 100 Rs. in this share after a year you will able to earn 100/5 = 20 on this Rs.100 (But provided that your projection on earning is fulfilled). Some investors read a high P/E as an “overpriced stock”. But on other hand, its also indicate the market has high hopes for this stock’s future. Conversely, a low P/E may indicate no interest by the market or it could mean that the market has just overlooked the stock.

In short, the P/E tells you what the market thinks of a stock. It tells you whether the market likes or dislikes the stock. If there is one number that people look at than more any other number, it is the “Price to Earning Ratio (P/E)”. But it doesn’t tell you everything. For more you have to look at other ratios. One of its most important is PEG.

PEG (Price to future growth ratio)

The market is usually more concerned about the future than the present, it is always looking for some way to figure out what will happen in the companies future. A ratio that will help you look at future earnings growth is called the PEG ratio.

You can calculate the PEG by taking the P/E and dividing it by the projected earnings growth.

PEG = (P/E) / (projected earnings growth)

For example, a stock with a P/E of 20 and projected earning growth next year of 15% would have a PEG of 20 / 10 = 2. The lower the PEG number, the less you pay for each unit of future earnings growth. So even a stock with a high P/E, but high projected earning growth may be a good value. note that the PEG ratio relies on the projected % earnings. These earnings are not always accurate and so the PEG ratio is not always accurate.

After understood these basic three ratios, you probably able to evaluate different stocks and predict which is good stock and what is not good.

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