Friday, November 14, 2008

Stock Market FAQ's

How do you measure inflation?

Inflation is one of the biggest stories of recent weeks, and has received a great deal of attention from the media and politicians. At the same time, inflation is an economic problem that the average person meets on a daily basis in terms of higher prices, particularly of food products.

How is inflation measured?

In India, there are two broad measures of inflation - based on the consumer price index (CPI) and based on the wholesale price index (WPI). Of the two, the latter has a higher profile because it is measured every week. When you read about inflation rising to 7%, it is probably referring to inflation based on WPI.

WPI is based on the wholesale prices of 435 items ranging from agricultural commodities like wheat, rice, groundnuts etc to manufactured products like steel, cement etc. A single index number is calculated based on those prices, and the inflation rate is calculated by comparing the most recent index number with that of a year ago.

What is the government going to do about inflation?

The government has taken some quick steps like trying to curb exports in sensitive commodities and reduce the cost of imports. The is done because exports reduce domestic supply adding to the pressure on prices . Therefore, the government has already banned the export of cement and non-basmati rice and may ban other commodity exports later.

RBI has also taken action by raising rates, which will reduce liquidity and the total demand in the economy that will reduce the pressure on prices.

What are P-Notes?

Participatory notes (P-Notes) are financial instruments used by hedge funds not registered with Sebi.

* Hedge funds invest in Indian stocks through custodians in India
* P-Notes are issued by registered FIIs to overseas investors who want to invest in India without registering

How do P-Notes work?

* India-based brokerages buy India-based securities and then issue P-Notes to foreign investors
* Any dividends or capital gains collected from the underlying securities go back to the investors

Why do FIIs use the Mauritius route?

* India has a double taxation avoidance agreement (DTAA) with Mauritius
* As per law, entities registered in Mauritius need not to be taxed in India
* Capital gains from the sale of shares is taxable in the country of residence of the shareholder

What is short selling?

When an investor goes long on an investment, it means the stock has been bought believing its price will rise in the future. Conversely, when an investor goes short, he is anticipating a decline in share price.

Short selling is the selling of a stock that the seller doesn't own. More specifically, short sale is the sale of a security that isn't owned by the seller, but that is promised to be delivered.

When you short sell a stock, your broker will lend it to you. The stock will come from the brokerage's own inventory, from another one of the firm's customers, or from another brokerage firm.

The shares are sold and the proceeds are credited to your account. Sooner or later, you must 'close' the short by buying back the same number of shares and returning them to your broker. If the price drops, you can buy back the stock at the lower price and make a profit on the difference. If the price of the stock rises, you have to buy it back at the higher price, and you lose money.

Since you don't own the stock, you must pay the lender of the stock any dividends or rights declared during the course of the loan. If the stock splits during the course of your short, you'll owe twice the number of shares at half the price.

Also, because you are being loaned the stock, you are buying on margin. In fact, you have to open a margin account to short stocks.

There are two main motivations to short a stock. The most obvious reason to short is to profit from an overpriced stock or market.

Sophisticated money managers short as an active investing strategy to hedge positions. This means they are protecting other long positions with offsetting short positions.

What are SWFs?

A sovereign wealth fund (SWF) is a state-owned fund composed of financial assets such as stocks, bonds, property or other financial instruments. These are state savings which are invested for the purpose of investment returns.

Some wealth funds are solely owned by Central banks. Most SWFs originate in foreign currency reserves. Traditional investment vehicles for SWFs have been debt instruments. There are 40 SWFs worldwide managing $ 3 trillion.

> SWFs are typically created when govts have budgetary surpluses

> SWFs are also created for economical or strategic reasons

> Foreign investment by SWFs may create national security issues
> Motives of SWFs could be to stifle competition
> SWFs hold 2% of total assets traded worldwide

> Govts of Singapore, Kuwait and Korea have provided $15 billion to Merril Lynch and Citigroup

> China's SWF has invested $3 bn in Blackstone IPO


Abu Dhabi Investment Authority - $875 bn
Govt Pension Fund of Norway - $350 bn
Govt of Singapore Investment - $330 bn
Kuwait Investment Authority - $250 bn
China Investment Corp - $200 bn
Temasek Holdings - $159bn
Australian Govt Future Fund - $61.3bn
Qatar Investment Authority - $50 bn

> The country’s forex reserves are at $315 billion along with a fiscal deficit

> RBI governor say there is case for SWF in India

> FM says no proposal for Sovereign Fund for India

What is credit limit?

The 'Credit limit' is the maximum amount you can spend or borrow using your Credit Card in one billing cycle. This limit is based on various factors relating to your income. The credit limit can be changed on the basis of your payment and transaction history.

How is the Sensex calculated?

The Sensex , an abbreviation of the BSE sensitive index, is a market capitalisation-weighted index of 30 stocks representing a sample of large, well-established and financially sound companies. It is the oldest index in India and has acquired a unique place in the collective consciousness of investors.

The index is widely used to measure the performance of the Indian stock markets. Sensex is considered to be the pulse of the Indian stock markets as it represents the underlying universe of listed stocks on The Stock Exchange, Mumbai. Further, as the oldest index of the Indian stock market, it provides time series data over a fairly long period of time (since 1978-79).

Sensex is not only scientifically designed but also based on globally accepted construction and review methodology.

Sensex Calculation Methodology

As per the methodology, the level of index at any point of time reflects the free-float market value of 30 component stocks relative to a base period. The market capitalisation of a company is determined by multiplying the price of its stock by the number of shares issued by the company. This market capitalisation is further multiplied by the free-float factor to determine the free-float market capitalisation.

The base period of Sensex is 1978-79, and the base value is 100 points. This is often indicated by the notation 1978-79=100. The calculation of Sensex involves dividing the free-float market capitalisation of 30 companies in the index by a number called the Index Divisor.

The Divisor is the only link to the original base period value of the Sensex. It keeps the index comparable over time and is the adjustment point for all index adjustments arising out of corporate actions, replacement of scrips etc.

During market hours, prices of the index scrips, at which latest trades are executed, are used by the trading system to calculate the Sensex every 15 seconds and disseminated in real time.

Understanding Free-float Methodology

Concept: Free-float Methodology refers to an index construction methodology that takes into consideration only the free-float market capitalisation of a company for the purpose of index calculation and assigning weight to stocks in the index.

Free-float market capitalisation is defined as that proportion of total shares issued by the company that are readily available for trading in the market.

It generally excludes promoters' holding, government holding, strategic holding and other locked-in shares that will not come to the market for trading in the normal course. In other words, the market capitalisation of each company in a free-float index is reduced to the extent of its readily available shares in the market.

In India, BSE pioneered the concept of free-float by launching BSE TECk in July 2001 and BANKEX in June 2003. While BSE TECk Index is a TMT benchmark, BANKEX is positioned as a benchmark for the banking sector stocks.

Definition of Free-float: Shares held by investors that would not, in the normal course, come into the open market for trading are treated as 'Controlling/ Strategic Holdings', and hence not included in free-float. In specific, the following categories of holding are generally excluded from the definition of free-float:

  • Holdings by founders/directors/ acquirers which has control element
  • Holdings by persons/ bodies with "Controlling Interest"
  • Government holding as promoter/acquirer
  • Holdings through the FDI Route
  • Strategic stakes by private corporate bodies/ individuals
  • Equity held by associate/group companies (cross-holdings)
  • Equity held by Employee Welfare Trusts

Locked-in shares and shares which would not be sold in the open market in normal course. The remaining shareholders would fall under the free-float category.

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