a smart guide to the financial markets

8/10/2019 A Smart Guide to the Financial Markets

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Index

A. Basics of Investment 4

1.

How does investing help in retirement planning? 52. Is there a risk-reward tradeoff? What does it mean for my investments? 7

3.

What are the advantages of borrowing through formal channels rather

than local moneylenders? 8

4. What are the various objectives of investment? 10

5. What does diversification mean? How is it helpful? 12

6. What factors should I consider while building my investment portfolio? 13

7. What is compound interest? How does it impact return on investments? 15

8. What is the difference between saving and investment? 17

9.

What is the impact of inflation on savings? Can investing help me

beat inflation? 1810. What is the 'present value' of money? How is it useful? 19

11. Why must I invest? 21

12. Why must I save? 22

13. Why should I start investing at an early stage? 23

B.

Trading 25

B. a.

Equity 26

a 14. How can I invest in the Indian share market? 27

a 15. How do I read a stock table or quote? 28

a 16. How does a stock exchange function? 30

a 17.

How is a futures contract different from an option? 32a 18. How is fundamental analysis different from technical analysis? 33

a 19. How is the Indian stock market regulated? 35

a 20. What are options? 37

a 21. What are stock futures? 39

a 22. What are stocks? 41

a 23. What are the advantages and drawbacks of options? 42

a 24. What are the most commonly used ratios while evaluating stocks?

What do these ratios mean? 44

a 25.

What are the various types of options? 46

a 26.

What is an IPO? 48

a 27. What is fundamental analysis? 49

a 28. What is margin trading? 51

a 29. What does 'support' and 'resistance' for a stock mean? 52

a 30. What is rollover in the stock market? 54

a 31. What is technical analysis? 55

a 32.

What is the meaning of long or short positions? 57


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a 33.

What is the purpose of fundamental analysis? 58

a 34. What is the purpose of technical analysis? 59

a 35. What is the relation between the price of a stock and its futures? 60

a 36. Who are the bulls and who the bears in a stock market? 61

a 37.

Why do I need a stockbroker? 62

a 38. Why do stock prices change? 63

B. b. Commodity 65

b 39. How can I trade in commodities? 66

b 40.

How does a commodities exchange function? Which are the major

commodity exchanges in India? 67

b 41. What are commodity futures? 69

b 42. What are the major factors that impact commodity prices? 70

b 43. What is commodity trading? 72

b 44. What is hedging? How is it done through commodity markets? 74

B. c.

Currency 75

c 45.

How can I trade in currencies? 76

c 46.

How is the price of a currency determined? 78

c 47. What are currency derivatives? 80

c 48. What is currency trading? 82

c 49. Why do people trade in currencies? 84

C.

Investment 85

C. a.

Mutual Fund 86

a 50. Benefits of investing in mutual funds 87

a 51.

How can I invest in a mutual fund? 89a 52. How can I redeem a mutual fund? 90

a 53. Tax benefits of mutual funds 91

a 54.

What are my rights as a mutual fund investor? 92

a 55. What are the costs associated with mutual fund? 93

a 56. What are the different types of mutual funds? 95

a 57. What is a mutual fund? 97

a 58. What is NAV of a mutual fund and how is it calculated? 98

C. b.

Bonds 99

b 59. Are bonds safer than stocks? 100

b 60.

Face value, coupon and maturity of bonds 102b 61. How and where can I buy bonds in India? 104

b 62. How are bonds rated? 105

b 63. What are junk bonds? 107

b 64. Relationship between price of a bond and the prevailing interest rate 108

b 65. Various types of bonds 110

b 66. What are bonds? 112


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b 67.

What are gilt funds? 114

b 68. What are zero coupon bonds? 115

b 69. What is the yield of a bond? 117

C. c.

Gold 119

c 70.

Is there a correlation between gold prices and stock market

performance? 120

c 71. Is there a correlation between gold prices and the US dollar? 122

c 72. What are gold ETFs? 124

c 73.

What are the factors that influence gold prices? 125

c 74.

What are the various ways in which one can invest in gold in India? 127

c 75. What makes gold a popular savings/investment option? 129

D.

Insurance 130

D. a.

Life Insurance 131

a 76. How can I file a life insurance claim? 132

a 77. How to compare different life insurance policies 134

a 78. Importance of disclosing correct information while buying life insurance 136

a 79. Types of life insurance products 138

a 80. What are my rights as a life insurance policy holder? 140

a 81. What are the factors that affect the premium of your life insurance

policy? 142

a 82. What are the tax benefits of life insurance? 144

a 83. What is difference between sum assured and guaranteed returns? 145

a 84. What is life insurance? 147

a 85.

What is survival benefit? How does it work? 149a 86. Who can be a nominee in a life insurance policy? What is the

nomination procedure? 151

a 87.

Why do I need life insurance? 152

D. b.

Health Insurance 153

b 88. Health insurance exclusions 154

b 89. Cashless vs reimbursement plans 156

b 90. Claims processing procedure by health insurance companies 158

b 91. Impact of your lifestyle on your health insurance premiums 160

b 92. Tax benefits of health insurance 162

b 93.

Things to look for while buying health insurance 163b 94. Types of health insurance plans 165

b 95. What are my rights as a health insurance policy holder? 167

b 96. What is cashless hospitalization? 168

b 97. What is health insurance portability? 170

b 98. What is health insurance? 171

b 99. Why do I need health insurance? 172


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A. Basics of Investment


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A. 1. How does investing help in retirement planning?

Investment can be an ideal option for individuals who want to be financially independent even after

retirement.

After working hard for several years, every individual dreams of a happy and secure retired life. This goal

is easily achievable if you have accumulated a large sum and are financially independent. One of the

best ways to ensure this is by investing your money in several instruments.

Here is how investing in strong instruments can ensure a financially independent retired life.

Grow your money

Saving money is certainly a good way to accumulate a retirement corpus. However, by investing this

amount in various instruments, you can grow your money and ensure that you get a larger amount for

your retirement. Fixed-income products like bonds, fixed deposits, etc. secure your initial investment

and, at the same time, provide a decent return every year.

Diversify your investment

While it is wise to invest your money in fixed-income products when planning your retirement, it makes

more sense to invest in a wider variety of products that provides you both safety and growth. Instead of

limiting your investments to just fixed deposits and bonds, you can diversify your portfolio by putting

money in high-yielding products like gold, stocks, mutual funds, etc. Such diversification can not only

ensure that you get high returns, but also secure your post retirement life.

Invest in the right schemes

There are various investment schemes available that can be used specifically to plan your retirement.These schemes can ensure that you get guaranteed returns throughout your life. For example, many

retirement plans offered by PSU banks in India provide regular income from the age of 40 years on

payment of monthly premiums during the pre-retirement period.


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If you want to be financially independent even after retirement, investment can be an ideal option for

you.


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A. 2. Is there a risk-reward tradeoff? What does it mean for my investments?

Understanding the risks involved in various investments, minimizing them and generating higher returns

is the key to successful investment.

The risk-reward tradeoff is the balance that an investor has to achieve between the risk involved in an

investment and its potential returns.

It is hence the process of deciding how much risk you are ready to take in order to achieve the desired

rewards. While determining this, it is important to note that every investment has some risk associated

with it; only the level of risk differs. Experts are of the opinion that the higher the risk the higher the

returns, and vice versa.

Investments like stocks and junk bonds often fall in the high risk category, while low risk investment

options include fixed deposits and savings certificates. Instruments like mutual funds and corporate

bonds are included in the moderate risk category.

How to determine risk benefit

Determining the amount the risk you can take depends on the type of investor you are. If your objective

is to earn decent returns without taking high risk, you should prefer investing in products like fixed

deposits, government bonds, etc. Similarly, if you are nearing retirement, your investment portfolio

should contain as little risk as possible. Instruments to be considered can be fixed-income products like

public provident fund (PPF), monthly income plans, etc. Conversely, if you are ready to take higher risk,

there are several products that have the potential to provide high returns. These include stocks,

commodities, junk bonds, etc.

Hence, it is first important to determine the level of risk you are ready to take, and then select the

appropriate instruments. This will ensure that your goals are not only met in time, but are also in

accordance to your risk profile.


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A. 3. What are the advantages of borrowing through formal channels rather than local

moneylenders?

Borrowing from formal channels like banks and non-banking financial companies is safer when

compared to private moneylenders.

Loan can be a serious liability for an individual and the correct management of the same is a crucial

aspect of business, and even life. The most common form of loan taken by individuals is a personal loan.

However, selecting the right mode of borrowing is crucial for your future years.

When it comes to loans, there are two types of lenders in the market today: formal channels like banks,

non-banking financial companies (NBFCs), etc., and private moneylenders. Before applying for a loan, itis important that you understand the pros and cons of borrowing from organized and unorganized

lenders.

Risk factor

Availing of a loan from banks, licensed NBFCs and microfinance institutions (MFIs) requires a significant

amount of paperwork, which may seem cumbersome. However, the level of security in loans from such

institutions is higher than that from unorganized lenders. There is little chance that a licensed lender will

overcharge or cheat you. In case of an unorganized lender, the process may be simple and thepaperwork may be minimal; however, the risk associated with such loans is higher, as the lending

process may not be transparent.

Rate of interest

The working of organized lenders is usually regulated by the central bank. In case of India, it is the

Reserve Bank of India (RBI) that puts in place policies to avoid unfair practices and take corrective

measures. Hence, the rate of interest charged by these players cannot exceed a certain level. However,

there is no such governing body when it comes to private money lenders. Consequently, they charge arate of interest that is usually much higher than that of banks and NBFCs.

Recovery process


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Another key factor that you need to keep in mind while availing a loan is the recovery process. In case of

late payment, organized players such as banks and NBFCs may charge a penalty. However, a similar

situation with an unorganized lender may result in personal visits from the lender or selling of the

collateral.

Benefits

Borrowing from a financial institution like a bank provides a number of tax benefits and improves the

credit rating of an individual or organization, if the debt is managed well. Such benefits are not available

in case of unorganized money lenders, as there is no documented record of the transaction.


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- Tax exemption

Some people invest their money in various financial products solely for reducing their tax

liability. Some products offer tax exemptions while many offer tax benefits on long-termprofits.

- Liquidity

Many investment options are not liquid. This means they cannot be sold and converted into

cash instantly. However, some people prefer investing in options that can be used during

emergencies. Such liquid instruments include stock, money market instruments and exchange-

traded funds, to name a few.


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A. 5. What does diversification mean? How is it helpful?

Diversification of an investment portfolio can reduce risks and get higher returns in the long term.

Before making an investment, it is essential to not only know where to invest, but also understand how

to invest. This ensures that your returns are high and you are able to meet your financial goals with

ease. In addition, experts suggest that diversification is the way to go for stable returns and protection

of your corpus.

What is diversification?

In investment terms, diversification is a risk management technique that collates a variety of

investments within a single portfolio. In other words, diversifying your portfolio means investing your

money in a variety of instruments to reduce risk and increase your earning potential.

Advantages of diversification

Not all industries or individual companies perform well all the time. Some have the tendency to rise in

value while some can decline. Diversification essentially ensures that the losses incurred on some

investments are compensated by the profits earned on others. Such distribution of investments brings

stability and safety to your portfolio and reduces the risk of losing money.

The ifs and buts

Even though diversification might help lower the risk associated with investments, there are certain

factors that should be kept in mind. If you are investing for short-term, say for 3-6 months, it is advisable

not to diversify too much, and invest in safer products like bonds or term deposits. This would prevent

the value of your investments from fluctuating too much. In other words, diversification in case of short-

term investment is not a good option. Similarly, if you are investing a comparatively smaller amount of

money, diversification is not needed.

Opting for a diversified portfolio requires a lot of research and in-depth knowledge. You must also

clearly understand the investment instruments and the expected returns of each before making the

investment.


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A. 6. What factors should I consider while building my investment portfolio?

Building an investment portfolio requires proper planning and knowledge. Here are a few pointers to

keep in mind.

Investment can be the means to achieve all financial goals, but it is often a tricky exercise. There are

multiple factors that should be considered and assessed while building an investment portfolio. You

need to ensure that your portfolio is able to meet future requirements, while also giving you peace of

mind. Most importantly, your investment portfolio should be aligned with your goals and risk profile.

Elaborated below are some factors that need to be considered while constructing your investment

portfolio.

Age and time horizon

Age is an important factor while making an investment. If you start investing early, you can have an

aggressive investment strategy, since your risk taking ability is high. You can gradually shift to safer

options as you grow older. If you are nearing retirement, your portfolio should consist mainly of fixed

income products, as you cannot afford to take high risks during your later years.

Investment objectives

Before starting off with your investment, you need to be clear about your objective for investing. If you

want more returns in the short-term, your investment strategy should be aggressive, and vice versa.

Tax implications

Many investment instruments provide substantial tax exemptions. If saving tax is your priority, your

portfolio should contain more tax-saving instruments. You may also have to hold assets for a longerperiod to become eligible for long-term tax exemption.

Balancing risk and reward


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One of the most important things to consider while building your investment portfolio is not taking

unnecessary risks. There should be a balance between the amount invested in high-risk and low-risk

options. Government bonds typically offer stable but unspectacular returns. Stocks, on the other hand,

promise higher returns but also carry higher risks. A diversified portfolio can balance risks and returns.


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A. 7. What is compound interest? How does it impact return on investments?

Compound interest is an essential component of investment, which is calculated on the sum of principal

and accrued interest.

When you deposit money in a bank, you earn interest on the principal amount. If the annual interest is

calculated only on the principal amount every year, it is known as simple interest. However, if the

interest is calculated on the total amount i.e. the principal amount as well as the interest earned in the

past, it is known as compound interest.

The calculation

Calculating compound interest on a given amount is a simple procedure that involves factoring in the

increased principal amount that includes the interest accumulated over the years. The most commonly

used formula is:

A = P (1+r/n)nt

Where

P = Initial investment

r = Rate of interest

n = Number of times the interest is compounded in a year

t = Number of years

A = Amount after adding compound interest

This formula can be explained with the help of a simple example. Say you invest Rs 10,000 for a period

of 5 years at an interest rate of 8 percent per annum. Under simple interest, the interest amount after 5

years would be Rs 4000, whereas the interest for the same period compounded annually would be Rs

4693.28.


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ROI and compound interest

As shown in the example above, investments with a compound rate of interest earn better return on

investment (ROI) than ones with simple interest. For investments in which the interest rate is

compounded twice a year or more, the return on investment (ROI) increases at an even faster rate.Hence, if given a choice, it would be more profitable if you select a compound rate of interest while

making investments.


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A. 8. What is the difference between saving and investment?

Although savings and investment can be used for meeting various expenses in life, there are some major

differences between them. Heres throwing light on some of them.

Come month end, and it is time to decide what you want to do with the money left over after paying off

all the expenses. You would typically have two options: you can either save it or invest it. Many people

wrongly assume that both the concepts are same. However, there are some major differences between

the two. Let us understand these two concepts in detail.

Meaning

Saving money means keeping aside a part of your income regularly in order to deal with unexpected

expenses. Investment means putting your saved money in various products in order to earn returns and

grow your wealth.

Time

Savings are usually used to meet your short term needs. People save in order to deal with emergency

situations and meet unexpected expenses. However, investment generally entails a longer horizon of six

months or more. It is designed to provide returns and grow your money over a period of time.

Risk and reward

Another difference between savings and investment is the risk they bear and returns they offer. While

savings stored in a safety vault are very safe, they will not generate any returns over the years. Even if

money is kept in a savings account, it will provide a negligible rate of return. On the other hand, money

invested in various products like stocks, mutual funds, gold, etc. is subject to more risks, but has the

potential to grow over time. If invested wisely, your money can grow manifold over years.

Liquidity

When it comes to liquidity, your savings are the most liquid assets, as they can be accessed at any time.

However, this is not the case with investments. It takes a few days for the money to reach your bank

account after you decide to sell your investments.


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A. 9. What is the impact of inflation on savings? Can investing help me beat inflation?

Rising inflation increases the cost of living, leaving a dent in your savings; investing in different

instruments can offer a solution to this problem.

In economics parlance, the term inflation means an increase in the price of goods and services,

resulting in a fall in buying power of money. Hence, inflation rate is the percentage of increase in prices.

Now, let us understand how it impacts your savings and what measures can be taken to beat inflation.

Impact of inflation on savings

Increase in inflation indicates an increase in price of goods and services at a certain rate. However, the

amount you save from your income every month may not increase at an equivalent rate. Therefore, the

price rise puts pressure on your savings. After a few years, the amount you have saved will be able to

buy lesser number of units due to increase in prices.

The impact of inflation on savings can be explained with the help of a simple example. Suppose you have

Rs 1,000 today, and the rate of inflation is 1 percent per year over the next 10 years. This means that a

product selling at Rs 1,000 today will cost Rs 1,105 after 10 years. However, the amount that is lying in

your safety vault (Rs 1,000) will remain the same even after 10 years. So, technically, you are losing Rs

105 in 10 years without even spending a rupee from your savings.

Investment can help beat inflation

As seen in the above example, the value of money drops over time if you simply store your savings in a

safety vault. Therefore, in order to beat inflation, you must invest in options that have a higher rate of

return than the rate of inflation. So, using the above example, you must earn at least Rs 105 on your Rs

1,000 in 10 years if you want to beat inflation.

There are several instruments you can invest in: stocks, gold, fixed deposits, corporate and government

bonds, property, etc. are some of them. You can invest a part of your money in each of these

instruments to grow your savings and beat inflation. In case you are unsure about the type of

investment, you can consult with a financial expert who can throw light on the different options that are

suitable for you.


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A. 12. Why must I save?

Saving money is crucial in securing your life from uncertainties and achieving your long-term financial

goals.

In a world where almost everything is available only in exchange of money, buying essential things in life

and securing our future comes at a price. Many a times, living from paycheck to paycheck leaves us with

little additional cash to take care of our future needs. In such a scenario, inculcating a habit of saving

goes a long way in ensuring that all your needs are fulfilled.

Saving is the process of keeping aside a part of your monthly income to accumulate a large sum over a

period of time. This habit essentially serves two important purposes: dealing with emergencies andachieving long-term goals. Let us discuss these two in detail.

Dealing with emergencies

Unexpected events can arise at any moment. Situations like medical emergencies, job loss or natural

disasters can occur without prior warning. If, during such times, you are not financially prepared,

borrowing money would be the only choice. It is therefore essential to keep some money aside every

month. The cumulated amount will come handy in dealing with such emergencies when they occur.

Achieving long-term goals

Every individual has various goals at different stages in life. However, to achieve these long-term goals

that may range from buying a car, saving for your childs education to planning your retirementyou

will need a lump-sum amount. This becomes difficult, especially if you have fixed spending habits.

Hence, inculcating the habit of saving regularly enables you to accumulate a sum that can achieve all

your long-term goals.

While savings can help you take care of the above-mentioned situations, investing the saved amount in

various financial instruments can help you grow your wealth and deal with situations in a better way.


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A. 13. Why should I start investing at an early stage?

Starting investment early can make your life comfortable and debt-free. Here is how.

Whether its learning a new skill or investing your money, starting early has its own advantages. Working

towards your goal early in life gives you ample time to achieve your goal and make necessary

amendments, if any.

When it comes to investing, there are a host of reasons to start early. Here are a few of them.

Provides compounded return

The earlier you start investing, the more returns you can earn, thanks to the magic of compound

interest. A compound rate of interest ensures that you earn interest on your interest income too.

Here is an example: if you invest Rs 10,000 in an instrument that gives you 10 percent annual interest,

you will earn Rs 1,000 in the first year. So, your total corpus becomes Rs 10,000 + Rs 1,000 = Rs 11,000.

Next year, you will earn 10 percent interest on your new corpus, i.e. Rs 11,000. In effect, you keep

earning more interest. Hence, it pays to start early.

Mends spending habits

You can only spend what you have. You would generally spend more if you have more disposable

income in your hand, often through impulse buying. Keeping aside a fixed amount of your monthly

salary for investment early on can not only help you prevent impulse spending, but also build a corpus in

the long run.

Boosts knowledge

The earlier you start investing, the earlier you learn to manage your finances. Involving yourself with the

actual investment process gives you first-hand, practical knowledge about how investments work, and

gives you personal finance lessons early in life.


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Improves the overall quality of life

Putting into action a well-planned investment plan early in life helps improve your standard of living,

and prevents you from taking hasty decisions during the later part of your life. It ensures a debt-free,

comfortable and a financially free life, even after retirement.


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B.

Trading


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B. Trading

B. a. Equity


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B. a. 14. How can I invest in the Indian share market?

Following the steps mentioned here will help you get started with investing in the stock market.

Stock market investments play an important role in planning of your finances. Profits and bonuses from

such investments can go a long way in adding to your regular income and meeting expenses. Once you

have decided to invest in the share market, there are a number of steps that need to be taken before

you can make your first transaction. Here are the most important ones:

- Get educated

Learn how the stock market works and what factors affect the movements of the stocks. Having the

broader picture in mind will enable you to take better investment decisions.

- Determine financial goals

Your financial goals will help determine the type of stocks you should invest in. If you are after quick

and aggressive returns, you may opt for volatile, high risk stocks. If you are a steady, long-term

investor, you may opt for blue chip stocks.

- Open a demat/trading account

To invest in the stock market, you will need to open a demat account. You can do this either offline

or online.

o Offline account: This is a traditional broking account, where you can place an order either

through the telephone or by visiting the brokerage house personally. While there are some

advantages of this method like professional advise, personal service, etc. there are some

drawbacks like longer execution time, high maintenance and service costs, etc. as well.

o Online account: You can also open an online account, which is linked to a depository

participant and your bank account. You can place buy/sell orders directly, and the money

will be accordingly debited from/credited into your bank account. Maintaining an online

account is less expensive, and the execution is quick.

- Make your first transaction

Once you have identified the stock that has the potential to meet your financial goals, you are

ready to make your first transaction. Note that the stock market is volatile and the stock prices

keep changing every minute. Seek advice from your broker or a financial advisor before buying or

selling any stock.


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B. a. 15. How do I read a stock table or quote?

Reading stock tables is easy. The process just involves understanding the abbreviations and making sense

of the numbers.

Almost every financial newspaper carries a page or two covered with numbers and symbols. These are

nothing but stock tables that help you track your investment; interpreting the information from these

tables is as simple as reading other pages of the newspaper. Let us understand what these tables mean

and how to read them.

Tables in most newspapers will look something like this:

Company Close % Chg Open Day H/L Vol. P/E

ABC

GHI

XYZ

29.75

44.20

35.70

0.2

5.0

-1.7

29.70

43.95

36.90

30.80/29.55

44.20/41.50

38/35.50

151K

169K

87K

-

221.0

30.3

The first column (Company) lists down the name of the companies listed on the stock exchange. The list

is usually sorted in alphabetical order (A-Z). So, if you are looking for a particular stock, search for it

alphabetically.

The second column Close is the price of the stock when the market closed for the day. Similarly, the

fourth column Open is the price when the market had opened. These two prices help you determine

the appreciation/depreciation in the stock price during the day, and your proportionate profit/loss.

However, you do not have to manually calculate the change in the price during the day. The % Chg

column, third in the above table, gives you the exact percentage change in the stock price on a given

day.


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The Day H/L column indicates the highest and the lowest price the stock has been traded at in a day. In

simple words, this is the maximum and the minimum price people have paid to buy the stock in that

trading day.

Vol. is the volume of the stock traded on that day.

The last column usually carries different information on different days of the week. In this case, it is P/E

(price-to-earnings ratio). Similarly, it may show market capitalization (Mcap), net profit, and so on

throughout the week.


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company is listed. The price of the stock is determined by the demand, supply and market demographics

at a particular time, and keeps changing by the minute.

Buyers/Sellers

When a company is listed on the stock exchange, traders/investors buy and sell stocks with the aim of

making money through price fluctuations. These traders/investors can be individuals, corporate entities,

governments, etc.

Brokers

Brokers or brokering houses are middlemen between the buyers/sellers and the stock exchange. They

have the authority to carry out a transaction on the behalf of the buyer or seller. It is mandatory for the

investor to have a broking account in order to trade/invest in stocks. Brokers charge an additional fee

for the service they provide, which is known as brokerage.


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B. a. 17. How is a futures contract different from an option?

Here is a comparison between the two most commonly-used methods of trading: futures and options.

While both futures and options are contracts between two parties to exchange a predefined number of

stocks at a fixed price on a future date, there are some differences that set the two apart. Let us

understand what these differences are.

Obligation

The first and the most important difference between a futures and an option contract is the obligation

they put on both the parties involved in the contract. In a futures contract, the buyer and the seller have

to exercise the trade on or before the specified date. However, in options, the buyer has the right, but is

not obliged to carry out the transaction. In case the buyer decides to exercise the option, the seller has

to sell his holdings.

Upfront cost

Apart from the obligations, upfront cost is another differentiator. Traders can participate in a futures

contract without paying any upfront cost. However, buying an option involves paying a premium. This

premium is a kind of fee paid by the buyer for waiver of the obligation to exercise the trade.

Liability

There is one huge difference in both types of trading, one that affects the potential profits and losses

incurred by traders. The buyers liability, in case of a futures contract, becomes unlimited if the prices

start moving in the opposite direction. However, in stock options, the buyers liability is limited only up

to the money invested in buying the options. Only the writers of options are exposed to unlimited

liability.

Expiration

When a futures contract expires, the buyer has to buy the specified number of stocks mentioned in the

contract. On the other hand, if the options are out of the money, the buyer can let the contract expire

and become worthless.


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B. a. 18. How is fundamental analysis different from technical analysis?

While the purpose of both the methods is same, there are many differences between both. Mentioned

here are a few of them.

Fundamental analysis and technical analysis are two important methods of forecasting the future trends

of instruments available in the financial markets. Although the two serve the same purpose of predicting

price movements and minimizing risks, there are some major differences between the two.

Heres a look at the differences:

Meaning

Fundamental analysis is a method of evaluating a companys stock in order to find its intrinsic value, and

analyze the factors that might affect the stock price in the future.

Technical analysis, on the other hand, is a statistical method used to find patterns and predict future

movements based on past market data.

Methodology

Fundamental analysis is done mainly by examining the financial data of the company, and other factors

like industry trends, competitors performance, countrys economic outlook, etc.

Technical analysis, however, asserts that there is almost no need to conduct fundamental research, as

most of the factors are accounted for in the price of the stock. It therefore refers to only past price

movements and market psychology to come to a conclusion.

Time horizon

Fundamental analysis takes a long-term approach, while technical analysis has a short-term view. The

former looks at how various factors will impact the stock price in a long duration (mostly in years), and


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the latter focuses on predicting the immediate (weeks, days and sometimes even minutes) price

movements.

Users

Since fundamental analysis examines all the factors that will impact the stock price in the years to come,

it is mainly used by investors who have a long-term view. However, technical analysis is used by a

different set of people. Traders and short-term investors rely on this method, as it serves as a tool for

forecasting price movements in the near future.


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B. a. 19. How is the Indian stock market regulated?

The Indian stock market is regulated as per the guidelines laid down by the Securities and Exchange

Board of India (SEBI). We bring you the details.

A regulating body called the Securities and Exchange Board of India (SEBI) was established in 1992 with a

view of protecting the interest of investors. This body lays down regulations in order to ensure orderly

growth and smooth functioning of the Indian capital market.

Some of the most important functions of SEBI to regulate the Indian stock market are listed below:

- Specifying rules and regulations

SEBI has the authority to specify rules and regulations to control the stock exchange. For instance,

the opening (9.15 am) and closing (3.30 pm) time of the market has been determined by SEBI, and

it has the right to change the timing if deemed necessary.

- Providing licenses to dealers and brokers

No dealer or broker can start distributing securities to investors without getting a prior approval

and license from SEBI. It also has the right to withhold or cancel the license of brokers and dealers

not adhering to the specified guidelines.

- Auditing the performance of various stock exchanges

The regulating body is also responsible for auditing the performances of various stock exchanges

and bringing transparency in their functioning.

- Controlling mergers, acquisitions and take-overs of the companies

Some companies try to manipulate stocks and buy a majority stake in other companies with anintention of a take-over. SEBI controls and prohibits such movements if it is not in the interest of

the company.

- Prohibiting unfair trade practices in the market


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While SEBI has laid down specific guidelines that promote fair trade practices, many companies

occasionally undertake activities that are not healthy for the market. SEBI has the power to prohibit

such activities and take action against the parties involved in such a trade.

Apart from these important functions, SEBI has many other responsibilities, which it exercises

appropriately in order to regulate the Indian stock market.


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B. a. 20. What are options?

An option is a contract between two parties to exchange a set of stocks at a future date. Learn more

about options here.

A stock option is a financial derivative that allows you to trade a stock at a specific price on a future

date. Here, the buyer gets the right, but not the obligation, to carry out the transaction on or before the

given date. However, the seller has to sell his holdings if the option is exercised.

Lets take an example to understand the concept better. Say, you find an apartment (for Rs 50 lakh) that

you would love to own, but do not have the money to buy now. You negotiate with the seller, and he

gives you an option to buy this house within 3 months. However, he charges an extra Rs 1 lakh for thisextension.

Now, even if the price skyrockets to Rs 80 lakh, the seller is obliged to sell this house to you if its what

you want, as he had already taken Rs 1 lakh on mutual agreement. In case the price moves down to Rs

30 lakh, you can still buy the house, but you dont have the compulsion to buy it. In the latter case, you

will lose the token amount (Rs 1 lakh) that you had initially paid.

Some of the terminologies used in options market are elaborated below.

Expiration is the date on which the contract expires. A stock option can be exercised on or before this

date. Usually, most options are valid for one month, and they expire on the last Thursday of each

month.

Strike priceis the price at which the stock mentioned in the contract will be bought or sold on or before

the expiry date.

In a call option, when the stock price moves above the strike price (and vice versa in put option), the

option is known to be in the money (ITM). On the other hand, in a call option, when the stock price

moves below the strike price (and vice versa in put option), it is known as out of the money (OTM).


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Premiumis the price of the option contract.


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B. a. 21. What are stock futures?

Stock futures are contracts between two parties, who agree to exchange stocks at a predetermined price

some time in future.

Stock futures are contracts between the buyer and the seller, agreeing to exchange a predefined

quantity of a stock at a fixed price (which is the future price), at a future delivery date. The specifications

like lot size, price per unit, expiry date, method of settlement, etc. are defined at the time the contract is

made.

Futures are usually traded in lot sizes ranging from 125 to 8000, depending on their underlying price;

multiple lots can be traded in one contract. Since these are futures contracts, the broker usually allowsclients to trade on margin. This means that the trader can buy/sell lots worth more than the available

cash balance in his trading account.

Traders usually take either long position or short position while entering into such a contract. Long

position entails buying the contract at a lower price and selling it within the specified period at a higher

price. Conversely, a short position means selling the contract first at a higher price and then buying it

again at a lower price, thereby making profit from the difference in price.

How are stock futures priced?

While the real price of a futures contract changes according to the change in demand and supply,

theoretically it is the total of the current price and the cost of carrying, minus dividends (if any). The

interest charged from the start of the contract till its maturity is known as cost of carrying.

So, the price of a futures contract = spot price + the cost of carryingdividends

Let us understand this with the help of an example. Suppose the stock of ABC company is traded at Rs

1,000 in the spot market with a prevailing interest rate of 7 percent, and there are no dividends

declared. The price of a futures contract of 1 month for that stock will be calculated as follows:


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Price of the futures contract = 1,000 + (1,000 x 0.07 x 30/365)

= 1,000 + 5.75

= Rs 1,005.75


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B. a. 22. What are stocks?

Stocks are shares in a company listed on the stock exchange. Stock holders are considered owners of the

company. Learn more about stocks here.

Stocks (also known as shares or equities) are a type of financial instrument issued by a corporate

organization with a view to raise capital. When you buy the stock of a company, you are actually helping

the company raise capital; such a transaction gives you proportionate ownership of the company.

Stocks of various companies are listed and traded on the stock exchange. They can be bought and sold

on the stock exchange by anyone who has a demat account. Various individuals, brokerages, traders and

corporate entities trade stocks through the two major stock exchanges in India, namely the National

Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). Companies need to meet specific criteria in

order to get listed on the stock exchange and issue shares to investors. Some of the largest Indian

companies have issued stocks to shareholders in order to start a business and raise capital.

Understanding stocks better

Heres an example to understand stocks better: imagine that you want to start a business that requires

an initial capital of Rs 1,00,000. In order to raise these funds, you divide the company in 10,000 pieces

and sell each piece at Rs 10 to people who are interested in investing their money in your business.

All the buyers are owners of your company in proportion to the number of shares they hold.

Consequently, they are given profits of the company in the same proportion. These shareholders elect a

few peopleknown as the Board of Directorsto take active interest in day-to-day operations of your

business. If any of the stock holders wish to quit being an owner, all they have to do is call their brokeror log into their demat account and sell their holdings.


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B. a. 23. What are the advantages and drawbacks of options?

Learning about this instruments advantages and drawbacks will enable you to make an informed

decision.

Options are considered to be one of the most versatile financial instruments available in the stock

market today. They provide the buyer the right, but not the obligation to exercise the contract. Before

trading in this instrument however, it would be wise to go through its benefits and drawbacks.

Let us have a look at some advantages.

Leverage

Options allow you to trade on margin. This means that you can invest in a large number of stocks by

paying for only a fraction of them. This enables you to earn more profit if the price moves in the

expected direction.

Hedging

Options can be used to hedge against the risks involved in your holdings. If, for instance, you hold 100shares of ABC company, and you believe that its price might fall in the near future, you can buy put

options in order to safeguard your current position.

Profit potential

Options give you the opportunity to earn in almost any market condition. Investors can make as much

profit from a falling market as from the markets upward movement.

While options provide good opportunities to make profit with a low investment, there are certain

drawbacksthat keep many investors away from this type of trading too.

Lower liquidity


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Options are traded at different prices with different expiry dates. However, some contracts have a very

low liquidity. There is a strong possibility of an uninitiated trader being stranded with an options

contract that no one is willing to buy, resulting in losses.

Complex

Options are quite difficult to understand, especially for beginners. The complicated nature of this

instrument, along with the fluctuations in the stock price makes it a very risky instrument for amateurs.

Time-bound

Stocks can be held for a long time, even decades. However, options contracts have an expiry date.

Hence, they may not be suitable for long-term investment needs.


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B. a. 24. What are the most commonly used ratios while evaluating stocks? What do

these ratios mean?

Mentioned here are the five most important financial ratios used to evaluate a stock before making an

investment.

Making money by investing in the stock market is not as difficult as it seems, especially if you know

where and why you are investing. One of the best methods to evaluate the financial strength of a

company is to understand the various financial ratios, and use them to compare stocks of companies in

the same industry.

Listed below are the five most common ratios used to evaluate stocks.

EPS ratio

Earnings per share (EPS) ratio determines the profitability of the company. It calculates the net income

allocated to each outstanding share of the company. The formula to calculate EPS is:

(Net incomeDividend on preferred stock) / Average outstanding shares

P/E ratio

Price to earnings (P/E) ratio is one of the most popular ratios used to evaluate a stock. It is the ratio of

the market share price of the company to its earnings per share. The ratio of one company can be

compared to that of another to determine how expensive their shares are. Usually, the lower the P/E

ratio, the better it is for investors. However, this may not always be the case. The formula of P/E ratio is:

Market price per share / Annual earnings per share

Dividend yield ratio

Since many investors buy stocks solely for the purpose of earning dividend income, it is important to

know how much dividend a stock earns. The dividend yield ratio helps in determining this. It is

calculated by using the following formula:

Dividend per share / Market price per share

ROE ratio

Return on equity (ROE) ratio shows how efficiently a company uses the money raised by issuing shares.

A higher ratio shows that the funds are being well-managed by the company. The formula to calculate

ROE ratio is:

Net income / Shareholders equity

Debt-to-equity ratio


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This ratio brings out the amount of financial leverage a company is using. It helps investors understand

the proportion of assets owned by the company through debt and equity. Usually, a higher debt-to-

equity ratio is considered worrisome. The formula of debt-to-equity ratio is:

Total liabilities / Shareholders equity


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B. a. 25. What are the various types of options?

Weve simplified the meaning and functioning of the two types of options (call and put), through an easy

example.

There are two types of options contracts available in the market for traders: Call option and put option.

Let us understand these two types in detail.

Call option

In this type of contract, the buyer has the right to buy securities at a given price, on or before a

specified date. However, he is not obligated to undertake the transaction. The seller is obliged to sell the

securities in a call option if the buyer chooses to execute the transaction. The buyer enters into such a

contract with a view of benefiting from the rise in price of the stock in future.

Here is an example of call option:

A trader purchases a call option to buy 1,000 shares of a company with strike price of Rs 300 (with the

current price of the stock being Rs 280) at an option price of Rs 10 per share. Now the initial investment

for the buyer is 1,000 shares X Rs 10 = Rs 10,000.

If the price of the stock goes up to Rs 320, the buyer still buys the stock at Rs 300 per share. So his net

gain is:

{(320300) x 1,000} - 10,000 (initial investment) = Rs 10,000

Put option

In this type of contract, the option buyer has the right, but is not obliged to sell securities to the option

seller at a given price, on or before a specified date. The buyer enters into such a contract with a view

to benefit from the fall in price of the stock in future. The example given below will make the concept

easier to understand.


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A trader purchases a put option to sell 1,000 shares of a company with a strike price of Rs 300 (current

price of the stock being Rs 320) at an option price of Rs 10 per share. Now the initial investment for the

buyer is 1,000 shares X Rs 10 = Rs 10,000.

If the price of the stock goes down to Rs 285, the buyer can still sell the stock at Rs 300 per share. So his

net gain is:

{(300285 x 1,000)}10,000 = Rs 5,000


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A fundamental analysis is a combination of both these factors, besides an economic, industry as well as

company analysis to determine a fair value of the stock. Depending on the difference between its

current stock price and its fair value, the stock is rated as undervalued, overvalued or fairly valued by

the analysts. Experts believe that the stock price gradually moves towards its fair value in the long run.

Companies with strong fundamentals are likely to perform well in the long run as compared to those

with weaker fundamentals. Fundamental analysis is, therefore, very useful for long-term investors.


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B. a. 28. What is margin trading?

Margin trading means buying and selling stocks using money borrowed from your broker. Read on to

learn more about this kind of trading.

Margin trading is essentially a method of buying stocks by borrowing money from your broker or

brokerage house. It is a leveraging mechanism that allows you to take positions in the market worth

more than what is possible with your own resources. However, in order to carry out margin trading, you

need a margin account.

Role of the broker

Not every broker has the authority to open a margin account for clients. Only brokerage houses with a

net worth of a minimum of Rs 3 crore enjoy this right. It is the responsibility of the broker to enter into a

margin trading agreement with the client as per the format specified by the Securities and Exchange

Board of India (SEBI).

Role of the trader

In India, an equity trader enjoys the right to borrow up to 50 percent of the total transaction value from

the brokerage house. However, before getting involving in such a transaction, the trader will have to

deposit the required amount (at least 50 percent of the value) with the broker.

A trader who buys stocks on the loan provided by the broker can keep the loan for as long as he intends;

but it comes at a cost. Interest is charged on the amount of the loan, and it keeps accruing until the

trader repays this amount in full.

Example

If you deposit Rs 10,000 in your margin account, you are eligible to buy stocks worth up to Rs 20,000.

However, interest will be changed only if you make a purchase of more than your cash balance, i.e. Rs

10,000 in this case.


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B. a. 29. What does 'support' and 'resistance' for a stock mean?

These terms are used to signify the price barriers the stock has experienced in the past. Heres more

information about them.

Support and resistance, in simple terms, are nothing but barriers for a stock price at the lower and upper

level respectively. They are considered to be of paramount importance in the world of technical

analysis. While the two terms may sound alien to beginners, understanding them is quite easy. Let us

learn the meaning and usefulness of these two concepts.

Support

Support is a level where the falling price of a stock usually finds support. This means that the price is

likely to bounce back (based on historic price trends) rather than go down further. However, technical

analysts believe that if the price falls well below the support level, it is likely to keep falling, until it finds

another support level.

Resistance

Resistance is the opposite of support. It is a level where the rising price of a stock finds resistance. This

means that the price is likely to fall rather than continue going up once it reaches this level. Once the

stock price climbs above this level, it is likely to continue its upward movement, until it finds another

resistance level.

Let us have a look at an example to understand the concept better.


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If a trader holds shares of ABC company and is planning to sell his holdings, looking at the above chart,

he can analyze that the stock has found resistance at Rs 20 and Rs 25 in the past. So, he would not wait

for the stock to go higher than these resistance levels , and sell his holdings before it starts moving down

again.

Similarly, there are support levels at Rs 15 and then at Rs 8. So, if the trader intends to buy this stock

again, he would not wait for the stock price to go lower than these support levels, or it might justbounce back.

08

15

20

25


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B. a. 31. What is technical analysis?

Technical analysis is a mathematical technique that is used to predict the price movements of a stock.

Learn how it works.

Fundamental and technical analysis are two common methods investors and traders use in order to

predict the future movements of a given stock. We have a separate article detailing how fundamental

analysis works. Now let us understand what technical analysis is, and how it works.

Technical analysis: The concept

Technical analysis is a method of forecasting a stocks future performance by studying its past

performance. It does not take into consideration the intrinsic or fundamental value of the company. The

analysis is done simply on the basis of certain assumptions, which may or may not be accurate.

The methodology

Through technical analysis, traders and investors study how the market behaves when the stock price

reaches a certain level. This method is based on three main assumptions:

- Stock price includes all the factors

-

Stock price follows certain trends

-

History repeats itself

Let us understand these assumptions in detail, as they form the foundation of technical analysis.

In the first assumption, it is assumed that the stock price, at any given moment, reflects whatever the

company and the surrounding factors have to offer. This includes the companys fundamentals, market

psychology, previous performances, etc. The price, this method assumes, is the summation of all the

factors. This assumption, hence also eliminates the need for separate research.


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The second assumption is that the stock price will follow a particular trend. This means that once the

market behaves in a specific manner in response to an event at a given price, it will follow the same

trend in the future as well.

Lastly, technical analysts believe that history repeats itself. This denotes that what has happened in the

past (related to price moments) is likely to happen again, irrespective of the market conditions or the

economic outlook.

After these three assumptions are factored in, the analysts examine previous price charts, and come to a

conclusion about the stocks future price movements.


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B. a. 32. What is the meaning of long or short positions?

Long and short positions are nothing but two methods of trading stocks. Heres throwing light on them.

Many investors use a host of strategies to earn profits by trading stocks. One such strategy is going long

or going short on a stock. Let us understand what these phrases mean and how are they useful to

traders.

Long position

Taking a long position means buying a contract with the intention of selling it at a higher price later and

thereby making profit. However, if the price goes down, the trader has to bear the loss up to the extent

of the fall in price. Many traders use the terms buy and long, inter-changeably.

Example:Say you purchase 100 shares of ABC at Rs 20 per share. So, you pay a total of Rs 2,000 for this

transaction. If a month later the price of this stock moves up to Rs 25, you sell these stocks and earn a

profit of Rs 500 (Rs 5 x 100 shares).

Short position

Taking a short position means selling a stock first with the intention of buying it back at a lower price,

thereby making a profit from the difference in price. In such a transaction, the trader borrows a set of

stocks from the broker, and sells it in the open market. He has to buy these stocks later since the

borrowed stocks must be returned to the broker. In such a scenario, if the price of the stock falls, the

trader will make a profit, and in case it goes up, he will incur losses.

Example:Say you sell 100 shares of ABC at Rs 10 per share. So, you receive a total amount of Rs 1,000.

If, after a month, the price of this stock comes down to Rs 7, you buy 100 shares again for Rs 700,

making a total profit of Rs 300 (Rs 1,000Rs 700).


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B. a. 34. What is the purpose of technical analysis?

The core purpose of technical analysis is to carry out stock price forecast by looking at past data.

While fundamental analysis is one of the most effective methods of determining the long-term

movements of a stock, technical analysis provides a similar tool for short-term traders. The latter is

used universally by a large number of traders as it is quite important to them for various reasons. Some

of them are elaborated below.

It identifies a pattern of fluctuations

One of the most important assumptions that is made while undertaking technical analysis is that the

stock price follows a trend, and this trend repeats itself in a logical pattern. While identifying these

patterns can be complex at times, it enables traders to make sense of the short-term fluctuations a

stock experiences. More importantly, it helps in predicting the future movements of stock prices.

It enables effective decision making

Since most traders buy stocks and sell them (or vice versa) on the same day, they need to decide quickly

on the purchase and sale price. However, using fundamental analysis for such a short-term trade is not

possible. In such a scenario, technical analysis is the only type of research that can provide traders some

idea about the direction of the stock price. There are several automated tools available today that can

pull out technical information according to your preference.

It is important to note here that this type of analysis is based on a number of assumptions, and it gives

utmost important to the price movement, ignoring other factors. Hence, the predictions related to price

movements may not be always accurate. Despite this, it is widely used by traders mainly because it

serves the above-mentioned two purposes.


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B. a. 36. Who are the bulls and who the bears in a stock market?

The terms bull and bear represents the rise or fall in the stock market respectively. Heres detailing

more about the concepts.

Bulls and Bears are the two most commonly used terms in the stock market. Let us understand what

these terms mean and why these terms are used in the market.

Bull market

A bull market, in simple words, is a rapidly rising market. Such a market is usually associated with

buoyant investor confidence, increased investment, and an overall improvement in the economic

conditions. When an upward movement continues for a many days in a row, it is considered to be a bull

run. And if someone expects the market to go up, he or she is said to have a bullish outlook.

Technically, when prices move up by more than 20 percent, it is considered to be a bull market.

Bear market

A bear market is the opposite of the bull market. When the stock market keeps declining for several

days, it is known as a bear market. Such a trend can be commonly noticed when the economy is weak,

and there is widespread pessimism and fear among investors. Technically, a fall of more than 20 percent

in the stock price is considered to be a bear market.

The origin of the terms bull and bear is unknown. However, many believe that it has to do with the

way these animals attack their enemies. Bulls usually toss their horns upwards and bears swing their

paws downwards. Regardless of how the terms were derived, they are now commonly used by market

traders and investors to indicate the direction the markets are moving in.


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B. a. 37. Why do I need a stockbroker?

A stockbroker is the agent between the stock exchange and the buyer/seller. Learn about stockbrokers

here.

By definition, a stockbroker is an individual or an organization having the authority to buy or sell stocks

on the stock exchange on behalf of clients. He is an agent who exercises a transaction as directed by the

buyer or the seller, and charges a fee for this service.

Do I need a stockbroker?

Yes. In order to invest/trade in the stock market, it is important to open a demat/trading account, and

only stockbrokers have the authority to open such an account for investors. These brokers are governed

by Securities Contracts (Regulation) Act, 1956, SEBI Act, 1992, and SEBI Rules and Regulations, 1992.

Apart from this service, stockbrokers provide many other optional services that might be useful for

investors. Beginners often find it difficult to understand how the stock market works, and how to pick

winning stocks. The terminologies, the rules and regulations, market trends, etc. seems a bit alien to

new investors.

In such a scenario, stockbrokers can play an important role. They have the requisite knowledge and can

explain the fundamentals of the market, the tips and tricks to participate in the trade, and help you

invest according to your financial goals.

How do I register with a stockbroker?

There are a number stockbrokers/brokerage houses all over India. These brokers are required to follow

uniform rules pertaining to service tax, security transaction tax, stamp duty, etc. However, other charges

like brokerage amount, annual maintenance fee, etc. varies from broker to broker. Conduct some

research online and consult with family and friends if they trade in the market to find a few choices. If

not, a financial advisor can refer one for you. After selecting the one that suits your requirements, you

can enter into a broker-client agreement to start using your brokers service.


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B. a. 38. Why do stock prices change?

A number of factors are responsible for a change in stock prices. We explain some of them here.

The demand for and supply of a particular stock is responsible for the price fluctuations it experiences

over a period of time. In simple terms, if demand for a particular stock is higher than its supply, the price

goes up. Similarly, if the demand is lower than the supply, the price goes down.

However, why does the demand for a particular stock fluctuate? What makes investors like or dislike a

stock? There are several factors that trigger such a response. Listed below are a few of them.

Profit of the company

One of the most important factors that influence stock prices in the long run is profit or earnings of the

company in question. If a company is doing well, it will expand, and its value will increase. Consequently,

an increasing number of people would want to take advantage of such growth.

Company announcements

Depending on the type of news the company announces, its stock price is likely to rise or fall. Favorablenews like expansion plans, strong financials, appointment of new members on the board, etc. is likely to

attract more buyers and take the price northwards. On the other hand, negative announcements like

weak financials, quitting of critical members of the board, huge debts, etc. can bring the price down.

Economic outlook

If the economic condition of a country is weak, investors are likely to be wary, and move to safer

investment options like fixed deposits or pension funds. During such a scenario, the overall stock

market, and therefore, the share price of any given company is likely to fall. Similarly, a strong economiccondition boosts stock prices.

Technical analysis


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Technical analysis is a method of predicting the future movement of a stock price by studying its past

movements. Most traders who actively participate in trading follow this method to buy and sell stocks.

Hence, the outcome of this analysis affects the stock price significantly.

While the aforementioned points are the most important factors, others like interest rates, inflation and

deflation, competition and industry outlook, etc. too play a crucial role in price fluctuations of a stock.


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B. Trading

B. b. Commodity


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B. b. 39. How can I trade in commodities?

Investors can trade in commodities through offline as well as online channels. Read on to learn more

about them.

Once you understand what the commodity market is and how it works, the next logical step is to learn

the process of commodity trading. Commodities can be bought and sold through online as well as offline

channels. Let us understand the meaning, advantages and shortcomings of the two channels.

Offline channel

One of the most common ways to buy/sell commodities is to hire a broker. Brokerage houses or brokers

are institutions or individuals licensed to buy/sell commodities on behalf of others. Once you have given

the responsibility of trading commodities to your broker, you can easily manage your portfolio without

actually spending time on it. Since these brokers are experts in commodity trading, they offer

professional advice and personal services to clients.

However, brokers usually charge an annual fee and brokerage commission that is much higher than the

fee charged by online accounts. Besides, it usually takes more time to execute an offline transaction,

which at times may result in losses.

Online channel

If you have an online commodities trading account, you can carry out all the transactions yourself. Since

this mode of trading requires no professional service and personal time of brokers, it is usually cheaper

than offline channels. Most companies charge a one-time membership fee, after which you are not

required to pay any maintenance charges. The brokerage fee per transaction is quite low too. This mode

is one of the quickest methods of trading, as it allows you to conduct real-time transactions.


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-

Defines rules and regulations of trading to carry out uniform trading practice

-

Provides dispute settlement mechanism

- Circulates price movements and market news to the participating members


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B. b. 41. What are commodity futures?

Commodity futures are buy/sell contracts of commodities at a price fixed today, but realized on a future

date. Read on for more information.

Commodity futures are contracts or agreements between two parties, agreeing to buy or sell certain

units of a commodity on a future date at a fixed price. On this future date, the buyer has to pay the price

that was agreed when the contact was made, and the seller has to transfer the ownership of the said

commodities to the buyer.

So, if you believe that the price of a certain commodity, say coffee, will rise in the next couple of weeks,

you can buy a futures contract which promises to sell coffee at todays price. When this commodity istransferred in your name, you can sell it at a profit. However, if the price falls, you will have to sell your

contract at a loss.

Where to trade?

Commodity transactions take place on a regulated commodity exchange. While any individual or

institution can take part in such trading, it needs to be done through a broker, who is a member of an

exchange and has the authority to carry out transactions on behalf of the traders.

Commodity futures, like currency derivatives, allow you to operate on a margin. This means that you

need to invest only a small percentage of the total transaction value while trading. This allows you to

earn more profit with a lesser amount (while exposing you to a higher risk).

For instance, many brokers might allow you to buy a futures contract of 1,000 barrels of oil worth

$50,000 for with an initial amount of $5,000. With such exposure, even a small rise in the price could

result in huge profits, and vice versa.

Things to remember

While entering into a commodity futures contract, it is important to note that the buyer should sell his

holdings before the expiry of the contract. Not closing an existing position might result in possession of a

large quantity of unwanted commodities.


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B. b. 42. What are the major factors that impact commodity prices?

Since commodities are traded in the world market, many factors are responsible for the price movements

of these commodities. Heres a look at some of them.

On basis of the sheer volumes traded every day, the commodities market is the worlds second largest

market after the currency market. Given the size of the market and the variety it offers, it is difficult to

identify the precise reasons that bring fluctuations in this market. However, there are a few general

factors that affect the movements of commodity prices in the long and short run. Mentioned below are

a few of them.

Demand and supply

When demand for a commodity is higher than the supply, its price increases, and vice versa. There is

always some imbalance between the two when it comes to commodities, which results in constantly

fluctuating prices.

Weather conditions

A majority of commodities traded in the world markets are agricultural goods, and the production of

these goods depends on the weather. Sudden changes in climatic conditions like inadequate rainfall or

draughts might affect the availability of agricultural goods in the world market, causing scarcity and

pushing commodity prices northwards.

Economic and political conditions

The prices of commodities are also impacted by the economic and political conditions of the countries

that are producing and consuming them. For instance, during the Gulf War in Iraqwhich was a major

producer of oilthe price of oil fluctuated very frequently. Moreover, weak economic conditions reduce

the spending power of consumers, leading to fall in demand, which results in movement in prices.

Government policies

Any changes in the government policy, especially the ones impacting import/export cost to the buyer or

seller will have a huge impact on commodity prices. If, for instance, the Indian government increases

import duty on edible oil, its price will show a proportionate increase, and vice versa.


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These and some other factors like inflation, seasonal variations, currency movements, etc. are majorly

responsible for price fluctuations in the commodity market.


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B. b. 43. What is commodity trading?

When physical substances like metals, food grains, etc. are traded in the global market to profit from the

expected changes in price, it is called commodity trading.

Commodity trading is the act of buying and selling commodities on major exchanges through

standardized contracts. Before we learn about how this market works, it is essential to understand what

commodities are and why people trade them.

Unlike products with brand names, commodities are essentially goods that have a common price per

unit across geographies (for instance, gold). Raw products that are used to produce other goods and

services are considered commodities. Some of the most common commodities traded around the globeinclude metals like gold, silver, copper, etc.; energy products like oil, gas, etc.; agricultural outputs like

corn, sugar, coffee, cotton, etc. The prices of these commodities are determined mainly by the supply

and demand of these goods in the global market.

There are three major national commodities exchanges in India. These are National Commodity and

Derivatives Exchange Ltd, Multi Commodity Exchange of India Ltd and National Multi Commodity

Exchange of India Ltd. Apart from these, about 18 other domestic commodity exchanges are also

operating in India.

Why commodity trading?

While earning profit is one of the chief reasons why people trade in commodities, several other

advantages of this investment also propel investors towards it. One such advantage is liquidity. Due to

the participation of several traders and speculators, the commodity market is among the most liquid in

the world.

Apart from liquidity, commodity trading also provides leverage, which allows traders to operate on

margin. This means that people can make large-value transactions by paying a small part of the total

transaction value.


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Moreover, commodities allow you to profit from the falling market as well. You can put your money on

the upside as well as the downside movement of commodity prices.

Constant fluctuation in this market is certainly a risk, but it also opens up the opportunity to earn higher

profits. Besides, if positions are hedged appropriately, risk is reduced substantially.


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B. b. 44. What is hedging? How is it done through commodity markets?

Hedging is the act of reducing your risk of losing money in the future.

Simply put, hedging is a kind of insurance for your portfolio. When people hedge, they are, in reality,

insuring their investment against any unpredicted events. Hedging does not prevent such events, but

reduces the impact they might otherwise have on your portfolio.

Portfolio managers, retail investors, corporations as well as governments use hedging to reduce their

risk exposure. However, when it comes to trading in commodities, hedging is not as simple as paying

your insurance premium. To offset the risk arising from one instrument, traders use other instruments.

How does it work in commodity trading?

The prices of commodities fluctuate constantly. If traders want to protect themselves from the risk of

future fluctuations, they buy or sell positions in the futures markets.

Let us understand this with the help of an example. If an individual involved in sugar processing believes

that the price of sugarwhich is currently say Rs 20/kgwill increase in the coming months, he will buy

a position in the futures market at todays price. So, even if the price rises from Rs 20/kg to Rs 23/kg in a

month, he will get a price of Rs 20/kg from the seller at the end of the contract. This act of buying long

positions to avoid upside risk in the futures market is called long hedging.

Similarly, if a farmer anticipates that the price of wheat might fall from Rs 50/kg to Rs 40/kg, he will sell

future contracts at todays price (i.e. Rs 50/kg). So, even if the price falls to Rs 40/kg, he will still get Rs

50/kg according to the contract. This act of selling positions in the future market in order to protect

ones investments against downside risk is called short hedging.


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B. Trading

B. c. Currency


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B. c. 45. How can I trade in currencies?

New to currency trading? This 5-step procedure will help you get started.

Before you start trading in currencies, you need to first understand what it is and how the market works.

Once your basic understanding is clear, you can try your hand at currency trading.

Elaborated below is a simple 5-step process that will help you get started.

Step1: Select a broker

In order to buy and sell various currencies, you will need to hire the services of a currency broker. There

is a plethora of brokers to choose from today; make the right selection by reviewing and comparing the

services and benefits offered by them.

Step 2: Open a demo account

After selecting the broker of your choice, ask for a demo account. Most brokers today offer this service,

which allows you to use their trading platform for a few weeks (usually 30 days) to trade without any

service cost. This demo account will help you understand how to use the platform without actuallytrading in real-time market.

Step 3: Understand about leveraging

Leverage is a kind of loan provided by the broker to the trader. So, if the trader offers a leverage of

200:1, you can use up to 200 times the money you are actually investing. Although this facility allows

you to carry out huge transactions with little money and provides an opportunity to earn huge returns, it

can be very risky if not used carefully. It is crucial to fully understand this concept before you start

trading.

Step 4: Learn to read charts


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Various types of currency charts with different time frames show past trends in the currency market.

Most charting softwares display information in the form of bars, candlesticks and lines. Spend some

time to understand the data these charts reveal, and select the software you are most comfortable with.

Step 5: Make your first trade

Making your first trade in a live market is very different from practicing it on your demo account. In this

case, real money is involved, with a potential for real profit or loss. Invest your money only if you

strongly believe in the news and facts that triggered your decision to trade.

Currency trading, or Forex trading as it is known, can be risky if you take hasty decisions. If you want to

become a good trader, learn everything

a smart guide to the financial markets

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