Why does BSE index moves upwards and volatile?

Mortgage market?

Reasons

• In USA most of the banks engaged in mortgage market by lending without seeing the client's credit worthiness. But most of the customers fail to repay the long term loan. The banks are allowed to recover such loans by sale of such properties.

• The total funds have to be reinvested in profitable way. Most of the banks see(BRIC countries)India is one of the countries where they can get better return and also india’s inflation is arround 4% and growth rate is around 9%.

• BRIC-Bracil, Russia, India and China

Derivatives

Prof.L. Augustin Amaladas M.com.,AICWA.,PGDFM.,B.Ed

.

5th December 2007

What do you mean by rest?

Leading Investment and Commercial banks

• Banc of America Securities LLC • Citigroup • Credit Suisse • Goldman Sachs • JPMorgan Chase • Lehman Brothers • Merrill Lynch • Morgan Stanley • UBS

banks in the international markets

• Categories of banks in the international markets:• 1. commercial banks-JP Morgan Chase• 2.investment banks-Goldman Sachsas, London

investment bank Morgan Grenfell Bankers Trust in New York, Crédit Lyonnais Belgium ,Brussels Moscow-based investment bank United Financial Group in Russia ,the German norisbank and Berliner Bank.

• 3.mixed banks-HSBC

Investment And Commercial Banks Differ?

• Commercial Banks (CB) accept deposits and make commercial loans as a financial intermediary.

• CB traditionally could underwrite only low-risk securities of governments per the Glass-Steagall Act.

• Many large firms now use the direct financial markets to finance rather than bank loans.

RISK /Uncertain???

• Case-1• An Indian Garments company has received an

order to supply I,00,000 units of shirts from USA. The price of $ 500,000 is receivable after six months. The current exchange rate is Rs.39.76/$. At the current exchange rate, the company would get: 39.76 × 500,000 = Rs 1,98,80,000. But the company anticipates appreciation of Indian rupee over time. Does the company loose/gain due to appreciation in the Indian Rupee? How does company minimise the risk?

Alternative work is rest

Minimising risk case-1

• The company can lock in the exchange rate by entering into an advance contract and forget about any fluctuation in the exchange rate. Suppose, the six-month forward exchange rate is Rs39.00/$ The company can make an agreement at spot rate at 39.76 in the spot market or at a lesser price. At the time of receiving dollar, it will exchange $500,000 at Rs39.76= Rs 1,98,80,000. or agreed price.

Happiness by giving/receiving?

Case 2

• You have imported machinery for $ 100,000 on 180 days credit at zero interest. The dollar quotes at Rs 39. Is this deal risk free?

• This deal is not free of risk because after six months when you pay the loan, if the dollar quotes anything more than Rs39., say Rs 40, you will end up paying more [Rs 1 extra for every $ 1, which is equivalent to Rs 100,000 additional cost]. On the other hand, if the dollar quotes anything less than Rs 39, you will stand to gain

• The question here is not whether you stand to gain or loose – it is the risk you are taking

• You have imported machinery for $ 100,000 on 180 days credit at zero interest. The dollar quotes at Rs 39. Is this deal risk free?

• This deal is not free of risk because after six months when you pay the loan, if the dollar quotes anything more than Rs39., say Rs 40, you will end up paying more [Rs 1 extra for every $ 1, which is equivalent to Rs 100,000 additional cost]. On the other hand, if the dollar quotes anything less than Rs 39, you will stand to gain

• The question here is not whether you stand to gain or loose – it is the risk you are taking

Happiness by giving not receiving

Case 03

• You have surplus cash for investment. You think of investing in Wipro, currently quoting at Rs 3,500, which you believe will rise to Rs 3,950 in six months. Is this deal risk free?

• This deal is not free of risk because there is no guarantee that Wipro’s shares would touch Rs 3,950 in six months time.

• The share prices could rise beyond Rs 3,950 or could also fall below Rs 3,500 – giving you no return on investment and you could stand to loose some portion of your investment

Old lady in a seashore!....

How do you protect yourself ?

• Use Derivative instruments.• What is derivatives?

• See the next example.

Picking up something?...

Example

• You [along with two friends] want to go for the Aero India January 2008 air show, for which tickets are sold out. Through one of your close friends, you obtain a recommendation letter, which will enable you to buy three tickets. The price of a ticket is Rs 1,000.

• Which is the commodity that you are suppose to buy?

• In order to buy the________ what are required now?

• Money/recommendation letter (instrument) or both?

People walking in the seashore scared?...

Financial instruments

• The recommendation letter is a derivative instrument. It gives you a right to buy the ticket

• The underlying asset is the ticket• The letter does not constitute ownership of the

ticket• It is indeed a promise to convey ownership• The value of the letter changes with changes in

the price of the ticket. It derives its value from the value of the ticket

Children are scared to go near by?...

Different risk coverage

• Firms are exposed to several risks in the ordinary course of operations and borrowing funds.

• For some risks, management can obtain protection from an insurance company(fire,loss of profit,loss of stock,marine insurance)

• Similarly, there are capital market products available to protect against certain risks. Such risks include risks associated with a rise in the price of commodity purchased as an input, a decline in a commodity price of a product the firm sells, a rise in the cost of borrowing funds and an adverse exchange rate movement. The instruments that can be used to provide such protection are called derivative instruments

What was see doing? Why?...

Meaning

• Derivative instruments are called so because they derive their value from whatever the contract is based on

• “A derivative contract is a financial instrument whose payoff structure is derived from the value of the underlying asset”

• These instruments include futures contracts, forward contracts, options contracts, swap agreements, and cap and floor agreements

See the next slide…

AdvantagesAdvantages

• The derivative market helps people meet diverse objectives such as:– Hedging– Profit making through price changes– Profit making through arbitrage

• The derivative market helps people meet diverse objectives such as:– Hedging– Profit making through price changes– Profit making through arbitrage

Guess what does she pick up?

uses

• Price discovery– Most price changes are first reflected in the derivative market.

That way derivative market feeds the spot market– For instance, if the dollars are going down, it means that the

professional investors are expecting dolor price to go down in the future – this is a good sign for you to buy in the spot market

• Risk transfer– A derivative market is like an insurance company– Derivative instruments redistribute the risk amongst market

players– However, if you want protection against adverse price

movements, you must pay a price, ie the premium

Children are not allowed to go near by…!

Derivative instruments on

Stocks (Equity)Agri Commodities including grains, coffee beans, pepper,.Precious metals like gold and silver.Crude oilForeign exchange rate BondsShort-term debt securities such as T-bills Index Interest rate

The old lady looked shabby…

TYPES OF DERIVATIVES

FuturesForwardsOptionFloorcap

Policemen also ask the public to go away from her

Players in the market

• Banks-Citi Bank

• Deutsche Bank

• Goldman Saches

• JP Morgan Chase

• HSBC

• ICICI

See next slide

Old lady in a seashore?Old lady in a seashore?

• She picked up broken glasses from seashore?

• Picked up stones?

• Does she harm anybody?

What is your answer?

Broken glasses should not harm the children

Lesson:1 What we perceive may not be what is real

Judge not based on outlook / colour

Lesson-2

Ways of making contract?

• 1. Private contracts- Known as Forwards

• 2. Through Stock - Known as exchanges Futures, Options

Swap, Floor and Cap

Threat is an opportunity

How do they settle the contract?

• Daily basis -Known as Marking to market

Present strengths are your threats

How does stock exchange operate?

• It collects amounts from both the parties of contract known as Initial Margin Money.

• Stock Exchange also collect additional margin money is known as Variation Margin.

Important terms• LIBOR• SWAP• OPTION HODER• EXERCISE THE CONTRACT• CURRENCY SWAPS• INTEREST SWAPS• PREMIUM• AMERICAN OPTION• EUROPEAN OPTION• BERMUDA OPTION• OPTION HOLDER• OPTION WRITER• CALL OPTION• PUT OPTION• LONG• SHORT

STRIKE PRICESPOT PRICE

EXPIRY OF CONTRACTBASIS RISK

COUNTER PARTY RISK

QUESTIONS?

• Thank you for all professors & students of II B.Com classes of SJCC .

• By Prof.Augustin Amaladas