Investment Valuation in India

LIBOR LIBOR stands for London Interbank Offered Rate is the average interest rate estimated by leading banks in London that they would be charged while borrowing from other banks. It is the primary benchmark, along with the Euribor, for short term interest rates around the world. As a popular benchmark, it is used for US Dollar, GB Pound, Euro, Swiss Franc, Canadian Dollar and Japanese Yen. Libor rates are calculated for ten currencies and 15 borrowing periods ranging from overnight to one year and are published daily at 11:30 am (London time) by Thomson Reuters. The British Bankers Association (BBA) collects data from 16 banks to calculate LIBOR for each maturity and for each currency. It weeds out the best four and the worst four and then calculates the average of remaining 8 rates which is published as LIBOR. Many financial institutions, mortgage lenders and credit card agencies set their own rates relative to it. At least $350 trillion in derivatives and other financia...

Hedging through Futures / Forward contracts With the business environment getting increasing complex, profitability often depends on factors that are beyond the control of an organisation like commodity prices, stock prices, interest rates, exchanges rates, etc. As a result, modern business has been subjected to more complexity, uncertainty and risk. Futures markets often permit managers to reduce or control risks through hedging strategies. In other words, futures markets can provide the managers certain tools to reduce and control their risks.  Simply put Hedging means reducing risk. It is the process of investment into securities (usually a derivative) with the objective of reducing or controlling risk. Examples of Hedging: E.g. 1. Firm A is a manufacturer of automobile cars in India and they import auto parts from USA. Firm views that parts may increase in future and thereby increase the cost of cars and this may significantly affect the profitability of the...

DERIVATIVES Overview - Session 1 WHAT IS A DERIVATIVE?   A derivative is an instrument whose value is "derived" from the price of some underlying instrument, reference amount or index. It generally represents a contractual relationship between two parties. Cash flows are exchanged between parties based on price/index movements. The terms of the agreements may be customized or they may be standardized to facilitate exchange clearance. Customized agreements are usually referred to as Over The Counter Transactions. (OTC) Generally doesn’t require physical delivery of the reference asset. WHAT ARE DERIVATIVES USED FOR? Trading -  Speculation (e.g., bet on movements in an underlying security, index, interest rate, commodity, currency or other financial instruments).  -  Arbitrage (utilized by many fund managers to take advantage of expected market movements or arbitrage opportunities, hoping to decrease financing costs or increase yields on exis...

FOREIGN EXCHANGE FORWARD CONTRACTS An enterprise having exposure to multiple currencies by virtue receivable and payables (e.g. import and export) is likely to be worried about the exchange rate fluctuations that may result in gains and losses in the future. In order to hedge its position and to avoid the losses due to foreign exchange rate changes, the enterprise may enter into a forward exchange contract to manage the amount of the reporting currency required or available at the settlement date of transaction. Generally Accepted Accounting Principles (GAAP) and International Financial reporting Standards (IFRS) provides that the difference between the forward rate and the exchange rate at the date of the transaction should be recognised as income or expense over the life of the contract. Further the profit or loss arising on cancellation or renewal of a forward exchange contract should be recognised as income or as expense for the period. Example: Suppose MSD Ltd needs USD 500,0...

CREDIT DERIVATIVES are over-the-counter contracts that allow credit risk to be exchanged across counterparties. A CREDIT DEFAULT SWAP (CDS) is a swap contract in which the buyer of the CDS pays premium (periodic or lump-sum) to the seller and, in exchange, receives a payoff if a credit instrument - typically a bond or loan - goes into default (fails to pay). This event of a default is called a “Credit event”. The payment made by the seller to the buyer is called a “Contingent payment” and is triggered by a credit event (CE) on the underlying credit. These contracts represent the purest form of credit derivatives (hence called Plain Vanilla), as they are not affected by fluctuations in market values as long as the credit event does not occur. Plain Vanilla CDS cater to the largest market share of the Credit Derivatives typically with 5 year maturities. Credit default swaps are often used to manage the credit risk (i.e. the risk of default) which arises from holding debt. Typically, t...

The Black and Scholes Model : The Black and Scholes Option Pricing Model didn't appear overnight, in fact, Fisher Black started out working to create a valuation model for stock warrants. This work involved calculating a derivative to measure how the discount rate of a warrant varies with time and stock price. The result of this calculation held a striking resemblance to a well-known heat transfer equation. Soon after this discovery, Myron Scholes joined Black and the result of their work is a startlingly accurate option pricing model. Black and Scholes can't take all credit for their work, in fact their model is actually an improved version of a previous model developed by A. James Boness in his Ph.D. dissertation at the University of Chicago. Black and Scholes' improvements on the Boness model come in the form of a proof that the risk-free interest rate is the correct discount factor, and with the absence of assumptions regarding investor's risk preferences. The M...

Futures Future contracts are agreements between two parties to buy or sell an asset (underlying) at a given point of time in the future. They are standardized contract i.e. an agreement, traded on a futures exchange, to buy or sell a standardized quantity of a specified commodity of standardized quality at a certain date in the future, at a price (the futures price) determined by the parties involved. The future date is called the delivery date or final settlement date. The official price of the futures contract at the end of a day's trading session on the exchange is called the settlement price for that day of business on the exchange. Assume that no cash settlement was done between the two parties. A futures contract gives the holder the obligation to make or take delivery under the terms of the contract. Also both parties of a futures contract must fulfill the contract on the settlement date – it is legally binding. The seller delivers the underlying asset to the buyer, or, if i...

Please find the link below to download the ebook on Futures and options trading strategies. Futures & Options Trading Strategies Please note that ebooks in the links may have specific copyrights and full credits are given to the authors and publishers. These are freely circulated for educational purposes only.

"India, with its strong internal drivers for growth, may escape the worst consequences of the global financial crisis. Indian banks have very limited exposure to the US mortgage market, directly or through derivatives, and to the failed and stressed financial institutions. The equity and the forex markets provide the channels through which the global crisis can spread to the Indian system. The other three segments of the financial markets - money, debt and credit markets could be impacted indirectly. Risk aversion, deleveraging and frozen money markets have not only raised the cost of funds for Indian corporates but also its availability in the international markets. This will mean additional demand for domestic bank credit in the near term. Reduced investor interest in emerging economies could impact capital flows significantly. The impending recession will also impact on Indian exports. Even EMEs which do not have direct or significant exposure to stressed financial instrumen...

What is a Futures Contract? Futures contract means a legally binding agreement to buy or sell the underlying security on a future date . Future contracts are the organised/standardised contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract. On expiry, futures can be settled by delivery of the underlying asset or cash . Cash settlement entails paying/receiving the difference between the price at which the contract was entered and the price of the underlying asset at the time of expiry of the contract. What is an Option contract? Option contract is a type of derivatives contract which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period . The buyer/holder of the option, purchases the right from the seller/wri...