New Margin Trading Rule by SEBI: Recently, SEBI published a new circular on margins that astonished the entire trading community along with the stockbrokers. Through this circular, SEBI announced tighter margin norms for the traders. In this article, we are going to discuss what exactly is this new margin rule introduced by SEBI and how it will affect the people trading in share market.
What is Margin trading?
In terms of the financial market, Margin would be a direct synonym to leveraging. It simply gives you the power to buy/trade in stocks that we can’t afford to buy. Through Margin trading, one is allowed to buy the stocks by just paying the part of the actual value of shares.
The margin can be paid either in terms of cash or in shares as security. The balance amount of shares are funded by the brokers. In other words, Margin simply refers to the amount of money borrowed from the broker to buy the shares of a company. The broker acts as the lender of money and the securities in the investor’s trading account, are kept as collateral.
The margin is settled later when the positions are squared off. We receive profit if we sell the shares at profit or we stand to lose the margin if we make losses.
— How to trade using Margin?
To trade using a margin account, one must have a separate margin account and not the standard brokerage account. A margin account is a separate trading account in which the broker lends money to the investor to buy a security which otherwise he will not be able to buy. The loan or the margin money which is borrowed from the broker comes at a cost i.e., the interest. Therefore, one should use a margin account for short term trading as the interest on the margin money keeps accruing.
Say, if you deposit Rs. 1,00,000 in your margin account and you have a 50% margin in your account, which means buying power of Rs. 2,00,000. Now, if you buy stocks of Rs. 70,000, you still have the buying power of Rs. 1,30,000. And we have enough cash in our margin account to cover for the transaction. We start borrowing only, once we have bought shares worth Rs. 1,00,000.
— Three steps in Margin trading
We need to maintain the Minimum Margin (MM) throughout the trading session because volatility in the stocks can push the prices (up or down) more than one’s anticipation.
The position needs to be squared off at the end of each session. If we have bought on margin, we need to sell it off before the end of the day (EOD) and vice-versa if we have sold using margin.
If we want to carry the trade onto the next session, we need to convert it to the delivery trade. And for that, we need to keep the cash ready.
If any of the above three steps are missed then the broker automatically squares off the position in the market.
New Margin Trading Rule by SEBI
The Securities and Exchange Board of India (SEBI) gave out guidelines pertaining to Margin trading (which account for nearly 90% of the daily turnover of the stock market), which has not been welcomed by the brokerage firms with open arms. These rules will put an end to intraday trading and turnover generated out of it.
The brokers have been instructed to collect VaR (value at risk) and ELM (extreme loss margin) upfront from their clients. These rules will be implemented in a phased manner starting in December 2020.
Phase 1: From December 2020, the brokers will be penalized if the margin is more than 25% of the sum of VaR and ELM.
Phase 2: From March 2021 and June 21, brokers will be penalized if the margin exceeds 50% and 70% of the sum of VaR and ELM
Phase 3: From August 2021, brokers will be penalized if the margin exceeds VaR and ELM
The broking community feels that this will put an end to leverage based intra-day trading. Currently, some brokers collect as low as Re. 1 for every Rs. 100 worth of trade. Here are some of the reactions from Big brokerage houses:
Nithin Kamath, CEO of Zerodha Brokerage Tweeted, “Today’s SEBI circular says that all brokerage firms have to stop intraday leverage products by August 2021 in a phased manner”. In another tweet, he added:
“While many (even we) don’t like restriction on intraday leverages by SEBI, I don’t think any regulator in the world has done so much to protect retail investors. A lot of this slows brokerage business but what is good for the client eventually is good for the business as well.”
Jimeet Modi, CEO, and founder of Samco Securities said, “This was expected since last year after the December 2019 circular. Now the industry and exchanges will need to adjust to this new reality. This probably will also accelerate the market share towards discount brokers from full-service brokers. Differentiated margins was a service offering by full-service brokers which has now been arbitraged away. Our estimate is that almost 30-35 percent of the intraday turnover is based on additional leverage provided by brokers. Now assuming full margin is required, total turnover would shrink by approx 20 percent since balance part margin was still being collected from clients.”
How Market Turnover is impacted by new SEBI rule?
On July 21, SEBI gave out a circular pertaining to new rules on Margin trading. And these rules are directly going to impact the market turnover both in the cash and derivatives segment. The cash segment on NSE recorded an average daily turnover of Rs. 50,322 cr (April), Rs. 52,656 cr (May), Rs. 61,395 cr (June). And the derivatives market is nearly 18-20 times of the cash market. NSE is the largest derivatives exchange in the world with an average daily turnover of more than rupees 11 lakh crore.
Some of the brokerage houses are of the view, with the new rules if VaR+ELM, the daily turnover may shrink by almost 20-30%. The clients will also have to maintain a higher margin in their account and which will also impact their return on investment. And these changes in rules will not only impact the brokers but will also impact the government, in the form of reduced Securities Transaction Tax (STT).
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!
Understanding what are Non-Banking Financial Companies (NBFCs) in India: One of the key approaches to make money from the stock market is to select a fast-growing industry and look for the best investment opportunity in that industry. If the industry is growing at a good pace, the chances are that the top constituent companies in that industry will too grow at a similar pace.
One industry that is very powerful, growing at a good pace since last decade and is often confused by banking industry in NBFC in India. In this article, we are going to discuss what are Non-Banking Financial Companies (NBFCs) in India, their examples, the definition of NBFCs as per RBI and a few top NBFCs in India. Let’s get started.
What are Non-Banking Financial Companies (NBFCs)?
In simple terms, Non-Banking Financial Companies are financial institutions that do not possess a banking license from the RBI but still provide bank-like financial services like loans, credit facility, retirement planning, etc.
The need for an NBFC arises when the banking structure already present does not fulfill all the financial needs in the economy. These may be due to rules and regulations that bind the banking sector or lack of reach in the service provided and accessibility to certain consumers across the nation. Here are some of the examples of NBFC’s:
Investment Banks
Mortgage Lenders
Money Market Funds
Insurance companies
Hedge and Private Equity Funds
P2P lenders
Currency Exchanges
Pawnshops
Chit Funds
After reading the definition, we must not mistake the role of an NBFC to a mere backup for banks in India. NBFC’s provide and lead in various services when compared to banks. NBFCs have alone made up for a 12.5% rise in Gross Domestic Product of our country.
NBFCs according to the RBI
According to the Reserve Bank of India (RBI), Non-Banking Financial Companies (NBFC) in India can be defined as:
“A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property.” (Source: RBI)
The RBI uses the 50-50 test in order to judge if financial activity forms the principal business of a company or not in order to be considered as an NBFC. According to this test
Financial Assets must constitute more than 50% of the total assets (And)
Income from these financial assets must constitute more than 50% of the gross income.
Companies that fulfill the criteria mentioned above are to be registered as NBFCs.
Difference between an NBFC and a Bank?
Even though a few activities may be performed by both they do possess the following differences:
NBFC cannot accept demand deposits: Demand deposits refer to deposits that can be withdrawn without any prior notice. NBFC’s are restricted from providing this service and banks provide then in the form of Current A/C and Savings A/C.
NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself
Deposit insurance facility: The deposits placed in banks are backed by insurance in order to protect the depositor against the failure of a bank. NBFC’s are not required to Insure the deposits placed.
Reserve Ratio: Banks are required to maintain a portion of their deposits as reserves as directed by the RBI. An NBFC is under no such requirement.
Foreign Capital: When it comes to banks the level of foreign investment is capped at 74%. Whereas 100% of foreign investment is allowed in an NBFC
Do all NBFC’s fall under the purview of RBI?
Not all NBFC’s fall under the purview of the RBI. Different NBFC’s are governed by different laws depending on the function they perform.
NBFC
GOVERNING BODY
Merchant Banker Venture Capital Fund Stock Exchange Stock Broker Sub Broker
That’s all for this post on Non-Banking Financial Companies in India. I hope it was useful for you. If you have any doubts related to NBFC in India, feel free to comment below. I’ll be happy to help. Happy Investing.
Understanding what happens to the equity shares when a company files bankruptcy: During the economic volatility period, investors tend to become more alert with regards to their investments in the form of shares of various companies. Generally, they try to sell their stocks if they find out that the company may not do well in the future or it may take longer than expected to recover. In such cases, companies get hit quite badly because investors are reducing and the market volatility affects the share price too.
The current unprecedented time of COVID-19 too is such that the majority of the investors have already taken necessary actions in order to safeguard their investments. The fear of losing money if the company goes bankrupt has made everyone scratch their heads quite often. However, it is not necessary that if a company is bankrupt then investors will certainly lose all of their money but the fact is that the common stockholders are the last ones on the list of preference for payment. There has also been a misconception of using insolvency and bankruptcy as a synonym but they both are different.
In this write-up, we will be discussing what happens to the shares of the equity shareholders when a company files bankruptcy. Here, we’ll be covering do we mean by insolvency and bankruptcy, options under the bankruptcy, the preference of the payment when any company files bankruptcy and relaxations, and exemptions provided by the government under the stimulus package during the global disease outbreak.
Understanding Insolvency and Bankruptcy
Solvency is a financial state or a condition when a person, firm, company, or any other legal entity’s total assets exceed its total liabilities at any point in time and it can meet its long-term debts and financial obligations. The opposite of it is called “Insolvency”.
The inability to repay its debts/obligations is a state of insolvency and it can be temporary as well. Such a situation may rise from poor cash management, increased expenses, reduction in cash inflow, or because of some unpredictable accidents, mishappenings or pandemic situations resulting in huge losses to the entity/firm. Here, the person or an entity is not even able to raise enough cash in order to pay off its liabilities and obligations in the due course.
The state of insolvency usually leads to filing for bankruptcy, although, it can be avoided by taking corrective actions such as negotiating terms with credits and other lenders, cutting down overhead costs to a large extent, and by generating surplus cash.
The Bankruptcy, on the other hand, is a legal procedure when an insolvent person or an organization declares its inability to pay off its debts. Under bankruptcy, the person or an entity seeks help from the government to repay its debts and obligations. The bankruptcy does not mean the closure of the company as there may be a chance for the company to recover to its normal state.
When a company files for its bankruptcy, it may ask the government to help the company restructure or reorganize its debts and repayment terms to ease out the repayments. The other option the company may seek from the government is to liquidate the company and decide the order of repayment by realizing cash from its assets.
Technically, the companies themselves file for their bankruptcy but sometimes, creditors may also file the application in the relevant court to declare the company as bankrupt. The Registrar of Companies may also pass a special resolution to declare an entity as bankrupt.
As discussed earlier, the two options under the Bankruptcy filing procedure provides flexibility to the corporates to either reorganize its debts and get some time to recover or to liquidate the company if the operations have already started closing down.
The Insolvency and Bankruptcy are now solely controlled by the Insolvency and Bankruptcy Code (IBC), 2016. In case of a reorganization, the relevant court appoints a resolution professional who will decide the terms of reorganization considering relevant laws and regulations of the code along with creditors’ and other lenders’ considerations.
Not only that, but the company is also given 180 days (further extended by 90 days upon presenting a valid reason) of the moratorium period. In this period, the company cannot transfer its assets or raise cash by itself, no creditor or any other lender can initiate any legal proceedings or enforcement against the company.
The common stockholders’ shares may reduce in value as the restructuring under insolvency affects the company’s share price. Also, since all other creditors and lenders will have more preference over the restructuring terms, the stock value after the reorganization may also get terribly hit. However, if the company proposes a strong plan post the restructuring then investors may be able to get the same value or more in the long term.
The second option of liquidation is more menacing and never liked by the investors. Under the liquidation procedure, the liquidator appointed by the court prepares liquidation terms and order of preference of payment where the common stockholders are the last ones to be paid back their investment. Sometimes, investors may not even get anything against the stock they hold.
— The Order of Preference for the Payment
While liquidating, an important point to mention is that everybody is not always equal in the tiers of creditors. Moreover, each tier must be paid in full before any money is repaid to the next tier. The order of preference under the Bankruptcy is provided under Section 178 of the Companies Act 2013 as provided below:
Firstly, the costs and expenses incurred by the bankruptcy professional appointed by the court, are paid.
Secured creditors are paid as they hold some security against their money receivable from the company.
Wages due to the employees
Financial debts payable to the unsecured creditors
Government and statutory dues
Any other debts of the unsecured creditors
Preference shareholders
Equity Shareholders
Quick Note: In the above order of Preference for the Payment, please note that the equity shareholders are last in the line and mentioned at the end. This is because the shareholders are practically the owners of the company and and therefore have accepted a greater risk compared to others.
Recent relaxations by the Government: COVID19 Stimulus Package
Due to the unprecedented time recently faced by everyone in our country and across the globe, the government as a part of the stimulus package announced the suspension of initiation of fresh insolvency proceedings for the next six months from 25th March. According to the stated announcement, there will be no default on the part of a company if the default is occurring out of the global disease outbreak.
Moreover, the minimum threshold amount to initiate the insolvency proceedings has also been increased from Rs. One Lakh to Rs. One Crore to cater many MSME sector companies. The government also declared sector-specific relaxations. This indicates that the investors’ money is safe for now and if the government can provide a pre-packaged resolution plan to certain companies then that will save the investors’ investments.
The Pre-Pakaged Resolution Plan (a Pre-Pack) is kind of a remedy provided by the government to the companies facing financial stress where the company and its creditors mutually agree on the sales terms with the buyer before initiating insolvency.
Companies that bounced back post Bankruptcy
Although, no investor would like his company to file bankruptcy but if that happens, there are examples of companies that filed bankruptcy and came back from the brink of the debt. Below are a few examples of such companies:
General Motors: During the economic fall down in 2009, GM had filed bankruptcy due to heavy debts and pensions exceeding its total value of assets. However, post-bankruptcy it had bounced back stronger than before.
Converse: The company filed for bankruptcy but later Nike acquired the stake in this company and since than the market cap of this company is rising.
Marvel Entertainment: Marvel had to file for bankruptcy due to the hefty debts as comic books sales fell badly, later on, Disney bought the stake and it managed to survive.
Closing Thoughts
The Bankruptcy and Insolvency are always scary for any investor. Being a holder of common stock of a listed company gives the last priority of being paid the invested money back. This is why it is always advisable to study the company before investing.
Studying the financials, due diligence reports, and other such statutory compliance will provide information to a greater extent about the company’s financial health and if they have any plan to file insolvency if their debts are already piling up. Moreover, post insolvency if the companies get better insolvency resolution plans then too the money will be safe.
The IBC 2016 has successfully reduced the time taken for resolution plans and not only that, but the recovery rates for the creditors have also increased over the period of time. Adding to that, the recent relaxations may also prove to be a financial booster for the majority of the MSME sector companies. However, the statistics of last year’s bankruptcy filing show a huge spurt by 123% compared to 2018.
The bottom line should be to study well before investing and be always cautious of what is happening in the company you have invested your money as the bankruptcy procedures can be sometimes painful or it may turn out to be a game-changer.
An overview of the Rupee Cost Average Approach: One of the basic strategies to succeed in the stock markets is to buy more when the prices are low. However, this involves in-depth knowledge to judge shares that are underpriced and perfect purchase timing. Today we try and look for answers in Rupee Cost Average (RCA) to reduce our losses from overpriced securities and make success in the long run.
What is Rupee Cost Average (RCA)?
Basically, Rupee Cost Average is an investment technique of buying a fixed amount of a particular investment consistently on a regular schedule over a long period of time, regardless of price. The Rupee Cost Averaging approach results in the average cost of the investment being lower in comparison to a single lump sum transaction.
RCA Relation with SIP
SIP (Systematic Investment Plan) allows an individual to invest in a fund, a predetermined amount at regular intervals. If we look at the above explanation of RCA we realize that a SIP allows us to buy fixed amounts in a fund on a regular schedule regardless of the price of the unit in the fund. Hence SIP helps an investor apply the RCA method and reap its benefits provided he/she indulges in the SIP for a long period of time.
Example to Understand Rupee Cost Average in SIP
Say for example we have Rs 4000 and decide to invest in an Index fund that tracks with the Sensex. As of January 1st, you have 2 options i.e to either invest in a lump sum or to invest by means of a SIP.
— Scenario 1: You Invest in a lump sum on January 1, 2020
Date
Amount Invested
NAV
Units
SENSEX
01/01/2020
4000
413.0602
9.6838
41,306.02
— Scenario 2: You decide to follow a SIP (with a decision to do so even after the amount is exhausted)
Date
Amount InvestedÊ
NAV
Units
SENSEX
01/01/20
1000
413.0602
2.4209
41,306.02
01/02/20
1000
397.3553
2.5166
39,735.53
02/03/20
1000
381.4402
2.6216
38,144.02
04/01/20
1000
282.6531
3.3579
38,265.31
Total
4000
(Avg) 360.4522
11.0971
The difference we should note in the two scenarios above are :
– Breakeven
In scenario one to make a profit the NAV per unit would have to rise above Rs 413.0602. In Scenario 2 if we are to observe the average cost on Investment would be lower.
Average cost = Amount Invested/ Units Received i.e. = 4000/11.0971 => Rs 360.45229.
Hence the breakeven is lower in the second case while investing through the SIP route.
— Units Received
If the units received are compared it becomes apparent the more units are received in Scenario 2. In RCA more securities are purchased when prices are low and fewer securities are bought when prices are high. This allows any losses that were made during a purchase made when the prices are high to be balanced off when the prices are reduced.
Generally, when we find products available at reduced costs we make sure we take advantage of the situation even if it resorts to hoarding. When it comes to stocks of a company, however, it is noticed that investors react differently.
Unfortunately, healthy companies with strong financials are also exposed to market falls. In such situations, investors panic and sell their shares invested in the company. Nonetheless, an investor with good financials observes the financials of the company, and if it looks good, he views the situation as an opportunity. He takes advantage of the situation and gains more shares.
However, it is observed that many market participants follow basic human instincts. They do this to protect their capital from further reduction. What RCA does is protect us from our own psychology. When we indulge in RCA through a SIP we keep investing regardless of the price. When the market falls and even when the market rises. Hence if followed we reap the benefits of RCA in the long term.
The Dow Jones market as on 03/09/1929 closed at $383. The Great Depression followed and devastated the US economy. The US stock market then took over 25 years to reach levels it stood at before The Great Depression. On 23/11/1954 the Dow Jones closed at $385. This would mean an investor would gain only $2 ( per $385) over a period of 26 years if he invested in 1929.
However, if an investor invested using DCA( Dollar Cost Average in the US) $10000 every year, the $260,000 investments over 25 years would be worth $1.5 million as of 11/23/1954.
This is because by spreading the investments even to periods when the markets were low the investor would benefit by not only making up for the loss incurred when the markets were high but also make larger profits when the markets normalize.
Closing thoughts
The Rupee Cost Average investment strategy definitely safeguards an investor from market bubbles. Unlike other investment strategies, applying RCA doesn’t involve complex strategy and does not even require daily market tracking. This makes it easier for any individual to engage and take advantage of the market. RCA, however, does not shed light on the right time to sell.
In the current situation of ‘The Great Lockdown, we can notice that the Sensex has fallen from the all-time high of January. But if an investor understands RCA applies accordingly, he would be able to profit greater once the market normalizes.
Introduction to Options Trading: Options are financial instruments whose value is derived from the value of an underlying (aka involved) asset like security or an asset. An options deal offers the buyer the opportunity to buy or sell depending on one’s view on the value of involved security. Owning a call option gives the right to buy shares on expiration at strike price and owning a put option gives right to sell at strike price at expiry.
The options when bought or sold need not necessarily be exercised at the Expiry and at strike price. They can be exercised anytime until the options expiry. So if used judiciously the options are considered less risky than stocks or futures contract. Because of this system, options are considered derivative securities – which means their price is derived from involved assets. However, options, do not represent ownership in the company.
Let’s understand with an example
Imagine Mohan has a wedding in his house after four months and wants to buy gold for the same. However, he is fearful of the fact that the gold price might go up in the future. Therefore, to protect himself from the risk of price fluctuations, he goes to a Jewelry shop, and enters into an agreement with the shop owner whereby he fixes the price for jewelry for buying four months down the line, at the current price of Gold.
But, you must be wondering as to, what is the incentive here for the Jewelry shop owner to fix the price because he is potentially taking a big price risk. If the price goes up after four months, still he’ll have to sell the jewelry at the pre-determined price. Here, his incentive is a small fee (i.e. Premium/Token) that he will be charging to Mr. Mohan for fixing the price of gold. And this fee here is non-refundable.
Say, four months down the line if the price of gold goes up then Mr. Mohan has the right to buy gold at the pre-decided price. On the other hand, if for some reason if the price of gold comes down then he does not have to exercise his right, i.e. he may choose to buy jewelry from some other shop at the discounted current price. He merely stands to lose his premium/token.
Why would an investor use options?
When an investor or trader is buying an options contract, he/she is betting on the stock price to go in his favour (up for call option and down for pit option). The price at which one agrees to buy the involved asset via the option is called the “strike price,” and the price paid for having this right is called the “options premium.”
Benefits of Options Contract
Here are a few key benefits of Options contracts:
As the name would suggest, the Options contract gives the right to option buyer to exercise his contract if he wishes to. If the Spot price doesn’t go in favor of the buyer of the contract he does not have to exercise his right, he stands to lose just the premium.
One time premium is the only fee that option buyer has to pay to ride the momentum of underlying price and be a part of a bigger game.
If an option seller is of the opposite view to that of option buyer, he can just sell the option contract and pocket premium income.
The options are less risky than equities. Say for example if a trader wants to buy 1000 shares of Reliance, then at CMP (Rs 1400 per share), one has to shed out Rs 14,00,000 (fourteen lakhs). But one can express the same view by buying 2 Call option contracts (500 shares each). Say if he buys At the Money contract of 1410 CE by paying a premium of 35 per lot. Then, his total cost would be = (500*35*2)= Rs. 35000 only. So, now If option were to expire Out of Money for option buyer, he just stands to lose premium only. But, if the share price of Reliance Industries comes down to Rs. 1300, then total loss of equity shareholders will be Rs. 1,00,000 (1000*100).
Return on investment for an option buyer is very high because the cost paid is just the premium and the potential return is unlimited.
Call and Put Options
The Call/Put options are financial derivative instrument, meaning that their movement is dependent on the price movement of the involved asset or security. The real purpose of buying a call option is that the trader/investor is expecting the price of the involved security to move up in the near future and vice versa for the call option seller.
A Put option is bought by the trader or investor when he expects the price of an involved asset to fall in near future and vice versa for put option seller or writer. The option writer although earns premium while selling but runs the risk of giving up the involved asset in case the options goes in favor of option buyer.
Breaking down Call Options
For U.S. style options, a call option buying contract gives the buyer to buy the involved asset at strike price anytime till the expiry date of contract. In case of an European style option, the call option owner has the power to exercise only on the expiry date.
It is beneficial for the call buyer to power his right to sell his call option if the spot price moves above strike price before expiry and call option writer to bind by his promise.
The premium paid by the option buyer gives him the right to buy the involved stock or security at strike price until the expiry of options agreement. If the price of the asset moves beyond the strike price, the option will be In the money
The options writer receives the premium. The premium received is the way of generating income for the option writer or seller. But the option writer’s income is limited to the money received as premium and runs the unlimited risk of paying up the option buyer in case the involved security going above the strike price.
Call options can be In, At, or Out of the money. For example, If the Index is currently trading at 9500, an In the money call option will be to buy the option with the strike below 9500 (say 9400 CE), An At the money call option will be to buy an option will the strike price at 9500 and an Out of money call option will be to but strike price above 9500 (say 9600 CE). An In the money call option are the most expensive ones and the out of money options are the cheapest but they carry the most risk of expiring worthless.
Breaking down Put Options
Options contract duration can vary from very short term (weekly) to long term (monthly contracts). It is profitable for the put option buyer to exercise or sell his option if the spot price of the involved security comes below the strike price.
The premium paid by the put option buyer gives him the right to sell the involved stock or security at strike price until the expiry of options agreement.
The options writer receives the premium. The premium received is the way of generating income for the option writer or seller. But the put option writers income is limited to the money received as premium and runs the unlimited risk of paying up the option buyer in case the involved security going below the strike price.
Just like Call option, even Put options can be In, At, or Out of the money. For example, If the Index is currently trading at 9500, an In the money put option will be to buy the option with the strike above 9500 (say 9600 PE), An At the money Put option will be to buy an option will the strike price at 9500 and an Out of money Put option will be to but strike price below 9500 (say 9400 PE).
An In the money pall option are the most expensive ones and the out of money put options are the cheapest but they carry the most risk of expiring worthless.
Various Option strategies depending on one’s view on Market
Market view
Option
Position Name
Other trading Alternatives
Premium
Bullish
Call Option (Buy)
Buy CE
Buy Futures(Spot)
Pay
Bearish
Put Option (Buy)
Buy PE
Sell Futures
Pay
Flattish or Bullish
Put Option (Sell)
Sell PE
Buy Futures (Spot)
Receive
Flattish or Bearish
Call Option (Sell)
Sell CE
Sell Futures
Receive
Closing Thoughts
In this article, we have discussed two basic options types: Call Options and Put options. But from the graph above, we see there are four different options trading players i.e., Call Option Buyer, Call option seller, Put option buyer, Put Option Seller.
Call option and put option buyers have limited risk to the tune of option premium but have unlimited gains potential. But the call and put options writer’s risks are unlimited and the maximum reward is the premium charged from option buyers.
To Summarize, an option is a contract which is optional i.e., it is not obligatory for the buyer to buy or sell the involved security or asset at pre decided strike price within the stipulated/expiration time. Because they’re cheaper to purchase (compared to buying same number of shares), they have the power of leveraging limited money of the investor.
Hitesh Singhi is an active derivative trader with over +10 years of experience of trading in Futures and Options in Indian Equity market and International energy products like Brent Crude, WTI Crude, RBOB, Gasoline etc. He has traded on BSE, NSE, ICE Exchange & NYMEX Exchange. By qualification, Hitesh has a graduate degree in Business Management and an MBA in Finance. Connect with Hitesh over Twitter here!
A complete beginner’s guide to learn how to invest in share market in India: Hello Investors. Today we are going to discuss one of the most elementary topics for a newbie- How to invest in share market? I have been planning to write this post for a number of days as there are many people who are willing to invest, however, do not know how to invest in share market. Through this article, they will get the answers to their question and learn the step-by-step process of how a beginner can start investing in indian share market.
Please note that this post might be a little longer as I am trying to cover all the basics that a beginner should know before entering the stock investment world. Make sure that you read the article till the end, cause it will be definitely worthwhile reading it. Let’s get started.
Pre-requisites before you start investing
For investing in the Indian stock market, there are few pre-requisites that I would like to mention first. Here are the few things that you will need to invest in share market:
Bank Savings account
Trading and Demat account
Computer/laptop/mobile
Internet connection
(Thanks to Reliance Jio, everyone has 4G internet connection now.. 😀 )
For opening a demat and trading account (usually opened altogether and called 2-in-1 account), the following documents are required:
PAN Card
Aadhar card (for address proof)
Canceled cheque/Bank Statement/Passbook
Passport size photos
You can have your savings account in any private/public Indian bank.
Where to open your trading and demat account?– This will be discussed later in this post on the section ‘choose your stock broker’ (STEP 4).
Get your documents ready. If you do not have a PAN card, then apply as soon as possible (if you are 18 years old or above).
3 basic advice before you start investing
When you are new to the stock market, you enter with lots of dreams and expectations. You might be planning to invest your savings and make lakhs in return.
Although there are hundreds of examples of people who had created huge wealth from the stock market, however, there are also thousands who didn’t.
Here are a few cautionary points for people who are just entering the world of investing.
— Pay down your ‘High-Interest’ debts first
If you have any kind of high-interest paying debts like personal loans, credit card dues debts, etc, then pay them first. The interests of these loans can be even as high as your returns from the market. There is no point in wasting your energy to give all the returns you made from the market as interests of your debts. Pay down these debts before entering the market.
— Invest only your additional/ surplus fund
Stop right there if you are planning to invest your next semester tuition fee, next month flat rent, savings for your daughter’s marriage which is going to happen next year or any similar reasons.
Only invest the amount that won’t affect your daily life. In addition, investing in debts/loans is really a bad idea, especially when you are new and learning how to invest in the share market.
— Keep some cash in hand
The cash in hand doesn’t just serve as your emergency fund. It also serves as your key to freedom. You can take big steps like changing your little flat, or quit your annoying job or simply shifting to a new city, only when you have cash in hand.
Do not get trapped by investing all your money and later losing your freedom. Do not sacrifice your personal freedom in the name of financial freedom.
Now that you have understood the pre-requisites and the basics, here are the seven steps to learn how to invest in share market on your own. Do follow the step sequences for an easy approach to enter the stock market world.
How to invest in share market?
Step 1: Define your investment goals
It’s important to start with defining your investment goals. Start with end goals in mind. Know what you want.
Do you want to grow you saved money (capital appreciation) to beat inflation and get higher returns? Do you want to build a passive income from your investments through dividends? Are you investing for a specific goal? Or do you just want to have fun in the market along with creating wealth?
If you want to just have fun and want to learn, that’s okay. But make sure that you do not over-invest or get too much attracted to the market? Moreover, most people start the same way and define their goals later.
Anyways, if you are starting for Goal-Based Investing, do remember that the time frame for different investment goals will be different. Your goal can be anything like buying a new house, new car, funding your higher education, children’s marriage, retirement, etc. However, if you are investing in your retirement, then you have a bigger time frame compared to if you are investing in buying your first house.
When you know your goals, you can decide how much you want and for how long you have to remain invested.
Step 2: Create a plan/strategy
Now that you know your goals, you need to define your strategies. You might need to figure out whether you want to invest in the lump sum (a large amount at a time) or by SIP (systematic investment plan) approach. If you are planning small periodic investments, analyze how much you want to invest monthly.
There’s a common misconception among our society that you need large savings to get started. Say, one lakh or above. But that’s not true. As a thumb rule, first, build an emergency fund and next start allocating a fixed amount let’s say 10-20% of your monthly income to save and invest. You can use the remaining portion of your earnings for paying your bills, mortgages, etc. Nevertheless, even if your allocated amount turns out to be Rs 3-5k or more, it’s good enough to build an investing habit.
Step 3: Read some investing books.
There are a number of decent books on stock market investing that you can read to brush up the basics. Few good books that I will suggest the beginners should read are:
Besides, there are a couple of more books that you can read to build good basics of the stock market. You can find the list of ten must-read books for Indian stock investors here.
Step 4: Choose your stock broker
Deciding an online broker is one of the biggest steps that you need to take. There are two types of stockbrokers in India:
Full-service brokers
Discount brokers
— Full-Service Brokers (Traditional Brokers)
They are traditional brokers who provide trading, research, and advisory facility for stocks, commodities, and currency. These brokers charge commissions on every trade their clients execute. They also facilitate investing in Forex, Mutual Funds, IPOs, FDs, Bonds, and Insurance.
Few examples of full-time brokers are ICICIDirect, Kotak Security, HDFC Sec, Sharekhan, Motilal Oswal, etc
— Discount Brokers (Budget Brokers)
Discount brokers just provide the trading facility for their clients. They do not offer advisory and hence suitable for a ‘do-it-yourself’ type of clients. They offer low brokerage, high speed and a decent platform for trading in stocks, commodities and currency derivatives.
A few examples of discount brokers are Zerodha, ProStocks, RKSV, Trade Smart Online, SAS online, etc.
I will highly recommend you to choose discount brokers (like Zerodha) as it will save you a lot of brokerage charges.
Initially, I started trading with ICICI direct (which is a full-service broker), but soon realized that it was too expensive when compared to discount brokers. It doesn’t make sense to pay extra brokerage charges even if you get similar benefits. And that’s why I shifted to Zerodha as my broker. (Related Post: Different Charges on Share Trading Explained- Brokerage, STT & More)
Zerodha (a discount broker) charges a brokerage of 0.01% or Rs 20 (whichever is lower) per executed order on Intraday, irrespective of a number of shares or their prices. For delivery, there is a zero brokerage charge in Zerodha. Therefore, the maximum brokerage that you’ve to pay per trade while using the Zerodha platform is Rs 20 and it doesn’t depend on the volume of trading.
This is way cheaper compared to ICICI direct (full-service broker) which asks a brokerage of 0.55% on each transaction. If you buy stocks for Rs 50,000 in ICICI direct, then you have to pay a brokerage of Rs 275 for delivery trading i.e. when you hold the stock for more than one day in your demat account.
Further, as this amount is charged on both sides of the delivery transaction (buying & selling), hence you have to pay a total of Rs 550 for the complete transactions in ICICI direct (way too expensive than Zerodha).
Step 5: Start researching common stocks and invest.
Start noticing the companies around you. If you like the product or services of any company, dig deeper to find out more about its parent company, like whether it is listed on the stock exchange or not, what is its current share price, etc.
Most of the products or services that you use in day to day life — From soap, shampoo, cigarettes, bank, petrol pump, SIM card or even your inner wears, there is a company behind everyone. Start researching about them.
For example- if you’ve been using HDFC debit/credit card for a long time and satisfied with the experience, then investigate further about HDFC Bank. The information of all the listed companies in India is publicly available. Just a simple ‘Google search’ of ‘HDFC share price’ will give you a lot of important pieces of information. (Try it now!)
Similarly, if your neighbor bought a new Baleno car lately, they try to find out more about the parent company, i.e. Maruti Suzuki. What other products it offers and how is the company performing recently- like how are its sales, profits, etc.
You do not need to start investing in stocks with hidden gems. Start with the popular large-cap companies. And once you are comfortable in the market, invest in mid and small caps.
Step 6: Select a platform to track your performance
You can simply use an excel or google spreadsheet to track your stocks. Make a spreadsheet with three tables containing:
The stocks that you are interested in and need to study/investigate,
Those stocks that you have already studied and found decent,
Miscellaneous stock- for the other stocks that you want to track.
This way, you can easily follow the stocks. Further, there are also a number of financial websites and mobile apps that you can use to keep track of the stocks. However, I find using google sheets the easiest for tracking my stocks.
Its always good to have an exit plan. There are two ways to exit a stock. Either by booking profit or by cutting a loss. Let’s discuss both these scenarios.
Basically, there are only four scenarios when you should sell a good stock in your portfolio: 1) When you badly need money 2) when the stock fundamentals have changed 3) When you find a better investment opportunity and 4) When you have reached your investment goals.
If your investment goals are met, then you can exit the stocks happily. Or at least, book a portion of the profit from your stock portfolio and shift it to other more safer investment options. On the other hand, if the stock has fallen under your risk appetite level, then again exit the stock. In short, always know your exit options before entering.
That’s all. There were seven steps that will help you learn how to invest in the share market. Now, here are a few other important points that every stock market beginner should know:
10 Additional points to take care
1. Start small
Do not put all your money on the market in the beginning. Start small and test what you have learned. You can start even with an amount of Rs 500 or 1000. For the beginners, it’s more important to learn than to earn. You can invest in a large amount once you have more confidence and experience.
2. Diversify your portfolio
It’s really important that you diversify your portfolio. Do not invest all in just one stock. Buy stocks from companies in different industries.
For example, two stocks of Apollo Tyres and JK Tyres in your portfolio won’t be called as a diversified portfolio. Although the companies are different, however, both companies belong to the same industry. If there is a recession/crisis in tyre sector, then your entire portfolio might be in RED.
A diversified portfolio can be something like Apollo tyres and Hindustan Unilever stocks in your portfolio. Here, Apollo Tyres is from Tyre industry and Hindustan Unilever is from FMCG industry. Both the stocks are from different industry in this portfolio and hence is diversified.
Blue chips are the stocks of those reputed companies who are in the market for a very long time, financially strong and have a good track record of consistent growth and returns in the past many years.
For example- HDFC banks (leader in the banking sector), Larsen and turbo (leader in the construction sector), TCS (leader in the software company), etc. A few other examples of blue-chip stocks are Reliance Industries, Sun Pharma, State bank of India, etc.
These companies have stable performance and are very less volatile. That’s why blue-chip stocks are considered safe to invest compared to other companies.
It’s recommendable for beginners to start investing in blue chips stocks. As you gain knowledge and experience, you can start investing in mid-cap and small-cap companies.
This is the biggest reason why people lose money in the stock market. They do not carry enough research on the stocks and blindly follow their friends/colleague’s tips and advice.
The stock market is very dynamic and it’s stock price and circumstances change every second. Maybe your friend has bought that stock when it was underpriced, however now it’s trading at a higher price range. Maybe, your friend has a different exit strategy than yours. There are a number of factors involved here, which may end up with you losing the money.
Avoid investing in tips/advice and do your own study.
5. Avoid blindly following the crowd
I know a number of people who have lost money by blindly following the crowd. One of my colleagues invested in a stock just because the stock has given double return to another of my college in 3 months. He ended up losing Rs 20,000 in the market just because of his blind investing.
Will you buy ABC company which produces Vinyl sulphone easter and dye intermediates even though you have zero knowledge of the chemical industry?
If you will, then it’s like giving some stranger 1 lakh rupee and expecting him to return the money with interests. If you are lending money to someone, you ask a number of questions like what he does, what is his salary, what is his background, etc.
However, while investing Rs 1 lakh in a company which people do not understand, they forget this common logic.
7. Know what to expect from the market
Do not set unrealistic expectations for the stock market. If you want to make your money double in one month, from the stock market, then you have set your expectations wrong. Have a logical expectation form the market.
People are happy with 4% simple interest from the savings account, but a return of 20% in a year sounds underperformance for them.
Do not get distracted if your portfolio starts performing too well or too bad in the first few months of investing. Many people increase their investment amount just in few weeks if they see their stock doing too well, and end up losing in the long run.
Similarly, many people exit the market soon and are not able to get profits when their stocks start performing. Have discipline and follow your strategy.
9. Invest regularly and continuously increase your investment amount
The stock investment gives the best returns when you invest for the long term. Do not invest in lump sump at just one time and wait for the next 10 years to see how much returns you got. Invest regularly whenever you get a good opportunity. Further, increase the investment amount as your savings increase.
10. Continue your education
Keep learning and keep growing. The stock market is a dynamic place and changes continuously. You can only keep up with the stock market if you also continue your education.
Besides, there are a number of more lessons which you will learn with time and experience.
Ready to start your journey to become a succesful stock market investor? If yes, then here’s an amazing course for newbie investors: HOW TO PICK WINNING STOCKS?
That’s all for this post on how to invest in the share market. I hope this is helpful to the readers. If you have any doubts, feel free to comment below.
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
Do You Need a Finance Degree For a Career in Stock Market? The finance industry in India has been growing at a very fast pace for the last two decades. And along with the growth in the industry, there’s also a boom in job opportunities and enthusiasts willing to work in this field.
Although there are many job opportunities available in the stock market, however, one of the most frequently asked questions is- “Can a student from non-finance degree get a job on Dalal street?” How much relevant is having a finance, commerce or business degree to land a job in the world on the stock market.
Well, the short answer to this question is that you do not need a finance or business degree to get all the jobs in the stock market. A lot of financial companies hire employees from Engineering, mathematics, science, computing or economics background. In the era of internet technology, most of the financial giants are looking more for the skills and the aptitude of the candidates rather than just the degree.
Anyways, there are still a few careers in the market like Investment Banking, Equity Research, Risk Management, Portfolio Management, etc where a special skill set and expert knowledge of finance is required and having a degree can give an advantage to the candidates.
Nonetheless, having or not having a finance/commerce/business degree is just the starting point. There are a lot more things that you need to know if you want to build a career in the stock market industry which we are going to discuss in this post.
It’s always beneficial to have a background in Finance
When you have a background in finance, business, accounting or commerce, you already have got a minor exposure to the investing world. You might already know the lingo and familiar with the frequently used terms in the stock market like dividends, assets, liabilities, etc.
On the other hand, most of the non-finance guys are not even familiar with the most common terms of the market. Moreover, they find reading and understanding financial statements is quite challenging compared to people with a finance background.
Getting a job at Dalal Street Market
In a scenario where you are appearing in a job interview for a financial position, knowing these financial terms can help you impress the interviewer or at least not feeling like a dumb one. Besides, as stated, in a few financial positions, the interviewers create a barrier by shortlisting only candidates with a graduate degree in finance, commerce, business or accounting. And in all these cases, having a degree can be advantageous for you.
Moreover, if you want to become a SEBI registered investment advisor or research analyst, you will require an educational qualification of graduate or post-graduate degree in finance/accounting/commerce, etc. If you don’t meet the educational qualification, you cannot become a SEBI registered advisors/analyst and hence can’t have a career in the advisory field.
Overall, if you’re planning to become an investment advisor/research analysis, you’ll require a degree in these fields. Nonetheless, you can always enroll in post-graduate degrees of one or two years to get the degree and meet the educational qualifications.
When it comes to trading & investing or managing your own portfolio, you don’t require any degree.
Anyone can open their trading accounts and start trading in stocks. Many engineers, math/science majors, arts graduate or even people who don’t have any degree have been investing successfully and made a huge fortune from the market. A lot of successful stock market traders/investors do not have any background in finance or never did any course in this field. One of the best examples is Charlie Munger, a successful stock investor and vice-chairman of Berkshire Hathaway.
In short, if you are not interested in a 9-to-5 job or career in the Dalal street and just want to trade in stocks on your own, you won’t require any degree or certification. Here you can make money by using your knowledge and skillsets.
What to do when you don’t have a degree in Finance/Commerce?
It’s often said that Self-Education is the best form of learning. Even though if you do not have a degree in finance, you can learn the skills and impress the interviewer with your enthusiasm to master the market.
Start by learning the lingo. It’s really important to know financial terms if you want to break the initial barrier of entering the stock market world. Know the most frequently used investing terms and how to read the financial statements.
Further, if possible, take a few online courses to learn the trading/investing concept. Attend local investing workshops, seminars, etc. It would be best if you can find a mentor. Expand your knowledge base and try simulating platforms to trade in stocks without risking your money. And finally, try to land an internship in the finance company so that you can have a real experience of how things work in this industry.
Most people believe that a career in the stock market is only for people with finance or business background. But this is not true. Do not stop yourself from entering the exciting world of the stock market just because you do not have a finance degree. Here, having a skill set is more important compared to a degree. Moreover, even if you do not have a graduation degree in Finance/Commerce, you can go for reputed financial certifications like CFA, FRM, PRM, etc that will put you in the same position as those with degrees.
My final advice will be to focus on enhancing your skills and acquiring specialized knowledge. This will help you more in building your dream life than chasing over degrees.
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
A complete NISM Certification Guide for Beginners: The majority of Commerce students that I come across these days are looking to make their career in the field of Finance. Even, a substantial number of engineering graduates whom I personally know, are currently changing their career to the Financial Services. At present, the Finance industry in India and across the globe is growing at a rapid pace. Therefore, it is of no doubt in saying that professional degrees and courses like MBA (Finance), CFA, FRM, and CFP are attracting a huge number of students every day.
However, apart from these mentioned courses, is there any other course which can give you the license to work as a self-employed individual in the Finance sector? Do you know of any course which is comparatively easier to pursue, affordable and gives you the ticket to pursue a career in the Finance industry?
The answer to both the questions is “NISM certification”.
But hey! Are you hearing the word ‘NISM’ for the first time? Even if yes, then you don’t need to worry at all. In this article, I would share a brief overview of the wide range of NISM courses available and how you can get certified with NISM.
What is NISM?
NISM (National Institute of Securities Markets) is headquartered in Navi Mumbai, India and offers a wide range of courses to the Indian students. It is a public trust which was established by SEBI (Securities and Exchange Board of India). SEBI is the apex body which regulates the securities markets in India.
The SCI (School for Certification of Intermediaries) is one of the six schools of excellence at NISM. The SCI is engaged in the development of Certification examinations and Continuing Professional Education (CPE) programmes in the Financial Markets domain. These are conducted for validating and enhancing the abilities of the associates working in the Indian capital markets.
What does the NISM offer?
The NISM campus in Patalganga (Maharashtra) offers two full-time courses in Finance. The first one is PGPSM (Post Graduate Programme in Securities Markets) and the other is PGD (Post Graduate Diploma) in FinTech.
Apart from these two stated courses, NISM also offers a few other long term courses in collaboration with international bodies. You can have a look at those courses clicking here.
Further, there are 22 short term certification courses offered by NISM. In this article, we would predominantly hold a discussion on these certifications. A majority of these short term courses are mandated by SEBI for those who are either self-employed like an investment advisor or research analyst or working in the Financial Services industry in India.
The rests are voluntary certifications that have not been mandatory for the finance professionals. But, the voluntary certifications are beneficial in the sense that they provide advanced knowledge in some specific area.
For example, Mutual Fund Distributors Certification Examination (Series V C) is a voluntary exam but its contents and way of testing the candidates is more difficult than other Mutual Funds exams.
Note: You can find the list of all the available 22 courses on the website of NISM here.
How to register for a NISM certification exam?
In order to register for any course offered by NISM, you first need to create your account on the NISM website. Click on this link and it will take you to the home page of the website. While creating your account, make sure you have a digital copy of your photograph, aadhar card and PAN card with you.
After you are done with the account creation, you can choose any module of your choice. To register for any module exam, you have to select the exam date, time and center first. After that, it will take you to the payment gateway.
Once you have paid the required exam fees, you would get the soft copy of the workbook (study material) and the hall ticket in your account. Take a physical printout of your hall ticket and carry it with you to the exam center on the day of your exam.
The NISM provides the students with soft copies of the study materials in the ‘pdf’ format. The content covers both theoretical and practical aspects of the Financial Markets. These courses teach you various jargons which you need to know for pursuing a career in the Financial Markets.
Anyways, you can also enroll in these courses if you are simply interested in gaining knowledge. These programmes teach you the key theoretical concepts of the Stock Market, Mutual Fund, Financial Planning, and many others. The exams are based on MCQ (Multiple Choice Questions) and the students are tested on their conceptual understanding. Although you don’t get the opportunity to work on demo projects here, you certainly get the chance to solve case study questions in the exams. Further, you cannot carry a scientific calculator in the exam. But, you are definitely allowed to do rough works in MS Excel, OpenOffice or digital calc on the given desktop in the exam hall.
The NISM certification exams majorly focus on the practical understanding rather than emphasizing on mugging up theories. The best feature of these certifications is that the course modules are updated in every year.
How much time does it take for the completion of a NISM course?
In case of a NISM certification examination, you don’t need any significant amount of time to complete the same unlike CA, CFA, or MBA (Finance). Practically speaking, you can book your exam slot at any time. However, it is recommended that you should prepare for at least two weeks to a month before taking any module exam. This is because when you register for an exam, you get the study material covering a minimum of 100 pages which needs a decent time for complete reading.
If you are only looking to clear the exam, you can do the same by referring to the mock tests of private institutions. But, if you are looking to gain knowledge of the financial markets and clear the exams with distinction marks, you must study the workbooks given to you by NISM.
What is the registration fee to be paid to opt for a NISM certification exam?
The registration fee for any exam is pretty reasonable in nature. Here, you don’t need to pay over 30 or 40 thousand rupees to write a semester of MBA or a level exam in CFA.
Today, you can register in a NISM exam for as low as Rs 1200. The module exam with the highest registration fee is Rs 3000. Whenever you are enrolling for an exam of NISM, you have to pay the required fees. If you are unable to attempt that exam or fail in the same, you have to pay the same fee again for re-appearing in the exam.
How’s the difficulty level of a NISM exam?
The difficulty level of the NISM exams is between average to moderately high. For some exams, the contents and way of testing could be more difficult than the rests. The NISM Investment Advisor Exams (Level 1 and 2) contain relatively more practical contents as compared to the other courses. On the other hand, exams like the NISM (Series VI) Depository Operations Certification Examination contain a very high share of theory portion in their syllabus.
In order to pass a module, you need to secure a minimum of 60% score in most of the module exams. Besides, these exams come with negative marking of 25% per question. A very few exams like NISM (Series V A) Mutual Funds Distributors Certification Examination have a minimum passing marks criteria of 50% and also they don’t have any negative marking feature.
Closing Thoughts
NISM exams are definitely one of the best in the industry if you are a fresher and willing to make a career in Finance. These certification exams are sufficient to give you an initial push in your career. They are strong enough to add a few keywords in your resume and make it look better than your peers. But, you must understand that clearing these exams are not going to make you stand at par with the jobseekers having CA, CFA, FRM or MBA (Finance) in their portfolio.
Nonetheless, in case you are looking for a job after graduation, these courses can help you in getting shortlisted on India’s top job websites. It is easy to start your career as a Mutual Fund Selling Agent or an Equity Dealer clearing the required NISM exams. But, if you are aiming for a career in Portfolio Management, Investment Banking or Fund Manager, you should look for the premier courses in Finance.
Financial statements are one of the widely relied upon tool to analyze a business. However, there are many ways in which companies cook their books and create a false impression of the company’s financial health using accounting gimmicks and financial shenanigans. In this post, we are going to look at how companies cook books and how you can identify such financial shenanigans using accounting red flags.
If you look into the past, you will find that cooking books is not a recent phenomenon, but has existed for a long time. We all know one or the other company which has resorted to accounting gimmicks to dupe investors into believing that the company is doing well. Each market has its own share of such “gutsy” companies which, instead of genuinely improving the business, resorts to cooking books to show improved performance.
Why Companies Cook Books?
The question is, why do companies need to cook books? Why does the management resort to such gimmicks instead of being honest with their investors? Well, cooking books is not just about looking great on paper, some of the common reasons why companies do so are explained below:
1. To meet or exceed market expectations:
Let’s honestly admit one thing, the world is a fiercely competitive place and everyone wants to be on the top of their game. Miss the mark by a few points, and the company’s stock price gets hammered badly by the market.
With ever intensifying competition and “Go big or go home” thinking, the management of every company is pressed to either beat or at least meet the growth expected by the market.
With such mounting pressure to perform, companies that fail to deliver as per expectations, often get involved in cooking books and create a false image of healthy growth.
2. Vested Interests of the Management:
The second reason why companies cook books is because the management has its own vested interest behind it. Nowadays, many companies offer share price linked incentives to their managers.
Such schemes are offered to align the interests of the shareholders to that of management so that both can benefit from the good performance of the business.
Incentives linked to the share price motivates the managers of the company to work harder and deliver a good performance.
When the times are tough, and business struggles to perform, top managers, driven by greed of incentives and fear of being penalized for poor performance start window dressing the accounts to paint a rosy picture of company’s performance.
3. To show a consistent growth rate by under-reporting current spurt of growth:
This is something that does not happen pretty often, but there are times when companies do under-report their financial performance. Why? Let me explain.
Investors love companies with strong consistent performance and growth, and company managers know this very well. There are some companies that have a seasonal business, where they perform well when times are favorable and do poorly otherwise.
Such companies during good times minimize the current earnings by under-reporting the revenues or by inflating current period expenses by postponing good financial information for the future period when the company is more likely to underperform.
This again creates an illusion for investors that the company has performed well compared to its peers even during tough times.
As a result, such companies command higher valuations which they do not actually deserve.
How Companies cook books?
Management of the companies may have different reasons behind cooking books, but the way it is achieved has hardly ever changed.
The only way management of the companies can manipulate books is by concealing information, in other words, by hiding it in places where it is difficult to detect easily.
So how do companies cook books? Well, as I said earlier, it’s all about hiding crucial information about the company within the financial statements so that they are not easily traceable.
There are only three ways a company can manipulate earnings, by manipulating earnings, profit, and cash flow.
1. Earnings Manipulation:
Earnings manipulation occurs when companies try to inflate (or in some cases, hide) their earnings such as revenue. There are two ways companies manipulate their earnings.
— Recording Revenue prematurely: Booking revenues in advance is one of the most commonly used financial shenanigan by the companies. It includes booking revenues even before the goods are sold or a project is completed.
An example of such premature recording of revenue was seen in Sobha Developers in 2008-09. In Q1 of 2008-09, Sobha Developers decided to recognize the revenue earlier during a project cycle. This led to a 20% jump in the company’s profits before tax.
— Recording income from investment as revenue: The second most common way to manipulating earnings is by recording revenue from other sources as operating revenue.
If proceeds from the sale of an asset (such as land, building, plant, and machinery) or income from an investment (such as maturity of a bond or proceeds from the sale of shares) is recorded as revenue, it will boost the total revenue of the company.
Since these are a one-time phenomenon, and cannot be repeated in the future, recording such one-time sources of revenue gives a false impression of improved financial performance.
2. Profit Manipulation:
Profit is considered to be the blood of a business, something which is necessary for the survival and prosperity of a business. Just like revenue, even profits can be manipulated in many ways.
From hiding expenses to making a simple change in the way in which depreciation is calculated, there are numerous ways a company can manipulate its profits numbers. Some of the most common ways companies cook books in terms of profit are as follows:
— Making expenses look like earnings: A simple change in accounting policy can have a significant impact on the way profits are presented. Many companies use this approach to manipulate Net Profits.
For example, a simple change in the way depreciation is calculated can change the entire picture, helping company management boost profits.
For Example, a small change in depreciation policy in case of Jet Airways created profits out of thin air. In the Q2 of 2008-09, Jet airways changed its depreciation policy from written down value method to straight-line value method, as a result of which, Jet Airways was able to write back ₹920 crores to its Profit and Loss account.
— Hiding Expenses as Capital Expenditure: Another way to boost profits is by treating expenses as capital expenditure; that is instead of treating it as expenses during the current financial year, it is treated as investment made to expand the business.
One such incident can be found in the USA, wherein the years 1990, AOL was found guilty of delaying expense.
AOL was distributing installation CDs as a part of its marketing campaign, but instead of treating it as an advertising expense, AOL decided to view it as capital expenditure. As a result of this, the entire amount was transferred from profit and loss statement to balance sheet of the company where the campaign would be expended over a period of years.
Because of AOL’s treatment of expenses as Capital Expenditure, the entire amount was written off the P&L Statement, which resulted in boosted profits.
3. Cash Flow Manipulation:
Cash flow is considered to be the most reliable source of the true financial health of the company for the simple reason that cash is difficult to manipulate. Investors like Warren Buffett rely heavily on numbers like free cash flow to assess the financial health of the business.
Since companies know this well, they have devised new ways where it is possible to manipulate the cash flow of a company using accounting gimmicks.
Detecting such tricks can be quiet challenging for an amateur investor who does not have a deep understanding of accounting and finance or does not have free time to go through the books of the company.
Some of the most common cash flow related financial shenanigans are explained below:
— Showing financing cash flow as operating cash flow: There are two ways a company can generate cash for itself, first, from its own business, where profits earned by the business get converted to cash, and second by borrowing cash from an external source in the form of loan by issuing bonds or bank loan.
The cash received from business operations is called Cash Flow from Operating Activity, and cash received from an external source is treated as cash flow from financing activity.
Many companies try to boost their operating cash flow by treating financing cash flows as operating one, which leads to a wrongful impression that the company is generating a lot of operating cash flow from its business.
— Using acquisitions as a boost to operating cash flow:
Cash flows can also be manipulated using mergers and acquisitions, especially if the target company is rich in cash.
Management often tries to win support from its shareholders by convincing the shareholders that a particular acquisition will be highly beneficial for the company.
As soon as the merger takes place, all the cash that belonged to the target company, now becomes a part of the parent company, thus boosting overall cash flow statements.
Investors must always be wary of the financial history of the target company and its business and find out if the merger is really going to benefit the business.
If an acquisition is happening just because it will boost the EPS or the cash flows of the parent company, with no meaningful benefit to the business, then such acquisitions must be avoided at all costs.
Cooking books is not limited to manipulating earnings or hiding crucial details about the weak performance of the company, management of companies go beyond the books and create their own parameters of measuring the growth and performance of a company.
Such parameters, though necessary in certain industries, are still non-standard as per the accounting standards. Because of such creative parameters, managements get an opportunity to change their definition of performance as per their requirements, allowing them to use creative methods to put encouraging but false performance numbers in front of investors.
Some of the examples of such no-standard parameters are explained below:
— Same Store Sales (Used In Retail Stores and Restaurants):
Same store sales is a parameter to measure the performance of retail stores. It gives information about how much sales revenue a store is generating during a fiscal year or more.
Same store sales also give investors an idea of how much revenue a company is generating from its existing stores and how much is contributed by new stores. If the percentage of sales revenue from new store sales is rising, it’s strong evidence that new stores are performing well, sounds rational, right?
This is where companies get a chance to manipulate with numbers without getting noticed. The management of the company may alter the criteria of eligible stores to be used in the metric.
For example, in one financial year, a company may use only those stores older than 3 years to show the same store sales performance while in the next year, if the performance of the stores older than 3 years deteriorates, the management may change the criteria and use only those stores that are older than 5 years.
Companies may keep changing their eligibility criteria as per their suitability to present the desired picture.
— ARPU (Average Revenue Per User):
ARPU stands for Average Revenue Per User and is a performance metric generally used by Telecom companies or DTH service providers. Just like same store sales, ARPU can also be used for manipulating earnings of a company.
Most telecom companies, especially in this age of smartphones, not only generate revenue from selling data, but also by selling ad space, and this is where the manipulation begins.
The right way to calculate ARPU is by calculating total revenue generated from data services provided divided by the total number of subscribers.
However, some companies, to show encouraging revenue growth add advertising revenue to the revenue from subscription, thereby falsely boosting the total ARPU.
How to detect if a company is cooking books?
So far we have seen why and how companies cook books, but the biggest question is, is it possible to detect these financial shenanigans? How would you know that a company is cooking books?
While detecting some of these financial shenanigans requires a degree in finance, most of them can be traced pretty easily if you just observe carefully.
— Improved Revenue with an absence of Cash Flow:
If the complicated accounting terms are giving you nightmares, and you have no clue what to do, here is something very simple and logical thing you can do. Just Watch out for cash flow.
Increase in revenue of the company should be reflected with an increase in cash flow of the company. If you see operating cash flow declining or stagnant even if the revenue is marching upwards, or if cash flow is much slower than the revenue generated, it usually means that the company is generating revenue but is unable to collect cash, or even worse, the revenue numbers are simply fake and bogus.
— If Q1+Q2+Q3+Q4 is not equal to FY:
In an ideal situation, if the financial results are audited, the annual sales and profits should simply be a sum of all the four quarterly sales and profit numbers, except for minor variations.
If there is a significant variation between annual sales and profit numbers and sum of all quarterly numbers, you can say that the books have been manipulated at least to some extent.
— If a company is on an acquisition spree:
Companies make acquisitions as it helps the acquirers grow inorganically while making an acquisition, companies make sure that the interests of both the companies are aligned and that the resources that an acquiring company needs are available with the company that is being acquired, at a bargain price.
In simple words, any acquisition should add value to the company more than what is being paid for it. There are many instances when companies are on an acquisition spree. Firms that make numerous acquisitions can get into trouble, their financials get restated and complicated to understand.
Aside from complicating things, acquisitions usually increase the risk of cooking books and bury the evidence under many layers of financial statements. So if a company is a serial acquirer, but does not show significant improvement in its financial performance, there is a good chance that the acquisitions were made simply to manipulate the numbers.
— If the company has bulging Trade Payables:
Many companies, especially in a competitive, customer-centric market loosen their credit terms, attracting more customers to buy goods and services now and pay later. While this is a great move that helps boost sales revenue, it may create a liquidity crisis in a company.
Longer credit duration means that company has to wait longer for the revenue to be converted into cash, but since a company has to meet its daily expenses in cash form, longer credit means company may run out of cash and may have to either borrow to meet its operational expenses or shut down its operations completely.
The best way to cross-check if the company’s revenue is simply because of loose credit terms is to check if there is a change in days receivables in the past few financial years.
If a company has increased the receivable days, it shows that all the revenue is just on paper and the cash is yet to be realized. Such practice is pretty common in infrastructure companies.
— If the CFO and auditors resign or get fired:
This is by far one of the most vital signs that a company is cooking books. There is an old saying in Latin “Who Watches the Watchmen?” when it comes to financial reporting, the watchmen are the Chief Financial Officer (CFO), and the corporate auditor.
If you find a company that is involved in some of the suspicious accounting activities as mentioned above, and you see the CFO of the company quitting abruptly for no valid or logical reasons, its time to stand guard and find out if there is something going on within the company that has not met your eyes yet.
The same rule applies to corporate auditors. IF a company frequently changes its auditors or fires them after some accounting issues come to light, be watchful and look for warning signs.
There have been many recent examples of auditors resigning after altercation from the company owners, which later revealed that company was involved in dressing up numbers to make things look good on the surface while it was really bad inside.
In the month of May 2018, Deloitte, corporate auditor of Manpasand beverages quit a few days before the declaration of annual result as the company was unable to share crucial data regarding capital expenditure and revenue. As a result, the stock price of Manpasand beverages tanked 20% within a day. You can read the news by clicking here
Another such incident happened recently where PWC (Price Waterhouse Coopers LLP) statutory auditor of Reliance Capital and Reliance Home Finance, quit just before the declaration of FY19 results.
In its resignation letter, PWC stated that as part of the ongoing audit for FY19, it noted certain observations and transactions, which, in its assessment, if not resolved satisfactorily, might be significant or material to the financial statements. You can read the new by clicking here
Conclusion:
If you are looking for a great investment, look for great businesses. The best way to understand if a business id great or not is by analyzing the financial statements of the company.
Since every investor relies on financial statements for his analysis, it’s important that companies remain honest and transparent and give only authentic information.
However, with the ever-mounting competition, and a race to perform better than peers puts a lot of pressure on the management to perform, because of which they often resort to unethical ways to manipulate the number so that the business “appears” healthy.
There is an Old Russian Proverb which means “Trust, but Verify”, taking things at face value can be dangerous and thus it is important that investors, even if they trust the management with the numbers, should always be vigilant and keep checking the authenticity before making an investment decision, after all, it’s your hard-earned money at risk, don’t take anyone else’s word for it.
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About the Author:
This article is a guest post by Ankit Shrivastava, a SEBI Registered Research Analyst. Ankit has been investing in stocks since 2004 and writes about fundamental analysis of companies, principles of investing, investment strategies and a lot more on his blog: Infimoney
Trade brains is a financial education blog focused to teach stock market investing and personal finance to the DIY (do-it-yourself) investors in order to make, grow & sometimes even spend money. #HappyInvesting
When I first entered the investing world, I spend a lot of time googling the key terms in share market. Definitely, Investopedia was my favorite website to learn the meaning of those words. Although there are thousands of terminologies that a stock market investor/trader should know, however, they are a handful of them which are repeatedly used. This basic domain knowledge of these terms is really important if you want to enter and succeed in the share market.
In this post, we are going to present an elementary guide for the beginners to help them understand the key terms in share market. Let’s get started.
27 Key terms in share market that you should know:
Share: A share is the part ownership of a company and represents a claim on the company’s assets and earnings. It fluctuates up or down depending on several different market factors and is exchangeable at stock exchanges. As you acquire more stock, your ownership stake in the company becomes greater.
Shareholder: An individual, institution or corporation that legally owns one or more shares of stock in a public or private corporation are called shareholder. Shareholders have a claim on the company’s ownership.
Primary market: Also known as New Issue Market (NIM). It is the market place where new shares are issued and the public buys shares directly from the company, usually through an IPO. The company gets the amount on the sale of shares.
Secondary Market: It is the place where formerly issued securities are traded. The second market involves indirect purchasing and selling of shares among investors. Brokers are Intermediary and the investors get the amount on the sale of shares.
Intraday: When you buy and sell the share on the same day, then it is called intraday trading. Here the shares are not purchased for investing, but to get profits by harnessing the movement in the market.
Delivery: When you buy a share and hold it for more than one day, then it is called delivery. It doesn’t matter whether you sell it tomorrow, after 1 week, 6 months or 5 years. If you hold the stock for more than one day, then it is called delivery.
Bull market: This is a term used to describe the scenario of the market. A bull market is when the share prices are rising and the public is optimistic that the share price will continue to rise.
Bear Market: When the share prices are falling and the public is pessimistic about the stock market, then it’s a bear market. The public is fearful and thinks that the market will continue to fall and hence, selling increases in this market.
IPO: When a privately listed company offers its sharers first time to the public to enter the share market, then it is called initial public offering.
Blue chip stocks: These are the stocks of those reputed companies who are in the market for a very long time, financially strong and have a good track record of consistent growth and returns in the past many years. Their stocks have low risk compared to mid cap and small cap stocks.
Broker: A stockbroker is an individual/organization who is a registered member of the stock exchange and are given license to participate in the securities market in place of its clients. Stockbrokers can directly buy & sell stocks in the share market on behalf of their clients and charge a commission for this service.
Portfolio: A stock portfolio is grouping all the stocks that you are holding. A portfolio shows the different stocks and the quantities that you are holding. It’s important to build a good portfolio to maintain risk-reward in the stock market.
Stock Exchange: Just like a vegetable market, exchanges act as a market where the stock buyers connect with stock sellers. There are two big stock exchanges in India- Bombay stock exchange (BSE) and National stock exchange (NSE).
Dividend: Whenever a company (whose shares you are holding) is in profit, the company can either reinvest the profit or distribute the amount among its shareholders. This share of the profit that you get from the company is called dividend.
Companies may or may not give dividends to their shareholders depending on their needs. If it’s growing fast, it might re-invest the profit in its expansion. However, if it has enough cash, the company will distribute it among its shareholders.
Index: Since there are thousands of company listed on a stock exchange, hence it’s really hard to track every single stock to evaluate the market performance at a time. Therefore, a smaller sample is taken which is the representative of the whole market. This small sample is called Index and it helps in the measurement of the value of a section of the stock market. The index is computed from the prices of selected stocks.
Sensex is the index of BSE and consists of 30 large companies from BSE. Nifty is the index of NSE and consists of 50 large companies from NSE.
Limit Order: Limit order means to buy/sell a share with a limit price. If you want to buy/sell a share at a given price, then you place a limit order. For example, if the current market price of ‘Tata motors’ is Rs 425, however you want to buy it at Rs 420, then you need to place a limit order. When the market price of Tata motors falls to Rs 420, then the order is executed.
Market order: When you want to buy/sell a share at the current market price, then you need to place a market order. For example, if the market price of ‘Tata Motors’ is Rs 425 and you are ready to buy the share at the same price, then you place a market order. Here, the order is executed instantaneously.
Good till cancellation (GTC) order: This order can be placed when an investor is willing to buy/sell the shares at a specific price and the order remains active till it is executed or canceled.
Day order: This order can be placed when an investor is willing to buy/sell shares on a particular day and the order gets automatically canceled if not fulfilled on that day.
Note: If you are new to share market and want to learn how to pick winning stocks, then here is an amazing crash course that I highly recommend you to check out.
Trading volume: It is the total number of shares being traded at a particular period of time. When securities are more actively traded, their trade volume is high. Higher trade volumes for a stock mean higher liquidity, better order execution and a more active market for connecting a buyer and seller.
Volatility: It means how fast a stock price moves up or down. More volatile assets are considered riskier than less volatile assets because the price is expected to be less predictable and may fluctuate dramatically.
Liquidity: Liquidity means how easily you can buy/sell a share without affecting the share price. A highly liquid share means that it can easily be bought or sold. A low liquid stock means that the buyers/sellers are hard to find.
Short selling: It is a practice where the trader sells share first (which he doesn’t even own at that time) and hope that the price of that share starts falling. He will make a profit by buying back those shares at a lower price. Overall, both selling and buying are done here, however, it’s sequence is opposite to the regular transactions to get the profit of the falling share prices.
Going long: This is buying the shares in expectations that the share price is going to increase. When a trader say I am “Going long…” or “Go long”, it indicates his interest in buying a particular share.
Average down: This is an approach that investors use to buy more shares when the share price starts falling. This results in an overall lower average price for that share. For example, you bought a stock at Rs 100. Then the stock price starts falling. You bought the stock again at Rs 80 and Rs 60. Hence, the average price of your investment will be lower i.e. Rs 80. This is the approach used in averaging down.
Public float (free float): Public float or free float represents the portion of shares of a company that is in the hands of public investors.
Market capitalization: It refers to the total rupee value of the company’s share. It is calculated by multiplying the total number of shares by its present market share price. We define large cap, mid cap or small cap companies based on their market capitalization.
Bid: The bid price represents the maximum price that the buyer/buyers are willing to give to buy a share.
Ask: This is the minimum price that the seller/sellers are willing to receive to sell their shares.
Bid-Ask spread: This is the difference between the ‘bid’ and ‘ask’ price of a share. Basically, its the difference between the highest price that the buyers are willing to buy a share and the lowest price that the sellers are willing to sell their shares.
Demat account: It is the short form for ‘Dematerialised account’. The demat account is similar to a bank account. Just as money is kept in your saving account, similarly bought stocks are kept in your demat account.
Trading Account: This is a medium to buy and sell shares in a stock market. In simple words, the trading account is used to place buy or sell order for a share in the stock market.
Margin: Trading on margin means borrowing money from your stock brokers to purchase stock. It allows the traders to buy more stocks than you’d normally be able to.
That’s all. Apart, there are thousands of more terminologies involved in trading/investing. However, these are the key terms in share market that a beginner should know. I hope this is helpful to the readers. Comment below if I missed any key term in share market that should be listed in this post. Happy Investing.
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
