What is stock split?

Stock split can be defined as issuing of new shares to the existing shareholders in proportion to current holdings. Stock split is basically dividing a stock into more number of stocks. This is generally done because of increased stock price and earnings. Stock split is generally a stock dividend of 50% or higher and less than 50% is called as simply stock dividend. Stock split is generally referred with split factor, such as split of 2:1, 7:3 etc. For example, if management declares a stock split of 3:2, it does imply that for every two shares owned by an investor, third share will be received. Stock split doesn’t create any cash flow generation and hence value of the company’s equity should stay contact. Then why do companies go for stock split if there is no change in the overall value.

Why companies go for stock split?

With the stock split, number of shares increases, say, in a 2:1 stock split number of outstanding shares will double. But this will be offset by reduction in the stock price. In theory, stock price would become exactly half of the original price in case of 2:1 stock split. What is the advantage to the companies in such case?

General belief is that stock split would increase the marketability and liquidity of a stock. Companies usually go for stock split when the stock price is too high. With the stock split, price of the stock reduces and hence it will be available to more number of marginal investors who may not buy the stock at higher price. For example, Apple announced a stock split of 7:1 in June 2014. Closing price of the stock before the stock split was $645 and it was closed at $ 93 after the stock split. Thus the Apple’s shares were made available to more number of investors.

Effect of stock split on volatility

Lower prices would attract more number of smaller investors who otherwise cannot afford that stock. Thus tradability of the stock increases with the stock splits. With the increase in trading, it is believed that demand for the stock would go up which would result in increased price of the stock there by increasing company’s value.

With such an increase in the trading, the volatility of the stock would increase. Investors might buy in large numbers in anticipation of higher returns because of the increasing demand, or it is also possible that large numbers might sell to reap the benefits of increased demand. So, the stock becomes volatile. A research conducted by Ohlson and Penman shows that stock splits cause increase in the volatility in the short term upon announcement and also increase in the volatility in the long term after the split is done.

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Companies generally face number of risks in their business activities. It may not be possible to avoid the risk but risk can be mitigated to some extent. This process of mitigating the risk is called as hedging the risk. One of the best tools used by corporates to hedge the risk is the use of derivatives. Warren Buffet and his company Berkshire Hathaway view derivatives as time bombs, both for the economic system and the parties dealing in them. But, contrasting with that stand of Warrant Buffet, the derivatives trading volume has been escalating like never before. Three of the most common ways to hedge the risk are:

1. To hedge foreign exchange risks
2. To hedge interest rate risk
3. To hedge against changing commodity prices

Hedging foreign exchange risks:

Changes in currency exchange rates has drastic effects on businesses mainly which are export/import based businesses. Corporates use the derivatives as an important tool to mitigate such risks. Say for example, consider a company ABC operating from India which exports its products to US. If the value of rupee depreciates against the dollar, the total value of the exports in rupees will increase for ABC. In case, if the value of the rupee appreciates against dollar, then the total value of the exports would decrease in terms of rupees which constant in terms of dollars. To hedge such risk of losing the money because of rupee appreciation, export companies buy futures contracts which acts exactly opposite to the rupee moment and hedges the risk.

Hedging interest rate risk:

Interest rate risks is another major risk for the corporates. This is true in case of floating rates. Companies are not sure of how much interest rate they will be paying for the outstanding debts. In such cases, companies generally go for interest rate swaps. Say ac company BCD, has some debt component with floating rate. Now, BCD would buy an interest swap with floating rate receipts and fixed payment. That is, the company will receive floating interest rate and will pay fixed interest rate on pre-decided amount. SO, BCD can use this floating rate receipts to pay for its floating rate debt component. In, overall it will be left with fixed rate debt which will stabilize its business.

Hedging against changing commodity prices

Those companies which depend heavily on raw material inputs or commodities are significantly sensitive to the ever changing commodity prices. For example, Airlines depend heavily on jet fuel. Hence, Airlines generally give importance to the deals to hedge risk against changing fuel prices. Companies generally use futures contracts to hedge such risks.

There are many such uses of derivatives to hedge the major risks faced by Businesses. They basically prepare companies to face any adverse changes.

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There are various sources like debt, public offering of shares or own capital to fund a project or a new venture. From last one decade we have been seeing a new concept of funding projects called crowdfunding. Crowdfunding can be defined as raising funds for a project or a new venture from large number of public in the form of monetary contributions. The majors/active players to fuel crowdfunding concept are:

1. The initiator of the project who proposes the new idea which is to be funded
2. The individuals who support the project and are ready to fund
3. A platform which helps both the parties meet

There are basically three types of crowdfunding. They are:

1. Rewards crowdfunding ( Donations)
2. Debt crowdfunding
3. Equity crowdfunding

Rewards crowdfunding: This is something where people contribute money for projects without expecting any returns. They invest just because they trust the project. They will be generally offered some rewards such as acknowledgements for the success of the project, free gifts etc. Generally, the returns are not tangible.  People perhaps donate with personal or social motives and feel happy for making the project a success.

Debt crowdfunding: This is also called as peer-to-peer lending. In this, people invest in projects with pre-defined expected returns. They get their investments back with interest. This generally bypasses the traditional banking system in lending.

Equity crowdfunding: People invest in projects in exchange for a share in the project. Money is exchanged for the equity share in the project or the new venture. Similar to regular shares, if the project is successful, that value of the shares goes up otherwise they will face losses.

It is believed that the first online crowdfunded project happened in 1997 for Rock band Marillion. They could not tour after the release of their seventh album. Then American fans have raised an amount of $60,000 through crowdfunding with which they have played in the US.  They have made use of this source of funding even for their following three albums. Many other creative projects like films and journalism soon followed the suit.

The first crowdfunding website was built in 2001. In 2012 there were about 500 such online platforms.

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Index, as name suggests, is an indicator. In case of stock market it tries to indicate the performance (price moments) of overall stocks listed on that particular exchange. Index is generally computed from the prices of a few selected stocks. Financial analysts and investors use index to describe the condition of the market. Index is used as a benchmark to compare returns on various investments. Examples of index are Sensex and Nifty.

Sensex is an indicator of the companies listed on Bombay Stock Exchange. Sensex composed of the top 30 largest and actively traded stocks on Bombay Stock Exchange. Nifty is the benchmark index of National Stock Exchange. It is composed of the top 50 companies on the exchange. The upward movement of Sensex (Nifty) indicates that the price of majority of stocks on BSE (NSE) have gone up. Similarly the downward movement of Sensex (Nifty) indicates that the price of majority of stocks on BSE (NSE) have gone down.

Apart from BSE and NSE we have many regional stock exchanges as well. Ahmedabad Stock Exchange, Bangalore Stock Exchange, Calcutta Stock Exchange and Hyderabad Stock Exchanges are some of the examples. Similarly we have many indices. There are industry specific and category specific indices also. “BSE Midcap index” is an example of category specific index which indicates the price movements of the midcap stocks trading on Bombay Stock Exchange. Similarly “BSE IT Index” is an example of sector specific index which indicates the price movements of stocks falling in IT sector. Similarly we can find indices for other stocks as well.

As mentioned above, index tries to represent majority of the stocks. To achieve this accurately, the value of the index is calculate by using the top stocks, 30 in case of Sensex which have the highest market capitalization. The method used to calculate the value is “Free-Float Market Capitalization Method”. This is one of the widely used methods across various stock exchanges in the world.

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These days we can hardly find a credit company which gives loans or credit cards to its customers without checking the credit score of the individual. The best source to get the credit information of an individual is the CIBIL score. The credit worthiness score given to an individual is called as CIBIL TransUnion score, from here on we call it as CIBIL score.

CIBIL uses some advanced financial analytics to calculate the CIBIL score. The score ranges from 300 to 900 and closer it is to 900 better the credit worthiness of the individual. However each bank has its own criteria and methodology to calculate the credit score. Even different banks have different cut-offs on credit scores to give loans depending on the risk appetite. Any score more than 750 is generally considered to be a good score.

As it was said various companies have various methodologies to calculate the credit score. But, the major factors that are considered for credit score calculation will be more or less the same, may be with slight variation in weightages assigned to these factors. The factors can be:

• Past Performance
• Credit type and Duration of the credit
• Credit exposure

Individuals’ past behavior in repaying various debt obligations will be a major criteria. Type of loan availed whether a secured one or not shows the repaying nature of the individual. Duration for which he has been under monitoring of CIBIL also does matter as trust increases with time. Amount of exposure towards credit indicates risk associated with that person if the loan is given. Say if the person is less exposed to credit, then it implies that he has less debt obligations and he can repay easily.

Some other factors like credit utilization, trade attributes and defaulting will also influence credit rating. Credit utilization shows the consumers behavioral pattern in using the total credit limit. Trade attributes measures the longevity of the credit history of the individual.  Defaulting shows the number of accounts in case of which the individual did not pay back.

CIBIL score not only influences qualification of an individual for a loan but also might influence the company in deciding the norms and conditions for the loan agreement. Hence repaying the EMIs on time and maintaining a healthy credit record will certainly should help improve the CIBIL score.

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What is Ratio Analysis?

It is difficult to read and make sense of large financial statements. So to make things easy financial ratios have been introduced which briefly explains the financial position of a company. This is one of the oldest methods of financial statements analysis. Banks and other lenders have developed this to evaluate various competing companies for credit. In some cases, there are recommend values for ratios which indicate healthy financial status. Some other ratios are analyzed in comparison with competitors and the companies’ past records.

Investors generally have minimum data to make decisions about a company. Financial statements provide a basis to analyze the internal operations of the company. Financial ratios would simplify these statements. These ratios also help to compare among various financial statements. Analysis like DuPont analysis would relate financial ratios and profitability of the company in an investor sensible way.

Primary source of data would be financial statements released by the companies and their competitors. Data can also be accessed from various reports published by consultancy firms. The various activities by companies on stock market can also be tracked to get the data useful for financial ratio analysis.

How to interpret the ratios?

Ratios are used to understand the financial status of a company. This is done either with respect to the company’s past performance or it compared to the industry benchmarks. Horizontal analysis is used to compare the same ratio over time. Cross-sectional analysis is used to compare one company with that of the industry benchmarks.

In horizontal analysis, one compare the present ratios of a company with the previous quarters’ and previous years’ values. With this one can understand the financial stability of an organization. Having the past track record also helps analysts in projecting future financials accurately.

Cross-sectional analysis helps analysts to evaluate a company on relative basis. There are different benchmarks to compare a company with. One may use industry average to see how best the company have performed over and above an average company in the industry. Those who are not satisfied being average would like to take industry leader as benchmark. If the company under consideration is industry leader in itself then best practices across the globe will be considered as benchmark.

Who uses Ratio Analysis?

There are numerous ratios in practice. It is important to know how these ratios can be used by different group of people for different purposes. Shareholders of any company are worried about the return on their investments. Hence they consider profitability ratios followed by cash flow ratios. In contrast the management is more bothered about the cause rather than the result. Hence they consider turnover ratios and operating performance ratios.

Debt holders and suppliers of any company are concerned if the company pay back the debts in the stipulated time. Hence they are concerned about the short term liquidity of the firm. Ratios that might useful to such groups is liquidity ratios and cash flow ratios. Unlike debt holders, credit rating agencies are concerned about the long term existence of the company. They use solvency ratios to see if the company can clear its obligations in the long run.

What are the Limitations?

Ratio analysis with no doubt is a best tool to understand the financial status of a company with least efforts. But, like any other technique, this also has its limitations.

It is possible that the company might deliberately show misleading financial statements. The companies do know what really fascinates the investors. Hence they try to show the financials accordingly within legal frameworks. So ratios cannot depict true picture of the company.

Different companies might be having different financial policies. Hence it becomes absurd to compare the financial ratios of such companies. Though regulators have been putting efforts to standardize the financial policies across the globe, still companies have the choice to choose their own policies.

Financial ratios are established thumb rules for conventional companies. But in the world of ecommerce, thousands of companies are being established each day with innovative business plans. Financial ratios analysis hardly gives any meaningful insights into such companies.

Financial ratios are in many ways the best tools to get insight into the financial status of any company. Considering their limitations, one should use them as supporting tools for analysis rather than depending solely on them.

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What are Credit Ratings?

Credit rating can simply be defined as assessment of the individuals’ or organization’s ability to clear the financial obligations. This ability to pay back the financial obligations is known as creditworthiness. Credit ratings are applicable to debt securities like bonds, notes and other debt instruments. But are not applicable to equity securities like stocks, mutual funds etc. This can be a useful data to be considered when deciding about investments. But decisions cannot be solely based on credit ratings as they have their drawbacks.

Rating of any company is subjective to the credit rating agency. As it purely depends on the procedure followed by the credit rating agency in rating any entity. Various factors like historical financial performance, operating experience and collateral performance may be considered. Credit rating agency’s expectations, assumptions and analytical models also do effect the rating of a company. Changes to the credit rating can happen at any time. And it cannot be guaranteed that a AAA rated debt would clear its financial obligations all the time.

Why Credit ratings?

Before investing any investor would like to evaluate various options available to him/her before taking the decision. Company’s reports, Financial Statements, other industry related data and ratings of the company if available can help an investor dissect various parameters before taking the decision. As it was said that credit ratings of a company varies with the credit rating agency. Hence it is important to consider credit ratings of multiple credit rating agencies for better evaluation. Credit rating should always be a supplement to the other research and analysis about the investment opportunity but it cannot be a replacement.

Evolution of Credit Rating agencies in Indian Financial Markets

With the increasing defaulters in the financial markets, role of credit rating can be highly appreciated. This would act as an alarming signal to the investors to know the creditworthiness of a company before investing. Changing global perspectives are showing impact on how the financial markets in India are evolving. India, set up credit rating agency in 1988, was the first among developing countries. It was formally functionalized when RBI made it mandatory for the issue of Commercial Paper. Subsequently SEBI made credit rating mandatory for certain debentures and debt instruments.

In June 1994, credit rating was made mandatory by the RBI to the Non-Banking Financial Companies. CRISIL (Credit Rating and Information Services of India Ltd) was the first credit rating agency in India which was established in 1987. This was followed by establishment of two more credit rating agencies namely ICRA Ltd (investment Information and Credit rating Agency of India Ltd) in 1991 and CARE Ltd (Credit Analysis and Research Ltd) in 1994. All-India Financial Institutions have promoted all the three credit rating agencies.

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Game theory is the scientific study of conflict and cooperation between two or more intelligent decision makers. Concepts of game theory apply to those situations where individual’s actions are independent form what others does. It is assumed that information is known to all the individuals. Game theory provides a platform to plan, model, analyze and understand strategic scenarios. The consistency and strong mathematical foundations of game theory makes it an important tool for modelling and decision making in automated interactive environments.

Game theory enables a decision-maker to analyze all the players and their strategic options and helps him consider their preferences and reactions in the process of decision making. Major assumption in game theory is that the players are rational. A rational individual is one who always chooses an action whose outcome is in his best interest, given he has information about other players’ actions.

Dominant strategy can be defined as that strategy which is expected to give the best possible outcome for any action taken by the opponents. A strategy which cannot give the preferred outcome for at least one strategy of the opponents is called as dominated strategy. Any rational player would choose a dominant strategy.

Game theory can be broadly classified into two categories. They are:

• Cooperative game theory
• Non-cooperative game theory

Cooperative game theory: This specifies only what payoffs each player would get by cooperation of its members. The process by which the cooperation is achieved is not specified. Nash equilibrium comes in the framework of cooperative game theory. Nash demonstrated that any finite game will always have an equilibrium point, at which each player chooses actions which give them the best results given opponents’ choices.

Non-cooperative game theory: This is concerned about analyzing the available strategic choices. In this model, details of the ordering and timing of players’ choices are important in determining the result of the game. In this model players are assumed to make decisions out of their own interest. Cooperation can at times occur in this model if an outcome appears to be in everyone’s best interests.

Non-cooperative game theory can be represented broadly in two forms. They are:

• Strategic from
• Extensive form

Strategic from: This is a basic type of representing non-cooperative game theory. This representation is also called as game matrix. This will list each player’s strategies and the outcome of each possible combination of strategies. Outcomes represented by payoffs for each player. Payoff can be simply defined as indicator of a player’s willingness to choose a strategy, given other players’ choices.

Extensive form: This representation is widely known as game tree. It is more detailed than strategic form including complete description about the way the game is played over the time. This model will take into consideration even the order in which various players act. Any game in extensive form can be analyzed directly or can be converted into equivalent strategic form.

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Crude oil prices have been hovering around $100-$110 per barrel during mid-2013 to mid-2014 and all of a sudden prices have fallen drastically to around $50 per barrel. This was due to strengthening dollar and a many other reasons. Prices have fallen to a 6 year low in the 1^st quarter of 2015. After a steep decrease, prices stopped falling below $ 50 per barrel. Currently the crude oil price is around $60 per barrel. Can we expect a further reduction in crude oil prices?

During 1940-70, only seven major oil producing companies know as seven sisters used to lead the market. These were British Petroleum, Gulf Oil, Chevron Corporation, Standard oil of California, Royal Dutch Shell, Standard Oil of New Jersey and Exxon Mobil. These seven companies used to hold about 85% of crude oil market. These companies formed OPEC to avoid competition and create entry barrier for others.

But now, the situation has changed with increasing technological innovations cost of producing oil has decreased. For countries like USA and China, who are the major consumers of oil, producing by themselves was a better option than importing. Hence many such countries started producing crude oil, thereby increasing the competition. The top 10 crude oil producers these days are Russia, Saudi Arabia, USA, China, Canada, Iraq, Iran, UAE, Kuwait and Mexico. These countries alone account for around 68% of total crude oil production.

What made oil prices fall?

OPEC was once having about 50% of the market share in total crude oil production. Hence it enjoyed the bargaining power in deciding the crude oil prices by increasing or reducing the oil production. High oil prices in 2010-13 ignited not-OPEC countries to innovate new cost-effective technologies and start their own production. By December 2014, USA was producing 9 million barrels of crude per day. Increase in USA’s domestic oil production led to fall of Saudi Arabia US customer Base by almost 50%. Similar impact was seen on all OPEC countries. To regain the market share, OPEC started reducing the crude oil price leading into a price war.

Will the prices fall below $50-$60 per barrel?

Crude oil production involves various activities contributing the costs. These are exploring and finding oil wells, development of wells, lifting crude oil and maintaining wells, heavy equipment and facilities, transportation and other administrative expenses.

A survey conducted by RAND Corporation says that the costs involved in producing a barrel of oil at a surface retorting complex in USA would range between $70-90. These costs are expected to fall to $35-48 per barrel with increasing technology and oil production. There are some countries which are producing at as low as $20-25 per barrel. So, they can continue producing crude oil even at prices as low as $25-30. But, many oil producers will not be able to recover the costs of production leave about the profits if the prices fall below $45-50 per barrel.

Hence, oil producers cannot increase the prices to as high as $90-100 because of the heavy competition. With the heavy competition, if the prices go up they cannot sell all their produced crude oil as the demand goes down. At the same time, the prices cannot be reduced below $45-50 per barrel as they cannot breakeven. With further decrease in oil prices, oil producers will reduce the production levels which will increase the demand for oil. As the supply will be less than the demand, it will again lead to increase in the prices. Hence oil prices can be expected to hover around $60-70 per barrel in the near future.

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The ability to set a goal is always a measure of a person’s ability to succeed. But then, setting goals really doesn’t make someone succeed. It requires a well established planning to achieve the goals. Planning is required because it ensures a direction for day-to-day actions in the process of achieving the goals. It would be similar for financial goals as well. Financial planning is as important as setting financial goals. The financial goals can be short term, medium term or even long term depending on the individual requirements. Hence financial planning varies from person to person depending on the goals set.

Creating a personal financial planning has in broad 6 basic steps:

• Determining current financial situation
• Developing financial goals
• Identifying alternative course of actions
• Evaluation of alternatives
• Creating and implementing financial plan
• Review and revise financial plan

Determining current financial situation

Before setting goals and developing financial planning to achieve the goals, it is very important to know the current status. Hence determining current financial situation is the first step in financial planning. Having a deep understanding of the current financial status would help one set realistic goals and also helps in setting up more practical and implementable strategies. Thus having a clear understanding of the current financial situation will give an advantage to achieve financial goals faster.

Developing financial goals

Once you have the understanding of current financial status, the next step in financial planning process is setting financial goals. This will give a clear destination thus setting up a roadmap to achieve the goals. To set financial goals one should consider some obvious objectives such as monthly income and expenditure, retirement plans etc., Goals should be smart, specific, realistic and time-based. One should be careful in differentiating between wants and needs when setting financial goals and should establish the priorities.

Identifying alternative courses

As said, setting financial goals would give an idea of the destination. But there can be many ways to reach the destination. It is important to identify and evaluate various ways available to achieve the goals. The evaluation can be based on various parameters depending individual’s priorities.

Evaluation of alternatives

Once the available options are identified, now it’s time to evaluate them based on ones financial objectives. The various parameters like income, expenses, savings, investment objectives, future goals etc., should be considered in evaluating the alternatives. This would help in choosing the alternative which yields the highest returns.

Creating and implementing financial plans

Majority of the work in financial planning has been done. Now, one should prioritize the goals and finalize the ways to achieving goals. The current situation and the urgency of different goals and their impact on achieving other goals should be considered while finalizing the financial plan.

Review and revise financial plan

This is the last step in financial planning but perhaps the most important of all. You might have put all your efforts in designing the financial plan, but however, it cannot be assured that everything goes as planned. It is highly possible that the strategies planned may not yield the expected results and requires regular adjustments to achieve the financial goals. Reviewing the financial plan regularly will also help in gauging the progress towards meeting one’s goals.

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