Definition : The yield is return on investments, usually on annual basis. The portfolio yield measures the net income generated from the portfolio on an annual basis as a percentage of the portfolio value. It is the income generated in the form of interest and dividend on investments. Example : For instance, the portfolio at the start of year stood at Rs. 1,000 and Rs 1,200 at the end of the year. The increase in value of the portfolio is Rs. 200. Portfolio yield, expressed as a percentage of the portfolio value, is 20% (200/1000*100) before tax.
Explanation : Portfolio yield is calculated by considering the change in the value of the portfolio over a particular reporting period. An increasing portfolio yield is considered positive in nature. Higher the portfolio yield, higher the ability of an investor to cover up his financial and operating expenses.
Difference between Portfolio Yield and Portfolio Return : Portfolio Yield considers only income generated where as Portfolio Return considers both income generated and appreciation/depreciation in portfolio value. Also return is retrospective or backward-looking describing what an investment has concretely earned. Yield, on the other hand, is prospective, or forward looking.
Definition : Interest rate risk is defined as the risk of change in bond prices due to a revision in interest rates. When there is a rise in interest rates, bond prices fall and vice versa.
Example : Let us consider a 10-year Government Bond with a face value of Rs. 100 and a coupon rate of 6% pa, that is, an investor will receive an interest of Rs. 6. If the lending rate is increased to 10%, the new bonds with the same face value of Rs. 100 and tenure of 10 years will provide a coupon rate of 10%, which makes the existing bonds at 6% coupon rate less attractive and thus will trade below its face value in the market. Similarly, if the interest rate is cut to 5%, the existing bonds at 6% coupon rate will attract more buyers and will trade at price higher than its face value
Explanation : Various economic factors and inflation, in particular, govern the direction of interest rates in the economy. Rising inflation leads to higher interest rates. A change in interest rate is reflected in the NAV of a debt mutual fund. A drop in interest rates will create more demand for existing bonds in the secondary market and increases the prices. Similarly, when interest rates increase, the existing bonds trade below their face value.
Definition : Yield to maturity (YTM) is the rate of return that an investment will generate if a bond is held till its maturity. It is a arrived at by discounting sums of all future cash flows to arrive at the present value of the investment. The yield-to-maturity is considered to be the best measure of the return rate, since it includes all aspects of the investment. It is generally given in terms of Annual Percentage Rate (APR), and it is an estimation of future return
Explanation : yield to maturity is widely used by investors as a way to compare bonds with different face values, coupon payments, and time till maturity. YTM of a bond can be calculated using bond valuation equation. It assumes that all coupon payments are reinvested at the same rate as the bond€™s current yield. Its calculation takes into account key factors such as bond price, face value, coupon rate and maturity date.ss
Example : A bond is selling at Rs.95, and has a coupon rate of 9%, it matures in 5 years and the par value is Rs.100. In this example, the YTM of the bond will be 10.33%.
Calculation of YTM can be illustrated as follows:-
|Year||Cash Flows (Rs.)||Particulars|
|0||-950||Cash outflow or bond price|
|1||90||Coupon Received for 1st year|
|2||90||Coupon Received for 2nd year|
|3||90||Coupon Received for 3rd year|
|4||90||Coupon Received for 4th year|
|5||1090||Coupon Received for 5th year plus value at maturity|
Difference between coupon and yield : The bonds come with specific features at the time of the issue. These are the size of the issue, the maturity date and the initial coupon or interest rate etc. For example, in 2012 the Government issued a 10-year bond due in 2022 with coupon of 8%. This means that investors who buy the bond at the time of issue and hold it till maturity expect to receive 8% a year for the life of the bond. However during the life of the bond the market interest rates change and value of the bonds change inversely to the interest rates change. Hence later depending on the current interest rates the same bonds would be available in the market at par, premium or discount. The yield or yield to maturity defines how much you will be paid in the future if you are buying these bonds on par, discounted or premium value.
Formula for yield to maturity :
Definition : The modern proponents of indexation are Friedman (1974) and Giersch (1974). Both called for widespread indexation, which is the linkage of wages, taxes and returns on financial assets to price level changes, as an instrument for macroeconomic stability. In simple terms, Indexation is a technique to counter the erosion in the value of the asset / income over a period of time so that it reflects inflation adjusted true value.
Implication: The compounding effect of inflation must be considered while carrying out the calculations. The purchasing power of money gets reduced; the amount invested 10 years back will not hold the same value in the current scenario. Hence, to curb the effect of inflation, the benefit of indexation is given by adjusting the wages to the inflation or to the investor by which he would not be taxed on the portion of gains that have been eroded away by inflation. As per the current Income Tax Act, 10% tax is charged on Long Term Capital Gains (investments held over a year) without indexation and 20% with indexation benefit, whichever is lower plus education cases.
Example : In 2011-12, Mr. X invested Rs. 1,00,000 in an income fund and sold the same in 2013-14 at a price of Rs. 1,25,000. As the period of holding was more than one year, gain of Rs. 25,000 (Rs. 1,25,000 - Rs. 1,00,000) would be considered as Long Term Capital Gain and hence tax payable would be Rs. 2,500 (Rs. 25,000 * 10%) (at the rate of 10% without indexation benefit). However, if the indexation benefit is taken by Mr. X, then the Long Term Capital Gain would be Rs. 5,382.17 ([Rs. 1,00,000 * 939/785] â€“ Rs. 1,25,000) (Cost Inflation Index for 2011-12 and 2013-14 is 785 and 939, respectively). Accordingly, the tax payable would be Rs. 1,076.43 (Rs. 5,382.17 * 20%). Therefore the amount of tax payable post indexation is much lower. Hence by considering indexation, one can take advantage of tax benefits for saving taxes on capital gain.
Definition : XIRR is a function used in Microsoft Excel that gives the value of the internal rate of return for a schedule of cash flows which is not periodic in nature. Internal rate of return denotes the rate of return on money invested at a fixed interval of time.
Example : The Syntax of the function is: XIRR (values, dates, [guess]) where, Values denote a series of cash flows which corresponds to a schedule of payments in dates. The first payment is optional and corresponds to a cost or payment that occurs at the beginning of the investment. If the first value is a cost or payment, it must be a negative value. All succeeding payments are discounted based on a 365-day year. The series of values must contain at least one positive value and one negative value.
Dates denote the schedule of payment dates. The first payment date denotes the beginning of the schedule of payments. All other dates can be in any order, but must be later than the first date.
Guess denotes a number which an investor guesses to be close to XIRR:
|-10,000||January 1, 2008|
|2,750||March 1, 2008|
|4,250||October 30, 2008|
|3,250||February 15, 2009|
|2,750||April 1, 2009|
|=XIRR(A2:A6,B2:B6,0.1)||The internal rate of return (0.373362535 or 37.34%)|
Explanation : XIRR can be used to compare two different business ideas and decide which one is better of the two. This is because while starting a business, one needs to invest money and the patterns of investment can be at times periodic and irregular in nature. In that case, XIRR can give better insight to investors regarding the potential returns from an investment.
Difference between IRR and XIRR: IRR is Internal Rate of Return and uses to calculate the returns received at a fixed interval i.e. after every 3 months or after every 1 yr. It is important that there should be equal time difference between two receipts. IRR does not solve one problem and that is when the payments are at Irregular interval. In that case XIRR is used.
Definition : Expense ratio is the annual fee charged to the unit holders of mutual funds by the Asset Management Companies (AMCs) to manage and operate the funds. It is per unit cost of managing the fund. Mutual Funds declare daily Net Asset Value of a fund after proving for expenses. The fund's expenses broadly cover the investment management and advisory fee, the marketing and distribution expenses and operating expenses etc. Market regulator SEBI prescribes ceiling for the expense ratio.
Explanation : The expense ratio is calculated by dividing the fund's total expenses by its assets under management (AUM). The funds with smaller asset base can have high expense ratio because of its need to meet its expenses from the restricted asset base. Funds having a higher asset base are likely to have lower expense ratio. Also expense ratio must be compared between similar asset classes. For example, comparisons between a diversified Equity Fund and an Index Fund would not present the true picture. The high expense ratio can eat into the returns, so it must be taken into account while investing in a mutual fund.
Definition : Profits made on sale of securities, units of mutual funds and capital assets (realty, gold etc) are called capital gains. Gains can be classified into long-term or short-term depending upon the period of holding of the asset and are taxed at different rates.
Formula: the basic formula is as follows: Capital Gain = Net Sales Consideration “Cost of Acquisition and with indexation* benefit is as follows: Capital Gain = Net Sales Consideration“ Indexed Acquisition Cost *We have discussed Indexation at length vide our mail dated 28th Feb. 2014.
Explanation : Shares and units of equity oriented mutual funds: If the profit is booked within one year from the date of purchase, then it is considered as Short-Term Capital Gain. Fixed income securities, listed bonds/NCDs and units of debt mutual funds: If the profit is booked within one year from the date of purchase, then it is considered as Short-Term Capital Gain. Real Estate, Gold etc:If the profit is booked within three year from the date of purchase, then it is considered as Short-Term Capital Gain. It would be long term capital gain; if the above investments are held for longer period than eligible for short term gain.
Example : House Property purchased for Rs. 20 Lakh and sold for Rs. 32 Lakh after 2 years has capital gains of Rs. 12 Lakh. However it would be taxed as short term gain as the period of holding of property is less than 3 years. A capital loss is incurred when the above situation is reversed.
Taxation :Long-term capital gains are usually taxed at a lower rate than regular income or short term gains. This is expected to encourage entrepreneurship and investment in the economy.
Definition : Foreign Direct Investment (FDI) as the name suggests is a direct investment made by an individual, a company or entity based in one country to a company or entity based in another country. It can be done either through buying a stake in a company in the target country or through increasing the business activity of the existing company.
Example :An Indian company building a factory and a supply chain in United States in order to increase its market share is an example of Foreign Direct Investment.
Explanation : Foreign direct investment includes mergers and acquisitions, building new facilities, reinvesting profits earned from overseas operations and intra company loans. It helps in capital formation by bringing fresh capital in the country and transfers the new technologies, management skills, intellectual property. FDI is an active form of investment as compared to portfolio investment which is more of passive form in terms of degree of influence and control over the company in which investment is made. In India, Foreign investment is reckoned as FDI only if the investment is made in equity shares, fully and mandatorily convertible preference shares and fully and mandatorily convertible debentures with the pricing being decided upfront as a figure or based on the formula that is decided upfront. Currently an Indian company may receive FDI under the two routes as given under -
Options contracts are instruments that give the holder of the instrument the right to buy or sell the underlying asset at a predetermined price. An option can be a 'call' option or a 'put' option.
A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is called 'strike price'. It should be noted that while the holder of the call option has a right to demand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if the buyer wants to buy the asset, the seller has to sell it. He does not have a right.
Similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer. Here the buyer has the right to sell and the seller has the obligation to buy.
So in any options contract, the right to exercise the option is vested with the buyer of the contract. The seller of the contract has only the obligation and no right. As the seller of the contract bears the obligation, he is paid a price called as 'premium'. Therefore the price that is paid for buying an option contract is called as premium.
The buyer of a call option will not exercise his option (to buy) if, on expiry, the price of the asset in the spot market is less than the strike price of the call. For eg: A bought a call at a strike price of Rs 500. On expiry the price of the asset is Rs 450. A will not exercise his call. Because he can buy the same asset from the market at Rs 450, rather than paying Rs 500 to the seller of the option.
The buyer of a put option will not exercise his option (to sell) if, on expiry, the price of the asset in the spot market is more than the strike price of the call. For eg: B bought a put at a strike price of Rs 600. On expiry the price of the asset is Rs 619. A will not exercise his put option. Because he can sell the same asset in the market at Rs 619, rather than giving it to the seller of the put option for Rs 600.
Definition : A Call option is a financial contract between the buyer and the seller which gives the Call option buyer the right but no obligation to buy a specified quantity of a stock or security or commodity at a specified price within a fixed period of time.
Example : Mr. A believes that price of shares of XYZ company will go up in future. Hence he buys a Call Option to buy 100 shares of the XYZ Company at a price of Rs. 60 per share. The current market price of the share is Rs.55 per share and the option premium is Rs. 5 per share. On expiration date of the contract the actual Market price of the stock is Rs. 80 per share. In this case, Mr. A is in a profitable position and he will exercise the call option. But if the market price of the company XYZ on March 25 is Rs. 40, then Mr. A will not exercise the option.
Explanation : In a Call option, the Call option buyer or Call option holder enters into a contract with the Call option writer or Call option seller to buy stocks or securities or commodities at a specified price on a specified date. The price at which the contract is entered into is known as strike price. The date on which the contract is to be exercised is known as expiration date. The Call option buyer can exercise the contract on or before the expiration date. Though the buyer has the right to exercise the option, but depending on the market conditions he may decide not to exercise it. The Call option buyer needs to make some payment as option premium to the option seller to buy the option. This option premium is determined on the basis of market volatility, market price and the expiration period.
Definition : A Put option is a financial contract between the buyer and the seller which gives the Put option buyer or Put option holder the right but no obligation to sell a specified quantity of a stock or security or commodity at a specified price within a fixed period of time.
Example : Mr. A perceives that price of rice will go down in the near future. Hence he enters into a contract with Mr. B on March 1 to purchase 10 kg of rice at Rs. 50/kg on March 25, 2014. Here, the expiry date of the contract is March 25 and the strike price is Rs. 50/Kg. Now suppose on March 25 the actual market price of rice becomes Rs. 60/kg, in that case Mr. A is in a profitable position and will not exercise the option. But if the market price of rice becomes Rs. 40/kg, then Mr. A will exercise the contract. Mr. B will be bound to buy the rice at Rs 50/kg as mentioned in the contract even though it is a loss for him.
Explanation : In a Put option, the Put option buyer or Put option holder enters into a contract with the Put option writer or Put option seller to sell stocks or securities or commodities at a specified price on a specified date. The price at which the contract is entered into is known as strike price. The date on which the contract is to be exercised is known as expiration date. The Put option buyer can exercise the contract on or before the expiry date. Though the Put option buyer has the right to exercise the option, but he may decide not to exercise it depending on the market conditions. In case the Put option buyer decides to exercise the contract, the Put option seller is bound to buy the underlying security at the strike price mentioned in the contract. Since the Put option seller here is at a risk, he is paid some amount for taking the additional risk known as option premium.
Definition : It covers the prices of consumer goods. The Consumer Price Index (CPI) indicates general rise in prices of a basket of consumer goods and services sold at retail level or purchased by households. The percentage change in the index over a period of one year indicates growth (positive or negative) rate of consumer inflation. It is used for macroeconomic purposes and forms basis for inflation target.
Explanation :The index is computed on the basis of weighted average of prices of various commodities. Broad categories for commodities include Food, beverages & tobacco, Fuel & light, Clothing, bedding & footwear and Housing. Among these, the highest weightage is allocated to Food, beverages & tobacco, which impacts the CPI Maoist. The movement of the index indicates change in the purchasing power of the household. The movement of the index has generally been upward in the past, suggesting that the same amount of money can now purchase smaller amount of goods compared to earlier.
The CPI data is released on a monthly basis by the Central Statistics Office (CSO) of the Ministry of Statistics and programme Implementation. The initial index data released is a provisional one and in the next month, final index is updated.
There are three different categories for CPI:
a. CPI for the urban population viz. CPI (Urban)
b. CPI for the rural population viz. CPI (Rural)
c. Consolidated CPI for Urban + Rural based on the above two CPIs
India is the only major country that uses a wholesale index to measure inflation. Most countries use the CPI as a measure of inflation, as this actually measures the increase in prices that consumer will ultimately pay for. Following recommendations of Urjit R. Patel committee report, the Reserve Bank of India had recently adopted the new CPI (combined) as the key measure of inflation.
Definition : Wholesale Price Index (WPI) represents the prices of goods and services at a wholesale or bulk level. In other words, WPI represents the prices of goods that are sold in bulk quantities and traded between organizations instead of retail consumers.
Explanation :WPI is the most widely used inflation indicator in India. It is based on the wholesale price of some relevant commodities which are chosen from among many on the basis of their importance. WPI is published by the Office of Economic Adviser under the Ministry of Commerce and Industry. It is extensively used by Governments, Banks, and business circles while formulating any policies or strategies in the long run. The movement of WPI also impacts fiscal and monetary policy changes.
WPI is calculated with respect to a base year. A major drawback of this inflation indicator is that the general people at large do not buy things at the wholesale level. Thus WPI does not indicate the extent of price pressure faced by the general public. Following recommendations of Urjit R. Patel committee report, the Reserve Bank of India had recently adopted the new CPI (combined) as the key measure of inflation.
Definition : Fiscal deficit is the difference between the Government’s income and expenditure. Every year in the Budget, the Government proposes a plan for its income and expenditure for the coming financial year. If the total expenditure exceeds the total income, then fiscal deficit appears in the economy.
Example : The Government in its the Interim Budget had said that the fiscal deficit for the financial year 2013-14 would be contained at 4.6% of GDP, revising the earlier target of 4.8%. However, for April-February (first eleven months of the fiscal year) it stood at 114.3% of the full year target, well above the Government's estimate. For FY15, the Government has targeted fiscal deficit to be at 4.2%. Explanation : High and persistent fiscal deficit is a concern for any economy. If high fiscal deficit persists for a long time, it adversely impacts the economic situation of a country and creates structural imbalances. High fiscal deficit increases the chance of inflation and higher rate of interest, which in turn may lower the welfare expenses of the Government.
What causes the high fiscal deficit?
Capital Budget : Capital is long-term in nature. Capital budget considers Government's capital receipts and capital payments. It is a plan for acquiring capital assets that have an expected lifetime that extends beyond the year of acquisition. A capital budget specifies funding sources which are necessary for long-term projects, like roads, bridges, and infrastructure.
Capital Receipts : The main items of capital receipts are loans raised by Government from the public known as Market Loans, borrowings by Government from Reserve Bank of India and other parties through sale of Treasury Bills, loans received from foreign Governments and bodies and recoveries of loans granted by Central Government to State and Union Territory Governments and other parties. It also includes disinvestment of Governments equity holdings in Public Enterprises, state provident funds, and special deposits.
Capital Expenditure : It is incurred for creating assets and improving infrastructure. It also includes resources used for reduction of liabilities. Assets like land, buildings, machinery, roads bridges and investments in shares etc. Loans and advances granted by the central government to state and union territory governments, government companies, corporations and other parties are also part of capital expenses.
Revenue Budget : The revenue budget consists of revenue receipts of the government (revenues from tax and other sources) and the various expenses.
Revenue Expenditure : These expenses are day to day in nature and do not lead to creation of capital assets. They include grants to state governments and other parties and expenses incurred in running various government departments, payment of salaries or other administrative costs and various services that it offers to its citizens.
Revenue receipts : There are tax and non-tax revenues. Tax revenues are from income tax, corporate tax, excise, customs and other duties which the government levies. Non-tax revenues are from interest& dividend on investments of Government and fees and other receipts for services rendered by Government.
Revenue Deficit : The negative difference between revenue receipts and revenue expenditure is result of Government spending more than it earns. This difference is called the revenue deficit.
The Government's expenditure is divided under two broad heads-Plan Expenditure and Non-Plan Expenditure.
Plan Expenditure : Expenditure on schemes and projects covered by the five-year Plans for Union and States and estimated after discussions amongst the ministries concerned and the Planning Commission. Plan expenditure constitutes substantial proportion of the total expenditure of the Central Government. It includes outlays for different sectors such as rural development and education. Eg Mid-day Meal scheme and the Sarva Shiksha Abhiyan. Plan expenditure can have both revenue and capital components. For instance, under the Pradhan Mantri Gram Sadak Yojana, administrative costs are revenue expenditure and the actual infrastructure costs are classified as capital expenditure.
Non-plan expenditure : Revenue and Capital expenditures of the government which are not covered by the Five Year Plans. It constitutes bulk of the government's expenditure and mainly consists of interest payments on Government Debt, subsidies (mainly on food and fertilizers), wage and salary payments to government employees, grants/loans to States and Union Territories governments, pensions, defense, economic services in various sectors, social services and grants to foreign governments other establishment costs of the government. Most of the non plan expenditures are obligatory in nature as the government can reduce allocation towards rural development or education if it does not have sufficient funds, but it cannot default on interest payments for borrowed funds.
Definition : Current Account Deficit (CAD) occurs when the value of total imports of a country exceeds that of its total exports. CAD takes place when the country Government, corporate houses and individuals import more goods and services than it exports. It is generally measured as a percentage of the country’s Gross Domestic Product.
Explanation :India’s CAD has been a cause of concern in recent years due to higher imports of crude oil and gold, but in the July-September 2013 quarter, it narrowed to 1.2% of GDP, as per data from the Reserve Bank of India. The Government’s measures to curb imports of non-essential items, especially gold, helped improve the CAD numbers. A CAD is mostly advantageous in the short-term as foreign investors prefer to invest capital into a country to drive its economic growth. However, if the CAD remains in the long term, it could hurt the country’s economy. Demand for the country’s assets, including the Government bonds, might fall. If that happens, yields will move up and the national currency will lose its value compared to other currencies.
In India the tax structure is divided amongst the Central Government and State Government.
Central Government Taxes : Income Tax, Custom Duties, Central Excise and Service Tax.
State Government Taxes : State Excise, Stamp Duty, VAT (Value Added Tax), Land Revenue and Professional Tax.
Direct Taxes : Taxes directly paid by the tax payers, an individuals or organizations, are direct taxes, eg Income Tax, Capital Gains Tax, Property Tax etc. Central Board of Direct Taxes (CBDT), a division of Department of Revenue, Ministry of Finance under the Revenue Act 1963 has the authority to implements and administers direct taxes in India. Direct taxes are not charged on the basis of citizenship but on the basis of residential status like Resident and Nonresident etc.
Indirect Taxes : Taxes paid by consumers on purchasing goods and services. These include service tax, VAT and Excise and Customs Duties. Service Tax is levied on services provided in India, except the State of Jammu and Kashmir. "Value Added Tax" (VAT) is a tax on value addition and levied at multi point, ie levied at every stage of sale. Customs Duties are the charges levied for goods imported and Excise Duties are paid by manufacturer on their products. Ultimately these charges are passed on to consumers. The Ministry of Finance (Department of Revenue) through the Central Board of Excise and Customs (CBEC), an apex indirect tax authority, implements and administers excise (central excise), customs and service tax laws.
Definition : Consumer goods are goods bought by end users for consumption. Consumer goods are classified into consumer durables and consumer non-durables. Consumer goods are finished products ready to be bought and consumed as opposed to products used by manufacturers to produce other goods.
Consumer durables : refer to products that have an extended product life and are not worn out or consumed quickly.
Consumer non-durables : refer to products purchased for immediate or almost immediate use and have a short life span. They are opposite of consumer durable.
Explanation : For statistical purposes, a durable good is expected to last at least three years. The dividing line is always rigid. Durables are purchased occasionally since they have an extended life, while non-durable goods are replenished on a regular basis.
Example : A washing machine is an example of a durable good - it will wear out after many years and multiple uses. However, the detergent powder used in the washing machine is a non-durable good, which will have to be purchased frequently. The Consumer Durables industry consists of durable goods and appliances for domestic use such as televisions, refrigerators, air conditioners and washing machines. Instruments such as cellphones and kitchen appliances like microwave ovens are also included in this category. Non-durable goods include food and clothing etc.
Definition : Goods which are bought by companies to produce other products which are sold later are called "industrial goods." These goods can be directly or indirectly used in the production of goods which are sold at retail. Industrial goods are classified according to their usage. The durable goods are called "capital items" as they are of very high values.
Industrial capital goods are tangible assets that are used in an industry to produce goods or services. On the other hand products bought for further processing are called Industrial products and are usually used within a year.
Industrial capital goods are distinct from industrial products as the purpose of their use is different. Industrial capital goods are used for the purpose of manufacturing other end products. It is also referred to as means of production. Industrial products, on the other hand, are consumed in the production process itself.
Example :Machines, equipments, tools etc are examples of industrial capital goods, whereas fabric used in textile industry is an example of industrial product.
Definition : Basis point or "bps" is a unit of measurement equivalent to one-hundredth (1/100) of one percentage point. To put it simply, one per cent (1%) is equal to 100 basis points (bps).
Explanation :Basis point is the smallest unit of measurement that is used to depict the change in value viz financial instrument or an index. The change in value is reported in terms of basis points and not percentage points. Basis point is mostly used to quote the yields of fixed income products. Basis points assume special significance in representing changes in interest rates or bond yields. There may be confusion when we say there has been a 1% increase in interest rates from the current level of 10% as it can be interpreted in two ways - (i) interest rates have been up from 10% to 10.1% [10% + (1% of 10)] and (ii) interest rates have risen from 10% to 11%. A hike by 100 basis points would signify an increase of 1%, from 10% to 11%.
Example RBI increases interest rates by 25 basis points. Then it can be concluded that interest rates have been increased by 0.25%.
Definition : Capital appreciation can be defined as an increase in the value of the capital or an investment made by an investor (retail or institutional) over a specified period of time. Capital appreciation is evaluated by the difference between the purchase price of an asset or a portfolio of assets and its corresponding sales price.
Explanation : Capital appreciation is one of the two main sources of investment returns, with the other being dividend or interest income. A retail investor invests in stocks, bonds and mutual funds in order to generate healthy returns over a period of time. An organization also makes investment to upgrade its operations or to expand its base of operations. Capital appreciation may take place in both the cases. From the perspective of an investor, capital appreciation results when his portfolio value increases due to bullish market and economic conditions. From the perspective of an organization, capital appreciation may result due to an increase in company’s profits. Increase in its stock prices may also lead to capital appreciation. Many mutual fund schemes have capital appreciation as their primary objective. The fund manager invests in securities whose values are expected to grow in the long run.
Example : Suppose an investor purchases a share for Rs. 10 which pays a dividend of Rs 1 per share and after one year the share is trading at Rs. 15. Thus capital appreciation in investment is Rs. 5 or 50% as the price of the share has increased by Rs. 5 over the year. The dividend being income return is Rs 1, or 10%, for a total return on the shares is Rs 6 or 60%.
Definition :Liquidity is the ability of a firm or a person to readily and easily obtain cash from the assets or its investments to meet the obligations or make purchases. Liquidity helps one use his money whenever he needs it.
Explanation : Liquidity can be defined differently in various contexts. There are various liquidity concepts like Market liquidity, Balance sheet liquidity, Macroeconomic liquidity etc.
Market liquidity means how easily one can buy or sell his financial asset at short notice, at low cost and large quantity, without causing a significant movement in its price.
Balance sheet liquidity refers broadly to the cash-like assets on the balance sheet of a firm.
Macroeconomic liquidity relates to the monetary conditions of a country. The central bank manages the macroeconomic liquidity through interest rate. In India, the Reserve Bank of India manages the liquidity in the system and its key indicators are Liquidity Adjustment Facility (LAF)* and Marginal Standing Facility (MSF)*.
* LAF is an important instrument of RBI to manage liquidity in the banking system. The RBI uses LAF window to provide funds in case of requirement or keep excess funds in case of excess liquidity on an overnight basis. It helps banks adjust their daily liquidity mismatches. LAF consists of repo and reverse repo operations.
*MSF comes into play once the banks have exhausted their borrowing limit under the LAF route. The MSF rate is the one at which scheduled banks can borrow funds overnight from the RBI against Government securities.
Definition :A company’s stock can be called blue chip if it has very sound financial condition and is a leading player in its industry. Blue chip stocks are considered more stable than mid-cap or small-cap stocks and thus the risks associated with investing is such companies are lower. Blue chip stocks derive their name from poker, a card game, in which the counters which have the highest value are blue in color.
Explanation : A blue chip company earns higher revenues than that of its industry peers and generates healthy earnings consistently. Shareholders also get regular dividends from a blue chip company. Owing to its robust balance sheet and generally lower debt liabilities, their credit ratings in the bond and unsecured debt markets are high. The market capitalization of blue chip companies is higher than other companies of the same sector
Example : In the Indian context, blue chip companies include TCS, Infosys, Reliance Industries, ITC, Hindustan Unilever besides many others.
Definition :The internal rate of return (IRR) is used in capital budgeting to measure and compare the profitability of investments. It is the interest rate at which the Net Present Value (NPV) of all the cash flows (both positive and negative) from a project or investment is equal to zero.
Explanation : In more specific terms, the IRR of an investment is the discount rate at which the net present value of costs (negative cash flows) of the investment equals the net present value of the benefits (positive cash flows) of the investment. IRR is used to evaluate and judge the desirability of investments or projects where the flow of income varies over time. It indicates the efficiency, quality or yield of an investment. Higher a project's internal rate of return compared to its expected rate of return, the more desirable it is to undertake the project. Assuming all other factors are equal among various projects, the project with the highest IRR would probably be considered the best and undertaken first. The term internal refers to the fact that its calculation does not incorporate environmental factors (e.g., the interest rate or inflation).
Definition : Cyclical stocks are referred to as those stocks that move in tandem with the economy as they have high correlation with the economic cycles. These stocks tend to rise when the economy turns up and fall when the economy turns down.
Explanation : When the economy is going through a downturn, the profits of a cyclical company tend to drop and so its share price. Conversely, when the economy is on the upswing, its share price tends to go up with the profit growth. Cyclical stocks are opposite of defensive stocks as these are directly linked to the economic cycle while defensive stocks remain relatively unaffected by different economic phases. Economic indicators like inflation, interest rates, etc. have direct bearing on these stocks. Investors with high risk appetite generally prefer cyclical stocks while those who cannot bear high risk normally settle for defensive stocks.
Example : Stocks from segments like housing, Metal, Auto, Capital Goods, luxury goods, etc. are cyclical as they are highly correlated with the economic cycle. When the economy is on an upswing, the consumer’s discretionary spending increases, resulting in a rise of demand of goods and services of these companies/stocks.
Definition : Defensive stocks refer to those companies that belong to an industry or market sectors that are normally not impacted by economic cycles. These companies produce goods or services which consumers need in their daily life irrespective of the state of the economy. The companies maintain a record of stable earnings and continuous dividend payments through periods of economic downturn
Explanation : Defensive stocks are opposite of cyclical stocks as these stocks are not correlated to the economic cycles. When an economy is doing well and the market is going through a bull phase, cyclical stocks generally perform well. On the other hand, defensive stocks come handy during market downturn. Ideally, investors should have a mix of both defensive and cyclical stocks to maintain balance in the portfolio. Investors having lower risk appetite prefer higher allocation towards defensive stocks.
Example :FMCG, Healthcare, Utilities are defensive sectors as consumer demand for such products or services remains strong irrespective of the economic condition.
Definition : Double taxation of income from two countries can occur when an economic asset earns income in one country but is owned by another. If the countries tax both the profits of firms operating in their territories, and the income of their residents, double taxation will occur unless there is an agreement between the two countries to prevent it. Source: Oxford Dictionary of Economics
Explanation : The taxation that falls on the same source of income in more than one country. Taxation is normally levied on a person’s worldwide income in the country of residence but, in addition, most countries also levy a charge on income that arises within that country (other than country of residence). As a result a large number of treaties (double taxation agreements) have been concluded between countries to ensure that their own residents are not doubly taxed. As a result, there are several different kinds of relief available from double taxation:
a. Relief by agreement, providing for exemption, in whole or in part, of certain categories of income
b. Credit agreement, in which tax charged in one country is allowed as a credit in the other
c. Deduction agreement, in which the overseas income is reduced by the foreign tax paid on it
Source: Oxford Dictionary of Business and Management
Double Taxation Agreement: An agreement between two countries to avoid double taxation of the same income. The absence of such agreement will discourage international investments. As most countries have both inward and outward capital movement, double taxation agreement between them can be mutually beneficial.