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Saturday, August 19 2017 | 02:38:26 PM

       Equity Markets
        Derivatives
  What is a Share ?
Share or Equity represents ownership of a business to the extent of shares held. A shareholder owns a piece the business. Why would you want a piece of the business? For the rewards of course. A shareholder has a right over the profits generated by the business. The company might pay out the profits generated every year by way dividends or it may retain the profits to grow them further.

There’s another way a shareholder can make money. If the company performs well, then its shares listed on the stock market become more valuable and the stock price appreciates. On the other hand, if the company performs badly. Then you would not get dividends but the stock price may also depreciate. Hence investing in shares is a risky affair.

When you invest in shares, you can expect certain returns based on the fundamentals of a business. However you have no control over it. What you have control over is managing risks associated with it.
  What is the need for Investments ?
Investing is building up to meet future consumption demands with the intention of making profits, as they are popularly known.

While the life expectancy of the average human being has increased, A human being is productive only between the ages of 25 and 60 years. Hence the short span of time that one is able to earn money needs to provide for our future when one may not be capable of earning.

Everything being the same, one could save a part of his earnings every year, that will come in handy when one will not be able to earn. However inflation destroys the value of what one saves. A sum of Rs10,000 saved this year will not have the same purchasing power ten years down the line. Hence one needs to preserve the purchasing power of what he saves.

The only way to hedge inflation is to invest ones savings in shares, debentures, bonds, gold, real estate, mutual funds etc, to earn returns from these assets that compensate for the decline in our purchasing power.
  What is the difference between investing and speculating?
An investment operation is one which, on thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.

That is a very brief reference to speculation. To simplify it a bit by saying that in speculative operations a successful result cannot be predicated on the processes of security analysis. Speculative operations are all concerned with changes in price. In some cases the emphasis is on price changes alone, and in other cases the emphasis is on changes in value, which are expected to give rise to changes in price.
  Who are the different types of Participants in a Stock Market ?
The different types of participants in a stock market are :

  1. Investor : One who invests for a long term
  2. Trader / Speculator : One who does intra day trades or trades for the short term.
  3. Arbitrageur: One who does arbitrage between the cash and cash on difference Exchanges or cash and futures segments of the Exchanges
  4. Hedger: One who hedges his portfolio / position in anticipation of some event that is to take place.
  What are the different asset classes one can normally invest in ?
The different types of asset classes that one can invest in are as follows :-
  1. Equity : Shares and Mutual Funds
  2. Debt Instruments : Fixed Deposits, Bonds, Debentures, Tax Saving Instruments such as PPF and or NSC.
  3. Bullion : Gold and Silver
  4. Real Estate : Residential and Commercial
  5. ULIPS / Insurance Policies.
  6. Cash : Bank Balance
  Why should one invest in Equity Shares?
Investing in shares is like owning part of a business. A profitable business keeps reinvesting its profits to earn more profits.

Investing in assets like gold and real estate, which are not liquid, or in bonds or debentures, which have fixed returns, the benefits of investing in equity shares hold very high upside potential, at it represent ownership in productive assets (business).

Investing in stock is very attractive as there is the power of compounding. In very simple terms it means that the returns on the principal earn returns too. In other words, Rs100 that earns mere returns of 15% per annum becomes Rs250 in ten years whereas Rs100 compounding at 15% per annum turns out to be Rs405 in ten years!

As you stretch the time horizon, your money appreciates further. Compounding at 15% per annum Rs100 becomes Rs405 in ten years, Rs810 in 15 years and Rs1,640 in 20 years. Hence the longer the duration of investment, the better are the returns.

Of course investing is risky. Higher returns always come with higher risks. However the risks of investing need not deter one. After all, the rewards outweigh the risks.
  What are the factors that determine Stock (Share) Prices ?
Share prices track the profits of a business in the long run whereas in the short run they are determined by market sentiment and demand for the shares. Hence share prices are predictable with a higher degree of certainty in the long run whereas in the short run these are very whimsical.

Which is why the strategy for a trader who hopes to benefit from short-term prices has to be different from that of an investor who expects to benefit from long-term prices.
  When can One buy shares?
Before one decides to make his first share purchase, it helps to take stock of his net worth. Remember while investing in shares is lucrative in the long run, it is also risky.

Hence the money that one uses to buy shares must necessarily be money that he does not need in the next few years. So one can start investing only when he has surplus money (after taking care of personal debts if any). Never borrow to invest in the stock market.

An important point to remember is that the earlier one starts investing in shares, the better the returns he can generate.

The surplus money that one has should be invested wisely in shares to reap the rewards. The surplus money is meant to create wealth. And it can’t generate wealth unless it is invested in shares.
  Can one invest all his savings in shares?
Investing in shares is risky but also lucrative over the long run. Hence it makes utmost sense to have the maximum exposure to shares when one is young and reduce your exposure as he grows older.

There is another factor that compels one to reduce his exposure as he ages. As a young single executive one has a lot of surplus but not enough needs; but as one gets married and has a family his expenses increase thereby reducing his surplus.
  How can risk that is associated with investment in shares be managed ?
Investing in stocks is risky since there are many uncertainties associated with the ability of a business to generate profits. Hence there is no control on the returns but an investor has control over managing his/her risks.

Portfolio diversification is a straight forward way to reduce exposure to business specific risks. It simply means that one should not keep all his eggs in one basket. Invest in a diversified set of stocks spanning different businesses. Equity risk does not add up as you spread the capital over a larger number of stocks.

Another way to handle risks associated with buying too high or too low at a given point in time is to spread ones investments across time. Never invest lump sum in the stock market. Spread your investments over a period of time. This is normally referred to as systematic investment plans.
  Can one invest in any share ?
When one buys a share he buys a business. The returns one makes depend on how the business performs. Most people buy shares to sell it at a higher price in the market, but then the appreciation in stock price hinges on the earnings of the business.

True that during periods of extreme bullishness or bearishness, a stock price may move divergent to the earnings of the underlying business. But these differences always correct.

So before one invests in any share he should ask a few questions on the fundamentals of the business to himself. Ascertain the background of the business and of the people running it to ensure that the business keeps earning higher profits.
  Is there anything that needs to be done before One can buy shares ?
There are three rules to follow before one takes his first steps in investing:

  1. Make a plan
  2. Take into account your strengths and weaknesses
  3. Review the plan often and change it as your needs and circumstances change


Follow these rules and you'll be able to sort out your financial needs.

All of us wish to be rich. But then, how does one actually get there? Betting on Horses is not what the stock market is all about. Done the right way, investing in shares can create wealth in a big way.

Here is how one can begin charting his way. It might seem a little obscure but the exercise is worth the efforts.

  1. Outline your personal financial goals.
  2. Know your strengths.
  3. Know where you stand financially.
  4. Reduce debt.
  5. Invest small, steady amounts regularly.
  6. Don't put all your eggs in one basket.
  7. Ask questions.
  8. Plan for the long haul.
  How does one buy a share?
Shares are traded on stock exchanges and you can buy them only from people recognized / authorised by the stock exchanges to buy or sell shares. These people are popularly known as stock brokers.

In order to buy your first share you need to become a client of a stock broker.

Once you are a client of a broker, then it is very easy. Call up your broker, check the quotes of the stock you wish to buy and place an order. These days it is a lot easier to trade online.
  How does one sell a share ?
The same way you buy one, you just order to sell this time around. You call your broker and tell him to sell your shares or you enter your sale incase you have an online account. You'll get the market price of the stock for that day.
  What if the price of the stock that one buys goes down?
That can be an even better reason for not selling. The price of your stock may fall at some time. Maybe your company will go through a period when business isn't so great. Then there are times when the whole stock market goes down because of external factors such as political instability, war, international problems etc.

But the best way to make money in the stock market is to buy shares in good companies that have the potential to grow and hold on to them. Over time the stock market tends to rise, discounting the downward blips along the way. When a stock price drops, ask yourself if you still like the company and think if its future looks good. If the answer is no, go ahead and sell your shares. If the answer is yes, hold on and maybe even buy some more.
  What are the common mistakes an investor should avoid ?
Panic selling

There is one certainty about investing in shares-that there will be a number of market panics during your investment lifetime. What you do during a market panic has a great impact on the eventual wealth that it creates.

Suppose you fall victim to panic selling, you hesitate from buying rapidly when the stock recovers. Everyone has experienced panic selling some time or the other? Maybe in the wake of some negative political developments, eg a no confidence motion against the government? One sells his holding fearing the stock price would crash, only to wake up the following day to discover that his fears were unfounded. He would then helplessly wait for the stock price to retreat below his selling price. And instead he'll be on the sidelines for a fairly long while, recovering his courage to be able to buy again.

Ones emotional healing process will be enhanced when the prices rise again. Nothing heals like rising prices in the stock market.

Most people who sell near a bottom fail to re-enter the stock until, towards the next top. This creates a very vicious cycle of buying at market tops and selling at market bottoms.

Never selling

Many investors fall into a trap by misinterpreting the buy & hold concept. Buying and holding forever will not prove wrong every time, but it is a far from perfect approach in most cases. It is based on false assumptions (either stated or unconscious) and proceeds from laziness and inertia. It also flows naturally from having no plan.

Buying and holding forever is based on four assumptions, all of them false:

  • The world will not change for the rest of my lifetime
  • The investors needs will never change as the years pass
  • The investor thinks he always makes good buying decisions
  • Stocks, bonds and funds will rise at a steady pace forever.


Considering how quickly all these assumptions change, one seldom makes a buy-to-hold-forever investment decision upfront. The holding forever syndrome creeps up on us afterwards when the stock price declines after one has purchased it. In most cases, the buy & hold concept gets dictated by the price of the stock. If the price happens to be lower than the purchase price, then many people commit the mistake of holding on without bothering to check if the reasons for buying the stock have changed to make it a sell.

Investing in cheap stocks

Many of us believe that it is easier for a Rs5 stock to appreciate to Rs30 rather than for a Rs100 stock to appreciate to Rs600. In reality, nothing can be so far away from the truth.

It is true that cheap stocks that survive give excellent returns but the failure rate is extremely high. Hence picking the right cheap stock that will fetch those extraordinary returns is like finding a needle in a haystack. The high risk ensures that buying cheap stocks can prove very costly.

Investing on tips

Tipsters are fair weather friends. All of us spend some time researching various car models/brands before making our purchase. One does that despite well-meaning suggestions from our friends.

Whereas while buying shares of a company, many investors buy shares like there is no tomorrow in the stock market. Many of us who have seen one complete bull and bear cycle in the stock market know the devastating effect it can have on one’s net worth.

Timing the market

Many wannabe investors extend the buy low, sell high argument to wait for the lowest price. In the process, they miss out on a buying opportunity and compound the mistake by actually buying at peak prices after getting tired of waiting.

It is believed that it is the time in the market and not timing the market that is important, just like it is not important how much one invest in a stock but in which stock he invest.
  What are Derivatives ?
Derivatives such as futures or options are financial contracts which derive their value from a spot price, which is called the underlying. For example a farmer may wish to enter into a contract to sell his harvest of sugarcane at a future date to eliminate the risk of a change in price by that date. Such a transaction would take place through a futures market. The prices of derivatives are driven by the spot market price of sugarcane i.e. underlying Derivatives are a key part of the financial system the world over. The most important contracts types are futures and options and the most important underlying markets are equity, commodities, foreign exchange etc.
  What is a contract ?
The term contract is often applied to denote the specific traded instrument, whether is is a derivative contract in sugarcane, wheat, gold or equity shares.
  What is a forward contract ?
In a forward contract two parties agree to do a trade at a future date, at a stated price and quantity. No money changes hands at the time the deal is signed.
  Why is forward contracting useful ?
Forward contracting is very valuable in hedging and speculation. An example of hedging would be a sugarcane farmer selling his harvest at a know price in order to eliminate price risk, conversely a sugar factory may want to buy sugarcane in order to plan its production without the risk of price fluctuations. If a speculator has information which forecasts an upturn in a price, the he can go long on the forward market instead of the cash market. A speculator would go long on the forward, wait for the price to rise and then take a reversing transaction there by making a profit.
  What are the problems of forward markets ?
Forward markets worldwide are afflicted by several problems :

  1. lack of centralization of trading
  2. illiquidity and
  3. counterparty risk.
  What is a futures contract ?
Futures markets are designed to solve all the three problems (listed in question 5) in forward markets. Futures markets are exactly like forward markets in terms of basic economics. However, contracts are standardized and trading is centralized (on an exchange). There is no counterparty risk as the clearing corporation becomes the counterparty to both sides of each transaction and guarantees the trade. Futures markets are highly liquid as compared to the forward markets.
  What are various types of derivative instruments traded on NSE ?
There are two types of derivatives instruments traded, namely Futures and Options

Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. All the futures contracts are settled in cash

Options: An option is a contract which gives the right, but not an obligation to buy or sell the underlying at a stated date and at a stated price. While a buyer of an option pays the premium and buys the right to exercise his option, the writer of an option is the one who received the option premium and therefore obliged to sell / buy the asset if the buyer exercises it on him. There are two types of Options – Call and Put

Call Option: gives the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date.

Put Option: gives the buyer the right but not the obligation to sell a given quantity of the underlying asset, at a given price on or before a given future date.

All options contracts are settled in Cash.

Options are classified based on the type of exercise. At present the exercise style can be European or American.

American Options – American options are option contracts that can be exercised at any time upto the expiration date. Options on individual securities available at NSE are American type of options.

European Options – European options are options that can be exercised only on the expiration date. All index options traded at NSE are European Options.
  What are various products available for trading in Futures and Options segment at NSE ?
Futures and options contracts are traded on Indices and on Single stocks.
  Why should I trade in derivatives ?
Futures trading will be of interest to those who wish to :-
  1. Invest - take a view on the market and buy and sell accordingly.
  2. Price Risk Transfer – Hedging – Hedging is buying and selling futures contracts to offset the risks of changing underlying market prices. Thus it helds in reducing the risk associated with exposures in underlying market by taking a counter- position in the futures market.
  3. Leverage - Since the investor is required to pay a small fraction of the value of the total contract as margins, trading in Futures is a leveraged activity since the investor is able to control the total value of the contract with a relatively small amount of margin. Thus the leverage enables the traders to make a larger profit (or loss) with a comparatively small amount of capital.

Options trading will be of interest to those who wish to :-
  1. Participate in the market without trading or holding a large quantity of stock
  2. Protect their portfolio by paying small premium amount.
  What are the benefits of trading in Futures and Options ?
  1. Able to transfer the risk to the person who is willing to accept them
  2. Incentive to make profit with minimal amount of risk capital.
  3. Lower transaction costs.
  4. Provides liquidity, enables price discovery in underlying market.
  What is the Expiration Day ?
It is the last day on which the contracts expire. Futures and Options contracts expire on the last Thursday of the expiry month. If the last Thursday is a trading holiday, the contracts expire on the previous trading day.
  Is there any Margin Payable ?
Yes margins are computed and collected on-line, real time on a portfolio basis at the client level. Members are required to collect the margin upfront from the client and report the same to the Exchange.
  How are the contracts settled ?
All Futures and Options contracts are settled in cash on a daily basis and at the expiry or exercise of the respective contracts as the case may be.