Finance Club Booklet - IIM Shillong

Finance Club IIM Shillong P a g e | 1

Contents Inflation, Stagflation, Disinflation, Deflation, CPI and WPI ........................................................................... 2

Policy Rates and Reserve ratios .................................................................................................................... 4

GDP and GNP ................................................................................................................................................ 5

Classical and Keynesian Theory .................................................................................................................... 6

Purchasing Power Parity ............................................................................................................................... 7

FDI and FII ..................................................................................................................................................... 7

Currency exchange rate and different exchange rate regimes .................................................................... 8

Fiscal and Monetary Policy ........................................................................................................................... 8

Microeconomics ............................................................................................................................................ 8

Types of Industry ........................................................................................................................................... 9

Money market and Capital market ............................................................................................................. 10

SENSEX Calculation ..................................................................................................................................... 10

Regional and national stock exchanges - how do you trade on exchange? ............................................... 10

How to trade on an Exchange? ................................................................................................................... 11

What are different caps of companies? ...................................................................................................... 11

Different Investor Types: ............................................................................................................................ 11

Difference between shareholders and stakeholders .................................................................................. 12

Promoters ................................................................................................................................................... 12

Different types of financial instruments – shares, bonds, options, futures and derivatives ...................... 12

Bull and bear market and strategies followed in markets .......................................................................... 13

Dematerialization and Depositories ........................................................................................................... 14

SEBI – its role as a regulator........................................................................................................................ 14

Accounts Basics ........................................................................................................................................... 15

Commercial banking v/s Investment Banking............................................................................................. 16

NBFCs .......................................................................................................................................................... 16

Types of Accounts ....................................................................................................................................... 17

Glossary of basic terms in finance .............................................................................................................. 18

Current Affairs ............................................................................................................................................. 21

Videos to watch .......................................................................................................................................... 21

Still hungry kya?? ........................................................................................................................................ 21


Inflation, Stagflation, Disinflation, Deflation, CPI and WPI

Since India has been witnessing unprecedented rise in inflation rates which has burnt a hole in tax

payer’s pocket one may be curious to know about inflation in greater depth. Put in simple terms inflation

indicates the rise in general price level of goods and services in an economy. If price of goods and

services increases then naturally the buying power of money will decrease as one can buy fewer goods

and services with each unit of currency. Let us take an example suppose one week earlier you went to

have breakfast in a nearby restaurant and you have taken a 50 rupee note with you. If the price a piece of

sandwich was Rs. 10 price then with you could buy 5 sandwich pieces. Now over the week the prices of

bread and vegetables have gone up on account of inflation and as a result the restaurant has increased

the price of a piece of sandwich to Rs.12.5. Now you can only buy 4 sandwich pieces with the same 50

rupee note today.

Now you may be thinking as to how one can measure inflation. The answer to your question is inflation

rate, the measure of rise in price level of goods and services. It indicates the rate of rise in price level of

goods and services. Given the large number of goods and services produced in an economy it is not

feasible to calculate the average change in price level of all goods and services. Consequently a

representative basket of goods and services (also known as market basket) is used for which the change

in price is calculated to get an indicative figure of change in overall price level, which is called inflation

rate.

Mathematically inflation rate is calculated as the percentage rate of change of a certain price index.

Generally each commodity in the market basket is linked to an index and the index has a certain value

(usually 100) in a particular year known as base year which is proportional to the price of commodity. This

index value keeps changing over time in proportion to change in price of commodity. The index for market

basket is calculated as the weighted average of the individual index of commodities where each

commodity has been assigned a particular weight based on its influence in economy. The index for

market basket is used for calculation of inflation rate. If the index values for the beginning and end of year

are known then the inflation rate for year is the percentage change in index value for year.

The measurement process will become clearer with a simple example that is being provided here. Let us

consider the market basket has only one product say rice. Assume the base year for index to be 2000

and corresponding index value to be 100. Let the price of sugar in base year is Rs. 5. Now suppose we

want to calculate the inflation rate for year 2009. For this as mentioned earlier we need to calculate the

index values at beginning and end of year 2009 which can be done using the price of sugar on the

corresponding date. Let the price of sugar at beginning and end of year 2009 be Rs. 6 and Rs.6.50

respectively. Applying unitary method the index value at the beginning and end of year 2009 is 120 and


125 respectively. Since the percentage increase in index value over the year 2009 is 4.17% so inflation

rate for year 2009 is 4.17%.

In above paragraph we illustrated the calculation of inflation rate for a year but you must have come

across newspaper articles reporting “Inflation rate for month ending December 31, 2010 was 8.43%’. So

now one needs to understand the meaning of the above mentioned statement. The statement also

mentions the inflation rate on a yearly basis only and for calculating the inflation rate the index values on

December 31, 2009 and December 31, 2010 are considered. The percentage change in index values for

the period between December 31, 2009 and December 31, 2010 gives the required inflation rate. If this

inflation rate keeps increasing over a period of time then it is said that the economy is facing inflation.

Based upon the type of price of commodity being considered for the calculation of index there are two

types of indexes – Consumer Price Index (CPI) and Wholesale Price Index (WPI). WPI accounts for price

change at the wholesaler or producer level whereas CPI measures the change in consumer price level

and retail margins. It is important to note that the composition of market basket for the two indexes is also

different. The market basket for CPI is determined and maintained by United States Bureau of Labor

Statistics. Another minor point of difference between the two indexes is that WPI is generally calculated

and reported on a weekly basis while CPI follows a monthly calculation and reporting procedure. At

present most of the countries including USA, UK, Japan and China use CPI for inflation rate calculation.

However India follows WPI method for inflation rate. The market basket of WPI consists of 435

commodities which are grouped into three categories:

1. Primary Articles: consist of food grains, fruits and vegetables, milk, eggs, meats and fishes,

condiments and spices, fibers, oil seeds and minerals. Their weight age is 22.02 %.

2. Fuel, Power, Light & Lubricants: consist of coal and petroleum related products, lubricants,

electricity etc. Their weight age is 14.23%.

3. Manufactured Products: consist of dairy products, atta, biscuits, edible oils, liquors, cloth,

toothpaste, batteries, automobiles etc. Their weight age is 63.75%.

The base year in India for WPI is 1993-94 and base index value is 100. However there is on-going debate

on increasing the number of commodities in market basket to 980 and shifting the base year to 2004-05.

However India does not follow the normal weekly reporting period for WPI and instead reports the

inflation rate on a monthly basis. The inflation rate calculation procedure remains same for both the

indexes. However there are four types of Consumer price indexes which are mentioned below:

1. CPI Industrial Workers;

2. CPI Urban Non-Manual Employees;


3. CPI Agricultural labourers;

4. CPI Rural labour.

When inflation is accompanied by an increase in unemployment rate then the situation is called

stagflation. The term stagflation is combination of two terms stagnation and inflation. Stagnation here

refers to economic stagnation which means a slowdown in economic growth as indicated by increase in

unemployment rate.

The counterpart of inflation is disinflation which is the case of decrease in inflation rate over a period of

time. This means that rate of increase in price level of goods and services has slowed down over the time

period. If the decrease in inflation rate continues then the rate may become negative, a situation referred

as deflation. During deflation the price level of goods and services decreases and consequently the

purchasing power of money increase. This means that one can buy more amount of a given commodity

with the same amount of money. Referring to the sandwich example given above now let us suppose that

the price of a piece of sandwich has dropped to Rs. 5 and so now you can buy 10 sandwich pieces for

Rs. 50.

Policy Rates and Reserve ratios

If one is a regular reader of business section of a newspaper then one must have come across at least

once in a month an article on RBI’s (Reserve Bank of India) monetary policy review in which different

rates and ratios like repo rate, cash reserve ratio, etc. are mentioned. It is important to understand the

meaning of these rates and ratios in order to appreciate the implication of change in their values.

At first let us consider two similar rates – bank rate and repo rate. Bank rate is the rate of interest that

commercial banks and other financial intermediaries have to pay on the loan that they take from country’s

central or federal bank. Repo rate is similar to bank rate except that it is applicable to short term loans

while bank rate is applicable to long term loans. In India Reserve Bank of India (RBI) is central bank.

Suppose that bank rate in India is 5% which means that if a commercial bank takes a loan of 1 million

rupees from central bank then it has pay 5% of 1 million i.e. Rs. 50,000 as the interest. Reverse repo rate

is the counterpart of repo rate. It is the rate of interest commercial banks and other financial

intermediaries receive on excess funds they deposit with the central bank. Now suppose the commercial

bank deposits 1 million rupees in central bank with reverse repo rate being 5% then the commercial bank

will receive Rs. 50, 00 as interest on their deposit. The three above mentioned rates are also referred to

as policy rates.

Cash reserve ratio(CRR) and statutory liquidity ratio(SLR) are reserve ratios which put a limit on the

minimum amount of reserve that commercial banks and other financial intermediaries are required to


keep in central bank. CRR is the percentage of their total deposits that the commercial banks have to

keep in central bank in form of cash. SLR is similar to CRR except that apart from cash other liquid assets

like precious metals such as gold and approved short term securities like treasury bills may be used to

meet the reserve requirements. A better understanding of reserve ratio will be possible after going

through the example provided below. Assume that the CRR and SLR are 6% and 20% respectively and a

commercial bank has a total deposit of 10 million rupees with itself. Now the bank has to keep 0.6 million

rupees in cash as a deposit with central bank and make a net deposit of 2 million rupees in form of liquid

assets with the central bank.

The RBI reviews these rates and ratios on a monthly basis with intent to keep a check on money supply

and inflation rate in economy. In order to increase the supply of money in economy RBI may decrease its

policy rates and reserve ratios. The decrease will have the combined effect of increasing the deposits

available with the commercial banks which may be offered as loans to general public thereby pumping

money into the economy. One can refer to the current value of these ratios and rates by visiting the

homepage of RBI’s website - http://www.rbi.org.in/home.aspx.

GDP and GNP

Gross Domestic Product (GDP) refers to the market value of goods and services produced within a

country in a financial year. GDP is calculated using the formula provided below:

GDP = Private Consumption + Investment + Government Spending + Net exports

Where Net Exports = Exports – Imports

Private Consumption here refers to the household consumption expenditure which will fall under one of

the three categories – durable goods, non-durable goods and services.

Investment here refers to business investment in buying new equipment like purchase of software, buying

of machinery, etc. and does not include exchange of assets. This should not be confused with financial

investment in purchase of financial products.

Government Spending is the expenditure of government on final goods and services. It is inclusive of

salaries of public servants and purchase of military equipment but excludes social security and

unemployment benefits.

GDP is considered to be an indicator of standard of living of a country. Countries with higher GDP are

considered to have better standard of living. When net income receipt is added to GDP then it gives

Gross National Product (GNP). Net income receipt is arrived at by summing the income from overseas

http://www.rbi.org.in/home.aspx


investment and subtracting from the sum the income earned by foreign nationals and companies

domestically. Let us consider an example for further clarification. Suppose the GDP and GNP of India are

to be calculated, now if an Indian company has a plant in China then the profit made by that plant will not

be included in GDP but will be included in GNP. Similarly if a Chinese firm has a plant in India then the

plant’s income will be accounted for in GDP but will be subtracted from GNP value. To summarize the

basis of production allocation is geographical location and ownership for GDP and GNP respectively.

Classical and Keynesian Theory

Microeconomics is economics related to individual and firms whereas macroeconomic deals with the

behaviour of economy as a whole and not just individual firms but entire industries. The history of

macroeconomics has witnessed several economic theories but the two pivotal theories among them have

been Classical and Keynesian theory given the influence they had in guiding the functioning of economy.

Classical theory’s origin may be traced back to the all-time classic book, Wealth of Nations by Adam

Smith in which the concept of ”invisible hand” was proposed.

The concept of invisible hand states that in a free market if individuals carry out their economic affairs for

their own self-interest then they will be led by the invisible hand to maximize the general welfare of the

economy. The concept should not be misinterpreted to mean that there will be no wealth inequality in a

country and that a country will be insulated from the effects of drought, war or political instability. It just

proposes that given the initial distribution of wealth in a country and the resources (natural, human and

technological) at its disposal, the existence of free markets will make country men as well of as possible.

Central to the existence of free market is the assumption of price and wage flexibility. Price and wage

flexibility assumption implies that price and wage adjust rapidly enough to maintain equilibrium where the

supply of a commodity equals its demand. For example if for a commodity say rice the quantity

demanded exceeds quantity supplied then the price rises to bring down the demand so that it equals

supply. Change in price and wage influence the action of people in an economy. As existence of free

market requires minimum regulatory requirements so followers of classical theory often advocate limited

role of government in functioning of economy.

The theory of classical economics took a severe blow in 1930 with its failure to come up with an effective

solution for Great Depression that had crippled the economy of United States. At that time a British

economist, John Maynard Keynes came up with an alternative to classical theory in his book The General

Theory of Employment, Interest and Money. The theory is popularly named Keynesian theory after his

name and it rejects the assumption of wage and price flexibility which forms the basis of classical theory.

Keynes on the contrary assumed that wages and prices adjust slowly and are not able to reduce the


number of people who want to work so as to make it equal to the number of people which the firm wants

to employ which results in unemployment.

Keynes proposed increased government intervention through purchase of goods and services as a

solution to the problem of high unemployment. Purchase of goods and services by government will

increase the market demand and the producers will have to ramp up production level to meet the

increasing demand that will require hiring more people which will bring down the unemployment rate. The

newly hired people will have more disposable income to spend which will further raise demand and

consequently employment. For this reason Keynesian theory advocated increased government

involvement for smooth functioning of economy.

Purchasing Power Parity

Purchasing Power Parity is a theory in economics which states that the cost of goods in one country

should be the same as the cost of goods in another country when adjusted for the exchange rates.

However in practice such a condition does not exist and we see price differentials across many countries.

The theory states that in the long run the prices in both the countries and the exchange rates would

stabilize such that we have the same cost of goods irrespective of the country in which the purchase is

made. To illustrate how the prices would adjust, suppose a TV set costs Rs. 30,000 in India and the same

set sells in the US for $700. Thus at the exchange rate of INR = 40/US$, the same product costs $700 in

the US when in India it costs $750. Thus ignoring the transportation costs, people would prefer to buy the

TV set in the US rather than in India. More practically, a company can buy thousands of TV sets in the US

and sell them in India at a profit. Because of this two things would happen. Firstly the demand in the US

would go up and that in India would go down. Also the company would have to buy the TV sets by paying

in dollars. Thus the company would buy dollars and sell rupees increasing the exchange rate. The

exchange rates and prices would finally settle down to values where we have purchasing power parity.

However such a situation does not occur in practice due to a variety of reasons like trade barriers, central

bank intervention in the Forex markets etc.

Generally PPP is measured by the cost of a basket of goods in different countries. A famous indicator

used to measure PPP is the Big Mac Index. This index was proposed by ‘The Economist’ and it measures

the price of McDonalds Hamburger across various countries.

FDI and FII

Foreign Direct Investment refers to the investment by foreign investors in projects in the country. This

type of investment is more involved with the management, technology transfer and other field expertise

and knowhow in the project. FII refers to Foreign Institutional Investors. These investors invest in the


country indirectly by purchasing stocks of the companies listed on the stock exchanges. The FII money

inflows or outflows are also called hot money flows.

Currency exchange rate and different exchange rate regimes

The currency exchange rates tell us how much one currency is worth in terms of the other currency. For

example when we write INR = 45.34/US$ we mean that we would receive INR 45.34 for every US$ we

possess.

The manner in which a country manages its exchange rate with other currencies in the world is called as

the exchange rate regime. There are many types of exchange rate regimes like Fixed, Floating and

Pegged float. Fixed exchange rate regime was prevalent before the 1970’s when there was a direct

convertibility between different currencies of the world that is the exchange rate is fixed in this regime.

Today most economies follow the floating exchange rate regime where the exchange rates are

determined by the market forces rather than the governments. Pegged floating rate is a type of floating

rate regime where the central bank of the country allows the exchange rate to fluctuate in a band about

the pegged value. If the rate moves outside the band, the central bank would intervene in the market by

buying or selling the currency to bring the rate back to the pegged value.

Fiscal and Monetary Policy

The government exerts its control over the nation’s economy using two distinct set of policies. One is the

monetary policy (the central bank manages this on behalf of the government) and secondly the fiscal

policy. With the help of the monetary policy the central bank (RBI) controls the total supply of money in

the market. With the control over the money supply the central bank could control the spending by various

people and institutions thus controlling the prices and the economic output. Monetary Policy comprises of

various policy rates and reserve ratios that are explained in a section above. The other tool that

government uses to control the nation’s economy is explained below:-

Fiscal policy: Fiscal policy refers to the government spending of its resources and taxation policies which

affect the economy of the country. The levels of taxation and expenditures are mostly decided when the

budget is presented in March. With the help of taxation, the government can change the levels of

disposable incomes which households have, thus modifying the demand levels in the country. Also with

the help of subsidies and special plans the government can support the growth certain sectors, regions,

social segments in the economy.

Microeconomics


Law of Demand

It basically establishes the relationship between the demand of a product and its price. It states that

“Demand of a particular product is inversely proportional to its price keeping other factors such as

Income, Price of substitutive products etc. constant”.

For example, if we consider the recent example we can easily see that the demand of the onion

decreased considerably with recent hike in its price.

Law of Supply

It basically establishes the relationship between the supply of a product and its price. It states that

“Supply of a particular product is directly proportional to its price keeping other factors such as supply of

substitutive products etc. constant”. The logic behind this law is actually the fact that the higher price

motivates the supplier to produce more for higher amount of profit.

For example, the rise in the price of the onion will motivate the farmers to produce more so that they will

get more profit in the future. One thing that we will have to keep in mind is the fact that in the short term

its supply will remain the same but in the long term its supply will increase considerably.

Types of Industry

Monopoly

It exists when a specific individual or an enterprise has sufficient control over a particular product or

service to determine significantly the terms on which other individuals shall have access to it. Monopolies

are thus characterized by a lack of economic competition to produce the good or service and a lack of

viable substitute goods.

For Example, Indian Railway has monopoly in serving passengers through train as no other player exists.

Oligopoly

An oligopoly is a market form in which a market or industry is dominated by a small number of sellers

.Because there are few sellers, each oligopolist is likely to be aware of the actions of the others. The

decisions of one firm influence, and are influenced by, the decisions of other firms.

Example: - Indian Petroleum Industries which is dominated by few players like HPCL, BPCL, IOCL etc.

and the decisions of the one influences the decision of the others.

Perfect competition


It describes markets such that no participants are large enough to have the market power to set the price

of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any

perfectly competitive markets. Still, buyers and sellers in some auction-type markets say for commodities

or some financial assets may approximate the concept. Perfect competition serves as a benchmark

against which to measure real-life and imperfectly competitive markets.

Money market and Capital market

Difference and demarcation between money market and capital market is made on the basis of maturity

period of instruments and claims.

Money Market: Short-term instruments maturing within a period of one year are traded in money market

such as inter-corporate deposits, certificate of deposits, treasury bonds, commercial papers, commercial

bills, etc. Money market is a wholesale market and the participants in money market are large institutional

investors, commercial banks, mutual funds, and corporate bodies.

Capital Market: capital market deals with longer maturity financial assets and claims. Capital market

includes trading in the financial instruments such as shares (equity as well as preference), public sector

bonds and units of mutual funds. In case of capital market even a small individual investor can deal by

sale/purchase of shares, debentures or mutual fund units.

SENSEX Calculation

The BSE Sensex or Bombay Stock Exchange Sensitive Index is a value-weighted index composed of the

30 largest and most actively traded stocks, representative of various sectors. These companies account

for around one-fifth of the market capitalization of the BSE. The Bombay Stock Exchange (BSE)

authorities review and modify its composition to make sure it reflects current market conditions.

Sensex in nothing but the average weighted movement of these stocks.

For E.g.: Reliance Industries LTD (RIL) has 10% weightage in the index and overall growth in RIL is 5%

on a particular day, so RIL contribution will be 10*1.05, and so on so forth. All the calculation will be done

by this method and final average increase or decrease of the BSE index is done.

Regional and national stock exchanges - how do you trade on exchange?

Regional Stock Exchange: A Regional stock exchange is usually located in a particular city and is open

for trading only to the residents of that particular city/state which makes it inaccessible for other investors

who do not reside in that region.


In India, there are 21 regional stock Exchanges existing in cities like Ahmedabad, Bangalore,

Bhubaneswar, Calcutta, Cochin, Coimbatore, Delhi, Guwahati, Hyderabad, Jaipur, Ludhiana, Madhya

Pradesh, Madras, Magadh, Mangalore, Meerut, OTC Exchange Of India, Pune, Saurashtra Kutch,

UttarPradesh and Vadodara.

National Stock Exchange: The BSE and NSE are the two national stock exchanges of India – meaning

they are common to all residents of the country. Today NSE network stretches to more than 1,500

locations in the country and supports more than 2, 30,000 terminals.

How to trade on an Exchange?

The stock market system is an avenue to trade stocks of the listed companies. The Securities can either

be bought when a company issues IPO or can be traded in the secondary market wherein stocks can be

bought and sold through brokers who facilitate this procedure. A particular individual can decide on which

stocks to buy or sell depending upon the company’s growth prospects and performance and various other

parameters. This information will help the investors to become more aware of the directions of the

companies where they have share of stocks on and this will also aid them in how to trade stock and

where to direct their investment strategies.

What are different caps of companies?

The sum derived from the current stock price per share times the total number of shares outstanding is

termed as market capitalization. It is indicative of the value of the Company. Depending upon the market

capitalization of a company, all the companies are divided into Large-cap, mid-cap and small-cap. Given

below are the approximate categories of Market Capitalization, but there is no sure shot definition:

Large Cap: Over Rs.550 crores

Mid Cap: Rs.150 cr to Rs.550 crores

Small Cap: Less than Rs. 150 crores

Source: Dalal Street Journal

Different Investor Types:

Conservative investors: They prefer investing in low risk profiles. Such people mostly put all their money

in interest bearing savings accounts, fixed deposit, mutual funds, treasury bills, Certificate of deposits.

Such instruments provide fixed amount of returns at a particular interest rate.

Moderate investors: They often invest in cash and bonds. They may even invest in stock market in stocks

with low or moderate risks.


Aggressive investors: Commonly invest in the stock market which is a higher risk. They also tend to

invest in business ventures as well as higher risk real estate. The return on investment here is not

guaranteed.

In stock market too, there are different types of investors:

Day Traders: Those who buy and sell various types of stocks, currencies, and futures within the same

day.

Short-term Traders: They hold the stocks/ investments for a very short time. Short-term trading minimizes

risk due to the fact that the shorter they hold the stock, the less time the price has to go down. Likewise

the gains that are to be had are also minimal, so the profits grow very slowly.

Long-term Traders: They have a long-term strategy and aren't in a rush to make quick money but to make

more money over a greater period.

Difference between shareholders and stakeholders

Shareholders: They hold shares in the company – that is they own part of it. They are mainly interested in

their dividends and capital growth of their shares. They have the right to vote at meetings for company

actions such as approving /rejecting merger proposals.

Stakeholders: They have an interest in the company but do not own it. A stakeholder is any individual or

organization that is affected by the activities of a business. Shareholders are a part of stake holders. The

other stakeholders can be Employees of the company, Vendors, Customers and Suppliers, Government,

Lenders.

Promoters

An individual or a company who devises a plan for a business venture or some kind of a business activity;

one who takes the preliminary steps necessary for the formation of a corporation. Promoters help in

raising the money to fund the new business from the public in the form of various investment instruments

such as limited partnerships and direct investment activities.

Different types of financial instruments – shares, bonds, options, futures and

derivatives

Shares: A unit of ownership interest in a corporation or financial asset. While owning shares in a business

does not mean that the shareholder has direct control over the business's day-to-day operations, being

a shareholder does entitle the possessor to an equal distribution in any profits, if any are declared in the

form of dividends. The two main types of shares are common shares and preferred shares.


Bonds: A debt investment in which an investor loans money to an entity (corporate or governmental) that

borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies,

municipalities, states and U.S. and foreign governments to finance a variety of projects and activities.

Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes,

along with stocks and cash equivalents.

Derivatives: A security whose price is dependent upon or derived from one or more underlying

assets. The derivative itself is merely a contract between two or more parties. Its value is determined by

fluctuations in the underlying asset. The most common underlying assets include stocks,

bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by

high leverage.

Options: A financial derivative that represents a contract sold by one party (option writer) to another party

(option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a

security or other financial asset at an agreed-upon price (the strike price) during a certain period of time

or on a specific date (exercise date).

Call options give the option to buy at certain price, so the buyer would want the stock to go up.

Put options give the option to sell at a certain price, so the buyer would want the stock to go down.

Futures: A financial contract obligating the buyer to purchase an asset (or the seller to sell an asset), such

as a physical commodity or a financial instrument, at a predetermined future date and price. Futures

contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading

on a futures exchange. Some futures contracts may call for physical delivery of the asset, while others

are settled in cash. The futures markets are characterized by the ability to use very high leverage relative

to stock markets.

Bull and bear market and strategies followed in markets

Bull market: A financial market of a group of securities in which prices are rising or are expected to rise.

The term "bull market" is most often used to refer to the stock market, but can be applied to anything that

is traded, such as bonds, currencies and commodities.

Bull markets are characterized by optimism, investor confidence and expectations that strong results will

continue. It's difficult to predict consistently when the trends in the market will change. Part of the difficulty

is that psychological effects and speculation may sometimes play a large role in the markets.


Bear market: A market condition in which the prices of securities are falling, and widespread pessimism

causes the negative sentiment to be self-sustaining. As investors anticipate losses in a bear market and

selling continues, pessimism only grows.

A bear market should not be confused with a correction, which is a short-term trend that

has duration of less than two months. While corrections are often a great place for a value investor to find

an entry point, bear markets rarely provide great entry points, as timing the bottom is very difficult to do.

Long (or Long Position): The buying of a security such as a stock, commodity or currency, with the

expectation that the asset will rise in value. In the context of options, it is the buying of an options

contract.

Short (or Short Position): The sale of a borrowed security, commodity or currency with the expectation

that the asset will fall in value. In the context of options, it is the sale (also known as "writing") of an

options contract.

Short Selling: The selling of a security that the seller does not own, or any sale that is completed by the

delivery of a security borrowed by the seller. Short sellers assume that they will be able to buy the stock

at a lower amount than the price at which they sold short.

Dematerialization and Depositories

Dematerialization: The move from physical certificates to electronic book keeping. Actual stock

certificates are slowly being removed and retired from circulation in exchange for electronic recording.

With the age of computers and the Depository Trust Company, securities no longer need to be in

certificate form. They can be registered and transferred electronically.

Depositories: On the simplest level, depository is used to refer to any place where something is deposited

for storage or security purposes. More specifically, it can refer to a company, bank or an institution that

holds and facilitates the exchange of securities. Or a depository can refer to a depository institution that is

allowed to accept monetary deposits from customers.

SEBI – its role as a regulator

The Securities and Exchange Board of India is the regulatory body for the investment market in India. The

purpose of this board is to maintain stable and efficient markets by creating and enforcing regulations in

the marketplace. The SEBI is relatively new (1992) but is a vital component in improving the quality of the

financial markets in India, both by attracting foreign investors and protecting Indian investors.


Accounts Basics

The accounting equation is given by:

ASSETS = LIABILITIES + OWNER’S EQUITY

Let us understand the terms in the accounting equation with an example. Consider that you are the owner

of a factory that produces shoes.

Assets: The valuable resources that your business owns are called assets. Examples of assets in your

shoe factory are the machines, the factory building etc.

Liabilities: The resources or obligations that your business owes to outside parties are called liabilities.

Example would be a, a bank loan which you had taken to buy leather from the market, which is the raw

material for the shoes. This loan is an obligation to the business and it needs to be paid back to the bank

and so is a liability. Another example would be the tax to be paid to the Government.

Owner’s Equity: A business has owner/owners who put in money to run the business. The owner’s equity

is divided generally in two parts: Paid-in capital and Retained earnings. Taking the same example once

again. You and your friend started the shoe factory by contributing Rs. 100,000 each to the business. So

the paid-in-capital is Rs. 200,000 (i.e. the money put into the business by the owners). After a successful

year of operations, the business churns out a profit of Rs. 60,000. You and your friend decided to keep

Rs. 10,000 and put the remaining Rs. 50,000 back into the business. This sum of Rs. 50,000 is called

retained earnings which is the earnings that have been retained in the business.

Current and Non- current Assets and Liabilities

There are many ways in which assets and liabilities are classified. One of the classifications is current or

non-current. The word current means that it (asset or liability) would be settled within a year. If the time

span is more than one year they are termed as non-current assets and liabilities or long term assets and

liabilities. Here are some of them using the shoe factory example

Current Assets: The cash the business has in hand to carry out day to day activities

Current Liabilities: A bank loan that the business needs to repay to the bank in the next 6 months

Non-current assets (also known as long term assets): Buildings and machinery owned by the business

Non-current liability (also known as long term liability): A long term loan i.e. which is to be paid back in 10

years.


Commercial banking v/s Investment Banking

A commercial bank is a financial institution which accepts deposits, provides loans for business and

personal purposes and offers services like providing accounts. Other services that these offer include

issuing Demand drafts, cheques, lockers (safe deposit boxes) credit cards and debit cards facilities etc.

Examples include State Bank of India, Punjab National Bank, Bank of Baroda, Canara Bank etc.

An Investment bank is financial investment institution that acts as an intermediary and offers the following

services:

1) Underwriting – The process by which capital is raised from investors on behalf of companies by

issuing shares(equity) or bonds(debt)

2) Help a company in the complete process of raising capital by arranging stock issues in market

and deciding the prices of the shares.

3) Strategic Advisory during mergers and acquisitions

4) Acting as broker for institutional investors

5) Preparing the company’s Red herring Prospectus

Examples include Goldman Sachs, Morgan Stanley, HSBC, JPMorgan Chase, Deutsche bank etc.

Differences: A commercial bank provides retail banking services like loans and deposits, but an

investment bank does not. Further, both of them handle different type of transactions.

NBFCs

Non-Banking Financial companies (NBFCs) are financial institutions that provide banking services, but do

not have a banking license. Ideally, they are not allowed to take deposits from the public.

Some of their services include:

1) Providing loans and credit facilities

2) Wealth Management

3) Advisory during Mergers and Acquisitions

4) Retirement Planning

5) Underwriting

It differs from commercial banks in the following aspects

1) NBFCs do not hold a banking license

2) NBFCs cannot take deposits from public


Types of Accounts

1) Savings Account: This type of account is most popular and commonly used account by

individuals. This account provides cheque facility and money can be withdrawn from the account.

However, there is a limit on the amount of cash that can be withdrawn on a single day. This

account also fetches interest on the amount of money deposited. Currently, the interest rate is

4.0% p.a .

2) Current Account: This account is used mainly by business houses and is not for investment. The

purpose of this account is to provide flexible liquidity and hence there is no limit on the amount of

money that can be withdrawn on a single day or on the number of withdrawals within a certain

period of time. No interest is paid on these accounts and bank actually levies service charges on

such accounts.

3) Fixed Deposit (FD) account: Customers deposit money in a fixed deposit account for a fixed

period of time at a fixed rate of interest. Money cannot be withdrawn from such accounts before

the time period ends, though some banks allow withdrawal by paying a penalty fee

4) Demat Accounts: Also known as dematerialized accounts, these are used for selling or buying

stocks in share market. In India, such accounts are maintained by NSDL (National Securities

Depository Ltd). The shares are stored digitally in such accounts.

5) Joint Account: This account is owned by two or more individuals. Any of the owners can withdraw

money from this account, but the permission of other owners is required.

6) NRI Account: It is a bank account opened in India by a non-resident Indian for the purpose of his

personal financial transaction.


Glossary of basic terms in finance

These are some of the few basic terms which should be known to all irrespective of their

background. This list is not binding and exhaustive at all. Please go through websites like

www.investopedia.com and www.wikipedia.com if you want to know about these terms or some others in

detail.

1) Acquisition - The acquiring of control of one corporation by another.

2) Amortization of a debt or a loan - The gradual reimbursement of a debt or a loan through regular

payments over a specified period of time.

3) Annual report - The formal financial statement issued yearly by a corporation. The annual report

shows assets, liabilities, revenues, expenses and earnings - how the company stood at the close

of the business year, how it fared profit-wise during the year, as well as other information of

interest to shareowners.

4) Assets - Everything a corporation owns or that is due to it: cash, investments, money due it,

materials and inventories, which are called current assets; buildings and machinery, which are

known as fixed assets; and patents and goodwill, called intangible assets.

5) Balance sheet - A snapshot of a company's assets and liabilities at a specific point in time.

6) Bearer share - A certificate representing one unit of ownership in a company, whose owner’s

name is not registered.

7) Bond - A debt instrument representing a share of a loan issued by a government, an institution or

a corporation. Bondholders are paid interest over the life of the loan. Its holder is a creditor of the

corporation and not a part owner.

8) Cash flow - The cash and cash equivalents generated by a company. Cash flow is a measure of

a company’s ability to finance growth, reimburse debt and pay dividends out of its own funds.

9) Depreciation - An expense recorded in a company's accounts to reduce the value of a capital

asset, reflecting its actual loss of value over time.

10) Diversification - The process of buying securities in different investment types, industry types,

risk levels, and companies in order to reduce the loss from a possible company-local or industry-

local loss of business (Diversification is illustrated by a famous saying, "Don't put all your eggs in

one basket.")


11) Dividend - The portion of a company’s earnings distributed to shareholders, as approved by the

Annual Meeting

12) Goodwill - The excess of the purchase price paid for a company over the fair market

value of that company’s net tangible assets. The purchasing company amortizes goodwill out of

its after-tax income. If the acquisition price is lower than the value of the net tangible assets, the

difference is referred to as negative goodwill or bad will.

13) Investment - The use of money for the purpose of making more money, to gain income, increase

capital, or both.

14) Liabilities - All the debts, funds and other commitments owed by a company. Liabilities include

accounts, wages and salaries payable; dividends declared payable; accrued taxes payable; and

fixed or long-term liabilities, such as mortgage bonds, debentures and bank loans.

15) Loans outstanding - Total amount of a company’s loans remaining to be repaid.

16) Market capitalization - The market value of a company, as calculated by multiplying the number of

outstanding shares by the price per share. Market value fluctuates daily with the share price. It

represents the price that would have to be paid to acquire 100% of the company’s capital.

17) Net financial position - A company’s total debt less cash and cash equivalents (bank balances,

short-term investments, and short-term loans). If the balance is negative (i.e. debt exceeds cash

and cash equivalents), the company is said to have net debt.

18) Net income - A company’s earnings after operating, interest and extraordinary expenses, as well

as corporate income tax.

19) Operating margin - The amount remaining after all a company’s operating expenses have been

deducted from sales. The operating margin reflects the financial health of a company before

taxes, interest expense and extraordinary items.’

20) Price/Earnings Ratio (PER) - The ratio between a company’s share price and its forecast

earnings per share for the year in progress. PER measures how expensive a stock is and

enables comparisons with other stocks in the same industry.

21) Return on capital employed (ROCE) - The ratio between operating income less interest expense,

taxes and income from companies accounted for by the equity method on the one hand, and the

total amount of capital employed in the company on the other. ROCE is a measure of a

company’s profitability.

22) Return on investment - A measure of the profitability of a project in relation to the amount of

money invested in it. Different ratios can be used, such as internal rate of return and net present

value.


23) Sales- The total revenues generated by the sale of goods and/or services over a given period of

time.

24) SEBI - The Securities and Exchange Board of India (frequently abbreviated SEBI) is the regulator

for the securities market in India. SEBI protects the interests of investors in securities and

promotes the development of the securities market through appropriate regulation.

25) Share - A certificate representing one unit of ownership in a company.

26) Stock exchange - An organized marketplace for securities featured by the centralization of supply

and demand for the transaction of orders by member brokers for institutional and individual

investors. BSE and NSE are the major stock exchanges in India.


Current Affairs Many of the important news relating to Global Economy and Indian Economy are covered extensively in

Niveshak, a monthly e-magazine of Finance Club, IIM Shillong. All the issues are available at:

http://iims-niveshak.com/

Videos to watch

Subprime Crisis Explained:

http://www.youtube.com/watch?v=bx_LWm6_6tA

Euro Zone Crisis:

http://www.youtube.com/watch?v=ttuXQWV_dtQ&feature=related

http://www.youtube.com/watch?v=LKsZ1hqHBHU

Still hungry kya??

Check out this link

http://www.nseindia.com/content/ncfm/Contents_revised.pdf

http://iims-niveshak.com/

http://www.youtube.com/watch?v=bx_LWm6_6tA

http://www.youtube.com/watch?v=ttuXQWV_dtQ&feature=related

http://www.youtube.com/watch?v=LKsZ1hqHBHU

http://www.nseindia.com/content/ncfm/Contents_revised.pdf


Documents

Finance Club Booklet - IIM Shillong