FINANCIAL INTRUMENTS

How Credit Default Swaps WorkCredit default swaps (CDSs) are essentially insurance policies issued bybanks(sellers) and taken out by investors (buyers) to protect against failure among their investments. Credit default swaps arederivatives-- any kind of financial instrument whose value is based on the value of another financial instrument [source:Risk Glossary]. The value of credit default swaps is derived from whether or not a company goes south. They can be valuable if it doesn't through premium payments, or they can be valuable as insurance if the company goes under. Think of it in terms of loans. When you invest in a company, you essentially give it a loan. It repays the loan in dividends, increased share prices or both. If a company goes bankrupt and its shares become worthless, then it's defaulted on the loan you gave it. Bankruptcy is one of severalcredit events-- triggers that allow a credit default swap buyer to call in the coverage it took out on its investment.This type of swap was initially created in the late 1990s to protect against defaults on extremely safe investments likemunicipal bonds(loans made to cities to finance projects). Monthly premium payments made these swaps a steady source of extra cash flow for the issuers. As a result, they became increasingly popular among the huge issuing banks and the investors who realized they could be traded as bets on the health of a company. Anyone confident about a company's health can purchase seller swaps and rake in premiums from swap buyers. Those who doubt a company's health can purchase buyer swaps, make premium payments on the swaps and cash them in when the company goes under.

Option pricingThe two components of an option premium are theintrinsic valueand thetime value. The intrinsic value is the difference between the underlying's price and the strike price. Specifically, the intrinsic value for a call option is equal to the underlying price minus the strike price; for a put option, the intrinsic value is the strike price minus the underlying price

Intrinsic Value (Call) = Underlying Price Strike Price

Intrinsic Value (Put) = Strike Price Underlying Price

By definition, the only options that have intrinsic value are those that arein-the-money. For calls, in-the-money refers to options where the exercise (or strike) price is less than the current underlying price. A put option is in-the-money if its strike price is greater than the current underlying price.

In-the-Money (Call) = Strike Price < Underlying Price

In-the-Money (Put) = Strike Price > Underlying Price

Any premium that is in excess of the option's intrinsic value is referred to as time value. For example, assume a call option has a total premium of $9.00 (this means that the buyer pays, and the seller receives, $9.00 for each share of stock or $900 for the contract, which is equal to 100 shares). If the option has an intrinsic value of $7.00, its time value would be $2.00 ($9.00 - $7.00 = $2.00).

Time Value = Premium Intrinsic Value

In general, the more time to expiration, the greater the time value of the option. It represents the amount of time that the option position has to become more profitable due to a favorable move in the underlying price. In general, investors are willing to pay a higher premium for more time (assuming the different options have the same exercise price), since time increases the likelihood that the position can become profitable. Time value decreases over time and decays to zero at expiration. This phenomenon is known astime decay.

An option premium, therefore, is equal to its intrinsic value plus its time value.

Option Premium = Intrinsic Value + Time Value

gold standardGold standard, monetary system in which the standard unit ofcurrencyis a fixed quantity of gold or is kept at the value of a fixed quantity of gold. The currency is freely convertible at home or abroad into a fixed amount of gold per unit of currency.in aninternational gold-standard system, gold or a currency that is convertible into gold at a fixed price is used as a medium of international payments. Under such a system,exchange ratesbetween countries are fixed; if exchange rates rise above or fall below the fixedmintrate by more than the cost of shipping gold from one country to another, large gold inflows or outflows occur until the rates return to the official level. These trigger prices are known asgold points. The gold standard was first put into operation in Great Britain in 1821. Prior to this time silver had been the principal world monetary metal; gold had long been used intermittently for coinage in one or another country, but never as the single reference metal, or standard, to which all other forms ofmoneywere coordinated or adjusted. For the next 50 years a bimetallic regime of gold and silver was used outside Great Britain, but in the 1870s a monometallic gold standard was adopted byGermany, France, and theUnited States, with many other countries following suit.QUANTITATIVE EASINGQuantitative easing is an occasionally used monetary policy, which is adopted by the government to increase money supply in the economy in order to further increase lending by commercial banks and spending by consumers. The central bank (Read: The Reserve Bank of India) infuses a pre-determined quantity of money into the economy by buying financial assets from commercial banks and private entities. This leads to an increase in banks' reserves.

Description:Quantitative easing is aimed at maintaining price levels, or inflation. However, these policies can backfire heavily, leading to very high levels of inflation. In case commercial banks fail to lend excess reserves, it may lead to an unbalance in the money market.

PnotesThese are used by overseas market participants that dont want to get registered as FIIs

Foreign institutional investors (FIIs) that invest in domestic capital markets need to register with the capital markets regulator, Securities and Exchange Board of India (Sebi). Overseas investors can also participate without formally registering with Sebi through a mechanism called participatory notes, or P-notes. WHAT ARE P-NOTES? These are used by overseas market participants that dont want to get registered as FIIs. P-notes are not issued in India, rather these are issued by an India registered FII to other overseas investors. The FII will be the entity to initiate a transaction in our stock markets, which could be on behalf of foreign clients. P-notes are then issued by the FII to the client, underlining that the securities are held on behalf of the client albeit in the name of the FII. The P-note holder is entitled to all the dividends, capital gains and other payouts on the underlying securities. FIIs have to periodically report to Sebi on P-note issuance without the need to name the final beneficiary.Bretenwood system

Nations attempted to revive thegold standardfollowing World War I, but it collapsed entirely during the Great Depression of the 1930s. Someeconomistssaid adherence to thegold standardhad prevented monetary authorities from expanding the moneysupplyrapidly enough to revive economic activity. In any event, representatives of most of the world's leading nations met atBretton Woods, New Hampshire, in 1944 to create a newinternational monetary system.

Because theUnited Statesat the time accounted for over half of the world'smanufacturing capacityand held most of the world's gold, the leaders decided to tieworld currenciesto the dollar, which, in turn, they agreed should be convertible into gold at $35 per ounce.Under theBretton Woodssystem, centralbanksof countries other than theUnited Stateswere given the task of maintaining fixedexchange ratesbetween their currencies and the dollar. They did this by intervening inforeign exchange markets. If a country's currency was too high relative to the dollar, itscentral bankwould sell itscurrency in exchange for dollars,driving down the value of its currency. Conversely, if thevalue of a country's moneywas too low, the country would buy its own currency, thereby driving up the price.

LIBORTheLondon Interbank Offered Rateis the average interest rate estimated by leading banks in London that the average leading bank would be charged if borrowing from other banks.[1]It is usually abbreviated toLibor(/labr/) orLIBOR, or more officially toICE LIBOR(forIntercontinental ExchangeLibor). It was formerly known asBBA Libor(forBritish Bankers' AssociationLibor or the trademarkbbalibor) before the responsibility for the administration was transferred toIntercontinental Exchange. It is the primary benchmark, along with theEuribor, for short-term interest rates around the world.[2][3]Libor rates are calculated for 5 currencies and 7 borrowing periods ranging from overnight to one year and are published each business day byThomson Reuters.[4]Many financial institutions, mortgage lenders and credit card agencies set their own rates relative to it. At least $350trillioninderivativesand other financial products are tied to the Libor.[5]BITCOIN

BITCOINBitcoin is a form of digital currency, created and held electronically. No one controls it. Bitcoins arent printed, like dollars or euros theyre produced by people, and increasingly businesses, running computers all around the world, using software that solves mathematical problems.What makes it different from normal currencies?Bitcoin can be used to buy things electronically. In that sense, its like conventional dollars, euros, or yen, which are also traded digitally.However, bitcoins most important characteristic, and the thing that makes it different to conventional money, is that it isdecentralized. No single institution controls the bitcoin network. This puts some people at ease, because it means that a large bank cant control their money.Who created it?A software developer calledSatoshi Nakamotoproposed bitcoin, which was an electronic payment system based on mathematical proof. The idea was to produce a currency independent of any central authority, transferable electronically, more or less instantly, with very low transaction fees

LIQUIDITY ADJUSTMENT FACILITYLiquidity Adjustment Facility (LAF) is the primary instrument of Reserve Bank of India formodulating liquidity and transmitting interest rate signals to the market. It refers to the difference between the two key rates viz. repo rate and reverse repo rate. Informally, Liquidity Adjustment Facility is also known as Liquidity Corridor.How Liquidity Adjustment Facility works? As mentioned above, the two components of LAF are repo rate and reverse repo rate. Under Repo, the banks borrow money from RBI to meet short term needs by putting government securities (G-secs) as collateral. Under Reverse Repo, RBI borrows money from banks by lending securities. While repo injects liquidity into the system, the Reverse repo absorbs the liquidity from the system. RBI only announces Repo Rate. The Reverse Repo Rate is linked to Repo Rate and is 100 basis points (1%) below repo rate. RBI makes decision regarding Repo Rate on the basis of prevalent market conditions and relevant factors.

REITSWhat are REITs?Real estate investment trusts (REITs) allow individuals to invest in large-scale, income-producing real estate. A REIT is a company that owns and typically operates income-producing real estate or related assets. These may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans. Unlike other real estate companies, a REIT does not develop real estate properties to resell them. Instead, a REIT buys and develops properties primarily to operate them as part of its own investment portfolio.Why would somebody invest in REITs?REITs provide a way for individual investors to earn a share of the income produced through commercial real estate ownership without actually having to go out and buy commercial real estate.What types of REITs are there?Many REITs are registered with the SEC and are publicly traded on a stock exchange. These are known as publicly traded REITs. Others may be registered with the SEC but are not publicly traded. These are known as non- traded REITs (also known as non-exchange traded REITs).Eurocurrency marketThemoney marketforborrowingandlendingcurrenciesthatareheldintheformofdepositsinbankslocatedoutsidethecountrieswherethecurrenciesareissuedaslegaltender.The Eurocurrency market is utilized by large firms and extremely wealthy individuals who wish to circumvent regulatory requirements, tax laws and interest rate caps that are often present in domestic banking, particularly in the United States.Rates on deposits in the Eurocurrency market are typically higher than in the domestic market, because the depositor is not protected by domestic banking laws and does not have governmental deposit insurance. Rates on loans in the Eurocurrency market are typically lower than those in the domestic market, because banks are not subject to reserve requirements on Eurocurrency and do not have to pay deposit insurance premiums.

CIBILCredit Information Bureau (India) Limitedis Indias first Credit Information Company (CIC) founded in August 2000. CIBIL collects and maintains records of an individuals payments pertaining to loans and credit cards. These records are submitted to CIBIL by member banks and credit institutions, on a monthly basis. This information is then used to create Credit Information Reports (CIR) and credit scores which are provided to credit institutions in order to help evaluate and approve loan applications. CIBIL was created to play a critical role in Indias financial system, helping loan providers manage their business and helping consumers secure credit quicker and on better terms.For credit grantors to gain a complete picture of the payment history of a credit applicant, they must be able to gain access to the applicant's complete credit record that may be spread over different institutions. CIBIL collects commercial and consumer credit-related data and collates such data to create and distribute credit reports to its Members which are credit institutions and banks in India. CIBILs over 900 strong member base includes all leading public & private sector banks, financial institutions, non-banking financial companies and housing finance companies.DIVIDEND POLICIESThere are basically 4 types of dividend policy. Let us discuss them on by one:1.) Regular dividend policy:in this type of dividend policy the investors get dividend at usual rate. Here the investors are generally retired persons or weaker section of the society who want to get regular income. This type of dividend payment can be maintained only if the company has regular earning.2) Stable dividend policy:here the payment of certain sum of money is regularly paid to the shareholders. It is of three types:a) Constant dividend per share:here reserve fund is created to pay fixed amount of dividend in the year when the earning of the company is not enough. It is suitable for the firms having stable earning.b) Constant pay out ratio:it means the payment of fixed percentage of earning as dividend every year.c) Stable rupee dividend + extra dividend:it means the payment of low dividend per share constantly + extra dividend in the year when the company earns high profit.Irregular dividend:as the name suggests here the company does not pay regular dividend to the shareholders. The company uses this practice due to following reasons: Due to uncertain earning of the company. Due to lack of liquid resources. The company sometime afraid of giving regular dividend. Due to not so much successful business.4) No dividend:the company may use this type of dividend policy due to requirement of funds for the growth of the company or for the working capital requirement.

George soros and the gbp

George Sorosis perhaps the most famous currency trader in the world, thanks to his timely and brave bet against the Bank of England, on what became known as Black Wednesday. With costs of around 3.3 billion, Britain's central bank was unable to defend itself from an attack in thecurrency markets, and Mr. Soros made an estimated $1 billion in profit as a result.Setting the Stage for Black WednesdayThe European Exchange Rate Mechanism (ERM) was setup in March of 1979 in order to reduce exchange rate variability and stabilizemonetary policyacross Europe before introducing a common currency that would eventually be known as the euro. Simple put, the ERM set an upper and lower margin in which exchange rates could vary - known as a semi-peg.Black Wednesday's Underlying CausesWhen Britain joined the ERM, the rate was set to 2.95 Deutsche Marks per Pound Sterling with a 6% permissible move in either direction. The problem was that the country'sinflation ratewas three times that of Germany's, interest rates were at 15%, and the country's economic boom was far into a period of unsustainable growth - setting the stage for a bust period.Currency traders took note of these underlying problems and began short selling the Pound Sterling - that is, borrowing and immediately converting them into a foreign currency with the agreement to re-convert them in the future. George Soros was one of these bearish currency traders, amassing ashort positionof more than $10 billion worth of Pound Sterling.Black Wednesday & Its AftermathThe UK's prime minister and cabinet members authorized spending billions of Pounds Sterling in an attempt to contain the short selling by speculators. Moreover, the British government announced that it would raise its interest rates from 10% to 15% to try and attract currency traders looking for greater yield on their currency holdings.Unfortunately, currency speculators didn't believe the government would make good on these promises and continued shorting the Pound Sterling. After an emergency meeting among top officials, the country was ultimately forced to withdraw from the ERM and let the market revalue its currency to more appropriate (lower) levels.The country was arguably thrown into arecessionafterwards, with many British citizens referring to the ERM as the "Eternal Recession Machine". While the government lost a lot of money, some politicians are glad the ERM disaster occurred, since it paved the way for a more conservative government to enter the fold and revive the economy.

TULIP MANIAIn 1593 tulips were brought from Turkey and introduced to the Dutch. The novelty of the new flower made it widely sought after and therefore fairly pricey. After a time, the tulips contracted a non-fatal virus known as mosaic, which didn't kill the tulip population but altered them causing "flames" of color to appear upon the petals. The color patterns came in a wide variety, increasing the rarity of an already unique flower. Thus, tulips, which were already selling at apremium, began to rise in price according to how their virus alterations were valued, or desired. Everyone began to deal in bulbs, essentially speculating on the tulip market, which was believed to have no limits.

The true bulb buyers (the garden centers of the past) began to fill up inventories for the growing season, depleting the supply further and increasingscarcityanddemand. Soon, prices were rising so fast and high that people were trading their land, life savings, and anything else they could liquidate to get more tulip bulbs. Many Dutch persisted in believing they would sell their hoard to hapless and unenlightened foreigners, thereby reaping enormous profits. Somehow, the originally overpriced tulips enjoyed a twenty-fold increase in value - in one month!Needless to say, the prices were not an accurate reflection of the value of a tulip bulb. As it happens in many speculative bubbles, some prudent people decided to sell and crystallize their profits. A domino effect of progressively lower and lower prices took place as everyone tried to sell while not many were buying. The price began to dive, causing people to panic and sell regardless of losses.

Dealers refused to honor contracts and people began to realize they traded their homes for a piece of greenery; panic and pandemonium were prevalent throughout the land. The government attempted to step in and halt the crash by offering to honor contracts at 10% of the face value, but then the market plunged even lower, making such restitution impossible. No one emerged unscathed from the crash. Even the people who had locked in their profit by getting out early suffered under the following depression.

The effects of the tulip craze left the Dutch very hesitant about speculative investments for quite some time. Investors now can know that it is better to stop and smell the flowers than to stake your future upon one.Greece crisisGreece kicked off the crisis in 2009 by admitting itsbudget deficitwould be 12.9% of GDP, more than four times the EU's 3% limit. Fitch, Moody's andStandard & Poor'swarned investors by lowering Greece's credit ratings. Unfortunately, this also drove up the cost of future loans, making it more unlikely that Greece could find the funds to repay its debt. How did Greece and the EU get into this mess in the first place? The seeds were sown back in 2001, when Greece adopted theeuroas its currency. Greece had been an EU member since 1981, but its annual budget deficit was never low enough to satisfy the eurozone's Maastricht Criteria.All went well for the first several years. Like other eurozone countries, Greece benefited from the power of the euro, which meant lowerinterest ratesand an inflow of investmentcapitaland loans.However, in 2004, Greece announced it had lied to get around the Maastrict Criteria. Surprisingly, the EU imposed no sanctions! Why not? There were three reasons.1. France andGermanywere also spending above the limit at the time. They'd be hypocritical tosanction Greeceuntil they imposed their own austerity measures first.2. There was uncertainty on exactly what sanctions to apply. They could expel Greece, but that would be highly disruptive and possibly weaken the euro itself.3. The EU wanted to strengthen, not weaken, the power of the euro in international currency markets. A strong euro would convince other EU countries, like the UK, Denmark, and Sweden, to adopt the euro.

As a result,Greek debt continued to riseuntil the crisis erupted. Now, the EU must stand behind its member or face the consequences of either Greece leaving the eurozone, or even worse, a Greek default.