 
World of Finance

By

Gaurav Garg

SMASHWORDS EDITION

* * * * *

PUBLISHED BY:

Gaurav Garg on Smashwords

World of Finance

Copyright © 2015 by Gaurav Garg

Table of Contents

1. Beginning of Financial journey

2. Retail Banking

3. Investment Banking

4. Equity Market

5. Debt Market

6. Commodity Market

7. Derivatives Market

8. Mutual Funds

9. Insurance

10. Forex (FX)

11. Interesting Analysis Tools

12. Inflation

13. Asset Management

14. Real Estate Investment Trust (REIT)

15. Unit Linked Insurance Plan (ULIP)

16. Exchange Traded Funds (ETF)

17. CRR, SLR, NDTL, Repo, Reverse Repo

18. How Gold rate is decided

19. How banks borrow money from other banks

20. How fuel (petrol/diesel) price is calculated

21. Who prints the money in India

22. FDI and FII

23. Venture Capital, Private Equity and Angel Investors

24. Credit Information Bureau (India) Limited (CIBIL)

25. Permanent Account Number (PAN)

Disclaimer

The author has made every effort to make sure that information in this book is correct. In any form author have no liability to any party for any kind of loss or damage or disruptions caused due to any error whether the error result from accident or negligence or any other cause.

Author current employer or any of the past employers is not linked to this book or guide, so in any form they have no liability to any party for any kind of loss or damage or disruptions caused due to any error whether the error result from accident or negligence or any other cause.

Beginning of Financial journey

Good job in a reputed company, finally this day have come in my life. Result of college placement is out and I have received the offer letter of my first company which is in elite group of Fortune 500 companies.

My parents bought me a white shirt, navy blue trouser and a red tie as a gift and wishing me a good luck for my professional life. Time to join the corporate world; it seems I am the first person in the office today.

Initial three days of induction in the office were really exciting where I got the opportunity to listen the experience of some of the successful people of the industry. Days passed and I got busy in my job but there is one thing which I never miss is to read the newspaper daily. I don't know how but reading news related to financial and economy kept me excited. During that time stock market was at its peak and in different newspapers or business magazine you could find some interesting article on it such as how a small amount could be turned into big fortunes. Though there was bad news too with the opposite scenarios which I had ignored (you could say I was highly optimistic or very stupid).

Good salary with no liability had given me the option to invest most of my saving into the stock market. I knew it was risky investment but I thought that high gain would come with high risk. My greed and inner desire to get rich as quickly as possible had stopped my thought process for any other option. There is nothing wrong in investing in the stock market but before making any investment it is important to do extensive research on the companies where you would like to invest.

I was not having much knowledge on this subject. However, I had looked it as a quick path for richness and started making investment in the stocks with the stock recommendation on the news channels and newspapers. In the starting, investment was made with small amounts and initial success took me thousands feet about the ground which made me feel I am the subject matter expert of the market.

In stock market it is very difficult to make profit every time which is even more difficult by doing the investment without proper research.

My greed was big enough to not get satisfied by small profits. I want to feel the richness of materialistic objects such as cars, big house and foreign trips and lot other such things as soon as possible.

One another day, I was working in office. My phone rang and after picking the call, a sweet voice comes to my ears. The voice becomes the sweetest voice in this universe when the voice on the other side of the phone had asked me "sir do you need loan". My voice struck up in my throat, I had tried hard to say yes but was unable to speak anything. That voice again asked me and this time I was managed to say yes.

I was happier when she told me that money would be given to me within three working days without any collateral. Collateral means a person need to give some guarantee against the loan amount.

Next day, I had submitted all the required documents to the bank executive without asking anything. With my salary slips and company reputation money, got the cheque which helped me to get the money within 3 days.

As usual, I had checked the stock tips from various channels and for big gain invested the entire amount in a single stock at one go.

With the hope of big returns, my day dreaming started about how to utilize the profits. Should I reinvest in the stocks or should I buy a branded watch or a car.

Two days passed and I was happy to see my wealth increasing; all my dreams were crashed down with the news of the meltdown of global economy. Stock market was crashing as if they were planning to create new world record of steepest crash. After looking my wealth which had vanished for seven consecutive days and took my stock value down by 80%, I had taken a day leave from office and locked myself in my room and cried for the complete day.

Nothing could be done now, all the damages were done. Hold on, I was not right. After one month, I got a reminder letter to pay my first installment of the loan and the amount written on it was another shock. On verification with the bank executive, he told me about the interest rate charged on the loan.

Further exploring the similar loan details with other banks, I got to know that the interest rate charged to me was much higher than the interest rate charged by other banks on the similar type of loans. I tried hard to negotiate with the bank executive but he told me no by showing the documents signed by me while taking the loan. These were the same documents which I had signed without reading.

After that experience, my mind had concluded that it was my bad luck due to which I had to bear such heavy losses and I could never be rich. So, I should only concentrate on my normal job.

I had stopped reading newspapers, magazines and living my life busy in my job. One year had passed after that horrible experience, but my mind and heart was not yet prepared to take any other risk or to realize my actual mistake. Self-confidence was at its lowest level to start making another investment.

My parents advised me to invest in financial instruments which were normally considered to be save such as bank FD, recurring account. But, I had no idea about all these investment products and even was not showing interest to understand it.

Stock market shock was not going out of my mind. I was not able to prepare myself for taking another risk.

All the money coming at the end of each month as my salary was totally spend on fun, entertainment or hanging out with friends. And the habit of taking alcohol and cigarette which was started after losses in the stock market was becoming an addiction. I was completely aware about the warning of consuming these things injurious to health. Still, these things have replaced my old good friends i.e. books/magazines as my companion.

Golden words: Regular investment with due diligence is the path to accumulate the wealth

Another year had passed with zero investment. One Saturday morning around 02:00 AM, after mixing half bottle of whisky with my blood, I returned back home and pressed the doorbell button. My father opened the door and uncomfortable feeling on my face was being scanned by his experienced eyes, he only said Good Night.

Next day in the morning he took me to the park and politely asked me about my problem. Next 30 mins, I was only speaking and he was politely hearing to me. After I finished, he had given me a golden piece of advice that we should invest money regularly for securing the future and before making any investment; extensive research should be made, keeping an eye on all the facts and figures. And, there is no shortcut for accumulating the wealth. In nutshell, "Regular investment with due diligence is the path to accumulate the wealth".

His advice took me two years back and forced me to flash back all my finance related decisions. And it was me who had made the mistakes not my bad luck. Investment in stock market was done without own personal analysis and not looking at any facts. Loan was taken without comparing the interest rate with any other bank and documents were signed without looking at it. Regular investment was not even in my dreams. On the name of the investment there was no single money saved at the end of the month and still paying back my loan. In total, my financial worth is in red, no assets but a liability in the form of a loan.

On that day, I had made one promise to myself that I would do an extensive research and study before making any investment.

Whatever had happened that could not be changed however I thought to leverage the experience of my father (who is one of renowned personality/expert in the financial market) and requested him to share his knowledge with me.

He gives me a smile while nodding his head in yes.

Let's try to explore and understand some of the areas of the world of finance and the various products available to deal with. This might help you to solve some of the unanswered puzzles related to your own personal wealth and could help you in taking right financial decision in future.

Finance knowledge

Finance, it is not a new thing for anyone of us. We all are dealing with it since our childhood days in many ways such as in form of pocket money or money given by our parents to buy something from the market. During that time a small amount was never too small as our aspiration was limited. As we grew older, our list of aspirations becomes so huge that every amount looks small. Slowly and gradually our finance gets out of track.

We could avoid it by managing well both our aspiration and the income.

He suggested first step you could take by opening a saving account in a bank. This would help to manage all our investment from a single place. All the cash flows going out or coming in could be checked from this account.

There might be few questions coming in your mind, what is a bank or account, how can we open it or what all services or products these banks are offering.

Let's give a start by taking the understanding of the banking system, different products and services offered by them. There are a lot of private and government banks offering the banking services with different financial products.

Retail Banking

Major categorization of the banks:

Government banks: These banks are also known as public sector or nationalized banks. The holdings in these banks are more than 50% owned by government. Banks are run by the representatives of government. Some of the Indian government banks are:

State bank of India, Punjab national bank, Bank of Baroda, Syndicate Bank, UCO bank and many more

Private Banks: The majority stake in these banks is owned by private bodies or individuals, not by the government. These are managed by the private entities. Some of the private banks in Indian market are:

ICICI bank, Yes bank, HDFC bank, Kotak Mahindra bank, Axis bank and many more.

If all these banks are run by different entities such as government, private groups or individuals then who creates the monetary policy for smooth and transparent banking system in a country, who is printing money, who is listening to customer problem and who is preventing lobbying.

Central bank

Every country is normally having a central bank to supervise the banks. If there is no common policy or regulation then every individual bank would work in its own way. This could bring entire financial system of a country on a big risk. There could be chances that customer interest are by passed no one is available to hear customer grievance.

In India, we have Reserve Bank of India (RBI) which is the central bank and take care of monetary policy in the country and also printing the currency. It also keeps any eye on the banks operations to safeguard the public interest. RBI also keeps a check on these banks that they take the calculated risk and do not indulge in practices such as lobbying by a group of banks to manipulate the financial system for their own benefits.

Categorization of customers:

Retail Customer: They are individual customers or the general public. Normally, banks design products and services fulfilling the requirements of a large group of people. Increase in Indian household income has made these types of customers as one of the most lucrative category.

Even an individual retail customer can took a number of services or products from a bank say personal loan, car loan, home loan, credit cards etc.

(We will discuss about different banking products and services in later part of this guide)

Corporate Customer: These could be large corporate or small businesses. Products and services are designed which could be same as that of retail customer or specifically designed for fulfilling the need to a particular group. So, products and services could be customized.

For example, you are approaching a bank as a retail customer and asking for a product say loan (we will be discussing about loans in the later part) then banks normally offer you something which is very standardized and could resist customizing for an individual say you want to bargain for reducing interest rate or no charges for prepayment.

Now, assume, you are approaching the bank as a corporate customer, your company or organization is having good profile in the market. You could bargain to customize the same product. Banks would normally not hesitate to at least have a look on how can a product be customized based upon a corporate customer need.

These customers could help the bank to offer number of products or services to its employees for example any corporate had applied for a loan then bank could also offer the organization to open a current account, salary account of its employees etc. Now, once employee becomes a customer than a bank could offer a number of services to the employees say credit cards, loans etc.

In this way a single corporate could help a bank to attract a number of new customers who are associated to any organization.

International Customers:

Non Resident Indians (NRI) customers: NRI are the people of Indian origin or nationality who are living outside India.

These customers can open three type of account:

Non Resident Ordinary Rupee Account (NRO): These are basically a domestic account of NRI. Income generated from investment in India for example rental income can be collected in these accounts. The account could be open and maintain in form of saving/current/recurring/fixed deposit. It is not a repatriable (Repatriable refers to the ability to move the investment into investors home country from the foreign country). Some exceptions are given by RBI for the transfer such as current income etc.

Non Resident External (NRE): The non-resident external rupee account which is also known as NRE scheme. The account could be open and maintain in form of saving/current/recurring/fixed deposit. This is a very convenient way to maintain and use the foreign earnings provided income tax is deducted. The interest rate on the accounts is defined by RBI. It is repatriable.

Foreign Currency Non Resident Account (FCNR): These are foreign currency account. However, it is not the case that the account owner can hold on any currency, the designated currencies are: US Dollar, Canadian Dollar, Australian Dollar, Pound Sterling, Japanese Yen and EURO.

Deposits are in foreign currency so repayment is also made in the currency of issue. This help to avoid exchange risk by the account owner. Only Term deposits type of account is allowed. It is repatriable.

Rural customers

More than 70% of the Indian population is living in rural areas. Banks design products to support people living in these areas. These include farmers, small and medium enterprises. Why they need the finance. Enterprises needed finance for running their business. Farmers needed the finance for farming related activities, buying equipment, seeds or even for personal needs.

After entering a retail banking branch nearby to my home, I walk over to one of the bank executive for asking the procedure for opening the bank account. She was a beautiful girl who welcomes me with a sweet smile and melodious voice, can I help you. She was so beautiful that I completely forget why I am in that place. Suddenly, I got a loud and harsh voice from my back; I take a turn to look towards the direction of voice, where a six feet tall person was staring at me.

I took no time and ask that beautiful girl for the procedure to open the account. She asked me sir you want to open which type of account. Oh god, what she is asking, I don't know what type of account. But, the fear of tall guy stops me to ask another question.

After returning back to my home, I thought to explore about different type of accounts.

Banking Accounts

So here is the main categorization of the accounts:

Current Account:

These accounts provide the customers a convenient operation facility. Customers have a little restriction on the number of transactions.

Such kind of facilities is not free of cost. The maintaining cost of such account is very high for the bank. This cost is passed on to the customers in the form of interest on the amount in the account. Banks do not pay any interest on the amount in these accounts. Some banks also insist the customers to maintain a minimum balance in the account. If any customer defaulted on this condition then bank also charges some money, we can say in form of fine or penalty with the customer.

These accounts can be open by individuals, public limited companies, private limited companies, sole proprietorship firms, partnership firms, trusts etc.

Saving Account:

These types of accounts attract a large number of small depositors. Instead of keeping money in unsafe place, they deposit money in their personal saving account and withdraw money on need or demand. And the good part is that depositors earn interest on the money kept in the account.

Though, interest paid is not so high still if we compare with current account where depositors did not earn anything this option is good.

Currently, saving account depositors are paid interest rate between 4%-6 % which vary from bank to bank.

Note: Every individual should have one separate saving account through which he/she can perform all the financial transactions which will ease out the tracking. For example investment in the mutual fund and dividend paid (if announced) would be deposit to this account (we will discuss about mutual funds, dividends in the later part). Individual can transfer the amount earned from different sources say salary or in business to this saving account. Now, from this account money can be transferred to different sources such as payment for any loan, credit card payment or the investment sources such as mutual fund. In the month end or at the end of quarter individual could balance out how much money is earned and how much have gone out either in debt i.e. loan or any investment.

Here are few things which customer normally gets on opening an account:

Passbook: It is like a book of records where you keep a record of all the transactions from your account for example how much money is flown out of your account or how much is coming in.

Cheque Book: It contains cheques which could be used as the means to transfer the money.

Cheque is the mode of payment where issuer is giving rights to the bank to make the payment written on the cheque to the person who is presenting it and the bank deduct the same amount from the cheque issuer saving account.

ATM/Debit card: It is the plastic card given by the bank which provides the account holder an option to withdraw money from your card. In this case it is not required to go to the bank directly. Banks have installed machines on the different locations from which money could be withdrawn. It could be also used for the shopping.

Type of transactions:

Interbank:

It is a service offered by banks to the account holders for transferring fund electronically to the account in some other bank in India. For example account holder of ICICI bank can transfer funds to SBI bank.

Intrabank:

It is a service offered by banks to the account holders for transferring fund electronically to the account within same bank in India. For example account holder of ICICI bank branch in Delhi can transfer fund to ICICI bank branch in Bombay.

This can be done through:

NEFT: National Electronic Fund Transfer: It is the payment facility given by the banks to transfer money electronically from one account to other account of the bank branch participating in this scheme. Banks could also charge the customer for doing these transactions and it all depends upon bank to bank.

IFSC is used by NEFT system.

IFSC: Indian Financial System Code: It is code which helps in identifying the bank and the branch participating in NEFT system. It is 11 digit code with first 4 characters representing the bank, 5th character is 0 and remaining 6 characters represent the branch.

RTGS: Real Time Gross Settlement: It is a system of fund transfer on the real time and on gross basis. Real time means payment is done almost in the real time and there is no waiting period. Gross Settlement here means that transaction is settled one to one basis and no netting is applied with any other transaction. The fund settlement took place directly into the books of RBI so transaction is final and is irrevocable.

The major difference between NEFT and RTGS is NEFT operates on Deferred Net Settlement (DNS) basis on which transaction is settled in batches. All the transactions are netted which are received till a cut off time. All the settlement after the cut off time has to wait till the next settlement time. However, in RTGS, transactions are settled individually and it does not have to wait till a scheduled settlement time. RTGS is meant for large transactions with minimum transaction of Rs 200000 with no upper limit.

IMPS- Immediate Payment Service: It is a service with which almost on instant basis money is transferred. It is a 24*7 service. The maximum limit of transfer is Rs 50000.

Mode of transactions:

Branch: These are the physical places where banking representatives are sitting to help the customers and you can have face to face dealing with them.

Internet/online: It is a virtual bank where you do different type of transactions such as fund transfer, checking your account statements etc. on the world of web or internet.

Phone: It is a facility given by the banks where you can solve your queries by speaking to one of the banking representatives on the phone or by listening to the recorded messages.

Reserve Bank of India (RBI) had replaced no-frill account (account with nil or very minimum charges) with basic saving deposit account in 2012. This is being done so that basic banking facilities could be provided to the people and it is uniform across the banking system. These accounts provides basic services such as deposit and withdraw, internet banking, ATM facility however there are few restriction like the limit on the number of transactions. It is basically for the lower income group or for the children and students.

What would happen if I will not operate my account for a considerable time such as 6 or more months?

Account which is not operated for a considerable time such as six or more months would be marked as dormant/inactive account by the bank. Such account can be activated by giving a request to the bank. It is normally done for protecting the customers from any fraud.

Is there any facility offered by the bank which could help me to safeguard my valuables such as gold ornaments:

Specific branches of some of the banks provide the safe locker facility. These vaults are kept in huge security. Here owner of the locker can keep their valuables in a safe custody i.e. lockers. In return, bank charges fees from the customers.

What would happen if a bank fails to pay back the depositors money?

Deposit Insurance and Credit Guarantee Corporation of India (DICGC), a wholly-owned subsidiary of RBI is present to safeguard customer's interest. All commercial banks including branches of foreign banks operating in India and regional rural banks are covered by DICGC. Insured banks are liable to pay the premium of the insurance. Savings/Current/Fixed/Recurring deposits are covered by DICGC; however, each depositor is insured up to a maximum of Rs 100000 which includes Principal and Interest amount.

Other products offered by the retail banks:

Account facility: It is already being discussed in earlier pages.

Loans: Banks offer you help in terms of giving money for different purposes such as buying car, home or if you need it for some personal reasons.

There is a catch; bank will not offer you this money for free they charge you a rate of interest which is the income for the bank. Interest rate depends upon the purpose/type of the loan.

Car Loan: For buying the car, bank will give you money but keep the papers of the car on its name till you have not paid all the payment.

Home Loan: For buying the house, bank will give you money but keep the papers of the house on its name till you have not paid all the payment.

Personal Loan: For some personal reasons such as for buying latest mobile, LCD etc.

Depending upon the quality of the collateral (in above cases car, home) the interest rate is charged. To make it clearer, let us try to understand in this way, it is a general assumption car value normally depreciates and home value appreciates. In case during the tenure of loan you are not able to make the bank payment then they could sell out the collateral. Car value will depreciate so bank might not be able to get their full money back, however they will get a significant amount. In case of mobile, LCD, amount which would be retrieved could be very low (Even bank is not aware what the purpose of taking the loan), in case it is taken for some occasion such as marriage then bank could lost the entire amount. In case of home it could be easy to retrieve the entire amount.

So, the interest on the home is normally less as compare to the other loans and on personal loan it is normally on the higher side.

What would happen in case a customer comes into a financial crisis (it could be due to any reason such as loss of job, medical emergency etc) and not able to repay the loan?

Debt Restructuring and Non-Performing Assets

We need to first understand about Non Performing Asset (NPA). Suppose, bank have given a loan and borrower stop making payment of principal and interest amount then this loan is a NPA for the bank. It means it's a loss to the bank if this money is not recovered. So, this is very important for banks to follow all the Know Your Customer procedures before approving the loan request. However, this measure could not completely help the banks to avoid NPA. Reason being, suppose today borrower economic condition is very good, bank have made the payment to the borrower and before completion of loan tenure the economic condition becomes unstable.

In such cases, banks first step is to verify in the long run how viable is for the borrower to make the payment. If bank thinks that the borrower can re-pay the loan then they could perform debt restructuring. In this procedure banks can modify the schedule of payment for example from 3 years to 5 years or even can waive off partial/complete interest amount (in this case at least principal amount is recovered).

RBI has laid down the guidelines for the banks to classify their asset on the on-going basis:

Standard Asset: These are performing asset which are making all payment on time (occasionally they might default up to 90 days).

Sub-standard assets: NPA whose principal or interest amount is overdue from more than 90 days up to 12 months.

Doubtful assets: NPA which remains a sub-standard asset for 12 months become doubtful case for bank to recover the money.

Loss assets: NPA which are uncollectible.

Banks normally engage external recovery agents to recover the NPA amount. These people make phone calls to the borrower, visit and talk to them. RBI has also given directives to the banks to follow certain procedures and policies for recovery. This is done to safeguard the borrower from any kind of wrong doing like threat by the recovery agents.

Deposits

Fixed Deposit (FD): It is the amount given to the bank for a fixed tenure or time and bank will return back the investor money after the tenure ends (or maturity date) with the interest amount which is being decided at the time of buying the FD.

Recurring deposit (RD): It is similar to FD, however the difference is that in the case of FD amount is given once to the bank, however in RD you have to deposit the money in the regular interval normally monthly for the decided tenure such as 1 yr, 2yrs etc.

What is the advantage to the banks for taking money from you and return it back with some extra amount?

The fact is that bank collects money from you and many other investors pay them an extra amount in the form of interest rate say 7% however before making you this payment, the collected amount is distributed in the form of loans to some other people who need the money and charge them higher rate of interest such as 10% or as high as 18% or more. This difference is the banks profit. The collected amount could also be used by banks to invest in some other place to earn more profits.

Bank Draft: It the payment done by the issuing bank on behalf of the payer. The bank can take this risk as it immediately debits* the exact amount from the payers account.

*Debit means money is deducted from the account and credit means money is deposited in the account.

It is similar to cheque however major difference is that issuer chances of defaulting the payment is very less in the case of draft. In simple terms, let's take an example, user B has to receive the payment from A and C.

A has given a cheque to B and B have received a draft from C. B go to the bank and deposited both in her saving account. In case of draft, issuing bank is making the payment so chance of default is minimum and payment is received without any issue. In case of cheque suppose C does not have enough funds in his account so cheque will bounce and payment not received in B's account.

Draft can also bounce, however, in the two cases either draft is fake or bank goes to bankruptcy.

Bankruptcy means legally individual or entity cannot repay the debts it owes to the creditors.

Please make a note that cheque bounce is a very serious offence and in the worst case defaulter could also be jailed.

We can also say that these financial institutes work as a facilitator between the borrower who wants to borrow money (for example in the form of car loan, housing loan etc) and the lender who want to earn some money from their extra money (for example saving account, Fixed Deposit etc).

Banks are evolving with time and started offering a wide range of products:

Credit Card

It is also known as plastic money. Banks offer you a card and with every card there is the maximum credit limit associated to it. This maximum limit is decided by the bank based upon your income and other internal guidelines set by the bank. Advantage of the credit card is that it will help you to avoid carrying a higher amount of paper money in your pocket or wallet.

This advantage can also become your liability if not used in a discipline manner. As an example your card is having credit limit of Rs 100000 which means you can do the purchasing of that value. Normally, people don't carry this much amount in the form of paper money in their pocket or wallet. So, spending is limited. Make sure that you are using this card wisely as the interest charged on the credit card amount is very high.

There is no charge for few days after transaction is done and the credit card bill is generated. Make sure, to make all the payment before due date (date after which interest is charged on the transaction amount). Interest rate on credit card payment is very high even much higher than personal loan. It varies from bank to bank. Normally, it is 2-3% per month which cost 24-36% annually. Moreover, in case for first month if you are not able to make the payment then interest will be charged on all the transactions even made in the subsequent months till the time user of the card is not making the payment. In case you get into this trap then make sure to make the payment of credit card prior to any of your other liability i.e. in case you have taken both personal loan and large credit card payment is due and you can make the payment of only one due to any financial crisis, so choose to pay credit card payment prior to the personal loan.

It is good to have one credit card which can help you in case of emergency, however, if you are not discipline enough in your spending then don't take any credit card even if it given in free.

What is the advantage to the credit card issuer company?

These companies/institutes are earning money on your transactions. If you are not making payment before due date then you needs to pay interest on the transaction amount. Moreover, for every transaction company is charging some amount from the vendor say 1-2%. Vendors are able to increase their sale by giving such facility to the customers. Even with the paper cash of Rs 100 in the customer pocket, and if they have credit card worth 100000 limit they can make the transaction up to 100000 with the card.

Major difference between credit card and debit card is that credit card is like a loan which you need to pay and debit card is nothing but you are using the cash in your saving account with the help of plastic card without physically carrying that cash in your pocket/wallet. If you are a very high spender then it is good to use debit card over credit card. It can help you to keep a check on your spending as you can spend maximum what is available in your saving account.

Point of Sale (PoS) Terminals

It is an electronic device which is used to process card payments (credit/debit). You might have seen such device on the shops, restaurants etc. This device reads the information of the card then it will check whether funds in the bank are sufficient or not. If the fund is sufficient then the transaction is processed. Once the transaction is successful then the seller prints a receipt and hand over to the customer. Normally, seller prints 2 copies: One is given to the customer and on the second receipt customer signature is taken by the seller which is kept by the seller for the records. Financial institutes get the benefit of installation of such a device on the seller place as normally for every transaction they charge some amount on it.

It is up to the seller to pass these charges to the customer or keep these charges on its own account.

Know Your Customer: RBI have issued few guidelines which every bank have to follow before opening any deposit account such as banks must be aware about customer identity, occupation, sources of income etc. In few cases, RBI has relaxed few norms such as for people below the poverty lines. However, due diligence in each case is must for the bank. This is one of the very important step to stop activities like money laundering (It is a process of changing money earned from illegal activities like smuggling, insider trading etc into legitimate money) etc.

**Complaints and Grievance:** Every bank has assigned few officials which will listen to customer complaints and solve them. In case customer is not getting any solution from the bank or they are not satisfied with the solution provided by the representative of the bank then could approach to banking ombudsman which is appointed by RBI.

Base Rates

It is a minimum rate which banks are allowed to charge from their customers.

Prior to base rate, Benchmark Prime Lending Rate (BPLR) was introduced in 2003. The calculation of BPLR done by banks was sometimes not so transparent and even they lend to their prime customers below BPLR (It is the interest rate normally charged by the banks to their credit worthy clients).

A working group committee was constituted by RBI to review the BPLR system. RBI took the input from the working group recommendations and suggestions from other stakeholders to introduce Base rate system which becomes effective in the banking system from 01 July 2010 and it is a much more transparent than BPLR system.

In some cases banks could price the loan without reference to the base rate. These are:

A. Differential Rate of Interest scheme (DRI) advances: This is provided to the weaker sections of the community so that they could utilize that money into productive activities. There are various conditions such as income ceiling of the family, loan amount, important categories such as SC/ST, borrower in agriculture activities etc. There is also a limit on the loan amount, normally no collateral /third party guarantee is required.

B. Loans to banks own employees

C. Loan to banks depositors against their own deposits.

Banks are required to review the base rate at least once in a quarter and required to exhibit it at all the branches and on the bank websites. They are also required to share this information with the general public. RBI normally also ask banks to share the details about the minimum and maximum lending rate. RBI main objective is to bring transparency into the system.

Loans are priced with reference to base rate. It would be applicable to all the new loans and the loans which come up for the renewal. The loans which were being issued during BPLR system would run till their maturity unless or until borrower show the interest to switch to the new system.

You might found different base rate for different banks. RBI does not fix the base rate. It only provides the guidelines how to arrive to the base rate, referring to these guidelines these rates are fixed by the banks. Factors considered in BPLR such as administrative cost was not transparent and was also not common across banks.

Banks are free to pick any benchmark to calculate the base rate but needs to be disclosed in a transparent manner. From retail banking, now we will see altogether a different class of the banking i.e. investment banking.

Investment Banking

Investment bank helps the individuals, companies and even governments to raise the capital for various purposes such as expansion of business, operating capital etc., by underwriting or acting as a client agent. These banks also assist in various other activities such as Merger and Acquisitions, market makers, trading in equities and fixed income instruments, currencies and commodities.

It means they wear many hats. In case of raising capital, they play the role of the middlemen or a role of advisor for supporting merger activities. They could also assist their client in trading and provide other support activities as a role of different actors/entities in the trade life cycle (we will learn more about the trade life cycle in the subsequent pages).

Sometimes they also play the role of asset manager which means managing the assets of their client and helping them for achieving their goals.

Market Participants

Some of the other major market participants are:

Stock Exchanges: It is a platform to buy/sell stocks, bonds and other securities. The examples of stock exchanges are National Stock Exchange (NSE), Bombay Stock Exchange (BSE) etc.

Regulators: Financial regulators act as a supervisor to the financial institutions, laid guidelines to be followed by different financial institutes. One of their main goals is to maintain the integrity of the financial system and protect the interest of the investors in securities. Securities and Exchange Board of India (SEBI) plays a very important role in making and implementation of the rules and regulations.

Brokers-Dealers: Stock brokers are the qualified professional who buy and sell securities for both retail and the institutional clients in turn they will get the fees or commission.

Dealer is a person or firm who is trading securities for its personal account.

Major difference between the broker and dealer is that broker does the trading for its client and dealer trade for its own account. Many firms are engaged in both broker and dealer operations making them broker-dealer.

Custodian: Its major role is to safeguard the assets or securities such as stocks, bonds, precious metals etc. The settlement of these assets both coming in and going out is being handled by the custodian.

Clearing Houses: The major role of the clearing houses is to perform clearing and settlement operation for the financial transactions of securities, commodities etc. Clearing is required to match buy and sell orders in the market. Settlement is delivering of the securities/ commodities corresponding to the trade. For example investor A bought 1000 shares of the company at the price of Rs 100 then A should get 1000 shares in his/her account at the settlement date and Rs 100000 is paid to the counterparty (selling party). For example NSCCL (National Securities Clearing Corporation Ltd), subsidiary of NSE helps in clearing and settlement operations in NSE.

Institutional Investors: They have a large pool of money such as mutual funds, pension funds, insurance companies etc. and invest in the financial market. As these institutes are normally involved in the bulk deal so their influence on the market is also very high

Retail/Individual Investors: This category of investors is the individuals who are normally making the investment in their personal capacity.

After getting this information, I got more excited to know about the different financial instruments.

Equity Market

**Shares/Stocks** : It is an equity or ownership in a firm for example you own 1000 shares of the firm whose 10000 shares are floated in the market it means you are 10% owner of that firm. If the company is doing well then you could earn the profits in form of dividends and share price could be appreciated however if the firm is in losses then share prices could be depreciated and it would be very difficult for the companies to share dividends with the investors.

Every share is having a face value e.g. Rs 10 and if share is trading at a price higher than this value it means stock is trading in the market at a premium.

Dividend: It is the profit which a company is sharing with its investors, say; company announces the dividend of 10% of the face value so for every share you are holding it will earn you Rs 1.

Different type of shares: Common and Preferred

Common shareholders have the voting rights regarding company decisions such as electing the board of directors (group of individuals that represents the owner of a company and involved in the major decisions of the company).

Preferred shareholders don't have the voting rights however you are eligible for getting the fixed dividend. This class of shareholders has more claims on the company's asset. In case company goes bankrupt then preferred shareholders are paid prior to the common shareholders.

How can I trade in the shares/stocks?

Stocks can be traded either in exchanges or in over the counter deals.

Exchange Traded

Exchange is a platform to buy/sell stocks, bonds and other securities. In order to trade in the exchange, the security must be listed there. Electronic systems normally give an advantage in terms of faster speed and lower transaction cost as compare to the physical markets. It brings more transparency and regulates the market. These exchanges keep a check on any malpractices by the registered traders/members. Trade on any exchange is done only by the members.

National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are the example of exchanges in India.

Initially when the share is not listed in the market then issuing of the new security is done in the primary market.

Let us try to understand the concept with this scenario: You are an owner of a firm and for further expansion of business need capital. Either you can take the loan or dilute your ownership in the firm by selling the shares of the firm. By borrowing owner is bind to pay the interest to the lender as per fixed time. If you are not interested to take the liability in the form of loan then you need to pick the other option. However, before jumping into the second option, make sure that your offer is so attractive i.e. your company financials and future prospects is so good that people don't mind to take the risk and invest in a private company. People will invest in your firm if they think the future of the firm is bright and profitable.

For the execution of second option, owner of the firm needs to issue the security in the primary market. This is normally done through an investment bank or financial syndicate and the process of issuing new security is known as underwriting.

A syndicate in finance is group of banks which lends a large amount of money to a single borrower for a specific purpose.

Underwriting: It is signing and accepting all the liability. In case of any loss or damage occurs the underwriter have to make the payment.

This sale process is known as Initial Public Offering (IPO). The shares of the company are sold to the public for the first time. Once the company is listed on the exchange then it is turned into public listed company from a private company. The shares of the company are freely traded in the market and company is not liable to pay anything back to investors in the form of interest which it needs to pay in case of loan.

Good companies, normally share the profits of the company in the form of dividends to the investors, however they are not liable to pay any with some exceptions as in the case of preferred shareholders.

Investment banks or financial syndicate will earn their commission in this entire process.

This free trading of shares is done in the secondary market.

How can I buy the shares as individual investor?

First of all you need to complete the required formalities or documentation work with a broker/sub-broker to open a demat account. In case of Indian market, if you buy any share or stock then it is being kept in the dematerialized form in the demat account. Investors normally do not take the physical possession of the share certificate.

Trade Life Cycle

Clients can directly book the trade via demat account or they could ask the broker to book the order* via telephone, fax, chat application etc. Order details are placed into the trading system for further processing.

*Order could be market or limit.

Market order is placing the order for buy/sell at the market price.

Limit order is placing the order for buy/sell at the price which client wants to buy/sell.

As an example you are interested to buy 1000 shares of company A which is currently trading at the market price of Rs 100. You are comfortable to buy at this (or close to this price) so you could place the market order. However, if you think stock price is high and the fair price of buying should be close to Rs 90 so you could place the limit order of Rs 90. In case price reached to that level then the order will be executed otherwise it will expire without execution.

After the order is placed, further verification/checks are performed such as suppose buy order then sufficient fund is available in the client's account. If sufficient fund is available then order is processed otherwise order is rejected.

Order detail is send to the exchange and in turn exchange could send a notification to the broker for the receipt of the order.

If the order is successfully executed in the exchange then order is converted into trade and exchange sends notification to the broker with the details like stock, quantity (how much is executed), price at which order is executed etc.

Broker will keep the record of all the orders against the corresponding client id (a unique id corresponding to each client). Once the order is executed then the broker will share the trade details with the client either real time or end of day as per broker contract with the client.

In this entire cycle of order to trade we can't miss the role of the custodian. Once the order is executed then the confirmation is being sent. On receiving of the confirmation message, affirmation message is being shared back to indicate that the trade detail is being received and under review.

After trade clears the review process by the custodian, it is being settled. In India, normal settlement is being completed in trading day+2 days. It indicates that in the case of buy order, client should have received the settled shares in his/her demat account and cash in case of sell order. In case trade didn't clear the review process then the trade would be rejected by the custodian.

Over the Counter (OTC)

In the case of exchange traded transactions, exchange act as an intermediary between the buyer and the seller. OTC trades are the direct trades of any security or commodity generally between two parties. It is less formalized than the exchange. In such kind of trade there is a high risk of counterparty default.

By reading the details about exchange and OTC, a question comes to my mind why and who would deal in OTC?

The major advantage of OTC is the flexibility offered to both the parties. They could create the customized contracts with mutual consent. They don't need to work in the limitations set by the regulatory bodies. It is well desired place for the small companies or business which is not eligible or qualifies to list on the exchange. OTC market is also a very big market similar to exchanges. One of main caution which both the parties should take is to have the required details about the counterparty. All the benefits could be wiped out if counterparty default or fail to fulfill the terms of the contracts.

How can I trade in OTC deals?

You need to open an account with the broker-dealer which allows trading in OTC securities. Suppose you are interested in buying 1000 shares of company A so you place an order. Now, broker will contact the other dealers. Dealers are the market maker* and offer selling price of the security. It is not strange if dealers offer different price of the same security to the different dealers. This is the reason OTC market is not very transparent. Dealer could also pull out security from the market any time which will bring down the liquidity and can raise the prices of the securities.

Often dealers share the bid-ask quotes via telephone, email, instant messaging system etc.

Trading could occur between different dealers or between dealers and their customers.

*Market Makers: These are individuals or firms which buy and sell the securities in order to keep the circulation of the security in the market possible. Dealer network is the backbone of OTC market for bringing the liquidity in the market. Bid-Ask spread is the main source of profit for market makers however this is a very risky business as they need to hold a large number of units of the securities.

Bid is the best price that a prospective buyer is ready to pay.

Ask is the best price that a prospective seller is ready to accept.

Spread is difference between the bid and ask prices.

Why should I invest in stocks?

If someone is buying then anyone is selling it. Buying and selling both are done with a purpose, and the purpose is to grow your money which will help you to achieve your goals. A correct picking up the stock could increase your wealth however a wrong investment decision in stock could also erode your wealth completely. So, it is always advisable to research as much as possible before making any investment.

Buying the stock means you partially own the company though the percentage of partnership depends upon how much you are investing. If the future of the company is good and it is growing then your money is not only safe but it will also grow.

What are the main parameters to be checked before buying?

There are no fix rules or checklist which if followed could help you win the game. However, keeping few things in the mind before making the investment in stocks could save your capital/money and also grow it.

Detail study about the sector in which you are looking forward to invest. What is the state of the market pertaining to that sector for example real estate, is there enough buyer in the market, is finance/credit accessible to the sector etc. Studying about the risk factors behind a sector/company is also very important.

The company falls under which category where you are interested to invest, it is in large cap, mid cap or small cap (cap or capitalization means multiple of company outstanding equity shares and market price). It gives you a sense about the size of the company. Normally stock of a large cap company is less volatile as compare to a small company.

Balance Sheet: How strong is the balance sheet of the company? What is the current revenue, what is the value of the fixed asset, net liability, profit and loss figures etc. It could be a very important source to know the financial health of the company.

Major competitors in the market and how easy or difficult is to enter into a particular industry. What is the edge/distinguishing factor of the company over others where you are looking to invest.

Management: Profile of the management running the company is very important. This group of people is the major driving force behind a company success or failure. A company fortune is dependent on them. Even, shareholding pattern is also important. If this group owns a stake in the company then it indicates management believes in the company future.

Volatility in the stock price: Look at the stock price record of at least 5 years to help you understand the volatility in the stock price.

Major Risks associated with the stock market

Volatility Risk: Investment in the stock market is volatile and not fixed. It would never commit with the fixed rate of return on your investments. There could be chances that you earn extraordinary returns and in worse case you could also erode your complete investments.

Liquidity Risk: In case investor would like to exit from the market or from an investment in a particular stock and the value of the stock is low due to any reason related to the company or the overall economy then it would be difficult to liquidate the investment or get the expected selling price.

Policy Risk: Impact on the stock market due to government policy or regulations such as limit on the foreign investment in a particular sector.

Currency Risk: Valuation of the currency of the home country of the listed exchange for example impact of rupee valuation on the dollar investment by the US investors.

Global Risk: The economic problems in one country could have a serious impact on the investor sentiments on the global markets such as problems arising in the Greece market is putting pressure in not only in its home country but also on the markets of the other countries.

There could be other risk specific to the dispute in the governing body of a company or the impact of the bad monsoon etc.

Debt Market

It is the place where different fixed income instruments or products are being issued and traded. These could be issued by the central or state government, municipal corporations, public sector units, private bodies etc. to raise capital.

Fixed income instruments provide the fixed payments in the form of interest and the principal or the invested amount is returned back to the investors on or after maturity date.

Categorization of bond market:

In India, primarily there are two high level categories:

A. Government or G-Sec or Gilts: It consists of central and state governments. These bonds are issued by RBI on the behalf of the government.

B. Corporate Bonds: It could consist of institutes such as corporate bonds/ debentures, public sector units, financial institutes.

Maturity period of the bonds: It could vary from less than a year to more than a decade.

Former category is more dominant in the debt market and normally sets a benchmark for the entire market.

Bonds

A bond is a debt instrument. Why it is categorized as a debt product because it requires a bond issuer to pay interest and the principal amount to the buyer.

Suppose a government has issued a bond with tenure of 10 years with a coupon payment of 8%, now you have purchased this bond. It means you have given or lend money to the government for which it will pay you an interest amount in a fixed time which is decided at the time of issuing the bond. The *face value of the bond is paid when it gets matured.

*Face value: It is the value of the bond or the amount which investor will receive at maturity and this value is used to calculate interest payments.

Coupon: It is the interest rate which buyer will receive on the face value of the bond.

Maturity Date: It is the date on which the bond holder will get the face value of the bond.

It trades on the secondary market on the maturity price. Premium means bond is trading on the price above its face value and discount means price of the bond is lower than the face value.

The major difference between stock and bond market from issuer prospective is that issuing a bond is a debt to the company or a liability to pay coupon to the bond holder, however in case of stocks, issuer don't have any such liability. In terms of investor prospective, buying stock will give them an ownership in the firm, however, in case of holding the bond didn't give them this ownership.

Market Participants:

There are mainly three participants:

A. Issuer: It is the entity which is offering the bond e.g. government, corporate etc.

B. Underwriter: It helps the issuer to sell their offering or product in the market.

C. Buyer: It could be individual investor or a corporate who buy this bond. Even government of one country could also buy the bond issued by the government of other country.

Government securities are mainly categorized as:

A. Treasury Bills (T-Bills): These are issued by government into mainly 3 tenors-91 days, 182 days and 364 days. No interest is paid however investors are benefited by getting the T-Bills on the discounted rate and on maturity get the complete face value.

B. Cash Management Bills (CMB): Similar to T-Bills, CMB are issued on the discounted rate and on maturity get the face value. No interest is paid in case of CMB. They are normally issued with the maturity date less than 91 days.

C. Dated Government Securities (DGS): These are long term securities which could even extend to multiple decades.

Major types of DGS are:

1. Fixed Rate Bond: Buyer will get the fixed interest rate payment on the regular intervals as per contract.

2. Floating Rate Bond: Buyer will get floating interest rate payment. It is adding a spread (normally the difference of yield of two bonds of different credit ratings) to the base rate.

3. Zero Coupon Bond: Buyer will not get any interest rate payment. However, they are sold at a discount on the face value and at the time of maturity buyer will get the entire principal amount.

D. State Development Loans (SDL): State government if required raises loans from the market.

DGS and SDL qualify for SLR (Statutory Liquidity Ratio: It is the percentage of bank reserve which needs to be mandatory parked in gold, cash or government approved securities. It is an important tool to control inflation). SLR is explained in more detail is later part of this guide.

There could be other bonds such as Inflation Bond to protect the investors from increase in inflation (normally a pre-decided index of inflation is taken into account and the investor is paid more than the ongoing inflation), bonds with call/put options which will give the option to buyer/seller (as per contract) to buy back or sell the bond before the maturity date.

How government securities are issued?

RBI conducts the auctions on an electronic NDS* auction platform. The members of this platform have to maintain a fund account and the security account with RBI. Some of the members are commercial banks, dealers, insurance companies etc.

Non-NDS members can also participate in the primary auction via scheduled commercial banks or the primary dealers. For this purpose they have to open a dematerialize account known as Gilt account. Selected entities can opt for SGL (Subsidiary General Ledger) account facility provided by RBI. Those who are not eligible for SGL could open Gilt account with these selected entities.

RBI issues advertisement in the leading English and Hindi newspapers and also publishes details about the auction on its website.

*NDS: Negotiated Dealing System: It is a platform where members can bid online during the auction purpose. NDS also facilitate the settlement of the transactions of the government securities from the secondary market.

NDS-Order Matching: RBI also provides the order driven electronic system facility to its participants. Order placement and its acceptance within the participants are being performed in an anonymous form. Electronic facility gives price transparency to its participants.

Government securities could be held in:

Physical Form: It is in the form of Stock certificates. These certificates are registered by PDO*.

*PDO: Public Debt Office of the RBI acts as a registrar and the central depository of the government securities.

Demat Form: Securities are kept in the dematerialized or electronic form in SGL or Gilt account. It is safer than physical form as chances of theft or damage is very minimal. The transfer option is also very easy.

Government securities are automatically listed on the stock exchange once they are issued.

Similar to the equity market, OTC market too exist in the debt market.

Participant looking forward to do the transactions in OTC market have to trade via a broker registered with SEBI. All the deals performed in the OTC market are reported on NDS.

Stock Exchanges (NSE & BSE) facilitate the trading of the government securities. NSE Wholesale Debt Market (WDM) is the automated screen-based trading platform.

Trading members can place the order and the system automatically matches the order. In case deal is being done outside exchange between the counterparties still deal is being reported in the system for approval.

Corporate Bonds:

Public sector units and the private corporate sector issue the corporate bonds.

Issuer has to apply for the listing of such securities on at least one of the recognized exchanges. Regulator had laid down some guidelines which need to be followed prior to the listing of the securities such as taking credit rating from the SEBI registered credit rating agency, agreement with the depositories, appointment of merchant bankers etc.

Price of the security may be determined after consultation with the merchant banker.

The debt securities listed in the exchange is traded, cleared and settled as per rules specified by SEBI. Even the deals made in OTC should be reported on the platform specified by the regulators.

Classification of Corporate Bonds

Two major types are:

Convertible: These bonds can be converted into pre-defined equity shares for example convertible debentures.

Non-Convertible: These bonds can't be converted into equity shares for example tax free bonds.

Clearing Corporation of India Limited (CCIL)

CCIL act as a clearing and the settlement agency for the government securities. It acts as a central counterparty between the two counterparties of the transactions. For both buyer and seller CCIL is the counterparty which will clear and settle the required obligations. In case one of the counterparty unable to provide the required funds or securities then CCIL will clear the dues as per contract to the other counterparty.

In order to safeguard itself from any default, participants are required to pay the margin amount to the CCIL.

It means CCIL protects the market participants from the counterparty risk (Risk where any of the counterparty unable to fulfill the required obligations).

Yield

It indicates the return an investor could get on a debt instrument. Here is the detail around the basic yields:

**Coupon/Nominal Yield:** Suppose a bond have a face value of Rs 100 and pays the interest rate of Rs 10 then the yield is 10%.

**Current Yield:** It gives a fair idea about the present yield. Its value is determined as:

Coupon (in %) multiplied by face value of the security divided by market price of the security

(Current Yield = Coupon * Face Value / Market Price)

Yield to Maturity (YTM):

This method of calculating the yield helps the investors to get an idea about the overall interest rate that could be earned. Two important assumptions which are made in this calculation are bond will be held till maturity and all coupon, principal payments would be made on the pre decided schedule without any default.

Formula for calculating YTM:

YTM = [(Face value/Bond price) 1/Time period]-1

In case bond coupon is equal to YTM then the buyer is getting the bond at par, coupon value less than YTM indicates buyer is getting the bond at discount and in case coupon value is more than YTM then the bond is getting sold at a premium.

How the Yield and Bond price are related?

Yield and bond price is inversely related which means a fall in bond price will give more yield. For example interest rate in the market increase then the price of the existing bonds will fall in order to match the yield of newer bonds with higher interest rate. We can also say this would happen as the demand of low yielding bond will go down because investors will invest their money in the high yielding bond. Ideally, prices of the older bond should fall down to a level where yield from older and newer bond would be same.

Major category of investors in the retail debt market

It includes pension funds, mutual funds, provident funds, Co-operative banks and even individual investors etc.

Major Risk associated with the debt market

Credit Risk: It is the risk where the issuer is not able to make the payment of interest or principal or both to the buyers. So, this is very important to get the details around the credit rating of the bond. Various credit rating agencies like CRISIL based upon their own parameters/criteria give the credit rating. Investors should also analyze the financial state of the company may be going through their balance sheet to get the idea about the financial condition about the company.

Interest Rate Risk: Major change in the interest rates could impact the valuation of the existing bonds in the market. If the interest rate is increased then the bond price will go down. In this case if buyer sells it then there are chances that he/she could receive lesser money it had invested. If interest rate goes down then the investors who would like to re-invest the interest rate he/she had received would not be able to invest at the higher rates.

Liquidity Risk: In case investor would like to sell the bond prior to the maturity date and unable to find the buyer on the right time then there could be liquidity problem or would not get the expected selling price.

There could be other risk such as increase in inflation or any bad news/ event which put a pressure on the payment ability of the bond issuer etc.

Commodity Market

Similar to equity, debt market we have a big commodity market.

Classification of commodities:

Soft commodity: This term generally refer to the agricultural products which are grown or livestock such as sugar, wheat, corn etc.

Hard commodity: These are mined/ extracted such as gold, oil etc

What is the need of commodity trading?

A simple example could be for example you are the owner of the juice manufacturing unit and sugar is one of the raw materials. In case, consumption of sugar after 3 months is 1000 kg. If you buy it now then there could be overhead of storing it in a safe place. What would happen if you go for shopping after 3 months and either required quantity is not available or the price of the sugar is very high?

In order to avoid these risk, you could go directly to the producer or a big dealer and have a deal that you would pick this much quantity after this time on a particular price. This will help you to get the required quantity on time and dealer will get the buyer of the inventory in advance, so it is a win-win situation for both producer and the consumer.

These type of deals occurred in the derivative market.

There is also a spot market where commodities are delivered and the payment is made on the immediate basis.

In addition to the producers or consumers there are investors who would like to gain by making investment in the commodity market.

Who all are the major investors in the commodity market?

Farmers, Corporates with a lot of dependency on the commodities as a raw material for the end product, Consumers like jewelers of gold/silver, investors etc.

Regulator of the commodity market

The central government gets the advice from Forward Markets Commission (FMC) in case of any matter arising out of the administration of the Forwards Contract (Regulation) Act 1952.

Commodity market is under the observations of FMC and it took the required actions as per power defined under the act. This body also makes the recommendations which could bring more efficiency in the working of the market. It also inspects the accounts of the registered association or any of the members of such associations. Goods on which any of the provision of the act is applicable, commission could collect, publish information and also submit periodic reports to the central government on the working of the forward market for such goods.

How can I trade in the commodity market?

Investor have to open a demat account to trade in commodities with a depository participant (DP) who is enrolled/registered with the exchange.

Commodities can be bought or sold during the trading hours of the exchanges. The commodities are stored in the exchange designated warehouses and its record is kept in the electronic form. A buyer would get the credit of the unit in the electronic form. In case buyer sold this unit then the ownership of the units would be transferred to the new buyer. At any point if buyer would like to have the physical delivery of the commodity, he/she could surrender the electronic units and could get the physical delivery with the help of warehouse receipt.

What is the procedure to get the physical delivery of the electronic unit of the goods?

Buyer would put a request to its DP via broker; this request would be forwarded to the registrar and the warehouse. As per specified date, buyer could go to the warehouse and take the physical delivery of the commodity.

How seller would get the electronic units of the physical good?

The seller would deliver the physical commodity in the designated warehouse where commodities would be analyzed such as quality, quantity by exchange specified experts or assayer.

Commodities would have to clear the exchange specified quality check with some allowed variances. After passing all the checks, warehouse would accept the commodity and update the details in the DP systems. In this way seller would get the credit in his/her electronic account.

How exchanges handle the complexity of the different qualities of the same commodity?

A complete quality range would be specified by the exchange and the commodity lying within this range would be accepted. In the contract, exchange mentioned about the quality grade of the tradable commodity.

There would be a premium/rebate based upon the quality of the commodity and it would be considered during the settlement of the deliverable position.

Which are the major exchanges dealing in commodities?

Multi Commodity Exchange of India Ltd (MCX), National Commodity and Derivative Exchange (NCDEX), National Spot Exchange Ltd (NSEL), National Multi Commodity Exchange of India Ltd (NMCE)

In addition to the exchange, commodities could be traded in the Over the Counter (OTC) market.

OTC trades normally took between two counterparties with the help of a middleman which are known as brokers/dealers. A simple example could be a cotton farmer wants to sell its produce and reached to the local market/mandi and meet one broker. If this broker directly don't have the buyer than he/she would contact with another brokers. In this way a trade is facilitated between buyer and the seller. Buyer gets the money, seller gets the product and broker/dealer gets its commission.

Companies normally took the route of OTC market when they are not eligible to fulfill the requirement specified by the regulators or exchanges. There might be chances that the credit history of such history is also not so good.

Producers such as farmers might take this route due to lack of knowledge or non-availability of the proper facilitator who could provide them support to take full advantage of the standard exchanges.

OTC transactions might help the small producers and consumers to fulfill their need without any overhead to meet exchange guidelines however there is a major risk associated to it such as lack of transparency in generating the prices, counterparty default risk where any of the party could default in meeting the obligations.

Some of the major benefits provided by exchanges are:

Price Transparency: Exchange provides the electronic platform for order matching. It brings transparency and is much more efficient way to provide fair price discovery mechanism to the market participants.

Managing Counterparty Risk: It takes care of the risk associated with the counterparty default by introducing central clearing house between buyer and the seller.

Liquidity: Exchange also provides more liquidity opportunity by bringing more participants on a common electronic platform.

Some of the major Risks associated with the commodity market

Price Risk: Major changes or movement in the commodity prices due to any reason such as poor monsoon impact the agriculture commodities.

Political Risk: Change in government policies such as banning of mining operations or imposing restriction for limited mining of the natural resources e.g. coal.

Liquidity Risk: In case market is not in the state of providing liquidity then it could be difficult for the investors to exit from it.

Global Risk: Tension in one country could have the impact on the global economy for example problem in oil producing country. It could bring a major volatility in the oil prices and imagine its impact on the economy like India where cost of importing oil is one of the biggest expenditure for us.

There could be other factors influencing the commodity prices such as global/domestic demand and supply, inflation, policies related to import-export, currency fluctuation etc.

Derivatives Market

It is a financial market for the derivatives instruments which is another product class and its value is derived with the value of the underlying assets. The underlying asset could be equity, bonds, commodities etc. (even there are the derivatives for the weather).

Derivatives are nothing but the contract between the parties whose obligation needs to be fulfilled in the future.

In the above topics, we discussed about spot market and the future market. So, derivatives come under future market.

Market for the derivative products

Exchange Traded: These are the standardized contracts which are tradable on the exchange. In this case clearance is done by the exchange so there is minimal counterparty risk.

Over the counter (OTC): These contracts are done directly normally by the two parties without any intermediary or exchange. So, these could be customized with the mutual consent between the two parties.

Common derivative products

Forwards: It is customized contract between the two parties where the buyer is agreeing to buy the underlying asset in a particular quantity by a give date on a pre-decided price. This is done over the counter.

Similar to the problems which we have read in the earlier discussion about OTC products, major one: counterparty default and non-transparent price mechanism, forward contract could also have the similar issues.

Futures: It is the contract where the buyer is agreeing to buy the underlying asset in a particular quantity by a given date on a pre-decided price. It is an exchange traded standardized contract.

Future contract overcome the problem which might be encountered in the case of forward contracts.

Options: It is the contract where the buyer is agreeing to buy the underlying asset in a particular quantity by a give date on a pre-decided price. It is an exchange traded standardized contract.

Category of Options: Call and Put

Call Option holder get the right (there is no obligation) to buy a given underlying asset at a given price prior or on given expiry date. This is known as call option.

Put Option holder get the right (there is no obligation) to sell a given underlying asset at a given price prior or on given expiry date. This is known as put option.

This right comes with a price known as premium which holder needs to pay to the other party.

It is also an exchange traded product.

An exercise right also divides the options into further two categories: American and European

American option could be exercised at any time till expiration date; however, European options could be exercised only at the expiration date.

Swap: It is basically exchange of cash flows on or before the specified date as per the contract and the value could be based on the underlying interest rate, currency exchange rate etc. For example, interest rate swap (IRS) is normally having multiple legs say one leg is fixed interest rate and another leg is floating interest rate. Companies normally use IRS to avoid risk due to fluctuation in the interest rates.

Participants

Hedger: Derivatives are bought by these traders for hedging the risk. For example an Indian company is entitled to get a payment after 6 months from a foreign entity. In order to hedge the risk of currency fluctuation it could buy a derivative contract.

Speculator: This class of traders normally trade in the derivative market for pure purpose of gaining profit. They would like to speculate the price movement of the asset in future and invest in the derivatives based upon the speculations. For example, a speculator predict the good earning quarter of the company based upon the order book or some positive news about the firm and buy a derivative contract prior to the quarterly result announcement. If things work in favour of the speculator and company announced the good quarterly results then he/she could gain based upon the upward price movement of the underlying stock (it is not necessary that there would be a sure price movement in the upward direction).

Arbitrageur: These traders would like to earn a risk free profits (theoretically as nothing is risk free in the practical terms). One of the strategies could be buying in one market and selling of the similar asset in the other market. Difference in the prices in the different market would help them to gain profits.

Categories of membership

Trading member: These members could trade on their own behalf or on the behalf of their clients.

Clearing Member: These members facilitate the clearing and settlement of all the deals executed by the Trading members.

Classification of Clearing Members:

Trading members who also act as a clearing member for their proprietary or clients trades, trades of other trading members or custodial participants.

Professional Clearing member who are not a trading member however settle and clear the trade of trading members and the custodial participants.

Self-Clearing member who are also trading members and can settle, clear their proprietary or clients trade. These members can not clear or settle the trade of other trading members of custodial participants.

How can I trade in the derivative market?

In order to buy the derivative contract from the exchange, investor needs to open an account with the trading member of the exchange. The trading member would provide a unique client identification number after completing the required formalities.

Trading in derivative market could help you to buy entire derivative contract with relatively small margin amount. It could help you to gain a large profit with small capital investment. However, make sure at least do the detailed analysis of the market, sector and the underlying company prior to making the investment. Small investment would also increase your exposure to a bigger market risk.

Modern exchanges provide the fully automated trading environment for screen base trading on the nationwide basis. It also provides online monitoring and surveillance mechanism.

The order driven market which is supported by these systems brings transparency into the market. Members entered their trade in the systems and system automatically matches the buy and the sell order.

Clearing Corporation

In India, we have multiple exchanges such as NSE, BSE, USE, MCX etc. The trades of these exchanges could be settled by different clearing houses. NSCCL (National Securities Clearing Corporation Limited) clears the financial derivatives traded on NSE, Equity derivatives traded on BSE are cleared by BSE, currency derivatives traded on USE are cleared by ICCL (Indian Clearing Corporation Limited) are some of the examples.

Settlement

Security settlement is being performed by NSDL (National Securities Depository Limited) and CDSL (Central Depository Services Limited) and Cash settlement is generally performed by the commercial banks

At the end of each trading date, the position of the contract is mark to market to the price of the contract. The profit/ loss calculated based upon the last trading day settlement price and current settlement price. The member who had made the loss would pay that amount to the NSCCL which in turn credit it to the profit making member bank account.

The pay-in and pay-out of this settlement is done on Trade Day + 1 day.

Regulator

SEBI (The Securities and Exchange Board of India) is the regulator which design and implement the regulatory framework for these exchanges. It monitors these exchanges including its clearing and settlement systems to keep a check on any irregularities.

Few major risk of the derivative market

Credit Risk: This type of risk arises due to counterparty default, in case of exchange traded derivatives, exchange took the required steps to mitigate the risk however in case of OTC deals; counterparty risk is very high.

Market Risk: Impact on the price of the underlying asset due to the market factors such as Inflation, interest rates etc.

Operational Risk: It could be technology issue for example technical problem in the trading system could impact the trading.

Systematic Risk: Failure of one big market participant putting pressure on other participants of the market.

There could be other risk such as legal risk in case of cross border trades coming under different legal jurisdiction, human error etc.

Mutual Funds

We have discussed about different financial instruments such as stocks, derivatives, bonds. It might be possible still you are not comfortable to invest in these products directly (at least in the early stages of your investment).

Don't worry, mutual fund could help you, investment is done and managed by the professionals and experts.

Categorization of mutual funds

Open ended funds mean you can subscribe (putting in money) or redeem (taking out money) in the fund any time in the trading day. The price taken into account is the close of the trading day price.

Close ended funds subscription and redemption is done only within the defined timelines set by the fund for example if timeline defined by fund is 1 year than you could not redeem your fund units prior to 1 year.

Funds are also sub categorized based upon the way investor would like to get back its money:

Income Fund: These funds are good for the investors who need regular investments. Income earned would be regularly distributed to the unit holders.

Growth Fund: These funds would reinvest the income earned which could help the investors for appreciation in the value of their invested capital in the long term.

Funds are further sub categorized on the basis of investment strategy:

Equity Fund: Investment is made by the fund in the equities/shares across different industries and sectors.

Debt Fund: Investment is made in the debt market like government or corporate bonds.

Equity Funds are very risky however if market condition is favorable then in the long run it could help the investors to generate wealth. Debt funds are the safe investment however investors could not hope for the high capital appreciation.

Balanced Funds: Funds follow the balanced approach in the investment in equity and debt. Depending upon the market conditions it keeps on switching the investment between these two segments.

Sector Funds: These funds invest in the companies of the particular sector for example power, infrastructure etc. If you are positive in a particular sector and not sure which company to pick then the sector funds could be a good mode of investment which will help you to diversify your portfolio by making investment in the various companies of a sector of your choice.

Gilt Funds: Funds invest only in the central and state government securities.

Indexed Funds: Funds are mapped to a specific index such as NIFTY and invest only in the securities included in the index for example if NIFTY includes 50 shares such as Infosys, Reliance etc than fund would invest only in these 50 stocks.

Tax Saving: Money invested in these funds could be used for getting the tax rebate such as ELSS (Equity Linked Saving Scheme) as per current tax laws.

Fund of Funds: In this case instead of investment in shares, bonds or other securities investment is made in the units of other funds. It could help the investor in more diversification as money is invested in the different fund categories however normally these funds have higher operating expense which means investor have to pay more fees.

Participants

Sponsor: It is the organization which initiates the launch of the fund.

Trustee: Sponsor creates the trust and appoints the trustee. This trust is registered with SEBI to convert it into the mutual fund.

Asset Management Company (AMC): Trustee appoints the AMC for managing the money. AMC can launch different schemes with the similar or different objectives. As per regulators guidelines, funds objectives should be clearly drafted in the prospectus.

Fund objectives could vary like which type of financial instrument should be picked (for example equity, bonds), which category to invest (large cap, mid cap or small cap), in which sector to invest (like real estate, pharmaceuticals), how much percentage should be invested etc.

Custodian: It is again appointed by the trustees. The major responsibility of the custodian is to keep the securities of the fund safely in their custody. They also help in clearing and the settlement of the securities.

Registrar and Transfer Agent: Mutual fund is involved in the multiple ways of transactions varying from buying/selling securities to fulfill the customer's request to update address, phone address or getting updates about the schemes etc. Sometimes, these fund houses outsource some of this work to Registrar and transfer agents and in return pay fees.

Fund Accountants: These are chosen by AMC which help in maintaining the accounting books related to the fund transactions and management. It also helps in computing the NAV* of the scheme on the daily basis.

* **NAV**

Every fund is having a NAV (Net Asset Value) which is the value of the underlying assets minus liability per unit of the fund for example it could be price of all the shares multiply by quantity a fund is owning minus the liabilities like fund fees. Whenever investor invests his/her money into the fund than fund units would be allocated based upon NAV value for example if NAV is Rs10 and you are investing Rs 1000 than you are entitled to receive 100 units.

Fund Manager: These are the people who plan and execute the fund investment strategy such as where to invest, how much to invest, when to invest etc. There could be one fund manager or many people working as the co-managers.

In case of Active fund, one of the key targets for the fund manager is to beat the index in returns whereas in case of passive funds, generally they try to replicate the return of the underlying index.

Investment Advisors: They help the fund manager in the designing the investment strategy by carrying out the analysis of the security and the market.

Legal Advisors: Legal team of advisors provides legal guidance for the different schemes.

Auditors: It performs the independent verification and validation of the accounting operations.

Regulator: SEBI (The Securities and Exchange Board of India) provides guideline to the funds with one of the key objective is to safeguard the investor interest.

New Fund Offer (NFO)

In the case of equities we have initial public offering similarly when a fund house launches a new fund than it offers new fund offer (NFO) to raise the capital. As these are the new offers so you would not be able to get the details about the past performance of the mutual fund scheme.

Load: It is the fees which mutual fund charges with the investors. Entry Load means fees charged at the time of subscription and the Exit Load means fees charged at the time of redemption.

How can I invest in the mutual funds?

There are different channels with which you could invest in the mutual funds. You could invest via Asset Management Company, fund houses, some banks also have the tie up with the fund houses, agents or through online trading account.

It means investor could buy either online or by filling the physical form with the help of the any of the above mentioned channels.

Mode of Investments

Lump sum: In this case, investors made a single payment.

SIP (Systematic Investment Plan) helps the investor to invest an amount as per investor convenience (minimum and maximum amount is decided by the AMC) on the regular basis. This facility helps the investors to cover all the cycles of stock market which could be high or low.

Advantages of the mutual funds

1. Mutual fund gives the option to the investors to diversify their portfolio instead of investing in limited stocks or financial product.

2. They is no liquidity problem, investors could redeem the units anytime.

3. The investors also have the option to create wealth by investing small amount in the regular intervals in the form of SIP in case they don't have the big lump sum amount to invest at one go.

4. Professionals/Experts took care of the investment.

5. A variety of options are available in the market in the form of different fund schemes with similar or different objectives.

Risk associated with the mutual funds

The constituent of the mutual fund could be stocks, bonds, commodities etc. So, all the different type of risk which is linked to these financial products has an impact on the mutual fund industry. These risks could be market risk, credit risk, interest rate risk, currency risk etc.

Insurance

It is a way to mitigate your risk which might or might not come in future. It is always good to be optimistic and thinking that everything will be good in future. However, it is not good to be over optimistic (in the real life it is normally very difficult that an individual would be only having good days, life could also show difficult time and insurance might help to sail that tough time with some ease).

Life Insurance

Life Insurance: Suppose there is an individual who is married and having two kids. This gentleman A is having a good salary and they are living a comfortable life. Suddenly, A met with an accident and he died. For this family no one can fill the loss of A, however, imagine in reality how they will survive with no financial income. How life insurance could help you? By paying a premium amount (which is calculated on the different parameters and varies from company to company) and meeting all the other required conditions of the insurance company, individual could be insured. In case person died then the nominee would be getting the insured amount (depending upon the type of policy).

Category of Life insurance

Term: In this case, if person is alive even on or after maturity date then no money will be paid either to the insured or the nominees (It is the individual or group of person to whom the insured amount is authorized to be paid).

Endowment plan: In this case, even a person is alive then after maturity date insured person will be paid the insured amount.

Normally, the premium amount of endowment plan is higher than the term plan.

Insurance should not be taken as a mode of saving and it should be always kept separate from your saving.

For example, If term plan is giving the insurance of Rs 10000000 and endowment plan is giving the insurance of Rs 1000000 with the same premium amount, so, may be the individual loose the money in cases person is alive on the maturity date in the former cases, still it would be better to take a term plan. Simple reason, if the insured person is no more than in today's world where price of everything is so high, for how many years family of 3 will survive with Rs 1000000.

In the case of term plan, if the person is alive on the maturity date then he/she will lose premium amount paid for so many years, however, individual could earn and save much more if he/she is fit and fine and work for the entire duration.

The basic intention for taking the life insurance is to make sure that even the earning individual of the family is no more still his/her family could remain financial independent.

Non- Life Insurance

Some of the major type of non-life insurance categories:

Health insurance: In case an individual is not well or got diagnosed with some disease so if his/her that disease is covered in the health insurance then the person will get a portion or even most of the medical treatment expenditure from the insurance company.

Car Insurance: This is to protect an individual from any loss incurred due to damage in the car or if it is stolen.

Home Insurance: This is to protect an individual from any loss incurred due to damage in the house such as theft, fire etc.

Crop Insurance: It could be purchased by the farmer to safeguard him/her in case of any damage to the crop. Risk could be weather, insects etc.

Travel Insurance: It is normally taken by the people travelling abroad and covers certain type of losses such as loss of belongings, medical expense during travel period etc.

There are various other types of insurance available in the market to protect the insurance buyer from the loss incurred on the insured asset. Depending upon the need, buyer could select the insurance policy. Some of the need could be personal like life, health or professional like protecting the business.

Payment in all the cases would be made by the insurance company if all the specified conditions laid down by them are met.

Insurance company which is selling the products would collect a fixed amount known as **Premium** from the buyer as onetime payment or on the regular intervals to protect him/her for any financial loss.

How can I buy any insurance policy?

Insurance policy could be bought directly from the insurance companies such as Life Insurance Corporation of India (LIC) or from the insurance agents which could be individual agents or the corporates.

After completing all the required formalities, insurance buyer could get the insurance policy. The policy document should cover everything which buyer should know like what is insured, insured value, maturity period, payment duration etc.

Regulator

Insurance Regulatory and Development Authority of India (IRDAI) regulates the insurance industry in India and protect the interest of the policy buyers.

IRDAI performs a lot of function; some of them are to register the insurance companies, give license to the agents, regulates and oversee the premium amount or investment of the collected funds, ensuring that the insurance company should maintain a solvency margin*.

*Solvency Margin is the amount which insurance company should keep aside. In case a big calamity took place like floods and the company is liable to pay a huge amount. If company becomes insolvent and not able to pay the liability amount then it could be a big risk and impact on the wider group of public. In this case, the purpose of buying the insurance policy would become meaningless.

People could start losing trust on the insurance industry and have a long term negative impact on the industry and on the lives of the people.

Forex (FX)

FX or currency market is a market for the trading of the currencies. In terms of volume it is a very big market.

This market determines the relative value of different currencies i.e. Exchange Rate say 1USD = 60 INR.

In addition to the large banks a small number of financial institutions known as dealers are involved in foreign exchange trading.

The foreign exchange market helps the governments, companies for international trading and investments.

If this market will not exist then it will be difficult to have the cross border transactions among different countries. Exchange rates could change on the daily basis which is nothing but the price on which two currencies could be exchanged.

Foreign exchange transaction is settled through Nostro and Vostro accounts.

**Nostro** : Reserve Bank of India (RBI) opens Nostro accounts in different countries.

**Vostro** : Many agencies such as World Bank maintain their accounts in RBI.

Foreign Exchange Management Act (FEMA), 1999 regulates the foreign exchange market in India. It is controlled by central bank of India i.e. RBI. Prior to this act the market was regulated by the RBI with Foreign Exchange Regulation Act (FERA).

Forex trading is allowed and legal in India if done via member brokers in one of the exchanges such as NSE, BSE etc.

**PIP (Percentage In Point):** It is the minimum price increase of a forex trading rate. The very common PIP is 0.0001.

Some of the main risk associated with forex trading is:

Interest Rate risk: If the interest rate of a country is increased then its currency could strengthen which would have a direct impact on the difference between the currency values.

Transaction Risk: This risk is associated with the time zone difference between start of a contract and its settlement time. More time difference increase the risk of more time for exchange fluctuation.

Country Risk: Stability of the issuing country is very important. If exchange rate is fixed with a particular currency such as US Dollar then it would become very important to maintain adequate reserve. Failing to do so could have a major impact on the local currency.

Interesting Analysis Tools

Simple Interest Rate: The interest paid on the principal amount.

It could be calculated as:

SI = Principal * Rate of Interest per year * Time (in years)

For Example:

Principal = Rs 100000

Rate of Interest per year = 10

Time =1

SI = 100000*0.10*1 = 10000

Total Amount = 100000+10000= 110000

Compound Interest Rate: Interest will include interest on interest too.

Compound Interest Amount (CIA)

CIA= Principal*(1+Interest rate per period)^Total number of periods

For Example:

Principal= Rs 100000

Interest rate per period= 2%

Total number of periods = 4 (Interest Rate Compounded quarterly)

CIA= 100000*(1+0.02)^4= 108243

If it would be simple interest rate then the total amount investor would have received 108000 (at 8% annual rate of interest).

Time Value money

The relationship of the value of the money today and in future is the time value of money.

Money invested today could help you earn more money in future if we include compounding or simple interest rate.

Future Value (FV) of money based upon compounding interest rate for the Present Value (PV) of money invested could be calculated as FV= PV * (1+interest rate)^time period

This calculation is good if we need to compute the future value for the money to be received once i.e. entire money would be paid once to the investor.

If investor needs to receive the money/cash flows at the regular interval then the future value would be calculated as:

Future Value = Uniform Cash Flow * (((1+ rate)^maturity time-1)/rate)

Inflation

Increase in the cost of living normally refers as Inflation. Cost of living means the cost of buying the good and services required for the living. It erodes the value of the money. With the same amount of money you would not be able to buy same quantity of goods in future what you could buy today if inflation is increased.

Whenever you calculate the amount required in future for meeting any goal or need then please consider the factor of inflation, otherwise inflation could give you a big shock in terms of shortage of money what you have originally planned.

Consumer Price Index (CPI)

CPI tracks the changes in the price of the basket of the common type of consumer goods.

The list of item used for tracking is the commonly bought food and household items such as vegetables & fruits, pulses, milk products, clothing, medical care etc.

Asset Management

Financial companies are helping its customers to manage their assets with the help of professionals. Depending upon the customer goals and risk profile, asset/portfolio manager recommends him/her the different asset classes to invest and the proportion in which money should be invested.

Risk Profiles: It depends upon how a customer would react on the volatility.

It could be Low, Medium and High. For example equity is normally considered to be volatile and fixed income products such as bank FD normally known to be very less volatile; reason being returns in equity is not fixed whereas in bank FD it is fixed.

Investment is made to meet any goal which could be Short, Medium or Long term.

Short term goals are the goals which need to be accomplished in short term such as within 1-2 years for example buying new car

Medium term goals are the goals which need to be accomplished in medium term such as within 3-5 years for example buying new house

Long term goals are the goals which need to be achieved in long time such as in 5+ years for example retirement.

Considering all the different parameters such as your risk profile, goal and time frame of achieving it, a portfolio is designed for you by your portfolio manager (professionals) which will help you to invest in your money. For example for short term you could be advised to invest in Debt funds (funds with the core holdings in the fixed income products such as bonds) and for medium and long term, equity could be good option.

A lot of different products are also being launched in the market by the financial firms to meet these objectives such as Retirement Plan, Child Plan etc.

Every individual should have an investment plan in place to meet the different goals of their life.

Plan should have high level three level of goals: Short, Medium and Long term.

After deciding all the goals and expected time to achieve it, set the amount needed to achieve it.

Also, just think about your risk profile like:

Low: I should not lose my money; even if returns are small still I am happy.

Medium: I could afford to lose partial money, but returns should be decent.

High: I could afford to lose a big amount or even the entire amount however returns should be very high.

Once you have identified your risk profile, pick the asset where you would like to invest.

Against each goal now map the asset you would like to invest.

Another important thing is the amount to be invested. Based upon the amount needed you should invest in the regular interval. For example buying a car might need lesser amount than a home, so you have to invest a small amount in case of car than house.

*It is very important to consider inflation and benefit of compounding in identifying the amount required to meet the goals.

Insurance is another key factor in a good portfolio. Make sure to take at least life insurance and health insurance policy and the insured amount should be enough to help the family in the smooth sailing (financially) during trouble time.

Real Estate Investment Trust (REIT)

It is trust which owns or finances the real estate projects. This could be a platform for the small investors to get a slice of the normally high priced real estate market.

The investors in REIT would get the benefit by the rental income of the properties or after sale profit sharing by all the shareholders.

We could also say that it is similar to the mutual fund where pooled fund from various investors are invested in the shares or other financial products. Investors get the benefit with the shares price appreciation or the income like dividend.

SEBI have issued the guidelines related to REIT which would clear the path for the listing of such trust on the exchanges.

Similar to the mutual funds, investor could buy the REIT units from both primary and the secondary market.

One of the major beneficiary of REIT could be the small investors who sometime dreams of getting a slice of the real estate market but unable to do so in reality due to lack of big investment amount associated to it.

DLF, one of country's largest real estate players is planning to launch India's first REIT in the near future.

Unit Linked Insurance Plan (ULIP)

It is a product which combines the feature of insurance and the investment.

The money collected as a premium by the ULIP issuer is used to pool this fund and invest in the various market products like equity, debt etc.

One portion of the premium amount is used for the insurance of the buyer and another portion is utilized for the investment in the other financial products.

So, we could also say the investment part is similar to the mutual funds. Buyer would get the units and each unit is having the Net Asset Value (NAV).

Policy buyers have the option to select in which category money should be invested like in debt or in equity or mix of both.

Risk: As the money is invested directly into the market like equity or debt so all the risk associated to the specific market would have to face and mitigate by the ULIP manager.

It is very important for the investors to understand the risk involved before making the investment.

Exchange Traded Funds (ETF)

ETF is a financial product which had offered the advantage of both stocks and the mutual funds.

It is a basket of stocks which is tradable on the exchange similar to the individual stocks. As an investor you have invested your money in a pool of stocks to diversify the risk and in addition to it similar to stocks you could trade it at any time within exchange trading time.

In case of mutual fund, investor comes to know about the price of the NAV at the end of trading day and the buy/sell is being done on this value whereas ETF are tradable throughout the day at the prevailing price.

The cost of distribution is also normally low which gives additional benefit to the investors in form of lower expense or cost.

Buyer has the option to invest in both primary and the secondary market.

CRR, SLR, NDTL, Repo, Reverse Repo

RBI has given a mandate to the banks to maintain a Cash Reserve Ratio (CRR). It means a certain portion of bank liquid cash of their net demand and time liability (NDTL) needs to be parked in RBI. It is one of the key instrument by which money supply can be controlled in the market. If CRR is increased, it means banks have to park more money with RBI and they have less money to lend which in turn tighten the liquidity in the money.

In case, CRR is decreased then banks will have more money to lend which will pump in more money in the system.

NDTL: In simple terms, account from which money can be withdrawn anytime such as saving accounts comes under demand liability and the account which took normally some time for withdrawal comes under Time liability for example fixed deposit.

SLR: Statutory Liquidity Ratio: It is the percentage of bank reserve which needs to be mandatory parked in gold, cash or government approved securities. It is an important tool to control inflation.

CRR and SLR both are the important tools used by RBI depending upon the economic condition to have a control on the money supply in the system.

Calculation of NDTL is required to calculate CRR, SLR

Repo rate: It is the rate at which RBI lends money to the commercial banks.

Reverse repo rate: It is the rate at which RBI borrows money from the commercial banks within the country.

How Gold rate is decided

In the international market, London Gold Fix used to decide the prices of the gold. First time it took place on 12th September 1919. The five participating members were the driving force behind the prices.

On 20th March 2015, London Gold Fix was replaced by LBMA Gold Price. IBA (ICE Benchmark Administration) manages the electronic auction process for LBMA Gold Price. The prices are set two times a day.

The gold in India could be imported by few specific organizations mainly banks. They are supplied to the bullion dealers after adding import duty and fees.

India Bullion and Jewellers Association (IBJA), a Mumbai based gold dealers association announced the prices in rupees on daily basis based on the quotes they receive from the member dealers.

Member dealers send their quotation on the basis of how much gold they want to buy or sell at a given price.

In the international market, gold rate is defined in ounce.

1ounce is equal to 28.3495 grams.

How banks borrow money from other banks

MIBOR is Mumbai Inter Bank Offered Rate.

It is the interest rate at which one bank can borrow from other banks in the Indian interbank market.

Banks normally borrow from other banks to cover short term liquidity problem.

MIBOR is calculated everyday by the National Stock Exchange of India (NSEIL) as a weighted average of lending rates of group of banks on funds lend to first class borrowers.

In the international market, LIBOR (London Inter Bank Offered Rate) is one of the widely used benchmark.

LIBOR is the interest rate at which banks borrow funds from other banks in the London interbank market. The rate is fixed by the British Banker's Association on the daily basis.

The rate is derived from average of world's most creditworthy banks interbank deposit rates for larger loans with maturities between overnight and full year.

How fuel (petrol/diesel) price is calculated

The prices are calculated on the basis on various parameters such as:

1. Cost of purchase of finished product i.e. oil.

2. Transportation cost.

3. Government tax rates and excise duty.

4. Currency fluctuation in which product is bought.

5. Subsidies (if any) given by the government.

For example, if fuel imported by the company from oil producing nation then there would be cost of buying, import duty in India, tax by state or central government and currency fluctuation (world major crude oil market normally traded in US Dollars, any fluctuation in the exchange rate could have a major impact on the cost imagine today 1US Dollar = 64 Indian Rupees and after a month it changed to 1 US Dollar = 80 Indian Rupees).

The overall cost could be reduced if government provides any subsidy to its citizens.

For example, after including all the cost if per litre price is Rs 70 and government provide the subsidy of Rs 5 then customer has to pay Rs 65.

Balance amount of Rs 5/litre government will compensate to the oil companies.

In the international market, prices are generally derived for crude oil per barrel (1 fluid barrel = 119.240471 Litres approx.).

Crude oil is extracted/pumped out from the ground by oil producing nations such as Saudi Arabia, Russia, and United States etc.

It is transported to the oil refineries via sea route in the ships known as tankers or pipelines. Refineries manufacture the finished petroleum product from the crude oil. A series of complex process is involved in this conversion. The finished products are than supplied to the local distributors or pumps.

Who prints the money and mint coins in India

Reserve Bank of India (RBI) is responsible for printing (notes), minting (coins) and distribution via its own printing press. After printing/minting it is send to the RBI regional offices which send it to the commercial banks.

RBI had also open currency chests (storehouse) in the commercial banks for the local distribution.

There are various factors due to which currency is printed such as what is the current demand of physical notes/coins with respect to cheques, credit/debit cards. The replacement need for the worn and dirty notes, current stock position of currency by government and banks etc.

RBI could print any quantity of notes or mint coins in its press however this is not done. One of the key factor for not doing excessive printing and minting is inflation. Assume RBI had decided and transfer 1 crore rupees to each citizen account. With this money in hand, purchasing power of the people got increased. Demand of the products would increase and in some cases demand will be much higher than supply. In such cases, cost of product could increase.

Overall, inflation could touch a new high and become uncontrollable.

This is one of key role and responsibility of RBI to decide how much money to feed in the economy. Excessive supply or shortage of supply both could have a serious consequence on the economy.

FDI and FII

FDI and FII are foreign investment in the country.

FDI (Foreign Direct Investment) is the investment by a company in the foreign country. They generally target to invest in the specific enterprise with the aim of either increasing its productivity/ capacity or changing its control of the management. It not only brings capital but also rich global experience of better governance practices or management skills and even sharing better technologies.

FII (Foreign Institutional Investors) is the investment made by the investors in the market of any foreign country. It is very easy for them to enter and exit the market.

If the economy is growing than a country could witness a huge inflow of money from FII in the equities and debt market. However, with the ease they could take out money (as in India), could bring huge volatility in the market and the exchange rates.

FDI is considered more stable and preferable than FII.

Venture Capital, Private Equity and Angel Investors

**Venture Capital (VC)** is the firm which invests in the company and they could also provide valuable help to the firm in terms of strategic advice for the company's growth, access to its wide network of contacts, help in hiring right talent etc.

However, sometimes with this investment they could also try to gain tremendous control over the company and drive the company's major decisions such as selling the business or replacing the firm's management with its own representative etc.

The goal is to grow the firm quickly and sell them for earning good returns.

These firms normally invest in the startups or early stage companies.

Sequoia Capital and Spark Capital are the example of VC firms.

**Private Equity (PE)** investors normally invest in mature companies which are under performing or under-valued. They invest in private companies i.e. which is not publicly traded. The goal is to improve the profitability and sell them for good return on their investment.

Everstone Capital and Bain Capital are the example of PE investors.

**Angel Investors** are generally the wealthy individuals who invest their own funds in startups to get a piece of their equity or convertible debt.

A group of angel investors are also creating the angel networks to leverage each other experience and research, even pool their capital for investment.

Credit Information Bureau (India) Limited (CIBIL)

CIBIL is the credit information company in India. It maintains the individuals data related to the loans and credit cards. The information is provided by the member banks and credit institutions on the regular basis.

The information is used to create a credit information report (CIR) and assign a credit score to the individual.

It is being used as one of the key parameter in evaluating and approving the individual loan request.

Report helps the banks/credit institutions to understand how loan applicant was making payment to the loans and credit card payments in the past (if any) and based upon the current commitments to the existing loans and earning income would he/she be able to make new payment (if loan is approved).

The score ranges from 300 to 900, closer the score to 900 better is the chance of the loan approval.

A score of "NA" or "NH" means you do not have the credit history or you are new to the credit system or you do not have credit activity in last few years or you have no credit exposure.

You can also get your credit score by following the instructions as mentioned here:

<https://www.cibil.com/online/credit-score-check.do>

Permanent Account Number (PAN)

It is a unique 10 alpha-numeric code issued under Indian Income Tax Act 1961 to the individual and valid for the life time of the holder. There is no impact on this number even in the case of change of address.

PAN is mandatory in India for majority of the financial transactions such as for getting bank account, salary by the salaried professionals, high value financial transactions (buying/selling of assets) etc.

You also need PAN for any communication with Income Tax Department for example filing income tax returns.

PAN structure:

First five letters are characters, next four characters are numeric and last letter is character.

First three letters is a random sequence of alphabets from AAA to ZZZ.

Fourth character helps to identify type of holders:

A-Association of Persons

B-Body of Individuals

C-Company

F-Firm

G-Government

H-Hindu Undivided Family

L-Local Authority

J-Artificial Judicial Person

P-Individual

T-Trust

Fifth character signifies the first character of surname or last name of person or name of Company/Firm/Government/HUF/Local Authority/Artificial Judicial Person/Trust

Next four numbers are random generated numbers.

Last character is an alphabetic check digit.

You can apply for a PAN card through online form submission to NSDL* by following instructions on:

<https://tin.tin.nsdl.com/pan/index.html>

*NSDL (National Securities Depository Limited) is a central depository (financial organization holding securities such as shares in dematerialized form so that ownership can be easily transferred through entry in the books in place of transferring physical certificates) for securities in India.
