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The first step for you to understand the stock market is to understand stocks.

A share of stock is the smallest unit of ownership in a company. If you own a share of a company’s
stock, you are a part owner of the company.

You have the right to vote on members of the board of directors and other important matters before
the company. If the company distributes profits to shareholders, you will likely receive a proportionate
share.

One of the unique features of stock ownership is the notion of limited liability. If the company loses a
lawsuit and must pay a huge judgment, the worse that can happen is your stock becomes worthless.
The creditors can’t come after your personal assets. That’s not necessarily true in private-held
companies.

There are two types of stock:

• Common stock
• Preferred stock

Most of the stock held by individuals is common stock.

Common Stock
Common stock represents the majority of stock held by the public. It has voting rights, along with the
right to share in dividends.

When you hear or read about “stocks” being up or down, it always refers to common stock.

Preferred Stock
Despite its name, preferred stock has fewer rights than common stock, except in one important area –
dividends. Companies that issue preferred stocks usually pay consistent dividends and preferred stock
has first call on dividends over common stock.

Investors buy preferred stock for its current income from dividends, so look for companies that make
big profits to use preferred stock to return some of those profits via dividends.

Liquidity
Another benefit of common stocks is that they are highly liquid for the most part. Small and/or
obscure companies may not trade frequently, but most of the larger companies trade daily creating an
opportunity to buy or sell shares.

Thanks to the stock markets, you can buy or sell shares of most publicly traded companies almost any
day the markets are open.

Demat refers to a dematerialised account.

Though the company is under obligation to offer the securities in both physical and demat mode, you have
the choice to receive the securities in either mode.

If you wish to have securities in demat mode, you need to indicate the name of the depository and
also of the depository participant with whom you have depository account in your application.
It is, however desirable that you hold securities in demat form as physical securities carry the risk
of being fake, forged or stolen.

Just as you have to open an account with a bank if you want to save your money, make cheque
payments etc, Nowadays, you need to open a demat

Opening an individual Demat account is a two-step process: You approach a DP and fill up
the Demat account-opening booklet. The Web sites of the NSDL and the CDSL list the
approved DPs. You will then receive an account number and a DP ID number for the
account. Quote both the numbers in all future correspondence with your DPs.

So it is just like a bank account where actual money is replaced by shares. You have to approach the
DPs (remember, they are like bank branches), to open your demat account. Let's say your portfolio
of shares looks like this: 150 of Infosys, 50 of Wipro, 200 of HLL and 100 of ACC. All these will show in
your demat account. So you don't have to possess any physical certificates showing that you own
these shares. They are all held electronically in your account. As you buy and sell the shares,
they are adjusted in your account. Just like a bank passbook or statement, the DP will provide you
with periodic statements of holdings and transactions.

Is a demat account a must? Nowadays, practically all trades have to be settled in dematerialised
form. Although the market regulator, the Securities and Exchange Board of India (SEBI), has allowed
trades of upto 500 shares to be settled in physical form, nobody wants physical shares any more.

So a demat account is a must for trading and investing.

Most banks are also DP participants, as are many brokers.

You can choose your very own DP.

To get a list, visit the NSDL and CDSL websites and see who the registered DPs are.

A broker is separate from a DP. A broker is a member of the stock exchange, who buys and sells shares on
his behalf and on behalf of his clients.

A DP will just give you an account to hold those shares.

You do not have to take the same DP that your broker takes. You can choose your own.

Alpha and Beta of Stocks

Every investment involves two important aspects – returns and risk. And every investor wants to
get the maximum returns with minimum risk. In this post is described the significance of
Alpha and beta parameters of the stock portfolio that are used to describe the two main risks
inherent in investing in stocks. Alpha relates to factors affecting the performance of an
individual stock or the fund manager’s skill in selecting the stocks while beta relates to market
risks.

Alpha of a stock or portfolio:


Alpha is the risk-adjusted return on an investment. It is excess return of a stock portfolio or fund
over a given benchmark and hence is usually used to measure the performance of fund manager
in managing the fund portfolio. So usually an investor’s strategy should be to buy securities with
positive alpha as these may be undervalued.

If an investment outperformed the benchmark, that means more reward for a given amount of
risk. In that case α > 0.

If an investment underperformed the benchmark; that means the investment has earned too little
for its risk. In that case α < 0.

For efficient markets, the expected value of the alpha is zero. i.e α = 0 and the investment has
earned a return adequate for the risk taken.

Fund managers are rated according to how much alpha their fund generates. It is thus a measure
of the fund manager’s ability to generate profits in excess of market returns. Fund managers are
usually paid in accordance to how much alpha their fund generates. Higher the alpha, the higher
is their fees.

Beta of stock portfolio:

Beta is a measure of a volatility of a stock and expresses the relation of movement of stock with
the movement of market as a whole. The S & P 500 Index is assigned a Beta of 1. So a stock can
have positive or negative value of beta.

If Beta = 1; that means security’s price will move in sync with the market.

If Beta is positive; that means stock moves more than the market and is more volatile.

If Beta is negative; that means stock moves less than the market and is less volatile.

High-beta stocks are generally riskier being more volatile but provide a potential for higher
returns as these are in the early stages of growth. On other side low-beta stocks pose less risk and
hence lower returns. Usually utilities stocks have a beta of less than 1 while high-tech stocks
have a beta of greater than 1.

Having gone through the fundamentals of alpha and beta; it can be inferred that low beta and
high alpha stocks are good. But blindly following this concept is not desirable because these
parameters are calculated based on historical data and history is never the indicator of future
performance of a stock portfolio.

What does the term term “Margin Trading” mean ?

November 3rd, 2010


Many times you would have come across a term Margin trading. What is trading on margin
and how is it different from normal trading is what is explicated here.

‘Margin” means borrowing money from your broker to buy a stock. Now the question is why
would you borrow? Investors generally go for trading on margin so to increase their purchasing
power so that they can own more stock without fully paying for it. That means you will pay a
part of the buy price and the broker will lend you the difference.

Let us understand this with an example:

Suppose you wish to buy a stock with market price of Rs 50. Under margin trading, you would
be paying Rs 25 in cash while remaining 25 Rs will be lent to you by the broker (Assuming the
initial margin requirement with your broker is 50%). How does this help? Let’s see. Suppose the
price of the stock rises to Rs 75.

In case of Margin trading – Your return on the investment is 100% because you paid Rs 25.

In case of normal trading – Your return on investment is 50% because you paid Rs 50.

However there is also an equal probability of higher loss for trading on margin. Suppose the
stock price falls to Rs 25. If you fully paid for the stock, you lost 50 percent of your money. But
if you have traded on margin, you lost 100 percent. And on the top of that you are supposed to
pay interest for the loan you have taken from the broker along with the broker’s commission.
Moreover if the investor doesn’t maintain minimum margin in his account the broker will have
the right to sell all your stocks without notifying you. By this you would even loose the chance to
make up your losses when the price goes up later. Below are certain terms that would make the
concept more clear.

Initial margin: The proportion of total purchase price an investor is supposed to deposit for
opening a margin account is referred as its initial margin and is generally 50% of the total value.

Maintenance margin: In order to keep the margin account open for doing margin trading, it is
necessary to maintain minimum cash or marginable securities which is called the maintenance
margin. This is just to prevent an investor from incurring a level of debt that he would not be
able to repay.

Margin call: If your account falls below the maintenance margin, your broker will make a
margin call to ask you to deposit more cash or securities into your account. If case you fail to
meet the margin call, your broker will sell your securities so to make up for the stipulated
maintenance requirement.

Lastly, for novice traders it is very important to have a realization that trading on margin can
help you magnify your profit and at the same time multiplies the associated risks.
Futures and options
Futures and options are the derivative instruments in which the buyer and seller enter into an
agreement or transaction which will get settled on a future date. In simple terms it is a promise
between buyer and seller to transfer the actual underlying assets (commodities, gold, stock,
currency etc) on a specific future date at a specific stipulated price as per the agreement.

To understand this in a better way, let’s have a look at the below comparison chart between
futures and option:
Futures Options
In futures contract the buyer and seller enter into an In options contract the buyer is given an option to
obligatory agreement to exercise the contract at decide whether or not he wants to exercise the contract
maturity. at maturity.
Buyer of the contract has the option to exercise it
Both the buyer and seller have the obligation to anytime on or before expiry but seller has the
exercise the contract which means on maturity, seller obligation to exercise it. If buyer demands to buy the
will transfer the underlying securities and buyer will asset, seller will have to sell it. Options are of two
make the cash payment as per agreed price. types:

The buyer does not have to pay any amount for buying Call option: It gives the buyer, the right to buy the
a futures contract because it is an enforceable asset at a strike price.
agreement which will get settled on maturity date.
Put Option: It gives the buyer a right to sell the asset
Example of future trading: at the ‘strike price’ to the buyer

A person bought a futures contract to buy security A at The buyer has to pay an amount called as “Premium”
a price of Rs 500 on a specific future date. On the for acquiring an additional right of having an option to
expiry date, the price went up to Rs 600. So the deal is exercise the contract or not.
good for buyer who will get the securities at Rs 100
lesser than the actual market price. On other side, it is Example of option trading:
devastating for the seller who is obliged to sell them at
lower price which has been agreed upon. A person bought a call option at a strike price of Rs
100. On maturity the price falls to Rs 80. He will not
exercise the contract because he can buy the same asset
from the market at Rs 80. However if price rises, he
will exercise the contract.

Similarly, a person bought a put option at a strike price


of Rs 100. On maturity the price shoots up to Rs 150.
He will not exercise the contract because he can sell the
same asset in the market at Rs 150, rather than giving it
to the seller at agreed upon price of Rs 100.

In both cases, he just lost his premium amount which is


marginal.
From the above description, it can be inferred that be it future or an option; these are the ways
of hedging the risk of investments. It provides a protection against unexpected rise or fall in the
price by entering into an agreement to be executed in future date. The concept is very old when
agreement used to be made by negotiating the price for harvest of season having been unaware
whether harvest will be meager or plentiful. When harvest time came, demand would rise sharply
and ultimately giving the holder of agreement a chance to earn more than what he had expected.

Whatever be the case, playing options and futures has always been a risky. So better be careful
before you enter into the arena!!

What are Derivatives ? A Brief Introduction

Derivatives, as the name indicates are the financial instruments which derive their value from
some other asset of monetary value called as “underlying asset”. This underlying asset can be
gold, currency, stock or any commodity. In short, derivative is not an asset in itself but an
agreement or a contract to transfer the real asset in future whenever exercised!! The date and
price of execution is mentioned in the contract as per agreement between the parties. There are
varieties of derivatives available at present like futures, options and swaps; futures and options
being the most common ones. Before looking into details here are few components of a
derivative agreement which need to be introduced first.

Holder: Holder is the buyer of derivative agreement. By buying an agreement, the buyer may
agree to buy or sell the underlying asset.

Seller: One who sells the contract to holder.

Expiry date: The date at which agreement will get matured / exercised.

Strike price: The price at which derivative will get exercised and is decided at the time of
entering into agreement (between buyer and seller).

Premium: It is the price which buyer pays for buying an option contract. The premium is not to
be paid for futures contract.

The reason of its appeal to investors which makes it different than other financial instruments is
that it is not an asset in itself but an agreement to convey the transfer of actual assets later in
future. The catch here is why to enter an agreement to buy/sell assets in future?? Why not buy
the real asset (underlying asset referred here) directly from spot market at current levels?? Why
making an agreement to be executed in future date? The answer is; derivates are usually seen as
instruments for bringing in protection against unexpected rise or fall in the price of underlying
asset. Secondly, derivatives are used to yield better returns with lower capital investment as
compared to the amount that will be invested to buy the shares directly form the spot market.

Types of derivative instruments:


Forward Contract: It is an agreement to buy or sell the derivative at a known date in the future
at a price decided as per negotiation between the contracting parties. These are not traded in
exchanges.

Futures Contract: It is an agreement to buy or sell a financial instrument at a known date in the
future at a price as per negotiation between contracting parties. These are traded on stock
exchange.

Option Contract: It is a contract that gives holder the right, but not the obligation to exercise it.
Call options give holder the right to buy while put option give the holder the right to sell at the
strike price at stipulated date as per agreement.

Warrants: These are long term options having 3-7 years of expiration. Warrants are issued by
companies for raising finance with no initial servicing costs like divided or interest. It is a type of
security issued by corporation usually together with a bond or preferred stock that gives holder
the right to buy a certain amount of common stock at a stated price. So it acts as a “sweetener
offered along with the fixed-income securities”.

Swap Contract: Swaps are agreements between counterparties to exchange one set of financial
obligations for another as per the terms of agreement.

Swaptions: Swaptions are options on swaps. They give holder the right to enter into having calls
options and put options.

Volatility of Stock Markets and its causes


Volatility is one of the best phenomenon without which stock markets will loose its charm.
It is the tendency of fluctuation of market indices over a period of time; more is the fluctuation,
higher is the volatility. The ups and downs of stock prices is what that adds spice to the market
behaviour. This see-sawing effect has its own implications, both good and bad. Good, because
prudent investors taking advantage buy on dips and sell on highs for profit booking. On the flip
side, greater volatility lowers investor’s confidence in the market prompting them to transfer
their investment in less risky options due to unexpected market behaviour.

Having observed the past major events of volatility, one can realise the root cause as
“unanticipated information” breaking out in the market. When this news stabilises, volatility
vanishes because the uncertainty related dies out.

Few examples from recent past:

• Govt announced buying of shares/bonds of Indian companies through participatory notes


(PN).
• CRR and repo rates hike by RBI.
• Satyam fiasco and Lehman’s bankruptcy news.
• Stringent IPO regulations.
• US recession fear. Jan 21, 2008 saw biggest ever fall of 1408 points due to volatility on
account of US fears of recession.

Now the question arises how this uncertainty leads to such aftershocks in market.

Firstly, investments by FIIs have a major influence on movement of SENSEX which came into
limelight during general elections of 2004. Owing to fear of reforms due to new government
there was continued selling pressure by FIIs resulting in sharp decline in the index. Later on
when the news regarding these reforms stabilised, FIIs started buying back the shares they sold
earlier. Thus aiming at profit booking and balancing the portfolio, FIIs keep relocating their
funds from time to time. For example if they find govt policies not in their favour, they would
withdraw their investments from Indian markets and invest in some other market leading to
sudden crash in index.

Secondly, Indian markets are sensitive to global markets. It has been observed that many
times if NASDAQ closes high, SENSEX opens in green. So an unwanted news broke out in US
may show its effects in Indian markets leading to intra-day volatility.
Thirdly, company specific news may cause volatile sessions in the market. From recent
example of Satyam computers ltd, markets were highly volatile due to investor’s sentiment
being in dilemma and anticipations about the future of company and related conglomerates.

Fourthly, Political news and news related to finance tend to affect market sentiment. Like RBI
declaring CRR hikes, lowering interest rates prompt investor to relocate their investments
accordingly. Likewise, news related to scams and frauds also create panic amongst investors
making the markets volatile.

Volatility in acceptable limits is a sign of healthy markets as it leads to correction if there is


overvaluation of prices. At the same time there is huge risk associated. The crux is that
whatever you have in your portfolio of stocks, wind may start blowing against you anytime.
So to play safe keep a margin to bear the volatility risk and don’t put all your eggs in same
basket as the basic rule of portfolio management says.

Basics of Mutual Funds


Money is merely a piece of paper until you realise the importance of saving and making it
grow spirally. There is plethora of investment avenues available at present, but what suits your
objective is the one you should opt for. On a broader picture, a common man can think of two
options, either invest in shares offering glamorous returns with an associated unknown risk or
invest in the regular income debt options offering lesser but safer returns.
Now the question arises: Is there a way in middle so that you get good returns like equity and
safety of investment like fixed income options. Yes, a Mutual fund is what you should look
for.

Why Mutual funds?

What if you are a novice in the world of stock markets but still want to invest? What if you don’t
have enough risk appetite for the investments you want to make? What if you don’t have time
and skill to manage your portfolio and want some professionally qualified people to invest on
your behalf? What if you are a novice in the world of stock markets but still want to invest?

What are Mutual funds?

As implicit by name, mutual fund is a fund mutually held by the investors who are the
beneficiaries of the fund. It is a type of Investment Company which collects money from so
many investors in common pool and then invests this capital raised in variety of options like
bonds, equity, gold, real estate etc. At the core of it are professionally qualified people called
fund managers analysing the markets conditions and making investment decisions with an
objective of maximization of profit. Substantially all the earnings of a MF are passed on to the
investors in proportion to their investments. In lieu of the services offered, the mutual fund also
charges some fees from the investors. The diagram below clearly indicates that investors invest
in mutual fund that further makes investment in various options.

Mutual Funds Basics

Having been through basics, one can infer that investing in mutual funds is an easy way of
playing safe in equity especially you being unaware of tactics of stock markets because it
provides professional expertise of fund managers who make investment decisions based on
constant study and market research. Besides this, it offers benefits like diversification of
portfolio. Since mutual fund is a collective investment vehicle, they have an option to invest in
different sectors of market like retail, real estate in addition to options like debt and commodities
market. This reduces the risks to which an individual investor would have been exposed if a
particular sector is in period of downfall. The simplicity of investment and various benefits
offered have made them so popular that can be seen from their growth in past. They came into
picture in 1963 with 67bn assets under management (AUM) compared to current figures of
4609.49bn with total of 35 mutual funds available at present and still expected to grow in years
to come.

Futures and Options Terminology


1. SPOT PRICE: The price at which an asset trades in spot market.

2. FUTURES PRICE: The price at which the futures contract trades in the futures market.

3. CONTRACT CYCLE: The period over which a contract trades. the Index futures contracts on the NSE have one month, two
months and three months expity cycles which expire on the last thursday of the month. Thus a january expiration contract expires
on the last thursday of January and a Febraury exoiration contract cease trading on the last thursday of Febraury. On the Friday
following the last thursday, a new contract having a three month expiry is introduces for trading.

4. EXPIRY DATE: It is the date specified in the futures contract. This is the last on which the contract will be traded, at the end
of which it will cease to exist.

5. BASIS: In the context of financial futures, basis can be defined as the future price minus the spot price. There will be a
different basis for each delivery month for each contract. In normal market, basis will be positive. This reflects that futures prices
normally exceed spot prices.

6. CONTRACT SIZE: The ammount of asset that has to be delivered under one contract. for instance, the contract size on
NSE's futures market is 50 Nifties

7. COST OF CARRY: The relationship between futures prices and spot prices can be summerized in terms of what is known as
the cost of carry. this measures the storage cost plus the interest that is paid to finance the asset less the the income earned on
the asset.

8. INITIAL MARGIN: The ammount that must be deposited in the margin account at the time a futures contract is forst entered
into is known as initial margin.

9. MARKING-TO-MARKET: In the futures market at the end of each trading day, the margin account is adjusted to reflect the
investers's gain or loss depending opon the futures closing price. This is called marking-to-market

10. MAINTENANCE MARGIN: This is somewhat lower than the initial margin. This is set to ensure that the balance in the
margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the invester
recieves a margin call and is expected to top up the margin account to the initial margin level before trading commences on the
next day.

Option Terminology
INDEX OPTIONS: These options have the index as underlying . Someoptions are options on individual . Like Index futures
contracts, index options contracts are also cash settled.

STOCK OPTIONS: Stock options are options on individual stocks. A contract gives the holde the right to buy or sell shares at
specified price.

BUYER OF AN OPTION: The buyer of an option is the one who by paying the option premium buys the right but not the
obligation to excersise his option on the seller/writer

WRITER OF AN OPTION: The writer of a call/put option is the one who recieves the option premium and is thereby obliged to
sell/buy the asset if the buyer exercises on him.

There are two basic types of Options, CALL OPTIONS & PUT OPTIONS.
CALL OPTION: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.

PUT OPTION: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price.

OPTION PRICE/PREMIUM : Option price is the price which the option buyer pays to the option seller. It is also referred to as
the option premium.

EXPIRATION DATE: The date specified in the options contract is known as the expiration date, the exercise date, the strike
date or the maturity.

STRIKE PRICE: The price specified in the options contract is known as the strike price or the exercise price.

IN-THE MONEY OPTION: An in-the-money (ITM) Option is an option that would lead to a positive cash flow to the holder if it
were exercised immediately. A call option on the index is said to be in-the-money when the current index stands at a lever higher
than the strike price (i.e., spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM.
In the case of a put, the put is ITM if the index is below the strike price.

AT THE MONEY OPTION: An at-the-money option (ATM) is an option that would lead to zero cash flow if it were exercised
immediately. An option on the index is at-the-money when the current index equals the strike price (i.e., spot price = strike price)

OUT-OF-THE MONEY OPTION: A out-of-the money (OTM) option is an option that would lead to a negative cash flow if it
were exercised immediately. A call option on the index is out of the money when the current stands at a level which is less than the
strike price (i.e., spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the
case of a put, the put is OTM if the index is above the strike price.

INTRINSIC VALUE OF AN OPTION: The option premium can be broken down into two components, INTRINSIC VALUE and
TME VALUE. The intrinsic value of a call is the ammount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero.

TIME VAUE OF AN OPTION: The time value of an option is the difference between its premium and its intrinsic value. Both
calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when
the option ATM. The longer the time to expiration, the greater is an option's time value, are alse equal. At expiration, an option
should have no time value.

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