28
Aug
09

HEDGE FUND

What is Hedge Fund?

The term “Hedge Fund” is defined as “any unregistered, privately-offered, managed pool of capital for wealthy, financially sophisticated investors.” Hedge funds are usually structured as partnerships, with the general partner being the portfolio manager, making the investment decisions, and the limited partners as the investors. The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.

Hedge funds are subject to the same market rules and regulations as any trader. The strategies they utilize are not as easily accessible, especially for other regulated entities, such as mutual funds. To achieve this “absolute return”, hedge fund managers have the flexibility to incorporate different strategies and techniques that may include:

Short-selling: Sale of a security that you do not own, with the anticipation of purchasing it in the future, at a reduced cost.

Arbitrage: Simultaneous buying and selling of a financial instrument in different markets to profit from the difference between the prices

Hedging: Buying/selling a security to offset a potential loss on an investment.

Leverage: Borrowing money for investment purposes.

Trading options or derivatives: contracts whose values are based on the performance of any underlying financial asset, index or other investment.

Investing in anticipation of a specific event: merger transaction, hostile takeover, spin-off, exiting of bankruptcy proceedings, etc.

Investing in deeply discounted securities: of companies about to enter or exit financial distress or bankruptcy, often below liquidation value.

Many of the strategies used by hedge funds benefit from being non-correlated to the direction of equity markets

 A hedge fund may take long positions in certain stocks, and short positions in certain other stocks such that their portfolio beta is close to zero. A beta close to zero means that the portfolio will remain relatively unchanged due to the broad market movement. Such a portfolio will primarily change if the stocks move more than the broad market.

 This would become clear with the example –

 A stock trader believes that the stock price of IP Ltd. will rise over the next month, due to this company’s new and efficient method of producing gadgets. He wants to buy IP Ltd. shares to profit from their expected price increase. But IP Ltd. is part of the highly volatile gadget industry. If the trader simply bought the shares based on his belief that the IP Ltd. shares were underpriced, the trade would be a speculation.

Since the trader is interested in the company, rather than the industry, he wants to hedge out the industry risk by short selling an equal value (number of shares × price) of the shares of PANKAJ Ltd. direct competitor, PANKAJ Ltd.

The first day the trader’s portfolio is:

  Long 1000 shares of IP Ltd. at Re1 each

  Short 500 shares of PANKAJ Ltd. at Rs2 each

(Notice that the trader has sold short the same value of shares.)

 

On the second day, a favourable news story about the widgets industry is published and the value of all widgets stock goes up. IP Ltd., however, because it is a stronger company, goes up by 10%, while PANKAJ Ltd. goes up by just 5%:

  Long 1000 shares of IP Ltd. at Rs.1.10 each — Rs100 profit

  Short 500 shares of PANKAJ Ltd. at  Rs.2.10 each — Rs50 loss

(In a short position, the investor loses money when the price goes up.)

 

The trader might regret the hedge on day two, since it reduced the profits on the IP Ltd. position. But on the third day, an unfavourable news story is published about the health effects of widgets, and all widgets stocks crash — 50% is wiped off the value of the widgets industry in the course of a few hours. Nevertheless, since IP Ltd. is the better company, it suffers less than PANKAJ Ltd.:

Value of long position (IP Ltd.):

  Day 1 — Rs1000

  Day 2 — Rs1100

  Day 3 — Rs550 => Rs450 loss

 

Value of short position (PANKAJ Ltd.):

  Day 1 — Rs1000

  Day 2 — Rs1050

  Day 3 — Rs525

Without the hedge, the trader would have lost Rs450. But the hedge – the short sale of PANKAJ Ltd. – gives a profit of Rs475, for a net profit of Rs25 during a dramatic market collapse.

 Another important characteristic is that hedge funds borrow heavily to increase their portfolio size.

To improve their security-specific returns, hedge funds leverage their portfolio. The fund may collect, say, Rs 100 crore from investors, borrow Rs 50 crore, and invest Rs 150 crore.

In the above instance, an unleveraged fund may have gained only 3 per cent of Rs 100 crore. But a hedge fund that has borrowed Rs 50 crore will gain 3 per cent on Rs 150 crore less interest cost on Rs 50 crore.

Who runs them?

A lot of hedge funds are run by former bankers or traditional investment managers who set up their own funds. They can make a lot of money out of them by charging high fees, typically a 2 per cent management fee as well as 20 per cent of the profits.

 Who invests in them?

Because they are unregulated and risky, the managers will only accept investment from wealthy, sophisticated investors (High Net-Worth Individuals).Some banks, pension funds, and companies also invest.

 There are approximately 14 distinct investment strategies used by hedge funds, each offering different degrees of risk and return. A macro hedge fund, for example, invests in stock and bond markets and other investment opportunities, such as currencies, in hopes of profiting on significant shifts in such things as global interest rates and countries’ economic policies. A macro hedge fund is more volatile but potentially faster growing than a distressed-securities hedge fund that buys the equity or debt of companies about to enter or exit financial distress. An equity hedge fund may be global or country specific, hedging against downturns in equity markets by shorting overvalued stocks or stock indexes. A relative value hedge fund takes advantage of price or spread inefficiencies. Knowing and understanding the characteristics of the many different hedge fund strategies is essential to capitalizing on their variety of investment opportunities.

 It is important to understand the differences between the various hedge fund strategies because all hedge funds are not the same — investment returns, volatility, and risk vary enormously among the different hedge fund strategies. Some strategies which are not correlated to equity markets are able to deliver consistent returns with extremely low risk of loss, while others may be as or more volatile than mutual funds. A successful fund of funds recognizes these differences and blends various strategies and asset classes together to create more stable long-term investment returns than any of the individual funds.

03
Apr
08

Effects of Loan-waiver

Before the budget

With a sorry 2.6% growth in the first year of the 11th Plan (compared to 3.8% in 2006-07) and a declining share in the GDP-24% in 2001-02 to 17.5% in 2007-08 which was attributed to slackening growth of rabi crops-the agricultural sector is crying out for long-term answers to economic viability.
There has been a loss of dynamism in the agriculture and allied sectors in recent years, pointing to poor credit reach, gradual degradation of natural resources through overuse and inept use of fertilisers, low public investment in agriculture and inability to attract sufficient private investment because of lower/unattractive returns, poor use of irrigation potential, an extension system in shambles and a delayed start to long-term productivity-boosting schemes.

Ironically, while accepting that production, yield and irrigated area added, have all stagnated or come down for key crops-paddy, wheat, pulses, oilseeds, even sugarcane- the government harps on one mantra to boost production: announce minimum support price (MSP) for these well before the sowing season. Indications, thankfully, are that the government will finally move into this regime as a matter of long-term policy. Presumably, this will also mean aligning support prices close to market prices.

Farmer Friendly Decisions

  1. Complete waiver of loans for small and marginal farmers holding upto 2 hectares of land. Agricultural loans restructured by banks through special packages. All such loans will also be eligible for waiver under the scheme. Implementation of loan waiver scheme is scheduled to be completed by June 30, 2008. Farmers will also be eligible for fresh loans. Govt plans to allocate 60,000 crore for this scheme
  2. New scheme of debt-waiver and debt relief for farmers.
  3. All agriculture loans disbursed by PSU banks, co-operatives till March 2007 waiting recovery to be covered under scheme
  4. One-time settlement scheme for “all other” farmers

Implications of the budget decisions

If you are a farmer that has less than 2 hectares of land and have taken a loan, government has announced that it will waive your loan. The Government of India will compensate the bank.

How does the relief to the farmer work out? How will the Rs 60,000 crore be provided for? What does providing liquidity to the banks mean ?
How the government explains it is that this is money out of the banking system. Some of it is already overdue, already non-performing assets.
So banks are already unsure as to how much of this Rs 60,000 crore would come back to them. It was decided to write off the loans and agree to provide liquidity of the equivalent amount to the banks. The banks have welcomed this arrangement, because they will have fresh liquidity to lend.
Everyone claims that waiving the loans would be a huge relief for farmers who are having a tough time with rising production cost and dwindling profit or growing loss.

What does the government aim to achieve by providing the loan waiver?
The 60,000 crore loan waiver will apparently touch crores of smll farmers in the remotest corners of our country does two things. One, it provides relief on 4 cr homes. Multiply that by 5.5, the size of the number of people in an average Indian home (as per 2001 census) and you have a total of 22 crore people touched directly by the largesee. That’s a lot of consumers.
Two, we need to understand a basic fact. For the farm homes in question, a rupee saved as an outgo on interest and indeed principal, is a rupee earned. This means that both interest burden and loan amount are off. So four cr farmers and their 18 cr dependents will now be rid of their debt burden from the formal sector. They still have the burden of the principal and interest due to the money lenders. Nevertheless, burden removed is a burden removed.
The moneylender’s cash flows are going be touched that much more. The small farmer will now pay the interest he owes that much more promptly. And if he runs out of money he still has an option of going to his friendly neighborhood bank and reapply for a loan.
The question arises- Will this loan waiver bring about an anticipated change in consumption? Engneering consumption artificially is a process that takes years altogether.

But will this step save the farmers of India? Will it revive agriculture in India?
This step is only going to put farmers and agriculture sector as a whole in deep trouble in coming years. We need a long term solution than a short term patch up to revive agriculture.
The fact that fresh loanees have not only plateaued, but actually nosedived in 2008-09 in a sector defined by farm distress have been hided. Indications are that the impending relief package will address this. Despite the diagnosis, the government is keener on populist initiatives such as loan waivers and rescheduling rather than a long-term solution to volatile fluctuations in crop prices that increased farmer suicides.
Admittedly, even a 2% cess would only come up with a modicum (Rs 8,000 crore-odd) of what’s really needed, but the government dodges any other long-term measure on the farm distress relief front.
It is a known fact that agricultural sector in India is suffering because agriculture no longer is a profitable business. As long as it is not a profitable business, people who are already into it try to get out of it and also it won’t attract more people into it.
Who wants to invest or waste time on something that won’t give them back their investment?
Instead of waiving Rs.60,000 crores of loan, if the government has used this money to increase the procurement price of agricultural products by say 3 times the present price the farmers who cultivate it would have made some profit and they will also be motivated to continue agriculture.
Also,
The waiver is meant for farmers owning less than 2 hectares of land with borrowings from commercial or rural regional banks and cooperatives. But half the farmers falling in this category (49.7%) have taken loans from local moneylenders. The scheme would provide no respite to this half of the indebted farmers.
The Budget makes not even a passing reference to the massive produce price fluctuation problems being faced by the farmer.

24
Mar
08

Private Equity

The contents of the article are:

  1. Basics of Private Equity
  2. Types of PE Investment
  3. Difference between VC and PE
  4. The INDIAN Perspective
  5. Private Equity Market

To download the article, CLICK HERE

12
Mar
08

Laffer Curve-Inside Out!

Most of us heard the FM talking about him attempting an increase in tax revenues this fiscal though there has been a significant improvement in the tax slabs. This aspect is described by the LAFFER CURVE.

So, following is an insight into the WHAT and HOW of the Laffer Curve!

Laffer Curve

The Laffer curve is used to illustrate the concept of “taxable income elasticity”, which is the idea that government can maximize tax revenue by setting tax rates at an optimum point and that neither a 0% tax rate nor a 100% tax rate will generate government revenue. The curve was popularized by Arthur Laffer, although the underlying principle was known since the time of Ibn Khaldun’s Muqaddimah. John Maynard Keynes, in his General Theory of Employment, Interest, and Money, described how increasing taxation past a certain point might lower revenue and vice versa.  Libertarian economist Ludwig Von Mises wrote in 1949: “In the United States the recent advances in tax rates produced only negligible revenue results beyond what would be produced by a progression which stopped at much lower rates”. Other economists have questioned the utility of the Laffer Curve. According to Nobel prize laureate James Tobin, “[t]he “Laffer Curve” idea that tax cuts would actually increase revenues turned out to deserve the ridicule with which sober economists had greeted it in 1981.”

The curve is most understandable at both extremes of income taxation—zero percent and one-hundred percent—where the government collects no revenue. At one extreme, a 0% tax rate means the government’s revenue is, of course, zero. At the other extreme, where there is a 100% tax rate, the government collects zero revenue because (in a “rational” economic model) taxpayers presumably change their behavior in response to the tax rate: either they have no incentive to work or they avoid paying taxes, so the government collects 100% of nothing. Somewhere between 0% and 100%, therefore, lies a tax rate percentage that will maximize revenue. Critiques commonly point out that socialist states, such as the U.S.S.R., have been able to derive revenues at a 100% tax rate, though they would have derived more if tax rates had been lower.

Laffer Curve

Diagram 1: Laffer Curve

Laffer Curve

Diagram 2: Laffer Curve

The extent to which these assumptions are true beyond the scope of the underlying mathematics is unprovable, as most economics takes place in the realm of political theory with implied objectivity that is impossible to prove or completely disprove. They nonetheless provide a basis for argument. You can “back into” a continuous curve by assuming the tax rate will be legislated with no more than a given number of decimal points. The resulting discrete function could then be interpolated with line segments, with the same result as the assumption of continuity.

The point at which the curve achieves its maximum will vary from one economy to another and depends on elasticities of demand and supply and is subject to much theoretical speculation. Complexities arises when taking into account possible differences in incentive to work for different income groups and when introducing progressive taxation.

Another contentious issue is whether a government should try to maximize its revenue in the first place. Moreover, the ideal level of taxation is dependent upon the use of government funds, as certain types of spending do more to encourage growth than others. The curve is primarily used by advocates who want government to reduce tax rates (such as those on capital gains) and believe that the optimum tax rate is below the current tax rate. In that case, a reduction in tax rates will actually increase government revenue and not need to be offset by decreased government spending or increased borrowing.

The Laffer-curve concept is central to supply side economics, and the term was reportedly coined by Jude Wanniski (a writer for The Wall Street Journal) after a 1974 afternoon meeting between Laffer, Wanniski, Dick Cheney, and his deputy press secretary Grace-Marie Arnett (Wanninski, 2005; Laffer, 2004). In this meeting, Laffer reportedly sketched the curve on a napkin to illustrate the concept, which immediately caught the imaginations of those present. Laffer himself professes no recollection of this napkin, but writes, “I used the so-called Laffer Curve all the time in my classes and with anyone else who would listen to me” (Laffer, 2004). Laffer also does not claim to have invented the concept, attributing it to 14th century Islamic scholar Ibn Khaldun and, more recently, to John Maynard Keynes.

Critiques of the Laffer Curve

Conventional economic paradigms acknowledge the basic notion of the Laffer curve, but they argue that government was operating on the left-hand side of the curve, so a tax cut would thus lower revenue. The central question is the elasticity of work with respect to tax rates. For example, Pecorino (1995) argued that the peak occurred at tax rates around 65%, and summarized the controversy as:
Just about everyone can agree that if an increase in tax rates leads to a decrease in tax revenues, then taxes are too high. It is also generally agreed that at some level of taxation, revenues will turn down. Determining the level of taxation where revenues are maximized is more controversial.

At least one empirical study, looking at actual historical data on tax rates, GDP, and revenue, placed the revenue-maximizing tax rate (the point at which another marginal tax rate increase would decrease tax revenue) as high as 80%. Paul Samuelson argues in his popular economic textbook that Reagan was correct in a very limited sense to view the intuition underlying the Laffer curve as accurate, because as a successful actor, Reagan was subject to marginal tax rates as high as 90% during World War II. The point is that in a progressive tax system, any given person’s perspective on the validity of the Laffer curve will be influenced by the marginal tax rate to which that person’s income is subject.

Keynesian Critique

Some economists argue that while tax cuts are beneficial to the economy, they are beneficial for different reasons. Keynesian economics suggests that an increased government deficit – for instance, resulting from a tax cut – will stimulate economic output. This leads some to identify instances of the ‘Laffer curve’ as periods of Keynesian demand stimulation.

08
Mar
08

Reliance Power IPO

FROM BEING THE MARKET’S DARLING TO A PARIAH

RelPow IPO

RelPow IPO

Let us look at the facts first. It was India’s largest initial public offer ever and hoped to mop up Rs.11,700 crores, which is about Rs.2,500 crores more than the largest IPO to date in India floated by real estate giant DLF. It had the best of the business as the lead bankers in the form of ABN Amro Rothschild, Deutsche Bank AG, Enam Securities, ICICI Securities, JM Financial Consultants Pvt, JPMorgan Chase & Co, Kotak Mahindra Capital Co and UBS AG.

Investors also gave it a two-thumbs up as they bid for as many as 72 times the number of shares that Reliance Power offered for subscription under its initial public offering (IPO). They have put in bids for over 1,654.8 crore shares as against the 22.8 crore shares on offer.

In terms of number of applications also Reliance Power IPO set a new record. It received nearly 31 lakh applications by the end of day three, the highest ever, according sources in the merchant banking industry handling the IPO. Valuation of the Reliance Power IPO seemed to be riding on the positive sentiment for the power sector. But there was also some concern about the pricing yet the retail investor blatantly subscribed the upper end of the price band.

So all in all the book building process was a very satisfying one for Mr. Anil Dhirubhai Ambani, who could hardly contain his happiness at the end of it all and vehemently claimed to be the messiah of investor confidence and trust.
But the market euphoria soon ended and the Sensex tanked more than 1400 points on January 21st, 2008, just three days after the book-building process for the R-Power issue ended.

Everyone, from Mr.Anil Ambani to the average retail investor could not see any relief in sight and the market kept wondering as to when the scrip would actually be listed.

At the same time, the situation left a lot of grey market operators fretting. A dispute had broken out among traders in the grey market, where deals had been entered into even before the issue’s price band had been fixed.

Market watchers said the situation had arisen following the company’s decision to float the shares at a face value of Rs 10 instead of Rs 2 as announced earlier.

A section of grey market operators, which had short sold Reliance Power shares in the grey market, and were, staring at potentially huge losses, used this development as a pretext to renege on their commitments. Technically, if there is a change in the face value of a share, the premium or discount will change to reflect the new face value. Also, the volatile market conditions further exacerbated the situation with no one knowing the fate of the scrip.

Transactions in the grey market are done purely on the basis of trust and there are no documents because the activity – though widely prevalent – is outlawed in the first place.

While the issue had been delayed, the premium in the grey market had been steadily on the rise. As a result a lot of grey market players had run up significant losses.

Interestingly, Reliance Power was the first instance of an IPO being traded in the grey market even before the price band had been fixed. Premium or discount in the grey market is linked to the price band. But in the case of Reliance Power, it was the purely the premium that was being traded.

“This (grey) market operates purely on faith and if that is broken, people will be wary of entering into deals,” said a broker who arranged transactions in the grey market. The deals are entered into verbally, and the shares change hands on the trading screen once they are listed. So what was the reason that the thug and the saint both believed in the Reliance Power IPO story alike?

11
Feb
08

Sensex may fall another 20% by year-end: First Global

Shankar Sharma, Vice-Chairman and Joint MD, First Global said the Sensex is likely to go down another 20% by the year end.

Read the complete document, Here

27
Jan
08

Common trading Mistakes

MISTAKE ONE: Lack of Knowledge and No Plan

It amazes that some people expect to trade the stock market successfully without any effort. Yet if they want to take up golf, for example, they will happily take some lessons or at least read a book before heading out onto the course.

The stock market is not the place for the ill informed. But learning what you need is straightforward – you just need someone to show you the way.

MISTAKE TWO: Unrealistic Expectations

Many novice traders expect to make a gazillion dollars by next Friday. Or they start to write out their resignation letter before they have even placed their first trade!

The stock market can be a great way to replace your current income and for creating wealth but it does require time. Not a lot, but some.

MISTAKE THREE: Listening to Others

When traders first start out they often feel like they know nothing and that everyone else has the answers. So they listen to all the news reports and so called “experts” and get totally confused.
And they take “tips” from their buddy, who got it from some cab driver…

MISTAKE FOUR: Getting in the Way

By this we mean letting your ego or your emotions get in the way of doing what you know you need to do.
When you first start to trade it is very difficult to control your emotions. Fear and greed can be overwhelming. Lack of discipline; lack of patience and over confidence are just some of the other problems that we all face.

It is critical you understand how to control this side of trading.

MISTAKE FIVE: Poor Money Management

It never ceases to amaze us how many traders don’t understand the critical nature of money management and the related area of risk management.
This is a critical aspect of trading. If you don’t get this right you not only won’t be successful, you won’t survive!

MISTAKE SIX: Only Trading Market in One Direction

Most new traders only learn how to trade a rising market. And very few traders know really good strategies for trading in a falling market.
If you don’t learn to trade “both” sides of the market, you are drastically limiting the number of trades you can take. And this limits the amount of money you can make.

MISTAKE SEVEN: Overtrading

Most traders new to trading feel they have to be in the market all the time to make any real money. And they see trading opportunities when they’re not even there.




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