Understanding the Equity Linked Debentures

Introduction
With the high volatility in the stock market investors are looking for the investment option which can secure there principal plus provide the assured return to their investment. Equity linked Debentures(ELD) are structured products which protects the principal and provide the return which can linked to basket of stocks or index (like nifty or sensex). ELDs came in two types: (a) principal protected, where the principal amount is fixed while the interest component is variable and linked to stock market movements; (b) the more risky variant is the non-principal protected instruments where even the principal is linked to the market.
These types of structured products are generally sold to the sophisticated investor by the big financial institutions like Merrill Lynch, Deutsche Bank, Kotak etc. The issuer of these instrument investment the part of the money in fixed income securities which generate the fixed return thus keeping the principal intact and part in the equity which give the return of the stock market. Let see how the return is calculated for these instruments.
Say fund houses come with initial value of the nifty which is often the average. The value of nifty for 1, 2&3 is 4000, 4100 & 4200 respectively then the average value comes to 4100 which is initial value calculating the return. Now nifty value for 34, 35 & 36 months is 4500, 4600 & 4800 respectively, average is 4633. The return would be 4633-4100/4100= 13%. So return generated over a period of 3 years would be 13% if the participation ratio was 100%. Participation ratio is the ratio at which ELD participate in the appreciation process. If participation ratio is 100% and return is 13% then total payout on maturity would be Principal+ Participation ratio* Return generated by index which is principal amt.+13% return generated on equity.

Indian Scenario
Comparatively new debt instrument in the Indian market. In India these ELD are mainly issued by foreign financial institutions. Now nearly all the AMC are offering equity FMP plans which provides guarantee of principal amount of investor with upside of equity. All these fund are close ended and there expense ratio is only .25%-1% but they discourage premature withdrawal by charging high exit load of up to 3 Popularly know as capital protection funds, mutual funds are now making these products available to retail investors as well. ICICI Prudential asset management company (AMC) launched their Nifty-linked FMP a closed-ended product and now Deutsche AMC has launched a similar product.
Although these ELD’s generates higher return than traditional FMP’s but financial planner & portfolio managers of the view that an investor can generate the same return or higher return if simple portfolios of stocks and bonds can be purchased and periodically. These products add nothing to retail investors’ portfolios that can’t be acquired from investments “already available in the market in the form of less risky, less complicated, or less costly products” and therefore fail the “reasonable-basis” suitability requirement for sale to retail investors.

Big Mac Index

India despite having a minuscule share in the world trade is part of BRIC, WTO and member of the nuclear club, but we are not yet part of big mac index. Big Mac index is based on the Principal of Purchasing Power Parity(PPP), it says exchange rate will move in a way that make the price of any goods identical across the countries. The logic is that if something is cheaper in one country compares to another, people will buy from first and sell to second till prices in both the countries are identical.

The big mac PPP is obtained by dividing the price of a Big Mac in one currency by its price in another currency. Then compared with the actual exchange rate; if it is lower then, the first currency is undervalued and if it is higher, then the first currency is overvalued. The latest index(in the 26 July magazine) of the Big Mac PPP for 32 countries confirms that most developing country currency excluding Turkey and Brazil, are undervalued. The index doesn't include the rupee why?

one of the reasons is that we don't have standard offering of the Mac Burger which contains beef as it is unacceptable in our country. But index is anyway rough guide to where global exchange should be, so we can look at McChicken Burger for exchange rate measurement. Taking nominal rupee-dollar exchange rate of Rs. 42 dollar, and McChicken Burger with cheese(Rs. 70), the index confirms that rupee is undervalued.

In fact rupee is more undervalued than the Chinese renminibi. According to the index Chinese currency is 49% undervalued against dollar while rupee is 53% undervalued. What it suggest is that we need not get so hyper each time the rupee appreciates since in reality it is hugely undervalued at present. Appreciation of currency bring in more in alignment with its PPP might help rein in prices. But RBI doesn't think so it say pass through of exchange rate is very minimal-less than .09%. But remember we import 70% of our crude oil requirements and though the government has not allowed a full pass-through higher oil prices(preferring instead to subsidise higher oil prices), there is no free lunch. The impact is felt through higher government borrowing to finance these subsidies. Logically therefore , an appreciation o the rupee should help. I think time has come to change our exchange rate policy.

Don't expect quick recovery in the indian equity market.

Don't expect a quick recovery. That's the conclusion from our '8-year' equity cycle model. To support the model's conclusion are weakening fundamental and economic factors, which suggest that a quick recovery in the Indian equity market is a far dream. The equity cycle though is a lead indicator that digs into past data and throws a likely trend. Having depicted a crash in 2008 post Sensex peaking at around 22k levels, the model now shows some pain before consolidation. For a small retail investor, it's a boon. Such investors can now get the opportunity to accumulate at regular intervals for the next boom in the Indian equity market.



History: The 8th Year Itch phenomenon

There was reasoning for every irrational behaviour. No wonder a model that showcased a sharp correction was completely ignored. Also, there were just three cycles before 2008 (for which data was computed) and data was marked by home grown scams. That could have put off some investors. What was however ignored was the fact that these three 40% plus corrections occurred over 28 years (though, Sensex was officially launched in 1986, it has a base of 1978/79 and is back computed). These data points appeared strong enough to base a theory and confidence sparked from the fact that trend lines were replicated every eighth year, though the band inched higher every cycle. So, in all probability, the correction had to happen.



The 40% Plus Corrections

1984 - Riots, Assassination, Bhopal Gas Tragedy, Economic Crisis

1992 - Harshad Mehta Scam

2000 - Ketan Parekh Scam/Dot com bubble bust

2008 - Sub prime meltdown



And then, one fine day in January 2008, it all came raining down. Sensex tanked and within a few trading sessions lost over 25%. Since then a lot has changed, fundamentals have deteriorated and economic events worsened. The Sensex is struggling to regain lost glory. If the cycle is to be believed, the recovery may not happen as yet. There's still some pain left.



The First Hit

Year 1984 1992 2000 2008
Sensex High 410 4467 5934 21207
Sensex Low 242 2476 3590 14809
Decline -41% -45% -40% -30%
Time 8mths 8mths 3mths

Note: Sensex Level on closing basis. Decline may be higher if calculations are based on intra-day high/low of Sensex



Recovery from the Lowest Point during the Correction Cycle

Year 1984 1992 2000 2008 High 410 4467 5934 20873
Lowest point NA 2084 2617 14809
Decline NA -53% -56% -30%
Time to Lowest Point NA 12mths 19mths
Recovery to Old Top 27mths 46mths


Note: Sensex Level on closing basis. Decline may be higher if calculations are based on intra-day high/low of Sensex



As evident from above, the corrections in every cycle were steep and fast. This was followed by a long cooling period, which could be 15-25 months. Once the base is built, the benchmark index swiftly moved up to achieve the earlier top that takes 27-46 months. At these levels, bouts of profit booking occurred from investors who believed a healthy correction was needed for markets to smoothly sail ahead. Eventually the underlying momentum on the back of strong fundamentals came into play and the index zoomed ahead to make newer highs.



The Current Phase

The 2008 cycle, in all probabilities, is the latest cycle. The benchmark index has corrected 30% odd and has witnessed some bounce back. If the cycle is to be believed, we may see some more pain in the offing - 10% or more.



The bounce back lacks strength. If you observe the chart below closely you would see that once the correction started, the Sensex has made lower tops and lower bottoms. These are signs of weakness in the equity market.



Weakness in the current equity market is evident - oil issues, MTM losses, inflation concerns, fiscal deficits, and US subprime concerns among others. There is no escaping to this fact. The market knows all these and seems to have been factored such events.. FIIs have already pumped out $5.6bn out of India and are reducing India Inc. ownership.



The other element one could consider is the US Presidential cycle. According to the theory, the US equity market bottoms out 1.8 years into the Presidential term. And recently we have seen that Indian equity market is not decoupled with the US market.

The Future
India's long term infra led growth story stays. However, we need to go through the current pain in order to witness the new Bull Run. As of now, Sensex EPS is expected to slow down. A 10-15% range would take Sensex EPS to Rs 950 valuing the market at 17 times FY09 earnings. Looking at the current market conditions, it appears expensive


MANISH BANSAL
MBA(FINANCE)

Indian are the not responsible for the high commodity prices

Recently American President George Bush blamed emerging economies like India and China for rising commodity prices around the world. I would say American are itself are the reason for the high food prices around the world. Americans are the largest consumer of meat around the world it is estimated that an average american eat 125kg of meat every year, and if we total figure comes to 35,000,000 tonnes meat every year. An average Chinese eat 70kg meat every year. Thing I want to highligh here is that animals are poor converter of energy for e.g. a cow takes 16kg of food grains to convert 1kg of meat and over 70% of the foodgrains produced in America is consumed by the cows and pigs for producing meat.

Meat is also an inefficient energy provider. would you believe that a beef eater needs more energy walking 1 kilometre than a car. and example would prove this point. The beef eater would spend 70kcal in wlaking 1 km . letus say he gets this energy back by eating a piece of beef containing 70 kcal. The beef-cow would have eaten foodgrains contining 1120 kcal to produce this piece of beef. The meat supply chain further necessiate chilled storage during transportation,warehousing, retainling and at beef-eater's domestic refrigerator tatalling 2240kcal. what quantiy of petrol would contain 2240 kcal. ? 70ml of petrol! And a car would go more that 1km.

Present Indian consumption is 3kg percaptia per year and all indian put together consume 3million tonnes of meat every year. presently indian cow feed on grass and pigs on garbage. Imaging if 70% of Indian foodgrains go feeding animals producing meat.

we Can't forget water, 10,000 litres of water is needed to produce 1kg of beef. where is water to produce million tonnes of meat. There is also a problem of disposing million tonnes of animal waste. So picture is clear in front is who is causing or reason for global food prices. why to blame ethanol?

Career Opportunities in Commodity Market

commodity is one field that is for long is overlooked by the Indian youth. If you look at the growth in indian commodity market you will find that it has surpassed all other commodity markets around the world in terms of volume growth. Indian commodity market now has a turnover of 70% of India's total GDP, which is very much huge when we compare to the other economies of the world. Also India is great Commodity producing country rich in natural resources and minerals. Now India and China has become the largest consumer of commodities due to strong growth in their economies.
During my research i found there is too much commodity player in the market and those are doing commodity business have the inherent shortage of the skilled labour. Many commodity trader failed due the shortage of the skilled manpower. As indian Commodity market is 4 years old there too much lack of people who have the good knowledge about the commodity market. It is predicted by the famous commodity guru JIM ROGERS that bull run in the equity market has over now it is the turn of the commodity market which we are seeing right now prices many commodity has now nearly doubled in recent last one year. This is one of the reason that Indian governement has banned many agri-commodity recently. following are the careers available to the commodity aspriants.
-dealer
-researcher
-speculator
-researcher
-manager
-delivery manager
many more similiar career opportunity available which has very much high growth potential.


manish bansal

Commodities as an asset class for investors

Recent years have seen a profound re-appraisal by many financial market players of the merits of commodity-related investments, both in terms of the companies that extract, refine, transport and market such key building blocks of modern economies and directly in those commodities themselves, their financial derivatives, and especially in indices of those commodities.
Commodities have once again risen to prominence, after a long period in the shadows.
The current market cycle has seen (at least until the recent turmoil around sub-prime mortgages) most asset classes appreciate in price in a high-liquidity, low inflationary environment, fuelled by easy credit conditions and additional liquidity from arbitrage between low- and high-yielding currencies.
Correlations-with prices tending to move in a similar direction or magnitude-increased across many asset classes, and risk premia between lower- and higher-risk investments were pared in the search for returns from a seemingly exponentially expanding pool of global investment capital.
Whilst these processes have played themselves out, commodities have once again risen to prominence, after a long period in the shadows. The stock market fall-out of 2000-2003 temporarily reduced some attractiveness of equities for long-side investment, while falls in interest rates put yields for more secure investment grade bonds under pressure.
As a result many investment managers have returned to commodities in one form or another in their search for alpha returns, and for themes to attract the ever-growing global pool of funds looking for a home.
Commodities have attracted their attention for a number of reasons, not least their recent upside price performance, their negatively- correlated portfolio diversification benefits against stocks and bonds, and as a hedge against inflation.
According to recent research, they have a happy knack (when aggregated in indices of commodity futures, at least) of tending to perform at their relative best exactly when stock and bond markets are at their most vulnerable, during the late periods of expansion and early periods of cyclical downtrends in the business cycle.


Manish Bansal
MBA(Finance)

MBA new horizon for success

This blog is for the mba student, who need help regarding their projects and how to go about in mba. This blog will provide information regarding all economic data, and what is happening around the world. You will updated with good articles in different fields which also help you to increase your knowledge