Floating & Fixed Exchange Rates

Hey guys, do you know the foreign exchange market is the largest market in the world? In fact, over $1 trillion is traded in the currency markets on a daily basis. This article is certainly not a primer for currency trading, but it will help you understand exchange rates and why some fluctuate while others do not.

What Is an Exchange Rate?

An exchange rate is the rate at which one currency can be exchanged for another. In other words, it is the value of another country's currency compared to that of your own.

Fixed

A fixed (pegged) rate is a rate the government (central bank) sets and maintains as the official exchange rate. A set price will be determined against a major world currency (usually the U.S. dollar, but also other major currencies such as the euro, the yen, or a basket of currencies). In order to maintain the local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged.

In order to maintain the rate, the central bank must keep a high level of foreign reserves. This reserved amount can be used to release (or absorb) extra funds into (or out of) the market. This ensures an appropriate money supply, appropriate fluctuations in the market (inflation/deflation), and ultimately, the exchange rate.

Floating

Floating exchange rate is determined by the private market through supply and demand. A floating rate is often termed "self-correcting", as any differences in supply and demand will automatically be corrected in the market. If demand for a currency is low, its value will decrease, and vice – versa.

The World Once Pegged

Between 1870 and 1914, there was a global fixed exchange rate. Currencies were linked to gold, meaning that the value of a local currency was fixed at a set exchange rate to gold ounces. This was known as the gold standard. This allowed for unrestricted capital mobility as well as global stability in currencies and trade; however, with the start of World War I, the gold standard was abandoned.

At the end of World War II, the conference at Bretton Woods, in an effort to generate global economic stability and increased volumes of global trade, established the basic rules and regulations governing international exchange. As such, an international monetary system, embodied in the International Monetary Fund (IMF), was established to promote foreign trade and to maintain the monetary stability of countries and therefore that of the global economy

It was agreed that currencies would once again be fixed, or pegged, but this time to the U.S. dollar, which in turn was pegged to gold at USD 35/ounce. The peg was maintained until 1971, when the U.S. dollar could no longer hold the value of the pegged rate of USD 35/ounce of gold.

From then on, major governments adopted a floating system, and all attempts to move back to a global peg were eventually abandoned in 1985. Since then, no major economies have gone back to a peg, and the use of gold as a peg has been completely abandoned.

Why Peg?

The reasons to peg a currency are linked to stability. Especially in today's developing nations, a country may decide to peg its currency to create a stable atmosphere for foreign investment. With a peg the investor will always know what his/her investment value is, and therefore will not have to worry about daily fluctuations. A pegged currency can also help to lower inflation rates and generate demand, which results from greater confidence in the stability of the currency.

Pegging Problems

Ø Mexican (1995), Asian and Russian (1997) financial crises

Ø Loss of independent monetary policy

Ø Transmission of shocks from anchor country (1995 Mexican Currency Crisis)

Ø Speculative attacks may leads BLACK MARKET which may leads to heavy re/devaluation of currency.

BOTTOM LINE…

In reality, no currency is wholly fixed or floating.

Sources…

Investopedia.com

Research paper from Fredrick Mishkin – Exchange Rate Pegging in Emerging Market Countries.

China Vs India

For yesterday’s post, Auxi asked me, why everybody talk about China and then India? Why not India and then China!!! See there are many reasons why people talk about China first. Namely

Ø It began opening its economy three decades ago, the nation has lifted more people out of poverty than any other nation in modern times and is poised to become the world’s third largest economy (Till now they have lifted 250+ million people from BPL, below poverty line).

Ø In 1992 itself China created 6 million private jobs.

Ø China’s Economic Reforms contains

o Except profitable government industries, they privatized/disinvested the other government industries.

o They study other Asian countries strategies and implement the useful ones. Because of this their import/export policy very strong.

o Promoting FDI.

o Development of Human Resource and creating a development friendly environment.

o They target 20% of GDP annually.

Ø China’s per capita income is round about $ 2300 and India’s is $ 950

Ø India implemented Family Planning in 1952 and China in 1970. But in 2001 birth rate in India is more than tripled as compared to China.

Ø China’s Labor sincerity. Not like ours.

Now coming to problems of China, it is facing some problems like…

Ø Chinas population is growing older. According to one survey in 2020 China is going to face 10 million people scarcity. A smaller number of workers will have to support an increasing number of elderly. The United Nations projects that China working age population will account for a decreasing share of the total after 2010, and will start shrinking in absolute terms after 2015.

Ø The strategies that have helped China grow from poverty to its current levels will not yield the same dividends in the future, says Homi Kharas, a scholar at the Brookings Institution and the World Banks former chief economist for Asia.

Ø In recent months, China has been plagued by shortages of petrol and electricity, illustrating the limits to its consumption. Chinas 1.3 billion people each consumed the equivalent of 1.4 tonnes of oil in energy last year. If each Chinese were to consume the same amount of energy as each person in the US does” the equivalent of 7.82 tonnes of oil” then China alone would consume nearly as much energy as the entire world does now.

Ø Just 30 years after it began moving away from socialism, China has become one of the world’s most unequal societies, based on measures of the gap between richest and poorest. Initially, the widening disparity was beneficial” forced equality under Mao Zedong prevented people from being productive. Today, it increasingly contributes to social instability, as people who lose their homes to make way for factories and others displaced by development express displeasure in sometimes violent protests.

Ø And many more, which I am not know………….

Now talking about India, I can’t say when India can take over US or China. But India has some advantages like it can become human power. According to one study, now 36% of population is under 15 years. By 2020 India can outsource 17, 10, 19, 6, million human power to US, China, Japan and Russia respectively.

And in addition this I can only say that, India needs to lot of reforms as China & Japanese did in 80 and 90s.

Resources

Udayvani (Kannada news paper)

Mint

TOI Article

India to reclaim Mughal-age economic aura

India and China are set to become the world's leading economic and political powers in about 50 years reclaiming the glory of the year 1700 when Mughal India and Qing China each accounted for about one-fourth of world GDP, a leading German bank said on Tuesday.

According to data compiled by economic historian Angus Maddison, as recently as 1700, Qing China and Mughal India each represented a little less than 25 per cent of world GDP, but their respective shares dropped to less than 5 per cent by 1950, the Deutsche Bank said in a report.

However, China and India are poised to reclaim their places as the world's largest economies over the next half century, Deutsche Bank Research said in the report.

Noting that the four BRIC nations Brazil, Russia, India and China are characterized by high economic growth rates, large populations and expanding middle classes, the report said China and India would "re-emerge as major economic and political powers over the next fifty years or so and China is projected to replace the United States as the world's largest economy by 2040."

In his book The World Economy: A Millennial Perspective, economic historian Angus Maddison has noted that during the years 0 to 1000, India figured as the world's pre-eminent economic power, closely followed by China. During 1500-1600 years also, India was only next to China in terms of world GDP share and remained among the top till as late as 17th century.

India was the world's largest economy with a 32.9 per cent share of the worldwide GDP in the first century and 28.9 per cent in the 11th century.

In 1700, when most part of the country was ruled by Mughals, India had a 24.4 per cent world GDP share, higher than entire Europe's 23.3 per cent. However, thereafter, it started falling and slipped below four per cent by 1952 and further to its lowest 3.1 per cent in 1973.

During 1700, when India was mostly ruled by the Mughals, China was being ruled by the Qing dynasty.

According to Deutsche Bank, the BRIC nations have different economic strategies. China relies on large domestic savings and high investment rates, a competitive exchange rate and a manufacturing-based export-oriented strategy, while the other three countries follow different models.

Further, it noted that while India's growth is heavily concentrated in services (and lagging in manufacturing), Brazil pursues a diversified growth strategy focusing on services, manufacturing and commodities simultaneously.

"These differences in economic strategy, especially as pertains to trade openness, stability of export revenues and savings generation capacity, are of relevance to the BRIC countries emerging role as international investors," the report said.

Moreover, China would be a major net capital exporter over the next decade mainly due to its large domestic savings and export-oriented development strategy.

Deutsche Bank pointed out those government-controlled external assets would increase in all BRIC countries and added, "on account of its large current account surpluses and large FDI inflows, China will also dwarf the other BRICs in terms of gross external asset accumulation, especially if the Chinese authorities continue to liberalize inward investment."

Nonetheless, all the four countries would emerge as important international investors, it added.

Sean's Comments

Hi Naveen, I thought your post was well written and succinct. If you would like more information on these instruments I run a couple of web sites that may be of interest:

http://www.otcderivatives.co.uk/index.htm

http://derivatives.blogware.com

Regards, Sean

Mr. Nifty Mehra's Comments

Hi, Naveen

For better understanding and examples of Derivatives all of us can visit the website - www.derivativesindia.com

Thanks and Regards,

Udit Mehra

Anna's Comments

The insight given by you on derivatives is really very good and simple. The way you explained options with example made it easy to understand. But if you can explain call and put options with example it will be helpful. Hope to see more on derivatives...

Anna's Comments

The insight given by you on derivatives is really very good and simple. The way you explained options with example made it easy to understand. But if you can explain call and put options with example it will be helpful. Hope to see more on derivatives...

Adi's Comments

Hey Naveen thanks for considering my request to post some simple stuff I really liked the way u gave the examples with which v can easily relate to anyways good job and expecting similar results from u .

Regards,

Adi

Derivatives (Futures and Options)

Other day my roomy Mr. Amit Chauhan asked me post something about F&O. And yesterday Anurag also asked me about it. And people like Adi and Tenzin are asking me to keep it as simple as possible. But when I want to write about Derivatives, I don’t think it is going to be simple, since derivatives are the most complex and riskier financial instruments. And more importantly I don’t trade in derivative segment, so I am also little untouched in this. But whatever little I know and whatever I got in the net I am posting that. So bear with me in this…

Derivative instrument

A derivative, as the name suggests, is a financial instrument whose value is derived from another asset (known as the underlying). The underlying can be a stock, a commodity, and a market index among other things. The value of the derivative instrument changes according to the changes in the value of the underlying. Futures and Options represent two of the most common form of "Derivatives".

Derivatives are of two types -- Exchange traded and Over The Counter (OTC).

Exchange traded derivatives are traded through organized exchanges around the world. These instruments can be bought and sold through these exchanges, just like the stock market. Some of the common exchange traded derivative instruments are futures and options.

Over the counter (OTC) derivatives are not traded through the exchanges. Some of the popular OTC instruments are forwards, swaps, swaptions etc.

Now I am posting only about F&Os not any other derivative instrument and let me start with option first…

Options

An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date.

Confused!!! Let me give an example. Once you decide to purchase a plot for Rs 400000. But don’t have that much amount right now with you so talk to the owner and negotiate a deal that give you an option to buy the plot in three months for a price of 400000. The owner agrees, but for this option, you pay a price of 4000.

Now there are two possibilities…

1. For some reason, value of the plot doubled in 3 months then at that time actual value will be 800000. But owner entered a contract with you for 400000 he has to sell you for 400000 only. Then you make a profit of 396000 (800000-40000-4000)

2. For some reason value of the plot reduced by 50% in 3 months

then its value will be 20000. Since you entered in Option

you need not buy that after 3 months. So you will loose only

Rs. 4000 what you paid for option contract.

Options are classified into American, which can be exercised at any time prior to the expiry date and European which can only be exercised at the expiry date.

In India options on individual stocks are American-style while options on indices like the Nifty are European.

Call and Put Options

The two types of options are calls and puts

A call gives the holder the right to buy an asset at a certain price (strike price) within a specific period of time. Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires.

A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires.

There are four types of participants in options markets depending on the position they take:

1. Buyers (holders) of calls
2. Sellers (writers) of calls
3. Buyers (holders) of puts
4. Sellers (writers) of puts

Buyers (holders) of the option contract (call or put) are not obligated to buy or sell. They have the choice to exercise their rights if they choose.

Sellers (writers) of the option contract (call or put) however, are obligated to buy or sell. This means that if the buyer/seller wants to buy/sell the asset, the seller of the contract has to buy/sell it. He does not have a right.

Terminology

To know option well you need understand certain terminologies

Strike price: The price at which an underlying stock can be purchased or sold.

In the money: For call options if the share price is above the strike price and put option is in-the-money when the share price is below the strike price. Its nothing but profit. Whether your contract is in profit or not!!!

Intrinsic value: The amount by which an option is in-the-money is referred to as intrinsic value. Means how much profit you are making.

Premium: The total cost of an option contract is called the premium. This price is determined by factors including the stock price, strike price, time remaining until expiration (time value) and volatility. And calculation of premium is complicated and I also don’t know about it.

How options work

Let's say that on May 1, the stock price of Mutnal & Mutnal Co. is Rs 67 and the premium is Rs 3.15 for a July 70 Call, which indicates that the expiration is the last Thursday of July and the strike price is Rs 70. The total price of the contract is Rs 3.15 x 100 = Rs 315. In reality, you'd also have to take commissions into account, but we'll ignore them for this example.

Remember, a stock option contract is the option to buy 100 shares; that's why you must multiply the contract by 100 to get the total price. The strike price of Rs 70 means that the stock price must rise above Rs 70 before the call option is worth anything; furthermore, because the contract is Rs 3.15 per share, the break-even price would be Rs 73.15.

Three weeks later the stock price is Rs 78. The options contract has increased along with the stock price and is now worth Rs 8.25 x 100 = Rs 825. Subtract what you paid for the contract, and your profit is (8.25 - 3.15) x 100 = Rs 510. You almost doubled our money in just three weeks! You could sell your option, which is called "closing your position," and take your profits - unless, of course, you think the stock price will continue to rise. For the sake of this example, let's say we let it ride.

By the expiration date, the price drops to Rs 62. Because this is less than our Rs 70 strike price and there is no time left, the option contract is worthless (I mean you don’t exercise your contract). You are now down to the original investment of Rs 315.

Futures

A 'Future' is a contract to buy or sell the underlying asset for a specific price at a pre-determined time. If you buy a futures contract, it means that you promise to pay the price of the asset at a specified time. If you sell a future, you effectively make a promise to transfer the asset to the buyer of the future at a specified price at a particular time.

Unlike options, buying a futures contract gives you the obligation to buy the underlying and thus involves greater risk. Another difference is that commodities like gold, cotton, crude oil etc are especially prominent in futures markets.

In every futures contract, everything is specified: the quantity and quality of the commodity, the specific price per unit, and the date and method of delivery. The “price” of a futures contract is represented by the agreed-upon price of the underlying commodity or financial instrument that will be delivered in the future.

Futures transactions can be settled in three ways: squaring off, delivery and cash settlement.

Squaring off means taking a position opposite your initial one. For example, you square off the purchase of a gold futures contract by selling the identical contract.

Delivery means physically delivering the underlying asset on the agreed date. If you sell a gold futures contract of say 1 kilogram then you will have to give real gold to the buyer on the mutually agreed date.

Cash settlement involves paying the difference between the futures price and the spot price of the underlying asset.

For example, if you sell a gold futures contract worth one kilogram for say Rs 1.2 lakh and the price of the contract on expiry day is Rs 1.3 lakh then you will have to pay the buyer the difference of Rs 10,000.

How Futures work

Buy a contract

In Futures, you buy a contract which will have a specific lot size depending on the stock.

Let's say you want to buy an Infosys Futures contract. This will comprise 100 shares. Or, you want to buy a HPCL Futures contract. This will be a lot of 650 shares. In Futures, you buy a lot. The lot size is set for each futures contract and it differs from stock to stock.

Margin payment

When you buy a Futures contract, you don't pay the entire value of the contract but just the margin. This margin amount too is prescribed by the exchange.

Let's say you buy a HPCL Futures contract. And the price of each HPCL share is Rs 311. This will amount to Rs 202150 (Rs 311 x 650 shares).

You don't pay the entire amount of Rs 202150. You only pay 15% to 20% of that amount and this is called the margin amount.

The margin depends on what the exchange sets for the day. Based on certain parameters, it declares the margin for each stock.

So the margin for Infosys will vary from, say, HPCL.

Let's say the margin for the HPCL Futures is 15%. So you end up just paying just Rs 30322 (not Rs 202150).

How you make or lose money

You purchased a HPCL Futures contract and the underlying price is Rs 311 per share. Let's say, the next day it moves to Rs 312. The difference is Rs 1 per share (312 - 311). You get a credit Rs 650 (Rs 1 per share x 650 shares). The following day, it dips to Rs 310. The difference is Rs 2 per share (312 - 310). Since the price has dipped, Rs 1,300 (Rs 2 per share x 650 shares) is debited from your account.

This will go on till you sell the Futures contract or it expires (last Thursday of the month). So, on a daily basis you make and lose money.

Sources…

Rediffmail.com

Investopedia.com

World's 8 biggest stock exchanges

According to July 2008 data released these are 8 biggest stock exchanges.

1. New York Stock Exchange: $21.79 trillion share trades

The New York Stock Exchange (NYSE) is nicknamed the 'Big Board'. This is the largest stock exchange in the world by dollar volume with 2,764 listed securities. It has the second most securities of all stock exchanges.

The NYSE originated on May 17, 1792. On that day, the Buttonwood Agreement was signed by 24 stock brokers outside New York's 68 Wall Street under a buttonwood tree.

2. NASDAQ: $11.81 trillion share trades

The NASDAQ is the acronym for National Association of Securities Dealers Automated Quotation System. An American stock exchange, NASDAQ is the largest electronic screen-based equity securities trading market in the US.

It is owned and operated by the NASDAQ OMX Group.

With about 3,200 companies in its ambit, NASDAQ has more trading volume per day than any other stock exchange.

NASDAQ came into being in 1971 by the National Association of Securities Dealers.

NASDAQ was the successor to the over-the-counter (OTC) and the 'Curb Exchange' systems of trading. As late as 1987, the NASDAQ exchange was commonly referred to as the OTC.

3. The London Stock Exchange: $7.57 trillion share trades

London Stock Exchange, or LSE, is located in London, England. It is part of the London Stock Exchange Group plc. One of the largest stock exchanges in the world, LSE was founded in 1801.

The trade in shares in London began with the need to finance two voyages: The Muscovy Company's attempt to reach China via the White Sea north of Russia, and the East India Company voyage to India and the east.

Unable to finance these costly journeys, the companies raised the money by selling shares to merchants, giving them a right to a portion of any profits eventually made.

4. Tokyo Stock Exchange: $5.82 trillion share trades

The Tokyo Stock Exchange, or TSE, located in Tokyo, Japan, is the second largest stock exchange in the world by market value, second to the New York Stock Exchange, but 4th in terms of worth of shares traded.

It currently lists 2,271 domestic companies and 31 foreign companies.

The Tokyo Stock Exchange was established on May 15, 1878, as the Tokyo Kabushiki Torihikijo under the direction of then Finance Minister Okuma Shigenobu and capitalist advocate Shibusawa Eiichi. Trading began on June 1, 1878.

In 1943, the exchange was combined with 10 other stock exchanges in major Japanese cities to form a single Japanese Stock Exchange. The combined exchange was shut down and reorganized shortly after the bombing of Nagasaki.

5. Euronext: $3.85 trillion share trades

Euronext N.V. is a pan-European stock exchange based in Paris with subsidiaries in Belgium, France, Netherlands, Luxembourg, Portugal and the United Kingdom.

In addition to equities and derivatives markets, the Euronext group provides clearing and information services.

Not too long ago, Euronext merged with NYSE Group to form NYSE Euronext, the 'first global stock exchange'.

Euronext was formed on September 22, 2000 in a merger of the Amsterdam Stock Exchange, Brussels Stock Exchange, and Paris Bourse.

In December 2001, Euronext acquired the shares of the London International Financial Futures and Options Exchange, which continues to operate under its own governance.

6. Deutsche Borse: $2.74 trillion share trades

Deutsche Borse AG is a marketplace organizer for the trading of shares and other securities. It also is a transaction services provider. It gives companies and investors access to global capital markets.

Deutsche Borse was founded in 1992. The headquarters are in Frankfurt, Germany.

More than 3,200 employees of the exchange serve customers in Europe, the US and Asia. Deutsche Borse has locations in Germany, Luxembourg, Switzerland, Czech Republic and Spain, as well as representative offices in London, Paris, Chicago, New York, Hong Kong, and Dubai.

FWB Frankfurter Wertpapierborse (Frankfurt Stock Exchange), is one of the world's largest trading centers for securities. With a share in turnover of around 90 per cent, it is the largest of the German stock exchanges.

Deutsche Borse AG operates the Frankfurt Stock Exchange.

In 2001, Deutsche Borse tried to merge with the London Stock Exchange, followed in 2006 by a takeover bid, both rejected by LSE.

7. Borsa Italiana: $1.59 trillion share trades

The Borsa Italiana based in Milan, is Italy's main stock exchange. It was privatized in 1997, and was acquired by the London Stock Exchange in October 2007.

Borsa Italiana has managing responsibility for Italy's derivatives markets and its fixed income market.

Milan's Borsa di Commercio (Commodities Exchange) opened under a vice-royal decree on 16 January 1808 and it operated under public ownership until 1998.

It was sold to a consortium of banks, and operated under a S.p. A. holding company between January 2, 1998 and an all-share takeover by the London Stock Exchange on October 1, 2007.

8. SWX Swiss Exchange: $1.40 trillion share trades

SWX Swiss Exchange is Switzerland's stock exchange, based in Zurich.

The main stock market index for the SWX Swiss Exchange is the SMI. The index consists of the 20 most significant equity-securities based on the free float market capitalization.

The exchange also trades other securities such as Swiss government bonds and derivatives such as stock options.

The SWX is the first stock exchange in the world to incorporate a fully automated trading system in 1995.

The SWX is the joint owners of the Eurex, world's largest futures and derivatives exchange along with their German partners Deutsche Borse.

Sources

Rediffmail.com

http://www.world-exchanges.org/WFE/home.asp?menu=395 (really good one)

Inflation

Hi guys, I am back with again inflation topic. Now days everybody is talking about inflation. So when I was browsing in the net I got this article, and I felt this is good article to read. I tried maximum to edit it, even after that it fetched to 4-5 pages…

Inflation is no stranger to the Indian economy. In fact, till the early nineties Indians were used to double-digit inflation and its attendant consequences. But, since the mid-nineties controlling inflation has become a priority for policy framers.

While inflation till the early nineties was primarily caused by domestic factors (supply usually was unable to meet demand, resulting in the classical definition of inflation of too much money chasing too few goods), today the situation has changed significantly. Inflation today is caused more by global rather than by domestic factors.

Global imbalance the cause for global liquidity

Global economy is in a state of extreme imbalance. This is simply because developed western economies, are consuming on a massive scale leading to gargantuan trade deficits.

Crucially their extreme levels of consumption and imports are matched by the developing countries having an export-driven economic model. Thus while developing countries produces, exports and also saves the proceeds by investing their forex reserves back in these countries, developed countries are consuming both the production and investment originating from the developing countries.

In effect, developing countries are building their foreign exchange reserves while the developed countries are accumulating the corresponding debt. For instance, the US current account deficit is estimated to be 7 per cent of GDP in 2006 and stood at approximately $900 billion. Obviously, the current account deficit of the US becomes the current account surplus of other exporting countries, viz. China, Japan and other oil producing and exporting countries.

The reason for this imbalance in the global economy is the fact that after the Asian currency crisis; many countries found the virtues of a weak currency and engaged in 'competitive devaluation.'

Under this scenario, many countries simply leveraged their weak currency against the US dollar to gain to the global markets. This policy to maintain their competitiveness is achieve and leading to accumulation of foreign exchange, notably the US dollar, against their own currency.

Implicitly it means that the developing world is subsidizing the rich developed world. Put more bluntly, it would mean that the US has outsourced even defending the dollar to these countries, as a collapse of the US currency would hurt these countries holding more dollars in reserves than perhaps the US itself!

Naturally, as the players fear a fall in the value of the dollar and reach out to various assets and commodities, the prices of these commodities and assets too will rise.

The psychological dimension

But as the imbalance shows no sign of correcting, players seek to shift to commodities and assets across continents to hedge against the impending fall in the US dollar. Thus, it is a fight between central banks and the psychology of market players across continents.

As a corrective measure, economists are coming to the conclusion that most of the currencies across the globe are highly undervalued against the dollar, which, in turn, requires a significant dose of devaluation. For instance, Yen is one of the most highly undervalued currencies (estimated at around 60%) along with the Chinese Yuan (estimated at 50%) followed by other countries in Asia. This artificial undervaluation of currencies is another fundamental cause for increasing global liquidity.

To get an idea of the enormity of the aggregation of these two factors on the world's supply of dollars, Jephraim P. Gundzik calculates the dollar value of rising prices of just one commodity -- crude oil.

In 2004, global demand for crude oil grew by a mere four per cent. Nevertheless higher oil prices advanced by as much as 34 per cent. Consequently, it is this factor that significantly contributed to increase the world's dollar supply by about $330 billion.

In 2005, international crude oil prices gained another 35 per cent and global demand for oil grew by only 1.6 per cent. Nonetheless, the world's supply of dollars increased by a further $460 billion.

Naturally, with all currencies refusing to be revalued, this leads to increased global liquidity. While one is not sure as to whether the increase in the prices of crude led to the increase of other commodities or vice versa, the fact of the matter is that, in the aggregate, increased liquidity has led to the increase in commodity prices as a whole.

What has further compounded the problem is the near-zero interest rate regime in Japan. With almost $905 billion forex reserves, it makes sense to borrow in Japan at such low rates and invest elsewhere for higher returns. Obviously, some of this money -- estimated by experts to be approximately $200 billion -- has undoubtedly found its way into the asset markets of other countries.

Most of it has been parked in alternative investments such as commodities, stocks, real estates and other markets across continents, leveraged many times over. Needless to reiterate, the excessive dollar supply too has fuelled the property and commodity boom across markets and continents.

The twin causes -- excessive liquidity due to undervaluation of various currencies and fear of the US dollar collapse leading to increased purchase of various commodities to hedge against a fall in US dollar (psychological) -- needs to be tackled upfront if inflation has to be confronted globally.

Higher international farm prices impact Indian farm prices

What actually compounds the problem for India is the fact that lowers harvest worldwide, specifically in Australia and Brazil, and the overall strength of demand Vs supply and low stock positions world over, global wheat prices have continued to rise.

Wheat demand is expected to rise, while world production is expected to decline further in the coming months, as a result of which global stocks, already at historically low levels, may fall further by 20 per cent. These global trends have put upward pressure on domestic prices of wheat and are expected to continue to do so during the course of this year.

No wonder, despite the government lowering the import tariffs on wheat to zero, there has been no significant quantity of wheat imports as the international prices of wheat are higher than the domestic prices.

Growth and forex flows

Another cause for the increase in the prices of these commodities has been due to the fact that both India and China have been recording excellent growth in recent years. It has to be noted that China and India have a combined population of 2.5 billion people.

Given this size of population even a modest $100 increase in the per capita income of these two countries would translate into approximately $250 billion in additional demand for commodities. This has put an extraordinary highly demand on various commodities. Surely growth will come at a cost.

The excessive global liquidity as explained above has facilitated buoyant growth of money and credit in 2005-06 and 2006-07. Crucially, incremental flow of foreign exchange into the country has resulted in increased credit flow by our banks. Naturally this is another fuel for growth and crucially, inflation.

Reserve Bank of India's strategy of dealing with excessive liquidity through the Market Stabilization Scheme (MSS), the increase in repo and CRR rates are policy interventions with serious limitations in the Indian context with such huge forex inflows.

How about the revaluation of the Indian Rupee?

Economic policy rests in the triumvirate of fiscal, monetary and trade policies. Theoretical understanding of economics meant that these policies are interdependent.

Also, one needs to understand that growth naturally comes with its attendant costs and consequences. While these policies are usually intertwined and typically compensatory, one has to understand that the issues with respect to inflation cannot be subjected to conventional wisdom in the era of globalization.

One policy route yet unexamined in the Indian context by the government is the exchange rate policy, especially revaluation of the Rupee as an instrument to control inflation.

It is time that we think about a revaluation of the Indian Rupee as a policy response to the complex issue of managing inflation; while simultaneously address the constraints on the supply side on food grains through increase in domestic production.

A higher Rupee value against the dollar would mean lower purchase price of commodities in Rupee terms. The Indian economy has undergone significant changes in the past decade and a half. With increased linkages to the global economy, it cannot duck the negatives of globalization.

Source…

Rediffmail.com

Author--M R Venkatesh

Chennai-based chartered accountant

“TECHNICALS” of fundamental analysis

Even though I don’t follow the so called fundamental analysis, I am posting this posting for my readers. People like Mr. Nifty Mehra, Rambhai & some others will be happy to see this and they can give more input on this, as I don’t practice fundamental analysis. (I strictly go by technicals)…

Fundamental analysis is the process of looking at a business at the basic or fundamental financial level. This type of analysis examines key ratios of a business to determine its financial health and gives you an idea of the value its stock.

Earnings

It’s all about earnings. When you come to the bottom line, that’s what investors want to know. How much money is the company making and how much is it going to make in the future. Increasing earnings generally leads to a higher stock price and, in some cases, a regular dividend. When earnings fall short, the market may hammer the stock.

While earnings are important, by themselves they don’t tell you anything about how the market values the stock. To begin building a picture of how the stock is valued you need to use some fundamental analysis tools.

EPS = Net Earnings / Outstanding Shares

For example, companies A and B both earn $100, but company A has 10 shares outstanding, while company B has 50 shares outstanding. Which company’s stock do you want to own?

Using example above, Company A had earnings of $100 and 10 shares outstanding, which equals an EPS of 10 ($100 / 10 = 10). Company B had earnings of $100 and 50 shares outstanding, which equals an EPS of 2 ($100 / 50 = 2).

So, you should go buy Company A with an EPS of 10, right? Maybe, but not just on the basis of its EPS. The EPS is helpful in comparing one company to another, assuming they are in the same industry, but it doesn’t tell you whether it’s a good stock to buy or what the market thinks of it. For that information, we need to look at some ratios.

Three types of EPS numbers:

• Trailing EPS – last year’s numbers and the only actual EPS
• Current EPS – this year’s numbers, which are still projections
• Forward EPS – future numbers, which are obviously projections

P/E = Stock Price / EPS

For example, a company with a share price of $40 and an EPS of 8 would have a P/E of 5 ($40 / 8 = 5).

What does P/E tell you? The P/E gives you an idea of what the market is willing to pay for the company’s earnings. The higher the P/E the more the market is willing to pay for the company’s earnings. Some investors read a high P/E as an overpriced stock and that may be the case, however it can also indicate the market has high hopes for this stock’s future and has bid up the price. Conversely, a low P/E may indicate a “vote of no confidence” by the market or it could mean this is a sleeper that the market has overlooked.

What is the “right” P/E? There is no correct answer to this question, because part of the answer depends on your willingness to pay for earnings. The more you are willing to pay, which means you believe the company has good long term prospects over and above its current position, the higher the “right” P/E is for that particular stock in your decision-making process. Another investor may not see the same value and think your “right” P/E is all wrong.

However, a high P/E may also be a strong vote of confidence that the company still has strong growth prospects in the future, which should mean an even higher stock price. Because the market is usually more concerned about the future than the present, it is always looking for some way to project out.

PEG = P/E / (projected growth in earnings)

For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 2 (30 / 15 = 2).

In this case, the lower the number the less you pay for each unit of future earnings growth. So even a stock with a high P/E, but high projected earning growth may be a good value.

Looking at the opposite situation; a low P/E stock with low or no projected earnings growth, you see that what looks like a value may not work out that way. For example, a stock with a P/E of 8 and flat earnings growth equals a PEG of 8. This could prove to be an expensive investment.

A few important things to remember about PEG:

• It is about year-to-year earnings growth
• It relies on projections, which may not always be accurate

Price to Sales (P/S) = Market Cap / Revenues (or Stock Price / Sales Price Per Share)

Companies that don’t have any earnings are bad investments? Not necessarily, but you should approach companies with no history of actually making money with caution. However, we still have the problem of needing some measure of young companies with no earnings, yet worthy of consideration. After all, Microsoft had no earnings at one point in its corporate life.

One ratio you can use is Price to Sales or P/S ratio. This metric looks at the current stock price relative to the total sales per share.

Much like P/E, the P/S number reflects the value placed on sales by the market. The lower the P/S, the better the value, at least that’s the conventional wisdom. However, this is definitely not a number you want to use in isolation. When dealing with a young company, there are many questions to answer…

P/B = Share Price / Book Value Per Share

Value investors look for some other indicators besides earnings growth and so on. One of the metrics they look for is the Price to Book ratio or P/B. This measurement looks at the value the market places on the book value of the company.

Like the P/E, the lower the P/B, the better the value. Value investors would use a low P/B is stock screens, for instance, to identify potential candidates.

Book Value = Assets – Liabilities

How much is a company worth and is that value reflected in the stock price? There are several ways to define a company’s worth or value. One of the ways you define value is market cap or how much money would you need to buy every single share of stock at the current price.

In other words, if you wanted to close the doors, how much would be left after you settled all the outstanding obligations and sold off all the assets.

A company that is a viable growing business will always be worth more than its book value for its ability to generate earnings and growth.

To compare companies, you should convert to book value per share, which is simply the book value divided by outstanding shares.

Dividend Payout Ratio (DPR) = Dividends Per Share / EPS

For example, if a company paid out $1 per share in annual dividends and had $3 in EPS, the DPR would be 33%. ($1 / $3 = 33%)

The real question is whether 33% is good or bad and that is subject to interpretation. Growing companies will typically retain more profits to fund growth and pay lower or no dividends. Companies that pay higher dividends may be in mature industries where there is little room for growth and paying higher dividends is the best use of profits.

Either way, you must view the whole DPR issue in the context of the company and its industry. By itself, it tells you very little.

Dividend Yield = annual dividend per share / stock's price per share

If you are a value investor or looking for dividend income then there are a couple of measurements that are specific to you. For dividend investors, one of the telling metrics is Dividend Yield. This measurement tells you what percentage return a company pays out to shareholders in the form of dividends.

For example, if a company’s annual dividend is $1.50 and the stock trades at $25, the Dividend Yield is 6%. ($1.50 / $25 = 0.06)

Return on Equity (ROE)

ROE is one measure of how efficiently a company uses its assets to produce earnings. You calculate ROE by dividing Net Income by Book Value. A healthy company may produce an ROE in the 13% to 15% range. Like all metrics, compare companies in the same industry to get a better picture.

While ROE is a useful measure, it does have some flaws that can give you a false picture, so never rely on it alone. For example, if a company carries a large debt and raises funds through borrowing rather than issuing stock it will reduce its book value. A lower book value means you’re dividing by a smaller number so the ROE is artificially higher. There are other situations such as taking write-downs, stock buy backs, or any other accounting slight of hand that reduces book value, which will produce a higher ROE without improving profits.

It may also be more meaningful to look at the ROE over a period of the past five years, rather than one year to average out any abnormal numbers.

My opinion

So what do you think readers!!! Easy???

But, I don’t think so. That’s why, I follow TECHNICAL ANALYSIS. If you guys want, I will post some basics but very effective techniques of TECHNICAL ANALYSIS……

KEEP READING

KEEP INVESTING

SOURCE

Stock.about.com