Saturday, July 30, 2005

Terms

Arbitrage Trading
“Arbitrage” trading is simply the purchase of securities on one market for immediate resale on another market in order to profit from a price discrepancy
Arbitrage traders will buy and sell the same or closely related securities at the same time. They take advantage of the price or value differences in two separate markets such as the NYSE and the CME futures. In perfect securities markets there would never be any arbitrage traders or trades. Since the securities markets are not perfect when news or other information moves a security or index they can and often do become unequal in price temporally. If the markets were perfect all identical securities would trade at the same value or price on each market they were traded on.
Lets say there is a Company that releases good news in a press release. The stock starts to trade higher on the NASDAQ, and there are call options available for the stock on the AMEX which have not had any or little action or volume. If you jump on the options before they catch up with the climbing stocks price you can often make money by selling the stock and buying the options at the same time. Remember the price disparities that offer the opportunities will not last long, seconds is the norm.
Although,large disparities will not last long, there is always a negligible arbitrage between markets which traders try to take advantage of. As I mail, there exists a 14 rupee disparity in INFY's price between NSE and BSE.
 
Scrip Name BSE Price (Rs)  NSE Price (Rs) 
INFOSYS                    2,349.00  (1.5%) 2,335.00  (1.0%)
 
 
Speculative attack on Currency
Paul Krugman in his recent op - ed piece commented "... at this point China's reserves of dollars are so large that a speculative attack on the dollar looks far more likely than a speculative attack on the yuan".
So what exactly is "speculative attack on a currency" ?
A speculative attack is essentially a confrontation between a central bank, which pledges to maintain its country's exchanger rate at a certain level, and international currency speculators, are willing to wager that the central bank is not committed to its exchanger rate goal. The speculators attack the currency by borrowing huge sums of it and then selling them on the currency market. The central bank can keeps its pledge by using its currency reserves to buy up the currency that the speculators are selling. If the central bank keeps its pledge, the speculators have little to lose because they can buy back the currency to repay their loans at about the same rate at which they sold it. If, however, the central bank is not willing to intervene to keep its currency stable, or if it runs low on the reserves it needs to do this, then the currency will fall. The speculators will be able to buy back their currency at a lower price and have great profits left even after they've paid back their loans.
Speculative attacks were responsible for the collapse of the Indonesian Rupiah and the Malaysian Ringgit in 1997-98 as well as the British pound and the Italian lira in 1992-93.
 
Negative Equity
The difference between the value of an asset and the outstanding portion of the loan taken out to pay for the asset, when the latter exceeds the former.
Negative equity normally results from a decline in the value of an asset after it is purchased.
Example : House prices have been growing at a breakneck pace in many developed countries —a fifth of American mortgages in 2003 were for more than 90% of the purchase price any fall in house prices could leave a lot of them with negative equity, forcing them to default
Bonds - Credit Quality and Credit Ratings
If you have been following market closely, you should have come across the big news on GM & Ford's bonds being  reduced to junk statusSome might wonder on why there exists ratings for bonds (and not for equities).  Since a bond may not be redeemed, or reach maturity, for years—even decades—credit quality is another important consideration when you’re evaluating a fixed—income investment. When a bond is issued, the issuer is responsible for providing details as to its financial soundness and creditworthiness. This information is contained in a document known as an offering document, prospectus or official statement, which will be provided to you by your investment advisor. But how can you know whether the company or government entity whose bond you’re buying will be able to make its regularly scheduled interest payments in five, 10, 20 or 30 years from the day you invest? Rating agencies assign ratings to many bonds when they are issued and monitor developments during the bond’s lifetime.
 
In the United States, major rating agencies include Moody’s Investors Service, Standard & Poor’s Corporation and Fitch Ratings. The highest ratings are AAA (S&P and Fitch Ratings) and Aaa (Moody’s). Bonds rated in the BBB category or higher are considered investment—grade; securities with ratings in the BB category and below are considered “high yield,” or below investment—grade.
 
Program Trading
Ever wondered how the Fund manager of an Index fund / bond like TATA Index Fund (or any other Index fund for that matter) trades in markets ?
They might employ Program Trading --  a trading technique involving large blocks of stock with trades triggered by computer programs
Program trading (also called computer-assisted trading) arose with the advent of computer and telecommunication technologies, whereby trade in different markets could be monitored simultaneously and manipulated accordingly. Because the size of the transactions often caused massive jolts in the stock market, many concluded that program trading was largely responsible for the 500-point drop in the Dow Jones Industrial Average on Oct. 19, 1987. During the economic recession that followed, the New York Stock Exchange put new restrictions on computerized trading, and many companies refused to do business with any brokerage house that engaged in program trading. With the unprecedented growth of the stock market in the later 1990s, program trading saw a resurgence in some trading houses.
The growth of program trading is due to fundamental changes over the past twenty-five years in the way individuals hold stocks. Rather than trade a few stocks directly through a retail broker, investors are now more likely to hold stocks indirectly through a mutual fund or a pension fund. When institutions use program trading for their customers' accounts, the effect is to lower customer costs. When institutions use index arbitrage program trades, the effect is to link the markets and thus to enhance their overall liquidity.
 
What Is Spread Betting?
Spread Betting is a tool that enables traders to profit from both up and down moves on a wide variety of financial markets, whether stock indexes, individual shares, currencies, bonds, and commodities such as gold or crude oil. What differentiates spread betting from other types of financial speculation is that ALL profits are 100% Tax-Free.
Spread Betting differs from fixed odds betting in that;
    • you don't risk a certain amount per bet, and 
    • there is no fixed profit or loss
 
The 'Spread' of Spread Betting
Spread Betting companies charge their clients no commissions, instead they make their money by earning the difference between the bid-offer spread that they quote on each financial product. The spread works in a similar fashion to how a market maker in the cash market operates.
    • Or to look at another way the spread works the same as a second hand car dealer 
    • You sell him your old car for $2,000 (the bid price) 
    • The dealer then advertises it in his showroom at $2,500 (the offer price) 
    • The $500 difference is therefore his profit (minus costs of course)
A spread bet broker will always quote a two-way price. The bid price at which spread betting clients can sell at, and the offer price which they can buy at. For example, on the NASDAQ the spread may well be 4100 - 4104, or 4100 bid, 4104 offered.

Understanding Short Selling
Tget a hold on Spread Betting, one must understand Short Selling. This is imperative because the whole point about speculation using spread bets is that they offer you total flexibility enabling you to take advantage of whatever way the markets move.

Forget About The Financial Markets - Look at Cricket
The concept of short selling is actually very simple to understand, but it can take some time to sink in because it is the opposite way of thinking to how most people have conducted themselves in the financial markets.
One of the best ways to understand short selling is to use cricket as an example.

India versus Australia
    • You are watching a cricket match with a friend from Australia
    • He boldly states that he fancies his Australian compatriots to score at least 400 runs 
    • You disagree and so decide to have a bet 
    • You wager Rs.1000 on the fact that Australia will not make 400 runs during their innings 
    • Therefore if the Australians score under 400 you'll win Rs.1000 from your friend 
    • If Australia scores over 400 runs you'll lose Rs.1000

Adding More Spice to the Wager
But in the financial markets deals are never executed for a fixed wager as in the example above. Let's expand on the cricket bet.
    • You and your friend both decide to have the same bet, you forecasting that Australia will score under 400 runs, your friend over 400 runs 
    • Instead of the flat Rs.1000 wager you now both bet Re.1 per run 
    • Meaning that for every run Australia scores under 400 you will profit by Re.1 multiplied by that number 
    • And conversely for every run that is scored over 400 you will lose Re.1 multiplied by the number 
    • You have effectively sold Australian runs short at 400

Three possible outcomes for your short trade:
    1. A Winning trade
        • Australia score 325 runs 
        • 400 (the level at which you went short) - 325 (final score) = 75 runs 
        • 75 runs x Re.1 (per run) = Rs.75 profit 
    2.
A Losing Trade
        • Australia score 450 runs 
        • 400 (the level at which you went short) - 450 (final score) = -50 runs 
        • -50 runs x Re.1 (per run) = -Rs.50 loss 
    3. Breakeven Trade
        • Australia score 400 runs 
        • 400 (the level at which you went short) - 400 (final score) = 0 runs 
        • 0 x Re.1 = no profit/loss
Now translate this cricket example into the stockmarket. Instead of selling Australian cricket runs at 400, sell short ABC Co. at Rs.1000. If ABC Co. declines then the short trade will make money, but it will lose money if the share price moves higher. The profit or loss will simply be multiplied by your stake (rupees per point).
 

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