Tuesday, November 30, 2010

Illegal Stock Market Activities

The Stock Market is a very sensitive and fragile entity whose value may rise and fall without apparent reason. As you may already know, the price of a stock may go up or down based on the demand and supply theory. So, coming to the topic, an illegal stock market activity is one where the actions of an individual is considered unethical and may cause losses to one or more investors (others) or may result in unusual profit for the person involved in the activity.

For ex: Scams perpetrated by Telgi or Harshad Mehta which resulted in losses to numerous Indian Investors can be considered illegal stock market activities.

Please Note: All of the activities mentioned in this article are illegal and all countries have laws forbidding citizens from indulging in such practices and they can be fined and/or imprisoned for the same when caught. Please do not try to do them and also do not help people who are trying to do it because it is a crime.

Now that we know what an illegal stock market activity is, let’s take a look at the types of these activities. The two main illegal stock market activities (and the most commonly occurring ones) are
1. Insider Trading and
2. Front Running

Insider Trading:

Insider Trading is one where an individual with upfront information about a company or organization and its business buys the stock of that company before the news goes public thereby gaining an undue advantage over the rest of the investors.

For Ex: Let us say you are the managing director of ABC Bank Ltd which is a stock market listed company. After weeks of negotiation you know that ICICI bank the country’s leading bank has accepted to buy your company and issues shares of its own company to investors who hold shares of your company. As any intelligent investor would know, shares of an ICICI Bank are much more valuable than shares of an ABC Bank. Once this news of ICICI acquiring ABC Bank goes public people will start accumulating shares of ABC Bank so that they can benefit out of the acquisition. This will send the price of ABC Bank skyrocketing. So, knowing this information, if you buy shares of ABC Bank for your personal share trading account before this news goes public, you can sell them off once the acquisition is complete and the share price has exploded. This way you gain an undue advantage and make a profit at the expense of the company.

This is insider trading.

So, to avoid this almost all company’s have rules related to trading of its own shares by its employees especially ones that are higher up in the food chain. Employees of a company cannot buy/sell shares of their company during predetermined windows every year for ex: during quarterly financial result announcing period. This is to avoid those employees who may possess vital statistics reg. the company performance from taking advantage of this to make quick bucks in the stock market.

By now you are mumbling, what else constitutes insider trading. Let us say your brother in law or uncle is working for a large organization which is going to post impressive annual results. He tips you of the same and you buy shares of that company. Though there is no rule stopping you from buying the share because you are not its employee, it is illegal because you got the inside information from your relative who is working for them. Hence this too constitutes Insider Trading.

Or, let us say you work for a brokerage firm for example ICICI Direct and you are a relationship manager who gets detailed reports about stock recommendations to the valued customers of the brokerage house. You are only supposed to share this information with your clients and not anyone else. You cannot buy shares from your wife’s account based on the recommendations or tip of your friend or relative to do the same because this is proprietary insider information which is meant strictly for the customers of the brokerage house and not everyone else. Hence this too constitutes Insider Trading.

Coming to a hypothetical situation – Lets say you are in a restaurant and a bunch of businessmen in your neighboring table are talking aloud about their company’s results and expecting jump in their share prices, you go ahead and buy the share prices. Though you heard from an insider about the company and bought the share, you do not have any concrete evidence that the company is indeed doing great and the share price may go up. In all probabilities the shares may go down and you may lose your money. Since your decision to buy the share would be considered an impulsive buy based on a rumor you heard, this will not constitute Insider Trading. But do remember the fact that, you are risking your hard earned money based on some small talk you heard in a restaurant is dangerous and it could all be a bluff and you may end up losing money.

Front Running:

Now that we have elaborated on what is and is not insider trading, let us take a look at the next big illegal activity in the stock market. “Front Running” is an activity wherein a stock broker/dealer who executes trades uses his position to execute trades for himself before executing the orders for his customers to gain from the difference in time gap between the orders executions. Let me explain with an hypothetical example.

Let us say that Mr. X is working for a trading house and is in charge of placing orders for its high value customer. The brokerage house attached to them has sent a recommendation to its customers to accumulate ICICI Bank shares with immediate effect. Because of which, many of its customers have placed huge orders to buy ICICI shares.

The trading day opens with ICICI shares @ Rs. 1000/- per share. The Trading house has received orders from numerous customers to buy around 1 lakh shares at market price. Mr. X knowing the fact that because of all these orders, the price of ICICI shares would go up, places an order of 1000 shares for himself at the day open price and then proceeds to place the remaining orders. By the time all the other orders are executed, because of the heavy demand for the shares, the price of ICICI has become Rs. 1050/- per share by midday. Taking advantage of this, Mr. X sells off his 1000 shares pocketing a lump profit of Rs. 50,000/-

This is “Front Running” and is illegal. A person who is executing trades for a brokerage/trading firm is not supposed to place his interest ahead of his customers and hence is not supposed to do this.

You are now thinking, what if Mr. X places orders for himself after executing the orders of his customers. Is this illegal? Of course No. This actually is termed as tailing and is not illegal. Because the person is placing orders for himself after his customers it will not affect their interest and hence is not illegal.

Apart from these 2 types, there are many other illegal activities that are prohibited in the stock market.

Painting the tape – Engaging in a series of transactions in securities that are reported publicly to give the impression of activity or price movement in a security;

Marking the close – Buying and selling securities at the close of the market in an effort to alter the closing price of the security;

Improper matched orders – Engaging in transactions where both the buy and sell orders are entered at the same time with the same price and quantity by different but colluding parties;

Engaging in buying activity at increasingly higher prices and then selling securities in the market at the higher prices (hype and dump) or vice versa (i.e. selling activity at lower prices and then buying at such lower prices);

Wash Sales – Engaging in transactions in which there is no genuine change in actual ownership of a security taking into consideration internal control systems adopted by the firms to prevent manipulative practices;

Squeezing the float – Taking advantage of a shortage of securities in the market by controlling the demand side and exploiting market congestion during such shortages in a way as to create artificial prices;

Disseminating false or misleading market information through media, including the internet, or any other means to move the price of a security in a direction that is favorable to a position held or a transaction; and

A Word to Wrap up:
Institutions like SEBI or SEC (USA) were created to safeguard the interests of the investors and to prevent anyone taking use of the stock market for their personal gains thereby causing losses to others. Their sole purpose is to protect the investor public and punish the wrong doers who indulge in the aforementioned illegal activities.

So, as responsible investors we should abide by all the laws and should not indulge in such dubious activities.

Please Note: I have made references to ICICI Bank and ICICI Direct just for explanation purposes. Since it is one of the largest and most famous banks in the country I thought people reading my article would be able to relate to the contents better and hence their usage. This does not mean that I endorse the brand or suggesting such incidents may happen in it. It is used strictly for the sake of example/illustration and nothing else.

Sunday, November 28, 2010

IPO Process Explained

We all know what an IPO is and what the purpose of an IPO is for the company issuing the share. But, not many of us know the different requirements that a company must satisfy in order to go public and the different stages in the life cycle of an IPO. The purpose of this article is to elaborate on this. So, lets get started.

What is an IPO – To Refresh:

An IPO stands for Initial Public Offering, wherein a company issues its shares to the public for the first time. Investors can place requests to buy these shares and once done, the share gets listed in a registerd stock exchange and the company uses the share issue proceeds for its development/growth. Before we take a look at the steps in an IPO process, lets take a look at the entry norms for an IPO.

Entry Norms for an IPO:

Not all company’s can issue shares to the public. SEBI has provided a list of requirements that need to be met by a company if they wish to go public. A company that wishes to go public needs to meet all of the below mentioned criteria…

Entry Norms I or EN I:
1. Net Tangible assets of atleast Rs. 3 crores for 3 full years
2. Distributable profits in atleast 3 years
3. Net worth of atleast 1 crore in 3 years
4. If there was a change in name, atleast 50% of the revenue in the preceeding year should be from the new activity
5. The issue size should not exceed 5 times the pre-issue networth of the company

To provide sufficient flexibility and also to ensure that genuine companies do not suffer on account of rigidity of the above mentioned rules, SEBI has provided 2 alternate routes to company’s that do not satisfy the criteria for accessing the primary market. They are as follows:

Entry Norms II or EN II:

1. Issue shall be only through the book building route with atleast 50% allotted mandatorily to Qualified Institutional Buyers (QIBs)
2. The minimum post issue face value capital shall be Rs. 10 crores or there shall be a compulsory market-making for atleast 2 years


Entry Norms III or EN III:

1. The “Project” is appraised and participated to the extent of 15% by FI’s/Scheduled Commercial Banks of which atleast 10% comes from the appraiser(s).
2. The minimum post issue face value capital shall be Rs. 10 crores or there shall be a compulsory market-making for atleast 2 years
3. In addition to the above mentioned 2 points, the company shall also satisfy the criteria of having atleast 1000 prospective allotees in future.

Steps in an IPO Process:

Let us now have a look at how an initial public offering process is initiated and reaches its conclusion. The entire process is regulated by the 'Securities and Exchange Board of India (SEBI)', to prevent the possibility of a fraud and safeguard investor interest.

Selection of Investment Bank

The first thing that company management must do when they have taken a unanimous decision to go public is to find an investment bank or a conglomerate of investment banks that will act as underwriters on behalf of the company. Underwriter's buy the shares of the company and resell them to the general public. The company must also hire lawyers that can guide them through the legal maze that an IPO setup can be. It must be ready with detailed financial records for intensive fiscal health scrutiny that SEBI would perform. Some companies may also opt to directly sell their shares through the stock market, but most prefer going through the underwriters.

Step 1: Preparation of Registration Statement

To begin an IPO process, the company involved must submit a registration statement to the SEBI, which includes a detailed report of its fiscal health and business plans. SEBI scrutinizes this report and does its own background check of the company. It must also see that registration statement fulfils all the mandatory requirements and satisfies all rules and regulations.

Step 2: Getting the Prospectus Ready

While awaiting the approval, the company, with assistance from the underwriters, must create a preliminary 'Red Herring' prospectus. It includes detailed financial records, future plans and the specification of expected share price range. This prospectus is meant for prospective investors who would be interested in buying the stock. It also has a legal warning about the IPO pending SEBI approval.

Step 3: The Roadshow

Once the prospectus is ready, underwriters and company officials go on countrywide 'roadshows', visiting the major trade hubs and promote the company's IPO among select few private buyers (Usually corporates or HNIs). They are fed with detailed information regarding company's future plans and growth potential. They get a feel of investor response through these tours and try to woo big investors.

Step 4: SEBI Approval & Go Ahead

Once SEBI is satisfied with the registration statement, it declares the statement to be effective, giving a go ahead for the IPO to happen and a date to be fixed for the same. Sometimes it asks for amendments to be made before giving its approval. The prospectus cannot be given to the public without the amendments suggested by SEBI. The company needs to select a stock exchange where it intends to sell its shares and get listed.

Step 5: Deciding On Price Band & Share Number

After the SEBI approval, the company, with assistance from the underwriters decide on the final price band of the shares and also decide the number of shares to be sold.

There are two types of issues: Fixed Price and Book Building

Fixed Price – In a Fixed price issue – the company decides the price of the share issue and the number of shares being sold. Ex: ABC Ltd public issue of 10 lakh shares of face value Rs. 10/- each at a premium of Rs. 55/- each is available to the public thereby generating Rs. 6.5 Crores.

Book Building – A Book building issue helps the company discover the price of the issue. The company decides a price band and it gives the investor an option to choose the price at which he/she wishes to bid for the company shares. Ex: ABC Ltd issue of 10 lakh shares of face value Rs. 10/- each at a price band of Rs. 60 to 70 is available to the public thereby generating upto Rs. 7 Crores. Here the amount generated through the issue would depend on the highest amount bid by most investors.

Step 6: Available to Public for Purchase

On the dates mentioned in the prospectus, the shares are available to public. Investors can fill out the IPO form and specify the price at which they wish to make the purchase and submit the application. This open period usually lasts for 5 working days which is a SEBI requirement.

Step 7: Issue Price Determination & Share Allotment

Once the subscription period is over, members of the underwriting banks, share issuing company etc will meet and determine the price at which shares are to be allotted to the prospective investors. The price would be directly determined by the demand and the bid price quoted by investors. Once the price is finalized, shares are allotted to investors based on the bid amounts and the shares available.

Note: In case of oversubscribed issues, shares are not allotted to all applicants.

Step 8: Listing & Refund

The last step is the listing in the stock exchange. Investors to whom shares were allotted would get the shares credited to their DEMAT accounts and for the remaining the money would be refunded.

Difference between IPO in India and Abroad:

1. In India the book the book is built directly but in the west the underwriter takes the shares on his books and then allots shares to the investors
2. In India the book building process is transparent whereas in the US it is confidential
3. In India the book has to be open for a minimum of 5 business days and the period needs to be revised if the price band is revised whereas it can be opened and closed anytime abroad
4. Abroad, the price band is soft – meaning the bidder can bid for a price outside the price band too whereas in india the band is fixed.
5. Retail investors in india have to put in a cheque or block an equivalent amount corresponding to the IPO bid in their DEMAT accounts but QIB’s do not pay any margin. Whereas abroad, neither category needs to pay any margin.

Other Questions:

What will happen if the company does not receive a minimum subscription of atleast 90% of the net offer to the public including devolvement of underwriters within 60 days of issue closure?

The company will have to refund the entire subscription amount received within 8 days.

Can a company whose listing is due raise additional capital?


Should the Red Herring prospectus disclose the exact price of the issue?


What is the maximum price in a price band?

The cap price should not be more than 20% of the floor price. For Ex: if the floor price is Rs. 100/- the cap price can be at max Rs. 120/- an issue with price band Rs. 100 – 150 is not possible

Can the issue price be revised?

Yes, provided the revision on either side is not beyond 20%

What is the time limit an IPO may remain open?

An IPO cannot remain open for more than 7 working days which can be extended to upto 10 days in case the offer price band was revised

If your net worth is Rs. 10 crores, how much IPO can you go for?

50 – 10 = 40 crores.

You can go for upto 40 crores to ensure that your post issue net worth does not go beyond 5 times your pre issue worth.

Who should the investors approach in case of delay of refund order?


Thursday, November 11, 2010

Personal Loans – De-mystified

The title sounds interesting and so will the article. Again, this is something I have wanted to write for quite some time. Personal Loans have become pretty famous over the past decade and almost every bank in our country is giving personal loans to its customers. If you are someone working in an IT Park or a Industrial Park, you would have definitely seen people from a number of banks waiting with colourful pamphlets in their hands near your office gates trying to sell you one. If you are one such person and have been tempted to think, shall I take this because this guy says its very low interest, this article is exactly for you. For the others, its always good to know about certain things that maybe useful for us. Ok, lets get started.

What is a Personal Loan?
A Personal Loan is an agreement between a lender (bank) and a borrower (customer) wherein the lender offers a fixed sum of money to the borrower which the borrower agrees to repay as equal monthly instalments over a fixed duration of time. The definition of other commonly known loans like a car loan or a home loan is almost the same as above with just one small difference. In case of a home loan or a car loan, the bank can lay claim to your house or car if you fail to repay the money. The Personal Loan is an unsecured loan wherein, the bank does not have any guarantee to your payment.
The documentation is relatively quite simple and you will get the money within 7-10 working days. Repayment terms are quite flexible, usually between 1-5 years. All this makes them very attractive.

Below are a few things you need to keep in mind before taking a personal loan…

Do you ‘really need’ this Personal Loan?

This is the most important question. Do we really need the loan is something we must ponder before taking the decision of applying for one. Be Cautious!! The loan may be easy, but that doesn’t mean that it is good for you.

There are two main reasons for such a warning.

First of all, personal loans are usually taken to go on a vacation trip, buying stuff for home such as LCD/Plasma TV or for a marriage, etc. All these are mainly personal use items. Taking loans to finance consumption is one of the worst financial mistakes you can ever make. Financial prudence suggests that you should always save some money regularly. Getting a PL is doing exactly the opposite i.e., spending today out of the unearned (and possibly uncertain) future income.

Secondly, these loans are quite expensive. Though your loan agent may say that the interest is low, it is still high.
A Point to Ponder:
A Bank makes money by giving loans to people and we make money by depositing surplus cash with the bank and earning an interest. If banks offer us interest rates of around 8% per year and they need to make a good profit on the money you deposited with them – imagine at what rates they will lend it?

So think twice! Do you really need to take this burden?

When does it make sense to apply for a personal loan?

Sometimes, personal loans may not be such a bad idea. It can help in debt restructuring. Suppose you have run-up a substantial outstanding on your credit cards and are finding it difficult to pay it off from your monthly income. And currently you don’t have any investments or FDs or some other savings, which you could utilize for paying the credit cards. Then, it may be wise to take a personal loan to pay-off the credit card bills, as the interest rate on credit cards could be 2-3 times that of a personal loan. Thereby, you would be saving a lot on the interest.

Or there could be a medical emergency that requires fairly large sums at a short notice.

Consider the alternatives

Before you jump on to the easy decision of taking the PL, consider other alternatives. Can your family, friends, or colleagues help you out in your financial crises? Your current situation could be a temporary problem and you could pay them back within a few months.

Do you have some illiquid investment, such as an LIC policy? Or do you have some bluechip shares, which you don’t want to sell? It is possible to get a loan against such investments and at a much cheaper rate.

Or you have a property (preferably commercial) rented out on lease. Many banks would be willing to lend you money against the future rental income from the property.

The above mentioned options are cheaper options to get money (of course the first being the cheapest wherein you usually do not pay interest to your friends or family) rather than pay higher interest on personal loans.

A Point to Ponder:
Have you ever wondered why banks offer mortgage loans or loan against securities at much cheaper rates than personal loans? The reason is the mortgage loans are safer for banks because if you do not pay them off, they can take possession of whatever is mortgaged and recover all or part of the debt you own them. Whereas in case of personal loans, the bank has no such option. Hence they charge you more, trying to recover as much money from you in the shortest span of time.

How much should you borrow?

Banks will work out your loan eligibility based on your income, age, commitment & liabilities, work experience etc. They would also take into account whether you are a salaried person or self-employed. A joint applicant like a working spouse would also enhance your loan limit.
Just because the bank says that it can lend you a certain amount, it doesn’t mean that you should take whatever maximum amount the banks are willing to lend. You should work out your need and the comfort level with which you can repay it. How much money is absolutely essential? How much EMI can you afford every month without compromising your living style? Will you be able to meet all your fixed expenses such as rent, school fees, telephone, electricity, travel, insurance premiums, etc. without straining your budget? Etc…

As a thumb rule, make sure that the total repayment per month on your personal loans, credit card outstanding and such other similar loan facilities do not exceed more than 15-20% of your monthly take-home salary. Worst case scenario try to cap it at 25% of your salary.

Documents required for a Personal Loan

As mentioned earlier, the documentation required for applying for a personal loan is very minimal as compared to many other loans.

They include:

One or two Photographs
An Identity Proof: PAN card, passport, or driving license, etc.
Residence or Address Proof: Passport, ration card or electricity/telephone bill, etc.
Income Proof: For salaried persons, the banks may ask for the latest salary slip, Form 16 and 6-months bank statement. A self-employed person would be asked to furnish 2-3 years IT returns, accounts, etc.

The exact requirement of documents may vary from bank to bank. If you are an existing customer to the bank, they may opt to process the loan with lesser documentation.

To Conclude: A Personal Loan is a boon for the needy. It is an easy way to raise money for emergencies or urgent requirements. But, if you can avoid taking the loan and manage without it, it is all the more better.

Will the Indian Market Sustain this Momentum?

This is a million or rather a billion dollar question. Everyone including you and me is surprised over the fact that the Indian stock market is strongly growing and the BSE is currently trading at an all time high of around 21000 points. This is indeed excellent news for all investors across the globe; who have invested in the stock markets in India. But happiness isn’t the only thing that’s on everyone’s minds. Caution or skepticism is also abundant among knowledgeable investors. The purpose of this article is multifold and will cover the status of the global and Indian markets, the outlook for the next few months. Lets get started!!!

Status of the global markets over the past month

The global markets in the USA, UK, China etc have been growing slowly but steadily over the past month on the back of improved economic news. Recent news suggests that the slowdown phase is probably over and policymakers across the globe have started to ease up on the tightening measures to aid this growth. Europe has been encouraging on the economic front and their policy towards the same has only fuelled further growth. Good manufacturing data is coming in from the US, China etc which suggest that the double dip recession maybe receding. US Consumer spending has increased significantly in the last quarter and the weekly jobless claims have also fallen, which is evident in the stock markets numbers.

The US Markets posted a net growth of around 5% in the numbers at the end of the month when compared to where it was at the beginning of the same. Similarly the European markets posted a growth of around 3% and the asian markets around 5%.

Overall the market outlook as a whole looks positive as well as promising.

Status of the Indian Market over the past month

The Indian stock market began on a positive note and has shown solid progress over the past month. The stock market is currently trading at the 21000 levels which is where it was a couple of years back before the global meltdown happened. Strong global cues, good or rather great Q2 advance tax payments by corporates and companies and sustained buying by FII’s boosted the sentiments of the Indian investors. FII’s have made investments of more than $5 billion over the past one month. The repo rate has been hiked 0.25% and has gone up to 6% and the reverse repo rate has gone up by 50 basis points to 5%. New policy decisions from the government of india about the reduction of corporate taxes helped sustain the growth of the markets.

The local markets posted solid gains of around 10% over the past month which is much higher than the growths posted by the US or the Euro markets.

Will the Indian markets be able to sustain the momentum?

If we compare india with its other emerging market peers, the Indian markets’ valuations are fair and justified though they are at a slight premium. Though our economy is sensitive to global shocks, india is a highly domestic-driven economy unlike our peers China or Brazil who are more dependent on exports and rely on the commodity markets for their GDP growth/expansion. This distinguishing factor will be greatly reflected in the equity valuations in our stock markets. Therefore, our markets will continue to attract a large share of FII inflows when compared to its peers.

The high domestic demand is the reason why, india was the first to recover from the slowdown. Though we have a solid export contribution to our GDP, the local or domestic demand contributes an even higher number and hence the earlier recovery.

Your next question is going to be – How long will this Rally continue?

Predicting the market especially one like the Indian market where liquidity is one of the important trend determining factors is extremely difficult. Even experts have burnt their fingers with their suggestions/recommendations. Coming back to the topic, liquidity flows will strongly determine the direction of the market, especially the flows from the FIIs. Also, the doubts about the US getting into a second recession or avoiding the same will determine the global equity flows. As for now, the global economic situation looks stable and we can expect the markets to perform strongly for the next few months.

Financial Industry, Capital Goods, Infrastructure, Power, Media, Hotels and Pharma can be expected to outperform the market. Whereas Automobiles, Consumer durables and a few of the banking stocks might underperform the market.

What Strategy should a small investor follow now?

This is by far the most trickiest question given the current scenario. In my personal opinion, small investors should invest only in large or big midcap companies with a sound management and fundamentals. Stay away from small caps or penny stocks that you do not know much about. Buy on dips would be a good strategy.

Pick out a good company and start buying in small portions everytime you see that the price is correcting or coming down by a decent number.

Overall, the market sounds positive and investing in good companies for the long term would definitely prove beneficial to all investors.

Happy Investing!!!
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