The magic of compounding
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Carry trade
Carry trade involves borrowing money in a market with low interest rates and investing in a market with high interest rates to profit from the interest rate differential. However, it also carries currency risk as it involves two different currencies. For carry trade to be profitable, the exchange rate between the two currencies must remain stable. If the currency of investment weakens against the currency of borrowing, the investor can face losses instead of gains.
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The document provides an overview of two key Indian monetary policy terms: the repo rate and statutory liquidity ratio (SLR). The repo rate is the interest rate at which commercial banks borrow funds from the Reserve Bank of India. A reduction in the repo rate will allow banks to borrow funds at a cheaper rate. The SLR is the minimum amount of funds that commercial banks must hold in government approved securities. The SLR is set by the RBI and helps control the expansion of bank credit. The SLR has recently been reduced by 100 basis points to 24% of deposits, freeing up more cash for banks to lend.
Revenue trade
This document discusses three types of deficits: fiscal deficit, revenue deficit, and trade deficit. A fiscal deficit occurs when a government spends more than it earns in a year. A revenue deficit is when a government's revenue expenditures are greater than its revenue receipts. Finally, a trade deficit is when the value of a country's imports exceeds the value of its exports.
Sortino
The Sharpe Ratio measures the relationship between a fund's returns and its volatility or risk, with a higher ratio indicating relatively less risk. It is calculated as the average return minus the risk-free rate divided by the standard deviation of returns. The Sortino Ratio is similar but uses downside deviation instead of standard deviation to exclude upside volatility and better measure only harmful volatility. Both ratios can help investors assess risk and select less volatile funds when the Sharpe Ratio may be lower due only to upward, not downward, price movements. For example, the Sharpe Ratio of Tata Infrastructure Fund was 0.0899 and the Sortino Ratio was 12.796 for the three-year period from June 2006 to May 2009.
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The document summarizes the issue of oil bonds in India. The government gives oil companies oil bonds to compensate them for selling fuel at controlled low prices instead of market prices. This creates problems for the oil companies by delaying payments and impacting their cash flow, forcing them to sell the bonds at a discount. In the long run, the government will have to repay the bonds, adding to fiscal deficits. Recently, fuel prices were raised more significantly, indicating a shift away from reliance on oil bonds towards allowing market-linked pricing.
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Run on a bank
The document discusses money supply expansion by banks and runs on banks. It explains that when a customer deposits money in a bank, the bank lends out a portion while keeping a 10% reserve. This lending allows new money to enter circulation, expanding the money supply. However, if too many depositors withdraw funds due to economic uncertainty, it can cause a bank run where the bank lacks sufficient reserves to pay everyone.
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Capital account convertibility
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2) The fund takes a more adventurous approach than peers by investing between 30-40% in mid-caps, seeking gains from smaller companies.
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Money supply
Banks are able to increase the money supply through fractional reserve banking. When a customer deposits money in a bank, the bank is only required to keep a portion of those deposits as reserves, typically around 10%, and can lend out the remaining 90% to borrowers. This lending creates new money, as the amount lent is also spent and deposited elsewhere. Through this process of lending and redepositing, the original $100 deposit can end up creating $190 in the total money supply. The central bank regulates money supply by adjusting the reserve requirement percentage - increasing it decreases lending and money supply while decreasing it has the opposite effect.
Measurements of money supply
Velocity of money is calculated by dividing GDP by the value of money supply. Different measurements of money supply (M0, M1, M2, M3) show different velocities, as they represent different components of the money supply. M0 only includes currency in circulation and bank reserves, while M3 includes a broader range of assets. Understanding how money moves between entities in an economy helps explain why velocity, or the rate of money circulation, is important for economic growth.
Fiscal deficit
The document explains fiscal deficit. It states that the government spends money on revenue expenses like salaries and capital expenses like constructing hospitals. However, the government's total expenses are always more than its total income from taxes and other sources, resulting in a fiscal deficit. This deficit is financed through government borrowings from the market or printing additional currency, with borrowing being the better option to avoid inflation. However, borrowing also cannot continue indefinitely and the only sustainable way to control the deficit is by spending less and earning more revenue.
Deflation
Deflation refers to a sustained reduction in the overall price level, where the inflation rate falls below zero percent and prices continue to decrease. This occurs when aggregate demand in the economy declines significantly. While a one-time price decrease is not a problem, sustained deflation can lead to a deflationary spiral as consumers delay purchases in expectation of even lower prices, further reducing demand and economic activity. Central banks aim to prevent deflation through monetary policies that increase the money supply, such as lowering interest rates, in order to stimulate demand. According to the passage, India's current low inflation rate is considered disinflation rather than deflation, as prices have not started falling continuously and the economy remains robust with around 6.5%
Cash reserve ratio
Cash Reserve Ratio (CRR) is a bank regulation that requires banks to hold a minimum amount of reserves, in the form of cash stored in vaults or deposited with the central bank, as a percentage of customer deposits. Higher CRR requirements mean banks can lend out less money, which limits the money supply and economic activity in the country. For example, with a 10% CRR, a Rs. 100 deposit allows Rs. 90 in loans creating Rs. 1000 in money supply. But with a 20% CRR, the same Rs. 100 deposit only allows Rs. 80 in loans, creating Rs. 500 in money supply. Central banks raise CRR to reduce inflation from excessive spending, and lower it to stimulate more
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The document summarizes the issue of oil bonds in India. The government gives oil companies oil bonds to compensate them for selling fuel at controlled low prices instead of market prices. This creates problems for the oil companies by delaying payments and impacting their cash flow, forcing them to sell the bonds at a discount. In the long run, the government will have to repay the bonds, adding to fiscal deficits. Recently, fuel prices were raised more significantly, indicating a shift away from reliance on oil bonds towards allowing market-linked pricing.
Money market
The money market is a place where large institutions and governments manage short-term cash needs through very short term debt securities maturing in less than one year. It specializes in safe, liquid instruments like treasury bills, certificates of deposit, commercial paper, and repurchase agreements. While offering lower returns than stocks, these conservative money market securities provide more safety. Individual investors can access the money market through money market mutual funds.
Speculative attacks
Speculative attacks refer to massive selling of a domestic currency in the foreign exchange market triggered by misinformation spread by greedy speculators aiming to profit from an artificially created fear of a currency devaluation. Central banks have some options to counter speculative attacks, including using reserves to maintain a fixed exchange rate (Plan A), raising interest rates to make the domestic currency more attractive (Plan B), or imposing capital controls (Plan C), but each option has costs and risks that must be weighed against benefits. If problems point to underlying economic weaknesses, the central bank may need to consider letting the currency devalue rather than exhausting its options.
Velocity of money
The velocity of money refers to how often a unit of currency is used to purchase goods and services within an economy over a specific time period, usually one year. It is calculated by dividing the total value of economic transactions (GDP) by the total money supply. In a simple example of a three person economy, a Rs100 note changed hands three times to facilitate Rs300 worth of transactions, giving a velocity of money of three. Understanding the velocity of money provides insight into how rapidly money moves through an economy and its impact on economic growth.
Run on a bank
The document discusses money supply expansion by banks and runs on banks. It explains that when a customer deposits money in a bank, the bank lends out a portion while keeping a 10% reserve. This lending allows new money to enter circulation, expanding the money supply. However, if too many depositors withdraw funds due to economic uncertainty, it can cause a bank run where the bank lacks sufficient reserves to pay everyone.
Understanding deflation
Deflation refers to a sustained reduction in the overall price level, while disinflation is a slowdown in the inflation rate even if prices remain positive. Deflation is caused by a fall in aggregate demand, creating a deflationary spiral as consumers delay purchases and lower economic activity. This can be countered by monetary policies to boost demand through lower interest rates or increasing the money supply. While India is experiencing disinflation currently, its strong GDP growth makes deflation unlikely as long as growth remains high and the government has tools to stimulate the economy if needed.
Government debt repayment
Governments have several ways to repay their debts, including developing fiscal surpluses through taxes and reducing expenses. They can also use dividends from public sector companies or divest holdings. As a last resort, governments may borrow more money or print currency to repay debts, which risks hyperinflation.
Stagflation
This document defines and explains the concept of stagflation. Stagflation occurs when inflation rises alongside a stagnant economy, with both prices and unemployment increasing. The Reserve Bank of India must balance fighting inflation through interest rate hikes with avoiding damaging economic growth and causing stagflation. For India's robust economy, this balancing act is less risky than for slower-growing countries. Removing structural obstacles and reforms can help unlock growth and steer an economy out of stagflation.
Capital account convertibility
Capital Account Convertibility (CAC) refers to the freedom to convert local financial assets into foreign assets and vice versa without restrictions. It allows for the free flow of capital across borders. India does not currently have full CAC as it regulates foreign investments and currency conversions to maintain economic stability and prevent mass capital outflows during times of crisis or uncertainty. Full CAC requires conditions like low inflation rates and fiscal deficits to be in place.
Sharpe
This document compares the Sharpe Ratio and Information Ratio as measures of fund performance. The Sharpe Ratio compares a fund's returns to the returns of a risk-free benchmark, while the Information Ratio compares the fund's returns and risk to a relevant market index. This difference is illustrated through an analogy comparing cricket players' batting averages and risks to different benchmarks. The Information Ratio shows the excess returns of a fund compared to the market, while the Sharpe Ratio shows returns relative to no risk.
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GST (Goods and Services Tax) is a proposed tax reform in India that would combine several taxes into a single tax applied to the production and distribution of goods and services. It is expected to simplify the tax system and reduce costs for businesses by eliminating cascading taxes and allowing credits for taxes paid at earlier stages of production. The example of leather goods producers Mr. A, B and C is used to illustrate how GST would streamline taxes by providing credits and reducing the overall tax burden through the supply chain compared to current individual taxes.
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Budget Highlights - A Fiscally Prudent Budget
The budget maintains the fiscal deficit target of 3.5% for FY17 and pegs it at 3% for FY18-19. Nominal GDP growth is pegged at 11% and gross tax revenues are budgeted to increase by 12%, while net tax revenues are budgeted to increase by 11%. Proceeds from disinvestments are pegged at Rs. 56,500 crore compared to Rs. 25,300 crore last year. Adhering to the fiscal consolidation plan raises the government's fiscal credibility and is expected to lead the RBI to cut rates by 25-50 basis points. However, higher supply of long-dated bonds could steepen the yield curve.
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Here's a newsletter from our CIO that contains his views on the important developments in the investment world in 2015 and the outlook for 2016.
Tata Balanced Fund - Plan A
This document discusses the Tata Balanced Fund, a hybrid equity-oriented fund. Some key points:
1) Over the last 10 years, the fund has outperformed its benchmark and category average, returning 16.7% annually compared to 10.7% for the benchmark and 13.5% average.
2) The fund takes a more adventurous approach than peers by investing between 30-40% in mid-caps, seeking gains from smaller companies.
3) Since 2000, the fund has outperformed its benchmark by over 80% and recovered well from the 2008 global financial crisis, now 35% above its pre-crisis high.
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Tata Group was declared India's most valuable brand with a value of $21.1 billion according to a list of the world's 500 most valued brand - Brand Finance Global 500 on 19th February, 2014.
It has retained its top place among Indian brands and its global ranking has also improved to 34th from 39th in 2013.
Gold is an excellent hedge against inflation
Here is an article featured in Forbes India magazine authored by our Chief Investment Officer, Ritesh Jain on “Why gold is an excellent hedge against inflation?”
Money supply
Banks are able to increase the money supply through fractional reserve banking. When a customer deposits money in a bank, the bank is only required to keep a portion of those deposits as reserves, typically around 10%, and can lend out the remaining 90% to borrowers. This lending creates new money, as the amount lent is also spent and deposited elsewhere. Through this process of lending and redepositing, the original $100 deposit can end up creating $190 in the total money supply. The central bank regulates money supply by adjusting the reserve requirement percentage - increasing it decreases lending and money supply while decreasing it has the opposite effect.
Measurements of money supply
Velocity of money is calculated by dividing GDP by the value of money supply. Different measurements of money supply (M0, M1, M2, M3) show different velocities, as they represent different components of the money supply. M0 only includes currency in circulation and bank reserves, while M3 includes a broader range of assets. Understanding how money moves between entities in an economy helps explain why velocity, or the rate of money circulation, is important for economic growth.
Fiscal deficit
The document explains fiscal deficit. It states that the government spends money on revenue expenses like salaries and capital expenses like constructing hospitals. However, the government's total expenses are always more than its total income from taxes and other sources, resulting in a fiscal deficit. This deficit is financed through government borrowings from the market or printing additional currency, with borrowing being the better option to avoid inflation. However, borrowing also cannot continue indefinitely and the only sustainable way to control the deficit is by spending less and earning more revenue.
Deflation
Deflation refers to a sustained reduction in the overall price level, where the inflation rate falls below zero percent and prices continue to decrease. This occurs when aggregate demand in the economy declines significantly. While a one-time price decrease is not a problem, sustained deflation can lead to a deflationary spiral as consumers delay purchases in expectation of even lower prices, further reducing demand and economic activity. Central banks aim to prevent deflation through monetary policies that increase the money supply, such as lowering interest rates, in order to stimulate demand. According to the passage, India's current low inflation rate is considered disinflation rather than deflation, as prices have not started falling continuously and the economy remains robust with around 6.5%
Cash reserve ratio
Cash Reserve Ratio (CRR) is a bank regulation that requires banks to hold a minimum amount of reserves, in the form of cash stored in vaults or deposited with the central bank, as a percentage of customer deposits. Higher CRR requirements mean banks can lend out less money, which limits the money supply and economic activity in the country. For example, with a 10% CRR, a Rs. 100 deposit allows Rs. 90 in loans creating Rs. 1000 in money supply. But with a 20% CRR, the same Rs. 100 deposit only allows Rs. 80 in loans, creating Rs. 500 in money supply. Central banks raise CRR to reduce inflation from excessive spending, and lower it to stimulate more
Credit default swaps
A credit default swap is a contract where a buyer pays a seller a periodic fee in exchange for a payout if a third party defaults on its debt obligations. For example, if party A lends to party B, party A can buy a CDS from party C to insure against party B's default. If party B defaults, party C pays party A instead of party B. CDS contracts transfer credit risk from one party to another and resemble insurance policies against borrower defaults.
American depository receipts
American Depository Receipts (ADRs) allow foreign companies to have their stock traded on American exchanges. ADRs represent ownership of shares in a foreign company and pay dividends in US dollars. They were introduced in 1927 to make it easier for American investors to buy shares of foreign companies without dealing with foreign market complexities like different currencies and trading times. ADRs are traded on major US exchanges like the NYSE and NASDAQ.
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