The “term structure” of interest rates refers to the relationship between bonds of different terms. When interest rates of bonds are plotted against their terms, this is called the “yield curve”. Economists and investors believe that the shape of the yield curve reflects the market’s future expectation for interest rates and the conditions for monetary policy.
Tag Archive: INFLATION
Its been over weeks that the world may world faces food crisis as worst US drought in more than 50yrs pushes agricultural commodity prices to record highs. The scenario is same across the globe and we have some political statements that India has not reached drought situation: Sharad Pawar – He is just waiting for the next big commodity import scam as reported by the leading news paper from India. View full article »
Whenever talk about Gold happens in India, the eyes of the investors lit up. True Indians are more attached towards the Indian metal and there are solids reasons to be bullish on it too. None of natural or man-made catastrophes have made gold price go down confirmed from a website which holds the historical prices since 1901. (Kit co Metals)
Last year Gold provided the splendid return of 31% where as the equity markets shaded away and remained choppy.
But its pretty important to analyze and understand the real scenario, In dollar terms the return on the gold last year is only 10.5 %. The Rupee free fall has been a major factor behind those inflationary gains of 31%.
Last week the Economist did the cover story on it and in process the finance minister of Brazil has officially announced that an International Currency War has already started. Certainly, a few isolated shots are being heard.
The intended target is non other than China. Emerging economies taking actions on their monetary front be it Brazil, Australia, India or Thailand; the recently action taken by Thailand- it has imposed a tax on foreign investors’ gains from local bonds, the latest in a series of countries seeking to curb their currencies’ rise either through curbs on capital inflows or direct intervention on the currency exchanges.
Whenever there is a volatile movement between the currencies speculators and arbitrageurs came into action and some new terminologies derived from them like Yen Carry trade, Super Carry trade and not to forget the haute couture Quantitative Easing.
Some FAQs on them:
The famous Yen carry trade:
This is where an investor, such as a hedge fund, borrows money cheaply in Yen, and then invests the proceeds elsewhere, such as a higher yielding currency. This is attractive because Yen interest rates are so low (near 1%), and investing in an alternative currency, such as US dollar bonds (at maybe 5% yield), provides a nice profit. In this example, the “positive carry” from the trade is 4% (5 -1%). An investor that does this trade accepts the risk that the yen appreciates. A 4% jump in the yen could wipe out an entire year’s worth of profit. The yen has been range bound, in a reasonable tight range for years, so many Hedge Funds and other investors have been happy to take the risk.
Super carry trade:
In the Yen carry trade the currency risk is always a major factor impacting the cash flow, Yen v/s Dollar, whereas in case of Super carry trade, countries like Brazil which offer dollar-denominated bonds, and the short-term interest rates in Brazil is 10.75% far higher than India. US banks today can borrow at virtually zero interest from the Fed and invest at high rates in Brazil, eliminating the currency risk termed as Super carry trade.
Central banks usually stimulate a slowing economy by cutting interest rates, which encourage people to spend by borrowing more or discouraging them to save. But with interest rates in the developed world already close to zero, that option is no longer available. In such situations, the central banks resort to pumping money directly into the economy, a process known as quantitative easing. It is done by buying bonds — usually government paper but can also be private bonds — from banks and financial institutions. The developed countries used quantitative easing to spur growth in the aftermath of the financial meltdown of 2008. (Source ET).
The world economy is now witnessing yen carry trade, super carry trade and quantitative easing, impacting the economies where cheap money from developed economies may flow into emerging economies and fuel asset bubbles and inflation there.
I have quarried the risk free rate for doing the valuation of equities and got some interesting answers, wanted to share here.
This is holistic view where an average of 10 year debt YTM of five lowest ratio of govt debt to GDP:
The 10yr Treasury is still a decent risk free rate, but the U.S.’s sovereign debt load will soon match Greece’s. It may already exceed that level if you count the unfunded liabilities of entitlement programs.
I’ll propose a better risk-free rate: An average of the 10yr debt YTMs of the five countries in the world with the lowest ratios of sovereign debt to GDP.
This is more holistic than the above one:
In practice, the risk free rate for equities is infinity (or indeterminate, or meaningless), whatever happens in Europe.
Equities are fundamentally a risky investment. Except in very special cases, the issuer has no legal obligation to pay anything back to the shareholder and not even dividends are assured. The ‘return’ obtained by selling equities to someone else is purely speculative, dependent upon some future market that may or may not exist.
Although US Treasuries are considered by many to be ‘risk free’, this would hardly be the case in hyper-inflation in which, even if the principal is repaid, the value of the dollar will be less than when the investment was made.
Even gold (I would say especially gold) is risky. See the link below for the supposed protection of gold in an inflationary environment.
This does not mean that equities might not be a good investment; only that there is a quite substantial risk factor.
The general outlook for the US economy, in the longer term, is for inflation, some say hyper-inflation. When inflation kicks in, the risk of holding equities becomes greater.
I am still discovering for the perfect risk free rate to be taken, I hope to see when Prof Damodaran update his views on the risk free rate.
The derivative instrument Interest rate future IRF is back in India after a period of 6 years .IRF was launched in the year 2003 for the first time in India, it did not took off as there was lack of liquidity and various complexities including the delivery of the product.
Last Saturday I attended the seminar at NSE, again introduction of IRFs in the Indian market. Came across various things and still could not able to digest few things because of the complexities.
The best part of IRFs is that they are deliverable at the end of maturity and the catch is IRFs will be functioning on the basis of underlying 7% Notional Government bond having a maturity of 10years.
The committee has recommended 11 Government of India Bonds having maturity not more than 10 years any of these could be delivered by the seller at the end of maturity depends upon the seller option.
At a time four contracts would be available to trade with the expiry of March, June, September and December so far only two are available they are of September and December.
The concept of Cheapest to Deliver CTD has been introduced (keeping in mind the lack of liquidity in the Indian bond market). Out of 11 bond chosen by the exchange the bond having less CTD will be delivered by the seller in the normal circumstances. Quoting the example:
An Upward sloping yield curve and having a long maturity will be delivered by the seller (keeping in mind the reinvestment risk so it would be CTD contact)
It’s a great move in reforming the India’s Bond market having lot of potentials to outperform in the world market. In India generally the IRF are traded by the Banks, Primary dealers, financial institutions and Mutual fund. Earlier IRF where only used for the balance sheet management and Mutual funds were allowed only to hedge their risk. Thankfully they will be allowed to trade now.
The market for the derivatives on Bond world wide is much bigger comparing to the size of equities market world over. The CBOT allow to trade spreads between the two different bonds. (Say a 10 year note and 30 year bond), means we can long on one and short on the other. The product attracts lot of volume and volatility.
In India calendar spread can be traded current month and the far month. The response in the last 10 days reported by the business newspaper is not that great. Hopefully the volume will pick up but the delivery part complexities will be there so IRFs could prove out to be great Trading, Arbitrage and hedging product.
Well India’s rating has been downgraded by S&P from stable BBB to -BBB, making situation more worse for the economy. Several measures on the fiscal side has been announced by the government reducing the excise duty by 2% and service tax by 2%. Concerns have been raised that the domestic firms will face problems while raising the money from abroad with the downgrading but I feel the affect will be negligible or 50/50. because looking at the current situation across the glob its equally difficult to raise the money from abroad because money has become a scarce commodity in the world. Several stimulus packages have been announced by the various governments bailing out the sectors.The situation has been conflagration from financial sector to the manufacturering sector which is said to be the growth engine for the economy.Lay offs and stocks lying in the go-down are common seen every where. Its time to better watch the things and then react because every day is a event day for economies.
A lot of for and against the debate has been revolving round the recently announced stimulus package by the government of India to boost the economy. The SENSEX again breached the 10,000 mark again. A kind of positive news flow has been conflagrated in the economy, but the ground reality and the bond market depicts the different picture of the economy.
The bench mark 10 year bond has taken the all time hit which closed at 5.16% and dropped up to 4.86% in intraday trade. This was because of the government intervention in the functioning of the RBI, the recent decision of reducing rates by the RBI infused Rs 3, 20,000 crores in the system, which will result in falling of the term deposits immediately. The inflation has been eased to 6% level resulting in reducing the lending rates. The provident funds will find it difficult to meet there mandated rates. The guaranteed return plans will vanish from the market.
The stimulus package is more on the monetary side rather then focusing on the fiscal side. I still doubt on the functioning of RBI as independent body, continuous government intervention for the sake of their policy is not a good sign for the RBI functioning.
The elections round the corner current government is making the most of it by announcing such kind of packages and more in the pipe lines but the ground reality is that it is not making any difference exporters in India has already cut around 65,500 jobs, Broking firms are still on the cost cutting side as there balance sheet is red and most of the analysts see double digit decline in corporate earnings. MBA (Finance) graduates completing there course finding it difficult to get a job. There is tough time lying ahead quality of the skills will be tested upon.
Wealth creation over the years has changed its avenues and area of interest for the investors in India. The prototype investment where the post offices and typically the scheduled banks through savings and fixed deposits have changed and with the awareness of finance, Mutual fund has became an excellent route to create wealth for the public at large.
“Mutual fund is a pool of money is invested in accordance with the common objective stated before the investment to the investors.”
Here is the concept of mutual fund which is a suitable for the common man as it offers an opportunity to invest and diversified, professionally managed basket of securities comparatively at low cost. The investors pool there money to the fund manager and the fund manager invest the money in the securities and after generating returns passed back to the investors.
The mutual fund has a structure which is regulated by SEBI and the Association of mutual funds of India (AMFI) plays an advisory role for the mutual funds. There are lot of entities involved in between Unit Holders and SEBI which includes Sponsors, Trustees, Asset Management Company (AMC), mutual fund, Transfer agent and custodian.
Basically there are only two types of mutual fund in the industry:
• Open Ended
• Close Ended
Open ended funds are those where investors sell and repurchases units at all times, commonly known as Unit trusts in UK and mutual fund in USA.
Close ended funds are generally fixed as it makes a one-time sale of fixed no. of units, known as Investment trusts in UK and Investment Company in USA.
There on mutual funds have been divided into more subcategories Load and No-load funds, Tax –exempt and Non –tax- exempt, money market/liquid funds, Gilt funds, diversified debt funds, focused debt funds, High Yield debt funds, Assured return funds, fixed term plan series, equity funds and so on.
The diversification has been broadened with the revolution and mutual fund has become a major investment destination by yielding more returns. I would like to conclude the article with a note that mutual fund as a investment destination is gaining momentum and in future mutual fund must emerge as a strong capital appreciation tool for the purpose of financial planning.
In order to inject liquidity in the system RBI reduced the CRR by 50 basis points this is one of the rare case were RBI has reduced the CRR over a period of time. This measure was to ease the unprecedented liquidity crunch faced by banks and also to boost capital in flows. It was expected the move will release Rs 20,000 crore into the system, a small relief for banks, who reckon the move could positively impact short-term rates, but not lead to any changes in lending rates.
But today dollar went up to 48.7300, and RBI again had to sell dollars which will lead to liquidity crisis again whatever RBI released through CRR will go back again while selling the dollar in order to control the exchange rates.RBI can do one action at a time weather it can control exchange rates or interest rates which is the main moti