Financial Disaster

/
2 Comments
[Note: If you think this post will be complex and that you are not well-versed with terms used in Finance, well I am on the same plane. I know as much as you do or maybe slightlyyyy more. So, don't shy away from reading it for that reason. Read it just for the joy of it and who knows you may get some idea and earn some extra buck.]

The title may be misleading, but it is a disaster, though may be in a different sense of whatever picture you have in your mind.

One of my most dreaded subjects of all times has been Financial Management. Reason? I don't know. I just find it too complex.

While studying for my exams was going through Bonds, Shares, Warrants, Convertibles, Options, etc. I realized that its all gambling !

The theory about which I heard long back, The Bigger Fool theory, seemed cent percent correct. The theory is nothing but the belief held by one who makes a questionable investment, with the assumption that they will be able to sell it later to "a bigger fool"; in other words, buying something not because you believe that it is worth the price, but rather because you believe that you will be able to sell it to someone else for an even better price. (source: Wikipedia)



Why, for instance, do you buy shares of a company? Isn't it only because you believe that the prices will go up from hereon (or someday) and that you will sell it and earn profit.

What is a warrant? The right to buy shares of a company in future at a price decided today ! When you buy a warrant, you will always think that tomorrow the share prices will rise and I will be able to buy it at today's price and earn profit.

Why do you buy a bond? What do you get? You buy say a Rs. 1000 bond today that gives you x% interest every year for 'n' years and then you get back your Rs.1000 as well after 'n' years. Seems like WOW right? You pay Rs. 1000 today, get back Rs. 1000 after 'n' years plus you also get some money everywhere. Would you even like to think for once that things may go sour, your money may go down the drain.

No, because optimism is the way forward :)

What is the concept of Time Value of Money for that matter? In evaluating a deal, you essentially calculate the NET PRESENT VALUE of the future cash flows you will be getting, which is nothing but DISCOUNTING future cash flows by a certain percentage, say R.

Why so?

Because anyone and everyone who has money right now will lend it to you and charge you R% interest, because he is pretty sure that if he hadn't given you the money, he would have used it to EARN more money which he now cannot because you have the money and so he should get some compensation. Ya, right ! Its so damn easy to earn than too lend (you may call it invest).

Though, slightly off-track, the concept of a Leverage Buy Out came to my mind all of a sudden. Now, this one is truly hilarious ! Trust me on this.

Company A wants to buy Company B.

What do you think about this now?

Company A mortgages (or pledges) all assets of company B (company B's assets on which A has no rights!) and raises debt (loans). Now using this money from loans it buys B. So simple.

Tata actually did a Leverage Buy Out of Tetley, that you now have Tata Tetley :)

How interesting and hilarious is this, that you take some company, based somewhere and PLEDGE that company's assets to someone and TAKE A LOAN. Using the money from the loan, you actually end up buying the company, whose assets you pledged. What about the loan now? Ah! thats a loan, you keep on paying installments and waive it off someday.

Besides, it seems loans are the most easiest way of getting money. Every now and then you take a loan and you do something with it, say buy a company's bonds. You may call it investment but it is actually giving out a loan to that company and earning interest.
So, it looks like A takes loan from B, B could give that loan because he had money which he borrowed from C, C in turn had raised debt from D, D had issued bonds which E bought, E got the money to buy bonds by issuing SHARES... and so on....

Its loans and loans, what is the ultimate source I wonder :)

Update : Just recalled the concept of SHORT SELLING, which to my understanding allows you to sell something you don't own and earn profit. Say, there is a share S of company C with price P. Now, even if you don't own this share S, by some logic (to me magic) you can sell this share 'S' at a price P + p (often the short-seller sells it to earn profit so we assume 'p' profit). Here, what he gets is profit 'p' only and not P + p because he didn't own that share worth 'P'. I know its pretty confusing. Am as much confused and amuzed as you are. And ya, now if you think even you want to earn this way, to my knowledge, as things stand today, short selling is not allowed in India.

Post Update : As Gunjan says, short selling is allowed now, toh jao kamao paise sab. And ya he mentioned futures which is nothing but buying or selling something in future at a price fixed today. The one who buys a future hope the price will go up and the one who sells is greedy, and thinks the price will go down.

When I asked how is it different from warrants, he said.

warrants mein you pay a premium...
and it is an option
future is an obligation
you have to irrespective of what the price is
warrant mein you have an option
future mein there is not option

Jisko samajh mein aaya ho woh thodi saral bhasha mein mujhe bhi samjha dena..par koi jaldi nahi hai...khud samajh lo...kama lo thoda bahut...if successful, then come and explain me.

(Image courtesy: thegoldguys.blogspot.com)


You may also like

2 comments:

tushar said...

Dude, u explained some real technical terms in Finance..my head was getting dizzy coz the reality is, even for me Finance is a Disaster!!!
Go Go Marketing :)

Gunjan said...

Hmnn..

Impressive Explanation,

Just a correction, Short selling is allowed in India.

It could be done using futures ( 1 more term for you to explain)

or it could be done through a stock borrowing mechanism, (where you borrow the stock from somebody at a certain Rate, and sell those shares in the market.) later on you buy back those shares, return them to the person you borrowed it from, and pay him the interest for the borrow and settle the transaction.

Powered by Blogger.