Financial Glossary starting with Alphabet B

  1. Bottom Fishing

    One day there was a man named Raj who was taking a stroll when he came across a bunch of ragpickers who seemed busy scanning through piles of garbage and waste. He realized they were searching for valuable stuff that sometimes erroneously makes their way into the garbage. This practice of the ragpickers reminded him of an oft-used term in investing known as Bottom Fishing.

    The stock market's health is largely dependent upon NEWS flow reflecting the state of the macro-economic environment. In other words, a good macro-economic environment leading to good and positive NEWS flow improves sentiments of investors. No investor would like to invest when the economic environment is not conducive because the risks of investing in adverse conditions are rather high.

    Let's say a country which erstwhile had favorable political conditions, suddenly finds itself in the throes of terrorism. Under such circumstances the stock market plummets to a level that is commonly referred to as the “bottom”. At such times the stock prices of perfectly healthy and robust companies also tend to test the bottom.

    At such times, the sentiments are so discouraging that everything is viewed from the same pessimistic lens and all companies good and bad get painted by the same gloomy and gray brush.

    However, such are times that present the best opportunities to astute investors. There are opportunities to identify stocks that are quoting at prices below their intrinsic values. Such under-valued stocks can yield handsome returns when the negativity in the macro-economic environment alleviates. Identifying such valuable stocks in what is popularly known as Bottom Fishing whichtranslates to fishing for good companies when the markets bottom out.

    Trust the above explanation has clarified the term. “Bottom Fishing”. (Source: Tata Mutual Fund)

  2. Bond Laddering

    Bond investing is much like a game of musical chairs in which bond prices move to the tune of interest rates. Sometimes you might feel that you have no control over what happens to your bond portfolio with the future movements in interest rates. But familiarity with ‘bond laddering’, an investment strategy, could help deal with what is called reinvestment risk.

    Understanding Bond Laddering - A bond ladder or bond laddering is an investment strategy based on a very simple concept.

    • It tries to minimize the risk associated with the future movements in interest rates while creating a regular flow of money for the bond holder.
    • A bond portfolio using laddering would consist of bonds having different maturity dates at regular intervals.
    However, the face value of each bond might be same. For example, a bond portfolio of Rs10 lacs may have 10 different bonds of Rs1 lacs each maturing after one year, two years, three years and so on.

    In such a situation, your bond portfolio would actually look like a ladder in which every year some of your bonds would be maturing, generating a steady cash flow. This cash flow, if you so like, can be reinvested again to create another rung of a bond ladder.

    This kind of strategy ensures that your entire bond portfolio does not mature on the same date. But how does it work?

    A bond ladder strategy is very useful in dealing with one of the most common risks facing your bond portfolio: reinvestment risk. How?

    Well, reinvestment risk of a bond is something that arises due to future movements in interest rates. Suppose you hold a bond portfolio which is currently earning you an interest of 8%. Your bonds would continue to earn an interest of 8% till the date of maturity.

    Now, In the meantime, interest rates might not remain static. They can very well go up or down. In case you choose to hold your bonds till maturity, your entire portfolio would be maturing on the same day.

    This means that you can reinvest your money only at the interest rates prevailing in the future. In case the rates are higher, you are lucky. But in case the rates are lower, your entire portfolio gets invested at a lower interest rate. This is what we call reinvestment risk.

    The arithmetic behind a bond ladder strategy is simple. Spreading out bond maturity dates, in fact, spreads out reinvestment risk.

    It seems like not putting all your eggs in the same basket. Likewise, your entire bond portfolio should not mature on the same date.

    The same logic would also apply to any other fixed income security, say, for instance, a certificate of deposit or even a bank’s fixed deposit, all of which are subject to reinvestment risk.

    But you should also keep in mind that spreading out your risk might also lower your overall return. The simple truth is that when you gain something then you might also lose something. The whole mechanism of bond laddering may require you to bear some kind of cost.

    What kind of cost? For instance, bonds of different maturity in a bond ladder would be earning different interest rates. In a normal situation, bonds maturing early pay lower interest than bonds maturing at a later date.

    So by investing your entire money into bonds of longer maturity you could get a higher rate of return. But despite lower overall rate of return, the prospects of a bond ladder look bright.

    As said, every year a part of your portfolio would be maturing, which means that every year you have an opportunity of making a new investment.

    To Sum Up, Bond laddering is an investment strategy that tries to minimize the risk associated with the future movement in interest rates. A bond portfolio using laddering would consist of bonds having same face value maturing on different dates at a regular interval. Bond laddering strategy is useful because it helps us in minimizing the reinvestment risk. (Source: TATA Mutual Fund)

  3. Bond Prices & Yields

    Why do bond yields go up when bond prices go down?

    You might have come across a set rule which states, ‘When bond prices go down, bond yield goes up & vice versa’. This rule is then simply memorized and never questioned.

    I am sure you will agree that when the seller of a good sells at a lower cost, he makes a lower profit. However, in the same deal the purchaser of the good makes a gain due to the attractive price of purchase.

    Hence when a seller of a bond sells it at a reduced price, while he loses, the buyer of the bond gains from the transaction. Thus the loss for the seller is the fall in price while the gain for the buyer is the benefit of higher yields.

    Now let’s understand with a simple example -

    Let’s assume that Ravi has a corporate bond of Rs 100 which is to give him 10% returns per annum. In other words, the company would pay him Rs. 110 at the end of the year for the Rs 100 loan that Ravi has given to the corporate. The 10% yield thus translates to Rs 10 of profits for Ravi.

    Now let’s assume that Ravi has an emergency and needs his money back. For this he goes to the market and finds his friend John. John realizes that Ravi needs money urgently. So he offers Ravi to buy his bond for Rs 90. Ravi agrees to the offer and sells the corporate bond for Rs 90.

    At the end of the year John receives the Rs 110 from the corporate. Thus John earns Rs. 20 from his investment of Rs 90 which he makes when he buys the corporate bond from Ravi.

    Thus, John’s % return (which is popularly known as the yield) works out to: {20/90} x 100 = 22.2%

    Thus while Ravi suffered a loss by selling his corporate bond at a lower price of Rs 90 instead of his purchase price of Rs 100 translated into a gain for John in terms of higher yield which for him went up from 10% to 22.22%.

    Having understood the concept, it will not be difficult for you to appreciate the inverse relationship between the price of the bond and its yield (for the buyer of the bond) - i.e. A bond’s yield goes up when its price goes down and conversely the yield of the bond comes down when the price of the bond goes up. (Source: Mutual Fund)

  4. Bonus Shares

    We all know that bonus shares exist. But why are they issued in the first place? Let us understand -

    Let’s say a company makes Rs 1000 as profit. Now suppose the company has 100 shares. Then earning per share is profit/no. of shares = Rs. 1000/100 = Rs. 10

    Suppose there is a surge in the demand for company’s product causing its profits to go up from Rs 1,000 to Rs 10,000! One should observe is that while the profit went up from Rs 1000 to Rs 10,000 the number of shares remains the same at 100.

    Hence, by definition, earnings per share would be 100. Now, as we know that Market Price = EPS x P/E

    If we were to assume a P/E of 10, the price per share would become Rs 1000. At a price of Rs 1000, it would be very difficult to expect retail participation because any investor would need a minimum of Rs 1000 to purchase a single stock!

    But that’s quite a large amount. Say, an investor has only Rs 500 but wants to invest in this company. What does he do?? Despite having the desire to buy the stock, he will not be able to participate for want of money.

    It, therefore, becomes essential for the company to increase the number of shares, so that the price per share is within the reach of retail participants.

    Let’s say the company declares a 1:4 bonus which essentially means that for every 1 share you get additional 4 shares. So, in effect, you get a total of 5 shares. This would increase the total number of shares from 100 to 500!

    The earnings per share would now become - EPS = Total Earnings/No. of Shares (or) Rs (10,000/500 = Rs 20). And that would bring down the price per share from an unaffordable Rs 1000 to a more amenable Rs 200 (EPS x P/E = 20 x 10).

    So in other words 100 shares x 1000 = Rs 10,000 is reconfigured as 500 shares x 200 = Rs 10,000.

    This division of shares thus increases retail participation and hence liquidity to the stock, making it easily tradable as more buyers and sellers are able to participate because of a lower unit value per share.

    And our friend is also in a better position & can buy at least two shares with his Rs 500 (2 x 200 = 400) & he will be left with Rs100.

    Thus we have seen how and why ‘Bonus Shares’ are issued in the stock market. Also we have understood that the overall capital remains the same even if bonus shares are declared.

    The only reason if at all for the stock price to go up would be because sentiments might turn positive by the news of bonus as it indicates that the company has earned good profit and hence could continue to do so and thereby attracting new investors and taking the price higher! (Source: Tata Mutual Fund)

  5. Bonus Shares Vs Stock Splits

    In both bonus shares and stock split the number of shares of a company increases. But what are bonus shares and what are stock splits and more importantly what’s the difference between them?

    When a company earns a profit, it distributes part of its profits as dividends and keeps the other part as reserves for future investments. Or sometimes it could keep the entire profit as reserves as well.

    Over the years, after the payout of dividend, it is possible that the reserve amount grows and becomes substantial. At this stage the company might want to capitalize on this reserve. By this we mean that it will convert part of the reserves into shares. This is called expanding the authorized share capital.

    Now how does the company do this? Let’s say the company wants to capitalize Rs. 100,000 (reserves). At Rs. 10 per share this translates to 10,000 shares.

    Let’s say there were a total of 10,000 shares in the market at this point in time. So there are 10,000 shares in the market & there are 10,000 shares created from reserves. In other words for every share the company can provide one bonus share.

    In this situation, we say that the company has declared a 1:1 bonus. Thus, after the bonus issue there would be 20,000 shares in the market.

    At this point, it’s important to understand that the market value of the 20,000 shares would be the same as that of the erstwhile 10,000 shares. Hence the value of a single share would fall proportionately.

    Thus if the market price of 10,000 shares was Rs 15 each, the market capitalization was Rs 150,000.

    Now, after the bonus shares have been released the total number of shares goes up to 20,000 but market capitalization stays at Rs 150,000 and hence the price per share falls to Rs 7.5 (150,000/20,000)

    Remember market capitalization is a function of the profits of the company during a year. Therefore just by issuing shares the profits of the company made during the year does not get affected. Hence market capitalization does not change.

    So to sum up when shares are formed from the reserves and distributed to shareholders we say the company has issued bonus shares. In the case of bonus shares, the market capitalization remains unchanged and price of the share in the market drops proportionately in keeping with the number of bonus shares issued.

    I hope you’ve understood bonus shares with this example.

    Now let’s see what’s stock split. Over a period of time as companies grow and get more profitable their market prices too start rising. For example let’s say company’s share value has risen to Rs 10,000 per share over a period of time.

    Many people would find it difficult to transact in such a stock because of its high price. For example, an investor may have only Rs 5000 to invest. Such a person would not be able to buy this stock because its price is Rs 10,000 which is beyond his means.

    Thus to help such investors to participate in stocks where prices have gone up, the companies goes for a stock split. Essentially what it means is to split the stock into smaller units of less value such that its liquidity in the market increases and more investors can participate.

    So in our example, the Rs 10,000 stock could be split in 4 parts, each of Rs 2,500 in value. So whosoever owns a stock of this company, will now have 4 stocks instead.

  6. Buyback of Shares

    We normally hear of promoters raising capital by issuing shares in the market. But there are times when the promoter wishes to buy back his shares from the investors. At such times he offers a buy back at a price which is better than the market price.

    There are several reasons for him to buy back shares. No promoter likes to see the prices of his company falling. Therefore if he feels that the price of shares is falling in the market, he may decide to buy back shares to shore up the prices.

    Another reason the promoter might offer a buy back is to increase his share-holding if he feels that someone in the market is buying a large number of shares of his company in a bid to take over the company.

    To protect himself from such a takeover bid, the promoter offers a buy back of his shares to his investors at an attractive price. The promoter may also buy back shares from the market, if he feels that the price of the share is lower than its intrinsic value.

    In other words, for the promoter, it is another way of giving back money to the investors.

    Hence sometimes it’s useful to observe such buy backs by promoters. The interest taken by the promoter indicates that prices could rise in the medium term. (Source: Tata Mutual Fund)

  7. Bottom Line & Top Line Growth

    We come across these terms so very often and perhaps have got use to it without even understanding

    Bikas was a “Bhelpuriwala”in Mumbai. He would sell Bhel at Marine Drive. Every day he would buy the ingredients worth Rs. 1000 to prepare his “Bhel”. By the end of the day he would sell all his stuff for Rs. 1200 thereby pocketing Rs. 200 for a day’s efforts.

    Thus from the perspective of day, his topline is Rs. 1200 while his bottom line is Rs 200.

    Thus the aggregation of “price” of the product comprises the “top-line” whereas the aggregation of “profits” comprise the “bottom-line”.

    Thus “top-line” growth would be in the shape of selling more units of Bhel which he can achieve by either working for longer hours or by hiring people under him or increasing the price per unit of bhel

    When the top-line (i.e. no. of units of bhel sold ) goes up profit margins remaining the same, the bottom-line too goes up proportionately. But it also important to note that “bottom-line” growth would also take place if the “bhelpuriwala” decides to increase the price of his “bhel”. Or it is able to buy the ingredients at lower price.

    So in a sense to increase his bottom-line it is not necessary to increase top-line. (Source: Tata Mutual Fund)

  8. Beta

    In finance, the Beta (β) of a stock is a number that tells you the relation of its returns with that of the financial market as a whole. When making an investment, it is necessary to check the fund returns but that alone is not a sufficient condition.

    Evaluating other parameters like “beta” helps in making better investment decisions in keeping with one’s risk profile. You can think of beta as the tendency of a security's returns to respond to swings in the market.

    A beta of 1 indicates that the security's price will move with the market.

    A beta of less than 1 means that the security will be less volatile than the market.

    A beta of greater than 1 indicates that the security's price will be more volatile than the market.

    For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market.

    Let’s demonstrate this with an example. Say there’s a housewife Mary. Her son is a complete brat. Perhaps he is the naughtiest boy not only in the building where they live, but also in his boarding school where he stays. Now suppose, Mary’s neighbour Alice has to attend to an emergency.

    Even Alice’s son is quite a brat and therefore most families in the neighborhood refuse to baby sit him. However Mary willingly agrees because her own son is much naughtier than Alice’s son. So as compared to managing her own son, she finds it extremely easy to look after Alice’s son.

    This example shows that certain decisions are taken by using comparison as a tool. Hence while taking an investment decision, it becomes important to understand the expected volatility of your fund with respect to the benchmark and not just the performance.