Financial Glossary starting with Alphabet R

  1. Rupee Appreciation or Depreciation Causes

    Recently we have seen our currency, the Rupee nose-diving to depths never seen before.

    But do we really understand what could be the possible causes for a nation’s currency to either appreciate or depreciate???

    Before we jump to the causes, let us first understand what we mean by currency appreciation or depreciation.

    Rupee depreciation means that rupee has become less valuable with respect to dollar. If the rupee moves from Rs. 50 per dollar to Rs. 60 per dollar then the rupee is said to depreciate. It means that the rupee is now weaker or cheaper than what it used to be earlier. While one dollar was available for Rs. 50 earlier, the same is now available for Rs. 60.

    Similarly, Rupee appreciation means that the rupee has become more valuable or stronger with respect to the dollar. If the rupee moves from Rs. 60 per dollar to Rs. 50 per dollar then the rupee is said to have appreciated. It means that the rupee can buy more dollars than earlier.

    This is vital because when we import goods, we have to first buy the dollars and then the goods. So if dollars are expensive, it follows that imports are expensive.

    Hope the concept of rupee appreciation or deprecation is made clear by the above explanation.

    Currency price like any commodity is also determined by demand and supply of that currency in the international market. When supply of rupee increases, value of the rupee falls. The opposite holds true when demand for rupee increases.

    Now let us understand the factors that can cause Rupee appreciation or depreciation

    Current Account Deficit is when a country’s imports are higher than its exports. When a country imports more, it needs to pay in foreign currency, causing the country’s currency to depreciate as demand for the foreign currency increases. The opposite holds true in case of Current Account Surplus.

    Capital Account Flows: Current Account Deficit is funded by capital flows and current account surplus generates capital outflows (investment in foreign countries). When there is capital inflows in India, demand for rupees increases leading to rupee appreciation. Capital outflow causes the rupee to depreciate because money moves out as dollars and hence the demand for dollars goes up causing rupee depreciation.

    Interest Rate: A country with high interest rates attracts foreign investors because interest rates in their country are less. Thus demand for the rupee increases, resulting in appreciation in the value. However this arbitrage benefit that is sought by investors is dependent on the stability of the currency. Else the returns due to incremental interest rates would get offset by currency depreciation.

    Inflation: High inflation impacts the country’s exports as goods become expensive for other countries resulting in decreased demand for the rupee leading to depreciated rupee value.

    Income Changes: When employment and per capita income in a country increases then increased domestic income is associated with an increased consumption of imported goods. As consumers purchase more imported goods, the demand for dollars will exceed its supply and dollar will appreciate.

    Monetary Policy - Countries with easy monetary policies can increase the supply of their currencies, which will cause the currency to depreciate. If a nation’s central bank is pursuing an expansionary monetary policy its currency is likely to weaken. (Source: Tata Mutual Fund)

  2. Real Estate Investment Trusts (REIT)

    A Real Estate Investment Trust or REIT is a company that owns and operates income-producing real estate. REITs are also known as real estate stocks. Some REITs not only operate, but also finance real estate. To be a REIT, a company must distribute at least 90% of its taxable income to shareholders annually in the form of dividends.

    Basically REITs were created in the US in 1960 to give anyone and everyone the ability to invest in large-scale commercial properties.

    REIT Basics -

    The shares of most REITs are publicly traded on major stock exchanges

    The US Congress created the legislative framework for REITs in 1960 to enable the investing public to benefit from investments in large scale real-estate enterprises

    REITs provide ongoing dividend income along with the potential for long-term capital gains through share price appreciation

    It is also a powerful tool for long-term portfolio diversification

    Categories of REITs -

    Equity REITs own and operate income-producing real estate

    Mortgage REITs lend money directly to real estate owners and their operators, or indirectly through acquisition of loans or mortgage backed securities

    Hybrid REITs are companies that both own properties and make loans to owners and operators

    REITs are now mainstream investments. In 2001, Standard & Poor’s recognized the evolution and growth of the REIT industry as a mainstream investment by adding REITs to its major indexes, including the S&P 500.

    With a diverse profile, the REIT industry offers investors many alternatives across a broad range of specific real-estate properties. Apartments, Office properties, Shopping Centres, Malls, Storage Centres / Warehouses, Industrial Parks, Hotels and Resorts and Health care facilities etc.

    Benefits of REITs -

    Ownership of REIT shares has historically increased investors’ total return and / or lowered the overall risk in both equity and fixed income portfolios due to diversification

    Dividend growth rates for REIT shares have outpaced inflation over the last decade

    REIT business enterprise is based in large part; on the value of tangible and quantifiable assets, namely large scale commercial real state

    How are REITs valued? NAV calculation – The REITs’ total assets minus all liabilities, divided by all outstanding equity shares of the REIT yields the NAV. Value of a REITs’ property assets can be enhanced through capital expenditures. This is significant because these expenditures, either for development or maintenance of property, can maintain or increase NAVs

    Investor Participation -

    Individual investors can participate broadly in opportunities available in the REIT industry through REIT mutual funds

    These REIT mutual funds are managed by portfolio managers with a high degree of expertise in the real estate industry

    REIT mutual funds provide investors with a cost-effective opportunity to add to a balanced investment portfolio

    REIT mutual funds offer diversified exposure to the real estate asset class

    REITs are similar to other businesses -

    Liquidity – REITs are traded on all major stock exchanges in the US, like any other publicly traded company

    Shareholder Value – REIT shareholders receive value in form of both dividends and price appreciation

    Active Management – REITs are professionally managed and adhere to corporate governance principles

    Disclosure Obligations – REITs are required to provide regular financial disclosures and audited financial statements

    Limited Liability – Shareholders have no personal liability for debts incurred by REITs. (Source: Tata Mutual Fund)

  3. Return on Capital Employed

    Return on Capital Employed (ROCE) is used in finance as a measure of returns that a company is realizing from its capital employed. Capital Employed is represented as total assets minus current liabilities. In other words, it is the value of the assets that contribute to a company’s ability to generate revenue

    ROCE is thus a ratio that indicates the efficiency and profitability of a company’s capital investments (stocks, shares and long term liabilities)

    Return on Capital Employed (ROCE) - It is expressed as:-

    ROCE = -------------------------------- X 100
                     Capital Employed

    The numerator is Earnings before Interest & Tax. It is net revenue after all the operating expenses are deducted. The denominator (capital employed) denotes sources of funds such as equity and short-term debt financing which is used for the day-to-day running of the company

    What does ROCE say, It is a useful measurement for comparing the relative profitability of companies. ROCE does not consider profit margins (percentage of profit) alone but also considers the amount of capital utilized for those profits to happen. It is possible that a company’s profit margin is higher than that of another company, but its ability to get better return on its capital may be lower. So, ROCE is a measure of efficiency also.

    Example - Company A makes a profit of Rs. 100 on sales of Rs. 1000. Company B makes a profit of Rs. 150 on sales of Rs. 1000.

    In terms of pure profitability, Company B has profitability of 15% (Rs. 15 / Rs. 1000). This is far ahead of company A which has 10% profitability (Rs. 100 / Rs. 1000)

    Now, Let us assume that Company A had employed Rs. 500 of capital and Company B used Rs. 1000 to earn their respective profits

    So, ROCE of A is:- (earnings / capital employed)

    • (Rs.100 / Rs. 500) X 100 = 20%

    • While ROCE of B is:-

    • (Rs. 150 / Rs. 1000) X 100 = 15%

    Thus ROCE shows us that Company A makes better use of its capital, though its profit percentage is lower than that of Company B. In other words, it is able to squeeze more earnings out of every rupee of capital it employs

    Usually ROCE should always be higher than the cost of borrowing. An increase in the company’s borrowings will put an additional debt burden on the company and will reduce shareholders’ earnings

    So, as a thumb rule, a ROCE of 20% or more is considered very good. If a company has a low ROCE, it means that it is using its resources inefficiently, even if its profit margin is high.