Month: October 2022

Introduction

Indexes are numerical representations of a stock market’s performance, and the index’s value fluctuates along with the stock prices. To compare the performance of investments to a relevant market index, it is necessary to use an index.

One such index is the Bombay Stock Exchange’s Benchmark index, known as the Sensex. As an amalgamation of the words ‘sensitive’ and ‘index’, Sensex is operated by Standard & Poor’s (S&P) and is also India’s oldest stock index. Investors and analysts use it to track the economic cycles in India and the rise and fall of specific sectors.

Please continue reading to know more about Sensex and what it is all about.

What Is Sensex?

A one-word answer to “what is Sensex?” is that it is a market index.

A market index indicates the overall performance of all publicly traded firms. In the stock market, it is a measurement of numerous elements such as market performance, price fluctuations, etc.

The Sensex, commonly known as the S&P BSE Sensex, is one of India’s oldest market indexes. The Sensex represents the Stock Exchange Sensitivity Index, and it includes the top 30 businesses listed for trading on the Bombay Stock Exchange.

A Brief History of Sensex

Since India’s economic liberalisation in 1991, Sensex has enjoyed substantial development. In the 21st century, the population increased from 5,000 in early 2000 to over 42,000 in January 2020. This is primarily due to India’s booming economy, which has risen at one of the fastest rates in the world for years. 

On April 18, 1992, the BSE Sensex fell 12.7%, its most significant drop ever, after the exposure of a scheme in which a renowned broker diverted funds from the public banking sector to invest in stocks. 

The expansion of India’s economy and Sensex is mainly attributed to the increase of the country’s middle class and vice versa. It is estimated that by 2030, over 80% of Indian families will have a median income, up from around 50% in 2019. The middle class is a significant force in driving consumer demand. 

In 2019, India’s economic growth reached its lowest point in a decade. The onset of the worldwide coronavirus pandemic at the beginning of 2020 has further slowed the economy, thus also the growth of Sensex and placed a shadow on future gains.

So How does Sensex Work?

The Sensex is computed using the free-float market capitalisation technique, which reflects the performance of thirty Sensex companies. The free-float market capitalisation technique reveals the percentage of a company’s marketable shares issued to the general public.

Many people often confuse the Sensex with the Nifty Index, even though they have significant differences. 

Nifty is the abbreviation for National Stock Exchange Fifty, the index of the National Stock Exchange. Nifty is managed by the NSE subsidiary NSE Indices Ltd. Sensex, on the other hand, is governed by BSE. Sensex’s base index value is 100, whereas Nifty’s base index value is 1000.

Sensex comprises 30 well-established corporations, while Nifty is formed of 50 leading companies listed for exchange on BSE and NSE, respectively. So, you might be curious about the Sensex companies which are included in the index.

Companies In The Sensex Index

The Bombay stock exchange Sensex has 30 companies listed, representing the market’s overall state. The Sensex companies included in the index are mentioned below.

The list mentioned above consists of the 30 companies listed in the BSE, which make up the Bombay stock exchange Sensex. These companies are chosen from a multitude of sectors to represent the market condition over all industries combined equally.

Now that you know which companies are present in the BSE Sensex, you might be curious about how the Sensex is calculated? 

How Is The Sensex Index Calculated?

The Sensex calculation was first done using the market capitalisation or “Full Market Capitalisation” technique but later switched to the “Free-float Market Capitalisation” approach on September 1, 2003. All significant index providers, including MSCI and FTSE, use this procedure for their index calculation.

Free float is the fraction of a company’s total issued shares easily accessible for public trade. 

It does not account for promoters’ holdings, government holdings, or other stocks that will not be offered for trade in the normal run of events.

Market Capitalisation x Free Float Factor = Free-Float Market Capitalisation

The “market capitalisation” is the company’s value, and it can be calculated by multiplying the share price by the number of shares issued.

For example, suppose that Company A has 100 shares, and 70 of these 100 are open to the general population, while 30 are government-owned. Therefore, 70% of the shares are ‘free-floating,’ and the free float fraction is 70%.

Therefore, to do the Sensex calculation:

• The total base market capitalisations of each of the index’s 30 constituent companies are determined.
• The free-float market capitalisation of the 30 sensex companies is determined.
• The Free Float market capitalisations of all companies summed up into a total. Then calculated using the following:

Sensex Value = (total free-float market capitalisation/base market capitalisation) * Base index value.

This calculation method helps achieve the value of the Sensex stock market and governs the current state of the stock exchange. Subsequently, there are numerous advantages of the Sensex as well. 

Advantages Of Sensex

The Sensex Stock market brings substantial advantages to investors other than just reflecting the state of the market. 

Here are some of the noticeable features of Sensex, which prove to be a considerable advantage for investors:

• High Liquidity 

Sensex gives investors more liquidity since the average daily volume traded is substantial. This liquidity makes it easier for any investor to purchase or sell their stocks on the BSE.

• Portfolio Diversification

The Bombay stock exchange Sensex provides investment in various sectors through a single index, which offers investors an extensive selection of investment options. In addition to giving investment options, this is also advantageous for limiting the inherent risks of stock investing by allowing portfolio diversification.

• Security & Reliability

The Stock Exchange Board of India (SEBI) administers the Sensex stock market. The SEBI is responsible for regulating stock exchanges, fostering their growth, and safeguarding investor rights. This indicates that a regulatory framework adequately protects investors’ interests when investing in the BSE Sensex. This considerably reduces the dangers associated with unscrupulous business practices.

• Convenience

The Sensex also provides the convenience of investing in numerous companies of substantial sizes and a proven track record, all at once, without the hassle of investing in each of them individually. This is one of the features of Sensex, for which it is well-reputed among investors.

These are just a few of the most considerable benefits of the BSE Sensex. But, with advantages comes disadvantages as well, and here are the cons or the limitations of the Sensex. 

Limitations Of Sensex

The Sensex stock market, like any other index, has its limitations. 

Even though these reasons might not be that big of a deal for regular investors, industry veterans might avoid investing the majority of their portfolio in indexes due to the following reasons:

• Inadequate Downside protection

Over Long-term, the stock market has shown to be an excellent investment, but it has had its share of ups and downs throughout the years. Investing in an index fund, such as the Sensex, can provide upside potential when the market is doing well, but leaves you entirely exposed to market declines.

Investors with substantial exposure to stock index funds may choose to hedge their exposure to the index by shorting Sensex futures contracts or purchasing a put option against the index. However, because these instruments move in the exact opposite direction of one another, combining them would defeat the purpose of investing. 

Thus, you consider these limitations when investing in the Sensex stock market. In the long term, such restrictions do not affect Sensex’s performance but are still worth noting.

SEBI’s role in the Sensex Stock Market

The Securities and Exchange Board of India (SEBI) is one of the chief governing authorities in India that monitors and effectively regulates the Indian Capital Markets, such as the BSE Sensex. 

SEBI is responsible for formulating structured policy development of securities markets. Specifically, this division strives to protect the interests of traders and investors on the Indian stock exchanges such as Sensex.

Bottom line

Having an explicit knowledge about the workings of the Sensex and its effects on the Bombay Stock Exchange is essential for any investor, regardless of their experience. 

Before investing in the index, you must have a comprehensive understanding of the Sensex calculation, its characteristics, and its limitations. Hopefully, the above article has helped you gather a thorough knowledge of Sensex.

Introduction 

If you are a relatively new investor to the market and are still familiarising yourself with the various terms you come across in the marketing world, you would surely have come across the term India VIX. Like any other marketing term, India VIX is important to understand for any investor in the market. So what does the term India VIX really mean and why is it so important to know? A short form of India Volatile Index, India VIX, indicates the volatility and swings in the market, which is important to know for investors and buyers. So, to understand the importance of this term, let’s go through it in a little more detail.

What does Volatility Index (VIX) mean, and how is it calculated? 

The volatility index (VIX) is a measure of market volatility, which is why it is called that. The Volatility Index represents the market’s expectation of near-term volatility. The market often moves quickly up or down during periods of market volatility, and the volatility index tends to rise. 

As volatility decreases, the volatility index decreases as well. The Volatility Index differs from a price index such as the NIFTY. The price index is generated by considering the underlying stocks’ price movement. The Volatility Index is calculated as an annualised percentage using the order book of the underlying index options.

History of Volatility Index (VIX)

To grasp the concept of a Volatility Index, one must first travel back to the 1970s, when there was no reliable technique for assessing investor confidence.

 The markets were frequently based on guesswork, making identifying the ‘fair price’ of stock extremely complex.

Three economists, Fischer Black, Robert Merton, and Myron Scholes, devised a model in 1973 that revolutionised the option pricing process.

The ‘Black Scholes Model’ is now widely used to assess market volatility worldwide.

In 1997, the three were awarded the Nobel Prize in Economics for their groundbreaking work. Merton, though, had died before that year, and the model is named after the survivors.

The model is represented as follows –

C = StN(d1) − Ke − rtN(d2)

When: d1 = σs tlnKSt+(r+2σv2) t

plus: d2 = d1− σs t

In this model, the legends mean the following –

C= Call option price

S= Current stock price; another underlying price (s) may be considered

r= Interest rate (risk-free)

K= Strike price

N= an ordinary/normal distribution

t= time to maturity

What is India VIX? 

Now that we have understood the concepts of VIX, let us take you through the basics of VIX India. The NSE’s order book of NIFTY options is used to construct a volatility indicator, which is the basis of India VIX meaning. 

This is done using the best bid-ask quotes of near and next-month NIFTY options contracts traded on the NSE’s F&O sector. 

The India Volatility Index (VIX) index indicates investors’ expectations for market volatility in the short term, i.e., over the next 30 calendar days. 

The higher the India Volatility Index (VIX) figure, the more volatile the market is expected to be, and vice versa.

Computation Methodology 

India Volatility Index (VIX) uses the CBOE’s calculation technique, with changes to fit the NIFTY options order book, such as cubic splines and so on.

In order to calculate the India Volatility Index (VIX), the following factors are considered:

Time to Expiry 

The time to expiry is estimated in minutes rather than days to reach the level of precision expected by experienced traders.

Interest Rate 

The risk-free interest rate for the different expiry months of the NIFTY option contracts is the relevant tenure rate for 30 to 90 days.

Forward Index Level 

Out-of-the-money option contracts are used to calculate the Volatility Index (VIX). The forward index level is used to identify it. 

The forward index level aids in determining the at-the-money strike, which aids in selecting the options contract to be utilised in the computation. 

The most recent accessible price of the NIFTY future contract for the respective expiry is used to calculate the forward index level.

Bid-Ask 

The ATM strike is the strike price of a NIFTY option contract that is available at a price slightly lower than the forward index level. 

Option NIFTY and call arrangements with strike prices more significant than the ATM strike are both viable options. 

Out-of-the-money options are contracts with a strike price less than the ATM strike, and the India Volatility Index (VIX) is calculated using the best bid and ask prices for such option contracts.

Values are computed by interpolation using a statistical approach known as the “Natural Cubic Spline” in the event of strikes for which appropriate quotations are unavailable. 

Following quotation identification, the variance (volatility squared) for near and mid-month expiry is calculated independently.

Uses of Volatility Index (VIX)

Some of the uses of the volatility index are as follows:

1) For equities traders, the Volatility Index (VIX) is an effective and reliable indication of market risk. 

Intraday and short-term traders might use it to see if market volatility is increasing or decreasing. 

As a result, they will be able to fine-tune their strategy. Intraday traders are at risk of stop losses being triggered prematurely when volatility is projected to surge significantly. 

As a result, they can either reduce their leverage or increase their stop losses.

2) For long-term investors, the Volatility Index (VIX) is also a good indicator, and short-term volatility is usually unimportant to long-term investors. 

Institutional investors and proprietary desks, on the other hand, are subject to risk and MTM loss limitations. 

They may increase their hedges in the form of puts to play the market both ways if the Volatility Index (VIX) signals that volatility is rising.

3) The Volatility Index (VIX) is also a helpful indicator for options traders.

Typically, volatility determines whether to buy or sell an option. 

When volatility is projected to increase, options become more appealing, and buyers are more likely to profit. 

When the Volatility Index (VIX) drops, there will be more squandering of time value, which will benefit option sellers.

4) It is also possible to trade volatility with it. 

If you think the markets will become more volatile, you might buy straddles or strangles. 

These, on the other hand, become prohibitively expensive when volatility is predicted to rise. 

A better strategy would be to buy Volatility Index (VIX) index futures, allowing you to profit from volatility without worrying about market direction.

5) The Volatility Index (VIX) index can benefit portfolio managers and mutual fund managers. 

They can try to raise their exposure to high beta stocks when the Volatility Index (VIX) has peaked, and they can try to increase their exposure to low beta equities when the Volatility Index (VIX) has bottomed.

6) The Volatility Index (VIX) is a very reliable and accurate predictor of index volatility.

If you plot the Volatility Index (VIX) and the Nifty’s movement over the last nine years, you will discover a clear negative correlation. 

When the Volatility Index (VIX) is at its lowest, markets often top, and when the Volatility Index (VIX) is at its highest, markets typically bottom. 

This is a crucial component of index trading.

How are Indian Markets affected? 

The ways in which India Volatility Index (VIX) affects the Indian market are as follows:

Market volatility and India’s Volatility Index (VIX) have similar trajectories. 

If the Volatility Index (VIX) is very high, investors can therefore reasonably expect some crucial announcements or developments in the NIFTY. 

To put it another way, a higher Volatility Index (VIX) suggests increased market volatility. Because the NIFTY 50 is a benchmark index, any change might significantly influence the economy as a whole.

To summarise, investors should keep an eye on recent Volatility Index (VIX) movements because they can predict future events. If the index is low, no significant changes are foreseen.

India Volatility Index (VIX) and NIFTY have a malicious link 

For example if India’s Volatility Index is high, NIFTY’s benchmark index will fall. This benchmark will be much higher if the Volatility Index (VIX) is low. 

When one considers the subprime loan crisis of 2008-09 and the following bankruptcy of Lehman Brothers (an investing and financial services behemoth founded in 1847), it is clear that the NIFTY index was in a funk.

The Volatility Index meaning has changed worldwide anytime there has been a massive influence on the global economy owing to unrelated occurrences. 

After each event, the formula for calculating this index (seen below) has been tweaked slightly. 

Volatility Index (VIX) reached all-time highs in 2001, just after the September 11th hijackings and attacks on the Twin World Trade Centre Towers and the Pentagon.

Helps investors measure market sentiment 

One of the most significant functions of a Volatility Index is to assist any investor, whether retail or institutional, in determining market sentiment. One can use the Volatility Index (VIX) to determine whether buying or selling certain stocks at current pricing is better.

A good example was an epidemic in 2020. Markets plummeted when the nationwide shutdown was announced in March. Indian equities have lost about 40% of their value, a severe economic shock that will take years to recover. 

Most indicators took this as a hint that they should ‘dump’ their stocks at whatever prices they were getting; there was concern that most equities would lose all value in months. 

Because companies’ market capitalisations were fast eroding, all trading was temporarily halted. 

The financial markets began to rise again around November, resulting in a decrease in the Volatility Index. It also shows that investors believe India’s economy is resilient and strong enough to weather the storm and will rebound shortly.

Low India Volatility Index (VIX) levels in November also suggest that India’s economy is unlikely to enter recession, formally defined as a contraction for three months in a row. 

The US economy has already entered a recession, raising fears that its ramifications could dampen all optimistic market emotions in other key global economies.

Before investing considerable sums of money in the market, new or inexperienced investors should exercise caution. It is best to look at a market’s Volatility Index for at least the past 2-3 months before taking action.

The Volatility Index (VIX) in India has taken on even more relevance as the country’s central government intervenes to bolster the economy’s sagging sectors.

Conclusion

In a nutshell, we can conclude that India VIX is a volatility index that is used as a measure to ascertain the volatility expectations of the market.

This volatility index also plays a crucial role in the determination of premium amounts and derivative contract prices.

The past has witnessed a substantial shift in share prices and indices due to high VIX values.

Introduction

Historically, corporations raised capital from investors based on a written guarantee, and this written assurance is referred to as a bond. At regular intervals, coupon bonds deliver coupons or interest payments. So, what are zero coupon bonds? As their name implies, Zero-Coupon Bonds do not pay coupons or interest throughout the term but instead return the face value at maturity.

Zero coupon bonds are bonds that don’t produce any interest during the duration of the issue. Instead, investors purchase zero coupon bonds at a substantial discount from the total price of zero coupon bonds, which is the amount they would get when the bond “reaches maturity” or “comes due.”

Numerous zero coupon bonds have maturities of various tenures such as ten, fifteen, or even twenty years. These long-term maturities enable investors to prepare for a long-term objective, like funding a child’s college tuition. With the steep discount, an investor may invest a little money that will rise over a long period.

On the secondary markets, investors may acquire several types of zero coupon bonds issued by various organisations, including the government treasury, companies, and state and local governments.

Because zero coupon bonds do not pay interest until maturity, their values on the secondary market vary more than those of other bonds. 

Moreover, investors may still be required to pay federal, state, and local income tax on the “phantom” or imputed interest that accrues annually on zero coupon bonds, even if no payments are made until maturity. 

Some investors avoid paying tax on imputed interest by acquiring municipal zero coupon bonds (assuming they reside in the state where the bond was issued) or the rare tax-exempt corporate zero-coupon bonds.

To gain an in-depth understanding of zero-coupon bonds, continue reading below.

What is a zero coupon bond?

The Zero Coupon Bond, commonly known as the discount bond, is acquired at a discount and does not pay fundholders coupons or periodic interest. 

During the term, money invested in zero coupon bonds does not accrue interest. At maturity, the yearly returns on the principal amount are included in the face value and given to the investor. Therefore, investors get a lump payment after the term.

Corporate zero coupon bonds and government zero coupon bonds are the two forms of zero coupon bonds.

Let us understand how bonds and zero coupon bonds work.

A bond is a means through which a corporation or government entity raises funds. When bonds are issued, they are purchased by investors, who serve as lenders to the issuing organisation. The investors get a return in the form of semiannual or annual coupon payments for the duration of the bond’s existence. At maturity, the bondholder receives a return equal to the face value of the bond. Investors can acquire a corporate bond for less than its face value when issued at a discount.

Other bonds become zero-coupon once a financial institution removes them from their coupons and reissues them. Because they give the complete payment at maturity, the price of zero coupon bonds fluctuates much more than that of coupon bonds.

For instance, an investor who acquires a bond at a discount of Rs. 920 would get Rs.1000. The investor’s profits or return for keeping the bond is the Rs.80 return + coupon payments received. Not all bonds, however, have coupon payments, and those without coupons are known as zero-coupon bonds. These bonds are issued at a substantial discount and pay back the face amount at maturity. The gap between the sales price and par value indicates the return on investment for the investor. The payout the investor receives equals the capital invested plus the accrued interest earned, compounded semiannually at a set rate.

The rate of return on a zero-coupon bond is attributed, meaning that it is an estimated rate of interest rather than a fixed rate. For instance, a bond with a face value of Rs.20,000 matures in 20 years, and a yield of 5.5% may be acquired for around Rs.6,855. After twenty years, the investor will get 20,000 rupees. The difference between Rs. 20,000 and Rs. 6,855, that is, Rs. 13,145 represents the bond’s compounding interest until maturity. Sometimes, imputed interest is also called “phantom interest.”

Zero Coupon Bonds are ideal for long-term investors who are prepared to get their return in a single sum. 

Individuals investing for a particular future event, such as a child’s education or a company, should use zero-coupon funds. This fund is appropriate for investors who want to continue investing without worrying about market fluctuations or trends. In addition, investors seeking portfolio diversification at a low-risk level may purchase a Zero Coupon bond. It will diversify the portfolio and provide a lump amount at a certain period.

The lack of a consistent income makes Zero Coupon Bond funds unattractive to many investors. 

Others, however, find it suited for achieving long-term investing goals. It enables investors to receive risk-free interest over an extended period. When the interest rate is high, purchasing Zero-Coupon Bonds might be quite advantageous. Buying tax-free municipal Zero-Coupons is an excellent strategy to avoid paying taxes. This only applies to investors who reside in the state where the bond was issued.

Now that you have an idea about the zero coupon bond, you might be wondering what advantages buying a zero coupon bond brings to the investor. 

Advantages of zero coupon bonds

Zero coupon bonds have quite a few benefits to the investors, making them a viable investment option. 

Before choosing a Zero Coupon bond as an investment, it is essential to comprehend the advantages of zero coupon bonds. 

The advantages of Zero-coupon bonds are listed below:

• No reinvestment risk.

Other coupon bonds do not let investors get a bond’s cash flow at the same pace as the necessary rate of return on the investment. However, zero coupon bonds eliminate the risk of reinvestment. Zero-coupon bonds do not permit periodic coupon payments; hence, the zero coupon rate of interest is guaranteed to be stable. 

• Fixed yields.

Bonds with no coupon payments are an excellent option for investors that favour long-term investments and desire a lump-sum payout. This is due to the guarantee of a set return, provided the investment is held until maturity.

• Long-term perspective.

The Zero Coupon bond’s lengthy-time horizon substantially benefits long-term investors. A long-term investment may obtain a set sum without concern about market volatility.

These are some of the most prominent advantages of zero coupon bonds investment, and knowing them would help you judge whether zero coupon bonds are a fit investment for you or not. Along with benefits, there are a few drawbacks that you should be aware of if you plan to invest in zero-coupon bonds. 

Drawbacks of zero-coupon bonds

No investment can be perfect, but even if there is no risk involved, zero-coupon bonds still have drawbacks. 

Despite its numerous advantages, the zero coupon bond has a few drawbacks, which are discussed below.

• No regular income.

Therefore, the zero-coupon bond prevents a regular cash flow, and this bond will not benefit investors who need steady cash flow.

• Interest Rate Danger

Zero coupon rate of interest may drop over time owing to market fluctuations. Therefore, investors will constantly be exposed to interest rate risk if they sell before maturity.

Due to the secondary market’s lack of liquidity, the value of this bond has a negative connection with the increase in the interest rate. An increase in the interest rate signifies a fall in the secondary market value of the fund.

• Duration Risk.

Duration risk is a bond’s price sensitivity to a one percentage point fluctuation in the interest rate. The longer the term, the greater its sensitivity to interest rate fluctuations.

These are some of the noticeable drawbacks of investing in zero coupon bonds. Keeping these factors in mind helps investors gain insight into the kind of returns they may expect from such investments. 

To calculate the capital gains from investment in zero coupon bonds, it is essential to know how zero coupon bonds are priced.

Pricing of zero coupon bond

You might be wondering how the price of a zero coupon bond is calculated. Here are the details based on the zero coupon bonds calculation of price is done:

Zero Coupon Bond Price = M / (1+r)n, 

Where M is the bond’s maturity value or face value, r is the needed interest rate, and n is the number of years before maturity.

The formula mentioned above is used to set the pricing of zero coupon bonds and subsequently calculate its face value and other factors surrounding it. Let us look into an example to gain more insight into how this works.

If an investor wants a 6% return on a bond with a par value of Rs.25,000 and a maturity date of three years, they will be willing to pay the following price: Rs.25,000/(1+0.06) = Rs.20,991. If the debtor accepts this price offer, the bond will be issued to the investor for a price of Rs.20,991/Rs25,000 = 84% of its face value. 

At maturity, the investor earns Rs.25,000 – Rs.20,991 = Rs.4,009, which corresponds to an annual yield of 6%. The longer the period before the bond matures, the lower the price the investor pays, and vice versa. The first maturities of zero-coupon bonds are typically at least ten years. 

These long-term maturities allow investors to plan for long-term objectives like investing in a child’s college education. Due to the bond’s steep discount, an investor may invest a small sum that will rise over time.

Zero-coupon bonds may be issued by the government treasury, state and local governments, and companies, among others. The majority of zero-coupon bonds are traded on the main markets.

How is it different from normal bonds?

Interest payments, or coupons, are the primary distinction between zero-coupon and ordinary bonds. Regular bonds, commonly known as coupon bonds, pay interest during the bond’s life and return the principal at maturity. 

Even though a zero-coupon bond does not pay interest but trades at a substantial discount, allowing the investor to realise a profit upon redeeming the bond at maturity for its total face value.

To get a clear understanding of the disparity between these two financial instruments, let us go into further details:

The payment of interest, often known as coupons, differentiates a common bond from a zero-coupon bond. 

A conventional bond pays bondholders interest, but a zero-coupon bond does not. Instead, bondholders of zero-coupon bonds get just the face value of the bond at maturity. Regular bonds, commonly known as coupon bonds, pay interest during the bond’s life and return the principal at maturity.

Difference From Investor’s Perspective 

Investors in long-term zero-coupon bonds profit from the difference between the purchase price and the amount received at maturity. 

This sum might be significant because zero-coupon bonds are generally acquired at substantial discounts to face value, and this discount typically results in greater long-term returns.

Due to the form of the yield curve, a zero-coupon bond will often provide better returns than a conventional bond of the same duration. Long-term bonds have greater yields than short-term bonds under a regular yield curve. The interest payments for common coupon bonds are due before the maturity date, and thus these payments are comparable to those on smaller, earlier-maturing zero-coupon bonds. Interest payments decrease both the waiting period and the risk, lowering predicted profits.

Variation From Speculator’s Perspective

Zero-coupon bonds are more volatile than regular bonds. Therefore speculators may earn more from projected short-term price fluctuations by investing in them. 

When interest rates fall, everything else being equal, the price of a zero-coupon bond will climb more than that of a standard coupon bond. Because the values of government treasury bonds react substantially to changes in interest rates, zero-coupon treasuries are favoured for interest rate speculation.

Additionally, zero-coupon corporate bond prices may be utilised to speculate on the health of the issuing business. Assume that a bankrupt corporation previously issued zero-coupon and coupon bonds maturing in five years. The market value of both bonds would have collapsed, resulting in coupon bonds that pay very high-interest rates compared to their initial price. This establishes a buffer in case the firm goes bankrupt before maturity. The zero-coupon bond lacks this protection, carries a greater risk, and yields more profits if the issuer survives.

Taxation Differences

Zero-coupon bonds may also appeal to investors who want to leave their descendants a substantial inheritance. If an Rs.2,000 bond is received as a gift, only Rs.2,000 of the annual gift tax exclusion is used. However, once the bond matures, the receiver finally gets a significant amount of more than Rs.2,000. Unfortunately for holders of zero-coupon bonds, some taxes may diminish the efficacy of this method.

Even though they do not pay periodic interest, zero-coupon bonds entail a tax obligation for interest payments in certain countries. 

This presents an issue of phantom revenue for bondholders. Finding the funds necessary to pay taxes on unearned income might be challenging. As a result, it is often prudent to store zero-coupon bonds in a tax-deferred retirement account to avoid paying taxes on future income.

All interest on these municipal bonds, including attributed interest on zero-coupon bonds, is exempt from federal taxations, and municipal bonds are often exempt from state and municipal taxes.

Conclusion

Zero-coupon bonds have both benefits and drawbacks. However, various investors may react differently to the characteristics. 

This bond is suited for investors with long-term investment objectives, although investors with short-term investment objectives may disagree. Accordingly, investors must determine whether or not to purchase zero-coupon bonds based on their investment objectives.

The above information has hopefully given you a thorough understanding of Zero-Coupon Bonds and their function.

Introduction

A company cannot function without its assets. They are the resources that are needed to run and progress a business. A company has current assets and non-current assets. Current assets are generally short-term assets as they can be easily converted into cash within a year, for example, raw materials, cash & cash equivalents, account receivables, etc. While non-current assets are long-term assets that cannot be converted into cash within a year. For example, intangible assets like goodwill and fixed assets like plants, machinery, building, land, etc., all benefit a company for several years.

When we talk about the day-to-day workings of a company, we generally think about current assets as they are the company’s highly liquid assets. They fund daily business operations as well as pay operating expenses like bills and loans.

However, a company also invests in long-term assets called non-current assets, which tell about the company’s investing activities. Unlike current assets, they provide benefits to a company for more than a year. Non-current assets support the core operations of a business. They are further classified into two types, tangible and intangible assets. Let’s discuss non-current assets in detail. 

What is a non-current asset?

A non-current asset is a long-term asset. A company can either invest in a non-current asset or can acquire it through mergers or acquisitions. A non-current asset is a low-liquid asset that cannot be converted into cash within a year. They appear on the balance sheet under the heading Property, Plant, and Equipment (PP&E), which helps investors understand the company’s capability to use resources and generate revenues. These assets can either be depleted, amortised, or depreciated. There are three types of non-current assets which are tangible, intangible, and natural resources. Let’s examine each in more detail. 

Types of non-current assets

Tangible Assets/Property, Plant, and Equipment (PP&E)

Tangible Assets or Fixed Assets have a physical form and a recorded monetary value. A company owns them for its core operations. You can derive the actual value of a tangible asset by subtracting the accumulated depreciation from the original acquisition cost of the asset. However, not all tangible assets depreciate. Some, for example, land appreciates in value over time.

It also helps in computing the company’s net worth. We can determine this by calculating the non-current asset to net worth ratio of a company. Net worth represents the true value of a company by subtracting liabilities from total assets. This ratio compares long-term assets with the part of assets that a company owns. A high non-current asset to net worth ratio simply means that a company has more non-current assets. Whereas if a company has a low ratio, it means that a company’s assets are in the form of debt, which means more financial trouble in its operations.

Example of Tangible Assets

• Land
• Building
• Plant
• Equipment
• Machinery
• Property 

Intangible Assets

An intangible asset is an asset that lacks a physical form but has an economic value. They are either definite or indefinite. 

• Definite- A patent has a limited life and stays for the duration of the agreement or contract with the company.
• Indefinite- Brand recognition stays for as long as the business stays afloat. 

A company can either create an intangible asset or acquire one through purchases, for example, mergers & acquisitions. 

Intangible assets are listed on the balance sheet as per the cost or revaluation model. However, goodwill is not amortised but checked for impairment annually. When the carrying value of an intangible non-current asset exceeds the fair value, then an impairment loss needs to be recognised. 

Examples of Intangible Assets

• Patent
• Copyright
• Trademark
• Goodwill
• Reputation
• Branding

Natural Resources

A company derives natural resources from the earth. They occur naturally and are readily available. They are also called exhaustible or wasting assets because they are used when they are extracted. For example, Natural Gas has to be pumped out of the earth to be used. 

Natural assets list on the balance sheet at the cost of acquisition plus development and exploration costs and less accumulated depletion. 

Examples of Natural Resources

• Fossil Fuels
• Oil fields
• Minerals
• Wood

Other Non-Current Assets Examples

Long Term Investments 

Long-term investments include assets such as equity which includes stocks, mutual funds, and bonds. When investors buy such securities in the financial market, they hope that these assets will appreciate and give a good return. These assets are also listed on the company’s balance sheet. 

Goodwill

When a company acquires another company, it buys assets and intangibles like a client base, quality of employees, brand name, or reputation. Therefore, it implies that the company pays the fair market value of the intangible assets. Goodwill is generally paid in excess of the acquired company’s net value (Assets – Liabilities). The difference between the total MV (market value) of liabilities and assets and the purchase price of an acquired company is the value of Goodwill. If the company is unable to assign this excess purchase price to any other intangible non-current asset, then it is set to Goodwill. 

How are non-current assets reported on the balance sheet?

There are two different methods to report non-current assets on the balance sheet, one is Cost Model, and the other is Revaluation Model. To know more, please go through the ensuing paragraphs. 

Cost Model

Under the cost model, the asset is recorded at the net book value, i.e., cost minus accumulated depreciation. Depreciation is the amount to record the reduction in the asset’s useful economic life. The depreciation charges are recorded in a separate account called the accumulated depreciation account. They help identify the net book value of a non-current asset at any time.

The cost model’s main advantage is that there will be no biases (unlike in the revaluation model) in valuation as a non-current asset cost is readily available. However, this does not provide a correct worth of a non-current asset since the prices of assets change with time. This is precisely right for non-current assets such as property, where prices constantly increase. 

Revaluation Model Approach

This model is known as the fair value method of asset valuation or mark-to-market approach. According to this method, a non-current asset is recorded at a revalued amount minus depreciation. To implement this method, the company needs to measure fair value reliably. If the company cannot derive a reliable, fair value, the asset should be valued using the cost model. 

An increase arising as a result of a revaluation should be credited to the separate reserve named ‘revaluation surplus’ and recognised as an income. If revaluation results in a drop in value, it should be recognised as an expense. Revaluation surplus should be directly transferred to retained earnings. Non-current assets under both models undergo depreciation to allow for the reduction in the useful life. 

The prime reason companies adopt a revaluation approach is that it provides a more accurate picture than the cost model. It ensures that non-current assets are shown at market value in financial statements. But this is an expensive exercise since revaluation must be carried out at regular intervals. Moreover, the management may sometimes get biased and assign an increased revalued amount to assets than the reasonable market value, thus leading to overestimation. 

Cost Model vs Revaluation Model

Financial Ratios of Non-current assets

Non-current Asset turnover ratio

This ratio determines how a company utilises its non-current assets and how optimally they are used to generate revenues. A low non-current turnover ratio implies that a company is not utilising its non-current assets optimally. And a high non-current asset turnover ratio suggests that a company is optimally using these assets.

Non-current Asset Turnover = Net Sales Revenue/Net Book Value of Non-Current Assets.

For example, if the company’s revenue for the period is £60 billion and non-current assets are £20 billion.

Then,

Non-current asset turnover = £60 bn / £20 bn = 3.

This ratio helps in the decision-making process by management; for example, if the management wishes to acquire a fixed asset, then it needs to calculate the fair cost price of the asset so that the ratio improves.  

Non-Current Asset to Net worth

This ratio measures the company’s investments in low liquid non-current assets. Non-current asset to net worth ratio is useful to evaluate shareholders’ equity amount that is used to finance a business operation. A high ratio suggests that the majority of a company’s long-term investments are in the form of debt. However, you need to analyse the balance sheet to see which non-current assets impact the calculation the most.

Non-current asset to Net worth = Non-current Assets/Net Worth.

For example, Let’s assume XYZ company’s balance sheet has total non-current assets (PP&E, intangible assets, advances, investments) worth $9,090 million and the shareholder’s equity or net worth valued at $ 2,770 million. Let’s apply this formula and find the ratio. 

NCA/NW = 9090/2770 = 3.281

We can see that the non-current assets of XYZ company are at least three times more than its shareholders’ equity. Therefore, we can see that the majority of the company’s assets are liabilities. Generally, this would be concerning, but you also need to look at the competitors’ results from the same industry as well. 

Importance of Non-current assets

• Non-current assets are essential to conducting a detailed financial analysis of a company. 
• The financial ratios of non-current assets help ascertain the revenues generated by a company in an accounting year. 
• Business owners can analyse if they can generate income from such assets in their venture. 
• Analysis of these assets assists in comparison between different companies. 

What is non-current liability?

It is easy to get confused between a non-current asset and non-current liability. A non-current liability is a long-term liability that appears under liabilities and shareholders’ equity on a balance sheet. 

A non-current liability is a company’s financial obligation that is not expected to be paid within an accounting year. The financial ratios analyse non-current liabilities to determine the company’s debt-to-asset ratio, debt-to-capital ratio, leverage, etc. Analysts and creditors keep a watchful eye on the company’s non-current liabilities as it determines the level of leverage and stability of cash flows. 

A stable cash flow means a company can bear a higher debt load without the risk of default. The inadequate non-current liabilities will make investors hesitant to invest in the company and keep creditors away from doing business with a company. 

Components of Non-current liabilities

• Long-term loans
• Bonds Payable
• Long-term lease
• Deferred Tax Liabilities
• Notes payable

What are Current Assets?

This article will be lacking if we do not discuss current assets. Because both current and non-current assets are recorded in a company’s balance sheet, and together they show a company’s total assets. 

Current Assets or current accounts are short-term assets that are expected to be consumed, exhausted, used, or sold within an accounting year. They are used for the company’s immediate needs, funding day-to-day expenses and operations. Current assets include accounts receivable, marketable securities, cash & cash equivalents, prepaid liabilities, stock inventories, and other liquid assets. 

Current Assets and their components

Current assets are highly liquid assets meaning they can be converted into cash within an accounting year. However, it relies on the nature of the business and the type of products it markets, for example, raw materials, inventory, crude oil, foreign currency, or fabricated goods. Generally, inventory comes under current assets, but it is tough to sell machinery or land, so it is excluded from current assets. But finished goods and raw materials are sold quickly; therefore, it falls under inventory. 

Inventory

Inventory is a current asset because the company plans to sell the products within a year. It includes raw materials (supplies that produce finished goods), work-in-progress (WIP), and finished goods (ready for sale). It appears as a buffer between manufacturing and sale. If an item in an inventory is sold, its cost is transferred to the Cost of Goods Sold (COGS). There are three methods to calculate inventory; First-in, first-out (FIFO), Last-in, first-out (LIFO), and weighted average method. If a business sells inventory faster than its competitors, it incurs low opportunity and holding costs. This helps to sell the goods efficiently.

For example, due to the fast sales turnover of the brand “Lifestyle,” another fashion retailer, “Max,” is constantly under pressure to quickly sell its inventory too. The production material and fabric to produce this apparel is considered raw material. 

Account Receivable

Account receivable is the company’s money for products or services used or delivered but is still unpaid by the consumers. As long as the consumers can pay within one year, they are considered current assets. A part of it might not make it under account receivable if they are long-term credits. 

It is also likely that some accounts may never pay in full. They would be considered under “allowance for doubtful accounts” and subtracted from account receivable. There is also a chance that an account might never be collected. Then it is considered a “bad debt expense” and is, therefore, not regarded as current assets. 

Prepaid Expense

Prepaid expenses are advanced payments made by a firm for goods or services to be received in the future. These are current assets, but they cannot be converted into cash. However, they free up the capital for other uses like payments to contractors or insurance companies.  

The highly liquid items are generally ranked higher and follow an order on the balance sheet. 

• Cash (Checking accounts, currency, petty cash)
• Short-term investments (liquid marketable securities)
• Accounts Receivable
• Inventory
• Supplies
• Prepaid Expenses

Significance of current assets

Apart from funding the business’s daily operations and paying daily expenses like loans and bills, current assets reflect the cash and liquidity position of a company. ​The investors and creditors keep a watchful eye on the company’s current assets to assess the risk in operations and the company’s value. 

Comparison- Current vs Non-current Assets

Why is asset management important?

1. Companies take an active role in managing current and non-current assets because it helps keep track of all the company’s assets; where they are, how they are used, what changes are made to them, and if they require any improvements. 
2. Regular maintenance of the assets helps to record depreciation and amortisation accurately in the balance sheet. 
3. It’s easier to identify and manage risks if the assets are regularly monitored and maintained. It helps the company to protect its value and overcome any challenge. 
4. An asset management plan helps the company make informed decisions as an accurate record is maintained about stolen, damaged, or lost assets in business books. This can enhance loss prevention. 

Conclusion

Assets are essential to run a company and scale its business. Managing an asset is very important as it monitors, tracks, and manages assets to deliver optimal results from their disposal. Managing current and non-current assets enables a company to identify and handle the associated risks to protect their value better. The correct records of both the assets help improve the accuracy of the financial statements. 

Non-current assets support a company’s core operations. They are long-term investments that accrue benefits for several years. Both tangible and intangible assets help in computing a company’s net worth.