Difference Between Capital Expenditure and Revenue Expenditure

What Is Capital Expenditure?

The amounts spent on acquiring, improving, and the upkeep of physical assets like real estate, buildings, plants, equipment, and technology are capital expenditures (CapEx). Businesses frequently utilise CapEx to fund new projects or expenditures.

CapEx refers to the amount of money a company spends on existing and new fixed assets to maintain or expand its operations. Any expenditure that a corporation capitalises or recognises as an investment on its balance sheet rather than an expense on its income statement is referred to as CapEx. 

The method of capitalising on an asset is to spread the expense of investment across the item’s useful life. The quantity of capital that a company is required to spend is determined by the industry in which it operates. The most capital-intensive businesses with the biggest capital expenditures include exploration and gas, telecommunications, manufacturing, and utilities.

CapEx may be reported as cash flow from investment activities in a company’s cash flow statement. Different organisations define CapEx differently, and an analyst or investor may see it represented as capital investment, property purchases, plant and equipment (PP&E), or acquisition expenditure. Capital expenditures can also be calculated using a corporation’s income statement and balance-sheet information. Determine the current period’s depreciation expenditure as reflected on the income statement. Find the current period’s property, plant, and equipment (PP&E) line-item balance on the balance sheet.

Find the prior period’s PP&E balance and subtract it from the current period’s PP&E balance to determine the change in the company’s PP&E balance. To calculate the company’s current-period CapEx, add the difference in PP&E to the current-period depreciation expense.

Operating expenses are not the same as capital expenditures (OpEx). Running expenses are short-term expenses required to meet a company’s continuous operational requirements.

Operating expenses, unlike capital expenditures, can be deducted from a company’s taxes in the year they occur. A cost is considered CapEx if it is a freshly bought capital asset or an investment with a life of more than one year or if it extends the usable life of an existing capital asset.

On the other hand, if the expense keeps the asset in its present condition, such as a repair, the cost is usually deducted in full in the year the item is acquired.

Types of Capital Expenditure

Capital expenditures may include purchasing the following items:

  • A building or factory, including any expansions or modifications
  • Vehicles used for commodities transportation, such as trucks, and manufacturing machines computers
  • Furniture

Businesses commonly use capital expenditures to support new initiatives or investments. CapEx is frequently used to boost a company’s revenue and profit.

On the other hand, revenue expenditures comprise operational costs for running the day-to-day business and maintenance fees to keep the asset in good working order.

Businesses frequently utilise debt or equity financing to meet the significant expenditures associated with acquiring critical assets for their growth. Borrowing money from a bank or issuing corporate bonds, IOUs issued to investors in return for periodic interest payments, are examples of debt financing. The practice of issuing shares of stock or equity to investors to acquire funding for expansion and capital investments is known as equity financing.

What Is Revenue Expenditure?

Revenue expenditure, often known as OPEX, accounts for expenses incurred throughout its operations. It is defined as the entire amount of money enterprises spend on manufacturing processes. Usually, such expenses do not result in asset development, and the advantages of OPEX are confined to a single fiscal year. They are generally not in charge of developing or expanding their earning potential. Regardless, they are crucial in optimising the management of operational activities and assets and generating revenue within a specific accounting period.

Rent, salary, wages, commission, freight fees, and other revenue expenses are only a few examples. Notably, factors such as the type of commercial enterprise, the purpose of a venture, the frequency of operations may be used to classify expenditures as OPEX.

In accounting, revenue expenditure for an accounting period is reflected in a corporation’s Income Statement. However, the company’s balance sheet does not reflect this.

Furthermore, they may be tax deductible in a particular accounting period because such expenses are recurrent. It is also worth noting that OPEX is not capitalised and that no depreciation is applied to such expenditures.

Revenue expenditures or operating expenses are reported on the income statement. These expenses are subtracted from the revenue earned by a company’s sales to determine the net income or profit for the period. Revenue costs may be tax-deductible in the year in which they occur. In other words, the expenses reduce the profit from a tax standpoint, decreasing taxable income for the tax period.

Types of Revenue Expenditure

Revenue spending falls into two categories:

  • Direct expenditures are expenses incurred mostly during manufacturing. The following are the most typical direct expenses: direct pay, freight charges, import duty, commission, rent, legal fees, and power costs.
  • Spending incurred due to the sale and distribution of completed goods or services is indirect expenditure. Examples are salary, repairs, interest, commission, depreciation, rent, and taxes. These costs may also include money spent on handling routine administrative expenses.

Here are a few more instances of revenue expenditures:

  1. Wages and pay for employees
  2. Any item that comes within the category of selling, general, and administrative expenditures, such as corporate office salaries (SG&A)
  3. Development and research (R&D)
  4. Utilities as well as rent
  5. Property taxes for business trips

Capital and Revenue Expenditure Examples

Consider the following examples to show how capital and revenue costs are recorded in the books of accounts:

Example of Capital Expenditure

Examples of capital expenditures are as follows:

  • Buildings (including subsequent costs that extend the useful life of a building)
  • Computer equipment
  • Office equipment
  • Furniture and fixtures (including the cost of furniture that is aggregated and treated as a single unit, such as a group of desks)
  • Intangible assets (such as a purchased taxi license or a patent)
  • Land (including the cost of upgrading the land, such as the cost of an irrigation system or a parking lot)
  • Machinery (including the costs required to bring the equipment to its intended location and for its intended use)
  • Software

Otherwise, a cost is reported if any of the following two conditions applies:

  • The spending is less than the business’s stated capitalisation limit. The capitalisation restriction is in place to prevent businesses from spending time monitoring low-value equipment, such as computer keyboards.
  • The expenditure is for an item consumed entirely within the current reporting period.

Example of Revenue Expenditure

A&J invests 100,000 BDT in manufacturing equipment. A monthly cost of 1,000 BDT is charged to maintain the machine’s operation. In this scenario, the revenue expenditure is 1000 BDT, utilised to pay the machine maintenance cost every month. When the revenue statement is created, a line item for the month the maintenance fee will be included in the 1000 BDT. If the machine develops a fault and requires repair, the repair cost will be included in revenue expenditure and reported in the month in which the expense occurred.

Difference between Capital expenditure and Revenue Expenditure

Parameters Capital Expenditure Revenue Expenditure
Definition The money spent by a company to acquire new assets or improve the quality of existing ones is referred to as capital expenditure. Revenue expenditure refers to the money spent by businesses to run their day-to-day activities.
Time-span Long-term capital investments are made. Revenue costs are often incurred over a shorter period and are confined to a fiscal year.
Treatment in accounting books CAPEX is documented in a company’s balance sheet. It is also included as a fixed asset on a company’s Balance Sheet. OPEX is frequently reported in an organisation’s P&L but not in its Balance Sheet.
Purpose A corporation will incur such costs to increase its earning capability. A corporation must bear such expenses for it to stay profitable.
Yield, The return on these investments is frequently long-term and not restricted to a single year. The return on these costs is effectively restricted to the current fiscal year.
Capitalisation of expenses Capital outlays are capitalised. Revenue expenditures are not capitalised.
Examples Buying machinery or obtaining a patent, gaining copyright, installing equipment and fittings, and so on. Wages and salaries, power costs, printing and stationery, inventory, postage, insurance, taxes, and maintenance fees are just a few examples.

What Is the Face Value of a Share?

The Indian stock market is growing at such turbo-speed that, according to a Bloomberg article, India’s listed market capital is just 4% behind the UK’s!

With the increasing enthusiasm of Gen-Z towards the market, India’s stock market participation is projected to keep expanding in the long term. But before you venture into the fascinating stock market world, it is crucial to start with the basics. And today, we deep dive into the meaning of face value and explain how it differs from market value.

So what exactly is the face value of a share?

Investors buy shares of companies at market price, but many are unaware that each share has a designated face value. Let us look at this fundamental feature of a share.

When a company is formed, it has to issue equity shares to its promoters and register the incorporation papers with the Registrar of Companies (RoC). The face value of the shares issued to promoters is mentioned in the Memorandum of Association (MoA), Articles of Association (AoA) and other documents submitted to the RoC and other Government Authorities. Hence, the face value of a share holds pivotal significance for a corporation.

Similarly, when a company goes public, i.e., makes a fresh issue of securities in the public market, it has to determine its shares’ face value. This face value is mentioned in the documents submitted to authorities at Initial Public Offering. Therefore, the issuing company’s responsibility is to keep the SEBI, Stock Exchanges, Clearing Houses, and the public informed of its shares’ par value.

About share/ bond certificate and some noteworthy takeaways

When a company goes public, it issues securities or bonds with a particular value. In the earlier decades, physical share and bond certificates were issued to the security holders. These physical certificates mentioned the face value for the holders’ reference. The mandatory requirement of physical certificate issuance is done away with, and the transfer happens through brokers’ online sites or apps.

Face value helps determine the accounting value of the shares and bonds issued, which is mentioned in the company’s financial statements – particularly the balance sheet.

For your detailed understanding, here are some crucial points to keep in mind:

  • The issuing company determines the face value of its shares.
  • The face value of stocks and bonds is duly noted in the company’s balance sheet. 
  • A Share’s face value is the initial cost of the share and duly assigned to it.

What is the essence of the face value of a share?

For an investor, it is crucial to be aware of the face value of the asset that they are purchasing. This knowledge comes in handy when stock splits happen due to corporate actions. So if a company decides to split its share with a face value of Rs. 10 into ten shares of the face value of Re. 1 each, the investor would notice a tenfold jump in the quantity of the inventory held. But that does not equate to a ten times monetary benefit as the market value of the share also gets aligned with the new face value.

Another point to note is that when a company declares dividends, it is based on the financial value of the share, irrespective of its market value. 

Face value knowledge helps in understanding the following –

  1. The market value of a share is correlated to its face value.
  2. Company issues dividends for its shares based on their face value.
  3. In the case of bonds, face value is the basis for calculating interest rates.

The fundamental difference between face value and market value

Market value is the rate at which the company’s shares are exchanged between the buyer and seller – determined by market conditions. Market value is not the same as the book value.

To understand the fundamental difference between the face value and market value of a share, let us look at the table below –

Particulars Face Value Market Value
Price The face value price remains constant until changed explicitly by the company itself. The market value price keeps changing as per market conditions. 
Determined by The issuing company fixes face value at its discretion. The market dynamics determine market value. It constantly changes as the trading on exchanges continues.
Calculation The total number of shares issued by the company multiplied by its face value determines its share capital. A company’s market capitalisation is calculated by multiplying the stock’s current market value with the number of outstanding shares.

Can the face value of shares be modified?

Once determined by the issuing company, the face value of a share mostly remains the same. In specific cases, the company may decide to change the face value. Such decisions need various compliance actions on the company’s behalf. The company would need to pass a shareholder’s resolution and alter the Capital Clause of the Memorandum of Association. Also, various submissions are to be made with the Registrar of Companies and Stock Exchanges.

Generally, face value changes when the company splits stocks. In such cases, the face value of the share is reduced as per the company’s directives. In some instances, the face value is also increased by the company.

Debt-to-Equity (DE) Ratio

Open up a company’s balance sheet, and you will see two separate columns or categories – Assets and Liabilities. While the assets represent the company’s owned resources that have the potential of generating income, liabilities represent what the company owes. 

Furthermore, the balance sheet contains a section on shareholder’s equity which shows the amount attributable to the company’s shareholders. When investing in a company, a study of the balance sheet can give you an insight into how the company is performing. You can also use various ratios to find the company’s potential. One such ratio is the debt to equity ratio. Let’s understand it. 

What Is Debt-to-Equity Ratio?

Debt is an external source of finance for a company, while equity is an internal source of finance. The company uses both these sources of finance to fund its operations and growth. However, when estimating the financial standing of a company, its debt and equity are viewed independently and in conjunction with one another. An analysis of debt v/s equity gives you an idea of how leveraged a company is and whether your investments would bear fruit or not. 

To this extent, investors use various gearing ratios to measure the company’s equity against its liabilities. The debt-to-equity ratio is one such ratio that can help investors understand how leveraged the company is. Let’s explore this ratio further. 

The debt-to-equity (D/E) ratio is a metric that helps you assess the proportion of debt and assets used by a company to finance its operations. 

How is the debt to equity ratio calculated?

The ratio is calculated using the following debt to equity ratio formula

Debt to equity ratio = Total liabilities / shareholders’ equity

In the formula, the numerator and denominator are defined as follows –

  • Total liabilities = short-term liabilities + long term liabilities + outstanding debt payments
  • Shareholders’ equity = equity share capital + reserves and surplus 

For instance, the balance sheet of HDFC Bank Limited for the financial year ending on 31st March 2021 is as follows (Source: https://www.moneycontrol.com/financials/hdfcbank/balance-sheetVI/HDF01) –

Particulars  Amount (Rs. in crores rounded off)
Equity share capital 551
Reserves and surplus  203,170
Deposits (liability) 1,335,060
Borrowings 135,487
Other liabilities and provisions 72,602

From this balance sheet, the calculations would be as follows –

Total liabilities  Deposits + borrowings + other liabilities and provisions 

= (1,335,060 + 135,487 + 72,602) crores

= Rs.1,543,149 crores

Shareholders’ equity Equity share capital + reserves and surplus

= Rs. (551 + 203,170) crores

= Rs.203,721 crores

Debt to equity ratio Total liabilities / shareholders’ equity 

= Rs.1,543,149 crores / Rs.203,721 crores

= 7.57

What does the ratio mean? 

The ratio of debt to equity gives investors considerable insights into a company and its financial standing. Here’s what the ratio says about a company’s finances: 

  • If the debt to equity ratio is high, i.e. above 2 or 2.5, the company is considered risky from the investment point of view. A high ratio indicates that the company has higher debts than equity. If the debts become too much, the company might fail to repay them and file for bankruptcy. 

If the company files for bankruptcy and liquidation, its assets would be first used for paying off the debts and then the shareholders. If the debts are high, there might be nothing left for the shareholders to claim. If you have invested in such a company, you will lose your capital.

A high ratio is, thus, considered risky. If you are a risk-averse individual, investing in companies with a high ratio of debt to equity might prove counterproductive. You should, thus, look for companies that have a low ratio, i.e. below 2 or 2.5.

  • A high debt to equity ratio can also be interpreted as being good. It shows that the company has availed of debt for expansion and growth. Since the cost of raising debt is lower than the cost of raising equity capital, the company might stand to benefit. Higher debt for growth might lead to enhanced revenue and, consequently, enhanced profits. If the profits exceed the cost of servicing the debt (i.e. the interest payable on the debt), the shareholders stand to benefit. Enhanced profits mean a possibility of enhanced dividend payouts. Moreover, when the company is profitable, its market perception increases. This also boosts the stock price. If you have invested in the company, an increasing cost price means better profits and capital appreciation. 
  • A high debt to equity ratio can also provide a higher return on equity (ROE) as the company can use debt to generate better returns for shareholders.
  • The Weighted Average Cost of Capital (WACC) can also be reduced with increased borrowing because of the cost factor. Debt capital is cost-effective compared to equity capital. A high debt to equity ratio, thus, is good for lowering the WACC of the company. 

A high debt to equity ratio can, thus, show both a negative and a positive picture. You should, thus, assess the ratio with other metrics too to analyse if the company is a worthy investment or not. 

Interpretation of the debt to equity ratio:

While the debt to equity ratio can help you assess the investment risk and the company’s growth potential, its interpretation is open to debate. It has certain drawbacks that you should keep in mind when understanding the ratio. 

For instance, companies in different industries can have different debt to equity ratios. This is because their sources of capital vary. For comparison purposes, the debt to equity ratio is industry-specific.

Take the instance of HDFC Bank, which was illustrated earlier. The bank’s debt to equity ratio is 7.57, which is very high compared to the accepted standard average of 2 or 2.5. Does this mean that HDFC Bank is a risky investment?

Not exactly. Take the instance of Axis Bank, another company in the same industry. Its balance sheet reads as follows:

Particulars  Amount (Rs. in crores rounded off)
Equity share capital 613
Reserves and surplus  100,990
Deposits (liability) 707,306
Borrowings 142,873
Other liabilities and provisions 44,336

Now if we calculate its debt to equity ratio, it would be done as follows –

Total liabilities  Deposits + borrowings + other liabilities and provisions 

= (707,306 + 142,873 + 44,336) crores

= Rs.894,515 crores

Shareholders’ equity Equity share capital + reserves and surplus

= Rs. (613 + 100,990) crores

= Rs.101,603 crores

Debt to equity ratio Total liabilities / shareholders’ equity 

= Rs.894,515 crores / Rs.101,603 crores

= 8.80

Axis Bank too has a high debt to equity ratio signifying that the banking sector might experience a high debt to equity ratio. A high ratio is common for the industry and does not necessarily depict higher risk.  

If you compare Axis Bank (debt to equity ratio of 8.80) and HDFC Bank (debt to equity ratio of 7.57), it would be a fair and relevant comparison. Both banks have a high debt to equity ratio compared to the standard value. However, Axis Bank tends to be slightly riskier than HDFC Bank based on its debt to equity ratio

Another limitation is the inclusion of liabilities when calculating the ratio. Some analysts use short-term and long-term liabilities and other provisions in calculating the ratio, while others use only short and long-term liabilities. Similarly, some analysts exclude non-interest-bearing debts while others don’t. There is even ambiguity in terms of including preferred share capital in liabilities. Some experts believe that preferred stock should be included in liabilities, while others have an opposing view. 

Reading the balance sheet and segregating the liabilities can also pose a problem when calculating the debt to equity ratio. Some items might look ambiguous, and getting the right value for liabilities can be challenging. 

So, be careful when interpreting the ratio to avoid any ambiguity. 

The bottom line

Investing your hard-earned money in a company requires a little research. You should analyse different financial ratios that depict the financial standing and stability of the company as well as its profitability. The debt to equity ratio is one such ratio that is an important parameter in assessing the leveraging opportunities that the company is using. 

Leverage shows how the company uses its assets and liabilities to generate profits and can also determine the share price movements. Assessing the leverage is, thus, important and the debt to equity ratio helps you do just that. So, understand what the ratio means and how to calculate it.

Also, use the debt to equity ratio in conjunction with other important ratios when considering investing in a company. 

What Is FII and DII? Difference Between FII and DII

To invest in the stock market, a person must understand the related different terms and types of investors. Investors of all kinds flood the stock market, whether retail or institutional. SEBI has set forth rules and regulations for both types of investors.

Retail investors are the traditional investors who trade on the stock exchange, be it in ETFs, mutual funds, and more, through their brokerage firms. These investors trade in stock markets for their personal use, and hence, the amount they invest is much lower, as per their budget. The Securities and Exchange Board of India (SEBI) defines retail investors as those who invest, buy, or hold shares up to Rs200,000. 

On the other hand, the institutional investors are divided into mutual funds, foreign institutional investors, domestic institutional investors, pension funds, etc. 

In this article, we will explore in detail what is FII and DII and what is the difference between FII & DII

What are FII and DII?

As a preliminary to understanding the difference between FII & DII, we will first explain what FII and DII are. Generally, foreign investors fall into three categories:

  • NRIs (non-resident Indians), 
  • PIOs (persons of Indian origin), and
  • FIIs (foreign institutional investors). 

Now, the question is, how can these foreign investors invest in India?

To invest in India, they must do so through the foreign direct investment route (FDI) or the foreign portfolio investment route (FPI). 

The FDI route can be divided into two categories: automatic and government. The automatic route includes, primarily, long-term investments in a particular business or company, which do not require RBI approval. In contrast, investments in the government route require specific consent by the government. Additionally, some sectors are not eligible for FDI, such as nuclear, energy, agriculture, etc. 

The foreign portfolio investment route (FPI) allows FIIs, NRIs, PIOs, and qualified foreign investors (QFIs) to invest in the Indian stock market, shares, and convertible debentures of Indian companies and units of domestic mutual funds. There is, however, a ceiling set by the RBI on how much these entities can invest under this scheme. 

Who are FIIs?

A foreign institutional investor (FII) is a group of investors who invests in a foreign country other than their home country. These investors may be hedge funds, charity trusts, pension funds, investment banks, mutual funds, insurance companies, or high-value debenture bonds. 

FIIs are incorporated outside India and must register themselves with SEBI and adhere to the rules and regulations. Some examples of FIIs are Morgan Stanley, Bank of Singapore, Vanguard. 

Now, let us understand how FIIs work.

The FPI route allows FIIs to invest in primary, secondary markets, dated government securities, and commercial papers traded on a recognized stock exchange. SEBI has further eased restrictions and allowed foreign institutional investors to invest in unlisted exchanges. RBI has even approved and authorized designated banks that can act as banks for FIIs. 

Unlike FDIs, which typically invest in technology, know-how, and research and development of the business, FIIs only transfer funds. Usually, these funds are in the form of promissory notes, also known as offshore derivatives. 

An FII can invest through a recognized sub-broker or a subaccount registered with SEBI. Every FII or subaccount must appoint a domestic Indian custodian registered under SEBI to hold securities. The custodian will monitor investments, report daily the transactions to SEBI and present the records for a specified period, as and when required by SEBI. 

As stated before, there are limits to the amount of investment. RBI permits foreign institutional investors to invest up to 10% of the equity in one company, subject to a maximum of 24 percent on investments by all FIIs, NRIs, and OCBs. Investment by foreign corporations or individuals registered as subaccounts of FII cannot exceed 5 % of paid-up capital as investment. However, the limit is lower (20%) for public sector banks. 

However, suppose the board and general body pass and approve a special resolution. In that case, the authorities can raise the 24% ceiling to 30% for a particular segment. Similarly, they can increase the ceiling by 10% for NRIs and OCBs, provided the general body passes and approves a resolution. The RBI monitors these ceilings daily.

Foreign investors have been flooding the news over the last few years, and names like Walmart and Tesla have been trending on the market. However, why are these names are so important that they are trending in the news? 

The following are some reasons why FIIs are crucial to Indian markets:

  • The FIIs invest at a higher percentage than retail investors, creating an influx of funds into the economy. Additionally, the investment is typically in the equities of Indian companies. This aspect helps strengthen the company’s balance sheet. 
  • FIIs generally invest in economies that are growing and offer ample growth prospects. This approach increases the trust in the companies among investors and creates a positive market sentiment.

Let us now understand the differences between FII and DII by explaining what dii means.

Who are DIIs?

When we talk about the difference between FII and DII, the investor’s nationality is a significant difference. FIIs are investors who are incorporated in a foreign country. In contrast, the DIIs (domestic institutional investors) reside in the same country where they invest.  

DIIs or Domestic institutional investors are the high-value Indian companies that invest in the Indian stock market to earn profits. These businesses may include hedge funds, insurance companies, and more. 

Their investment is related to how favorable the investment conditions are in the country, both political and legal. The conducive conditions include tax subsidies, tax holidays, tax exemptions, and other financial incentives. 

Thus, by creating a favorable environment, the government ensures that the Indian companies invest in their own country rather than abroad. Similar to foreign institutional investors, DIIs are also responsible for creating liquidity in the market. 

Since March last year, the DIIs have invested more than Rs 1 lakh crore in Indian equities. Some examples of top DII investors are HDFC Life, LIC, and Nippon AMC. 

FII Vs. DII

Here are some key differences between FII and DII.

  • Headquarters

The primary difference between FII and DII is the investor’s residence. While in FII, the investor is incorporated and registered in the foreign country, in DII, the investor is of Indian origin itself. 

  • Risks and restrictions

When we talk about FII vs. DII, other factors that come up are the risk and restrictions. One may consider FIIs a more risky investment since these investors can pull out their investment anytime and get out of the country. Their sudden withdrawals can impact the market very adversely. For instance, in early 2020, the FIIs sold about Rs 39,000 crores from Indian equity markets.

On the other hand, DIIs are a more reliable support to the markets; they have invested about Rs 72,000 crores during the same year. In the last couple of years, they have pumped more investments and even outperformed the global markets by 26% in USD terms. 

The risks involved are why FIIs are prone to more restrictions than DIIs by SEBI.

  • Research team

Also, since FIIs are strangers to the investment country, they need to conduct more detailed research before investing. Thus, in other words, they need a stronger R&D and research team, as compared to the DIIs. However, due to this superior research, the investors rely more on the FIIs investments. 

  • Types of FII and DII

Another difference between FII & DII is their types. DIIs include 4 types, namely, mutual funds, insurance companies, local pension funds, and banks and financial institutions. FIIs are more extensive and include pension funds, mutual funds, investment trusts, banks, insurance companies, sovereign wealth funds, and more. 

 

What Types of FII vs. DIIs are allowed in India?

Here are different types of FIIs and DIIs which can be registered under India :

For FIIs

  1. International Pension Funds

  2. Mutual funds

  3. Investment Trusts

  4. Banks

  5. Insurance company/Reinsurance company

  6. Foreign government agencies

  7. Sovereign Wealth Funds

  8. International Multilateral organization

  9. Endowments for public interest

  10. Charitable Trusts for public interest

  11. Foundations for public interest

  12. Foreign Central Banks

  13. University Funds serving public interests

For DIIs

  1. Indian mutual funds

In India, mutual funds are one of the most popular investment vehicles. They pool the money of different investors based on their risk appetite and invest it in desirable assets. 

As with other retail investors, DIIs can choose funds based on their financial goals. Since March, more than Rs 1 lakh crore was invested in the economy through SIPs of mutual funds. 

  • Indian insurance companies

The importance of insurance companies has grown multifold in India. 

Not only do they provide insurance coverage against unforeseen medical emergencies and death, but they also provide financial security. As of March, they have offered around Rs 20,000 crore to DIIs. 

  • Local pension funds

Financial stress is the last thing anyone wants to deal with when retiring. Investing in pension funds is a great way to avoid this issue. Since these funds are government-backed, their authenticity and transparency are assured. 

By investing in the National Pension Scheme and Public Provident Fund, people can build a comfortable corpus and live a stress-free retirement age. They are also among the major contributors to DIIs. 

  • Indian banking and financial institutions 

Their products include loans, lockers, insurance, etc. The returns from these instruments are invested in equity markets. 

The pandemic hit the banking institutions hard, resulting in large NPAs and more. As a result, to help them turn around, governments lowered their repo rates and introduced other schemes. However, NPAs have decreased in recent years, and AUM under these institutions have increased steadily.

Final thoughts

The article above aims to provide a good understanding of FIIs and DIIs, and the differences between them. Last year, FIIs were more in a sell-out position, and DIIs were more in a buy-in position.

Before, the focus was exclusively on foreign institutional investors as a major funding source. However, this thought is changing slowly and steadily. 

Foreign investors may pull out in times of volatility. Consequently, the government imposes ceiling limits on FII investments to prevent adverse effects on the business and keep the economy afloat. 

FIIs and DIIs are indicators of liquidity and strength in the market. However, following either of them blindly is not wise. As an investor, you must track FII and DII to understand the market movements better. 

Additionally, research the stocks, balance sheet of companies, current economic conditions, and then invest. For queries or doubts, you can always consult a financial advisor.  

Foreign Direct Investment (FDI) – Meaning, Types, Advantages & Disadvantages

What is Foreign Direct Investment?

The concept of foreign direct investment has gained massive popularity in recent times. A foreign direct investment primarily benefits both parties involved in the transaction. Hence, it is an attractive mode of investment.

When a company (foreign company – located outside the country) invests in a domestic company by purchasing the interest of that company, it is known as foreign direct investment. The investment can be made either by a foreign company as a whole or an investor.

The term FDI is often used to describe the acquisition of a significant stake by a foreign entity. It can be done for several purposes, primarily to boost the global presence, expand its business to a larger scale, etc. Though this concept speaks of investment, it is not necessarily a stock investment made by the investing company.

Working of Foreign Direct Investments (FDI)

Some of the factors that play a significant role in investors’ decision-making process are:

  • Economies where the government regulation is stabilised. Thus, this ensures due control.
  • Economies wherein there is a surge in a skilled workforce.
  • Economies offering more-than-average growth prospects.

As the FDI is a far-sighted concept, it includes making provisions for equipment, technology, and professional high-level management. It depicts that FDI is far beyond capital investment.

FDIs help build a robust control of the business. It might also influence the firm’s decision-making activities substantially.

Some of the special considerations are as follows:

  • When an entity intends to invest in a foreign company, it looks to have control reasonably. Control is one of the critical elements of FDI. It describes the intent of the investing entity to supervise and oversee the operations of the firm, be an active manager, and influence decision-making.
  • The Organisation of Economic Co-operation and Development (OECD) has set aside a threshold limit for foreign direct investment to qualify as having a controlling interest in the entity it invests. Per the OECD guidelines, a minimum of 10% ownership stake in a foreign-based company will be eligible for a controlling interest. However, there have been instances when an effective control has been established in a company with less than 10% of voting shares.

What are the various types of Foreign Direct Investment?

Foreign direct investment can be categorized as horizontal, vertical, or conglomerate.

  • In the case of a horizontal direct investment, a company tries to build a similar type of business function in a foreign country as it does in its home country – for example, a Korea-based cell phone provider investing in a chain of mobile phone outlets in Russia.
  • In the case of a vertical direct investment, a business aims to acquire a complementary business, i.e., a business which will complement its current business operation in a different country. For example, an India-based manufacturer is eyeing an interest acquisition in a China-based company that supplies the raw materials it needs for its primary business in its home country.
  • Another type of FDI is the conglomerate. In this case, a company invests in a foreign company with an unrelated business operation regarding its primary business. As the business is not related, the investing entity will not have expertise in the lines of business of foreign companies. This is when they enter a joint venture.

The rise of FDI in India

Even amid the COVID-19 pandemic-induced disruptions, which began way back in March 2020 with a series of lockdowns, the Indian economy has grown with about USD 22.53 billion worth of direct investments from April to June 2021 quarter. This is about 90% higher than the comparative quarter of 2020, when the economy was at a standstill owing to the pandemic. 

The automobile industry received about 27% of FDI equity inflow, making it the highest foreign direct investment receiving sector. The other sectors, such as computer hardware and software, accounted for about 17% of FDI inflow, and the services sector had around 11% FDI inflow. 

Of this total number of USD 22.53 billion,  approximately 98% of the investments have come in from the automatic route, which means that the investing entity does not require government approval for making this investment. Also, it indicates the relaxation in trade restrictions of FDI in India. This relaxation of FDI in India has led India to rank higher in the World Bank’s list of nations of ease of doing business by 79 positions. India is now ranked in the 63rd position out of the list of 190 countries. 

This shift and upward movement of India’sIndia’s rank has happened between 2014 to 2019, as per the report released in December 2020. India is expected to get into the list of top 50 nations for ease of doing business by the close of the coming financial year.

Why importance must be given to boost FDI for India:

As there is a tremendous boost in the Indian economy due to the benefits of FDI, India must have the investments coming on a more significant scale. It helps support the non-debt financial resource acting as a relief for a developing economy. Companies investing in India also get the advantages of FDI like reduced wage cost and improved technical know-how, which facilitates employment growth at an overall level.

The Indian government to solidify the interest favoring foreign direct investments has eased the norms in several sectors. The following are power and stock exchanges, defence units, and PSU refineries, which have led to a sharp increase in investments in these sectors. With this move of creating favorable policies, the government has ensured a constant flow of capital into the economy. Both parties immensely build their economies through the benefits of FDI.

Now that we have got a fair idea about the basics and background of foreign direct investments let us look at the advantages of foreign direct investment:

Increase in Economic growth:

One of the benefits of FDI is the creation of jobs. A developing nation is always on the lookout to attract heavy foreign investments as it leads to an overall improvement in the way an economy functions. It also helps improve the standard of living of the people. One of the more significant benefits of foreign investment is that it focuses on driving up the results of the service and manufacturing sectors of the nation and helps combat the fight against rising unemployment rates. 

As the income earning capacity of the people increases, it leads to more disposable income in the hands of the people. The more disposable income, the higher the buying power, which provides an overall boost to the nation’s economic condition.

Development of human capital:

Every entity intending to grow its business through foreign investments invests a part of its capital in developing the required human resource. As the lower-level management and the staff carry out the implementation of the strategies of the top management, the due focus must be given to developing their competency and knowledge base. 

The people of lower-level management learn and receive a scope to enhance their skills by gaining experience in their allocated tasks. This can be achieved by conducting training sessions across all departments. The practice adopted by the organisation to develop the skills of their workforce creates a ripple effect in the economy, and other sectors try to follow suit.

Technology:

Foreign companies derive enormous benefits from FDI through improved technology and tools. Newer and improved operational practices are adopted to make the vision a reality. Utilising the latest financial tools across all company sections ensures improved effectiveness and efficiency in conducting operations.

Rise in exports:

The FDI usually does produce goods keeping the global markets in mind, and therefore the goods produced by them are export compatible. This leads to an increase in exports, and it is achieved by creating 100% export-oriented units.

Facilitates the stability in the exchange rate:

If the economy successfully maintains a constant flow of foreign capital through FDI, it simply translates into a flow of regular foreign exchange in the country. This flow will help build a growing foreign exchange reserve, ultimately stabilising the exchange rates, which the Central Bank maintains.

FDI leads to the creation of a Competitive Market:

Another advantage of foreign direct investment is that it facilitates the entry of foreign entities into the local marketplace. This move helps to build and sustain a healthy competitive environment. When a healthy competitive environment is built, it will further help to break down the domestic monopolies. 

It encourages firms and their people to develop a shared vision and go beyond their call of duty to deliver improved services and products through renewed processes. Due to this, there has been a tremendous rise in innovations in the domestic marketplace in recent times. As newer and more valuable products get introduced in the market, the consumers get access to better quality and a wide range of products priced competitively.

Helps in combating climate change:

Due to the mounting issues surrounding climate change, the United Nations has encouraged the route of foreign direct investments, realizing that it will help fight the problems.

What are the benefits of foreign direct investment?

Having gone through the advantages of foreign direct investment, let us get an overview of the benefits of FDI. 

They are as follows:

Stimulates the economic development of a nation:

When there is a rise in foreign investments, it may lead to the development of factories to manufacture goods. It will give rise to employment, thereby improving the employability rate. It further helps to generate tax revenue and the regular tax revenue of the Government. This tax revenue can be reinfused into the economy to better infrastructure not just physically but financially.

Ease in conducting the international trade:

As every country lays its import tariff, it isn’t easy to conduct trade. To ensure that the sales targets and overall goals are achieved, most economic sectors need to have their international presence in place. This can be accomplished by adopting the foreign direct investment methodology. It helps to meet the demands and requirements efficiently.

What are the other advantages of FDI?

A few more points need to be considered apart from those mentioned above. 

Stated below are the other advantages of FDI. 

  • It helps in the revolutionary transformation of the underdeveloped areas of the nation into a full-fledged industrial sector.
  • Goods can be promoted and marketed via FDI both in the domestic and international markets, in turn contributing to the nation’s foreign exchange revenues.

Like other investment avenues, FDI also has advantages and disadvantages, primarily geo-political. It might impact domestic investments, trigger risks for the country’s political changes, and may or may not positively influence exchange rates always.

 

Meaning, Types & Examples of Government Securities in India

Government Securities and its Types: 

It is often believed that investing is for people with deep pockets and a robust risk appetite. However, this is not the case. Every investor has a different appetite for risk holding and investing. Some choose to invest in the high-risk, high-reward categories, while others pick low-risk investments. Investors with less risk can also invest and earn decent returns; it all depends on what they are investing in. For such cautious investors, investing in government securities is the right choice. 

What are Government Securities?

Government Securities, also commonly known as G-Secs, is a category of debt instruments offered to the common masses by the government. These securities have a low-risk appetite and guarantee and a fixed income at regular intervals. 

Like corporate funds are utilised by companies to fund operational expenses, purchase advancement equipment & technology, or expand their exteriors. Similarly, these securities are a way for the government to raise funds to carry out its activities. The state or the union government can fund military operations or expand the infrastructure, or cover other operational expenses through these.  

In India, government securities are distributed in bills, treasury, bonds, or notes. 

Let’s look at the different types of government securities in India to have a better understanding of them.

Different Types of Government Securities in India: 

In India, there are different types of bonds and securities. Broadly the securities and bonds are Treasury Bills, State Development Loans, Cash Management Bills, Zero-coupon bonds, and many more. Here’s a detailed overview of the different types of government securities: 

Treasury Bills:

T-bills are government securities issued for a short term. These securities are money-market instruments. Thus, the maturity period is less than a year. In India, T-Bills are available to citizens in three maturity periods – 91 days, 182 days, and 364 days. Investing in such securities does not have any interest payments but is usually issued at a discount. This type of government security is very commonly used in India. 

Dated Government Securities:

These are also known as Dated G-Secs, and are long-term in nature. These have a maturity life-cycle starting from 5 years and can go up to 40 years. Investors of this government security are called primary dealers. The various types of Dated G-Secs are Special Securities, Fixed Rate bonds, 75% Savings Bonds, STRIPS, and Capital Indexed Bonds. 

Cash Management Bills:

This was launched in 2010 jointly by India and the RBI. It is a relatively new concept in the Indian financial market due to its less popularity. These are similar to T-bills with one significant difference. The maturity period for Cash Management Bills is less than 91 days or 3 months. Thus, these bills are called short-term government securities available to Indian investors. The government uses these securities to accelerate temporary cash-flow requirements. 

State Development Loans:

These are issued by the state governments and are similar to dated G-Secs. States issue bonds and securities to meet or generate additional funds for an ongoing infrastructure or operational expense in the state. These can be issued at the auctions organised once every two weeks by the state Negotiation Dealing System. The repayment procedure and range of tenures are the same as the dated G-secs. 

Capital Indexed Bonds:

These are those government bonds with a fixed rate of interest. These are floated to the public on a tap basis as of December 29, 1997. The redemption is based on the Wholesale price index, giving the investors a hedge above the inflation in the country. 

Zero-Coupon Bonds:

Bonds issued to the public at a discount on face value but redeemed at par are zero-coupon bonds. These were first issued on January 19, 1994. These bonds have a fixed maturity period. The difference between the discounted rate at face value and the redeemable amount at par acts as the return on investment. 

Partly Paid Stocks:

These types of government securities are issued at par but repaid at regular intervals, maybe half-yearly. The interest rate is fixed, and security is redeemable at the bonds’ maturity date. 

Floating rate Bonds:

These are classified bonds that do not have a fixed coupon or rate. These coupons are set at regular intervals like every half-yearly by adding a margin on a base rate. For most of the floating-rate bonds issued by the government, the base rate represents the cut-off yield calculated as the weighted average for the prior three 364-day Treasury note auctions before the reset date. The auction determines the coupon and spread. 

Can retail investors with limited funds buy government securities?

A year back, small investors had to invest in mutual funds or policies offered by life insurance companies to diversify their investments by buying government securities. The government and the Reserve Bank of India (RBI) took initiatives to attract direct investments. 

And finally, the RBI announced in February 2021 that individual investors would be able to buy and sell government securities directly on its platform. An investor can bid in these securities auctions and buy them in the secondary market through the RBI’s Retail Direct scheme. These auctions would take place through their Demat accounts.

How to buy Government Securities? 

The Government of India and the RBI have initiated many ways an individual can purchase and invest in government securities. Primarily, the RBI organises auctions twice in two weeks. Interested investors can participate in Non-competitive Bidding or Competitive Bidding based on their eligibility. Banks, mutual funds, and insurance firms can invest through competitive bidding. The Government of India and the RBI began non-competitive bidding in 2017 for government bonds like treasury bills, SDL, etc., to encourage individual or retail investments. 

Retail investors can purchase government securities through primary and secondary markets. This can be done by initiating a gilt account with the national banks. 

A gilt account is like a regular bank account in any designated bank in India. The only difference is that instead of money, any gilt account conducts transactions in treasury bills, SDL, or other forms of government securities. These non-competitive bidding forms encourage retail investment of G-secs and allow the opening of new and safer forms of investments. 

Why purchase Government Securities? 

Purchasing different types of government bonds in India may have various advantages and disadvantages. Let’s look at some of them – 

Advantage: 

  • Government securities have less risk than other assets such as mutual funds and equities. 
  • The government guarantees the return on investment or income. Therefore, it ensures a fixed sum of returns at regular intervals. 
  • The limited risk in government securities can be nullified by remaining invested until its maturity. 
  • Government securities ensure a fixed rate of investment interest. By remaining invested till its maturity, one can surely attain maximum profits. 
  • Investing in different government securities will allow one to diversify their portfolio. 
  • Government bonds will also ensure a stable portfolio for any individual. 

Disadvantages: 

  • Government securities offer adequate liquidity due to high demand from financial institutions.
  • Investing in such securities and bonds requires in-depth research and regular participation in auctions. 
  • The secondary market for government securities is still not developed completely.

The Bottom Line: 

Thus, investing in government securities is an excellent opportunity to invest your hard-earned money as it is secure and generates fixed returns. If you are not a big-shot investor and prefer a low-risk game, investing in government securities would be the right choice for you. A diversified portfolio is essential for financial security and stability. 

It is wise to invest in different types of government bonds and securities. However, if one intends to build a balanced portfolio, keeping in mind their goals and risk appetite, one should consult a financial advisor. You can contact financial advisors through various digital platforms. You can discuss your investment goals and choices with them and make the right decisions.

Margin Against Shares

We all must have found an exciting offer at some point but had to stand back and think about it for a considerable amount of time. So, what would be our plans? The first option that would come to our mind would be to pay it from our own pockets. However, there are two issues with this solution. First, what happens when we do not have enough funds in our DEMAT account? It will take time to get funds. However, by the time we get enough funds, the bargain will have expired. And second, it will enhance the overall market risk exposure. But if our broker offers a margin, there is another way to solve the situation.

So, what is that unique facility that experienced traders are familiar with and use to leverage in the market? The answer is margin against shares. A person now might have a question in mind, i.e., what exactly is a margin against shares in the share market? It is a financing facility provided by our broker as an additional service to assist us in our investment with them. We can overdraw our DEMAT account to pay the margin and realize profit without increasing our risk quotient when there is a good bargain in the share market. The broker uses the stocks as collateral and lends us money to trade for a limited time.

What Is Margin Against Shares?

Margin against shares in the share market is like a loan against shareholding that a stockbroker offers at an agreed interest rate for trading reasons. A share broker provides this as a value-added service. Because margin against shares carries a higher risk, only a few stockbrokers in India offer it.

This service allows clients to obtain margin funding for trades by using shares in their Demat account. Collateral Margin is the term for it.

What Is Collateral Margin?

Demat account holders are entitled to collateral margins if they meet a specific condition: they must keep a specified proportion of the collateral’s value as a cash margin.

Many brokers make this service available to their clients. The facility benefits both a brokerage and an investor. The amount of margin offered to an investor is determined by subtracting the haircut from the current market price of the pledged stock. The haircut is the amount that compensates a broker for the chance that the collateral share prices would fluctuate wildly. The quantity of the haircut is calculated as a percentage.

Only a few brokerage firms in India provide collateral margins. This is due to the significantly high risk involved with the process. Many investors also fail to keep the cash–collateral ratio in check, an essential and most important requirement for receiving a collateral margin. The cash–collateral position is calculated in a 10:90 ratio in a client’s account.

How Does Margin Against Shares in Share Market Works?

If someone is interested in a margin against shares, they first need to check with their broker to see if margin against shares (MAS) is available as a value-added service.

Margin against shares works in the following way:

  • Clients move their shares from their accounts to a broker’s beneficiary account.
  • After that, a broker moves those shares to a client’s margin account with the broker’s depository participant.
  • The margin amount is determined by subtracting a haircut from the value of the shares.
  • The margin amount can be used on various financial products, including intraday stock trading, equities futures trading, indices, currency trading, etc.
  • On the other hand, you cannot utilize this margin to purchase options or take delivery of shares.
  • If the client no longer wants to use the margin, he can return the collateral stocks at any time.

What Happens to the Shares in Margin Against Shares?

The ownership does not change when shares are invested or used for margin against shares. The client still owns the shares in the margin account. If the client continues to meet their obligations, like paying interest, they can use the margin for as long as they choose. When a shareholder sells shares from their margin account, the proceeds are sent to their broker, who will alter the margin amount.

There are a few more considerations to consider while using margin against shares. You should keep a few more things in mind while any investor uses margin against shares. All securities cannot be used as margin collateral. Only particular securities can be used as margin collateral. An investor should keep the ready list with them, which the brokers should provide to the investors. 

How much is the margin against shares?

When they apply for a loan against the stock, the broker will advance the funds after deducting the exchange-approved haircut.

Furthermore, employing 100 percent of the margin for a trade is prohibited by the exchange. The cash collateral ratio has been established at 50:50, which means that only 50% of the total deal volume can be paid using margin, with the remaining amount requiring new cash investment.

Let us now look at an example to understand the situation better; an investor/shareholder wishes to buy NIFTY Futures worth Rs 3,14,120. To make an order for the deal, they must pay Rs 1,57,060 in cash, which is 50% of the total deal value, before paying the remaining amount with a margin against shares.

Additional Charges for Using Margin Against Shares

The cost of borrowing includes interest and Demat pledge/unpledged fees, which can be considered an additional charge.

Interest is calculated at a rate of about 0.05 percent every day. The cost of pledging and unpledged shares is roughly 50 rupees per script.

Calculation of margin

After the haircut amount is exchanged, the client receives a margin against the shares.

The haircut is the percentage amount used to cover the risk of stock price fluctuations. The stock market always specifies the haircut, and it remains the same for all brokers.

For example, if a client transfers shares valued at Rs 1 lakh and the exchange requires a 15% haircut, the shares’ collateral value will be Rs 85,000. In the customer’s account, the Cash-Collateral proportion for the position held by the client will always be calculated in the ratio of 10-90. As a result, to take advantage of the total Rs 85,000 collateral benefit, the client must have a minimum cash margin of Rs. 9444 (Rs. 85000 * 10/90).

Benefits of Margin Against Shares

While there are numerous advantages to opening a margin account, it’s also vital to thoroughly comprehend the dangers before proceeding. Before we go into the risks, let’s look at the main advantages of employing margin.

  • Leveraging assets: When investors buy shares on margin, they may boost their investment by leveraging the value of assets they already hold. If the value of their investment improves, they can increase their profits.
  • Profit from declining share price: Short selling is a complex strategy in which an investor benefits from a falling stock price. After borrowing shares, the investor sells them and then repurchases them at a lower price later. Their profit would be the difference between the proceeds of the initial sale and the cost of buying back the shares. An investor should borrow stock from any brokerage business to sell a security short. It also requires making sure that the margin account is authorized.
  • Flexibility of repayment: As long as the investor’s debt does not exceed the margin maintenance need of the broker, the investor can repay the loan at their own free will.
  • Interest rates are comparably low: A margin loan will include interest costs like any other loan. Because margin loan rates are tied to the central bank’s target rate, the interest rate might be cheaper than a credit card cash advance or a bank loan, especially on more significant amounts. Margin rates may be competitive with home equity loan rates without paperwork and application fees.
  • Portfolio diversification: An investor may be placing too many eggs in one basket if a substantial block of shares dominates their portfolio from one firm, such as a current or previous employer. An investor might use such shares as collateral for a margin loan if they have a margin account. They may then diversify their portfolio using the loan money instead of selling your initial stock. 

This method is beneficial if an investor has a substantial unrealized capital gain that they wish to maintain.

However, an investor should never forget that where there is a chance of such rewards and potential, there is a high chance of risk.

Some Risks in Margin Against Shares Trading

  • Leverage Risk: Since the flexibility is so high, an investor can incur a huge loss.
  • Unable to meet the margin call: Depending on an investor’s assets and whether they borrow money to acquire more shares or sell short, their brokerage company will need them to maintain a certain amount of equity in their account. Equity is computed by deducting the margin loan balance from the total value of their account to represent their ownership stake. For example, if your account’s securities value is $15,000 and their margin loan amount is $10,000, the equity is about $5,000, or 33%. The minimum equity maintenance requirement for stock investments is usually 30%, although it may be greater depending on various securities and account characteristics. They need to add cash or assets to their account to grow the equity. The brokerage company may sell stocks they hold without alerting the investor to raise the equity in their account if they do not respond quickly.

How to Manage the Account Risk

  • To lower the probability of a margin call, an investor should consider establishing a cash buffer in their account.
  • Investing in assets with a high rate of return, the securities that an investor buys on margin should, at the very least, be able to earn more than the loan’s interest rate.
  • Investors should make a customized trigger point for themselves; When their margin account balance approaches the margin maintenance requirement, maintain extra financial resources on hand to contribute to it.
  • Investors should make sure that they regularly pay interest; Interest costs are added to the account every month, so it’s good to pay them off before they become unmanageable.

Conclusion

Now that we have learned about the details of margin against shares, the calculations, the benefits, the risks, and how to maintain those risks, we hope that any investor finds it easy to invest. An investor should never forget that margin against a share in a facility increases their investment capacity; a line of credit from their broker allows them to trade for more significant stakes. They can hedge their net risk meter by pledging their current stocks and ETFs as collateral. However, it is a two-edged blade that one must use with care.

Types of Futures

Before we understand what futures are and their types, we need to learn about derivatives. So let us begin.

What are Derivatives?

Like share trading in the cash segment (buying and selling shares), the derivative is a type of trading instrument. It consists of unique contracts that derive their worth from an underlying security.

Futures and options are two different types of derivatives that you can trade on Indian stock exchanges. In India, the futures market is quite popular and has much liquidity. The Securities and Exchange Board of India (SEBI) has 188 securities for which futures contracts are available.

You can trade these securities in the Exchange’s Capital Market category. These contracts have predetermined prices and expiration dates.

In futures trading, the trader buys or sells a contract for an index (e.g., NIFTY) or a company (e.g., Reliance). The trader makes a profit if the price moves in the trader’s favor throughout the contract life (rises in the case of a buy position or falls in the case of a sell position). The trader loses money if the price trend is negative.

What are Futures?

Futures are standardized derivative financial contracts that bind the parties to trade an item at a defined future date and price. It specifies the quantity of the underlying asset and allows trading on a futures exchange. 

You can utilize futures for hedging or trade speculation on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE).

Regulation of Futures Market

The SEBI regulates the futures market in India. It aims to protect investors’ interest in putting tight measures in place to ensure that neither buyer nor seller fails on their agreement. 

In a contract, the buyer or seller can withdraw from their commitment if the price goes in a negative trend. However, this backing out is not possible in a futures contract. The exchange ensures that both the buyer and the seller honor their contracts by acting as a counterparty. 

As a result, the buyer buys from the exchange, and the seller sells to it. If a buyer fails to pay the required amount, the exchange will pay the seller instead of the buyer and retrieve the money. Therefore, there is no risk of counterparty default.

What is the Difference between Futures and Options?

A futures contract is an agreement between two parties to acquire or sell an item at a certain price at a future period. A buyer with an option contract has the opportunity to purchase an item for a specified price. On the other hand, the buyer is not obligated to settle the purchase.

What Distinguishes Futures Trading from Margin Trading?

Buy/sell transactions in the margin segment must be squared off the same day. However, in the futures, they can be carried out until the contract’s expiration and squared off at any moment throughout the contract’s life.

You can convert your margin positions to spot delivery. But you must have the proper trading limits for purchase positions and the requisite number of shares in Demat for sale positions. 

This exchange is not possible in futures because all futures transactions are cash-settled. Suppose you wish to convert your futures holdings into delivery positions. In that case, it must first square off transactions in the future market before acquiring a cash position in the cash market.

Types of Futures

Let us look at the different types of futures.

  • Stock Futures

These futures are based on particular stocks. You must deposit an initial margin with the broker before trading in stock futures. The bigger the volume of transactions, the higher the profit. However, the dangers are also greater. 

Furthermore, you can only trade on stock exchanges such as the BSE and NSE for a limited number of equities.

  • Index Futures

Index futures are useful to bet on the future fluctuations of indexes such as the Sensex and Nifty. If stock prices fall, portfolio managers use these futures to hedge their equity investments.

  • Currency Futures

This futures contract allows risk managers and speculators to trade a currency at a fixed rate against another currency at a predetermined date in the future. An importer in India, for example, may purchase USD futures to protect against a rupee depreciation.

  • Commodity Futures

Hedging against price fluctuations in the future of numerous items is possible with commodity futures, including gold, silver, and petroleum. Commodity futures are also used to bet on price movements. 

Due to the low beginning margins in commodities, these futures traders can take large bets. Of course, the profit potential is enormous, but the risks tend to be high. 

  • Interest rate futures

It is an agreement to trade a debt instrument at a certain price on a specific date. Government bonds or Treasury bills, which trade on the NSE and BSE, are the underlying assets.

Advantages of Futures 

  • Leverage: 

When buying equity shares on the spot market, you must pay the whole contract value upfront. But in the futures, you can acquire positions by paying only the first margin, allowing traders to access significant holdings with less cash.

  • Higher Returns with Limited Capital: 

Investors can make bigger profits because of the considerable leverage. Investors might earn bigger returns than on the spot market, as they have access to higher holdings.

  • Hedging of Risk: 

Hedgers frequently utilize futures to hedge their spot market bets. 

Let us say an investor has 250 shares of any company in the spot market. However, they are concerned that the stock may drop soon. He can sell futures contracts to hedge their spot market position against this trend.

  •  Short-Selling Opportunities: 

Short-selling in the spot market requires settling your position within the same trading day. Investors are required to square off even if they are losing money due to this aspect. In contrast, you can keep your futures contract until it expires. As a result, investors have plenty of time to cover their short holdings.

Basics of Futures Contract in India

  • Lot Size: 

Futures contracts also have strand raised lot sizes to trade them.

  • Futures Price: 

It is the price at which you can purchase a share. The cost of a futures contract is often greater than the underlying asset’s price (in our example, stocks).

  • Contract Value: 

The contract value is the real worth of your position. By multiplying the lot size with the futures contract price, you can determine the contract value. 

  • Expiry Date: 

Every futures contract has a set expiration date. All futures contracts expire on the last Thursday of each month. The contract will terminate on Wednesday if last Thursday is a holiday.

  • Underlying Price: 

It is the underlying asset’s price, which is the cash market share price in an ideal world. The futures prices would move in the same direction as underlying prices.

  • Buyer of a futures contract: 

The buyer of the futures contract is an individual who has an optimistic opinion of the stock and expects the price to rise in the future. As a result, he is purchasing it at a lower price today. This strategy is known as a long position on a stock.

  • Seller of a futures contract: 

The individual who sells a futures contract with a pessimistic perspective on the stock is known as a seller of a futures contract. His goal is to lock in the selling price today so that a future decline will not give him a loss. Such a trick is referred to as a short position.

  • Settlement of a futures contract: 

Most futures contracts in India are cash-settled before expiration. It implies that if you buy a futures contract, you must sell it before or on expiration, or vice versa. 

  • Open Interest: 

The market displays several open contracts or positions on a particular day. A considerable open interest indicates a high level of liquidity.

  1. The addition of new contracts raises the open interest.
  2. Resolution or squaring off of contracts leads to a fall in open interest.
  • Change in Open Interest: 

This graph depicts the daily movement in the futures contract. A positive price movement indicates the addition of more contracts and that investors are going long on the futures contract (purchasing). 

  • Square off: 

Square off means selling a future position. For example, if you buy 1 lot of NIFTY futures on 20th Aug 2014 and decide to sell it on 24th Aug 2014; you square off your future position.

  • Cover Order:

Cover order is a type of order used to sell squares off an open futures position.

Conclusion

Indian investors can trade futures on the NSE and BSE. It is critical to choose one’s future trading strategy. You might select to invest in futures depending on your knowledge and research. 

Futures in the stock agreement is a contract to exchange equity at a certain price in the future. It is a wager on how a stock’s price will fluctuate in the future. A futures buyer benefits from a price increase, whereas a selling benefits from a price decrease.

How to Use Pivot Point in Intraday Trading

What is the Pivot Table and the Pivot Point?

Traders mostly use it to analyze multiple stocks with their opening and closing value to predict their movement. This is done with the help of resistance value and support value (basically the highest and the lowest the stock touches during the trading session). It can help determine the entry and exit position in the trade during different time frames and lower the risk of loss.

The benefits of trading in Pivot points are as follows:

  1. Pivot points are mathematically derived and thus provide higher accuracy in the results 
  2. Once the user understands the formula, it becomes easy to trade and understand the system 
  3. Pivot points can be used to understand the stock market graph and thus helps to trade in a short and longer period of time.
  4. They are helpful in research and analysing methods 

Pivot point: 

A pivot point is a technical analysis indicator or set of computations used to determine the market’s overall trend. The pivot point is just the average of the preceding day’s high and low and closing price. Trading above the pivot point is considered bullish, while below is deemed to be bearish. 

There are four main ways to calculate for pivot points:

  • Standard: A pivot point is a technical analysis indicator or calculation used to determine the market’s overall trend. The pivot point is simply the average of the intraday high and low, as well as the previous trading day’s closing price.
  • Woodie: Pivot calculation differs significantly from the standard pivot points formula. One of the primary distinctions is that the Woodie’s formula emphasizes the closing price. It is important to note that the Pivot Point (PP) calculation involves multiplying the closing price by 2, then adding the High and Low. Divide this number by four to get the PP level.
  • Camarilla: Nick Scott invented Camarilla Pivot Points in the late 1980s. They are similar to Woodie’s in that they compute the levels using the previous day’s closing price and range. However, instead of two levels of resistance and two levels of support, the Camarilla equation calls for four levels of resistance and four levels of support. Add in the Pivot Point level, and Camarilla has a total of 9 levels plotted.
  • Fibonacci: In the market, Fibonacci studies such as retracements, extensions, and projections are widespread. The 38.2 percent and 61.8 percent retracement levels are the primary Fibonacci levels that traders pay close attention to.

Different traders take the help of the Pivot points to understand the stock’s status and trade in the market accordingly. Traders can also use pivot points to understand which levels must be broken for a strong entry point in the trade. Pivot points are easy to understand and accurate to a certain extent, where the trader can determine if there will be any price fluctuations. 

Pivot point trading strategies: 

Pivot points are used to identify the overall trend of the share – where the range above the point is considered an uptrend, while in the opposite, a range below the pivot point is viewed as a downtrend. It is not entirely accurate, but the result is very close to reality with the value of support and resistance.

Candlestick pivot point strategy: Pivot points are most effective on candlestick charts as they give the best idea on the candles, which determine the bullish and bearish trend with their patterns. One can have a better idea of the nature of the trade after using this method.

Support and resistance pivot point strategy: A trader can estimate the entry point using the pivot points for Support level 1, Support level 2, Resistance level 1, and Resistance level 2. In trading, it’s always best to follow the trend, thus in a broad upswing, a trader would look for pullbacks to Support level 1 or Support level 2, and in downtrends, they’ll try to sell at retracements to Resistance level 1 or Resistance level 2.

Day Trading Using Pivot Points: Intraday trading is the type of stock trading where you buy and sell the stock on the same day before the trading session ends. It is a risky yet fast and profitable option due to the fluctuation in the share price. Hence, it is the most popular option with traders. There are many ways to determine the approximate position of the share, but the most preferred method is pivot tables and pivot points to make accurate trading decisions. 

The basic rule of the pivot point is that if the calculation of the average is higher than the pivot, then the stock is higher in value and bullish in trend. At the same time, if the average calculation is lower than the pivot point, then the stock is lower in value and bearish in trend.

The pivot points are divided into seven categories to determine the stock: 

Resistance – 

Resistance 1

Resistance 2

Resistance 3

 

Supports – 

Support 1

Support 2

Support 3

And the pivot point in the centre is the main point.

Calculation of Pivot Points:

Pivot points are determined by the OHLC (Open, High, Low, and Closing) of a stock price from the previous day.

Where the calculation of Pivot point is – (High+Low+Close)/3

While the resistance and support points are calculated in the following manner –

Resistance 1 = (2xPP) – Low

Resistance 2 = (PP – S1)+R1

Resistance 3 = (PP – S2) + R2

 

Support 1 = (2xPP) – High

Support 2 = PP – (R1 – S1)

Support 3 = PP – (R2 – S2)

Resistance is the maximum level the stock may reach in a day in terms of value, while the support is the minimum level the stock may fall in a day in terms of value. The seven points together give the total concept and the pivot point calculation, which is further used in two ways to determine the market situation.

  1. Pivot level breakout 
  2. Pivot point bounce 

1) Pivot level breakout: Pivot level breakout uses a stop limit (a price pre-set to mitigate the risk of loss) and then trades when the stock price is above the pivot point. If the trend is bullish, one should hold the position for the whole day, but if the trend is bearish, one should hold onto the position for the short trade. The best time to use this trend is in the morning, where the chances of loss are less, and the breakouts are more. 

If the market price rises to higher highs, entry orders placed above resistance will be ready to buy. Orders to sell below the S4 line of support, on the other hand, will be activated if the market moves to lower lows. Traders who want more confirmation should wait for a candle to close before triggering a market order. The idea is to enter the market when there is a new price spike, which usually coincides with economic news.

2) Pivot Point Bounce: The approach is a trading method that uses daily pivot points. When the close candle is more than the Pivot Point Zone, buy trades are entered, and sell trades are entered when the close candle is less than the Pivot Point Zone. The system trades the price as it moves forward and then alters it by bouncing off any other pivot points.

It works on the principle of reversal, which means that when a price reaches a pivot point for the first time in each direction, it reverses the trend.

How to Trade Pivot Point Bounce?

The following are the steps to understand how traders can trade with the help of the pivot point bounce strategy.

Step 1: Choose a stock and add the daily pivot points, and open the OHLC (Open, High, Low, and Close) bar chart for that.

Step 2: Follow the pattern and keep a tab when your stock price reaches the Pivot Point Zone.

Step 3: Wait until the price closes below or above the Pivot Point Zone.

Step 4: Input your trading position.

When a long trading position reaches a pivot point, the price bars should ideally make new lows, whereas when a short trading position reaches a pivot point, the price bars should touch figures above the pivot point. 

Your doubts will be dispelled by the explanation that follows.

For Long (Buy) Trading Position:

  • On the daily chart, the primary trend is bullish.
  • On the hourly chart, the hourly candle close is above the Pivot Point Zone.
  • If the hourly close falls below the Pivot Zone or reaches a resistance level, one should close the trade.

For Short (Sell) Trading Position: 

  • On the daily chart, the primary trend is bearish.
  • The hourly candle close is below the Pivot Point Zone on the hourly chart.
  • If the hourly close falls above the Pivot Zone or reaches a support level, one should close the trade.

What is a Stop Loss?

This trading strategy can put a stop-loss at the pivot point or the entry bar’s high/low. Though it depends on the market, you are trading in. A trader must use no specific orders for this trading strategy, though a limit order is preferred to protect traders from risk.

When to Exit the Trade?

The trade automatically fills once you meet your desired trading price or hit the stop loss.

As per the market you are trading in, you can adjust the target to the next pivot point or change the stop loss to suit your trading limits.

Conclusion:

The pivot point itself is the primary support and resistance when calculating it. This means that the most significant price movement is anticipated at this price. The other support and resistance levels are less influential, but they can still cause substantial price movements.

Pivot points are an excellent tool for identifying support and resistance areas, but they are most effective when combined with other types of technical analysis.

Pivot points are based on a simple calculation, and while they may be helpful for some traders, they may not be for others. There is no guarantee that the price will stop, reverse, or even reach the levels drawn on the chart. At times, the price will bounce back and forth between levels.

How to Invest in Foreign Stocks from India?

Investing in international markets may be challenging. Learning how to buy global stocks can be difficult. Language and currency changes, as well as foreign exchange and laws, are all obstacles. Nonetheless, most financial counselors recommend including international equities in a diversified portfolio. Moreover, knowing how to invest in global stocks has become quite common in India. This has several advantages, one of which is the high return. It does, however, have many drawbacks, including high brokerage fees. 

The rising exchange rate, which allows investors to make significant gains, is one of the key reasons many are exploring how to buy international stocks. Furthermore, various individuals might strive for a diverse portfolio by investing outside the country’s boundaries. Moreover, the U.S. stock market is home to some of the world’s most well-known and successful companies, including Tesla, Google, Amazon, Facebook, General Motors, Apple, Microsoft, and a slew of others. As the next generation of industry innovators, such as U.S. stocks, perform ecstatically well, their net worth continues to develop at a quick rate.

With this, you must benefit from investing in foreign stocks. But eventually, you would want to know how to invest in international stocks. You’ll get to know how to go about it through this article.

How Can You Invest Internationally? 

Investing under the Liberalized Remittance Scheme (LRS):

The RBI’s Liberalized Remittance Scheme, or LRS, allows you to participate in the U.S. stock market. Every Indian resident can send up to $250,000 per year under the plan. This maximum applies to all individuals, including children. Therefore a family of four can send up to USD 1 million every fiscal year. Any investments, such as U.S. stocks, real estate, and bank deposits, as well as all abroad costs, such as international travel and student education, are included in this quota.

Direct Investment:

An investor can invest in foreign stocks directly by opening an overseas trading account with an Indian broker, such as Axis Securities, HDFC Securities, or ICICI Direct. It is partnered with a foreign broker or opens an overseas trading account with a foreign broker (such as T.D. Ameritrade, Charles Schwab International Account, Interactive Brokers, and others).On the other hand, certain overseas brokers may ask investors to make a minimum deposit, which may increase their capital needs.

Investing in Foreign Stocks Listed on GIFT City IFSC:

The India International Exchange (IFSC) Limited (also known as India INX), an arm of the BSE, and the NSE International Exchange (also known as NSE IFSC), a wholly-owned subsidiary of NSE Ltd., are the two largest international exchanges situated in the IFSC at Gujarat International Finance Tec-City (GIFT City). These stock exchanges provide Indian investors with a global trading platform to invest overseas.

Mutual Funds:

An investor can also use mutual funds if in doubt about investing in international stocks. One can invest in either a global or an Indian fund in overseas equities. Several Index funds can be used as alternative ways to invest in foreign companies. For example, those index funds that invest in international indices such as the S&P 500, NASDAQ 100, Dow Jones, Russel, etc.

Investors who don’t have an excellent grasp of the stock market but wish to diversify their portfolio might consider this method of investing in foreign equities.

ETFs (Exchange Traded Funds):

An international exchange-traded fund provides investors with a convenient way to gain exposure to foreign markets. Choosing the right exchange-traded fund (ETF) can be easier than putting together a stock portfolio on your own.

Some ETFs offer exposure to multiple markets, whereas others concentrate on a single country. These funds invest in various asset classes, including market capitalization, geographical region, investment styles, and sectors.

iShares by BlackRock, State Street Global Advisors, Vanguard, FlexShares, Charles Schwab, Direxion, First Trust, Guggenheim Investments, Invesco, WisdomTree, and VanEck are among the leading ETF providers. Before purchasing an international ETF, investors should consider costs and fees, liquidity, trading volumes, tax issues, and portfolio holdings.

Factors to be Considered Before Investment in Foreign Stocks

Diversification by geography:

Your portfolio will be more stable if you diversify geographically. Long-term, developed-country markets are less volatile than emerging-market economies. You may join in the global growth narrative by investing in the stock market of the United States. If you invest in Alibaba, China’s largest retailer, for example, you are now a part of China’s economic boom. You may acquire exposure to broader economies through ETFs traded on the U.S. market. For example, the NYSE-listed EWG ETF invests in some of Germany’s major corporations. You may also invest in new topics on the foreign stock market, which is currently inaccessible in India. 

Foreign Exchange Effects:

The fluctuation in the currency rate is an essential element to consider while investing in the U.S. market. The Rupee has lost 3 to 5% of its value versus the U.S. dollar on average in recent years. When you invest in U.S. markets, you’re also investing in the U.S. Dollar, and you’re taking on the risk that comes with it. When the value of the U.S. dollar rises, so does the value of your portfolio, and vice versa. Your Indian bank may charge you an F.X. conversion fee or spread when remitting money to invest in the United States. Depending on the bank, it can range from 0.5-2 percent of the total amount sent.

Risk of Volatility:

Volatility risk is defined by swings in the prices of equities in either direction. In layman’s terms, volatility is the risk associated with the magnitude of variations in a stock’s value. The riskier the stock, the higher the volatility since the exact price becomes uncertain. More robust established markets with lower volatility are preferable from an investing standpoint.

Economic Vulnerability:

Economic risk refers to a negative shift in an economy’s macroeconomic variables. Unemployment, interest rate fluctuations, political instability, unfavorable changes in regulations, and so on are just a few issues that can significantly influence an organization’s operations and, as a result, its share values. As a result, before investing in any foreign stock, an investor should consider all the country’s macroeconomic characteristics.

Liquidity:

Liquidity refers to the ease with which an investment can be converted into cash. The investor should understand the time duration for conversion of their investment in cash at the investment time. The investor should know whether there is any minimum lock-in period for the investment or any restrictions on remittances of the proceeds.

Tax Implications:

Investing in the international market may attract tax obligations from the country where the investment is made. Before investing, the investor should understand the tax arrangements between India and the country wherein the investment is made and understand the tax implications on the returns of the investment. The investor should also consider the tax obligations in estimating the rate of return.

Tax Collection at Source (TCS)

In the case of an Indian investor making an investment in foreign stocks under LRS, tax collected at source (TCS) at a rate of 5% would be levied and managed by the authorized dealer bank by Section 206C (1G) of the Income Tax Act, 1961 (“I.T. Act”), provided the remittance exceeds the prescribed threshold limit of INR 7 lakh in a particular financial year. TCS will be applied on payments over INR 7 lakh. If a PAN card or an Aadhar card is not available, the TCS rate may be increased to 10%.

Also, as investing in the international markets attracts a vast transaction cost, the investor should research well about the available investment opportunities and take the assistance of financial advisors instead of making investment decisions based on gut feeling.

Costs Related to Investment in Foreign Stocks

It’s worth noting that transaction costs for overseas equities are often higher than for Indian ones. The gap between a foreign currency’s purchasing and selling rates is one example of a hidden transaction cost (say U.S. dollar).

To prevent repeated foreign exchange conversions, it’s a good idea to create a bank account in the same currency as your investments.

The following are other critical elements:

  1. Brokerage
  2. Money needed for margining
  3. Fees from the bank
  4. Costs of depository
  5. If applicable, any applicable goods and services tax/VAT/STT
  6. The transaction cost might be anything from 0.5 percent to 2 percent on average, assuming a fair portfolio.

Bottom Line

Understanding the political and economic situations in the nation where you’re investing is critical to determining the elements that may affect your results. Investors should constantly keep their investment objectives, costs, and expected returns in mind while also considering their risk tolerance.

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