Is Investing in the Stock Market Really That Difficult?

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(Source: MasteryOfWealth)

There is a theory in finance which says “The value of any asset is the sum of the present value of its future cash flows.”

Let’s take Warren Buffet’s famous Gumball Machine to explain this. Let’s say you own a gumball machine. The gumball machine gives you, after all the expenses spent on it, $100 every year as net revenue. You are about to sell this gumball machine now.

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How much would you sell it for? The sum of the price of its spare parts? Seems reasonable. But let’s assume that the spare parts of the machine are long outdated and have no value in the market. So, should you give it away for free? No, of course not. The gumball machine is not just about its spare parts. It gives you the additional $100 in spite of the value of its spare parts. Shouldn’t you consider that? You should. If you held on to that gumball machine for eternity (Just consider), it would give you $100 perpetually.

However, getting $100 today is not the same as getting $100 5 years later. Time erodes the Value of Money. Let’s say that the interest rate in the country is 2%. This means that, to get $100 5 years down the line, you simply need to invest $90.60 today (Approximately) i.e. 90.60*1.02^5. This basically means that the present value of receiving $100 5 years down the line is equivalent to receiving $90.60 today.

Going back to our gumball machine with the understanding of the time value of money, we can easily determine, using the perpetuity formula, that the value of the gumball machine today is $100/0.02, which is $5000. This is the intrinsic value of the gumball machine. You should probably sell the gumball machine for $5000, give or take.

Now imagine an economy full of gumball machines. Everyone’s buying and selling gumball machines and all these machines are perfectly identical. What would you do if you find a gumball machine selling at $4500? You would buy it, definitely. Because just by paying $4500, you are getting a present value of $5000. $500 profit, cool. And what if you find gumball machines selling at $6000 in the economy? You will sell your gumball machine and make a cool profit of $1000.

Easy, right? Wrong. What if you buy the gumball machine at $4500 and suddenly there’s a huge drop in demand of gumballs? And what if because of that, your yearly net revenue drops to $60 instead? You would then be sitting on a present value of $3000, making a loss of $1500. You can make every beautiful assumption and pull out well-constructed forecasts, but in truth nobody knows the future. You only expect that your average yearly revenue will be $100. It can just as easily be $150 or it can be $60.

The gumball machine can be directly related to companies. In the case of companies, the $100 can be equated to the company’s free-cash flow (Cash flow of the company after accounting for all possible expenses and debt payments), although a company’s cash flow may vary from one year to another. You discount this free cash flow to its present value, divide it by the number of shares of the company and voila! You have the intrinsic value of the company. This is the premise of valuing a company’s share.

Let’s say you project, forecast and discount the free-cash flow on XYZ Company and arrive at the figure $25. This means that the price of XYZ company should tend to $25 in the share market. But you will find that this is not usually the case. The market is made up of millions of people and not everyone does a DCF Analysis of the stock before buying or selling it. They act on impulse and news, mostly. You might have figured out a really golden company, but if the majority of people in the stock market are not interested in the stock, it would barely move. Or quite simply, your projections and assumptions in the initial valuation phase might have been wrong.

“The markets can remain irrational longer than you can stay solvent.”

Also, a company’s share price is not all about numbers. It is also largely dependent on the company’s competitive position in the market, the company’s management and so many other fundamental factors, which need expertise to understand. Most people in the stock market may not care about this at all.

On top of all this, there is always the stark truth that the unpredictable can happen at any time. Take a look at the following graph of the historical price movement of a famous company’s share. Forget all the mathematical calculations and try to answer from instinct: “Will you buy this company’s share?”

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If past performance was an indication of the future, you would be inclined to say “Yes”. I mean, heck, many Ivy-league educated Wall Street investors said “Yes”. That’s why the share price has increased sharply towards the end of the graph. But can you guess which company this is? It’s Enron.

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Nobody knew Enron would get caught in the Accounting Scandal the way it did and nobody knew that it would wipe out the company. The most intelligent investors got out of Enron real fast, sure. But the the scandal caught everyone off-guard. Such events can happen to any company. At such times, it is only your expertise of in the business of the company that will help you determine if you should buy more of the stock or sell it. The shares of many big companies lost 50–60% of their value immediately after the 2008 crisis. If you’d invested in any of those companies, for instance GE or Goldman Sachs, for instance, you would be reaping profits now (You can look at their historical price movements in sites like Bloomberg).

So to answer the question, it is not difficult at all to determine the fair price (The price at which you are willing to buy) of a company’s share. It is, however, difficult to understand human beings. And human beings determine the market price (The price at which you can sell) of the company’s share. It takes years of expertise, patience and determination to make a huge profit out of the share market.

This article was written by Dinesh Sairam (PGDM, Batch 21, XIME-B)

The Question of Battling Poverty by Printing More Money

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(Source: GaryK)

For many people, one stream of thought that seems very logical, but has never been implemented in real life is the question: “Why can’t we just print more money and give it to poor people?” Let’s explore the life of the momentarily fictional now-rich poor.

The Wolves of Tel Aviv: Israel’s Binary Trading Industry

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Original Article: The wolves of Tel Aviv: Israel’s vast, amoral binary options scam exposed by Simona Weinglass

“I always wanted to move to Israel,” says Guralnek, who attended a Jewish day school in Sydney.

He was working in the administration of a factory in Australia when his boss died suddenly, and, at the age of 28, he realized it was a good time for him to move to Israel. “I thought, ‘I’m free, no strings attached, I can go.’”

Guralnek enrolled in Jerusalem’s Ulpan Etzion to learn Hebrew, then moved to the vibrant and bustling city of Tel Aviv, where he landed a series of minimum-wage jobs for NIS 25 (a little over $6) an hour: chopping vegetables in a restaurant, driving a disabled person, working the night shift at a hot-dog stand.

But in a city with sky-high rents and a cost of living relative to salaries second only to Japan, Guralnek could not survive. He heard that jobs in an industry called binary options paid twice what he was earning, plus commission.

‘It’s gambling and we’re a bookie’ — ex-binary options salesman

“As soon as I started looking for a job, I was getting calls from binary options companies every day,” he recalls. “They dominate the job advertisement space.”

Nor did Guralnek have any difficulty landing a job.

“You walk in and they make a big show like they’re assessing whether or not they want you. But they want you.”

On the day Guralnek stepped into the lavish offices of his new employer in the seaside town of Herzliya Pituah, he knew he had arrived.

“There was free coffee, free food,” says Guralnek. “My salary was 7,500 shekels ($1,900) per month, plus commission.”

Guralnek sat in a call center with about 50 other employees, many of whom were new immigrants fluent in a variety of languages. His job was to call people around the world and persuade them to “invest” in an ostensible financial product called “binary options.” The clients would be encouraged to make a deposit — to send money to his firm — and then use that money to make “trades”: The clients would try to assess whether a currency or commodity would go up or down on international markets within a certain, short period of time. If they predicted correctly, they won money, between 30 and 80 percent of the sum they had put down. If they were wrong, they forfeited all the money they put on that “trade.” Guralnek soon saw that the more trades a client made, the closer they came to losing the entirety of their initial deposit.

He had been instructed to present the binary option as an “investment” and himself as a “broker,” even though he knew they would most likely lose all their money. “The client isn’t actually buying anything. What he’s buying is a promise from our company that we will pay him. It’s gambling and we’re a bookie,” he says now.

Before he started the job, the company gave Guralnek a week-long sales course in which he was taught enough financial knowledge to sound good to a customer who knew less than him. He was also instructed in high-pressure sales tactics.

“They taught us how to make people uncomfortable, how to answer objections, how to keep them on the phone.”

The training session was known as a “conversion course” and the goal was to learn how to turn a telephone lead into a customer by taking their first deposit. At his company, salespeople were not allowed to take a deposit of less than $250.

During the sales course, the company’s management gave Guralnek advice that haunted him later. “They told us to leave our conscience at the door.”

As the weeks passed, more and more questions formed in Guralnek’s mind — questions that underlined the bizarre financial netherworld he had entered. Why didn’t he know the surnames of his managers? Why were workers prohibited from speaking Hebrew or bringing cellphones into the call center? Who was the company’s CEO? Why was it okay for the company’s Arab-Israeli staff to sell binary options in places like Saudi Arabia while other countries, like Israel, the United States and Iran were off-limits?

Even worse, Guralnek began to suspect that beyond the poor odds customers had of actually making any money, and beyond the aggressive sales tactics, what the company was doing was downright illegal.

For instance, every salesperson was asked to invent a fake name and biography. The call center used Voice over Internet Protocol (VoIP) technology, which displayed a local phone number to customers anywhere in the world. The company’s website listed an address in Cyprus.

“I was told to tell people I had years of experience in the market, that I had studied at Oxford and worked for the Bank of Scotland.”

Guralnek says he was told to present himself as a broker who made a commission on the trades and to emphasize how much money the customer could make while downplaying the risk. In fact, rather than helping customers to make smart trades, the “broker’s” true interest was for them to make unsuccessful predictions and lose their money.

Guralnek says he was also increasingly disquieted by what happened when the clients tried to quit. That’s when they would be asked for a lot of paperwork.

“We would say, ‘You want to withdraw? OK. We need to verify your identity before we can release the funds. You need to send us a photocopy of your utility bill, your driver’s license, your passport, your credit card’” — requirements, needless to say, that had not been mentioned when the client put money in.

While the customer was gathering and submitting this paperwork, a “retention” agent would call them and go through their trades, purportedly figuring out what went wrong and convincing them to continue trading. “We could delay that withdrawal for a long time.”

‘Why should I be blamed for selling something to stupid people? If someone is over 18 and wants alcohol, cigarettes, a knife, a binary option account, it’s his own responsibility’ — Facebook post

If a customer was persistent, says Guralnek, very often the company would stop taking their calls, or send them an email saying ‘we suspect you of fraud’ and freeze all their funds. Because the customer didn’t know the real name or location of their salesperson, “they had nowhere to turn to get their money back,” explains Guralnek.

But the grimmest part of the job for the young immigrant was asking for money from people who seemed poor and dejected.

“They believe they’re doing something good: They’re making an investment, doing something responsible. And they’re not. Every story is sad. Everyone’s got people depending on them. Lots of people are finally getting back on their feet after a drug problem or something.”

The worst was when a client told him, “I’m in hospital.”

“When someone says ‘I’m in hospital and I have cancer,’ we’re supposed to still sell them. But I would throw the sale every time. I couldn’t do it.”

If you type the words “binary options” or “forex” into Facebook groups that cater to new olim (immigrants to Israel), you will encounter long threads of heated exchanges.

“Do any of you who are involved in Forex/Binary options realize that this is a highly unregulated business that it is soliciting gambling to misinformed or uneducated persons?’ reads one such post in the popular Secret Tel Aviv group.

“Why should I be blamed for selling something to stupid people?” a woman replies. “If someone is over 18 and wants alcohol, cigarettes, a knife, a binary option account, it`s his own responsibility.”

“Would you sell it to your grandmother?” the original poster fires back.

In the “Keep Olim in Israel Movement” Facebook group, a woman writes, “Hi all, can someone explain to me what are Binary and Forex jobs and why people are so anti-working in these industries in Israel?”

“This field is dishonorable,” reads one reply. “I’ve done it and I felt nothing but shame and self-loathing for harassing people who never asked for this call and trying to get money out of them that they’re unlikely to ever get back.”

“If you don’t like it, don’t do it,” reads another. “Work what you feel is an ‘honest’ job, make your 6,000 shekels (approx $1,500) a month take away, spend it half on rent and live like a rodent with the rest of it.” He continues, “While the Binary and Forex industry and I pay 50% taxes on our salaries to pay for your health care, social security, and security, I can speak for all of us, we don’t need to be judged.”

No one seems to know precisely how big the binary options and forex industries are in Israel. Not even the Israel Securities Authority, which, when posed the question, responded via text message, “As the industry is still unregulated, we don’t have the full picture.”

But conservative estimates put the number of people employed in the industry at several thousand, mostly in Tel Aviv and its suburbs like Herzliya and Ramat Gan, while annual revenue could be anywhere from hundreds of millions to over a billion US dollars.

Globally, the term forex normally refers to legitimate trade in foreign currency, while binary options is the name of a financial instrument. In Israeli popular parlance, however, “binary options” and “forex” are often lumped together as part of the same industry: When Israelis refer to forex companies, they often mean companies that “trade” the binary options on currencies. Sometimes the terms Forex and binary options are used interchangeably to refer to rapid, all-or-nothing trades on a range of assets.

At some binary options firms, the online platform is manipulated to provide false results that ensure the customer loses

The “trading” process can work as follows, The Times of Israel was told. Having transferred their first financial deposit to the company, customers log in to an online trading platform, as directed by the company’s salespeople, and place money on a prediction that the price of a currency or commodity will go up or down on international markets in, say, the next five minutes. If the customer predicts correctly, he makes a profit of a certain percentage and the company loses money. If the customer is wrong, he loses all the money he placed on the trade, and the company keeps it. Professional options traders consulted by The Times of Israel said that even a financial genius cannot predict with any confidence what, say, the price of gold will do in the next five minutes; rather than an investment, the transaction is really nothing more than a gamble.

The misrepresentation of gambling as responsible investment would be bad enough.

What’s worse, though, and blatantly corrupt, The Times of Israel was told, is that, at some companies, the house is bent. A variety of ruses are used. The potential payout for a correct prediction is complex, opaque and calculated to minimize the company’s loss. If an asset is behaving in a predictable way — say, the price of copper starts to climb following an earthquake in Chile — the company will pull that asset from the online platform. At some binary options firms, the online platform is manipulated to provide false results that ensure the customer loses.

Estimates of the number of binary options and forex companies in Israel vary from 20 to several hundred. The IVC Research Center, a company that provides information about Israel’s technology sector, estimated in its 2015 yearbook that there are 100 online trading companies in Israel, the overwhelming majority of which fall into the categories of forex and binary options. IVC estimates these companies employ more that 2,800 people in Israel. However, the yearbook states, “it’s difficult to gauge the actual size of the online financial trading industry in Israel,” in part because the industry is “low-key” and its “Israel nexus is often understated.”

What is the Repo Rate and Why Does Everyone Care So Much About It?

What is a Repo? A ‘repo’ is nothing but a ‘repurchase agreement’. Even normal individuals can enter in a repo agreement. I give you a signed piece of paper in exchange for Rs. 10k. The paper states that “I will repurchase the signed piece of paper from you at a given date in the future for Rs. 11k.” The Rs. 1k or 10% is the ‘Repo Rate’. In the case of repo agreements between a central bank and commercial banks, the piece of paper is called the ‘Repo Rate Agreement’.

Why does the central bank do this? Because a central bank needs to control the ‘cash in the system’, so to say. That’s in their job description. In order to do that, they usually put up a handful of rules, the primary being the reserve requirements for banks and the ‘repo’ rates.

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What are the reserve requirements? In India, the RBI has told the banks that they need to have a CRR (Cash Reserve Ratio) of 4% and a SLR (Statutory Liquidity Ratio) of 21%. This simply means that for every Rs. 100 that a bank has in its hands, it needs to give for safe-keeping Rs. 4 in hot cash and Rs. 21 as mostly investment in government bonds to the RBI. This Rs. 25 acts as a guarantee of sorts in case the bank collapses.

Where does Repo figure in this? Let’s suppose that a bank has only received Rs. 100 worth of deposits. The bank gives the RBI Rs. 25 by way of maintaining the CRR and SLR. Slowly, the bank lends out the remaining Rs. 75 to its customers. Now, the banks figures out that there is still some demand for loans. It’s out of money though. So the bank tells the RBI “Hey, lend me Rs. 50. I’ll give you back Rs. 12.5 by way of CRR and SLR. Let me utilize the remaining Rs. 37.50 for my business.” Remember, the RBI prints money. The RBI can never run out of money to lend, unlike the banks. The RBI replies “Fine, take this Rs. 50. But for your SLR requirements, you will have to purchase government bonds from me. So, at a given date in the future, you will repurchase your agreement from me at Rs. 50 plus 6.50% interest per annum and I will repurchase my government bonds from you at 6.00% per annum.” The first part of the agreement, where the bank repurchases its agreement from the RBI is called the Repo Agreement. The second part of the agreement, where the RBI repurchases its government bonds from the bank is called the Reverse Repo Agreement. You might have noticed that the Reverse Repo Rate is always lesser than the Repo Rate. That’s one of the perks of being the controller of the banking system of the country.

The central bank and the commercial banks engage in these repo transactions (Called ‘Repo Rate Auctions’) very often. The repo is basically how money flows from the central bank to the banks and into the system.

Why does the Repo Rate matter so much? So, we’ve seen how a repo works, both generally and in the banking system. But why does the 6.50% matter so much? Every two months, the RBI does a policy review. The most important part of it is the modification of ‘key rates’ (Repo, CRR, SLR, MSF), if any.

Indian banks are currently ‘borrowing’ from the RBI at 6.50%. Imagine that the RBI announces a 50 Basis Points ‘rate cut’. The 6.50% drops to 6.00%. The banks can now borrow more and pay lesser interest to the RBI. Higher cash in the hands of the bank will mean higher lending from the banks to the public. Higher cash in the hands of the public means more spending on goods and services. More spending and demand leads to inflation – or rise in prices of goods and services. The public starts suffering from inflation.

The RBI now intervenes and increases the Repo Rate, to say 7.25%. Now, the banks can borrow only lesser and pay a higher interest rate on it as well. You can probably fill in the gaps of what will happen next based on what we saw above. This gradually leads to a recession. The RBI again intervenes and ‘cuts’ the rate, again. It’s a vicious cycle and a cycle which needs to be monitored closely. Ineffective monetary policy will lead to depression, hyper-inflation and all sorts of economic anomalies. Although the Repo Rate is not the only weapon at the disposal of a central bank, it’s the quickest and deadliest.

Alice Rivlin, the former Vice-Chair of the U.S. Federal Reserve puts it in a nutshell: “The job of the Central Bank is to worry.

P. S. Incidentally, ‘Bps’ or ‘Basis Points’ refers to decimal places. 10 Basis Points is equal to 0.10%, 25 Basis Points is equal to 0.25% and so on.

This article was written by Dinesh Sairam (PGDM, Batch 21, XIME-B)

The Economics of a Religious Ritual

India is a very religious country. As such, there are numerous religious rituals involved. Once such religious ritual is throwing coins into ponds located within a temple. In the non-religious parlance, this can be related to throwing coins into fountains and wells for luck. How do the wasted coins affect the economy? Does the economy become poorer for all the lost wealth? Well, not quite.

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(Source: www.democraticpaper.com)

Imagine that there is a lunatic out on the loose whose sole purpose in life is to steal money from people – and burn it. Now he has successfully burnt down all but Rs. 100 worth of money in the hands of every single person in the country. Imagine now what would be the likely effect on the economy. There will be deflation, heck, depression.

People will not spend at all. They will guard their Rs. 100 with their life. They will spend it sparingly, only for food and other necessities. The prices of all other goods and services will crash. Businesses will shut down. If at all some business remains operational, their good or service will be sold at a very marginal rate. Dresses will sell for Rs. 10 or so, cars will sell for Rs. 1000 and so on (Okay, not really, but at least in theory).

Putting aside the destruction and despair, think for a moment what happened to the value of money. Before the lunatic, you could get a Lay’s chips for Rs. 10, but after the fiasco, you are able to get a dress for the same amount. The value of money increased multi-fold.

This is the economic impact of what we call ‘money burning’ in Economics. When you burn money/throw it away, you make everyone else using the same currency richer by a very, very, very tiny part. In the long term you also become richer, but of course you become immediately poorer if you burn your money/throw your money away.

For those of us economically inclined, the Quantity Theory of Money establishes exactly this. Although there are some strong critics of the theory, it holds true. Otherwise, Central Banks across the world would not have ‘controlling money supply’ as one of their major motives.

Before you try this experiment for yourself, note that destroying money is a punishable offense is most countries. This is due to the fact that money is not something you own. Money is simply an instrument created by the government to represent what you own aka your wealth. But at least, the next time you throw away a few coins into a pond, pause for a second and realize how you’ve made your country richer by a teeny-tiny part.

This article was written by Dinesh Sairam (PGDM, Batch 21, XIME-B)