Excise duty and duty free credit entitlement

Excise duty is levied on things produced within the country.Excise duty is a part of the p&L statement of most of the construction companies.

There is sometimes another term used known as the accruals under duty free credit entitlement
It is basically an entitlement to import capital goods duty free under the duty free credit entitlement certificate route.

"The only exception to the latest standpoint would be import of agriculture, dairy products, motorcars, sports utility vehicles and all-purpose vehicles. These products and items cannot be imported under the entitlement available in the DFCEC route.

Under the DFCEC route, service providers (other than hotels) are entitled to duty-free imports equivalent to 10 per cent of the average foreign exchange earned by them in preceding three licensing years. Hotels are entitled for duty-free imports equivalent to 5 per cent of the average foreign exchange earned by them in preceding three years.
This entitlement would be available only to those service providers, who have a total foreign exchange earning of over Rs 30 lakh in the preceding one/two/three licensing years."

Share Issue expenses

Share issue expenses are adjusted against the share premium account. and are not part of the expenses in profit and loss. So, according to the double entry book keeping one entry would go to the cash flow statement i.e. Decrease the asset size and the other would be part of the balance sheet i.e. Equity and would decrease it.

Therefore since Equity decreases and asset decreases the equation
A=E+L is balanced

Distributions

It is hard to compare distributions, so we use summary statistics to simplify the task and compare the data with each other.

4 ways to characterize the distribution
1) Central Tendency
1) Arithmetic Average
2) Median (Divides the sample of data in half)
3) Most frequently observed value
2) Dispersion from center (What is the average departure from the centre)
1) Range of deviation
2) Mean absolute deviation. (Average distance from the mean)
3) Variance: Average squared distance from the mean
3) Symmetry
1)Skewness: - am i more likely to see more observations above the mean or below the mean.
4) Pointiness: Kurtosis: Does my tail look fat to you. Relative measure of the pointedness of the distribution and tails. More kurtosis means that we can expect more extreme observations than we do in the normal distribution.

Real worlds is negative skewed and excess kurtosis
These summary statistics help us get the shape and the location of the distribution

Time Value of Money

Time value of money is similar to opportunity cost. I have some money that i can invest in some project, but what is my next best opportunity. If i can see the difference, then okay but if not then search for another opportunity given the resources that you have.

Value is relative, compare with next best investment, if it does then it generates value for you.
Every instrument can be thought of as a series of cash flows. The diagram that we draw is called the time line. Divide future in periods. Give them a time subscript. you make an investment at time=0 to buy something and after that you hope to operate this or get some positive returns from the business. Forever perhaps or for a limited time period. The ideas is to figure out when cash flows occur. Using this diagram is extremely simple. Do use the time line even if the problem looks trivial. Donot hesitate to use the time line in order to note the time value of money.

We talk about two values, present value and future value.what would my cash flows be worth, if i kept investing these cash flows in the next best opportunity. Cash flows earn interest on interest as cash flows are invested year after year or period after period.

How much of the next-best investment would i buy to get these cash flows

PV and FV are additive in nature, that i can break up.

For loans
PV of payments = principal that you borrow
At any time at balance = FV of principal - FV of payments made

Interest Rates
APR (Annual Percentage Return ) is Bull shit. It is less than informative.
We need information on the following things
Time period covered by the Rate
Compounding Frequency
Rate

THree ways to quote rates or return of rates
Periodic Rate, Rp. The r that we use in FV and PV is a periodic rate. so first figure out what the periodic rate is.

Second way) Stated annual rate RA.
THird way )Very Handy tool as it is very informative = 1 year periodic rate =simple annual rate =annual rate compounded 1 per year.

(1+annual rate ) = (1+rp)^n
rp=ra/m

Why is the depreciation added back ?

The depreciation is added back as it is a non-cash expense or in other words it can be understood as follows

When the company purchases an asset, it is spending the entire amount to buy it at a single point of time, but in accounting it only takes the depreciation into account, therefore while calculating the FCFE we subtract the capex of the company and also depreciation. In order to account for that depreciation which was subtracted above add it back.

Why are other non-cash expenses like bad debts not added back

They are not added back because they are already accounted for in the working capital. Whenever we have bad debts, we treat them as expenses and reduce an equivalent amount from the accounts recievable, thereby netting the whole thing. Therefore there is no need to add back these expenses.

Working

Operating Income	20 cr
Operating expenses(Inclusive of losses due to bad debts and depreciation):	16cr
Net operating Income (EBIT)	4cr
Interest expense	50lkh
PBT	3.5cr
Tax rate	40% (Marginal tax rate)
PAT	2.1cr
Less:Changes in working capital(Current assets - current liabilities) = Debtors+Inventory-Bad debts-current liabilites)	30lk
Less:Net Capex	50lkh (Capex-depreciation)
Therefore the FCFE becomes	1.3cr

There are two things that we must note here:

• Depreciation has not been added back explicitly because, it was present in the net capex already and when we subtracted net capex deprecation was effectively added back


• The same is the case with bad debts, when we subtracted working capital changes, the bad debt effectively was added back

My Doubts

While calculating the cost of capital, we take the D/E ratio, while calculating the Cost of equity we use beta which is a function of D/E so are we not double counting the entire thing.?

Should Cash be considered a part of Working Capital

This question can be looked in two different ways

The first view is that the cash that is present with the companies is generally invested in treasury bills, short term government securities and commerical papers.Moreover they are riskless investments so while discounting we do not us a risk free rate. Therefore there comes a logical inconsistency

The second view is that, there are industries which are working capital intensive and hence require a large amount of cash for their day to day operations, for such companies it makes sense to assume that 5% of the cash would to be a part of the working capital cycle

Should short term debt and part of long term retiring be considered a part of current liabilities ?

They should not be considered a part of the working capital and should be considered while calculating the cost of capital. There is no sense in double counting it. But if you use the FCFE method then it makes sense to include the short term debt to be a part of the working capital as it will not be taken into account during the Cost of equity calculation

Effect of Net operating Losses

For firms which have huge net operating losses carried forward there is tremendous potential for savings in the first few years, till they generate positive earnings.
Till the time there is Non operating losses accumulated with the firm, the firm would not be paying any tax, as the profits start flowing in, first the NOL will be covered and after than any taxable income that remains would be taxed. The tax rate would be calculated on the taxrate*taxable income/Total Income. Therefore the tax rate can build up over a period of time to 35% in the end

IS FCFE correct ?

This question once came to my mind, is the FCFE method correct because drawing an analogy from the bond markets, the value of the bond is the PV of all the future cash flows from the bond. Hence the PV of a share should be the PV of all the cash flows that would be received by the shareholder. So in that sense the DDM becomes the best method, but still people do not use it. It is shunned by the investor community. Then i looked up the internet to find the answer that i needed

A. Damodaran has put this answer very beautifully in his book, he says that FCFE assumes that all the potential cash that is left after payment of debt holders, taxes and operating expenses is assumed to be paid to the equity holders. Therefore we can say that the investors get the FCFE. It assumes that there is no cash build up in the company and all the cash available is distributed to the shareholders. Therefore we would have seen that the cash component of the present year is added separately to the equity value.

Also the reason for the firm not giving out Dividends =FCFE are as follows

The company might have future needs for huge capex. Therefore in order to account for that requirement the company doesnot pay out in full

Companies, in good time generally do not tend to increase the dividends becuase if in the future time periods they were to decrease the dividend, the market takes it as a bad signal and beats the stock price. Therefore we often see a lag between the increase in dividend distributed and the increase in earnings

The management might want to build an empire of its own, and hence wants to increase the cash present with it

What does a reduction in Risk premium IN CAPM mean

It means that the country has matured, the economy has matured, the risk associated with investing has decreased. Or if the investment is in emerging markets it means the markets will emerge over time and the investors will ask for a lesser premium to invest in these countries.

Dividend Discount Model

Is the Perpetual dividend assumption in the DDM correct ?

It makes perfect economic sense to assume the dividend payment being made till perpetuity because of two reason

1) The value of the cash flow received at the end of the 50 year is very less and so is the present value of a rupee received at the end of 200 years. It is almost a 20 millionth of a cent when discounted.

2) It makes the computations much more simpler and easy to handle. This is so becuase assuming a perpetual life removes the exponential terms from the formula and leaves us with simple algebraic formula.

Geometric Mean and Arithmetic Mean

Geometric mean of returns can be calculated as
Let us say that there are returns over a period of time as follows

20% , 15%, 25%, -20%, 10%

(1+x)^5=(1+,20)*(1+.15)*(1+.25)*(1-.2)*(1+.1)
x = (1.2*1.15*1.25*0.8*1.1)^1/5
x =

CAPM

The usage of CAPM requires us to estimate three things

* The value of rf
* The beta of the company
* The risk premium

Though empirical evidence suggests that CAPM does not give the correct expected returns and various models have been proposed over time in order to overcome the problems associated with the CAPM equation. But due to the simplicity associated with using CAPM it still is one of the widely used methodology in the industry.

Now coming to the questions that were raised, first let us answer the value of Rf. The value of Rf should be such that it matches the duration of the cash flows. Since we assume the business is going to last for perpetuity, the longest available Rf is used which in case of India is the 30 year government bond. For portfolio management on the other hand we can use 1 year Rf.

Now for calculation of beta we can either choose the Sensex or the Nifty for regressing with the stock price. It has been found empirically that both give the same result. Now what should be the duration for which we should consider the stock prices should we take the data for the past 2 years, 5 years, 10 years. The answer can be looked at from the factors affecting beta. If we can say that the operational risk and the financing risk of the company has remained constant over certain period then that should be the period that we should be considering.usually we take a period of 2-3 years for the calculation of beta.

Now second question is should you take the monthly return or the daily returns. If we go by larger the data better it is then we should be taking the daily returns only but this logic doesnot hold good if we consider the following two facts
* Daily prices are highly volatile
* Illiquid stocks(Stocks for which no trade has taken place) might be a problem because we will be underestimating the returns in this case.

Mathematically

Week day Price Price shown in databases Returns
F 50 50
M - 50 0%
T - 50 0%
W 51 51 some no
T 52 52 some no
F - 52 0%

So now the beta is the ratio of covariance of market with stock and variance of market. Covariance of market will come down as the correlation coefficient between the stocks would be less given that some values are 0. Therefore it would be an underestimation of the value of beta.

There can be situation when the beta might have changed significantly for the company in order to take care of the same, we can see the beta for the other firms in the industry and unlever them to get an average unlevered beta and then lever the beta again with the firm specific debt/equity ration and get the corresponding beta value.

Beta(levered)= Beta unlevered *(1+(1-tax rate)*D/E) - Beta debt *D/E(1-t)

Beta debt is calculated in a reverse process. We generally include the cost of debt first and then calculate the beta of the stock.

Now Rm-Rf has generally been found out to be 7% in case of US and 10% in case of India.

Operating Income

For the purpose of valuation, the most essential component that needs to be calculated(For present year) and estimated(For future years) is the operating income. The best way to decided the operating income is not through the sales figure given in the profit and loss account. The best way is to visualize the operating income as constituting of those parts which are recurrent in nature.

This classification has been proposed by Mckinsey. They classify the income as recurring and non recurring. The recurring part of the income is due to day2day operations where as the non-recurring part is generally a one time event. Let us say for example Bajaj Auto, the company has 50% of its assets in investments so not considering the income from these investments would not be a good option as the income would be earned each year.

In short the rule is "If it is recurring, it is operating income"

Hedge Funds

Difference between a hedge fund and a mutual fund
To start with let us see why the name hedge fund? Why not some other fund, well i would say that hedge funds are a misnomer, hedge funds are actually investment vehicles generating absolute returns. Mutual funds have a lot of constraints but a hedge fund has no constraints, that is because they can take money from only accredited investors, they are people who have $5million. Provide steady returns or the illusion of low risk returns. Ideally do not rock the boat. Ensure low volatility by investing in a lot of different markets so that you are not over exposed to any one particular market. Long term capital management called their strategy as "Sucking nickels that others could not. One single observation can destroy thousand of years of confirmation. All you need is one single bet to destroy the years of returns. "Sometimes even the improbable happens". Rare events happen more often, and when they happen they are far more devasting when they happen.

• A mutual fund will not go short, while a hedge fund will be short on quite a many occasions. The simple reason being that when you are short and your bet goes wrong you might loose quite a major chunk of your investment. The reason why it is so is simple let us say you buy a stock with the current market price at 100 and u expect the stock to go up but it does not go up and say it reaches a value of 0. So the maximum you loose is 100 rupees. But let us say you are short on a security because you expect the price to go down. Now instead the price goes up, the problem here is the price can go up-to any range. If it goes upto 250 then you will make a loss of 150 rupees. Therefore mutual funds prefer not to short. So mutual funds generally tend to make losses when share price goes down



• Hedge funds normally do not have any benchmark index to beat, they run on absolute returns.Now to illustrate that let us say that the market is down 20% so the mutual fund might say that we are down only 18% thus we are better off by 2% but that is not what hedge funds do, they belive in a absoulte return, irrespective of how the market moves, they must give their investors a 20% return



• Hedge funds believe in a lot of leverage, so the return are quite big in case you have a correct position. Let us say that you have 2000 rupees as your personal wealth. Now you can leverage up to 4 times. So you have now 25000 in all. You buy let us say 500 shares @50. Now the price goes up to 60 rupees. So the net profit that you make is 10*500=5000. Let us say the margin money that you had was at a interest of 15% per annum and you had the position till one month. So the interest payable becomes 20000*1*15/(12*100)=250. So net profit =5000-250. The return is 5250/5000 which is more than 100% return.



• Hedge funds are not regulated, then generally do not have to disclose how they operate what strategies they adopt but a typical mutual fund will have to calculate the NAV (Net asset value every day and report it to the investors). Moreover due to their unregulated nature the decisions to market events can be made quickly as compared to mutual funds which take a long time in decision making.

The hedge fund collapse Reason

Earlier people believed that there were only white swams and everywhere they went they could only see white swams. So it was like no other color swam could be exist but one fine day explorers discovered a black swam in Australia and hence the age hold finding were destroyed. you just require one major event to prove everything wrong even the mathematical models.All you need is one single behemoth to destroy your years of track record. Sometimes even the highly improbable happens.People underestimate the likely hood of rare events. Rare events happen far more frequently and they are far more devastating than can be thought by mathematical models.a crisis of confidence because of the event that seemed improbable until it happened.

Strategies adopted by a hedge fund?

There are different methods adopted by hedge funds to make money
they short and long both. The hedge fund where i worked believed in a view of fundamental Mispricing and made money on the basis of that. If they had a variant perception about a particular thing then they would hold on that view till the market also included that view in their calculations.

Understanding the Google Buisness

Google has been a technology giant for a long period of time since its inception. It has been able to deliver the users results most relevant to them and has drawn huge number of people towards it. In india People are generally heard saying "Google humari mata hain humme kuch nahi aata hain" (Google is our mother, we donot know anything"). Ask an engineering or an MBA graduate and he would tell you the importance of Google in his degree. In fact it would be appropriate to say that all Engineerign and MBA colleges should on their degrees write in association with Google. Google is like an index to a book. You need to go to this page if you need to go anywhere otherwise you will be lost in the billion page book.

Google has managed itself well over the years and the culture prevalent is one that many would want to work in. But everyone is not so lucky. Well I can go on telling how Google has helped me and people around me. But the point of writing this blog is not to praise Google or anything, but understanding how Google earns its revenues and an understanding of the various terms on its annual reports which is pretty interesting to read btw.

Let us start with the most important thing, everything that Google offers to people like you and me is free of cost so where does it run, how do they generate revenues.
Well it was a question that pestered me quite a lot when i had the sense to understand that companies have to generate revenues themselves to survive, government does not help them. Finally i came to know that Google earns revenues through its adWords Program. Now next question would be do they earn enough through this to sustain themselves. The answer is yes they earn an amazing amount by this method.
To tell you in brief adWords is a program under which advertisers bid for placing their ads on the top, based on the key words entered by the users. These ads are displayed on the Google website when you search for a keyword as sponsored links on the right side. Every time you click on the ad Google gets revenue. Its like you are leasing a part of the Google web page and pay them only when the user clicks on the ads. Now a problem is the user might click accidentally on the ad. Earlier this used to be the case, so the simple solution was make click able only the link and not the whole ad thus preventing the accidental clicks.

The second program is the adSense, this program is used by people like us to earn revenues through our blogs. As an individual you need to get yourself registered on the adSense program and then you can paste the ads on your website. These ads are of two types adSense for Search and adSense for Content. adSense for search is when the website owner uses the Google search on his website customized to his tastes and the website. adSense for content becomes effective on html pages like blogs or articles. Google tries to draw an inference about the type of page and then on the basis of this displays the relevant ads. Now all these websites on which Google places its ads are referred to as Google Network Websites. Now the next logical question is what is the incentive for us to allow Google to place their ads on our websites. Well the logical answer to this logical question is MONEY. Google shares with us the revenues that the advertiser pay Google. The model works like this, if a reader on your website clicks the ads, then a part of the revenue comes to you and a part goes to Google. The portion of the fee that gets payed to the network members is referred to as the traffic acquisition cost or TAC.

99% of the revenues for Google since the past 4 years have been coming through the two programs alone. The remaining 1%comes from its licensing of its search application for enterprise clients.

Cost of revenues comprises of the following costs, money shared with the network members, cost in maintaining the data centers, to partners who put Google toolbars etc for distribution (referred to as Access points), money to those who direct search queries on Google website. It also includes depreciation, labor and bandwidth costs along with credit card and transaction fees.

The Indian Financial Structure

"Banking industry is consolidating and diversifying". The mergers in banks are not like the mergers that take place in companies. In case of companies the two parties decide among themselves whether to go for the merger or not. But in case of Banks it is the RBI that governs which banks should go ahead with the merger. In case of US the government initially there were 1600 banks at the start of the 19th century but now there are more than 13 banks. In India the situations is not like that and there are a large number of banks, the sole reason has been that in India sentiments of hte locals play a huge in rule in decision making on the choice of the bank. People of mysore would prefer to put there money in Bank of Mysore and not Bank of Travancore. Though both belong to State bank but if they are merged then the money might move out to a third bank.

Diversification is in terms of services offered by the bank. Earlier banks used to be places simply for parking your money and borrowing money but over time this outlook is changing and banks are getting into different business lines like underwriting, M&A advisory and trading scrips.

Difference between banks and Non Banking Financial Institutions ?
Both are same apart from the fact that NBFC's are not allowed to issue negotiable instruments like bill of exchange (Cheque's) and promisory notes (notes, cash that we normally have with us)

What are scheduled banks and Non-scheduled banks?
Scheduled banks are those which are mentioned in the schedule II of the Reserve Bank of India(RBI) Act, 1934 [http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/54435.pdf] (Page 54 first two bullets). Scheduled banks must meet two requirements

• Paid up capial must be greater than 5 lakh


• RBI should feel that the banks should not run away with the capital

For a list of the scheduled banks in India refer to the link below
http://finance.indiamart.com/investment_in_india/scheduled_commercial_banks.html

Non-scheduled banks are only 4 in India namely




How are banks in India incorporated ?
Banks in india can be incorporated by three laws
SBI act
Banking regulation act
COmpanies act 1934

SOme of the banks like Kotak Mahindra are incorporated as companies the reason being that getting a license to operate as a bank under the banking regulation act is quite difficult.

TRENDS
During the 19th century there was a credit repression which was being faced by the industry. You could not give the credit freely based on the credentials of the person. The person to whom you would lend was being regulated by the RBI. RBI would make statements like "you would this year lend only to equipment manufacturers". But this has changed now and the banks are free to lend to anyone they deem credit worthy.

Eg.2 Till the 1990's the education loan interest rate was being guided by the RBI. so there was parity in the interest rates given by banks. But as the market got re-regulated RBI now only specifies the upper cap and banks are free to charge what they wish to.

To put in short till the 1990's we were in a regulated financial service market but now it has been re-regulated(do what-ever you feel but up-to a limit not beyond) and deregulated (do whatever you feel like).

The banking sturucture
1st tier
2nd tier
3rd tier

Infrastructure sector

Rising cost put pressures on margins. The construction business is very sensitive to input costs as they comprise around 80% of the total costs. The prices of bitumen, steel, oil and cement have blown through the roofs and have almost doubled in the last couple of years. Due to this the margins will be impacted to a large extent.

One more thing most of the stocks of the construction companies are owned by FII so now they are trying to exit the position thus creating a selling pressure on the stocks.

The raw materials cement and steel make upto 35% of the input cost in case of railways.
The government is planning to modify the way in price escalation clauses are built. Now instead of linking the price rise to WPI indices they have linked the price rise to prices published by the steel authority of India for the steel prices. In the future the same may be expected in order to prevent the contractors from bearing all the price increase pressure.

Too Much Data

There is too much data about a particular listed company and hence there is a need to make sure that the information that your require reaches you correctly and in the manner that you want, you must store it in a proper manner otherwise lots of problem start surfacting when you see that you have not actually done much over data gathering but you remember faint traces of data and hte information that you need. You would feel oh yes i saw this information once but where that is forgotten.

So friends better to be organized while looking at a large amount of data as it helps a lot in the long run and managing things better always gives us that extra advantage that many lack

Hope i also do the justice to the data that i have been entrusted with