SHARE MARKET

A PLACE FOR INVESTMENT

1- INTRODUCTION
2- DECLARATION

CONTENTS
3- TYPES OF SHARES
3.A EQUITY SHARES
3.B PREFERENCE SHARE
3.C DEBENTURE
3.D BONDS

4- REQUIRMENT FOR THE TRADING

5- SELECTION OF SHARES
5.A MEDIA REPORTS
5.B INSIDERS
5.C NEWS PAPERS
5.D INTERNET
5.E EXPERTS

6- BUYING AND SELLING OF SHARES

7- DECISION MAKING
8- FUTURES AND OPTIONS
8.A MEANING OF FUTURES
8.B MEANING OF OPTIONS
8.C INDEX
8.D INDEX FUTURES
8.E INDEX OPTIONS
8.F STOCK FUTURES
8.G STOCK OPTIONS

9- FOREX
9.A WHAT IS FOREX
9.B COMMERCIAL COMPANIES
9.C CENTRAL BANKS
9.D FOREIGN EXCHANGE FIXING
9.E INVESTMENT MANAGEMENT FIRMS
 9.F RETAIL FOREIGN EXCHANGE TRADERS
9.G NON-BANKING FOREIGN EXCHANGE TRADERS
9.H MONEY TRANFER/REMITTANCE COMPANIES

10- DETERMINANTS OF EXCHANGE RATES

10.A INTERATIONAL PARITY CONDITIONS
10.B BALANCE OF PAYMENTS MODEL
10.C ASSET MARKET MODEL
10.D ECONOMIC FACTORS
10.E POLITICAL CONDITIONS
11- FINACIAL INSTRUMENTS
11.A SPOT
11.B FORWARD
11.C NON-DELEVERABLE FORWARD (NDF)
11.D SWAP
11.E FUTURES
11.F OPTIONS
12- TREND ANALYSIS
13- PORTFOLIO MANAGEMENT
13.A PORTFOLIO SIZE
13.B INVESTMENT / SHARE REVIEW
13.C SET TARGET
13.D DIVERSIFY YOUR PORTFOLIO
13.E DONT FALL IN LOVE WITH YOUR SHARES
13.F CUT YOUR LOSSES
13.G BOOK YOUR PROFITS
14- Ration Analysis for Investment
14.A Market value ratios
14.B Earnings Ratio
14.C Gearing Ratios
14.D Debt Service coverage ratios
14.E Profitability Ratios
14.F Liquidity Ratios
14.G Asset Management Ratios
14.H Limitations of Ratio Analysis
 SHARE MARKET

A PLACE FOR INVESTMENT

Introduction
Today people are finding the more ways of making money. There are the various
options available in the market. Like fixed deposits, saving deposits, recurring
deposits, investing in lands etc. In this kind of source of investment, one of the
measure place is share market or stock market. todays generation is being aware
about investment for the future, for the marriage, for the child education, higher
education, medicine expenses, emergencies, tours, and finally for the retirement.

Putting money in one place wont go to be worth full for the owner. It is hundred
times better is investing in the someplace. Today there are various wealth
manager or consulters are available in the market. Who advice to invest the
money at so and so place

When the Investment word comes in the mind. Various options seem for it. And
stock market or share market is a place where investment can be most worth full
with the great rate of returns, with time to time interest/ dividend.

Any wealth manager first advice to invest in mutual funds, equity share,
preference shares, debentures, bonds, and other form of securities, after
analyzing the market strategy, research on market condition, expected rate of
returns, chances of risk, and so on.

Few who dont want to will to take the advice of any expert due to trust issue? So
they can also make the strategies. There are various online sites that can help to
design their portfolio and they also can take the help of news papers, t v
channels, magazines, etc. It is very easy available to each and everyone.

They share their opinions, and you have to only select that with which option you
would like to go with. And all the information related to trade are easily available
at the websites of NSE & BSE. (National stock exchange & Bombay stock
exchange) also. That any investor can go though before investing in this market.

Meaning of stock market

Stock market is a place where shares can be bought and sold at pre-determined
price with the intension of making yield or profit. It is very popular way of
investment in todays age with the help of the brokers. There are many firms
which provide broking services in this field. i.e Share khan, Angle broking,
Jirodha, ICICI Bank, HDFC Bank, and so on.

In India there are two measure stock markets are available. BSE (Bombay stock
exchange) & NSE (national stock exchange)

The details about NSE & BSE are given on next page
 Bombay Stock Exchange (BSE)

Introduction:- Established in 1875, BSE (formerly known as Bombay stock

exchange ltd.), is Asias first & the fastest stock exchange in world with the
speed of 6 micro seconds and one of Indias leading exchange groups.

Over the past 141 years, BSE has facilitated the growth of the Indian corporate
sector by providing it an efficient capital-raising platform. Popularly known as BSE,
the bourse was established as "the native share & stock brokers' association" in
1875.

Today BSE provides an efficient and transparent market for trading in equity,
currencies, debt instruments, derivatives, mutual funds. It also has a platform for
trading in equities of small-and-medium enterprises (SME). India INX, Indias first
international exchange. BSE is also the 1st listed stock exchange of India.

The Bombay Stock Exchange (BSE) is an Indian stock exchange located at dalal
street, kala, Mumbai

(Formerly Bombay), Maharashtra, India.

Established in 1875, the BSE is Asias first stock exchange, it claims to be the
world's fastest stock exchange, with a median trade speed of 6 micro seconds, the
BSE is the world's 11th largest stock exchange with an overall market
capitalization of more than $ 2 trillion as of July, 2017.
More than 5500 companies are publicly listed on the BSE. Of these, as of
November 2016, there are only 7,800 listed companies of which only 4000 trade
on the stock exchanges at BSE and NSE. Hence the stocks trading at the BSE and
NSE account for only about 4% of the Indian economy
 NATIONAL STOCK EXCHANGE (NSE)

Introduction:-The National stock exchange (NSE) is the leading stock

exchange in India and the fourth largest in the world by equity trading volume in
2015, according to world federation of exchanges (WFE).it began operations in
1994 and is ranked as the largest stock exchange in India in terms of total and
average daily turnover for equity shares every year since 1995, based on annual
reports of SEBI.

NSE launched electronic screen-based trading in 1994, derivatives trading (in the
form of index futures) and internet trading in 2000, which were each the first of
its kind in India.

NSE has a fully-integrated business model comprising our exchange listings,

trading services, clearing and settlement services, indices, market data feeds,
technology solutions and financial education offerings. NSE also oversees
compliance by trading and clearing members and listed companies with the rules
and regulations of the exchange.

NSE is a pioneer in technology and ensures the reliability and performance of its
systems through a culture of innovation and investment in technology. NSE
believes that the scale and breadth of its products and services, sustained
leadership positions across multiple asset classes in India and globally enable it to
be highly reactive to market demands and changes and deliver innovation in both
trading
- and non-trading businesses to provide high-quality data and services to market
participants and clients.

Mr. Ashok chawla is the chairman of the board of directors of nse and mr. Vikram
limaye is the managing director and ceo of nse.
 TYPES OF SHARES
In this market there are various types of shares are available in stock market as
per customer choice. Followings are:

Equity shares:- equity shareholders are the real owner of the company. They
gets ownership right after buying the sum of the shares of any particular
company. But there is no security for returns.

if company performed well then they will entitaled to get the devident, but in
case if companys performance is not good so they wont get the devident. It is
very risky capital. But with the risk there is some benefits also. If company
performed acceptionally well. Then these shareholders not

Only get there devident but also , company can issue bonus shares to equity
shareholders.

They are having voting rights in the management of the company. There voting
depend on there number of share held by them.

They are very free so select there representative. The selected representative act
as the bod (board of director) of the company.

Preference Shares:- preference shares are the shares who get some
preferential rights like, they will get fixed rate of returns, after maturity period of
shares, company have to pay them all amount with pre-selected rate of dividend.
And at the winding up of the company, preference share holder will get there full
money invested in the company.
Preference shareholder do not enjoy the voting right in the management of the
company, neither they gets the bonus and nor there interest rate would be higher
in case of company performed extremely well because they are creditors of the
company. They have invested in the company with the intension of fixed rate of
return at a particular date.

Bonds:- Bonds are the security which is generally offered by the government
companies for expansion of owe fund or borrowed fund. Bond holder gets fixed
rate of dividend and at the time of maturity they will get there full money back
with their respective rate of interest. Sometimes its called g-sec. Which means
government security? Due to it is generally issued by the government
organization.

As per the company act 2013, any private company is also able to issue the bond
certificate if they required the capital for movement of the company with its
terms.

Bond holders will not have voting rights in the management due to they are
creditors of the company. But if they are purchasing the Convertible Bonds. So
after a specific period there bond can be converted into equity shares.

At the liquidation of the company bond holder will get there full amount invested
in the organization. As per company rules and regulation.

Investing in bond is one of the safest mode of investment in the company with
low risk and high return as compare to investment in any banks.
Debenture:-Debenture holders are the creditors of the company. They invested
their money in the company in the form of debenture certificate. They enjoys
fixed rate of return either company earn the profit or suffer from the loss. At the
liquidation of company debenture holder first get their money back from the
company. Then company gives to other investors.

So it is the form of securities that can be traded in the national stock exchange or
Bombay stock exchange(NSE & BSE) or any other stock market for the sake of
good rate of returns.

Investing in the debenture lead the good rate of return with the minimum risk
held by debenture holder. But they cant participate in the management of the
company, they dont have voting rights, bonus benefits, etc.

Debenture generally issued by those companies how wants quick capital for the
expansion and diversification of the business. Before issuing debenture Certificate
Company have to issue prospectus of debenture issue. Its decision also taken by
the shareholders of the company at the companys meeting held by company
secretary
 SELECTION OF SHARES
Share selection really a tough thing because anyone dont know about when
share price will start rising and when it will start falling.

For preventing the uncertainties, various kind of analysis are required like
company reports, annual budgets, past balance sheets, technical and
fundamental analysis of the company.

These analyses really help to select right share for investment.

In share selection we require to diversified the portfolio that will help to

minimization of risk, choosing blue chip companies, using method of (buy low
price share), focusing on volume of the price, reverse trend, should not invest in
unlisted shares. Do not invest in the company with the poor industrial relation
track record, and never react on sudden rises and falls

Today we also can gather the data from various sources, such as Media Reports,
Insiders, News papers, Internet, and Experts etc.

Media Reports: - media plays a good role in the decision making by providing
valuable information. And media reports also reliable for the investment. Because
they are very closely connected with the organizations or industries. so that they
can provide accurate data for decision making.
After gathering the data they are analyzing it very well with their expert team.
And then recommending there viewers to choose from them

In India now a days competition are very stiff, so each and every channel using
full effort to provide satisfactory data for gaining there TRP (top rating point) and
proving there loyalty.

NDTV Profit, CNBC India, & Zee Business. Are the good examples of it.

Insiders:- An insider means the people who is already working in the company.
They having sufficient information regarding the company and their future steps.
But as per the standard report, information from insiders are not good. It is the
breach of trust. It can be false also an investor may suffer from huge loss.

News papers & Magazines:- News papers are writing various articles
over company information. That can be trusted by the people around the world.
Today leading papers are Economic Times, Dalal street investment journal,
Forbes India magazine etc.
Internet:- Internet is the great platform for the information regarding the
details of the companies. Which are easy accessable and realible. All companies
itself uploads the valuable information. I.e annual genral meeting, bonus issue, or
expansion and diversification of the company.

so internet is the great platform for the information for the new comers or the
expert ones also. Internet is very reliable place in the matter of trust. Because
there are lots of options are available that we can compare with each others and
select our desired one.

Various online sites are there for the investment strategies are available on the
web with easy accessible for everyone.

Buying and Selling Of Shares

According to the experts, the best time of buying shares is when its price is fall
down because every expert believes that market goes up for went down and
went down for goes up

After falling in the price and a limit of falling when price get stable it may be the
best time for buy or invest in the share market.

But as per experts there is no real value to confirm that market will stop falling
after this limit or previous years downturn. So invest when price become stable
and seems that rpice can be move up from now. For selling time same logic is
there. if price get so its time to sell the shares and earn some profit.

As this picture is showing that buy margin and sell margin. Buying at lower and
selling at higher and the difference between amounts will be profit of investor.
But make sure and research properly due to market can be fall down any time.
 DECISION MAKING

There is few scenarios of investment in share market.

Mr. Anil is a young man age 23. He is able to save his salary around 15000 INR per
month. After 5 year he is planning to get marriage. So what will be the best option
of investment?

Mr. Akash is a salaried employee. He has two children studing in 5 & 7 standards.
He is planning to send them abroad for study. His income is around 2,00,000 he is
able to save 50% of it. What will be the best option for him?

Mr. Anish is a manager is a private company. His salary is 34000 inr. He is able to
save his salary around 12000 per month. He needs to save money for his
doughters marriage with in 5 years what will be the best senerio of investment
for him?

There are three different person with three different risk barring capacity. We
need to guide them about the best way for investment.

So here are the follows.

Mr. Anil is a young and he have less pressure of responsibility. And after 5 years
he want to do marriage. So Mr. Anil is able to take risk.

He should invest his 30% in blue chip shares, that he will be safe there. And rest of
40% he can invest in newly or rapidly developing company. If and 20 % of amount
he can invest in mutual fund. And remain 10% he may go for fixed deposits.

Mr. Akash have enough time for planning and investment for there children for
studing in abroad. So they should go for 40% investment in blue chip companies.
That they can make a safe shelter. And 35 % in any emerging companies. And
remain 25% he can go in mutual fund or fixed deposite.

Mr. Anish required money for his daughters marriage after 5 years. It is a
sensitive case for. Mr anish should go for 50% in blue chip companies. That can
make sure there money wont be sink. Other 30% he can invest in mutual fund or
any bonds or debentures. And rest 20% he can take the risk for investing any
emerging companies.
 Other Ways of Selecting Market Leaders

One make money on the stock exchange not by following in crowd, but by
spotting budding market leaders at an early statge and then betting on them.

Radhu palat in his book shares for investment and wealth described. His
colleague was renovating his house and his contractor suggested that he tile his
house with a certain band. These tiles had been introduced only a little while
earlier. He liked it and used it. during the next few months, he came across many
establishments (hotels, houses, and offices) that has the same tiles. Believing that
his company had a good product and a good future, he bought shares in the
company. He has never regretted it and has seen his original investment
appreciate several times. He was lucky and shrewd to identify budding market
leaders. This was by chance. There was other ways one can identify them.

Futures And Options

Meaning Of Futures:- A futures exchange or futures market is a central financial

exchange where people can trade standardized futures contracts; that is, a
contract to buy specific quantities of a commodity or financial instrument at a
specified price with delivery set at a specified time in the future. These types of
contracts fall into the category of derivatives. The opposite of the futures
market is the spots market, where trades will occur immediately (2 business days)
after a transaction agreement has been made, rather than at a predetermined
time in the future. Futures instruments are priced according to the movement of
the underlying asset (stock, physical commodity, index, etc.). The aforementioned
category is named "derivatives" because the value of these instruments
are derived from another asset class.
Meaning of Options: An option is a financial derivative that represents a contract
sold by one party (the option writer) to another party (the option holder). The
contract offers the buyer the right, but not the obligation, to buy (call) or sell (put)
a security or other financial asset at an agreed-upon price (the strike price) during
a certain period of time or on a specific date (exercise date)

Options are extremely versatile securities. Traders use options to speculate,

which is a relatively risky practice, while hedgers use options to reduce the risk of
holding an asset. In terms of speculation, option buyers and writers have
conflicting views regarding the outlook on the performance of an underlying
security.

Index

The market is represented by an index. An index is made up of various shares

from different sectors that trade in a market. Each share has a certain weightage
in the index and depending on the movement of these stocks, the index goes up
or down. These are the several indexes, the most popular being Bombay Stock
Exchange Sensitivity Index Known as Sensex.

Index Futures

An index future is a contract entered into on the future of the index. There is no
underlying security that has to be delivered to fulfil the terms of the contract.
These are settled in cash.

Let us assume the Sensex is 25000. You believe that the index will rise futher. You
enter into a contract to buy 100 units.the initial margin is 10%. The investment
made therefore be INR 2,50,000.

Every buyer need a seller. Let us assume that Mr Ram believes that the amount.
He would also pay a margin of 10% i.e INR 25,000.
Everyday the index future is market to market. This means that if the price falls,
the purchaser has to pay the difference in the margin money to the broker who in
turn passes it on the seller.

If on the last day the Sensex is 27,000, the buyer would receive the deposit of
2,50,000 plus the increase (27,000 less 25,000) multiplied by the number of units
purchased.

If however, the index has fallen, then the person would have to bear the loss.

Index Options

Index options give the right but not obligation to buy or sell the index at future
date. These are also cash settled. Generally these are European style. This means
that right can be exercised only on the expiration date. The indices for the index
options are those that are permitted by the exchange.

Stock Futures

A stock future is a contract to buy or sell a specific stock at a future date at an

agreed price. Single stock futures are cash settled.

It must be remembered that when you buy a share, you pay the market price of
the share ( and the commission to the broker) and become the part of the owner
of the company.

When you buy a future contract, you enter into the contract. No money is paid
other that the commission to the broker. You will also need to pay a certain
amount of margin (around 10%) as good faith to cover possible losses. If the
margin call in short met, the broker has to right to liquidate your position.
The benefit of entering into a future contract is leverage the ability to purchase
more. Let us assume you have INR 1,00,000. The shares of Nivya Ltd. are trading
at 200 each. If you buy the shares outright, you will be able to purchase 500
shares. If the margin of share is 50%, you will be able to purchase 1000 shares. If
the price rises by 10% your profit if you had entered into a futures contract would
be INR 20,000. On other hand, if you had purchased outright, the profit made
would be only INR 10,000

Stock Options

Stock options are options contracts where the underlyings are individual stocks.
These contracts are usually cash settled and are American style. This means that
the options can be excised on or before the expiration date.

If an investor believes the price will rise, hed buy a call option. On the other
hand, if it is believed the price will fall, a put option would be purchased. The
premium or discount for each option reflects what the market feels.

Forex Market

The foreign exchange market is the "place" where currencies are traded.
Currencies are important to most people around the world, whether they realize
it or not, because currencies need to be exchanged in order to conduct foreign
trade and business. If you are living in the U.S. and want to buy cheese
from France, either you or the company that you buy the cheese from has to pay
the French for the cheese in Euros (EUR). This means that the U.S. importer would
have to exchange the equivalent value of U.S. dollars (USD) into euros. The same
goes for traveling. A French tourist in Egypt can't pay in euros to see the pyramids
because it's not the locally accepted currency. As such, the tourist has to
exchange the Euros for the local currency, in this case the Egyptian pound, at the
current exchange rate.
The need to exchange currencies is the primary reason why the forex market is
the largest, most liquid financial market in the world. It dwarfs other markets in
size, even the stock market, with an average traded value of around U.S. $2,000
billion per day. (The total volume changes all the time, but as of August 2012,
the Bank for International Settlements (BIS) reported that the forex market
traded in excess of U.S. $4.9 trillion per day.)

One unique aspect of this international market is that there is no central

marketplace for foreign exchange. Rather, currency trading is conducted
electronically over-the-counter (OTC), which means that all transactions occur via
computer networks between traders around the world, rather than on one
centralized exchange.

The market is open 24 hours a day, five and a half days a week, and currencies are
traded worldwide in the major financial centers of London, New York, Tokyo,
Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney - across almost every
time zone. This means that when the trading day in the U.S. ends, the forex
market begins anew in Tokyo and Hong Kong. As such, the forex market can be
extremely active any time of the day, with price quotes changing constantly.

Commercial companies

An important part of the foreign exchange market comes from the financial
activities of companies seeking foreign exchange to pay for goods or services.
Commercial companies often trade fairly small amounts compared to those of
banks or speculators, and their trades often have little short-term impact on
market rates. Nevertheless, trade flows are an important factor in the long-term
direction of a currency's exchange rate. Some multinational corporations (MNCs)
can have an unpredictable impact when very large positions are covered due to
exposures that are not widely known by other market participants.

Central banks

National central banks play an important role in the foreign exchange markets.
They try to control the money supply, inflation, and/or interest rates and often
have official or unofficial target rates for their currencies.

They can use their often substantial foreign exchange reserves to stabilize the
market. Nevertheless, the effectiveness of central bank "stabilizing speculation" is
doubtful because central banks do not go bankrupt if they make large losses, like
other traders would. There is also no convincing evidence that they actually make
a profit from trading.

Foreign exchange fixing

Foreign exchange fixing is the daily monetary exchange rate fixed by the national
bank of each country. The idea is that central banks use the fixing time and
exchange rate to evaluate the behavior of their currency. Fixing exchange rates
reflect the real value of equilibrium in the market. Banks, dealers and traders use
fixing rates as a market trend indicator.

The mere expectation or rumor of a central bank foreign exchange intervention

might be enough to stabilize a currency. However, aggressive intervention might
be used several times each year in countries with a dirty float currency regime.
Central banks do not always achieve their objectives. The combined resources of
the market can easily overwhelm any central bank. Several scenarios of this
nature were seen in the 199293 European Exchange Rate Mechanism collapse,
and in more recent times in Asia.

Investment Management Firms

Investment management firms (who typically manage large accounts on behalf of

customers such as pension funds and endowments) use the foreign exchange
market to facilitate transactions in foreign securities. For example, an investment
manager bearing an international equity portfolio needs to purchase and sell
several pairs of foreign currencies to pay for foreign securities purchases.
Some investment management firms also have more speculative
specialist currency overlay operations, which manage clients' currency exposures
with the aim of generating profits as well as limiting risk. While the number of this
type of specialist firms is quite small, many have a large value of assets under
management and can therefore generate large trades.

Retail Foreign Exchange Traders

Individual retail speculative traders constitute a growing segment of this market

with the advent of retail foreign exchange trading, both in size and importance.
Currently, they participate indirectly through brokers or banks. Retail brokers,
while largely controlled and regulated in the USA by the Commodity Futures
Trading Commission and National Futures Association, have previously been
subjected to periodic foreign exchange fraud. To deal with the issue, in 2010 the
NFA required its members that deal in the Forex markets to register as such (I.e.,
Forex CTA instead of a CTA).

Those NFA members that would traditionally be subject to minimum net capital
requirements, FCMs and IBs, are subject to greater minimum net capital
requirements if they deal in Forex. A number of the foreign exchange brokers
operate from the UK under Financial Services Authority
regulations where foreign exchange trading using margin is part of the wider
over-the-counter derivatives trading industry that includes contracts for
difference and financial spread betting.

There are two main types of retail FX brokers offering the opportunity for
speculative currency trading: brokers and dealers or market makers. Brokers serve
as an agent of the customer in the broader FX market, by seeking the best price in
the market for a retail order and dealing on behalf of the retail customer. They
charge a commission or "mark-up" in addition to the price obtained in the
market. Dealers or market makers, by contrast, typically act as principals in the
transaction versus the retail customer, and quote a price they are willing to deal
at.

Non-bank foreign exchange companies

Non-bank foreign exchange companies offer currency exchange and international

payments to private individuals and companies. These are also known as "foreign
exchange brokers" but are distinct in that they do not offer speculative trading
but rather currency exchange with payments (i.e., there is usually a physical
delivery of currency to a bank account).
It is estimated that in the UK, 14% of currency transfers/payments are made via
Foreign Exchange Companies. These companies' selling point is usually that they
will offer better exchange rates or cheaper payments than the customer's bank.
These companies differ from Money Transfer/Remittance Companies in that they
generally offer higher-value services. The volume of transactions done through
Foreign Exchange Companies in India amounts to about USD 2 billion per day This
does not compete favorably with any well developed foreign exchange market of
international repute, but with the entry of online Foreign Exchange Companies
the market is steadily growing . Around 25% of currency transfers/payments
in India are made via non-bank Foreign Exchange Companies. Most of these
companies use the USP of better exchange rates than the banks. They are
regulated by FEDAI and any transaction in foreign Exchange is governed by
the Foreign Exchange Management Act, 1999 (FEMA).

Money transfer/remittance companies

Money transfer companies/remittance companies perform high-volume low-

value transfers generally by economic migrants back to their home country. In
2007, the Aite Group estimated that there were $369 billion of remittances (an
increase of 8% on the previous year). The four largest markets
(India, China, Mexico and the Philippines) receive $95 billion. The largest and best
known provider is Western Union with 345,000 agents globally, followed by UAE
Exchange Bureaux de change or currency transfer companies provide low value
foreign exchange services for travelers. These are typically located at airports and
stations or at tourist locations and allow physical notes to be exchanged from one
currency to another. They access the foreign exchange markets via banks or non
bank foreign exchange companies.

Determinants of Exchange Rates

The following theories explain the fluctuations in exchange rates in

a floating exchange rate regime (In a fixed exchange rate regime, rates are
decided by its government)
International Parity Conditions

Relative purchasing power parity, interest rate parity, Domestic Fisher effect,
International Fisher effect. Though to some extent the above theories provide
logical explanation for the fluctuations in exchange rates, yet these theories falter
as they are based on challengeable assumptions [e.g., free flow of goods, services
and capital] which seldom hold true in the real world.

Balance of Payments Model

This model, however, focuses largely on tradable goods and services, ignoring the
increasing role of global capital flows. It failed to provide any explanation for the
continuous appreciation of the US dollar during the 1980s and most of the 1990s,
despite the soaring US current account deficit.

Asset Market Model

Views currencies as an important asset class for constructing investment

portfolios. Asset prices are influenced mostly by people's willingness to hold the
existing quantities of assets, which in turn depends on their expectations on the
future worth of these assets. The asset market model of exchange rate
determination states that the exchange rate between two currencies represents
the price that just balances the relative supplies of, and demand for, assets
denominated in those currencies.

Economic Factors

Economic policy comprises government fiscal policy (budget/spending practices)

and monetary policy (the means by which a government's central bank influences
the supply and "cost" of money, which is reflected by the level of interest rates).
Government budget deficits or surpluses: The market usually reacts negatively to
widening government budget deficits, and positively to narrowing budget deficits.
The impact is reflected in the value of a country's currency.

Balance of trade levels and trends: The trade flow between countries illustrates
the demand for goods and services, which in turn indicates demand for a
country's currency to conduct trade. Surpluses and deficits in trade of goods and
services reflect the competitiveness of a nation's economy. For example, trade
deficits may have a negative impact on a nation's currency.

Political conditions

Internal, regional, and international political conditions and events can have a
profound effect on currency markets.
All exchange rates are susceptible to political instability and anticipations about
the new ruling party. Political upheaval and instability can have a negative impact
on a nation's economy. For example, destabilization of coalition
governments in Pakistan and Thailand can negatively affect the value of their
currencies. Similarly, in a country experiencing financial difficulties, the rise of a
political faction that is perceived to be fiscally responsible can have the opposite
effect. Also, events in one country in a region may spur positive/negative interest
in a neighboring country and, in the process, affect its currency.

Financial Instruments

Spot

A spot transaction is a two-day delivery transaction (except in the case of trades

between the US dollar, Canadian dollar, Turkish lira, euro and Russian ruble,
which settle the next business day), as opposed to the futures contracts, which
are usually three months. This trade represents a direct exchange between two
currencies, has the shortest time frame, involves cash rather than a contract, and
interest is not included in the agreed-upon transaction. Spot trading is one of the
most common types of Forex Trading. Often, a forex broker will charge a small fee
to the client to roll-over the expiring transaction into a new identical transaction
for a continuation of the trade. This roll-over fee is known as the "Swap" fee.

Forward

One way to deal with the foreign exchange risk is to engage in a forward
transaction. In this transaction, money does not actually change hands until some
agreed upon future date. A buyer and seller agree on an exchange rate for any
date in the future, and the transaction occurs on that date, regardless of what the
market rates are then. The duration of the trade can be one day, a few days,
months or years. Usually the date is decided by both parties. Then the forward
contract is negotiated and agreed upon by both parties.

Non-deliverable forward (NDF)

Forex banks, ECNs, and prime brokers offer NDF contracts, which are derivatives
that have no real deliver-ability. NDFs are popular for currencies with restrictions
such as the Argentinean peso. In fact, a Forex hedger can only hedge such risks
with NDFs, as currencies such as the Argentinean Peso cannot be traded on open
markets like major currencies.
Swap
The most common type of forward transaction is the foreign exchange swap. In a
swap, two parties exchange currencies for a certain length of time and agree to
reverse the transaction at a later date. These are not standardized contracts and
are not traded through an exchange. A deposit is often required in order to hold
the position open until the transaction is completed.

Futures
Futures are standardized forward contracts and are usually traded on an
exchange created for this purpose. The average contract length is roughly 3
months. Futures contracts are usually inclusive of any interest amounts.
Currency futures contracts are contracts specifying a standard volume of a
particular currency to be exchanged on a specific settlement date. Thus the
currency futures contracts are similar to forward contracts in terms of their
obligation, but differ from forward contracts in the way they are traded.
They are commonly used by MNCs to hedge their currency positions. In addition
they are traded by speculators who hope to capitalize on their expectations of
exchange rate movements.

Option
A foreign exchange option (commonly shortened to just FX option) is a derivative
where the owner has the right but not the obligation to exchange money
denominated in one currency into another currency at a pre-agreed exchange
rate on a specified date. The FX options market is the deepest, largest and most
liquid market for options of any kind in the world.

Trend Analysis
Trends of the prices of shares cab be plotted to determine whether a share is on
an uptrend or a downtrend. These trends plotting are useful in determining
whether one should purchase or sell the share.

So, how does it work?

In the bullish period, when prices are rising, the price trend will be similar to the
figure mentioned as bellow
The price dips and rises but the trend is ascending. These uptrend lines connect
two or more interim low prices with a straight line.

A Price Uptrend

On the other hand, in a bearish phase the price trend will show a definite decline.
A downtrend line connects two or more peaks in a downward direction.

The secondary movements which reverse the direction of an uptrend are called
reactions and movement that reverse the direction of a downtrend are called
rallies.

Figure of price downtrend line is mentioned bellow.

A Price Downtrend
There may be situations when although prices may rise, they return to their
original price. These are known as horizontal trend lines.

Figure of horizontal trend line is mentioned bellow.

A Horizontal Trend Line

If share prices follow a particular direction for a period of time, a channel gets
established. A channel requires two trend lines drawn share price stays within its
channel. The Dow Theory holds that course or some time. Thus, prices are
expected to stay bellow downtrend lines, and Vice Versa. Additionally, these lines
define support and resistance levels.

If trend lines are broken, it is assumed a new trend has started. Trend lines are
very useful in making decisions:

1- They indicate the trend of share prices. Thus, share should only be brought
only when there is an uptrend.

2- Trend lines suggest when a share should be brought or sold. An investor

who holds a share would tell another to sell just below an uptrend line.
Similarly, he would buy when shares break upward from a downtrend line.

However, although they give indications, trend lines are not absolute guide and
should not be taken as gospel. There could be other forces that might confuse
trends. A trend line should be taken for what it is an indication and not a
certainly. As an investor or an analyst, what one should try and indentify is a
change in trend. This is what will enable one to make a decision.

The general price patterns that emerge have been named as detailed below

Portfolio Management

Shares are not purchased with the sole intension of selling them promptly at a
profit. They are assets that yield a return both in the income and the capital
appreciation and consequently are assets that can be used for savings and
enhance ones net worth. Additionally, as one saves, the savings need to be
parked somewhere profitably. There is a limit to the number of houses or
apartments one can buy. Fixed Deposits with the banks and other institutions are
not particularly remunerative. Shares, on the other hand, appreciate at a rate
exceeding the rate of inflation, often many times more. Also, ones share
investment, specially in good blue chip companies, is fairly safe. Earlier this blue
chip companies were controlled by the Tatas & Birlas, large business houses or
multinationals. The suggestion now is to look at the NIFTY 50 as the fastest shares
as they are reputed companies and large. These companies reward shareholders
consistently though conservatively.

Anyone who purchases shares will, in time, end up with a portfolio. One may have
a 100 shares each in 300 companies or just 5,000 shares each in 5 companies or
just 200 shares each in 10 companies. The value of ones portfolio may be
I,00,000 or 10,00,000 or even 100,00,000 INR. Irrespective of whether the
portfolio is small or large, it must be managed if it is to grow effectively. It must
be fit and lean, with no fat. The weeds must be taken out periodically. Otherwise,
the growth in the portfolios value would be sluggish out its yield less that
satisfactory. Hence, it is important that one should properly manage ones
portfolio in order to maximize returns.

Portfolio Size
The shares one chooses to buy would always be based on ones natural bent. Of
one is conservative blue chips would be purchased and held for a long period of
time. On the other hand, the speculative investor would purchase volatile shares
in the hope of quick profit. Be that as it may, it is important to limit the number
on companies whose share one has. The reason for this is simple. It one has to
shares in 400 companies. It will be incredibly difficult to keep track of company
results, dividend payments, etc. unless the course one is a professional
investment manager. Even then it would take up ridiculously long period of time.
The average investor does not have such time. The investor has a hurried 45
minutes in morning and an hour in evening. In this time it is not possible to keep
abreast of the happenings of and information on more than 20 to 25 companies,
it that.

How many companies should you invest in? what should be size of your
portfolio? To answer this question you should determine that how many
companies you can review periodically. If you believe you can review 40
companies, then you should invest in not more than 40 companies. If, on the
other hand. If you feel you can review only 20 companies, then you should not
invest more than 20 companies. The point is, you should be clear in how many
companies you can meaningfully review and you should not hold shares in more
than that. This also never exceeding the limit that youve set yourself. Let us
assume you feel you can review 25 companies and you hold shares in 25
companies. If you buy the shares yet of another company. It is imperative that
you sell the share of a company that you hold in order to get back to your figure
25. By doing this one will control ones portfolio and be able to give each
investment personalized attention. You will know which company is doing better
and which is not. If a company is doing badly you will be able to get rid of it before
the price crashes and if a company is doing well you will watch to purchase more
hare. Thus, as an investor, you will be forever ahead.

Investment / Share Review

It is important to review your investments regularly. Failure to do so can lead to

losses.
In reviewing your investments you should check the performance of your shares
against a target that you have set and its performance within the industry or as
the market average. This review should be done at least once in a quarter after
the review shares that not performed should be sold and new target should be
laid down.

It must however, be remembered that it may not be prudent in certain conditions

to sell your investment just because targets laid down have not been met in one
quarter. If you reviewed targets set in May 2006 (when the market crushed) you
may have ended up selling all your shares. That would have been both
inappropriate and unwise. One must review performance realistically taking into
account the political and economic environment.

Apart from a chart one should also review investments on a daily basis. This will
give one an opportunity to be familiar with price movement over a period of time
and will enable one to take prompt buy or sell action.

Such a daily review not takes much time. After determining what the closing
prices were, there should be written down preferably on columnar paper. If
possible, the price should also be plotted on graph paper. This will give a physical
representation of prices over a period of time and can assist one in evolving an
investment strategy. Graphs can be improved by superimposing monthly average
price of the shares and the daily highs and lows. This does not now require much
work as such computerized charts are easily available on the internet, etc.

Set Targets

Shares are not held for sentimental reasons. They are held for income and for
profit. Consequently on purchasing a share should set a price target for each
share. The target will naturally vary according to the types of share purchased. If
the share is speculative, the targeted growth and expansion may be high as 50%.
On the other hand, if it is a conservative share you may target growth of only
10%. The target should be for a specific period of time such as 3 months, 6
months, or a year, and the performance must be examined at the end of that
period. As was stated in earlier section, if the target has not been met or of the
possibility exists of it not being met he share should be sold. One the other hand,
if the target has been met, a decision should be taken whether to continue
holding it or not. If the decision is to hold the share, then new targets should be
set.

While reviewing performance against targets consideration must be made for

extremes. In a bull phase shares may double whereas in a bear phase the
opposite may happen. Therefore, some adjustment should be made for such
happenings.

Diversify Your Portfolio

A diversified portfolio ensures that one is cushioned against a downturn in an

industry. It is very risky placing all ones money in one company or in one industry
since a downturn can wipe out the value of the portfolio.
In short, by diversifying ones portfolio one is able to hedge industry recession. It
is rare for all industries to be doing badly at the same time. The shares held in one
company may go down on account of various factors but then the shares held in
others may increase in price, thus neutralizing the effect of a slump in an industry
that beats shares prices down. There could be other extraneous factors such as a
large tax demand.

One should, therefore, not invest in just one company or industry. The questions
that logically arise then are how much can be invested. There is no hard and fast
dictum on this. It will depend on ones ability to take risk, ones nature and the
like. As a thumb rule in my personal opinion one should:

1. Limit ones investment in any single industry to around 15%.

2. Limit ones investment in a single company to 10%.

This will ensure a reasonable speared.

Dont Fall In Love with Your Shares

A share is a commodity that one buys for gain, gain in the form of income and
capital appreciation and it should be treated exactly like that. One should not fall
in love with a share and hold it because the name is melodious or the chairman is
a celebrity. These are wrong reasons for holdings a share and will lead only to
unhappiness and losses.

Cut Your Losses

One purchases share to make money or to receive income or as a hedge against

inflation or for some other similar reason. As an investment, shares must be
closely watched and if there is a possibility (however remote that may be) that
prices are likely to fall and keep one falling, it will be proper to sell them
immediately even if it is at a loss. This is to save oneself from greater loss at a
future time.

Book Your Profits

Until you have actually booked your profits, you have not made a profit. Profits
are meaningless. They are here today and gone tomorrow. The question that rally
arises is, what should one do? As a general rule, irrespective of the price the share
will subsequently attain, one should sell 20% of ones holding as soon as the price
reaches 20% above his purchased price. He should offload another 30% when the
price reaches 40% above his purchase price. In this way he reduces his take and
maintaining as interest.

A bird in hand is worth two in the bush.

A person early 2015 bought 1,000 shares of XYZ Ltd. at 219 INR per share. The
price rose rapidly to 423 INR. The person patted himself on being a tremendous
picker of shares. On an investment of 19,000 INR he had in a few months made a
profit nearly 60%. But he did nothing about it. The market worsened. Orders
ceased and the company collapsed. The person how not fully recovered from the
episode. What should he have done? He should have, when the price reached 423
INR. Offloaded the shares

Example

Mr. Sharma purchased 1,000 shares of Expandex Ltd. at 20 INR per share on 5
January 2015.
On 2 March 2015 the price was 24.50 INR per share.

At this price he sold 200 shares

On 23 May 2015 the price was 28 INR per share. At this price he sold 300 shares.

INR

5 January 2015 purchased of 1,000 shares 20,000

2 March 2015 sale of 200 shares 4,900

15,100

23 May 2015 sale of 300 shares 8,400

6,700

The value of 500 shares in now 6,700 or 13.40 INR a share which is a much
reduced price from the original 20 INR per share.

On 18 June 2015 the price reached 31 INR per share. Mr. Sharma sold a further
200 shares and received a cheque for 6,200 INR.

Ration Analysis for Investment

Market Value Ratios

A valuation ratio used by investors which compares a stock's per-share price
(market value) to its book value (shareholders' equity). The price-to-book value
ratio, expressed as a multiple (i.e. how many times a company's stock is trading
per share compared to the company's book value per share), is an indication of
how much shareholders are paying for the net assets of a company.

The book value of a company is the value of a company's assets expressed on the
balance sheet. It is the difference between the balance sheet assets and balance
sheet liabilities and is an estimation of the value if it were to be liquidated.

The price/book value ratio, often expressed simply as "price-to-book", provides

investors a way to compare the market value, or what they are paying for each
share, to a conservative measure of the value of the firm.

Formula:

Components:

The dollar amount in the numerator, $67.44, is the closing stock price for Zimmer
Holdings as of December 30, 2005, as reported in the financial press or over the
Internet in online quotes. In the denominator, the book value per share is
calculated by dividing the reported shareholders' equity (balance sheet) by the
number of common shares outstanding (balance sheet) to obtain the $18.90 book
value per-share figure. By simply dividing, the equation gives us the price/book
value ratio indicating that, as of Zimmer Holdings' 2005 fiscal yearend, its stock
was trading at 3.6-times the company's book value of $18.90 per share.
Price-Earnings Ratio - P/E Ratio

The price-earnings ratio (P/E ratio) is the ratio for valuing a company that
measures its current share price relative to its per-share earnings. The price-
earnings ratio is also sometimes known as the price multiple or the
earnings multiple.

The P/E ratio can be calculated as:

Market Value per Share / Earnings per Share

For example, suppose that a company is currently trading at $43 a share and
its earnings over the last 12 months were $1.95 per share. The P/E ratio for the
stock could then be calculated as 43/1.95, or 22.05.

EPS is most often derived from the last four quarters. This form of the price-
earnings ratio is called trailing P/E, which may be calculated by subtracting a
companys share value at the beginning of the 12-month period from its value at
the periods end, adjusting for stock splits if there have been any. Sometimes,
price-earnings can also be taken from analysts estimates of earnings expected
during the next four quarters. This form of price-earnings is also called projected
or forward P/E. A third, less common variation uses the sum of the last two actual
quarters and the estimates of the next two quarters.

Gearing Ratio

A gearing ratio is a general classification describing a financial ratio that compares

some form of owner's equity (or capital) to funds borrowed by the
company. Gearing is a measurement of the entitys financial leverage, which
demonstrates the degree to which a firm's activities are funded by owner's funds
versus creditor's funds.

Degree of Leverage

Higher calculations of a gearing ratio indicate a company has higher degree of

leverage and is more susceptible to downturns in the economy and in
the business cycle. This is because companies that have higher leverage have
higher amounts of debt when compared to owners equity. Therefore, entities
with high gearing ratio findings have higher amounts of debt to service.
Companies with lower gearing ratio calculations have more equity to rely upon as
financing is needed.

Gearing Ratio Evaluation

Gearing ratios are most beneficial to companies when used as a tool for
comparison. As a standalone calculation, a gearing ratio may not hold any weight
or meaning. For example, a company may have a debt ratio of 0.6. Although this
figure alone provides some information as to the companys financial structure, it
is more meaningful to benchmark this figure against another. For instance, the
company had a debt ratio last year of 0.3, the industry average is 0.8 and the
companys main competitor has a debt ratio of 0.9. More information is derived
through the use of comparing gearing ratios to each other.

Users of Gearing Ratios

Gearing ratios are useful for both internal and external parties. Financial
institutions utilize gearing ratio calculations in preparation of issuing loans. In
addition, loan agreements may require companies to operate with specified
guidelines regarding acceptable gearing ratio calculations. Alternatively, internal
management utilizes gearing ratios to analyze future cash flows and leverage.

Gearing Ratio Tendencies

A high gearing ratio typically indicates a high degree of leverage. This does not
indicate a company is in poor financial condition. Instead, a company with a high
gearing ratio has a riskier financing structure than a company with a lower gearing
ratio. Regulated entities typically have higher gearing ratios, as they are able to
operate with higher levels of debt. In addition, companies in monopolistic
situations often operate with higher gearing ratios, as their strategic marketing
position puts them at a lower risk of default. Finally, industries that utilize
expensive fixed assets typically have higher gearing ratios, as these fixed assets
typically are financed with debt.

Debt-Service Coverage Ratio (DSCR)

In corporate finance, the Debt-Service Coverage Ratio (DSCR) is a measure of

the cash flow available to pay current debt obligations. The ratio states net
operating income as a multiple of debt obligations due within one year,
including interest, principal, sinking-fund and lease payments.

In government finance, it is the amount of export earnings needed to meet

annual interest and principal payments on a country's external debts.

In personal finance, it is a ratio used by bank loan officers to determine income

property loans.

A DSCR greater than 1 means the entity whether a person, company or

government has sufficient income to pay its current debt obligations. A
DSCR less than 1 means it does not.

In general, it is calculated by:

DSCR = Net Operating Income / Total Debt Service

A DSCR of less than 1 means negative cash flow. A DSCR of .95 means that there is
only enough net operating income to cover 95% of annual debt payments. For
example, in the context of personal finance, this would mean that the borrower
would have to delve into his or her personal funds every month to keep the
project afloat. In general, lenders frown on a negative cash flow, but some allow it
if the borrower has strong outside income.

Net operating income is a company's revenue minus its operating expenses, not
including taxes and interest payments. It is often considered equivalent
to earnings before interest and tax (EBIT). Some calculations include non-
operating income in EBIT, however, which is never the case for net operating
income. As a lender or investor comparing different companies' credit-worthiness
or a manager comparing different years' or quarters' it is important to apply
consistent criteria when calculating DSCR. As a borrower, it is important to realize
that lenders may calculate DSCR in slightly different ways.

Total debt service refers to current debt obligations, meaning

any interest, principal, sinking-fund and lease payments that are due in the
coming year. On a balance sheet, this will include short-term debt and the current
portion of long-term debt.

Income taxes complicate DSCR calculations, because interest payments are

tax deductible, while principle repayments are not. A more accurate way to
calculate total debt service is therefore:

Interest + (Principle / [1 - Tax Rate])

Lenders will routinely assess a borrower's DSCR before making a loan. If the
ratio is less than 1, the borrower is unable to pay current debt obligations without
drawing on outside sourceswithout, in essence, borrowing more. If it is too
close to 1, say 1.1, the entity is vulnerable, and a minor decline in cash flow could
make it unable to service its debt. Lenders may in some cases require that the
borrower maintain a certain minimum DSCR while the loan is outstanding. Some
agreements will consider a borrower who falls below that minimum to be
in default.

The minimum DSCR a lender will demand can depend on macroeconomic

conditions. If the economy is growing, credit is more readily available, and lenders
may be more forgiving of lower ratios. A broad tendency to lend to less-qualified
borrowers can in turn affect the economy's stability, however, as happened
leading up to the 2008 financial crisis. Subprime borrowers were able to obtain
credit, especially mortgages, with little scrutiny. When these borrowers began to
default en masse, the financial institutions that had financed them collapsed.
Profitability Ratios

Profitability ratios are a class of financial metrics that are used to assess a
business's ability to generate earnings compared to its expenses and
other relevant costs incurred during a specific period of time. For most of these
ratios, having a higher value relative to a competitor's ratio or relative to the
same ratio from a previous period indicates that the company is doing well.

Some industries experience seasonality in their operations. The retail industry, for
example, typically experiences higher revenues and earnings for the Christmas
season. It would not be useful to compare a retailer's fourth-quarter profit
margin with its first-quarter profit margin. Comparing a retailer's fourth-quarter
profit margin with the profit margin from the same period a year before would be
far more informative.

Some examples of profitability ratios are profit margin, return on assets (ROA)
and return on equity (ROE). Profitability ratios are the most popular metrics used
in financial analysis. Read the short guide on Profitability Indicator Ratios:
Introduction.

Profit Margins

Different profit margins are used to measure a company's profitability at various

cost levels, including gross margin, operating margin, pretax margin and net profit
margin. The margins shrink as layers of additional costs are taken into
consideration, such as cost of goods sold (COGS), operating and non-operating
expenses, and taxes paid. Gross margin measures how much a company can mark
up sales above COGS. Operating margin is the percentage of sales left after
covering additional operating expense. The pretax margin shows a company's
profitability after further accounting for non-operating expense. Net profit margin
concerns a company's ability to generate earnings after taxes.
Return on Assets

Profitability is assessed relative to costs and expenses, and it is analyzed in

comparison to assets to see how effective a company is in deploying assets to
generate sales and eventually profits. The term return in the ROA ratio
customarily refers to net profit or net income, the amount of earnings from sales
after all costs, expenses and taxes. The more assets a company has amassed, the
more sales and potentially more profits the company may generate. As
economies of scale help lower costs and improve margins, return may grow at a
faster rate than assets, ultimately increasing return on assets.

Return on Equity

ROE is a ratio that concerns a company's equity holders the most, since it
measures their ability of earning return on their equity investments. ROE may
increase dramatically without any equity addition when it can simply benefit from
a higher return helped by a larger asset base. As a company increases its asset
size and generates better return with higher margins, equity holders can retain
much of the return growth when additional assets are the result of debt use.

Liquidity Ratios

Liquidity ratios measure a company's ability to pay debt obligations and its margin
of safety through the calculation of metrics including the current ratio, quick
ratio and operating cash flow ratio. Current liabilities are analyzed in relation
to liquid assets to evaluate the coverage of short-term debts in an
emergency. Bankruptcy analysts and mortgage originators use liquidity ratios to
evaluate going concern issues, as liquidity measurement ratios indicate cash flow
positioning.

Liquidity ratios are most useful when they are used in comparative form. This
analysis may be performed internally or externally. For example, internal analysis
regarding liquidity ratios involves utilizing multiple accounting periods that are
reported using the same accounting methods. Comparing previous time periods
to current operations allows analysts to track changes in the business. In general,
a higher liquidity ratio indicates that a company is more liquid and has better
coverage of outstanding debts.

Alternatively, external analysis involves comparing the liquidity ratios of one

company to another company or entire industry. This information is useful to
compare the company's strategic positioning in relation to its competitors when
establishing benchmark goals. Liquidity ratio analysis may not be as effective
when looking across industries, as various businesses require different financing
structures. Liquidity ratio analysis is less effective for comparing businesses of
different sizes in different geographical locations.

Solvency versus Liquidity

Solvency relates to a company's overall ability to pay debt obligations and

continue business operations, while liquidity focuses more on current financial
accounts. A company must have more total assets than total liabilities to be
considered solvent and more current assets than current liabilities to be
considered liquid. Although solvency is not directly correlated to liquidity, liquidity
ratios present a preliminary expectation regarding the solvency of a company.

Examples of Liquidity Ratios

The most basic liquidity ratio or metric is the calculation of working capital.
Working capital is the difference between current assets and current liabilities. If
a business has a positive working capital, this indicates it has more current assets
than current liabilities and in the event of an emergency; the business can pay all
of its short-term debts. A negative working capital indicates that a company is
illiquid.

The current ratio divides total current assets by total current liabilities. This ratio
provides the most basic analysis regarding the coverage level of current debts by
current assets. The quick ratio expands on the current ratio by only including
cash, marketable securities and accounts receivable in the numerator. The quick
ratio reflects the potential difficulty in selling inventory or prepaid assets in the
result of an emergency.
Asset Management Ratios

Asset Management Ratios attempt to measure the firm's success in managing its
assets to generate sales. For example, these ratios can provide insight into the
success of the firm's credit policy and inventory management. These ratios are
also known as Activity or Turnover Ratios.

Receivables Turnover and Days' Receivables

The Receivables Turnover and Days' Receivables Ratios assess the firm's
management of its Accounts Receivables and, thus, its credit policy. In general,
the higher the Receivables Turnover Ratio the better since this implies that the
firm is collecting on its accounts receivables sooner. However, if the ratio is too
high then the firm may be offering too large of a discount for early payment or
may have too restrictive credit terms. The Receivables Turnover Ratio is
calculated by dividing Sales by Accounts Receivables. (Note: since Accounts
Receivables arise from Credit Sales it is more meaningful to use Credit Sales in the
numerator if the data is available.)

The Days' Receivables Ratio is calculated by dividing the number of days in a year,
365, by the Receivables Turnover Ratio. Therefore, the Days' Receivables indicates
how long, on average, it takes for the firm to collect on its sales to customers on
credit. This ratio is also known as the Days' Sales Outstanding (DSO) or Average
Collection Period (ACP).
Fixed Assets Turnover

The Fixed Assets Turnover Ratio measures how productively the firm is managing
its Fixed Assets to generate Sales. This ratio is calculated by dividing Sales by Net
Fixed Assets. When comparing Fixed Assets Turnover Ratios of different firms it is
important to keep in mind that the values for Net Fixed Assets reported on the
firms' Balance Sheets are book values which can be very different from market
values.

Total Assets Turnover

The Total Assets Turnover Ratio measures how productively the firm is managing
all of its assets to generate Sales. This ratio is calculated by dividing Sales by Total
Assets.

Limitations of Ratio Analysis

Financial ratio analysis is one of the most popular financial analysis techniques for
companies and particularly small companies. Ratio analysis provides business
owners with information on trends within their own company, often called trend
or time-series analysis, and trends within their industry, called industry or cross-
sectional analysis.

Financial ratio analysis is useless without comparisons. In doing industry analysis,

most business use benchmark companies. Benchmark companies are those
considered most accurate and most important and are those used for comparison
regarding industry average ratios. Companies even benchmark different divisions
of their company against the same division of other benchmark companies.

There are other financial analysis techniques to determine the financial health of
their company besides ratio analysis, with one example being common
size financial statement analysis. These techniques fill in the gaps left by the
limitations of ratio analysis discussed below.

Benchmark to Industry Leaders' Ratios, Not Industry Averages

This may be contrary to everything you have ever learned. But, think about it. Do
you want high performance for your company? Or do you want average
performance? I think all business owners know the answer to that one. We all
want high performance. So benchmark your firm's financial ratios to those of high
performing firms in your industry and you will shoot for a higher goal.

As for a limitation of ratio analysis, the only limitation is if you use average ratios
instead of the ratios of high-performance firms in your industry.

Companies' Balance Sheets Are Distorted By Inflation

Ever wonder why you always hear that balance sheets only show historical data?
This is why. A balance sheet is a statement of a firm's financial condition at a point
in time. So, looking back on a balance sheet, you see historical data. Inflation may
have occurred since that data was gathered and the figures may be distorted.

Reported values on balance sheets are often different from "real" values. Inflation
affects inventory values and depreciation, profits are affected. If you try to
compare balance sheet information from two different time periods and inflation
has played a role, then there may be distortion in your ratios.
Ratio Analysis Just Gives You Numbers, Not Causation Factors.

You can calculate all the ratios you can find from now until doomsday. Unless you
try to find the cause of the numbers you come up with, you are playing a useless
game. Ratios are meaningless without comparison against trend data or industry
data. Ratios are also meaningless unless you take the limitations listed in this
article into account.

Different Divisions May Need Comparison to Different Industry Averages

Very large companies may be composed of different divisions manufacturing

different products or offering different services. To make ratio analysis mean
something, different industry averages may need to be used for each different
division. The ratio analysis, used in this way, will certainly be more accurate than
if you tried to do a ratio analysis for this type of large company.

Companies Choose Different Accounting Practices

Different companies may use different methods to value their inventory. If

companies are compared that use different inventory valuation methods, the
comparisons won't be accurate. Another issue is depreciation. Different
companies use different depreciation methods. The use of different depreciation
methods affects companies' financial statements differently and won't lead to
valid comparisons.

Companies Can Use Window Dressing to Manipulate Their Financial

Statements

Ratio analysis is based entirely on the data found in business firms' financial
statements. If the financial statements for a company are not quite as good as
they should be and a company would like better numbers to show up in an annual
report, the company may use window dressing to manipulate the data in the
financial statements. Bear in mind this is completely against the concept of
financial and business ethics and flies in the face of corporate governance.

What exactly is window dressing? The company will perform some sort of
transaction at the end of its fiscal year that will impact its financial statements
and make them look better but is then taken care of as soon as the new fiscal
year starts. That is the simplest form of window dressing.

You can see that if ratio analysis is used with knowledge and intelligence and not
in a mechanical and unthinking manner (like just cranking out the numbers), it can
be a very valuable tool for financial analysis for the business owner. Its limitations
have to be kept in mind, but they should be more or less intuitive to a savvy
business owner.