the beginning of the end : Death Bonds!

In the early 1980's and 90's, AIDS was rampant and incurable. The sufferers needed cash, and so they started selling their life-insurance policies to investors/companies who were ready to pay cash. They got the much need cash and they did not have to pay premium anymore! The investors paid the premium till the insured died and made themselves a neat profit, if they died early!

"Death Bonds" or "Life Settlement-backed Security" are rapidly becoming the safety nets for companies from the turbulence of the other investments for the obvious reason that 'Life Expectancy' is not as volatile as the other financial instruments - but for the terrorists who are likely to have invested only in Death Bonds. Life insurance policies are pooled together, repackaged ('securitized') into bonds and sold to investors.

"Profiting From Mortality - Death bonds may be the most macabre investment scheme ever devised by Wall Street " - Businessweek Cover Story, July 2007

For example, if the person is insured for Rs 10 lakhs upon death, the investor buys the policy at a lump sum of Rs 5 lakhs. For the insured, this is quick and easy cash - the investor bears the premium and waits to the get the money upon death of the insured.

Death Bonds are still unheard of in India; but they are fast becoming a popular and safe investment in Europe and United States. Death Bonds may still be far in the future in India, but how eerie is it knowing that the investor wants you DEAD!

Vicious Circle Fuelled by Oil Price

There has been a lot of hush hush in the newspapers about rising fuel costs and search for alternate fuel sources. Why is fuel becoming expensive? How does it touch each of our lives? We try and analyze the vicious cause-effect cycle driven by the fuel costs.

CAUSE & EFFECTS
Here is a list 9 potential factors which drive the fuel prices up.


  1. OPEC Policies : Since mid-eighties Organisation of Petroleum Exporting Countries (OPEC) has been creating an artificial scarcity i.e. it produces only to fill the gap between global oil demand and production by non-OPEC countries. This has resulted in OPEC having a lot of idle capacity and thus a control over the oil prices. But recently with surging oil demands OPEC has hardly any idle capacity left i.e. no safety net and a higher risk premium.
  2. Petro-Dollars to Petro-Euros : Till recently almost all oil buying and selling was in US-dollars (petro-dollars) through exchanges in London and New York. But the OPEC countries are now shifting to petro-euros. So till ~ 2002 the USD-Euro conversion rate were independent of the oil price; but now are directly correlated.
  3. Political Instability : Most of the known oil reserves are in West Asia (or the Middle East). The other major petroleum exporting countries are Russia, Nigeria, Indonesia and Venezuela. These countries have been politically unstable in the recent past and this has also led to the oil traders demanding a premium.
  4. Speculations in Oil Futures by large amounts of funding also drive prices up.
  5. Weak Dollar Policy : With most oil deals worldwide are priced in US dollars; and the dollar's devaluation puts on the pressure for higher oil prices. To maintain an income and purchasing power, raising prices has become a major strategy of OPEC members.
  6. Rising demand from emerging nations like China and India. Rise in oil prices applies brakes to the fast growing economies.
  7. Rising cost of corn and ethanol : An increase in oil prices increases the demand for alternate fuel i.e corn and ethanol; which increases costs of cattle feed and ultimately food-products. Inflation goes up sharply resulting in cracking of the economy.



Gold vs Liquid Gold
Gold / Oil prices have maintained a ratio of ~15 for half a century, but the sudden steep surge in oil prices has resulted in this ratio halving! Also, a strong negative correlation is seen between the Gold/Oil price ratio and Dollar/Euro conversion rate.


The Bank HOLIdays and taking stock

With the long holiday (20/03 to 23/03) that all market participants are facing, it is a good time to 'take stock' of the situation that nayainvestors could be facing

  1. You bought gold/ gold BEES as suggested by NAYAinvestor - you would be sitting pretty on the strong holdings or it would be the perfect hedge for your underperforming portfolio
  2. You are still looking for an opportune moment to enter the mayhem that is the stock market
  3. You did enter the market with equity positions and consequently have burned you fingers (hopefully to a small extent only)
So what should you do in each of the positions???
Well the one thing we have never professed to be is a site / blog attempting to tell you how to run your investments, instead we plan to put in front of you the situation, our reading of it and also try to read between the lines that you see daily and then let you make the informed choice... sounds good??

Stunning occurences of the week
Bear Stearns getting bought out at less than 10% of its market value and that too with FED sponsored money - is it a desperate measure or are they trying to build investor confidence by providing the sponsor amount??

LB results: 57% decile in First Quarter Profits

Lehman’s first-quarter profit equates to 81 cents a share, which is significantly ahead of the consensus analyst forecast of 72 cents and sent the group’s stock up 46 per cent to close at $46.49. However, the share price jump, from $31.75, followed declines of 15 per cent and 19 per cent in the previous two trading days as Bear Stearns’s firesale to JPMorgan was hammered out. Bear Stearns was unable to meet a surge in margin calls by its creditors late last week as the credit crunch continued to escalate. After the Bear Stearns sale, Lehman had been among the group of Wall Street firms viewed as most likely to follow suit, in large part because it was the biggest underwriter of mortgage-backed bonds last year and owned $80 billion of them at the end of November.

Probability of lower earnings from companies for this quarter (awaiting the results season - and how each result is going to change the fortunes of traders/speculators and Investors is a big learning that naya investors should attempt to take away from this season. It is a time when we will notice how deviation from an expected value hits/props the price of a stock either way.

When America sneezes, Asia doesn't catch cold

Off late there has been a lot of concern all over the world concerning the impending US Recession. Many naysayers have predicted that when US falters the world around crumbles. Fortunately however this time that is far from true. The recent sub prime mortgage crisis has caused US Banks to seek capital injections from Sovereign wealth funds. It is pertinent to note that all the major US banks were bailed out by Asian funds predominantly from Singapore, Dubai and China. That is a refreshing break from the earlier days when Asia would seek alms from the Almighty US. Even as the world gets more integrated every day the impending US recession will prove that the world isn't exactly flat but round and wrinkled. This economic downturn will prove that when America sneezes, Asia doesn't catch a cold. Yes Asia (notably India & China) will be affected but not as severely as it has been made out to be.

Heading for the Rocks

To elucidate this point, let's scratch the key attributes of the US market. US market had always been a consumer market. The Chugging US Economy thrived on consuming goods rather than producing them. This classic dichotomy can be best illustrated by looking at a few data points. Consider petroleum, the world's biggest consumer market remains the US. 20.6 million barrels a day, while second place China even with a billion and more people has a consumption of 6.9 million barrels a day. India uses 2.6 million barrels a day. Americans bought 16.9 million cars and trucks last year, India at 1.1 million. Take food, energy or services America remains the worlds biggest consumer market. While the world over people made money by feeding this behemoth, America made its money simply by consuming them. So when there is a recession this glutton loses some appetite and the grocers in the world market have no body to sell goods to. This is the dynamics of the world market.

However the landscape is changing, China recently overtook America as the biggest consumer of steel, Iron and Zinc. If India continues with it's on again and off again reforms, it could become a significant market for the world supermarkets. Nations in Eastern Europe, Central Asia and East Asia are now building an appetite that can re route the supply chain to some extent. The big picture in this case is that if the much touted US recession arrives then India or China could lose a big client to sell goods to but can make up this loss by browsing the world market for other buyers. This is what is called decoupling. Asia is trying to decouple from the US at a peripheral level. China has generated so much internal demand that it has little to worry about a shrinking demand from US. India to some extent is still dependent on it's IT exports and forex from MNC and will feel the pinch.

Who has to lose sleep ?

This may not be the best of time for Dalal street. As naya investors be wary of companies that relies solely on US exports. The US Dollar has not bottomed out yet and if RBI does not intervene you will see INR appreciating further vis-a-vis US Dollar. That may not be good news for Exports but as they say necessity is the mother of invention. Japan had the same dilemma in the 70's and the world commentators predicted Japans Cremation. Japan simply continued to play to it's strength and what proceeded later is history. The Knowledge exporters from India will have to urgently scout for other customers to replace this consumer behemoth. If India Inc manages it, happy times are here again. As the popular adage goes, today's problems come from yesterdays solutions !

The Subprime Crisis - Demystified

Enough and more has been said about sub prime in the recent few months. Every financial analyst worth his salt has dissected the anatomy of the sub prime crisis and how they saw it coming. It is pertinent for new investors to understand the ensuing drama and be aware of similar fracas being pulled out by financial institution in their vicinity simply because history has this nasty tendency to repeat. Here at Naya Investors we try to demystify Sub prime crisis in the US and let you draw inferences from this intriguing crisis of recent times. The article was co written with Ashish Kaimal, MBA candidate from the University of Hong Kong and London Business School.
Naya Investors thank him for his contribution.


What is subprime lending all about?

Subprime lending, also called "B-Paper", "near-prime" or "second chance" lending, is a general term that refers to the practice of making loans to borrowers who do not qualify for market interest rates because of problems with their credit history (HSBC).


Every adult American should have a “credit score”. This number ranges between 300 and 850 and indicates his or her creditworthiness. This figure is derived from credit reports based on past performance and income levels and is compiled by three major credit bureaus i.e. Experian, Equifax and TransUnion.


When a lending institution extends funds to a person with a credit score of less than 620, the loan is known as a subprime loan. These loans would generally have higher interest rates than prime loans which is the compensation for the higher risk borne.


Given the low interest rate environment and easy availability of credit, mortgage lending institutions in the US had been under pressure to raise revenues and profits. The only way to do this was to lend money to higher risk borrowers at higher rates of interest with the hope (or was it belief?) that repayments would be made in full and on time.


To entice subprime borrowers, mortgage lenders introduced what is called a 2/28 ARM (adjustable rate mortgage). This involves low teaser rates for the first two years and then a floating rate based on an industry index like the 1 year CMT or 6 month Libor. Rates would rise sharply after the reset and then fluctuate with the market. Subprime borrowers usually take these 2/28 loans and then try to improve their credit ratings or scores so that they can refinance their mortgages before the floating rates kick in.


How did simple mortgages end up causing a worldwide financial crisis?


To answer this question it is worthwhile to follow the subprime money trail through the financial system. Diagram courtesy HSBC.

The Money Trail

  1. A subprime borrower takes a mortgage from a mortgage institution like Wells Fargo Home Mortgage at the 2/28 ARM terms.
  2. The mortgage institution or lender pools together many such mortgages and sells these onwards to financial institutions like banks.
  3. The banks then proceed to securitize these loans, chop them up, and package them into products called CDOs or Collateralised Debt Obligations which entitle the holders to the cash flows from the underlying mortgages.
  4. These CDOs are then sold to other market participants like hedge funds, pension funds, other banks and insurance companies based all over the world.
  5. The CDOs may then be traded like any financial security and thus ended up being held by banks and other market participants all over the world.


From mortgage to crisis – how did this happen?

When investment banks started packaging the loans into CDOs, they put together tranches composed of varying proportions of prime, medium prime and subprime loans to get a desired rating for each instrument.


As these were credit products the banks needed rating agencies like S&P, Moodies, Fitch etc to rate their credit worthiness. Unfortunately the credit rating firms followed an average risk approach to rate these CDOs.


The prime loan portions of the CDOs led the rating firms to bestow their highest possible ratings i.e. “AAA” on most of these instruments. AAA rated instruments imply the highest level of security or lowest risk. This indicates to possible investors that the there is very little risk of default.


The basic principle of finance states that higher the risk, higher the expected return. Yet these CDOs were rated almost completely risk free but were offering returns that were typical of junk rated bonds or firms.


Should the market in general have questioned this paradox earlier? One would expect so but in the atmosphere of “irrational exuberance” that was prevailing in the credit markets nobody did. Most participants were taken in by junk yields being offered on AAA rated instruments. Greed, it appears is the lowest common denominator.


One must keep in mind the prevailing low interest rate environment in North America and Europe in the last couple of years. Stock markets too have not exactly been delivering outstanding returns. Banks and other financial instruments were under significant pressure to boost profits and return on investment. CDOs, in these circumstances seemed too good to resist.


The tide began to turn in late 2006 and early 2007. Large numbers of subprime mortgage foreclosures started being seen. Investment banks holding the CDOs tried to sell them back to the mortgage lenders under so called “repurchase agreements”. Some like New Century Financial Corporation were forced to shut down. Hedge funds too started facing redemption pressures. The defaults started forcing market players to liquidate their holdings.


Widespread panic and lack of confidence led most market players to stop lending to each other. Most investment banks and hedge funds had to write down the value of their holdings or liquidate other investments to meet redemptions. With CDO prices at rock bottom levels, market players were forced to borrow heavily.


Most market participants at this time were not aware of how much of the subprime CDOs other participants were holding. Faced with this uncertainty, most refused to lend funds in the overnight money markets to hedge funds or banks no matter what interest rates were being offered.


This led to a huge liquidity crunch in the global markets and subsequently runs on and the collapse of a few banks in Europe. With nobody ready to lend money, overnight rates in the money markets skyrocketed setting the stage for further runs on banks and even the freezing or possible collapse of the entire banking system.


And thats how the cookie crumbles!!

Investment Options in Gold

Here are four possible investment options in Gold

Click to Enlarge
  1. Jewellery

Most popular and easy to buy, this is the most inefficient gold investment. When you buy jewels you not only pay for the gold, but also pay making charges and the manufacturing wastages incurred by the gold smith, besides the taxes. Also, jewellery is normally made out of less pure and the deteriorating quality of the gold. Another concern is that physical gold requires security (greater risk).


  1. Gold coins / Gold biscuits

Available with many banks like ICICI, BoI, SBI etc for sale with a premium of about 10% in sealed packages. It is certified by the authority and hence there is no worry about the purity. You may be able to sell them back to the bank or any other trader at the prevailing market price with no premium of course. Security concern is also applicable in this case.


  1. Gold funds

Mutual funds invest in commodity gold / related industry scripts. This is an indirect paper trade similar to any other mutual fund. You buy units of Rs.10 each and the fund will invest in companies who are into gold and related commodities. There is no need to monitor the gold price (the fund manager's headache!) with a service cost of about 6 %.


  1. Exchange traded funds - Gold BEES / Kotak BEES

This is the best bet for a cost effective investment. Gold Bees is listed in the stock exchanges (like any other stock) and traded on a daily basis. It tracks the gold price closely within a margin of +/- 1 %. The advantage of this fund is the liquidity (lots of buying and selling) of the asset, so you can buy or sell the gold in units of 1 gram. Pre-requisite is that you may need a Demat and trading account with a broker. No hassles about the purity of the gold or the wastages involved!

Investment in Real Estate, NEXT WEEK.



Falling market - black monday, terrible tuesday, may be a wonderful wednesday

Dear new investors
Do not miss this golden opportunity because the time is right enter the market. If you already have a demat and trading account then just jump over and start buying: also identify your target profit to sell.

No special skill is required to identify the good ones.
Just look at some of the big shots in the business
  1. Reliance six pack : R-industries, R-communication, R-energy, R-petro, R-natural resources, R-capital (also R-power)
  2. Tata pack - T-motors, T-telecommunication, T-tea, T-steel
  3. Bank pack- SBI, ICICI, Canara B, B of India, Corporation B, B of Baroda, Yes B, HDFC B, Kotak B
  4. Infrastructure - GMR, IVRCL, Maytas, Gammon, L & T, IDFC, Hindustan construction
  5. Capital goods ABB, BHEL, BEL, BEML, Seimens, Voltas
  6. Telecommunication - Bharati, Idea
But if you haven't opened demat and trading accounts (but have a PAN card) you need not get disappointed. The Plan-B reap dividends is: - invest in MUTUAL FUNDS. Just walk into any of the state banks and ask for
  1. Magnum mutual fund application - you can select from midcap, multicap, commodities, technology, fmcg, service, infrastructure, taxgain of any sector specific fund or any other open equity funds. (more about mutual funds soon!)
Please keep sufficient numbers of copies of the PAN card / application details and the number of cheque leaves and a good black pen to fill up the form and sign.

If you are still not convinced, read the following article of Udayan Mukerjee (posted in Moneycontrol portal). Many thanks to his matured advice always appreciated by Thangam and me (we never miss his evening sessions on the market analysis!).

Here goes,
The thing about life is that one makes mistakes. Many mistakes were made in the second half of 2007 and those sins have to be washed away by blood, such is the way of financial markets. Some participants will go down under and never be able to get back to the market again but most will survive. The pain will linger for many months, maybe years but lessons have to be learnt. Every such debacle has lessons for us and the sooner we forget them the more we suffer. The first lesson is not to let stock price performance become the sole reason for buying, a mistake which was made in abundance in the last 3 months. What couldn't be explained by fundamentals was credited to liquidity. The present lost all relevance as people chose to focus on the distant future, perhaps simply because the present could never justify those ticker prices; only a hazy dream of the future could. Traders and investors had no time for fundamental analysts, in many cases they were labelled "cribbing fools". Chartists became the most celebrated tribe on the street as only they could see and predict the one way run to glory for many of the hot stocks even as fundamental watchers cringed at valuations....till the music stopped. Don't get me wrong, charts do work in trending markets but once stock prices veer away completely from fundamental value, people need to get careful. But they never are. Now that the blinkers are off, people should ask themselves why stocks like RNRL, Ispat, RPL, Essar oil and Nagarjuna fertilisers have lost 50-70% of their value. It is simply because their stock prices had snapped all connection with underlying business fundamentals, earnings and value. Their stock prices became the only reasons for buying them which works for a while but not forever. The other big lesson, one which should have been driven in earlier in May 2006, is the danger of overextending oneself in the futures market. The lure of stock futures is easy to understand. Put in some margin, take a big exposure on a fast moving stock, make a killing when prices shoot up. Repeat exercise. Just that people forgot that prices may also come down and at a pace which noone can even imagine, maybe their friendly stockbrokers forgot to tell them that part of the story. The result : unbridled speculation that ran into lakhs of crores, excesses that we are paying for today. Even this fall will not cure investors of their love for futures speculation but if at least some amount of caution is injected it would have been a worthwhile learning. Futures are not toys for amateurs, they are time bombs in the hands of inexpert and inexperienced traders, it's only a matter of when the fuse runs out. The other learning which I hope will play out in the future, as it has in the past, is that it pays to be brave in times of panic such as these. If I was allowed to invest myself , which I am not, I would have no hesitation in deploying serious money into the market today, knowing fully well that prices may fall more tomorrow. And I would be standing there tomorrow to buy more of the same, till my money ran out. India is going to be a terrific stock market story for many years to come, even an intermediate bearish patch cannot shake that conviction of mine. At best, one will have to wait a bit for the returns to follow. That's alright. You are happy to put money in a bank FD and then wait for one full year to collect that measly 8%, aren't you? Then why does the stock market need to give you 20% every month? In the last one year, I haven't seen so many good stocks trade at such mouth watering levels. Forget trading, avoid the duds which were fuelled up by operators, just go out and buy those bluechips. They will deliver, even if there is a global market meltdown for a while, and if you are a bit patient you will be rewarded. But do remember January 2008, as history will repeat itself again in the future. Just that our memories tend to be too short and our greed too much. Udayan Mukherjee

Reliance romance : Reliance Power IPO

'Guru' is back!

Dhirubhai Ambani started the equity cult in India more than 30 years ago. More than 58,000 investors, many from the great Indian middle-class (first time retail investors!), subscribed to Reliance's IPO in 1977. Greatly rewarded were these investors, and thus began their love affair with Reliance.


What is an IPO or Intial Public Offering?

It is the first sale of stock by a private company to the public. The company is giving 'stake' or part ownership to public, in the process raising funds. IPOs are often issued by younger companies seeking capital to expand. IPOs are also offered to institutional investors like foreign funding agencies.

Reliance Power, owned by Anil Dhirubhai Ambani, is the largest ever IPO subscribed in India. It is oversubscribed by more than 70 times i.e
number of shares company is offering = 260 million (10.1% of Reliance Power)
number of shares public is ready to buy > 18200 million!!


The IPO was fully subscribed 60 seconds after it opened Tuesday. The shares were priced at 405-450 rupees.

Many first time investors sought this opportunity to enter the equity market. Road side vendors, panwalas, petty-shop keepers, painters, rickshaw-walas and thousands of factory workers have applied for Reliance Power shares. Mumbai's famous dabbawalas handed out application forms with the lunchboxes.

Reliance Power is a unit of Reliance Energy. It is developing 13 medium and large power projects with a combined planned capacity of 28,200 megawatts. Reliance Power is yet to generate a single watt of energy. The first plant will not begin production until the end of 2009.