Prometheus NewsletterPrometheus Newslettersimplifying FINANCE Prometheus, The Finance Club, Alliance Business School Bangalore The first edition of the finance club newsletter brings to you a plethora of information that adds value to the learnings in the classroom. At prometheus, it is our humble endeavor to give everyone a platform from where one can learn and apply theirknowledge. We profusely thank the members of the finance club for their relentless support and cooperation.
The first edition of the financeclub newsletter brings to youa plethora of information that
adds value to the learnings in theclassroom.
At prometheus, it is our humble endeavor to give everyone aplatform from where one can learn and apply their knowledge. We profusely thank the members of the financeclub for their relentless support and cooperation.
At the outset let me congratulate the team atAlliance that has worked toward this Newsletter. As I amwriting this message, I see a lot of enthusiasm amongstudents especially in blending academics withprogrammes like sessions on Technical Analysis,debates on stock trading, Seminars etc. I am extremelyhappy that the Newsletter is turning out to be a hybridmix of academic and corporate exposure. I would like tocongratulate my students who have shown keeninterest in such activities.
I sincerely hope that this will set a trend of developing Research bent of mind among students andin the future this Newsletter will shape up into aprominent asset in the bookshelves of academicians allover.
Dr P.JanakiramuduArea Chair,Finance.
Message from the Hon.Dean
I am very happy with the initiatives taken by the finance clubto enhance their learning. I hope students make full use of the knowledge imparted.
I wish them good luck in this endeavour and hope it isa grand success.
Dr. Madhukar Angur Hon. DeanAlliance Business School
This article talks about the similarities that we see between calculations that we make while dealing with Newtonian Mechanics on one hand andcalculations coming in the realm of certain fixed income securities on the other. We then brief about some extensions required to deal with random cashflows.
Suppose in the game of cricket a batsman hitting a sixer gets a payoff depending upon the height the ball reaches. Then the computations involvedare just the ones that we do in elementary physics namely writing down the equations concerning the projectile motion. This is a deterministic model aswe can decide in a definitive manner as to what can be the payoff if we give inputs like the initial velocity and the angle of elevation. This fictitious scenario
is created just to get the feel as to how differential equations are fundamental in some deterministic models. For those of the readers who can recollecttheir high school physics, here is the equation that essentially fixes the payoff (for the above game) given the inputs:
Y = (g/u2)x2
is the Cartesian equation of the projectile (the path of the sixer!) while
H = u2sin2(Φ)/2g
is the polar equation that essentially helps us compute the maximum height attained when u is the initial velocity and Φ is the angle of elevation.
The key observation that we require for what is to follow is that given such a deterministic model, once we know the initial conditions one can crack thepuzzle by mere number crunching.
The Differential Equation concerning Bond Price Dynamics :
Suppose an asset price S(t)2 is exhibiting a linear growth which means that the price grows/declines proportionally with time. So the differential form of thisproperty is exhibited by the equation:
dS(t)/dt = k, or dS(t) = kdt.
Let us suppose that at the start i.e. time-0 the price paid for the asset was S 0. Then the above simple equation on solution gives us the form as requiredfor calculations namely:
S(t) = kt + S0.
One can immediately see the similarity of these calculations with one of the laws for motion laid out by Newton.
We now move on to an important differential equation that gives us a pricing formula for a zero coupon bond, at any point of time during the life of the
Bond. Let B(t) be the price of the bond at time ‘t’. Let B0 be the initial price. And r(t) be the continuously fluctuating interest rate. Clearly the price of thebond at time t is a function of interest rate r(t). The Differential Equation of our interest here is:
dB(t) = -r(t)B(t)dt.
• The parameter ‘t’ here implies that the asset price depends on the time variable
• One should read 'k' as a positive number if it is growth and negative if it is the other way round.
With the initial value we have assumed we get the solution as:
B(t) = B0 e-∫r(u)du
The integral should be computed between limits t and T, which we have not written in the above expression to avoid notational complications.
Some simplifications.
Suppose B0 is 100 and the interest rate is fixed throughout as r. Then the above equation simplifies to:
B(t) = 100.e-r(T-t).
Now, one can really look at the Graph of the above function B(t). In fact the Taylor series expansion around a time point t = t0 can be examined a bit closely.Let us first look at the first order approximation of this Taylor series. It gives us a linear function. The second order approximation gives us a parabola. Weleave it to the reader to actually plot the graph and verify that the Bond price gets closer to par value as one approaches the maturity time T. Interestingly theterms like Modified duration and Convexity of the bond can be readily defined by the second order Taylor series expansion of the above mentionedexpression for B(t).
In case of assets like stocks one has to deal with noise coming out of Market friction which takes us into Into Calculus.
About Author:
Mr. J. V. Ramana RajuSenior Research Associate
Dept. of FinanceAlliance Business School
References:
• S.Neftci:'An introduction to the Mathematics of Financial Derivatives', Academic Press NY.• J.C.Hull:'Options Futures and other Derivatives' Pearson Publications, 6th Edition
When the markets are breaching the 8000 mark at will, fundamental analysis seems to go for a toss. Many experts such as Mr. Shiv Kumar, VP- ILFS andMr. Nandish, VP Sharewealth are of the opinion that this is a traders market and any fundamentals will take 2 or more years to gain full swing. They see2009 as the year of the traders. Keeping this in mind, a lot depends on understanding how sentiments drive fear, which in turn drives the volatility in themarket. As such, the NSE Volatility Index or the VIX is a good indicator of the market volatility and a dependable measure of market sentiments.
So what is a Volatility Index?The National Stock Exchange's Volatility Index (VIX) is tracked to find the Market Volatility. It is based on the Nifty 50 and is used to calculate the expected
market volatility over the next 30 calender days.
A high VIX indicates market fear while a lower value indicates that the markets are cold. The thumb rule for VIX is:20s indicate complacent marketMid 30s to upper 40s indicates market fear Above 50 indicates panic
The graph above shows the VIX from 2nd February,1993 to 22nd February,2009. A closer look at the recent behavior of the VIX shows that it peaked
indicating a state of panic in the market around November 2008, coinciding with the market crashes. At the current level of 45.49, the VIX still indicates a
state of market fear with the first signs of complacency hitting it around C1 = 17.79 and then C2 = 9.97.
The near term outlook for the market should be between the 30 to 55 levels which would provide enough volatility for intraday swings but this volatility is
expected to hit 70 levels again if the Sensex drops below 7000 and the Nifty 2400.
In the arena of Mergers & Acquisitions there are two major considerations from the acquiring company’s viewpoint – fundamentals of the company
being acquired and price of acquisition – where price is just an externality. The acquisition of overvalued companies is justifiable by reasons which are more
strategic than financial in nature.
The good times for ITES valuation may be coming to an end. During the period 2000-01 the ITES sector has been enjoying high post-investmentvaluations. The post-investment valuation of some ITES companies like Spectramind, Daksh eServices and CustomerAsset have been to the tune of over two
times the revenues.
Wipro had invested $10 million for a 24 percent stake in Spectramind while its revenue was around $20 million. Similarly ICICI bought over
CustomerAsset for $19.5 million, twice the revenues of CustomerAsset. But, with increasing competition in this sector valuations would dip as compared to the
initial stages. AmulGogna, former Executive Director (ICRA) had said in a press release way back in 2002 that the up-trend of high levels of post-investment
valuations in the ITES sector would last for another six to nine months. In line with ICRA, VCs like Infinity Ventures and Baring Private Equity Partners (I)
Limited also believed that the high post money valuations of the ITES companies would not last long. A similar trend was observed in the software industry as
well which peaked off with passing time.
Following Wipro’s acquisition of Spectramind at over 2.5 times forward revenue, deals were hinged around 1-1.5 t imes forward revenue, the only
exception being IBM-Daksh deal which commanded a higher premium. Analysts and industry experts were not ready to accept this deal as a benchmark for
future valuations in Indian BPO sector. Though the IBM deal further endorsed India as an offshore destination for outsourcing, it did not imply that valuations
of BPO companies will move up. Susir Kumar, CEO (Intelenet) feels Indian companies will command a premium only if they have either reached scalability or
have a niche expertise. According to him, “Strategic buyers like IBM will pay a premium but it can’t be used as a benchmark for valuation of deals from a
private equity investment point of view”.
In 2007-08 there wer e further adjustments in valuations made by the private equity investors owing to the strengthening rupee against US$; on top of
that there was a continuing concern for attrition in the BPO sector. Though there was feeling among the PE investors that the interest in the BPO sector still
existed, the rising rupee had impacted their profitability. But, the valuations have changed. "The rising rupee and the sub-prime crisis will affect the mood of
investors in a big way," said Raju Venkatraman, Joint MD and COO, Firstsource.
Valuations, at any given time, reflect the company’s profitability and growth. Since there are not too many large players left and the predominantobjective of PE investors had been higher scales, therefore there are not many choices left. According to industry estimates (2007) at least 10 of the top15 third party BPO companies have received PE backing in one form or the other.
Around 65% of the Indian BPO companies are captive units whereas 35% are third-party. The industry outlook says that there would be moreManagement Buyouts (MBO) in the captive BPO segment as many large companies are exiting from their non-core businesses. The acquisition of Citi’sIndian BPO arm by TCS is an example of it. PE players also expect the tick size of MBOs to increase progressively.Sources:
According to The New York Times, 18th-century Swiss mathematician Leonhard Euler studiedconundrums called Latin squares, which involved plugging the same set of numbers into eachrow and column in a grid. Two hundred years after Euler, in 1979, retired American architectHoward Garns contributed puzzles titled Number Place for publication by Connecticut-basedcrossword giant Dell Magazines. Number Place added a key element to Latin squares, thenine boxes within the overall grid.
Enter Japanese publisher Nikoli Co., which in 1984 published Garns-style puzzles under thename sudoku. Pronounced "soo-DOH-koo," the word roughly translates as "only singlenumbers allowed." In 1997, Wayne Gould, a New Zealander and retired Hong Kong judge, wasvacationing in Tokyo, where he stumbled across a sudoku book. It intrigued him and hedeveloped a computer program to generate more of the puzzles.
When Gould was in London in October 2004, he dropped by The Times newspaper offices andconvinced them to try publishing sudoku. Within weeks, the puzzles appeared in print, andreaders were hooked. "I came across this puzzle that needed a lot of help andencouragement," Gould told Psychology Today, adding he is "the stepfather," not the father, of sudoku. Today, the puzzles appear in almost 400 newspapers in 60 countries.
• Every row of 9 numbers must include all digits 1 through 9 in any order • Every column of 9 numbers must include all digits 1 through 9 in any order • Every 3 by 3 subsection of the 9 by 9 square must include all digits 1 through 9
• Bombay Stock Exchange Limited (the Exchange) is the oldest stock exchange in Asia with a rich heritage. Popularly known as "BSE", it was established as "The
Native Share & Stock Brokers Association" in 1875.
• Wall Street gets its name from a defensive wall that was put up to protect New Amsterdam (now New York) from New Englanders
• The Dow Jones Industrial Average is an average of 30 stocks. When it started there were only 12 stocks. General Electric is the only company of the original 12
still in the index.
• Arnold Schwarzenegger was a finance major!
• The NASDAQ was started on February 8, 1971. 199 years after the New York Stock Exchange. Originally only median quotes were listed.
• It took the Dow Jones Industrial average 25 years to recoup its losses from the crash in 1929 and the Great Depression.
• Zombies, also called living dead, in finance they are companies that continue to operate even though they are bankrupt.
• Originally, a buck referred to a deerskin or buckskin, which was commonly used as money.
