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Understanding Call Option in a Simply simply way

Understanding Call Options using Ramlal the Kirana Store Owner’s example

After Ramlal, the Kirana Store Owner signed up a contract with his customer, Seema he realized the power of such contracts.

Now he has another idea which he believes is called Call Option by Stock Brokers.

His idea is as explained below:-

1) Ramlal has a stock of 100 packs of Maggi priced at Rs 10 each

2) The demand for Maggi has been sky rocketing and there has been talk in the media of an impending Price Hike.

3) This situation gives Ramlal an idea. He tells one of his favorite customer Shilpa that since she has been a regular customer of his, he wishes to reward her with a scheme that would fix the price of Maggi for the next 6 months

4) Under the Scheme he will fix the Price of a Maggi Pack at the Current Price of Rs 10 each for the next 6 months whatever be the amount of Price Hike

5) For this service, he would charge Shilpa a token amount of 25 paise per day equalling to Rs 45 for a period of 6 months or 180 days.

6) Shilpa realizes that for a mere Rs 45 she was getting Price guarantee for 6 months.

7) Shilpa expects that due to the shortage, prices most likely would go up by Rs 2 per pack which means an additional expense of nearly Rs 360 in 6 months.

8) As against Rs 360, this scheme appears cheap at Rs 45. So she confirms her participation with Ramlal.

9) Ramlal on the other hand is happy as well because he strongly believes that the price won’t go up and will continue to be Rs 10 per pack of Maggi

10) So he believes this scheme gives him the opportunity to earn an additional income of Rs 45 in 6 months. He can multiply his earnings by selling this scheme to several of his loyal customers.

11) This scheme of giving Shilpa “the Right to Buy” at Rs 10/- is nothing other than a “Call Option”.

12) The Rs 10 price at which she has a right to buy is the “Strike Price”. The Rs 45 for 3 months that Ramlal charges is the Premium for the Call Option.

Hope the above example has clarified the concept of “Call Option”, “Strike Price” & Premium.

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Compounding stories Selling Skills Stories Story Selling Timeless

Understanding Derivatives in a Simply simply way

Understanding Derivatives the Simply Simple way.

1) There is a shopkeeper Ramlal selling Maggi.

2) Seema loves her Maggi & daily visits the shop to buy her packet of Maggi for Rs 10.

3) She is obviously very money conscious.

4) One day while gossiping with her friend Subhash, she is informed that price of Maggi may go up substantially in the next one year.

5) Next day she tells Ramlal that she would would promise to pay next years Maggi supply of 100 packs at the rate of Rs 12.

6) Ramlal thinks to himself that the idea is not bad at all because be can ensure himself a profit of an additional Rs.200.

7) So he provides her coupons of Maggi which she can use next year.

8) Seema pays Rs 100 x 12 = Rs 1200 and goes home.

9) But as Ramlal is walking home he thinks to himself that in case Maggi prices go beyond Rs 12 after a year then he would incur a loss.

10) But being a super intelligent man he gets an idea to protect his interest.

11) He decides to buy 100 packets Maggi for Rs 10 today for Seema and store it in his shop.

12) One year passes by and Maggi prices do go up as Seema had anticipated.

13) The price which was Rs 10 a year ago now is Rs 14.

14) Seema is very upbeat as she enters Ramlal’s shop with her coupons.

15) She expects Ramlal to be in a foul mood as he would be losing Rs 2 (Rs 14 – Rs 12) × 100 = Rs 200

16) But to her astonishment, Ramlal is seen smiling which Seema cannot understand.

17) When Seema asks for her order, he instructs his employee to go to the store room behind the shop and get the 100 packs of Maggi purchased a year ago on her behalf Seema.

18) Thus Seema leaves happily thinking that she has made a clean Rs 200 (Rs 2 per packet × 100 packets ) profit.

19) Ramlal on the other hand also smiles because the 100 packs he sold Seema were purchased by him for Rs 10 one year ago which he sold for Rs 12. Thus he too made a clean profit of Rs 200 (Rs 2 × 100 packs of Maggi)

20)This situation clearly ended in a win win manner and left both Ramlal and Seema happy.

The key learnings from this story are as under :-

1) The above example explains the principle on which Arbitrage Funds work. In this example Ramlal is the Arbitrage Fund. As Ramlal safeguarded his interest and ensured that he will not be at a loss in the same way Arbitrage funds are very safe.

2)This example also explains the meaning of Derivative Instrument. The coupons which represented 200 future Maggi packs represent what we call as derivative instruments because it’s value is derived from the value of the underlying Maggi packs

3) This example also explains how derivative instruments can be used as a hedging tool. Althought Ramlal sold 200 packs of Maggi for a future date by way of giving Seema the coupons, he hedged himself by buying 200 packs Maggi and storing the same for future use.

4) What Ramlal did was he sold a future product without owning it. We call this kind of selling as “going short”. Instead of selling product he sold the coupons which over here represent a derivative instrument.

5) However one must appreciate although he sold without owning the product it was his obligation to honor his word. He had two choices.

a) One was to purchase from the current market at Rs 14 and supply it to Seema at Rs 12. This kind of a situation is called as “Naked position” where your losses are not hedged or protected.

b) The second option was to hedge his position by buying 200 packs of Maggi and storing it for Seema at the same time he sold the Coupons (Derivative Instrument). Your short stands covered when you hedge and this is called short covering.

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Understand Most Important Concept of Debt Funds

  1. Understanding the most difficult formula of Debt Funds

Most are confused by the Debt Funds formula that “When interest rates rise debt funds NAV drops and when interest rates fall debt funds NAV rise”.

How this happens perplexes most.

As they say Ghee jab seedhi ungli se nahi nikalti toh use tedhi ungli se nikalni padti hai.

So let’s understand this debt fund NAV relationship through an analogy.

Let’s say two friends Ram & Shyam take up similar jobs. The only difference is Ram’s job has him to sign up a bond or agreement of serving for at least 2 years while Shyam’s has it for a mere 5 months.

Both like their jobs and they work diligently.

However,  2 months later an amazing opportunity arises by way of another “job offer” paying double the salary they are currently drawing.

Now what do you think will happen to sentiments of Ram and Shyam.

Remember Ram has a 2 years contract / bond and only 2 months have elapsed.

Shyam on the other hand has a 5 months bond / contract  which is just 3 months away.

If there was an NAV that represented Positive & Negative sentiments what do you think would happen to the NAV of Ram and NAV of Shyam.

Ram would be extremely upset as he is bonded to his job for another 22 months and has no option but to let go the greatest offer of his life. His NAV representing his sentiments would drop significantly.

Shyam on the other hand has just 3 months for his bond/contract/agreement to expire and he believes he will be able to to grab the greatest offer of his life. He would be a little anxious because of the 3 months that he would have to manage but because 3 months isn’t that long a period his Happiness NAV would not be adversely affected.

This is exactly what happens in debt funds having either long duration or short duration investment papers when interest rates rise.

Rising interest rate is an opportunity to migrate to a higher yielding paper.

The long duration fund does not have an escape route and hence its NAV falls while the short duration fund has an exit route round the corner. Hence it’s NAV is less impacted.

Therefore when one is expecting interest rates to go up, one must move from long duration Corporate Bond Funds and Banking and PSU Bond Funds to Low Duration Funds.

Hope this explanation once for all puts at rest every confusion that arises out of the blindly followed formula “If Interest Rates go up NAV comes down and If Interest Rates come down NAV goes up”

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Dr Advisor

The market is like the engine of a car or the operation theatre of a hospital.

The customer prefers the engine covered by the bonnet. The engineer may love his engine, the carburetor, the spark plug, the crank shaft and the heart of the car; the engine.

Likewise the doctor may love his OT with the huge lights, the knives, scalpel, oxygen cylinders and the works but the patient’s family like to stand outside the closed OT as the doctor performs his skillful role inside.

The same is the philosophy when it comes to stock markets. It is important for client’s to focus on their goals and monitor their journey than open up the bonnet and peek into the markets from time to time.

The Financial Advisor is like the doctor in the OT or the Engineer who loves the world under the bonnet. Let markets best be handled by them and let the investor look at the world above the bonnet ; goals, dreams and aspirations

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Why is Marketing Misunderstood

Marketing is nothing but product communication through a “fun” or “entertaining” lens

Now the challenge is that hardworking students of marketing feel a kind of loyalty towards numbers and math and somewhere deep down believe that “fun” isn’t meant for good people.

What most people don’t realise is that communication only works when you focus on the likes and interest of the listener.

And it just takes little to realise that most people are easily drawn towards “fun” and “entertainment”.

Therefore a good marketer should dress up the brand appear as a “entertainer” or “performer”. This is popularly known as brand building.

Some categories by virtue of their form are more “fun” than others.

For example

1) Sports

2) Music

3) Bollywood and movies

4) Travel

It is easy to market the above categories because “fun” is an integral part of their soul.

The birth of advertising lies in this philosophy and smart brands have used advertising to good effect.

Categories like cars, clothes, soft drinks, cigarettes, alcohol, cosmetics have made their advertisement entertaining and thereby added the element of “fun” into their personalities.

This is the only formula for marketing. And hard working students need to understand that one has to work harder to manufacture “fun”.

Albert Einstein famously said, “Not everything that counts can be counted, and not everything that can be counted counts”.

Hence love your math and numbers only to that extent and embrace creativity thereafter.

Categories like mutual funds have a long way to go on this path and as an individual I have been trying my best through my contributions.

If your clients like the images which have “fun” as their key ingredient do not be surprised.

People love those things and importantly those people that make them smile.

“Fun” and “Fear” are the only two ways to ensure engagement and learning.

And clearly between the two ‘fun’ is healthier.

Educating clients is our vision but doing it in an entertaining manner should be our mission.

So as marketers, we are artists & entertainers but we also educate as a consequence

I rest my case.

#marketing

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Review

Understanding the difference between REVIEW and RELIVE

*****

Anchoring bias paralyses decision making on account of some unpleasant past experience.

Let’s say somebody experienced a loss during a past market meltdown and walked out of equity investing never to step in again.

This is anchoring bias or we can say anchored to the past.

The way out of this bias is to REVIEW the bias rather than RELIVE the bias.

When you REVIEW you analyse dispassionately with you mind keeping the heart out of the process. There is no place for emotion in REVIEW.

When you REVIEW you figure out

1) Market correction is the nature of the beast. Correction is part and parcel of equity investing and one has to take it in one’s stride in order to benefit over the long term. What happened was what was meant to be.

2) Market correction ain’t permanent loss. It is a temporary notional loss and the loss would recover over time.

3) Market correction is not driven by investment but by environment (macro factors) which eventually markets recover

4) Having patience and conviction is more important than having knowledge

5) Market crashes are opportunities to invest and a time to reclaim lost opportunities of the past

Any person who REVIEWS an event will land up gaining from it.

However, instead of REVIEWING if you start RELIVING the past you allow your emotions to overpower your ability of cognitive thinking; the power to dissect and analyse a situation dispassionately.

You experience the same feelings that you had felt in the past and it seems it will recur all over again. The past experience becomes the present feeling and the mind freezes and logic becomes elusive. The memory of loss overwhelms everything else and the heart just takes over decision making. All emotion and no cognition.

Therefore learn to REVIEW, learn from it and move on in life.

And stop RELIVING.

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Stay In The Game

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