Forward Market

Forward market is an over the counter market.lets understand what is OTC market?Over the counter market is an important alternative to exchange and measured in term of total volume and trading.It is a telephone and computer linked network of dealers who do not physically meet.Trades are done between a financial institution and one of its corporate clients.Trades in the over-the-counter market are typically much larger than trade in the exchange traded market .

Now understand what is forward contracts?
A forward contract is particularly simple derivative.It is an agreement to buy or sell an asset at a certain future time for certain price.

“Forward contract is traded in the over-the-counter market.Usually between two financial institution and one of its clients.” forward contract on foreign exchange are very popular most large bank have “forward desk” within their foreign exchange trading room.

Forward in the debt market.
The forward contracts that are found in the debt market are.
1) Forward Interest rate contracts:-Forward interest rate for a future period of time implied by the rates prevailing in the market.Forward interest rates are the rats of interest implied by current zero rates for periods of time in the future.

2)Repurchase agreements(Repo rate):-Repurchase agreement a contract where an investment dealer who owns securities agrees to sell them to another company now and buy them back letter at slightly higher price.
The difference between the price at which the securities are sold and the price at which they are repurchase is the interest it earns.The interest rate is referred to as the repo rate.

Type of repurchase agreement .
1) Open repurchase agreement :-Open repurchase agreement is where there no agreed termination date.Both parties have the option to terminate the agreement without notice .Rate of these agreement is usually a floating rate.
2)Fixed term repurchase agreement-Where the rate and the term are agreed at the outset of the agreement.The term of repos usually ranging from a day to a few months.

3)Forward rate agreement:-A forward rate agreement is an over-the-counter agreement that a certain interest rate will apply to a certain principal during a specified future period of time. FRA is agreement between two parties based on a notional amount for an contract period.This is a contract where interest rate is fixed for future.FRA hedge the interest rate risk.its consist of one to six month.

 

 

 

 

 

 

Financial services

Financial services is an intermediary activity involved in security the saving of the public fund and facilitating them to be available to the needy for investment.The presence of well organized financial system is highly imperative for the development of any country.Financial system is the nerve point which are accelerate the economic growth.

Role of financial services
Saving culture
Investment opportunity
Neutralizing the risk
Enhancing the return
Economic development

Type of financial service
Saving oriented service
Investment related service
Facilitating service
Income related service

Classification of financial services
Financial services offered not only lending and deposit money but also serve many more thing like easy banking,investment.This era of digitalization.Technology made services more easy and advanced like mobile banking and e-wallets.

Classifying services
Fund based activities
Dealing with security market services
Underwriting of share debenture and bond
Participating in new issue market
Dealing in foreign exchange market

Non-fund based activities
Financial institution provide services on fee basis that is called non-fund based activity.Financial product are taken by clients only when they are suitably supported with the services.Capital market consist of term lending institution and investing institution which mainly provide long term fund.Money market consist of commercial bank,co-operative bank.Financial services industry include all kind of organization which facilitate services for both individuals and corporate customer.

 

 

 

 

 

 

 

 

Active equity management

The security analyst always faced with the problem of buy hold or sell decision.He/she must evaluate the past performance of the security for forecasting the future performance.

Valuation of preference share and bond is straight forward because return generally constant and certain.Equity valuation is different because return on equity is uncertain and it can change time to time.therefore analysis and forecasting of equity is crucial.Stock market is not totally efficient.

Active Equity investment style:
Active equity management has two styles top-down and bottom-up.In top-down equity management style begins with overall  economic environment forecasting near term outlook and make a general asset allocation decision.Top-down managers analyses the stock market is an attempt to identify economic sector after identifying attractive and unattractive sectors and industries top-down managers finally select a portfolio of individual stock.

Bottom-up equity management style:
In bottom-up styles managers focuses analysis of individual security instead economic and environmental analysis using financial analyst or computer screening bottom-up managers analyses company performance ratio analysis,price earning ratio other financial ratio,management efficiency.

Beta Estimation

The security ‘s beta, which measures the sensitivity of the security ‘s return to those of the market because beta captures the market risk of security as opposed to its diversifiable risk, it is the appropriate measure of risk or a wealth diversified investor.
                 Using historical returns
We would like to know a stock’s beta in the future that is how sensitive will its features returns to market risk. In practice, We estimate beta based on the stock’s historical sensitivity. This approach makes sense if a stock is a beta that remains relatively stable over time, which appears to be the case for most firms.
               Many data sources provide estimates of beta based on historical data. Typically those data sources estimate.correlation and volatilities from two or five years of weekly or monthly returns.
Beta estimation has two method.                  

                                                     

                                     Direct method


Beta is the measures of systematic risk and it is a ratio of covariance between market return variance.
\beta _{j} =\frac{Covarj,m}{\sigma ^{2}m}

=\frac{\sigma _{j}\sigma _{m}corj,m}{\sigma _{m}\times \sigma _{m}}=\frac{\sigma _{j}}{\sigma _{m}}\times cor_{j,m}

Let’s consider an example suppose that percent return on the market. Represented by the BSE Sensex(sensitivity index) and the share of ABC Infotech limited for recent five years.
                                Return on Sensex and ABC Infotech

Year Market return(%) ABC infotech(%)
1 18.60 28.46
2 -16.50 -36.15
3 63.85 52.64
4 -20.65 -7.29
5 -17.80 -12.95

Beta estimation for ABC infotech limited

year r_{m} r_{j} (r_{m}-\bar{r}_{m}) (r_{j}-\bar{r}_{j}) (r_{m-}\bar{r}_{m} )\times(r_{j}-\bar{r}_{j}) (r_{m}-\bar{r}_{m})^{2}
1 18.60 23.46 13.11 19.51 255.91 171.98
2 -16.50 -36.13 -21.98 -40.08 880.83 483.08
3 63.83 52.64 58.35 48.69 2841.35 3404.85
4 -20.65 -7.29 -26.13 -11.24 293.64 682.96
5 -17.87 -12.95 -23.35 -16.90 394.57 545.35
  \bar{r}_{m}=5.48 \bar{r}_{j}=3.95     sum=4666.30 sum=5288.23

i)Average return on market
cov_{m.j}=\frac{4666.30}{5}=933.26

ii) Square deviations of market return
\sigma ^{2}=\frac{5228.23}{5}=1057.65

iii) Divide the covariance of market and ABC infotech by the market variance to get beta.
\beta _{j}=\frac{cov_{j,m}}{\sigma ^{2}m}=\frac{933.26}{1057.65}=0.88

The intercept term is given by the following formula
\alpha _{j}=\bar{r}_{j}-\beta _{j}\times\bar{r}_{_{m}}
3.95-0.88\times 5.48=-0.89
   The characteristic line of ABC Infotech p=0.89+0.88

                              

                   The market model or Index model


Another procedure of calculating beta is the use of market model.In the market model, we regress return on a security against returns of the market index.The market model is given by the following regression equation.
                                       R_{j}=\alpha+\beta _{j}R_{m}+e_{j}
where
R_{j}=expected market return
\alpha= intercept
e_{j}=error term
\beta _{j}=rgression measures the variability of the security’s beta

Beta is the ratio of the covariance between the security returns and the market returns and it is the covariance between the security returns and the market returns to the variance of the market return.\alpha indicates the return on a security when the market return is zero. It could be interpreted as the return on security on account of unsystematic risk. Over a along given the randomness of unsystematic risk .
                            The observed return on market and ABC share and a regression line. The regression line of the market model is called the characteristics line.
The characteristics line
The value of \alpha is 0.89 and the value of \beta is 0.88.
The value of \beta and \alpha in the regression equation are given by the following equations.

\beta = \frac{N\Sigma XY-(\Sigma X)(\Sigma Y)}{N\Sigma X^{2}-(\Sigma X^{})^{2}}

\beta _{j}=\frac{(5)4,774.49)-(27.42)(19.73)}{(5)(5,438.58)-(27.42)^{2}}

      =\frac{23,872.45-541.00}{27,192.90-751.86}
    
      =\frac{23,331.45}{26,441.04}   =0.88


Alpha=\alpha=\bar{Y}-\beta \bar{X}
Alpha=\alpha _{j}=3.95-(0.88)(5.48)= -0.89

 Estimation for the regression equation

Year X_{m}(X) r_{m}(Y)  XY X^{2} Y^{2}
1 18.60 23.46 436.30 345.88 550.37
2 -16.50 -36.13 595.99 272.10 1305.38
3 63.83 52.64 3360.26 4074.86 2770.97
4 -20.65 -7.29 150.54 426.42 53.14
5 -17.87 12.95 231.41 319.31 167.70
Sum \Sigma X=27.42 \Sigma Y=19.73 \Sigma XY=4774.49 \Sigma X^{2^{}}=5438.58 \Sigma Y^{2}=4847.56
Average \bar{X}=5.48 \bar{Y}=3.95      

Beta estimation in practice
In practice, the market portfolio is approximate by a well-diversified share price index. Portfolio should include all risky assets shares, bonds,gold, silver real estate art objects, etc.
                   In computing beta by regression .We need data on return market index and the security for which beta is estimating over a period of time.There are no theoretical determined time intervals for calculating beta. The time period and the time interval may vary. The returns may be measured on daily,weekly, or monthly basis.
              The return on a share and market index may be calculated as a total return that is, divided yield plus capital gain.

 Rate of return=Current dividend+(share price in th beginningshare price at the endshare price in the beginning

                               r=\frac{D_{t}+(P_{t-1})}{P_{t-1}}=\frac{D_{t}}{P_{t-1}}+[\frac{P_{t}}{P_{t-1}}-1]

In practice, one may use capital gain/loss or price return that is  p_{t}/p_{t-1}-1 rather total return to estimate beta of the company’s share. A further modification may be made in calculating the return.