INFLATION

Inflation as it is more popularly known is nothing but the decrease in the purchasing power of money over a period of time. Agree??

Well take an example – one Kg potatoes were costing Rs. 10 last yr. This year Rs. 10 will buy you only 800 gm potatoes. Or in other words, one Kg potatoes will cost you Rs 12 (approx). So this is what inflation is – the decreasing power of money over a time period. So what would an item cost next year at 6.5% inflation if it is costing Rs 1500 today?

Ans: 1500 * 1.065 = Rs. 1598 (rounded).

Simple isn’t it?

Recently India’s Inflation reached double digits riding on record prices of rice, wheat and other foodstuff, along with the sky-high oil price.

Measures to keep it under check:

Ask the Finance minister: Inflation is one barometer to measure where the economy is headed to.

While preparing the annual budget, the FM and his team take all necessary steps to keep inflation deflated. In other words, prices of day-to-day commodities, like food grains, groceries, energy in the form of electricity, petroleum products and FMCG products are tried to keep in check. Various norms are set, policies are amended and implied, taxes and duties are levied or relieved, all to get the inflation number correct. The government has been taking steps to control prices when inflation rises, for example, banning exports of sensitive items like non-basmati rice and scrapping import duties on cooking oils and maize. Price ceiling on commodities if all other measures fail to bring down inflation is one option to keep inflation in check - a law last used in the 1970s.

Also first time in the last 5 years have the prices of petrol and diesel actually been decreased. All this in order to help Indians fight inflation.

In the US, there is a factor called as the “Cost-of-living”. This factor changes year by year depending upon the price of daily commodities like soaps to soups, wines and dines, clothes, healthcare, etc. This is nothing but what we can say the inflation check that they do YOY. Various norms are set depending upon the cost-of-living, right from employee compensation to taxes levied to sponsorship plans to pensions etc.

In short, Inflation is not a local or national issue. It has global roots. And thus the primary concern of the G8 (plus China & India etc) should be economics and not world pollution, which can be taken care at a local level.

Exchange Traded Funds (ETFs)

Well most of us know what a mutual fund is. To keep it simple, it is an investment house (company) that collects funds available with retail investors and invests them in stocks, bonds, commercial papers etc of various companies & the govts. alike, and in return, gives mutual fund units (or MF shares as they are called in the US) to the investors.

Exchange traded funds (ETFs) is a security like an index fund, a commodity, or a basket of assets with a difference that it trades on the exchange (like the NSE) just like common stock, thus it would have intra-day price fluctuations like stock as compared to Mutual Fund Units whose NAVs show price change only at the end of the day (everyday for open-ended schemes, weekly etc for closed ended schemes). Thus ETF could be classified as an open ended MF.

Thus ETFs’ price changes on the exchange just as it is bought and sold thru the exchange. Thus an ETF will not have its NAV calculated at the end of each trading day, but the final close price after closing bell on the exchange is the price of that ETF.

Advantages of an ETF:

Well put it this way. It is a combo offer. How? So as I said that it is a mutual fund (or pretty much like it), thus an investor would get the diversification of a Mutual fund, along with the option of trading it like a stock (like short-selling, margin, intra-day trading etc). Another advantage is that the expense / costs with ETFs are much lower than those of normal mutual funds, meaning you pay a much lesser commission to your broker for ETF than for any other MF.

Some key features of ETF:

1. Open ended MF – though not technically MFs, can be traded on an exchange like common stock.

2. Generally comprise of basket of securities.

3. These are passively managed MFs

4. Generally traded in large blocks (of 50000 units etc).

5. For convenience, the Net Asset Value (NAV) of the ETF is usually represented as a fraction of its underlying index.

Facts and figures:

1. ETFs are fastest growing MF structure in the world.

2. The first ETF in India was launched by benchmark MF and was called ‘Nifty BeAS’ – Nifty Benchmark Exchange traded scheme. In Dec 2001.

3. For instance, the Benchmark Nifty ETF has an NAV that is one-tenth of the prevailing Nifty value.

4. Some Indian ETFs are:

1. Nifty BeAS

2. Juniior BeAS

3. SUNDER – UTI AMC

4. SPiCE – PruICICI AMC etc.

Index Funds

An Index fund is nothing but a mutual fund which invests in a particular index and all the stocks that comprise that index in the same proportion that these stocks are in the Index. For example, some Indian Index Funds are HDFC INDEX FUND (NIFTY), HDFC INDEX (SENSEX), FT INDIA INDEX SENSEX etc.

So what is the advantage?

Advantages are two. One, since the index fund tracks the stocks in a particular index, the returns from these funds will be comparable to the index. Thus most index funds would at the least match the index. Secondly, the Index funds are passively managed funds, thus the administration cost incurred are far less as compared to other MF. Also these funds track the index stocks with minimum transactions, so the transaction cost incurred are reduced substantially, which all reflects in the NAV eventually.

Any disadvantages?

Yes. Though the index funds track the index stocks, these are not short of the risk involved with the type of asset the fund holds. Thus index funds do not mitigate market risks.

Index fund scenario in India as against that in the US.

In India, the index funds came in very late as compared to the US. Infact, when you compare with the US, the mutual fund industry started way too late in India.

The idea of Index funds in India is borrowed from the US, with the same objective to reduce administrative costs and also match the market returns, both at the same time.

The US index funds for example operate at expense ratios of 0.1 to 0.8 as against in India, the Indian Index funds have expense ratios of 1.0 to 2.1. Thus when compared to the US, we our Index funds have some catching up to do.

The Outlook

As mentioned earlier that Indian Index fund market is still in the nascent stage and way behind the performance of the US counterparts. But these funds are gaining popularity and with better expense ratios achieved YOY, there is no doubt that the outlook for index funds is positive, with merits attached to invest some portion of you investment fund in the Index funds.

An Index (Stock Index)

Ok from the name, what do you think an Index would be? Are you thinking of the Index Finger? :)

Well an Index is a group of many stocks trading on a stock exchange, such that the movement of this index gives the essence of the movement of the market in general. An index would comprise of stocks from various sectors, IT, manufacturing, telecom, FMCG etc. One or more companies from each of these sectors would be selected to be a part of this Index, such that it would represent the sector.

Let us take an example of an Index. Nifty, BSE Sensex, BSE 100, CNX IT, Bank NIFTY, CNX MIDCAP 200, etc are examples of some indices. Let us examine one more closely, the BSE SENSEX.

BSE Sensex is an Index that is marked on the Bombay Stock exchange (BSE). The Sensex (as it is called) represents 30 stocks from varied sectors like manufacturing, IT, Infrastructure, Banking, Telecom etc which are all independently listed on the BSE. The 30 stocks are not necessarily the same. The stocks can be added and removed from the Sensex depending upon how adequately that specific stock defines and represents its sector. But for the Sensex, the number of stocks is kept constant at 30.

Let us see which these stocks are:

Sector	Stocks	No
Cement	ACC, Ambuja cements	2
Auto	Bajaj Auto ; Hero Honda ; Maruti Udyog ; Tata Motors	4
Telecom	Bharti ; Reliance Comm;	2
Pharma	Dr Reddy's ; Cipla ; Ranbaxy	3
Engineering	BHEL ; Larsen	2
Finance	HDFC	1
Bank	HDFC bank, ICICI ; SBI	3
Metals	Hindalco ; Tata Seel	2
FMCG	HLL ; ITC ;	2
IT	Infosys ; Satyam ; TCS ; Wipro	4
Power	NTPC ; ONGC ; Reliance Energy	3
Manufacturing	Reliance	1
Retail	Grasim	1
Total Scrips =		30

Thus the above combination of stocks makes the Sensex index.

Thus when the SENSEX is in the green, it means that on the whole, the 30 stocks (above) have moved up (in general) thus pulling the Sensex. This would also mean that there are more advances than declines (again in general) on the BSE. But note that if the Sensex is in green, it does not necessarily mean that other BSE indices like the BSE 100 etc would also follow suit. The performance of two indices is derived from the value gained or lost by the underlying stocks on that day and not by the market movement in general, though most times the Sensex falling would also see the market in red, but this not being a rule.

Similarly the NIFTY is an Index comprising 50 stocks, BSE IT would comprise only the IT companies (not necessarily all) that are listed on the BSE etc.

Gross Domestic Product (GDP)

The gross domestic product (GDP) is the primary indicator used to gauge the health of a country's economy. The GDP of a country is defined as the market value of all final goods and services produced within a country in a given period of time - you can think of it as the size of the economy. Usually, GDP is expressed as a comparison to the previous quarter or year. For example, if the year-to-year GDP was up 3%, it means that the economy has grown by 3% over the last year.

The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

GDP = C (consumption) + G (government spending) + I (investment) + NX (net exports)

Where:

"C" is equal to sum of expenditures by households on durable goods, nondurable goods, and services. Examples include clothing, food, and health care.
"G" is the sum of expenditures by all government bodies on goods and services. Examples include naval ships and salaries to government employees.
"I" is the sum of all the country's businesses spending on capital. Examples include machinery, unsold products, and housing.
"NX" is the nation's total net exports, calculated as total exports minus total imports. (NX = Exports - Imports)

India's GDP recently (2007) crossed the trillion-dollar mark for the first time and with this India has joined the elite club of 12 countries with a trillion dollar economy. Countries that have breached trillion-dollar GDP level in the past are the US, Japan, Germany, China, UK, France, Italy, Spain, Canada, Brazil and Russia.