FTFM Practical Questions RAOS COLLEGE 98400 63269 CA

FTFM Practical Questions RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Greenfield Privatization • This term connotes Government of India’s intention to allocate more and more industrial sectors exclusively for private sector. • More specifically, Sunrise industries and such other industries that are not highly capital intensive, or social benefit related etc, were sought to the encouraged under private sector, with a parallel effort to reduce budgetary support to excising PSU’s. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Government of India selected five different reasons to go about implementing the process of Greenfield privatization 1. Delicensing – Many industries that were exclusively reserved to the taken up in public sector were delicensed; thus opening up opportunities for private sector investment, introducing a spirit of healthy competition. 2. Reducing the budget allocation. 3. Stream lining decision making systems 4. Allowing accusing external aids and grants, particularly for infrastructure related projects, and 5. Reduction in anomaly in duty structure. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Financial Engineering • According to John Finnerty “Financial engineering involves the design, the development, and the implementation of innovative financial instruments and processes, and the formulation of creative solutions to problems in finance”. • There are eleven factors responsible for financial innovation. These factors are: RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

1. Tax Advantage 2. Reduced Transaction Cost 3. Reduces Agency Cost 4. Risk Reallocation 5. Increased Liquidity 6. Regulatory or Legislative Factors 7. Level and Volatility of Interest Rates 8. Level and Volatility of Prices. 9. Academic Work 10. Accounting Benefits 11. Technological Development and Other Factors RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Financial Engineering • The financial derivatives can be used for speculation but the essential objective of the development of derivatives Instrument is risk management. • The science of using various derivative instrument is collectively called financial engineering. • The futures and options are used for shorter term risk management the swap are used for longer term risk management. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Computational Finance or Financial Engineering • Computational finance or financial engineering is a cross-disciplinary field which relies on computational intelligence, mathematical finance, numerical methods and computer simulations to make trading, hedging and investment decisions, as well as facilitating the risk management of those decisions. • Utilising various methods, practitioners of computational finance aim to precisely determine the financial risk that certain financial instruments create. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Global Depository receipts. • A Depository receipts is basically a negotiable instrument, certificate, denomination in us dollars, that represents a non US company’s publicly traded local currency (Indian Rupees) Equity share in theory, though a depository receipts can also represent a debt instrument, in practice it rarely does. • Depository Receipts is created when a local currency share of an Indian company are delivered to the Depository bank (such as the bank of New York) issue depository receipt in US Dollar. • These DR’s may trade freely in the overseas market like any other dollar denominated security, either on a foreign stock exchange markets on among a restricted group, such as qualified institutional every. • Indian issues have taken the form of GDR’s to reflect the fact that they are marketed globally, rather than in a specific country or market. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

REPO • These are Money Market transactions entered into by players in the money market such as commercial banks, financial institutions, large players like Mutual Funds but are in restricted use because of reserve Bank of India policy guidelines. • The word “REPO” is the abbreviation of a Repurchase Option. • An agreement by which a borrower sells certain acceptable securities to a lender against funds received and agrees to reverse the transaction at an agreed future date is the essential feature of a REPO transaction. • In essence it is a contract of lending and the difference between the prices of the securities on the two dates will represent the cost of funds which the borrower agrees to bear. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

REPO & REVERSE REPO • A single transaction as described above is a ‘REPO’ transaction when viewed from the point of view of the borrower-seller of securities; the same transaction when viewed from the point of view of the lender-buyer is understood as a ‘REVERSE REPO’. • Hence, essentially, there is no difference between a ‘REPO’ and a ‘REVERSE REPO’ transaction excepting that the identification is from a different point of view. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Features of a REPO 1. A financial institution places certain securities (presently restricted to Treasury Bills) with the buyer and borrows a certain amount of money. 2. On a given date specified in advance (between 14 days to 1 year) the entire transaction is reversed. 3. The difference between the purchase and sale price is the interest or gain to the buyer. Sometimes the seller may also gain from a transaction. This is when the buyer is in need of securities and initiates the transaction. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

SCBA • The moral responsibility of both PSU and private sector enterprises to undertake socially desirable projects – that is, the social contribution aspect needs to be kept in view. • Industrial capital investment projects are normally subjected to rigorous feasibility analysis and cost benefit study from the point of view of the investors. Such projects, especially large ones often have a ripple effect on other sections of society, local environment, use of scarce national resources etc. • SCB is also important for private corporations who have a moral responsibility to undertake socially desirable projects, use scarce natural resources in the best interests of society, generate employment and revenues to the national exchequer. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Indicators of the social contribution include 1. Employment potential criterion; 2. Capital output ratio – that is the output per unit of capital; 3. Value added per unit of capital; 4. Foreign exchange benefit ratio. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Refinancing • The term “refinancing” would refer to a process by which a lending institution reimburses and thus takes over the exposure or assistance provided by another financing institution to an industrial or business unit. For example, a nationalized bank may provide financial assistance to a number of small scale units and may get the amount reimbursed by Small Industries Development Bank of India (SIDBI). RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

• Refinancing is a useful process by which a large lending institution which is not poised to do retail lending can do the activity through other banks/lending institutions which have infrastructure for and are focused on retail lending. • It is a convenient tool for large public institutions with developmental or social goals to reach small needy borrowers. • In India, National Agricultural Bank for Reconstruction and Development (NABARD) has refinancing schemes for agricultural financial assistance provided by commercial and rural banks. Another example can be that of Small Industries Development Bank of India (SIDBI) which re-finances assistance made to small scale units by other banks and institutions. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Venture Capital Financing • Venture capital financing refers to financing of new highrisk ventures promoted by qualified entrepreneurs who lack experience and funds to give shape to their ideas. • A venture capitalist invests in equity or debt securities floated by such entrepreneurs who undertake highly risky ventures with a potential of success. • Common methods of venture capital financing include: 1. Equity Financing 2. Conditional Loan 3. Income Note 4. Participating Debenture RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

1. Equity financing: The undertaking’s requirements of long-term funds are met by contribution by the venture capitalist but not exceeding 49% of the total equity capital; 2. Conditional Loan: Which is repayable in the form of royalty after the venture is able to generate sales; 3. Income Note: A hybrid security combining features of both a conventional and conditional loan, where the entrepreneur pays both interest and royalty but at substantially lower rates; 4. Participating debenture: The security carries charges in three phases – start phase, no interest upto a particular level of operations; next stage, low interest; thereafter a high rate. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Inter Bank Participation Certificate (IBPC) • This is a Money Market instrument to even out the short-term liquidity within the banking system. It is issued by a bank requiring funds and is subscribed to by another bank wanting to deploy surplus funds. It is issued against an underlying ‘standard’ advance and during the term of participation should always be covered by the outstanding balance in the account concerned. • IBPC can provide advantage to both the issuing bank and the participating bank. To the issuing bank it provides an opportunity to obtain funds against its advances without actually diluting the asset portfolio. To the participating lenderbank it provides an opportunity to deploy short-term funds profitably against assets qualified for bank funding. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

• IBPC is an instrument that has to comply with Reserve Bank of India’s norms and can be issued by any scheduled commercial bank. IBPC’s can be issued in two types – one with risk to the lender and the other without risk to the lender. If it is with risk to the lender, the issuing bank will reduce the amount of participation from the advances outstanding and the participating bank will show the participation as part of it’s advances. • When the issue is without risk passing on, the issuing bank will show the participation as borrowings from banks and the participating bank will show it as advances to other banks. Inter-bank Participation Certificates are short-term instruments to even out issues of short-term liquidity within the banking system. • The primary objective is to provide some degree of flexibility RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU in the credit portfolio of banks.

Take Over by Reverse-Bid • When the smaller company gains control of a larger one. Then it is called “Take-over by reverse bid”. This concept has been successfully followed for revival of sick industries. • The concept of take-over by reverse bid, or of reverse merger, is thus not the usual case of amalgamation of a sick unit which is nonviable with a healthy or prosperous unit but is a case whereby the entire undertaking of the healthy and prosperous company is to be merged and vested in the sick company which is non-viable. • Under the Sick Industrial Companies (Special Provision) Act, 1985, a company becomes a sick industrial company when there is erosion of its net worth. This alternative is also known as taking over by reverse bid. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

• The three tests in a takeover by reverse bid that are required to be satisfied are, namely, – (i) the assets of the transferor company are greater than the transferee company; – (ii) equity capital to be issued by the transferee company pursuant to the acquisition exceeds its original issued capital, and – (iii) the change of control in the transferee company will be through the introduction of minority holder or group of holders. In reverse takeover control goes to the shareholders (and usually management) of the company that is formally the target of the bid. • The term reverse takeover is also be applied to the purchase of a listed company by an unlisted company with control passing to the shareholders and management of the unlisted company. This is sometimes known as a ‘back door listing’. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

• A reverse takeover will almost always take place by way of a pure equity acquisition, also called a share swap. • A reverse takeover for the purpose of obtaining a back door listing is accomplished by the shareholders of the unlisted company selling all of their shares to the listed company in exchange for shares of the listed company. • This is a cost effective method of obtaining a public listing because it avoids the expenses associated with a floatation. Sometimes, the unlisted company usually take -over a listed company, a company i. e. , listed but not actively traded on the stock exchange. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Credit Rating • Credit rating is a symbolic indication of the current opinion regarding the relative capability of a corporate entity to service its debt obligations in time with reference to the instrument being rated. • It enables the investor to differentiate between instruments on the basis of their underlying credit quality. • To facilitate simple and easy understanding, credit rating is expressed in alphabetical or alphanumerical symbols. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

• Credit rating aims to (i) provide superior information to the investors at a low cost; (ii) provide a sound basis for proper risk-return structure; (iii) subject borrowers to a healthy discipline and (iv) assist in the framing of public policy guidelines on institutional investment. Thus, credit rating financial services represent an exercise in faith building for the development of a healthy financial system. • In India the rating coverage is of fairly recent origin, beginning 1988 when the first rating agency CRISIL was established. At present there are few rating agencies like: – (i) Credit Rating Information Services of India Ltd. (CRISIL). – (ii) Investment Information and Credit Rating Agency of India (ICRA). – (iii) Credit Analysis and Research Limited (CARE). – (iv) Duff & Phelps Credit Rating India Pvt. Ltd. (DCRI) – (v) ONICRA Credit Rating Agency of India Ltd. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Determinants of Dividend Policy • Dividend Payout Ratio • Stability of Dividend • Legal, Contractual & Internal Constraints and Restrictions • Owner’s Consideration • Capital Market Conditions and Inflation RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Objectives of Portfolio Management 1. Capital appreciation. 2. Safety or security of an investment. 3. Income by way of dividends and interest. 4. Marketability. 5. Liquidity. 6. Tax Planning - Capital Gains Tax, Income tax and Wealth Tax. 7. Risk avoidance or minimization of risk. 8. Diversification, i. e. combining securities in a way which will reduce risk. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Money Market vs. Capital Market • There is a basic difference between the money market and capital market. The operation in the money market are for a duration upto one year and deals in short term financial assets whereas in the capital market operations are for a larger period beyond one year and therefore deals in medium and long term financial assets. • Secondly, the money market is not a well-defined place like the capital market where business is normally done at a defined place like a stock-exchange. The transactions in the money market are done through electronic media and other written documents. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

1. In the capital market, there is a classification between primary market and secondary market. 2. Capital market deals for fund requirements of a long-term whilst money market generally caters to short-term requirements. 3. The quantum of transactions in the capital market is decidedly not as large as in the money market. 4. The type of instruments dealt in the money market are like inter bank call money, notice money upto 14 days, short-term deposits upto three months, 91 days/182 days treasury bills, commercial paper etc. 5. The players in the capital market are general/retail investors, brokers, merchant bankers, registrars to the issue, under-writers, corporate investors, FIIs and bankers while the money market participants are the Government, Reserve Bank of India and the banks. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Credit Cards Credit cards are a simple and convenient means of access to short term credit for consumers. They enable the consumer to: 1. Dispense with using cash for every transaction. 2. Make Monthly payments. 3. No interest charges if paid on due date every month. 4. Insurance benefits are available. 5. Special discounts can be availed which are not applicable on cash transactions. 6. For high value purchases the consumer can use the roll over facility and pay for his purchases in instalments. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Credit Cards The disadvantages of credit cards are: • The consumer commits his future income. • If not used wisely the consumer lands into a debt trap. • The rate of interest on credit cards for long term finance (roll over) is around 40% per annum. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Stock Lending Scheme • In stock lending, the legal title of a security is temporarily transferred from a lender to a borrower. The lender retains all the incidents of ownership, other than the voting rights. The borrower is entitled to use the securities/shares as required but is liable to the lender for all benefits such as dividends, interest, rights etc. • The stock lending scheme is a means to cover short sales viz. , selling shares without possessing them. The procedure is used by the lenders to maximize yield on their portfolio. • Incidentally, borrowers use the shares/securities lending programme to avoid settlement failures. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Stock Lending Scheme • Securities/stock lending provides income opportunities for security-holders and creates liquidity to facilitate trading strategies among borrowers. • Stock lending is particularly attractive for large institutional areas, as this is an easy way of generating income to offset custody fees and requires little, if any, of their involvement or time. • Stock lending gives borrowers access to tender portfolios which provide the flexibility necessary when borrowing for strategic posturing and financing inventories. From the point of view of market, stock lending and borrowing facilitates timely settlement, increases the settlements, reduces market volatility and improves liquidity. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Capital Structure • Capital structure of a firm is a reflection of the overall investment and financing strategy of the firm. • Capital structure can be of various kinds as described below: 1. Horizontal Capital Structure 2. Vertical Capital Structure 3. Pyramid shaped capital structure 4. Inverted pyramid shaped capital structure RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Horizontal Capital Structure • Horizontal capital structure: the firm has zero debt component in the structure mix. • Expansion of the firm takes through equity or retained earnings only. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Vertical Capital Structure Vertical capital structure: the base of the structure is formed by a small amount of equity share capital. This base serves as the foundation on which the super structure of preference share capital and debt is built. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Pyramid & Inverted Pyramid Capital Structure • Pyramid shaped capital structure: this has a large proportion consisting of equity capital; and retained earnings. • Inverted pyramid shaped capital structure: this has a small component of equity capital, reasonable level of retained earnings but an ever-increasing component of debt. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Significance of Capital Structure • Reflects the firm’s strategy • Indicator of the risk profile of the firm • Acts as a tax management tool • Helps to brighten the image of the firm. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Factors influencing Capital Structure • Corporate strategy • Nature of the industry • Current and past capital structure RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Bridge Loan • A bridge loan (usually bridging loan in UK, and also known in some applications as a swing loan) is a type of short-term loan, typically taken out for a period of 2 weeks to 3 years pending the arrangement of larger or longer-term financing. • A bridge loan is interim financing for an individual or business until permanent or the next stage of financing can be obtained. • Money from the new financing is generally used to "take out" (i. e. to pay back) the bridge loan, as well as other capitalization needs. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Forecasting Exchange Rates • International transactions are usually settled in the near future. Exchange rate forecasts are necessary to evaluate the foreign denominated cash flows involved in international transactions. Thus, exchange rate forecasting is very important to evaluate the benefits and risks attached to the international business environment. • There are two pure approaches to forecasting foreign exchange rates: RAO’S COLLEGE • The fundamental approach. • The technical approach. 98400 63269 CA. GOPAL KRISHNA RAJU

Fundamental Approach • The fundamental approach is based on a wide range of data regarded as fundamental economic variables that determine exchange rates. • These fundamental economic variables are taken from economic models. Usually included variables are GNP, consumption, trade balance, inflation rates, interest rates, unemployment, productivity indexes, etc. • In general, the fundamental forecast is based on structural (equilibrium) models. These structural models are then modified to take into account statistical characteristics of the data and the experience of the forecasters. It is a mixture of art and science. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Technical Approach • The technical approach (TA) focuses on a smaller subset of the available data. In general, it is based on price information. • The analysis is "technical" in the sense that it does not rely on a fundamental analysis of the underlying economic determinants of exchange rates or asset prices, but only on extrapolations of past price trends. • Technical analysis looks for the repetition of specific price patterns. Technical analysis is an art, not a science. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Efficient Market Hypothesis • In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient", or that prices on traded assets, e. g. , stocks, bonds, or property, already reflect all known information. • The efficient-market hypothesis states that it is impossible to consistently outperform the market by using any information that the market already knows, except through luck. • Information or news in the EMH is defined as anything that may affect prices that is unknowable in the present and thus appears randomly in the future. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

• In semi-strong-form efficiency, it is implied that share prices adjust to publicly available new information very rapidly and in an unbiased fashion, such that no excess returns can be earned by trading on that information. • Semi-strong-form efficiency implies that neither fundamental analysis nor technical analysis techniques will be able to reliably produce excess returns. • To test for semi-strong-form efficiency, the adjustments to previously unknown news must be of a reasonable size and must be instantaneous. To test for this, consistent upward or downward adjustments after the initial change must be looked for. • If there any such adjustments it would suggest that investors had interpreted the information in a biased fashion and hence in an inefficient manner. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Balance of Payment • "Balance of Payments is a statistical statement that summarizes transactions between residents and non-residents during a period. "The balance of payments comprises the current account, the capital account, and the financial account. "Together, these accounts balance in the sense that the sum of the entries is conceptually zero. " – The current account consists of the goods and services account, the primary income account and the secondary income account. – The financial account records transactions that involve financial assets and liabilities and that take place between residents and non-residents. – The capital account in the international accounts shows (1) capital transfers receivable and payable; and (2) the acquisition and disposal of non-produced non-financial assets. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Balance of Payments identity • The balance of payments identity states that: – Current Account = Capital Account + Financial Account + Net Errors and Omissions RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Gilt-edged primary market • Primary Market: The Primary Market consists of the issuers of the securities, viz. , Central and Sate Government and buyers include Commercial Banks, Primary Dealers, Financial Institutions, Insurance Companies & Co-operative Banks. • RBI also has a scheme of non-competitive bidding for small investors. • There are 14 primary dealers approved by RBI RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Yield curve • In finance, the yield curve is the relation between the interest rate (or cost of borrowing) and the time to maturity of the debt for a given borrower in a given currency. • For example, a bank may offer a "savings rate" higher than the normal checking account rate if the customer is prepared to leave money untouched for five years. • Investing for a period of time t gives a yield Y(t) RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Financial distress • Financial distress is a term in Corporate Finance used to indicate a condition when promises to creditors of a company are broken or honoured with difficulty. • Sometimes financial distress can lead to bankruptcy. • Financial distress is usually associated with some costs to the company; these are known as costs of financial distress. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Insolvency • Insolvency means the inability to pay one's debts as they fall due. Usually used in Business terms, insolvency refers to the inability for a 'limited liability' company to pay off debts. This is defined in two different ways: • Cash flow insolvency - Unable to pay debts as they fall due. An indicator of this on the balance sheet, is if there is "net current liabilities". • Balance sheet insolvency - Having negative net assets: liabilities exceed assets; or net liabilities. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

• A business may be cash flow insolvent but balance sheet solvent if it holds illiquid assets, particularly against short term debt. • Conversely, a business can have negative net assets showing on their balance sheet but still be cash flow solvent if ongoing revenue is able to meet debt obligations, and thus avoid default – for instance, if it holds long term debt. • Insolvency is not a synonym for bankruptcy, which is a determination of insolvency made by a court of law with resulting legal orders intended to resolve the insolvency. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Insolvency • Insolvency means the inability to pay one's debts as they fall due. Usually used in Business terms, insolvency refers to the inability for a 'limited liability' company to pay off debts. This is defined in two different ways: • Cash flow insolvency - Unable to pay debts as they fall due. An indicator of this on the balance sheet, is if there is "net current liabilities". • Balance sheet insolvency - Having negative net assets: liabilities exceed assets; or net liabilities. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Financial Futures • A financial future is a futures contract on a short term interest rate (STIR). Futures contracts based on financial instruments, such as Treasury Bonds, CDs, currencies or indexes. • Contracts vary, but are often defined on an interest rate index such as 3 -month sterling or US dollar LIBOR. They are traded across a wide range of currencies, including the G 12 country currencies and many others. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Commodity Futures • An agreement to buy or sell a set amount of a commodity at a predetermined price and date. Buyers use these to avoid the risks associated with the price fluctuations of the product or raw material, while sellers try to lock in a price for their products. Like in all financial markets, others use such contracts to gamble on price movements. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

• Trading in commodity futures contracts can be very risky for the inexperienced. One cause of this risk is the high amount of leverage generally involved in holding futures contracts. • For example, for an initial margin of Rs: 5, 000, an investor can enter into a futures contract for 1, 000 barrels of oil valued at Rs: 500, 000. • Given this large amount of leverage, even a very small move in the price of a commodity could result in large gains or losses compared to the initial margin. Unlike options, futures are the obligation of the purchase or sale of the underlying asset. • Simply not closing an existing position could result in an inexperienced investor taking delivery of a large quantity of an unwanted commodity. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU

Commodity Futures • An agreement to buy or sell a set amount of a commodity at a predetermined price and date. Buyers use these to avoid the risks associated with the price fluctuations of the product or raw material, while sellers try to lock in a price for their products. Like in all financial markets, others use such contracts to gamble on price movements. RAO’S COLLEGE 98400 63269 CA. GOPAL KRISHNA RAJU