Basis Point - BPS

What Does Basis Point - BPS Mean?

A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes and the yield of a fixed-income security.

The relationship between percentage changes and basis points can be summarized as follows: 1% change = 100 basis points, and 0.01% = 1 basis point.

So, a bond whose yield increases from 5% to 5.5% is said to increase by 50 basis points; or interest rates that have risen 1% are said to have increased by 100 basis points.

Lifetime Payout Annuity

What Does Lifetime Payout Annuity Mean?

A type of insurance product that pays out a portion of the underlying portfolio of assets over the life of the investor. A lifetime payout annuity can provide fixed or variable payments. In a fixed payout scheme, the investor receives a fixed dollar amount for each payment, potentially with cost of living adjustments (COLA). Payouts under a variable payout scheme will fluctuate because payments are based on the value of the investments held in the annuity's portfolio.

Investors may choose a lifetime payout annuity to head off the risk of outliving the amount of money set aside for retirement. Basically, the guaranteed payments for life reduce a person's longevity risk. However, this payout scheme can cause problems for those wanting to leave estates to heirs. Payouts from a lifetime payout annuity typically end with the death of the policyholder. The policyholder can purchase adjustments which allow payments to continue to an estate or which allow for a guaranteed number of payments, but these can result in a different payout.

Earnings Manangement

Before diving into what earnings management is, it is important to have a solid understanding of what we mean when we refer to earnings. Earnings are the profits of a company. Investors and analysts look to earnings to determine the attractiveness of a particular stock. Companies with poor earnings prospects will typically have lower share prices than those with good prospects. Remember that a company's ability to generate profit in the future plays a very important role in determining a stock's price.

That said, earnings management is a strategy used by the management of a company to deliberately manipulate the company's earnings so that the figures match a pre-determined target. This practice is carried out for the purpose of income smoothing. Thus, rather than having years of exceptionally good or bad earnings, companies will try to keep the figures relatively stable by adding and removing cash from reserve accounts (known colloquially as "cookie jar" accounts).

Abusive earnings management is deemed by the Securities & Exchange Commission to be "a material and intentional misrepresentation of results". When income smoothing becomes excessive, the SEC may issue fines. Unfortunately, there's not much individual investors can do. Accounting laws for large corporations are extremely complex, which makes it very difficult for regular investors to pick up on accounting scandals before they happen.

Although the different methods used by managers to smooth earnings can be very complex and confusing, the important thing to remember is that the driving force behind managing earnings is to meet a pre-specified target (often an analyst's consensus on earnings). As the great investor Warren Buffett once said, "Managers that always promise to "make the numbers" will at some point be tempted to make up the numbers".

Bonus Issue

Bonus Issue

What Does Bonus Issue Mean?

An offer of free additional shares to existing shareholders. A company may decide to distribute further shares as an alternative to increasing the dividend payout.

Also known as a "scrip issue" or "capitalization issue".

New shares are issued to shareholders in proportion to their holdings. For example, the company may give one bonus share for every five shares held.

What is a Book closure/Record date?

The registered shareholders of the company are entitled to corporate benefits such as dividend, bonus, rights etc. announced by the company from time to time. Since, the ownership of shares of companies traded on the stock exchange is freely transferable and to enable the company to know the persons entitled to the benefits, all transfers of securities have to be registered with the company (this is required in case of transfer of shares in physical form). Since transfer of securities is a continuous process open any time, the company announces cut off dates from time to time and members on the register of shareholders as of these cut off dates are entitled to the benefits. Such cut-off dates are record dates. Alternatively, the company might choose the close the register of shareholders for registration of transfer during a specified period. All transfer requests received before the commencement of the book closure or on or before the record date are considered for the purpose of transfer. A Company cannot close its books for more than 30 days at stretch for a book closure, and not more 45 days in a year. The period between two Book Closure cannot be less than 90 days

What is the difference between book-closure and record-date?

ACC announced a Book Closure (BC) for the period 6th July to 30th July'96. During this period, the company had closed its register of security holders. This was done to determine the number of registered members who were eligible for the Bonus 3:5 and a dividend of 40%. The process of transfer of shares was operational till 5th July'96. The company announced a No Delivery period from 12th June to 9th July'96 before the Book Closure. During this period, trading was permitted in the securities but the trades were settled only after 9th July. Hence, the buyers of the shares were not be eligible for the Bonus 3:5 and a 40% dividend. The first day of the No Delivery period is considered as an Ex - Date since the buyer of the shares is not eligible for the corporate benefits for this BC.

The same logic holds good for Record date, but the two main differences are that : In case of a record date, the company does not close its register of security holders. Record date is a cut off date ( in the above example '5th july96) for determining the number of registered members who are eligible for the corporate benefits [Interim dividend (30%) ].

What is a 'No Delivery' period?

Whenever, a book closure or a record date is announced by a company, the exchange sets up a 'No Delivery' period for that security. During this period, trading is permitted in the security. However, these trades are settled only after the No-Delivery period is over. The start of No-Delivery period is the ex-date of the settlement.The settlement is clubbed with the settlement of the week whose pay-out date falls just after the end of the no-delivery period. This is done to ensure that investor's entitlement for the corporate benefits is clearly determined. No-delivery period generally extends to all weekly cycles touched from 15 days prior to the record date and 4 days subsequent to the record date (both inclusive).

What is an ex-date?

The first day of the 'No Delivery' period is the ex-date viz., if there is any corporate benefit such as rights, bonus, dividend etc. announced for which book closure/record date is fixed, the buyer of the shares on or after the ex-date will not be eligible for the benefits while the seller would be eligible for the same.

What Are Depositary Receipts?

A depositary receipt (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity, that is issued by a foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. One of the most common types of DRs is the American depositary receipt (ADR), which has been offering companies, investors and traders global investment opportunities since the 1920s.

Since then, DRs have spread to other parts of the globe in the form of global depositary receipts (GDRs) (the other most common type of DR), European DRs and international DRs. ADRs are typically traded on a U.S. national stock exchange, such as the New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated in U.S. dollars, but can also be denominated in euros.

How Does the DR Work?

The DR is created when a foreign company wishes to list its already publicly traded shares or debt securities on a foreign stock exchange. Before it can be listed to a particular stock exchange, the company in question will first have to meet certain requirements put forth by the exchange. Initial public offerings, however, can also issue a DR. DRs can be traded publicly or over-the-counter. Let us look at an example of how an ADR is created and traded:

Example

Say a gas company in Russia has fulfilled the requirements for DR listing and now wants to list its publicly traded shares on the NYSE in the form of an ADR. Before the gas company's shares are traded freely on the exchange, a U.S. broker, through an international office or a local brokerage house in Russia, would purchase the domestic shares from the Russian market and then have them delivered to the local (Russian) custodian bank of the depository bank. The depository bank is the American institution that issues the ADRs in America. In this example, the depository bank is the Bank of New York. Once the Bank of New York's local custodian bank in Russia receives the shares, this custodian bank verifies the delivery of the shares by informing the Bank of New York that the shares can now be issued in the United States. The Bank of New York then delivers the ADRs to the broker who initially purchased them.

Based on a determined ADR ratio, each ADR may be issued as representing one or more of the Russian local shares, and the price of each ADR would be issued in U.S. dollars converted from the equivalent Russian price of the shares being held by the depository bank. The ADRs now represent the local Russian shares held by the depository, and can now be freely traded equity on the NYSE.

After the process whereby the new ADR of the Russian gas company is issued, the ADR can be traded freely among investors and transferred from the buyer to the seller on the NYSE, through a procedure known as intra-market trading. All ADR transactions of the Russian gas company will now take place in U.S. dollars and are settled like any other U.S. transaction on the NYSE. The ADR investor holds privileges like those granted to shareholders of ordinary shares, such as voting rights and cash dividends. The rights of the ADR holder are stated on the ADR certificate.

Pricing and Cross-Trading

When any DR is traded, the broker will aim to find the best price of the share in question. He or she will therefore compare the U.S. dollar price of the ADR with the U.S. dollar equivalent price of the local share on the domestic market. If the ADR of the Russian gas company is trading at US$12 per share and the share trading on the Russian market is trading at $11 per share (converted from Russian rubles to dollars), a broker would aim to buy more local shares from Russia and issue ADRs on the U.S. market. This action then causes the local Russian price and the price of the ADR to reach parity. The continual buying and selling in both markets, however, usually keeps the prices of the ADR and the security on the home market in close range of one another. Because of this minimal price differential, most ADRs are traded by means of intramarket trading.

A U.S. broker may also sell ADRs back into the local Russian market. This is known as cross-border trading. When this happens, an amount of ADRs is canceled by the depository and the local shares are released from the custodian bank and delivered back to the Russian broker who bought them. The Russian broker pays for them in roubles, which are converted into dollars by the U.S. broker.

The Benefits of Depositary Receipts

The DR functions as a means to increase global trade, which in turn can help increase not only volumes on local and foreign markets but also the exchange of information, technology, regulatory procedures as well as market transparency. Thus, instead of being faced with impediments to foreign investment, as is often the case in many emerging markets, the DR investor and company can both benefit from investment abroad. Let's take a closer a look at the benefits:

For the Company

A company may opt to issue a DR to obtain greater exposure and raise capital in the world market. Issuing DRs has the added benefit of increasing the share's liquidity while boosting the company's prestige on its local market ("the company is traded internationally"). Depositary receipts encourage an international shareholder base, and provide expatriates living abroad with an easier opportunity to invest in their home countries. Moreover, in many countries, especially those with emerging markets, obstacles often prevent foreign investors from entering the local market. By issuing a DR, a company can still encourage investment from abroad without having to worry about barriers to entry that a foreign investor might face.

For the Investor

Buying into a DR immediately turns an investors' portfolio into a global one. Investors gain the benefits of diversification while trading in their own market under familiar settlement and clearance conditions. More importantly, DR investors will be able to reap the benefits of these usually higher risk, higher return equities, without having to endure the added risks of going directly into foreign markets, which may pose lack of transparency or instability resulting from changing regulatory procedures. It is important to remember that an investor will still bear some foreign-exchange risk, stemming from uncertainties in emerging economies and societies. On the other hand, the investor can also benefit from competitive rates the U.S. dollar and euro have to most foreign currencies.

Conclusion

Giving you the opportunity to add the benefits of foreign investment while bypassing the unnecessary risks of investing outside your own borders, you may want to consider adding these securities to your portfolio. As with any security, however, investing in ADRs requires an understanding of why they are used, and how they are issued and traded.

Leverage

What Does Leverage Mean?

1. The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment.

2. The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged.

Leverage is most commonly used in real estate transactions through the use of mortgages to purchase a home.

Investopedia Explains Leverage

1. Leverage can be created through options, futures, margin and other financial instruments. For example, say you have $1,000 to invest. This amount could be invested in 10 shares of Microsoft stock, but to increase leverage, you could invest the $1,000 in five options contracts. You would then control 500 shares instead of just 10.

2. Most companies use debt to finance operations. By doing so, a company increases its leverage because it can invest in business operations without increasing its equity. For example, if a company formed with an investment of $5 million from investors, the equity in the company is $5 million - this is the money the company uses to operate. If the company uses debt financing by borrowing $20 million, the company now has $25 million to invest in business operations and more opportunity to increase value for shareholders.

Leverage helps both the investor and the firm to invest or operate. However, it comes with greater risk. If an investor uses leverage to make an investment and the investment moves against the investor, his or her loss is much greater than it would've been if the investment had not been leveraged - leverage magnifies both gains and losses. In the business world, a company can use leverage to try to generate shareholder wealth, but if it fails to do so, the interest expense and credit risk of default destroys shareholder value.

Labor Intensive

What Does Labor Intensive Mean?

A process or industry that requires a large amount of labor to produce its goods or services. The degree of labor intensity is typically measured in proportion to the amount of capital required to produce the goods/services; the higher the proportion of labor costs required, the more labor intensive the business.

Labor intensive industries include restaurants, hotels, agriculture and mining. Advances in technology and worker productivity have moved some industries away from labor-intensive status, but many still remain.

Labor costs are considered variable, while capital costs are considered fixed. This gives labor-intensive industries an advantage in controlling expenses during market downturns by controlling the size of the employee base. Disadvantages include limited economies of scale (you can't pay workers less by hiring more of them), and susceptibility to wage forces within the labor market.