What is the role of Money?

Money plays a number of extremely important roles in a modern economy. Money has three broad roles:

1. It is a medium of exchange
2. It is a measure of value
3. It can be used as a store of wealth

The most obvious role of money is as a medium of exchange. During the early days of human civilization, it was realized that the barter system suffers from the problem of “double coincidence of wants”. This means that a barter system will only work if two persons can be found whose disposable possessions mutually suit each other’s wants. In a country or in an economy, there may be many people wanting a particular good and there may be many people who possess those things wanted, but to allow a barter or a direct exchange of goods to happen, there has to be a double coincidence of wants. For example, to have his food, a hungry tailor will have to find a farmer who needs a shirt. This is unlikely to happen. The second problem with a pure barter system is that it must have a rate of exchange, where each commodity is quoted in terms of every other commodity. This complication can be avoided if any one commodity be chosen, and its ratio of exchange with each other commodity is known. Such a commodity can be used as a unit of account or a numeraire. To overcome these problems of barter, use of a commonly accepted medium of exchange started. This medium also acted as a measure of value. Different civilizations used different commodities as the medium of exchange.

In some African countries, the medium of exchange was decorative metallic objects called Manilla. The Fijians used whales’ teeth for the same purpose. In some parts of India, cowry or sea shells were used as the medium of exchange and measure of value. Such usages of commodities as the medium of exchange and measure of value correspond to what we presently call ‘Money’. By the 19th century, commodity money narrowed down to usages of precious metals like silver and gold. Interestingly, during the World War II, cigarettes emerged as a form of commodity money in prisoner of war (POW) camps. This however limits the amount of money in the economy as it is constrained by the availability of precious metals which are exhaustible resources. Since then we have moved to an era of paper money. The use of paper money has become widespread because it is a convenient medium of exchange, is easy to carry and store and is also a measure of value for the large number of goods and services produced in a modern economy.The value of money stems from the fact that private individuals cannot legally create money. Only designated authorities are allowed to supply money. This limitation in the supply of money ensures that money retains its value. This also means that money can also be viewed as a store of wealth. It is worth pointing out here that modern currencies are not backed by any equivalent gold or silver reserves. Based on a host of macroeconomic factors, the government or the central bank decides the amount of money to be supplied to an economy.

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Measures for controlling Inflation

In my previous posts I explained about the Impact of inflation over macro-economic factors. In this post lets see how can this inflation be controlled. There are broadly two ways of controlling inflation in an economy – Monetary measures and fiscal measures.

The most important and commonly used method to control inflation is monetary policy of the Central Bank. Most central banks use high interest rates as the traditional way to fight or prevent inflation. Monetary measures used to control inflation include (i) bank rate policy (ii) cash reserve ratio and (iii) open market operations. Besides these monetary policy steps, the fiscal measures to control inflation include taxation, government expenditure and public borrowings. The government can also take some protectionist measures such as banning the export of essential items such as pulses, cereals and oils to support the domestic consumption, encourage imports by lowering duties on import items etc..,

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Impact of Inflation on macroeconomic variables

Inflation is crucial in determining the purchasing value of money. This has its impact in macro level and lets discuss here the impact of inflation over some macro economic factors such as Exchange rate, Export and Import, Interest rate and Unemployment.

Exchange Rate

Persistently higher inflation in a country (say India rupee ₹) relative to the inflation in another country (say US dollar) generally leads to depreciation of a Rupee in India. Depreciation of the currency of India means decrease in the value of the currency of country relative to the currencies of United States. In other words, if India persistently experiences higher inflation than United states, in exchange for the same number of units of Rupee ₹, the residents of India will get fewer units of US dollar $ than before.

Exports and Imports

As stated, relatively higher inflation in a country leads to the depreciation of its currency vis-à-vis that of the country with lower inflation. If the two countries happen to be trading partners, then the commodities produced by the higher inflation country will lose some of their price competitiveness and hence will experience lesser exports to the country with lower inflation. A currency depreciation resulting from relatively higher inflation leads not only to lower exports but also to higher imports.

Interest Rates

When the price level rises, each unit of currency can buy fewer goods and services than before, implying a reduction in the purchasing power of the currency. So, people with surplus funds demand higher interest rates, as they want to protect the returns of their investment against the adverse impact of higher inflation. As a result, with rising inflation, interest rates tend to rise. The opposite happens when inflation declines.

Unemployment

There is an inverse relationship between the rate of unemployment and the rate of inflation in an economy. It has been observed that there is a stable short run trade-off between unemployment and inflation. This inverse relationship between unemployment and inflation is called the Phillip’s Curve. when an economy is witnessing higher growth rates, unless it is a case of stagflation, it typically accompanies a higher rate of inflation as well. However, the surging growth in total output also creates more job opportunities and hence, reduces the overall unemployment level in the economy. On the flip side, if inflation breaches the comfort level of the respective economy, then suitable fiscal and monetary measures follow to douse the surging inflationary pressure. In such a scenario, a reduction in the inflation level also pushes up the unemployment level in the economy.

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Why Macroeconomics is important for the Investors?

For Investors or people in finance, understanding macroeconomics and its factor is very important because each of the major macroeconomic factors such as growth, inflation, business cycles etc.., have strong impact on the financial markets. They also have strong impact on the financial sector.

For example, when the economy gets into downturn, many firms find it difficult to repay their loans and as a result, the financial health of banks gets affected. Furthermore, changes in macroeconomic policies influence key variables of financial markets such as interest rates, liquidity and capital flows.

On the other hand, what is happening in the financial market can have a strong impact on the rest of the economy. Some examples of such transmission can be observed during the financial crises. In the United States, weaknesses in the financial sector stemming from a sudden and substantial decline in the prices of real estate, led to a downturn for the entire economy. In fact, almost all the countries of the world were affected because of this problem in the United States. In many countries across the world, this crisis hit not only the financial markets but also the entire economy, causing major recession and unemployment. The governments of these countries had to undertake serious coordinated policy measures to pull their economies out from recession.
As finance and macroeconomics are intimately interlinked, it becomes imperative for a finance professional to have at least a working knowledge of macroeconomics, so that they can better predict how firms and individuals behave in different situations, what risks and opportunities arise in what macroeconomic situation, how changes in policy changes can affect different macroeconomic variables and so on.

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what is T+2 or T+3 days settlement in share trading?

Indian and European capital markets follows T+2 Rolling Settlement whereas countries like South Africa and United States follows T+3 settlement.

• T is the transaction date
• ‘+2’ or ‘+3’ denotes the number of days for settlement

Thus, trades done on Monday are settled 2 working days later viz. Wednesday and In case of T+3 days, settlement is made after 3 working days i.e. on Thursday.

All transactions executed on the stock exchanges are to be settled through the Clearing Corporation/House of the stock exchanges. However, the following exceptions are provided:

• Total connectivity failure to the exchange/STP (Specific connectivity issues of the custodians and members are not to be considered as valid exceptions).
• International Holidays that may be decided upfront by the stock exchanges in consultation with the custodians.
• Closing down of national/international centres due to calamities.

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Hedge funds–Simple and Easy explanation

Hedge funds are generally created by a limited number of wealthy investors who agree to pool their funds and hire experienced professionals (fund managers) to manage their portfolio. These funds are private agreements and generally have little or no regulations governing them. This gives a lot of freedom to the fund managers.

For example, hedge funds can go short (borrow) funds and can invest in derivatives instruments which mutual funds cannot do.

Hedge funds generally have higher management fees than mutual funds as well as performance based fees. The management fee (paid to the fund managers), in the case of hedge funds is dependent on the assets under management (generally 2 - 4%) and the fund performance (generally 20% of the excess returns over the market return generated by the fund).

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Open ended and closed-ended funds–Explained

Funds are usually open or closed-ended.

In an open-ended fund, the units are issued and redeemed by the fund, at any time, at the NAV prevalent at the time of issue / redemption. The fund discloses the NAV on a daily basis to facilitate issue and redemption of units.

Unlike open-ended funds, closed-ended funds sell units only at the outset and do not redeem or sell units once they are issued. The investors can sell or purchase units to (or from) other investors and to facilitate such transactions, such units are traded on stock exchanges. Price of closed ended schemes are determined based on demand and supply for the units at the stock exchange and can be more or less than the NAV of the units.

We now examine the different kind of funds on the basis of their investments. Mutual fund investments represented as units in a single portfolio, in real life, fund houses float various schemes from time-to-time, each a constituting a portfolio where inputs translate into units. These schemes are differentiated by their charter which mandates their investment into asset classes. Beyond the type of instruments they invest in, fund houses are also differentiated in terms of their investment styles. The approaches to equity investing could be diversified or undiversified, growth, income, sector rotators, value, or market-timing based.

Each mutual fund scheme has a particular investment policy and the fund manager has to ensure that the investment policy is not breached. The policy is laid right at the outset when the fund is launched and is specified in the prospectus, the ‘Offer Document’ of the scheme. The investment policy determines the instruments in which the money from a specific scheme will be primarily invested. Based on these securities, mutual funds can be broadly classified into equity funds (growth funds and income funds), bond funds, money market funds, index funds, etc. Generally, fund houses have dozens of schemes floating in the market at any given time, with separate investment policies for each scheme.

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things you need to know about a Company Share or Stock

 

Simply put, the shareholders of a company are its owners. As owners, they participate in the
management of the company by appointing its board of directors and voicing their opinions,
and voting in the general meetings of the company. The board of directors have general oversight of the company, appoints the management team to look after the day-to-day running of the business, set overall policies aimed at maximizing profits and shareholder value.

Shareholders of a company are said to have limited liability. The term means that the liability of shareholders is limited to the unpaid amount on the shares. This implies that the maximum loss of shareholder in a company is limited to her original investment. Being the owners, shareholders have the last claim on the assets of the company at the time of liquidation, while debt- or bondholders always have precedence over equity shareholders. At its incorporation, every company is authorized to issue a fixed number of shares, each priced at par value, or face value in India.

The face value of shares is usually set at nominal levels (Rs. 10 or Re. 1 in India for the most part). Corporations generally retain portions of their authorized stock as reserved stock, for future issuance at any point in time. Shares are usually valued much higher than the face value and this initial investment in the company by shareholders represents their paid-in capital in the company. The company then generates earnings from its operating, investing and other activities. A portion of these earnings are distributed back to the shareholders as dividend, the rest retained for future investments. The sum total of the paid-in capital and retained earnings is called the book value of equity of the company.

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