Harshad Mehta Scam, 1992

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Scams in India are no news. Whenever we talk about Stock Market scams, Harshad Mehta’s scam is the first that pops up in anybody’s head. So what exactly happened in the 1992 Securities Scam that it still is the most talked about scam in the world of bulls and bears.

Mehta was born in a small, middle-class family, he completed his schooling and moved to New Delhi. After a few switches in his job, he became a stock brokers registered with Bombay Stock Exchange. In less than a decade, people started calling him as the ‘Big Bull’ of the industry. Harshad Mehta was having the time of his life, he was living in a 15,000 square feet house with flashy cars parked outside his home. He once even paid advance tax of 28 crores, his lavish lifestyle caught a lot of attention.

So, what exactly was Mehta doing?
He was investing very heavily in stocks of particular companies, so heavily that it lead to an almost 4400% rise in the share prices of those companies. It can be imagined what would happen to the markets the day he will sell these shares.

However, this is not what was wrong, interestingly, very few people questioned about the money; nobody knew where he was getting so much money for investment. And, it turned out that was where all the mystery lied. Harshad Mehta was making use of a process called ‘Ready Forward’, it basically means that banks can borrow from each other although the borrowing banks needs to deposit some securities with the lending bank and then after a certain amount of time buy back the securities, usually at a higher price. Also, usually the broker is the mediator between both the banks, the banks might not even know who they are dealing with.

But here the trick was that Mehta was using Bank Receipts to carry out such transactions. So what used to happen was that securities were not traded in actuality rather the borrowing bank used to present a receipt to the lending bank which used to acknowledge the amount being lent and the securities being the property of the lender bank now for the given period.

Now all that Mehta required was banks who would be willing to issue fake bank receipts to him, and he found out two small banks: Bank of Karad, Vijaya Bank & Metropolitan Cooperative Bank. Mehta used to take fake bank receipts from these banks and then present the same to other banks who in turn lent him money which he used to invest in stock markets and after gaining huge profits, the BRs were retired.

Soon, his trick was discovered by Sucheta Dalal, and banks realised that they were holding mere papers, because those bank receipts were not backed by any securities.

“Mehta was arrested and banished from the stock market with investors holding him responsible for causing a loss to various entities. He was arrested by the CBI on 9 November 1992 for allegedly misappropriating more than 2.8 million shares of about 90 companies through forged share transfer forms. The total value of the shares was placed at ₹2.5 billion.”

 

In the next blog, we’ll learn about the next biggest scam: The Ketan Parekh Scam, who was known to be the protege of Harshad Mehta.

 

Omission Bias

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The recent act of Demonetization attracted a lot of attention. The immediate reaction of the public was showing disagreement for the government action and there’s a perfectly good economic reason behind it.

According to us, Government had two choices:
1st choice: To act on the decision of demonetizing currency which might lead to lesser amount of black money in the economy or maybe lead to even more chaos.
2nd choice: To not take any action and everything stay where it already is.

We always have two choices: whether to perform a particular act or do not perform it. We usually think about the consequences that will follow after performing it, and never generally give weight to the act of not performing. We are accustomed to put more weight on our harmful actions and less on our inactions.  And, therefore the obvious human reaction was to stand against the government action without even realizing the effects of no action.

Do you think letting someone die is as bad as killing? Do you think not telling the truth is as bad as lying? Well, we all will consider the latter more harmful than the former. Studies have proven that humans often rate harmful omissions as less immoral, or less bad as decisions, than harmful commissions. A case has been illustrated below for better understanding:

Mr. A has two patients in front of him, suppose it is an obligation for him to kill one of them, the first patient is ill and would need a certain medicine to stay alive and the second patient is perfectly healthy as of now. There are two choices in front of him:
1st choice: Kill the second patient and save the first one by giving him the medicine.
2nd choice : Don’t do anything and let the first patient die.

When asked about which choice is better, people usually opted for the second one because it seemed less bad/immoral or less guilty. But if we analyse both the situations, we’ll understand that both of them lead to the same consequence, death. Then, why is the second choice less bad? Maybe because the first choice required some action, and action always attracts attention which leads to judgement while our inaction never puts us in the spotlight.

But is playing safe always the best option?
Patrick Doyle, CEO of Dominos Pizza in his talk at the CEO Summit organized by Business Leaders for Michigan stated that “ Leaders who want to shake things up have to be comfortable with the idea that failure is an option. In a world of hyper-competition and nonstop disruption, playing it safe is the riskiest course of all.”

So, while we are customarily more inclined towards taking no action to stay in the safe zone, we must not forget the opportunity cost of no action.

Minimum Wages- Another side

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Minimum wages have always been considered as a necessary and a well-defined industry standard, Government recently hiked the minimum wages for contract workers to Rs. 10,000. What I was wondering was, are the minimum wages enough to save a worker’s interest?

Suppose I am a firm, I hired a contract worker for a particular job which I value at Rs. 8,500 but due to the industry standards I have to pay him Rs. 10,000 Now when I am paying Rs. 1,500 more, why would I want to have the same worker? Why shouldn’t I go for a more skilled worker. And, that is how the interests of the non-skilled worker are being undermined. Also, if I am paying more than I can then I won’t hire as many people as I was hiring in the first place.

Additionally, suppose I do employ the same worker, then I am not exchanging my money with a more qualified worker, rather I am paying more for the same worker which I would have hired at Rs. 8,500. Loss for the firm, and how would it recover it? By increasing the price of the good. Increase in the prices leads to inflation. And consumer, either will stop having that good (if that good is a luxury) but if it is a necessity, he will shift to a cheaper substitute. Now, this is again a loss to the firm. And it won’t be a single firm in reality, there would be many firms like this. Implying, that it would be a loss to the economy.

Don’t interpret this article wrongly, I don’t intend to say that minimum wages is not an important law. It certainly is, and it does save worker’s interests: it provides more job opportunities, decreases turnover ratio. But, every coin has another side and so does this scheme.

 

 

 

Disclaimer: It is just an opinion piece, I don’t intend to point a finger at the Supreme Court’s decision.

Green Shoe Option

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The name might not suggest what the topic is all about, green shoe is a term used in stock markets.
Why such an amusing name?
The company that started this phenomenon was ‘Green Shoe Manufacturing Company’. Though green shoe is not a legal term, the legal term used is ‘over allotment option’

GS

 

Green shoe is provision available in an IPO (Initial Public Offer) prospectus. It allows underwriters to buy upto an additional 15% shares (in excess to the ones issued) at the offering prices.

The role of the green shoe option is to stabilize the prices.
Suppose that the prices of the shares shoot up then to bring it down to the original level the green shoe option is exercised and more shares are sold to stabilize the prices. Underwriters buy the shares from the company and sell them in the market and the difference is their profits. In the similar way, the other situation works out as well.

There are various types of green shoe options:

  1. Partial Green shoe- This option says that you can buy only some shares before the prices gets higher.
  2. Full Green shoe- This option says that you cannot buy any shares until and unless the prices rise.
  3. Reverse green shoe- It is the other situation in our example. If the share prices fall then the underwriters need to buy shares in the market and sell them back to the investors, the difference again is their profits. The fact to note here is that they are buying at the market prices while selling at the offering price and that’s where the difference comes. This is known as reverse Green shoe.

    One of the most important role of Green shoe is stabilizing the prices, when prices fluctuates it doesn’t pose a very good image of the company in front of the investors and that is why, price stabilization is important.

    Alibaba used the similar option and earned couple of billions more. Here is the story

 

ALL-YOU-CAN-EAT BUFFETS

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Have you been to any buffet? Did you like it? That’s not a very good question, I mean who doesn’t love a buffet?

There are usually two kinds of people, one who goes to a buffet and eats the normal amount, and other one (with me included) who doesn’t eat anything from the start of the day because obviously it’s an ALL-YOU-CAN-EAT BUFFET! The name says it all.

Does it ever occur to you that how does restaurants benefit from the buffets and why do individuals opt for one when they can’t eat equivalent to what they paid?

Restaurants follow the concept of diminishing marginal utility which says that our utility or satisfaction decreases as we keep on consuming more. Assuming that a customer eats 3 plates of food, for one he will pay Rs.100 for the next one he will pay Rs. 55 and for the last one he will pay Rs.5, afterwards his utility derived from the food will be zero and hence he wouldn’t pay more. Restaurants considers all these costs and always keep the cost of buffet a little above these. There are always two kinds of consumers, one who will eats way less than what they paid and one who eats well but still not equivalent to the price of a buffet. Restaurants benefit from the former so much that it compensates the latter.

Why do people like buffets when the benefits derived is so much less than the cost paid?Maybe because it offers plethora of choices and who doesn’t like variety in food?

Do you think you will feel differently for buffets serving the same kind of food but charging different amount, say one charges Rs.1000 and the other charges Rs.1500?
Most of you must be thinking that you will feel the same since the food served is no different.

That’s not what we found!

Studies shows that people found the food to be more tastier when it costed Rs.1500 than when it costed Rs.1000 because we assess the taste of food with it’s price.Studies also shows that people tend to eat more when they are offered a buffet costing more and vice versa.

It is usually seen that people try to eat more at buffets to cover their costs but we should know one thing that the cost paid at buffet is a sunk cost (you can know more about the concept from my previous article- There ain’t no such thing as a free lunch ) and that it no longer matters, so don’t stress over eating more rather try to eat different things which you wouldn’t have tried otherwise.

Did you know that restaurants have their own way of keeping you away from the expensive food?
The cheapest and most-filling items are placed at the start with huge spoons, the expensive items are usually kept down the line with a smaller spoon. Plus, you are never offered full-sized dinner plates or large soup bowls but you will always find huge glasses for water/cold drinks.I never knew people put so much thought behind something as simple as buffets.

 

Recommendation: Pirates of Grill , I visited this place a few months ago, not a very fancy place but the food was good. You can give it a try 🙂

Pay what you want

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‘Pay what you want’ gained limelight when Radiohead released their album ‘In Rainbows’ and left it to the discretion of their fans to pay whatever they feel like for the album, surprisingly they earned hundreds of thousands of dollars as revenue and that’s when it became an important topic to research upon.

So, what is pay what you want ?
Pay what you want is basically a technique wherein businesses do not decide a price for their product and leaves it upon their customers to pay a price which they think is worth it.

To understand how will this technique work, we need to focus on the psyche of the person who comes and visits us. When somebody is offered a pay what you want, there are a lot of things that comes to his/her mind. A person will pay a nice amount when he/she actually feels that they owe something to the seller or they might just do it to boost their self-image. Now, the next question is how much to pay? When I am availing some service whose value is familiar to me, I’ll know how much to pay but when I am taking away something whose value is not so familiar with me then I wouldn’t know what is the right amount. When it happens, usually the person will see what others are paying and might just pay a similar amount and when they’ll see that nobody is really bothered about paying then it might leave an impression that the service isn’t worth it and they won’t pay. When I heard about this thing, what came into my mind is that why would anybody like to pay any amount when they can get away from the situation for free? They’ll only pay when they’ll feel indebted to you otherwise nobody will bother. On the other hand, when we’ll relate this to some social cause then people will pay more. Why? Because now they have something to relate to.

There were many studies over the same topic which revealed some really interesting results:

  1. As I mentioned earlier as well, one study says that when we attach some social cause to our good then ‘pay what you want’ becomes really successful, because now people are emotionally attached to the good and they would like to pay more than it is worth. At one time, people paid five times the amount they paid earlier.
  2. Other study shows that sometimes ‘pay what you want’ turns out to be less successful because it raises a question of fairness, as nobody wants to pay any less amount and don’t wanna feel guilty about it later and therefore the demand for the product might just get lower. But when, the business will lower the amount of their product say from Rs.100 to Rs.95 then demand would be much more higher because of low price and because the concerns for fairness and self image is also gone.
  3. Also, there was a research done wherein people were asked to pay anonymously for their meal or pay to the owner and it turns out that people pay more anonymously as compared to the owner because apparently it boosts their self-image.

There is one more concept – ‘Pay forward’ which proved to be more efficient than ‘Pay what you want’. Here what is done is that, rather than asking you to pay for yourself they ask you to pay for someone who came before you or after you so its like you are paying on behalf of someone else as a gift ,which research shows will lead to an increased revenue. Karma Kitchen did the same experiment with the following cards:

And at the end they noticed that the revenue turned out to be in the following manner
Paying for someone coming after you > Paying for someone who came before you > Pay what you want for yourself

When you are paying for someone else, you feel a sense of responsibility for the other person and again you pay more to boost your self-confidence.

Concluding, Pay what you want seems like a good option but not the best at your disposal. There are much better options to know your audience. But we can’t ignore the fact that it is a good way of increasing your reach and building customer base.

The topic is vast, and the studies will go on forever, we can always add more things to each study and find out more results! I’ll definitely do a follow-up with this topic which will include more researches.
And, the next article will be a continuation on our previous discussion ‘There ain’t no such thing as a free lunch’. Keep following 🙂

The Valentine’s theory

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Valentine’s Day is here and many must be thinking about what to buy for their Valentines!
Well, if we apply Economics here then it says that don’t buy anything! Yes, that’s the best option. Confused? Let’s find out how.

So, we are applying the principle of ‘Game theory’ here.
What is game theory?
Under Game theory, we analyze different situations where the actions of one person critically affect the other.

What are the possible situations in our case?

  1. Both guy and girl get gifts.
  2. Guy gets gift, girl doesn’t.
  3. Girl gets gift, guy doesn’t.
  4. Nobody buys gifts.

Let’s put the outcomes in a table to understand better.

Game theory

Let’s see what both of them must be thinking:

Guy:

  • If I don’t get a gift and she does then I am dead- Option ruled out.
  • If I get a gift, and she doesn’t then I am the good one here- Option in consideration.
  • If we both get gifts, best situation- Option in consideration.
  • If we both don’t get gifts, again best situation but I don’t know if she is getting me a gift or not- Too much risk, Option ruled out.

So, the guy is definitely going to buy a gift. Similar situation goes for the girl as well.

They both would be getting gifts. Ofcourse, this will definitely lead to an uplift in their utility levels but it will come at a huge cost. While, if they would have got nothing for each other then the utility levels would still have risen (because the occasion is about spending time with the one you admire) without involving any kind of costs. This option is not being considered by them because they are taking decisions individually.

The other two cases where one is getting a gift while the other is not can lead to a fall in satisfaction level of any one. So, it is not a desirable situation.

Hence, we come to a conclusion that the situation where nobody buys gift for each other is the most desirable yet the most ignored situation (because there is just too much pressure to conform to the traditions).

I just came across this interesting article, do check it out: 14 ways in which an Economist says I Love You.

 

PS: I’ll be writing my next two articles about budget, since the budget day is very close. So, keep following the blog 🙂

 

Arbitrage

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Have you ever tried buying something at a lower price and then selling the same thing at a higher price ? If you have, then unknowingly you have done what we call- Arbitrage.

Arbitrage is nothing but buying a security from one market and selling it in another where the price is much higher (in terms of trading arbitrage). There are many kinds of arbitrage like Trading arbitrage, Risk arbitrage, Sports arbitrage, Municipal bonds arbitrage, etc. People perceive arbitrage to be similar to gambling. But the major difference between the two is that gambling involves a lot of risk while arbitrage is risk-free.

We’re going to talk about three types of arbitrage ,which are often used.

First one is ‘Trading Arbitrage’. So, I’ve already defined the topic. Suppose, you have the similar security priced Rs. 40 at BSE and Rs. 45 at NSE. Now, if you’re holding the security at BSE, then you can sell it at Rs. 45 at NSE and earn a profit!
You can see a few examples of Arbitrage Opportunities .

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Next one is, ‘ Risk Arbitrage’. I’ve been saying that Arbitrage is not gambling as it does not involve any kind of risk. But you can say that this is an exception because as the name suggests, it does involve risk.

Risk Arbitrage can be understood in case of companies where we witness two kinds: Mergers & Acquisitions arbitrage and Liquidation arbitrage.
Let’s understand these with the help of examples.

Suppose, there are two companies Company X and Company Y. Company Y plans to takeover Company X which will lead to the rise in worth of the shares from Rs 100 to Rs. 120. Suppose the early trading leads the price to rise upto Rs. 115, we still have an incentive of Rs. 5 for which we can undertake risk. But where’s the risk ?

I said, Company Y PLANS to takeover Company X, it didn’t happen yet. There are equal chances of the vice versa happening as well, and that’s where the risk comes into the picture.

For ‘ Liquidation arbitrage’ , similar thing holds true. You don’t know if the company will liquidate and therefore risk exists.

Lastly we have ‘ Sports arbitrage’. This again can be well understood by an example. Suppose two teams are playing, Kolkata Knight Riders & Mumbai Indians (Following IPL Auctions, can’t help it :P). And there are two match predictors who predict the winning of either teams.

Suppose ABC says that Kolkata Knight Riders would win and he’ll pay Rs. 1000 if the opposite happens. While, XYZ says that Mumbai Indians will win and he’ll pay the same amount which we’ll bet if vice versa occurs.

Now, suppose you bet on both the teams, Rs. 500 each.
Now, if Kolkata Knight Riders wins, you’ll lose your 500 with ABC but get 500 from XYZ with your initial amount.
But, if Mumbai Indians wins, you’ll lose 500 to XYZ. And, you’ll get Rs. 1000 from ABC in addition to your initial amount.

You don’t lose anything in each case. Either you’re at a no profit, no loss situation or you’re making profits.

(This is a made-up situation, everything varies with different situations)

Arbitrage is not easy. You need to have a pretty good knowledge of the concerned sector.

Hope it helped. Contact me in case of queries 🙂

Written by Tanya Jain

Stock Quotes

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Stock quotes often seem complicated because of the terminology used. But surprisingly, it’s very easy to understand.

Take the stock quotes of Google Inc for instance,

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Starting from the left :

  1. Previous Close– It refers to the closing price of the stock on the preceding day of trading. If today is Tuesday, then previous close would be closing price of the concerned stock on Monday.
  2. Open– Open is the opening price of the stock. Now, why is it different from the previous close is because of the fact that a number of factors can affect the price of a stock in between the closing and the opening bell, a good news can lead to an increment while a bad one can do the opposite.
  3. Bid– Bid is the maximum price a buyer is willing to pay for the stock.
  4. Ask– Ask is the minimum price at which seller is willing to sell his stock.
    (The number alongside both bid and ask, ie, 300 represents the lot size, one lot is equivalent to 100 shares. In this case 300 represents 30,000 meaning you can sell/buy this much shares at the given price)
  5. 1 y Target Est (1 year target estimate)– It is nothing but an estimate of the future price of stock done by the analysts.
  6. Beta– Beta measures the systematic risk of a security with respect to the entire market. There can be three cases:
    Beta=1 : This implies the security will move with the market.
    Beta<1:  This implies that the security’s price will be less volatile compared to the market.
    Beta>1: This implies that the security’s price will be more volatile compared to the market.
    In this case, it is 1.23 which means it will be 20% more volatile than the market.
  7. Next Earnings Date– It refers to the date on which the company will report its earning for the previous quarter.

Moving on to the right:

  1. Day’s Range– Day’s range conveys the highest and lowest prices of the stock traded on that day.
  2. 52wk Range– It shows you the lowest and highest price at which the stock has been traded in the past 52 weeks.
  3. Volume– Volume refers to the number of shares traded on the given day.
  4. Average Volume (3m)– Average volume is the average of shares traded over a period of time, in this case the time period is 3 months (3m)
  5. Market Cap– Market Capitalization refers to the market value of its outstanding shares (shares held by shareholders, institutional investors, etc). It is calculated by multiplying number of outstanding shares with the prevailing market price.
  6. P/E (ttm)– P/E refers to Price of the share/ Earnings per share from the last 12 months ( ttm- trailing twelve months). It tells you that how much an investor is willing to pay per dollar of your earnings.Here it is 21.95, implying that an investor will pay $21.95 dollar for each $1 of the earning that the company generates.
  7. EPS (ttm)– Earnings per share (EPS) refers to the amount of profit allocated to each share out of the total profit. It is calculated by subtracting dividends from profits and then dividing it by the number of shares outstanding.
  8. Div & Yield– It provides information about the dividend and yield. Dividend refers to the payment made by the company to its shareholder and yield is the ratio of the same expressed in percentage terms. For example: A share of $100 gives you a dividend worth $50 then the yield would be 50/100 x 100= 50%. If its mentioned that it is NA, this implies that the company does not offer dividend.

I hope it helped. Contact me in case of any queries. Thank you 🙂

The Cobra Effect

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It is often said that no government is ever going to be as smart as the people scheming against them. Whatever incentive scheme is introduced no matter how clever it is, people will find a way to beat it. And hence, these incentives which are supposed to act as a solution to a problem works against it. In Economics, we call it ‘Cobra Effect’.

So, what exactly is Cobra Effect ?
We call it Cobra effect simply because this effect originated from a situation where minimizing the population of Cobras was the agenda.
During colonial times, British government wanted to decrease the population of venomous cobra snakes and hence offered a reward for every dead snake. But the opposite happened, Indians started breeding more snakes in greed of more income. When British government realised this, they canceled the incentive and as a result the breeders set the snakes free which led to more population rise. In simple terms, Cobra effect is coming up with solutions that actually worsens the situation.

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Cobra effect was witnessed in many other situations as well, in Vietnam a similar incident happened. Here, it was rats instead of snakes, people were supposed to present the tails of rats to prove that the rats are actually dead. Soon the British officials started noticing rats with no tails. What people were doing was that, they used to chop off the tails and put the rats at one place where they would procreate and produce more of them which increased the income of the rat catchers. Hence, the incentive was again used for the bad.

There are tons of example to prove that this phenomenon actually exists. One can be taken from Afghanistan where farmers were given incentive to shift from producing opiums to other crops. Soon, many farmers started producing opium so as to get the incentive of shifting and that is how the plan backfired.

Applying it to the current situation. Government introduced odd-even formula to reduce pollution in our country. The scheme simply implies that on odd days, people with odd-numbered cars are allowed to drive and vice-versa. But again, the plan can backfire with people buying more cars with both types of number-plates.

It is very similar to the ‘Streisand Effect’ which says that when we try to hide/remove any kind of information, it rather than becoming unpopular, gets publicized a lot (used for Internet, usually ). You can read about it’s instance here.

Coming back, so the incentive schemes which are employed for our good, is sometimes misused by us. I don’t see any solution for this. People just need to be a little more co-operative, that’s the only thing which will ensure that the schemes work appropriately.