Friday, December 19, 2008
11:02 AM
[I found this text somewhere in saved documents on my laptop...I don't know who is author of this]
How can we reduce inflation?Well, low inflation is very hard to fight. We have to reduce domestic demand without generating a large recession. That, by definition, is an extremely hard task. However, when a country has low inflation one more point (or one less point) is not a huge deal. The central bank can deal with the labor market pressures slowly.
High inflations are, on the other hand, the easiest ones to reduce. The main reason is the dollarization. As was mentioned before, in Dollars the inflation rate is the US one. So, if the Central Bank introduces a new currency (the Rigobonian) fixed to the Dollar, then the inflation rate in the new currency should be low. However, if the main cause of the monetary expansion was an irresponsible government and the fiscal policy does not change after the introduction of the new currency, agents know that the fixed exchange rate will be abandoned in the future. This means that there is an expected devaluation of the Rigobonian, and therefore, the inflation rate will be larger than in US Dollars. The lack of credibility generates the problem of not being able to reduce inflation. The question is then how we deal with the problem of credibility?
Medium inflation rates are the hardest ones to control. There are two main reasons:
inertia and relative price disequilibrium.
First, the inertia is the result that current inflation rate highly depends on the previous year inflation rate. This is the result of both the behavior of the agents and the institutionalization of the inertia in wage contracts. For example, there is a clause that says that current wage increases will recover the real wage lost in the previous year. This is a backward looking indexation, generating inertia in the contracts. The stabilization program in this case, not only requires the same ingredients of the high inflationary programs but also needs institutions that can break the existing inertia in the contracts. These institutions have to be extremely credible in order to achieve its goal.
Second, when there is medium inflation, prices in domestic currency increase in a non-coordinating way (not all of them increase at the same time). For example, assume that shoes' prices increase in odd months, while socks' prices increase in even months. There is no coordination between the industries. If suddenly prices are stopped at the middle of an odd month, the price of shoes is relatively too high with respect to the price of socks. The reason is that shoes have just adjust their price, and socks is just going to do it (note that this does not happen in hyperinflation, when the prices are set in dollars and therefore the relative price is equal to the international relative price. This is equivalent of having price increases every day). This disequilibrium cannot be maintained. What happens? Well, the relative price has to move, and the usual way is that the good that is relatively too cheap increases its price. In other words, there is some inflation rate that occurs because relative prices have to adjust. This takes a couple of months, after that inflation should be small.
Saturday, December 13, 2008
7:32 AM
Basically, households have three choices with regard to savings options:
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Hold the liabilities of traditional intermediaries, such as banks, thrifts, and insurance companies. This means holding savings accounts, money market deposit accounts (MMDAs), and so forth.
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Hold securities directly, such as stocks and bonds purchased directly through brokers and other intermediaries.
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Hold securities indirectly, through mutual funds and pension funds.
Investors always have direct investing as an option, making their own buy and sell decisions, typically through a brokerage account.If an investor has the time and ability, he/she can make the decisions in terms of managing the portfolio. With direct investing, individual makes the decisions about his/her own investment.
Most of the many investor don't have enough funds to invest, don't have enough time and expertise to make ongoing changes in the portfolio, making the necessary selling and buying decision based on current market information. Pension funds and mutual funds are the type of indirect type of investment options for people who lack in funds, time and expertise.
What is Mutual fund ?
A mutual fund is an investment company that pools the money of various investors and buys and manages a diversified portfolio of securities. The investors, or shareholders, buy shares of he mutual fund, representing ownership in all of the fund's securities. Investors share in the success, or lack of success, of the mutual fund they buy in direct proportion to the amount of the mutual fund shares they own.
Mutual funds can be classified into four groups:
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Equity funds (hold stocks of various corporations)
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Bond funds (hold debt securities of various issuers, such as governments and corporations)
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Hybrid funds (hold a combination of stocks and bonds and sometimes other securities)
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Money Market Funds (hold short-term, very safe assets such as Treasury bills and bank certificates of deposit)
ADVANTAGES OF MUTUAL FUNDS:
- Professional Management: The basic advantage of mutual funds is that they are professionally managed by well qualified professional. Investor does not have time or the expertise to manage their portfolio. So mutual funds are less expensive to make and monitor their investments.
- Diversification: Mutual funds invest in a number of companies across a broad cross-section of industries and sectors. So by purchasing mutual funds, risk is spread out and minimized to certain extent as the loss in any particular investment is minimized by gains in others.
- Convenient Administration: Investing in a mutual fund reduces paper work and helps you avoid many problems such as bad deliveries, delayed payments and unnecessary follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient.
- Return Potential: Over a medium to long term, mutual funds have the potential to provide a higher return as they invest in a diversified basket of selected securities.
- Low costs: Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investor.
- Liquidity: In open ended scheme, you can get your money back promptly at net asset value related prices from the Mutual fund itself. With closed- ended schemes, you can sell your units on a stock exchange at the prevailing market price or avail of the facility of direct repurchase at NAV related prices which some close-ended and interval schemes offer you periodically.
- Transparency: You get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund managers investment strategy and outlook.
- Flexibility: You can systematically invest or withdraw funds according to your needs and convenience.
- Choice of Schemes: Mutual Funds offer a family of schemes to suit your varying needs over a lifetime.
- Well Regulated: All mutual funds are registered with SEBI and they function with the provision of strict regulations designed to protect the interest of investors. The operations of mutual Funds are regularly monitored by SEBI.
- Tax Benefits: There is a 100% Income Tax exemption on all mutual fund dividends.
More updates will come soon...
Economic thinking is often divided into two categories—positive and normative.
Positive economics is that branch of economic inquiry that is concerned with the world as it is rather than as it should be. It deals only with the consequences of changes in economic conditions or policies. A positive economist suspends questions of values when dealing with issues suck as crime or minimum wage laws. The object is to predict the effect of changes in the criminal code or the minimum wage rate—not to evaluate the fairness of such changes.
Normative economics is that branch of economic inquiry that deals with value judgments—with what prices, production levels, incomes, and government policies ought to be. A normative economist does not shrink from the question of what the minimum wage rate ought to be. To arrive at an answer, the economist weighs the results of various minimum wage rates on the groups affected by them—the unemployed, employers, taxpayers, and so on. Then, on the basis of value judgments of the relative need or merit of each group, the normative economist recommends a specific minimum wage rate. Of course, values differ from one person to the next. In the analytical jump from recognizing the alternatives to prescribing a solution, scientific thinking gives way to ethical judgment.
Thursday, December 11, 2008
7:07 AM
Original Link :- "
Business management Theory"
A Business Management Theory is akin to the general concept of management which refers to directing and controlling a group of people for the achievement of a collective objective which is beyond the scope of individual effort. A Business Management Theory is a study of the principles and practices of a business to attain its desired organizational goals conducting effective management. Business Management Theory is a range of approaches including the principles of accounting, public relations, operations, labor relations, time management, investment and corporate governance to improve the performance of a business in some measurable or otherwise provable manner. Business management theory encompasses the deployment and manipulation of human, financial, technological and natural resources and their effective allocation for the optimum level of output for the business.
Business management theory is closely related with the concept of business management strategy and it deals with the steps that are taken by the collective decision of the managerial authority of the business as well as the workers for the attainment of the desired objective. It should be noted in this context that decision-making plays a key role in the process of management which rests on the principles of planning, organizing, directing and controlling in the business. While planning and organizing deals with strategically formulating the long term goals the business seeks to attain which is generally taken by the top level management of the company, the operational business processes involving the day-to-day activities of the business is also a part of business management theory. Controlling refers to the evaluation of the performance towards the desired objective; directing, being a part of the business management theory refers to the supervision such that the workers work towards the accomplishment of organizational goals.
Business management theories undergo testing in the real world circumstances and the theories are continuously evaluated and evolutes after every 5-10 years. One of the major cornerstones of the modern business management theory is the theory of games, otherwise considered to be branch of economic analysis.
In the last twenty five years game theory has addressed some of the key issues related to antitrust analysis and monetary policy, the design of auction institutions to patent wars to dispute resolutions between warring business firms. Game Theory is now being incorporated into business management theory which gives a meaningful insight into the way business decisions can be modeled and analyzed. Business management theories covering the issues of finance, accounting, strategies and organizational design can be dealt with in detail by applying the principles of game theory or industrial organization. The specific application areas of the theories of business management including market competition, bargaining, competitive bidding to auctions involving the situation where a number of economic agents in pursuit of their respective self interests take actions is a fundamental area of concentration of game theory.
Game theory proves to be a compelling guide for any business strategy even in the case of imperfect markets where cooperative and non-cooperative game theoretic approaches can be used. The “balance of power” between the firm, its buyers and suppliers is what makes it a basic tool for understanding business management theory and strategy which are basically the all inclusive steps that the businesses should follow to attain its long-term objectives so as to achieve the highest rates of growth and profits in the long run. As already mentioned, business strategy based on the industrial organization approach is based on economic theory and deals with issues such as competitive rivalry, resource allocation and the economies of scale. Strategy formulations mainly include self evaluation and competitor analysis which determines the objectives and the planning strategies are devised according to them.
Deflation is reduction in the level of national income and output, usually accompanied by a fall in the general price level.
Deflation is opposite of inflation.A decrease in the personal investment and spending of the government can also lead to deflation. As a result of deflation, the economy can witness increased unemployment as the demand for goods and services in the economy falls.
Causes of Deflation
- Decrease in Money supply
- Increase in goods supply
- Fall in Demand
Nature of Deflation: Deflation is viewed as a continuous process of decrease in some of the normally-followed collective indicator of price movements, like the GDP deflator or the Consumer Price Index (CPI). In general cases, a one-time reduction in the price levels does not necessarily hints at the initiation of Deflation. In fact, for Deflation to affect an economy, there must be a persistent fall in the prices for more than a year's time.
Effects of Deflation: Under Deflation, when the price fall persists, it normally creates a spiral of negative attributes comprising accelerative defaults on loan, reduction in incomes and increase in unemployments, downturn of profits and closing down of factories and manufacturing units.
What is FDI? / what is Foreign Direct Investment?
Foreign direct investment is the investment in which the invester invest in a company, which is in a different nation distinct from the investor's country of origin
FDI relationship has two sides, one is the bussiness enterprise and other is its foreidn affiliate. Bussiness enterprise and foreign affiliate together comprise an MNC. Investor enterprise through its foreign direct investment efforts seek to exercise substantial control over the foreign affiliate company.
Ownership share of the investor is categorized as FDI only if investor holds 10% or more shares or access to voting rights, otherwise the investment is termed as portfolio investment
Classification of Foreign Direct Investment
FDI can be classified as Inward or Outward. Inward FDI is the investment of foreign capital in local resources. The factors propelling the growth of Inward FDI comprises tax breaks, relaxation of existent regulations, loans on low rates of interest and specific grants. The idea behind this is that, the long run gains from such a funding far outweighs the disadvantage of the income loss incurred in the short run. Flow of inward FDI may face restrictions from factors like restraint on ownership and disparity in the performance standard.
Foreign direct investment, which is outward, is also referred to as “direct investment abroad”. In this case it is the local capital, which is being invested in some foreign resource. Outward FDI may also find use in the import and export dealings with a foreign country. Outward FDI flourishes under government backed insurance at risk coverage.
Outward FDI faces following restrictions
- Tax incentives or the lack of it for firms, which invest outside their country of origin or on profits, which are repatriated.
- Industries related to defense are often set outside the purview of outward FDI to retain government's control over the defense related industrial complex.
- Subsidy scheme targeted at local businesses.
- Lobby groups with vested interests possessing support from either inward FDI sector or state investment funding bodies.
- Government policies, which lend support to the phenomenon of industry nationalization.
Wednesday, December 10, 2008
5:14 AM
Repo is the rate at which RBI lends money to banks.
Reserve repo is the rate at which it accepts surplus funds from banks.
Sunday, December 7, 2008
2:54 AM
Future, as the name indicates, is a trade whose settlement is going to take place in the future. However, before we take a look at futures, it will be beneficial for us to take a look at forward rate agreements.
What is a forward rate agreement?
A forward rate agreement is one in which a buyer and a seller enter into a contract at a specified quantity of an asset at a specified price on a specified date.
An example for this is the exporters getting into forward rate agreements on currencies with banks. But there is always a risk of one of the parties defaulting. The buyer may not pay up or the seller may not be able to deliver. There may not be any redressal for the aggrieved party as this is a negotiated contract between two parties.
What is a future?
A future is similar to a forward rate agreement, except that it is not a negotiated contracted but a standard instrument. A future is a contract to buy or sell an asset at a specified future date at a specified price. These contracts are traded on the stock exchanges and it can change many hands before final settlement is made. The advantage of a future is that it eliminates counterparty risk. Since there is an exchange involved in between, and the exchange guarantees each trade, the buyer or seller does not get affected with the opposite party defaulting.
Futures
| Forwards |
|---|
| Futures are traded on stock exchange | Forwards are non tradable, negotiated instruments |
| Futures are contracts having standard terms and conditions. | Forwards are contracts customized by the buyer and seller. |
| No default risk as the exchange provides a counter guarantee. | High risk of default by either party. |
| Exit route is provided because of high liquidity on the stock exchange. | No exit routes for these contracts. |
| Highly regulated with strong margining and surveillance. | No such systems are present in a forward market. |
There are two kinds of futures traded in the market- index futures and stock futures. There are three types of futures, based on the tenure. They are 1, 2 or 3 month future. They are also known as near and far futures depending on the tenure. What are Index futures Index futures are futures contract on the index itself. One can buy a 1, 2 or 3-month index future. If someone wants to take a call on the index, then index futures are the ideal instruments for him. Let us try and understand what an index is. An index is a set of numbers that represent a change over a period of time. A stock index is similarly a number that gives a relative measure of the stocks that constitute the index. Each stock will have a different weight in the index The Nifty comprises of 50 stocks. BSE Sensex comprises of 30 stocks. For example, Nifty was formed in 1995 and given a base value of 1000. The value of Nifty today is 1172. What it means in simple terms is that, if Rs 1000 was invested in the stocks that form in the index, in the same proportion in which they are weighted in the index, then Rs 1000 would have become Rs 1172 today.
There are two popular methods of computing the index. They are price weighted method like Dow Jones Industrial Average (DJIA) or the market capitalization method like Nifty or Sensex.
What the terminologies used in a Futures contract?
The terminologies used in a futures contract are:
- Spot Price: The current market price of the scrip/index.
- Future Price: The price at which the futures contract trades in the futures market.
- Tenure: The period for which the future is traded
- Expiry date: The date on which the futures contract will be settlec
- Basis : The difference between the spot price and the future price
Why are index futures more popular than stock futures?
Globally, it has been observed that index futures are more popular as compared to stock futures. This is because the index future is a relatively low risk product compared to a stock future. It is easier to manipulate prices for individual stocks but very difficult to manipulate the whole index. Besides, the index is less volatile as compared to individual stocks and can be better predicted than individual stock.
Saturday, December 6, 2008
5:23 AM
What is an Option?
Every exchange-traded option is either a call option or a put option. The owner of a call option has the right to purchase the underlying good at a specific price, and this right lasts until a specific date. The owner of a put option has the right to sell the underlying good at a specific price, and this right lasts until a specific date. In short, the owner of a call option can call the underlying good away from someone else. Likewise, the owner of a put option can put the good to someone else by making the opposite party buy the good. To acquire these rights, owners of options buy them from other traders by paying the price, or premium, to a seller.
Options are created only by buying and selling. Therefore, for every owner of an option there is a seller. The seller of an option is also known as an option writer. The seller receives payment for an option from the purchaser. in exchange from payment received, the seller confers rights to the option owner. Ther seller of a call option receives payment and, in exchange, gives the owner of a call option the right to purchase the underlying good at a specific price with this right lasting for a specific time. The seller of a put option receives payment from the purchaser and promises to buy the underlying good at a specific price for a specific time, it the owner of the put option so chooses.
In these agreements, all rights lie with the owner of the option. in purchasing an option, the buyer makes payments and receives rights to buy or sell the underlying good on specific terms. In selling an option, the seller receiver payment and promises to sell or purchase the underlying good on specific temrs- at the discretion of the option owner. With put and call options the buyers and sellers, four basic positions are possible. Notice that the owner of an option has all the rights. After all, that is what the owner purchases. The seller of an option has all the obligations, because the seller undertakes obligations in exchange for payment.
Every option has an underlying good.The call writer gives the purchase the right to demand the underlying good from the writer. However, the writer of a call need not own the underlying good when he or she writes the option. If a seller writer a call and does not own the underlying good, the call is a naked call. If the writer owns the underlying good, he has sold a covered call. When a trader writes a naked call, he undertakes the obligation of immediately securing the underlying good and delivering it if the purchaser of the call chooses to exercise the call.
An option Example
Consider an option with a share of XYZ stock as the underlying good. Assume that today is March 1 and that XYX share trade at $110. The market, we assume, trades a call option to buy a share of XYZ at $100 with this right lasting until August 15 and the price of this option being $15. In this example, the owner of a call must pay $100 to acquire the stock. This $100 price is called the exercise price or the striking price. The price of the option, or the option premium, is $15. The option expires in 5.5 months, which gives 168 days until expiration.
If a trader buys the call option, he pays $15 and receives the right to purchase a share of XYZ stock by paying an additional $100, it he/she so chooses, by August 15. The seller of the option receives $15, and he/she promises to sell a share of XYZ for $100; if the owner of the call chooses to buy before August 15. Notice that the price of the option, the option premium, is paid when the option trades. The premium the seller receives is his/hers to keep whether or not the owner of the call decides to exercise the option. If the owner of the call exercises his option, he will pay $100 no matter what the current price of XYZ stock may be. If the owner of the option exercises his option, the seller of the option will receive the $100 exercise price when hi/she delivers the stock as he/she promised.
At the same time, puts will trade on XYZ. Consider a put with a striking price of $100 trading on March 1 that also expires on August 15. Assume that the price of the put is $5. If a trader purchases a put, he/she pays $5. In exchange, he/she receives the right to sell a share of XYZ for $100 at any time until August 15. The seller of the put receives $5, and he/she promises to buy the share of XYZ for $100 if the owner of the put option chooses to sell before August 15.
In both the put and call examples, the payment by the purchases is gone forever at the time the oprtion trades. The seller of the option receives the payment and keeps it, whatever the owner of the option decides to do. If the owner of the call exercises his/her option, then hi/she pays the exercise price as an additional amount and receives a share. Likewise, if the owner of the put exercises his.her option, then he/she surrenders the share and receives the exercise price as an additional amount. The owner of the option may choose never to exercise; in that case, the option will expire on August 15. The payment the seller receives is his/hers to keep whether or not the owner exercises. If the owner chooses not to exercise, the seller has a profit equal equal to premium received and does not have to perform under the terms of the option contract.
What is Moneyness?
"Moneyness" is an option concept that refers to the optential profit or loss from the immediate exercise of an option. An option may be in-the-money, out-of-the-money, or at-the-money.
A call option is in-the-money if the stock price exceeds the exercise price. e.g., a call option with an exercise-price of $100 on a stock trading at $110 is $10 in-the-money.
A call option is out-of-the-money if the stock price is less than the exercise price. e.g. if the stock is at $110 and the exercise price on a call is $115, the call is $5 out-of-the-money.
A call option is at-the-money if the stock price equals(or is very near to) the exercise price.
A put option is in-the-money if the stock price is below the exercise price. As an example, consider a put option with an exercise price of $70 on a stock that is worth $60. The put is $10 in-the-money, because the immediate exercise of the put would give $10 cash inflow. Similarly, if the put on the same stock had an exercise price of $55, the put would be $5 out-of-the-money. If the put had an exercise price equal to the stock price, the put would be at-the-money. Puts and calls can also be deep-in-the-money or deep-out-of-the-money, if the cash flows from an immediate exercise would be large in the speaker's judgment.
Friday, December 5, 2008
4:32 AM
I follow one site "www.devdutt.com", this is a part of one of the article from this site...
Dharma is that which makes human divine - our ability to say no to the beast within us, our ability to renounce the law of the jungle. The law of the jungle, that might is right, is acceptable for animals - but when humans follow it and dominate the weak, they subscribe to adharma. From the desire to dominate comes greed, the insatiable urge for power, for land, from the desire to dominate comes the desire to win, even in a gambling match, from the desire to dominate comes the willingness to wager one’s brothers and one’s wife. From adharma comes righteous indignation - the desire to impose one’s will on others.
Dharma is about listening, not speaking; dharma is about giving, not taking; dharma is about helping the helpless; dharma is about affection, not domination. Dharma happens when hungry men share their food. Gandhari’s children died because they refused to share their land. Draupadi’s children died because she could not forgive. So long as we refuse to share, so long as we refuse to forgive, so long as we find excuses to justify our greed, war will happen and heroes will never find peace.
Vyasa raises both his hands and shouts, “Follow dharma and there will be peace in the world. True peace, not peace born by dominating the other.” Is anyone listening?
Sunday, November 30, 2008
2:25 AM
This is one of the 1st book on finance I read...
Though some people find this book not that good. I have read this book and found it much more interesting... This is a very good book for people who are on employee side and really want to change there thinking about money and the way it grows....
Everyone needs money... "Some people play for not to LOSE and SOME PEOPLE PLAY TO WIN"...
Idea is very simple, your money management depends on the way you think about money....
For all those who are really interested to KICK start their thinking about the changing economy and about the money, and our emotions about money and security should go for this book...
And then the second book by same author "Cash Flow Quadrants..."
Keep reading...
Friday, November 28, 2008
5:34 AM
This article is about CRR ratio... understanding of CRR... I got this article from this link... (click on this)
What is CRR?
Indian banks are required to hold a certain proportion of their deposits as cash. In reality they don’t hold these as cash with themselves, but with Reserve Bank of India (RBI), which is as good as holding cash. This ratio (what part of the total deposits is to be held as cash) is stipulated by the RBI and is known as the CRR, the cash reserve ratio. When a bank’s deposits increase by Rs100, and if the cash reserve ratio is 10, banks will hold Rs10 with the RBI and lend Rs 90. The higher this ratio, the lower is the amount that banks can lend out. This makes the CRR an instrument in the hands of a central bank through which it can control the amount by which banks lend. The RBI’s medium term policy is to take the CRR rate down to 3 per cent.
What does a hike in this rate mean?
The hike in CRR from 4.5 to 5 per cent will increase the amount that banks have to hold with RBI. It will therefore reduce the amount that they can lend out. The move is expected to shift Rs 8,000 crore of lendable resources to RBI. In the past few months the money that banks have available for giving out as credit is greater than the amount they have been lending out. This has led to “an overhang of liquidity” in the system. The objective of the CRR hike is to “mop up” some of the “excess liquidity” in the system.
Will this mean a rise in interest rates on my deposits and home loans too? By when and by how much?
The hike in CRR is not likely to lead to an immediate increase in interest rates. There is excess liquidity in the system even after a higher amount is deposited with RBI as reserves.
Unless the demand for credit picks up to the extent that the money is all lent out, banks will not have an incentive to raise interest rates.
The inflation rate may continue to be high, the economy may also continue to witness growth which will keep the demand for credit high, and international trends are for rates to move up. This means that sooner or later interest rates will go up. The first rates to get impacted are yields on government bonds. We have already seen this happening. If the inflation rate keeps rising, RBI may raise the ‘repo rate’, the short term rate at which banks park excess funds with the RBI. This makes it less attractive for banks to lend.
Further, RBI may raise the bank rate, the rate at which it lends to banks.
At this point you may expect interest rates on home loans and fixed deposits to go up as well. Over a year rates could go up by as much as 3 per cent.
Wednesday, November 26, 2008
2:28 AM
This is Just an attempt to understand inflation derivatives, it is a very vast topic to understand but I am putting my efforts to understand derivatives... :)
My project report is as below
Saturday, November 15, 2008
10:57 PM
From the MicroEconomics Essentials
The Costs of Inflation
Economists do not pay much heed to the usual complaints about inflation. For most people the impact of rising prices is offset by rising wages. Those living on fixed incomes, such as welfare recipients or old-age pensioners, can (although may not) be protected through appropriate policy action. Arbitrary redistribution of wealth, such as rises in real estate values, comes about mainly if an inflation is unanticipated, in which case economists would condemn it.
From their study of microeconomics economists know that our economic system works well because prices act as signals to induce producers to produce the things we value most at the lowest cost—the right prices ensure that the economy maximizes the total welfare of its participants. This is what is meant when it is said that the price system is a very efficient way of allocating and distributing goods and services. To economists, the main cost of inflation is the resource misallocation it causes—the loss of efficiency that results because inflation distorts price signals. This happens in many different ways, some examples of which follow.
-During periods of inflation people are more interested in investing their savings in assets designed to protect them against inflation, such as real estate, rather than in productive investments that enhance the growth and efficiency of the economy. A classic example is people in Brazil holding wealth in the form of Volkswagens during high-inflation periods.
- During high inflation business finds it worthwhile to collect bills more promptly, using resources for this purpose that could otherwise have been used to produce goods or provide other services.
- Low inflations are steady and predictable; high inflations are volatile and unpredictable. This volatility creates uncertainty in the business community, reducing investment activity. Reduced investment in turn reduces economic growth. Some estimates suggest that reducing inflation from 10 percent to 5 percent will increase productivity by about 0.2 percent per year.
- Individuals reduce money holdings to cut wealth losses caused by rising prices lowering the purchasing power of their cash and checking accounts. Getting along with fewer money holdings is inconvenient, misallocating the individual's personal resources of time, energy, and leisure. The cost of this inconvenience is estimated to be equivalent to about 0.05 percent of GDP per extra percentage point of inflation above normal.
- In the extreme case of hyperinflation, inflation of over 100 percent per year, the currency system breaks down, and the economy reverts to the far less efficient barter system. During the spectacular German hyperinflation of 1923 prices at times rose by over 200 percent per week, severely affecting economic activity—people would work only if paid immediately, and spent every spare moment buying things to get rid of cash.
Offsetting these arguments, however, is the fact that many prices are inflexible or "sticky" in the downward direction. Many prices that should fall tend not to do so, instead just remaining constant. This implies that for the price system to operate efficiently, relative prices must change through selected price increases, rather than by having some prices rise and others fall. In reality the efficiencies of the price system can be gained only by allowing some inflation.
Most laypersons are amazed to discover that economists' measure of the harm done by inflation reflects phenomena of such seemingly little severity. It seems there are few substantive costs to modest inflation, and some benefits. Why, then, are we so paranoid about inflation?
For reasons explained at length later in this book, inflation is very quick to rise but very slow to fall. Although a low, steady rate of inflation does not carry significant cost, to bring inflation down to this level a high cost must be paid in the form of a prolonged period of high unemployment. We fear inflation because if it rises above the modest level we are willing to live with, we will have to pay a high unemployment cost to bring it back down.
Thursday, November 13, 2008
7:05 AM
This article is from Myiris Feed... I found it interesting so I am putting it.
Click Here to check original article.
In a broader sense, oil prices are influenced by socio economic as well as geo political factors. When political tensions arise in oil regions, oil prices seem to climb upward. It has been noted that there is a strong relation between Oil, gold and dollar, however it is the market trend that decides whether the relation is direct or inverse.
Let`s glance through a few indicators -
Gold, crude oil and dollar are interconnected and interdependent for the valuation
since there was age-old practice of oil producing countries to hold gold in exchange
for oil.
Oil, gold and commodities have all been priced in US dollars since 1975 when
OPEC officially agreed to sell its oil exclusively for US dollars. Since then the global
oil trade was priced in dollar. Hence any appreciation or depreciation of dollar impac
oil prices.
Crude prices directly affect the oil import bill of any country resulting into trade
deficit. This trade deficit would pressurize the value of local currency eventually
hitting money circulation in the economy thereby leading to the inflation. Inflationary
conditions in crude oil markets, which stoke uncertainty, inevitably spark a rally in
global gold prices.
Gold plays an anticipatory role. Gold which acts as the hedging option against the
inflationary situation for investor, attract investments, thereby leading to appreciation
in value. If crude price rises, Gold also moves up.
All over the world, the international trade is denominated in US currency. Hence any
negative news about the US economy, such as slowdown in consumption, rise in
inflation, or a cut in interest rates by the Federal Reserve, weakens the dollar. As
the dollar`s exchange value falls, it takes more dollars to buy gold so the dollar falls,
while gold prices rise and vice versa.
Similarly, most of the countries hold foreign reserves in the form of US dollars. If the
dollar loses value, the entire basket which is denominated in US dollar, loses value.
So, countries look for safe haven i.e. Gold. If dollar loses value, Gold moves up, and
vice versa.
Foreign gold market paves the path for the Indian gold market as almost the entire
gold requirement is met thought imports. Besides, volatile financial markets, appear
to be good for gold as an investment.
To conclude, one would find an inverse relation between dollar and gold; however the gold and oil prices are directly related to each other. In recent days, the gold, crude oil are considered to be crucial commodities whose prices are directed by geopolitical tensions and economic uncertainties. In the light of the above facts, it may be inferred that it is the US currency that rules the gold and oil markets
Wednesday, November 12, 2008
10:46 AM
Breakeven inflation
Breakeven inflation is the difference between nominal yield on fixed rate investment and the real yield on an inflation linked investment of similar maturity and credit equality. If average inflation is more than the break even, the inflation linked investments outperform the fixed rate and if inflation averages below the break even the fixed rate investments outperforms.
Break-even inflation = comparable fixed rate – inflation linked real yield
In theory calculating Break-even inflation from simply subtracting real yield from a nominal yield is crude from of properly compounded calculation.
Breakeven for a market with an annual yield
(1 + bei) = (1 + n) / (1 + r) where bei is break-even inflation
For semi-annual market
(1 + bei) = [( 1 + n/2 ) ^2] / [( 1 + r/2)^2]
Where ‘n’ is a yield on nominal bond
And ‘r’ is a yield on inflation-linked bond
Tuesday, November 11, 2008
11:28 PM
Seasonality
Inflation is subject to recurring pattern over the course of year and so the CPI. Consumer behavior exhibit seasonal features; in many industrialized countries consumer spending goes up to Christmas, which often followed by price discounting in January; then demand for energy and warm cloths is higher in the cold winter months than in the summer and so on. To the extent that such behavior causes prices to fluctuate this should in turn be reflected by seasonal movements in the consumer price indices. Government behavior can also influence these cycles
Existence of Seasonality complicates the analysis of inflation-linked bond prices. There are significant advantage in a well-established index being employed, but such indices often exhibits seasonal pattern. Potential solution for this is to use a seasonally adjusted price index, but in general such series is less understood. Choice of a seasonal price index leads to two issues; expected nominal size of future cash flows will be impacted by their timing with respect to the seasonal pattern, and yields quoted using standard market convention will also be impacted.
Inflation Linked Bonds (ILB) – An Inflation linked Bond (ILB) is a bond which provides protection against inflation, since principal amount of such bonds is indexed to inflation. The coupon payment for ILB is lesser than the fixed rate bonds with a comparable maturity. But in case of ILB, as the principle amount grows, the payment increases with inflation.
All ILBs are linked to Inflation, however the precise provision vary around the world. Most often, the outstanding principle is adjusted in response to changes in the Consumer Price Index (on daily basis). In general, the principal and interest payments on an inflation-linked bond rise with any substantial increases in the consumer prices so that the bonds cash flow increases in line with a rise in inflation.
Monday, November 10, 2008
9:58 AM
CAUSES OF INFLATION Inflation may be caused by an increase in the quantity of money in circulation. This has been seen most graphically when governments have financed spending in a crisis by printing money excessively, often leading to hyperinflation where prices rise at extremely high rates. Another cause can be a rapid decline in the demand for money as happened in Europe during the black plague.
The money supply is also thought to play a role in determining levels of more moderate levels of inflation, although there are differences of opinion on how important it is. For example, Monetarist economists believe that the link is very strong; Keynesian economics by contrast typically emphasize the role of aggregate demand in the economy rather than the money supply in determining inflation.
A fundamental concept in such Keynesian analysis is the relationship between inflation and unemployment, called the Phillips curve. This model suggested that price stability was a trade off against employment. Therefore some level of inflation could be considered desirable in order to minimize unemployment. The Philips curve model described the US experience well in the 1960s, but failed to describe the combination of rising inflation and economic stagnation (sometimes referred to as stagflation) experienced in the 1970s.
Another Keynesian concept is the natural gross domestic product, a level of GDP where the economy is at its optimal level of production. If GDP exceeds its natural level, inflation will accelerate as suppliers increase their prices. If GDP falls below its natural level, inflation will decelerate as suppliers attempt to fill excess capacity.
What is Inflation – Inflation is a situation in economy where, there is more money chasing less of goods and services. In other words it means there is more supply or availability of money in the economy and there are less goods and services to buy with that increased money. Thus goods and services command higher price than actual as more people are willing to pay a higher value to buy the same goods. In this inflationary situation, there is no real growth in the output of the economy per sector. It’s simply more money chasing few goods and services.
THE BASIC TYPES OF INFLATION Demand-Pull Inflation Demand-pull inflation places responsibility for inflation squarely on the shoulders of increases in aggregate demand. This type of inflation results when the four macroeconomic sectors (household, business, government, and foreign) collectively try to purchase more output that the economy is capable of producing.- In terms of the simple production possibilities analysis, demand-pull inflation results when the economy bumps against, and tries to go beyond, the production possibilities frontier. Then end result is inflation.
- In more elaborate aggregate market analysis, demand-pull inflation results when aggregate demand increases beyond aggregate supply creating economy-wide shortages. As with market shortages, the price (or price level) rises. Then end result is inflation.
Cost-Push Inflation Cost-push inflation places responsibility for inflation directly on the shoulders of decreases in aggregate supply that result from increase in production cost. This type of inflation occurs when the cost of using any of the four factors of production (labor, capital, land, or entrepreneurship) increases.- In terms of the production possibilities analysis, this means that the production possibilities frontier is shrinking closer to the origin, causing it to bump down against the aggregate demand. Then end result is inflation.
- In the aggregate market analysis, aggregate supply decreases to less than aggregate demand creating economy-wide shortages. As with any market shortages, the price (price level) rises. Then end result is inflation.
The Inflation Rate and the Price Level
The inflation rate is the percentage change in the price level.
The formula for the annual inflation is
Inflation Rate = (Current year's price index - Last year's price index) / Last year's price indexWHAT ARE THE WAYS OF MEASURİNG INFLATION?
Consumer Price Index (CPI) - This measures the consumer prices of a basket of commodities in different cities.
Wholesale Price Index (WPI) - This measures the different prices of a basket of commodities in the wholesale markets. The basket is broadly made up of Primary products, Fuel products, and manufactured products.
GDP Deflector - This is used to adjust measure of gross domestic product for inflation.
