Real-Time/ Instant/ Faster Payments in its most stripped-off definition is the transfer of funds (money) from A to B instantaneously. A and B can be a person or a business. 

RTPs are you scanning a QR code to pay for that orange you bought at the grocery store or the funds that you sent to your friend for that lunch money (s)he loaned you. Essentially, any financial transfer that happens within seconds.

That’s it. I’ll go on a limb and assume that you know the ‘What’ of RTPs. So, in this piece, we are going to double click on how real-time payments happen, the intermediaries that make it happen, and why they are so happening!

To make this piece as comprehensive as possible, I will take the example of you buying the most orange orange on Amazon, paid for via UPI (Unified Payments Interface: RTP payment form in India).

But before we start, let me introduce you to the main characters in the RTP flow.

Virtual Payment Address (VPA/ also called UPI ID with love) is a unique identifier of your bank account. Your name, bank account number, bank branch, and other details are encrypted to a VPA. A UPI transfer can be done only with a VPA. Examples can be myorange@citibank or needmymoneyback@upi

You: The one who fell in love with them oranges

Merchant: Seller - Amazon in our example

Acquiring bank: Merchant’s bank. Also called as sponsor/ payee/ beneficiary bank

Issuing bank: Your bank. Also known as destination/ remitter/ payer bank

Network Operator: The entity responsible for facilitating payments. Every transaction passes via this nodal authority. They act as intermediaries and facilitate the authorisation, clearing, and settlement of transactions Examples: NPCI, RBI, Fed. In case of credit/ debit card transactions, this role is assumed by entities such as Visa, Mastercard, Discover and the like

Payment Gateway: The entity responsible for providing the required tech infrastructure for various types of payments. A PG also tokenizes/ encrypts payments details, does fraud checks, among other things. Amazon can either be a PG (Amazon Pay) or use services of other PGs (Stripe, Instamojo, CCAvenue, Braintree). In our example, PG would be Razorpay

Payment Aggregator: A PA allows merchants to accept payments from customers by integrating with their websites or Apps and then settle that to the merchants as per agreed-upon timelines. In short, it provides a sub-merchant account. Banks used to dominate the PA market before but most tech players have made inroads now. Examples: Cashfree, Paypal, Amazon Pay

Payment Service Providers or Third-Party Application Providers (PSPs/ TPAPs): A PSP is responsible for maintaining customer details, transaction logs, and for issuing, maintaining, and resolving VPAs. These are players like Google Pay, Apple Pay, PhonePe, PayTm who have an application layer (UI) for client interactions and a backend to manage the above mentioned activities. The backend layer is also known as a PSP backend

Only banks and approved technology partners can act as PSP backends and can interact with the operator. Having a standalone PSP backend or frontend makes no business sense and hence most PSPs act as one single unified entity with banks backing them up. PSPs such as PhonePe, BHIM, Gpay provide both frontend and backend facilities

Note: You’d hear names like Razorpay, Stripe, Paypal, Adyen, PayTm also being referred to as PSPs. This is because PSP is a generalized name used for PGs + PAs (entities providing payment services). Gpay, PhonePe are UPI PSPs which for all intents and purposes can work with, say, Stripe to provide a rich UX to customers.

The Flow

1. You go to the seller app, select orange, go to the checkout page and opt for ‘place order and pay’

2. The merchant website redirects you to a PG (Imagine Razorpay here) with multiple options to pay: cards, net banking, wallets, RTP/ UPI (Imagine BHIM, PhonePe, Google Pay). You opt for Gpay. You can access UPI payment modes by either providing your mobile number or VPA

3. The PG forwards the request to your PSP (Gpay here). Gpay then authenticates your details. As per RBI guidelines in India, TPAPs have to follow a two-factor authentication (2 FA). The first factor can be decided by the provider (imagine FaceID/ PIN/ Biometrics to login to the App), but the second factor is defined by the nodal authority (UPI PIN/ MPIN)

4. The PSP backend of Gpay forwards the verified request to the network operator

5. The network operator then sends the payment request to the payee PSP for resolution of beneficiary VPA/ address

6. Upon resolution of bene address by the Payee PSP, the operator sends the debit request to the issuing bank

7. The issuing bank sends the success/ failure response of the debit request to the operator. Considering how much you love oranges, we shall assume that the payment is a success

8. The operator accepts the success response and furthers a credit request to the beneficiary bank

9. The bene bank sends a successful credit message to the network. The Payee PSP sends a status check request to the network, which gets responded with a success in our case

10. The payee PSP forwards the success message to the payment gateway. The PG sends that to the Merchant

11. The merchant shows a Hurray message to you and asks you to wait for them Oranges

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Scratching the Surface

Now, I just named the whole process ‘The Flow’, but the overall transaction cycle doesn’t end here. The flow described above is just the authorization cycle. This means that the merchant’s and your bank only got a confirmation of the transaction and the actual money never got transferred between banks. The banks credited the money to you from their accounts with a trust that they will get the consolidated funds from the operator later on.

Confused? Let me explain. In 2021, we had an average of 120 UPI transactions every second. Now transferring money at such a frequency is a massive challenge (compare this against 1 bitcoin transaction taking approximately 60 minutes to get completed). But confirmations can flow smoothly (take your text messages on WhatsApp). Hence, the actual USP of UPI is in the mechanism wherein it allows payers and payees to act on messages and transfers actual funds (by netting the debit and credit positions of the banks) at predefined cycles later on.

The process of clearing (computing which bank owes how much and the net amount) happens in real-time. You can imagine this as passing debit and credit entries against banks in a ledger after every transaction. At the time of settlement, the operator forwards the file with net positions against the banks to the financial institutions. Banks then settle the funds amongst themselves. For UPI in India, the actual settlement happens only 8 times in a day.

In case you are wondering about what happens when a bank defaults and says, ‘though you have got your oranges but I ain’t paying for it later!’, then fret not. The operator usually has a settlement guarantee fund to honor the commitments of other banks. But this thread is not about SGFs and settlement risks, so let’s stop here.

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Modalities for Further Reading

I understand that there was a lot of unpack, but in case you were observant enough, you’d have questions such as:

1. When do these payments time-out? 90s, 120s?

2. How request and response messages are sent, at what frequency, and for how long?

3. Does the VPA act as my public key for RTP transfers?

4. Which payment mode is used for gross settlement of funds?

5. What is a settlement guarantee fund? What other risks do RTPs pose?

6. Also, what happens when the communication link (REST APIs in XML) breaks between the operator, PSPs, PGs, and banks?

7. Does a payment aggregator use escrow account to settle payments to merchants?

8. What are the charges involved? Do interchange, switching, PSP Fees/ MDR apply to?

9. How does QRs and POS machines fit into the RTP ecosystem?

And though these problems are super exciting and have quite innovative solutions; for now, they fall outside the scope of this thread. But if you are curious enough, drop me a line!

Links for Further Reading

1. https://www2.deloitte.com/content/dam/Deloitte/us/Documents/strategy/us-cons-real-time-payments.pdf

2. https://www.forbes.com/sites/boblegters/2022/02/10/why-all-the-fuss-about-real-time-payments/?sh=355e39bb3d4c

3. https://en.wikipedia.org/wiki/List_of_online_payment_service_providers

4. Popular PGs

   

5. Sample PG System Architecture

   

6. https://razorpay.com/blog/what-is-upi-and-how-it-works/

7. Real time cross border payments

   

Share Markets 101

Over these years, I have dumped a lot of things in my notebook, struggled with them and have tried to create a repository sans noise. If you are an aspiring PM/ APM, then the below guide to Tech should be useful for you!

Here we go! Geronimo!

Index

1. Foundation

2. Basics on how internet works and information gets transferred

3. Python and other links

4. Basics of System Design

5. API Fundamentals

6. Designing Database Schema

7. Basics of SQL

8. GIT Hands on

9. Dev Environments

10. Data Structure and Algorithm Basics

11. OS Basics

12. Books - will keep adding to this

13. Full course on CS basics: CS50 by Harvard

14. Exercises

15. Drop me a mail if you want more detailed notes on any of the above topics

Note: Whatever you do not understand, keep googling the terms, asking your friends or those in your network. You would learn a lot this way. We live in a rockstar age of learning.

Important Stuff

Start with

1. http://highscalability.com/blog/2017/12/11/netflix-what-happens-when-you-press-play.html

More readings

1. https://medium.com/@divyadhar/how-to-prepare-for-googles-product-management-technical-round-when-you-are-not-technical-474de3ee01b3

2. https://www.departmentofproduct.com/blog/technology-skills-product-managers/

3. https://www.pmtechlessons.com/

4. https://medium.com/@lulu_cheng/getting-to-technical-enough-as-a-product-manager-5b372513cd1c

What happens when a user types a URL and presses Enter

About HTTP

HTTP Methods: Post/Get/Put/Delete Calls -

Watch System Design tutorials (Google stuff as you don't understand, but go on nonetheless and complete the series)

1. SudoCode

1. Gaurav Sen -

API Fundamentals:

Xplainerr

A to Z of API's for Product Managers

Welcome to my second newsletter. This one is on API’s! (And this will be a 12-minute read :p) There is a joke that my one of my (developer) friend always use to tell me - If a Product Manager knows APIs, then I know that they understand technology. In this newsletter, I will try to explain what an API is? I will also deep dive into …

Read more

5 years ago · 32 likes · 9 comments · Venkatesh

1. https://www.smashingmagazine.com/2019/01/api-based-platforms-product-managers/

2. https://www.departmentofproduct.com/blog/apis-explained-for-product-managers/

1. Rest API Contains practical examples:

Designing Database schema [IMP for PMs]

Basics of SQL here [IMP for PMs]

1. https://www.khanacademy.org/computing/computer-programming/sql

2. https://www.hackerrank.com/domains/sql

3. https://mode.com/sql-tutorial/

Learn about some terms devs would use here [For some terms like GIT Pull, Push, Merge, PR that developers folks would use]

GIT [Hands on]

1. https://www.freecodecamp.org/news/learn-the-basics-of-git-in-under-10-minutes-da548267cc91/

About Development environments [Staging, QA, Production etc.]

1. [Hindi]

I recommend that you do basics of HTML here (No need to be an expert, just understand how it works)

http://www.dontfeartheinternet.com/

Learning Test

Post all the above, If you can understand this, you are good to go

More:

Data Structure and Algorithm Basics

1. https://medium.com/basecs/tagged/data-structures

2. https://www.interviewcake.com/data-structures-and-algorithms-guide

3. Book: Common–Sense Guide to Data Structures and Algorithms

Operating Systems Basics

1. https://medium.com/computethecloud/operating-system-concepts-4dff340775ab

Books -

Vinay Trivedi (Author) - How to Speak Tech - The non-techie's guide to Key technology concepts

Ashwin Pranam (Author) - Product Management Essentials

Purchase on Amazon/Flipkart or Check on → libgen.is

If you want to do a full course in CS basics

Course - CS 50: https://online-learning.harvard.edu/course/cs50-introduction-computer-science?delta=0

Exercise for you:

Exercise 1:

Design the post checkout systems in an e-commerce company (Myntra). It should have the following use cases solved. Please provide the schema (table names, column names where data will be stored) of the tables that would be involved and how they would be linked to each other.

1. Order receiving

2. Order fulfillment

3. Order delivery

4. Order Accounting

Bonus: Cover return item use case, multiple orders use case, return 1 item among multiple orders use case etc.

Exercise 2:

Design the DB schema for content system for Facebook.

Cases to cover

• Posting Images, texts, videos

• Profile information

• Friend connection information

• Personal data

• Newsfeed browsing

(some cases may use already created schema, but would require understanding how schemas will be connected)

Exercise 3:

List down potential APIs that would be used in Swiggy Home Screen, with some request and response. <Discuss this with your tech friends>

Exercise 4:

Think about System design for Whatsapp. Take a cut on it and then look for answers on Youtube/ Google

For more detailed notes, email me at gauravjain.iimk@gmail.com. Cheers!

I hope you get the context. For nuances, read on.

Index

1. Primer on ONDC

2. Why ONDC?

3. How does ONDC work?

4. What does the network provide?

5. Flows/ Target Segments Captured by ONDC

6. Potential Sectors

7. Challenges

Open Network for Digital Commerce (ONDC)

ONDC is an enabler to digital commerce. An open, interoperable, and democratic ecosystem for buyers and sellers to interact and transact, ensuring a flow of value rather than a store of value. 

Wow, jargon. Let me break it down.

Open: Anyone willing to sell and buy can participate. Anyone willing to contribute can participate. One need not be an employee of a big e-comm giant to build seller-friendly Apps. The platform is open source, if you one day feel that there needs to be an efficient product cataloging App for the small Kirana stores, you can build that, unlock value and integrate the same with ONDC.

Interoperable: You need not be a buyer and seller registered on an app to buy or sell. A seller is available across the platforms after a one-time registration, and buyers can discover it from any buyer-side Apps. Just like the UPI. 

Store-of-Value versus Flow-of-Value: In a platform-based model, the rules of engagement, terms of onboarding, handling of data, and the search algorithm are some of the many things controlled by the platform. The platform indirectly owns the entire value chain. Comparer avec, a network-based model, only specifies the protocols for communication between different players in the value chain. It unbundles the value chain and allows it to flow in a manner decided as efficient by the market.

Okay. But why ONDC?

Consider this. Only 15,000 of the 12 million small Kirana shops in India are online. That’s only 0.13%. The analog shops have to depend upon ones who know the shop and are willing to walk to them. The digital commerce penetration in India is only 4.3%, against, say, 25% for China. Measure this against the growth in the Indian e-commerce space, expected to rise to $111 bn by 2025 from $46 bn in 2020. 

In terms of the ecosystem issues, buyers and sellers have to deal with closed environments today. The whole onboarding experience, terms and conditions, product discoverability, and last-mile logistics of the sellers are determined by the platform. These marketplaces also control the UX of buyers.

ONDC aims to remove all these inefficiencies and create a uniform communication code amongst market players. To put this simply, if you were in an iOS ecosystem before, ONDC is proposing an android for the masses. I mean, sort of.

How does ONDC work?

ONDC connects buyers and sellers via a defined set of communication schema. These are BeckN open protocols for ONDC, but more on them later. Imagine the below user journey.

Market Entities: Buyer (you), Buyer-side Apps (say Amazon, PhonePe if they wish to participate), Aggregators, Gateway (similar to NPCI for UPI), Seller-side Apps (Supermarkets, Kirana stores, Retailer, Logistics providers, Other service providers) and Sellers. 

1. The Buyer, 'X', logs in to a Buyer side App

2. X searches for Oranges, the buyer-side app converts the search item into a uniform product code, communicates with ONDC registry, searches for the items in the seller side App, and returns the result

3. Buyer side App provides the ability to sort items via distance, self pick-up, lowest price, delivery in next 1 hour, to name a few

4. X selects the store/ aggregator for the item. If they wish, they can segregate the delivery from the purchase bit and select a delivery partner

5. Buyer pays for the items and to the delivery partner

• The buyer and seller side Apps control the UX - similar to how a PhonePe and Google Pay control your journey within their Apps

• All communications happen via open APIs

• Data is stored anonymously in an aggregate and abstract manner within the DEPA framework for statutory reasons, registry, and operational controls

• Other open networks can freely connect with ONDC as long as they follow the BeckN protocols. OCEN (Open Credit Enablement Network) can be a significant credit enabler by providing short-term low ticket loans to Kirana stores for their working capital requirements

• ONDC will maintain a single, multi-domain registry

• National protocol, anyone can order from anywhere

• One-stop-shop. Enrollment is a one-time activity

How are these Buyer and Seller side Apps helpful?

Buyer side App controls the buyer-side UX, and the seller-side Apps are free to innovate for sellers. However, BeckN governs the interaction in the ecosystem. Consider the UX and cross-selling tactics of a PhonePe, Google Pay or PayTm.

What will ONDC provide?

1. Registry: Of all market participants - retail, aggregators, travel, hospitality, mobility

2. Network Policies - To keep the ecosystem open and democratic, prevent monopolies; for instance: NPCI mandates PSPs to not have more than 30% market share in terms of UPI volumes

3. Reputation Ledger - For ratings, complaints, and queries

4. OpenData Ledger - Based on digital contracts, immutable logs 

5. Inter-network interoperability - no monopoly in terms of who will control the UX

6. Payment processor - not prioritized for FY '22 release

Which flows can ONDC propel?

Wholesale, Food Delivery, Mobility - Metro tickets to Cabs, Tourism and Hospitality, Travel - Flights, Trains, B2B: Merchants and retail shops.

Fintech: Buyer Apps connected with seller Apps via AA to provide loans, sell other banking products: insurance, BNPL, Fastags.

Amazing. What benefits can end-to-end integration bring?

• Reduced time-to-market and time-to-scale via plug and play Apps

• Platforms like Shopify, Wix, BigCommerce for Kirana stores to go online at minimum cost can integrate with the network

• PGs like Razorpay, PayU can provide immediate payment integration solutions for upcoming sellers to cater to a pan-India audience

• Scanners and Cataloguing Apps services to bring in uniformity in product discoverability

• Logistics support from Zepto/ Dunzo/ Genie to control the last-mile UX

• Experience Apps like Ferns and Petals can integrate with ONDC to leverage other market participants and deliver an enhanced UX

• Small value credits are a big issue for sellers. The Account Aggregator (AA) framework can go a long way in delivering it. The same goes with the demand for BNPL on the buyer-side

• Inter-state logistics based on demand and supply-side data can be made more efficient by players like Blackbuck, Rivigo, Delhivery

• Blockchain can be leveraged for digital contracts

Challenges to ONDC

• Handling of refunds, especially in cases where selection of goods and logistics partner is not from one provider

• Returns: Clarity in terms of who will bear the cost for returns

• User Experience: A fragmented ecosystem has to be dependent upon multiple players to provide a seamless UX. A Kirana store still has to depend upon a, say, Dunzo to make their customers happy

• Reach: Last-mile penetration is heavily dependent upon the availability of smart phones. ONDC’s reach is limited to this extent

• Grievance Redressal and Customer Service: A fragmented ecosystem reduces accountability which in turn impacts credibility

Tell me more!

There is, indeed, more. On how fintech can help, what are the possibilities on the payment front. What are BeckN protocols and how do they operate?

But, we should take your leave now. More on this, next Sunday.

1. Basics of COVID: Keeping Yourself Safe

2. 3 Things About COVID

3. Polypharmacy

4. Vaccination pe Charcha

5. Questions

Basics of COVID: Keeping Yourself Safe

COVID-19 is a disease caused by a new strain of coronavirus. 'CO' stands for corona, 'VI' for virus, and 'D' for disease. Formerly, this disease was referred to as '2019 novel coronavirus' or '2019-nCoV.'

How COVID is different from your normal flu?

• Influenza viruses vrs SARS-CoV-2

• Gestation period is longer

• Serious illnesses

• More contagious

List of Most Common Symptoms

• Fever

• Cough

• Headaches

• Fatigue

• Muscle or body aches

• Loss of taste or smell

• Sore throat

• Nausea

• Diarrhea

Precautions

• Wear a mask that covers your nose and mouth to help protect yourself and others

• Stay 6 feet apart from others who don’t live with you. A typical 6 feet is the length of a cow. Practise physical distancing not social distancing

• Get a COVID-19 vaccine when it is available to you

• Avoid crowds and poorly ventilated indoor spaces

• Wash your hands often with soap and water. Use hand sanitizer if soap and water aren’t available

3 Things About COVID

WASH HANDS. AVOID CROWDED AREAS. DOUBLE MASKING

Polypharmacy

In simple terms, 'polypharmacy' refers to the use of multiple medications. A 'polypharmacy patient' then, is one who has been prescribed and is taking multiple medications for multiple conditions. More here

If you aren’t feeling well – GO VISIT A DOCTOR. The early you treat COVID, the better. However, be cognizant of what’s been prescribed to you. More isn’t always better

Why?

1.     Resources are limited: When you over-consume, you not only eat into the resources available for others who might need that medicine but would invariably create long term side-effects for your body as well

3.     Incentives aren’t aligned properly: A doctor in private sector often has more incentives to prescribe more as their efficacy is measured by the amount of medicines they can dole out. Below conversation between Jishnu Das on his research with a Delhi doc would throw some light on this (circa 2005)

What works then?

Inputs by Dr Anup Aggarwal (lead author of the ICMR-led trial on convalescent plasma (PLACID trial), physician at Rehoboth McKinley Christian Hospital Healthcare Services, New Mexico, U.S.) in conversation with the Hindu

• For mild symptoms, paracetamol and levocetirizine are sufficient 

• Plasma doesn’t work (as advised by ICMR) expect in rare cases for the 1st 3 days. Our RT-PCR tests have longer timelines – earlier usage was more eminence based then evidence based

• Remdesivir doesn’t reduce mortality only the time spent in an hospital– urge to prescribe more than to prescribe rationally

• Dexamethasone is as effective as Betamethasone and cheaper

• Steroids (severe cases, immunosuppressant), anticoagulants (reduce blood clots) and oxygen

Vaccine Conversations

Go Vaccinate. Further details on an in-session deck, with inputs from AHRQ and AMDA. All latest updates from CDC are also hyperlinked in the slides

Questions

In session

How can you reach us?

WhatsApp group here.
Email subscription here.

References

https://indianexpress.com/article/lifestyle/health/what-are-steroids-and-why-are-they-given-to-covid-positive-patients-7315149/

https://economictimes.indiatimes.com/news/politics-and-nation/dexamethasone-has-life-saving-potential-for-critically-ill-covid-19-patients-who/videoshow/76521256.cms

https://www.biospace.com/article/comparing-covid-19-vaccines-pfizer-biontech-moderna-astrazeneca-oxford-j-and-j-russia-s-sputnik-v/

https://blog.cureatr.com/defining-polypharmacy-and-understanding-its-risks-and-benefits

References to CDC and ICMR and hyperlinked as required in our notes and in presentations

Video played at the beginning

It’s basic common sense: if you’ve made a mistake, don’t make a fuss about it. This, almost, always backfires. 

In October 2020, NY Post posted a series of emails – allegedly from Joe Biden’s son, ‘Hunter Biden’s’ laptop – indicating a corruption scheme that Hunter was privy to. Twitter, being the poster child for left in US, quickly removed all such articles while blocking NY Post’s own twitter account. Researchers at MIT cited an increase of over 5000 shares per 15 minutes after the twitter ban.

In finance, companies often fall into this trap by deliberately trying to hide/fudge a parameter that they failed to perform on. Luckin’ Coffee (once touted as the next Starbucks) in China made a big mess of themselves when they created dummy customers to hide their mistake of unusually high per customer spends.

SE just asks you to keep quiet and improve. Do you see something similar happening in India? And why aren’t we talking about this?

That’s it. Thanks.

You might say that, “I paid ₹20,000 of the ₹20,100 I got as my bill. I can pay the 3% monthly penalty on the remaining ₹100 next month. How does it matter, dude? 100-rupiah ka toh 1 litre petrol bhi nahi aata aajkal!”

I might not take offence at you calling me dude inasmuch as you realizing that you do not pay the 3% on the ₹100 alone but on an amount much larger than that. Let’s understand

Typical credit card bills are generated on a monthly cycle (30 days) with an allowance by the company to keep the amount for that cycle outstanding for 45 days. This means that if your billing date is 30th April, you can pay that amount by 15th May without incurring any charges. However, if you don’t pay your bill in full by 15th May, your credit card company will not only penalize you for the outstanding amount but also for the expenses made on the credit card between 30th April and 15th May! So, if say of that 20,100, you spent 16,000 on airpods on 5th May, you’ll have to pay interest for those airpods too on top of the measly interest you were paying on ₹100 outstanding. This holds true even if you are short by ₹1 in your payment. This is dirty and I know it, but we thought you should too

So, no matter what, pay your credit card bills in full always. This process of moving your credits (debt) to next month is called as ‘revolve’ and revolving credits are detrimental for folks who don’t understand it

This was inspired by Deepak Shenoy. All credits to him!

That’s all for now.
Take care and don’t watch Radhe. Or watch it. Who cares, dude!

Things which are off-topic and are still included in this post

inasmuch

PHRASE

You use inasmuch as to introduce a statement which explains something you have just said, and adds to it.

[formal]This was a good decision inasmuch as it worked for you.

Central governments have been running a fiscal deficit for decades now. Fiscal deficit is nothing but the difference in government’s income and its expenses. For instance, if NDA spends ₹1000 this year and earns only ₹800 from taxes, disinvestments, loans then it will said to have a fiscal deficit of ₹200

But how do governments fund this deficit of ₹200, you may ask? It is majorly via borrowing through these two routes – 

1.     Issue a 10-year maturity bond every year (G-sec) - This is similar to government issuing 10 x ₹20 bonds that people can purchase. In return, GoI will agree to pay you an interest of, say, 5% per annum with a full repayment of principal in 10 years. Remember the hefty loan you took for your education? You were the GoI if the loan were bonds, but more on bonds later

2.     Small Savings Scheme - Generally, big institutions – NBFCs, MFs, Banks, Corporates – participate in sale and purchase of bonds. In order to increase the retail participation, government floats these small savings scheme, i.e., the PF you pay is used by the government to make good of that fiscal deficit among other things

Now that we know what these schemes are, let’s see the products that form a part of this ecosystem. I believe, the below table should be helpful***

Time deposits, NSC (national savings scheme), KVP (Kisan Vikas Patra) work exactly like FDs – you pay a lumpsum at a given time with a promise from GoI that the amount will be paid at maturity along with a pre-determined interest

RDs, PPF, Sukanya (SSY – savings account for girl child, upto 2 in a family – below 10 years of age) work like SIPs. You invest at regular intervals and receive the full amount at maturity

PPF and SSY are with floating rates though, i.e., every time GoI changes rates, your accumulated amount also receives the new rate. Is this a decent thing to do? Well, as bad as it sounds, ‘yes’. As countries develop the rates offered for floating scheme should decline. However, this is not the case for KVPs, NSCs which will offer you the same rate at maturity as what was agreed-upon at the time of investment

You also get 80C advantage for an aggregate investment of ₹1,50,000 for SSY, PPF, NSC, FD (5 years) and Senior Citizen’s Saving Scheme 

So, that’s all for today. If you wish to know further, just ask your parents. They’ll happy knowing that their child is also interested in PPF in addition to hodling alt currencies

Goodbye. Have a nice day!

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*** The finance minister withdrew her decision of changing the rates of these savings scheme. The rates as of 4th April 2021, still stands as below

We have two exciting sessions lined up for you tomorrow, March 21st. This Sunday!

Mutual Funds 101 (last revision): 12:00 PM - 12:45 PM
Mutual Funds: Beyond Basics (clarification session): 1:00 PM - 1:30 PM

Both sessions are on zoom and below are the details!

Topic: Mutual Funds 101 (B)

Time: Mar 21, 2021 12:00 PM Mumbai, Kolkata, New Delhi

Join Zoom Meeting

https://us05web.zoom.us/j/9303322525?pwd=MWFjRUFnMHNQR2c1K2pndjM5V25LZz09

Meeting ID: 930 332 2525

Passcode: markets101

Topic: Mutual Funds 102 (E)

Time: Mar 21, 2021 01:00 PM Mumbai, Kolkata, New Delhi

Join Zoom Meeting

https://us05web.zoom.us/j/9303322525?pwd=MWFjRUFnMHNQR2c1K2pndjM5V25LZz09

Meeting ID: 930 332 2525

Passcode: markets101

A Japanese magnate paid around $40 mn dollars in 1987 for the painting ‘Sunflowers’ from Vincent Van Gogh. This somehow upset Banksy – an artist – and led to his artwork, ‘Morons’ in 2006. The artwork contained the words, “I can’t believe you morons actually buy this shit”. And this was bought by a NY gallery at around $95K the same year

Sheet, right? Hold on.
On 4th March 2021, an anonymous group, now calling itself ‘Burnt Banksy’ burned Banksy’s original art piece and created a NFT for the same, which got auctioned at $394K. They said they did this to preserve the true value of this artwork

Beeple, another artist sold his digital artwork as an NFT for $69.3K USD. You can download that from below or view the same on Google images. Now before you say, what the duck is happening, let’s move to what NFTs actually are!

NFTs are non-fungible tokens. In economics, fungible goods are defined as ones that can be interchanged. Consider the ₹2000 you have, these are no different from the ₹2000 I have and have the same value and use case. However, a non-fungible good is one of a kind which cannot be replaced or traded

Put simply, NFTs are digital artworks stored using the ETH blockchain technology. If you can buy physical properties/goods and gain ownership of the same, then why digital artworks be any different? 

This got prominence with the blockchain tech being at the core of all NFTs. Like bitcoins, all the relevant details of the artwork – can be music, paintings, cards – are stored on the ETH blockchain tech and are then sold/ auctioned to the collectors. Since, the data on blockchain cannot be altered/ corrupted, people believe that NFTs are the best way to preserve one’s arts. 

Sir, I get all of this BUT can I not just download these images off the internet like you did?

Yes, you can, and you should. Take a printout and hang it on your wall. Similar to what you did with that Mona Lisa painting that originally belongs to Louvre in Paris. However, this would not give you the ownership of the original painting. An artist can ask for royalties and if wish can share that with the NFT owner but you cannot claim anything on your printout. Like we cannot change Markets 101’s logo to Mona Lisa because it is just not legit

Another dominant feature of NFTs is to trace an object’s digital provenance – place of origin – which is transparent and visible to all. So, if you sing really well and believe you can sell your art at a decent price – go for it! It will be safe and secure as an NFT and you’ll get full credits for your song. To hell with those corporate credit-seeking duckers!

Moving on.

However, do the cost benefit analysis as setting up NFTs and the overall costs till their sale adds up to around $70 - $100. You can head on to Open Sea if you wish to get a flavour of NFTs and explore the ones over there while you are at it

Increased transparency, effective decentralization and a sprinkle of ‘this is cool’ has made NFT the dish it is today. But it has potential and it very well might be the future of art. But, who knows? 

For more on NFTs, you can watch this really NFT-worthy video by WSJ!

That’s all folks. Now, go make your day!

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Also, the scope of this article is limited to the extent of you understanding what this tech is on a high-level and to apply those concepts to understand cyptocurrencies and deFi – which might very well be the future of finance

So, with that advisory note let’s start!

A blockchain is a specific type of database. What’s a database (DB)? Take this fictitious bank statement (B.1) as an example. It’s a database on Microsoft’s excel. It’s just a record of your financial transactions with an audit trail stored electronically. Now DBs come in different shapes and sizes, but for starters we will consider the below table only as our database.

Now, this statement is personal to you and is visible to only you. If you wish, you can download a copy and make changes to 14th Feb in order to remove those bad memories

Blockchains are also databases, but what differentiates them from spreadsheets are that

1.     Databases are often limited in terms of their scope. For e.g., your bank can go to the extent of maintaining a database of all the people who have an account with them. Blockchains are decentralized, there’s no account or governing power. All the transactions within their ecosystem are recorded. So all those people would bought old monk that day would leave a trail in the blockchain network

How blockchains record transactions/data?

1.     This tech is based upon millions of users, sitting at their desks in front of their computers. These computers are often referred as nodes and the community of users is called as a peer-to-peer (P2P) network

2.     When a transaction happens, it is sent for verification to all the nodes. To verify those transactions/ data points, each user is given a puzzle to solve. The first user to solve the puzzle sends his/her answer (called as ‘proof-of-work’) to other nodes. If everyone agrees, then a block is created. That block contains the details of that transaction along with a hash code. This block would also contain the hash code of the previous block

3.     A hash code is a unique reference number allotted to every block

4.     This block would then be appended to the ‘chain’ of previous blocks

5.     The working is similar to Snake Xenzia, wherein the snake grows in size after gobbling those crumbs

2.     They are immutable. If the transactions in the above sheet were recorded on the blockchain ledger then nobody could possibly alter them(B.1). Neither can your bank or Satoshi Nakamoto. A change can only be made by appending a new block. Consider the block excel below (B.3). All the line items can be considered as blocks in the blockchain network (except closing balance). If you make changes to the 14th Feb item, then it will change the hash code for the same and everyone in your peer network would get an error as this block is dependent on the one previous to it and the previous block on the one before that. You get the idea, right? A ‘consensus’ is required to make even a minute change. And such consensus in real world is close to impossible

3.     All transactions/ data points in the blockchain network are viewable to all. Your identities would be anonymous but the transactions would indeed be visible to all

4.     There’s no intermediary involved. No bank, no government. Each node has full information and there’s no bank fees/ TDS/ governing councils. Do note that when you pay for your coffee via your credit card or UPI, the transaction is recorded and subsequently processed by intermediaries. They record your details and charge you money for this. Blockchains would only record the amount transacted with a unique address, not your name and there’s no intermediary

5.     They are available all the time. A bank or an org may not be available 24*7, but transactions via this network can be settled 24*7. The same applies to cross-country transactions as well

Now, before we move forward, we might need to take a little pause. While explaining blockchain, we made certain assumptions and as we move forward, it stands to reason that we unpack them

a.     Our discussion points till now have revolved around transactions. But blockchains can be used to facilitate a voting system. Each individual can be given the address of the person to vote for and they can send their Boolean ‘yes’ or ‘no’ to those addresses for final counting

They can also be used to keep records of property related transactions. Wouldn’t it be nice if we actually knew who owned that piece of land at Ayodhya and when the places of worship were destroyed and rebuilt and so on?

Or for your health. A record of all the medical issues you’ve had right from your birth. To be honest, blockchain has been applied for all such similar cases in certain regions across the globe with considerable success

b.     Also we assumed complete decentralisation while discussing blockchain. But it need not be, say, for a firm using this for their internal record keeping purpose. They can use this tech to maintain their supply chain wherein some or all the details are visible to all the parties available, but changes can only be made by the peers/nodes who have those rights or maybe on the basis of smart contracts, say, i.e., “only pay the supplier her due if and only if less than 2% items that reached our ports are defective”

c.     Again, smart contracts are fully available in more enhanced techs based on blockchain. Part of the reason why ETH (Ethereum) is growing in demand

Moving to disadvantages!

1.     Huge energy costs. Just see the number of computers involved and the ultimate computational power required

2.     Speed inefficiency. Owing to these proof-of-work validations that we discussed above, the blockchain network can only process 7 transactions per second (TPS). Other cryptocurrencies like Ethereum perform better than bitcoin, but compare that to Visa which processes around 24,000 tps and you stand nowhere

3.     Illegal activity. You are anonymous. You can buy or sell anything without coming under the radar of the ‘system’

Now, people are paid in ‘bitcoins’ for an activity called mining… But more on that later and with this we will take a pause here. There’s a lot going on in this space with cryptocurrencies, deFi (decentralized finance) and smart contracts. And they truly represent how our future might look like but it is important to not consume everything in one shot. Let’s look at deFi in our next thread.

Stay tuned!

And if this was too much, we are sorry!

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Links

1. https://www.investopedia.com/terms/c/consensus-mechanism-cryptocurrency.asp

2. https://www.coindesk.com/what-is-defi

3. https://www.theverge.com/22310188/nft-explainer-what-is-blockchain-crypto-art-faq

4. https://www.euromoney.com/learning/blockchain-explained/what-is-blockchain

5. https://www.finextra.com/blogposting/19383/smart-working-with-blockchain-based-smart-contracts

Derivatives are financial instruments whose value is ‘derived’ from the underlying asset or group of assets. Put simply, a gold derivative might allow you to trade with the fluctuations in the price of gold. All those options, futures and forwards that we studied are known as derivatives. Why? For their value is based on the movement of stocks or bonds or assets they represented.

In our example for call options, wherein the value of flat rose to ₹3 cr from ₹2 cr after Sarkar built metro, the call option would be called as a derivative because it derived its identity from the rise or fall in the value of that flat in Bellandur. Derivatives can be traded on an exchange like NSE/ BSE (e.g., futures, options) or can be setup like a contract between two parties – consider, forwards.

Now, delta is the financial geek food. Basics: It is the change in the value of the derivative with respect to the change in the value of the underlying asset. A delta of, say, 0.35 would mean that with every ₹1 change in the value of the Bellandur flat, the price of its call option would increase by ₹0.35. Quite obvious, if the value of your property is rising, you’d definitely want a higher token amount from the buyer to give her the right to purchase it at a later date. Delta just tells you as to by how much can you increase that token amount when the price of property rises by ₹1. The value of call options ranges from 0 to 1 and for put options they vary from -1 to 0. 

But before you move out of this chat, we’ll stop; for, this is just the basics. We will try to cover more on spreads and delta trading strategy in 102s and 103s.

Bye for now!

And your job’s great and meaningful. Was kidding. Enjoy.

Discussion Points

1. What are Mutual Funds? Basic terms associated with MFs

2. Types of Mutual Funds

3. Where and how to invest?

4. Deciding a fund for yourself

5. Taxation and good strategies

What are Mutual Funds

A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds. Each share represents an investor’s part ownership in the fund and the income it generates

Why should you buy a MF?

1. Professional management

2. Diversification: The AMC investing in money markets, debts, bonds, even NASDAQ on your behalf

3. Affordability: With a small fee you can continue with your day job

4. Liquidity: Most funds charge no exit fee if you exit after 7 days. Taxes are also low compared to FDs if MFs are held for longer periods

5. Segregation: You can invest according to your future objectives

Common terms associated with MFs

NAV (Net Asset Value): Put simply, this is the price at which you can buy a unit of mutual fund at. Specifically, it is the per unit value of net assets (value of their holdings, cash and cash equivalents, among others) and liabilities (short-term payments, expenses, etc)

AMC: A company that pools money from investors. The pooled money is then invested in different in different schemes that they provide. IDBI, Axis, Nippon, Aditya Birla Sunlife, ICICI Prudential are some of the examples

Expense ratio: (Total costs involved in running a fund/Total assets of that fund). These are directly deducted from daily NAVs and don’t reflect as a specific charge to investors

if you invested $10,000 in a fund with a 10% annual return, and annual operating expenses of 1.5%, after 20 years you would have roughly $49,725. If you invested in a fund with the same performance and expenses of 0.5%, after 20 years you would end up with $60,858

Exit load: This is a penalty that an AMC might charge when an investor decides to prematurely exit from its fund. For example, a fund with 1% exit load for withdrawals before a year would charge 1% of your NAV (NAV at time of withdrawal) if you redeem your investments after 6, 7 or 8 months

Ways to invest

Regular: You invest in mutual funds via your broker. The broker directly deal with investments and you pay a small amount to her/him to manage your portfolio

Direct: You pay the money directly to the AMCs or via a low to no cost agency like Coin by Zerodha, PayTM money or ET money. These plans have lower expense ratios when compared to regular plans as there are no distribution costs

Types of investing

Active: The fund manager takes a hands-on approach, does research and take full advantage of market fluctuations in a bid to beat the market. ER is higher in these cases

Passive: In this the fund mirrors an index or sector and the returns are near to the returns that are offered by indices or sectors

Types of Mutual Funds

Basics

Equity based funds: Funds that invest more than 65% of their money in equity. All other funds are classified as non equity based funds in India

The core of finance is “High risks, high returns” and “Long term beats short term deviations and to a certain extent tail risks”

Growth funds are preferred for wealth creation, dividend funds for regular income and liquid funds for parking your money temporarily (30 - 60 days)

SIPs are systematic investment plans that allow you to deposit a certain amount on regular intervals. Lumpsum is when you make a one-time investment

Based on structure

1. Open ended funds: These are the funds in which investments and redemptions can be made throughout the year. These are ideal for those who want liquidity with no restrictions on maturity periods

2. Close ended funds: CEs can only be purchased via NFO (new fund offering). They can be bought or sold only for a few days after the launch. Post this they are traded in secondary market and are bought and sold like stocks. The mandate for these funds end after their maturity period

3. Interval funds: These funds can be bought or sold on specific dates only - like bid on 5th of every month and redemption only on 25th. These might be listed on bourses

Based on asset class

1. Equity funds: These funds have a mandate to invest in securities listed in the market. These are high risk, high return funds

   • Large cap: These funds choose stocks which are relatively stable. These are safest option amongst equity funds

   • Mid cap/ small cap: Investments basis the range of market capitalisation that a company falls in. Small cap funds are amongst the riskiest in the market

   • Multi cap: These funds have a mandate to invest in any and all the companies they deem suitable given the portfolio fulfils investors objective

   Debt funds: These invest in, as the name suggests, debt - company debentures, government bonds and other fixed income instruments

   • Liquid funds: These funds invest in commercial papers, government bills, essentially all g-secs and instruments that have a maturity date of less than 91 days. These are not wealth-generating funds but can be considered for parking your money on short term basis. These can be redeemed even within a day and are typically better than FDs

   • Ultra short term/ other funds: These funds invest in corporate bonds or other similar debt instruments basis their maturity periods and inherent risks

   • Balance or hybrid funds: These funds invest in a mix of asset classes to balance out risk and reward. A fund might have say 60 - 80% in equities and 20 - 40% in debt (e.g., Franklin India Balanced Fund)

   Solution based funds

   • Growth funds: These funds have an objective of capital appreciation. They typically invest all the dividends in the fund back and provide a better NAV. These are riskier options but recommended if you are starting out early

   • Income funds: These funds provide you regular incomes either via dividends or interests they earn on debt instruments. Good if you need additional money apart from my monthly earnings

   • ELSS: These funds have a lock-in period of 3 years with investments in equities. You cannot redeem investments in ELSS before the lock-in period. Investments upto ₹1.5 lakhs are eligible for tax benefits under 80C of the Income Tax Act

   • Others: pension funds, capital protection funds, fixed maturity funds

   Specialty funds

   • Sector Funds: These are funds that invest in a particular sector of the market e.g. Infrastructure funds invest only in those instruments or companies that relate to the infrastructure sector. Returns are tied to the performance of the chosen sector. The risk involved in these schemes depends on the nature of the sector

   • Index Funds: These are funds that invest in instruments that represent a particular index on an exchange so as to mirror the movement and returns of the index e.g. buying shares representative of the BSE Sensex

   • Fund of funds: These are funds that invest in other mutual funds and returns depend on the performance of the target fund. These funds can also be referred to as multi manager funds. These investments can be considered relatively safe because the funds that investors invest in actually hold other funds under them thereby adjusting for risk from any one fund

Where and How to Invest

(Below are my personal preferences only)

Always invest in direct plans. Expense ratios suck a lot of money from you in long term. Investment can be made via RTGS/NEFT/UPI directly by going to an AMC’s website

*Demo in class*

For better management, apps like PayTm Money, Coin by Zerodha, Groww, ET money provide low to NIL cost investing options. But if they don’t charge you anything, how do they earn money?

*Demo in class*

Now How?

KY: Know yourself. First ask two basic questions.

1. What’s your horizon? Do you want this money in next 2 years, next 10 years or you really don’t care? Also, is this for your marriage, you child’s education or a trip you are planning?

2. What’s your risk appetite? Does it give you the heebie jeebies when the market corrects (goes down) or flinch and take the investments out or you stayed calm even during COVID when the market threw tantrums

Analysis

Below metrics can be looked into -

1. Performance against NIFTY/ SENSEX or any relevant benchmark

2. Performance against category

3. The 3x3 matrix to validate if the fund meets your objective

4. Consistency and size of the AUM

5. Asset allocation and your trust in the companies in the portfolio

6. Expense ratio and exit load if you have a short-term horizon

7. Fund manager

*demo in class*

How to decide a fund for the first time?

*Live demo in class*

Valueresearch online

Money control

Taxation

For investments post January 2018

STCG: Short term capital gains for investments withdrawn before 1 year for equity based funds and before 3 years for other funds. Always applied on SIP or lumpsum on FIFO basis (investments made first are withdrawn first)

LTCG: Long term capital gains are when investments are kept for more than a year for equity based funds and for more than 3 years for other funds. Taxes are again always applied on FIFO basis

Indexation: This provides the benefits of inflation on taxes. The inflation growth between bid and redemption is deduction from the tax rate for non equity based funds in case of long term gains

Details on above here.

*Grandfathering cause applies in case you had investments before 31st January 2018. We will not study that in depth for the benefit of class. However, you can refer the same with some pretty neat examples here.*

Strategies

These are pretty much the basics, but are nevertheless important for investing of any kind. Follow below

• KYY: Know your risk appetite and time horizon for investment

• Never keep all your eggs in one basket. Diversify

• If possible, stay long term. On an average only 1% of day traders can beat returns from a low cost ETF

• Don’t go for an overlapping portfolio. If you have SENSEX 50 SBI Index fund in your portfolio, then it doesn’t make sense to go for a similar index fund with ICICI. Why take that risk?

• If you are young, go for growth options and look for wealth generating schemes

1References

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But first, this: Two events are said to be independent if the chances of occurrence of one is independent of the chance of occurrence of other. The chances of me getting my car damaged/totaled are different from your car’s chances of the same. It depends on the kind of drivers we are and also on the traffic situation. However, the events are said to be correlated if the chances of our cars getting totaled are same/dependent – take the example of a hurricane damaging both our cars equally

Imagine you open a new car insurance business, ‘Khareedlo’, and by commenting for better reach on LinkedIn, you finally have 100 customers – all from, say, Uttarakhand

At the start of every year, you charge your customers an annual premium for a simple agreement in which you pay them ₹1 lakhs if their car gets damaged. However, if nothing happens, you pay them nothing. You get your premium for that year though. Real world may have other scenarios too, but why complicate the same here

Now, you took some help from your front-bencher friend, ‘Debu’ and figured out that the chances of a car getting totaled is 14.5%. So, what’s the expected loss in a year, you asked Debu? He quickly referenced the EV thread on whatgaurav and figured out that the amount would be ₹14,500 [1,00,000 x 14.5% + 0 x 85.5%].

Given this, you jumped in joy and set the price of the premium to ₹16,000, adding 1500 as convenience fees on top of those 14.5k. With this your annual revenues are 16k x 100 = INR 16 lakhs. But this means, that you can pay for a maximum of 16 cars in a year, anything more than that and you’d be at loss.

You went to Debu and asked him, what would be the chances of you making a loss in a year (more than 16 cars getting damaged)? Only 28% in a year, he said. And if you stay in business for 20 years, it goes to 2%. Pretty swell, right?

Nope. This is where those tail risks come in. Let’s consider that there’s a hurricane in Uttarakhand and all the cars you gave insurance for are totaled. In this case you’d have to pay out a sum of ₹1 cr (1 lakh x 100). Remember you’ve been making a profit of only 1.5 lakhs per year, so if the hurricane comes sooner than later, you’d go bankrupt. Debu tells you that the chances of a hurricane coming in is only 5%, but that one event is bad enough. These are tail risks – those tails in your normal distribution – and they so happened because the events (cars getting totaled) were correlated. Do note that in normal scenarios you damaging your car is an ‘independent event’

So, I’ll keep the nerdy stuff aside and tell you that the chances of an independent event (cars getting damaged) in this case are only 10% and for correlated events it is 5%. Together, the math would give you 14.5% and more often than not, people get fooled by this 14.5% figure. But those 5% inherent events are the most dangerous

Consider more such examples of tail risks – 

1.     COVID hitting your investment portfolio

2.     Bitcoin gains going for a toss if RBI bans them

3.     Even darker, your relationship with XYZ if they cease to exist

In our example, if we really want our chances of accumulating losses to go to those 2% that we were happy about before, the premium has to go 50% higher to 24k

Moral: Tail risks need to be accounted for. There are often bad events in our lives that take away everything we had before like in the case above. The only way to avoid them is to increase our premiums today. Diversify investments, plan for contingencies and give a little bit more to those relationships so that them future fights aren’t that damaging and live life to the fullest – today 

So, that’s all for the Sunday. Hope you have no tail risks in future! Bye.

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Since you are reading this, let us gift you a $1 and open a Zerodha account for you. And as hypothetical as the previous statement is, consider that you get a magical stock, ‘MAG’ which only either doubles or halves every month with a 50/50 chance. You have no way of predicting which way it would go, the only liberty you have is to rebalance* your portfolio at the start of every month.

Given this, how would you invest your money so that you get decent returns after 20 years (240 months)? 

The EV principle says that on an average you would get: $2 (doubling)*1/2(chance of that happening) + $1/2(halving)*1/2 = $1.25. 25% whopping returns over a month. According to EV, you should just sit tight and invest $1 in month one and let the compounding happen, right?

Nope. That’s where MBA profs duped you. If you follow above, there’s a 50%+ chance that you’ll end up with <$1 and only 3% chance that you’d be a billionaire. Why? Because of Kelly’s criterion. But more on that tonight.

Aside, MBA seems like a scam. Only good for finding your partner. Okay, bye for now.

Your expected (average) values do not work because outliers skew the average! Different investing styles, different results. After 20 years, investing style A (let’s call it, IA) might give $100, IB $1, IC $0.1, and probably some I(infi) would give a billion dollars. Your professors are right about EV only when you’ve had infinite iterations because some of those billion dollars plus outcomes are so good that they lift the entire average. But this is never the case in real life. YOLO, you never gonna live foreva.

The most likely outcome is seldom the average outcome. So, to escape this ‘lottery’ situation you need a strategy. Kelly ‘the genius’ found just that. At the start of each month, rebalance your portfolio so that exactly half the money is in cash and the other half in MAG. 50-50. This is Kelly’s criterion.

In real life, invest 50% in risky assets (stock, MFs) and 50% in safe assets (FDs, Blue chip MFs). Whatever is left or gained after that month/ period, divvy that up again 50-50. There’s a 50%+ chance of you ending up a millionaire with this strategy, against a measly 10% chance you had when you followed your prof’s EV strategy.

This works even if the stock doesn’t double and half as in the mentioned example. What if there’s more than 2 investment options? Works then too. Kelly knew this because he built an entire mathematical model around this.

SIPs also provide approximately the same advantage. 

So, that’s it.

Been a geeky day, innit? Take this as an exception please.

Before we jump into understanding bell curves further, let’s revise what we call as a standard deviation. SD (σ) is nothing but the dispersion of a dataset from its average value. A stock with an opening and closing price of 50 and 120 (mean is say around 84) would be said to have higher σ than the equally priced stock with OP and CP as 80 and 90. More volatile stocks have higher σ

Coming back.

Bell curves are widely used in statistics, business and in markets. Some common examples would be the distribution on heights of people, returns on stocks, grades in an exam and your salaries. Let’s say that the average price of RIL stock across 2020 has been INR 1600 with a standard deviation of INR 30 daily. What are the chances that the stock would be between ₹1570 and ₹1630 on any random day in 2020? A: ~68% basis the table below

So, that’s the primer on bell curves.

Now, bell curves are pretty common and it’s a high possibility that you were already aware of them. However, bell curves are extremely important in understanding tail risks. Tail risks are the numbers that we usually ignore but should NEVER. Anyone willing to start a business or invest in markets should be aware of the inherent tail risks. Just keep this refresher on normal distribution handy for we will discuss them bad tail risks in our next thread

Goodbye!

Okay, let’s up the ante now.

Starters

Options are contracts that give you the right to buy or sell a security at an agreed-upon price (strike-price) before the date (expiry date) spelled-out in the contract. They are classified as ‘puts’ or ‘calls’. For simplicity, I’ll take the example of only call options in this thread

Main course

1.  Options always mean “100-share” multiples. For e.g., one call contract would give you the right to buy 100 shares, 7 call contracts would give you the right for 700 and so on. Consider, a 2K RIL 1-year call contract that would give you the right to buy 100 shares at ₹2000 within a year

2.  Tadkas: Let’s say that the RIL stock trades at 2500 after 6 months from now. Since you can then effectively exercise your option and buy them at 2k and subsequently sell them at 2.5k, you are ‘in the money’ or at profit. If the price 6 months from now is 2k, then your option would be called as ‘at the money’; for prices less than 2k, your option would be classified as ‘out of the money’

3.  Flavours: Options are classified as either American or European (CA and CE for call respectively). CAs give you the right to buy the stocks at any time between the purchase date and the expiry date but CEs can only be exercised at the expiry date. India only has European-type options currently

4.  Presentation: Like stocks, options also have ticker symbols, mostly 21-character long. Below is a dandy image from 10K diver to explain the same. MSFT is the ticker for Microsoft with $200 as their strike price

5. GST: Like all stocks, options are also sold at a price in the market. This price is what is called as a premium. A premium is always at a stock level. So, for our RIL example, if a call is purchased at ₹30,000 then the premium would be ₹300. Now this premium is typically between 12 – 15% for long term buys but varies according to the situation. If the stock is doing good then the premium increases, if the expiry date is nearby then the premium increases. The logic behind this is what lies at the core of finance: less time, more returns, more risk and vice versa

Finisher

If you have the F&O option enabled in your trading apps then you can dabble with some options yourself. But be cautious. 

There’s more on trading strategies for options in Options 103. Stay tuned and goodbye!

Thanks!

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Links
https://www.whatgaurav.com/p/options-101
https://www.whatgaurav.com/p/financial-instruments

Musk made Tesla buy bitcoins worth $1.5 bn. RBI plans on banning cryptocurrencies. China is busy mining it – pretty aggressively. Whatever you feel about ₿, it’s been the news maker. Let’s take a look

But first the basics. Bitcoin is just one of many digital currencies (called as cryptocurrencies) based on the blockchain technology. Blockchain is a wow technology for those who pretend to understand it and pretty impressive for those who actually understand it. Touchy. Coming back

Let’s look into the differences between normal fiat currencies (₹, $) and bitcoin

1. Decentralized – no one controls it. You cannot print money just because you wish to

2. Libertarian values – if you own it, you can use it. Anywhere, everywhere, irrespective of your nationality

3. All the transactions done till date are available for everyone to inspect; however, they can never be altered

4. No trail of transactions – all of them are anonymous 

5. Apart from Bitcoin you have other cryptocurrencies too – Ethereum, Ripple and others

Bitcoin as an investment option?

Many pandits said no. They recall the great fall in 2017 when its price dropped to $3k from $20k and believe that this is just another bubble. Stay away, they say

The supporters don’t agree though. They contend that most investments pre-2018 were by retail investors. However, many institutional investors are pouring money now. As per a recent survey, around 25% FIIs invest in bitcoin now. Fidelity, Cohen and some hedge funds have also put their money on the table

However, cryptos should not be seen as payment methods now but only as investments – extremely risky ones, so to say. We cannot put all our money in it, but if you spend ₹200 on coffee every day, you can do your tapriwala a favour and put ₹150 in crypto

There’s no underlying asset here so exercise some restraint but it’s also not a no-no. Coinbase, CoinDCX, Zebpay can be used to invest in them in India

That’s all. Wish you all the luck for Ballentine’s Day tomorrow.

Prateik loves naked calls. He knows that it’s risky and not what is acceptable to prudes, but he just cannot let go. He must have had, say, 100s of these in the past 5 years.

We’ll go a little easy today. No biggies. Just 5 exciting fin and eco terms. Let’s roll.

Cockroach theory: This theory proposes that if a firm declares some bad news then there’s probably a lot more bad stuff going on behind the scenes. The crisis of 2008 was the resultant of the firms like New Century Financial declaring bankruptcy in 2007

Razorblade model: This is when a business sells dependent goods for higher prices. The first item sold is often cheaper. More like your razorblades wherein the razor is pretty cheap but the cartridges you buy subsequently adds to the company’s profits. This has been cleverly done by Paytm in recent past with their free magic boxes. Even though it just announces UPI transactions, customers/shopkeepers prefer Paytm thinking that their transactions are more secure with Paytm because of this box.

Chasing nickels around dollar bills: This comes into effect when big companies cut trivial costs – like only tea and coffee, no biscuit – to shore up their profits, while continue wasting money on large expenses like R&D for an outdated technology

Big uglies: Often for profitable veteran firms in industries like mining or steel. Woke twitteratis consider it a strategy to sell these stocks for ‘cleaner’ trendier ones. Just kidding.

Naked call strategy: This relates to the sale of call options without having the stocks to cover them if the need arises. As you’d know from our options thread, traders usually buy calls hoping that the price for that stock would rise up in future; however, if they feel that their hypothesis was wrong, they can also sell those options to other buyers at the premium they paid for those stocks initially. But this would mean that the new buyer can now ask them to deliver stocks if (s)he feels like and for the same the seller would then be obligated to buy them at whatever market price they are at and handover them to the new buyer. The loss in this case is unlimited and hence the strategy is known as a naked call strategy.

So, that’s it.

And Prateik’s indeed a great guy. I guess now you know why. 

Bye bye.

For options: https://www.whatgaurav.com/p/options-101

There are three things which are all the rage in the financial world these days – reddit stocks that memers invest in, bitcoin and SPACs. Since we have already discussed the first two, it would be unjust to leave out the SPACs.

Let’s unpack. SPACs are short for Special Purpose Acquisition Company. These are formed specifically to acquire an existing private company.

Let’s say a group of sponsors – you, me and Bagpiper – wish to float a SPAC. In order to do so we will first register a company with some capital (initial funds). The company though would have no commercial operations, i.e., the company does not do anything – like your managers. Next, we would boldly go and announce that we would be taking this ‘blank cheque’ company public and if you wish to invest in the IPO, please do so. We will then take all the money and put it into an interest-bearing trust account

But why all this hassle? It’s because a SPAC has the mandate to find a company to merge with them and they have a maximum of 2 years to do so. They hire underwriters and investments bank to negotiate with the target companies and once done, those companies become a part of the SPAC

Pros

• A small private firm need not go through the hassle of filing an IPO and then waiting for it to open successfully

• Initial investors often get huge returns on their investments

• If the deal isn’t closed in 2 years then the money is returned to the investors

• A SPAC’s working capital is often the interest earned from the initially invested amount

• Specialised ‘going public’ process

Cons

• Opportunity cost of the interest you could’ve earned in a scenario of the deal not materialising in 2 years

• No control over the company SPAC would be merging with

• 40% of the money invested in SPACs in 2020-21 are from retail investors. Questions on why qualified investors wouldn’t want a piece of this

Anyhoo, SPACs are interesting. However, as ‘mint’ writes the SPAC-ships are still UFO in India. But with the startup ecosystem seeing the light of the day, our regulators should consider this.

That’s all for the day. Thank you.

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