Monday, August 27, 2007

Recession or Growth ?

source: The Fed

Former US Treasury Secretary Lawrence Summers fear of recession seems un-real to me. The US interest rates are rising not because of inflation but because of growth in the economy as reflected by rise in real interest rates. The growth implies greater investment opportunities while the savings are slightly less than usual due to consumer driven growth. This imbalance of demand vs supply of money is the root cause of rising interest rates. The fear of recession does not seem real to me.

India Inc and Global domination!

Are the days of cheap money for buyouts over?

The rising bond yields suggest so. Media reports or Blackstone's stock performance also suggests so. Does it means the end of Mergers and Acquisitions around the world and especially the much talked about India Inc' overseas acquisitions?

I do not think so.

Indian companies were not acquiring overseas companies because interest rates were low earlier. Predominantly all Indian acquisitions were strategic and growth oriented. They were either to acquire technology or to acquire market access and customers. Those fundamentals of India Inc are still very much intact and hence the intent to acquire is intact. The question of funding though important but is not ultimate decider. Indian companies have been borrowing large sums overseas to fund the acquisitions only because funds are cheaper there. The increased interest rates will increase cost of borrowing but will equally reduce the valuations. In that scenario the increased interest expenses should be more than compensated with reduced cost of asset overseas. The US stock markets are down by about 6% while interest rate is up by about 4%. Hence the overall impact is only towards the better liking of India Inc. Instead of slowing down global acquisitions it is rather a buying opportunity!

Sunday, August 26, 2007


Butterfly - not this colorful one found in nature but is found around the world's financial markets! ... It is a fixed income (bonds / swaps) basket trading strategy to profit from anomalies of the interest rate term structure. The arbitrage is based on the principal of mean reversion where market expects the term structure's curvature to oscillate around its historical average position. Traders predict the shape of term structure and make a bet on it.

A Butterfly trading strategy is designed to profit from a relative mis-pricing of securities of different maturities while protecting against market and curvature risk. For instance if a trader maintains a view that a particular bond ,say a 4 yr zero, is priced higher relative to other bonds, he could short this bond in the hope that it would become cheaper in the near future. However such a strategy would involve too much market risk. If the interest rates fall then an outright short position in a 4yr bond would lose money anyway even if the trader had been right and the bond did become cheap relative to other bonds.

One way in which the trader could protect the short position is by buying a nearby issue, say a 2yr zero. In this case if the interest rates fall then the loss on the short position would be covered by the corresponding long position in the 2yr bond and vice versa. Thus if the relative mis-pricing were to correct the trader would make money regardless of the direction of the market movement. In other words such a strategy protects the trader against parallel shifts in the term-structure.

However one possible problem with such a strategy arises for non-parallel shifts in term structure. If the yield curve flattens, the yield on the 4yr bond might fall while the 2yr remains unchanged. Thus in this case the trader would lose money on the short position while the long would remain unchanged, thus even if the relative mis-pricing were to correct the trader would lose money. To cover the slope (change) risk the trader might take a long position in another bond with duration higher then 4 yrs, say a 6yr zero. With this strategy in place if the term structure flattens then the trader would lose money on the 4yr bond, gain on the 6yr bond while the position in the 2yr bond remains unchanged. If the term structure becomes steeper the opposite would hold true .Thus if the relative mis-pricing of the 4yr bond were to correct here the trader would register a net gain irrespective of any change in the term structure. In other words the strategy becomes direction neutral.

Such a strategy involving three securities of different maturities is called a butterfly trading strategy. The security in the middle of the maturity range, in this case the 4yr bond, is called the body, while the other two securities are called the wings. As described above such a strategy is designed to profit from relative mis-pricing while protecting against the interest rate level and slope risk.

Saturday, August 25, 2007

Jaguar & Land Rover in Rs 1 lakh

Whats the Tata strategy?

One on end Tata is pushing for the highest end of Jaguar and Land Rover while on the another is the Tata's "bottom of the pyramid" much hyped Rs 1 Lakh car. Is Tata spreading itself too thin or there is some deliberate thought behind? Lets think about it...

1 Lakh car is primarily for India and other India like emerging economies. Its more about the scale economics and knock down costs by fully redesigning and probably redefining what we know now as a car. The whole supply chain has to improve efficiency by order of magnitudes if the output has to be a car. Also technologically the fuel efficiency of this cars has to be improved by leaps and bounds such that it is not just a cheap car like Mauti 800 (even cheaper) but is overall a "bottom of the pyramid" car with lower total monthly cost of ownership. It will need to have fuel efficiencies closer to a two wheeler to compete in the market where at the lower side two wheelers owners look for flexibility and costs while at the higher side maruti 800 owners look for convenience and also the cost. If Tata has to sell its cars then it has to marry the two segments. Put together a car which is low cost but also offer convenience and flexibility. It should not be a car competing against a 3 yr old Maruti 800 available in second hand market for prices closer to Rs 1 lakh. No fun there!

So do Mr. Tata have the technology for a car with fuel efficiencies more than 40 KM per liter?

If he does not... I doubt the success of 1 Lakh car.
If he do.. then I believe we should long tata motors stock as not only 1 lakh car but also the Land Rovers and the Jaguars are going to do very well!

Why Rover and Jaguar? The biggest problem with these money loosing highly aspirational brands is the "gas guzzler" nature embedded deep in the very design of these 'cars'. If the 1 lakh car fuel technology can be applied here.. then we have at our hands a premium car which is as fuel efficient as a normal car. It is then the aspiration brand value in these brands will kick in and Tata can have winning proposition at hand.