Money no longer gets locked in IPOs

When investors apply for Initial Public Offering (IPO), they have to pay money upfront to the registrar/banker with whom the money gets locked for a few weeks, until the IPO price is decided and the shares are allocated. If the number of shares allocated is lesser than applied, the balance money is refunded to the investor. Since the money is locked for a few weeks, the investor loses interest amount he could earn otherwise on that money.

On the other side, bankers get floating interest on investor's money, for those few weeks. Well, to say the least, when money runs into Crores, however small the interest percentage is, the interest amount will be huge.

According to a SEBI statement, the money will now remain in the investor’s bank account till the allotment price and quantity is finalized. This would eliminate the refund process. This would also save money collecting and refunding time and thus will reduce the burden on registrars.
More news here.

At a macro level, the locking of money denies the markets to have the much needed liquidity (money in the hands of people that can be used for trading in stock markets), particularly when they are falling and need money to push it up. Thus, money locked in IPOs has a serious impact on stock markets.

An example is something that happened in January 2008, when investor money was locked in Reliance Power and Future IPOs. These IPOs were huge and have raked in most of the liquidity from stock markets. When markets fell during that time due to US recession fears and other reasons, investors didn’t have money with them to buy shares (when markets fall, share prices also fall due to which investors buy shares which in turn will pull the market up) and stop the market from falling further. Reason; their money was locked with Reliance and Future IPOs!

The move by the regulator may not solve the liquidity problem during IPO as SEBI is planning to have some arrangements with which money would be locked in the investor's bank account so that there won't be any lack of funds in the investor's account when the IPO allotment comes. But this will atleast give the investors interest income on their money.

Credit card and effective interest rate

Suppose you own a credit card that charges an interest rate of 3.1% per month for revolving credit. What would be the yearly interest rate you end up paying the bank that have issued you the credit card? Is it 3.1 x 12 = 37.2%? Well, no!

Let’s see why.
Consider that you have made a purchase of Rs. 50,000 in your credit card having 3.1% monthly interest and have paid only 20,000 on the due date. The bank will take forward the remaining amount (30,000) to the next month's bill with an interest charge of Rs. 930 (3.1% of 30,000), making the total amount due to be Rs. 30,930.

Now suppose once again you couldn’t pay the entire amount and you paid only 20,000 out of the total due amount of 30,930. The bank will charge an interest of 3.1% on the remaining 10,930 (not 10,000). Thus the bank charges interest on the previous interest amount also or simply, the interest charged is compounded! Due to compounding, the effective annual interest rate will be higher than 3.1% x 12.

The effective annual interest rate, when monthly interest rate is quoted can be found out using the following method.

Effective annual rate = (1 + i/m)^m – 1
where i is the nominal yearly interest rate (3.1% x 12 = 37.2%) and m is the total number of compounding periods in a year (12, since monthly).

Effective annual rate = (1 + 0.372/12)^12 – 1 and that comes out to be 44.25% instead of 37.2%!

Think about a lender who charges 44.25% for the money that you borrow from him. That’s exactly the reason why we should keep our credit card spending to the minimum with absolutely no revolving credit.

Base year and number of commodities used for inflation calculation in India

By this year end, the government will adopt a revised Wholesale Price Index (WPI), besides considering actual prices from next month.

Instead of the current 435 commodities, the revised WPI will have 980 commodities included in it, which will be rationalized by incorporating new items, removing unimportant items and amalgamating similar items.

The base year will also be revised to 2004-05 from the current base year of 1993-94. Thus the new WPI would give a more accurate figure for inflation. More news here.

So finally, the government is doing something on various debates happened over inflation calculation in India.

Related Articles
- How is WPI inflation rate calculated in India?
- Commodities and their weight-ages in WPI calculation of India
- Inflation rates of India (2009)
- Inflation rates of India (2008)
- The magic of Inflation

Poll Result: Will India attain double digit growth rate?

Will India attain double digit growth rate?

From rags to riches

A crorepati who lives in a hut!

The awe-inspiring story of a first generation entrepreneur! Sarath opens up his mind about the hardships he faced while making his company a success. I particularly liked the following statement he makes.

Quoting Sarath,
We talk about India shining and India growing, but we should ensure that people do not die of hunger. We can be a developed country but we should not leave the poor people behind. I am worried for them because I know what hunger is... Thoughts that are quite in line with the article by Pankaj Mishra about which I wrote in this post.

Sarath is a classmate of mine from IIMA's MBA programs. I hope that his story will be an inspiration for each and every one of us to start something similar and take India to one of the topmost countries in the world.