Key Concepts

Bailout:

• This is when a financial institution requires external financial assistance, often from the government or other banks, to stay solvent.

Capital Infusion:

• External entities like SBI and institutional investors provide funds to the struggling bank to restore its capital base and ensure its continued operations.

Moat

• It refers to a company's ability to maintain competitive advantages over its rivals to protect its long-term profits and market share.
• This concept, popularized by Warren Buffett.

Credit Default Swaps (CDS)

• It is a financial contract where the buyer seeks protection against default by paying a premium to the seller, who agrees to compensate the buyer if the underlying debt defaults.

Collateralized Debt Obligation (CDO)

• It is a financial instrument that pools together a variety of loans (e.g., mortgages, auto loans, corporate debt) and packages them into a single security that can be sold to investors.

Mortgage-Backed Security (MBS)

• It is a financial product created by bundling together a group of home loans (mortgages) and selling them as an investment.
• The idea is that investors who buy MBS get a share of the payments made by homeowners on their mortgages (principal + interest).

Pump and Dump

• It is a scheme where the price of an asset, such as a stock or cryptocurrency, is artificially inflated (pumped) through false, misleading claims.
• Once the price rises significantly, the perpetrators sell off (dump) their holdings at a profit. Ex. Wolf of Wall Street

Insider Trading

• It refers to the buying or selling of a publicly traded company's stock or other securities by someone who has non-public, material information about the company.

Ponzi Schemes / MLM (Multi-Level Marketing)

• It is a fraudulent investment scam that promises high returns with little or no risk to investors.
• Instead of generating profits from legitimate business activities, returns to earlier investors are paid using funds from new investors.
• Early participants receive their promised "returns", creating the illusion of a successful and profitable venture.
• The scheme depends on recruiting new investors to pay earlier participants. There’s no actual profit-generating activity.
• When recruitment slows or many investors demand their money back, the scheme collapses, and most participants lose their money.

Front Running

• It is an unethical or illegal practice in which a person, typically a broker, trader, or insider, uses advanced knowledge of a pending transaction to place their own trade ahead of it to profit from the subsequent price movement.
• This is not only present in equity market, also present in real estate, cryptocurrency etc.

Circular Trading

• It is a fraudulent practice in financial markets where a group of traders or entities trade the same securities or goods among themselves to create the illusion of high trading activity.
• This manipulation inflates trading volume, misleading investors into believing the security is in high demand, which can influence its price.

Plateauing of house prices in 2013

• It refers to a period during which the rapid increase in housing prices seen in prior years began to slow down or stabilize.
• This phenomenon was observed in several regions around the world, particularly in markets like the United States, the United Kingdom, and parts of Europe and Asia.

Correction in Stock Market

• A stock market correction occurs when the market or a specific stock experiences a decline of 10% to 20% from its recent high.
• These are usually temporary and can happen due to various reasons like negative news, economic uncertainty, or profit-booking by investors.
• A correction is typically between 10% and 20%. If the decline exceeds 20%, it is termed a bear market instead of a correction.

Why Corrections Happen?

• Investors sell stocks to lock in profits after a strong rally.
• Inflation, interest rate hikes, or geopolitical tensions can lead to corrections.
• Fear of overvaluation or negative news.
• Corrections are normal and healthy for the market, providing opportunities for investors to buy good stocks at lower prices.

Dotcom Bubble (1995-2002)

The Dotcom Bubble was a period in the late 1990s and early 2000s when excessive speculation in internet-based companies led to inflated stock prices.

Investors believed the internet revolution would yield enormous profits, leading to a rapid increase in the stock prices of tech companies, particularly those with ".com" in their names.

Many startups and tech companies went public through Initial Public Offerings (IPOs), despite lacking a solid business model or profitability.

The media hype around the internet and technology companies fueled irrational optimism, causing stock prices to soar beyond reasonable valuations.

The bubble burst in 2000, when investors realized that many of these companies had no sustainable business models and were overvalued.

Stock prices of many tech companies, especially dotcom companies, plummeted sharply, causing massive losses for investors.

The collapse of dotcom companies led to the closure of many businesses that had been unable to generate profits, resulting in significant layoffs and bankruptcies.

The bursting of the bubble wiped out trillions of dollars in market value, leading to the recession of 2001.

The crash led to a loss of confidence in the stock market, especially in the technology sector, and caused a slowdown in investment and innovation in tech.

The Federal Reserve responded by lowering interest rates, aiming to stimulate the economy and mitigate the effects of the crash.

The Great Recession of 2008/Lehman Brothers crisis (2003-2008)

It was a major global economic downturn that resulted in significant financial and social consequences. It was primarily triggered by the collapse of the U.S. housing market and the subsequent financial crisis.

Repeal of the Glass-Steagall Act in 1999 allowed commercial banks to engage in risky investment practices, including trading in mortgage-backed securities (MBS).

After the Dotcom bubble burst, banks wanted to stimulate the economy by reducing interest rates.

Banks offered low-interest loans, prompting people to invest in real estate instead of bonds or the stock market, which offered lower returns.

Banks bundled loans into MBS and sold them to investors, transferring the risk away from themselves.

Both banks and borrowers believed housing prices would continue to rise, leading to overconfidence in the market.

Financial institutions borrowed heavily to invest in MBS and CDOs, amplifying their exposure to losses.

Foreign banks and investors also bought MBS, spreading the risk globally.

In September 2008, Lehman Brothers, heavily exposed to subprime loans, filed for bankruptcy, causing panic in global markets.

Investors, including hedge funds and pension funds, were eager to buy MBS because they offered high returns and seemed safe due to high ratings from agencies like Moody’s and S&P.

Even if the borrower defaulted, banks believed they could sell the property and reimburse the cash to the investors.

To sustain profits, banks targeted subprime borrowers as a new revenue stream.

Since banks sold MBS to investors, they didn’t bear the full risk of borrower defaults.

As many homeowners began to default on home loans, there were many homes for sale, which caused housing prices to fall drastically.

The U.S. government provided bailouts through programs like TARP (Troubled Asset Relief Program), injecting billions of dollars into failing banks to prevent total economic collapse.

Banks profited from the crisis by betting against their own risky products, contributing to the collapse.

Banks like Goldman Sachs shorted CDOs by purchasing credit default swaps (CDS).

A CDS acts like insurance: If the CDO fails (defaults), the holder of the CDS gets paid.

By shorting, banks profited when the very products they sold, such as MBS and CDOs, collapsed in value.

RBI's Tightening Measures

The Reserve Bank of India (RBI) implements tightening measures as part of its monetary policy to control inflation, stabilize the currency, and maintain economic stability.
These measures are aimed at reducing the amount of money circulating in the economy to curb excessive demand.

Rupee Depreciation:

It occurs when the value of the Indian Rupee (INR) falls relative to foreign currencies, especially the US Dollar (USD).

India imports more than it exports, leading to higher demand for foreign currency (like USD) to pay for imports.

Foreign investors withdrawing funds from Indian markets reduce the demand for INR, weakening its value.

India is a major importer of crude oil. Higher prices increase the demand for USD, putting pressure on the rupee.

Differences in interest rates between India and other countries can lead to currency shifts.

Harshad Mehta Scam (1992)

Harshad Mehta was an Indian stockbroker and financier, often referred to as the "Big Bull" of the Indian stock market. He gained fame for his role in the 1992 Indian stock market scam.

He operated Growmore Research and Asset Management, a stockbroking firm.

He used his reputation as The Big Bull to attract significant attention and trust in the stock market.

Mehta exploited the Ready Forward (RF) market, a short-term loan system where banks lend money to each other.

He exploited the RF market by convincing the banks to issue cheques in his name for these RF deals. However, in many cases, these cheques were not backed by proper collateral or the legitimate sale of securities.

Using these diverted funds, he heavily invested in the stock market, inflating prices of select stocks, including ACC, which rose from ₹200 to ₹9,000.

Mehta collaborated with certain bank officials who facilitated these irregular transactions.

The scam was exposed in 1992 when journalists discovered that funds were being misused in securities transactions.

The total misappropriated amount was over ₹4,000 crores, causing massive losses to banks and investors.

The stock market crashed after the scam was revealed, wiping out investor wealth.

Harshad Mehta was arrested and charged with multiple financial crimes, although he claimed innocence in some cases.

The scandal led to significant regulatory changes, including the strengthening of SEBI to oversee the stock market and prevent such frauds in the future.

Ketan Parekh Scam (2001)

Ketan Parekh was a stockbroker who masterminded the Ketan Parekh Scam (2001), a major financial fraud in the Indian stock market.

He rose to prominence through his involvement in the Techno-Commercial Group (TCG), which was used to manipulate stock prices, especially in the technology sector.

Parekh manipulated stocks by creating artificial demand and driving up prices, especially for stocks in small IT companies, leading to inflated valuations.

He borrowed large sums of money from banks, including Bank of India, using front companies to finance his stock purchases.

Through circular trading, Parekh bought and sold stocks among his own set of companies, creating an illusion of liquidity and increasing prices.

Parekh focused on tech stocks, artificially driving their prices up to create a false perception of high demand.

Several brokers and banks were complicit in helping him carry out the scam by providing loans and engaging in illegal trading practices.

The scam was exposed in 2001 when it was discovered that Parekh had over-leveraged himself by borrowing large sums to manipulate stock prices.

As the manipulated stocks began to lose value, the market crashed, causing significant losses for investors who had bought into the inflated stocks.

The crash triggered an intervention by SEBI to tighten stock market regulations and prevent such frauds in the future.

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