Impact of RBI policies on stock markets

Interest is nothing more than the cost someone pays for the use of someone else's money. Homeowners, credit cards users etc know about this scenario very well. They borrow money from bank and in return they pay interest to bank for using the privilege. Interest rate is an integral part of our spending habit as we borrow from the bank for buying house, cars, house old items etc. For the business community interest rate is also very important as they borrow money from bank for investment activities like capacity expansion, setting up of plants, acquisitions, modernization etc. So interest rates play a critical role in a business’s profitability and hence, on stock prices.

SO WHAT INTEREST RATE AM I TALKING ABOUT HERE?

REPO RATE. This is the interest rate that applies to investors. This is the cost that banks are charged for borrowing money from The Reserve Bank of India. Why is this number so important? It is the way RBI attempts to control inflation. Inflation is caused by either excess Aggregate Demand or cost push factor (supply side factors), which causes prices to increase. By influencing the amount of money available for purchasing goods, RBI can control inflation. Basically, by increasing the Repo rate, the RBI attempts to lower the supply of money by making it more expensive to obtain. Though sometimes CRR cut also acts a stimulant in lending rate changes, repo rate has an edge over CRR in terms of deciding lending rates.
 

HOW DOES IT AFFECT STOCK PRICES?

Interest rate and stock prices have an inverse relationship or I can say their relationship is like a SEESAW. Changes in the Repo rate affect the behavior of consumers and businesses, but the stock market is also affected. One method of valuing a company is to take the sum of all the expected future cash flows from that company discounted back to the present. To arrive at a stock's price, take the sum of the future discounted cash flow and divide it by the number of shares available. This price fluctuates as a result of the different expectations that people have about the company at different times. Because of those differences, they are willing to buy or sell shares at different prices.

If a company is seen as cutting back on its growth spending or is making less profit - either through higher debt expenses or less revenue from consumers - then the estimated amount of future cash flows will drop. All else being equal, this will lower the price of the company's stock. If enough companies experience declines in their stock prices, the whole market, or the indexes (like the BSE Sensex or NSE Nifty) that many people equate with the market, will go down.

Following points are also worth taking note-

Capital intensive industries such as real estate, automobiles etc are highly sensitive to interest rates but when the interest rates are lower they would be gaining the most.

Companies with a high amount of Debts would be affected very seriously. Interest cost would go up and hence affecting their EPS and ultimately the stock prices.

Pharma sector does not get much affected with the interest rates. Pharma is considered as the defensive sector (now more of a Growth Sector) and investors can invest here during uncertain and volatile market conditions.

In a high interest rate scenario, companies with zero or near zero debts in their balance sheets would be kings. FMCG or fast moving consumer goods is one sector that’s considered as a defensive sector due to its low debt nature.

High rates have an immediate impact on profits, and so affect a bank’s stock price as well. One more major reason is that they have a low Debt Equity ratio. The Spread (the difference between the interest they earn on the money they lend and the interest they pay to the depositors) for banks is likely to increase leading to growth in profits & the stock prices.

The following data depicts the changes made by The RBI since September 2010 and its impact on Sensex.

Date	New Repo rate	Change in Sensex
16-Sep-10	6%	-85
2-Nov-10	6.25%	-10
25-Jan-11	6.50%	-180
17-Mar-11	6.75%	-200
3-May-11	7.25%	-460
16-Jun-11	7.50%	-150
26-Jul-11	8%	-363
16-Sep-11	8.25%	57
24-Oct-11	8.50%	144
16-Apr-12	8%	56
30-Jan-13	7.75%	14
19-Mar-13	7.50%	-285
3-May-13	7.25%	-160
20-Sep-13	7.50%	-352
29-Oct-13	7.75%	359
18-Dec-13	7.75%	265
28-Jan-14	8%	24

The above table shows that Sensex reacted negatively whenever repo rate was hiked post September 2010. As a matter of fact, on 03-May-2010 when The RBI hiked repo rate by 50bps, the Sensex plunged by 460 points. However, when repo rates were upped to 8.25 percent and 8.50 percent respectively from their previous levels, market in fact reacted positively as India was driven by strong economic growth during that time and the rate has reached to its stability. A 50 basis point hike in the rates on 28-Jan-14 failed to create any stimulus in the market as Sensex moved only 24 points.

Change in repo rate has “Mumbo Jumbo” effect on stock market. Increase in repo rate not only increases the cost of debt/capital for business but it also shifts the investment in favour of deposits which offer higher rate of return. The same happens when the repo rate is trimmed. The market may or may not react significantly to a rate cut of 25 bps but the real impact comes over only after a period of time.

2015 will be a good year but not as good as 2014 was since 2015 may not see some wonderful rallies which took Sensex and Nifty to their lifetime high. However one thing that could trigger a rally in Sensex and Nifty will be the possible rate cut by the RBI in the New Year. Apart from Banking and Finance companies being the direct beneficiaries of the rate cut, companies with high debt capital structure will also benefit.  Expecting a rate cut by the RBI, I recommend the readers to consider the following stock:

- Bajaj Electricals

- Future Retail

- Tata Communications

- HDFC Bank Ltd

- ICICI Bank Ltd

DISCLAIMER: Among many other factors to be considered while investing in stocks market, interest rate is one of them. One can never say with confidence, therefore, that an interest rate hike will have an overall negative effect on stock prices.

M&A - the game

Mergers & Acquisitions - Synergies

Synergies refer to expected cost savings, growth opportunities, and other financial benefits that occur as a result of the combination of two companies. A correct estimation of synergies is needed to produce a successful transaction. The combination of two entities will not create value if the value of synergies is zero or negative. The synergy from a merger or an acquisition is the value of the combined entity minus the fair value of the two firms as separate entities. The fair value is the true or intrinsic value of the entity exclusive of any element of value arising from the expectation of a merger or acquisition. The gain in value of the combined entity is the present value of the synergy cash flows.

The size and degree of likelihood of realizing potential synergies plays an important role in framing the purchase price of acquisition. Due to their critical role in valuation and potential to make or break a deal, investment bankers need to understand the nature and magnitude of the expected synergies carefully. The buy-side team (investment bankers on acquirer side) must ensure that the synergies are accurately reflected in the financial model and M&A analysis, as well as in communication to the investors and markets.
Synergies arise from the increase in size of expected future cash flows (the additional cash flows resulting from the combination of assets). The additional cash flow for a given year may arise from:

Revenue Synergies
Revenue synergies refer to the enhanced sales growth opportunities presented by the combination of businesses. A typical revenue synergy is the acquirer’s ability to sell the target’s products through its own distribution channels without cannibalizing existing acquirer or target sales i.e. The post merger combined entity is expected to sell more than the two merged firms separately (selling the same products to more clients, more products to the existing client base, or both). Also, revenue synergies occur as the combined entity may get a larger market share that enables it to raise the price of its products. Another revenue synergy occurs when the acquirer leverages the target’s technology, geography presence, or know-how to enhance or expand its existing product or service offerings.
Revenue synergies tend to be more speculative than cost synergies. As a result, valuation and M&A analysis typically incorporate conservative assumptions regarding revenue synergies.

Cost Synergies
Cost synergies, which are easily quantifiable, tend to have a higher likelihood of success than revenue synergies. Cost synergies are also rewarded by the markets via stock price appreciation. Typical cost synergies include headcount reduction, consolidation of overlapping facilities, and the ability to buy key inputs at lower rates due to increased purchasing power. Increased size of the acquirer provides for economies of scale i.e. larger companies are able to produce and sell more units at a lower cost per unit than smaller competitors.
Decrease in operating costs as a result of the combination (2+2=3): Reduction in overhead expenses (discounts for raw material purchase due to increase in quantity) and economies in marketing and distribution generally lead to an improvement in cost of goods sold and selling and general and administrative expenses.
Decrease in the capital requirements of the combined entity: Capital requirements are the new investments required in working capital and fixed assets. For example, after a merger, the combined entity may be able to use its combined assets more efficiently by cross-using factories on a regional basis.

Likelihood and Timing of Synergies Realization
The business combination will project various benefits, some of which have a very high likelihood of success while others may be long shots. For example, the likelihood that the administrative costs associated with the target’s board of directors can be eliminated is about 100%. Conversely, achieving certain sales goals against stiff competition is probably far less definite. These differences must be noted and allowed for in the forecast.
The timing of synergies realization is very important. The successful and timely delivery of expected synergies is extremely important for the acquirer. Failure to achieve the synergies can result in share price decline as well as weakened support for future acquisitions from shareholders, creditors and rating agencies. A McKinsey study points out – ‘Unless synergies are realized within, say, the first full budget year after consolidation, they might be overtaken by subsequent events and wholly fail to materialize.’

The net present value of synergies can then be valued with the usual discounted-cash-flow model.

Mutual Funds - A beginners guide!

Hello friends, today we will learn about mutual funds in general..

Let's take example of a person..

An Investor has got INR1000 for investment. He wishes to spend his money in buying shares of start-up companies in India since he had been completely bowled over by reading the success stories of people who invested in shares of start-up companies. However, he faced many road blocks for carrying out his decision to invest in the start-ups. Some of them were lack of knowledge about different companies in the start-up sector, illiteracy of technicality in investment in shares, absence of professionals to guide and above all, insufficient amount of money to invest in all the companies.

Here is why Mutual funds become life saver in these types of situations.

Mutual Funds are created and run by companies called Asset Management Company (AMC) which invites people of like-minded financial goals to pool their money. This sum which is now handed over to the AMCs’ will be professionally managed and parked in the appropriate stocks of companies in Start-up sectors which is identified to be potential return-givers to those investors. In short, a layman gets to use his own money in a wise manner with the guidance of professionals in stock markets and for the shares he desired. Profits/returns generated by these AMCs’ will be handed over to these investors after deducting the fees charged for services AMCs’ provided and it will be distributed in the proportion in which investors pooled-in their money. Total value of the market price of stocks included in the mutual fund divided by the number of units of mutual fund distributed to investors is termed as NET-ASSET-VALUE (NAV) on the basis of which each unit of that particular mutual fund is available in the market.

How to go if you want to invest in Mutual funds?

1. Approach the banks or other AMCs’ to open a demat account and a trading account.

2. Submit Photograph, PAN card, Name and Address proof, Bank Account Details and KYC Compliance.

3. Decide the right kind of mutual fund to achieve your financial goals (AMCs’ will guide you in that area).

4. If an equal amount of money is to be consistently invested in the future, it is better to choose SIP investment than investing manually every time. (SIP stands for Systematic Investment planning which allows one to buy units on a given date each month or quarter automatically by a standing instruction from the bank)

5. Keep a track of NAV when bought, number of units purchased and latest value of MF as on date so that you know whether you are on a profit or loss.

Expenses an investor has to incur for mutual funds are entry load (one-time-fee charged at beginning of investment; Rs.100-150/-), Exit load (at the time of redemption; 1%-3%) and recurring charges (during the time period of investment; max.2.5% p.a on AUM).

Mutual funds are not fully risk-insulated since its risk lies on the stocks in which it puts the money. However, one way to assess a fund’s level of risk is to look at how much its returns change from every year. If the fund’s returns vary a lot, it may be considered higher risk because its performance can change quickly in either direction.

Investing in mutual fund gives many benefits in one package like professional guidance, umpteen stock choices, low costs, risks reduction, liquidity etc. However, like every other financial instrument, it requires time and patience to grow your money through mutual funds. Best advice that can be given is START EARLY AS POSSIBLE.

NSE Certifications - A begginer's guide

The professional marketplace is proliferated with people who want to make a mark for themselves. With the increased granularity of the profession and evolution of financial markets comes the need for greater specialisation. How useful a credential is to its holder and his employer depends upon your area of focus and the rigour and scope of your designation.

There has been a paradigm shift in the way financial markets operate now — there are a variety of new functions that need different levels and a completely new way of specialisation and orientation has emerged. Taking into account international experience and the needs of the Indian financial markets, with a view for protecting interests of investors in financial markets and more importantly, for minimising risks of losses arising out of deficient understanding of markets and instruments, National Stock Exchange has introduced a facility for testing and certification by launching NSE’s Certification in Financial Markets (NCFM).

Here are some certifications that will hone your skills in Finance and give you a ‘hands on’ of the working of the financial markets — both money and capital.

NCFM modules

NCFM currently tests expertise in different modules. It offers a comprehensive range of modules covering many different areas in Finance. The modules are in three categories - Basic, Intermediate and Advanced.

Basic Modules

There are basic modules on Financial Markets, Mutual Funds, Currency Derivatives, Equity Derivatives, Interest Rate Derivatives, Commercial Banking in India, Debt market and Securities Market.

Intermediate Modules

Once you are done with the basic certifications in any/each of these modules, you can graduate to Intermediate modules that cover certifications in the same topics like Capital Markets, Mutual Funds, Currency Derivatives, and the like.

The duration of the tests varies from 105-120 minutes and the number of questions is 60. The maximum marks for tests varies from 100-120 and the passing marks are 50 to 60 per cent depending on which test you have gone in for. There is negative marking for incorrect answers.

For successful candidates, certificates are valid for five years from the test date.

Advanced modules

These modules have been prepared with a view to provide candidates with a comprehensive and in depth knowledge about the financial markets. The modules are on Financial Markets, Securities Markets, Derivatives, Mutual Funds, Options Trading, Equity Research, Issue Management, Market Risk, Financial Modeling, Credit Risk Analysis Certification and the like

NSE Certified Market Professional (NCMP)

These certificates are in levels 1-5 and are issued to those candidates who have cleared NCFM modules. In case you have cleared 3-4 modules, you will be given Level 1, 5-6 modules will give you level 2. 7-8 would get you level 3, 9-10 modules will make you eligible for level 4, clearing of more than 11 modules will get you level 5. The NCMP certificate itself has no validity period.

Proficiency Certificate

Depending upon the NCFM modules successfully cleared by you, you would also be eligible for Proficiency Certifications.

Eligibility

The qualifying criteria for the various certifications are as given below:

NSE Certified Derivatives Pro (NCDP)

On passing NCFM Equity Derivatives: A Beginners' Module + Derivatives Market (Dealers) Module + Options Trading Strategies Module.

NSE Certified Derivatives Champion (NCDC)

On passing NCFM Equity Derivatives: A Beginners' Module + Derivatives Market (Dealers) Module + Options Trading Strategies Module + Option Trading (Advanced) Module.

NSE Certified Investment Analyst Pro (NCIAP)

On passing NCFM Investment Analysis and Portfolio Management Module + Technical Analysis Module + Fundamental Analysis Module.

NSE Certified Investment Analyst Champion (NCIAC)

On passing NCFM Investment Analysis and Portfolio Management Module + Technical Analysis Module + Fundamental Analysis Module + Wealth Management Module.

NSE’s Capital Market Aptitude Test (NCMAT)

If you wish to hone your skills in the area of capital markets and investment, this test is for you. In order to assess the aptitude, knowledge and skills in the capital markets. The duration of the test is 120 minutes and the number of questions is 100. The passing marks is 60 per cent with no negative marking. You would be asked questions on Equity and Debt Markets, Derivatives, Portfolio Theory, Risk and Return etc. The certification accelerates your job opportunities in the capital market and in the banking sector.

National Institute Of Securities Markets (NISM)

NISM is a public trust, established by the Securities and Exchange Board of India (SEBI), the regulator for securities markets in India. NISM has launched an effort to deliver financial and securities education at various levels and across various segments in India and abroad. It develops and implements certification examinations for professionals employed in various segments of the Indian securities markets. The School for Certification of Intermediaries (SCI) at NISM is engaged in developing certification examinations for professionals employed in various segments of the Indian securities markets.

The NISM exams are in series:

• NISM Series I: Currency Derivatives Certification Examination
• NISM Series II A: Registrars and Transfer Agents (Corporate) Certification Examination
• NISM Series II B: Registrars and Transfer Agents (Mutual Fund) Certification Examination
• NISM Series-III-A: Securities Intermediaries Compliance (Non-Fund) Certification
• ISM Series-III-B: Issuers Compliance Certification Examination
• NISM Series IV: Interest Rates Derivatives Certification Examination
• NISM Series V A: Mutual Fund Distributors Certification Examination
• NISM-Series V-B: Mutual Fund Foundation Certification Examination
• NISM-Series-V-C: Mutual Fund Distributors (Level 2) Certification Examination+
• NISM Series VI: Depository Operations Certification Examination
• NISM Series VII: Securities Operations and Risk Management Certification Examination
• NISM-Series-VIII: Equity Derivatives Certification Examination
• NISM Series-IX: Merchant Banking Certification Examination
• NISM-Series-X-A: Investment Adviser (Level 1) Certification Examination
• NISM-Series-X-B: Investment Adviser (Level 2) Certification Examination
• NISM-Series-XI: Equity Sales Certification Examination+
• NISM Series-XII: Securities Markets Foundation Certification Examination
• NISM Series-XIII: Common Derivative Certification Examination
• ISM Series-XV: Research Analyst Certification Examination

The duration of each of these exams is two hours and the pass marks range from 50 to 60 per cent. There is negative marking also.

Summing up

The certifications mentioned above would make you assess your own aptitude and hone your skills for the area you wish to make your career or are pursuing your career. Far reaching reforms during the past few decades have transformed the Indian capital markets into a transparent, liquid and vibrant market place and also made it imperative for those seeking a career in the financial sector to stay abreast with the latest trends in both the primary and secondary markets.

So, in case you wish to cut the clutter and make a mark for yourself, these certifications would not only add some meat to your resume but also hold you in good stead in the financial job market.

Investors guide to trade in Nifty

To deal with stock market an individual must know about Nifty and nifty future. Nifty is basically a termed defined as an index of performance of top companies listed in NSE – National Stock Exchange. The NSE India enlists thousands of companies but only 50 companies are responsible for variations in Nifty. Nifty future is basically a financial instrument through which transactions are done on the basis of index of NSE. This can also be said as agreement between two parties in order to buy or sell at the particular price at particular time. The Nifty future is an essential so as to perform transaction of physical commodities and financial instrument in stock exchange market.

Nifty Futures is a volatile market of Indian stock market. It varies on continuous basis. It always involves certain risk as it is a fluctuating market. There are many firms that provide you free Nifty tips in order to carry out transactions appropriately. This is essential especially at times when individual do not have sufficient time to see the fluctuations in market before investing into it. Thus it sticks to Nifty tips provided by these financial firms. Some of those Nifty tips may include the following:

Patience: Patience is really important while investing in Nifty futures as the investment can turn to profit in long term basis one need to be patient along with complete knowledge of the changes of the market.

Judgments and inferences: The judgment is of the current and past trends of the existing Nifty market is essential so as to go on with the trends of market. It is also necessary to fine inferences of the current market from the judgment one makes before actually investing.

Choosing the correct contract: it is also essential to select the appropriate contract before investing a huge capital in Nifty market because these decision can either lead to undue profit or even a loss.

Loss must be minimized: one cannot decide the amount of profit it would get but the losses from the investment in Nifty future can be minimized with correct decisions kept in mind while carrying the transactions.

Knowledge: Knowledge of the stock market is essential for investment in this market. The individual investing in Nifty must have required knowledge necessary. One can lead to loss if it does not knows the current and past trends of this market as not knowing the past and current one cannot judge for the future of the amount invested.

Advice: the Nifty is a fluctuating market even sometimes the experiences individuals of these markets fail in transactions and leads to loss thus it is essential to go with the expert advice and knowledge one gathered through times.

Everyone knows that the Nifty future market keeps on varying with time and the fact remains that even sometimes the great experienced also lead to big losses thus it is very important to make a proper decision before investing in Nifty futures. This can be done by taking proper advice from certain existing advisory firms so that you lead to profit and profit only.

All about SIP (Systematic Investment Plan)

This is the market revolutionary change happened, achieved fame and many of us heard of it without knowing much about it.

Unfortunately, many new investors seem to be under a misconception that it is a type of mutual fund. A Systematic Investment Plan is not a type of mutual fund; it is a method of investing in a mutual fund.

Here's to coming to terms associated with mutual funds. There are two ways in which we can invest in a mutual fund.

•   A one-time outright payment

If we invest directly in the fund, we just hand over the cheque and we get our fund units depending on the value of the units on that particular day.

Let's say we want to invest Rs 10,000. All we have to do is approach the fund and buy units worth Rs 10,000. There will be two factors determining how many units we get.

a)      Entry load

This is the fee we pay on the amount we invest. Let's say the entry load is 2%. Two percent on Rs 10,000 would Rs 200. Now, we have just Rs 9,800 to invest.

b)      NAV

The Net Asset Value is the price of a unit of a fund. Let's say that the NAV on the day we invest is Rs 30.

So we will get 326.67 units (Rs 9800 / 30).

• Periodic investments or SIP (Our present area of concentration)

This is referred to as a SIP.

That means that, every month, we commit to investing, say, Rs 1,000 in our fund. At the end of a year, we would have invested Rs 12,000 in our fund.

Let's say the NAV on the day we invest in the first month is Rs 20; we will get 50 units.

The next month, the NAV is Rs 25. We will get 40 units.

The following month, the NAV is Rs 18. We will get 55.56 units.

So, after three months, we would have 145.56 units. On an average, we would have paid around Rs 21 per unit. This is because, when the NAV is high, we get fewer units per Rs 1,000. When the NAV falls, we get more units per Rs 1,000.

Other important points relating to SIP-

§  

Exit load -

 An exit load is a fee we pay at the time of selling the units, just like the entry load is a fee we pay when we buy the units.

Initially, funds never charged an entry load on SIPs. Now, however, a number of them do. We will also have the check if there is an exit load. Generally, though, there is none. Also, if there is an entry load, an exit load will not be charged. An exit load may be charged if we stop the SIP mid-way. Let's say we have a one-year SIP but discontinue after five months, then an exit load will be levied. These conditions will wary between mutual funds.  

§  

Periodic Investments -

 If we do a onetime investment, the minimum amount that we have to invest is Rs 5,000.

If we invest via an SIP, the amount drops. Each fund has their own minimum amount. Some may keep it at least Rs 500 per month; others may keep it as Rs 1,000.

§  

Frequency of investment - It

 would depend on the fund. Some insist the SIP must be done every month. Others give us the option of investing once in three months or once in six months. They also give fixed dates. So we will get the option of various dates and we will have to choose one. Let's say we are presented with these dates: 1, 10, 20 or 30. We can pick any one date. If we pick the 10th of the month, then on that day, the amount we have decided to invest in the fund has to be credited to our mutual fund.

§  

Nature of payment - 

We can opt for the Electronic Clearance Service from our bank; this means the mutual fund will, as per our instructions, debit a certain amount from our account every month. Let’s say we have a SIP of Rs 1,000 every month and we have chosen to invest in it on the 10th of every month. Under this option, we can instruct our mutual fund to directly debit our bank account of Rs 1,000 on the due date. If we don't have the required money in our account, then for that month, no units will be allocated to us. But, if this continues periodically, the mutual fund will discontinue the SIP. We need to check with each mutual fund what their parameters are.

Alternately, we can give cheques to our mutual fund. In this case, they may ask for five Post Dated Cheques upfront with our first investment. Since these cheques are dated ahead of time, they cannot be processed till the date indicated.

§  

Duration of investment –

 one have to state whether we want it for a year or two years, etc. If, during the course of this period, we realize we cannot continue with the SIP, all we have to do is inform the fund 15 days prior to the payout. The SIP will be discontinued. We can continue to keep our money with the fund and withdraw it when we want. 

§  

Type of funds that offer SIP -

 All types of equity funds (funds that invest in the shares of companies), debt funds (funds that invest in fixed-return investments) and balanced funds (funds that invest in both) offer a SIP.

Liquid funds, cash funds and floating rate debt funds do not offer an SIP. These are funds that invest in very short-term fixed-return investments. Floating rate debt funds invest in fixed return investments where the interest rate moves in tandem with interest rates in the economy (just like a floating rate home loan).

§  

Tax implications - 

Let's say we have invested in the SIP option of a diversified equity fund. If we sell the units after a year of buying, there is no need to pay capital gains tax. If we sell if before a year, we are required to pay capital gains tax of 15%.

Let's say we have invested through a SIP for 12 months: January to December 2015. Now, in February 2016, we want to sell some units. The system of first-in, first-out applies here. So, the amount we invest in January 2015 and the units we bought with that money will be regarded as the units we sell in February 2016.

For tax purposes, the units that we sell first will be considered as the first units bought.

·       

How can be SIP is different and help full when compared to regular method of investing in mutual fund-

When we buy the units of a fund, we may do so when the NAV is really high. For instance, let's say we bought the units of a fund when the bull Run was at its peak, leading to a high NAV.

If the market dips after that, the value of our investments falls and we may have to wait for a long while to make a return on our investment. But, if we invest via a SIP, we do not commit the error of buying units when the market is at its peak. Since we are buying small amounts continuously, our investment will average out over a period of time. We will end up buying some units at a high cost and some units a lower price. Over time, our chances of making a profit are much higher when compared to an one-time investment.

Understanding VISA Business model

Ever wondered how VISA and Master Card generates billions of money...?? Through my this article, i would like to explain you how it works. 

VISA business model is very different from a traditional business model. It is not very intuitive enough. Though most of us use VISA credit cards for our payments, very few of us would know how VISA works. In fact, many of us would not even know that VISA is a public-traded company and is listed in the New York stock exchange.

VISA is a Technology company providing global payment solutions to the banks. Its payment product platforms are used by the banks to develop credit and debit card programs for their customers. VISA does not issue credit cards or extends credit to the consumers. Instead, it operates an “Open-loop payments Network” to manage the exchange of information between different financial institutions.

To understand how VISA works, which customer segments it serves, what it offers to its customer segments, and how does it makes money from them, we need to get familiar with few terms. VISA classifies the banks as either Issuers or Acquirers. Issuers issue cards to the cardholders, whereas the Acquirers manage the relationship with the merchants. The diagram below explains what happens behind-the-scenes when a cardholder presents a card for payment to a merchant.

When a cardholder presents a card for payment to a merchant, the payment request is forwarded to the acquirer. The acquirer contacts the issuer through the VISA network. The issuer shares the information on whether sufficient balance is available to carry out the transaction. The information is then routed to the merchant. In case sufficient balance is available, the payment is accepted. Else, it is rejected. The issuer bills the cardholder on a monthly basis. The cardholder pays those bills then.

This is a very simplified explanation of what happens behind-the-scenes. The actual process involves separate loops for Authorization and Clearing & Settlement. VISA also offers several value-added services such as risk management, debit issuer processing, loyalty services, dispute management and value-added information services.

What the above diagram does not tell is how VISA and banks make money in the process. They make money from the transaction fees charged to merchants. To understand how it works, imagine a Rs. 100 payment from a cardholder to merchant. In case the merchant fee is 2.4%, the merchant would get Rs. 97.60 from the transaction. Rs. 2.40 would get unevenly split between issuer and acquirer, depending upon the interchange fee. In case of an interchange rate of 1.8%, the issuer will keep Rs.1.80 and acquirer will keep Rs.0.60. Issuer gets to keep more of the merchant fee because of a higher risk of payment default from the cardholder. VISA makes money on payment volumes, transaction processing, and value-added services.

VISA creates value for all its stakeholders during the process. Cardholders’ benefit because of convenience, security, and rewards associated with card payments. Merchants benefit from improved sales by offering payment method options to the customers. Banks get new revenue streams through card fees, late payment interests, and transaction fee cuts.

VISA captures value through the following revenue streams: Service revenues from banks for their participation in card programs; Data processing revenues for authorization, clearing, settlement, and transaction processing services; International revenues from transactions where the cardholder issuer country is different from the merchant’s country.

In order to create the value, VISA has built a global processing infrastructure consisting of multiple synchronized processing centers. These centers are inter-linked and are engineered for redundancy. Managing these payment networks is a core part of VISA operations to ensure a safe, efficient, and consistent service to the banks, cardholders, and merchants.

VISA is a great example of a “Multi-sided Platform” business model pattern. The platform induces “cross-side” network effects. More the cardholders use VISA, more the merchants will accept it and vice-versa. Since merchants are on the ‘money side’ of the platform, VISA focuses its marketing efforts on the cardholders who are the ‘subsidy side’ of the platform. VISA sponsored FIFA world cup in 2010 and will be Olympic sponsor through 2020. This marketing focus helps VISA in building a strong brand and attracting more consumers

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