TCS Buy Back

TCS has announced a share buy back at its board meeting on 20th Feb.

The board has approved a proposal to buyback up to ~5.61 crore shares for an amount not exceeding Rs 16,000 crores. The buyback price will be at Rs 2.850. The number of shares bought back will be 2.85% of the total paid-up capital.

Why do companies buy back their shares? Why TCS?

Companies can use their profits
1. Use for new capex / investments to grow the  business
This is done if the project returns gives an ROE that is near current levels

2. Pay out dividend
If no more cash is required after the capex/investments

3. Keep the cash and invest in money market instruments
Keep excess cash

As the cash pile increases, companies can pay out more dividend. Dividend is taxable before the payout (in India).

A share buyback is a market operation and signals to the market that the value of the company is more than the current market price and this is a way to pay out cash to the shareholders in a tax efficient way.

Shareholders can tender their shares through a broker. Only a proportion of shares will be accepted by TCS. This will be in proportion to their holding and the number of shares tendered to TCS.

For every 100 shared one holds, assuming all tender their shares, 2.85 shares will be purchased by TCS @ Rs 2850/-

For the shareholder, if Securities Transaction Tax is paid, there is no Long Term Capital Gains applicable if they have held the shares for more than one year.

Introduction to Financial Derivatives

A derivative is a financial instrument whose value is derived from another underlying asset. The underlying asset could be

• Stock
• Interest rate or foreign exchange rate
• Index value such as a stock index value
• Commodity price or index

Value of a derivative is ‘derived’ from another variable

The four basic derivatives types are

• Forwards
• Futures
• Options
• Swaps

A. Forwards

A forward contract gives the owner the right and obligation to buy a specified asset on a specified date at a specified price. On the specified date, the underlying asset will be received or delivered at this price.

• The seller of the forward contract has the right and obligation to sell the asset on the date for the price
• At the end of the forward contract, at “delivery,” ownership of the good is transferred and payment is made from the purchaser to the seller
• Generally, no money changes hands on the origination date of the forward contract
• However, collateral may be demanded

Delivery options may exist concerning the

• quality of the asset
• quantity of the asset
• delivery date
• delivery location

If your position has value, you face the risk that your counterparty will default.

B. Futures

This is a financial contract

• obligating the buyer
• to purchase an asset (or the seller to sell an asset),
• such as a physical commodity (crude oil, wheat, corn) or a financial instrument (debt instruments, stock index, currencies)
• at a predetermined future date
• at a predetermined future price

Futures contracts are standardised and are be traded on exchanges. Default risk is lower as they are cleared on exchanges.

Futures and Forwards are identical in structure. The key difference is

• Futures are exchange traded and hence have no counterparty risk, Forwards are OTC (Over the Counter) products
• Futures are standardized contracts (done by the Exchange), Forwards are customized by the parties.

C. Options

These are derivatives with the following features

The buyer of an option

• Has the right
• but not the obligation
• to buy (or sell) a particular product
• on a particular date (Exercise Date)
• at a particular price (Strike or Exercise Price)

The seller of the option

• Receives a premium for selling the right
• Has the obligation to deliver the product when the buyer exercises the option
• An option seller is also called a ‘WRITER’

Listed Options are standardised and are traded on exchanges

OTC Options are customized and not traded on exchanges

Call Options

• A call option is a contract that gives the owner of the call option the right, but not the obligation, to buy an underlying asset, at a fixed price, on (or sometimes before) a pre-specified day, which is known as the expiration day
• The seller of a call option, the call writer, is obligated to deliver, or sell, the underlying asset at a fixed price, on (or sometimes before) expiration day
• The fixed price is called the strike price, or the exercise price.

Put Options

• A put option is a contract that gives the owner of the put option the right, but not the obligation, to sell an underlying asset, at a fixed price, on (or sometimes before) a pre-specified day, which is known as the expiration day
• The seller of a put option, the put writer, is obligated to take delivery, or buy, the underlying asset at a fixed price, on (or sometimes before) expiration day.
• The fixed price is called the strike price, or the exercise price.

Options that can only be exercised at expiration are called “European” options.

Options that can be exercised any time until expiration are called “American” options

D. Swaps

• A swap is an agreement between counter-parties to exchange cash flows at specified future times according to pre-specified conditions
• Involves the exchange of cash flows arising from specific
• Assets
• Liabilities
• To exchange one set of cash flows for another without involving the transfer of the asset or liability itself
• A swap is like a portfolio of forwards. Each forward in a swap has a different delivery date, and the same forward price