WHAT IS LEVERAGE? TYPES OF LEVERAGE

Leverage is the means using which a business firm can increase profits. The force will be applied on debt, the benefit of this reflected in the form of higher returns to equity shareholders. In simplae words, leverage is an investment strategy of using borrowed money—specifically, the use of various financial instruments or borrowed capital—to increase the potential return of an investment.

Following are the types of leverages:

1. Financial leverage: Financial leverage is primarily concerned with the financial activities which involve raising of funds from the sources for which a firm has to bear fixed charges such as interest expenses, loan fees etc. These sources include long-term debt (i.e., debentures, bonds etc.) and preference share capital. Financial leverage signifies the relationship between the earning power of equity and interest rate on borrowed capital.

2. Operating leverage: Operating leverage occurs when a firm incurs fixed costs which are to be recovered out of sales revenue irrespective of the volume of business in a period. In a firm having fixed costs in the total cost structure, a given change in sales will result in a disproportionate change in the operating profit or EBIT of the firm. It shows the ability of the firm to use fixed operating cost to increase the effect of change in sales on its operating profits.

3. Combined leverage: Both operating and financial leverages are closely concerned with ascertaining the firm’s ability to cover fixed costs or fixed rate of interest obligation, if we combine them, the result is total leverage and the risk associated with combined leverage is known as total risk. This leverage shows the relationship between a change in sale and the corresponding change in taxable income.
Leverage is a doubledouble-edged sword. It magnifies profits as well as losses. An aggressive or highly leveraged firm has high fixed costs and a conservative or non-leveraged firm has low fixed costs. 

WHAT IS DEBT MARKET ?

The debt market is any market where trading debt instruments takes place. Examples of debt instruments includes mortgages, promissory notes, bonds, Certificates of deposits, etc. A debt market establishes a structured environment where these types of debt instruments are traded with ease between interested parties.
In the event that the debt market deals primarily in bond issues, it is known as bond market and if mortgages and loans are the main focus of the trading in the debt market , it is known as credit market. And if the instruments are issued with a fixed coupon or interest rate , the market for such issued instruments can be termed as fixed income market.

Following are some of the debt instruments:

1. Government Securities: Government securities are issued by the National Bank on behalf of the Goverment. These securities are issued for a period ranging between 1 to 30 years. For shorter term, Treasury Bills are issued.

2. Corporate Bonds: These bonds are issued by the Public and Private sector companies usually for a term not more than 15 years. Normally, the rate of return is higher for corporaye bonds as compared to government securities as they carry higher risk. This risk is determined by various determinants like the nature of business of the entity, the industry in which it operates, competition, brand image, etc.

3. Certificate of Deposit: Certificate of Deposits (CDs) usually offer higher returns than bank deposits and are issued in demat form. Banks issue CDs with maturity term of 7 days to 1 year while other financial institutions issue them with a maturity term between 1 year to 3 years.

4. Commercial Papers: These are short term instruments with maturity up to one year.

5. Structured Debt: It is an instrument created by the lender with the needs and circumstances of the borrower in mind. Usually the package includes incentives for the borrower so as to attract them for doing business with the lender. The lender, too, enjoys benefits of the transaction inthe long term. The main goal of structured debt is to create a situation that provides the borrower with incentives while keeping the debt load low.

WHAT ARE BONDS AND SOME TYPES OF BONDS

A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). A bond could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments. Bonds are used by companies, municipalities, states, and sovereign governments to finance projects and operations. Owners of bonds are debtholders, or creditors, of the issuer. Bond details include the end date when the principal of the loan is due to be paid to the bond owner and usually includes the terms for variable or fixed interest payments made by the borrower.

Following are some types of bonds:
1. Municipal Bonds: Municipal bonds (“munis”) are issued by state and local governments to fund the construction of schools, highways, housing, sewer systems, and other important public projects. These bonds tend to be exempt from income tax and, in some cases, from state and local taxes for investors who live in the jurisdiction where the bond is issued. Munis tend to offer competitive rates but with additional risk because local governments can go bankrupt.

2. Corporate Bonds: Corporations may issue bonds to fund a large capital investment or a business expansion. Corporate bonds tend to carry a higher level of risk than government bonds, but they generally are associated with higher potential yields. The value and risk associated with corporate bonds depend in large part on the financial outlook and reputation of the company issuing the bond.

3. Zero Coupon Bonds: This type of bond (also called an “accrual bond”) doesn’t make coupon payments but is issued at a steep discount. The bond is redeemed for its full value upon maturity. Zero-coupon bonds tend to fluctuate in price more than coupon bonds. They can be issued by the Nation's Treasury, corporations, and state and local government entities and generally have long maturity dates.

4. Government Bonds: A government bond is a debt instrument issued by the Central and State Governments of India. Issuance of such bonds occur when the issuing body (Central or State governments) faces a liquidity crisis and requires funds for the purpose of infrastructure development. Government bond in India is essentially a contract between the issuer and the investor, wherein the issuer guarantees interest earnings on the face value of bonds held by investors along with repayment of the principal value on a stipulated date.

5. Fixed Rate Bonds: Bonds of this nature come with a fixed rate of interest which remains constant throughout the tenure of investment irrespective of fluctuating market rates.The coupon on a Bond is mentioned in nomenclature.

6. Floating Rate Bonds: As the name suggests, FRBs are subject to periodic changes in rate of returns. The change in rates is undertaken at intervals which are declared beforehand during the issuance of such bonds. For instance, an FRB could have a pre-announced interval of 6 months; which means interest rates on it would be re-set every six months throughout the tenure. There is another variant to FRBs, wherein the rate of interest rate is bifurcated into two components: a base rate and a fixed spread. This spread is decided through auction and remains constant throughout the maturity tenure.

MICHAEL PORTER'S 5 FORCES ANALYSIS

Porter's Five Forces is a model that identifies and analyzes five competitive forces that shape every industry and helps determine an industry's weaknesses and strengths. Five Forces analysis is frequently used to identify an industry's structure to determine corporate strategy. Porter's model can be applied to any segment of the economy to understand the level of competition within the industry and enhance a company's long-term profitability. The Five Forces model is named after Harvard Business School professor, Michael E. Porter.

The five forces are as follows:

1. Bargaining power of Buyers: The bargaining power of customers is also described as the market of outputs: the ability of customers to put the firm under pressure, which also affects the customer's sensitivity to price changes. Firms can take measures to reduce buyer power, such as implementing a loyalty program. Buyers' power is high if buyers have many alternatives. It is low if they have few choices.

2. Bargaining power of Suppliers: The bargaining power of suppliers is also described as the market of inputs. Suppliers of raw materials, components, labor, and services (such as expertise) to the firm can be a source of power over the firm when there are few substitutes. If you are making biscuits and there is only one person who sells flour, you have no alternative but to buy it from them. Suppliers may refuse to work with the firm or charge excessively high prices for unique resources.

3. Threat of substitute products or services: A substitute product uses a different technology to try to solve the same economic need. Examples of substitutes are meat, poultry, and fish; landlines and cellular telephones; airlines, automobiles, trains, and ships; beer and wine; and so on. Potentials factors for this are buyer's propensity to substitute, relative price performance of substitute, ease of substitution, availability of close substitute, etc.

4. Threat of New Entrants: Profitable industries that yield high returns will attract new entities. New entrants eventually will decrease profitability for other firms in the industry. Unless the entry of new firms can be made more difficult by existing players, abnormal profitability will fall towards zero (perfect competition), which is the minimum level of profitability required to keep an industry in business. Some examples of entry barriers are sophisticated technology, legal factors, limited access to raw materials, etc.

5. Intensity of competition amongst firms: For most industries the intensity of competitive rivalry is the biggest determinant of the competitiveness of the industry. Having an understanding of industry rivals is vital to successfully marketing a product. Positioning depends on how the public perceives a product and distinguishes it from competitors‘. An organization must be aware of its competitors' marketing strategies and pricing and also be reactive to any changes made.
Porter's framework has been challenged by other academics and strategists. For instance, Kevin P. Coyne and Somu Subramaniam claim that three dubious assumptions underlie the five forces:
[ ] That buyers, competitors, and suppliers are unrelated and do not interact and collude.
[ ] That the source of value is structural advantage (creating barriers to entry).
[ ] That uncertainty is low, allowing participants in a market to plan for and respond to changes in competitive behavior.
Five forces analysis helps organizations to understand the factors affecting profitability in a specific industry, and can help to form decisions regarding : whether to enter a specific industry , whether to increase the capacity in a specific industry and developing competitive strategies.