Friday, March 25, 2011

Posted by venkatesh at 7:45 AM

What is Badla system?

Badlaa = In Hindi movies it means ‘revenge’ but for Stock market it means “on your behalf”

BASIC CONCEPT OF BADLA

There is a lottery ticket costing Rs.50, first price is 1 crore rupees. You don’t have a single penny to buy it, so you talk to your friend and he buys it for you on your behalf.
If you win, you don’t have to pay that friend any share from the 1 crore you won.
You only have to give him Rs. 50 after winners are declared and in the meantime interest on that 50 rupees as long as the result doesn’t come.
That’s how Badlaa system rolls.

HOW DOES IT WORK IN REAL LIFE?

Suppose you purchase 10 shares of Reliance Power for Rs. 3000, and at the end of the day, the stock closes at Rs.3300.
You speculate that this Reliance power share price will go even further up and you can make a handsome profit out of this. But you don’t have the money to pay to the broker and take delivery of these shares!
To solve this problem, you enter into a badlaa transaction, so your broker will carry out the money payment on your behalf. You’ve to keep paying him the interest rate for it (as long as you ‘hold’ these shares and donot sell them to someone else).
Badla transactions are settled on Saturday session each week.
The interest rate on Badlaa transaction is determined by market forces of supply and demand.
i.e. if lot people entering into Badlaa contract that means money is in high demand = Interest rate on Badlaa increases. If broker believes that xyz share prices will go really high then he’ll demand more interest for financing it because the customer will be making big profit. And so on…
In English this is called “Carry forward transaction” because you’re carrying forward the payment date for those shares you’ve purchased.

As you can see, any no0b without sufficient money can enter in this speculating game as long as he has some money to pay interest rates on Badlaa transactions. And if luck favors him, he can walk away with a decent profit.
So lot of people doing speculative share-trading like this = speculation + volatility
but it may happen that share prices don’t work out as they had speculated and then they refuse to pay money or go bankrupt or suicide = not good for economy.
After ‘92s Harsha Mehta scam, badla system was banned in the county for a while.
As such Baldaa is not bad because it allows you to arrange money. And it also allows the brokers-financiers to lend you money and earn interest on it.
Pitfalls in Badlaa system are same as in overspending with credit card or buying way too much stuff on loans to an extend where 70% of your monthly salary goes in EMI payments!

In Badlaa you’ve to regularly keep paying interest-rate to the broker as long as you ‘hold’ the shares. So your hands are ‘tied’
In options (or Vaada/Waayda) contract, there is only one time premium to be paid. So your hands are not ‘tied’ in interest payment.