Professional Documents
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GUIDE MANUAL
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Government: Government may borrow funds to take care of the budget deficit or as a measure of
controlling the liquidity, etc. Government may require funds for long terms (which are raised by issue of
Government loans) or for short-terms (for maintaining liquidity) in the money market. Government makes
initial investments in public sector enterprises by subscribing to the shares, however, these investments
(shares) may be sold to public through the process of disinvestments.
Regulators: Financial system is regulated by different government agencies. The relationships among
other participants, the trading mechanism and the overall flow of funds are managed, supervised and
controlled by these statutory agencies. In India, two basic agencies regulating the financial market are the
Reserve Bank of India (RBI ) and Securities and Exchange Board of India (SEBI). Reserve Bank of India,
being the Central Bank, has the primary responsibility of maintaining liquidity in the money market It
undertakes the sale and purchase of T-Bills on behalf of the Government of India. SEBI has a primary
responsibility of regulating and supervising the capital market. It has issued a number of Guidelines and
Rules for the control and supervision of capital market and investors protection. Besides, there is an array
of legislations and government departments also to regulate the operations in the financial system.
Market Intermediaries: There are a number of market intermediaries known as financial intermediaries or
merchant bankers, operating in financial system. These are also known as investment managers or
investment bankers. The objective of these intermediaries is to smoothen the process of investment and to
establish a link between the investors and the users of funds. Corporations and Governments do not market
their securities directly to the investors. Instead, they hire the services of the market intermediaries to
represent them to the investors. Investors, particularly small investors, find it difficult to make direct
investment. A small investor desiring to invest may not find a willing and desirable borrower. He may not
be able to diversify across borrowers to reduce risk. He may not be equipped to assess and monitor the
credit risk of borrowers. Market intermediaries help investors to select investments by providing
investment consultancy, market analysis and credit rating of investment instruments. In order to operate in
secondary market, the investors have to transact through share brokers. Mutual funds and investment
companies pool the funds(savings) of investors and invest the corpus in different investment alternatives.
5.Financial Markets can be categorized into six types:
1.Capital Markets: Stock markets and Bond markets
2.Commodity Markets
3.Money Markets
4.Derivatives Markets: Futures Markets
5.Insurance Markets
6.Foreign Exchange Markets
6. Capital market: Classification
The Primary market consists of issue of initial public offers wherein the issuer directly
allots the shares/debt to the investor.
In the Primary Capital Market, the public issue could be either equity i.e. equity shares or
debts like debentures, bonds etc.
In the secondary market, one investor sells to another investor through the stock
exchange.
Primary market provides opportunity to issuers of securities, Government as well as
corporates, to raise resources to meet their requirements of investment and/or discharge
some obligation. The issuers create and issue fresh securities in exchange of funds through
public issues and/or as private placement. They may issue the securities at face value, or at
a discount/ premium and these securities may take a variety of forms such as equity, debt or
some hybrid instrument. They may issue the securities in domestic market and/or
international market through ADR/GDR/ECB route.
Secondary market is the place for sale and purchase of existing securities. It enables an
investor to adjust his holdings of securities in response to changes in his assessment about
risk and return. It also enables him to sell securities for cash to meet his liquidity needs. It
essentially comprises of the stock exchanges which provide platform for trading of securities
and a host of intermediaries who assist in trading of securities and clearing and settlement
of trades. The securities are traded, cleared and settled as per prescribed regulatory
framework under the supervision of the Exchanges and SEBI.
Equity shares are instruments issued by companies to raise capital and it represents the title
to the ownership of a company. You become an owner of a company by subscribing to its
equity capital (whereby you will be allotted shares) or by buying its shares from its existing
owner(s).
The public issue can be kept open to public or on private placement basis.
In private placement, specified informed investors invest i.e. the general public or individual
investors are not allowed to invest. In such cases the issue is also not publicized.
Primary issue could be at par i.e. is sold at the face value of the share/debenture or it could
be at a premium or discount.
The primary issue is publicized by issue of an offer document called prospectus containing
the details of the issue and the past performance/future plans of the issuer. Public issues
are offered by public limited companies.
Profit is shared with the share holders in the form of Dividend annually.
Types of Investors
a. Public issue
Securities are issued to the members of
the public, and anyone eligible to invest
can participate in the issue. This is
primarily retail issue of securities.
Resident individuals
Hindu undivided
family (HUF)
8. Debt Market:
Minors through
guardians
Registered societies
and clubs
Non-resident Indians
Individual investors are further categorized based on the
(NRI)
amount invested as
c.Preferential issue
Persons of Indian
Retail, who invests less than Rs.2 lakhs in a
Origin (PIO)
single issue and
Qualified Foreign
Non-Institutional Buyers (NIBs), who invest
investors (QFI)
more than Rs. 2 lakhs in a single issue.
Banks
b. Private placement
Association of persons
Companies
Partnership firms
Trusts
Foreign institutional
investors (FIIs)
Limited Liability
Partnerships (LLP
Corporate Fully
Convertible Debentures(FCDs)/
Party Convertible
Debentures (PCDs)/
Non Convertible
Debentures (NCDs)/
PSU Bonds/Zero
Coupon Bonds/Deep Discount
Bonds
than 12 months. Near substitute to money means any financial asset which can be
converted into cash quickly with minimum transaction cost.
What is traded in the Indian money market?
Treasury Bills
Call Money
Major players:
Reserve Bank of India
Private banks
Public sector banks,
Development banks and other Non-Banking Financial Companies(NBFCs) such as Life
Insurance Corporation of India (LIC), Unit Trust of India (UTI), the International Finance
Corporation, mutual funds, FIIs, Provident Funds and Trusts.
Commercial Paper
Commercial Paper (CP) is an unsecured money market instrument issued in the form of a
promissory note.
Issuers: Highly rated corporate borrowers, primary dealers (PDs) and satellite
dealers (SDs) and all-India financial institutions (FIs).
Rating: All eligible participants should obtain the credit rating for issuing CP.
Minimum and maximum period of maturity:
Minimum of 7 days and a maximum of up to one year from the date of issue.
The maturity date of the CP should not go beyond the date up to which the credit
rating of the issuer is valid.
Denomination - Rs.5 lakh or multiples thereof.
Who can invest?
Individuals, banking companies, other corporate bodies (registered or incorporated in
India) and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional
Investors (FIIs) etc. can invest in CPs.
However, investment by FIIs would be within the limits set for them by Securities and
Exchange Board of India (SEBI) from time-to-time.
Certificate of Deposit (CD)
Certificate of Deposit (CD) is a negotiable money market instrument.
Issuers- (i) Scheduled commercial banks except Regional Rural Banks& Local Area
Banks (ii) select All-India Financial Institutions (FIs) that have been permitted by RBI
to raise short-term resources within the umbrella limit fixed by RBI.
Minimum and maximum period of maturity- 7 days and not more than one year,
from the date of issue
Denomination - Rs.1 lakh or multiples thereof.
Who can invest?
12.PFRDA
The Pension Fund Regulatory & Development Authority Act was passed on 19th September,
2013 and the same was notified on 1st February, 2014. PFRDA is regulating NPS, subscribed
by employees of Govt. of India, State Governments and by employees of private
institutions/organizations & unorganized sectors. The PFRDA is ensuring the orderly growth
and development of pension market.
The Government of India had, in the year 1999, commissioned a national project titled
OASIS (an acronym for old age social & income security) to examine policy related to old
age income security in India. Based on the recommendations of the OASIS report,
Government of India introduced a new Defined Contribution Pension System for the new
entrants to Central/State Government service, except to Armed Forces, replacing the
existing system of Defined Benefit Pension System. On 23rd August, 2003, Interim Pension
Fund Regulatory & Development Authority (PFRDA) was established through a resolution by
the Government of India to promote, develop and regulate pension sector in India. The
contributory pension system was notified by the Government of India on 22nd December,
2003, now named the National Pension System (NPS) with effect from the 1st January, 2004.
The NPS was subsequently extended to all citizens of the country w.e.f. 1st May, 2009
including self employed professionals and others in the unorganized sector on a voluntary
basis.
13.RBI
Main Functions
a.Monetary Authority:Formulates, implements and monitors the monetary policy.
Objective: maintaining price stability and ensuring adequate flow of credit to productive
sectors.
b.Regulator and supervisor of the financial system:
Prescribes broad parameters of banking operations within which the country's banking and
financial system functions.
Objective: maintain public confidence in the system, protect depositors' interest and provide
cost-effective banking services to the public.
c.Manager of Foreign Exchange
Manages the Foreign Exchange Management Act, 1999.
Objective: to facilitate external trade and payment and promote orderly development and
maintenance of foreign exchange market in India.
d.Issuer of currency:
Issues and exchanges or destroys currency and coins not fit for circulation.
Objective: to give the public adequate quantity of supplies of currency notes and coins and
in good quality.
e.Developmental role
14.SEBI
Securities and Exchange Board of India (SEBI) was first established in the year 1988 as a
non-statutory body for regulating the securities market. It became an autonomous body in
1992 and more powers were given through an ordinance. Since then it regulates the market
through its independent powers.
Objectives of SEBI:
As an important entity in the market it works with following objectives:
1. It tries to develop the securities market.
Under this rule every brokers and sub brokers have to get registration with SEBI
and any stock exchange in India.
For Underwriters:
According to this law all Indian companies are free to determine their
respective share prices and premiums on the share prices.
15.NIFTY 50
The Nifty 50 is a well diversified 50 stock index
accounting for 13 sectors of the economy. It is used for
a variety of purposes such as benchmarking fund
portfolios, index based derivatives and index funds.
Nifty 50 is owned and managed by India Index Services
and Products Ltd. (IISL). IISL is India's first specialised
company focused upon the index as a core product.
The Nifty 50 Index represents about 66.17% of the free
float market capitalization of the stocks listed on NSE
as on March 31, 2015.
The total traded value of Nifty 50 index constituents for the last six months ending
March 2015 is approximately 46.22% of the traded value of all stocks on the NSE.
Impact cost of the Nifty 50 for a portfolio size of Rs.50 lakhs is 0.06% for the month
March 2015.
Nifty 50 is professionally maintained and is ideal for derivatives trading.
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Small cap stocks are potentially big gainers as they are yet to be discovered within the
sector and can show growth potential in large numbers once unfurled in the market.
A thorough research is required regarding the promoters' credentials, management strength
and track record, and long and short term growth plans of the company before investing.
Small caps can prove to be a very wise 'long term' investments especially if the chosen
companies are good businesses and are well-managed.
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A.CORPORATE DEBT
i) Debentures and ii) Bonds
i) Debentures are instrument issued by companies to raise debt capital. As an investor,
you lend you money to the company, in return for its promise to pay you interest at a fixed
rate (usually payable half yearly on specific dates) and to repay the loan amount on a
specified maturity date say after 5/7/10 years (redemption).Normally specific asset(s) of
the company are held (secured) in favour of debenture holders. This can be liquidated, if
the company is unable to pay the interest or principal amount. Unlike loans, you can buy or
sell these instruments in the market.
Types of debentures:
Non convertible debentures (NCD) Total amount is redeemed by the issuer
Partially convertible debentures (PCD) Part of it is redeemed and the remaining is
converted to equity shares as per the specified terms
Fully convertible debentures (FCD) Whole value is converted into equity at a
specified price
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rate) of 34 basis points (0.34%) was decided. Hence the coupon for the first six months was
fixed at 6.84%.
vi)Zero Coupon Bonds Zero coupon bonds are bonds with no coupon payments. Like
Treasury Bills, they are issued at a discount to the face value. The Government of India
issued such securities in the nineties, It has not issued zero coupon bond after that.
vii)Capital Indexed Bonds These are bonds, the principal of which is linked to an
accepted index of inflation with a view to protecting the holder from inflation. A capital
indexed bond, with the principal hedged against inflation, was issued in December 1997.
These bonds matured in 2002. The government is currently working on a fresh issuance of
Inflation Indexed Bonds wherein payment of both, the coupon and the principal on the
bonds, will be linked to an Inflation Index (Wholesale Price Index). In the proposed structure,
the principal will be indexed and the coupon will be calculated on the indexed principal. In
order to provide the holders protection against actual inflation, the final WPI will be used for
indexation.
viii)Bonds with Call/ Put Options Bonds can also be issued with features of optionality
wherein the issuer can have the option to buy-back (call option) or the investor can have the
option to sell the bond (put option) to the issuer during the currency of the bond.
6.72%GS2012 was issued on July 18, 2002 for a maturity of 10 years maturing on July 18,
2012. The optionality on the bond could be exercised after completion of five years tenure
from the date of issuance on any coupon date falling thereafter. The Government has the
right to buyback the bond (call option) at par value (equal to the face value) while the
investor has the right to sell the bond (put option) to the Government at par value at the
time of any of the half-yearly coupon dates starting from July 18, 2007
B. GOVERNMENT DEBT
Government Securities
A government security is a tradable instrument issued by the central government or the
state governments.
It acknowledges the governments debt obligation.
Government paper with tenor beyond one year is known as dated security.
At present, there are central government dated securities with a tenor up to 30 years
in the market.
Treasury Bills
1.Treasury bills or T-bills, which are money market instruments, are short term debt
instruments issued by the Government of India and are presently issued in three tenors,
namely, 91 day, 182 day and 364 day.
2.Treasury bills are zero coupon securities and pay no interest. They are issued at a discount
and redeemed at the face value at maturity.
3. For example, a 91 day Treasury bill of Rs.100/- (face value) may be issued at say Rs.
98.20, that is, at a discount of say, Rs.1.80 and would be redeemed at the face value of
Rs.100/-.
4.The return to the investors is the difference between the maturity value or the face value
(that is Rs.100) and the issue price (for calculation of yield on Treasury Bills please see
answer to question no. 26).
5.The Reserve Bank of India conducts auctions usually every Wednesday to issue T-bills.
Payments for the T-bills purchased are made on the following Friday.
The 91 day T-bills are auctioned on every Wednesday. The Treasury bills of 182 days and 364
days tenure are auctioned on alternate Wednesdays. T-bills of of 364 days tenure are
auctioned on the Wednesday preceding the reporting Friday while 182 T-bills are auctioned
on the Wednesday prior to a non-reporting Fridays. The Reserve Bank releases an annual
calendar of T-bill issuances for a financial year in the last week of March of the previous
financial year. The Reserve Bank of India announces the issue details of T-bills through a
press release every week.
A Government security is a tradable instrument issued by the Central Government or the
State Governments. It acknowledges the Governments debt obligation. Such securities are
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1.Short term (usually called treasury bills, with original maturities of less than one
year) or
2.Long term (usually called Government bonds or dated securities with original
maturity of one year or more).
In India, the Central Government issues both, treasury bills and bonds or dated securities
while the State Governments issue only bonds or dated securities, which are called the State
Development Loans (SDLs).
Government securities carry practically no risk of default and, hence, are called risk-free giltedged instruments.
Government of India also issues savings instruments (Savings Bonds, National Saving
Certificates (NSCs), etc.) or special securities (oil bonds, Food Corporation of India bonds,
fertiliser bonds, power bonds, etc.).
They are, usually not fully tradable and are, therefore, not eligible to be SLR securities.
20.How is the yield of a Treasury Bill calculated?
Wherein;
P Purchase price
ILLUSTRATION:
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Capital protection The borrower promises to repay the face value when the
securities mature, and some will pledge collateral to support interest and principal
payments.
DiversificationBonds can be an integral part of a diversified investment portfolio
that includes other asset classes such as stocks and alternative investments.
LiquidityLiquidity is a measure of how easily a security can be sold in a secondary
market, and fixed income securities can range from highly liquid to relatively illiquid.
Tax exemptionsInterest income from securities issued by government entities may be
fully or partially exempt from local, state or federal income taxes.
Mutual Funds
23. Mutual Funds
Mutual funds are a
1.Vehicle to mobilize moneys from (Pool of Money)
2.Investors,
3.To invest in different markets and securities,
4. In line with the investment objectives agreed upon,
investors.
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Mutual funds collect money from many investors and invest this corpus in equity, debt or a
combination of both, in a professional and transparent manner. In return for your
investment, you receive units of mutual funds which entitle you to the benefit of the
collective return earned by the fund, after reduction of management fees.
Working of a Mutual Fund:
17
Interval funds are a variant of closed end funds which become open-ended during
specified periods. During these periods investors can purchase and redeem units like in an
open-ended fund. The specified transaction periods are for a minimum period of two days
and there must be a minimum gap of 15 days between two transaction periods. Like closedended funds, these funds have to be listed on a stock exchange.
(B) By Investment Objective
1.Growth Schemes
Aim to provide capital appreciation over the medium to long term. These schemes normally
invest a majority of their funds in equities and are willing to bear short term decline in value
for possible future appreciation.
These schemes are NOT for investors seeking regular income or needing their money back
in the short term.
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Ideal for:
Investors in their prime earning years.
Investors seeking growth over the long term.
2.Income Schemes
Aim to provide regular and steady income to investors. These schemes generally invest in
fixed income securities such as bonds and corporate debentures.
Capital appreciation in such schemes may be limited.
Ideal for:
Retired people and others with a need for capital stability and regular income.
Investors who need some income to supplement their earnings.
3.Balanced Schemes
Aim to provide both growth and income by periodically distributing a part of the income and
capital gains they earn. They invest in both shares and fixed income securities in the
proportion indicated in their offer documents. In a rising stock market, the NAV of these
schemes may not normally keep pace or fall equally when the market falls.
Ideal for:
Investors looking for a combination of income and moderate growth.
4.Money Market / Liquid Schemes
Aim to provide easy liquidity, preservation of capital and moderate income. These schemes
generally invest in safer, short term instruments such as treasury bills, certificates of
deposit, commercial paper and interbank call money. Returns on these schemes may
fluctuate, depending upon the interest rates prevailing in the market.
Ideal for:
Corporates and individual investors as a means to park their surplus funds for short
periods or awaiting a more favorable investment alternative.
5. Growth Fund
1.A diversified portfolio of stocks that has capital appreciation as its primary goal, with little
or no dividend payouts.
2.Portfolio companies would mainly consist of companies with above-average growth in
earnings that reinvest their earnings into expansion, acquisitions, and/or research and
development.
3.Most growth funds offer higher potential capital appreciation but usually at above-average
risk. Growth funds are more volatile than funds in the value and blend categories.
4.The companies in a growth fund portfolio are in an expansion phase and they are not
expected to pay dividends. Investing in growth funds requires a tolerance for risk and a
holding period with a time horizon of five to 10 years.
6. Equity and equity related funds
These would entail two types of funds:
An equity fund (invests in shares)
A balanced fund (invests in shares and fixed income instruments) that has more than
50% of its investments in shares.
If investor sells the units of such funds within a year of purchase, the profit on this sale is
called a short-term capital gain. Investor will be taxed 10% on short-term capital gain.
If investor make a profit by selling the units after a year, it is called long-term capital gain.
This is not taxed.
7.Debt Funds
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Definition: Debt funds are mutual funds that invest in fixed income securities like bonds and
treasury bills. Gilt fund, monthly income plans (MIPs), short term plans (STPs), liquid funds,
and fixed maturity plans (FMPs) are some of the investment options in debt funds. Apart
from these categories, debt funds include various funds investing in short term, medium
term and long term bonds.
Description: Debt funds are preferred by individuals who are not willing to invest in a highly
volatile equity market. A debt fund provides a steady but low income relative to equity. It is
comparatively less volatile.
DEBT FUNDS
1.Gilt funds invest in only treasury
bills and government securities,
which do not have a credit risk (i.e.
the risk that the issuer of the
security defaults).
2.Diversified debt funds on the
other hand, invest in a mix of
government and non-government
debt securities.
3.Junk bond schemes or high
yield bond schemes invest in
companies that are of poor credit
quality. Such schemes operate on
Some
the premise that
the Important
attractive
returns offered
by the investee
Features
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4.Fixed maturity plans are a kind
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5.Floating
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These
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largely in floating rate debt
invest
government
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where
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6.Liquid schemes
or Money
lend money
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Market Schemes are a variant of
organisations or
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return
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8.Income Funds
A type of mutual fund that emphasizes current income, either
on a monthly or quarterly basis, as opposed to capital
appreciation. Such funds hold a variety of government,
municipal and corporate debt obligations, preferred stock,
money market instruments, and dividend-paying stocks.
Share prices of income funds are not fixed; they tend to fall
when interest rates are rising and to increase when interest
rates are falling. Generally, the bonds included in the
portfolios of these funds are of investment grade. The other
securities are of sufficient credit quality to assure a
preservation of capital.
There are two popular high-risk funds that also focus mainly
on income: high-yield bond funds and bank loan funds. The
former invests primarily in corporate "junk" bonds and the
latter in floating-rate loans issued by banks or other financial
institutions.
9.Actively managed funds
Funds where the fund manager has the flexibility to choose
the investment portfolio, within the broad parameters of the
investment objective of the scheme. Since this increases the
role of the fund manager, the expenses for running the fund
turn out to be higher. Investors expect actively managed
funds to perform better than the market
10.Passive funds
20
Passive funds invest on the basis of a specified index, whose performance it seeks to track.
Thus, a passive fund tracking the BSE Sensex would buy only the shares that are part of the
composition of the BSE Sensex. The proportion of each share in the schemes portfolio would
also be the same as the weightage assigned to the share in the computation of the BSE
Sensex. Thus, the performance of these funds tends to mirror the concerned index. They are
not designed to perform better than the market. Such schemes are also called index
schemes.
11. Equity Funds
Diversified equity fund is a category of funds that invest in a diverse mix of securities
that cut across sectors.
Sector funds however invest in only a specific sector. For example, a banking sector fund
will invest in only shares of banking companies. Gold sector fund will invest in only shares of
gold-related companies.
Thematic funds invest in line with an investment theme. For example, an infrastructure
thematic fund might invest in shares of companies that are into infrastructure construction,
infrastructure toll-collection, cement, steel, telecom, power etc. The investment is thus more
broad-based than a sector fund; but narrower than a diversified equity fund.
Equity Linked Savings Schemes (ELSS), as seen earlier, offer tax benefits to investors.
However, the investor is expected to retain the Units for at least 3 years.
Equity Income / Dividend Yield Schemes invest in securities whose shares fluctuate
less, and therefore, dividend represents a larger proportion of the returns on those shares.
The NAV of such equity schemes are expected to fluctuate lesser than other categories of
equity schemes.
Arbitrage Funds take contrary positions in different markets / securities, such that the risk
is neutralized, but a return is earned. For instance, by buying a share in BSE, and
simultaneously selling the same share in the NSE at a higher price.
12.Types of Hybrid Funds
Monthly Income Plan seeks to declare a dividend every month. It therefore invests
largely in debt securities. However, a small percentage is invested in equity shares to
improve the schemes yield e.g. debt (80%) and equity (20%)..
Capital Protected Schemes are close -ended schemes, which are structured to
ensure that investors get their principal back, irrespective of what happens to the
market. This is ideally done by investing in Zero Coupon Government Securities
whose maturity is aligned to the schemes maturity. (Zero coupon securities are
securities that do not pay a regular interest, but accumulate the interest, and pay it
along with the principal when the security matures).
Hybrid funds:
Balanced funds
Monthly Income Plans: It seeks to declare a dividend every month though
not guaranteed. They invest mostly in debt (80%) and equity (20%).
Flexible Asset Allocation for fund manager
13. Gold Funds
These funds invest in gold and gold-related securities. They can be structured in
either of the following formats:
Gold Exchange Traded Fund, which is like an index fund that invests in gold. The
structure of exchange traded funds is discussed later in this unit. The NAV of such
funds moves in line with gold prices in the market.
Gold Sector Funds i.e. the fund will invest in shares of companies engaged in gold
mining and processing. Though gold prices influence these shares, the prices of these
shares are more closelylinked to the profitability and gold reserves of the companies.
Therefore, NAV of these funds do not closely mirror gold prices
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They take exposure to real estate. Such funds make it possible for small investors to take
exposure to real estate as an asset class. Although permitted by law, real estate mutual
funds are yet to hit the market in India.
15. Commodity Funds
Commodities, as an asset class, include:
food crops like wheat and chana
spices like pepper and turmeric
fibres like cotton
industrial metals like copper and aluminium
energy products like oil and natural gas
precious metals (bullion) like gold and silver
As with gold, such funds can be structured as Commodity ETF or Commodity Sector
Funds. In India, mutual fund schemes are not permitted to invest in commodities. Therefore,
the commodity funds in the market are in the nature of Commodity Sector Funds, i.e. funds
that invest in shares of companies that are into commodities. Like Gold Sector Funds,
Commodity Sector Funds too are a kind of equity fund.
16. Fund of Funds
Funds can be structured to invest in various other funds, whether in India or abroad. Such
funds are called fund of funds. These fund of funds pre-specify the mutual funds whose
schemes they will buy and / or the kind of schemes they will invest in. They are designed to
help investors get over the trouble of choosing between multiple schemes and their variants
in the market.
A fund of funds allows investors to achieve a broad diversification and an appropriate asset
allocation with investments in a variety of fund categories that are all wrapped up into one
fund. However, if the fund of funds carries an operating expense, investors are essentially
paying double for an expense that is already included in the expense figures of the
underlying funds.
17.Exchange Traded Funds
Exchange Traded funds (ETF) are open-ended index funds that are traded in a stock
exchange.
A feature of open -ended funds, which allows investors to buy and sell units from the mutual
fund, is made available only to very large investors in an ETF.
27.Systematic Transactions
Mutual funds offer investors the facility to automate their investment and redemption
transactions to meet their needs from the investment. Systematic investment plans (SIP),
systematic withdrawal plans (SWP), systematic transfer plans (STP) and switches are some
of the facilities provided.
i.Systematic Investment Plans (SIP)
In a systematic investment plan, investors commit to invest a fixed sum of money at regular
intervals over a period of time in a mutual fund scheme.
SIP Date
Investment Amount
(Rs) (A)
NAV(
B)
Units
Allotted(A/B)
10-Feb-14
2500
10.50
238.10
10-Mar-14
2500
11.70
213.68
22
10-Apr-14
2500
12.30
203.25
10-May-14
2500
12.10
206.61
10-Jun-14
2500
11.95
209.21
10-Jul-14
2500
10.25
243.90
Total
15000
1314.75
11.41
23
Government securities
Corporate bonds
Company deposits
30.Limitations of a Mutual Fund
i.Lack of portfolio customization:The unit-holder cannot influence what securities or
investments the scheme would buy.
ii.Choice overload :Over 800 mutual fund schemes offered by 38 mutual funds and multiple
options within those schemes.
iii.No control over costs
31.ULIP and MF
Description
Unit Linked Insurance Plans refer to
Unit Linked Insurance Plans offered by
insurance companies. These plans
allow investors to direct part of their
premiums into different types of funds
(equity, debt, money market, hybrid
etc.).
Objective
Unit Linked Insurance Plans are long
term plans offering you a dual benefit
of insurance and investment.
Tax Benefit
All Unit Linked Plans offer tax benefits
under section 80C.
Switching options
Additional Benefits
Some of the Unit Linked Plans give you
an additional benefit or loyalty benefit
by issuing extra fund units.
Liquidity
Unit Linked Plans have limited
liquidity. One needs to stay invested
for a minimum period of time as
specified in the policy before
redeeming the units.
Charges
structure
Benefit Snapshot
1. Investment
tool suitable for
short to medium
term.
2. Easy exit
possible.
3. Tax benefit
available only on
tax saving funds
24
Commercial
papers and
certificate of
deposit
Others
B.
Capital Market Securities
Equity shares
Preferences
shares
Debentures
Non-Security Form
Bank Deposit
Post Office
Deposit
Insurance
Schemes
Mutual Fund
Deposit Schemes
of NBFC
Exercise: Indicate the type of returns i.e.
yield/capital appreciation by mentioning
(Yes or No) ,
Risk(High/Low) and Liquidity (High/Low) in
the table given next to this box:
25
7%
12%
18%
22
Inflation Rate
4%
6%
8%
10%
12
12
2.88
5.66
9.26
10.91
34.RISK
Risk is defined as deviation of actual returns from expected return. Risk in
investment is categorized as Systematic and Unsystematic also called Non diversifiable and
Diversifiable risk. Unsystematic risk can be reduced through Diversification. Systematic risk
is a Market Risk which can not be reduced through Diversification.
Systematic risk or market risk refers to those risks that are applicable to the entire
financial market or a wide range of investments. These risks are also known as
undiversifiable risks, because they cannot be eliminated through diversification. Systematic
risk is caused due to factors that may affect the economy/markets as a whole, such as
changes in government policy, external factors, wars or natural calamities.
Inflation risk, exchange rate risk, interest rate risk and reinvestment risk are systematic
risks. Inflation risk affects all investments, though its highest impact is on fixed rate
instruments. All overseas investments are subject to exchange rate risk. Interest rate and
reinvestment risk impact all debt investments.
Unsystematic risk is the risk specific to individual securities or a small class of
investments. Hence it can be diversified away by including other assets in the portfolio.
Unsystematic risk is also known as diversifiable risk. Credit risk, business risk, and liquidity
risks are unsystematic risks.
Diversification can be achieved through:
Across different asset classes e.g. equity, debt, commodities, precious metals, real
estate.(Product Diversification)
Across different countries.
Across different securities e.g. Different Stocks, Different Bonds etc.
Across maturities e.g. short term, long term, for life etc.(Time Diversification).
Hedging: Systematic risk cannot be diversified out of portfolio. It can be Hedged. This is
done with the help of derivative products like futures, options, swaps.
What is risk appetite?
The amount and type of risk an individual is willing to take in order to meet his investment
objectives.
Risk appetite and Risk tolerance:
26
While risk appetite i.e risk an individual is willing to take differs from person to person, risk
tolerance is usually estimated keeping in mind the present financial circumstances and other
factors of the individual.
Factors that help to determine risk appetite are:
Age,Experience,Knowledge,Income ,Expenses
Risk Profiling is understanding the risk appetite of the Client.
Balancing the Risk: Spreading the investment among different asset classes
(Equity,Bond,G-Sec, Debentures, Gold,Real Estate)
Case-2:
If the earlier average/expected return was 20% whereas the risk(standard deviation) was 6. Now due to diversified portfolio the
return increases to 30% from 20% (i.e. increase of 50% i.e. increase of 10 for 20) whereas the risk either remains as it is (i.e. 6 itself)
Or increases to 6.6 from 6 (i.e. increase of 10% i.e. increase of 0.60 for 6). Return Increased
50%
Risk increased
10%
Case-3:
36.ANNUITY
27
An annuity is a series of equal payments made at fixed intervals of time. For example a
Recurring Deposit account in a Bank accepting a monthly instalment of Rs.1000 for 5 years
at 10% interest.While the payments in an annuity can be made as frequently as every week,
in practice, ordinary annuity payments are made monthly, quarterly, semi-annually or
annually. The opposite of an ordinary annuity is an annuity due, where payments are made
at the beginning of each period.
In SIP, an investor commits to pay an annuity amount regularly. Here investor needs to invest the same
amount of money in a particular mutual fund at every stipulated time period.
P/E Ratio =
28
A third variation that is also sometimes seen uses the EPS of the past two quarters and
estimates of the next two quarters.
40.Ponzi scheme
A Ponzi scheme is a fraudulent investment operation where the operator, an individual or
organization, pays returns to its investors from new capital paid to the operators by new
investors, rather than from profit earned by the operator. Operators of Ponzi schemes
29
usually entice new investors by offering higher returns than other investments, in the form
of short-term returns that are either abnormally high or unusually consistent.
Ponzi schemes occasionally begin as legitimate businesses, until the business fails to
achieve the returns expected. The business becomes a Ponzi scheme if it then continues
under fraudulent terms.
41.Tax Planning:
a) Important Terms:
Assessment Year: The period of 12 months commencing on the first day of April every
year. All the income earned by persons during the previous year is assessed in the
assessment year and the taxes on the same are paid during the assessment year itself.
For instance, the period from April 1, 2011 to March 31, 2012 shall be the assessment year
for the income earned during previous year i.e. from April 1,2010 to March 31,2011.
Previous Year: It is defined as the financial year immediately preceding the Assessment
year. The previous year can also be understood as the year in which the income is earned by
a person.
Gross Total Income: Is the aggregate of income under all heads of income.
Taxable Income: Is the income arrived at, after allowing all deductions and exemptions.
PAN: Permanent Account Number - a ten digit number which helps the IT department to
identify any person liable to pay income tax.
TAN: tax deduction and collection account number a 10 digit alpha numeric number to be
obtained by all persons/entities who are entrusted with the task of collecting or deducting
tax.
TDS: Income tax shall be deducted while effecting payments like salary, interest,
contractors settlement, Consultants fee etc. and remitted to the Central Government
through an authorized bank.
Tax Structure:
Direct Tax(Paid by tax payer directly to
Government)
1.Income Tax
2.Wealth Tax
3.Gift Tax
4.Security Transaction Tax
5.Capital Gains Tax
Collected by :Central Board of Direct
Taxes
Indirect Tax(Paid to
the Government by a
third party and
collected from tax
payer)
1.Custom Duty
2.Excise Duty
3.Service Tax
4.Value Added Tax
Collected by: Central
Board of Excise and
Customs
Who is a person?
Under Section 2(31) Income Tax Act
1.Individual
4.Firm
2.HUF (Hindu Undivided
Family)
7.Any other
artificial person
5.Association of Persons
(Incorporated or Not)
30
3.Company
6.Local Authority
31
32
6.Dearness
7.Overtime
8.Special Allowance
Income
Level
Tax
Rate
Income Level
Tax
Rate
Income Level
Tax
Rate
Rs.
2,50,000
Nil
Upto Rs.
3,00,000
Nil
Upto Rs.
5,00,000
Nil
Rs.
2,50,001 Rs.
500,000
10%
10%
20%
Rs.
500,001 Rs.
10,00,000
20%
20%
Above Rs.
10,00,000
30%
Above Rs.
10,00,000
30%
Above Rs.
10,00,000
30%
Section
80C
Unit Linked
Insurance Plan
(ULIP)
Section
80C
Infrastructure
Bonds (NO
LONGER
AVAILABLE FOR
FRESH
INVESTMENT)
Section
80C
Contribution to
EPF / GPF /
Section
80C
Tax on Income
Varies from
Varies from year
scheme to
to year
scheme
Varies from
Varies from year
scheme to
to year
scheme
Varies from
issue to
issue. These
were around 8%
+ in Dec 2011.
These have lost
their charm as Taxable
Additional Tax
rebate of Rs
20,000 is NOT
given now from
FY 2012-13
onwards.
8.75% on EPF
Interest
for 2013-14
earned is tax
33
Maturity
Varies from scheme to
scheme
Varies from scheme to
scheme (15 to 20 years)
3 to 5 years
(announced in
August 2013)
Voluntary PF
Insurance
Policies
Section
80C
6 to 7% only
ULIPS
Section
80C
Market linked
free
Earnings are
tax free in
most of the
cases
Earnings are
tax free
years)
8.70% for FY
2015-16
Interest
earned is tax
free
Section
80C
Market Linked
Interest
earned is tax
free
Section
80C
Not applicable
Section
80C
Not applicable
Section
80C
Varies from
bank to bank
Taxable
(around 7.50% 8.75%)
5 Years
Senior Citizens
Savings Scheme
Section
2004 (from
80C
financial year
2007-08)
9.30% for FY
2015-16
Taxable
Taxable
NPS
Tuition Fees
including
admission fees
or college fees
paid for full time
education of any
two children of
the assessee.
Repayment of
Housing Loan
(Principal)
Bank Tax Saving
Fixed Deposits
Schemes - 5
Years
Under this section, the contributions by individuals towards "Pension" schemes of LIC
or any other Insurance company, is allowed as deduction of Rs.10,000/-. However, as
provided under section 80CCE, the aggregate deduction u/s 80C, and u/s 80CCC and
34
80CCD can not exceed Rs.1,50,000/-. Thus effectively, now these are covered under
the maximum limit of Rs.1,50,000/- under section 80C.
e) Deductions Under Section 80 D :
Basic Deduction under Section 80D, Mediclaim premium paid for Self, Spouse or
dependant children has now been raised to Rs 25,000 wef FY 2015-16.
The deduction for senior citizens is raised from Rs 20,000 to Rs 30,000. For
uninsured super senior citizens (more than 80 years old) medical expenditure
incurred up to Rs 30,000 shall be allowed as a deduction under section 80D.
However, total deduction for health insurance premium and medical expenses for
parents shall be limited to Rs 30,000.
35
Suppose, you bought a single premium life insurance policy where you had paid an annual
premium of Rs 25000 and choose a sum assured of Rs 2.5 lakhs, then in this scenario your
policy would be eligible for Sec 10 (10)(d) of the Income Tax Act and will have tax-free
maturity benefit/death benefit/surrender value.
i)
Some of the incomes are completely exempted from income tax and that too without any
upper limit. The following incomes are tax free :(1) Interest on EPF / GPF / PPF
(2) Interest on GOI Tax Free Bonds / Tax Free Bonds issued with specific stipulation to this
effect
(3) Dividends on Shares and Mutual Funds. Dividend income from companies / Equity
Oriented Mutual funds is completely exempt in the hands of investors. Dividend is also tax
free in the hands of investors in case of debt-oriented Mutual Fund schemes. (However, the
Asset Management Company is liable to deduct 22.44% distribution tax in case of non
individuals / non HUF investors and 14.025% in case of individuals or HUF investors.)
(4) Capital receipts from Life Insurance policies i.e. sums received either on death of the
insured or on maturity of Life insurance plans. However, in case of life insurance policies
issued after March 31, 2004, exemption on maturity payment u/s 10(10D) is available only if
premium paid in any year does not exceed 20% of the sum asssured;
(5) Interest on Saving Bank accounts in banks upto Rs10,000/- per year (from FY 2012-13
onwards)
(6) Long term capial gains on sale of shares and equity mutual funds after 01/10/2004, if
security transaction is paid / imposed on such transactions.
j) Assessment Year 2016-17
a) Surcharge: The amount of income-tax shall be increased by a surcharge at the rate of
12% of such tax, where total income exceeds one crore rupees. However, the surcharge
shall be subject to marginal relief (where income exceeds one crore rupees, the total amount
payable as income-tax and surcharge shall not exceed total amount payable as income-tax
on total income of one crore rupees by more than the amount of income that exceeds one
crore rupees).
b) Education Cess: The amount of income-tax and the applicable surcharge, shall be further
increased by education cess calculated at the rate of two per cent of such income-tax and
surcharge.
c) Secondary and Higher Education Cess: The amount of income-tax and the applicable
surcharge, shall be further increased by secondary and higher education cess calculated at
the rate of one per cent of such income-tax and surcharge.
d) Rebate under Section 87A: The rebate is available to a resident individual if his total
income does not exceed Rs. 5,00,000. The amount of rebate shall be 100% of income-tax or
Rs. 2,000, whichever is less.
k) Case Study 1:
Calculate the income tax payable (Tax Liability) by Satish aged 36 years for the financial
year 2014-15(Assessment year 2015-16). Gross Annual Income for 2014-15 - Rs.9.5 lacs.
His investments are as under:
36
PPF.
Rs.55000.
NSC.
Rs.45000.
Life Insurance
Rs.20000.
ELSS
Rs.20000.
ULIP
Rs.15000.
His has taken medical insurance are as under:
Mediclaim (Self/Spouse)
Rs.20000.
Mediclaim (Parents-age 61Yrs)
Rs.25000.
150000
20000
25000
195000
Step 3:
Total Income:
Rs. 9, 50,000
Less Eligible Exemptions (i.e. 1.5 Lakh+15K+20K): Rs. 1, 95,000
Taxable Income:
Rs. 7, 55,000
Step 4
42.Financial Planning
37
Nil
10%
20%
38
transfer mechanism where a small premium payment can result in payments from the
insurance company to tide over risks from unexpected events.
4.Investment Planning and Asset Allocation: A crucial component in financial planning and
advisory is the funding of financial goals of a household. Investment planning involves
estimating the ability of the household to save, and choosing the right assets in which such
saving should be invested.
5.Tax Planning: Income is subject to tax and the amount a household can save, the return
they earn on their investment and therefore the corpus they are able to build for their future
goals, are all impacted by the tax regime they fall under.
6.Estate Planning: Wealth is passed on across generations. This process of inter-generational
transfer not only involves legal aspects with respect to entitlements under personal law, but
also documentation and processes that will enable a smooth transition of wealth in a taxefficient way.
45.Financial Planning Delivery Process
Financial planning requires financial advisors to follow a process that enables acquiring client
data and working with the client to arrive at appropriate financial decisions and plans, within
the context of the defined relationship between the planner and the client. The following is
the six-step process that is used in the practice of financial planning.
1.Establish and define the client-planner relationship: The planning process begins when the
client engages a financial planner and describes the scope of work to be done and the terms
on which it would be done.
2.Gather client data, including goals: The future needs of a client require clear definition in
terms of how much money will be needed and when. This is the process of defining a
financial goal.
3.Analyse and evaluate financial status: The current financial position of a client needs to be
understood to make an assessment of income, expenses, assets and liabilities. The ability to
save for a goal and choose appropriate investment vehicles depends on the current financial
status.
4.Develop and present financial planning recommendations: The planner makes an
assessment of what is already there, and what is needed in the future and recommends a
plan of action. This may include augmenting income, controlling expenses, reallocating
assets, managing liabilities and following a saving and investment plan for the future.
5.Implement the financial planning recommendations: This involves executing the plan and
completing the necessary procedure and paperwork for implementing the decisions taken
with the client.
6.Monitor the financial planning recommendations: The financial situation of a client can
change over time and the performance of the chosen investments may require review. A
planner monitors the plan to ensure it remains aligned to the
Case Study on Goal
goals and is working as planned and makes revisions as may
Value
be required.
The current cost of a
college admission may
46. Goal Value
be Rs. two lakhs. But
The goal value that is relevant to a financial plan is not the
after 5 years, the cost
current cost of the goal but the amount of money required for
would typically be higher.
the goal at the time when it has to be met. The current cost of
This increase in the cost
the goal has to be converted to the value in future.
of goods and services is
The amount of money required is a function of
called inflation. While
Current value of the goal or expense
saving for a goal,
Time period after which the goal will be achieved
therefore, it is important
Rate of inflation at which the cost of the expense is
to estimate the future
expected to go up
value of the goal
because that is the
amount that has to be
47. Risk Profiling of a Client
accumulated.
The future value of a
goal = Current Value x
39
(1+ Rate of Inflation) ^
(Years to Goal)
Rs.200000 x (1+10%) ^
5= Rs.322102.
Risk Profiling of a Client is Clients' financial risk tolerance . Risk tolerance is the
assumed level of risk that a client is willing to accept.
40
41
42
The amount of
insurance you need to
buy (Human Life
Value)
There are two distinct stages in retirement: the accumulation stage and the distribution
stage. The accumulation stage is the stage at which the saving and investment for the
retirement corpus is made. Ideally, the retirement savings should start as early as possible
so that smaller contributions made can also contribute to the corpus significantly with the
benefit of compounding.
Retirement planning involves the following steps:
Compute the retirement corpus required based on the estimation of expenses in
retirement or income at retirement.
Determine the periodic savings required to accumulate the retirement corpus.
Analyse the current financial situation to determine the savings possible.
Set in place a long-term savings plan based on the expected income Identify the
investment products in which the savings will be invested.
Monitor the performance of the investment and the growth of the retirement corpus
periodically.
Review the adequacy of the retirement corpus whenever there is a change in
personal situation that has an impact on income or expenses.
Make mid-course corrections, if required.
Rebalance the portfolio to reflect the current stage in the retirement plan.
There are different methods used to estimate the amount of income required in retirement.
1. The Income Replacement method and the
2. Expense Protection Method
Income Replacement Method
The income replacement ratio is the percentage of the income just before retirement that
will be required by an individual to maintain the same standard of living in retirement. While
estimating this ratio, the current income has to be adjusted for a few heads of expenses that
may no longer be relevant in retirement. At the same time, there may be a larger outlay on
other heads of expense such as medical and healthcare. Some people may like to have a
higher discretionary income for travel or entertainment. Some of the expenses that have to
be reduced from the income include:
1.The portion of the income that is being used towards paying taxes.
2.The mandatory deduction from income being made, such as provident fund The
portion of income going to savings for goals.
3.Employment related expenses, such as those related to transportation.
The steps for estimating the income required in retirement under this method are:
1.Calculate the current income
2.Estimate the rate at which the income is expected to grow over the years to retirement
3.Calculate the years to retirement
4.Calculate the income at the time of retirement as Current value x(1+ rate of
growth)^(Years to retirement)
5.Apply the income replacement ratio to this income to arrive at the income required in
retirement.
Case Study: Income Replacement Method
Pradeep has a current annual income of Rs. 10,00,000. He is 30 years of age and expects to retire at
the age of 55. He also expects his income to grow at a rate of 10% and estimates that he will require
an income replacement of 75%. What is the income required by Pradeep in retirement?
43
1000000
Age
30
Retirement age
55
Years to Retirement
25
10%
10834706
75%
55-30
1000000*(1+10%)^25
10834706*75%
50000
Proportion of household
expenses
60%
44
30000
Additional discretionary
expense in retirement
10000
40000
25
60% of Rs.50000
Retirement age(55)
Current
age(30)
6%
Case Study
Rani requires a monthly income of Rs.35000 by todays value for her retirement 25 years
away at the age of 60. She expects to live up to 80 years. What is the retirement corpus
required if the banks deposit into which she will invest her retirement savings is likely to
yield 8% and the rate of inflation is 6%?
There are two stages to calculating the retirement corpus: in first step the income required
to meet expenses at retirement should be calculated and in the next step the corpus that
will generate this income has to be computed.
Rs.35,000
25
45
Expected inflation
6%
150215
35000 x (1+6%)^25
20
(80-60)
8%
Inflation rate
6%
1.89%
{((1+8%)/(1+6%))-1}X100
: 12%/12
: Rs. 30,048,832
46
The monthly savings required is Rs. 15,835. If this sum is invested at an annual rate of 12%
for 25 years, then the savings will compound to a value of Rs. 30,048,832, which is the
retirement corpus required.
What will be the effect if Rani had 30 years to save for the same amount? The amount of
monthly savings will come down to Rs. 8512 since there is a longer period over which Rani
can make contributions, and the money can be invested and grow to the corpus required.
51. Derivatives
A derivative refers to a financial product whose value is derived from another. A derivative is
always created with reference to the other product, also called the underlying.
A derivative is a risk management tool used commonly in transactions where there is risk
due to an unknown future value.
For example, a buyer of gold faces the risk that gold prices may not be stable. When one
needs to buy gold on a day far into the future, the price may be higher than today. The
fluctuating price of gold represents risk. Gold represents the underlying asset in this case.
A derivative market deals with the financial value of such risky outcomes. A derivative
product can be structured to enable a pay-off and make good some or all of the losses if gold
prices go up as feared.
Derivatives are typically used for three purposes: hedging, speculation and arbitrage.
a. Hedging
When an investor has an open position in the underlying, he can use the derivative markets
to protect that position from the risks of future price movements.
b. Speculation
A speculative trade in a derivative is not supported by an underlying position in cash, but
simply implements a view on the future prices of the underlying, at a lower cost.
c.Arbitrage
If the price of the underlying is Rs.100 and the futures price is Rs.110, anyone can buy in the
cash market and sell in the futures market and make the riskless profit of Rs.10. This is
called arbitrage.
Arbitrageurs are specialist traders who evaluate whether the Rs.10 difference in price is
higher than the cost of borrowing. If yes, they would exploit the difference by borrowing and
buying in the cash market, and selling in the futures market at the same time (simultaneous
trades in both markets). If they settle both trades on the expiry date, they will make the gain
of Rs.10 less the interest cost, irrespective of the settlement price on the contract expiry
date, as long as both legs settle at the same price.
52.FUTURES
47
A futures is a contract for buying or selling a specific underlying, on a future date, at a price
specified today, and entered into through a formal mechanism on an exchange. The
terms of the contract (such as order size, contract date, delivery value and expiry date) are
specified by the exchange.
Example:
FUTIDX NIFTY 26 Feb 2014 is a futures contract on the Nifty index that expires on
26th February 2014.
The value is 6235, which means a buyer or seller agrees to buy or sell Nifty for a
delivery value of 6235 on a future date.
It is available to trade from the date it is introduced by the exchange to its expiry
date on 26th February 2014.
On expiry, the settlement price at which this future contract will be settled may be
higher or lower than 6235. If it is higher, any investor who had bought the future
contract at a price of 6235 would have made profits and a seller at that price would
have made losses. If the settlement price is lower, then the situation is reversed for
the buyer and seller.
53.OPTIONS
Options are derivative contracts, which splice up the rights and obligations in a futures
contract. The buyer of an option has the right to buy (in case of call) or sell (in case of
put) an underling on a specific date, at a specific price, on a future date. The seller of an
option has the obligation to sell (in case of call) or buy (in case of put) an underlying on
a specific date, at a specific price, on a future date. An option is a derivative contract that
enables buyers and sellers to pick up just that portion of the right or obligation, on a future
date.
54. Absolute Return
The absolute return on an investment is computed as:
((End Value Beginning Value)/Beginning Value) x 100
OR
(Return on Investment/Original Investment) x 100
The rate of return is converted into percent terms by multiplying by 100.
Example:
There are two investment opportunities as under:
Period of
Investment
Beginning Value
End Value
Investment A
one year
23000
28000
Investment B
Three years
2500
3100
48
Investment A has a higher amount of return in terms of rupees, but earns a lower rate of
return as compared to investment B.
55. Annualized return
Annualized return is a standardized measure of return on investments in which the return is
computed as percent per annum (% p.a.).
It is calculated as:
(End value - Beginning value)/Beginning value) x 100 x (1/ holding period of investment in
years)
Measuring returns as percent per annum is the accepted way to measure investment return.
In the example given in section 54, the annualized return on the two investments is
computed as:
Annualized return = ( (30 lakh-20 lakhs)/20 lakhs) x100 x(1/1)= 50%
Annualized return = ( (30 lakh-20 lakhs)/20 lakhs) x100 x(1/3)= 16.3%
As expected, investment B has a much lower annualized return, because the same absolute
return is earned over a longer holding period.
56.TOTAL RETURN
The returns from an investment can be in different forms such as interest income
(debentures, bank deposits), dividend (mutual funds, equity shares) and profits on sale
(capital gain on selling a house).
An investment could provide more than one type of return.
For example, equity shares can give dividend income, as well as profits on sale. A
house property can yield rentals, and also capital gains on sale. A complete measure of
return should take all benefits from an investment into consideration.
Total return can be positive as well as negative. The sign of total return depends on its
components and whether they are positive or negative.
Example-1
consider an equity share
of face value Rs.10,
which yields a dividend
of 30%. The share is
purchased for Rs. 200,
but sold for Rs.190 after
one year.
In this example the loss
component is greater
than the positive
dividend earned so the
total return becomes
negative.
1.Loss on Sale: Rs.200Rs.190=Rs.10.00
2.Income as dividend
Rs.3 (30% of face value
of Rs.10)
3.Net Loss is Rs.7.00
Example-2
An investor bought a
house for Rs.10 lakh. He
earned a monthly rental
income of Rs.3000 for 2
years. He then sold off
the house for Rs.12 lakh.
What is his total return?
Rental Income = Rs.3000
x 24 = Rs.72000
Profit from selling after 2
years = Rs.12 lakhs Rs.10 lakhs =
Rs.200000
Total return =
200,000+72000 =
Rs.272000 on an
investment of
Rs.10,00,000
The rate of return
49 per
cent p.a.=
(272000/10,00,000) x
(1/2) x 100 = 13.6%
OR
HPR = Cash inflows + (Ending value Beginning value)
Beginning value of investment
50
9.The shares of Alpha were bought on Jan 1 ,2003 for Rs.45.The year end prices were as under:
2003
Rs.50
2004
Rs.55
2005
Rs.48
What is the total return percentage.
A. 4.36%
B. 2.22%
C. 7%
D. 8.42%
10.What is the yield of a Bond bearing a coupan rate of 8% payable annually and currently priced at Rs.950 with a
face value of Rs.1000?
A. 4.36%
B. 2.22%
C. 8.42%
D. 8.42%
11.Interest rate has following relation with share valuation:
A. Directly proportional to the stock price rise
B. Inversely proportional to the stock price rise
C. No Impact
D. None of the above
12.In respect of investing in Index Funds, which one of the following statement is true?
A. Suitable to investors who seek returns much in excess of market returns.
B. Aggressive investment strategy
C. Active investment strategy
D. Suitable to investors who expect index returns on the investment.
13.A retired couple should ideally prefer which of the following asset allocation plan?
Equity
Debt
cash
A.
60%
35%
5%
B.
50%
40%
10%
51
C.
D.
80%
20%
20%
70%
Nil
10%
14.A young man of 25 years,who has just joined an IT company as a programmer should prefer which kind of
investment planning.
A. Systematic Investment plans that take care of capital growth and life insurance
B. All money in life insurance plans
C. He should not invest now as he is too young. Should enjoy life.
D. Make lump sum investment in index funds.
15.Mutual fund distributors are regulated by:
A. AMFI
B. RBI
C. FPSB
D. IRDA
16.As a financial planner, if you expect the interest rate to rise, you should recommend:
A. Long Term bonds to clients
B. Government Securities
C. Short Term instruments
D. Stock Market
17.If the expected return of two stocks are the same then the investor should prefer that stock where the
A. Risk is higher
B. Risk is lower
C. Risk is same
D. No Risk involved
18. Mr. Samant has invested in 10% GOI Tax Free Relief Bonds.If he is paying income tax at the rate of 30%,the tax
effective yield on these bonds to Mr.Samant would work out to:
A. 10%
B. 12.5%
C. 14.28%
D. 16.23%
19.The rate of return on a stock in a particular year was 19.5%.The rate of inflation during that year was 5%.What is
the real raturn on the stock?
A. 14.5%
B. 13.33%
C. 15.8%
D. 16.2%
Hint: Real rate =[{(1+nominal rate/100)/(1+Inflation Rate/100)}-1] *100
20.
A. Rs.75
B. Rs.100
C. Rs.50
D. Rs.120
Hint: 3/(1+.12)^1+3.24/(1+.12)^2+{3.50+94.48/(1+.12)^3}
21.Which of the following strategies is not related to Managing Risk:
A. Avoiding Risk
B. Transferring Risk
C. Controlling Risk
D. Accepting Risk
E. Dividing Risk
52
22. The premium paid is used to purchase units in investment assets chosen by the policyholder after deducting
for all the charges and premium for risk cover under policy.
Identify the investment option which matches above style of payments:
1.Mutual Fund
2.Equity
3.Commodity
4.ULIP
23.In a whole life plan with limited payments,the sum assured becomes payable :
1.At the end of premium paying term
2.Only on death of the policy holder
3.At the end of the premium term or on the death whichever is earlier
4.The sum assured is not payable at all if the policy holder survives the premium paying term.
24. In an Endowment Insurance Plan ,the sum assured becomes payable :
1.At the end of premium paying term
2.Only on death of the policy holder
3.At the end of the term of the policy or on the death whichever is earlier
4.The sum assured is not payable at all if the policy holder survives the premium paying term.
26.Unit linked insurance plans are basically:
A.Short term and low cost Insurance plans
B.Low cost investment plan with no risk.
C.Market related plans with emphasis on investment
D.Market related plans with emphasis on insurance
27.An investor who wants to invest in immediate pension plan seeks your advice on what option to choose.He is 50
years of age and he expects to live for another 30 years at least.Which of the following option is best for him?
A.Guaranteed pension for 5 years offering 7% p.a.
B. Guaranteed pension for 25 years offering 6.5% p.a.
C.Guaranteed pension for life and thereafter to his spouse offering 7% p.a.
D.Invest in Mutual Fund rather than pension offering min 10% offering.
28.Which of the following funds is suitable for an investor who is happy with the equity market returns:
A.Balanced Fund
B.Money Market Fund
C.Gilt Fund
D.Index Fund
29.A Pharma Fund can be categorized as:
A.Thematic Fund
B.Offshore Fund
C.Real Estate Fund
D.Sectoral Fund
30.NAV minus Repurchase Price is
A. Sale Price
B. Exit Load
C. Entry Load
D. Redeem Price
ANS:1.D,2.A,3.C,4.True,5.A,6.D,7.B,8.D,9.B,9.B,10.C,11.B,12.D,13.D,14.A,15.A,16.C,17.B,18.C ,19.B,20.A,21.E
22.4,23.2,24.3,25.C,26.C,27.D,28.D,29.D,30.B,
61.Problems on future value
1.
2.
3.
4.
Mr. A deposits Rs. 50000 for 6 years with a finance company which pays interest of 15% p.a. Compute the
future value.
115655
Mrs.B invests Rs. 37,000 for 2 years at 10.5% per annum compounded annually. Calculate the redemption
value.
45177.9
Mr.B invests Rs. 44,000 in FD for 2 years at 3% per annum compounded quarterly. Calculate the maturity value
of the FD.
46,710
Mr.X deposits Rs. 94,000 for 3 years at 4.25% per annum compounded semi-annually. Calculate the maturity
value.
106640
53
5.
6.
7.
Mr. Prasad lends Rs. 125000 to Mr. Yaswanth for 3 years at the rate of 18% p.a. Compute the amount payable
by Mr. Ramrasad after 3 years.
205379
Mr. ABC deposits Rs. 10000, Rs.20000, Rs.30000, Rs.20000 and Rs.15000 respectively in the year 1, 2, 3, 4 and
5 respectively. His deposit earns an interest of 12% p.a. Calculate the amount he gets after 5 years.
118865
Mr. XYZ is a Lawyer and deposits his savings every year in a deposit which gives him an interest of 10% p.a.
Calculate the Future value if he deposits the money yearly as below. 284014.5
Year
Cash Flow
1
45000
2
30000
3
20000
4
50000
5
63000
8. Six annual payments of Rs. 5000 are made into a deposit account that pays 14% interest per year. What is the
future value of this annuity at the end of 6 years?
42,677.6
9. Mr. Pradeep deposits Rs. 10000 every year for 4 years and deposit earns an interest of 10% p.a. Determine how
much money he will have at the end of 4 years.
46,410
10. Ms. Smitha deposits Rs. 8000 each year for 6 years and the deposit earns a compound interest @ 14% p.a.,
how much amount will she receive after 6 years?
68,284
62.Problems on present value
1.
2.
3.
4.
5.
What is the present value of Rs.800 to be received at the end of 8 years, assuming an annual interest rate
of 8 percent? 432
Mr. Venkatesh wants to have Rs. 20,00,000 lakhs after 6 years for his daughters marriage. How much he
has to deposit today if the rate of interest is 14% p.a. 9,11,200
Mr. Lakshman is expecting Rs. 8,00,000 as retirement benefit after 5 years from now. How much loan he
can take so today if the interest rate is 11% p.a. 474800
Find the present value of 1,000 to be received at the end of 2 years at a 12% nominal annual interest rate
compounded quarterly. 789.4
What is the present value of the following cash stream
Year
0
1
2
3
4
Cash Flow
5000
6000
8000
9000
8000
26,629.14
6.
An investor wants to have Rs.10000, Rs.15000, Rs.8000, Rs.11000 and Rs.4000 respectively 1,2,3,4 and 5
years. Find out the amount he has to deposit today if discount rate is 10%?
37,494.96
7. A person wants to get Rs. 20,000 for the next 5 years. If his investment earns an interest 12%p.a., how
much he has to deposit today?
72096
8. A Company borrows Rs.500000 at an interest rate of 15% and the loan is to be repaid in 5 equal
installments payable at the end of each of the next 5 years. What shall be the size of installment?
1676100
9. You buy a house for Rs.5 lakh and immediately make cash payment of Rs.1 lakh. You finance the balance
amount at 12% for 6 years with equal annual installments. How much are the annual installment?
1644560
10. A 10,000 car loan has payments of 361.52 due at the end of each month for three years. What is the
nominal interest rate? 18%
63.Questions on CAGR
Example: An Face
investor
QUESTION
Date of
purchased mutual
fund units
at
No.
Value
Purchase
an NAV of Rs.11. After 450
days, she redeemed it at
Rs.13.50. What is her
NAV at
purchase
54
Date of
Sale
1.
Rs.10
15.01.2015
Rs.250.00
28.02.20
16
Rs.280.00
2.
Rs.10
10.04.2015
Rs.9.00
20.05.20
16
Rs.11.50
3.
Rs.10
12.03.2014
Rs.6.00
22.11.20
16
Rs.25.00
4.
Rs.100
01.01.2015
Rs.120.00
28.02.20
17
Rs.189.00
64.
Question
No.
Investmen
t
Rate of Intt on
Investment
Tax Bracket
Of the
Invstor
Period of
Investment
1.
Rs.1,00,00
0
8%
30%
2 years
2.
Rs.2,00,00
0
12%
20%
3 years
3.
Rs.3,00,00
0
10%
50%
4 years
4.
Rs.1,00,00
0
9%
30%
5 years
55
c.4.10%
d.4.53%
Hint:{(1+NR/1+IR)-1}*100
4. An investment earns a return of 11% p.a., but the income is taxable in the hands of the
investor. The investors marginal tax rate is 30%. What is his after tax rate of return?
a.7.70%
b.7.13%
c.7.10%
d.7.53%
5.An investor is considering a tax-free bond that pays 8% p.a. and a taxable bank deposit
that pays 9% p.a. The tax bracket of the investor is 20%.What is the nominal return on Tax
Free Bond?
a.10.00%
b.7.02%
c.8.12%
d.15.53%
6. Which of the following amount is the maturity amount of an investment of Rs.25000 for
25 years in a Bank Fixed Deposit @10% p.a.?
a.Rs.2,70,868
b.Rs.87,500
c.Rs.1,70,868
d.Rs.1,87,500
7. Which of the following amount is the maturity amount of an SIP of Rs.2500 per month for
25 years in Mutual Fund @10% p.a.?
a. Rs.33,17,083
b.Rs.87,33,500
c.Rs.11,70,868
d.Rs.31,87,500
8. Which of the following factor is the PVIF for 25 years at an interest rate of 10% p.a.?
a. Rs.9.0770
b.Rs.8.0980
c.Rs.11.9807
d.Rs.3.9879
9. Which of the following factor is the FVIF (Annuity)for 25 years at an interest rate of 10%
p.a.?
a. Rs.98.347
b.Rs.80.980
c.Rs.119.807
d.Rs.39.879
10.Mrs. Kapoor has been accumulating mutual funds over the past two years.
She decides to sell her holdings on January 31, 2014, on which date the value of her
investments is as shown below.
What is the annualized rate of return on her investments?
Purchase Date
Dec 10, 2011
May 15, 2012
56
57