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Chapter3.2:MutualFundBasicConcepts&Terminology
OPENSHARE
Asyoulearnandunderstandallaboutmutualfunds,youwillcomeacrosstermsareconceptsthatarespecifictomutualfunds. TRADING
Heresajargondebusterforyou:
ACCOUNT
NOW
NETASSETVALUE:

Thisisperhapsthemostimportanttermtoknowwithrespecttomutualfunds.NetAssetValue(NAV)isimportanttounderstandthe FullName
performanceofaparticularschemeofamutualfund.Asaninvestor,whenyouputinmoneyinamutualfund,youwillbeissuedunits.
Youwillthenbecomeaunitholder.Thisisakintoashareholdingbuyingstocks. 10DigitMobileNo.

Mutualfundsinvestthemoneycollectedfromtheinvestorsinthesecuritiesmarkets.Insimplewords,NetAssetValueisthemarketvalue
EmailAddress
ofallthesecuritiesheldbythescheme.Itismeasuredonaperunitbasis.Sincemarketvalueofsecuritieschangeseveryday,NAVofa
schemealsovariesondaytodaybasis.
Mumbai
NAViscalculatedbydividingthetotalnetassetsbythetotalnumberofunitsissued.Totalnetassetsisthemarketvalueofalltheassets
amutualfundholds,lessanyliabilities,asofacertaindate.

SUBMIT

Note

WHYCAPITALGAINS
REPORT?
Snapshotofprofit/loss
Reflectsperformanceofyour
portfolio

Helpscomputetaxes

Forexample,ifthemarketvalueofsecuritiesofamutualfundschemeisRs200croreandithasissued10croreunitstoinvestors,then
thefundsNAVperunitisRs20.NAVisrequiredtobedisclosedbymutualfundsonaregularbasiseitherdailyorweeklydepending
onthetypeofscheme.

ASSETSUNDERMANAGEMENT(AUM):

Amutualfundpoolsmoneyfrominvestorsandusesthismoneytobuyassetslikestocks,bondsandothersecurities.Thetotalvalueof
theassetsafundbuysiscalledtheassetsundermanagement(AUM).

AUTOMATICREINVESTMENT:
Amutualfundgivesreturnintwowaysdividendsand
anincreaseinvalue.Thelattercanbeutilizedonly
whenyousellthemutualfundunit.
Thedividends,however,areaccessibleassoonasthey
aredistributed.Asaninvestoryoucanusethisintwo
waysreinvestmentorpayout.Whenyouchoosethe
payoutoption,thedividendamountwillgetcreditedin
yourbankaccount.Incaseofreinvestment,thedividend
amountwillbeutilizedtobuymoreMFunitsofthe
scheme.
COMPOUNDING
Whenyouinvestinafinancialasset,youearnonthe
amountinvested.Overtime,youcaneitherreinvestthis
amountorputitinabankaccount.Eitherway,youearn
someamountonyourexistingprofitseitherthrough
investmentreturnsorfrombankinterest.Thus,yourtotal
returnsovertimeincrease.Thisiscalledcompounding.
Overtime,compoundingcanproducesignificantgrowth
inthevalueofaninvestment.
Forexample,youinvestRs1000todayandearnRs
100profitayearfromnowareturnof10%.Youdecide

Theautomaticreinvestmentoptionisaservicethefund
toreinvestthisamounttoo.Thenextyear,areturnof Knowthepowerof
houseprovidestoshareholders,givingthemoptionto
10%givesyouRs110,notRs100.Thegreaterthe compounding
frequencyofinvestmentorinterestpayments,thehigher
purchaseadditionalsharesusingdividends
istheeffectofcompounding.
automatically.
DEPRECIATION:
Thisisthedeclineinyourinvestmentsvalueinthe
mutualfund.Thismeans,youwillmakeacapitalloss

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CAPITALGAINSDISTRIBUTIONS: whenyousellthemutualfundunits.Itisjustthe
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Apartfromdividends,mutualfundsalsodistributethe oppositeofappreciation. Sensex:30,126.21 231.41(0.77%) GetQuote
profitsitmakesfromsellingsomeoftheunderlying
assetsathighervalues.Thisiscalledcapitalgains
distribution.ThiscanalsobeusedtobuymoreMFunits
(reinvestment).

DIVERSIFICATION:
Diversificationisoneofthekeybenefitsaswellascharacteristicofamutualfund.Itisthepracticeofinvestingindifferenttypesof
securitiesorassetclasses.Thisisdonetoreducerisk.

Theunderlyingprincipleisthatnoteveryassetmovesintandem.Somerise,whilesomefallatthesametime.Sowhenyouownboth
thestocksinyourportfolio,anylossesfromonewouldbenullifiedbythegainsintheother,thusreducingyouroverallrisk. (http://www.slideshare.net/KotakSecurities/power
ofcompounding)
ReadMore>
(http://www.slideshare.net/KotakSecurities/power
ofcompounding)

AVERAGEPORTFOLIOMATURITY:
Theaveragematurityofallthesecuritiesinabondor
moneymarketfundsportfolio.

RUPEECOSTAVERAGING:
Everyday,valuesoffinancialassetschange.So,when
youbuyattwodifferenttimes,yourpurchase/market
pricewilldiffer.Forexample,todayyoubuy10unitsat
Rs100each.

Tomorrow,youmaybuyanother10unitsforRs120
each.Youraveragepriceofthe20unitswillbeRs110
theaverage.So,whenyoufinallyselltheunitsforRs
150,yourprofitwillbeRs40/unit.

Usually,investorsfixtheamounttobeinvestedevery
monthorquarter.Thisisusuallydoneinthehopesof
reducingtheaveragepricebybuyingmoreunitswhen
thepricesarelow,andfewerunitswhenpricesare
high.

PORTFOLIO
Thisisthecollectionofassetsownedbythemutualfund
orevenyouasanindividual.Itincludesallthefinancial
instrumentsinvestedinlikestocks,bonds,andother
securities.

Inamutualfund,anexperthandlesalltheseassets.He
orshealsodecideswhichassetstobuyandsell.This
specialistiscalledthePortfolioManager.Thefrequency
ofthetradingactivityhowoftenassetsareboughtand
soldinthefundsportfolioiscalledthePortfolio
Turnover.

EXDIVIDENDDATE:
Justlikecompanies,mutualfundhousestooannouncetheamountofdividendtobedistributedafewdaysbeforetheactual
distribution.Thedateofthedistributioniscalledthedividenddate.Oncethishappens,thefundsnetassetvaluereducesasthe
dividendsaredeductedfromthefundsassets.Thedayofthisdeductioniscalledtheexdividenddate.

LOAD:
Thisistheamountamutualfundchargesinvestorsfor
variousreasons.Therearedifferentkindsofloads
managementfees,entryorfrontendloads,exitloads.

Theamountpaidtoyourfundmanagerforhis
expertiseandportfoliomanagement(/ksweb/Our
Offerings/AccountTypes/PortfolioManagement
Service)skillsiscalledmanagementfees.

Entry/frontendloadistheamountamutualfund
chargeswhenunitsarepurchasedbyinvestors.
Thisisusuallyrare.

Exitloadistheamountamutualfundchargesyou
forsellingorredeemingyourshares.

Allthesesharesusuallydifferfromfundtofund.Therearefundswhichdonotchargeanyfeesorloads.ThesearecalledNoload
funds.MFsthatchargeinvestorsarecalledLoadfunds.

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Tocompareonefundfromotheronthebasisoftheamounttheychargeinvestors,theexpenseratioisused.Itiscalculatedby
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dividingafundstotalexpensestoitstotalassets,expressedinpercentageformat.Apartfromthis,investorsmayalsohavetopay
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theirbrokersorsalesagentsasmallfeecalledCommission.

TOTALRETURN:
Thisisthetotalamountofprofitsaninvestormakeskeepinginmindthedividends,capitalgainsfromsellingunits,distributionoffund
incomeaswellasreturnsearnedonreinvestments.Thetotalamountpaidtofundsintheformoffeesorcommissionsshouldbe
deductedtogetthetotalreturn.Itcanbeusedtomeasureafundsperformance.Itisoftenwrittenasapercentageofthetotalinitial
investment.

Yieldisalsousedbyanalyststomeasuretheincomeearnedbytheunderlyingassetsinafundsportfolio.Itiscalculatedby
subtractingthefundsexpensesfromtheincomeearnedbytheassetsthroughdividendpaymentsandcapitalgains,andthen
dividingbythetotalpricepershare.Theyieldisusuallyexpressedasapercentage.

FUNDSWITCH/EXCHANGEPRIVILEGE:
Manyfundhousesgroupasetofmutualfundstogetherbasedontheirinvestmentobjectives,orotherfactorslikemanagement.This
iscalledafamilyoffunds.Fundhousesthengiveinvestorsanoptiontotransfertheirinvestmentswithinthefundfamilyfromone
schemetoanotherasandwhentheyrequire.Thisiscalledafundswitchoranexchangeprivilege.

Forexample,afamilyoffundsmayincludeanequityscheme,adebtschemeandabalancedscheme.Aninvestorcouldthen
choosetomovehis/hermoneyamongstthefundsasandwhenneedsandobjectiveschange.

INVESTMENTOBJECTIVE:
Everyinvestorputshismoneyinfinancialinstrumentsforaparticularreason.Thismaybetoincreasewealthoraccumulatemoney
forbuyingsomethinginthefuture,orsimplytopreserveyourmoneyfrominflation.Thisgoaliscalledyourinvestmentobjective.

Similarly,themutualfundalsohasagoal,whichitaimstoachieveonbehalfofitsinvestors.Itcouldbecapitalappreciationprofits
inthelongtermordistributingregularfixedincome.

PROSPECTUS:
Everymutualfundissupposedtogivedetailsaboutitscompany,theinvestmentobjectivesofthefund,therisksitperceives,services
offeredaswellasfees.Thisofficialdocumentiscalledtheprospectus.Thisisamust,andeveryinvestorshouldreadthefineprint
carefully.Somemutualfundsalsoofferashorterversionofthisdocumentinaddition.Thisiscalledthesummaryprospectus.

INVESTMENTCOMPANY:
AmutualfundisregisteredwithSEBIasaninvestmentcompany.Thisisthecorporationortrustthatinveststhefundscollectedfrom
investorsontheirbehalfacrosssecurities.

EXCHANGETRADEDFUND(ETF):
Anexchangetradedfundisaninvestmentvehiclemuch
likeamutualfund,butwhichistradedonstock
exchanges.Itgenerallytracksanindex,abasketof
assetsoracommodity.Thevalueofthefundkeeps
fluctuatinglikeashareduetodemandsupplyforces.
SincemostETFstrackacertainbenchmarkasset,it
doesnotneedactiveportfoliomanagementservices.
Forthisreason,itschargesareusuallylower.
FUNDSOFFUNDS:
Mutualfundsinvestinmultipletypesofassetslike
stocksandbonds.Theycanalsoinvestacrossmutual
funds.Thesearecalledfundoffunds.
NEWFUNDOFFERING(NFO):
Whenastockgetslistedontheexchange,itcomesup
withanIPOorInitialPublicOffering.Similarly,whena
mutualfundstartsanewschemeandinvitesinvestors
toputinmoneyinexchangeforunits,itiscalledaNew
FundOfferingorNFO.

REDEEM:
Therearetwowaystoexitamutualfundsellittoanotherinvestororbacktothefund.Thelatteriscalledredeeming.Oncean
investorredeemshisorherlotofMFunits,theNAVofthefundchanges.Thisisbecausethetotalnumberofunitsissuedtoinvestors
differs.

Manymutualfundschargeinvestorsforexitingwithincertainperiodoftime.ThischargeisdeductedfromtheNetAssetValue(NAV)
andtheremainingispaidtotheinvestor.Thispriceiscalledtheredemptionprice.

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RISK/RETURNTRADEOFF:
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Whatisriskinthesecuritiesmarket?Itissimplythedegreeoffluctuationinyourassetsprice.Ahighriskiswhentheassetsprice
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changesalot.Itcouldbeonthehighersideoronthelowerside.Forthisreason,itisbelievedthathighreturnispossibleonlyifyou
takeagreatrisk.Similarly,ifyouarenotwillingtotakeahighrisk,youmustbesatisfiedwithlowreturns.Asaninvestor,youhaveto
choosehowmuchriskyouarewillingtotake,andhowmuchareyouwillingtocompromiseonyourreturns.

Theprincipleofriskreturntradeoffissimilartothis.Itbelievesthataninvestmentwouldpotentiallygivehigherreturnstocompensate
forthelikelihoodofhighervolatility.Simplyput,youasaninvestorcouldbecompensatedmorerichlyifyoutakemorerisks.

DEBTMARKETRELATEDTERMS

Whileinvestingindebtmutualfunds,youmaycomeacrosssometermsspecifictobondsandthedebtmarket.Thesewillhelpyou
understandyourdebtmutualfundbetter.
Herearesomeofthem:

ISSUER:
Thisistheorganizationthatissuesdebtmarket
securitieslikebonds,commercialpapersandcertificate
ofdeposits.Itcouldbeacompany,agovernment
organizationorthegovernmentitself.
COMMERCIALPAPER:
Theseareagainadebtmarketinstrument,issuedby
corporationstoraisemoneyfortheshortterm.Theyare
usuallyunsecureasthecompanydoesnotpledgeany
ofitsassetsascollateral.
Theyhavesmallmaturityperiods.Commercialpaper
asaformofinvestmentisrarelyavailabletoretail
investors.
CERTIFICATEOFDEPOSIT(CD):
Thisisakindofdebtmarketinstrumentissuedbybanks
orfinancialorganizations.Itactsasaproofofsavingby
theinvestorandpromisesinterestpayments.
INTERESTRATERISK:
Inabondmarket,therearetwodifferentinterestrates
prevalent.Oneisthefixedrateforinterestpayment,and
theotheriscalledtheyieldtomaturity.Thisistherateof
returnyoucanexpectifyouheldthebondtillits
maturity.Simplyput,itisakindofinterestrate.
Thistakesintoaccountthereturnyouearnon
reinvestmentofyourinterestpayments.YTMislinkedto
alotoffactorslikebondscurrentprice,maturityperiod,
couponinterestrateaswellasmarketfactors.It
changesregularly.
TheYTMisinverselyproportionaltothebondsprice
theamountatwhichthebondistradedinthemarket.As
theinterestrateorYTMincreases,yourbondsprice
falls.Similarly,astheYTMfalls,yourbondspricerises.
Thisfluctuationininterestratesexposesinvestorstoa
risk.Thisiscalledtheinterestraterisk.

Acertificateofdepositisusuallyvalidonlyforacertain
periodoftime,afterwhichtheentireprincipalamountis
returnedwiththeinterest.Thisperiodiscalledthe
maturity.

WHATNEXT?

Nowthatyouarearmedwithknowledgeaboutvitaltermsandconcepts,letsmoveontounderstandingmutualfundsingreaterdepth
andhowtoinvestintheseinstruments.Clickhere

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