Department of Distance and

Continuing Education
University of Delhi

BBA(Financial Investment Analysis)

Course Credit - 4
Semester-I
Generic Elective (GE)

As per the UGCF - 2022 and National Education Policy 2020

 Editorial Board
Dr. Kumar Bijoy
Dr. Pratibha Maurya

Content Writers
Dr. Reema Aggarwal, Dr. Pratibha Maurya
Ms. Manisha Yadav, Ms. Chandani Jain,
Yogesh Sharma, Ankit Suri, Dr. Sharif Mohd,
Dr. Mohd Rafee,Imaran Ahmad

Academic Coordinator
Mr. Deekshant Awasthi

© Department of Distance and Continuing Education

ISBN: 978-93-95774-23-9
1st edition: 2022
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management@col.du.ac.in

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Disclaimer

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Corrections/Modifications/Suggestions proposed by Statutory Body,

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 Fundamentals of Stock Trading

INDEX
Lesson 1: Introduction to Investment ............................................................. 1
1.1 Learning Objectives
1.2 Introduction
1.3 Fundamentals of investment
1.4 Features of investment
1.5 Investment environment
1.6 Principles of sound investment
1.7 The investment decision process
1.8 Modes of investment
1.9 Approaches to investing
1.10 Risk return trade off
1.11 Summary

Lesson 2: Types of Securities ........................................................................ 34

2.1 Learning Objectives
2.2 Introduction
2.3 Types of securities
2.4 Alternative investments
2.5 Summary

Lesson 3: Indian Securities Market ............................................................. 73

3.1 Learning Objectives
3.2 Introduction
3.3 Money Market
3.4 Capital Market
3.5 Primary Market
3.6 Secondary Market
3.7 Summary

Lesson 4: Market Participants ....................................................................... 92

4.1 Learning Objectives

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 BBA(FIA)

4.2 Introduction to the stock market

4.3 Market participants
4.4 Role of the stock exchange
4.5 Stock exchanges in India
4.6 Securities (Stock) Indices
4.7 Summary

Lesson 5: Trading Mechanism On Exchanges ........................................... 111

5.1 Learning Objectives
5.2 Introduction
5.3 Trading Mechanism on the Stock Exchanges
5.4 Clearing and Settlement Procedure in the Stock Exchanges
5.5 NSE: Trading and Settlement
5.6 Summary

Lesson 6: Online Trading ............................................................................. 129

6.1 Learning Objectives
6.2 Introduction
6.3 Online Trading Mechanism
6.4 Types of Orders:
6.5 Placing an Order
6.6 Summary

Lesson 7: Introduction to Mutual Fund ..................................................... 147

7.1 Learning Objectives
7.2 Concept of Mutual Funds
7.3 Mutual Fund indirect mode of investment
7.4 History of mutual fund
7.5 Structure of Mutual Fund
7.6 Advantages and Disadvantages in investing in Mutual Fund

Lesson 8: Introduction to Mutual Fund ..................................................... 164

8.1 Learning Objectives
8.2 Introduction
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 Fundamentals of Stock Trading

8.3 Types of Mutual Fund schemes

8.4 Multiple Choice Questions
8.5 Answers
8.6 Summary
Lesson 9: Assessment of NAV and Performance of Mutual Fund ........... 183
8.1 Learning Objectives
8.2 Meaning of Mutual Fund and Net Asset Value
8.3 Cost Incurred in Mutual Funds
8.4 Return in Mutual Funds
8.5 Types of Loads in Mutual Funds
8.6 Performance Evaluation of Mutual Funds
8.7 Factors affecting the choice of Mutual funds
8.8 Mutual funds in India
8.9 CRISIL and their Rankings for mutual funds
8.10 CRISIL Ranking Methodology
8.11 Usage of Mutual Fund Rankings
8.12 Summary

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 Fundamentals of Stock Trading

LESSON 1
INTRODUCITON TO INVESTMENT
Chandni Jain
Assistant Professor
University of Delhi
chandni.90.jain@gmail.com

STRUCTURE

1.1 Learning Objectives

1.2 Introduction
1.3 Fundamentals of investment
1.4 Features of investment
1.5 Investment environment
1.5.1 Meaning of investment environment
1.5.2 Elements of investment environment
1.6 Principles of sound investment
1.7 The investment decision process
1.8 Modes of investment
1.8.1 Direct
1.8.2 Indirect
1.9 Approaches to investing
1.9.1 Active
1.9.2 Passive
1.9.3 Which is better?
1.10 Risk return trade off
1.10.1 Definition
1.10.2 Explanation
1.10.3 Managing risk return trade off
1.10.4 Importance of risk return trade off
1.11 Summary
1.12 Glossary
1.13 Answer to In-text Questions

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 BBA(FIA)

1.14 Self-Assessment Questions

1.15 References/Suggested Readings

1.1 LEARNING OBJECTIVES

After studying this chapter, students will be able to:

• Understand the meaning and fundamentals of investment
• Describe the features of investment
• Comprehend what is investment environment
• Know principles of sound investment
• Discuss investment decision process
• Understand various modes of investment
• Understand approaches to investing
• Analyse the concept of risk return trade

1.2 INTRODUCTION

Unless it is invested, money has no worth. A huge sum of money kept in a person's cabinet will
not increase in value. To earn a return, it must be invested in a financial asset. Without risk,
there can be no return. Investments must be undertaken within this framework of risk and
reward. It is presumed that a person is risk averse and simultaneously hopes to make a profit
on his investments. An investor must therefore make a trade-off between risk and return. In
this chapter, the concepts "investment," "speculation," and "gambling" are defined.
Additionally, it describes the investment process and offers investment media.

1.3 FUNDAMENTALS OF INVESTMENT

A number of definitions for the term "investment" are possible based on various philosophies
and principles. It is a word that has a variety of applications. The various definitions of
"investment" are more similar than different, though. Investment, in general, is the use of
money to generate more income. Investment also refers to savings or consumption-delayed
savings. Economics defines investment as the use of resources to boost earnings or
manufacturing output in the future. Economists and financial specialists have differing
perspectives on what is meant by the word "investment."

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 Fundamentals of Stock Trading

According to finance, the act of investing is the purchase of a financial product or any other
valuable good with the expectation of future financial gain. The fact that financial investments
have a high level of market liquidity is their most crucial characteristic. Investments are
financial commitments made over a lengthy period of time with the goal of increasing an
investor's wealth and providing them with additional income in addition to their normal
income. A future reward in the form of income through recurring interest, dividends, premiums,
or an increase in the value of the primary capital is what investing entails.
For example, financial Investments are the deployment of financial resources with the hope of
a positive return that varies with risk, ranging from risk free to risky investments. The goal of
the investor must be to balance risk and return. The sources of "capital" are investors, and in
their eyes, an investment is a commitment of money made with the intention of receiving future
income in the form of interest, dividends, rent, premiums, pension benefits, or an increase in
the value of one's initial capital. For a financial investor, it makes little difference whether
money is invested for a worthwhile purpose or to buy used goods like shares in already-existing
companies or stocks that are traded on stock markets. The majority of investments are viewed
as transfers of money from one person to another.
Economists consider it as new and productive capital and financial experts emphasize on
allocation and transfer of resources from one person to another. The term "investment" is
defined by the economist as net additions to the capital stock of the economy, which comprises
of products and services employed in the creation of other goods and services. For them, the
phrase "investment" denotes the creation of fresh, useful capital in the form of new buildings,
fresh manufacturing machineries like plant and equipment, fresh inventories, and fresh human
capital. Investment has a dual connotation that cannot be distinguished because it is associated
with economists and financial professionals. Individuals' savings that enter the capital market
directly or via institutions constitute investments, which can be used to finance "new" or "used"
capital. The market serves as a meeting place for investors who are "suppliers" and investors
who are "users" of long-term funds. However, the term "investment" will be used in this book
in its "financial meaning," and investment will include the tools and institutional media that are
utilised to invest savings.
The phrases investment and speculation are distinct from one another as are the risks, time
commitments, and gains associated with each. Investment requires a long-term commitment,
and this must be made crystal clear. The differences between investment, speculation, and
gambling can be found in the risk, length of commitment, and gains.

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 BBA(FIA)

IN-TEXT QUESTIONS
1. ___________ is the application of money for earning more money.
2. Horse racing, game of cards, lottery are the typical examples of?

1.4 FEATURES OF INVESTMENT

The features of investments can be summarized as :

Return
The anticipation of a return is the defining feature of all investments. In actuality, obtaining a
return is the main goal of investments. You might get the return in the form of interest plus
capital growth. Capital appreciation is the increase in value between the purchase and sale
prices. The yield on an investment is the dividend or interest earned. The nature of the
investment, the maturity term, and a number of other factors all affect the return on an
investment. Return = Capital Gain + Yield. The main goal of investing is to expect a return.
Investors anticipate a constant stream of high returns on their cash.
Risk
Every investment has some level of risk. It is a crucial aspect of investment and refers to things
like principal loss, late interest and capital payments, etc. It is the loss of an investment's
principal amount. One of the key aspects of an investment is risk. The following variables
affect risk: longer investment maturity means greater risk for the investor in this scenario.
Government or semi-government entities are issuing less risky securities. Due to the secured
and fixed interest that is payable on debt instruments and fixed deposits, the risk of the aforesaid
investment is lower. Consider debentures. Due to their unsecured status, variable return, and
ownership nature, ownership instruments like equity or preference shares carry a higher risk.
When comparing ownership capital to borrowed capital, the risk of degree of return
unpredictability is higher. The return on risk would be affected by the tax regulations. Most
investors prefer to invest in less riskier securities.
Safety
The protection of an investor's initial investment and anticipated rate of return is referred to as
safety. One of the most important and fundamental components of investment is safety.
Investors seek security for their money. Capital is the assurance of return without financial loss
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 Fundamentals of Stock Trading

or a long period of time to retain it. Government bonds are the choice of the investor who
desires lower risk investments. Private securities are preferred by investors who want a high
rate of return since they offer less security. Investors desire security for their money. They want
protection for their investment or principal amount and return certainty.
Before selecting the sorts of investments, the investor should carefully examine economic and
industrial trends to ensure the protection of their principal. The investor should take asset
diversification into account to protect the safety of principal. Investment commitments should
be mixed according to industry, location, management, financial type, and maturity for
adequate diversification. If these components were properly combined, the likelihood of loss
would be decreased. It is necessary to achieve diversification in suitable investment
programmes in a reasonable manner.
Marketability
The fact that investments can be sold is another characteristic of them. It refers to the market's
buying, selling, or transferability of securities.
Liquidity
Liquidity refers to an investment's ease of realisation, saleability, or loss-free marketability. In
other terms, liquidity refers to the ability to quickly sell or convert an investment into cash
without suffering a loss. In light of this, most investors favour liquid investments. The return
could be poor when liquidity is strong. Consider UTI units. An investor often favours assets
with liquidity, financial security with little risk, and maximising return on investment. To cover
crises, an investor needs to have a certain amount of liquidity in his holdings. If the investor
purchases a fraction of easily tradable assets from his entire portfolio, liquidity will be
guaranteed. Therefore, he may preserve a limited amount of cash, fixed deposits, and liquid
investment securities. Stocks, real estate, and other investments cannot guarantee rapid
liquidity.
Stability of Income
Investors put their money into the market with high expectations of profit. Therefore, the return
on their investment needs to be sufficient and constant. Any investing strategy must have steady
revenue that is generated on a regular basis. In addition to stability, it's critical to ensure that
income is sufficient after taxes. There are several reputable stocks that essentially pay out all
of their revenues in dividends.

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 BBA(FIA)

Appreciation and Purchasing Power Stability

To combat any instability in the purchase power of their assets, investors should balance their
portfolios. Investors should assess price level inflation, investigate the potential for gain and
loss in the assets they have access to, and take into account the constraints of their personal and
family circumstances. Investors ought to make an effort to predict which securities will
increase in value. Property that is purchased at the right time will eventually increase in value.
Growth stock will increase over time as well. However, this should be carried out through
analysis rather than through guesswork or gambling.
Legality and Freedom from Care
Every investment should receive legal approval. Be educated on the law pertaining to minors,
estates, trusts, shares, and insurance. Investors that purchase illegal securities will face a variety
of issues. Investing in assets such as Unit Trust of India, Life Insurance Corporation, mutual
funds, or savings certificates is one option to live a carefree life. The Trust is then entrusted
with the management of the securities and is responsible for diversifying the investments in
accordance with safety, stability, and liquidity while taking their investment policy into
account. The investor will be able to prevent a lot of issues by understanding legal securities
and investing in them.
Tangibility
Because of price level inflation, confiscatory laws, or social collapse, intangible securities have
frequently lost value. Some investors prefer to maintain a portion of their money in physical
assets like real estate, equipment, and buildings. However, it may be argued that tangible
property does not provide revenue other than the immediate satisfaction of ownership.

IN-TEXT QUESTIONS

3. Which of the following refers to the ability of an investment to be converted into

cash?
a) Liquidity c) Safety
b) Growth d) Tax saving
4. Risk in any investment involves
a) Loss of principal amount c) Higher returns at low risk
b) Regulations and guidelines d) All of the above

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 Fundamentals of Stock Trading

1.5 INVESTMENT ENVIRONMENT

1.5.1 Meaning of investment environment

Investors make such decisions in an environment where higher (lower) returns are correlated
with higher (lower) risk when they decide to invest in either stocks or bonds or attempt to make
an investment in a portfolio of assets in any market or across markets (i.e., international
investing).
The term "Investment Environment" broadly refers to all types of investment opportunities
(including various financial and real assets), investment vehicles or alternatives in the market
that are available to an investor, financial markets, the investment process, market structure
that enables buying and selling of investments, the regulatory framework that fosters an
enabling environment to invest, and market intermediaries.
Investment environment refers to changes in the national and global economies that have an
effect (positive or negative) on asset prices or values of various asset classes as well as
associated risk.
1.5.2 Elements of Investment Environment
There are seven elements of the investment environment that one should be aware of:

Assets and investment vehicles: Stocks, corporate bonds, government bonds (such as Treasury
Bills, which are typically very safe in terms of default risk), municipal bonds, money market
instruments (which are short-term, highly marketable, and typically very low risk), derivatives,
currencies, real estate, and commodities are among the numerous existing types of assets that
an investor typically has to choose from. Additionally, an investor has a variety of investment
vehicles to pick from, including mutual funds, hedge funds, and exchange traded funds (ETFs).
Financial markets: It is a market where buyers and sellers of assets trade with one another,
including derivatives, equities, bonds, and currencies. These markets stand out because the
prices of various asset classes are decided by market forces. Financial markets often feature a
wide range of financial products, transparent pricing, and specific laws pertaining to trading,
expenses, and fees. The primary and secondary stock markets, bond markets, money markets,
cash or spot markets, derivatives markets (options, futures, swap agreements, etc.), foreign
currency and interbank markets, and over-the-counter (OTC) markets are all examples of
financial markets.
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 BBA(FIA)

Market structure: The structure of financial markets, such as the equities, debt, foreign
currency, mortgage, and derivatives markets, is analogous. The stock market is the most
frequently observed market, but from the perspective of economic activity, the debt market is
crucial since buyers and sellers there are key factors in establishing interest rates.
Market intermediaries: A few others who fall under this category are primary dealers, brokers,
financial consultants, stock exchanges, investment banks, commercial banks (banks operate in
the money and capital markets), and insurance and pension firms.
Investment process: The same basically outlines the steps necessary to build an investment
portfolio based on identifying an investor's investment goals and risk tolerance, asset allocation
policy, or how an investor's investments are diversified among various asset classes, which has
a significant impact on a portfolio's overall performance, putting an investment strategy into
practise, and rebalancing the portfolio (which is consistent with an investor's chosen or desired
asset allocation strategy). Later on in this chapter, the procedure is covered in more detail.
Regulation: An essential component of the investment environment is the regulation of the
securities markets. Financial market trading is governed by a myriad of regulations in nations
like the US, the UK, and others to guarantee that investors and traders have enough information
to make informed investment-related decisions and to stop fraudulent actions. For instance, in
the US, the Securities and Exchange Commission (SEC) and the Commodity Futures Trading
Commission are the two government entities responsible for general regulatory control of
financial markets. Exchanges also have their own regulating bodies. The two most prominent
instances of financial market regulation are the regulation of the stock and corporate bond
markets.
Economy: The prices of assets and the volatility associated with them are significantly
influenced by changes in the local and global economies with regard to GDP, inflation, interest
rates, fiscal deficits, and monetary policy (prices of financial assets, particularly stock prices
are often very volatile). Additionally, asset allocation is the most crucial choice in the field of
asset management and has a big impact on portfolio performance. Additionally, the
construction of numerous forward-looking macroeconomic scenarios and the analysis of both
the domestic and global economies form the key foundation for decisions on asset allocation
and related investments. As a result, macroeconomic analysis, which considers both
assessments of the domestic economy and the global economy, is essential for asset allocation.

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 Fundamentals of Stock Trading

IN-TEXT QUESTIONS
5. Investors will only agree to invest in high-risk investments if which of the
following conditions are true?
a) There are any real rumours
b) The expected return is sufficient for taking a risk
c) The return is inadequate
d) There are no other safe options outside retaining cash
6. Financial markets include?
i. Bond markets iii. Money markets v. Spot markets
ii. Derivatives markets iv. Foreign exchange

7. In the case of ownership instruments, the risk is more due to

a) Unsecured nature c) Variability of their return
b) Ownership character d) All of above

1.6 PRINCIPLES OF SOUND INVESTMENT

A very straightforward and inexpensive strategy for long-term investment success is sound
investing.
Today's investing environment can be a bit dangerous. One could become paralysed by dread
as a result of worrying about the potential effects of things like Brexit, market volatility, local
and international elections, and terrorist threats.
We consistently adhere to a few key tenets that have proven effective for investors over a long
period of time.
Learn the Market Cycle
The investment market typically (but not always) moves through the boom, bust, depression,
and recovery phases. While it is clear that not all of the many circumstances will coincide.
There will always be anomalies, like the historically low interest rates we've witnessed in recent
years, but keeping track of the market cycle will help you keep undue caution or greed from
clouding your judgement.
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Establish a financial plan based on your goals

An investor needs to be realistic about his goals and review his plan at least annually. Changes
need to be made changes as the life circumstances change. Planning well can increase net
worth. A person might start along the path of wealth accumulation by sticking to a plan. Future-
focused investors are more likely to take the necessary actions to reach their financial
objectives.
Diversification is key
Investors are often tempted to pursue the newest and purportedly best hyped-up investment.
This may involve only investing in real estate or, more likely, acting on a terrific share "advice".
It's incredibly risky to invest all of money in one place; if something goes wrong, the investor
may lose everything.
Always diversify the risks and increase the wealth by investing in funds or asset-pools. An
investor will be somewhat protected by this diversification from the failure of one of the
businesses in which he have investments or even of one of the asset classes. Keep following
points in mind:
• Know your comfort level with temporary losses
• Understand that asset classes behave differently
• Don't chase past performance
Know the magic of compound interest
Pension and investment portfolios are significantly impacted by compound interest. It is crucial
to start investing early and to continue investing for this reason. The power of compound
interest may really work its magic the longer time each instalment of your investment gets to
increase.
Rebalance your portfolio regularly
• Be disciplined about your tolerance for risk
• Stay engaged with your investments
• Understand that asset classes behave differently
Your portfolio's regular rebalancing helps it stay in line with your risk tolerance.
A portfolio's initial stock and bond allocation was split 50/50, and it was never rebalanced. The
portfolio lost more money during the COVID-19 meltdown in early 2020 as a result of the
portfolio's drift during the following ten years to an allocation of 71% stocks and only 29%
bonds than it would have if it had been periodically rebalanced.
Ongoing monitoring is important. Although portfolio churn should be avoided because
customers may invest for the long term, it is equally crucial for advisers to monitor the portfolio
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 Fundamentals of Stock Trading

by keeping an eye on scheme performance, shifting valuations, interest rate trajectory, and
economic indicators. Rebalancing should be done proactively to take advantage of tactical
opportunities and maintain the asset allocation.
Ignore the noise, volatility is normal
Volatility can raise a lot of anxiety when people become obsessed on momentary changes in
their investment and pension holdings. Investors become concerned when attention is drawn
to those temporary drops in return. But volatility is just a characteristic of long-term
investing. Markets may fluctuate; therefore the key strategy is to keep investing and resist the
need to respond to immediate circumstances.
It is foolish to attempt market timing. It has been repeatedly demonstrated that rather than
attempting to time the peaks and troughs, investors are better off simply riding them out. The
volatility of long-term investing is a characteristic.
Minimize fees and taxes
• Markets are uncertain; fees are certain
• Pay attention to net returns
• Minimize taxes to maximize returns
• Minimize cost.
Markets might change at any time. Costs never go away. An investor's ability to profit from an
investment increase with decreasing investment expenses. Additionally, studies indicate that
investments with lower costs have typically outperformed those with greater costs. Investments
should be managed for tax efficiency to retain even greater return. Investors have some control
over the tax and cost bite but not the markets.
Know what you’re investing in and why
The investor must be aware of all the components of his investment, including the company,
the security, the stage of business and of market prices, as well as the forecast for credit and
banking. This is the most fundamental investment principle. He has to comprehend. "Where
he knows, he can invest. Where he does not know, he is only speculating"
Consistency and Discipline
The best chance to succeed over the long run is to apply the principles of discipline and
consistency to your long-term investment approach. Maintain your long-term discipline and
perspective. Strong emotions might be triggered by investing. When the market is volatile,
some investors may find themselves acting rashly or, on the other hand, becoming paralysed
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 BBA(FIA)

and unable to put their investment plan into action or rebalance their portfolio as needed.
Through times of market turbulence, discipline and perspective, which includes objective
financial counsel for those who choose it, can help investors stay dedicated to a long-term
investment programme.

IN-TEXT QUESTIONS
8. ‘Don’t put all your eggs in one basket’ refers to which principle of sound
investment?
a) Diversification is the key c) Volatility is normal
b) Establish a financial plan based on your goals
d) Know magic of compound interest

1.7 INVESTMENT DECISION PROCESS

Managing money or funds is the process of making investment decisions. The investment
choice process outlines the best way for investors to approach decision-making. Usually, this
technique is explained in steps. Following is a discussion of the stages:
1. Investment Policy
The first and most crucial step in the process of making investment decisions is setting an
investment policy. Setting investment goals is a part of investment policy. Prior to making
investments, the initial stage entails determining and involving personal financial affairs and
goals. The investment policy should have particular goals based on the investor's desired rate
of return and risk tolerance. For instance, the investment strategy might stipulate that the aim
for the investment's average return should be 15% while also preventing losses of greater than
10%. The most crucial goal is to determine an investor's risk tolerance because it goes without
saying that every investor wants to maximise their return. However, because risk and return
have a positive connection, it is inappropriate for an investor to frame their investment
objectives as simply "to make a lot of money." Investment goals need to be expressed in terms
of risk and return.

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 Fundamentals of Stock Trading

Other significant restrictions that can affect the management of investments should also be
stated in the investment policy. Constraints may include the investor's predicted investment
horizon, any liquidity requirements, as well as the investor's own demands and preferences.
The time frame for investing is known as the investment horizon. The projected temporal
horizon may be brief, extensive, or even limitless. The evaluation of an individual investor's
present and long-term financial goals is the basis for setting investment goals. The amount that
can be invested today and the amount that the investor needs to have at the end of the
investment horizon determine the required rate of return for the investment. Investors who want
to increase the return on their investments must evaluate the level of risk they should take and
determine if it applies to them or not. The tax situation of the investor may be covered by the
investment policy. The identification of suitable financial asset categories for inclusion in the
investment portfolio marks the end of this step of the investment decision-making process. The
determination of the prospective categories is based on the investor's tax situation, investment
horizon, investment horizon, and investment objectives. We could see that different financial
assets could naturally be more or less hazardous, and that generally speaking, the way in which
they can generate returns varies depending on the type. As an illustration, common stock will
not be the best sort of investment for an individual with a low risk tolerance.
2. Investment Analysis
The various investment kinds can be analysed once the investment strategy is established, the
investor's objectives are specified, and the prospective financial asset categories for inclusion
in the investment portfolio are determined. This stage entails looking at many pertinent
groupings of investment vehicles as well as the specific vehicles within these groups. The
analysis will focus on the common stock as an investment, for instance, if it was determined
that it was a relevant investment vehicle for investors. Such study and evaluation only serve to
highlight the investment vehicles that, at the moment, seem to be mispriced. There are
numerous ways to do such an analysis. Technical analysis and fundamental analysis are the
two types of analysis that are utilised the most commonly.
Technical analysis involves the analysis of market prices in an attempt to predict future price
movements for the particular financial asset traded on the market. This research studies
previous price trends and is predicated on the idea that similar trends or patterns will recur in
the future.
Fundamental analysis in its simplest form is focused on the evaluation of the intrinsic value of
the financial asset. This valuation is predicated on the notion that an investment's intrinsic value
represents the present value of its anticipated future returns. It is possible to determine which

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financial assets are under- or over-priced by comparing their intrinsic worth and market value.
This stage entails selecting the precise financial assets to invest in and calculating their
proportions within the investment portfolio.
3. Portfolio Construction
The formation of diversified investment portfolio is the next step in the investment
management process. Investment portfolio is the set of investment vehicles, formed by the
investor seeking to realize its’ defined investment objectives. The investor must handle the
issues of diversification, timing, and selectivity during the portfolio creation phase. Selectivity
is a term for micro forecasting that focuses on predicting the price changes of specific assets.
Timing entails macro-forecasting of price changes for a specific kind of financial asset in
comparison to fixed-income securities as a whole. Diversification involves forming the
investor’s portfolio for decreasing or limiting risk of investment. 2 techniques of
diversification:
• random diversification, when several available financial assets are put to the portfolio
at random;
• objective diversification when financial assets are selected to the portfolio
following investment objectives and using appropriate techniques for analysis and evaluation
of each financial asset. Investment management theory is focused on issues of objective
portfolio diversification and professional investors follow settled investment objectives then
constructing and managing their portfolios.
4. Measurement and evaluation of portfolio performance
This step entails assessing the performance of the portfolio on a regular basis, taking into
account both its risk and return. Benchmarks and acceptable metrics of return and risk are
required for the evaluation of portfolio performance. A benchmark is a predetermined set of
assets' performance that was gathered for comparison. A well-known index of suitable assets,
such as an index of stocks or bonds, may serve as the benchmark. Institutional investors
frequently utilise the benchmarks when assessing the performance of their investments. It is
crucial to note that the process of investment management is a continuous process that is
affected by shifts in the investment environment as well as shifts in investor attitudes. While
market globalisation gives investors new opportunities, it also makes investment management
more difficult as uncertainty rises.

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5. Portfolio revision
This stage of the investment process deals with the routine review of the earlier phases. This is
required because a long-term investor's investment objectives may change over time, which
would mean that the portfolio the investor now holds would no longer be optimal and would
even conflict with the newly established investment objectives. The investor should create a
fresh portfolio by liquidating some of his current holdings and acquiring new ones. Other
factors for changing a portfolio could include the fact that prices for various assets fluctuate
over time, making some assets that were once appealing less so. In light of this, an investor
should, in their opinion, sell one asset and purchase another that is currently more desirable.
The choice to make adjustments to your portfolio revision depends on a variety of factors,
including the transaction costs involved. Portfolio adjustment is a constant and crucial aspect
of what institutional investors do. Individual investors who manage their own portfolios must
regularly revise their holdings. The stated investment goals must be periodically revaluated
since financial markets fluctuate, tax laws and security requirements change, and other events
affect the stated investment goals.

IN-TEXT QUESTIONS
9. The first step in investment process is
a) Portfolio revision c) Investment analysis
b) Investment policy setting d) None of the above

10. Which kind of analysis is based on the assumption that the trends or patterns repeat
themselves in the future?
a) Fundamental analysis c) Technical analysis
b) EIC analysis d) Market analysis

1.8 MODES OF INVESTING

There are numerous other investment options and investment outlets. If the investor becomes
familiar with the numerous alternative investments available, a strong investment programme
can be built. Investment media come in a variety of forms; some are straightforward and
straightforward, while others provide complicated issues that require analysis and research.

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Some investments are good for a particular sort of investor, while others can be suitable for a
different person.
Finding a selection of assets that fit this taste for risk and projected return is the investor's
ultimate goal. The portfolio that will maximise the investor's utility is chosen.
In addition to extremely speculative shares and debentures, securities offer a wide variety of
risk-free instruments. The investor will need to choose the securities that maximise his utility
from this wide spectrum. In other words, the investor has a challenge with optimization. Under
specific conditions, he must select the security that will maximise his predicted returns.
Although choosing an investment is an optimization problem, each investor has a different goal
function. The fulfilment of the investor's requirement is just as important as building a portfolio
that promises the best expected return. One investor might, for instance, run into a scenario
where he needs a lot of liquidity. Additionally, he might desire security. He will therefore need
to pick a security with modest returns.
Another investor, who does not have financial difficulties, might not mind taking on a high
level of risk in exchange for a high rate of return. Such a shareholder can invest his savings in
growth stocks since he is risk-tolerant. The investor's personality and psychology are also
crucial factors. Some investors have the temperament to take risks, while others are unwilling
to do so even when the potential return is large. While one investor could favour secure
government bonds, another might be open to buying blue-chip corporate stock.
Alternative investments are widespread. These can be categorized in many ways.
Direct and indirect investment alternatives is one way of classification.

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Modes of
investing

Direct Indirect

Variable Non security

Fixed principal
principal investments
investments
securities

1.8.1 Direct investments

Direct investments are ones in which the investor chooses and decides on his own. Investors
who use direct investing buy, sell, and manage their own personal investment portfolios. As a
result, when investing directly through financial markets, investors assume all the risk, and
successful investing depends on an investor's knowledge of the financial markets, their
volatility, as well as their skills at analysing, evaluating, and managing their portfolio of
investments.
Direct investment alternatives include the following:
1. Fixed principal investments
2. Variable principal securities
3. Non security investments
Fixed principal investment securities are those whose terminal value and principal amounts are
known in advance and do not change. These include:
• Cash
• Savings accounts
• Savings certificates
• Government bonds

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• Corporate bonds and debentures

Variable principal securities – securities whose terminal values are known with certainty are
variable principal securities. These include:
• Preference shares
• Equity shares
• Convertible securities
Non- security investments – These are other than corporate securities. They include the
following:
• Real estate
• Mortgages
• Commodities
• Business ventures
• Art, antiques and other valuables
1.8.2 Indirect investments
Indirect investments are those in which the individual has no direct hold on the amount he
invests. He gives his savings to certain institutions like the Unit Trust of India (UTI) or the Life
Insurance Corporation (LIC) and relies on them to invest on his and other people's behalf.
Therefore, there is no direct liability nor a hold on the securities. A person may also make
indirect investments for retirement benefits in the form of pension and provident funds, life
insurance policies, shares of investment companies, and mutual fund securities. These
investments are not under the control of any individual. They are placed in the particular
organization's custody. A group of trustees manages the provident funds of companies like Life
Insurance Corporation or Unit Trust of India in accordance with its investment strategy on
behalf of the investor. Alternatives to indirect investments are a significant and quickly
expanding sector of our economy.
Investors that use indirect investing buy or sell financial instruments from financial
intermediaries (financial institutions), who own portfolios and invest substantial amounts of
money in the financial markets. Investors who engage in indirect investing are spared from
managing their portfolio decisions. Investors are entitled to their share of dividends, interest,
and capital gains as shareholders with an ownership interest in portfolios managed by financial
institutions (investment companies, pension funds, insurance companies, and commercial
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banks), and they are also responsible for paying their fair share of the institution's costs and
portfolio management fee. Risk for investors who use indirect investing is more closely tied to
the legitimacy of the institution they choose and the competence of their portfolio managers.
In general, indirect investing is more closely associated with financial organisations that invest
in and manage a portfolio of securities (various types of investment funds or investment
companies, private pension funds). These businesses can provide them with a wide range of
services, including professional management of their financial assets and liquidity, in addition
to diversification, by pooling the money of thousands of investors.
Indirect investment alternatives include:
• Pension fund
• Provident fund insurance
• Investment companies
• Trust companies

To summarize:
• Direct investments are those where the individual has a direct hold on his investment
decision while indirect investments are those where the investor is dependent on another
organization.
• Direct investing is realized using financial markets and indirect investing involves
financial intermediaries.
From the viewpoint of businesses receiving funding, direct and indirect investing can be
explained as follows:
Companies can use the financial market to issue and sell their securities in order to get the
necessary capital directly from the general public (those who have extra money to invest).
Direct investing is this.
As an alternative, they can use financial intermediaries to get money from the general public
indirectly. And the middlemen make money by letting the general public hold investments like
savings accounts, certificates of deposit, and other comparable instruments. This type of
investment is indirect.
Types of investing Alternatives for financing

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Direct investing (through financial markets) Raising equity capital/ borrowing in

financial markets
Indirect investing (through financial Borrowing from financial institutions
institutions)

IN-TEXT QUESTIONS
11. Insurance and pensions companies, investment banks, commercial banks, primary
dealers, are examples of?

12. _________ is realized using financial markets and ___________ involves financial
intermediaries.
a) Direct investing, indirect investing
b) Indirect investing, direct investing
c) Direct investing, direct investing
d) Indirect investing, indirect investing

1.9 APPROACHES TO INVESTING

1.9.1 Active Investing

Active investing is a technique that often trades with the objective of outperforming index
returns.
Active investing, as its name implies, takes a hands-on approach and requires that someone
act in the role of a portfolio manager. The goal of active money management is to beat the
stock market’s average returns and take full advantage of short-term price fluctuations. It
involves a much deeper analysis and the expertise to know when to pivot into or out of a
particular stock, bond, or any asset.
One can do active investing oneself, or can outsource it to professionals through actively
managed mutual funds and active exchange-traded funds (ETFs). These provide you with a
ready-made portfolio of hundreds of investments.
A portfolio manager usually oversees a team of analysts who look
at qualitative and quantitative factors, then gaze into their crystal balls to try to determine
where and when that price will change.

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Active investing requires confidence that whoever is managing the portfolio will know exactly
the right time to buy or sell. Successful active investment management requires being right
more often than wrong.
Investing actively entails choosing mutual funds whose portfolio managers chose investments
based on a third-party evaluation of their value; in other words, they aim to pick the most
alluring investments. In general, active managers want to "beat the market" or outperform
predetermined benchmarks.
Active Investing Advantages
Advantages to active investing, according to Wharton:
• Flexibility: Active managers are not mandated to adhere to a certain index. They are
free to purchase the stocks they consider to be "diamonds in the rough."
In order to avoid catastrophic losses during bear markets, the active investor may
choose to switch to a defensive holding, such as cash or government bonds, says Brian
Stivers, investment advisor and founder of Stivers Financial Services in Knoxville,
Tennessee. Similar to this, investors might reallocate their holdings to include more
stocks in expanding areas. They could be able to outperform market indexes in the
short run by reacting to real-time market conditions.
• Hedging: Active managers can also hedge their bets using various techniques such
as short sales or put options, and they're able to exit specific stocks or sectors when
the risks become too big. Passive managers are stuck with the stocks the index they
track holds, regardless of how they are performing.
• Tax management: Even though this strategy could trigger a capital gains tax, advisors
can tailor tax management strategies to individual investors, such as by selling
investments that are losing money to offset the taxes on the big winners. A savvy
financial advisor or portfolio manager can use active investing to execute trades that
offset gains for tax purposes. This is called tax-loss harvesting.
• Expanded trading options. Active investors can boost their chances of outperforming
market indices by using trading tactics like stock shorting or option hedging to
generate profits. But these can also significantly raise the expenses and hazards of
active investing, thus it is best to leave these strategies to experts and very experienced
investors.

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• Risk management: The ability to get out of specific holdings or market sectors when
risks get too large.
Active Investing Disadvantages
But active strategies have these shortcomings:
• Very expensive: The average expense ratio for an actively managed stock fund is
estimated by the Investment Company Institute to be 0.68%, while it is merely 0.06%
for an average passive equity fund. 2 Fees are greater because of transaction expenses
caused by all the active buying and selling, in addition to the fact that you're paying
the salaries of the analyst team who is looking into potential stock investments. Over
decades of investing, all those expenses can destroy returns.
• Active risk: Active managers are free to buy any investment they think would bring
high returns, which is great when the analysts are right but terrible when they're wrong.
• Poor track record: The results demonstrate that just a small percentage of actively
managed portfolios outperform their passive benchmarks, particularly after accounting
for taxes and fees. In fact, only a select few actively managed mutual funds outperform
their benchmark index across medium to long time horizons.
• Requires a lot of skill: If you’re a highly skilled analyst or trader, you can make a lot
of money using active investing. Unfortunately, almost no one is this skilled. Sure,
some professionals are, but it’s tough to win year after year even for them.
• Can lead to a big tax bill: While commissions on stocks and ETFs are now zero at
major online brokers, active traders still have to pay taxes on their net gains, and a lot
of trading could lead to a huge bill come tax day.
• Requires a lot of time: Being an active trader takes a lot of time because of all the
research you need to perform, in addition to being tough to do correctly. Spending
more time to perform worse doesn't really make sense unless you're also actively
trading for fun.
• Investors often buy and sell at the worst times: Due to human psychology, which is
focused on minimizing pain, active investors are not very good at buying and selling
stocks. They tend to buy after the price has run higher and sell after it’s already fallen.
1.9.2 Passive Investing

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A passive investor is one who makes investments over the long term. This is a very economical
technique to invest because passive investors keep the quantity of buying and selling within
their portfolios to a minimum. The tactic necessitates a buy-and-hold mindset. That entails
resisting the urge to respond to or predict the stock market's next move in advance.
Purchasing an index fund, where the fund management changes holdings in response to
changes in the index the fund is tracking, is a good example of passive investing. Instead than
concentrating on absolute returns, the fund aims to mirror the index return.
The prime example of a passive approach is to buy an index fund that follows one of the major
indices like the S&P 500. Whenever these indices switch up their constituents, the index funds
that follow them automatically switch up their holdings by selling the stock that’s leaving and
buying the stock that’s becoming part of the index. This is why it’s such a big deal when a
company becomes big enough to be included in one of the major indices: It guarantees that
the stock will become a core holding in thousands of major funds.
Your returns come from merely sharing in the general stock market's long-term upward
trajectory of company earnings when you hold minuscule fractions of thousands of equities.
Successful passive investors overlook short-term setbacks, even sudden downturns, and keep
their eyes fixed on the goal.
It's best characterised as a hands-off strategy: You select a security and then hold on
throughout ups and downs with a longer-term goal in mind, like retirement.
If you are a passive investor, you wouldn't evaluate the merit of any particular investment. Instead
of striving to outperform particular market indices, your objective would be to perform on par with
them. Simply put, passive managers aim to own all of the stocks that make up a certain market
index in the same proportion that those stocks make up that index. Passive investing has frequently
outperformed active because of its lower fees. This is because active investing is typically more
expensive (you must pay research analysts and portfolio managers in addition to additional costs
due to more frequent trading). As a result, many active managers do not beat the index after
deducting costs.
Passive investing methods seek to avoid the fees and limited performance that may occur with
frequent trading. Passive investing’s goal is to build wealth gradually. Also known as a buy-and-
hold strategy, passive investing means buying a security to own it long-term. Unlike active traders,
passive investors do not seek to profit from short-term price fluctuations or market timing. The
underlying assumption of passive investment strategy is that the market posts positive returns over
time.

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Passive investment is cheaper, less complex, and often produces superior after-tax results over
medium to long time horizons than actively managed portfolios.
Passive Investing Advantages
Some of the key benefits of passive investing are:
• Ultra-low fees: There's nobody picking stocks, so oversight is much less
expensive. Passive funds simply follow the index they use as their benchmark.
• Transparency: An index fund's assets are always transparent. With passive
investment, you get exactly what you see. In reality, your fund's name frequently
includes the index it follows, and it will never own investments outside of that index.
On the other hand, actively managed funds don't always offer this level of openness;
much is left to the manager's judgement, and some strategies may even be kept secret
from the public to maintain a competitive edge.
• Tax efficiency: Their buy-and-hold strategy doesn't typically result in a
massive capital gains tax for the year.
• Simplicity: When compared to a dynamic approach that necessitates ongoing research
and adjustment, owning an index or group of indices is far simpler to adopt and
comprehend. more likely to succeed. Compared to active investing, passive investing
is simpler. You don't need to conduct any research, choose the specific stocks, or carry
out any other due diligence if you invest in index funds. Being a passive investor is now
simpler than ever thanks to the availability of low-fee mutual funds and exchange-
traded funds, which is the strategy advised by famed investor Warren Buffett.
• Excellent way to achieve diversification: Successful investing requires maintaining
a well-diversified portfolio, and index investing is a great approach to achieve
diversification. By holding all or a representative sample of the securities in their
objective benchmarks, index funds diversify their risk. reduces the possibility that one
bad investment may ruin your entire portfolio.
• Higher average returns: If you’re investing for the long term, passive funds of all
kinds almost always give higher returns.
• Requires minimal time. In the best-case scenario, passive investors may examine their
holdings for 15 to 20 minutes each year during tax season and then be through. As a
result, you no longer have to worry about investing and can spend your time anyway
you like.

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Passive Investing Disadvantages

Proponents of active investing would say that passive strategies have these weaknesses:
• Too limited: Investors are locked into those assets, regardless of what occurs in the
market, because passive funds are restricted to a particular index or fixed set of
investments with little to no volatility.
• Small returns: As their main holdings are locked in to track the market, passive funds
will by definition almost never outperform the market, even in tumultuous times. A
passive fund may occasionally outperform the market somewhat, but until the market
as a whole boom, it will never achieve the high returns that active managers seek. On
the other side, active managers have the potential to produce greater returns (see
below), however those benefits also carry higher risk.
⦁ The entire market's risk is present in passive investing. Since index funds follow the
entire market, they fall along with the overall stock market or bond prices.
1.9.3 Which is better?
As we've seen, active investing has the potential to generate larger returns than the market, but
it also has a higher risk due to the uncertainty of meeting investment expectations, as well as
additional fees, taxes, and research time. Passive investing, in contrast, has the potential to
consistently earn the equity risk premium with low-cost exposure and less research needed to
match the market portfolio, but this strategy ignores market inefficiencies and therefore has the
potential to earn higher returns and outperform the benchmark.
The optimum plan, according to many investing gurus, is a mix of active and passive
strategies, which helps lessen the large swings in stock prices amid turbulence. For advisers,
choosing between passive and active management does not have to be a binary decision.
Combining the two can increase portfolio diversification and even aid in risk management.
Over a lifetime of saving for significant milestones like retirement, there is a time and place
for both active and passive investing for the majority of people. Despite the criticism the two
sides level at one another over their respective techniques, more advisors end up combining
the two approaches.
But there's more to the decision of whether to invest actively or passively than that broad
overview. In some investing environments, active strategies have a tendency to be more
advantageous for investors, whereas passive methods have a tendency to outperform. Active
managers may perform better than passive managers more often when the market is volatile or
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the economy is faltering, for instance. Passive techniques, on the other hand, can be the best
choice when certain market securities are moving in harmony or when stock valuations are
more consistent. Investors may gain from combining passive and active strategies—the best of
both worlds—in a way that takes use of these insights, depending on the opportunity in various
sectors of the capital markets. But because market conditions are constantly shifting, choosing
when and how much to favour passive assets over active ones frequently requires a keen eye.
It is also important to keep in mind that, when attempting to achieve the "best of both worlds,"
consistently successful active management has historically proven more challenging in some
asset classes and market segments, such as among the stocks of large corporations. As a result,
it might make sense, if it's appropriate for your circumstances, to lean a little more toward
passive investing in those areas and to rely more on active investing in asset classes and regions
of the market were doing so has historically produced higher returns, such as among
international stocks in emerging markets and those of smaller companies.
Some investors may not be persuaded by the nuanced view that both approaches may have a
place in individuals' portfolios since they have extremely strong feelings on this subject. An
entirely passive portfolio can make sense if lowering fees and trading costs is the investor's top
aim. We can assume that a mixed strategy may be advantageous for all investors—conservative
and aggressive alike—as investors tend to care more about things like risk, return, and liquidity
than they do costs.
As with many choices investors face, it really comes down to their personal priorities, timelines
and goals.

IN-TEXT QUESTIONS
13. The portfolio must be frequently adjusted according to the _____________
approach.
a) Combative c) Passive
b) Active d) Inactive

14. Less fees, transparency and simplicity are advantages of

a) Active investing c) Passive investing
b) Balanced investing d) Indirect investing

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1.10 RISK RETURN TRADE OFF

1.10.1 Definition
Larger risk is linked to a higher likelihood of higher return, whereas lower risk is linked to a
higher likelihood of smaller return. The risk return trade-off refers to the trade-off that an
investor must make when weighing investment options between risk and return.
1.10.2 Explanation
Rohan, for instance, must weigh the risks with the rewards of investing. He will receive a
meagre return from the bank's interest rate if he deposits all of his funds in a savings account,
but they will all be insured up to a maximum of Rs. 1 lakh (currently the Deposit Insurance and
Credit Guarantee Corporation in India provides insurance up to Rs 1 lakh).
But if he invests in stocks, he runs the danger of losing a significant portion of his money while
still having a possibility to earn a significantly bigger return than he would from a bank savings
account.
“The tendency for potential risk to vary directly with the potential return, so that the more risk
involved, the greater the potential return, and vice versa.”
For any investor, the return on investment is of utmost importance. However, although earning
better returns, investors neglect to take into account the associated hazards. Any investment's
returns on a financial market are directly correlated with its risk level. Risk-return trade-off is
the name given to this occurrence.
Every investment type has some risk, which might differ greatly between two possibilities. For
instance, equity stocks have one of the biggest potential returns while also carrying one of the
highest degrees of risk on the financial markets. If you have chosen high-quality equities, your
annual returns could exceed 10%–12%.
On the other hand, investment options such as bank FDs come with minimum risk with annual
returns around the range of 6%-7%. Every type of investment, equity, mutual funds, bullion
market, or even real estate, this relationship between risk and returns is prevalent everywhere.
So, every investor must consider the risk-return trade-off at the time of selecting an investment
to meet their goals.
Risk and reward are in a positive relationship. Your risk is at its lowest when you invest in
secure assets like bank FDs, government bonds, or treasury bills, but your returns are also at
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their lowest. Your returns and risk both rise proportionately as you move up the risk ladder.
The volatility or standard deviation of the returns is used here to characterise risk. That implies
that the more your risk appetite and, consequently, the higher your potential for rewards, the
more volatility of returns you are willing to accept.
According to the risk-return trade-off, as the level of risk rises, so should the amount of
return that may be expected from an investment. As a result, investors will be less likely
to pay a high price for low-risk investments like high-grade corporate or government
bonds. Some investors will gladly invest in low-return assets because there is a low danger
of losing the investment, but various individuals will have varied tolerances for the level
of risk they are ready to accept. Others, who have a higher risk tolerance, will invest in
riskier assets despite the possibility of losing money in order to achieve a better return. In
an effort to achieve a more balanced risk-return trade-off, some investors build a portfolio
that includes both high-risk and low-return investments.
A savvy investor investigates the fundamentals of a potential investment to learn more
about the actual level of risk involved. If the investor believes that the actual risk level is
different from how others perceive it, they can take advantage of this perception gap to
generate returns that are above average.

The risk-return trade-off is one of the crucial factors that investors consider when making
investment decisions and when evaluating their portfolios as a whole. The risk-return trade-
off at the portfolio level might take into account evaluations of the concentration or diversity
of assets as well as whether the mix poses an excessive amount of risk or a lower-than-desired
potential for returns.
1.10.3 Managing Risk and Return
There are numerous formulas, tactics, and algorithms devoted to studying and making an
effort to quantify the relationship between risk and return.
The SF Ratio, also known as Roy's safety-first criterion, is a method for making investment
choices that establishes a minimal required return for a specific amount of risk.
A portfolio's chance of earning the minimum necessary return is calculated using its formula;
an investor's best course of action is to select the portfolio with the highest SF Ratio.

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The Sharpe ratio is another well-liked metric. This computation contrasts the performance of
an asset, fund, or portfolio with that of a risk-free investment, most frequently the Treasury
bill. The risk-adjusted performance is better the higher the Sharpe ratio.
1.10.4 Importance of risk return trade off
The risk-return trade-off has a wide range of practical applications for a number of fundamental
reasons. Let's examine these special instances of the risk-return trade-off.
One can better comprehend the risk-return relationship thanks to it. This serves as the
foundation for building the portfolio and making long-term plans to achieve financial
objectives. One can afford to take on more risk if he/she has a longer time frame since one
needs to obtain better returns.
Understanding the relationship's causality is crucial. For instance, higher returns come with
more risk, but risk does not always equate to higher profits. By investing all of the funds in a
commodity fund, for instance, one can take a very high risk.
However, even though an investor took on more risk, his portfolio will significantly
underperform and deliver negative returns if the commodity experiences a protracted multi-
year bear cycle. As a result, one should only take calculated risks.
The foundation of financial planning is the development of a risk-return matrix. Selecting the
asset class that most closely resembles the financial objectives by grouping multiple asset
classes into different risk-return buckets is one of the best methods to go about it. For instance,
liquid funds for objectives of one-year, short-term funds for goals of two years, debt funds for
goals of three years, debt funds for goals of five years, balanced funds for goals of seven years,
equity funds for goals of ten years or more, etc. The task of asset allocation and financial
planning is made easier by this matrix.
It aids in optimising a portfolio. One must either decrease the risk for a given level of return or
increase return for a given level of risk. The overall amount of risk the investors are ready to
assume can then be divided into smaller components for each asset type.
Never forget that building a portfolio involves more than just gathering assets, it also involves
knowing how they are correlated internally. The danger from internal risk set-offs is lower the
correlation of the assets in a portfolio. When the risk-return matrix has been established and it
is clear that risk must be lowered to match returns, diversification is an option. That is the
luxury that investors receive from the risk-return trade-off.
Important note -

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Risk and return do indeed have a positive correlation (a relationship in which two variables
move in the same direction), but there is a key qualification. There is no assurance that
increasing the risk will result in a higher return. Instead, increasing your risk could mean that
you lose more money. High-risk investing options certainly have the potential for bigger
profits, but there is also always the chance of significant losses.
The correlation between risk and prospective return is likely to be positive, which would be a
more accurate statement. A lower risk investment typically has a lower chance of success. A
higher risk investment offers a larger chance of success but also a higher chance of failure.

IN-TEXT QUESTIONS
15. Correlation between risk and return can be defined as
a) Negative c) Positive
b) No relation d) Neutral

1.11 SUMMARY

Investments are financial commitments made over a lengthy period of time with the goal of
increasing an investor's wealth and providing them with additional income in addition to their
normal income. A future reward in the form of income through recurring interest, dividends,
premiums, or an increase in the value of the primary capital is what investing entails.
Investments exhibit a lot of characteristics with risk, return, marketability, liquidity and safety
among others.
Investors make such judgments in an investment environment when they decide to invest in
either stocks or bonds or try to invest in a portfolio of assets in any market or across markets
(i.e., international investing). Investment environment refers to changes in the national and
global economies that have an effect (positive or negative) on asset prices or values of various
asset classes as well as associated risk.
A process followed by investors for making investment decision is referred to as investment
decision process involving various stages, namely, setting investment policy, analysis of
investments, construction of portfolio, evaluation of its performance and lastly, its revision.
This process can be undertaken by the individual himself or it can be entrusted to organisations
like UTI, etc. the former is known as direct investing and later as indirect investing. Once the

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investment is made, it can be managed actively to outperform the market or can be manged
passively with portfolio of investor matching the performance of the benchmark index.
The entire decision of investing, discussed above, is based on the risk-return relation.
Larger risk is linked to a higher likelihood of higher return, whereas lower risk is linked to a
higher likelihood of smaller return. The risk return trade-off refers to the trade-off that an
investor must make when weighing investment options between risk and return.

1.12 GLOSSARY

Investment: Any method for producing potential future revenue might be referred to as an
investment.
Risk: Risk is the probability that actual results will differ from expected results.
Return: The money gained or lost on an investment over time is referred to as a return.
Financial market: Financial markets, which include the stock market, bond market, currency
market, and derivatives market, among others, are any marketplace where trading in securities
takes place.
Risk return trade off: larger risk is linked to a higher likelihood of higher return, whereas
lower risk is linked to a higher likelihood of smaller return. The risk return trade-off refers to
the trade-off that an investor must make when weighing investment options.
Diversification: A risk management strategy that distributes investments among various
financial instruments, industries, and other categories in order to reduce risk. By investing in
several sectors that would produce larger and longer-term profits, this method aims to optimize
returns.
Active investing: An investment approach involving the investor continuously purchasing and
selling securities. Active investors buy securities and keep a close eye on their activities to take
advantage of lucrative circumstances.

1.13 ANSWERS TO IN TEXT QUESTIONS

1. Investment 9. Investment policy setting

2. Gambling 10. Technical analysis

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3. Liquidity 11. Financial intermediaries

4. Loss of principal amount 12. Direct investing, indirect investing
5. The expected return is sufficient for 13. Active
taking a risk
6. All of the above 14. Passive investing
7. All of the above 15. Positive
8. Diversification is the key

1.14 SELF – ASSESSMENT QUESTIONS

1. What do you understand by the term investment?

2. Explain the characteristics of investment.
3. Discuss the terms risk and return. How are they related to each other?
4. Which approach to investing – active or passive, is better? Elucidate.
5. Explain and discuss the term investment environment.
6. Discuss the stages in the investment decision process.
7. Distinguish between direct and indirect investing.

1.15 REFERENCES/SUGGESTED READINGS

Chandra, P. Investment Analysis and Portfolio Management. McGraw Hill Education.

Greeshma. V, Sanesh. C. Fundametals of Investment. Kerala:University of Calicut.
R. Kasilingam. Investment and Portfolio Management. Pondicherry University.
Hagin, R.L. (2004). Investment Management: Portfolio Diversification, Risk, and Timing—
Fact and Fiction. New Jersey: John Wiley & Sons.
Levišauskaite , K. (2010). Investment Analysis and Portfolio Management. Lithuania:
Vytautas Magnus University.
Reilly, F.K. & Brown, C.K. (2012). Investment Analysis & Portfolio Management. United
States: South Western Cengage Learning.

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Rustogi, R.P. Fundamentals of Investment. Delhi: Sultan Chand & Sons

Smart, S.B., Zutter, C J. (2020). Fundamentals of Investing. New York: Pearson
Smart, S.B., Zutter, C.J., Vishwakarma, V.K. & Yüce, A. (2022). Fundamentals of Investing.
Canada: Pearson
Singh, P. (2018). Fundamentals of Investment. Delhi: Himalaya Publishing House.

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LESSON 2
TYPES OF SECURITIES
Chandni Jain
Assistant Professor
University of Delhi
chandni.90.jain@gmail.com

STRUCTURE

2.1 Learning Objectives

2.2 Introduction
2.3 Types of securities
2.3.1 Equity shares
2.3.2 Bonds and debentures
2.3.3 Government securities
2.4 Alternative investments
2.4.1 Mutual Funds
2.4.2 Derivatives
2.4.3 Unit Linked Insurance Policy (ULIP)
2.4.4 Exchange Traded Funds (ETFs)
2.4.5 Collective Investment Schemes (CIS)
2.4.6 Real Estate Investment Trusts (REITs)
2.6 Summary
2.7 Glossary
2.8 Answers to In-text Questions
2.9 Self-Assessment Questions
2.10 References
2.11 Suggested Readings

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2.1 LEARNING OBJECTIVES

This lesson will enable students to:

• Understand various types of securities
• Discuss and comprehend alternative investment avenues

2.2 INTRODUCTION

A financial instrument that is fungible and negotiable and has some kind of monetary worth
is referred to as a "security." A security can represent rights to ownership as indicated by an
option, a creditor relationship with a government agency or company, ownership of that
entity's bond, or ownership of stock in a firm. Trading and fungible financial products called
securities are utilized in both public and private markets to raise funds.

2.3 TYPES OF SECURITIES

2.3.1 EQUITY SHARES

Any corporation can obtain long-term finance through equity shares. These shares are not
redeemable and are issued to the general public. Such shares give shareholders the ability to
vote, partake in profits, and claim a company's assets. Equity share value can be expressed
using a variety of terminology, including par value, face value, book value, and more.
Companies issue equity shares as a means of raising capital. These non-redeemable shares
are made available to the general public. Investors who purchase these shares acquire the
right to vote, a portion of the company's income, and ownership of its assets. The investor
also receives dividends from the business as an equity stakeholder.
Features of Equity Shares
i. Although equity shares have high risk elements and are volatile, they offer significant
profits. Therefore, if you have a higher risk tolerance, investing in equity shares can
help you build a sizable corpus with excellent returns.
ii. The company's issued shares are non-redeemable and permanent in nature. These
shares cannot be returned unless the company decides to shut down operations.
iii. The majority of equity investors enjoy voting privileges. This enables them to decide

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who will run the business.

iv. Equity shareholders have the right to receive any extra profits a firm makes throughout
a fiscal year. This raises the overall wealth of individual investors who have a sizable
interest in a company's stock shares.
Benefits of Investing in Equity Shares
High risk, high reward
Equity shares are associated with high-risk characteristics. However, the profits offered by
investing in equities shares increase with increased risk. Investors gain from a company's
profitability when it pays dividends to shareholders.
Easy and efficient
An investor can use a stockbroker or financial planner to make investments in the equity
market. Using a Demat account, investors can purchase shares of any firm they choose. Trading
transactions are made simple and effective with a Demat account.
Diversity
By investing in firm shares from multiple sectors or industries, investors can build a broad
investment portfolio. By exposing you to stocks from different industries, diversification helps
you build a stable portfolio with predictable returns.
High Income
With the assistance of equity investing, you can produce a significant income. A consistent
dividend payout helps you create wealth in addition to building a sizable corpus with strong
yields.
Hedge against inflation
Profits from equity market investments enable investors to invest with greater purchasing
power. Profits are made at a rate greater than inflation-adjusted buying power. The investment
value rises as a result over time.
Risks Associated with investment in Equity shares
Volatility
The share price will fluctuate over time for a variety of causes; this is known as volatility. If
the price of an equity share varies by 100 to 200 points in a single day, it is said to be more
volatile than a share whose price varies by 140 to 160 points in a single day. The equity share
price can become volatile quickly because the market price of a share is determined by a variety
of factors, including market sentiment, social and political concerns, among others. When you
buy the shares at their cheapest price, you can profit from the volatile share and make money
even if the share price slightly rises. To maximise your returns, you can sell equities when the
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share price rises.

Capital Loss
The supply and demand for equity shares are used to determine the share price. Investors start
buying more shares of a firm if they believe it will continue to grow in the future. The price of
the share also rises when shares are purchased in bulk. In contrast to this scenario, investors
may elect to sell all of their shares if they anticipate the company will do poorly. This implies
that when demand for the share’s declines, the price of the shares could also decline. As a
result, if you invested in such shares, a decline in demand could cause you to lose money.
2.3.2 BONDS AND DEBENTURES
Two of the most popular types of debt investments for investors are bonds and debentures.
Bonds are certificates of debt issued by either government agencies or enterprises to raise
money, whilst debentures are debt instruments issued by businesses that are either convertible
or non-convertible.
The Latin word "debere," which means to borrow, is the source of the English word
"debenture." A debenture is a written instrument that accepts a debt with the enterprise's general
authorization. It consists of an agreement for the payment of interest at a specified rate due to,
typically either yearly or half-yearly on fixed dates, as well as for the repayment of principal
after a specific period, at intervals, or at the enterprise's discretion. A "Debenture" is defined
as a "Debenture Inventory," "Bond," and any other securities of a company, whether or not
they include a charge on the assets of the enterprise, according to Section 2(30) of The
Companies Act, 2013. A trust indenture must be written before issuing a debenture. The first
trust is a contract between the trustee and the issuing corporation that governs the interests of
the investors.
Characteristics of bonds:
• At the time of maturity, the bonds' face value, also known as their par value, is paid to
the bondholder. Corporate bonds typically cost $1,000, but government bonds may
cost more.
• The coupons are typically paid every six months for bonds, although they can also be
paid monthly, quarterly, or annually.
• The maturity phase might be as short as one day or as long as thirty years. The general
norm is that the coupon rate directly relates to the maturity time, with larger coupon
rates being observed for longer maturities.

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Characteristics of debentures:
• The debentures often belong to a series that was issued over a specific time period.
• Because debenture holders are creditors of the corporation, they are not entitled to vote.
• Debenture interest rates are fixed by nature.
• The maturity length for the debentures, which serve as long-term financial sources,
typically ranges from 10 to 20 years.
Types of Bonds
The following types of bonds can be generally categorised:
• Actively managed bonds: These bonds' fund managers aggressively trade the funds to
meet the investment objective of generating better returns than the market.
• Passively managed bonds: These bonds are also referred to as index funds since the
fund managers of these kinds of bonds benchmark the fund allocation to a certain index
so that the fund performance resembles that of the index.
• Open-end bonds: The market offers for these bonds are subject to the discretion of the
fund managers, who may also choose to redeem any outstanding bonds. After
redeeming their assets, the current investors may reinvest in the new fund offerings.
• Closed-end bonds: The number of tradeable shares in these bonds is constrained. Both
actively managed and index funds are options for these bonds.
• Exchange-traded funds: These funds are endlessly scalable bouquets of different
bonds. The name comes from the fact that these bonds are traded on the exchange
through brokers.
Types of debentures
The classification of debentures is based on factors such as redemption, tenure, convertibility,
security, redemption method, interest rate structure, coupon rate, demonstrability, etc. The
following forms of debentures can be roughly categorised:
From the Point of view of Convertibility
• Convertible debentures: These debentures have the option of being converted into
equity shares or other securities. There are fully convertible and partially convertible
debentures.

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• Non-convertible debentures: These debentures cannot be changed into securities or

equity shares. When opposed to convertible debentures, non-convertible debentures
often offer a better return.
From security point of view
• Secured debentures: These debentures are backed by collateral securities in the form
of the company's assets.
• Unsecured debentures: These kinds of debentures are not backed by any kind of
collateral securities.
From the Point of view of Tenure
• Redeemable Debentures: These bonds are ones that must be repaid in full or in
instalments at the end of the time period, depending on how long the business has
been operating. Debentures may be redeemed at par or at a premium.
• Irredeemable Debentures: These bonds are sometimes known as perpetual
debentures because the corporation makes no effort to return any funds obtained or
borrowed through the issuance of such bonds. These debentures must be repaid when a
business shuts down or when a considerable amount of time has passed.
From the view Point of Registration
• Registered Debentures: These bonds are the kind of bonds in which all information,
including addresses, names, and holding details of the bondholders, is recorded in a
register maintained by the business. Such debentures can only be transferred via a
standard transfer document.
• Bearer Debentures: The company does not keep any records of the holders of these
debentures, which can be transferred by delivery. A person who provides the interest
coupon that is included with the debentures will receive the interest due.
From the view Point of order of payment
• First and Second: The first debenture is the one that gets paid off initially, followed
by the subsequent debentures. Following the repayment of the first debenture, the
second debenture is paid.
Advantages
The following are some of the main benefits of bonds and debentures:
For investors

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• Conservative investors are thought to be the greatest candidates for both bonds
and debentures.
• When compared to equity shares, the prices of bonds and debentures are more
stable.
• Fixed income investors that choose lower risk investments like them.
For companies
• When compared to equity capital for the businesses, they are much less expensive sources
of funding. They are less expensive to finance through than preferred or equity capital
because the interest on debentures is tax deductible.
• Debentures do not have voting rights, therefore funding through them does not affect the
management control held by equity shareholders.
Disadvantages
The following are some of the main drawbacks of bonds and debentures:
For companies
The cost of interest on bonds and debentures is deducted from profits, therefore they had to be
paid whether the issuing corporation made a profit or a loss.
• The amount of borrowing each business can do varies. The ability of a business to
borrow money in the future is lowered by the issuance of debentures.
• With a redeemable debenture, the corporation is required to make arrangements for
repayment on the designated date, even while the company is experiencing financial
difficulties.
• During recessions, this may place a heavy financial load on the businesses.
For investors
• Lower returns relative to equity stockholders; lower risk. The previously discussed idea
of risk return trade-off is applied.
• These investors lack both representation in the board of directors and voting privileges.
As a result, they have no influence over business affairs.
• Debenture holders might be at danger from inflation. Here, there is a chance that the
interest rate paid on the debt will fall behind the rate of inflation. Price rises dependent
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on the economy are measured by inflation. Let's take an example where inflation raises
prices by 3%. In the event that the debenture coupon pays at 2%, the holders may
experience a net loss.
• Interest rate risk is also included with debentures. Investors keep fixed-rate debts in this
risk scenario while market interest rates are rising. These investors might discover that
the returns on their debt are lower than those offered by other investments paying the
current, higher market rate. If this occurs, the yield received by the holder of the
debenture is decreased.
• Debentures may also be subject to credit risk and default risk. Debentures are only as
secure as the underlying issuer's financial stability, as was previously mentioned.
Investors run the risk of having their debentures defaulted upon if the company
experiences financial difficulties as a result of internal or external macroeconomic
causes. As a consolation, in the event of bankruptcy, debenture holders would be paid
back before stockholders of common stock.
Is a Bond/Debenture an Asset or a Liability?
Whose viewpoint is taken into account will determine this. A debenture is a debt instrument,
which makes the issuer, who is effectively borrowing money by issuing these securities, liable.
Owning a debenture is a valuable possession for a bondholder or investor.
2.3.3 GOVERNMENT SECURITIES
G-Secs, also known as Government securities, are essentially debt instruments that are issued
by governments. Both the central government and the state governments of India have the
authority to issue these securities. When you invest in these possibilities, you often earn a
consistent interest income. The risk involved with these investment products is almost
negligible because they are backed by the government.
Different Types of Government Securities in India:
Different kinds of bonds and securities are available in India. Bonds and securities generally
include:
1) Treasury Bills
2) State Development Loans
3) Cash Management Bills
4) State Development Loans

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Treasury Bills
Short-term government securities are known as T-bills. These securities are items used in the
money market. As a result, the maturity time is shorter than a year. There are three maturity
periods for T-Bills in India: 91 days, 182 days, and 364 days. Although these securities are
typically issued at a discount, they do not pay interest. In India, this kind of government security
is employed frequently.
Dated Government Securities
These are long-term contracts, also referred to as Dated G-Secs. These have a mature life cycle
that can last up to 40 years and begins at 5 years. The people that purchase these government
securities are known as main dealers. Special Securities, Fixed Rate Bonds, 75% Savings
Bonds, STRIPS, and Capital Indexed Bonds are some of the different categories of Dated G-
Secs.
Cash Management Bills
India and the RBI jointly launched this in 2010. Due to its lack of popularity, it is a relatively
new concept in the Indian financial market. With one important exception, they differ
significantly from T-bills. For Cash Management Bills, the maturity time is shorter than 91
days or 3 months. These bills are therefore referred to as short-term government securities that
are accessible to Indian investors. These securities are used by the government to meet short-
term cash flow needs faster.
State Development Loans:
These are comparable to dated G-Secs and are issued by the state governments. States issue
bonds and securities to cover ongoing infrastructure or operational costs in the state or to raise
additional funds. These can be issued at the auctions that the state Negotiation Dealing System
organises once every two weeks. The dated G-secs have the same repayment process and tenure
range.
Some other types of government securities are :
Capital Indexed Bonds:
These are those bonds issued by the government having a set interest rate. As of December 29,
1997, they are offered on a tap basis to the general public. Based on the Wholesale Price Index,
the redemption provides investors with a hedge against national inflation.
Zero-Coupon Bonds:
Zero-coupon bonds are those that are offered to the public at a discount from face value but are
redeemed at par. The first of them was released on January 19, 1994. The maturity date of these

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bonds is fixed. The return on investment is calculated as the difference between the discounted
rate at face value and the redeemable amount at par.
Partly Paid Stocks:
These government securities are issued at par but returned on a regular basis, perhaps every six
months. The interest rate is set, and the security can be redeemed when the bonds reach
maturity.
Floating rate Bonds:
These bonds are categorised as not having a fixed coupon or rate. These coupons are set by
adding a margin to a base rate at regular periods, such as every six months. The base rate is the
cut-off yield determined as the weighted average of the previous three 364-day Treasury note
auctions held prior to the reset date for the majority of the government's floating-rate bonds.
The coupon and spread are decided by the bidding.
How to buy Government Securities?
The RBI and the Indian government have established numerous avenues for people to invest
in and buy government securities. The RBI organises auctions mostly twice every two weeks.
Depending on their eligibility, potential investors can engage in either a competitive or non-
competitive bid. Through competitive bidding, banks, mutual funds, and insurance companies
can invest. To promote individual or retail investments, the Indian government and the RBI
started non-competitive bidding for government bonds in 2017 such as treasury bills, SDL, etc.
Government securities are available for purchase by retail investors on the primary and
secondary markets. You can accomplish this by opening a gilt account with one of the national
banks.
In any recognised bank in India, a gilt account functions similarly to a regular bank account.
The sole distinction is that any gilt account transacts in treasury bills, SDLs, or other types of
government securities rather than actual money. These non-competitive bidding procedures
promote retail G-sec investment and permit the opening of new, safer investment avenues.
Advantages of Government Securities or g-secs
1. Low risk
Since there is no record of the Indian government missing payments on domestic bonds, G-secs are
regarded to be risk-free. G-secs are referred to as risk-free gilt-edged products for this reason.
2. Better yields than fixed deposits and savings accounts
Interest rates have been kept low to promote borrowing and enhance investment in order to support
the economy during the pandemic. Naturally, both savings account interest rates and fixed account
interest rates have remained low. The yield on g-secs has increased as a result of the falling interest
rates.

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3. Fixed-income through coupons

Through coupon payments, investors can get a guaranteed income at regular periods. The interest
rate would be expressed as a percentage of the g-face sec's value. A periodic coupon payment is
made to the investors.
Disadvantages of Government Securities
1. Low returns
The ideal asset would compensate you for the risk you assume when investing in it. A risk premium
is the name given to the higher return provided in exchange for the increased risk. This risk premium
does not apply to government securities because they are thought to be risk-free. Because of this,
the returns on government bonds are typically lower than those on private bonds, which carry a
certain element of risk.
2. Interest rate risk
In general, as new bonds with higher coupon rates become the favoured investment option, the price
of existing government bonds will decline as interest rates rise. There is a price risk from interest
rate fluctuations because it is challenging to foresee the movements in interest rates. It should be
highlighted that if investors buy bonds at issue and retain them until maturity, collecting the
principal, they will not be impacted by these changes.

IN-TEXT QUESTIONS
1. A ____________________ represents part ownership in a public firm.
a) Cumulative preferred stock c) Preference share
b) Common stock d) Convertible bond
2. Which of the following is not a feature associated with investment in equity
shares?
a) Volatility c) Capital loss
b) High risk d) Fixed income
3. Which of the following investments offer the greatest potential for risk and
reward?
a) Commercial paper c) Derivatives
b) Preferred stock d) Bonds
4. The characteristics of government securities are?
a) Low risk c) Low return
b) Interest rate risk d) All of the above

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2.4 ALTERNATIVE INVESTMENTS

2.4.1 MUTUAL FUNDS

A mutual fund is a type of trust that combines the savings of many investors who have similar
financial objectives. Mutual funds provide two unique services: investment knowledge and
diversity. Mutual funds invest on behalf of investors who join the scheme in the stock and debt
markets. Without mutual funds, a small investor with, say, Rs. 10,000 in excess funds each
year could not be able to receive such professional guidance or diversification. Thus, investors
not only have a similar financial objective, but they also pay the same price for diversification
and professional counsel.
Organisation of mutual funds
A mutual fund can be set up as a trust. It can also be set up as a corporate entity. Unit Trust of
India (UTI) was established as a corporation in India in 1964 as a result of a parliamentary act.
A trust must be used to create a mutual fund according to SEBI regulations on mutual funds.
The trust document must take the form of a deed that has been duly executed by the sponsor in
favour of the trustees specified therein and duly registered under the Mutual Funds the Indian
Registration Act, 1908 (16 of 1908) regulations. While Mutual Funds registered as trust floats
schemes and collects money, the actual investment is made by a different entity called Asset
Management Company (AMC). AMC is typically constituted as a company registered under
Companies Act, 1956.
An individual, a group of individuals, or a company must sponsor mutual funds. The Trustees
who will oversee the mutual funds are also chosen by the sponsors. AMC is also chosen by
Sponsors or Trustees, and they and AMC sign into a contract for the management of money.
Sponsors frequently advertise an AMC for the mutual funds as well. When investors buy or
sell units, the transfer agent updates its database of unit holders. The securities that the fund
purchased are kept by the custodian. We will talk about each organisation and the part it played
in the mutual fund sector.
Sponsor
Runs the show, similar to a company's promoters. According to the SEBI (Mutual Funds)
Regulations, 1996, a sponsor is any individual who creates a mutual fund either on their own
or in collaboration with another body corporate. The sponsor establishes the Trust, names the
trustees, selects the AMC to administer the fund, and may also name a custodian to retain the
fund's assets. According to the SEBI (Mutual Fund) Regulations, 1996, the sponsor must pay
at least 40% of the asset management company's net worth when submitting an application for
the mutual fund's registration. Without the sponsor meeting the qualifying requirements, the
Board may reject the application.

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Asset Management Companies

The Memorandum and Articles of Association of the AMC would have to be approved by
SEBI in accordance with regulations before AMC could conduct business. Accordingly, the
Memorandum and Articles of Association must be authorised by SEBI before a business can
register as an AMC under the Companies Act 1956.
Transfer Agents
They are primarily responsible for: I (ii) (iii) (v) (vi) I (ii) (iii) Receiving and processing
investor application forms Unit/Share Certificates are issued on behalf of a Mutual Fund. Keep
thorough records of the transactions of the Unit Holders iv) Acquiring, transferring, disposing
of, and redeeming Unit/Share Certificates issuing warrants for revenue or dividends, checks,
etc. establishing a security interest on the units or certificates to permit borrowing against them.
Advertiser
A major duty of an advertising is to: Assist mutual fund organisers in creating a media strategy
for marketing the fund. releasing or purchasing advertising space in newspapers and other
electronic media to promote a fund's many aspects setting up hoardings in public areas.
Trustees
Trustees are responsible for overall management and get a management fee. Trustees act as
fiduciaries when managing the money of unit holders. A minimum of two-thirds of the trustees
must be independent individuals with no connection to the sponsors.
Custodian
The following duties are performed by a custodian, which is once more a business entity: holds
investments whenever investors sell or purchase Units, it receives and delivers securities.
income, interest, and dividends from the securities holds and handles money.
Unit Holder
The general population who invests in the AMCs' schemes.
Benefits of mutual funds
Professional Management.
The research is done for you by the fund managers. They choose the securities and keep an eye
on the results.

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Diversification or “Don’t put all your eggs in one basket.” Mutual funds frequently make
investments across a variety of businesses and sectors. This reduces the danger of you losing
money if one firm fails.
Affordability.
For first investments and subsequent purchases, the majority of mutual funds have relatively
low dollar thresholds.
Liquidity
Investors in mutual funds can conveniently redeem their shares at any time for the current net
asset value (NAV) plus any redemption costs.
Administrative Advantage
Demat services are offered by mutual funds, lowering the possibility of share transfer
delays while also saving investors' time. The leadership is sensible. absence of
documentation
Return Potential due to power of compounding
Every dividend and capital gain, no matter how little, is reinvested, increasing the overall
return. The interest you receive on your accrued interest is essentially what is meant by
the term "power of compounding." Due to the compounding effect, if you invest a specific
principal amount in a financial instrument and earn interest on it, you will also earn
interest on your interest in the later years of your investment. The purpose of mutual
funds is to maximise the power of compounding. When the value of fund units increases,
investors profit. The power of compounding will be fully unlocked if invest horizon is long-
term horizon, which will help increase the investment. This is especially true for mutual funds
because the capital gains returns are reinvested to produce even more profits. If you decide to
invest Rs 1,000 every month for the next ten years in a mutual fund scheme and the rate of
return is 8% per year, you will see that your investment of Rs 1,20,000 in 10 years would result
in a profit of Rs 1,82,946. Now, if you decide to continue investing it for, say, a further 10
years, the money that has already been reinvested will grow even faster, earning you Rs
3,94,967. Compounding has the unusual property of allowing your current investment, return
on investment, and fresh investment each month to all contribute to future gains.
Transparency
SEBI regulates mutual funds, and they are required to report their portfolios every six months.
For open ended funds, NAVs are calculated daily and published in newspapers for investors'
information.
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Flexibility
Some mutual funds give investors the choice to swap between different schemes without
incurring any fees.
Choice of schemes
With mutual funds, you can choose the portfolio you wish to invest in based on the risk and
return you want from your investments.
Tax benefits
Benefits from taxes on invested funds, returns, dividends, and capital gains.
Capital appreciation
Without having to observe the performance peaks or valleys of several scripts.
Drawbacks of investments in Mutual Funds
No guarantee on returns
The returns on investments in mutual funds are not certain. In some cases, the proportionate
increase in mutual fund value may be equal to or less than the return an investor would have
gotten from an investment in risk-free securities. Mutual Funds may occasionally lose value as
well.
Diversification
Diversification lowers risks, but too much of it can have an adverse impact on returns.
Fund Selection
If the underlying assumptions for investments are flawed.
Cost Factor
There is a possibility that the amount paid to the fund managers has nothing to do with the
fund's success. Cost would be a disadvantage for the investors in this situation.
Types of mutual funds
Mutual funds can be categorised in a variety of ways depending on their structure, investment
goals, investment patterns, and returns, among other factors. Mutual funds may be categorised
as follows depending on their structure:
• Open - Ended Schemes
• Close-Ended Schemes
• Interval Schemes
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Based on the investment objective, the classification could be:

• Growth Funds / equity funds
• Income Funds / debt funds
• Balanced Schemes
Based on structure or function
Open-Ended Funds
In an open-ended plan, the mutual fund will publish the daily price for the scheme's Units for
purchase and sale. You can purchase the same Units today at the discounted price. If you decide
to sell the units after six months, you might be able to do so at the purchase price the mutual
fund disclosed on that day. Thus, by taking on the duty of buying back the Units, the mutual
fund provides immediate liquidity for your investment under an open-ended scheme. The size
of the funds is unrestricted. Investors can make investments whenever they want. Net Asset
Value is used to establish the acquisition price (NAV). NAV is calculated by dividing the
market value of the fund's assets by the total number of outstanding shares or units. An open-
ended fund is one that accepts subscriptions all year long. There is no set maturity for these.
Investors can easily purchase and sell Units at prices that are proportional to Net Asset Value
("NAV"). Liquidity is an important aspect of open-ended plans.
Close-Ended Funds
There is no repurchase facility in close-ended plans. However, because the Units are traded on
the stock market, investors can purchase and sell them just like any other type of security. The
mutual fund sells the securities it purchased through the plan and distributes the proceeds to
unit holders at the conclusion of its "specific life" (let's say, 10 or 5 years). Many of the schemes
drew investors during a strong stock market, and the secondary market was also active. But
after a few stock market flops, they lost the interest of the investors. Only a very small number
of close-ended plans have been floated in recent months, and they are essentially extinct today.
Regarding the fund's crops and the number of shares, these funds have set sizes. No new Units
are generated in closed-ended funds after the first offer of the plan expires. These funds'
shares/units cannot be redeemed at their NAV at any time throughout their existence, unlike
open-ended funds. Shares of these funds are traded on secondary markets. Market prices, which
may be above or below their NAV, are used to price stocks on stock exchanges.
Interval Funds
The advantages of both open-ended and closed-ended plans are combined in interval funds. At
NAV-related prices, they are available for purchase or redemption at predetermined intervals.

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According to their investment goals and portfolio, mutual funds are divided into the following
categories:
Growth Funds
Growth funds are designed to offer capital growth over the medium to long term. These
programmes typically invest the majority of their corpus in stocks. It has been demonstrated
that long-term stock returns have outperformed most other types of investments. For investors
with a long-term vision looking for growth over time, growth schemes are perfect. 34 Managed
and Institutional Portfolios.
Income Funds
Investors' regular and steady income is the goal of income funds. These programmes typically
invest in government securities, corporate debentures, and fixed income products like bonds.
The best option for consistent income and capital stability is an income fund.
Balanced Funds
Balanced funds are designed to offer both growth and dependable income. These programmes
periodically disperse a portion of their profits and invest in fixed income and equity securities
in the amounts specified in their offer agreements. The NAV of these schemes may not
typically rise along with the market in a bull market or decline in lockstep with the market in a
bear market. For investors seeking a balance of income and moderate growth, they are perfect.
Based on ownership
Public Sector Mutual Funds
Sponsored by a company of public sector.
Private Sector Mutual Funds
Sponsored by company of private sector.
Foreign Mutual Funds
Sponsored by foreign companies operating in India.
Other funds
Money Market Funds
Money market funds are designed to offer simple liquidity, capital preservation, and moderate
income. These programmes typically invest in less risky short-term financial products such
treasury bills, CDs, commercial paper, and interbank call money. The returns on these
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strategies could change based on the market interest rates. These are the best options for
corporate and individual investors looking to temporarily park their excess cash.
Load Funds
For entry or exit, a load fund levies a commission. This means that a commission will be due
each time you buy or sell Units in the fund. Entry and exit loads typically vary from 1% to 2%.
If the fund has a strong track record of performance, it can be worthwhile to pay the load.
No-Load Funds
A fund that doesn't charge a commission for entrance or departure is known as a no-load
fund. In other words, there is no commission due on the acquisition or sale of Units in the
fund. A no load fund's benefit is that the entire corpus is invested.
Tax Saving Schemes
As the government provides tax incentives for investment in specific avenues, these
programmes offer tax rebates to the investors in accordance with specific sections of the Indian
Income Tax Act. Investments made in pension plans and equity linked savings schemes (ELSS)
are deductible under Section 88 of the Income Tax Act of 1961. Equities-Linked Tax Savings
Program (ELSS). Under section 80C of the Income Tax Act, this fund offers investors the
chance to reduce their tax liability. The fund has a minimum lock-in period of three years,
which helps investors avoid issues with making lump-sum investments and also enables them
to take advantage of averaging.
How to buy and sell mutual funds?
Instead of purchasing mutual fund shares from other investors, investors purchase them directly
from the fund or through a broker for the fund. Investors must also pay any purchase-related
costs, such as sales loads, in addition to the mutual fund's per-share net asset value.
Evaluating Performance of Mutual Funds
The mutual fund's "calling card," or net asset value, is the sum that unit holders would receive
if the mutual fund were closed. NAV is the net value of all assets and liabilities, or the market
value of all assets and liabilities, because unit holders are partial owners of the mutual fund's
assets and liabilities. What makes NAV unique is:
• NAV changes daily
• NAV is computed as a value per unit holding
• Returns to the investor are determined by Cost of Mutual Fund and Net Asset Value

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NAV = Net assets of the scheme / Number of units outstanding

2.4.2 DERIVATIVES
The two main uses of financial derivatives are speculation and investment hedging. A securities
with a price that is based on or derived from one or more underlying assets is referred to as a
derivative. A contract between two or more parties based on the asset or assets constitutes the
derivative itself. Changes in the underlying asset's value affect its value. Stocks, bonds,
commodities, currencies, interest rates, and market indices are some of the most popular
underlying assets.
The majority of derivatives trade over-the-counter (OTC). On specialised exchanges, however,
some of the contracts are exchanged, such as options and futures.
Types of Derivatives
Derivative items fall into two categories: "lock" and "option." Lock products (such as futures,
forwards, or swaps) obligate the parties to the terms of the contract from the beginning. On the
other hand, option products (such as stock options) give the holder the right but not the
responsibility to acquire or sell the underlying asset or security at a particular price on or before
the option's expiration date.
1. Futures
An agreement between two parties for the purchase and delivery of an item at a certain price
at a later time is known as a futures contract, or simply futures. Standardized contracts known
as futures are traded on an exchange. A futures contract is used by traders to manage risk or
make predictions about the value of an underlying asset. The parties are required to carry out
an agreement to purchase or sell the underlying asset.
Say, for illustration, that on Nov. 6, 2021, Company A purchases an oil futures contract with
an expiration date of Dec. 19, 2021, at a cost of $62.22 per barrel. The reason the corporation
takes this action is that it needs oil in December and is worried that the price will increase
before it must buy. Because the seller is required to provide oil to Company A for $62.22 per
barrel after the contract expires, purchasing an oil futures contract helps the company to hedge
its risk. Assume that by December 19th, 2021, oil will cost $80 per barrel. Company A has the
option to accept delivery of the oil from the futures contract seller, but it also has the option to
sell the contract before it expires and pocket the profits if it decides it no longer needs the oil.
In this instance, the buyer and seller of futures both insure against risk. Company A required
oil in the future and intended to take a long position in an oil futures contract to reduce the
chance that the price would increase in December. An oil business that was concerned about
declining oil prices and sought to reduce that risk by selling or shorting a futures contract that
set the price it would get in December may be the seller.

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Not all futures contracts have their underlying asset delivered in order to settle them at
expiration. It is improbable that either of the speculating investors or traders who are both
parties to a futures contract would desire to arrange for the delivery of several barrels of crude
oil. By closing (unwinding) their contract prior to expiration with an offsetting contract, traders
can terminate their obligation to buy or deliver the underlying commodity.
2. Forwards
These are financial agreements that require those who sign it to buy a specific asset at a
predetermined price on a given future date. Futures and forwards have essentially the same
characteristics.
However, because the parties can alter the underlying commodity, the quantity of the
commodity, and the date of the transaction, forwards are more adaptable contracts. While
futures are standardised contracts that are traded on exchanges, the former are not.
A type of credit risk, counterparty risks involve the possibility that the parties may be unable
to fulfil their contractual obligations. The other party may be left with no options and risk losing
the value of its position if one party becomes bankrupt.
Once a forward contract is established, the parties can trade off their positions with other
counterparties, which raises the possibility of counterparty risk as more traders participate in
the same contract.
3. Options
The buyer of the contracts is given the option to buy or sell the underlying asset at a specified
price, but they are not obligated to do so. The buyer can exercise the option on the maturity
date (for European options) or on any day prior to the maturity, depending on the type of option
(American options).
Options and futures differ primarily in that with an option, the buyer is not required to carry
out their commitment to buy or sell. It is merely an opportunity, not a commitment like futures.
Options, like futures, can be used to speculate or hedge against changes in the price of the
underlying asset.
4. Swaps
Swaps are derivative arrangements that let two parties exchange cash flows. A fixed cash flow
is typically exchanged for a floating cash flow in swaps. Interest rate swaps, commodity swaps,
and currency swaps are the three most common types of swaps.
Swaps can be created to swap cash flows from other business activities, loan default risk, and
currency exchange rate risk. A very common type of derivative is one that deals with the cash
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flows and probable defaults of mortgage bonds. In the past, they've actually been a little too
popular. This type of swap's counterparty risk ultimately contributed to the 2008 credit crisis.
Advantages of Derivatives
Hedging Risks
Derivatives are the ideal tool for risk hedging, which is the process of lowering risk in one's
investment by making another investment. Derivatives are typically utilised with the aim of
decreasing risk in the market and are used as an insurance policy to mitigate risk. The
aforementioned example makes it evident that the corn farmer and the buyer employed
derivatives to hedge price risk by fixing the price of maize.
Low Transaction cost
Compared to traditional assets like shares or bonds, trading in the derivatives markets has lower
transaction costs. Derivatives enable lower transaction costs because they essentially serve as
a risk management tool.
Underlying asset price determination
The price of the underlying asset is frequently decided via derivatives. As an illustration, the
spot prices for the futures can be used to approximate the price of a commodity.
Market efficiency
Derivatives are thought to improve the effectiveness of financial markets. Derivative contracts
can be used to mimic an asset's payment. To prevent arbitrage opportunities, the prices of the
underlying asset and the related derivative typically are in equilibrium.
Access to unavailable assets or markets
Organizations can use derivatives to gain access to resources or markets that would otherwise
be closed off. A business may use interest rate swaps to get an interest rate that is better than
the interest rates available via direct borrowing.
Transfer of risk
The risk-averse can transfer risk (and the associated profits) to the risk-takers using derivatives
Disadvantages of Derivatives
High Risk

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Changes in the value of the underlying asset have a significant influence on these contracts
because the value of these instruments is derived from the underlying asset. The values of the
underlying, such as shares, bonds, etc., are subject to unpredictable market fluctuations.
Speculative nature
The most popular tool for speculating in order to make money is derivatives. Because of the
market's unpredictability, speculation is quite dangerous and can lead to significant losses.
Counter-party risk
Some contracts traded over-the-counter do not include a baseline for due diligence, even
though derivatives traded on exchanges often go through a full due diligence procedure.
Therefore, there is a chance of a counter-party default.
2.4.3 ULIP
What Is a Unit Linked Insurance Plan (ULIP)?
A unit linked insurance plan (ULIP) is a versatile instrument that provides investing exposure
in bonds or stocks in addition to insurance coverage. Policyholders must regularly pay
premiums for this product. A portion of the premiums is used to pay for insurance coverage,
while the remainder is combined with the assets of other policyholders and invested in either
stocks, bonds, or a mix of both equities and bonds.
One of the most important advances in the life insurance industry over the past few decades
has been the introduction of unit-linked insurance plans (ULIPs). It has addressed and
dispelled a number of customer worries regarding life insurance, including those relating to
liquidity, flexibility, and transparency, with the use of one product category. Different aims
of an individual were handled by various products prior to the emergence of ULIPs. However,
ULIPs are a one-stop shop for a person's financial objectives. They are made to help people
plan and achieve all of their long-term financial objectives, including wealth accumulation,
marriage, child rearing, and retirement savings. The structure of ULIPs allows for the
separation of the protection (insurance) and savings components, which may then be managed
in accordance with each individual's needs, providing previously unheard-of flexibility and
transparency.
Features of Unit-Linked Insurance Plans (ULIPs)
Selection of Investment
You have the freedom to select your investment channels with ULIPs based on your risk
tolerance. While investing in debt funds is cautious, investing in equity funds involves
substantial risk. Investors can invest in stocks, debt funds, or balanced funds to get the best of
both worlds, depending on their level of risk tolerance.

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Lock-in Period
The money invested in ULIPs is kept locked up for a minimum of five years. The policyholder
is prohibited from making any withdrawals from the funds during this time. He is also
prohibited from switching or giving up the money during this time.
Fund Switch
You always have the choice to transfer from one type of funds to another within the same plan
if the performance of your chosen funds is unsatisfactory or if you additionally predict a future
change in market conditions. In order to take advantage of market upswings and market
downturns, you can transfer from equity funds to debt funds. This fund switch is available
following the 5-year lock-in term.
Partial Withdrawal
After the five-year lock-in period, you can also partially withdraw money to cover any financial
crises. The insurance company decides how many withdrawals there will be and how long there
will be between each withdrawal.
Top-Ups
In addition to the base premium, one can invest more money to increase returns by purchasing
more units.
Mode of Payment
According to his or her convenience, a policyholder can select a certain manner of premium
payment from annually, biannually, quarterly, or monthly.
Charges
The ULIPs impose numerous fees on the policyholder, including fund management charges,
administration fees, switch fees, and rider fees, among others.
Types of funds offered by ULIPs
• Equity funds:
These are riskier investments. Your money is invested in company stocks through equity
funds. Over an extended investment horizon, they may provide large returns. Nevertheless,
compared to debt and balanced funds, they can be incredibly volatile.
• Debt funds:
In fixed income instruments, debt funds invest. In comparison to equities funds, these funds
are considerably less risky and offer consistent returns.

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• Balanced funds
By combining debt and equity funds, balanced funds provide medium risk. Since these
funds invest in both the stock and debt markets, you can expect to receive a balanced return.
Balanced funds, as their name suggests, can assist minimize exposure by offsetting the high
risk of equity with the low risk of debt securities.
Benefits of ULIPs
All-in-one scheme
The finest feature of a unit-linked insurance plan is that, for a single premium, you may benefit
from both risk coverage provided by the insurance policy and the chance to invest your money
in order to make money and finally build up a sizable savings.
Regular Savings
The key to effective long-term financial planning is the practise of consistent, disciplined
saving, which is what ULIPs encourage. You can profit from wealth creation for your loved
ones by paying premiums on time.
Protection:
ULIPs offer the security of a Life Cover, which protects your family safe while you are away.
The flexibility of Investment
You can attain your financial goals by using ULIPs, also known as unit-linked insurance plans,
because they give you the flexibility to:
• Alternate between investing funds in accordance with your shifting demands.
• Single premium increases to enable you to invest extra sums of money (in addition to the
regular premium paid) as and when required.
• Partial withdrawals following the conclusion of the first 5-year lock-in term.
Tax Benefits:
Section 80C of the Income Tax Act of 1961 allows for a tax deduction of up to Rs. 1.5 lakh on
the premium paid for ULIP plans. At the same time, Section 10(10D) of the Income Tax Act
of 1961 exempts the maturity/death benefit earned under the ULIP plan from taxes.
Potential for Growth:
The ability of equities and debt funds has the potential to produce larger returns. This will assist
you in achieving your life's objectives, including paying for your child's further education,
purchasing a new home, and dream car, among other things.
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Market linked returns :

Unit-linked insurance plans allow you the chance to earn market-linked returns since a
percentage of the premiums are invested in market-linked funds that, in varied amounts, invest
in a variety of market instruments, including debt and equity.
Greater Rewards for Staying Invested:
Your money increases when the insurance provider increases your savings through incentives
or additions and makes ULIPs available to you in a variety of ways (such as, Loyalty Additions
and Wealth Boosters).
How does a unit linked insurance plan work?
We must first comprehend the meaning of the word "unit" in order to comprehend how a Unit
Linked Insurance Plan functions. The insurer combines all of the investors' investment funds
in a ULIP. According to the preferences of the investor, the insurer makes investments in
various portfolios using this pool of funds. The whole sum is then split up into "units," each of
which has a distinct value. The units are subsequently distributed to each investor based on
their investment. The plan is hence known as a "Unit" Linked Insurance Plan.
Who should opt for a ULIP?
ULIPs are great for investors who are prepared to put their money into their investments for
longer periods of time and go the distance.
• Safe investors as well as risk-takers
• A ULIP is the best solution for both investors who want to be safer and invest less in
stock and more in other, risk-free options and who want to increase their equity
investments. This is because ULIPs provide investors control over their portfolios.
• Investors who want to keep an eye on their funds
Because it is so transparent and adaptable, a ULIP is one of the finest solutions for
investors who wish to keep a close eye and a controlling hand on their portfolios.
2.4.4 ETF
ETFs, also referred to as exchange-traded funds, are a grouping of different securities, such as
bonds, shares, money market instruments, etc., that frequently track an underlying asset. ETFs
are, to put it simply, a combination of many investment strategies. They combine the greatest
features of mutual funds and stocks, two well-known financial assets.
When it comes to form, rules, and management, ETF funds resemble mutual funds slightly.
They are a pooled investment vehicle that offers diversified investing into many asset classes

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like equities, commodities, bonds, currencies, options, or a combination of these, just like
mutual funds. Additionally, they are even tradable on stock exchanges like stocks.
Uses of ETFs
Investors that require specialised exposure to a particular sector, asset class, geographic area,
or currency at an affordable price may find ETFs to be quite helpful. Such investors are relieved
of the burden of conducting industry research. Additionally, because of their minimal operating
costs, 'buy & hold' investors can use them as long-term holdings.
They are helpful to people anticipating the asset allocation method to investing as well. There
are exchange-traded funds that concentrate on specific asset classes and have very low
correlation coefficients with the other investments in your portfolio. In other words, the ETFs
you're looking for tend to "zag" if your portfolio "zigs." This should reduce the volatility of
your portfolio.
One of the financial instruments with the fastest historical growth is ETFs. You can make up
your mind and choose whether exchange-traded funds in India make sense for your portfolio
now that you are knowledgeable about their fundamentals.
Types of Exchange Traded Funds (ETFs)
To meet the needs of nearly all investors, there are numerous ETFs available. The following
are some of the ETF types that are accessible to people:
1. Bond ETFs
These are typical ETFs designed to provide exposure to different types of bonds. Investing in
bonds is a good way to mitigate the ups and downs of investing and diversifying a portfolio.
2. Currency ETFs
An investor can take part in currency market transactions using these assets without having to
buy any particular currency. The goal of these investments is to monitor and profit from
changes in the value of a certain currency or a basket of currencies.
3. Inverse ETFs
Such funds are intended to yield the opposite of what the underlying market index offers in
returns. The share prices of these funds fluctuate in the opposite way from those of the inverse
ETFs.
4. Liquid ETFs
These funds invest in a variety of short-term government securities, such as money and money
market instruments with short maturities, in an effort to reduce price risks, increase returns,
and preserve liquidity.

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5. Gold ETFs
These funds invest in a variety of short-term government securities, such as money and money
market instruments with short maturities, in an effort to reduce price risks, increase returns,
and preserve liquidity.
6. Index ETFs:
The performance of an index fund's underlying index is tracked. Replication and
representational ETFs are two other divisions. Replication ETFs are index funds that
exclusively invest in the underlying securities of the index. A representative ETF, on the other
hand, invests the bulk of its fund corpus in representative samples and the balance in other
assets, such as futures, options, and so forth.
Advantages of Exchange Traded Funds (ETFs)
Liquidity
Even though certain funds are traded more frequently than others, ETFs can be sold on stock
exchanges at any time of the day. Finding a willing seller or buyer is easier the more
frequently a fund is traded.
Lower cost
ETF fee ratios are substantially lower than those of conventional mutual funds. The reason for
this is that ETF shareholders are not required to foot the bill for the group of managers, analysts,
and brokers that trade money on their behalf and oversee the inflows and outflows of the fund.
Transparency
For both open-ended and closed-ended schemes, ETFs report the fund's holdings and its
NAV on a daily basis, unlike mutual funds, which are only required to do so once every three
months.
Diversification
ETFs give investors the option to diversify their holdings across a range of verticals, including
different industries, sectors, styles, or nations. Additionally, ETFs are traded on almost all of
the world's main currencies, commodities, and asset classes.
2.4.5 COLLECTIVE INVESTMENT SCHEMES
Meaning
Any scheme or arrangement that complies with the requirements listed in sub-section (2) of
section 11AA of the SEBI Act is considered a collective investment scheme. A CIS is any plan
or arrangement created or made available by a business in which the contributions or payments
made by investors are gathered and used with the goal of receiving profits, income, produce,

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or property and are managed on the investors' behalf. Investors have no direct influence over
how this scheme or arrangement is run on a daily basis.
Parties involved
The Parties involved in Collective Investment Schemes are :
1) Shareholders
2) Collective Investment Management Company
3) Trustee
4) Manager of the Fund
Benefits of Collective Investment Schemes
The advantages of participating in a collective investment plan are as follows:
• Portfolio of Securities
An investor who is thinking about investing in a CIS would have a diverse portfolio to
take into account. Therefore, an investor can select an appropriate portfolio to invest in
based on his needs.
• Maximisation of Profits
Profits can be maximised with the help of this method. The returns would be maximised
by using diverse investment types in various collective investment schemes.
• Diversification
Diversification of the portfolio is one of the key goals of investing in such a programme.
One can increase returns and lower investment risk by diversifying their portfolio.
• Liquidity
Schemes for collective investment are very liquid and marketable. Therefore, thinking
about investing in such a strategy would maximise the investor's income.
2.4.6 REAL ESATE INVESTMENT TRUSTS
What are REITs?
Real estate investment trusts, or REITs, are businesses that own and manage properties in
order to make money. Companies that manage the portfolios of high-value real estate
properties and mortgages are known as real estate investment trust companies. For instance,
they rent out properties and get paid for it. The stockholders are then given income and
dividends from the rent that was thusly collected.

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Typically, REITs give investors the chance to own expensive real estate and give them the
chance to generate dividend income to eventually increase their capital. Investors can take
advantage of the chance to increase their capital and produce income at the same time in
this way.
Anyone may own or finance real estate through REITs in the same way that one may invest
in other sectors of the economy: by purchasing shares. The investors of a REIT receive a
portion of the revenue generated by real estate investment, similar to how shareholders gain
from owning shares in other firms, without actually having to go out and purchase or finance
real estate.
Structure of a REIT
Manager
Responsible for the daily management and operations of the REIT; accountable for overseeing
all aspects of REIT asset management, including dividend declaration, appointment of auditors,
primary valuer, and main valuer appointment.
Principal valuer
Need to be a registered valuer in accordance with Section 247 of the Companies Act of 2013,
have at least five years of real estate valuation experience, be hired to provide an asset valuation
for each asset purchase or sale by REIT, and be accountable for the impartial, accurate, and fair
valuation of REIT assets.
Trustee
should not be a close associate of the Sponsor, Manager, or Principal Valuer. The trustee is in
charge of holding REIT assets in its name and making sure that they are legally and marketable
title. He is entrusted with the fiduciary duty of ensuring correct use of the subscription money,
ensuring that all significant contracts entered into on behalf of the REIT are legitimate, valid,
binding, and enforceable, and supervising Manager's operations and acquiring quarterly
compliance certificates.
Sponsor
He is in charge of establishing the REIT. A person is also considered a Sponsor if they exchange
their SPV shares for REIT units.
Unit holder
Foreign investors are also allowed to invest in a REIT, subject to permits from the Reserve
Bank of India (RBI) and Government of India. can be any individual, with the exception of the
Trustee, Principle Valuer, or another REIT.
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Types of Properties REITs Invest In

REITs are experts at making investments in a range of properties that generate income. Let's
look at a few typical ones.
Residential REITs
These REITs are the ones that own and manage rental homes. These range from rental homes
for one family to multiple apartment complexes. The demand for rental housing has an impact
on the value of these REITs. Due to the fact that housing and rent typically take up a larger
portion of most people's budgets, residential REITs are more resilient to recessions.
Commercial REITs
Commercial REITs focus on overseeing commercial real estate. This group of properties
includes office buildings, warehouses, and industrial facilities as well as shopping centres and
other retail establishments. Because they are more prone to economic volatility than residential
REITs, they frequently offer larger returns.
Health Care REITs
These kinds of REITs focus on real estate with a medical theme. These kinds of REITs, which
include senior housing complexes, research facilities, and medical office buildings among
others, each have advantages and disadvantages. They perform well in a diversified portfolio
if other assets are not impacted by shifts in medical demand or health care legislation.
Types of Real Estate Investment Trust (REIT)
Equity
One of the most common types of REIT is this one. Typically, it focuses on running and
overseeing commercial buildings that produce income. Notably, rents are a typical source of
income in this area. Equity REITs are the owners of a variety of property types, including
hotels, offices, malls, and more. Rent on those assets accounts for the majority of the income
for equity REITs. Equity REITs distribute dividends to their stockholders once a year after
covering operating costs.
Mortgage
It is also known as mREITs, and its primary activities include extending mortgage facilities
and making loans to business owners. Additionally, REITs frequently buy mortgage-backed
securities. Mortgage REITs also make money through interest on the money they lend to
business owners. Both residential and commercial buildings may be financed by mREITs.
Interest earned on investments in mortgages or mortgage-backed securities provides the
majority of mREITs' income.
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Commercial real estate mortgages have higher interest rates than those underpinning residential
real estate because they are viewed as riskier. As a result, individuals who invest in commercial
mortgage REITs will benefit from higher interest rates (although taking on greater risk) than
those who do so in residential mortgage REITs.
Hybrid
With this choice, investors can diversify their holdings by putting money in equity and
mortgage REITs. Therefore, the sources of income for this specific type of REIT are both rent
and interest. They provide investors with more variety and better defence against fluctuations
in the real estate market. They can complement portfolios that are focused on growth and
income equally effectively.
Private REITS, publicly traded REITS, and publicly non-traded REITS are a few further
categories.
Publicly Traded REITs
The NSE or BSE, for example, are stock exchanges where these REITs are traded. They are
accessible to all kinds of investors and are extremely liquid, meaning they may be bought or
sold at any moment, preventing your money from being locked up. Any online trading platform
allows you to open a brokerage account and start buying REITs. For their real estate, the vast
majority of investors purchase publicly traded REITs.
Non-Listed REITs
All people can purchase this kind of REIT, although it is not listed on public exchanges. There
are both ethical and dishonest justifications for this, such as when a project calls for maintaining
a low profile for competitive purposes. You need to be aware of who you're dealing with and
have a thorough understanding of the project and its risk because these ventures frequently lack
transparency and frequently demand upfront payments.
A bigger return that represents the higher risk you're taking is the potential upside. For
inexperienced investors, there are major potential drawbacks as well. These REITs merely need
to submit a report to the government in order to be in compliance with the rules. Purchasing a
public non-listed REIT entails giving up consumer rights and legal channels for redress, in
addition to the danger of fraud.
Private REITs
The general public cannot invest in these kinds of securities. They are only offered for sale to
accredited or institutional investors and are not registered. Since they might be difficult to sell,
these REITS sometimes have high minimum investments and are regarded as illiquid
investments.

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Benefits of REITs :
Consistent dividend income and capital growth
Over the long term, investing in REITs is expected to offer significant dividend income as well
as consistent capital growth.
Option to diversify
Investors have the chance to diversify their real estate holdings because the majority of REITS
are routinely traded on the stock exchanges.
Transparency in dealing
REITs must submit financial reports that have been independently audited since they are
subject to SEBI regulation. It makes the entire process open by giving investors the chance to
access information on matters such as taxation, ownership, and zoning.
Liquidity
Investors in REITs benefit from liquidity, or the capacity to quickly turn an investment into
cash, because these securities can be purchased and sold on significant stock exchanges. Since
actual real estate is illiquid and takes time to turn into cash, investors who buy real estate
directly frequently experience cash flow issues.
Passive Real Estate Ownership: When you invest in real estate passively, you get to reap the
rewards of home ownership without having to deal with the hassles of property management.
Disadvantages of REITs
Particularly with non-exchange traded REITs, there are considerable dangers. Non-traded
REITs have unique risks because they are not traded on a stock exchange:
Share Value Transparency
While the market price of a publicly traded REIT is easily available, estimating the value of a
share of a non-traded REIT can be challenging. Non-traded REITs normally don't reveal their
estimated share value until 18 months following the closing of their offering. Years may pass
after you make your investment before this happens. As a result, for a considerable amount of
time, you might be unable to determine the value and volatility of your non-traded REIT
investment.
Distributions May Be Paid from Offering Proceeds and Borrowings
The relatively high dividend yields of non-traded REITs in comparison to those of publicly
traded REITs may entice investors. Non-traded REITs usually pay distributions above their
funds from operations, in contrast to publicly traded REITs. They may do this by using the
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money from the offering and borrowing. This approach, which is uncommon among publicly
traded REITs, lowers the value of the shares and the amount of cash the business has to invest
in new properties.
Conflicts of Interest
Non-traded REITs often employ no staff save an external manager. Potential conflicts of
interest with stockholders may result from this. For instance, based on the volume of real estate
purchases and assets managed, the REIT might pay the external manager substantial fees. The
interests of shareholders may not always be aligned with those of these fee incentives.
Lack of Liquidity
Illiquid investments include non-traded REITs. Typically, they are difficult to easily sell on the
open market. With shares of a non-traded REIT, you might not be able to immediately sell an
asset to raise cash.
Indian framework for REITs
• A REIT must be registered under the SEBI (Real Estate Investment Trusts), Regulations
2014 and be a Trust established under the Indian Trust Act, 1882.
• Minimum asset size, to be proposed by REITs, is prescribed as Rs. 500 crore and the
minimum offer size for initial offer is prescribed as Rs. 250 crores. • REITs to raise
funds by an initial offer and subsequently through follow on offer, rights issue, qualified
institutional placement, etc.
• A REIT must have at least 200 subscribers to be formed (excluding related parties)
• Listing of REIT units on recognised Indian stock exchanges is a legal requirement.
Additionally, they must be in demineralized form.
• The minimum public share in the initial offering shouldn't be less than 25% of the
REIT's post-issue unit count.
• Additionally, at least 90% of the sale proceeds from the sale of assets must be
distributed to unit holders, unless they are reinvested in another property.
In India, since there is no real estate sector regulator, the establishment of REITs is a positive
development that would assist bring in:
1. liquidity
2. transparency
3. better governance
4. organised platform for retail investment

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5. an ecosystem, which is professionally managed and protects investors

Generally speaking, the Indian REIT regime is on par with the worldwide REIT framework
and appears to have all the necessary components to provide the Indian real estate market the
proper boost.

IN-TEXT QUESTIONS
5. ____________ is the market value of the fund's assets divided by the
number of outstanding Units in the fund.
a) NAV c) NTV
b) NUV d) None of above
6. Contracts known as options grant buyers
a) The commitment to purchase or dispose of an underlying asset
b) The capacity to possess an underlying asset
c) The right to buy or sell an underlying asset
d) The option to change payment sources
7. Which of the following qualifies as both an investment and insurance?
a) Endowment plan b) Unit Link Insurance Plan
b) Money back policy d) Mutual Funds
8. ETFs have much lower expense ratio than traditional mutual funds. True
or False?
9. _____ can finance both residential and commercial properties.

2.6 SUMMARY

A financial instrument that is fungible and negotiable and has some kind of monetary
worth is referred to as a "security". Security invested in by the investor can be either an equity
share, a debenture or a bond or a government security. The risk return characteristics of all of
these securities vary and investor chooses one of them or creates portfolio depending on his
risk appetite. Where equity shares are riskier and gives an ownership share in a company,
debentures and bond are much safer but offer lesser returns when compared to equity. With

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time there has been some progress in the investment avenues available to the investors.
Investors can now choose to invest in mutual funds, REITs, ETFs, or collective investment
schemes. More risky option would be to invest in derivatives which has the potential to offer
higher returns but not without the commensurate high risk involved.

2.7 GLOSSARY

Security: Any financial asset that can be traded is considered to be a security.

Equity shares: As a long-term financing alternative for businesses seeking money, equity
shares are offered. Each equity share is a fractional ownership interest in the company. The
public is given the chance to invest in equity shares, often known as common stock or common
shares.
Volatility: A term frequently used to describe the degree of risk or uncertainty associated with
the magnitude of variations in a security's value.
Debentures: A debenture is a medium- to long-term debt instrument used by large companies
to borrow money, at a fixed rate of interest, repayable after the maturity period is over.
Government securities: Government securities are financial instruments that are issued by the
national and state governments with a promise of the full repayment of invested principal at
maturity of the security.
AMC: Asset Management Company
Interval Funds: Interval funds combine the features of open-ended and close-ended schemes
of mutual funds.
NAV: The net asset value of an investment fund is calculated by dividing the net value of the
fund's assets less its liabilities by the number of outstanding shares. Most frequently applied to
mutual funds or exchange-traded funds (ETF).

2.8 ANSWERS TO IN-TEXT QUESTIONS

1. Common stock 6. The right to buy or sell an underlying

2. Fixed income asset
3. Derivatives 7. Unit Link Insurance Plan
4. All of the above 8. True
5. NAV 9. mREITS

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2.9 SELF-ASSESSMENT QUESTIONS

1. What do you understand from the term security?

2. Are bonds and debentures fixed income securities? Discuss their types.
3. Elaborate on the advantages and disadvantages of investing in government securities.
4. Why do people choose to invest via mutual funds? Explain.
5. ULIPs offer a combination of insurance and investment. Discuss.
6. Which features of ULIPs make them attractive to investors?
7. Explain the term ETF. What are their types?
8. Discuss in detail the types of REITs and the properties they invest in.
9. What are futures and forwards? Differentiate between the two.
10. In the absence of a regulator for the real estate sector, introduction of REITs in India is
a welcome move that will help bring in?
i. liquidity
ii. transparency
iii. better governance
iv. organised platform for retail investment
a) i, ii
b) ii, iii
c) iii, iv
d) i, ii, iii, iv
11. Which of the following statements regarding ETFs are false?
a) They are similar to mutual funds in a certain manner but are more liquid
b) They are listed and traded on exchanges like stocks.
c) ETFs are Index Funds
d) None of the above

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12. Which of the following statements about ULIPs are true?

a) An opportunity to partly withdraw funds to meet any financial emergencies after
the 5-year lock-in period.
b) Choose a particular method of premium payment from yearly, half-yearly,
quarterly or monthly.
c) ULIPs invest in equity funds only.
d) Both 1 and 2
13. Futures differ from forwards because they are
a) Used to hedge portfolios.
b) A standardized contract.
c) Used to hedge individual securities.
d) Used in both financial and foreign exchange markets
14. Which of the following is not a financial derivative?
a) Futures
b) Options
c) Stock
d) Forward contracts
15. The aim of which of the following type of mutual funds is to provide both growth and
regular income?
a) Growth fund
b) Income fund
c) Balanced fund
d) Both 1 and 2

2.10 REFERENCES/SUGGESTED READINGS

Chandra, P. Investment Analysis and Portfolio Management. McGraw Hill Education.

Greeshma. V, Sanesh. C. Fundametals of Investment. Kerala:University of Calicut.
R. Kasilingam. Investment and Portfolio Management. Pondicherry University.
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Levišauskaite , K. (2010). Investment Analysis and Portfolio Management. Lithuania: Vytautas

Magnus University.
Nidhi Bothra . Mutual Funds. Vinod Kothari & Company.
Real Estate Investment Trust (REIT) regime in India. (2015). New Delhi: Grant Thorton.
Rustogi, R.P. Fundamentals of Investment. Delhi: Sultan Chand & Sons
Singh, P. (2018). Fundamentals of Investment. Delhi: Himalaya Publishing House.
Smart, S.B., Zutter, C J. (2020). Fundamentals of Investing. New York: Pearson
Smart, S.B., Zutter, C.J., Vishwakarma, V.K. & Yüce, A. (2022). Fundamentals of Investing.
Canada: Pearson

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LESSON 3
INDIAN SECURITEIS MARKET
Dr. Reema Aggarwal
Assistant Professor
Campus of Open Learning
reemaaggarwal@sol-du.ac.in
&
Manisha Yadav
Assistant Professor
Campus of Open Learning
University of Delhi
manishayadav@sol-du.ac.in

STRUCTURE

3.1 Learning Objectives

3.2 Introduction
3.3 Money Market
3.3.1 Money market instruments
3.4 Capital Market
3.4.1 Difference between capital market and money market
3.5 Primary Market
3.5.1 Role of Primary Market
3.5.2 Types of issue in Primary Market
3.5.3 Difference between the IPO and FPO
3.5.4 Difference between the OFS (offer for sale) and public offer (IPO/FPO)
3.5.5 Methods of IPO pricing
3.5.6 Book building method
3.6 Secondary Market
3.6.1 Role of Secondary Market
3.6.2 Trading systems in secondary market
3.6.3 Segments in secondary market
3.6.4 Difference between the primary and secondary market
3.7 Summary
3.8 Answers to in-Text Questions
3.9 Self-Assessment Questions
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3.10 Suggested Readings

3.1 LEARNING OBJECTIVES

After reading this lesson, students will be able to:

• Understand the elementary structure of the Indian securities market
• Comprehend the various financial instruments of the money market
• Differentiate between money and capital markets
• Grasp the importance of primary and secondary market
• Apprehend the advent of offer-for-sale instrument
• Differentiate between primary and secondary markets
• Wrap their heads around the book building process

3.2 INTRODUCTION

In the preceding lesson, you got acquainted with various financial securities. In the present
lesson, we will endeavour to subsume these instruments under different types of the Indian
securities market. We will mount a structure of the Indian securities market for a holistic
understanding of the markets. Essentially the lesson will help you in answering the following:
1. What is the role of the money market?
2. How do money and capital markets cater to the different needs of the borrowers and
savers to boot?
3. How does the primary market nurture capital formation in an economy?
4. How the primary market shares a symbiotic relationship with the secondary market?
5. Which is the most efficient method to discover the price a potential investor is willing
to fork out for new securities?
6. How can an underwriter issue more shares than initially planned by the issuer?
First, let's slice and dice the jargon securities market. What are securities in stock markets?
"Security" is a financial instrument that is fungible, negotiable and has a monetary value

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attached to it. A "Market" is a composition of systems, institutions, procedures, social relations,

or infrastructures whereby parties engage in exchange. Thus, a security market is a constituent
of a broader financial market where securities get traded based on market forces of demand
and supply.

Fig 3.1: Structure of Indian securities market

The above diagram succinctly depicts the working of the securities market. The two main
constituents of the market get subsumed under market participants and market segments.
Market participants: there are three categories of market participants: issuers, intermediaries,
and investors. The issuers of the security are the borrowers or deficit
savers. The investors are the lenders or surplus savers who deploy their saved money by
subscribing to the issued securities. The intermediaries are the agents facilitating the transfer
of funds from the savers to the borrowers for a commission. Resource mobilisation and
channelisation get continuously monitored by the regulators. The regulator's prime job is to
protect the investors and ensure fair market practices are deployed, especially by the
intermediaries and the issuers.

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Market segment: the securities market has broadly two segments; the money market and the
capital market. The money market is the market for short-term finance, and the capital market
is the market for long-term finance. The capital market further has two branches, one is the
primary market, and the second is the secondary market. Let us now peruse the details of each
market.

3.3 MONEY MARKET

An institution—government or corporate—has two types of capital requirements: (a) for day-

to-day operations, known as Working Capital requirements, and (b) for the long-term
advancement of the business, known as Fixed Capital requirements. The money market
satiates the former, i.e. need for short-term finance.
The money market consists of negotiable debt instruments of short-term maturity traded over
the counter (OTC). OTC trade means these get privately traded—proffered to a select clique
of people—instead of via a centralised exchange. These instruments are highly liquid and get
vend at a wholesale level. Treasury bills (T-bills), certificates of deposits (CDs), and
commercial papers (CPs) are some prominent cases in point. In India, commercial banks,
cooperative banks, primary dealers (PDs), insurance companies, mutual funds (MFs), non-
banking financial companies (NBFCs), and corporates are permitted to participate in money
markets. Retail investors can have a piece of the pie indirectly through money market mutual
funds (MMMFs).
The money market is an indispensable cog in the financial markets. It facilitates the efficient
use of funds by connecting the surplus savers having excess funds for a short tenure with the
deficit savers wanting them for their daily operations. Additionally, the short-term money
market rates often serve as operational targets of the central banks, thereby playing a pivotal
role in the transmission of monetary policy. Therefore it only stands to reason that the
Reserve Bank of India (RBI) is the regulator of the money markets in India.

3.3.1 Money market instruments

These instruments facilitate the mobilisation of excess funds for a short tenure with surplus
savers and deploy it to deficit-savers to meet their day-to-day operations requirements.
The money market includes short-term instruments: unsecured (uncollateralised) interbank
loans, secured (collateralised) loans (including repurchase agreements), T-bills, CPs, and CDs.
A well-functioning interbank market (where banks borrow from and lend to each other) can
ensure efficient liquidity transfer between surplus and needy banks. Following are a few
prominent instruments used:
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1. Interbank lending market: RBI obliges banks to salt away some cash or cash
equivalents in reserve so that they never run short and have to refuse a customer's
withdrawal, possibly triggering a bank run.
Banks borrow and lend money in the interbank lending market to manage liquidity
and satisfy reserve requirements (CRR and SLR) regulations. The interbank lending
market can be further divided into:
a. Call Money Market: as the name alludes, such a loan/debt is repayable on
demand. The maturity period spans from one day to fourteen days or overnight
to a fortnight. The money lent for one day in this market is known as "call
money". In India, MIBOR (Mumbai Interbank Offered Rate) is the proxy for
the call rate. It is the benchmark rate for the call money market. The money lent
for more than one day and up to fourteen days is known as "notice money".
Point to ponder: WACR (weighted average call rate) is the operating target of
monetary policy in India.
b. Term Money Market: in this market, short-term finance with a maturity period
stretching from fourteen days to a year gets traded. In India, it is an
underdeveloped market primarily due to two reasons. First, uncertainty is
associated with the extended time period involved. Second, borrowing upward
of fourteen days is accounted for in the calculation of NDTL (Net demand and
time liability), which calls for higher SLR and CRR maintenance rendering the
trade pricier to the borrower.
2. Repo: During COVID, you must have come across repo rate (also known as policy
rate) tweaks by the RBI. Essentially repo is a money market instrument which enables
collateralised short-term borrowing and lending through purchase/sale. Under a repo
transaction, a holder of securities sells them to an investor with an agreement to
repurchase at a pre-determined date and rate.
Moreover, during foreign exchange market volatility, repos have been used to prevent
speculative activity as the funds tend to flow from the money market to the foreign
exchange market. For instance, a fixed-rate repo auction system was instituted in
November 1997 to ensure an effective floor for the short-term interest rates to ward off
the spread of contagion during the South-East Asian crisis. The repo rates were reduced
with the return of capital flows, which imparted stability to the foreign exchange
market.
3. Commercial Paper (CP): is an unsecured promissory note issued by non-banking
companies and All-India Financial Institutions (AIFIs). The issuer can issue CP in
multiples of Rs. 5 lakhs, with a maturity period ranging from 15 days to 1 year.

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Additionally, the issuer base has widened by allowing primary dealers (PDs), satellite
dealers (SDs), and AIFIs, apart from corporates to issue CPs to access short-term funds.
The pricing of CP usually lies between some representative money market rate (which
represents the opportunity cost of bank funds) and the scheduled commercial banks'
lending rate (since corporates do not otherwise have the incentive to issue CP).
Schedule commercial banks drive the demand for CPs in India, which, in turn, is
governed by bank liquidity.
4. Certificates of Deposit (CD): The certificate of deposit is an unsecured negotiable
money market instrument issued in a dematerialised form or as a Usance promissory
note. Scheduled commercial banks, regional rural banks (RRBs), small finance banks
(SFBs), and AIFIs (as directed by RBI) are allowed to issue CDs with a minimum
denomination of Rs. 5 lakh and multiples of Rs. 5 lakhs thereafter. The maturity period
should be more than seven days but less than a year. However, banks are not allowed
to sanction loans against CDs.
5. Treasury bills (T-bills): T-bills are zero-coupon securities issued by the RBI on behalf
of the GOI (Government of India). Being zero-coupon securities means these are issued
at a discount and get redeemed at face value. Currently, in India, three types of t-bills
are issued with a tenor of 91 days, 182 days, and 364 days. T-bills get administered
either to meet the short-term fund requirements of the GOI or to regulate the money
supply in the market via the OMO (open market operation) of the RBI. As per the RBI
regulations, minimum of Rs. 25,000 is to be invested by any willing investor to procure
these instruments. Higher investments must be made in multiples of Rs. 25,000.
6. Money Market Mutual Funds (MMMFs): These are open-ended debt funds with a
maturity of less than one year. MMMFs invest in short-term debt instruments (like t-
bills, repos, CPs, CDs, etc.) and cash equivalents that are rated high quality. It is for
this reason that MMMFs are considered an investment with minimal risk. MMMFs,
which were regulated under the guidelines issued by the Reserve Bank, have been
brought under the purview of the SEBI regulations since March 7, 2000.

3.4 CAPITAL MARKET

Remember the two types of capital requirements of an institute we advert to at the beginning
of the lesson. It is a market for long-term financial instruments. Banks, pension funds, mutual
funds, insurance companies, and other investors are the suppliers of funds. Corporations and
governments are the general seekers of these funds. The stock market, bond/debt market and

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mutual funds are the most prominent forms of capital markets. The capital market has two
segments, namely, the primary market and the secondary market. SEBI (securities and
exchange board of India) is the regulator of the capital markets in India. It aims to protect the
interest of investors, promote the growth of the securities market, and regulate such markets.
Today there are myriads of capital market instruments available. Some of the most well-known
are enumerated below:
1. Equity (instrument of ownership)
2. Debt (loan instruments)
a. Corporate debt (debentures and bonds)
b. Government debt (dated G-secs)
3. Mutual funds (growth funds, income funds, balanced funds, money market mutual
funds, index funds, etc.)
The nitty-gritty of all the above-mentioned instruments has already been discussed in the
previous lesson.

3.4.1 Difference between capital market and money market

S.No. Basis Money Market Capital market

1. Definition It is a market for short-term It is a market for long-term

securities. securities.

2. Maturity Less than a year One year or more

3. Liquidity Highly liquid Comparatively lower

4. Return on investment Lower than capital market Higher than money market

5. Instruments Call money, term money, CDs, Equity, debt, mutual funds, etc.
CPs, T-bills, MMMFs, etc.

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IN-TEXT QUESTIONS
1. Who regulates the money market in India?
a. RBI b. PFRDA c. SEBI d. IRDAI
2. Who regulates the MMFs?
a. RBI b. PFRDA c. SEBI d. IRDAI
3. Which of the following is a market participant?
a. Issuer b. Investor c. Intermediaries d. All of the above
4. What is the minimum amount of money to be invested in a T-bill?
a. Rs. 25,000 b. Rs. 20,000 c. Rs. 30,000 d. Rs. 45,000

3.5 PRIMARY MARKET

Generally, when an enterprising individual or group of individuals starts a business venture,

they invest their own personal savings in conjunction with contributions from friends and
relatives.
However, this may not be feasible in the case of capital-intensive or large projects as the
entrepreneur (promoter) may not be able to bring in his share of equity, which may be
sizable, even after availing term loans from Financial Institutions/Banks. Thus, the
availability of capital is a major constraint for setting up or expanding ventures on a large
scale. Instead of depending upon a limited pool of savings of a small circle of friends and
relatives, the promoter has the option of raising money from the public across the
country/world by issuing) shares of the company. For this purpose, the promoter can invite
investment to his/her venture by issuing an offer document which gives full details about the
track record, the company, the nature of the project, the business model, etc. If the investor is
comfortable with this proposed venture, he may invest and thus become a shareholder of the
company. Through aggregation, even small amounts available with a very large number of
individuals translate into usable capital for corporates. The primary market is a market
wherein corporates issue new securities for raising funds generally for the long-term capital
requirement.

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A primary market is, hence, a source of new securities where the investor directly buys the
securities from the issuer. The issuer can be a government company or a corporate that issues
the new securities (debt, equity, etc.) at face value or a discount/premium. Funds raised can
be used for a new venture, expansion, modernisation, diversification, etc. The primary market
plays a pivotal role in capital formation in an economy. SEBI (securities and exchange board
of India) is the regulator of the primary market.
For example, Life Insurance Corp (LIC) IPO was the biggest IPO in India in 2022, raising
Rs. 20,557 Crore for the government.

3.5.1 Role of Primary Market

The primary market holds immense significance to the economy of a country. The following
points underscore the role of the primary markets in an economy:
1. Acts as a conduit for the sale and purchase of new securities.
2. Bridge the gap between surplus-savers and deficit-savers.
3. Enables productive use of funds by diverting small savings towards manufacturing new
products, services, etc.
4. It helps in the efficient price discovery of new securities.

3.5.2 Types of issue in Primary Market

There are five types of primary market issues which are succinctly laid out below:
i. Public Issue: When a company raises funds by selling (issuing) its shares (or
debenture/bonds) to the public through the issue of an offer document (prospectus), it
is called a public issue. It is of two types:
a. IPO (Initial Public Offer): When an unlisted company makes a public issue for the
first time and gets its shares listed on the stock exchange, the public issue is called an
initial public offer (IPO).
For instance: Zomato introduced its IPO on 14th July 2021 @ Rs. 76, morphing from
a private company into a public company.
b. FPO (Follow-on Public Offer): When an already listed company makes a public issue
to raise capital, it is called a follow-on public offer (FPO).
For instance: In December 2022, Adani Enterprise's BOD approved the FPO of Rs.
20,000 crores. If it goes through, then this will be India's biggest FPO ever.
ii. OFS (Offer for sale): To promote greater transparency, SEBI in the year 2010
introduced Minimum Public Shareholding (MPS) guidelines. Accordingly, every listed
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company must have a minimum of 25% free float. To this end, in 2012, SEBI proposed
an avenue coined as offer-for-sale. Offer-for-sale provides a way for the promoters or
non-promoters with shareholding upwards of 10% to divest/offload it. OFS window is
open only for a day, and the issuer is required to apprise the stock exchange of the issue
at least two days in advance. Therefore, it is much more time effective in comparison
to the FPO. Recently, SEBI exempted PSUs from the requirement of the MPS.
For instance: In 2021, GOI sold 5% of the total equity of the Steel Authority of India
Limited (SAIL) through OFS.
iii. Indian Depository Receipts (IDR): The world is virtually a borderless state, at least
from a financial perspective. So, when a foreign company listed on the stock exchange
abroad wish to raise money from Indian investors by selling (issuing) shares. These
shares are held in a trust by a foreign custodian bank against which a domestic custodian
bank issues an IDR denominated in Indian rupees. IDR gets traded on the stock
exchange like any other shares, and the holder is entitled to rights of ownership,
including receiving the dividend.
Standard Chartered Plc. is the first to issue an IDR.
iv. Private placement: to circumvent the elaborate process concomitant to the public
issue, an instrument named private placement is put to use. Under the private
placement, only a hand-picked cohort of people can subscribe to the securities. Unlike
a public offering, private placement is exempt from filing an offer document with the
SEBI for its comments. Further, it may not involve any form of a general
announcement, general solicitation, advertising, or any seminar or meeting whose
attendees have been invited by a general solicitation or advertisement. Corporations
access the private placement market because of its inherent advantages:
a. It is a cost and time-effective method of raising funds.
b. It can be structured to meet the needs of entrepreneurs and investors.
c. The private placement does not require detailed compliance with formalities as
required in a public issue
v. Rights Issue: is a route adopted by a company to reward its existing shareholders for
their patronage by extending to them the first dibs on the new securities. Put
differently, when a company raises funds from its existing shareholders by selling
(issuing) them new shares/debentures, it is called a rights issue. The offer document
for a rights issue is called the Letter of Offer. Existing shareholders are entitled to
apply for new shares in proportion to the number of shares already held. Illustratively,
in a rights issue of a 1:5 ratio, the investors have the right to subscribe to one (new)
share of the company for every five shares held by the investor.

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For instance: In May 2020, the Mukesh Ambani-led RIL came with a rights issue of
Rs. 53,125 crores in the ratio 1:15. It is the biggest ever rights issue in India.

3.5.3 Difference between the IPO and FPO

S.No. Basis IPO FPO

1. Meaning IPO is the issue or sale of FPO is the issue of securities to
securities by a company to public by an already listed
public for the first time. company.
2. Issue It is the first issue by the Any issue subsequent to IPO is
company. termed as FPO. So, it may be
second issue, third issue, etc.
3. Issue company Unlisted company. Listed company.
4. Nature of IPO is the issue of new or FPO is the issue of securities
Securities fresh securities. which are already listed on
exchange.
5. Risk High Comparatively low
6. Return IPO is more profitable. FPO is comparatively less
lucrative.

3.5.4 Difference between the OFS (offer for sale) and public offer (IPO/FPO)

S.No. Basis OFS Public offer

1. Meaning OFS facilitates promoters or In an IPO an unlisted company
non-promoters (with issues fresh shares and goes
minimum 10% stake) of a public. In FPO, an already listed
listed company to dilute or company issues fresh shares to
offload their holding in that new or existing shareholders.
company in a transparent
manner with wider
participation through
exchange platform.

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2. Objective It aims to meet the legal IPO and FPO are brought with
requirements of minimum an aim to raise finance for the
public shareholding. company.
3. New securities No new securities are created New securities are created
created because it is not a fresh issue. through a fresh issue.
4. Time period It is available for one trading IPO and FPO are lengthy
day only. processes which take 3-10 days.
5. Price band Only a floor price is fixed by There is a price band in which
the company/. investors can bid.
6. Cost Cost effective as no Higher cost as lot of
documentation requirements documentation like draft red-
like draft red-herring herring prospectus, book
prospectus. building, etc. is required.

3.5.5 Methods of IPO pricing

There are three methods to price an IPO, viz. fixed price method, book building method, and
combination of both.
i. Fixed Price Method: Under the fixed price method, the price of the offered shares is
pre-decided by the issuer company. However, the demand for the IPO cannot be
anticipated with certitude. The accurate demand is known after the issue is closed.
For instance: Phil Knight, in his novel The Shoe Dog, reveals that he pegged Nike's
share @ $22 apiece because he believed that Nike was no less than the company
Apple—whose shares were issued in the same week @ $22 per share. This is a very
precarious methodology to determine the price of new securities.
ii. Book Building Method: It is essentially a process of price and demand discovery. The
issuer company offers a price band to the prospective investors, who then bid the price
(within the band) and the corresponding quantity they wish to purchase. This process
is known as building the book, where the issuer elicits demand for its offer. The book
is open for bids for 3-7 days (3 more days in case of price band revision). The issue
price gets determined after the book closure.
For instance: Zomato set the price band of Rs. 72-76 for its IPO. On the back of
overwhelming demand, the final cut-off discovered was Rs. 76 per share.
iii. Combination of fixed price and book building methods: As per the SEBI's
guidelines, an issuer company can either issue securities through a 100% book building

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process or the combination of fixed price method and book building process (75% of
the net offer through the book building process and 25% at a price ascertained through
the book building process).

3.5.6 Book building method

The book building method is the mechanism to find the optimal price for an IPO/FPO. Under
this method, the underwriter/book runner attempts to find a cut-off price at which the
IPO/FPO will neither be oversubscribed nor undersubscribed. Book building helps in
efficient price discovery by gauging the market demand for the securities.
Difference between Book Building Issue and Fixed Price Issue
S.No. Basis Fixed price method Book building
1. Pricing Price is pre-determined before Price is determined after
the issue. receiving the bids.
2. Demand Demand for the securities can be Demand can be known every day
known only after the issue is during the bidding open period.
over.
3. Preference Not many issuers prefer this. It is widely preferred in the
developed world.
4. Effectiveness Considered to be flawed method Best way to determine price as it
of pricing. is premised on the demand.

Book Building Process

1. The issuer nominates the lead merchant banker (listed with SEBI) as a 'book runner'.
2. The issuer specifies the number of securities to be issued and the price band for the
bids.
3. The issuer also appoints the syndicate members with whom the orders are to be placed
by the prospective investors.
4. The syndicate members input the orders into an 'electronic book'. This process is known
as 'bidding'.
5. At the close of the book, the book runner, along with the issuer, decides the final
price/cut-off price at which the securities are to be issued.

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6. The securities get issued to the bidders who bid at or above the cut-off price. The rest
gets a refund.
Please note: The retail investors (ones investing below Rs. 2,00,000) are given the option in
the bid form to bid at the cut-off price.
Greenshoe option
A greenshoe option is an over-allotment option. It is the right extended by the issuer to the
underwriter to sell more shares than initially planned by the issuer if the demand overshoots
the supply of the securities. It acts as a stabilising force in case there is an overwhelming
demand in the market. After the issue, two scenarios can emerge:
a. The price of the security immediately plummets in such a scenario the underwriter can cover
his short position by buying the shares from the market itself instead of buying it from the
issuer at an issue price.
b. There is an upsurge in the price; in this case, the underwriter will exercise his right and cover
his short position by buying the securities at an issue price from the issuer, hence booking a
profit.
In both scenarios, the right of the green shoe option helps in taming the ensuing price volatility
immediately after the IPO in the market.
For example: At the time of the META (facebook inc.) IPO in 2012, the underwriter (Morgan
Stanley) sold 484 million shares at $38 apiece against the planned 421 million shares (15%
above the initial allocation), effectively producing a short position of 63 million shares.
However, the share prices declined after the issue, so the underwriter covered their short
position by buying the shares from the market without exercising their greenshoe option right
and hence, warding off the steeper fall in the prices.
(Note: Remember we mentioned SAIL FPO under the FPO section. In that issue also, the option
to sell an additional 5% shares of SAIL got exercised. The overall divestment, firm plus
greenshoe, was 10%.)

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IN-TEXT QUESTIONS

5. As per MPS regulations, what is the minimum share of free float?

a. 10% b. 12.5% c. 30% d. 25%

6. Which is the most efficient method of ascertaining the issue price for new
securities?

a. Fixed-price method b. Book-building method

c. Combination of Fixed-price and book building d. Any

7. IDR is denominated in which currency?

a. Dollar b. Indian rupee c. Yen d. Euro

8. What is an offer document called at the time of a rights issue?

3.6 SECONDARY MARKET

Growth of the primary market and liquidity in the financial system needs a well-functioning
efficient secondary market. The secondary market represents a market where the purchase and
sale of already issued security occur. The secondary market helps investors in adjusting the
risk-return of their holdings. It also allows investors to convert their holdings into cash form.
The secondary market also provides signals through movement in the price of a security, which
helps organisations allocate funds in the primary market.

3.6.1 Role of Secondary Market

1. Liquidity and Marketability: Secondary market helps investors convert their holdings
into cash. It provides a market for investors for the sale and purchase of securities. The
presence of the secondary market provides some assurance to investors that at any point of
time they could convert their holdings to cash.

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2. Provides Information: Through the secondary market, investors receive regular

information about securities. The market forces, i.e., demand and supply, help investors in
determining the price of the security along with associated risk.
3. Barometer of Economy: It is an indicator of measuring the economic health of a country.
Any major change at country level could be seen through the rise and fall of security price.
The rise in stock values shows the economy is in a boom and the decline in stock values
shows a slump in the economy. Through stock market activity, the strength of the economy
can be gauged. Therefore, it is also known as the Barometer of the economy.
4. Helps investors build and revise their portfolio: The movement in the stock market
facilitates investors in building their portfolios and revising their existing portfolios.

3.6.2 Trading systems in secondary market

There are following two types of systems in secondary markets through which the market
operates:

i. Over the counter (OTC) market: OTC is an informal trade without formal
exchange or a formal exchange regulator. Government securities are primarily traded
in this market. Additionally, this market is a good option for spot trades where
immediate delivery and payment are required.
ii. Exchange traded market: The stock exchange provides a platform for investors to
buy and sell securities. Earlier exchanges were physical places where buyers and
sellers used to interact physically. Eventually, with technological advancement,
physical exchanges moved to online platforms. All trades are settled in T days. The
exchange reduces the counterparty risk. Therefore, it has less risky than OTC (Over
the Counter market). Example- NASDAQ, NSE, BSE, etc., are a few examples of
stock exchanges.

3.6.3 Segments in secondary market

The secondary market can be further bifurcated into two segments: the cash and derivatives
market.
i. Cash Market: Immediate delivery of security takes place in the cash market. In the
cash market, the buyer receives the delivery of security, and the seller receives cash
immediately.
ii. Derivatives Market: Derivates market was introduced in 2000 in India to facilitate
the trade of derivatives in the stock exchange. Derivatives refer to securities whose

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value is derived from underlying assets. Here underlying assets could be the
currency, commodity, stocks, index, interest rate, etc. Derivatives include futures,
Swaps, options, and forwards. (Please refer to lesson no 2 to know more about
derivatives).

3.6.4 Difference between the primary and secondary market

Primary Market Secondary Market

Securities for the first time are issued in the In the secondary market, existing securities
Primary market by the new or existing are traded.
company.

Through the book-building method, the Through market forces (demand and supply)
company decides the security price. price of the security is determined.

The primary market provides a platform for The secondary market facilitates liquidity to
the company to raise funds, expansion and investors. It doesn’t provide a platform for
diversification. companies to raise funds for diversification
and expansion.

The primary market company is the seller, Both buyers and sellers are usually investors
and the investor is the buyer. in the secondary market.

Underwriters, registrars, merchant bankers, Brokers, sub-brokers, etc., are the main
collection banks, etc., are the main intermediaries in the secondary market.
intermediaries in the primary market.

The security price doesn’t fluctuate due to The price of a security fluctuates due to the
market forces, rather it remains fixed. interplay of market forces (i.e., demand and
supply of securities)

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IN-TEXT QUESTIONS
9. In which market new securities are launched?

a. Primary Market b. Secondary Market

c. Derivative Market d. Any of the above

10. In which market securities are traded privately?

3.7 SUMMARY

In this lesson, we understood the meaning of the securities market. A security market is a part
of a broader financial market where securities get traded based on market demand and supply.
There are three market participants, viz. issuer, intermediary, and investor. The securities
market has two constituents, viz. money market, and the capital market. The money market is
a market for short-term financial securities, whereas the capital market channelizes the funds
toward the long-term capital requirements of an issuer. The capital market can further be
bifurcated into the primary and secondary markets. The primary market is a market for new
securities, where the issuer directly interacts with the investor, on the other hand, the secondary
market is the market for previously issued securities. Under the book-building process, the
price of the new issue is not preordained, rather it is discovered through the bids submitted by
the prospective investors. RBI is the regulator of the money market (barring MMMFs) and
SEBI is the regulator of the capital market in India.

3.8 ANSWERS TO INTEXT QUESTIONS

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1. a. RBI 6. b. Book-building method

2. c. SEBI 7. b. Indian rupee
3. d. All of the above 8. Letter of Offer
4. a. Rs. 25,000 9. a. Primary Market
5. d. 25% 10. OTC

3.9 SELF- ASSESSMENT QUESTIONS

1. Write a short note on money market. (B. Com (P) DU 2018)

2. What is the role and importance of primary market?
3. Differentiate between primary and secondary market. Is their role complementary or
competitive to each other?
4. What is an IPO? Explain the process of book building. (B. Com (H) DU 2019)
5. Write a short note on secondary market.

1.15 REFERENCES/SUGGESTED READINGS

1. Tripathi, Vanita and Panwar, Neeti: Investing in Stock Markets. Taxmann Publications.
2. Chandra, Prasanna: Investment Analysis and Portfolio Management. McGraw Hill
Education.
3. Rustagi, R.P., Investment Management. Sultan Chand Publications.
4. Tripathi, Vanita: Security Analysis and Portfolio Management. Taxmann Publications.

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LESSON 4
MARKET PARTICIPANTS
Yogesh Sharma and Ankit Suri
Atal Bihari Vajpayee School of Management and Entrepreneurship
Jawaharlal Nehru University
Yogesh.ysharma93@gmail.com
ankitsuridse@gmail.com

STRUCTURE

4.1 Learning Objectives

4.2 Introduction to the stock market
4.3 Market participants
4.3.1 Issuer of the securities
4.3.2 Investors
4.3.3 Intermediaries
4.4 Role of the stock exchange
4.5 Stock exchanges in India
4.5.1 History and regulations
4.5.2 NSE and BSE
4.5.3 Role of SEBI
4.6 Securities (Stock) Indices
4.6.1 Broad Market Indices
4.6.2 Sectoral Indices
4.6.3 Thematic Indices
4.7 Summary
4.8 Glossary

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4.9 Answers to In-text Questions

4.10 Self-Assessment Questions
4.11 Objective Type Questions (MCQs)
4.12 References
4.13 Suggested Readings

4.1 LEARNING OBJECTIVES

The following are the learning objectives of the lesson:

• To Understand the role of market participants.
• To understand the various types of stock market participants.
• To understand the concept of a stock market index.
• To understand the various types of stock market indices.
• To understand how the stock market Index is formulated.
• To highlight the role of Stock Exchanges in the market.
• To understand the brief history of Indian stock exchanges.

4.2 INTRODUCTION TO THE STOCK MARKET

As we know that any business or corporation is a non-living entity that is owned by the
shareholders and has elected board members to oversee the proper functioning of its activities.
Even a school or college has a number of employees who work for a specific department in
order to ensure smooth operations like conducting exams, opening admissions, and regular
classes and timetable management. They also have a repository of marks obtained by every
student in each subject of a particular classroom. After the student gives the exam, the school
or college prepares and issues the result.
Similarly, in capital markets also, there are numerous participants investing in different
sectors by buying and selling shares at different prices. Somebody provides a platform to these
participants, and somebody else records their transactions and provides the final results of
buying and selling stocks. Just like exams have a limited time period to attempt the paper, stock

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markets also open and close every day at a specific time for a limited time period, which is
decided by the stock exchange platform.
The phrase "stock market" describes a number of marketplaces where shares of publicly
traded firms can be purchased and sold. Considering the stock market as a group of individuals
and institutions; these individuals and institutions collectively make the ecosystem where
mobilisations of savings from those who save and want to invest to those who run businesses
and want funding happens.
For the purpose of understanding, think of the stock market as a bank. Investors go to
the stock market in search of opportunities where they can invest their money and earn a decent
return just like depositors go to the bank to put their money in various kinds of deposit accounts.
The stock market then brings together the investors to the companies who are looking for
funding for their businesses just like banks lend the deposited money as loans to the businesses.
In fact, a stock market even brings together various investor who wants to buy and sell the
securities with each other. The function of moving savings towards funding needs is called
‘mobilisation of savings. Overall, A stock market as the name suggests is a marketplace which
links buyers and sellers.
Participants are all those parties who are connected to this ecosystem; this includes,
Issuers of securities (Companies) - those who need funds, Investor in these securities (Retail
investors, Domestic institutional investors, Foreign institutional investors, Qualified
institutional buyers, and High net worth individuals) - those who want to trade and invest and
Intermediaries (Stock exchange, Depositories, Underwriters, Regulators etc.) - those who
facilitate and regulate investment and trade.

Issuer of
Securities

Stock
Market

Intermediaries Investors

Fig 1: Stock market participants (Source: Author’s compilation)

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4.3 MARKET PARTICIPANTS

The stock market participants can be simply divided into three participants (Figure 1), i.e.,
1. Issuer of Securities,
2. Investors, and,
3. Intermediaries.
4.3.1 Issuer of the securities:
Any financial security (Equity Share, Debenture, Bond, etc) originates somewhere. The
point of inception of a security is called the issuer of such security. For eg., when a company
decides to open itself for the general public to invest in, such a company becomes an issuer.
The security which originates in such a process is a share. The "Issuer" is the organisation that
distributes or issues securities. The issuers are legally responsible for all responsibilities related
to the issuance, as well as for disclosing the financial situation, significant developments, and
any other operational actions in accordance with local rules.
The market where securities are circulated by the issuer for the first time is called the
primary market. Through a process called IPO (Initial public offering), the issuer asks the
general public to come and invest in the company’s shares. Thereafter, once the securities are
sold in the primary market, the task of the issuer becomes minimised and investors keep on
selling and buying the securities in the open secondary market via stock exchanges.
It is to be noted that, it is not necessary for that an issuer should only be a company; an
issuer can be an individual, national and international government (In case of sovereign bonds),
Asset management company (In case of mutual funds), and even Municipalities (In case of
municipal bonds).
4.3.2 Investors:
As the name suggests, an investor is a participant who invests his/her money by
purchasing stock in a company that is listed on the stock exchange. They are the buyers or the
backbone of the market. This is because a company’s financial stability depends on its
shareholders and their investments. Any announcements, such as merger, acquisition, or
divestment, if negatively perceived by the shareholders in the market can make them sell their
existing shares in the secondary market due to the fear of losing share value. Similarly, any
positively perceived news will allow the stock prices to increase and also increase the number
of buyers.

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Investors can be of two types:

a. Retail investors
These are the individual participants who directly invest in the stock market from their
Demat account. The threshold for investment for retail investors is Rs 2,00,000 or less.
Sometimes, It also includes high-net-worth individuals (HNIs), who have large financial
holdings to invest. (Usually between Rs 5 lacs to Rs 5 Crore).
b. Institutional investors
These are the financial institutional investors such as banks, mutual fund companies,
insurance companies, and other investment companies. It also includes qualified institutional
buyers (QIBs), who are deemed sophisticated investors.
4.3.3 Intermediaries:
The intermediaries play an important role in the smooth functioning of capital market
transactions. They are neither the buyers (investors) nor the sellers (issuers of securities). Their
objective is to ensure smooth and secure transactions as per the rules specified by the regulator.
Intermediaries will include the following functional participants:
1. Depository
These are the organizations that store and process the huge digital data containing
transactions that happen every day in the stock market. National Securities Depository (NSDL
- https://nsdl.co.in/) and Central Depository Services (CDSL- https://www.cdslindia.com/) are
the two depositories available in India and are registered with the Securities and Exchange
Board of India (SEBI- https://www.sebi.gov.in/). They came into existence after the
digitalization of the stock exchange.
2. Trading agents
An individual participant cannot directly transact with the stock exchange. Hence, they
will require a digital platform or a Demat account for trading. Demat accounts came into
existence after the digitalization and dematerialization of physical share certificates. The
trading agents help the participants by opening their Demat account in order to trade stocks in
the stock exchange market. Trading agents can be individual brokers, trading firms, banks, etc.,
who provide trading services and charge a fee for opening the Demat account.
3. Clearing house
These houses are the mediator between the buyer and seller. They provide a guarantee
for all the financial transactions that take place on the stock exchange and eliminate any risks
involved during the transaction.
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4. Clearing members
They are the mediators working in the clearing house and their job is to ensure the
clearance and settlement of all the transactions that take place every day in the stock market.
5. Clearing bank
A clearing bank is a linkage between the clearing house and clearing members. The
clearing members maintain an account with a sufficient balance amount for clearance and
settlement of all the transactions.

IN-TEXT QUESTIONS
3. Only individual investors are allowed to invest in the stock market. (True/False)
4. Foreign Companies cannot invest in Indian Companies by law. (True/False)
5. An Index is a measure of ___________ of the stock market.
6. ___________ indices portray the picture of various sectors in the stock market.
7. Nifty IT Index is a sectoral index for ___________ stocks.

4.4 ROLE OF THE STOCK EXCHANGE

The term stock exchange can be understood by breaking the two words, i.e., stock and
exchange. Stock generally represents an ownership certificate for owning and holding a
fraction of a company’s capital. The owner of the stock is called as a shareholder. An exchange
takes place in a marketplace, where buyers and sellers are interested in the exchange of a
particular commodity for a price. Therefore, a stock exchange is a marketplace or a platform
where the exchange of stock takes place. Trading of various types of securities takes place in a
stock exchange, hence, it is also known as a securities exchange market.
The role of the stock exchange becomes very important when millions of transactions
take place every day. Therefore, the stock exchange performs the following roles and functions:
1. Platform for the buyers and sellers
The idea behind creating a stock exchange is basically to facilitate the sale and purchase
of securities in a transparent and secure manner. The transfer of securities is like a long

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chain, where it is purchased from one buyer today and may be sold to another the next
day. The seller may sell it due to various reasons, such as urgent liquidity, a decrease
in the price of the security, diversifying the portfolio, or sudden changes in the
economic or political scenario. Since the stock exchange is the mediator, all the buyers
and sellers available will exchange their securities with the guarantee and surety of sale
and purchase.
2. Encouraging potential individuals to invest
It conducts awareness and educational programs and certificate courses for individual
investors to increase their awareness about the stock market and help clarify their
doubts, which in turn helps in building confidence in the participants.
3. Ensures price continuity
Due to the large number of transactions taking place on a day-to-day basis, the stock
exchange keeps a record and reports the prices of different securities when the market
opens and closes. It also moderates the price during the day when the market opens.
4. Representative of economic and business health
The stock market is very sensitive to any changes in the political, economic, or
international markets. Due to any change in the economic or business environment such
as depression, pandemic, or major investments or divestment, the participants may start
buying or selling their stocks in order to gain profits or avoid any risk of loss due to
such changes. Therefore, the stock market is representative and an indicator of the
economic and business conditions of a country.
5. Liquidity and mobilizing capital
The transactions of buying and selling securities happen quickly and digitally.
Depending on whether the participant has bought securities or sold them, the total
amount is added or deducted from the participant’s account. Therefore, the securities
are transformed into liquidity and can be reinvested by the participant into some other
securities immediately. The role of the stock exchange is to ensure proper mobility of
the amount for further investments.
6. Acts as an equalizer to control market abnormalities
There can be speculations and rumours in the market. Expecting an increase in prices,
the speculators may start buying certain securities. Similarly, they may start selling
certain securities when they speculate on any decrease in prices. The rest of the
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participants in the stock market usually follow herd behaviour and may start following
the speculators, leading to a strong wave of fluctuation and bringing turbulence in the
market. In order to control any abnormalities and fluctuations in the market, the stock
exchange takes restrictive measures and ensures equilibrium in the market.
7. Ensuring genuine and top-performing companies participate
It is not easy for any company to list its securities on the stock exchange. The well-
established stock exchanges have eligibility criteria for the companies to list themselves
in the stock exchange. This restricts the participation of only those companies that are
financially stable and can be allowed to trade. It ensures the investors’ safety, and
security and builds confidence in the stock market. Every participant has an equal
chance to transact with other participants and ensure fair trading.

IN-TEXT QUESTIONS

6. Once decided, A company is never removed from the broad market index.
(True/False)
7. SEBI was established in which year?
8. 100 is not the base value of Nifty 50. (True/False)
9. In Nifty 50, what does 50 represents?

4.5 STOCK EXCHANGES IN INDIA

4.5.1 History and regulations:

In the 19th century, the idea of stock has been there in scattered forms and stock
investments were majorly in form of associations before the concept of the stock exchange
came into existence. In the 1800s, the East India Company along with some banks issued some
shares. Slowly the market started growing and the number of brokers started increasing. By
1887, stock brokers associated together to open an organization called the Native Share and
Stockbrokers Association, which mobilized funds from industry and government. The push
towards native trading in the early 1900 by Mahatma Gandhi led to the formation of Calcutta
as the hub of trading. By the 1940s, new stock exchanges started operating in Delhi and
Hyderabad, and by impendence in 1947, the number increased to seven stock exchanges. Later
on, twelve more stock exchanges came. Currently, there are seven stock exchanges in India,
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and twenty-eight have been granted exit by SEBI. Table 1 shows the list of present stock
exchanges operating in India.
As per the SEBI Securities Contracts (Regulation) Act, 1956, a stock exchange is
“Any body of individuals, whether incorporated or not, constituted before
corporatisation and demutualisation, for the purpose of assisting, regulating or controlling the
business of buying, selling or dealing in securities.”
Table 1: List of stock exchanges present in India in 2022.

S.no. Name of Stock Exchange

1 BSE Ltd.

2 Calcutta Stock Exchange Ltd.

3 Metropolitan Stock Exchange of India Ltd.

4 Multi Commodity Exchange of India Ltd.

5 National Commodity & Derivatives Exchange Ltd.

6 Indian Commodity Exchange Ltd.

7 National Stock Exchange of India Ltd.

Source: SEBI | Details of Stock Exchanges. (2022). Sebi.gov.in. https://www.sebi.gov.in/stock-
exchanges.html
4.5.2 NSE and BSE:
In India, there are two national-level stock exchanges, namely National Stock Exchange
(NSE) and the Bombay Stock Exchange (BSE), and rest are regional stock exchanges (RSEs),
making a total of seven stock exchanges. Most of the trading takes place at NSE and BSE.
While the BSE came into existence in 1875, the NSE started its operations in 1994. While NSE
is the largest stock exchange in India in terms of volume, the BSE is the oldest stock exchange
in whole of Asia. Both stock exchanges have market indexes based on time series data known
as Nifty on NSE and Sensex on BSE. While Nifty includes the top 50 performing listed
companies, Sensex includes the top 30 listed companies. Table 2 shows the number of listed
companies in both stock exchanges for FY 2022.

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Table 2: Number of listed companies in NSE and BSE

Year Number of Number of Total

companies listed in NSE Companies listed in BSE

FY2022 2012 5291 7303

Sources: NSE | All Companies Based on Market Capitalisation. (2022).

https://static.nseindia.com//s3fs-public/inline-files/MCAP31032022.xlsx
All India Market Capitalization | BSE Listed stocks Market Capitalization. (2022).
Bseindia.com. https://www.bseindia.com/markets/equity/EQReports/allindiamktcap.aspx
The majority of the well-established firms in India are listed in both exchanges. Both
exchanges provide a digital platform where in the buyer and sellers can exchange securities
anonymously in a secure and transparent manner. The stock market opens at 9:15 am and closes
by 3:30 pm between Monday to Friday. The settlement of any transaction is done in T+2 days.
It means if any transaction takes place on Monday, it will be settled by Wednesday.

ACTIVITY
Find out from the internet the relevant information about the listed companies for
the last five years either in NSE or BSE and create a table showing the number of
listed companies on the NSE/BSE in the last five years.

4.5.3 Role of SEBI:

SEBI plays an important role as a regulator. It came into existence in 1992 and since
then it has been actively watching the markets. SEBI’s role is to develop policies and
regulations in order to supervise the stock market. Not only it ensures the best market practices
are followed, but it also imposes hefty penalties in case of non-compliance with the regulations.

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CASE STUDY
Role of SEBI in protecting shareholders’ rights: A Case Study of Indian Investor
Mr Naveen is an investor in a company which is not yet public. Meaning thereby
that the company has not yet floated its share to the general public for trading. The Board
members of the company are planning to go public next year via an Initial Public offering
(IPO). The company plans to issue 50 lakh shares in the IPO. Mr Naveen is afraid that
even though he is one of the earliest investors in the company he will not get preferential
treatment over other investors, which he should get. Mr Jayant, A senior board member
of the company explains to Naveen that the idea of the IPO is not to take away anyone’s
right and to give it to someone else but to expand the size of the company and get some
extra funding. Jayant further explains that the Security and Exchange Board of India
ensures that rights of the shareholders should be protected by the company. Mr Naveen
is satisfied with the argument that Jayant puts forwards but is unaware of how SEBI will
ensure shareholder’s rights since what happens in the company is behind its closed doors.
Discuss with your classmates the workings of SEBI and how shareholder’s rights are
protected.

4.6 SECURITIES (STOCK) INDICES

A stock market index (Indices for plural) is essentially a market representative figure
which helps an investor tracking the day-to-day trend of the market. An index work as a
measure of the performance in the market. For example, suppose there are 2500 companies
listed on the stock exchange. and Mr. Naveen wants to see how the stock market is behaving
overall. One thing that Mr. Naveen can do is see to look at the stock prices of all 2500
companies and then think for himself about the performance of the market. Even though the
stock price information is freely and readily available, it is still a tedious task to do considering
the fact that all the 2500 stock has to be tracked daily. To deal with this problem, Mr. Naveen
can be a little picky and select 500 stocks that are widely traded in the market and look at their
performance. Now, this is a comparatively more straightforward task but stock tracking 500
stocks takes a little extra effort for the investor/trader.
Consider the fact that most of the stocks that are regularly traded in the market belong
to companies which are of different sizes in terms of their market capitalisation (Price of a
Share x The no. of publicly held shares). Further, these companies belong to different

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industries/sectors, etc. What if one day Mr. Naveen wants to look at the steel industry's
performance? Will it be possible for him to now track steel stocks along with tracking 500
high-volume traded stocks? And what if he wants telecommunications too? all these problems
can be solved just by looking at a single indicator that represents the performance of the market
as a whole or of a specific sector.
An index compiles data from several businesses across various industries and sectors.
When combined, this data produces a comprehensive collage or image that enables you to
assess price trends over time and estimate the market's overall performance.
How are Stock Indices helpful?
From the perspective of the investors, the stock market index assists in a wide variety
of decisions like:
• Understanding the sentiments of the market
• Understanding the performance of the market and its specific sectors
• Investing passively in the market
• Having a benchmark for comparison of various securities
Stock market indices can be of different types based on which companies they represent. Figure
2 shows the four broad categories of indices.

Fig 2: Categories of indices (Source: Author’s compilation)

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4.6.1 Broad Market Indices:

The most popular indices in the stock market are broad market indices, which include
the big, liquid stocks listed on the exchange. They provide a standard against which the
performance of individual equities or investment portfolios like mutual funds is compared. The
most popular broad market indices are Sensex by the Bombay Stock Exchange, and Nifty by
the National Stock Exchange.
These Indices are based on the market capitalisation of companies. Market
capitalisation is a measure of the size of the company. It is calculated by multiplying the market
price of the share by the no. of publicly floated shares. Usually, the top companies in terms of
their market capitalisation are selected for the purpose of creating a broad market index (50
Companies for Nifty, and 30 Companies for Sensex).
How a Broad Market Index is Calculated?
An index is calculated based on the ‘Free-float market capitalisation of companies.
Free-float means the no. of shares that are freely available to the general public for trading and
investing. Companies are ranked in order of their free-float market capitalisation and selected
top companies are taken out of the list. Their market capitalisation is added up together. The
date on which the index is first started is considered as the starting date of the index. For this
date the total market cap is assumed to be 100 or 1000. and thus the performance of the market
is tracked.
Eg.:- Suppose the total market cap of 30 companies on the inception of the market index
(MI30) is 50,60,000 which was assumed to be 100. 3 years have passed since that date. Today
the total free-float market capitalisation is 75,40,000. The value of MI30 today will be as
follows:
Current index value =
Current year Free − Float Market Capitalisation x Base index value
Current year Free − Float Market Capitalisation

75,40,000 x 100
=
50,60,000
= 149.011
Therefore we can easily see that what was 100 three years ago is now worth 149.
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4.6.2 Sectoral Indices:

One can calculate the index in a similar fashion for particular industries, say
Information technology (IT), Banking, Telecom, Infra, Healthcare, Steel, Pharmaceuticals etc.
Such indices are called Sectoral indices. These Indices are helpful for investors who have an
interest in particular sectors, also it becomes easier to see the impact of a particular event (for
eg. Demonetisation, War, Lockdown) on various sectors and compare them with each other.
Some of the most popular sectoral indices in India are Nifty Auto Index (Tracks
Automobile stocks), Nifty IT Index (Tracks Information technology stocks), Nifty FMCG
Index (Tracks fast moving consumer goods companies).
4.6.3 Thematic Indices:
Thematic indices are created for measuring the performance of companies that lie in
particular themes that are not necessarily sectors or industries. For e.g.: Nifty 100 ESG is a
thematic index created by the National Stock Exchange that tracks the top 100 companies listed
in NSE in terms of their environmental, social, and governance scores. The Nifty India
Consumption Index tracks the stocks of companies that deal in consumption items like
healthcare, non-durable items, telecom services, entertainment, etc.

4.7 SUMMARY

The stock market is dynamic and volatile. It is dynamic as it invites participants from
diverse backgrounds to sell and purchase publicly issued securities by the listed companies on
the stock exchange. It is a group of individuals and institutions that creates an ecosystem for
the mobilization of savings for the purpose of investment in publicly favoured businesses with
the expectation of gaining higher returns. It is volatile, as it is an indicator of the economic and
political situation of a country. Any changes in the business environment led to the stock
market get affected. The stock market has three major participants, namely, the issuer of
securities, investors, and intermediaries. The role of the stock exchange is to provide a platform
for buyers and sellers, encourage individuals to invest, ensure price continuity, represent
business and economic health, and act as an equalizer to control market abnormalities. The
Indian stock market has a rich history, including pre- and post-independence developments.
NSE and BSE being the largest stock exchanges in the country have been conducting smooth
trading of securities in the stock market since their inception. SEBI being the watchdog of
various financial markets ensures the compliance of regulations and charges hefty penalties for

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non-compliance. Stock indices provide a glimpse of the day-to-day market trends. It includes
broad market indices, sectoral indices and thematic indices.

4.8 GLOSSARY

Market Capitalisation: The total value of the company (No. of shares x Market price of each
share).
Free-float: Shares that are publicly available for trading.
Indices: Plural of Index.
Broker: A person or institution who facilitates trade as an intermediary.
Demat: Short for Dematerialisation. An electronic form of securities.
Sovereign Bonds: Bonds issued by national and international governments to raise funds for
themselves.
Portfolio: A mix of diversified securities in which an investor has invested his/her money.
Liquidity: The ability of a security to get converted into cash quickly without losing its value.
Divestment: Selling the Share which is owned in an organisation to someone else.

4.9 ANSWERS TO IN-TEXT QUESTIONS

1. False 6. False
2. False 7. 1992
3. Performance 8. True
4. Sectoral 9. No. of companies in the Index
5. Information Technology

4.10 SELF-ASSESSMENT QUESTIONS

1. Explain the concept of a broad market index. Discuss the various types of broad market
index in India.
2. How is sectoral index different from thematic index?

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3. Discuss the role of SEBI in regulating the stock market.

4. What role does a depository plays in the stock market?
5. What is SENSEX? Explain its constitution.

4.11 OBJECTIVE TYPE QUESTIONS (MCQs)

1. Which of the following is not a type of Index

a. Sensex
b. Nifty
c. NSE IT
d. DLF
2. Sensex is based on which type of calculation
a. Market capitalisation based
b. Stock price based
c. No. of shares based
d. Company reputation based
3. What is the meaning of ‘Free-float’
a. Available to the promoters
b. Available to the general public
c. Available to the employees
d. Available to government
4. Which of the following is the correct formula for Market capitalisation:
a. No. of shares x Market price per share
b. No. of shares x Company’s weight in the index
c. No. of shares x Amount of capital
d. Company’s goodwill x No. of shareholders

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5. Which of the following is not a market participant

a. Brokers
b. Investors
c. Employees
d. SEBI
6. A Demat account belongs to:
a. Company
b. Individual share
c. Investor
d. Demator
7. Which of the following is a stock exchange:
a. SEBI
b. SEC
c. BSE
d. Nifty
8. Nifty belongs to which of the following stock exchanges
a. Bombay stock exchange
b. New York stock exchange
c. Hong Kong stock exchange
d. National Stock Exchange
9. Which of the following is not the role played by stock exchange
a. To initiate a business idea
b. To help raise loans
c. To provide extra customer base
d. All of the above

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10. Which among the following is the oldest stock exchange in Asia
a. National Stock Exchange
b. Bombay Stock Exchange
c. Calcutta Stock Exchange
d. Delhi Stock Exchange Association
11. Who provides daily stock prices
a. Security Exchange Board of India
b. Reserve Bank of India
c. Bombay Stock Exchange
d. Ministry of Finance, Government of India
12. Who regulates the stock market in India
a. SEC
b. SEBI
c. RBI
d. SBI
13. What is the meaning of savings mobilisation
a. Taking money from companies to investors
b. Taking money from the regulator to companies
c. Taking money from brokers to investors
d. Taking money from investors to companies
14. Nifty was started with a base value of:
a. 100
b. 200
c. 500
d. 1000

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15. Who regulated the capital market before 1992?

a. Security Exchange Commission
b. Reserve Bank of India
c. Controller of Capital Issues
d. Bombay Stock Exchange
Answer Key:
1. d 6. c 11. c
2. a 7. c 12. b
3. b 8. d 13. d
4. a 9. d 14. d
5. c 10. b 15. c

4.12 REFERENCES

BSE. (2022). All India Market Capitalization | BSE Listed stocks Market Capitalization.
https://www.bseindia.com/markets/equity/EQReports/allindiamktcap.aspx
NSE. (2022). All Companies based on Market Capitalisation. NSE India.
https://www.nseindia.com/regulations/listing-compliance/nse-market-capitalisation-all-
companies
SEBI. (2022). Details of Stock Exchanges. SEBI. https://www.sebi.gov.in/stock-
exchanges.html

4.13 SUGGESTED READINGS

Bodie, Zvi., Kane Alex and Alan J. Marcus, (2021). Investments, McGraw Hill.
Reilly, Frank K, and Brown, Keith C., (2011). Investment Analysis and Portfolio Management,
Cengage Learning.
Chandra, P., (2017). Security Analysis and Portfolio Management, Tata McGraw Hill.
Damodaran, A., (2012). Investment Valuation, John Wiley & Sons.
Sharpe William F, and Bailey Jeffery V, Alexander Gordon J, (1998). Investments, PHI
Learning.
Bhalla, V. K., (2008). Investment Management, S. Chand & Company Ltd.
Das, S. (2009). Perspectives on Financial Services. Allied Publishers.
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LESSON 5

TRADING MECHANISM ON EXCHANGES

Dr. Sharif Mohd.
smohd2991@gmail.com

STRUCTURE

5.1 Learning Objectives

5.2 Introduction
5.3 Trading Mechanism on the Stock Exchanges
5.3.1 Types of Securities
5.3.2 Types of Delivery
5.3.3 Margin and Margin Trading
5.3.4 Book Closure and Record Date
5.3.5 Trend Line and Trading Volume
5.4 Clearing and Settlement Procedure in the Stock Exchanges
5.4.1 Trading
5.4.2 Clearing
5.4.3 Settlement
5.4.4 Rolling Settlement
5.5 NSE: Trading and Settlement
5.5.1 Settlement & Clearing of Equities
5.6 Summary
5.7 Glossary
5.8 Answers to In-text Questions
5.9 Self-Assessment Questions
5.10 References
5.11 Suggested Readings
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5.1 LEARNING OBJECTIVES

Stock exchanges are used as an indicator of a country's economic health. It is the capital
market's most active and well-organized segment, especially in developing nations like India.
The students will be able to comprehend various stock exchange, stock exchange operations,
trading and settlement at the NSE , clearing mechanisms, and settlement of equities after
completing this lesson.

5.2 INTRODUCTION

The markets where the buying and selling of securities takes place are called stock
exchanges. A secondary market is one where securities are exchanged that have already
undergone an initial public offering (IPO) in the primary market and were made available to
the public. These securities must be listed there in order to be traded on the stock exchange.
Most trading takes place on the secondary market. Both the debt and equity markets make up
the secondary market. The secondary market offers the average investor an effective platform
for trading his assets. Investors are given the chance to sell their shares whenever they need to.
The Board of Directors or Council of Management, which is made up of elected brokers
and government and public representatives selected by SEBI, supervises the operation of the
stock exchanges. The boards of stock exchanges have the authority to enact and uphold rules,
bylaws, and regulations that apply to all of its participants. People who are financially stable
and have the necessary experience or knowledge in the stock market are typically granted
membership in stock exchanges. They must pay an annual fee to SEBI, who controls and
regulates their membership enrolment. A "broker" is a stock exchange participant who is
authorised to act both on behalf of and in his own name. Only through members may a non-
member transact in securities. A broker may also use a sub-broker, whom he may designate as
part of the registration process.

5.3 TRADING MECHANISM ON THE STOCK EXCHANGES

The stock exchanges are important institutions that facilitate the issuance and selling of
various securities. Every area of the capital market activity revolves on it. People with savings
would be unlikely to invest in corporate securities without the stock exchange because there

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wouldn't be any liquidity for them (buying and selling facility). As a result, public corporate
investments would have been less.
Thus, stock exchanges serve as a market place for the purchase and sale of securities
while also providing liquidity for the benefit of investors. The stock markets serve as the capital
market's hub and are a good indicator of how the country's economy is doing overall.
In the stock market, investors and traders use their brokers to connect to the exchanges
and place buy or sell orders there. Based on their company's position, market value, and
significance, a group of 50 NSE stocks and 30 BSE stocks are chosen to be included in a
weighted formula that calculates the index's "worth." The National Stock Exchange, or NSE,
is India's top stock exchange. The world's fourth largest, it (based on equity trading volume).
It was the first stock exchange in India to offer a screen-based trading system, and it is situated
in Mumbai. The NSE was originally created with the intention of bringing transparency to the
Indian market system and it ultimately succeeded in meeting its objectives pretty successfully.
The NSE successfully provides services including trading, clearing, and the settlement in debt
and stocks to domestic and foreign investors with the assistance of the government. Compared
to the NSE, the Bombay Stock Exchange is much older. Asia's first stock exchange was there.
The BSE is the fastest stock exchange in the world, with trades being completed in under 6
microseconds.
In the stock market, securities are traded using the settlement basis, spot basis, and cash
basis methods.
"Cash" shares or "B" category shares are the names given to shares of companies that
aren't on the spot list. They can only be traded on a cash basis or a delivery basis; settlement
basis is not an option. In the case of cash basis trading, the actual delivery of securities and
payment must be made on or before the specified settlement date.
For spot trading, the actual delivery of the securities to the buying broker must occur
within 48 hours after the contract. On receipt of the securities, the buyer is anticipated to pay
the seller promptly. Any security may be traded on a spot basis or a cash basis, regardless of
whether it is on the specified list or the cash list.
5.3.1 Types of Securities:
Securities that are traded on stock exchanges can be categorised as follows:
(1) Listed cleared Securities: Also known as securities that have been played by the
Board on the list of cleared securities and have been permitted for trading on the exchange after
meeting all listing conditions.
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(2) Authorized Securities: When the stock exchanges where they are not listed permit
them to be traded, the securities listed on certain of the recognised stock exchanges are referred
to as permitted securities. If appropriate clauses are present in the stock exchanges' regulations,
this licence will be granted.

ACTIVITY
Due to the large number of companies listed on stock exchanges, it is quite difficult
to monitor every stock and evaluate the market performance simultaneously. As a
result, stock exchange indexes are useful in determining the worth of a particular
sector of the stock exchange. Majorly Sensex, also called BSE 30 and NSE Nifty or
NIFTY 50 are the market indexes where well-established and financially sound
companies are listed You’re needed. You must visit the BSE and NSE websites and
review their performance over the previous ten years.

5.3.2 Types of Delivery:

Spot delivery, hand delivery, and special delivery are some types of deliveries at stock
exchanges. When securities must be delivered and paid for on the same day or the following
day, the delivery is referred to as spot delivery. If the delivery and payment are to be made on
the delivery date established by the stock exchange authorities, the delivery is considered to
have been done by hand.
A special delivery is one that must take place after the time frame set by the stock
exchange authorities for delivery.
5.3.3 Margin and Margin Trading:
A margin is a portion of the value of a stock transaction that is paid in advance. how
much credit a broker or lender gives a consumer to buy stocks.
In order to reduce speculative trading in shares that causes price volatility in securities,
SEBI established margin trading.
In this sense, "initial margin" refers to the minimal sum that the client must deposit with
the broker prior to making the actual purchase. It is computed as a percentage of the transaction

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value. The balance money may be advanced by the broker in order to fulfil all settlement
requirements.
The term "maintenance margin" refers to the minimal sum that a client must have on
deposit with the broker and is determined as a percentage of the market value of the assets
based on the closing price of the previous trading day.
The broker must initiate margin calls right away if the amount deposit in the client's
margin account is less than the necessary maintenance margin. However, the client cannot be
given any further exposure based on a rise in the market value of the securities.
If the client doesn't deposit the checks the day after the day the margin call was issued,
doesn't satisfy the margin calls the broker has made, or if the check has been returned unpaid,
the broker may liquidate the securities.
The brokers may also sell the securities if, during the time between making the margin
call and receiving payment from the client, the customer's deposit in the margin account (after
subtracting mark-to-market losses) is 30% or less of the securities' most recent market value.
On or before 12 Noon the following day, the broker must provide the stock exchange with
information regarding gross exposure, including the name of the client, unique identification
number, name of the scrip, and, if the broker has borrowed money in order to provide margin
trading facilities, the name of the lender and the amount borrowed.
The market is informed by stock exchanges of the scripwise gross outstanding in margin
accounts with all brokers. Next the close of business the following day, the website will make
these disclosures about margin trading conducted on any given day accessible.
Margin trading therefore serves as a check on clients' propensity to manipulate markets
by placing orders with brokers without having enough funds or securities to support the
transactions. transaction. Trading on margin will also put a stop to short sales and short
purchases. The decrease in the aforementioned consumer tendencies lowers price volatility on
the stock exchange and gives regular investors stability.
5.3.4 Book Closure and Record Date:
Book closure is the routine closing of the company's membership register and transfer
books in order to keep track of the shareholders' entitlement to dividends, bonuses, right shares,
and other share-related rights. Record date refers to the day that a company's books are closed
in order to identify the stockholders who should receive dividends, proxies, etc. Book closure
is required in order to pay dividends and create rights or bonus issues. At least seven days
before to the start of the book closure, the registered company must publish a notice of it in a
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newspaper. The participants whose names are listed in the registry members as of the final day
of book closure are eligible to receive dividend, right, or bonus share benefits, as appropriate.
5.3.5 Trend Line and Trading Volume:
A price line is regarded as established when share prices move consistently in one
direction over an extended period of time. The trend is referred to as BULLISH when it moves
upward and BEARISH when it moves downward. A bear market is a weak or declining market
where sellers predominate. In contrast, a bull market is a market that is rising with lots of buyers
and few sellers.
Reactions are secondary movements that momentarily revert the upward trend. Rallies
are movements that momentarily revers the downward trend. It is referred to as a trend reversal
when an upward trend shifts downward.
Trading volume determines whether a price increase or decrease is in line with the
general trend. In the same way that high trading volume is based on rising prices, it is also
associated with falling prices. They represent, respectively, BULLISH and BEARISH trends.
The amount of BULLISH interest in various scrips is indicated by their net turnover and
outstanding positions, which are combined with trading volume to determine the intensity of
the phase, whether BULLISH or BEARISH. The daily turnover of important stocks will
significantly increase during BULL phases, whereas BEAR phases will see the opposite.

IN-TEXT QUESTIONS
1. Which of these is a stock exchanges function?
a. The function of an economic barometer
b. Securities valuation
c. Promoting savings and investments
d. All of the above
2. What quantity of companies make up the Sensex (Stock Exchange Sensitive
Index)?
a. 20
b. 30
c. 50
d. 100
3. With margin trading, you can purchase securities with________ money.
a. lending
b. borrowing
c. spending
d. avoiding the situation and

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4. Based on what? NIFTY and SENSEX are calculated.

5. Free-Float capitalization
6. Market capitalization,
7. Authorised share Capital
8. Paid-up capital
9. The exchange rate between two currencies ______ is known as the spot
exchange rate.
a. For delivery later
b. For delivery in the future at a specific location
c. For prompt delivery
d. None of the preceding

5.4 CLEARING AND SETTLEMENT PROCEDURE IN THE STOCK

EXCHANGES

There are always buyers and sellers in the stock market. Thus, another trader sells the
shares when someone purchases a certain number of them. Only after the buyer receives the
shares and the seller receives payment is this transaction considered settled. A secondary
market transaction happens in three stages:
Let's examine the procedure in greater detail.

Trading

Clearing

Settlement

Figure 5.1: Three phases of a secondary market transaction(source: Author Complied)

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5.4.1 Trading:
Shares in a specific company are purchased and sold during stock trading. There are
numerous trades going on at once in the stock market. An electronic order matching system is
used by the stock exchanges to match "buy" and "sell" orders from various traders. Each trade
is carried out in this way. Take stock "X" as an example, which is trading on the stock exchange.
For this stock, the buy and sell orders are as follows:

Figure 5.2: Buy and sell matching system in stock exchanges (source: Author Complied)
Here, the priciest buy prices are compared to the cheapest sell prices that are currently
offered, and whenever the buy price is less than or equal to the best sell price that is currently
offered, a match is made. This is known as market depth and naturally depends on the various
quantities that are available for both buys and sells.
Therefore, even though a particular price might result in a match, the buy order will
still not be fully traded if there is not enough quantity available at the seller side at that price.
The brokerages that gather orders from various investors and transmit them to the stock
exchanges, most likely the two most well-known exchanges in India — the Bombay Stock
Exchange and the National Stock Exchange, and the Bombay Stock Exchange (NSE).
Brokerages serve as a middleman in this process between the investor and the stock exchange.

Figure 5.3: The procedure for trading in stock exchanges (source: Author Complied)
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• Creating a Demat Account: A demat account needs to be opened by the investor.

Because the securities will be kept in the demat account, this will happen.
• Choice of Broker: Only authorised brokers may be used by investors to purchase or
sell securities. The broker through whom the trades will be placed must be chosen by
the investor.
• Obtaining a special client number: Each investor has a special ID. Through this ID,
the trades are tracked. The depository provides this client ID.
• Entering the scrip's ISIN: Each security has a distinct 12-digit ISIN of its own. It
serves as the security's identification number. When placing the trade, the investor must
include the ISIN of the security.
• Placing of the Order: Investors must confirm their orders for the securities they wish
to purchase or sell.
• Finishing the Contract Note: The broker sends the client a contract note for each trade.
• Trading Transaction Settlement: The settlement process involves both parties. In a
purchase transaction, money is paid and the security is obtained; in a sale transaction,
the opposite occurs. The BSE and NSE settlement occurs on T+2 days, or two working
days following the transaction days.
5.4.2 Clearing:
The clearing procedure starts after a trade is executed and two orders match. Identification of
the security that belongs to the buyer and the amount that belongs to the seller is known as
clearing. 'Clearing houses' oversee the entire process. These are separate organisations. But in
the actual market environment, traders frequently engage in multiple transactions. The clearing
house thus recognises all transactions and determines the net sum or net securities owed to the
trader.
5.4.3 Settlement:
The importance of acting is to satisfy the financial commitments noted in the clearing step.
This includes settling the transaction for the buyers and sellers. Therefore, the transaction is
complete once the buyer receives the security and the seller receives the money. You will
encounter two different types of settlements when investing in equity, and they are as follows:
• Spot settling: The rolling settlement principle of T+2 is immediately followed by this
type of settlement.
• In-front settlement: When you agree to settle the trade at a later time—which could
be T+5 or T+7—this settlement is applicable.

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5.4.4 Rolling Settlement:

In a rolling settlement, the trade is settled over the course of several days. With this type of
settlement, trades are concluded after the second working day after being settled in T+2 days.
This period does not include Sunday, Saturday, bank holidays, or exchange holidays. A trade
will therefore be closed on a Thursday if it is made on a Tuesday. Similar to this, if you purchase
shares of stock on Friday, you must pay the broker on that day, but the shares will be credited
to your account the following Tuesday. On the day your trades are settled, you are regarded as
the shareholder of record. The equity settlement day is crucial for dividend-seeking investors.
If the purchaser desires to collect a profit before the record date in order to settle the trade and
receive a dividend from the company.
All intervening holidays, such as bank holidays, exchange holidays, Saturdays, and Sundays,
are disregarded when calculating the settlement day. Trades made on Monday are typically
settled on Wednesday, those made on Tuesday are typically settled on Thursday, and so forth.
All open positions at the end of the day must automatically result in payment or delivery 'n'
days later under rolling settlement. Rolling settlement trades are currently settled on a T+2
basis, where T is the trade day. For instance, a trade made on Monday must be settled by
Wednesday (considering two working days from the trade day).
There is no difference for intraday traders due to rolling settlement. There would be no change
for institutional investors, who are already prohibited from competing. For small-scale
investors who take leveraged positions over the course of one night or more that roll over
settlement. T+2 days are used for the pay-in and pay-out of funds and securities.
The day that sellers deliver sold securities to the exchange and buyers make funds for purchased
securities available to the exchange is known as pay-in day. On pay-out day, the exchange
delivers the securities purchased to the buyers and gives the sellers the money for the securities
sold. Currently, the pay-in and pay-out occur on the second working day following the
execution of the trade on the exchange, or T+2 rolling settlement.
When a business announces a record date or book closure, for that security, the exchange
establishes a no-delivery period. Only trading in the security is allowed during this time. These
trades, however, are only finalised after the no-delivery period has passed. To make sure that
the investor's entitlement to the corporate benefit is identified clearly, this is done.
The exchange puts securities up for auction when a trading member fails to deliver securities
on the pay-in day. This guarantees that the securities are received by the buying trading
member. The Exchange gives the purchasing trading member the necessary quantity that it has
purchased in the auction market.

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Table 5.1: Settlement Cycle for Rolling Settlement (Source: www.icsi.edu)

Activity Day
Trading Rolling settlement T
Clearing Custodial confirmation and delivery generation T+1 working days
Settlement Securities and funds pay-in and pay-out T+2 working days
Post settlement Auction T+3 working days
Bad delivery reporting T+4 working days
Auction settlement T+5 working days
Rectified bad delivery pay-in and pay-out T+6 working days
Re-bad delivery reporting and pick up T+8 working days

CASE STUDY

Impact of Index Futures Trading On Spot Market: A case study of India

Sathya Swaroop Debasish conducted study on the effect of futures trading on the underlying Indian
stock market's volatility and operational efficiency in 2009 using a sample of specially selected
individual stocks. The study specifically investigates whether trading in Indian index futures has
significantly changed the spot price volatility of the underlying stocks and how trading in Indian index
futures has impacted market/trading efficiency. An extensive time frame from June 1995 to May 2009
is used to examine the impact of the introduction of futures trading. In order to determine whether the
introduction of index futures trading has significantly changed the volatility and efficiency of stock
returns, this study employed an event study methodology. The research contrasts before and after
futures trading are implemented in the stock indices, spot price volatility varies. He found an association
between reduction spot price volatility and decreased trading efficiency in the underlying stock market
following the introduction of Nifty index futures trading in India. The findings of his study appear to
suggest that, at least in the short term, there is a trade-off between the benefits and expenses related to
the introduction of derivatives trading. For the purpose of market stabilisation, the market would have
to pay a certain price, such as a reduction in market efficiency. He goes on to say that an ideal
derivatives market policy would be one that would maintain market stability without impairing market
efficiency in the underlying spot market.

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IN-TEXT QUESTIONS
10. Which of the following could cause a stock market to suddenly lose value?
a. Terrorist attack b. Major corporation declaring bankruptcy
worldwide recession d. All of the above
11. Which system is used to settle cash market transactions in the current
environment?
a. T day b. T+1
c. T+5 d. T+2
12. Who handles stock market securities transfers electronically?
a. RBI, b. Depositories,
c. Clearing Agencies, d. SEBI,
13. The phrase "Bulls and Bears" is related to
a. Speculator b. Import and Export
c. Banking d. Marketing
14. Which of the following is the mode of settlement of securities where in the
transfer of securities and funds happen simultaneously?
a. Delivery versus Payment (DvP),
b. Clearing Corporation of India Ltd. (CCIL)
c. None of the listed options
d. All of the Above

5.5 NSE: TRADING AND SETTLEMENT

Fully automated screen-based trading was made available by NSE for the first time in
India. It employs a cutting-edge, fully computerised trading system created to provide investors
with a secure and convenient way to invest across the country. The National Exchange for
Automated Trading (NEAT) system used by the NSE is a fully automated screen-based trading
system that adheres to the idea of an order-driven market.
The National Securities Clearing Corporation Limited (NSCCL), a wholly owned
subsidiary of the National Stock Exchange of India Limited, is responsible for clearing and

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settling trades made on the NSE's capital market platform. This company promptly completes
the settlement without postponement or delay. It functions. on behalf of the clearing
participants from and to Mumbai's central clearing centres and regional clearing centres.
Through the automated system of the clearing corporation, it was the first organisation to begin
pre-delivery verification to find bad papers like fake or forged certificates or lost and stolen
share certificates. A facility is offered to lend/borrow securities and money at market-
determined rates, allowing for the efficient and on-time delivery of securities. This corporation
provides clearing and settlement services for other exchanges in addition to Index Futures. It
is affiliated with National Securities Depository Limited (NSDL) and Central Depositories
Services (India) Limited (CDSL).
On a netted basis, rolling segment trades are cleared and settled. The
Exchange/Clearing Corporation occasionally specifies trading and settlement times. At the
conclusion of each trading period, the deals that were completed are netted, and the settlement
obligations for that settlement period are calculated. It is decided to use a multilateral netting
procedure to calculate the net settlement obligations.
In a rolling settlement, each trading day is regarded as a separate trading period, and
trades are netted to determine the day's net obligations. Settlement obligations result from every
deal, including trade-for-trade and limited physical market transactions, which are settled on a
trade-for-trade basis.

Figure 5.4: Trading and settlement process on NSE (Source: https://www.edelweiss.in)

• 1: Trading information from Exchange to NSCCL (real-time and end of day
trade file).
• 2: The NSCCL notifies the clearing members/custodians who have returned the
form of the details of the completed trade. NSCCL applies multilateral netting
and establishes obligations based on the affirmation.
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• 3: Downloading of the obligation and payment-in advice of funds/assets.

• 4: Directing clearing banks to release funds by the pay-in deadline.
• 5: Directing depository institutions to make securities available through pay-in-
time.
• 6: Pay-in of securities (NSCCL advises depository to credit its account and debit
the pool account of custodians/CMs and depository follows this advice).
• 7: Funds are paid in (NSCCL advises clearing banks to credit their accounts and
debit the custodians'/CMs' accounts)
• 8: Security payout (NSCCL suggests depository join credit pool) debit its
account and the depository does it on behalf of custodians/CMs)
• 9: Funds are paid out (NSCCL advises clearing banks to credit custodians'/CMs'
accounts and debit their accounts.
• 10: Through DPs, the Depository notifies the Custodians/CMs.
• 11: Custodians/CMs are informed by clearing banks.
5.5.1. Settlement & Clearing of Equities:
According to the settlement cycles of various sub-segments in the Equities segment,
NSCCL performs clearing and settlement duties. The clearing corporation's clearing function
aims to determine what counter parties owe and what on the settlement date, counter parties
are expected to receive. Settlement is a two-way process in which title to funds, securities, or
other assets is legally transferred on the settlement date.
Additionally, NSCCL has developed a system to deal with a number of exceptional
circumstances, such as security gaps, problematic deliveries, business objections, and auction
outcomes. Eight clearing banks have been appointed by NSCCL to offer banking services to
trading members, and connectivity with both depositories has been established for electronic
settlement of securities. The clearing process of determining obligations, followed by
settlement to discharge those obligations.
Trading members and custodians are the two different types of clearing members in the
NSCCL. If the custodians confirm the obligation to NSCCL, the trading members may transfer
it to them. All trades whose obligations the trading member proposes to transfer to the

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custodian are sent, for confirmation, to the custodian by NSCCL. The custodian must confirm
these trades on a basis of T + 1 days.
When the aforementioned tasks are finished, NSCCL begins performing its clearing
function. The obligations of counter parties are determined using the multilateral netting
concept. A clearing member would therefore have separate pay-in and pay-out obligations for
funds and securities. In order for members to fulfil their obligations on the settlement day
(T+2), their pay-in and pay-out obligations for funds and securities are therefore determined at
the latest by T + 1 day and forwarded to them.
The following sub-segments of the Equities segment are served by NSCCL for the
clearing and settlement of trades:
• All trades carried out in the Rolling/Book entry segment.
• Each and every transaction made in the Limited Physical Market segment.

IN-TEXT QUESTIONS
15. Which of the following factors causes changes in the Sensex?
a. Fiscal policy b. Monetary policy
c. Instability in politics d. All of the above
16. The main responsibilities of NSCCL are risk management and trade clearing
and settlement.
a. Untrue b. True
17. Who settles trades made on the NSE?
a. NSDL b. Members clearing
c. SEBI d. NSCCL
18. Who transfers the securities that are available in the members' accounts to
the NSCCL?
a. Clearing banks b. Custodians
c. Cleaning members d. Depositories
19. What entity coordinates the funds settlement between Clearing Members
and NSCCL?
a. Clearing banks b. Depositories
c. Cleaning members d. NSE

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5.6 SUMMARY

The stock exchange is a vital institution that makes it easier to issue and sell different
kinds of securities. Every aspect of the capital market activity revolves around it. People with
savings would be unlikely to invest in corporate securities without the stock exchange because
there wouldn't be any liquidity for them (buying and selling facility). As a result, public
corporate investments would have been less. There are two types of securities traded on stock
exchanges: listed cleared securities and permitted securities. Settlement is the process of netting
transactions, actual delivery of securities and transfer deeds, and payments of the agreed upon
amount. The National Stock Exchange of India Limited's wholly owned subsidiary, National
Securities Clearing Corporation Limited, was established to carries out clearing and settlement
of trades made on the National Stock Exchange's capital market. The BOLT and NEAT systems
are now used by the member-brokers at BSE &NSE to enter orders to buy or sell securities
from Trader Work Stations (TWSs). Thus, stock exchanges serve as a market place for the
purchase and sale of securities while also ensuring their liquidity for the benefit of investors.

5.7 GLOSSARY

Trend Line: when share prices move consistently in one direction over an extended period of
time.
Margin: A margin is a portion of the value of a stock transaction that is paid in advance
Bear Market: A weak or falling market characterized by the dominance of sellers.
Bull Market: A rising market with abundance of buyers and relatively few sellers.
Cash Market: A market for sale of security against immediate delivery, as opposed to the
futures market.
Clearing: Settlement or clearance of accounts, for a fixed period in a Stock Exchange.
Daily Margin: The amount that has to be deposited at the Stock Exchange on a daily basis for
the purchase or sale of a security. This amount is decided by the stock exchange.
Jobber: Member brokers of a stock exchange who specialize, by giving two-way quotations,
in buying and selling of securities from and to fellow members. Jobbers do not have any direct
contact with the public but they serve the useful function of imparting liquidity to the market.

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Spot Delivery: If the delivery of and payment for securities are to be made on the same day or
the next day.
Algorithmic Trading: With the increasing trend amongst capital market players of generating
orders through automated execution logic.
Settlement: To fulfil the financial obligations identified in the clearing step. This involves the
transaction settlement for the buyers and sellers.

5.8 ANSWERS TO IN-TEXT QUESTIONS

1. All of the above 9. Speculator

2. 30 10. Delivery versus Payment (DvP),
3. Borrowing 11. All of the above
4. Free-Float capitalization 12. TRUE
5. For prompt delivery 13. NSCCL
6. All of the above 14. Depositories
7. T+2 15. Clearing Banks
8. Depositories

5.9 SELF-ASSESSMENT QUESTIONS

1 Which organisations participate in clearing and settlement? List the steps taken in the
settlement process and explain any two.
2 How do transaction cycles work? Explain with the help of a diagram,
3 Discuss the rolling settlement process for the settlement of securities.
4 Discuss the framework for borrowing and lending securities.
5 What is rolling settlement ? How trades are cleared and settled in the stock market?

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5.10 REFERENCES

H. R. Machiraju (2009). The Working of Stock Exchanges in India (3rd ed.). New Delhi New
Age International.
Dhankar, R.S. (2019). Clearance and Settlement Process in Capital Markets and Investment
Decision Making., New Delhi, Springer, Retrieved from, https://doi.org/10.1007/978-81-322-
3748-8_2.
ICSI (2017). Capital Markets and Securities Laws, Retrieved from, www.icsi.edu.

5.11 SUGGESTED READINGS

H. R. Machiraju (2009). The Working of Stock Exchanges in India (3rd ed.) New Delhi, New
Age International.
Vanita Tripathi and Neeti Panwar (2019) Investing In Stock Markets (4th ed.). New Delhi,
Taxmann Publications.
Rustagi, R.P. (2021). Investment Management: Theory & Practice. New Delhi, Sultan Chand
& Sons

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 Fundamentals of Stock Trading

LESSON 6

ONLINE TRADING
Dr. Pratibha Maurya
Assistant Professor
Department of Commerce
Delhi School of Economics
University of Delhi
pratibhamaurya@commerce.du.ac.in

STRUCTURE

6.1 Learning Objectives

6.2 Introduction
6.3 Online Trading Mechanism
6.3.1 Online Real-Time Price
6.3.2 Quotations:
Bid-Ask Spread
Tick Size:
Last Traded Price (LTP)
Average Trading Price (ATP):
6.4 Types of Orders:
6.4.1 Orders Based on Price
6.4.2 Orders Based on Time
6.4.6 Orders Based on Volume
6.5 Placing an Order
6.5.1 View/Modify/Cancel an Order:
6.6 Summary
6.7 Glossary
6.8 Answers to In-Text Questions
6.9 Self-Assessment Questions
6.10 Objective Type Questions (MCQs)
6.11 References
6.12 Suggested Readings

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6.1 LEARNING OBJECTIVES

The objective of the lesson is to help students to understand the online trading mechanism,
understand various types of price quotations, and various type of order conditions. After
reading this lesson the student can differentiate between delivery-based trading and can also
initiate an order.

6.2 INTRODUCTION

In recent times, an investor sitting in a coffee shop can invest in the securities market using
his/her smartphone. Online trading involves buying and selling securities on an online
platform. It is a much faster way of trading securities as compared to the offline trading system.
All we need for online trading is a good quality internet, a mobile banking application, a
DEMAT account, and sufficient funds in the bank to invest in the market. There are various
online service providers for trading various financial instruments such as equities,
commodities, mutual funds, govt bonds, etc. To begin trading online you need to understand
the online trading mechanism which involves the online placing of an order, its shorting,
matching and execution, settlement and confirmation, brokerage charges and other expenses.

6.3 ONLINE TRADING MECHANISM

The Internet-Based Trading mechanism has been accepted by SEBI considering the
recommendations of Internet Based Trading and Services Committee 2000. The system follows
an order-routing system that sends online orders to the clients to the exchange which
automatically compares the prices across the available exchanges and gets the best price for
the buyer/seller. The SEBI has approved an updated version i.e. Smart Order Routing (SOR)
facility in August 2010.

BROKER 1 STOCK
BUYER (BUYER'S EXCHANGE BROKER 2 SELLER
BROKER) NSE/BSE

Fig 1: Online Trading Mechanism (Source: Prepared by author)

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Order Placing: An investor can place an order with a trading and Demat account in any bank.
The broker provides an internet-based order-placing platform to buy or sell the security. The
trade orders placed are routed through trading members to the stock exchange for execution.
The orders placed by the investors through such stockbrokers are shorted and matched by the
exchange on a real-time basis.
Order Shorting: The orders are sorted based on the best price mechanism. The best price
decision is different for buying and selling orders. The best buy price is the one with the highest
price and the best sell price is the lowest price in the order received. Hence, all the buy and sell
orders are shorted in descending and ascending order respectively.
Order Matching and Execution: The stock exchange uses the price/time matching order rule
for execution. The matching and execution is also an automated order matching system.

Buy Order 101.05 101.75 101.90 101.95 102.05 102.10

Sell Order 102.05 102 101.85 101.75 101.55 101.25

Fig 2: Matching and Shorting of Orders (Source: Prepared by Author)
Trade Settlement and Execution: All orders executed are shown in the trade book of the
investor and the investor also receives an SMS for the trade taken, however, the stock is not
reached to the Demat account yet. After the settlement of trade in T+2 1 day basis the contract
note is sent to the client via email and reflected in Demat account.
Brokerage charge and Other Expenses: All the broker charges some amount for the services
rendered which is known as brokerage. Full-service and discount brokers are available in India
where discount broker has gained popularity all over the country due to low brokerage charges.
6.3.1 ONLINE REAL-TIME PRICE: Real-time price quotes show the instantaneous price
and volume of security without a time lag. Real-time price quotes are helpful for high-
frequency traders to make investment decisions.

1
SEBI has recently introduced the T+1 settlement rule, yet to be implemented in a smooth manner. To speed
the process of clearing and settlement.
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ACTIVITY-1
A Demat account helps investors to buy/ sell or hold the security through electronic
form. It also keeps proper track on the securities in the market. Analyse the
performance, services, brokerage, accessibility, and services provided by
stockbroker and choose one of your preferences. Open a Demat account for your
investment in stock market in future.

6.3.2 QUOTATIONS: Quotations are the price of the security quoted in the stock exchange.
The Index provides information about price quotations like bid price, ask price, ATP, LTP, 52
weeks high, 52 weeks low price, etc. Earlier, the price quotations are picked by the investors
from magazines, and newspapers like; business standards, and economic times but such
information is delayed information. Now, investors rely on real-time price quotations from
stock exchanges (NIFTY, SENSEX, BANK NIFTY, etc.) various stock broking companies
such as moneycontrol.com, trading view.com, economictimes.com, various news channels, etc.
Let’s understand the price quotations:
Bid Price: Bid refers to the highest buying price a buyer is ready to pay to buy a specific number
of shares at a given time
Ask Price: Ask price refers to the price at which the seller is ready to sell a specific number of
shares at a given time.
Bid Price Ask Price
Meaning Bid refers to the highest buying price Ask price refers to the price at
a buyer is ready to pay to buy a which the seller is ready to sell a
specific number of shares at a given specific number of shares at a
time given time.
Example Say a bid cost is Rs 46 X 200 which Say an ask cost Rs 19 X 150
means that the purchaser is offering indicating that the vendor is ready
Rs 46 for up to 200 stocks. to offer Rs 19 up to 150 shares.
Users The Bid price is meant for the seller The ask price is meant for the
of the stock. buyers of the stock.

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Brokers View The broker attempt to remove the The brokers attempt to bring the
maximum from the purchasers as the ask price down as it is the
bid price is the selling cost (bid price) representative of the price of
for them. buying the stock
Table 1: difference between Ask and Bid price. (https://zerodha.com/varsity/)
BID-ASK SPREAD: It refers to the difference between the Bid price and the Ask price. The
amount is usually the bid price of a securities market instrument in the market above the bid
price. The bid-ask spread price is a very useful tool to measure the demand and supply of a
given security. Here, the market demand for the asset is represented by the bid price and the
supply of the
TICK SIZE: The minimum price change between various bids and the ask price of an asset in
the stock market is known as tick size. it is the minimum price movement of a stock. The BSE
has earlier fixed the tick size of 5 paise but to increase the liquidity in the market it has been
further reduced it to 1 paise in the case of Mutual Funds and for some categories (F group) of
equity shares.
Example: If the tick size of a particular stock is 5 paise and the last traded price is Rs. 75, the
next few best price for the stock shall be Rs. 75.05, Rs. 75.10, Rs, 75.15, etc.
Last Traded Price (LTP): It is the price at which the last transaction of the stock got executed.
The last traded price is very relevant information for a few investors to forecast the stock price
movement and further helps in buying and selling decisions. LTP and closing prices are closely
related to each other and hence people get confused about the same but the closing price is the
weighted average price of the last 60-minute trading price. However, LTP is the price of the
last transaction executed for the stock.
Average Trading Price (ATP): The average trading price is the volume-based weighted price
of the share purchased or sold. ATP usually reports the average closing prices of trading days.
It can be used as a benchmark to compare the share prices and helps to check whether the stock
is under-priced or overpriced. A few investors use ATP to facilitate entry and exit opportunities
in the stock market.
6.3.6 CIRCUIT BREAKERS: The stock market sometimes becomes very risky and
extreme market volatility may result in a catastrophic decline in share prices. To avoid the
impact of high fluctuation a circuit breaker technique is used to stop the overloaded danger
caused by loss of money in the stock market. In June 2021 SEBI implemented an index-based
circuit breaker rule where the breaks are triggered if the security experiences a large percentage
swing in its prices in either direction. The concept of circuit breakers in the securities market

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was introduced by the US in 1987 when the Dow Jones index declined by 22 percent in one
day. The circuit break is basically the halt time (temporary stoppage) given the investor to
rethink and let the market cool down. The limit of ups and down in circuit breaks are known
as the Upper and Lower circuits explained below:
UPPER CIRCUIT, LOWER CIRCUIT: The stock hits the upper circuit when the price point
of the stock can’t move beyond a certain stock price/ market index value in a day which means
there are only buyers available in the market, no seller present. However, the lower circuit
prevents the security price from sinking beyond a point as a limit. A lower circuit also indicates
that there are only sellers in the market and the circuit break stops no more sell-order
entertainment.
NSE RULES REGARDING CIRCUIT BREAKS: The index-based NSE market has three-
stage index movement at 10 %, 15 % and 20 %.

Market Pre-Open Call

Trigger Limit Trigger Time Halt Auction Session Post
Duration Market Halt

45
Before 1:00 pm. 15 Minutes
Minutes

10% 15
At or after 1:00 pm upto 2.60 pm 15 Minutes
Minutes

At or after 2.60 pm No halt Not applicable

1 hour 45
Before 1 pm 15 Minutes
minutes

At or after 1:00 pm before 2:00 45

15% 15 Minutes
pm Minutes

Remainder
On or after 2:00 pm Not applicable
of the day

Remainder
20% Any time during market hours Not applicable
of the day
Table 2: NSE rules regarding circuit breaks (Source: National Stock Exchange of India ltd.)
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PRICE BANDS: The NSE and BSE set a price-band that gives the boundaries/ range in which
the value can move in a single day. The exchange usually does not accept any order beyond
the minimum and maximum price range. The main objective of the price band is to control the
bulk purchase and sale of securities to curb the panic setting. The NSE and BSE have 20%,
10%, 5%, and 2% either-ways price bands based on the previous day’s closing. A market-wide
price band is implemented through circuit breakers explained above.
RULES REGARDING PRICE BANDS ON NSE: The NSE and BSE have 20%, 10%, 5%,
and 2% either-ways (i.e. upper and lower price bands) based on the previous day’s closing. For
the scrips on which derivative instruments are available, there is no price band. There is a 20
percent price band for all remaining scrips such as preference shares, debentures, etc.

IN-TEXT QUESTIONS
1. The highest buying price a buyer is ready to pay to buy a specific number of
shares at a given time is known as ____________________.
2. If the stock price or the stock index crosses the range to which the price or the
index is allowed to move is known as circuit breakers. True / False.
3. The difference between ask and bid is known as ATP. True / False
4. The current index-based circuit break system applies at three stages of
movements, either way viz. 20%, 60% and 40%. True / False
5. The correct steps followed by an investor to invest in the stock market are:
a) Settlement of order, opening a trading account and Demat account, Placing
an order, Execution of order
b) Opening a trading account and Demat account, Placing an order, Settlement
of order, Execution of order.
c) Placing an order, Opening a trading account and Demat account, Execution
of order, Settlement of order
d) Placing an order, Opening a trading account and Demat account, Execution
of order.

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6.4 TYPES OF ORDERS

Orders in online trading is just a set of instructions given by the investor to buy or sell the
security on the online trading platform i.e. to the stockbroker. The traditional way of quoting
only “buy” or “sell” may result in slippage to the investors (slippage is the difference between
the expected price and the actual price of the order), hence, the stockbroker provides various
combinations of options to place an order more wisely. There are different type of orders in the
market such as market orders, limit orders, stop-loss orders, stop-loss limit orders, stop-loss
market orders etc.

Market Order

Limit Order
Price
Stop Loss Order

Stop Loss Market

Order

DAY

IOC (Immdeiate or
Orders Cancel)
Time
Good-Till Day

Good-Till
Cancelled

All or None

Quantity Mininmum Fill

Disclosed Quantity

Fig 6: Types of Orders (Source: Prepared by Author)

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6.4.1 ORDERS BASED ON PRICE:

MARKET ORDER: A market order is an instruction where the investor either wants to buy
or sell the securities at the current market price. Such type of order gives a guarantee to be
executed but does not guarantee the execution price of the bid/ask. Here, the investor cannot
control the price and gets instantaneously executed. There is a risk of slippage in the market
order may occur due to a minute lag between the placement and execution of the order.
LIMIT ORDER: A limit order is an option for the investor to buy or sell the security at a fixed
price or better. In the case of buying a security in a limit order, the order is executed at the limit
price given by the buyer or at a lower price, however, a sell limit order can get executed at the
limit price or higher.
STOP LOSS ORDER: This is an order placed by the investor to buy or sell the security
whenever the stock price reaches a fixed value. The execution of the order is more likely than
the limit order because the transaction remains dormant until the stock reaches the pre-defined
price and once the price reached that level the order becomes a market order. Investors use
such orders to avoid major losses that’s why it is known as a stop-loss order.
STOP LOSS (LIMIT) ORDER: In the stop-loss limit orders, the investor sends a limit order
to exchange rates where the trigger price is reached.
Example: You have purchased 100 shares of Reliance ltd. at Rs 1,500 per share expecting a
price rise, but the market goes against your expectations and the prices started falling. Using
stop loss limit order at Rs. 1480 with a trigger price of Rs. 1489 (based on the support level of
Reliance Ltd.) you can stop any unexpected loss by selling the security at a particular price.
However, a stop-loss limit order doesn’t guarantee the execution of security.
STOP LOSS (MARKET) ORDER: Stop loss market order is similar to the stop loss limit
order but here allows the broker to execute the transaction when the price reaches over and
above the trigger price. A stop-loss order guarantees the execution of the order.
Example: You have purchased shares of Madhu ltd. At Rs 550 per share. The maximum stop
loss you are ready to take is Rs 2 only. Hence, you can set the stop loss preference with a trigger
price of Rs 548, the moment the price reaches Rs 548 a market order to sell the security will
be sent to the exchange by the broker itself.
6.4.2 ORDERS BASED ON TIME:
DAY: It is an order buy or sell order based on time i.e., for a day and if it is not executed on
the same day, it automatically expires. The deal in such orders gets executed only if the asset
hits a specific price quoted by the buyer or seller at any point during the trading day.

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Example: You can order buy 100 shares at Rs58. If the market falls to Rs 58, the day order will
automatically get executed but if the market does not fall to RS 58 during the trading day the
order will automatically cancel at the end of the day without execution.
IMMEDIATE OR CANCEL (IOC): IOC is a condition to buy or sell the security
immediately. If the order is not executed immediately, it will be instantaneously cancelled.
Investors use IOC orders when the market is very volatile and try to take the trade at the current
market price. IOC orders can also be filled with a preference for ‘limit’ or ‘market’ orders.
GOOD-TILL-DAY (GTD): Good-till-Day is good till ‘date/day/time’ means it is valid till the
specified date or time given by the investor to buy or sell the security unless it has been
cancelled by the investor itself. It is helpful for long-term investors because as a replacement
for setting the same orders every day they can hold this order till a given date and time.
Sometimes, the traders forget about their GTD orders which may become unfavourable due to
the volatile market and may cause huge losses to the investors.
GOOD-TILL-CANCELLED (GTC): A good-till-cancelled order allows the investor to
place an order which remains in the system until it gets executed or cancelled manually without
worrying about its expiration. However, to reduce the unplanned losses the broker usually asks
the investor to limit the timeframe to which a GTC order can be kept open.
6.4.6 ORDERS BASED ON VOLUME
ALL OR NONE: It is an order to buy or sell the security that must be executed entirely, there
is no option for partial fills otherwise the order will not execute. It is also known as duration
order or contingent order. The main disadvantage with the All or None order is that the changes
in the price of the security do not change/impact the transaction process and hence influence
the total cost incurred by the investor.
MINIMUM FILL: Minimum fill order allows the investor to fill a minimum quantity and the
order gets executed only if the minimum quantity is filled.
Example: You can buy 1,000 shares with a minimum volume fill of 500 shares, the order can
get executed only if 500 or more shares are available in the market.
DISCLOSED QUANTITY (DQ): A disclosed quantity order allows the user to disclose only
a part of the order quantity while buying or selling the security. DQ orders are allowed in Equity
(cash), Commodity, and currency but not allowed in the F&O segment. The DQ orders are
allowed for the market session only but not allowed for the pre-open and post-closing market
session.

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 Fundamentals of Stock Trading

Example: If a user wants to place an order of 750 shares and sets Disclosed Quantity of 150
shares. The order sends to exchange for only 150 shares, and once the order is executed next
DQ of 150 shares will be released for trading purposes.

IN-TEXT QUESTIONS
6. When the market hits the upper/lower circuit the market
a. Starts working
b. Halts as per Guidelines
c. Works normally
d. None of the above
7. CTCL stands for ____________________________.
8. The small broker uses the exchange developed software NEAT and
___________.
9. Best buying price is known as ___________ and best-selling price is known
as ______.
10. Any person willing to enter in securities market would require three accounts
_________, _____________, and ____________.
11. NEAT stands for ____________________________.
11. DAY order remains valid till executed/cancelled manually.
12. All orders received by the exchange are sorted with the best-priced order
getting the priority of matching.

6.5 PLACING AN ORDER

Trading in the security market can be done using software known as National Exchange for
Automated Trading (NEAT). The steps for sending the order via NEAT are as follows:
1. Select the buy/sell in the order form provided by the broker, select the scrip name, the
quantity, the price, the order (Cash or MIS), the order type (market, limit, stop loss,
stop-loss-market), and hit buy button after giving your preference. You have other
advanced options also to select such as trigger price, disclosed quantity, etc.

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2. Once the preferences are submitted by the investor, the status of the order can be seen
on the broker’s page. The moment the order gets filled; it gets executed on exchange
the order status will change itself to completed.
6.5.1 VIEW/MODIFY/CANCEL AN ORDER:
All the orders placed by the investor will appear in his/her order book. The order book is very
powerful filter tab provided by the broker to the investor which helps him in modify and cancel
the order if not executed.
The status of the order can be seen, and the investor can check the price, quantity, and time
quoted. If the orders are pending, there is an option to open the order and modify it till
execution. To modify the order the investor can simply select a particular trade and
change/cancel the preferences as per his/her own desire. However, once the order is executed
investor loses the opportunity to modify anything because the order has already been executed
in the market.

ACTIVITY-2
Visit the website of National Stock Exchange i.e. https://www.nseindia.com/ and
select ten stocks of your choice. Observe the prevailing market price, closing price,
and average trading price using any virtual trading platform.
1. Place a buy order for the best five stocks observed.
2. Cancel any two least-performing stocks from your portfolio and modify
the limit price of any one stock.
3. Open the trade book and check the order has been successfully executed or
not.

6.6 SUMMARY

• Online trading involves buying and selling securities on an online platform. It is a much
faster way of trading securities as compared to the offline trading system.

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 Fundamentals of Stock Trading

• A person i.e., an investor should be aware of different types of prices, time, and volume
orders which are available for trading. Such orders in the market are market orders,
limit orders, stop-loss orders, stop-loss limit orders, stop-loss market orders etc.
• Ask, Bid, LTP are the most popular and quotations in the stock market.
• The difference between ask and bid is known as the spread price.
• Circuit breakers and price bands are the tools used to restrict the volatility in the
securities market.
• Online trading platform gives the option to view, modify and cancel the order by the
investor.

6.7 GLOSSARY

Demat: Short for Dematerialisation. An electronic form of securities.

Price Quotations: Quotations are the price of the security quoted in the stock exchange.
ATP and LTP: Average Trading price and Last Trading Price

6.8 ANSWERS TO IN-TEXT QUESTIONS

1. bid price 9. Bid price, ask price.

2. True 10. Bank account, demat account and trading
account.
6. False: Spread
11. National Exchange for Automated
4. False
Trading
5. b
12. False
6. b
16. True
7. Computer-to-computer link facility
8. BOLT

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6.9 SELF-ASSESSMENT QUESTIONS

1. What are the different types of orders we can place while investing in the securities
market?
2. Differentiate between the followings:
a. Market Order and Limit Order.
b. Stop loss order and Market Order.
3. What are the circuit breakers? Explain the recent rules framed by NSE regarding circuit
breakers.
4. How does the stop loss orders can cap possible losses? Illustrate with an example.
5. How can the order be modified and cancelled?

6.10 OBJECTIVE TYPE QUESTIONS (MCQs)

1. The fully automated screen-based trading system is known as:

a. NEET
b. NEAT
c. SEBI
d. BEAT
2. NSE started its online trading in the year
a. 2010
b. 2006
c. 2000
d. 2002
3. ____________the bid-ask spread, __________ the liquidity of a security.
a. Higher, lower
b. Higher, higher

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c. Lower, Higher
d. Lower, lower
4. A trader can give various_____________ while placing an order
a. Price preferences
b. Time preferences
c. Volume preferences
d. All of the above
5. Which of the following orders gives a guarantee to fill:
a. Market Order
b. Limit Order
c. Stop loss Market Order
d. Option A and C
e. All of the above
6. Which of the following order/orders are executed at the best prevailing price in the
market?
a. Market Order
b. Limit Order
c. Both of the Above
d. None of the Above
7. A trader can specify the time condition for his/her order. Which of the following is not
a time related condition.
a. Immediate or Cancel (IOC)
b. Good till Date (GTD)
c. Day
d. Stop-loss

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8. _____________ is a quantity-related condition where the trader has the option to

disclose only a few quantities.
a. Disclosed quantity
b. All or None
c. Minimum Fill
d. Undisclosed Quantity
9. Minimum fill is a condition where the orders are executed only when
a. Minimum time condition is matched
b. Minimum quantity condition is matched
c. Minimum price condition is matched
d. Minimum limit condition is matched
10. The daily price bands (either way) on securities as NOT specified by exchange are as
follows:
a. 2% based on the previous day’s closing
b. 5% based on the previous day’s closing
c. 10 % based on the previous day’s closing
d. 14% based on the previous day’s closing
11. If the trigger limit is below 10 percent between 1:00 PM to 2:60 pm, the market halt
time is:
a. 45 Minutes
b. 60 minutes
c. 15 Minutes
d. No halt.
12. If the trigger limit is below 20 percent anytime during the market hour, the market halt
time is:
a. 45 Minutes

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b. 60 minutes
c. 15 Minutes
d. Remainder of the day
13. If the trigger limit is below 15 percent between 1:00 PM to 2:60 pm, the market halt
time is:
a. 45 Minutes
b. 60 minutes
c. 15 Minutes
d. Remainder of the day
14. The broker gives an option to _____________ the order in the order book
a. View
b. Modify
c. Cancel
d. All of the above.
15. The broker gives an option to _____________ the order in the order book if the order
is executed.
a. View
b. Modify
c. Cancel
d. None the above.
Answer Key:
16. b 21. c 26. b
17. b 22. d 27. d
18. c 23. a 28. a
19. d 24. b 29. d
20. d 25. d 30. d

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6.11 REFERENCES

Bodie, Zvi., Kane Alex and Alan J. Marcus, (2021). Investments, McGraw Hill.
Bhalla, V. K., (2008). Investment Management, S. Chand & Company Ltd.
Bala, A. (2016). Indian stock market-review of literature. TRANS Asian Journal of Marketing
& Management Research (TAJMMR), 2(7), 67-79.
Chandra, P., (2017). Security Analysis and Portfolio Management, Tata McGraw Hill.
Das, S. (2009). Perspectives on Financial Services. Allied Publishers.
Keller, C., & Siegrist, M. (2006). Investing in stocks: The influence of financial risk attitude
and values-related money and stock market attitudes. Journal of Economic Psychology, 27(2),
285-606.
Reilly, Frank K, and Brown, Keith C., (2011). Investment Analysis and Portfolio Management,
Cengage Learning.
Tripathi, V., & Panvar, N. (2022). Investing in Stock Market (6th ed.). Taxmann Publication.

6.12 SUGGESTED READINGS

https://www.nseindia.com/products-services/equity-market-circuit-breakers

https://www.nseindia.com/products-services/equity-market-price-bands
https://zerodha.com/varsity/

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LESSON 7

INTRODUCTION TO MUTUAL FUND

Dr. Mohd Rafee
Assistant Professor
University of Ladakh
kamranenigma90@gmail.com

STRUCTURE

7.1 Learning Objectives

7.2 Concept of Mutual Funds
7.2.1 Types of Mutual Fund
7.2.2 Exchange Trade Fund (EFTs)
7.3 Mutual Fund indirect mode of investment
7.4 History of mutual fund
7.4.1 Evolution of Mutual Fund in India
7.5 Structure of Mutual Fund
7.5.1 Sponsor
7.5.2 Mutual Fund as Trustee
7.5.3 Asset Management Company (AMC)
7.5.3.1 General Obligation
7.5.4 Custodian
7.6 Advantages and Disadvantages in investing in Mutual Fund
7.7 Conclusion
7.8 Glossary

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7.9 Answers to In-text Questions

7.10 Self-Assessment Questions
7.11 References
7.12 Suggested Readings

7.1 LEARNING OBJECTIVES

The objectives of the lesson will indicate the Intended Learning Outcomes is learning
about the mutual fund and investment in mutual funds. The concept of mutual fund and
investment is recent. It also explains the evolution of mutual funds in India and its types and
functions. The advantages and disadvantages in investing in mutual fund is also explained.
Learning It will state clearly what the learners are expected to learn after reading the lesson.

7.2 INTRODUCTION

Concept of Mutual Fund

To pool the savings of investors a mutual fund is a financial intermediary or collective
investment in a diversified portfolio of securities. A fund is called 'mutual' as the returns as
the expenses minus returns are shared by the mutual fund's investors.
The Securities and Exchange Board of India (SEBI) (Mutual Funds) Regulations, 1996,
explains a mutual fund as a 'a fund formed in the form of a trust to raise money through the
sale of units to the masses or a part of the masses under many schemes for investing in
securities, including, market instruments, gold, money or gold related instruments or real estate
assets".
The above definition explains, that a mutual fund in India can raise resources through sale of
units to the masses. It can be set up in the form of a trust under the (INA) Indian Trust Act.
The Definition has been further extended by allowing mutual funds to diversify their activities
in:
a) Management of money market funds
b) Portfolio management services
c) Management of venture capital funds
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d) Management of off-shore funds

e) Management of real estate funds
f) Providing advice to off-shore funds
g) Management of pension or provident funds
The link between the investor and the securities market is served by mutual funds, by
mobilising the savings from the investors and investing them in the securities market to
generate returns. Thus, a mutual fund is similar to portfolio management services (PMS).
Although, both are conceptually the same, they are different from each other. To the highly net
worth individuals Portfolio management services are offered, taking into account their risk
profile, their investments are managed separately. Under a scheme the savings of small
investors are polled and the profit/return are divided in the proportion of the investments made
by the investors/unit-holders.
Mutual funds in India are not much different from portfolio managers for select corporates and
high net worth individuals whose collective share in MF investment is more than 80%.
Mutual funds play an important role in mobilising the savings of small investors and
channelizing the same for productive ventures in the Indian economy. Mutual fund is a
collective savings scheme. Mutual fund is similar to a Collective Investment Scheme (CIS)
which pools the savings and invests them to generate returns. While mutual fund invests in
securities, CIS invests only in real estate, plantations and art funds.
7.2.1 Types of Mutual Funds
Open-Ended and Closed-Ended Funds.
Closed End and Open End are the two basic forms of mutual fund. Open-end funds can
advertise extensively and on the other hand, except at the time of issue, closed-end funds, like
other publicly quoted companies are not permitted to advertise their shares.
There are some limitations in both the forms of close ended and open ended, as the open-ended
fund is obliged to redeem its shares at any time, it must ensure its liquidity. It must have to sell
off its assets, If redemptions exceed new purchases. That means its assessment is limited to
highly marketable securities.
In closed ended fund the liquidity is achieved through transferability rather than through
redemption which means it’s able to invest in less marketable assets.
7.2.2 Exchange-Traded Funds (ETFs). 1.2.1
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This type of investment is invented in 1990s, the exchange-traded fund (ETF) which was very
new.. This was traded on an exchange as an index fund. The ETF is somewhat different from
that of an investment. Rather than issuing shares, the organisers of an ETF sell to the public
"ware-house receipts" for a basket of shares that they have deposited with a custodian. The
basket is designed a similar share index like the S&P 500, the Dow Jones, or Russian stocks.
In 1993, the American Exchange invented ETFs in the hopes of reversing the steady decline in
its trading volume. Its first SPDR (S&P Depository Receipt), ETFs was a tremendous success
and was followed by others linked to other indexes. By 2000, two-thirds of the trading volume
trading on the American Exchange was through the ETFs account. In May 2001, there were
over $70 billion of ETFs outstanding which was only about 1% of the total amount of mutual
funds outstanding.
There are some advantages of ETFs over open-end index funds as the ETFs trade continuously
throughout the day, only at the end of the day their prices are continuously available. Similarly,
investors can move in and out at any time rather than only at the end of the day as with a mutual
fund. Because the management fees are very low and the structure is so simple, even compared
to most index funds. However, ETFs also have some tax advantages and trading in ETFs, like
any trading on an exchange, incurs brokerage fees while the redemption and purchase of most
index mutual funds does not involve fees.
Unlike closed-end funds, ETFs trade on an exchange, they generally do not suffer from the
same problem of trading at a chronic discount. That is the reason they are less “closed."
The sponsors of an ETF stand ready to exchange receipts for shares and shares for exchange
of receipt. Consequently, if SPDRs start trading at a discount relative to the S&P 500 index,
arbitrageurs will buy them up and redeem them for the underlying shares. Their buying will
drive the price of the SPDRs up and the discount disappears.

7.3 MUTUAL FUNDS INDIRECT MODES OF INVESTMENT

An investor has the choice of investment of direct and indirect mode of investment. In
individual securities they can invest directly or indirectly through a financial intermediary.
Internationally, the mutual funds have established themselves as the means of investment for
the retail investor.
I. Professional Management in the capital market operation an average investor lacks
the knowledge and partially or fully can’t reap the benefits of investment. Hence, they

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require the help of an expert. It is difficult to identify the real expert and also expensive
to hire the services of an 'expert'. Professional managers manage the Mutual funds who
have the requisite skills, information and experience to analyse the performance and
prospects of companies. They make an organised investment strategy, which is hardly
possible for an individual investor to understand and absorb.
II. Portfolio Diversification An investor calls the risk if he invests all his funds in a single
basket. Mutual funds invest in a number of companies across various sectors and
industries. This diversification reduces the loss or the risk of loss of the investments.
III. Reduction in Transaction Costs To pass on the benefit of economies of scale the
direct investing in the capital market and investing through the funds is relatively less
expensive.
IV. Liquidity In case of mutual funds; they can easily encash their investment by selling
their units to the fund if it is an open-ended scheme or selling them on a stock exchange
if it is a close-ended scheme but often, investors cannot sell the securities held easily.
V. Convenience Investing saves time, reduces paperwork, and makes investment easy.
VI. Flexibility Mutual funds this offer an umbrella of schemes, and investors have the
option of transferring their holdings from one scheme to another.
VII. Transparency Mutual every month transparently declare their portfolio. Thus, an
investor knows where the invested money is being deployed and in case they are not
satisfied with the portfolio they can withdraw at a short notice.
VIII. Stability to the Stock Market Mutual funds increase liquidity in the money and capital
market. It also has a large amount of funds which provide economies of scale by which
they can consume any losses in the stock market and continue investing in the stock
market.
IX. Equity Research Mutual funds can afford data requirement and information for
investments as they have equity research teams available with them and large amount
of funds also.
X. Protection of Interest SEBI regulates the investment invested in the mutual fund
which has to adhere to the strict regulation designed to protect the interest of the
investors.

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IN-TEXT QUESTIONS
1. In India, AMC must be registered with____________.
A) Reserve Bank of India B) Securities Exchange Board of India
C) No registration required. D) Companies’ Act, 2003
2. ___________ is a type of investment vehicle consisting of a portfolio of stocks,
bonds, or other securities.
A) Derivatives B) shares C) Government Securities D) Mutual Funds
3. ___________ funds are available throughout the year for subscription. a) Gold
Funds b) Close-Ended Funds c) Interval Funds d) Open-Ended Funds
4. _______________ are available only during specified days for subscription.
a) Open-Ended Funds b) Close-Ended Funds c) Gold Funds d) Interval Funds
5. What is the full form of NAV?

7.4 HISTORY OF MUTUAL FUND

STORY OF MUTUAL FUNDS

The history of mutual funds dates back to the 19th century in Europe. In 1868, Robert Fleming
set up the first investment trust called Foreign and Colonial Investment Trust which promised
to manage the finances of the elite classes of Scotland by spreading the investment over a
number of different stocks. This investment trust and other investment trusts which were
subsequently set up in Europe and the US, resembled today's close-ended mutual funds. In
March 1924, the first mutual fund in the US, Massachusetts Investors' Trust was set up. This
was the first open-ended mutual fund.
The Great Depression of 1929 and the outbreak of the Second World War slackened the pace
of growth of the mutual fund industry. The increase in Innovations in products and services
can be seen, in 1950 and 1960s the popularity of mutual funds increased. In 1940s in the US
the first international stock mutual fund was introduced. In the 1976, the first tax-exempt
municipal bond funds emerged and the first money market mutual funds were created in 1979.
The latest additions are the international bond fund in 1986 and arm funds in 1990. In the
1980s and 1990s the industry witnessed substantial growth when there was a significant
increase in the number of mutual funds, schemes, shareholders and assets. In the US, a tenfold
growth in the mutual fund industry registered in the 1980s only, with 25 % of the household
sector's investment in financial assets made through them. In 1980 Fund Assets increased from
less than USD 150 billion by the end of 1997 to over USD 4 trillion. Since 1996, bank deposits
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exceed mutual fund assets. In size the mutual fund industry and the banking industry virtually
rival to each other.
7.4.1 Growth of Mutual Funds in India
The Indian mutual fund industry has evolved over a period of time in different stages. The
growth of the mutual fund industry India can be separated into four phases: Phase I (1964-87),
Phase II (1987-92), Phase III (1992-97), and Phase IV (beyond 1997).
Phase I
The concept of mutual fund was introduced in India in 1963, under the UTI Act, 1963, by
parliament special act. It became operational in 1964 with a major objective of diversifying
the savings through the sale of units and investing them in securities of corporations for
growing the yield and capital appreciation. With the launch of the Unit Scheme 1964 (US-64)
this phase commenced which was the first open-ended and the most popular scheme. UTI's
investible funds, at a market which grew from Rs. 49 cr in 1965 to 8219 cr in 1970-71 to 21,126
cr in 1980-81 and in June 1987 to 25.068 cr. The base of investors had also grown to about two
million investors. Its fund umbrella included, open-ended schemes and five income-oriented
schemes which were sold largely through its agent network built up over the years. Master
share, the equity growth fund launched in 1986, proved to be a grand marketing success. Master
share was the first real close-ended scheme floated by UTI. It launched the India Fund in 1986-
-the first Indian offshore fund for overseas investors, which was listed on the London Stock
Exchange. UTI maintained its monopoly and experienced consistent growth till 1987.

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Phase II
The nationalised banks and insurance companies witnessed in the entry of mutual fund
companies in the second phase. Under the Indian Trust Act, 1882, in 1987, Canbank Mutual
Fund and SBI Mutual Fund were set up as trusts. , The India Growth Fund listed on the New
York Stock Exchange (NYSE) UTI floated another off-shore fund. the two nationalised
insurance giants, GIC and LIC in 1990, and other nationalised banks started operations of
wholly-owned mutual fund subsidiaries. RBI issued the first regulatory guidelines in October
1989 but only applicable to the bank sponsored mutual funds.
The government of India issued comprehensive guidelines in June, 1990 covering all the
mutual fund.
These guidelines emphasised compulsory registration with the SEBI and an arm- length
relationship be maintained between the Asset Management Company (AMC) and sponsor.
With the entry of public sector funds, there was a tremendous growth in the size of the mutual
fund industry with investible funds, at market value, increasing to 753,462 cr and the number
of investors increasing to over 23 million. The equity markets in the early nineties and tax
benefits under equity-linked savings schemes enhanced the attractiveness of equity funds.
Phase III
In the history of mutual funds in India the year 1993 marked a turning point. In January 1993
a Mutual Fund Regulations was issued by the Securities and Exchange Board of India (SEBI).
The SEP notified regulations bringing all mutual funds which excludes the UTI under the
regulatory framework. In the mutual fund industry the foreign, Private and Domestic players
were allowed entry. In 1993, Kothari group in joint venture with Pioneer, a US fund company,
set up the first private mutual fund, the Kothari Pioneer Mutual Fund.
In1993 Kothari Pioneer introduced the first open-ended fund Prima. During this phase several
other private sector mutual funds were set up. In May 1992, UTI launched a new scheme,
Master-gain, which was a phenomenal success with a subscription of 24,700 cr from 6% lakh
applicants. The industry's investible funds at market value increased to 378,655 cr and the
number of investor accounts increased to 50 million. However, the year 1995 was the beginning
of the sluggish phase of the mutual fund industry. During 1995 and 1996, unit-holders saw an
erosion in the value of their investments due to a decline in the NAVs of the equity funds.
Moreover, the decline in service quality of mutual funds happened due to a rapid growth in the
number of investor accounts, and the in-adequacy of service infrastructure. A lack of
performance of the public sector funds and miserable failure of foreign funds like Morgan

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Stanley eroded the confidence of investors in fund managers. Investor’s perception about
mutual funds, gradually turned negative. It’s difficult for Mutual funds which found it
increasingly to raise money. The average annual sales declined from about 713,000 cr in 1991-
94 to about 79,000 cr in 1995 and 1996.
Phase IV
In this phase the sharp increase in the flow of funds into mutual funds. In the capital market
this significant increase was aided by a more positive sentiment, significant improvement and
tax benefits, in the quality of investor service. Investible funds, at market value, of the industry
rose by June 2000 to over 71,10,000 cr with UTI having a 68 per cent of the market share.
In 2001-02 a sluggish economy coupled with bad investment decisions and crumbling global
equity markets, made life tough for big funds investors across the world. The strong effect of
this problem was felt strongly in India. In 2002 the Bank of India Mutual Fund liquidated all
its schemes.
During the years 2000-01 and 2001-02, the Indian mutual fund industry stagnated at around
1,00,000 cr assets. This stagnation was partly a result of stagnated equity markets and an
indifferent performance by players. As against this, on May 3, 2002, the aggregate deposits of
scheduled commercial banks (SCBs), stood at 711,86,468 cr. Mutual funds’ assets under
management (AUM) form just around 10 percent of deposits of SCBs.
During this period the Unit Trust of India (UTI) lost out to other private sector players. During
the year 2002, an increase in AUM by around 11%, on the contrary, lost more than 11% in
AUM. The AUM of this sector grew by around 60 per cent for the year ending March 2002.
There was a record growth in funds mobilised through a record number of new schemes during
the year 2004-05. The mutual fund industry has shown impressive growth not just in the scale
of AUM in the last decade, but also in terms of schemes and products. Buoyed by robust capital
inflows and strong participation of retail investors, the asset base of the mutual fund industry
again produced record breaking numbers in 2016-17. The total AUM of the sector stood at
819,51,775 cr as of June 30,2017. In the year ending March, 2017 the AUM of the industry
saw a lucrative year-on-year growth of 42.3 percent. However, AUM to GDP (151,83 lakh cr
at current prices) ratio of 12.8 per cent indicates a large untapped market potential and very
low penetration vis-a-vis global and peer benchmarks.

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IN-TEXT QUESTIONS

6. The 1st phase of mutual fund in India is 1987-1992 True / False

7. The IInd phase of mutual fund in India is 1992-1997 True / False
8. The growth of the mutual fund industry India can be divided into six phases
True / False
10. The history of mutual funds in India can be divided into ………. phases. a. 4
b. 6 c. 7 d. 5
11. The Great Depression and the crash of stock market happened in _____

7.5 STRUCTURE OF MUTUAL FUND

7.5.1 Sponsor
A sponsor one who acts alone or in collaboration with another body corporate and establishes
a mutual fund. A promoter is similar to the sponsor as both get registered with the SEBI.
Some criteria has to be fulfilled before registering on the SEBI and the following criteria are
as follows:
• The sponsor and any of the principal or directors are to be employed by the mutual fund, and
both should not have been found guilty or convicted of an offence involving economic offences
or moral turpitude or fraud.
The sponsor forms a trust and appoints a board of trustees. He also appoints an AMC as fund
managers. The sponsor, either directly or acting through the trustees, also appoints a custodian
to hold the fund assets. The sponsor is required to contribute at least 40 % of the minimum net
worth of the asset management company.
A mutual fund can be sponsored by a financial institution, bank or companies whether Indian
or foreign or a joint venture between Indian and foreign entities. Out of the 39 mutual funds in
India, 4 are bank sponsored, 1 by Life Insurance Corporation, 16 by Indian entities, 5 by foreign
entries, and the remaining are joint ventures. For example, Reliance Mutual Fund is sponsored
by Reliance Capital Ltd ; HDFC Mutual Fund is a joint venture sponsored by HDFC and British
investment firm Standard Life Investments Limited. All the mutual funds have assets under
management of around 78 lakh cr.
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7.5.2 Mutual Funds as Trusts

Under the Indian Trusts Act,1882, mutual funds in India are constituted in the form of a public
trust. The sponsor forms the trust and registers it with the SEBI. The fund sponsor acts as the
settler of the trust, contributing to its initial capital and appoints a trustee for the benefit of the
unit holders holding the assets of the trust, those are the beneficiaries of the trust. The trust
deed deals with the establishment of the trust, the authority, and responsibility of the trustees
towards the unit holders and the AMC. The fund then invites investors to contribute their
money in the common pool by subscribing to 'units' issued by various schemes established by
the trust as evidence of their beneficial interest in the fund. Thus, a mutual fund is just a 'pass
through' vehicle. The board of trustees manages most of the funds in India, which is an
independent body and acts as protector of the unit holders' interests. With a minimum of 2/3rd
of the trustees will be independent trustees but those should not associate with an associate,
subsidiary, or sponsor in any manner. HDFC Trustee Company Ltd is wholly owned subsidiary
of HDFC. The trustees, on the board of trust of the fund, hold its property for the benefit of the
unit-holders, which are the company/ of trustees using two-thirds trustees by the investors. The
trustees have the authority of control and superintendence over the AMC. The AMC manages
the funds by making investments in various types of securities. According to new regulations
of SEBI, at-least 2/3rd of the trustees, on the Board of Trustees must be independent meaning
they should not be associated with the sponsors. The new regulations ensure that the trustees
will be able to be associated with only one mutual fund and also, bar trustees of one mutual
fund to be on the board of trustees or AMC of another mutual fund.
7.5.3 Asset Management Company (AMCs)
With the prior approval of the SEBI, the trustees appoint the asset management company. The
AMC is a company formed and registered under the Companies Act, 1956, to manage the
affairs of the mutual fund and operate the schemes of such mutual funds. An Investment
Management Agreement is executed between the trustee and the AMC to manage the mutual
fund. It charges a fee for the services it renders to the mutual fund trust. It acts as the investment
manager to the trust under the supervision and direction of the trustees. The AMC, in the name
of the trust, floats and then manages the different investment schemes as per the regulations of
the SEBI and the trust deed. The AMC should be registered with the SEBI.

The AMC of a mutual fund must have a net worth of at least 750 cr at all times and this net
worth should be in the form of liquid. It cannot act as a trustee of any other mutual fund. It is
required to disclose the scheme particulars and base of calculation of Net Annual Value. It can
undertake specific activities such as advisory services and financial consultancy. It must submit

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quarterly reports to the mutual fund. The trustees are empowered to terminate the appointment
of the AMC and may appoint a new AMC with the prior approval of the unit holders and SEBI.
At least 50 % of the directors of the board of directors of AMC should not be associated with
its subsidiaries, trustees or sponsors.
Most AMCs in India are private limited companies. The capital of the AMC is contributed by
the sponsor and its associates. AMCs are the investment managers of mutual funds. They
provide portfolio management/advisory services and design new products, set up offices and
distribution centres, allocate the funds, appoint distributors and report the portfolio
performance to investors and trustees.
Reliance Mutual Fund schemes are managed by RCAM, a subsidiary of Reliance Capital
Limited, which holds 93.37 % of the paid-up capital of RCAM, the balance paid up capital
being held by minority shareholders. RCAM is an un-listed Public Limited Company
incorporated under the Companies Act, 1956.
7.5.3.1 General Obligations of AMC.
These obligations are:
I. Every AMC, a proper book of accounts shall be kept maintained and recorded for each
scheme and proper documentation is necessary, so as to disclose and explain its
transactions at any point of time. The financial position of each and every scheme must
give a true and fair view of the state of affairs of the fund and inform the board about
the place where such accounts, books of record and documents are maintained.
II. Every year as on March 31, the financial year for all the schemes shall end. Every
mutual fund or the AMC shall prepare, in respect of each financial year, an annual
report and annual statement of accounts of the schemes and the fund as specified in the
11th schedule.
III. The audited accounts of the annual statement made by the auditor who is not associated
with the AMC must be there for every mutual fund.
7.5.4 Custodian
A custodian is responsible for safekeeping of securities and cash of the mutual fund. In case of
a gold exchange traded fund scheme, the assets of the scheme being gold-related instruments
are kept in custody of a bank which is registered as a custodian with the SEBI. The custodian
is also involved in settlement of dematerialised securities transactions on behalf of mutual
funds.

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Custodian is appointed by the trustee and is independent of the sponsor. No custodian in which
the sponsor or its associates hold 50 % or more of the voting rights of the share capital of the
custodian or where 50 % or more of the directors of the custodian represent the interest of the
sponsor or its associates shall act as custodian for a mutual fund constituted by the same sponsor
or any of its associates or subsidiary company.
The Reliance Capital Trustee Co. Limited trustee of the Reliance Mutual Fund has appointed
Deutsche Bank, AG as the Custodian of the securities that are bought and sold under the
Scheme. A Custody Agreement has been entered between Reliance Capital Trustee Co.
Limited and Deutsche Bank.
A custodian provides post-trading and custodial services to the mutual fund, keeps securities
and other instruments belonging to the scheme in safe custody, tracks corporate actions and
pay-outs such as rights, bonus, offer for sale, dividends, interest, and redemptions on the
securities held by the fund, ensures smooth inflow or outflow of securities and such other
instruments as and when necessary, in the best interests of the unit-holders, ensures that the
benefits due to the holdings of the Mutual Fund are recovered, offer fund accounting and
valuation services to mutual funds, and is responsible for loss of or damage to the securities
due to negligence on its part on the part of its approved agents.

IN-TEXT QUESTIONS
12. With the prior approval of the SEBI, the trustees appoint the asset management
company (AMC) True / False
13. Custodian is appointed by the trustee and is independent of the sponsor True /
False
14. The ________ can issue offer documents on behalf of the trustees.
a) AMC b) Custodian c) AMD d) Agents
15. AMC stands for ____________.
16. The trustees at the request of an AMC can terminate the assignments of the
AMC True / False

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7.6 ADVANTAGES AND DISADVANTAGES OF MUTUAL FUNDS

Advantages of Investing Mutual Fund

In modern days the most popular investment tools is the investment in mutual fund and few
of the advantages of investing in mutual funds are as below:
I. Advanced Portfolio Management where we pay a management fee as part of our
expense ratio, which is used to hire a professional portfolio manager who buys and
sells bonds , stocks. This is a relatively low price to pay for help in the management
of an investment portfolio.
II. Dividend Reinvestment The dividends and other interest income is declared for the
fund, which can be used to purchase more additional shares in the mutual fund, thus
helping your investment to grow.
III. Risk Reduction (Safety) A risk is achieved through the use of diversification, as most
mutual funds will invest in anywhere from 70 to 210 different securities - depending
on their focus. Several index stock mutual funds own 1500 or more individual stock
positions.
IV. Convenience and Fair Pricing makes it very easy to buy Mutual funds. They
typically have low minimum investments and they are traded only once per day at the
closing NAV. This eliminates price fluctuation throughout the day and various
arbitrage opportunities that day traders practice.
Disadvantages of Investing Mutual Fund
However, it’s not only the advantages but also there are disadvantages in investing in mutual
funds and some of the disadvantages are as under:
I. High Expense Ratios and Sales Charges If you're not paying attention to mutual
fund expense ratios and sales charges, they can get out of hand.
II. Management Abuses Churning, turnover and window dressing may happen if your
manager is abusing the authority. To fix the books unnecessary excessive trading
replacement and selling the losers prior to quarter end.
III. Tax Inefficiency investors do not have a choice when it comes to capital gain pay-
outs in mutual funds. Due to the turnover, redemptions, gains or losses in security

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holdings throughout the year, investors typically receive distributions from the fund
that are an uncontrollable tax event.
IV. Poor Trade Execution If we place the mutual fund trade any time before the cut-off
time for same-day NAV, we'll receive the same closing price NAV for our buy or sell
on the mutual fund. For investors looking for faster execution times, maybe because
of short investment horizons, timing the market, day trading, mutual funds provide a
weak execution strategy.

7.7 CONCLUSION

In India mutual fund investment has lot of potential to grow. Mutual fund companies have to
market and create innovative products and frame distinct marketing strategies. Product
innovation will be one of the key determinants to success. The mutual fund industry has to
bring lot of innovative projects and concepts. To penetrate into the mass population the mutual
fund has to educate the masses by providing seminars and workshops at grass root level.
Mutual funds are dominant shareholders in portfolio companies they can influence corporate
governance by questioning the actions of the company management.

7.8 GLOSSARY

Exchange-Traded Fund (ETF) A block of stocks that trades as a single security on an

exchange.
Open-end Investment Company (mutual fund) one that issues new shares and redeems old
ones according to demand.
Investment Company A financial intermediary that raises funds entirely by issuing equity
claims or shares.

7.9 ANSWERS TO IN-TEXT QUESTIONS

1. Securities Exchange Board of India 9. 4

2. Mutual Funds 10. 1929
3. Open-Ended Funds 11. True
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4. Close-Ended Funds 12. True

5. Net Asset Value 13. AMC
6. False 14. Asset Management Company
7. False 15. True
8. False

7.10 SELF-ASSESSMENT QUESTIONS

1. Explain the concept of Mutual fund and investment in mutual funds.

2. What are the Phases of Mutual Fund in India, Explain?
3. Discuss the structure of mutual funds.
4. What are the Advantages and Disadvantages of investing in mutual funds?

7.11 REFERENCES

Sharath Jutur(2004),“Evaluating Indian Mutual Funds”, Chartered Financial Analyst, July

Lakshmi.N. (2007),“Performance of the Indian Mutual Fund Industry: A Study with Special
Reference to Growth Schemes”, a published thesis: Pondicherry University, Puducherry
Raja Mannar B(2013),“Performance of Mutual Funds in Private Sector Banks”, an unpublished
thesis: Sri Venkateswara University Tirupati.
Sundar Sankaran(2012),“Indian Mutual Funds Hand Book” Vision Books Pvt. Ltd, Delhi

7.12 SUGGESTED READINGS

Chetna. T. Parmar (2010),“An Empirical Investigation on Performance of Mutual Fund

Industry in India.” a published thesis: Saurashtra University, Rajkot.
Prabakaran, G and Jayabal G (2010),“Performance Evaluation of Mutual Fund Schemes in
India: An Empirical Study”, Finance India, Vol.24 (4), 2010, pp.1347-1363.
Deepak Agrawal (2011),“Measuring Performance of Indian Mutual Funds” Finance India

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J.S. Yadav and O.S. Yadav (2012), “The Indian Stock Market: A Comparative Study of Mutual
Funds and Foreign Institutional Investors” Indian Journal of Finance, Vol. 6 No. 9
Nalini Prava Tripathy(2007),“Mutual Funds in India: Emerging Issues” Excel Books, New
Delhi.
Sundar Sankaran(2012),“Indian Mutual Funds Hand Book” Vision Books Pvt. Ltd, Delhi.
Ingle D.V.(2013),“Mutual Funds in India” New Century Publications, New Delhi.
Shome(1994),“A Study of Performance of Indian Mutual Funds”, unpublished thesis:
Bundelkhand University, Jhansi.
Naushad Alam (2010),“Indian Mutual Funds Industry since Liberalization: A Case Study of
HDFC Mutual Fund”, an unpublished thesis: Aligarh Muslim University Aligarh.
Raja Mannar B(2013),“Performance of Mutual Funds in Private Sector Banks”, an unpublished
thesis: Sri Venkateswara University Tirupati.
Meenakshi Garg (2014),“A Study on Performance Evaluations of Selected Mutual Funds in
India”, a published thesis: Maharishi Markandeshwar University, Haryana, 2014.

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LESSON 8

TYPES OF MUTUAL FUND SCHEMES

Imaran Ahmad
ahmad.imran367@gmail.com

STRUCTURE

8.1 Learning Objectives

8.2 Introduction
8.3 Types of Mutual Fund schemes
8.3.1 Open ended, Close ended and Interval funds
8.3.2 Domestic Funds and offshore funds
8.3.3 Growth funds, Income funds and Balanced funds
8.3.4 Equity Fund Schemes
8.3.5 Debt Fund Schemes
8.3.6 Gilt Funds
8.3.7 Money Market Mutual Funds(MMMFs)
8.3.8 Equity Linked Saving Schemes(ELSS)
8.3.9 Index Funds
8.3.10 Sectoral Funds
8.3.11 Ethical Funds
8.3.12 Load and No-load Funds
8.3.13 Fund of Funds
8.3.14 Systematic Investment Plan(SIP)
8.3.15. Systematic Withdrawal Plan(SWP)
8.3.16 Systematic Transfer Plan (STP)
8.3.17. Exchange Traded Funds(ETFs)
8.4 Multiple Choice Questions
8.5 Answers
8.6 Summary
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8.7 Glossary
8.8 Self-Assessment Questions
8.9 References
8.10 Suggested Readings

8.1 LEARNING OBJECTIVES

1. Understand the classification of mutual funds on the basis of operations, investment

objectives and others.
2. Identify main features related to various mutual fund schemes
3. Differentiate between open-ended, close-ended and interval funds
4. Understand the concept of entry load and exit load and evaluate its impact on the return
of investors.
5. Discuss the money market mutual funds and capital market mutual funds.
6. Illustrate the benefits of Systematic Investment Plan(SIP)

8.2 INTRODUCTION

Mutual funds provide better return to investors at minimum risk. Mutual funds issue
units to the investors in proportion to the funds contributed by the investors. These mutual
funds offer different types of schemes on the basis of investment, operations and type of income
distribution.
Mutual fund schemes are of different types and invest in a wide range of securities.
Some invest in short term debt instruments while others in long term investments. Some invest
in equities only while others invest in combination of debt and equities.
The various Mutual fund schemes provide following benefits:
1. Regular return
2. Capital appreciation
3. Tax benefits
4. Steady flow of income
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8.3 TYPES OF MUTUAL FUND SCHEMES

The schemes floated by mutual funds can be grouped into three broad categories based
on their operations, investment objectives and others. Fig 8.1 depicts the detailed classifications
of mutual funds in India.
CLASSIFICATION OF MUTUAL FUNDS

Classification 1. Open-ended Funds

By 2. Close-ended Funds
Operation 3. Interval Funds
1. Growth Fund
2. Balanced Fund
Classification 3. Income Fund
By 4. Money market Fund
Investment 5. Gilt Funds
Objectives 6. Floating Rate Funds
7. Treasury management Funds
8. High yield Debt Funds
9. Fixed Maturity Plan
10. Monthly Income Plan
11. Sector Funds
1. Index Fund
2. Tax Saving Fund
3. Exchange Traded Fund
4. Gold ETF
Others 5. Fund of Funds(FoF)
6. Quantitative Fund
7. Assured Return Scheme
8. Arbitrage Fund
9. Load/Unload Fund
10. Life style Fund

Fig 8.1: Classifications of Mutual Funds in India

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Some of these schemes have been explained below:

8.3.1 OPEN-ENDED, CLOSE-ENDED AND INTERVAL FUNDS
Open-ended Funds:
Open-ended funds are available for subscription and repurchase on a continuous basis.
There is no fixed maturity. It does not specify any period of redemption. Investors have the
option to buy and sell units at pre-determined price i.e. Net Assets Value(NAV) which is
declared on a daily basis. The NAV changes daily based on the prices of stocks in the market.
There is no limit on maximum amount the investor can invest in these funds. The essential
feature of open-ended scheme is the liquidity. They increase liquidity of the investors as the
units can be bought and sold continuously. The fund’s past performance is available in the case
of open-ended funds.
Open-ended funds do not have to be listed on the stock exchange and can also offer
repurchase soon after allotment. Investors can enter and exit the scheme any time during the
life of the fund. The corpus of fund increases or decreases, depending on the purchase or
redemption of units by investors.
Close-ended Funds:
Close-ended fund is the fund where investment is locked in for a specified period only.
Investors can subscribe only during the New Fund Offer(NFO) and redemption can take place
only after the lock in period is over. After initial offering, subsequent sale and purchase take
place only in secondary market. The market prices of these funds is determined by the market
forces of demand and supply.
Close-ended schemes have a fixed corpus and a stipulated maturity period ranging
between two to three years. The NAV of close ended schemes are disclosed generally on
weekly basis.
Basis Open-ended Close-ended
Buy-in- Investors can buy in or buy out at any Investors can buy in only during a
period time limited period
Investment These are perpetual funds with no fixed The investment tenure is between 3
tenure maturity to 5 years
Listing These are not listed on any stock They are listed on recognized stock
exchange exchange

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Trading The fund houses manages the trading of The units are traded on the stock
the units exchanges they are listed on
No of shares No limit Limited and fixed
issued

Interval Funds:
Interval funds provide the perfect mix of both close-ended funds and open-ended funds.
These funds can be listed on stock exchanges or various fund houses may allow redemption
during specified time period at on-going NAV.
8.3.2 DOMESTIC FUNDS AND OFF-SHORE FUNDS
Domestic Funds
These Funds are available for subscription by investors of the country of origin only.
They mobilise funds from a particular geographical locality like a country or region. The
market is limited and confined to the boundaries of a nation in which the fund operates. They
invest only in the securities which are issued and traded in the domestic financial markets.
Off-shore Funds
These Funds are to be subscribed abroad and provides forex to the capital market. It is
based in an offshore location. It provides investment exposure to the international markets.
They also provide some tax benefits as well. They attract foreign capital for investment in the
country of the issuing company. Such mutual funds can invest in securities of foreign
companies. They open domestic capital market to international investors.
CASE STUDY

Raghav is 31, newly married and a successful director in the Indian film industry.
Right from his struggling days, Raghav always saved a part of his income and invested in
safe instruments like fixed deposits. However, during the internet boom in early 2000,he
successfully invested in equities and mutual funds. Raghav thought that he was always well-
diversified but when the internet stock bubble burst in 2002, he lost the majority of his stock
portfolio. A major mistake he made was that even though he was diversified, he invested only
in tech stocks. Currently, Raghav suffers from the asthma and thus he is not willing to
participate in the equity market at all. He now misses the high return that his portfolio had
earned during the internet boom days. He has come to you to seek your suggestions to help
his portfolio generate higher returns.

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1. What do you think is Raghav’s ability and willingness to take risk?

2. Will you recommend a stock only portfolio to Raghav or a mutual funds only
portfolio for Raghav?
3. What kind of mutual fund will you recommend to Raghav?
4. Explain to Raghav how his new mutual fund portfolio achieves diversification.
Why diversification is important?

8.3.3 GROWTH FUNDS, INCOME FUNDS AND BALANCED FUNDS

Growth Funds
These Funds mainly focuses on capital appreciation and also provide dividend benefits to
the investors. It is suitable for investors having medium to long term investment opportunities.
The large proportion of the fund is invested in equity and equity linked instruments. They invest
most of the corpus in equity shares with significant growth potential and offer higher return to
investors in the long run. There is no assurance or guarantee of returns. These schemes are
usually close ended and listed on stock exchanges.
Income Funds
The funds which provide regular income in the form of dividends to the investors is known
as Income Funds. It usually invest in fixed income investments such as bonds, debentures,
government securities and commercial paper etc. These funds are less risky whereas capital
growth is less. The aim of income funds is to provide safety of instruments and regular income
to investors. The return as well as the risk are lower in income funds as compared to growth
funds.
Balanced Funds
These kinds of funds invest in both equity and debt. They provide both capital appreciation
and regular income. They divide their investment between equity shares and fixed bearing
instruments in such a proportion that the portfolio is balanced. Their exposure to risk is
moderate and they offer a decent rate of return. The portfolio usually comprises companies
with good profit and dividend track records. The NAVs of such funds are likely to be less
volatile compared to pure equity funds.

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8.3.4 EQUITY FUNDS SCHEMES

Under these schemes, funds are invested in equity shares only. Equity securities
represent ownership claims on a company’s assets. The degree of risk under these schemes are
high. However, these funds diversify the investments in different shares of companies to reduce
the risk. Since risk is high, equity funds schemes may give high returns. These schemes may
be income schemes or growth schemes.
Equity funds are riskier compared to debt funds and they can be further classified on the
basis of their investment strategy as diversified, aggressive, growth, value and sector funds.
Example of equity funds are index funds, diversified funds, arbitrage funds, large cap funds,
small cap funds, midcap funds, sector funds and equity linked saving schemes.
Diversified Equity Funds:
These funds invest in equity shares and hold a diversified equity portfolio. Their
performance is linked to the performance of the stock market. The various categories of
Diversified Equity Funds are:
a) Large cap funds: They make investments in share of big companies with market
capitalization of more than ₹1000 crore.
b) Mid cap funds: They make investments in share of companies that have a market
capitalization between ₹500 crore and ₹1000 crore. They have huge potential to grow big.
c) Small cap funds: They invest in small companies with a market capitalisation of up to ₹500
crore. They have ability to grow faster and potential of providing high returns.

8.3.5 DEBT FUNDS SCHEMES

Under these schemes the funds are invested in debt securities. Debt securities are financial
assets that entitle the security holder to a regular interest payment. Debt schemes are generally
income scheme. Debt funds are characterized as low risk and high liquidity investments. Debt
fund schemes may be in the form of government securities wherein the funds are invested in
government securities only. Debt funds invest in government securities, money market
instruments, corporate debt instruments and floating rate bonds. Examples of debt funds are
liquid/money market funds, income funds, gilt funds, fixed maturity plans and floating rate
funds. Debt fund schemes can be of short term or long-term period, depending on investment
horizon.

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Short Term Debt Funds: These funds provide a high degree of liquidity and reasonable
returns. They invest in short term debt and money market instruments. They are primarily made
up of corporate bonds.
Long term debt funds: They invest in long term government dated securities and corporate
bonds.

8.3.6 Gilt Funds

Under these schemes, the funds are invested in government securities only. These funds
have low return and low risk. Risk averse investors prefer to invest in these schemes.
Government securities include central government dated securities, state government securities
and treasury bills. These schemes give better returns than direct investments in these securities
through investing in various government securities yielding differentiated returns.
SBI Magnum Gilt Fund, ICICI Prudential Gilt Fund, Axis Gilt Fund, Nippon India Gilt
Securities Fund and Edelweiss Government Securities Fund are some of the gilt funds in India.
8.3.7 MONEY MARKET MUTUAL FUNDS(MMMFs)
Under these schemes, the funds are invested in highly liquid investment instruments
such as treasury bills, certificate of deposits, commercial papers and interbank call money.
They are set up with the objective of investing in money market instruments. These fund
schemes are part of short-term pooling arrangement of funds. Low risk and moderate income
are the main features of these schemes. They do not carry either interest rate risk or entry or
exit loads. It is favourable for those who want to invest their surplus funds for shorter periods.
Corporates invest in these funds to park their short-term surplus funds.
UTI Money Market fund, Tata Money Market funding India Liquid Fund etc are some of the
examples of these funds.
8.3.8 TAX SAVING OR EQUITY LINKED SAVING SCHEMES(ELSS)
These schemes are designed to avail tax exemptions to investors. They help individual
investor in their tax planning. They are entitled to tax benefit under Section 80C of the Income
tax Act. These are diversified schemes investing in shares of blue-chip companies. Returns are
linked to the returns of the stock market. Investment in these schemes carry a lock in period of
3 years before the end of which funds cannot be withdrawn. They fall in high risk and high
return category. Due to fixed tenure, these funds are free from the pressure of redemption and
performance during a short time. It facilitates an opportunity to make investments in schemes
that is market linked.
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Bank of India Tax Advantage Fund, Kotak Tax Saver Fund, DSP tax Saver Fund, Mirae Asset
Tax Saver Fund etc are some of the major tax saving funds in India.
8.3.9 INDEX FUNDS
These funds replicate the performance of a stock market index or a particular segment
of the stock market. The funds collected are invested in the shares forming the Stock exchange
Index. They do not actively traded stocks throughout the year. They offer many benefits to the
investors. The investor is indirectly able to invest in a portfolio of a blue-chip stock that
constitutes the index. The funds are allocated on the basis of proportionate weight of different
shares in the underlying Index. They offer diversification across a various sector. There is low
cost of management. These schemes provide moderate risk, moderate return and well
diversified portfolio. It is favourable for long term investors.
In India, an index fund reflects the major market index like NIFTY or SENSEX by investing
all the stocks that comprise in proportions equal to the weightage of those stocks in the index.
The S&P 500 index, the Russell 2000 Index and the Wilshire 5000 Total market Index are few
examples of market indexes that index funds may seek to track.
Nippon India Index S&P BSE Sensex, HDFC Index S&P BSE Sensex fund, IDFC Nifty50
Index, Tata Nifty 50 Index Fund, Motilal Oswal Nifty Midcap 150 Index Fund, UTI Nifty 200
Momentum 30 index Fund are some of the examples of index fund in India.
8.3.10 SECTORAL FUNDS
They invest their funds to a specified segment or sector of the economy such as energy,
real estate, banking, Information technology, healthcare, FMCG etc. These funds allocate
capital in a specified particular industry. They generate high returns if the particular sector
perform well. They focus on only one sector of the economy. They limit diversification. As
these funds do not allow diversification, the risk is more in comparison to other well diversified
portfolio. These funds are also known as Thematic Funds. It is favourable for investors who
have already decided to invest in a particular sector.
IDFC Infrastructure Fund, SBI magnum COMMA Fund, Nippon India Power And Infra Fund,
Mirae Asset great Consumer Fund, Franklin Build India Fund are some of the examples of
Sectoral fund in India.
8.3.11 ETHICAL FUNDS
Ethics is a branch of philosophy that involves systematic study of human actions from
the point of view of its rightfulness or wrongfulness. Values, norms, principles, and beliefs are
some of the tools used to showcase ethical actions.

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Ethical funds restrict their investment activity to companies operating ethically. It

focuses on issues like labour treatment, employee’s relation, animal welfare, environmental
issues, manufacturing weapons etc. It caters to the investors who want to behave in a socially
responsible way.
8.3.12 LOAD AND NO-LOAD FUNDS
A load fund is the one that levies a fixed percentage of NAV as entry or exit fees. A
fee is charged by the fund to meet the various expenses such as administrative, advertisement
etc. A No load fund is one which does not charge any fee during entry or exit. All transactions
are done at NAV.
Entry Load is a sales charge that the investors pay when they buy some units of a mutual
fund scheme. This charge reduces the amount of their investment in fund. It is also called as
Front-end Load or Sales Load. Schemes that do not charge a load are called ‘No Load’ schemes.
Exit Load is the amount of money that the investor needs to pay to the mutual fund
companies when intend to exit from a scheme. It is calculated as a percentage of NAV rather
than the amount invested by investors. It is also called as ‘Repurchase’ or ‘Back-end’ Load.
8.3.13 FUND OF FUNDS
Fund of funds invests in other mutual funds and offers return to investors. It enables
diversification at two stages. The first stage is achieved by the Mutual funds which invest in
various securities and second stage results when FoFs invests in various MFs.This enables the
investors to obtain diversity in risk allocation.
A Fund of Funds(FOF) scheme invests in a combination of equity and debt mutual fund
schemes available in the market. The fund manager changes the percentage of equity and debt
allocation based on the market view.FOF becomes useful for those who want to invest in
different MFs but do not have time or inclination to track their performance. There can be
sectoral FOFs which focus on industry or geographic sector investments.
8.3.14 SYSTEMATIC INVESTMENT PLAN(SIP)
A SIP is an easy and convenient way to invest money in mutual funds. An investor
is required to invest a certain pre-determined amount at a regular interval. The investor can
invest smaller amounts in instalments rather than at once. Based on the market value of
investment the mutual fund will allocate a certain number of units. The additional units are
purchased at the market rate i.e. prevailing NAV and added to the unit holder’s account. Cost

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averaging and Compounding are the two benefits of investing in SIP. It is suitable for an
investor who is willing to invest regularly. It is the method of investing in a mutual fund.
SIP is the flexible method allowing investors to invest in a disciplined manner over long term.S
IP has following benefits:
a) Cost Averaging:
The NAV of the mutual fund schemes is volatile. The units available to the investor over
a longer period would be based on the average NAV. If NAV falls, an investor will get more
units at lower rates and in case of increase in prices, an investor would get lesser units. Thus,
SIP may bring down the average unit price in long run. SIP helps reducing the average cost per
unit and helps an investor to take advantage of market fluctuations and thereby reduces the
risk.
b) Compounding:
An investor can invest regularly at fixed interval in small amount or he can accumulate
these small savings and invest at yearly interval. For example: He may invest 1000 every month
or 1200 at the end of the year. He continues this process for 5 years at the rate of 10% interest.
In the first case he will get more interest as compared to the second one.
Thus, SIP is the disciplined and easy mode of investment that have the potential to deliver
attractive returns over a long term.
8.3.15 SYSTEMATIC WITHDRWAL PLAN(SWP)
It is a facility provided by a fund house to its unitholders to withdraw from the scheme on
a regular interval. It is suitable for those who wants a regular income from their investments.
It allows investors to meet their short-term goals and access their money to meet expenses. It
is available in two options:
a) Fixed withdrawal: fixed amount is withdrawn on monthly or quarterly basis
b) Appreciation withdrawal: certain fixed proportion of the appreciated amount is withdrawn
on monthly or quarterly basis.
8.3.16 SYSTEMATIC TRANSFER PLAN(STP)
If the investor desires to transfer money from one scheme to another, then the plan
available is known as STP.It enables an investor to switch or transfer a fixed amount of money
at regular intervals from his fixed income scheme investments to designated equity and

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balanced schemes. It is similar to SIP, except that in a SIP the investment flows from a bank
account into the fund and here it flows from one scheme to another.
8.3.17 EXCHANGE TRADED FUNDS(ETFs)
Exchange Traded Funds(ETFs) is a basket of securities that are tradeable at a stock
exchange. They are listed on a stock exchange and are traded as any other listed security. They
are organised as unit trusts and are similar to index mutual funds but are traded more like a
stock. ETF provides investors a fund that closely tracks the performance of the index with the
ability to buy and sell on an intra-day basis. A security firm creates an ETF by depositing a
portfolio of shares in line with an Index selected. The security firm creates units against this
portfolio of shares. These units are sold to the retail investors.
ETFs are a hybrid of open-ended mutual funds and listed individual stocks. They do not
sell their shares directly to investors for cash. The shares are offered to investors over the stock
exchange.
The ETF portfolio once created does not change. In case of mutual funds, the portfolio
may change. The market value of the units of ETF changes in line with the Index automatically.
The ETFs have all the benefits of indexing such as diversification, low cost and transparency.
As the funds are listed on the exchange, costs of distribution are much lower and the reach is
wider. They are passive index funds and due to passive fund management these funds charge
lesser fees as compared to other funds.
ETFs offer following advantages:
1. ETFs bring the trading and real time pricing advantages of individual stocks to mutual
funds.
2. ETFs are simple to understand and hence they can attract small investors.
3. ETFs can be used to arbitrate effectively between index futures and spot index.
4. ETFs provide the benefits of diversified index funds.
5. ETFs is passively managed and hence have higher NAV against an index fund of the
same portfolio.
6. Financial institutions can use ETFs for utilising idle cash, managing redemptions,
modifying sector allocations and hedging market exposure.

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ACTIVITY
Make the comparison of Exchange Traded Fund(ETF) with Open-ended
Fund(OEF) and Close-ended Fund(CEF) on the basis of following parameters:
1. Fund Size
2. NAV
3. Liquidity provider
4. Sale Price
5. Availability
6. Portfolio Disclosure

GOLD EXCHANGE TRADED FUNDS

Gold Exchange Traded Funds track closely the price of physical gold. These are a
listed security backed by allocated gold held in a custody of a bank on behalf of investors.
Investing in Gold ETF provides the benefit of liquidity and marketability. There is no physical
gold transactions, hence the owners of these funds do not bear any carrying cost. A gold ETF
has an underlying asset as a specific quantity of gold. The market price of Gold ETF unit moves
in tandem with the price of the actual gold.

8.4 MULTIPLE CHOICE QUESTIONS

1. SIP is a ___________________.
a. Method of regular investment
b. Name of a mutual fund
c. Brand of a tea stock
d. Method of one-time investment

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2. SIP stands for ________________.

a. Systematic Investment Plan
b. Simple Investment Plan
c. Simplified Investment Programme
d. Single Investment Plan
3. The __________ is the market value of the securities that mutual funds have purchased
minus any liabilities per unit.
a. Net Asset Value
b. Book Value
c. Gross Asset value
d. Net Worth Value
4. What is an open-ended mutual fund?
a. It is the one that has an option to invest in any kind of security
b. It has units available for sale and repurchase at all times.
c. It has an upper limit on its NAV
d. It has a fixed fund size
5. In __________ funds, the money is invested primarily in short term or very short-term
instruments e.g. T-Bills,CPs etc.
a. Growth Funds
b. Income Funds
c. Liquid Funds
d. Tax-Saving Funds(ELSS)
6. _________ ended fund are highly liquid.
a. Close
b. Open
c. Old
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d. New
7. Which of the following is a risk associated with debt fund?
a. Less volatile
b. Unsafe Investment
c. Fixed Return
d. Tax Efficient
8. Which of the following is not true for Index Funds?
a. These funds invest in the shares that constitute a specific index
b. The investment in shares is in the same proportion as in the index
c. These funds take only the overall market risk
d. These funds are not diversified
9. In which of the following do debt funds not invest?
a. Government debt instruments
b. Corporate Paper
c. Financial Institutions bonds
d. Equity of private companies
10. Investment in ___________ is best suited for investors with moderate risk appetite.
a. Large-cap funds
b. Mid cap funds
c. Small cap funds
d. Multi cap funds

8.5 ANSWERS

1. A
2. A

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3. A
4. B
5. C
6. B
7. C
8. C
9. C
10. C

8.6 SUMMARY

1. Open ended schemes are those schemes where investors can redeem and buy new units
all throughout the year as per their convenience at NAV-related prices.
2. Close ended schemes are open for subscription only for a specified period and have a
fixed corpus.
3. Equity linked saving schemes are diversified tax saving schemes with a lock-in period
of 3 years.
4. Index fund scheme means a mutual fund scheme that invests in securities in the same
proportion as an index of securities.
5. Index funds replicate the portfolio of a particular index such as the BSE Sensex or the
S&P CNX Nifty.
6. A Fund of funds scheme invests in schemes of the same mutual fund of other mutual
funds.
7. Gilt funds invest exclusively in government securities.
8. Schemes that charge a load(a percentage of NAV for entry or exit) are known as Load
Fund.
9. Exchange Traded Funds are index funds listed and traded on stock exchange.

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10. Gold Exchange Traded Fund is a listed security backed by allocated gold held in a
custody of a bank on behalf of investors.
11. An investor may put in a fixed sum of money each month, over a period of time
regardless of the mutual fund’s unit price. This mode of investment is known as
Systematic Investment Plans(SIPs).
12. A Systematic withdrawal plan(SWP) enables an investor to take out money of a fund
account in a regular interval, without getting exposed to timing risk.
13. If an investor transfers a fixed amount of money or appreciation on the unit value in
one scheme to another at regular intervals for profit booking or exposure to a new asset
class, it is known as Systematic Transfer Plan.

8.7 GLOSSARY

Bond: A loan security(instrument) issued by Government or a private sector company to raise

funds. It is redeemable at maturity.
Capital Market: Financial Market in which financial assets with a term to maturity of more than
one year are traded.
Commercial paper: A type of money market instrument. It represents unsecured promissory
notes of large and financially sound companies.
Debenture: A bond that may or may not be secured by specific property. It is written
acknowledgment of a debt.
Derivatives: Those securities which derive their value from some underlying asset
Diversification: The process of adding securities to a portfolio in order to reduce the portfolio’s
unique risk and therby, the portfolio’s total risk.
Dividend: cash payments made to stockholders by the company.
Equity: Refers to equity shareholders’ wealth- equity share capital plus reserves and surpluses.
Equity Share Capital: It is the capital other than preference share capital.
Gilt or gilt edged: refers to government securities. These are considered to be risk free and have
low yield.
Listed security: A security that is traded on an organised security exchange.
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Liquidity(or marketability): The ability of investors to convert securities to cash at a price

similar to the price of the previous trade in the security.
Market risk (or Systematic Risk): the portion of a security’s total risk that is related to moves
in the market portfolio and hence cannot be diversified away.
Money market: Financial market in which financial assets with a term of maturity of one year
or less are traded
Net Asset value: The market value of an investment company’s assets less any liabilities
divided by the number of shares outstanding.
Optimal portfolio: The feasible portfolio that offers an investor the maximum level of
satisfaction.
Risk: The uncertainty associated with the end of period value of an investment.
Secondary market: The market in which securities are traded that have been issued at some
previous point of time.
Share: the smallest part of the total share capital of a company. It has a distinctive number
and a par value.

8.8 SELF-ASSESSMENT QUESTIONS

1. Briefly explain the different types of mutual funds classified based on their operations
and investment objectives.
2. What are the types of mutual fund schemes prevalent in India? Give details.
3. What is the Systematic Investment Plan(SIP) and what are the benefits of SIP?
4. What do you mean by entry load and exit load? How do these affect the return to
investors?
5. Distinguish between:
a. Income and Growth funds.
b. Open-ended and Close-ended funds
c. Load and No-load funds
d. Money market and capital market funds.
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6. What do you mean by close-ended mutual fund? How it can be converted into an
open-ended fund?
7. Explain ETF. What are the pros and cons of ETF as compared to an open-ended
mutual fund?
8. Write short notes on the following:
a. Exchange Traded Fund
b. Net Asset value
c. Load Fund
d. ELSS
e. Ethical Fund

8.9 REFERENCES

As per APA style (APA Manual 6th Edition to be referred)

Marek, M. W., Chew, C. S., & Wu, W. C. V. (2021). Teacher experiences in converting classes
to distance learning in the COVID-19 pandemic. International Journal of Distance Education
Technologies (IJDET), 19(1), 89-109.

8.10 SUGGESTED READINGS

As per APA style (APA Manual 6th Edition to be referred)

Marek, M. W., Chew, C. S., & Wu, W. C. V. (2021). Teacher experiences in converting classes
to distance learning in the COVID-19 pandemic. International Journal of Distance Education
Technologies (IJDET), 19(1), 89-109.

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LESSON 9
ASSESSMENT OF NAV AND PERFORMANCE OF MUTUAL FUND
Ankit Suri and Yogesh Sharma
Atal Bihari Vajpayee School of
Management and Entrepreneurship
Jawaharlal Nehru University
ankitsuridse@gmail.com;
Yogesh.ysharma93@gmail.com

STRUCTURE

9.1 Learning Objectives

9.2 Meaning of Mutual Fund and Net Asset Value
9.3 Cost Incurred in Mutual Funds
9.3.1 Operating Expenses
9.3.2 Load
9.3.3 Regulatory Expenses
9.4 Return in Mutual Funds
9.5 Types of Loads in Mutual Funds
9.5.1 Entry load/Front end load
9.5.2 Exit load/Back-end load
9.5.3 Difference between load and No-load mutual funds
9.6 Performance Evaluation of Mutual Funds
9.7 Factors affecting the choice of Mutual funds
9.7.1 Direct factors
9.7.2 Market factors
9.8 Mutual funds in India
9.9 CRISIL and their Rankings for mutual funds
9.10 CRISIL Ranking Methodology
9.11 Usage of Mutual Fund Rankings

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9.12 Summary
9.13 Glossary
9.14 Answers to In-text Questions
9.15 Self-Assessment Questions
9.16 Objective Type Questions (MCQs)
9.17 References
9.18 Suggested Readings

9.1 LEARNING OBJECTIVES

Following are the learning objectives of lesson:

• To highlight the concept of mutual fund and Net Asset Value.
• To understand the cost incurred in the mutual funds.
• To understand the return on mutual fund investment.
• To pinpoint the concept of load in mutual fund.
• To understand how to evaluate mutual fund performance.
• To highlight the factors affecting mutual fund choice.
• To get a glimpse of Indian mutual fund industry.
• To understand the mutual fund rating framework.
• To know how mutual fund rankings are used.

9.2 MEANING OF MUTUAL FUND AND NET ASSET VALUE

Mutual fund Investment companies (Eg. Unit Trust of India, Axis Asset Management
Company Ltd.) are called Asset Management Companies (AMC). These are essentially
financial intermediaries in the capital market which collect money from investors (both big and
small). Based on the specifications of the mutual fund scheme, they invest/park the collected
pool of funds into various investment avenues like stocks, govt. and corporate bonds, treasury
bills, certificates of deposit, and sometimes in other mutual funds.
The most basic underlying concept of a mutual fund investment is the pooling of funds which
gives the investor the benefit of diversification even in small size of investments. Mutual fund

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investments make it possible for investors to buy a variety of financial securities that they
otherwise would not have been able to do.
For e.g.:- Ms Ishita is a retail investor in the capital market having an investible surplus of Rs.
10,000 at her disposal. She wants to invest in the following stocks:
RIL (Price: Rs 2,470)
Adani Enterprise Ltd (Price: Rs 3,310)
Shree Cement- Price (Rs 20,950)
Clearly, If she tries to buy even a single unit of the three stocks then she won’t be able to do
so.
She will not be able to hold a portfolio that has these three stocks. For this reason, mutual fund
investment will be helpful for her. She can buy units of a mutual fund company that will in turn
use her investible surplus along with other people’s investible surplus and with the large pool
of money buys stocks of these companies. In such a way, Ishita can hold a portfolio of these
three company stocks. Thus, Mutual funds offer a way for small investors to "join up" (Hence
the name ‘Mutual funds’) and reap the rewards of large-scale investing.
Now the question arises that how will Ishita know what is the value of her investment after 1
year. In the case of individual stocks, she would have been able to know the value just by
looking at the current stock price. In the case of mutual funds, the value of her investment is
equivalent to the Net Asset Value multiplied by the number of units of mutual funds that she
holds. All mutual funds combine the assets of their investors, but they also have to distribute
the rights to those assets among the participants. Ownership in mutual fund is based on the
number of units acquired by investors. The net asset value, or NAV, is the value of each unit.

(Market value of Assets − Liabilities)

𝑁𝑁𝑁𝑁𝑁𝑁 =
Total Number of Units
Example:
Suppose the mutual fund in which Ishita invested has a portfolio of securities worth Rs 1200
Crores. Further, the mutual fund owes Rs 50 Crore to landowners, Employees and Investment
analysts. There are a total of 50 crore units of mutual funds that the company has sold out of
which, Ishita owns 1000 units.
Therefore, the NAV (Net Asset Value) will be:
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(Rs 1200 Cr - Rs 50 Crore)/50 Crore Units

= Rs 23 Per Unit
Ishita’s Investment Value = Rs 23 x 1000 Units
= Rs 23,000

IN-TEXT QUESTION
1. The data from 31 March 2021 balance sheet of Canara Robeco mutual fund is
given below:
Investment in Debt: Rs 2000 Crore
Investment in Equity Share (Large Cap): Rs 2250 Crore
Investment in Equity Share (Small Cap): Rs 250 Crore
Liabilities: Rs 60.20 Crore
Shares: 28 Crore
From the data given above, calculate the Net Asset Value of Canara Robeco
Mutual Fund as on 31 March 2021.

9.3 COST INCURRED IN MUTUAL FUNDS

Investing in a mutual fund entails a number of fees and expenses. Therefore, before investing,
it's crucial for investors to understand all of the charges. Cost associated with mutual fund
investment is a crucial factor in a mutual fund investment decision. Usually an ‘Asset
Management Company’ hires a professional team of individuals who work as investment
analysts and are responsible for deciding where the pool of funds will be parked and for how
long. These professional analysts are paid heavy salaries. the burden of these salaries is passed
on to the investors in terms of “Fee”.
Fees associated with the mutual funds can be categorised in three major categories depending
upon their nature and the time at which they are incurred.
9.3.1 Operating Expenses:
These are the indispensable part of expenses that goes into running an asset management
company. These include the obvious advisory fee paid to the financial advisor, marketing costs,

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salaries to staff, rents, electricity, water, communication bills, etc. The operating expenses are
generally shown in terms of percentage of the total asset under management. A typical expense
ratio can be anywhere between 0.02% of the total asset under management (AUM) to 2% of
the total asset under management.

ACTIVITY
Open MoneyControl.com or ValueResearch.com and make a list of top 20 Mutual
fund schemes. Rank the list in order of their Expense ratio. Find the Fund with the
highest expense ratio and the fund with the lowest expense ration

9.3.2 Load:
A load is a charge paid on a transaction of a mutual fund. The load is levied depending upon
the nature of the transaction (Sale or Purchase). A load charged when the investor buys mutual
fund units is called a “Front-end load”, and a load charged during the sale is called a “Back-
end load”. Although it is rare, there are also funds that do not charge any commission on either
sale of purchase. These funds are called “No-load funds”.
9.3.3 Regulatory Expenses:
These are some compulsory expenses that are to be incurred apart from the normal operating
expenses. These include some indirect costs like the opening of a demat account by the
investor, brokerage charges, security transaction tax etc. Although these expenses are nominal
but still they should be heavily considered especially by retail investors.

IN-TEXT QUESTIONS
2. Security transaction tax paid on sale of a mutual fund unit is a type of back-end
load. (True/False)
3. A fund which mirrors Sensex has a higher expense ratio than their funds.
(True/False)
4. Operating expenses in the mutual funds is not same across all the funds and
schemes. (True/False)
5. While deciding between two mutual funds, demat account opening charges
should be considered as a crucial factor. (Yes/No)

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9.4 RETURN IN MUTUAL FUNDS

Just as any other real asset or financial asset, a mutual fund also has a return associated with it.
As mentioned above, The Net Asset Value (NAV) represent the current market value of the
mutual fund unit. The increase or decrease in the NAV directly affects the return on mutual
fund investment.
Further, It should be noted that Mutual funds also distribute capital gains and other incomes
(Dividends) with their unit holders. These incomes are also counted in the return.
Therefore, A return on a mutual fund investment is simply, the change in the value of NAV
plus any income distribution over the original NAV.
(NA𝑉𝑉 1 − 𝑁𝑁𝑁𝑁𝑁𝑁 0 + Income and Capital Gain distribution)
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑜𝑜𝑜𝑜 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 =
𝑁𝑁𝑁𝑁𝑁𝑁 0
Example: Canara Robeco mutual fund has a NAV on 1st April 2021 as Rs 50. During the
financial year 2021-22 they distributed dividend worth Rs 3/Unit and a capital gain distribution
of Rs 2/unit. The NAV reported on 31st March 2022 is Rs 55. The return on the mutual fund
is as follows:
Rate of Return = [(Rs 55 - Rs 50) + Rs 3 + Rs 2]/Rs 50
= [Rs 5 + Rs 3 + Rs 2]/Rs 50
= Rs 10/Rs 50
= 0.20 %

IN-TEXT QUESTIONS

6. Front end Load is also known as _____________.

7. A commission which is charged when security is sold is termed as
_______________
8. Net Asset Value is the amount of debt that Mutual funds owe. (True/False)
9. Given: NAV yesterday = Rs 20, NAV Today = Rs 21. What is the rate of return?
10. Asset Under Management (AUM) is same as NAV multiplied by No. of Units
of a mutual fund. (True/False)

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CASE STUDY
Lokesh’s “Analysis”
Mr Arvind Kumar is a retail investor. He has a portfolio of two different mutual
fund schemes. The first fund is a hybrid fund having investment in both Equity shares
and Debt. The second fund is a pure equity fund. Both of the funds have NAV = Rs 200
as on 31 March 2022.
Both of these mutual funds has given identical returns to Arvind over the past year. One
day, Lokesh, A close friend of Arvind calls him and says that he has come to the
conclusion that in the long run, first mutual fund will fail and he should take his money
out of the hybrid fund and buy more of the pure equity fund. When Arvind asks him the
reason he cuts the call. Later Lokesh texts Arvind and mentions that since the first mutual
fund has debt in their portfolio, It are bound to fail.
Based on the available information and the logic that Lokesh gave, do you think Lokesh’s
analysis of both mutual funds is accurate? Do you think Arvind should take the decision
of selling the first mutual fund and buy more of the second?

9.5 TYPES OF LOADS IN MUTUAL FUNDS

Mutual fund firms charge the investor when they join and quit the plan. The charge is
commonly referred to as load.
When investing in mutual funds, investors must be aware of the costs that are involved. Mutual
fund investments need the payment of entry and exit load costs, which are an essential
component of these investments. A load fund is a mutual fund that has a sales fee or
commission attached to it. The load is paid by the fund investor and is used to compensate a
sales intermediary, such as a broker, financial planner, or investment adviser, for his time and
experience in selecting a suitable fund for the client.
There are several sorts of mutual funds that include loads such as sales loads or commissions
on fund purchases, as well as funds that are sold before a certain time period after acquisition.

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Mutual funds that require you to pay a load on purchase are known as entry load funds, whereas
funds that need you to pay a load on selling are known as exit load funds.
An investor can sometimes reduce the cost by negotiating with the broker to waive the load.
When looking for a good mutual fund for yourself, remember to compare the mutual fund's
objectives and risk, as well as internal costs and sales charges. No load mutual funds are mutual
funds that do not charge a load.
9.5.1 Entry load/Front end load
This is a fee or commission paid to the mutual fund firm by the investor at the time of the initial
stage of investment acquisition. Typically, the entrance burden is taken from the investment
amount, lowering the amount of investment. To compensate the company's distribution costs,
an entrance load is paid. Various mutual funds have different entry fees. In basic words,
investors would acquire a mutual fund at the net asset value (NAV) plus the entrance load.
Until 2009, an entrance load of up to 2.25% of the investment amount was levied in India. This
has been prohibited, which has had a severe influence on the mutual fund sector.
9.5.2 Exit load/Back-end load
In a mutual fund, an exit load is a fee paid to intermediaries for selling mutual fund shares on
behalf of investors before the specified time period. The commission is a proportion of the
value of the sold share. The return on sale is lowered since the exit load is deducted from the
NAV. Exit load varies depending on the scheme. The exit load is retained by the asset
management business and is not considered part of the scheme's returns.
9.5.3 Difference between load and No-load mutual funds
A load mutual fund charges an investor on the acquisition of shares in addition to the original
sales cost. This fee is several percentages of the entire amount invested. For example, if
someone invests Rs.1,000 in a 2% load fund, they would invest Rs.998 since the remaining
Rs.2 will be removed as fee by the mutual fund provider. In the market, there may be several
types of load funds. The cost in a back-end load fund is charged when the mutual fund shares
are redeemed, whereas the fee in a front-end load fund is payable in advance.
A no-load mutual fund allows investors to acquire or redeem shares after a set length of time
without incurring any sales charges or commissions. However, banks or brokers may levy a
redemption fee for a third-party mutual fund. Most no-load mutual funds impose a fee if an
investor redeems their shares too soon. Long-term investors do not need to be concerned if they
invest in a no-load mutual fund.

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9.6 PERFORMANCE EVALUATION OF MUTUAL FUNDS

A mutual fund investor has to evaluate the performance of the mutual fund they have invested
their investible surplus in. Generally speaking, mutual fund schemes are evaluated on the
following criteria:
9.6.1 Risk-Adjusted Returns:
The returns on a mutual fund investment is compared with the level of variability in such a
return which is in turn measured in terms of standard deviation. If the level of return earned as
a ratio of risk taken is more than the peers in the market then the mutual fund is said to be
performing well.
9.6.2 Performance as compared to Index:
The Mutual fund’s performance can also be compared against the stock market Index like
Nifty, Sensex, Nifty Next 50, or other sectoral Indices. These Indices act as an important
benchmark in the market. If a particular mutual fund is performing better than the Index, then
it is said to be over-performing the market, and if its performance is worse than that of the
market index then such a fund is said to be underperforming the market.
9.6.3 Performance based on fee:
Before investing in a mutual fund, the Investor should ideally look at the fee structure of the
fund. Fees are the essential charges that the asset management company charges from the
investor for its operations and services. The expense ratio is a vital factor in a fund’s
performance. A mutual fund with a higher expense ratio as compared to its peer should be
avoided if such a fund is not highly out-performing than its peers.
9.6.4 Alpha Ratio:
The alpha ratio is a mathematical measure of how much the fund has performed as compared
to the benchmark index. The alpha ratio can be Zero, Positive or Negative. A positive Alpha
denotes that the particular fund has outperformed the market, whereas a negative Alpha means
the fund has underperformed the market benchmark index. A zero Alpha essentially means the
performance of the fund is in line with that of the benchmark.
9.6.5 Beta Ratio:
It is a statistical measure of fund performance. In simple terms, Beta means how much the
return of the fund will fluctuate as compared to the fluctuation of the market benchmark index.
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If the Beta value is 1, it means the fluctuation in the fund’s return is equal to the fluctuation in
the market benchmark index. A beta value of more than 1 means the fund’s return is more
volatile as compared to the benchmark and a beta value of less than 1 means the fund’s return
is less volatile than the benchmark. Generally, A Beta value of less than 1 is preferred.

9.7 FACTORS AFFECTING THE CHOICE OF MUTUAL FUNDS

Mutual funds are surrounded by many uncontrollable market risks and it is not possible to
accurately predict whether the value will increase or decrease in the future. There are various
types of risks involved. The higher the risk, the higher the return. That is not true always, as
sometimes when naïve decisions are made, that leads to hefty losses. But it doesn’t mean that
one should abstain from taking risks. Smart and calculated risks can help the investor sail
through the turbulent market's waves.
An investor can stay safe by considering numerous factors that can affect the choice of selecting
a fund. Broadly these factors can be classified into two categories, i.e., direct factors and market
factors. The table 1 shows the various factors for consideration.
Table 1: Factors affecting choice of mutual funds
Direct Factors Market Factors
• Objective of Investment • Market Volatility
• Time Period • Competitor’s Performance
• Risk Involved • AMC’s Performance
• Performance of Fund
• Expense Ratio
• Liquidity
9.7.1 Direct Factors
These are the factors that directly impact the choice of deciding which mutual fund is the best
performer among the various options available. The investor may look into the following
factors before making any decision:
A. Objective of Investment - The very first question is why the investor wants to invest
in a mutual fund. Is it to buy a new car, or house, go on a vacation, or do retirement
planning? It will lead to a financial goal or the returns an investor is expecting in the
future.
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B. Time Period - The objectives will determine the time period of the investment. The
investment can be short-term (up to 3 years), medium-term (3 – 5 years), or long-term
(5 years and more).
C. Risk Involved - It measures the tolerance level of the investor to take up the risk.
Generally, the risk is dependent on the type of mutual fund, time period, investment
amount, and the stability of the market. In 2015, the market regulator, the Securities
and Exchange Board of India (SEBI), made it mandatory for mutual fund providers to
have a riskometer on their website, that allows the investor to calculate their risk. The
figure 1 shows the riskometer that has 6 different risk levels, which are low, low to
moderate, moderate, moderate to high, high, and very high.

Figure 1: Riskometer. Source: Author’s compilation.

D. Performance of fund - A mutual fund scheme is a combination of the various segments
of allocated and invested funds. Investment in Small-cap, mid-cap, and large-cap will
have a different level of risk involved and yield different rates of return. A diverse
combination of allocation among small cap, mid cap, and large cap is generally
suggested by experts to balance risk and returns.
E. Expense Ratio - To manage the fund, the Asset Management Company (AMC) will
assign a fund manager to decide the proportion of investments to be made on behalf of
their clients. Therefore, the AMC will incur administration costs, management costs,
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promotion, and distribution costs. Therefore, they will charge a certain fee/commission
from their clients. The maximum expense ratio that an AMC can charge is capped at
2.25% by SEBI. So, the investor while calculating their profits should deduct this
amount and wisely select the mutual fund scheme with the lowest fee.
F. Liquidity - It refers to how quickly a mutual fund scheme can be sold in order to receive
cash. It depends on whether the investments are made in stocks or bonds and if the
investment can be sold quickly in the stock market. It depends on whether it is an open-
ended fund or a close-ended fund.
9.7.2 Market Factors
The market factors will include those factors that can externally impact the mutual fund scheme
in the short and long run. These factors are generally at the macro level and can impact the
whole market. Some of the factors can be:
A. Market volatility - This will include all the economic changes at the macro level that
impacts the mutual funds market. The performance of a certain industry, policy changes
by the government, global markets, recessions, pandemics, etc. have an impact on the
financial markets, hence will impact the mutual funds.
B. Competitor’s performance - It is instinctive to compare similar types of mutual fund
schemes offered by competitors to get the holistic picture. Information related to the
competitors’ expense ratios, liquidity, fund performance, etc. can be assessed and
compared on various parameters in order to find the best scheme in the market.
C. Asset Management Company (AMC) performance - AMC’s performance will
decide how much returns its clients will get. An AMC should be able to provide returns
consistently to its investors. In order to do so, AMC should hire experienced fund
managers. The funds are in the hands of the manager, as they decide on behalf of their
clients about where to invest based on their expertise in analysing past data and
reviewing the performance of various financial securities available in the market. The
fund manager will identify the best combination of stocks and bonds at a given time in
order to ensure positive returns.

9.8 MUTUAL FUNDS IN INDIA

The concept of a mutual fund is not new. In 1774, a Dutch merchant started a diversified
investment fund (Das, 2009). Later on, an investment company based in Belgium started
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financing industries with higher risks. The idea started spreading in England, the USA, and
Canada, and more commercialized forms of mutual funds started appearing in the market in
the early 20th century. This led to the expansion of mutual funds in Europe, Asia, and Latin
American countries (LAC), making the mutual fund a global concept.
In India, the concept of the mutual fund started gaining attention in the 1960s with the
formation of the Unit Trust of India (UTI) in 1963. It was under the regulatory control of the
Reserve Bank of India (RBI), and later on, in 1978, the Industrial Development Bank of India
(IDBI) took over the control. The mutual fund industry was initially monopolistic; therefore, it
only saw significant growth after 1987, with the amendment of the Banking Regulation Act,
which allowed the banks to set up mutual funds subsidiaries under their names. The
recommendations of the Abid Hussain Committee further pushed the growth of this industry,
as a result, LIC and GIC also started offering mutual funds. Further, in 1991, after the
government allowed liberalization, private companies also started participating. The main
reasons for growth in the mutual funds can be associated to:
1. Opening up the mutual fund market after a long time allowed the banks to raise and
invest funds in a diverse manner.
2. It allowed small investors to invest partially and share the risk, as they were earlier not
keen to invest all amount and bear the risk alone.
3. The mutual fund-based subsidiaries started giving more returns to their customers.
By observing the growth in the mutual fund industry, the government realized that it requires
a custodian to ensure the safety of investors. By 1993, SEBI introduced mutual fund
regulations, which were further revised in 1996. Tremendous growth was seen in the early
2000s when many national and international companies started setting up their offices in India
by the way of mergers and acquisitions. The figure 2 shows the various phases of the Indian
mutual fund industry.

Figure 2: Phases of the Indian mutual fund industry. Source: Author’s compilation.
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The Indian mutual fund industry has shown a whopping 5-fold growth between 2012-2022,
from ₹ 7.2 trillion rupees to ₹38.43 trillion rupees. There are more than 138 million mutual
fund accounts/folios in 2022 (AMFI, 2022). This also led to the development of various
rankings and the inclusion of rating agencies such as CRISIL.

9.9 CRISIL AND THEIR RANKINGS FOR MUTUAL FUNDS

CRISIL, formerly known as the Credit Rating Information Services of India Ltd., was the first
rating agency in India, established in 1987 jointly by ICICI and UTI. It provides services like
ratings, data analytics, research, and solutions. CRISIL issued its IPO in 1993 and launched its
equity index called CRISIL500 in late 1995. It launched a variety of indices and indexes for
the capital markets in 1998 and suggested Risk Assessment Model (RAM) focusing on risk
management practices, which became a benchmark for banks. Seeing its growth, the American
rating agency, S&P Global became the major stakeholder of CRISIL in 2005.
In 2000, CRISIL launched its Mutual Fund Ranking (CMFR) which is based on the concepts
of NAV and other factors. It assesses the mutual fund on various parameters including returns
with adjusted risk, asset allocation, duration, quality, and liquidity. Then it allocates relative
ranks that are between 1 to 5, where 1 means “very good performance”. For equity, medium,
and long-term funds, it considers NAV for the last three years, while for arbitrage, bonds, and
liquid funds, it considers only one year of NAV history.

9.10 CRISIL RANKING METHODOLOGY

CRISIL only considers open-ended mutual fund schemes for ranking purposes. Other
eligibility criteria include:
• Complete portfolio disclosure
• 3- Year Net Asset Value data availability
• 1-Year Net Asset Value data availability for liquid and short-term schemes.
• Asset Under Management (AUM) over the following limits:
Table 2: Minimum AUM for CRISIL ranking eligibility
Scheme Type Asset under Management (At least)
Equity fund 10 Crore

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Hybrid Fund 50 Crore

Debt funds (less than 1 Year) 250 Crore
Money Market Funds 1000 Crore

The Ranking done by CRISIL is based on the following quality criteria:

A. Average return and risk: Average return is calculated as the mean of average returns
calculated for daily NAVs of the past period under consideration. The risk is calculated
as the standard deviation of these returns.
B. Diversification analysis: Diversification of the portfolio is meaning how the
investment is done across various asset classes. A well-diversified portfolio is the one
where there are a wide variety of securities and Vice-Versa. It is always better to have
a well-diversified portfolio because it minimizes the unsystematic (Controllable) risk.
C. Liquidity analysis: It assesses how simple it is to liquidate a portfolio. The smaller the
score, the more liquid is the portfolio. It counts the days needed to liquidate the portfolio
in the case of stocks.
D. Industry risk analysis: CRISIL also measures the risk associated with various
industries. Based on the evaluation of industries, Industry Risk Score is assigned to the
industries. Therefore, the ranking of the mutual funds is also based on the sensitivity of
each of these funds on various industries.
E. Default probability: It is the measure of asset quality. In case of debt investment, the
likeliness of the debt issuer to default on the payment is also taken under consideration
while ranking the mutual funds.
F. Duration: Duration should not be considered as the time period of the investment. On
the contrary, It is a measure of interest rate sensitivity in fixed-income securities. Higher
duration means the price of the security will change by a huge amount when the interest
rate changes and Vice-Versa. The lower the value of duration, the better it is.
G. Tracking Error: In the case of an Index fund (Mutual funds which try to mirror a
stock exchange index like Sensex, Nifty, or Nifty Next 50), A tracking error is a
variation in the fund’s performance as compared to the mirrored index’s performance.
H. Negative Returns: It is a measure of the downside risk of the fund when the NAV
starts to decline thereby giving negative returns.
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9.11 USAGE OF MUTUAL FUND RANKING

Mutual fund rankings have become popular due to their simplicity and quick assessment of the
mutual funds available in the market. There are thousands of mutual fund schemes that are of
different varieties. There can be variations within a category of funds. Rankings allow the
investor to quickly compare and understand which fund has got better rankings.
For example, a fund with five stars will be better than a fund with four stars. Rankings are easy
to understand, and hence do not require much technical information and calculations by the
investor. The ranking is a robust method as it considers the relevant factors, including both
qualitative and quantitative aspects, to be considered while comparing mutual funds and it is
backed by thorough analysis and research. It also considers historical data and past trends
before ranking the funds. Therefore, ranking infers the position of the fund and its performance
in long term. Ultimately, it helps the investor in building confidence in their investment
decisions.

9.12 SUMMARY

In India, mutual funds have a very recent history. It all began in 1964 with the founding of the
Unit Trust of India. However, it wasn't until public sector banks entered this market in 1987
that things really took off. The experience of other nations demonstrates that as the capital
market develops, a growing amount of family savings are anticipated to be directed into the
secondary market through organisations like mutual funds. The rising popularity of mutual
funds in India makes this clear. Because they provide a mix of liquidity, return, and safety
based on performance, mutual funds have proven to be a popular investment choice for many
individuals throughout the world. Additionally, the investor receives these advantages without
actually investing in a diversified portfolio. She/he can only profit from a diverse portfolio that
is managed by experts by investing in a single fund. With the types of cutting-edge programmes
that are now on the market, mutual funds meet the demands of different investors. Numerous
private sector funds have performed quite well when compared to market performance,
according to an examination of their past performance.

9.13 GLOSSARY

AUM: Asset under management is the value of the total asset that an Asset management
company holds.
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Duration: Duration is a measure of Interest rate sensitivity in fixed-income securities. It

measures how much the price of the security changes with respect to the change in the level of
interest rates.
Index: An Index is a benchmark in the stock market that depicts the price performance of the
pre-specified basket of securities.
Money Market: The money market is the market for short-term securities having a maturity
of less than 1 year for eg. Treasury bills, Certificates of deposit etc.
NAV: Net Asset Value is per unit market price of a mutual fund.
Outperform: Outperforming means earning more than a benchmark.
Rate of Return: It is the rate of return that the investor earns on their investment in mutual
funds.
Unsystematic Risk: It is the part of total risk which is firm specific. Unsystematic risk can be
controlled by the investor by way of diversification.

9.14 ANSWERS TO IN-TEXT QUESTIONS

1. Rs 158.564 6. Entry Load

2. False 7. Back-end load/Exit load
3. False 8. False
4. True 9. 5%
5. No 10. False

9.15 SELF-ASSESSMENT QUESTIONS

1. Explain the concept of Load. Discuss the types of loads in the mutual fund.
2. What are the types of mutual fund schemes that are available in India? Mention the names
and types of schemes with suitable examples.
3. Discuss the history of Indian mutual fund industry.

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4. A mutual fund has securities worth Rs 20 crore, and liabilities worth Rs 5 crore. The no. of
outstanding shares stands at 3 crores. Suppose the securities increase by 10 %.
Calculate the original NAV and new NAV. Also calculate the percentage change in the
portfolio of an investor who has invested Rs 25,000 in this mutual fund.
5. As an investor, what are the factors that affects your choice of investment in mutual
funds?
6. Ranking a mutual fund is different from comparing the returns of the funds. Mention all
ranking criteria that go in rating a mutual fund.
7. Do you think historical data of the mutual fund is relevant from the perspective of
ranking? Mention the importance of historical data with respect to the different rating
criteria used by CRISIL.
8. A mutual fund company wants to calculate the net asset value for a single share. Using
the following information, calculate NAV.
● Value of securities in the portfolio: Rs 79 crore (based on end of day closing prices)
● Cash and cash equivalents worth of Rs 12 crore
● Accrued income for the day of Rs 20 crore
● Short-term liabilities of Rs 1 crore
● Long-term liabilities of Rs 12 crore
● Accrued expenses equivalent of Rs 3 crore
● 2 crore shares outstanding

9.16 OBJECTIVE TYPE QUESTIONS (MCQS)

1. What is the full form of AUM:

a. Assets under management
b. Asset undertaking management
c. Asset under money-market
d. Asset under moderation
2. If a mutual fund has 50 lacs worth of assets, 20 lac cash and owe 10 lacs in liability.
What is the NAV if there are 2,00,000 shares outstanding.
a. Rs 25
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b. Rs 28
c. Rs 30
d. Rs 20
3. Unit trust of India was established in which year?
a. 1960
b. 1962
c. 1963
d. 1965
4. A commission charged by the AMCs during the purchase of the mutual fund may be
termed as?
a. Back-end load
b. Front end load
c. Top end load
d. Bottom end load
5. How much is the liabilities of the mutual fund companies based on the following
information:
NAV = 25
Assets = 20 Crore
Shares outstanding = 1,00,00,000
Cash and Cash equivalents = 7 crore
a. Zero
b. 1 Crore
c. 3 Crore
d. 2 Crore
6. Which type of mutual funds are not allowed to operate in India?
a. Hybrid mutual funds
b. Pure equity mutual funds
c. Closed ended mutual funds
d. Open ended mutual funds
7. Suppose the market value of the securities of a mutual fund scheme is Rs 500 lakh. The
mutual fund issues 10 lakh units of Rs 10 each to its investors. What will be the NAV?
a. 10
b. 20
c. 40
d. 50
8. A hybrid fund is:
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a. Mix of debt and equity

b. Mix of open ended and closed ended
c. Mix of small cap and closed ended
d. Mix of load and no-load funds
9. CMFR stands for:
a. CRISIL Money Fund Ranking
b. CRISIL Mutual Fund Ranking
c. CRISIL Mutual Formal Ranking
d. CRISIL Monetary Fund Ranking
10. Post-liberalisation, the mutual fund industry in India started:
a. Decline
b. Stabilise
c. Increase
d. No-effect
11. In the term ‘Mutual funds’, what does ‘Mutual’ mean?
a. Mutual risk
b. Mutual return
c. Mutual results
d. Mutual pool of money
12. Liquidity in the stock market is a measure of:
a. How fast the documentation takes place
b. How fast you can view the ranking
c. How fast you can sell the security for cash
d. How fast you can buy a mutual fund
13. What does duration signify?
a. Interest rate sensitivity
b. Maturity of investment
c. Rate of return sensitivity
d. Yield sensitivity
14. With respect to a mutual fund manager, which of the following skills is irrelevant?
a. Analytical skill
b. Computing skills
c. Experience in the industry
d. Content development skills
15. Liquidity is highest in which of the following securities
a. Open ended mutual funds

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b. Closed ended mutual funds

c. Gold bonds
d. Debentures

Answer Key:

1. a 6. c 11. d
2. c 7. d 12. c
3. c 8. a 13. a
4. b 9. b 14. d
5. d 10. c 15. a

9.17 REFERENCES

AMFI. (2022). Indian Mutual Fund Industry’s Average Assets Under Management (AAUM)
stood at ₹ 39.88 Lakh Crore (INR 39.88 Trillion). https://www.amfiindia.com/indian-mutual
Mohanan, S. (2006). Mutual fund industry in India: development and growth. Global Business
and Economics Review, 8(3-4), 280-289.
CRISIL Mutual Fund Ranking - Methodology. (n.d.). Retrieved October 23, 2022, from
https://www.crisil.com/content/dam/crisil/generic-images1/our-businesses/india-
research/pdfs/capital-market/mutual-fund/CRISIL_Mutual_Fund_Ranking_Methodology.pdf

9.18 SUGGESTED READINGS

Bodie, Zvi., Kane Alex and Alan J. Marcus, (2021). Investments, McGraw Hill.
Reilly, Frank K, and Brown, Keith C., (2011). Investment Analysis and Portfolio Management,
Cengage Learning.
Chandra, P., (2017). Security Analysis and Portfolio Management, Tata McGraw Hill.
Damodaran, A., (2012). Investment Valuation, John Wiley & Sons.
Sharpe William F, and Bailey Jeffery V, Alexander Gordon J, (1998). Investments, PHI
Learning.
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Bhalla, V. K., (2008). Investment Management, S. Chand & Company Ltd.

Das, S. (2009). Perspectives on Financial Services. Allied Publishers.

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