ASSIGNMENT

DRIVE WINTER 2013

PROGRAM M.COM
SEMESTER IV
SUBJECT CODE & NAME MCC 401 & Management of Financial Services

Q.No 1 Explain the measures of performance of mutual funds. (10 marks)

Answer:
Some of the most significant and widely used measures of performance are given below:
1. The Treynor Measure
2. The Sharpe Measure
3. Jenson Model
4. Fama Model
1. The Treynor Measure
The Treynor Measure was developed by Jack Treynor. This performance measure is used for evaluating
funds on the basis Treynors index. This Index is a ratio of return generated by the fund over and above
risk free rate of return (generally taken to be the return on securities backed by the government, as there
is no credit risk associated), during a given period and systematic risk associated with it (beta).
Symbolically, it can be represented as:
Treynors Index (Ti) = (Ri Rf)/Bi.
Where, Ri represents return on fund, Rf is risk free rate of return and Bi is beta of the fund.
This value would like to be maximized by all the risk-averse investors. A positive Treynors index presents
a superior risk-adjusted performance of a fund and a negative Treynors Index indicates unfavourable
performance.
2. The Sharpe Measure
Here, the evaluation of the performance of a fund is done on the basis of the Sharpe Ratio. This ratio is a
ratio of returns generated by the fund over and above risk free rate of return and the total risk associated
with it. According to Sharpe, it is the total risk of the fund that the investors are concerned about.
Thus, in this model, the evaluation of funds is done on the basis of reward per unit of total risk.
Symbolically, it can be written as:
Sharpe Index (Si) = (Ri Rf)/Si
Where, Si is standard deviation of the fund.
While a high and positive Sharpe Ratio shows a superior risk-adjusted performance of a fund, a low and
negative Sharpe Ratio is an indication of unfavorable performance.
3. Jenson Model
Jensons model proposes another risk adjusted performance measure. This measure was developed by

Michael Jenson and is sometimes referred to as the Differential Return Method. This measure involves
evaluation of the returns that the fund has generated vs the returns actually expected out of the fund given
the level of its systematic risk. The surplus between the two returns is called Alpha, which measures the
performance of a fund compared with the actual returns over the period. Required return of a fund at a
given level of risk
(Bi) can be calculated as:
Ri = Rf + Bi (Rm Rf)
Where, Rm is average market return during the given period. After calculating it, alpha can be obtained by
subtracting required return from the actual return of the fund.
Higher alpha represents superior performance of the fund and vice versa.
Limitation of this model is that it considers only systematic risk not the entire risk associated with the
fund and an ordinary investor cannot mitigate unsystematic risk, as his knowledge of market is primitive.
4. Fama Model
The Eugene Fama model is an extension of Jenson model. This model compares the performance,
measured in terms of returns, of a fund with the required return commensurate with the total risk
associated with it. The difference between these two is taken as a measure of the performance of the fund
and is called net selectivity.
The net selectivity represents the stock selection skill of the fund manager, as it is the excess return over
and above the return required to compensate for the total risk taken by the fund manager. Higher value of
which indicates that fund manager has earned returns well above the return commensurate with the level
of risk taken by him.
Required return can be calculated as: Ri = Rf + Si/Sm*(Rm Rf)
Where, Sm is standard deviation of market returns. The net selectivity is then calculated by subtracting
this required return from the actual return of the fund.
2 Explain Taxability of the Originator. 10 marks
Answer: The tax liability of the Originator would depend on:
(i) Whether the securitization transaction results in the legal transfer of property in the assets being
securitized; and
(ii) Whether the gain or loss (in the case where there is a transfer of the property) is treated as a business
gain or a capital gain by the tax authorities. Where there is a legal transfer of property (true sale) in the
assets to be securitized, the tax authorities may levy tax on gains if any arising on the transfer, depending
on whether the gain is construed as a capital gain or as a business gain.
Currently, a company incorporated in India is taxed at 38.5 per cent (35 per cent basic rate plus 10 per
cent surcharge thereon) on its business income.
A foreign company is taxed at 48 per cent on its net business income. The situation where the income in
the assets has been transferred without a transfer of the property has been stipulated in Section 60 of the
Act, which states that all income arising to any person by virtue of a transfer whether revocable or not
and whether effected before or after the commencement of this Act, where there is no transfer of the
assets from which the income arises, be chargeable to income tax as income of the transferor and shall be
included in his total income.
The above section makes it clear that the liability to pay tax is on the owner of the assets from which the
income arises, and it does not matter if the income is received by any other entity. The tenet involved here
would be that of an application of income and not diversion of income before it reaches the Originator.
The transfer of income without transferring the assets concerned is a form of application of income.

The tax rules distinguish between the application of income and its accrual and hence the income
continues to be taxed in the hands of the owner of the assets. However, it may be noted that in such a
situation the Originator would be able to claim capital allowances on the asset. The two situations
envisaged above, in the case of securitization of receivables transactions would be: (1) Where only the
receivables in the securitization transaction and not the asset is transferred (e.g. in securitization of lease
receivables, housing rent or hotel receipts). In such a situation, under the provisions of Section
60, the income would be deemed to accrue to the asset-owner (Originator) and he would be liable to tax
thereon. However, the asset-owner could claim capital allowances on the asset, and
(2) Where the asset itself is transferred (e.g. in securitization of hire purchase receivables, where the only
asset claimed by the asset-owner is the right to receive instalments and such asset is transferred). In such
a case, on transfer, the income generated from the receivable would be deemed to have been transferred
to the transferee and he would be liable to pay tax on such income. The gain, i.e. the difference between
the sum received from the transferee and the value of the asset at which it is outstanding, less any
expenses incurred by the asset-owner would be considered as either business profit of the asset-owner or
capital gains of the asset owner, depending on whether the asset being transferred is a non-capital or
capital asset.
3 Explain the five features of venture capital. 10 marks
Answer: The important features of venture capital are as follows:
1. It involves high risk As discussed above, venture capital generally finances the risky projects of first
time entrepreneurs. Mostly, venture capital is provided in the software-based projects. There are different
types of risks involved. These risks can be categorized into four types:
Management risk: It is defined as the inability of management teams to work together. A project
requires co-operation of all the members of the teams.
Market risk: Even if a product of a company is new and innovative, it might not click with the
customers. The product may fail in the market. The customers have to be made aware about how the
product is better than the rest in the market.
Product risk: Most of the venture capital projects are technology based. It may happen that on papers,
the product was viable to be produced, but when it is produced commercially, it loses its viability.
Operation risk: Operations of the new business may not be cost effective initially as it involves
recovering both fixed cost and the variable cost.
2. High technology is involved: Venture capital is associated with hi-tech projects. In this
modernization era, most of the innovations take place in the field of technology. It is a surprise that none
of venture capitalists have financed any traditional cottage industries.
3. It is a misconception that venture capital is available for the start of a risky project in the field of
technology. It is also available for expansion of existing businesses or if an entrepreneur wants to diversify
in a new industry and the risk involved is high. The finance will also be available from the traditional
sources but will be at a higher rate. Because of this reason, entrepreneurs approach a venture capitalist for
financing his project.
4. Venture capital has equity participation and capital gains from financing a risky project: Since the
entrepreneur has less finance, it makes venture capital a partner in the business by giving share in the
capital. The entrepreneurs issue the shares to the venture capital.
5. Venture capital investors participate with the management of the venture in decision making: As the
success of the business is a matter of concern for the venture capital investors, they provide value addition
to the management as a matter of support. They constantly monitor the operations of the concern and
provide follow up assistance.

6. Length of investment: The typical venture capital investment is for three to seven years. Within this
period, the venture capital investor is able to judge the profitability and the success of the venture. If a
project appears to be more profitable, the venture capital investor will continue the relation a little longer.
However, if the project does not move in the desired direction, the investor can also make an early exit
even by incurring a loss.
7. Illiquid Investment:
Most of venture capital investments are illiquid. This means investment of the venture capital cannot be
returned on demand. The investment made by the venture capital investor can only be liquidated by
selling out the stake that the investor holds to the third party in the market, and thus make capital gains.
If the project is a complete failure, venture capital can sell the assets of the project to get back at least
some money. Venture capital is prepared for at least five to seven years to hold until his investment can be
recovered.
4 Discuss some factors that are involved in determining the pricing strategy of a product
offered by a financial service provider. 10 marks
Answer: A financial service provider needs quantitative approaches for successfully handling and
controlling such multi-channel architectures or organizations in order to handle the tradeoff between
additional costs and the sales of such a concept. Currently, several marketing-software-providers like the
British company
Engage (www.engage.com) offer e-business applications. Siebel Systems
(www.siebel.com) offers with its ISS (Interactive Selling Suite) a sell-side e-commerce application that
offers a customer-centric configuration and dynamic pricing functionality to maximize the value of each
customer interaction.
The following factors are involved in pricing strategy:
Company Objectives: The pricing strategy that needs to be adopted depends upon the objectives of the
company. This affects the banks profitability in two ways. The price paid by the customers generates
income and secondly the price influences the volume of sales.
Legal Restrictions and Regulations: Banks have to frame their products according to the law. For
example, in mutual funds, the entry load and exit load keeps changing according to the law. The interest
rates on PPF,
RDs are according to regulations given by the Reserve Bank of India (RBI).
Competition: This has become an important factor in pricing strategy. The banks have to charge their
services according to what their competitors are doing. Public sector banks charge less for their services as
compared to private sector banks. But private sector banks provide more services like Internet Banking,
mobile banking, etc. However, in recent times, public sector banks have also improved their services.
Technology: As and when new technology comes into the banking industry, banking services improve.
For example, the transfer of funds via NEFT and RTGS has improved wire transfer.
5 Discuss the need for marketing research by companies. (10 marks)
Answer: Marketing is mostly associated with the selling of a product. It is theoretically used to describe
all the steps that lead to the final sales. It involves the process of planning and execution of pricing,
promotion and distribution to satisfy individual and organizational needs.
Marketing is much more than just the process of selling a product or service and is an essential part of
business, and without marketing, even the best products and services may fail. Companies constantly fail

because they do not know what is happening in the marketplace, and as a result, they are not fully
meeting their customers needs. It is a common mistake committed by organizations to believe that with
the proper amount of advertising, the customers will buy whatever they are offered.
Marketing is the process of discovering and translating consumer wants into products and services. It
begins with the customer (by finding their needs) and ends with the customer (by satisfying their needs).
Marketing consists of making decisions regarding the four Ps:
Product
Place/Distribution
Promotion
Pricing
Marketing of services consists of making decisions regarding the seven Ps:
Price
Place
Product
Promotion
People
Physical Evidence
Packaging
Today, everything offered to the customer at private banks is rather attractive and fancy. The cards issued
by them are attractive. They are delivered in attractive packages. At the bank itself, the staff attending to
the customers are turned out well in attractive and smart uniforms. They are trained to speak well to the
customers, patiently and calmly and make the customer feel at home. There are customer care centres at
convenient locations, ATMs near all major shopping malls and customer care executives available on the
phone to attend to customers needs 24x7. What is more, executives also visit customers homes, if
required to facilitate work.
6 Try to find out the various types of problems faced by the housing finance industry in
India. 10 marks

Answer: Any sector is likely to be influenced by both demand and supply constraints. On the demand
side, mainly income levels of the people, overall cyclical condition of the economy and affordability of
housing play the most important role. The availability of land, finance at reasonable price, infrastructure,
legal and regulatory framework are some of the major constraints from the supply side. Here we will
discuss the financial constraints of the housing sector.
As already mentioned, finance for the developers as well as finance for the households, particularly for the
low cost/affordable housing category is one of the major constraints of the housing sector. The existing
financing mechanism of our country mostly targets middle and high income sections of the society.
Commercial banks and traditional means of housing finance typically do not serve low-income groups.
Housing constitutes a long term asset for a large segment of population in rural and urban areas. As debt
markets are not very deep, access to long term funding for housing finance institutions is difficult. Most
banks use their short-term funds from deposits and deploy these funds in long-term housing loans,
thereby creating an asset liability mismatch. Reserve Bank of India has cautioned banks of the dangers of
borrowing short and lending long. To mitigate such problem, in some countries, banks have been

permitted to float long-term mortgage bonds to match their mortgage assets. To tackle the interest rate
risks, most assets and liabilities are on a floating rate basis. In India, there has been a long-standing
demand to allow pension and provident funds to invest in housing finance. These funds are suppliers of
long-term capital. They typically have a low risk tolerance but do crave for diversification. The mutuality
of interest is strong between homeowners and long-term institutional investors.
A housing loan is inherently different from any other retail loan. This is because a house is probably the
single largest investment a person makes in his/her lifetime. It has been noticed that a customer seeking a
housing loan does not just require finance they may also need ancillary services like loan counselling or
legal advice to ensure the title of the property is clear or technical advice to ensure that the structural
aspects of the property are in order. It is these add-on services that distinguish the good quality of services
from not so good. Most loan products are fairly standardised plain vanilla home loan products, loans for
home improvement and extension, land loans, loans for non-residential premises and the newer breed of
loans include home equity and topup/ personal loans. Against the backdrop of lower interest rates seen
across the region, most home loans are on floating rate loans. In India, the floating rate of some banks
and housing finance institutions is benchmarked to prime lending rate. It has been noticed that several
customers opt for floating rate loans without understanding the inherent risks involved. Even most of the
existing fixed rate loans have been converted into floating rates.
The problems being faced by the housing finance industry in India may be summarized as follows:
There is variation in standards in lending to the public. This variation in standards across the industry
has posed systematic risk.
In order to increase sales, aggressive approach has been used by various institutions. This has led to
large scale defaults. The NPAs have increased in the balance sheets.
The interest rates are volatile. People who have to borrow for long term are not encouraged to borrow
seeing the volatility in the market.
Due Diligence issues: There have been many cases of dilution in due diligence. The loans that are
sanctioned without strictly following the rule, systems and procedures have defaulted.
The industry players do not follow uniform norms. Public sector players are more law abiding than the
private sector players.
Asset-liability mismatch is the biggest risks in housing industry.