Project 4th Sem

A
Research Project Report

On
Empirical Analysis of Debt Funds- A
Parametric Approach
Submitted in the Partial Fulfillment of the requirement for the award of
Post Graduate Diploma in Management
Submitted To Submitted By
Dr. Vandana Shrivastva Prashant Kumar
Senior Professor-SMS Lucknow (Roll No. : PG/08/26)
SCHOOL OF MANAGEMENT SCIENCES

LUCKNOW
A REPORT
ON
Empirical Analysis of Debt Funds- A
Parametric Approach
Submitted By
Prashant Kumar
(Roll No. : PG/08/26)
SCHOOL OF MANAGEMENT SCIENCES

LUCKNOW
2
Certificate
This is to certify that Mr. Prashant Kumar, student of Post Graduate Diploma in
Management, of 4th semester (2008-10), School of Management Sciences-Lucknow,
has undergone his research work in the area of finance. The topic of the research is
“Empirical Analysis of Debt Funds- A Parametric Approach”.
The research report is an authentic work done by the student for
the partial fulfillment for the award of the degree of PGDM.
Signature
Dr. Vandana Shrivastva (Project Guide)
School Of Management Sciences-Lucknow
3
Abstract
Over the last few years, where equity markets were on the ascent, equity funds were
favorites with investors. On the other hand, debt funds were considered unnecessary as
they dragged down the portfolios performance. Even risk averse investors didn’t want to
miss the boat by being invested in debt instruments. However with the global meltdown
eroding the Sensex – and along with it, small investors’ faith in the equity markets –
mutual funds, which had started becoming one of the preferred investment vehicles for
investing in the market, suddenly found themselves out of favor. Many investors lost
their hard earned money who had invested in equities either directly or indirectly. Now in
the year 2009-10, every investor surely is looking for good returns along with the safety
of their capital. Hence investors are increasingly shunning equity funds in favor of debt
funds as they are a safer investment avenue in 2009-10.
Till recently, choice wasn't an issue for investors in debt funds. Mutual funds offered
similar schemes, all of which invested in debt issued by companies and public sector
undertakings, government bonds, the call money market and other debt instruments.
Today, however, the choice is widening rapidly. Even a committed debt fund enthusiast
can get quite confused by what's already available here. Apart from the regular debt
funds, and their income and growth options, there are also money market and liquid
funds, as well as gilt funds to choose from.
The project work entitled “Empirical Analysis of Debt Funds- A Parametric
Approach” encompasses a detailed analysis of current investment scenario so as to
optimize the risk-return trade-off for the investors. The analysis is made using a holistic
blend of both quantitative and qualitative approach. It includes Macroeconomic study
(Indian as well as Global), a brief study of equity and debt markets and identification of
appropriate debt fund category. It further involves parametric analysis (risk-return
analysis using risk-adjusted ratios such as Sharpe ratio, Treynor ratio, Jensen’s alpha)
with an objective of acquainting the investor with the knowledge of top performing funds
in that category.
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DECLARATION
I hereby state that the Project Report titled “Empirical Analysis of Debt
Funds-A Parametric Approach.” submitted in partial fulfillment of the
degree of Post Graduate Diploma In Management is an original work
done entirely by me and is based entirely on my own observations. It has not
previously formed the basis for the award of any other degree, diploma,
fellowship or any other similar title. The facts presented here are true to the
best of my knowledge.
Prashant Kumar
PG/08/26
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Table of Contents
Contents Page no
Acknowledgements…………………………………………………………..
10
Objective of the project……………………………………………………..

11
Scope of the study……………………………………………………………

11
Methodology ………………………………………………………………..
12
Limitations of the study……………………………………………………..

13
Literature Review……………………………………………………………
14
1. Introduction………………………………………………………………...
15
1.1 Concept of a Mutual Fund………………………………………………...

16
1.2 Types of Mutual

Funds…………………………………………………... 17
1.3 Advantages of Investing in Debt

Funds………………………………….. 19
1.4 Debt
Instruments…………………………………………………………. 20
1.5 Yield Curve……………………………………………………………….
21
6
1.6 Factor Affecting Yield Curve - Interest
Rate…………………………….. 23
1.7 Interest Rate Drivers………………………………………………………
24
1.8 Yield Spread………………………………………………………………

27
1.9 Bond
Indices……………………………………………………………… 28
1.10 Performance Evaluation of Mutual

Funds……………………………… 29
I.Calculation of Simple
Return…………………………………………… 29
II. Calculation of Risk …………………………………………………….
31
7
III. Risk-adjusted
returns…………………………………………………… 33
2. Data Analysis……………………………………………………………..
39
2.1 Indian Economic

Analysis……………………………………………….. 40
2.2 Global Economic

Analysis……………………………………………….. 54
2.3 Regression Analysis

1……………………………………………………. 57
2.4 Global Equity Market

Analysis…………………………………………... 58
2.5 Indian Equity and Debt Market

Analysis………………………………… 60
Yield Curve Analysis………………………………………………….. 66
2.7 Yield spread

analysis……………………………………………………... 68
2.8 Regression Analysis 2……………………………………………………
70
8
2.9 Regression Analysis
3……………………………………………………. 71
2.10 Scenario
Analysis……………………………………………………….. 72
2.11 Performance Evaluation of GILT

FUNDS……………………………… 73
2.12 Performance Evaluation of INCOME

FUNDS…………………………. 75
3.FINDINGS…………………………………………………………………
79
3.1 Top 3 GILT Performers…………………………………………………..
81
3.2Top 3 INCOME
Performers………………………………………………. 84
4. Recommendations…………………………………………………………………..
87
5. References…………………………………………………………………
88
List of Tables
SL Details P.No
No.
1 Growth rate of different Industries in Indian economy 41
2 Details of Deficit in Indian economy 48
3 Major items of India’s BOP 51
4 Details of net capital flows 53
5 Returns from market 63
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6 Performance of Gilt funds 74
7 Performance of Income funds 76
List of Figures
SL. No Details P.No
1 Risk Return Matrix 15
2 Mutual Fund investment cycle 16
3 Normal Yield Curve 21
4 Flat yield curve 22
5 Risk Return matrix of bonds 24
6 GDP Growth 40
7 Inflation to deflation 42
8 Crude Oil Prices 43
9 Details of REPO, REVERSE REPO & CRR 45
10 Details of Call Rates 46
11 IDR & CDR 47
12 Rs vs US $ 49
13 Rs. Vs Euro 50
14 GDP in terms of World economy 54
15 Breakup of the emerging economies GDP 55
16 Commodity Prices 55
17 Dow Jones 59
18 Nikkei 59
19 Hang Sang 60
20 Sensex 61
21 BSE Midcap 62
22 BSE Smallcap 62
23 FDI & FII as % of GDP 64
24 Foreign Eq investment 64
25 I- Composite index 65
26 I-Sec Li-Bex 65
27 NSE MIBOR 66
28 Yield Curve Analysis 66
29 Government Borrowings 68
30 Yield Spread Analysis 68
31 Top 3 Gilt Performers-1 81
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34 Top 3 Income Performers-1 84
Acknowledgements
A successful project can never be accomplished by individual effort of the person to

whom the project is assigned; rather it is the synergy of knowledge, skill and experience
of a legion of able minded people. I am greatly obliged to School Of management
Sciences-Lucknow for providing me an opportunity to take up this project and providing
me a platform to learn and enhance my professional skill.
I would like to express my deep sense of gratitude to Dr. Vandana Shrivastva, my
academic guide, for her kind help, support and valuable guidance throughout the project.
I am thankful to her for providing me with necessary insights and helping me out at every
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single step. I also express my deep gratitude to Dr. Sudhir Sharan – Director, School of
Management Sciences-Lucknow.
I am also highly thankful to other faculty members, whose able guidance in this project
make my way simple & easy. I am also thankful to my colleagues for their continuous
support during the tenure of the project.
Prashant Kumar
PGDM
PG/08/26
SMS- Lucknow
Objective of the project
The objective of my project is:

• To study the investment scenario during recession period
• Based on this study identifying which debt fund is more attractive to invest in
• Evaluating the performance of the selected fund category among 15 Asset

Management Companies
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• To acquaint the investor with best funds from the universe of debt funds.
• Restructure recommendations on asset allocation matrix based on project

findings.
Scope of the study
The analysis of performance of the Gilt & Income Funds is based on “Risk & Return”
parameters. A comparative analysis of these funds has been done .Various parameters
like Standard Deviation, Beta, Jensen’s Alpha, Sharpe Ratio and Trenyor Ratio has been
calculated to make possible the tedious task of analysis of these funds. Further top
performing funds have been identified based on these parameters for providing a helping
hand to the interested investors for their decision making process.
Methodology:
Macroeconomic research is through Secondary data obtained through mediums like

Internet, Business Magazines, Journals, and Newspapers etc.
13
Regression analysis has been carried out to see the impact of interest rate drivers on
interest rate and the impact of interest rate on the yield curve. Based on this a Scenario
Analysis has also been done to see the returns in changing interest rate environment.
Parametric analysis is through Secondary data (fund fact sheets) as well as through
Primary data obtained by quantitative analysis.
In India, at present, mainly there are 36 Asset Management Companies which compete
with each other for mobilizing the investment funds with individual investors and other
organizations by offering attractive returns, minimum risks, high safety and prompt
liquidity. Investors desirous of placing their funds with the particular mutual fund
category would like to know the comparative performance of each against a benchmark
index so as to select the best fund or the investment company. And hence parametric
evaluation will solve the purpose.
After identifying suitable fund category in current investment scenario, 15 Asset
Management Companies (AMC’s) have been shortlisted on the basis of the companies
brand image and funds size so as to compare the fund’s performance among these
AMC’s. The AMCs are:
1. BIRLA SUNLIFE MUTUAL FUND
2. DSP BLACKROCK MUTUAL FUND
3. FIDELITY MUTUAL FUND
4. FRANKLIN TEMPLETON MUTUAL FUND
5. HDFC MUTUAL FUND
6. HSBC MUTUAL FUND
7. ICICI PRUDENTIAL MUTUAL FUND
8. IDFC MUTUAL FUND
9. KOTAK MUTUAL FUND
10. LIC MUTUAL FUND
11. PRINCIPAL MUTUAL FUND
12. RELIANCE MUTUAL FUND
13. SBI MUTUAL FUND
14. TATA MUTUAL FUND
15. UTI MUTUAL FUND
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NAV and Return of these funds and their Benchmarks are calculated for the fiscal year
2008-2009 .Risk and Return analysis of these funds are done on the basis of different
parameters such as Standard Deviation, Beta, Jensen’s measure, Sharpe Ratio, Treynor’s
measure. Finally their comparative analysis is done and these funds are ranked on the
basis of the individual ranking of the parameters mentioned above.
Limitations of the study
Every study suffers from some limitations which are inevitable:
• Recommendations for investment are based on current investment scenario so the

advice should not be considered as best fit in all investment scenarios.
• Parametric analysis (Ratio analysis) will be based on historical data thus past
performance of the fund may not always be an indicative of future performance.
• Weekly NAV’s have been considered for the study. Daily NAV’s would
have given more precise results.
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Literature Review
Sharpe, William F (1966) suggested a measure for the evaluation of portfolio

performance. Drawing a result obtained in these fields of portfolio analysis, economists
Treynor has suggested a new predictor of mutual funds performance, one that differs
from virtually all those used previously by incorporating the volatility of funds return in a
simple yet meaningful manner.
Michael C.Jensen (1967) derived a risk adjusted measure of portfolio performance

(Jensen’s Alpha) that estimates how much a Funds forecasting ability contributes to funds
return.
S. Narayan Rao , et al evaluated performance of Indian mutual funds in a bear market

through relative performance index and risk return analysis using Sharpe ratio, Treynor
ratio and Jensens alpha. The study used 269 open ended schemes (out of total schemes of
433) for computing relative performance index. Then after excluding funds whose returns
are less than risk free returns, 58 schemes are finally used for further analysis. The results
of performance measures suggest that most of mutual fund schemes in the sample of 58
were able to satisfy investors expectations by giving excess returns over expected returns
based on both premium for systematic risk and total risk.
Bijan Roy, et. al., conducted an empirical study on conditional performance of Indian
mutual funds. This paper uses a technique called conditional performance evaluation on a
sample of Eighty-nine Indian mutual fund schemes .This paper measures the performance
of various mutual funds with both unconditional and conditional form of CAPM,
Treynor- Mazuy model and Henriksson-Merton model. The effect of incorporating
lagged information variables into the evaluation of mutual fund managers’ performance
is examined in the Indian context. The results suggest that the use of conditioning lagged
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information variables improves the performance of mutual fund schemes, causing alphas
to shift towards right and reducing the number of negative timing coefficients.
Lehmann and Modest (1987) discuss the effect of benchmark used on the performance.
1. Introduction
Mutual Fund is a topic which is of enormous interest not only to researchers all over the
world, but also to investors. Mutual funds as a medium-to-long term investment option
are preferred as a suitable investment option by investor.
Figure 1
17
Mutual funds are considered one of the best available investments as compare to others as
they are very cost efficient and also easy to invest in, thus by pooling money together in a
mutual fund, investors can purchase stocks or bonds with much lower trading costs than
if they tried to do it on their own. But the biggest advantage to mutual funds is
diversification, by minimizing risk & maximizing returns.
1.1 Concept of a Mutual Fund:
Figure 2
• Many investors with common financial objectives pool their money.
• Investors, on a proportionate basis, get mutual fund units for the sum contributed
to the pool
• The money collected from the investors is invested into shares, debentures and
other securities by the fund Fund
• The fund Fund realizes gains or losses, and collects dividend or interest income.
• Any capital gains or losses from such investments are passed on to the investors
in proportion of the number of units held by them
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Mutual funds are broadly divided into Equity funds & Debt funds
1.2 Types of Mutual Funds
1. Equity Funds:
These funds invest a maximum part of their corpus into equities holdings. Equity
Schemes come in many variants and thus can be segregated according to their risk levels.
At the lowest end of the equity funds risk – return matrix come the index funds while at
the highest end come the sectorial schemes or specialty schemes.
The Equity Funds are sub-classified depending upon their investment objective, as
follows:
• Diversified Equity Funds: An investment fund which contains a wide array of

securities to reduce the amount of risk in the fund. Actively maintaining
diversification prevent event that affect one sector from affecting the entire
portfolio, make large losses less likely.
• Index Funds: Funds invest in stocks comprising indices, such as the Nifty 50,
which is a broad based index comprising 50 stocks. ‘This Fund will invest in
stocks comprising the Nifty and in the same proportion as in the index’.
• Sector Specific Funds: Funds that invest in stocks from a single sector or related
sectors are called Sectoral funds. Examples of such funds are IT Funds, Pharma
Funds, Infrastructure Funds, etc.
• Tax Savings Funds (ELSS): These schemes serve the dual purpose of equity
investing as well as tax planning for the investor; however it must be noted that
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investors cannot, under any circumstances, get their money back before 3 years
are over from the date of investment.
Equity investments are meant for a longer time horizon, thus Equity funds rank high on
the risk-return matrix.
2. Debt Funds:
The objective of these Funds is to invest in debt papers. Government authorities, private
companies, banks and financial institutions are some of the major issuers of debt papers.
By investing in debt instruments, these funds ensure low risk and provide stable income
to the investors. Debt funds are further classified as:
• Gilt Funds: Invest their corpus in securities issued by Government, popularly

known as Government of India debt papers. These Funds carry zero Default risk
but are associated with Interest Rate risk. These schemes are safer as they invest
in papers backed by Government.
• Income Funds: Invest a major portion into various debt instruments such as
bonds, corporate debentures and Government securities.
• MIPs: Invests maximum of their total corpus in debt instruments while they take
minimum exposure in equities. It gets benefit of both equity and debt market.
These scheme ranks slightly high on the risk-return matrix when compared with
other debt schemes.
• Short Term Plans (STPs): Meant for investment horizon for three to six months.
These funds primarily invest in short term papers like Certificate of Deposits
(CDs) and Commercial Papers (CPs). Some portion of the corpus is also invested
in corporate debentures.
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• Liquid Funds: Also known as Money Market Schemes, These funds provides
easy liquidity and preservation of capital. These schemes invest in short-term
instruments like Treasury Bills, inter-bank call money market, CPs and CDs.
These funds are meant for short-term cash management of corporate houses and
are meant for an investment horizon of 1day to 3 months. These schemes rank
low on risk-return matrix and are considered to be the safest amongst all
categories of mutual funds.
1.3 Advantages of Investing in Debt Funds
Fixed income securities make up a substantial proportion of individual investors

portfolios, for the following reasons:
• Diversification: In a stock market downturn, fixed income securities can help

offset stock losses.
• Predictable source of income: Some investors want or need a steady stream

of income. When you retire, for example, you could purchase long term bonds
and live off their interest. The interest payments are usually a fixed amount for the
life of the bond, so one knows with certainty how much income you will be
receiving.
• Profit on price changes: Bond prices go up and down over time in response
to changes in market interest rates: when interest rates go up, bond prices go
down and vice- versa. If you are a buy and hold investor, this does not matter to
you because you will be holding the bond to maturity. If you must sell a bond
before its maturity date, however, you may find that the market price is more or
less than what you paid for it, resulting in a capital gain or capital loss.
• Lower risk: If you have assessed your risk tolerance, and find that you prefer
to bear less risk, even though it may mean receiving a lower return, you may
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prefer bond investing to stock investing. When you buy a bond from a
creditworthy company, you know that you will most likely receive your promised
interest payments and that your principal will be repaid at maturity. For many
investors, this level of certainty is more important than the uncertain possibility of
greater returns from a risky stock.
• Matching time horizon: Because bonds have fixed maturity date, some
investors like them because they can match the time horizon of their investment
with the future needs. Similarly, the fixed period of investment may be consistent
with an investors needs.
1.4 Debt Instruments
Debt instruments are contracts in which one party lends money to another on pre-
determined terms with regard to rate of interest to be paid by the borrower to the lender,
the periodicity of such interest payment, and the repayment of the principal amount
borrowed (either in installments or in bullet). In the Indian securities markets, we
generally use the term ‘bond’ for debt instruments issued by the Central and State
governments and public sector organizations, and the term ‘debentures’ for instruments
issued by private corporate sector.
There are three main segments in the debt markets in India,

• Government Securities
• Public Sector Units (PSU) bonds, and
• Corporate Securities.
The market for Government Securities comprises the Centre, State and State-sponsored
securities. In the recent past, local bodies such as municipalities have also begun to tap
the debt markets for funds. The PSU bonds are generally treated as surrogates of
sovereign paper, sometimes due to explicit guarantee and often due to the comfort of
22
public ownership. Some of the PSU bonds are tax free, while most bonds including
government securities are not tax-free. The RBI also issues tax-free bonds, called the
6.5% RBI relief bonds, which is a popular category of tax-free bonds in the market.
Corporate bond markets comprise of commercial paper and bonds. These bonds typically
are structured to suit the requirements of investors and the issuing corporate, and include
a variety of tailor- made features with respect to interest payments and redemption. The
less dominant fourth segment comprises of short term paper issued by banks, mostly in
the form of certificates of deposit
1.5 Yield Curve:
The relationship between time and yield (return) on a homogenous risk class of securities
is called the Yield Curve. It is a measure of the market's expectations of future interest
rates given the current market conditions. This enables investors to be able to compare
the yields offered by short-term, medium-term and long-term bonds The relationship
represents the time value of money - showing that people would demand a positive rate
of return on the money they are willing to part today for a payback into the future. It also
shows that a Rupee payable in the future is worth less today because of the relationship
between time and money. A yield curve can be positive, neutral or flat. A positive yield
curve, which is most natural, is when the slope of the curve is positive, i.e. the yield at the
longer end is higher than that at the shorter end of the time axis. These results as people
demand higher compensation for parting their money for a longer time into the future.
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Figure 3
A neutral yield curve is that which has a zero slope, i.e. is flat across time. This occurs
when people are willing to accept more or less the same returns across maturities. The
negative yield curve (also called an inverted yield curve) is one of which the slope is
negative, i.e. the long term yield is lower than the short term yield. It is not often that this
happens and has important economic ramifications when it does. It generally represents
an impending downturn in the economy, where people are anticipating lower interest
rates in the future. Therefore, the yield curve could give an indication about, which
instruments are attractive and which are not in a particular market environment.
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Figure 4
1.6 Factor Affecting Yield Curve - Interest Rate
The price of a debenture is inversely proportional to changes in interest rates that in turn
are dependent on various factors. Changes in interest rates can mean big opportunities for
astute investors.
For example, if an investor subscribes to a bond issue at a coupon rate (interest rate) of
9.5% and if subsequently, i.e. after a week the coupon rate for another issue is 10%, then
the investor would have got 0.5% extra had he waited for a week. If this investor wants to
sell the bond subscribed, the price of this bond will be below par as it carries 9.5%
coupon rate as against the current market rate of 10%. Therefore, this risk of losing the
value for the bond on account of interest rate changes is known as interest rate risk.
When interest rates rise, the prices of bonds in the market fall, as increase in interest rates
erode the NAVs of the debt funds and the extent of fall in NAVs is higher in the longer
tenure debt funds and it is exactly the opposite scenario when interest rate falls i.e. as
interest rates fall, the prices of bonds in the market rise leading to rise in the NAVs and
the extent of rise in NAVs is higher in the long term funds.
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Interest rates are mainly a function of economic cycles. Hence we need to forecast key
macroeconomic variables, which will determine the course of the business environment
over the next fiscal. But an understanding of the future is impossible without a careful
study of the past.
Longer-Term Bonds Price Rise the Most When Interest Rate Falls and Vice-Versa
The degree of interest risk you assume and, equally, the degree of return you can expect,
in fixed income investing is closely tied to the time horizon of the instrument concerned.
That's why longer-term investments typically pay higher yields, to compensate the
investor for the additional risk he or she takes on. Normally, the longer the investment
horizon, the higher the interest rate risk, or return, associated with it.
Figure 5
This is true because the longer you hold a fixed income investment, the greater the
possibility of interest rate fluctuations, resulting in changes of the fixed income security's
26
value and price in the secondary market where it trades. Therefore, the closer your
security gets to maturity, the less it will be affected by changing market interest rates.
1.7 Interest Rate Drivers:
• GDP Growth
Economic growth and its prospects affect interest rates. This is because the monetary
policy is largely influenced by the health of the economy. The growth prospects of the
economy affect the allocation of capital. If there are little or no growth prospects, the
demand for capital will be sluggish. Banks would be saddled with surplus funds, which
would probably be diverted to the debt markets. Also, in a slowing economy, banks
themselves might not be comfortable giving loans to the industry for fear of accumulating
bad debts. Consequently, the investment avenue that guarantees almost risk free returns is
the G-secs and T-bills. This drives up demand for debt instruments. Higher demand
results in prices of debt instruments being marked up, implying that interest rates decline.
On the other hand, when the growth prospects for the economy become brighter the
demand for these instruments weakens.
• Inflation
Typically a higher inflation rate means higher interest rates. The interest rates prevailing
in an economy at any point of time are nominal interest rates, i.e., real interest rates plus a
premium for expected inflation. Due to inflation, there is a decrease in purchasing power
of every rupee earned on account of interest in the future; therefore the interest rates must
include a premium for expected inflation. In the long run, other things being equal,
interest rates rise one for one with rise in inflation.
• Liquidity & Monetary Scenario
27
The government borrows money by issuing G-Secs (longer duration) and T-bills. The
interest the government pays on short-term instruments is the benchmark for all financial
activity in the country (this rate is considered to be close to risk free). Suppose the
Reserve Bank feels that there is too much liquidity in the financial system and there is a
threat that inflation may rise. In such a scenario the Reserve Bank will adopt a tight
monetary policy. It therefore sells government bonds (and collects money), reducing the
money availability in the system. In case the central bank wants to ease the monetary
policy, it buys back the bonds, in effect infusing liquidity in the economy.
• Fiscal scenario
The fiscal policy controls the government’s earnings and spending. If a government
spends more than it earns it will incur a fiscal deficit. A higher fiscal deficit increases the
risk of default by a government. Therefore, the interest rates are higher. Rising budget
deficits cause the yield curve to be steep while falling budget deficits tend to flatten the
curve. However, in case a fiscal situation of a country looks precarious the short-term
interest rates will tend to be much higher than long-term interest rates. The long-term
interest rates will be relatively lower on hopes that the situation improves in the future.
But if the fiscal deficit continues to rise then interest rates in the long term will be higher
because the government will continue to borrow to meet its fiscal deficit, increasing the
demand for money. The markets as a result would demand higher interest rates causing
the prices for instruments to decline.
• Exchange Rate Movements
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Depreciation of a currency affects an economy in two ways, which are in a way counter
to each other. On the one hand, it makes the exports of a country more competitive,
thereby leading to an increase in exports. On the other hand, it decreases the value of a
currency relative to other currencies, and hence imports like oil become dearer resulting
in an increase of deficit.
• Balance of Payments
Both current account and capital account deficit have an impact on the external sector as
well as on the interest rates.
1.8 Yield Spread
Yield spread analysis is the most important techniques used in the bond investment
decisions. It is a measure of default risk. It is the difference or additional yield in
comparison to a benchmark which is usually a government security. Spreads can be
between two risk classes or can be between tenors in the same risk class. For example
130 bps between AAA and GOI means a 1.30% spread between a AAA issue and that
made by the Government of India. For the investor in bonds, it is necessary to evaluate
the changes in the yield spreads as these changes influence the bond price.
Predicting changes in a credit spread is difficult because it depends on both the specific
corporate issuer and overall bond market conditions. For example, a credit upgrade on a
specific corporate bond, say from S&P BBB to A, will narrow the credit spread for that
particular bond because the risk of default lessens. If interest rates are unchanged, the
total yield on this "upgraded" bond will go down in an amount equal to the narrowing
spread, and the price will increase accordingly.
29
After purchasing a corporate bond, the bondholder will benefit from declining interest
rates and from a narrowing of the credit spread, which contributes to a lessening yield to
maturity of newly issued bonds. This in turn drives up the price of the bondholder's
corporate bond. On the other hand, rising interest rates and a widening of the credit
spread work against the bondholder by causing a higher yield to maturity and a lower
bond price. So, because narrowing spreads offer less ongoing yield and because any
widening of the spread will hurt the price of the bond, investors should be wary of bonds
with abnormally narrow credit spreads.
But interest rates and credit spreads can move independently. In terms of business cycles, a
slowing economy tends to widen credit spreads as companies are more likely to default, and an
economy emerging from a recession tends to narrow the spread as companies are theoretically
less likely to default in a growing economy. However, in an economy that is growing out of a
recession, there is also a possibility for higher interest rates, which would cause Treasury yields
to increase. This is a factor that offsets the narrowing credit spread, so the effects of a growing
economy could produce either higher or lower total yields on corporate bonds.
1.9 Bond Indices
A bond index is a product to accurately measure the performance of the bond markets. It
is a benchmark against which fund managers and investment managers can measure their
performance. Bond indices use additional liquidity criteria besides just returns. This is
specifically required to meet the needs of active traders and investment managers.
Market benchmarks serve a purpose of providing information to the participants about the
prices prevailing in the markets. In the bond markets, the most important market
indicator, which every participant wants to track, is the movement in interest rates.
Market indicators enable pricing, valuation and performance evaluation.
I-Sec bond indices: It track returns on Government Securities. It’s of following types:
I Sec Li Bex
30
I Sec Si Bex
I Sec Composite Index Return
Crisil Composite Bond Index: It tracks returns on bonds.
NSE-MIBOR: Stands for Mumbai Interbank Offered Rate. It provides the money market
benchmark.
1.10 Performance Evaluation of Mutual Funds
In India, at present, there are 36 Asset Management Companies which compete with each
other for mobilizing the investment funds with individual investors and other
organizations by offering attractive returns, minimum risks, high safety and prompt
liquidity. Investors desirous of placing their funds with the particular mutual fund
category would like to know the comparative performance of each against a benchmark
index so as to select the best fund or the investment company.
Performance evaluation of mutual funds is important for both fund managers and
investors. Though past performance alone cannot be indicative of future performance, it
is, the only quantitative way to judge how good a fund is at present. Therefore, there is a
need to correctly assess the past performance of different mutual funds.
Return alone cannot be considered as the basis of measurement of the performance of a

mutual fund scheme, it should also include the risk taken by the fund manager because of
different funds will have different levels of risk attached to them. Total process of
measuring performance of mutual fund involves three steps:-
31
I. Calculation of simple return
II. Calculation of risk
III. Calculation of return per unit of risk
I.Calculation of Simple Return

Return from mutual funds depends on the aggregate performance of the individual
security held under the scheme. Returns have two components. One is cash inflow in
terms of dividend or interest and another is from growth in the value of securities. It can
be calculated by any one of the following way:-
a) By calculating weighted average returns of individual securities in the portfolio.
Return = WaRa + WbRb + WcRc + . . . . . . . . +WnRn
Where Wa, Wb, Wn etc are showing proportion amount of individual security and Ra, Rb,
Rc etc are showing return from respective securities under the portfolio
b) By calculating percentage growth in NAV
Return = (NAV at Periodn – NAV at Period n-1) + Dividend

NAV at Periodn-1
For the purpose of clear understanding I am showing a comparison of return from UTI
G-Sec debt fund with the return of benchmark I Sec Li-Bex:
NAV at 31st March 2008 = 13.035

NAV at 31st March 2009 = 20.036
32
Dividends during the year = NIL
Return = {(20.036 -13.035) + 0}/ 13.035
= .5371 or 53.71%
Index as on 31st March 2008 = 1556.72

Index as on 31st March 2009 = 1932.41
Return = (1932.4 – 1556.72)/1556.72
= .2413 or 24.13%
Comparison of Return
In simple terms the above calculated returns of fund is compared with the Benchmark
Index return like I Sec Li-Bex. Return from UTI G-Sec Debt Fund is 53.71% as
compared to 24.31% from Index. Return from the fund is 2.22 times more than the
returns from Index. But as we all know that risk also goes with return. Risk and return are
two sides of a coin. A risk averse investor always wants higher return for higher risk.
Therefore returns have to be compared with Risk adjusted returns. We also have to
understand how risk is measured
II. Calculation of Risk
Return alone should not be considered as the basis of measurement of the performance of
a mutual fund scheme, it should also include the risk taken by the fund manager because
different funds will have different levels of risk attached to them. Risk associated with a
fund, in a general, can be defined as variability or fluctuations in the returns generated by
it. The higher the fluctuations in the returns of a fund during a given period, higher will
be the risk associated with it. These fluctuations in the returns generated by a fund are
resultant of two guiding forces. First, general market fluctuations, which affect all the
securities, present in the market, called market risk or systematic risk and second,
33
fluctuations due to specific securities present in the portfolio of the fund, called
unsystematic risk. The Total Risk of a given fund is sum of these two and is measured in
terms of standard deviation of returns of the fund. Systematic risk, on the other hand, is
measured in terms of Beta, which represents fluctuations in the NAV of the fund vis-à-
vis market. The more responsive the NAV of a mutual fund is to the changes in the
market; higher will be its beta. Beta is calculated by relating the returns on a mutual fund
with the returns in the market. While unsystematic risk can be diversified through
investments in a number of instruments, systematic risk cannot. By using the risk return
relationship, we try to assess the competitive strength of the mutual funds vis-à-vis one
another in a better way.
a) Standard Deviation
A measure of the dispersion of a set of data from its mean. The more spread apart the
data, the higher the deviation. Standard deviation is calculated as the square root of
variance.
SD = √ [{∑ (xi – xµ) ^2}/n]
Where,
xi = Price of the security at the month end

xµ= Mean price of the security for the given period
n = Number of months
Calculation of Standard deviation of UTI G-Sec Fund is shown here for ready reference:
Month NAV Return(X) (x- xµ) (x– xµ)^2

Mar-08 13.035
Apr-08 14.327 0.0991178 0.0542 0.0029396

May-08 15.82 0.1042088 0.0593 0.0035175
Jun-08 14.474 -0.0850822 -0.1300 0.0168954
34
July-08 17.618 0.2172171 0.1723 0.0296932
Aug-08 21.606 0.2263594 0.1815 0.0329275
Sept-08 19.677 -0.0892808 -0.1342 0.0180045
Oct-08 22.22 0.1292372 0.0843 0.0071127
Nov-08 23.49 0.0571557 0.0123 0.0001502
Dec-08 27.817 0.184206 0.1393 0.0194062
Jan-09 23.747 -0.1463134 -0.1912 0.0365626
Feb-09 23.462 -0.0120015 -0.0569 0.0032378
Mar-09 20.036 -0.1460234 -0.1909 0.0364518
Total 244.29 0.5388 Variance 0.0172
Mean 20.36 0.0449 SD 0.1313
b) Beta
A Beta is a measure of risk that when applied to investment portfolios, provides useful
statistical information. It indicates a fund’s past price volatility relative to a particular
stock market index. High beta stocks react strongly to variations in the market, and low
beta stocks are less affected by market variations.
β= σi / σm
Where,
σi = Standard deviation of Portfolio

σm = Standard deviation of Market
• If Beta is 1, then an issue has the same volatility as the general market. It
is either growing at the same rate or declining at the same rate.
• If Beta is greater than 1, then an issue is more volatile. At 1.25 it will
probably move 25% more than the market. If the market is in an uptrend,
then the security will gain 25% more than the general market.
• If Beta is less than 1, then an issue is less volatile. At 0.5 it probably will
move only 50% or a half of the market. If the market is In a downtrend, it
will only lose 50% of what the general market loses.
35
• If beta is less than 0, then the stock is moving in a reverse pattern to the
index. When the index moves up the stock declines and vice versa.
III. Risk-adjusted returns
Comparative evaluation of rate of return earned by different debt schemes with the
rate of return earned by a benchmark index can be incomplete and sometimes even
misleading. Hence I will use risk adjusted returns for comparison which will be
involving following measures:
Sharpe Ratio (Reward to Variability Ratio)
The Sharpe ratio tells us whether a portfolio's returns are due to smart investment
decisions or a result of excess risk. This measurement is very useful because although
one fund can reap higher returns than its peers, it is only a good investment if those
higher returns do not come with too much additional risk. The greater a funds Sharpe
ratio, the better its risk-adjusted performance has been
Sharpe Ratio = Rp - Rf
σ
Where,
Rp = Expected return of the fund
Rf = Risk Free Rate
σ = Standard Deviation
To better understand how this works, suppose that the 10-year annual return for the S&P
500 (market portfolio) is 10%, while the average annual return on Treasury bills (a good
proxy for the risk free rate) is 5%. Then assume you are evaluating three distinct portfolio
Funds with the following 10-year results:
36
Fund Annual Portfolio Standard
Return Deviation
Fund 14% 0.11

X
Fund 17% 0.20
Y
Fund Z 19% 0.27
Now, we compute the Sharpe value for each:
S (market) = (.10-.05)/.18 = .278

S (Fund X) = (.14-.05)/.11 = .818
S (Fund Y) = (.17-.05)/.20 = .600
S (Fund Z) = (.19-.05)/.27 = .519
Once again, we find that the best portfolio is not necessarily the one with the highest
return. Instead, it's the one with the most superior risk-adjusted return, or in this case the
fund headed by Fund X.
To give you some insight, a ratio of 1 or better is considered good, 2 and better is very
good, and 3 and better is considered excellent.
Treynor Ratio (Reward to Volatility Ratio)
The Treynor ratio is a risk-adjusted measure of return based on systematic risk. It

is similar to the Sharpe ratio, with the difference being that the Treynor ratio uses beta as
the measurement of volatility.
TR = Rp - Rf
37
βp
Where
Rp= Expected fund return

Rf= Risk Free Rate
βp= Beta value
To better understand how this works, suppose that the 10-year annual return for the S&P
500 (market portfolio) is 10%, while the average annual return on Treasury bills (a good
proxy for the risk free rate) is 5%. Then assume you are evaluating three distinct portfolio
Funds with the following 10-year results:
Funds Average Annual Return Beta
Fund A 10% 0.90
Fund B 14% 1.03
Fund C 15% 1.20
Now, we compute the Treynor value for each:
T (market) = (.10-.05)/1 = .05

T (Fund A) = (.10-.05)/0.90 = .056
T (Fund B) = (.14-.05)/1.03 = .087
T (Fund C) = (.15-.05)/1.20 = .083
The higher the Treynor measure, the better the portfolio. If you had been evaluating the
portfolio Fund (or portfolio) on performance alone, you may have inadvertently identified
38
Fund C as having yielded the best results. However, when considering the risks that each
Fund took to attain their respective returns, Fund B demonstrated the better outcome. In
this case, all three Funds performed better than the aggregate market.
Jensen’s alpha
It represents the difference between actual return and expected return.
 αi < rf: the investment has earned too little for its risk (or, was too risky for the
return)
 αi = rf: the investment has earned a return adequate for the risk taken
 αi > rf: the investment has a return in excess of the reward for the assumed risk
Jensen's Alpha = Portfolio Return – Benchmark Portfolio Return
Where: Benchmark Return = Risk Free Rate of Return + Beta (Return of Market – Risk-
Free Rate of Return)
So, if we assume a risk-free rate of 5% and a market return of 10%, what is the alpha for
the following funds?
Fund Average Annual Return Beta
Fund D 11% 0.90
Fund E 15% 1.10
Fund F 15% 1.20
39
First, we calculate the portfolio's expected return:
ER (D) = .05 + 0.90 (.10-.05) = .0950 or 9.5% return

ER (E) = .05 + 1.10 (.10-.05) = .1050 or 10.50% return
ER (F) = .05 + 1.20 (.10-.05) = .1100 or 11% return
Then, we calculate the portfolio's alpha by subtracting the expected return of the portfolio
from the actual return:
Alpha D = 11%- 9.5% = 2.5%

Alpha E = 15%- 10.5% = 4.5%
Alpha F = 15%- 11% = 4.0%
Fund E did best because, although Fund F had the same annual return, it was expected
that Fund E would yield a lower return because the portfolio's beta was significantly
lower than that of portfolio F.
40
2. Data Analysis
41
2.1 Indian Economic Analysis
Slowing Pace of Indian Economy
Real GDP, which witnessed substantial moderation during Jan-Dec 08, is one of the key
indicators of an economy that is losing steam. During Jan-Dec 08, India's GDP growth
averaged 7.4% as compared with 9.2% (Refer to figure 1) during the corresponding
period of the previous year.
Figure 6
Source: RBI- Weekly Supplement
42
The manufacturing sector's growth slowdown was more pronounced and almost halved to
4.02% during Jan-Dec 08 from 9.9% during Jan-Dec 07(Refer to Table 1), which caused
moderation in industrial GDP growth at 5.7% during Jan-Dec 08 as compared with 9.4%
during Jan-Dec 07.
Besides, demand was subdued in real estate and consumer durables sectors on account of
high interest rates. The RBI further hiked key policy rates in Jan 2007 amidst rising
concerns of overheating of the economy; this high interest rate regime lasted till mid-
2008. High interest regime and consequent moderation in retail credit off take caused
deceleration in credit-funded consumption demand. As a result, growth in private final
consumption expenditure slowed down to 7.0% during Jan-Dec 08 as against 7.9%
during the corresponding period of the previous year.
Industry Q1 Q2 Q3 09 Growth rate in %
2008-09 (Estimated YoY)

Agriculture, forestry 3.0 2.7 -2.2 2.6%
& fishing
Manufacturing 5.6 5 -0.2 4.1%
Construction 11.4 9.7 6.7 6.5%
Financing, insurance, 9.3 9.2 9.5 8.6%
real estate & business
Services
Mining & quarrying 4.8 3.9 5.3 4.7%
Trade, hotels, 11.2 10.7 6.8 10.3%
transport and
communication
Community, social & 8.5 7.7 17.3 9.3%
personal services
Electricity, gas & 2.6 3.6 3.3 4.3%
water supply
43
Source: RBI- Hand Book of Statistics Table 1
From the fear of high inflation to the early signs of deflation
Source: Ministry of Commerce Figure 7
At the start of the year, surge in food and fuel prices placed inflationary pressures on
several commodities, causing the WPI inflation to breach the 4% mark. A potential
threat, however, was the steady rise in oil prices. The unabated rise in global oil prices
and the resultant increase in under recoveries of oil companies and fiscal burden (due to
issuance of oil bonds) necessitated the Government to increase the domestic prices of
petrol, diesel and LPG twice within a span of five months. The Central Government
decided to increase domestic fuel prices first in Feb 08 (Feb 14, 2008) and then
subsequently in Jun 08 (Jun 4, 2008) when the prices of international crude oil crossed
US$ 100 and US$ 130 per barrel mark, respectively.
44
This added to the inflationary pressures in the economy, causing WPI inflation to cross
the RBI's tolerance level of 5- 5.5% in mid Feb 08 and by Jun 08, inflation was at a
double-digit level.
Inflation continued its march northwards and reached its peak of 12.72% (Refer to Figure
2) during Aug 08 as the second round impacts of the oil price hike began to unfold.
Demand-supply imbalances coupled with the knock-on effects of increase in fuel prices
led to a spurt in Food articles inflation to 6.56% in Aug 08 from 2.1% in Jan 08.The
prices of Non-Food Articles also soared, thereby causing the Primary articles inflation to
rise from 4.0% in Jan 08 to 11.0% in Aug 08. Price of Manufactured products also
witnessed perceptible increase in 2008 owing to steep rise in prices of basic metal alloys
and alloy products and food products (particularly edible oil & oil cakes). Manufacturing
inflation more than doubled to reach 11.7% in Aug 08 from4.15% at the start of the year.
The contribution of Basic metal alloys and alloy products to overall inflation surged from
5.5% in Jan 08 to 15.0% in Aug 08.
Source: CCIL- Market Analytics Figure 8
45
From Aug 08, global commodity prices started receding and this provided some respite to
the overall price situation in the economy. Thus, driven by receding international
commodity prices viz., crude oil (global oil prices plunged to 30 US$/Barrel during Dec-
08 from a peak of US$ 147.2 per barrel during Jul-08, refer to Figure 3), metals and food
articles, the headline inflation began to moderate since Sep 08. It receded from its above
12.0% level to touch 6.43% during Dec 08. Further, with the sustained fall in global oil
prices and the cut in prices of petrol and diesel by the Government (effective from Dec 6,
08), the fuel group inflation plummeted to a territory of deflation during Dec 08.
In fact, rapid deceleration in WPI in the last few months and with some of the
commodities expected to witness deflationary trends, concerns of deflation looms large in
the near term as inflation touched 0.27% in March 2009.
From a Stance of Monetary Tightening to Monetary Softening
The Indian economy ushered in 2008 amidst excess liquidity related problems in the
system. Growth in money supply saw 21.2 % increase in the last week of April 2008 on
y-o-y basis, it touched 22.5% in May end and slowed to 20.7% by the end of June 2008.
During Jan-May08, the call rates largely remained within the repo and reverse repo
corridor indicating easy liquidity condition. With inflation and money supply growing far
above RBI's target, the RBI raised the CRR by as much as 75 basis points effective in 3
phases during April and May to control excess liquidity and to rein in inflationary
expectations. Between June and Aug 08, the RBI increased repo rate by 125 basis points
and CRR by 75 basis points to 9.0% each (Refer to Figure 4). The increase in capital
outflows especially from the equity markets had put significant downward pressure on
the rupee value. This in turn led to RBI intervention in the forex market through dollar
sales to support the falling value of rupee and thereby adding to the tight liquidity
conditions. Consequently, call rates surged to 9.0% during Jul 08 and remained above
this level for most part of Aug 08.
46
Sou
rce:
RBI-
Weekly Supplement Figure 9

Global financial woes intensified significantly in Sep 08, with the collapse of Lehman
Bros and bankruptcy of some other big financial institutions. The financial distress
caused thereby was characterized by severe credit freeze and crisis of confidence
worldwide. The substantial FII outflows from domestic stock markets coupled with tight
monetary policy followed by the RBI till Aug 08 led to significant liquidity crunch in the
money market. Meanwhile, FII outflows from equity, increased dollar demand by oil
importers (due to surging oil prices) and strengthening of dollar against other major
currencies exerted significant downward pressure on rupee value. In order to arrest
further fall in rupee value, the RBI intervened in the forex market by way of dollar sales,
which in turn resulted into absorption of liquidity from the system and added to the
liquidity pressures. Tight liquidity conditions in the banking system was evident from
firming up of call rates to 19.74% (weighted average call rates) on October 10, 2008
(Refer to Figure 5)
47
Figure 10
Due to Moderation in Inflation the focus of monetary policy shifted from inflation
control to stimulating growth and easing liquidity pressures. Thus, in an endeavor to
maintain domestic macro-economic and financial stability amidst turmoil in the global
financial markets, the RBI announced a slew of measures, which included cut in CRR,
Repo rate and Reverse Repo rate by 400 bps, 350 bps and 200 bps respectively during
Oct 08-Jan 09. With RBI signaling towards lower interest rates, banks lowered their
lending rates. As a result, the PLR declined to 12.50-13.25% in Dec 08 from 13.00-
13.50% during Nov 08. Also, call rates eased significantly to 5.28% by end December
2008 as cut in CRR and other measures taken by the RBI infused significant liquidity into
the system. A sharp decline in domestic inflation as well as global crude oil prices
coupled with easy monetary policy stance followed by RBI provided impetus to bond
prices. The 10- year benchmark bond yield fell to 5.25% by the end of the year.
48
Figure 11
The sentiment in the bond market remained largely bearish during Jan-Aug 08 owing to
surge inflation and RBI's tight monetary policy and the ten-year benchmark bond yield
surged to 9.28% during the beginning of Aug 08.
Fiscal Scenario
According to the information on Central Government finances for 2008-09 (April-

November), the revenue deficit and fiscal deficit were placed higher than those in April-
November 2007 both in absolute terms and as per cent (Refer to Table 2) of budget
estimates (BE) primarily on account of higher revenue expenditure.
Tax revenue as per cent of BE was lower than a year ago on account of lower growth in
income tax, corporation tax and customs duties owing to economic slowdown. Aggregate
expenditure as per cent of BE, was higher than a year ago on account of higher revenue
expenditure, particularly, subsidies, defence, other economic services, social services and
plan grants to States/Union Territories.
49
Year Primary Deficit Revenue Deficit Gross Fiscal Deficit
Center
2007-08 RE -0.6 1.4 3.1
2008-09 BE -1.1 1 2.5
States
2007-08 RE 0.1 -0.5 2.3
2008-09 BE 0.1 -0.5 2.1
Combined
2007-08 RE -0.3 0.9 5.3
2008-09 BE -0.8 0.5 4.6
Table 2
BE: Budgeted Estimates
RE: Revised Estimates
While expenditure is slated to increase on account of the fiscal stimulus measures

undertaken by the Government to address the problem of economic slowdown, growth of
tax revenue is likely to decelerate in the coming months of 2008-09 due to moderation in
economic activity. The net cash outgo on account of the two supplementary demand for
grants is placed at Rs. 1,48,093 crore. This, in turn, is reflected in the non-attainability of
the deficit targets for 2008-09 as envisaged in the Union Budget 2008-09.
During 2008-09 (up to January 13, 2009), special bonds amounting to Rs.44000 crore and
Rs.14,000 crore have been issued to oil marketing companies and fertilizer companies,
respectively.
Trends in the Exchange Rates:
50
Source: RBI- Weekly Supplement Figure 12
The rupee moved in the range of Rs.39.89-50.53 per US dollar during the financial year
2008-09 so far (up to January 20, 2009, Refer to Figure 7). The rupee showed a
depreciating trend during the second quarter of 2008-09, which started in the beginning
of current financial year. The rupee remained around the level of Rs.43 per US dollar
during third week of May 2008 to second week of August 2008, depreciated thereafter
sharply mainly on the back of widening trade deficit, capital outflows and strengthening
of US dollar
From January to May 22nd Rupee depreciated by 7% as against the US dollar. Rupee was
also seen to pick up from Rs 57/ Euro in January 2008 to Rs 68/Euro in May 2008(Refer
to Figure 8), weakening by 11% even touching a five year low of 50.65 (intra-day) during
Dec 08. The Indian rupee depreciated by about 20 per cent against the US dollar in 2008
due to a combination of factors. As the credit crisis deepened in the West, foreign money
started leaving Indian shores, which resulted in the rupee falling. Money from all across
the world flowing into US Treasury bonds in search of safety resulted in the US dollar
appreciating. As a result currencies across the world, including the Indian rupee,
depreciated.
51
Source: RBI Weekly Supplement Figure 13
The rupee is expected to appreciate in the next fiscal and to be around 46.5/US$ by the
end of FY10. On an average, rupee is expected to be around 45.90/US$ during FY09 and
47.50/US$ during FY10. The appreciation in rupee in next fiscal (towards end) would be
on account of an expected fall in value of US dollar and resumption in the FII inflows as
the global economy begins to stabilize the latter part of FY10
Balance of Payments
The key features of India’s BoP that emerged in the first half of fiscal 2008-09 were:
(i) Widening trade deficit ($ 69.2 billion) led by high imports,
(ii) Significant increase in invisible surplus ($ 46.8 billion) led by remittances from
overseas Indians and software services exports,
(iii) Higher current account deficit ($ 22.3 billion, Refer to Table 3) due to high trade
deficit,
(iv) Volatile and relatively lower net capital inflows ($ 19.9 billion) than April-
September 2007-08 ($ 50.9 billion), and
52
(v) Decline in reserves (excluding valuation) of $ 2.5 billion (as against an accretion
to reserves of $ 40.4 billion in April-September 2007-08).
Major Items of India's Balance of Payments (US$ Million)
The key features of BoP for October-December (Q3) of 2008-09:

Table3 Source: RBI Hand Book of Statistics
Export growth turned negative during Q3 of 2008-09 for the first time after 2001-02 due
to global economic slowdown. Import growth on BoP basis decelerated to a single digit
of 2008-09 after a gap of almost 6 years mainly led by lower crude oil prices and non-oil
imports. Private transfer receipts declined only marginally during the quarter despite
slowdown in economic activities in Gulf countries and in the advanced economies like
the US and European countries. Even with the deepening of the global economic crisis,
Item April-June July-September October-December
2007-08 2008-09 2007-08 2008-09 2007-08 2008-09

(PR) (PR) (PR) (PR) (PR) (P)
1 2 3 4 5 6 7
1. Exports 34,356 49,120 38,273 47,700 40,985 36,707
2. Imports 56,346 79,637 59,510 86,213 67,038 73,014
3. Trade Balance (1-2) -21,990 -30,517 -21,237 -38,513 -26,053 -36,307
4. Invisibles, net 15,310 21,521 16,940 25,684 21,522 21,663
5. Current Account -6,680 -8,996 -4,297 -12,829 -4,531 -14,644

Balance (3+4)
6. Capital Account 17,880 11,231 33,533 8,095 31,269 -3,237

Balance*
7. Change in Reserves# -11,200 -2,235 -29,236 4,734 -26,738 17,881
(-Indicates increase;+
indicates decrease)
*: Including errors and omissions. #: On BoP basis excluding valuation.
53
P: Preliminary. PR: Partially Revised.
software exports recorded a growth of around 12 per cent. The current account deficit at
US$ 14.6 billion (Refer to Table 4) during Q3 of 2008-09 was the highest quarterly
deficit since 1990.
For the first time since Q1 of 1998-99, the capital account balance turned negative during
Q3 of 2008-09 mainly due to net outflows under portfolio investment, banking capital
and short-term trade credit. The foreign exchange reserves on BoP basis (i.e., excluding
valuation) declined due to widening of current account deficit combined with net
outflows under the capital account. The largest decline in reserves during any one quarter
in earlier years at US$ 4.7 billion.
Net Capital Flows (US$ Million)
Item April-March April-December
2006- 2007-08PR 2007-08PR 2008-09P

07
1 2 3 4 5
1. Foreign Direct Investment (FDI) 7,693 15,401 6,905 15,373
Inward FDI 22,739 34,236 20,039 27,357
Outward FDI 15,046 18,835 13,134 11,984
2. Portfolio Investment 7,060 29,556 33,292 -11,341
Of which:
FIIs 3,225 20,327 24,471 -12,408
ADR/GDRs 3,776 8,769 8,390 1,142
54
3. External Assistance 1,775 2,114 1,274 1,861
4. External Commercial Borrowings 16,103 22,633 17,410 7,114
5. NRI Deposits 4,321 179 -931 2,115
6. Banking Capital excluding NRI Deposits -2,408 11,578 6,862 -2,244
7. Short-term Trade Credits 6,612 17,183 10,719 547
8. Rupee Debt Service -162 -121 -45 -33
9. Other Capital 4,209 9,470 6,478 1,900
Total (1 to 9) 45,203 107,993 81,964 15,292
Table 4
Source: RBI Hand Book of Statistics
2.2 Global Economic Analysis
The global financial imbroglio emanated from the US created a Domino impact in other
parts of the world. De-leveraging of the balance sheets and re-institutional lenders lead to
a drying up of credit. As credit drives investment, a freeze on credit off-take culminated
in a reduction in autonomous investment. A fall in investment leads to a higher fall in
consumption through the reverse multiplier mechanism. As consumption falls,
inflationary pressures dampen. Commodity prices plummeted to extremely low levels
and deflation seemed a realistic proposition (Refer to figure 11). IMF projected the global
growth rate to fall to 0.5% in 2009. Growth rates in advanced and emerging economy
revised downwards (Refer to figure 9). Increased risk paranoia has factored in to the long
term yields of Government bonds resulting in an inverted yield curve in major
economies.
55
Figure 14
Source: IMF- World Economic Outlook
The world GDP size stood at 54,840.90 billion USD. The size of GDP in the European
Unicon and North America stood at 15,741.10 billion USD respectively. Among the
European Union countries, Germany with a GDP size of USD3320.90 billion stood at the
top. The size of the emerging market economies stood at USD 17270.80 billion
Breakup of the emerging economies GDP
56
Source: IMF- World Economic Outlook Figure 15
Commodity Prices
Source: IMF- World Economic Outlook Figure 16
Outlook
57
• IMF has estimated that world economic growth will fall to 0.5% in 2009, which is
the lowest rate since World War II. The advanced economies are expected to
contract by 2 percent in 2009, while growth in emerging and developing
economies is expected to slow sharply from over 6% in 2008 to just a little over
3% in 2009.
• The lending rates are expected to come down further during FY09(11.75-12.25)
as the aggressive monetary easing measures undertaken by the RBI since mid-Sep
08 would have injected sufficient liquidity into the system and would drive down
interest rates.
• Moreover, the decline in inflation rate owing to correction in global commodity

prices and a fall in import dependency on oil will provide more flexibility to the
RBI to further ease its monetary stance, thereby signaling towards lower interest
rate regime. This will boost the price of long term bonds causing a fall in their
yield.
• The fall in oil prices will trigger a correction in the current account deficit. This
will in turn provide a soothing effect on fiscal deficit
• With weaker demand for bank credit due to

o Increase in risk aversion of banks
o Lower demand for bank credit by industry deferred investment plans
o Deferred consumption of high-end consumer product and lower demand for home
loans RBI expects banks to park funds in the G-sec market, thereby driving up the
demand for government securities.
• Money from all across the world flowing into US Treasury bonds in search of
safety resulted in the US dollar appreciating. As a result currencies across the
58
world, including the Indian rupee, depreciated. The trend may continue for some
more time.
2.3 Regression Analysis 1(Affect of Indian Inflation, RS/US$ movement &

Government Borrowings on Interest rates)
Regression Statistics
Multiple R 0.990073624
R Square 0.98024578
Adjusted R
Square 0.96378393
Standard Error 0.268749635
Observations 36
ANOVA
Significance
Df SS MS F F
Regression 5 21.504142 4.30082836 59.546514 4.94684E-05
0.07222636
Residual 6 0.4333582 6
Total 11 21.9375
Standard Upper
Coefficients Error t Stat P-value Lower 95% 95%
-
- 0.21882934
Intercept 0.760219853 3.4740306 8 0.8340367 -9.2608665 7.7404268
4.50763365
Inflation 0.264566348 0.058693 7 0.0040707 0.120949856 0.4081828
0.48066313
US Inflation 0.108277846 0.2252676 3 0.6477799 -0.442932193 0.6594879
Federal Fund 0.89094031
Rate 0.517843924 0.581233 1 0.4072659 -0.904382027 1.9400699
RS/US$ 0.10530953 0.0694215 2.51695916 0.1800678 -0.06455868 0.2751777
Govt 2.79393672
Borrowings 1.01121E-05 1.457E-05 2 0.5136776 -2.55444E-05 4.577E-05
59
Interpretation: Since the t–value in case of Indian Inflation, RS/US$ movement &
Government Borrowings is more than +/- 1.96 we reject the Null Hypothesis that these 3
variables do not effect Interest rate Which means that the above 3 variables effect Interest
rate. In case of US Inflation & Federal Funds Rate the t-value is lower so we accept the
Null hypothesis.
2.4 Global Equity Market Analysis
Equity markets poor show continued throughout the fiscal year 2008-2009 as economies
across the globe went through the worst credit crisis even the governments direct
intervention viz. various stimulus packages and easing of monetary policies seems
ineffective to restore the confidence of market participants. Also, continuous downgrade
in economic growth forecast as well as credibility of corporate/Financial Institutions
added gloom to the current woes. The Nasdaq and Dow Jones fell by 40.54% and 33.84
%( Refer to figure 12) respectively in the last 1 year period. The Nikkei and HangSeng
fell by 42.12% and 48.27 %( Refer to figure 13 & 14) respectively in the last 1 year
period. During November, MSCI World index was down by 6.72% as most of the
corporate houses started cutting down their earnings forecasts. US Equity market in line
with other markets ended the highly volatile month as its key indices made a wild swing
on series of economic and political news. US market showed some sign of stabilization
after Obama won the US presidential election but chain of poor economic data.
Dow Jones
60
Source: NSE Figure 17
Nikkei
61
HangSeng
2.5 Indian Equity and Debt Market Analysis
Indian equity started the January’09 month on an upbeat note as coordinated fiscal and
monetary measures by policymakers to boost sagging growth and firm global markets
boosted the domestic bourses. However, Satyam Computer’s mega accounting scandal
turned the market into negative territory and thereafter it continued to fall amid
increasing worries about world economy and subdued Q3 results of the Indian
companies. But towards the end market recovered and pared its monthly loss as Obama’s
stimulus plan, cut in fuel and cooking gas prices and expectation of rate cut by RBI
boosted the sentiments of the market. Despite, RBIs neutral stand on the interest rate
front and marginal rise in inflation to 5.64% for the week ended January 17, the market
trended up. Fund managers remained bearish on the market outlook in the short term on
the concern of domestic growth, earning downgrade and also on the political front as
elections are due in May. However, most of them expect that long term prospects remain
robust on the back of strong macro fundamentals of India and also see value buying at
62
current levels. BSE Sensex and CNX Nifty both closed in a negative territory in the
month of January’09.
BSE Sensex
Source: BSE Figure 20
S&P Nifty
Source:NSE
63
Mid caps and Small caps underperformed its counterpart Large caps by huge margin and
registered a decline of 9.4% and 7.2% respectively.
BSE Midcap
Source:NSE Figure: 21
BSE Small Cap
Figure 22
Source: BSE
64
BSE Banking sector registered a decline of 11% as Q3 results witnessed rise in NPA
levels and slow down in loan growth which worried investors over its near term outlook.
However, BSE IT Index was up by 0.5% even though heavy weight Satyam tumbled
down heavily after investors came to know about its accounting fraud.
Returns (in Absolute Terms) (Indian Indices)

Index Name From To Date(01/01/2009) Absolute
Date(01/01/2008)
BSE Sensex 20300.71 9903.46 -51.22

S&P Nifty 6144.35 3033.45 -50.63
BSE Mid Cap 9937.99 3319.1 -66.6
BSE Small Cap 13706.28 3810.41 -72.2
BSE FMCG 2368.3 1991.98 -15.89
BSE METAL 20194.68 5528.38 -72.62
Source: NSE Table 5
During the month of January’09, FIIs registered net outflows to the extent of INR
42.45bn as worries of poor Q3 results and Satyam fiasco has left a big question mark on
corporate governance in India which had sent a negative signal to the foreign institutional
investors. While in the month of December’08, it has registered the net inflows to the
tune of INR 16.56bn.
65
FDI and FII (as percentage of GDP)
Source: RBI- Handbook of Statistics Figure 23
Foreign Equity Investment
Source: RBI- Handbook of Statistics Figure 24

In comparison to the equity indices, the bond indices have performed well and have given
better returns to the investors. In the debt fund category also we see that indices tracking
returns of Gilt and Income funds have shown an upward movement when we saw RBI
easing the monetary policy through significant rate cuts as compared to the indices (NSE
MIBOR) tracking money
market funds.
66
I- SEC Composite Index
Source: ICRA Figure 25
I-Sec Li-Bex
67
NSE MIBOR
Yield Curve Analysis
Source:
CCIL-
Market
Analytics Figure 28
68
Yields in the government securities market hardened at the beginning of the current
financial year with the 10-year yield reaching 8.23 per cent on April 21, 2008 (Refer to
Figure 24) from 7.93 per cent on end-March 2008 in response to higher reading in
domestic inflation. Subsequently, heightened inflationary expectations emanating from
the sharp increase in global commodity prices and concomitant policy responses in the
form of hike in CRR and repo rate, led to further hardening of yields. The 10-year yield
consequently rose to 9.51 percent on July 15, 2008. During such conditions, when long
term interest rates are more than the short term investors expect higher yields for fixed
income instruments with long-term maturities that occur farther into the future. In other
words, the market expects long-term fixed income securities to offer higher yields than
short-term fixed income securities.
Yields in the government securities market generally eased from end-July till around
mid-September 2008 following the reduction in inflationary pressures tracking softening
crude oil prices. The yields, however, hardened in the second fortnight of September
2008 as the liquidity conditions tightened mainly reflecting advance tax outflows in
conjunction with the impact of adverse developments in international financial markets.
The 10-year yield increased from 8.08 per cent to 8.63 per cent over the second half of
end- September 2008. Subsequently, the yields eased substantially in tandem with the
liquidity enhancing measures, including cuts in CRR, reduction in policy rates and the
sharp decline in WPI. The 10-year G-sec yield stood at 5.87 per cent as at January 23,
2009.
In January the government had surprised the markets with an additional borrowing of
INR 250bn for the period January-March 2009 (Refer to figure 25). This additional
borrowing is over and above the INR 450bn of additional borrowing announced earlier,
taking the total additional borrowing for 2008-09 to INR 700bn. The nervousness on
government borrowing pushed up yields, negating the policy easing efforts of RBI.
69
Government Borrowings
Source: RBI Weekly Statistics Figure 29
2.7 Yield spread analysis
70
Source: CCIL- Market Analytics Figure 30
Government bonds witnessed a mixed trend in the month of September’08. The first half
of the month saw a sharp rally while in the second half of the month yields went up
substantially. Bond prices continued their upward momentum in the first half, powered
by large purchases by banks for meeting their reserve requirements. It also rallied after
crude oil fell below USD 100 per barrel for the first time in six months while yields on
benchmark 10-year fell to the lowest in more than three months and closed at 8.09% as
on 16th September’08. However, the bond yields failed to sustain in the second half of
the month as higher oil prices raised the spectre of inflation. Also scheduled auctions and
tight cash conditions weighed on sentiments firming up yields across the curve causing
the 10 year benchmark to end at 8.62% for the month. Credit spreads moved up sharply
in the first two weeks of the month as corporate bonds did not follow the government
bond rally. The spread between the benchmark 10 year AAA corporate bond yield over
the 10 year benchmark government bond expanded to 270bps as on 16th September and
then contracted to close the month at 242bps as G Sec yields started moving upward.
Corporate bond yields lacked a definite trend but comfortable liquidity condition resulted
the yields to ease off during December. The yields on 10 year AAA corporate bond came
off by 31bps to 11.14%. The uneven movement of yields at different tenors resulted in
71
similar uneven movement of spreads across the curve. The spread between the
benchmark 10-year AAA corporate bond yield over the 10 year benchmark government
security widened by 5bps to close at 408bps during the month while 1 year corporate
spread contracted by 72bps to 440bps and the yields came off by 127bps.
Bond yields maintained their south bound trajectory, fuelled by abating inflationary
pressures and weak global oil prices. There was sustained buying of G Sec on
expectations of more policy interventions from the RBI amidst mounting fears of a
deceleration in the GDP growth. The 10 year benchmark, 8.24% 2018 yield fell by
181bps to close the month at 5.26% a multi-year low. Bond volumes have picked up over
the past month and totaled INR 115.7bn (USD 2.4bn) on the central bank’s trading
platform. However towards, the end of the month bond yields ended steady, erasing a fall
made on expectations of lower interest rates as investors cashed in at the end of the week
and as tensions with Pakistan caused a ripple of jitters. The yields on 5 year AAA
corporate bond moved down by 259bps to 8.55%. The spread between the benchmark 5-
year AAA corporate bond yield over the 5 year benchmark government security
contracted by 93bps to close at 315bps during the month while 1 year corporate spread
widened by 9bps to 413bps.
Bond markets suffered the worst month in a decade despite monetary easing by the RBI
to all-time lows at the beginning of the month. Bonds ended a five-month rally and the
10-year benchmark 8.24% 2018 G Sec bond yield surged 98bps over the month of
January 2009 to 6.23% as concerns mounted that the government would borrow more
than planned to finance additional spending. The yields on 5 year AAA corporate bond
moved higher by 40bps to close the week at 8.94%. The spread between the benchmark 5
year AAA corporate bond yield over the 5 year benchmark government bond contracted
by 21bps to 294bps.
2.8 Regression Analysis 2( Impact of REPO rate on Yield movement)
R Square 0.85265578
72
Adjusted R
Square 0.81991262
Observations 24
ANOVA
Significance
Df SS MS F F
12.6478410 6.32392052 0.00018092
Regression 2 5 7 26.0407292 5
2.18562561
Residual 9 3 0.24284729
14.8334666
Total 11 7
Coefficient Standard Upper
s Error t Stat P-value Lower 95% 95%
-
1.08935796 1.21956995 0.25362319 1.13575067 3.7928
Intercept 1.32854824 2 5 4 1 5
0.11678532 0.53570976 1.0640
Repo 0.79989651 1 6.49289839 7.4793E-05 2 8
0.92432025 0.37943521 -2.43355E-
Borrowing 1.6814E-05 1.81902E-05 9 7 05 5.8E-05
73
Interpretation: In case of Repo Rate the t-value is more than +/- 1.96 hence we reject
the null hypothesis that Repo Rate does not have any impact on the Yield movement
(Intercept). In other words it means that Repo Rate effects the Yield movement. But in
case of government borrowings we accept the null hypothesis that it does not have any
impact on the Yield movement since the t-value is less than +/- 1.96.
2.9 Regression Analysis 3(Impact of REPO on G-Sec Yield)
R Square 0.8386684
Adjusted R
Square 0.8225353
Observations 12
ANOVA
Significanc
Df SS MS F eF
12.4403601 12.4403601 51.984146
Regression 1 1 1 3 2.89E-05
2.39310655 0.23931065
Residual 10 3 5
14.8334666
Total 11 7
Coefficient Standard
s Error t Stat P-value Lower 95% Upper 95%
0.0272673 3.76783347
Intercept 2.0229345 0.78311951 2.58317466 9 0.278035 1
0.10444495 7.21000321 0.98576628
Repo 0.7530484 1 1 2.8917E-05 0.520331 6
74
Interpretation: In case of Repo Rate the t-value is more than +/- 1.96 hence we reject
the null hypothesis that Repo Rate does not have any impact on the Yield movement
(Intercept). In other words it means that Repo Rate effects the Yield movement.
Moreover R Square suggests that 82.3% variation in G-Sec Yield is caused by Repo Rate.
So with fall in interest rates Yield will also fall and hence bond prices will
2.10 Scenario Analysis
Scenario 1
• A Gilt Fund namely X (with 90% of the assets in Sovereign Bonds) generates a
compounded annualized return of 10% (Point to Point) over 1 Year period.
• The 1 Year G-Sec Yield is 7.01% when interest rate is 4.75%
• A 1% reduction in interest rate will lead to a fall in G-Sec yield to 6.17%.
(approx)
• The fall will also affect the yield of Gilt Funds X whose return will be
diminished in the same proportion to 9.16% (assuming that the fund house is not
resorting to portfolio churning in the reference period).
• The fall in Yield will lead to a rise in prices and hence a rise in NAV of the Fund.
Scenario 2
• An Income Fund namely Y (with 90% of the assets in AAA rated corporate
bond) generates a compounded annualized return of 12% (Point to Point) over 1
year period.
75
• The 1 year G-Sec Yield is 7.01% when interest rate is 4.75%. Spread on 1 year
almost 450 Bps. Hence the yield on the corporate bond will be 12.838%.
• A fall in interest rate by 1% will lead to a fall in return to 12%. (assuming that the
fund house is not resorting to portfolio churning in the reference period).
• The fall in Yield will lead to a rise in prices and hence a rise in NAV of the Fund
2.11 Performance Evaluation of GILT FUNDS
Simple Annualised % (Rolling) 1 Month (Daily) RF=6%
1 3 6 1 Year Beta Sharpe Jensen Std.

Scheme Name Month/] Months Months Dev.
Birla Sun Life G 15.8503 15.8503 15.8503 15.8503 0.2660 0.2649 0.2813 0.9085
Sec Fund - LT –
Growth
Birla Sun Life 15.0058 15.0058 15.0058 15.0058 0.6184 -0.1677 -0.0538 0.8837
GPRP - Growth
DSP BlackRock 23.1210 23.1210 23.1210 23.1210 0.3794 -0.3944 -0.1755 0.5920
G Sec Fund Plan
A Long Duration
- (G)
ICICI Prudential 23.3646 23.3646 23.3646 15.7641 0.4503 -0.2584 -0.1294 0.7669
GFIP - Growth
IDFC G Sec 12.3237 12.3237 12.3237 12.3237 0.5669 -0.1839 -0.0779 0.8942
Fund -
Investment - Plan
A - Growth
Kotak Gilt - 13.6608 13.6608 13.6608 13.6608 0.5784 -0.1773 -0.0646 0.8625
Investment
Regular Plan –
Growth
76
LIC G Sec Fund 7.2402 7.2402 7.2402 7.2402 0.5262 -0.1855 -0.0625 0.7699
– Growth
PRINCIPAL G 6.8606 6.8606 6.8606 6.8606 0.3253 -0.1891 -0.0686 0.6255

Sec - Investment
– Growth
SBI Magnum Gilt 4.3920 4.3920 4.3920 4.3920 0.2844 -0.2724 -0.1057 0.5474
LTP - Growth
Tata Gilt 5.5978 5.5978 5.5978 5.5978 0.5471 -0.1915 -0.0778 0.8424
Securities Fund –
Growth
Templeton India 22.3197 22.3197 22.3197 22.3197 0.1079 0.0734 0.0220 0.2521
GSF - Composite
Plan - Growth
Templeton India 24.0497 24.0497 24.0497 24.0497 0.1226 0.0983 0.0091 0.2833
GSF - LTP –
Growth
UTI G-Sec Fund 4.4345 4.4345 4.4345 4.4345 0.4612 -0.2877 -0.1234 0.6735
– Growth
Indices
I-Sec Li-BEX 15.4390 18.0416 13.3256 11.9334 0.2065 0.2011 0.2135 0.9834
I-Sec Composite 12.7074 13.7528 11.6163 11.0003 0.2387 0.2278 0.2108 0.9473
Index
Table 6
77
2.12 Performance Evaluation of INCOME FUNDS
78
Simple Annualized % (Rolling)
Average 1 Month 3 6 1 Year

Maturity Months Months
(Yrs)
Scheme Name
Birla Sun Life Dynamic Bond Fund - Ret – Growth 2.5096 13.1516 13.1516 13.1516 13.1516
Birla Sun Life Income Fund – Growth 6.8411 10.1523 10.1523 10.1523 10.1523
Birla Sun Life Income Plus – Growth 6.4000 14.2739 14.2739 14.2739 14.2739
DSP BlackRock Bond Fund - Retail Plan – Growth 6.5205 10.6370 10.6370 10.6370 10.6370
DSP BlackRock Strategic Bond Fund - Retail – 0.1890 6.9399 6.9399 6.9399 6.9399
Growth
Fidelity Flexi Bond Fund - Ret – Growth 3.0986 9.6285 9.6285 9.6285 9.6285
Franklin India International Fund -- 25.4731 25.4731 25.4731 25.4731
ICICI Prudential Income Fund –Growth 10.8795 17.6270 17.6270 17.6270 13.7815
ICICI Prudential L T P – Cumulative 0.7890 9.2420 9.2420 9.2420 8.9795
IDFC D B F- Plan A – Growth 11.2493 15.7018 15.7018 15.7018 15.7018
IDFC SSIF - Invt. Plan - Plan A – Growth 10.4192 12.8560 12.8560 12.8560 12.8560
IDFC SSIF - MTP - Plan A – Growth 2.7699 8.5247 8.5247 8.5247 8.5247
Kotak Bond Deposit – Growth 5.2301 13.8600 13.8600 13.8600 13.8600
Kotak Bond Regular Plan – Growth 5.2301 14.4198 14.4198 14.4198 14.4198
79
LIC Bond Fund – Growth 5.4712 11.5400 11.5400 11.5400 11.5400
PRINCIPAL Income Fund – Growth 6.8411 7.2879 7.2879 7.2879 7.2879
Reliance Income Fund - Retail - G P - Growth 10.0795 13.8992 13.8992 13.8992 12.0038
Reliance Medium Term Fund – Growth 0.6493 8.1752 8.1752 8.1752 7.6860
SBI Magnum Income – Growth 3.7507 2.0796 2.0796 2.0796 2.0796
SBI Magnum NRI Investment Fund - Long Term 0.0027 -3.3396 -3.3396 -3.3396 -3.3396
Bond Plan – Growth
Tata Dynamic Bond Fund - Option A - Growth 12.8986 3.4452 3.4452 3.4452 3.4452
Tata Income Fund - Growth 3.1589 4.6569 4.6569 4.6569 4.6569
Tata Income Plus Fund - Plan A – Growth 8.1589 8.3485 8.3485 8.3485 8.3485
Templeton India IBA - Plan A – Growth 2.7205 7.5883 7.5883 7.5883 7.5883
Templeton India Income Fund – Growth 4.1507 8.5619 8.5619 8.5619 8.5619
UTI Bond Fund – Growth 4.5178 7.2193 7.2193 7.2193 7.2193
Indices
Crisil Composite Bond Fund Index 7.3388 7.3017 7.3402 7.7760
Table 7
INCOME FUNDS
80
1 Month (Daily) RF=6% Rating
Scheme Name
Beta Sharpe Jensen Std. AAA/P+

Dev.
Birla Sun Life Dynamic Bond Fund - Growth 0.1303 0.0107 0.0217 0.1647 93.2436
Birla Sun Life Income Fund – Growth 0.4861 -0.2136 - 0.6850 49.6402
0.0721
Birla Sun Life Income Plus – Growth 0.5704 -0.1134 0.0024 0.7466 59.4815
DSP BlackRock Bond Fund - Retail Plan – Growth 0.3534 -0.2791 - 0.4741 19.3924
0.0784
DSP BlackRock Strategic Bond Fund – Growth 0.0005 0.3787 0.0062 0.0162 82.7386
Fidelity Flexi Bond Fund – Growth 0.2609 0.0058 0.0414 0.2788 50.6534
Franklin India International Fund - -0.1236 - 0.6909 93.1251

0.1882 0.1141
ICICI Prudential
PRINCIPAL Income
Income Fund
Fund –Growth
– Growth 0.4375
0.4159 -0.1509
-0.1959 -- 0.5696
0.5422 51.1123
48.1200
0.0191
0.0427
ICICI Prudential
Reliance Income L T P -–Retail
Fund Cumulative
- G P – Growth 0.0003
0.3700 0.6992
-0.1751 0.0132- 0.0188
0.4633 #####
61.1445
0.0246
IDFC D BMedium
Reliance F- Plan Term
A – Growth
Fund – Growth 0.5451- -0.1331
0.6784 0.0127- 0.8147
0.0188 42.7105
97.3487
0.0001 0.0252
IDFC SSIF - Invt.
SBI Magnum Plan– -Growth
Income Plan A – Growth 0.5528
0.3071 -0.1820
-0.1977 -- 0.8238
0.4423 30.7393
37.1610
0.0656
0.0406
IDFC SSIF - MTP
SBI Magnum - Plan A – Growth
NRI Investment Fund - Long Term Bond 0.3519
0.0035 -0.1447
0.1080 0.0039- 0.5318
0.0309 --93.3480
Plan – Growth 0.0232
Kotak Bond Deposit
Tata Dynamic – Growth
Bond Fund - Option A – Growth 0.4364
0.6354 -0.1642
-0.0646 0.0518- 0.5854
0.6989 26.2202
13.9487
0.0295
Kotak Bond Regular
Tata Income Plan – Growth
Fund - Growth 0.4363
0.2919 -0.1642
-0.2020 -- 0.5854
0.4738 26.2202
54.0750
0.0295
0.0511
LIC
Tata Bond Fund
Income Plus– Fund
Growth
- Plan A – Growth 0.2300- -0.0177
0.1289 0.0298
0.0042 0.3006
0.0397 --43.3741
0.0062
Templeton India IBA - Plan A – Growth 0.1418 -0.0663 0.0100 0.1762 75.6370
Templeton India Income Fund – Growth 0.1665 -0.0037 0.0247 0.1856 73.3246
UTI Bond Fund – Growth 81 0.3678 -0.2807 - 0.5067 72.0765

0.0861
Crisil Composite Bond Fund Index
3. FINDINGS
82
• After comparing the returns of equity & debt markets in current scenario we find
out that this is the appropriate time to invest in debt funds.
• We have found out through regression analysis that inflation has an impact on
interest rates hence the decline in inflation rate owing to correction in global
commodity prices and a fall in import dependency on oil will provide more
flexibility to the RBI to further ease its monetary stance, thereby signaling
towards lower interest rate regime. This will boost the price of long term bonds
causing a fall in their yield.
• The lending rates are expected to come down further during FY09(11.75-12.25)
as the aggressive monetary easing measures undertaken by the RBI since mid-Sep
08 would have injected sufficient liquidity into the system and would drive down
interest rates. We have found that interest rates cause 82.3% variation in G- Sec
yield so any rate cuts by RBI will also cause Yield to fall and we know that yield
& bond prices are inversely related so bond prices will move up hence it is
suitable to invest in GILT & INCOME FUNDS.
• A 1% reduction in interest rate will lead to a fall in G-Sec yield to 6.17%.

(approx)
The fall will also affect the yield of Gilt Funds X whose return will be
diminished in the same proportion to 9.16% (assuming that the fund house is not
resorting to portfolio churning in the reference period). The fall in Yield will lead
to a rise in prices and hence a rise in NAV of the Fund.
• The 1 year G-Sec Yield is 7.01% when interest rate is 4.75%. Spread on 1 year
almost 450 Bps. Hence the yield on the corporate bond will be 12.838%. A fall in
interest rate by 1% will lead to a fall in return to 12%.
•
83
3.1 Top 3 GILT Performers
1. Birla Sun Life G Sec Fund - LT – Growth
a. Returns against benchmark
b. Risk adjusted returns against benchmark
Figure 31
84
2. Templeton India GSF - Composite Plan - Growth
b.
c. Risk adjusted returns against benchmark
Figure 32
85
3. Templeton India GSF - LTP – Growth
Figure 33
86
3.2Top 3 INCOME Performers
1. ICICI Prudential L T P - Cumulative
b.
c. Risk adjusted returns against benchmark
Figure 34
87
2. Reliance Medium Term Fund – Growth
Figure 35
88
3. Birla Sun Life Dynamic Bond Fund - Growth
Figure 36
89
Recommendations:
1. The volatility in the global equity markets as indicated by CBOE volatility index
has led to a global erosion of investor’s wealth and in this turbulent time debt
markets will be generating good returns to the investors.
2. Since the longer end of the yield curve gets impacted the most due to interest rate
fluctuations, hence the funds whose portfolio consists of longer duration papers
has a potential to give more returns to investors. Considering the Indian economy
scenario, the shorter end of the yield curve is not expected to exhibit volatility due
to voluminous trade and the reverse repo market due to risk aversion by banks
lending to the corporate has come to virtual halt. In these circumstances the RBI
will not like to see the yield going above the 7% figure as this will make lending
to corporate costly hence we expect the benchmark yield to hover in the range of
6.3-6.5% in the next 6 months. At present the yields are in the range of 6.5-6.8%
so any fall in the yield to the tune of 30-50bps will generate a good return to the
investors. Hence the rationale for recommending Gilt funds.
3. As regards the income funds we are witnessing a fall in the corporate bond
spread. And in the next 6-8 months with better corporate earnings the ratings will
improve and the spread between AAA rated bonds and the benchmark will fall.
Hence the rationale for recommending income funds.
4. Top 3 GILT Performers are Birla Sun Life G Sec Fund - LT – Growth, Templeton
India GSF - Composite Plan – Growth, Templeton India GSF - LTP – Growth.
Depending on his risk appetite an investor can invest in any one out of these 3
funds.
5. Top 3 INCOME Performers are ICICI Prudential L T P – Cumulative,

Reliance Medium Term Fund – Growth, Birla Sun Life Dynamic Bond Fund –
90
Growth. Depending on his risk appetite an investor can invest in any one out of
these 3 funds.
References
Internet:
http://www.rbi.org.in
http://www.debtonnet.com
http://www.commerce.nic.in
http://www.ccilindia.com
http://www.fimmda.org
http://indianbusiness.nic.in
http://www.valueresearchonline.com
http://www.amfiindia.com
http://www.mutualfundsindia.com
http://www.investopedia.com
http://www.nseindia.com
Journals & Articles:

“The Real Term Structure and Consumption Growth,” Journal of Financial Economics,
vol. 22, pp. 305-53.
Kessel, Reuben A. 1965. “The Cyclical Behavior of the Term Structure of Interest
Rates,” National Bureau of Economic Research, Occasional Paper 91.
Harvey, Campbell R. 1989. “Forecasts of Economic Growth from the Bond and Stock
Markets,” Financial Analysts Journal, September/October, pp. 38-45.
Caporale, Guglielmo Maria. 1994. “The Term Structure as a Predictor of Real Economic
Activity: Some Empirical Evidence,” London Business School, Discussion Paper no. 4-
94, February.
Ferson, Wayne E., and Rudi W. Schadt, 1996, Measuring fund strategy and performance
in changing economic conditions, Journal of Finance 51, 425-461.
Teo, Melvyn, and Sung-Jun Woo, 2001, Persistence in style-adjusted mutual fund
returns, working paper, Harvard University
91
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A

Research Project Report

Submitted in the Partial Fulfillment of the requirement for the award of

Post Graduate Diploma in Management

SCHOOL OF MANAGEMENT SCIENCES

SCHOOL OF MANAGEMENT SCIENCES

Objective of the project……………………………………………………..

Scope of the study……………………………………………………………

Limitations of the study……………………………………………………..

1.1 Concept of a Mutual Fund………………………………………………...

1.2 Types of Mutual

1.3 Advantages of Investing in Debt

1.8 Yield Spread………………………………………………………………

1.10 Performance Evaluation of Mutual

2.1 Indian Economic

2.2 Global Economic

2.3 Regression Analysis

2.4 Global Equity Market

2.5 Indian Equity and Debt Market

2.7 Yield spread

2.11 Performance Evaluation of GILT

2.12 Performance Evaluation of INCOME

A successful project can never be accomplished by individual effort of the person to

Objective of the project

The objective of my project is:

• Evaluating the performance of the selected fund category among 15 Asset

• Restructure recommendations on asset allocation matrix based on project

Scope of the study

Macroeconomic research is through Secondary data obtained through mediums like

Limitations of the study

Every study suffers from some limitations which are inevitable:

• Recommendations for investment are based on current investment scenario so the

Sharpe, William F (1966) suggested a measure for the evaluation of portfolio

Michael C.Jensen (1967) derived a risk adjusted measure of portfolio performance

S. Narayan Rao , et al evaluated performance of Indian mutual funds in a bear market

1.1 Concept of a Mutual Fund:

• Many investors with common financial objectives pool their money.

1.2 Types of Mutual Funds

• Diversified Equity Funds: An investment fund which contains a wide array of

• Gilt Funds: Invest their corpus in securities issued by Government, popularly

1.3 Advantages of Investing in Debt Funds

Fixed income securities make up a substantial proportion of individual investors

• Diversification: In a stock market downturn, fixed income securities can help

• Predictable source of income: Some investors want or need a steady stream

1.4 Debt Instruments

There are three main segments in the debt markets in India,

1.5 Yield Curve:

1.6 Factor Affecting Yield Curve - Interest Rate

1.7 Interest Rate Drivers:

• Liquidity & Monetary Scenario

• Exchange Rate Movements

1.8 Yield Spread

1.9 Bond Indices

Crisil Composite Bond Index: It tracks returns on bonds.

1.10 Performance Evaluation of Mutual Funds

Return alone cannot be considered as the basis of measurement of the performance of a

I.Calculation of Simple Return

a) By calculating weighted average returns of individual securities in the portfolio.

Return = WaRa + WbRb + WcRc + . . . . . . . . +WnRn

b) By calculating percentage growth in NAV

Return = (NAV at Periodn – NAV at Period n-1) + Dividend

NAV at 31st March 2008 = 13.035

Index as on 31st March 2008 = 1556.72

II. Calculation of Risk